(BQ) Part 2 book Macroeconomics - Principles, applications, and tools has contents: Aggregate demand and aggregate supply, fiscal policy, investment and financial markets, money and the banking system, the federal reserve and monetary policy, macroeconomic policy debates, international trade and public policy,...and other contents.
Find more at http://www.downloadslide.com Aggregate Demand and Aggregate Supply CHAPTER As we explained in previous chapters, recessions occur when output fails to grow and unemployment rises But why recessions occur? And how economies recover from these recessions? In a sense, recessions are massive failures in economic coordination For example, during the Great Depression in the 1930s, nearly one-fourth of the U.S labor force was unemployed Unemployed workers could not afford to buy goods and services Factories that manufactured those goods and services had to be shut down because there was little or no demand As these factories closed, even more workers became unemployed, fueling additional factory shutdowns This vicious cycle caused the U.S economy to spiral downward This failure of coordination is not just a historical phenomenon In December 2007 the economy also entered a very steep downturn—although not nearly as severe as the Great Depression How could the destructive chain of events have been halted? Equally important is how economies can recover from recessions The U.S economy was very slow to recover from the Great Depression and did not truly reach full employment until World War II And, despite active government intervention, the recovery from the 2007 recession was also painfully slow LEARNING OBJECTIVES • Explain the role sticky wages and prices play in economic fluctuations • List the determinants of aggregate demand • Distinguish between the short-run and long-run aggregate supply curves • Describe the adjustment process back to full employment MyEconLab MyEconLab helps you master each objective and study more efficiently 185 Find more at http://www.downloadslide.com 186 e C H A P T E R • A G GREGA T E D EM A ND AND AGGREGATE SUPPLY conomies not always operate at full employment, nor they always grow smoothly At times, real GDP grows below its potential or falls steeply, as it did in the Great Depression Recessions and excess unemployment occur when real GDP falls At other times, GDP grows too rapidly, and unemployment falls below its natural rate “Too slow” or “too fast” real GDP growth are examples of economic fluctuations— movements of GDP away from potential output We now turn our attention to understanding these economic fluctuations, which are also called business cycles During the Great Depression, there was a failure in coordination Factories would have produced more output and hired more workers if there had been more demand for their products In his 1936 book, The General Theory of Employment, Interest, and Money, British economist John Maynard Keynes explained that insufficient demand for goods and services was a key problem of the Great Depression Following the publication of Keynes’s work, economists began to distinguish between real GDP in the long run, when prices have time to fully adjust to changes in demand, and real GDP in the short run, when prices don’t yet have time to fully adjust to changes in demand During the short run, economic coordination problems are most pronounced In the long run, however, economists believe the economy will return to full employment, although economic policy may assist it in getting there more quickly In the previous two chapters, we analyzed the economy at full employment and studied economic growth Those chapters provided the framework for analyzing the behavior of the economy in the long run, but not in the short run, when there can be sharp fluctuations in output We therefore need to develop an additional set of tools to analyze both short- and long-run changes and the relationship between the two 9.1 Sticky Prices and Their Macroeconomic Consequences Why recessions occur? We previously discussed how real adverse shocks to the economy could cause economic downturns We also outlined the theory of real business cycles, which focuses on how shocks to technology cause economic fluctuations Now we examine another approach to understanding economic fluctuations Led by Keynes, many economists have focused attention on economic coordination problems Normally, the price system efficiently coordinates what goes on in an economy—even in a complex economy The price system provides signals to firms as to who buys what, how much to produce, what resources to use, and from whom to buy For example, if consumers decide to buy fresh fruit rather than chocolate, the price of fresh fruit will rise and the price of chocolate will fall More fresh fruit and less chocolate will be produced on the basis of these price signals On a day-to-day basis, the price system works silently in the background, matching the desires of consumers with the output from producers F lex ible and Sticky Pr ices But the price system does not always work instantaneously If prices are slow to adjust, then they not give the proper signals to producers and consumers quickly enough to bring them together Demands and supplies will not be brought immediately into equilibrium, and coordination can break down In modern economies, some prices are very flexible, whereas others are not In the 1970s, U.S economist Arthur Okun distinguished between auction prices, prices that adjust on a nearly daily basis, and custom prices, prices that adjust slowly Prices for fresh fish, vegetables, and other food products are examples of auction prices—they typically are very flexible and adjust rapidly Prices for industrial commodities, such as steel rods or machine tools, are custom prices and tend to adjust slowly to changes in demand As shorthand, economists often refer to slowly adjusting prices as “sticky prices” (just like a door that won’t open immediately but sometimes gets stuck) Find more at http://www.downloadslide.com PART 187 Steel rods and machine tools are input prices Like other input prices, the price of labor also adjusts very slowly Workers often have long-term contracts that not allow employers to change wages at all during a given year Union workers, university professors, high-school teachers, and employees of state and local governments are all groups whose wages adjust very slowly As a general rule, there are very few workers in the economy whose wages change quickly Perhaps movie stars, athletes, and rock stars are the exceptions, because their wages rise and fall with their popularity But they are far from the typical worker in the economy Even unskilled, low-wage workers are often protected from a decrease in their wages by minimum-wage laws For most firms, the biggest cost of doing business is wages If wages are sticky, firms’ overall costs will be sticky as well This means that firms’ product prices will remain sticky, too Sticky wages cause sticky prices and hamper the economy’s ability to bring demand and supply into balance in the short run H o w D e m a n d Det ermin es Ou t pu t in the Shor t Run Typically, firms that supply intermediate goods such as steel rods or other inputs let demand—not price—determine the level of output in the short run To understand this idea, consider an automobile firm that buys material from a steelmaker on a regular basis Because the auto firm and the steel producer have been in business with one another for a long time and have an ongoing relationship, they have negotiated a contract that keeps steel prices fixed in the short run But suppose the automobile company’s cars suddenly become very popular The firm needs to expand production, so it needs more steel Under the agreement made earlier by the two firms, the steel company would meet this higher demand and sell more steel—without raising its price—to the automobile company As a result, the production of steel is totally determined in the short run by the demand from automobile producers, not by price But what if the firm discovered that it had produced an unpopular car and needed to cut back on its planned production? The firm would require less steel Under the agreement, the steelmaker would supply less steel but not reduce its price Again, demand—not price—determines steel production in the short run Similar agreements between firms, both formal and informal, exist throughout the economy Typically, in the short run, firms will meet changes in the demand for their products by adjusting production with only small changes in the prices they charge their customers What we have just illustrated for an input such as steel applies to workers, too, who are also “inputs” to production Suppose the automobile firm hires union workers under a contract that fixes their wages for a specific period If the economy suddenly thrives at some point during that period, the automobile company will employ all the workers and perhaps require some to work overtime If the economy stagnates at some point during that period, the firm will lay off some workers, using only part of the union labor force In either case, wages are sticky—they will not change during the period of the contract Retail prices to consumers, like input prices to producers, are also subject to some “stickiness.” Economists have used information from mail-order catalogues to document this stickiness Retail price stickiness is further evidence that many prices in the economy are simply slow to adjust Over longer periods of time, prices change Suppose the automobile company’s car remains popular for a long time The steel company and the automobile company will adjust the price of steel on their contract to reflect this increased demand These price adjustments occur only over long periods In the short run, demand, not prices, determines output, and prices are slow to adjust To summarize, the short run in macroeconomics is the period in which prices not change or not change very much In the macroeconomic short run, both formal and informal contracts between firms mean that changes in demand will be reflected primarily in changes