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平狄克微观经济学 第七版 英文答案
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Chapter 1: Preliminaries
INTRODUCTION:
MARKETS AND PRICES
PRELIMINARIES
TEACHING NOTES
Chapter 1 covers basic concepts students first saw in their introductory course but could bear
some repeating.
Since most students will not have read this chapter before the first class, it is a good
presented. You
definition of economics.
Make sure to emphasize scarcity and trade-offs.
Remind students that the
objective of economics is to explain observed phenomena and predict behavior of consumers and firms
as economic conditions change.
Ask about the differences (and similarities) between microeconomics
and macroeconomics and the difference between positive and normative analysis. Review the concept of
a market and the role prices play in allocating resources.
Discussions of economic theories and models
groundwork
discussion that might take place when you cover consumer behavior in Chapter 3.
prices. Given
understand
difference
compute real prices.
Most students know about the Consumer Price Index, so you might also mention
Consumption
Expenditures
(PCE) Pric
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你可能喜欢23MEASURING A NATION’S INCOMEWHAT’S NEW IN THE FIFTH EDITION:There is more clarification on the GDP deflator. Olympics?‖ is now an FYI box.The Case Study on ―Who Wins at theLEARNING OBJECTIVES:By the end of this chapter, students should understand: ??why an economy’s total income equals its total expenditure. ??how gross domestic product (GDP) is defined and calculated. ??the breakdown of GDP into its four major components. ??the distinction between real GDP and nominal GDP. ??whether GDP is a good measure of economic well-being.CONTEXT AND PURPOSE:Chapter 23 is the first chapter in the macroeconomic section of the text. It is the first of a two-chapter sequence that introduces students to two vital statistics that economists use to monitor the macroeconomy—GDP and the consumer price index. Chapter 10 develops how economistsmeasure production and income in the macroeconomy. The following chapter, Chapter 11, develops how economists measure the level of prices in the macroeconomy. Taken together, Chapter 10 concentrates on the quantity of output in the macroeconomy while Chapter 11 concentrates on the price of output in the macroeconomy.The purpose of this chapter is to provide students with an understanding of the measurement and the use of gross domestic product (GDP). GDP is the single most important measure of the health of the macroeconomy. Indeed, it is the most widely reported statistic in every developed economy.KEY POINTS:?? Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy. ?? Gross domestic product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services. More precisely, GDP is the market value of all final goods and services produced within a country in a given period of time. ?? GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports. Consumption includes spending on goods and services by households, with the exception of purchases of new housing. Investment includes spending on new equipment and structures, including households’ purchases of new housing. Government purchases include spending on goods and services by local, state, and federal governments. Net exports equal the value of goods and services produced domestically and sold abroad (exports) minus the value of goods and services produced abroad and sold domestically (imports). ?? Nominal GDP uses current prices to value the economy’s production of goods and services. Real GDP uses constant base-year prices to value the economy’s production of goods and services. The GDP deflator―calculated from the ratio of nominal to real GDP―measures the level of prices in the economy. ?? GDP is a good measure of economic well-being because people prefer higher incomes to lower incomes. But it is not a perfect measure of well-being. For example, GDP excludes the value of leisure and the value of a clean environment.CHAPTER OUTLINE:Regardless of whether microeconomics is taught before macroeconomics or vice versa, students need to be reminded of the differences between the two areas of study. Begin by defining the two terms and contrasting and comparing their focus.I. Review of the Definitions of Microeconomics and Macroeconomics A. Definition of microeconomics: the study of how households and firms make decisions and how they interact in markets.B.what it is. The macroeconomics: the study of economy-wide phenomena both Definition of basic point that you must get across is that GDP is a measure of including inflation, aggregate income and economic period of aggregate production andunemployment, in a nation over agrowth. one year. You can II. The Economy’s Income and Expenditure generates income, which provides the purchasing power that generates the demand for the A. To judge whether or not an economy is doing well, it is useful to look at Gross Domestic Product (GDP).Students have heard of GDP and they are genuinely interested in learning more aboutdemonstrate this by using the circular-flow diagram and explaining that production products.1. GDP measures the total income of everyone in the economy. 2. GDP measures total expenditure on an economy’s output of goods and services. B. For an economy as a whole, total income must equal total expenditure. 1. If someone pays someone else $100 to mow a lawn, the expenditure on the lawn service ($100) is exactly equal to the income earned from the production of the lawn service ($100). 2. We can also use the circular-flow diagram from Chapter 2 to show why total income and total expenditure must be equal.Figure 1a. Households buy goods and firms use this money to pay for resources purchased from households. b. In the simple economy described by this circular-flow diagram, calculating GDP could be done by adding up the total purchases of households or summing total income earned by households. c. Note that this simple diagram is somewhat unrealistic as it omits saving, taxes, government purchases, and investment purchases by firms. However, because a transaction always has a buyer and a seller, total expenditure in the economy must be equal to total income. III. The Measurement of Gross Domestic Product A. Definition of gross domestic product (GDP): the market value of all final goods and services produced within a country in a given period of time.To put GDP in terms the student may understand better, explain to them that GDP represents the amount of money one would need to purchase one year’s worth of the economy’s production of all final goods and services. Have a contest and see which student can come closest in guessing the level of GDP for the United States last year.B. ―GDP Is the Market Value . . .‖ 1. To add together different items, market values are used. 2. Market values are calculated by using market prices. C. ―. . . Of All . . .‖ 1. GDP includes all items produced and sold legally in the economy. 2. The value of housing services is somewhat difficult to measure. a. If housing is rented, the value of the rent is used to measure the value of the housing services. b. For housing that is owned (or mortgaged), the government estimates the rental value and uses this figure to value the housing services. 3. GDP does not include illegal goods or services or items that are not sold in markets. a. When you hire someone to mow your lawn, that production is included in GDP. b. If you mow your own lawn, that production is not included in GDP. D. ―. . . Final . . .