(BQ) Part 2 book Macroeconomics - A contemporary introduction has contents: Fiscal policy, federal budgets and public policy, federal budgets and public policy, banking and the money supply, banking and the money supply, international trade, international finance, economic development.
Find more at http://www.downloadslide.com 11 Fiscal Policy • President Barack Obama claimed on February 17, 2010, that “it is largely thanks to the Recovery Act that a second depression is no longer a possibility.” The Japanese government cut taxes and increased spending to stimulate its troubled economy These are examples of fiscal policy, which focuses on the effects of taxing and public spending on aggregate economic activity What is the proper role of fiscal policy in the economy? • Can fiscal policy reduce swings in the business cycle? • Why did fiscal policy fall on hard times for a quarter century, and what brought it back to life? • Does fiscal policy affect aggregate supply? • And how did the cash-for-clunkers program work out? Answers to these and other questions are addressed in this chapter, which examines the theory and practice of fiscal policy © AP Photo/Damian Dovarganes In this chapter, we examine the role of fiscal policy in moving the economy to its potential output We review U.S fiscal policy during the last century, and discuss limitations to its effectiveness The Great Recession had a major impact on the economy We’ll consider the fiscal response to that calamity A more complex model of fiscal policy appears in the appendix to this chapter Topics discussed include: • Theory of fiscal policy • Limits of fiscal policy • Discretionary fiscal policy • Deficits, surpluses, then more deficits • Automatic stabilizers • Fiscal policy response to the Great • Fiscal policy in practice Recession 227 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 228 Part Fiscal and Monetary Policy 11-1 Theory of Fiscal Policy Our macroeconomic model so far has viewed government as passive But government purchases and transfer payments at all levels in the United States total more than $5 trillion a year, making government an important player in the economy From highway construction to unemployment compensation to income taxes to federal deficits, fiscal policy affects the economy in myriad ways We now move fiscal policy to center stage As introduced in Chapter 3, fiscal policy refers to government purchases, transfer payments, taxes, and borrowing as they affect macroeconomic variables such as real GDP, employment, the price level, and economic growth When economists study fiscal policy, they usually focus on the federal government, although governments at all levels affect the economy 11-1a automatic stabilizers Structural features of government spending and taxation that reduce fluctuations in disposable income, and thus consumption, over the business cycle discretionary fiscal policy The deliberate manipulation of government purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability, and economic growth Fiscal Policy Tools The tools of fiscal policy sort into two broad categories: automatic stabilizers and discretionary fiscal policy Automatic stabilizers are revenue and spending programs in the federal budget that automatically adjust with the ups and downs of the economy to stabilize disposable income and, consequently, consumption and real GDP For example, the federal income tax is an automatic stabilizer because (1) once adopted, it requires no congressional action to operate year after year, so it’s automatic, and (2) it reduces the drop in disposable income during recessions and reduces the jump in disposable income during expansions, so it’s a stabilizer, a smoother Discretionary fiscal policy, on the other hand, requires the deliberate manipulation of government purchases, transfer payments, and taxes to promote macroeconomic goals like full employment, price stability, and economic growth President Obama’s 2009 stimulus plan is an example of discretionary fiscal policy Some discretionary policies are temporary, such as one-time tax cuts or government spending increases to fight a recession President Bush’s 2008 one-time tax rebate is an example Let’s next consider how, in theory, fiscal policy can be used to close a recessionary gap and an inflationary gap Discretionary Fiscal Policy to Close a Recessionary Gap 11-1b expansionary fiscal policy An increase in government purchases, decrease in net taxes, or some combination of the two aimed at increasing aggregate demand enough to reduce unemployment and return the economy to its potential output; fiscal policy used to close a recessionary gap What if the economy produces less than its potential? Suppose the aggregate demand curve AD in Exhibit intersects the aggregate supply curve at point e, yielding the short-run output of $13.5 trillion and price level of 105 Output falls short of the economy’s potential, opening up a recessionary gap of $0.5 trillion Unemployment exceeds the natural rate If markets adjusted naturally to high unemployment, the shortrun aggregate supply curve would shift rightward in the long run to achieve equilibrium at the economy’s potential output, point e History suggests, however, that wages and other resource prices could be slow to respond to a recessionary gap Suppose policy makers believe that natural market forces will take too long to return the economy to potential output They also believe that the appropriate increase in government purchases, decrease in net taxes, or some combination of the two could increase aggregate demand just enough to return the economy to its potential output A $0.2 trillion increase in government purchases reflects an expansionary fiscal policy that increases aggregate demand, as shown in Exhibit by the rightward shift from AD to AD* If the price level remained at 105, the additional spending would increase the quantity demanded from $13.5 to $14.5 trillion This increase of $1.0 trillion reflects the simple spending multiplier effect, given a constant price level At the original price level of 105, however, excess quantity demanded causes the price level to rise As the price level rises, real GDP supplied increases, but real GDP Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 229 Chapter 11 Fiscal Policy E x h ibi t Discretionary Fiscal Policy to Close a Recessionary Gap Potential output LRAS Price level SRAS110 e* 110 105 e" e’ AD* e AD 13.5 14.0 Recessionary gap 14.5 Real GDP (trillions of dollars) The aggregate demand curve AD and the short-run aggregate supply curve, SRAS110, intersect at point e” Output falls short of the economy’s potential The resulting recessionary gap could be closed by discretionary fiscal policy that increases aggregate demand by just the right amount An increase in government purchases, a decrease in net taxes, or some combination could shift aggregate demand out to AD*, moving the economy out to its potential output at e* © Cengage Learning 2014 demanded decreases along the new aggregate demand curve The price level rises until quantity demanded equals quantity supplied In Exhibit 1, the new aggregate demand curve intersects the aggregate supply curve at e*, where the price level is 110, the one originally expected, and output equals potential GDP of $14.0 trillion Note that an expansionary fiscal policy aims to close a recessionary gap The intersection at point e* is not only a short-run equilibrium but a long-run equilibrium If fiscal policy makers are accurate enough (or lucky enough), the appropriate fiscal stimulus can close the recessionary gap and foster a long-run equilibrium at potential GDP But the increase in output results in a higher price level What’s more, if the federal budget was in balance before the fiscal stimulus, an increase in government spending creates a budget deficit In fact, the federal government has run deficits in all but of the last 40 years What if policy makers overshoot the mark and stimulate aggregate demand more than necessary to achieve potential GDP? In the short run, real GDP exceeds potential output In the long run, the short-run aggregate supply curve shifts back until it intersects the aggregate demand curve at potential output, increasing the price level further but reducing real GDP to potential output Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 230 Part Fiscal and Monetary Policy Discretionary Fiscal Policy to Close an Expansionary Gap 11-1c contractionary fiscal policy A decrease in government purchases, increase in net taxes, or some combination of the two aimed at reducing aggregate demand enough to return the economy to potential output without worsening inflation; fiscal policy used to close an expansionary gap Suppose output exceeds potential GDP In Exhibit 2, the aggregate demand curve, AD, intersects the aggregate supply curve to yield short-run output of $14.5 trillion, an amount exceeding the potential of $14.0 trillion The economy faces an expansionary gap of $0.5 trillion Ordinarily, this gap would be closed by a leftward shift of the shortrun aggregate supply curve, which would return the economy to potential output but at a higher price level, as shown by point e But the use of discretionary fiscal policy introduces another possibility By reducing government purchases, increasing net taxes, or employing some combination of the