Introduction to Economic Analysis Chapter 4 The US Economy

Chapter Economy An important aspect of economics is economic statistics , and an army of economists collects and analyzes these statistics . This chapter presents an overview of the economic activity of the United States . How much do you need to know about these statistics ?

It would be ridiculous to memorize them . At the same time , it would be undesirable to be ignorant of how we are changing and how we are not . Basic Demographics LEARNING OBJECTIVE Who lives in the United States ?

There are about 300 million people in the United States , up from 76 million in 1900 . Figure US . URL books 54 Population ' 36 ' Year During the last century , the population has become primarily an urban population , growing from 40 to 80 urban . The population is primarily white , with 12 African American and classified as other . These proportions are relatively stable over the century , with the white population falling from 89 to 83 . The census is thought to understate minority populations because of greater difficulties in contacting minorities . The census does not attempt to classify people but instead accepts people descriptions of their own race . Figure US . and URL , org books 55

. Urban ( 1900191019201930194019501960197019801990 2000 The population has been aging , with the proportion of seniors ( over 65 Percent years of age ) tripling over the past century , and the proportion of young people dropping by over . Indeed , the proportion of children between and years old has dropped from of the population to under . Figure ' II pI ' ago ( Percent 200 ) I I I I I I I I I I I 1900 1910 1930 1940 1950 1960 1970 1980 1990 2000 The baby dramatic increase in births for the years visible in as the population in the age group begins increasing in 1950 , peaking in 1970 , and then declining significantly as the baby boom moves into the to bracket . URL books 56

There is a slight echo of the baby boom , most readily seen by looking at the age bracket . Figure undo ! ago Percent , ego , ebb , 90 690 The aging of the American population is a consequence of greater life expectancy . When social security was created in 1935 , the average American male lived to be slightly less than 60 years old . The social security , which didn start until age 65 , thus were not being paid to a substantial portion of the population . Figure US . ul biz ! URL books 57

' i , 057 White Male i i White Female if 33 Nonwhite Male Nonwhite Female ' I ( I This graph shows life expectancy at birth , thus including infant mortality . The significant drop in life expectancy in nearly 30 years old for primarily a consequence of the great , which killed about of the people who contracted it and killed more Americans in 1918 than did World War I . The Great Depression ( also reduced life expectancy . The steady increase in life expectancy is also visible , with white females now living 80 years on average . Figure US . by continent ' URL books

Europe Asia Latin Am Total 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 It is said that the United States is a country of immigrants , and a large fraction of the population had ancestors who came from elsewhere . Immigration into this United States , however , has been increasing after a long decline , and the fraction of the population that was born in foreign countries is about 11 in nine . Figure origin Germany , Ireland , Italy , Norway , Sweden , Soviet Union , Other , UK , China , Canada , Africa , Caribbean , Mexico , URL books 59

The majority of immigrants during this century came from Europe , but immigration from Europe has been declining for most of the century , while immigration from Asia and Latin America has grown substantially . The graph the total origin data over the century to identify the major sources of immigrants . One hears a lot about divorce rates in the United States , with statements like Fifty percent of all marriages end in Although it has grown , the divorced population is actually a small fraction of the population of the United States . Figure Male ( Never Married Married Widowed Divorced Percent 2000 Figure Female status ( Never Married Married Widowed Divorced Percent I I I I I I I I 1900191019201930194019501960197019801990 2000 Marriage rates have fallen , but primarily because the never married category has grown . Some of the never married probably represent unmarried couples , since the proportion of children from unmarried women has risen fairly dramatically . Even so , URL books so

marriage rates are greater than they were a century ago . However , a century ago there were more unrecorded and marriages than there probably are today . Figure Biz ! lo ) I ( Ol ' While we are on the subject , however , the crisis in teenage pregnancies 1991 1994 1997 2000 doesn appear to be such a crisis when viewed in terms of the proportion of all births that involve a teenage mother , illustrated in the graph below . Figure Biz ! or less ( 25 ' 15 ' 10 1940 1943 1946 949 952 955 958 961 964 1967 970 973 976 979 982 985 991 997 2000 URL books 51

KEY TAKEAWAYS No one in his or her right mind memorizes the takeaways of this chapter the goal is to have a sense of one nation . There are about 300 million people in the United States , up from 76 million in The population has become primarily an urban population , growing from 40 to 80 urban in the past century . The population is primarily white , with 12 African American . The population has aged , with the proportion of seniors ( over 65 years of age ) tripling over the past century , and the proportion of young people dropping by over . The baby boom was a dramatic increase in births for the years 1946 to The aging of the American population is a consequence of greater life expectancy . About 11 of Americans were born in foreign countries . The divorced population is about 10 . Marriage rates have fallen , but primarily because the never married category has grown . Education LEARNING OBJECTIVE Who goes to school and how much ?

Why are the Western nations rich and many other nations poor ?

What creates the wealth of the developed nations ?

