1. Chapter 6
Aggregate Incomes
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2. Chapter Outline 6.1 Inequality Around the World
6 Aggregate Incomes
Chapter Outline
6.1 Inequality Around the World
6.2 Productivity and the Aggregate Production Function
6.3 The Role and Determinants of Technology
EBE Why is the average American so much richer than the average Indian?
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3. 6 Aggregate Incomes
Key Ideas
There are very large differences across countries in income or GDP per capita.
We can compare income differences across countries using GDP per capita at current exchange rates or adjusted for purchasing power parity differences.
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4. 6 Aggregate Incomes
Key Ideas
The aggregate production function links a country’s GDP to its capital stock, its total efficiency units of labor, and its technology.
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.
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5. 6.1 Inequality Around the World
We use the two terms, income per capita and GDP per capita, interchangeably in this course:
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6. Population = 310 million persons GDP per capita = $46,613 per person
6.1 Inequality Around the World
United States in 2010
GDP = $14.45 trillion
Population = 310 million persons
GDP per capita = $46,613 per person
The data for this slide are from the Penn World Tables 7.1: National Account Data. Nominal GDP is the sum of CHUR+GCUR+ICUR+NPCUR+EXPC-IMPC.
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7. Question: How does U.S. GDP compare with GDP in Peru and Norway?
6.1 Inequality Around the World
Question: How does U.S. GDP compare with GDP in Peru and Norway?
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8. GDP = 444.46 billion nuevo sols
6.1 Inequality Around the World
Peru in 2010
GDP = billion nuevo sols
Total population = million people
GDP per capita = 15,353 sols per person
Instructor: Remind the students that this calculation is in nuevo sols rather than U.S. dollars.
The data for this slide are from the Penn World Tables 7.1: National Account Data. Nominal GDP is the sum of CHUR+GCUR+ICUR+NPCUR+EXPC-IMPC.
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9. Total population = 4.68 million people
6.1 Inequality Around the World
Norway in 2010
GDP = 2.57 trillion kroner
Total population = 4.68 million people
GDP per capita = 549,962 kroner per person
Instructor: Remind the students that this calculation is in kroner rather than U.S. dollars.
The data for this slide are from the Penn World Tables 7.1: National Account Data. Nominal GDP is the sum of CHUR+GCUR+ICUR+NPCUR+EXPC-IMPC.
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10. 6.1 Inequality Around the World
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
Instructor: Tell the student that the first method is easier to apply but the second method is more appropriate due to price differences.
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11. Peru GDP in 2010, Using Exchange Rates
6.1 Inequality Around the World
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 × $ / sol
= $5,435 per person
The data for this slide are from the Penn World Tables 7.1.
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12. Norway GDP in 2010, Using Exchange Rates
6.1 Inequality Around the World
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 × $ / kroner
= $90,744 per person
The data for this slide are from the Penn World Tables 7.1.
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13. GDP per Capita Rankings, Using Exchange Rates
6.1 Inequality Around the World
GDP per Capita Rankings, Using Exchange Rates
Ranking
Country
GDP per Capita 1
Qatar
141,845 2
Luxembourg
108,537 3
Norway
90,744 12
United States
46,613 87
Peru
5,435
189
Dem. Rep. of Congo
190
Burundi
151
191
Somalia
109
The data for this slide are computed from the Penn World Tables 7.1. Small countries with fewer than 75,000 people, like Monaco, Liechtenstein, Bermuda, and the Cayman Islands, have been removed.
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14. Prices of goods and services can vary across economies.
6.1 Inequality Around the World
There are two problems with using exchange rates to compare GDP across countries:
Prices of goods and services can vary across economies.
Exchange rates fluctuate throughout the year due to reasons beyond price changes.
Instructor: Prices of goods and services are usually lower in developing countries.
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15. GDP per capita = GDP per capita in local currency × PPP adjustment
6.1 Inequality Around the World
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
Instructor: Remind the student that the first method is easier to apply, but the second method is more appropriate due to price differences.
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16. Peru GDP in 2010, Using PPP Adjustment
6.1 Inequality Around the World
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 × $ / sol
= $9,012
The data for this slide are from the Penn World Tables 7.1.
