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Chairman, Board of Governors of the Federal Reserve System KATE ANTONOVICS University of California, San Diego ORI HEFFETZ Cornell University with special contribution by PER J NORANDER Missouri State University PRINCIPLES OF MACROECONOMICS, SIXTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2016 by McGrawHill Education All rights reserved Printed in the United States of America Previous editions © 2013, 2009, and 2007 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper DOW/DOW ISBN 978-0-07-351899-2 MHID 0-07-351899-9 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@ The Speed of Thought: Using a Digital Nervous System New York: Warner Books, USA, 1999 Chapter 5, page 117: Babe Ruth, Reported reply when a reporter objected that the salary Ruth was demanding ($80,000) was more than that of President Herbert Hoover’s ($75,000), quoted in Benjamin G Rader, Baseball: A History of America’s Game, Chicago, IL: University of Illinois Press, 2002, p 134; p 434: Javier C Hernandez, “Prices of Consumer Goods Hold Steady, Indicating That Inflation Is at Bay,” The New York Times, March 18, 2010 Chapter 10, page 279: M Douglas Ivester, The New York Times, October 28, 1999, p C1; Constance L Hays, “Variable-Price Coke Machine Being Tested,” The New York Times, October 28, 1999 Chapter 11, page 308: The studies are “Did the 2008 Tax Rebates Stimulate Short-Term Growth?”, “Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output as of September 2009,” and “Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from October 2009 through December 2009.” All three studies are available at www.cbo.gov/publications/collections/collections.cfm?collect=12 Library of Congress Control Number: 2014959483 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites www.mhhe.com D E D I C AT I O N For Ellen R H F For Anna B S B For Fiona and Henry K A For Katrina, Eleanor, and Daniel O H A BOUT THE AUTHOR S ROBERT H FRANK BEN S BERNANKE Robert H Frank is the H J Louis Professor of Management and Professor of Economics at Cornell’s Johnson School of Management, where he has taught since 1972 His “Economic View” column appears regularly in The New York Times He is a Distinguished Senior Fellow at Demos After receiving his B.S from Georgia Tech in 1966, he taught math and science for two years as a Peace Corps Volunteer in rural Nepal He received his M.A in statistics in 1971 and his Ph.D in economics in 1972 from The University of California at Berkeley During leaves of absence from Cornell, he has served as chief economist for the Civil Aeronautics Board (1978–1980), a Fellow at the Center for Advanced Study in the Behavioral Sciences (1992–93), Professor of American Civilization at l’École des Hautes Études en Sciences Sociales in Paris (2000–01), and the Peter and Charlotte Schoenfeld Visiting Faculty Fellow at the NYU Stern School of Business in 2008–09 His papers have appeared in the American Economic Review, Econometrica, the Journal of Political Economy, and other leading professional journals Professor Frank is the author of a best-selling intermediate economics textbook—Microeconomics and Behavior, Ninth Edition (Irwin/McGraw-Hill, 2015) His research has focused on rivalry and cooperation in economic and social behavior His books on these themes include Choosing the Right Pond (Oxford, 1995), Passions Within Reason (W W Norton, 1988), What Price the Moral High Ground? (Princeton, 2004), Falling Behind (University of California Press, 2007), The Economic Naturalist (Basic Books, 2007), The Economic Naturalist’s Field Guide (Basic Books, 2009), and The Darwin Economy (Princeton, 2011), which have been translated into 22 languages The Winner-Take-All Society (The Free Press, 1995), co-authored with Philip Cook, received a Critic’s Choice Award, was named a Notable Book of the Year by The New York Times, and was included in BusinessWeek’s list of the 10 best books of 1995 Luxury Fever (The Free Press, 1999) was named to the Knight-Ridder Best Books list for 1999 Professor Frank has been awarded an Andrew W Mellon Professorship (1987–1990), a Kenan Enterprise Award (1993), and a Merrill Scholars Program Outstanding Educator Citation (1991) He is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought He was awarded the Johnson School’s Stephen Russell Distinguished Teaching Award in 2004, 2010, and 2012, and the School’s Apple Distinguished Teaching Award in 2005 His introductory microeconomics course has graduated more than 7,000 enthusiastic economic naturalists over the years Professor Bernanke received his B.A in economics from Harvard University in 1975 and his Ph.D in economics  from MIT in 1979 He taught at the Stanford Graduate School of Business from 1979 to 1985 and moved to  Princeton University in 1985, where he was named the  Howard Harrison and Gabrielle Snyder Beck Professor of Economics and Public Affairs, and where he served as Chairman of the Economics Department Professor Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System—his second term expired January 31, 2014 Professor Bernanke also serves as Chairman of the Federal Open Market Committee, the Fed’s principal monetary policymaking body He was appointed as a member of the Board to a full 14-year term, which expires January 31, 2020 Before his appointment as Chairman, Professor Bernanke was Chairman of the President’s Council of Economic Advisers, from June 2005 to January 2006 Professor Bernanke’s intermediate textbook, with Andrew Abel and Dean Croushore, Macroeconomics, Eighth Edition (Addison-Wesley, 2011), is a best seller in its field He has authored more than 50 scholarly publications in macroeconomics, macroeconomic history, and finance He has done significant research on the causes of the Great Depression, the role of financial markets and institutions in the business cycle, and measurement of the effects of monetary policy on the economy Professor Bernanke has held a Guggenheim Fellowship and a Sloan Fellowship, and he is a Fellow of the Econometric Society and of the American Academy of Arts and Sciences He served as the Director of the Monetary Economics Program of the National Bureau of Economic Research (NBER) and as a member of the NBER’s Business Cycle Dating Committee In July 2001, he was appointed editor of the American Economic Review Professor Bernanke’s work with civic and professional groups includes having served two terms as a member of the Montgomery Township (N.J.) Board of Education PR EFAC E KATE ANTONOVICS Professor Antonovics received her B.A from Brown University in 1993 and her Ph.D in economics from the University of Wisconsin in 2000 Shortly thereafter, she joined the faculty in the Economics Department at the University of California, San Diego, where she has been ever since Professor Antonovics is known for her superb teaching and her innovative use of technology in the classroom Her highly popular introductory-level microeconomics course regularly enrolls over 450 students each fall She also teaches labor economics at both the undergraduate and graduate level In 2012, she received the UCSD Department of Economics award for best undergraduate teaching Professor Antonovics’s research has focused on racial discrimination, gender discrimination, affirmative action, intergenerational income mobility, learning, and wage dynamics Her papers have appeared in the American Economic Review, the Review of Economics and Statistics, the Journal of Labor Economics, and the Journal of Human Resources She is a member of both the American Economic Association and the Society of Labor Economists ORI HEFFETZ Professor Heffetz received his B.A in physics and philosophy from Tel Aviv University in 1999 and his Ph.D in economics from Princeton University in 2005 He is an Associate Professor of Economics at the Samuel Curtis Johnson Graduate School of Management at Cornell University, where he has taught since 2005 Bringing the real world into the classroom, Professor Heffetz has created a unique macroeconomics course that introduces basic concepts and tools from economic theory and applies them to current news and global events His popular classes are taken by hundreds of students every year, on the Cornell Ithaca campus and, via live videoconferencing, in dozens of cities across the U.S., Canada, and beyond Professor Heffetz’s research studies the social and cultural aspects of economic behavior, focusing on the mechanisms that drive consumers’ choices and on the links between economic choices, individual well-being, and policymaking He has published scholarly work on household consumption patterns, individual economic decision making, and survey methodology and measurement He was a visiting researcher at the Bank of Israel during 2011, is currently a Faculty Research Fellow at the National Bureau of Economic Research (NBER), and serves on the editorial board of Social Choice and Welfare lthough many millions of dollars are spent each year on introductory economics instruction in American colleges and universities, the return on this investment has been disturbingly low Studies have shown, for example, that several months after having taken a principles of economics course, former students are no better able to answer simple economic questions than others who never even took the course Most students, it seems, leave our introductory courses without having learned even the most important basic economic principles The problem, in our view, is that these courses almost always try to teach students far too much In the process, really important ideas get little more coverage than minor ones, and everything ends up going by in a blur Many instructors ask themselves, “How much can I cover today?” when instead they should be asking, “How much can my students absorb?” Our textbook grew out of our conviction that students will learn far more if we attempt to cover much less Our basic premise is that a small number of basic principles most of the heavy lifting in economics, and that if we focus narrowly and repeatedly on those principles, students can actually master them in just a single semester The enthusiastic reactions of users of previous editions of our textbook affirm the validity of this premise Avoiding excessive reliance on formal mathematical derivations, we present concepts intuitively through examples drawn from familiar contexts We rely throughout on a well-articulated list of seven Core Principles, which we reinforce repeatedly by illustrating and applying each principle in numerous contexts We ask students periodically to apply these principles themselves to answer related questions, exercises, and problems Throughout this process, we encourage students to become “economic naturalists,” people who employ basic economic principles to understand and explain what they observe in the world around them An economic naturalist understands, for example, that infant safety seats are required in cars but not in airplanes because the marginal cost of space to accommodate these seats is typically zero in cars but often hundreds of dollars in airplanes Scores of such examples are sprinkled throughout the book Each one, we believe, poses a question that should make any curious person eager to learn the answer These examples stimulate interest while teaching students to see each feature of their economic landscape as the reflection of one or more of the Core Principles Students talk about these examples with their friends and families Learning economics is like learning a language In each case, there is no substitute for actually speaking By inducing students to speak economics, the Economic Naturalist examples serve this purpose A ix www.downloadslide.com I-2 INDEX Basic Keynesian model—Cont fiscal policy role, 284 focus on short run, 372 key assumption, 284–286, 359 multiplier, 301, 317–318 planned aggregate expenditures versus actual spending, 287 components of, 286 consumer spending, 288–290 and output, 290–292 planned spending and output gaps, 296–301 versus self-correcting economy, 370–372 short-run equilibrium output, 293–296 on taxes and transfer payments, 305 theories of short-term fluctuations, 284 Basket of goods and services base-year basket, 119 in