Ebook Macroeconomics for today (6th edition): Part 2

(BQ) Part 2 book Macroeconomics for today has contents: Fiscal policy, the public sector, federal deficits, surpluses, and the national debt, monetary policy, money creation, money and the federal reserve system, economies in transition, international trade and finance,...and other contents.

CHAPTER CHAPTER 11 Fiscal Policy © David Muir/Digital Vision/Getty Images I n the early 1980s, under President Ronald Reagan, Fiscal policy is one of the major issues that touches the federal government reduced personal income everyone’s life Fiscal policy is the use of government tax rates The goal was to expand aggregate demand and spending and taxes to influence the nation’s output, boost national output and employment in order to end employment, and price level Federal government spend- the recession of 1980–1981 In the 1990s, a key part of ing policies affect Social Security benefits, price supports President Bill Clinton’s economic program was to for dairy farmers, and employment in the defense indus- stimulate economic growth by boosting government try Tax policies can change the amount of your paycheck spending on long-term investment This investment and therefore influence whether you purchase a car or program included highways, bridges, fiber-optic commu- attend college nications networks, and education In 2001, the United Using fiscal policy to influence the performance of the States experienced a recession, and President George W economy has been an important idea since the Bush proposed and signed into law a tax cut in order to Keynesian revolution of the 1930s This chapter removes stimulate the economy And in 2003, another tax cut bill the political veil and looks at fiscal policy from the view- was passed to create jobs and stimulate economic point of two opposing economic theories First, you will growth From May to July 2008, Americans received study Keynesian demand-side fiscal policies that “fine- about $170 billion in a tax-rebate stimulus package tune” aggregate demand so that the economy grows and intended to trigger a spending spree that would enable achieves full employment with a higher price level Sec- the economy to avoid a recession ond, you will study supply-side fiscal policy, which gained 282 prominence during the Reagan administration Supplysiders view aggregate supply as far more important than aggregate demand Their fiscal policy prescription is to increase aggregate supply so that the economy grows and achieves full employment with a lower price level In this chapter, you will learn to solve these economic puzzles: • Does an increase in government spending or a tax cut of equal amount provide the greater stimulus to economic growth? • Can Congress fight a recession without taking any action? • How could one argue that the federal government can increase tax revenues by cutting taxes? Discretionary Fiscal Policy Here we begin where the previous chapter left off—that is, discussing the use of discretionary fiscal policy, as Keynes advocated, to influence the economy’s performance Discretionary fiscal policy is the deliberate use of changes in government spending or taxes to alter aggregate demand and stabilize the economy Exhibit lists three basic types of discretionary fiscal policies and the corresponding ways in which the government can pursue each of these options The first column of the table shows that the government can choose to increase aggregate demand by following an expansionary fiscal policy The second column lists contractionary fiscal policy options the government can use to restrain aggregate demand Increasing Government Spending to Combat a Recession Suppose the U.S economy represented in Exhibit has fallen into recession at equilibrium point E1, where aggregate demand curve AD1 intersects the aggregate supply curve, AS, in the near-full-employment range (Note that for simplicity the aggregate demand and aggregate supply curves are drawn here as straight lines.) The price level measured by the CPI is 150, and a real GDP gap of $100 billion exists below the full-employment output of $6.1 trillion real GDP As explained in the previous chapter (Exhibit 5), one approach the president and Congress can follow is provided by classical theory The classical economists’ prescription is to wait because the economy will self correct to full employment in the long run by adjusting downward along AD1 But election time is approaching, so there is political pressure to something about the recession now Besides, recall Keynes’s famous statement, “In the long run, we are all dead.” Hence, policymakers follow Keynesian economics and decide to shift the aggregate demand curve rightward from AD1 to AD2 and thereby cure the recession How can the federal government this? In theory, any increase in consumption (C), investment (I), or net exports (X À M) can spur aggregate demand But these spending boosts are not directly under the government’s control as is government spending (G) After all, there is always a long wish list of spending proposals for federal highways, health care, education, environmental programs, and so forth Fiscal policy The use of government spending and taxes to influence the nation’s spending, employment, and price level Discretionary fiscal policy The deliberate use of changes in government spending or taxes to alter aggregate demand and stabilize the economy 283 284 PA RT MACROECONOMIC THEORY AND POLICY EXHIBIT Discretionary Fiscal Policies Expansionary Fiscal Policy Contractionary Fiscal Policy Increase government spending Decrease taxes Increase government spending and taxes equally Decrease government spending Increase taxes Decrease government spending and taxes equally Rather than crossing their fingers and waiting for things to happen in the long run, suppose that members of Congress gladly increase government spending to boost employment now But just how much new government spending is required? Note that the economy is operating $100 billion below its full-employment output, but the horizontal distance between AD1 and AD2 is $200 billion This gap between AD1 and AD2 is indicated by the dotted line between points E1 and X This means that the aggregate demand curve must be shifted to the right by $200 billion But it is not necessary to increase government spending by this amount The following formula can be used to compute the amount of additional government spending required to shift the aggregate demand curve rightward and establish a new full-employment real GDP equilibrium: Initial change in government spending (ΔG) Â spending multiplier ¼ change in aggregate demand (total spending) Spending multiplier (SM) The ratio of the change in real GDP to an initial change in any component of aggregate expenditures, including consumption, investment, government spending, and net exports As a formula, spending multiplier equals 1/(1 À MPC) or 1/MPS The spending multiplier (SM) in the formula amplifies the amount of new government spending The spending multiplier is the change in aggregate demand (total spending) resulting from an initial change in any component of aggregate demand, including consumption, investment, government spending, and net exports Assume the MPC is 0.75, and therefore the value for the spending multiplier in our example is The next section explains the algebra behind the spending multiplier so our example can be solved: ΔG Â ¼ $200 billion ΔG ¼ $50 billion Note that the Greek letter Δ (delta) means “a change in.” Thus, it takes $50 billion worth of new government spending to shift the aggregate demand curve to the right by $200 billion As described in the previous chapter (Exhibit 6), bottlenecks occur throughout the upward-sloping range of the AS curve This means prices rise as production increases in response to greater aggregate demand Returning to Exhibit 2, you can see that $50 billion worth of new government spending shifts aggregate demand from AD1 to AD2 As a result, firms increase output upward along the aggregate supply curve, AS, and total spending moves upward CHAPTER 11 EXHIBIT FISCAL POLICY Using Government Spending to Combat a Recession The economy in this exhibit is in recession at equilibrium point E1 on the intermediate range of the aggregate supply curve, AS The price level is 150, with an output level of $6 trillion real GDP To reach the full-employment output of $6.1 trillion in real GDP, the aggregate demand curve must be shifted to the right by $200 billion real GDP, measured by the horizontal distance between point E1 on curve AD1 and point X on curve AD2 The necessary increase in aggregate demand from AD1 to AD2 can be accomplished by increased government spending Given a spending multiplier of 4, a $50 billion increase in government spending brings about the required $200 billion rightward shift in the aggregate demand curve, and equilibrium in the economy changes from E1 to E2 Note that the equilibrium real GDP changes by $100 billion and not by the full amount by which the aggregate demand curve shifts horizontally AS E2 155 Price level (CPI) E1 X 150 AD2 AD1 Full employment 6.1 6.2 Real GDP (trillions of dollars per year) CAUSATION CHAIN Increase in government spending Increase in the aggregate demand curve Increase in the price level and the real GDP along aggregate demand curve AD2 This adjustment mechanism moves the economy to a new equilibrium at E2, with full employment, a higher price level of 155, and a real GDP of $6.1 trillion per year At point E2 the economy experiences demand-pull inflation And here is the important point: Although the aggregate 285 286 PA RT MACROECONOMIC THEORY AND POLICY EXHIBIT The Spending Multiplier Effect Round All other rounds Component of Total Spending New Consumption Spending Government spending Consumption Consumption Consumption Consumption Total spending $ 50 38 29 22 61 $200 Note: All amounts are rounded to the nearest billion dollars per year demand curve has increased by $200 billion, the equilibrium real GDP has increased by only $100 billion, from $6 to $6.1 trillion Conclusion In the intermediate segment of the aggregate supply curve, the equilibrium real GDP changes by less than the change in government spending times the spending multiplier Spending Multiplier Arithmetic Revisited1 Marginal propensity to consume (MPC) The change in