table of
contents
FYI: Adam Smith and the Invisible Hand 12
Preface: To the Student ix
How the Economy as a Whole Works 13 Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services 13 In The News: Why You Should Study Economics 14 Principle 9: Prices Rise When the Government Prints Too Much Money 15 Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment 16 FYI: How to Read This Book 17
Acknowledgments xiii
Conclusion 17
Chapter 2
Thinking Like an Economist 21
I Introduction
Part
1
Chapter 1
Ten Principles of Economics 3 How People Make Decisions 4 Principle 1: People Face Trade-offs 4 Principle 2: The Cost of Something Is What You Give Up to Get It 5 Principle 3: Rational People Think at the Margin 6 Principle 4: People Respond to Incentives 7 Case Study: The Incentive Effects of Gasoline Prices 8 In The News: Incentive Pay 9 How People Interact 10 Principle 5: Trade Can Make Everyone Better Off 10 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity 10 Principle 7: Governments Can Sometimes Improve Market Outcomes 11
The Economist as Scientist 22 The Scientific Method: Observation, Theory, and More Observation 22 The Role of Assumptions 23 Economic Models 24 Our First Model: The Circular-Flow Diagram 24 Our Second Model: The Production Possibilities Frontier 26 Microeconomics and Macroeconomics 29 The Economist as Policy Adviser 29 FYI: Who Studies Economics? 30 Positive versus Normative Analysis 30 Economists in Washington 31 In The News: The Economics of President Obama 32 Why Economists’ Advice Is Not Always Followed 32 Why Economists Disagree 34 Differences in Scientific Judgments 34 Differences in Values 34 Perception versus Reality 35 Let’s Get Going 35 In The News: Environmental Economics 37 APPENDIX Graphing: A Brief Review 40 Graphs of a Single Variable 40 Graphs of Two Variables: The Coordinate System 41 Curves in the Coordinate System 42 Slope 44 Cause and Effect 46
xix Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
xx
contents
Chapter 3
Chapter 4
Interdependence and the Gains from Trade 49
The Market Forces of Supply and Demand 65
A Parable for the Modern Economy 50 Production Possibilities 50 Specialization and Trade 52
Markets and Competition 66 What Is a Market? 66 What Is Competition? 66
Comparative Advantage: The Driving Force of Specialization 54 Absolute Advantage 54 Opportunity Cost and Comparative Advantage 54 Comparative Advantage and Trade 55 The Price of the Trade 56 FYI: The Legacy of Adam Smith and David Ricardo 57
Demand 67 The Demand Curve: The Relationship between Price and Quantity Demanded 67 Market Demand versus Individual Demand 68 Shifts in the Demand Curve 69 Case Study: Two Ways to Reduce the Quantity of Smoking Demanded 71
Applications of Comparative Advantage 57 Should Tom Brady Mow His Own Lawn? 57 Should the United States Trade with Other Countries? 58 In The News: The Changing Face of International Trade 59 Conclusion 59
Supply 73 The Supply Curve: The Relationship between Price and Quantity Supplied 73 Market Supply versus Individual Supply 73 Shifts in the Supply Curve 74 Supply and Demand Together 77 Equilibrium 77 Three Steps to Analyzing Changes in Equilibrium 79 In The News: Price Increases after Disasters 82 Conclusion: How Prices Allocate Resources 84
Chapter 5
Elasticity and Its Application 89 The Elasticity of Demand 90 The Price Elasticity of Demand and Its Determinants 90 Computing the Price Elasticity of Demand 91 The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities 91 The Variety of Demand Curves 92 FYI: A Few Elasticities from the Real World 94 Total Revenue and the Price Elasticity of Demand 94 Elasticity and Total Revenue along a Linear Demand Curve 96 Other Demand Elasticities 97 The Elasticity of Supply 98 The Price Elasticity of Supply and Its Determinants 98 Computing the Price Elasticity of Supply 98 The Variety of Supply Curves 99
