Macroeconomics principles, applications, and tools

Macroeconomics PRINCIPLES, APPLICATIONS, AND TOOLS SEVENTH EDITION Arthur O’Sullivan Lewis and Clark College Steven M Sheffrin Tulane University Stephen J Perez California State University, Sacramento Prentice Hall Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo The Pearson Series in Economics Hartwick/Olewiler The Economics of Natural Resource Use Abel/Bernanke/Croushore Macroeconomics* Bade/Parkin Foundations of Economics* Berck/Helfand The Economics of the Environment Bierman/Fernandez Game Theory with Economic Applications Heilbroner/Milberg The Making of the Economic Society Heyne/Boettke/Prychitko The Economic Way of Thinking Hoffman/Averett Women and the Economy: Family, Work, and Pay Blanchard Macroeconomics* Blau/Ferber/Winkler The Economics of Women, Men and Work Boardman/Greenberg/Vining/Weimer Cost-Benefit Analysis Boyer Principles of Transportation Economics Holt Markets, Games and Strategic Behavior Hubbard/O’Brien Economics* Money, Banking, and the Financial System* O’Sullivan/Sheffrin/Perez Economics: Principles, Applications and Tools* Parkin Economics* Perloff Microeconomics* Microeconomics: Theory and Applications with Calculus* Perman/Common/McGilvray/Ma Natural Resources and Environmental Economics Phelps Health Economics Pindyck/Rubinfeld Microeconomics* Riddell/Shackelford/Stamos/Schneider Economics: A Tool for Critically Understanding Society Hughes/Cain American Economic History Ritter/Silber/Udell Principles of Money, Banking & Financial Markets* Husted/Melvin International Economics Roberts The Choice: A Fable of Free Trade and Protection Jehle/Reny Advanced Microeconomic Theory Rohlf Introduction to Economic Reasoning Johnson-Lans A Health Economics Primer Ruffin/Gregory Principles of Economics Keat/Young Managerial Economics Sargent Rational Expectations and Inflation Klein Mathematical Methods for Economics Sawyer/Sprinkle International Economics Krugman/Obstfeld/Melitz International Economics: Theory & Policy* Scherer Industry Structure, Strategy, and Public Policy Laidler The Demand for Money Schiller The Economics of Poverty and Discrimination Cooter/Ulen Law & Economics Leeds/von Allmen The Economics of Sports Sherman Market Regulation Downs An Economic Theory of Democracy Leeds/von Allmen/Schiming Economics* Silberberg Principles of Microeconomics Ehrenberg/Smith Modern Labor Economics Lipsey/Ragan/Storer Economics* Ekelund/Ressler/Tollison Economics* Lynn Economic Development: Theory and Practice for a Divided World Stock/Watson Introduction to Econometrics Introduction to Econometrics, Brief Edition Branson Macroeconomic Theory and Policy Brock/Adams The Structure of American Industry Bruce Public Finance and the American Economy Carlton/Perloff Modern Industrial Organization Case/Fair/Oster Principles of Economics* Caves/Frankel/Jones World Trade and Payments: An Introduction Chapman Environmental Economics: Theory, Application, and Policy Farnham Economics for Managers Folland/Goodman/Stano The Economics of Health and Health Care Miller Economics Today* Understanding Modern Economics Fort Sports Economics Miller/Benjamin The Economics of Macro Issues Froyen Macroeconomics Miller/Benjamin/North The Economics of Public Issues Fusfeld The Age of the Economist Mills/Hamilton Urban Economics Gerber International Economics* Greene Econometric Analysis Mishkin The Economics of Money, Banking, and Financial Markets* The Economics of Money, Banking, and Financial Markets, Business School Edition* Macroeconomics: Policy and Practice* Gregory Essentials of Economics Murray Econometrics: A Modern Introduction Gregory/Stuart Russian and Soviet Economic Performance and Structure Nafziger The Economics of Developing Countries Gordon Macroeconomics* * denotes titles Log onto www.myeconlab.com to learn more Studenmund Using Econometrics: A Practical Guide Tietenberg/Lewis Environmental and Natural Resource Economics Environmental Economics and Policy Todaro/Smith Economic Development Waldman Microeconomics Waldman/Jensen Industrial Organization: Theory and Practice Weil Economic Growth Williamson Macroeconomics About the Authors ARTHUR O’SULLIVAN is a professor of economics at Lewis and Clark College in Portland, Oregon After receiving his B.S in economics at the University of Oregon, he spent two years in the Peace Corps, working with city planners in the Philippines He received his Ph.D in economics from Princeton University in 1981 and has taught at the University of California, Davis, and Oregon State University, winning teaching awards at both schools He is the author of the best-selling textbook Urban Economics, currently in its seventh edition Professor O’Sullivan’s research explores economic issues concerning urban land use, environmental protection, and public policy His articles have appeared in many economics journals, including the Journal of Urban Economics, Journal of Environmental Economics and Management, National Tax Journal, Journal of Public Economics, and Journal of Law and Economics Professor O’Sullivan lives with his family in Portland, Oregon For recreation, he enjoys hiking, kiteboarding, and squash STEVEN M SHEFFRIN is professor of economics and executive director of the Murphy Institute at Tulane University Prior to joining Tulane in 2010, he was a faculty member at the University of California, Davis, and served as department chairman of economics and dean of social sciences He has been a visiting professor at Princeton University, Oxford University, London School of Economics, and Nanyang Technological University, and he has served as a financial economist with the Office of Tax Analysis of the United States Department of the Treasury He received his B.A from Wesleyan University and his Ph.D in economics from the Massachusetts Institute of Technology Professor Sheffrin is the author of 10 other books and monographs and over 100 articles in the fields of macroeconomics, public finance, and international economics His most recent books include Rational Expectations (second edition) and Property Taxes and Tax Revolts: The Legacy of Proposition 13 (with Arthur O’Sullivan and Terri Sexton) Professor Sheffrin has taught macroeconomics and public finance at all levels, from general introduction to principles classes (enrollments of 400) to graduate classes for doctoral students He is the recipient of the Thomas Mayer Distinguished Teaching Award in economics He lives with his wife Anjali (also an economist) in New Orleans, Louisiana, and has two daughters who have studied economics In addition to a passion for current affairs and travel, he plays a tough game of tennis STEPHEN J PEREZ is a professor of economics and NCAA faculty athletics representative at California State University, Sacramento After receiving his B.A in economics at the University of California, San Diego, he was awarded his Ph.D in economics from the University of California, Davis, in 1994 He taught economics at Virginia Commonwealth University and Washington State University before coming to California State University, Sacramento, in 2001 He teaches macroeconomics at all levels as well as econometrics, sports economics, labor economics, and mathematics for economists Professor Perez’s research explores most macroeconomic topics In particular, he is interested in evaluating the ability of econometric techniques to discover the truth, issues of causality in macroeconomics, and sports economics His articles have appeared in many economics journals, including the Journal of Monetary Economics; Econometrics Journal; Economics Letters; Journal of Economic Methodology; Public Finance and Management; Journal of Economics and Business; Oxford Bulletin of Economics and Statistics; Journal of Money, Credit, and Banking; Applied Economics; and Journal of Macroeconomics iii TO OUR CHILDREN CONOR, MAURA, MEERA, KIRAN, DAVIS, AND TATE Editorial Director: Sally Yagan Editor in Chief: Donna Battista Acquisitions Editor: Noel Seibert Editorial Project Manager: Carolyn Terbush Managing Editor: Nancy H Fenton Senior Production Project Manager: Meredith Gertz Supplements Production Project Manager: Alison Eusden Director of Marketing: Kate Valentine Executive Marketing Manager: Lori DeShazo Marketing Assistant: Kim Lovato Art Director/Cover Designer: Anthony Gemmellaro Text Designer: Liz Harasymczuk Design Illustration (Interior): GEX Publishing Services Manager, Rights and Permissions, Text: Michael Joyce Image Manager/Image Asset Services: Rachel Youdelman Photo Researcher: Caroline Commins Cover