consumption spending resulting from a given change in income Now let’s pause to tackle the task of explaining in more detail the spending multiplier of used in the above example The spending multiplier begins with a concept called the marginal propensity to consume (MPC) The marginal propensity to consume is the change in consumption spending resulting from a given change in income Algebraically, MPC ¼ change in consumption spending change in income Exhibit illustrates numerically the cumulative increase in aggregate demand resulting from a $50 billion increase in government spending In the initial round, the government spends this amount for bridges, national defense, and so forth Households receive this amount of income In the second round, these households spend $38 billion (0.75 Â $50 billion) on houses, cars, groceries, and other products In the third round, the incomes of realtors, autoworkers, grocers, and others are boosted by $38 billion, and they spend $29 billion (0.75 Â $38 billion) Each round This section duplicates material presented earlier in the chapters titled “The Keynesian Model” and “The Keynesian Model in Action.” The reason for repeating this material is that an instructor may choose to skip the Keynesian model presented in these two chapters CHAPTER 11 287 FISCAL POLICY of spending creates income for consumption re-spending in a downward spiral throughout the economy in smaller and smaller amounts until the total level of aggregate demand rises by an extra $200 billion Conclusion Any initial change in spending by the government, households, or firms creates a chain reaction of further spending, which causes a greater cumulative change in aggregate demand You might recognize from algebra that the spending multiplier effect is a process based on an infinite geometric series The formula for the sum of such a series of numbers is the initial number times 1/(1 À r), where r is the ratio that relates the numbers Using this formula, the sum (total spending) is calculated as $50 billion (ΔG) Â [1/(1 À 0.75)] ¼ $200 billion By simply defining r in the infinite series formula as MPC, the spending multiplier for aggregate demand is expressed as Spending multiplier ¼ 1 À MPC Aplying this formula to our example: Spending multiplier ¼ 1 ¼ ¼4 À 0:75 0:25 If households spend a portion of each extra dollar of income, then the remaining portion of each dollar is saved The marginal propensity to save (MPS) is the change in saving resulting from a given change in income Therefore: The change in saving resulting from a given change in income MPC ỵ MPS ẳ rewritten as MPS ¼ À MPC Hence, the above spending multiplier formula can be rewritten as Spending multiplier ¼ Marginal propensity to save (MPS) MPS Since MPS and MPC are related, the size of the multiplier depends on the size of the MPC What will the result be if people spend 80 percent or 33 percent of each dollar of income instead of 50 percent? If the MPC increases (decreases), consumers spend a larger (smaller) share of each additional dollar of output/income in each round, and the size of the multiplier increases (decreases) Exhibit lists the multiplier for different values of MPC and MPS Economists use real-world macroeconomic data to estimate a more complex multiplier than the simple multiplier formula developed in this chapter Their estimates of the long run real-world MPC range from 0.80 to 0.90 An MPC of 0.50 is used in the above examples for simplicity 288 PA RT MACROECONOMIC THEORY AND POLICY EXHIBIT (1) Marginal Propensity to Consume (MPC) 0.90 0.80 0.75 0.67 0.50 0.33 Relationship between MPC, MPS, and the Spending Multiplier (2) Marginal Propensity to Save (MPS) 0.10 0.20 0.25 0.33 0.50 0.67 (3) Spending Multiplier 10 1.5 CHECKPOINT What Is the MPC for Uncle Sam’s Stimulus Package? Assume there is concern that the economy is heading into a recession, and a stimulus package of $170 billion is passed by the federal government The administration predicts that this measure will provide a $850 billion boost to GDP this year because consumers will spend their extra cash on plasma televisions and other items For this amount of stimulus, what is the established value of MPC used in this forecast? Cutting Taxes to Combat a Recession Another expansionary fiscal policy intended to increase aggregate demand and restore full employment calls for the government to cut taxes Let’s return to point E1 in Exhibit As before, the problem is to shift the aggregate demand curve to the right by $200 billion But this time, instead of a $50 billion increase in government spending, assume Congress votes for a $50 billion tax cut How does this cut in taxes affect aggregate demand? First, disposable personal income (take-home pay) increases by $50 billion—the amount of the tax reduction Second, once again assuming the MPC is 0.75, the increase in disposable personal income induces new consumption spending of $38 billion (0.75 Â $50 billion) Thus, a cut in taxes triggers a multiplier process similar to, but smaller than, the spending multiplier Exhibit demonstrates that a tax reduction adds less to aggregate demand than does an equal increase in government spending Column reproduces the effect of increasing government spending by $50 billion, and column gives for comparison the effect of lowering taxes by $50 billion Note that the only difference between increasing government spending and cutting taxes by the same amount is the impact in the initial round The reason is that a tax cut injects zero new spending into the economy because the government has purchased no new goods and services CHAPTER 11 EXHIBIT 289 FISCAL POLICY Comparison of the Spending and Tax Multipliers Increase in aggregate demand from Round All other rounds Note: Component of Total Spending (1) $50 billion Increase in Government Spending (ỵG) (2) $50 billion Cut in Taxes (ÀΔ T) Government spending Consumption Consumption Consumption $ 50 $ 38 29 22 38 29 22 Consumption Total spending 61 $200 61 $150 All amounts are rounded to the nearest billion dollars per year The effect of a tax reduction in round is that people spend a portion of the $50 billion boost in after-tax income from the tax cut introduced in round Subsequent rounds in the tax multiplier chain generate a cumulative increase in consumption expenditures that totals $150 billion Comparing the total changes in aggregate demand in columns and of Exhibit leads to the following: Conclusion A tax cut has a smaller multiplier effect on aggregate demand than an equal increase in government spending The tax multiplier can be computed by using a formula and the information from column of Exhibit The tax multiplier is the change in aggregate demand (total spending) resulting from an initial change in taxes Mathematically, the tax multiplier is given by this formula: Tax multiplier ¼ À spending multiplier Returning to Exhibit 2, the tax multiplier formula can be used to see how large a tax cut is needed to shift the aggregate demand curve rightward by $200 billion and restore full employment Applying the formula given above and a spending multiplier of yields a tax multiplier of À3 Note that the sign of the tax multiplier is always negative Thus, a $66.6 billion tax cut is needed to shift the aggregate Tax multiplier The change in aggregate demand (total spending) resulting from an initial change in taxes As a formula, tax multiplier equals À spending multiplier 290 PA RT MACROECONOMIC THEORY AND POLICY demand curve rightward by $200 billion and restore full-employment equilibrium at point E2 Mathematically, Change in taxes Tị tax multiplier ẳ change in aggregate demand ΔT Â À3 ¼ $200 billon ΔT ¼ À$66.6 billon A word of warning concerning the above analysis: In reality, the assumption that the MPC remains unchanged in response to a tax cut may be invalid In 1964, Congress enacted President Kennedy’s tax-cut proposal The tax multiplier worked, and consumer spending lifted the economy out of a recession On the other hand, in 1975, President Gerald Ford persuaded Congress to reduce income taxes to help increase aggregate demand during a recession This time, however, the size of the tax multiplier fell because consumers reduced their MPC This occurred because people saved much of the tax cut, rather than spending it As a result, the anticipated boost to aggregate demand did not materialize Early in 2001, the United States experienced a recession that ended the longest economic expansion in U.S history In response, President Bush and Congress agreed to send out about $40 billion in tax rebates and phase in new lower marginal rates in coming years In 2003, the personal income tax rate reductions scheduled for later years by the 2001 tax cut law were accelerated Again, the key to the amount of real GDP growth depends on the size of the MPC, and in turn the tax multiplier What proportion of the tax cut is spent for consumption? The answer means the difference between a deeper or milder recession, as well as the speed of recovery Using Fiscal Policy to Combat Inflation So far, Keynesian expansionary fiscal policy, born of the Great Depression, has been presented as the cure for an economic downturn Contractionary fiscal policy, on the other hand, can serve in the fight against inflation Exhibit shows an economy operating at point E1 on the classical range of the aggregate supply curve, AS Hence, this economy is producing the full-employment output of $6.1 trillion real GDP, and the price level is 160 In this situation, any increase in aggregate demand only causes inflation, while real GDP remains unchanged Suppose Congress and the president decide to use fiscal policy to reduce the CPI from 160 to 155 because they fear the wrath of voters suffering from the consequences of inflation Although a fall in consumption, investment, or net exports might the job, Congress and the president may be unwilling to wait, and they prefer taking direct action by cutting government spending Given a marginal propensity to consume of 0.75, the spending multiplier is As shown by the horizontal distance between point E1 on AD1 and point E0 on AD2 in Exhibit 6, aggregate demand must be decreased by $100 billion in order to shift the aggregate demand curve from AD1 to AD2 and establish equilibrium at E2, with a price level of 155 Mathematically, ΔG Â ¼ À$100 billion ΔG ¼ À$25 billion Using the