CPI calculation, 120–121 Baumol, William, 192 Behrens, William W., Jr., 198n Benefits compared to costs, measured in proportion, 6–7 relevant, 8–9 Bequest saving definition, 218 in Japan, 218 Bernanke, Ben S., 273n, 378n, 384n, 386n Birkhaman, 33, 37 Blanchard, Olivier, 384n, 392n BMW, 16 Board of Governors, 321 Bondholders, 226 selling in bond market, 227 Bond market, 227 allocation of savings, 231–232 informational role, 230–231 risk sharing and diversification, 231–232 Bond prices definition, 227 relation to interest rates, 227–228, 341 Bonds coupon payments, 226 coupon rate, 226 definition, 226 high-yield, 226 maturation date, 226 municipal, 226, 227 mutual funds for, 232 principal amount, 226 short- vs long-term, 278 tax treatment, 226 term of, 226 Bonds, Barry, 117, 118, 124 Boom economic, 266 in stock market in 1990s, 334 Boskin Commission Report controversy over, 128 inflation overstated, 127 quality adjustment bias, 127 substitution bias, 128 Boston Red Sox, 37 Bracket creep, 131 Braille dots on ATMs, 16–17 Brazil, real GDP per person 1870–2008, 179–180 Break-even calling volume, 29 Brin, Sergei, 191 British pound, 400–402 Bull market of 1990s, 211–212 Bureau of Economic Analysis, 104–106 Bureau of Labor Statistics attempts to correct CPI, 127 calculation of consumer price index, 119 estimates on discouraged workers, 166 unemployment survey data for 2011, 162 unemployment rate 1960–2010, 163 Bush, George W., 216, 236, 307, 308 Bush administration (2nd), 303, 309 Business Cycle Dating Committee, 267 Business cycles, see also Expansion; Recessions AD-AS model for understanding, 352–370 causes of demand shocks, 366–367 inflation shocks, 367–368 definition, 264 using AD-AS model to study, 368–370 Businesses, demand for money, 337 Business fixed investment, 100 Business saving, 214–215 component of national saving, 217 incentives for, 236 Buyers effect on price and quantity, 62–65 income effect, 63 substitution effect, 63 Buyer’s reservation price definition, 64 in voluntary exchange, 83 Buyer’s surplus, 83 Buying power; see also Purchasing power indexing to maintain, 125–126 of production workers 1970–2010, 125 C Canada comparative advantage in, 38 effect of U.S recession 2007–2009, 300 hours of work, 392 nominal exchange rate for dollar, 401 real GDP growth 2002–2010, 268 Canadian dollar, 401–402 Capital creating, 197 diminishing returns to, 188 Capital depreciation allowance, 131–132 Capital formation, 198, 208 and investment, 223–226 reliance on foreign savers for, 425–426 Capital gains, 210–212 definition, 210 effect on wealth, 211–212 from stocks, 228 tax rate reduction, 236 Capital goods business fixed investment, 100 definition, 100 enhancing productivity, 186–187 as final goods, 95, 100 investment in, 197 in measuring GDP, 96 Capital income, 103–104 Capital inflows definition, 420 and real interest rate, 420–421 and saving and investment, 423–425 from trade deficit, 425 Capital investment per worker, 48 Capitalist system, 59 Capital losses, 210–212 definition, 210 effect on wealth, 209–212 Capital outflows definition, 420 and real interest rate, 420–421 Car heaters, 16 Carnegie, Andrew, 191 Carter, Jimmy, 388 Cash advantages of, 247 cost of holding during inflation, 132 economizing on holding, 132 Cash on the table, 83 Casino economy, 133 Central bank independence contributing factors, 385 definition and merits of, 385 Federal Reserve System, 385 and lower rate of inflation, 385 Central Bank of Brazil, 386 Central bank reputation as inflation dove, 388 as inflation hawk, 388 Central banks, 244; see also Federal Reserve System Bank of Canada, 386 Bank of England, 386 Bank of Israel, 386 Central Bank of Brazil, 386 credibility of monetary policy, 384–388 central bank independence, 385 reputation, 388 target rate announcements, 386–388 effect of type of exchange rate, 403–404 European Central Bank, 405 making monetary policy, 255 monetary policy, 320 and money supply, 255–256 oversight of financial markets, 320 Reserve Bank of New Zealand, 386 Central planning, 194 abandoned in China, 62 versus markets, 61–62 Chain weighting, 106n Change in aggregate demand, 355 Change in demand definition, 72–73 shift of demand curve, 73 Change in quantity demanded, 72–73 Change in quantity supplied, 73 Change in supply, 73 Chaplin, Charlie, 50–51 Checks, 250 China abandonment of central planning, 61 environmental problems, 109 medieval economic stagnation, 191–192 real GDP growth, 109 real GDP per person 1870–2008, 180 U.S trade deficit with, 424 Choice rational vs irrational, 13 under scarcity, 3–6 Chronically unemployed, 166 Civil War, hyperinflation during, 134, 259 Class size cost-benefit analysis, 2–3 economics classes, 1–2 Clinton, Bill, 51 Closed economy, monetary policy, 411 CNBC, 319 Coca-Cola Company, 286 weather-sensitive vending machine, 279 Coincident indicators, 267 Commercial banks; see Banking system Commercial crises, 267 Communication complex, 53 in early America, 177 Communism difficulty in recovering from, 194 reasons for failure absence of free markets, 194 absence of property rights, 193 political/legal environment, 193 Communist countries, former and remaining, 61 Communist Manifesto, 267 Companies, investment decisions, 224 Comparative advantage, 33–53 versus absolute advantage, 34 of banks, 244 definition, 34 www.downloadslide.com INDEX economic naturalist baseball’s 400 hitters, 37–38 digital video market, 39 free-trade agreements, 51 outsourcing, 52–53 exchange and opportunity cost, 34–39 gains from specialization and exchange, 44–47 and globalization, 157 and international trade, 51–53 principle of, 35–38 production possibilities curve effect of individual productivity, 42–44 many-person economy, 45–47 shift factors, 47–51 two-person economy, 39–45 productivity information, 35–37 sources of individual level, 38 national level, 38 noneconomic factors, 38–39 from specialization, 34 from technology, 189 usefulness of money, 247 Competition, and labor unions, 169 Complements definition, 73 effect on demand curve, 73–74 Complex communication, 53 Compound interest definition, 181 example, 180–181 formula, 181–182 Computer game purchase, Computerization, and outsourcing, 52–53 Computers with “free” software, 15 invention of, 191 investment in, 225 Confederate States of America, 135, 259 Congressional Budget Office, 273, 308 Constant, 22 Consumer price index adjustments for inflation by deflating, 122–123 deflating a nominal quantity, 123–125 by indexing, 119 indexing to maintain buying power, 125–126 base year, 118, 119 base-year basket, 119 Boskin Commission Report on inflation overstated, 127 quality adjustment bias, 127 substitution bias, 128 Bureau of Labor Statistics attempt to correct, 128 construction of, 119 construction of, 118–119 definition, 118 deflating process, 122 formula, 120 impact of indexing on federal budget, 127 indexing procedures, 119 and inflation, 120–122 price level vs relative price, 130 as true measure of inflation, 126–128 and typical family’s cost of living, 119–120 values 1929–1933, 121 Consumers, benefits of trade, 159 Consumer spending and economy, 288–290 and stock market decline 2000–2002, 289–290 Consumption, 100 autonomous, 289 sacrificed to capital formation, 198–200 versus saving, 219–220 Consumption expenditures and consumer price index, 119–120 and disposable income, 288–289 durable goods, 100 effect of real interest rate on, 329 effect of tax cuts, 306–307 by households, 213 insufficient, 284 nondurable goods, 100 in planned aggregate expenditures, 286 quality adjustment bias, 127 relation to output gaps, 274–275 services, 100 substitution bias, 128 Consumption function definition, 288 and disposable income, 289–290 of United States 1960–2010, 288 Consumption tax vs income tax, 236 Contraction, 264; see also Recessions Contractionary policy, 302 to end expansionary gap, 331–332 Core competencies, 52 Core rate of inflation, 122 Corporations, bond issues, 226–228 Cost(s) compared to benefits, of economic growth consumption sacrificed to capital formation, 198 creating new capital, 197 investment in capital goods, 197 research and development costs, 198 of holding money, 337 of inflation, 130–134 measured in proportion, 6–7 of price changes, 285 of public goods and services, 95 relevant, 8–9 of research and development, 198 of space shuttle program, 10 of unemployment economic, 164 frictional unemployment, 166 psychological, 164–165 social, 164 structural unemployment, 167 of university classes, 1–2 Cost-benefit principle/analysis, 14 applying, 3–6 computer game purchase, economic surplus, opportunity cost, 4–5 role of economic models, 5–6 Braille dots on ATMs, 16–17 buyer’s reservation price, 64 car heaters, 16 of class size, 2–3 for decision making, 5–6 decision pitfalls failure to think at the margin, 8–12 ignoring implicit costs, 6–8 improper cost measurement, 6–7 definition, economic growth, 199–200 “free” software, 15–16 and government policy, 109 high school completion, 111 holding money, 336–337 hours of work, 108 incentive principle, 13 investment in capital goods, 222–223 investment in computers, 225 marginal analysis in, 9–12 as normative economic principle, 13 of outsourcing, 52 and preferences and tastes, 76 for production, 84 of saving, 219 of schooling, 186 stock purchases, 228 supply of labor, 154 tax rates, 389 I-3 Cost of living CPI as measure of, 119–120 merits of CPI on, 127–128 overstating, 127 Costs of production basis of supply curve, 76 benefits to nonbuyers, 84 causing pollution, 84 effect of decrease on supply curve, 78 effect of increase on supply curve, 77 effect of new technology, 79 in market equilibrium, 84 and price determination, 73–74 Coupon payments, 226 Coupon rate and credit risk, 226 definition, 226 on newly issued bonds, 226–227 short- vs long-term bonds, 226 CPI; see Consumer price index Credibility of monetary policy central bank independence, 385 central bank reputation, 388 definition, 384 target rate announcements, 386–388 Credit, access to, 226 Creditors effect of interest rate changes, 136–138 effects of inflation, 133 Credit risk, 226 Crowding out, by government budget deficits, 235 Cuba, 61 Currencies appreciation, 402–403 depreciation, 402–403 euro, 404–405 strength related to strong economy, 409 Currency board, Argentina, 340 Cyclical unemployment, 167 decline in 1990s, 273 and natural rate of unemployment, 272–274 negative, 273 Okun’s law, 274–276 output gaps and, 271–272 in recession of 2007–2009, 274 in recessions, 275 D Darity, William, Jr., 165n Debtors effect of interest rate changes, 136–138 effects of inflation, 133 Decision making with cost-benefit analysis, 5–6 pitfalls in cost-benefit analysis failure to think at the margin, 8–12 ignoring implicit costs, 7–8 improper measurement, 6–7 summary, 12 Deflating, 122 Deflation, 121 in Japan in 1990s, 387 in United States in 1930s, 387 Demand excess, 67–68 met at preset prices, 284–286 shifts in, 81–82 for stocks, 228–230 Demand curve buyer’s reservation price, 64 and change in demand, 73 definition, 63 downward-sloping, 63–64 effect of increase in cost of production, 77 to find market equilibrium, 66–69 horizontal interpretation, 64 and income effect, 63 www.downloadslide.com I-4 INDEX Demand curve—Cont for labor, 148, 149 and price controls, 83 with rent control, 69–70 shift factors, 76 complements, 73–74 expectations, 76 four rules governing, 80–81 income, 75–76 normal vs inferior goods, 76 preferences and tastes, 76 substitutes, 74–75 shift of, 73 and substitution effect, 63 vertical interpretation, 64 Demand for dollars factors increasing, 409 to purchase U.S assets, 407 to purchase U.S goods, 408 Demand for labor reason for shifts in changes in economy, 150 increase in prices of output, 150–151 productivity improvements, 152–153 and wages demand curve, 149 diminishing returns, 148 example, 148–149 productivity issue, 147–148 value of the marginal product, 148 Demand for money benefits of holding money, 335–337 by businesses, 337 cost-benefit principle, 336 and cost of holding money, 337 definition, 336 by individuals, 337 liquidity preference, 336 macro factors affecting nominal interest rate, 337 price level, 338 real income and output, 337–338 portfolio allocation decision, 336 Demand shock and business cycles, 366 negative, 