| CHAPTER OUTLINE |
1. Describe what, how, and for whom goodsand services are produced in the United States.
A. WhatDo We Produce?
1. Consumption Goods and Services
2. Capital Goods
3. Government Goods and Services
4. Export Goods and Services
B. HowDo We Produce?
1. Land
2. Labor
3. Capital
4. Entrepreneurship
C. ForWhom Do We Produce?
1. Rent
2. Wages
3. Interest
4. Profit (or Loss)
2. Describe what,how, and for whom goods and services are produced in the global economy.
A. The People
B. The Countries
1. AdvancedEconomies
2. EmergingMarket and Developing Economies
C. Whatin the Global Economy?
1. WhereIs the Global Pie Baked?
2. SomeDifferences In What Is Produced
3. SomeSimilarities In What is Produced
D. How in the GlobalEconomy?
1. HumanCapital Differences
2. PhysicalCapital Differences
E. For Whom in the GlobalEconomy?
1. PersonalDistribution of Income
2. InternationalDistribution
3. AHappy Paradox and a Huge Challenge
3. Use thecircular flow model to provide a picture of how households, firms, andgovernments interact in the
A. Households and Firms
B. Markets
1. Goods Markets
2. Factor Markets
C. Real Flows and Money Flows
D. Governments
1. FederalGovernment
2. Stateand Local Government
E. Governments in the CircularFlow
F. Federal GovernmentExpenditures and Revenue
F. State and Local GovernmentExpenditures and Revenue
G. Circular Flows in the Global Economy
1. International Trade
2. International Finance
n What’s New in this Edition?
Chapter 3 is an updated version ofChapter 2 in the fifth edition. The overview of differences and similarities inwhat is produced in advanced and developing economies in Section 2.2 has beenrewritten with new headings.
n Where We Are
In Chapter 2, we describe what, how, and for whom goods and servicesare produced in the
n Where We’ve Been
In the previous chapter, we covered thedefinition of economics and distinguished between microeconomics andmacroeconomics. We described what economists do and some of the problems theyencounter. In addition, we explored the four core ideas that define the wayeconomists think about macroeconomic questions. Finally, we explained why economicsis worth studying.
n Where We’re Going
In the next chapter, we develop our firsteconomic model, the production possibilities frontier. We use the model to illustratesome of the concepts that have been developed in Chapters 1 and 2, such as the“what” question, the “how” question, and opportunity cost.
IN THECLASSROOM
nClass Time Needed
The materialin this chapter should be covered in no more than one class session.
An estimate of the time per checklisttopic is:
· 2.1 What, How, and for Whom?—15to 20 minutes
· 2.2 The Global Economy—15 to20minutes
· 2.3 The Circular Flows—20 minutes
Classroom Activity: Part of this chapterfocuses on the standard of living that we enjoy. As an icebreaker you mightwant to poll students by asking them what they believe are some of the mostimportant achievements since 1900 that have helped raise the standard of livingof Americans and people around the world. You could give students two minutesin class to compose a list of about ten items. Make sure to tell them thatthere really are no right or wrong answers. The only requirements are that theitems were introduced (not necessarily invented) in the twentieth century andhad some impact on our standard of living. When time is up, have students sharewith you their items and merge them with a list of your own. As an aid, here isa short list that might prove useful:
Electricity, Automobile,Airplane, Radio, Television, Telephone, Air conditioning, Computer, Highways, Spacecraft,Internet, Refrigeration, Laser and fiber optics, Nuclear power
Discussion of this listcould center around a number of issues. First, it will allow you the opportunityto get students to question the mainstream view that an increase in thestandard of living depends only on the quantities of goods and servicesproduced and the number of people among whom those goods and services areshared. Point out that official measurements of standard of living around theworld focus on average income earned per day. As a standard benchmark, thesedata are extremely useful, but they do hide some very important information,namely the quality of goods and services. You could pick any number of items onthis list and ask students what kinds of advancements have occurred that makethe good or service better. The automobile will likely be a favorite. Here is ashort list of some of the advancements of the modern automobile: airbags, 5m.p.h. bumpers, fuel injection (instead of carburetors), safety glass, seatbelts, window defrosters, global positioning systems, radio, television,compact disc players, climate control systems, four-wheel drive, anti-lockbraking systems, power steering, power brakes, power seats, power locks,daytime running lights, side crash severity sensors, and cruise control.Students will probably have a ball talking about all that has changed with thepersonal computer.