II HWork ow Markets
Part
63
Three Applications of Supply, Demand, and Elasticity 101 Can Good News for Farming Be Bad News for Farmers? 101 Why Did OPEC Fail to Keep the Price of Oil High? 103 Does Drug Interdiction Increase or Decrease Drug-Related Crime? 105 Conclusion 106
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contents
xxi
How a Lower Price Raises Consumer Surplus 138 What Does Consumer Surplus Measure? 140
Chapter 6
Supply, Demand, and Government Policies 111 Controls on Prices 112 How Price Ceilings Affect Market Outcomes 112 Case Study: Lines at the Gas Pump 114 Case Study: Rent Control in the Short Run and the Long Run 115 How Price Floors Affect Market Outcomes 116 Case Study: The Minimum Wage 117 Evaluating Price Controls 119 In The News: Should Unpaid Internships Be Allowed? 120 Taxes 121 How Taxes on Sellers Affect Market Outcomes 121 How Taxes on Buyers Affect Market Outcomes 123 Case Study: Can Congress Distribute the Burden of a Payroll Tax? 124 Elasticity and Tax Incidence 125 Case Study: Who Pays the Luxury Tax? 127 Conclusion 128
Producer Surplus 141 Cost and the Willingness to Sell 141 Using the Supply Curve to Measure Producer Surplus 142 How a Higher Price Raises Producer Surplus 144 Market Efficiency 145 The Benevolent Social Planner 145 Evaluating the Market Equilibrium 146 In The News: Ticket Scalping 148 Case Study: Should There Be a Market in Organs? 149 Conclusion: Market Efficiency and Market Failure 150
Chapter 8
Application: The Costs of Taxation 155 The Deadweight Loss of Taxation 156 How a Tax Affects Market Participants 157 Deadweight Losses and the Gains from Trade 159 The Determinants of the Deadweight Loss 160 Case Study: The Deadweight Loss Debate 162 Deadweight Loss and Tax Revenue as Taxes Vary 163 Case Study: The Laffer Curve and Supply-Side Economics 165 In The News: New Research on Taxation 166 Conclusion 166
Chapter 9
Application: International Trade 171 The Determinants of Trade 172 The Equilibrium without Trade 172 The World Price and Comparative Advantage 173
III MWelfare arkets and
Part
133
Chapter 7
Consumers, Producers, and the Efficiency of Markets 135 Consumer Surplus 136 Willingness to Pay 136 Using the Demand Curve to Measure Consumer Surplus 137
The Winners and Losers from Trade 174 The Gains and Losses of an Exporting Country 174 The Gains and Losses of an Importing Country 175 The Effects of a Tariff 177 FYI: Import Quotas: Another Way to Restrict Trade 179 The Lessons for Trade Policy 179 Other Benefits of International Trade 180 In The News: Trade Skirmishes 181 The Arguments for Restricting Trade 182 The Jobs Argument 182 In The News: Should the Winners from Free Trade Compensate the Losers? 183 The National-Security Argument 184 In The News: Second Thoughts about Free Trade 184 The Infant-Industry Argument 185 The Unfair-Competition Argument 186 The Protection-as-a-Bargaining-Chip Argument 186 Case Study: Trade Agreements and the World Trade Organization 186 Conclusion 187
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xxii
contents
Chapter 11
Public Goods and Common Resources 217 The Different Kinds of Goods 218 Public Goods 220 The Free-Rider Problem 220 Some Important Public Goods 220 Case Study: Are Lighthouses Public Goods? 222 The Difficult Job of Cost–Benefit Analysis 223 Case Study: How Much Is a Life Worth? 223
Economics IV The of the Public
Part
Sector
193
Chapter 10
Externalities 195 Externalities and Market Inefficiency 197 Welfare Economics: A Recap 197 Negative Externalities 198 Positive Externalities 199 In The News: The Externalities of Country Living 200 Case Study: Technology Spillovers, Industrial Policy, and Patent Protection 201 Public Policies toward Externalities 202 Command-and-Control Policies: Regulation 203 Market-Based Policy 1: Corrective Taxes and Subsidies 203 Case Study: Why Is Gasoline Taxed So Heavily? 204 Market-Based Policy 2: Tradable Pollution Permits 205 Objections to the Economic Analysis of Pollution 207 In The News: Cap and Trade 208 Private Solutions to Externalities 209 The Types of Private Solutions 210 The Coase Theorem 210 Why Private Solutions Do Not Always Work 211 Conclusion 212