Modern economic analysis attributes much of the growth of the United States and other developed nations to its educated workforce , and not to natural resources . Japan , with a relative scarcity of natural resources but a highly URL books 62 educated workforce , is substantially richer than Brazil , with its abundance of natural resources . Figure in yours ( I I I I ' Just less than 85 of the population completes 12 years of schooling , not counting kindergarten . Not all of these students graduate from high school , but they spend 12 years in school . The proportion that completes only or fewer years of elementary school has dropped from about one quarter of the population to a steady . At least years of university now represents a bit more than one quarter of the population , which is a dramatic increase , illustrated in Figure Educational attainment in years ( percentage of population ) Slightly fewer women ( 25 28 ) complete years of university , although women are more likely to complete years of high school . Graduation rates are somewhat below the number of years completed , so that slightly less than three quarters of the population actually obtain their high school degree . Of those obtaining a high school degree , nearly half obtain a university or college degree . Figure rules ( URL books 63

There are several interesting things to see in Figure Graduation rates ( percentages ) First , high school completion dropped during World War II ( but rebounded afterward . Second , after World War II , college graduation spiked when many soldiers were sent to university by the government under a program called the GI As the number of high school students rose , the portion of high school graduates going to university fell , meaning that a larger segment of the population became high school educated . This increase represents the creation of the middle class previously , high school completion and university attendance was in large part a sign of wealth . The creation of a large segment of the population who graduated from high school but didn attend university led to a population with substantial skills and abilities but no inherited wealth and they became the middle class . High school completion has been declining for 30 years . This is surprising given the high rate of financial return to education in the United States . Much of the reduction in completion can be attributed to an increase in General Education Development ( GED ) which is a program that grants diplomas ( often erroneously thought to be a General Equivalent Degree ) after successfully passing examinations in subject URL , org books 64

areas . Unfortunately , those people who obtain GED are not as successful as high school graduates , even marginal graduates , and indeed the GED certification does not seem to help students succeed , in comparison with high school graduation . KEY TAKEAWAYS An estimated 85 of the population completes 12 years of schooling , not counting kindergarten . One quarter of the population completes at least years of university . High school graduates comprise the bulk of the middle class . High school completion has been declining for 30 years . This is surprising given the high rate of financial return to education in the United States . Households and Consumption LEARNING OBJECTIVE . How much stuff do we have ?

There are approximately 100 million group of people sharing living the United States . The number of residents per household has consistently shrunk during this century , from over four to under three , as illustrated in Figure Household occupancy . Figure ( I I I I I I I I 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 URL books 55

The shrinking size of households not just a reduction in but also an increase in the number of people living alone as illustrated in Figure Proportion of households by type . More women live alone than men , even though four times as many families with a single adult member are headed by women . This more women both living on their own and living with children and no partner , even though there are about the same number of men and women accounted for by the greater female longevity already noted . Figure 100 90 80 i 70 60 50 40 Male 30 Single Female 20 10 1947 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2001 2002 Where do we live ?

About 60 of households live in detached homes , meaning houses that stand alone . Another or so live in attached houses , such as row Slightly over live in mobile homes or trailers , and the remainder live in housing , including apartments and . About two thirds of American families own their own homes , up from 43 in 1940 . Slightly less than of the population is incarcerated in state and federal prisons , as illustrated URL books 66

in Figure Percentage of incarcerated residents . This represents a fourfold increase over 1925 to 1975 . Figure ( No ?

99 No ?

39 Ten percent of households do not have an automobile , and have a telephone . called land line telephones may start to fall as apartment dwellers , especially students , begin to rely exclusively on cell phones . Just under 99 of households have complete plumbing facilities ( running water , bath or shower , toilet ) up from in 1940 . How much income do these households make ?

What is the distribution of income ?

One way of assessing the distribution is to use to measure dispersion . is one , or 20 , of a group . Thus the top income quintile represents the top 20 of income earners , the next represents those ranking 60 , and so Income shares for three shows the earnings of the top , middle , and bottom . Figure ( URL books 67

60 Lowest 50 , Middle Highest 40 30 20 10 a , Neg ) 86 ?

303 Figure Family income , A , IL ! 30 ) 90 ) The earnings of the top quintile fell slightly until the late , when it began to rise . All other lost income share to the top quintile starting in the . Figures like these suggest that families are getting poorer , except for an elite few . However , families are getting richer , just not as fast as the top quintile . Figure Family , cumulative change URL books 58

250 200 150 100 50 I on ( LO LO 50 ?

Figure Family income shows the income , adjusted for to be in 2001 dollars , for families at various points in the income spectrum . For example , the 60 line indicates families for whom 40 of the families have higher income , and 60 have lower income . Incomes of all groups have risen , although the richer families have seen their incomes rise faster than poorer families . That is readily seen when percentage changes are plotted in Figure Family income , cumulative percentage change . Real income gains in percentage terms have been larger for richer groups , even though the poor have also seen substantially increased incomes . If the poor have fared less well than the rich in percentage terms , how have African Americans fared ?

