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10 Real GDP and the Price During the early 2000s, Japan’s price level declined at a steady pace Then, between late 2003 and 2008, the price level went through brief periods in which it oscillated very slightly upward or downward On net, however, Japan’s price level still dropped somewhat during this second period Then, in the late 2000s, the price level suddenly jumped upward at a rate of more than percent per year before plunging downward at a rate exceeding percent per year What caused Japan’s price level to behave as it did across the 2000s? To answer this question, you must understand how a nation’s equilibrium price level is determined Helping you develop an understanding of this concept is a key goal of this chapter LEARNING OBJECTIVES Level in the Long Run After reading this chapter, you should be able to: ̈ Understand the concept of long-run aggregate supply ̈ Describe the effect of economic growth on the long-run aggregate supply curve ̈ Explain why the aggregate demand curve slopes downward and list key factors that cause this curve to shift ̈ Discuss the meaning of long-run equilibrium for the economy as a whole ̈ Evaluate why economic growth can cause deflation ̈ Evaluate likely reasons for persistent inflation in recent decades MyEconLab helps you master each objective and study more efficiently See end of chapter for details 209 210 PART ■ REAL GDP DETERMINATION AND FISCAL POLICY Did You Know That ? until the spring of 2008, the U.S price level had not exhibited a decline during any single 12-month interval since 1955? Thus, the U.S economy experienced a full year of deflation, or a decrease in the price level over time, for the first time in half a century Why was there such a lengthy period between deflationary bouts in the United States? What can cause deflation to occur? In addition, why did inflation, or an increase in the prive level over time, take place during every other 12-month interval following 1955? To answer these questions, you must learn about the causes of both deflation and inflation, which are key topics that this chapter addresses Output Growth and the Long-Run Aggregate Supply Curve Aggregate supply The total of all planned production for the economy In Chapter 2, we showed the derivation of the production possibilities curve (PPC) At any point in time, the economy can be inside or on the PPC but never outside it Along the PPC, a country’s resources are fully employed in the production of goods and services, and the sum total of the inflation-adjusted value of all final goods and services produced is the nation’s real GDP Economists refer to the total of all planned production for the entire economy as the aggregate supply of real output Long-run aggregate supply curve A vertical line representing the real output of goods and services after full adjustment has occurred It can also be viewed as representing the real GDP of the economy under conditions of full employment—the full-employment level of real GDP Base-year dollars The value of a current sum expressed in terms of prices in a base year Endowments The various resources in an economy, including both physical resources and such human resources as ingenuity and management skills The Long-Run Aggregate Supply Curve Put yourself in a world in which nothing has been changing, year in and year out The price level has not changed Technology has not changed The prices of inputs that firms must purchase have not changed Labor productivity has not changed All resources are fully employed, so the economy operates on its production possibilities curve, such as the one depicted in panel (a) of Figure 10-1 below This is a world that is fully adjusted and in which people have all the information they are ever going to have about that world The long-run aggregate supply curve (LRAS ) in this world is some amount of real GDP—say, $15 trillion of real GDP—which is the value of the flow of production of final goods and services measured in base-year dollars We can represent long-run aggregate supply by a vertical line at $15 trillion of real GDP This is what you see in panel (b) of the figure below That curve, labeled LRAS, is a vertical line determined by technology and endowments, or resources that exist in our economy It is the full-information and full-adjustment level of real output of FIGURE 10-1 The Production Possibilities Curve and the Economy’s Long-Run Aggregate Supply Curve Panel (a) Panel (b) LRAS Price Level Capital Goods At a point in time, a nation’s base of resources and its technological capabilities define the position of its production possibilities curve (PPC), as shown in panel (a) This defines the real GDP that the nation can produce when resources are fully employed, which determines the position of the long-run aggregate supply curve (LRAS) displayed in panel (b) Because people have complete information and input prices adjust fully in the long run, the LRAS is vertical PPC Consumption Goods 12 13 14 15 16 17 Real GDP per Year ($ trillions) 18 CHAPTER 10 ■ Real GDP and the Price Level in the Long Run goods and services It is the level of real GDP that will continue being produced year after year, forever, if nothing changes Another way of viewing the LRAS is to think of it as the full-employment level of real GDP When the economy reaches full employment along its production possibilities curve, no further adjustments will occur unless a change occurs in the other variables that we are assuming to be stable Some economists suggest that the LRAS occurs at the level of real GDP consistent with the natural rate of unemployment, the unemployment rate that occurs in an economy with full adjustment in the long run As we discussed in Chapter 7, many economists like to think of the natural rate of unemployment as consisting of frictional and structural unemployment To understand why the LRAS is vertical, think about the long run, which is a sufficiently long period that all factors of production and prices, including wages and other input prices, can change A change in the level of prices of goods and services has no effect on real GDP per year in the long run, because higher prices will be accompanied by comparable changes in input prices Suppliers will therefore have no incentive to increase or decrease their production of goods and services Remember that in the long run, everybody has full information, and there is full adjustment to price level changes (Of course, this is not necessarily true in the short run, as we shall discuss in Chapter 11.) 211 Go to www.econtoday.com/ch10 to find out how fast wages are adjusting Click on “Employment Costs,” and then on “Employment Cost Index.” Economic Growth and Long-Run Aggregate Supply In Chapter 9, you learned about the determinants of growth in per capita real GDP: the annual growth rate of labor, the rate of year-to-year capital accumulation, and the rate of growth of the productivity of labor and capital As time goes by, population gradually increases, and labor force participation rates may even rise The capital stock typically grows as businesses add such capital equipment as new informationtechnology hardware Furthermore, technology improves Thus, the economy’s production possibilities increase, and as a consequence, the production possibilities curve shifts outward, as shown in panel (a) of Figure 10-2 below The result is economic growth: Aggregate real GDP and per capita real GDP increase This means that in a growing economy such as ours, the LRAS will shift outward to the right, as in panel (b) below We have drawn the LRAS for the year 2013 to the right of our original LRAS of $14.3 trillion of real GDP We assume that between now and 2013, real GDP increases to $15 trillion, to give us the position of the LRAS2013 curve Thus, it is to the right of today’s LRAS curve We may conclude that in a growing economy, the LRAS shifts ever farther to the right over time If the LRAS happened to shift rightward at a constant pace, real GDP FIGURE 10-2 The Long-Run Aggregate Supply Curve and Shifts in It Panel (a) Panel (b) LRAS LRAS2013 Price Level Capital Goods In panel (a), we repeat a diagram that we used in Chapter 2, on page 37, to show the meaning of economic growth Over time, the production possibilities curve shifts outward In panel (b), we demonstrate the same principle by showing the long-run aggregate supply curve initially as a vertical line at $14.3 trillion of real GDP per year As our productive abilities increase, the LRAS moves outward to LRAS2013 at $15 trillion Consumption Goods 11 12 13 14 14.3 15 Real GDP per Year ($ trillions) 16 17 212 PART ■ REAL GDP DETERMINATION AND FISCAL POLICY FIGURE 10-3 A Sample Long-Run Growth Path for Real GDP 18 Full-Employment Real GDP ($ trillions) Year-to-year shifts in the long-run aggregate supply curve yield a long-run trend path for real GDP growth In this example, from 2013 onward, real GDP grows by a steady percent per year Long-run real GDP growth path 17 15.9 15.5 15 14.7 14.3 13 12 2011 2012 2013 2014 2015 Year 2016 2017 would increase at a steady annual rate As shown in Figure 10-3 above, this means that real GDP would increase along a long-run, or trend, path that is an upward-sloping line Thus, if the LRAS shifts rightward from $14.3 trillion to $15 trillion between now and 2013 and then increases at a steady percent annual rate every year thereafter, in 2014 long-run real GDP will equal $15.5 trillion, in 2015 it will equal $15.9 trillion, and so on Why might the U.S trend growth path become shallower if U.S leaders follow through on plans to cut greenhouse gas emissions dramatically? EXAMPLE How Much Might “Going Green” Reduce U.S Economic Growth? President Obama and leaders in the U.S Congress have agreed that reduction of greenhouse gas emissions should be a national priority Their near-term goal is to reduce such emissions to 2005 levels by no later than 2014 Their longer-term goal is to reduce emissions by an additional 30 percent by 2030 Attainment of these goals would constrain the ability of businesses to use resources at lowest cost As a consequence, production of capital goods would decline, and that would reduce future economic growth Economists at the Environmental Protection Agency (EPA) have estimated that these efforts to cut emissions of greenhouse gases likely would lead to a cumulative reduction in real GDP of about percent by 2030 Based on the current level QUICK QUIZ of U.S real GDP, this estimated eventual decrease in annual real GDP would be equivalent to the reduction that occurred during the Great Recession of the late 2000s Instead of being a short-term decrease in real GDP as in the recession, however, the reduction generated by the proposed emissions regulations would be permanent FOR CRITICAL ANALYSIS Why you think that economists suggest that any regulatory policies that generate cuts in production of capital goods will tend to reduce the nation’s long-run growth rate for real GDP? See page 228 for the answers Review concepts from this section in MyEconLab The long-run aggregate supply curve, LRAS, is a _ line determined by amounts of available resources such as labor and capital and by technology and resource productivity The position of the LRAS gives the full-information and full-adjustment level of real GDP The _ rate of unemployment occurs at the longrun level of real GDP given by the position of the LRAS If labor or capital increases from year to year or if the productivity of either of these resources rises from one year to the next, the LRAS shifts _ In a growing economy, therefore, real GDP gradually _ over time CHAPTER 10 ■ Real GDP and the Price Level in the Long Run 213 Total Expenditures and Aggregate Demand In equilibrium, individuals, businesses, and governments purchase all the goods and services produced, valued in trillions of real dollars As explained in Chapters and 8, GDP is the dollar value of total expenditures on domestically produced final goods and services Because all expenditures are made by individuals, firms, or governments, the total value of these expenditures must be what these market participants decide it shall be The decisions of individuals, managers of firms, and government officials determine the annual dollar value of total expenditures You can certainly see this in your role as an individual You decide what the total dollar amount of your expenditures will be in a year You decide how much you want to spend and how much you want to save Thus, if we want to know what determines the total value of GDP, the answer is clear: the spending decisions of individuals like you; firms; and local, state, and national governments In an open economy, we must also include foreign individuals, firms, and governments (foreign residents, for short) that decide to spend their money income in the United States Simply stating that the dollar value of total expenditures in this