above formula, a $25 billion cut in real government spending would cause a $100 billion decrease in the aggregate demand curve from AD1 to AD2 The result is a temporary excess aggregate supply of $100 billion, measured by the distance CHAPTER 11 EXHIBIT FISCAL POLICY Using Fiscal Policy to Combat Inflation The economy in this exhibit is in equilibrium at point E1 on the classical range of the aggregate supply curve, AS The price level is 160, and the economy is operating at the full-employment output of $6.1 trillion real GDP To reduce the price level to 155, the aggregate demand curve must be shifted to the left by $100 billion, measured by the horizontal distance between point E1 on curve AD1 and point E0 on curve AD2 One way this can be done is by decreasing government spending With MPC equal to 0.75, and therefore a spending multiplier of 4, a $25 billion decrease in government spending results in the needed $100 billion leftward shift in the aggregate demand curve As a result, the economy reaches equilibrium at point E2, and the price level falls from 160 to 155, while real output remains unchanged at full capacity An identical decrease in the aggregate demand curve can be obtained by a hike in taxes A $33.3 billion tax increase works through a multiplier of and provides the needed $100 billion decrease in the aggregate demand curve from AD1 to AD2 AS Price level (CPI) E1 160 E′ E2 155 AD2 Full employment AD1 6.1 Real GDP (trillions of dollars per year) CAUSATION CHAIN Decrease in government spending or increase in taxes Decrease in the aggregate demand curve Decrease in the price level from E0 to E1 As explained in Exhibit of the previous chapter, the economy follows classical theory and moves downward along AD2 to a new equilibrium at E2 Consequently, inflation cools with no change in the full-employment real GDP Another approach to the inflation problem would be for Congress and the president to raise taxes Although tax increases are often considered political suicide, let’s suppose Congress calculates just the correct amount of a tax hike required to reduce aggregate demand by $100 billion Assuming a spending multiplier of 4, the tax multiplier is À3 Therefore, a $33.3 billion tax hike provides the necessary $100 billion 291 Production function The relationship between the maximum amounts of output that a firm can produce and various quantities of inputs Production possibilities curve A curve that shows the maximum combinations of two outputs an economy can produce in a given period of time with its available resources and technology Progressive tax A tax that charges a higher percentage of income as income rises Proportional tax A tax that charges the same percentage of income, regardless of the size of income Also called a flat-tax rate or simply a flat tax Protectionism The government’s use of embargoes, tariffs, quotas, and other restrictions to protect domestic producers from foreign competition Public choice theory The analysis of the government’s decision-making process for allocating resources Public good A good or service with two properties: (1) users collectively consume benefits, and (2) there is no way to bar people who not pay (free riders) from consuming the good or service Q Quantity theory of money The theory that changes in the money supply are directly related to changes in the price level Quota A limit on the quantity of a good that may be imported in a given time period R Rational expectations theory The belief that people use all available information to predict the future, including future monetary and fiscal policies Systematic and predictable macroeconomic policies can therefore be negated when businesses and workers anticipate the effects of these policies on the economy Rational ignorance The voter’s choice to remain uninformed because the marginal cost of obtaining information is higher than the marginal benefit from knowing it Real balances effect The impact on total spending (real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value Real GDP The value of all final goods produced during a given time period based on the prices existing in a selected base year Real income The actual number of dollars received (nominal income) adjusted for changes in the CPI Real interest rate The nominal rate of interest minus the inflation rate 562 GLOSSARY Recession A downturn in the business cycle during which real GDP declines, and the unemployment rate rises Also called a contraction Recessionary gap The amount by which the aggregate expenditures curve must be increased to achieve fullemployment equilibrium Recovery An upturn in the business cycle during which real GDP rises Also called an expansion Regressive tax A tax that charges a lower percentage of income as income rises Required reserve ratio The percentage of deposits that the Fed requires a bank to hold in vault cash or on deposit with the Fed Required reserves The minimum balance that the Fed requires a bank to hold in vault cash or on deposit with the Fed Resources The basic categories of inputs used to produce goods and services Resources are also called factors of production Economists divide resources into three categories: land, labor, and capital Robinson-Patman Act A 1936 amendment to the Clayton Act that strengthens the Clayton Act against price discrimination Rule of reason The antitrust doctrine that the existence of monopoly alone is not illegal unless the monopoly engages in illegal business practices S Saving The part of disposable income households not spend for consumer goods and services Say’s Law The theory that supply creates its own demand Scarcity The condition in which human wants are forever greater than the available supply of time, goods, and resources Sherman Act The federal antitrust law enacted in 1890 that prohibits monopolization and conspiracies to restrain trade Short run A period of time so short that there is at least one fixed input Short-run aggregate supply curve (SRAS) The curve that shows the level of real GDP produced at different possible price levels during a time period in which nominal incomes not change in response to changes in the price level Shortage A market condition existing at any price where the quantity supplied is less than the quantity demanded Slope The ratio of the change in the variable on the vertical axis (the rise or fall) to the change in the variable on the horizontal axis (the run) Social benefits and costs The sum of benefits to everyone in society, including both private benefits and external benefits Social costs are the sum of costs to everyone in society, including both private costs and external costs Socialism An economic system characterized by government ownership of resources and centralized decision making Speculative demand for money The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other nonmoney financial assets Spending multiplier (SM ) The ratio of the change in real GDP to an initial change in any component of aggregate expenditures or aggregate demand, including consumption, investment, government spending, and net exports As a formula, the spending multiplier equals 1/(1ÀMPC) or 1/MPS Stagflation The condition that occurs when an economy experiences the twin maladies of high unemployment and rapid inflation simultaneously Stock A quantity measured at one point in time For example, an inventory of goods or the amount of money in a checking account Store of value The ability of money to hold value over time Structural unemployment Unemployment caused by a mismatch of the skills of workers out of work and the skills required for existing job opportunities Subprime mortgage loan A home loan made to borrowers with an above-average risk of default Substitute good A good that competes with another good for consumer purchases As a result, there is a direct relationship between a price change for one good and the demand for its “competitor” good Substitution effect The change in quantity demanded of a good or service caused by a change in its price relative to substitutes Supply A curve or schedule showing the various quantities of a product sellers are willing to produce and offer for sale at possible prices during a specified period of time, ceteris paribus Supply curve of labor A curve showing the different quantities of labor workers are willing to offer employers at different wage rates in a given time period, ceteris paribus Supply-side fiscal policy A fiscal policy that emphasizes government policies that increase aggregate supply in order to achieve long-run growth in real output, full employment, and a lower price level Surplus A market condition existing at any price where the quantity supplied is greater than the quantity demanded T Tariff A tax on an import Tax incidence The share of a tax ultimately paid by consumers and sellers Tax multiplier The change in aggregate expenditures (total spending) resulting from an initial change in taxes As a formula, tax multiplier equals 1Àspending multiplier Tax multiplier The change in aggregate demand (total spending) resulting from an initial change in taxes As a formula, tax multiplier equals 1Àspending multiplier Technology The body of knowledge applied to how goods are produced Term auction facility (TAF) A monetary policy tool created in 2007 during the financial crisis to encourage banks to borrow reserves and thereby extend new loans Under this program, banks in sound financial condition are allowed to make interest rate bids for short-term collateralized Federal Reserve loans Total cost (TC ) The sum of total fixed cost and total variable cost at each level of output Total fixed cost (TFC ) Costs that not vary as output varies and that must be paid even if output is zero These are payments that the firm must make in the short run, regardless of the level of output Total revenue The total number of dollars a firm earns from the sale of a good or service, which is equal to its price multiplied by the quantity demanded Total utility The amount of satisfaction received from all the units of a good or service consumed Total variable cost (TVC ) Costs that are zero when output is zero and vary as output varies Traditional economy A system that answers the What, How, and For Whom questions the way they always have been answered Transactions costs The costs of negotiating and enforcing a contract