Macroeconomics: Principles for a Changing World, Fourth Edition
By Eric P Chiang
Contents
Exploring Economics
BY THE NUMBERS Economics as a Career
What Is Economics About?
Why Should One Study Economics?
Microeconomics Versus Macroeconomics
Economic Theories and Reality
Model Building
Ceteris Paribus: All Else Held Constant
Efficiency Versus Equity
ISSUE Do Economists Ever Agree on Anything?
Positive Versus Normative Questions
Key Principles of Economics
Principle 1: Economics Is Concerned With Making Choices With Limited Resources
Principle 2: When Making Decisions, One Must Take Into Account Tradeoffs and Opportunity Costs
Principle 3: Specialization Leads to Gains for All Involved
Principle 4: People Respond to Incentives, Both Good and Bad
ISSUE Would a City Change Its Name for a Game Show?
Principle 5: Rational Behavior Requires Thinking on the Margin
Principle 6: Markets Are Generally Efficient; When They Aren’t, Government Can Sometimes Correct the Failure
Principle 7: Economic Growth, Low Unemployment, and Low Inflation Are Economic Goals That Do Not Always
Coincide
Principle 8: Institutions and Human Creativity Help Explain the Wealth of Nations
AROUND THE WORLD Nunavut: Land of Abundance and Scarcity
Summing It All Up: Economics Is All Around Us
ADAM SMITH (1723–1790)
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
APPENDIX
Working With Graphs and Formulas
Graphs and Data
Time Series
Scatter Plots
Pie Charts
Bar Charts
Simple Graphs Can Pack In a Lot of Information
A Few Simple Rules for Reading Graphs
Graphs and Models
Linear Relationships
Computing the Slope of a Linear Line
Nonlinear Relationships
Computing the Slope of a Nonlinear Curve
Ceteris Paribus, Simple Equations, and Shifting Curves
Ceteris Paribus: All Else Equal
Simple Linear Equations
Shifting Curves
Correlation Is Not Causation
Production, Economic Growth, and Trade
BY THE NUMBERS Growth, Productivity, and Trade Are Key to Our Prosperity
Basic Economic Questions and Production
Basic Economic Questions
Economic Systems
Resources and Production
Land
Labor
Capital
Entrepreneurial Ability
Production and Efficiency
AROUND THE WORLD Ironbridge: The Beginnings of the Industrial Revolution
Production Possibilities and Economic Growth
Production Possibilities
Opportunity Cost
Increasing Opportunity Costs
Economic Growth
Expanding Resources
Technological Change
Summarizing the Sources of Economic Growth
ISSUE Is the Ocean the Next Frontier? Land Reclamation and Underwater Cities
Specialization, Comparative Advantage, and Trade
Absolute and Comparative Advantage
The Gains from Trade
Practical Constraints on Trade
ISSUE Do We Really Specialize in That? Comparative Advantage in the United States and China
DAVID RICARDO (1772–1823)
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Supply and Demand
BY THE NUMBERS The World of Markets
Markets
ISSUE Do Markets Exist for Everyone, Including Dogs and Cats?
The Price System
Demand
Willingness-to-Pay: The Building Block of Market Demand
The Law of Demand: The Relationship Between Quantity Demanded and Price
The Demand Curve
Determinants of Demand
Tastes and Preferences
Income
Prices of Related Goods
The Number of Buyers
Expectations About Future Prices, Incomes, and Product Availability
Changes in Demand Versus Changes in Quantity Demanded
Supply
The Law of Supply: The Relationship Between Quantity Supplied and Price
The Supply Curve
Market Supply Curves
Determinants of Supply
Production Technology
Costs of Resources
Prices of Related Commodities
Expectations
Number of Sellers
Taxes and Subsidies
Changes in Supply Versus Changes in Quantity Supplied
Market Equilibrium
Moving to a New Equilibrium: Changes in Supply and Demand
Predicting the New Equilibrium When One Curve Shifts
ISSUE Two-Buck Chuck: Will People Drink $2-a-Bottle Wine?
