The U.S. Economy

Chapter 2Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.McGraw-Hill/Irwin

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Gross Domestic Product (GDP)

• Gross Domestic Product (GDP) is the total value of final goods and services produced in a country during a given period of time.

• It is a summary measure of a nation’s output measured by the Bureau of Economic Analysis—part of the Commerce Department (see www.bea.gov).

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Nominal GDP

• Nominal GDP is the value of GDP measured in current dollars.

• Because of inflation, it is useless to compare nominal GDP from one year to another.

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Real GDP

• Real GDP is the inflation-adjusted value of GDP or the value of output measured in constant prices.

• These inflation adjustments delete the effects of rising prices by valuing output in constant prices.

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International Comparisons

• In 2009, the U.S. economy produced nearly $15 trillion in output.

• With 5% of the world’s population, the U.S. economy produces over 20% of the entire world’s output.

• The U.S. economy is two and a half times larger than Japan’s—the world’s third-largest—and twelve times larger than Mexico’s.

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Figure 2.1

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Per Capita GDP

• Per capita GDP is total GDP divided by total population: average GDP.

• It is an indicator of how much output each person would get if all output were divided evenly among the population.

• In 2009, per capita GDP in the U.S. was approximately $49,000—more than five times the world average.

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Historical Comparisons

• The living standards Americans now call “poor” resemble the lifestyle of the middle class in the 1930s.

• Since 1900, the per capita output of the economy has increased 500 percent.

• Even with minor setbacks like 2008-09, persistent economic growth is the norm for the United States.

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Historical Comparisons

• Economic growth is an increase in output (real GDP), or an expansion of production possibilities.

• America’s real GDP has increased by about 3% a year, while the population is growing by only 1% a year.

• If real GDP keeps growing 2% faster than population, per capita incomes will double again in about 35 years.

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The Mix of Output

• The major uses of total output include:– Household consumption– Business investment– Government services– Exports

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Figure 2.2

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C=Consumer Goods

• As the world’s leading “consumer” economy, consumer goods account for two-thirds of total U.S. output.

• There are three types of consumer goods:– Durable goods– Nondurable goods– Services

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Consumer Goods

• Durable goods - expected to last three years.– They tend to be big-ticket items like cars,

appliances, and furniture.– Purchases of durable goods are often cyclical, that is, very sensitive to economic trends.

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• Nondurable goods - items that are bought frequently.– They include clothes, food, and gasoline.

• Services - the largest and fastest-growing component in consumption.– Over half of all consumer output consists

of medical care, entertainment, utilities, and other services.

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Consumer Goods

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I=Investment Goods

• Investment is expenditures on (production of) new plant and equipment (capital) in a given time period, plus changes in business inventories.– Investment goods include the plant,

machinery, and equipment that are produced for use in the business sector.

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Investment Goods

• Investment goods are used:

– To replace worn-out equipment and factories, thus maintaining our production possibilities.

– To increase and improve our stock of capital, thereby expanding our production possibilities.

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G=Government Services

• Federal, state, and local governments purchase resources to police the streets, teach classes, write laws, and build highways.

• These resources are not available for consumption or investment.

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Government Services

• Only that part of federal spending used to acquire resources and produce services is counted in GDP.

• The federal government spends nearly $4 trillion per year.

• In 2009, federal purchases of goods and services accounted for 7% of total output.

• Income transfers are not counted in GDP.

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Government Services

• Income transfers are payments to individuals for which no current goods or services are exchanged.– Examples include Social Security, welfare,

and unemployment benefits.

• State and local governments use far more of our scarce resources than does the federal government.

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NX=Net Exports

• Exports are goods and services sold to foreign buyers.

• Imports are goods and services purchased from foreign sources.

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Net Exports

• Net Exports = Exports – Imports

– In 2009, the value of exports was less than the value of imports.

– We used more goods and services than we produced in that year.

– Net exports were negative.

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Changing Industry Structure

Decline in Farming:

• Over time the mix of output has changed dramatically.

• In 1900, nearly 4 of 10 workers were employed in agriculture.

• Today fewer than 2% of workers are farmers due in great part to technological advances.

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Growth of Services

• America has become largely a service economy.

• Total service industries (including government) generate over 70% of total output.

• Between 2010 and 2020, 98% of net job growth will be in service industries.

• The opportunity cost of producing services is the forgone production of goods.

