Economics, Fourth Edition PDF by Paul Krugman and Robin Wells


Economics, Fourth Edition
By Paul Krugman and Robin Wells
Economics, Fourth Edition


Preface xxv
PART 1 What Is Economics?
Business of Life ……………………1
The Invisible Hand 2
My Benefit, Your Cost 3
Good Times, Bad Times 3
Onward and Upward 4
An Engine for Discovery 4
uCHAPTER 1 First Principles …………………………..5
Principles That Underlie Individual Choice:
The Core of Economics 6
Principle #1: Choices Are Necessary Because
Resources Are Scarce 6
Principle #2: The True Cost of Something Is Its
Opportunity Cost 7
Principle #3: “How Much” Is a Decision at
the Margin 8
Principle #4: People Usually Respond to
Incentives, Exploiting Opportunities to Make
Themselves Better Off 9
FOR INQUIRING MINDS: Cashing In at School 10
ECONOMICS ➤ IN ACTION Boy or Girl? It Depends
on the Cost 10
Interaction: How Economies Work 12
Principle #5: There Are Gains from Trade 12
Principle #6: Markets Move Toward Equilibrium 13
FOR INQUIRING MINDS: Choosing Sides 14
Principle #7: Resources Should Be Used Efficiently to
Achieve Society’s Goals 15
Principle #8: Markets Usually Lead to Efficiency 16
Principle #9: When Markets Don’t Achieve Efficiency,
Government Intervention Can Improve Society’s
Welfare 16
ECONOMICS ➤ IN ACTION Restoring Equilibrium on
the Freeways 17
Economy-Wide Interactions 18
Principle #10: One Person’s Spending Is Another
Person’s Income 18
Principle #11: Overall Spending Sometimes Gets Out
of Line with the Economy’s Productive Capacity 19
Principle #12: Government Policies Can Change
Spending 19
ECONOMICS ➤ IN ACTION Adventures in Babysitting 20
BUSINESS CASE: How Revolutionized the Travel
Industry 21
uCHAPTER 2 Economics Models:
Trade-offs and Trade……………..25
Models in Economics: Some Important Examples 26
FOR INQUIRING MINDS: The Model That Ate the Economy 26
Trade-offs: The Production Possibility Frontier 27
Comparative Advantage and Gains from Trade 33
Comparative Advantage and International Trade,
in Reality 36
GLOBAL COMPARISON: Pajama Republics 37
Transactions: The Circular-Flow Diagram 37
ECONOMICS ➤ IN ACTION Rich Nation, Poor Nation 39
Using Models 40
Positive versus Normative Economics 40
When and Why Economists Disagree 41
FOR INQUIRING MINDS: When Economists Agree 42
ECONOMICS ➤ IN ACTION Economists, Beyond the
Ivory Tower 43
BUSINESS CASE: Efficiency, Opportunity Cost, and
the Logic of Lean Production 45
Economics …………………………..51
Getting the Picture 51
Graphs, Variables, and Economic Models 51
How Graphs Work 51
Two-Variable Graphs 51
Curves on a Graph 53
A Key Concept: The Slope of a Curve 54
The Slope of a Linear Curve 54
Horizontal and Vertical Curves and Their Slopes 55
The Slope of a Nonlinear Curve 56
Calculating the Slope Along a Nonlinear Curve 56
Maximum and Minimum Points 58
Calculating the Area Below or Above a Curve 59
Graphs That Depict Numerical Information 60
Types of Numerical Graphs 60
Problems in Interpreting Numerical Graphs 62
PART 2 Supply and Demand
uCHAPTER 3 Supply and Demand ………………67
Supply and Demand: A Model of a Competitive
Market 68
The Demand Curve 69
The Demand Schedule and the Demand Curve 69
Shifts of the Demand Curve 70
GLOBAL COMPARISON: Pay More, Pump Less 71
Understanding Shifts of the Demand Curve 73
ECONOMICS ➤ IN ACTION Beating the Traffic 78
The Supply Curve 79
The Supply Schedule and the Supply Curve 79
Shifts of the Supply Curve 80
Understanding Shifts of the Supply Curve 81
ECONOMICS ➤ IN ACTION Only Creatures Small
and Pampered 85
Supply, Demand, and Equilibrium 86
Finding the Equilibrium Price and Quantity 86
Why Do All Sales and Purchases in a Market
Take Place at the Same Price? 87
Why Does the Market Price Fall If It Is Above
the Equilibrium Price? 88
Why Does the Market Price Rise If It Is Below
the Equilibrium Price? 88
Using Equilibrium to Describe Markets 89
ECONOMICS ➤ IN ACTION The Price of Admission 89
Changes in Supply and Demand 90
What Happens When the Demand Curve Shifts 91
What Happens When the Supply Curve Shifts 92
Simultaneous Shifts of Supply and Demand Curves 93
FOR INQUIRING MINDS: Tribulations on the Runway 94
ECONOMICS ➤ IN ACTION The Cotton Panic and
Crash of 2011 95
Competitive Markets—And Others 96
BUSINESS CASE: An Uber Way to Get a Ride 97
uCHAPTER 4 Consumer and Producer
Surplus …………………………………………….103
Consumer Surplus and the Demand Curve 104
Willingness to Pay and the Demand Curve 104
Willingness to Pay and Consumer Surplus 104
How Changing Prices Affect Consumer Surplus 107
FOR INQUIRING MINDS: A Matter of Life and Death 110
ECONOMICS ➤ IN ACTION When Money Isn’t Enough 110
Producer Surplus and the Supply Curve 111
