Principles of Macroeconomics for AP® Courses 2e Chapter 6 Economic Growth

The Pe FIGURE The Great Depression At times , such as when many people having trouble making ends meet , it is easy to tell how the economy is doing . This photograph shows people lined up during the Great Depression , waiting for relief checks . At other times , when some are doing well and others are not , it is more to ascertain how the economy of a country is doing . Credit of Waiting for relief checks . California by of Congress Prints and Photographs Division Washington , 20540 USA , Public Domain ) CHAPTER OBJECTIVES In this chapter , you will learn about Measuring the Size of the Economy Gross Domestic Product Adjusting Nominal Values to Real Values Tracking Real over Time Comparing among Countries How Well Measures the of Society Introduction to the Perspective BRING IT HOME How is the Economy Doing ?

How Does One Tell ?

The were boom years for the US . economy . Beginning in the late , from 2007 to 2014 , economic performance in the US . was poor . The economy experienced another period of strong growth between 2014 and 2019 , before rocked the world economy in March and April of 2020 . What causes the economy to expand or contract ?

Why do businesses fail when they are making all the right decisions ?

Why do workers lose their jobs when they are hardworking and productive ?

Are bad economic times a failure of the market system ?

Are they a 138 The Perspective failure of the government ?

These are all questions of , which we will begin to address in this chapter . We will not be able to answer all of these questions here , but we will start with the basics How is the economy doing ?

How can we tell ?

The macro economy includes all buying and selling , all production and consumption goes on in every market in the economy . How can we get a handle on that ?

The answer begins more than 80 years ago , during the Great Depression . President Franklin Roosevelt and his economic advisers knew things were how could they express and measure just how bad it was ?

An economist named Simon , who later won the Nobel Prize for his work , came up with a way to track what the entire economy is producing . In this chapter , you will learn how the government constructs , how we use it , and why it is so important . focuses on the economy as a whole ( or on whole economies as they interact ) What causes ?

What makes unemployment stay high when are supposed to be over ?

Why do some countries grow faster than others ?

Why do some countries have higher standards of living than others ?

These are all questions that addresses . involves adding up the economic activity of all households and all businesses in all markets to obtain the overall demand and supply in the economy . However , when we do that , something curious happens . It is not unusual that what results at the macro level is different from the sum of the parts . What seems sensible from a point of view can have unexpected or counterproductive results at the level . Imagine that you are sitting at an event with a large audience , like a live concert or a basketball game . A few people decide that they want a better view , and so they stand up . However , when these people stand up , they block the view for other people , and the others need to stand up as well if they wish to see . Eventually , nearly everyone is standing up , and as a result , no one can see much better than before . The rational decision of some individuals at the micro stand up for a better up as at the macro level . This is not , but it is an apt analogy . is a rather massive subject . How are we going to tackle it ?

Figure illustrates the structure we will use . We will study from three different perspectives . What are the goals ?

as a discipline does not have goals , but we do have goals for the macro economy . What are the economists can use to analyze the ?

Finally , what are the policy tools governments can use to manage the ?

Goals Framework Policy Tools Economic growth Aggregate demand ! Monetary policy Low unemployment Aggregate supply Fiscal policy Low inflation model Neoclassical model FIGURE Goals , Framework , and Policies This chart shows what is about . The box on the left indicates a consensus of what are the most important goals for the macro economy , the middle box lists the economists use to analyze changes ( such as inflation or recession ) and the box on the right indicates the two tools the federal government uses to influence the macro economy . Goals In thinking about the overall health , it is useful to consider three primary goals economic growth , low unemployment , and low . Economic growth ultimately determines the prevailing standard of living in a country . Economists measure growth by the percentage change in real ( gross domestic product . A growth Access for free at

Measuring the Size of the Economy Gross Domestic Product 139 rate of more than is considered good . Unemployment , as measured by the unemployment rate , is the percentage of people in the labor force who do not have ajob . When people , the economy is wasting a precious , and the result is lower goods and services produced . Unemployment , however , is more than a represents people livelihoods . While measured unemployment is unlikely to ever be zero , economists consider a measured unemployment rate of or less low ( good ) is a sustained increase in the overall level of prices , and is measured by the consumer price index . If many people face a situation where the prices that they pay for food , shelter , and healthcare are rising much faster than the wages they receive for their labor , there will be widespread unhappiness as their standard of living declines . For that reason , low rate of a major goal . As you learn in the micro part of this book , principal tools that economists use are theories and models ( see Welcome to Economics ! for more on this ) In , we used the theories of supply and demand . In , we use the theories of aggregate demand ( AD ) and aggregate supply ( AS ) This book presents two perspectives on the Neoclassical perspective and the perspective , each of which has its own version of AD and AS . Between the two perspectives , you will obtain a good understanding of what drives the . Policy Tools National governments have two tools for the . The first is monetary policy , which involves managing the money supply and interest rates . The second is policy , which involves changes in government and taxes . We will explain each of the items in Figure in detail in one or more other chapters . As you learn these things , you will discover that the goals and the policy tools are in the news almost every day . Measuring the Size of the Economy Gross Domestic Product LEARNING OBJECTIVES By the end of this section , you will be able to Identify the components of on the demand side and on the supply side Evaluate how economists measure gross domestic product ( Contrast and calculate , net exports , and net national product is an empirical subject , so the first step toward understanding it is to measure the economy . How large is the economy ?

Economists typically measure the size ofa nation overall economy by its gross domestic product ( which is the value of all goods and services produced within a country in a given year . Measuring involves counting the production of millions of different goods and phones , cars , music downloads , computers , steel , bananas , college educations , and all other new goods and services that a country produced in the current summing them into a total dollar value . This task is straightforward take the quantity of everything produced , multiply it by the price at which each product sold , and add up the total . In 2020 , the totaled trillion , the largest in the world . Each of the market transactions that enter into must involve both a buyer and a seller . We can measure an economy either by the total dollar value of what consumers purchase in the economy , or by the total dollar value of what is the country produces . There is even a third way , as we will explain later . Measured by Components of Demand Who buys all of this production ?

