Stableness
13-05-2004, 16:20
HOW THE ECONOMY AS A WHOLE WORKS
We started by discussing how individuals make decisions and then looked at how people interact with one another. All these decisions and interactions together make up “the economy.” The last three principles concern the workings of the economy as a whole.
Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
The differences in living standards around the world are staggering. In 2000 the average American had an income of about $34,100. In the same year, the average Mexican earned $8,790, and the average Nigerian
Changes in living standards over time are also large. In the United States, incomes earned $800. Not surprisingly, this large variation in average income is reflected in various measures of the
quality of life. Citizens of high-income countries have more TV sets, more cars, better nutrition, better health care, and longer life expectancy than citizens of low-income countries.
have historically grown about 2 percent per year (after adjusting for changes in the cost of living). At this rate, average income doubles every 35 years. Over the past century, average income has risen about eightfold.
What explains these large differences in living standards among countries and over time? The answer is surprisingly simple. Almost all variation in living standards is attributable to differences in countries’ productivity—that is, the amount of goods and services produced from each hour of a worker’s time. In nations where workers can produce a large quantity of goods and services per unit of time, most people enjoy a high standard of living; in nations where workers are less productive, most people must endure a more meager existence. Similarly, the growth rate of a nation’s productivity determines the growth rate of its average income.
The fundamental relationship between productivity and living standards is simple, but its implications are far-reaching. If productivity is the primary determinant of living standards, other explanations must be of secondary importance. For example, it might be tempting to credit labor unions or minimum-wage laws
for the rise in living standards of American workers over the past century. Yet the real hero of American workers is their rising productivity. As another example, some commentators have claimed that increased competition from Japan and other countries explained the slow growth in U.S. incomes during the 1970s and 1980s. Yet the real villain was not competition from abroad but flagging productivity growth in the United States.
The relationship between productivity and living standards also has profound implications for public policy. When thinking about how any policy will affect living standards, the key question is how it will affect our ability to produce goods and services. To boost living standards, policymakers need to raise productivity by ensuring that workers are well educated, have the tools needed to produce goods and services, and have access to the best available technology.
Principle #9: Prices Rise When the Government Prints Too Much Money
In Germany in January 1921, a daily newspaper cost 0.30 marks. Less than two years later, in November 1922, the same newspaper cost 70,000,000 marks. All other prices in the economy rose by similar amounts. This episode is one of history’s most spectacular examples of inflation, an increase in the overall level of
prices in the economy.
Although the United States has never experienced inflation even close to that in Germany in the 1920s, inflation has at times been an economic problem. During the 1970s, for instance, the overall level of prices more than doubled, and President Gerald Ford called inflation “public enemy number one.” By contrast, inflation in the 1990s was about 3 percent per year; at this rate it would take more than 20 years for prices to double. Because high inflation imposes various costs on society, keeping inflation at a low level is a goal of economic policymakers around the world.
What causes inflation? In almost all cases of large or persistent inflation, the culprit turns out to be the same—growth in the quantity of money. When a government creates large quantities of the nation’s money, the value of the money falls. In Germany in the early 1920s, when prices were on average tripling every month, the quantity of money was also tripling every month. Although less dramatic, the economic history of the United States points to a similar conclusion: The high inflation of the 1970s was associated with rapid growth in the quantity of money, and the low inflation of the 1990s was associated with slow growth in the quantity of money.
Principle #10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment
When the government increases the amount of money in the economy, one result is inflation. Another result, at least in the short run, is a lower level of unemployment. The curve that illustrates this short-run tradeoff between inflation and unemployment is called the Phillips curve, after the economist who first examined this relationship.
The Phillips curve remains a controversial topic among economists, but most economists today accept the idea that society faces a short-run tradeoff between inflation and unemployment. This simply means that, over a period of a year or two, many economic policies push inflation and unemployment in opposite directions. Policymakers face this tradeoff regardless of whether inflation and unemployment both start out at high levels (as they were in the early 1980s), at low levels (as they were in the late 1990s), or someplace in between.
The tradeoff between inflation and unemployment is only temporary, but it can last for several years. The Phillips curve is, therefore, crucial for understanding many developments in the economy. In particular, it is important for understanding the business cycle—the irregular and largely unpredictable fluctuations in
economic activity, as measured by the number of people employed or the production of goods and services.
Policymakers can exploit the short-run tradeoff between inflation and unemployment using various policy instruments. By changing the amount that the government spends, the amount it taxes, and the amount of money it prints, policymakers can influence the combination of inflation and unemployment that the economy experiences. Because these instruments of monetary and fiscal policy are potentially so powerful, how policymakers should use these instruments to control the economy, if at all, is a subject of continuing debate.