Cost and Producer Surplus 111
How Changing Prices Affect Producer Surplus 114
ECONOMICS ➤ IN ACTION High Times Down on the
Farm 115
Consumer Surplus, Producer Surplus, and
the Gains from Trade 116
The Gains from Trade 116
The Efficiency of Markets 117
Equity and Efficiency 121
ECONOMICS ➤ IN ACTION Take the Keys, Please 121
A Market Economy 122
Why Markets Typically Work So Well 123
A Few Words of Caution 124
ECONOMICS ➤ IN ACTION A Great Leap—Backward 125
BUSINESS CASE: StubHub Shows Up The Boss 126
uCHAPTER 5 Price Controls and
Quotas: Meddling with
Markets …………………………………………… 131
Why Governments Control Prices 132
Price Ceilings 132
Modeling a Price Ceiling 133
How a Price Ceiling Causes Inefficiency 134
FOR INQUIRING MINDS: Winners, Losers, and
Rent Control 136
FOR INQUIRING MINDS: Mumbai’s Rent-Control
Millionaires 138
So Why Are There Price Ceilings? 139
ECONOMICS ➤ IN ACTION Price Controls in Venezuela:
“You Buy What They Have” 140
Price Floors 141
How a Price Floor Causes Inefficiency 143
GLOBAL COMPARISON: Check Out Our Low, Low Wages! 145
So Why Are There Price Floors? 146
ECONOMICS ➤ IN ACTION The Rise and Fall of the Unpaid
Intern 146
Controlling Quantities 147
The Anatomy of Quantity Controls 148
The Costs of Quantity Controls 151
ECONOMICS ➤ IN ACTION Crabbing, Quotas, and
Saving Lives in Alaska 152
BUSINESS CASE: Medallion Financial: Cruising
Right Along 154
uCHAPTER 6 Elasticity ………………………………………… 161
Defining and Measuring Elasticity 162
Calculating the Price Elasticity of Demand 162
An Alternative Way to Calculate Elasticities:
The Midpoint Method 164
ECONOMICS ➤ IN ACTION Estimating Elasticities 165
Interpreting the Price Elasticity of Demand 166
How Elastic Is Elastic? 166
Price Elasticity Along the Demand Curve 171
What Factors Determine the Price Elasticity
of Demand? 172
ECONOMICS ➤ IN ACTION Responding to Your Tuition
Bill 173
Other Demand Elasticities 174
The Cross-Price Elasticity of Demand 174
The Income Elasticity of Demand 175
FOR INQUIRING MINDS: Will China Save the U.S
Farming Sector? 176
GLOBAL COMPARISON: Food’s Bite in World Budgets 176
The Price Elasticity of Supply 177
Measuring the Price Elasticity of Supply 178
What Factors Determine the Price Elasticity of
Supply? 179
ECONOMICS ➤ IN ACTION European Farm Surpluses 180
An Elasticity Menagerie 181
BUSINESS CASE: The Airline Industry: Fly Less, Charge
More 182
PART 3 Individuals and Markets
uCHAPTER 7 Taxes ………………………………………………….187
The Economics of Taxes: A Preliminary View 188
The Effect of an Excise Tax on Quantities and
Prices 188
Price Elasticities and Tax Incidence 191
The Benefits and Costs of Taxation 194
The Revenue from an Excise Tax 194
Tax Rates and Revenue 195
FOR INQUIRING MINDS: French Tax Rates and L’Arc Laffer 197
The Costs of Taxation 198
Elasticities and the Deadweight Loss of a Tax 200
ECONOMICS ➤ IN ACTION Taxing the Marlboro Man 202
Tax Fairness and Tax Efficiency 203
Two Principles of Tax Fairness 203
Equity versus Efficiency 204
ECONOMICS ➤ IN ACTION Federal Tax Philosophy 205
Understanding the Tax System 206
Tax Bases and Tax Structure 206
Equity, Efficiency, and Progressive Taxation 207
Taxes in the United States 208
GLOBAL COMPARISON: You Think You Pay High Taxes? 209
Different Taxes, Different Principles 209
FOR INQUIRING MINDS: Taxing Income versus Taxing
Consumption 209
ECONOMICS ➤ IN ACTION The Top Marginal Income Tax
Rate 210
BUSINESS CASE: Amazon versus 211
uCHAPTER 8 International Trade ……………….. 217
Comparative Advantage and International Trade 218
Production Possibilities and Comparative
Advantage, Revisited 219
The Gains from International Trade 221
Comparative Advantage versus Absolute
Advantage 222
GLOBAL COMPARISON: Productivity and Wages Around
the World 223
Sources of Comparative Advantage 224
FOR INQUIRING MINDS: Increasing Returns to Scale and
International Trade 226
Its Shirts 226
Supply, Demand, and International Trade 227
The Effects of Imports 228
The Effects of Exports 230
International Trade and Wages 232
ECONOMICS ➤ IN ACTION Trade, Wages, and Land Prices
in the Nineteenth Century 233
The Effects of Trade Protection 234
The Effects of a Tariff 234
The Effects of an Import Quota 236
ECONOMICS ➤ IN ACTION Trade Protection in the United
States 237
The Political Economy of Trade Protection 238
Arguments for Trade Protection 238
The Politics of Trade Protection 238
International Trade Agreements and the World Trade
Organization 239
FOR INQUIRING MINDS: Tires Under Pressure 240
Challenges to Globalization 240
ECONOMICS ➤ IN ACTION Beefing Up Exports 242
BUSINESS CASE: Li & Fung: From Guangzhou to You 244
