1. Chapter 6 Aggregate Incomes © 2015 Pearson Education, Ltd.

2. 6 Aggregate Incomes Chapter Outline 6.1 Inequality Around the World 6.2Productivity and the Aggregate Production Function 6.3 The Role and Determinants of Technology EBEWhy is the average American so much richer than the average Indian? © 2015 Pearson Education, Ltd.

3. Key Ideas 1.There are very large differences across countries in income or GDP per capita. 2.We can compare income differences across countries using GDP per capita at current exchange rates or adjusted for purchasing power parity differences. 6 Aggregate Incomes © 2015 Pearson Education, Ltd.

4. Key Ideas 3.The aggregate production function links a country’s GDP to its capital stock, its total efficiency units of labor, and its technology. 4.Cross-country differences in GDP per capita partly result from differences in physical capital per worker and the human capital of workers, but differences in technology and the efficiency of production are even more important. 6 Aggregate Incomes © 2015 Pearson Education, Ltd.

5. 6.1 Inequality Around the World We use the two terms, income per capita and GDP per capita, interchangeably in this course: © 2015 Pearson Education, Ltd.

6. United States in 2010 GDP = $14.45 trillion Population = 310 million persons GDP per capita = $46,613 per person 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

7. Question: How does U.S. GDP compare with GDP in Peru and Norway? 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

8. Peru in 2010 GDP = 444.46 billion nuevo sols Total population = 28.95 million people GDP per capita = 15,353 sols per person 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

9. Norway in 2010 GDP = 2.57 trillion kroner Total population = 4.68 million people GDP per capita = 549,962 kroner per person 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

10. Question: How do we make GDP comparisons between the United States and Peru and Norway? Method #1: Convert GDP into U.S. dollars, using current exchange rates: GDP per capita = GDP per capita in local currency × $ / local currency exchange rate 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

11. Peru GDP in 2010, Using Exchange Rates GDP per capita = Peru GDP per capita in sols × $ / sol exchange rate GDP per capita = 15,353 sols per person × 0.354 $ / sol = $5,435 per person 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

12. Norway GDP in 2010, Using Exchange Rates GDP per capita = Norway GDP per capita in kroner × $ / kroner exchange rate GDP per capita = 549,962 kroner per person × 0.165 $ / kroner = $90,744 per person 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

13. Ranking CountryGDP per Capita 1 Qatar141,845 2 Luxembourg108,537 3 Norway90,744 12 United States46,613 87 Peru5,435 189 Dem. Rep. of Congo189 190 Burundi151 191 Somalia109 GDP per Capita Rankings, Using Exchange Rates 6.1 Inequality Around the World © 2015 Pearson Education, Ltd.

14. There are two problems with using exchange rates to compare GDP across countries: 1.Prices of goods and services can vary across economies. 2.Exchange rates fluctuate throughout the year due to reasons beyond price changes. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

15. Question: How do we make GDP comparisons between the United States and Peru and Norway? Method #2: Convert Peru GDP by using the prices of goods and services in Peru relative to the prices of the same goods and services in the United States (purchasing power parity): GDP per capita = GDP per capita in local currency × PPP adjustment © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

16. Peru GDP in 2010, Using PPP Adjustment GDP per capita = Peru GDP per capita in sol × $ / peso PPP adjustment GDP per capita = 15,353 sol per person × 0.587 $ / sol = $9,012 © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

17. Norway GDP on 2010, Using PPP Adjustment GDP per capita = Norway GDP per capita in kroner × $ / kroner PPP adjustment GDP per capita = 549,962 kroner per person × 0.109 $ / kroner = $59,946 © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

18. Even though PPP adjustments raise the income levels of the developing countries, there are still very large disparities in income per capita across countries. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

19. Ranking CountryGDP per Capita 1 Qatar142,876 2 Luxembourg95,537 3 United Arab Emirates70,899 6 Norway59,946 12 United States46,613 87 Peru9,012 182 Burundi451 183 Zimbabwe368 184 Dem. Rep. of Congo282 GDP per Capita Rankings, using PPP Adjustment © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

20. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World Exhibit 6.1 Income per Capita Around the World in 2010 (PPP-adjusted 2005 constant dollars)

21. © 2015 Pearson Education, Ltd. Exhibit 6.2 A Map of Income per Capita Around the World 6.1 Inequality Around the World

22. The age structure and labor participation rates vary across countries. These variations impact income per capita. Therefore, we may want to consider: © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

23. Ranking CountryGDP per CapitaGDP per Worker 1 Qatar142,876182,297 2 Luxembourg95,537101,180 3 United Arab Emirates70,89991,694 6 Norway50,48894,863 10 United States46,61382,359 87 Peru9,01213,931 182 Burundi397770 183 Zimbabwe368606 184 Dem. Rep. of Congo282628 GDP per Capita vs. GDP per Worker © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

24. © 2015 Pearson Education, Ltd. Exhibit 6.3 Income per Worker Across Countries in 2010 (PPP-adjusted 2005 constant dollars) 6.1 Inequality Around the World

25. Ultimately, it is productivity differences that drive income per capita and income per worker differences across countries. Productivity The value of goods and services that a worker generates for each hour of work. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

26. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

27. There is be a positive relationship between income per capita (and income per worker) and various measures of standard of living. The next three slides present evidence of this relationship, using absolute poverty rates, life expectancy, and the Human Development Index to measure the standard of living. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World

28. © 2015 Pearson Education, Ltd. Exhibit 6.4 The Relationship Between Poverty and Income per Capita in 2010 (PPP-adjusted 2005 constant dollars) 6.1 Inequality Around the World

29. © 2015 Pearson Education, Ltd. Exhibit 6.5 The Relationship Between Life Expectancy at Birth and Income per Capita in 2010 (PPP-adjusted 2005 constant dollars) 6.1 Inequality Around the World

30. © 2015 Pearson Education, Ltd. 6.1 Inequality Around the World Exhibit 6.6 The Relationship Between the Human Development Index and Income per Capita in 2010 (PPP-adjusted 2005 constant dollars)

31. Productivity differences are the ultimate drivers of income per capita and income per worker differences across countries. There are three reasons productivity differs across countries: 1.Human capital 2.Physical capital 3.Technology © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

32. Human capital The stock of skills embodied in labor to produce output. This stock of skills, or total efficiency units of labor, is written: H = L × h where l is total number of workers h is the average human capital or efficiency © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

33. Physical capital The stock of business structures (plants) and equipment (machines) used for production. © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

34. Technology Superior knowledge in production or more efficient production processes so that more output can be produced with the same amount of human and physical capital. © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

35. How exactly do increases in a factor of production lead to increases in productivity and GDP? Macroeconomists use the aggregate production function to model the relationship between aggregate GDP and its factors of production. © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

36. The aggregate production function is: where Y is GDP K is the physical capital stock H is the total efficiency units of labor F() is a mathematical function A is an index of technology © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

37. The aggregate production function has the same two properties as the production function of an individual firm. 1.“More is better” An increase in either physical capital or total efficiency units of labor, holding the other factor constant, leads to an increase in GDP. © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

38. 2.Law of diminishing marginal product The marginal contribution of either physical capital or total efficiency units of labor to GDP diminishes when we increase the quantity used of that factor (holding all other factors of production constant). © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function

39. © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function Exhibit 6.7 The Aggregate Production Function with Physical Capital Stock on the Horizontal Axis (with the total efficiency units of labor held constant)

40. © 2015 Pearson Education, Ltd. 6.2 Productivity and the Aggregate Production Function Exhibit 6.8 The Aggregate Production Function with the Efficiency Units of Labor on the Horizontal Axis (with physical capital stock held constant)

41. With more advanced technology, more output can be produced with the same amount of physical capital and total efficiency units of labor. Therefore, technology will shift the production function upward. 6.3 The Role and Determinants of Technology © 2015 Pearson Education, Ltd.

42. 6.3 The Role and Determinants of Technology Exhibit 6.9 The Shift in the Production Function Resulting from More Advanced Technology

43. Technology can be embodied or contained in H. Workers today possess (1) knowledge of how to produce new goods such as smartphones and also (2) knowledge of how to perform certain tasks more efficiently, like writing a term paper in the latest version of Microsoft Word. © 2015 Pearson Education, Ltd. 6.3 The Role and Determinants of Technology

44. Technology can be embodied or contained in K. Physical capital today contains (1) knowledge of how to produce new goods such as smartphones and (2) knowledge of how to run certain software, like the latest version of Microsoft Word. © 2015 Pearson Education, Ltd. 6.3 The Role and Determinants of Technology

45. Advances in technology result mostly from purposeful, optimizing decisions by entrepreneurs and firms. Firms and the government in the United States spent $430 billion (or 2.8% of GDP) in research and development (R&D) to find new ways of applying science to production methods and to develop new and improved goods and services. © 2015 Pearson Education, Ltd. 6.3 The Role and Determinants of Technology

46. One example of how purposeful activity like R&D can increase the technology of the economy is Moore’s Law. Named after Intel cofounder Gordon Moore, Moore’s Law predicts that the number of transistors packed on a computer chip (i.e., the processing speed) should double every two years. © 2015 Pearson Education, Ltd. 6.3 The Role and Determinants of Technology

47. © 2015 Pearson Education, Ltd. 6.3 The Role and Determinants of Technology Exhibit 6.10 Moore's Law

48. Question: Why is the average American so much richer than the average Indian? Answer: Exhibit 6.12 presents data on income per worker, human capital per worker (schooling), and physical capital per worker relative to the United States. © 2015 Pearson Education, Ltd. 6 Aggregate Incomes Evidence-Based Economics Example

49. © 2015 Pearson Education, Ltd. 6 Aggregate Incomes Exhibit 6.12 The Contribution of Human Capital, Physical Capital, and Technology to Differences in Income per Worker

50. In column 1, income per worker in the United States is actually 9 times that in India (82,359/9,010 = 9). In column 4, income per worker in the United States would be 3.5 times that in India (82,359/24,071 = 3.5) if an Indian worker had the same technology as a U.S. worker. This translates into an almost threefold increase in income per worker (24,071/9,010 = 2.7). © 2015 Pearson Education, Ltd. 6 Aggregate Incomes

51. Question: Why is the average American so much richer than the average Indian? Answer: The average American is so much richer than the average Indian mostly because of better technology in the United States. © 2015 Pearson Education, Ltd. 6 Aggregate Incomes