single pg chapter opener, full text 4/c design

1. 2
Production,
Economic Growth
and Trade
“
We live in a consumer world. Everywhere you look people are purchasing and
consuming things. Everything from plastic wrap to baseballs, from artichokes to cellular
phones, gets produced, traded, and consumed. Whether an economy is a capitalistic mar-
ket economy as in the United States, a capitalist marketplace with a strong touch
“
of socialism as in many European countries, or a predominately communist
economy as is true of many of China’s markets, goods and services must
The ideas of economics and political philosophers,
change hands. Several centuries ago, individuals produced most of what
they consumed. Today, most of us produce little of what we consume.
both when they are right and when they are wrong,
Instead we work at specialized jobs, and then use our wages to purchase the
goods we need. And purchase we do. are right and when they are wrong, are more
Though newspapers frequently report consumption excesses—and
powerful than is commonly understood. Indeed, the
these excesses occur in rich and poor countries around the globe—we
should not let these excesses obscure the fact that consumption is a great world is ruled by little else. I am sure that the power
driver of economic growth. In many respects, consumption is simply a way
of vested interests isvastly exaggerated
for people to better themselves, to make their lives less of a drudgery or to
enrich their lives. Farmers in poor countries move from a precarious exis-
compared to the gradual encroachment of ideas.
tence as subsistence farmers to producers of cash crops—keeping enough to
live on but generating a surplus to sell—in order to obtain those consump- —John Maynard Keynes
tion goods that better their lives.
Another great driver of economic growth is technological change. In
1950, only a small minority of households had television sets. Today, nearly every home has
at least one color television set, and the average home has nearly three! In response to the
resulting change in demand for programming, channels have multiplied; programming
choices are almost limitless. But what brought about these changes in the first place?
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2. 28 29
Chapter 2 Production, Economic Growth and Trade
Technological advances from 1950 through the present day have led to cheaper, higher perfor- BASIC ECONOMIC QUESTIONS AND PRODUCTION
mance television sets. This has allowed more families to afford, not just one TV, but flat screen
After studying this
HDTVs with huge screens and theater quality surround sound that are a fraction of the weight
chapter you should Regardless of the country, its circumstances, or its precise economic structure, every econ-
and size of older sets. New devices permit viewers to record and watch programs at their leisure. omy must answer three basic questions.
be able to:
Technological advances have similarly led to a telecommunications industry that sim-
ply was not dreamed of fifty years ago. In 1950, long distance phone calls were placed with
Describe the three basic questions
Basic Economic Questions
the assistance of live operators, every minute costing the average consumer several hours’
that must be answered for any
worth of pay. Today, fiber-optic cables allow thousands of calls to be made on one cable,
economy.
The three basic economic questions that each society must answer are:
thus drastically reducing the cost of telephone service. Cell phones, meanwhile, have
Describe production and the
become business necessities because of their convenience and productivity. The globe is What goods and services are to be produced?
I
factors that go into producing
shrinking as communications bring us closer together. How are these goods and services to be produced?
various goods and services. I
Another factor reducing the size of the world is airline travel. Fifty years ago, few peo-
Who will receive these goods and services?
I
Describe the opportunity cost an ple flew cross-country or overseas. Jets were nonexistent, tickets were expensive—the
economy incurs to increase the equivalent of a month’s wages to fly coast to coast—and flights took forever. Today, because The response an economy makes to the first question—What to produce?—depends on the
production of one product. of technological change, jet aircraft can whisk us across the country or overseas at a price goods and services a society wants. In a communist state, the government will decide what
well within the budgets of most Americans.
