Lecture 2. CONSUMERS & GROSS DOMESTIC PRODUCT

Economic activity consists of the production and sale of 
goods and services, followed eventually by their 
consumption. Only the retail value of the goods and 
services adds to the output of the economy. Thus, the size 
of our national economy is measured by its GDP, the total 
retail value of domestic products and services delilvered 
annually.

We call the average tax rate at all levels of government 
the “Tax Burden” or TB. After paying taxes, 
consumers have a disposable income, from which they can 
either consume goods and services or save in various 
accounts. In economic literature, the average proportion of
disposable income consumed is called the “Marginal 
Propensity to Consume” or MPC. The disposable income
not spent is saved and the average proportion saved is 
called the “Marginal Propensity to Save” or 
MPS.
  

The partition of consumer spending among TB, MPC, and MPS 
is critical to the economy. Consumers always have needs and
when they have a secure source of money, the “life 
blood” of the economy, MPC will dominate MPS. When 
consumers are insecure about their source of money, MPC 
falls as MPS rises, the GDP drops, and - voilà - a 
recession!
 

Therefore, to avoid a recession or to recover from a 
recession, there are certain
BASIC REQUIREMENTS:
1. The amount of money in the economy must be sufficient and 
assured.

2. The money in the economy must be distributed so that the 
entire population can purchase essential goods and services.
(We now have the greatest maldistribution of wealth and
income since the Great Depression.)

3. Since, according to our Constitution, it is the basic 
purpose of the U.S. government to “...promote the 
General Welfare and secure the Blessing of Liberty to 
ourselves and our Posterity,...”, the “essential goods and
services” include all the food, shelter, play, and health
care needed by children and all the education children
can absorb until their education is complete, regardless
of the wealth or poverty of their parents.


4. Since the well-being of children is inseparable from the 
well-being of their parents, grandparents, guardians, and 
employees of schools, hospitals, merchants, producers, and 
other members of their community, “essential goods and
services” include the food, shelter, and health care needed
by adults, regardless of their weath or poverty.


5. Since the states cannont issue sovereign currency, it is 
impossible for the states to to manage the economy so that
“essential goods and services” may be purchased by the entire 
public.

Therefore, it is the sole responsibility of the federal 
government to manage the economy so that “essential 
goods and services” may be purchased by the entire 
public. States cannot control their economies or maintain 
the highest standards in delivery of health and education 
services. They are bound to fail as they are now failing.

6. Since, according to the preamble of our Constitution,
it is the will of "We, the people, in order to form...,
establish..., insure..., provide..., promote..., and 
secure..." whatever we need, the federal government should 
be big enough to do what needs to be done.


The central thesis of Keynesian theory is that the 
policy of the federal government should be to do what needs
to be done to fulfill these requirements.

A small government cannot build the world's greatest
infrastructure.

Without the world's greatest infrastructure, we will not
have the world's greatest industrial base.

Without the world's greatest industrial base, we will
not have the world's greatest military, naval, and air
defense.

Without the world's greatest defense, our very existence
as a nation is in jeopardy.

A small government is a betrayal of our heroes who died
so that a great nation could provide a great defense
against a dangerous world.

A small government is the road to serfdom. 

A small government is only the fetish of small minds.
GDP = Productivity x Employment Rate x Time
While the GDP is our economy's output, the economy's 
efficiency is measured by its productivity, defined as:

(1) Productivity = GDP / Total Annual Working Hours

Thus, nations differ in the average value of the goods
and/or services that each hour of work will produce. A 
nation grows richer due to a gain in productivity.

Multiplying equation (1) by its denominator yields:

(2) GDP = Productivity × Total Annual Working Hours

To understand the factors that determine GDP, we define:

(3) Employment Rate = Total Annual Working Hours
             ÷ Total Annual Available Working Hours

Employment Rate is directly proportional to production 
capacity. The economy is considered to be at peak 
production capacity when the unemployment rate is 2%,
(This assumes that at least 2% of the working population
is always otherwise occupied.)
 

