One of the best ways to understand something is to make a model of it. Physicists make models of the universe and the solar system. Architects make models of buildings before they are built. Biologists make models of the most complicated cells in order to better understand them. Sociologists make models of societies and groups they are trying to understand. And yes, clothing designers hot new items are displayed first by super models.
Today we are going to make a model of an economic entity, perhaps a country. We’ll name it Noz and it has a population of 10 people. These 10 people produce various goods and services. If you recall from a previous lesson, the Gross Domestic Product of any entity is the sum of all goods and services produced for a year. To keep it simple, let’s say half the people make $10,000 a year, and the other half make $20,000 a year.
What’s the Gross Domestic Product for Noz? Well, 5 times $10,000 and 5 times $20,000 should get us there. The Gross Domestic Product of Noz is $150,000 for this year.
Is $150,000 a good number or a not so good number? The Standard of Living, which we also discussed before, will help us answer that question. The Standard of Living for an economic entity is the sum of all the products and services that are consumed. How well off people are is measured by what they buy, they use, they consume. For the purpose of example, we will say that all of the products and services that are made in Noz are consumed. The Standard of Living for Noz as a whole is $150,000. Does that mean that the people who earned and spent $10,000 have the same Standard of Living as the ones who earned and spent $20,000? Is a repairman’s Standard of Living going to be the same as a doctor’s? Not at all, it simply means that the Standard of Living for Noz as a whole is $150,000. There are differences within the individual unit, but for this lesson we are viewing the country of Noz as a whole.
We’re now on the verge of discovering the first and most basic economic principle: production. Let’s say our repairman decides to work 12 hours a day instead of the 8 he has worked in the past. He used to just repair washers and dryers, but he is now also going to repair refrigerators and stoves. And the doctor is going to expand from just pediatrics to patients of all ages. Let’s suppose that we also have a farmer who bought some new farm equipment and can now produce twice as many crops without working any extra hours. This year because some people work longer hours, some people work smarter, and some people work with better tools, there are more things produced in Noz.
Now my question to you is this: If the Standard of Living of Noz is equal to consumption (the consuming of all products and goods made); and if this year we have everything we had last year plus more farm goods, medical services, and repair services, is there any possibility the Gross Domestic Product and the Standard of Living can go any way but up?