in output, not prices short run in macroeconomics The period of time in which prices not change or not change very much Find more at http://www.downloadslide.com 188 C H A P T E R • A G GREGA T E D EM A ND AND AGGREGATE SUPPLY application MEASURING PRICE STICKINESS IN CONSUMER MARKETS APPLYING THE CONCEPTS #1: What does the behavior of prices in consumer markets demonstrate about how quickly prices adjust in the U.S economy? Economists have taken a number of different approaches to analyze the behavior of retail prices Anil Kashyap of the University of Chicago examined prices in consumer catalogs In particular, he looked at the prices of 12 selected goods from L.L Bean, Recreational Equipment, Inc (REI), and The Orvis Company, Inc Kashyap tracked several goods over time, including several varieties of shoes, blankets, chamois shirts, binoculars, and a fishing rod and fly He found considerable price stickiness Prices of the goods he tracked were typically fixed for a year or more (even though the catalogs came out every six months) When prices did eventually change, Kashyap observed a mixture of both large and small changes During periods of high inflation, prices tended to change more frequently, as we might expect Mark Bils of the University of Rochester and Peter Klenow of Stanford University examined the frequency of price changes for 350 categories of goods and services covering about 70 percent of consumer spending, based on unpublished data from the BLS for 1995 to 1997 Compared with previous studies they found more frequent price changes, with half of goods’ prices lasting less than 4.3 months Some categories of prices changed much more frequently Price changes for tomatoes occurred about every three weeks And some, like coin-operated laundries, changed prices on average only every 612 years or so Related to Exercises 1.5, 1.7, and 1.8 SOURCES: Based on Anil Kashyap, “Sticky Prices: New Evidence from Retail Catalogs,” Quarterly Journal of Economics 110, no (1995): 245–274, and Mark Bils and Peter Klenow, “Some Evidence on the Importance of Sticky Prices,” Journal of Political Economy 112, no (2004): 987–985 9.2 Understanding Aggregate Demand In this section, we develop a graphical tool known as the aggregate demand curve Later in the chapter, we will develop the aggregate supply curve Together the aggregate demand and aggregate supply curves form an economic model that will enable us to study how output and prices are determined in both the short run and the long run This economic model will also provide a framework in which we can study the role the government can play in stabilizing the economy through its spending, tax, and money-creation policies W h at I s t he Aggr egate Dem and C ur ve? aggregate demand curve (AD) A curve that shows the relationship between the level of prices and the quantity of real GDP demanded Aggregate demand is the total demand for goods and services in an entire economy In other words, it is the demand for currently produced GDP by consumers, firms, the government, and the foreign sector Aggregate demand is a macroeconomic concept, because it refers to the economy as a whole, not to individual goods or markets The aggregate demand curve (AD) shows the relationship between the level of prices and the quantity of real GDP demanded An aggregate demand curve, AD, is shown in Figure 9.1 It plots the total demand for GDP as a function of the price level (Recall that the price level is the average level of prices in the economy, as measured by a price index.) At each price level, shown on the y axis, we ask what the total quantity demanded will be for all goods and services in the economy, shown on the x axis Find more at http://www.downloadslide.com Price level, P PART Aggregate demand, AD Real GDP, y ▲ FIGURE 9.1 Aggregate Demand The aggregate demand curve plots the total demand for real GDP as a function of the price level The aggregate demand curve slopes downward, indicating that the quantity of aggregate demand increases as the price level in the economy falls In Figure 9.1, the aggregate demand curve is downward sloping As the price level falls, the total quantity demanded for goods and services increases To understand what the aggregate demand curve represents, we must first learn the components of aggregate demand, why the aggregate demand curve slopes downward, and the factors that can shift the curve T h e Co m po nen t s o f Ag g regat e D em and In our study of GDP accounting, we divided GDP into four components: consumption spending (C), investment spending (I), government purchases (G), and net exports (NX) These four components are also the four parts of aggregate demand because the aggregate demand curve really just describes the demand for total GDP at different price levels As we will see, changes in demand coming from any of these four sources—C, I, G, or NX—will shift the aggregate demand curve W h y th e A g gregat e Deman d Cu rv e Slop es D ownwar d To understand the slope of the aggregate demand curve, we need to consider the effects of a change in the overall price level in the economy First, let’s consider the supply of money in the economy We discuss the supply of money in detail in later chapters, but for now, just think of the supply of money as being the total amount of currency (cash plus coins) held by the public and the value of all deposits in savings and checking accounts As the price level or average level of prices in the economy changes, so does the purchasing power of your money This is an example of the real-nominal principle REAL-NOMINAL PRINCIPLE What matters to people is the real value or purchasing power of money or income, not the face value of money or income 189 Find more at http://www.downloadslide.com 190 C H A P T E R • A G GREGA T E D EM A ND AND AGGREGATE SUPPLY As the purchasing power of money changes, the aggregate demand curve is affected in three different ways: • The wealth effect • The interest rate effect • The international trade effect Let’s take a closer look at each wealth effect The increase in spending that occurs because the real value of money increases when the price level falls THE WEALTH EFFECT The increase in spending that occurs because the real value of money increases when the price level falls is known as the wealth effect Lower prices lead to higher levels of wealth, and higher levels of wealth increase spending on total goods and services Conversely, when the price level rises, the real value of money decreases, which reduces people’s wealth and their total demand for goods and services in the economy When the price level rises, consumers can’t simply substitute one good for another that’s cheaper, because at a higher price level everything is more expensive THE INTEREST RATE EFFECT With a given supply of money in the economy, a lower price level will lead to lower interest rates With lower interest rates, both consumers and firms will find it cheaper to borrow money to make purchases As a consequence, the demand for goods in the economy (consumer durables purchased by households and investment goods purchased by firms) will increase (We’ll explain the effects of interest rates in more detail in later chapters.) THE INTERNATIONAL TRADE EFFECT In an open economy, a lower price level will mean that domestic goods (goods produced in the home country) become cheaper relative to foreign goods, so the demand for domestic goods will increase For example, if the price level in the United States falls, it will make U.S goods cheaper relative to foreign goods If U.S goods become cheaper than foreign goods, exports from the United States will increase and imports will decrease Thus, net exports—a component of aggregate demand—will increase Sh ift s in the Aggr egate Dem and C ur ve A fall in price causes the aggregate demand curve to slope downward because of three factors: the wealth effect, the interest rate effect, and the international trade effect What happens to the aggregate demand curve if a variable other than the price level changes? An increase in aggregate demand means that total demand for all the goods and services contained in real GDP has increased—even though the price level hasn’t changed In other words, increases in aggregate demand shift the curve to the right Conversely, factors that decrease aggregate demand shift the curve to the left—even though the price level hasn’t changed Let’s look at the key factors that cause these shifts We will discuss each factor in detail in later chapters: • Changes in the supply of money • Changes in taxes • Changes in government spending • All other changes in demand CHANGES IN THE SUPPLY OF MONEY An increase in the supply of money in the economy will increase aggregate demand and shift the aggregate demand curve to the right We know that an increase in the supply of money will lead to higher demand by both consumers and firms At any given price level, a higher supply of money will mean more consumer wealth and an increased demand for goods and services A decrease in the supply of money will decrease aggregate demand and shift the aggregate demand curve to the left Find more at http://www.downloadslide.com PART CHANGES IN TAXES A decrease in taxes will increase aggregate demand and shift the aggregate demand curve to the right Lower taxes will increase the income available to households and increase their spending on goods and services—even though the price level in the economy hasn’t changed An increase in taxes will decrease aggregate demand and shift the aggregate demand curve to the left Higher taxes will decrease the income available to households and decrease their spending CHANGES IN GOVERNMENT SPENDING At any given price level, an increase in government spending will increase aggregate demand and shift the aggregate demand curve to the right For example, the government could spend more on national defense or on interstate highways Because the government is a source of demand for goods and services, higher government spending naturally leads to an increase in total demand for goods and services Similarly, decreases in government spending will decrease