Essentials of Economics, Sixth Edition
By R. Glenn Hubbard, Anthony Patrick O’Brien
Contents:
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
Applications
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
Segment.com 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
Strategy
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