356 positive, 356 role of stabilization policy, 378–379 expansionary fiscal policy, 379 expansionary monetary policy, 379 and shift in demand curve, 355–356 definition, 356 house prices, 356 Demonstration effects and low U.S saving rate, 221–222 and saving, 221–222 Dependent variable, 21 Deposit insurance, function and drawbacks, 324 Deposits, in banking system, 250–253 Depreciation allowance, 131–132 Depreciation (currency), 402–403 of dollar after 2002, 411 and purchasing power parity, 415–418 relation to inflation, 415–417 in South America, 417 Thai baht, 404 U.S dollar 1985–1987, 417 Depression, 263 Developing countries economic well-being, 110 obstacles to economic growth, 197 wage inequality, 159 Dickens, William T., 388n Digital video market, 39 Diminishing returns to capital, 188 Diminishing returns to labor, 148 Direct window lending, 344 Discount rate, 344 Discouraged workers Bureau of Labor Statistics estimates, 164 definition, 166 Discrimination, by landlords, 70 Disposable income and autonomous consumption, 289 and consumption expenditure, 288–289 and marginal propensity to consume, 290 Distribution of food in New York, 60 Diversification, 336 benefits of, 231–232 in bond and stock markets, 230–231 definition, 231 Dividends definition, 228 disappointing growth after 2000, 253 expected, 229–230 tax rate reduction, 236 Domestic product, 98 Dot-com bubble, 367, 379 Dow Jones Industrial Average, 93 Downward-sloping demand curve, 63–64 Doyle, Arthur Conan, Dubin, Al, 243 Durable goods, 100, 268 effect of recessions on, 368 Duration of Great Depression, 266 of recessions, 265 of unemployment, 163–165 Dynamic labor market, 166 E Earnings; see also Wages comparison over time, 117–118, 124 effects of inflation, 117–118 growth rate 1960–2010, 156–157 related to education, 146 East Asia effect of U.S recession 2007–2009, 300 financial crisis of 1990s, 405 East Germany, 50 eBay, 286 Economic activities compared by location and time, 104–107 nonmarket, 108–109 Economic conditions over time cost of living, 118–120 interest rate and income differences, 117–118 purchasing power, 123–125 Economic costs of unemployment, 165 Economic data, 94 Economic efficiency, 84 Economic growth changes in U.S since 1789, 177–178 costs of consumption sacrificed to capital formation, 198 creating new capital, 197 investment in capital goods, 197 research and development, 198 determinants of average labor productivity entrepreneurship, 190–192 human capital, 184–186 land and natural resources, 189 management, 190–192 physical capital, 186–187 political and legal environment, 192–194 technology, 189–190 factors promoting increasing human capital, 195 legal and political environment, 197 research and development, 197 saving and investment, 195–196 and Fed policy in 1990s, 334 and labor market, 145 and poorest countries, 196–197 question of limits to, 198–200 reasons for capital investment per worker, 48 investment, 48 knowledge improvements, 48–49 population growth, 48 savings rate, 48 technology improvements, 48–49 rise in living standards, 178–182 role of average labor productivity, 182–184 small differences in growth rates, 180–182 Economic Growth and Tax Relief Act of 2001, 307 Economic inequality, 109–110 Economic integration, 403, 404 Economic models and cost-benefit principle, 5–6 statistical, 393 Economic naturalism, 14–15 Economic naturalist Braille dots on ATMS, 16–17 car heaters, 16 comparative advantage baseball’s 400 hitters, 37–38 digital video market, 39 free-trade agreements, 51 outsourcing, 52–53 Federal Reserve System dollars held in Argentina, 340 inflation and stock market, 333 free public education, 195 “free” software, 15–16 gross domestic product directions of nominal and real GDP, 106 schooling in rich vs poor countries, 111–112 shorter workweek, 108 investment in computers, 225 low rate of inflation, 122 macroeconomic policies causes of Great Moderation, 383–384 inflation of 1980s, 382–383 working hours, U.S vs Europe, 391–392 in micro and macro levels of economy, 94 rise and decline of stock market, 254 in supply and demand pay raises and rent increases, 75–76 seasonal price movements, 82 term paper revisions, 79 terms for money, 243 weather-sensitive vending machine, 279 Economic principles, 13–15 Economics definition, macroeconomics, 13–14 microeconomics, 13–14 normative, 13 positive, 13 Economics classes, Economic stagnation in medieval China, 191–192 Economic statistics, 94 Economic Stimulus Act of 2008, 308 Economic surplus, Economic well-being GDP related to availability of goods and services, 110 basic indicators, 111 cost-benefit principle, 110 health and education, 110–112 rich vs poor countries, 110–111 real GDP as imperfect measure environmental quality, 109 leisure time, 107–108 nonmarket activities, 108–109 poverty and income inequality, 109–110 quality of life, 109 revenue depletion, 109 underground economy, 109 www.downloadslide.com INDEX Economies benefit of net capital inflows, 425 benefit of unions for, 169 complexity of, 61 consumer spending in, 288–290 effect of changes on demand for labor, 150 exogenous variables, 393 free-market, 62 high-income, 45n impact of military spending, 304–305 inflation as grease for, 388 interest in measuring, 94 in long-run equilibrium, 352 long-term economic growth, 309 low-income, 45n many-person, 45–47 mixed, 62 self-correcting, 277, 370–372 shift factors for production possibilities curve, 47–51 in short-run equilibrium, 353 short-term fluctuations, 264 statistical models of, 394 strength of currency and strength of, 410 trade-offs in, two-product, 39–45 during World War II, 266 Economists agreement among, 62 former faith in fine-tuning, 394 opposition to price controls, 71 statistical models, 394 tolerance of some inflation, 387 Education to develop human capital, 185–186 and economic well-being, 110–112 to increase human capital, 195 relation to earnings, 146 Educational vouchers, 195 Efficiency from globalization, 157 in physical capital, 186–188 Efficiency principle definition, 84 labor market legislation, 169–170 and recessionary gap, 271 transition aid, 159 Efficient point definition, 41 illustration, 42 Eight Crossings, 52 Employed persons, 162 Employment; see also Unemployment entries effect of skill-biased technological change, 160–161 increase since 1970, 146–147 trends in effects of globalization, 157–159 effects of technological change, 159–161 labor supply in U.S., 157 productivity growth, 155–156 slowdown in wage growth, 156–157 Engels, Friedrich, 267 English, de facto world language, 38 Entrepreneurship, 190–192 definition, 191 early examples of, 191 factors favoring, 191–192 Jobs and Wozniak, 191 source of comparative advantage, 38 and stagnation in China, 191–192 Environmental quality, omitted from GDP, 109 Environmental safeguards, 198 Equations constructed from tables, 26–28 definition, 22 derived from graph, 23–24 simultaneous, 92 solving simultaneous, 28–30 straight-line demand curve, 91 straight-line graph, 22–23 straight-line supply curve, 91 verbal description for constructing, 21–22 Equilibrium definition, 66 long-run, 352 market out of, 83 market tendency toward, 67–68 in money market, 340–341 real interest rate, 232–233 short-run, 352 Equilibrium price algebra of, 92 and cash on the table, 83–84 and decreased costs of production, 78 definition, 66 effect of complements, 73–74 effect of price controls on, 69–72 effect of simultaneous supply and demand shifts, 81–82 effect of substitutes, 74–75 effect of technology changes, 79 and excess demand, 66 and excess supply, 66 and increased costs of production, 77 information conveyed by, 83 market tendency toward, 67–68 regulations preventing, 83 Equilibrium principle definition, 84 free public education, 195 Equilibrium quantity algebra of, 92 definition, 66 effect of complements, 73–74 effect of price controls on, 69–72 effect of simultaneous supply and demand shifts, 81–82 effect of substitutes, 74–75 market tendency toward, 67–68 maximizing total surplus, 85 Equity, 228; see also Stock entries Euro, 340, 404–405 Europe financial panic, 351 hours of work, 391 precautionary saving, 222 European Central Bank, 405 European Monetary System, 404 European Union common currency, 404–405 debt crisis, 404 Maastricht Treaty, 404 nominal exchange rate for dollar, 400 problem of monetary policy, 405 Excess demand, 67 Excess supply, 67 Exchange and comparative advantage, 34–39 and gains from specialization, 37 voluntary transactions, 83 Exchange rates consequences of variability, 400 and euro, 404–405 fixed, 400 flexible, 400 flexible vs fixed, 403–405 impact on price of exports and imports, 407–408 in international trade, 400, 404 long-run determination changes in demand for dollars, 410 monetary policy, 410–412 purchasing power parity theory, 415–416 real exchange rate, 412–414 shortcomings of purchasing power parity, 417–418 I-5 strong currency–strong economy theory, 409–410 nominal, 401–403 short-run determination change in supply of dollars, 408–409 supply and demand analysis, 405–408 as tool of monetary policy, 410–412 tourists in United Kingdom, 399–400 Expansion, 266 stages of, 266 Expansionary fiscal policy, 379 Expansionary gap and contractionary policy, 302 definition, 272 economists’ views, 272 and Fed policy 1999–2000, 275 Fed’s response to, 354–355 inflation as, 331 raising interest rate to end, 333 and self-correcting economy, 370 and slope of aggregate supply curve, 363–364 from too much spending, 284 unsustainable, 272 Expansionary monetary policy, 379 Expansionary policies, 302 Expansions causes of, 276–279 changes in potential output, 269–270 felt throughout economy, 267 global impact, 267–268 Expectations effect on demand curve, 76 effect on supply curve, 79 Expenditure line definition, 292 properties of, 292 Expenditure method; see Gross domestic product Exports definition, 101 effect of real exchange rate, 412–414 impact of exchange rates on prices, 407 F Face-to-face jobs, 53 Federal Express, 75 Federal funds rate, 335 definition, 325 versus discount rate, 344 from 1970 to 2011, 325 raised in 2004–2005, 333 role in monetary policy, 325–326 at time of terrorist attack, 330 Federal Open Market Committee, 319, 320, 394 composition of, 321 federal funds rate announcements, 325 federal funds rate cut in 2001, 330 and inflation of early 1980s, 382 raise in interest rates 2004–2005, 333 Federal Reserve Act of 1913, 320, 385 Federal Reserve Bank of New York, 321, 331, 393 Federal Reserve Bank of St Louis, 402 Federal Reserve banks, 320 Federal Reserve districts, 320 Federal Reserve System, 244; see also Central banks accommodating policy, 381 actions to slow economy 1999–2000, 275 anchored inflationary expectations, 382 avoidance of target rate announcement, 386 and banking panics, 321–324 Board of Governors, 321 control of money supply discount window lending, 344 interest paid on reserves, 345 open-market operations, 342–344 reserve requirements, 344–345 definition, 256 www.downloadslide.com I-6 INDEX Federal Reserve System—Cont districts, 320 economic naturalist dollars held in Argentina, 339 inflation and stock market, 333 Federal Open Market Committee, 320 and Greenspan Briefcase Indicator, 319 history and structure, 320–321 interest rate deduction 2001–2002, 289 and interest rates, 335–342 demand for money, 336–337 federal funds rate, 335 money demand curve, 338–340 money supply and market equilibrium, 340–341 money supply determination, 335 low rate of inflation, 355 monetary policy and changes in asset prices, 334 control of interest rate, 324–325 federal funds rate, 325–326 to fight inflation, 331–333 to fight recession, 329–331 planned aggregate expenditures and real interest rate, 326–329 monetary policy rule, 354–355 open-market operations, 256 oversight of financial markets, 255 public scrutiny of, 319–320 relative independence of, 385 response to inflation of 1970s–80s, 382–383 response to inflation shock, 380–384 response to recessionary gap 2001, 275 response to recession of 2001, 379 response to terrorist attack, 330–331 responsibility for monetary policy, 255 role in stabilizing financial markets, 321–324 supervision of banks, 322 Final goods and services capital goods, 96–97 categories of users, 99–100 definition, 95 determining market value