Parkin Macroeconomics

This book enables you to focus on the economic way of thinking and choose your own course structure in your principles course.


MICHAEL PARKIN


452 Pages

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  • MICHAEL PARKIN   
  • 452 Pages   
  • 18 Feb 2015
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    MACROECONOMICSTENTH EDITIONMICHAEL PARKINUniversity of Western Ontario read more..

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    Editor in ChiefDonna BattistaSenior Acquisitions EditorAdrienne D’AmbrosioDevelopment EditorDeepa ChungiManaging EditorNancy FentonAssistant EditorJill KolongowskiPhoto ResearcherAngel ChavezProduction CoordinatorAlison EusdenDirector of MediaSusan SchoenbergSenior Media ProducerMelissa HonigExecutive Marketing ManagerLori DeShazoRights and Permissions AdvisorJill DouganSenior Manufacturing BuyerCarol MelvilleSenior Media BuyerGinny MichaudCopyeditorCatherine BaumArt Director and Cover read more..

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    TO ROBIN read more..

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    ivMichael Parkin is Professor Emeritus in the Department of Economics atthe University of Western Ontario, Canada. Professor Parkin has held facultyappointments at Brown University, the University of Manchester, the University ofEssex, and Bond University. He is a past president of the Canadian EconomicsAssociation and has served on the editorial boards of the American EconomicReview and the Journal of Monetary Economics and as managing editor of theCanadian Journal of Economics. Professor read more..

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    vPART ONEINTRODUCTION 1CHAPTER1 What Is Economics? 1CHAPTER2 The Economic Problem 29CHAPTER3 Demand and Supply 51PART TWO MONITORING MACROECONOMICPERFORMANCE 83CHAPTER4 Measuring GDP and Economic Growth 83CHAPTER5 Monitoring Jobs and Inflation 107PART THREE MACROECONOMIC TRENDS 133CHAPTER6 Economic Growth 133CHAPTER7 Finance, Saving, and Investment 159CHAPTER8 Money, the Price Level, and Inflation183CHAPTER9 The Exchange Rate and the Balance ofPayments 211PART FOUR MACROECONOMIC FLUCTUATIONS read more..

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    viiALTERNATIVE PATHWAYS THROUGH THE CHAPTERSChapter 5Monitoring Jobsand InflationChapter 4Measuring GDP andEconomic GrowthChapter 10Aggregate Supply andAggregate DemandChapter 8Money, the Price Level,and InflationChapter 9The Exchange Rate andthe Balance of PaymentsChapter 11Expenditure Multipliers:The Keynesian ModelChapter 7Finance, Saving,and InvestmentChapter 6Economic GrowthChapter 12U.S. Inflation,Unemployment, andBusiness CycleChapter 13Fiscal PolicyChapter 14Monetary PolicyMacro read more..

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    viiiTABLE OF CONTENTSactionGoTo:45,APPENDIXactionGoTo:45,Graphs in EconomicsactionGoTo:45,13actionGoTo:45,Graphing Data actionGoTo:45,13Scatter Diagrams14actionGoTo:48,Graphs Used in Economic actionGoTo:48,Models actionGoTo:48,16Variables That Move in the Same Direction16Variables That Move in Opposite Directions17Variables That Have a Maximum or a Minimum18Variables That Are Unrelated19actionGoTo:52,The Slope of a RelationshipactionGoTo:52,20The Slope of a Straight Line20The Slope of a Curved read more..

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    ContentsixactionGoTo:83,CHAPTER actionGoTo:83,3actionGoTo:83,◆ actionGoTo:83,DEMAND AND SUPPLY actionGoTo:83,51actionGoTo:84,Markets and Prices actionGoTo:84,52actionGoTo:85,Demand actionGoTo:85,53The Law of Demand53Demand Curve and Demand Schedule53A Change in Demand54A Change in the Quantity Demanded Versus aChange in Demand56actionGoTo:90,Supply actionGoTo:90,58The Law of Supply58Supply Curve and Supply Schedule58A Change in Supply59A Change in the Quantity Supplied Versus aChange in read more..

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    actionGoTo:115,PARTactionGoTo:115, TWOactionGoTo:115,MONITORING MACROECONOMICactionGoTo:115,PERFORMANCE actionGoTo:115,83actionGoTo:115,CHAPTER 4actionGoTo:115,◆ actionGoTo:115,MEASURING GDP AND actionGoTo:115,ECONOMIC GROWTH actionGoTo:115,83actionGoTo:116,Gross Domestic Product actionGoTo:116,84GDP Defined84GDP and the Circular Flow of Expenditure and Income85Why Is Domestic Product “Gross”?86actionGoTo:119,Measuring U.S. GDP actionGoTo:119,87The Expenditure Approach87The Income read more..

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    actionGoTo:165,PARTactionGoTo:165, THREEactionGoTo:165,MACROECONOMIC TRENDS actionGoTo:165,133actionGoTo:165,CHAPTER 6actionGoTo:165,◆ actionGoTo:165,ECONOMIC GROWTH actionGoTo:165,133actionGoTo:166,The Basics of Economic GrowthactionGoTo:166,134Calculating Growth Rates134The Magic of Sustained Growth134Applying the Rule of 70135actionGoTo:168,Economic Growth TrendsactionGoTo:168,136Growth in the U.S. Economy136Real GDP Growth in the World Economy137actionGoTo:171,How Potential GDP Grows read more..

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    actionGoTo:215,CHAPTER 8actionGoTo:215,◆ actionGoTo:215,MONEY, THE PRICE LEVEL, actionGoTo:215,ANDactionGoTo:215,INFLATION actionGoTo:215,183actionGoTo:216,What Is Money? actionGoTo:216,184Medium of Exchange184Unit of Account184Store of Value185Money in the United States Today185actionGoTo:219,Depository Institutions actionGoTo:219,187Types of Depository Institution187What Depository Institutions Do187Economic Benefits Provided by Depository Institutions188How Depository Institutions Are read more..

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    actionGoTo:273,PARTactionGoTo:273, FOURactionGoTo:273,MACROECONOMICactionGoTo:273,FLUCTUATIONS actionGoTo:273,241actionGoTo:273,CHAPTER 10actionGoTo:273,◆ actionGoTo:273,AGGREGATE SUPPLY ANDactionGoTo:273,AGGREGATE DEMAND actionGoTo:273,241actionGoTo:274,Aggregate Supply actionGoTo:274,242Quantity Supplied and Supply242Long-Run Aggregate Supply242Short-Run Aggregate Supply243Changes in Aggregate Supply244actionGoTo:278,Aggregate Demand actionGoTo:278,246The Aggregate Demand Curve246Changes in read more..

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    actionGoTo:327,CHAPTER 12actionGoTo:327,◆ actionGoTo:327,U.S. INFLATION,actionGoTo:327,UNEMPLOYMENT, ANDactionGoTo:327,BUSINESS CYCLE actionGoTo:327,295actionGoTo:328,Inflation Cycles actionGoTo:328,296Demand-Pull Inflation296Cost-Push Inflation298Expected Inflation300Forecasting Inflation301Inflation and the Business Cycle301actionGoTo:334,Inflation and Unemployment: actionGoTo:334,The Phillips Curve actionGoTo:334,302The Short-Run Phillips Curve302The Long-Run Phillips Curve303Changes in the read more..

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    actionGoTo:379,CHAPTER 14actionGoTo:379,◆ actionGoTo:379,MONETARY POLICY actionGoTo:379,347actionGoTo:380,Monetary Policy Objectives and actionGoTo:380,Framework actionGoTo:380,348Monetary Policy Objectives348Operational “Stable Prices” Goal349Operational “Maximum Employment” Goal349Responsibility for Monetary Policy350actionGoTo:382,The Conduct of Monetary PolicyactionGoTo:382,350The Monetary Policy Instrument350The Fed’s Decision-Making Strategy351actionGoTo:385,Monetary Policy read more..

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    The future is always uncertain. But at some times,and now is one such time, the range of possiblenear-future events is enormous. The major source ofthis great uncertainty is economic policy. There isuncertainty about the way in which internationaltrade policy will evolve as protectionism is returningto the political agenda. There is uncertainty aboutexchange rate policy as competitive devaluationrears its head. There is extraordinary uncertaintyabout monetary policy with the Fed having read more..

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    ■Currency fluctuations and the managed Chineseyuan in Chapter 9■Fiscal stimulus and the debate about the fiscalstimulus multipliers in Chapter 13■Monetary stimulus in Chapter 14 and the dangersof targeting unemployment in an updated conver-sation with Stephanie Schmitt-Grohé■Real-world examples and applications appear inthe body of each chapter and in the end-of-chapter problems and applicationsA selection of questions that appear daily inMyEconLab in Economics in the News are also read more..

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    ◆ Features to Enhance Teachingand LearningReading Between the LinesThis Parkin hallmark helps students think like econo-mists by connecting chapter tools and concepts to theworld around them. In Reading Between the Lines,which appears at the end of each chapter, studentsapply the tools they have just learned by analyzing anarticle from a newspaper or news Web site. Each arti-cle sheds additional light on the questions first raisedin the Chapter Opener. Questions about the articlealso appear read more..

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    End-of-Chapter Study MaterialEach chapter closes with a concise summary organ-ized by major topics, lists of key terms with page ref-erences, and problems and applications. Theselearning tools provide students with a summary forreview and exam preparation.Economics in Action BoxesThis new feature uses boxes within the chapter toaddress current events and economic occurrences thathighlight and amplify the topics covered in the chap-ter. Instead of simply reporting the current events, thematerial read more..

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    Interviews with EconomistsEach major part of the text closes with a summaryfeature that includes an interview with a leadingeconomist whose research and expertise correlates towhat the student has just learned. These interviewsexplore the background, education, and researchthese prominent economists have conducted, as wellas advice for those who want to continue the study ofeconomics. I have returned to Jagdish Bhagwati,Stephanie Schmitt-Grohé, and Richard Clarida (all ofColumbia University) read more..

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    and format of the end-of-chapter text problems andprovide the instructor with a whole new set of testingopportunities and/or homework assignments.Additionally, end-of-part tests contain questions thatcover all the chapters in the part and feature integra-tive questions that span more than one chapter.Computerized Testbanks Fully networkable, the testbanks are available for Windows® and Macintosh®.TestGen’s graphical interface enables instructors toview, edit, and add questions; transfer read more..

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    MYECONLABMyEconLab’s powerful assessment and tutorial sys-tem works hand-in-hand with Macroeconomics. Withcomprehensive homework, quiz, test, and tutorialoptions, instructors can manage all assessment needsin one program.■All of the Review Quiz questions and end-of-chapter Problems and Applications are assignableand automatically graded in MyEconLab.■Students can work all the Review Quiz questionsand end-of-chapter Study Plan Problems andApplications as part of the Study Plan read more..

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    ◆ AcknowledgmentsI thank my current and former colleagues and friendsat the University of Western Ontario who have taughtme so much. They are Jim Davies, Jeremy Greenwood,Ig Horstmann, Peter Howitt, Greg Huffman, DavidLaidler, Phil Reny, Chris Robinson, John Whalley, andRon Wonnacott. I also thank Doug McTaggart andChristopher Findlay, co-authors of the Australian edi-tion, and Melanie Powell and Kent Matthews, coau-thors of the European edition. Suggestions arisingfrom their adaptations of read more..

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    ◆ ReviewersEric Abrams, Hawaii Pacific UniversityChristopher Adams, Federal Trade CommissionTajudeen Adenekan, Bronx Community CollegeSyed Ahmed, Cameron UniversityFrank Albritton, Seminole Community CollegeMilton Alderfer, Miami-Dade Community CollegeWilliam Aldridge, Shelton State Community CollegeDonald L. Alexander, Western Michigan UniversityTerence Alexander, Iowa State UniversityStuart Allen, University of North Carolina, GreensboroSam Allgood, University of Nebraska, LincolnNeil Alper, read more..

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    Patrick Emerson, Oregon State UniversityTisha Emerson, Baylor UniversityMonica Escaleras, Florida Atlantic UniversityAntonina Espiritu, Hawaii Pacific UniversityGwen Eudey, University of PennsylvaniaBarry Falk, Iowa State UniversityM. Fazeli, Hofstra UniversityPhilip Fincher, Louisiana Tech UniversityF. Firoozi, University of Texas, San AntonioNancy Folbre, University of Massachusetts, AmherstKenneth Fong, Temasek Polytechnic (Singapore)Steven Francis, Holy Cross CollegeDavid Franck, University read more..

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    Robert Kirk, Indiana University-Purdue University, IndianapolisNorman Kleinberg, City University of New York, Baruch CollegeRobert Kleinhenz, California State University, FullertonJohn Krantz, University of UtahJoseph Kreitzer, University of St. ThomasPatricia Kuzyk, Washington State UniversityDavid Lages, Southwest Missouri State UniversityW. J. Lane, University of New OrleansLeonard Lardaro, University of Rhode IslandKathryn Larson, Elon CollegeLuther D. Lawson, University of North Carolina, read more..

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    Herman Quirmbach, Iowa State UniversityJeffrey R. Racine, University of South FloridaRamkishen Rajan, George Mason UniversityPeter Rangazas, Indiana University-Purdue University, IndianapolisVaman Rao, Western Illinois UniversityLaura Razzolini, University of MississippiRob Rebelein, University of CincinnatiJ. David Reed, Bowling Green State UniversityRobert H. Renshaw, Northern Illinois UniversityJavier Reyes, University of ArkansasJeff Reynolds, Northern Illinois UniversityRupert Rhodd, read more..

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    Supplements AuthorsLuke Armstrong, Lee CollegeSue Bartlett, University of South FloridaKelly Blanchard, Purdue UniversityJames Cobbe, Florida State UniversityCarol Dole, Jacksonville UniversityKaren Gebhardt, Colorado State UniversityJohn Graham, Rutgers UniversityJill Herndon, University of FloridaGary Hoover, University of AlabamaPatricia Kuzyk, Washington State UniversitySang Lee, Southeastern Louisiana UniversitySvitlana Maksymenko, University of PittsburghRuss McCullough, Iowa State read more..

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    actionGoTo:10,PARTactionGoTo:10, ONE IntroductionYou are studying economics at a time of extraordinary challenge and change.The United States, Europe, and Japan, the world’s richest nations, are still notfully recovered from a deep recession in which incomes shrank and millions ofjobs were lost. Brazil, China, India, and Russia, poorer nations with acombined population that dwarfs our own, are growing rapidly and playingever-greater roles in an expanding global economy.The economic events of read more..

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    2CHAPTER 1 What Is Economics?◆ actionGoTo:10,Definition of EconomicsA fundamental fact dominates our lives: We wantmore than we can get. Our inability to get everythingwe want is called scarcity. Scarcity is universal. It con-fronts all living things. Even parrots face scarcity!Because we can’t get everything we want, we mustmake choices. You can’t afford both a laptop and aniPhone, so you must choose which one to buy. Youcan’t spend tonight both studying for your next testand going to read more..

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    Two Big Economic Questions3◆ actionGoTo:10,Two Big Economic actionGoTo:10,QuestionsTwo big questions summarize the scope of economics:■How do choices end up determining what, how,and for whom goods and services are produced?■Can the choices that people make in the pursuit oftheir own self-interest also promote the broadersocial interest?What, How, and For Whom?Goods and servicesare the objects that people valueand produce to satisfy human wants. Goods are physi-cal objects such as cell read more..

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    4CHAPTER 1 What Is Economics?CapitalThe tools, instruments, machines, buildings,and other constructions that businesses use to pro-duce goods and services are called capital.In everyday language, we talk about money,stocks, and bonds as being “capital.” These items arefinancial capital. Financial capital plays an importantrole in enabling businesses to borrow the funds thatthey use to buy physical capital. But because financialcapital is not used to produce goods and services, it isnot a read more..

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    Two Big Economic Questions5Can the Pursuit of Self-Interest Promote theSocial Interest?Every day, you and 311 million other Americans,along with 6.9 billion people in the rest of the world,make economic choices that result in what, how, andfor whom goods and services are produced.Self-Interest A choice is in your self-interestif youthink that choice is the best one available for you.You make most of your choices in your self-inter-est. You use your time and other resources in theways that make read more..

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    6CHAPTER 1 What Is Economics?The Information-Age Economy The technologicalchange of the past forty years has been called theInformation Revolution.The information revolution has clearly servedyour self-interest: It has provided your cell phone,laptop, loads of handy applications, and the Internet.It has also served the self-interest of Bill Gates ofMicrosoft and Gordon Moore of Intel, both of whomhave seen their wealth soar.But did the information revolution best serve thesocial interest? Did read more..

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    Two Big Economic Questions7Economic Instability The years between 1993 and2007 were a period of remarkable economic stability,so much so that they’ve been called the GreatModeration. During those years, the U.S. and globaleconomies were on a roll. Incomes in the UnitedStates increased by 30 percent and incomes in Chinatripled. Even the economic shockwaves of 9/11We’ve looked at four topics and asked many ques-tions that illustrate the big question: Can choicesmade in the pursuit of read more..

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    8CHAPTER 1 What Is Economics?◆ actionGoTo:10,The Economic WayactionGoTo:10,of ThinkingThe questions that economics tries to answer tell usabout the scope of economics, but they don’t tell ushow economists think and go about seeking answersto these questions. You’re now going to see how econ-omists go about their work.We’re going to look at six key ideas that define theeconomic way of thinking. These ideas are■A choice is a tradeoff.■People make rational choices by comparing bene-fits read more..

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    The Economic Way of Thinking9As you well know, being a student eats up manyhours in class time, doing homework assignments,preparing for tests, and so on. To do all these schoolactivities, you must give up many hours of what wouldotherwise be leisure time spent with your friends.So the opportunity cost of being in school is allthe good things that you can’t afford and don’t havethe spare time to enjoy. You might want to put adollar value on that cost or you might just list allthe items that read more..

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    10CHAPTER 1 What Is Economics?◆ actionGoTo:10,Economics as Social Science andactionGoTo:10,Policy ToolEconomics is both a social science and a toolkit foradvising on policy decisions.Economist as Social ScientistAs social scientists, economists seek to discover howthe economic world works. In pursuit of this goal,like all scientists, economists distinguish betweenpositive and normative statements.Positive Statements A positive statement is aboutwhat is. It says what is currently believed about read more..

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    Summary11The Economic Way of Thinking (pp. 8–9)■Every choice is a tradeoff—exchanging more ofsomething for less of something else.■People make rational choices by comparing benefitand cost.■Cost—opportunity cost—is what you must give upto get something.■Most choices are “how much” choices made at themargin by comparing marginal benefit and mar-ginal cost.■Choices respond to incentives.Working Problems 4 and 5 will give you a better under-standing of the economic way of read more..

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    12CHAPTER 1 What Is Economics?Definition of Economics (Study Plan1.1)1. Apple Inc. decides to make iTunes freely availablein unlimited quantities.a. Does Apple’s decision change the incentivesthat people face?b. Is Apple’s decision an example of a microeco-nomic or a macroeconomic issue?Two Big Economic Questions (Study Plan1.2)2. Which of the following pairs does not match?a. Labor and wagesb. Land and rentc. Entrepreneurship and profitd. Capital and profit3. Explain how the following news read more..

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    actionGoTo:10,APPENDIXactionGoTo:10,Graphs in EconomicsAfter studying this appendix,you will be able to:Make and interpret a scatter diagramIdentify linear and nonlinear relationships andrelationships that have a maximum and aminimumDefine and calculate the slope of a lineGraph relationships among more than twovariables◆ actionGoTo:10,Graphing DataA graph represents a quantity as a distance on a line.In Fig. A1.1, a distance on the horizontal line repre-sents temperature, measured in degrees read more..

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    Figure A1.2(a) is a graph about iTunes song downloadsin January 2010. The x-axis measures the quantity ofsongs downloaded per day and the y-axis measures theprice of a song. Point A tells us what the quantity andprice were. You can “read” this graph as telling youthat in January 2010, 8.3 million songs a day weredownloaded at a price of 99¢ per song.Figure A1.2(b) is a graph about iTunes song andalbum downloads in January 2010. The x-axis meas-ures the quantity of songs downloaded per day read more..

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    Figure A1.4(b) shows a scatter diagram of U.S.inflation and unemployment during the 2000s. Here,the points for 2000 to 2008 show no relationshipbetween the two variables, but the high unemploymentrate of 2009 brought a low inflation rate that year.You can see that a scatter diagram conveys awealth of information, and it does so in much lessspace than we have used to describe only some of itsfeatures. But you do have to “read” the graph toobtain all this information.Appendix: Graphs in read more..

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    Breaks in the Axes The graph in Fig. A1.4(a) hasbreaks in its axes, as shown by the small gaps. Thebreaks indicate that there are jumps from the origin,0, to the first values recorded.The breaks are used because the lowest values ofincome and expenditure exceed $20,000. If we madethis graph with no breaks in its axes, there would be alot of empty space, all the points would be crowdedinto the top right corner, and it would be difficult tosee whether a relationship exists between these read more..

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    5 hours and speed. For example, point A shows thatwe will travel 200 miles in 5 hours if our speed is 40miles an hour. If we double our speed to 80 miles anhour, we will travel 400 miles in 5 hours.Figure A1.5(b) shows the relationship betweendistance sprinted and recovery time (the time it takesthe heart rate to return to its normal resting rate).This relationship is an upward-sloping one thatstarts out quite flat but then becomes steeper as wemove along the curve away from the origin. The read more..

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    Figure A1.6(c) shows the relationship betweenthe amount of leisure time and the number of prob-lems worked by a student. Increasing leisure timeproduces an increasingly large reduction in the num-ber of problems worked. This relationship is a nega-tive one that starts out with a gentle slope at a smallnumber of leisure hours and becomes steeper as thenumber of leisure hours increases. This relationship isa different view of the idea shown in Fig. A1.5(c).Variables That Have a Maximum or a read more..

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    Variables That Are UnrelatedThere are many situations in which no matter whathappens to the value of one variable, the other vari-able remains constant. Sometimes we want to showthe independence between two variables in a graph,and Fig. A1.8 shows two ways of achieving this.In describing the graphs in Fig. A1.5 through Fig.A1.7, we have talked about curves that slope upwardor slope downward, and curves that become less steepor steeper. Let’s spend a little time discussing exactlywhat we mean read more..

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    ◆ actionGoTo:10,The Slope of a RelationshipWe can measure the influence of one variable onanother by the slope of the relationship. The slopeof a relationship is the change in the value of thevariable measured on the y-axis divided by thechange in the value of the variable measured on thex-axis. We use the Greek letter (delta) to represent“change in.” Thus y means the change in the valueof the variable measured on the y-axis, and xmeans the change in the value of the variable meas-ured on read more..

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    when x increases from 2 to 6, y increases from 3 to6. The change in x is +4—that is, x is 4. Thechange in y is +3—that is, y is 3. The slope of thatline isIn part (b), when x increases from 2 to 6, ydecreases from 6 to 3. The change in y is minus 3—that is, y is –3. The change in x is plus 4—that is,x is 4. The slope of the curve isNotice that the two slopes have the same magni-tude (3/4), but the slope of the line in part (a) is posi-tive (+3/+4 = 3/4) while that in part (b) is read more..

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    Therefore the slope isSo the slope of the curve across the arc BC is 3/4.This calculation gives us the slope of the curvebetween points B and C. The actual slope calculatedis the slope of the straight line from B to C. Thisslope approximates the average slope of the curvealong the arc BC. In this particular example, theslope across the arc BC is identical to the slope of thecurve at point A, but the calculation of the slope of acurve does not always work out so neatly. You mighthave fun read more..

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    numbers used to plot that curve are those in thefirst and third columns of the table. For example, ifthe temperature is 90°F, 20 gallons are consumedwhen the price is $2.75 a scoop and 36 gallons areconsumed when the price is $2.25 a scoop.When the price of ice cream changes but the tem-perature is constant, you can think of what happens inthe graph as a movement along one of the curves. At70°F there is a movement along the blue curve and at90°F there is a movement along the red curve.When read more..

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    actionGoTo:10,MATHEMATICAL NOTEactionGoTo:10,Equations of Straight actionGoTo:10,LinesIf a straight line in a graph describes the relationshipbetween two variables, we call it a linear relationship.Figure 1 shows the linear relationship between a person’sexpenditure and income. This person spends $100 aweek (by borrowing or spending previous savings)when income is zero. Out of each dollar earned, thisperson spends 50 cents (and saves 50 cents).All linear relationships are described by the read more..

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    To calculate the slope of the line, subtract equation(1) from equation (2) to obtainyb x(3)and now divide equation (3) by x to obtainy/ xb.So the slope of the line is b.Position of LineThe y-axis intercept determines the position of theline on the graph. Figure 3 illustrates the relationshipbetween the y-axis intercept and the position of theline. In this graph, the y-axis measures saving and thex-axis measures income. When the y-axis intercept, a, is positive, the linehits the y-axis at a read more..

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    26CHAPTER 1 What Is Economics?actionGoTo:10,SUMMARY1Explain how we “read” the three graphs in FigsA1.1 and A1.2.2Explain what scatter diagrams show and whywe use them.3Explain how we “read” the three scatter dia-grams in Figs A1.3 and A1.4.4Draw a graph to show the relationship betweentwo variables that move in the same direction.5Draw a graph to show the relationship betweentwo variables that move in opposite directions.6Draw a graph to show the relationship betweentwo variables that read more..

