Macroeconomics This page intentionally left blank Macroeconomics Fourth Edition R Glenn Hubbard Columbia University Anthony Patrick O’Brien Lehigh University Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo Editorial Director: Sally Yagan Editor in Chief: Donna Battista AVP/Executive Editor: David Alexander VP/Development Director: Stephen Deitmer Executive Development Editor: Lena Buonanno Editorial Project Manager: Lindsey Sloan Editorial Assistant: Emily Brodeur Marketing Director: Patrice Jones AVP/Executive Marketing Manager: Lori DeShazo Marketing Assistant: Courtney Kamauf Senior Managing Editor: Nancy H Fenton Production Project Manager: Carla Thompson Manufacturing Director: Evelyn Beaton Senior Manufacturing Buyer: Carol Melville Senior Media Buyer: Ginny Michaud Creative Director: Christy Mahon Senior Art Director, Cover: Jonathan Boylan Image Manager: Rachel Youdelman Text Permissions Project Supervisor: Michael Joyce Media Director: Susan Schoenberg Content Lead, MyEconLab: Noel Lotz Senior Media Producer: Melissa Honig Associate Production Project Manager: Alison Eusden Full-Service Project Management/Interior Design/Photo Research/Composition: PreMediaGlobal, Inc Printer/Binder: Courier, Kendallville Cover Printer: Courier, Kendallville Text Font: Minion Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text (or on page C-1) Microsoft® and Windows® are registered trademarks of the Microsoft Corporation in the U.S.A and other countries Screen shots and icons reprinted with permission from the Microsoft Corporation This book is not sponsored or endorsed by or affiliated with the Microsoft Corporation Copyright © 2013, 2010, 2009, 2008, 2006 Pearson Education, Inc All rights reserved Manufactured 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Andrew, and Daniel —Anthony Patrick O’Brien This page intentionally left blank ABOUT THE AUTHORS Glenn Hubbard, policymaker, professor, and researcher R Glenn Hubbard is the dean and Russell L Carson Professor of Finance and Economics in the Graduate School of Business at Columbia University and professor of economics in Columbia’s Faculty of Arts and Sciences He is also a research associate of the National Bureau of Economic Research and a director of Automatic Data Processing, Black Rock Closed-End Funds, KKR Financial Corporation, and MetLife He received his Ph.D in economics from Harvard University in 1983 From 2001 to 2003, he served as chairman of the White House Council of Economic Advisers and chairman of the OECD Economy Policy Committee, and from 1991 to 1993, he was deputy assistant secretary of the U.S Treasury Department He currently serves as co-chair of the nonpartisan Committee on Capital Markets Regulation Hubbard’s fields of specialization are public economics, financial markets and institutions, corporate finance, macroeconomics, industrial organization, and public policy He is the author of more than 100 articles in leading journals, including American Economic Review, Brookings Papers on Economic Activity, Journal of Finance, Journal of Financial Economics, Journal of Money, Credit, and Banking, Journal of Political Economy, Journal of Public Economics, Quarterly Journal of Economics, RAND Journal of Economics, and Review of Economics and Statistics His research has been supported by grants from the National Science Foundation, the National Bureau of Economic Research, and numerous private foundations Tony O’Brien, award-winning professor and researcher Anthony Patrick O’Brien is a professor of economics at Lehigh University He received his Ph.D from the University of California, Berkeley, in 1987 He has taught principles of economics for more than 15 years, in both large sections and small honors classes He received the Lehigh University Award for Distinguished Teaching He was formerly the director of the Diamond Center for Economic Education and was named a Dana Foundation Faculty Fellow and Lehigh Class of 1961 Professor of Economics He has been a visiting professor at the University of California, Santa Barbara, and the Graduate School of Industrial Administration at Carnegie Mellon University O’Brien’s research has dealt with such issues as the evolution of the U.S automobile industry, sources of U.S economic competitiveness, the development of U.S trade policy, the causes of the Great Depression, and the causes of black-white income differences His research has been published in leading journals, including American Economic Review, Quarterly Journal of Economics, Journal of Money, Credit, and Banking, Industrial Relations, Journal of Economic History, and Explorations in Economic History His research has been supported by grants from government agencies and private foundations In addition to teaching and writing, O’Brien also serves on the editorial board of the Journal of Socio-Economics vii BRIEF CONTENTS Preface A Word of Thanks xxi xlvii PART 1: Introduction Chapter 1: Economics: Foundations and Models Appendix: Using Graphs and Formulas Chapter 2: Trade-offs, Comparative Advantage, and the Market System Chapter 3: Where Prices Come From: The Interaction of Demand and Supply Chapter 4: Economic Efficiency, Government Price Setting, and Taxes Appendix: Quantitative Demand and Supply Analysis Chapter 5: The Economics of Health Care 26 Chapter 12: Aggregate Expenditure and Output in the Short Run Appendix: The Algebra of Macroeconomic Equilibrium 38 68 100 Chapter 13: Aggregate Demand and Aggregate Supply Analysis Appendix: Macroeconomic Schools of Thought 374 415 418 451 PART 5: Monetary and Fiscal Policy 131 Chapter 14: Money, Banks, and the Federal Reserve System 454 136 Chapter 15: Monetary Policy 490 Chapter 16: Fiscal Policy 530 Appendix: A Closer Look at the Multiplier Chapter 17: Inflation, Unemployment, and Federal Reserve Policy Chapter 6: Firms, the Stock Market, and Corporate Governance 168 Appendix: Tools to Analyze Firms’ Financial Information 195 204 PART 3: Macroeconomic Foundations and Long-Run Growth Chapter 8: GDP: Measuring Total Production and Income 240 Chapter 9: Unemployment and Inflation 266 Chapter 10: Economic Growth, the Financial System, and Business Cycles 302 viii 336 PART 4: Short-Run Fluctuations PART 2: Firms in the Domestic and International Economies Chapter 7: Comparative Advantage and the Gains from International Trade Chapter 11: Long-Run Economic Growth: Sources and Policies 570 576 PART 6: The International Economy Chapter 18: Macroeconomics in an Open Economy 608 Chapter 19: The International Financial System 638 Appendix: The Gold Standard and the Bretton Woods System 662 Glossary Company Index Subject Index Credits G-1 I-1 I-2 C-1 CONTENTS Preface A Word of Thanks xxix lvii PART 1: Introduction Chapter 1: Economics: Foundations and Models Why Are Some Doctors Leaving Private Practice? 1.1 Three Key Economic Ideas People Are Rational People Respond to Economic Incentives Making the Connection: Does Health Insurance Give People an Incentive to Become Obese? Optimal Decisions Are Made at the Margin Solved Problem 1.1: A Doctor Makes a Decision at the Margin 1.2 The Economic Problem That Every Society Must Solve What Goods and Services Will Be Produced? How Will the Goods and Services Be Produced? Who Will Receive the Goods and Services Produced? Centrally Planned Economies versus Market Economies The Modern “Mixed” Economy Efficiency and Equity 1.3 Economic Models The Role of Assumptions in Economic Models Forming and Testing Hypotheses in Economic Models Normative and Positive Analysis Economics as a Social Science Don’t Let This Happen to You Don’t Confuse Positive Analysis with Normative Analysis Making the Connection: Should Medical School Be Free? 1.4 Microeconomics and Macroeconomics 1.5 A Preview of Important Economic Terms Conclusion An Inside Look: Doctors Moving Less, Retiring Later *Chapter Summary and Problems 5 8 9 10 10 11 12 12 13 14 14 15 15 16 17 19 20 22 Key Terms, Summary, Review Questions, Problems and Applications Appendix: Using Graphs and Formulas Graphs of One Variable Graphs of Two Variables Slopes of Lines Taking into Account More Than Two Variables on a Graph 26 27 28 29 29 Positive and Negative Relationships Determining Cause and Effect Are Graphs of Economic Relationships Always Straight Lines? Slopes of Nonlinear Curves Formulas Formula for a Percentage Change Formulas for the Areas of a Rectangle and a Triangle Summary of Using Formulas Problems and Applications 33 34 34 34 35 35 36 Chapter 2: Trade-offs, Comparative Advantage, and the Market System 38 Managers Making Choices at BMW 2.1 Production Possibilities Frontiers and Opportunity Costs Graphing the Production Possibilities Frontier Solved Problem 2.1: Drawing a Production Possibilities Frontier for Rosie’s Boston Bakery Making the Connection: Facing Trade-offs in Health Care Spending Increasing Marginal Opportunity Costs Economic Growth 2.2 Comparative Advantage and Trade Specialization and Gains from Trade Absolute Advantage versus Comparative Advantage Comparative Advantage and the Gains from Trade Don’t Let This Happen to You Don’t Confuse Absolute Advantage and Comparative Advantage Solved Problem 2.2: Comparative Advantage and the Gains from Trade 2.3 The Market System The Circular Flow of Income The Gains from Free Markets The Market Mechanism Making the Connection: A Story of the Market System in Action: How Do You Make an iPad? The Role of the Entrepreneur The Legal Basis of a Successful Market System Conclusion An Inside Look: Managers at General Motors Approve Production of a Plug-in Cadillac 30 31 39 40 40 42 43 44 45 46 46 48 49 49 50 51 52 52 54 55 56 57 59 60 Chapter 3: Where Prices Come From: The Interaction of Demand and Supply 68 The Tablet Computer Revolution 3.1 The Demand Side of the Market Demand Schedules and Demand Curves The Law of Demand What Explains the Law of Demand? 