3. [[8 pts8 pts]] Indicate whether each of the following is counted in counted in

the U.S. GDPthe U.S. GDP for the year 2006. Explain each of your answers.

(a) The value of used textbookused textbook sold through online auction in 2006.Answer: No, it was counted the year it was produced. Because it was Answer: No, it was counted the year it was produced. Because it was not produced againnot produced again, , it would not beit would not be counted. counted. That would be double counting.That would be double counting.[2 pts: 1 pt for saying not included and 1 pt for saying not produced in 2006][2 pts: 1 pt for saying not included and 1 pt for saying not produced in 2006]

b. RentRent paid in 2006 by residents in an apartment building built in 2000

Answer: Yes, payment is being made for productive services of the Answer: Yes, payment is being made for productive services of the broker. So the purchase of stocks would not count but his work would.broker. So the purchase of stocks would not count but his work would.[2 pts: 1 pt for “yes” [2 pts: 1 pt for “yes” and and 1 pt for saying 1 pt for saying this is the payment forthis is the payment for services] services]

c. CommissionsCommissions earned in 2006 by a stockbroker

Answer: Yes, rents consist of the income received by the households andAnswer: Yes, rents consist of the income received by the households andbusinessesbusinesses that that supply property resources. supply property resources. The properties have to be maintainedThe properties have to be maintained

or “serviced” each year. or “serviced” each year. It is included in the income approachIt is included in the income approach to GDP. to GDP. [2 pts: 1 pt for “yes”[2 pts: 1 pt for “yes” and and 1 pt1 pt for saying this is the payment for services] for saying this is the payment for services]

d. The value of autos produced in 2006 entirely in South Korea by a firm fully owned by U.S. citizensAnswer: No, GDP measures production inside the U.S. regardless of Answer: No, GDP measures production inside the U.S. regardless of ownership. These autos were produced in South Korea.ownership. These autos were produced in South Korea.[2 pts: 1 pt for “not included” and 1 pt for saying produced in Korea][2 pts: 1 pt for “not included” and 1 pt for saying produced in Korea]

ECONOMIC GROWTHECONOMIC GROWTHAn increase in real GDP over timeAn increase in Real GDP per capita over time[Real GDP/population = Real GDP per capita]

•Increase in population decrease in the standard of living•Growth is a Goal [lessens the burden of scarcity]

•Main Sources of Growth•Increases in Resources•Increases in Productivity [Health, training,

education and motivation improvements]

$5,000 invested at 7 percent interest per year, will double in size in 10 years

70/ 7 = 10

Rule of 70- the time it takes a variable that grows gradually over time to double

Can only be applied to positive growthCan only be applied to positive growth

7 yrs 6 yrs 8 yrs

6

15

Productivity refers to the amount of goods and services produced from each unit of labor input.

A nation’s standard of living is determined largely by the productivity of its workers.

The inputs used to produce goods and services are called the factors of production.

The factors of production include:Physical capital (buildings and machinery)Human capital (education and training)Natural resourcesTechnological knowledge (inventions)

The factors of production directly determine productivity.

How Productivity Is DeterminedPhysical Capital- produced factor of production

and stock of equipment and structures that are used to produce goods and services.

Tools used to build or repair automobiles.Tools used to build furniture.Office buildings, schools, etc.

Human Capital- knowledge and skills that workers acquire through education, training, and experience

Natural Resources- inputs used in production that are provided by nature

Renewable resources include trees and forests.

Nonrenewable resources include petroleum and coal.

can be important but are not necessary for an economy to be highly productive in producing goods and services.

Technological Knowledge- society’s understanding of the best ways to produce goods and services. (super important)

http://www.youtube.com/watch?v=rSKS96DVx1M

Labor productivity- output/workerSustained growth in rGDP/capita occurs only when amount of output produced by the average worker increases steadily

This is the only way to measure growth, not unemployment rate

Healthier workers are more productive.

Good investments in the health of the population can lead to increase living standards.