After World War 11 , African American families earned about 50 of white family income . This ratio has risen gradually , noticeably in the after Rights that prohibited segregation based on race in schools , public places , and is credited with integrating workplaces throughout the southern United States . African American family income lagged white income growth throughout the but has been rising again , a trend illustrated Black family income as a percentage of white income . Figure Blur ( I ?

as ( URL books 69 70 60 50 40 30 20 10 ) These income measures attempt to actually measure purchasing power , and thus adjust for . How much will buy ?

This is a complicated question , because changes in prices aren goods get relatively cheaper , while others become more expensive , and the overall cost of living is a challenge to calculate . The price index typically used is the consumer price index ( a price that adjusts for what it costs to buy a standard bundle of food , clothing , housing , electricity , and other items . Figure Consumer price index ( 1982 100 ) shows the over most of the past century , where 1982 is set as the reference year . There have been three major in the past century . Both World War I and World War II , with a large portion of the goods and services diverted to military use , saw significant . In addition , there was a substantial during the , after the Vietnam War in the . The price level fell during Depression , a prolonged and severe economic downturn from 1929 to 1939 . Falling price levels create investment problems because interest rates , which must adjust for , are forced to be high , since unadjusted interest rates can not be negative . Changes in the absolute price level are hard to estimate , so the change is separately in Figure percentage changes . Figure ( IL ( 1982 100 ) URL books

200 180 160 140 120 100 80 60 40 20 ?

96 ) Figure 20 15 . The cost of food has fallen quite dramatically over the past century . Figure Food expenditure as percentage of income , and proportion spent out shows that the percentage of household income spent on food has fallen from 25 to about 10 . This fall is a of greater incomes and the fact that the real cost of food has fallen . Moreover , a much greater fraction of expenditures on food are spent away from home , a fraction that has risen from under 15 to 40 . URL books 71

Figure Food as , spent our ( Food 35 Eating Out ?

No ?

39 How do we spend our income ?

The major categories are food , clothing , housing , medical , household operation , transportation , and recreation . The percentage of disposable income spent on these categories is shown for the years 1929 , 1965 , and 2001 in Figure income shares . Figure ) income URL books 72

The cost of food has shrunk substantially , but we enjoy more recreation and spend a lot more staying healthy . The cost of food is larger than in Figure Food expenditure as percentage of income , and proportion spent out because these figures use disposable income , rather than income . This is not only a consequence of our aging population but also of the increased technology available . KEY TAKEAWAYS There are approximately 100 million households in the United States . The number of residents per household has shrunk , from over four to under three , over the past 100 years . About 60 of households live in detached homes . Slightly less than of the population is incarcerated in state and federal prisons . This represents a increase over 1925 to Ten percent of households do not have an automobile , and have a telephone . Just under 99 of households have complete plumbing facilities ( running water , bath or shower , flush toilet ) up from 55 in A quintile ( or fifth ) is a group of size 20 . URL books 73

The earnings of the top quintile fell slightly until the late , when it began to rise . All other lost income share to the top quintile starting in the . Figures like these suggest that families are getting poorer , except for an elite few . However , families are getting richer , just not as fast as the top quintile . Just after World War II , African American families earned about 50 of white family income . This ratio has risen gradually , noticeably in the after the 1964 Civil Rights Act . The consumer price index ( which adjusts for what it costs to buy a standard bundle of food , clothing , housing , electricity , and other items , is the most common price index . There have been three major in the past century , associated with World War I , World War II , and the . The price level fell during the Great Depression ( The cost of food has fallen quite dramatically over the past century . Have prices actually risen ?

Economists generally agree that the meaning of prices have risen is that you would prefer past prices to current prices . What makes this challenging is that the set of available products change over time . Cars have gone up significantly in price but are also more reliable . Would you be better off with your current income in 1913 than today ?

You would be very rich with current average income in 1913 but would not have access to modern medicine , television , electronics , refrigeration , highways , and many other technologies . If you made annually in 1913 , how would you live and what would you buy ?

Do some research . Compare a income in 1980 to the present . What differences are there in available products ?

In the quality of products ?

How rich does URL books 74 make you in each time period ?

In which period would you choose to live , and why ?

Production LEARNING OBJECTIVE . What do we make ?

We learned something about where we live and what we buy . Where do we get our income ?

Primarily , we earn by providing goods and services . Nationally , we produce about 11 trillion worth of goods and services . Broadly speaking , we spend that 11 trillion on personal consumption of goods and services , savings , and government . This , by the way , is often expressed as I , which states that income ( is spent on consumption ( investment ( I , which comes from savings ) and government ( One can consume imports as well , so the constraint looks like I , where is imports and is exports . How much does the United States produce ?

