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ECON Argumentative Essay

When it comes to explaining fundamental economic principles by drawing on current economic issues and events, there is no one more trusted than Nobel laureate and New York Times columnist Paul Krugman and co-author, Robin Wells. In this best-selling introductory textbook, Krugman and Wells’ signature storytelling style and uncanny eye for revealing examples help readers understand how economic concepts play out in our world.

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MACROECONOMICS K

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MACROECONOMICS Paul Krugman Robin Wells FOURTH EDITION

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RLD VIEW

GLOBAL COMPARISONS

1: Common Ground, 5

2: From Kitty Hawk to Dreamliner, 25

3: NEW: A Natural Gas Boom, 67

4: Big City, Not-So-Bright Ideas, 103

5: NEW: The Everywhere Phone, 131

6: NEW: The Pain in Spain, 169

7: The New #2, 191

8: NEW: Hitting the Braking Point, 217

9: NEW: Airpocalypse Now, 245

10: Funds for Facebook, 279

11: From Boom to Bust, 317

12: NEW: What Kind of Shock?, 349

13: How Big Is Big Enough?, 385

14: NEW: Funny Money, 419

15: NEW: The Most Powerful Person in Government, 455

16: Bringing a Suitcase to the Bank, 485

17: From Purveyor of Dry Goods to Destroyer of Worlds, 513

18: A Tale of Two Slumps, 539

19: Switzerland Doesn’t Want Your Money, 563

2: Pajama Republics, 37

3: Pay More, Pump Less, 71

4: Check Out Our Low, Low Wages!, 116

5: Productivity and Wages Around the World, 137

6: NEW: Slumps Across the Atlantic, 177

7: GDP and the Meaning of Life, 204

8: Natural Unemployment Around the OECD, 230

9: NEW: What’s the Matter with Italy? 260

10: NEW: Bonds Versus Banks, 299

12: Supply Shocks of the Twenty-first Century, 372

13: The American Way of Debt, 404

14: The Big Moneys, 421

15: Inflation Targets, 470

16: Disinflation Around the World, 502

19: Big Surpluses, 569

Applications in Macroeconomics

CHAPTER-OPENING STORIESCHAPTER

1: First Principles, 5

2: Economic Models: Trade-offs and Trade, 25

3: Supply and Demand, 67

4: Price Controls and Quotas: Meddling with Markets, 103

5: International Trade, 131

6: Macroeconomics: The Big Picture, 169

7: GDP and the CPI: Tracking the Macroeconomy, 191

8: Unemployment and Inflation, 217

9: Long-Run Economic Growth, 245

10: Savings, Investment Spending, and the Financial System, 279

11: Income and Expenditure, 317

12: Aggregate Demand and Aggregate Supply, 349

13: Fiscal Policy, 385

14: Money, Banking, and the Federal Reserve System, 419

15: Monetary Policy, 455

16: Inflation, Disinflation, and Deflation, 485

17: Crises and Consequences, 513

18: Macroeconomics: Events and Ideas, 539

19: Open-Economy Macroeconomics, 563

KrugWellsEC4e_Macro_inside_front_cover.indd 2 2/6/15 11:21 AM

BUSINESS CASESECONOMICS IN ACTION

1: Boy or Girl? It Depends on the Cost, 10 n Restoring Equilibrium on the Freeways, 17 n Adventures in Babysitting, 20

2: Rich Nation, Poor Nation, 39 n Economists, Beyond the Ivory Tower, 43

3: Beating the Traffic, 78 n Only Creatures Small and Pampered, 85 n The Price of Admission, 89 n NEW: The Cotton Panic and Crash of 2001, 95

4: NEW: Price Controls in Venezuela: “You Buy What They Have,” 110 n NEW: The Rise and Fall of the Unpaid Intern, 116 n NEW: Crabbing, Quotas, and Saving Lives in Alaska, 122

5: NEW: How Hong Kong Lost Its Shirts, 140 n Trade, Wages, and Land Prices in the Nineteenth Century, 147 n Trade Protection in the United States, 151 n Beefing Up Exports, 156

6: Fending Off Depression, 172 n Comparing Recessions, 178 n A Tale of Two Countries, 180 n A Fast (Food) Measure of Inflation, 182 n NEW: Spain’s Costly Surplus, 184

7: Creating the National Accounts, 201 n Miracle in Venezuela?, 205 n Indexing to the CPI, 209