PART 4 Economics and Decision
uCHAPTER 9 Decision Making by
Individuals and Firms …………249
Costs, Benefits, and Profits 250
Explicit versus Implicit Costs 250
Accounting Profit versus Economic Profit 251
Making “Either–Or” Decisions 253
FOR INQUIRING MINDS: A Tale of Two Invasions 253
ECONOMICS ➤ IN ACTION Farming in the Shadow
of Suburbia 254
Making “How Much” Decisions: The Role of
Marginal Analysis 255
Marginal Cost 256
Marginal Benefit 258
Marginal Analysis 259
GLOBAL COMPARISON: Portion Sizes 261
A Principle with Many Uses 262
ECONOMICS ➤ IN ACTION The Cost of a Life 263
Sunk Costs 263
ECONOMICS ➤ IN ACTION A Billion Here, a Billion
There… 264
Behavioral Economics 265
Rational, but Human, Too 265
Irrationality: An Economist’s View 266
FOR INQUIRING MINDS: In Praise of Hard Deadlines 267
Rational Models for Irrational People? 269
ECONOMICS ➤ IN ACTION “The Jingle Mail Blues” 269
BUSINESS CASE: J. C. Penney’s One-Price Strategy Upsets Its
Customers 271
CHAPTER 9 APPENDIX Toward a Fuller
Understanding of
Present Value ……………………277
How to Calculate the Present Value of One-Year
Projects 277
How to Calculate the Present Value of Multiyear
Projects 278
How to Calculate the Present Value of Projects with
Revenues and Costs 279
PART 5 The Consumer
uCHAPTER 10 T he Rational
Consumer ………………………………….281
Utility: Getting Satisfaction 282
Utility and Consumption 282
The Principle of Diminishing Marginal Utility 283
FOR INQUIRING MINDS: Is Marginal Utility Really
Diminishing? 284
ECONOMICS ➤ IN ACTION Oysters versus Chicken 284
Budgets and Optimal Consumption 285
Budget Constraints and Budget Lines 285
Optimal Consumption Choice 287
FOR INQUIRING MINDS: Food for Thought on Budget
Constraints 288
ECONOMICS ➤ IN ACTION The Great Condiment
Craze 289
Spending the Marginal Dollar 290
Marginal Utility per Dollar 291
Optimal Consumption 292
ECONOMICS ➤ IN ACTION Buying Your Way Out of
Temptation 294
From Utility to the Demand Curve 294
Marginal Utility, the Substitution Effect, and the Law of
Demand 294
The Income Effect 295
ECONOMICS ➤ IN ACTION Mortgage Rates and Consumer
Demand 296
BUSINESS CASE: Having a Happy Meal at McDonald’s 298
Preferences and
Consumer Choice ………303
Mapping the Utility Function 303
Indifference Curves 303
Properties of Indifference Curves 306
Indifference Curves and Consumer Choice 307
The Marginal Rate of Substitution 308
The Tangency Condition 311
The Slope of the Budget Line 312
Prices and the Marginal Rate of Substitution 313
Preferences and Choices 315
Using Indifference Curves: Substitutes and
Complements 316
Perfect Substitutes 316
Perfect Complements 318
Less Extreme Cases 319
Prices, Income, and Demand 319
The Effects of a Price Increase 319
Income and Consumption 320
Income and Substitution Effects 323
PART 6 The Production Decision
uCHAPTER 11 Behind the Supply
Curve: Inputs and
Costs ………………………………………………329
The Production Function 330
Inputs and Output 330
GLOBAL COMPARISON: Wheat Yields Around the World 332
From the Production Function to Cost Curves 334
ECONOMICS ➤ IN ACTION The Mythical Man-Month 336
Two Key Concepts: Marginal Cost and Average
Cost 337
Marginal Cost 337
Average Total Cost 339
Minimum Average Total Cost 342
Does the Marginal Cost Curve Always Slope
Upward? 343
ECONOMICS ➤ IN ACTION Smart Grid Economics 344
Short-Run versus Long-Run Costs 345
Returns to Scale 348
Summing Up Costs: The Short and Long of It 349
ECONOMICS ➤ IN ACTION There’s No Business Like Snow
Business 350
BUSINESS CASE: Kiva Systems’ Robots versus Humans: The
Challenge of Holiday Order Fulfillment 351
uCHAPTER 12 Perfect Competition
and the Supply Curve ……..357
Perfect Competition 358
Defining Perfect Competition 358
Two Necessary Conditions for Perfect
Competition 358
Free Entry and Exit 359
FOR INQUIRING MINDS: What’s a Standardized Product? 360
ECONOMICS ➤ IN ACTION Paid to Delay 360
Production and Profits 361
Using Marginal Analysis to Choose the Profit-
Maximizing Quantity of Output 362
When Is Production Profitable? 364
The Short-Run Production Decision 367
Changing Fixed Cost 370
Summing Up: The Perfectly Competitive Firm’s
Profitability and Production Conditions 370
ECONOMICS ➤ IN ACTION Farmers Move Up Their Supply
Curves 371
The Industry Supply Curve 372
The Short-Run Industry Supply Curve 372
The Long-Run Industry Supply Curve 373
The Cost of Production and Efficiency in Long-Run
Equilibrium 377
ECONOMICS ➤ IN ACTION From Global Wine Glut to
Shortage 378
BUSINESS CASE: Shopping Apps, Showrooming, and the
Challenges Facing Brick-and-Mortar
Retailers 379
PART 7 Market Structure: Beyond
Perfect Competition
uCHAPTER 13 Monopoly ……………………………………385