Illustration: Russell Lipp Media Director: Susan Schoenberg Senior Media Producer: Melissa Honig Content Lead, MyEconLab: Noel Lotz Full-Service Project Management: GEX Publishing Services Composition: GEX Publishing Services Printer/Binder: Courier Kendallville Cover Printer: Lehigh, Phoenix/Hagerstown Text Font: 10/12 Janson Text Senior Manufacturing Buyer: Carol Melville Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text (or on page 418) Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A and other countries Screen shots and icons reprinted with permission from the Microsoft Corporation This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation Many of the designations by manufacturers and seller to distinguish their products are claimed as trademarks Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps Copyright © 2012, 2010, 2008, 2006, 2003 by Pearson Education, Inc All rights reserved Manufactured in the United States of America This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Rights and Contracts Department, 501 Boylston Street, Suite 900, Boston, MA 02116, fax your request to 617-671-3447, or e-mail at http://www.pearsoned.com/legal/permissions.htm Library of Congress Cataloging-in-Publication Data O’Sullivan, Arthur Macroeconomics: principles, applications, and tools / Arthur O’Sullivan, Steven M Sheffrin, Stephen J Perez -7th ed p cm Includes index ISBN 978-0-13-255549-4 (pbk.) Macroeconomics I Sheffrin, Steven M II Perez, Stephen J III Title HB172.5.O85 2012 339 dc22 2010048072 10 1—CRK—15 14 13 12 11 ISBN 10: 0-13-255549-2 ISBN 13: 978-0-13-255549-4 Brief Contents PART Introduction and Key Principles 10 Fiscal Policy 205 Introduction: What Is Economics? 11 The Income-Expenditure Model The Key Principles of Economics 28 12 Investment and Financial Markets 253 Exchange and Markets Demand, Supply, and Market Equilibrium 65 PART 49 Measuring a Nation’s Production and Income 97 Unemployment and Inflation 120 The Economy at Full Employment Why Do Economies Grow? 158 PART Money and the Banking System 14 The Federal Reserve and Monetary Policy 291 PART 139 Economic Fluctuations and Fiscal Policy Aggregate Demand and Aggregate Supply 185 272 Inflation, Unemployment, and Economic Policy 15 Modern Macroeconomics: From the Short Run to the Long Run 311 16 The Dynamics of Inflation and Unemployment 329 17 Macroeconomic Policy Debates The Economy in the Long Run Money, Banking, and Monetary Policy 13 The Basic Concepts in Macroeconomics PART PART 223 PART 347 The International Economy 18 International Trade and Public Policy 19 The World of International Finance 364 385 v Contents Preface xiv Using Microeconomics to Make Personal and Managerial Decisions 12 Using Microeconomics to Evaluate Public Policies 13 * SUMMARY 13 * KEY TERMS 13 * EXERCISES 13 PART Introduction and Key Principles APPENDIX A: Using Graphs and Percentages 15 Introduction: What Is Economics? What Is Economics? USING GRAPHS 15 Positive versus Normative Analysis The Three Key Economic Questions: What, How, and Who? Economic Models The Key Principles of Economics 28 Economic Analysis and Modern Problems Economic View of Traffic Congestion Economic View of Poverty in Africa The Principle of Opportunity Cost 5 Economic View of the Current World Recession The Economic Way of Thinking Use Assumptions to Simplify Think at the Margin The Cost of College 29 The Cost of Military Spending 30 Opportunity Cost and the Production Possibilities Curve 31 The Marginal Principle Rational People Respond to Incentives APPLICATION Responding to Production Rewards Example: London Addresses its Congestion Problem 33 How Many Movie Sequels? 34 Renting College Facilities 35 Automobile Emissions Standards 36 APPLICATION Why Not Walk up an Escalator? 36 Driving Speed and Safety 37 APPLICATION The Economic Solution to Spam 10 The Principle of Voluntary Exchange Preview of Coming Attractions: Macroeconomics 11 APPLICATION Jasper Johns and Housepainting 38 Using Macroeconomics to Understand Why Economies Grow 11 Using Macroeconomics to Understand Economic Fluctuations 11 Using Macroeconomics to Make Informed Business Decisions 12 Preview of Coming Attractions: Microeconomics 12 Using Microeconomics to Understand Markets and Predict Changes 12 vi 29 APPLICATION Don’t Forget the Costs of Time and Invested Funds 32 Isolate Variables—Ceteris Paribus COMPUTING PERCENTAGE CHANGES AND USING EQUATIONS 23 APPLICATION The Perils of Percentages 24 Exchange and Markets 37 37 Online Games and Market Exchange 38 The Principle of Diminishing Returns 39 APPLICATION Fertilizer and Crop Yields 39 Diminishing Returns from Sharing a Production Facility 40 The Real-Nominal Principle 40 APPLICATION The Declining Real Minimum Wage 41 APPLICATION Repaying Student Loans 42 vii * SUMMARY 43 * KEY TERMS 43 * EXERCISES 43 * ECONOMIC EXPERIMENT 47 Market Effects of Changes in Demand Change in Quantity Demanded versus Change in Demand 75 Increases in Demand Shift the Demand Curve 76 Decreases in Demand Shift the Demand Curve 78 A Decrease in Demand Decreases the Equilibrium Price 79 Exchange and Markets 49 Comparative Advantage and Exchange 50 Specialization and the Gains from Trade 50 Comparative Advantage versus Absolute Advantage 52 The Division of Labor and Exchange 52 Market Effects of Changes in Supply 79 Comparative Advantage and International Trade 53 Outsourcing 53 APPLICATION Candy Cane Makers Move to Mexico for Cheap Sugar 54 Markets 55 Virtues of Markets 55 The Role of Entrepreneurs Example of the Emergence of Markets: POW Camps 57 APPLICATION The Shakers and the Market for Garden Seeds 58 Market Failure and the Role of Government 58 Government Enforces the Rules of Exchange 59 Government Can Reduce Economic Uncertainty 60 * SUMMARY 60 * KEY TERMS 61 * EXERCISES 61 Demand, Supply, and Market 65 The Demand Curve 66 The Individual Demand Curve and the Law of Demand 66 From Individual Demand to Market Demand 68 The Supply Curve Change in Quantity Supplied versus Change in Supply 79 Increases in Supply Shift the Supply Curve 81 An Increase in Supply Decreases the Equilibrium Price 82 Decreases in Supply Shift the Supply Curve 83 A Decrease in Supply Increases the Equilibrium Price 83 Simultaneous Changes in Demand and Supply 84 Predicting and Explaining Market Changes 86 56 APPLICATION Gold Farming for World of Warcraft 57 Equilibrium 75 69 The Individual Supply Curve and the Law of Supply 69 Why Is the Individual Supply Curve Positively Sloped? 71 From Individual Supply to Market Supply 71 Why Is the Market Supply Curve Positively Sloped? 73 Market Equilibrium: Bringing Demand and Supply Together 73 Excess Demand Causes the Price to Rise 74 Excess Supply Causes the Price to Drop 75 Applications of Demand and Supply 86 APPLICATION Hurricane Katrina and Baton Rouge Housing Prices 87 APPLICATION Honeybees and the Price of Ice Cream 87 APPLICATION The Supply and Demand for Cruise Ship Berths 88 APPLICATION The Bouncing Price of Vanilla Beans 89 APPLICATION Drought in Australia and the Price of Rice 90 * SUMMARY 91 * KEY TERMS 91 * EXERCISES 91 * ECONOMIC EXPERIMENT 95 PART The Basic Concepts in Macroeconomics Measuring a Nation’s Production and Income 97 The “Flip” Sides of Macroeconomic Activity: Production and Income 98 The Circular Flow of Production and Income 99 The Production Approach: Measuring a Nation’s Macroeconomic Activity Using Gross Domestic Product 100 The Components of GDP 102 Putting It All Together: The GDP Equation 105 The Income Approach: Measuring a Nation’s Macroeconomic Activity Using National Income 105 viii Measuring National Income 105 Measuring National Income through Value Added 107 APPLICATION Using Value Added to Measure the True Size of Wal-Mart 107 An Expanded Circular Flow Measuring Real versus Nominal GDP How to Use the GDP Deflator 110 109 Fluctuations in GDP 111 APPLICATION Comparing the Severity of Recessions 112 GDP as a Measure of Welfare 113 Shortcomings of GDP as a Measure of Welfare 113 APPLICATION The Links Between SelfReported Happiness and GDP 114 * SUMMARY 115 * KEY TERMS 115 * EXERCISES 116 Unemployment and Inflation 120 Examining Unemployment 121 How Is Unemployment Defined and Measured? 121 Alternative Measures of Unemployment and Why They Are Important 122 APPLICATION After Growing Sharply, Women’s Labor Force Participation has Leveled Off 123 124 APPLICATION More Disability, Less Unemployment? 