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(BQ) Part 2 book Survey of economics has contents: Fiscal policy, federal deficits, surpluses, and the national debt, money creation, monetary policy, money and the federal reserve system, international trade and finance, economies in transition, growth and the less developed countries,....and other contents.
CHA www.downloadslide.com PTER 14 Aggregate Demand and Supply © Colossus RM/MediaBakery C H A P T E R PR E V I E W In to ● ● ● In U.S history, the 1920s are known as the Roaring Twenties New industries blossomed, including automobiles, public power, radio, and motion pictures It was a time of optimism and prosperity The spirit of the times was captured in the lyrics of a popular song of the day, “Nothing but blue skies I see … Nothing but blue skies from now on.” Between 1920 and 1929, real GDP rose by about 40 percent Stock prices soared year after year, and many investors became rich As business boomed, companies invested in new factories, and the U.S economy was a job-creating machine Then, in the early 1930s, the business cycle took an abrupt downturn, and unemployed men fought over jobs, sold apples on the corner to survive, and walked the streets in bewilderment The misery of the Great Depression created a revolution in economic thought Prior to the Great Depression, the classical economists introduced in this chapter recognized that over the years business cycles would interrupt the nation’s prosperity, but this chapter, you will learn they believed these episodes would be temporary They solve these economics puzzles: argued that in a short time the price system would automatically restore an economy in depression to full Why does the aggregate supply employment without government intervention curve have three different segments? What was wrong? Why didn’t the economy of the Would the greenhouse effect cause 1930s self-correct to the full-employment level of real inflation, unemployment, or both? GDP? The stage was set for a new theory offered by Was John Maynard Keynes’s British economist John Maynard Keynes (pronounced prescription for the Great Depression right? “canes”) Keynes argued that the economy was not self-correcting and, therefore, could indeed remain below full employment indefinitely because of www.downloadslide.com CHAPTER 14 • Aggregate Demand and Supply 289 inadequate aggregate (total) spending Keynes’s work not only explained the Great Crash but also offered cures requiring the government to play an active role in the economy More recently, faced with the Great Recession, Keynesian management of the economy was used to stabilize the U.S and global economy In this chapter, you will use aggregate demand and supply analysis to study the business cycle The chapter opens with a presentation of the aggregate demand curve and then the aggregate supply curve Once these concepts are developed, the analysis shows why modern macroeconomics teaches that shifts in aggregate supply or aggregate demand can influence the price level, the equilibrium level of real GDP, and employment You will probably return to this chapter often because it provides the basic tools with which to organize your thinking about the macro economy THE AGGREGATE DEMAND CURVE Aggregate demand curve (AD) The curve that shows the level of real GDP purchased by households, businesses, government, and foreigners (net exports) at different possible price levels during a time period, ceteris paribus Here we view the collective demand for all goods and services, rather than the market demand for a particular good or service Exhibit 14.1 shows the aggregate demand curve (AD), which slopes downward and to the right for a given year The aggregate demand curve shows the level of real GDP purchased by households, businesses, government, and foreigners (net exports) at different possible price levels during a time period, ceteris paribus Stated differently, the aggregate demand curve shows us the total dollar amount of goods and services that will be demanded in the economy at various price levels As for the demand curve for an individual market, the lower the economywide price level, the greater the aggregate quantity demanded for real goods and services, ceteris paribus The downward slope of the aggregate demand curve shows that at a given level of aggregate income, people buy more goods and services at a lower average price level While the horizontal axis in the market supply and demand model measures physical units, such as bushels of wheat, the horizontal axis in the aggregate demand and supply model measures the value of final goods and services included in real GDP Note that the horizontal axis represents the quantity of aggregate production demanded, measured in base-year dollars The vertical axis is an index of the overall price level, such as the chain price index or the CPI, rather than the price per bushel of wheat As shown in Exhibit 14.1, if the price level measured by the CPI is 300 at point A, a real GDP of $8 trillion is demanded in a given year If the price level is 200 at point B, a real GDP of $12 trillion is demanded Note that hypothetical data is used throughout this chapter and the next unless otherwise stated Although the aggregate demand curve looks like a market demand curve, these concepts are different As we move along a market demand curve, the price of related goods is assumed to be constant But when we deal with changes in the general or average price level in an economy, this assumption is meaningless because we are using a market basket measure for all goods and services CONCLUSION The aggregate demand curve and the demand curve are not the same concept www.downloadslide.com 290 PART • The Macroeconomy and Fiscal Policy E XH I BI T 14.1 The Aggregate Demand Curve 400 A 300 Price level (CPI) B 200 100 AD 12 16 20 24 Real GDP (trillions of dollars per year) CAUSATION CHAIN Decrease in the price level Increase in the real GDP demanded The aggregate demand curve (AD) shows the relationship between the price level and the level of real GDP, other things being equal The lower the price level, the larger the GDP demanded by households, businesses, government, and foreigners If the price level is 300 at point A, a