country depends on what individuals, firms, governments, and foreign residents decide to really doesn’t tell us much, though Two important issues remain: What determines the total amount that individuals, firms, governments, and foreign residents want to spend? What determines the equilibrium price level and the rate of inflation (or deflation)? The LRAS tells us only about the economy’s long-run real GDP To answer these additional questions, we must consider another important concept This is aggregate demand, which is the total of all planned real expenditures in the economy Aggregate demand The total of all planned expenditures in the entire economy The Aggregate Demand Curve The aggregate demand curve, AD, gives the various quantities of all final commodities demanded at various price levels, all other things held constant Recall the components of GDP that you studied in Chapter 8: consumption spending, investment expenditures, government purchases, and net foreign demand for domestic production They are all components of aggregate demand Throughout this chapter and the next, whenever you see the aggregate demand curve, realize that it is a shorthand way of talking about the components of GDP that are measured by government statisticians when they calculate total economic activity each year In Chapter 12, you will look more closely at the relationship between these components and, in particular, at how consumption spending depends on income The aggregate demand curve gives the total amount, measured in base-year dollars, of real domestic final goods and services that will be purchased at each price level—everything produced for final use by households, businesses, the government, and foreign residents It includes iPods, socks, shoes, medical and legal services, computers, and millions of other goods and services that people buy each year A graphical representation of the aggregate demand curve is seen in Figure 10-4 on the next page On the horizontal axis, real GDP is measured For our measure of the price level, we use the GDP price deflator on the vertical axis The aggregate demand curve is labeled AD If the GDP deflator is 110, aggregate quantity demanded is $15 trillion per year (point A) At the price level 115, it is $14 trillion per year (point B) At the price level 120, it is $13 trillion per year (point C ) The higher the price level, the lower the total real amount of final goods and services demanded in the economy, everything else remaining constant, as shown by the arrow along AD in Figure 10-4 Conversely, the lower the price level, the higher the total real GDP demanded by the economy, everything else staying constant Aggregate demand curve A curve showing planned purchase rates for all final goods and services in the economy at various price levels, all other things held constant PART ■ REAL GDP DETERMINATION AND FISCAL POLICY FIGURE 10-4 The Aggregate Demand Curve The aggregate demand curve, AD, slopes downward If the price level is 110, we will be at point A with $15 trillion of real GDP demanded per year As the price level increases to 115 and to 120, we move up the aggregate demand curve to points B and C Price Level 214 C 120 B 115 A 110 AD 11 12 13 14 15 16 Real GDP per Year ($ trillions) 17 Let’s take the year 2011 Estimates based on U.S Department of Commerce preliminary statistics reveal the following information: • Nominal GDP was estimated to be $15,067.5 billion • The price level as measured by the GDP deflator was about 112.4 (base year is 2005, for which the index equals 100) • Real GDP was approximately $13,405.8 billion in 2005 dollars What can we say about 2011? Given the dollar cost of buying goods and services and all of the other factors that go into spending decisions by individuals, firms, governments, and foreign residents, the total amount of planned spending on final goods and services by firms, individuals, governments, and foreign residents was $13,405.8 billion in 2011 (in terms of 2005 dollars) What Happens When the Price Level Rises? What if the price level in the economy rose to 160 tomorrow? What would happen to the amount of real goods and services that individuals, firms, governments, and foreigners wish to purchase in the United States? We know from Chapter that when the price of one good or service rises, the quantity of it demanded will fall But here we are talking about the price level—the average price of all goods and services in the economy The answer is still that the total quantities of real goods and services demanded would fall, but the reasons are different When the price of one good or service goes up, the consumer substitutes other goods and services For the entire economy, when the price level goes up, the consumer doesn’t simply substitute one good for another, for now we are dealing with the demand for all goods and services in the nation There are economywide reasons that cause the aggregate demand curve to slope downward They involve at least three distinct forces: the real-balance effect, the interest rate effect, and the open economy effect THE REAL-BALANCE EFFECT A rise in the price level will have an effect on spending Individuals, firms, governments, and foreign residents carry out transactions using money, a portion of which consists of currency and coins that you have in your pocket (or stashed away) right now Because people use money to purchase goods and services, the amount of money that people have influences the amount of goods and CHAPTER 10 ■ Real GDP and the Price Level in the Long Run services they want to buy For example, if you find a $100 bill on the sidewalk, the amount of money you have increases Given your now greater level of money, or cash, balances—currency in this case—you will almost surely increase your spending on goods and services Similarly, if your pocket is picked while you are at the mall, your desired spending would be affected For instance, if your wallet had $150 in it when it was stolen, the reduction in your cash balances—in this case, currency—would no doubt cause you to reduce your planned expenditures You would ultimately buy fewer goods and services This response is sometimes called the real-balance effect (or wealth effect) because it relates to the real value of your cash balances While your nominal cash balances may remain the same, any change in the price level will cause a change in the real value of those cash balances—hence the real-balance effect on total planned expenditures When you think of the real-balance effect, just think of what happens to your real wealth if you have, say, a $100 bill hidden under your mattress If the price level increases by percent, the purchasing power of that $100 bill drops by percent, so you have become less wealthy You will reduce your purchases of all goods and services by some small amount THE INTEREST RATE EFFECT There is a more subtle but equally important effect on your desire to spend A higher price level leaves people with too few money balances Hence, they try to borrow more (or lend less) to replenish their real money holdings This drives up interest rates Higher interest rates raise borrowing costs for consumers and businesses They will borrow less and consequently spend less The fact that a higher price level pushes up interest rates and thereby reduces borrowing and spending is known as the interest rate effect Higher interest rates make it more costly for people to finance purchases of houses and cars Higher interest rates also make it less profitable for firms to install new equipment and to erect new office buildings Whether we are talking about individuals or firms, a rise in the price level will cause higher interest rates, which in turn reduce the amount of goods and services that people are willing to purchase Therefore, an increase in the price level will tend to reduce total planned expenditures (The opposite occurs if the price level declines.) THE OPEN ECONOMY EFFECT: THE SUBSTITUTION OF FOREIGN GOODS Recall from Chapter that GDP includes net exports—the difference between exports and imports In an open economy, we buy imports from other countries and ultimately pay for them through the foreign exchange market The same is true for foreign residents who purchase our goods (exports) Given any set of exchange rates between the U.S dollar and other currencies, an increase in the price level in the United States makes U.S goods more expensive relative to foreign goods Foreign residents have downward-sloping demand curves for U.S goods When the relative price of U.S goods goes up, foreign residents buy fewer U.S goods and more of their own At home, relatively cheaper prices for foreign goods cause U.S residents to want to buy more foreign goods instead of domestically produced goods Thus, when the domestic price level rises, the result is a fall in exports and a rise in imports That means that a price level increase tends to reduce net exports, thereby reducing the amount of real goods and services purchased in the United States This is known as the open economy effect What Happens When the Price Level Falls? What about the reverse? Suppose now that the GDP deflator falls to 100 from an initial level of 120 You should be able to trace the three effects on desired purchases of goods and services Specifically, how the real-balance, interest rate, and open economy effects cause people to want to buy more? You should come to the conclusion 215 Real-balance effect The change in expenditures resulting from a change in the real value of money balances when the price level changes, all other things held constant; also called the wealth effect Interest rate effect One of the reasons that the aggregate demand curve slopes downward: Higher price levels increase the interest rate, which in turn causes businesses and consumers to reduce desired spending due to the higher cost of borrowing Open economy effect One of the reasons that the aggregate demand curve slopes downward: Higher price levels result in foreign residents desiring to buy fewer U.S.-made goods, while U.S residents now desire more foreign-made goods, thereby reducing net exports This is equivalent to a reduction in the amount of real goods and services purchased in the United States 216 PART ■ REAL GDP DETERMINATION AND FISCAL POLICY that the lower the price level, the greater the total planned spending on goods and services The aggregate demand curve, AD, shows the quantity of aggregate output that will be demanded at alternative price levels It is downward sloping, just like the demand curve for individual goods The higher the price level, the lower the real amount of total planned expenditures, and vice versa Demand for All Goods and Services versus Demand for a Single Good or Service Even though the aggregate demand curve, AD, in Figure 10-4 on page 214 looks similar to the one for individual demand, D, for a single good or service that you encountered in Chapters and 4, the two are not the same When we derive the aggregate demand curve, we are looking at the entire economic system The aggregate demand curve, AD, differs from an individual demand curve, D, because we are looking at total planned expenditures on all goods and services when we construct AD Shifts in the Aggregate Demand Curve In Chapter 3, you learned that any time a nonprice determinant of demand changes, the demand curve will shift inward to the left or outward to the right The same analysis holds for the aggregate demand curve, except we are now talking about the non-price-level determinants of aggregate demand So, when we ask the question, “What determines the position of the aggregate demand curve?” the fundamental proposition is as follows: Any non-price-level change that increases aggregate spending (on domestic goods) shifts AD to the right Any non-price-level change that decreases aggregate spending (on domestic goods) shifts AD to the left The list of potential determinants of the position of the aggregate demand curve is long Some of the most important “curve shifters” for aggregate demand are presented in Table 10-1 below Why did the U.S aggregate demand curve shift leftward between 2007 and 2009? TABLE 10-1 Determinants of Aggregate Demand Aggregate demand consists of the demand for domestically produced consumption goods, investment goods, government purchases, and net exports Consequently, any change in total planned spending on any one of these components of real GDP will cause a change in aggregate demand Some possibilities are listed here Changes That Cause an Increase in Aggregate Demand Changes That Cause a Decrease in Aggregate Demand An increase in the amount of money in circulation Increased security about jobs and future income Improvements in economic conditions in other countries A reduction in real interest rates (nominal interest rates corrected for inflation) not due to price level changes Tax decreases A drop in the foreign exchange value of the dollar A