Economists measure output with domestic product ( which is the value of traded goods and services produced within the borders of the United States . thus excludes output of Japanese factories owned by Americans but includes the output of factories owned by the Japanese . Importantly , excludes goods and services . Thus , unpaid housework is not included . If you clean your own home , and your neighbor cleans his or her home , the cleaning does not contribute to . On the other hand , if you and your neighbor pay each other to clean each other homes , goes up by the payments , even though the actual production of goods and services remains unchanged . Thus , does not measure our total output as a nation , because it neglects unpaid services . Why does it neglect unpaid services ?

Primarily because we can readily measure them . Data on transactions are generated by tax information and reporting requirements imposed on URL , org books 75 businesses . For the same reason , neglects illegal activities as well , such as illegal drug sales and pirated music sales . Thus , is not a perfect measure of the production of our society . It is just the best measure we have . Figure Output , consumption , investment , and government shows the growth in and its components of personal consumption , government expenditures , and investment . The are expressed in constant 1996 is , adjusted for . The for government includes the government purchases of goods and , highways , rockets , does not include transfer payments like social security and welfare programs . Transfer payments are excluded from this calculation because actual dollars are spent by the recipient , not by the government . The cost of making the transfer payments ( printing and mailing the checks ) however , is included in the cost of government . Figure ( 0000 Consumption Investment Government ' It is often visually challenging to draw useful information from graphs like Figure Output , consumption , investment , and government , because economic activity is growing at a constant percentage . Consequently , economists often use scale rather than a dollar scale . A logarithmic scale has the useful property URL books 76

that a straight line gives constant percentage growth . Consider a variable takes on values at time Ax to be the percentage change Then ( Ax ) Thus , if the percentage change is constant over time , log ( will be a straight line over time . Moreover , for small percentage changes , Ax ) Ax so that the slope is approximately the growth rate . Figure Major components in log scale shows these statistics with a logarithmic scale . Figure in log scale I a . Government ON ON ON ON ON ON ON ON oo 00 ON ON ON ON ON ON ON ON ON ON ON ON ON ON ON ON ON Immediately noticeable is the approximately constant growth rate from 1950 to the present , because a straight line with a log scale represents a constant growth rate . In addition , government has grown much more slowly ( although recall that transfer payments , another aspect of government , aren shown ) A third feature is the volatility of shows much greater changes than output and consumption . Indeed , URL books 77

during the Great Depression ( income fell somewhat , consumption fell less , government was approximately , and investment plunged to 10 of its former level . Some of the growth in the American economy has arisen because there are more of us . Double the number of people , and consume twice as many goods , and individually we aren better off . How much are we producing per capita , and how much are we consuming ?

output of goods , services , and consumption has grown substantially over the past 75 years , a fact illustrated in Figure Per capita income and consumption . In addition , consumption has been a steady percentage of income . This is more clearly visible when income shares are plotted in Figure Consumption , investment , and government ( Figure ' Consumption 930 1940 950 1960 970 1980 1990 2000 Figure ( URL , org books 78

Consumption was a very high portion of income during the Great Depression because income itself fell . Little investment took place . The wartime economy of World War II reduced consumption to below 50 of output , with government spending a similar fraction as home consumers . Otherwise , consumption has been a relatively stable 60 70 of income , rising modestly during the past 20 years , as the share of government shrank and net imports grew . Net imports rose to of in 2001 . The most basic output of our economic system is food , and the economy does a remarkable job producing food . The United States has about 941 million acres under cultivation to produce food , which represents of the surface area of the United States . Land use for agriculture peaked in 1952 , at million acres , and has been dwindling ever since , especially in the northeast where farms are being returned to forest through disuse . Figure US . agricultural output , 1982 constant dollars shows the output of agricultural products in the United States , adjusted to 1982 prices . Figure US . 82 ( URL books 79

( ID ' no ( ED on LIN ( 00 ON ON ON ON ON ON ON ON ON ON ON ON ON The growth in output is more pronounced when viewed per worker involved in agriculture in Figure Agricultural output , total and per worker ( 1982 dollars , log scale ) Figure 000 Per Worker 10 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 Where do we work ?

Economists divide production into goods and services . Goods are historically divided into mining , construction , and manufacturing . Mining includes production of raw materials of all kinds , including metals , oil , bauxite , and gypsum . Construction involves production of housing and business space . Manufacturing URL books

involves the production of everything from computers to those little chefs hats that are placed on turkey legs . Figure Major nonagricultural sectors of economy ( describes the major sectors of the economy . Because the data come from firms , agriculture is excluded , although goods and services provided to farms would be included . Figure Major sectors . economy ( Mining has diminished as a major factor in the economy , a consequence of the growth of other sectors and the reduction in the prices for raw materials . Contrary to many popular predictions , the prices of raw materials have fallen even as output and population have grown . We will see later in this book that the fall in prices of raw in fixed supply given the limited capacity of the that people expect a relative future abundance , either because of technological improvements in their use or because of large as yet undiscovered pools of the resources . An example of technological improvements is the substitution of optic cable for copper wires . An enormous amount of copper has been recovered from telephone lines , and we can have more telephone lines and use less copper than was used in the past . URL books 69 81

