1. Chapter 2
The U.S. Economy

2. What America Produces/How Much Output
The output of the U.S. economy is large and varied.
By multiplying the physical output of each good by its price, we can determine the total value of each good produced.

3. The Measurement of Output

4. Gross Domestic Product (GDP)
Gross Domestic Product (GDP) is the total value of final goods and services produced within a nation’s borders in a given time period.
It is a summary measure of a nation’s output.

5. Real GDP
Real GDP is the inflation-adjusted value of GDP or the value of output measured in constant prices.
These inflation adjustments delete the effects of rising prices by valuing output in constant prices.

6. Inflation Adjustments

7. International Comparisons
With just 5% of the world’s population, the U.S. economy produces over 20% of the entire planet’s output.
The U.S. economy is two and a half times larger than Japan’s, the world’s third-largest.

8. International Comparisons
The U.S. economy is twelve times larger than Mexico’s.
U.S. output exceeds by a wide margin the combined production of all countries in Africa and South America.

9. How Much Output Nations Produce

10. Per Capita GDP
Per capita GDP is total GDP divided by total population: average GDP.
It is an indicator of how much output each person would get if all output were divided evenly among the population.

11. Per Capita Incomes Around the World (2004)

12. Historical Comparisons
People who the U.S. government currently classifies as poor:
Enjoy a much higher living standard than the human masses in Third World nations.
Are also more comfortable than the average American family was in the 1950s.

13. Historical Comparisons
Economic growth is an increase in output (real GDP); an expansion of production possibilities.

14. Historical Comparisons
America’s real GDP has increased by about 3% a year, while the population is growing by only 1% a year.
If real GDP keeps growing 2% faster than population, per capita incomes will double again in about 35 years.

15. Social Welfare
We must not confuse GDP with broader measures of social welfare.
GDP measures only output produced for the market.

16. Social Welfare GDP: GDP includes production we’d rather do without.
Doesn’t include home production or volunteer activities.
Doesn’t directly measure noise, congestion, and pollution that often accompany increased output.
GDP includes production we’d rather do without.

17. The Mix of Output The major uses of total output include:
Household consumption
Business investment
Government services
Exports

18. The Uses of GDP

19. Consumer Goods
Consumer goods account for two-thirds of total U.S. output.
There are three types of consumer goods:
Durable goods
Nondurable goods
Services

20. Consumer Goods Durable goods - expected to last three years.
They tend to be big-ticket items like cars, appliances, and furniture.
Purchases of durable goods are often cyclical, that is, very sensitive to economic trends.

21. Consumer Goods Nondurable goods - items that are bought frequently.
They include clothes, food, and gasoline.
Services - the largest and fastest- growing component in consumption.
Over half of all consumer output consists of medical care, entertainment, utilities, and other services.

22. Investment Goods
Investment is expenditures on (production of) new plant and equipment (capital) in a given time period, plus changes in business inventories.
Investment goods include the plant, machinery, and equipment that are produced for use in the business sector.

23. Investment Goods Investment goods are used:
To replace worn-out equipment and factories, thus maintaining our production possibilities.
To increase and improve our stock of capital, thereby expanding our production possibilities.

24. Government Services
Federal, state, and local governments purchase resources to police the streets, teach classes, write laws, and build highways.
These resources are not available for consumption or investment.

25. Government Services
Only that part of federal spending used to acquire resources and produce services is counted in GDP.
Income transfers are not counted in GDP.

26. Government Services
Income transfers are payments to individuals for which no current goods or services are exchanged.
Examples include Social Security, welfare, and unemployment benefits.
State and local governments use far more of our scarce resources than does the federal government.

27. Federal Outlays, by Type

28. Net Exports Exports are goods and services sold to foreign buyers.
Imports are goods and services purchased from foreign sources.

29. Net Exports Net Exports = Exports – Imports
In 2005, the value of exports was less than the value of imports.
We used more goods and services than we produced in that year.
Net exports were negative.

30. The Changing Mix of Output

31. Changing Industry Structure: Decline in Farming
Over time the mix of output has changed dramatically.
In 1900, nearly 4 of 10 workers were employed in agriculture.
Today fewer than 2% of workers are farmers.

32. Decline of Manufacturing Share
Between 1860 and 1920, the manufactured share of GDP doubled.
After World War II, the manufactured share of output declined and now accounts for less than 20% of total output.

33. Decline of Manufacturing Share
Just in the last 50 years, manufactured output has increased fourfold even though manufacturing employment has increased only 20 percent.
As a result, the volume of manufactured output has increased, even while the manufacturing share of GDP has declined.

34. Growth of Services America has largely become a service economy.
Total service industries (including government) generate over 70% of total output.
Between 2005 and 2115, 98% of net job growth will be in service industries.

35. Growth of Trade International trade is increasingly important.
The import ratio (imports divided by GDP) has increased from 5% in the 1920s to over 16% today.

36. Growth in Trade
Increasing globalization of the U.S. economy is likely to continue due to:
Removal of trade barriers.
Advances in communications and transportation technologies.
Increased consumption of services.

37. How America Produces
International trade has also affected HOW goods and services are produced.
Factors of Production - resource inputs used to produce goods and services, e.g., land, labor, capital, entrepreneurship.

38. Factors of Production
The U.S. has ample resources to produce goods and services:
Third-largest population in the world.
World’s fourth-largest land area.
Profuse natural resources (e.g., oil, fertile soil, hydropower).