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    Study Plan Problems and Applications27actionGoTo:10,STUDY PLAN PROBLEMS actionGoTo:10,AND APPLICATIONSYou can work Problems 1 to 11 in MyEconLab Chapter 1A Study Plan and get instant feedback.Use the following spreadsheet to work Problems 1 to3. The spreadsheet provides data on the U.S. econ-omy: Column A is the year, column B is the inflationrate, column C is the interest rate, column D is thegrowth rate, and column E is the unemployment rate.7. Calculate the slope of the following read more..

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    28CHAPTER 1 What Is Economics?actionGoTo:10,ADDITIONAL ASSIGNABLE PROBLEMS AND APPLICATIONSYou can work these problems in MyEconLab if assigned by your instructor.Use the following spreadsheet to work Problems 12to 14. The spreadsheet provides data on oil and gaso-line: Column A is the year, column B is the price ofoil (dollars per barrel), column C is the price of gaso-line (cents per gallon), column D is U.S. oil produc-tion, and column E is the U.S. quantity of gasolinerefined (both in read more..

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    After studying this chapter, you will be able to:Define the production possibilities frontier and use it tocalculate opportunity costDistinguish between production possibilities and preferences and describe an efficient allocation ofresourcesExplain how current production choices expand futureproduction possibilitiesExplain how specialization and trade expand production possibilitiesDescribe the economic institutions that coordinatedecisionsactionGoTo:11,2Why does food cost much more today than read more..

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    30CHAPTER 2 The Economic Problem◆ actionGoTo:11,Production Possibilities actionGoTo:11,and Opportunity actionGoTo:11,CostEvery working day, in mines, factories, shops, andoffices and on farms and construction sites across theUnited States, 138 million people produce a vastvariety of goods and services valued at $50 billion.But the quantities of goods and services that we canproduce are limited both by our available resourcesand by technology. And if we want to increase ourproduction of one read more..

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    Production Possibilities and Opportunity Cost31also shows other production possibilities. For exam-ple, we might stop producing pizza and move all thepeople who produce it into producing cola. Point Ain the figure and possibility A in the table show thiscase. The quantity of cola produced increases to 15million cans, and pizza production dries up.Alternatively, we might close the cola factories andswitch all the resources into producing pizza. In thissituation, we produce 5 million pizzas. Point read more..

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    32CHAPTER 2 The Economic ProblemWe’ve seen that what we can produce is limitedby the production possibilities frontier. We’ve alsoseen that production on the PPF is efficient. But wecan produce many different quantities on the PPF.How do we choose among them? How do we knowwhich point on the PPF is the best one?Because opportunity cost is a ratio, the opportunitycost of producing an additional can of cola is equal tothe inverse of the opportunity cost of producing anadditional pizza. Check read more..

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    Using Resources Efficiently33◆ actionGoTo:11,Using Resources EfactionGoTo:11,ficiently We achieve production efficiency at every point on thePPF, but which point is best? The answer is the pointon the PPF at which goods and services are producedin the quantities that provide the greatest possiblebenefit. When goods and services are produced at thelowest possible cost and in the quantities that providethe greatest possible benefit, we have achieved alloca-tive efficiency.The questions that we read more..

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    34CHAPTER 2 The Economic ProblemWillingness to pay (cans of cola per pizza)12345012345MBABCDEDecreasing marginalbenefit from a pizzaPizzas (millions)Preferences and Marginal BenefitThe marginal benefitfrom a good or service is thebenefit received from consuming one more unit of it.This benefit is subjective. It depends on people’spreferences—people’s likes and dislikes and the inten-sity of those feelings.Marginal benefit and preferences stand in sharpcontrast to marginal cost and read more..

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    Using Resources Efficiently35Marginal cost exceedsmarginal benefit—producefewer pizzasMarginal cost and marginal benefit(cans of cola per pizza)1234501.52.53.55MBMC(b) Marginal benefit equals marginal costToo few pizzasToo manypizzasPoint ofallocativeefficiencyMarginal benefit exceedsmarginal cost—producemore pizzasMarginal benefitequals marginal cost—efficientquantity of pizzasPizzas (millions)1510501.52.53.55PPFABC(a) On the PPFCola (millions of cans)Pizzas (millions)You now understand read more..

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    36CHAPTER 2 The Economic Problem◆ actionGoTo:11,Economic GrowthDuring the past 30 years, production per person inthe United States has doubled. The expansion ofproduction possibilities is called economic growth.Economic growth increases our standard of living, butit doesn’t overcome scarcity and avoid opportunitycost. To make our economy grow, we face a trade-off—the faster we make production grow, the greateris the opportunity cost of economic growth.The Cost of Economic GrowthEconomic read more..

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    Economic Growth37A Nation’s Economic GrowthThe experiences of the United States and Hong Kongmake a striking example of the effects of our choicesabout consumption and capital goods on the rate ofeconomic growth.If a nation devotes all its factors of production toproducing consumption goods and services and noneto advancing technology and accumulating capital,its production possibilities in the future will be thesame as they are today.To expand production possibilities in the future, anation read more..

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    TABLE 2.1Liz’s Production Possibilities38CHAPTER 2 The Economic Problem◆ actionGoTo:11,Gains from TradePeople can produce for themselves all the goods andservices that they consume, or they can produce onegood or a few goods and trade with others. Producingonly one good or a few goods is called specialization.We are going to learn how people gain by specializingin the production of the good in which they have acomparative advantage and trading with others.Comparative Advantage and read more..

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    TABLE 2.3Liz and Joe Gain from TradeGains from Trade39(e) Gains from tradeLizJoeSmoothies+5+5Salads+5+5Joe produces, he must decrease his production of sal-ads by 5. And for each additional salad he produces,he must decrease his production of smoothies by 1/5of a smoothie. SoJoe’s opportunity cost of producing 1 smoothie is 5 salads,andJoe’s opportunity cost of producing 1 salad is 1/5 of a smoothie.Joe’s customers, like Liz’s, buy smoothies and saladsin equal quantities. So Joe spends read more..

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    40CHAPTER 2 The Economic ProblemLiz has 20 smoothies—the 30 she produces minusthe 10 she sells to Joe. She also has the 20 salads thatshe buys from Joe. Liz has increased the quantities ofsmoothies and salads that she can sell to her cus-tomers—see Table 2.3(d). Liz and Joe both gain 5smoothies and 5 salads an hour—see Table 2.3(e).To illustrate her idea, Liz grabs a fresh napkin anddraws the graphs in Fig. 2.6. The blue PPF in part (a)shows Joe’s production possibilities. Before trade, read more..

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    Economic Coordination41◆ actionGoTo:11,Economic CoordinationPeople gain by specializing in the production of thosegoods and services in which they have a comparativeadvantage and then trading with each other. Liz andJoe, whose production of salads and smoothies westudied earlier in this chapter, can get together andmake a deal that enables them to enjoy the gainsfrom specialization and trade. But for billions of indi-viduals to specialize and produce millions of differentgoods and services, read more..

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    42CHAPTER 2 The Economic Problemproduced all the goods that it sells. He became richby specializing in providing retail services and buyingfrom other firms that specialize in producing goods(just as Liz and Joe did). This trade between firmstakes place in markets.MarketsIn ordinary speech, the word market means a placewhere people buy and sell goods such as fish, meat,fruits, and vegetables. In economics, a market has amore general meaning. A marketis any arrangementthat enables buyers and read more..

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    Economic Coordination43◆You have now begun to see how economistsapproach economic questions. Scarcity, choice, anddivergent opportunity costs explain why we specializeand trade and why firms, markets, property rights, andmoney have developed. You can see all around you thelessons you’ve learned in this chapter. Reading Betweenthe Lines on pp. 44–45 provides an opportunity toapply the PPF model to deepen your understanding ofthe reasons for the increase in the cost of food associatedwith read more..

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    44actionGoTo:11,READING BETWEEN THE actionGoTo:11,LINESactionGoTo:11,The Rising OpporactionGoTo:11,tunityactionGoTo:11,Cost of FoodFuel Choices, Food Crises, and Finger-PointingactionURI(http://www.nytimes.com):http://www.nytimes.comApril 15, 2008The idea of turning farms into fuel plants seemed, for a time, like one of the answers to highglobal oil prices and supply worries. That strategy seemed to reach a high point last yearwhen Congress mandated a fivefold increase in the use of biofuels.But read more..

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    45ECONOMIC ANALYSISOther goods and services0350400 420500Corn (millions of metric tons)In the rest of the world,the opportunity cost ofcorn increased because ...450… the area plantedincreased ...… and the yieldper acre decreasedPPF07PPFPPF08Other goods and servicesFigure 1 U.S. PPFFigure 2 Rest of the World PPF0250300360400Corn (millions of metric tons)BIn the United States, theopportunity cost of cornincreased because thearea planted andproduction increasedA■Ethanol is made from corn in read more..

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    46CHAPTER 2 The Economic ProblemEconomic Growth (pp. 36–37)■Economic growth, which is the expansion of pro-duction possibilities, results from capital accumu-lation and technological change.■The opportunity cost of economic growth isforgone current consumption.■The benefit of economic growth is increasedfuture consumption.Working Problem 11 will give you a better understandingof economic growth.Gains from Trade (pp. 38–41)■A person has a comparative advantage in pro-ducing a good if read more..

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    Study Plan Problems and Applications47Use the following graphs to work Problems 7 to 10.Harry enjoys tennis but wants a high grade in hiseconomics course. The graphs show his PPF for thesetwo “goods” and his MB curve from tennis.7. What is Harry’s marginal cost of tennis if heplays for (i) 3 hours a week; (ii) 5 hours a week;and (iii) 7 hours a week?8. a. If Harry uses his time to achieve allocativeefficiency, what is his economics grade andhow many hours of tennis does he play?b. Explain read more..

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    48CHAPTER 2 The Economic ProblemEconomic Growth (Study Plan 2.3)11. A farm grows wheat and produces pork. Themarginal cost of producing each of these prod-ucts increases as more of it is produced.a. Make a graph that illustrates the farm’s PPF.b. The farm adopts a new technology that allowsit to use fewer resources to fatten pigs. Useyour graph to illustrate the impact of the newtechnology on the farm’s PPF.c. With the farm using the new technologydescribed in part (b), has the opportunity read more..

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    Additional Problems and Applications49Production Possibilities and Opportunity CostUse the following table to work Problems 21 to 22.Suppose that Yucatan’s production possibilities areFoodSunscreen(pounds per month)(gallons per month)300and0200and50100and1000and15021. a. Draw a graph of Yucatan’s PPF and explainhow your graph illustrates a tradeoff.b. If Yucatan produces 150 pounds of food permonth, how much sunscreen must it produceif it achieves production efficiency?c. What is Yucatan’s read more..

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    50CHAPTER 2 The Economic Problemc. Why did the cost of producing corn increasein the rest of the world?d. Is it possible that the increased quantity ofcorn produced, despite the higher cost of pro-duction, moves the United States closer to al-locative efficiency?30. Malaria Eradication Back on the TableIn response to the Gates Malaria Forum inOctober 2007, countries are debating the prosand cons of eradication. Dr. Arata Kochi of theWorld Health Organization believes that withenough money read more..

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    51After studying this chapter, you will be able to:Describe a competitive market and think about a price as an opportunity costExplain the influences on demandExplain the influences on supplyExplain how demand and supply determine prices and quantities bought and soldUse the demand and supply model to make predictions about changes in prices and quantitieshat makes the price of oil double and the price of gasoline almost double injust one year? Will these prices keep on rising? Are the oil read more..

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    52CHAPTER 3 Demand and SupplyLet’s begin our study of demand and supply,starting with demand.◆ actionGoTo:11,Markets and PricesWhen you need a new pair of running shoes, want abagel and a latte, plan to upgrade your cell phone, orneed to fly home for Thanksgiving, you must find aplace where people sell those items or offer those ser-vices. The place in which you find them is a market.You learned in Chapter 2 (p. 42) that a market is anyarrangement that enables buyers and sellers to read more..

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    ◆ actionGoTo:11,DemandIf you demand something, then you1. Want it,2. Can afford it, and3. Plan to buy it.Wants are the unlimited desires or wishes that peo-ple have for goods and services. How many timeshave you thought that you would like something “ifonly you could afford it” or “if it weren’t so expen-sive”? Scarcity guarantees that many—perhapsmost—of our wants will never be satisfied. Demandreflects a decision about which wants to satisfy.The quantity demandedof a good or read more..

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    Figure 3.1 shows the demand curve for energybars. A demand curveshows the relationship betweenthe quantity demanded of a good and its price whenall other influences on consumers’ planned purchasesremain the same.The table in Fig. 3.1 is the demand schedule forenergy bars. A demand schedule lists the quantitiesdemanded at each price when all the other influenceson consumers’ planned purchases remain the same.For example, if the price of a bar is 50¢, the quantitydemanded is 22 million a read more..

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    Six main factors bring changes in demand. Theyare changes in■The prices of related goods■Expected future prices■Income■Expected future income and credit■Population■PreferencesPrices of Related Goods The quantity of energy barsthat consumers plan to buy depends in part on theprices of substitutes for energy bars. A substituteis agood that can be used in place of another good. Forexample, a bus ride is a substitute for a train ride; ahamburger is a substitute for a hot dog; and read more..

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    Preferences Demand depends on preferences.Preferences determine the value that people place oneach good and service. Preferences depend on suchthings as the weather, information, and fashion. Forexample, greater health and fitness awareness hasshifted preferences in favor of energy bars, so thedemand for energy bars has increased.Table 3.1 summarizes the influences on demandand the direction of those influences.A Change in the Quantity Demanded Versus a Change in DemandChanges in the influences read more..

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    the quantity demanded and a change in demand isthe same as that between a movement along thedemand curve and a shift of the demand curve.A point on the demand curve shows the quantitydemanded at a given price, so a movement alongthe demand curve shows a change in the quantitydemanded. The entire demand curve shows demand,so a shift of the demand curve shows a change indemand. Figure 3.3 illustrates these distinctions.Movement Along the Demand Curve If the price ofthe good changes but no other read more..

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    ◆ actionGoTo:11,SupplyIf a firm supplies a good or service, the firm1. Has the resources and technology to produce it,2. Can profit from producing it, and3. Plans to produce it and sell it.A supply is more than just having the resources andthe technology to produce something. Resources andtechnology are the constraints that limit what ispossible.Many useful things can be produced, but they arenot produced unless it is profitable to do so. Supplyreflects a decision about which technologically read more..

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    Minimum Supply Price The supply curve can beinterpreted as a minimum-supply-price curve—acurve that shows the lowest price at which someone iswilling to sell. This lowest price is the marginal cost.If a small quantity is produced, the lowest price atwhich someone is willing to sell one more unit is low.But as the quantity produced increases, the marginalcost of each additional unit rises, so the lowest priceat which someone is willing to sell an additional unitrises along the supply curve.In read more..

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    Expected Future Prices If the expected future price ofa good rises, the return from selling the good in thefuture increases and is higher than it is today. So sup-ply decreases today and increases in the future.The Number of Suppliers The larger the number offirms that produce a good, the greater is the supply ofthe good. As new firms enter an industry, the supplyin that industry increases. As firms leave an industry,the supply in that industry decreases. Technology The term “technology” is read more..

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    Figure 3.6 illustrates and summarizes thesedistinctions. If the price of the good changes andother things remain the same, there is a change in thequantity supplied of that good. If the price of the goodfalls, the quantity supplied decreases and there is amovement down along the supply curve S0. If theprice of the good rises, the quantity supplied increasesand there is a movement up along the supply curve S0.When any other influence on selling plans changes,the supply curve shifts and there is a read more..

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    ◆ actionGoTo:11,Market EquilibriumWe have seen that when the price of a good rises, thequantity demanded decreases and the quantity sup-plied increases. We are now going to see how the priceadjusts to coordinate buying plans and selling plansand achieve an equilibrium in the market.An equilibrium is a situation in which opposingforces balance each other. Equilibrium in a marketoccurs when the price balances buying plans and sell-ing plans. The equilibrium priceis the price at whichthe quantity read more..

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    million bars a week, as shown by the blue arrow. Ateach price below $1.50 a bar, there is a shortage of bars.For example, at $1.00 a bar, the shortage is 9 millionbars a week, as shown by the red arrow.Price AdjustmentsYou’ve seen that if the price is below equilibrium,there is a shortage and that if the price is above equi-librium, there is a surplus. But can we count on theprice to change and eliminate a shortage or a surplus?We can, because such price changes are beneficial toboth buyers read more..

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    ◆ actionGoTo:11,Predicting Changes in Price actionGoTo:11,and QuantityThe demand and supply model that we have juststudied provides us with a powerful way of analyzinginfluences on prices and the quantities bought andsold. According to the model, a change in price stemsfrom a change in demand, a change in supply, or achange in both demand and supply. Let’s look first atthe effects of a change in demand.An Increase in DemandIf more people join health clubs, the demand forenergy bars read more..

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    Predicting Changes in Price and Quantity65Economics in ActionThe Global Market for Crude OilThe demand and supply model provides insights intoall competitive markets. Here, we’ll apply what you’velearned about the effects of an increase in demand tothe global market for crude oil.Crude oil is like the life-blood of the global econ-omy. It is used to fuel our cars, airplanes, trains, andbuses, to generate electricity, and to produce a widerange of plastics. When the price of crude oil read more..

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    66CHAPTER 3 Demand and SupplyAn Increase in SupplyWhen Nestlé (the producer of PowerBar) and otherenergy bar producers switch to a new cost-savingtechnology, the supply of energy bars increases.Figure 3.9 shows the new supply schedule (the sameone that was shown in Fig. 3.5). What are the newequilibrium price and quantity? The price falls to$1.00 a bar, and the quantity increases to 15 millionbars a week. You can see why by looking at the quan-tities demanded and supplied at the old price read more..

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    Economics in ActionThe Market for StrawberriesCalifornia produces 85 percent of the nation’s straw-berries and its crop, which starts to increase inMarch, is in top flight by April. During the wintermonths of January and February, Florida is the mainstrawberry producer.In a normal year, the supplies from these tworegions don’t overlap much. As California’s produc-tion steps up in March and April, Florida’s produc-tion falls off. The result is a steady supply ofstrawberries and not much read more..

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    Decrease in Both Demand and Supply Figure 3.10(i)shows the case in which demand and supply bothdecrease. For the same reasons as those we’ve justreviewed, when both demand and supply decrease,the quantity decreases, and again the direction of theprice change is uncertain.Decrease in Demand and Increase in Supply You’veseen that a decrease in demand lowers the price anddecreases the quantity. And you’ve seen that anincrease in supply lowers the price and increases thequantity. Fig. 3.10(f ) read more..

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    Predicting Changes in Price and Quantity69Demand3.00051520Price (dollars per bar)Quantity (millions of bars)102.502.001.501.000.50Demand3.00051520Price (dollars per bar)Quantity (millions of bars)102.502.001.501.000.50(d) Increase in supply(e) Increase in both demand and supply(f) Decrease in demand; increase in supply(g) Decrease in supply(i) Decrease in both demand and supply(h) Increase in demand; decrease in read more..

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    70Coffee Surges on Poor Colombian HarvestsFT.comJuly 30, 2010Coffee prices hit a 12-year high on Friday on the back of low supplies of premium Arabicacoffee from Colombia after a string of poor crops in the Latin American country. The strong fundamental picture has also encouraged hedge funds to reverse their previousbearish views on coffee prices.In New York, ICE September Arabica coffee jumped 3.2 percent to 178.75 cents per pound,the highest since February 1998. It traded later at 177.25 read more..

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    71Figure 2 The effects of the expected future priceDS1S0Figure 1 The effects of the Columbian cropDecrease inColumbia crop ...Price (cents perpound)Quantity (millions of bags)0160110 116130140120170174180190200100... anddecreasesquantity... raisesprice ...D0D1S1S0Rise in expected futureprice increases demandand decreases supply ...Price (cents perpound)Quantity (millions of bags)0160110 116130140120170180190200210220230100... and raisesprice furtherECONOMIC ANALYSIS■This news article reports read more..

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    72CHAPTER 3 Demand and SupplyactionGoTo:11,MATHEMATICAL NOTEactionGoTo:11,Demand, Supply, and actionGoTo:11,EquilibriumDemand CurveThe law of demand says that as the price of a good orservice falls, the quantity demanded of that good orservice increases. We can illustrate the law of demandby drawing a graph of the demand curve or writingdown an equation. When the demand curve is astraight line, the following equation describes it:where P is the price and QD is the quantitydemanded. The a and b read more..

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    Market EquilibriumDemand and supply determine market equilibrium.Figure 3 shows the equilibrium price (P *) and equilib-rium quantity (Q*) at the intersection of the demandcurve and the supply curve.We can use the equations to find the equilibriumprice and equilibrium quantity. The price of a goodadjusts until the quantity demanded QD equals thequantity supplied QS. So at the equilibrium price (P* )and equilibrium quantity (Q* ),To find the equilibrium price and equilibriumquantity, substitute read more..

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    ■Supply depends on the prices of factors of produc-tion used to produce a good, the prices of relatedgoods produced, expected future prices, the num-ber of suppliers, technology, and the state ofnature.Working Problems 6 to 9 will give you a better under-standing of supply.Market Equilibrium (pp. 62–63)■At the equilibrium price, the quantity demandedequals the quantity supplied.■At any price above the equilibrium price, there is asurplus and the price falls.■At any price below the read more..

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    how do you expect the following would change:a. The demand for beef? Explain your answer.b. The demand for rice? Explain your answer.5. In January 2010, the price of gasoline was$2.70 a gallon. By spring 2010, the price hadincreased to $3.00 a gallon. Assume that therewere no changes in average income, popula-tion, or any other influence on buying plans.Explain how the rise in the price of gasolinewould affecta. The demand for gasoline.b. The quantity of gasoline demanded.Supply (Study Plan read more..

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    Market Equilibrium (Study Plan 3.4)10. “As more people buy computers, the demand forInternet service increases and the price of Internetservice decreases. The fall in the price of Internetservice decreases the supply of Internet service.”Explain what is wrong with this statement.11. The demand and supply schedules for gum areQuantityQuantityPricedemandedsupplied(cents per pack)(millions of packs a week)20180604014010060100140806018010020220a. Draw a graph of the market for gum andmark in the read more..

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    Markets and Prices18. What features of the world market for crude oilmake it a competitive market?19. The money price of a textbook is $90 and themoney price of the Wii game Super MarioGalaxy is $45.a. What is the opportunity cost of a textbook interms of the Wii game?b. What is the relative price of the Wii game interms of textbooks?Demand20. The price of gasoline has increased during thepast year.a. Explain why the law of demand applies togasoline just as it does to all other goods read more..

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    c. Sellers want to receive the highest possibleprice, so why would they be willing to acceptless than $16 a pizza?26. a. If the price of a pizza is $12, is there a short-age or a surplus and does the price rise or fall?b. Buyers want to pay the lowest possible price,so why would they be willing to pay morethan $12 for a pizza?27. The demand and supply schedules for potatochips arePriceQuantityQuantity(centsdemandedsuppliedper bag)(millions of bags per read more..

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    79actionGoTo:11,Your Economic actionGoTo:11,RevolutionactionGoTo:11,PARTactionGoTo:11, ONEout the wire, another straight-ens it, a third cuts it, a fourthpoints it, a fifth grinds it. Threespecialists make the head, anda fourth attaches it. Finally, thepin is polished and packaged.But a large market isneeded to support the divisionof labor: One factory employing ten workers would need tosell more than 15 million pins a year to stay in business!Three periods in human history stand out as ones of read more..

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    So growth in the pie seemed to be the principal (butnot the only) component of an anti-poverty strategy.To supplement growth’s good effects on the poor, theIndian plannerswere also dedi-cated to education,health, socialreforms, and landreforms. Also, theaccess of the low-est-income andsocially disadvan-taged groups to the growth process and its benefitswas to be improved in many ways, such as extensionof credit without collateral.Today, this strategy has no rivals. Much empiricalwork shows read more..

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    81JAGDISH BHAGWATI is University Professor atColumbia University. Born in India in 1934, hestudied at Cambridge University in England, MIT,and Oxford University before returning to India.He returned to teach at MIT in 1968 and movedto Columbia in 1980. A prolific scholar, ProfessorBhagwati also writes in leading newspapers andmagazines throughout the world. He has beenmuch honored for both his scientific work and hisimpact on public policy. His greatest contributionsare in international trade read more..

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    82determine whether a product is, say, Jordanian orTaiwanese if Jordan qualifies for a preferential tariffbut Taiwan does not and Taiwanese inputs enter theJordanian manufacture of the product.I have called the resulting crisscrossing of prefer-ences and rules of origin the “spaghetti bowl” problem.The world trading system is choking under these pro-liferating bilateral deals. Contrast this complexity withthe simplicity of a multilateral system with commontariffs for all WTO members.We now read more..

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    actionGoTo:12,PARTactionGoTo:12, TWO Monitoring Macroeconomic actionGoTo:12,PerformanceAfter studying this chapter, you will be able to:Define GDP and use the circular flow model to explain why GDP equals aggregate expenditure and aggregate incomeExplain how the Bureau of Economic Analysis measures U.S. GDP and real GDPDescribe how real GDP is used to measure economicgrowth and fluctuations and explain the limitations ofreal GDP as a measure of economic well-beingWill our economy expand more read more..

