Eastlake High School Chapter 4 & 6 Gross National Product Discussion

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Instructions: Post a significant sentence from each chapter 4-6. And please explain why it is a significant sentence. 

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CHAPTER 4
The Aggregate Economy
FUNDAMENTAL QUESTIONS
1. What is the private sector?
2. What is a household, and
what is household income
and spending?
Dimas Ardian/Bloomberg/Contributor/Getty Images
3. What is a business firm, and
what is business spending?
4. How does the international
sector affect the economy?
5. What is the public sector?
What is public sector
spending?
6. How do the private and
public sectors interact?
Preview
top: ! Carsten Reisinger/Shutterstock
If there is a point on which most economists agree, it is that trade among nations makes
the world better off. When a firm or an individual buys a good or a service produced
more cheaply abroad, the firm or individual benefits. The good is cheaper, thereby leaving them with more income to spend elsewhere; the product may better fit their needs
than similar domestic offerings; or the good may not be available domestically. The foreign producer also benefits by making more sales than it could selling solely in its own
market and by earning foreign exchange (currency) that can be used by itself or others in
the country to purchase foreign-made products.
65
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66
Chapter 4 The Aggregate Economy
When we discuss international trade, it is not typically the individual buyer or seller
microeconomics
The study of economics using
the individual – individual
consumer, individual firm.
macroeconomics
The study of economics using
aggregate sectors –
households, businesses,
government, and the foreign
sector.
we are talking about. It is, instead, the country as a whole or specific sectors of economies such as the household, business, or government sector. When economists examine individual markets, individual buyers, and individual sellers, they are engaging in
microeconomics. When they look at how the aggregate sectors of the economy and
other economies interact, they are involved with macroeconomics. In this chapter we
introduce the aggregate sectors of an economy.
4-1 The Private Sector
household
One or more persons who
occupy a unit of housing.
Buyers and sellers of goods and services and resource owners are linked together in an economy and across economies. For every dollar someone spends, someone else receives a dollar
as income. For instance, suppose you decide to buy a new Toyota, so you go to a Toyota
dealer and exchange money for the car. The Toyota dealer has rented land and buildings
and hired workers in order to make cars available to you and other members of the public.
The employees earn incomes paid by the Toyota dealer and then use those incomes to buy
food from the grocery store. This transaction generates revenue for the grocery store, which
hires workers and pays them incomes that they then use to buy groceries and Toyotas.
Your Toyota may have been manufactured in Japan and then shipped to the United
States before it was sold by the local Toyota dealer. Your purchase of the Toyota thus creates
revenue for both the local dealer and the manufacturer, which pays autoworkers to assemble
the cars. When you buy your Toyota, you pay a sales tax, which the government uses to support its expenditures on police, fire protection, national defense, the legal system, and other
services. In short, many people in different areas of the economy are involved in what seems
to be a single transaction.
The aggregate sectors involved are the household sector, the business sector, and the
foreign sector. We classify the buyers and the resource owners into the household sector; the
sellers or business firms are the business sector; households and firms in other countries,
who may also be buyers and sellers of this country’s goods and services, are the international
sector. These three sectors—households, business firms, and the international firms and consumers—constitute the private sector of the economy. The private sector refers to any part
of the economy that is not part of government. The public sector refers to the government,
government spending and taxing, and government-sponsored and government-run entities.
The relative sizes of private and public sectors vary from economy to economy. The market
economies tend to have smaller public sectors relative to the total economy than do the
more socialist or centrally planned economies.
consumption
Household spending.
4-1a Households
1. What is the private sector?
private sector
Households, businesses, and
the international sector.
public sector
The government.
NOW YOU TRY IT
What is the difference
between the “private” sector
and the “public” sector?
2. What is a household, and
what is household income
and spending?
A household consists of one or more persons who occupy a unit of housing. The unit of
housing may be a house, an apartment, or even a single room, as long as it constitutes separate living quarters. A household may consist of a single person, related family members, like
a father, mother, and children, or it may comprise unrelated individuals, like three college
students sharing an apartment. The person in whose name the house or apartment is owned
or rented is called the householder.
Household spending is called consumption. Household spending (also called consumer
spending) per year in the United States is shown in Figure 1, along with household income.