‖ 1. Intermediate goods are not included in GDP.Make sure that students realize that investment goods (such as structures and vehicles used in production) are not intermediate goods. Investment goods represent products purchasedvalue of intermediate goods is already included as part of the value of the final 2. The for final use by business firms.good. 3. Goods that are placed into inventory are considered to be ―final‖ and included in GDP as a firm’s inventory investment. a. Goods that are sold out of inventory are counted as a decrease in inventory investment. b. The goal is to count the production when the good is finished, which is not necessarily the same time that the product is sold. E. ―. . . Goods and Services . . .‖1. GDP includes both tangible goods and intangible services. F. ―. . . Produced . . .‖ 1. Only current production is counted. 2. Used goods that are sold do not count as part of GDP. G. ―. . . Within a Country . . .‖ 1. GDP measures the production that takes place within the geographical boundaries of a particular country. 2. If a Canadian citizen works temporarily in the United States, the value of his output is included in GDP for the United States. If an American owns a factory in Haiti, the value of the production of that factory is not included in U.S. GDP.Students sometimes have trouble understanding that the production of a foreign firm operating in the United States is part of U.S. GDP. Help them make the connection by using the circular-flow diagram. Show them that, even if it is a foreign firm, the firm’s workers are living in the United States and buying clothes, groceries, and other goods in the United States. Thus, the workers in the foreign firm operating in the United States are fueling the domestic economy.H. ―. . . in a Given Period of Time.‖1. The usual interval of time used to measure GDP is a quarter (three months). 2. When the government reports GDP, the data are generally reported on an annual basis. 3. In addition, data are generally adjusted for regular seasonal changes (such as Christmas). I. In addition to summing expenditure, the government also calculates GDP by adding up total income in the economy. 1. The two ways of calculating GDP almost exactly give the same answer. 2. The difference between the two calculations of GDP is called the statisticaldiscrepancy.J.FYI: Other Measures of IncomeIt can be a challenge to teach all of these definitions without putting your students to sleep. Concentrate on the measures that will mean the most to students as the semester progresses.A. Gross National Product (GNP) is the total income earned by a nation’s permanent residents. 1. GNP includes income that American citizens earn abroad. 2. GNP excludes income that foreigners earn in the United States. B. Net National Product (NNP) is the total income of a nation’s residents (GNP) minus losses from depreciation (wear and tear on an economy’s stock of equipment and structures). C. National income is the total income earned by a nation’s residents in the production of goods and services. 1. National income differs from NNP by excluding indirect business taxes and including business subsidies. 2. NNP and national income also differ due to ―statistical discrepancy.‖ D. Personal income is the income that households and noncorporate businesses receive. E. Disposable personal income is the income that households and noncorporate businesses have left after taxes and other obligations to the government. IV. The Components of GDP A. GDP (Y ) can be divided into four components: consumption (C ), investment (I ), government purchases (G ), and net exports (NX ).Y ? C ? I ? G ? NXStudents will ask why GDP is called ―Y.‖ Remind them that in equilibrium GDP expenditures must be equal to income. The ―Y ‖ stands for income because the letter ―I ‖ is used for investment.B. Definition of consumption: spending by households on goods and services, with the exception of purchases of new housing. C. Definition of investment: spending on capital equipment, inventories, and structures, including household purchases of new housing. 1. GDP accounting uses the word ―investment‖ differently from how we use the term in everyday conversation. 2. When a student hears the word ―investment,‖ he or she thinks of financial instruments such as stocks and bonds. 3. In GDP accounting, investment means purchases of investment goods such as capital equipment, inventories, or structures. D. Definition of government purchases: spending on goods and services by local, state, and federal governments. 1. Salaries of government workers are counted as part of the government purchases component of GDP. 2. Transfer payments are not included as part of the government purchases component of GDP.Spend some time in class distinguishing between government purchases and transfer payments. Point out that transfer payments are actually negative taxes representing payments from the government to individuals (with no good or service provided in return) rather than payments from individuals to the government. Define net taxes as the difference between taxes and transfers.E. Definition of net exports: spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports).Table 1F. Case Study: The Components of U.S. GDP 1. Table 1 shows these four components of GDP for 2007. 2. The data for GDP come from the Bureau of Economic Analysis, which is part of the Department of Commerce.Make sure that you point out Table 1. Call attention to the importance of consumption and the negative number in the net exports column.V. Real Versus Nominal GDP A. There are two possible reasons for total spending to rise from one year to the next. 1. The economy may be producing a larger output of goods and services. 2. Goods and services could be selling at higher prices. B. When studying GDP over time, economists would like to know if output has changed (not prices). C. Thus, economists measure real GDP by valuing output using a fixed set of prices. D. A Numerical ExampleMake sure that you do this example or a similar numerical example in class. If you feel comfortable improvising, let the students pick two goods and then make up an example with them.Table 21. Two goods are being produced: hot dogs and hamburgers.Year 10Price of Hot Dogs $1 $2 $3Quantity of Hot Dogs 100 150 200Price of Hamburgers $2 $3 $4Quantity of Hamburgers 50 100 1502. Definition of nominal GDP: the production of goods and services valued at current prices.Nominal GDP for 2008 = ($1 × 100) + ($2 × 50) = $200. Nominal GDP for 2009 = ($2 × 150) + ($3 × 100) = $600. Nominal GDP for 2010 = ($3 × 200) + ($4 × 150) = $1,200.3. Definition of real GDP: the production of goods and services valued at constant prices.Let’s assume that the base year is 2008. Real GDP for 2008 = ($1 ×100) + ($2 ×50) = $200. Real GDP for 2009 = ($1 ×150) + ($2 ×100) = $350. Real GDP for 2010 = ($1 ×200) + ($2 ×150) = $500. Make sure that it is clear to students how to calculate these numbers so that they can compute nominal GDP and real GDP on their own.E. Because real GDP is unaffected by changes in prices over time, changes in real GDP reflect changes in the amount of goods and services produced.Emphasize that when there is inflation, nominal GDP can increase while real GDP actually declines. Make sure that students understand that real GDP will be used as a proxy for aggregate production throughout the course.ALTERNATIVE CLASSROOM EXAMPLE: The country of ____________ (insert name based on school mascot such as ―Pantherville‖ or ―Owlstown‖) produces two goods: footballs and basketballs. Below is a table showing prices and quantities of output for three years: Year Year 1 Year 2 Year 3 Price of Footballs $10 12 14 Quantity of Footballs 120 200 180 Price of Basketballs $12 15 18 Quantity of Basketballs 200 300 275Nominal GDP in Year 1 = ($10 ×120) + ($12 ×200) = $3,600 Nominal GDP in Year 2 = ($12 ×200) + ($15 ×300) = $6,900Nominal GDP in Year 3 = ($14 × 180) + ($18 × 275) = $7,470Using Year 1 as the Base Year: Real GDP in Year 1 = ($10 ×120) + ($12 × 200) = $3,600 Real GDP in Year 2 = ($10 ×200) + ($12 × 300) = $5,600 Real GDP in Year 3 = ($10 ×180) + ($12 × 275) = $5,100 (Note that nominal GDP rises from Year 2 to Year 3, but real GDP falls.) GDP deflator for Year 1 = ($3,600/$3,600) × 100 = 1 × 100 = 100 GDP deflator for Year 2 = ($6,900/$5,600) × 100 = 1.2321 × 100 = 123.21 GDP deflator for Year 3 = ($7,470/$5,100) × 100 = 1.4647 × 100 = 146.47F. The GDP Deflator 1. Definition of GDP deflator: a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100.GDP deflator ?Nominal GDP ? 