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    84CHAPTER 4 Measuring GDP and Economic GrowthIf we were to add the value of intermediate goodsand services produced to the value of final goods andservices, we would count the same thing manytimes—a problem called double counting. The valueof a truck already includes the value of the tires, andthe value of a Dell PC already includes the value ofthe Pentium chip inside it.Some goods can be an intermediate good in somesituations and a final good in other situations. Forexample, the ice cream read more..

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    Gross Domestic Product85HOUSEHOLDSFIRMSGGICCIX – MX – MYYGOVERNMENTSRESTOFWORLDFACTORMARKETSGOODSMARKETSHouseholds makeconsumption expen-ditures (C); firmsmake investments(I ); governmentsbuy goods andservices (G); andthe rest of the worldbuys net exports (X – M). Firms payincomes (Y) tohouseholds.Aggregate incomeequals aggregateexpenditure.Source of data: U.S. Department ofCommerce, Bureau of EconomicAnalysis. (The data are for the secondquarter of 2010 annual rate.)Billions of dollarsin read more..

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    86CHAPTER 4 Measuring GDP and Economic Growthpurchase of new plant, equipment, and buildings andthe additions to inventories are investment, shown bythe red flow labeled I.Governments Governments buy goods and servicesfrom firms and their expenditure on goods and ser-vices is called government expenditure. In Fig. 4.1, gov-ernment expenditure is shown as the red flow G.Governments finance their expenditure withtaxes. But taxes are not part of the circular flow ofexpenditure and income. read more..

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    Measuring U.S. GDP87◆ actionGoTo:12,Measuring U.S. GDPThe Bureau of Economic Analysis (BEA) uses theconcepts in the circular flow model to measure GDPand its components in the National Income andProduct Accounts. Because the value of aggregate pro-duction equals aggregate expenditure and aggregateincome, there are two approaches available for mea-suring GDP, and both are used. They are■The expenditure approach■The income approachThe Expenditure ApproachThe expenditure approach measures GDP read more..

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    88CHAPTER 4 Measuring GDP and Economic Growthincome, corporate profits, and proprietors’ income.Net interest is the interest households receive onloans they make minus the interest households payon their own borrowing.Rental income is the payment for the use of landand other rented resources.Corporate profits are the profits of corporations,some of which are paid to households in the form ofdividends and some of which are retained by corpora-tions as undistributed profits. They are all read more..

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    Measuring U.S. GDP89Nominal GDP and Real GDPOften, we want to compare GDP in two periods, say2000 and 2010. In 2000, GDP was $9,952 billionand in 2010, it was $14,579 billion—46 percenthigher than in 2000. This increase in GDP is a com-bination of an increase in production and a rise inprices. To isolate the increase in production from therise in prices, we distinguish between real GDP andnominal GDP.Real GDP is the value of final goods and services pro-duced in a given year when valued at the read more..

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    90CHAPTER 4 Measuring GDP and Economic Growth◆ actionGoTo:12,The Uses and Limitations actionGoTo:12,of actionGoTo:12,Real GDPEconomists use estimates of real GDP for two mainpurposes:■To compare the standard of living over time■To compare the standard of living across countriesThe Standard of Living Over TimeOne method of comparing the standard of living overtime is to calculate real GDP per person in differentyears. Real GDP per personis real GDP divided by thepopulation. Real GDP per read more..

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    The Uses and Limitations of Real GDP91A common definition of recessionis a period dur-ing which real GDP decreases—its growth rate isnegative—for at least two successive quarters. Thedefinition used by the National Bureau of EconomicResearch, which dates the U.S. business cycle phasesand turning points, is “a period of significant declinein total output, income, employment, and trade, usu-ally lasting from six months to a year, and marked bycontractions in many sectors of the economy.”An read more..

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    92CHAPTER 4 Measuring GDP and Economic GrowthReal GDP per person(2005 U.S. dollars)Year08,00019802010200520001995199019856,0002,0004,000PPP pricesin U.S. dollars Domestic prices atmarket exchange rate Real GDP per person in China has grown rapidly. But howrapidly it has grown and to what level depends on how realGDP is valued. When GDP in 2010 is valued at the marketexchange rate, U.S. income per person is 15 times that inChina. China looks like a poor developing country. But thecomparison is read more..

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    The Uses and Limitations of Real GDP93Whose production is more valuable: the chef’s whose workgets counted in GDP ... ... or the busy mother’s whose dinner preparation and childminding don’t get counted?and more families now eat in restaurants—one of thefastest-growing industries in the United States—anduse day-care services. This trend means that an increas-ing proportion of food preparation and child care thatwere part of household production are now measuredas part of GDP. So real read more..

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    94CHAPTER 4 Measuring GDP and Economic Growthatmosphere from automobile emissions is part ofGDP. But if we did not use such pieces of equipmentand instead polluted the atmosphere, we would notcount the deteriorating air that we were breathing asa negative part of GDP.An industrial society possibly produces moreatmospheric pollution than an agricultural societydoes. But pollution does not always increase as webecome wealthier. Wealthy people value a clean envi-ronment and are willing to pay for read more..

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    The Uses and Limitations of Real GDP95Economics in ActionA Broader Indicator of Economic Well-BeingThe limitations of real GDP reviewed in this chapteraffect the standard of living and general well-being ofevery country. So to make international comparisonsof the general state of economic well-being, we mustlook at real GDP and other indicators.The United Nations has constructed a broadermeasure called the Human Development Index(HDI), which combines real GDP, life expectancyand health, and read more..

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    96actionGoTo:12,READING BETWEEN THE actionGoTo:12,LINESShape of Recovery Long, Slow Growth … a “Square Root” SlogactionURI(http://www.denverpost.com):http://www.denverpost.comJuly 26, 2010Hopes for a “V-shaped” recovery have shifted to fears of a “W-shaped” double dip.William Greiner, president of Scout Investment Advisors, wants to add another symbol to themix—the square root. The square root represents a rebound, a smaller version of the V, followed by an extended peri-od of read more..

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    97ECONOMIC ANALYSIS■The 2008 recession was an unusually deep one andeven by the middle of 2010, recovery was weak.■Figure 1 illustrates the severity of the 2008 recessionusing the concepts of potential GDP and real GDP thatyou learned about in this chapter.■At the trough in the second quarter of 2009, real GDPwas almost $1 trillion below potential GDP.■When real GDP is below potential GDP, the economyis operating inside thePPF (Chapter 2, pp. 30–31)and production is lost.■To put the read more..

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    actionGoTo:12,APPENDIXactionGoTo:12,Graphs in MacroeconomicsAfter studying this appendix, you will be able to:Make and interpret a time-series graphMake and interpret a graph that uses a ratio scale◆ The Time-Series GraphIn macroeconomics we study the fluctuations andtrends in the key variables that describe macroeco-nomic performance and policy. These variablesinclude GDP and its expenditure and income com-ponents that you’ve learned about in this chapter.They also include variables that read more..

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    Ratio Scale Reveals TrendA time-series graph also reveals whether a variable hasa cycle, which is a tendency for a variable to alternatebetween upward and downward movements, or atrend, which is a tendency for a variable to move inone general direction. The unemployment rate in Fig. A4.1 has a cyclebut no trend. When a trend is present, a special kindof time-series graph, one that uses a ratio scale on they-axis, reveals the trend.A Time-Series with a TrendMany macroeconomics variables, among read more..

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    100CHAPTER 4 Measuring GDP and Economic GrowthactionGoTo:12,MATHEMATICAL NOTEactionGoTo:12,Chained-Dollar Real GDPIn the real GDP calculation on p. 89, real GDP in2010 is 1.6 times its value in 2005. But suppose thatwe use 2010 as the reference base year and value realGDP in 2005 at 2010 prices. If you do the math,you will see that real GDP in 2005 is $150 million at2010 prices. GDP in 2010 is $300 million (in 2010prices), so now the numbers say that real GDP hasdoubled. Which is correct: Did read more..

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    Mathematical Note101$145 million plus $14 million, which equals $159million. Because real GDP in 2009 is in 2009 dollars,real GDP in 2010 is also in 2009 dollars.Although the real GDP of $159 million isexpressed in 2009 dollars, the calculation uses theaverage of the prices of the final goods and servicesthat make up GDP in 2009 and 2010.Link (Chain) to the Base YearThe third step is to express GDP in the prices of thereference base year. To do this, the BEA performs cal-culations like the ones read more..

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    102CHAPTER 4 Measuring GDP and Economic GrowthKey PointsGross Domestic Product (pp. 84–86)■GDP, or gross domestic product, is the marketvalue of all the final goods and services producedin a country during a given period.■A final good is an item that is bought by its finaluser, and it contrasts with an intermediate good,which is a component of a final good.■GDP is calculated by using either the expenditureor income totals in the circular flow model.■Aggregate expenditure on goods and read more..

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    Study Plan Problems and Applications103Gross Domestic Product (Study Plan 4.1)1. Classify each of the following items as a finalgood or service or an intermediate good orservice and identify which is a component ofconsumption expenditure, investment, orgovernment expenditure on goods and services:■Banking services bought by a student.■New cars bought by Hertz, the car rental firm.■Newsprint bought by USA Today .■The purchase of a new limo for the president.■New house bought by Al read more..

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    104CHAPTER 4 Measuring GDP and Economic GrowthUse the following news clip to work Problems 14 and 15.Toyota to Shift U.S. Manufacturing EffortsToyota announced it planned to adjust its U.S. man-ufacturing operations to meet customer demands forsmaller, more fuel-efficient vehicles. In 2008, Toyotastarted building a plant to produce the 2010 Prius forthe U.S. market in Blue Springs, Mississippi. Earliermodels of the Prius were produced in Asia.Source: CNN, July 10, 200814. Explain how this change read more..

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    Additional Problems and Applications105You can work these problems in MyEconLab if assigned by your instructor.ADDITIONAL PROBLEMS AND APPLICATIONSMeasuring U.S. GDPUse the following data to work Problems 27 and 28.The table lists some macroeconomic data for theUnited States in 2009.Item Billions of dollarsWages paid to labor 8,000Consumption expenditure 10,000Net operating surplus3,400Investment 1,500Government expenditure 2,900Net exports –34027. Calculate U.S. GDP in 2009.28. Explain the read more..

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    106CHAPTER 4 Measuring GDP and Economic Growthb. Why might $2 a day underestimate the stan-dard of living of the poorest Indians?Economics in the News36. After you have studied Reading Between the Lineson pp. 96–97 answer the following questions.a. Which measure of GDP would you use todescribe the shape of the recovery from reces-sion: real GDP or nominal GDP? Explainyour answer.b. Which measure of GDP would you use todescribe the rate of growth of the standard ofliving: real GDP or nominal read more..

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    After studying this chapter, you will be able to:Explain why unemployment is a problem, define theunemployment rate, the employment-to-population ratio,and the labor force participation rate, and describe thetrends and cycles in these labor market indicatorsExplain why unemployment is an imperfect measure ofunderutilized labor, why it is present even at fullemployment, and how unemployment and real GDPfluctuate together over a business cycleExplain why inflation is a problem, how we measurethe read more..

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    108CHAPTER 5 Monitoring Jobs and Inflation◆ actionGoTo:12,Employment and UnemploymentWhat kind of job market will you enter when yougraduate? Will there be plenty of good jobs to chooseamong, or will jobs be so hard to find that you endup taking one that doesn’t use your education andpays a low wage? The answer depends, to a largedegree, on the total number of jobs available and onthe number of people competing for them.The class of 2009 had an unusually tough time inthe jobs market. At the read more..

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    Employment and Unemployment109Think about a manager who loses his job when hisemployer downsizes. The only work he can find isdriving a taxi. After a year in this work, he discoversthat he can’t compete with new MBA graduates.Eventually, he gets hired as a manager but in a smallfirm and at a lower wage than before. He has lostsome of his human capital.The cost of unemployment is spread unequally,which makes it a highly charged political problem aswell as a serious economic problem.Governments read more..

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    110CHAPTER 5 Monitoring Jobs and InflationThe Unemployment Rate The amount of unemploy-ment is an indicator of the extent to which peoplewho want jobs can’t find them. The unemploymentrateis the percentage of the people in the labor forcewho are unemployed. That is,andIn June 2010, the number of people employed was139.1 million and the number unemployed was 14.6million. By using the above equations, you can verifythat the labor force was 153.7 million (139.1 millionplus 14.6 million) and the read more..

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    Employment and Unemployment111jobs at a faster rate than the working-age populationgrew. This indicator also fluctuates: It falls during arecession and increases during an expansion.The Labor Force Participation Rate The number ofpeople in the labor force is an indicator of the will-ingness of people of working age to take jobs. Thelabor force participation rateis the percentage of theworking-age population who are members of thelabor force. That is, In June 2010, the labor force was 153.7 read more..

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    112CHAPTER 5 Monitoring Jobs and InflationPart-Time Workers Who Want Full-Time Jobs Manypart-time workers want to work part time. Thisarrangement fits in with the other demands on theirtime. But some part-time workers would like full-time jobs and can’t find them. In the official statistics,these workers are called economic part-time workersand they are partly unemployed.Most Costly UnemploymentAll unemployment is costly, but the most costly islong-term unemployment that results from job read more..

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    Unemployment and Full Employment113◆ actionGoTo:12,Unemployment and FullactionGoTo:12,EmploymentThere is always someone without a job who is search-ing for one, so there is always some unemployment.The key reason is that the economy is a complexmechanism that is always changing—it experiencesfrictions, structural change, and cycles.Frictional UnemploymentThere is an unending flow of people into and out ofthe labor force as people move through the stages oflife—from being in school to read more..

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    114CHAPTER 5 Monitoring Jobs and Inflationways are swept aside and millions of jobs are lost andthe skill to perform them loses value. The amount ofstructural unemployment fluctuates with the paceand volume of technological change and the changedriven by fierce international competition, especiallyfrom fast-changing Asian economies. A high level ofstructural unemployment is present in many parts ofthe United States today (as you can see in Economicsin Action below).The Real Wage Rate The natural read more..

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    Unemployment and Full Employment115Figure 5.5 illustrates these fluctuations in theUnited States between 1980 and 2010—the outputgap in part (a) and the unemployment rate and natu-ral unemployment rate in part (b).When the economy is at full employment, theunemployment rate equals the natural unemploy-ment rate and real GDP equals potential GDP sothe output gap is zero. When the unemploymentrate is less than the natural unemployment rate,real GDP is greater than potential GDP and theoutput gap read more..

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    116CHAPTER 5 Monitoring Jobs and InflationactionGoTo:12,◆ The Price Level, Inflation,actionGoTo:12,and DeflationWhat will it really cost you to pay off your studentloan? What will your parent’s life savings buy whenthey retire? The answers depend on what happens tothe price level, the average level of prices, and thevalue of money. A persistently rising price level iscalled inflation;a persistently falling price level iscalled deflation.We are interested in the price level, inflation, read more..

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    The Price Level, Inflation, and Deflation117The Monthly Price Survey Each month, BLSemployees check the prices of the 80,000 goods andservices in the CPI basket in 30 metropolitan areas.Because the CPI aims to measure price changes, it isimportant that the prices recorded each month referto exactly the same item. For example, suppose theprice of a box of jelly beans has increased but a boxnow contains more beans. Has the price of jelly beansincreased? The BLS employee must record the detailsof read more..

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    118CHAPTER 5 Monitoring Jobs and InflationWe’ll work through these three steps for the simpleartificial economy in Table 5.1, which shows thequantities in the CPI basket and the prices in the baseperiod (2010) and current period (2011).Part (a) contains the data for the base period. Inthat period, consumers bought 10 oranges at $1 eachand 5 haircuts at $8 each. To find the cost of the CPIbasket in the base-period prices, multiply the quanti-ties in the CPI basket by the base-period prices. read more..

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    The Price Level, Inflation, and Deflation119Distinguishing High Inflation from a HighPrice LevelFigure 5.7 shows the CPI and the inflation rate in theUnited States between 1970 and 2010. The two partsof the figure are related and emphasize the distinctionbetween high inflation and high prices.When the price level in part (a) rises rapidly, (1970through 1982), the inflation rate in part (b) is high.When the price level in part (a) rises slowly, (after1982), the inflation rate in part (b) is low.A read more..

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    120CHAPTER 5 Monitoring Jobs and InflationOutlet Substitution Bias When confronted withhigher prices, people use discount stores more fre-quently and convenience stores less frequently. Thisphenomenon is called outlet substitution. The CPIsurveys do not monitor outlet substitutions.The Magnitude of the BiasYou’ve reviewed the sources of bias in the CPI. Buthow big is the bias? This question was tackled in1996 by a Congressional Advisory Commissionon the Consumer Price Index chaired by read more..

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    The Price Level, Inflation, and Deflation121Core CPI InflationNo matter whether we calculate the inflation rateusing the CPI, the chained CPI, the personal con-sumption expenditure deflator, or the GDP deflator,the number bounces around a good deal from monthto month or quarter to quarter. To determine thetrend in the inflation rate, we need to strip the rawnumbers of their volatility. The core CPI inflation rate,which is the CPI inflation rate excluding volatile ele-ments, attempts to do just read more..

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    122actionGoTo:12,READING BETWEEN THE actionGoTo:12,LINESU.S. Labor Force Shrinks Amid Jobs Market WoesactionURI(http://www.ft.com):http://www.ft.comAugust 8, 2010When the U.S. unemployment rate moved up from 9.7 percent to 9.9 percent in April,economists cheered it as an oddly encouraging sign. The increase was largely the result of a massive influx of 805,000 workers into the laborforce—Americans who were not even looking for a job during the recession and finally feltthey had better chances read more..

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    123ECONOMIC ANALYSIS■This news article reports and comments on some labormarket data for April through July 2010.■During 2010, the economy was expanding following adeep recession. Figure 1 shows real GDP bottomed inmid-2009.■Despite the expanding economy, the labor forceparticipation rate continued on a downward trend (as reported in the news article) and the unemploymentrate continued to rise.■Figure 2 shows that the unemployment rate continuedto rise until October 2009 when it reached read more..

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    124CHAPTER 5 Monitoring Jobs and Inflation■Over the business cycle, real GDP fluctuatesaround potential GDP and the unemploymentrate fluctuates around the natural unemploymentrate.Working Problems 6 to 11 will give you a better under-standing of unemployment and full employment.The Price Level, Inflation, and Deflation (pp. 116–121)■Inflation and deflation that are unexpected redis-tribute income and wealth and divert resourcesfrom production.■The Consumer Price Index (CPI) is a measure read more..

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    Study Plan Problems and Applications125What is a discouraged worker? Explain how anincrease in discouraged workers influences theofficial unemployment rate and U–4.Unemployment and Full Employment (Study Plan 5.2)Use the following news clip to work Problems 6 to 8.Nation’s Economic Pain DeepensA spike in the unemployment rate—the biggest inmore than two decades—raised new concerns thatthe economy is heading into a recession. The U.S.unemployment rate soared to 5.5% in May from 5%in read more..

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    126CHAPTER 5 Monitoring Jobs and Inflationcounted as part of the economy’s structuralunemployment or part of its cyclicalunemployment?11. Which of the following people are unemployedbecause of labor market mismatching?■Michael has unemployment benefits of $450 aweek and he turned down a full-time job pay-ing $7.75 an hour.■Tory used to earn $60,000 a year and heturned down a low-paid job to search for onethat pays at least $50,000 a year.■David turned down a temporary full-time jobpaying read more..

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    Additional Problems and Applications127Employment and Unemployment21. What is the unemployment rate supposed tomeasure and why is it an imperfect measure?22. The Bureau of Labor Statistics reported the fol-lowing data for 2005:Labor force participation rate: 66 percentWorking-age population: 226 millionEmployment-to-population ratio: 62.7Calculate thea. Labor force.b. Employment.c. Unemployment rate.23. In the New Orleans metropolitan area in August2005, the labor force was 634,512 and read more..

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    128CHAPTER 5 Monitoring Jobs and Inflation32. Governor Plans to Boost Economy with Eco-friendly JobsOregon’s 5.6 percent unemployment rate hoversclose to the national average of 5.5 percent. A fewyears ago, Oregon had one of the highest unem-ployment rates in the nation. To avoid risingunemployment, Oregon Governor Kulongoskiintroduced a plan that provides public schoolsand universities with enough state funds to meetgrowing demand for skilled workers. AlsoKulongoski wants to use state and read more..

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    David Hume, a Scot who lived from 1711 to 1776, didnot call himself an economist. “Philosophy and generallearning” is how he described the subject of his life’s work.Hume was an extraordinary thinker and writer. Pub-lished in 1742, his Essays, Moral and Political, rangeacross economics, political science, moral philosophy, histo-ry, literature, ethics, and religion and explore such topicsas love, marriage, divorce, suicide, death, and the immor-tality of the soul! His economic essays read more..

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    130The combination of these shocks brought anunusually large decrease in real GDP and increase inunemployment. These shocks also severly disruptedinternational trade and financial markets and triggeredthe largest ever fiscal and monetary stimulus measures.When did the recession begin and end and why is therecovery so painfully slow?The National Bureau of Economic Research (withwhom I am affiliated as a Research Associate) is thearbiter of when a recession begins and ends and theBureau declared read more..

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    131that are not associated with financial crises. In thiscase—I hope my forecast is wrong—it would seemthat the United States runs the risk of going througha sustained period of slow growth.As the recovery gains momentum, do you think wemight have a period of stagflation like the 1970s?Because of the recession, inflation in the UnitedStates was well below two percent, the level that theFed and most central banks strive for. This is mostlydue to the large output gap that opened up duringthe read more..

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    132now lagging, not lead-ing global growth, andthe share of dollars inglobal portfolios willcontinue to trenddown. I don’t see a freefall or crash landing inthe dollar, if only be-cause the euro, at thistime, is not a viable al-ternative.Why isn’t the euro a viable alternative to the dollar?At this time there isn’t an integrated financial marketin Europe. There is a collection of a dozen markets.Also, with the privileges of being a global reserve cur-rency come obligations. Global growth read more..

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    actionGoTo:13,PARTactionGoTo:13, THREE Monitoring Macroeconomic actionGoTo:13,TrendsAfter studying this chapter, you will be able to:Define and calculate the economic growth rate andexplain the implications of sustained growthDescribe the economic growth trends in the UnitedStates and other countries and regionsExplain how population growth and labor productivitygrowth make potential GDP growExplain the sources of labor productivity growthExplain the theories of economic growth, the read more..

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    134CHAPTER 6 Economic Growth◆ actionGoTo:13,The Basics of Economic actionGoTo:13,GrowthEconomic growth is a sustained expansion of produc-tion possibilities measured as the increase in realGDP over a given period. Rapid economic growthmaintained over a number of years can transform apoor nation into a rich one. Such have been the sto-ries of Hong Kong, South Korea, and some otherAsian economies. Slow economic growth or theabsence of growth can condemn a nation todevastating poverty. Such has read more..

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    The Basics of Economic Growth135imately 70 divided by the annual percentage growthrate of the variable. Using the Rule of 70, you can nowcalculate how many years it takes your $100 tobecome $200. It is 70 divided by 5, which is 14 years.Applying the Rule of 70The Rule of 70 applies to any variable, so it applies toreal GDP per person. Figure 6.1 shows the doublingtime for growth rates of 1 percent per year to 12 per-cent per year.You can see that real GDP per person doubles in70 years (70 read more..

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    136CHAPTER 6 Economic Growth◆ actionGoTo:13,Economic Growth TrendsYou have just seen the power of economic growth toincrease incomes. At a 1 percent growth rate, it takesa human life span to double the standard of living.But at a 7 percent growth rate, the standard of livingdoubles every decade. How fast is our economygrowing? How fast are other economies growing? Arepoor countries catching up to rich ones, or do thegaps between the rich and poor persist or evenwiden? Let’s answer these read more..

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    Economic Growth Trends137Real GDP Growth in the World EconomyFigure 6.3 shows real GDP per person in the UnitedStates and in other countries between 1960 and2010. Part (a) looks at the seven richest countries—known as the G7 nations. Among these nations, theUnited States has the highest real GDP per person.In 2010, Canada had the second-highest real GDPper person, ahead of Japan and France, Germany,Italy, and the United Kingdom (collectively theEurope Big 4).During the fifty years shown here, read more..

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    138CHAPTER 6 Economic Growth5,5002,7504008001,60022,00011,00044,000Real GDP per person (2000 dollars; ratio scale)United StatesHong KongSingaporeKoreaChinaYearClosing the Gap201020001980197019901960Even modest differences in economic growth ratessustained over a number of years bring enormous dif-ferences in the standard of living. And some of thedifferences that you’ve just seen are enormous. So thefacts about economic growth in the United Statesand around the world raise some big read more..

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    How Potential GDP Grows139◆ actionGoTo:13,How Potential GDP actionGoTo:13,GrowsEconomic growth occurs when real GDP increases.But a one-shot rise in real GDP or a recovery fromrecession isn’t economic growth. Economic growth is asustained, year-after-year increase in potential GDP.So what determines potential GDP and what arethe forces that make it grow?What Determines Potential GDP?Labor, capital, land, and entrepreneurship producereal GDP, and the productivity of the factors of pro-duction read more..

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    140CHAPTER 6 Economic Growthquantity depends on the price of labor, which is thereal wage rate.The real wage rateis the money wage rate dividedby the price level. The real wage rate is the quantityof goods and services that an hour of labor earns. Itcontrasts with the money wage rate, which is thenumber of dollars that an hour of labor earns. The real wage rate influences the quantity oflabor demanded because what matters to firms isnot the number of dollars they pay (money wagerate) but how read more..