8: Failure to Launch, 223 n Structural Unemployment in East Germany, 232 n Israel’s Experience with Inflation, 239

9: India Takes Off, 249 n NEW: Is the End of Economic Growth in Sight?, 256 n NEW: Why Did Britain Fall Behind?, 262 n Are Economies Converging?, 266 n NEW: The Cost of Limiting Carbon, 272

10: Sixty Years of U.S. Interest Rates, 292 n Banks and the South Korean Miracle, 300 n The Great American Housing Bubble, 306

11: NEW: Sand State Slump, 320 n Famous First Forecasting Failures, 326 n Interest Rates and the U.S. Housing Boom, 331 n Inventories and the End of a Recession, 339

12: Moving Along the Aggregate Demand Curve, 1979–1980, 358 n NEW: Sticky Wages in the Great Recession, 367 n Supply Shocks Versus Demand Shocks in Practice, 375 n Is Stabilization Policy Stabilizing?, 378

13: What Was in the Recovery Act?, 392 n NEW: Austerity and the Multiplier, 396 n Europe’s Search for a Fiscal Rule, 401 n NEW: Are We Greece?, 409

14: The History of the Dollar, 425 n It’s a Wonderful Banking System, 429 n Multiplying Money Down, 434 n The Fed’s Balance Sheet, Normal and Abnormal, 440 n Regulation After the 2008 Crisis, 447

15: A Yen for Cash, 460 n The Fed Reverses Course, 466 n What the Fed Wants, the Fed Gets, 471 n International Evidence of Monetary Neutrality, 475

16: Zimbabwe’s Inflation, 491 n NEW: The Phillips Curve in the Great Recession, 499 n The Great Disinflation of the 1980s, 503 n NEW: Is Europe Turning Japanese?, 506

17: The Day the Lights Went Out at Lehman, 517 n Erin Go Broke, 522 n Banks and the Great Depression, 527 n NEW: If Only It Were the 1930s, 532 n Bent Breaks the Buck, 534

18: When Did the Business Cycle Begin?, 540 n The End of the Great Depression, 544 n The Fed’s Flirtation with Monetarism, 550 n NEW: The 1970s in Reverse, 553 n NEW: Lats of Luck, 558

19: The Golden Age of Capital Flows, 572 n Low-Cost America, 580 n China Pegs the Yuan, 585 n NEW: The Little Currency That Could, 589

Blue type indicates global example

1: How Priceline.com Revolutionized the Travel Industry, 21

2: Efficiency, Opportunity Cost, and the Logic of Lean Production at Boeing, 45

3: NEW: An Uber Way to Get a Ride, 97

4: Medallion Financial: Cruising Right Along, 124

5: Li & Fung: From Guangzhou to You, 158

6: NEW: The Business Cycle and the Decline of Montgomery Ward, 186

7: Getting a Jump on GDP, 211

8: NEW: Day Labor in the Information Age, 240

9: NEW: How Boeing Got Better, 274

10: NEW: Grameen Bank: Banking Against Poverty, 308

11: What’s Good for America Is Good for GM, 341

12: NEW: Slow Steaming, 380

13: NEW: Here Comes the Sun, 411

14: The Perfect Gift: Cash or a Gift Card?, 449

15: PIMCO Bets on Cheap Money, 477

16: Licenses to Print Money, 508

19: NEW: A Yen for Japanese Cars, 591

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Paul Krugman Princeton University

Robin Wells

MACROECONOMICS F O U R T H E D I T I O N

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To beginning students everywhere, which we all were at one time.

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Paul Krugman, recipient of the 2008 Nobel Memorial Prize in Economic Sciences, taught at

Princeton University for 14 years and, as of June

2015, he will have joined the faculty of the Gradu-

ate Center of the City University of New York. In

his new position, he is associated with the Luxem-

bourg Income Study, which tracks and analyzes

income inequality around the world. He received

his BA from Yale and his PhD from MIT. Before

Princeton, he taught at Yale, Stanford, and MIT.