aggregate demand and shift the curve to the left Price level, P ALL OTHER CHANGES IN DEMAND Any change in demand from households, firms, or the foreign sector will also change aggregate demand For example, if the Chinese economy expands very rapidly and Chinese citizens buy more U.S goods, U.S aggregate demand will increase Or, if U.S households decide they want to spend more, consumption will increase and aggregate demand will increase Expectations about the future also matter For example, if firms become optimistic about the future and increase their investment spending, aggregate demand will also increase However, if firms become pessimistic, they will cut their investment spending and aggregate demand will fall When we discuss factors that shift aggregate demand, we must not include any changes in the demand for goods and services that arise from movements in the price level Changes in aggregate demand that accompany changes in the price level are already included in the curve and not shift the curve The increase in consumer spending that occurs when the price level falls from the wealth effect, the interest rate effect, and the international trade effect is already in the curve and does not shift it Figure 9.2 and Table 9.1 summarize our discussion Decreases in taxes, increases in government spending, and increases in the supply of money all shift the aggregate demand curve to the right Increases in taxes, decreases in government spending, and decreases in the supply of money shift it to the left In general, any increase in demand Increased AD Initial AD Decreased AD Output, y ▲ FIGURE 9.2 Shifting Aggregate Demand Decreases in taxes, increases in government spending, and an increase in the supply of money all shift the aggregate demand curve to the right Higher taxes, lower government spending, and a lower supply of money shift the curve to the left 191 Find more at http://www.downloadslide.com 192 C H A P T E R • A G GREGA T E D EM A ND AND AGGREGATE SUPPLY TABLE 9.1 Factors That Shift Aggregate Demand Factors That Increase Aggregate Demand Factors That Decrease Aggregate Demand Decrease in taxes Increase in government spending Increase in the money supply Increase in taxes Decrease in government spending Decrease in the money supply (not brought about by a change in the price level) will shift the curve to the right Decreases in demand shift the curve to the left How t h e M ultip lier M akes the Shift Bigger multiplier Let’s take a closer look at the shift in the aggregate demand curve and see how far changes really make the curve shift Suppose the government increases its spending on goods and services by $10 billion You might think the aggregate demand curve would shift to the right by $10 billion, reflecting the increase in demand for these goods and services Initially, the shift will be precisely $10 billion In Figure 9.3, this is depicted by the shift (at a given price level) from a to b But after a brief period of time, total aggregate demand will increase by more than $10 billion In Figure 9.3, the total shift in the aggregate demand curve is shown by the larger movement from a to c The ratio of the total shift in aggregate demand to the initial shift in aggregate demand is known as the multiplier Price level, P The ratio of the total shift in aggregate demand to the initial shift in aggregate demand a b c AD1 AD2 AD0 Output, y ▲ FIGURE 9.3 The Multiplier Initially, an increase in desired spending will shift the aggregate demand curve horizontally to the right from a to b The total shift from a to c will be larger The ratio of the total shift to the initial shift is known as the multiplier Why does the aggregate demand curve shift more than the initial increase in desired spending? The logic goes back to the ideas of economist John Maynard Keynes Here’s how it works: Keynes believed that as government spending increases and the aggregate demand curve shifts to the right, output will subsequently increase, too As we saw with the circular flow in Chapter 5, increased output also means increased income for households, as firms pay households for their labor and for supplying other factors of production Typically, households will wish to spend, or consume, part of that income, which will further increase aggregate demand It is this additional spending by consumers, over and above what the government has already spent, that causes the further shift in the aggregate demand curve The basic idea of how the multiplier works in an economy is simple Let’s say the government invests $10 million to renovate a federal court building Initially, total spending in the economy increases by this $10 million paid to a private construction firm The construction workers and owners are paid $10 million for their work Suppose the owners and workers spend $6 million of their income on new cars (although, as we Find more at http://www.downloadslide.com PART will see, it does not really matter what they spend it on) To meet the increased demand for new cars, automobile producers will expand their production and earn an additional $6 million in wages and profits They, in turn, will spend part of this additional income— let’s say, $3.6 million—on televisions The workers and owners who produce televisions will then spend part of the $3.6 million they earn, and so on To take a closer look at this process, we first need to look more carefully at the behavior of consumers and how their behavior helps to determine the level of aggregate demand Economists have found that consumer spending depends on the level of income in the economy When consumers have more income, they want to purchase more goods and services The relationship between the level of income and consumer spending is known as the consumption function: C = Ca + by where consumption spending, C, has two parts The first part, Ca, is a constant and is independent of income Economists call this autonomous consumption spending Autonomous spending is spending that does not depend on the level of income For example, all consumers, regardless of their current income, will have to purchase some food The second part, by, represents the part of consumption that is dependent on income It is the product of a fraction, b, called the marginal propensity to consume (MPC), and the level of income, or y, in the economy The MPC (or b in our formula) tells us how much consumption spending will increase for every dollar that income increases For example, if b is 0.6, then for every $1.00 that income increases, consumption increases by $0.60 Here is another way to think of the MPC: If a household receives some additional income, it will increase its consumption by some additional amount The MPC is defined as the ratio of additional consumption to additional income, or MPC = consumption function The relationship between consumption spending and the level of income autonomous consumption spending The part of consumption spending that does not depend on income marginal propensity to consume (MPC) The fraction of additional income that is spent additional consumption additional income For example, if the household receives an additional $100 and consumes an additional $70, the MPC will be +70 = 0.7 +100 You may wonder what happens to the other $30 Whatever the household does not spend out of income, it saves Therefore, the marginal propensity to save (MPS) is defined as the ratio of additional savings to additional income MPS = additional savings additional income The sum of the MPC and the MPS always equals one By definition, additional income is either spent or saved Now we are in a better position to understand the multiplier Suppose the government increases its purchases of goods and services by $10 million This will initially raise aggregate demand and income by $10 million But because income has risen by $10 million, consumers will now wish to increase their spending by an amount equal to the marginal propensity to consume multiplied by the $10 million (Remember that the MPC tells us how much consumption spending will increase for every dollar that income increases.) If the MPC were 0.6, then consumer spending would increase by $6 million when the government spends $10 million Thus, the aggregate demand curve would continue to shift to the right by another $6 million in addition to the original $10 million, for a total of $16 million But the process does not end there As aggregate demand increases by $6 million, income will also increase by $6 million Consumers will then wish to increase their marginal propensity to save (MPS) The fraction of additional income that is saved 193 Find more at http://www.downloadslide.com 194 C H A P T E R • A G GREGA T E D EM A ND AND AGGREGATE SUPPLY spending by the MPC * $6 million or, in our example, by $3.6 million (0.6 * $6 million) The aggregate demand curve will continue to shift to the right, now by another $3.6 million Adding $3.6 million to $16 million gives us a new aggregate demand total of $19.6 million As you can see, this process will continue, as consumers now have an additional $3.6 million in income, part of which they will spend again Where will it end? Table 9.2 shows how the multiplier works in detail In the first round, there is an initial increase in government spending of $10 million This additional demand leads to an initial increase in GDP and income of $10 million Assuming that the MPC is 0.6, the $10 million of additional income will increase consumer spending by $6 million The second round begins with this $6 million increase in consumer spending Because of this increase in demand, GDP and income increase by $6 million At the end of the second round, consumers will have an additional $6 million; with an MPC of 0.6, consumer spending will therefore increase by 0.6 * $6 million, or $3.6 million The process continues in the third round with an increase in consumer spending of $2.16 million It continues, in diminishing amounts, through subsequent rounds If we add up the spending in all the (infinite) rounds, we will find that the initial $10 million of spending leads to a $25 million increase in GDP and income That’s 2.5 times what