real GDP of $8 trillion is demanded If the price level is 200 at point B, the real GDP demanded increases to $12 trillion © Cengage Learning 2013 REASONS FOR THE AGGREGATE DEMAND CURVE’S SHAPE The reasons for the downward slope of an aggregate demand curve include the real balances effect, the interest-rate effect, and the net exports effect Real Balances Effect Recall from the discussion in the chapter on inflation that cash, checking deposits, savings accounts, and certificates of deposit are examples of financial assets whose real value changes with the price level If prices are falling, the purchasing power of households rises and they are more willing and able to spend Suppose you have $1,000 in a checking account with which to buy 10 weeks’ worth of groceries If prices fall by 20 percent, $1,000 will now buy enough groceries for 12 weeks This rise in your real wealth may make you more willing and able to purchase a new iPhone out of current income CONCLUSION Consumers spend more on goods and services when lower prices make their dollars more valuable Therefore, the real value of money is measured by the quantity of goods and services each dollar buys When inflation reduces the real value of fixed-value financial assets held by households, the result is lower consumption, and real GDP falls The effect of www.downloadslide.com CHAPTER 14 • Aggregate Demand and Supply Real balances effect The impact on total spending (real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value 291 the change in the price level on real consumption spending is called the real balances effect The real balances effect is the impact on total spending (real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value Interest-Rate Effect Interest-rate effect The impact on total spending (real GDP) caused by the direct relationship between the price level and the interest rate A second reason why the aggregate demand curve is downward sloping involves the interest-rate effect The interest-rate effect is the impact on total spending (real GDP) caused by the direct relationship between the price level and the interest rate A key assumption of the aggregate demand curve is that the supply of money available for borrowing remains fixed A high price level means people must take more dollars from their wallets and checking accounts in order to purchase goods and services At a higher price level, the demand for borrowed money to buy products also increases and results in a higher cost of borrowing, that is, higher interest rates Rising interest rates discourage households from borrowing to purchase homes, cars, and other consumer products Similarly, at higher interest rates, businesses cut investment projects because the higher cost of borrowing diminishes the profitability of these investments Thus, assuming fixed credit, an increase in the price level translates through higher interest rates into a lower real GDP Net Exports Effect GLOBAL Economics Net exports effect The impact on total spending (real GDP) caused by the inverse relationship between the price level and the net exports of an economy Whether American-made goods have lower prices than foreign goods is another important factor in determining the aggregate demand curve A higher domestic price level tends to make U.S goods more expensive than foreign goods, and imports rise because consumers substitute imported goods for domestic goods An increase in the price of U.S goods in foreign markets also causes U.S exports to decline Consequently, a rise in the domestic price level of an economy tends to increase imports, decrease exports, and thereby reduce the net exports component of real GDP This condition is the net exports effect The net exports effect is the impact on total spending (real GDP) caused by the inverse relationship between the price level and the net exports of an economy Exhibit 14.2 summarizes the three effects that explain why the aggregate demand curve in Exhibit 14.1 is downward sloping E XH I BI T 14.2 Why the Aggregate Demand Curve Is Downward Sloping Effect Causation chain Real balances effect Price level decreases ! Purchasing power rises !Wealth rises ! Consumers buy more goods ! Real GDP demanded increases Interest-rate effect Price level decreases ! Purchasing power rises ! Demand for fixed supply of credit falls ! Interest rates fall ! Businesses and households borrow and buy more goods ! Real GDP demanded increases Net exports effect Price level decreases ! U.S goods become less expensive than foreign goods ! Americans and foreigners buy more U.S goods ! Exports rise and imports fall ! Real GDP demanded increases © Cengage Learning 2013 www.downloadslide.com 292 PART • The Macroeconomy and Fiscal Policy NONPRICE-LEVEL DETERMINANTS OF AGGREGATE DEMAND As was the case with individual demand curves, we must distinguish between changes in real GDP demanded, caused by changes in the price level, and changes in aggregate demand, caused by changes in one or more of the nonprice-level determinants Once the ceteris paribus assumption is relaxed, changes in variables other than the price level cause a change in the location of the aggregate demand curve Nonprice-level determinants include the consumption (C), investment (I), government spending (G), and net exports (X − M) components of aggregate expenditures explained in Chapter 11 on GDP CONCLUSION Any change in the individual components of aggregate expenditures shifts the aggregate demand curve Exhibit 14.3 illustrates the link between an increase in expenditures and an increase in aggregate demand Begin at point A on aggregate demand curve AD1, with a price level of 200 and a real GDP of $12 trillion Assume the price level remains constant at 200 and the aggregate demand curve increases from AD1 to AD2 Consequently, the level of real GDP rises from $12 trillion (point A) to $16 trillion (point B) at the price level of 200 The cause might be that consumers E XH I BI T 14.3 A Shift in the Aggregate Demand Curve 400 300 Price level (CPI) 200 A B 100 AD1 12 16 AD2 20 24 Real GDP (trillions of dollars per year) CAUSATION CHAIN Increase in nonprice-level determinants: C, I, G, (X – M) Increase in the aggregate demand curve At the price level of 200, the real GDP