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Chapter 2
The U.S. Within the World Economy

Overview
This chapter begins with an analysis of the price system and the manner in which a free market economy
determines what, how, and for whom to produce. In terms of production, we then consider the basic
resources which include land, labor, capital, and entrepreneurship. The author analyzes the concept of
productivity and the current state of the U.S. economy and its relationship to the global economy. In this
regard, the chapter moves on to cover the basics of GDP and then emphasizes the importance of per capita
real GDP. Lastly, we examine the growth in the population of the U.S. as well as other countries and
consider the significance of the changes in population on the U.S. and global economies.
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Learning Objectives
After reading this chapter students should be able to:
 Explain how the price system answers the basic questions of what, how, and for whom to produce.
 List and explain the four main factors of production.
 Position the U.S. economy within the total world economy with respect to income, labor force, and
global integration.
 Contrast GDP with per capita GDP and per capita real GDP.
 Compare the likely future population growth in the U.S. with that of Europe, China, and India.
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Outline
I.
Three Basic Economic Questions: In any economy we must answer the following three questions:
A) What to Produce: In a free market economy, the price level of any good will provide an
indication of that good’s relative scarcity and serve as an indication to producers as to what
goods they should produce in what quantities.
B) How to Produce: In a free market economy, producers will use the least-cost combination of
inputs in order to generate the highest profits possible.
C) For Whom to Produce: In a free market economy, the individuals with both the ability and the
willingness to purchase a good will receive that good.
II.
Resources: A resource is something that is used to produce a good. Resources are sometimes also
called factors of production.
A) Land: The term “land” refers not only to areas of real estate but also to all natural resources
present on that land.
B) Labor: Labor includes all services of anyone who helps to produce a good; labor is known as
the human resource.
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The U.S. Within the World Economy
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C) Capital: Capital refers to any manufactured good used to make another good, including such
items as machinery and factories.
D) Entrepreneurship: Entrepreneurship refers to the ability of individuals to start businesses,
introduce new products, improve production techniques, and take risks.
II.
Productivity: The concept of productivity describes the amount of output produced by a given
amount of resources. Most frequently we measure output in relation to the amount of labor used.
III. Focus on the U.S. Economy: The U.S. has transformed from a relatively undeveloped economy in
the late 1800s to perhaps the most developed economy in the world with significant improvements in
income per person and consumption per person.
A) Labor Force: The labor force is defined as the number of people over age 16 who are either
working or trying to find work. At present, the U.S. labor force is approximately 150 million.
B) Goods Produced: Many years ago U.S. production was limited to agricultural products but
today U.S. production is much more diverse.
1. Information Age: Due to the advances in computers, the focus of the U.S. economy has
shifted to information and communication.
2. Service Economy: The U.S. labor force has also shifted from agriculture to manufacturing
to services such as healthcare, education, and banking.
IV. The U.S. in the World Economy: Although the U.S. is one of the most impressive economies
throughout the world, we are still part of a larger, global economy.
A) World Labor Supply: U.S. companies are utilizing labor from across the world because of
lower labor cost outside of the U.S. Although U.S. businesses are creating jobs elsewhere in the
world, this does not imply that the U.S. labor force is declining. In fact, the U.S. labor force has
grown steadily for some time.
B) Growth: The U.S. economy continues to grow as indicated by the increase in the average
income level and the number of jobs over the last 25 years.
V.
Measurement: From an economic perspective, we need a means of measuring production within the
economy to determine if the nation’s productive capacity is increasing and to determine if there are
problems with business activity across the economy.
A) GDP: Gross Domestic Product or GDP is the value of all final goods and services produced in
our nation each year. GDP is also a representation of national output.
1. Per Capita GDP: To gain a more accurate picture of the standard of living for the citizens of
a country, we must consider per capita GDP, which is GDP divided by the population.
2. Real GDP: Money or nominal GDP adjusted to account for changes in the prices of the
goods produced is real GDP. Real GDP refers to the quantity of goods produced.
B) Comparing the U.S. to Other Economies: It is difficult to compare GDP from the U.S. to
other countries because the statistics from some less developed countries may not be accurate
and because it is difficult to convert values expressed in terms of other countries’ currencies.
However, it is reasonable to compare the U.S. GDP to other highly developed economies.