decrease in the amount of money in circulation Decreased security about jobs and future income Declines in economic conditions in other countries A rise in real interest rates (nominal interest rates corrected for inflation) not due to price level changes Tax increases A rise in the foreign exchange value of the dollar CHAPTER 10 ■ Real GDP and the Price Level in the Long Run EXAMPLE 217 Explaining the Drop in Aggregate Demand in the Late 2000s In 2006 and 2007, prices of houses, which for many families are major components of their household wealth, began to decline considerably throughout much of the United States By late 2007 and 2008, the market values of many houses purchased with mortgage loans from banks had fallen below the amounts people had borrowed Many borrowers decided simply to walk away from their houses, leaving banks with the lower-valued homes As a consequence, many banks found themselves financially constrained and responded by cutting back on loans to businesses Firms, in turn, terminated employees QUICK QUIZ and cut back on new hiring Thus, the bulk of U.S residents suddenly experienced decreased security about their jobs and their future incomes and wealth, which resulted in a significant decrease in aggregate demand FOR CRITICAL ANALYSIS Why you suppose that the Federal Reserve responded to the decrease in aggregate demand by trying to engineer reductions in real interest rates? (See Table 10-1.) See page 228 for the answers Review concepts from this section in MyEconLab Aggregate demand is the total of all planned _ in the economy, and aggregate supply is the total of all planned _ in the economy The aggregate demand curve shows the various quantities of total planned _ on final goods and services at various price levels; it is downward sloping causing people to desire to spend more or less, depending on whether the price level decreases or increases The _ _ effect is caused by interest rate changes that mimic price level changes At higher interest rates, people seek to buy _ houses and cars, and at lower interest rates, they seek to buy _ There are three reasons why the aggregate demand curve is downward sloping They are the _ _ effect, the _ _ effect, and the _ _ effect The _ - _ effect occurs because price level changes alter the real value of cash balances, thereby The open economy effect occurs because of a shift away from expenditures on _ goods and a shift toward expenditures on _ goods when the domestic price level increases Long-Run Equilibrium and the Price Level As noted in Chapter 3, equilibrium occurs where the demand and supply curves intersect The same is true for the economy as a whole, as shown in Figure 10-5 below: The equilibrium price level occurs at the point where the aggregate demand curve (AD) FIGURE 10-5 Long-Run Economywide Equilibrium LRAS Price Level For the economy as a whole, longrun equilibrium occurs at the price level where the aggregate demand curve crosses the long-run aggregate supply curve At this long-run equilibrium price level, which is 120 in the diagram, total planned real expenditures equal real GDP at full employment, which in our example is a real GDP of $15 trillion 140 120 100 AD 12 13 14 15 16 17 Real GDP per Year ($ trillions) 18 19 PART ■ REAL GDP DETERMINATION AND FISCAL POLICY 218 crosses the long-run aggregate supply curve (LRAS) At this equilibrium price level of 120, the total of all planned real expenditures for the entire economy is equal to actual real GDP produced by firms after all adjustments have taken place Thus, the equilibrium depicted in Figure 10-5 on page 217 is the economy’s long-run equilibrium The Long-Run Equilibrium Price Level Note in Figure 10-5 on the previous page that if the price level were to increase to 140, actual real GDP would exceed total planned real expenditures Inventories of unsold goods would begin to accumulate, and firms would stand ready to offer more services than people wish to purchase As a result, the price level would tend to fall In contrast, if the price level were 100, then total planned real expenditures by individuals, businesses, and the government would exceed actual real GDP Inventories of unsold goods would begin to be depleted The price level would rise toward 120, and higher prices would encourage firms to expand production and replenish inventories of goods available for sale The Effects of Economic Growth on the Price Level We now have a basic theory of how real GDP and the price level are determined in the long run when all of a nation’s resources can change over time and all input prices can adjust fully to changes in the overall level of prices of goods and services that firms produce Let’s begin by evaluating the effects of economic growth on the nation’s price level ECONOMIC GROWTH AND SECULAR DEFLATION Take a look at panel (a) of Figure 10-6 below, which shows what happens, other things being equal, when the LRAS shifts rightward over time If the economy were to grow steadily during, say, a 10-year interval, the long-run aggregate supply schedule would shift to the right, from LRAS1 to LRAS2 In panel (a), this results in a downward movement along the aggregate demand schedule The equilibrium price level falls, from 120 to 80 FIGURE 10-6 Secular Deflation versus Long-Run Price Stability in a Growing Economy Panel (a) illustrates what happens when economic growth occurs without a corresponding increase in aggregate demand The result is a decline in the price level over time, known as secular deflation Panel (b) shows that, in principle, secular deflation can be eliminated if the aggregate demand curve shifts rightward at the same pace that the long-run aggregate supply curve shifts to the right Panel (a) LRAS2 LRAS1 160 Price Level Price Level LRAS1 Panel (b) 120 80 AD 15 16 17 18 19 20 21 22 Real GDP per Year ($ trillions) LRAS2 160 120 80 AD1 15 16 17 18 19 20 21 22 Real GDP per Year ($ trillions) AD2 I-3 ■ INDEX Consumption expenditures, 168 Consumption function, 253, 254 defined, 252 investment function combined with, 260, 261 shifts in, 257 Consumption goods defined, 251 tradeoff with capital goods and, 37–38 Consumption plus investment line, 260 Contraction, 152 Contractionary monetary policy impact of, 377 net exports and, 352 with overutilized resources, 351 Treasury securities and, 358 Coordinate axes, 19 Core inflation rate, 380 Corporate income tax federal schedule of, 127 tax incidence and, 127 Corporate taxes, in Ireland, 130 Corsica, spillover effect in agriculture, 99 Cost(s) See also Opportunity cost external, 99–100, 101 law of increasing additional, 34–35 menu, 385 small menu, 385, 386 transaction, 75 Cost of capital See Capital Cost of inflation, repricing (menu), 151 Cost-of-living adjustments (COLAs), 151 Cost-push inflation, 241–242 Council of Economic Advisers (CEA), Great Recession and, 387 Counterfeiters, 319 Coupons, rationing by, 80 CPI See Consumer Price Index C ϩ I ϩ G ϩ X curve, aggregate demand curve and, 268–269 Crash of 2008 See Great Recession (2000s) Creative destruction, economic development and, 203 Credit, economic growth and access to, 401–403 Credit market, equilibrium in, 231–232 Creditors, unanticipated inflation and, 151 Credit unions, 322 Crowding-out effect defined, 281 indirect, 281–282 public debt and, 304–305 Currency See also Money changes in foreign, 354 euro as global, 744–745 Federal Reserve notes as, 322 global, 726 as medium of exchange, 319 trading in real estate business for, 743 in Venezuela, 321 in world history, 744 Currency programs, for local business purchases, 339 Currency swaps, 742 Currency values current account balances and, 739 percentage changes in, 739 Current account balancing, 730 capital account and, 731 defined, 729 Current account balances currency values and, 739 percentage changes in, 739 Current foreign exchange rate, 741 Curve See also Phillips curve aggregate demand, 213, 216 demand, 51–52 demand for money, 347 Laffer, 284 linear (slope of line), 21–22 long-run aggregate supply, 210–211 nonlinear, 22–23 Phillips, 378 production possibilities, 31–32, 210 supply, 60–61 Cyclical unemployment defined, 144 in Japan, 144 natural rate of unemployment and, 376 D Dalum Papir, 244 Daylight saving time, 26, 42 Dead capital defined, 400 economic growth and, 401 inefficient production and, 401 Debit-card transactions, 325–326 Debt See also Deficit spending; Foreign debt; Public debt deficit compared with, 299 European government interest on, 304 household debt, housing wealth, disposable income, stock wealth, and, 271 U.S as leader in, 312–313 Debtors, unanticipated inflation and, 151 Decision making collective, 111–113 systematic, Defense, international, 105 Deficit, on international accounts, 728 Deficit spending, public debt and, 298–311 Deflation, 210 contractionary monetary policy and, 351 defined, 146 historical, in U.S., 149 in Japan, 222–223 secular, 218–219 Deflation rate, 378 Demand See also Aggregate demand; Demand shifts; Derived demand aggregate, 213–216, 234–235 for all goods and services vs single good or service, 216 asset, 346–347 ceteris paribus conditions and, 55 changes in demand and supply, 76–79 defined, 49 for euros, 734, 736–737 law of, 49–50 other determinants of, 55–57 precautionary, 346 shifts in, 54–57, 737 substitute goods and, 56 supply and, 48–69 transactions, 346 for water, 74 Demand curve, 51–52 See also Aggregate demand curve defined, 52 horizontal summation of, 53 individual, 52–53 market, 52–53 movement along, 58 shifts in, 54 Demand-determined equilibrium real GDP, at less than full employment, 236 Demand for money, 346–347 Demand for money curve, 347 Demand-pull inflation, 241 Demand schedule, 51–53 individual, 52 shift in, 737 supply schedule combined with, 64 Demand shifts, 54–57 vs changes in quantity demanded, 57 effects of, 76–77 income and, 55 Demand shock, aggregate, 240, 245 Demand-side inflation, 220–221 Denmark, stability vs growth in, 244 Departments of government See under United States Dependent variable, 17 Deposit See also Saving creation process, 333 fractional reserve banking, money expansion, and, 333, 334 insurance of federal, 336–339 transactions, 320, 322 Deposit insurance See also Federal Deposit Insurance Corporation adverse selection, moral hazard, and, 338–339 artificially low premiums on, 338 bank failures and, 336–337 increase risk taking by bank managers and, 337–338 moral hazard in, 338–339 rationale for, 337 reform of, 338–339 regulation and, 338 Depository institutions defined, 322 Fed and, 327, 329 reserves of, 328, 331 reserves since 2008, 364 Depreciation, 172 defined, 170, 733 of euros, 734–735 in GDP, 172 inflationary premium vs., 150 Depression, 152 See also Great Depression; Great Recession (2000s) Derived demand downward-sloping, 735 for euros, 734 example of, 735 Desalination See Seawater Developing countries birthrates in, 201 freedom of information and growth in, 400 private investment in, 403 Development, long-term, 407 Development economics, 200 See also Economic development Dial-up Internet access, 69 Direct effect, of money supply increases, 350 Direct expenditure offsets, 283 Direct financing, vs indirect financing, 324 Direct relationship, 17 Dirty float, 740 Discount rate, defined, 358 Discouraged workers, 143 Discretionary fiscal policy, 278–284 Fed and, 391 time lags and, 285 INDEX ■ Discretionary policymaking See Active (discretionary) policymaking Disequilibrium, as accounting identity, 728 Disposable income consumption and, 270–271 GDP and (2011), 174 real, 250, 251 Disposable personal income (DPI), 174 tax rebates and, 289 Dissaving, 251 autonomous consumption and, 254–255 defined, 253 Distribution of account balances and balance of payments, 732 of output and income, 188 Distribution of wealth, 257 take from rich and give to poor, 257 Division of labor, 39–40 Divorce services, as normal good, 55 Dollar (U.S.), 726 aggregate demand and, 243–244 aggregate supply and, 242–243 appreciation of, 352 Canadian exchange rate and, 727 constant, 175 depreciation of, 733 effects of weaker, 242–244 exports and value of, 737 nominal and real value of, 146 Dollar-denominated accounts, 745 Domestic investment, gross private, 168 Domestic jobs, protecting, 715 Donations, charitable, Double coincidence of wants, 318–319 Double taxation, 126–127 Downward slope of aggregate demand curve, 214 of derived demand, 735 Dumping countering, 714–715 defined, 714 Durable consumer goods, 168 Durables, producer, 168 Duration, of unemployment, 142 Dynamic tax analysis of capital gains tax, 134 defined, 129 E Early warning systems, of financial crises, 408 Earnings, retained, 127 Easterlin, Richard, 180 Easterlin paradox, 180–181 Eberstadt, Nicholas, 201 Economic analysis, power of, Economic Community of West African States, 719 Economic depression See Depression Economic development, 200–203 keys to, 203 population growth and, 200–201 stages of, 201 Economic freedom defined, 399 economic growth and, 399–400 Economic