Transactions demand for money The stock of money people hold to pay everyday predictable expenses Transfer payment A government payment to individuals not in exchange for goods or services currently produced Trough The phase of the business cycle in which real GDP reaches its minimum after falling during a recession Trust A combination or cartel consisting of firms that place their assets in the custody of a board of trustees U Unemployment compensation The government insurance program that pays income for a short time period to unemployed workers Unemployment rate The percentage of people in the civilian labor force who are without jobs and are actively seeking jobs GLOSSARY 563 Unit of account The function of money to provide a common measurement of the relative value of goods and services Unitary elastic demand A condition in which the percentage change in quantity demanded is equal to the percentage change in price Utility The satisfaction, or pleasure, that people receive from consuming a good or service V Variable input Any resource for which the quantity can change during the period of time under consideration Velocity of money The average number of times per year a dollar of the money supply is spent on final goods and services Vertical merger A vertical merger is a merger of a firm with its suppliers Vicious circle of poverty The trap in which countries are poor because they cannot afford to save and invest, but they cannot save and invest because they are poor 564 GLOSSARY W Wage and price controls Legal restrictions on wage and price increases Violations can result in fines and imprisonment Wage and price guidelines Voluntary standards set by the government for “permissible” wage and price increases Wage-price spiral A situation that occurs when increases in nominal wage rates are passed on in higher prices, which, in turn, result in even higher nominal wage rates and prices Wealth The value of the stock of assets owned at some point in time Wealth effect A decrease in consumption spending when the value of assets, such as stocks and homes, falls and an increase in consumption spending when the value of these assets rises World Bank The lending agency that makes long-term low-interest loans and provides technical assistance to less-developed countries World Trade Organization (WTO) An international organization of member countries that oversees international trade agreements and rules on trade disputes INDEX A Ability-to-pay principle, 313–314 Absolute advantage, 463–464 Adaptive expectations theory aggregate demand-aggregate supply model, 439–441 definition, 434–435 political business cycle and, 436 vs rational expectations theory, 439–441 Adjustable-rate mortgages (ARMs), 183, 410–411 Ad valorem tax, 464 Advertising, 59, 94–95 Africa, 460, 513 African-Americans, 166, 167 After-tax income, 138 Agency for International Development (AID), 528–529 Aggregate demand automatic stabilizers, 294–295 classical range, 255 classical view of, 248–250 definition, 198 demand-pull inflation, 184 discretionary fiscal policy, 283–293 effects of increases in, 254 government spending and, 341–342 inflation, 257–259 inflationary gap, 235 Keynesian view of, 247–248, 260 macroeconomic equilibrium, 251–255 monetary policy and, 403–407 nonprice-level determinants, 245–247, 257 Phillips curve and, 429–430, 433 price level and, 243–246 spending multiplier, 229 supply-side fiscal policy and, 295 tax multiplier and, 297 various macroeconomic theories of, 412, 415 Aggregate demand-aggregate supply model (AD-AS) See also Selfcorrecting aggregate supply and aggregate demand model changes in macroeconomic equilibrium, 253–255 classical range, 255 crowding out effect, 341 demand-pull inflation, 259 expectation theories and, 439–441 federal budget and, 328 impact of monetary policy using, 403, 405 intermediate range, 253, 255 Keynes and, 250 Keynesian range, 253 Phillips curve and, 429–430 Aggregate demand curve, 243–244 analysis of, 260 decrease in, 273–275 increase in, 261–262, 271–273, 276–277 interest-rate effect, 244–245 net exports effect, 245 real balances effect, 244 real GDP and, 243, 246 Aggregate expenditures, 198, 226, 231, 234 Aggregate expenditures function, 212–213 Aggregate expenditures-output model, 223–226, 233 Aggregate investment demand, 211 Aggregate output, 226 Aggregate spending, 198 Aggregate supply classical view of, 248–250, 255 Keynes on, 247–248 nonprice-level determinants, 255–257 supply-side fiscal policy and, 295–296, 300 Aggregate supply curve analysis of, 260 classical range, 251 discretionary fiscal policy, 283–286, 290–291 expectations and, 439–440 increase in, 261–262 inflation, 257–259 intermediate range, 251 Keynesian range, 250–251 Keynesian view of, 247–248, 260 macroeconomic equilibrium, 251–255 Phillips curve, 429–431 price level and, 248–249, 251–252 ranges of, 250–252 real GDP and, 248–249, 251–252 shifts in, 256 Agricultural price supports, 101–102 AIDS vaccination market, 106–107 American Greetings, 10 American Medical Association (AMA), 120 American Revolution, 363 Amish, 492, 497 Anti-inflationary theories, 424–425 See also Fiscal policy Anti-recession theories, 423–424 See also Fiscal policy Apple Computer Company, 102 Appreciation of currency, 479 Asia, 460, 513 Asia-Pacific Economic Cooperation, 469 Assets, 376 Associated Press, 70 Association vs causation, 9–10 Australia, 310, 312, 337–338, 513–514 Austria, 471, 514 Automatic stabilizers, 293–295 Automatic transfer of savings accounts, 360 Autonomous consumption, 199 Autonomous expenditures, 211–212 Autonomous government spending, 223 Autonomous investment demand, 211–212 Average tax rate, 314 B Balanced budget multiplier, 292–293 Balance of payments, 470–475 Balance of trade, 470–471, 473–475 See also International trade Balance of trade deficit, 471, 474–475 Balance of trade surplus, 471 Banana imports, 468–469 Bangladesh, 514, 516, 517 Bank failures, 361, 366 Banking revolution, 367–369 Banking system See also Federal Reserve System discount rate, 385–387 how a single bank creates money, 375–380 Monetary Control Act of 1980, 367–369, 387 multiplier expansion of money by, 380–382 open market operations, 382–385 required reserve ratio, 387–388 revolution in, 367–369 savings and loan crisis, 369 Bank One Investment Advisers, 10 Bankruptcy, 337 Banks, regulation of, 366 Barter, 355 Base-year prices, 175 Baum, L Frank, 482 Bear Stearns, 410–411 Beige Book, 388 Belgium, 471, 514 Benefit-cost analysis, 318, 320 Benefits-received principle, 312–313 Bernanke, Ben, 363 Betting money, 398 Black market, 98, 319, 442 Black Thursday, 196, 212 Blue Book, 388 Board of Governors of Federal Reserve System, 363–365 Bolivia, 186, 514 Bookkeeping, banker, 376–377 Boston Globe, 507 Boston Snow Index, 10 Bottlenecks, 253 565 Brain drain, 519–520 Brazil, 514 Break-even income, 199 Bretton Woods system, 483 Bryan, William Jennings, 482 Buchanan, James, 318 Budget deficit, 293, 331, 332–334 Budget Enforcement Act, 332 The Budget of the United States, 329 Budget resolution, 329 Budget surplus, 293, 331, 332–334, 336 Bulgaria, 471 Bureaucratic inefficiency, 322 Bureau of Economic Analysis, 123, 135 Bureau of Engraving and Printing, 382 Bureau of Labor Statistics, 157, 173 Burmester, Sven, 507 Burns, Arthur, 443 Bush, George H.W., 12, 334 Bush, George W., 282, 290, 306, 336, 363 Business Conditions Digest, 154 Business Cycle Dating Committee, 152 Business cycles historical record of, 153 indicators, 154–155, 156 phases of, 150–153 real GDP growth rates internationally, 154 total spending and, 155–156 Business inventories, 127 Business investment, 154 Business taxes, 210–211 Buyers, expectations of, 61, 62 C Canada economic system of, 503–504 GDP per capita, 514 government expenditures in, 310 gross domestic product, 133 as industrially advanced nation, 513 NAFTA and, 468 national debt in, 337, 338 taxes in, 310, 312 trade deficit, 474–475 as trading partner, 459, 460 unemployment, 160 Capacity utilization, 210 Capital accumulation of, 275–276, 520–522 in circular flow model, 125–126 definition, 4–5 depreciation, 129, 131 government gross investment, 128 gross private domestic investment, 127 human resources, 275, 519–520 566 INDEX in industrially advanced countries, 513 in less-developed countries, 520–522, 524–525, 527–528 potential real GDP, 275 privately owned, 499, 500 production possibilities curve, 42–43 public, 43 publicly owned, 502, 503 Capital account, 472–474 Capital budget, 343 Capital flight, 521 Capital formation, 43 Capital goods, 34–35, 42, 136, 521, 525 Capitalism, 499–500 Caplan, Arthur, 75 CARE, 528 Carlson, Chester, 39 Carnegie Mellon University, 163 Carter, Jimmy, 441 Castro, Fidel, 502 Causation vs association, 9–10 Cause-and-effect relationships, 9–10 Center for Clinical Medical Ethics, 74 Central American Free Trade Agreement (CAFTA), 469 Central authority, 492 Centralized decision making, 502, 503 Central planning, 492–496 Certificates of deposit, 131 Ceteris paribus assumption, 8–9 Chan, Anthony, 10 Chavez, Hugo, 505 Cheap foreign labor argument, 467 Checkable deposits, 360, 361, 376 Chile, 514 China communism in, 501 economic system of, 503–504, 505–508, 506–507 free market reforms in, 506–507 free trade and, 469 GDP per capita, 514 gross domestic product, 131, 133 Hong Kong and, 526 inflation in, 185 mixed economy, 497, 499 quality-of-life measures of development, 517 real GDP, 155 technological changes in, 522 trade deficit and, 474–475 as trading partner, 459, 460 Chiquita Brands International, 468 Chodad, John, 358 Choice, 5–6, 33 Churchill, Winston, 491 Church World Relief, 528 Circular flow model, 124–126, 147–148 Civilian labor force, 157 Civilian unemployment rate, 157, 167 Classical economic theory on aggregate supply, 248–250, 255 compared to other macroeconomic theories, 412–415 on contractionary fiscal policy, 424–425 on expansionary fiscal policy, 423–424 on inflation, 291, 412, 444 introduction, 199–200 on investment expenditures, 207, 405 Keynes on, 223, 226, 260, 415 monetarism and, 406–407, 408 monetary policy, 412 overview of, 412–415 rational expectations theory and, 438–439 recession and, 283 supply-side fiscal policy and, 295 unemployment, 412 Classical range, 250–252, 254–255 Clearing checks, 379–380 Clinton, Bill, 282, 306, 334 Coincidence of wants, 355 Coincident indicators, 154, 156 Colbert, Jean Baptiste, 311 Command