100 Real GDP2. Example CalculationsGDP Deflator for 2008 = ($200 / $200) × 100 = 100. GDP Deflator for 2009 = ($600 / $350) × 100 = 171. GDP Deflator for 2010 = ($1200 / $500) ×100 = 240. Make sure that you point out that nominal GDP and real GDP will be equal in the base year. This implies that the GDP deflator for the base year will always be equal to 100.G. Case Study: Real GDP over Recent HistoryFigure 21. Figure 2 shows quarterly data on real GDP for the United States since 1965. 2. We can see that real GDP has increased over time. 3. We can also see that there are times when real GDP declines. These periods are called recessions. VI. Is GDP a Good Measure of Economic Well-Being?Get students involved in a discussion of the merits and problems involved with using GDP as a measure of well-being. Students are often as interested in what is not included in GDP as they are in what is included. Have the students break into small groups and list the things that might be missing if we use GDP as a measure of well-being. Then, have each group report their results and summarize them on the board.A. GDP measures both an economy’s total income and its total expenditure on goods and services. B. GDP per person tells us the income and expenditure level of the average person in the economy. C. GDP, however, may not be a very good measure of the economic well-being of an individual. 1. GDP omits important factors in the quality of life including leisure, the quality of the environment, and the value of goods produced but not sold in formal markets. 2. GDP also says nothing about the distribution of income. 3. However, a higher GDP does help us achieve a good life. Nations with larger GDP generally have better education and better health care. D. In the News: The Underground Economy 1. The measurement of GDP misses many transactions that take place in the underground economy.2. This article compares the underground economies of the United States and several other countries. E. Case Study: International Differences in GDP and the Quality of LifeTable 31. Table 3 shows real GDP per person, life expectancy, adult literacy rates, and Internet usage for 12 countries. 2. In rich countries, life expectancy is higher and adult literacy and Internet usage rates are also high. 3. In poor countries, people typically live only into their 50s, only about half of the adult population is literate, and Internet usage is very rare.Activity 1—GDP and Well-BeingType: Topics: Materials needed: Time: Class limitations: In-class demonstration Per capita GDP None 15 minutes Works in any size classPurpose This activity examines the usefulness and limits of measures of GDP. Students often have difficulty accepting the use of GDP as a proxy for well-being. Per capita GDP does not directly measure well-being but it is highly correlated with direct measures. Making this correlation explicit helps students understand the emphasis on GDP in macroeconomics. Instructions Ask students the following questions. Discuss each before moving to the next question. 1. 2. 3. If GDP is a good measure of well-being, why is Switzerland’s GDP so much lower than India’s GDP or China’s GDP? What measures would be better to compare the well-being of different countries? How do you expect these direct measures to correlate with per capita GDP?Common Answers and Points for Discussion 1. GDP itse Switzerland’s GDP is much lower than that of India or China, yet Swiss citizens have one of the highest standards of living in the world. The difference, of course, is population. Switzerland is a small country, so its GDP is relatively small, despite its wealth. The appropriate comparison is per capita GDP. A more interesting question is ―Is per capita GDP a good measure of well-being?‖ Or worded another way: ―What constitutes well-being?‖ 2. Well-being can be measured directly in a variety of ways. Students often suggest these: Health care Food E. Education Wins at the Olympics? FYI: Who These are certainly better measures than money income, but they can be difficult to collect and interpret. 1. When the Olympics end, commentators use the number of medals each nation 3. Although per capita GDP of not a direct measure of well-being, it can be used as a proxy takes as a measure is success. for direct measures. The wealthiest countries have per capita incomes over 10 times higher than the poorest. 2. In studying the determinants of success at the Olympics, two economists have found that the level of total GDP matters. It does not matter if the high total comes from a high level of GDP per person or from a large population.3. In addition to GDP, two other factors influence the number of medals won. a. The host country usually earns extra medals. b. The former communist countries of Eastern Europe earn more medals than other countries with similar levels of GDP.SOLUTIONS TO TEXT PROBLEMS:Quick Quizzes:1. Gross domestic product measures two things at once: final goods and services. (1) the total income ofeveryone in the economy and (2) the total expenditure on the economy’s output of It can measure both of these things at once because all expenditure in the economy ends up as someone’s income. 2. The production of a pound of caviar contributes more to GDP than the production of a pound of hamburger because the contribution to GDP is measured by market value and the price of a pound of caviar is much higher than the price of a pound of hamburger. 3. The four components of expenditure are: (1) (2) (3) The largest component is and (4) net exports.consumption, which accounts for more than two-thirds of total expenditure. 4. Real GDP is the production of goods and services valued at constant prices. Nominal GDP is the production of goods and services valued at current prices. Real GDP is a better measure of economic well-being because changes in real GDP reflect changes in the amount of output being produced. Thus, a rise in real GDP means people have produced more goods and services, but a rise in nominal GDP could occur either because of increased production or because of higher prices. 5. Although GDP is not a perfect measure of well-being, policymakers should care about it because a larger GDP means that a nation can afford better healthcare, better educational systems, and more of the material necessities of life.Questions for Review: 1. An economy's income must equal its expenditure, because every transaction has a buyer and a seller. Thus, expenditure by buyers must equal income by sellers.2. The production of a luxury car contributes more to GDP than the production of an economy car because the luxury car has a higher market value. 3. The contribution to GDP is $3, the market value of the bread, which is the final good that is sold. 4. The sale of used records does not affect GDP at all because it involves no current production. 5. The four components of GDP are consumption, such as the purchase of a music CD; investment, such as the purchase of a co government purchases, such as an order f and net exports, such as the sale of American wheat to Russia. (Many other examples are possible.) 6. Economists use real GDP rather than nominal GDP to gauge economic well-being because real GDP is not affected by changes in prices, so it reflects only changes in the amounts being produced. You cannot determine if a rise in nominal GDP has been caused by increased production or higher prices. 7.Year Nominal GDP 100 X $2 = $200 200 X $3 = $600Real GDP 100 X $2 = $200 200 X $2 = $400GDP Deflator ($200/$200) X 100 = 100 ($600/$400) X 100 = 150The percentage change in nominal GDP is (600 ? 200)/200 x 100 = 200%. The percentage change in real GDP is (400 ? 