Manufacturing has become less important for several reasons . Many manufactured goods cost less , pulling down the overall value . In addition , we import more manufactured goods than in the past . We produce more services . PU stands for transportation and public utilities , and includes electricity and telephone services and transportation including rail and air travel . This sector has shrunk as a portion of the entire economy , although the components have grown in absolute terms . For example , the number of airplane trips has grown dramatically , as illustrated in Figure . 32 Air travel per capita . Figure Air ' per ) ca 99 ' Electricity production has risen dramatically , as Figure Electricity production ( shows . Figure ( URL books 82

I I I I 1900 1920 1940 1960 1930 2000 However , energy use more generally has not grown as much , just doubling over the postwar period , which is illustrated in Figure Energy use ( quadrillion ) Figure 80 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 The number of automobiles per capita in the United States peaked in the early , which looks like a reduction in transportation since then . However , we still drive more than ever , suggesting the change is actually an increase in the reliability of automobiles . URL books 83

Both of these facts are in Figure Cars per thousand population and miles driven per capita , with miles on the left axis and cars per thousand on the right . Figure ( and ( Miles Cars 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 The cost of selling and retail relatively stable , as does FIRE , which stands for finance , insurance , and real estate costs . Other services , ranging from restaurants to computer tutoring , have grown substantially . This is the called service economy that used to be in the news frequently , but is less so these days . A bit more than 60 of the population works , with the historical percentage Percentage of population employed ( military and prisoners excluded ) The larger numbers in recent years are partially a of the baby boom entry into working years , reducing the proportion of elderly and children in American society . However , it is partially a of an increased propensity for households to have two income earners . Figure ' population ( URL books 84

1940 1943 1946 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 Figure ) rules . all and ' 70 60 50 40 30 20 10 I I I I 1900 1920 1940 1960 1980 2000 Female participation in the labor force has risen quite dramatically in the United States , as shown in Figure Labor force participation rates , all women and married women . The overall participation rate has roughly tripled during the century and significantly exceeds the rate prevailing during World War II , when many women went to work . In addition , participation of married women has now risen above the level for unmarried women . The participation rate for single women is even higher , currently at 68 , and it is higher than the overall average participation rate of all residents . The URL , org books 85

difference is primarily elderly women , who are disproportionately more likely to be widowed rather than married or single , and who are less likely to be working . Another sector of the economy that has been of focus in the news is national defense . How much do we spend on the military ?

In this century , the large expenditure occurred during World War II , when about 50 of was spent by the government and 37 of went to the armed forces . During the Korean War , we spent about 15 of on military goods and less than 10 of during the Vietnam War . The military buildup during Ronald Reagan presidency ( increased our military expenditures from about to of large percentage change in military expenditures , but a small diversion of . The fall of the Soviet Union led the United States to reduce military expenditures , in what was called the peace dividend , but again the effects were modest , as illustrated in Figure Defense as a percentage of . Figure ( as ( of Historically , defense represents the largest expenditure by the federal government . However , as we see , defense has become a much smaller part of the economy overall . Still , the federal government plays many other roles in the modern economy . KEY TAKEAWAYS Economists measure output with the gross domestic product ( which is the value of traded goods and services produced within the borders of the United States . Importantly , excludes goods and services . Thus , is not a perfect measure of the production of our society . It is just the best measure we have . Economists often use a logarithmic scale rather than a dollar scale . On a logarithmic scale , a straight line gives constant percentage growth . Economists divide production into goods and services . Goods are historically divided into mining , construction , and manufacturing . URL books 86

The prices of raw materials have fallen even as output and population have grown . Manufacturing has become less important for several reasons . Many manufactured goods cost less , pulling down the overall value . In addition , we import more manufactured goods than in the past . We produce more services . Electricity production has risen dramatically . The number of automobiles per capita in the United States peaked in the early , but we still drive more than ever , suggesting the change is actually an increase in the reliability of automobiles . The cost of selling and retail relatively stable , as does FIRE ( finance , insurance , and real estate costs ) Other services have grown substantially . A bit more than 60 of the population works . Female participation in the labor force has risen quite dramatically in the United States . Military expenditures peaked during World War II , when about 50 of was spent by the government , and 37 of went to the armed forces . During the Korean War , we spent about 15 of on the military and less than 10 of during the Vietnam War . The military buildup during Ronald Reagan presidency ( increased our military expenditures from about to of large percentage change in military expenditures , but a small diversion of . Government LEARNING OBJECTIVE . How big is government and what does the government spend money on ?