Classroom Activity: You can generate some discussion by getting the students to thinkabout what life might be like after another 200 years of economic growth. Providesome numbers: In 2011, income per person in the United States was about $100 aday. In 1811 it was about 70¢ a day, and if the past growth rate prevails foranother 200 years, in 2211 it will be $14,000 a day. Emphasize the magic ofcompound growth. If they think that $14,000 a day is a big income, get them todo a ballpark estimate of the daily income of Bill Gates (about $14 million!) Encourage a discussion of whyscarcity is still present even at these large incomes.
Classroom Activity: After introducing the factors of production, break students intosmall groups and ask them to select a specific good. Then ask them tobrainstorm a detailed list of every factor of production they can identify thatwas used to produce that good and break this list into the 4 categories. Thisshould help students apply their new understanding of the factors of productionand become capable of distinguishing between the 4 categories of factors ofproduction. Moreover, this exercise should also give students a betterappreciation of the complexity of the factors of production for each good towhich they are exposed. No matter how thorough they believe they are inidentifying the factors of production for the good they chose, they will haveundoubtedly left off various inputs that you can help them identify. But don’tfool yourself – even given a few minutes, you will likely just be scratchingthe surface of the factors of production for even the most “simple” of goods.
CHAPTER LECTURE
n 3.1 absolute advantage
What Do We Produce?
Goodsand services produced are divided into four categories:
· Consumption goodsand services are items that are bought byindividuals and used to provide personal enjoyment and contribute to a person’squality of life. Consumption goods and services account for about 61 percent oftotal production.
· Capital goods are goods that are bought by businesses to increase theirproductive resources. Capital goods account for about 11 percent of totalproduction.
· Government goods andservices are items bought by governments. Governmentgoods and services account for about 17 percent of total production.
· Export goods andservices are goods and services produced in onecountry and sold in other countries. Exported goods account for about 11percent of total production.
How Do We Produce?
Goodsand services are produced using four factorsof production: land, labor, capital, and entrepreneurship.
· Land is the “gifts of nature” or natural resources, which includes notonly land in the everyday sense but also minerals, energy, water, air, wildplants, animals, birds and fish.
· Labor is the work time and work effort that people devote to producinggoods and services. Human capital is the knowledge and skills that people obtain from education,on-the-job training, and work experience.
· Capital consists of the tools, instruments, machines, buildings, and other itemsthat have been produced in the past and that businesses now use to producegoods and services. Capital does not include financial capital likemoney, stocks, or bonds.
· Entrepreneurship is the human resource that organizes labor, land, and capital to producegoods and services. Entrepreneurs make business decisions and bear the risksthat arise from these decisions.
Lecture Launcher: To help make the ideaof “factors of production” more tangible, ask the students to think about whathome-based business they could start right now. (baking, web site creation,cleaning houses, catering, babysitting, mowing lawns…) They should make a listof the factors of production they currently possess and classify them accordingto land, labor, capital, and entrepreneurship. For example, one student mightsuggest that “I could be a caterer.” This student could then list for the factorsof production:
1. Land:I own the land my house is on, I could grow food products on it.
2. Labor:I own my own labor power
3. Capital:I own a kitchen, sink, refrigerator, phone, etc. I know how to cook (human capital)
4. Entrepreneurship:I know how to organize my efforts and promote them.
qLand Mine: When you write the four productive resources on the board (land,labor, capital, and entrepreneurship) the greatest challenge is to get studentsto think “out of the box.” Students often take each of the terms too literally.For instance, when economists use the term land, it is important to emphasizethat this term encapsulates allnatural resources, not just the obvious area of land in terms of acres orplots. “Land” also includes water, oil, and other important and strategicminerals.
Labor refers to human labor. There is anatural tendency for students to think of the entire population and the laborforce as synonymous. Take care to mention that the labor force includes notonly people who are working but also people who are unemployed and activelyseeking work. In addition, it is worth mentioning that the size of the laborforce can change from increases in population and also from changes in demographics.
Capital is usually not a concept that isdifficult for students to grasp. However, it is sometimes confused withfinancial capital. Point out that unless economists specifically say “financialcapital,” they are invariably referring to physical capital such as factories,machines, and equipment. Inform them that financial capital is a term that isused in business to refer to cash, loans, stocks, and bonds.
Lastly is the termentrepreneurship. While the obvious icon here is that of a business person whois responsible for bringing together all the other factors of production, it isworth noting that the most important characteristic of an entrepreneur is thatof being a risk taker. Explain that risk taking is a trait that is quite scarcein supply. If students ask for proof, merely ask them what most people do for aliving. The answer is that they work for someone else. The very act of being anemployee involves a certain implicit preference of risk aversion.
For Whom Do We Produce?
· Rent is paid for the use of land, wages are paid for the services of labor, interestis paid for the use of capital, andentrepreneurs receive a profit or incur a loss.
· The functionaldistribution of income is the distribution ofincome among the factors of production. In the United States in 2010 laborreceived 69 percent of total income.