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17. Norway GDP on 2010, Using PPP Adjustment
6.1 Inequality Around the World
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 × $ / kroner
= $59,946
The data for this slide are from the Penn World Tables 7.1.
Flash could be added to the slide so that the students have time to make the calculations themselves.
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18. 6.1 Inequality Around the World
Even though PPP adjustments raise the income levels of the developing countries, there are still very large disparities in income per capita across countries.
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19. GDP per Capita Rankings, using PPP Adjustment
6.1 Inequality Around the World
GDP per Capita Rankings, using PPP Adjustment
Ranking
Country
GDP per Capita 1
Qatar
142,876 2
Luxembourg
95,537 3
United Arab Emirates
70,899 6
Norway
59,946 12
United States
46,613 87
Peru
9,012
182
Burundi
451
183
Zimbabwe
368
184
Dem. Rep. of Congo
282
Instructor: Point out to the students how PPP adjustment raised GDP per capita for developing countries like Burundi, Democratic Republic of Congo, and especially Peru and lowered GDP per capita for rich countries like Luxembourg and Norway. The United States is the same since the PPP adjustment like the exchange rate coverts GDP to U.S. dollars.
The data for this slide are computed from the Penn World Tables 7.1. Small countries with less than 75,000 people like Monaco, Liechtenstein, Bermuda, Cayman Islands have been removed.
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20. 6.1 Inequality Around the World
Instructor: There are 19 countries with less than $1,000 per capita, including Burundi, Democratic Republic of Congo, Ethiopia, Liberia, and Zimbabwe.
There are another 23 countries with incomes between $1,000 and $2,000 per capita, including Afghanistan, Haiti, Kenya, Tajikistan, Uganda, and Zambia.
There are seven countries with incomes greater than $50,000 per capita, including Luxembourg, Macao, Norway, Qatar, and the United Arab Emirates.
Exhibit 6.1 Income per Capita Around the World in (PPP-adjusted 2005 constant dollars)
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21. Exhibit 6.2 A Map of Income per Capita Around the World
6.1 Inequality Around the World
Instructor: Reds, oranges, and yellows correspond to lower income per capita, and greens correspond to relatively high income per capita.
Exhibit 6.2 A Map of Income per Capita Around the World
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22. The age structure and labor participation rates vary across countries.
6.1 Inequality Around the World
The age structure and labor participation rates vary across countries.
These variations impact income per capita.
Therefore, we may want to consider:
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23. GDP per Capita vs. GDP per Worker
6.1 Inequality Around the World
GDP per Capita vs. GDP per Worker
Ranking
Country
GDP per Capita
GDP per Worker 1
Qatar
142,876
182,297 2
Luxembourg
95,537
101,180 3
United Arab Emirates
70,899
91,694 6
Norway
50,488
94,863 10
United States
46,613
82,359 87
Peru
9,012
13,931
182
Burundi
397
770
183
Zimbabwe
368
606
184
Dem. Rep. of Congo
282
628
Instructor: You may want to ask why Norway is higher than United Arab Emirates in GDP per worker.
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24. 6.1 Inequality Around the World
Instructor: Exhibit 6.3 with GDP per worker is similar to Exhibit 6.1 with GDP per capita.
Exhibit 6.3 Income per Worker Across Countries in (PPP-adjusted 2005 constant dollars)
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25. 6.1 Inequality Around the World
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.
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26. 6.1 Inequality Around the World
Instructor: The OECD, or Organisation for Economic Co-Operation and Development, is a group of 30 highly industrialized countries.
There is a positive relationship in that an increase in real GDP per capita (moving left to right) is associated with an increase in real GDP per hours worked (moving bottom to top).
The data is from OECD StatExtracts.
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27. relationship between income per capita (and income per
6.1 Inequality Around the World
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.
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28. 6.1 Inequality Around the World
Instructor: The graph shows a negative relationship in that an increase in real GDP per capita (moving left to right) is associated with a decrease in the poverty rate (moving top to bottom).
The World Bank estimates that a person needs on average to earn $1.25 per day to purchase the needed calories to survive.
Exhibit 6.4 The Relationship Between Poverty and Income per Capita in 2010 (PPP-adjusted 2005 constant dollars)
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29. 6.1 Inequality Around the World
Instructor: The graph shows a positive relationship in that an increase in real GDP per capita (moving left to right) is associated with an increase in life expectancy at birth (moving bottom to top).