two, the government can implement a contractionary fiscal policy to reduce aggregate demand This could move the economy to potential output without the resulting inflation If the policy succeeds, aggregate demand in Exhibit shifts leftward from AD to AD*, establishing a new equilibrium at point e* Again, with just the right reduction in aggregate demand, output falls to $14.0 trillion, the potential GDP Closing an expansionary gap through fiscal policy rather than through natural market forces results in a lower price level, not a higher one Increasing net taxes or reducing government purchases also reduces a government deficit or increases a surplus So a contractionary fiscal policy could reduce inflation and reduce a federal deficit Note that a contractionary fiscal policy aims to close an expansionary gap Such precisely calculated expansionary and contractionary fiscal policies are difficult to achieve Their proper execution assumes that (1) potential output is accurately gauged, (2) the relevant spending multiplier can be predicted accurately, (3) aggregate demand can be shifted by just the right amount, (4) various government Ex h ib i t Discretionary Fiscal Policy to Close an Expansionary Gap Potential output LRAS SRAS110 e” e’ Price level 115 e* 110 AD’ AD* 14.0 14.5 Expansionary gap Real GDP (trillions of dollars) The aggregate demand curve AD’ and the short-run aggregate supply curve, SRAS110, intersect at point e’, resulting in an expansionary gap of $0.5 trillion Discretionary fiscal policy aimed at reducing aggregate demand by just the right amount could close this gap without inflation An increase in net taxes, a decrease in government purchases, or some combination could shift the aggregate demand curve back to AD* and move the economy back to potential output at point e* Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it © Cengage Learning 2014 Find more at http://www.downloadslide.com 231 Chapter 11 Fiscal Policy entities can somehow coordinate their fiscal efforts, and (5) the shape of the short-run aggregate supply curve is known and remains unaffected by the fiscal policy itself 11-1d The Multiplier and the Time Horizon In the short run, the aggregate supply curve slopes upward, so a shift of aggregate demand changes both the price level and the level of output When aggregate supply gets in the act, we find that the simple multiplier overstates the amount by which output changes The exact change of equilibrium output in the short run depends on the steepness of the aggregate supply curve, which in turn depends on how sharply production costs increase as output expands The steeper the short-run aggregate supply curve, the less impact a given shift of the aggregate demand curve has on real GDP and the more impact it has on the price level, so the smaller the spending multiplier If the economy is already producing its potential, then in the long run, any change in fiscal policy aimed at stimulating aggregate demand increases the price level but does not affect output Thus, if the economy is already producing its potential, the spending multiplier in the long run is zero CHECK PO I NT What discretionary fiscal policies could close an expansionary gap? What discretionary fiscal policies could close an inflationary gap? Fiscal Policy Up to Stagflation of the 1970s 11-2 Now that you have some idea of how fiscal policy can work in theory, let’s take a look at fiscal policy in practice, beginning with the approach used before the Great Depression 11-2a Prior to the Great Depression Before the 1930s, discretionary fiscal policy was seldom used to influence the macroeconomy Public policy was shaped by the views of classical economists, who advocated laissez-faire, the belief that free markets were the best way to achieve economic prosperity Classical economists did not deny that depressions and high unemployment occurred from time to time, but they argued that the sources of such crises lay outside the market system, in the effects of wars, tax increases, poor growing seasons, natural disasters, changing tastes, and the like Such external shocks could reduce output and employment, but classical economists also believed that natural market forces, such as changes in prices, wages, and interest rates, could correct these problems Simply put, classical economists argued that if the economy’s price level was too high to sell all that was produced, prices would fall until the quantity supplied equaled the quantity demanded If wages were too high to employ all who wanted to work, wages would fall until the quantity of labor supplied equaled the quantity demanded And if the interest rate was too high to invest all that had been saved, interest rates would fall until the amount invested equaled the amount saved So the classical approach implied that natural market forces, through flexible prices, wages, and interest rates, would move the economy toward potential GDP There appeared to be no need for government intervention What’s more, the government, like households, was expected to live within its means The idea of government running classical economists A group of 18th- and 19th-century economists who believed that economic downturns corrected themselves through natural market forces; thus, they believed the economy was self-correcting and needed no government intervention Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 232 Part Fiscal and Monetary Policy a deficit year after year was considered immoral Thus, before the onset of the Great Depression, most economists believed that discretionary fiscal policy could more harm than good Besides, the federal government itself was a bit player in the economy At the onset of the Great Depression, for example, all federal outlays were only 3 percent relative to GDP (compared to about 24 percent today) 11-2b Employment Act of 1946 Law that assigned to the federal government the responsibility for promoting full employment and price stability The Great Depression and World War II Although classical economists acknowledged that capitalistic, market-oriented economies could experience high unemployment from time to time, the depth and duration of the depression strained belief in the economy’s ability to heal itself The Great Depression was marked by four consecutive years of contraction during which unemployment reached 25 percent Investment plunged 80 percent Many factories sat idle With vast unemployed resources, output and income fell well short of the economy’s potential The stark contrast between the natural market adjustments predicted by classical economists and the years of high unemployment during the Great Depression represented a collision of theory and fact In 1936, John Maynard Keynes of Cambridge University, England, published The General Theory of Employment, Interest, and Money, a book that challenged the classical view and touched off what would later be called the Keynesian revolution Keynesian theory and policy were developed in response to the problem of high unemployment during the Great Depression Keynes’s main quarrel with the classical economists was that prices and wages did not seem to be flexible enough to ensure the full employment of resources According to Keynes, prices and wages were relatively inflexible in the downward direction—they were “sticky”—so natural market forces would not return the economy to full employment in a timely fashion Keynes also believed business expectations could at times become so grim that even very low interest rates would not spur firms to invest all that consumers might save Three developments in the years following the Great Depression bolstered the use of discretionary fiscal policy in the United States The first was the influence of Keynes’s General Theory, in which he argued that natural forces would not necessarily close a recessionary gap Keynes thought the economy could get stuck well below its potential, requiring the government to increase aggregate demand to boost output and employment The second development was the impact of World War II on output and employment The demands of war greatly increased production and erased cyclical unemployment during the war years, pulling the U.S economy out of its depression The third development, largely a consequence of the first two, was the passage of the Employment Act of 1946, which gave the federal government responsibility for promoting full employment and price stability Prior to the Great Depression, the dominant fiscal policy was a balanced budget During 1930, the first full year of the Great Depression, the federal budget showed a surplus Indeed, to head off a modest deficit in 1932, federal tax rates were raised, which only deepened the depression In the wake of Keynes’s General Theory and World War II, however, policy makers grew more receptive to the idea that fiscal policy could improve economic stability The objective of fiscal policy was no longer to balance the budget but to promote full employment with price stability even if budget deficits resulted 11-2c Automatic Stabilizers This chapter so far has focused mostly on discretionary fiscal policy—conscious decisions by public policy makers to change taxes and government spending to achieve the economy’s potential output Now let’s get a clearer picture of automatic stabilizers Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Chapter 