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    How Potential GDP Grows141there is neither a shortage nor a surplus of labor. Inthis situation, there is no pressure in either directionon the real wage rate. So the real wage rate remainsconstant and the market is in equilibrium. At thisequilibrium real wage rate and level of employment,the economy is at full employment.Potential GDP You’ve seen that the production func-tion tells us the quantity of real GDP that a givenamount of labor can produce—see Fig. 6.4. Thequantity of real GDP read more..

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    142CHAPTER 6 Economic Growththese two factors has kept the average hours perworking-age person (approximately) constant.Growth in the supply of labor has come fromgrowth in the working-age population. In the longrun, the working-age population grows at the samerate as the total population.The Effects of Population GrowthPopulation growthbrings growth in the supply of labor, but it does notchange the demand for labor or the production func-tion. The economy can produce more output by usingmore read more..

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    How Potential GDP Grows143Growth of Labor Productivity Labor productivityis thequantity of real GDP produced by an hour of labor.It is calculated by dividing real GDP by aggregatelabor hours. For example, if real GDP is $13 trillionand aggregate hours are 200 billion, labor productiv-ity is $65 per hour.When labor productivity grows, real GDP per per-son grows and brings a rising standard of living. Let’ssee how an increase in labor productivity changespotential GDP.Effects of an Increase in read more..

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    144CHAPTER 6 Economic Growth◆ actionGoTo:13,Why Labor Productivity GrowsYou’ve seen that labor productivity growth makespotential GDP grow; and you’ve seen that labor pro-ductivity growth is essential if real GDP per personand the standard of living are to grow. But why doeslabor productivity grow? What are the preconditionsthat make labor productivity growth possible andwhat are the forces that make it grow? Why doeslabor productivity grow faster at some times and insome places than read more..

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    Why Labor Productivity Grows145It was the presence of secure property rights inBritain in the middle 1700s that got the IndustrialRevolution going (see Economics in Action below).And it is their absence in some parts of Africa todaythat is keeping labor productivity stagnant.With the preconditions for labor productivitygrowth in place, three things influence its pace:■Physical capital growth■Human capital growth■Technological advancesPhysical Capital GrowthAs the amount of capital per read more..

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    146CHAPTER 6 Economic GrowthChange in average hours per workerChange in employment-to-population ratio Working-age population growthPhysical capital growthHuman capital growth Education and training Job experienceTechnological advancesLaborsupplygrowthLaborproductivitygrowthPopulationgrowthReal GDP perperson growthReal GDPgrowthLabor supply growth andlabor productivity growthcombine to determine realGDP growth. Real GDP perperson growth depends onreal GDP growth and popu-lation read more..

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    Growth Theories, Evidence, and Policies147◆ actionGoTo:13,Growth Theories, Evidence, andactionGoTo:13,PoliciesYou’ve seen how population growth and labor pro-ductivity growth make potential GDP grow. You’vealso seen that the growth of physical capital andhuman capital and technological advances makelabor productivity grow. How do all these factorsinteract? What is cause and what is effect? Growththeories address these questions.Alternative theories of economic growth provideinsights into read more..

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    148CHAPTER 6 Economic GrowthThen technology begins to advance at a morerapid pace across a range of activities. The transistorrevolutionizes an emerging electronics industry.New plastics revolutionize the manufacture ofhousehold appliances. The interstate highway sys-tem revolutionizes road transportation. Jet airlinersstart to replace piston-engine airplanes and speed airtransportation.These technological advances bring new profitopportunities. Businesses expand, and new businessesare created read more..

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    Growth Theories, Evidence, and Policies149has been discovered, the productivity of this knowl-edge capital has relentlessly increased. In 1990, it costabout $50 to sequence one DNA base pair. That costhad fallen to $1 by 2000 and to 1/10,000th of apenny by 2010.The implication of this simple and appealingobservation is astonishing. Unlike the other twotheories, new growth theory has no growth-stoppingmechanism. As physical capital accumulates, thereturn to capital—the real interest read more..

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    150CHAPTER 6 Economic GrowthNew Growth Theory VersusMalthusian TheoryThe contrast between the Malthusian theory and newgrowth theory couldn’t be more sharp. Malthusians seethe end of prosperity as we know it today and newgrowth theorists see unending plenty. The contrastbecomes clearest by thinking about the differing viewsabout population growth.To a Malthusian, population growth is part of theproblem. To a new growth theorist, population growthis part of the solution. People are the ultimate read more..

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    Growth Theories, Evidence, and Policies151Stimulate Research and Development Everyone canuse the fruits of basic research and developmentefforts. For example, all biotechnology firms can useadvances in gene-splicing technology. Because basicinventions can be copied, the inventor’s profit is lim-ited and the market allocates too few resources to thisactivity. Governments can direct public funds towardfinancing basic research, but this solution is not fool-proof. It requires a mechanism for read more..

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    152actionGoTo:13,READING BETWEEN THE actionGoTo:13,LINESChina Pips Japan but “Still a Developing Nation”actionURI(http://www.afp.com):http://www.afp.comAugust 17, 2010China insisted Tuesday it was still a developing nation despite overtaking Japan as the world’ssecond largest economy, in the face of pressure to take on a greater role in global affairs. ...Thirty years after opening its doors to the outside world, China has enjoyed spectaculareconomic growth and already claimed the titles read more..

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    153ECONOMIC ANALYSISFigure 3 Real GDP per person in PPP pricesFigure 2 Real GDP in PPP pricesFigure 1 GDP in U.S. dollarsYearGDP (trillions of U.S. dollars)020105151980 1985 1990 1995 2000 2005 2010 2015ChinaUnited StatesJapanYearGDP(trillions of 2005 U.S. PPP dollars)02510515201980 1985 1990 1995 2000 2005 2010 2015ChinaUnited StatesJapanYearGDP (thousands of 2005 U.S. PPPdollars per person)050302010401980 1985 1990 1995 2000 2005 2010 2015ChinaUnited read more..

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    154CHAPTER 6 Economic Growth■Only labor productivity growth makes real GDPper person and the standard of living grow.Working Problems 7 to 14 will give you a better under-standing of how potential GDP grows.Why Labor Productivity Grows (pp. 144–146)■Labor productivity growth requires an incentivesystem created by firms, markets, property rights,and money.■The sources of labor productivity growth aregrowth of physical capital and human capital andadvances in technology.Working Problems 15 read more..

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    Study Plan Problems and Applications155How long, at the current growth rate, will it takefor China to double its real GDP per person?Economic Growth Trends (Study Plan 6.2)6. China was the largest economy for centuriesbecause everyone had the same type of econ-omy— subsistence—and so the country with the most people would be economically biggest.Then the Industrial Revolution sent the West on a more prosperous path. Now the world isreturning to a common economy, this timetechnology- and read more..

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    156CHAPTER 6 Economic Growth11. If workers in developing Asian economies workmore hours than Americans, why are they notthe world’s most productive?Use the following tables to work Problems 12 to 14.The tables describe an economy’s labor market andits production function in 2010.Real wage rateLabor hoursLabor hours(dollars per hour)supplieddemanded80455704010603515503020402525302030201535LaborReal GDP(hours)(2005 dollars)542510800151,125201,400251,625301,800351,925402,00012. What are the read more..

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    Additional Problems and Applications157The Basics of Economic Growth19. If in 2010 China’s real GDP is growing at 9 per-cent a year, its population is growing at 1 percent ayear, and these growth rates continue, in what yearwill China’s real GDP per person be twice what itis in 2010?20. Mexico’s real GDP was 8,600 trillion pesos in2009 and 8,688 trillion pesos in 2010. Mexico’spopulation was 107 million in 2009 and 108million in 2010. Calculatea. The economic growth rate.b. The growth read more..

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    158CHAPTER 6 Economic GrowthWhy Labor Productivity Grows28. India’s Economy Hits the WallJust six months ago, India was looking good.Annual growth was 9%, consumer demand washuge, and foreign investment was growing. Butnow most economic forecasts expect growth toslow to 7%—a big drop for a country that needsto accelerate growth. India needs urgently toupgrade its infrastructure and education andhealth-care facilities. Agriculture is unproductiveand needs better technology. The legal read more..

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    After studying this chapter, you will be able to:Describe and define the flows of funds through financialmarkets and the financial institutionsExplain how investment and saving along with borrow-ing and lending decisions are made and how thesedecisions interact in the loanable funds marketExplain how a government deficit (or surplus) influencesthe real interest rate, saving, and investment in the loan-able funds marketExplain how international borrowing or lending influ-ences the real interest read more..

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    160CHAPTER 7 Finance, Saving, and Investment◆ actionGoTo:13,Financial Institutions andactionGoTo:13,Financial MarketsThe financial institutions and markets that we studyin this chapter play a crucial role in the economy.They provide the channels through which savingflows to finance the investment in new capital thatmakes the economy grow.In studying the economics of financial institutionsand markets, we distinguish between:■Finance and money■Physical capital and financial capital Finance read more..

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    Financial Institutions and Financial Markets161you earn $5,000 (net of taxes) and spend $1,000 onconsumption goods and services so your saving is$4,000. Your bank account increases to $4,250 andyour wealth becomes $4,550. The $4,000 increase inwealth equals saving. If coins rise in value and yourcoin collection is now worth $500, you have a capitalgain of $200, which is also added to your wealth.National wealth and national saving work like thispersonal example. The wealth of a nation at the read more..

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    162CHAPTER 7 Finance, Saving, and Investmentto Union Pacific, GM wants to be paid when theitems are shipped. But Union Pacific doesn’t want topay until the locomotives are earning an income. Inthis situation, Union Pacific might promise to payGM $101 million three months in the future. A bankwould be willing to buy this promise for (say) $100million. GM gets $100 million immediately and thebank gets $101 million in three months when UnionPacific honors its promise. The U.S. Treasury read more..

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    Financial Institutions and Financial Markets163Pension Funds Pension funds are financial institu-tions that use the pension contributions of firms andworkers to buy bonds and stocks. The mortgage-backed securities of Fannie Mae and Freddie Mac areamong the assets of pension funds. Some pensionfunds are very large and play an active role in thefirms whose stock they hold.Insurance Companies Insurance companies enablehouseholds and firms to cope with risks such as acci-dent, theft, fire, read more..

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    164CHAPTER 7 Finance, Saving, and InvestmentInterest Rates and Asset PricesStocks, bonds, short-term securities, and loans arecollectively called financial assets. The interest rate ona financial asset is the interest received expressed as apercentage of the price of the asset.Because the interest rate is a percentage of theprice of an asset, if the asset price rises, other thingsremaining the same, the interest rate falls. Conversely,if the asset price falls, other things remaining thesame, the read more..

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    The Loanable Funds Market165If we export less than we import, we borrow (M – X ) from the rest of the world to finance someof our investment. If we export more than we import,we lend (X – M ) to the rest of the world and part ofU.S. saving finances investment in other countries.The sum of private saving, S, and government sav-ing, (T – G ), is called national saving. National savingand foreign borrowing finance investment.In 2010, U.S. investment was $1.8 trillion.Governments (federal, read more..

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    166CHAPTER 7 Finance, Saving, and Investment$500. So the real interest rate is the 5 percent nomi-nal interest rate minus the 2 percent inflation rate1.The real interest rate is the opportunity cost ofloanable funds. The real interest paid on borrowedfunds is the opportunity cost of borrowing. And thereal interest rate forgone when funds are used either tobuy consumption goods and services or to invest innew capital goods is the opportunity cost of not sav-ing or not lending those funds.We’re read more..

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    The Loanable Funds Market167Expected profit rises during a business cycleexpansion and falls during a recession; rises whentechnological change creates profitable new products;rises as a growing population brings increaseddemand for goods and services; and fluctuates withcontagious swings of optimism and pessimism, called“animal spirits” by Keynes and “irrational exuber-ance” by Alan Greenspan. When expected profit changes, the demand forloanable funds curve shifts.The Supply of Loanable read more..

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    168CHAPTER 7 Finance, Saving, and InvestmentDefault RiskDefault risk is the risk that a loan will notbe repaid. The greater that risk, the higher is theinterest rate needed to induce a person to lend andthe smaller is the supply of loanable funds.Shifts of the Supply of Loanable Funds Curve Whenany of the four influences on the supply of loanablefunds changes, the supply of loanable funds changesand the supply curve shifts. An increase in disposableincome, a decrease in expected future income, read more..

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    The Loanable Funds Market169change in the supply of loanable funds, there is ashortage of funds at a real interest rate of 6 percent ayear. The real interest rate rises until it is 7 percent ayear. Equilibrium is restored and the equilibriumquantity of funds has increased.An Increase in Supply If one of the influences onsaving plans changes and increases saving, the supplyof loanable funds increases. With no change in thedemand for loanable funds, the market is flush withloanable funds. read more..

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    170CHAPTER 7 Finance, Saving, and InvestmentEconomics in ActionsLoanable Funds Fuel Home Price BubbleThe financial crisis that gripped the U.S. and globaleconomies in 2007 and cascaded through the finan-cial markets in 2008 had its origins much earlier inevents taking place in the loanable funds market.Between 2001 and 2005, a massive injection ofloanable funds occurred. Some funds came from therest of the world, but that source of supply has beenstable. The Federal Reserve provided funds to read more..

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    Government in the Loanable Funds Market171◆ actionGoTo:13,Government in the LoanableactionGoTo:13,Funds MarketGovernment enters the loanable funds market whenit has a budget surplus or budget deficit. A govern-ment budget surplus increases the supply of loanablefunds and contributes to financing investment; a gov-ernment budget deficit increases the demand forloanable funds and competes with businesses forfunds. Let’s study the effects of government on theloanable funds market.A Government read more..

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    172CHAPTER 7 Finance, Saving, and Investmentincomes, saving increases today. Private saving andthe private supply of loanable funds increase tomatch the quantity of loanable funds demanded bythe government. So the budget deficit has no effecton either the real interest rate or investment. Figure7.9 shows this outcome.Most economists regard the Ricardo-Barro view asextreme. But there might be some change in private sav-ing that goes in the direction suggested by the Ricardo-Barro effect that read more..

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    The Global Loanable Funds Market173rate. The interest rate on a risky loan minus that on asafe loan is called the risk premium.International capital mobility brings real interestrates in all parts of the world to equality except fordifferences that reflect differences in risk—differencesin the risk premium.International Borrowing and LendingA country’s loanable funds market connects withthe global market through net exports. If a coun-try’s net exports are negative (X < M ), the rest read more..

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    174CHAPTER 7 Finance, Saving, and InvestmentIf this country were isolated from the global mar-ket, the real interest rate would be 6 percent a year(where the DLF and SLFD curves intersect). But ifthe country is integrated into the global economy,with an interest rate of 6 percent a year, funds wouldflood into it. With a real interest rate of 5 percent ayear in the rest of the world, suppliers of loanablefunds would seek the higher return in this country. Ineffect, the country faces the supply of read more..

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    The Global Loanable Funds Market175Economics in ActionGreenspan’s Interest Rate PuzzleThe real interest rate paid by big corporations in theUnited States fell from 5.5 percent a year in 2001 to2.5 percent a year in 2005. Alan Greenspan, then theChairman of the Federal Reserve, said he was puzzledthat the real interest rate was falling at a time when theU.S. government budget deficit was increasing.Why did the real interest rate fall?The answer lies in the global loanable funds mar-ket. Rapid read more..

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    176actionGoTo:13,READING BETWEEN THE actionGoTo:13,LINES“Borrowing to Live” Weighs on Families, Firms, NationactionURI(http://www.dallasmorningnews.com):http://www.dallasmorningnews.comJune 13, 2010... In the last decade, American household, business, and government debts doubled to $39.2trillion. We did not double the size of the economy. And that’s the problem. ...The average Dallas consumer owed $26,599 in March [2010] on credit cards and loans coveringcars, tuition, and other personal read more..

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    177ECONOMIC ANALYSISReal interest rate (percent per year)Loanable funds (trillions of 2005 dollars)01102345671214161815DLF09PDLFDLF08SLFFigure 1 The global loanable funds marketIncrease ingovernmentdeficits ...... raises interestrate and crowdsout investmentReal interest rate (percent per year)Loanable funds (trillions of 2005 dollars)011.52345672.02.53.03.5DLF09PDLFDLF08SLFFigure 2 The U.S. loanable funds marketBorrowingfrom rest ofworld shrinksCrowding out Increase ingovernmentdeficit■The read more..

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    178CHAPTER 7 Finance, Saving, and Investment■Equilibrium in the loanable funds market deter-mines the real interest rate and quantity of funds.Working Study Plan Problems 6 to 9 will give you a betterunderstanding of the loanable funds market.Government in the Loanable Funds Market (pp. 171–172)■A government budget surplus increases the supplyof loanable funds, lowers the real interest rate, andincreases investment and the equilibrium quantityof loanable funds.■A government budget read more..

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    Study Plan Problems and Applications179a. Is the purchase of corporate equities part ofhousehold consumption or saving? Explainyour answer.b. Equities reap a capital gain in the same waythat houses reap a capital gain. Does thismean that the purchase of equities is invest-ment? If not, explain why it is not.5. G-20 Leaders Look to Shake off LingeringEconomic TroublesThe G-20 aims to take stock of the economicrecovery. One achievement of the G-20 inPittsburgh could be a deal to require read more..

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    180CHAPTER 7 Finance, Saving, and Investmenta. U.S. household income has grown considerablysince 1984. Has U.S. saving been on a down-ward trend because Americans feel wealthier?b. Explain why households preferred to buy cor-porate equities rather than bonds.Government in the Loanable Funds Market(Study Plan 7.3)Use the following table to work Problems 10 to 12.The table shows an economy’s demand for loanablefunds and the supply of loanable funds schedules,when the government’s budget is read more..

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    Additional Problems and Applications181Financial Institutions and Financial Markets19. On January 1, 2009, Terry’s Towing Serviceowned 4 tow trucks valued at $300,000. During2009, Terry’s bought 2 new trucks for a total of$180,000. At the end of 2009, the market valueof all of the firm’s trucks was $400,000. Whatwas Terry’s gross investment? Calculate Terry’sdepreciation and net investment.Use the following information to work Problems 20and 21.The Bureau of Economic Analysis reported read more..

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    182CHAPTER 7 Finance, Saving, and Investmentthe end of 2008. A Goldman Sachs report suggeststhat India needs to lower the government’s deficit,raise educational achievement, control inflation, andliberalize its financial markets.Source: Business Week, July 1, 200828. If the Indian government reduces its deficit andreturns to a balanced budget, how will the demandfor or supply of loanable funds in India change?29. With economic growth forecasted to slow, futureincomes are expected to fall. If read more..

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    After studying this chapter, you will be able to:Define money and describe its functionsExplain the economic functions of banks and otherdepository institutions Describe the structure and functions of the FederalReserve System (the Fed)Explain how the banking system creates moneyExplain what determines the demand for money, thesupply of money, and the nominal interest rateExplain how the quantity of money influences the pricelevel and the inflation rate in the long runMoney, like fire and the read more..

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    184CHAPTER 8 Money, the Price Level, and Inflation◆ actionGoTo:14,What Is Money?What do wampum, tobacco, and nickels and dimeshave in common? They are all examples of money,which is defined as any commodity or token that isgenerally acceptable as a means of payment. A meansof paymentis a method of settling a debt. When apayment has been made, there is no remaining obli-gation between the parties to a transaction. So whatwampum, tobacco, and nickels and dimes have incommon is that they have read more..

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    What Is Money?185Economics in ActionOfficial Measures of U.S. MoneyThe figure shows the relative magnitudes of the itemsthat make up M1 and M2. Notice that M2 is almostfive times as large as M1 and that currency is a smallpart of our money.have to visit many different stores to establish theprice of each good in terms of another and then cal-culate the prices in units that are relevant for yourown decision. The hassle of doing all this researchmight be enough to make a person swear off read more..

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    186CHAPTER 8 Money, the Price Level, and InflationAre M1 and M2 Really Money? Money is the meansof payment. So the test of whether an asset is moneyis whether it serves as a means of payment. Currencypasses the test. But what about deposits? Checkingdeposits are money because they can be transferredfrom one person to another by writing a check orusing a debit card. Such a transfer of ownership isequivalent to handing over currency. Because M1consists of currency plus checking deposits and eachof read more..

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    Depository Institutions187◆ actionGoTo:14,Depository InstitutionsA depository institutionis a financial firm that takesdeposits from households and firms. These depositsare components of M1 and M2. You will learn whatthese institutions are, what they do, the economicbenefits they bring, how they are regulated, andhow they have innovated to create new financialproducts.Types of Depository InstitutionsThe deposits of three types of financial firms makeup the nation’s money. They read more..

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    188CHAPTER 8 Money, the Price Level, and Inflation3. Securities are U.S. government bonds and otherbonds such as mortgage-backed securities. Theseassets can be sold and converted into reserves butat prices that fluctuate, so they are riskier thanliquid assets and have a higher interest rate.4. Loans are funds committed for an agreed-uponperiod of time to corporations to finance invest-ment and to households to finance the purchaseof homes, cars, and other durable goods. Theoutstanding balances read more..

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    Depository Institutions189Financial InnovationIn the pursuit of larger profit, depository institutionsare constantly seeking ways to improve their productsin a process called financial innovation.During the late 1970s, a high inflation rate sentthe interest rate on home-purchase loans to 15 per-cent a year. Traditional fixed interest rate mortgagesbecame unprofitable and variable interest rate mort-gages were introduced.During the 2000s, when interest rates were lowand depository institutions read more..

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    190CHAPTER 8 Money, the Price Level, and Inflation◆ actionGoTo:14,The Federal Reserve SystemThe Federal Reserve System(usually called the Fed) is thecentral bank of the United States. A central bankis abank’s bank and a public authority that regulates anation’s depository institutions and conducts monetarypolicy, which means that it adjusts the quantity ofmoney in circulation and influences interest rates.We begin by describing the structure of the Fed.The Structure of the FedThree key read more..

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    The Federal Reserve System191The Fed’s Balance SheetThe Fed influences the economy through the size andcomposition of its balance sheet—the assets that theFed owns and the liabilities that it owes.The Fed’s Assets The Fed has two main assets:1. U.S. government securities2. Loans to depository institutionsThe Fed holds U.S. securities—Treasury bills andTreasury bonds—that it buys in the bond market.When the Fed buys or sells bonds, it participates inthe loanable funds market (see pp. read more..

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    192CHAPTER 8 Money, the Price Level, and InflationAmerica to the Fed, so the Bank of America’s assetsdecrease by $100 million and the Fed’s assets increaseby $100 million, as shown by the blue arrow runningfrom the Bank of America to the Fed.The Fed pays for the securities by placing $100million in the Bank of America’s reserve account atthe Fed, as shown by the green arrow running fromthe Fed to the Bank of America.The Fed’s assets and liabilities increase by $100million. The Bank of read more..

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    How Banks Create Money193The Bank of America uses $100 million of itsreserves to pay for the securities.Both the Fed’s assets and liabilities decrease by$100 million. The Bank of America’s total assets areunchanged: It has used reserves to buy securities.The New York Fed conducts these open-markettransactions on directions from the FOMC.Last Resort Loans The Fed is the lender of last resort,which means that if a bank is short of reserves, it canborrow from the Fed. But the Fed sets the read more..

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    194CHAPTER 8 Money, the Price Level, and InflationThe Monetary Base You’ve seen that the monetarybase is the sum of Federal Reserve notes, coins, andbanks’ deposits at the Fed. The size of the monetarybase limits the total quantity of money that the bank-ing system can create. The reason is that banks have adesired level of reserves, households and firms have adesired holding of currency, and both of these desiredholdings of the monetary base depend on the quan-tity of deposits.Desired read more..

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    How Banks Create Money195The Money MultiplierThe money multiplieris the ratio of the change in thequantity of money to the change in monetary base.For example, if a $1 million increase in the monetarybase increases the quantity of money by $2.5 million,then the money multiplier is 2.5.The smaller the banks’ desired reserve ratio andthe smaller the currency drain ratio, the larger is themoney multiplier. (See the Mathematical Note onpp. 204–205 for details on the money multiplier).Increase read more..

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    196CHAPTER 8 Money, the Price Level, and Inflation◆ actionGoTo:14,The Money MarketThere is no limit to the amount of money wewould like to receive in payment for our labor or asinterest on our savings. But there is a limit to howbig an inventory of money we would like to holdand neither spend nor use to buy assets that gener-ate an income. The quantity of money demanded isthe inventory of money that people plan to hold onany given day. It is the quantity of money in ourwallets and in our read more..

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    The Money Market197A decrease in real GDP decreases the demand for money.The demand for money curve shifts leftward from MD0 toMD1. An increase in real GDP increases the demand formoney. The demand for money curve shifts rightward fromMD0 toMD2. Financial innovation generally decreases thedemand for money.The Demand for MoneyThe demand for moneyis the relationship between the quantity of real money demanded and the nomi-nal interest rate when all other influences on theamount of money that read more..

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    198CHAPTER 8 Money, the Price Level, and InflationMoney Market EquilibriumYou now know what determines the demand formoney, and you’ve seen how the banking system cre-ates money. Let’s now see how the money marketreaches an equilibrium.Money market equilibrium occurs when thequantity of money demanded equals the quantity ofmoney supplied. The adjustments that occur tobring money market equilibrium are fundamentallydifferent in the short run and the long run.Short-Run Equilibrium The quantity read more..