We can divide this demand into four main parts consumer spending ( consumption ) business spending ( investment ) government spending on goods and services , and spending 140 The Perspective on net exports . See the following Clear It Up feature to understand what we mean by investment . Table shows how these four components added up to the in 2020 , Figure ( a ) shows the levels of consumption , investment , and government purchases over time , expressed as a percentage of , while Figure ( shows the levels of exports and imports as a percentage of over time . A few patterns about each of these components are worth noticing . Table shows the components of from the demand side . Components of on the Demand Side ( in trillions of dollars ) Percentage of Total Consumption Investment Government Exports Imports Total 100 TABLE Components of in 2022 From the Demand Side ( Source , Table ) I ( FIGURE Percentage of Components of on the Demand Side Consumption makes up over half of the demand side components of the . Totals in the chart do not add to 100 due to rounding . Source , Table ) CLEAR IT UP What does the word investment mean ?

What do economists mean by investment , or business spending ?

In calculating , investment does not refer to purchasing stocks and bonds or trading assets . It refers to purchasing new capital goods , that is , new commercial real estate ( such as buildings , factories , and stores ) and equipment , residential housing construction , and inventories . Inventories that manufacturers produce this year are included in this year if they are not yet sold . From the accountant perspective , it is as if the invested in its own inventories . Business investment in 2020 was trillion , according to the Bureau of Economic Analysis . Access for free at

Measuring the Size of the Economy Gross Domestic Product 141 I , I TU , ELI ' 40 , Exports Sim , I , I ( cu . oz go . i I I I ' I I ' In in i if in i . I LI , I ! CI ( an ac ( Year Year ! I ?

lIl and gI ! li ! and exports FIGURE Components of on the Demand Side ( a ) Consumption is about of , and it has been on a slight upward trend over time . Business investment hovers around 15 of , but it fluctuates more than consumption . Government spending on goods and services is slightly under 20 of and has declined modestly over time . Exports are added to total demand for goods and services , while imports are subtracted from total demand . It exports exceed imports , as in most of the 19605 and 19705 in the economy , a trade surplus exists . It imports exceed exports , as in recent years , then a trade deficit exists . Source , Table ) Consumption expenditure by households is the largest component of , accounting for about of the in any year . This tells us that consumers spending decisions are a major driver of the economy . consumer spending is a gentle elephant when viewed over time , it does around too much , and has increased modestly from about 60 of in the and . expenditure refers to purchases of physical plant and equipment , primarily by businesses . If Starbucks builds a new store , or Amazon buys robots , they count these expenditures under business investment . Investment demand is far smaller than consumption demand , typically accounting for only about of , but it is very important for the economy because this is where jobs are created . However , it more noticeably than consumption . Business investment is volatile . New technology or a new can spur business investment , but then can drop and business investment can pull back sharply . have noticed any of the infrastructure projects ( new bridges , highways , airports ) launched during the 2009 recession , or ifyou received a stimulus check during the recession of , you lave seen how important government spending can be for the economy . Government expenditure in the States is close to 20 , and includes spending by all three levels of government federal , state , and local . The only part of government spending counted in demand is government purchases of goods or services produced in the economy . Examples include the government buying a new for the Air Force ( federal government spending ) building a new highway ( state government spending ) or a new school ( local government spending ) A portion of government budgets consists of transfer payments , like unemployment , veteran , and Social Security payments to retirees . The government excludes these payments from because it does not receive a new good or service in return or exchange . Instead they are transfers of income from taxpayers to others . Ifyou are curious about the awesome undertaking of adding up , read the following Clear It Up feature .

142 The Perspective CLEAR IT UP How do statisticians measure ?

Government economists at the Bureau of Economic Analysis ( BEA ) within the Department of Commerce , piece together estimates of from a variety of sources . Once every five years , in the second and seventh year of each decade , the Bureau of the Census carries out a detailed census of businesses throughout the United States . In between , the Census Bureau carries out a monthly survey of retail sales . The government adjusts these with foreign trade data to account for exports that are produced in the United States and sold abroad and for imports that are produced abroad and sold here . Once every ten years , the Census Bureau conducts a comprehensive survey of housing and residential . Together , these sources provide the main basis for figuring out what is produced for consumers . For investment , the Census Bureau carries out a monthly survey of construction and an annual survey of expenditures on physical capital equipment . For what the federal government purchases , the statisticians rely on the Department of the Treasury . An annual Census of Governments gathers information on state and local governments . Because the government spends a considerable amount at all levels hiring people to provide services , it also tracks a large portion of spending through records that state governments and the Social Security Administration collect . With regard to foreign trade , the Census Bureau compiles a monthly record of all import and export documents . Additional surveys cover transportation and travel , and make adjustments for services that are produced in he United States for foreign customers . Many other sources contribute to estimates . Information on energy comes from the Department of Transportation and Department of Energy . The Agency for Health Care Research and Quality collects information on . Surveys of landlords find out about rental income . The Department of Agriculture collects statistics on arming . All these bits and pieces of information arrive in different forms , at different time intervals . The BEA them to produce estimates on a quarterly basis ( every three months ) The BEA then these numbers by multiplying by four . As more information comes in , the BEA updates and these estimates . BEA releases the advance estimate for a certain quarter one month after a quarter . The preliminary estimate comes out one month after that . The BEA publishes the final estimate one month later , but it is not actually final . July , the BEA releases roughly updated estimates forthe previous calendar year . Then , once every five years , after it has processed all the results of the latest detailed business census , the BEA all of the past estimates according to the newest methods and data , going all the way back to 1929 . LINK IT UP Visit this website to read on the BEA site . You can even email your own questions ! When thinking about the demand for domestically produced goods in a global economy , it is important to count spending on produced goods that a country sells abroad . Similarly , we must also subtract spending on that a country produces in other countries that residents of this country purchase . The net export component is equal to the dollar Value of exports ( minus the dollar value of imports ( We call the gap between exports and imports the trade balance . If a country exports are larger than its imports , then a country has a trade surplus . In the United States , exports typically exceeded imports in the 19605 and , as Figure ( shows . Access for free at