Predicting the New Equilibrium When Both Curves Shift
AROUND THE WORLD Tokyo Disneyland: Is THAT the Line for Space Mountain?!
ALFRED MARSHALL (1842–1924)
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Markets and Government
BY THE NUMBERS Price Controls and Supports in the Economy Today
Consumer and Producer Surplus: A Tool for Measuring Economic
Efficiency
Using Consumer and Producer Surplus: The Gains from Trade
The Consequences of Deviating from Market Equilibrium
When Prices Exceed Equilibrium
When Prices Fall Below Equilibrium
NOBEL PRIZE: PAUL A. SAMUELSON (1915–2009)
Market Failure
Lack of Competition
Information Is Not Shared by All Parties
AROUND THE WORLD Singapore: Resolving Traffic Jams and Reducing Pollution Using Price
Controls
The Existence of External Benefits or Costs
The Existence of Public Goods
Market Efficiency Versus Equity
Price Ceilings and Price Floors
Price Ceilings
Price Floors
ISSUE Are Price Gouging Laws Good for Consumers?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Introduction to Macroeconomics
BY THE NUMBERS A Slow and Steady Macroeconomic Recovery
Business Cycles
Defining Business Cycles
Dating Business Cycles
Alternative Measures of the Business Cycle
National Activity Index
Leading Economic Index
Yield Curve
ISSUE The End of the Recession . . . It Does Not Feel Like It
National Income Accounting
The Core of the NIPA
The Circular Flow Diagram
Spending and Income: Looking at GDP in Two Ways
NOBEL PRIZE: SIMON KUZNETS (1901–1985)
Gross Domestic Product
The Expenditures (Spending) Approach to Calculating GDP
Personal Consumption Expenditures
Gross Private Domestic Investment
Government Purchases
Net Exports of Goods and Services
Summing Aggregate Expenditures
The Income Approach to Calculating GDP
Compensation of Employees
Proprietors’ Income
Corporate Profits
Rental Income
Net Interest
Miscellaneous Adjustments
Summing Up Income Measures
GDP and Our Standard of Living
Different Ways of Comparing GDP Across Countries
Population and GDP per Capita
Environmental Quality
AROUND THE WORLD Costa Rica: Pura Vida and Happiness Without a High Level of GDP
Nonmarket Activities and the Informal Economy
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Measuring Inflation and Unemployment
BY THE NUMBERS The Twin Evils of Inflation and Unemployment
Inflation
What Causes Inflation?
Measuring Inflation: Consumer Price Index, Producer Price Index, and GDP Deflator
The Consumer Price Index
The Producer Price Index
The GDP Deflator
Adjusting for Inflation: Escalating and Deflating Series (Nominal Versus Real Values)
Escalator Clauses
Deflating Series: Nominal Versus Real Values
The Effect of Overstating Inflation
The Consequences of Inflation
Hyperinflation
ISSUE The Consequences of Counterfeit Money on Inflation
Unemployment
The Historical Record
Defining and Measuring Unemployment
Employed
Unemployed
Labor Force
Monthly Employment Surveys
The Household Survey
The Payroll Survey
Employment Trends
Weekly Jobs Report
Relationship Between Employment and the Unemployment Rate
Problems with Unemployment Statistics
Underemployment and Marginally Attached Workers
AROUND THE WORLD The Boom and Bust of Dickinson, North Dakota
Unemployment and the Economy
Types of Unemployment
Frictional Unemployment
Structural Unemployment
Cyclical Unemployment
Defining Full Employment
The Natural Rate of Unemployment
Changes in the Unemployment Rate Around the Natural Rate
Jobless Recoveries Prolong Unemployment Above the Natural Rate
ISSUE Why Do Unemployment Rates Differ So Much Within the United States?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Economic Growth
BY THE NUMBERS Why Should We Care About Economic Growth?
Why Is Economic Growth Important?
How Is Economic Growth Measured?
Small Differences in Growth Lead to Large Differences in Income Over Time
Power of Compounding Growth Rates
Rule of 70
ISSUE Can Economic Growth Bring a Billion People Out of Poverty?
