McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The U.S. Economy: A Global View Chapter 2

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. What America Produces With less than 5 percent of the world’s population.. and 12 percent of the world’s arable land.. the U.S. produces more than 20 percent of the world’s output.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP Comparisons Gross domestic product (GDP) is a basic measure of an economy’s size. –Gross Domestic Product (GDP) is the total market value of all final goods and services produced within a nation’s borders in a given time period.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Comparative Output 2002 Gross Domestic Product (in U.S. $ trillion) Haiti Ethiopia Saudi Arabia South Korea Mexico Britain Germany Japan China United States

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Per Capita GDP Per Capita GDP is the dollar value of GDP divided by total population; average GDP. It indicates how much output the average person would get if all output were divided up evenly among the population.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP Per Capita Around the World (2002)

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP Growth Economic growth is the increase in output (real GDP) – an expansion of production possibilities.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP Growth U.S. GDP per capita keeps rising. –U.S. output grows by roughly 3 percent per year. –U.S. population grows by 1 percent per year.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. U.S. Output and Population Growth Since ,000 1,200 1,400 1,600 1,800 INDEX OF REAL OUTPUT AND POPULATION (1900 = 100) YEAR Increasing GDP per capita Real GDP Population

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Poor Nations 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.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. Today, nearly 75 percent of U.S. output consists of services, not goods.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The Mix of Output The relative decline in goods production does not mean the U.S. is producing fewer goods than before. –Manufacturing and farm output has increased tremendously. –The mix of output is simply different.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The Changing Mix of Output 1800 Services Agriculture Manufacturing, mining and construction Percent of employment

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Development Patterns The transformation of the U.S. into a service economy is a reflection of our high incomes.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Today’s Mix of Output America is primarily a service economy and will become increasingly so in the future.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Today’s Mix of Output The four major uses of total output are: –Consumption –Investment –Government services –Net exports

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. WHAT America Produces Consumer Goods 71% Investment 15% State and local 12% Net exports -5% Federal 7% Government Purchases

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Consumer Goods and Services Consumer goods and services include items like breakfast cereals, movie rentals, and college education. This category of production accounts for over two-thirds of total output.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Investment Goods and Services Investment 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.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Investment Goods and Services Investment goods: –Maintain our production possibilities by replacing worn out equipment and factories. –Expand our production possibilities by increasing and improving our stock of capital.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Government Services Only that part of federal spending used to acquire resources and produce services is counted in GDP. Income transfers are payments to individuals for which no current goods or services are exchanged.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Net Exports Exports are goods and services sold to foreign buyers. Imports are goods and services purchased from foreign sources. Net Exports are the value of exports minus the value of imports.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. U.S. Exports and Imports Total $773 billion Percent of world exports 18% Exports of goods (in billions) To Japan $65 $236 $16 $165 $179 $112 To EU To Canada To Mexico To China To rest of the world Total $1223 billion Percent of world imports 19% Imports of goods (in billions) $100 $147 $393 $220 $229 $134 From China From Japan From EU From Canada From Mexico From rest of the world

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Comparative Advantage International trade allows countries to produce and export goods what they do best and import goods they don’t produce as efficiently.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Comparative Advantage Comparative advantage is the ability of a country to produce a specific good at a lower opportunity cost than its trading partners.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. How America Produces All goods and service included in GDP are produced within the borders of the United States.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Factors of Production Factors of production are the resource inputs used to produce goods and services, such as land, labor, capital, entrepreneurship.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Productivity Productivity is output per unit of input such as output per labor hour. The productivity of workers is more important than sheer numbers.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Factors of Production The high productivity of the U.S. economy results from highly educated workers using capital-intensive production processes.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Capital Stock A capital-intensive production process is one that use a high ratio of capital to labor inputs. American production tends to be capital- intensive.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Human Capital Human capital is the knowledge and skills possessed by the workforce. The high productivity of the U.S economy results from using highly educated workers in capital-intensive production processes.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The Education Gap Between Rich and Poor Nations 46% Poor countries 75% Middle- income countries 91% High-income countries 94% United States Enrollment in secondary school

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Factor Mobility Our continuing ability to produce the goods and services that consumers demand depends on our ability in reallocating resources from one industry to another.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Technological Advance Whenever technology advances, an economy can produce more output with existing resources.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Outsourcing and Trade Technology facilitates global resource use. Outsourcing allows U.S. workers to pursue their comparative advantage in high-skill, capital-intensive jobs.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Role of Government Government plays a critical role in establishing a framework in which private business can operate.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Economic Freedom and Growth GDP Growth Rate (percent per year) st (most improved) 2nd3rd4th5 th (least improved) Quintiles of Improvement in Economic Freedom ( )

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Providing a Legal Framework One of the most basic functions of government is to establish and enforce the rules of the game.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Protecting the Environment Externalities are the costs (or benefits) of a market activity borne by a third party. To reduce the external costs of production, the government limits air, water, and noise pollution and regulates environmental use.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Protecting Consumers The government protects consumers by preventing individual business firms from becoming too powerful. A monopoly is a firm that produces the entire market supply of a particular good or service.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Protecting Labor The government regulates how labor resources are use in the production process.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Striking a Balance Government interventions are designed to change the way in which resources are used. Government failure might replace market failure, leaving us no better off – possibly worse off.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. For Whom America Produces How many goods and services you get largely depends on your income.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Distribution An income quintile is one-fifth of the population, rank-ordered by income (for example, top fifth).

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Distribution 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.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The U.S. Distribution of Income

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The U.S. Distribution of Income Poorest fifth Richest fifth of population Fourth fifth Third fifth Second fifth

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Global Inequality Income disparities are greater in many other countries. Poor people in the United States receive more goods and services than the average household in most low-income countries.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. Income Share of the Rich

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved. The U.S. Economy: A Global View End of Chapter 2