of, 95–98 in gross domestic product, 94–98 versus intermediate goods and services, 95–96 long-lived capital goods, 96, 100 value added concept, 94–95 Financial assets, 208, 336 Financial crisis/panic East Asia, 404 in European Union, 405 negative demand shock, 369 in U.S and Europe, 351 Financial intermediaries definition, 244 reasons for, 244–245 Financial investments, 101, 219 bonds, 226–228 diversification of, 231 risks, 231 stocks, 228–230 Financial markets, 232–233 crisis of 2007, 300 Fed oversight of, 255 reaction to changes in money supply, 342–343 Financial system allocation of savings by, 232–236 banking system, 244–246 bond market, 232 components, 244 improving savings allocation, 244 stock market, 230–231 of United States, 232 Finder’s fees, 70 Fine-tuning, 395 Fiscal policy, 302–303 definition, 303 and demand curve shift, 357–358 to eliminate output gaps, 284 expansionary, 379 inside lag, 393 less flexible than monetary policy, 320 outside lag, 394 and recessions American Recovery and Reinvestment Act of 2009, 308 Economic Growth and Tax Relief Act of 2001, 307 Economic Stimulus Act of 2008, 308 eliminating output gaps by government purchases, 303–304 government purchases and planned spending, 302–305 impact of military spending, 304–305 recession of 2007–2009, 308 tax cuts to eliminate output gaps, 306–307 taxes, transfers, and aggregate spending, 305–307 as stabilization tool and automatic stabilizers, 309 deficit problem, 309 relative inflexibility, 309 and supply side of economy, 308 and supply-side economics, 388–392 Fisher, Irving, 139 Fisher effect, 138–139 Fixed exchange rate, 400 abandoned by Argentina, 404 abandoned by United Kingdom, 404 definition, 403 effect on central banks, 403–404 effect on trade, 404 versus flexible rates, 403–405 Flexibility, lacking in fiscal policy, 309 Flexible exchange rates, 400 definition, 403 effect on central banks, 403 effect on trade, 404 versus fixed rate, 403–405 and monetary policy, 411 Floating exchange rate, 403; see also Flexible exchange rates Flows contrasted with stock, 209–210 definition, 209 Food supply, New York City, 59–60 Forbes 400 richest Americans, 34 Ford, Henry, 191 Foreign aid, 197 Foreign assets, 406 Foreign exchange market definition, 403 market equilibrium in exchange rates, 406 supply and demand analysis changes in demand for dollars, 410 changes in supply of dollars, 408–409 demand for dollars, 407–408 effect of monetary policy, 410–412 market equilibrium value of dollar, 408 supply of dollars, 406–407 yen-dollar market, 406, 407 Foreign goods and services, 406 Fractional-reserve banking, 251–253, 322 France, hours of work, 391 Frank, Robert H., 319n Free and open exchange of ideas, 193 Free-market system, 62 absent in communism, 193–194 Free public education, 195 “Free” software with computers, 15 Free-trade agreements controversy over, 51 opposed by politicians, 158 Frictional unemployment, 166–167 always present in economy, 272 and output gaps, 272 Friedman, Milton, 195, 256–257, 323 Friedman, Thomas L., 145 Full employment, impediments to health and safety regulations, 170 labor unions, 169 minimum wage laws, 168–169 unemployment insurance, 170 Full-employment output, 269 G Gains from exchange, 44–45 Gains from specialization, 44–45 and exchange, 37 real-world, 49 Gap between haves and have-nots, 145 Garber, Peter, 200n Gasoline, price controls on, 70–71 Gates, Bill, 3, 52, 191 Germany hours of work, 391 hyperinflation of 1923, 135, 259 post-World War II recovery, 185–186 real GDP growth 2002–2010, 268 real GDP per person 1870–2008, 180 Ghana, real GDP per person 1870–2008, 180–182 Glaeser, Edward, 392n Global economy, social conflicts in, 145 Globalization, 145, 157 adjusting to effects of need for transition aid, 159 worker mobility, 159 impact on labor market, 146 and increasing wage inequality, 157–159 main benefits of, 157 Global Positioning System, 196 Glover, Paul, 248 Goldsmith, Arthur H., 164n Good, Barbara A., 248n Goods inferior, 76 normal, 76 socially optimal quantity, 84 Goods and services; see also Final goods and services; Intermediate goods and services availability of, 110 market values, 94–95 not in market, 95 Google Inc., 191 Gould, Stephen Jay, 38n Government bond issues, 226–228 impact on total spending, 276–277 public investment, 196 social safety net, 221 support for basic research, 196 Government bonds inflation-protected, 138 interest rates on, 137 Government budget balanced, 215 and public saving, 215–217 Government budget deficits crowding-out effect, 235 definition, 215 effect of fiscal policy on, 308 effect on investment, 234 effect on real interest rate, 234 effect on saving, 234 leading to inflation, 258 reasons for, 216 recent history of, 218 resulting in hyperinflation, 259 Government budget surplus, 215 Government expenditures effect of fiscal policy on, 357 effect on recessions, 303–305 equal to government purchases, 214–215 government purchases, 303 www.downloadslide.com INDEX impact of indexing on, 126 interest payments, 213–214 military spending, 304–305 as recession aid, 309 transfer payments, 213 Government purchases, 215 to close recessionary gap, 303 definition, 109 in GDP, 109 in planned aggregate expenditures, 286 public capital, 213 Government saving calculating, 215–217 component of national saving, 217 Graphs aggregate supply curve, 363 changes in vertical intercept, 25–26 constructed from tables, 26–28 demand curve, 63 deriving equations of straight line from, 25–27 effect of rent control, 70, 71 equation of a straight line, 22–23 equilibrium price, 66 excess demand, 67 excess supply, 65 pizza price controls, 72 of production possibilities curve, 43, 45, 46 quantity demanded vs increase in demand, 73, 84 rules on supply and demand shifts, 80 simultaneous supply and demand shifts, 81 supply and demand, 68 supply curve, 65 unregulated housing market, 69 Great Depression, 309; see also Recessions banking panic of 1930–1933, 322–323 and basic Keynesian model, 284 duration of, 266 effects of, 283–284 ended by World War II, 304–305 from insufficient spending, 284 and stabilization policies, 284 Great Moderation, 383–384 Great Recession, 351–352, 357, 368–370, 378 Greece, financial crisis, 405 Greenspan, Alan, 275n, 319, 321, 334 Greenspan Briefcase Indicator, 319–320 Gross domestic product, 94; see also Nominal GDP; Real GDP base year, 105 comparisons over time and place, 104–106 computer purchases percent of, 225 definition, 94 economic naturalist directions of nominal and real GDP, 106 schooling in rich vs poor countries, 111 shorter workweek, 108 equation, 102 expenditure components, 100–102, 103 expenditure method of measuring, 99–103 categories of users of goods and services, 99–100 consumption expenditures, 100 government purchases, 101 investment, 100–101 net exports, 101–102 incomes of capital and labor, 103–104 measurement options market values, 99–100 total expenditure, 100 measure of output excluding intermediate goods and services, 95–96 final goods and services, 95–96 within a given country, 98 during a given period, 98 market value, 94–95 military spending percentage of, 304–305 omissions environmental quality, 109 intermediate goods and services, 95–97 leisure time, 107–108 nonmarket economic activities, 108–109 poverty in income inequality, 109–110 quality of life, 109 resource depletion, 109 underground economy, 108 relation to economic well-being availability of goods and services, 110 basic indicators, 111 health and education, 110–111 rich vs poor nations, 110–111 three expressions of, 104 Gross domestic product per person and average labor productivity, 182–184 doubled 1960–2010, 146 and share of population employed, 182–183 Grossman, Gene M., 199n Growth rates, small differences in, 180–182 H Haines, Mark, 319 Head Start, 195 Health and economic well-being, 110–112 Health and safety regulations, impediment to full employment, 170 Health care, from economic growth, 180 Heston, Alan, 48n Hewlett-Packard, 191 High-income countries, 45n High school completion rates, 111 High-yield bonds, 226 Holmes, Sherlock, Home equity loans, 222 Hoover, Herbert, 117 Horizontal interpretation of demand curve, 64 of supply curve, 65 Hours of work shortened, 108 U.S vs Europe, 391–392 Households consumption expenditures, 212 wealth and bull market of 1990s, 211–212 Household saving, 208, 214 component of national saving, 217 incentives for, 234 in United States, 221–222 Housing bubble, 300, 334, 351 Housing market, effect of rent controls, 60–61, 69–71 Housing prices and demand shock, 355–356 growth 1999–2006, 335 increase after 2001, 289 in U.S 1953–2011, 299–300 Housing shortage, New York City, 60 Human capital analogous to physical capital, 186 assembly line production, 184–185 benefit of schooling, 186–187 definition, 185 determinant of average labor productivity, 185–187 economic recovery of Germany and Japan, 185–186 policies to increase, 195–196 Hungary, hyperinflation, 135 Hyperinflation in Confederate states of America, 259 definition, 134 in Germany in 1923, 259 massive wealth redistribution, 135 means of stopping, 259 occurrences of, 135 result of government budget deficits, 259 I-7 I Implicit costs, ignoring, 7–8 Implicit value, opportunity cost as, Imports definition, 101 effect of real exchange rate, 412–414 impact of exchange rates on prices, 416 Incentive principle, 13 and cash on the table, 84 definition, 13 effect on supply, 76 in market equilibrium, 67–68 and rent control, 70 Incentives in economic system, 133 Income of capital, 103–104 CEOs vs typical workers, 110 effect on demand curve, 75–76 of labor, 103–104 nominal vs real, 123 Income effect, 63 Income-expenditure multiplier, 301, 317–318 Income tax vs consumption tax, 236 Increasing opportunity cost diminishing returns to capital, 188 diminishing returns to labor, 148 effect on supply curve, 77 investment decisions, 224 and physical capital, 186 and production possibilities curve, 47 Independent variable, 21 Indexing, 119 definition, 125 impact on federal budget, 127 of labor contracts, 126 to maintain buying power, 125–126 of taxes, 131 India, real GDP per person 1870–2008, 180 Individual comparative advantage, 38 Individual Retirement Accounts, 196 Induced expenditure, 292 Industrialized countries economic well-being, 110 factors leading to productivity growth, 155–156 increase in real wage, 155–156 Inefficiency of barter, 247 Inefficient point definition, 41 illustration, 42 Infant mortality rates, 111 Inferior goods, 76 Inflation; see also Rate of inflation AD-AS model to analyze, 352–353 basis of price comparisons over time, 117–118 Boskin Commission Report on CPI, 126–128 CPI adjustments for by deflating, 123 deflating a nominal quantity, 123–125 by indexing, 119 indexing to maintain buying power, 125–126 core, 122 and cost of holding cash, 132 cost to government of indexing, 126 to currency depreciation, 416–418 definition, 120 economists’ tolerance of, 387 effect on real exchange rate, 416 effect on stock market, 333 as expansionary gap, 331 in expansions and recessions, 268–269 Fed policy 1999–2000, 275 Fed response to, 330–331 Fisher effect, 138–139 hyperinflation, 134 imagined cost of popular confusion, 129 price level vs relative price, 129–130 and interest rate comparisons, 118 www.downloadslide.com I-8 INDEX Inflation—Cont and interest rates Fisher effect, 138–139 real interest rate, 135–138 minimum wage not indexed for, 126 as monetary phenomenon, 256–257 and money in long run, 258–259 money supply growth in Latin America, 256 and output gaps expansionary gap, 362 no output gap, 362 recessionary gap, 362 over time, 118 and purchasing power parity, 415–416 in South America, 416 true costs of effect on long-term planning, 133–134 noise in price system, 130–131 shoe leather costs, 132 tax distortions, 131–132 unexpected wealth redistribution, 132–133 in U.S in 1970s–80s, 382 Inflation-adjusted quantities, 123 Inflation dove, 388 Inflation expectations aggregate supply curve shift and changes in, 382 and credibility of monetary policy, 384–388 in expansionary gap, 371 and inflation inertia, 361 shift in aggregate supply curve and changes in, 382 Inflation hawk, 388 Inflation inertia definition, 359 versus economic variables, 359 inflation expectations, 360–361 long-term wage