The pattern is generally one of steady increase, but you can see that from the second quarter
2008 to the second quarter 2010, real household expenditures actually declined. (A quarter
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Chapter 4
67
The Aggregate Economy
FIGURE 1 Consumption or household spending and income
12,000
11,000
10,000
9,000
Billion Dollars
8,000
7,000
Personal Income
6,000
5,000
Personal Consumption
4,000
3,000
2,000
1,000
0
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Year
Household spending is the largest of the aggregate sectors in the economy. The primary determinant
of the spending is income.
Source: U.S. Department of Commerce, Bureau of Economic Analysis; www.census.gov.
refers to three months.) This was a period of financial crisis and recession. As income
declined, so did consumption.
Spending by the household sector is the largest component—constituting about 70 percent of total spending in the economy.
4-1b Business Firms
A business firm is a business organization controlled by a single management. The terms
company, enterprise, and business are used interchangeably with firm.
Firms are organized as sole proprietorships, partnerships, or corporations. A sole
proprietorship is a business owned by one person. This type of firm may be a one-person
operation or a large enterprise with many employees. In either case, the owner receives all
the profits and is responsible for all the debts incurred by the business.
A partnership is a business owned by two or more persons who share both the profits
of the business and the responsibility for the firm’s losses. The partners can be individuals,
estates, or other businesses.
A corporation is a business whose identity in the eyes of the law is distinct from the
identity of its owners. For instance, the owners are not responsible for the debts of the corporation. This is referred to as limited liability. The liabilities of the corporation are limited
to the extent that an owner’s own assets cannot be taken to pay the liabilities of the corporation. In fact, a corporation is an economic entity that, like a person, can own property and
borrow money in its own name.
business firm
A business organization
controlled by a single
management.
sole proprietorship
A business owned by one
person who receives all the
profits and is responsible for
all the debts incurred by the
business.
partnership
A business with two or more
owners who share the firm’s
profits and losses.
3. What is a business firm, and
what is business spending?
corporation
A legal entity owned by
shareholders whose liability
for the firm’s losses is limited
to the value of the stock they
own.
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68
Chapter 4 The Aggregate Economy
multinational business
A firm that owns and
operates producing units in
foreign countries.
investment
Spending on capital goods to
be used in producing goods
and services.
NOW YOU TRY IT
Why do you think that
investment fluctuates more
than consumption?
A firm may refer to a business at a single location or a worldwide business. Many firms
are global in their operations, even though they may have been founded and may be owned
by residents of a single country. Firms typically first enter the international market by selling
products to foreign countries. As revenues from these sales increase, the firms realize advantages by locating subsidiaries in foreign countries. In addition, companies seek the location
where taxes and regulations are the lowest and, of course, where profit potential is highest.
A multinational business is a firm that owns and operates producing units in foreign countries. The best-known U.S. corporations are multinational firms. Ford, IBM, PepsiCo, and
McDonald’s all own operating units in many different countries.
Expenditures by business firms for capital goods—machines, tools, and buildings—that
will be used to produce goods and services are called investment. Notice in Figure 2 that
investment spending declined from 2007 to 2010; businesses had reduced expenditures on
capital goods in 2007 through 2009 because sales had declined and the outlook for future
sales was not very good. Investment slowly increased from 2009 to 2013, reflecting the slow
growth of the overall economy. Sales declined because households were spending less.
Investment is equal to roughly one-fourth of consumption, or household spending, but
fluctuates a great deal more than consumption. Investment spending between 1959 and
2013 is shown in Figure 2. Unlike consumption, which generally just increases, investment
rises but does not do so in a smooth manner.
4-1c The International Sector
4. How does the international
sector affect the economy?
Economic conditions in the United States affect conditions throughout the world, and conditions
in other parts of the world have a significant effect on economic conditions in the United States.
The nations of the world may be divided into two categories: industrial countries and
developing countries. (Developing countries are often referred to as emerging markets or
FIGURE 2 U.S. Investment Spending
3,000
U.S. Investment (billion dollars)
2,500
2,000
Investment Expenditures
1,500
1,000
500
0
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Year
Business expenditures on capital goods have been increasing erratically since 1959.
Source: Economic Report of the President, 2010.
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Chapter 4
The Aggregate Economy
LDCs, less-developed countries.) Developing countries greatly outnumber industrial
countries (see Figure 3). The World Bank (an international organization that makes loans to
developing countries) groups countries according to per capita income (income per person).
Low-income economies are those with per capita incomes of less than $1,000. Middle-income
economies have per capita annual incomes of $1,000–$10,000. High-income economies—oil
exporters and industrial market economies—are distinguished from the middle-income
economies and have per capita incomes of greater than $10,000. Some countries are not
members of the World Bank and so are not categorized, and information about a few small
countries is so limited that the World Bank is unable to classify them.