Types of Market Structure 386
The Meaning of Monopoly 387
Monopoly: Our First Departure from Perfect
Competition 387
What Monopolists Do 387
Why Do Monopolies Exist? 389
ECONOMICS ➤ IN ACTION Newly Emerging Markets: A
Diamond Monopolist’s Best
Friend 392
How a Monopolist Maximizes Profit 393
The Monopolist’s Demand Curve and Marginal
Revenue 393
The Monopolist’s Profit-Maximizing Output and
Price 397
Monopoly versus Perfect Competition 398
Monopoly: The General Picture 398
ECONOMICS ➤ IN ACTION Shocked by the High Price of
Electricity 399
Monopoly and Public Policy 400
Welfare Effects of Monopoly 401
Preventing Monopoly 402
Dealing with Natural Monopoly 402
ECONOMICS ➤ IN ACTION Why Is Your Broadband So
Slow? And Why Does It Cost
So Much? 406
Price Discrimination 407
The Logic of Price Discrimination 408
Price Discrimination and Elasticity 409
Perfect Price Discrimination 410
ECONOMICS ➤ IN ACTION Sales, Factory Outlets, and
Ghost Cities 412
BUSINESS CASE: Amazon and Hachette Go to War 414
uCHAPTER 14 Oligopoly ……………………………………. 419
The Prevalence of Oligopoly 420
ECONOMICS ➤ IN ACTION Is It an Oligopoly or Not? 421
Understanding Oligopoly 422
A Duopoly Example 422
Collusion and Competition 423
ECONOMICS ➤ IN ACTION Bitter Chocolate? 425
Games Oligopolists Play 426
The Prisoners’ Dilemma 426
FOR INQUIRING MINDS: Prisoners of the Arms Race 429
Overcoming the Prisoners’ Dilemma: Repeated
Interaction and Tacit Collusion 429
ECONOMICS ➤ IN ACTION The Rise and Fall and Rise of
OPEC 431
Oligopoly in Practice 433
The Legal Framework 433
GLOBAL COMPARISON: Contrasting Approaches to Antitrust
Regulation 434
Tacit Collusion and Price Wars 435
Product Differentiation and Price Leadership 436
How Important Is Oligopoly? 437
Christmas 438
BUSINESS CASE: Virgin Atlantic Blows the Whistle …
or Blows It? 440
uCHAPTER 15 Monopolistic Competition
and Product
Differentiation ………………………..445
The Meaning of Monopolistic Competition 446
Large Numbers 446
Differentiated Products 446
Free Entry and Exit in the Long Run 447
Product Differentiation 447
Differentiation by Style or Type 447
Differentiation by Location 448
Differentiation by Quality 448
ECONOMICS ➤ IN ACTION Any Color, So Long As It’s
Black 449
Understanding Monopolistic Competition 449
Monopolistic Competition in the Short Run 450
Monopolistic Competition in the Long Run 451
FOR INQUIRING MINDS: Hits and Flops 453
ECONOMICS ➤ IN ACTION The Housing Bust and
the Demise of the 6%
Commission 454
Monopolistic Competition versus Perfect
Competition 455
Price, Marginal Cost, and Average Total Cost 455
Is Monopolistic Competition Inefficient? 456
Controversies About Product Differentiation 457
The Role of Advertising 457
Brand Names 458
ECONOMICS ➤ IN ACTION The Perfume Industry: Leading
Consumers by the Nose 459
BUSINESS CASE: Gillette versus Schick: A Case of Razor
Burn? 461
PART 8 Microeconomics and
Public Policy
uCHAPTER 16 Externalities……………………………..465
External Costs and Benefits 466
FOR INQUIRING MINDS: Talking, Texting, and Driving 466
Pollution: An External Cost 467
The Socially Optimum Quantity of Pollution 467
Why a Market Economy Produces Too Much
Pollution 468
Private Solutions to Externalities 469
ECONOMICS ➤ IN ACTION How Much Does Your Electricity
Really Cost? 471
Policies Toward Pollution 472
Environmental Standards 472
Emissions Taxes 473
GLOBAL COMPARISON: Economic Growth and Greenhouse
Gases in Six Countries 473
Tradable Emissions Permits 474
Comparing Environmental Policies with an
Example 475
ECONOMICS ➤ IN ACTION Cap and Trade 477
Positive Externalities 478
Preserved Farmland: An External Benefit 479
Positive Externalities in Today’s Economy 480
ECONOMICS ➤ IN ACTION The Impeccable Economic Logic
of Early-Childhood Intervention
Programs 480
Network Externalities 481
The External Benefits of a Network Externality 481
ECONOMICS ➤ IN ACTION The Microsoft Case 483
BUSINESS CASE: Are We Still Friends? A Tale of Facebook,
MySpace, and Friendster 485
uCHAPTER 17 Public Goods and
Common Resources ………..489
Private Goods—and Others 490
Characteristics of Goods 490
Why Markets Can Supply Only Private Goods
Efficiently 491
Renaissance 492
Public Goods 493
Providing Public Goods 493
How Much of a Public Good Should Be Provided? 494
FOR INQUIRING MINDS: Voting as a Public Good 496
GLOBAL COMPARISON: Voting as a Public Good: The Global
Perspective 496
Cost-Benefit Analysis 497
Common Resources 499
The Problem of Overuse 499
FOR INQUIRING MINDS: When Fertile Farmland Turned
to Dust 501
The Efficient Use and Maintenance of a Common
Resource 501
ECONOMICS ➤ IN ACTION Saving the Oceans with
ITQs 502