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    The Money Market1995Real money (trillions of 2005 dollars)03.046Interest rate (percent per year)2.93.1MDMS0MS1MS2Decrease inmoney supplyraises interestrateIncrease inmoney supplylowersinterest rateAn increase in the supply of money shifts the supply ofmoney curve from MS0 toMS1 and the interest rate falls. Adecrease in the supply of money shifts the supply of moneycurve from MS0 toMS2 and the interest rate rises.in the quantity of money. Why does this outcomeoccur in the long run?The reason is read more..

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    200CHAPTER 8 Money, the Price Level, and Inflation◆ actionGoTo:14,The Quantity TheoractionGoTo:14,y of MoneyIn the long run, the price level adjusts to make thequantity of real money demanded equal the quantitysupplied. A special theory of the price level and infla-tion—the quantity theory of money—explains thislong-run adjustment of the price level. The quantity theory of moneyis the proposition thatin the long run, an increase in the quantity of moneybrings an equal percentage increase read more..

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    The Quantity Theory of Money201◆You now know what money is, how the bankscreate it, and how the quantity of money influencesthe nominal interest rate in the short run and theprice level in the long run. Reading Between the Lineson pp. 202–203 looks at the Fed’s incredible actionsin the recent financial crisis.20050150Money growth rate (percent per year)150010020025025050Figure 2 134 Countries: 1990–2005Inflation rate (percent per read more..

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    202actionGoTo:14,READING BETWEEN THE actionGoTo:14,LINESIt Falls to the Fed to Fuel RecoveryThe Financial TimesAugust 30, 2010The U.S. recovery is stalling. ... The recovery is in danger of petering out altogether. Recentnumbers have been dismal. Second-quarter growth was marked down to 1.6 percent onFriday. Earlier, signs of a new crunch in the housing market gave the stock market anotherpummelling. Already low expectations were disappointed nonetheless: Sales of existingsingle-family homes in read more..

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    203ECONOMIC ANALYSISFigure 1 Monetary baseMonth/yearMonetary base (trillions of dollars)2.500.500Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 101.001.502.00Jan 11Quantitative easingincreased the monetarybase by more than$1 trillionFigure 2 Nominal interest ratesMonth/yearShort-term rateLong-term rateInterest rate (percent per year)86420Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11The short-terminterest rate fell,but the long-terminterest rate didn'tchangeFigure 3 The long-term real interest read more..

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    204CHAPTER 8 Money, the Price Level, and InflationactionGoTo:14,MATHEMATICAL NOTEactionGoTo:14,The Money MultiplierThis note explains the basic math of the money mul-tiplier and shows how the value of the multiplierdepends on the banks’ desired reserve ratio and thecurrency drain ratio.To make the process of money creation concrete,we work through an example for a banking system inwhich each bank has a desired reserve ratio of 10 per-cent of deposits and the currency drain ratio is 50percent read more..

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    Mathematical Note205money, look closely at the numbers in the figure. Theinitial increase in reserves is $100,000 (call it A). Ateach stage, the loan is 60 percent (0.6) of the previousloan and the quantity of money increases by 0.6 of theprevious increase. Call that proportion L (L = 0.6). Wecan write down the complete sequence for the increasein the quantity of money asAALAL2AL3AL4AL5... .Remember, L is a fraction, so at each stage in thissequence, the amount of new loans and new moneygets read more..

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    206CHAPTER 8 Money, the Price Level, and InflationHow Banks Create Money (pp. 193–195)■Banks create money by making loans.■The total quantity of money that can be createddepends on the monetary base, the desired reserveratio, and the currency drain ratio.Working Problems 10 to 14 will give you a better under-standing of how banks create money.The Money Market (pp. 196–199)■The quantity of money demanded is the amountof money that people plan to hold.■The quantity of real money equals read more..

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    Study Plan Problems and Applications207declined to comment on the health of specificcompanies but said that Wall Street firms havelearned a great deal from Bear Stearns and havereduced leverage and built up their liquidity.Today, investment banks are stronger than theywere a month-and-a-half ago.Source: CNN, June 5, 20085. Explain a bank’s “balancing act” and how theover-pursuit of profit or underestimation of riskcan lead to a bank failure.6. During a time of uncertainty, why might it read more..

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    208CHAPTER 8 Money, the Price Level, and InflationHow Banks Create Money (Study Plan 8.4)10. The commercial banks in Zap have Reserves$250 millionLoans$1,000 millionDeposits$2,000 millionTotal assets$2,500 millionIf the banks hold no excess reserves, calculatetheir desired reserve ratio.Use the following information to work Problems 11and 12.In the economy of Nocoin, banks have deposits of$300 billion. Their reserves are $15 billion, twothirds of which is in deposits with the central read more..

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    Additional Problems and Applications209What Is Money?20. Sara withdraws $1,000 from her savings accountat the Lucky S&L, keeps $50 in cash, anddeposits the balance in her checking account atthe Bank of Illinois. What is the immediatechange in M1 and M2?21. Rapid inflation in Brazil in the early 1990scaused the cruzeiro to lose its ability to functionas money. Which of the following commoditieswould most likely have taken the place of thecruzeiro in the Brazilian economy? Explain why.a. read more..

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    210CHAPTER 8 Money, the Price Level, and InflationThe Money Market31. Explain the change in the nominal interest ratein the short run ifa. Real GDP increases.b. The money supply increases.c. The price level rises.32. In Minland in Problem 15, the interest rate is 4percent a year. Suppose that real GDP decreasesto $10 billion and the quantity of money sup-plied remains unchanged. Do people buy bondsor sell bonds? Explain how the interest ratechanges.The Quantity Theory of Money33. The table read more..

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    After studying this chapter, you will be able to:Describe the foreign exchange market and explain howthe exchange rate is determined day by dayExplain the trends and fluctuations in the exchange rateand explain interest rate parity and purchasing powerparityDescribe the alternative exchange rate policies andexplain their effectsDescribe the balance of payments accounts and explainwhat causes an international deficitThe dollar ($), the euro (€), and the yen (¥) are three of the world’s read more..

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    212CHAPTER 9 The Exchange Rate and the Balance of Payments◆ actionGoTo:14,The Foreign Exchange MarketWhen Wal-Mart imports DVD players from Japan, itpays for them using Japanese yen. And when JapanAirlines buys an airplane from Boeing, it pays usingU.S. dollars. Whenever people buy things fromanother country, they use the currency of that countryto make the transaction. It doesn’t make any differ-ence what the item is that is being traded internation-ally. It might be a DVD player, an read more..

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    The Foreign Exchange Market213thousands of traders every hour of every business day.Because it has many traders and no restrictions onwho may trade, the foreign exchange market is acompetitive market.In a competitive market, demand and supplydetermine the price. So to understand the forces thatdetermine the exchange rate, we need to study thefactors that influence demand and supply in the for-eign exchange market. But there is a feature of theforeign exchange market that makes it read more..

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    214CHAPTER 9 The Exchange Rate and the Balance of Paymentsprice of the U.S. dollar rises from 100 yen to 120 yenbut nothing else changes, the quantity of U.S. dollarsthat people plan to buy in the foreign exchange mar-ket decreases. The exchange rate influences the quan-tity of U.S. dollars demanded for two reasons:■Exports effect■Expected profit effectExports Effect The larger the value of U.S. exports,the larger is the quantity of U.S. dollars demandedin the foreign exchange market. But read more..

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    The Foreign Exchange Market215Supply in the Foreign Exchange MarketPeople sell U.S. dollars and buy other currencies so thatthey can buy foreign-produced goods and services—U.S. imports. People also sell U.S. dollars and buy for-eign currencies so that they can buy foreign assets suchas bonds, stocks, businesses, and real estate or so thatthey can hold part of their money in bank depositsdenominated in a foreign currency.The quantity of U.S. dollars supplied in the for-eign exchange market is read more..

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    216CHAPTER 9 The Exchange Rate and the Balance of PaymentsMarket EquilibriumEquilibrium in the foreign exchange market dependson how the Federal Reserve and other central banksoperate. Here, we will study equilibrium when centralbanks keep out of this market. In a later section (onpp. 222–224), we examine the effects of alternativeactions that the Fed or another central bank mighttake in the foreign exchange market.Figure 9.3 shows the demand curve for U.S. dol-lars, D, from Fig. 9.1 and the read more..

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    Exchange Rate Fluctuations217◆ actionGoTo:14,Exchange Rate FluctuationsYou’ve seen (in Economics in Action on p. 213) thatthe U.S. dollar fluctuates a lot against the yen andthe euro. Changes in the demand for U.S. dollars orthe supply of U.S. dollars bring these exchange ratefluctuations. We’ll now look at the factors that make demand and supply change, starting with thedemand side of the market.Changes in the Demand for U.S. DollarsThe demand for U.S. dollars in the foreign read more..

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    218CHAPTER 9 The Exchange Rate and the Balance of PaymentsChanges in the Supply of U.S. DollarsThe supply of U.S. dollars in the foreign exchangemarket changes when there is a change in■U.S. demand for imports■U.S. interest rate relative to the foreign interest rate■The expected future exchange rateU.S. Demand for Imports An increase in the U.S.demand for imports increases the supply of U.S. dol-lars in the foreign exchange market. To see why, thinkabout Wal-Mart’s purchase of DVD read more..

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    Exchange Rate Fluctuations219(a) 2005–2007The Rising and Falling U.S. DollarQ0D07S07Quantity (trillions of U.S. dollars per day)0Exchange rate (yen per U.S. dollar)Exchange rate (yen per U.S. dollar)103123(b) 2007–2008Q0D08D05D07S08S05S07Quantity (trillions of U.S. dollars per day)0123107Exchangerate fallsExchangerate risesEconomics in ActionThe Dollar on a Roller CoasterThe foreign exchange market is a striking example ofa competitive market. The expectations of thousandsof traders around read more..

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    220CHAPTER 9 The Exchange Rate and the Balance of PaymentsFundamentals, Expectations, and ArbitrageChanges in the expected exchange rate change theactual exchange rate. But what makes the expectedexchange rate change? The answer is new informationabout the fundamental influences on the exchangerate—the world demand for U.S. exports, U.S.demand for imports, and the U.S. interest rate rela-tive to the foreign interest rate. Expectations aboutthese variables change the exchange rate throughtheir read more..

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    Exchange Rate Fluctuations221The Real Exchange RateThe real exchange rateis the relative price of U.S.-produced goods and services to foreign-producedgoods and services. It is a measure of the quantity ofthe real GDP of other countries that a unit of U.S.real GDP buys.The real Japanese yen exchange rate, RER, isRER(E P)/P *,where E is the exchange rate (yen per U.S. dollar), P isthe U.S. price level, and P * is the Japanese price level.To understand the real exchange rate, suppose thateach read more..

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    222CHAPTER 9 The Exchange Rate and the Balance of Payments◆ actionGoTo:14,Exchange Rate PolicyBecause the exchange rate is the price of a country’smoney in terms of another country’s money, govern-ments and central banks must have a policy toward theexchange rate. Three possible exchange rate policies are■Flexible exchange rate■Fixed exchange rate■Crawling pegFlexible Exchange RateA flexible exchange rateis an exchange rate that isdetermined by demand and supply in the read more..

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    Exchange Rate Policy223cannot maintain the exchange rate at 100 yen perU.S. dollar indefinitely. To hold the exchange rate at100 yen, the Fed must buy U.S. dollars. When theFed buys U.S. dollars in the foreign exchange market,it uses U.S. official foreign currency reserves. So theFed’s action decreases its foreign currency reserves.Eventually, the Fed would run out of foreign cur-rency and would then have to abandon the targetexchange rate of 100 yen per U.S. dollar.Crawling PegA crawling peg read more..

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    224CHAPTER 9 The Exchange Rate and the Balance of Paymentson average. The peg seeks only to prevent largeswings in the expected future exchange rate thatchange demand and supply and make the exchangerate fluctuate too wildly.A crawling peg departs from the ideal if, as oftenhappens with a fixed exchange rate, the target ratedeparts from the equilibrium exchange rate for toolong. When this happens, the country either runs outof reserves or piles up reserves.In the final part of this chapter, we read more..

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    Financing International Trade225◆ actionGoTo:14,Financing International actionGoTo:14,TradeYou now know how the exchange rate is determined,but what is the effect of the exchange rate? How doescurrency depreciation or currency appreciation influ-ence our international trade and payments? We’regoing to lay the foundation for addressing these ques-tions by looking at the scale of international trading,borrowing, and lending and at the way in which wekeep our records of international read more..

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    226CHAPTER 9 The Exchange Rate and the Balance of PaymentsThe capital and financial account balance plus thecurrent account balance equals the change in U.S. offi-cial reserves. In 2010, the capital and financial accountbalance of $439 billion plus the current account bal-ance of –$436 billion equaled $3 billion. Officialreserves increased in 2010 by $3 billion. Holding moreforeign reserves is like lending to the rest of the world,so this amount appears in the official settlementsaccount in read more..

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    Financing International Trade227To pay for expenditure of $52,000 in excess ofher income, Jackie must either use the money thatshe has in the bank or take out a loan. Suppose thatJackie took out a loan of $50,000 to help buy herhouse and that this loan was the only borrowingthat she did. Borrowing is an inflow in the capitalaccount, so Jackie’s capital account surplus was$50,000. With a current account deficit of $52,000and a capital account surplus of $50,000, Jackie wasstill $2,000 short. read more..

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    228CHAPTER 9 The Exchange Rate and the Balance of PaymentsCurrent Account BalanceWhat determines a country’s current account balanceand net foreign borrowing? You’ve seen that net exports(NX ) is the main item in the current account. Wecan define the current account balance (CAB) asCABNXNet interest income Net transfers.We can study the current account balance by lookingat what determines net exports because the other twoitems are small and do not fluctuate much.Net ExportsNet exports are read more..

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    Financing International Trade229–$1,295 billion and the private sector balance was$759 billion. The government sector balance plus theprivate sector balance equaled net exports of –$536billion.Where Is the Exchange Rate?We haven’t mentioned the exchange rate while dis-cussing the balance of payments. Doesn’t it play arole? The answer is that in the short run it does butin the long run it doesn’t.In the short run, a fall in the dollar lowers the realexchange rate, which makes U.S. read more..

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    230actionGoTo:14,READING BETWEEN THE actionGoTo:14,LINESDollar Faces Increasingly Strong Set of HeadwindsactionURI(http://www.financialtimes.com):http://www.financialtimes.comAugust 5, 2010Only a few weeks ago, the dollar was powering toward its highest levels in four years, thebeneficiary of widespread gloom about Europe’s debt crisis and rising optimism about theU.S. recovery.Since then, investors have soured on the world’s largest economy. The dollar has tumbled 9percent on a read more..

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    231ECONOMIC ANALYSISFigure 1 The falling dollar and rising Indonesian rupiahMonth/yearExchange rate (rupiah per dollar)12,00010,0009,00011,000Mar 09 Jun 09 Sept 09 Dec 09 Mar 10 Jun 108,000Sept 10The dollar hasfallen against theIndonesian rupiah ...Figure 2 U.S. and Indonesian interest ratesFigure 3 Profit from U.S.–Indonesian "carry trade"Month/yearIndonesia bankdeposit rateU.S. primelending rateU.S. commercialbill rateInterest rates(percent per year)12642810Mar 09 Jun 09 Sept 09 read more..

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    232CHAPTER 9 The Exchange Rate and the Balance of Payments■In the long run, the nominal exchange rate is amonetary phenomenon and the real exchange rateis independent of the nominal exchange rate.Working Problems 7 to 15 will give you a better under-standing of exchange rate fluctuations.Exchange Rate Policy (pp. 222–224)■An exchange rate can be flexible, fixed, or a crawl-ing peg.■To achieve a fixed or a crawling exchange rate, acentral bank must intervene in the foreignexchange market read more..

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    Study Plan Problems and Applications233exchange market for Colombian pesos, whathappens toa. The demand for pesos?b. The supply of pesos?c. The quantity of pesos demanded?d. The quantity of pesos supplied?e. The exchange rate of the peso against the U.S.dollar?9. If a euro deposit in a bank in Paris, France, earnsinterest of 4 percent a year and a yen deposit inTokyo, Japan, earns 0.5 percent a year, every-thing else remaining the same and adjusted forrisk, what is the exchange rate expectation read more..

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    234CHAPTER 9 The Exchange Rate and the Balance of Payments13. The price level in the Eurozone is 112.4, theprice level in the United States is 109.1, and thenominal exchange rate was 80 euro cents perU.S. dollar. What is the real exchange rateexpressed as Eurozone real GDP per unit of U.S.real GDP?14. The U.S. price level is 106.3, the Japanese pricelevel is 95.4, and the real exchange rate is 103.6Japanese real GDP per unit of U.S. real GDP.What is the nominal exchange rate?15. Dollar Hits read more..

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    Additional Problems and Applications235The Foreign Exchange Market20. Suppose that yesterday, the U.S. dollar was trad-ing on the foreign exchange market at 0.75 eurosper U.S. dollar and today the U.S. dollar is trad-ing at 0.78 euros per U.S. dollar. Which of thetwo currencies (the U.S. dollar or the euro) hasappreciated and which has depreciated today?21. Suppose that the exchange rate fell from 84 yenper U.S. dollar to 71 yen per U.S. dollar. What isthe effect of this change on the quantity read more..

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    236CHAPTER 9 The Exchange Rate and the Balance of Payments29. Does purchasing power parity hold? If not, doesPPP predict that the Brazilian real will appreciateor depreciate against the U.S. dollar? Explain.30. Does interest rate parity hold? If not, why not?Will the Brazilian real appreciate further ordepreciate against the U.S. dollar if the Fed raisesthe interest rate while the Brazilian interest rateremains at 8.75 percent a year?Exchange Rate PolicyUse the following news clip to work read more..

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    237actionGoTo:14,Expanding the FrontierEconomics is about how we cope with scarcity. We cope as indi-viduals by making choices that balance marginal benefits andmarginal costs so that we use our scarce resources efficiently. Wecope as societies by creating incentive systems and social institu-tions that encourage specialization and exchange.These choices and the incentive systems that guide them deter-mine what we specialize in; how much work we do; how hard we work at school tolearn the mental read more..

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    238countries, and convergence of income levels shouldoccur. Convergence doesn’t occur, so, said its critics,neoclassical theory must be wrong.It turned out that it was this criticism that waswrong. Growth depends on the productivity of yourcookies and on how many cookies you save. If youdon’t save any cookies, you don’t grow, even if yourmarginal product is large.Conditional convergence is the idea that incomeper person will converge only if countries have simi-lar savings rates,similar read more..

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    239These are general principles. Because we knowthese principles we should ask: How come Africa isstill poor? The answer is, it is very hard to translate“Markets are good” and “Property rights work” intopractical actions. We know that Zimbabwe has toguarantee property rights. With the government ithas, that’s not going to work. The U.S. constitutionworks in the United States. If you try to copy theconstitution and impose the system in Zimbabwe, it’snot going to work.You’ve done a read more..

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    240let them trade. Because we have agricultural subsi-dies, trade barriers, and tariffs for their products, theycan’t sell to us.Africans should globalize themselves. They shouldopen, and we should let them open. They shouldintroduce markets. But to get markets, you need legalsystems, police, transparency, less red tape. You need alot of the things we have now. They have corrupteconomies, very bureaucratic, with no property rights,the judiciary is corrupt. All of that has to change.They need read more..

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    actionGoTo:15,PARTactionGoTo:15, FOUR Macroeconomic actionGoTo:15,FluctuationsAfter studying this chapter,you will be able to:Explain what determines aggregate supply in the longrun and in the short runExplain what determines aggregate demandExplain how real GDP and the price level are determinedand how changes in aggregate supply and aggregatedemand bring economic growth, inflation, and thebusiness cycleDescribe the main schools of thought in macroeconomicstodayThe pace at which production read more..

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    242CHAPTER 10 Aggregate Supply and Aggregate Demand■Long-run aggregate supply■Short-run aggregate supplyLong-Run Aggregate SupplyLong-run aggregate supplyis the relationship betweenthe quantity of real GDP supplied and the price levelwhen the money wage rate changes in step with theprice level to maintain full employment. The quan-tity of real GDP supplied at full employment equalspotential GDP and this quantity is the same regard-less of the price level.The long-run aggregate supply curve read more..

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    Aggregate Supply243Short-Run Aggregate SupplyShort-run aggregate supplyis the relationship betweenthe quantity of real GDP supplied and the price levelwhen the money wage rate, the prices of other resources,and potential GDP remain constant. Figure 10.1 illus-trates this relationship as the short-run aggregate sup-ply curve SAS and the short-run aggregate supplyschedule. Each point on the SAS curve correspondsto a row of the short-run aggregate supply schedule.For example, point A on the SAS read more..

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    244CHAPTER 10 Aggregate Supply and Aggregate DemandAn Increase in the Quantity of CapitalA Pepsi bottlingplant with two production lines bottles more Pepsi thandoes an otherwise identical plant that has only one pro-duction line. For the economy, the larger the quantity ofcapital, the more productive is the labor force and thegreater is its potential GDP. Potential GDP per personin the capital-rich United States is vastly greater thanthat in capital-poor China or Russia.Capital includes human read more..

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    Aggregate Supply245An Advance in TechnologyA Pepsi plant that has pre-computer age machines produces less than one thatuses the latest robot technology. Technologicalchange enables firms to produce more from any givenamount of factors of production. So even with fixedquantities of labor and capital, improvements in tech-nology increase potential GDP.Technological advances are by far the most impor-tant source of increased production over the past twocenturies. As a result of technological read more..

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    246CHAPTER 10 Aggregate Supply and Aggregate Demandwealth is the amount of money in the bank, bonds,stocks, and other assets that people own, measurednot in dollars but in terms of the goods and servicesthat the money, bonds, and stocks will buy.012.0Real GDP (trillions of 2005 dollars)Price level (GDP deflator, 2005 = 100)9010011012013014012.513.013.514.014.5A'B'C'D'E'ADDecrease in quantity ofreal GDPdemandedIncrease in quantity ofreal GDPdemandedPrice levelReal GDP demanded(GDP read more..

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    Aggregate Demand247People save and hold money, bonds, and stocks formany reasons. One reason is to build up funds foreducation expenses. Another reason is to build upenough funds to meet possible medical expenses orother big bills. But the biggest reason is to build upenough funds to provide a retirement income.If the price level rises, real wealth decreases. Peoplethen try to restore their wealth. To do so, they mustincrease saving and, equivalently, decrease currentconsumption. Such a decrease read more..

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    248CHAPTER 10 Aggregate Supply and Aggregate DemandAn increase in the expected future inflation rateincreases aggregate demand today because peopledecide to buy more goods and services at today’s rela-tively lower prices.An increase in expected future profits increases theinvestment that firms plan to undertake today andincreases aggregate demand.Fiscal Policy and Monetary Policy The government’sattempt to influence the economy by setting andchanging taxes, making transfer payments, and read more..

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    Aggregate Demand249so people around the world buy the cheaper phonefrom Finland. Now suppose the exchange rate falls to1 euro per U.S. dollar. The Nokia phone now costs$120 and is more expensive than the Motorolaphone. People will switch from the Nokia phone tothe Motorola phone. U.S. exports will increase andU.S. imports will decrease, so U.S. aggregate demandwill increase.An increase in foreign income increases U.S.exports and increases U.S. aggregate demand. Forexample, an increase in income read more..

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    250CHAPTER 10 Aggregate Supply and Aggregate DemandactionGoTo:15,◆ Explaining MacroeconomicactionGoTo:15,Trends and FluctuationsThe purpose of the AS-AD model is to explainchanges in real GDP and the price level. The model’smain purpose is to explain business cycle fluctuationsin these variables. But the model also aids our under-standing of economic growth and inflation trends.We begin by combining aggregate supply and aggre-gate demand to determine real GDP and the pricelevel in read more..

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    Explaining Macroeconomic Trends and Fluctuations251With an excess demand for labor, the money wagerate rises.Figure 10.7 shows the long-run equilibrium andhow it comes about. If short-run aggregate supplycurve is SAS1, the money wage rate is too high toachieve full employment. A fall in the money wage rateshifts the SAS curve to SAS* and brings full employ-ment. If short-run aggregate supply curve is SAS2, themoney wage rate is too low to achieve full employ-ment. Now, a rise in the money wage read more..

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    252CHAPTER 10 Aggregate Supply and Aggregate DemandThe Business Cycle in the AS-AD ModelThe business cycle occurs because aggregate demandand short-run aggregate supply fluctuate but themoney wage rate does not adjust quickly enough tokeep real GDP at potential GDP. Figure 10.9 showsthree types of short-run equilibrium.Figure 10.9(a) shows an above full-employmentequilibrium. An above full-employment equilibriumisan equilibrium in which real GDP exceeds potentialGDP. The gap between real GDP and read more..

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    Explaining Macroeconomic Trends and Fluctuations253Figure 10.9(b) is an example of full-employmentequilibrium,in which real GDP equals potential GDP.In this example, the equilibrium occurs where theaggregate demand curve AD1 intersects the short-runaggregate supply curve SAS1 at an actual and poten-tial GDP of $13 trillion.In part (c), there is a below full-employment equi-librium. A below full-employment equilibrium is anequilibrium in which potential GDP exceeds realGDP. When potential GDP read more..