200)/200 x 100 = 100%. The percentage change in the deflator is (150 ? 100)/100 x 100 = 50%.8. It is desirable for a country to have a large GDP because people could enjoy more goods and services. But GDP is not the only important measure of well-being. For example, laws that restrict pollution cause GDP to be lower. If laws against pollution were eliminated, GDP would be higher but the pollution might make us worse off. Or, for example, an earthquake would raise GDP, as expenditures on cleanup, repair, and rebuilding increase. But an earthquake is an undesirable event that lowers our welfare.Problems and Applications1. a. Consumption increases because a refrigerator is a good purchased by a household. b. Investment increases because a house is an investment good.c.Consumption increases because a car is a good purchased by a household, but investment decreases because the car in Ford’s inventory had been counted as an investment good until it was sold.d. Consumption increases because pizza is a good purchased by a household. e. Government purchases increase because the government spent money to provide a good to the public. f. Consumption increases because the bottle is a good purchased by a household, but net exports decrease because the bottle was imported. g. Investment increases because new structures and equipment were built. 2. With transfer payments, nothing is produced, so there is no contribution to GDP. 3. If GDP included goods that are resold, it would be counting output of that particular year, plus sales of goods produced in a previous year. It would double-count goods that were sold more than once and would count goods in GDP for several years if they were produced in one year and resold in another. 4. a. Nominal GDP for each year is found in the following table:Year 1 2 3Nominal GDP P1Q1 P2Q2 P3Q3b. Real GDP for each year is found in the following table:Year 1 2 3c.Real GDP P1Q1 P1Q2 P1Q3The GDP deflator for each year is found in the following table:Year 1 2 3GDP deflator 100 (P2/P1)100 (P3/P1)100d. Real GDP growth from Year 2 to Year 3 equal to [(Q3 – Q2)/Q2] × 100 percent. e. The inflation rate as measured by the GDP deflator is [(P3 – P2)/P2] × 100 percent. 5. a. Calculating nominal GDP:2008: ($1 per qt. of milk ? 100 qts. milk) + ($2 per qt. of honey ? 50 qts. honey) = $200 2009: ($1 per qt. of milk ? 200 qts. milk) + ($2 per qt. of honey ? 100 qts. honey) = $400 2010: ($2 per qt. of milk ? 200 qts. milk) + ($4 per qt. of honey ? 100 qts. honey) = $800 Calculating real GDP (base year 2008): 2008: ($1 per qt. of milk ? 100 qts. milk) + ($2 per qt. of honey ? 50 qts. honey) = $200 2009: ($1 per qt. of milk ? 200 qts. milk) + ($2 per qt. of honey ? 100 qts. honey) = $400 2010: ($1 per qt. of milk ? 200 qts. milk) + ($2 per qt. of honey ? 100 qts. honey) = $400 Calculating the GDP deflator: 2008: ($200/$200) ? 100 = 100 2009: ($400/$400) ? 100 = 100 2010: ($800/$400) ? 100 = 200b. Calculating the percentage change in nominal GDP:Percentage change in nominal GDP in 2009 = [($400 ? $200)/$200] ? 100 = 100%. Percentage change in nominal GDP in 2010 = [($800 ? $400)/$400] ? 100 = 100%. Calculating the percentage change in real GDP: Percentage change in real GDP in 2009 = [($400 ? $200)/$200] ? 100 = 100%. Percentage change in real GDP in 2010 = [($400 ? $400)/$400] ? 100 = 0%. Calculating the percentage change in GDP deflator: Percentage change in the GDP deflator in 2009 = [(100 ? 100)/100] ? 100 = 0%. Percentage change in the GDP deflator in 2010 = [(200 ? 100 output levels did not change from 2009 to 2010. This means that the percentage change in real GDP is zero.)/100] ? 100 = 100%. Prices did not change from 2008 to 2009. Thus, the percentage change in the GDP deflator is zero. Likewise,c. Economic well-being rose more in 2008 than in 2009, since real GDP rose in 2009 but not in 2010. In 2009, real GDP rose but prices did not. In 2010, real GDP did not rise but prices did. 6.Year Nominal GDP (billions) $9,873 $9,269GDP Deflator (base year: 3a. The growth rate of nominal GDP is ($9,873 ? $9,269)/$9,269 ? 100% = 6.5%. b. The growth rate of the deflator is (118 ? 113)/113 ? 100% = 4.4%. c. Real GDP in 1999 (in 1996 dollars) is $9,269/(113/100) = $8,203.d. Real GDP in 2000 (in 1996 dollars) is $9,873/(118/100) = $8,367. e. The growth rate of real GDP is ($8,367 ? $8,203)/$8,203 ? 100% = 2.0%. f. The growth rate of nominal GDP is higher than the growth rate of real GDP because of inflation. 7. Many answers are possible. 8. a. GDP is the market value of the final good sold, $180. b. Value added for the farmer: $100.Value added for the miller: $150 – $100 = $50. Value added for the baker: $180 – $150 = $30.c. Together, the value added for the three producers is $100 + $50 + $30 = $180. This is the value of GDP. 9. In countries like India, people produce and consume a fair amount of food at home that is not included in GDP. So GDP per person in India and the United States will differ by more than their comparative economic well-being. 10. a. The increased labor-force participation of women has increased GDP in the United States, because it means more people are working and production has increased. b. If our measure of well-being included time spent working in the home and taking leisure, it would not rise as much as GDP, because the rise in women's labor-force participation has reduced time spent working in the home and taking leisure. c. Other aspects of well-being that are associated with the rise in women's increased labor-force participation include increased self-esteem and prestigefor women in the workforce, especially at managerial levels, but decreased24c.quality time spent with children, whose parents have less time to spend with them. Such aspects would be quite difficult to measure.11. a. GDP equals the dollar amount Barry collects, which is $400. b. NNP = GDP – depreciation = $400 ? $50 = $350. National income = NNP ? sales taxes = $350 ? $30 = $320. $220. e. Disposable personal income = personal income ? personal income tax = $220 ? $70 = $150. d. Personal income = national income ? retained earnings = $320 ? $100 =MEASURING THE COST OF LIVINGWHAT’S NEW IN THE FIFTH EDITION:There are no major changes to this chapter.LEARNING OBJECTIVES:By the end of this chapter, students should understand: ??how the consumer price index (CPI) is constructed. ??why the CPI is an imperfect measure of the cost of living. ??how to compare the CPI and the GDP deflator as measures of the overall price level. ??how to use a price index to compare dollar figures from different times.??the distinction between real and nominal interest rates.CONTEXT AND PURPOSE:Chapter 24 is the second chapter of a two-chapter sequence that deals with how economists measure output and prices in the macroeconomy. Chapter 23 addressed how economists measure output. Chapter 24 develops how economists measure the overall price level in the macroeconomy.The purpose of Chapter 24 is twofold: first, to show students how to generate a price index and, second, to teach them how to employ a price index to compare dollar figures from different points in time and to adjust interest rates for inflation. In addition, students will learn some of the shortcomings of using the consumer price index as a measure of the cost of living.KEY POINTS:?? The consumer price index (CPI) shows the cost of a basket of goods and services relative to the cost of the same basket in the base year. The index is used to measure the overall level of prices in the economy. The percentage change in the consumer price index measures the inflation rate. ?? The consumer price index is an imperfect measure of the cost of living for three reasons. First, it does not take into account consumers’ ability to substitute toward goods that become relatively cheaper over time. Second, it does not take into account increases in the purchasing power of the dollar due to the introduction of new goods. Third, it is distorted by