He also spent a year on the staff of the Council of

Economic Advisers in 1982–1983. His research has

included pathbreaking work on international trade,

economic geography, and currency crises. In 1991,

Krugman received the American Economic Association’s John Bates Clark

medal. In addition to his teaching and academic research, Krugman writes

extensively for nontechnical audiences. He is a regular op-ed columnist for

the New York Times. His best-selling trade books include End This Depression

Now!, The Return of Depression Economics and the Crisis of 2008, a history of

recent economic troubles and their implications for economic policy, and The

Conscience of a Liberal, a study of the political economy of economic inequal-

ity and its relationship with political polarization from the Gilded Age to the

present. His earlier books, Peddling Prosperity and The Age of Diminished

Expectations, have become modern classics.

Robin Wells was a Lecturer and Researcher in Economics at Princeton University. She received her BA from the University of Chicago and her PhD from

the University of California at Berkeley; she then did postdoctoral work at MIT.

She has taught at the University of Michigan, the University of Southampton

(United Kingdom), Stanford, and MIT.

1

Author__Krugman/Wells___ Title _Economics 4e____

Perm. Fig.# __P001_ New Fig.# _ PUN01 Old Fig.# __________

L/LC/TS/CP/B&W/CAR N/PU/PUAC

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ABOUT THE AUTHORS

Ligaya Franklin

vii

BRIEF CONTENTS

Preface xvii

PART 1 What Is Economics? Introduction The Ordinary Business of Life 1 Chapter 1 First Principles 5 Chapter 2 Economic Models: Trade-offs

and Trade 25 Appendix Graphs in Economics 51

PART 2 Supply and Demand Chapter 3 Supply and Demand 67 Chapter 4 Price Controls and Quotas: Meddling

with Markets 103 Chapter 5 International Trade 131

Appendix Consumer and Producer Surplus 163

PART 3 Introduction to Macroeconomics

Chapter 6 Macroeconomics: The Big Picture 169 Chapter 7 GDP and the CPI: Tracking the

Macroeconomy 191 Chapter 8 Unemployment and Inflation 217

PART 4 Long-Run Economic Growth Chapter 9 Long-Run Economic Growth 245 Chapter 10 Savings, Investment Spending, and

the Financial System 279 Appendix Toward a Fuller Understanding of

Present Value 313

PART 5 Short-Run Economic Fluctuations

Chapter 11 Income and Expenditure 317 Appendix Deriving the Multiplier Algebraically 347 Chapter 12 Aggregate Demand and Aggregate

Supply 349

PART 6 Stabilization Policy Chapter 13 Fiscal Policy 385

Appendix Taxes and the Multiplier 417 Chapter 14 Money, Banking, and the Federal Reserve

System 419 Chapter 15 Monetary Policy 455

Appendix Reconciling the Two Models of the Interest Rate 481

Chapter 16 Inflation, Disinflation, and Deflation 485 Chapter 17 Crises and Consequences 513

PART 7 Events and Ideas Chapter 18 Macroeconomics: Events and Ideas 539

PART 8 The Open Economy Chapter 19 Open-Economy Macroeconomics 563

Macroeconomic Data Tables M-1 Solutions to “Check Your Understanding” Questions S-1 Glossary G-1 Index I-1

viii

CONTENTS

Preface xvii

PART 1 What Is Economics?

uINTRODUCTION The Ordinary Business of Life ........................1

ANY GIVEN SUNDAY 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 COMMON GROUND 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 Priceline.com Revolutionized the Travel

Industry 21

uCHAPTER 2 Economics Models: Trade-offs and Trade.................25

FROM KITTY HAWK TO DREAMLINER 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

CHAPTER 2 APPENDIX Graphs in 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

ix

x C O N T E N T S

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 A NATURAL GAS BOOM 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 Price Controls and Quotas: Meddling with Markets ...................................................103

BIG CITY, NOT-SO-BRIGHT IDEAS 103 Why Governments Control Prices  104

Price Ceilings 104 Modeling a Price Ceiling 105 How a Price Ceiling Causes Inefficiency 106

FOR INQUIRING MINDS: Mumbai’s Rent-Control Millionaires 109

So Why Are There Price Ceilings? 110 ECONOMICS ➤ IN ACTION Price Controls in Venezuela:

“You Buy What They Have” 110

Price Floors 111 How a Price Floor Causes Inefficiency 113

GLOBAL COMPARISON: Check Out Our Low, Low Wages! 116 So Why Are There Price Floors? 116

ECONOMICS ➤ IN ACTION The Rise and Fall of the Unpaid Intern 116

Controlling Quantities 118 The Anatomy of Quantity Controls 118 The Costs of Quantity Controls 121