Thinking About Short-Run and Long-Run Economic Growth
Short-Run Versus Long-Run Growth
Short-Run Growth Involves a Fixed Capacity
Long-Run Growth Involves Expanding Capacity
Factors of Production
Production Function
Applying the Production Function: Achieving Economic Growth
Achieving More Land or Natural Resources
Growth of the Labor Force
Increasing the Quality of the Labor Force
Increasing the Capital-to-Labor Ratio
THOMAS MALTHUS (1766–1834)
Improvements in Technology and Ideas
Including Everything Else: Total Factor Productivity
AROUND THE WORLD Kazakhstan: The Next Destination of Growth and Trade
The Role of Government in Promoting Economic Growth
Government as a Contributor to Physical Capital, Human Capital, and Technology
Physical Capital: Public Capital and Private Investment
Human Capital: Public Education and Financial Aid
Technology: Government R&D Centers and Federal Grants
Government as a Facilitator of Economic Growth
Enforcement of Contracts
Protection of Property Rights
Stable Financial System
Government as a Promoter of Free and Competitive Markets
Competitive Markets and Free Trade
Economic Freedom
ISSUE Did Economic Growth Peak a Century Ago? Prospects for Future Growth
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Aggregate Expenditures
BY THE NUMBERS The Role of Spending in the Economy
Aggregate Expenditures
Some Simplifying Assumptions
Consumption and Saving
Average Propensities to Consume and Save
Marginal Propensities to Consume and Save
Other Determinants of Consumption and Saving
Investment
Investment Demand
Aggregate Investment Schedule
The Simple Aggregate Expenditures Model
Macroeconomic Equilibrium in the Simple Model
JOHN MAYNARD KEYNES (1883–1946)
The Multiplier
The Multiplier Works in Both Directions
Paradox of Thrift
ISSUE Do High Savings Rates Increase the Risk of a Long Recession?
AROUND THE WORLD Brazil’s Beco Do Batman: How Graffiti Revived a Neighborhood
The Full Aggregate Expenditures Model
Adding Government Spending and Taxes
Tax Changes and Equilibrium
The Balanced Budget Multiplier
Adding Net Exports
Recessionary and Inflationary Gaps
Recessionary Gap
Inflationary Gap
ISSUE Was Keynes Right About the Great Depression?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Aggregate Demand and Supply
BY THE NUMBERS The Sheer Size of Aggregate Demand and Aggregate Supply
Aggregate Demand
Why Is the Aggregate Demand Curve Negatively Sloped?
The Wealth Effect
Export Price Effect
Interest Rate Effect
Determinants of Aggregate Demand
Consumer Spending
Investment
Government Spending and Net Exports
AROUND THE WORLD Myanmar: Opening a Country to a Boom in Aggregate Demand
Aggregate Supply
Long Run
Determinants of Long-Run Aggregate Supply
Short Run
Determinants of Short-Run Aggregate Supply
Input Prices
Productivity
Taxes and Regulation
Market Power of Firms
Inflationary Expectations
Macroeconomic Equilibrium
The Spending Multiplier
The Great Depression
Demand-Pull Inflation
Cost-Push Inflation
ISSUE Why Didn’t Stimulus Measures Over the Past Decade Lead to Inflation?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
APPENDIX
Deriving the Aggregate Demand Curve
Fiscal Policy and Debt
BY THE NUMBERS Your Government and Its Financial Operation
Fiscal Policy and Aggregate Demand
Discretionary and Mandatory Spending
Discretionary Fiscal Policy
Government Spending
Taxes
Transfers
Expansionary and Contractionary Fiscal Policy
Fiscal Policy and Aggregate Supply
Infrastructure Spending
Reducing Tax Rates
Expanding Investment and Reducing Regulations
AROUND THE WORLD Qatar: A Nation Built for the Future
Implementing Fiscal Policy
Automatic Stabilizers
Fiscal Policy Timing Lags
The Government’s Bias Toward Borrowing and Away from Taxation
Financing the Federal Government
Defining Deficits and the National Debt
Balanced Budget Amendments
ISSUE How Big Is the Economic Burden of Interest Rates on the National Debt?