Multiplying equation (3) by its denominator yields:

(4) Total Annual Working Hours
                    = Employment Rate
              × Total Annual Available Working Hours

Finally, substituting equation (4) into equation (2),
we have:

(5) GDP = Productivity
        x Employment rate
        x Total Annual Available Work Hours

Thus, the GDP depends on three factors:

1. Productivity increase can arise from two sources:
 A. Technological innovation.
     These productivity gains are the result of
     two developments:

  (a) Basic infrastructure: long-term developements,
       such as systems of transportation,
       communication, etc. These require political
       commitment to large investments with distant
       pay-offs. This can happen only with unusual
       leadership and national unity.
      
       It also requires an excellent system of
       education, especially in science. Currently,
       the US is behind dozens of nations in
       science education. In particular, Asian
       countries are running far ahead of us.
       Worse yet, teachers salaries and pensions
       are under severe attack by short-sighted
       deficit hawks.

 (b) Short-term innovations such as TV, cell-phones,
     etc. Industry produces these inventions, but
     industry depends upon a work force with a
     sufficient level of technical education, which
     is a long-term investment.

 B. Increased human effort (“speed-up”)

    This occurs especially during during a
    recession when industry cuts costs by laying
    off well-paid employees with fringe benefits
    and ordering the remaining employees to take
    on an additional load, sometimes augmented by
    temporary aid without fringe benefits.

    During the current recession, productivity has
    increased over 9% during a three-year period
    with negligible increase in hours worked or
    salary. 

    Even during prosperity, the US falls behind
    most advanced nations in vacation time, paid
    maternity leave, and similar benefits. For
    this reason, productivity comparisons between
    nations is deceiving.


Thus, productivity requires long-term investment,
which requires an intelligent electorate.

2. During a recession, employment rate is a factor that 
government can affect in the near term only by heavy 
investment in infrastructure, including defense: a 
stimulus. (World War II was an extreme example.) In 
general, full employment is the responsibility of the 
federal government, requiring the joint efforts of the 
administration, Congress, and the Federal Reserve. In 
particular, the nation cannot recover from a major 
financial collapse, such as the Great Depression or our
2008 meltdown, without the joint effort of all branches of
government.

At present (mid-2011), the unemployment rate is about 9%.
Underemployment (those working less than 30 hours per week
and seeking full-time work) is at about 16%. Thus, the 
effective unemployment rate is about 17%.

Raising employment by ten million workers would add over 
$1T annually to the GDP. The tax revenue on such GDP growth
would be over $300B. The reduction in relief benefits would
add another $300B yielding a $600B total budget gain 
annually. The ten-year gain would be $6T. For our 20 million
unemployed, the ten-year gain would be $12T.  What deficit?

Thus, the employment rate is a measure of prosperity. The
view of Keynesian theory is that the federal government 
should pursue a policy of full employment to meet the BASIC
REQUIREMENTS listed above.

Conservatives claim that tax reduction for the wealthiest
would increase the employment rate. That may happen during
prosperity, but that is exactly the point at which tax 
revenue should be maximized to avoid inflation and control
the deficit. During a recession, the profits and tax burden
of industry (especially small business) are too low to 
influence a decision. Low interest rates, cheap labor, and
abundant capacity insure that any good opportunity will be
easily funded. 

The chart below (from the Bureau of Labor Statistics and 
Tax Policy Center) plots average employment growth versus 
top tax rate.

There is no evidence that lower tax rates for the rich
stimulates job growth. If everyone complaining about the 
lowest tax level in 60 years would buy an automobile,
they would know who creates jobs.

3. Total Available Working Hours is a long-term GDP factor 
dependent upon population, birth and death rates, 
immigration and emmigration, and cultural changes such as
percentage of women at work, youth in school, etc. In 
general, government can do little to affect Total Annual
Available Work Hours in the near term.

In the long term, pro-family programs could increase the
population and immigration policy could become more 
liberal, especially with regard to foreign students and 
scientists.  Again, there is much anti-immigration opinion
among conservatives.
CONCLUSION:
The growth of GDP, the most important measure of our 
national wealth and health, is dependent upon gains in 
productivity and infrastructure. Gains in productivity are 
likewise dependent upon infrastructure, especially our 
system of public education. Thus, our future depends almost
entirely upon public investment in infrastructure.
Proceed to:
Lecture 3. THE ACCOUNTING MODEL OF GDP
Thanks for your interest.
  Marvin Sussman, retired engineer

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