goods, 28 Economic growth See also Global economic growth access to credit and, 401–403 arithmetic of, 398–399 bureaucratic inefficiency and, 402 capital goods and, 400–403 cellphone services and, 406 costs and benefits of, 189–190 dead capital and, 401 defined, 188 in Denmark, 244 distribution of output, income, and, 188–189 freedom of information in developing nations and, 400 government inefficiencies, investment, and, 401 historical record of U.S., 190 immigration, property rights, and, 199–200 innovation, knowledge, and, 197–198 international comparison of, 197 labor resources and, 398–400 long-run aggregate supply and, 211–212 new growth theory and, 195–198 open economy and, 196–197 political freedom and, 400 population growth and, 398–399 price level and, 218–219 production possibilities curve and, 35–36 productivity and, 192–193 rates of, 190–192 saving and, 193–194 scarcity and, 36 secular deflation and, 218–219 tariff barriers to international trade and, 197 tracking divergence in, 191 worldwide, 189 Economic performance See also Economic growth measurement of, 161–180 U.S government deficits and, 308–311 Economics See also Behavioral economics; Economic development; Normative economics; Positive economics defined, 2–3 of Medicare, 107–108 nature of, 1–11 normative, 714 of public education, 110–111 as science, 7–10 supply-side, 284–285 Economic stability, perceptions of, 738 Economic system centralized command and control, defined, mixed, 4–5 price system, U.S mixed system, 12 Economic well-being, per capita real GDP and, 180–181 Economy See also Economic performance; Open economy government deficits and, 308–311 government ensuring of stability in, 105 impact of shocks on, 245–246 sticky-price, real GDP and price level in, 386–387 Economywide reasons, for aggregate demand curve downward slope, 214 Education See also Public education economic development and, 203 Effect time lag, 285 Efficiency of daylight saving time, 42 defined, 34 externalities and, 99 Effluent fee, 102 E-mail, postal firms and, 113 I-4 Emigrants, assisting to help family members at home, 76 Emissions of pollutants, reducing, 114–115 Empirical science, Employment See also Unemployment demand-determined equilibrium real GDP and, 236 full, 145, 236 labor force and, 140 real GDP and, 233 EMU See European Monetary Union EMU euros See Euro Endowments, 210 Entitlements budget deficit and reduction of, 310–311 defined, 310 Entrepreneurs FDIC coverage, moral hazard, and, 340 supporting with public funds, 409 Entrepreneurship defined, 28 property rights and, 199–200 Environmental Protection Agency (EPA), 212 Equation of exchange, 353–354 Equilibrium, 64–66 See also Long-run equilibrium as accounting identity, 728 adjustment to, 79 in credit market, 231–232 defined, 64 Keynesian, 263–264 in labor market, 233 long-run, 217–219 money supply and, 381–382 short-run, 280, 381–382 Equilibrium exchange rate, 736–737 Equilibrium federal funds rate, reserve supply and, 360 Equilibrium foreign exchange rate, 733–738 Equilibrium interest rate, 232 Equilibrium level of GDP per year, 264 of real GDP, 264 Equilibrium price, 64 defined, 64 demand and supply shifts and, 76–78 excise taxes and, 132 rent controls and, 83 for water, 74 Equilibrium price level, determining, 209 Equilibrium quantity, taxes and, 132 Equilibrium real GDP, 259, 263 autonomous spending and, 268 Essay on the Principle of Population, An (Malthus), 201 EU See European Union Euro, 726 appreciation and depreciation of, 734–735 deriving demand for, 734 global currency status of, 744–745 shaky status of, 745 shift in supply of, 738 supply of, 735, 736–737, 738 total demand for and supply of, 736–737 Europe government interest on debt in, 304 IMF and financial crisis in, 407 European Economic Community, 740 See also European Union European Monetary Union (EMU) euro as currency of, 732 foreign exchange rates and, 732 I-5 ■ INDEX European Union (EU), 719, 740 trade within, 40 Excess reserves, 364 Exchange equation of, 353 voluntary, 75 Exchange rate, 178, 726, 727, 732–738 current arrangements, 741 defined, 178, 733 equilibrium rate, 733–738 fixed vs floating, 740–743 market determinants of, 738 as shock absorber, 742–743 Exchange rate floats, 742–743 Excise, 131–132 Excise taxes defined, 131 effects of, 132 payment of, 132–133 Expansion defined, 152 money, 332–333, 334 Expansionary monetary policy graphing, 350 impact of, 376 net exports and, 352 Expectations importance of, 370–380 rational, 381–385 shifting Phillips curve and, 380 Expenditure approach defined, 167 presenting, 169–171 Expenditures See also Entitlements; Spending autonomous, 255 consumption, 168 direct expenditure offsets and, 283 reducing, 309–310 total, and aggregate demand, 213–216 transactions demand and, 346 Expenses, nonincome, 172 Exports See also International trade GDP calculation and, 263 imports and, 713 merchandise trade, 729 service, 729 subsidizing, 712, 721 U.S expansion of, 721 value of dollar and, 737 External costs, in graphical form, 100–101 Externality, 99–100 defined, 99 negative, 102 positive, 102–103 railcar pollution as, 114 reducing emissions and, 114–115 External shocks, business fluctuations and, 153–154 F Factor market, 163 Factors of production See also Resource(s) defined, 27 technology as, 195 Family restaurants, unemployment and, 154 Farm Security Act (2002), 85 Farm subsidies See Agriculture Farrow, Mia, 83 FDIC See Federal Deposit Insurance Corporation (FDIC) Fed, the See Federal Reserve System Federal budget deficit See Budget deficit Federal deficit See Budget deficit Federal deposit insurance See Deposit insurance Federal Deposit Insurance Corporation (FDIC), 317 See also Deposit insurance defined, 337 moral hazard and, 340 Federal Deposit Insurance Reform Act (2005), 338 Federal funds market, 358 Federal funds rate defined, 358 equilibrium, 360 market for bank reserves and, 359–360 neutral, 361 target for, 360 Taylor rule and, 362 Federal government See also Government; United States share of economic activity, 311 Federal income tax See Income tax Federal Insurance Contributions Act (FICA, 1935), 127 Federal Open Market Committee (FOMC), 327, 328 FOMC Directive and, 360 Federal Reserve Act (1913), 327 Federal Reserve Bank of New York, 327 Federal Reserve notes, as currency, 322 Federal Reserve System (the Fed), 329 in crisis, 330–331 discretion of, 391 FOMC Directive of, 360 functions of, 327–330 interest rates and, 348–351 on natural rate of unemployment, 145–146 open market operation of, 332 organization of, 327, 328 policy implementation by, 357–360 policy target of, 356–357 as U.S central bank, 327–331 Federal taxation, 125–128 See also Taxation capital gains tax, 126 corporate income tax, 126–127 personal income tax, 125–126 Social Security taxes, 127–128 unemployment, 128 Federal Trade Commission (FTC), 103 Fertility revolution, 201 FICA See Federal Insurance Contributions Act Fiduciary currency, from Fed, 327–328 Fiduciary monetary system, 321 Films See Movie industry Final goods and services, 162 Final output, stress on, 164 Financial crash of 2008 See Great Recession (2000s) Financial crises alternative structures for limiting, 408 IMF and, 407 Financial flows, private international and global growth, 402–405 Financial institution See also Bank(s); Savings and loan associations liability of, 325 Financial intermediaries assets and liabilities of, 325 defined, 324 Financial intermediation, 323–326 defined, 324 process of, 324 Financial transactions, exclusion from GDP, 165 Financing See also Funding of global growth, 403–405 incomplete information and, 405 positive externalities and, 102 Firetag, Ray, 743 Firm See also Business investment decision by, 281 number in industry, 63 Fiscal agent, Fed as, 329 Fiscal policy, 277–290 See also Monetary policy in abnormal times, 287 changes in government spending and, 295–296 defined, 278 discretionary, 278–284 expansionary and contractionary, 279, 280 in normal times, 287 possible offsets to, 280–284 tax changes and, 296 time lags and, 285 “5yr5yr rate,” inflation and, 392 Fixed exchange rate, 740–743 floating exchange rates and, 740–743 pros and cons of, 742–743 Fixed investment, 168, 252 Fixed price, real GDP determination with, 237 Fixed price level, assumption of, 297 Fixed-quantity price index, CPI as, 148 Flexible exchange rates, 733 Flexible prices, 231, 381–383 real GDP determination with, 237 Flexible wages, 231, 381–383 FLIR systems, technology of, 188 Floating exchange rates, 740–743 Flow See also Circular flow; Saving defined, 141 of income, 167 of production, 164 stocks and, 251 of world trade, 712 FOMC See Federal Open Market Committee (FOMC) FOMC Directive, 360 Food, Conservation, and Energy Act (2008), 85 Food for Peace program, surplus food and, 84 Food stamps, 106 Food supply, population growth and, 201 Force, government use of, 113 Forecasts See also Expectations policy irrelevance and, 383 Foreign aid, to poor nations, 404 Foreign currency markets, Fed and, 329 Foreign debt, by U.S residents, 306 Foreign direct investment, 403 Foreign exchange market, 732 Foreign exchange rate See Exchange rate Foreign exchange reserves, 741 Foreign exchange risk, 742 Foreign expenditures See also Net exports GDP and, 169 Foreign goods, substitution of, 215 Foreign residents, U.S debt to, 305 Foreign sector, Keynesian equilibrium and, 263 Foreign subsidies, countering, 714–715 Foreign trade See International trade; Trade 45-degree reference line, 253–254 Fracking (fraccing), for natural gas, 63 INDEX ■ Fractional reserve banking defined, 331 Fed, money supply, and, 331–333, 334 money expansion and, 332 Frankel, Jeffrey, 719 Franklin, Benjamin, 42 Freedom of information, and growth in developing nations, 400 Free-rider problem, 105 Free trade, 711 arguments against, 714–715 Frictional unemployment, 374–375 defined, 143–144 full employment and, 145 Friedman, Milton, 388 FTC See Federal Trade Commission Full employment defined, 145 demand-determined equilibrium real GDP and, 236 frictional unemployment and, 145 Full-Employment Act (1946), 105 Fund(s), distribution pools across multiple banks, 340 Funding See also Financing; Government spending; Spending for charter schools, 111 of public sector, 121–135 Future public debt in, 305 trade-off with present, 36–38 G Gains, capital, 126 Gains from trade consumer surplus, producer surplus, and, 96 defined, 96 price controls and, 97 Gaps See Inflationary gap; Recessionary gap Gasoline, taxes on, 132–133 GATT See General Agreement on Tariffs and Trade GDI See Gross domestic income GDP See Gross domestic product GDP deflator, 147, 148–149 General Agreement on Tariffs and Trade (GATT), 718 Gibby, Wendell, 133 Gifts, perceived value of, Global currency, 726 euro as, 744–745 features of, 745 Global economic growth asymmetric information as barrier to, 404 development and, 187–205 international institutions and, 405–408 policies and prospects for, 397–409 private international financial flows for, 403–405 rates of, 189 Global economy See Global economic growth Globalization, of international money markets, 352 Global per capita real GDP, 191 rule of 70 and, 192 “Going green,” reduction of U.S economic growth and, 212 Gold standard, 740 Goods See also Product; Services capital, 37–38, 168, 252, 400–403 consumption, 251 defined, 28 durable consumer, 168 economic, 28 final, 162 government, 112 government-inhibited, 105–106 inferior, 55 intangible, 28 intermediate, 164 nondurable consumer, 168 normal, 55 political, 112 private, 103 public, 104 secondhand, 166 Goods and services demand for all vs single, 216 world output of, 706 Gould, David, 715 Government See also Federal government; Government spending; Local government; Regulation; Taxation; United States allocation of spending by, 107 clean-energy technology and, 114–115 deficit reduction by, 308–311 economic functions of, 103–105 force used by, 113 funding of, 121–135 funding to banks by, 12 incentives from, inefficiencies, investment, economic growth and, 401 inefficiency of, 112 negative externalities corrected by, 102 positive externalities corrected by, 102 price controls by, 80–81 price supports by, 84 sources of tax receipts, 125 water prices and, 74 Government budget constraint, 122 Government budget deficit, 299 Government budget surplus, 299 Government finance, taxation and, 300–301 Government (political) goods, 112 Government-inhibited good, 105–106 Government spending See also Entitlements; Medicaid; Medicare changes in, 278–279 expansionary and contractionary fiscal policy and, 279 federal compared to state and local, 108 fiscal policy and, 295–296 GDP and, 169 Keynesian equilibrium and, 263 taxation and, 299 total outlays over time, 107 transfer programs and, 106–111 Government-sponsored financial institutions, 325 Government-sponsored good broadband access as, 106 defined, 105 Government transfer programs, exclusion from GDP, 165 Grant, Laura, 42 Graphical analysis crowding-out effect, 281–282 of