Artificially Scarce Goods 503
ECONOMICS ➤ IN ACTION Blacked-Out Games 504
BUSINESS CASE: Mauricedale Game Ranch and Hunting
Endangered Animals to Save Them 506
uCHAPTER 18 The Economics of
the Welfare State …………………511
Poverty, Inequality, and Public Policy 512
The Logic of the Welfare State 512
FOR INQUIRING MINDS: Justice and the Welfare State 513
The Problem of Poverty 513
GLOBAL COMPARISON: Redistribution and Inequality in Rich
Countries 515
Economic Inequality 517
Economic Insecurity 519
ECONOMICS ➤ IN ACTION Long-Term Trends in Income
Inequality in the United
States 519
The U.S. Welfare State 521
Means-Tested Programs 522
Social Security and Unemployment Insurance 523
The Effects of the Welfare State on Poverty and
Inequality 523
ECONOMICS ➤ IN ACTION Welfare State Programs and
Poverty Rates in the Great
Recession, 2007–2010 524
The Economics of Health Care 525
The Need for Health Insurance 525
FOR INQUIRING MINDS: A California Death Spiral 527
Government Health Insurance 527
The Problem of the Uninsured Before the Affordable
Care Act 528
Health Care in Other Countries 529
The Affordable Care Act 530
ECONOMICS ➤ IN ACTION What Medicaid Does 533
The Debate over the Welfare State 534
Problems with the Welfare State 534
The Politics of the Welfare State 535
FOR INQUIRING MINDS: “We Are the 99%!” 536
ECONOMICS ➤ IN ACTION French Family Values 536
BUSINESS CASE: Welfare State Entrepreneurs 538
PART 9 Factor Markets and Risk
uCHAPTER 19 Factor Markets and
the Distribution of
Income ………………………………………….543
The Economy’s Factors of Production 544
The Factors of Production 544
Why Factor Prices Matter: The Allocation of
Resources 544
Factor Incomes and the Distribution of Income 544
FOR INQUIRING MINDS: The Factor Distribution of Income and
Social Change in the Industrial
Revolution 545
ECONOMICS ➤ IN ACTION The Factor Distribution
of Income in the United
States 545
Marginal Productivity and Factor Demand 546
Value of the Marginal Product 546
Value of the Marginal Product and Factor Demand 548
Shifts of the Factor Demand Curve 550
The Marginal Productivity Theory of Income
Distribution 551
The Markets for Land and Capital 553
The Marginal Productivity Theory of Income
Distribution 555
ECONOMICS ➤ IN ACTION Help Wanted! 555
Is the Marginal Productivity Theory of Income
Distribution Really True? 556
Wage Disparities in Practice 557
Marginal Productivity and Wage Inequality 558
Market Power 559
Efficiency Wages 560
Discrimination 561
FOR INQUIRING MINDS: How Labor Works the German
Way 561
So Does Marginal Productivity Theory Work? 562
ECONOMICS ➤ IN ACTION Marginal Productivity and the
“1%” 562
The Supply of Labor 563
Work versus Leisure 563
Wages and Labor Supply 564
FOR INQUIRING MINDS: Why You Can’t Find a Cab When It’s
Raining 566
Shifts of the Labor Supply Curve 566
GLOBAL COMPARISON: The Overworked American? 567
ECONOMICS ➤ IN ACTION The Decline of the Summer
Job 568
BUSINESS CASE: Wages and Workers at Costco and
Walmart 569
CHAPTER 19 APPENDIX Indifference Curve
Analysis of Labor
Supply …………………………………………575
The Time Allocation Budget Line 575
The Effect of a Higher Wage Rate 576
Indifference Curve Analysis 579
uCHAPTER 20 Uncertainty, Risk, and
Private Information ……………581
The Economics of Risk Aversion 582
Expectations and Uncertainty 582
The Logic of Risk Aversion 583
FOR INQUIRING MINDS: The Paradox of Gambling 587
Paying to Avoid Risk 587
ECONOMICS ➤ IN ACTION Warranties 588
Buying, Selling, and Reducing Risk 588
Trading Risk 589
Making Risk Disappear: The Power of
Diversification 592
FOR INQUIRING MINDS: Those Pesky Emotions 594
The Limits of Diversification 595
ECONOMICS ➤ IN ACTION When Lloyd’s Almost
Lost It 596
Private Information: What You Don’t Know Can
Hurt You 596
Adverse Selection: The Economics of Lemons 597
Moral Hazard 599
ECONOMICS ➤ IN ACTION Franchise Owners Try
Harder 600
BUSINESS CASE: The Agony of AIG 602
PART 10 Introduction to
uCHAPTER 21 Macroeconomics:
The Big Picture …………………..607
The Nature of Macroeconomics 608
Macroeconomic Questions 608
Macroeconomics: The Whole Is Greater Than the Sum
of Its Parts 609
Macroeconomics: Theory and Policy 609
ECONOMICS ➤ IN ACTION Fending Off Depression 610
The Business Cycle 611
Charting the Business Cycle 612
The Pain of Recession 613
FOR INQUIRING MINDS: Defining Recessions and
Expansions 614
Taming the Business Cycle 615
GLOBAL COMPARISON: Slumps Across the Atlantic 615
ECONOMICS ➤ IN ACTION Comparing Recessions 616
Long-Run Economic Growth 616
FOR INQUIRING MINDS: When Did Long-Run Growth
Start? 618
ECONOMICS ➤ IN ACTION A Tale of Two Countries 618
Inflation and Deflation 619