Common Resources 224 The Tragedy of the Commons 224 Some Important Common Resources 225 In The News: The Case for Toll Roads 226 Case Study: Why the Cow Is Not Extinct 228 Conclusion: The Importance of Property Rights 229
Chapter 12
The Design of the Tax System 233 A Financial Overview of the U.S. Government 234 The Federal Government 235 Case Study: The Fiscal Challenge Ahead 238 State and Local Government 240 Taxes and Efficiency 242 Deadweight Losses 242 Case Study: Should Income or Consumption Be Taxed? 243 In The News: The Temporarily Disappearing Estate Tax 244 Administrative Burden 244 Marginal Tax Rates versus Average Tax Rates 245 Lump-Sum Taxes 245 Taxes and Equity 246 The Benefits Principle 246 The Ability-to-Pay Principle 247 Case Study: How the Tax Burden Is Distributed 248 Tax Incidence and Tax Equity 249 Case Study: Who Pays the Corporate Income Tax? 250 In The News: The Value-Added Tax 250 Conclusion: The Trade-off between Equity and Efficiency 252
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contents xxiii
Chapter 14
Firms in Competitive Markets 279 What Is a Competitive Market? 280 The Meaning of Competition 280 The Revenue of a Competitive Firm 280
V FtheirmOrganization Behavior and
Part
of Industry
257
Chapter 13
The Costs of Production 259 What Are Costs? 260 Total Revenue, Total Cost, and Profit 260 Costs as Opportunity Costs 260 The Cost of Capital as an Opportunity Cost 261 Economic Profit versus Accounting Profit 262 Production and Costs 263 The Production Function 263 From the Production Function to the Total-Cost Curve 265 The Various Measures of Cost 265 Fixed and Variable Costs 266 Average and Marginal Cost 267 Cost Curves and Their Shapes 268 Typical Cost Curves 270 Costs in the Short Run and in the Long Run 271 The Relationship between Short-Run and Long-Run Average Total Cost 271 Economies and Diseconomies of Scale 272 FYI: Lessons from a Pin Factory 273 Conclusion 274
Profit Maximization and the Competitive Firm’s Supply Curve 282 A Simple Example of Profit Maximization 282 The Marginal-Cost Curve and the Firm’s Supply Decision 283 The Firm’s Short-Run Decision to Shut Down 285 Spilt Milk and Other Sunk Costs 286 Case Study: Near-Empty Restaurants and Off-Season Miniature Golf 287 The Firm’s Long-Run Decision to Exit or Enter a Market 288 Measuring Profit in Our Graph for the Competitive Firm 288 The Supply Curve in a Competitive Market 289 The Short Run: Market Supply with a Fixed Number of Firms 290 The Long Run: Market Supply with Entry and Exit 290 Why Do Competitive Firms Stay in Business If They Make Zero Profit? 292 A Shift in Demand in the Short Run and Long Run 293 Why the Long-Run Supply Curve Might Slope Upward 293 Conclusion: Behind the Supply Curve 295
Chapter 15
Monopoly 299 Why Monopolies Arise 300 Monopoly Resources 301 Government-Created Monopolies 301 Natural Monopolies 302 How Monopolies Make Production and Pricing Decisions 303 Monopoly versus Competition 303 A Monopoly’s Revenue 304 Profit Maximization 306 A Monopoly’s Profit 308 FYI: Why a Monopoly Does Not Have a Supply Curve 308 Case Study: Monopoly Drugs versus Generic Drugs 309 The Welfare Cost of Monopolies 310 The Deadweight Loss 311 The Monopoly’s Profit: A Social Cost? 313
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xxiv contents
Price Discrimination 314 A Parable about Pricing 314 The Moral of the Story 315 The Analytics of Price Discrimination 315 Examples of Price Discrimination 317 Public Policy toward Monopolies 318 In The News: TKTS and Other Schemes 318 Increasing Competition with Antitrust Laws 319 In The News: President Obama’s Antitrust Policy 320 Regulation 321 Public Ownership 323 Doing Nothing 323