level is $12 trillion at point A on AD1 An increase in one of the nonprice-level determinants of consumption (C), investment (I), government spending (G), or net exports (X − M) causes the level of real GDP to rise to $16 trillion at point B on AD2 Because this effect occurs at any price level, an increase in aggregate expenditures shifts the AD curve rightward Conversely, a decrease in aggregate expenditures shifts the AD curve leftward © Cengage Learning 2013 www.downloadslide.com CHAPTER 14 • Aggregate Demand and Supply 293 have become more optimistic about the future and their consumption expenditures (C) have risen Or possibly an increase in business optimism has increased profit expectations, and the level of investment (I) has risen because businesses are spending more for plants and equipment The same increase in aggregate demand could also have been caused by a boost in government spending (G) or a rise in net exports (X − M) A swing to pessimistic expectations by consumers or firms will cause the aggregate demand curve to shift leftward A leftward shift in the aggregate demand curve may also be caused by a decrease in government spending or net exports THE AGGREGATE SUPPLY CURVE Aggregate supply curve (AS) The curve that shows the level of real GDP produced at different possible price levels during a time period, ceteris paribus Just as we must distinguish between the aggregate demand and market demand curves, the theory for a market supply curve does not apply directly to the aggregate supply curve Keeping this condition in mind, we can define the aggregate supply curve (AS) as the curve that shows the level of real GDP produced at different possible price levels during a time period, ceteris paribus Stated simply, the aggregate supply curve shows us the total dollar amount of goods and services produced in an economy at various price levels Given this general definition, we must pause to discuss two opposing views—the Keynesian horizontal aggregate supply curve and the classical vertical aggregate supply curve Keynesian View of Aggregate Supply Keynes wrote in a time of great uncertainty and instability In 1936, seven years after the beginning of the Great Depression and three years before the beginning of World War II, John Maynard Keynes published The General Theory of Employment, Interest, and Money In this book, Keynes, a Cambridge University economist, argued that price and wage inflexibility during a recession means that unemployment can be a prolonged affair Unless an economy trapped in a depression or severe recession is rescued by an increase in aggregate demand, full employment will not be achieved This Keynesian prediction calls for government to intervene and actively manage aggregate demand to avoid a depression or recession Why Keynesians assume that product prices and wages are fixed? Reasons for upward inflexibility include the following: first, during a deep recession, there are many idle resources in the economy Consequently, producers are willing to sell at current prices because there are no shortages to put upward pressure on prices Second, the supply of unemployed workers willing to work for the prevailing wage rate diminishes the power of workers to increase their wages Reasons for downward inflexibility include the following: first, union contracts prevent businesses from lowering wage rates Second, minimum wage laws prevent lower wages Third, employers believe that cutting wages lowers worker morale and productivity Therefore, during a recession employers prefer to freeze wages and lay off or reduce hours for some of their workers until the economy recovers In fact, the CPI for the last month of each recession since 1948 was at or above the CPI for the first month of the recession Given the Keynesian assumption of fixed or rigid product prices and wages, changes in the aggregate demand curve cause changes in real GDP along a horizontal aggregate supply curve In short, Keynesian theory argues that only shifts in aggregate demand can revitalize a depressed economy Exhibit 14.4 portrays the core of Keynesian theory We begin at equilibrium E1, with a fixed price level of 200 Given aggregate demand schedule AD1, the equilibrium level of real GDP is $8 trillion Now government spending (G) increases, causing aggregate demand to rise from AD1 to AD2 and equilibrium to shift from E1 to E2 along the horizontal aggregate supply curve (AS) At E2, the economy moves to $12 trillion, which is closer to the full-employment GDP of $16 trillion www.downloadslide.com 294 PART • The Macroeconomy and Fiscal Policy E XH I BI T 14.4 The Keynesian Horizontal Aggregate Supply Curve 400 Price level (CPI) 300 E1 200 E2 AS 100 AD1 12 AD2 16 Full employment 20 24 Real GDP (trillions of dollars per year) CAUSATION CHAIN Government spending (G) increases Aggregate demand increases and the economy moves from E1 to E2 Price level remains constant, while real GDP and employment rise The increase in aggregate demand from AD1 to AD2 causes a new equilibrium at E2 Given the Keynesian assumption of a fixed price level, changes in aggregate demand cause changes in real GDP along the horizontal portion of the aggregate supply curve, AS Keynesian theory argues that only shifts in aggregate demand possess the ability to restore a depressed economy to the full-employment output © Cengage Learning 2013 CONCLUSION When the aggregate supply curve is horizontal and an economy is in recession below full employment, the only effects of an increase in aggregate demand are increases in real GDP and employment, while the price level does not change Stated simply, the Keynesian view is that “demand creates its own supply.” Classical View of Aggregate Supply Prior to the Great Depression of the 1930s, a group of economists known as the classical economists dominated economic thinking.1 The founder of the classical school of economics was Adam Smith (discussed in Chapter 22 on economies in transition) Macroeconomics had not developed as a separate economic theory, and classical economics was therefore based primarily on microeconomic market equilibrium theory The classical school of economics was mainstream economics from the 1770s to the Great Depression era The classical economists