With a budget over trillion , the federal government represents just under 20 of the economy . It is one of the largest organizations in the world only nations are larger organizations , and only a handful of nations are larger . URL books 87 The size of the federal government , as a percentage of , is shown in Figure Federal expenditures and revenues ( percent of ) Federal expenditures boomed during World War II ( but shrank back to nearly prewar levels shortly afterward , with much of the difference attributable to veterans benefits and continuing international involvement . Federal expenditures , as a percentage of , continued to grow until Ronald Reagan presidency in 1980 , when they began to shrink slightly after an initial growth . Figure Federal expenditures and revenues ( percent of ) also shows federal revenues , and the difference between expenditures and apparent , especially for World War II and 1970 to 1998 . Figure ( and ( Revenue Expenditures ' Much has been written about the federal government abdication of various services , 2000 which are pushed onto state and local government . Usually this behavior is attributed to the Reagan presidency ( There is some evidence of this behavior in the postwar data , but the effect is very modest and long term . Most of the growth in state and local government occurred between 1947 and 1970 , well before the Reagan presidency state and local government has been stable since then . Moreover , the URL books 88

expenditure of the federal government , which shows ups and downs , has also been fairly stable . In any event , such effects are modest overall . Figure , I ) Total Federal Regional ) ON ( in ) In 00 ' 01 Figure Federal , state , and local level , and total government receipts ( sets out the taxation at both the federal and state and local ( merged to be regional ) level . Figure Federal , regional , and total expenditures ( shows expenditures of the same entities . Both are stated as a percentage of . State and local taxation and expenditures doubled over the postwar period . The two figures are very similar . The federal government expenditures have varied more than its revenues . Figure Federal , Total Federal Regional ' Ix in cu Ix In Ix ox In In xo no Ix Ix co co ox ox ox 01 ( ox URL books 39

A peculiarity of the federal government is a preference for expenditures . Originally , such items involved corporations like ( which commercialized satellite technology ) and ( the Radio Corporation of America , which commercialized radio ) as well as other and sustaining operations . Over time , however , items became a way of hiding the growth of government , through a process that became known as smoke and The scope of these items is in Figure Federal expenditures , on and off budget ( Figure Forlorn ( on and ( 15 A A . Budget ! During the , the public became aware of items . Political awareness made items cease to work as a device for evading requirements , and few new ones were created , although they continue to be debated . Sporadically , there are attempts to push social security . Figure and ( URL books 90

Executive Military Federal . Regional 000 I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I 61 ' 29 22 29 03 ?

Federal employees include two major categories uniformed military personnel and the executive branch . State and local government is much larger and has tripled in size since 1962 , a fact illustrated in Figure Federal and regional government employment . The biggest growth areas involve public school teachers , police , corrections ( prisons ) and hospitals . About of the federal employees work for the postal service . 800 Transfers To Regional Interest ( 9999929999299998 URL books 91

Social Security Medical Welfare Unemployment Veterans 030 ' 10 ( Li ! In II ) Transfers to individuals represent almost 50 of federal expenditures . These transfers are direct payments to individuals in the form of a check . Such transfers include social security , Medicare , Medicaid , unemployment insurance , and veteran . Transfers to state and local governments are listed as regional . Other grants also involve sending checks , usually with strings attached . Expenditure shares are in Figure Major expenditures of the federal government , while the breakdown of federal transfers is provided in Figure Major transfer payments ( of federal budget ) The growth in social security during the and is primarily a consequence of increasing benefit levels . The growth in Medicare and Medicaid payments over the period 1970 to 1990 , in contrast , is primarily a consequence of increased costs of existing programs rather than increases in levels . Figure ( URL books 92

Revenue Expenditure 00 10 ( A question you may ask , quite reasonably , is whether the social security program can 1961 1967 1973 1979 1985 1991 1997 survive to the time when you retire . A common misunderstanding about social security is that it is an investment the taxes individuals pay in are invested and returned at retirement . As Figure Social security revenue and expenditure ( millions ) makes clear , for most of its existence the social security program has paid out approximately what it took in . The social security administration has been ostensibly investing money and has a current value of approximately trillion , which is a bit less than four times the current annual expenditure on social security . Unfortunately , this money is invested in the federal government , and thus is an obligation of the federal government , as opposed to an investment in the stock market . Consequently , from the perspective of someone who is hoping to retire in , say , 2050 , this investment isn much comfort , since the URL books 93

investment won make it easier for the federal government to make the social security payments . The good news is that the government can print money . The bad news is that when the government prints a lot of money and the obligations of the social security administration are in the tens of trillions of dollars , it isn worth very much . Figure ( Dept ( 1000 , 000 40 ' I I I I I I I I I I I I 39 950 953 990 990 000 The federal government runs deficits , spending more than it earned . In most of the past 75 years , we see from Figure Federal expenditures and revenues ( percent of ) that the government runs a deficit , bringing in less than it spends . Interest has been as high as 15 of the cost of the federal government ( see Figure Major expenditures of the federal government ) How large is the debt , and how serious is it ?