ECONOMICS ➤ IN ACTION Crabbing, Quotas, and Saving Lives in Alaska 122

BUSINESS CASE: Medallion Financial: Cruising Right Along 124

uCHAPTER 5 International Trade .................... 131 THE EVERYWHERE PHONE 131 Comparative Advantage and International Trade 132

Production Possibilities and Comparative Advantage, Revisited 133 The Gains from International Trade 135 Comparative Advantage versus Absolute Advantage 136

GLOBAL COMPARISON: Productivity and Wages Around the World 137

Sources of Comparative Advantage 138

FOR INQUIRING MINDS: Increasing Returns to Scale and International Trade 140

ECONOMICS ➤ IN ACTION How Hong Kong Lost Its Shirts 140

Supply, Demand, and International Trade 141 The Effects of Imports 142 The Effects of Exports 144 International Trade and Wages 146

ECONOMICS ➤ IN ACTION Trade, Wages, and Land Prices in the Nineteenth Century 147

The Effects of Trade Protection 148 The Effects of a Tariff 148 The Effects of an Import Quota 150

ECONOMICS ➤ IN ACTION Trade Protection in the United States 151

The Political Economy of Trade Protection 152 Arguments for Trade Protection 152

C O N T E N T S xi

The Politics of Trade Protection 152 International Trade Agreements and the World Trade Organization 153

FOR INQUIRING MINDS: Tires Under Pressure 154 Challenges to Globalization 154

ECONOMICS ➤ IN ACTION Beefing Up Exports 156 BUSINESS CASE: Li & Fung: From Guangzhou to You 158

CHAPTER 5 APPENDIX Consumer and Producer Surplus .............163

Consumer Surplus and the Demand Curve 163 Willingness to Pay and the Demand Curve 163 Willingness to Pay and Consumer Surplus 164

Producer Surplus and the Supply Curve 165 Cost and Producer Surplus 165

The Gains from Trade 167

PART 3 Introduction to Macroeconomics

uCHAPTER 6 Macroeconomics: The Big Picture .......................... 169

THE PAIN IN SPAIN 169 The Nature of Macroeconomics 170

Macroeconomic Questions 170 Macroeconomics: The Whole Is Greater Than the Sum of Its Parts 171 Macroeconomics: Theory and Policy 171

ECONOMICS ➤ IN ACTION Fending Off Depression 172

The Business Cycle 173 Charting the Business Cycle 174 The Pain of Recession 175

FOR INQUIRING MINDS: Defining Recessions and Expansions 176

Taming the Business Cycle 177 GLOBAL COMPARISON: Slumps Across the Atlantic 177 ECONOMICS ➤ IN ACTION Comparing Recessions 178

Long-Run Economic Growth 178

FOR INQUIRING MINDS: When Did Long-Run Growth Start? 180

ECONOMICS ➤ IN ACTION A Tale of Two Countries 180

Inflation and Deflation 181 The Causes of Inflation and Deflation 181 The Pain of Inflation and Deflation 182

ECONOMICS ➤ IN ACTION A Fast (Food) Measure of Inflation 182

International Imbalances 183 ECONOMICS ➤ IN ACTION Spain’s Costly Surplus 184 BUSINESS CASE: The Business Cycle and the Decline of

Montgomery Ward 186

uCHAPTER 7 GDP and the CPI: Tracking the Macroeconomy ............... 191

THE NEW #2 191 The National Accounts 192

The Circular-Flow Diagram, Revisited and Expanded 192 Gross Domestic Product 195 Calculating GDP 196

FOR INQUIRING MINDS: Our Imputed Lives 197

FOR INQUIRING MINDS: Gross What? 200 What GDP Tells Us 201

ECONOMICS ➤ IN ACTION Creating the National Accounts 201

Real GDP: A Measure of Aggregate Output 202 Calculating Real GDP 202 What Real GDP Doesn’t Measure 203

GLOBAL COMPARISON: GDP and the Meaning of Life 204 ECONOMICS ➤ IN ACTION Miracle in Venezuela? 205

Price Indexes and the Aggregate Price Level 205 Market Baskets and Price Indexes 206 The Consumer Price Index 207 Other Price Measures 208

ECONOMICS ➤ IN ACTION Indexing to the CPI 209 BUSINESS CASE: Getting a Jump on GDP 211

uCHAPTER 8 Unemployment and Inflation ................................... 217

HITTING THE BRAKING POINT 217 The Unemployment Rate 218

Defining and Measuring Unemployment 218 The Significance of the Unemployment Rate 219 Growth and Unemployment 221