and price contracts, 361 main reasons for, 361 and slope of aggregate supply curve, 358–365 Inflation-protected bonds, 138 Inflation shock and business cycle, 366 definition, 365 effect on aggregate supply curve, 380 negative, 366 positive, 366 and shift in aggregate supply curve, 363, 364 stabilization policy, 379–384 accommodating policy, 380–381 anchored inflationary expectations, 382 cause of Great Moderation, 383–384 Fed’s response in 1980s, 382–384 Information provided by financial system, 243–244 from stock and bond markets, 232 Information and communication technologies, 190 Information gathering, costs reduced by banks, 225 Infrastructure, 196 Input prices, effect on supply curve, 79 Inside lag of fiscal policy, 392 of monetary policy, 393 Interest compound, 180–181 government payments, 214 simple, 181 Interest paid on reserves, 345 Interest rates; see also Nominal interest rate; Real interest rate and bond prices, 341 and control of money supply, 335–336 Fisher effect, 138–139 formula for compound interest, 181–182 and inflation, 135–138 many in economy, 325–326 over time, 118 reduced by Fed 2001–2002, 289 relation to bond prices, 227–228 and supply of dollars, 408–409 Intermediate goods and services definition, 95 excluded from GDP, 95–96 versus final goods and services, 94–96 International capital flows determinants real interest rate, 421–423 return and risk, 421–423 and domestic saving/investment, 422–425 and financial markets, 423 nature of, 420–421 roles of, 422–423 International Monetary Fund, 405 International trade and comparative advantage, 51–53, 157 effect of fixed or flexible rates, 404 effect on labor markets, 158–159 and exchange rates, 400–401 free-trade agreements, 51, 158 importance to United States, 420 international capital flows, 418–428 and outsourcing, 51–53 and strength of dollar, 412 trade balances, 418–419 trade balances and net capital inflows, 421 trade deficit, 419–420 trade surplus, 420 and wage inequality, 159 Internet, 198 Interstate highway system, 389 Intuit Corporation, 15 Inventory investments, 101 Investment business fixed investment, 100 and capital formation, 222–226 in capital goods, 197 and capital inflows, 421–424 company reasons for, 223–225 in computers, 225 definition, 100 effect of government budget deficits, 235–236 effect of new technologies, 234–235 effect of real interest rate, 232–234, 328 effects of recession 2007–2009, 302 inventory, 101 opportunities for foreign investors, 426 in planned aggregate expenditures, 286 planned vs actual, 286–287 policies to promote, 197 and productivity growth, 48 public, 195–196 and real interest rate, 224–225 real vs financial, 101, 286n residential, 101 and value of the marginal product, 225 Investment/GDP ratio, 425 Investment spending, 212, 213 Investors and interest rates, 137 irrational exuberance, 334 return and risk investments, 421–422 Involuntary part-time workers, 166 Iraq war, 216, 236, 304–305 Ireland, financial crisis, 405 Irrational choices, 13 Irrational exuberance, 334 Israel, hyperinflation, 135 Italy, hours of work, 391 Ithaca Hours, 247–248 It’s a Wonderful Life, 322 J Jamail, Joe, 34 James, Bill, 38 Japan banking crisis of 1990s, 246 deflation of 1990s, 387 high housing prices, 222 hours of work, 391 lifetime employment, 218 nominal exchange rate for dollar, 401 post-World War II recovery, 185 precautionary saving, 222 real GDP growth 2002–2010, 268 real GDP per person 1870–2008, 179 reasons for saving, 218 recession of 1990s, 299 JetBlue Airways, 387n Jevons, W Stanley, 63 Jobs face-to-face, 53 heterogeneous, 166 increase in number of, 146 less vulnerable to outsourcing, 53 losses and gains, 53 rules-based, 53 Jobs, Steven, 191 Johnson, David S., 307n Junk bonds, 226 Jurassic Park, 76 Just-in-time systems, 192 K Kahneman, Daniel, 6n Katz, Lawrence, 273n Keeler, Wee Willie, 37–38 Kennedy, John F., 274n Key deposits, 70 Keynes, John Maynard, 284, 303 Keynesian cross, 284, 297; see also Basic Keynesian model definition, 296 “King of Torts,” 34 Knowledge, improvements in, 48–49 Koga, Maiko, 218n Korean War, 304–305 Koromvokis, Lee, 52 Krueger, Alan B., 199n, 273n Kuznets, Simon, 94 L Labor diminishing returns to, 148 low-skilled, 159 marginal product of, 148 reservation price, 153 wages and demand for, 147–149 Labor contracts composition of, 169 indexed for inflation, 125–126 not indexed for inflation, 132 Labor force definition, 162 size of, 53 Labor force participation rate, 162 by women, 157 Labor income, 103–104 Labor market dynamic, 166 and economic growth, 145 effect of globalization, 146 effect of technological change, 146 heterogeneous, 166 increased efficiency of, 273 matching jobs to skills, 166 national and international, 169 during recessions, 268 supply and demand analysis, 147–155 demand shifts, 150–153 supply of labor, 153–154 www.downloadslide.com INDEX supply shifts, 154 wages and demand for labor, 147–149 trends in growth in real wage in 20th century, 146 increased number of jobs, 146 increase in wage inequality, 146 slowed growth since 1970, 146 trends in real wages effect of globalization, 157–159 effects of technological change, 159–161 in industrialized countries, 155 productivity growth, 155–156 slowed in U.S since 1970, 156–157 two-tier, 146 worker mobility, 159 Labor productivity and entrepreneurs, 190–191 growth in U.S since 1995, 190 Labor supply, 153–154 cost-benefit principle, 153 nature of, 153 predicted slowdown, 157 reasons for increase in, 157 reservation price for working, 153 shifts in, 154 willingness to work, 154 Labor supply curve, 154 Labor unions impediment to full employment, 168 opponents of, 169 opposition to NAFTA, 51 political role, 169 strike threat, 169 Land, determinant of average productivity growth, 188 Latin America, inflation and money growth in, 256 Law of one price definition, 414 and purchasing power parity, 414–417 Least developed countries, economic well-being, 110–111 Leisure time, 107–108 LETS (local electronic trading system), 247 Levy, Frank, 52–53 Lewis and Clark expedition, 177 Lexus and the Olive Tree (Friedman), 145 Liabilities of banks, 250–251 definition, 208 Life-cycle saving for buying a home, 222 definition, 217 in Japan, 218 and social safety net, 221 Life expectancy, 111 Lifetime employment, Japan, 218 Limits to Growth (Meadows et al.), 198–199 Limits to growth thesis problems with, 199–200 environmental issues, 199 ignoring market mechanisms, 199 overlooking environmental safeguards, 198 report on, 198 Liquidity preference, 336 Literacy rates, 112 Living standards effect of saving rate on, 220 and high saving rate, 236 improved by economic growth health care, 178 real GDP per person, 178–179 transportation, 178 from long-run economic growth, 263–264 rich vs poor countries, 196–197 Loans credit risk, 226 evaluated by banks, 245 Long-distance telephone billing equation, 22–30 Long-lived capital goods, 100 Long run money and inflation in, 258–259 self-correcting economy in, 370–372 success of purchasing power parity in, 418 Long-run determination of exchange rate purchasing power parity theory, 414–418 real exchange rate, 413–414 shortcomings of purchasing power parity, 417–418 Long-run economic growth, 263–264 Long-run equilibrium, 353 Long-term planning, effect of inflation on, 133–134 Long-term unemployed, 165 Long-term wage and price contracts, 361 Low-hanging-fruit principle, 47 Low-income countries, 45n Low-skilled workers, 159 Low-wage foreign workers, 52 Ludd, Ned, 160 Luddites, 160, 161 M Maastricht Treaty, 404 Macroeconomic factors in demand for money, 337–338 Macroeconomic policies, see also Fiscal policy; Monetary policy; Public policy accommodating policy, 380–381 as art or science, 393–394 automatic stabilizers, 309 cause of Great Moderation, 383 difficulty of conducting, 378 economic naturalist causes of Great Moderation, 383–384 hours of work, U.S vs Europe, 391–392 inflation of 1980s, 382–383 fiscal policy and supply side, 388–392 former belief in fine-tuning, 394 identifying output gaps, 394 inside lag, 394 outside lag, 394 requirements for perfection, 393 stabilization policies, 284, 302 to stop inflation in 1980s, 382–383 uncertainties of economists about natural rate of unemployment, 393–394 about potential output, 393–394 Macroeconomics AD-AS model, 352–353 definition, 13–14, 94 economic conditions over time, 117, 118 Macroeconomic variables, 94 Maddison, Angus, 179 Major League Baseball, lack of 400 hitters, 37–38 Management, determinant of average labor productivity, 191–192 Many-person economy, production possibilities curve in, 45–47 Margin, failure to think at the, 8–12 Marginal analysis, 64 Marginal benefit versus average benefit, 10, 11–12 definition, equal to marginal cost, 84 space shuttle program, 10–11 Marginal cost versus average cost, 10, 11–12 definition, effect of reduction on supply curve, 78 space shuttle program, 10–11 Marginal product of labor, 148 I-9 Marginal propensity to consume and disposable income, 290–291 effect of multiplier, 301 effect of tax cuts on, 306–307 and multiplier, 317–318 not known, 393 Marginal tax rate, 389–392 Market(s) absent in communism, 193–194 buyers and sellers in demand curve, 63–64 supply curve, 64–65 versus central planning, 62 definition, 62 determination of prices, 62–63 out of equilibrium, 83 tendency toward equilibrium, 67–68 Market-clearing wage and real wage, 168 union wages higher than, 169 Market equilibrium definition, 66 effect of complements, 73–74 effect of price controls, 69–72 effect of substitutes, 74–75 equilibrium price and quantity, 66–69 and excess demand, 67 and excess supply, 67 information from equilibrium prices in, 83 maximizing total surplus, 85 not always ideal, 69 Market equilibrium exchange rate, 406 Market equilibrium value of exchange rate, 408 Market mechanisms, 199 Market value to calculate GDP, 95 changes over time, 105–106 of final goods and services, 95–98 of goods and services drawbacks of using, 95 ways of aggregating, 94–95 nonexistent for public goods, 95 Marshall, Alfred, 63, 73 Marshall Plan, 186 Marx, Karl, 50 on price determination, 62 on recessions, 267 Maturation date definition, 226 length of, 226 McDonald’s, 60 Meadows, Dennis L., 198n Meadows, Donella H., 198n Medical records transcription, 51–52 Medicare, 221 Medium of exchange, 246 private money, 247–248 Menu costs, 359 definition, 285 impact of new technologies, 285–286 Method of simultaneous equations, 29 Mexico effect of U.S recession 2007–2009, 300 nominal exchange rate for dollar, 401 Mexico City, air pollution, 199–200 Microeconomics, 13–14, 147 Microsoft Corporation, 52, 407 Military spending impact on economy, 304–305 by U.S 1940–2010, 304–305 Minimum wage impediment to full employment, 168–170 not indexed, 126 Mixed economies, 62 Models, statistical, 394 Modern Times (film), 50–51 M1 money supply definition and components, 249 velocity of, 257–258 www.downloadslide.com I-10 INDEX Monetary policy; see also Credibility of monetary policy accommodating alternative to, 381 definition and implications, 381 anti-inflationary, 382 cause of Great Moderation, 384 and changes in asset prices, 334–335 control of money supply discount window lending, 344–345 interest paid on reserves, 345 open-market operations, 342–344 reserve requirements, 344–345 control of nominal interest rate, 324 control of real interest rate, 324–325 definition, 255 and demand curve shift, 357 determinant of exchange rates, 400, 410–412 effect of type of exchange rate, 403–405 effect on exchange rates, 410–412 exchange rate as tool of, 411 expansionary, 379 federal funds rate, 325–326 to fight inflation, 331–333 to fight recession, 329–331 inside lag, 394 and interest rates, 335–342 control of nominal interest rate, 342–345 demand for money, 336–338 money demand curve, 338–340 money supply and market equilibrium, 340–341 to minimize output gaps, 355 more flexible than fiscal policy, 320 outside lag, 394 planned aggregate expenditures and real interest rate, 326–328 problem for European Union, 404–405 problem in addressing asset bubbles, 334–335 role of stabilization policy with demand shocks, 379 with inflation shocks, 380–384 and self-correcting economy, 378 as stabilization policy, 302 tightening in early 1980s, 411 Monetary policy rule, 354–355, 371 Money; see