1.3 Contents
Preface xx
Section 1
Basic Economic Concepts 1
Any Given Sunday 1
Module 1 The Study of Economics 2
Individual Choice: The Core of Economics 2
Resources Are Scarce 3
Opportunity Cost: The Real Cost of Something Is What You Must Give Up to Get It 4
Microeconomics versus Macroeconomics 4
Macroeconomics: Theory and Policy 5
ECONOMICS IN ACTION: Fending Off Depression 6
The Use of Models in Economics 6
Positive versus Normative Economics 7
When and Why Economists Disagree 8
Module 1 Review 9
Module 2 The Production Possibility Frontier Model 11
Trade-offs: The Production Possibility Frontier 11
Efficiency 13
Opportunity Cost 14
Economic Growth 15
Module 2 Review 16
Module 3 Comparative Advantage and Trade 18
Gains from Trade 18
Comparative Advantage and Gains from Trade 19
ECONOMICS IN ACTION: Rich Nation, Poor Nation 22
Comparative Advantage and International Trade, in Reality 23
Sources of Comparative Advantage 23
Module 3 Review 24
BUSINESS CASE: Efficiency, Opportunity Cost, and the Logic of Lean Production at Boeing 26
Section 1 Review 27
Section 2
Supply and Demand 31
Blue Jean Blues 31
Module 4 Demand 32
Supply and Demand: A Model of a Competitive Market 32
The Demand Curve 33
The Demand Schedule and the Demand Curve 33
Shifts of the Demand Curve 34
Understanding Shifts of the Demand Curve 36
ECONOMICS IN ACTION: Beating the Traffic 41
Module 4 Review 41
Module 5 Supply and Equilibrium 43
The Supply Curve 43
The Supply Schedule and the Supply Curve 43
Shifts of the Supply Curve 44
Understanding Shifts of the Supply Curve 46
ECONOMICS IN ACTION: Only Creatures Small and Pampered 50
Supply, Demand, and Equilibrium 50
Finding the Equilibrium Price and Quantity 51
Why Do All Sales and Purchases in a Market Take Place at the Same Price? 52
Why Does the Market Price Fall If It Is Above the Equilibrium Price? 52
Why Does the Market Price Rise If It Is Below the Equilibrium Price? 52
Using Equilibrium to Describe Markets 52
Module 5 Review 54
Module 6 Changes in Equilibrium 56
Changes in Supply and Demand 56
What Happens When the Demand Curve Shifts 56
What Happens When the Supply Curve Shifts 57
Simultaneous Shifts of Supply and Demand Curves 58
ECONOMICS IN ACTION: The Rice Run of 2008 60
Module 6 Review 60
Module 7 Price Controls and Quantity Controls 63
Why Governments Control Prices and Quantities 63
Price Ceilings 63
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How a Price Ceiling Causes Inefficiency 64
So Why Are There Price Ceilings? 66
Price Floors 67
ECONOMICS IN ACTION: Price Floors and School Lunches 68
How a Price Floor Causes Inefficiency 69
So Why Are There Price Floors? 70
Quantity Controls 70
The Costs of Quantity Controls 73
ECONOMICS IN ACTION: The Clams of the Jersey Shore 74
Module 7 Review 74
Module 8 International Trade 77
International Trade and Globalization 77
Supply, Demand, and International Trade 78
The Effects of Imports 78
The Effects of Exports 80
International Trade and Wages 80
ECONOMICS IN ACTION: Skill and Comparative Advantage 82
The Effects of Trade Protection 82
The Effects of a Tariff 83
The Effects of an Import Quota 84
Challenges to Globalization 84
Module 8 Review 85
BUSINESS CASE: Li & Fung: From Guangzhou to You 87
Section 2 Review 88
Section 3
Macroeconomic Measurement 95
The New #2 95
Module 9 Introduction to Macroeconomics 96
The Business Cycle 97
The Pain of Recession 97
ECONOMICS IN ACTION: Defining Recessions and Expansions 98
Taming the Business Cycle 99
ECONOMICS IN ACTION: Comparing Recessions 99
Long-Run Economic Growth 100
Inflation and Deflation 101
International Imbalances 102
Module 9 Review 104
Module 10 The Circular-Flow Diagram and the National Accounts 105
The National Accounts 105
The Circular-Flow Diagram 106
The Simple Circular-Flow Diagram 106
The Expanded Circular-Flow Diagram 107
ECONOMICS IN ACTION: Creating the National Accounts 109
Module 10 Review 110
Module 11 Gross Domestic Product (GDP) 111
Gross Domestic Product Defined 111
Calculating GDP 111
The Components of GDP 114
GDP: What’s In and What’s Out? 115
ECONOMICS IN ACTION: Our Imputed Lives 116
Module 11 Review 116
Module 12 Interpreting Real Gross Domestic Product 118
What GDP Tells Us 118
Real GDP: A Measure of Aggregate Output 118
Calculating Real GDP 119
ECONOMICS IN ACTION: Miracle in Venezuela? 120
What Real GDP Doesn’t Measure 120
ECONOMICS IN ACTION: GDP and the Meaning of Life 121
Module 12 Review 122