Case Study: OPEC and the World Oil Market 358 Other Examples of the Prisoners’ Dilemma 358 The Prisoners’ Dilemma and the Welfare of Society 360 Why People Sometimes Cooperate 360 Case Study: The Prisoners’ Dilemma Tournament 361 Public Policy toward Oligopolies 362 Restraint of Trade and the Antitrust Laws 362 Case Study: An Illegal Phone Call 363 Controversies over Antitrust Policy 363 Case Study: The Microsoft Case 365 Conclusion 366 In The News: The Next Big Antitrust Target? 367
Conclusion: The Prevalence of Monopolies 323
Chapter 16
Monopolistic Competition 329 Between Monopoly and Perfect Competition 330 Competition with Differentiated Products 332 The Monopolistically Competitive Firm in the Short Run 332 The Long-Run Equilibrium 332 Monopolistic versus Perfect Competition 335 Monopolistic Competition and the Welfare of Society 336 In The News: Insufficient Variety as a Market Failure 338 Advertising 338 The Debate over Advertising 340 Case Study: Advertising and the Price of Eyeglasses 340 Advertising as a Signal of Quality 341 FYI: Galbraith versus Hayek 342 Brand Names 343 Conclusion 344
Chapter 17
Oligopoly 349 Markets with Only a Few Sellers 350 A Duopoly Example 350 Competition, Monopolies, and Cartels 351 In The News: Public Price Fixing 352 The Equilibrium for an Oligopoly 353 How the Size of an Oligopoly Affects the Market Outcome 354 The Economics of Cooperation 355 The Prisoners’ Dilemma 355 Oligopolies as a Prisoners’ Dilemma 357
Economics VI The of Labor Markets
Part
373
Chapter 18
The Markets for the Factors of Production 375 The Demand for Labor 376 The Competitive Profit-Maximizing Firm 377 The Production Function and the Marginal Product of Labor 377 The Value of the Marginal Product and the Demand for Labor 379 What Causes the Labor-Demand Curve to Shift? 380
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contents
FYI: Input Demand and Output Supply: Two Sides of the Same Coin 381 FYI: The Luddite Revolt 382 The Supply of Labor 383 The Trade-off between Work and Leisure 383 What Causes the Labor-Supply Curve to Shift? 383 Equilibrium in the Labor Market 384 Shifts in Labor Supply 385 In The News: The Economics of Immigration 386 Shifts in Labor Demand 386 Case Study: Productivity and Wages 387 FYI: Monopsony 389 The Other Factors of Production: Land and Capital 389 Equilibrium in the Markets for Land and Capital 390 FYI: What Is Capital Income? 391 Linkages among the Factors of Production 391 Case Study: The Economics of the Black Death 392 Conclusion 393
Chapter 19
Earnings and Discrimination 397
xxv
The Measurement of Inequality 416 U.S. Income Inequality 416 Inequality around the World 417 The Poverty Rate 419 Problems in Measuring Inequality 420 Case Study: Alternative Measures of Inequality 421 In The News: What’s Wrong with the Poverty Rate? 422 Economic Mobility 423 The Political Philosophy of Redistributing Income 424 Utilitarianism 424 Liberalism 425 Libertarianism 427 Policies to Reduce Poverty 427 Minimum-Wage Laws 428 Welfare 428 Negative Income Tax 429 In-Kind Transfers 430 In The News: The Root Cause of a Financial Crisis 430 Antipoverty Programs and Work Incentives 431 Conclusion 432
Some Determinants of Equilibrium Wages 398 Compensating Differentials 398 Human Capital 398 Case Study: The Increasing Value of Skills 399 Ability, Effort, and Chance 400 Case Study: The Benefits of Beauty 401 An Alternative View of Education: Signaling 402 The Superstar Phenomenon 402 In The News: The Human Capital of Terrorists 403 Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and Efficiency Wages 404 The Economics of Discrimination 405 Measuring Labor-Market Discrimination 405 Case Study: Is Emily More Employable than Lakisha? 407 Discrimination by Employers 407 Case Study: Segregated Streetcars and the Profit Motive 408 Discrimination by Customers and Governments 408 Case Study: Discrimination in Sports 409 In The News: Gender Differences 410 Conclusion 411