The Causes of Inflation and Deflation 619
The Pain of Inflation and Deflation 620
ECONOMICS ➤ IN ACTION A Fast (Food) Measure of
Inflation 620
International Imbalances 621
ECONOMICS ➤ IN ACTION Spain’s Costly Surplus 622
BUSINESS CASE: The Business Cycle and the Decline of
Montgomery Ward 624
uCHAPTER 22 GDP and the CPI: Tracking
the Macroeconomy …………629
THE NEW #2 629
The National Accounts 630
The Circular-Flow Diagram, Revisited and
Expanded 630
Gross Domestic Product 633
Calculating GDP 634
FOR INQUIRING MINDS: Our Imputed Lives 635
What GDP Tells Us 639
ECONOMICS ➤ IN ACTION Creating the National
Accounts 639
Real GDP: A Measure of Aggregate Output 640
Calculating Real GDP 640
What Real GDP Doesn’t Measure 641
GLOBAL COMPARISON: GDP and the Meaning of Life 642
ECONOMICS ➤ IN ACTION Miracle in Venezuela? 643
Price Indexes and the Aggregate Price Level 643
Market Baskets and Price Indexes 644
The Consumer Price Index 645
Other Price Measures 646
ECONOMICS ➤ IN ACTION Indexing to the CPI 647
BUSINESS CASE: Getting a Jump on GDP 649
uCHAPTER 23 Unemployment and
Inflation ……………………………………..655
The Unemployment Rate 656
Defining and Measuring Unemployment 656
The Significance of the Unemployment Rate 657
Growth and Unemployment 659
ECONOMICS ➤ IN ACTION Failure to Launch 661
The Natural Rate of Unemployment 662
Job Creation and Job Destruction 662
Frictional Unemployment 663
Structural Unemployment 665
The Natural Rate of Unemployment 667
GLOBAL COMPARISON: Natural Unemployment Around the
OECD 668
Changes in the Natural Rate of Unemployment 668
ECONOMICS ➤ IN ACTION Structural Unemployment in
East Germany 670
Inflation and Deflation 671
The Level of Prices Doesn’t Matter . . . 671
. . . But the Rate of Change of Prices Does 672
Winners and Losers from Inflation 675
Inflation Is Easy; Disinflation Is Hard 676
ECONOMICS ➤ IN ACTION Israel’s Experience with
Inflation 677
BUSINESS CASE: Day Labor in the Information Age 678
PART 11 Long-Run Economic Growth
uCHAPTER 24 Long-Run Economic
Growth ……………………………………….683
Comparing Economies Across Time and Space 684
Real GDP per Capita 684
Growth Rates 686
ECONOMICS ➤ IN ACTION India Takes Off 687
The Sources of Long-Run Growth 688
The Crucial Importance of Productivity 688
Explaining Growth in Productivity 689
Accounting for Growth: The Aggregate Production
Function 689
What About Natural Resources? 693
ECONOMICS ➤ IN ACTION Is the End of Economic Growth
in Sight? 694
Why Growth Rates Differ 695
Explaining Differences in Growth Rates 696
GLOBAL COMPARISON: What’s the Matter with Italy? 698
The Role of Government in Promoting Economic
Growth 698
FOR INQUIRING MINDS: The New Growth Theory 699
ECONOMICS ➤ IN ACTION Why Did Britain Fall
Behind? 700
Success, Disappointment, and Failure 701
East Asia’s Miracle 702
Latin America’s Disappointment 703
Africa’s Troubles and Promise 703
Converging? 704
Is World Growth Sustainable? 706
Natural Resources and Growth, Revisited 706
Economic Growth and the Environment 708
ECONOMICS ➤ IN ACTION The Cost of Limiting
Carbon 710
BUSINESS CASE: How Boeing Got Better 712
uCHAPTER 25 Savings, Investment
Spending, and the
Financial System ……………… 717
Matching Up Savings and Investment Spending 718
The Savings–Investment Spending Identity 718
FOR INQUIRING MINDS: Who Enforces the Accounting? 721
The Market for Loanable Funds 722
FOR INQUIRING MINDS: Using Present Value 723
ECONOMICS ➤ IN ACTION Sixty Years of U.S. Interest
Rates 730
The Financial System 731
Three Tasks of a Financial System 732
Types of Financial Assets 734
Financial Intermediaries 735
GLOBAL COMPARISON: Bonds Versus Banks 737
ECONOMICS ➤ IN ACTION Banks and the South Korean
Miracle 738
Financial Fluctuations 739
The Demand for Stocks 739
FOR INQUIRING MINDS: How Now, Dow Jones? 740
The Demand for Other Assets 741
Asset Price Expectations 741
FOR INQUIRING MINDS: Behavioral Finance 742
Asset Prices and Macroeconomics 743
ECONOMICS ➤ IN ACTION The Great American Housing
Bubble 744
BUSINESS CASE: Grameen Bank: Banking Against
Poverty 746
PART 12 Short-Run Economic
uCHAPTER 26 Income and
Expenditure…………………………… 751
The Multiplier: An Informal Introduction 752
ECONOMICS ➤ IN ACTION Sand State Slump 754
Consumer Spending 755
Current Disposable Income and Consumer
Spending 755
Shifts of the Aggregate Consumption Function 758
ECONOMICS ➤ IN ACTION Famous First Forecasting
Failures 760
Investment Spending 761
The Interest Rate and Investment Spending 762
Expected Future Real GDP, Production Capacity, and
Investment Spending 763
Inventories and Unplanned Investment Spending 764
ECONOMICS ➤ IN ACTION Interest Rates and the U.S.