BUSINESS CASE: Getting a Jump on GDP 124
Section 3 Review 125
Section 4
Unemployment and Inflation 131
A Very British Dilemma 131
Module 13 Defining Unemployment 132
The Unemployment Rate 132
Defining and Measuring Unemployment 132
The Significance of the Unemployment Rate 133
Growth and Unemployment 135
ECONOMICS IN ACTION: Failure to Launch 137
Module 13 Review 138
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Module 14 Categories of Unemployment 140
Job Creation and Job Destruction 140
Frictional Unemployment 141
Structural Unemployment 142
The Natural Rate of Unemployment 145
Changes in the Natural Rate of Unemployment 145
ECONOMICS IN ACTION: Natural Unemployment Around the OECD 147
Module 14 Review 148
Module 15 The Costs of Inflation 149
The Inflation Rate 149
The Level of Prices Doesn’t Matter … 149
… But the Rate of Change of Prices Does 150
The Economic Costs of High Inflation 151
ECONOMICS IN ACTION: Israel’s Experience with Inflation 151
Winners and Losers from Inflation 153
Inflation is Easy; Disinflation is Hard 154
Module 15 Review 155
Module 16 Measuring Inflation 157
The Aggregate Price Level 157
Market Baskets and Price Indexes 157
The Consumer Price Index 159
Other Price Measures 160
ECONOMICS IN ACTION: Indexing to the CPI 161
Module 16 Review 162
BUSINESS CASE: A Monster Slump 164
Section 4 Review 165
Section 5
Long-Run Economic Growth 171
Tall Tales 171
Module 17 Sources of Long-Run Economic Growth 172
Comparing Economies Across Time and Space 172
Real GDP per Capita 172
Growth Rates 174
ECONOMICS IN ACTION: India Takes Off 175
What Are the Sources of Long-Run Growth? 176
The Crucial Importance of Productivity 176
Explaining Growth in Productivity 176
Module 17 Review 177
Module 18 Productivity and Growth 179
The Aggregate Production Function 179
Growth Accounting 181
ECONOMICS IN ACTION: The Information Technology Paradox 182
What About Natural Resources? 183
Is World Growth Sustainable? 184
Economic Growth and the Environment 185
Module 18 Review 187
Module 19 Long-Run Growth Policy 189
Why Growth Rates Differ 189
Explaining Differences in Growth Rates 189
The Role of Government in Promoting Economic Growth 191
ECONOMICS IN ACTION: The Brazilian Breadbasket 193
Success, Disappointment, and Failure 193
East Asia’s Miracle 194
Latin America’s Disappointment 195
Africa’s Troubles and Promise 195
ECONOMICS IN ACTION: Are Economies Converging?196
Module 19 Review 198
BUSINESS CASE: Big Box Boom 199
Section 5 Review 200
Section 6
Savings, Investment Spending, and the Financial System 205
Funds for Facebook 205
Module 20 Savings and Investment Spending 206
Matching Up Savings and Investment Spending 206
The Savings–Investment Spending Identity 206
ECONOMICS IN ACTION: America’s Low Savings 210
Module 20 Review 211
Module 21 The Market for Loanable Funds 212
The Role of the Loanable Funds Market 212
The Demand for Loanable Funds 213
The Supply of Loanable Funds 214
The Equilibrium Interest Rate 215
Shifts of the Demand for Loanable Funds 216
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Shifts of the Supply of Loanable Funds 217
Inflation and Interest Rates 218
ECONOMICS IN ACTION: Fifty Years of Fluctuations in U.S. Interest Rates 219
Module 21 Review 220
Module 22 The Time Value of Money 222
The Concept of Present Value 222
Borrowing, Lending, and Interest 223
Defining Present Value 223
Using Present Value 225
ECONOMICS IN ACTION: How Big Is That Jackpot, Anyway? 226
Module 22 Review 227
Module 23 The Financial System 228
Understanding the Financial System 228
Three Tasks of a Financial System 229
Types of Financial Assets 230
Financial Intermediaries 232
Financial Fluctuations and Macroeconomic Policy 234
ECONOMICS IN ACTION: The Great American Housing Bubble 235
Module 23 Review 236
Section 6 Review 237
Section 7
Income and Expenditure 241
From Boom to Bust 241
Module 24 The Multiplier 242
The Multiplier: An Informal Introduction 242
ECONOMICS IN ACTION: The Multiplier and the Great Depression 245
Module 24 Review 245
Module 25 Consumption and Investment Spending 247
Consumer Spending 247
Current Disposable Income and Consumer Spending 247
Shifts of the Aggregate Consumption Function 251
Investment Spending 252
The Interest Rate and Investment Spending 253
Expected Future Real GDP, Production Capacity, and Investment Spending 253
Inventories and Unplanned Investment Spending 254
ECONOMICS IN ACTION: Interest Rates and the U.S.