It is readily apparent from Figure 3 that low-income economies are heavily concentrated
in Africa and Asia. As we discussed in the first chapter, an important question in economics
is: Why are some countries rich and others poor? Why are poor countries concentrated in
Africa and Asia with some in Latin America?
FIGURE 3 World Economic Development
N o r t h
A m e r i c a
S o u t h
A m e r i c a
Low-income economies
$1,000 or less
Lower-middle-income economies
$1,000 to $4,999
Upper-middle-income economies
$5,000 to $10,000
High-income economies
$10,000 or more
The colors on the map identify low-income, middle-income, and high-income economies. Countries
have been placed in each group on the basis of GNP per capita and, in some instances, other
distinguishing economic characteristics.
Source: World Bank; http://nebula.worldbank.org/website/GNIwdi/viewer.htm.
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69
70
Chapter 4 The Aggregate Economy
ECONOMIC INSIGHT
The Successful Entrepreneur
Sometimes It’s Better to Be Lucky Than Good
Entrepreneurs do not always develop an abstract idea into
reality when starting a new firm. Sometimes people stumble
onto a good thing by accident and then are clever enough
and willing to take the necessary risk to turn their lucky find
into a commercial success.
In 1875, a Philadelphia pharmacist on his honeymoon
tasted tea made from an innkeeper’s old family recipe. The
tea, made from 16 wild roots and berries, was so delicious
that the pharmacist asked the innkeeper’s wife for the recipe.
When he returned to his pharmacy, he created a solid concentrate of the drink that could be sold for home consumption.
The pharmacist was Charles Hires, a devout Quaker, who
intended to sell “Hires Herb Tea” to hard-drinking Pennsylvania
coal miners as a nonalcoholic alternative to beer and whiskey.
A friend of Hires suggested that miners would not drink anything called “tea” and recommended that he call his drink
“root beer.”
The initial response to Hires Root Beer was so enthusiastic that Hires soon began nationwide distribution. The yellow box of root beer extract became a familiar sight in homes
and drugstore fountains across the United States. By 1895,
Hires, who started with a $3,000 loan, was operating a business valued at half a million dollars (a lot of money in 1895)
and bottling ready-to-drink root beer across the country.
Hires, of course, is not the only entrepreneur who was
clever enough to turn a lucky discovery into a business success. In 1894, in Battle Creek, Michigan, a sanitarium handyman named Will Kellogg was helping his older brother
prepare wheat meal to serve to patients in the sanitarium’s
dining room. The two men would boil wheat dough and then
imports
Products that a country buys
from other countries.
exports
Products that a country sells
to other countries.
run it through rollers to produce thin sheets of meal. One day
they left a batch of the dough out overnight. The next day,
when the dough was run through the rollers, it broke up into
flakes instead of forming a sheet.
By letting the dough stand overnight, the Kelloggs had
allowed moisture to be distributed evenly to each individual wheat berry. When the dough went through the rollers,
the berries formed separate flakes instead of binding together. The Kelloggs toasted the wheat flakes and served
them to the patients. They were an immediate success. In
fact, the brothers had to start a mail-order flaked-cereal
business because patients wanted flaked cereal for their
households.
Kellogg saw the market potential of the discovery and
started his own cereal company (his brother refused to join
him in the business). He was a great promoter who used
innovations like four-color magazine ads and free-sample promotions. In New York City, he offered a free box of corn
flakes to every woman who winked at her grocer on a speci!, but Kellogg’s
fied day. The promotion was considered risque
sales in New York increased from two railroad cars of cereal
a month to one car a day.
Will Kellogg, a poorly paid sanitarium worker in his midforties, became a daring entrepreneur after his mistake with
wheat flour led to the discovery of a way to produce flaked
cereal. He became one of the richest men in America
because of his entrepreneurial ability.
Source: From FUCINI. ENTREPRENEURS. 1985 Gale, a part of Cengage
Learning, Inc.
The World Bank uses per capita income to classify countries as either low income or
high income; low-income countries are called “emerging” and high-income are called
“industrial market economies,” or in the case where oil or another resource makes a country
high income but not an industrial country, it is called “still developing.”.
The economies of the industrial nations are highly interdependent, meaning that as
conditions change in one country, business firms and individuals may shift large sums of
money from one country to another, thereby affecting many economies. As a result, countries are forced to pay close attention to each other’s economic policies.