Chapter 20
Income Inequality and Poverty 415
Part
VII Topics for Further Study 437
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xxvi contents
Chapter 21
The Theory of Consumer Choice 439 The Budget Constraint: What the Consumer Can Afford 440
People Aren’t Always Rational 480 People Care about Fairness 481 In The News: Sin Taxes 482 People Are Inconsistent over Time 484 Conclusion 485
Preferences: What the Consumer Wants 441 Representing Preferences with Indifference Curves 442 Four Properties of Indifference Curves 443 Two Extreme Examples of Indifference Curves 444 Optimization: What the Consumer Chooses 446 The Consumer’s Optimal Choices 446 FYI: Utility: An Alternative Way to Describe Preferences and Optimization 447 How Changes in Income Affect the Consumer’s Choices 448 How Changes in Prices Affect the Consumer’s Choices 449 Income and Substitution Effects 450 Deriving the Demand Curve 452 Three Applications 453 Do All Demand Curves Slope Downward? 453 Case Study: The Search for Giffen Goods 454 How Do Wages Affect Labor Supply? 454 Case Study: Income Effects on Labor Supply: Historical Trends, Lottery Winners, and the Carnegie Conjecture 457 In The News: Backward-sloping Labor Supply in Kiribati 458 How Do Interest Rates Affect Household Saving? 459 Conclusion: Do People Really Think This Way? 461
Part
Data of VIII The Macroeconomics
Chapter 22
Frontiers of Microeconomics 467 Asymmetric Information 468 Hidden Actions: Principals, Agents, and Moral Hazard 468 FYI: Corporate Management 469 Hidden Characteristics: Adverse Selection and the Lemons Problem 470 Signaling to Convey Private Information 471 Case Study: Gifts as Signals 471 Screening to Uncover Private Information 472 Asymmetric Information and Public Policy 473 Political Economy 473 The Condorcet Voting Paradox 474 Arrow’s Impossibility Theorem 475 In The News: Arrow’s Problem in Practice 476 The Median Voter Is King 478 Politicians Are People Too 479 Behavioral Economics 480
489
Chapter 23
Measuring a Nation’s Income 491 The Economy’s Income and Expenditure 492 The Measurement of Gross Domestic Product 494 “GDP Is the Market Value…” 494 “… of All …” 494 “… Final …” 495 “… Goods and Services …” 495 “… Produced …” 495 “… Within a Country …” 495 “… In a Given Period of Time.” 495 The Components of GDP 496 FYI: Other Measures of Income 497 Consumption 497 Investment 497 Government Purchases 498
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contents xxvii
Net Exports 498 Case Study: The Components of U.S. GDP 499 Real versus Nominal GDP 499 A Numerical Example 500 The GDP Deflator 501 Case Study: Real GDP over Recent History 502 Is GDP a Good Measure of Economic Well-Being? 503 In The News: The Underground Economy 504 In The News: Beyond Gross Domestic Product 506 Case Study: International Differences in GDP and the Quality of Life 507 Conclusion 508
Chapter 24
Measuring the Cost of Living 513 The Consumer Price Index 514 How the Consumer Price Index Is Calculated 514 FYI: What Is in the CPI’s Basket? 516 Problems in Measuring the Cost of Living 517 In The News: Shopping for the CPI 518 The GDP Deflator versus the Consumer Price Index 520 Correcting Economic Variables for the Effects of Inflation 521 Dollar Figures from Different Times 522 Indexation 522 FYI: Mr. Index Goes to Hollywood 523 Real and Nominal Interest Rates 523 Case Study: Interest Rates in the U.S. Economy 525 Conclusion 526
Part
IX in ThetheReal Economy Long Run
529
Chapter 25
