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Chapter 1
THE FACTS
TO BE
EXPLAINED
Modified for EC 375 by
Bob Murphy
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Facts to Be Explained
• Huge Differences In Living Standards Across Countries Today
• Immense Differences Over Time in Living Standards
• Differences in Economic Growth Rates Across Countries
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Facts to Be Explained
• Throughout this course we will shed light on the quesCons of why countries differ in their living standards.
• Also we will seek to explain why countries grow or fail to grow over Cme.
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Table 1.1 Top Eleven Countries in Year 2009
According to Three Different Measures
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Figure 1.1 The Parade of World Income
Source: Heston, Summers, and Aten (2011).
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Figure 1.2 GDP per Capita in the
United States, 1870–2009
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Calculating Growth Rates
Growth between two years is given by:
xt+1 − xt
g=
xt
105 − 100
5
Example: g =
=
= 0.05 = 5%
100
100
Since xt+1 = xt [1+ g] we can roll forward to obtain:
xt+n = xt [1+ g]
n
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Calculating Growth Rates
Rearrange to obtain average growth over n years:
1/n
⎡ xt+n ⎤
⎢ x ⎥ −1 = g
⎣ t ⎦
Example:
1/20
⎡ 200 ⎤
g=⎢
⎥
100
⎣
⎦
− 1 = 1.035 − 1 = 0.035 = 3.5%
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Calculating Growth Rates
• Rule of 72: Doubling Cme = 72/g
• The Use of RaCo (Logarithmic) Scales: Figures 1.3 and 1.4.
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Figure 1.3 The Effect of Using a Ratio Scale
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Figure 1.4 GDP per Capita in the United
States, 1870–2009 (Ratio Scale)
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Figure 1.5 GDP per Capita in the United
States, the United Kingdom, and Japan,
1870–2009
Sources: Maddison (1995), Heston, Summers, And Aten (2011).
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Figure 1.6 The Distribution of Growth Rates,
1975–2009
Source: Heston, Summers, and Aten (2011).
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Figure 1.7 GDP per Capita by Country Group,
1820–2008
Sources: Maddison (2008), Heston, Summers, and Aten (2011).
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Figure 1.8 World Inequality and Its
Components, 1820–1992
Source: Bourguignon and Morrison (2002).
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Growth Before 1820
• World:
– 1700-­‐1820 0.07% per year
– 1500-­‐1700 0.04% per year
• Western Europe: – 1500-­‐1820 0.14% per year
• Income differences between countries were very small by modern standards. Factor of 1.5-­‐2.0 for rich versus poor.
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Growth as Measured from Outer Space
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Measuring and Comparing GDP
• Over Time: Familiar approach, use price index to account for inflaCon over Cme. For example, compute real GDP by deflaCng nominal GDP by price index.
• Across Countries: More difficult
– Market exchange rates fluctuate a lot.
– Price of Traded Goods compared to Non-­‐Traded Goods is higher in poor than rich countries.
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Measuring and Comparing GDP
• Exchange rates tend to be such that traded goods prices are equalized across countries.
• GDP measured at market exchange rates systemaCcally understates relaCve income of developing countries. • So, construct arCficial exchange rates-­‐-­‐PPP Exchange Rates.
• Use standardized basket of goods and services, both traded and non-­‐traded.
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Measuring and Comparing GDP
• An example (Table 1.2 from text):
• Using market exchange rate (1 Richland dollar/1 Poorland dollar): GDP per capita in Richland is 6 Cmes GDP per capita in Poorland.
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Measuring and Comparing GDP
• Instead, compute PPP exchange rate using basket of goods consumed worldwide:
• 1 television to 10 haircuts.
• Worth 30 Richland $ and 20 Poorland $.
• So, PPP exchange rate is 3 Richland $/2 Poorland $.
• Use this to compute value of per capita GDP
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Measuring and Comparing GDP
• Poorland’s GDP per capita = 30 Richland $.
• This is 1/4 of Richland’s GDP per capita of 120 Richland $.
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Table 1.3 The Effect of Using PPP on
Comparisons of GDP
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