also Demand for money bank creation of, 250–253 versus barter, 247 brokerage accounts, 248 definition, 246, 336 historical kinds of, 246 and inflation in long run, 258–259 meanings of, 243 measurements of, 247 medium of exchange, 246 private, 247–248 quantity equation, 258 store of value, 246–247 unit of account, 246–247 velocity of, 257–258 Money demand curve, 338–340 Money market equilibrium, 340–341 Money supply and banking panic of 1930–1933, 322–324 change in reserve-deposit ratio, 323 credit card balances excluded, 248 with currency and deposits, 253–255 determination of, 250 effect of banks on, 250–253 effect of Christmas shopping, 254 effect of open market operations, 255–256 Fed control of and demand for money, 336–338 discount window lending, 344 interest paid on reserves, 345 money demand curve, 338–340 money market equilibrium, 340–341 open-market operations, 342–344 reserve requirements, 344–345 setting interest rates, 335–336 and Fed control of reserves, 324–325 inflation in Latin America, 256 M1 money supply, 248 and money market equilibrium, 340–341 M2 money supply, 248 reaction of financial markets to changes in, 343 reduced to stop hyperinflation, 259 relation to prices, 256–257 role of central banks, 255–256 U.S dollars, 406–407 Money supply curve, 341 Morgan, J P., 191 Movement along a demand curve, 73 M2 money supply definition and components, 249 velocity of, 257–258 Multiplier, 301–302, 317–318 definition, 301 Municipal bonds, 227 Murnane, Richard, 52–53 Mutual funds, 232 N National Aeronautics and Space Administration, 10–11 National Bureau of Economic Research arbiter of recessions, 265 Business Cycle Dating Committee, 266 on Great Depression, 266 on recession of 2001, 307, 330 National comparative advantage, 38 National saving, 208 accounting identity, 212–213 aggregate spending components, 212 components, 217 private saving, 213–215 public saving, 215 current income minus spending, 212 definition, 213 effect of new technologies, 234 and government purchases, 213 measurement of, 212–213 and net capital inflows, 422 policies to increase, 235 public capital, 213 public saving and government budget, 215–217 rate in U.S 1960–2010, 214 and real interest rate, 324 reduced by government budget deficits, 235 National saving/GDP ratio, 425–426 National saving rate, cause of trade deficit, 425–426 National Science Foundation, 196 Nations high-income, 45n low-income, 45n rich vs poor, 111–112 Natural rate of unemployment and cyclical unemployment, 272–274 definition, 273 lower in late 2000s than in 1990s, 273–274 reasons for decline, 273–274 Natural resources determinant of average productivity growth, 188 exploitation of, 109 Natural selection, 15 Negative cyclical unemployment, 273 Negative demand shock, 356, 358, 369 dot-com bubble, 379 and stabilization policy, 378 Negative inflation rate, 121 Negative inflation shock, 365 Negative output gap, 271 Nepal, 33 population density, 50 Net capital inflows benefit to economy, 426 definition, 420 and national saving, 423, 424 and real interest rate, 420–421 and trade balance, 418–419 Net exports, 418 effect of real exchange rate, 412–414 and GDP, 110–112 and national saving, 212–213 in planned aggregate expenditures, 286–293 Net taxes, 214 Net worth, 208 New Division of Labor (Levy & Murnane), 52–53 News Hour with Jim Lehrer, 52, 53 Newton, Isaac, 62 New York City food supply and demand, 59–60 housing shortage, 60 rent control, 61 Silicon Alley, 167 New York Stock Exchange, 228 New York Times, 122, 145, 263 Nickell, Stephen, 392n No-free-lunch principle, 4; see also Scarcity Noise in the price system, 130–131 Nominal exchange rate, 400 Canadian dollar and British pound, 401 and currency appreciation, 402–403 and currency depreciation, 402–403 definition, 401 national comparisons, 400 in United States, 402 Nominal GDP, 257 definition, 105 moving in opposite direction, 106 versus real GDP, 104–107 Nominal income, 123 Nominal interest rate, 135–138 and control of money supply, 335–336 definition, 136 and demand for money, 336–337 Fed control of, 324–325 Fed control over, 342–345 Fisher effect, 138–139 formula, 136 and money demand curve, 338–340 in U.S 1970–2010, 136–138 Nominal quantities definition, 123 deflating, 123–125 earnings over time, 124 versus real quantities, 123 real quantity converted to, 125–126 real wages, 124–125 Nominal wage, 124–125 and inflation expectations, 360 lowered for airlines, 387n resistance to cuts in, 388 Nondurable goods, 100 effect of recessions on, 368 Noneconomic factors in comparative advantage, 38–39 Nonmarket activities, omitted from GDP, 108–109 Normal goods, 76 Normative economic principle, 13 North American Free Trade Agreement controversy, 51 North Carolina Research Triangle, 167 North Korea, 50, 61 O Obama, Barack, 308 Obama administration, 302, 308 Offshore call centers, 53 www.downloadslide.com INDEX Oil prices doubled 2007–2008, 369 impact on U.S economy, 368 increased by OPEC, 365 Oil price shocks, 351, 368 Oil reserves, 199 Okun, Arthur, 274 Okun’s law cyclical unemployment, 274–276 definition, 179 equation, 274 and output gap in United States, 274–276 100 percent reserve banking, 251 Online job services, 273 Open economy monetary policy, 410–412 saving-investment diagram, 423–424 Open-market operations, 340–341, 342–344 definition, 256 effect on supply of reserves, 325 Open-market purchase, 342–344 definition, 255 Open-market sale, 343 definition, 256 Opportunity cost; see also Increasing opportunity cost of activities, all costs as, of capital investment, 224 and comparative advantage, 34–39 definition, gains from specialization and exchange and, 45 and implicit value, in many-person economy, 46–47 in principle of comparative advantage, 37 and supply curve, 64–65 of time for schooling, 186 in two-product economy, 41 of working less, 108 Organization of Petroleum Exporting Countries, 365 Out of the labor market, 162 Output; see also Potential output; Short-run equilibrium output AD-AS model to analyze, 352–353 and autonomous expenditure, 292 and benefit of holding money, 337 effect of decline in aggregate spending, 284 effect of increase on demand for labor, 150 full-employment, 269 gross domestic product as measure of, 94–99 and induced expenditure, 292 market values, 94–95 and planned aggregate expenditures, 291–293 reduced by unemployment, 164 of U.S economy 1929–2010, 107 Output gaps causes and cures, 276–277 definition, 271 effect on taxes and transfer payments, 213 eliminated by monetary policy, 324 eliminated by stabilization policies, 302–303 eliminating, 272 fiscal policy to eliminate, 284 and inflation, 362 measuring, 271 monetary policy to fight, 329–330 monetary policy to minimize, 355 Okun’s law, 274–276 and planned aggregate expenditures decline leading to recession, 297–298 determination of short-run equilibrium output, 298 Japanese recession of 1990s, 299–301 U.S recession 2007–2009, 299–301 reasons for short-term fluctuations, 271–272 formula, 371 positive, 371 relation to aggregate spending, 284 relation to spending, 277–279 and self-correcting economy, 378 and slope of aggregate supply curve, 363–364 types of, 271–272 and unemployment, 272–274 in United States 1949–2010, 271–272 Output per person from increase in average labor productivity, 182–184 in U.S 1929–2010, 179 in U.S 1960–2009, 182, 183 Outside lag of fiscal policy, 394 of monetary policy, 393–394 Outsourcing of computerized tasks, 52–53 definition, 51 economic naturalist on, 52–53 and foreign wages, 52 jobs less vulnerable to, 53 medical records example, 51–52 P Page, Larry, 191 Parameter, 21 Parker, Jonathan A., 307n Participation rate; see Labor force participation rate Part-time workers, involuntary, 166 Pay raise, and rent increases, 75–76 PBS evening news, 52–53 Peace Corps, 33 Peak, 265 Pentagon attack, 330–331 Perot, Ross, 51 Perry, George L., 388n Personal saving, 214 Petty, William, 94 Physical capital capital goods, 187 definition, 186 determinant of average labor productivity, 186–188 diminishing returns to capital, 188 effect of additional capital on output, 187 and efficiency, 186 human capital analogous to, 186 Picasso, Pablo, 62 Pizza price ceiling, 71–72 Planned aggregate expenditures versus actual spending, 286–287 autonomous expenditure, 292 consumer spending, 288–290 consumption expenditure in, 286 definition, 286 expenditure line, 292 factors affecting, 355–356 government purchases in, 286 induced expenditure, 292 investment component, 286 and monetary policy rule, 354–355 net exports component, 286 and output, 291–292 and output gaps decline leading to recession, 297–298 Japanese recession of 1990s, 299–301 short-run equilibrium output, 294–296, 297–298 U.S recession 2007–2009, 299–301 and real interest rate, 225, 326–328 Planned spending, 284 Plato, 62 Political and legal environment determinants of average labor productivity free and open exchange of ideas, 193 and political instability, 194 well-defined property rights, 192 I-11 for economic growth, 197 and failure of communism, 193 Political instability, 194 and desire to hold dollars, 341 Pollock, Jackson, 62, 63 Pollution Mexico City, 199–200 from production, 84 Poor, the, effect of price controls on, 71 Poor countries and economic growth, 197–198 economic well-being, 110–112 Population density, in Nepal, 50 Population growth, 48 Portfolio allocation decision definition, 336 diversification, 336 Portugal, financial crisis, 405 Positive demand shock, 358 Positive economic principle, 13 Positive inflation shock, 365 Potential GDP, 269 Potential output characteristics, 269–270 definition, 269 effect of fiscal policy on, 309 equal to average output, 362 reasons for variations in, 269–270 recession and expansion explained by changes in, 270 supply-side policy, 388–392 of United States 1949–2010, 271 Poterba, James M., 289 Poverty, 109–110 in Nepal, 33 Poverty line in U.S 2010, 109 Precautionary saving definition, 217 in Japan, 218 U.S vs Japan and Europe, 222 Preferences, effect on demand curve, 76 Prescott, Edward C., 391 Price(s); see also Equilibrium price; Inflation; Rate of inflation; Reservation price of bonds, 227 and cash on the table, 83–84 and change in demand, 73 and change in quantity demanded, 72–73 changes over time, 104–106 and CPI, 118–120 determination of production theory, 62 value theory, 63 widespread confusion, 62 effect of increases on demand for labor, 150–152 impact of exchange rates on exports, 408 impact of exchange rates on imports, 407 and income effect, 63 low rate of inflation, 122 menu costs, 285–286, 359 nominal quantities measured in, 123 predicting and explaining changes in four rules governing, 80–82 shift in demand curve, 73–76 shift in supply curve, 76–79 preset, 284–286 quality adjustment bias, 127 relation to money supply, 255–259 relative, 129–130 seasonal movements, 82 substitution bias, 128 and substitution effect, 63 and supply curve, 64–65 unit of account, 246–247 Price ceiling definition, 71 on pizza, 71–72 www.downloadslide.com I-12 INDEX Price change GDP measure excluding, 105 as information, 131 Price controls on gasoline, 70–71 opposed by economists, 71 pizza prices, 71–72 reducing total surplus, 83 on rent, 59–60, 69–71 rent control, 60–61, 69–71 Price index, 120 Price level and benefit of holding money, 337 CPI as measure of, 118–120 definition, 129 versus relative price, 129–130 Priceline.com, 285 Price signals, distorted by inflation, 131 Price system, noise in, 130–131 Principal amount, 226 Principle of comparative advantage, 34–38 definition, 37 Principle of increasing opportunity cost, 47 Private money, 247–248 Private saving component of national saving, 213–215 definition, 214 incentives to increase, 236 Production; see also Costs of production cost-benefit principle, 84 effect of changes in planned spending, 292–293 market value vs physical volume of, 105 without specialization, 45 Production possibilities curve attainable point, 41–42 countries slow to specialize, 49–50 definition, 40 downward slope of, 41, 42 effect of individual productivity, 42–44 efficient point, 41–42 gains from specialization and exchange, 44–45 inefficient point, 41–42 for many-person economy, 45–47 possibility of too much specialization, 50–51 principle of increasing opportunity cost, 47 purpose