Essentials of Economics 6th Edition PDF by R. Glenn Hubbard and Anthony Patrick O’Brien


Essentials of Economics, Sixth Edition

By R. Glenn Hubbard, Anthony Patrick O’Brien

essentials of economics, 6th edition


Preface P-1

A Word of Thanks P-23

PART 1 Introduction

CHAPTER 1: Economics: Foundations and Models 2

Why Does Ford Assemble Cars in Both the

United States and Mexico? 2

1.1 Three Key Economic Ideas 4

People Are Rational 5

People Respond to Economic Incentives 5

Apply the Concept: Does Health Insurance

Give People an Incentive to Become Obese? 5

Optimal Decisions Are Made at the Margin 7

Solved Problem 1.1: The Marginal Benefit and

Marginal Cost of Speed Limits 7

1.2 The Economic Problem That Every Society Must Solve 8

What Goods and Services Will Be Produced? 9

How Will the Goods and Services Be Produced? 9

Who Will Receive the Goods and Services Produced? 9

Centrally Planned Economies versus Market

Economies 10

The Modern “Mixed” Economy 10

Efficiency and Equity 11

1.3 Economic Models 12

The Role of Assumptions in Economic Models 12

Forming and Testing Hypotheses in

Economic Models 13

Positive and Normative Analysis 14

Don’t Let This Happen to You: Don’t Confuse

Positive Analysis with Normative Analysis 14

Economics as a Social Science 15

Apply the Concept: What Can Economics

Contribute to the Debate over Tariffs? 15

1.4 Microeconomics and Macroeconomics 16

1.5 Economic Skills and Economics as a Career 16

1.6 A Preview of Important Economic Terms 17

Conclusion 19

An Inside Look: Is Manufacturing Returning to

the United States? 20

*Chapter Summary and Problems 22

Key Terms, Summary, Review Questions, Problems and

Applications, and Critical Thinking Exercises

Appendix: Using Graphs and Formulas 28

Graphs of One Variable 29

Graphs of Two Variables 30

Slopes of Lines 31

Taking into Account More Than Two Variables

on a Graph 32

Positive and Negative Relationships 32

Determining Cause and Effect 34

Are Graphs of Economic Relationships

Always Straight Lines? 35

Slopes of Nonlinear Curves 35

Formulas 36

Formula for a Percentage Change 37

Formulas for the Areas of a Rectangle and

a Triangle 37

Summary of Using Formulas 38

Problems and Applications 38

CHAPTER 2: Trade-offs, Comparative

Advantage, and the Market System 40

Managers at Tesla Motors Face Trade-offs 40

2.1 Production Possibilities Frontiers and

Opportunity Costs 42

Graphing the Production Possibilities Frontier 42

Solved Problem 2.1: Drawing a Production

Possibilities Frontier for Tesla Motors 44

Increasing Marginal Opportunity Costs 46

Economic Growth 47

2.2 Comparative Advantage and Trade 48

Specialization and Gains from Trade 48

Absolute Advantage versus Comparative

Advantage 50

Comparative Advantage and the Gains from Trade 51

Don’t Let This Happen to You: Don’t Confuse

Absolute Advantage and Comparative

Advantage 51

Solved Problem 2.2: Comparative Advantage and

the Gains from Trade 52

Apply the Concept: Comparative Advantage,

Opportunity Cost, and Housework 53

2.3 The Market System 54

The Circular Flow of Income 55

The Gains from Free Markets 56

The Market Mechanism 56

Apply the Concept: A Story of the Market System

in Action: How Do You Make an iPad? 57

The Role of the Entrepreneur in the Market System 59

The Legal Basis of a Successful Market System 59

Apply the Concept: Managers at Feeding

America Use the Market Mechanism to

Reduce Hunger 62

* These end-of-chapter resource materials repeat in all chapters. Select chapters also include Real-Time Data Exercises.

Students can complete all questions, problems, and exercises in MyLab Economics.

PART 2 Markets in Action: Policy and


CHAPTER 4: Market Efficiency and

Market Failure 108

What Do Food Riots in Venezuela and the

Rise of Uber in the United States Have

in Common? 108

4.1 Consumer Surplus and Producer Surplus 110

Consumer Surplus 110

Apply the Concept: The Consumer Surplus

from Uber 113

Producer Surplus 114

What Consumer Surplus and Producer Surplus

Measure 115

4.2 The Efficiency of Competitive Markets 115

Marginal Benefit Equals Marginal Cost in

Competitive Equilibrium 115

Economic Surplus 116

Deadweight Loss 117

Economic Surplus and Economic Efficiency 117

4.3 Government Intervention in the Market:

Price Floors and Price Ceilings 118

Price Floors: Government Policy in Agricultural

Markets 118

Apply the Concept: Price Floors in Labor Markets:

The Debate over Minimum Wage Policy 119

Price Ceilings: Government Rent Control Policy in

Housing Markets 121

Don’t Let This Happen to You: Don’t Confuse

“Scarcity” with “Shortage” 122

Black Markets and Peer-to-Peer Sites 122

Solved Problem 4.3: What’s the Economic

Effect of a Black Market in Renting

Apartments? 123

The Results of Government Price Controls:

Winners, Losers, and Inefficiency 124

Apply the Concept: Price Controls Lead to

Economic Decline in Venezuela 124

Positive and Normative Analysis of Price Ceilings

and Price Floors 126

4.4 Externalities and Economic Efficiency 126

The Effect of Externalities 126

Externalities and Market Failure 128

What Causes Externalities? 129

4.5 Government Policies to Deal with

Externalities 129

Imposing a Tax When There Is a Negative

Externality 129

Providing a Subsidy When There Is a Positive

Externality 130

Apply the Concept: Should the Government

Tax Cigarettes and Soda? 131

Solved Problem 4.5: Dealing with the

Externalities of Car Driving 132

Conclusion 63

An Inside Look: Tesla Bets Big on Nevada Battery

Plant 64

Chapter Summary and Problems 66

CHAPTER 3: Where Prices Come From:

The Interaction of Demand and Supply 72

How Smart Is Your Water? 72

3.1 The Demand Side of the Market 74

Demand Schedules and Demand Curves 74

The Law of Demand 75

What Explains the Law of Demand? 75

Holding Everything Else Constant: The Ceteris Paribus

Condition 76

Variables That Shift Market Demand 76

Apply the Concept: Virtual Reality Headsets:

Will a Substitute Fail for a Lack of

Complements? 77

Apply the Concept: Millennials Shake Up the

Markets for Soda, Groceries, Big Macs, and

Running Shoes 78

A Change in Demand versus a Change in

Quantity Demanded 81

Apply the Concept: Forecasting the Demand for

Premium Bottled Water 81

3.2 The Supply Side of the Market 82

Supply Schedules and Supply Curves 83

The Law of Supply 83

Variables That Shift Market Supply 83

A Change in Supply versus a Change in

Quantity Supplied 86

3.3 Market Equilibrium: Putting Demand and

Supply Together 86

How Markets Eliminate Surpluses

and Shortages 87

Demand and Supply Both Count 88

Solved Problem 3.3: Demand and Supply Both

Count: A Tale of Two Letters 88

3.4 The Effect of Demand and Supply Shifts on

Equilibrium 90

The Effect of Shifts in Demand on Equilibrium 90

The Effect of Shifts in Supply on Equilibrium 90

The Effect of Shifts in Demand and Supply

over Time 90

Apply the Concept: Lower Demand for Orange

Juice—But Higher Prices? 92

Solved Problem 3.4: Can We Predict Changes in

the Price and Quantity of Organic Corn? 94

Shifts in a Curve versus Movements along a Curve 95

Don’t Let This Happen to You: Remember:

A Change in a Good’s Price Does Not Cause

the Demand or Supply Curve to Shift 96

Conclusion 97

An Inside Look: McDonald’s Looks for

New Ways to Attract Customers 98

Chapter Summary and Problems 100

Command-and-Control versus Market-Based

Approaches 134

The End of the Sulfur Dioxide Cap-and-Trade

System 135

Are Tradable Emission Allowances Licenses to

Pollute? 135

Apply the Concept: Should the United States

Enact a Carbon Tax to Fight Global

Warming? 135

Conclusion 137

An Inside Look: Will Uber Be Required to Pay

British VAT? 138

Chapter Summary and Problems 140

CHAPTER 5: The Economics of Health Care 150

Where Will You Find Health Insurance? 150

5.1 The Improving Health of People in the

United States 152

Changes over Time in U.S. Health 153

Reasons for Long-Run Improvements in U.S.

Health 153

5.2 Health Care around the World 154

The U.S. Health Care System 154

Apply the Concept: The Increasing Importance

of Health Care in the U.S. Economy 156

The Health Care Systems of Canada, Japan, and the

United Kingdom 157

Comparing Health Care Outcomes around

the World 158

How Useful Are Cross-Country Comparisons of

Health Outcomes? 159

5.3 Information Problems and Externalities in the

Market for Health Care 160

Adverse Selection and the Market for “Lemons” 160

Asymmetric Information in the Market for Health

Insurance 161

Don’t Let This Happen to You: Don’t Confuse

Adverse Selection with Moral Hazard 162

Externalities in the Market for Health Care 163

Should the Government Run the Health

Care System? 165

5.4 The Debate over Health Care Policy in the

United States 166

The Rising Cost of Health Care 166

Apply the Concept: Are U.S. Firms Handicapped

by Paying for Their Employees’

Health Insurance? 168

Explaining Increases in Health Care Spending 169

The Continuing Debate over Health

Care Policy 172

Solved Problem 5.4: Recent Trends in U.S.