11 Fiscal Policy Automatic stabilizers smooth out fluctuations in disposable income over the business cycle by stimulating aggregate demand during recessions and dampening aggregate demand during expansions Consider the federal income tax The federal income tax system is progressive, meaning that the fraction of income paid in taxes increases as a taxpayer’s income increases During an economic expansion, employment and incomes rise, moving some taxpayers into higher tax brackets As a result, taxes claim a growing fraction of income This slows the growth in disposable income and, hence, slows the growth in consumption Therefore, the progressive income tax relieves some of the inflationary pressure that might otherwise arise as output increases during an economic expansion Conversely, when the economy is in recession, output declines, and employment and incomes fall, moving some people into lower tax brackets As a result, taxes take a smaller bite out of income, so disposable income does not fall as much as GDP Thus, the progressive income tax cushions declines in disposable income, in consumption, and in aggregate demand Another automatic stabilizer is unemployment insurance During economic expansions, the system automatically increases the flow of unemployment insurance taxes from the income stream into the unemployment insurance fund, thereby moderating consumption and aggregate demand During contractions, unemployment increases and the system reverses itself Unemployment payments automatically flow from the insurance fund to the unemployed, increasing disposable income and propping up consumption and aggregate demand Likewise, welfare payments automatically increase during hard times as more people become eligible Because of these automatic stabilizers, GDP fluctuates less than it otherwise would, and disposable income varies proportionately less than does GDP Because disposable income varies less than GDP does, consumption also fluctuates less than GDP does (as was shown in an earlier chapter’s case study) The progressive income tax, unemployment insurance, and welfare benefits were initially designed not so much as automatic stabilizers but as income redistribution programs Their roles as automatic stabilizers were secondary effects of the legislation Automatic stabilizers not eliminate economic fluctuations, but they reduce their magnitude The stronger and more effective the automatic stabilizers are, the less need for discretionary fiscal policy Because of the greater influence of automatic stabilizers, the economy is more stable today than it was during the Great Depression and before As a measure of just how successful these automatic stabilizers have become in cushioning the impact of recessions, consider this: Since 1948, real GDP declined 10 years, but real consumption fell only four years—in 1974, 1980, 2008, and 2009 Without much fanfare, automatic stabilizers have been quietly doing their work, keeping the economy on a more even keel 11-2d From the Golden Age to Stagflation The 1960s was the Golden Age of fiscal policy John F Kennedy was the first president to propose a federal budget deficit to stimulate an economy experiencing a recessionary gap Fiscal policy was also used on occasion to provide an extra kick to an expansion already under way, as in 1964, when Kennedy’s successor, Lyndon B Johnson, cut income tax rates to keep an expansion alive This tax cut, introduced to stimulate business investment, consumption, and employment, was perhaps the shining example of fiscal policy during the Golden Age The tax cut seemed to work wonders, increasing disposable income and consumption The unemployment rate dropped under percent for the first time in seven years, the inflation rate dipped under percent, and the federal budget deficit in 1964 equaled only 0.9 percent of GDP (compared with an average of 3.4 percent between 1980 and 2012) Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 233 Find more at http://www.downloadslide.com 234 Part Fiscal and Monetary Policy Discretionary fiscal policy is a demand-management policy; the objective is to increase or decrease aggregate demand to smooth economic fluctuations But the 1970s brought a different problem—stagflation, the double trouble of higher inflation and higher unemployment resulting from a decrease in aggregate supply The aggregate supply curve shifted left because of crop failures around the world, sharply higher OPEC-driven oil prices, and other adverse supply shocks Demand-management policies are ill suited to cure stagflation because an increase of aggregate demand would increase inflation, whereas a decrease of aggregate demand would increase unemployment CHECK PO I NT 11-3 Summarize fiscal policy from the Great Depression to stagflation Limits on Fiscal Policy’s Effectiveness Other concerns besides stagflation also caused policy makers and economists to question the effectiveness of discretionary fiscal policy These concerns included the difficulty of estimating the natural rate of unemployment, the time lags involved in implementing fiscal policy, the distinction between current income and permanent income, and the possible feedback effects of fiscal policy on aggregate supply We consider each in turn Fiscal Policy and the Natural Rate of Unemployment 11-3a political business cycles Economic fluctuations that occur when discretionary policy is manipulated for political gain As discussed in the previous chapter, the unemployment that occurs when the economy is producing its p otential GDP is called the natural rate of unemployment Before adopting discretionary policies, public officials must correctly estimate this natural rate Suppose the economy is producing its potential output of $14.0 trillion, as in Exhibit 3, where the natural rate of unemployment is 5.0 percent Also suppose that public officials mistakenly believe the natural rate to be 4.0 percent, and they attempt to reduce unemployment and increase real GDP through discretionary fiscal policy As a result of their policy, the aggregate demand curve shifts to the right, from AD to AD In the short run, this stimulation of aggregate demand expands output to $14.2 trillion and reduces unemployment to 4.0 percent, so the policy appears successful But stimulating aggregate demand opens up an expansionary gap, which in the long run results in a leftward shift of the short-run aggregate supply curve This reduction in aggregate supply pushes up prices and reduces real GDP to $14.0 trillion, the economy’s potential Thus, policy makers initially believe their plan worked, but pushing production beyond the economy’s potential leads only to inflation in the long run Given the effects of fiscal policy, particularly in the short run, we should not be surprised that elected officials might try to use it to get reelected Research suggests that public officials use fiscal policy to boost their reelection chances This has created what some argue is a political business cycle, which results from the economic fluctuations that occur when discretionary policy is manipulated for political gain During an election year, incumbent presidents use expansionary policies to stimulate the economy For example, a study of 18 industrial economies over three decades found that incumbents Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Chapter 11 Fiscal Policy E x hi bit When Discretionary Fiscal Policy Overshoots Potential Output Potential output LRAS Price level 120 SRAS120 SRAS110 c b AD’ 110 a AD 14.0 14.2 Real GDP (trillions of dollars) If public officials underestimate the natural rate of unemployment, they may attempt to stimulate aggregate demand even if the economy is already producing its potential output, as at point a This expansionary policy yields a short-run equilibrium at point b, where the price level and output are higher and unemployment is lower, so the policy appears to succeed But the resulting expansionary gap will, in the long run, reduce the short-run aggregate supply curve from SRAS110 to SRAS120, eventually reducing output to its potential level of $14.0 trillion while increasing the price level to 120 Thus, attempts to increase production beyond potential GDP lead only to inflation in the long run © Cengage Learning 2014 boosted health care spending during election years.1 There is also evidence that municipal officials, just before an election, spend more on those public goods most visible to the electorate, such as city parks.2 Read the online case study for more on how political considerations could shape fiscal policies 11-3b Lags in Fiscal Policy The time required to approve and implement fiscal legislation may hamper its effectiveness and weaken discretionary fiscal policy as a tool of macroeconomic stabilization Even if a fiscal prescription is appropriate for the economy when proposed, the months and sometimes years required to approve and implement legislation means the medicine could more harm than good The policy might kick in only after the economy has already turned itself around Because a recession is not usually identified until at least six months after it begins, and because the 11 recessions since 1945 lasted only 11 months on average, discretionary fiscal policy allows little room for error (more later about timing problems) Niklas Potrafke, “The Growth of Public