Measuring the Size of the Economy Gross Domestic Product 143 Since the early , imports have typically exceeded exports , and so the United States has experienced a trade in most years . The trade grew quite large in the late and in the . Figure ( also shows that imports and exports have both risen substantially in recent decades , even after the declines during the Great Recession between 2008 and 2009 . As we noted before , if exports and imports are equal , foreign trade has no effect on total . However , even if exports and imports are balanced overall , foreign trade might still have powerful effects on particular industries and workers by causing nations to shift workers and physical capital investment toward one industry rather than another . Based on these four components of demand , we can measure as Consumption Investment Government Trade balance ( Understanding how to measure is important for analyzing connections in the macro economy and for thinking about policy tools . Measured by What is Produced Everything that we purchase somebody must produce . Table breaks down what a country produces into categories durable goods , goods , services , structures , and the change in inventories . Before going into detail about these categories , notice that total measured according to what is produced is exactly the same as the measured by looking at the components of demand . Figure provides a visual representation of this information . Components of on the Supply Side ( in trillions of dollars ) Percentage of Total Goods Durable goods goods Services Structures ) Change in inventories Total 100 TABLE Components of on the Production Side , 2020 ( Source inde , Table )

144 The Perspective 81 Change in inventories ( 00 ) Durable goods ( goods ( 13 ) FIGURE Percentage of Components of on the Production Side Services make up over 60 percent of the production side components of in the United States . Since every market transaction must have both a buyer and a seller , must be the same whether measured by what is demanded or by what is produced . Figure 646 shows these components ofwhat is produced , expressed as a percentage of , since 1950 . 65 60 55 50 Services 45 40 35 30 goods 25 Durable goods Percentage of 20 10 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 Year FIGURE Types of Production Services are the largest single component of total supply , representing over 60 percent of , up from about 45 percent in the early . Durable and goods constitute the manufacturing sector , and they have declined from 40 percent of in 1950 to about 30 percent in 2016 . goods used to be larger than durable goods , but in recent years , goods have been dropping Access for free at

Measuring the Size of the Economy Gross Domestic Product 145 to below the share of durable goods , which is less than 20 of . Structures hover around 10 of . We do not show here the change in inventories , the component of aggregate supply . It is typically less than of . In thinking about what is produced in the economy , many immediately focus on solid , long lasting goods , like cars and computers . By far the largest part , however , is services . Moreover , services have been a growing share of over time . A detailed breakdown of the leading service industries would include healthcare , education , and legal and services . It has been decades since most of the economy involved making solid objects . Instead , the most common jobs in a modern economy involve a worker looking at pieces of paper or a computer screen meeting with , customers , or suppliers or making phone calls . Even within the overall category of goods , durable goods like cars and refrigerators are about the same share of the economy as goods like food and clothing . The category of structures includes everything from homes , to buildings , shopping malls , and factories . Inventories is a small category that refers to the goods that one business has produced but has not yet sold to consumers , and are still sitting in warehouses and on shelves . The amount of inventories sitting on shelves tends to decline if business is better than expected , or to rise is worse than expected . Another Way to Measure The National Income Approach is a measure of what is produced in a nation . The primary way is estimated is with the Expenditure Approach we discussed above , but there is another way . Everything a produces , when sold , becomes revenues to the . Businesses use revenues to pay their bills Wages and salaries for labor , interest and dividends for capital , rent for land , to the entrepreneur , etc . So adding up all the income produced in a year provides a second way of measuring . This is why the terms and national income are sometimes used interchangeably . The total value of a nation output is equal to the total value of a nation income . The Problem of Double Counting We as the current value of all goods and services produced in a nation in a year . What are goods ?

They are goods at the furthest stage of production at the end ofa year . Statisticians who calculate must avoid the mistake of double counting , in which they count output more than once as it travels through the production stages . For example , imagine what would happen if government statisticians counted the value of tires that a tire manufacturer produces , and then counted the value ofa new truck that an sold that contains those tires . In this example , the statisticians would have counted the value of the tires because the truck price includes the value of the tires . To avoid this problem , which would overstate the size of the economy considerably , government statisticians count just the value of goods and services in the chain of production that are sold for consumption , investment , government , and trade purposes . Statisticians exclude intermediate goods , which are goods that go into producing other goods , from calculations . From the example above , they will only count the Ford truck value . The value of what businesses provide to other businesses is captured in the products at the end of the production chain . The concept of is fairly straightforward it is just the dollar value of all goods and services produced in the economy in a year . In our decentralized , economy , actually calculating the more than 21 with how it is changing every few a for a brigade of government statisticians .

146 The Perspective What is Counted in What is not included in Consumption Intermediate goods Business investment Transfer payments and activities Government spending on goods and services Used goods Net exports Illegal goods TABLE Counting Notice the items that are not counted into , as Table outlines . The sales of used goods are not included because they were produced in a previous year and are part of that year . The entire underground economy of services paid under the table and illegal sales should be counted , but is not , because it is impossible to track these sales . In Friedrich Schneider recent study of shadow economies , he estimated the underground economy in the United States to be of , or close to trillion dollars in 2013 alone . Transfer payments , such as payment by the government to individuals , are not included , because they do not represent production . Also , production of some as home production as when you make your not counted because these goods are not sold in the marketplace . LINK up Visit this website ( to read about the New Underground Other Ways to Measure the Economy Besides , there are several different but closely related ways of measuring the size of the economy . We mentioned above that we can think of as total production and as total purchases . We can also think of it as total income since anything one produces and sells yields income . One of the closest cousins is the gross national product ( includes only what country produces within its borders . adds what domestic businesses and labor abroad produces , and any payments that foreign labor and businesses located in the United States send home to other countries . In other words , is based more on what a country citizens and firms produce , wherever they are located , and is based on what happens within a certain county geographic boundaries . For the United States , the gap between and is relatively small in recent years , only about . For small nations , which may have a substantial share of their population working abroad and sending money back home , the difference can be substantial . We calculate net national product ( by taking and then subtracting the value of how much physical capital is worn out , or reduced in value because of aging , over the course ofa year . The process by which capital ages and loses value is called depreciation . We can further subdivide into national income , which includes all income to businesses and individuals , and personal income , which includes only income to people . The gross national income ( includes the value of all goods and services produced by people from a in the country or not . Unlike the other methods , essentially measures the wealth ofa nation because it focuses on income , not output . As you will see in the discussion regarding global economic diversity , the World Bank now uses to classify nations according to economic status . For practical purposes , it is not vital to memorize these . However , it is important to be aware that these differences exist and to know what statistic you are examining , so that you do not accidentally compare , say , in one year or for one country with or in another year or another country . To get an idea of Access for free at

Measuring the Size of the Economy Gross Domestic Product 147 how these calculations work , follow the steps in the following Work It Out feature . Calculating , Net Exports , and Based on the information in Table a . What is the value of ?