Housing Boom 255
Module 25 Review 256
Module 26 The Income–Expenditure Model 258
Using the Income–Expenditure Model 258
Planned Aggregate Spending and Real GDP 259
Income–Expenditure Equilibrium 260
The Multiplier Process and Inventory Adjustment 262
ECONOMICS IN ACTION: Inventories and the End of a Recession 265
Module 26 Review 266
BUSINESS CASE: Making It Through in Muskegon 267
Section 7 Review 268
Section 8
Aggregate Demand and Aggregate Supply 273
Shocks to the System 273
Module 27 Aggregate Demand 274
The Aggregate Demand Curve 274
Why Is the Aggregate Demand Curve Downward Sloping? 275
The Aggregate Demand Curve and the Income–Expenditure Model 276
Shifts of the Aggregate Demand Curve 278
ECONOMICS IN ACTION: Moving Along the Aggregate Demand Curve, 1979–1980 282
Module 27 Review 282
Module 28 Aggregate Supply 284
The Aggregate Supply Curve 284
The Short-Run Aggregate Supply Curve 284
Shifts of the Short-Run Aggregate Supply Curve 287
The Long-Run Aggregate Supply Curve 289
From the Short Run to the Long Run 292
ECONOMICS IN ACTION: Prices and Output During the Great Depression 293
Module 28 Review 294
Module 29 The AD–AS Model 296
Putting the Aggregate Supply Curve and the Aggregate Demand Curve Together 296
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Short-Run Macroeconomic Equilibrium 296
Shifts of Aggregate Demand: Short-Run Effects 297
Shifts of the SRAS Curve 298
Long-Run Macroeconomic Equilibrium 300
ECONOMICS IN ACTION: Supply Shocks versus Demand Shocks in Practice 303
Macroeconomic Policy 303
Policy in the Face of Demand Shocks 304
Responding to Supply Shocks 304
Module 29 Review 305
BUSINESS CASE: United in Pain 307
Section 8 Review 308
Section 9
Fiscal Policy 313
To Stimulate or Not to Stimulate? 313
Module 30 Fiscal Policy Basics 314
What Is Fiscal Policy? 314
Taxes, Purchases of Goods and Services, Government Transfers, and Borrowing 315
The Government Budget and Total Spending 316
Expansionary and Contractionary Fiscal Policy 317
Can Expansionary Fiscal Policy Actually Work? 318
A Cautionary Note: Lags in Fiscal Policy 320
ECONOMICS IN ACTION: What Was in the Recovery Act? 321
Module 30 Review 321
Module 31 Fiscal Policy and the Multiplier 323
Multiplier Effects of Fiscal Policy 323
Multiplier Effects of an Increase in Government Purchases of Goods and Services 323
Multiplier Effects of Changes in Government Transfers and Taxes 324
How Taxes Affect the Multiplier 325
ECONOMICS IN ACTION: Multipliers and the Obama Stimulus 326
Module 31 Review 327
Module 32 Budget Deficits and Public Debt 328
The Budget Balance 328
The Budget Balance as a Measure of Fiscal Policy 328
The Business Cycle and the Cyclically Adjusted Budget Balance 329
Should the Budget Be Balanced? 331
ECONOMICS IN ACTION: Europe’s Search for a Fiscal Rule 332
Long-Run Implications of Fiscal Policy 332
Deficits, Surpluses, and Debt 333
Problems Posed by Rising Government Debt 334
Deficits and Debt in Practice 335
Implicit Liabilities 336
Module 32 Review 337
BUSINESS CASE: Priming the Pumps 339
Section 9 Review 340
Section 10
Money, Banking, and the Federal Reserve System 345
Funny Money 345
Module 33 Defining and Measuring Money 346
The Meaning of Money 346
What is Money? 346
Roles of Money 347
Types of Money 348
ECONOMICS IN ACTION: The History of the Dollar 349
Measuring the Money Supply 350
Module 33 Review 351
Module 34 Banking and Money Creation 353
The Monetary Role of Banks 353
What Banks Do 353
The Problem of Bank Runs 354
