INTRODUCTION THE U.S. ECONOMY: A GLOBAL VIEW WHAT AMERICA PRODUCES COMPARATIVE OUTPUT PER CAPITA GDP COMPARATIVE OUTPUT

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1 Chapter 2 THE U.S. ECONOMY: A GLOBAL VIEW INTRODUCTION Each nation has very different production possibilities and uses different mechanisms for deciding WHAT, HOW, and FOR WHOM to produce. The objective of this chapter is to assess how the U.S. economy stacks up. 2 WHAT AMERICA PRODUCES The U.S. has less than 5 percent of the world s population. It has 10 percent of the world s arable land. Yet it produces more than 20 percent of the world s output. The market value of output (GDP) is a basic measure of an economy s size. Gross Domestic Product (GDP) is the market value of all final goods and services produced within a nation s borders in a given time period. 3 COMPARATIVE OUTPUT In 2000, the U.S. economy produced about $10 trillion worth of output. Most recent data has output at $14.6 trillion in 2008 The second largest economy, China, produced only half that much. In 2008, China produced $4.33 trillion. 4 COMPARATIVE OUTPUT 9.8 United States Gross domestic product (in U.S. $ trillion) China Japan GermanyBritain Mexico Saudi Ethiopia Haiti Arabia PER CAPITA GDP Per Capita GDP is the dollar value of GDP divided by total population. It indicates how much output the average person would get if all output were divided up evenly among the population. Americans have access to far more goods and services than people in other nations. GDP per capita in the U.S. is over $34,000 per year (when the text went to print. In 2009 it was estimated at $46,381.) Per capita incomes in Ethiopia and Haiti, are less than $1,200 per year less than $4 per day. 5 6

2 GDP PER CAPITA AROUND THE WORLD 35,000 34,260 30,000 26,460 24,470 25,000 20,000 17,340 15,000 11,050 10, , GDP GROWTH Economic growth is the increase in output (real GDP) an expansion of production possibilities. On average, U.S. output has grown by roughly 3 percent per year. U.S. population growth has been about 1 percent per year, causing GDP per capita to grow tremendously. 8 U.S. OUTPUT AND POPULATION GROWTH SINCE 1900 POOR NATIONS INDEX OF REAL OUTPUT AND POPULATION ( = 100) 1,800 1,600 1,400 1,200 1, Real GDP YEAR Increasing GDP per capita Population 2000 The populations of rich countries are growing slowly so that gains in per capita GDP are easily achieved. The populations of the poorest countries are still growing rapidly, making it difficult to raise living standards THE MIX OF OUTPUT A century ago, about two-thirds of U.S. output consisted of goods while one-third of output consisted of services. Since then, over 25 million people have left farms and sought jobs in other sectors. Today, nearly 75 percent of U.S. output consists of services, not goods. Over 98 percent of future job growth will be in service producing industries. THE MIX OF OUTPUT The relative decline in goods production does not mean the U.S. is producing fewer goods than before. Manufacturing and farm output has increased tremendously. The mix of output is simply different

3 THE CHANGING MIX OF OUTPUT DEVELOPMENT PATTERNS Percent of emp ployment Agriculture Services Manufacturing, mining and construction The transformation of the U.S. into a service economy is a reflection of our high incomes. Poor people don t have enough income to buy many services, so the mix of output in poor countries is weighted toward goods, not services. We can develop a clearer picture of our answer to the WHAT question by examining the uses to which our output is put THE FOUR MAJOR USES OF TOTAL OUTPUT ARE: WHAT AMERICA PRODUCES Consumption Investment Government services Net exports Net exports -1% Investment 15% Consumer Goods 67% Government Purchases Federal 7% State and local 12% CONSUMER GOODS AND SERVICES Consumer goods and services (C) include items like breakfast cereals, movie rentals, and college education. This category of production accounts for over two-thirds of total output. 17 INVESTMENT GOODS AND SERVICES Investment (I) includes expenditures on (production of) new plant, equipment, and structures (capital) in a given time period, plus changes in business inventories. The U.S. devotes 15 percent of output to investment. Investment goods: Maintain our production possibilities by replacing worn out equipment and factories. Expand our production possibilities by increasing and improving our stock of capital. 18

4 INVESTMENT GOODS AND SERVICES Poor countries desperately need capital investment, but cannot afford to cut back on consumer goods. Most of them depend on foreign aid and other capital inflows to finance investment or risk continuing stagnation or even decline of living standards. GOVERNMENT SERVICES (G) Only that part of federal spending used to acquire resources and produce services is counted in GDP. At present, the production of government services absorbs roughly one-fifth of U.S. total output GOVERNMENT SERVICES Income transfers are payments to individuals for which no current goods or services are exchanged: e.g., Social Security, welfare, unemployment benefits. Much of federal government spending is in the form of income transfers. The output of all state and local government accounts for roughly 12 percent of total GDP. NET EXPORTS Exports (X) are goods and services sold to foreign buyers. Imports (M) are goods and services purchased from foreign sources. Net Exports (X-M) are the value of exports minus the value of imports U.S. EXPORTS AND IMPORTS COMPARATIVE ADVANTAGE $65 To Japan Exports of goods (in billions) $165 $179 $112 To EU Total $773 billion Percent of world exports 18% $16 $236 To To Canada Mexico China To To rest of the world Imports of goods (in billions) $393 $220 $229 $147 $134 $100 From Japan From EU From From Canada From From Mexico China rest of the world Total $1223 billion Percent of world imports 19% The motivation for international trade originates in our quest for more output. Our decision to import is not based on our inability to produce items, but on the efficiency of importing the items. Comparative advantage is the ability of a country to produce a specific good at a lower opportunity cost than its trading partners