69 70 70 71 71 *These end-of-chapter resource materials repeat in all chapters ix SUBJECT INDEX open market operations, 473 operating income, 200 Operation Twist, 502–503 opportunity cost, 8, 41, 182, 209 example, 49 increasing marginal, 45 money, holding, 495 optimal decisions at margin, 7–8 Organization for Economic Cooperation and Development (OECD), 144 Organization of Petroleum Exporting Countries (OPEC), 442–443, 590 origin, 27 Otellini, Paul, 322, 389 outflow, capital, 611 outlet bias, 285 outside directors, 173 over-the-counter market, 178 overvalued currency, 650 Owens, Jim, 208 Pace, Noemi, 6–7 Pack, Howard, 311 Page, Larry, 337 Pakistan child labor, 226 factories, 225 Palmer, Brian, 25 Panama, 333, 355 Papandreou, George, 648 par exchange rate, 663–664 paradox of thrift, 405 Parker, Jonathan, 548 parking regulations, adherence to, 358–359 partnership, 170 patents, 57, 348 Patient Protection and Affordable Care Act (PPACA), 16, 137, 147, 149, 151, 152, 156–157, 161, 163, 167 Pavcnik, Nina, 226–227 payroll, establishment survey, 275–276 payroll tax, 534–535 Pearson, Mark, 144 Peers, Martin, 98 pegging, 649–652 penny, 461 Peppers, Larry, 555 percentage change formulas, 34–35 perfectly competitive market, 70 permanent income, 548 Perón, Juan, 603 Perotti, Roberto, 552 Perry, Rick, 606 personal consumption expenditures price index (PCE), 514–515 personal income, 258 Peru, 251, 252 per-worker production function, 344–345 Phelps, Edmund, 580–582 Philippines, 651 Phillips, A.W., 578–579, 601 Phillips curve, 578 with aggregate demand and aggregate supply curves, 579–580 defined, 578–579 inflation rate and monetary policy, expectations of, 581–583 long-run, 580–581 policy menu, 580 short-run and long-run, 583–587 short-run shifts, 584 stability of short-run, 580 supply shock, effect on, 590–591 vertical, monetary policy and, 584–586, 589–590 physical capital, 18, 343 physicians See doctors pie chart, 27 planned investment actual investment versus, 377 aggregate expenditure, 376, 387–388 cash flow, 388 future profitability, expectations of, 387–388 interest rate, 388 taxes, 388 Pogue, David, 69 Poland, 513, 645 policy channels, 628 policy menu, 580 pollution, exclusion from GDP, 252–253 Poole, William, 524, 528, 605 population, demand shift, 74 Portugal, 212–213, 646, 647, 648 positive analysis, 14 international trade, 228–229 normative analysis, confusing, 15 price ceilings, 115 positive externality, 150 Posner, Richard, 95 Postal–Vinay, Fabien, 172 potential GDP, 311, 428 actual and, 312 Phillips curve, 580 Power, Stephen, 98 PPACA See patient protection and Affortable Care Act pre-existing conditions, 148–149, 159 premiums, 141 Prescott, Edward, 452, 561, 590 prescription drugs, 159, 162 present value, 195 to calculate bond prices, 197–198 to calculate stock prices, 198–199 for investment decisions, 195–197 price contracts, 429 of inputs, 80–81 market mechanism, 54 stability and Federal Reserve, 492–493 price ceiling, 102 positive and normative analysis, 115 rent control policy in housing markets, 101, 112–113 winners, losers, and inefficiency, 115 price floor, 102 farm program, 110–111 in labor markets (minimum wage policy), 111–112 positive and normative analysis, 115 winners, losers, and inefficiency, 115 price indexes See consumer price index (CPI) price level, 256, 283 aggregate demand, 405 business cycle, 324 consumption, 421 exchange rates, 646 inflation rate versus, 325 net exports, 391 primary care physicians, 13 primary dealers, 519 primary market, 178, 474 principal, 175 principal–agent problem, 147–148, 173 corporations, 173–174 financial crisis of 2007–2009, 185 private placements, 186 private property, legal protection of, 57–58, 310 private spending, reduction in, 546 process technologies, 215 procyclical policy, 504 producer price index (PPI), 283, 286 producer surplus, 105–106 Calculation, 132–134 measurement, 106–107 production factors of, 18 circular-flow diagram, 245 gross domestic product (GDP), 243–245 shortcomings, 250–251 per-worker production function, 344–345 I-11 product markets, 51 product technologies, 215 production possibilities frontier (PPF), 40 graphing, 40–43 productive efficiency, 11 productivity cost of health care, 154 educational system, 351 exchange rates, 646 technological change, 80 profit, 18, 171, 258 division of income, 258–259 property rights, 57, 357 enforcement of, 57–58 International Property Rights Index study (2009), 67 low-income countries, 357–358 and rule of law, enhancing, 361 protectionism, 227–228 public education, 359–360 public finance, 115 public good, 150 public health movement, 139 purchasing power, 255 purchasing power parity, 643–644 QEZ See quantitative easing quality bias, 285 quantitative easing (QEZ), 502–503 quantitative estimates, 415 quantity demanded, 70, 75–77 quantity equation, 476–477 quantity supplied, 78, 81–82 quantity theory of money, 477 equation, 476–477 high rates of inflation, 479–480 inflation, 477–479 Quinn, Michael A., 23 quota, 220, 644 costs of, 222–224 exchange rate impact, 646 gains from unilateral elimination, 224 sugar, 220–221 Ramey, Valerie, 552 Ransom, Roger, 264 Rassweiler, Andrew, 55 rational decisions, 54 rational expectations, 452, 588–589 rational thought, Rauwald, Christoph, 39 Reagan, Ronald, 23, 526, 595 real business cycle model, 452, 590 real exchange rate, 615, 622 I-12 SUBJECT INDEX real gross domestic product (GDP), 254 in Botswana, 310–311 calculating, 254–255 comparing to nominal GDP, 255–256 fiscal policy, 536–539 fiscal policy multiplier, 570–571 growth 307–308 monetary policy, 507–508 per capita, 305, 307 real interest