Introduction to The US Economy

FIN 30220: Macroeconomic Analysis

How do we measure a country’s size? Total production would be a good start…but

Canada

China

Egypt

India

MexicoJapan

South Africa

USA

GermanyWhere do BMWs come from?

Where does your IPhone come from?

Imports of the iPhone in 2009 contributed $1.9 billion to the U.S. trade deficit with China.

Two measures of a country’s production

Gross Domestic Product represents the total current market value of all goods and services produced within a country over the course of some time period

Gross National Product represents the total current market value of all goods and services produced by a country’s citizens over the course of some time period

The Bureau of Economic Analysis (BEA) reports Gross Domestic Product (GDP) for the United States on a quarterly basis:

For the third quarter of 2014, GDP in the United States was (on an annualized basis) was...

$17,599,800,000,000.00

* Source: www.bea.gov

Gross National product

$17,829,600,000,000.00

Gross Domestic Product: $1.3BGross National Product: $7.54B (+580%)

Why East Timor’s GNP is almost six times as high as its GDP

Gross Domestic Product: $210.3BGross National Product: $164.2B (-25%)

Why is Ireland’s GNP so much lower than its GDP?

(Do a google search on this)

How does the US Economy compare in size to other countries around the world? (World Economy = $87T ; the countries listed below are 75% of the total)

Japan

$4.7T

United States

$16.7T

European Union

$15.8T

Australia

$998B

Brazil

$2.4T

PPP Method 2013 est. * Source: CIA Factbook

China$13.4T

India

$4.9T

Russia$2.5T

California

$2.0T

Mexico

$1.8T

England

$2.4T

Gross Domestic Product represents the total current market value of all goods and services produced within a country over the course of some time period

The average price of a Big Mac in the United States is*

$4.62

The average price of a Big Mac in China is*

16.60 Yuan

Problem: How do we compare economies using different currencies?

1 Chinese Yuan = .16 U.S. dollarsThe Market Exchange rate method involves converting foreign prices to US dollars using the current market exchange rate. Y16.60 x .16 = $2.65

*2014 Prices

or1 US Dollar = 6.24 Chinese Yuan

Problem: With the extreme variability in exchange rates, is the market exchange method accurate?

Yua

n P

er U

S D

olla

r

The Purchasing Power Parity method values foreign production at prevailing US prices.

Market Exchange rate method Purchasing Power Parity Method

$4.62 No Calculation Necessary!

VS.

The average price of a Big Mac in the United States is*

$4.62

The average price of a Big Mac in China is*

16.60 Yuan1 Chinese Yuan = .16 U.S. dollars

16.60 x .16 = $2.65

The Purchasing Power Parity method assumes that if markets are functioning properly, profitable trading opportunities will eventually be eliminated

In this example, you could make money by buying Big Macs in China and then resell them in The US. There is a unique exchange rate that eliminates this profit opportunity.

16.60 x exchange rate = 4.62

exchange rate =4.62

16.60= .28 ($ per Yuan) (3.57 Yuan per $)

(This is known as the PPP exchange rate)

The average price of a Big Mac in the United States is*

$4.62

The average price of a Big Mac in China is*

16.60 Yuan1 Chinese Yuan = .16 U.S. dollars

$2.65 by current exchange rate

The PPP exchange rate seems to eliminate the short term variation, but do markets really eliminate profit opportunities?

.28

.16

55%Dol

lars

Per

Yua

n

PPP

Valuing currencies using the Big Mac Standard

“Overvalued”

“Undervalued”

China

Note that the method by which countries are evaluated sometimes greatly change the results!

PPP Approach Market Exchange Rate

Country GDP Rank GDP Rank

USA $16.72T #1 $16.72T #2

European Union $15.84T #2 $17.03T #1

China $13.39T #3 $9.33T #3

India $4.96T #4 $1.76T #7

Japan $4.73T #5 $5.00T #4

Germany $3.23T #6 $3.60T #5

Russia $2.55T #7 $2.11T #6

*2013 Estimate ** CIA Factbook

* Source: www.bea.gov

Lets use the PPP method as a reasonable method for comparing countries. Per Capita GDP is calculated by dividing total GDP by the current population.

Per Capita GDP = $17T320M

= $53,125

Per capita GDP is a better measure of the well being of an average American.