unmeasured changes in the quality of goods and services. Because of these measurement problems, the CPI overstates annual inflation by about one percentage point. ?? Like the consumer price index, the GDP deflator also measures the overall level of prices in the economy. Although the two price indexes usually move together, there are important differences. The GDP deflator differs from the CPI because it includes goods and services produced rather than goods and services consumed. As a result, imported goods affect the consumer price index but not the GDP deflator. In addition, while the consumer price index uses a fixed basket of goods, the GDP deflator automatically changes the group of goods and services over time as the composition of GDP changes. ?? Dollar figures from different times do not represent a valid comparison of purchasing power. To compare a dollar figure from the past to a dollar figure today, the older figure should be inflated using a price index. ?? Various laws and private contracts use price indexes to correct for the effects of inflation. The tax laws, however, are only partially indexed for inflation. ?? A correction for inflation is especially important when looking at data on interest rates. The nominal interest rate is the interest r it is the rate at which the number of dollars in a savings account increases over time. By contrast, the real interest rate takes into account changes in the value of the dollar over time. The real interest rate equals the nominal interest rate minus the rate of inflation.CHAPTER OUTLINE:I. The Consumer Price Index A. Definition of consumer price index (CPI): a measure of the overall cost of the goods and services bought by a typical consumer.B. How the Consumer Price Index Is CalculatedTable 11. Fix the basket. a. The Bureau of Labor Statistics uses surveys to determine a representative bundle of goods and services purchased by a typical consumer. b. Example: 4 hot dogs and 2 hamburgers. 2. Find the prices. a. Prices for each of the goods and services in the basket must be determined for each time period. b. Example:Year 103. Compute the basket’s cost.Price of Hot Dogs $1 $2 $3Price of Hamburgers $2 $3 $4a. By keeping the basket the same, only prices are being allowed to change. This allows us to isolate the effects of price changes over time. b. Example:Cost in 2008 = ($1 × 4) + ($2 × 2) = $8. Cost in 2009 = ($2 × 4) + ($3 × 2) = $14. Cost in 2010 = ($3 × 4) + ($4 × 2) = $20. It is very important that students understand how to make these calculations. Students often have a difficult time recreating the steps taken in class without the instructor’s help.ALTERNATIVE CLASSROOM EXAMPLE: Using the example from Chapter 23: 1. Fix the basket: 3 footballs and 4 basketballs. 2. Find the prices: Year Year 1 Year 2 Price of Footballs $10 12 Price of Basketballs $12 15
Activity 1— Create a Student Price IndexType: Topics: Class limitations: Take-home assignment Consumer price index Works in any size classPurpose This assignment gives students a practical look at how price indices are measured. It also establishes base prices for calculating inflation rates later in the term. Instructions The students should pick real transaction prices for goods they actually purchase. If the indices will be used to calculate inflation rate, they should save a copy of this assignment in a safe place. They should not use prices from catalogs because such prices will not be subject to much change over the semester. Points for Discussion This assignment makes a good introduction to a discussion of market basket selection for price indices. The goods that students usually pick for their market basket account for a relatively small portion of consumer spending compared to housing, medical care, transportation, etc. Ask the students which goods are likely to change price frequently.This can be used to introduce problems with the measurement of the consumer price index.Assignment The consumer price index includes the prices of hundreds of goods purchased by consumers. It is possible to construct many other price indexes. Your mission: Create a personalized student price index. 1. 2. 3. 4. Choose five (or more) different products. — be specific e.g., unleaded gasoline, Budweiser beer Pick a quantity for each product. This will be your market basket. — e.g., 15 gallons gasoline, 12 pack of the index. 4. Choose a base year and compute Budweiser Find the actual price for each product. Calculate The base cost of the benchmark against which other years are compared. a. the total year is buying these products.At the end of The formula forhave students find the prices for these same five products and the semester, calculating the price index is: b. recalculate the cost of their market basket. Then, have them calculate their SPI (Student Price Index) and the rate of inflation.? cost of basket in current year ? CPI ? ? ? ? 100 ? cost of basket in base year ?c.Example (using 2008 as the base year):CPI for 2008 = ($8)/($8) × 100 = 100. CPI for 2009 = ($14)/($8) ×100 = 175. CPI for 2010 = ($20)/($8) ×100 = 250. Point out that the CPI must be equal to 100 in the base year.5. Compute the inflation rate. a. Definition of inflation rate: the percentage change in the price index from the preceding period.Make sure that you explain that inflation does not mean that the prices of all goods in the economy are rising. Inflation means that prices on average are rising. In fact, the prices of many electronic goods (such as computers and DVD players) have fallen in recent years.b. The formula used to calculate the inflation rate is:? CPI Year 2 ? CPI Year 1 ? inflation rate ? ? ? ? 100% CPI Year 1 ? ?c.Example:Inflation Rate for 2009 = (175 – 100)/100 × 100% = 75%. Inflation Rate for 2010 = (250 – 175)/175 × 100% = 43%. Be sure to point out to students that it is possible for the CPI to fall if deflation is present. Point out to students that, even though they have not experienced deflation in their lifetimes, it has occurred during several periods of U.S. history (especially during the Great Depression).C. The Producer Price Index 1. Definition of producer price index (PPI): a measure of the cost of a basket of goods and services bought by firms. 2. Because firms eventually pass on higher costs to consumers in the form of higher prices on products, the producer price index is believed to be useful in predicting changes in the CPI.D. FYI: What Is in the CPI’s Basket?Figure 11. Figure 1 shows the makeup of the market basket used to compute the CPI. 2. The largest category is housing, which makes up 43% of a typical consumer’s budget.One way to highlight this is to draw the pie chart on the board without the category names and let the students decide what goes where. Most likely, they will be surprised by the sizes of recreation and medical care.E. In the News: Accounting for Quality Change 1. When considering how price changes affect consumers’ well-being, it is important to measure changes in the quality of goods and services over time. 2. This is an article from the Wall Street Journal that discusses how the Bureau of Labor Statistics takes product improvements into account when computing the CPI. F. Problems in Measuring the Cost of Living 1. Substitution Bias a. When the price of one good changes, consumers often respond by substituting another good in its place. b. The CPI does not allow f it is calculated using a fixed basket of goods and services. c. This implies that the CPI overstates the increase in the cost of living over time.2. Introduction of New Goods a. When a new good is introduced, consumers have a wider variety of goods and services to choose from. b. This makes every dollar more valuable, which lowers the cost of maintaining the same level of economic well-being.c.Because the market basket is not revised often enough, these new goods are left out of the bundle of goods and services included in the basket.3. Unmeasured Quality Change a. If the quality of a good falls from one year to the next, the val if quality rises, the value of the dollar rises. b. Attempts are made to correct prices for changes in quality, but it is often difficult to do so because quality is hard to measure. 