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Chapter 3 The State of the Economy
The IMF Comes to Town
In early 2002, a team from the International Monetary Fund (IMF) flew to Buenos Aires, Argentina. Argentina had been prospering during most of the 1990s, but more recently it had begun to run into economic problems. The IMF is an organization that attempts to help countries having financial difficulties.
An IMF team consists of professionally trained economists. These teams visit many countries, such as Argentina, on a regular basis. In this chapter, we imagine that the IMF added you to this mission and asked you to report back on the state of the Argentine economy. As we proceed, we think about how you might have approached this task.
You arrive at Aeropuerto Internacional Ministro Pistarini de Ezeiza Airport, which is a clean and modern airport on the outskirts of Buenos Aires. You ride into the city in a new car along modern highways lined with fancy billboards. When you get to the city center, you notice that there are luxurious shopping malls. You see high-end stores selling luxury brands, such as Louis Vuitton, Versace, Hermes, and Christian Dior. The city seems prosperous, reminiscent of Paris or New York. Just looking around, you see immediately that you are not in one of the really poor countries of the world.
Source: Image taken by authors.
As you explore the city, though, you begin to look more closely and notice that things are not quite what they seemed at first glance. The luxury stores do not have many customers in them. Some buildings show signs of a lack of maintenance; it has been a while since they were repainted. Some stores are boarded up or bear signs saying that they are going out of business. There seem to be a lot of people who are not working or who are making a living selling goods on the street.
Reflecting on these conflicting clues to Argentina’s prosperity, you quickly realize that it is difficult to assess the health of an economy by casual observation. In addition, you have seen almost nothing of the country. Argentina covers over one million square miles; it is almost one-third of the size of the United States and has a population of nearly 40 million. The more you think about this, the harder the problem seems. Forty million people are buying things, selling things, making things, and consuming things every day. It seems an impossible task to make sense of all this activity and say anything useful about the economy as a whole. That challenge is the subject of this chapter.
How can we evaluate the overall performance of something as complicated as an economy?
If you think about this question for a bit, you will realize that it has more than one dimension.
- First, we need measurement. We must summarize the economy in a manageable way, which is impossible unless we find some way of measuring what is going on in the economy. One of the primary tasks of economics is accounting. That leads to other questions: what should we count, and how should we count it?
- Data are not enough. Measurement will not take us very far unless we can combine it with some understanding of how the economy works. We need to know how to interpret the things we count. We need to know what our numbers mean. For this, we need frameworks that help us make sense of the economy.
These two ideas guide our discussion in this chapter.
Think for a moment in very general terms about what happens in an economy. An economy possesses some resources. These include the time and abilities of the people who live in the economy, as well as natural resources, such as land or mineral deposits. An economy also possesses various means of changing, or transforming, one set of things into other things (see the following figure). For example, we have a process for making tea. We produce tea by taking cold water, energy, and dried leaves and transforming those inputs into a hot beverage that people like to drink. The simple act of making a cup of tea is an example of production.
Figure 3.2 From Inputs to Output
One of the main economic activities is production: the transformation of inputs (raw materials, labor time, etc.) into output (goods and services that people value).
We are interested in measuring how much production occurs in an economy. Obviously, however, we cannot hope to count all the times that people drop a teabag into a cup, and it would not make much sense to do so. Economic activity typically involves more than production; it also includes the notion of exchange—buying and selling. If you make a cup of tea for yourself at home, we do not think of this as economic activity. If you buy a cup of tea at your local coffee shop, we do think of this as economic activity. A very rough definition of economic activity is as follows.
Economic activity is the production of goods and services for sale.
Any definition this straightforward is bound to be too simple, and we will see that there are several subtleties in the actual measurement of economic activity, particularly since some goods and services are not actually bought and sold. Still, if you keep this idea in mind, it will help you as we progress through the basics of economic measurement in this chapter.