the government initially spent So in this case, the multiplier is 2.5 TABLE 9.2 THE MULTIPLIER IN ACTION The initial $10 million increase in aggregate demand will, through all the rounds of spending, eventually lead to a $25 million increase Round of Spending Increase in Aggregate Demand (millions) Increase in GDP and Income (millions) Increase in Consumption (millions) Total $10.00 6.00 3.60 2.16 $25.00 $10.00 6.00 3.60 2.16 $25.00 $6.00 3.60 2.16 1.30 $15.00 Instead of calculating spending round by round, we can use a simple formula to figure out what the multiplier is: multiplier = 11 - MPC Thus, in the preceding example, when the MPC is 0.6, the multiplier would be = 2.5 11 - 0.62 Now you should clearly understand why the total shift in the aggregate demand curve from a to c in Figure 9.3 is greater than the initial shift in the curve from a to b This is the multiplier in action The multiplier is important because it means that relatively small changes in spending could lead to relatively large changes in output For example, if firms cut back on their investment spending, the effects on output would be “multiplied,” and this decrease in spending could have a large, adverse impact on the economy In practice, once we take into account other realistic factors such as taxes and indirect effects through financial markets, the multipliers are smaller than our previous examples, typically near 1.5 for the U.S economy This means that a $10 million increase in one component of spending will shift the U.S aggregate demand curve by approximately $15 million Some economists believe the multiplier Find more at http://www.downloadslide.com INDEX Deposit insurance, 266 Depreciation, 103 as function of stock of capital, 181–182 saving, capital deepening and, 180–184 Depreciation of a currency, 304, 386–387 Depression, 113, 224 DeSoto, Hernando, 177 Devaluation, 400 Developing countries economic growth in, 163–165 knowledge accumulation in, 174 lack of incentives for growth in, 176 price structures in, 162 property rights in, 176–177 Dickens, William, 332 Diminishing marginal returns, 142 Diminishing returns, 39 Diminishing returns principle, 39, 142, 167, 180–181 Disability insurance, unemployment and, 127 Discount rate, 296 Discouraged workers, 123 Discretionary spending, 211 Division of labor, exchange and, 53 Doha trade negotiations, 375 Dollars See U.S dollar Dolphins, tuna fishing and, 377–378 Domestic industries, helping, with protectionist policies, 373–374 Dominican Republic-Central America Free Trade Agreement (DR-CAFTA), 375 Double coincidence of wants, 273 Draghi, Mario, 385 Driving speed, marginal principle and, 36 Drug prices, 90 Duggan, Mark, 127 Dumping, 376–377 E Earnings, retained, 261 Easterly, William, 176 Econometric models, 210 Economic analysis, problem solving and, 5–7 Economic boom, returning to full employment after, 315–316 Economic fluctuations, 186 lags and, 208–210 technology and, 149–150 using macroeconomics to understand, 11 Economic growth, 102 in Africa, 159 capital deepening and, 165–168 culture, evolution, and, 175 in developing countries, 163–165 global warming and, 164 inequality and, 165 international comparisons of, 162–163 measuring, 161–162 new growth theory and, 174–175 vs per capita income, 163–164 property rights and, 176–177 rates, 160–165 role of government in, 176 role of political factors in, 174 sources of, 170 technological progress and, 168–171, 180–184 using macroeconomics to understand, 11 Economic models, 4–5 classical models, 140 to determine causes of recessions, 195 econometric, 210 Economic policy debates over, 347–361 speed of adjustment and, 316–317 using, to fight recession, 317 Economic principles, 30 See also Diminishing returns principle; Marginal principle; Opportunity cost; Real-nominal principle; Voluntary exchange principle Economic questions, Economic rate of return, civil liberties and, 62 Economic recovery, after recession, 314–315 Economics, 1, classical, 324–325 supply-side, 205, 213–214, 218 Economic stability, 240 Economic uncertainty, 61, 210–211, 255 Economic way of thinking elements of, 7–9 example, 9–10 Economic well-being, 97 Economy boom, 200–201, 315–316 centrally planned, 56 in short run, 200–201, 224 Edison, Thomas, Education, 173–174 Efficiency, Elections, 318 Email, spam, 10 Employment free trade and, 368–369 part-time, 123 Employment taxes, labor demand and supply and, 147–148 Energy prices, investment spending and, 255 Entitlement and mandatory spending, 212 Entitlement programs, 210, 212 Entrepreneurs, role of, 58 Entrepreneurship, 2, Environment, GDP and, 114–115 Environmental protection, trade laws and, 377–378 Equality, economic growth and, 165 Equations, using, to compute missing values, 25 Equilibrium labor market, 144, 146–147 long-run, 201 in money market, 297–299 short-run, 201 Equilibrium output, 224–226 adjusting to, 226–227 consumption function and, 229–233 421 Find more at http://www.downloadslide.com 422 IN D E X determining, 225 formulas for, 249–252 in open economy, 241–242 saving and investment and, 230–231 Equilibrium price consequences of price above, 78 decrease in demand and, 81–82 decrease in supply and, 87 increase in demand and, 80–81 increase in supply and, 85–86 simultaneous changes in demand and supply and, 87–89 Equilibrium quantity, simultaneous changes in demand and supply and, 87–89 Estate taxes, 213 Euro, 386, 387–390, 402 Europe, taxes differences in, 150 European Central Bank, 385 European Community (EC), 49, 55 European Union (EU), 375 Evolution, economic growth and, 175 Excess demand, 76–77 Excess reserves, 278, 280 Excess supply, 77–78 Exchange comparative advantage and, 50–55 division of labor and, 53 Exchange rate, 304, 386 appreciation, 397 current systems of, 401 depreciation, 397–398 determination of, 386–390 fixed, 397–401 flexible, 399–401 net exports and, 391 real, 390–393 Excise taxes, 213 Expansion, 112 Expansionary policies, 207, 317 Expectations of inflation, 330 Expectations Phillips curve, 333–336 Expected real interest rate, 258 Expenditures, planned, 225 Exports, 54, 104 in income-expenditure model, 241–242 net, 102, 104–105, 152 Externalities, negative, 59–60 F Fackler, Jack, 195 Factors of production, Fannie Mae, 265, 266, 267 Federal budget, 211–216 See also Budget deficit debate over balancing, 348–354 recent history of, 348–350 Federal deficit, 214–216 Federal funds market, 296 Federal funds rate, 296, 306–307, 317 Federal government See also Government states and, 354 Federal Open Market Committee (FOMC), 283 Federal Reserve commodity prices and, 297 functions of, 281–282 housing boom and, 357 independence of, 283–284 inflation and, 337–339 inflation targeting by, 355–358 interest rates and, 297–299, 300, 301 market expectations and, 306– 307 monetary policy and, 282, 283, 291–307 money supply and, 295–297 open market operations of, 295–296, 300 quantitative easing by, 297 response by, in financial crisis, 284–285, 294 structure of, 282–283 tools of, 295–297 Federal Reserve Banks, 282–283 Federal Reserve float, 284 Federal Reserve System, 281–284 Federal revenues, 212–214 Federal spending, 211–212, 220 Feldstein, Martin, 148 Fertilizer, crop yields and, 40 Fiat money, 274–275 Final goods and services, 101 Finance, investment and, 253 Financial account, 394–396 Financial crises of 2008-2009, 266–267, 272, 285, 311, 329, 402 economic view of, 6–7 management of, 402–404 response of Federal Reserve to, 284–285, 294 Financial intermediaries, 263–268 Financial panics, 281 Fiscal multipliers, 207–208, 234–237 Fiscal policy, 206 aggregate demand and, 206–207 automatic stabilizers, 214–215, 237–240 contractionary policies, 207 expansionary policies, 207 federal deficit and, 214–216 Keynesian, 234, 236–237, 238 lags and, 208–210 role of, 206–211 stabilization policies, 208–210 in U.S history, 216–220 Fiscal stimulus, 218–219, 237 Fiscal-year basis, 211 Fischer, Stanley, 164, 385 Fitoussi, Jean-Paul, 97 Fixed exchange rates, 397–401 Fixed exchange rate system, 399 Flat tax, 360–361 Flexible exchange rate system, 399–401 Flexible prices, 186–187 Forecasting, economic uncertainties, 210–211 Foreign competition, workers and, 373 Foreign demand, affect on output of, 243 Foreign exchange market intervention, 398–399 Find more at http://www.downloadslide.com INDEX Foreign producers, dumping by, 376–377 45° line, 224–225 France GDP per capita in, 139 GNI per capita, 162 government consumption in, 152 Freddie Mac, 265, 266, 267 Freedom House, 62 Free trade, 173, 364, 365 dumping and, 376–377 employment and, 368–369 reasons for protests against, 380 Frictional unemployment, 126, 140 Friedman, Milton, 311, 317, 333, 343 Full employment, 127, 140, 186 dividing output among competing demands for GDP at, 151–155 labor market equilibrium and, 146–147 opportunity cost of increased government spending at, 153 returning to, after recession, 314–315 returning to, from a boom, 315–316 wage and price changes and, 314–318 Full-employment model, 140, 147–151 Full-employment output, 146–147 G Galor, Oded, 175 GATT See General Agreement on Tariffs and Trade (GATT) GDP See Gross domestic product GDP deflator, 110–111 General Agreement on Tariffs and Trade (GATT), 375 The General Theory of Employment, Interest, and Money (Keynes), 237 Genetically modified crops, 378 Germany central bank of, 338 government investment in, 152 U.S dollar and, 400–401 Gift taxes, 213 Global economy, 53–54 Globalization, 150 Global recession, 97, 223, 272 Global warming See Climate change GNP See Gross national product Gold prices, inflation and, 329 Gold standard, 274 Goods basket of, 130 complement, 80 complementary, 81 inferior, 80, 81 intermediate, 101 new, and bias in CPI, 132 nondurable, 379 normal, 79, 81 public, 60 smuggled, 372 substitute, 80, 81 Google, 171 Government capital deepening and, 167–168 enforcement of rules of exchange by, 60–61 role of, in market economy, 59–62, 176 size of, 352–353 Government bonds, 214 Government debt, 212, 329, 348 See also Budget deficit as burden on future generations, 350–351 international comparisons of, 352 as percentage of GDP, 349–350, 352 Government investment, 152, 167–168 Government