4. The size of these problems is also difficult to measure. 5. Most studies indicate that the CPI overstates the rate of inflation by approximately one percentage point per year. 6. The issue is important because many government transfer programs (such as Social Security) are tied to increases in the CPI. G. The GDP Deflator versus the Consumer Price Index 1. The GDP deflator reflects the prices of all goods produced domestically, while the CPI reflects the prices of all goods bought by consumers.Figure 22. The CPI compares the prices of a fixed basket of goods over time, while the GDP deflator compares the prices of the goods currently produced to the prices of the goods produced in the base year. This means that the group of goods and services used to compute the GDP deflator changes automatically over time as output changes. 3. Figure 2 shows the inflation rate as measured by both the CPI and the GDP deflator. II. Correcting Economic Variables for the Effects of Inflation A. Dollar Figures from Different Times 1. To change dollar values from one year to the next, we can use this formula:? Price level in Year 2 ? Value in Year 2 dollars ? Value in Year 1 dollars ? ? ? ? Price level in Year 1 ?2. Example: Babe Ruth’s 1931 salary in 2007 dollars:Salary in 2007 dollars = Salary in 1931 dollars × Salary in 2007 dollars = $80,000 × (207/15.2). Salary in 2007 dollars = $1,089,474.Price level in 2007 Price level in 1931ALTERNATIVE CLASSROOM EXAMPLE: Your father graduated from school and took his first job in 1972, which paid a salary of $7,000. What is this salary worth in 2007 dollars? CPI in 1972 = 41.8 CPI in 2007 = 195 Value in 2007 dollars = 1972 salary × (CPI in 2005/CPI in 1972) Value in 2007 dollars = $7,000 × (207/41.8) = $7,000 ×4.95 = $34,6503. FYI: Mr. Index Goes to Hollywood a. Reports of box office success are often made in terms of the dollar values of ticket sales. b. These ticket sales are then compared with ticket sales of movies in the past. c. However, no correction for changes in the value of a dollar are made.Activity 2—You Paid How Much?Type: Topics: Class limitations: Take-home assignment Consumer price index Works in any size classPurpose This assignment gives students a chance to see how much dollar values have changed over time. It also provides them some practice at using the formula to calculate the change in dollar values over time. InstructionsHave students ask their parents (or grandparents) how much they paid for their first car and in what year they bought it. (If there are older students in the class, ask them to remember how much they paid for their first car.) Students can then determine how much they would have to pay in current dollars using the consumer price index.B. Indexation1. Definition of indexation: the automatic correction of a dollar amount for the effects of inflation by law or contract. 2. As mentioned above, many government transfer programs use indexation for the benefits. The government also indexes the tax brackets used for federal income tax. 3. There are uses of indexation in the private sector as well. Many labor contracts include cost-of-living allowances (COLAs). C. Real and Nominal Interest RatesUse an example to make the importance of real interest rates clear. Suppose a student has $100 in his savings account earning 3% interest. Ask students what will happen to the purchasing power of that money if prices rise 3% during the year. Then, change the inflation rate to 5% and then 1% and go through the example again.1. Example: Sally Saver deposits $1,000 into a bank account that pays an annual interest rate of 10%. A year later, she withdraws $1,100. 2. What matters to Sally is the purchasing power of her money. a. If there is zero inflation, her purchasing power has risen by 10%. b. If there is 6% inflation, her purchasing power has risen by about 4%. c. If there is 10% inflation, her purchasing power has remained the same.d. If there is 12% inflation, her purchasing power has declined by about 2%. e. If there is 2% deflation, her purchasing power has risen by about 12%. 3. Definition of nominal interest rate: the interest rate as usually reported without a correction for the effects of inflation. 4. Definition of real interest rate: the interest rate corrected for the effects of inflation.real interest rate ? nominal interest rate ? inflation rate5. Case Study: Interest Rates in the U.S. EconomyFigure 3a. Figure 3 shows real and nominal interest rates from 1965 to the present. b. The nominal interest rate is always greater than the real interest rate in this diagram because there was always inflation during this period. c. Note that in the late 1970s the real interest rate was negative because the inflation rate exceeded the nominal interest rate.SOLUTIONS TO TEXT PROBLEMS:Quick Quizzes1. The consumer price index measures the overall cost of the goods and services bought by a typical consumer. It is constructed by surveying consumers to Prices determine a basket of goods and services that the typical consumer buys. times, and a base year is chosen. and multiply by 100. 2. Since Henry Ford paid his workers $5 a day in 1914 and the consumer price index was 10 in 1914 and 207 in 2007, then the Ford paycheck was worth $5 ? 207 / 10 = $103.50 a day in 2007 dollars.of these goods and services are used to compute the cost of the basket at different To compute the index, we divide the cost of the market basket in the current year by the cost of the market basket in the base yearQuestions for Review1. A 10% increase in the price of chicken has a greater effect on the consumer price index than a 10% increase in the price of caviar because chicken is a bigger part of the average consumer's market basket. 2. The three problems in the consumer price index as a measure of the cost of living are: (1) substitution bias, which arises because people substitute toward goods that have become relat (2) the introduction of new goods, which are not reflected quickly in the CPI; and (3) unmeasured quality change.3. If the price of a Navy submarine rises, there is no effect on the consumer price index, because Navy submarines are not consumer goods. But the GDP price index is affected, because Navy submarines are included in GDP as a part of government purchases. 4. Because the overall price level doubled, but the price of the candy bar rose sixfold, the real price (the price adjusted for inflation) of the candy bar tripled. 5. The nominal interest rate is the rate of interest paid on a loan in dollar terms. The real interest rate is the rate of interest corrected for inflation. The real interest rate is the nominal interest rate minus the rate of inflation.Problems and Applications1. a. Find the price of each good in each year:Year Cauliflower $2 $3Broccoli $1.50 $1.50Carrots $0.10 $0.20b. If 2008 is the base year, the market basket used to compute the CPI is 100 heads of cauliflower, 50 bunches of broccoli, and 500 carrots. We must now calculate the cost of the market basket in each year:2008: (100 x $2) + (50 x $1.50) + (500 x $.10) = $325 2009: (100 x $3) + (50 x $1.50) + (500 x $.20) = $475 Then, using 2008 as the base year, we can compute the CPI in each year: 2008: $325/$325 x 100 = 100 2009: $475/$325 x 100 = 146c. We can use the CPI to compute the inflation rate for 2009:(146 ? 100)/100 x 100% = 46%2. Many answers are possible. 