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1. Portray the following hypothetical data on a two- B+ or better. He concludes from observation that the fol-
variable diagram: lowing figures are typical:

Number of grades of B+ or better 0 1 2 3 4
Academic Total Enrollment in Number of job offers 1 3 4 5 6
Year Enrollment Economics Courses
1994“1995 3,000 300 Put these numbers into a graph like Figure 1(a). Measure
1995“1996 3,100 325 and interpret the slopes between adjacent dots.
1996“1997 3,200 350
4. In Figure 6, determine the values of X and Y at point K
1997“1998 3,300 375
and at point E. What do you conclude about the slopes
1998“1999 3,400 400
of the lines on which K and E are located?
Measure the slope of the resulting line, and explain what 5. In Figure 8, interpret the economic meaning of points A
this number means. and B. What do the two points have in common? What
is the difference in their economic interpretation?
2. From Figure 5, calculate the slope of the curve at point M.
3. Colin believes that the number of job offers he will get
depends on the number of courses in which his grade is

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Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

The Economy: Myth and Reality
E pluribus unum (Out of many, one)

T his chapter introduces you to the U.S. economy and its role in the world. It may
seem that no such introduction is necessary, for you have probably lived your
entire life in the United States. Every time you work at a summer or part-time job, pay
your college bills, or buy a slice of pizza, you not only participate in the American
economy”you also observe something about it.
But the casual impressions we acquire in our everyday lives, though sometimes cor-
rect, are often misleading. Experience shows that most Americans”not just students”
either are unaware of or harbor grave misconceptions about some of the most basic eco-
nomic facts. One popular myth holds that most of the goods that Americans buy are
made in China. Another is that business profits account for something like a third of
the price we pay for a typical good or service. Also, “everyone knows” that federal gov-
ernment jobs have grown rapidly over the past few decades. In fact, none of these
things is remotely close to true.
So, before we begin to develop theories of how the economy works, it is useful to get
an accurate picture of what our economy is really like.

The American Workforce: What It Earns The Government as Business Regulator
SKETCH Capital and Its Earnings Government Expenditures
Taxes in America
A Private-Enterprise Economy THE OUTPUTS: WHAT DOES AMERICA
The Government as Redistributor
A Relatively “Closed” Economy PRODUCE?
But with Bumps along the Growth Path
The American Workforce: Who Is in It?
The Government as Referee
The American Workforce: What Does It Do?

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Part 1
22 Getting Acquainted with Economics

The U.S. economy is the biggest national economy
on earth, for two very different reasons. First, there
are a lot of us. The population of the United States
is just over 300 million”making it the third most

SOURCE: © The New Yorker Collection, 1992 Lee Lorenz from
populous nation on earth after China and India. That
vast total includes children, retirees, full-time stu-
dents, institutionalized people, and the unemployed,
none of whom produce much output. But the work-

cartoonbank.com. All Rights Reserved.
ing population of the United States numbers about
150 million. As long as they are reasonably produc-
tive, that many people are bound to produce vast
amounts of goods and services. And they do.
But population is not the main reason why the
U.S. economy is by far the world™s biggest. After all,
India has nearly four times the population of the
United States, but its economy is smaller than that
“And may we continue to be worthy of consuming a disproportionate of Texas. The second reason why the U.S. economy
share of this planet™s resources.” is so large is that we are a very rich country. Because
American workers are among the most productive
in the world, our economy produces more than $45,000 worth of goods and services for
Inputs or factors of
every living American”over $90,000 for every working American. If each of the 50 states
production are the labor,
was a separate country, California would be the fifth largest national economy on earth!
machinery, buildings, and
natural resources used to Why are some countries (like the United States) so rich and others (like India) so poor?
make outputs. That is one of the central questions facing economists. It is useful to think of an economic
system as a machine that takes inputs, such as labor and other things we call factors of
Outputs are the goods and
production, and transforms them into outputs, or the things people want to consume. The
services that consumers
American economic machine performs this task with extraordinary efficiency, whereas the
and others want to acquire.

U.S. Share of World GDP”It™s Nice To Be Rich
The approximately 6.6 billion people of the world 2007 Gross Domestic Product (GDP) per Capita in 7 Industrial Countries
produced approximately $50 trillion worth of
goods and services in 2007. The United States, 50000
with only about 4.5 percent of that population,
turned out approximately 27 percent of total out-
put. As the accompanying graph shows, the United
States is still the leader in goods and services,
with over $45,000 worth of GDP produced per 35000
GDP per Capita ($)

person (or per capita). Just seven major industrial
economies (the United States, Japan, Germany,
France, Italy, the United Kingdom, and Canada”
which account for just 11 percent of global popu-
lation) generated 59 percent of world output. But 20000
their share has been falling as giant nations like
China and India grow rapidly.