purchases, 102, 104, 152, 153–154 Government spending aggregate demand and, 206 Broken Windows fallacy and, 238 capital deepening and, 167–168 423 changes in, and aggregate demand curve, 191 crowding in and, 154–155, 324 crowding out and, 322–323 decreases in, 324 federal budget and, 211–212 GDP and, 233–234 income-expenditure model and, 233–240 multiplier, 234–235, 251 U.S consumption and, during WWII, 154 U.S investment and, during WWII, 154 Graphs of negative relationships, 21–22 of nonlinear relationships, 22–23 of single variable, 15–17 of two variables, 17–19 using, 15–23 Great Depression, 113, 186, 197 bank failures during, 266 deflation during, 134 fiscal policy during, 216 inside lag during, 209 labor market policies and, 151 unemployment during, 127, 140, 185 Greece, hyperinflation in, 3, 341–342 Greenspan, Alan, 263, 291, 305, 338–339 Gross domestic product (GDP), 100 affect of imports and exports on, 243 chain-weighted index for, 130–131 components of, 102–105 contributions to growth of real, 169 debt as percent of, 349–350, 352 dividing output among competing demands for, 151–155 fluctuations in, 112–113 GDP equation, 105 vs GNP, 106–107 government spending and, 233–234 Find more at http://www.downloadslide.com 424 IN D E X growth in, 160 growth rates of U.S., 1871-2011, 238 happiness and, 109 historical U.S price index for, 133 interest rates and, 301–303 investment spending as share of U.S., 255 as measure of welfare, 113–115 measuring macroeconomic activity using, 100–105 measuring real vs nominal, 109–110 money demand and, 292–293 nominal, 101–102, 109–111 per capita, 139 real, 101, 102, 109–111 real, per capita, 161 real exchange rates and net exports as percentage of, 391 research and development as percentage of, 172 shortcomings in, 114–115 Gross investment, 103–104 Gross national income, international comparisons of, 162–163 Gross national product (GNP), 106–107 real, 162 Group think, 313 Growth accounting, 169–171 Growth rate, 161 international comparisons of, 162–163 vs per capita income, 163–164 Growth version of the quantity equation, 340–341 H Hall, Robert E., 323, 360 Hamilton, Alexander, 354 Hanseatic League, 49 Happiness GDP and, 109 unemployment, social norms, and, 129 Hausman, Jerry, 132 Hayek, Friedrich, 56 Hazlitt, Henry, 238 Health-care expenditures, crowding out and, 323 Heller, Walter, 217 Heston, Alan, 162 Home prices, 229 Homes, underwater, 263 Honeybees, price of ice cream and, 89 Hong Kong economic growth in, 176 financial crisis in, 403 government consumption in, 152 Hoover, Herbert, 151, 216 Hormone-treated beef, 378 Housework, GDP and, 114 Housing boom, 357 Housing market, 253, 267 Housing prices fall in, 253, 266, 291 increase in, 67 in Japan, 162 Howitt, Peter, 175 Hulten, Charles, 171 Humana index, 62 Human capital, 2, 160, 173–174 Human capital theory, 173–174 Hungary, hyperinflation in, 341–342, 343 Hybrid vehicles, incentives to buy, Hyperinflation, 135, 339, 341–343, 404 I Ice cream prices, honeybee population and, 89 Iceland, bank failures in, 272 Illiquid, 295 Imperfect competition, 60 Imperfect information, 60 Import bans, 369–370 Import licenses, 370–371 Import quotas, 370 Imports, 54, 104, 241–242, 374 Incentives, 8–9, 176 Income, 98–99 circular flow of, 99–100 consumer spending and, 227, 240 decrease in, 80, 81 increase in, 79, 81 national, 106–109 per capita, 162–164 permanent, 218 personal, 107 personal disposable, 107 relationship between hours worked and, 17–18 Income-expenditure model, 224–227 aggregate demand curve and, 243–245 automatic stabilizers in, 237–240 consumption function in, 227–233 equilibrium output in, 229–233 exports and imports in, 241–242 government spending and taxation in, 233–240 multiplier in, 232–233 Income inequality, outsourcing and trade and, 379–380 Income tax, 212–213, 239–240 India central bank of, 282 economic growth in, 164, 243 GNI per capita, 162 per capita output in, 167 price structures in, 162 sources of growth in, 170 Individual demand curve, 68–70 Individual supply curve, 72–73 Indonesia, 403 Induced innovation, 173 Industrial Revolution, 174, 175 Inefficiencies, Inequality economic growth and, 165 international trade and, 379 Infant industries, 373 Inferior good, 80, 81 Inflation, 98, 132–134, 261, 401 anticipated, 134–135 Argentinian statistics on, 120 Find more at http://www.downloadslide.com INDEX budget deficits and, 350 costs of, 134–135 credibility of central bank and, 337–339 effect on real minimum wage, 41–42 expectations of, 330 gold prices and, 329 hyperinflation, 339, 341–343, 404 public expectations about, 334 repayment of student loans and, 42 in steady state, 330–331 unanticipated, 134, 135, 333 unemployment and, 333–336 U.S., and unemployment in 1980s, 334–335 velocity of money and, 340–341 Inflation expectations central banks and, 337–339 interest rates and, 330–331 money demand and, 331 Inflation rate, 132–134 Inflation targeting, by Fed, 355–358 Information about consumer products, 60–61 imperfect, 60 Innovation, 53 induced, 173 monopolies and, 172–173 Input prices, 187, 197–198 Inside lags, 208–210, 305–306 Insourcing, 54 Institutional changes, 336 Institutions, economic growth and, 176 Insurance, 56, 61 deposit, 266 disability, 127 risk and, 264–265 unemployment, 128–129, 237 Intangible capital, growth accounting and, 171 Intellectual property rights, 172–173 Interest, net, 212 Interest rate effect, 190 Interest rates approaching zero, 320 bond prices and, 299–300 on corporate and government investment, 2002-2022, 259 crowding out and, 324 determination of, 297–301 GDP and, 301–303 inflation and, 330–331 investment and, 260–261, 301–303 on long-term bonds, 306–307 monetary policy and, 302 money demand and, 292–293 nominal, 258–260, 261, 320, 331 present value and, 256–257 real, 258–260, 261 Intermediate goods, 101 International comparisons of government debt, 352 of growth rate, 162–163 International Financial Statistics, 152 International Monetary Fund, 152, 162, 403, 404 International trade, 365 See also Free trade; Trade comparative advantage and, 53–54 income-expenditure model and, 241–242 inequality and, 379 monetary policy and, 303–305 International trade effect, 190 Inventions, patents on, 56 Inventory cycle, 240 Inventory management, 240 Investment, 152, 240, 254–256 finance and, 253 financial intermediaries and, 263–268 government, 152 gross, 103–104 interest rates and, 260–261, 301–303 multiplier and, 232–233 neoclassical theory, 261 net, 103–104, 167 present value and, 260 private, 103–104 425 Q-theory of, 262 saving and, 166–167, 230–231 stock market and, 261–263 Investment decisions, 260–263 Investment spending accelerator theory of, 254 energy prices and, 255 money market and, 301–302 multiple-accelerator model, 256 procyclical, 254 real interest rates and, 261 as share of U.S GDP, 255 Investors, 254, 264 Invisible hand, 57 iPod, 360–361 iPod Shuffle, Iraq invasion of Kuwait by, 305 war in, 349 Italy, GNI per capita, 162 J Japan economic growth in, 163 financial crisis in, 266 GNI per capita, 162, 163 government spending in, 237 housing prices in, 162 protectionist policies, 372 recession in, 236 Job loss, from outsourcing, 54 Johnson, Lyndon, 217 Jones, Benjamin, 164 Jones, Charles I., 323 Jorgenson, Dale, 261 Juo, Yu, 216 K Kashyap, Anil, 188 Kennedy, John F., 205, 217 Kennedy administration, fiscal policy during, 217 Keynes, John Maynard, 186, 192, 197, 224, 237, 311 classical economics and, 324–325 on economic stabilization, 317 on investment spending, 254 Find more at http://www.downloadslide.com 426 IN D E X Keynesian cross, 224 Keynesian fiscal policy, 234, 236–237, 238 Kilian, Lutz, 199 Kirchner, Cristina, 120 Klenow, Peter, 188 Kleven, Henrik Jacobsen, 150 Knowledge accumulation, 173 Koppel, Ted, 90 Kuwait, Iraqi invasion of, 305 L Labor, 2, 141 child, 163 division of, and exchange, 53 relationship between output and, 141–142 skilled, 380 taxes and demand and supply for, 147–148 unskilled, 380 wages and demand and supply for, 143–145 Labor demand curve, 143, 147–148 Labor force, 121, 122, 123 Labor force participation rate, 121, 125 Labor market, Labor market equilibrium, 144 full employment and, 146–147 Labor market policies, Great Depression and, 151 Labor productivity, 171, 336 Labor supply curve, 144, 147–148 Laffer, Arthur, 213–214 Laffer curve, 213–214 Lags, 208–210, 305–306 Landais, Camille, 150 Latvia, 49, 55 Law of demand, 69–70 cigarettes and, 71 Law of one price, 393 Law of supply, 73, 76 Learning by doing, 373 Lebergott, Stanley, 148 LEED certification Lehman Brothers, 266–267, 285 Leisure, GDP and, 114 Lender of last resort, 281, 282 Leverage, 265 Liabilities, 277 Liberty ships, 373 Life expectancy, entitlement programs and, 210 Lincoln, Abraham, 54 Liquid, 263 Liquidity demand for money, 295 Liquidity traps, 313, 317, 319 Living standards, 1, 130 Black Death and, 145 differences in, 160 growth in GDP and, 160 trade and, 379 Loan repayment, effect of inflation and deflation on, 42 Locomotive effect, 243 Long run crowding out in, 322–324 neutrality of money in, 320–322 Long-run aggregate supply curve, 196–197, 314 Long-run equilibrium, 201 Long run in macroeconomics, 312 Long-run neutrality of money, 320–322 Lucas, Robert E., 174, 334 Luxembourg, 162 M M1, 275, 279 M2, 275–276, 340 Macroeconomic activity measuring using gross domestic product, 100–105 measuring using national income, 106–109 Macroeconomic policy, debates over, 347–361 Macroeconomics, 10, 98 linking the short and long run in, 200–201, 312–314 short run in, 187–188 use of, 11 Malaysia, 403 Malthus, Thomas, 145, 324 Mandatory spending, 212 Manufacturing firms, inventory management by, 240 Marginal benefit, 33 Marginal change, 8, 10 Marginal cost, 33 Marginally attached workers, 123 Marginal principle, 33–36, 73, 144 automobile emissions standards and, 35–36 driving speed and, 36 movie sequels and, 34–35 of renting facility, 35–36 Marginal propensity to consume (MPC), 192, 227, 232–234, 239–240 Marginal propensity to import, 241 Marginal propensity to save (MPS), 192, 231 Market changes, predicting and explaining, 90–91 Market demand curve, 70–71 Market economy, 55–56 risk in, 61 role of government