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Roger LeRoy Miller • Understanding Modern Economics
VI. Population Growth: The U.S. population has experienced steady population growth for the past 200
years. An increase in the population will also increase the size of the labor force but it will also
increase the number of people who may need various social services.
A) Immigration as the Key: While the U.S. population is expected to increase by 100 million over
the next 50 years, the fertility rate for U.S. couples is relatively low at 2.1. Therefore, the
expected increase in population is dependent on immigration from other countries to the U.S.
B) World Populations: While many expect that the U.S. population will stabilize at around
400 million, China and India each have populations in excess of one billion, which suggests that
these countries may enjoy significant economic power in the future. In contrast, the populations
of various European countries are likely to decrease, which might lead to a decline in the
importance of trade with these countries.
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Lecture Tips
For Whom Do We Produce: In a free market economy, we produce for those with the ability and the
willingness to purchase the good. While most students readily agree with this statement, they may not
realize some additional implications. Namely, in a free market economy those people who simply want a
good do not receive it. More significantly, in a true free market economy even those who actually need a
good do not receive the good.
GDP as a Measure of Output and Income: Students generally recognize that GDP is a measure of
output. However, what they may not recognize is that GDP is also a measure of national income. This is
true because of the fact that one person’s expenditures will become income to others. The circular flow of
funds model can be helpful in illustrating this relationship. It is critical that students recognize this
relationship so that they will understand the importance of per capita real GDP.
Produced Domestically: GDP is defined as “the value of all final goods and services produced in our
nation each year.” This definition is very specific with good reason. The nationality of the individual or
company responsible for production is irrelevant to the measurement of GDP so long as those individuals
are producing inside our borders.
Final Goods: Another key phrase in the definition of GDP is the reference to “final goods.” Any
intermediate good is not and should not be counted. For example, if an oven that was installed in a new
home by the builder was included in GDP, the oven would actually be counted twice—once when the
builder purchased the oven and again when the consumer purchased the home. The price of the home
included the value of the oven. As a result, we do not want to add the sale of intermediate goods into GDP.
Population Growth: Students will frequently view population growth as only a negative. Many times
they recognize that a large population requires more schools, more social services, and other expenditures
by various levels of government. While this is true, students should also recognize the benefits of
population growth. First, the larger population leads to a larger work force, which is a significant positive
for the economy. This larger work force will create more economic activity, which will also create more
tax revenue. Without this growth, the average age of the existing population is likely to increase, which
would lead to more retirees who could require support.
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Further Questions for Class Discussion
1.
Real GDP (or more specifically per capita real GDP) is our best tool for measuring the economic
well-being of a country. However, real GDP is not a perfect measurement by any means. How would
items such as household production, environmental damage, or improvements in the quality of goods
impact real GDP? What problems or shortcomings would these items imply with respect to real GDP
as a measurement tool?
Real GDP neglects to account for items such as household production, environmental damage, or
improvements in the quality of goods. As a result real GDP may overstate or understate the output
level of our economy or the well-being of our country. In the case of household production of a
service such as childcare, an important service is being produced, but real GDP cannot account for
this service since there is no explicit market value. With regard to environmental damage, several of
the goods that we produce cause damage to the environment through their production and our use of
these items. Although the benefits of these goods should be acknowledged, the costs to the
environment are effectively ignored by measuring real GDP. Lastly, although real GDP accounts for
the quantity of goods, it does not account for changes in the quality of goods. Therefore if we produce
computers with a higher processing speeds or cars with increased gas mileage, there will be no
impact on real GDP even though we are better off with these improvements.
2.
Sales of used goods are not counted in GDP. How does the amount of production required for the
sale of a used good compare to the amount required for the sale of a new good? How would the sale
of each type of good impact employment? As a result, is it appropriate or inappropriate to exclude
the sale of used goods in GDP?
Very little additional production would be associated with the sale of a used good, while the sale of a
new good would require at least some effort to be made in terms of production. As a result of the
productive effort involved in each case, the sale of new goods results in more employment while the
sale of used goods results a much lesser change in employment. For this reason, it is appropriate to
exclude the sale of used goods from GDP.
3.
For the purposes of this example, assume that the only goods that U.S. companies produce are jeans.
In 2003, if the price of each pair of jeans was $45 and U.S. companies sold one million pair, what
would the money or nominal GDP equal? In 2004, if the price increased to $50 and U.S. companies
again sold one million pair, what would the money GDP equal? Was the increase in money GDP the
result of an increase in output or price? Would this increase imply a corresponding increase in
employment or no change in employment? Why?
