When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Describe what, how, and for whom goods and services are produced in the United States. 1 Use the circular flow model to provide a picture of how households, firms, and governments interact. Describe the macroeconomic performance— standard of living, cost of living, and economic fluctuations—of the United States and other economies. 2 3

2.1 WHAT, HOW, AND FOR WHOM?  What Do We Produce? We divide the vast array of goods and services produced into: Consumption goods and services Investment goods Government goods and services Exports of goods and services

Consumption goods and services Goods and services that are bought by individuals and used to provide personal enjoyment and contribute to a person’s standard of living. For example, movies and Laundromat services. Investment goods Goods that are bought by businesses to increase their productive resources. For example, cranes and trucks. 2.1 WHAT, HOW, AND FOR WHOM?

Government goods and services Goods and services that are bought by governments. For example, missiles and bridges. Exports goods Goods and services produced in the United States and sold in other countries. For example, computers and banking services. 2.1 WHAT, HOW, AND FOR WHOM?

Figure 2.1(a) shows the relative magnitudes of the different types of goods and services in 2002: 2.1 WHAT, HOW, AND FOR WHOM? Consumption 61% Investment 13% Government 17% Exports 9%

2.1 WHAT, HOW, AND FOR WHOM? Figure 2.1(b) shows the largest five items of services produced. And the largest five items of goods produced.

2.1 WHAT, HOW, AND FOR WHOM?  How Do We Produce? Factors of production The productive resources used to produce goods and services. Factors of production are grouped into four categories: Land Labor Capital Entrepreneurship

2.1 WHAT, HOW, AND FOR WHOM? Land All the “gifts of nature” that we use to produce goods and services. All the things we call natural resources. Land includes minerals, water, air, wild plants, animals,birds, and fish as well as farmland and forests.

2.1 WHAT, HOW, AND FOR WHOM? Labor The work time and work effort that people devote to producing goods and services. Human capital The knowledge and skill that people obtain from education, on-the-job training, and work experience.

2.1 WHAT, HOW, AND FOR WHOM? Figure 2.2 shows measures of human capital and how they have changed since 1910.

2.1 WHAT, HOW, AND FOR WHOM? Capital Tools, instruments, machines, buildings, and other constructions that have been produced in the past and that businesses now use to produce goods and services. Capital includes semifinished goods, office buildings, and computers. Capital does not include money, stocks, and bonds. They are financial resources.

2.1 WHAT, HOW, AND FOR WHOM? Entrepreneurship The human resource that organizes labor, land, and capital. Entrepreneurs come up with new ideas about what and how to produce, make business decisions, and bear the risks that arise from these decisions.

2.1 WHAT, HOW, AND FOR WHOM?  For Whom Do We Produce? Factors of production are paid incomes: Rent Income paid for the use of land. Wages Income paid for the services of labor. Interest Income paid for the use of capital.

2.1 WHAT, HOW, AND FOR WHOM? Profit (or loss) Income earned by an entrepreneur for running a business. Functional distribution of income The percentage distribution of income among the factors of production. Personal distribution of income The percentage distribution of income among individual persons.

2.1 WHAT, HOW, AND FOR WHOM? Figure 2.3(a) shows the functional distribution of income: Labor income 72% Net interest income 8% Personal rental income 2% Corporate income 9 % Proprietors’ income 9%

2.1 WHAT, HOW, AND FOR WHOM? Figure 2.2(b) shows the personal distribution of income: The richest 20% earned 47% of total income. The poorest 20% earned only 5% of total income.

2.2 CIRCULAR FLOWS Circular flow model A model of the economy that shows: The circular flow of expenditures and incomes that result from decision makers’ choices and the way those choices interact in markets to determine what, how, and for whom goods and services are produced.

2.2 CIRCULAR FLOWS  Households and Firms Households Individuals or people living together as decision-making units. Firms Institutions that organize production of goods and services.

2.2 CIRCULAR FLOWS  Markets A market is any arrangement that brings buyers and sellers together and enables them to get information and do business with each other. Factor markets are markets in which factors of production are bought and sold. Goods markets are markets in which goods and services are bought and sold.

2.2 CIRCULAR FLOWS In factor markets: Households supply factors of production Firms hire factors of production. Firms supply goods and services produced. Households buy goods and services. In goods markets:  Real Flows and Money Flows

2.2 CIRCULAR FLOWS These are the real flows in the economy  Real Flows and Money Flows Money flows run in the opposite direction to the real flows.