Health Care 173

Apply the Concept: How Much Is That

MRI Scan? 175

Conclusion 177

Chapter Summary and Problems 178

PART 3 Microeconomic Foundations:

Consumers and Firms

CHAPTER 6: Firms, the Stock Market, and

Corporate Governance 184

Is Snapchat the Next Facebook . . . or the

Next Twitter? 184

6.1 Types of Firms 186

Who Is Liable? Limited and Unlimited

Liability 186

Corporations Earn the Majority of Revenue and

Profits 187

Apply the Concept: Why Are Fewer Young

People Starting Businesses? 188

The Structure of Corporations and the

Principal–Agent Problem 189

6.2 How Firms Raise Funds 190

Sources of External Funds 190

Apply the Concept: The Rating Game: Are the

Federal Government or State Governments

Likely to Default on Their Bonds? 191

Stock and Bond Markets Provide Capital—and

Information 193

The Fluctuating Stock Market 194

Don’t Let This Happen to You: When Snap

Shares Are Sold, Snap Doesn’t Get

the Money 194

Apply the Concept: Why Are Many People Poor

Stock Market Investors? 196

Solved Problem 6.2: Why Does Warren Buffett

Like Mutual Funds? 197

6.3 Using Financial Statements to Evaluate a

Corporation 198

The Income Statement 198

The Balance Sheet 199

6.4 Recent Issues in Corporate Governance Policy 200

The Accounting Scandals of the Early 2000s 200

Corporate Governance and the Financial Crisis of

2007–2009 200

Government Regulation in Response to the

Financial Crisis 201

Did Principal–Agent Problems Help Cause the

2007–2009 Financial Crisis? 201

Apply the Concept: Should Investors Worry

about Corporate Governance at Snapchat? 202

Conclusion 204

Chapter Summary and Problems 205

CHAPTER 7: Consumer Choice and Elasticity 210

J.C. Penney Customers Didn’t Buy into

“Everyday Low Prices” 210

7.1 Utility and Consumer Decision Making 212

An Overview of the Economic Model of

Consumer Behavior 212

Utility 212

The Principle of Diminishing Marginal Utility 213

The Rule of Equal Marginal Utility per

Dollar Spent 213

Solved Problem 7.1: Finding the Optimal Level

of Consumption 216

What if the Rule of Equal Marginal Utility per

Dollar Does Not Hold? 217

Don’t Let This Happen to You: Equalize

Marginal Utilities per Dollar 218

The Income Effect and Substitution Effect of a

Price Change 219

7.2 Where Demand Curves Come From 220

Apply the Concept: Are There Any Upward-

Sloping Demand Curves in the Real World? 222

7.3 Social Influences on Decision Making 223

The Effects of Celebrity Endorsements 223

Network Externalities 224

Does Fairness Matter? 225

Apply the Concept: Who Made the Most Prof it

from the Broadway Musical Hamilton? 227

Solved Problem 7.3: Why Doesn’t Tesla Charge

Its Employees to Park Their Cars? 229

7.4 Behavioral Economics: Do People Make

Rational Choices? 231

Pitfalls in Decision Making 231

Apply the Concept: A Blogger Who

Understands the Importance of Ignoring

Sunk Costs 232

“Nudges”: Using Behavioral Economics to

Guide Behavior 233

The Behavioral Economics of Shopping 234

Apply the Concept: J.C. Penney Meets

Behavioral Economics 235

7.5 The Price Elasticity of Demand and Its

Measurement 236

Measuring the Price Elasticity of Demand 237

Elastic Demand and Inelastic Demand 237

An Example of Calculating Price Elasticities 238

The Midpoint Formula 238

Solved Problem 7.5: Calculating the Price

Elasticity of Demand 239

When Demand Curves Intersect, the Flatter Curve

Is More Elastic 240

Polar Cases of Perfectly Elastic and Perfectly

Inelastic Demand 241

Don’t Let This Happen to You: Don’t Confuse

Inelastic with Perfectly Inelastic 241

7.6 The Determinants of the Price Elasticity

of Demand 243

Availability of Close Substitutes 243

Passage of Time 243

Luxuries versus Necessities 243

Definition of the Market 243

Share of a Good in a Consumer’s Budget 243

Some Estimated Price Elasticities

of Demand 244

7.7 The Relationship between Price Elasticity of

Demand and Total Revenue 245

Elasticity and Revenue with a Linear

Demand Curve 246

Solved Problem 7.7: Price and Revenue

Don’t Always Move in the Same

Direction 247

Apply the Concept: Why Does Amazon Care

about Price Elasticity? 248

Conclusion 250

Chapter Summary and Problems 251

CHAPTER 8: Technology, Production,

and Costs 262

Will the Cost of MOOCs Revolutionize

Higher Education? 262

8.1 Technology: An Economic Definition 264

Apply the Concept: Would You Please

Be Quiet? Technological Change at 264

8.2 The Short Run and the Long Run in

Economics 265

The Difference between Fixed Costs and

Variable Costs 265

Apply the Concept: Fixed Costs in the

Publishing Industry 266

Implicit Costs versus Explicit Costs 266

The Production Function 267

A First Look at the Relationship between

Production and Cost 268

8.3 The Marginal Product of Labor and the

Average Product of Labor 269

The Law of Diminishing Returns 269

Graphing Production 270

Apply the Concept: Adam Smith’s Famous

Account of the Division of Labor in a

Pin Factory 271

The Relationship between Marginal Product and

Average Product 271

An Example of Marginal and Average Values:

College Grades 272

8.4 The Relationship between Short-Run

Production and Short-Run Cost 273

Marginal Cost 273

Why Are the Marginal and Average Cost Curves

U Shaped? 273

Solved Problem 8.4: Calculating Marginal Cost

and Average Cost 275

8.5 Graphing Cost Curves 276

8.6 Costs in the Long Run 278

Economies of Scale 278

Long-Run Average Cost Curves for Automobile

Factories 279

Solved Problem 8.6: Using Long-Run

Average Cost Curves to Understand

Business Strategy 279

Apply the Concept: The Colossal River Rouge:

Diseconomies of Scale at Ford Motor

Company 281

Don’t Let This Happen to You: Don’t Confuse

Diminishing Returns with Diseconomies

of Scale 282

Conclusion 283

Chapter Summary and Problems 284

PART 4 Market Structure and Firm


CHAPTER 9: Firms in Perfectly Competitive

Markets 292

Are Cage-Free Eggs the Road to Riches? 292

9.1 Perfectly Competitive Markets 295

A Perfectly Competitive Firm Cannot Affect the

Market Price 295

The Demand Curve for the Output of a Perfectly

Competitive Firm 296

Don’t Let This Happen to You: Don’t Confuse

the Demand Curve for Farmer Parker’s Wheat

with the Market Demand Curve for Wheat 296

9.2 How a Firm Maximizes Profit in a Perfectly

Competitive Market 297

Revenue for a Firm in a Perfectly Competitive

Market 298

Determining the Profit-Maximizing Level of Output 298

9.3 Illustrating Profit or Loss on the Cost

Curve Graph 300

Showing Profit on a Graph 301

Solved Problem 9.3: Determining Prof it-

Maximizing Price and Quantity 302

Don’t Let This Happen to You: Remember

That Firms Maximize Their Total Prof it, Not

Their Prof it per Unit 304

Illustrating When a Firm Is Breaking Even or

Operating at a Loss 304

Apply the Concept: Losing Money in the

Restaurant Business 305

9.4 Deciding Whether to Produce or to

Shut Down in the Short Run 306

The Supply Curve of a Firm in the Short Run 307

Solved Problem 9.4: When to Shut Down

a Farm 308

The Market Supply Curve in a Perfectly

Competitive Industry 309

9.5 “If Everyone Can Do It, You Can’t Make

Money at It”: The Entry and Exit of Firms in the

Long Run 310

Economic Profit and the Entry or Exit Decision 310

Long-Run Equilibrium in a Perfectly Competitive

Market 312

The Long-Run Supply Curve in a Perfectly

Competitive Market 314

Apply the Concept: In the Apple App Store,

Easy Entry Makes the Long Run

Pretty Short 315

Increasing-Cost and Decreasing-Cost Industries 316

9.6 Perfect Competition and Economic

Efficiency 316

Productive Efficiency 316

Solved Problem 9.6: How Productive

Efficiency Benef its Consumers 317

Allocative Efficiency 318

Conclusion 319

Chapter Summary and Problems 320

CHAPTER 10: Monopoly and Antitrust

Policy 328

A Monopoly on Lobster Dinners in Maine? 328

10.1 Is Any Firm Ever Really a Monopoly? 330

Apply the Concept: Is the NCAA a

Monopoly? 330

10.2 Where Do Monopolies Come From? 332

Government Action Blocks Entry 332

Apply the Concept: Does Hasbro Have a Monopoly

on Monopoly? 333

Control of a Key Resource 334

Apply the Concept: Are Diamond Prof its

Forever? The De Beers Diamond

Monopoly 334

Network Externalities 335

Natural Monopoly 336

10.3 How Does a Monopoly Choose

Price and Output? 337

Marginal Revenue Once Again 337

Profit Maximization for a Monopolist 338

Solved Problem 10.3: Finding the Prof it-

Maximizing Price and Output for a

Cable Monopoly 340

Don’t Let This Happen to You: Don’t Assume

That Charging a Higher Price Is Always

More Prof itable for a Monopolist 341

10.4 Does Monopoly Reduce Economic

Efficiency? 341

Comparing Monopoly and Perfect Competition 341

Measuring the Efficiency Losses from

Monopoly 342

How Large Are the Efficiency Losses Due to

Monopoly? 343

Market Power and Technological Change 344

10.5 Government Policy toward Monopoly 344

Antitrust Laws and Antitrust Enforcement 344

Apply the Concept: Have Generic Drug Firms

Been Colluding to Raise Prices? 345

Mergers: The Trade-off between Market Power

and Efficiency 346

The Department of Justice and FTC Merger

Guidelines 348

Regulating Natural Monopolies 350

Solved Problem 10.5: What Should Your

College Charge for a MOOC? 351

Conclusion 352

Chapter Summary and Problems 353

CHAPTER 11: Monopolistic Competition

and Oligopoly 360

Will Panera’s “Pure Food” Advantage Last? 360

11.1 Demand and Marginal Revenue for a Firm

in a Monopolistically Competitive Market 362

The Demand Curve for a Monopolistically

Competitive Firm 362

Marginal Revenue for a Firm with a Downward-

Sloping Demand Curve 363

11.2 How a Monopolistically Competitive Firm

Maximizes Profit in the Short Run 365

Solved Problem 11.2: Does Minimizing Cost

Maximize Prof it at Apple? 366

11.3 What Happens to Profits in the Long Run? 368

How Does the Entry of New Firms Affect the

Profits of Existing Firms? 368

Don’t Let This Happen to You: Don’t Confuse

Zero Economic Profit with Zero Accounting

Prof it 369

Apply the Concept: Is “Clean Food” a Sustainable

Market Niche for Panera? 369

Is Zero Economic Profit Inevitable in the

Long Run? 370

Solved Problem 11.3: Red Robin Abandons

an Experiment in Fast-Casual Restaurants 371

11.4 Comparing Monopolistic Competition

and Perfect Competition 372

Excess Capacity under Monopolistic Competition 373

Is Monopolistic Competition Inefficient? 373

How Consumers Benefit from Monopolistic