trade-offs, 30 I-6 Graphs constructing, 17–19 of numbers in table, 19–20 reading and working with, 17–23 Great Depression See also Great Recession (2000s) business activity during, 153 fiscal policy during, 287 Keynes on, 278 Great Recession (2000s), 68 business activity during, 68–69, 153 difficulty of moderating, 387 going green and, 212 income and purchasing declines during, 122 inventory buildup during, 262 male job loss during, 140 small business unemployment and, 154 Taylor rule and, 362 Greece, IMF and financial crisis in, 407 Greenhouse gases, 212 Gross domestic income (GDI) defined, 171–172 in 2011, 173 Gross domestic product (GDP) See also Real GDP components of, 170 correcting for price changes, 175, 176 defined, 164 deriving components of, 174–175 equilibrium real, 259, 263 exclusions from, 165–166 federal budget deficit as percentage of, 301 French de-emphasis on, 167 GDP deflator and, 148 historical picture of, 169–171 income approach for deriving, 171–172 limitations of, 166 measurement of, 167–172 ratio of private credit to, 402 in 2011, 173 worldwide comparison of, 178–179 Gross private domestic investment, 168, 170 Gross public debt, 302 Growth See Economic growth H Hair salons, electric hair clippers and, 69 Happiness, per capita real GDP and, 180–181 Health care See also Medicaid; Medicare free, 33 growth of subsidies to, 109–110 publicly subsidized, 107 Hedge, 742 Horizontal number line, 18 Household, business receipts and, 162 Household production, exclusion from GDP, 166 Household wealth, disposable income and, 270–271 Housing low-cost, 83 rental payments and, 168 rent control and, 82 sawdust shortage and, 66 Human capital defined, 28 importance of, 198 Human Development Index (HDI), of United Nations, 167 I-7 ■ INDEX Hungary, inflation in, 346 Hyperinflation, in Zimbabwe, 363 I Ideas economic growth and, 198 transmitting through international trade, 711–712 Identity See also Accounting identities equation of exchange as, 353 IMF See International Monetary Fund Immigration, property rights, growth, and, 199–200 Implicit rental value, 168 Import quotas, 87, 716 Imports See also International trade discouraging, 712 exports and, 713 of Japanese autos into U.S., 715, 716, 717 merchandise trade, 729 service, 729 unemployment rate and, 715 U.S reduction of, 721 Incentives to control student drinking, 41 defined, Medicare, 109 for movie producer, 11 for public education, 110 responding to, Incentive structure, 112 Income See also Health care; National income circular flow of, 162–164, 163 consumption plus saving as, 257 demand shifts and, 55–56 as determinant of saving, 252–253 disposable, 174, 270–271 distribution of, 188 dollar value of total output and, 163–164 national, 174 personal, 174 real disposable, 250, 251 redistribution of, 106 saving, consumption, and, 252 temporary tax rebates and, 289–290 total, 162–163 Income approach defined, 167 for deriving GDP, 171–172 Income redistribution, 106 Income tax corporate, 126–127 federal personal, 125–126 progressive, 106 Income transfer payments, as automatic stabilizers, 286 Income velocity of money (V), 353 Incomplete information, international financial crises and, 405 Increasing additional cost, law of, 34–35 Independent variable, 17 Indexes See also Misery index; Price index Consumer Price Index, 147 of leading indicators, 153 Personal Consumption Expenditures, 147 Producer Price Index, 147 for real disposable income and household wealth, 270–271 wholesale price indexes, 148 Index number, 147 India, capital in, 408 Indicators See Leading indicators Indirect business taxes, 172 Indirect crowding out, 281–282 Indirect effect, of money supply increases, 350 Indirect financing, vs direct financing, 324 Individual demand curve, 52–53 Individual Retirement Accounts (IRAs), 338–339 Individuals, average marginal income tax rate for, 124 Indonesia, IMF and financial crisis in, 407 Industry See also Business command and control economy in, 12, 13 infant, 714 number of firms in, 63 regulation of, 715–717 Inefficiency, of daylight saving time, 42 Inefficient point, 34 Inefficient production, and dead capital, 401 Infant industry argument, 714 Infant mortality, modernization and, 201 Inferior goods defined, 55 in Great Recession of 2000s, 68 Inflation anticipated and unanticipated, 150–151 business fluctuations and, 152–154 causes of, 219 COLAs and, 151 contractionary monetary policy and, 351 core rate of, 380 cost-push, 241–242 creditors, debtors, and, 151 current and future, 373 defined, 146 demand-pull, 241 demand-side, 220–221 expectations, Phillips curve, and, 380 Fed forecasts of, 391 and “5yr5yr rate,” 392 historical, in U.S., 149 interest rates and, 150–151 measuring rate of, 147 measuring with TIPS, 392 media headlines about, 380 misery index and, 155–156 monetary policy and, 353–354 money supply growth and, 346 money supply growth rates and, 354 NAIRU and, 378–379 net effects of aggregate demand and aggregate supply, 244 new Keynesians and, 389 in North Korea, 354 in Pakistan, 222 persistent, 220 protecting against, 151 purchasing power of money and, 146 real GDP and, 388 repricing (menu) cost of, 151 resource cost of, 151 short-run variations in, 241–244 supply-side, 219 Taylor rule and, 361 unemployment trade-off with, 378 in United States, 220 weaker dollar and, 244 Inflationary gap, 240–241, 279 Inflationary premium, 150 Inflation rate, 139 unemployment rate and, 388 Information, asymmetric, 324, 404 Innovation See also Patents; Technology defined, 197 economic growth and, 197–198 Input See also Labor costs to produce product, 62 Inquiry into the Nature and Causes of the Wealth of Nations, An (Smith) See Wealth of Nations, The (Smith) Institute for International Economics, 715 Insurance deposit, 336–337, 338–339 federal deposit, 336–339 unemployment, 374 Intangible goods, 28, 169 See also Services Intellectual property, 712 Interest See also Interest rate deficit, public debt, and, 303 in GDI, 171 Interest payments, on public debt, 302–304 Interest rate See also Interest rate changes cost of holding money and, 347 equilibrium, 232 Fed and, 348–351, 357–358 inflation and, 150–151 Keynesian approach to, 371 nominal, 150–151 as policy target, 356–357 price of existing bonds and, 349 real, 150–151 on reserves, 358–359 transmission mechanism based on, 355 Interest rate changes, induced, 281 Interest rate effect, 214, 215 Intermediate goods, 164 Intermediation See Financial intermediation International accounts, surplus and deficit items on, 728 International Bank for Reconstruction and Development, 405 International Center for Settlement of Investment Disputes, 406 International competitiveness, 713 International Development Association, 405 International Finance Corporation, 405 International financial crises defined, 405 incomplete information and, 405 International institutions, global growth policies and, 405–408 International investment obstacles to, 403–405 private, 403 International issues See also under Global entries comparing GDP, 178–179 defense as, 105 Japanese “nonregularity” in cyclical unemployment, 144 women and economic life in India, International Monetary Fund (IMF), 405, 406–407 Bretton Woods and, 740 defined, 406, 731 gold standard and, 740 World Bank and, 407–408 International money markets, globalization of, 352 International trade, 40–41, 197 barriers to, 197, 705 comparative advantage and, 708 flows in, 712 gains from, in used merchandise, 711 growth of, 706 idea transmission through, 711–712 percentage in regional trade blocs, 719 production without, 708 reasons for, 707–712 INDEX ■ restricting, 715, 716 specialization among nations and, 707–711 tariff barriers to, 197 worldwide importance of, 706–707 International trade organizations, 718–720 Internet broadband access as governmentsponsored good and, 106 dial-up access for, 69 smart phone access to, 51 Interstate trade, 40 Inventions alternative uses of, 188 patents of, 187 Inventories buildup during Great Recession, 262 desired saving and, 270 unplanned changes in, 262 Inventory investment, 168, 252 Inverse relationship, 17 Investment in China, 194 consumption and, 261 defined, 168, 252 determinants of, 257–259 in developing nations, 403 fixed, 168, 252 foreign direct, 403 government inefficiencies, economic growth, and, 401 gross private domestic, 168 inventory, 168, 252 net, 171 planned investment function and, 258–259 planned vs actual, 261–262 portfolio, 403 private, 403 saving and, 231–232 Investment companies, 325 Investment decision, 281 Investment function consumption function combined with, 260, 261 shifts in, 259 Investment-knowledge cycle, 198 Investment line, consumption plus, 260 Investment spending, interest rates and, 232 iPhone, Internet access and, 51 Ireland, corporate taxes in, 130 ITC Limited, 400 J Japan automobile imports into U.S and, 715, 716, 717 cyclical unemployment in, 144 deflation in, 222–223 economic development and natural resources in, 203 “nonregularity” in cyclical unemployment, 144 rate of price changes since 2000, 223 restriction on import of automobiles from, 715, 716, 717 tariff on laptops imported from, 717 Job(s), protecting domestic, 715 Job leaver, defined, 12 Job losers defined, 142 unemployment benefits for, 142 Job loss, by men in 2000s, 140 JPMorgan Chase, 12 K Katz, Lawrence, 374 Keynes, John Maynard, 230 See also New Keynesians on interest rate, 252 traditional Keynesian analysis and, 278 Keynesian economics fiscal policy and, 295–297 and Keynesian short-run aggregate supply curve, 235–236 monetary policy and, 370–371 “soothing” effect of, 288 Keynesian equilibrium, with government and foreign sector, 263–264 Keynesian macro analysis, 229 Keynesian model, 230, 251 multiplier and, 276 Keynesian short-run aggregate supply curve, 235–236 Kidney transplants, price ceiling on, 75 Knowledge economic growth and, 197–198 ideas and, 198 technology and, 33 Kotchen, Matthew, 42 Kremer, Michael, 199 L Labor See also Labor unions; Unemployment defined, 28 division of, 39 Labor force defined, 140 discouraged workers and, 143 temporary workers in, 144 Labor force participation rate, defined, 143 Labor market equilibrium in, 233 natural rate of unemployment and, 145–146 price floors in, 85–86 transaction costs in, 145 Labor productivity, defined, 192 Labor resources, economic growth and, 398–400 Labor unions, 374 Mexico-U.S trade and, 720 Laffer, Arthur, 284 Laffer curve, 284 Land, 27 Landowners, price supports and, 85 Law (economic) of demand, 49–50 of increasing additional cost, 34–35 Say’s, 230–231 of supply, 58–61 Law (governmental rules) See also Antitrust laws; Regulation; Tariff minimum wage, 374 Leading indicators, 153–154 Leakage, circular flow and, 231 Legal system, government provision of, 103 Legislation See Antitrust laws; Regulation Lender of last resort, 330 Liability defined, 325 financial institution, 325 Line (linear curve), slope of, 20, 21–23 “Liquid glass,” 88 Liquidity defined, 320 of money, 320 I-8 Liquidity approach See also M2 to measuring money, 323 Local government, spending by, 108 Long run See also Short run new Keynesian sticky-price theory and, 387 quantity of labor demanded in, 86 real GDP and price level in, 209–222 shocks in, 245 Long-run aggregate supply economic growth and, 211–212 shifts in, 238, 239 Long-run aggregate supply curve (LRAS), 237–238, 278 contractionary policy and, 377 defined, 210 expansionary policy and, 350, 376 output growth and, 210–212 shifts in, 211 short-run equilibrium and, 280 Long-run equilibrium, 381–382 price level and, 217–219 Long-run macroeconomic effects, of higher budget deficits, 308 Long-run price stability, secular deflation and, 218 Long-run real GDP, expansionary policy and, 376 Long-term development issues, 407 Loss, capital, 126 Low-cost housing, controls over, 83 LRAS See Long-run aggregate supply curve (LRAS) Lump-sum tax, 263 Luxury tax, 129 M M1 composition of, 322 defined, 322 as transactions approach to measuring money, 322–323 M2 composition of, 323 defined, 323 as liquidity approach to measuring money, 323 Macro analysis, classical, 229, 230–235 Macroeconomics business fluctuations and, 152–154 defined, inflation, deflation, and, 146–152 unemployment and, 140–145 Macroeconomy, 139–156 government deficits and, 308–311 MacTavish, Donald, 363 Majority rule, 113 Malaysia IMF and financial crisis in, 407 private entrepreneurs supported by, 409 Malthus, Thomas Robert, 201, 230 Managers, salaries in banking, 12 Manufacturing stage of development, 201 Marginal propensity to consume (MPC), 256 Marginal propensity to save (MPS), 256 Marginal tax rate, 123, 124 budget deficit reduction and, 309 changes in, 283 defined, 123 response to increase in, 133 Marginal tax rate cuts, Laffer curve and, 284 I-9 ■ INDEX Market for bank reserves and Fed funds rate, 359–360 defined, 49 factor, 163 federal funds, 358, 359–360 foreign exchange, 732 for “liquid glass,” 88 for nonabsorbable fat, 204 price system and, 75–76 product, 163 Market