Countries can get caught in a vicious cycle. People cannot People cannot

afford adequate afford adequate health care and health care and nutritious food.nutritious food.

People are poorPeople are poor

Why do economics focus on rGDP/capita as a measure of economic progress rather than nGDP or rGDP?

Although China and India have higher growth rates than the US, typical Chinese and Indian households are far poorer than US households, why?China and India have just begun to grow rapidly, so China and India have just begun to grow rapidly, so Chinese and Indian households have not yet caught up with Chinese and Indian households have not yet caught up with US householdsUS households

Look at a measure that rises with the standard of living Look at a measure that rises with the standard of living because the economists believe that if citizens are better because the economists believe that if citizens are better off than that’s the best measure of progress. rGDP/capita off than that’s the best measure of progress. rGDP/capita accounts for changes in population and changes in accounts for changes in population and changes in pricesprices

AGGREGATE PRODUCTION FUNCTION

Shows how productivity depends on the quantities of physical capital/worker and human capital/worker as well as the state of technology

GDP/worker= t(pc/worker) x (hc/worker)t= technology

pc= physical capital/worker

hc= human capital/worker

.4 .6

Production Function: another expressionY = A F(L, K, H, N)

Y = quantity of outputA = available production technologyL = quantity of laborK = quantity of physical capitalH = quantity of human capitalN = quantity of natural resourcesF( ) is a function that shows how the inputs are combined.

The Production Function

Setting x = 1/L, Y/ L = A F(1, K/ L, H/ L, N/ L)Y/ L = A F(1, K/ L, H/ L, N/ L)

Where:Y/L = output per workerK/L = physical capital per workerH/L = human capital per workerN/L = natural resources per worker

As the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing returns.

Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while.

In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth in these areas.

DIMINISHING RETURNS TO PHYSICAL CAPITAL

If human capital/worker and technology are fixed, each successive increase in the amount of physical capital/worker leads to a smaller increase in productivity

More expensive equipment won’t make a worker exponentially more productive

Growth accounting- estimate contribution of each major factor in the aggregate production function to economic growthAllows ability to calculate effects of greater physical and human capital on economic growth

Total factor productivity- amount of output that can be achieved with a given amount of factor inputs

MaintainingMaintainingour productionour production

possibilitiespossibilities

Expanding Productive CapacityExpanding Productive Capacity

Static Productive CapacityStatic Productive Capacity

Declining Productive CapacityDeclining Productive Capacity

increasedincreased

decreaseddecreased

No changeNo change

International differences in rGDP/capita tend to narrow over time

Catch-up effect- condition that, other things being equal, it is easier for a country to grow fast if it starts out relatively poor

Asia Increased savings Education- generate new ideas about how best to produce goods and

services, which in turn, might enter society’s pool of knowledge and provide an external benefit to others.

Technology (used technology that had already been invented by the time they were ready)

Problems (Africa and Latin America) Political instability Corruption Lack of investment Irresponsible gov’t policy eroding savings

Table 1 The Variety of Growth Experiences

Copyright©2004 South-Western

Green = free Orange = partly free Red = not free

PROPERTY RIGHTS AND POLITICAL STABILITY

Property rights refer to the ability of people to exercise authority over the resources they own.

An economy-wide respect for property rights is an important prerequisite for the price system to work.

It is necessary for investors to feel that their investments are secure.

The amounts of physical and human capital/worker are unchanged, but there’s significant technological progress, what’s the effect on the growth rate of productivity?

The amount of physical capital/worker grows, but the level of human capital/worker and technology are unchanged?

Productivity will grow, but due to diminishing Productivity will grow, but due to diminishing marginal returns, each successive increase marginal returns, each successive increase results in smaller productivityresults in smaller productivity

Positive growth rate, because of the impact Positive growth rate, because of the impact of technologyof technology

DIFFERING GROWTH RATES

Increased IIncreased importance of educationResearch and developmentRole of gov’t

Infrastructure- education, transportation, communication, and technology

Reliable banking

Encourage saving and investment. Encourage investment from abroad Encourage education and training. Establish secure property rights and maintain political stability.