Figure Federal debt , total and percent of gives the size of the federal debt in absolute dollars and as a percent of . The debt was increased dramatically during World War II ( but over the next 25 years little was added to it , so that as a portion of growing , the debt fell . Starting in the late , the United States began accumulating debt faster than it was growing , and the debt began to rise . That trend wasn stabilized until the , and URL books 94

then only because the economy grew at an extraordinary rate by historical standards . The expenditures following the September 11 , 2001 , terrorist attacks , combined with a recession in the economy , have sent the debt rising dramatically , wiping out the reduction of the . The national debt isn out of control , yet . At interest rates on federal borrowing , we spend about of on interest servicing the federal debt . The right evaluation of the debt is as a percentage of viewed as a percentage , the size of the debt is of moderate but not critical . The serious side of the debt is the coming retirement of the baby boom generation , which is likely to put additional pressure on the government . An important distinction in many economic activities is one between a stock and a . A stock is the current amount of some material represents the rate of change in the amount of some material that exists from one instant to the next . Your bank account represents a stock of money expenditures and income represent a . The national debt is a stock the is the addition to the debt and is a . If you think about a lake with incoming water and evaporation , the amount of water in the lake is the stock of water , while the incoming stream minus evaporation is the . Table Expenditures on agencies as percent of expenditures Department or Agency 2002 Legislative Judiciary Agriculture Commerce Education Energy URL books 95

Homeland Security Housing Urban Dev . Interior Labor State Transportation Treasury Veterans Corps of Engineers Environmental . Fed Emergency . GSA Assistance Table Expenditures on agencies as percent of expenditures gives the expenditures on Various agencies , as a percentage of expenditures , where discretionary is a euphemism for expenditures that aren transfers . Transfers , which are also known as entitlements , include social security , Medicare , aid to families with dependent children , unemployment insurance , and Veteran benefits . Table Expenditures on agencies as percent of expenditures provides the expenditures by what is sometimes known as the Alphabet Soup of federal agencies ( DOD , DOE , SEC , URL books 95

The National Science Foundation ( provides funding for basic research . The general idea of research is that it is useful for ideas to be in the public domain and , moreover , that some research isn commercially viable but is valuable nevertheless . Studying asteroids and meteors produces little , if any , revenue but could , perhaps , save humanity one day in the event that we needed to a large incoming asteroid . Many scientists appear pessimistic about actually an asteroid . Similarly , research into nuclear weapons might be commercially viable but , as a society , we don want selling nuclear weapons to the highest bidder . In addition to the , the National Institutes of Health , also a government agency , funds a great deal of research . How much does the government spend on research and development ( Figure Federal spending on ( shows the history of expenditures . The space race competition between the United States and the Soviet Union led to the greatest federal expenditure on , and it topped of . There was a modest increase during the Reagan presidency ( 1988 ) in defense , which promptly returned to earlier levels . Figure Federal ( on ( Military Civilian Total Where does the government get the money to buy all these things ?

As we see in Figure Sources of federal government revenue , the federal income tax currently URL books 97 produces just under 50 of federal revenue . Social security and Medicare taxes produce the next largest portion , with around 30 of revenue . The rest comes from corporate profits taxes ( about 10 ) excise taxes like those imposed on liquor and cigarettes ( under ) and other taxes like tariffs , fees , sales of property like radio spectrum and oil leases , and fines . The major change since World War II is the dramatic increase in social security , a consequence of the federal government attempt to ensure the future viability of the program , in the face of severely adverse demographics in the form of the retirement of the baby boom generation . Figure ( I ' I ' 55 ' An important aspect of tax collection is that income taxes , like the federal income tax as well as social security and Medicare taxes , are very inexpensive to collect relative to sales taxes and excise taxes . Income taxes are straightforward to collect even relative to corporate income taxes . Quite reasonably , corporations can deduct expenses and the costs of doing business and are taxed on their profits , not on revenues . What is an allowable deduction , and what is not , makes corporate complicated to administer . Moreover , from an economic perspective , corporate taxes are paid by consumers in the form of higher prices for goods , at least when industries are competitive . URL books 93

KEY TAKEAWAYS With a budget over trillion , the federal government represents just under 20 of the economy . Federal employees include military personnel and the executive branch . State and local government employment is much larger than federal employment and has tripled in size since 1962 . Transfers to individuals represent almost 50 of federal expenditures . Such transfers include social security , Medicare , Medicaid , unemployment insurance , and veteran benefits . Transfers are also known as entitlements , and other expenditures are called discretionary spending . The social security program has paid out approximately what it took in and is not an investment program . The federal government runs deficits , spending more than it earned . Starting in the late , the United States began accumulating debt faster than it was growing , and the debt began to rise . That trend stabilized until the , and then only because the economy grew at an extraordinary rate by historical standards . The expenditures following the September 11 , 2001 , terrorist attacks , combined with a recession in the economy , have sent the debt rising dramatically . The best way to evaluate the debt is as a percentage of . An important distinction in many economic activities is one between a stock and a flow . Your bank account represents a stock of money expenditures and income represent a flow . The national debt is a stock the deficit is the addition to the debt and is a flow . Government funded research and development represents about of , divided about equally between military and civilian research . The federal income tax currently produces just under 50 of federal revenue . Social security and Medicare taxes produce the next largest URL books 99

portion , about one third of revenue . The rest comes from corporate profits taxes ( about 10 ) and excise taxes like those imposed on liquor and cigarettes ( under ) LEARNING OBJECTIVE . What do we trade with other nations ?