125 Categories of Unemployment 126 Types of Unemployment: Cyclical, Frictional, and Structural 126 The Natural Rate of Unemployment 127 The Costs of Unemployment 128 APPLICATION Social Norms, Unemployment, and Perceived Happiness 129 The Consumer Price Index and the Cost of Living 129 The CPI versus the Chain Index for GDP 130 Problems in Measuring Changes in Prices 131 APPLICATION The Introduction of Cell Phones and the Bias in the CPI 132 Inflation 134 Anticipated Inflation 134 Unanticipated Inflation 135 * SUMMARY 136 * KEY TERMS 136 * EXERCISES 136 108 A Closer Examination of Nominal and Real GDP 108 Who Are the Unemployed? The Costs of Inflation 132 Historical U.S Inflation Rates The Perils of Deflation 133 PART The Economy in the Long Run The Economy at Full Employment 139 Wage and Price Flexibility and Full Employment 140 The Production Function 140 Wages and the Demand and Supply for Labor 143 Labor Market Equilibrium 143 Changes in Demand and Supply 144 APPLICATION The Black Death and Living Standards in Old England 145 Labor Market Equilibrium and Full Employment 145 Using the Full-Employment Model 147 Taxes and Potential Output 147 Real Business Cycle Theory 148 APPLICATION A Nobel Laureate Explains Why Europeans Work Less Than U.S Workers or the Japanese 149 APPLICATION Can Labor Market Policies Account for the Great Depression? 151 Dividing Output among Competing Demands for GDP at Full Employment 151 International Comparisons 152 Crowding Out in a Closed Economy 152 Crowding Out in an Open Economy 153 Crowding In 154 * SUMMARY 155 * KEY TERMS 155 * EXERCISES 155 Why Do Economies Grow? 158 Economic Growth Rates 159 Measuring Economic Growth 160 Comparing the Growth Rates of Various Countries 161 APPLICATION Global Warming, Rich Countries, and Poor Countries 162 Are Poor Countries Catching Up? 163 133 APPLICATION Growth Need Not Cause Increased Inequality 164 ix Capital Deepening 164 Saving and Investment 165 How Do Population Growth, Government, and Trade Affect Capital Deepening? 166 The Key Role of Technological Progress 168 How Do We Measure Technological Progress? 168 APPLICATION Sources of Growth in China and India 169 Using Growth Accounting 170 APPLICATION Growth Accounting and Information Technology 170 What Causes Technological Progress? 171 Research and Development Funding 171 Monopolies That Spur Innovation 172 The Scale of the Market 172 Induced Innovations 172 Education, Human Capital, and the Accumulation of Knowledge 172 APPLICATION The Role of Political Factors in Economic Growth 173 APPLICATION Culture, Evolution, and Economic Growth 174 New Growth Theory Shifts in the Aggregate Demand Curve 190 How the Multiplier Makes the Shift Bigger 192 Understanding Aggregate Supply APPLICATION Two Approaches to Determining the Causes of Recessions 198 APPLICATION How the U.S Economy Has Coped with Oil Price Fluctuations 199 Supply Shocks 199 From the Short Run to the Long Run 200 Looking Ahead 201 * SUMMARY 202 * KEY TERMS 202 * EXERCISES 202 10 Fiscal Policy 205 The Role of Fiscal Policy 206 Fiscal Policy and Aggregate Demand 206 The Fiscal Multiplier 207 The Limits to Stabilization Policy 208 The Federal Budget Federal Spending 174 195 The Long-Run Aggregate Supply Curve 195 The Short-Run Aggregate Supply Curve 196 210 210 A Key Governmental Role: Providing the Correct Incentives and Property Rights 175 APPLICATION Lack of Property Rights Hinders Growth in Peru 176 APPLICATION Increasing Life Expectancy and Aging Populations Spur Costs of Entitlement Programs 212 * SUMMARY 177 * KEY TERMS 177 * EXERCISES 177 APPLICATION The Confucius Curve? 214 APPENDIX A: A Model of Capital Deepening 180 Aggregate Demand and Aggregate 185 Sticky Prices and Their Macroeconomic Consequences 186 Flexible and Sticky Prices 186 How Demand Determines Output in the Short Run 187 APPLICATION Measuring Price Stickiness in Consumer Markets 188 Understanding Aggregate Demand 212 The Federal Deficit and Fiscal Policy Automatic Stabilizers 215 Are Deficits Bad? 215 214 Fiscal Policy in U.S History 216 PART Economic Fluctuations and Fiscal Policy Supply Federal Revenues 188 What Is the Aggregate Demand Curve? 188 The Components of Aggregate Demand 189 Why the Aggregate Demand Curve Slopes Downward 189 The Depression Era 216 The Kennedy Administration 217 The Vietnam War Era 217 The Reagan Administration 218 The Clinton and George W Bush Administrations 218 APPLICATION Evaluating the Obama Fiscal Stimulus 219 * SUMMARY 220 * KEY TERMS 220 * EXERCISES 221 11 The Income-Expenditure Model 223 A Simple Income-Expenditure Model Equilibrium Output 224 Adjusting to Equilibrium Output The Consumption Function 224 225 227 Consumer Spending and Income 227 Changes in the Consumption Function 227 419 Index Key terms and the page on which they are defined appear in boldface 45° line, 225 A Absolute advantage, 52 Accelerator theory, 254 Accounting growth, 168–171 Accounting rules, 55 Acemoglu, Daron, 173 Adjustment process economics of, 318–324 speed of, 315–317 Adverse technological shocks, 150 Afghanistan War, 349 Africa economic growth in, 158, 163 poverty in, 5–6, 158 Aggregate demand, 188–195 components of, 189 fiscal policy and, 206–207 long-run aggregate supply and, 196 money supply and, 302 multiplier and, 192–195 short-run aggregate supply and, 197–198 Aggregate demand curve (AD), 188–189, 314 deriving, 244 downward slope of, 189–190 income-expenditure model and, 243–245 shifts in, 190–192, 245 Aggregate supply, 195–200 Aggregate supply curve (AS), 195 long-run, 195–196 short-run, 196–199 supply shocks and, 199–200 Aghion, Phillipe, 175 Aging populations, entitlement programs and, 212 Airbus, 374 American International Group (AIG), 268, 285 Anticipated inflation, 134–135 Antitrust policy, 60 Apple iPod, 360–361 Appreciation of a currency, 304, 386–387 Argentina financial crisis in, 403 hyperinflation in, 342 Asian financial crisis, 404 Asian Pacific Economic Cooperation (APEC), 375 Assets, 277 Assumptions, use of, for simplification, 7, 9–10 Auction prices, 186 Authoritarian institutions, 173 Automatic stabilizers, 215, 238–241, 354, 356 Automobile emissions standards, marginal principle and, 36 Autonomous consumption, 227–229 Autonomous consumption spending, 192 B Balanced budget, debate over, 348–354 Balanced-budget amendment, 354 Balanced-budget multiplier, 236, 251 Balance of payments, 393, 395–397 Balance of payments deficit, 400 Balance of payments surplus, 400 Balance sheet, 277–278 Bank failures, 266 Bank of England, 282, 339 Bank runs, 266 Banks See also Central banks; Federal Reserve balance sheet for, 277–278 creation of money by, 277–281 excess reserves held by, 280 reserve ratio of, 278, 279 reserve requirements for, 295–296 Barbie doll, 49 Bar graphs, 15 Barro, Robert, 233, 354 Barter, 273 Base year, 130 Basket of goods, 130, 131 Bastiat, Frédéric, 374 Bear Stearns, 267, 285 Becker, Gary, 173 Beef, hormone-treated, 378 Bernanke, Ben S., 291, 317, 356 Big Mac, exchange rates and price of, 392 Bils, Mark, 188 Black Death, living standards and, 145 Blanchflower, David, 114 Blinder, Alan, 305 Board of Governors of the Federal Reserve, 283 Boeing, 374 Bolivia, hyperinflation in, 342 Bond prices economy and, 300–301 interest, 298–301 open market operations and, 300 Bonds corporate, 259–260, 262 interest rates on long-term, 306–307 Boom economy, 200–201 returning to full employment after, 315 Bosworth, Barry, 169 Bretton Woods system, 399, 401 Broda, Christian, 379 Brown, E Cary, 216–217 Bubonic plague, 145 Buchholz, Todd, 53 Budget deficit, 214–216, 219 1996–2009, 220 as burden on future generations, 350–351 debates over, 350–354 as good for economy, 353–354 hyperinflation and, 342–343 inflation and, 350 recent history of, 348–350 size of government and, 352–353 Budget surplus, 215, 348–349 Bureau of Labor Statistics (BLS), 120, 123 Bush, George H W., 98, 334 Bush, George W., 218–219, 237, 349 Bush administration, fiscal policy during, 218–219 Business cycles, 111–113, 186 political, 317–318 real business cycle theory, 148–151 Business decisions, using macroeconomics to make, 12 420 INDEX C Cagan, Phillip, 341, 343 Candy cane production, 54 Capital diminishing returns to, 180 human, 2, 159, 172–173 increase in supply of, 165 physical, stock of, 141, 142–143 Capital account, 394–395 Capital consumption allowance, 103 Capital deepening, 159, 164–167 economic growth and, 169 influences on, 166–167 model of, 180–183 Capital gains, 359–360 Carter, Jimmy, 98, 334 Central banks, 281, 282, 284 See also Federal Reserve credibility of, and inflation, 337–339 independence of, 338–339 inflation targeting by, 357 Centrally planned economy, 55 Ceteris paribus, 8, 10, 67, 68, 69, 70, 75, 79 Chain-weighted index, 111, 130–131 Chairman