The United States tends to buy primary products such as agricultural produce and minerals
from the developing countries and manufactured products from the industrial nations. Products
that a country buys from another country are called imports. Products that a country sells to
another country are called exports. The United States tends to sell, or export, manufactured
goods to all countries.
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The Aggregate Economy
David R. Frazier Photolibrary, Inc. / Alamy
Chapter 4
“The best and brightest are leaving.” Statements like this are heard in many nations
throughout the world. The best trained and most innovative people in many countries find
their opportunities greater in the United States. As a result, they leave their countries to gain
citizenship in the United States. But it is not easy for people to move from one country to
another. The flow of goods and services among nations—international trade—occurs more
readily than does the flow of workers.
The economic activity of the United States with the rest of the world includes U.S.
spending on foreign goods and foreign spending on U.S. goods. Figure 4 shows how U.S.
exports and imports are spread over different countries. Notice that the largest trading partners with the United States are Canada, Mexico, China, and Western Europe.
FIGURE 4 Direction of U.S. Trade
450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
0
Canada
Japan
Western
Europe
U.S. Exports to:
Mexico
China
OPEC
U.S. Imports from:
This chart shows that a trade deficit exists for the United States, since U.S. imports greatly exceed
U.S. exports. The chart also shows that the largest trading partners with the U.S. are Western
Europe, Japan, Canada, Mexico, and China.
Source: Economic Report of the President, 2010; www.census.gov/foreign-trade/Press-Release/current_press_release/exh14a.xls.
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71
72
Chapter 4 The Aggregate Economy
FIGURE 5 Net Exports
100
0
–100
(Billions of Dollars)
–200
–300
–400
–500
–600
–700
–800
–900
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Year
U.S. Exports are sales of U.S. goods and services to other countries. U.S. Imports are purchases by
the United States of goods and services from other countries. Exports minus Imports is Net Exports.
Negative net exports means that imports exceed exports or that the United States has a trade deficit.
Source: U.S. Department of Commerce: Bureau of Economic Analysis
trade surplus
The situation that exists when
imports are less than exports.
trade deficit
The situation that exists when
imports exceed exports.
net exports
The difference between the
value of exports and the value
of imports.
When exports exceed imports, a trade surplus exists. When imports exceed
exports, a trade deficit exists. The term net exports refers to the difference between
the value of exports and the value of imports: Net exports equals exports minus imports.
Figure 5 traces U.S. net exports over time. Positive net exports represent trade surpluses;
negative net exports represent trade deficits. The trade deficits (indicated by negative net
exports) starting in the 1980s were unprecedented. Reasons for this pattern of international
trade are discussed in later chapters.
RECAP
1. A household consists of one or more persons
who occupy a unit of housing.
4. Business investment spending fluctuates
widely over time.
2. Household spending is called consumption.
5. The majority of U.S. trade is with the industrial
market economies.
3. Business firms may be organized as sole proprietorships, partnerships, or corporations.
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Chapter 4
73
The Aggregate Economy
4-2 The Public Sector
When we refer to the public sector, it is government that we are talking about. Government
in the United States consists of federal, state, and local government. In the United States,
government’s influence is extensive. From conception to death, individuals are affected by
the activities of the government. Many mothers receive prenatal care through government
programs. We are born in hospitals that are subsidized or run by the government. We are
delivered by doctors who received training in subsidized colleges. Our births are recorded
on certificates filed with the government. Ninety percent of students attend public schools as
opposed to private schools. Many people live in housing that is directly subsidized by the
government or have mortgages that are insured by the government. Most people, at one
time or another, put savings into accounts that are insured by the government. Virtually all
of us, at some time in our lives, receive money from the government—from student loan
programs, unemployment compensation, disability insurance, food stamps, social security,
or Medicare. We drive on government roads, recreate on government lands, and fish in government waters.
5. What is the public sector?
What is public sector
spending?
4-2a Growth of Government
Blair_witch/Dreamstime.com
The United States was founded as a republic, meaning that government is divided between the
federal level and state and local levels. Local government includes county, regional, and municipal units. Each level affects us through its taxing and spending decisions and its laws regulating
behavior. In 1900, the federal government was a small player. States had the power—called
states’ rights—because the country’s founders believed that government closest to the people
The United States Capitol is where the Senate and House of Representatives meet. The Capitol
represents the public sector—government. Thomas Jefferson insisted the legislative building be
called the “Capitol” rather than “Congress House.” He thought “Capitol” represented the
shining city on a hill. The word capitol comes from Latin, meaning city on a hill.