Use a production possibilities a society wants, but in a capitalist economy consumers are allowed to signal what products
A further driver of economic growth—trade—is less obvious. Yet its effect is clear.
frontier (PPF) or curve to analyze they want by way of their demands for specific commodities. In the next chapter, we will
Nearly every country engages in commercial trade with other countries to expand the
the limits of production. investigate how the consumer demand for individual products is determined and how
opportunities for consumption and production by its people. As products are consumed, markets meet these demands. For now, we will assume that consumers, individually and as
Describe economic growth and the new products must be produced, so increased consumption in one country can spur eco- a society, are able to decide on the mix of goods and services they most want, and that pro-
impacts of expanding resources nomic growth in another. Given the ability of global trade to open economic doors and ducers supply these items at acceptable prices.
through increasing human raise incomes, it is vital for growth in developing nations. Once we know what goods a society wants, the next question its economic system
resources, capital accumulation, In the previous chapter we noted that a reduction in America’s growth rate of only 1 must answer is how these goods and services are to be produced. In the end, this problem
and technological improvements. percentage point each year since 1930 would have significant consequences today. Figure 1 comes down to the simple question of how labor, capital, and land should be combined to
shows real (adjusted for inflation) Gross Domestic Product (GDP) since 1930 and real
Describe the concepts of absolute produce the desired products. If a society demands a huge amount of corn, say, we can
GDP if the rate of growth was just 1 percentage point less. As the graph shows, real GDP
and comparative advantage and expect its utilization of land, labor, and capital will be different from a society that demands
would be roughly half today. One important point to get from the graph is that the 1 per-
explain what they tell us about the digital equipment. But even an economy devoted to corn production could be organized in
centage point reduction had minimal impact for the first 20 years or so, but the impact
gains from trade when countries different ways, perhaps relying on extensive use of human labor, or perhaps relying on
widens as time marches forward. Policies that affect economic growth today and in the
specialize in certain products. automated capital equipment.
future have their biggest impact several generations later. Once an economy has determined what goods and services to produce and how to
Describe the practical constraints
This chapter will give you a framework for understanding economic growth. It pro- produce them, it is faced with the distribution question: Who will get the resulting prod-
on free trade and how some
vides a simple model for thinking about production, and then applies this model to ucts? Distribution refers to the way an economy allocates the goods and services it produces
industries might be affected. Figure 3
economiesElasticity of so you will know how to think about economic growth and its determi-
at large Demand and Total Revenue to consumers. In a capitalist economy, most products are distributed through private mar-
nants. It then goes on to analyze international trade as a special case of economic growth. kets. In a socialist economy, many goods are produced in state-owned facilities.
By the time you finish this chapter, you should understand the importance of economic Theoretically, governments in socialist economies use tax monies to subsidize producers,
growth and what drives it. To start, we turn to an examination of the three basic questions to consumers. In a capitalist economy, most products are distributed through private
that every economy, no matter how it is organized, must solve. P r o d u c t i o n : the process of converting
maron their efficiency and the quality of their products.
resources (factors of production) -- land,
labor, capital, and entrepreneurial ability -
- into goods and services.
Panel A Resources, Production and Efficiency
Panel B
Total Revenue and Relatively Inelastic Demand Total Revenue and Relatively Elastic Demand
R e s o u r c e s : Productive resources
Having answered the three basic economic questions, let’s take a look at the production
include land (land and natural resources),
process. Production involves turning resources into products and services that people want.
labor (mental and physical talents of peo-
Let’s begin our discussion of this process by examining the scarce resources used to pro- ple), capital (manufactured products used
5 5 duce goods and services.
Revenue Gained to produce other products), and entre-
preneurial ability (the combining of the
Revenue Gained
b
Land other factors to produce products and
4
4
assume the risk of the business).
b For economists, the term land includes both land in the usual sense, but it also includes all
other natural resources that are used in production. Natural resources like mineral
3 3 L a n d : Includes natural resources such as
Price
Price
deposits, oil and natural gas, and water are all included by economists in the definition of mineral deposits, oil, natural gas, water
c
c a
a and land in the usual sense of the word.
land. Economists refer to the payment to land as rents.
2 2
The payment to land as a resource is
D
called rents.
D
Labor
1 1
L a b o r : Includes the mental and physical
Revenue Lost Labor as a factor of production includes both the mental and physical talents of people. Few
Revenue Lost
talents of individuals that are used to pro-
goods and services can be produced without labor resources. Improvement to labor capabili-
duce products and services. Labor is
ties from training, education, and apprenticeship programs, typically called human capital, all
0 100 200 300 400 500 600
0 100 200 300 400 500 600 paid wages.
add to labor’s productivity and ultimately to a higher standard of living. Labor is paid wages.