What is the value of net exports ?

What is the value of ?

Government purchases 120 billion Depreciation 40 billion Consumption 400 billion Business Investment 60 billion Exports 100 billion Imports 120 billion Income receipts from rest of the world 10 billion Income payments to rest of the world billion TABLE Step . To calculate use the following formula Consumption Investment Government spending ( Exports Imports ) 400 60 120 ( 120 ) 560 billion Step . To calculate net exports , subtract imports from exports . Net exports 100 120 20 billion Step . To calculate , use the following formula Income receipts from the rest of the world Income payments to the rest of the world Depreciation 560 10 40 522 billion

148 The Perspective Adjusting Nominal Values to Real Values LEARNING OBJECTIVES By the end of this section , you will be able to Contrast nominal and real Explain Calculate real based on nominal Values When examining economic statistics , there is a crucial distinction worth emphasizing . The distinction is between nominal and real measurements , which refer to whether or not has distorted a given statistic . Looking at economic statistics without considering is like looking through a pair of binoculars and trying to guess how close something is unless you know how strong the lenses are , you can not guess the distance Very accurately . Similarly , if you do not know the rate , it is to out ifa rise in is due mainly to a rise in the overall level of prices or to a rise in quantities of goods produced . The nominal value of any economic statistic means that we measure the statistic in terms of actual prices that exist at the time . The real value refers to the same statistic after it has been adjusted for . Generally , it is the real value that is more important . Converting Nominal to Real Table shows at intervals since 1960 in nominal dollars that is , measured using the actual market prices prevailing in each stated year . Figure also this data in a graph . Year Nominal ( billions of dollars ) Deflator ( 2005 100 ) 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 TABLE . Nominal and the Deflator ( Source , Table and Table ) Access for free at

Adjusting Nominal Values to Real Values i i i ' Nominal ( billions of dollars ) 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 Year FIGURE Nominal , Nominal values have risen exponentially from 1960 through 2020 , according to the BEA . If an unwary analyst compared nominal in 1960 to nominal in 2010 , it might appear that national output had risen by a factor of more than 38 over this time ( that is , of trillion in 2020 divided by of 543 billion in 1960 38 ) This conclusion would be highly misleading . Recall that we nominal as the quantity of every good or service produced multiplied by the price at which it was sold , summed up for all goods and services . In order to see how much production has actually increased , we need to extract the effects of higher prices on nominal . We can easily accomplish this using the . The is a price index measuring the average prices of all goods and services included in the economy . We explore price indices in detail and how we compute them in , but this will do in the context of this chapter . Table provides the data and Figure shows it graphically . 100 oo In Deflator ( 2012 100 ) LO ! LO ( 07 xi xi ( 07 ?

03 ( xi xi xi xi xi xi xi xi ( Year FIGURE Deflator , Much like nominal , the deflator has risen exponentially from 1960 through 2010 . Source BEA , Table ) Figure shows that the price level has risen dramatically since 1960 . The price level in 2020 was seven times higher than in 1960 ( the for 2020 was 113 versus a level of 17 in 1960 ) Clearly , much of the growth in nominal was due to , not an actual change in the quantity of goods and services produced , in other words , not in real . Recall that nominal can rise for two reasons an increase in output , an increase in prices . What is needed is to extract the increase in prices from nominal so as to measure only changes in output . After all , the dollars used to measure nominal in 1960 are worth more than the dollars of the price index tells exactly how much more . This adjustment is easy to do ifyou 149

150 The Perspective understand that nominal measurements are in value terms , where Value Price Quantity or Nominal Real Let look at an example at the micro level . Suppose the company , sells 10 at a price of each . nominal revenue from sales Price Quantity 10 90 Then , real income . 10 In other words , when we compute real measurements we are trying to obtain actual quantities , in this case , 10 . With , it is just a tiny bit more complicated . We start with the same formula as above Nominal Real Price Index For reasons that we will explain in more detail below , mathematically , a price index is a decimal number like or or . Because some people have trouble working with , when the price index is published , it has traditionally been multiplied by 100 to get integer numbers like 100 , 85 , or 125 . What this means is that when we nominal to get real ( by dividing the nominal by the price index ) We also need to remember to divide the published price index by 100 to make the math work . Thus , the formula becomes Nominal Real Price 100 Now read the following Work It Out feature for more practice calculating real . Computing It is possible to use the data in Table to compute real . Step . Look at Table , to see that , in 1960 , nominal was billion and the price index ( deflator ) was . Step . To calculate the real in 1960 , use the formula Nominal Real Price 100 billion 19 100 billion We do this in two parts to make it clear . First adjust the price index 19 divided by 100 . Then divide into nominal billion billion . Step . Use the same formula to calculate the real in 1965 . Access for free at

Adjusting Nominal Values to Real Values Nominal Index 100 billion 100 billion Real Step . Continue using this formula to calculate all of the real values from 1960 through 2010 . The calculations and the results are in Table . Nominal ( billions of Deflator ( 2005 Real ( billions of 2005 Ye dollars ) 100 ) dollars ) 960 100 ) 965 743 20 7437 3663 100 ) 970 100 ) 975 1688 34 ( 34 4952 100 ) 980 100 ) 985 4346 62 ( 62 6977 100 ) 990 100 ) 995 7664 82 ( 82 9346 100 ) 2000 100 ) 2005 13095 100 ' 13095 ( 2010 ( TABLE Converting Nominal to Real ( Source Bureau of Economic Analysis , There are a couple things to notice here . Whenever you compute a real statistic , one year ( or period ) plays a special role . It is called the base year ( or base period ) The base year is the year whose prices we use to compute the real statistic . When we calculate real , for example , we take the quantities of goods and services produced in each year ( for example , 1960 or 1973 ) and multiply them by their prices in the base year ( in this case , 2005 ) so we get a measure of that uses prices that do not change from year to year . That is why real is labeled Constant Dollars or , in this example , 2005 Dollars , which means that real is constructed 151