rate, 288–289, 316, 382 real variables, 286 real-world deposit multiplier, 470 rebate checks, 548 Rebelo, Sergio, 552 recession, 242, 320 business expansion during, 321–322 declaring, 321 expansionary monetary policy, 503–504 pay cuts, 419 recession of 2007–2009 automobile sales, 241 in Europe, 647–649 financial crisis, 441 freight volumes, 444–445 inflation and deflation of housing market “bubble,” 440–441 oil price increase, 441 potential GDP, length of time to return to, 437–438 restaurant industry, 408–409 severity, 276–277, 550–551 unemployment, 274–277 rectangle, area of, 35 Redburn Tom, 238 Redlick Charles, 552 Reichsbank, 479–480 Reinhardt, Uwe, 3, 16, 21, 63 Reinhart, Carmen M., 435, 550–551 rent, 258–259 rent-control regulations, 101, 121 black markets, 114 housing market, effect on, 112–113, 121 required reserve ratio, 464 required reserves, 464, 473 reserves, 464 Residency Review Committee (RRC), 25 residential investment, 246 residential mortgage loan, 474 resources economic, 18 increasing marginal opportunity, 45 unexpected changes in price, 431 restaurant industry, 408–409 retained earnings, 175, 312 revaluation, 664 revenue, 18 reverse causality, 32–33 revolutions, low-income countries, 359 Ricardo, David, 212, 233, 453 Ricchiuto, Steven, 375 Riehle, Hudson, 408 risk, financial system, 313 risk pooling, 146 rival, 150 Rogoff, Kenneth, 435, 550–551 Rolley, David, 192 Roman Empire, 372, 484–485 Romer, Christina, 449, 552, 602, 660 Romer, David, 552, 603 Romer, Paul, 348, 363 Romero, Jessle, 526 Romero, Simon, 125 Roosevelt, Franklin D., 554–555 Roubini, Nouriel, 362 rounding tax, 461 Royal, Ségolène, 298 Rudebusch, Glenn, 502–503, 528 rule of law, 357–358 rule of 70, 307–308 Russia exchange rate, 659 investments, 627 labor productivity, 332 Ruth, Babe, 97 Sacendote, Bruce, 561 Sahni, Nikhil R., 3, 21 sales taxes, 117–118 Samuelson Paul A., 606 Sarbanes-Oxley Act of 2002, 183–184, 194 Sargent, Thomas, 452, 588–590 disinflation, 592–593 Sarkozy, Nicolas, 648 Sataline, Suzanne, 16 Saudi Arabia, 215 savings and investment, 314–315 low-income countries, 360 movements, explaining, 317–319 policies, 363 policies promoting, 363 saving and investment equation, 624–625 scarcity, 4, 40 shortage versus, 113 schedule, demand, 70–71 Schember, Jack, 16 Schiff, Peter, 634 Scholes, Myron, 596 Schuker, Lauren A E., 23 Schultz, Jennifer Saranow, 149 Schumpeter, Joseph, 349, 369 Schuster, Jeff, 260, 261 Schwartz, Anna Jacobson, 451 scientific method, 14 Scott, Paul D., 230 Scott, Robert E., 230 seasonal unemployment, 278 secondary market, 178, 474 Securities and Exchange Commission (SEC), 186, 194 securities dealers, 178 securitization, 184, 474 security, 474 seigniorage, 461 sellers’ taxes, 118–119 separation of ownership from control, 173 services, 18 business cycle, 327 consumption spending, 382–383 which to produce, shadow banking system, 474 shadow market, 186 Shah, Neel, 444 shareholders, 169, 187 Sharp, Isadore, 322 Shea, Christopher, 95 Shiller, Robert J., 582–583, 603 Shiue, Carol, 368 Shmueli, Galit, 125 short-run aggregate supply (SRAS) curve, 420, 428–431 shifts versus movements along, 430 variables shifting, 430–431 short-term nominal rate of interest, 498 shortage, 83 scarcity versus, 113 Sikorsky, Igor, 56 Simmermaker, Roger, 238 simple deposit multiplier, 466–470 Singapore economic growth, 309, 333 government intervention, 53 real GDP growth, 353 single-payer health care system, 142, 157 Skidelsky, Robert, 301 Sloan-Kettering Cancer Center, 15 slope graphing cause and effect, 31–33 more than two variables, 29–31 positive and negative relationships, 30 small business health insurance costs, 137 importance to U.S economy, 172 Small Business Health Options Program (SHOP), 159–160, 167 Smerd, Jeremy, 127 Smith, Adam, 53–54, 65, 97, 453 on “invisible hand,” 66 Smith, Fred, 56, 419 Smoot–Hawley Tariff Act(1930), 401–402, 663 Sobel, Robert, 321–322 Sobotta, David, 78 social insurance programs, 281 socialized medicine, 143 social problems, 253 social science, economics as, 14 Social Security, 110–111, 119–120, 166, 177, 389, 535–536 sole proprietorship, 170 Solow, Robert, 347–348 Sood, Neeraj, 6–7 South Africa, 310, 455 inflation policy, 513 South Korea budget deficits, 627 central bank, 609, 629 exchange rate, 645, 649, 651, 652–653 inflation targeting, 513 production, 66 real GDP growth, 353, 354 sovereign debt crisis, 648 Soviet Union as centrally planned economy, 10 economy, failure of, 346–347, 370 Marxism, 453 S&P 454, 179 Spain central bank, independence of, 598 economic growth, 648 health care spending, 152 inflation targeting, 513 real GDP growth, 356 specialization, 46–48, 214 Spector, Mike, 73 speculative attacks, 651 speculators, 617 Spencer, Peter, 488 stagflation, 436 standard of deferred payment, 457–458 standard of living, income and, 342–343 Standard & Poor’s/Case-Shiller Home Price Index, 299, 381 SUBJECT INDEX state and local governments, grants to, 534 state health exchanges, 156 statistical discrepancy, 613 Steil, Benn, 525 Stein, Herbert, 604 Stern Robert M., 226 sticky prices, 429 sticky wages, 429 stimulus package See American Recovery and Investment