Financing Debt and Deficits
Why Is the Public Debt So Important?
Is the Size of the Public Debt a Problem?
Does It Matter If Foreigners Hold a Significant Portion of the Public Debt?
Does Government Debt Crowd Out Consumption and Investment?
How Will the National Debt Affect Our Future? Are We Doomed?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Saving, Investment, and the Financial System
BY THE NUMBERS The Financial System and Its Sheer Size and Scope
What Is Money?
The Functions of Money
Medium of Exchange
Unit of Account
Store of Value
Defining the Money Supply
AROUND THE WORLD Using Plastic Money (Literally) in Australia
Narrowly Defined Money: M1
A Broader Definition: M2
The Market for Loanable Funds
Supply and Demand for Loanable Funds
Shifts in the Supply of Loanable Funds
Economic Outlook
Incentives to Save
Income or Asset Prices
Government Deficits
Shifts in the Demand for Loanable Funds
Investment Tax Incentives
Technological Advances
Regulations
Product Demand
Business Expectations
The Financial System
The Bridge Between Savers and Borrowers
The Roles of Financial Institutions
Reducing Information Costs
Reducing Transaction Costs
Diversifying Assets to Reduce Risk
Types of Financial Assets
Bond Prices and Interest Rates
Stocks and Investment Returns
Financial Tools for a Better Future
Short-Term Borrowing
The Power (or Danger) of Compounding Interest
Risk Assessment and Asset Allocation
Saving for the Future: Employer-Based Programs
To Contribute or Not to Contribute?
In What Assets Should One Invest?
Other Retirement Savings Tools: Social Security, Pensions, and IRAs
Social Security
Pension Plans
ISSUE Can a Stock Market Crash Increase Long-Term Savings?
Individual Retirement Arrangements (IRAs)
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Money Creation and the Federal Reserve
BY THE NUMBERS Banks and the Federal Reserve
How Banks Create Money
Creating Money as If Out of Thin Air
Fractional Reserve Banking System
The Money Creation Process
The Money Multiplier and Its Leakages
Bank Reserves and the Money Multiplier
Money Leakages
Bank Leakages
Leakages by Individuals and Businesses
The Effect of Foreign Currency Holdings
What Is the Actual Money Multiplier in the Economy?
AROUND THE WORLD The Rise and Fall of the Famous (and Infamous) Swiss Bank Account
The Federal Reserve System
The Structure of the Federal Reserve
The Board of Governors
Federal Reserve Banks
Federal Open Market Committee
The Fed as Lender of Last Resort
The Federal Reserve at Work: Tools, Targets, and Policy Lags
Reserve Requirements
Discount Rate
Open Market Operations
The Federal Funds Target
Monetary Policy Lags
Information Lags
Recognition Lags
Decision Lags
ISSUE What Can the Fed Do When Interest Rates Reach 0%?
Implementation Lags
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Monetary Policy
BY THE NUMBERS Monetary Policy in Action
What Is Monetary Policy?
The Twin Goals of Monetary Policy
Examples of Monetary Policy in Action
Why Is the Interest Rate So Important to the Economy?
When Is It Optimal to Loosen or Tighten Monetary Policy?
Expansionary Monetary Policy
Contractionary Monetary Policy
Monetary Theories
The Short Run Versus the Long Run: What’s the Difference?