152 The Perspective using prices that existed in 2005 . While the example here uses 2005 as the base year , more generally , you can use any year as the base year . The formula is deflator 100 formula and using the data from 2005 Nominal Real Price Index 100 billion 100 100 billion Comparing real and nominal for 2005 , you see they are the same . This is no accident . It is because we have chosen 2005 as the base year in this example . Since the price index in the base year always has a value of 100 ( by ) nominal and real are always the same in the base year . Look at the data for 2010 . Nominal Real Price Index 100 billion 100 billion Use this data to make another observation As long as inflation is positive , meaning prices increase on average from year to year , real should be less than nominal in any year base year . The reason for this should be clear The value of nominal is inflated by inflation . Similarly , as long as inflation is positive , real should be greater than nominal in any year before the base year . Figure shows the nominal and real since 1960 . Because 2005 is the base year , the nominal and real Values are exactly the same in that year . However , over time , the rise in nominal looks much larger than the rise in real ( that is , the nominal line rises more steeply than the real line ) because the presence of , especially in the exaggerates the rise in nominal . I ! i i ( 07 ( I 9999999988838 Year FIGURE Nominal and Real , The red line measures in nominal dollars . The black line measures in real dollars , where all dollar values are converted to 2012 dollars . Since we express real in 2012 dollars , the two lines cross in 2012 . However , real will appear higher than nominal in the years before 2012 , because dollars were worth less in 2012 than in previous years . Conversely , real will appear Access for free at

Tracking Real over Time 153 lower in the years after 2012 , because dollars were worth more in 2012 than in later years . Let return to the question that we posed originally How much did increase in real terms ?

What was the real growth rate from 1960 to 2012 ?

To the real growth rate , we apply the formula for percentage change 2020 1960 al 100 change 100 376 In other words , the US . economy has increased real production of goods and services by nearly a factor of since 1960 . Of course , that the material improvement since it fails to capture improvements in the quality of products and the invention of new products . There is a quicker way to answer this question approximately , using another math trick . Because Nominal Price Quantity change in Nominal change in Price change in Quantity OR change in Quantity change in Nominal change in Price Therefore , real growth rate ( change in quantity ) equals the growth rate in nominal ( change in value ) minus the rate ( change in price ) Note that using this equation provides an approximation for small changes in the levels . For more accurate measures , one should use the formula . Tracking Real over Time LEARNING OBJECTIVES By the end of this section , you will be able to Explain , depressions , peaks , and troughs Evaluate the importance of tracking real over time When news reports indicate that the economy grew in the quarter , the reports are referring to the percentage change in real . By convention , governments report growth at an rate Whatever the calculated growth in real was for the quarter , we multiply it by four when it is reported as if the economy were growing at that rate for a full year . um ) if 000 DUO , 000 Real ( billions of 2009 dollars ) I ' a I I I Year FIGURE , Real in the United States in 2020 ( in 2012 dollars ) was about trillion . After adjusting to remove the effects of inflation , this represents a roughly increase in the production of goods and services since 1930 . Source )

154 The Perspective Figure 610 shows the pattern of real since 1930 . Short term declines have regularly interrupted the generally upward path of . We call a decline in real a recession . We call an especially lengthy and deep recession a depression . The severe drop in that occurred during the 19305 Great Depression is clearly visible in the , as is the Great Recession and the recession induced by in 2020 . Real is important because it is highly correlated with other measures of economic activity , like employment and unemployment . When real rises , so does employment . The most human problem associated with ( and their larger , uglier cousins , depressions ) is that a slowdown in production means that need to lay off or some of their workers . Losing a job imposes painful and personal costs on workers , and often on their extended families as well . In addition , even those who keep theirjobs are likely to that wage raises are scanty at their employers may ask them to take pay cuts . Table lists the pattern of and in the US . economy since 1900 . We call the highest point of the economy , before the recession begins , the peak . Conversely , the lowest point of a recession , before a recovery begins , is the trough . Thus , a recession lasts from peak to trough , and an economic upswing runs from trough to peak . We call the economy movement from peak to trough and trough to peak the business cycle . It is intriguing to notice that the three longest of the twentieth century have happened since 1960 . The most recent recession was caused by the pandemic . It started in February 2020 and ended formally in May 2020 . This was the most severe recession since the Great Depression , but also the shortest . The previous recession , called the Great Recession , was also very severe and lasted about 18 months . The expansion starting in June 2009 , the trough from the Great Recession , was the longest on 128 months with the recession . Trough Peak Months of Contraction Months of Expansion December 1900 September 1902 18 21 August 1904 May 1907 23 33 June 1908 January 1910 13 19 January 1912 January 1913 24 12 December 1914 August 1918 23 44 Marci 1919 January 1920 10 July 921 May 1923 18 22 July 924 October 1926 14 27 November 1927 August 1929 23 21 Marci 1933 May 1937 43 50 June 1938 February 1945 13 80 oer 1945 November 1948 37 oer 1949 July 1953 11 45 TABLE Business Cycles since 1900 ( Source ) Access for free at

Comparing among Countries Trough Peak Months of Contraction Months of Expansion May 1954 August 1957 10 39 April 1958 April 1960 24 February 1961 December 1969 10 106 November 1970 November 1973 11 36 March 1975 January 1980 16 58 July 1980 July 1981 12 November 1982 July 1990 16 92 March 1991 March 2001 120 November 2001 December 2007 73 January 2009 February 2020 128 TABLE Business Cycles since 1900 ( Source ) A private think tank , the National Bureau of Economic Research ( tracks business cycles for the economy . However , the effects ofa severe recession often linger after the official ending date assigned by the . Comparing among Countries LEARNING OBJECTIVES By the end of this section , you will be able to Explain how we can use to compare the economic welfare of different nations Calculate the conversion to a common currency by using exchange rates Calculate per capita using population data It is common to use as a measure of economic welfare or standard of living in a nation . When comparing the of different nations for this purpose , two issues immediately arise . First , we measure a country in its own currency the United States uses the dollar Canada , the Canadian dollar most countries of Western Europe , the euro Japan , the yen Mexico , the peso and so on . Thus , comparing between two countries requires converting to a common currency . A second issue is that countries have very different numbers ofpeople . For instance , the United States has a much larger economy than Mexico or Canada , but it also has almost three times as many people as Mexico and nine times as many people as Canada . Thus , if we are trying to compare standards of living across countries , we need to divide by population . Converting Currencies with Exchange Rates To compare the of countries with different currencies , it is necessary to convert to a common denominator using an exchange rate , which is the value of one currency in terms of another currency . We express exchange rates either as the units of country A currency that need to be traded for a single unit of country currency ( for example , Japanese yen per British pound ) or as the inverse ( for example , British pounds per Japanese yen ) We can use two types of exchange rates for this purpose , market exchange rates 155