We started by discussing how individuals make decisions and then looked at how people interact with one another. All these decisions and interactions together make up “the economy.” The last three principles concern the workings of the economy as a whole.
Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
The differences in living standards around the world are staggering. In 2000 the average American had an income of about $34,100. In the same year, the average Mexican earned $8,790, and the average Nigerian
Changes in living standards over time are also large. In the United States, incomes earned $800. Not surprisingly, this large variation in average income is reflected in various measures of the
quality of life. Citizens of high-income countries have more TV sets, more cars, better nutrition, better health care, and longer life expectancy than citizens of low-income countries.
have historically grown about 2 percent per year (after adjusting for changes in the cost of living). At this rate, average income doubles every 35 years. Over the past century, average income has risen about eightfold.
What explains these large differences in living standards among countries and over time? The answer is surprisingly simple. Almost all variation in living standards is attributable to differences in countries’ productivity—that is, the amount of goods and services produced from each hour of a worker’s time. In nations where workers can produce a large quantity of goods and services per unit of time, most people enjoy a high standard of living; in nations where workers are less productive, most people must endure a more meager existence. Similarly, the growth rate of a nation’s productivity determines the growth rate of its average income.
The fundamental relationship between productivity and living standards is simple, but its implications are far-reaching. If productivity is the primary determinant of living standards, other explanations must be of secondary importance. For example, it might be tempting to credit labor unions or minimum-wage laws
for the rise in living standards of American workers over the past century. Yet the real hero of American workers is their rising productivity. As another example, some commentators have claimed that increased competition from Japan and other countries explained the slow growth in U.S. incomes during the 1970s and 1980s. Yet the real villain was not competition from abroad but flagging productivity growth in the United States.
The relationship between productivity and living standards also has profound implications for public policy. When thinking about how any policy will affect living standards, the key question is how it will affect our ability to produce goods and services. To boost living standards, policymakers need to raise productivity by ensuring that workers are well educated, have the tools needed to produce goods and services, and have access to the best available technology.
Principle #9: Prices Rise When the Government Prints Too Much Money
In Germany in January 1921, a daily newspaper cost 0.30 marks. Less than two years later, in November 1922, the same newspaper cost 70,000,000 marks. All other prices in the economy rose by similar amounts. This episode is one of history’s most spectacular examples of inflation, an increase in the overall level of
prices in the economy.
Although the United States has never experienced inflation even close to that in Germany in the 1920s, inflation has at times been an economic problem. During the 1970s, for instance, the overall level of prices more than doubled, and President Gerald Ford called inflation “public enemy number one.” By contrast, inflation in the 1990s was about 3 percent per year; at this rate it would take more than 20 years for prices to double. Because high inflation imposes various costs on society, keeping inflation at a low level is a goal of economic policymakers around the world.
What causes inflation? In almost all cases of large or persistent inflation, the culprit turns out to be the same—growth in the quantity of money. When a government creates large quantities of the nation’s money, the value of the money falls. In Germany in the early 1920s, when prices were on average tripling every month, the quantity of money was also tripling every month. Although less dramatic, the economic history of the United States points to a similar conclusion: The high inflation of the 1970s was associated with rapid growth in the quantity of money, and the low inflation of the 1990s was associated with slow growth in the quantity of money.
Principle #10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment
When the government increases the amount of money in the economy, one result is inflation. Another result, at least in the short run, is a lower level of unemployment. The curve that illustrates this short-run tradeoff between inflation and unemployment is called the Phillips curve, after the economist who first examined this relationship.
The Phillips curve remains a controversial topic among economists, but most economists today accept the idea that society faces a short-run tradeoff between inflation and unemployment. This simply means that, over a period of a year or two, many economic policies push inflation and unemployment in opposite directions. Policymakers face this tradeoff regardless of whether inflation and unemployment both start out at high levels (as they were in the early 1980s), at low levels (as they were in the late 1990s), or someplace in between.
The tradeoff between inflation and unemployment is only temporary, but it can last for several years. The Phillips curve is, therefore, crucial for understanding many developments in the economy. In particular, it is important for understanding the business cycle—the irregular and largely unpredictable fluctuations in
economic activity, as measured by the number of people employed or the production of goods and services.
Policymakers can exploit the short-run tradeoff between inflation and unemployment using various policy instruments. By changing the amount that the government spends, the amount it taxes, and the amount of money it prints, policymakers can influence the combination of inflation and unemployment that the economy experiences. Because these instruments of monetary and fiscal policy are potentially so powerful, how policymakers should use these instruments to control the economy, if at all, is a subject of continuing debate.