in, 59–62, 176 Market effects of changes in demand, 78–82 of changes in supply, 83–89 of simultaneous changes in demand and supply, 87–89 Market equilibrium, 76–78 Market-equilibrium price See Equilibrium price Market expectations, 306–307 Market failure, role of government and, 59–61 Markets, 2, 50, 55–59 See also Labor market development of, 58–59 emergence of, in POW camps, 58 perfectly competitive, 68, 75 role of entrepreneurs in, 58 scale of, 173 using microeconomics to understand, 12 virtues of, 56–58 voluntary exchange and, 37–38 Market supply curve, 74–75 slope of, 75 Find more at http://www.downloadslide.com INDEX McMillin, Douglas, 195 Medicaid, 210, 212 Medicare, 210, 212, 213 Medium of exchange, 273–274 Menu costs, 134 Merrill Lynch, 266 Meteorite market, 59 Mexico financial crisis in, 402–403, 404 GNI per capita, 162–163 Microeconomics, 12–13 Military spending, opportunity cost of, 30–31 Mill, John Stuart, 324 Minimum supply price, 73 Minimum wage, 187 value of the, 41–42 Mining industry, 67 Minorities, unemployment and, 123–124 Moav, Omer, 175 Modigliani, Franco, 325, 385 Monetarists, 343 Monetary policy, 281, 283 challenges, 305–307 contractionary, 317 expansionary, 317 Fed and, 291–307 housing boom and, 357 interest rates and, 302 international trade and, 303–305 lags in, 305–306 in long run, 322 in short run, 322 Monetary systems, types of, 274–275 Monetizing the deficit, 350 Money, 273 changes in growth rate of, and steady state, 331–332 commodity, 274 creation of, by banks, 277–281 demand for, 292–295 fiat, 274–275 long-run neutrality of, 320–322 M1, 275, 279 M2, 275–276 measuring, in U.S economy, 275–277 as medium of exchange, 273–274 nominal value of, 41 properties of, 273–274 real-nominal principle and, 40–42 real value of, 41 as store of value, 274 velocity of, 340–341 Money demand GDP and, 293–294 inflation and, 331 interest rates and, 292–293, 297–301 other components of, 295 price level and, 293–294 transaction, 292 Money illusion, 330 Money market, 292–295 equilibrium in, 297–299 investment spending and, 301–302 Money multiplier, 279–281 Money supply aggregate demand and, 302–303 changes in, 190 Federal Reserve and supply of, 295–297 interest rates and, 297–301 Monopolies antitrust policies and, 61 helping domestic firms establish, in world markets, 373–374 innovation and, 172–173 Mortgages, subprime, 266, 267, 285, 291, 357 Movie sequels, marginal principle and, 34–35 Mozambique, Multilateral real exchange rate, 391 Multiple-accelerator model, 256 Multiplier effect, 243 Multiplier(s), 192–195, 207–208 balanced-budget, 235, 251 fiscal, 207–208, 234–237 formulas for, 249–252 government spending, 234–235, 251 427 in income-expenditure model, 232–233 money, 279–281 tax, 234–235, 236, 251 using, 235–237 using long-term macro data to measure, 233 Music piracy, 172–173 N National Bureau of Economics Research (NBER), 113 National debt See Budget deficit; Government debt National income, 106 measuring, 106–108 value added and, 107–108 National Industrial Recovery Act, 151 Natural disasters, 149 Natural rate of unemployment, 126–128, 146–147, 332, 336 Natural resources, Negative externalities, 59–60 Negative relationship, 19 graphing, 21–22 Neoclassical theory of investment, 261 Net exports, 102, 104–105, 152, 391 Net interest, 212 Net international investment position, 396 Net investment, 103–104, 167 Net national product (NNP), 107 New Deal, 151 New growth theory, 174–175 New York Federal Reserve, 283 New Zealand, central bank of, 338, 358 Nicaragua, hyperinflation in, 342 Nigeria, GNI per capita, 162 NNP See Net national product (NNP) Nominal GDP, 101–102, 109–111 Nominal interest rate, 258–260, 320, 331 Nominal value, 41 Find more at http://www.downloadslide.com 428 IN D E X Nominal wages, 330 Nondurable goods, 379 Nonlinear relationships, graphing, 22–23 Normal good, 79, 81 Normative analysis, 3–4 North American Free Trade Agreement (NAFTA), 364, 375 Norway, 162 O Obama, Barack, 219 Obama administration, fiscal stimulus of, 218–219, 237, 349 Obstfeld, Maurice, 163 Offshoring, 54 Ohanian, Lee E., 151 Oil industry, 67 Oil prices, 148–149, 297 Oil supply disruptions, 199 Okun, Arthur, 186 Olken, Benjamin, 164 Online games, market exchange and, 38 Open economy, 154 crowding out in, 154 equilibrium output in, 241–242 Open market operations, 295–296, 300 Open market purchases, 295 Open market sales, 295 Opportunity cost, 29, 50 of college degree, 29–30 crowding out and, 152–153 of holding money, 292–293 of military spending, 30–31 production possibilities curve and, 31–33 productivity and, 50, 55 of running a business, 33 Opportunity cost principle, 153, 215, 237, 256, 292, 351, 365 Ostry, Jonathan, 165 Oswald, Andrew, 109 Output determining long-run, 196–197 dividing among competing demands for GDP, at full employment, 151–155 equilibrium, 224–227 full-employment, 146–148 interest rates and, 301–303 potential, 146–148 relationship between labor and, 141–142 short-run determination of, 187–188 taxes and, 147–148 Outside lags, 208–210, 305–306 Outsourcing, 54, 379–380 Owner’s equity, 277 P Pakistan economic growth in, 164 GNI per capita, 162, 163 price structures in, 162 Participatory institutions, 174 Part-time employment, 123 Patents, 56, 172 Patinkin, Don, 325 Peak, 112 Pecan prices, 82 Per capita incomes, 162–164 Percentage changes, computing, 23–25 Perfectly competitive markets, 68, 75 Permanent income, 218 Personal disposable income, 107 Personal income, 107 Peru, lack of property rights in, 177 Phelps, Edmund, 333 Phillips, A.W., 333 Physical capital, Pie graphs, 15 Pinkovskiy, Maxis, 159 Piracy, 172–173 Planned expenditures, 225 Point of diminishing return, 39, 167 Political business cycles, 318 Political institutions, affect on economic growth of, 174 Political parties, 318 Pollution, 59–60 GDP and, 114–115 Poor, impact of tariffs on, 372 Poor countries See Developing countries Population, decreases in, 82 Population growth, capital deepening and, 167 Population increases, 80 Positive analysis, 3–4 Positive relationship, 19 Potential output, 146 taxes and, 147–148 Poverty, in Africa, 5–6, 159 Present value, 256–257 interest rates and, 256–257 Presidential elections, 318 Presidential popularity, economic conditions and, 98 Price ceiling, 77 Price discrimination, 377 Price flexibility, full employment and, 140 Price floor, 78 Price level determining long-run, 196–197 money demand and, 292–293 Price-level targeting, 357 Prices adjustment over time in, 312–314 auction, 186 changes in demand and, 90 of complementary goods, 80 custom, 186 decreases in, 90 demand schedule and, 68–69 equilibrium, 80–82, 85–89 excess demand and, 76–77 excess supply and, 77–78 expectations of higher, 80 expectations of lower, 82 flexible, 186–187 full employment and, 314–318 inflation and, 132–134 input, 187, 197–198 in market economy, 57 minimum supply price, 73 Find more at http://www.downloadslide.com INDEX problems in measuring changes in, 131 retail, 188 scarcity and, 57 sticky, 186–187, 188 of substitutes, 80 supply schedule and, 72 trade and, 379 wages and, 312–314 Prisoner of war (POW) camps, emergence of markets in, 58 Private investment expenditures, 102, 103–104 Problem solving, economic analysis and, 5–7 Procyclical, 254 Production, 98–99 circular flow of, 99–100 factors of, 2, 140–141 Production facilities, sharing, and diminishing returns, 39 Production function, 140–143, 146 Production possibilities curve, 31, 160–161, 365–367 opportunity cost and, 31–33 scarcity and, 31 shifting the, 32 Productivity increased, from specialization, 53 labor, 171 opportunity cost and, 50, 55 Property rights, 176–177 Prosperity, Protectionist policies, 369–374 import bans, 369–370 quotas, 370–371 artionales for, 372–374 responses to, 371–372 tariffs, 371 voluntary export restraints, 370–371 Protestantism, 175 Protests, against free trade, 380 Public goods, 60 Public policies, using microeconomics to evaluate, 12–13 Purchasing power parity, 393 Q Q-theory of investment, 262 Quantitative easing, 297 Quantity demanded, 68, 78–79 Quantity equation, 340 Quantity supplied, 71–72 Quotas import, 370 vs tariffs, 371 R Rabushka, Alvin, 360 Rainforest conservation, 28 Rational expectations, 334, 338 Reagan, Ronald, 98, 205, 218, 335 Reagan administration, fiscal policy during, 218 Real business cycle theory, 148–150 Real exchange rates, 390–393 Real GDP, 101, 102, 109–111 contributions to growth of, 169 fluctuations in growth of, 186 Real GDP per capita, 161 Real GNP, 162 Real interest rate, 258–260 Real-nominal principle, 40–42, 101, 129, 189, 258, 292, 313, 319, 331, 390 Real value, 41 Real wages, 41, 143, 330 Recessions, 112 2007-2009, 112–113, 223 budget deficits and, 353 causes of, 195 economic view of current, 6–7 reasons for, 185, 186 returning to full employment after, 314–315 since WWII, 113 using economic policy to fight, 317 Redlick, Charles, 233 Repetition, 53 Required reserves, 278 Research and development as percentage of GDP, 172 technological progress and, 172 Reserve Bank of India, 282 Reserve ratio, 278, 279 Reserve requirements, 296 Reserves, 278, 282 Resources, scarcity of, Retail prices, 188 Retained earnings, 261 Revaluation, 400 Revolutionary War debt, 354 Ricardian equivalence, 351–352 Ricardo, David, 324 Risk financial intermediaries and, 263–265 insurance and, 56, 61 in market economy, 61 Rogoff, Kenneth, 163 Romalis, John, 379 Romer, Paul, 174 Ronaldo, Cristiano, 150 Roosevelt, Franklin, 216, 274 Rule of 70, 161–162 Rules of thumb approach, to predicting inflation, 334 Russia, hyperinflation in, 341–342 S Saez, Emmanuel, 150 Safety, driving speed and, 36 Sales taxes, 358–361 Sali-i-Martin, Xavier, 159 Samuelson, Paul, 333 Sargent, Thomas J., 339, 354 Savers, 264 Saving, 166–167 consumption taxes and, 359 depreciation, capital deepening and, 180–184 as function of stock of capital, 181–182 increase in, 182–184 investment and, 230–231 Savings accounts, 276 Savings and loan crisis, 266 Savings function, 231 Say, Jean-Baptiste, 324 Say’s law, 324 Scale of the market, 173 429 Find more at http://www.downloadslide.com 430 IN D E X Scarcity, prices and, 57 production possibilities curve and, 31 trade-offs