believed in the laissez-faire, or “leave it alone,” theory that the economy was self-regulating and would correct itself over time without government The classical economists included Adam Smith, J B Say, David Ricardo, John Stuart Mill, Thomas Malthus, Alfred Marshall, and others www.downloadslide.com CHAPTER 14 • Aggregate Demand and Supply E XH I BI T 14.5 295 The Classical Vertical Aggregate Supply Curve AS 400 Price level (CPI) Surplus 300 E1 E′ E2 200 AD1 100 AD2 Full employment 12 16 20 24 Real GDP (trillions of dollars per year) CAUSATION CHAIN Aggregate demand decreases at full employment and the economy moves from E1 to E′ At E′ unemployment and a surplus of unsold goods and services cause cuts in prices and wages The economy moves from E′ to E2, where full employment is restored Classical theory teaches that prices and wages adjust to keep the economy operating at its full-employment output of $16 trillion A decline in aggregate demand from AD1 to AD2 will temporarily cause a surplus of $4 trillion, the distance from E′ to E1 Businesses respond by cutting the price level from 300 to 200 As a result, consumers increase their purchases because of the real balances effect, and wages adjust downward Thus, classical economists predict the economy is self-correcting and will restore full employment at point E2 E1 and E2 therefore represent points along a classical vertical aggregate supply curve, AS © Cengage Learning 2013 intervention The classical economists believed, as you studied in Chapter 4, that the forces of supply and demand naturally achieve full employment in the economy because flexible prices (including wages and interest rates) in competitive markets bring all markets to equilibrium After a temporary adjustment period, markets always clear because firms sell all goods and services offered for sale In short, recessions would naturally cure themselves because the capitalistic price system would automatically restore full employment Exhibit 14.5 uses the aggregate demand and supply model to illustrate the classical view that the aggregate supply curve, AS, is a vertical line at the fullemployment output of $16 trillion The vertical shape of the classical aggregate supply curve is based on two assumptions First, the economy normally operates at its full-employment output level Second, the price level of products and production costs change by the same percentage, that is, proportionally, in order to maintain a full-employment level of output This classical theory of flexible prices and wages is at odds with the Keynesian concept of sticky (inflexible) prices and wages Exhibit 14.5 also illustrates why classical economists believe a market economy over time automatically self-corrects without government intervention to full employment Following the classical scenario, the economy is initially in equilibrium at E1, the price level is 300, real output is at its full-employment level of $16 trillion, and the aggregate demand curve AD1 traces total spending www.downloadslide.com 296 PART • The Macroeconomy and Fiscal Policy Now suppose private spending falls because households and businesses are pessimistic about economic conditions This condition causes AD1 to shift leftward to AD2 At a price level of 300, the immediate effect is that aggregate output exceeds aggregate spending by $4 trillion (E1 to E′), and unexpected inventory accumulation occurs To eliminate unsold inventories resulting from the decrease in aggregate demand, business firms temporarily cut back on production and reduce the price level from 300 to 200 At E′, the decline in aggregate output in response to the surplus also affects prices in the factor markets As a result of the economy moving from point E1 to E′, there is a decrease in the demand for labor, natural resources, and other inputs used to produce products This surplus condition in the factor markets means that some workers who are willing to work are laid off and compete with those who still have jobs by reducing their wage demands Owners of natural resources and capital likewise cut their prices How can the classical economists believe that prices and wages are completely flexible? The answer is contained in the real balances effect, explained earlier When businesses reduce the price level from 300 to 200, the cost of living falls by the same proportion Once the price level falls by 33 percent, a nominal or money wage rate of, say, $21 per hour will purchase 33 percent more groceries after the fall in product prices than it would before the fall Workers will therefore accept a pay cut of 33 percent, or $7 per hour Any worker who refuses the lower wage rate of $14 per hour will be replaced by an unemployed worker willing to accept the going rate Exhibit 14.5 shows an economywide proportional fall in prices and wages by the movement downward along AD2 from E′ to a new equilibrium at E2 At E2, the economy has self-corrected through downwardly flexible prices and wages to its fullemployment level of $16 trillion worth of real GDP at the lower price level of 200 E1 and E2 therefore represent points along a classical vertical aggregate supply curve, AS (The classical model is explained in more detail in the appendix to this chapter.) CONCLUSION When the aggregate supply curve is vertical at the fullemployment GDP, the only effect over time of a change in aggregate demand is a change in the price level Stated simply, the classical view is that “supply creates its own demand.”2 Although Keynes himself did not use the AD-AS model, we can use Exhibit 14.5 to distinguish between Keynes’s view and the classical theory of flexible prices and wages Keynes believed that once the demand curve has shifted from AD1 to AD2, the surplus (the distance from E′ to E1) will persist because he rejected price-wage downward flexibility The economy therefore will remain at the less-than-full-employment output of $12 trillion until the aggregate demand curve shifts rightward and returns to its initial position at AD1 CONCLUSION Keynesian theory rejects classical theory for an economy in recession because Keynesians argue that during a recession prices and wages not adjust downward to restore an economy to full-employment real GDP THREE RANGES OF THE