of the Federal Reserve, 283 Change in demand, 76 vs change in quantity demanded, 75–76 market effects of, 87 Change in quantity demanded, 68 vs change in demand, 75–76 Change in quantity supplied, 70 vs change in supply, 79–81 Change in supply, 81 vs change in quantity supplied, 79–81 effects of, across markets, 87–88 prices and, 89–90 Changes marginal, 8, 10 using microeconomics to predict, 12 Checkable deposits, 275 Check collection and clearing system, 281–282, 284 Checking accounts, 275, 276, 279 Childcare, GDP and, 113 Child labor, 162 China economic growth in, 173, 242 exchange rate of, 392 fiscal policy in, 237 global recession and, 223 government investment in, 152 sources of growth in, 169 trade sanctions on, 364 trade with, 379 Circular flow of production and income, 99–100, 108 Clark, Andrew E., 129 Clark, Gregory, 145, 174 Classical economics, 324–325 Classical models, 140 Climate change See Global warming Clinton, Bill, 98, 209, 218, 236 Clinton administration, fiscal policy during, 218 Closed economy, 153 crowding out in, 152–153 Cole, Harold L., 151 College degree benefits of, 173 opportunity cost of, 29–30 College facilities rental, marginal principle and, 35–36 Collins, Susan, 169 Committees, effectiveness of, 305 Commodity money, 274 Comparative advantage, 51 vs absolute advantage, 52 exchange and, 50–53 international trade and, 53–54 terms of trade and, 367 Competition imperfect, 59 in market economy, 60 unfair, 374 Complements, 68, 77, 78 Computer software, pirated, 172 Concorde, 374 Congressional Budget Office, 210–211, 349 Constrained discretion, 356 Consumer confidence, autonomous consumption and, 228–229 Consumer markets, measuring price stickiness in, 188 Consumer preferences shifts in, 77, 79 Consumer Price Index (CPI), 130 vs chain index for GDP, 130–131 components of, 131 cost-of-living adjustments and, 132 Consumer products, information about, 59–60 Consumer spending falling home prices and, 229 income and, 227, 240 Consumer wealth, autonomous consumption and, 228 Consumption autonomous, 227 consumer, 240 inequality, trade, and, 379 Consumption expenditures, 102, 103, 152 Consumption function, 192, 227–229 changes in, 227–229 equilibrium output and, 229–234 tax rate and, 239 Consumption possibilities curve, 367–368 Consumption taxes, 358–361 Continuity, 53 Contractionary policies, 207, 316 Contracts, 55 Convergence, 163 Corporate bonds, 259–260, 262 Corporate taxes, 213 Costa Rica, GNI per capital, 162 Cost of living, 130 Cost-of-living adjustments (COLAs), 132 Costs marginal, 33 menu, 134 opportunity See Opportunity cost shoe-leather, 134 Cost savings, from outsourcing, 54 Council of Economic Advisors, 219 Counterfeiters, 272 Creative destruction, 172 Credit cards, 276–277 Crop yields, fertilizer and, 39 Crowding in, 154 Crowding out, 152 in closed economy, 152–153 increasing health-care expenditures and, 323 in long run, 322–324 in open economy, 153–154 Cruise ship berths, supply and demand of, 88–89 INDEX Culture, economic growth and, 174 Currency appreciation, 304, 386–387 demand and supply of, 387–390 depreciation, 303–304, 386–387 devaluation, 400 Federal Reserve and supply of, 281 revaluation, 400 Currency markets, 385–386 Current account, 393, 394–395 Current account deficit, 396–397 Curves See also Demand curve; Production possibilities curve; Supply curve consumption possibilities, 367–368 expectations Phillips, 332–334 Laffer, 213–214 moving along vs shifting, 20–21 nonlinear, 22–23 slope of, 19 supply, 69–73 Custom duties, 213 Custom prices, 186 Cyclical unemployment, 126, 140, 146 D Debit cards, 277 Decision making by committees, 305 in market economy, 55–56 using microeconomics for, 12 Deflation, 42, 133–134 Dell, Melissa, 162 DeLong, Brad, 164 Demand, 66 See also Aggregate demand aggregate, 188–195 change in, 75–76 changes in, and aggregate demand curve, 191–192 currency, 387–390 excess, 74–75 increases in, 76–78 labor, wages and, 143–145 law of, 66–68, 67 market effects of changes in, 75–79 for money, 292–294 short-run determination of output by, 187–188 simultaneous changes in supply and, 84–86 Demand and supply model, 86–90 Demand curve, 66–69 See also Aggregate demand curve (AD) decreases in, 78–79 individual, 67 labor, 143, 147 law of demand and, 66–68 market, 68–69 movement along, 68 shifts in, 76–79 Demand deposits, 275 Demand policies, 316 Demand schedule, 66–67 Demographics, 335 Denison, Edward, 168 Deposit accounts, 275 Deposit creation formula, 290 Deposit insurance, 266 Depreciation, 103 as function of stock of capital, 181 saving, capital deepening and, 180–183 Depreciation of a currency, 303–304, 386–387 Depression, 113, 224 Devaluation, 400 Developing countries economic growth in, 163–164 knowledge accumulation in, 173 lack of incentives for growth in, 176 price structures in, 161 property rights in, 175, 176 Diminishing marginal returns, 142 Diminishing returns, 39, 40 Diminishing returns principle, 39–40, 142, 166, 180 Disability insurance, unemployment and, 125 Discount rate, 296–297 Discouraged workers, 123–124 Discretionary spending, 211 Division of labor, exchange and, 52–53 Doha trade negotiations, 375 Dollars See U.S dollar Dolphins, tuna fishing and, 377–378 Domestic industries helping, with protectionist policies, 373–374 protection of, 54 Dominican Republic-Central America Free Trade Agreement (DR-CAFTA), 375 Double coincidence of wants, 273 421 Driving speed, marginal principle and, 37 Dumping, 376–377 E Earnings, retained, 261 Earthquakes, price of paper and, 65 Easterly, William, 176 Econometric models, 210 Economic analysis problem solving and, 5–7 Economic boom, returning to full employment after, 315 Economic fluctuations, 186 lags and, 208–210 technology and, 148–151 using macroeconomics to understand, 11–12 Economic growth, 101, 159–160 in Africa, 158 capital deepening and, 164–167 culture, evolution, and, 174 in developing countries, 163–164 global warming and, 162 inequality and, 164 international comparisons of, 161–162 measuring, 160–161 new growth theory and, 174–175 vs per capita income, 163 property rights and, 175, 176 rates, 159–164 role of government in, 175–176 role of political factors in, 173 sources of, 169 technological progress and, 168–171, 180–183 using macroeconomics to understand, 11 Economic models, 4–5 classical models, 140 to determine causes of recessions, 198 econometric, 210 Economic policy debates over, 347–361 speed of adjustment and, 315–317 using, to fight recession, 316–317 Economic principles, 30 See also Diminishing returns principle; Marginal principle; Opportunity cost; Real-nominal principle; Voluntary exchange principle 422 INDEX Economic questions, Economic recovery interest rates and, 300 after recession, 314–315 Economics, 1, classical, 324–325 supply-side, 213–214, 218 Economic stability, 240–241 Economic uncertainty, 60, 210, 255 Economic way of thinking elements of, 7–9 example, 9–11 Economic well-being, 97 Economy boom, 200–201, 315 centrally planned, 55 in short run, 200–201, 224 Edison, Thomas, Education, 172–176 Efficiency, Elections, 318 E-mail, spam, 10 Emigration, 139 Employment free trade and, 368–369 part-time, 124 Employment taxes labor demand and supply and, 147–148 Energy prices, investment spending and, 255 Entitlement and mandatory spending, 211 Entitlement programs, 211, 212 Entrepreneurs, role of, 56–57 Entrepreneurship, 2, Environment, GDP and, 115 Environmental protection, trade laws and, 377–378 Equations, using, to compute missing values, 25 Equilibrium labor market, 143–144, 145–147 long-run, 201 in money market, 297–298 short-run, 201 Equilibrium output, 224–225 adjusting to, 225–227 consumption function and, 229–234 determining, 226 formulas for, 249–252 in open economy, 241–242 saving and investment and, 231–232 Equilibrium price decrease in demand and, 78–79 decrease in supply and, 83–84 increase in demand and, 77–78 increase in supply and, 82–83 simultaneous changes in demand and supply and, 84–86, 88–89 Equilibrium quantity, simultaneous changes in demand and supply and, 84–86 Escalators, marginal principle and, 36 Estate taxes, 213 Euro, 386, 387–390, 402 Europeans, work hours of, 149 European Union (EU), 375 Evolution, economic growth and, 174 Excess demand, 74–75 Excess reserves, 278, 280 Excess supply, 75 Exchange comparative advantage and, 50–53 division of labor and, 52–53 rules of, government enforcement of, 59–60 Exchange rate, 303–304, 386 appreciation, 397 current systems of, 401–402 depreciation, 397–398 determination of, 386–390 fixed, 397–401 flexible, 399–401 net exports and, 391 real, 