economy, 492–496 Command socialism, 500 Commerce Department, 123, 128, 154 Commodity money, 358–359 Common Market, 470 Communism, 500–501 Communist Manifesto (Marx), 501 Comparative advantage, 462–463 Competition, 102, 104 Complementary goods, 61, 63 Conditional positive statements, 11 Congressional Budget Office, 329 Consumer Confidence Index, 154 Consumer goods, 36 Consumer price index (CPI), 139, 173–180 Consumer protection, 366–367 Consumer sovereignty, 499 Consumer surplus, 85–86 Consumption, 128, 199, 203, 206, 208, 257 Consumption function, 198–200, 203, 204–207 Consumption possibilities, 460 Continental Congress, 363 Continuing resolutions, 329 Contractionary fiscal policy, 283–284, 424–425 See also Fiscal policy Copayment rate, 117 Core CPI, 389 Corporate income tax, 310 Corporate profits, 130, 138 Costa Rica, 469 Cost-of-laughing index, 178–179 Cost-of-living adjustment (COLA), 181 Cost-push inflation, 184–185, 257–259, 431 Council of Economic Advisers, 329, 442 Counterfeiting, 357 Cowen & Co., 70 Credit cards, 357 Crowding-out effect, 341–343, 415 Cuba, 503–505 Currency, 359, 360, 478, 479 See also Money Current account, 470–473 Current-dollar GDP, 139 Current-year prices, 174 Cyclical unemployment, 162 Cyprus, 471 Czech Republic, 471 D Dairy price support program, 103 Das Kapital (Marx), 501 Deadweight loss, 88, 89 Debt See National debt Debt ceiling, 334 Decentralized decision making, 499 Deficit Reduction Act, 332 Deflation, 173, 176 Dell, 70, 102 Demand advertising on, effect on, 94–95 changes in quantity demanded vs changes in demand, 56–58 excess quantity, 75 as factor market, 125–126 for foreign exchange, 476–481 health care market, 117–120 increases and decreases in, 271–275 individual, 55–56 law of, 22, 55–56, 180 market equilibrium and, 94 nonprice determinants of, 57–63, 119 Demand analysis, and market supply, 73–75 Demand arrow, in circular flow model, 124–126 Demand curve definition, 55 example, 76 health care market and, 119 market equilibrium, effects of shifts on, 95 movement along vs shift in demand, 59 Demand deposit, 360 Demand for money curve, 398–399 Demand-pull inflation, 184, 257–259, 285, 295, 429 Demand shifters, 57 Demand-side fiscal policy, 296, 299 Deng Xiaoping, 505–506 Denmark, 471, 514 Deposit insurance, 368 Deposit multiplier, 381 Depository Institutions Deregulation and Monetary Control Act of 1980, 360, 367–369 Deposits, accepting new, 377–378 Depreciation, 129, 130, 131 Depreciation of currency, 478 Depression, 150 See also Great Depression Detroit Symphony Orchestra, 163 Development, quality-of-life measures, 516–517 Directive, 389 Direct relationships, 19–20 Discount rate, 385–387 Discount window, 385 Discouraged worker, 158, 166 Discretionary fiscal policy balanced budget multiplier, 292–293 to combat inflation, 290–292 to combat recession, 283–286, 288–290 spending multiplier, 286–288 Disequilibrium, 224 Disinflation, 176 Disposable personal income, 137–138, 288 Dissaving, 199 Distribution of products, 132–134 Divisibility, 358 Dole Food Company, 468 Dominical Republic, 469 Double counting, 124 Dow Jones Industrial Average, 212–213 Drug trade, illegal, 134 Durable goods, stock of, 207 Dust Bowl, 166 E Eastern Europe, 501 EconCentral Web site, 26 Economic bads, 134 Economic efficiency, 500 Economic freedom, 500 Economic growth See also International growth and development definition, 152 internationally, 154 public capital and, 43 resource changes, 39 sources of, 37–42 technological changes, 39 Economic Report of the President, 175 Economics careers in, 12–14 definition, 5–6 disagreement in, 11–12 fundamental questions, 32 graphs in, 19–26 methodology of, 6–8 normative, 11–13 positive, 11, 13 Economic systems capitalism, 499–500 command economy, 492–496 communism, 500–501 comparison of, 503–504, 506–507 market economy, 496–497 mixed economy, 497–499 socialism, 500–503 traditional economy, 492 in transition, 504–508 types of, 492–532 Economic way of thinking disagreements, 11–12 hazards of, 8–10 methodology, 6–8 scarcity, 3–5 scarcity and choice, 5–6 Efficiency, economic, 500 Efficient points, 35 Egypt, 185, 514, 517 Einstein, Albert, Eisenhower, Dwight, 441 El Salvador, 469 Embargo, 464 Employee compensation, 129–131 Employment, effect of monetary policy on, 403–405 See also Unemployment Employment Act of 1946, 156 Employment argument, 467 Engels, Friedrich, 501 Entrepreneurship, 4, 41 Equal Credit Opportunity Act, 366–367 Equation of exchange, 406–407 Equilibrium Keynesian, 224–226 macroeconomic, 251–255 market, 94–97 market supply and demand analysis, 73–75 price level, 276 in self-correcting aggregate demand and supply models, 270–271 Equilibrium interest rate, 399–401 Equilibrium price, 98 Essential services, 97 Estonia, 471 Ethiopia, 513, 514 Euro, 470–471 European Central Bank, 471 INDEX 567 European Economic and Monetary Union, 470 European Economic Community, 470 European Union banana imports, 468–469 economic system of, 503 free trade and, 468–469, 470 as trading partner, 460 Excess quantity of money demanded, 400–401 Excess quantity of money supplied, 401 Excess quantity of supply, 75 Excess reserves, 376 Exchange, equation of, 406–407 Exchange, medium of, 355–356 Exchange rates fluctuations in, 481–484 gold standard, 482–483 relative incomes and, 479 relative price level changes, impact of, 480–481 relative real interest rates and, 481 shifts in supply and demand for foreign exchange, 477–481 supply and demand for foreign exchange, 476–477 tastes and preferences, 478–479 Excise tax, 310 Expansion, 150 See also Recovery Expansionary fiscal policy, 283–284, 290, 423–424, 436 Expectations, 184, 205, 210 Expectations theory, 439–441 See also Adaptive expectations theory; Rational expectations theory Expenditure approach to GDP, 126–129, 132 Exports, 128–129 External benefit, 105, 106 External cost, 105, 106 External debt, 474 Externalities, 105–107 External national debt, 339 F Factor markets, 125–126 Factors of production, Fair Labor Standards Act, 13 False beacon, GDP as, 135 Favorable balance of trade, 471 Federal Advisory Council, 364–365 Federal budget, 328–334 AD-AS model, 328 debt ceiling, 334 deficits and surpluses, 293, 331, 332–334, 336 568 INDEX expenditures, 307, 310, 331, 333 national debt and, 329–332, 334–343 process of, 328–329, 330 revenues, 331, 333 surplus debate, 336 Federal debt See National debt Federal Deposit Insurance Corporation (FDIC), 366, 369 Federal Express, 41 Federal funds market, 386 Federal funds rate, 386, 389 Federal income tax rate schedule, 315 Federal net interest, 339 Federal Open Market Committee (FOMC), 364–365, 383, 388–389 Federal Reserve Act of 1913, 362 Federal Reserve banks, 365–367 Federal Reserve System See also Fiscal policy; Monetary policy; Money creation activist monetary policy, 423 Board of Governors, 363–365 definition, 361 discount rate, 385–387 Federal Reserve districts, 364 incomes policy, 443 open market operations, 382–385 organizational chart, 362–365 political business cycle, 436–437 required reserve ratio, 387–388 Federal Savings and Loan Insurance Corporation (FSLIC), 369 Federal Tax Code, 318 Fiat money, 359 Final goods, 124, 156 Financial capital See Capital Financial Services Modernization Act, 369 Finland, 471, 514 Fiscal policy, 282–300 anti-inflationary theories, 424–425 anti-recession theories, 423–424 automatic stabilizers, 293–295 balanced budget multiplier, 292–293 classical view of, 412 contractionary, 283–284, 424–425 cutting taxes to combat a recession, 288–290 demand-side, 296 discretionary fiscal policy See Discretionary fiscal policy expansionary, 283–284, 290, 423–424, 436 inflation, 290–292 Keynesian view of, 412, 415 lags in monetary vs fiscal policy, 390 monetarist view of, 412 nondiscretionary fiscal policy, 293 spending multiplier, 284, 286–288 supply-side, 295–300 used to combat inflation, 290–292 Fixed investment, 127 Fixed money target, 408–409 Fixed resources, 34–35 Fixed-wage contracts, 268 Fixed-weight price index, 174 Flat tax, 316–317, 319 Flow, 126 FOMC directives, 364 Food and Drug Administration (FDA), 120 Food stamps, 109 Forbes, Steve, 306, 319 Ford, Gerald, 12, 290, 443 Ford, Henry, 39 Forecasts, Foreign aid, 527–528 Foreign labor, 467 Foreign loans, 528–529 Foreign private investment, 525, 527 45-degree line, 199–200, 202, 204–205, 215, 225 Fractional reserve banking, 375 France economic system of, 503 free trade and, 471 GDP per capita, 514 government expenditures in, 309, 310 gross domestic product, 133 mixed economy, 499 national debt in, 338 real GDP, 155 taxes in, 310, 312 trade deficit and, 475 unemployment, 160 Freedom, economic, 500 Free enterprise system, 499–500 Free market reforms in China, 506–507 Free riders, 107 Free to Choose (Friedman), 108 Free trade, 464–466, 468–470 Free Trade Area of the Americas (FTAA), 469 Frictional unemployment, 160–161 Friedman, Milton free lunch comment, 32 on inflation, 444 monetarism and, 408, 412 on monetary policy, 413 on private ownership, 500 on school vouchers, 108–109 Friedman, Rose, 108–109 Full employment, 163–164 Full Employment and Balanced Growth Act of 1978, 156–157 Fully employed resources, 35 Future production possibilities curve, 42–44 G Gambling, 134 Gasoline price ceiling, 98–100 Gateway, 102 GDP chain price index, 139–141, 173 GDP gap, 164–167, 225 GDP per capita, 513–516 General Agreement on Tariffs and Trade (GATT), 464–465, 468, 523 General Motors (GM), 123, 130–131 The General Theory of Employment, Interest, and Money (Keynes), 198, 221, 247–248, 260, 397, 415 Georgia, 514 German Weimar Republic, 187 Germany free trade and, 471 GDP per capita, 514 government expenditures in, 309, 310 gross domestic product, 133 inflation in, 185, 187 national debt in, 338 real GDP, 155 taxes in, 310, 312 trade deficit and, 475 unemployment, 160 Gold, 367 Goldsmiths, 375 Gold standard, 482–483 Goods capital, 34–35, 42, 136, 521, 525 inferior, 59–62 intermediate, 124 military, 36 normal, 59–60, 62 public, 107–109, 312–313 substitute, 61, 63 Gosplan, 493 Government See also Federal budget; Government spending consumption expenditures and gross investment, 128, 307 expenditure patterns, 307–309 expenditures, 307, 310, 331, 333 financing budgets, 309–311 gross investment, 128 purchases, 128 regulation See Regulation revenues, 311, 331, 333 size and growth, 307–309 Government spending aggregate demand and, 341–342 autonomous, 