5 HOW AMERICA PRODUCES All goods and service included in GDP are produced within the borders of the United States. Productivity is output per unit of input such as output per labor hour. 25 CAPITAL STOCK A capital-intensive production process is one that use a high ratio of capital to labor inputs. American production tends to be capital-intensive. Human capital is the knowledge and skills possessed by the workforce. The knowledge and skills workers possess can be accumulated. The high productivity of the American economy is explained in part by the quality of its labor resources. 26 THE EDUCATION GAP BETWEEN RICH AND POOR NATIONS FACTOR MOBILITY Enrollment in secondary school 51% Poor countries 71% Middleincome countries 96% 96% High-income countries United States Our continuing ability to produce the goods and services that consumers demand depends on our ability in reallocating resources from one industry to another. Whenever technology advances, an economy can produce more output with existing resources. A positive relationship has been documented between the degree of economic freedom in a country and its economic growth. 28 ECONOMIC FREEDOM AND PER CAPITA GDP PROVIDING A LEGAL FRAMEWORK Government establishes\enforces the rules. $25,000 $20,000 $15,000 $10,000 $5, Level of Economic Freedom $23,325 $11,549 $3,238 $3,829 Externalities are the costs (or benefits) of a market activity borne by a third party. To reduce the external costs of production, the government limits air, water, and noise pollution and regulates environmental use. Prevents individual business firms from becoming too powerful through regulation of monopolies. Free Mostly Free Mostly Unfree Repressed 29 30

6 PROTECTING LABOR The government regulates how labor resources are used in the production process. Child labor laws and compulsory schooling prevent minor children from being exploited. Government regulations set standards for work place safety, minimum wages, fringe benefits, and overtime provisions. STRIKING A BALANCE There is no guarantee that government regulation of HOW goods are produce always make us better off. Government failure might replace market failure, leaving us no better off possibly worse off FOR WHOM AMERICA PRODUCES How many goods and services you get largely depends on your income. An income quintile is one-fifth of the population, rank-ordered by income (for example, top fifth). The top 20 percent (quintile) of U.S. households gets nearly half of all U.S. income. The poorest 20 percent (quintile) get less than 4 percent of all income. THE U.S. DISTRIBUTION OF INCOME Income Quintile 2000 Income (dollars) Average Income (dollars) Share of Total Income (percent) Lowest fifth 0 18,000 10, Second fifth 18,000 33,000 25, Third fifth 33,000 52,300 42, Fourth fifth 52,300 82,000 65, Highest fifth above 82, , INCOME SHARE OF THE RICH Second fifth Third fifth Richest fifth of population Fourth fifth Poorest fifth 35 TOTAL NET WORTH (SOURCE: UCSC.EDU) Year Top 1 percent Next 19 percent Bottom 80 percent % 47.5% 18.7% % 46.2% 16.5% % 46.6% 16.2% % 45.4% 16.1% % 45.3% 16.6% 6% % 51.0% 15.6% % 50.3% 15.3% % 50.5% 15.0% There has been an "astounding" 36.1% drop in the wealth (marketable assets) of the median household since the peak of the housing bubble in By contrast, the wealth of the top 1% of households dropped by far less: just 11.1%. So as of April 2010, it looks like the wealth distribution is even more unequal than it was in

7 GLOBAL INEQUALITY Poor people in the United States receive more goods and services than the average household in most low-income countries. INCOME STAGNATION? One central concern for the economy tomorrow is how fast incomes will grow. Future growth depends on the willingness to allocate scarce resources to investment in human and physical capital. If we aren t satisfied with the market s response, we might also try to increase investment and growth with government intervention ENVIRONMENT DESTRUCTION? In the quest for faster income growth, we must also pay heed to HOW we produce. Advancing technology and rising incomes have made environmental protection both possible and desirable for those nations who can afford it. WIDENING INEQUALITY? The challenge is to develop a set of government regulations, incentives, and prohibitions that will balance environmental concerns with the continuing quest for material advancement. How much inequality will we accept in the economy tomorrow? MARKET SIGNALS The recent surge in inequality is largely due to changing demand for labor. Market-driven inequalities are both a reward to productive achievement and an incentive to produce more. The government may have to intervene because the market alone may not reduce inequalities quickly or adequately. End of Chapter 2 THE U.S. ECONOMY: A GLOBAL VIEW 41

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