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74
Chapter 4 The Aggregate Economy
could be constrained better than a federal government. But soon after the country’s founding,
people began to demand more federal government and less states’ rights.
From 1789 until 1930 government grew, but compared to what has occurred since
1930, that growth was minimal. The number of people employed by the local, state, and federal governments combined grew from 3 million in 1930 to more than 18 million today;
there are now more people employed in government than in manufacturing. Annual expenditures by the federal government rose from $3 billion in 1930 to $4.5 trillion today. In
1929, government spending constituted less than 2.5 percent of total spending in the economy. Today it is around 35 percent, as shown in Figure 6.
4-2b Government Spending
transfer payments
Income transferred by the
government from a citizen
who is earning income to
another citizen.
Federal, state, and local government spending for goods and services as a percent of the total
spending in the economy is shown in Figure 6. Total government spending is larger than
investment spending but smaller than consumption. In addition to purchasing goods and
services, government also takes money from some taxpayers and gives it to others. This is
called a transfer payment. In 2013, total expenditures of federal, state, and local government for goods and services were about $6.5 trillion. In this same year, transfer payments
made by the federal government were about $2.5 trillion. Federal government transfer payments are shown in Figure 7.
The magnitude of federal government spending relative to federal government revenue
from taxes has become an important issue in recent years. The federal budget (revenue less
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
2013
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
0
1950
0.05
1947
U.S. Government Spending (billion dollars)
FIGURE 6 Government Spending
Year
State and Local
as percent of GDP
Federal as
percent of GDP
Total Govt
as percent of GDP
Total Government Spending—federal, state, and local divided by gross domestic product (GDP)—the
total spending of all sectors in the economy as a percent of total GDP.
In 1929, government spending constituted less than 2.5 percent of total spending in the economy.
Today it is around 37 percent.
Source: U.S. Department of Commerce: Bureau of Economic Analysis retrieved from Federal Reserve Bank of St. Louis. FRED data
retrieval.
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Chapter 4
75
The Aggregate Economy
FIGURE 7 Federal Government and Total Government Transfer Payments
Billions of Dollars Quarterly
3000
2500
2000
1500
1000
500
0
1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Year
Transfer payments are payments made by government that do not purchase anything. They are funds transferred from one group to
another group.
Source: U.S. Department of Commerce: Bureau of Economic Analysis
spending) was roughly balanced until the early 1970s. The budget is a measure of spending
and revenue. A balanced budget occurs when federal spending is approximately equal to federal revenue. This was the case through the 1950s and 1960s.
If federal government spending is less than tax revenue, a budget surplus exists. The
federal government deficit and surplus are shown in Figure 8. By the early 1980s, federal
government spending was much larger than revenue, so a large budget deficit existed. The
federal budget deficit grew very rapidly to about $290 billion by the early 1990s before
budget surplus
The excess that results when
government spending is less
than tax revenue.
budget deficit
The shortage that results
when government spending
is greater than tax revenue.
FIGURE 8 Federal Government Surplus or Deficit.
400000
Federal Surplus or Deficit [–]
200000
0
–200000
–400000
–600000
–800000
–1000000
–1200000
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
1945
1940
1935
1930
1925
1920
1915
1910
1905
–1600000
1900
–1400000
Year
The difference between federal government expenditures and tax revenues is the surplus or deficit. Since 1930 the government has run a
deficit in all but 3 years.
Source: Data are from the Economic Report of the President, 2010.
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76
Chapter 4 The Aggregate Economy
FIGURE 9 Total Government Debt
18000000
Federal Debt: Total Public Debt
16000000
14000000
12000000
10000000
8000000
6000000
4000000
2000000
0
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Year
When the federal government borrows in order to finance its deficits, it creates public debt. The total public debt has risen to about $17
trillion today.
beginning to drop and turning to surplus by 1998. After four years of surpluses, a deficit was
again realized in 2002, and the deficit has grown since then. It exploded during the period
2008 to 2013. Since the deficit rose, so too did government debt; when the federal government spends more than it takes in, it must borrow. Debt is the accumulation of deficits; each
deficit adds to the debt. The total debt of the U.S. federal government exceeds $17 trillion.
The federal government debt is shown in Figure 9.
RECAP
1. The public sector refers to government.
2. Government spending is larger than investment spending bu