2.2 CIRCULAR FLOWS Firms pay households incomes for the services of factors of production.  Real Flows and Money Flows Households pay firms for the goods and services they buy. These are the money flows. The blue flows are incomes. The red flows are expenditures.

 Governments We divide governments into two broad levels: Federal government State and local government Federal Government The federal government’s major expenditures are to provide: 1.Goods and services 2.Social security and welfare benefits 3.Transfers to state and local governments 2.2 CIRCULAR FLOWS

The federal government finances its expenditures by collecting taxes. The main taxes are: 1.Personal income taxes 2.Corporate (business) taxes 3.Social security taxes During the early 2000s, the federal government is spending and collecting in taxes more than $2 trillion a year—about 20 cents in every dollar earned. 2.2 CIRCULAR FLOWS

State and Local Governments State and local governments expenditures provide: 1.Goods and services 2.Welfare benefits State and local governments finance these expenditures by collecting taxes. The main taxes levied are: 1.Sales taxes 2.Property taxes 3.State income taxes 2.2 CIRCULAR FLOWS

Households and firms pay taxes and receive transfers. Governments buy goods and services from firms.  Government in the Circular Flow 2.4 CIRCULAR FLOWS

 Federal Government Expenditures Figure 2.6(a) shows federal government expenditures. 2.2 CIRCULAR FLOWS

 Federal Government Revenue Figure 2.6(b) shows federal government revenue. 2.2 CIRCULAR FLOWS

 Federal Government Expenditures and Revenue National debt The total amount that the government has borrowed to make expenditures that exceed tax revenue—to run a government budget deficit. During the early 2000s, the federal government’s budget is in deficit and the national debt is increasing. 2.2 CIRCULAR FLOWS

 State and Local Government Expenditures and Revenue The largest part of the state and local governments expenditures are on: Education Highways Public welfare benefits 2.2 CIRCULAR FLOWS

 State and Local Government Expenditures Figure 2.7(a) shows state and local government expenditures. 2.2 CIRCULAR FLOWS

 State and Local Government Revenue Figure 2.7(b) shows state and local government revenue. 2.2 CIRCULAR FLOWS

 Standard of Living Standard of living depends on: Quantities of goods and services produced Number of people who share those goods and services The greater the value of production per person, the higher is the standard of living. 2.3 MACROECONOMIC PERFORMANCE

World Population U.S. population: 287,991,639 (September 8, 2002) World population: 6,248,847, MACROECONOMIC PERFORMANCE

Classification of Countries Advanced Economies The highest living standards, 28 countries Developing Economies Not yet achieved a high standard of living, 128 countries Transition Economies Transition from state-ownership of capital to free enterprise, 28 countries. 2.3 MACROECONOMIC PERFORMANCE

Figure 2.8 shows the standard of living around the world. Average income per person ranges from $100 a day in the United States to $5 a day in Africa. 2.3 MACROECONOMIC PERFORMANCE

Unemployment and Living Standards Unemployment influences the standard of living. The harder it is to find a job, the longer is the period of unemployment. The average unemployment rate in the United States in the past 20 years has been 6 percent and it takes about 15 weeks to find a suitable job. 2.3 MACROECONOMIC PERFORMANCE

Figure 2.9 shows average unemployment rates around the world. The unemployment rate is much higher in Spain than in most advanced economies. The U.S. unemploy- ment rate is among the lowest. 2.3 MACROECONOMIC PERFORMANCE

 Cost of Living The amount of money it takers to buy the goods and services that a typical family consumes. Inflation The rising cost of living. Most countries experience inflation, but its rate varies enormously.

Figure 2.10 shows inflation rates around the world. Transition economies and Central and South America have high average inflation rates. 2.3 MACROECONOMIC PERFORMANCE

Figure 2.10 shows inflation rates around the world. The least severe inflation is in: Japan United States 2.3 MACROECONOMIC PERFORMANCE

 Economic Fluctuations Economies expand at an uneven pace and sometimes shrink for a while. These ebbs and flow are the business cycle. 2.3 MACROECONOMIC PERFORMANCE

The most recent U.S. recessions occurred in 1991 and Between these recessions, the U.S. economy expanded rapidly.

2.3 MACROECONOMIC PERFORMANCE The transition economies slumped during the 1990s. Japan stagnated. A recession occurred in Asia in 1998.