223 increase to combat a recession, 283–286 in Keynesian model, 222–223 as nonprice-level determinant, 257 recessionary gap, 230–232 spending multiplier effect, 227 The Grapes of Wrath (Steinbeck), 166 Graphing Workshop, 26 Graphs, 19–26 direct relationship, 19–20 inverse relationship, 20–22 slope of a curve, 23–24 slope of a straight line, 22 study hint for using, 26 three-variable relationship, 24–26 Great Depression aggregate expenditures function and, 212 business cycles and, 150 expectations during, 210 inflation and, 172, 176–177 Keynesian model and, 196 Keynes on, 221, 226 monetary policy during, 413–414 price level and, 414 unemployment during, 156, 159, 162, 166, 414 “Great Inflation,” 172 Greece, 471, 514 Green Book, 388 Greenspan, Alan, 336, 410–411 Gross domestic product (GDP), 122–141 See also Nominal GDP; Real GDP chain price index, 139–141, 173 current-dollar, 139 definition, 123–124 disposable personal income, 138 economic bads, 134 employee compensation, 129–131 expenditure approach, 126–129, 132 as false beacon, 135 final goods, 124, 156 formula for, 129 gap, 164–167, 225 government consumption expenditure and gross investment, 128 gross private domestic investment, 127–128 income approach, 129, 132 industrially advanced countries, 513–515 internationally, 131, 133 measurement of, 124–126 national income, 135–138 neglect of leisure time, 134 net exports, 128–129, 222–223, 257 new domestic production, 123–124 nominal, 139–141 nonmarket transactions, 132 per capita, 513–516 personal consumption expenditures, 126–127, 154 personal income, 136–138, 288 pollution and, 135 potential real GDP, 164–165, 275 products, distribution, kind, and quality of, 132–134 shortcomings of, 132–136 underground economy, 134 Gross private domestic investment, 127–128 Gross public debt, 330 Growth, economic, 152 See also International growth and development internationally, 154 public capital and, 43 resource changes, 39 sources of, 37–42 technological changes, 39 Guatemala, 469 Gun trade, illegal, 134 H Haiti, 185, 514, 527 Hayek, Friedrick von, 499 Health care market applying supply and demand analysis with, 117–120 impact of health insurance, 117–119 market failure, 118 shifts in demand curve, 119 shifts in supply curve, 120 Health insurance, 117–119 Heilbroner, Robert L., 492 Hewlett-Packard, 70 Hispanics, 166, 167 Hitler, Adolf, 396 Hogan, Daniel E., 10 Honduras, 469 Hong Kong, 469, 503–504, 514, 522, 526–527 Hoogewerft, Rupert, 507 Hoover, Herbert, 413 Housing bubble, 410–411 Huckabee, Mike, 319 Hu Jintao, 507 Human capital, 275, 519–520 Human Report, 507 Human resources, 519–520 Hungary, 471 Hyperinflation, 185–186 I IBM, 102 Ice cream quotas, 233 Identity, 406–407 If-then predictions, 11 Illegal drug trade, 134 INDEX 569 Illegal gun trade, 134 Illegal market See Black market Illiteracy rates, 519 Imports, 128–129 Income demand for health care and, 119 disposable personal, 138, 288 inflation consequences, 180–181 national income, 136 as nonprice determinant of demand, 59–62 personal, 136–138 real, 180–181 real disposable, 199–201, 203–204, 206, 211 rental, 130 taxable, 314 Income approach to GDP, 129, 132 Income inequality, 108–109 Income security, 307 Incomes policy, 441–443 Incomplete knowledge, 268 Increasing opportunity costs, law of, 37, 38, 459 Independent relationship, 22–23 India, 155, 514, 517 Indirect business taxes, 130, 131 Individual demand, 55–56 Individual income taxes, 309 Indonesia, 514 Industrially advanced countries (IACs) assistance to less-developed countries, 524–529 capital in, 513 compared to less-developed nations, 513–517 GDP per capita, 513–515 Hong Kong, 526–527 quality-of-life measures of development, 516–517 Infant industry argument, 466 Inferior goods, 59–62 Infinite geometric series, 287 Inflation aggregate demand, 257–259 classical view of, 291, 412, 444 consequences of, 180–184 consumer price index, 173–176, 177–180 cost-push, 184–185, 257–259, 431 demand-pull, 184, 257–259, 285, 295, 429 fiscal policy used to combat, 290–292 during Great Depression, 172, 176–177 “Great Inflation,” 172 historically, 176–177, 432 hyperinflation, 185–186 income, effect on, 180–181 interest rates and, 183–184 570 INDEX internationally, 185–187 Keynesian view of, 412, 444–445 meaning and measurement of, 173–180 monetarist view of, 412, 444–445 Phillips curve and, 431, 433 rational expectations theory and, 438 real interest rate and, 183–184 various macroeconomic models cure for, 444–445 wealth and, 182 WIN button, 443 Inflationary gap, 234, 235 Inflation psychosis, 187 Inflation rate, 175 Infrastructure, 521, 523 An Inquiry into the Nature and Causes of the Wealth of Nations See The Wealth of Nations (Smith) Inside lag, 390 Intercept, 22 Interest, net, 130–131 Interest, private, 502 Interest rate consumption function and, 207 equilibrium, 399–401 exchange rates and, 481 federal net, 339 inflation and, 183–184 investment demand and, 211 investment demand curve and, 209 monetary policy, effect of, 401–403 nominal, 183 Interest-rate effect, 244–245 Intermediate goods, 124 Intermediate range, 250–255 Internal national debt, 338–339 International debt of U.S., 474–475 International growth and development accumulation of capital, 520–522 determinants of, 524 human resources, 519–520 infrastructure, 521, 523 international trade See International trade law and order, 523 natural resources, 519 political environment, 522–524 production possibilities curve, 517–518, 521 technological progress, 522 International Monetary Fund (IMF), 483, 528 International trade absolute advantage, 463–464 balance of payments, 470–475 balance of trade, 470–471, 473, 474–475 benefits of, 461 cheap foreign labor argument, 467 comparative advantage, 462–463 economic growth and development, 523 embargo, 464 employment argument, 467 exchange rates, 476–484 free trade, arguments for, 468–470 free trade vs protectionism, 464–466 infant industry argument, 466 national security argument, 466–467 need for, 459–462 production possibilities curve and, 459 protectionism, arguments for, 466–468 quota, 466 specialization, 460–462 tariffs, 464–465 U.S trading partners, 460 Invention, 39 Inventory, 224–225 Inverse relationships, 20–22 Investment, 43, 127–128, 208–209, 211, 257, 525, 527 Investment demand as autonomous expenditure, 211–212 business taxes, 210–211 capacity utilization, 210 expectations, 210 fixed, 127 instability of, 210–212 interest rates and, 211 technological changes, 210 Investment demand curve, 207–209, 405 Investment expenditures, 207–209, 405 Investment tax credit, 211 Invisible hand, 496, 497, 498, 499 Iran, 185, 514 Ireland, 471, 514 Israel, 503, 514 Italy as EU member, 471 GDP per capita, 514 government expenditures in, 310 national debt in, 338 taxes in, 310, 312 trade deficit and, 475 unemployment, 160 J Jackson, Andrew, 327 Jagger, Mick, 12 Japan economic system of, 503–504 free trade and, 469 GDP per capita, 514 government expenditures in, 310 gross domestic product, 131, 133 as industrially advanced nation, 513 mixed economy, 499 national debt in, 338 production possibilities curve for, 39 quality-of-life measures of development, 516, 517 real GDP, 155 taxes in, 312 technological changes in, 522 trade deficit and, 474–475 as trading partner, 459, 460 unemployment, 160 Jawboning, 441 Johnson, Lyndon, 441 Jordan, 514 J.P Morgan Chase, 410–411 K Keating, Charles, Jr., 368 Kennedy, John, 290, 441 Keynes, John Maynard See also Keynesian economic theory on aggregate supply, 247–248 assessment of, 260 on classical economic theory, 223, 226, 260, 415 compared to other economists, 412 on fiscal policy, 412, 415 on the Great Depression, 221, 226 on inflation, 444 introduction, 196–198 on investment expenditures, 207–209 on investment spending, 405 letter to Shaw, 221 on monetary policy, 397, 412 on personal consumption, 204 Keynes, John Neville, 260 Keynesian economic theory, 196–213, 221–235 adaptive expectations theory and, 434 AD-AS model, 250 on aggregate demand, 247–248, 260 aggregate demand curve See Aggregate demand curve aggregate expenditures function, 212–213 aggregate expenditures-output model, 223–226, 233 aggregate supply curve and See Aggregate supply curve consumption function, 198–200, 203–207 on contractionary fiscal policy, 424–425 development of, 197–205 on effect of fiscal policy, 412 on expansionary fiscal policy, 423–424 government spending, 222–223 Great Depression and, 196 on inflation, 412, 444–445 inflationary gap, 235 introduction, 196–198 investment expenditures, 207–209 Keynesian equilibrium, 224–226 marginal propensity to consume, 200–204, 230, 286–288 marginal propensity to save, 200–204, 230, 287–288 vs monetarism, 413 net exports, 128–129, 222–223, 257 overview of, 415 on rational expectations theory, 438–439 recessionary gap, 230–234 spending multiplier effect, 226–230, 286 unemployment, 412 view of role of money, 397–401 Keynesian equilibrium, 224–226 Keynesian monetary policy transmission mechanism, 403, 406 Keynesian range, 250–252, 253–254 Korean War, 442 Kushner, Malcolm, 178–179 L Labor, 4–5, 101 See also Labor markets Labor, Department of, 157, 173 Labor markets, 297, 435–437 See also Unemployment Laffer, Arthur, 298, 444 Laffer curve, 298, 306 Lagging indicators, 154–155, 156 Laissez-faire theory, 197, 406, 496, 526 Land, Latin America, 460, 468–469, 503, 513 Latvia, 471 Law and order, 523 Leading indicators, 154–155, 156 Leisure time, 134 Lenin, Vladimir, 396 Less-developed countries (LDCs) assistance from industrially advanced countries, 524–529 capital in, 520–522, 524–525, 527–528 compared to industrially advanced nations, 513–517 foreign aid, 527–528 foreign loans, 528–529 foreign private investment, 525, 527 GDP per capita, 513–515 production possibilities curve for, 525 quality-of-life measures of development, 516–517 Levi Strauss Company, Liabilities, 376 Lincoln, Abraham, 327 Lincoln Savings and Loan, 368 Liquidity, 356–357 Lithuania, 471 Loans, making, 378–379 Loan-sharking, 134 Logrolling, 321 Long-run aggregate supply curve (LRAS), 269, 270, 276–277 Long-run Phillips curve See also Phillips curve adaptive expectations theory, 434–435 labor market and, 435–437 natural rate hypothesis, 432–434 vs short-run, 433 Lucas, Robert, 437, 444 Luxembourg, 471, 514 M M1, 359–360, 377–384, 390 See also Money M2, 361, 390 See also Money Macroeconomic equilibrium, 251–255 Macroeconomic models, 