390–393 Excise taxes, 213 Expansion, 111 Expansionary policies, 207, 219, 316 Expectations of inflation, 330 Expectations Phillips curve, 332–333, 334 Expected real interest rate, 259 Expenditures, planned, 225 Exports, 53, 104 in income-expenditure model, 241–243 net, 102, 104, 152 Externalities negative, 58–59 F Fackler, Jack, 198 Factors of production, Fannie Mae, 265, 267, 268 Federal budget, 210–216 See also Budget deficit debate over balancing, 348–354 recent history of, 348–350 Federal deficit, 214–216 Federal funds market, 296–297 Federal funds rate, 297, 306–307, 317 Federal government See also Government Federal Open Market Committee (FOMC), 283 Federal Reserve functions of, 281–282 housing boom and, 356 independence of, 283–284 inflation and, 337–338 inflation targeting by, 355–358 interest rates and, 298, 300, 301 market expectations and, 306–307 monetary policy and, 282, 283, 291–307 money supply and, 294–297 open market operations of, 295, 300 response by, in financial crisis, 284–285, 296 structure of, 282–283 tools of, 295–297 Federal Reserve Banks, 282–283 Federal Reserve float, 284 Federal Reserve System, 281 Federal revenues, 212–213 Federal spending, 210–212, 220 Feldstein, Martin, 148 Fertilizer, crop yields and, 39 Fiat money, 274–275 Final goods and services, 100 Finance, investment and, 253 Financial account, 394–396 Financial crises of 2008–2009, 267, 285, 329, 402 economic view of, 6–7 management of, 402–405 response of Federal Reserve to, 284–285, 296 Financial intermediaries, 263–268, 264 Financial panics, 281 Fiscal imbalances, long-term, of U.S., 353 Fiscal multipliers, 207–208, 234–238 INDEX Fiscal policy, 206 aggregate demand and, 206–207 automatic stabilizers, 215, 238–241 contractionary policies, 207 expansionary, 219 expansionary policies, 207 federal deficit and, 214–215 Keynesian, 234, 236–237 lags and, 208–210 role of, 206–210 stabilization policies, 208–210 in U.S history, 216–220 Fiscal stimulus, 205, 219, 237 Fiscal-year basis, 210 Fischer, Stanley, 163 Fitoussi, Jean-Paul, 97 Fixed exchange rates, 397–401 Fixed exchange rate system, 399 Flat tax, 360–361 Flexible exchange rate system, 399–401 Flexible prices, 186–187 Forecasting, economic uncertainties, 210 Foreign competition, workers and, 373 Foreign demand, affect on output of, 242 Foreign exchange market intervention, 398–399 Foreign producers, dumping by, 376–377 France GNI per capital, 161 government consumption in, 152 Freddie Mac, 265, 267, 268 Free trade, 172, 364, 365 dumping and, 376–377 employment and, 368–369 reasons for protests against, 380 Frictional unemployment, 126–127, 140 Friedman, Milton, 316, 332, 343 Full employment, 127, 140, 186 dividing output among competing demands for GDP at, 151–155 labor market equilibrium and, 145–147 opportunity cost of increased government spending at, 153 returning to, after recession, 314–315 returning to, from a boom, 315 wage and price changes and, 313–319 Full-employment model, 140, 147–151 Full-employment output, 146–147 G Galor, Oded, 174 Garden-seed market, 58 GATT See General Agreement on Tariffs and Trade (GATT) GDP See Gross domestic product GDP deflator, 110–111 General Agreement on Tariffs and Trade (GATT), 375 Genetically modified crops, 378 Germany central bank of, 338 government investment in, 152 U.S dollar and, 400–401 Gift taxes, 213 Global economy, 53–54 Global recession, 97, 223 Global warming economic growth and, 162 GNP See Gross national product Gokhale, Jagadeesh, 353 Gold prices, inflation and, 329 Gold standard, 274 Goods basket of, 130 complement, 77 complementary, 78 inferior, 77, 78 intermediate, 100 nondurable, 379 normal, 76, 78 public, 59 substitute, 77, 78 Gordon, Robert J., 170–171 Government capital deepening and, 167 enforcement of rules of exchange by, 59–60 role of, in market economy, 59–60, 175–176 size of, 352–353 Government bonds, 214 Government debt, 211–212, 329, 348 See also Budget deficit as burden on future generations, 350–351 international comparisons of, 352 as percentage of GDP, 349–350, 352 Government investment, 152, 167 423 Government purchases, 102, 103–104, 152, 153 Government spending in 2009 stimulus package, 205 aggregate demand and, 206 capital deepening and, 167 changes in, and aggregate demand curve, 191 crowding in and, 154 federal budget and, 210–212 GDP and, 233, 234 income-expenditure model and, 234–241 multiplier, 234–235, 251 U.S consumption and, during WWII, 153 U.S investment and, during WWII, 154 Graphs of negative relationships, 21–22 of nonlinear relationships, 22–23 of single variable, 15–17 of two variables, 17–19 using, 15–23 Great Depression, 113, 134, 186, 196 bank failures during, 266 city-issued money during, 276 fiscal policy during, 216–217 inside lag during, 209 labor market policies and, 151 unemployment during, 140, 185 Greece, hyperinflation in, 341 Greenspan, Alan, 291, 306 Gross domestic product (GDP), 100 affect of imports and exports on, 243 chain-weighted index for, 130–131 components of, 102–104 contributions to growth of real, 169 debt as percent of, 349–350, 352 dividing output among competing demands for, 151–155 fluctuations in, 111–113 GDP equation, 105 vs GNP, 106 government spending and, 233, 234 growth in, 159 growth rates of U.S., 1871–2009, 239 happiness and, 114 historical U.S price index for, 133 interest rates and, 301–303 investment spending as share of U.S., 255 as measure of welfare, 113–115 424 INDEX measuring macroeconomic activity using, 100–105 measuring real vs nominal, 109–110 money demand and, 292–293 nominal, 101, 108–111 real, 101, 102, 108–111 real, per capita, 160 real exchange rates and net exports as percentage of, 391 research and development as percentage of, 171 shortcomings in, 113–115 Gross investment, 103 Gross national income, international comparisons of, 161–162 Gross national product (GNP), 106 real, 161 Growth accounting, 168–171 Growth rate, 160 international comparisons of, 161–162 vs per capita income, 163 Growth version of the quantity equation, 340–341 H Hall, Robert E., 323, 360 Happiness GDP and, 114 unemployment, social norms, and, 129 Hayek, Friedrich, 55 Health-care expenditures, crowding out and, 323 Heller, Walter, 217 Heston, Alan, 161 Home prices, 229 Homes, underwater, 265 Honeybees, price of ice cream and, 87–88 Hong Kong economic growth in, 175 government consumption in, 152 Hoover, Herbert, 151, 217 Hormone-treated beef, 378 Houses prices, Hurricane Katrina and, 87 Housework, GDP and, 113 Housing boom, 356 Housing market, 253 Housing prices fall in, 253, 266–267, 291 in Japan, 161 Human capital, 2, 159, 172–173 Human capital theory, 173–174 Hungary, hyperinflation in, 341, 343 Hurricane Katrina, housing prices and, 87 Hyperinflation, 135, 341–343 I Ice cream prices, honeybee population and, 87–88 Illiquid, 293 Immigration, 139 Imperfect competition, 59 Imperfect information, 59 Import bans, 369–370 Import licenses, 370–371 Import quotas, 370 Imports, 53, 104, 241–243 Incentives, 8–9, 176 Income, 98–99 circular flow of, 99–100 consumer spending and, 227, 240 decrease in, 77, 78 increase in, 76, 78 national, 105–108 per capita, 161–162, 163 permanent, 218 personal, 106 personal disposable, 106 Income-expenditure model, 224–227 aggregate demand curve and, 243–245 automatic stabilizers in, 238–241 consumption function in, 227–234 equilibrium output in, 229–234 exports and imports in, 241–243 government spending and taxation in, 234–241 multiplier in, 232–234 Income inequality, outsourcing and trade and, 379–380 Income tax, 212–213, 239 India central bank of, 282 economic growth in, 163, 242 per capita output in, 167 price structures in, 161 sources of growth in, 169 Individual demand curve, 67 Individual supply curve, 69–70, 71 Induced innovation, 172 Industrial Revolution, 173, 174 Inefficiencies, Inequality economic growth and, 164 international trade and, 379 Infant industries, 373 Inferior good, 77, 78 Inflation, 98, 132–134, 261, 401 anticipated, 134–135 budget deficits and, 350 costs of, 134–135 credibility of central bank and, 337–339 effect on real minimum wage, 41 expectations of, 330 gold prices and, 329 hyperinflation, 341–343 public expectations about, 333–334 repayment of student loans and, 42 in steady state, 330–331 unanticipated, 134, 135 unemployment and, 332–336 U.S., and unemployment in 1980s, 334–335 velocity of money and, 339–341 Inflation expectations central banks and, 337–339 interest rates and, 330–331 money demand and, 331 Inflation rate, 132, 133, 134 Inflation targeting, by Fed, 355–358 Information about consumer products, 59–60 imperfect, 