ECONOMICS ➤ IN ACTION Failure to Launch 223

The Natural Rate of Unemployment 224 Job Creation and Job Destruction 224 Frictional Unemployment 225 Structural Unemployment 227 The Natural Rate of Unemployment 229

GLOBAL COMPARISON: Natural Unemployment Around the OECD 230

Changes in the Natural Rate of Unemployment 230 ECONOMICS ➤ IN ACTION Structural Unemployment in

East Germany 232

xii C O N T E N T S

Inflation and Deflation 233 The Level of Prices Doesn’t Matter . . . 233 . . . But the Rate of Change of Prices Does 234 Winners and Losers from Inflation 237 Inflation Is Easy; Disinflation Is Hard 238

ECONOMICS ➤ IN ACTION Israel’s Experience with Inflation 239

BUSINESS CASE: Day Labor in the Information Age 240

PART 4 Long-Run Economic Growth

uCHAPTER 9 Long-Run Economic Growth 245

AIRPOCALYPSE NOW 245 Comparing Economies Across Time and Space 246

Real GDP per Capita 246 Growth Rates 248

ECONOMICS ➤ IN ACTION India Takes Off 249

The Sources of Long-Run Growth 250 The Crucial Importance of Productivity 250 Explaining Growth in Productivity 251 Accounting for Growth: The Aggregate Production Function 251 What About Natural Resources? 255

ECONOMICS ➤ IN ACTION Is the End of Economic Growth in Sight? 256

Why Growth Rates Differ 257 Explaining Differences in Growth Rates 258

FOR INQUIRING MINDS: Inventing R&D 259 GLOBAL COMPARISON: What’s the Matter with Italy? 260

The Role of Government in Promoting Economic Growth 260

FOR INQUIRING MINDS: The New Growth Theory 261 ECONOMICS ➤ IN ACTION Why Did Britain Fall

Behind? 262

Success, Disappointment, and Failure 263 East Asia’s Miracle 264 Latin America’s Disappointment 265 Africa’s Troubles and Promise 265

ECONOMICS ➤ IN ACTION Are Economies Converging? 266

Is World Growth Sustainable? 268 Natural Resources and Growth, Revisited 268 Economic Growth and the Environment 270

ECONOMICS ➤ IN ACTION The Cost of Limiting Carbon 272

BUSINESS CASE: How Boeing Got Better 274

uCHAPTER 10 Savings, Investment Spending, and the Financial System .................. 279

FUNDS FOR FACEBOOK 279 Matching Up Savings and Investment Spending 280

The Savings–Investment Spending Identity 280

FOR INQUIRING MINDS: Who Enforces the Accounting? 283 The Market for Loanable Funds 284

FOR INQUIRING MINDS: Using Present Value 285 ECONOMICS ➤ IN ACTION Sixty Years of U.S. Interest

Rates 292

The Financial System 293 Three Tasks of a Financial System 294 Types of Financial Assets 296 Financial Intermediaries 297

GLOBAL COMPARISON: Bonds Versus Banks 299 ECONOMICS ➤ IN ACTION Banks and the South Korean

Miracle 300

Financial Fluctuations 301 The Demand for Stocks 301

FOR INQUIRING MINDS: How Now, Dow Jones? 302 The Demand for Other Assets 303 Asset Price Expectations 303

FOR INQUIRING MINDS: Behavioral Finance 304 Asset Prices and Macroeconomics 305

ECONOMICS ➤ IN ACTION The Great American Housing Bubble 306

BUSINESS CASE: Grameen Bank: Banking Against Poverty 308

CHAPTER 10 APPENDIX Toward a Fuller Understanding of Present Value .............. 313

How to Calculate the Present Value of One-Year Projects 313

How to Calculate the Present Value of Multiyear Projects 313

How to Calculate the Present Value of Projects with Revenues and Costs 314

How to Calculate the Price of a Bond Using Present Value 315

How to Calculate the Price of a Share of Stock Using Present Value 316

C O N T E N T S xiii

PART 5 Short-Run Economic Fluctuations

uCHAPTER 11 Income and Expenditure................................. 317

FROM BOOM TO BUST 317 The Multiplier: An Informal Introduction 318 ECONOMICS ➤ IN ACTION Sand State Slump 320