Competition 374

Apply the Concept: One Way to Differentiate

Your Restaurant? Become a Ghost! 374

11.5 Oligopoly and Barriers to Entry 375

Barriers to Entry 376

Apply the Concept: Got a Great Recipe for

Cookies? Don’t Try Selling Them in

Wisconsin or New Jersey 378

11.6 Game Theory and Oligopoly 379

A Duopoly Game: Price Competition between

Two Firms 380

Firm Behavior and the Prisoner’s Dilemma 381

Solved Problem 11.6: Is Offering a College

Student Discount a Prisoner’s Dilemma for

Apple and Spotify? 381

Can Firms Escape the Prisoner’s Dilemma? 383

Apply the Concept: Are the Big Four Airlines

Colluding? 384

Cartels: The Case of OPEC 386

Conclusion 388

Chapter Summary and Problems 389

PART 5 Macroeconomic Foundations

CHAPTER 12: GDP: Measuring Total Production

and Income 400

The Ford Motor Company Meets Macroeconomics 400

12.1 Gross Domestic Product Measures Total

Production 403

Measuring Total Production: Gross Domestic

Product 403

Solved Problem 12.1: Calculating GDP 404

Production, Income, and the Circular-Flow

Diagram 404

Components of GDP 406

Don’t Let This Happen to You: Remember

What Economists Mean by Investment 407

An Equation for GDP and Some Actual Values 407

Apply the Concept: Microsoft’s Steve Ballmer

Uses the U.S. Constitution to Reorganize

Government Data 408

Measuring GDP Using the Value-Added Method 410

12.2 Does GDP Measure What We Want It

to Measure? 410

Shortcomings in GDP as a Measure of Total

Production 410

Apply the Concept: Why Do Many Developing

Countries Have Such Large Underground

Economies? 411

Shortcomings of GDP as a Measure of

Well-Being 412

12.3 Real GDP versus Nominal GDP 413

Calculating Real GDP 413

Solved Problem 12.3: Calculating Real GDP 413

Comparing Real GDP and Nominal GDP 414

The GDP Deflator 415

Apply the Concept: Did the Standard of Living

in Nigeria Almost Double Overnight? 416

12.4 Other Measures of Total Production and

Total Income 417

Gross National Product 417

National Income 417

Personal Income 418

Disposable Personal Income 418

The Division of Income 418

Conclusion 419

Chapter Summary and Problems 420

CHAPTER 13: Unemployment and Inflation 426

Why Would Boeing Cut Thousands of Jobs as the

Economy Expands? 426

13.1 Measuring the Unemployment Rate, the

Labor Force Participation Rate, and the

Employment–Population Ratio 428

The Household Survey 428

Solved Problem 13.1: What Happens if the BLS

Includes the Military? 430

Problems with Measuring the Unemployment Rate 431

Trends in Labor Force Participation 432

Unemployment Rates for Different Groups 433

How Long Are People Typically Unemployed? 434

Apply the Concept: Eight Million Workers

Are Missing! 434

The Establishment Survey: Another Measure of

Employment 436

Revisions in the Establishment Survey

Employment Data: How Bad Was the 2007–2009

Recession? 437

Job Creation and Job Destruction over Time 437

13.2 Types of Unemployment 438

Frictional Unemployment and Job Search 438

Structural Unemployment 439

Cyclical Unemployment 439

Full Employment 440

Apply the Concept: How Should We Categorize

the Unemployment Resulting from Boeing’s

Layoffs? 440

13.3 Explaining Unemployment 441

Government Policies and the Unemployment Rate 441

Labor Unions 442

Efficiency Wages 443

13.4 Measuring Inflation 443

The Consumer Price Index 443

Is the CPI Accurate? 445

Don’t Let This Happen to You: Don’t Miscalculate

the Inflation Rate 445

The Producer Price Index 446

13.5 Using Price Indexes to Adjust for the Effects

of Inflation 446

Solved Problem 13.5: What Has Been Happening

to Real Wages in the United States? 447

13.6 Nominal Interest Rates versus Real Interest

Rates 449

13.7 Does Inflation Impose Costs on the Economy? 450

Inflation Affects the Distribution of Income 451

The Problem with Anticipated Inflation 451

The Problem with Unanticipated Inflation 452

Apply the Concept: What’s So Bad about

Falling Prices? 452

Conclusion 454

Chapter Summary and Problems 455

PART 6 Long-Run Economic Growth

and Short-Run Economic Fluctuations

CHAPTER 14: Economic Growth, the Financial

System, and Business Cycles 466

Economic Growth and the Business Cycle at

Chevron Corporation 466

14.1 Long-Run Economic Growth 468

Apply the Concept: The Connection between

Economic Prosperity and Health 469

Calculating Growth Rates and the Rule of 70 471

What Determines the Rate of Long-Run Growth? 472

Solved Problem 14.1: Where Does Productivity

Come From? 473

Apply the Concept: Can India Sustain Its Rapid

Growth? 474

Potential GDP 476

14.2 Saving, Investment, and the

Financial System 477

An Overview of the Financial System 477

The Macroeconomics of Saving and Investment 478

The Market for Loanable Funds 480

Apply the Concept: Ebenezer Scrooge:

Accidental Promoter of Economic

Growth? 481

Solved Problem 14.2: Are Future Budget Def icits

a Threat to the Economy? 483

14.3 The Business Cycle 485

Some Basic Business Cycle Definitions 485

How Do We Know When the Economy Is in a

Recession? 486

What Happens during the Business Cycle? 487

Don’t Let This Happen to You: Don’t Confuse

the Price Level and the Inflation Rate 489

Will the U.S. Economy Return to Stability? 492

Conclusion 493

Chapter Summary and Problems 494

CHAPTER 15: Aggregate Demand and

Aggregate Supply Analysis 500

The Fortunes of KB Home Follow the

Business Cycle 500

15.1 Aggregate Demand 502

Why Is the Aggregate Demand Curve Downward

Sloping? 502

Shifts of the Aggregate Demand Curve versus

Movements along It 504

The Variables That Shift the Aggregate

Demand Curve 504

Don’t Let This Happen to You: Understand

Why the Aggregate Demand Curve Is

Downward Sloping 505

Solved Problem 15.1: Movements along the

Aggregate Demand Curve or Shifts of

the Curve? 506

Apply the Concept: Which Components of

Aggregate Demand Changed the Most during

the 2007–2009 Recession? 508

15.2 Aggregate Supply 510

The Long-Run Aggregate Supply Curve 510

The Short-Run Aggregate Supply Curve 511

Apply the Concept: How Sticky Are Wages? 512

Shifts of the Short-Run Aggregate Supply

Curve versus Movements along It 514

Variables That Shift the Short-Run Aggregate

Supply Curve 514

15.3 Macroeconomic Equilibrium in the

Long Run and the Short Run 516

Recessions, Expansions, and Supply Shocks 517

Apply the Concept: Does It Matter What Causes

a Decline in Aggregate Demand? 518

Apply the Concept: How Long Is the Long Run

in Macroeconomics? 521

15.4 A Dynamic Aggregate Demand and

Aggregate Supply Model 523

What Is the Usual Cause of Inflation? 524

The Recession of 2007–2009 524

Solved Problem 15.4: Showing the Oil Shock of

1974–1975 on a Dynamic Aggregate Demand

and Aggregate Supply Graph 527

Conclusion 528

Chapter Summary and Problems 529

Appendix: Macroeconomic Schools of Thought 538

The Monetarist Model 538

The New Classical Model 539

The Real Business Cycle Model 539

The Austrian Model 540

Apply the Concept: Karl Marx: Capitalism’s

Severest Critic 540

PART 7 Monetary and Fiscal Policy

CHAPTER 16: Money, Banks, and the Federal

Reserve System 542

Does India Need Paper Currency? 542

16.1 What Is Money, and Why Do We

Need It? 544

Barter and the Invention of Money 544

The Functions of Money 545

What Can Serve as Money? 546

Apply the Concept: Your Money Is No

Good Here! 547

16.2 How Is Money Measured in the United States

Today? 548

M1: A Narrow Definition of the Money Supply 548

M2: A Broad Definition of Money 549

Don’t Let This Happen to You: Don’t Confuse

Money with Income or Wealth 550

Solved Problem 16.2: The Def initions of

M1 and M2 550

What about Credit Cards and Debit Cards? 551

Apply the Concept: Are Bitcoins Money? 551

16.3 How Do Banks Create Money? 552

Bank Balance Sheets 552

Apply the Concept: Will Fintech Make It Easier

for You to Borrow? 553

Using T-accounts to Show How a Bank Can

Create Money 554

The Simple Deposit Multiplier 556

Don’t Let This Happen to You: Don’t Confuse

Assets and Liabilities 557

Solved Problem 16.3: Showing How Banks

Create Money 558

The Simple Deposit Multiplier versus the

Real-World Deposit Multiplier 560

16.4 The Federal Reserve System 561

The Establishment of the Federal

Reserve System 561

How the Federal Reserve Manages the

Money Supply 562

The “Shadow Banking System” and the Financial

Crisis of 2007–2009 565

16.5 The Quantity Theory of Money 567

Connecting Money and Prices: The Quantity

Equation 568

The Quantity Theory Explanation of Inflation 568

How Accurate Are Forecasts of Inflation Based

on the Quantity Theory? 569

High Rates of Inflation 570

Apply the Concept: The German Hyperinflation

of the Early 1920s 570

Conclusion 571

Chapter Summary and Problems 572

CHAPTER 17: Monetary Policy 580

Why Would a Bank Pay a Negative

Interest Rate? 580

17.1 What Is Monetary Policy? 582

The Goals of Monetary Policy 582

17.2 The Money Market and the Fed’s Choice

of Monetary Policy Targets 584

Monetary Policy Targets 584

The Demand for Money 584

Shifts in the Money Demand Curve 585

How the Fed Manages the Money Supply:

A Quick Review 586

Equilibrium in the Money Market 586

A Tale of Two Interest Rates 588

Choosing a Monetary Policy Target 588

The Importance of the Federal Funds Rate 588

The Fed’s New Policy Tools 589

17.3 Monetary Policy and Economic Activity 590

How Interest Rates Affect Aggregate Demand 590

The Effects of Monetary Policy on Real GDP and

the Price Level 591

Apply the Concept: Too Low for Zero: Central

Banks, Quantitative Easing, and Negative

Interest Rates 592

Can the Fed Eliminate Recessions? 594

Fed Forecasts 595

Apply the Concept: Trying to Hit a Moving

Target: Making Policy with

“Real-Time Data” 596

A Summary of How Monetary Policy Works 597

Don’t Let This Happen to You: Remember

That with Monetary Policy, It’s the Interest

Rates—Not the Money—That Counts 598

17.4 Monetary Policy in the Dynamic Aggregate

Demand and Aggregate Supply Model 598

The Effects of Monetary Policy on Real GDP and

the Price Level: A More Complete Account 599

Using Monetary Policy to Fight Inflation 600

Solved Problem 17.4: The Effects of Monetary

Policy 601

17.5 A Closer Look at the Fed’s Setting of

Monetary Policy Targets 603

Should the Fed Target the Money Supply? 603

Why Doesn’t the Fed Target Both the Money

Supply and the Interest Rate? 603

The Taylor Rule 604

Solved Problem 17.5: Applying the

Taylor Rule 605

Inflation Targeting 606

Apply the Concept: Should the Fed Worry

about the Prices of Food and Gasoline? 607

17.6 Fed Policies during the 2007–2009

Recession 608

The Inflation and Deflation of the Housing Market

Bubble 608

The Changing Mortgage Market 610

The Role of Investment Banks 610

Apply the Concept: The Wonderful World of

Leverage 611

The Fed and the Treasury Department Respond 612

Conclusion 614

Chapter Summary and Problems 615

CHAPTER 18: Fiscal Policy 624

Can Fiscal Policy Increase Economic Growth? 624

18.1 What Is Fiscal Policy? 626

What Fiscal Policy Is and What It Isn’t 626

Automatic Stabilizers versus Discretionary

Fiscal Policy 626

An Overview of Government Spending and Taxes 626

Apply the Concept: Is Spending on Social

Security and Medicare a Fiscal Time Bomb? 629

18.2 The Effects of Fiscal Policy on Real GDP

and the Price Level 631

Short-Run Expansionary and Contractionary

Fiscal Policy 631

Don’t Let This Happen to You: Don’t Confuse

Fiscal Policy and Monetary Policy 633

A Summary of How Fiscal Policy Affects

Aggregate Demand 633

18.3 Fiscal Policy in the Dynamic Aggregate

Demand and Aggregate Supply Model 634

18.4 The Government Purchases and Tax

Multipliers 635

The Effect of Changes in the Tax Rate 638

Taking into Account the Effects of Aggregate

Supply 638

The Multipliers Work in Both Directions 639

Solved Problem 18.4: Fiscal Policy Multipliers 639

18.5 The Limits to Using Fiscal Policy to Stabilize

the Economy 640

Apply the Concept: Why Was the Recession of

2007–2009 So Severe? 641

Does Government Spending Reduce

Private Spending? 642

Crowding Out in the Short Run 642

Crowding Out in the Long Run 644

Fiscal Policy in Action: Did the Stimulus Package