59 Information technology, growth accounting and, 170–171 Innovation, 53 induced, 172 monopolies and, 172 Input prices, 187, 197 Inside lags, 208–210, 305–306 Insourcing, 54 Institutional changes, 335 Institutions, economic growth and, 175 Insurance, 55, 60 deposit, 266 disability, 125 risk and, 264–265 unemployment, 128 Intellectual property rights, 172 Interest, net, 211–212 Interest rate effect, 190 INDEX Interest rates approaching zero, 319 bond prices and, 298–301 on corporate and government investment, 2002–2008, 259 determination of, 297–301 economic recovery and, 300 GDP and, 301–303 inflation and, 330–331 investment and, 260–261, 301–303 on long-term bonds, 306–307 monetary policy and, 302 money demand and, 292–293 nominal, 258–260, 261, 319, 331 present value and, 256–257 real, 258–260, 261 Intermediate goods, 100 International comparisons of government debt, 352 of growth rate, 161–162 International Financial Statistics, 152 International Monetary Fund, 152, 161, 404 International trade, 365 See also Free trade; Trade comparative advantage and, 53–54 income-expenditure model and, 241–243 inequality and, 379 monetary policy and, 303–304 International trade effect, 190 Inventions, patents on, 55 Inventory cycle, 241 Inventory management, 241 Investment, 152, 240–241, 254–256 finance and, 253 financial intermediaries and, 263–268 government, 152 gross, 103 interest rates and, 260–261, 301–303 multiplier and, 232–234 neoclassical theory, 261 net, 103, 166 present value and, 260 private, 103 Q-theory of, 262 saving and, 165–166, 231–232 stock market and, 261–263 Investment decisions, 260–263 Investment spending accelerator theory of, 254 energy prices and, 255 money market and, 301 multiple-accelerator model, 256 procyclical, 254 real interest rates and, 261 as share of U.S GDP, 255 Investors, 254, 263 Invisible hand, 56 iPod, 360–361 iPod Shuffle, Iraq invasion of Kuwait by, 306 war in, 349 Italy, GNI per capital, 161 J Japan economic growth in, 162 financial crisis in, 266 GNI per capital, 161, 162 government spending in, 237–238 housing prices in, 161 recession in, 236–237 work hours in, 149 Job loss, from outsourcing, 54 Johnson, Lyndon, 217 Jones, Benjamin, 162 Jones, Charles I., 323 Jorgenson, Dale, 171, 261 K Kashyap, Anil, 188 Kennedy, John F., 217 Kennedy administration, fiscal policy during, 217 Keynes, John Maynard, 186, 192, 196, 224, 237 classical economics and, 324–325 on economic stabilization, 317 influence of, 238 on investment spending, 254 Keynesian cross, 224 Keynesian fiscal policy, 234, 236–237 Klenow, Peter, 188 Knowledge accumulation, 172–173 Korean VCRs, price discrimination and, 377 Kuwait, Iraqi invasion of, 306 Kuznets, Simon, 164 L Labor, 2, 141 child, 162 division of, and exchange, 52–53 425 relationship between output and, 141–142 skilled, 380 taxes and demand and supply for, 147–148 unskilled, 380 wages and demand and supply for, 143–145 Labor demand curve, 143, 147 Labor force, 121, 122, 123 Labor force participation rate, 121 Labor market, Labor market equilibrium, 143–144 full employment and, 145–147 Labor market policies, Great Depression and, 151 Labor productivity, 170, 336 Labor supply curve, 144, 147–148 Laffer, Arthur, 213 Laffer curve, 213–214 Lags, 208–210, 305–306 Law of demand, 67 Law of one price, 393 Law of supply, 70 Learning by doing, 373 Lebergott, Stanley, 148 Lehman Brothers, 267, 285 Leisure, GDP and, 113 Lender of last resort, 281, 282 Leverage, 265–266 Liabilities, 277 Liberty ships, 373 Life expectancy, entitlement programs and, 212 Lincoln, Abraham, 53 Liquid, 263 Liquidity demand for money, 293 Liquidity traps, 317, 319 Living standards, 1, 130 Black Death and, 145 differences in, 159 growth in GDP and, 159 trade and, 379 Loan repayment, effect of inflation and deflation on, 42 Locomotive effect, 242 Long run crowding out in, 322–324 neutrality of money in, 320–322 Long-run aggregate supply curve, 195–196, 314 Long-run equilibrium, 201 426 INDEX Long run in macroeconomics, 312 Long-run neutrality of money, 320–322 Lottery winners, present value and, 258 Lucas, Robert E., 174, 333 Luxembourg, 161 M M1, 275, 279 M2, 275–276, 340 Macroeconomic activity measuring using gross domestic product, 100–105 measuring using national income, 105–108 Macroeconomic policy, debates over, 347–361 Macroeconomics, 11, 98 linking the short and long run in, 200–201, 312–313 short run in, 187–188 use of, 11–12 Malthus, Thomas, 145, 324 Mandatory spending, 211 Manufacturing firms inventory management by, 241 Marginal benefit, 33 Marginal change, 8, 10 Marginal cost, 33 Marginally attached workers, 123–124 Marginal principle, 33–37, 71, 144 automobile emissions standards and, 36 driving speed and, 37 movie sequels and, 34–35 of renting facility, 35–36 Marginal propensity to consume (MPC), 192, 227, 233, 240 Marginal propensity to import, 241 Marginal propensity to save (MPS), 192, 231 Market changes, predicting and explaining, 86 Market demand curve, 68–69 Market economy, 55 Market economy risk in, 60 role of government in, 59–60, 175–176 Market effects of changes in demand, 75–79 of changes in supply, 79–86, 87–88 of simultaneous changes in demand and supply, 84–86 Market equilibrium, 73–75, 74 Market expectations, 306–307 Market failure, 58 Markets, 2, 50, 55–58 See also Labor market applications of demand and supply model to, 86–90 of changes in demand, 87 development of, 57–58 emergence of, in POW camps, 57–58 perfectly competitive, 66, 72 role of entrepreneurs in, 56–57 scale of, 172 using microeconomics to understand, 12 virtues of, 55–56 voluntary exchange and, 37–38 Market supply curve, 71–73 slope of, 73 Mattel, 49 McMillin, Douglas, 198 Medicaid, 211, 212 Medicare, 211, 212, 213, 353 Medium of exchange, 273–274 Menu costs, 134 Merrill Lynch, 267 Mexico financial crisis in, 402–404 GNI per capital, 162 Microeconomics, 12–13 Military spending, opportunity cost of, 30–31 Mill, John Stuart, 324 Minimum supply price, 71 Minimum wage, 187 inflation’s effect on real, 41 Moav, Omer, 174 Modigliani, Franco, 325 Monetarists, 343 Monetary policy, 281, 283 challenges, 304–307 contractionary, 316 expansionary, 316 Fed and, 291–307 housing boom and, 356 interest rates and, 302 international trade and, 303–304 lags in, 305–306 in long run, 321 in short run, 321 Monetary systems, types of, 274–275 Monetizing the deficit, 350 Money, 273 changes in growth rate of, and steady state, 331–332 city-issued, during Great Depression, 276 commodity, 274 creation of, by banks, 277–281 demand for, 292–294 fiat, 274–275 long-run neutrality of, 320–322 M1, 275, 279 M2, 275–276 measuring, in U.S economy, 275–277 as medium of exchange, 273–274 nominal value of, 42 properties of, 273–274 real-nominal principle and, 40–43 real value of, 42 as store of value, 274 velocity of, 339–341 Money demand GDP and, 293–294 inflation and, 331 interest rates and, 292–293, 297–301 other components of, 294 price level and, 293 transaction, 292 Money illusion, 330 Money market, 292–294 equilibrium in, 297–298 investment spending and, 301 Money multiplier, 279–281 Money supply aggregate demand and, 302 changes in, 190 Federal Reserve and supply of, 294–297 interest rates and, 297–301 Monopolies antitrust policies and, 60 helping domestic firms establish, in world markets, 373–374 innovation and, 172 Mortgages, subprime, 267, 285, 291, 356 Movie sequels, marginal principle and, 34–35 Mozambique, Multilateral real exchange rate, 391 Multiple-accelerator model, 256 Multiplier effect, 243 INDEX Multiplier(s), 192–195, 207–208 balanced-budget, 236, 251 fiscal, 207–208, 234–238 formulas for, 249–252 government spending, 234–235, 251 in income-expenditure mode, 232–234 money, 279–281 tax, 235, 236, 251 using, 236–238 using long-term macro data to measure, 233 Music piracy, 172 N National Bureau of Economics Research (NBER), 112–113 National debt See Budget deficit; Government debt National income, 105 measuring, 105–106, 107 value added and, 107 National Industrial Recovery Act, 151 Natural disasters, 148 Natural rate of unemployment, 127–128, 146, 335–336 Natural resources, Negative externalities, 58–59 Negative relationship, 19 graphing, 21–22 Neoclassical theory of investment, 261 Net exports, 102, 104, 152, 391 Net interest, 211–212 Net international investment position, 396 Net investment, 103, 166 Net national product (NNP), 106 New Deal, 151 New growth theory, 174–175 New York Federal Reserve, 283 New Zealand, central bank of, 338, 357 Nicaragua, hyperinflation in, 342 NNP See Net national product (NNP) Nominal GDP, 101, 108–111 Nominal interest