Health Expenditures in OECD Countries: Do Government Ideology and Electoral Motives Matter?” Journal of Health Economics, 29 (December 2010): 797–810 Linda Veiga and Francisco Veiga, “Political Business Cycles at the Municipal Level,” Public Choice, 131 (April 2007): 45–64 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 235 Find more at http://www.downloadslide.com 236 Part Fiscal and Monetary Policy Discretionary Fiscal Policy and Permanent Income 11-3c permanent income Income that individuals expect to receive on average over the long term It was once believed that discretionary fiscal policy could be turned on and off like a water faucet, stimulating or dampening the economy at the right time by just the right amount Given the marginal propensity to consume, tax changes could increase or decrease disposable income to bring about desired change in consumption A more r ecent view suggests that people base their consumption decisions not merely on changes in their current income but on changes in their permanent income Permanent income is the income a person expects on average over the long term Changing tax rates does not affect consumption much if people view the change as only temporary For example, one-time tax rebates seem to have had little impact on consumption The stimulative effects of the $117 billion tax-rebate p rogram in early 2008 were disappointing Surveys showed that only about 20 percent of households spent most of their rebate check Other households saved most of it or paid down debt.3 The temporary nature of the tax cuts meant that households faced only a small increase in their permanent income Because permanent income changed little, consumption changed little In short, to the extent that consumers base spending decisions on their permanent income, attempts to fine-tune the economy with temporary tax changes are less effective CHECK PO I NT 11-4 Identify some reasons why discretionary fiscal policy may not work very well Fiscal Policy Since 1980 After examining fiscal policy up through the era of stagflation and considering limitations of fiscal policy, you are in a position to look at fiscal policy in recent decades 11-4a Fiscal Policy During the 1980s So far we have limited the discussion of fiscal policy to its effect on aggregate demand Fiscal policy may also affect aggregate supply, although this is usually unintentional For example, suppose the government increases unemployment benefits, paid with higher taxes on earnings If the marginal propensity to consume is the same for both groups, the increased spending by beneficiaries just offsets the reduced spending by workers There would be no change in aggregate demand and thus no change in equilibrium real GDP, simply a redistribution of disposable income from the employed to the unemployed But could the program affect labor supply? Higher unemployment benefits reduce the opportunity cost of not working, so some job seekers may decide to search at a more leisurely pace Meanwhile, higher tax rates reduce the opportunity cost of leisure, so some with jobs may decide to work fewer hours In short, the supply of labor could decrease as a result of higher unemployment benefits funded by higher taxes on earnings A decrease in the supply of labor would decrease aggregate supply, reducing the economy’s potential GDP See Matthew Shapiro and Joel Slemrod, “Did the 2008 Tax Rebated Simulate Spending?” American Economic Review, 99 (May 2009): 374–379 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 434 Index Czech Republic GDP per capita, 412 international trade, 366 D Deaton, Angus, 181 debit cards, 297–299 debt ceiling, 263 debt default, 263 decision-making lag, 342 defense spending, as percentage of federal outlays, 59, 249 deficits crowding out and crowding in, 254–255 defined, 105 history of, 253–254 international finance, 387–388 overview, 252 persistence of, 254 philosophies and, 253 rationale for, 252 twin, 255–256 deflation, 150 demand aggregate, 99–102, 318–329 changes in equilibrium price and quantity, 80–84 defined, 67 demand curve, 68–73 demand schedule, 68–70 disequilibrium, 84–85 foreign exchange, 389–390 individual, 70 investment, 319 law of, 67–68 market, 70 market creation through, 77–79 money, 315–319 demand curve aggregate, 100–101, 150– 151, 201–205 defined, 68 investment, 192 movement along given, 72–73 overview, 68–70 shifts in, 70–73, 80–84 demand schedules, 68–70 demand-pull inflation, 150 demand-side economics, 105 Democratic Republic of the Congo fertility rates, 405 infant mortality, 404 Internet users, 411 per capita income, 402–403 telephone lines, 410 dependent variables, 20–21 deposit insurance, 263, 283–284 depository institutions, defined, 279 depreciation, defined, 123 depressions, 96 See also Great Depression deregulation, 284 developed (industrial market) countries, 169, 402, 406, 415 DI (disposable income), 119, 133–134 diminishing marginal returns, 166 direct (positive) relation between variables, 21, 23 discount rates, 309 discouraged workers, 138, 148 discretionary fiscal policy to close expansionary gaps, 230–231 to close recessionary gaps, 229–230 defined, 228 inflation expectations and, 344–345 permanent income and, 236 policy rules versus, 349–351 stagflation, 234 disequilibrium defined, 84 price ceilings, 84–85 price floors, 84 disinflation, 150 disposable income (DI), 119, 133–134 distribution question, 40 diversification, banking and, 300 dividends, 48 division of labor, 33–34 Dodd-Frank Wall Street Reform and Consumer Protection Act, 289–290, 332 Doha Round, 374–375, 414 domestic content requirements, 372 double coincidence of wants, 271 double counting, 115, 117 double-entry bookkeeping system, 114, 383 Draghi, Mario, 334 dual banking system, 279 dumping, 373, 377 durable goods, 48–49, 115 dysfunctional (corrupt) governments, 414 E economic analysis art of, 7–9 pitfalls of faulty, 13 science of, 9–14 wants versus resources, 2–6 economic decision makers firms, 49–53 governments, 55–62 household production, 54–55 households, 47–49 overview, rest of world, 62–65 economic development differences in, 401–406 education and, 169–170 foreign aid and, 417–420 international trade and, 415–417 productivity as key to, 406–413, 415 economic fluctuations (business cycles) defined, pure capitalism and, 41 in United States, 96–98 economic growth defined, 37 education and economic development, 169–170 governmental role in, 57 international comparisons, 173–176 leading economic indicators, 98–99 national debt and, 265–266 output per capita, 173 overview, 162, 169 production possibilities frontier and, 37, 39, 162–164 rules of the game, 167–169 slowdown and rebound in, 172–173 technology and, 176–180 US labor productivity, 170–171 in US since 1929, 109–112 economic models (economic theories), 9, 13 economic systems custom- or religion-based, 43–45 defined, 39 goods and services, 39 mixed and transitional, 42–43 pure capitalism, 39–40 pure command system, 40–41 economic theories (economic models), 9, 13 economic tools, 26–45 economics, defined, economies of scale, 366 economy, defined, 93 Ecuador, use of dollar, 295–296 education college majors and annual earnings, 14–16 economic development and, 169–170, 407 opportunity cost of, 27–28 effectiveness lag, 342 efficiency defined, 35 production possibilities frontier and, 34–35, 39 Egypt Big Mac Index, 394 women in labor force, 406 Einstein, Albert, Emergency Jobs Appropriation Act, 342 employee compensation, 134–135 employment See also unemployment full, 57, 147 rate of, 21, 333 wage flexibility and, 218, 221 Employment Act of 1946, 105, 232 entitlement programs, 251 entrepreneur(s) defined, evolution of firms, 49–50 entrepreneurial ability in circular-flow model, 5–6 defined, entrepreneurship, economic development and, 409–410 equation of exchange, 325 equilibrium aggregate demand and aggregate supply, 101–102 changes in equilibrium price and quantity, 80–84 defined, 79 market, 78–79 equilibrium interest rate, 316–318 equilibrium point, 79 equilibrium price, 79–84 equilibrium quantity, 79–84 Ethiopia fertility rates, 405 infant mortality, 404 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Index 435 Internet users, 411 natural resources, 408 per capita income, 402–403 telephone lines, 409–410 euro zone, 389 Europe inflation, 154 unemployment, 143, 145 European Central Bank, 334, 348 European Union common markets, 375–376 economies of scale, 366 US trade deficit with, 385 excess quantity demanded (shortages), 79 excess quantity supplied See surpluses excess reserves, 302 exchange See also foreign exchange; international trade comparative advantage, 31 overview, 30–31 specialization and, 32–33 exchange rates defined, 388 determining, 391–392 fixed, 395 flexible, 395 overview, 62–63 exhaustible resources, expansionary gaps active policy versus passive policy, 340–341 aggregate supply in long run, 213–215 defined, 214 discretionary fiscal policy, 230–231 wage flexibility, 218 expansionary policy, 228, 320– 321, 344–346 expansions, 96–97 expectations consumer, 80, 190–191 demand curve and changes in, 72 income, 72 price, 72 rational, 343–344, 350–351 role of in macro policy, 343–347 supply curve and changes in, 76 expected marginal benefit, 8, 14–16 expected marginal cost, 8, 14–16 expenditure See also aggregate expenditure in circular-flow model, 5–6 of personal income, 48–49 