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    254CHAPTER 10 Aggregate Supply and Aggregate DemandFluctuations in Aggregate DemandOne reason real GDP fluctuates around potentialGDP is that aggregate demand fluctuates. Let’s seewhat happens when aggregate demand increases.Figure 10.10(a) shows an economy at fullemployment. The aggregate demand curve is AD0,the short-run aggregate supply curve is SAS0, andthe long-run aggregate supply curve is LAS. RealGDP equals potential GDP at $13 trillion, and theprice level is 110.Now suppose that the read more..

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    Explaining Macroeconomic Trends and Fluctuations255SAS0 toward SAS1. The rise in the money wage rateand the shift in the SAS curve produce a sequence ofnew equilibrium positions. Along the adjustmentpath, real GDP decreases and the price level rises. Theeconomy moves up along its aggregate demand curveas shown by the arrows in the figure.Eventually, the money wage rate rises by the samepercentage as the price level. At this time, the aggre-gate demand curve AD1 intersects SAS1 at a new read more..

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    256CHAPTER 10 Aggregate Supply and Aggregate DemandactionGoTo:15,◆ Macroeconomic actionGoTo:15,SchoolsactionGoTo:15,of ThoughtMacroeconomics is an active field of research, andmuch remains to be learned about the forces thatmake our economy grow and fluctuate. There is agreater degree of consensus and certainty about eco-nomic growth and inflation—the longer-term trendsin real GDP and the price level—than there is aboutthe business cycle—the short-term fluctuations inthese variables. read more..

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    Macroeconomic Schools of Thought257Aggregate Supply Response In the Keynesian view,the money wage rate that lies behind the short-runaggregate supply curve is extremely sticky in thedownward direction. Basically, the money wage ratedoesn’t fall. So if there is a recessionary gap, there isno automatic mechanism for getting rid of it. If itwere to happen, a fall in the money wage rate wouldincrease short-run aggregate supply and restore fullemployment. But the money wage rate doesn’t fall, read more..

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    258actionGoTo:15,READING BETWEEN THE actionGoTo:15,LINESGDP Figures Revised DownwardAssociated PressAugust 27, 2010The economy grew at a much slower pace this spring than previously estimated, mostlybecause of the largest surge in imports in 26 years and a slower buildup in inventories.The nation’s gross domestic product—the broadest measure of the economy’s output—grewat a 1.6 percent annual rate in the April-to-June period, the Commerce Department said Fri-day. That’s down from an read more..

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    259ECONOMIC ANALYSISFigure 2AS-AD in second quarter of 2010 Price level (GDP deflator, 2005 = 100)Real GDP (trillions of 2005 dollars)100LAS09LAS10AD09AD10SAS09SAS10Outputgap 2010AD and SAS increaseby more than LAS butoutput gap remains12.8 13.213.9 14.11101200Figure 1AS-AD in second quarter of 2009Price level (GDP deflator, 2005 = 100)Real GDP (trillions of 2005 dollars)100LAS09AD09SAS09Outputgap 200912.813.91101200■U.S. real GDP grew at a 1.6 percent annual rateduring the second quarter of read more..

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    260CHAPTER 10 Aggregate Supply and Aggregate DemandExplaining Macroeconomic Trends and Fluctuations(pp. 250–255)■Aggregate demand and short-run aggregate supplydetermine real GDP and the price level.■In the long run, real GDP equals potential GDPand aggregate demand determines the price level.■The business cycle occurs because aggregatedemand and aggregate supply fluctuate.Working Problems 8 to 16 will give you a better under-standing of macroeconomic trends and read more..

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    Study Plan Problems and Applications2616. Mexico trades with the United States. Explainthe effect of each of the following events on thequantity of real GDP demanded and aggregatedemand in Mexico.■The United States goes into a recession.■The price level in Mexico rises.■Mexico increases the quantity of money.7. Durable Goods Orders Surge in May, New-Homes Sales DipThe Commerce Department announced thatdemand for durable goods rose 1.8 percent,while new-home sales dropped 0.6 percent inMay. read more..

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    262CHAPTER 10 Aggregate Supply and Aggregate Demandequilibrium after aggregate supply changed? Ifpotential GDP is $1 trillion, does the economyhave an inflationary gap, a recessionary gap, orno output gap?10. Some events change aggregate demand from AD0to AD1 and aggregate supply from SAS0 to SAS1.What is the new macroeconomic equilibrium?Use the following data to work Problems 11 to 13.The following events have occurred in the history ofthe United States:■A deep recession hits the world read more..

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    Additional Problems and Applications263Aggregate Supply 20. Explain for each event whether it changes thequantity of real GDP supplied, short-run aggre-gate supply, long-run aggregate supply, or a com-bination of them.■Automotive firms in the United States switchto a new technology that raises productivity.■Toyota and Honda build additional plants inthe United States.■The prices of auto parts imported from Chinarise.■Autoworkers agree to a cut in the nominalwage rate. ■The U.S. price read more..

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    264CHAPTER 10 Aggregate Supply and Aggregate DemandUse the following information to work Problems 29and 30.Spending by Women JumpsThe magazine Women of China reported thatChinese women in big cities spent 63% of theirincome on consumer goods last year, up from a mea-ger 26% in 2007. Clothing accounted for the biggestchunk of that spending, at nearly 30%, followed bydigital products such as cellphones and cameras(11%) and travel (10%). Chinese consumption as awhole grew faster than the overall read more..

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    After studying this chapter, you will be able to:Explain how expenditure plans are determined whenthe price level is fixedExplain how real GDP is determined when the pricelevel is fixedExplain the expenditure multiplier when the price level is fixedExplain the relationship between aggregate expenditureand aggregate demand and explain the multiplier whenthe price level changesAlicia Keys sings into a microphone in a barely audible whisper and throughthe magic of electronic amplification, her read more..

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    266CHAPTER 11 Expenditure Multipliers: The Keynesian Model◆ actionGoTo:15,Fixed Prices andactionGoTo:15,Expenditure PlansIn the Keynesian model that we study in this chapter,all the firms are like your grocery store: They set theirprices and sell the quantities their customers are will-ing to buy. If they persistently sell a greater quantitythan they plan to and are constantly running out ofinventory, they eventually raise their prices. And ifthey persistently sell a smaller quantity than they read more..

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    Fixed Prices and Expenditure Plans267PlannedDisposableconsumptionPlannedincomeexpendituresaving(trillions of 2005 dollars)A01.5–1.5B23.0–1.0C44.5–0.5D66.00E87.50.5F109.01.045° Line Figure 11.1(a) also contains a 45° line,the height of which measures disposable income. Ateach point on this line, consumption expenditureequals disposable income. Between A and D, con-sumption expenditure exceeds disposable income,between D and F consumption expenditure is lessthan disposable income, and at read more..

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    268CHAPTER 11 Expenditure Multipliers: The Keynesian ModelMarginal Propensities toConsume and SaveThe marginal propensity to consume(MPC ) is the frac-tion of a change in disposable income that is spent onconsumption. It is calculated as the change in con-sumption expenditure (ΔC) divided by the change indisposable income (ΔYD). The formula isIn the table in Fig. 11.1, when disposable incomeincreases by $2 trillion, consumption expenditureincreases by $1.5 trillion. The MPC is $1.5 read more..

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    Fixed Prices and Expenditure Plans269Economics in ActionThe U.S. Consumption FunctionThe figure shows the U.S. consumption function.Each point identified by a blue dot represents con-sumption expenditure and disposable income for aparticular year. (The dots are for the years 1970 to2010, and the dots for five of those years are identifiedin the figure.)The U.S. consumption function is CF0 in 1970and CF1 in 2010.The slope of the consumption function in the fig-ure is 0.9, which means that a $1 read more..

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    270CHAPTER 11 Expenditure Multipliers: The Keynesian Model◆ actionGoTo:15,Real GDP with a Fixed Price actionGoTo:15,LevelYou are now going to see how, at a given price level,aggregate expenditure plans determine real GDP. Westart by looking at the relationship between aggregateplanned expenditure and real GDP. This relationshipcan be described by an aggregate expenditure sched-ule or an aggregate expenditure curve. The aggregateexpenditure schedule lists aggregate planned expendi-ture read more..

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    Real GDP with a Fixed Price Level271Actual Expenditure, Planned Expenditure,and Real GDPActual aggregate expenditure is always equal to realGDP, as we saw in Chapter 4 (p. 86). But aggregateplanned expenditure is not always equal to actualaggregate expenditure and therefore is not alwaysequal to real GDP. How can actual expenditure andplanned expenditure differ? The answer is that firmscan end up with inventories that are greater or smallerthan planned. People carry out their read more..

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    272CHAPTER 11 Expenditure Multipliers: The Keynesian ModelEquilibrium ExpenditureEquilibrium expenditure is the level of aggregate expendi-ture that occurs when aggregate planned expenditureequals real GDP. Equilibrium expenditure is a level ofaggregate expenditure and real GDP at which spend-ing plans are fulfilled. At a given price level, equilib-rium expenditure determines real GDP. Whenaggregate planned expenditure and actual aggregateexpenditure are unequal, a process of convergencetoward read more..

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    Real GDP with a Fixed Price Level273points A through F along the AE curve. The 45° lineshows all the points at which aggregate plannedexpenditure equals real GDP. So where the AE curvelies above the 45° line, aggregate planned expenditureexceeds real GDP; where the AE curve lies below the45° line, aggregate planned expenditure is less thanreal GDP; and where the AE curve intersects the 45°line, aggregate planned expenditure equals real GDP.Point D illustrates equilibrium expenditure. At read more..

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    274CHAPTER 11 Expenditure Multipliers: The Keynesian Model◆ actionGoTo:15,The MultiplierInvestment and exports can change for many reasons.A fall in the real interest rate might induce firms toincrease their planned investment. A wave of innova-tion, such as occurred with the spread of multimediacomputers in the 1990s, might increase expectedfuture profits and lead firms to increase their plannedinvestment. An economic boom in Western Europeand Japan might lead to a large increase in read more..

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    The Multiplier275$0.5 trillion to AE0. Equilibrium expenditure decreasesfrom $15 trillion to $13 trillion. The decrease in equi-librium expenditure ($2 trillion) is larger than thedecrease in autonomous expenditure that brought itabout ($0.5 trillion).Why Is the Multiplier Greater Than 1?We’ve seen that equilibrium expenditure increases bymore than the increase in autonomous expenditure.This makes the multiplier greater than 1. How come?Why does equilibrium expenditure increase by morethan the read more..

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    276CHAPTER 11 Expenditure Multipliers: The Keynesian ModelThe Multiplier and the Slope of the AECurveThe magnitude of the multiplier depends on theslope of the AE curve. In Fig. 11.6, the AE curve inpart (a) is steeper than the AE curve in part (b), andthe multiplier is larger in part (a) than in part (b). Tosee why, let’s do a calculation.Aggregate expenditure and real GDP changebecause induced expenditure and autonomous expen-diture change. The change in real GDP (ΔY ) equalsthe change in read more..

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    The Multiplier277Imports and Income TaxesImports and income taxes influence the size of themultiplier and make it smaller than it otherwisewould be.To see why imports make the multiplier smaller,think about what happens following an increase ininvestment. The increase in investment increases realGDP, which in turn increases consumption expendi-ture. But part of the increase in expenditure is onimported goods and services. Only expenditure onU.S.-produced goods and services increases U.S. read more..

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    278CHAPTER 11 Expenditure Multipliers: The Keynesian ModelBusiness Cycle Turning PointsAt business cycle turning points, the economy movesfrom expansion to recession or from recession toexpansion. Economists understand these turningpoints as seismologists understand earthquakes. Theyknow quite a lot about the forces and mechanismsthat produce them, but they can’t predict them. Theforces that bring business cycle turning points are theswings in autonomous expenditure, such as invest-ment and read more..

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    The Multiplier and the Price Level279◆ actionGoTo:15,The Multiplier and the Price actionGoTo:15,LevelWe have just considered adjustments in spendingthat occur in the very short run when the pricelevel is fixed. In this time frame, the economy’scobblestones, which are changes in investment andexports, are not smoothed by shock absorbers likethose on Michael Bloomberg’s car. Instead, they areamplified like Alicia Keys’ voice. But these out-comes occur only when the price level is fixed. read more..

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    280CHAPTER 11 Expenditure Multipliers: The Keynesian Modelexpenditure decreases to $12 trillion. If the pricelevel decreases to 90, the aggregate expenditurecurve shifts upward to AE2, which intersects the 45°line at point C. Equilibrium expenditure increasesto $14 trillion.We’ve just seen that when the price level changes,other things remaining the same, the aggregateexpenditure curve shifts and the equilibrium expendi-ture changes. But when the price level changes, otherthings remaining the read more..

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    The Multiplier and the Price Level281a new aggregate demand curve. The aggregatedemand curve has shifted rightward to AD1.But how do we know by how much the AD curveshifts? The multiplier determines the answer. Thelarger the multiplier, the larger is the shift in theaggregate demand curve that results from a givenchange in autonomous expenditure. In this example,the multiplier is 2. A $1 trillion increase in invest-ment produces a $2 trillion increase in the aggregatequantity of goods and read more..

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    282CHAPTER 11 Expenditure Multipliers: The Keynesian ModelAn Increase in Aggregate Demand in the Short RunFigure 11.10 describes the economy. Initially, in part(a), the aggregate expenditure curve is AE0 and equi-librium expenditure is $13 trillion—point A. In part(b), aggregate demand is AD0 and the short-runaggregate supply curve is SAS. (Chapter 10,pp. 243–245, explains the SAS curve.) Equilibriumis at point A in part (b), where the aggregate demandand short-run aggregate supply curves read more..

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    The Multiplier and the Price Level283◆You are now ready to build on what you’velearned about aggregate expenditure fluctuations.We’ll study the business cycle and the roles of fiscalpolicy and monetary policy in smoothing the cyclewhile achieving price stability and sustained eco-nomic growth. In Chapter 12 we study the U.S.business cycle and inflation, and in Chapters 13 and14 we study fiscal policy and monetary policy,respectively. But before you leave the current topic,look at Reading read more..

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    284actionGoTo:15,READING BETWEEN THE actionGoTo:15,LINESBusiness Inventories Post Biggest Gain in 2 YearsactionURI(http://www.seattletimes.com):http://www.seattletimes.comSeptember 14, 2010Inventories held by businesses jumped in July by the largest amount in two years while salesrebounded after two months of declines.Business inventories rose 1 percent in July, the biggest monthly gain since a similar increasein July 2008, the Commerce Department reported Tuesday. Inventories have grown for read more..

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    285ECONOMIC ANALYSIS(b) Unplanned inventory change in 2010Figure 2 Equilibrium expenditure in 2010Unplanned inventory change(trillions of 2005 dollars)Real GDP(trillions of 2005 dollars)–0.2–0.400.20.413.2 13.413.613.012.6(a) Convergence to equilibrium expenditure in 2010Aggregate expenditure (trillions of 2005 dollars)Real GDP (trillions of 2005 dollars)0Unplanneddecrease ininventoriesUnplannedinventoryinvestment45º lineAE0AE112.612.813.013.413.613.213.213.413.613.012.612.8Figure 1 Real read more..

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    286CHAPTER 11 Expenditure Multipliers: The Keynesian ModelactionGoTo:15,MATHEMATICAL NOTEactionGoTo:15,The Algebra of the KeynesianactionGoTo:15,ModelThis mathematical note derives formulas for equilib-rium expenditure and the multipliers when the pricelevel is fixed. The variables are■Aggregate planned expenditure, AE■Real GDP, Y■Consumption expenditure, C■Disposable income, YD■Investment, I■Government expenditure, G■Exports, X■Imports, M■Net taxes, T■Autonomous consumption read more..

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    Mathematical Note287Equilibrium ExpenditureEquilibrium expenditure occurs when aggregate plannedexpenditure (AE ) equals real GDP (Y ). That is,AEY.In Fig. 2, the scales of the x-axis (real GDP) and they-axis (aggregate planned expenditure) are identical,so the 45° line shows the points at which aggregateplanned expenditure equals real GDP.Figure 2 shows the point of equilibrium expendi-ture at the intersection of the AE curve and the 45°line.To calculate equilibrium expenditure, solve read more..

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    288CHAPTER 11 Expenditure Multipliers: The Keynesian ModelGovernment Expenditure MultiplierThe government expenditure multiplierequals thechange in equilibrium expenditure and real GDP (Y )that results from a change in government expenditure(G ) divided by the change in government expendi-ture. Because autonomous expenditure is equal toAabTaIGX,the change in autonomous expenditure equals thechange in government expenditure. That is,ΔA ΔG.You can see from the solution for equilibriumexpenditure read more..

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    Mathematical Note289Balanced Budget MultiplierThe balanced budget multiplierequals the change inequilibrium expenditure and real GDP (Y ) thatresults from equal changes in government expenditureand lump-sum taxes divided by the change in govern-ment expenditure. Because government expenditureand autono-mous taxes change by the same amount,the budget balance does not change.The change in equilibrium expenditure that resultsfrom the change in government expenditure isAnd the change in equilibrium read more..

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    290CHAPTER 11 Expenditure Multipliers: The Keynesian Model■The multiplier is determined by the slope of theAE curve.■The slope of the AE curve is influenced by themarginal propensity to consume, the marginalpropensity to import, and the income tax rate.Working Problems 8 to 11 will give you a better under-standing of the multiplier.The Multiplier and the Price Level (pp. 279–283)■The AD curve is the relationship between thequantity of real GDP demanded and the pricelevel, other things read more..

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    Study Plan Problems and Applications291c. If real GDP is $6 billion, what is happeningto inventories?6. Explain the difference between induced con-sumption expenditure and autonomous con-sumption expenditure. Why isn’t all consump-tion expenditure induced expenditure?7. Recovery?In the second quarter, businesses increasedspending on equipment and software by 21.9%,while a category that includes home buildinggrew amid a rush by consumers to take advan-tage of tax credits for homes.Source: The read more..

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    292CHAPTER 11 Expenditure Multipliers: The Keynesian Modelof $2 trillion increases equilibrium expenditure by $8 trillion. 10. Calculate the multiplier and the marginalpropensity to consume.11. What happens to the multiplier if an income taxis introduced?The Multiplier and the Price Level (Study Plan 11.4)Use the following data to work Problems 12 to 16.Suppose that the economy is at full employment, theprice level is 100, and the multiplier is 2. Investmentincreases by $100 billion.12. What is read more..

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    Additional Problems and Applications293Fixed Prices and Expenditure PlansUse the following data to work Problems 23 and 24.You are given the following information about theeconomy of Australia.Disposable incomeSaving (billions of dollars per year)0–51002020045300704009523. Calculate the marginal propensity to save.24. Calculate consumption at each level of disposableincome. Calculate the marginal propensity toconsume.Use the following news clip to work Problems 25 to 27.Americans $1.7 trillion read more..

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    294CHAPTER 11 Expenditure Multipliers: The Keynesian ModelThe Multiplier 31. Obama’s New StimulusThe Obama recovery plan announced onMonday includes proposed spending of $50 bil-lion to rebuild 150,000 miles of roads, constructand maintain 4,000 miles of rail, and fix orrebuild 150 miles of runways.Source: USA Today, September 10, 2010If the slope of the AE curve is 0.7, calculate theimmediate change in aggregate planned expendi-ture and the change in real GDP in the short runif the price read more..

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    After studying this chapter, you will be able to:Explain how demand-pull and cost-push forces bringcycles in inflation and outputExplain the short-run and long-run tradeoff betweeninflation and unemploymentExplain how the mainstream business cycle theory andreal business cycle theory account for fluctuations inoutput and employmentBack in the 1970s, when inflation was raging at a double-digit rate, economistArthur M. Okun proposed what he called the “misery index.” Misery, he sug-gested, read more..

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    296CHAPTER 12 U.S. Inflation, Unemployment, and Business Cycle◆ actionGoTo:16,Inflation CyclesIn the long run, inflation is a monetary phenome-non. It occurs if the quantity of money grows fasterthan potential GDP. But in the short run, many fac-tors can start an inflation, and real GDP and theprice level interact. To study these interactions, wedistinguish between two sources of inflation:■Demand-pull inflation■Cost-push inflationDemand-Pull InflationAn inflation that starts because read more..

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    Inflation Cycles297Money Wage Rate Response Real GDP cannotremain above potential GDP forever. With unem-ployment below its natural rate, there is a shortage oflabor. In this situation, the money wage rate begins torise. As it does so, short-run aggregate supplydecreases and the SAS curve starts to shift leftward.The price level rises further, and real GDP begins todecrease.With no further change in aggregate demand—that is, the aggregate demand curve remains atAD1—this process ends when the read more..

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    298CHAPTER 12 U.S. Inflation, Unemployment, and Business Cycleare good for workers in Kalamazoo, and the soda fac-tory finds it hard to hang on to its best people. To doso, it offers a higher money wage rate. As the wagerate rises, so do the soda factory’s costs.What happens next depends on aggregatedemand. If aggregate demand remains constant, thefirm’s costs increase but the price of soda does notincrease as quickly as its costs. In this case, the firmcuts production. Eventually, the money read more..

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    Inflation Cycles299Aggregate Demand Response When real GDPdecreases, unemployment rises above its natural rate.In such a situation, there is often an outcry of con-cern and a call for action to restore full employment.Suppose that the Fed cuts the interest rate andincreases the quantity of money. Aggregate demandincreases. In Fig. 12.3(b), the aggregate demandcurve shifts rightward to AD1 and full employment isrestored. But the price level rises further to 121.A Cost-Push Inflation Process The read more..

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    300CHAPTER 12 U.S. Inflation, Unemployment, and Business CycleCost-Push Inflation in Kalamazoo What is going onin the Kalamazoo soda-bottling plant when the econ-omy is experiencing cost-push inflation?When the oil price increases, so do the costs ofbottling soda. These higher costs decrease the supplyof soda, increasing its price and decreasing the quan-tity produced. The soda plant lays off some workers.This situation persists until either the Fedincreases aggregate demand or the price of oil read more..

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    Inflation Cycles301This broader account of the inflation process andits short-run effects show why the quantity theory ofmoney doesn’t explain the fluctuations in inflation.The economy follows the course described in Fig.12.5, but as predicted by the quantity theory, only ifaggregate demand growth is forecasted correctly.Forecasting InflationTo anticipate inflation, people must forecast it. Someeconomists who work for macroeconomic forecastingagencies, banks, insurance companies, labor read more..

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    302CHAPTER 12 U.S. Inflation, Unemployment, and Business Cycle◆ actionGoTo:16,Inflation and Unemployment: actionGoTo:16,The Phillips CuractionGoTo:16,veAnother way of studying inflation cycles focuses onthe relationship and the short-run tradeoff betweeninflation and unemployment, a relationship calledthe Phillips curve—so named because it was first sug-gested by New Zealand economist A.W. Phillips.Why do we need another way of studying infla-tion? What is wrong with the AS-AD explanation read more..

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    Inflation and Unemployment: The Phillips Curve303The Long-Run Phillips CurveThe long-run Phillips curveshows the relationshipbetween inflation and unemployment when theactual inflation rate equals the expected inflation rate.The long-run Phillips curve is vertical at the naturalunemployment rate. In Fig. 12.7, it is the vertical lineLRPC.The long-run Phillips curve tells us that anyexpected inflation rate is possible at the naturalunemployment rate. This proposition is consistentwith the AS-AD read more..

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    304CHAPTER 12 U.S. Inflation, Unemployment, and Business CycleIf the natural unemployment rate increases from 6percent to 9 percent, the long-run Phillips curveshifts from LRPC0 to LRPC1, and if expected infla-tion is constant at 10 percent a year, the short-runPhillips curve shifts from SRPC0 to SRPC1. Becausethe expected inflation rate is constant, the short-runPhillips curve SRPC1 intersects the long-run curveLRPC1 (point E ) at the same inflation rate at whichthe short-run Phillips curve read more..

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    The Business Cycle305◆ actionGoTo:16,The Business CycleThe business cycle is easy to describe but hard toexplain and business cycle theory remains unsettledand a source of controversy. We’ll look at twoapproaches to understanding the business cycle:■Mainstream business cycle theory■Real business cycle theoryMainstream Business Cycle TheoryThe mainstream business cycle theory is that poten-tial GDP grows at a steady rate while aggregatedemand grows at a fluctuating rate. Because themoney read more..

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    306CHAPTER 12 U.S. Inflation, Unemployment, and Business CycleThis mainstream theory comes in a number ofspecial forms that differ regarding the source of fluc-tuations in aggregate demand growth and the sourceof money wage stickiness.Keynesian Cycle Theory In Keynesian cycle theory,fluctuations in investment driven by fluctuations inbusiness confidence—summarized by the phrase“animal spirits”—are the main source of fluctuationsin aggregate demand.Monetarist Cycle Theory In monetarist read more..

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    The Business Cycle307The RBC Mechanism Two effects follow from achange in productivity that sparks an expansion or acontraction:1. Investment demand changes.2. The demand for labor changes.We’ll study these effects and their consequencesduring a recession. In an expansion, they work in thedirection opposite to what is described here.Technological change makes some existing capitalobsolete and temporarily decreases productivity.Firms expect the future profits to fall and see theirlabor read more..