Production and Growth 531 Economic Growth around the World 532 FYI: A Picture Is Worth a Thousand Statistics 534 FYI: Are You Richer Than the Richest American? 536 Productivity: Its Role and Determinants 536 Why Productivity Is So Important 536 How Productivity Is Determined 537 FYI: The Production Function 539 Case Study: Are Natural Resources a Limit to Growth? 539 Economic Growth and Public Policy 540 Saving and Investment 540 Diminishing Returns and the Catch-Up Effect 541 Investment from Abroad 542 Education 543 Health and Nutrition 544 In The News: Promoting Human Capital 545 Property Rights and Political Stability 546 Free Trade 547 Research and Development 548 Population Growth 548 In The News: One Economist’s Answer 550 Conclusion: The Importance of Long-Run Growth 552
Chapter 26
Saving, Investment, and the Financial System 555 Financial Institutions in the U.S. Economy 556 Financial Markets 556 Financial Intermediaries 558 FYI: Key Numbers for Stock Watchers 559 Summing Up 560 FYI: Financial Crises 561 Saving and Investment in the National Income Accounts 561 Some Important Identities 562 The Meaning of Saving and Investment 563 The Market for Loanable Funds 564 Supply and Demand for Loanable Funds 564 Policy 1: Saving Incentives 566
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xxviii contents
Policy 2: Investment Incentives 568 Policy 3: Government Budget Deficits and Surpluses 568 Case Study: The History of U.S. Government Debt 570 Conclusion 572
Chapter 27
The Basic Tools of Finance 577 Present Value: Measuring the Time Value of Money 578 FYI: The Magic of Compounding and the Rule of 70 580 Managing Risk 580 Risk Aversion 580 The Markets for Insurance 581 Diversification of Firm-Specific Risk 582 The Trade-off between Risk and Return 583
Minimum-Wage Laws 606 FYI: Who Earns the Minimum Wage? 608 Unions and Collective Bargaining 608 The Economics of Unions 609 Are Unions Good or Bad for the Economy? 610 The Theory of Efficiency Wages 610 Worker Health 611 Worker Turnover 611 Worker Quality 611 Worker Effort 612 Case Study: Henry Ford and the Very Generous $5-a-Day Wage 612 Conclusion 613
Asset Valuation 584 Fundamental Analysis 585 The Efficient Markets Hypothesis 585 In The News: A Cartoonist’s Guide to Stock Picking 586 Case Study: Random Walks and Index Funds 587 In The News: Is the Efficient Markets Hypothesis Kaput? 588 Market Irrationality 590 Conclusion 590
Chapter 28
Unemployment 593 Identifying Unemployment 594 How Is Unemployment Measured? 594 Case Study: Labor-Force Participation of Men and Women in the U.S. Economy 597 Does the Unemployment Rate Measure What We Want It To? 598 How Long Are the Unemployed without Work? 600 Why Are There Always Some People Unemployed? 600 In The News: The Rise of Long-Term Unemployment 601 FYI: The Jobs Number 602 Job Search 602 Why Some Frictional Unemployment Is Inevitable 603 Public Policy and Job Search 603 Unemployment Insurance 604 In The News: How Much Do the Unemployed Respond to Incentives? 604
Part
and Prices X Min oney the Long Run
617
Chapter 29
The Monetary System 619 The Meaning of Money 620 The Functions of Money 621 The Kinds of Money 621 In The News: Mackereleconomics 622 Money in the U.S. Economy 623 FYI: Why Credit Cards Aren’t Money 624 Case Study: Where Is All the Currency? 624
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contents xxix
The Federal Reserve System 625 The Fed’s Organization 626 The Federal Open Market Committee 626 Banks and the Money Supply 627 The Simple Case of 100-Percent-Reserve Banking 627 Money Creation with Fractional-Reserve Banking 628 The Money Multiplier 629 Bank Capital, Leverage, and the Financial Crisis of 2008–2009 631 The Fed’s Tools of Monetary Control 632 How the Fed Influences the Quantity of Reserves 633 How the Fed Influences the Reserve Ratio 634 Problems in Controlling the Money Supply 635 Case Study: Bank Runs and the Money Supply 636 The Federal Funds Rate 636 In The News: Bernanke on the Fed’s Toolbox 638 Conclusion 640
Chapter 30