expenditure approach to GDP, 114–116 explicit wage agreements, 209 export promotion, 416–417 export subsidies, 372 externality(ies) defined, 57 governmental role in dealing with, 57 F Facebook, 54, 181 fallacy of composition, 13 farm households, 47 FDIC (Federal Deposit Insurance Corporation), 263, 283 federal budgets deficits, 252–256 defined, 249 national debt, 259–266 process, 249–252 relative size of public sector, 258–259 surpluses, 254–257 federal debt See national debt Federal Deposit Insurance Corporation (FDIC), 263, 283 Federal Farm Credit System, 263 federal funds market, 303 federal funds rate, 303, 308–309, 322–323 Federal Open Market Committee (FOMC), 281–282, 308, 322–324, 344 Federal Reserve System (The Fed) See also fiscal policy; monetary policy Board of Governors, 281–282 control of money supply, 308–311 defined, 280 deposit insurance, 283 districts of, 280 Federal Reserve notes, 295 goals of, 283 during Great Depression, 281 interest rates, 318–320 money creation, 303–306 organization chart of, 282 origins of, 279–280 powers of, 281 reducing bank reserves, 307–308 regulating money supply, 283 starting banks, 301–303 targets for monetary policy, 329–334 transparency, 323–324 fiat money, 277 final goods and services, 115 finance companies, 300 financial account, 386–387 financial institutions See banking; financial system financial intermediaries, 279 financial markets circular flow of output and income, 119–120 defined, 119 Financial Stability Oversight Council, 290 financial system bank failures, 284 bank notes and fiat money, 277 banking deregulation, 284 commercial banks and thrifts, 279 early banking, 276–277 Federal Reserve System, 279–283 Great Recession, 287–292 lost deposits and increasing inflation, 283–284 value of money, 277–278 when money performs poorly, 278–279 Firefox, 53 firm(s) circular flow of output and income, 119–121 in circular-flow model, 5–6 cooperatives, 51–52 defined, 50 as economic decision makers, evolution of, 49–50 not-for-profit organizations, 52–53 types of, 50–51 fiscal policy automatic stabilizers, 232–233 contractionary, 230 defined, 57, 228 discretionary, 229–231 history of, 231–234, 236–240 limits on effectiveness of, 234–236 overview, 228 simple spending multiplier and time horizon, 231 tools of, 228 fixed exchange rates, 395 flat tax (proportional taxation), 60 flexible (floating) exchange rates, 395 flow variables, 94 FOMC (Federal Open Market Committee), 281–282, 308, 322–324, 344 Food for Peace program, 418 Ford, Gerald, 158 foreign aid convergence, 419–420 debate over, 418–419 defined, 418 overview, 417–418 foreign exchange arbitrageurs, 392–393 defined, 63 demand for, 389–390 determining rate, 391–392 fixed exchange rates, 395 flexible exchange rates, 395 overview, 388–389 purchasing power parity, 393 speculators, 392–393 supply of, 390 foreign exchange markets, 63, 390–391 fractional reserve banking system, 276 France GDP per capita, 175 government outlays, 58, 258 net debt, 261 post-high school degrees, 170 real GDP, 176 research and development spending, 178 top banks, 291 as US trading partner, 62, 361 free goods, perception of, frictional unemployment, 145 Friedman, Milton, 330–331 full employment defined, 147 governmental role in, 57 functional finance, 253 functional relations between variables, 20–21 G G-7 (Group of Seven), 169 GATT See General Agreement on Tariffs and Trade Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 436 Index GDP See gross domestic product GDP price index, 100, 128–129 Gell-Mann, Murray, 95 General Agreement on Tariffs and Trade (GATT) defined, 373 Doha Round, 374–375, 414 Uruguay Round, 373 General Motors (GM), 289, 378 Germany aging population, 405 central bank independence, 348 convergence, 420 demise of Bretton Woods system, 397 exports as share of GDP, 360 fertility rates, 405 GDP per capita, 175 government outlays, 58, 258 infant mortality, 404 Internet users, 411 net debt, 261 per capita income, 402 post-high school degrees, 170 real GDP, 176 research and development spending, 178 telephone lines, 410 top banks, 291 unemployment, 98 as US trading partner, 62, 361 GM (General Motors), 289, 378 GNI (gross national income), 401 GNP (gross national product), 133–134 gold standard, 396 Golden Age of fiscal policy, 233–234 good(s) capital, 163, 361 in circular-flow model, 5–6 consumer, 163, 361 defined, durable, 48–49, 115 economic systems and production of, 39 final, 115 free, perception of, households as demanders of, 49 inferior, 70–71 intermediate, 115 nondurable, 48–49, 115 normal, 70–71 overview, 3–4 prices of, 71–72, 75–76, 82 private, 56 production possibilities frontier, 35–38 public, 41, 56 supply curve and changes in prices of, 75–76 Google, 54 Gore, Al, 158 government circular flow of output and income, 119–121 debate over proper role of, 12, 41 as economic decision makers, price ceilings, 84–86 price floors, 84 pure command system, 41–42 role of in market system, 41, 55–57 size and growth of, 58–59 sources of revenue, 59–60 structure and objectives of, 57–58 tax principles and tax incidence, 60–62 government consumption and gross investment, 115–116 government purchases changes in, 244 demand-side effects of, 244–245 as determinant of aggregate expenditure, 194–195 expenditure approach to GDP, 115–116 Great Recession, 239–240 as share of US GDP, 116–117 of surpluses (excess quantity supplied), 84 Gramm-Leach-Bliley Act of 1999, 285 graphs defined, 20 drawing, 21–22 line shifts, 25 overview, 20–21 slope, units of measurement, and marginal analysis, 22–23 slope of straight line, 22 slopes of curved lines, 23–24 Great Depression Board of Governors, 281–282 deposit insurance, 283 economic growth since, 109–110 Federal Open Market Committee, 281–282 fiscal policy, 232 goals of Fed, 283 money supply regulation, 283 overview, 103–104, 281 unemployment rate, 139–140 Great Recession bailing out AIG, 331–332 Cash for Clunkers program, 240–241 as change in rules of the game, 168 consumption and, 188–189 Dodd-Frank Act, 289–290 end of, 98 federal deficits, 253, 257 Fed’s response to, 331–333 fiscal policy, 238–240 incentive problems, 287–289 labor productivity, 175 monetary control, 310 overview, 107–108 quantitative easing, 332–333 reducing risk of “too big to fail”, 332 subprime mortgages and mortgage-backed securities, 287 top banks, 290–292 Troubled Asset Relief Program, 289 uncertainty about rules of the game, 39 unemployment benefits, 147 unemployment rate, 140–142 Greece aging population, 405 federal debt, 262–263 green accounting (green GDP), 124 Greenspan, Alan, 323, 331, 351 gross debt, 259 gross domestic product (GDP) based on expenditure approach, 115–116 based on income approach, 117–118 computation of, 114 defined, 93 economic welfare and, 124 government share of, 58–59 leisure, quality, and variety, 122–123 net production versus, 123 not all costs reflected in, 123–124 not all production reflected in, 122 output per capita, 173–175 gross national income (GNI), 401 gross national product (GNP), 133–134 gross private domestic investment, 115, 191 gross world product, 93 Group of Seven (G-7), 169 H Haiti, human capital, 165 happiness, income and, 180–181 health infant mortality, 404 malnutrition, 403 overview, 402–403 hedonic method, 127 high birth rates, 404–406 HIV/AIDS, 402–403 Hong Kong convergence, 419 deflation, 150 export promotion, 417 price levels, 190 Hoover, Herbert, 95 horizontal axis, 20 households in circular-flow model, 5–6, 119–121 as demanders of goods and services, 49 as economic decision makers, evolution of, 47 production by, 49, 54–55 as resource suppliers, 47–48 utility maximization by, 47 human capital defined, labor productivity, 165 production possibilities frontier, 37 Hungary aging population, 405 Big Mac Index, 394 GDP per capita, 412 hyperinflation defined, 150 in Zimbabwe, 149–150, 278, 408 hypotheses defined, 11 formulating, 11–12 testing, 12 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Index 437 I IMF (International Monetary Fund), 396 immigration, 416 implementation lag, 342 implicit wage agreements, 209 import quotas defined, 63 overview, 370–371 in practice, 371–372 tariffs versus, 372 import substitution, 416–417 in kind payments, 122 income aggregate expenditure and, 195–198 in circular-flow model, 5–6 consumption and, 185–186 demand curve and changes in, 70–71 governmental role in equal distribution of, 57 happiness and, 180–181 sources of personal, 48 income approach to GDP, 114, 117–118 income distribution, economic development and, 415 income effect(s), of price changes, 68 income expectations, 72 income-expenditure model, 197 independent (unrelated) variables, 20–21, 23 index numbers, 99, 125 India Big Mac Index, 394 caste system, 43 fertility rates, 405 human capital, 165 import substitution, 417 infant mortality, 404 Internet users, 409, 411 per capita income, 402 telephone lines, 410 as US trading partner, 361 individual demand, 70 individual income taxes as percentage of federal government revenue, 59–60 principles of, 60 individual supply, 74 Indonesia Big Mac Index, 394 currency stabilization, 395 industrial market (developed) countries, 169, 402, 406, 415 industrial policy, 179–180 Industrial Revolution, 50 inefficiency, 35 infant mortality, 404 inferior goods, 70–71 inflation consumer price index and, 128 defined, 96, 273 discretionary policy and expectations of, 344–345 