ECONOMICS IN ACTION: It’s a Wonderful Banking System 355
Bank Regulation 356
Determining the Money Supply 356
How Banks Create Money 357
Reserves, Bank Deposits, and the Money Multiplier 358
The Money Multiplier in Reality 359
Module 34 Review 361
Module 35 The Federal Reserve System 362
The Structure of the Fed 362
The Evolution of the American Banking System 363
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The Crisis in American Banking at the Turn of the Twentieth Century 364
Responding to Banking Crises: The Creation of the Federal Reserve 365
The Savings and Loan Crisis of the 1980s 366
Back to the Future: The Financial Crisis of 2008 366
ECONOMICS IN ACTION: Regulation After the 2008 Crisis 369
Module 35 Review 370
BUSINESS CASE: The Perfect Gift: Cash or a Gift Card? 371
Section 10 Review 372
Section 11
Monetary Policy 377
Person of the Year 377
Module 36 The Federal Reserve and Monetary Policy 378
Functions of the Federal Reserve System 378
How the Fed Conducts Policy 379
The Reserve Requirement 379
The Discount Rate 379
Open-Market Operations 380
ECONOMICS IN ACTION: Who Gets Interest on the Fed’s Assets? 381
Module 36 Review 382
Module 37 The Money Market 383
The Demand for Money 383
The Opportunity Cost of Holding Money 383
The Money Demand Curve 385
Shifts of the Money Demand Curve 386
ECONOMICS IN ACTION: A Yen for Cash 388
Money and Interest Rates 388
The Equilibrium Interest Rate 388
Two Models of Interest Rates? 390
Module 37 Review 390
Module 38 Monetary Policy and the Interest Rate 392
The Fed, the Money Supply, and the Interest Rate 392
Long-Term Interest Rates 394
ECONOMICS IN ACTION: The Fed Reverses Course 395
Monetary Policy and Aggregate Demand 395
Expansionary and Contractionary Monetary Policy 395
Monetary Policy in Practice 396
The Taylor Rule Method of Setting Monetary Policy 397
Inflation Targeting 398
The Zero Lower Bound Problem 399
ECONOMICS IN ACTION: What the Fed Wants, the Fed Gets 399
Module 38 Review 400
Module 39 Money, Output, and Prices in the Long Run 402
Money, Output, and Prices 402
Short-Run and Long-Run Effects of an Increase in the Money Supply 403
Monetary Neutrality 404
Changes in the Money Supply and the Interest Rate in the Long Run 405
ECONOMICS IN ACTION: International Evidence of Monetary Neutrality 406
Module 39 Review 406
BUSINESS CASE: PIMCO Bets on Cheap Money 408
Section 11 Review 409
Section 12
Policy Responses to Unemployment and Inflation 413
Bringing a Suitcase to the Bank 413
Module 40 Inflation, Disinflation, and Deflation 414
Money and Inflation 414
The Classical Model of Money and Prices 414
The Inflation Tax 416
The Logic of Hyperinflation 418
ECONOMICS IN ACTION: What Caused Zimbabwe’s Inflation? 419
Moderate Inflation and Disinflation 419
The Output Gap and the Unemployment Rate 420
Module 40 Review 422
Module 41 The Phillips Curve 423
Inflation and Unemployment in the Short Run 423
The Short-Run Phillips Curve 423
Inflation Expectations and the Short-Run Phillips Curve 424
Inflation and Unemployment in the Long Run 426
The Long-Run Phillips Curve 426
The Natural Rate of Unemployment, Revisited 428
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ECONOMICS IN ACTION: The Great Disinflation of the 1980s 428
The Costs of Disinflation 429
Deflation 429
Debt Deflation 430
Effects of Expected Deflation 430
ECONOMICS IN ACTION: The Deflation Scare of 2010 432
Module 41 Review 433
Module 42 Crises and Consequences 435
Banking: Benefits and Dangers 435