415 See also Classical economic theory; Keynesian economic theory; Monetarism; New classical economists; Supply-side economics Macroeconomics, 5–6 Majority-rule problem, 318–321 Malta, 471 Mantle, Mickey, 75 Mao Tse-Tung, 505 Marginal analysis, 34 Marginal propensity to consume (MPC), 200–204, 230, 286–288 Marginal propensity to save (MPS), 200–204, 230, 287–288 Marginal rule, 320 Marginal tax rate, 315–316 Market, 71 Market basket, 173–174 Market clearing, 74 Market demand, 55 Market demand curve, 57, 86 Market economy, 54, 249, 428, 496–497, 499 Market efficiency, 85, 88–89, 102 Market equilibrium, 94–97 Market failure definition, 88, 102 externalities, 105–107 health care market and, 118 income inequality, 108–109 INDEX 571 Market failure (Cont.) lack of competition, 102, 104 public goods, 107–108 Market supply, 65 Market supply and demand analysis, 71–77 Market supply curve, 65–66, 87 Marshall, Alfred, 74 Marx, Karl, 500–501 Mattress money, 397 McCain, John, 306, 319 McKinley, William, 482 Medicaid, 117 Medicare, 117, 307 Medium of exchange, 355–356 Mercantilism, 496 Merrill Lynch, 411 Merva, Mary, 166 Mexico economic system of, 503 free trade and, 469, 483–484 GDP per capita, 514 gross domestic product, 133 NAFTA and, 468 real GDP, 155 trade deficit and, 474–475 as trading partner, 459, 460 Microeconomics, 5–6 Middle East, as trading partner, 460 Military goods, 36 Milk industry, 103 Minimum wage, 13, 100–101 Ministry of Economy, Trade, and Industry (METI), 499 Misery index, 431 Mixed economy, 497–499 Model, Model development, 6–7 Monetarism classical economic theory on, 406–408 equation of exchange, 406–407 fiscal policy, effects of, 412 fixed money target, 408–409 housing bubble, 410–411 on inflation, 412, 444–445 vs Keynesian model, 413 modern monetarism, 408 on monetary policy, 412 money, role of, 405–411 overview of, 415–416 quantity theory of money, 407–408 transmission mechanism, 405–411 unemployment and, 212 velocity, 409–412 Monetary Control Act of 1980, 367–369, 387 A Monetary History of the United States (Friedman/Schwartz), 413 Monetary policy, 396–416 activist, 423 572 INDEX AD-AS model, impact of using, 403, 405 aggregate demand, effect on, 403–407 classical view of, 412 creation of money and, 382–388 demand for money, 397–399 discount rate, 385–387 employment, effect on, 403–405 equilibrium interest rate, 399–401 expansionary monetary policy effects on aggregate demand, 404 Federal Open Market Committee (FOMC), 388–389 Federal Reserve System and, 423 during Great Depression, 413–414 interest rate, effect on, 401–403 Keynesian view of, 397–401 lags in monetary vs fiscal policy, 390 monetarist view of, 412 money multiplier inaccuracy, 388–389 money supply, effect of, 390 money supply, effect of changes in, 401–403 nonbanks, 389 open market operations, 382–385, 386 prices, output, and employment, effects on, 403–405 prices and, 403–405 required reserve ratio, 387–388 shortcomings of, 388–390 transmission mechanism, 403, 406 Monetary rule, 408–409 Money commodity, 358–359 credit cards and, 357 definition, 355 demand curve, 399 demand for, 397–399 divisibility, 358 excess quantity demanded, 400–401 excess quantity supplied, 401 fiat, 359 functions of, 355–357, 358 history of in American colonies, 362–363 as medium of exchange, 355–356 monetarist view of role of, 405–411 other properties of, 357–358 portability, 358 precautionary demand for, 397 quantity theory of, 407–408 role of in monetarism, 405–411 scarcity, 357 speculative demand for, 398 as store of value, 356–357 transaction demand for, 397 uniformity, 358 as unit of account, 356 velocity of, 406, 409–411, 412 Yap, 358 Money creation, 374–390 accepting new deposits, 377–378 banker bookkeeping, 376–377 clearing loan checks, 379–380 discount rate, 385–387 making loans, 378–379 monetary policy and, 382–388 money multiplier, 381–382 multiplier expansion of money by banking system, 380–382 open market operations, 382–385 required reserve ratio, 387–388 shortcomings of monetary policy, 388–390 in single bank, 375–380 Money GDP, 139 Money income, 180 Money multiplier, 381–382, 388–389 Money supply changes, effect of, 401–403 checkable deposits, 360, 361 currency, 359, 360, 478–479 decreasing, 402–403 definitions, 359–361 expansion of, 381 Great Depression and, 414 increasing, 401–402 M1, 359–360 M2, 361 presidential elections and, 437 role of Federal Reserve banks, 365 savings deposits, 360–361 small time deposits, 360–361 Money supply curve, 399 Money target, fixed, 408–409 Morocco, 514 Mozambique, 514, 516, 517 N National Aeronautics and Space Administration (NASA), 500 National Association for Business Economics, 212 National Bureau of Economic Research, 152, 213 National debt causes of, 334 crowding out private-sector spending, 341–343 external, 339 federal budget and, 343 federal net interest, 339 financing, 329–332 historically, 335 internal, 338–339 international, 474–475 internationally, 338 ownership of, 340 passing burden to children, 337–340 possibility of bankruptcy, 337 National defense, 107, 307–308, 466–467 National income, 135–138 National income accounting goods and bads, 135 National Metal Industries, 10 National sales tax, 319 National security argument, 466–467 National Transplant Organ Act of 1984, 74 Natural rate hypothesis, 432–434 Natural rate of unemployment, 163–164, 435 Natural resources, 519 Negative externality, 105, 134 Negative slope, 22 Negotiable order of withdrawal accounts, 360 Neighborhood effects, 105 Net exports, 128–129, 222–223, 257 Net exports effect, 245 Netherlands, 471, 514 Net interest, 130–131 Net public debt, 330 New classical economists, 439, 444–445 New domestic product, 123–124 New economy, 39 Newsweek, 186 New York Times, 70 New Zealand, 513, 514 Nicaragua, 469 Nixon, Richard, 98, 233, 441, 442, 443, 483 Nominal GDP, 139–141 Nominal income, 180–181 Nominal interest rate, 183 Nonbanks, 389 Nondiscretionary fiscal policy, 293 Nonmarket transactions, 132 Nonprice determinants of demand, 57–63 advertising and, 59 buyers, number of, 58, 62, 119 expectations of buyers, 61, 62 income, 59–61, 62, 119 personal computer prices and, 70 prices of related goods, 61, 63 prices of substitutes, 119 tastes and preferences, 59, 62, 119 terminology for changes in, 60 Nonprice determinants of supply definition, 66 expectations of producers, 69, 71–72 personal computer prices and, 70 prices of other goods the firm could produce, 71, 73 resource prices, 69, 72, 120 sellers, number of, 69, 72, 120 taxes and subsidies, 69, 72 technology, 69, 72 terminology for changes in, 68 Nonprice-level determinants, 245–247, 255–257 Nonproductive financial transactions, 124 Nonrenewable resources, Normal goods, 59–60, 62 Normative economics, 11–13 North American Free Trade Agreement (NAFTA), 468, 483, 523 North American Indians, 362–363 North Korea, 503–504 Norway, 514 No-saving income, 199 O Obama, Barack, 306 O’Connor, Sandra Day, 12 Office of Management and Budget (OMB), 328–329, 336 Oil companies, 39 Oil embargo, 99, 259, 443 Okun, Arthur, 180 Old Age, Survivors, and Disability Health Insurance (OASDHI) See Social Security OPEC (Organization of Petroleum Exporting Countries), 184, 257, 443, 472 Open market operations, 382–386 Operating budget, 343 Opportunity cost, 32–34, 37, 38, 98, 397 Organ transplants, 74–75 Output, effect of monetary policy on, 403–405 Outside lag, 390 Overpopulation, 520 Ownership, private, 499 Ownership, public, 502 P Package delivery service, 41 Pakistan, 514 Panama, 514 Panic of 1907, 361 Pay-as-you-go budget rules, 334 Payroll taxes, 316 Peace dividend, 41, 161 Peak, 150 Peck, Andrew, 70 People’s Republic of China See China Personal computer market, 102, 104 Personal computer prices, 70 Personal consumption expenditures, 126–127, 154, 204, 211 Personal income, 136–138, 288 Phillips, A.W., 429 Phillips curve, 429–431 aggregate demand and, 429–430, 433 historically, 431 labor market and, 435–437 long run, 431–437 long-run vs short-run, 433 in practice, 430–431 in theory, 429–430 unemployment and, 431, 433 Poland, 471 Political business cycle, 436–437 Political environment, and economic growth, 522–524 Pollution, 105–106, 135 Population growth, 58 Portability, 358 Portugal, 471, 514 Positive economics, 11, 13 Positive externality, 105 Positive slope, 22 Potential real GDP, 164–165, 275 Poverty, 521 Precautionary demand for money, 397 Predictions, Present investment, 42–44 Presidential elections, 437 Presidential jawboning, 441 Price changes in, 60 rationing function of, 75, 77 of related goods, 61, 63 of substitute goods, 119 Price ceilings, 97–100 Price controls, 97–102 incomes policy and, 442–443 price ceilings, 97–100 price floors, 100–102 Price floors, 100–102 Price guidelines, 441–442 Price level aggregate demand curve and, 243, 245–246 aggregate supply curve and, 248–249, 251–252 consumption function and, 207 exchange rates, impact of changes on, 480–481 Great Depression and, 414 unemployment and, 260 Prices, 98, 403–405, 495 Price supports, 101–103 Price system, 74–75, 77 Price-wage flexibility, 412 Private domestic investment, 127–128 Private interest, 502 INDEX 573 Private ownership, 499 Private-sector spending, 341–343 Problem identification, Producers, expectations of, 69, 71–72 Producer surplus, 86–88 Production costs, 42–44 Production possibilities curve capital and, 42–43 economic growth and, 517–518, 521 external financing, effect of, 525 future, 42–44 international trade and, 459 Japan and, 39 for less-developed countries, 525 for military goods, 36 outward shift of, 40 overview of, 34–37 during World War II, 340 Product markets, 124–125 Products, quality of, 132–134 Profit motive, 496 Profits, 130 Progressive taxes, 314–315 Proportional taxes, 316–317 Proprietors’ income, 130 Prostitution, 134 Protectionism, 464–469 Public assistance, 307 Public capital, economic growth and, 43 Public choice theory, 318 Public debt, 330 Public goods, 107–109, 312–313 Public interest, 500, 502 Public ownership, 502 Public sector, 306–322 Puma, John la, 74 Purchasing power, 180, 207 Q Quality-of-life measures of development, 516–517 Quality of products, 132–134 Quantity theory of money, 407–408 Quotas, 466 R Ranges classical, 250–252, 254–255 intermediate, 250–255 Keynesian, 251–254 Rational expectations theory, 434, 437–441 Rational voter ignorance, 321–322 Rationing, 77 Rationing devices, 442 574 INDEX