Thomas Tatro's List: ECON TCO1

• The other measure of GDP is the expenditure approach (or  production approach, or output approach). There are four components of GDP  using this approach--consumption, investment, and government spending. The  National Accounting Tutorial describes clearly how these components make up  GDP.

   

  Look closely at the definition of GDP--GDP is  the total market value of all final goods and services  produced within an economy in a given year. Several key  phrases are highlighted in this definition:

   

  Total Market Value measures GDP in monetary terms. All  goods and services are multiplied by their prices to arrive at GDP.

   

  Final Goods and Services are the only goods and  services that get counted towards GDP, as opposed to intermediate goods and  services. This is because we want to avoid multiple counting. Intermediate goods  are goods that are used up in the production process. Oranges purchased by  Tropicana to make orange juice are intermediate goods. Those oranges do not get  counted towards GDP. The orange juice is the final product and that is what gets  counted in GDP. If we counted the oranges AND the orange juice, we would have  double counted and end up overstating GDP.

   

  As the name gross domestic product implies, GDP  measures only Domestic Production – i.e. goods produced  within an economy, say the U.S. economy. In the U.S., consumers,  business firms, and government import goods from Mexico, China, India, Canada,  and other countries. So C, I, and G include imported cars, imported food,  imported clothes, and so on. These goods were produced in other countries using  the factors of production of those countries. They do not belong in U.S. gross  domestic product, so we need to subtract them out. Similarly, some goods are  produced in the U.S. using U.S. CELL but end up being exported out of the U.S.  to other countries. These goods must be added back into GDP. The net exports  component of GDP, Xn, handles this.

   

  Only goods produced in a given year must be included in  GDP. GDP for 2011 should only include goods produced in 2011. So, all used items  that are resold do not count in GDP. The house that was manufactured in 2004 and  resold in 2011 does not get counted in 2011 GDP because it was already counted  in GDP in 2004. Counting it again in 2011 would result in multiple counting.  However, if upgrades were made to the house in 2011 before it was resold (e.g.  adding a sunroom or patio), those additions would get counted in GDP.

• GDP is calculated by multiplying market prices and quantities of  goods and services. Nominal GDP uses current prices to measure the market value  of goods and services while real GDP uses a constant or base year price to  measure the market value of goods and services. If we want to compare economic  growth from one year to another, what measure should we look at: nominal GDP or  real GDP? We need to use real GDP because we know that prices change from year  to year. If we use nominal prices which change from year to year, GDP would  change even when quantities of goods and services remain the same. Let's  illustrate using a simple example.

                    

  Year	Bicycles		Milk		Nominal GDP
  2009	$20	50	$3.00	100	$1300
  2010	$30	50	$4.00	100	$1900

   

  Let's say a country produces only two goods--bicycles and milk.  The market value for both goods in 2009 was $20 * 50 + $3.00 * 100 = $1300. The  market value for both goods in 2010 when prices went up is $30 * 50 + $4 *100 =  $1900. Nominal GDP increased from $1300 to $1900 even though the quantity of  bicycles and milk remained the same. Reporting nominal GDP growth  rate would show that nominal GDP grew 46% between 2009 and  2010. We have to use the growth rate formula [1900-1300/1300X100] to find  the growth rate.
  
  Now, let's calculate the market value  of these goods using constant prices--that is, real GDP. Let's make 2009  our base year and so we use 2009 prices for both 2009 and 2010 GDP calculations.  

                    

  Year	Sandwiches		Bottled Water		Real GDP Using 2009 base year  prices
  2009	$20	50	$3.00	100	$1300
  2010	$20	50	$3.00	100	$1300

   

  We can see that the growth of real GDP does not change from 2009  to 2010 because production did not change. If you use nominal GDP, you may get  excited that GDP has increased 46% but when you use the real GDP, it is clear to  see that what really matters (production) has not changed and real GDP has grown  by 0%. What really matters is the real value and not the nominal value. So real  GDP is a better measure of economic growth.