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    308CHAPTER 12 U.S. Inflation, Unemployment, and Business Cyclefrom working in the current period with the expectedreturn from working in a later period. You make sucha comparison every day in school. Suppose your goalin this course is to get an A. To achieve this goal, youwork hard most of the time. But during the few daysbefore the midterm and final exams, you work espe-cially hard. Why? Because you believe that the returnfrom studying close to the exam is greater than thereturn from studying read more..

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    The Business Cycle309You saw in Fig. 12.11(a) that the decrease in thedemand for loanable funds lowers the real interest rate.This fall in the real interest rate lowers the return tocurrent work and decreases the supply of labor.In Fig. 12.11(b), the labor supply curve shiftsleftward to LS1. The effect of the decrease in pro-ductivity on the demand for labor is larger than theeffect of the fall in the real interest rate on the sup-ply of labor. That is, the demand curve shifts fartherleftward read more..

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    310actionGoTo:16,READING BETWEEN THE actionGoTo:16,LINESEvidence and Denial; Obama Advisers Refuse to BelieveThey’re FailingThe Washington TimesAugust 4, 2010... President Obama likes to say that he inherited the “worst” economy since the Great De-pression, but the fact is that the economic “Misery Index” (inflation plus unemployment) ...was twice as high when President Reagan took office [in 1981]. (By the time PresidentReagan left the presidency, the Misery Index had dropped to less read more..

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    311ECONOMIC ANALYSISFigure 2 The inflation–unemployment pathsCPI inflation rate (percent per year)Unemployment rate (percentage of labor force)3BarackObamaABCDEJimmyCarterRonaldReaganBarackObamaJimmyCarterRonaldReagan50–3678910111296Figure 1 The U.S. misery indexYearMisery index(inflation plus unemployment)02515510201950196019701980199020102000■When President Obama assumed office in January2009, the CPI inflation rate was zero and the unem-ployment rate was 7.7 percent, so the misery read more..

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    312CHAPTER 12 U.S. Inflation, Unemployment, and Business Cycle■The long-run Phillips curve, which is vertical,shows that when the actual inflation rate equalsthe expected inflation rate, the unemployment rateequals the natural unemployment rate.Working Problems 12 to 14 will give you a better under-standing of inflation and unemployment: the Phillips curve.The Business Cycle (pp. 305–309)■The mainstream business cycle theory explains thebusiness cycle as fluctuations of real GDP read more..

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    Study Plan Problems and Applications313b. Describe the initial effects of a cost-pushinflation.c. Describe what happens as a cost-pushinflation spiral proceeds.4. Some events occur and the economy is expectedto experience inflation.a. List the events that might cause an expectedinflation.b. Describe the initial effects of an expectedinflation.c. Describe what happens as an expected infla-tion proceeds.5. Suppose that people expect deflation (a fallingprice level), but aggregate demand remains at read more..

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    314CHAPTER 12 U.S. Inflation, Unemployment, and Business CycleUse the following news clip to work Problems 9 to 11.Tight Money Won’t Slay Food, Energy InflationIt’s important to differentiate between a general in-crease in prices—a situation in which aggregate de-mand exceeds their aggregate supply—and a relativeprice shock. For example, a specific shock to energyprices can become generalized if producers are able topass on the higher costs. So far, global competitionhas made that read more..

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    Additional Problems and Applications315Inflation CyclesUse the following news clip to work Problems 16 and 17.Bernanke Sees No Repeat of ’70s-Style InflationThere is little indication today of the beginnings of a1970s-style wage-price spiral. Then, as now, a seriousoil price shock occurred, but today’s economy is moreflexible in responding to difficulties and the countryis more energy efficient than a generation ago,Bernanke said. Also, today the Fed monitors “infla-tion expectations.” read more..

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    316CHAPTER 12 U.S. Inflation, Unemployment, and Business Cycle“entrenched” an economy will experience “a per-sistent output gap.”Use the following information to work Problems 24and 25.Because the Fed doubled the monetary base in 2008and the government spent billions of dollars bailingout troubled banks, insurance companies, and autoproducers, some people are concerned that a seriousupturn in the inflation rate will occur, not immedi-ately but in a few years’ time. At the same time, read more..

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    John Maynard Keynes, born in England in 1883, wasone of the outstanding minds of the twentieth century.He represented Britain at the Versailles peace conferenceat the end of World War I, was a master speculator oninternational financial markets (an activity he conduct-ed from bed every morning and which made and losthim several fortunes), and played a prominent role increating the International Monetary Fund.He was a member of the Bloomsbury Group, a circleof outstanding artists and writers that read more..

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    318well diversified, and they experience capital outflowsthat exacerbate the impact of recessionary shocks. Theirdomestic financial sectors are small and often becomestrained during recessions, making it difficult to reallo-cate scarce resources toward those who need them themost. To make matters worse, the government’s abilityto use fiscal policy becomes impaired by the capital out-flows, and monetary policy is also out of the questionwhen the currencyis in free fall andliabilities are read more..

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    319I do not think the distinction between bubblesand fundamentals is as clear-cut as people describe.Probably outside periods of liquidity crises, all assetshave some bubble component in them. The questionis how much.You’ve studied situations in which capital suddenlystops flowing into an economy from abroad. What arethe lessons you’ve learned from this research?The most basic lesson for emerging markets is thatcapital flows are volatile. Sometimes they simplymagnify domestic problems, but read more..

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    320You’ve suggested that an insatiable appetite for safe se-curities is the root cause of the global financial crisisand that governments must accept a larger responsi-bility for bearing risk arising from the financial sys-tem. Would you explain this idea?Foreign central banks and investors and U.S. finan-cial institutions have an insatiable demand for safesecurities, which puts enormous pressure on the U.S.financial system. The global financial crisis was theresult of an interaction between read more..

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    actionGoTo:16,PARTactionGoTo:16, FIVE Macroeconomic actionGoTo:16,PolicyAfter studying this chapter, you will be able to:Describe the federal budget process and the recenthistory of outlays, tax revenues, deficits, and debtExplain the supply-side effects of fiscal policyExplain how fiscal policy choices redistribute benefitsand costs across generationsExplain how fiscal stimulus is used to fight a recessionactionGoTo:16,13In 2010, the federal government spent 28 cents of every dollar that read more..

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    322CHAPTER 13 Fiscal Policy◆ actionGoTo:16,The Federal BudgetThe federal budget is an annual statement of the out-lays and receipts of the government of the UnitedStates together with the laws and regulations thatapprove and support them. The federal budget hastwo purposes:1. To finance federal government programs andactivities, and2. To achieve macroeconomic objectivesThe first purpose of the federal budget was itsonly purpose before the Great Depression of the1930s. The second purpose arose read more..

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    The Federal Budget323This act recognized a role for government actions tokeep unemployment low, the economy expanding, andinflation in check. The Full Employment and BalancedGrowth Act of 1978, more commonly known as theHumphrey-Hawkins Act, went farther than theEmployment Act of 1946 and set a specific target of 4percent for the unemployment rate. But this target hasnever been treated as an unwavering policy goal. Underthe 1946 act, the president must describe the currenteconomic situation and read more..

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    324CHAPTER 13 Fiscal Policy051015202520152010199019952000200519801985YearReceipts and outlays (percentage of GDP)30ReceiptsOutlaysBudget deficitBudget surplusgovernment expenditures and are a major source ofconcern and political debate.Expenditure on goods and services is the expenditureon final goods and services, and in 2011, it isexpected to total $1,181 billion. This expenditure,which includes that on national defense, homelandsecurity, research on cures for AIDS, computers forthe Internal read more..

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    The Federal Budget325surplus since 1969 emerged. But by 2002, the budgetwas again in deficit and during the 2008–2009 reces-sion, the deficit reached a new all-time high.Why did the budget deficit grow during the 1980s,vanish in the late 1990s, and re-emerge in the 2000s?Did outlays increase, or did receipts shrink, and whichcomponents of outlays and receipts changed most toswell and then shrink the deficit? Let’s look at receiptsand outlays in a bit more detail.Receipts Figure 13.3(a) shows read more..

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    Economics in ActionThe U.S. Government Budget inGlobal PerspectiveThe U.S. government budget deficit in Fiscal 2010was projected to be 11.8 percent of GDP. You’ve seenthat this deficit is historically high but how does itcompare with the deficits of other countries?To compare the deficits of governments acrosscountries, we must take into account the differences inlocal and regional government arrangements. Somecountries, and the United States is one of them, havelarge state and local read more..

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    The Federal Budget327State and Local BudgetsThe total government sector of the United Statesincludes state and local governments as well as thefederal government. In 2010, when federal govern-ment outlays were $4,129 billion, state and local out-lays were a further $2,000 billion. Most of theseexpenditures were on public schools, colleges, anduniversities ($550 billion); local police and fire ser-vices; and roads.It is the combination of federal, state, and localgovernment receipts, outlays, and read more..

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    328CHAPTER 13 Fiscal Policy◆ actionGoTo:16,Supply-Side EffectsactionGoTo:16,of Fiscal PolicyHow do taxes on personal and corporate incomeaffect real GDP and employment? The answer tothese questions is controversial. Some economists,known as supply-siders, believe these effects to belarge and an accumulating body of evidence sug-gests that they are correct. To see why these effectsmight be large, we’ll begin with a refresher on howfull employment and potential GDP are determinedin the absence read more..

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    Supply-Side Effects of Fiscal Policy329Economics in ActionSome Real World Tax WedgesEdward C. Prescott of Arizona State University, whoshared the 2004 Nobel Prize for Economic Science,has estimated the tax wedges for a number of coun-tries, among them the United States, the UnitedKingdom, and France.The U.S. tax wedge is a combination of 13 per-cent tax on consumption and 32 percent tax onincomes. The income tax component of the U.S. taxwedge includes Social Security taxes and is the mar-ginal read more..

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    330CHAPTER 13 Fiscal PolicyTaxes and the Incentive to Save and InvestA tax on interest income weakens the incentive to saveand drives a wedge between the after-tax interest rateearned by savers and the interest rate paid by firms.These effects are analogous to those of a tax on laborincome. But they are more serious for two reasons.First, a tax on labor income lowers the quantity oflabor employed and lowers potential GDP, while a taxon capital income lowers the quantity of saving andinvestment read more..

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    Supply-Side Effects of Fiscal Policy331Tax Revenues and the Laffer CurveAn interesting consequence of the effect of taxes onemployment and saving is that a higher tax rate doesnot always bring greater tax revenue. A higher tax ratebrings in more revenue per dollar earned. Butbecause a higher tax rate decreases the number of dol-lars earned, two forces operate in opposite directionson the tax revenue collected.The relationship between the tax rate and theamount of tax revenue collected is called read more..

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    332CHAPTER 13 Fiscal PolicyactionGoTo:16,◆ actionGoTo:16,Generational Effects of actionGoTo:16,Fiscal PolicyIs a budget deficit a burden on future generations? Ifit is, how will the burden be borne? And is thebudget deficit the only burden on future generations?What about the deficit in the Social Security fund?Does it matter who owns the bonds that the govern-ment sells to finance its deficit? What about thebonds owned by foreigners? Won’t repaying thosebonds impose a bigger burden than read more..

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    Generational Effects of Fiscal Policy333International DebtSo far in our discussion of government deficits anddebts, we’ve ignored the role played by the rest of theworld. We’ll conclude this discussion by consideringthe role and magnitude of international debt.You’ve seen that borrowing from the rest of theworld is one source of loanable funds. And you’vealso seen that this source of funds became largerduring the late 1990s and 2000s. How large is the contribution of the rest of read more..

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    334CHAPTER 13 Fiscal Policythe world. Instead of running a large net exportsdeficit, the United States will need a surplus ofexports over imports. To make a surplus possible,U.S. saving must increase and consumption mustdecrease. Some tough choices lie ahead.◆ actionGoTo:16,Fiscal StimulusThe 2008–2009 recession brought Keynesian macro-economic ideas (see p. 256) back into fashion andput a spotlight on fiscal stimulus—the use of fiscal pol-icy to increase production and employment. read more..

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    Fiscal Stimulus335sion, wages and profits rise, so tax revenues fromthese incomes rise. When real GDP decreases in arecession, wages and profits fall, so tax revenues fall.Needs-Tested Spending The government creates pro-grams that pay benefits to qualified people and busi-nesses. The spending on these programs results intransfer payments that depend on the economic stateof individual citizens and businesses. When the econ-omy expands, unemployment falls, the number ofpeople experiencing read more..

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    336CHAPTER 13 Fiscal PolicyU.S. Structural Budget Balance in 2010 The U.S.federal budget in 2010 was in deficit at $1.4 trillionand the recessionary gap (the gap between real GDPand potential GDP) was close to $1 trillion. With alarge recessionary gap, you would expect some of thedeficit to be cyclical. But how much of the 2010deficit was cyclical and how much was structural?The Congressional Budget Office (CBO) answersthis question by analyzing the detailed items in thebudget. According to the read more..

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    Fiscal Stimulus337Discretionary Fiscal StimulusMost discussion of discretionary fiscal stimulus focuseson its effects on aggregate demand. But you’ve seen(on pp. 328–331) that taxes influence aggregate sup-ply and that the balance of taxes and spending—thegovernment budget deficit—can crowd out invest-ment and slow the pace of economic growth. So dis-cretionary fiscal stimulus has both supply-side anddemand-side effects that end up determining its over-all effectiveness.We’re going to read more..

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    338CHAPTER 13 Fiscal PolicyThe description of the effects of discretionary fiscalstimulus and its graphical illustration in Fig. 13.11make it look easy: Calculate the recessionary gap andthe multipliers, change government expenditure andtaxes, and eliminate the gap. In reality, things are notthat easy.Getting the magnitude and the timing right is dif-ficult, and we’ll now examine this challenge.Magnitude of Stimulus Economists have divergingviews about the size of the government spending read more..

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    Fiscal Stimulus339Law-Making LagThe law-making lag is the time ittakes Congress to pass the laws needed to changetaxes or spending. This process takes time becauseeach member of Congress has a different idea aboutwhat is the best tax or spending program to change,so long debates and committee meetings are neededto reconcile conflicting views. The economy mightbenefit from fiscal stimulation today, but by thetime Congress acts, a different fiscal medicine mightbe needed.Impact LagThe impact lag read more..

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    340actionGoTo:16,READING BETWEEN THE actionGoTo:16,LINESRepublicans’ Two-Point Plan to Create Jobs: Can It Work?actionURI(http://www.csmonitor.com):http://www.csmonitor.comSeptember 21, 2010Republicans in Congress are urging two simple steps they say will help put Americans backto work: Freeze all tax rates at current levels and reduce federal spending. ... Cut governmentspending when the private sector is in slow gear? That’s not what the textbooks typically offeras a way to rev up growth. read more..

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    341ECONOMIC ANALYSISLarge increase in aggregatedemand needed to closerecessionary gapRecessionary gap Figure 1 The labor market and cyclical unemploymentReal wage rate (2005 dollars per hour)Employment (millions of workers)0Large increase in demandfor labor needed to restorefull employmentLSLDLD*20253035147139160130Figure 2 Aggregate supply and aggregatedemand in 2010Price level (GDP deflator, 2005 = 100)Real GDP (trillions of 2005 read more..

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    342CHAPTER 13 Fiscal PolicyGenerational Effects of Fiscal Policy (pp. 332–334)■Generational accounting measures the lifetime taxburden and benefits of each generation.■A major study estimated the U.S. fiscal imbalanceto be $79 trillion—5.8 times the value of oneyear’s production.■Future generations will pay for 57 percent of thebenefits of the current generation.■About two thirds of U.S. government debt is heldby the rest of the world. Working Problems 8 and 9 will give you a read more..

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    Study Plan Problems and Applications3437. What Obama Means for BusinessThe core of Obama’s economic plan is (a) moregovernment spending: $65 billion a year for uni-versal health insurance, $15 billion a year onalternative energy, $20 billion to help homeown-ers, $60 billion to bolster the nation’s infrastruc-ture, $10 billion annually to give students collegetuition in exchange for public service, and onand on; and (b) ending the Bush tax cuts on fam-ilies making more than $250,000 and read more..

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    344CHAPTER 13 Fiscal PolicyFiscal Stimulus (Study Plan 13.4)10. The economy is in a recession, and the recession-ary gap is large.a. Describe the discretionary and automatic fis-cal policy actions that might occur.b. Describe a discretionary fiscal stimulus pack-age that could be used that would not bring anincrease in the budget deficit.c. Explain the risks of discretionary fiscal policyin this situation.Use the following news clip to work Problems 11 to 13.Obama’s Economic Recovery PlanIf read more..

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    Additional Problems and Applications345The Federal Budget22. U.S. Budget Deficit to Hit $1.3 trillionThe Congressional Budget Office said this year’sbudget gap would be $71 billion less than lastyear’s. The U.S. budget deficit of $1.3 trillionmakes it the second largest deficit ever in dollars,trailing only last year’s $1.4 trillion. To put thosenumbers in perspective, the shortfalls for 2009and 2010 are each three times as big as the gov-ernment’s annual deficit had ever been read more..

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    346CHAPTER 13 Fiscal Policyprograms. According to the latest projectionsfrom the Congressional Budget Office, spendingon the big three entitlement programs—SocialSecurity, Medicare, and Medicaid—is to rise by70 percent, 79 percent, and 99 percent, respec-tively, over the next 10 years.Source: The Wall Street Journal, October 5, 2010If politicians continue to avoid debating the pro-jected increases in these three entitlement pro-grams, how do you think the fiscal imbalance willchange? If read more..

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    After studying this chapter, you will be able to:Describe the objectives of U.S. monetary policy and theframework for setting and achieving themExplain how the Federal Reserve makes its interest ratedecision and achieves its interest rate targetExplain the transmission channels through which theFederal Reserve influences real GDP, jobs, and inflationExplain the Fed’s extraordinary policy actionsAt eight regularly scheduled meetings a year, and in an emergency betweenregular meetings, the read more..

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    348CHAPTER 14 Monetary Policy◆ actionGoTo:17,Monetary Policy Objectives actionGoTo:17,and FrameworkA nation’s monetary policy objectives and the frame-work for setting and achieving those objectives stemfrom the relationship between the central bank andthe government.We’ll describe the objectives of U.S. monetary pol-icy and the framework and assignment of responsibil-ity for achieving those objectives.Monetary Policy ObjectivesThe objectives of U.S. monetary policy are set out in the read more..

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    Monetary Policy Objectives and Framework349Operational “Stable Prices” GoalThe Fed pays attention to two measures of inflation:the Consumer Price Index (CPI) and the personalconsumption expenditure (PCE) deflator. But thecore PCE deflator, which excludes food and fuelprices, is the Fed’s operational guide and the Feddefines the rate of increase in the core PCE deflatoras the core inflation rate.The Fed focuses on the core inflation rate becauseit is less volatile than the total CPI read more..

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    350CHAPTER 14 Monetary PolicyResponsibility for Monetary PolicyWho is responsible for monetary policy in the UnitedStates? What are the roles of the Fed, Congress, andthe president?The Role of the Fed The Federal Reserve Act makesthe Board of Governors of the Federal ReserveSystem and the Federal Open Market Committee(FOMC) responsible for the conduct of monetarypolicy. We described the composition of the FOMCin Chapter 8 (see p. 190). The FOMC makes a mon-etary policy decision at eight read more..

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    The Conduct of Monetary Policy351loans supplied and the smaller is the quantity ofovernight loans demanded. The equilibrium federalfunds rate balances the quantities demanded andsupplied.An equivalent way of looking at the forces thatdetermine the federal funds rate is to consider thedemand for and supply of bank reserves. Banks holdreserves to meet the required reserve ratio and so thatthey can make payments. But reserves are costly tohold because they can be loaned in the federal fundsmarket read more..

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    352CHAPTER 14 Monetary Policyfederal funds rate target; and if inflation is below oris expected to move below the bottom of the comfortzone, it considers lowering the interest rate.Unemployment Rate The Fed monitors and forecaststhe unemployment rate and its relation to the natu-ral unemployment rate (see pp. 113–115). If theunemployment rate is below the natural rate, a laborshortage might put upward pressure on wage rates,which might feed through to increase the inflationrate. So a higher read more..

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    Monetary Policy Transmission353◆ actionGoTo:17,Monetary Policy TransmissionYou’ve seen that the Fed’s goal is to keep the pricelevel stable (keep the inflation rate around 2 percent ayear) and to achieve maximum employment (keepthe output gap close to zero). And you’ve seen howthe Fed can use its power to set the federal funds rateat its desired level. We’re now going to trace theevents that follow a change in the federal funds rateand see how those events lead to the ultimate read more..

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    354CHAPTER 14 Monetary PolicyShort-Term Bill Rate The short-term bill rate is theinterest rate paid by the U.S. government on 3-month Treasury bills. It is similar to the interest ratepaid by U.S. businesses on short-term loans. Noticehow closely the short-term bill rate follows the federalfunds rate. The two rates are almost identical.A powerful substitution effect keeps these twointerest rates close. Commercial banks have a choiceabout how to hold their short-term liquid assets, andan read more..

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    Monetary Policy Transmission355ing the same, the U.S. dollar appreciates, and when theFed lowers the federal funds rate, the U.S. interest ratedifferential falls and, other things remaining the same,the U.S. dollar depreciates.Many factors other than the U.S. interest rate differ-ential influence the exchange rate, so when the Fedchanges the federal funds rate, the exchange rate doesnot usually change in exactly the way it would withother things remaining the same. So while monetarypolicy read more..

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    356CHAPTER 14 Monetary PolicyThe Change in Aggregate Demand, RealGDP, and the Price LevelThe final link in the transmission chain is a changein aggregate demand and a resulting change in realGDP and the price level. By changing real GDP andthe price level relative to what they would have beenwithout a change in the federal funds rate, the Fedinfluences its ultimate goals: the inflation rate andthe output gap.The Fed Fights RecessionIf inflation is low and real GDP is below potentialGDP, the Fed read more..

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    Monetary Policy Transmission357In Fig. 14.6(c), the supply of loanable funds curveshifts rightward from SLF0 to SLF1. With thedemand for loanable funds at DLF, the real interestrate falls from 6 percent to 5.5 percent a year. (We’reassuming a zero inflation rate so that the real interestrate equals the nominal interest rate.) The long-terminterest rate changes by a smaller amount than thechange in the short-term interest rate for the reasonexplained on p. 760.The Market for Real GDP Figure read more..

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    358CHAPTER 14 Monetary PolicyThe Fed Fights InflationIf the inflation rate is too high and real GDP is abovepotential GDP, the Fed takes actions that aredesigned to lower the inflation rate and restore pricestability. Figure 14.7 shows the effects of the Fed’sactions starting in the market for reserves and endingin the market for real GDP.Market for Bank Reserves In Fig. 14.7(a), whichshows the market for bank reserves, the FOMC raisesthe target federal funds rate from 5 percent to 6 per-cent read more..

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    Monetary Policy Transmission359The increase in the short-term interest rate, thedecrease in the supply of bank loans, and the increasein the real interest rate decrease aggregate plannedexpenditure. (Not shown in the figures, a rise in theinterest rate raises the exchange rate, which decreasesnet exports and aggregate planned expenditure.)The decrease in aggregate expenditure, ΔE, decreasesaggregate demand and shifts the aggregate demandcurve to AD0 –ΔE. A multiplier process begins. read more..

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    360CHAPTER 14 Monetary PolicyLoose Link from Federal Funds Rate to SpendingThe real long-term interest rate that influencesspending plans is linked only loosely to the federalfunds rate. Also, the response of the real long-terminterest rate to a change in the nominal interest ratedepends on how inflation expectations change. Andthe response of expenditure plans to changes in thereal interest rate depend on many factors that makethe response hard to predict.Time Lags in the Adjustment Process The read more..

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    Extraordinary Monetary Stimulus361◆ actionGoTo:17,ExtraordinaryactionGoTo:17,Monetary StimulusDuring the financial crisis and recession of 2008–2009,the Fed lowered the federal funds rate target to thefloor. The rate can’t go below zero, so what can the Feddo to stimulate the economy when it can’t lower theinterest rate any further?The Fed has answered this question with someextraordinary policy actions. To understand thoseactions, we need to dig a bit into the anatomy of thefinancial read more..

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    362CHAPTER 14 Monetary PolicyThe Policy ActionsPolicy actions in response to the financial crisis drib-bled out over a period of more than a year. But byNovember 2008, eight groups of policies designed tocontain the crisis and minimize its impact on the realeconomy were in place. Figure 14.9 summarizesthem, describes their effects on a bank’s balance sheet(red and blue arrows), and identifies the problem thateach action sought to address.An open market operation is the classic policy(see pp. read more..

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    Extraordinary Monetary Stimulus363Policy Strategies and ClarityTwo alternative approaches to monetary policy havebeen suggested and one of them has been used inother countries. They are■Inflation rate targeting■Taylor ruleInflation Rate Targeting A monetary policy strategyin which the central bank makes a public commit-ment to achieve an explicit inflation target andexplain how its policy actions will achieve it is calledinflation rate targeting. Australia, Canada, NewZealand, Sweden, the read more..

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    364actionGoTo:17,READING BETWEEN THE actionGoTo:17,LINESPoor U.S. Jobs Data Open Way for StimulusactionURI(http://www.ft.com):http://www.ft.comOctober 8, 2010Worse-than-expected September jobs figures underlining the U.S. economy’s chronic weak-ness has removed the last major hurdle to a new stimulus program by the Federal Reserve. ...A number of Fed officials have said that the U.S. central bank should act soon unless the eco-nomic data improve. The September jobs report represented the last read more..