Promote free trade. Promote research and development.Tax rates- too high? See Laffer CurveThe Russian government forced thousands of people to move to Siberia in order to develop the natural resources and economy of the region.

Figure 1 Growth and Investment

Copyright©2003 Southwestern/Thomson Learning

(a) Growth Rate 1960–1991 (b) Investment 1960–1991

South Korea

Singapore

Japan

Israel

Canada

Brazil

West Germany

Mexico

United Kingdom

Nigeria

United States

India

Bangladesh

Chile

Rwanda

South Korea

Singapore

Japan

Israel

Canada

Brazil

West Germany

Mexico

United Kingdom

Nigeria

United States

India

Bangladesh

Chile

Rwanda

Investment (percent of GDP)Growth Rate (percent)0 1 2 3 4 5 6 7 0 10 20 30 40

00

100100

m m

n

l

Tax revenue (dollars)Tax revenue (dollars)

Tax

rat

e (%

)T

ax r

ate

(%)

MaximumMaximumTaxTax

RevenueRevenue

Tax rate (percent)0 100b

b

ca

Maximum Tax Revenue

President Reagan said that after WWII, when he started making big money, that he could do 4 movies before making$200,000 and hitting the top marginal tax rate of 91%. After four, he would quit making movies until the next year.

For rich peoplerich people, this was a disincentive to keep workingdisincentive to keep working, , so they would quitso they would quit when they hit the top marginal tax rate. For most workersmost workers, this was not the casenot the case.

RReaganeagan

Tax

rev

enu

e (d

oll

ars)

Country Per CapitaLLuxembourguxembourg 80,800 80,800QatarQatar 75,90075,900BermudaBermuda 60,00060,000NorwayNorway 55,60055,600KuwaitKuwait 55,30055,300U.A.E.U.A.E. 55,20055,200U.S.U.S. $46,000 $46,000IrelandIreland 45,60045,600Hong KongHong Kong 42,00042,000SwitzerlandSwitzerland 39,80039,800IcelandIceland 39,40039,400CanadaCanada 38,20038,200AustraliaAustralia 37,50037,500DenmarkDenmark 37,40037,400

China and India are still poorer than he U.S. was in 1900.China and India are still poorer than he U.S. was in 1900.7575% of % of Africans live on less than $2 a day Africans live on less than $2 a day & it is& it is getting worse. getting worse.

Country Per CapitaSweden 36,900U.K. 35,300Germany 34,400France 33,800Japan 33,800Italy 31,000Australia 24,000Russia 14,600Mexico 12,500China 5,300Swaziland 4,800Liberia 500Zimbabwe 500Congo, Rep of 300

GDP Per CapitaGDP Per Capita[in 1992 dollars][in 1992 dollars]

TThe he PoorestPoorest NationNationssNation Nation Per CapitaPer Capita1.1. Congo, Rep. ofCongo, Rep. of$300$3002.2. ZimbabweZimbabwe $500$5003.3. LiberiaLiberia $500$5004.4. SomaliaSomalia $600$6005.5. EthiopiaEthiopia $700$7006.6. NigerNiger $700$7007.7. Cen. African Rep.Cen. African Rep. $700$7008.8. Gambia, TheGambia, The $800$8009.9. Sierra LeoneSierra Leone $800$80010.10. MalawiMalawi $800$800 DjiboutiDjibouti $1,000$1,000

There are 6.6 billion people on our planet; 5 b5 billion illion are are in thein the Third ThirdWorldWorld. 2.5 billion2.5 billion live on less than $2 a dayless than $2 a day. The direst povertydirest poverty is in AfricaAfrica, home of the world’s 10world’s 10 poorest countriespoorest countries. Over ½½ the people of Sub-Sahara Africathe people of Sub-Sahara Africa live on less thanless than $2 a day$2 a day.