and, 2–3 Schumpeter, Joseph, 172 Seasonal unemployment, 125 Seat belts, marginal principle and, 36 Securitization, 265, 266, 267 Seignorage, 343 Self-interest, 37, 57–58 Self-sufficiency, 37, 50, 51 Sen, Amartya, 97 September 11, 2001, 218, 236, 284 Shoe-leather costs, 134 Shortage, 76–77 Short-run aggregate supply curve, 197–199, 314 Short-run equilibrium, 201 Short run in macroeconomics, 187–188, 224, 312 Simon, Herbert, 334 Six-month treasuries, 259–260 Skilled labor, 380 Slope, of aggregate demand curve, 189–190 Slope of a curve, 19, 73, 75 Smith, Adam, 8–9, 37, 53, 57, 173 Smoot-Hawley Tariff Act, 372 Smoot-Hawley tariffs, 374–375 Smuggling, 372 Soccer players, taxes on, 150 Social insurance taxes, 213 Social safety net, 61 Social Security, 210, 212, 213 cost-of-living adjustments, 131 real-nominal principle and, 41 Solow, Robert, 169, 180, 333, 385 South Korea, 403 Sovereign investment fund, 397 Spam, 10 Specialization benefits of, 365–369 gains from trade and, 50–52 increased productivity and, 53 rationale for, 55 voluntary exchange and, 37, 38 Speculation, in oil markets, 199 Speculative demand for money, 295 Speed, marginal principle and, 36 Spigel, Mark, 337 Stabilization policies, 208–210, 317, 356 Stagflation, 199–200 Standard of living See Living standards State government, federal government and, 354 Steady state growth rate of money and, 331–332 inflation in, 330–331 Steel tariffs, 372 Sticky prices, 186–187, 188 Stiglitz, Joseph, 97, 403 Stockman, David, 348 Stock market, investment and, 261–263 Stock of capital, 141, 142–143, 180–184, 254 Store of value, 274 Structural unemployment, 126, 140 Student loans, inflation and cost of repaying, 42 Subprime mortgage crisis, 267 Subprime mortgages, 266, 285, 291, 357 Sub-Saharan Africa, 1, 5–6, 176 Subsidized firms, 374 Substitutes, 70, 80, 81 Summers, Robert, 162 Supply aggregate, 196–200 of capital, 165–166 currency, 387–390 decrease in, and equilibrium price, 87 excess, 77–78 increase in, and equilibrium price, 85–86 labor, wages and, 143–145 law of, 73, 76 market effects of changes in, 83–89 of money, 190 simultaneous changes in demand and, 87–89 Supply curve, 71–76 aggregate, 314 decreases in supply and shifts in, 86 downward shift in, 83 increase in supply and shifts in, 83–85 individual, 72–73 labor, 144, 147–148 market, 74–75 movement along, 73 rightward shift, 83 slope of, 73, 75 Supply schedule, 72 Supply shocks, 199–200 Supply-side economics, 205, 213–214, 218 Surplus, 77–78 Switzerland, central bank of, 338 T Tariffs, 364, 371 history of, 374–375 impact of, on poor, 372 Tax cuts during Bush administration, 218–219, 349 as economic stimulus, 205 during Kennedy administration, 205, 217 in long run, 323–324 during Reagan administration, 205, 218 Taxes 1996–2011, 220 aggregate demand and, 206 changes in, and aggregate demand curve, 191 consumption, 358–361 corporate, 213 estate, 213 excise, 213 flat, 360–361 Find more at http://www.downloadslide.com INDEX gift, 213 government investment and, 167–168 income, 212–213, 239–240 income-expenditure model and, 233–240 increases in, 324 potential output and, 147–148 revenues from, 212–213 sales, 358–361 on soccer stars, 150 social insurance, 213 value-added, 360–361 withholding, 213 Tax multiplier, 234–235, 236, 251 Tax rates, 213–214, 239–240, 353 Tax revenues economy and, 214 tax rates and, 214 Tax system, 135 Taylor, John, 219, 356–357 Technological progress, 160 causes of, 172–175 economic growth and, 168–171, 180–184 measuring, 169–170 new growth theory and, 174–175 Technology, economic fluctuations and, 149–150 Teenagers, unemployment and, 123–124 Temin, Peter, 195 Terms of trade, 367 Thailand, 403 Time-series graph, 16–17 Tobin, James, 262 Total market value, 100 Trade See also Free trade; International trade benefits of, 365–369 capital deepening and, 168 comparative advantage and terms of, 367 gains from, and specialization, 50–52 income inequality and, 379–380 inequality and, 379 international, comparative advantage and, 53–54 policy debates, 376–380 protectionist policies and, 369–374 rationale for, 55 Trade agreements, history of, 374–375 Trade balance, 105 Trade deficit, 105, 168, 396–397 Trade laws, environmental protection and, 377–378 Trade sanctions, 364 Trade surplus, 105 capital deepening and, 168 Traffic congestion economic view of, economic way of thinking about, 9–10 Transaction demand for money, 292–293 Transfer payments, 104, 237 Traveler’s checks, 275 Treasury Department, 398 Treasury securities, 294 Troubled Asset Relief Program (TARP), 267 Trough, 112 Truman, Harry S., Tuna fishing, dolphins and, 377–378 Two-variable graphs, 17–19 U Unanticipated inflation, 134, 135, 333 Underground economy, GDP and, 114 Underwater homes, 263 Unemployed, 121 Unemployed individuals, 123–125 Unemployment, 98, 121–229 in 2011, 311 alternative measures of, 122–123 categories of, 125–126 costs of, 128–129 cyclical, 126, 140, 146 disability insurance and, 127 duration of, 128 frictional, 126, 140 during Great Depression, 140, 185 inflation and, 333–336 measurement of, 121–122 natural rate of, 126–128, 146–147, 332, 336 prolonged, 311 seasonal, 125 social norms, happiness, and, 129 statistics on, 123–124 structural, 126, 140 Unemployment insurance, 61, 128–129, 237 Unemployment rate, 121 in 2012, 121–122, 124 in developed countries, 122 Unfair competition, 373–374 United Kingdom central bank of, 282, 284, 338 GNI per capita, 162 inflation targeting in, 357 United States annual productivity growth, 1947–2011, 171 consumption and government spending during WWII in, 153–154 consumption of GDP in, 152 exchange rates in, 400–401 fiscal policy in, 216–220 GDP per capita in, 139 GNI per capita, 162 growth rates of GDP, 1871–2011, 238 inflation and unemployment in 1980s, 334–335 investment and government spending during WWII in, 154 investment spending as share of GDP, 255 net international investment position, 396 prosperity in, real GNP, 162 431 Find more at http://www.downloadslide.com 432 IN D E X research and development funding in, 172 trade deficit of, 396–397 world trade and, 242–243 Unit of account, 274 Unskilled labor, 380 U.S China currency tensions, 392 U.S dollar demand and supply of, 387–390 depreciation, 297, 304 government intervention with price of, 398–399 U.S economy oil supply disruptions and, 199 world economy and, 242–243 U.S Treasury bonds, 212, 259–260 V Value added, 100, 107–108 Value-added tax (VAT), 360–361 Variables, graphs of single, 15–17 graphs of two, 17–19 isolation of, 7–8, 10 negative relationships between, 21–22 nonlinear relationships between, 22–23 VAT See Value-added tax (VAT) Velocity of money, 340–341 Vertical intercept, 18 Vietnam War era, fiscal policy during, 217–218 Volcker, Paul, 291, 335 Voluntary exchange principle, 37–38, 52, 274 markets and, 37–38 online games and, 38 specialization and, 38 Voluntary export restraint (VER), 370 Voter expectations, 318 W Wachovia Bank, 266 Wage flexibility, full employment and, 140 Wage-price spiral, 313, 317 Wages adjustment over time in, 312–314 demand and supply for labor and, 143–145 full employment and, 314–318 inequalities, and outsourcing, 379–380 minimum, 187 nominal, 330 prices and, 312–314 real, 143, 330 real-nominal principle and, 41 sticky, 187 taxes and, 147–148 Wal-Mart, 100, 379 War on terror, 349 Wars, 149 Wealth, autonomous consumption and, 228 Wealth effect, 190, 229 Wealth of Nations (Smith), 53 Weber, Max, 175 Welfare, GDP as measure of, 113–115 Withholding taxes, 213 Women, in labor force, 122 Wool industry, 76 Worker productivity, 55 Workers discouraged, 123 foreign competition and, 373 marginally attached, 123 skilled, 380 unskilled, 380 Work hours, relationship between income and, 17–18 World Bank, 62, 162, 176 World savings, 396 World Trade Organization (WTO), 375 Y Yellen, Janet, 297 Z Zambia, economic growth in, 164 Zambia, GNI per capita, 162 Zimbabwe, hyperinflation in, 343 Find more at http://www.downloadslide.com This page intentionally left blank Find more at http://www.downloadslide.com Applying the Concepts Questions and Applications Chapter Introduction: What Is Economics? Chapter Unemployment and Inflation Applying the Concepts #1: Application 1: How people respond to incentives? Incentives to Buy Hybrid Vehicles Applying the Concepts #1: Applying the Concepts #2: Application 2: What is the role of prices in allocating resources? The Economic Solution to Spam Application 1: Applying the Concepts #3: Application 3: How we compute percentage changes? The Perils of Percentages Chapter The Key Principles of Economics Applying the Concepts #2: Application 2: Applying the Concepts #3: Applying the Concepts #1: Application 1: What is the opportunity cost of running a business? Don’t Forget the Costs of Time and Invested Funds Applying the Concepts #2: Application 2: How people think at the margin? How Fast to Sail? Applying the Concepts #3: Chapter Application 3: What is the rationale for specialization and exchange? Jasper Johns and Housepainting Applying the Concepts #4: Application 4: Do farmers experience diminishing returns? Fertilizer and Crop Yields Application 1: Applying the Concepts #5: Application 5: How does inflation affect lenders and borrowers? Repaying Student Loans Chapter Exchange and Markets Applying the Concepts #1: Application 1: What is the rationale for specialization and trade? Absolute Disadvantage and Comparative Advantage in Latvia Applying the Concepts #2: Application 2: Why markets develop? The Market for Meteorites Applying the Concepts #3: What is the role of government in a market economy? Civil Liberties and Efficiency of Government Application 3: Chapter Demand, Supply, and Market Equilibrium Application 3: Applying the Concepts #4: Application 4: Does more liberal disability insurance decrease measured unemployment? More Disability, Less Unemployment? Are you less upset about being unemployed if unemployment is common in your peer group? Social Norms, Unemployment, and Perceived Happiness How large is the bias in the CPI due to not immediately incorporating new goods? The Introduction of Cell Phones and the Bias in the CPI The Economy at Full Employment Applying