156 The Perspective and purchasing power parity ( equivalent exchange rates . Market exchange rates vary on a basis depending on supply and demand in foreign exchange markets . exchange rates provide a longer run measure of the exchange rate . For this reason , economists typically use exchange rates for cross country comparisons . We will discuss exchange rates in more detail in Exchange Rates and International Capital Flows . The following Work It Out feature explains how to convert to a common currency . Converting to a Common Currency Using the exchange rate to convert from one currency to another is straightforward . Say that the task is to compare Brazil in 2020 of trillion reals with the of trillion for the same year . Step . Determine the exchange rate for the year . In 2020 , the exchange rate was reals . These numbers are realistic , but rounded off to simplify the calculations . Step . Convert Brazil into dollars Brazil in reals Brazil US Exchange rate ( trillion reals reals per 55 Step . Compare this value to the in the United States in the same year . The was trillion in 2020 , which is almost seven times that of in Brazil . Step . View Table which shows the size of and variety of of different countries in 2020 , all expressed in dollars . We calculate each using the process that we explained above . I in Billions of Domestic Domestic . Dollars ( in billions of ry Currency Equivalent ) dollars ) Brazil reals Canada dollars China yuan Egypt pounds Germany euros India rupees Japan yen Mexico pesos South Korea won TABLE Comparing Across Countries , 2020 ( Source ) Access for free at

Comparing among Countries 157 in Billions of Domestic Domestic . Dollars ( in billions of Bu ry Currency Equivalent ) dollars ) pounds Kingdom United dollars States TABLE Comparing Across Countries , 2020 ( Source ) Per Capita The economy has the largest in the world , by a considerable amount . The United States is also a populous country in fact , it is the third largest country by population in the world , although well behind China and India . Is the US . economy larger than other countries just because the United States has more people than most other countries , or because the economy is actually larger on a basis ?

We can answer this question by calculating a country per capita that is , the divided by the population . per capita The second column of Table lists the of the same selection of countries that appeared in the previous Real over Time and Table , showing their as converted into dollars ( which is the same as the last column of the previous table ) The third column gives the population for each country . The fourth column lists the per capita . We obtain per capita in two steps First , by multiplying column two ( in billions of dollars ) by 1000 so it has the same units as column three ( Population , in millions ) Then divide the result ( in millions of dollars ) by column three ( Population , in millions ) Country ( in billions of dollars ) Population ( in millions ) Per Capita ( in dollars ) Brazil Canada China Egypt Germany India Japan Mexico South Korea TABLE Per Capita , 2020 ( Source )

158 The Perspective Country ( in billions of dollars ) Population ( in millions ) Per Capita ( in dollars ) United Kingdom United States TABLE Per Capita , 2020 ( Source ) Notice that the rankings by in billions of dollars , and by per capita , are different than the ranking by each country currency . Measured by its own currency , the rupee , India has a somewhat larger than Germany . On a per capita basis in dollars , Germany has more than times India per capita on terms . CLEAR IT UP China going to surpass the United States in terms of standard of living ?

China has the largest in terms 24 trillion compared to the United States 21 trillion . But China has a much larger population so that in per capita terms , its is less than one fourth that of the United States ( compared to ) The Chinese people are still quite poor relative to the United States and other developed countries . One caveat For reasons we will discuss shortly , per capita can give us only a rough idea of the differences in living standards across countries . The world the United States , Canada , the Western European countries , and have per capita in the range of to . countries , which include much of Latin America , Eastern Europe , and some countries in East Asia , have per capita in the range of to . The world countries , many of them located in Africa and Asia , often have per capita of less than per year . How Well Measures the of Society LEARNING OBJECTIVES By the end of this section , you will be able to Discuss how productivity the standard of living Explain the limitations of as a measure of the standard of living Analyze the relationship between data and fluctuations in the standard of living The level of per capita clearly captures some of what we mean by the phrase standard of living . Most of the migration in the world , for example , involves people who are moving from countries with relatively low per capita to countries with relatively high per capita . Standard of living is a broader term than . While focuses on production that is bought and sold in markets , standard includes all elements that affect people , whether they are bought and sold in the market or not . To illuminate the difference between and standard of living , it is useful to spell out some things that does not cover that are clearly relevant to standard of living . Limitations of as a Measure of the Standard of Living measures economic activity , not all activity . As a result , economists like Kate see it as a somewhat outdated and limited indication and prosperity . While measures output of work done at home , as well as spending on travel , it does capture unpaid work or leisure time . So , two countries may have equal , but one nation workers may have an average workday of eight hours , while the other has an average workday of twelve hours . In that case , is their equal truly measuring the prosperity of those Access for free at

How Well Measures the of Society 159 nations ?

The per capita of the economy is larger than the per capita of Germany , as Table showed , but does that prove that the standard of living in the United States is higher ?