· The personaldistribution of income is the distribution ofincome among household. In the United States in 2010 the richest 20 percent of householdsearned 51 percent of total income and the poorest 20 percent of households earnedonly 3 percent of total income.
· The distribution of income isconstantly changing and is becoming increasingly unequal.
People: The world population was approximately 6.9 billion as of June 5, 2011.
Countries: The International Monetary Fund classifies the 175 economies into two broad categories:
· Advanced economies. These are the 29countries (or areas) that have the highest standard of living. Included in thislist are the
· Emerging market anddeveloping economies.The emerging market economies are the 28 countries in Europe and Asia thatwere, until the early 1990s, part of the Soviet Unionor its satellites and today are moving toward market-based economies. The developingeconomies are the 118 countries in Africa, Asia, the Middle East, Europe, andCentral and South America that have notachieved a high standard of living. More than 5 billion people live in thesenations.
What in the Global Economy?
Where is the global pie baked?: The advanced economies produce 53 percent of the world’s total production, including 20 percent in the United States.
Some differences in what is produced: Developing economies have large and growing manufacturing industries. Agriculture accounts for a small percentage of total production within advanced economies and a large percentage of total production within developing economies. Even so, advanced economies produce about 33 percent of the world’s total agricultural output. The contrast between the share of production of agriculture and the total production results because total production is much larger in advanced economies.
Some similarities in what is produced: Other advanced economies often have similar stores and brands as those in the United States. Services are the most rapidly growing sector in advanced economies, while agriculture and manufacturing are declining as a share of total production.
How in the Global Economy?
Goods and services are produced using land, labor, capital, and entrepreneurship, and the combination of these resources used are chosen to produce at the lowest possible cost.
Human capital differences: Levels of education, training, and experience are higher in advanced economies than in developing economies, meaning human capital will play a more important role in production in advanced economies.
Physical capital differences: The more advanced the economy, the greater are the amount and the level of sophistication of the capital equipment used in production. While select regions and industries in developing economies may have advanced technology and capital, it is not nearly as widespread as in advanced economies.
For Whom in the Global Economy?
Personal distribution: The distribution of income in the global economy is quite unequal—the lowest-paid 20 percent of the world’s population receives 2 percent of world income and the highest-paid 20 percent receives 70 percent of world income.
International distribution: The U.S. has an average income of $129 a day, Canada is $126 a day and Japan is $116 a day. Average incomes in the UK and Euro zone are about 80 percent of U.S. income. Africa has an average income of only $4 a day and India is about $3 a day.
A happy paradox and a huge challenge: Despite rising inequality within most countries, inequality in the world income has decreased during the past 20 years because incomes in China and India, both heavily populated and poor nations, have grown rapidly. Lifting Africa from poverty remains one of today’s biggest challenges.
Lecture Launcher: Students tendto think in terms of individuals when they think about standards of living. Irecommend that you start there and then try to develop a kind of “nationalaverage” by making a list. Have students suggest things that they think areconsidered basic necessities to the “average” American family: airconditioning? Automobile? Electric refrigerator? Hot and cold running water?Indoor plumbing? Cell phone? Internet? From there, you can ask if these goodsand services would be necessities in a developing economy.
Let’s now more away from the world of the hunter-gatherer and intothe dinnerware market.So let’s say we’re going to talk about two products twotypes of dinnerware.We’ll have cups on this axis And let’s say we have aproducer,charlie and if he were to focus all of his time on cups,he couldproduce,let me put these(labels)10,20,30.So if he were to focus all of his timeon cups,he could produce 30 cups,and if he were to focus all of his time onplates he could produce 10 plates.And we’re going to assume he has a linearPPF.So,this is what his PPF is going to look like.We draw a little bit,actuallycomect the 2 dots,So that’s dots I want to make it more looking like a line,sothat’s about as good as I can do.So that right over there is the PPF forCharlie.Now let’s his opportunity cost does not change.The slope of his line isnot changing.It’s not that bow-shaped carve that we saw for thehunter-gatherer.So it’s going to be a fixed opportunity cost for one productrelative to the other at any point along this PPF.So let’s say we’re sittingover here,this will just make things simple to just think about the endpoints,and he’s producing 30 cups,what is his opportunity cost of producing 10plates?Well to produce 10 plates,he’s going to have to give up those 30 cups.Orif you want the OC for one plant,you just divide both sides by 10and so you getthe OC of 1 plates equal to 3 cups,That’s fair enough.Now,let’s think about thesame S’(1:54)or let’s think about another producter,in this marbet for dinnerware.Let’scall her Party.If Patty focused all of her time on cups he could produce 10cups in a day,and if she focused all of her time on plants,he could produce 30plants in a day.SO that is Patty and she also has a line or PPF,so that rightover there is the PPF for Patty.And let’s think about her OC for producing aplate.So the OC,if she’s sitting right over here,and she was focused all oncups,and if she wanted to produce 30 plates and I’m intentionally suing the endpoints to make the match more do vious.If she wanted to produce 30 plates thenshe would have to give up 10 cups.So her OCs to produce 30 plates is equal to10 cups.Or if you divide both sides by 30,the OC of her producing 1 plate in ofcups,is 10 divided by 30,is ⅓,⅓of a cup.Now,this is interesting,we can nowconpare their relative OC.The OC for Charlie to produce a plate is 3 cups,theOC for Patty to produce a plate is ⅓ of a cup.So for Patty,especially when youmeasure it in terms of cups,it is cheaper for her to produce a plate.She has alower OC than Charlie does in producing plates.So relative to Charlie,we saybecause her OC is lower in producing plates,⅓ relative to 3.We say that Pattyhas the comparative advantage in plates relative to Charlie.And it’s not justbecause she can produce.We’ll see situations in maybe the next class where we’llactually show this.It doesn’t even have to be the case that she can producesmore plates in a given day.This is not why she has a comparative advantage.Thisis called an absolute advantage and we’ll talk about that more she hascomparative advantage because her OC is cover.