effects of, 155–158 increasing, 283–284 measuring, 151–154 money and, 278 overview, 149–150 sources of, 150–151 targets for monetary policy, 333–334 inflation rate, 105–106 inflation targets, 349 information asymmetric, 300 needed for choice, opportunity cost and, 29 scarcity of, information economy overview, 14–16 user-generated products, 53–54 Information Revolution, 55 injections, 121 in-kind transfers, 48 interest in circular-flow model, 5–6 defined, 3, 156 payments on national debt, 261–262 as percentage of government outlay, 59 as source of personal income, 48 interest rate(s) aggregate demand in short run, 318–320 crowding out, 255 defined, 156 as determinant of consumption, 190 inflation and, 156–157 as monetary policy target, 329–331 money demand and, 316 intermediate goods and services, 115 international finance balance of payments, 383–388 development of, 396–398 foreign exchange, 388–393, 395 International Monetary Fund (IMF), 396 international trade arguments for restrictions on, 376–379 economic development and, 415–417 efforts to reduce barriers to, 373, 375–376 expenditure approach to GDP, 115–116 gains from, 360–367 opportunity cost and, 62 restrictions on and welfare loss, 367–372 trade deficits, 256 inventories expenditure approach to GDP, 115 real GDP demanded for given price level, 197 inverse (negative) relation between variables, 21, 23 investment annual percentage change in, 193 effect of government deficits and surpluses on, 254–255 expenditure approach to GDP, 115 gross, 123 investment and income, 192–193 investment demand curve, 192 money and aggregate demand in short run, 318–320 net, 123 overview, 191 as share of US GDP, 116–117 variation in, 193–194 investment banks, 108 investment demand, 319 investment demand curve, 192 “invisible hand”, 41, 77, 104 Ireland, federal debt, 263 Islamic law, 43 Italy aging population, 405 central bank independence, 348 GDP per capita, 175 government outlays, 58, 258 net debt, 261 post-high school degrees, 170 real GDP, 176 research and development spending, 178 J Japan aging population, 405 Big Mac Index, 394 convergence, 420 education, 407 fertility rates, 405 GDP per capita, 175 government outlays, 58, 258–259 infant mortality, 404 inflation, 154 Internet users, 411 natural resources, 408 net debt, 260–261 per capita income, 402 post-high school degrees, 169–170 productivity, 164 real GDP, 176 research and development spending, 178 telephone lines, 410 top banks, 291 Treasury securities, 264–265 unemployment, 143, 145 US debt to, 256 US trade deficit with, 385 as US trading partner, 62, 361 Johnson, Lyndon B., 233 Jordan, women in labor force, 406 JPMorgan Chase, 290–291 K Kazakhstan, GDP per capita, 412 Kennedy, John F., 233 Kenya fertility rates, 405 infant mortality, 404 Internet users, 411 migration, 416 per capita income, 402 telephone lines, 410 Kerry, John, 158 Keynes, John Maynard, 104–105, 192, 232, 252 Keynesianism, 104–105 Knittel, Christopher, 241 Kuwait, natural resources, 408 Kuznets, Simon, 114, 166–167 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 438 Index L labor in circular-flow model, 5–6 defined, division of, 33–34 personal income from, 48 labor force, defined, 138 labor force participation rate, 138–139 labor productivity defined, 164 economic development and, 407 inefficient use of labor, 407–408 overview, 165 slowdown and rebound in, 172 in United States, 170–171 lagging economic indicators, 99 laissez-faire, 41, 103, 231 law of comparative advantage, 31–33 law of demand demand schedule and demand curve, 68–70 income effect of price change, 68 substitution effect of price change, 67–68 wants and needs, 67 law of diminishing marginal returns, 166 law of increasing opportunity cost defined, 36 production possibilities frontier, 36, 39 law of supply, 73 leading economic indicators, 98–99 leakages, 121 legal tender, 277, 296–297 Lehman Brothers, 108, 238, 288–289, 331–332 leisure, 122–123 Lesotho, HIV/AIDS in, 402 liabilities, 301–302 LibreOffice, 53 Libya, women in labor force, 406 limited liability corporations, 51 Linux, 53 liquidity, 302–303 loanable funds market, 156–157 loan-to-value ratio, 288 long run aggregate demand in, 324–329 aggregate supply in, 213–221 in macroeconomics, 214 money demand in, 324–329 long-run aggregate supply (LRAS) curve aggregate supply decreases, 223–224 aggregate supply increases, 221–222 defined, 217 expansionary gaps, 213 overview, 217 recessionary gap, 215 shifts of, 221–224 tracing potential output, 217–218 wage flexibility and employment, 218, 221 long-run equilibrium, 214 long-run Phillips curve, 353–355 long-term unemployed, 141 LRAS curve See long-run aggregate supply curve Lucas, Robert, 343–344 M M1, 295, 298, 327–329 M2, 297–298, 327–329 macro policy active policy versus passive policy, 338–343 Phillips curve, 351–356 policy rules versus discretion, 349–351 role of expectations, 343–347 macroeconomics aggregate demand and supply, 99–102 defined, economic fluctuations and growth, 96–99 history of US economy, 103–112 national economy, 93–95 overview, 8–9 malnutrition, 403 managed float system, 397–398 Marathon Oil, 75 marginal, defined, marginal analysis, 8, 22–23 marginal benefit, 8, 14–16 marginal cost (MC) expected, 8, 14–16 supply and, 73 marginal propensity to consume (MPC), 187–188, 199–200 marginal propensity to save (MPS), 187, 200 marginal returns, law of diminishing, 166 marginal tax rate defined, 60 federal personal income tax, 60–61 market(s) creation of through supply and demand, 77–79 defined, overview, 77 market demand, 70 market failures, 55 market supply, 74 market system, 41 Marshall, Alfred, 137 MC See marginal cost McDonald’s division of labor, 33 entrepreneurship, 410 Medicare, 59, 249, 259, 266–267 medium of exchange, 272 mercantilism, 95, 114 merchandise trade balance, 62, 383–385 Mercosur, 375 Merrill Lynch, 283–284 Mexico Big Mac Index, 394 debt default, 264 Federal Reserve and, 334 migration, 416 North American Free Trade Agreement, 375 post-high school degrees, 169 US trade deficit with, 385 as US trading partner, 62, 360–361 microeconomics, 8–9 migration, 416 Mitchell, Wesley C., 96 mixed economic systems, 42–43 monetary policy Board of Governors and, 281–282 defined, 57 money and aggregate demand in long run, 324–329 money and aggregate demand in short run, 318–323 money demand, 315–316 money supply, 315–318 targets for, 329–334 money banking and, 276–279 barter and double coincidence of wants, 271 coins, 275–276 counterfeit, 296–297 creating, 303–307 defined, 272 as medium of exchange, 32, 94, 272 overview, 271 properties of ideal, 273–274 as store of value, 273 as unit of account, 272 money aggregates defined, 295 as monetary policy target, 331 money demand defined, 315 interest rates and, 316 overview, 315–319 money income changes in demand curve and, 80 defined, 68 money market mutual funds, 284, 297 money multiplier, 306 money supply creating money, 303–307 credit cards and debit cards, 297–299 equilibrium interest rate and, 316–318 Fed’s control of, 308–311 interest rates and investment, 318–319 M1, 295 M2, 297 as monetary policy target, 329–330 multiple contraction of, 307–308 overview, 315–316 regulating, 283 monopolies, natural, 56 mortgage-backed securities, 287–288 movement along given demand curves, 72 movement along supply curves, 77 MPC (marginal propensity to consume), 187–188, 199–200 MPS (marginal propensity to save), 187, 200 multilateral assistance, 418 multiple currency system, 150 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Index 439 N NAFTA (North American Free Trade Agreement), 375 National Banking Act of 1863, 279 national banks, 279 National Bureau of Economic Research (NBER), 96–97 national debt (federal debt) crowding out and capital formation, 264–265 debt ceiling and debt default, 263 defined, 107, 259 economic growth and, 265–266 held by public, 259–260 interest payments on, 261–262 international perspective on, 260–261 measuring, 259–260 overview, 259 sustainability of, 262–263 who bears burden of, 264 national income accounting system limitations of, 122 overview, 114–115 personal and disposable income, 133–134 summary income statement of economy, 134–135 natural monopolies, 56 natural rate hypothesis, 355 natural rate of unemployment, 209, 211, 234–235 natural resources in circular-flow model, 5–6 defined, differences in endowments of, 365–366 economic development and, 408 misuse of, 414 NBER (National Bureau of Economic Research), 96–97 negative (inverse) relation between variables, 21, 23 negative externalities, 57 net debt, 260–261 net domestic product, 123 net exports defined, 116 as determinant of aggregate expenditure, 195 as share of US GDP, 116–117 net interest national income accounts, 134–135 as percentage of federal outlays, 249 net investment income, 385–386 net investment income from abroad, 386 net taxes (NT), 119, 194–195, 244–246 net unilateral transfers abroad, 386 net wealth, 188–190 net worth, 301 Netherlands exports as share of GDP, 360 government outlays as percentage of GDP, 258 net debt, 261 as US trading partner, 62, 361 New Zealand, central bank independence, 348 Nigeria civil war, 414 convergence, 420 Nixon, Richard, 106 nominal GDP, 124 nominal interest rate, 156–157 nominal wages defined, 208 stickiness of, 218 nondurable goods, 48–49, 115 normal goods, 70–71 normative economic statements (value judgments), 