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Figure 2.4

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Growth in Trade

• International trade is very important.

• Increasing globalization of the U.S. economy is likely to continue due to:– Advances in communications and

transportation technologies.– Increased consumption of services

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How America Produces

• International trade has also affected HOW goods and services are produced.

• Factors of Production - resource inputs used to produce goods and services, e.g., land, labor, capital, entrepreneurship.

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Capital Stock

• The U.S. capital stock is over $60 trillion worth of machinery, factories, and buildings.

• American production tends to be very capital intensive:– Capital intensive – production processes

that use a high ratio of capital to labor inputs.

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Factor Quality

• Productivity - output per unit of input, e.g., output per labor hour.

• Human capital - the knowledge and skills possessed by the work force.

• The high productivity of the U.S. economy results from using highly educated workers in capital-intensive production processes.

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Factor Mobility

• Our continuing ability to produce the goods and services that consumers demand also depends on our agility in reallocating resources from one industry to another.

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Business Organization

• The three different legal organizations:– Corporations - owned by many

individuals who owns shares of (stock in) the corporation and have limited liability.

– Partnerships - owned by a small number of individuals who share liability.

– Proprietorships - owned by one individual with sole liability.

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Corporate America

• Corporations tend to be much larger than other businesses and produce the largest portion of GDP. They account for almost 90% of business sales.

• Proprietorships are the most numerous but produce a small portion of GDP. Although 72% of all firms are proprietorships, they generate only 4% of all sales.

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Figure 2.5

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Government Regulation

• Government plays a large role in deciding WHAT, HOW, and FOR WHOM goods are produced by:– Providing a Legal Framework– Protecting Consumers– Protecting Labor– Protecting the Environment

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Providing a Legal Framework

• One of the most basic functions of government is to establish and enforce the rules of the game.

• The government gives legitimacy to contracts by establishing the rules for such pacts and by enforcing their provisions.

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Striking a Balance

• Government interventions reflect the view that the market alone would not always select the best possible way of producing goods and services.

• Government failure might replace market failure, leaving us no better off and possibly even worse off.– Excessive regulation may inhibit

production, raise product prices, and limit consumer choices.

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For Whom America Produces

• Who gets which slice of the pie?– Will everyone get an equal slice?– Will some get a lot more than others?

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• In a market economy, an individual’s income depends on:– The quantity and quality of resources

owned.– The price that those resources command

in the market.

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For Whom America Produces

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• Karl Marx believed that:– Capitalists would continue to accumulate

wealth, power, and income.– All capitalist are rich, all workers are poor.

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For Whom America Produces

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• Marx’s predictions of how output would be distributed turned out to be wrong in two ways:– Labor’s share of output has risen greatly

over time.– Differences within the labor and capitalist

classes have become more important than differences between the classes.

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For Whom America Produces

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• The distinction between workers and capitalists has been blurred by profit-sharing plans, employee ownership, and widespread ownership of corporate stock.

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For Whom America Produces

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The Distribution of Income

• The richest fifth (or quintile) of U.S. households gets half of all the income.

• The poorest fifth gets only a sliver.

• Inequalities tend to be larger in poorer countries.

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• As countries develop, the personal distribution of income tends to become more equal:

– Personal distribution of income - the way total personal income is divided up among households or income classes.

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The Distribution of Income

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Table 2.4

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Taxes and Transfers

• People may feel that the distribution of income is not “fair”.

• Therefore, another role of government is to redistribute incomes.

• Taxes and transfers are used to do this.

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Taxes

• Progressive tax - a tax system in which tax rates rise as incomes rise.– An example is the federal income tax.

• A progressive tax makes after-tax incomes more equal than before-tax incomes.

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• Regressive tax - a tax system in which tax rates fall as incomes rise.– Examples include Social Security payroll

taxes and state and local sales taxes.

• A regressive tax tends to make the after-tax distribution of income less equal.

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Taxes

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• The progressive nature of the federal income tax is just about offset by the regressive nature of other sales, payroll, and property taxes.

• As a result, the tax system does not equalize incomes very much.

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Taxes

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Income Transfers

• The largest income-transfer program is Social Security.

• Over $700 billion per year is paid to 50 million older or disabled persons.

• The income-transfer system gives lower-income households more output than the market itself would provide and raises their share from 1% to 3.4% of total income.

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