Housing Boom 765
The Income–Expenditure Model 766
Planned Aggregate Spending and Real GDP 767
Income–Expenditure Equilibrium 768
The Multiplier Process and Inventory Adjustment 770
ECONOMICS ➤ IN ACTION Inventories and the End of a
Recession 773
BUSINESS CASE: What’s Good for America Is Good for
GM 775
CHAPTER 26 APPENDIX Deriving the Multiplier
Algebraically ……………………781
uCHAPTER 27 Aggregate Demand and
Aggregate Supply ……………783
Aggregate Demand 784
Why Is the Aggregate Demand Curve Downward
Sloping? 785
The Aggregate Demand Curve and the
Income–Expenditure Model 786
Shifts of the Aggregate Demand Curve 788
Government Policies and Aggregate Demand 791
ECONOMICS ➤ IN ACTION Moving Along the
Aggregate Demand Curve,
1979–1980 792
Aggregate Supply 792
The Short-Run Aggregate Supply Curve 793
FOR INQUIRING MINDS: What’s Truly Flexible, What’s Truly
Sticky 794
Shifts of the Short-Run Aggregate Supply Curve 795
The Long-Run Aggregate Supply Curve 798
From the Short Run to the Long Run 800
ECONOMICS ➤ IN ACTION Sticky Wages in the Great
Recession 801
The AD–AS Model 802
Short-Run Macroeconomic Equilibrium 802
Shifts of Aggregate Demand: Short-Run Effects 803
Shifts of the SRAS Curve 804
GLOBAL COMPARISON: Supply Shocks of the Twenty-first
Century 806
Long-Run Macroeconomic Equilibrium 806
FOR INQUIRING MINDS: Where’s the Deflation? 809
ECONOMICS ➤ IN ACTION Supply Shocks Versus Demand
Shocks in Practice 809
Macroeconomic Policy 810
FOR INQUIRING MINDS: Keynes and the Long Run 811
Policy in the Face of Demand Shocks 811
Responding to Supply Shocks 812
ECONOMICS ➤ IN ACTION Is Stabilization Policy
Stabilizing? 812
BUSINESS CASE: Slow Steaming 814
PART 13 Stabilization Policy
uCHAPTER 28 Fiscal Policy ………………………….. 819
Fiscal Policy: The Basics 820
Taxes, Purchases of Goods and Services, Government
Transfers, and Borrowing 820
The Government Budget and Total Spending 821
Expansionary and Contractionary Fiscal Policy 822
Can Expansionary Fiscal Policy Actually Work? 824
A Cautionary Note: Lags in Fiscal Policy 825
ECONOMICS ➤ IN ACTION What Was in the Recovery
Act? 826
Fiscal Policy and the Multiplier 827
Multiplier Effects of an Increase in Government
Purchases of Goods and Services 827
Multiplier Effects of Changes in Government Transfers
and Taxes 828
How Taxes Affect the Multiplier 829
ECONOMICS ➤ IN ACTION Austerity and the Multiplier 830
The Budget Balance 831
The Budget Balance as a Measure of Fiscal Policy 832
The Business Cycle and the Cyclically Adjusted Budget
Balance 832
Should the Budget Be Balanced? 835
ECONOMICS ➤ IN ACTION Europe’s Search for a Fiscal
Rule 835
Long-Run Implications of Fiscal Policy 836
Deficits, Surpluses, and Debt 837
GLOBAL COMPARISON: The American Way of Debt 838
Problems Posed by Rising Government Debt 839
Deficits and Debt in Practice 840
FOR INQUIRING MINDS: What Happened to the Debt from World
War II? 841
Implicit Liabilities 841
ECONOMICS ➤ IN ACTION Are We Greece? 843
BUSINESS CASE: Here Comes the Sun 845
CHAPTER 28 APPENDIX Taxes and the
Multiplier ……………………………..851
uCHAPTER 29 Money, Banking, and
the Federal Reserve
System ……………………………………….853
The Meaning of Money 854
What Is Money? 854
Roles of Money 855
Types of Money 856
Measuring the Money Supply 857
FOR INQUIRING MINDS: What’s with All the Currency? 858
ECONOMICS ➤ IN ACTION The History of the Dollar 859
The Monetary Role of Banks 860
What Banks Do 860
The Problem of Bank Runs 861
Bank Regulation 862
ECONOMICS ➤ IN ACTION It’s a Wonderful Banking
System 863
Determining the Money Supply 864
How Banks Create Money 864
Reserves, Bank Deposits, and the Money
Multiplier 866
The Money Multiplier in Reality 867
ECONOMICS ➤ IN ACTION Multiplying Money Down 868
The Federal Reserve System 869
The Structure of the Fed 869
What the Fed Does: Reserve Requirements and the
Discount Rate 870
Open-Market Operations 871
FOR INQUIRING MINDS: Who Gets the Interest on the Fed’s
Assets? 873
The European Central Bank 873
ECONOMICS ➤ IN ACTION The Fed’s Balance Sheet,
Normal and Abnormal 874
The Evolution of the American Banking System 875
The Crisis in American Banking in the Early Twentieth
Century 875
Responding to Banking Crises: The Creation of the
Federal Reserve 876
The Savings and Loan Crisis of the 1980s 878
Back to the Future: The Financial Crisis of 2008 878
ECONOMICS ➤ IN ACTION Regulation After the 2008
Crisis 881
BUSINESS CASE: The Perfect Gift: Cash or a Gift Card? 883
uCHAPTER 30 Monetary Policy …………………889
The Demand for Money 890
The Opportunity Cost of Holding Money 890
The Money Demand Curve 892
Shifts of the Money Demand Curve 893
ECONOMICS ➤ IN ACTION A Yen for Cash 894
Money and Interest Rates 895
The Equilibrium Interest Rate 895
Two Models of Interest Rates? 897
Monetary Policy and the Interest Rate 897
Long-Term Interest Rates 899
ECONOMICS ➤ IN ACTION The Fed Reverses Course 900
Monetary Policy and Aggregate Demand 901
Expansionary and Contractionary Monetary Policy 901
Monetary Policy in Practice 902
The Taylor Rule Method of Setting Monetary Policy 903
Inflation Targeting 903
GLOBAL COMPARISON: Inflation Targets 904
The Zero Lower Bound Problem 905
ECONOMICS ➤ IN ACTION What the Fed Wants, the Fed
Gets 905
