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GDP and the Players Three

Consumers: Buyers, Buyers Everywhere

As you have surely noticed, Americans are avid consumers. The advertising, credit card, banking, and retail industries—and the economy's ability to generate jobs—have created an environment in which people spend freely on the things they want and need. In contrast, the Japanese put a higher percentage of their incomes into savings, and both Asians and Europeans make much less use of credit cards. Consumer demand in the United States fuels continual economic growth.

Aside from all of those slick advertisements and our appetite for goods and services, several more fundamental factors drive U.S. consumer spending. They also drive consumer spending in other nations. The most important of these are:

EconoTip

You may have heard the term Gross National Product, or GNP. If so, you may be wondering why am I using GDP instead.

Economist now usually use GDP—gross domestic product—rather than GNP to measure the economy. Here's why: GDP includes all goods and services produced within a nation's borders. GNP includes all goods and services produced by a nation, including those produced overseas by that nation's companies. Given the number of foreign companies, such as car manufacturers, now operating in the United States, most economists see GDP as the better measure of economic activity in the country. U.S. companies have operations in foreign nations, but that does not create jobs or income here in the United States.

  • Population growth and household formation
  • Employment
  • Incomes
  • Interest rates and taxes

Let's examine each of these drivers individually.

Population Growth and Household Formation

The more consumers there are in an economy, the more goods and services the economy will consume (all other things being equal). A steady or sharp increase in the population in an economy will drive demand upward. This occurred in the post-World War II years, when returning servicemen married and started families. The individuals born during baby boom years of 1946 to 1965 have a well-documented record of consumption.

The post-World War II years were a time of high rates of household formation. When people (usually two) form a household, a whole series of purchases becomes necessary. First, there's the housing itself. Economists keep a close eye on housing starts—the number of single-family houses and multifamily dwellings on which construction began in a period—because a home is the largest purchase that most families ever make. Second, people then need to buy a huge number of items for the house or apartment—furniture, televisions, carpeting, appliances, pots, pans, dishes, and so on. Finally, in most households, sooner or later one plus one equals three, which brings us back to population growth.

EconoTalk

Economic indicators are measures of economic activity, such as growth rates, levels of income and spending, and percentages (such as the unemployment rate) that point to what is going on in the economy and, at times, forecast future trends.

Full employment occurs when every person in the economy who is willing and able to work has a job. In the United States, economists consider full employment to have been achieved when the unemployment rate falls to about 4 percent. That 4 percent is considered frictional unemployment—mainly people who just entered or re-entered the work force or who are between jobs.

Disposable income is household income minus taxes. Disposable income is either spent, and thus boosts consumption, or is saved, which makes it available for investment by businesses.

Economists look at population growth, as well as the age patterns within the population, to gauge long-term economic growth. However, the growth rate of the population is a very long-term indicator of economic growth. Short-term indicators of economic growth include household formation and housing starts.

Let's Work: Employment

The more money people have, the more they spend. But to spend money you must make money, which is why employment and growth in employment are so important. Moreover, people need jobs not only so they can take care of their needs, but also to occupy themselves productively. High unemployment is associated with high crime and political instability, as well as with poverty.

Economists look at employment in several ways:

  • Employment is the percentage of the workforce that is either employed or self-employed. This may also be the reported number of people employed (rather than or in addition to the rate). This is usually expressed as nonfarm employment, to focus the number on nonseasonal jobs, and excludes the armed services.
  • The unemployment rate is the percentage of the workforce that is out of work but looking for work and willing to work. The unemployment rate is reported more commonly than employment because it is a bit more accurate because people file claims for unemployment insurance. As a smaller number it is also easier to comprehend changes in it.
  • New jobs is (as you surely suspected) the number of new jobs generated by the economy in a period, usually a calendar quarter or year. The number of new jobs is commonly reported in the business news.
  • Jobs lost is also just what it sounds like—the number of jobs eliminated in the economy in the period being considered. Net new jobs is the number of new jobs, minus the number of jobs lost. Jobs lost and net new jobs are also reported in the business news.

These employment and job data all indicate the health of the economy. The larger the portion of the workforce that is employed, the better. A growing economy creates jobs, which is one reason that governments want to keep their economies growing. Political questions surround the government's role in ensuring full employment.

Income and Income Growth

Income is the total amount of money that households receive for supplying labor and capital in the economy: salaries, wages, bonuses, tips, benefits, interest, dividends, and so on. Rising incomes give people more money to spend and save. That increases demand and fuels economic growth.

Households can do only one of two things with their disposable income: spend it or save it. Whether they spend it or save it has a profound effect on the economy. For now, it's enough to know that higher incomes (or lower taxes) put more money into people's pockets. When they spend it, they are increasing consumption—the “C” in the GDP formula. Yet even when they save it, they are fueling GDP growth. Some of that savings goes into bank accounts or investments that put money into the hands of businesses, which in turn invest that money and boost the “I” in the GDP formula.

Interest Rates and Taxes

The other main drivers of consumption are interest rates and taxes. U.S. consumers are the world's greatest users of credit. When interest rates are low, people will borrow and spend more money. This is particularly true with regard to rates on home mortgages and auto loans. When lower taxes increase people's disposable income, they dispose of it either by spending it and boosting consumption or by saving it, which makes it available for investment. Higher taxes, which nobody ever wants, take money away from households and thus lower consumption expenditure. Yet higher taxes do not necessarily reduce GDP. If the government purchases goods and services with all the money raised through higher taxes, then total demand and GDP remain unchanged.

I mention interest rates and taxes together because they are two of the three major levers that the federal government uses to implement economic policy. The other lever is government spending.

Let's turn to the role of business investment in the economy.

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Excerpted from The Complete Idiot's Guide to Economics © 2003 by Tom Gorman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

To order this book direct from the publisher, visit the Penguin USA website or call 1-800-253-6476. You can also purchase this book at Amazon.com and Barnes & Noble.

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