Money Growth and Inflation 643 The Classical Theory of Inflation 644 The Level of Prices and the Value of Money 645 Money Supply, Money Demand, and Monetary Equilibrium 645 The Effects of a Monetary Injection 647 A Brief Look at the Adjustment Process 648 The Classical Dichotomy and Monetary Neutrality 649 Velocity and the Quantity Equation 650 Case Study: Money and Prices during Four Hyperinflations 652 The Inflation Tax 652 FYI: Hyperinflation in Zimbabwe 654 The Fisher Effect 655 The Costs of Inflation 656 A Fall in Purchasing Power? The Inflation Fallacy 656 Shoeleather Costs 657 Menu Costs 658 Relative-Price Variability and the Misallocation of Resources 658 Inflation-Induced Tax Distortions 659 Confusion and Inconvenience 660 A Special Cost of Unexpected Inflation: Arbitrary Redistributions of Wealth 661 Inflation Is Bad, But Deflation May Be Worse 662 Case Study: The Wizard of Oz and the Free-Silver Debate 662 In The News: Inflationary Threats 664 Conclusion 664
Part
The Macro XI economics of Open Economies
669
Chapter 31
Open-Economy Macroeconomics: Basic Concepts 671 The International Flows of Goods and Capital 672 The Flow of Goods: Exports, Imports, and Net Exports 672 Case Study: The Increasing Openness of the U.S. Economy 673 In The News: Breaking Up the Chain of Production 674 The Flow of Financial Resources: Net Capital Outflow 676 The Equality of Net Exports and Net Capital Outflow 677 Saving, Investment, and Their Relationship to the International Flows 678 Summing Up 679 Case Study: Is the U.S. Trade Deficit a National Problem? 680 The Prices for International Transactions: Real and Nominal Exchange Rates 682 Nominal Exchange Rates 682 FYI: The Euro 683 Real Exchange Rates 684
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xxx
contents
A First Theory of Exchange-Rate Determination: Purchasing-Power Parity 685 The Basic Logic of Purchasing-Power Parity 686 Implications of Purchasing-Power Parity 686 Case Study: The Nominal Exchange Rate during a Hyperinflation 688 Limitations of Purchasing-Power Parity 689 Case Study: The Hamburger Standard 689 Conclusion 690
Chapter 32
A Macroeconomic Theory of the Open Economy 695 Supply and Demand for Loanable Funds and for Foreign-Currency Exchange 696 The Market for Loanable Funds 696 The Market for Foreign-Currency Exchange 698 FYI: Purchasing-Power Parity as a Special Case 700 Equilibrium in the Open Economy 701 Net Capital Outflow: The Link between the Two Markets 701 Simultaneous Equilibrium in Two Markets 702 FYI: Disentangling Supply and Demand 704 How Policies and Events Affect an Open Economy 704 Government Budget Deficits 704 Trade Policy 706 Political Instability and Capital Flight 709 Case Study: Capital Flows from China 711 In The News: Alternative Exchange-Rate Regimes 712 Conclusion 712
Part
Short-Run XII Economic
Fluctuations
717
Chapter 33
Aggregate Demand and Aggregate Supply 719 Three Key Facts about Economic Fluctuations 720 Fact 1: Economic Fluctuations Are Irregular and Unpredictable 720 Fact 2: Most Macroeconomic Quantities Fluctuate Together 722 Fact 3: As Output Falls, Unemployment Rises 722 Explaining Short-Run Economic Fluctuations 722 The Assumptions of Classical Economics 722 The Reality of Short-Run Fluctuations 723 In The News: The Social Influences of Economic Downturns 724 The Model of Aggregate Demand and Aggregate Supply 724 The Aggregate-Demand Curve 726 Why the Aggregate-Demand Curve Slopes Downward 726 Why the Aggregate-Demand Curve Might Shift 729 The Aggregate-Supply Curve 731 Why the Aggregate-Supply Curve Is Vertical in the Long Run 731 Why the Long-Run Aggregate-Supply Curve Might Shift 732 Using Aggregate Demand and Aggregate Supply to Depict Long-Run Growth and Inflation 734 Why the Aggregate-Supply Curve Slopes Upward in the Short Run 734 Why the Short-Run Aggregate-Supply Curve Might Shift 738 Two Causes of Economic Fluctuations 740 The Effects of a Shift in Aggregate Demand 740 FYI: Monetary Neutrality Revisited 743 Case Study: Two Big Shifts in Aggregate Demand: The Great Depression and World War II 744 Case Study: The Recession of 2008–2009 745 In The News: Modern Parallels to the Great Depression 746 The Effects of a Shift in Aggregate Supply 748 Case Study: Oil and the Economy 750 FYI: The Origins of the Model of Aggregate Demand and Aggregate Supply 751 Conclusion 752