Reagan, Ronald, 12, 282, 295–296, 298, 306, 336 Real balances effect, 244, 250 Real consumption, 200, 203, 206, 208 Real disposable income, 199–201, 203–204, 206, 211 Real GDP aggregate demand curve and, 243, 246 aggregate supply curve and, 248–249, 251–252 changes in, 275–276 Great Depression and, 414 inflationary gap, 234 international growth rates, 154 Keynesian aggregate expendituresoutput model, 226 nominal GDP and, 139–141 recessionary gap, 231 unemployment and, 260 variations in, 155 Real income, 180–181 Real interest rate, 183–184 Real investment, 208–209, 211 Real investment expenditures, 211 Real personal consumption, 204 Recession classical economic theory on, 283 cutting taxes to combat, 288–290 definition, 150 historically, 152 increase government spending to combat, 283–286 monetary policy tools, 387, 389 stock market crashes and, 212–213 Recessionary gap, 230–234 Recession of 2001, 410–411 Recovery, 150 Red Cross, 528 Regressive taxes, 315–316 Regulation, 105, 107, 257 Relative incomes, 479 Relative price level, 480–481 Relative real interest rates, 481 Renewable resources, Rental income, 130 Rent controls, 97–98, 99 Required reserve ratio, 376–377, 387–388 Required reserves, 376 Research and development, 39 Resolution Trust Corporation, 369 Resources definition, 3–5 economic growth and, 39 fixed, 34–35 fully employed, 35 as nonprice-level determinant, 257 prices of, 69, 72, 120 Rinehart, James R., 74 The Road to Serfdom (Hayek), 499 “Roaring 20s,” 196, 212 Robot Hall of Fame, 163 Robots, 163 Romania, 471, 514 Roosevelt, Franklin D., 482–483 Russia economic system of, 503–504, 505 foreign loans and, 529 free trade and, 469 GDP per capita, 514 gross domestic product, 133 inflation in, 185 real GDP, 155 technological changes in, 522 Rwanda, 514 S Salaries, in various fields of economics, 14 Samuelson, Paul, 430 San Francisco Chronicle, 186 Saving, 199 Savings and loan crisis, 369 Savings deposits, 360, 361 Say, Jean Baptiste, 197 Say’s Law, 197 Scarcity, 3–6, 33, 357 School vouchers, 108–109 Schwartz, Anna, 413 Schwarzenegger, Arnold, 12 Search unemployment, 161 Seasonal unemployment, 160–161 Secondhand transactions, 123 Securities and Exchange Commission (SEC), 368 Self-correcting aggregate supply and aggregate demand model, 268–277 decrease in demand, impact of, 273–275 equilibrium in, 270–271 increase in demand, impact of, 271–273 long-run aggregate supply curve, 270 policy debates using, 423–425 short-run aggregate supply curve, 268–270 Self-interest, 496 Sellers, number of, 69, 72, 120 September 11 terrorist attack, 154, 212, 387 Shaw, George Bernard, 11, 221 Shortage, 71 Short-run aggregate supply curve, 268–271, 273–274, 423, 439 Shortsightedness effect, 322 Singapore, 514, 522, 527 Slope of a curve, 23–25 Slope of a straight line, 22 Slovakia, 471 Slovenia, 471 Small time deposits, 360, 361 Smith, Adam as founder of classic economic theory, 199, 248, 412–413 invisible hand, 496–499 lack of competition, 102 laissez faire, 526 market economy, 496–497 vs Marx, 501 on self-interest, 318 Smith, Frederick W., 41 Smoot-Hawley Act of 1930, 465 Social insurance taxes, 309 Socialism, 500–503 Social Security, 137, 138, 306, 307 Social Security Administration, 330–331 Solow, Robert, 430 South Africa, 514 South Korea, 514, 522, 527 Soviet Union, 493, 501 Spain, 160, 310, 471, 514 Special-interest group effect, 321 Specialization, 460–462 Speculative demand for money, 398 Spending See also Consumption aggregate, 198 business cycles and, 155–156 government, 222–223, 341–342 investment, 405 in Keynesian model, 222–223 as nonprice-level determinant, 257 private-sector, 341–343 recession and, 283–286 recessionary gap, 230–232 total, 155–156 Spending multiplier aggregate demand and, 229 arithmetic, 228–230 definition, 228 fiscal policy and, 284, 286–288 vs tax multipliers, 289 Spending multiplier effect, 226–230, 286 Spillover effects, 105 Stability of economy, 412 Stagflation, 257, 295 Stalin, Josef, 502 Standex International Corporation, 10 Steel market, 105–106 Steinbeck, John, 166 Stock, 126 Stock market crashes, 212–213 Store of value, 356–357 Strauss, Levi, Structural unemployment, 161–162 Subprime loan crisis, 183 Subsidies, 107, 257 Substitute goods, 61, 63 Super Bowl, 10 Superfund law, 135 Supply changes in quantity supplied vs changes in supply, 66–68 definition, 65 excess quantity, 75 for foreign exchange, 476–477, 477–481 health care market and, 117–120 law of, 63–66 market equilibrium and, 94–95 market supply, 65 nonprice determinants of, 66, 69–73, 120 Supply arrow, in circular flow model, 124, 126 Supply curve effects of shifts on market equilibrium, 96 example, 76 health care market and, 120 individual, 64 movement along vs shift in supply, 67 Supply shifters, 66 Supply shock, 257, 431 Supply-side economics, 298–299, 444–445 Supply-side fiscal policy, 295–300, 306 Supreme Court, 109 Surplus, 71 Survey of Current Business, 135 Sweden economic system of, 503 free trade and, 471 GDP per capita, 514 government expenditures in, 309, 310 national debt in, 337, 338 taxes in, 310, 312 Switzerland, 160, 514 T T-accounts, 376 Taiwan, 514, 522, 527 Tannenbaum, Carl, 212 Tariffs, 464–465 Tastes and preferences, 59, 62, 119, 478–479 Taxable income, 314 Tax credit, 211 Tax cuts to combat recession, 288–290 recessionary gap, 232, 234 supply side, 298–299 supply-side vs demand-side effects of, 299 Taxes ability-to-pay principle, 313–314 ad valorem, 464 art of, 311–322 benefits-received principle, 312–313 bureaucratic inefficiency, 322 on businesses, 210–211 corporate income, 310 cutting to combat a recession, 288–290 excise, 310 federal income tax rate schedule, 315 flat, 316–317, 319 growth in as percentage of GDP, 313 indirect business, 130–131 individual income, 309 internationally, 310–311, 312 majority-rule problem, 318–321 marginal rate, 315–316 national sales tax, 319 as nonprice determinant, 69, 72 as nonprice-level determinant, 257 payroll, 316 pollution and, 106 progressive, 314–315 progressive vs flat, 317 proportional, 316–317 public choice theory, 318 rational voter ignorance, 321–322 rebates, 290 reformation of, 317–318 regressive, 315–316 shortsightedness effect, 322 social insurance, 309 special-interest group effect, 321 Tax evasion, 134 Tax multiplier, 232, 289, 297 Tax rate, average, 314 Tax rebates, 290 Tax-rebate stimulus package, 282 Tax Reform Act of 1986, 318 Technology definition, 35 economic growth and, 39, 522 investment demand and, 210 as nonprice determinant, 69, 72 as nonprice-level determinant, 257 Tennessee Valley Authority (TVA), 500 Terrorism, 154, 212 Thailand, 514 Theory, 6, 8, 407 Third parties, 105, 117 Three-variable relationship, 24–26 Thrift Bailout Bill, 369 Time, 507 Time deposit, 361 Tobacco, 363 Total spending, 155–156 Toyota, 123 Toyota Motor Corp., 163 Trading partners, 460 Traditional economy, 492 Transactions demand for money, 397 INDEX 575 Transfer payments, 124, 128, 138, 232, 293, 307 Transitional unemployment, 161 Transmission mechanism, 405–411 Traveler’s checks, 360 Trough, 150 Truman, Harry, 11, 441 Turkey, 514 U Ukraine, 514 Underemployment, 159 Underground economy, 134 Unemployment African-Americans, 166–167 classical view of, 412 cyclical, 162 discouraged workers, 158, 166 frictional, 160–161 full employment, 163–164 GDP gap, 164–167, 225 Great Depression, 156, 159, 162, 166 Hispanics and, 166–167 historically, 432 human costs of, 166 internationally, 157 Keynesian view of, 412 monetarist view of, 412 nonmonetary and demographic consequences of, 165–167 overview of, 156–159 Phillips curve and, 431, 433 price level and, 260 real GDP and, 260 search, 161 seasonal, 160–161 structural, 161–162 transitional, 161 types of, 159–163 Unemployment compensation, 109, 307 Unemployment rate adaptive expectations theory, 434–435 criticisms of, 157–160 definition, 157 by demographic group, 166–167 formula for, 157 during Great Depression, 414–415 inflation and, 259 576 INDEX internationally, 160 as lagging indicator, 156 natural rate of, 163–164, 435 Phillips curve, 429–434 rational expectations theory, 438 during recessions, 150, 152 various economic theories on, 444 wage and price controls, 442 Unfavorable balance of trade, 471 Uniformity, 358 United Arab Emirates, 513, 516 United Kingdom free trade and, 471 GDP per capita, 514 government expenditures in, 310 gross domestic product, 133 Hong Kong and, 526 national debt in, 337, 338 real GDP, 155 taxes in, 310, 312 trade deficit and, 475 unemployment, 160 United Network for Organ Sharing, 75 Unit of account, 356 Unplanned inventory investment accumulation, 225 Unplanned inventory investment depletion, 224 U.N Population Fund, 507 Upshaw, David L., 10 USA Today, 70, 109 U.S Postal Service, 500 Usury laws, 99 V Vaccination market, 106–107 Value, money as store of, 356–357 Variables direct relationship, 19–20 independent relationship, 22–23 inverse relationship, 20–22 three-variable relationship, 24–26 Velocity of money, 406, 409–412 Veneman, Ann, 233 Venezuela, 185, 475, 505 Venture capital, 41 Vicious circle of poverty, 521 Vietnam, 514 Vietnam War, 177, 259, 442 Volatility, 208 Vouchers, 108–109 W Wage controls, 442–443 Wage guidelines, 441–442 Wage-price spiral, 187, 434–435 Wall Street Journal, 70, 186, 233 War of 1812, 467 War on terrorism, 41 Washington, George, 363 Wealth, 182, 205–207 Wealth effect, 207, 244 The Wealth of Nations (Smith), 102, 413, 496, 501 Whip Inflation Now button, 443 Wilson, Woodrow, 362 WIN button, 443 Women, 167 The Wonderful Wizard of Oz (Baum), 482 Woods, Tiger, 12 World Bank, 528 World Trade Center, 212 World Trade Organization (WTO), 465, 468–469, 505, 523 World War I, 187 World War II, 176–177, 334, 340, 442 X Xerox Corporation, 39 Y Yap, 358 Yen, 478 Z Zimbabwe, 185, 186 ... rather than rising to 20 0 (a) Demand-side fiscal policy (b) Supply-side fiscal policy AS AS1 25 0 25 0 E2 AS2 20 0 20 0 E1 Price level 150 (CPI) E1 Price level 150 (CPI) E2 100 100 AD2 50 AD1 Full employment... Government Spending (ỵG) (2) $50 billion Cut in Taxes (ÀΔ T) Government spending Consumption Consumption Consumption $ 50 $ 38 29 22 38 29 22 Consumption Total spending 61 $20 0 61 $150 All amounts... expenditures 25 20 15 10 Federal government expenditures 1 929 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 20 00 20 05 20 10 Year SOURCES: Economic Report of the President, 20 08, http://www.gpo.access.gov/eop/,