• The economic perspective focuses largely on marginal  analysis—comparisons of marginal benefits and marginal costs, usually  for decision making. To economists, “marginal” means “extra,” “additional,” or  “a change in.” Most choices or decisions involve changes in the status quo,  meaning the existing state of affairs.

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  • • Generalizations Economic principles are generalizations  relating to economic behavior or to the economy itself. Economic principles are  expressed as the tendencies of typical or average consumers, workers, or  business firms. For example, economists say that consumers buy more of a  particular product when its price falls. Economists recognize that some  consumers may increase their purchases by a large amount, others by a small  amount, and a few not at all. This “price-quantity” principle, however, holds  for the typical consumer and for consumers as a group.
   
  • • Other-things-equal  assumption In constructing their theories, economists use the ceteris paribus or other-things-equal  assumption—the assumption that factors other than those being considered  do not change. They assume that all variables except those under immediate  consideration are held constant for a particular analysis. For example, consider  the relationship between the price of Pepsi and the amount of it purchased.  Assume that of all the factors that might influence the amount of Pepsi  purchased (for example, the price of Pepsi, the price of Coca-Cola, and consumer  incomes and preferences), only the price of Pepsi varies. This is helpful  because the economist can then focus on the relationship between the price of  Pepsi and purchases of Pepsi in isolation without being confused by changes in  other variables.  
     

    ORIGIN OF THE IDEA

     

    O 1.4

     

    Ceteris paribus

   
  • • Graphical  expression Many economic models are expressed graphically. Be sure to  read the special appendix at the end of this chapter as a review of  graphs.

• Conclusion: Economic growth is the result of (1) increases in supplies of  resources, (2) improvements in resource quality, and (3) technological advances.  The consequence of growth is that a full-employment economy can enjoy a greater  output of both consumption goods and capital goods.

• Exchange can, and sometimes does, occur through barter—swapping  goods for goods, say, wheat for oranges. But barter poses serious problems  because it requires a coincidence of wants between the buyer  and the seller.

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  AFTER  READING THIS CHAPTER, YOU SHOULD BE ABLE TO:
   
   
  • 1 Define economics and the features of the  economic perspective.
   
  • 2 Describe the role of economic theory in  economics.
   
  • 3 Distinguish microeconomics from  macroeconomics and positive economics from normative economics.  
   
  • 4 List the categories of scarce resources  and delineate the nature of the economizing problem.
   
  • 5 Apply production possibilities analysis,  increasing opportunity costs, and economic growth.
   
  • 6 Explain how economic growth and  international trade increase consumption possibilities.
   
  • 7 (Appendix) Understand graphs, curves,  and slopes as they relate to economics.
• This unyielding truth underlies the definition of economics, which  is the social science concerned with how individuals, institutions, and society  make optimal (best) choices under conditions of scarcity

• economic principle

   

   

  A widely accepted generalization about the economic behavior of  individuals or institutions

• Economists call such sacrifices opportunity costs:  To obtain more of one thing, society forgoes the opportunity of getting the next  best thing. That sacrifice is the opportunity cost of the choice.
• “Purposeful behavior” simply means that people make decisions with some desired  outcome in mind.

• Positive economics concerns what is, whereas normative  economics embodies subjective feelings about what ought to be.
• Positive economics concerns what is, whereas normative  economics embodies subjective feelings about what ought to be
• Microeconomics is  the part of economics concerned with decision making by individual customers,  workers, households, and business firms. At this level of analysis, we observe  the details of their behavior under a figurative microscope
• Positive  economics focuses on facts and cause-and-effect relationships. It  includes description, theory development, and theory testing. Positive economics  avoids value judgments. It tries to establish scientific statements about  economic behavior and deals with what the economy is actually like. Such  scientific-based analysis is critical to good policy analysis

• Macroeconomics examines either the economy as a whole or its  basic subdivisions or aggregates, such as the government, household, and  business sectors. An aggregate is a  collection of specific economic units treated as if they were one unit.  Therefore, we might lump together the millions of consumers in the U.S. economy  and treat them as if they were one huge unit called “consumers.”
• Figuratively, macroeconomics looks at the beach, not the pieces of sand, the  rocks, and the shells
• Economic policy, on the other hand, involves normative  economics, which incorporates value judgments about what the economy  should be like or what particular policy actions should be recommended to  achieve a desirable goal. Normative economics looks at the desirability of  certain aspects of the economy.