The United States is a major trading nation . Figure Total imports and exports as a proportion of represents total imports and exports , including foreign investments and earnings ( earnings from foreign assets ) As is clear from this , the net trade surplus ended in the , and the United States now runs substantial trade , around of the . In addition , trade is increasingly important in the economy . Figure Total ) I ' AD ' 190 URL books 100

As already stated , Figure Total imports and exports as a proportion of includes investments and earnings . When we think of trade , we tend to think of goods soybeans , movies and computers sold abroad , as well as automobiles , toys , shoes , and wine purchased from foreign countries . Figure US . trade in goods and services shows the total trade in goods and services , as a percentage of . These are surprisingly similar , which show that investments and earnings from investment are roughly United States invests abroad to a similar extent as foreigners invest in the United States . Figure US . rude in goods ' Figure Income and payments ( shows the earnings on assets abroad and the payments from assets owned by foreigners . These forms of exchange are known as capital accounts . These accounts are roughly in balance , while the United States used to earn about of from its ownership of foreign assets . Figure Income ( Payments Earnings ' URL books 101

Table Top trading partners and trade Volumes ( billions ) Countries Japan United Kingdom Korea , South 17 13 Italy Malaysia 15 Brazil . Who does the United States trade with ?

Table Top trading partners and trade Volumes ( billions ) details the top 15 trading partners and the share of trade . The United States and Canada remain the top trading countries of all pairs of countries . Trade with Mexico has grown substantially since the enactment of the 1994 North American Free Trade Act ( which extended the earlier agreement URL books 102

to include Mexico , and Mexico is the second largest trading partner of the United States . Together , the top 15 account for three quarters of foreign trade . KEY TAKEAWAYS The United States is a major trading nation , buying about 16 of and selling about 12 , with a trade deficit . Income from investments abroad is roughly balanced with foreign earnings from investments these are known as the capital accounts . The United States and Canada remain the top trading countries of all pairs of countries . Mexico is the second largest trading partner of the United States . China and Japan are third and fourth . Together , the top 15 account for three quarters of international trade . Fluctuations LEARNING OBJECTIVE . What is a recession ?

The economy has , a term that refers to a period marked by a drop in gross domestic output . are officially called by the National Bureau of Economic Research , which keeps statistics on the economy and engages in various kinds of economic research . Generally , a recession is called whenever output drops for half of a year . Figure Postwar ' and URL books 103

IP 120 Recession 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Figure Postwar industrial production and shows the overall industrial production of the United States since World War II . Drops in output are clearly noticeable . The official are also marked . There are three booms that lasted about a decade these are the longest booms in history and much longer than booms ordinarily last . Prior to World War II , a normal boom lasted years and the longest boom was years . have historically lasted for to years , a pattern that continues . Indeed , the average recession since World War II has been shorter than the average recession prior to that time . These in output are known as the business cycle , which is not an exact periodic cycle but instead a random cycle . Figure ( URL books 104

1940 1943 19465 1948 1951 19545 1957 1960 1963 19665 19695 1972 19755 19785 1981 19845 1987 19905 1993 19965 1999 20025 An important aspect of the business cycle is that many economic variables move together , or . Some economic variables vary less with the business cycle than others . Investment varies very strongly with the business cycle , while overall employment varies weakly . Interest rates , stock prices , unemployment , and many other variables also vary systematically over the business cycle . are clearly visible in the percentage of the population employed , as illustrated in Figure Percentage of the population employed Some economic variables are much more variable than others . For example , investment , durable goods purchases , and utilization of production capacity vary more dramatically over the business cycle than consumption and employment . Figure Industrial factory capacity utilization shows the percentage of industrial capacity utilized to produce manufactured goods . This series is more volatile than production itself and responds more strongly to economic conditions . Figure In ( URL books 105

I I I I ( I ?

CI cI Source FRED . Most of the of is devoted to understanding the of growth and of , but further consideration of this important topic is beyond the scope of a text . KEY TAKEAWAYS The economy has , a term that refers to a drop in gross domestic output . are officially called by the National Bureau of Economic Research , which keeps statistics on the economy and engages in various kinds of economic research . Generally a recession is called whenever output drops for one half of a year . Prior to World War II , a normal boom lasted years and the longest boom was years , but they have been much longer since 1960 . have historically lasted for to years , a pattern that continues . Fluctuations in output are known as the business cycle , which is not an exact periodic cycle but instead a random cycle . An important aspect of the business cycle is that many economic variables move together , or . Investment varies very strongly with URL books 105

the business cycle , while overall employment varies weakly . Interest rates , inflation , stock prices , unemployment , and many other variables also vary systematically over the business cycle . Some economic variables are much more variable than others . Investment , durable goods purchases , and utilization of production capacity vary more dramatically over the business cycle than consumption and employment . URL books 107