Act of 2009 stock, 175, 177, 312 calculating prices by formula, 199 prices, calculating with present value, 198–199 prices, tracking on financial pages, 180–181 stock and bond markets, 177–179 price fluctuations, 179–180 stockholders’ equity, 201 store of value, 457 structural relationship, 580 structural unemployment, 279 substitutes, 73–74 price of, in production, 80 substitution bias, 285 substitution effect, 71 Sufi, Amir, 381–382, 411 sugar import policy, 220–221 Summers, Lawrence, 63, 598 Sundback, Gideon, 56 Sung, Chinmei, 55 supply change in supply versus change in quantity supplied, 81–82 expected future prices, 80–81 law of supply, 79 loanable funds market, 315–316 number of firms in the market, 80 price of inputs, 80 prices of substitutes in production, 80 quantity supplied, 78 schedule, 78–79 shift, effect on market equilibrium, 85–91 tax effects, 560–561 technological change, 80 variables shifting, 79–81 supply curve, 78–79 supply schedule, 78 supply shock, 431, 436–437 effect on Phillips curve, 590–591 supply-side economics, 558 surplus, 83 economic, 108 eliminating, in market equilibrium, 83 measurement 106–107 Sutch, Richard, 264 Swartz, Paul, 525 Sweden currency, 646–647 health care spending, 152 inflation targeting, 513 Switzerland central bank, independence of, 598 comparative advantage, 215 exchange rate, 644 production, 66 real GDP growth, 353 Sylla, Richard, 310 tablet computers, 69, 92–93, 96, 98 T-accounts, 464–466 Taiwan display screen shortage, 92 real GDP growth, 353, 355 tangent line, 34 Tanzania, 235, 310 tariff, 206, 219, 644 costs of, 222–224 exchange rate impact, 646 gains from unilateral elimination, 224 TARP See Troubled Asset Relief Program tastes, 74 tax cuts multiplier, 543 taxes tax incidence, 117 division of income, 259 economic efficiency, effect on, 115–116 health care reform legislation, 156–157 incidence buyer versus seller taxes, 118–119 on demand and supply graph, 116–117 sales tax example, 117–118 Social Security, burden on workers versus firms, 119–120 long-run effects of policy change, 558–559 tax multipliers aggregate supply, effects of, 543–544 balanced budget, 572–573 changes in tax rates, effects of, 543 equilibrium real GDP, 570–571 fiscal policy, 540–543 formula, 572 government purchases formula, 571–572 open economy, 573–574 rate changes, 573 tax reform, economic effect of, 559–560 tax wedge, 558 taxi medallions, 127 Taylor, John, 512–513, 552, 567 Taylor rule, 512–513 technological change, 80, 343 economic growth, long-run, 345–346 government policy, 363 long-run economic growth, 308–309 productivity growth, 351–352 short-run aggregate supply curve, shifts in, 430 technology, 17, 308 comparative advantage, 215 cost, of health care, 154–155 spending, 388–389 Temporary Assistance for Needy Families, 534 terms of trade, 211 Thailand destabilizing speculation, 650–651 dollar pegging, 649–650 thrift, paradox of, 405 Thornton, Daniel L., 529 time comparative advantage, 217 job creation and job destruction, 277 time-series graph, 27 Tinseth, Randy, 303 Toll, Robert, 526 toyoda, Sakichi, 57 trade, 46 balance of, 610–611 comparative advantage, 49–51 specialization, 46–48 Trade Agreements Act, 230–231 trade deficit, 610 trade-offs, car buying, 39, 58 health care spending, 43–44 scarcity, 40 trade rounds, 225 trade surplus, 610 trading desk, 473 transfer payments, 246, 258, 380, 534 economic stabilization, 327–328 traveler’s checks, 460 Treasury bills and bonds See U.S Treasury bills and bonds I-13 Treasury Department, 519–520 triangle, area of, 35 Trigari, Antonella, 552 Troubled Asset Relief Program (TARP), 520 Truman, Harry, 156 Trump, Donald, 23 Tuohy, Kevin, 56 Turner, Ted, 23 twin deficits, 625–626 Tyler, Tony, 330 U.K See United Kingdom unattainable production possibilities, 41 underground economy, 251–252 undervalued currency, 650 underwriting, 185 unemployment, 268 by demographic group, 273 establishment survey, 275–277 explaining efficiency wages, 282 government policies and unemployment rate, 280–282 labor unions, 282 household survey, 268–271 inflation, short-term trade-off with described, 578–579 expectations, 581–582 long-run Phillips curve, 580–581 Phillips curve with aggregate demand and aggregate supply curves, 579–580 policy menu, Phillips curve as, 580 stability of short-run Phillips curve, 580 workers’ understanding of, 582–583 job creation and job destruction over time, 277 length of time unemployed, 273–275 problems measuring, 271–272 trends in labor force participation, 272–273 types of, 277 cyclical unemployment, 279 frictional unemployment and job search, 278 full employment, 279 structural unemployment, 279 unemployment insurance, 327–328 unemployment rate, 268, 273–275 business cycle, 325–326 measurement problems, 271–272 I-14 SUBJECT INDEX unions See labor union unit of account euro, early days of, 647 money defined, 457 United Kingdom (U.K.) child labor, 226 consumption as percentage of GDP, 248 currency, 461, 659–660 economic growth and health, 306 EU, 646 exchange rate, 615, 643, 644, 662 health, link to economic prosperity, 306 health care spending, 152 health care system, 143, 144, 145, 155 inflation targeting, 