8 million people die each year because they are too poor to stay alive.8 million people die each year because they are too poor to stay alive.

$6,538$6,538

19291929

$15,931$15,931

19671967

$25,989$25,989

19961996

$46,000$46,000

20072007

½ of the world’s ½ of the world’s population have population have yet to yet to make theirmake their first phone call.first phone call.

Sustained growth- continuing in the face of limited supply of resources and impact on environmentMalthus- population will grow geometrically while resources will grow arithmetically Stretch natural resources

Dilute capital stock

Technology: What is missing?Radios: 1, Telephones: 0, Televisions: 1, VCRs: 0, Cars: 0

No running water, sink, or bathroom! Most Valued Possession – the T.V. Interesting Details – kids must walk 3 hours to get to and from school each day kids work 21 -28 hours a week

Technology: What is missing?Radios: 1, Telephones: 0 Televisions: 0, Cars: 0Why they don’t have a TV? (No electricity. They have never seen a TV.)

Most Valued PossessionsYou can’t see them, but can you guess what they are?Religious books (parents, 1st daughter) Schoolbooks (1st son) Jump-rope (1st daughter)

Technology: What is missing?Radios: 2, Telephones: 0, Televisions: 1, Cars: 0No washing machine: The women wash clothes in the pond! No bathroom: They have two outhouses.

Most valued possession: bicycle

Technology: What is missing?Radios: 5, Telephones: 4, Televisions: 2, VCRs: 0, Stereos: 3, Cars: 2

Most valued possession: sailboat

Technology: What is missing?Radios: 0, Telephones: 0, Televisions: 0, VCRs: 0, Cars: 0 (No electricity, running water, or bathroom.)

Most valued possession: none80% of their income is spent on food –

breakfast ic, potaoes, fish and coffee, lunch is only potatoes, they do not eat dinner

Technology: What is missing?Radios: 1, Telephones: 1, Televisions: 1, VCRs: 1, Cars: 1

Most valued possession: family and children

Technology: What is missing?Nothing is missing! Radios: 3, Telephones: 1, Televisions: 1, Cars: 1, VCRs: 1, Microwave ovens: 1, Computers: 1

Most valued possession: family and heirloom ring and pottery

Technology: What is missing?Radios: 4, Telephones: 5, Televisions: 2, VCRs: 2, Computers: 1, Cars: 4

Size of Home 4850 sq. ft. houseTheir home is the one with a satellite dish on the roof and a refrigerator in the carport. Living room, sitting room, dining room, kitchen, 4 bedrooms, 4 bathrooms. Office, indoor swimming pool, and servants’ quarters.

Technology: What is missing?Radios: 1, Telephones: 0, Televisions: 0, VCRs: 0, Bicycles: 1, Cars: 0 (They have no electricity. No running water, no kitchen sink, no bathroom.)

Most Valued PossessionBicycle (Father)What do you suppose they wish for in the future?(An irrigation system for their garden. An enclosed garden. A motorcycle.)

Technology: What is missing?Radios: 1, Telephones: 0, Televisions: 1, VCRs: 1, Stereos: 2, Cars: 0Why do they have big bottles of water?(They have running water. The city runs water lines to the street. Every family runs a garden hose from the street water main into their apartment.)

Most valued possession: T.V.

Technology: What is missing?Radios: 2, Telephones: 2, Televisions: 2, VCRs: 0, Stereos: 1, Cars: 1

Most valued possession: mother (after the picture was taken, the father was murdered, so the mother takes care of the family alone)

What do you suppose they wish for in the future?(The mother hopes to repair her car. Cost of repairs: $2,500)

Technology: What is missing?Radios: 1, Telephones: 0, Televisions: 1, VCRs: 0, Cars: 0, Motorscooters: 1 (No bathroom or running water: Mom washes in rubber tubs.)

Most Valued Possessions: Motorscooter