AGGREGATE SUPPLY CURVE Having studied the differing theories of the classical economists and Keynes, we will now discuss an eclectic or general view of how the shape of the aggregate supply curve varies as real GDP expands or contracts The aggregate supply This quotation is known as Say’s Law, named after the French classical economist Jean-Baptiste Say (1767–1832) www.downloadslide.com CHAPTER 14 • Aggregate Demand and Supply E XH I BI T 14.6 297 The Three Ranges of the Aggregate Supply Curve AS Classical range Price level (CPI) Keynesian range Intermediate range Full employment YK YF Real GDP (trillions of dollars per year) The aggregate supply curve shows the relationship between the price level and the level of real GDP supplied It consists of three distinct ranges: (1) a Keynesian range between and YK wherein the price level is constant for an economy in severe recession; (2) an intermediate range between YK and YF, where both the price level and the level of real GDP vary as an economy approaches full employment; and (3) a classical range, where the price level can vary, while the level of real GDP remains constant at the full-employment level of output, YF © Cengage Learning 2013 Keynesian range The horizontal segment of the aggregate supply curve, which represents an economy in a severe recession Intermediate range The rising segment of the aggregate supply curve, which represents an economy as it approaches full-employment output Classical range The vertical segment of the aggregate supply curve, which represents an economy at fullemployment output curve, AS, in Exhibit 14.6 has three quite distinct ranges or segments, labeled (1) Keynesian range, (2) intermediate range, and (3) classical range The Keynesian range is the horizontal segment of the aggregate supply curve, which represents an economy in a severe recession In Exhibit 14.6, below real GDP YK, the price level remains constant as the level of real GDP rises Between YK and the full-employment output of YF, the price level rises as the real GDP level rises The intermediate range is the rising segment of the aggregate supply curve, which represents an economy approaching fullemployment output Finally, at YF, the level of real GDP remains constant, and only the price level rises The classical range is the vertical segment of the aggregate supply curve, which represents an economy at full-employment output We will now examine the rationale for each of these three quite distinct ranges Aggregate Demand and Aggregate Supply Macroeconomic Equilibrium In Exhibit 14.7, the macroeconomic equilibrium level of real GDP corresponding to the point of equality, E, is $8 trillion, and the equilibrium price level is 200 This is the unique combination of price level and output level that equates how much people want to buy with the amount businesses want to produce and sell Because the entire real GDP value of final products is bought and sold at the price level of 200, there is no upward or downward pressure for the macroeconomic equilibrium to change Note that the economy shown in Exhibit 14.7 is operating on the edge of the Keynesian range, with a negative GDP gap of $8 trillion Suppose that in Exhibit 14.7 the level of output on the AS curve is below $8 trillion and the AD curve remains fixed At a price level of 200, the real www.downloadslide.com glossary A Ability-to-pay principle The concept that those who have higher incomes can afford to pay a greater proportion of their income in taxes, regardless of benefits received Absolute advantage The ability of a country to produce a good using the same or fewer resources than another country Adjustable-rate mortgage (ARM) A home loan that adjusts the nominal interest rate to changes in an index rate, such as rates on Treasury securities Agency for International Development (AID) The agency of the U.S State Department that is in charge of U.S aid to foreign countries Aggregate demand curve The curve that shows the level of real gross domestic product (GDP) purchased by households, businesses, government, and foreigners (net exports) at different possible price levels during a time period, ceteris paribus Aggregate supply curve The curve that shows the level of real GDP produced at different possible price levels during a time period, ceteris paribus Appreciation of currency A rise in the price of one currency relative to another Arbitrage The activity of earning a profit by buying a good at a low price and reselling the good at a higher price Automatic stabilizers Federal expenditures and tax revenues that automatically change levels in order to stabilize an economic expansion or contraction; sometimes referred to as nondiscretionary fiscal policy Average fixed cost (AFC) Total fixed cost divided by the quantity of output produced Average tax rate The tax divided by the income Average total cost (ATC) Total cost divided by the quantity of output produced Average variable cost (AVC) Total variable cost divided by the quantity of output produced B Balance of payments A bookkeeping record of all the international transactions between a country and other countries during a given period of time Benefit-cost analysis The comparison of the additional rewards and costs of an economic alternative Benefits-received principle The concept that those who benefit from government expenditures should pay the taxes that finance their benefits Board of Governors of the Federal Reserve System The seven members appointed by the president and confirmed by the U.S Senate who serve for one nonrenewable 14-year term Their responsibility is to supervise and control the money supply and the banking system of the United States Budget deficit A budget in which government expenditures exceed government revenues in a given time period Budget surplus A budget in which government revenues exceed government expenditures in a given time period Business cycle Alternating periods of economic growth and contraction, which can be measured by changes in real GDP C Capital Human-made goods that are used to produce goods and services Capitalism An economic system characterized by private ownership of resources and markets Cartel A group of firms that formally agree to reduce competition by coordinating the