Now let’s think about it the other way around.Who has a comparativeadvantage in cups?Well,let’s swap both sides.So the OC for Charlie of producing3 cups,is equal to 1 plate.Or if you divide both sides by 3.OC if 1 cup is ⅓ of9 plate.If we go to the situation for Patty.Let’s swao these 2 around,the OCfor 10 cups is 30 plates.If you divide both sides by 10,the OC of 1 cup,isequal to 3 plates.And obviously,and we’ve talked about this before,the OC of 1incremantal unit is the same thing as the marginal cost of a cup.But anyway,who has the lower OC for producing cups?Well,let’s see,Charlie can producea cup,or Charlie’s OC for producing an extra cup,is ⅓ of a plate and Patty’s is 3 plates.So Charliehas the lower OC for producing a cup.So it’s only ⅓ plate relative to 3plates.So this is where Charlie has the comparative advantage.What we’re goingto see is if both of these parties specialize in their comparative advantageand then trade,they can get outcomes that are beyond,each of their individualPPF.So what we can see is,for example they can get an outcome where they areeach able to get 15 cups and 15 plates,which would have been impossible left totheir own devices.So let’s see how they can actually do it.So we’ve said thatCharlie has a comparative advantage in cups.His OC of producing a cup is lowerthan it is for Patty.It’s only ⅓ of a plate relative to 3 plates(6:14)So let’smake him specialize in cups.So cups specialties.So he’s going to specialize incups,and Patty for the same reason,is going to specialize in plates.So Charliespecializing in cups means he’ going to focus only on cups.So he’s going toproduct 30 cups everyday.And Patty specializing in plates means that she’sgoing to produce 30 plates every day.Let me do this in a different colorCharlie magenta.She’s going to produce 30 plates every day.Now imagine,I’mgoing to make an assumption here,but imagine that they both do that but theydon’t each only want to have what they’re producing,they want to have some talk more about markets in the future.But Iassume that they agree to trade at 1 cup for 1 plate.And this makes sense foreither of them,because this trading price,or this market price is lower thantheir OC.So here’s Charlie he’s got all of these cups left to his owndevices,if he wanted an extra plate,he would have to spend 3 cups bu now in the market,with this price over here,heonly has spend 1 cup for an extra plate.So this makes sense for him because themarket price is lower than his OC.So he would definitely rather get a plate inthe market.(7:41)than have to do it by producing it himself.It’s cheaper thisway.And the same thing for Patty.She has all of these plates,but if she wants acup,left by herself,she would have to spend 3 plates to do it.She would have togive up 3 plates.But now in the mark,she would only have to give up 1 plate.Sothis is a good deal,this is timer than her OC.So she’ll want to transact.And sothey can do,each of them so for example,Charlie could keep trading cups forplates and he could end up anywhere on this line over there.And Patty couldactually do the same thing.She could trade the cups for plates and end upsomeplace over there.But obviously where they end up is dependent on how muchthe other one is willing to trade.But let’s say that they both want to get tothat 15-15S’.So they can both trade 15 cups,the other person.So Charlie couldtrade 15 cups for 15 plates and obviously Patty would be trading 15 plates for15 cups.And they would both be able to get right over there.Which is asituation that was unattainable left to their own production possibilities.Sohopefully you found that interesting.By specializing they could get these gainsof trade.They specialize in their comparative advantage.