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contents xxxi
Chapter 34
The Influence of Monetary and Fiscal Policy on Aggregate Demand 757 How Monetary Policy Influences Aggregate Demand 758 The Theory of Liquidity Preference 759 The Downward Slope of the Aggregate-Demand Curve 761 FYI: Interest Rates in the Long Run and the Short Run 762 Changes in the Money Supply 764 The Role of Interest-Rate Targets in Fed Policy 765 FYI: The Zero Lower Bound 766 Case Study: Why the Fed Watches the Stock Market (and Vice Versa) 766
Rational Expectations and the Possibility of Costless Disinflation 800 The Volcker Disinflation 801 The Greenspan Era 802 The Phillips Curve during the Financial Crisis 804 In The News: Do We Need More Inflation? 805 Conclusion 806
How Fiscal Policy Influences Aggregate Demand 767 Changes in Government Purchases 768 The Multiplier Effect 768 A Formula for the Spending Multiplier 769 Other Applications of the Multiplier Effect 770 The Crowding-Out Effect 771 Changes in Taxes 772 FYI: How Fiscal Policy Might Affect Aggregate Supply 773 Using Policy to Stabilize the Economy 773 The Case for Active Stabilization Policy 773 Case Study: Keynesians in the White House 775 The Case against Active Stabilization Policy 775 In The News: How Large Is the Fiscal Policy Multiplier? 776 Automatic Stabilizers 777 In The News: Offbeat Indicators 779 Conclusion 780
Chapter 35
The Short-Run Trade-off between Inflation and Unemployment 785 The Phillips Curve 786 Origins of the Phillips Curve 786 Aggregate Demand, Aggregate Supply, and the Phillips Curve 787 Shifts in the Phillips Curve: The Role of Expectations 789 The Long-Run Phillips Curve 789 The Meaning of “Natural� 791 Reconciling Theory and Evidence 792 The Short-Run Phillips Curve 793 The Natural Experiment for the Natural-Rate Hypothesis 794 Shifts in the Phillips Curve: The Role of Supply Shocks 796 The Cost of Reducing Inflation 798 The Sacrifice Ratio 799
inal XIII FThoughts
Part
809
Chapter 36
Six Debates over Macroeconomic Policy 811 Should Monetary and Fiscal Policymakers Try to Stabilize the Economy? 812 Pro: Policymakers Should Try to Stabilize the Economy 812 Con: Policymakers Should Not Try to Stabilize the Economy 812 Should the Government Fight Recessions with Spending Hikes Rather Than Tax Cuts? 814 Pro: The Government Should Fight Recessions with Spending Hikes 814 Con: The Government Should Fight Recessions with Tax Cuts 815
Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
xxxii contents
Should Monetary Policy Be Made by Rule Rather Than by Discretion? 816 Pro: Monetary Policy Should Be Made by Rule 817 Con: Monetary Policy Should Not Be Made by Rule 818 FYI: Inflation Targeting 819 Should the Central Bank Aim for Zero Inflation? 819 Pro: The Central Bank Should Aim for Zero Inflation 820 Con: The Central Bank Should Not Aim for Zero Inflation 821 In The News: What Is the Optimal Inflation Rate? 822 Should the Government Balance Its Budget? 823 Pro: The Government Should Balance Its Budget 823 Con: The Government Should Not Balance Its Budget 824
In The News: Dealing with Debt and Deficits 826 Should the Tax Laws Be Reformed to Encourage Saving? 826 Pro: The Tax Laws Should Be Reformed to Encourage Saving 826 Con: The Tax Laws Should Not Be Reformed to Encourage Saving 828 Conclusion 829 Glossary 833 Index 839
Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.