Not necessarily , since it is also true that the average worker works several hundred hours more per year more than the average German worker . Calculating does not account for the German worker extra vacation weeks . While includes what a country spends on environmental protection , healthcare , and education , it does not include actual levels of environmental cleanliness , health , and learning . includes the cost of buying equipment , but it does not address whether the air and water are actually cleaner or dirtier . includes spending on medical care , but does not address whether life expectancy or infant mortality have risen or fallen . Similarly , it counts spending on education , but does not address directly how much of the population can read , write , or do basic mathematics . includes production that is exchanged in the market , but it does not cover production that is not exchanged in the market . For example , hiring someone to mow your lawn or clean your house is part , but doing these tasks yourself is not part . One remarkable change in the economy in recent decades is the growth in womens participation in the labor force . As of 1970 , only about 42 of women participated in the paid labor force . By the second decade of the , nearly 60 of women participated in the paid labor force according to the Bureau of Labor Statistics . As women are now in the labor force , many of the services they used to produce in the economy like food preparation and child care have shifted to some extent into the market economy , which makes the appear larger even if people actually are not consuming more services . However , as points out and was explored in the chapter on the labor market , even women who are fully employed expend effort ( generally more than men ) in raising children and maintaining a home . advocates that economic measures include and goods and services , so that the status and contributors to each economy are more accurate . has nothing to say about level of inequality in society . per capita is only an average . When per capita rises by , it could mean that for everyone in the society has risen by , or that of some groups has risen by more while that of others has risen by even declined . also has nothing in particular to say about the amount of variety available . Ifa family buys 100 loaves of bread in a year , does not care whether they are all bread , or whether the family can choose from wheat , rye , pumpernickel , and many just looks at the total amount the family spends on bread . Likewise , has nothing much to say about what technology and products are available . The standard of living in , for example , 1950 or 900 was not affected only by how much money people was also affected by what they could buy . No matter how much money you had in 1950 , you could not buy an iPhone or a personal computer . In certain cases , it is not clear a rise in is even a good thing . If a city is wrecked by a hurricane , and then experiences a surge of rebuilding construction activity , it would be peculiar to claim that the hurricane was therefore economically . If people are led by a rising fear of crime , to pay for installing bars and burglar alarms on all their ows , it is hard to believe that this increase in has made them better off . Similarly , some people would argue that sales of certain goods , like pornography or extremely violent movies , do not represent a gain to society standard of living . Does a Rise in Overstate or Understate the Rise in the Standard of Living ?

The fact that per capita does not fully capture the broader idea of standard of living has led to a concern that the increases in over time are illusory . It is theoretically possible that while is rising , the standard of living could be falling if human health , environmental cleanliness , and other factors that are not included in are worsening . Fortunately , this fear appears to be overstated . In some ways , the rise in the actual rise in the standard of living . For example , the typical for a worker has fallen over the last century from about 60 hours per week to less than 40 hours per week . Life expectancy and health have risen dramatically , and so has the average level of education . Since

160 The Perspective 1970 , the air and water in the United States have generally been getting cleaner . Companies have developed new technologies for entertainment , travel , information , and health . A much wider variety of basic products like food and clothing is available today than several decades ago . Because does not capture leisure , health , a cleaner environment , the possibilities that new technology creates , or an increase in variety , the actual rise in the standard of living for Americans in recent decades has exceeded the rise in . On the other side , crime rates , congestion levels , and income inequality are higher in the United States now than they were in the . Moreover , a substantial number of services that women primarily provided in the economy are now part of the market economy that counts . By ignoring these factors , would tend to overstate the true rise in the standard of living . LINK up Visit this website ( to read about the American Dream and standards of living . is Rough , but Useful A high level should not be the only goal of policy , or government policy more broadly . Even though does not measure the broader standard of living with any precision , it does measure production well and it does indicate when a country is materially better or worse off in terms ofjobs and incomes . In most countries , a higher per capita occurs hand in hand with other improvements in everyday life along many dimensions , like education , health , and environmental protection . No single number can capture all the elements of a term as broad as standard of Nonetheless , per capita is a reasonable , measure of the standard of living . BRING IT HOME How is the Economy Doing ?

How Does One Tell ?

To determine the state of the economy , one needs to examine economic indicators , such as . To calculate is quite an undertaking . It is the broadest measure of a nation economic activity and we owe a debt to Simon , the creator of the measurement , for that . The sheer size of the . economy as measured by nominal is of the third quarter of 2021 , trillion worth of goods and services were produced annually . During the recession , which lasted just two months according to and was concentrated across Quarters and of 2020 , real dropped larger and quicker of a drop than previous economic downturn , the Great Recession ( The economy quickly bounced back , and as of Quarter . of 2021 , real had slightly surpassed the level it was at prior to the start of the pandemic . These statistics show the severity of the recession , and while real fully recovered , there are other ways in which the economy has not . While and per capita give us a rough estimate of a nation standard of living , there are many other ways to track the health of the economy . This chapter is the building block for other chapters that explore more economic indicators such as unemployment , inflation , or interest rates , and perhaps more importantly , will explain how they are related and what causes them to rise or fall . Access for free at

Key Terms 161 Key Terms business cycle the economy relatively movement in and out of recession depreciation the process by which capital ages over time and therefore loses its value depression an especially lengthy and deep decline in output double counting a potential mistake to avoid in measuring , in which output is counted more than once as it travels through the stages of production durable good good like a car or a refrigerator exchange rate the price of one currency in terms of another currency good and service output used directly for consumption , investment , government , and trade purposes contrast with intermediate good per capita divided by the population gross domestic product ( the value of the output of all goods and services produced within a country in a year gross national product ( includes what is produced domestically and what is produced by domestic labor and business abroad in a year intermediate good output provided to other businesses at an intermediate stage of production , not for users contrast with good and service inventory good that has been produced , but not yet been sold national income includes all income earned wages , rent , and income net national product ( minus depreciation nominal value the economic statistic actually announced at that time , not adjusted for contrast with real value good good like food and clothing peak during the business cycle , the highest point of output before a recession begins real value an economic statistic after it has been adjusted for contrast with nominal value recession a decline in national output service product which is intangible ( in contrast to goods ) such as entertainment , healthcare , or education standard of living all elements that affect people happiness , whether people buy or sell these elements in the market or not structure building used as residence , factory , building , retail store , or for other purposes trade balance gap between exports and imports trade exists when a nation imports exceed its exports and it calculates them as imports trade surplus exists when a nation exports exceed its imports and it calculates them as exports imports trough during the business cycle , the lowest point of output in a recession , before a recovery begins Key Concepts and Summary Size ofthe Economy Gross Domestic Product Economists generally express the size of a nation economy as its gross domestic product ( which measures the value of the output of all goods and services produced within the country in a year . Economists measure by taking the quantities of all goods and services produced , multiplying them by their prices , and summing the total . Since measures what is bought and sold in the economy , we can measure it either by the sum ofwhat is purchased in the economy or what is produced . We can divide demand into consumption , investment , government , exports , and imports . We can divide what is produced in the economy into durable goods , goods , services , structures , and inventories . To avoid double counting , counts only output of goods and services , not the production of intermediate goods or the value of labor in the chain of production .