SOURCE: International Monetary Fund, World Economic Outlook
Database, October 2007, http://www.imf.org, accessed Febru-
United United Canada France Germany Italy Japan
ary 2008, and Central Intelligence Agency, The World Factbook,
States Kingdom
2008. Note: Foreign GDPs are converted to U.S. dollars using
exchange rates.

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Licensed to:
Chapter 2 23
The Economy: Myth and Reality

Indian machine runs quite inefficiently (though it is improving rapidly). Learning why
this is so is one of the chief reasons to study economics.
Thus, what makes the American economy the center of world attention is our unique
combination of prosperity and population. There are other rich countries in the world, like
Switzerland, and there are other countries with huge populations, like India. But no na-
tion combines a huge population with high per-capita income the way the United States
does. Japan, with an economy well under half the size of ours, is the only nation that
comes close”although China, with its immense population, is moving up rapidly.
Although the United States is a rich and populous country, the 50 states certainly were
not created equal. Population density varies enormously”from a high of about 1,200 peo-
ple per square mile in crowded New Jersey to a low of just one person per square mile in
the wide-open spaces of Alaska. Income variations are much less pronounced. But still,
the average income in West Virginia is only about half that in Connecticut.

A Private-Enterprise Economy
Part of the secret of America™s economic success is that free markets and private enter-
prise have flourished here. These days more than ever, private enterprise and capitalism
are the rule, not the exception, around the globe. But the United States has taken the idea of
free markets”where individuals and businesses voluntarily buy and sell things”further
than almost any other country. It remains the “land of opportunity.”
Every country has a mixture of public and private ownership of property. Even in the
darkest days of communism, Russians owned their own personal possessions. In our
country, the post office and the electricity-producing Tennessee Valley Authority are en-
terprises of the federal government, and many cities and states own and operate mass
transit facilities and sports stadiums. But the United States stands out among the world™s
nations as one of the most “privatized.” Few industrial assets are publicly owned in the
United States. Even many city bus companies and almost all utilities (such as electricity,
gas, and telephones) are run as private companies in the United States. In Europe, they
are often government enterprises, though there is substantial movement toward transfer
of government firms to private ownership.
The United States also has one of the most “marketized” economies on earth. The stan-
dard measure of the total output of an economy is called gross domestic product (GDP), Gross domestic product
(GDP) is a measure of the
a term that appears frequently in the news. The share of GDP that passes through markets
size of the economy”the
in the United States is enormous. Although government purchases of goods and services
total amount it produces in
amount to about 18 percent of GDP, much of that is purchased from private businesses.
a year. Real GDP adjusts this
Direct government production of goods is extremely rare in our society. measure for changes in the
purchasing power of
money, that is, it corrects
A Relatively “Closed” Economy
for inflation.
All nations trade with one another, and the United States is no exception. Our annual ex-
ports exceed $1.7 trillion and our annual imports exceed $2.4 trillion. That™s a lot of
money, and so is the gap between them. But America™s international trade often gets more
attention than it deserves. The fact is that we still produce most of what we consume and
consume most of what we produce, although the shares of imports and exports have been
growing, as Figure 1 shows. In 1959, the average of exports and imports was only about
4 percent of GDP, a tiny fraction of the total. It has since gone up to over 14 percent. While
this is no longer negligible, it still means that almost 86 percent of what Americans buy
every year is made in the United States.
Among the most severe misconceptions about the U.S. economy is the myth that this
country no longer manufactures anything but, rather, imports everything from, say,
China. In fact, only about 17 percent of U.S. GDP is imported, with imports from China
making up only about one seventh of this”or a little over 2 percent of GDP. It may sur-
prise you to learn that we actually import more merchandise from Canada than we do
from China.
Economists use the terms open and closed to indicate how important international trade
is to a nation. A common measure of “openness” is the average of exports and imports,

Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Part 1
24 Getting Acquainted with Economics

F I GU R E 1
Share of U.S. Gross Domestic Product (GDP) Exported and Imported, 1959“2007


SOURCE: Economic Report of the President (Washington, DC: U.S.
Average of Exports and Imports,

as a share of GDP (%) 12



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