>	Econ 100b Created 4/30/1996 Go to Brad De Long's Home Page

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Lecture One

Introduction
(Economics 100b; Spring 1996)

Brad DeLong

January 19, 1996 [originally scheduled for January 17, 1996; postponed due to chicken pox]

• A final exam
• Two "midterms" (March 8 and April 17)
• About ten problem sets--which can only improve your grade...

• Measures of net economic product correct for depreciation--calculate, for example, that a factory producing X during the year didn't really produce X but instead only X-Y, because the process of production put Y worth of wear-and-tear on the factory's capital stock.
• Measures of gross economic product do not correct for depreciation. Measures of net product are, conceptually, better--but they are very hard to do, the people at the Commerce Department's Bureau of Economic Analysis who create these numbers have little confidence in the accuracy of their depreciation estimates, and they prefer to focus on numbers they think they can measure adequately--even if it is not quite the concept they would ideally like to measure.

"Domestic" means that we are looking at all marketed and government production taking place inside the boundaries of the United States. We don't care that New York's Rockefeller Center is owned by people who live in Japan--the services provided by Rockefeller Center to those who rent office space there, and the income generated by the rental are part of domestic product. Conversely, income generated abroad by factories located in Malaysia owned by U.S. citizens does not enter into domestic product.

• The alternative concept, "national" product, would include products made and income generated by extra-U.S. property owned by U.S. citizens, and would exclude products made and income generated by property in the U.S. that was owned by non-U.S. citizens. We now use domestic product because our estimates of cross-border income and profit flows are riddled with error, and thus our estimates of national product are of signficantly lower quality than our estimates of domestic product.

"Product." Finally, a noun. The economic product of a country, a region, an individual is the market value of goods and services produced over the course of a year. For example, my mother the psychologist "produces" some $80,000 of therapy each year. She works. Patients feel better and more well-adjusted--and find it worthwhile to pay her, or their insurance companies do. That $80,000 is her income, and it is also value-added for the economy as a whole: something produced over the course of a year which consumers were willing to pay for.

"Real" and "(1995 Prices)". Measured economic product could change because the volume of economic activity changed, or it could change because the prices at which goods and services sell changed--either because of general inflation or deflation, or because of shifts in relative prices. We want to ignore shifts in measured economic product caused by shifts in the price level. So we look at real GDP at 1995 prices. The idea is to take a representative slice of what was produced at some other date, and ask "what would this sell for if we brought it forward in time to 1995?" This way we manage to--imperfectly--control for shifts in price levels and in relative prices. Seasonal adjustment you do not have to worry about yet.

"Per Worker." Real GDP is a measure only of economic activity that passes through the market--is bought or sold (with a few exceptions). Within-the-household-production is counted in GDP if it is bought or paid for, and if not, is not. As the share of the American adult population in the paid labor force has risen, so measured GDP has risen even though part of what has been going on has been the shifting boundary between categories of work that used to be outside, but are now inside the market. So we divide real GDP by the size of the American labor force to attempt to control for the shifting boundary between market and non-market work, and also to control for the overall growth of population. So there is the unpacked title of the graph. It is a measure of the average productivity, controlling for inflationary and deflationary shifts in the price level, of the American labor force.

"Average" in the sense that we have taken the market value of all goods and services produced in the U.S. and divided by the number of workers. It is a gross measure in that it doesn't take account of depreciation and capital consumption--the fact that this year's production has placed wear-and-tear on the nation's accumulated capital stock. When we look at this graph, what do we see? It has gone up a lot over the past century. In 1890, real GDP per worker (at 1995's prices) was only some $12,000 a year. Take what the average worker produced in 1890, bring it forward in time to 1995, and sell it--and you will get some $12,000 for it. By contrast, real GDP per worker crossed $50,000 a year sometime early in this decade, and continues to rise.

• It would not be a mistake to say, roughly, that we today are at least 4.5 times as well-off as our predecessors who lived in the U.S. in 1890. In fact, the factor of 4.5 is almost surely an underestimate. We can today purchase or use a much broader range of goods and services than people could in 1890, real GDP measures take no account of the extra welfare produced by an enhanced range of choice among different types of commodities. The work year has also dropped from perhaps 2400 hours a year on average then to perhaps 1800 hours a year on average now.
• Make your guesses as to how much the expanded range of capabilities and powers produced over the past century--as opposed to increased quantities of things we knew how to make a century ago--has contributed to your welfare, and adjust for the declining workweek, and come up with estimates that range from my favorite of 10 to as high as 30 for the multiplication of the average productivity of the American worker over the past century.
• So the first thing to note is that there has been an enormous amount of economic growth over the past century. And we are going to spend some time decomposing that growth into its various sources and causes this semester.

The second thing to notice is that the pace of growth is not all that smooth:

• The economy falls off of a cliff at the end of the 1920s--the Great Depression.
• Mobilization for World War II sees a steep increase that is not sustained at the end of the war as shifts shrink back from 12 to 8 hours and as government demand for the heavy industrial materials of modern war falls.
• The first generation after World War II sees rapid growth--the Korean War Boom, the boom of the 1960s.
• The second generation after World War II sees relatively slow growth--in the 1970s product per worker comes close to stagnating, and the 1980s did not see a bounce-back to make up any of the lost ground. When people talk of the "productivity slowdown" they are talking of the bend in this real GDP per worker curve at the end of the 1960s that separates the first, fast-growth post-World War II generation from the more recent, slow-growth period.

The third thing to notice is that the graph has wiggles. These wiggles are this country's "business cycles": expansions and recessions, episodes of rising and falling unemployment, and so forth.

• These business cycles have less of an impact on the country's overall economic welfare than does the secular tide of rising incomes and productivity traced over the whole century; they have less of an impact than do the episodes of productivity speed-up and slow-down seen in comparisons of pre- to post-1970 experience.
• But these business cycles--the little wiggles--are the major source of uncertainty over the one-to-ten year span of time that most of us plan for. And these business cycles are also the most clearly affected and influenced by government policy. So we will spend most of our time on them.
• Moreover, the business-cycle-wiggles have much more important consequences for economic welfare than they do for economic activity because of the correlation between business-cycle swings in output and swings in unemployment.

• Why does a given business-cycle swing--a fall of, say, five percent in output relative to the long-run potential growth path of the American economy--have such big effects on economic welfare?
• Because the distribution of the costs of unemployment--and thus of the business cycle--is so unequal.
• One of the major presumptions of this course is that business-cycle fluctuations are, in a sense, very odd--much bigger than you would expect given the "normal" workings of a market economy as a social calculating mechanis for deciding what and how much to produce.
• Note, once again, the centrality of the Great Depression in our experience over the past century. We would all sleep much, much easier if you could guarantee that nothing like the Great Depression will ever come again.

• Feeling that measuring rods are unstable.
• Feeling that the income "lost" as a result of high inflation is a loss of real income.
• Consequences of high inflation are bad enough: deranging the price mechanism; lots of windfall gains and losses; difficulty in persuading people that the burst of inflation has come to an end.

• Two weeks on the economy in "equilibrium"
• A section on domestic economic policy, and business cycles
• A section on the international dimension.
• A section on long-run growth.