In 2003, the money GDP would be $45 million. In 2004, the money GDP would be $50 million. In
this example, the increase was the result solely of an increase in price. This change in money GDP
would not imply an increase in employment because no additional output was produced.
4.
Which factor of production—land, labor, capital, or entrepreneurship—is most important? Which of
the factors is least important? Is it possible to exclude one of these factors of production and still
produce any good?
We cannot say that any of the factors of production are more or less important than the others. At
some points, we may rely on one factor more than another but this does not indicate that any one is
more important than the others is not true. It is necessary to utilize all four factors of production to
some degree in order to produce any good.
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Roger LeRoy Miller • Understanding Modern Economics

Answers to Questions for Critical Analysis
1.
Measured productivity can rise when inefficient plants are phased out. What are other, more positive,
ways for businesses to raise productivity?
If businesses are able to increase the productivity of existing resources, they can increase the rate of
output without some of the negative consequences such as plant closings. Such increases in
productivity might be possible as a result of additional training of employees increasing their
technical proficiency. Another option is to cross-train employees in various tasks so that the workers
can rotate from one task to another. This will counter the monotonous nature of some jobs and also
allow one worker to fill in for another if the situation calls for it.
2.
After examining the many steps involved in just one part of a car sold in the U.S., what must you
conclude about the average cost of shipping?
Based on the steps involved, we would conclude that the average cost of shipping must be fairly low.
More specifically, we would conclude that the combined shipping costs are less than the increase in
costs if KIA were to assemble or pay someone else to assemble the entire CD player in South Korea.
If the existing production process that includes a significant amount of shipping was not the least cost
method of producing the item in question, KIA would be very unlikely to use this method.
3.
Since 1990, Forbes magazine estimates that the number of billionaires in the United States has
increased by almost 130 percent. During the same period, the number of billionaires in Germany
increased by only 15 percent. Is the U.S. necessarily better off than Germany? Why or why not?
The U.S. is not necessarily better off than Germany since Forbes did not provide any details
regarding the population or distribution of income. Although the number of billionaires has increased,
the population could have increased to a greater degree. In reality, the population did not increase to
this degree. In addition, these statistics provide no indication of the distribution of income and the
income levels of the remainder of the population. For example, if the number of billionaires increased
by 130% but the number of households living beneath the poverty line increased by 150%, the U.S.
might not be better off.

Answers to Mastering Economic Concepts
Questions and Problems
1.
Prices signal to producers what items they should produce. These items will be produced using the
least cost combination of inputs. These items will be distributed to those consumers that have the
ability and the willingness to purchase the items.
2.
No, in a free market economy you are not entitled to an item no matter how badly you want it. In a
true free market economy, you are not entitled to it even if you need the item to survive. You must be
able to afford it.
3.
The other category of resources or factor of production is entrepreneurship. Examples of
entrepreneurship include a willingness to take risk, an ability to create new products or services, and a
talent to improve the production process.
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4.
Real GDP depicts money GDP adjusted for changes in the price level. However, real GDP does not
provide any adjustment for the change in quality of the goods being produced. As such, this is a
shortcoming of real GDP as a measure of economic well-being.
5.
The price of domestic goods purchased by U.S. consumers would increase because labor, a key factor
of production, would become scarcer. Therefore the price of labor would increase which would lead
to an increase in the cost of U.S. goods.
6.
Yes, Earle’s creative abilities would be considered a resource. His creativity could possibly be useful
to firms producing video games or designing web pages.
7.
A CD player purchased by GM to be installed in a new Chevy Malibu would not be included in GDP
because it is not a final good.
Lawn care service that I provide for free to my brother while visiting him would not be included in
GDP because there is not market value assuming that I do not charge my brother.
A watch made in Switzerland sold in New York City would not be included in the U.S. GDP because
it was not made in the U.S.
A 1998 Cadillac sold to a retired U.S. steel worker in 2004 would not be counted in the GDP for the
year 2004, because it was not made in 2004.
8.
A stable population implies that the birth rate is relatively low. Because of medical advances, life
expectancy has been increasing. Combining these two factors we would expect to see an increase in
the average age if we have a stable population.
9.