price and output of a product Ceteris paribus A Latin phrase that means while certain variables change, “all other things remain unchanged.” Change in demand An increase or a decrease in the quantity demanded at each possible price An increase in demand is a rightward shift in the entire demand curve A decrease in demand is a leftward shift in the entire demand curve Change in quantity demanded A movement between points along a stationary demand curve, ceteris paribus Change in quantity supplied A movement between points along a stationary supply curve, ceteris paribus Change in supply An increase or a decrease in the quantity supplied at each possible price An increase in supply is a rightward shift in the entire supply curve A decrease in supply is a leftward shift in the entire supply curve Checkable deposits The total money in financial institutions that can be withdrawn by writing a check Balance of trade The value of a nation’s imports subtracted from its exports Balance of trade can be given in terms of goods, services, or goods and services Circular flow model A diagram showing the exchange of money, products, and resources between households and businesses Barrier to entry Any obstacle that makes it difficult for a new firm to enter a market Barter The direct exchange of one good or service for another good or service rather than for money Civilian labor force The number of people 16 years of age and older who are employed or who are actively seeking a job, excluding members of the armed forces, homemakers, discouraged workers, and other persons not in the labor force Base year A year chosen as a reference point for comparison with some earlier or later year Classical economics The theory that free markets will restore full employment without government intervention 550 www.downloadslide.com GLOSSARY 551 Classical economists A group of economists whose theory dominated economic thinking from the 1770s to the Great Depression They believed recessions would naturally cure themselves because the price system would automatically restore full employment Currency Money, including coins and paper money Classical range The vertical segment of the aggregate supply curve, which represents an economy at full-employment output D Coincident indicators Variables that change at the same time that real GDP changes Deflation A decrease in the general (average) price level of goods and services in the economy Collective bargaining The process of negotiating labor contracts between the union and management concerning wages and working conditions Demand A curve or schedule showing the various quantities of a product consumers are willing to purchase at possible prices during a specified period of time, ceteris paribus Command economy An economic system that answers the What, How, and For Whom questions by a dictator or central authority Demand curve for labor A curve showing the different quantities of labor employers are willing to hire at different wage rates in a given time period, ceteris paribus It is equal to the marginal revenue product of labor Commodity money Anything that serves as money while having market value based on the material from which it is made Communism A stateless, classless economic system in which all the factors of production are owned by the workers and people share in production according to their needs In Marx’s view, this is the highest form of socialism toward which the revolution should strive Comparable worth The principle that employees who work for the same employer must be paid the same wage when their jobs, even if different, require similar levels of education, training, experience, and responsibility A nonmarket wage-setting process is used to evaluate and compensate jobs according to point scores assigned to different jobs Comparative advantage The ability of a country to produce a good at a lower opportunity cost than another country Complementary good A good that is jointly consumed with another good As a result, there is an inverse relationship between a price change for one good and the demand for its “go together” good Constant returns to scale A situation in which the long-run average cost curve does not change as the firm increases output Consumer price index (CPI) An index that measures changes in the average prices of consumer goods and services Consumer sovereignty The freedom of consumers to cast their dollar votes to buy, or not to buy, at prices determined in competitive markets Cost-push inflation An increase in the general price level resulting from an increase in the cost of production that causes the aggregate supply curve to shift leftward Crowding-in effect An increase in private-sector spending as a result of federal budget deficits financed by U.S Treasury borrowing At less than full employment, consumers hold more Treasury securities and this additional wealth causes them to spend more Business investment spending increases because of optimistic profit expectations Crowding-out effect A reduction in private-sector spending as a result of federal budget deficits financed by U.S Treasury borrowing When federal government borrowing increases interest rates, the result is lower consumption by households and lower investment spending by businesses Cyclical unemployment Unemployment caused by the lack of jobs during a recession Debt ceiling A legislated legal limit on the national debt Demand for money curve A curve representing the quantity of money that people hold at different possible interest rates, ceteris paribus Demand-pull inflation A rise in the general price level resulting from an excess of total spending (demand) caused by a rightward shift in the aggregate demand curve Depreciation of currency A fall in the price of one currency relative to another Derived demand The demand for labor and other factors of production that depends on the consumer demand for the final goods and services the factors produce Direct relationship A positive association between two variables When one variable increases, the other variable increases, and when one variable decreases, the other variable decreases Discount rate The interest rate the Fed charges on loans of reserves to banks Discouraged worker A person who wants to work, but