of, 34 shift factors knowledge and technology, 48–49 population growth, 48 productivity growth, 47–48 for two-product economy, 39–45 unattainable point, 41–42 Productivity and demand for labor, 147–149 effect of changes in production possibilities curve, 42–44 effect of improvements on demand for labor, 152–153 growth rate 1960–2010, 156–157 and increase in real wage, 155–156 reasons for growth in, 47–49 Professional baseball, lack of 400 hitters, 37–38 Property rights absent in communism, 193 well-defined, 192 Proportions, measuring in, 6–7 Psychological costs of unemployment, 165 Public capital, 213 Public goods, measuring market value of, 94 Public investment, 196 Public policy; see also Macroeconomic policies cost-benefit principle, 110 to increase human capital, 195 to increase national saving, 235 to promote saving and investment, 195–196 to support research and development, 196 Public saving component of national saving, 214, 215 definition, 214 equal to budget surplus, 215 and government budget, 215–217 means of increasing, 235–236 negative since 1970s, 217 reduced by government budget deficits, 235 Purchase of foreign assets, 406 of foreign goods, 406 of U.S assets, 408 of U.S goods and services, 407–408 Purchasing power comparisons over time, 123–125 effect of inflation, 132 increase in U.S., 108 and real interest rate, 136 Purchasing power parity theory definition, 415 determination of exchange rates, 414–417 failure in U.S in 1980s, 417 inflation and depreciation, 416–417 and law of one price, 415, 418 and nonstandardized commodities, 418 nontraded goods, 417 price of goods and real exchange rate, 415 shortcomings of, 417–418 short run vs long run, 417 Q Quality adjustment bias, 127 Quality of life, 109 Quantity changes over time, 104–106 predicting and explaining changes in four rules governing, 80–82 shift in demand curve, 73–76 shift in supply curve, 76–79 socially optimal, 84 Quantity equation definition, 258 historical importance, 258 Quicken software, 15 R Randers, Jorgen, 199n Rate of inflation, 94 annualized 2007–2010, 122 changes 2006–2010, 120–121 and credibility of monetary policy, 385–386 definition, 120 and monetary policy rule, 354–355 negative, 121 overstated, 387 price level vs relative price, 129 short-run fluctuations, 122 target rate, 357 in U.S 1900–2010, 121 in U.S 1960–2010, 268 in U.S 1970–2010, 137 in U.S 1978–1985, 383 in U.S in 1970s, 129 Rational choice, 13 Rational person definition, pitfalls in cost-benefit analysis, 6–12 Ratio rise/run, 23 Reagan, Ronald W., 309 Real assets, 208 Real estate prices, in Japan in 1980s, 246 Real exchange rate, 400 definition, 414 effect on exports and imports, 414 formula, 414–415 purchase of domestic or imported goods, 413–414 Real GDP calculating chain weighting, 106n by changes over time, 104–106 changing volatility of, 383 definition, 105 in definition of recession, 265 fluctuations in U.S 1929–2010, 264 growth in, 198 growth in major nations 2002–2010, 268 as imperfect measure of well-being, 107–112 inadequate measure of well-being environmental quality, 109 leisure time, 107–108 nonmarket activities, 108–109 poverty and economic inequality, 109–110 quality of life, 109 resource depletion, 109 underground economy, 109 and increase in supply of dollars, 408, 409 moves in opposite direction, 106 negative in early 1980s, 382–383 versus nominal GDP, 104–107 in United States 1978–1985, 382 Real GDP per person and air pollution, 200 from economic growth, 178–180 national comparisons, 179–180 Real income, 123 and benefit of holding money, 338 Real interest rate, 135–138 calculating, 136 definition, 136 demand curve shift and changes in, 357–358 determinant of international capital flows, 422–424 effect of government budget deficits, 235–236 effect of new technologies, 234–235 effect of surge on creditors and debtors, 135 effect on autonomous consumption, 289 effect on consumption and investment, 329 effect on exchange rates, 410–412 effect on investment decisions, 224 effect on planned aggregate expenditures, 324 effect on saving, 232–234 equilibrium level, 233 Fed control of, 324–325 to fight recession, 329–331 formula, 136 on government bonds 1975–2010, 136 and inflation, 135–138 and inflation-protected bonds, 138 and monetary policy rule, 354–355 versus nominal rate, 136 and planned aggregate expenditures and capital investments, 327 and consumption expenditure, 326 effect on firms, 326 effect on households, 326 and short-run equilibrium output, 328 raised to end expansionary gap, 331–333 reasons for raising in 2004–2005, 333 and saving, 218–222 uncertain as to effects of changes in, 394 in U.S 1970–2010, 137 in U.S 1978–1985, 382 Real quantity, converted to nominal quantity, 125–126 Real rate of return, 136, 220 Real wage, 124–125 decline since 1970, 146 growth in 20th century, 146 and inflation expectations, 360 market-clearing, 168 as price for labor, 147 and productivity, 156–157 recent trends in, 157–160 in recessions, 367, 368 Recession aid, 309 Recessionary gap cure for, 331 www.downloadslide.com INDEX from decline in autonomous expenditures, 298–299 definition, 271 economists’ views, 272 efficiency principle, 272 elimination of by government purchases, 303–304 by tax cuts, 306–307 Fed policy of 2001, 275 Fed’s response to, 355, 381–382 monetary policy to deal with, 329 and self-correcting economy, 370–372 and slope of aggregate supply curve, 363 from too little spending, 284 Recessions, 266 big vs small, 269 and Business Cycle Dating Committee, 267 causes of, 276–279 changes in potential output, 270–271 cyclical unemployment, 166, 167, 267 duration, 265 duration of unemployment, 164–165 effect on government budget, 215 fall in planned spending leading to, 296–297 in Japan in 1990s, 299 in U.S 2007–2009, 299–301 from Fed policy in early 1980s, 382–383 Fed’s repines in 2001, 379 felt throughout economy, 267 and fiscal policy contractionary policy, 302 expansionary policy, 302 government purchases and planned spending, 303 stabilization policies, 302 taxes, transfers, and aggregate spending, 305–307 U.S policy 2007–2009, 299 and fiscal policy 2007–2009, 308 global impact, 267–268 informal definition, 265 in Japan in 1990s, 246 monetary policy to fight, 329 nature of, 1990–2009, 266 trough, 265 and unemployment rate, 272–273 in U.S 2007–2009, 263, 351–352 in U.S since 1929, 265–266 Redistribution of wealth by hyperinflation, 135 by inflation, 132 Regulation, in developing countries, 197 Relative price definition, 129 versus price level, 129–130 Rent control and discrimination, 70 effect on quality of housing, 70 finder’s fees, 70 key deposits, 70 misallocation from, 70 in New York City, 60–62 opposed by economists, 62 Required rate of return, 229, 252 Research and development costs of, 198 policies to support, 197 Reservation price of buyer, 64 for labor, 152 of seller, 65 in voluntary exchange, 83 Reserve Bank of New Zealand, 386 Reserve-deposit ratio, 251–253, 323 definition, 344 Fed control over, 344 Reserve requirements, to control money supply, 344–345 Reserves; see Bank reserves Residential investments, 101 Resource depletion, omitted from GDP, 109 Resources, shift in aggregate supply curve and changes in, 364 Retirement, saving for, 217–218 Return, determinant of international capital flows, 422–423 Rich countries economic well-being, 110–112 foreign aid from, 197 role of average labor productivity, 182–184 Risk determinant of international capital flows, 422–423 effect on capital flows, 423 in stock prices, 230 Risk and return, 336 Risk premium, 230 Risk sharing in financial markets, 243, 244 function of bond and stock markets, 231–232 Rockefeller, John D., 191 Rotemberg, J., 272n Rules-based jobs, 53 Ruth, Babe, 117, 124 S Sacerdote, Bruce, 392n Salaries of professors, Satellite navigation systems, 16 Saving allocation by financial system by Japanese banks, 246 providing information, 245 risk sharing, 244 allocation by stock and bond markets, 231–232 and capital formation, 208 and capital inflows, 422–425 versus consumption, 220–222 definition, 207 demonstration effects, 220–222 effect of government budget deficits, 235 effect of new technologies, 234 effect of real interest rate, 232–233 as flow, 209–210 importance of, 207 policies to promote, 196 private, 214 public, 215 and real interest rate, 219–220 reasons for bequest saving, 218 in Japan, 218 life-cycle saving, 217–218 precautionary saving, 218 related to wealth, 209 self-control hypothesis, 220–222 supply and demand analysis, 233–234 target savers, 220 types of, 217 by U.S households, 222 Saving-investment diagram effect of new technologies, 234 and government budget deficits, 235 open economy, 423–424 supply and demand analysis for saving, 233 Saving rate definition, 208 in Japan, 218 and living standards, 236 and productivity growth, 48 and trade deficit, 425–426 of U.S households, 222 Savings and loan associations bankruptcies, 324 Scarcity choices under, 3–6 I-13 fundamental fact of, rational person assumption, Scarcity principle, 14 clean environment, 200 and comparative advantage, 34 costs of economic growth, 198 definition, and slope of production possibilities curve, 41 Schwartz, Anna J., 323 Scottish pin factory, 49 Seasonal price movements, 82 Self-control hypothesis and low U.S saving rate, 223 and saving rate, 221–222 Self-correcting economy, 277 assumptions behind, 378 versus basic Keynesian model, 370–372 from expansionary gap, 371 in long run, 372 from recessionary gap, 371–372 role of stabilization policies with demand shocks, 379 with inflation shocks, 380–384 Sellers, effect on price and quantity, 62–65 Seller’s reservation price, 65 in voluntary exchange, 83 Seller’s surplus, 83 Services category of consumption, 100 effect of recessions on, 368 Share of population employed and average labor productivity, 182–184 in U.S 1960–2009, 183 Shift factors for aggregate demand curve, 355–358 for aggregate supply curve, 363–365 Shifts in demand; see Demand Shimer, Robert, 273n Shoe leather costs of inflation, 132 Short run demand met at preset prices, 284–286 exchange rate determination, 406–411 failure of purchasing power parity in, 416 focus of basic Keynesian model, 372 Short-run equilibrium, 353 Short-run equilibrium output after fall in planned spending, 297–299 definition, 293 graphical approach, 295 and multiplier, 301 numerical determination, 294–295 and real interest rate, 327–328 Short-term economic fluctuations and basic Keynesian model, 284 business cycle, 264 versus depressions, 264 global impact, 267–268 historical data, 267–268 industries most affected, 268 inflation, 268 and monetary policy, 324–335 natural rate of unemployment vs cyclical rate, 272–274 Okun’s law, 274–276 output gaps and cyclical unemployment, 269–272 reasons for, 276–279 recessions and expansions, 264–268 unemployment, 268 Short-term unemployed, 165 Silicon Alley, New York City, 167 Silicon Valley, 167 Silver Blaze (Doyle), Simon, John R., 384n Simple interest, 181 Simultaneous equations, 92 method of, 29 solving, 28–30 Skill-biased technological change, 160–161 www.downloadslide.com I-14 INDEX Slope, 25–26 definition, 23 of demand curve, 63–64 of production possibilities curve, 41–44, 46 of supply curve, 64–65 Small businesses, access to credit, 245 Smart for one, dumb for all behaviors, 84 Smith, Adam on prices, 62 on specialization, 49 Social costs of unemployment, 164–165 Socially optimal quantity, 84 Social safety net, 221 Social Security, 221 indexing of benefits, 125–126 Software industry, 15 Solmon, Paul, 52–53 Souleles, Michael S., 307n South America hyperinflation, 135 inflation and depreciation 1995–2004, 417 Southwest Airlines, 387n Soviet Union, 61 reasons for failure, 193–195 Space shuttle program, 10–11 Spain decline as economic power, 193 financial crisis, 405 Spanish Inquisition, 193 Specialization Adam Smith on, 49 aided by money, 246 in baseball, 38 comparative advantage from, 34 cost of failure, 44 gains from, 35–37, 44–45 from globalization, 157 Marx on, 50 nations slow in, 49–50 and population density, 50 possibility of too much, 50–51 real-world gains and losses, 49 Spielberg, Steven, 76 Squawk Box, 319 Stabilization policies, 284 definition, 302 and demand curve shift fiscal policy changes, 357 monetary policy changes, 357 fiscal