Quantity
Quantity

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Chapter 2 Production, Economic Growth and Trade
ing 2,000 microcomputers and 4,000 jackets. Clearly some resources are not being used—
CASE STUDY
Application Issue: Increasing Opportunity Costs
unemployment exists. When fully employed, the economy’s resources could produce more
of both goods (point d).
I n m o s t c a s e s , land, labor, and capital cannot easily be shifted from producing one
Because the PPF represents a maximum output, the economy could not produce 4,000
microcomputers and still produce 10,000 leather jackets. This situation, shown by point h, good or service to another. You cannot take a semi-truck and use it to plow a farm field, even
lies to the right of the PPF and hence outside the realm of possibility. Anything to the right
though the semi and a top-notch tractor cost about the same money. The fact is that some
of the PPF is impossible for our economy to attain; all points along the curve represent full
resources are suited to specific sorts of production, just as some people seem to be better
employment.
suited to performing one activity over another. Some people have a talent for music or art,
Opportunity Cost and they would be miserable—and inefficient—working as accountants or computer pro-
Whenever a country reallocates resources to change production patterns, it does so at a grammers. Some people find they are more comfortable working outside, while others require
price. This price is called opportunity cost. Opportunity cost is the price an economy or an
the amenities of an environmentally controlled, ergonomically correct office.
individual must pay, measured in units of one product, to increase its production (or con-
Thus, a more realistic production possibilities frontier is shown in Figure 3. This PPF
sumption) of another product. In moving from point b to point e in Figure 2, microcom-
puter production increases by 3,000 units, from 1,000 units to 4,000 units. In contrast, our curve is bowed out from the origin since opportunity costs rise as more factors are used to
country must forego producing 6,000 leather jackets because production falls from 10,000 produce increasing quantities of one product. Let us consider why this is so.
Pro d u c t i o n : the process of converting jackets to 4,000 jackets. Giving up 6,000 jackets for 3,000 more computers represents an
Let’s begin at a point where the economy’s resources are strictly devoted to leather jack-
resources (factors of production) -- land, opportunity cost of 6000 jackets, or of 2 jackets for each microcomputer.
labor, capital, and entrepreneurial ability - et production (point a). Now assume that society decides to produce 3,200 microcomputers.
Opportunity cost thus represents the trade-off required when an economy wants to
- into goods and services.
increase its production of any single product. Governments must choose between guns and This will require a move from point a to point b. As we can see, 2,000 leather jackets must be
butter, or between military spending and social spending. Since there are limits to what tax-
Re s o u rc e s : Productive resources given up to get the added 3,200 microcomputers. This means the opportunity cost of 1 micro-
include land (land and natural resources), payers are willing to pay, spending choices are necessary. Think of opportunity costs as
computer will be .625 leather jackets (2,000 ÷ 3,200 = 0.625). This is a low opportunity cost,
labor (mental and physical talents of peo- what you or the economy must give up to have more of a product or service.
ple), capital (manufactured products used because those resources that are better suited to producing microcomputers will be the first
When the electric light bulb was invented, it not only created a new industry (some-
to produce other products), and entre-
one had to produce light bulbs), but it also revolutionized other industries. Factories could ones shifted into this industry, resulting in rapidly increasing returns from specialization.
preneurial ability (the combining of the
stay open longer since they no longer had to rely on the sun for light. Workers could see
other factors to produce products and But what happens when this society decides to produce an additional 2,000 computers,
assume the risk of the business). better, thus improving the quality of their work. The result was that resources operated
or moves from point b to point c on the graph? As Figure 3 illustrates, each additional com-
more efficiently throughout the entire economy.
puter costs 2 leather jackets since producing 2,000 more computers requires the society to
The modern day equivalent to the light bulb might be the cellular phone. Widespread
use of these devices enables people all across the world to produce goods and services more sacrifice 4,000 leather jackets. Thus, the opportunity cost of computers has more than tripled
efficiently. Insurance agents can file claims instantly from disaster sites, deals can be closed due to diminishing returns on the computer side, which arise from the unsuitability of these
while one is stuck in traffic, and communications have been revolutionized. Thus, this new
new resources as more resources are shifted to microcomputers.