who has given up searching for work because he or she believes there will be no job offers Discretionary fiscal policy The deliberate use of changes in government spending or taxes to alter aggregate demand and stabilize the economy Diseconomies of scale A situation in which the long-run average cost curve rises as the firm increases output Disinflation A reduction in the rate of inflation Disposable personal income (DI) The amount of income that households actually have to spend or save after payment of personal taxes E Economic growth The ability of an economy to produce greater levels of output, represented by an outward shift of its production possibilities curve Also, an expansion in national output measured by the annual percentage increase in a nation’s GDP Economic profit Total revenue minus explicit and implicit costs www.downloadslide.com 552 GLOSSARY Economic system The organizations and methods used to determine what goods and services are produced, how they are produced, and for whom they are produced Economics The study of how society chooses to allocate its scarce resources to the production of goods and services in order to satisfy unlimited wants Economies of scale A situation in which the long-run average cost curve declines as the firm increases output Elastic demand A condition in which the percentage change in quantity demanded is greater than the percentage change in price Embargo A law that bars trade with another country Entrepreneurship The creative ability of individuals to seek profits by taking risks and combining resources that produce innovative products Equation of exchange An accounting identity stating that the money supply times the velocity of money equals total spending Equilibrium A market condition that occurs at any price and quantity at which the quantity demanded and the quantity supplied are equal Excess reserves Potential loan balances held in vault cash or on deposit with the Fed in excess of required reserves Exchange rate The number of units of one nation’s currency that equals one unit of another nation’s currency Expansion An upturn in the business cycle during which real GDP rises Also called a recovery Expenditure approach The national income accounting method that measures GDP by adding all the spending for final goods during a period of time Fiat money Money accepted by law and not because of its tangible value Final goods Finished goods and services produced for the ultimate user Fiscal policy The use of government spending and taxes to influence the nation’s output, employment, and price level Fixed input Any resource for which the quantity cannot change during the period of time under consideration Foreign aid The transfer of money or resources from one government to another for which no repayment is required Fractional reserve banking A system in which banks keep only a percentage of their deposits on reserve as vault cash and deposits at the Fed Free trade The flow of goods between countries without restrictions or special taxes Frictional unemployment Temporary unemployment caused by the time required of workers to move from one job to another Full employment The situation in which an economy operates at an unemployment rate equal to the sum of the frictional and structural unemployment rates Also called the natural rate of unemployment G Game theory A model of the strategic moves and countermoves of rivals GDP chain price index A measure that compares changes in the prices of all final goods during a given year to the prices of those goods in a base year Explicit costs Payments to nonowners of a firm for their resources GDP gap The difference between full-employment real GDP and actual real GDP External national debt The portion of the national debt owed to foreign citizens GDP per capita The value of final goods produced (GDP) divided by the total population Externality A cost or benefit imposed on people other than the consumers and producers of a good or service Government expenditures Federal, state, and local government outlays for goods and services, including transfer payments F Gross domestic product (GDP) The market value of all final goods and services produced in a nation during a period of time, usually a year Federal Deposit Insurance Corporation (FDIC) A government agency established in 1933 to insure customer bank deposits up to a specified limit if a bank fails Federal funds market A private market in which banks lend reserves to each other for less than 24 hours Federal funds rate The interest rate banks charge for overnight loans of reserves to other banks Federal Open Market Committee (FOMC) The Federal Reserve’s committee that directs the buying and selling of U.S government securities, which are major instruments for controlling the money supply The FOMC consists of the seven members of the Federal Reserve’s Board of Governors, the president of the New York Federal Reserve Bank, and the presidents of four other Federal Reserve district banks Federal Reserve System The 12 Federal Reserve district banks that service banks and other financial institutions within each of the Federal Reserve districts; popularly called the Fed H Human capital The accumulation of education, training, experience, and health that enables a worker to enter an occupation and be productive Hyperinflation An extremely rapid rise in the general price level I Implicit costs The opportunity costs of using resources owned by the firm Independent relationship A zero association between two variables When one variable changes, the other variable remains unchanged Industrially advanced countries (IACs) High-income nations that have market economies based on large stocks of technologically www.downloadslide.com GLOSSARY advanced capital and well-educated labor The United States, Canada, Australia, New Zealand, Japan, and most of the countries of Western Europe are IACs Inelastic demand A condition in which the percentage change in quantity demanded is less than the percentage change in price Inferior good Any good for which there is an inverse relationship between changes in income and its demand curve Inflation An increase in the general (average) price level of goods and services in the economy Infrastructure Capital