clearing price defined, 64 price ceilings and, 80 of solar cells, 68 Market decision making, public-sector decision making and, 111–113 Market demand curve, 52–53 Market determinants, of exchange rates, 738 Market failure, 99 Marketing loan programs, to agriculture, 85 Market price, taxes and, 132 Market size, 57 Market supply, excise taxes and, 132 Market supply curve, 60–61 Market system, See also Price system Marshall, DuWayne, 720 Maryland, “millionaires” tax in, 130 Massachusetts health care, “overuse” of, 110 Maximum feasible rates of production, 708 Medicaid, 109 as entitlement, 310, 311 as transfers in kind, 106 Medical care See also Health care scarcity and, 27 Medicare, 107–109 economic effects of subsidies for, 108 as entitlement, 310, 311 incentives to, 109 tax for, 127 Medicine See Health care Medium of exchange defined, 318 money as, 318–319 River Currency as, 339 Menu costs, 385 of inflation, 151 Merchandise trade, exports and imports, 729 Mercosur, 719 Mexico commercial trucks prohibited on U.S highways, 720 IMF and financial crisis in, 407 Meyer, Bruce, 374 Microeconomics, Microlending, 403 Microsoft Corporation, ideas as, 198 Middlemen, roles of, 76 Mill, John Stuart, 230 “Millionaires” tax, in Maryland, 130 Minimum wage defined, 85 economic effects of, 86–87 timing for increasing, 87 in United States, 85–86 Minimum wage laws, 374 Misallocations, of externalities, 101–102 Misery index, 139, 155–156 since early 1950s, 155 reducing in 2010s, 156 Mission creep, at Fed, 330–331 Mixed economic systems, 4–5 Mobile payments, 326 Model See also Classical model; Keynesian model; Theory defined, economists’ models as behavioral models, realism and, 7–8 usefulness of, 8–9 Modernization, childbearing declines and, 201 Monetary policy, 318, 345 See also Contractionary monetary policy; Expansionary monetary policy; Federal Reserve System (the Fed); Money supply in aggregate demand–aggregate supply model, 356 Fed and, 329 inflation and, 353–354 Keynesian perspective on, 370–371 open economy transmission and, 351–352 transmission mechanism of, 355–357 Monetary shock, real shocks and, 384–385 Monetary standards, 320–321 Monetary system, fiduciary, 321 Money, 317 See also Bank(s); Banking defined, 318, 322–323 demand for, 346–347 expansion of, 332–335 functions of, 318–320 income velocity of (V), 353 liquidity of, 320 measuring, 322–323 as medium of exchange, 318–319 properties of, 320–321 quantity theory of, 353 as standard of deferred payment, 320 types of, 318 as unit of accounting, 319 in Venezuela, 321 Money balances, 346 Money illusion, 231 Money market, globalization of, 352 Money market mutual funds, M2 and, 323 Money multiplier defined, 335 real-world, 335 Money price defined, 50 vs relative price, 50–51 Money supply See also Federal Reserve System (the Fed); Monetary policy decreasing, 371 defined, 322, 323 as Fed policy target, 356–357 fractional reserve banking and, 332–333 increasing, 349–351, 371 inflation and, 346 interest-rate-based transmission mechanism and, 355 Keynesian approach to, 370–371 Money supply curve, 355 Money supply growth rates, rates of inflation and, 354 Money transfer payments, 106 Monopoly, defined, 103 Moral hazard defined, 324 deposit insurance, adverse selection, and, 338–339 FDIC coverage and, 340 Movie industry, ticket prices and inflation in, 146, 147 Movie producer, incentives for, 11 MPC See Marginal propensity to consume MPS See Marginal propensity to save Multilateral defense organizations, 105 Multinational Investment Guarantee Agency, 406 Multiplier, 265–267 balanced-budget, 296 defined, 265 formula for, 266–267 Keynesian model and, 276 money, 335 real GDP, consumption, and, 250 significance of, 267 Multiplier effect, Keynesian approach and, 371 N NAIRU (nonaccelerating inflation rate of unemployment), 378–379 defined, 378 Nakamura, Leonard, 169 National debt See Public debt National defense, free trade issues and, 715 National income capital gains tax rates and capital gains in, 135 defined, 174 National income accounting, 164–167 components of, 172–175 Natural gas, fracking for, 63 Natural rate of unemployment, 145–146, 374–380 defined, 145, 375 departures from, 376–377 in United States, 375 Natural resources, economic development and, 203 Natural unemployment rate, NAIRU and, 379 NDP See Net domestic product Needs, wants and, 28–29 Negative externalities, government correction of, 102 Net, use of term, 170 Net domestic product (NDP), 170, 172–174 Net exports contractionary monetary policy and, 352 expansionary monetary policy and, 352 GDP and, 169 Net investment, defined, 171 Net public debt, 298 accumulation of, 302 defined, 302 as percentage of GDP, 303 Net wealth, 257 Neutral federal funds rate, 361 New entrant, 142 New growth theory, 195–198 defined, 195 human capital and, 198 New Keynesian inflation dynamics, 386–387, 392 defined, 386 evaluating, 389 New Keynesian Phillips curve, 388–390 New Keynesians, 385 small menu costs, sticky prices, and, 385 sticky-price theory and, 386–387 New York Federal Reserve Bank, 327 NI See National income Nixon, Richard, gold standard and, 740 Nominal GDP equation of exchange and, 353 plotting of, 176–177 INDEX ■ Nominal rate of interest defined, 150 real rate of interest vs., 150–151 Nominal unit, of product of service, 78 Nominal values defined, 175 of dollar, 146 vs real values, 175–178 Nonabsorbable fat, market for, 204 Nonaccelerating inflation rate of unemployment (NAIRU) See NAIRU Noncontrollable expenditures, 310 See also Entitlements Nondiscretionary policymaking See Passive (nondiscretionary) policymaking Nondurable consumer goods, 168 Nonincome expense items, 172 Nonlinear curve, slope of, 22–23 Nonmarket product, exclusion from GDP, 166 Nonprice rationing devices, 80–81 Nonprice rationing methods, 79–80 “Nonregularity,” in Japanese cyclical unemployment, 144 Normal goods defined, 55 divorce services as, 55 Normative analysis, 10–11 Normative economics, 714 defined, 10 vs positive economics, 10–11 North American Free Trade Agreement, 719 North Atlantic Treaty Organization (NATO), 105 North Korea, inflation in, 354 Number line combining vertical and horizontal, 18–19 defined, 18 O Obama, Barack capital gains tax and, 121 Great Recession and, 387 tariffs and, 705 Official reserve account transactions, 731 Oil industry, reduction in oil resources, 384–385 Online trading, of foreign currencies, 743 Open economy aggregate demand and supply in, 242–244 comparative advantage and, 705 economic growth and, 196–197 federal budget deficits in, 306 monetary policy and, 351–352 Open economy effect, 214, 215 Open market operations defined, 332 interest rates and, 348 reasons for not eliminating, 335 Open market sale, 334 Opportunity cost, 26 alternative choices and, 29, 30 comparative advantage and, 38 of daylight saving time, 42 public choice theory and, 112 public goods and, 104 scarcity, choice, and, 29 of student drinking parties, 41 Organization(s), international trade, 718–720 Output See also Total output determination using aggregate demand and aggregate supply, 236–238 distribution of, 188 gains from specialization, 707 mutual gains from exchange and, 707 world, 706 Output growth, long-run aggregate supply curve and, 210–212 Overallocation of resources, 101 Overemployment, 143 Overutilized resources, contractionary monetary policy with, 351 P Paired observation, of variables, 19 Pakistan, inflation in, 222 Par value, 740 Passive (nondiscretionary) policymaking defined, 374 economic factors favoring, 390–391 Patents, 187 defined, 195 grants in U.S., 196 growth benefits in China, 204–205 Payment mobile, 326 money as deferred, 320 via debt-card transactions, 325–326 Payment-clearing systems, of Fed, 328 PCE Index See Personal Consumption Expenditures Index Pension fund companies, 325 Per capita real GDP, 177–178 economic growth, 188 economic well-being and, 180–181 global, 191, 399 saving rate and, 194 Perfect competition See Competition Personal Consumption Expenditures (PCE) Index, 147, 148, 149 Personal income (PI), defined, 174 Personal income tax, federal, 125–126 Phelps, Edmond, 388 Phillips, A W., 378 Phillips curve, 378 active vs passive policymaking and, 390 defined, 378 new Keynesian, 388–389 shift in, 379, 380 Phones See also Cellular phone services; iPhone Internet access with, 51 Physical capital, 28 Pigou, A C., 230 Plane, 18 Planned consumption, determinants of, 252–257 Planned investment, vs actual saving and investment, 261–262 Planned investment function, 258–259 Planned saving vs actual saving and investment, 261–262 determinants of, 252–257 Policy See also Fiscal policy; Monetary policy Fed departure from, 364–365 unanticipated, 382 Policy activism, real business cycles and, 383–385 Policy irrelevance proposition defined, 383 rational expectations and, 382–383 I-10 Policymaking active (discretionary), 374, 385–387 passive (nondiscretionary), 374 Political freedom, economic growth and, 400 Political goods, defined, 112 Pollution as negative externality, 102 reducing, 114–115 Poor countries See also Poverty foreign aid to, 404 per capita real income in, 180–181 Population economic growth and, 398–399 employment and unemployment in, 141 worldwide, 200–201 Population growth arithmetic of, 398–399 economic development and, 200–201 by 2050, 202 Pork prices, in China, 78 Portfolio investment, 403 Positive economics defined, 10 vs normative economics, 10–11 Positive externalities, government correction of, 102 Positive slope, 21 Postal firms, e-mail and, 113 Post offices, e-mail and, 113 Potential money multiplier, 335 Poverty See also Poor countries worldwide, 200 PPC See Production possibilities curve PPI See Producer Price Index Precautionary demand, 346 Predictability of value, of money, 321 Preferences declared vs revealed, demand shifts and, 55–56 Present, trade-off with future, 36–38 President’s Council of Economic Advisers (CEA), 145 Price(s) See also Price flexibility; Price floor of bonds, 348, 349 in classical model, 231 constant-quality unit, 51 demand and, 50 equilibrium, 64–65 at holiday periods, 374 laws prohibiting increases in, 219 market, 132 market clearing, 64 money, 352 quantity demanded and, 44 quantity theory of, 353 rationing function of, 79–80 relative, 50 rent controls and, 82–83 Price ceilings black markets and, 80–81 defined, 80 eliminating, 88–89 on kidneys, 75 Price controls defined, 80 gains from trade and, 97 government-imposed, 80–81 Price flexibility active vs passive policymaking and, 390 adjustment speed and, 78–79 Price floor, 84–85 in agriculture, 84, 85 defined, 80 I-11 ■ INDEX Price floor (continued) gains from trade and, 97 in labor market, 85–87 Price index, 147–150 computing, 147 defined, 147 real-world, 147–148 wholesale, 148 Price index changes, correcting GDP for, 176 Price level See also Equilibrium price level classical theory, vertical aggregate supply, and, 234 of Coca-Cola, 230 economic growth and, 218–219 fall in, 215–216 long-run equilibrium and, 217–219 real autonomous spending and, 267–268 real GDP and, 267 real GDP in long run and, 209–222 real GDP in sticky-price economy and, 386–387 rises in, 214–215 Price supports, 84–85 Price system, 4, 75 defined, 75 efficiency of, 99 failures of, 99 gains from trade within, 96 markets and, 75–76 rationing and, 80 spillover effects in, 99 in United States, 12 Principle of rival consumption, 104 Private credit See Credit Private domestic investment, 168 Private firms, space travel produced by, 104 Private goods, 103 Private investment in developing nations, 403 supporting entrepreneurs with public funds and, 409 Private sector, public goods provided by, 104 Private transfer programs, exclusion from GDP, 166 Producer, taxation and, 131–133 Producer durables, 168 Producer Price Index (PPI), 148 defined, 147 types of, 148 Producer surplus, 95–96 consumer surplus, gains from trade, and, 96 defined, 96 Product(s) See also Goods circular flow of, 163 Production See also Factors of production allocation of resources for, 33 defined, 27 flow of, 164 positive externalities and, 102 sales value, value added, and, 165 specialization in, 709 without trade, 708 in two-country, two-good world, 708 Production possibilities curve (PPC), 30–31 assumptions underlying, 32–33 defined, 30 economic growth and, 35–36 goods off curve, 33–34 and long-run aggregate supply curve, 210 Productive efficiency, 34 Productivity economic growth and, 192–193 labor, 192–193 specialization and, 38–40 technology and, 63 Product market, 163 Profit, 162 in GDI, 172 Progressive income tax, 106 Progressive taxation, 124 Property, intellectual, 712 Property rights, 103 defined, 100 economic development and, 203 entrepreneurship and, 199–200 immigration, growth, and, 199–200 Proportional rule, 113 Proportional taxation, 124 Protectionism economic development and, 203 regional trade blocks and, 720 Psychological thought processes, economic predictions and, 9–10 Public choice public spending and, 98 theory of, 111 Public