513 investment in United States, 654 production, 66 real GDP growth, 355–356 trade as percentage of GDP, 208 trade as percent of world exports, 207 United States (U.S.) account surplus, 632 assets owned by foreigners, 627 Centers for Disease Control (CDC), 5–6 central bank, independence of, 598 consumption, 9, 30–31, 248–249 currency, 458–459 deficits, 626–627 demographics, 75 economic growth, long-run, 45, 304–305, 349–350 health and, 306–307 productivity slowdown of 1973–1994, 350–351 real GDP growth, 353 since 1950, 350 economic stability, 327–328 entrepreneur, 17 exchange rate Bretton Woods system, 663–665 consumers and, 630–631 currency appreciation and depreciation, 640 demand shift, 617–618 determinants, 646 equilibrium, 618 exports and imports, 620–621 fluctuations, 621 net exports, 390–392, 421–422 purchasing power parity, 643 relative price levels, 619–620 supply shift, 618 expectations of inflation rate and monetary policy, 587–590 farm program, 110–111 financial crisis of 2007–2009, 184–185 foreign investment in, 654 government intervention, 53 federal budget, 315 spending, 533–534 transfer payments, 635 health, link to economic prosperity, 306–307 health care changes, 18, 137, 138–139 costs, 43–44, 128, 152, 162–163 height, 139–140 insurance, 5–7, 147 medical school, 15–16 reasons for long-run improvements, 140–141 system, 3, 141–142 international trade, 205–207 balance of payments, 610 financial account, 611 trade flows, 612 world context, 207–208 as market or modern mixed economy, 10–11 minimum wage program, 111–112 money, defining, 459–463 multinational corporations, 257 restaurant industry, 408–409 small businesses, 17, 172 tax system history, 534–535 technology, 86 as world’s largest debtor, 626–627 universal health insurance, 142–143 “upside down” on mortgage, 519 U.S See United States U.S Bureau of Labor Statistics (BLS), 18 U.S Constitution, property rights amendments (5th and 14th), 57 U.S Department of Treasury, 641 U.S International Trade Commission (ITC), 223 U.S Treasury bills and bonds China, 652 effect on other investments, 625–626 nominal interest rate, 288–289 raising funds through, 556–557 ratings, 176–177 Valentino-DeVries, Jennifer, 66 value, store of, 457 value-added method, measuring GDP by, 250 variables aggregate demand (AD) curve, 422–425 aggregate supply curve, 430–431 foreign, 423 graphing more than two, 29–31 one, 27–28 of two, 29–30, 33–34 omitted, 32 short-run aggregate supply curve (SRAS), 420–421 supply, 79–81 Varian, Hal, 234–235 vault cash, 464 Vegh, Carlos A., 552 Velde, Franỗois, 461, 485 velocity of money (V), 476477 Venezuela, 127, 354, 355 venture capital firms, 185–186, 357 Veterans Health Administration, 138, 142 Viard, Alan, 562 Vitner, Mark, 444 Voelcker, John, 60 Volcker, Paul, 493 disinflation and, 591–593, 605 inflation rate during term of, 595 target for federal funds rate, 513 voluntary exchange, 11 voluntary export restraint (VER), 220 von Furstenberg, Diane, 23 Walvoord, Barbara E., 16, 22 Wang, Shirley S., 16 Warner, Melodie, 73 wars, low-income countries, 359 Wascher, William, 112 wealth, money versus, 462 wealth effect, 421 Weber, Seth, 260 Weidner, Justin, 604 Weir, David, 188 Welsh, Jonathan, 97 Wessel, David, 635 western Europe catch-up, 355–357 government intervention, 53 Whaples, Robert, 461 Wieland, Volker, 552, 567 Williams, John C., 604 Wilson, Robert, 137 wire hanger industry, cost of tariffs in, 223–224 Wiseman, Eric, 322 Wolak, Frank, 233 The Wonderful Wizard of Oz (Baum), 63–64 Woo, Stu, 69 Wood, Robert, 321 Woodyard, Chris, 97 workers child labor, unintentional consequences of banning, 226–227 short-run aggregate supply curve, 431 World Bank, 226, 264, 358–359, 369 world price, 217 World Trade Organization (WTO), 225 creation, 663 opposition to, 225–226 World War II, 253–254, 338, 360, 434, 484, 533–534, 554, 646 Wozniak, Steve, 56 Wright, Orville, 17, 56, 172 Wright, Wilbur, 17, 56, 172 x-axis, 27 wages adjustments, slowness in, 429 contracts, 429 division of income, 258–259 protectionism, 227 Waldfogel, Joel, 125 Waldman, Deane, 20 Wall, Brandon, 172 Wall Street Journal, 180–181, 654 Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), 184 Walton, Sam, 23 y-axis, 27 yen See Japan Young, Alwyn, 309 Zahourek, Kelsey, 67 Zedong, Mao, 11, 484 Zélie, Mademoiselle, 484 Zhang, Junfu, 172 Zimbabwe, 251, 252, 455, 460, 479, 484, 488 Zuckerberg, Mark, 169, 172, 186, 192 CREDITS Photo Front matter, page vii, Courtesy of the authors; page xxxvii, Wavebreakmedia, Ltd./Shutterstock; page xl, MCT/Getty Images Chapter 1, page 2, Getty Images; page 15, Ocean/Corbis Chapter 2, page 38, Bloomberg/ Getty Images; page 43, Caro/ Alamy; page 53, JupiterImages; page 53, MBI/Alamy; page 53, Mikael Damkier/Shutterstock; page 53, Elena Elisseeva/ Shutterstock; page 55, Brooks Kraft/Corbis Chapter 3, page 68, Wavebreakmedia, Ltd./ Shutterstock; page 73, British Retail Photography/Alamy; page 77, MCT/Getty Images Chapter 4, page 100, Janine Wiedel Photolibrary/Alamy Chapter 5, page 136, StockbrokerXtra/Glow Images; page 151, Official White House Photo by Pete Souza; page 160, Jim West/Alamy Chapter 6, page 168, Bloomberg/ Getty Images; page 172, Mangostock/Shutterstock; page 186, Getty Images Chapter 7, page 204, Charles Rex Arbogast/AP Images; page 216, Sean Pavone Photo/Shutterstock; page 223, Robert F Bukaty/ AP Images; page 226, Joerg Boethling/Alamy Chapter 8, page 240, Jeff Kowalsky/ Bloomberg/Getty Images; page 245, Mikael Damkier/Shutterstock; page 245, Eric Gevaert/Shutterstock; page 245, Bill Aron/PhotoEdit, Inc.; page 245, JupiterImages; page 245, Yoshio Tomii/SuperStock; page 251, Mohamed Nureldin Abdallah/ Reuters Chapter 9, page 266, Richard Levine/Alamy; page 280, Chris Keane/Reuters Chapter 10, page 302, Stephen Brashear/Getty Images; page 316, Everett Collection; page 322, Paul Sakuma/AP Images Chapter 11, page 336, Zuma Press/Newscom; page 339, Author’s Image Ltd/Alamy; page 342, Grant Neuenburg/ Reuters/Corbis; page 346, Lionel Cironneau/AP Images; page 362, Claro Cortes IV/Reuters/Corbis Chapter 12, page 374, Justin Sullivan/Staff/Getty Images; page 401, Everett Collection/ SuperStock Chapter 13, page 418, AGE Fotostock/SuperStock; page 434, Kimberly White/Corbis; page 437, Kevin Dietsch/UPI/Newscom; page 453, Lebrecht Music and Arts/Photo Library/Alamy Chapter 14, page 454, Marco Di Lauro/Getty Images; page 459, Brooks Kraft/Corbis; page 461, James L Amos/Photo Researchers, Inc.; page 474 (far left and third from right), Lynne Sladky/AP Images; page 474 (center left and center right), Ezio Petersen/UPI/Landov; page 474 (third from left and far right), Eightfish/Alamy; page 474 (bottom left), Imagebroker/ Alamy; page 479, Bettmann/ Corbis Chapter 15, page 490, Matt Nager/Bloomberg/Getty Images; page 503, NetPhotos/Alamy; page 514, Iofoto/Shutterstock; page 518, Rebecca Cook/Reuters/ Corbis Chapter 16, page 530, Justin Sullivan/Getty Images; page 535, Tom Grill/Corbis Super RF/ Alamy; page 550, David Banks/ EPA/Corbis; page 554, AP Images Chapter 17, page 576, Bloomberg/Getty Images; page 582, Corbis Super RF/ Alamy; page 586, David J Green-Lifestyle/Alamy Chapter 18, page 608, Imaginechina/Corbis; page 615, Iain Masterton/Alamy Chapter 19, page 638, Meigneux/ SIPA/AP Images; page 642, Thomas Barwick/Getty Images; page 644, Bloomberg/Getty Images; page 648, Yves Logghe/ AP Images C-1 This page intentionally left blank Chapter Title Chapter Opener Making the Connection An Inside Look Why Are Some Doctors Leaving Private Practice? Does Health Insurance Give People an Incentive to Become Obese? • Should Medical School Be Free? Doctors Moving Less, Retiring Later Managers Making Choices at BMW Facing Trade-offs in Health Care Spending • A Story of the Market System in Action: How Do You Make an iPad? Managers at General Motors Approve Production of a Plug-in Cadillac The Tablet Computer Revolution Are Quiznos Sandwiches Normal Goods and Subway Sandwiches Inferior Goods? • The Aging of the Baby Boom Generation • Forecasting the Demand for iPads • The Falling Price of Blu-ray Players Will Shortage of Display Screens Derail Computer Tablet Sales? Should the Government Control Apartment Rents? The Consumer Surplus from Broadband Internet Service • Price Floors in Labor Markets: The Debate over Minimum Wage Policy • Is the Burden of the Social Security Tax Really Shared Equally between Workers and Firms? and the RentControlled Apartment Goes to Actress Faye Dunaway! Small Businesses Feel the Pinch of Escalating Health Care Costs Should the Government Run the Health Care System? • How Much Is That MRI Scan? • Health Exchanges, Small Businesses, and Rising Medical Costs Health Care Spending Expected to Increase 70 Percent by End of Decade How Can You Buy a Piece of Facebook? How Important Are Small Businesses to the U.S Economy? • The Rating Game: Is the U.S Treasury Likely to Default on Its Bonds? • Following Abercrombie & Fitch’s Stock Price in the Financial Pages • Are Buyers of Facebook Stock Getting a Fair Deal? Shares of Private Companies Available to Qualified Investors Does the Federal Government’s “Buy American” Policy Help U.S Firms? How Caterpillar Depends on International Trade • Leave New York City? Risky for Financial Firms • Save Jobs Making Hangers … and Lose Jobs in Dry Cleaning • The Unintended Consequences of Banning Goods Made with Child Labor Did Home Depot Knowingly Defy the “Buy American” Policy? CHAPTER Economics: Foundations and Models CHAPTER Trade-offs, Comparative Advantage, and the Market System CHAPTER Where Prices Come From: The Interaction of Demand and Supply CHAPTER Economic Efficiency, Government Price Setting, and Taxes CHAPTER The Economics of Health Care CHAPTER Firms, the Stock Market, and Corporate Governance CHAPTER Comparative Advantage and the Gains from International Trade Chapter Title Chapter Opener Making the Connection An Inside Look Ford Motor Company Feels the Effects of the Recession Will U.S Consumers Be Spending Less? • Why Do Many Developing Countries Have Such Large Underground Economies? • Did World War II Bring Prosperity? Analysts Lower Estimates for New Car Sales in 2011 and 2012 Bank of America Announces Plans to Lay Off 30,000 Employees How Unusual Was the Unemployment Situation Following the 2007–2009 Recession? • How Should We