technology has ultimately expanded time, the most finite of our resources. A similar argu-
To describe what has happened in plain terms, when the economy was producing 12,000
ment could be made for the internet. It has profoundly changed how many products are
bought, sold, and delivered, and has expanded communications and the flow of information. leather jackets, all its resources went into jacket production. Those members of the labor
force who are engineers and electronic assemblers were probably not well suited to produc-
Expanding Resources
ing jackets. As the economy backed off of jackets to start producing microcomputers, the
The production possibilities frontier represents the constraints on an economy at a specific
opportunity cost of computers was low, since the resources first shifted, including workers,
time. But economies are constantly changing, and so are PPFs. Capital and labor are the prin-
were likely to be the ones most suited to computer production and least suited to jacket man-
cipal resources that can be changed through government action. Land and entrepreneurial
talent are important factors of production, but neither is easy to change by government poli- ufacture. Eventually, however, as computers became the dominant product, manufacturing
cies. The government can make owning a business easier or more profitable by reducing reg- more computers required shifting leather workers to the computer industry. Employing these
ulations, or by offering low-interest loans or favorable tax treatment to small businesses.
less suitable resources drives up the opportunity costs of computers.
However, it is difficult to turn people into risk-takers through government policy.
Increasing Labor and Human Capital A clear increase in population, the number of
households, or the size of the labor force will shift the PPF outward, as shown in Figure 4.
training fit into this category. Improving human capital means people are more productive,
With added labor, the production possibilities available to the economy expand from PPF0
resulting in higher wages, a higher standard of living, and an expanded PPF for society.
to PPF1. Such a labor increase can be caused by higher birthrates, increased immigration,
or an increased willingness of people to enter the labor force. This last type of increase has
Capital Accumulation Increasing the capital used throughout the economy, usually
occurred over the past several decades as more women have entered the labor force on a
brought about by investment, would similarly shift the PPF outward as shown in Figure 4.
permanent basis. America’s high immigration (legal and illegal) fuels our strong rate of
Additional capital makes each unit of labor more productive and thus results in higher pos-
economic growth.
sible production throughout the economy. Adding robotics and computer controlled
Rather than simply increasing the number of people working, however, the labor factor
machines to production lines, for instance, means each unit of labor produces many more
can also be increased by improving workers’ skills. Economists refer to this as investment in
units of output.
human capital. Activities such as education, on-the-job training, and other professional

4. 36 37
Chapter 2 Production, Economic Growth and Trade
ical improvements as we have been discussing in this chapter. It then looked at some ben-
Karl Marx (1818–1883) efits from good government policies that stimulate growth, and finally examined the indus-
try and individual firm level for clues to the microeconomic sources of growth. Some of
the findings include:
A one percentage point increase in business investment as a percent
I
nomics in the Road to Serfdom is, if anything, more
All societies have to
of Gross Domestic Product (GDP) would lead to an increase in per
widely read today than it was in 1940, the year of
answer the three basic
capita GDP of 1.3 percent.
publication. Hayek attributed failures in socialism to
economic questions. The
An additional one-year increase in average education levels
I
an inefficient use of knowledge and information.
1974 Nobel-prize winners
increases per capita GDP by 4 to 7 percent.
Central planners, in his view, were no match for the
Friedrich von Hayek and
A 0.1 percentage point increase in research and development as a
pricing mechanism as a means of communicating
Gunnar Myrdal proposed I
percent of GDP increases per capita GDP by 1.2 percent.
information. The pricing system evolved sponta-
very different answers.
neously from the interplay of individuals with limited
Karl Marx was the fore- Reducing both the level and variability of inflation by one percent-
I
and particular information. A decentralized system
most advocate of free age point leads to an increase in per capita GDP of 2.3 percent.
with competition and price freedom, therefore, was
markets and classical eco-
A 1 percentage point increase in the tax burden as a percent of GDP
I
the most efficient and socially beneficial way to
nomics during the heyday
leads to a 0.3 percent reduction in per capita GDP.