12 North American Free Trade Agreement (NAFTA), 375 North Korea private ownership, 412–413 pure command system, 42 Norway, Big Mac Index, 394 not-for-profit organizations, 52–53 NT (net taxes), 119, 194–195, 244–246 number of consumers, changes in, 72, 80 number of producers, changes in, 76–77, 82 O Obama, Barack, 159, 228, 238– 240, 267, 289, 338, 342 1/r (simple money multiplier), 306–307 OPEC (Organization of the Petroleum Exporting Countries), 106, 385 open-market operations, 282–283, 308–309 open-market purchases, 308 open-market sales, 308 opportunity cost absolute advantage versus comparative advantage, 31 defined, 27 higher education, 27–28 holding money, 316 ideal money, 273–274 international trade and, 62 overview, 27 production possibilities frontier, 36, 39 subjectivity of, 29–30 sunk cost, 30 women in labor force, 47 Organization of the Petroleum Exporting Countries (OPEC), 106, 385 origin, defined, 20 other-things-constant (ceteris paribus) assumption, 10, 67, 73 output per capita, 173 P panics, 280 partnerships, 50–52 passive policy closing expansionary gaps, 340–341 closing recessionary gap, 338–339 lags in, 341–343 overview, 338 payroll taxes, as percentage of federal government revenue, 59–60 pecuniary, 272 permanent income, 236 persistent dumping, 377 personal consumption expenditures, 115 personal income, 133–134 Peru, import substitution, 417 per-worker production function (PF), 165–167 Philippines, migration, 416 Phillips, A W., 351–352 Phillips curve defined, 352 evidence of, 355–356 framework, 352–353 long-run, 354–355 natural rate hypothesis, 355 overview, 351–352 short-run, 353–354 physical capital defined, 2–3 expenditure approach to GDP, 115 labor productivity, 165 production possibilities frontier, 37 Poland Big Mac Index, 394 GDP per capita, 412 political business cycles, 234–235 Pollakowski, Henry, 86 poorest-billion category, 413–414 Portugal aging population, 405 federal debt, 263 positive (direct) relation between variables, 21, 23 positive economic statements, 12 positive externalities, 57 potential output defined, 209 overview, 209 tracing, 217–218 when output exceeds potential, 210–211 poverty, poorest-billion category, 413–414 PPF See production possibilities frontier PPP (purchasing power parity) theory, 393 predatory dumping, 377 preferences See tastes and preferences president, role in federal budget process, 250 price(s) changes in equilibrium price and quantity, 80–84 consumer price index, 125–128 demand and, 67–69 demand curve and changes in, 71–72 effects of surpluses and shortages on, 79 GDP price index, 128–129 of goods, 75–76 income effect of changes in, 68 of resources, 75 substitution effect of changes in, 67–68 supply and, 73–74 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 440 Index price ceilings, 84–90 price expectations, 72 price floors, 84–85 price indexes chain-weighted system, 129–130 consumer price index, 125–128 defined, 125 GDP price index, 100, 128–129 overview, 124–125 price levels aggregate demand curve and, 201–203 aggregate output and, 99–100 aggregate supply in short run, 209–211 defined, 99 as determinant of consumption, 190 inflation and, 151–152 price stability central bank independence and, 348 governmental role in, 57 primary discount rate, 309 prisons, economics in, 274–275 private goods, 56 private property rights in China, 42–43 defined, 40 privatization, 174, 412 producer cooperatives, 52 producer expectations, changes in, 82 producer surplus, from market exchange, 367–368 product markets, defined, production, defined, 164 production possibilities frontier (PPF) defined, 35 diagram of, 36 efficiency and, 34–35 growth and, 162–164 inefficient and unattainable production, 35 lessons learned from, 39 shape of, 35–36 shifts in, 37–39 without trade, 361–363 productivity defined, 164 education and economic development, 169–170 international comparisons, 173–176 as key to economic development, 406–413, 415 labor productivity, 165, 170–171 output per capita, 173 overview, 162 per-worker production function, 165–166 production possibilities frontier and, 162–164 rules of the game, 167–169 slowdown and rebound in, 172–173 technological change, 166–167, 176–180 products, in circular-flow model, 5–6 profit in circular-flow model, 5–6 defined, profitability, liquidity versus, 302–303 progressive taxation, 60 property rights, private, 40, 42–43 proportional taxation (flat tax), 60 proprietors defined, 48 sole proprietorships, 50 proprietors’ income national income accounts, 134–135 as source of personal income, 48 public (communal) ownership of property, 41 public good(s) defined, 56 governmental role in providing, 56 pure capitalism and, 41 public sector, relative size of, 258–259 purchasing power, 278 purchasing power parity (PPP) theory, 393 pure capitalism, 39–41 pure command system, 40–42 Q Qatar, natural resources, 408 quantitative easing, 332–333 quantity demanded defined, 69 overview, 69–70 quantity supplied, 74 quantity theory of money, 325326 Quesnay, Franỗois, 114 quotas defined, 63 overview, 370–371 in practice, 371–372 tariffs versus, 372 R race income and happiness, 181 unemployment rate, 141–142 Radford, R.A., 274 rational expectations defined, 343–344 rules and, 350–351 rational ignorance, 372 rational self-interest defined, overview, Reagan, Ronald, 107, 158, 237 real GDP (real gross domestic product) aggregate supply and demand, 101–102 annual percentage change in, 193 defined, 100 economic fluctuations, 97–98 Great Recession, 239–240 if exceeds spending, 197–198 if spending exceeds, 197 international comparisons, 173–174, 176 real GDP (real gross domestic product) demanded, 196–197, 201–203 real income, 68 real interest rate, 156 real wages, 208 realized capital gains, 51 recessionary gaps active policy versus passive policy, 338–339 aggregate supply in long run, 215–216 defined, 216 discretionary fiscal policy and, 229–230 expansionary monetary policy and, 320–321 wage flexibility and, 218, 220 recessions, 9, 96–97 See also Great Recession recognition lag, 341–342 redistribution of wealth as percentage of federal outlays, 59, 249–250 role of government in, 57 regressive taxation, 61 relative price changes, inflation and, 155–156 religion-based economic systems, 43–45 renewable resources, rent in circular-flow model, 5–6 defined, rent seeking, 379 rental housing imputed rental income, 122 rent ceilings, 84–90 secondary effects of controlling, 14 as source of personal income, 48, 134–135 required reserve ratio, 302 required reserves, 302, 307 research and development, 177–179 reserve accounts, 302 reserve ratio, 276 reserves, defined, 281 residential construction, 115 resource(s) in circular-flow model, 5–6 defined, household production and, 47–48, 54 overview, 2–3 production possibilities frontier and availability of, 37–38 supply curve and changes in prices of, 75, 82 resource markets in circular-flow model, 5–6 defined, rest of world circular flow of output and income, 119–121 as economic decision maker, exchange rates, 62–63 international trade, 62 trade restrictions, 63–65 revenue, in circular-flow model, 5–6 Romania, GDP per capita, 412 Roosevelt, Franklin D., 281 rules of game defined, 37, 167 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Index 441 economic development and, 411–413 governmental role in establishing and enforcing, 56 production possibilities frontier, 37–38, 164 production possibilities frontier and improvements in, 37–39 pure capitalism and, 41 Russia Big Mac Index, 394 debt default, 264, 322 Federal Reserve and, 334 fertility rates, 405–406 GDP per capita, 412 infant mortality, 404 Internet users, 411 per capita income, 402 productivity, 164 telephone lines, 409–410 Treasury securities, 265 S S corporations, 51 salary, 272 Saudi Arabia Big Mac Index, 394 natural resources, 408 women in labor force, 406 savings in China, 191 as expenditure of personal income, 49 savings deposits, 297 scarcity defined, determination of price, 67 of goods and services, 3–4 of information, production possibilities frontier and, 39 of resources, 2–3 of time, scientific method diagram of, 11 formulating hypothesis, 11–12 identifying question and defining variables, 10 overview, 10 specifying assumptions, 10–11 testing hypothesis, 12 Scotland, top banks, 291 seasonal unemployment, 145 secondary discount rate, 309 secondary effects (unintended consequences), 13–14, 61 self-correcting economic forces, 338 September 11, 2001 terrorist attacks, 107, 168, 237, 310 service(s) balance on, 385 in circular-flow model, 5–6 defined, economic systems and production of, 39 expenditure approach to GDP, 115 as expenditure of personal income, 48 final, 115 households as demanders of, 49 intermediate, 115 overview, 3–4 scarcity of, 3–4 US imports and exports, 360 shadow banking system, 332 Shakespeare, William, 30 shift of demand curves, 72 shift of supply curves, 77 short run aggregate demand in, 318–324 aggregate supply in, 208–212 in macroeconomics, 210–211 money demand in, 318–323 shortages (excess quantity demanded), 79 short-run aggregate supply (SRAS) curve aggregate supply decreases, 223–224 defined, 211 expansionary gaps, 213–214 money and aggregate demand in short run, 320–321 overview, 211–212 recessionary gap, 215–216 shifts of, 222–224 short-run equilibrium, 214 short-run Phillips curve, 353–356 simple money multiplier (1/r), 306–307 simple