162 Questions Adjusting Nominal Values to Real Values The nominal value of an economic statistic is the commonly announced value . The real value is the value after adjusting for changes in . To convert nominal economic data from several different years into real , data , the starting point is to choose a base year arbitrarily and then use a price index to convert the measurements so that economists measure them in the money prevailing in the base year . Tracking Real over Time Over the long term , real have increased dramatically . At the same time , has not increased the same amount each year . The speeding up and slowing down of growth represents the business cycle . When declines , a recession occurs . A longer and deeper decline is a depression . begin at the business cycles peak and end at the trough . Comparing among Countries Since we measure in a country currency , in order to compare different countries , we need to convert them to a common currency . One way to do that is with the exchange rate , which is the price of one country currency in terms of another . Once we express in a common currency , we can compare each country per capita by dividing by population . Countries with large populations often have large , but alone can be a misleading indicator of a nation wealth . A better measure is per capita . How Well Measures the of Society is an indicator of a society standard of living , but it is only a rough indicator does not directly take account of leisure , environmental quality , levels of health and education , activities conducted outside the market , changes in inequality of income , increases in variety , increases in technology , or the ( positive or negative ) value that society may place on certain types of output . Questions . Country A has export sales of 20 billion , government purchases of billion , business investment is 50 billion , imports are 40 billion , and consumption spending is billion . What is the dollar value of ?

Which of the following are included in , and which are not ?

The cost of hospital stays The rise in life expectancy over time Child care provided by a licensed day care center Child care provided by a grandmother A used car sale A new car sale The greater variety of cheese available in supermarkets The iron that goes into the steel that goes into a refrigerator bought by a consumer . 57 ?

Using data from Table how much of the nominal growth from 1980 to 1990 was real and how much was ?

Without looking at Table 67 , return to Figure . Ifwe define a recession as a decline in national output , can you identify any in addition to the recession ?

This requires a judgment call . According to Table , how often have occurred since the end of World War II ( 1945 ) According to Table , how long has the average recession lasted since the end of World War II ?

According to Table , how long has the average expansion lasted since the end of World War 11 ?

Access for free at Review Questions 163 . Is it possible for to rise while at the same time per capita is falling ?

Is it possible for to fall while per capita is rising ?

The Central African Republic has a of million francs and a population million . The exchange rate is francs per dollar . Calculate the per capita of Central African Republic . 10 . Explain whether each of the following would cause to overstate or understate the degree of change in the broad standard of living . a . The environment becomes dirtier . The crime rate declines A greater variety of goods become available to consumers Infant mortality declines Review Questions 11 . Wiat are the main components of measuring with what is demanded ?

12 . are the main components of measuring with what is produced ?

13 . ould you usually expect as measured by what is demanded to be greater than measured by hat is supplied , or the reverse ?

iy must you avoid double counting when measuring ?

is the difference between a series of economic data over time measured in nominal terms versus the same data series over time measured in real terms ?

16 . How do you convert a series of nominal economic data over time to real terms ?

17 . Wiat are typical patterns for a economy like the United States in the long run and the short run ?

18 . Wiat are the two main difficulties that arise in comparing different countries ?

19 . List some of the reasons why economists should not consider an effective measure of the standard of living in a country . Critical Thinking Questions 20 . data are among the best in the world . Given what you learned in the Clear It Up How do statisticians measure ?

does this surprise you , or does this simply the complexity ofa modern economy ?

21 . What does not tell us about the economy ?

22 . Should people typically pay more attention to their real income or their nominal income ?

If you choose the latter , why would that make sense in today world ?

Would your answer be the same for the ?

23 . Why do you suppose that is so much higher today than 50 or 100 years ago ?

24 . Why do you think that does not grow at a steady rate , but rather speeds up and slows down ?

25 . Cross country comparisons of per capita typically use purchasing power parity equivalent exchange rates , which are a measure of the long run equilibrium value of an exchange rate . In fact , we used equivalent exchange rates in this module . Why could using market exchange rates , which sometimes change dramatically in a short period of time , be misleading ?

26 . Why might per capita be only an imperfect measure of a country standard of living ?

164 Problems 27 . How might you measure a green ?

Problems 28 . 29 . 30 . 31 . 32 . 33 . Last year , a small nation with abundant forests cut down 200 worth of trees . It then turned 100 worth of trees into 150 worth of lumber . It used 100 worth of that lumber to produce 250 worth of bookshelves . Assuming the country produces no other outputs , and there are no other inputs used in producing trees , lumber , and bookshelves , what is this nation ?

In other words , what is the value of the goods the nation produced including trees , lumber and bookshelves ?

The prime interest rate is the rate that banks charge their best customers . Based on the nominal interest rates and rates in Table , in which of the years would it have been best to be a lender ?

Based on the nominal interest rates and rates in Table , in which of the years given would it have been best to be a borrower ?

Year Prime Interest Rate Inflation Rate 1970 1974 1978 1981 TABLE A mortgage loan is a loan that a person makes to purchase a house . Table provides a list of the mortgage interest rate for several different years and the rate of for each of those years . In which years would it have been better to be a person borrowing money from a bank to buy a home ?

In which years would it have been better to be a bank lending money ?

Year Mortgage Interest Rate Inflation Rate 1984 1990 10 2001 TABLE Ethiopia has a of billion ( measured in dollars ) and a population of 55 million . Costa has a of billion ( measured in US . dollars ) and a population of million . Calculate the per capita for each country and identify which one is higher . In 1980 , Denmark had a of 70 billion ( measured in dollars ) and a population of million . In 2000 , Denmark had a of 160 billion ( measured in dollars ) and a population of million . By what percentage did Denmark per capita rise between 1980 and 2000 ?

The Czech Republic has a of billion . The exchange rate is 25 . dollar . The Czech population is 20 million . What is the per capita of the Czech Republic expressed in US . dollars ?

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