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• Our example illustrates the law of increasing  opportunity costs. As the production of a particular good increases, the  opportunity cost of producing an additional unit rises.

• Society must assess the marginal benefit (MB) and marginal cost (MC) of  additional defense goods to determine their optimal amounts—where to locate on  the defense goods–civilian goods production possibilities curve

• In pure capitalism—or laissez-faire  capitalism—government’s role would be limited to protecting private property and  establishing an environment appropriate to the operation of the market system.
• The command system is  also known as socialism or communism. In a  command system, government owns most property resources and economic decision  making occurs through a central economic plan. A central planning board  appointed by the government makes nearly all the major decisions concerning the  use of resources, the composition and distribution of output, and the  organization of production

• Every society needs to develop an economic system—a  particular set of institutional arrangements and a coordinating mechanism—to  respond to the economizing problem. The economic system has to determine what  goods are produced, how they are produced, who gets them, how to accommodate  change, and how to promote technological progress.

   

  Economic systems differ as to (1) who owns the factors of production  and (2) the method used to motivate, coordinate, and direct economic activity.  Economic systems have two polar extremes: the command system and the market  system.
• The polar alternative to the command system is the market system, or capitalism. The system is  characterized by the private ownership of resources and the use of markets and  prices to coordinate and direct economic activity. Participants act in their own  self-interest. Individuals and businesses seek to achieve their economic goals  through their own decisions regarding work, consumption, or production

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• But in the capitalism practiced in the United States and most other countries,  government plays a substantial role in the economy. It not only provides the  rules for economic activity but also promotes economic stability and growth,  provides certain goods and services that would otherwise be underproduced or not  produced at all, and modifies the distribution of income. The government,  however, is not the dominant economic force in deciding what to produce, how to  produce it, and who will get it.

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  • • Freedom of  enterprise ensures that entrepreneurs and private businesses are free to  obtain and use economic resources to produce their choice of goods and services  and to sell them in their chosen markets.
   
  • • Freedom of choice  enables owners to employ or dispose of their property and money as they see fit.  It also allows workers to try to enter any line of work for which they are  qualified. Finally, it ensures that consumers are free to buy the goods and  services that best satisfy their wants and that their budgets allow.  

• QUICK REVIEW 2.1

   
   
  • • The market  system rests on the private ownership of property and on freedom of enterprise  and freedom of choice.
   
  • • Property  rights encourage people to cooperate and make mutually agreeable economic  transactions.
   
  • • The market  system permits consumers, resource suppliers, and businesses to pursue and  further their self-interest.
   
  • • Competition  diffuses economic power and limits the actions of any single seller or  buyer.
   
  • • The  coordinating mechanism of capitalism is a system of markets and  prices
• A market is an  institution or mechanism that brings buyers (“demanders”) and sellers  (“suppliers”) into contact. A market system conveys the decisions made by buyers  and sellers of products and resources

• specialization is  extraordinary. Specialization means using the resources of an individual, firm,  region, or nation to produce one or a few goods or services rather than the  entire range of goods and services. Those goods and services are then exchanged  for a full range of desired products.

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  QUICK REVIEW 2.2
   
   
  • • The market  systems of modern industrial economies are characterized by extensive use of  technologically advanced capital goods. Such goods help these economies achieve  greater efficiency in production.
   
  • • Specialization is extensive in market systems; it enhances efficiency  and output by enabling individuals, regions, and nations to produce the goods  and services for which their resources are best suited.
   
  • • The use of  money in market systems facilitates the exchange of goods and services that  specialization requires.

• The key features of the market system help explain how market  economies respond to five fundamental questions:

   

   

   

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  What goods and services will be produced?

   

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  How will the goods and services be produced?

   

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  Who will get the goods and services?

   

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  How will the system accommodate change?

   

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  How will the system promote progress?