Exhibit 6.5 The Relationship Between Life Expectancy at Birth and Income per Capita in 2010 (PPP-adjusted 2005 constant dollars)
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30. 6.1 Inequality Around the World
Instructor: The Human Development Index combines information on income per capita, life expectancy, adult literacy, and school enrollment rates.
The graph shows a positive relationship in that an increase in real GDP per capita (moving left to right) is associated with an increase in the Human Development Index (moving bottom to top).
Exhibit 6.6 The Relationship Between the Human Development Index and Income per Capita in 2010 (PPP-adjusted 2005 constant dollars)
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31. There are three reasons productivity differs across countries:
6.2 Productivity and the Aggregate Production Function
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:
Human capital
Physical capital
Technology
Instructor: Human capital is each person’s ability to produce output. Physical capital is any good, including machines and buildings, used for production. Technology is improvements in the design of production so more output can be produced with the same human and physical capital.
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32. The stock of skills embodied in labor to produce output.
6.2 Productivity and the Aggregate Production Function
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
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33. 6.2 Productivity and the Aggregate Production Function
Physical capital
The stock of business structures (plants) and equipment (machines) used for production.
Instructor: Human capital is each person’s ability to produce output. Physical capital is any good, including machines and buildings, used for production. Technology is better knowledge in production or more efficient production processes so that human capital and/or physical capital can produce more output.
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34. 6.2 Productivity and the Aggregate Production Function
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.
Instructor: Technology can be new products, like the steam engine or personal computer, or new ways to organize production, like the assembly line or just-in-time production.
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35. 6.2 Productivity and the Aggregate Production Function
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.
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36. The aggregate production function is:
6.2 Productivity and the Aggregate Production Function
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
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37. 6.2 Productivity and the Aggregate Production Function
The aggregate production function has the same two properties as the production function of an individual firm.
“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.
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38. Law of diminishing marginal product
6.2 Productivity and the Aggregate Production Function
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).
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39. 6.2 Productivity and the Aggregate Production Function
Instructor: Remind the students that the production function relates two inputs, K and H, to one output, Y. Therefore, we must hold the other input constant when we plot one input against output.
Exhibit 6.7 The Aggregate Production Function with Physical Capital Stock on the Horizontal Axis (with the total efficiency units of labor held constant)
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40. 6.2 Productivity and the Aggregate Production Function
Instructor: Remind the students that the production function relates two inputs, K and H, to one output, Y. Therefore, we must hold the other input constant when we plot one input against output.
Exhibit 6.8 The Aggregate Production Function with the Efficiency Units of Labor on the Horizontal Axis (with physical capital stock held constant)
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41. Therefore, technology will shift the production function upward.
6.3 The Role and Determinants of Technology
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.
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42. 6.3 The Role and Determinants of Technology
Instructor: As technology improves, the aggregate production function shifts upward, indicating that with the same amount of physical capital stock (or total efficiency units of labor), more output can be produced.
Exhibit 6.9 The Shift in the Production Function Resulting from More Advanced Technology
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43. Technology can be embodied or contained in H.
6.3 The Role and Determinants of Technology
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.
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44. Technology can be embodied or contained in K.
6.3 The Role and Determinants of Technology
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.
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45. 6.3 The Role and Determinants of Technology
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.
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46. 6.3 The Role and Determinants of Technology
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.
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47. 6.3 The Role and Determinants of Technology
Instructor: The number of transistors is a key determinant of how fast a computer processor is. So roughly speaking, Moore’s Law implies that computer processor power should double approximately every
2 years.
Exhibit 6.10 Moore's Law
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48. Evidence-Based Economics Example
6 Aggregate Incomes
Evidence-Based Economics Example
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.
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49. 6 Aggregate Incomes
Instructor: Columns 1–4 contain actual data and column 5 lists the hypothetical income per worker for each country if he or she had the same technology as the United States.
Exhibit 6.12 The Contribution of Human Capital, Physical Capital, and Technology to Differences in Income per Worker
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50. 6 Aggregate Incomes
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).
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51. Question: Why is the average American so much richer than the
6 Aggregate Incomes
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.
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