policy, 302–303 monetary policy, 302 monetary policy flexibility, 320 qualifications on fiscal policy, 308–310 and self-correcting economy with demand shocks, 379 with inflation shocks, 380–384 versus speed of self-correcting, 372 summary of effects on demand curve, 359 Standard and Poor’s 500 index, 211, 289, 334 and dot-com bubble, 367 Standardized commodities, 417–418 Standard of living, 110 Statistical models, 394 Stiroh, Kevin J., 191n Stockholders capital gains, 228 dividends, 228 Stock market allocation of savings, 231–232 boom of late 1990s, 334 bull market of 1990s, 211–212 decline 2000–2002, 289–290 and dot-com bubble, 367 hurt by news of inflation, 333 informational role, 230–231 performance in early 2000s, 212 risk sharing and diversification, 231–232 Stock prices determination of, 228–229 factors affecting, 231–232 fall in 2000–2001, 334 future determination, 229 in Japan in 1980s, 246 and purchasers’ expectations, 232 and risk, 230 Stocks definition, 228 dividends on, 228 mutual funds for, 232 required rate of return, 229, 230 risk premium, 230 risky investment, 230 shares in new company, 228–229 Stocks contrasted with flows, 209–210 Stone, Richard, 94 Store of value, 246 Straight line deriving equation of, from graph, 23–26 graphing equation of, 23–24 Strike threat, 169 Structural policies, 194 in developing countries, 197 Structural unemployment always present in economy, 272 costs of, 166 and economic change, 167 factors contributing to, 167 labor market features, 167 mismatch between skills and jobs, 167 and output gaps, 271–272 Substitutes definition, 74 effect on demand curve, 74–75 Substitution bias, 128 Substitution effect, 63 Summers, Robert, 48n Sung period in China, 191–192 Sunk cost definition, 8–9 example, Supply excess, 67 shifts in, 81–82 Supply and demand, 59–92 algebra of, 91–92 buyers and sellers, 62–65 buyer’s reservation price, 64 changes in prices and quantities, 72–82 demand curve, 63–64 economic naturalist pay and rent increases, 75–76 seasonal price movements, 82 term paper revisions, 79 effect of simultaneous shifts in, 81–82 efficiency and equilibrium, 83–85 income effect, 63 market equilibrium, 66 New York food supply, 59–60 substitution effect, 63 supply curve, 64–65 Supply and demand analysis central planning vs markets, 61–62 of foreign exchange market, 405–412 of labor market, 147–155 demand shifts, 150–153 labor supply, 153–154 supply shifts, 154 wages and demand for labor, 147–149 minimum wage laws, 168–169 price ceilings, 71–72 rent control effects, 61, 69–71 of saving, 232–236 Supply curve definition, 64 to find market equilibrium, 66–69 horizontal interpretation, 65 for labor, 154 low-hanging-fruit principle, 65 with rent control, 69–70 shift factors expectations, 79 four rules governing, 80–81 increasing opportunity cost, 77–78 input prices, 79 reduction of marginal cost, 78–79 technology changes, 79 upward-sloping, 64–65 vertical interpretation, 65 Supply of dollars, 406–407 factors decreasing, 408 factors increasing, 408–409 to purchase foreign assets, 406 to purchase foreign goods, 406 Supply of labor; see Labor supply Supply-side policy, 309 and average tax rate, 389–392 definition, 389 and fiscal policy, 388–392 interstate highway system, 389 and marginal tax rate, 389–392 taxation and transfers, 389 T Tables, constructing equations and graphs from, 26–28 Target inflation rate, 357, 382 announcements avoided by Fed, 387 credibility of announcements, 385–388 additional information in, 386 examples of, 386 strict vs flexible adherence to, 386 success of, 386 too low at zero, 387–388 Target savers, 220 Tastes, effect on demand curve, 76 Taxation bracket creep, 131 in developing countries, 197–198 distortions from inflation, 131–132 impact on incentives, 389 income vs consumption tax, 236 response to output gaps, 278 and shift in aggregate demand curve, 355 Tax cuts to close recessionary gap, 306–307 legislation of 2001, 308 Tax policy, and recessions, 305 Tax rates average, 391–392 on dividends and capital gains, 236 effect on hours of work, 388–392 marginal, 389–391 reduced in early 2000s, 216 Tax rebates, 307 Tax treatment of bonds, 226 Technological advances/changes, 160, 161, 178 effect on saving, investment, and real interest rate, 232–234 impact on labor market, 145–146 impact on menu costs, 285–286 of 19th and 20th centuries, 190 skill-biased, 160–161 and wage inequality, 159–161 workers opposed to, 160, 161 Technology comparative advantage from, 189 determinant of average labor productivity, 190 effect of changes on supply curve, 79 improvements in, 48–49 information and communication, 190 shift in aggregate supply curve and changes in, 364 U.S productivity growth, 190 Temporary help agencies, 173 Term of bonds, 227 www.downloadslide.com INDEX Terrorist attack of 2001, 330 Fed response to, 330–331 Thai currency depreciation, 404 Thaler, Richard, 9n Tierney, John, 60n Tjoa, Bill, 17 Total cost, varying, 10 Total spending, 288, 302 Total surplus definition, 83 and efficiency, 84 increasing or decreasing, 84 in market equilibrium, 85 Trade balance components of, 423 definition, 418 of United States 1960–2010, 420, 425–426 of United States in 1980s, 411 Trade balance/GDP ratio, 425 Trade barriers, lowered by NAFTA, 51 Trade deficit with China, 424 definition, 418 leading to capital inflows, 426 national saving rate as main cause of, 425–426 problem for capital formation, 426 and saving rate, 425–426 of United States in 1985, 411 Trade-offs, between competing interests, and economic surplus, in opportunity cost, 4–5 Trade surplus, 418 Transactions buyer’s surplus from, 83 seller’s surplus from, 83 total surplus from, 83 Transfer payments, 213 excluded from government purchases, 286 impact on incentives, 389 and recessions, 306–307 response to output gaps, 286 unemployment insurance, 170 Transition aid, 159 Transportation in early America, 177 from economic growth, 179–180 Trough, 265 TurboTax, 15 Tversky, Amos, 6n Two-product economy, production possibilities curve in, 39–45 Two-tier labor market, 146 U Unattainable point definition, 41 illustration, 42 Underground economy, 109 Unemployed persons, 162 Unemployment among young workers, 273 chronically unemployed, 166, 167 costs of economic, 164 frictional unemployment, 166 psychological, 164 social, 164 structural unemployment, 167 cyclical and natural rate of unemployment, 272–274 Okun’s law, 274–275 output gaps and, 271–272 definition, 274 duration of, 165–166 indicator of short-term fluctuations, 268 long-term unemployed, 165 measures of Bureau of Labor Statistics survey, 162 definition of labor force, 162 participation rate, 163, 164 unemployment rate, 163 from minimum wage, 168–169 relation to output gaps, 272–274 frictional unemployment, 272–273 structural unemployment, 273 short-term unemployed, 165 types of cyclical, 166 frictional, 166–167 structural, 167–168 unemployment spell, 165 in U.S 1960–2010, 163 Unemployment insurance, impediment to full employment, 170 Unemployment rate, 93 critics of measures of, 166 decline 1999–2000, 275 decline in World War II, 304–305 in recessions, 272–273 versus true rate discouraged workers, 166 involuntary part-time workers, 166 in United States 1978–1985, 383 in United States in 2004, 333 Unemployment spell, 165 Unexploited opportunities, 83, 84 Union wage contracts, 361 United Kingdom abandons fixed exchange rate, 404 decimal monetary system, 399n hours of work, 391 nominal exchange rate for dollar, 401 real GDP growth 2002–2010, 268 real GDP per person 1870–2008, 179 United Parcel Service, 75 United States dollar appreciation 1980–1985, 417 appreciation in early 1980s, 411 circulating in Argentina, 340 depreciation 1986–1987, 417 depreciation after 2002, 411 fluctuations over time, 402 in foreign exchange market changes in demand, 409 changes in supply, 408–409 demand for dollars, 409 effect of monetary policy, 411 market equilibrium value, 408 supply of dollars, 406–407 nominal exchange rates for, 401–403 trade and strength of, 410 United States economy annualized inflation rate 2007–2010, 122 annual real GDP per person 1960–2009, 182 average labor productivity 1960–2009, 182 bull market of 1990s, 211–212 comparative advantage in, 38 consumption function 1960–2010, 288 decline in poverty, 109–110 deflation of 1930s, 387 earnings growth, 156–157 employment data 2011, 163 expansions 1933–2001, 266 expenditure components of GDP, 100–102, 103 failure in digital video market, 39 failure of purchasing power parity in 1980s, 416 financial system, 232–234 hours of work, 391 housing bubble, 300–301 impact of dot-com bubble, 367 impact of oil prices, 368 importance of trade to, 419 inflation 1960–2010, 266–268 inflation rate 1900–2010, 121 I-15 inflation rate 1970–2010, 138 labor productivity growth since 1995, 190 macro data 1978–1985, 382 monetary statistics 1929–1933, 323 national saving rate 1960–2010, 213 nominal exchange rate 1973–2010, 402 nominal interest rate 1970–2010, 138 Okun’s law and output gap, 274–275 output 1929–2010, 107 output gaps1949–2010, 271–272 output per person 1929–2010, 179 and outsourcing, 51–53 potential output 1949–2010, 270 productivity growth, 156–157 real GDP fluctuations 1929–2010, 264 real GDP growth 2002–2010, 268 real GDP per person 1870–2008, 180 real interest rate 1970–2010, 137 real wage trends, 155–156 recession of 2007–2009, 263, 300, 351–352 recessions since 1929, 265–266 share of population employed 1960–2009, 183 shorter work hours, 108 size of labor force, 53 slowed by Fed in 1999–2000, 275 slowed growth of real wage, 156–157 trade balances 1960–2010, 420, 425–426 trade deficit with China, 424 unemployment rate 1960–2010, 163 velocity of money, 258 wages of production workers, 124 United States exchange rate, 405–412 Unit of account, 246–247 Upward-sloping supply curve, 64–65 V Value, expressed in money, 247 Value added definition, 97 to determine market values, 97–98 Value of marginal product, 148 investment decisions, 224 Value theory of prices, 63 Variable, 21 Velocity of money definition, 258 factors determining, 258 and quantity equation, 258 in United States economy, 258 Vending machine, weather-sensitive, 278–279, 286 Vertical intercept changes in, 25–26 definition, 23 of production possibilities curve, 45–46 Vertical interpretation of demand curve, 64 of supply curve, 65 Vietnam War, 304–305 Volcker, Paul, 321, 382, 388, 411 W Wage inequality in developing countries, 159 from globalization, 157–159 increase in, 146 from international trade, 159 from skill-biased technological change, 160–161 from technological change, 159–161 Wages and demand for labor demand curve, 149, 150 diminishing returns, 148 example, 148–149 www.downloadslide.com I-16 INDEX Wages—Cont productivity issue, 147–148 value of marginal product, 148 effect of globalization, 145, 146 effect of technological change, 146 effect on supply curve, 78 higher buying power, 108 market-clearing, 168–169 minimum wage, 168–169 not indexed for inflation, 132 and outsourcing, 52 of production workers 1970–2010, 125 of production workers 1979–2010, 124–125 real vs nominal, 124–125 in two-tier labor market, 146 union wage, 169 Walmart, 109 Warren, Harry, 243 Washington, DC, pay raises and rent increases, 75–76 Washington, George, 177, 178 Wealth capital gains and losses, 210–212 definition, 208 money as store of value, 247 redistributed by hyperinflation, 135 redistribution by inflation, 132–133 related to saving, 210 Wealth effect definition, 289 and stock market decline 2000–2002, 289–290 Wealth of Nations (Smith), 62 Weather-sensitive vending machine, 278–279 Weimar Republic, 259 Well-defined property rights, 192 Williams, Ted, 37–38 Willingness to work, 184 Women, labor market participation, 157 Word-processing technology, 79 Worker mobility, 159 Workers capital investment in, 48 discouraged, 166 heterogeneous, 166 involuntary part-time, 166 low-wage foreign, 52 opposed to technological change, 160, 161 transition aid for, 159 two classes from minimum wage, 168–169 Workweek, 107–108 World Bank, 198 World Trade Center attack, 330–331 World War II, 304–305 Wozniak, Steven, 191 Y Yen-dollar market, 406 Yom Kippur War, 365 Z Zero inflation rate, 387–388 Zimbabwe, hyperinflation, 135 ... 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