The Purpose of Banking 435
Shadow Banks and the Re-emergence of Bank Runs 436
Banking Crises and Financial Panics 436
ECONOMICS IN ACTION: Lights Out at Lehman 438
The Consequences of Banking Crises 439
Banking Crises, Recessions, and Recovery 439
Why Are Banking-Crisis Recessions So Bad? 440
Governments Step In 441
The 2008 Crisis and Its Aftermath 443
Severe Crisis, Slow Recovery 444
Aftershocks in Europe 444
The Stimulus–Austerity Debate 444
The Lesson of the Post-Crisis Slump 445
Regulation in the Wake of the Crisis 445
Module 42 Review 447
BUSINESS CASE: Licenses to Print Money 448
Section 12 Review 449
Section 13
Open-Economy Macroeconomics 453
Switzerland Doesn’t Want Your Money 453
Module 43 Capital Flows and the Balance of Payments 454
The Balance of Payments Accounts 454
Understanding the Balance of Payments 454
ECONOMICS IN ACTION: GDP, GNP, and the Current Account 458
Modeling the Financial Account 459
Underlying Determinants of International Capital Flows 461
Two-way Capital Flows 462
Module 43 Review 462
Module 44 The Foreign Exchange Market 464
The Role of the Exchange Rate 464
Understanding Exchange Rates 464
The Equilibrium Exchange Rate 465
Inflation and Real Exchange Rates 468
Purchasing Power Parity 470
ECONOMICS IN ACTION: Burgernomics 471
Module 44 Review 471
Module 45 Exchange Rate Policy 473
Exchange Rate Regimes 473
Fixed and Floating Exchange Rates 473
How Can an Exchange Rate Be Held Fixed? 474
The Exchange Rate Regime Dilemma 475
ECONOMICS IN ACTION: China Pegs the Yuan 476
Module 45 Review 477
Module 46 Exchange Rates and Macroeconomic Policy 479
Devaluation and Revaluation of Fixed Exchange Rates 480
ECONOMICS IN ACTION: From Bretton Woods to the Euro 480
Monetary Policy Under a Floating Exchange Rate Regime 481
International Business Cycles 482
Module 46 Review 483
BUSINESS CASE: War of the Earthmovers 484
Section 13 Review 485
Section 14
Macroeconomics: Events and Ideas 489
A Tale of Two Slumps 489
Module 47 History and Alternative Views of Macroeconomics 490
Classical Macroeconomics 490
Money and the Price Level 490
The Business Cycle 490
The Great Depression and the Keynesian Revolution 491
Keynes’s Theory 491
Policy to Fight Recessions 493
ECONOMICS IN ACTION: The End of the Great Depression 493
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Challenges to Keynesian Economics 494
The Revival of Monetary Policy 494
Monetarism 494
Inflation and the Natural Rate of Unemployment 497
The Political Business Cycle 497
Rational Expectations, Real Business Cycles, and New Classical Macroeconomics 498
Rational Expectations 498
Real Business Cycles 499
Module 47 Review 500
Module 48 The Modern Macroeconomic Consensus 502
Consensus and Conflict in Modern Macroeconomics 502
Question 1: Is Expansionary Monetary Policy Helpful in Fighting Recessions? 503
Question 2: Is Expansionary Fiscal Policy Helpful in Fighting Recessions? 503
Question 3: Can Monetary and/or Fiscal Policy Reduce Unemployment in the Long Run? 503
Question 4: Should Fiscal Policy Be Used in a Discretionary Way? 504
Question 5: Should Monetary Policy Be Used in a Discretionary Way? 504
Crisis and Aftermath 504
The Debate over Fiscal Policy 505
The Debate over Monetary Policy 505
ECONOMICS IN ACTION: An Irish Role Model? 506
Module 48 Review 508
Section 14 Review 509
Appendix A
Graphs in Economics A-1
Appendix B
Macroeconomic Data B-1
Solutions to Module Review Questions S-1
Glossary G-1
Index I-1
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