Money, Output, and Prices in the Long Run 906
Short-Run and Long-Run Effects of an Increase in the
Money Supply 906
Monetary Neutrality 908
Changes in the Money Supply and the Interest Rate in
the Long Run 908
ECONOMICS ➤ IN ACTION International Evidence of
Monetary Neutrality 909
BUSINESS CASE: PIMCO Bets on Cheap Money 911
CHAPTER 30 APPENDIX Reconciling the
Two Models of the
Interest Rate ……………………915
The Interest Rate in the Short Run 915
The Interest Rate in the Long Run 916
uCHAPTER 31 Inflation, Disinflation,
and Deflation ……………………….. 919
Money and Inflation 920
The Classical Model of Money and Prices 920
The Inflation Tax 922
The Logic of Hyperinflation 923
ECONOMICS ➤ IN ACTION Zimbabwe’s Inflation 925
Moderate Inflation and Disinflation 925
The Output Gap and the Unemployment Rate 926
The Short-Run Phillips Curve 928
FOR INQUIRING MINDS: The Aggregate Supply Curve and the
Short-Run Phillips Curve 930
Inflation Expectations and the Short-Run Phillips
Curve 931
ECONOMICS ➤ IN ACTION The Phillips Curve in the Great
Recession 933
Inflation and Unemployment in the Long Run 934
The Long-Run Phillips Curve 934
The Natural Rate of Unemployment, Revisited 936
The Costs of Disinflation 936
GLOBAL COMPARISON: Disinflation Around the World 936
ECONOMICS ➤ IN ACTION The Great Disinflation of the
1980s 937
Deflation 938
Debt Deflation 938
Effects of Expected Deflation 939
Japanese? 940
BUSINESS CASE: Licenses to Print Money 942
uCHAPTER 32 Crises and
Consequences ……………………947
Banking: Benefits and Dangers 948
The Trade-off Between Rate of Return and
Liquidity 948
The Purpose of Banking 949
Shadow Banks and the Re-emergence of Bank
Runs 950
ECONOMICS ➤ IN ACTION The Day the Lights Went Out at
Lehman 951
Banking Crises and Financial Panics 952
The Logic of Banking Crises 952
Historical Banking Crises: The Age of Panics 954
Modern Banking Crises Around the World 955
The Consequences of Banking Crises 957
Banking Crises, Recessions, and Recovery 957
Why Are Banking-Crisis Recessions So Bad? 958
Governments Step In 959
ECONOMICS ➤ IN ACTION Banks and the Great
Depression 961
The 2008 Crisis and Its Aftermath 962
Severe Crisis, Slow Recovery 962
Aftershocks in Europe 963
The Stimulus–Austerity Debate 965
The Lesson of the Post-Crisis Slump 966
ECONOMICS ➤ IN ACTION If Only It Were the 1930s 966
Regulation in the Wake of the Crisis 967
ECONOMICS ➤ IN ACTION Bent Breaks the Buck 968
PART 14 Events and Ideas
uCHAPTER 33 Macroeconomics:
Events and Ideas………………973
Classical Macroeconomics 974
Money and the Price Level 974
The Business Cycle 974
ECONOMICS ➤ IN ACTION When Did the Business Cycle
Begin? 974
The Great Depression and the Keynesian
Revolution 975
Keynes’s Theory 976
FOR INQUIRING MINDS: The Politics of Keynes 977
Policy to Fight Recessions 978
ECONOMICS ➤ IN ACTION The End of the Great
Depression 978
Challenges to Keynesian Economics 979
The Revival of Monetary Policy 979
Monetarism 980
Limits to Macroeconomic Policy: Inflation and the
Natural Rate of Unemployment 983
The Political Business Cycle 983
ECONOMICS ➤ IN ACTION The Fed’s Flirtation with
Monetarism 984
Rational Expectations, Real Business Cycles, and
New Classical Macroeconomics 984
Rational Expectations 985
Real Business Cycles 986
FOR INQUIRING MINDS: Supply-Side Economics 986
ECONOMICS ➤ IN ACTION The 1970s in Reverse 987
Consensus and Conflict in Modern
Macroeconomics 988
Question 1: Is Expansionary Monetary Policy Helpful in
Fighting Recessions? 988
Question 2: Is Expansionary Fiscal Policy Effective in
Fighting Recessions? 989
Question 3: Can Monetary and/or Fiscal Policy Reduce
Unemployment in the Long Run? 989
Question 4: Should Fiscal Policy Be Used in a
Discretionary Way? 989
Question 5: Should Monetary Policy Be Used in a
Discretionary Way? 990
Crises and Aftermath 990
ECONOMICS ➤ IN ACTION Lats of Luck 992
PART 15 The Open Economy
uCHAPTER 34 Open-Economy
Macroeconomics ………………997
Capital Flows and the Balance of Payments 998
Balance of Payments Accounts 998
Account 1000
Modeling the Financial Account 1002
GLOBAL COMPARISON: Big Surpluses 1003
Underlying Determinants of International Capital
Flows 1005
FOR INQUIRING MINDS: A Global Savings Glut? 1005
Two-Way Capital Flows 1006
ECONOMICS ➤ IN ACTION The Golden Age of Capital
Flows 1006
The Role of the Exchange Rate 1007
Understanding Exchange Rates 1008
The Equilibrium Exchange Rate 1008
Inflation and Real Exchange Rates 1011
Purchasing Power Parity 1013
FOR INQUIRING MINDS: Burgernomics 1013
ECONOMICS ➤ IN ACTION Low-Cost America 1014
Exchange Rate Policy 1015
Exchange Rate Regimes 1016
How Can an Exchange Rate Be Held Fixed? 1016
The Exchange Rate Regime Dilemma 1018
FOR INQUIRING MINDS: From Bretton Woods to the Euro 1018
ECONOMICS ➤ IN ACTION China Pegs the Yuan 1019
Exchange Rates and Macroeconomic Policy 1020
1. Devaluation and Revaluation of Fixed Exchange
Rates 1020
2. Monetary Policy Under Floating Exchange
Rates 1021
3. International Business Cycles 1022
ECONOMICS ➤ IN ACTION The Little Currency That
Could 1023
BUSINESS CASE: A Yen for Japanese Cars 1025
Macroeconomic Data Tables M-1
Solutions to “Check Your Understanding” Questions S-1
Glossary G-1
Index I-1

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