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    365ECONOMIC ANALYSISFigure 3 The risk of inflationQE open marketoperation leavesfederal funds rateunchangedFederal funds rate (percentper year)RDRS0RS1Figure 1 The market for bank reservesFigure 2 The market for loanable fundsReserves on deposit at the Fed (trillions of dollars)0.51.01.52.02.53.00.50.21.01.52.02.50QE increasesthe supply ofloanable funds Real interest rate (percentper year)DLFSLF0SLF1Loanable funds (trillions of dollars)0.51.01.52.02.53.02.53.03.50Expected dollar read more..

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    366CHAPTER 14 Monetary PolicyKey PointsMonetary Policy Objectives and Framework (pp. 348–350)■The Federal Reserve Act requires the Fed to usemonetary policy to achieve maximum employ-ment, stable prices, and moderate long-term inter-est rates.■The goal of stable prices delivers maximumemployment and low interest rates in the long runbut can conflict with the other goals in the shortrun.■The Fed translates the goal of stable prices as aninflation rate of between 1 and 2 percent per read more..

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    Study Plan Problems and Applications367Monetary Policy Objectives and Framework(Study Plan 14.1)1. “Unemployment is a more serious economicproblem than inflation and it should be the focusof the Fed’s monetary policy.” Evaluate this state-ment and explain why the Fed’s primary policygoal is price stability.2. “Because the core inflation rate excludes theprices of food and fuel, the Fed should pay noattention to it and should instead be concernedabout the CPI inflation rate.” Explain read more..

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    368CHAPTER 14 Monetary PolicyExtraordinary Monetary Stimulus (Study Plan 14.4)Use the following news clip to work Problems 21 to 23.Dollar Under Pressure Amid QE2 SpeculationPersistent speculation that the Federal Reserve wouldsoon embark on a fresh program of long-term assetpurchases—a second round of quantitative easing orQE2—kept the dollar under pressure in the foreignexchange market ahead of crucial U.S. employmentdata.Source: ft.com, October 7, 201021. What is the connection between read more..

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    Additional Problems and Applications369Monetary Policy Objectives and FrameworkUse the following information to work Problems 27to 29.The Fed’s mandated policy goals are “maximumemployment, stable prices, and moderate long-terminterest rates.”27. Explain the harmony among these goals in thelong run.28. Explain the conflict among these goals in theshort run.29. Based on the performance of U.S. inflation andunemployment, which of the Fed’s goals appearsto have taken priority since 2000?30. read more..

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    370CHAPTER 14 Monetary Policy45. Dollar Tumbles to 15-year Low Against YenThe dollar tumbled to a fresh 15-year low onpersistent fears over the U.S. economic outlook.Source: yahoo.com, October 7, 2010a. How do “fears over the U.S. economic out-look” influence the exchange rate?b. How does monetary policy influence the ex-change rate?Use the following news clip to work Problems 46 and 47.Top Economist says America Could Plunge intoRecessionRobert Shiller, Professor of Economics at read more..

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    After studying this chapter, you will be able to:Explain how markets work with international tradeIdentify the gains from international trade and itswinners and losersExplain the effects of international trade barriersExplain and evaluate arguments used to justifyrestricting international tradeiPods, Wii games, and Nike shoes are just three of the items you might buythat are not produced in the United States. In fact, most of the goods that youbuy are produced abroad, often in Asia, and read more..

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    372CHAPTER 15 International Trade Policy◆ actionGoTo:17,How Global Markets WorkBecause we trade with people in other countries, thegoods and services that we can buy and consume arenot limited by what we can produce. The goods andservices that we buy from other countries are ourimports; and the goods and services that we sell topeople in other countries are our exports.International Trade TodayGlobal trade today is enormous. In 2009, globalexports and imports were $31 trillion, which is read more..

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    How Global Markets Work373Why the United States Imports T-ShirtsThe United States imports T-shirts because the rest ofthe world has a comparative advantage in producingT-shirts. Figure 15.1 illustrates how this comparativeadvantage generates international trade and howtrade affects the price of a T-shirt and the quantitiesproduced and bought.The demand curve DUS and the supply curve SUSshow the demand and supply in the U.S. domesticmarket only. The demand curve tells us the quantityof T-shirts read more..

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    374CHAPTER 15 International Trade PolicyWhy the United States Exports AirplanesThe United States exports airplanes because it has acomparative advantage in producing them. Figure15.2 illustrates how this comparative advantage gener-ates international trade in airplanes and how this tradeaffects the price of an airplane and the quantities pro-duced and bought.The demand curve DUS and the supply curve SUSshow the demand and supply in the U.S. domesticmarket only. The demand curve tells us the read more..

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    How Global Markets Work375Winners and Losers from International TradeInternational trade has winners, and it has losers. It isbecause some people lose that we often hear com-plaints about international competition. We’re nowgoing to see who wins and who loses from interna-tional trade. Then you will be able to understand whocomplains about international competition and why.You will learn why we hear producers complainingabout cheap foreign imports. You will also see why wenever hear consumers read more..

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    376CHAPTER 15 International Trade PolicyTariffs raise revenue for the government andenable the government to satisfy the self-interest ofthe people who earn their incomes in the import-competing industries. But as you will see, tariffs andother restrictions on free international trade decreasethe gains from trade and are not in the social interest.Let’s see why.The Effects of a Tariff To see the effects of a tariff, let’sreturn to the example in which the United Statesimports T-shirts. With read more..

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    International Trade Restrictions377what happens with a tariff set at $2 per T-shirt. Thefollowing changes occur in the market for T-shirts:■The price of a T-shirt in the United States rises by $2.■The quantity of T-shirts bought in the UnitedStates decreases.■The quantity of T-shirts produced in the UnitedStates increases.■The quantity of T-shirts imported into the UnitedStates decreases.■The U.S. government collects a tariff revenue.Rise in Price of a T-ShirtTo buy a T-shirt, read more..

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    378CHAPTER 15 International Trade PolicyU.S. Producers of the Good GainBecause the price ofan imported T-shirt rises by the amount of the tariff,U.S. T-shirt producers are now able to sell their T-shirts for the world price plus the tariff. At the higherprice, the quantity of T-shirts supplied by U.S. pro-ducers increases. The combination of a higher priceand larger quantity produced increases the producers’profits. So U.S. producers gain from the tariff.U.S. Consumers Lose More Than U.S. read more..

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    International Trade Restrictions379The Effects of an Import Quota The effects of animport quota are similar to those of a tariff. The pricerises, the quantity bought decreases, and the quantityproduced in the United States increases. Figure 15.4illustrates the effects.Figure 15.4(a) shows the situation with freeinternational trade. Figure 15.4(b) shows what hap-pens with an import quota of 10 million T-shirts ayear. The U.S. supply curve of T-shirts becomes thedomestic supply curve, SUS, plus read more..

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    380CHAPTER 15 International Trade PolicyVoluntary Export Restraints A voluntary exportrestraint is like a quota allocated to a foreignexporter of a good. This type of trade barrier isn’tcommon. It was initially used during the 1980swhen Japan voluntarily limited its exports of carparts to the United States.Export SubsidiesA subsidy is a payment by the government to a pro-ducer. When the government pays a subsidy, the costof production falls by the amount of the subsidy sosupply increases. An read more..

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    The Case Against Protection381◆ actionGoTo:17,The Case Against ProtectionFor as long as nations and international trade haveexisted, people have debated whether a country isbetter off with free international trade or with protec-tion from foreign competition. The debate continues,but for most economists, a verdict has been deliveredand is the one you have just seen. Free trade pro-motes prosperity for all countries; protection is ineffi-cient. We’ve seen the most powerful case for read more..

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    382CHAPTER 15 International Trade Policyagainst globalization and for protection. The mostcommon ones are that protection■Saves jobs■Allows us to compete with cheap foreign labor■Penalizes lax environmental standards■Prevents rich countries from exploiting developingcountriesSaves JobsFirst, free trade does cost some jobs, but it also createsother jobs. It brings about a global rationalization oflabor and allocates labor resources to their highest-valued activities. International trade read more..

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    The Case Against Protection383the global economy to achieve higher environmentalstandards than would otherwise be possible.Prevents Rich Countries from ExploitingDeveloping CountriesAnother argument for protection is that internationaltrade must be restricted to prevent the people of therich industrial world from exploiting the poorer peo-ple of the developing countries and forcing them towork for slave wages.Child labor and near-slave labor are serious prob-lems that are rightly condemned. But read more..

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    384CHAPTER 15 International Trade Policybefore the 1990s, tapping these vast resources was justtoo costly. But at today’s cost of a long-distance tele-phone call or Internet connection, resources in Indiacan be used to produce services in the United States ata lower cost than those services can be produced byusing resources located in the United States. And withthe incomes that Indians earn from exporting services,some of the services (and goods) that Indians buy areproduced in the United read more..

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    The Case Against Protection385Agreement (NAFTA) with Canada and Mexico, it setup a $56 million fund to support and retrain workerswho lost their jobs as a result of the new trade agree-ment. During NAFTA’s first six months, only 5,000workers applied for benefits under this scheme. Thelosers from international trade are also compensatedindirectly through the normal unemployment com-pensation arrangements. But only limited attempts aremade to compensate those who lose.The main reason why full read more..

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    386actionGoTo:17,READING BETWEEN THE actionGoTo:17,LINESChina: Tire trade penalties will hurt relations with U.S.USATodaySeptember 12 2009WASHINGTON—President Obama’s decision to impose trade penalties on Chinese tireshas infuriated Beijing. …The federal trade panel recommended a 55% tariff in the first year, 45% in the secondyear, and 35% in the third year. Obama settled on 35% the first year, 30% in the second,and 25% in the third, [White House Press Secretary Robert] Gibbs said.“For read more..

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    387ECONOMIC ANALYSISFigure 1 The surge in tire importsPrice (dollars per tire)Quantity (millions of tires per year)020DUSSUS08SUS04Price of rubberdoubles and U.S.supply decreasesImportsin 2008Importsin 2004Worldprice406080100300220235280200250Figure 2 The effects of the tariff on tire importsPrice (dollars per tire)Quantity (millions of tires per year)020DUSSUS09ImportsshrinkTariffWorldpriceWorld priceplus tariffTaxrevenue554080100300215240280250200■In the global economy, 450 firms produce read more..

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    388CHAPTER 15 International Trade PolicySUMMARYKey TermsDoha Development Agenda (Doha Round), 378Dumping, 381Exports, 372Export subsidy, 380General Agreement on Tariffs and Trade (GATT), 377Import quota, 378Imports, 372Infant-industry argument, 381Offshore outsourcing, 383Offshoring, 383Outsourcing, 383Rent seeking, 385Tariff, 376World Trade Organization (WTO), 378Key PointsHow Global Markets Work (pp. 372–375)■Comparative advantage drives international trade.■If the world price of a good read more..

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    Study Plan Problems and Applications389exporter. Fifty years ago, Petrobras was formed as atrading company to import oil to support Brazil’sgrowing economy. Two years ago, Brazil reached itslong-sought goal of energy self-sufficiency.Source: International Herald Tribune,January 11, 20084. Describe Brazil’s comparative advantage in pro-ducing oil and explain why its comparativeadvantage has changed.5. a. Draw a graph to illustrate the Brazilian marketfor oil and explain why Brazil was an read more..

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    390CHAPTER 15 International Trade PolicyInternational Trade Restrictions (Study Plan 15.2)Use the following news clip to work Problems 9 and 10.Steel Tariffs Appear to Have Backfired on BushPresident Bush set aside his free-trade principles lastyear and imposed heavy tariffs on imported steel tohelp out struggling mills in Pennsylvania and WestVirginia. Some economists say the tariffs may havecost more jobs than they saved, by driving up costsfor automakers and other steel users.Source: The read more..

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    Additional Problems and Applications391How Global Markets Work22. Suppose that the world price of sugar is 10 centsa pound, the United States does not trade inter-nationally, and the equilibrium price of sugar inthe United States is 20 cents a pound. TheUnited States then begins to trade internationally.a. How does the price of sugar in the UnitedStates change?b. Do U.S. consumers buy more or less sugar?c. Do U.S. sugar growers produce more or lesssugar?d. Does the United States export or import read more..

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    392CHAPTER 15 International Trade PolicyInternational Trade RestrictionsUse the following information to work Problems 29to 31.Before 1995, trade between the United States andMexico was subject to tariffs. In 1995, Mexico joinedNAFTA and all U.S. and Mexican tariffs have gradu-ally been removed.29. Explain how the price that U.S. consumers payfor goods from Mexico and the quantity of U.S.imports from Mexico have changed. Who are thewinners and who are the losers from this freetrade?30. Explain read more..

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    393actionGoTo:17,Tradeoffs and FreeactionGoTo:17,LunchesA policy tradeoff arises if, in taking an action to achieve one goal,some other goal must be forgone. The Fed wants to avoid a rise inthe inflation rate and a rise in the unemployment rate. But if theFed raises the interest rate to curb inflation, it might lower expen-diture and increase unemployment. The Fed faces a short-runtradeoff between inflation and unemployment.A policy free lunch arises if in taking actions to pursue one goal, some read more..

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    394actionGoTo:17,TALKING WITHrate volatility. Dollarization also makes inflationaryfinance of the Treasury Department impossible.And what are the costs of dollarization?One cost is that the country loses the revenues itgains from issuing money. A second cost is that thecountry loses the ability to conduct monetary stabi-lization policy. In effect, the domestic central bankcan no longer influence the business cycle throughinterest rate or exchange rate policy. The questionthat Martin and I wanted read more..

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    395to us: Mexican dollarization and actual Mexicanmonetary policy. A second tool that we developed isanother algorithm to compute optimal monetary pol-icy—the best available monetary policy.Knowing the highest level of economic welfarethat can be achieved allows us to judge how closepractical policy proposals come to optimal policy.And what was your biggest surprise?I think our biggest surprise in this research programwas how small the welfare costs of some very simplepolicy rules are read more..

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    396You've done some recent research with Martin on theoptimal or best inflation rate. What is the optimal rate? Many central banks have an inflation target. In devel-oped economies it is about 2 percent per year and inemerging market economies it is about 4 percent peryear. Martin and I are trying to answer the seeminglysimple and innocent question: Which level of theinflation rate should a central bank target? Is it theobserved values of 2 percent and 4 percent? Orshould it be zero, or 6 read more..

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    G-1actionGoTo:17,GLOSSARYAbove full-employment equilibriumA macroeconomic equilibrium inwhich real GDP exceeds potentialGDP. (p. 252)Absolute advantage A person has anabsolute advantage if that person ismore productive than another person.(p. 38)Aggregate demand The relationshipbetween the quantity of real GDPdemanded and the price level. (p. 246)Aggregate planned expenditure Thesum of planned consumption expen-diture, planned investment, plannedgovernment expenditure on goods andservices, and read more..

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    G-2GlossaryCompetitive market A market thathas many buyers and many sellers, sono single buyer or seller can influencethe price. (p. 52)Complement A good that is used inconjunction with another good. (p. 55)Consumer Price Index (CPI) Anindex that measures the average of theprices paid by urban consumers for afixed basket of the consumer goodsand services. (p. 117)Consumption expenditure The totalpayment for consumer goods andservices. (p. 85)Consumption function The rela-tionship between read more..

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    GlossaryG-3Employment-to-population ratioThe percentage of people of workingage who have jobs. (p. 110)Entrepreneurship The humanresource that organizes the other threefactors of production: labor, land, andcapital. (p. 4)Equilibrium expenditure The levelof aggregate expenditure that occurswhen aggregate planned expenditureequals real GDP. (p. 272)Equilibrium price The price atwhich the quantity demanded equalsthe quantity supplied. (p. 62)Equilibrium quantity The quantitybought and sold at the read more..

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    G-4GlossaryHyperinflation An inflation rate of50 percent a month or higher thatgrinds the economy to a halt andcauses a society to collapse. (p. 116)Import quota A restriction that lim-its the maximum quantity of a goodthat may be imported in a given peri-od. (p. 378)Imports The goods and services thatwe buy from people in other coun-tries. (pp. 86, 372)Incentive A reward that encouragesan action or a penalty that discouragesone. (p. 2)Induced expenditure The sum ofthe components of aggregate read more..

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    GlossaryG-5Marginal propensity to import Thefraction of an increase in real GDPthat is spent on imports. It is calculat-ed as the change in imports divided bythechange in disposable income.(p. 269)Marginal propensity to save Thefraction of a change in disposableincome that is saved. It is calculated asthechange in saving divided by thechange in disposable income. (p. 268)Marginally attached worker A per-son who currently is neither workingnor looking for work but has indicat-ed that he or she read more..

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    G-6Glossaryreserves, which are the government’sholdings of foreign currency. (p. 225)Offshore outsourcing A U.S. firmbuys finished goods, components, orservices from other firms in othercountries. (p. 383)Offshoring A U.S. firm hires foreignlabor and produces in a foreign coun-try or a U.S. firm buys finished goods,components, or services from firms inother countries. (p. 383)Open market operation The pur-chase or sale of government securi-ties—U.S. Treasury bills andbonds—by the Federal read more..

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    GlossaryG-7value of another variable for a numberof different values of each variable. (p. 14)Self-interest The choices that youthink are the best ones available foryou are choices made in your self-interest. (p. 5)Short-run aggregate supply Therelationship between the quantity ofreal GDP supplied and the price levelwhen the money wage rate, the pricesof other resources, and potential GDPremain constant. (p. 243)Short-run macroeconomic equilibri-um A situation that occurs when thequantity of read more..

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    I-1actionGoTo:17,INDEXAbove full-employment equilibrium,actionGoTo:284,252Absolute advactionGoTo:70,antage, 38Accounting, generational, actionGoTo:364,332Actual aggregate expendituractionGoTo:303,e, 271actionGoTo:271,Africa, 239–240After-tax interest actionGoTo:362,rate, 330Aggregate actionGoTo:278,demand, 246, actionGoTo:278,246–249changes actionGoTo:312,in, 280–281in classical viewactionGoTo:288,, 256cost-push inflation actionGoTo:331,and, 299demand-pull inflation actionGoTo:328,and, read more..

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    Circular flowof expenditure and actionGoTo:117,income, 85–86through actionGoTo:74,markets, 42, actionGoTo:75,43actionGoTo:225,Citibank, 193, actionGoTo:414,382Clarida, RicharactionGoTo:162,d, 130–132Classical growth theory,actionGoTo:179, 147Classical macractionGoTo:279,oeconomics, 247, actionGoTo:288,256Climate actionGoTo:38,change, 6Coffee prices (Reading Between the Lines),actionGoTo:106,74–75Columbia UniversityactionGoTo:42,, 10Commercial bankscredit crisis of actionGoTo:393,2008, read more..

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    Economic Report of the President (Councilof Economic Advisors), actionGoTo:355,323Economyin actionGoTo:170,Asia, 138perpetual actionGoTo:181,motion, 149–150real GDP and world, actionGoTo:169,137–138actionGoTo:125,underground, 93–94Education, to stimulate economic growth,actionGoTo:183,151EfficiencyactionGoTo:37,, 5actionGoTo:65,allocative, 33, actionGoTo:67,35actionGoTo:63,production, 31of ractionGoTo:65,esources, 33–35actionGoTo:146,wage, 114Employ American Workers Act read more..

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    I-4IndexFiscal actionGoTo:366,stimulus, 334, actionGoTo:367,335–339aggregate demand actionGoTo:369,and, 337aggregate supply actionGoTo:370,and, 338actionGoTo:367,automatic, 335discretionary,actionGoTo:369, 337–339magnitude ofactionGoTo:370,, 338–339time actionGoTo:371,lags, 339Fiscal yearactionGoTo:354,, 322Fixed exchange actionGoTo:254,rate, 222, actionGoTo:254,222–223Fixed pricesexpenditure plans actionGoTo:298,and, 266–269real GDP with, actionGoTo:302,270–273Flexible exchange read more..

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    IndexI-5Inferior actionGoTo:92,goods, 60IactionGoTo:148,nflation, 116in AS-AD model, actionGoTo:283,251–252business cycle actionGoTo:333,and, 301actionGoTo:330,cost-push, 298–300CPactionGoTo:150,I, 118–119, actionGoTo:381,349cyactionGoTo:328,cles, 296–301actionGoTo:328,demand-pull, 296–298actionGoTo:332,expected, 300–301Fed actionGoTo:390,fighting, 358–359forecasting, actionGoTo:333,301money growth actionGoTo:232,and, 200–201real GDP actionGoTo:148,and, 116unemployment read more..

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    I-6IndexManufacturing actionGoTo:35,production, 3Margin, actionGoTo:41,9Marginal actionGoTo:41,benefit, 9decractionGoTo:66,easing, 34demand and, actionGoTo:90,58preferences actionGoTo:66,and, 34–35Marginal costincractionGoTo:94,ease, 62PPF actionGoTo:65,and, 33supply actionGoTo:95,and, 63Marginally attached workeractionGoTo:143,, 111,actionGoTo:143,111–112Marginal propensity to consumeactionGoTo:300,(MPC), 268Marginal propensity to imporactionGoTo:301,t, 269Marginal propensity to save read more..

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    IndexI-7Operational price stability actionGoTo:381,goal, 349Opportunity actionGoTo:40,cost, 8, actionGoTo:40,8–9, actionGoTo:63,31incractionGoTo:64,easing, 32production possibilities actionGoTo:62,and, 30–32as actionGoTo:63,ratio, 31–32relative price as, actionGoTo:88,56Organization of Petroleum ExportingCountries (OPactionGoTo:101,EC), 69Origin, actionGoTo:45,13OactionGoTo:355,utlays, 323Outlet substitution actionGoTo:152,bias, 120Output gap, actionGoTo:146,114, actionGoTo:147,115, read more..

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    I-8IndexReserve ratiodesiractionGoTo:226,ed, 194requiractionGoTo:225,ed, 193Resources, efficient use ofactionGoTo:65,, 33–35Resource actionGoTo:88,allocation, 56, actionGoTo:148,116Restoring American Financial Stability Actof 2010, actionGoTo:195,163RevenuetariffactionGoTo:416,, 384–385actionGoTo:363,tax, 331, actionGoTo:366,334–335Ricardo, David, actionGoTo:179,147, actionGoTo:204,172, actionGoTo:271,239Ricardo-Barro actionGoTo:204,effect, 172RiskactionGoTo:200,default, 168pool, read more..

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    marginally attached actionGoTo:143,workers, 111–112misery index and rate ofactionGoTo:327,, 295,actionGoTo:342,310–311most costlyactionGoTo:144,, 112Phillips curve, actionGoTo:327,295, actionGoTo:334,302–304price level actionGoTo:148,and, 116–121problem ofactionGoTo:140,, 108–109real GDP actionGoTo:146,and, 114–115stractionGoTo:145,uctural, 113–115Unemployment actionGoTo:142,rate, 110, actionGoTo:145,113, actionGoTo:335,303–304,actionGoTo:384,352Union PactionGoTo:193,acific, read more..

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    C-1actionGoTo:17,PHOTO CREDITSMichael Parkin (page vii) John TamblynCollege campus (page 1) Image Source/Getty ImagesParrot cartoon (page 2) Copyright © 1985 The New YorkerCollection/Frank Modell from cartoonbank.com. All RightsReserved.Sneaker factory (page 5) Adek Berry/Getty ImagesIntel Chip (page 6) Imagebroker/AlamyPollution (page 6) Digital VisionLehman Brothers (page 7) Kurt Brady/AlamyCorn (page 29) MNPhoto/AlamyEthanol gasoline pump (page 29) Alex Farnsworth/TheImage WorksBoeing (page read more..

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    Abel/Bernanke/CroushoreMacroeconomics*Bade/ParkinFoundations of Economics*Berck/HelfandThe Economics of theEnvironmentBierman/FernandezGame Theory withEconomic ApplicationsBlanchardMacroeconomics*Blau/Ferber/WinklerThe Economics of Women,Men and WorkBoardman/Greenberg/Vining/ WeimerCost-Benefit AnalysisBoyerPrinciples of TransportationEconomicsBransonMacroeconomic Theory and PolicyBrock/AdamsThe Structure of AmericanIndustryBrucePublic Finance and theAmerican EconomyCarlton/PerloffModern read more..

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    Reading Between the Lines, which appears at the end of each chapter, helps students think likeeconomists by connecting chapter tools and concepts to the world around them.2Fuel Choices, Food Crises, and Finger-Pointing443Coffee Surges on Poor Colombian Harvests704Shape of Recovery Long, Slow Growth … a “Square Root” Slog965U.S. Labor Force Shrinks Amid Jobs Market Woes1226China Pips Japan but “Still a Developing Nation”1527“Borrowing to Live” Weighs on Families, Firms, Nation1768It read more..

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    1 Life in a small and ever-shrinking world5Chips and windows6Greenhouse gas emissions6A credit crunch72 Increasing opportunity cost on the farm32Hong Kong catching up to the United States 37The United States and China gain from trade 413 The global market for crude oil65The market for strawberries674 A broader indicator of economic well-being 955 What keeps Ben Bernanke awake at night108Structural unemployment and labor reallocationin Michigan1146 Fast trains on the same track138Intellectual read more..

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