the Concepts #1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Chapter What factors account for the decline in the labor force participation rate in the last decade? Declining Labor Force Participation How can changes in the supply of labor affect real wages? The Black Death and Living Standards in Old England What evidence is there that taxes on high-paid soccer stars in Europe affect their location decisions among countries? Do European Soccer Stars Change Clubs to Reduce Their Taxes? Can real business cycle models explain the origin and persistence of the Great Depression? Can Labor Market Policies Account for the Great Depression? Why Do Economies Grow? Applying the Concepts #1: Application 1: How may global warming affect economic growth? Global Warming, Rich Countries, and Poor Countries Applying the Concepts #2: Is there a necessary trade-off between equality and growth? Economic Equality May Sustain Economic Growth Applying the Concepts #1: Application 1: What is the law of demand? Law of Demand and Cigarettes Applying the Concepts #2: Application 2: What is the law of supply? Law of Supply and Woolympics Application 3: How can we use economic analysis to understand the sources of growth in different countries? Sources of Growth in China and India Applying the Concepts #3: What are consequences of a price above the equilibrium price? Shrinking Wine Lakes Applying the Concepts #4: Application 4: How you measure the technological revolution? Growth Accounting and Intangible Capital How does a change in demand affect the equilibrium price? Chinese Demand and Pecan Prices Applying the Concepts #5: Application 5: How varying political institutions affect economic growth? The Role of Political Factors in Economic Growth Application 3: Applying the Concepts #4: Application 4: Application 5: How does a change in supply affect the equilibrium price? Honeybees and the Price of Ice Cream Applying the Concepts #6: Application 6: What explains a decrease in price? Why Lower Drug Prices? Applying the Concepts #5: Chapter Measuring a Nation’s Production and Income Applying the Concepts #1: Application 1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Application 2: Applying the Concepts #3: Applying the Concepts #6: Application 6: Applying the Concepts #7: Application 7: Chapter Why are clear property rights important for economic growth in developing countries? Lack of Property Rights Hinders Growth in Peru Aggregate Demand and Aggregate Supply How can we use economic analysis to compare the size of a major corporation to the size of a country? Using Value Added to Measure the True Size of Wal-Mart Applying the Concepts #1: How long did it take to recover from the last recession? Recovering from a Recession Applying the Concepts #2: Do increases in gross domestic product necessarily translate into improvements in the welfare of citizens? The Links between Self-Reported Happiness and GDP Applying the Concepts #3: Application 1: Application 2: Application 3: Did culture or evolution spark the Industrial Revolution? Culture, Evolution, and Economic Growth What does the behavior of prices in consumer markets demonstrate about how quickly prices adjust in the U.S economy? Measuring Price Stickiness in Consumer Markets How can we determine what factors cause recessions? Two Approaches to Determining the Causes of Recessions Are oil price increases caused by true shocks to supply? Oil Supply Disruptions, Speculation and Supply Shocks Find more at http://www.downloadslide.com Applying the Concepts Questions and Applications Chapter 10 Chapter 15 Fiscal Policy (continued) Modern Macroeconomics: From the Short Run to the Long Run Why are the United States and many other countries facing dramatically increasing costs for their government programs? Increasing Life Expectancy and Aging Populations Spur Costs of Entitlement Programs Applying the Concepts #1: Applying the Concepts #2: Application 2: How are tax rates and tax revenues related? The Confucius Curve? Application 2: Applying the Concepts #3: Application 3: Was the fiscal stimulus in 2009 successful? A Closer Look at the 2009 Stimulus Package Applying the Concepts #1: Application 1: Chapter 11 The Income-Expenditure Model Applying the Concepts #1: Application 1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Applying the Concepts #4: Application 4: Chapter 12 Application 1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Applying the Concepts #4: Application 4: Application 1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Applying the Concepts #4: Application 4: Application 1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Applying the Concepts #3: Application 3: Chapter 16 Application 1: Applying the Concepts #2: Application 2: How countries benefit from growth in their trading partners? The Locomotive Effect: How Foreign Demand Affects a Country’s Output Chapter 17 How Do Fluctuations in Energy Prices Affect Investment Decisions by Firms? Energy Price Uncertainty Reduces Investment Spending How can understanding the concept of present value help us evaluate an annuity? The Value of an Annuity Application 1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Chapter 18 How have recent financial innovations created new risks for the economy? Securitization: The Good, the Bad, and the Ugly Application 1: Applying the Concepts #2: Application 2: How small Brazilian towns use currency to encourage local commerce? Money with the Face of Rodents Applying the Concepts #3: Why have banks recently started to hold vast amounts of excess reserves? The Growth in Excess Reserves Application 3: How did the Fed manage to keep the financial system in operation immediately following the attacks on September 11, 2001? The Financial System under Stress: September 11, 2001 Application 4: How did the Fed successfully respond to the collapse of major financial institutions in 2008? Coping with the Financial Chaos Caused by the Mortgage Crisis Application 1: How has the Fed recently expanded its role in financial markets? Beyond Purchasing Treasury Securities What is the link between a dollar depreciation and increases in commodity prices? Did Fed Policy Cause the Commodity Boom? Is it better for decisions about monetary policy to be made by a single individual or by a committee? The Effectiveness of Committees Applying the Concepts #4: Can changes in the way central banks are governed affect inflation expectations? Increased Political Independence for the Bank of England Lowered Inflation Expectations Why hyperinflations end suddenly? The Ends of Hyperinflations Why did the early U.S federal government take over the debts of the thirteen colonies? Creating the U.S Federal Fiscal System through Debt Policy Did the Federal Reserve cause the housing boom through excessively loose monetary policy? Would a Policy Rule Have Prevented the Housing Boom? Can the United States adopt a European-style valueadded tax? Is a VAT in Our Future? Do tariffs (taxes) on imported goods hurt the poor disproportionately? The Impact of Tariffs on the Poor What have been the local effects of Chinese imports? Chinese Imports and Local Economies How does the Commerce Department try to determine whether countries are dumping their products? Are They Really Dumping? Why might international trade reduce measured inequality in the United States? Trade, Consumption, and Inequality The World of International Finance Applying the Concepts #1: Applying the Concepts #2: Application 2: Applying the Concepts #3: Application 3: Applying the Concepts #4: Application 4: How can data on vacancies and unemployment be used to measure shifts in the natural rate? Shifts in the Natural Rate of Unemployment International Trade and Public Policy Applying the Concepts #1: Chapter 19 Will increases in health-care expenditures crowd out consumption or investment spending? Increasing Health-Care Expenditures and Crowding Out Macroeconomic Policy Debates Applying the Concepts #1: Is reducing the debt owed on home mortgages a good policy to deal with an ailing housing market? Debt Forgiveness? What are the links between presidential elections and macroeconomic performance? Elections, Political Parties, and Voter Expectations The Dynamics of Inflation and Unemployment Applying the Concepts #1: Applying the Concepts #3: Application 3: The Federal Reserve and Monetary Policy Applying the Concepts #1: Applying the Concepts #2: How does Keynesian economics change our normal ideas of economic scarcity? The Broken Window Fallacy and Keynesian Economics Money and the Banking System Applying the Concepts #1: Chapter 14 What evidence does the long historical record provide about multipliers? Using Long-Term Macro Data to Measure Multipliers Investment and Financial Markets Applying the Concepts #1: Chapter 13 How changes in the value of homes affect consumer spending? Falling Home Prices, the Wealth Effect, and Decreased Consumer Spending Application 1: Why did Chairman Bernanke change his views on how to fight a liquidity trap? How to Fight a Liquidity Trap How can the price of a Big Mac in China shed light on the U.S.−Chinese currency tensions? The Chinese Yuan and Big Macs What factors may allow the United States to continue running large trade deficits with the rest of the world? World Savings and U.S Current Account Deficits What are the fundamental causes for the problems with the euro? A Troubled Euro What are the causes of financial collapses that occur throughout the globe? The Argentine Financial Crisis ... Application on page 188.) 9 .2 2.1 2. 2 2. 3 2. 4 2. 5 2. 6 2. 7 2. 8 2. 9 9.3 3.1 3 .2 3.3 Understanding Aggregate Demand Which of the following is not a component of aggregate demand? a Consumption b Investment... Entitlements and mandatory spending Social Security Medicare and Medicaid Other programs and offsetting receipts Net interest Outlays (billions) Percent of GDP $3,598 1346 700 646 2, 025 725 835 466 22 7 24 .1%... (1995): 24 5 27 4, and Mark Bils and Peter Klenow, “Some Evidence on the Importance of Sticky Prices,” Journal of Political Economy 1 12, no (20 04): 987–985 9 .2 Understanding Aggregate Demand In