Consumer Spending 321 Current Disposable Income and Consumer Spending 321 Shifts of the Aggregate Consumption Function 324

ECONOMICS ➤ IN ACTION Famous First Forecasting Failures 326

Investment Spending 327 The Interest Rate and Investment Spending 328 Expected Future Real GDP, Production Capacity, and Investment Spending 329 Inventories and Unplanned Investment Spending 330

ECONOMICS ➤ IN ACTION Interest Rates and the U.S. Housing Boom 331

The Income–Expenditure Model 332 Planned Aggregate Spending and Real GDP 333 Income–Expenditure Equilibrium 334 The Multiplier Process and Inventory Adjustment 336

ECONOMICS ➤ IN ACTION Inventories and the End of a Recession 339

BUSINESS CASE: What’s Good for America Is Good for GM 341

CHAPTER 11 APPENDIX Deriving the Multiplier Algebraically ........................347

uCHAPTER 12 Aggregate Demand and Aggregate Supply ...............349

WHAT KIND OF SHOCK? 349 Aggregate Demand 350

Why Is the Aggregate Demand Curve Downward Sloping? 351 The Aggregate Demand Curve and the Income–Expenditure Model 352 Shifts of the Aggregate Demand Curve 354 Government Policies and Aggregate Demand 357

ECONOMICS ➤ IN ACTION Moving Along the Aggregate Demand Curve, 1979–1980 358

Aggregate Supply 358 The Short-Run Aggregate Supply Curve 359

FOR INQUIRING MINDS: What’s Truly Flexible, What’s Truly Sticky 360

Shifts of the Short-Run Aggregate Supply Curve 361 The Long-Run Aggregate Supply Curve 364 From the Short Run to the Long Run 366

ECONOMICS ➤ IN ACTION Sticky Wages in the Great Recession 367

The AD–AS Model 368 Short-Run Macroeconomic Equilibrium 368 Shifts of Aggregate Demand: Short-Run Effects 369 Shifts of the SRAS Curve 370

GLOBAL COMPARISON: Supply Shocks of the Twenty-first Century 372

Long-Run Macroeconomic Equilibrium 372

FOR INQUIRING MINDS: Where’s the Deflation? 375 ECONOMICS ➤ IN ACTION Supply Shocks Versus Demand

Shocks in Practice 375

Macroeconomic Policy 376

FOR INQUIRING MINDS: Keynes and the Long Run 377 Policy in the Face of Demand Shocks 377 Responding to Supply Shocks 378

ECONOMICS ➤ IN ACTION Is Stabilization Policy Stabilizing? 378

BUSINESS CASE: Slow Steaming 380

PART 6 Stabilization Policy

uCHAPTER 13 Fiscal Policy ................................385 HOW BIG IS BIG ENOUGH? 385 Fiscal Policy: The Basics 386

Taxes, Purchases of Goods and Services, Government Transfers, and Borrowing 386 The Government Budget and Total Spending 387 Expansionary and Contractionary Fiscal Policy 388 Can Expansionary Fiscal Policy Actually Work? 390 A Cautionary Note: Lags in Fiscal Policy 391

ECONOMICS ➤ IN ACTION What Was in the Recovery Act? 392

Fiscal Policy and the Multiplier 393 Multiplier Effects of an Increase in Government Purchases of Goods and Services 393 Multiplier Effects of Changes in Government Transfers and Taxes 394 How Taxes Affect the Multiplier 395

ECONOMICS ➤ IN ACTION Austerity and the Multiplier 396

The Budget Balance 397 The Budget Balance as a Measure of Fiscal Policy 398 The Business Cycle and the Cyclically Adjusted Budget Balance 398 Should the Budget Be Balanced? 401

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ECONOMICS ➤ IN ACTION Europe’s Search for a Fiscal Rule 401

Long-Run Implications of Fiscal Policy 402 Deficits, Surpluses, and Debt 403

GLOBAL COMPARISON: The American Way of Debt 404 Problems Posed by Rising Government Debt 405 Deficits and Debt in Practice 406

FOR INQUIRING MINDS: What Happened to the Debt from World War II? 407

Implicit Liabilities 407 ECONOMICS ➤ IN ACTION Are We Greece? 409 BUSINESS CASE: Here Comes the Sun 411

CHAPTER 13 APPENDIX Taxes and the Multiplier ....................................417

uCHAPTER 14 Money, Banking, and the Federal Reserve System ...............................................419