debt burdens of, 304–305 deficit, interest, and, 303 deficit spending and, 298–311 defined, 299–300 to foreign residents, 305 interest payments on, 302–303 paying off in future, 305 rising, 302–305 taxation and, 299 Public education, economic issues of, 110–111 Public funds, supporting private entrepreneurs with, 409 Public goods characteristics of, 104 defined, 104 government provision of, 103–105 Public sector See Government Public-sector decision making, 111–113 Public spending See Government spending Purchasing power defined, 146 of money, 146 true, 178–179 Purchasing power parity, 178–179 Pure competition active vs passive policymaking and, 390 in classical model, 231 Pure market system, competition in, 99 Q Quality-adjusted price, 51 Quantity, government restrictions on, 87 Quantity demanded, 57 price and, 44 Quantity supplied, changes in supply vs., 63–64 Quantity theory of money and prices, 353–354 Queues, rationing by, 79 Quota, import, 87 Quota subscription, 407 Quota system See also Quota defined, 716 on trade, 716–717 R Railcars, as pollution, 114 R&D See Research and development Random assignment, rationing by, 80 Rate of discount, 358 Rate of growth See also Economic growth contractionary monetary policy and, 351 Rate of inflation, measuring, 147 Rate of interest See also Interest rate nominal, 150–151 real, 150–151 Rate of production, maximum feasible, 708 Rational expectations hypothesis defined, 381 flexible wages, prices, policy irrelevance, and, 381–383 Rationality, bounded, 9–10 Rationality assumption, 5–6 Rationing essential role of, 80 nonprice methods of, 79–81 price controls and, 80 prices and, 79–80 by queues, 79 by random assignment or coupons, 80 of uses of housing, 82 Real autonomous spending, real GDP and, 267–268 Real-balance effect, 214–215 Real business cycles, policy activism and, 383–385 Real consumption schedule, 253 Real disposable income, 250, 251 Real estate business, trading in, 743 Real GDP, 175–178 aggregate demand decline and, 377 aggregate demand increase and, 376 autonomous spending and, 267–268 base year for, 177 in China, 180 consumption, multiplier, and, 250 determination with fixed vs flexible prices, 237 direct expenditure offsets and, 283 employment and, 233 equilibrium, 259, 263 equilibrium level of, 264 global per capita, 191 labor productivity and, 192, 398–399 long-run growth path for, 212 per capita, 177–178 plotting of, 176–177 as price-corrected GDP, 175 and price level in long run, 209–222 and price level in sticky-price economy, 386–387 and price level in the United States, 221 real autonomous spending and, 267–268 spending, tax cuts, and, 284 weaker dollar and, 244 Real investment, planned, 258 Realism, models and, 7–8 Real rate of interest changes in, 738 defined, 150 nominal rate of interest vs., 150–151 Real saving schedule, 253 Real shock, monetary shock and, 384–385 Real values defined, 175 of dollar, 146 vs nominal values, 175–178 Receipts, business, 162 Recession, 152 See also Great Recession (2000s) Recessionary gap, 240, 278 defined, 240 INDEX ■ Recognition time lag, 285 Redistribution of income, 106 Redlick, Charles, 124 Reentrant, 142 Regional trade agreements, 719 Regional trade blocs defined, 719 percentage of world trade in, 719 protectionism and, 720 Regions, trade among, 40–41 Regressive taxation, 124 Regulation See also Antitrust laws deposit insurance and, 338 by Fed, 331 of negative externalities, 102 positive externalities and, 102 of trade, 715 Related goods, 56 Relative price defined, 50 vs money price, 50–51 Rent in GDI, 172 housing and, 168 Rent controls attempts to evade, 82–83 defined, 82 winners and losers from, 83 Repricing (menu) cost of inflation, 151 Research and development (R&D), 195, 198 Reserve(s) defined, 331–332 of depository institutions, 364 excess, 364 interest rate on, 358–359 Reserve account, official, 731 Reserve ratio, 332 Resource(s) See also Factors of production; Resource allocation defined, endowments as, 210–222 labor, 398–400 misallocations of externalities, 101–102 overallocation of, 101 overutilized, 351 reduction in supply of, 384 scarcity and, 27–28 time as, 42 underallocation of, 102, 350 Resource allocation, 3–4 Resource cost, of inflation, 151 Retail price, at holiday periods, 373 Retained earnings, 127 Revenue, tax, 131 Rewards, for charitable contributions, Ricardian equivalence theorem, 282–283 Ricardo, David, 230, 282 Rice, price ceiling on, 81 Risk foreign exchange, 742 systematic, 330 Rival consumption, principle of, 104 Riverwest, Wisconsin, River Currency and, 339 Rocklin, Thomas, 41 Romania, currency of, 354 Romer, Paul, 198 Ruffin, Roy, 715 Rule of 70, 192 Rule of thumb, 9–10 Rules of origin, 719 Russia, IMF and financial crisis in, 407 S Sahara Care House, 76 Sales taxes defined, 128 maximizing revenues from, 131 states with highest and lowest, 129 Sales value, value added and, 165 Satellites, space debris and, 100 Saving defined, 251 economic growth and, 193–194 income and, 257 inventory accumulation and, 270 investment and, 231–232 national rates of, 193, 194 planned, 252–257 planned vs actual, 261–262 relating to income and consumption, 252–253 savings vs., 251 Saving function, 253, 254 Saving rate, 251 per capita real GDP and, 194 Savings and loan associations (S&Ls), 322 Savings banks, 322 Savings deposits, M2 and, 323 Say, J B., 230 Say’s law, 230–231 Scale, of savings, 325 Scaling, of number line, 18 Scarcity, 26, 27 choice, opportunity cost, and, 29 defined, 27 economic growth and, 36 rationing and, 80 resources and, 27–28 self-interest, specialization and, 39 shortage and, 27, 66 Schedule of demand See Demand schedule Schedule of supply See Supply schedule Schumpeter, Joseph, 203 Science economics as, 7–10 empirical, SDRs See Special drawing rights (SDRs) Seasonal unemployment, 145 Seawater, salt removal from, 89 Secondhand goods, exclusion from GDP, 166 Secular deflation, 218–219 Securities See also Bonds; Stock exclusion from GDP, 165 Fed and, 357 Self-interest in classical model, 231 defined, scarcity, specialization, and, 39 Services See also Goods and services defined, 28, 168 exports and imports, 729 final, 162 Service sector, of economy, 201 Services stage of development, 201 Shipping, railcars and, 114 Shock aggregate demand, 240, 245, 390 aggregate supply, 240, 245 economic impacts of, 245–246 exchange rate and, 742–743 external, 153–154 monetary vs real, 384–385 Shock absorber, exchange rate as, 742–743 Shoe repair services, 68 Shortages, 64, 66 defined, 66 I-12 eliminating price ceilings and, 88–89 scarcity and, 27, 66 of Super Bowl tickets, 67 of water, 74, 88 Short run See also Long run deflation rate in, 378 inflation rate in, 377–378 new Keynesian sticky-price theory and, 387 shocks in, 245 variations in inflation in, 241–244 Short-run aggregate supply output determination using, 236–238 shifts in, 238–239 Short-run aggregate supply curve defined, 237 Keynesian, 235–236 Short-run aggregate supply schedule (SRAS), 236–238, 278 contractionary policy and, 377 expansionary policy and, 376 shifts in, 239 Short-run equilibrium, with monopolistic competition, 381–382 LRAS and, 280 Short-run macroeconomic effects, of higher budget deficits, 308 Simon, Carly, 83 Simon, Julian, 199 Single good or service, demand for all goods and services vs., 216 Slope defined, 21 of line (linear curve), 20, 21–23 of nonlinear curve, 22–23 positive, 21 Small business, unemployment and, 154 Small-denomination time deposits, M2 and, 323 Small menu costs defined, 385 in market for imported beer, 386 Smart phones, Internet access and, 51 Smith, Adam, 5, 230 Smoking See Cigarettes Smoot-Hawley Act (Tariff Act, 1930), 717 Social Security as entitlement, 310, 311 taxes for, 127–128 Solar cells, market clearing price of, 68 South Korea, IMF and financial crisis in, 407 Soybeans, in India, 400 Space junk, 100 Space travel, private production of, 104 Spain, IMF and financial crisis in, 407 Special drawing rights (SDRs), 407, 733 Specialization comparative advantage and, 41 consumption with, 709 defined, 38 in goods for international trade, 711 national and worldwide gains from, 710 among nations, 707–711 output gains from, 707 in production, 709 productivity and, 38–40 scarcity, self-interest, and, 39 Spending See also Consumption, spending drop in U.S.; Expenditures; Government spending; Health care government, 278–279 real GDP and, 284 vs voting, 113 I-13 ■ INDEX Spillover effect, 99, 100 of benefits, 102 SRAS See Short-run aggregate supply schedule SSI See Supplemental Security Income Stabilization, in integrated world economy, 373 Stabilizers, automatic (built-in), 286 Stable aggregate supply, inflationary gap and, 241 Stagflation, 385 Standard of deferred payment, money as, 320 Standard-of-living calculations, GDP and, 166 Standard of value, money as, 319 State(s) allocation of spending by, 107 competition maintained by, 103 with highest and lowest sales tax rates, 129 public education and, 110 spending by, 108 Static tax analysis, 128–129 of capital gains tax, 134 defined, 128 Stevenson, Betsey, 181 Sticky-price economy, real GDP and price level in, 386–387 Sticky prices new Keynesian aggregate supply curve and, 389–390 small menu costs and, 385 Stock defined, 141 flows and, 251 Store of value, 319 Structural unemployment, 144, 374–375 Students, incentives to stop drinking by, 41 Subsidy agricultural, 84, 85 “cash for clunkers,” 88 defined, 63 for exports, 712, 721 foreign, 714 for health care, 109–110 for Medicare, 108 as negative tax, 102 taxes and, 63 Substitute defined, 56 prices of, demand shifts and, 56 Substitution, of foreign goods, 215 Super Bowl market, ticket shortage and, 67 Supplemental Security Income (SSI), 286 Supply aggregate, 239 ceteris paribus conditions and, 62 changes in, vs changes in quantity supplied, 63–64 changes in demand and supply, 76–79 defined, 58 demand and, 48–69 of euros, 735, 736–737, 738 law of, 58–61 of natural gas, 63 other determinants of, 62–63 Supply curve, 60–61 See also Market supply curve aggregate, 237–239 defined, 60 horizontal summation of, 60 individual producer’s supply schedule and, 59 Keynesian short-run aggregate, 235–236 long-run aggregate, 210–212 market, 60–61 Supply schedule, 59–60 See also Supply demand schedule combined with, 64 Supply shifts, 62, 76–78 Supply shocks, aggregate, 240, 245 Supply-side economics defined, 284 tax changes and, 290 Supply-side effects, of changes in taxes, 283–284 Supply-side inflation, 219 Support price See Price floor Surplus, 64, 66–67 See also Budget surplus agricultural, 84 consumer, 94–95 defined, 66 on international accounts, 728 producer, 95–96 Swaps, currency, 742 Systematic decisions, Systematic risk, 330 Systematic risk regulator, Fed as, 330 T Table, graphic numbers in, 19–20 TANF See Temporary Assistance to Needy Families Tangent line, slope of, 23 Tangible goods, 169 Tariff, 705, 706, 716, 717–718 effect on Japanese-made laptop computers, 717 in United States, 717, 718 Tastes, demand shifts and, 55–56 Tax analysis, static, 128–129 Taxation See also Federal taxation; Health care; Income tax ad valorem, 128, 132 as automatic stabilizer, 286 on capital gains, 121 changes in, 279–281 on corporate income, 126–127, 130 double, 126–127 federal, 125–128 fiscal policy and, 296 in future, 311 government spending and, 300–301 indirect business, 172 lump-sum, 263 luxury, 129 marginal and average rates of, 123 Medicare, 127 “millionaires” tax in Maryland, 130 for negative externalities, 102 from producers’ and consumers’ points of view, 131–133 progressive, 124 progressive income, 106 proportional, 124 public debt and, 299 regressive, 124 on richest one percent, 309 sales, 128 Social Security, 127 sources of government tax receipt, 125 supply and, 53 supply-side effects of changes in, 283–284 systems of, 122–124 tax incidence and, 127 unemployment, 128 unit, 131 VAT as, 123 Tax base capital gains tax increase and, 134 defined, 123 Tax bracket, 123 Tax cuts, real GDP and, 284 Tax incidence, 127 Tax rate average, 123 capital gains, 134, 135 defined, 123 dynamic tax analysis and, 129 marginal, 123, 124 sales taxes, 128 static tax analysis and, 128–129 Tax rebates, temporary, 289–290 Tax revenues, maximizing, 130, 131 Taylor rule defined, 361 Fed policy with, 362 plotting on graph, 361–362 Technology clean-energy, 114–115 defined, 33 as factors of production, 195 free trade issues and, 715 growth in, 195 infrared cameras and, 188 productivity and, 63 Temporary Assistance to Needy Families (TANF), 286 Temporary workers, 144 Terrorism, technology against, 188 Tertiary (service) sector, of economy, 201 Thailand, IMF and financial crisis in, 407 Theory See also Model defined, of public choice, 111 Third parties, defined, 100 Thrift institutions, 322 Time comparative advantage and, 40 as resource, 42 Time lags, 285 discretionary fiscal policy and, 285 TIPS (Treasury inflation-protected securities), 392 Tobacco, as money, 318 Total income defined, 162 total output and, 162–163 