The Long Run: The Classical Theory
IRVING FISHER (1867–1947)
Short-Run Effects of Monetary Policy
Money Illusion and Sticky Wages and Prices
Keynesian Model
Monetarist Model
NOBEL PRIZE: MILTON FRIEDMAN (1912–2006)
Summary of the Effectiveness of Monetary Policy
Monetary Policy and Economic Shocks
Demand Shocks
Supply Shocks
Implications for Short-Run Monetary Policy
Modern Monetary Policy
Rules Versus Discretion
The Federal Funds Target and the Taylor Rule
A Recap of the Fed’s Policy Tools
Transparency and the Federal Reserve
ISSUE The Record of the Fed’s Performance
New Monetary Policy Challenges
The Fed: Dealing with an Economic Crisis Not Seen in 80 Years
The Eurozone Crisis and the Role of the European Central Bank
ISSUE The Challenges of Monetary Policy with Regional Differences in Economic Performance
AROUND THE WORLD Why Would a Country Give Up Its Monetary Policy?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Macroeconomic Policy: Challenges in a Global Economy
BY THE NUMBERS The Long Road Back: The Great Recession and the Jobless Recovery
The Great Recession and Macroeconomic Policy
From the Housing Bubble to the Financial Crisis
Subprime Mortgages and Collateralized Debt Obligations
Collapsing Financial Markets
The Government’s Policy Response
The Financial Crisis and Its Effects
Effectiveness of Macroeconomic Policy: Phillips Curves and Rational Expectations
Unemployment and Inflation: Phillips Curves
Productivity, Prices, and Wages
The Importance of Inflationary Expectations
Inflationary Expectations and the Phillips Curve
The Long-Run Phillips Curve
Accelerating Inflation
Returning Inflation to Normal Levels
NOBEL PRIZE: ROBERT LUCAS
Rational Expectations and Policy Formation
Policy Implications of Rational Expectations
A Critique of Rational Expectations
Macroeconomic Issues That Confront Our Future
Are Recoveries Becoming “Jobless Recoveries”?
Will Rising Debt and Future Debt Obligations Lead to Inflation?
Rising Future Debt Obligations: Health Care and Social Security
The Cost of Financing Debt
The Effects of Debt on Inflation
ISSUE Inflating Our Way Out of Debt: Is This an Effective Approach?
Will Globalization Lead to Increased Obstacles to Economic Growth?
AROUND THE WORLD Life on the Autobahn: Germany’s Role in European Growth and Stability
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
International Trade
BY THE NUMBERS International Trade
The Gains from Trade
Absolute and Comparative Advantage
Gains from Trade
Practical Constraints on Trade
ISSUE The Challenge of Measuring Imports and Exports in a Global Economy
The Terms of Trade
Determining the Terms of Trade
The Impact of Trade
How Trade Is Restricted
Effects of Tariffs and Quotas
ISSUE Do Foreign Trade Zones Help or Hurt American Consumers and Workers?
Arguments Against Free Trade
Traditional Economic Arguments
Infant Industry Argument
Antidumping
Low Foreign Wages
National Defense Argument
Recent Globalization Concerns
Trade and Domestic Employment
Trade and the Environment
Trade and Its Effect on Working Conditions in Developing Nations
AROUND THE WORLD Can One Country’s Festival Disrupt World Trade?
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Open Economy Macroeconomics
BY THE NUMBERS The Foreign Exchange Market
The Balance of Payments
The Current Account
Imports and Exports
Income
Transfers
The Capital Account
Exchange Rates
Defining Exchange Rates
Nominal Exchange Rates
Real Exchange Rates
Purchasing Power Parity
Exchange Rate Determination
A Market for Foreign Exchange
Flexible Exchange Rates
Currency Appreciation and Depreciation
Determinants of Exchange Rates
Exchange Rates and the Current Account
Changes in Inflation Rates
Changes in Domestic Disposable Income
Exchange Rates and the Capital Account
Interest Rate Changes
Expected Exchange Rate Changes
Exchange Rates and Aggregate Supply and Demand
ISSUE Would a Stronger Chinese Yuan Be Good for Americans?
Monetary and Fiscal Policy in an Open Economy
Fixed and Flexible Exchange Rate Systems
Pegging Exchange Rates Under a Flexible Exchange Rate System
Policies Under Fixed Exchange Rates
Policies Under Flexible Exchange Rates
AROUND THE WORLD Hyder, Alaska: An American Town That Uses the Canadian Dollar
NOBEL PRIZE: ROBERT MUNDELL
Chapter Summary
KEY CONCEPTS
QUESTIONS AND PROBLEMS
ANSWERS TO QUESTIONS IN CHECKPOINTS
Sources for By the Numbers
Glossary
Index