organize an economy. He also saw markets as
of the Keynesian revolution. Born in 1899, Hayek
An increase in trade exposure ( a combined measure of imports
I
advancing human liberty and freedom.
was the son of a botanist. After serving in World
and exports as a percent of GDP) of 10 percentage points increas-
In contrast to Hayek, Swedish economist and
War I, he studied law and political science at the
es per capita GDP by 4 percent.
sociologist Gunnar Myrdal argued for a different
University of Vienna, later joining a group of young
way to organize an economy. He advocated a more
academics in a private seminar conducted by the
active role for government. Myrdal established his
eminent economist Ludwig von Mises. From 1932
The Gains from Trade
reputation with the 1944 publication of his book on
until his death in 1992, Hayek taught at several
race relations in the United States, An American
schools including the London School of Economics To see how specialization and trade can benefit both trading partners, even when one has
Dilemma. Considered a classic of social scientific
and the University of Chicago. the ability to produce more of both goods than the other, assume each country is at first
literature, the work has been compared to Alexis de
Hayek’s early work was primarily concerned (before trade) operating at point a in Figure 7. At this point, both countries are producing
Tocqueville’s Democracy in America. Myrdal’s criti-
with business cycles. Hayek argued that economic and consuming only their own output; the U.S. produces and consumes 20 million barrels
cisms of the doctrine of “separate but equal” had a
booms could lead to financial conditions in which of oil and 20 million computer chips, Mexico 5 million barrels of oil and 2 million com-
major influence on the 1954 Supreme Court ruling
investment exceeded savings, resulting in a mis- puter chips. Table 1 summarizes these initial conditions. When the United States signed the
in “Brown v. Board of Education,” which outlawed
match between consumption and output and, con- North American Free Trade Agreement with Canada and Mexico, many people experienced
segregation in public schools.
sequently, an economic contraction while a balance what we have just been discussing. Some American jobs went south to Mexico because of
Born in Sweden in 1898, Myrdal received his
between the two was being achieved. Hayek low production costs. By opening up more markets for American products, however,
degree in law and economics in 1927 from Stfor the
viewed this “concertina effect” as the primary NAFTA did stimulate economic growth, such that retrained workers may end up with new
Twentieth Century Fund, which led to the book,
explanation for business cycles. He was one of the and better jobs.
Asian Drama: An inquiry into the Poverty of Nations
few economists of his era to predict the Great
and the Challenge of World Poverty, where he
Depression.
advocated a major role for government in directing
After the mid-1930s, Hayek focused on cri- TABLE 1 Initial Consumption-Production Pattern
economies. Myrdal died in 1987.
tiques of socialism and centralist economic plan-
U.S. Mexico Total
ning. His impassioned defense of libertarian eco-
Oil 20 5 25
Chips 20 2 22
As you can see, there are many ways to stimulate economic growth. A society can
expand its output by using more resources, perhaps encouraging more people to enter the
Economic growth in the United States has slowed over the second half of the twentieth
work force or raising educational levels of workers. The government can encourage people
century, but our standard of living has nonetheless risen dramatically. Expansion of our sug-
to invest more, as opposed to devoting their earnings to immediate consumption. The pub-
gests. Women have entered the work force in droves, immigration has expanded, and tech-
lic sector can spur technological advances by providing incentives to private firms to do
nd consuming only their own output; the U.S. produces and consumes 20 million barrels
research and development or underwrite research investments of its own.
of oil and 20 million computer chips, Mexico 5 million barrels of oil and 2 million com-
puter chips. Table 1 summarizes these initial conditions. When the United States signed the
Estimating the Sources of Economic Growth nology has advanced by leaps and bounds, thus spurring the production of more goods and
services. Expanding global trade has opened up new markets for our products and increased
But just how important are each of these factors? A recent study by the Organization for
imports from areas with lower production costs. These developments have contributed to
Economic Co-operation and Development focused on what has been driving economic
nology has advanced by leaps and bounds, thus spurring the production of more goods and
growth in 21 nations over the last several decades. The study first looked at contribution to
America’s economic growth and improved the economic welfare of its people.
economic growth from the macroeconomic perspective of added resources and technolog-