39. Capital Stock
The U.S. capital stock is over $40 trillion worth of machinery, factories, and buildings.
American production tends to be very capital intensive:
Capital intensive – production processes that use a high ratio of capital to labor inputs.

40. Factor Quality
Productivity - output per unit of input, e.g., output per labor hour.
Human capital - the knowledge and skills possessed by the work force.
The high productivity of the U.S. economy results from using highly educated workers in capital-intensive production processes.

41. Factor Mobility
Our continuing ability to produce the goods and services that consumers demand also depends on our agility in reallocating resources from one industry to another.

42. Business Organization
The three different legal organizations:
Corporations - owned by many individuals, each of whom owns shares (stock) of the corporation.
Partnerships - owned by a small number of individuals.
Proprietorships - owned by one individual.

43. Corporate America
Corporations tend to be much larger than other businesses and produce the largest portion of GDP.
Proprietorships are the most numerous but produce a small portion of GDP.

44. U.S. Business Firms: Numbers vs. Size

45. Government Regulation
Government plays a large role in deciding WHAT, HOW, and FOR WHOM goods are produced by:
Providing a Legal Framework
Protecting Consumers
Protecting Labor
Protecting the Environment

46. Providing a Legal Framework
One of the most basic functions of government is to establish and enforce the rules of the game.
The government gives legitimacy to contracts by establishing the rules for such pacts and by enforcing their provisions.

47. Providing a Legal Framework
By establishing ownership rights, contract rights, and other rules of the game, the government lays the foundation for market transactions.

48. Protecting Consumers
The government tries to protect consumers from a monopoly:
Monopoly - a firm that produces the entire market supply of a particular good or service.
Antitrust laws prohibit mergers or acquisitions that threaten competition.

49. Protecting Consumers
The U.S. Department of Justice and the Federal Trade Commission also regulate pricing practices and advertising claims.
The government ensures the safety of products by requiring testing of new drugs, food additives, and other products.

50. Protecting Labor
Child labor laws prevent the exploitation of children.
Labor has the right to organize and set rules for union-management relations.

51. Protecting the Environment
Historically the environment was not protected.
Decisions on how to produce were based on costs alone, not on how the environment is affected.
This resulted in air, water, and noise pollution.

52. Protecting the Environment
Without government intervention, these side effects of production would be common.
Decisions on how to produce would be based on private costs alone, not on how the environment is affected.
Externalities - costs (or benefits) of a market activity borne by a third party.

53. Striking a Balance
Government interventions reflect the conviction that the market alone would not always select the best possible way of producing goods and services.

54. Striking a Balance
Government failure might replace market failure, leaving us no better off and possibly even worse off.
Excessive regulation may inhibit production, raise product prices, and limit consumer choices.

55. For Whom America Produces
Who gets which slice of the pie?
Will everyone get an equal slice?
Will some get a lot more than others?

56. For Whom America Produces
In a market economy, an individual’s income depends on:
The quantity and quality of resources owned.
The price that those resources command in the market.

57. For Whom America Produces
Karl Marx believed that:
Capitalists would continue to accumulate wealth, power, and income.
All capitalist are rich, all workers are poor.

58. For Whom America Produces
Marx’s predictions of how output would be distributed turned out to be wrong in two ways:
Labor’s share of output has risen greatly over time.
Differences within the labor and capitalist classes have become more important than differences between the classes.

59. For Whom America Produces
The distinction between workers and capitalists has been blurred by profit-sharing plans, employee ownership, and widespread ownership of corporate stock.

60. The Distribution of Income
The richest fifth (or quintile) of U.S. households gets half of all the income.
The poorest fifth gets only a sliver.
Inequalities tend to be larger in poorer countries.

61. The Distribution of Income
As countries develop, the personal distribution of income tends to become more equal:
Personal distribution of income - the way total personal income is divided up among households or income classes.

62. Slices of the U.S. Income Pie

63. Unequal Incomes

64. Income Mobility
Permanent inequality is more the exception than the rule in the U.S. economy.
Income mobility makes lifelong incomes much less unequal than annual incomes.

65. In-Kind Income
In-kind income - goods and services received directly, without payment in a market transaction.
Examples of in-kind income include:
Public housing
Food stamps
Subsidized public education
Medicare subsidies

66. In-Kind Income
Because of in-kind income, the distribution of money income understates the standard of living for some.
The distribution of money income is not synonymous with the distribution of goods and services.

67. Taxes and Transfers
Taxes and transfers affect the FOR WHOM question by affecting the distribution of income.

68. Taxes
Progressive tax - a tax system in which tax rates rise as incomes rise.
An example is the federal income tax.
A progressive tax makes after-tax incomes more equal than before-tax incomes.

69. Taxes
Regressive tax - a tax system in which tax rates fall as incomes rise.
Examples include Social Security payroll taxes and state and local sales taxes.
A regressive tax tends to make the after-tax distribution of income less equal.

70. Taxes
The progressive nature of the federal income tax is just about offset by the regressive nature of other sales, payroll, and property taxes.
As a result, the tax system does not equalize incomes very much.

71. Transfers The largest income-transfer program is Social Security.
Over $500 billion a year is paid to 50 million older or disabled persons.

72. Transfers
The income-transfer system gives lower-income households more output than the market itself would provide.
The tax-transfer system raises their share from 1% to 3.4% of total income.

73. The U.S. Economy
End of Chapter 2