FUNNY MONEY 419 The Meaning of Money 420

What Is Money? 420 Roles of Money 421

GLOBAL COMPARISON: The Big Moneys 421 Types of Money 422 Measuring the Money Supply 423

FOR INQUIRING MINDS: What’s with All the Currency? 424 ECONOMICS ➤ IN ACTION The History of the Dollar 425

The Monetary Role of Banks 426 What Banks Do 426 The Problem of Bank Runs 427 Bank Regulation 428

ECONOMICS ➤ IN ACTION It’s a Wonderful Banking System 429

Determining the Money Supply 430 How Banks Create Money 430 Reserves, Bank Deposits, and the Money Multiplier 432 The Money Multiplier in Reality 433

ECONOMICS ➤ IN ACTION Multiplying Money Down 434

The Federal Reserve System 435 The Structure of the Fed 435 What the Fed Does: Reserve Requirements and the Discount Rate 436 Open-Market Operations 437

FOR INQUIRING MINDS: Who Gets the Interest on the Fed’s Assets? 439

The European Central Bank 439

ECONOMICS ➤ IN ACTION The Fed’s Balance Sheet, Normal and Abnormal 440

The Evolution of the American Banking System 441 The Crisis in American Banking in the Early Twentieth

Century 441 Responding to Banking Crises: The Creation of the Federal Reserve 442 The Savings and Loan Crisis of the 1980s 444 Back to the Future: The Financial Crisis of 2008 444

ECONOMICS ➤ IN ACTION Regulation After the 2008 Crisis 447

BUSINESS CASE: The Perfect Gift: Cash or a Gift Card? 449

uCHAPTER 15 Monetary Policy .....................455 THE MOST POWERFUL PERSON IN GOVERNMENT 455 The Demand for Money 456

The Opportunity Cost of Holding Money 456 The Money Demand Curve 458 Shifts of the Money Demand Curve 459

ECONOMICS ➤ IN ACTION A Yen for Cash 460

Money and Interest Rates 461 The Equilibrium Interest Rate 461 Two Models of Interest Rates? 463 Monetary Policy and the Interest Rate 463 Long-Term Interest Rates 465

ECONOMICS ➤ IN ACTION The Fed Reverses Course 466

Monetary Policy and Aggregate Demand 467 Expansionary and Contractionary Monetary Policy 467 Monetary Policy in Practice 468 The Taylor Rule Method of Setting Monetary Policy 469 Inflation Targeting 469

GLOBAL COMPARISON: Inflation Targets 470 The Zero Lower Bound Problem 471

ECONOMICS ➤ IN ACTION What the Fed Wants, the Fed Gets 471

Money, Output, and Prices in the Long Run 472 Short-Run and Long-Run Effects of an Increase in the Money Supply 472 Monetary Neutrality 474 Changes in the Money Supply and the Interest Rate in the Long Run 474

ECONOMICS ➤ IN ACTION International Evidence of Monetary Neutrality 475

BUSINESS CASE: PIMCO Bets on Cheap Money 477

CHAPTER 15 APPENDIX Reconciling the Two Models of the Interest Rate ........................481

The Interest Rate in the Short Run 481 The Interest Rate in the Long Run 482

C O N T E N T S xv

uCHAPTER 16 Inflation, Disinflation, and Deflation .............................485

BRINGING A SUITCASE TO THE BANK 485 Money and Inflation 486

The Classical Model of Money and Prices 486 The Inflation Tax 488 The Logic of Hyperinflation 489

ECONOMICS ➤ IN ACTION Zimbabwe’s Inflation 491

Moderate Inflation and Disinflation 491 The Output Gap and the Unemployment Rate 492

FOR INQUIRING MINDS: Okun’s Law 494 The Short-Run Phillips Curve 494

FOR INQUIRING MINDS: The Aggregate Supply Curve and the Short-Run Phillips Curve 496

Inflation Expectations and the Short-Run Phillips Curve 497

ECONOMICS ➤ IN ACTION The Phillips Curve in the Great Recession 499

Inflation and Unemployment in the Long Run 500 The Long-Run Phillips Curve 500 The Natural Rate of Unemployment, Revisited 502 The Costs of Disinflation 502

GLOBAL COMPARISON: Disinflation Around the World 502 ECONOMICS ➤ IN ACTION The Great Disinflation of the