rate, 258–261, 319, 331 Nominal value, 42 Nominal wages, 330 Nondurable goods, 379 Nonlinear relationships, graphing, 22–23 Normal good, 76, 78 Normative analysis, 3–4 North American Free Trade Agreement (NAFTA), 364, 375 Norway, 161 O Obama, Barack, 205 Obama administration, fiscal stimulus of, 205, 219, 237, 349 Obstfeld, Maurice, 163 Offshoring, 53–54 Ohanian, Lee E., 151 Oil prices, 148, 199 Okun, Arthur, 186 Olken, Benjamin, 162 Online games, market exchange and, 38–39 Open economy, 153 crowding out in, 153 equilibrium output in, 241–242 Open market operations, 295, 300 Open market purchases, 295 Open market sales, 295 Opportunity cost, 29, 50 of college degree, 29–30 crowding out and, 152–153 of holding money, 292–293 in market development, 57 of military spending, 30–31 production possibilities curve and, 31–33 productivity and, 50 of running a business, 32 Opportunity cost principle, 152, 216, 237, 256, 292, 351, 365 Oswald, Andrew, 114 Output determining long-run, 196 dividing among competing demands for GDP, at full employment, 151–155 equilibrium, 224–227 full-employment, 146–148 interest rates and, 301–303 potential, 146–148 relationship between labor and, 141–142 short-run determination of, 187–188 taxes and, 147–148 Outside lags, 208–210, 305–306 Outsourcing, 53–54, 379–380 Owitt, Peter, 175 Owner’s equity, 277 427 P Pakistan economic growth in, 163 price structures in, 161 Paper prices, 65 Participatory institutions, 173 Part-time employment, 124 Patents, 55, 172 Patinkin, Don, 325 Peak, 111 Per capita incomes, 161–162, 163 Percentage changes computing, 23–25 Perfectly competitive markets, 66, 72 Permanent income, 218 Personal disposable income, 106 Personal income, 106 Peru, lack of property rights in, 176 Phelps, Edmund, 332 Philippines, emigration from, 139 Phillips, A.W., 332 Physical capital, Pie graphs, 15 Piketty, Thomas, 164 Pinkovskiy, Maxis, 158 Piracy, 172 Planned expenditures, 225 Point of diminishing return, 166 Political business cycles, 317–318 Political institutions, affect on economic growth of, 173 Political parties, 318 Pollution, 58–59 GDP and, 115 Poor impact of tariffs on, 371 Poor countries See Developing countries Population, decreases in, 79 Population growth, capital deepening and, 166–167 Population increases, 77 Positive analysis, 3–4 Positive relationship, 19 Potential output, 146–147 taxes and, 147–148 Poverty, in Africa, 5–6, 158 Predatory pricing, 377 Prescott, Edward, 149 Present value, 256–257 interest rates and, 256–257 lottery winners and, 258 428 INDEX Presidential elections, 318 Presidential popularity, economic conditions and, 98 Price ceiling, 75 Price discrimination, 377 Price flexibility, full employment and, 140 Price floor, 75 Price level determining long-run, 196 money demand and, 292–293 Prices adjustment over time in, 312–313 auction, 186 change in supply and, 89–90 changes in demand and, 87 of complementary goods, 77 custom, 186 demand schedule and, 66–67 equilibrium, 77–79, 82–85 excess demand and, 74–75 excess supply and, 75 expectations of higher, 77 expectations of lower, 79 flexible, 186–187 full employment and, 313–319 inflation and, 132–134 input, 187, 197 in market economy, 56 minimum supply price, 71 predatory, 377 problems in measuring changes in, 131–132 reactions to changes in, 90 retail, 188 scarcity and, 56 sticky, 186–187, 188 of substitutes, 77 supply schedule and, 69 trade and, 379 wages and, 312–313 Prisoner of war (POW) camps, emergence of markets in, 57–58 Private investment expenditures, 102, 103 Problem solving, economic analysis and, 5–7 Procyclical, 254 Production, 98–99 circular flow of, 99–100 factors of, 2, 140–141 Production facilities, sharing, and diminishing returns, 40 Production function, 140–143, 141, 146 Production possibilities curve, 31, 365–367 economic growth and, 159–160 opportunity cost and, 31–33 scarcity and, 31 shifting the, 33 Productivity increased, from specialization, 52–53 labor, 170 opportunity cost and, 50 Property rights, 175, 176 Prosperity, Protectionist policies, 369–372 import bans, 369–370 quotas, 370–371 rationales for, 372–374 responses to, 372 tariffs, 372 voluntary export restraints, 370–371 Protests, against free trade, 380 Public goods, 59 Public policies using microeconomics to evaluate, 13 Purchasing power parity, 393 Q Q-theory of investment, 262 Quantity demanded, 66, 75–76 Quantity equation, 340 Quantity supplied, 69 Quotas import, 370 vs tariffs, 372 R Rabushka, Alvin, 360 Rational expectations, 333–334, 338 Reagan, Ronald, 98, 218, 334 Reagan administration, fiscal policy during, 218 Real business cycle theory, 148–151, 149 Real exchange rates, 390–393 Real GDP, 101, 102, 108–111 contributions to growth of, 169 fluctuations in growth of, 186 Real GDP per capita, 160 Real GNP, 161 Real interest rate, 258–261 Real minimum wage, 41 Real-nominal principle, 40–43, 101, 129–130, 189, 258, 292, 313, 319, 331, 390 Real value, 42 Real wages, 43, 143, 330 Recessions, 111 of 1990, 111 2007–2009, 205, 223 budget deficits and, 353–354 causes of, 198 comparing severity of, 112 economic recovery from, 300 economic view of current, 6–7 reasons for, 185, 186 returning to full employment after, 314–315 since WWII, 111–112 using economic policy to fight, 316–317 Redlick, Charles, 233 Repetition, 52 Required reserves, 278 Research and development as percentage of GDP, 171 technological progress and, 171–172 Reserve Bank of India, 282 Reserve ratio, 278, 279 Reserve requirements, 295–296 Reserves, 278, 282 Resources, scarcity of, Retail prices, 188 Retained earnings, 261 Revaluation, 400 Ricardian equivalence, 351–352 Ricardo, David, 324 Rice prices, drought and, 90 Risk financial intermediaries and, 263–265 insurance and, 55, 60 in market economy, 60 Rogoff, Kenneth, 163 Romalis, John, 379 Romer, Christina, 219 Romer, Paul, 174 Roosevelt, Franklin, 151, 216–217, 274 Rule of 70, 160–161 Rules of thumb approach, to predicting inflation, 333 Russia, hyperinflation in, 341–342 INDEX S Saez, Emmanuel, 164 Sales taxes, 358–361 Sali-i-Martin, Xavier, 158 Samuelson, Paul, 332 Savers, 263 Saving, 165–166 consumption taxes and, 358–359 depreciation, capital deepening and, 180–183 as function of stock of capital, 181 increase in, 182–183 investment and, 231–232 Savings accounts, 276 Savings and loan crisis, 266 Savings function, 231 Say, Jean-Baptiste, 324 Say’s law, 324–325 Scale of the market, 172 Scarcity, prices and, 56 production possibilities curve and, 31 trade-offs and, 2–3 Schumpeter, Joseph, 172 Seasonal unemployment, 126 Securitization, 265, 267 Seignorage, 342–343 Self-interest, 37, 56 Self-sufficiency, 38, 50, 51 Sen, Amartya, 97 September 11, 2001, 218, 237, 284 Shoe-leather costs, 134 Shortage, 74–75 Short-run aggregate supply curve, 196–199, 314 Short-run equilibrium, 201 Short run in macroeconomics, 187–188, 224, 312 Simon, Herbert, 333 Six-month treasuries, 259 Skilled labor, 380 Slope of aggregate demand curve, 189–190 Slope of a curve, 19, 71, 73 Smetters, Kent, 353 Smith, Adam, 8–9, 37, 52, 53, 56, 172 Smoot-Hawley tariffs, 374–375 Social insurance taxes, 213 Social safety net, 60 Social Security, 211, 212, 213, 353 cost-of-living adjustments, 132 real-nominal principle and, 42–43 Solow, Robert, 168, 180, 332 Sovereign investment fund, 397 Spam, 10 Spangler Candy Company, 54 Specialization benefits of, 365–369 gains from trade and, 50–52 increased productivity and, 52–53 voluntary exchange and, 38 Speculative demand for money, 293 Stabilization policies, 208–210, 316, 356–357 Stagflation, 199–200 Standard of living See Living standards Steady state growth rate of money and, 331–332 inflation in, 330–331 Sticky prices, 186–187, 188 Stiglitz, Joseph, 97, 404 Stock market, investment and, 261–263 Stock of capital, 141, 142–143, 180–182, 254 Store of value, 274 Structural unemployment, 127, 140 Student loans, inflation and cost of repaying, 42 Subprime mortgages, 267, 285, 291, 356 Sub-Saharan Africa, 1, 5–6, 176 Subsidized firms, 374 Substitutes, 68, 77, 78 Sugar prices, 54 Summers, Robert, 161 Supply aggregate, 195–200 of capital, 165 currency, 387–390 decrease in, and equilibrium price, 83–84 excess, 75 increase in, and equilibrium price, 82–83 labor, wages and, 143–145 law of, 70 market effects of changes in, 79–86, 87–88 of money, 190 simultaneous changes in demand and, 84–86 Supply curve, 69–73 aggregate, 314 decreases in supply and shifts in, 83 429 downward shift in, 81 increase in supply and shifts in, 81–82 individual, 69–70, 71 labor, 144, 147–148 market, 71–73 movement along, 70 rightward shift, 81 slope of, 71, 73 Supply