Class Notes 4

Hello class,

Thanks to all of you for paying attention during today's class which was more of a lecture than I would normally like to have. There was a lot to cover, and I think that you got what I was trying to get across:

  1. The "big picture" is not just "the little picture" added up. If one person stands up in a stadium to get a better view, it is not the case that everyone will get a better view if everyone stands up!

  2. The economy produces goods and services for our wants and needs, and these are distributed as Consumption (what we can buy for ourselves), Government spending (what we need the government to buy for us as a country), Investment (what businesses buy to make the economy better able to produce), Exports (what the Rest of the World buys from us) and Imports (what we buy from the rest of the world). The last two are summarized as "Net Exports", NX.

  3. The economy is embedded in a society that supports it, and the economy and society are embedded in a natural world that supports both.

  4. The economy is a dynamic system. In a given time period, we can look at flows, such as income, savings, deficits and surpluses. Flows can make stocks, or accumulated amounts, go up or down. For example, a flow of profit during the year can add to a company's equity stock as "retained earnings". A deficit flow can add to a government's debt, just as a surplus flow can subtract from the debt. Investment creates a positive flow adding to a country's capital stock, which hopefully is greater than the outflow of depreciation, deterioration, and depletion of the capital stock. ... Another feature of a dynamic system is that outputs become inputs: that is, production gives us income, which we can turn around and spend or invest, leading to more production, round and round.

  5. The aggregates can get out of balance (for a while) with one another, leading to problems. For example:

    1. If Consumption is too great, and there is no savings, then there can't be investment and the productive capacity of the economy at best will not improve and at worst will deteriorate.

    2. If a lot of production happens but the income doesn't go to people so they can't spend, then business gets in trouble because they have overcapacity and inadequate demand. This has been the case of China, for example, for the past few years, and they are having to rebalance and increase the share of Consumption.

    3. When NX is negative for too long, i.e. there is a trade deficit with the rest of the world for many years, essentially the country is running up a tab and giving out IOUs -- promises of a share of future production -- and at some point the rest of the world stops believing in the IOUs and starts asking to be paid back NOW. The US has been able to get away with this because the rest of the world doesn't actually want the dollar to become worth less, since they are holding a lot of their wealth in dollars.

    4. If Government spending exceeds government tax revenues by too much or for too long (there are big deficits year after year), this can have a negative effect on Investment because savings are going as a loan to the government instead of as loans to businesses. The hope is that the government is doing things with that money that the economy needs and that businesses cannot do, but that may not be the case. (We'll have more on what happens with government debts next class.)

    5. Not in the picture, but important: if a country's population grows faster than the economy's ability to produce, then there will be a decrease in production capacity per person. Population increases can come about through fertility (having babies) or decreased mortality (dying less from diseases, dying later). The hope is that increases in population will lead to increases in productive capacity, if the new or not-dead people go get a productive job, but if there are no productive jobs for them then more people just means less to go around.

    6. Not in the (usual) picture, but crucial: if the uncounted things such as unpaid housework, social capital and institutions, and natural capital that are crucial to the functioning of the economy are losing their capacity, then this will undermine the economy's ability to function. So, for example, in Russia, everyone is on the take: the police, government officials, company managers, etc. It is extremely difficult to engage in productive economic activity when no one can be trusted. Or another example: if it used to be the case that children were looked after by grandparents and other extended-family members, freeing young parents to work, then if the society becomes more mobile and people live far away from family, young parents will have a harder time going to work. They will either have to pay for babysitting or stay out of the workforce temporarily. The economy will have to make up for the loss of unpaid services. And with the natural world we have loads of examples of services we cannot do without: take the way that wetlands act as a sponge to absorb storm surges. It is impossible to build such a thing and very, very expensive to build substitutes, such as levees, which are not as effective anyway. And when we don't have the services, we end up with destroyed cities--not very good for the economy. There will be more on this later in the course.
Next class we will look at how we count and some of the problems that come from the way we count, specifically: what happens when prices change, whether we are counting everything we should be counting, and how what we count affects what we pay attention to.

Take-home point: everything adds up (even the stuff we're not counting!), and when things get out of balance, pressure builds up to get them back into balance.