1980s 503

Deflation 504 Debt Deflation 504 Effects of Expected Deflation 505

ECONOMICS ➤ IN ACTION Is Europe Turning Japanese? 506

BUSINESS CASE: Licenses to Print Money 508

uCHAPTER 17 Crises and Consequences .........................513

FROM PURVEYOR OF DRY GOODS TO DESTROYER

OF WORLDS 513 Banking: Benefits and Dangers 514

The Trade-off Between Rate of Return and Liquidity 514 The Purpose of Banking 515 Shadow Banks and the Re-emergence of Bank Runs 516

ECONOMICS ➤ IN ACTION The Day the Lights Went Out at Lehman 517

Banking Crises and Financial Panics 518 The Logic of Banking Crises 518 Historical Banking Crises: The Age of Panics 520 Modern Banking Crises Around the World 521

ECONOMICS ➤ IN ACTION Erin Go Broke 522

The Consequences of Banking Crises 523 Banking Crises, Recessions, and Recovery 523 Why Are Banking-Crisis Recessions So Bad? 524 Governments Step In 525

ECONOMICS ➤ IN ACTION Banks and the Great Depression 527

The 2008 Crisis and Its Aftermath 528 Severe Crisis, Slow Recovery 528 Aftershocks in Europe 529 The Stimulus–Austerity Debate 531 The Lesson of the Post-Crisis Slump 532

ECONOMICS ➤ IN ACTION If Only It Were the 1930s 532

Regulation in the Wake of the Crisis 533 ECONOMICS ➤ IN ACTION Bent Breaks the Buck 534

PART 7 Events and Ideas

uCHAPTER 18 Macroeconomics: Events and Ideas..................539

A TALE OF TWO SLUMPS 539 Classical Macroeconomics 540

Money and the Price Level 540 The Business Cycle 540

ECONOMICS ➤ IN ACTION When Did the Business Cycle Begin? 540

The Great Depression and the Keynesian Revolution 541

Keynes’s Theory 542

FOR INQUIRING MINDS: The Politics of Keynes 543 Policy to Fight Recessions 544

ECONOMICS ➤ IN ACTION The End of the Great Depression 544

Challenges to Keynesian Economics 545 The Revival of Monetary Policy 545 Monetarism 546 Limits to Macroeconomic Policy: Inflation and the Natural Rate of Unemployment 549 The Political Business Cycle 549

ECONOMICS ➤ IN ACTION The Fed’s Flirtation with Monetarism 550

Rational Expectations, Real Business Cycles, and New Classical Macroeconomics 550

Rational Expectations 551 Real Business Cycles 552

FOR INQUIRING MINDS: Supply-Side Economics 552 ECONOMICS ➤ IN ACTION The 1970s in Reverse 553

xvi C O N T E N T S

Consensus and Conflict in Modern Macroeconomics 554

Question 1: Is Expansionary Monetary Policy Helpful in Fighting Recessions? 554 Question 2: Is Expansionary Fiscal Policy Effective in Fighting Recessions? 555 Question 3: Can Monetary and/or Fiscal Policy Reduce Unemployment in the Long Run? 555 Question 4: Should Fiscal Policy Be Used in a Discretionary Way? 555 Question 5: Should Monetary Policy Be Used in a Discretionary Way? 556

Crises and Aftermath 556 ECONOMICS ➤ IN ACTION Lats of Luck 558

PART 8 The Open Economy

uCHAPTER 19 Open-Economy Macroeconomics ..................563

SWITZERLAND DOESN’T WANT YOUR MONEY 563 Capital Flows and the Balance of Payments 564

Balance of Payments Accounts 564

FOR INQUIRING MINDS: GDP, GNP, and the Current Account 566

Modeling the Financial Account 568 GLOBAL COMPARISON: Big Surpluses 569

Underlying Determinants of International Capital Flows 571

FOR INQUIRING MINDS: A Global Savings Glut? 571 Two-Way Capital Flows 572

ECONOMICS ➤ IN ACTION The Golden Age of Capital Flows 572

The Role of the Exchange Rate 573 Understanding Exchange Rates 574 The Equilibrium Exchange Rate 574 Inflation and Real Exchange Rates 577 Purchasing Power Parity 579

FOR INQUIRING MINDS: Burgernomics 579 ECONOMICS ➤ IN ACTION Low-Cost America 580