schedule, 69 Supply shocks, 199–200 Supply-side economics, 213–214, 218 Surplus, 75 Switzerland, central bank of, 338 T Tariffs, 364, 372 history of, 374–375 impact of, on poor, 371 Tax cuts during Bush administration, 218–219, 349 during Kennedy administration, 217 Taxes 1996–2009, 220 aggregate demand and, 206 changes in, and aggregate demand curve, 191 consumption, 358–361 corporate, 213 estate, 213 excise, 213 flat, 360–361 gift, 213 government investment and, 167 income, 212–213, 239 income-expenditure model and, 234–241 potential output and, 147–148 revenues from, 212–213 sales, 358–361 social insurance, 213 value-added, 360, 361 withholding, 213 work hours and, 149 Tax multiplier, 235, 236, 251 Tax rates, 214, 239–240, 354 Tax rebates, 219 Tax revenues economy and, 214 tax rates and, 214 Tax system, 135 430 INDEX Taylor, John, 356 Technological progress, 159 causes of, 171–175 economic growth and, 168–171, 180–183 measuring, 168–169 new growth theory and, 174–175 Technology, economic fluctuations and, 148–151 Temin, Peter, 198 Terms of trade, 367 The General Theory of Employment, Interest, and Money (Keynes), 237, 238 Time-series graph, 16–17 Tobin, James, 262 Total market value, 100 Trade See also Free trade; International trade benefits of, 365–369 capital deepening and, 167 comparative advantage and terms of, 367 gains from, and specialization, 50–52 income inequality and, 379–380 inequality and, 379 international, comparative advantage and, 53–54 policy debates, 376–380 protectionist policies and, 369–374 Trade agreements, history of, 374–375 Trade balance, 105 Trade deficit, 104, 167, 396–397 Trade laws, environmental protection and, 377–378 Trade sanctions, 364 Trade surplus, 104 capital deepening and, 167 Traffic congestion economic view of, economic way of thinking about, 9–11 Transaction demand for money, 292–293 Transfer payments, 104 Traveler’s checks, 275 Treasury Department, 398 Treasury securities, 296 Troubled Asset Relief Program (TARP), 267–268 Trough, 111 Truman, Harry S., 3, 347 Tuna fishing, dolphins and, 377–378 Two-variable graphs, 17–19 U Unanticipated inflation, 134, 135 Underground economy, GDP and, 113–115 Underwater homes, 265 Unemployed, 121 Unemployed individuals, 124–126 Unemployment, 98, 121–126 in 2007, 311 in 2009, 205, 219, 311 alternative measures of, 122–124 categories of, 126–128 costs of, 128–129 cyclical, 126, 140, 146 disability insurance and, 125 duration of, 128–129 frictional, 126–127, 140 during Great Depression, 140, 185 inflation and, 332–336 measurement of, 121–122 natural rate of, 127–128, 146, 335–336 prolonged, 311 seasonal, 126 social norms, happiness, and, 129 statistics on, 125 structural, 127, 140 Unemployment insurance, 60, 128 Unemployment rate, 121 in 2010, 120, 122, 125 in developed countries, 122 exclusions from, 120 Unfair competition, 374 United Kingdom central bank of, 282, 284, 338 GNI per capital, 161 inflation targeting in, 357 United States annual productivity growth, 1959–2007, 170 consumption and government spending during WWII in, 153 consumption of GDP in, 152 exchange rates in, 400–401 fiscal policy in, 216–220 GNI per capital, 161 growth rates of GDP, 1871–2009, 239 inflation and unemployment in 1980s, 334–335 investment and government spending during WWII in, 154 investment spending as share of GDP, 255 long-term fiscal imbalances of, 353 net international investment position, 396 prosperity in, real GNP, 161 research and development funding in, 172 trade deficit of, 396–397 work hours in, 149 world trade and, 242 Unit of account, 274 Unskilled labor, 380 U.S.-China currency tensions, 392 U.S dollar demand and supply of, 387–390 depreciation, 303–304 government intervention with price of, 398–399 U.S economy oil price fluctuations and, 199 world economy and, 242 U.S Treasury bonds, 211, 259 V Value added, 107 Value-added tax (VAT), 360, 361 Vanilla bean prices, 89–90 Variables, graphs of single, 15–17 graphs of two, 17–19 isolation of, 7–8, 10 negative relationships between, 21–22 nonlinear relationships between, 22–23 Velocity of money, 339–341 Vertical intercept, 18 Vietnam War era, fiscal policy during, 217–218 Virtual currency, 57 Volcker, Paul, 291, 334 Voluntary exchange principle, 37–39, 52, 274 markets and, 37–38 online games and, 38–39 specialization and, 38 Voluntary export restraint (VER), 370 Voter expectations, 318 INDEX W Wachovia Bank, 267 Wage flexibility, full employment and, 140 Wage-price spiral, 313, 316 Wages adjustment over time in, 312–313 demand and supply for labor and, 143–145 full employment and, 313–319 inequalities, and outsourcing, 379–380 minimum, 187 nominal, 330 prices and, 312–313 real, 143, 330 real-nominal principle and, 43 sticky, 187 taxes and, 147–148 Wal-Mart, 107, 379 War on terror, 349 Wars, 148 Wealth, autonomous consumption and, 228 Wealth effect, 190, 229 Wealth of Nations (Smith), 52 Weber, Max, 175 Welfare, GDP as measure of, 113–115 Withholding taxes, 213 Women, in labor force, 122, 123 Wood pulp prices, 65 Workers discouraged, 123–124 foreign competition and, 373 marginally attached, 123–124 skilled, 380 unskilled, 380 U.S vs European, 149 Work hours, European, 149 World Bank, 161, 175, 176 World of Warcraft (WoW), 57 World savings, 396 World Trade Organization (WTO), 375 Z Zambia, economic growth in, 163 Zimbabwe, hyperinflation in, 343 431 Students learn best when they attend and assignments…but learning MyEconLab Picks Up Where Instructors choose MyEconLab: “MyEconLab’s e-text is great Particularly in that it helps offset the skyrocketing cost of textbooks Naturally, students love that.” —Doug Gehrke, Moraine Valley Community College “MyEconLab offers them a way to practice every week They receive immediate feedback and a feeling of personal attention As a result, my teaching has become more targeted and efficient.” —Kelly Blanchard, Purdue University “Students tell me that offering them MyEconLab is almost like offering them individual tutors.” —Jefferson Edwards, Cypress Fairbanks College “Chapter quizzes offset student procrastination by ensuring they keep on task If a student is having a problem, MyEconLab indicates exactly what they need to study.” “MyEconLab helps both students and instructors There’s something there for everyone.” “Someone has already pulled out articles that relate to economics and to the chapter at hand As much as MyEconLab helps the student, that helps the instructor.” —Diana Fortier, Waubonsee Community College ® Visit www.myeconlab.com for all of the information you need on using MyEconLab e lectures and keep up with their reading shouldn’t end when class is over Lectures and Office Hours Leave Off Students choose MyEconLab: In a recent study, 87 percent of students who used MyEconLab regularly felt it improved their grade “It was very useful because it had EVERYTHING, from practice exams to exercises to reading Very helpful.” —student, Northern Illinois University “I like how every chapter is outlined by vocabulary and flash cards It helped me memorize equations and definitions It was like having a study partner.” —student, Temple University “It made me look through the book to find answers so I did more reading.” —student, Northern Illinois University “It was very helpful to get instant feedback Sometimes I would get lost reading the book, and these individual problems would help me focus and see if I understood the concepts.” —student, Temple University “I really like the way MyEconLab took me through the graphs step-by-step The Fast Track tutorials were the most helpful for the graph questions I used the 1-2-3 buttons all the time.” —student, Stephen F Austin State University “I would recommend MyEconLab to a friend It was really easy to use and helped in studying the material for class.” —student, Northern Illinois University “I would recommend taking the quizzes on MyEconLab because it gives you a true account of whether or not you understand the material.” —student, Montana Tech ... Changes in Demand Change in Quantity Demanded versus Change in Demand 75 Increases in Demand Shift the Demand Curve 76 Decreases in Demand Shift the Demand Curve 78 A Decrease in Demand Decreases... TERMS 61 * EXERCISES 61 Demand, Supply, and Market 65 The Demand Curve 66 The Individual Demand Curve and the Law of Demand 66 From Individual Demand to Market Demand 68 The Supply Curve Change... Attractions: Macroeconomics 11 APPLICATION Jasper Johns and Housepainting 38 Using Macroeconomics to Understand Why Economies Grow 11 Using Macroeconomics to Understand Economic Fluctuations 11 Using Macroeconomics