If every couple had two children, then each person of an older generation would have one person in
the next generation. There would be a one to one relationship. The fertility rate just over 2.0 allows
for some couples who do not have children as well as deaths at younger ages.
10. Real GDP per person would increase by approximately 6%.
11. The relatively high price indicated to DaimlerChrysler that the PT Cruiser was desirable to
consumers.
12. Shrimp in a fishery are a resource used by a company selling seafood.
A pair of roller blades would not be considered a resource because they do not typically help in the
production of other goods.
An airline pilot is a resource used in providing air travel.
Education is a resource in that it increases the productivity of labor.
13. The $30 commission would be included in GDP because this is a service that you consumed and it
does have a market value. However, the $2,350 that you paid to acquire the shares of stock does not
add to U.S. GDP because nothing is produced; this is simply a transfer of partial ownership.
14. If very few tickets are available for an event because of a smaller venue the tickets will be scarcer and
the price is likely to increase.
If the event is very popular, the added interest will make extra tickets more scarce causing the price to
increase.
If the event is about to begin, the potential buyers for the tickets may become more scarce. Most
spectators want to see the entire event. Since the buyers will become more scarce as opposed to the
tickets, we would expect prices to decrease immediately before the start.
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Roger LeRoy Miller • Understanding Modern Economics
15. Per capita real GDP increased because real GDP increased by 20% and the population increased by
only 15%.
16. The price level across the economy increased approximately 3%, which accounts for the difference
between the money GDP and the real GDP.
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Answers to Thinking Critically Questions
1.
If these groups and the consumers who believed in their argument refused to buy the cars that did not
include the desired safety measures, there would be a very large incentive for the automakers to
comply. Furthermore, these groups could organize a boycott of all models from the manufacturers
that do not include the safety devices on any one model. Such action would send a very clear message
and likely produce a response from the automakers relatively quickly.
2.
The wealthiest 20% would earn 20% of the income and the poorest 20% would earn 20% of the
income. However, this type of income equality would limit or eliminate any incentive that citizens
have to earn more for themselves and as a result economic growth would likely decrease as well.
3.
If the parent is no longer at work, he or she is no longer assisting in the production of any final good;
this decreases GDP. If the parent is providing childcare there is no impact on GDP because there is
no market value for goods provided for one’s own household. While GDP is a reasonable manner in
which to account for economic well-being, GDP cannot account for the production of goods or
services within the home.
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Homework Set Answer Key
1.
(a)
(b)
(c)
(d)
2.
Real GDP per person would increase by approximately 3%.
3.
(a) Tax preparation service would be counted in GDP.
(b) A Toyota Camry produced in West Virginia would be counted in GDP.
(c) A new sink intended to be included in a new home for sale would not be counted in GDP when it
was produced. The value of the sink would be included in the price of the new home.
(d) A snickers bar would be counted in GDP.
4.
At the original price level of $199 the Xbox was becoming less scarce; Microsoft could not sell
enough units and it is likely that the company’s inventory was increasing. The decreased scarcity and
lower price indicate that Microsoft faced significant competition from Sony and Nintendo.
5.
If the population of a country declines, this imply a fertility rate less than 2.0. Each couple is not
having enough children to ‘replace’ themselves. Immigration could provide significant additions to
the populations, while emigration would decrease the population.
6.
Brazil has the greatest degree of income inequality for the countries listed.
A computer network would be classified as capital, specifically physical capital.
Copper deposits would be classified as land.
Creative ability would be classified as entrepreneurship.
A UPS driver would be classified as labor.
Chapter 2
The U.S. Within the World Economy
7.
An increased income tax on the wealthy will lead to less income inequality. However, this would
decrease the incentive to earn more money and similarly decrease the level of economic growth.
8.
The price of SUVs would begin to decrease, which would serve as a signal to producers that they
need to make more fuel efficient vehicles.
9.
False. U.S. citizens have experienced an increase in their standard of living during the last century.
False. Capital includes physical capital as well as human capital.
False. GDP includes the market value of all goods produced within the U.S.
False. The term ‘real GDP’ refers to the money GDP adjusted for changes in the price level.
10. Per capita GDP increased since GDP increased by 20.8% while the population increased by only
0.8%.
Media Resource List
 Load your CD-ROM to listen to the audio introduction to this chapter.
 Test your knowledge of chapter concepts with a quiz at www.miller-ume.com.
 Link to Web resources related to text coverage at www.miller-ume.com.
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