Total output dollar value of, 163–164 total income and, 162–163 Trade See also International trade balance of, 727 barriers to, 197 consumption with, 709 free, 711, 714–715 gains from, 96 interstate, 40 national and worldwide gains from specialization and, 710 regional, 40–41 regional blocs, 719 restrictions on Japanese imports and, 715 Trade agreements, regional, 719 Trade deficit, 306 federal budget deficits and, 307 Trade deflection, 719 Trade diversion, 719 Trade Expansion Act (1962), 718 Trade-offs, 30–31 between e-readers and netbooks, 32, 33 INDEX ■ between inflation and unemployment, 378 between present and future, 36–38 Trade policy, of United States, 721 Trading Desk defined, 360 at Federal Reserve Bank of New York, 364 Traditional Keynesian analysis, 278 Transaction costs defined, 75–76 in labor market, 145 Transactions approach defined, 322 M1 as measurement of money, 322–323 Transactions demand, 346 Transactions deposits, 320, 322 Transfer(s) exclusion from GDP, 165–166 unilateral, 730 Transfer payments defined, 106 exclusion from GDP, 165–166 government spending and, 106–111 Transfers in kind, 106 Transmission mechanism, of monetary policy, 355–357 Traveler’s checks, 323 Treasury bills, 357 Trend, 212 Trucking industry, prohibition against Mexican trucks on U.S highways, 720 Truman, Harry, 740 Turkey currency of, 354 IMF and financial crisis in, 407 Two-country, two-good world, production and consumption in, 708 Two-good example, of choice, 32 Tyson, Cicely, 83 U Unanticipated inflation anticipated inflation and, 150–151 defined, 150 Underallocation of resources, 102 expansionary monetary policy with, 350 Underground transactions, exclusion from GDP, 166 Unemployment, 140–145 See also Unemployment rate(s) aggregate demand decline and, 377 aggregate demand increase and, 376 arithmetic determination of, 140–143 business fluctuations and, 152–154 categories of people without work, 142 cyclical, 144 defined, 140 discouraged workers and, 143 duration of, 142 1890-2020, 141 frictional, 143–144, 374–375 historical rates of, 140 inflation trade-off with, 378 labor force and, 140, 142 as macroeconomic issue, 140 major types of, 143–145 minimum wage increases and, 87 misery index and, 156 NAIRU and, 378–379 natural rate of, 145–146, 374–380 seasonal, 145 small businesses and, 154 structural, 144, 374–375 Unemployment compensation, stabilizing impact of, 286 Unemployment insurance benefits, job searches and, 374 Unemployment rate(s), 139 imports and, 715 logic of, 142 NAIRU (nonaccelerating inflation rate of unemployment) and, 378–379 Unemployment tax, 128 Unilateral transfers, by U.S residents and government, 730 Unions See Labor unions United Nations, Human Development Index (HDI) of, 167 United States See also Congress (U.S.) historical business activity in, 152–153 inflation and deflation in, 149 inflation in, 220 as leader in deficits and debt, 312–313 minimum wage in, 85–86 natural rate of unemployment in, 375 post offices in, 113 poverty line in, 200 real GDP and price level in, 221 secular deflation in, 219 tariffs in, 717, 718 trade policy objective of, 721 U.S Department of Commerce See also Bureau of Economic Analysis indexes of leading indicators from, 153 U.S Department of Energy, clean technology and, 115 U.S Department of Justice, antitrust laws enforced by, 103 U.S Department of Labor, Bureau of Labor Statistics, 140 U.S government See Federal government U.S Patent and Trademark Office (USPTO), 196 U.S Postal Service (USPS), 112 U.S Treasury, Treasury bills, 357 Unit of accounting, money as, 319 Unit tax, defined, 131 Universities, alcohol consumption at, 41 Used merchandise, gains from international trade in, 711 USPS See U.S Postal Service V Value of gifts, money and, 319, 321 nominal vs real, 175–178 Value added, 164, 165 Variable dependent, 17 direct and inverse relationships between, 17 independent, 17 VAT (value added tax), 123 Vault cash, Fed and, 327–328 Venezuela price ceiling on white rice, 81 private moneys in, 321 Venice, patent development in, 187 Vertical aggregate supply, classical theory, price level, and, 234 Vertical number line, 18 VIE See Voluntary import expansion I-14 Villagomez, Elizabeth, 720 Volkammer, Ingo, movie production incentives and, 11 Voluntary exchange, 75 Voluntary import expansion (VIE), 717 Voluntary restraint agreement (VRA), 716 Voting, vs spending, 113 VRA See Voluntary restraint agreement (VRA) W Wage(s) See also Income tax; Minimum wage; Taxation in classical model, 231 in GDI, 171 minimum wage laws and, 374 Wage flexibility, active vs passive policymaking and, 390 Wampum, 318 Wants defined, needs and, 28–29 War, inflation, deflation, and, 149–150 Water demand for, 74 removing salt from, 89 shortage of, 74, 88 Wealth defined, 257 distribution of, 257 household debt, housing wealth, disposable income, stock wealth, and, 271 net, 257 Wealth effect, 215 Wealth of Nations, The (Smith), 5, 39 Well-being per capita real GDP and, 180–181 public-choice theory and, 111 Wholesale price indexes, 148 Wolfers, Justin, 181 Woodbridge, G L., 715 Workers See Labor World, poverty in, 200 World Bank, 405–407 defined, 405 distribution of lending since 1990, 406 IMF and, 407–408 World output, of goods and services, 706 World population, expected growth by 2050, 202 World trade See International trade World Trade Organization (WTO), 718–719 World War II, inflation, deflation, and, 149–150 WTO See World Trade Organization (WTO) X X axis, 18–19 Y Y axis, 18–19 Yunus, Muhammad, 401–403 Z Zimbabwe hyperinflation in, 363 inflation and money supply growth in, 346 registering business property in, 398 OUR NATIONAL INCOME ACCOUNTS AND REAL GDP SINCE 1929* Disposable Personal Income Real GDP (2005 dollars) 0.3 103.2 9.9 93.3 0.8 9.4 84.7 2.4 0.0 1.4 3.7 84.3 2.6 81.7 *** 1933 45.8 1.6 8.3 0.1 55.7 7.6 48.1 0.3 9.0 39.4 -4.0 0.0 0.5 3.7 46.3 1.4 44.9 *** 1940 71.0 13.4 1.2 1.4 100.1 9.4 90.7 0.4 11.5 79.6 2.0 2.4 2.8 5.2 77.6 2.6 75.0 *** 1944 108.2 7.7 97.1 -2.2 210.9 12.0 198.9 3.5 19.8 182.6 6.7 6.4 9.7 4.7 164.5 18.9 145.6 *** 1950 192.1 55.1 38.8 0.7 286.7 23.6 263.1 1.5 24.8 239.8 6.8 6.5 6.8 8.4 228.1 20.6 207.5 *** 1955 257.9 69.7 75.3 0.4 403.3 34.3 369.0 2.6 35.3 336.3 13.2 8.2 6.0 5.3 314.2 35.4 278.8 *** 1960 331.7 78.9 111.6 4.2 526.4 55.6 470.8 3.1 -1.0 474.9 25.4 22.3 21.7 6.0 411.5 46.1 365.4 2758.7 1965 443.8 118.2 151.5 5.6 719.1 69.4 649.7 5.3 1.6 653.4 38.0 36.3 31.3 7.9 555.7 57.6 498.1 3605.9 1966 480.9 117.7 171.6 3.9 787.7 76.5 711.2 5.1 6.2 710.1 32.1 37.1 38.1 1.0 603.8 66.4 537.4 3845.3 1967 507.8 118.7 192.5 3.6 832.4 82.9 749.5 5.4 4.5 750.4 29.1 39.2 35.3 1.3 648.1 73.0 575.1 3942.5 1968 558.0 132.1 209.3 1.4 909.8 90.4 819.4 6.1 4.3 821.2 29.3 42.3 39.6 1.7 711.7 87.0 624.7 4133.4 1969 605.1 147.3 221.4 1.4 984.4 103.6 880.8 6.1 -1.6 888.5 27.2 43.3 40.0 0.3 778.3 104.5 673.8 4261.8 1970 648.5 152.4 233.8 4.0 1038.5 106.7 931.8 6.4 7.3 930.9 24.6 46.4 34.8 13.7 838.8 103.1 735.7 4264.4 1971 701.6 169.9 246.4 0.6 1126.8 117.8 1009.0 7.6 11.0 1005.6 29.7 50.3 38.2 15.7 903.1 101.7 801.4 4413.3 1972 770.6 198.5 263.4 -3.4 1237.9 127.2 1110.7 9.4 9.8 1110.3 39.0 58.3 42.3 21.9 992.6 123.6 869.0 4647.7 1973 852.4 244.5 281.7 4.1 1382.7 139.3 1243.4 12.5 8.5 1247.4 45.6 75.5 50.0 34.4 1110.7 132.4 978.3 4905.0 1974 933.4 249.4 317.9 -0.8 1500.0 162.5 1337.5 15.5 10.9 1342.1 29.8 85.2 52.8 48.3 1222.6 151.0 1071.6 4881.8 1975 1034.4 230.2 357.7 16.0 1638.3 187.7 1450.6 13.0 17.7 1445.9 50.2 89.3 51.6 80.2 1335.0 147.6 1187.4 4870.9 1976 1151.9 292.0 383.0 -1.6 1825.3 205.2 1620.1 16.9 25.2 1611.8 59.0 101.3 65.3 88.6 1474.8 172.3 1302.5 5130.6 1977 1278.6 361.3 414.1 -23.1 2030.9 230.0 1800.9 20.3 22.3 1798.9 73.2 113.1 74.4 95.0 1633.2 197.5 1435.7 5367.2 1978 1428.5 438.0 453.6 -25.4 2294.7 262.3 2032.4 21.6 26.6 2027.4 81.0 131.3 84.9 107.5 1837.7 229.4 1608.3 5666.3 1979 1592.2 492.9 500.8 -22.5 2563.3 300.1 2263.2 31.9 46.0 2249.1 75.7 152.7 90.0 131.5 2062.2 268.7 1793.5 5845.3 1980 1757.1 479.3 566.2 -13.1 2789.5 343.0 2446.5 34.2 41.4 2439.3 49.9 166.2 87.2 171.9 2307.9 298.9 2009.0 5830.6 1981 1941.1 572.4 627.5 -12.5 3128.4 388.1 2740.3 32.9 30.8 2742.4 68.0 195.7 84.3 196.9 2591.3 345.2 2246.1 5978.7 1982 2077.3 517.2 680.5 -20.0 3255.0 426.9 2828.1 36.5 0.3 2864.3 65.4 208.9 66.5 251.8 2775.3 354.1 2421.2 5862.7 1983 2290.6 564.3 733.5 -51.7 3536.7 443.8 3092.9 37.1 45.8 3084.2 100.1 226.0 80.6 283.2 2960.7 352.3 2608.4 6128.2 1984 2503.3 735.6 797.0 -102.7 3933.2 472.6 3460.6 36.3 14.6 3482.3 130.3 257.5 97.5 292.5 3289.5 377.5 2912.0 6568.5 *Note: Some rows may not add up due to rounding errors Personal Income 8.9 Transfer Payments and Net Interest Earnings 16.7 Undistributed Corporate Profits 77.3 National Income 1929 Net Exports Year Personal Income Taxes and Nontax Payments Equals Corporate Income Taxes Equals Less Social Security Taxes Net U.S Income Earned Abroad Indirect Business Taxes, Transfers, Adjustments Plus Depreciation Less Gross Domestic Product Less Equals Government Purchases of Goods and Services Plus Gross Private Domestic Investment Equals Personal Consumption Expenditures The Sum of These Expenditures Equals Less Net Domestic Product In this table we see historical data for the various components of nominal GDP These are given in the first four columns We then show the rest of the national income accounts going from GDP to NDP to NI to PI to DPI The last column gives real GDP MACROECONOMIC PRINCIPLES Nominal versus Real Interest Rate in ϭ ir ϩ expected rate of inflation where in ϭ nominal rate of interest ir ϭ real rate of interest Marginal versus Average Tax Rates Marginal tax rate = Average and Marginal Propensities APC = APS = MPC = change in taxes due change in taxable income MPS = total taxes due Average tax rate = total taxable income real consumption real disposable income real saving real disposable income change in real consumption change in real disposable income change in real saving change in real disposable income The Multiplier Formula GDP—The Expenditure and Income Approaches Multiplier = GDP ϭ C ϩ I ϩ G ϩ X where C ϭ consumption expenditures I ϭ investment expenditures G ϭ government expenditures X ϭ net exports GDP ϭ wages ϩ rent ϩ interest ϩ profits Say’s Law Supply creates its own demand, or desired aggregate expenditures will equal actual aggregate expenditures Saving, Consumption, and Investment Consumption ϩ saving ϭ disposable income Saving ϭ disposable income Ϫ consumption Multiplier ϫ 1 = MPS - MPC change in change in autonomous ϭ equilibrium real spending real GDP Relationship Between Bond Prices and Interest Rates The market price of existing (old) bonds is inversely related to “the” rate of interest prevailing in the economy Government Spending and Taxation Multipliers Mg = MPS Mt = -MPC * MPS MACROECONOMIC PRINCIPLES Cost of Holding Money Potential Money Multiplier The cost of holding money (its opportunity cost) is measured by the alternative interest yield obtainable by holding some other asset The reciprocal of the reserve ratio, assuming no leakages into currency, is the potential money multiplier Policy Irrelevance Proposition Under the assumption of rational expectations on the part of decision makers in the economy, anticipated monetary policy cannot alter either the rate of unemployment or the level of real GDP Regardless of the nature of the anticipated policy, the unemployment rate will equal the natural rate, and real GDP will be determined solely by the economy’s long-run aggregate supply curve Natural Rate of Unemployment The natural rate of unemployment is the rate of unemployment that exists when workers and employers correctly anticipate the rate of inflation Potential money multiplier = reserve ratio Definition of Money Supply M1 ϭ currency ϩ transactions deposits ϩ traveler’s checks M2 ϭ M1 ϩ Savings deposits at all depository institutions Small-denomination time deposits Balances in retail money market mutual funds Equation of Exchange MsV = PY where Ms ϭ actual money balances held by the nonbanking public V ϭ income velocity of money, or the number of times, on average, each monetary unit is spent on final goods and services P ϭ price level or price index Y ϭ real GDP Relationship Between Imports and Exports In the long run, imports are paid for by exports Therefore, any restriction of imports ultimately reduces exports ... as the rate of change in the price level dropped as low as -2 .5 percent 2. 0 1.5 1.0 0.5 0.0 –0.5 –1.0 –1.5 2. 0 2. 5 20 00 20 02 2004 20 06 20 08 20 10 20 12 2014 Year Deflation Volatility Since the. .. Figure 1 0-3 , 21 2 • MyEconLab Study Plan 10.1 • Video: The Long-Run Aggregate Supply Curve • Animated Figures 1 0 -2 , 1 0-3 aggregate demand, 21 3 aggregate demand curve, 21 3 real-balance effect, 21 5 interest... percent per year Long-run real GDP growth path 17 15.9 15.5 15 14.7 14.3 13 12 2011 20 12 2013 20 14 20 15 Year 20 16 20 17 would increase at a steady annual rate As shown in Figure 1 0-3 above, this means