spending multiplier defined, 200 fiscal policy, 231 increase in spending, 198–199 overview, 198 using, 199–200 Singapore convergence, 419 export promotion, 417 slope alternative, 23 of curved line, 23–24 defined, 22 dependent on unit of measure, 22–24 of straight line, 22 Smith, Adam, 33, 41, 77, 103–104 social capital, 413 Social Security cost-of-living adjustments, 158 ignored in measuring national debt, 259–260 payroll taxes, 59, 61 as percentage of federal outlays, 249 reforming, 266–267 Social Security Act of 1935, 147 sole proprietorships, 50, 52 Solyndra, 180 South Africa, Big Mac Index, 394 South Korea Big Mac Index, 394 capitalist economy, 42 convergence, 419 export promotion, 417 as US trading partner, 62, 361 Southern African Customs Union, 376 Soviet Union, 43 Spain aging population, 405 central bank independence, 348 federal debt, 263 government outlays as percentage of GDP, 258 net debt, 261 special interests, trade liberalization and, 417 specialization comparative advantage, 31–32 diagram of, 33 disadvantages of, 34 division of labor and gains from, 33–34 exchange and, 32–33 of labor, 34 overview, 30–31 reasons for international, 365–367 specific tariffs, 368–369 speculators, 392–393 sporadic dumping, 377 SRAS curve See short-run aggregate supply curve stagflation, 105–106, 151, 233–234 Starbucks, state banks, 279 statistical discrepancy, 387 Steinbeck, John, 137 stimulus spending, 105, 108, 180, 228, 237–241, 253, 339 stock variables, 94 stocks, corporate, 51, 115–116 stores of value, 273 storytelling, 12–13 stress test, 332 structural unemployment, 146 subprime mortgages, 287–288 substitutes defined, 71 demand curve and availability of, 80 substitution effect of price changes, 67–68 Sudan, women in labor force, 406 Sultan of Brunei, 29 sunk cost, 30 Sunkist, 52 supernote, 296 supply See also aggregate supply; money supply changes in equilibrium price and quantity, 80–84 defined, 73 disequilibrium, 84–85 foreign exchange, 390 individual, 74 law of, 73 market, 74 market creation through, 77–79 money, 283, 295, 297–299 supply curve, 73–77 supply schedule, 73–75 supply curve aggregate, 101, 151, 211– 212, 217–221, 320–321 defined, 73 movement along, 77 overview, 73–75 shifts in, 75–77, 81–84 supply schedules, 73–75 supply shocks adverse, 222–223 beneficial, 222 defined, 221 supply-side economics, 107 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com 442 Index surpluses (excess quantity supplied) crowding out and crowding in, 254–255 defined, 78–79 government purchases of, 84 international finance, 387–388 short-lived, 256–257 Swaziland, HIV/AIDS in, 402 Sweden Big Mac Index, 394 exports as share of GDP, 360 Switzerland aging population, 405 Big Mac Index, 394 central bank independence, 348 exports as share of GDP, 360 Treasury securities, 265 T Taiwan Big Mac Index, 394 capitalist economy, 42 convergence, 419 export promotion, 417 Treasury securities, 265 as US trading partner, 361 tariffs defined, 63 overview, 368–370 quotas versus, 372 TARP (Troubled Asset Relief Program), 108, 238, 289 tastes and preferences changes in demand curve and, 80 defined, 72 demand curve and changes in, 72–73 differences in, 366–367 tax incidence, 60–62 tax principles, 60–62 taxation as automatic stabilizer, 228, 233 avoidance of through household production, 54–55 budget surpluses, 256–257 as expenditure of personal income, 48–49 by percentage of federal government revenue, 59–60 Reagan-era cuts, 107 as source of revenue, 59–60 tax cuts, 233, 236–237, 239, 253, 257 Taylor, John, 351 technology changes in supply curve and, 82 economic development and, 407 evolution of firms, 50 household production and changes in, 55 industrial policy, 179–180 production possibilities frontier and changes in, 37–38, 163–164 productivity and growth and, 166–167 research and development, 177–179 supply curve and changes in, 75 unemployment and, 176–177 terms of trade, 363 Texas Medical Center, 53 Thatcher, Margaret, 174 thrift institutions (thrifts), 279 time as basis of resource payments, 3 needed for choice, opportunity cost and, 29 as resource for labor, scarcity of, time deposits (certificates of deposit [CDs]), 297 time-inconsistency problem, 345 time-series graphs, 20–21 token money, 275 “too big to fail”, 289, 332 Torvalds, Linus, 53 trade deficits, 384 trade restrictions, 63–65 trade surpluses, 384 trading partners, 360–361 transaction costs defined, 77 evolution of firms, 49 reduction of, 55 of variable inflation, 155 transfer payments defined, 48 as source of personal income, 48 variation in, 194 transitional economies, 42–43, 412–413 Treasury securities, 255–256, 259, 261, 264 Troubled Asset Relief Program (TARP), 108, 238, 289 Truman, Harry, 137 Turkey, Big Mac Index, 394 Twitter, 54 U UConn Co-op, 52 U-Haul, 79 Ukraine, GDP per capita, 412 unanticipated inflation, 155 unattainable production, 35 underemployment, 148, 407 underground economy, 122 underwater loans, 288–289 unemployment full employment, 147 inefficient use of labor and, 407–408 measuring, 137–143, 148 natural rate of, 209, 234–235 sources of, 143–146 technological change and, 176–177 unemployment benefits, 147–148 unemployment insurance, 233 unemployment rate, defined, 138 unilateral transfers and current account balance, 386 unintended consequences (secondary effects), 13–14, 61 unit of account, 272 United Arab Emirates, natural resources, 408 United Kingdom Big Mac Index, 394 exports as share of GDP, 360 fertility rates, 405 GDP per capita, 174–175 government outlays, 58, 258 Great Depression era employment and wages, 220 infant mortality, 404 Internet users, 411 net debt, 261 per capita income, 402 post-high school degrees, 170 promotion of happiness, 180 real GDP, 176 research and development spending, 178 telephone lines, 410 top banks, 291 Treasury securities, 265 as US trading partner, 62, 361 United States adverse supply shocks, 223 aging population, 405 banking in, 279–284, 287–292 Big Mac Index, 394 change in real GDP, 97–98 circular flow, 118–121 college majors and annual earnings, 14–16 consumption and income, 185–186 consumption and investment, 193–194 economic fluctuations, 96–98 economic growth since 1929, 109–110 exports, 360 federal outlays, 59 federal personal income tax rates, 60–61 fertility rates, 405 GDP, 58, 115–118, 258 government structure, 57 HIV/AIDS, 402 imports, 360 income and happiness, 181 infant mortality, 404 inflation, 151–154 Internet users, 411 labor productivity, 170–173 mixed economy, 42 national income accounts, 114–115, 122–124 net debt, 260–261 output gaps and wage flexibility, 219–220 output per capita, 173–175 per capita income, 402–403 personal income and expenditures, 48 post-high school degrees, 169–170 price indexes, 124–125 research and development spending, 177–178 sources of government revenue, 59 telephone lines, 410 top banks, 291 trade with rest of the world, 62 trading partners, 360–361 types of firms, 50–52 unemployment, 138–145 units of account, 272 units of measurement, 22–23 unrelated (independent) variables, 20–21, 23 Uruguay Round, 373 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Index 443 US Agency for International Development (USAID), 418 US Bureau of Weights and Measures, 56 USAID (US Agency for International Development), 418 user-generated products, 53–54 utility, defined, 47 utility maximization, by households, 47 V value added, 117–118 value judgments (normative economic statements), 12 variable(s) defined, 10 defining, 10 graphing, 20–25 that affect market demand, 70 variety, 122–123 velocity of money defined, 325 determining factors, 327 stability of, 327–329 vending machines, 10 Venezuela inflation, 150 nationalization, 412 vertical axis, 20 Vietnam GDP per capita, 412–413 use of dollar, 295 Volcker, Paul, 331, 351 Volkswagen, 378 Voltaire, 95 voluntary exchange, 58 vote maximization, 58 W wage(s) in circular-flow model, 5–6 college majors and, 14–16 defined, as source of personal income, 48 wage flexibility employment and, 218, 221 US output gaps and, 219–220 Wales, Jimmy, 53 Walmart, 67–68 Walton, Sam, 67 Washington Mutual, 290 welfare as automatic stabilizer, 233 as percentage of federal outlays, 249 Wells Fargo, 290–291 Wikipedia, 53 women in developing countries, 406 fertility rates, 405–406 high birth rates, 404–406 income and happiness, 181 infant mortality, 404 in labor force, 47, 139 occupations dominated by, 43 unemployment rate, 141–142 World Bank, 401 world price, 369 World Trade Organization (WTO), 373–374, 376–377 Y YouTube, 54 Z Zimbabwe hyperinflation, 149–150, 278, 408 unemployment, 408 zombie banks, 284 Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Find more at http://www.downloadslide.com Copyright 2012 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it ... Government Purchases by Quarter (Annualized Rate) Real GDP Gov't Purchases 2 –4 –6 –8 –10 20 0 8 -2 20 0 8-3 20 0 8-4 20 0 9-1 20 0 9 -2 20 0 9-3 20 0 9-4 20 1 0-1 20 1 0 -2 Source: National Economic Accounts, Bureau of Economic... Concepts Automatic stabilizers 22 8 Classical economists 23 1 Permanent income 23 6 Discretionary fiscal policy 22 8 Employment Act of 1946 23 2 Expansionary fiscal policy 22 8 Political business... functional finance is that chronic deficits accumulate into a national debt that at some point could cripple an economy 1 2- 2 c 25 3 Chapter 12 Federal Budgets and Public Policy annually balanced