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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. Chapter 2 THE U.S. ECONOMY: A GLOBAL VIEW 2 WHAT AMERICA PRODUCES COMPARATIVE OUTPUT The U.S. has less than 5 percent of the world’s population. It has 10 percent of the world’s arable land. Yet Y t it produces d more than th 20 percentt off the th world’s output. The market value of output (GDP) is a basic measure of an economy’s size. 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, economy China, China produced only half that much. In 2008, China produced $4.33 trillion. 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 4 PER CAPITA GDP COMPARATIVE OUTPUT 9.8 Gross domestic product (in U.S. $ trillion) 4.9 3.3 Per Capita GDP is the dollar value of GDP divided by total population. 2.1 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. 1.4 0.86 United China States 0.22 0.04 0.01 Japan GermanyBritain Mexico Saudi Ethiopia Haiti Arabia 5 6 GDP GROWTH GDP PER CAPITA AROUND THE WORLD 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. year U.S. population growth has been about 1 percent per year, causing GDP per capita to grow tremendously. 35,000 34,260 30,000 26,460 24,470 25,000 20,000 17,340 15,000 11,050 8810 10,000 7350 4040 5,000 3940 2390 1400 1150 660 0 8 POOR NATIONS U.S. OUTPUT AND POPULATION GROWTH SINCE 1900 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. INDEX OF REAL O OUTPUT AND POPULATION (1 1900 = 100) 1,800 1,600 1,400 1 200 1,200 Real GDP 1,000 Increasing GDP per capita 800 600 400 200 1900 Population 1920 1940 1960 YEAR 1980 2000 10 9 THE MIX OF OUTPUT 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, 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. 11 The relative decline in goods production does not mean the U.S. is producing fewer goods than before. G G Manufacturing and farm output has increased tremendously. The mix of output is simply different. 12 DEVELOPMENT PATTERNS THE CHANGING MIX OF OUTPUT 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 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. Percent of emp ployment 100 Services 80 60 40 Agriculture Manufacturing, mining and construction 20 0 1800 1840 1880 1920 1960 1993 14 13 WHAT AMERICA PRODUCES THE FOUR MAJOR USES OF TOTAL OUTPUT ARE: Consumption Investment Government services Net exports Net exports -1% Investment 15% Government Purchases Consumer Goods 67% Federal 7% State and local 12% 15 16 CONSUMER GOODS AND SERVICES INVESTMENT 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. 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: G G 17 Maintain our production possibilities by replacing worn out equipment and factories. Expand our production possibilities by increasing and improving our stock of capital. 18 INVESTMENT GOODS AND SERVICES Poor countries desperately need capital investment, but cannot afford to cut back on consumer goods. I 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, present the production of government services absorbs roughly one-fifth of U.S. total output. 19 20 GOVERNMENT SERVICES NET EXPORTS 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. Exports (X) are goods and services sold to foreign buyers. Imports (M) are goods and services purchased from foreign sources. sources Net Exports (X-M) are the value of exports minus the value of imports. 21 U.S. EXPORTS AND IMPORTS Exports of goods (in billions) COMPARATIVE ADVANTAGE 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, 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. Imports of goods (in billions) $393 $236 $220 $229 $179 $165 $147 $112 $134 $100 $65 $16 To Japan To To To To To EU Canada Mexico China rest of the world Total $773 billion Percent of world exports 18% 22 From From From From From From Japan EU Canada Mexico China rest of the world Total $1223 billion Percent of world imports 19% 23 24 HOW AMERICA PRODUCES CAPITAL STOCK 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. 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. 25 The high productivity of the American economy is explained in part by the quality of its labor resources. 26 FACTOR MOBILITY THE EDUCATION GAP BETWEEN RICH AND POOR NATIONS 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. Enrollment in secondary school 96% 96% High-income countries United States 71% 51% Poor countries Middleincome countries 28 PROVIDING A LEGAL FRAMEWORK ECONOMIC FREEDOM AND PER CAPITA GDP $25,000 Government establishes\enforces the rules. Externalities are the costs (or benefits) of a market activity borne by a third party. 2002 Level of Economic Freedom $23,325 To reduce the external costs of p production,, the government limits air, water, and noise pollution and regulates environmental use. $20,000 $11,549 $15,000 Prevents individual business firms from becoming too powerful through regulation of monopolies. $10,000 $5,000 Free Mostly Free $3,238 $3,829 Mostly Unfree Repressed 29 30 PROTECTING LABOR STRIKING A BALANCE 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. 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. 31 FOR WHOM AMERICA PRODUCES 32 THE U.S. DISTRIBUTION OF INCOME How many goods and services you get largely depends on your income. An income quintile is one-fifth of the population rank-ordered population, rank ordered by income (for example, top fifth). Income Quintile 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. 2000 Income (dollars) Average Income Share of Total Income (percent) (dollars) L Lowest fif fifthh 0 – 18,000 18 000 10 300 10,300 36 3.6 Second fifth 18,000 – 33,000 25,400 8.9 Third fifth 33,000 – 52,300 42,500 14.9 Fourth fifth 52,300 – 82,000 65,600 23.0 above 82,000 141,100 49.6 Highest fifth 33 34 TOTAL NET WORTH (SOURCE: UCSC.EDU) INCOME SHARE OF THE RICH Year 1983 1989 1992 1995 1998 2001 2004 2007 Third fifth Second fifth Fourth fifth Poorest fifth Richest fifth of population 35 Top 1 percent 33.8% 37.4% 37.2% 38.5% 38 1% 38.1% 33.4% 34.3% 34.6% Next 19 percent 47.5% 46.2% 46.6% 45.4% 45 3% 45.3% 51.0% 50.3% 50.5% Bottom 80 percent 18.7% 16.5% 16.2% 16.1% 16 6% 16.6% 15.6% 15.3% 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 2007. 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 36 than it was in 2007. GLOBAL INEQUALITY INCOME STAGNATION? Poor people in the United States receive more goods and services than the average household in most low-income countries. 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. 37 38 ENVIRONMENT DESTRUCTION? WIDENING INEQUALITY? 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. 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? 39 40 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. 41 End of Chapter 2 THE U.S. ECONOMY: A GLOBAL VIEW