* Source: CIA FactbookNote: 2013 GDP estimates measured on a Purchasing Power Parity Basis

In Per Capita Terms, the US drops to #14 while China drops to #121 ($9,800)!! The European Union comes in at #41 ($34,500)

Side note: Calculating rates of growth:

t = 0 t = 1 t = 2 t = 3 t = 4

100 125 140 160 175

How would you calculate this rate of growth?

%25100*100

100125

100 to 125 is a 25% increase… But, from 125 to 100 is a 20% decrease?

%20100*125

125100

Which is it??

Using natural logs is the preferred method because the forward/backward problem is eliminated!

t = 0 t = 1 t = 2 t = 3 t = 4

100 125 140 160 175

%3.22100*100ln125ln

100 to 125 is a 22.3% increase…

And, from 125 to 100 is a 22.3% decrease

%3.22100*125ln100ln

Period GDP (Billions)

2013Q3 16,872

2013Q4 17,078

2014Q1 17,044

2014Q2 17,328

2014Q3 17,599

A better measure of economic performance would be the rate of growth in output rather than the level of output

Year on Year growth (2013Q3-2014Q3)

ln 17,599 ln 16,872 *100 4.2%

However, be careful here!

Year on Year Growth

Annualized Growth

Annualized Growth (2014Q3)

ln 17,599 ln 17,328 *4*100 6.2%

GDP measures current dollar value of all goods and services produced. When GDP rises, its impossible to distinguish between an increase in production and an increase in prices!!

Economy A: Zero growth, high inflation.

Year Price Quantity GDP

2010 $1 100 $100

2011 $1.25 100 $125

Economy B: Rapid growth, no inflation.

Year Price Quantity GDP

2010 $1 100 $100

2011 $1 125 $125

Both have (approximately) 25% annual growth in GDP!!!

Period GDP (Billions) Price Level

2013Q3 16,872 106.9

2013Q4 17,078 107.3

2014Q1 17,044 107.6

2014Q2 17,328 108.2

2014Q3 17,599 108.6

We can approximate real growth by subtracting the inflation rate

* Source: www.bea.gov

Year on Year Inflation (2013Q3 - 2014Q3) ln 108.6 ln 108.2 *4*100 1.5%

Year on Year growth (2013Q3-2014Q3)

Real Growth = 2.6%

Annualized Growth (2014Q3)

Annualized Inflation (2014Q3)

ln 108.6 ln 106.9 *100 1.6% Real Growth = 4.7%

ln 17,599 ln 16,872 *100 4.2% ln 17,599 ln 17,328 *4*100 6.2%

* Source: CIA FactbookNote: 2013 GDP estimates measured on a Purchasing Power Parity Basis

In terms of real GDP Growth the US drops to #157

t = 0 t = 1 t = 2 t = 3 t = 4

100 175

How would you calculate the average per period growth?

%15100*1100

175 4

1

%14100*4

100ln175ln

or

We have the same forward/backward problem here

No forward/backward problem here!!

Year GDP Price

1947Q3 $250B 13.3

2014Q3 $17,599B 108.6

Perhaps to get a better sense of the US, we should look at average performance over a long time period.

ln 17,599 ln 250*100 6.3%

67

Total Growth Price Growth (Inflation)

ln 108.6 ln 13.3*100 3.2%

67

Real Growth = 6.3% - 3.2% = 3.1%

Average Real Growth = 3.2%

Note that the US seems to be slowing down…we’ll talk about this later

Current Real Growth

Let’s compare the US with countries that are in our “peer group” in terms of development:

United States•GDP: $17.0T•GDP Per Capita: $50,000•Real GDP Growth: 2.0%•Inflation Rate: 1.6%

European Union•GDP: $15.8T•GDP Per Capita: $34,500•Real GDP Growth: 1.6%•Inflation Rate: 1.5%

*Source: CIA Factbook (2013 estimates)

~70% of US

Real Per Capita GDP, Europe and the United States: 1820 - 2000

Let’s look at historical data for the US and Europe. Europe fell behind the US in the mid 1800s and has been struggling to catch up ever since!

To understand this, let’s look at the sources of economic growth….where does GDP come from?

LKAFY ,,Real GDP

“is a function of”

Productivity CapitalEmployment

Real GDP Growth

Capital Growth

Productivity Growth

Employment Growth

Therefore, we should be able to break down economic growth into its individual components

% % ,% ,%Y F A K L

Real GDP Growth = 1.72%

Real GDP Growth = 1.42%

Real GDP Growth = 2.35%

Real GDP Growth = 2.15%

Real GDP Growth = 2.57%

Real GDP Growth = 2.94%

So, what jumps out at you?