3. a. The percentage change in the price of tennis balls is (2 – 2)/2 × 100% = 0%.The percentage change in the price of golf balls is (6 – 4)/4 × 100% = 50%. The percentage change in the price of Gatorade is (2 – 1)/1 × 100% = 100%.b. The cost of the market basket in 2009 is ($2 × 100) + ($4 × 100) + ($1 × 200) = $200 + $400 + $200 = $800.The cost of the market basket in 2010 is ($2 × 100) + ($6 × 100) + ($2 × 200) =$200 + $600 + $400 = $1,200. The percentage change in the cost of the market basket from 2009 to 2010 is (1,200 – 800)/800 ×100% = 50%.c. This would lower my estimation of the inflation rate because the value of a bottle of Gatorade is now greater than before. The comparison should be made on a per-ounce basis. d. More flavors enhance consumers’ well-being. Thus, this would be considered a change in quality and would also lower my estimate of the inflation rate. 4. a. The cost of the market basket in 2009 is (1 × $40) + (3 × $10) = $40 + $30 = $70.The cost of the market basket in 2010 is (1 × $60) + (3 ×$12) = $60 + $36 = $96. Using 2009 as the base year, we can compute the CPI in each year: 2009: $70/$70 x 100 = 100 20109: $96/$70 x 100 = 137.14 We can use the CPI to compute the inflation rate for 2010: (137.14 ? 100)/100 x 100% = 37.14%b. Nominal GDP for 2009 = (10 × $40) + (30 × $10) = $400 + $300 = $700.Nominal GDP for 2010 = (12 × $60) + (50 × $12) = $720 + $600 = $1,320. Real GDP for 2009 = (10 ×$40) + (30 ×$10) = $400 + $300 = $700. Real GDP for 2010 = (12 ×$40) + (50 ×$10) = $480 + $500 = $980. The GDP deflator for 2009 = (700/700) × 100 = 100. The GDP deflator for 2010 = (1,320/980) ×100 = 134.69. The rate of inflation for 2010 = (134.69 – 100)/100 ×100% = 34.69%.c. No, it is not the same. change. 5. a. Because the increase in cost was considered a quality improvement, there was no increase registered in the CPI. The rate of inflation calculated by the CPI holds thebasket of goods and services constant, while the GDP deflator allows it tob. The argument in favor of this is that consumers are getting a better good than before, so the price increase equals the improvement in quality. The problem is that the increased cost might exceed the value of the improvement in air quality, so consumers are worse off. In this case, it would be better for the CPI to at least partially reflect the higher cost. 6. a. intro b. unmea c. d. unmea e. substitution bias 7. a. ($0.75 ? $0.15)/$0.15 x 100% = 400%. b. ($14.32 ? $3.23)/$3.23 x 100% = 343%. c. In 1970: $0.15/($3.23/60) = 2.8 minutes. In 2000: $0.75/($14.32/60) = 3.1 minutes. d. Workers' purchasing power fell in terms of newspapers. 8. a. If the elderly consume the same market basket as other people, Social Security would provide the elderly with an improvement in their standard of living each year because the CPI overstates inflation and Social Security payments are tied to the CPI. b. Because the elderly consume more health care than younger people do, and because health care costs have risen faster than overall inflation, it is possible that the elderly are worse off. To investigate this, you would need to put together a market basket for the elderly, which would have a higher weight on health care. You would then compare the rise in the cost of the &elderly& basket with that of the general basket for CPI. 9. In deciding how much income to save for retirement, workers should consider the real interest rate, because they care about their purchasing power in the future, not the number of dollars they will have. 10. a. When inflation is higher than was expected, the real interest rate is lower than expected. For example, suppose the market equilibrium has an expected real interest rate of 3% and people expect inflation to be 4%, so the nominal interest rate is 7%. If inflation turns out to be 5%, the real interest rate is 7% minus 5% equals 2%, which is less than the 3% that was expected. b. Because the real interest rate is lower than was expected, the lender loses and the borrower gains. The borrower is repaying the loan with dollars that are worth less than was expected.25c.Homeowners in the 1970s who had fixed-rate mortgages from the 1960s benefited from the unexpected inflation, while the banks that made the mortgage loans were harmed.PRODUCTION AND GROWTHWHAT’S NEW IN THE FIFTH EDITION:There are two new In the News boxes on ―Measuring Capital‖ and ―Escape from Malthus.‖LEARNING OBJECTIVES:By the end of this chapter, students should understand: ??how much economic growth differs around the world. ??why productivity is the key determinant of a country’s standard of living. ??the factors that determine a country’s productivity. ??how a country’s policies influence its productivity growth.CONTEXT AND PURPOSE:Chapter 25 is the first chapter in a four-chapter sequence on the production of output in the long run. Chapter 25 addresses the determinants of the level and growth rate of output. We find that capital and labor are among the primary determinants of output. In Chapter 26, we address how saving and investment in capital goods affect the production of output, and in Chapter 27, we learn about some of the tools people and firms use when choosing capital projects in which to invest. In Chapter 28, we address the market for labor.The purpose of Chapter 25 is to examine the long-run determinants of both the level and the growth rate of real GDP per person. Along the way, we will discover the factors that determine the productivity of workers and address what governments might do to improve the productivity of their citizens.KEY POINTS:??Economic prosperity, as measured by GDP per person, varies substantially around the world. The average income in the world’s richest countries is more than ten times that in the world’s poorest countries. Because growth rates of real GDP also vary substantially, the relative positions of countries can change dramatically over time. The standard of living in an economy depends on the economy’s ability to produce goods and services. Productivity, in turn, depends on the amounts of physical capital, human capital, natural resources, and technological knowledge available to workers. Government policies can try to influence the economy’s growth rate in many ways: encouraging saving and investment, encouraging investment from abroad, fostering education, promoting good health, maintaining property rights and political stability, allowing free trade, and promoting the research and development of new technologies. The accumulation of capital is subject to diminishing returns: The more capital an economy has, the less additional output the economy gets from an extra unit of capital. As a result, while higher saving leads to higher growth for a period of time, growth eventually slows down as the economy approaches a higher level of capital, productivity, and income. Also because of diminishing returns, the return to capital is especially high in poor countries. Other things being equal, these countries can grow faster because of the catch-up effect. Population growth has a variety of effects on economic growth. On the one hand, more rapid population growth may lower productivity by stretching the supply of natural resources and by reducing the amount of capital available for each worker. On the other????????hand, a larger population may enhance the rate of technological progress because there are more scientists and engineers.CHAPTER OUTLINE:I.Economic Growth Around the WorldTable 1A. Table 1 shows data on real GDP per person for 13 countries during different periods of time. 1. The data reveal the fact that living standards vary a great deal between these countries. 2. Growth rates are also reported in the table. Japan has had the largest growth rate over time, 2.76% per year (on average).Use Table 1 to make the point that a one-percentage point change in a country’s growth rate can make a significant difference over several generations. The powerful effects of compounding should be used to underscore the process of economic growth.3. Because of different growth rates, the ranking of countries by income per person changes over time. a. In the late 19th century, the United Kingdom was the richest country in the world. b. Today, income per person is lower in the United Kingdom than in the United States and Canada (two former colonies of the United Kingdom). B. FYI: Are You Richer Than the Richest American? 