Categorize Unemployment at Bank of America? • What’s So Bad About Falling Prices? Will Pink Slips Be in the Mail for Postal Workers? Growth and the Business Cycle at Boeing The Connection between Economic Prosperity and Health • What Explains Rapid Economic Growth in Botswana? • Ebenezer Scrooge: Accidental Promoter of Economic Growth? • Can a Recession Be a Good Time for a Business to Expand? Airlines Face the Business Cycle Google’s Dilemma in China Why Did the Industrial Revolution Begin in England? • Is Income All That Matters? • What Explains the Economic Failure of the Soviet Union? • What Do Parking Tickets in New York City Have to Do with Poverty in the Developing World? • Will China’s Standard of Living Ever Exceed That of the United States? Despite a Plan for Change, Investment Still Spurs China’s Growth Fluctuating Demand Helps— and Hurts—Intel and Other Firms Do Changes in Housing Wealth Affect Consumption Spending? • Intel Tries to Jump Off the Roller Coaster of Information Technology Spending • The Multiplier in Reverse: The Great Depression of the 1930s Turnaround Projected for the Restaurant Industry The Fortunes of FedEx Follow the Business Cycle Which Components of Aggregate Demand Changed the Most during the 2007–2009 Recession? • Does It Matter What Causes a Decline in Aggregate Demand? • How Long Does It Take to Return to Potential GDP? Economic Forecasts Following the Recession of 2007–2009 • Karl Marx: Capitalism’s Severest Critic Smaller Freight Volumes Signal Continued Economic Troubles CHAPTER GDP: Measuring Total Production and Income CHAPTER Unemployment and Inflation CHAPTER 10 Economic Growth, the Financial System, and Business Cycles CHAPTER 11 Long-Run Economic Growth: Sources and Policies CHAPTER 12 Aggregate Expenditure and Output in the Short Run CHAPTER 13 Aggregate Demand and Aggregate Supply Analysis Chapter Title Chapter Opener Making the Connection An Inside Look Coca-Cola Dries Up as Money Floods Zimbabwe Apple Didn’t Want My Cash! • Do We Still Need the Penny? • The German Hyperinflation of the Early 1920s Increased Lending Boosts Money Supply Growth Monetary Policy, Toll Brothers, and the Housing Market Too Low for Zero: The Fed Tries “Quantitative Easing” and “Operation Twist” • Trying to Hit a Moving Target: Making Policy with “Real-Time Data” • How Does the Fed Measure Inflation? • The Wonderful World of Leverage Fed Attempts to Stimulate Housing Market Again Does Government Spending Create Jobs? Is Spending on Social Security and Medicare a Fiscal Time Bomb? • Why Was the Recession of 2007–2009 So Severe? • Did Fiscal Policy Fail during the Great Depression? Obama Proposes Additional Spending to Stimulate the Economy Why Does CarMax Worry about Monetary Policy? Do Workers Understand Inflation? • Does the Natural Rate of Unemployment Ever Change? Can the Fed Balance the Trade-off between Unemployment and Inflation? A Strong Dollar Hurts McDonald’s Profits Exchange Rate Listings • What Explains the Fall and Rise and Fall of the Dollar? • Why Is the United States Called the “World’s Largest Debtor”? Struggling Economy Contributes to a Weak Dollar Airbus Deals with Fluctuating Exchange Rates The Canadian Province of Arizona? • The Big Mac Theory of Exchange Rates • Can the Euro Survive? • Crisis and Recovery in South Korea Can Tariffs Offset the Effect of Overvaluation? CHAPTER 14 Money, Banks, and the Federal Reserve System CHAPTER 15 Monetary Policy CHAPTER 16 Fiscal Policy CHAPTER 17 Inflation, Unemployment, and Federal Reserve Policy CHAPTER 18 Macroeconomics in an Open Economy CHAPTER 19 The International Financial System We use business examples to explain economic concepts This table highlights the topic and real-world company introduced in the chapter-opening vignette and revisited throughout the chapter This table also lists the companies that appear in our Making the Connection and An Inside Look features This page intentionally left blank MyEconLab and Hubbard/O’Brien, Macroeconomics, Fourth Edition: The Power of Practice MyEconLab creates the perfect pedagogical loop that provides not only text-specific assessment and practice problems, but also tutorial support to make sure students learn from their mistakes Auto-generated Test and Assignments MyEconLab comes with preloaded assignments, all of which are automatically graded and include 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that’s entirely your own www.pearsoncustom.com Custom Customized Solutions Contact your Pearson representative for more information on Pearson Choices ... stimulating the sluggish housing market Further changes to the fourth edition The following are further changes to the fourth edition: • This edition provides many new Making the Connection features, which... policymakers, and the public In this new edition, we help students understand recent economic events and the policy responses to them As in the earlier editions, we place applications at the forefront... real-world business examples Our goal was to keep our classes “widget free.” New to the Fourth Edition The severe economic downturn that began in 2007 with the bursting of the housing bubble