of 2009 Succeed? 644

18.6 Deficits, Surpluses, and Federal

Government Debt 647

How the Federal Budget Can Serve as an

Automatic Stabilizer 648

Apply the Concept: Did Fiscal Policy

Fail during the Great Depression? 649

Should the Federal Budget Always Be Balanced? 650

Solved Problem 18.6: The Greek Government

Confronts a Budget Def icit 651

The Federal Government Debt 652

Is Government Debt a Problem? 653

18.7 Long-Run Fiscal Policy and Economic

Growth 653

Explaining Long-Run Increases in Real GDP 653

How Can Fiscal Policy Affect Long-Run

Economic Growth? The Long-Run Effects of

Tax Policy 654

Tax Simplification 655

The Economic Effects of Tax Reform 656

How Large Are Supply-Side Effects? 657

Apply the Concept: Will President Trump’s Policy

Proposals Raise the Rate of Economic Growth? 658

Conclusion 660

Chapter Summary and Problems 661

CHAPTER 19: Comparative Advantage,

International Trade, and Exchange Rates 670

President Trump, Oreo Cookies, and Free Trade 670

19.1 The United States in the International

Economy 672

The Importance of Trade to the U.S. Economy 673

U.S. International Trade in a World Context 674

19.2 Comparative Advantage in International

Trade 674

A Brief Review of Comparative Advantage 675

Comparative Advantage and Absolute

Advantage 675

19.3 How Countries Gain from International

Trade 676

Increasing Consumption through Trade 676

Why Don’t We See Complete Specialization? 678

Does Anyone Lose as a Result of International

Trade? 678

Don’t Let This Happen to You: Remember

That Trade Creates Both Winners and

Losers 678

Apply the Concept: Who Gains and Who Loses

from U.S. Trade with China? 679

Where Does Comparative Advantage Come From? 681

19.4 Government Policies That Restrict

International Trade 682

Tariffs 684

Quotas and Voluntary Export Restraints 684

Measuring the Economic Effect of the

Sugar Quota 685

Solved Problem 19.4: Measuring the Economic

Effect of a Quota 686

The High Cost of Preserving Jobs with Tariffs

and Quotas 687

Apply the Concept: Smoot-Hawley, the Politics

of Tariffs, and the Cost of Protecting a

Vanishing Industry 687

19.5 The Debate over Trade Policies and

Globalization 689

Why Do Some People Oppose the World Trade

Organization? 689

Apply the Concept: Protecting Consumer Health

or Protecting U.S. Firms from Competition? 692

Dumping 693

Positive versus Normative Analysis (Once Again) 693

19.6 The Foreign Exchange Market and

Exchange Rates 694

Equilibrium in the Market for Foreign

Exchange 694

How Do Shifts in Demand and Supply Affect the

Exchange Rate? 695

Some Exchange Rates Are Not Determined by

the Market 697

How Movements in the Exchange Rate Affect

Exports and Imports 697

Don’t Let This Happen to You: Don’t Confuse

What Happens When a Currency

Appreciates with What Happens When It

Depreciates 698

Solved Problem 19.6: Toyota Rides the

Exchange Rate Rollercoaster 698

Conclusion 699

Chapter Summary and Problems 700

Glossary G-1

Company Index I-1

Subject Index I-2

Credits C-1

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