It seems that the biggest difference between the US and Europe involves employment and productivity. With that in mind, let’s decompose GDP per capita differently…

Pop

E

E

hr

hr

Y

Pop

Y**

GDP per capita

Hrs. per employee

GDP per hour (productivity)

Employment (% of Population)

Lets measure output per hour in the US (a reasonable measure of productivity)…

Employed 139 Million

Recall, GDP = $17 Trillion

139 Million X 1,794 (hours/yr.) = 250 Billion hours per year

$17T250B Hrs.

= $68 Per hour

Here’s American productivity relative to European productivity.

Country Labor Productivity (2004) *

Productivity Growth (1989 -2000)

Productivity Growth (2000-2005)

USA 100 1.7% 2.5%

Germany 92 1.7% 1.0%

France 107 1.5% 1.3%

Italy 92 1.7% 0.0%

England 87 1.8% 2.0%

* USA = 100 ** Source: OECD

Real GDP per Hour, Europe and the United States: 1870 - 2000

As with GDP per capita, productivity in Europe has lagged behind that of the US until recent years.

Ratio of Europe to the United States: 1820 - 2000

Europe had been falling behind the US in both productivity and output per capita until recent years. However, while productivity has caught up with the US, output per capita still lags.

Productivity in Europe is comparable to the US, but output per capita is much lower. How can that be?

L

E

E

hr

hr

Y

Pop

Y**

Lower in Europe

Equal to the US

This must be lower in Europe!

The US has maintained a lower average unemployment rate that Europe as well as a higher employment rate

Country Unemployment Rate (Average)

Average annual hours

USA 5.0% 1,794 (34.5 hrs per wk)

Germany 10.0% 1,426 (27.4 hrs per wk)

France 9.0% 1,441 (27.7 hrs per wk)

Italy 9.0% 1,585 (30.4 hrs per wk)

England 5.5% 1,669 (32.0 hrs per wk)

** Source: OECD

Lately, we have seen wages diverge from productivity …especially in the US!

Country Labor Productivity (2004) *

Real Compensation (2004)* - Using Mkt. Exchange Rates

Productivity Growth (2000-2005)

Real Compensation Growth (2000 -2005)

USA 100 100 2.5% 1.7%

Germany 92 147 1.0% -0.5%

France 107 103 1.3% 0.9%

Italy 92 88 0.0% 0.5%

England 87 107 2.0% 3.4%

* USA = 100 ** Source: OECD

Index: 1947 = 100

The “wage gap” is the difference between productivity and wages

Percent

65%

?

Historically, labor’s share of income has been constant at around 65%, but has decreased since the 1980s.

So, where is the extra income going?

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Under $2,500 $12,500 to$14,999

$25,000 to$27,499

$37,500 to$39,999

$50,000 to$52,499

$62,500 to$64,999

$75,000 to$77,499

$87,500 to$89,999

Source: US Census Bureau (www.census.gov) Total Households = 121M

Median Household Income = $50,000

Mean Household Income = $68,000

Note that the distribution of household income is skewed to the left. That is, there is a large segment of the population that is below average income

Source: US Census Bureau (www.census.gov)

One indicator of growing inequality is a separation of the mean and the median

Average Income by Quintiles (2012)

Source: US Census Bureau (www.census.gov)

$119,000+

$76,000 - $119,000

$50,000 - $76,000

$27,000 - $50,000

$0 - $27,000

The Lorenz Curve

The Lorenz curve plots the cumulative distribution of US income

The Gini Coefficient

0 = Perfect Equality

1 = Perfect inequality

BA

AGini

The US currently has a Gini coefficient of .45

The Gini coefficient allows us to “quantify” the differences in income inequality across countries.

Country Gini (1989) Gini (2007) % Change

USA .338 .450 28%

Germany .257 .270 5%

France .287 .306 7%

Italy .303 .333 9%

England .336 .323 -4%

*Source: Luxembourg Income Study

The fact that income inequality in the US is rising is reflected in a rising Gini coefficient

This suggests that while the US market based economy is a real engine of growth, not everyone benefits equally from our economic success…the poor are getting poorer relative to the wealthy!

Start of the “wage gap”

Note that income inequality in the US was worse back in the 1920’s

The Good Old Days: Economic Growth from 1947-1973

The Times, They are a Changin’: Economic growth from 1977-1989

Here we can see both the declining growth as well as the rising inequality.