How The Economy As A Whole Works

Westarted by discussing how individuals make decisions and then looked at how people interact with one another. All these decisions and interactions together make up "»Ik economy." The last Ihree principles concern the workings of Ihe 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 2006, the average American had an income of about $44,260. In the same year, the average Mexican earned 511,410. and Ihe average Nigerian earned $U150. No! 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 healthcare, and a longer life expectancy than citizens of low-income countries.

Changes in living standards over lime are also large. In Ihe United States, incomes have historically grown about 2 percent per year (after adjusting for market power tti« ability of a «ingle economic actor {or small group of acto«) to have a uibsuntul influence on market prices changes in the cost of living). At this rate, average income doubles every 35 years. O'er the past century, average income has risen about eightfold.

What explains these large differences in living standards aiming 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 serv ices produced from each unit of labor input. In nations where workers can produce a large quantity of goods and service» per unit of time, most people enjoy a high standard of living: in nations where workers are less productive, most people 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 fiir 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 thai 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, tlx* 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.

productivity the quantity of goods and services produced from oach unit of labor input

Principle 9: Prices Rise When tut Govr.rnmf.nt Prints Too Much Money

In January 1921, a daily newspaper in Germany 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 inflatk->n even close to that in Germany in the 1920s, inflation Ivas at times been an economic problem. During the 1970s, for instance, when the overall level of prices more than doubled. President Cerald Ford called inflation "public enemy number one." By contrast, inflation in the first decade of the 21st century has run about 2Vi percent per year; al this rate, it would take almost 30 years for prices to double. Bixiause 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 is growth in the quantity of money. When a government creates large quantities of the nation's money, the value of the money falls In Cermany 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 point* to a similar conclusion: The high inflation of the 1970s was associated with rapid growth in the quantity of money, and the low inflation an increase in the overall tovel of pric«» in th<» economy

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