1. According to the magazine American Heritage, the richest American of all time is John B. Rockefeller, whose wealth today would be the equivalent of $200 billion. 2. Yet, because Rockefeller lived from 1839 to 1937, he did not get the chance to enjoy many of the conveniences we take for granted today such as television and air conditioning.3. Thus, because of technological advances, the average American today may enjoy a ―richer‖ life than the richest American who lived a century ago. C. FYI: A Picture Is Worth a Thousand Statistics 1. This box presents three photos showing a typical family in three countries – the United Kingdom, Mexico, and Mali. Each family was photographed outside their home, together with all of their material possessions. 2. These photos demonstrate the vast difference in the standards of living in these countries.II.Productivity: Its Role and DeterminantsA. Why Productivity Is So Important 1. Example: Robinson Crusoe a. Because he is stranded alone, he must catch his own fish, grow his own vegetables, and make his own clothes. b. His standard of living depends on his ability to produce goods and services. 2. Definition of productivity: the amount of goods and services a worker produces in each hour of work. 3. Review of Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services. B. How Productivity Is Determined 1. Physical Capital per Worker a. Definition of physical capital: the stock of equipment and structures that are used to produce goods and services. b. Example: Crusoe will catch more fish if he has more fishing poles. 2. Human Capital per Worker a. Definition of human capital: the knowledge and skills that workers acquire through education, training, and experience.b. Example: Crusoe will catch more fish if he has been trained in the best fishing techniques. 3. Natural Resources per Worker a. Definition of natural resources: the inputs into the production of goods and services that are provided by nature, such as land, rivers, and mineral deposits. b. Example: Crusoe will have better luck catching fish if there is a plentiful supply around his island. 4. Technological Knowledge a. Definition of technological knowledge: society’s understanding of the best ways to produce goods and services. b. Example: Crusoe will catch more fish if he has invented a better fishing lure. c.Case Study: Are Natural Resources a Limit to Growth? This section points outthat as the population has grown over time, we have discovered ways to lower our use of natural resources. Thus, most economists are not worried about shortages of natural resources.C. FYI: The Production Function 1. A production function describes the relationship between the quantity of inputs used in production and the quantity of output from production. 2. The production function generally is written like this:Y ? A F(L, K, H, N)where Y = output, L = quantity of labor, K = quantity of physical capital, H = quantity of human capital, N = quantity of natural resources, A reflects the available production technology, and F () is a function that shows how inputs are combined to produce output. 3. Many production functions have a property called constant returns to scale. a. This property implies that as all inputs are doubled, output will exactly double. b. This implies that the following must be true:xY ? A F(xL, xK, xH, xN)where x = 2 if inputs are doubled. c. This also means that if we want to examine output per worker we could set x = 1/L and we would get the following:Y/L ? A F(1, K/L, H/L, N/L)This shows that output per worker depends on the amount of physical capital per worker (K /L), the amount of human capital per worker (H /L), and the amount of natural resources per worker (N /L).D. In the News: Measuring Capital 1. The concept of ―capital‖ is sometimes interpreted broadly. 2. This is an article from the Wall Street Journal describing differences in ―intangible wealth‖ across countries. III. Economic Growth and Public PolicyStart out by asking students what factors they believe will lead to greater economic growth in the future.A. Saving and Investment 1. Because capital is a produced factor of production, a society can change the amount of capital that it has. 2. However, there is an opportun if resources are used to produce capital goods, fewer goods and services are produced for current consumption. B. Diminishing Returns and the Catch-Up Effect 1. Definition of diminishing returns: the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases.Figure 1a. As the capital stock rises, the extra output produced from an additional unit of capital will fall.b. This can be seen in Figure 1, which shows how the amount of capital per worker determines the amount of output per worker, holding constant all other determinants of output. c. Thus, if workers already have a large amount of capital to work with, giving them an additional unit of capital will not increase their productivity by much. d. In the long run, a higher saving rate leads to a higher level of productivity and income, but not to higher growth rates in these variables. 2. An important implication of diminishing returns is the catch-up effect. a. Definition of catch-up effect: the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich. b. When workers have very little capital to begin with, an additional unit of capital will increase their productivity by a great deal. C. Investment from Abroad 1. Saving by domestic residents is not the only way for a country to invest in new capital. 2. Investment in the country by foreigners can also occur. a. Foreign direct investment occurs when a capital investment is owned and operated by a foreign entity. b. Foreign portfolio investment occurs when a capital investment is financed with foreign money but operated by domestic residents. 3. Some of the benefits of foreign investment flow back to foreign owners. But the economy still experiences an increase in the capital stock, which leads to higher productivity and higher wages. 4. The World Bank is an organization that tries to encourage the flow of investment to poor countries. a. The World Bank obtains funds from developed countries such as the United States and makes loans to less-developed countries so that they can invest in roads, sewer systems, schools, and other types of capital.b. The World Bank also offers these countries advice on how best to use these funds. D. Education 1. Investment in human capital also has an opportunity cost. a. When students are in class, they cannot be producing goods and services for consumption. b. In less-developed countries, this opportunity cost is c as a result, children often drop out of school at a young age. 2. Because there are positive externalities in education, the effect of lower education on the economic growth rate of a country can be large. 3. Many poor countries also face a ―brain drain‖—the best educated often leave to go to other countries where they can enjoy a higher standard of living. 4. In the News: Promoting Human Capital a. Human capital is a key to economic growth. b. This is an article that describes how some developing countries now give parents an immediate financial incentive to keep their children in school. E. Health and Nutrition 1. Human capital can also be used to describe another type of investment in people: expenditures that lead to a healthier population. 2. Other things being equal, healthier workers are more productive. 3. Making the right investments in the health of the population is one way for a nation to increase productivity. F. Property Rights and Political Stability 1. Protection of property rights and promotion of political stability are two other important ways that policymakers can improve economic growth. 2. There is little incentive to produce products if there is no guarantee that they cannot be taken.