goods usually provided by the government, including highway, bridges, waste and water systems, and airports In-kind transfers Government payments in the form of goods and services, rather than cash, including such government programs as food stamps, Medicaid, and housing Interest-rate effect The impact on total spending (real GDP) caused by the direct relationship between the price level and the interest rate Intermediate goods Goods and services used as inputs for the production of final goods Intermediate range The rising segment of the aggregate supply curve, which represents an economy as it approaches fullemployment output Internal national debt The portion of the national debt owed to a nation’s own citizens 553 Lagging indicators Variables that change after real GDP changes Land Any natural resource provided by nature that is used to produce goods and services Law of demand The principle that there is an inverse relationship between the price of a good and the quantity buyers are willing to purchase in a defined time period, ceteris paribus Law of diminishing returns The principle that beyond some point the marginal product decreases as additional units of a variable factor are added to a fixed factor Law of increasing opportunity costs The principle that the opportunity cost increases as production of one output expands Law of supply The principle that there is a direct relationship between the price of a good and the quantity sellers are willing and able to offer for sale in a defined time period, ceteris paribus Leading indicators Variables that change before real GDP changes Less-developed countries (LDCs) Nations without large stocks of technologically advanced capital and well-educated labor LDCs are economies based on agriculture, such as most countries of Africa, Asia, and Latin America Long run A period of time so long that all inputs are variable International Monetary Fund (IMF) The lending agency that makes short-term conditional low-interest loans to developing countries Long-run aggregate supply curve (LRAS) The curve that shows the level of real GDP produced at different possible price levels during a time period in which nominal incomes change by the same percentage as the price level changes Inverse relationship A negative association between two variables When one variable increases, the other decreases, and when one variable decreases, the other variable increases Long-run average cost curve (LRAC) The curve that traces the lowest cost per unit at which a firm can produce any level of output when the firm can build a plant of any desired plant size Investment The accumulation of capital—such as factories, machines, and inventories—that is used to produce goods and services M Invisible hand A phrase that expresses the belief that the best interests of a society are served when individual consumers and producers compete to achieve their own private interests K Keynesian economics The theory, first advanced by John Maynard Keynes, that the role of the federal government is to increase or decrease aggregate demand to achieve economic goals Keynesian range The horizontal segment of the aggregate supply curve, which represents an economy in a severe recession L M1 The narrowest definition of the money supply It includes currency, traveler’s checks, and checkable deposits M2 The definition of the money supply that equals M1 plus near monies, such as savings deposits and small time deposits of less than $100,000 Macroeconomics The branch of economics that studies decision making for the economy as a whole Marginal analysis An examination of the effects of additions to or subtractions from a current situation Marginal cost (MC) The change in total cost when one additional unit of output is produced Marginal product (MP) The change in total output produced by adding one unit of a variable input, with all other inputs used being held constant Labor The mental and physical capacity of workers to produce goods and services Marginal propensity to consume (MPC) The change in consumption spending resulting from a given change in real disposable income Laffer curve A graph depicting the relationship between tax rates and total tax revenues Marginal revenue (MR) The change in total revenue from the sale of one additional unit of output www.downloadslide.com 554 GLOSSARY Marginal revenue product (MRP) The increase in a firm’s total revenue resulting from hiring an additional unit of labor or other variable resource Mutual interdependence A condition in which an action by one firm may cause a reaction from other firms Marginal tax rate The fraction of additional income paid in taxes N Market Any arrangement in which buyers and sellers interact to determine the price and quantity of goods and services exchanged Market economy An economic system that answers the What, How, and For Whom questions using prices determined by the interaction of the forces of supply and demand National debt The total amount owed by the federal government to owners of government securities National income (NI) The total income earned by resource owners, including wages, rents, interest, and profits NI is calculated as GDP minus depreciation of the capital worn out in producing output Nationalization The act of transforming a private enterprise’s assets to government ownership Market failure A situation in which market equilibrium results in too few or too many resources used in the production of a good or service This inefficiency may justify government intervention Natural monopoly An industry in which the long-run average cost of production declines throughout the entire market As a result, a single firm can supply the entire market demand at a lower cost than two or more smaller firms Market structure A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry into and exit from the market Net exports effect The impact on total spending (real GDP) caused by the inverse relationship between the price level and the net exports of an economy Medium of exchange The primary function of money to be widely accepted in exchange for goods and services Microeconomics The branch of economics that studies decision making by a single individual, household, firm, industry, or level of government Mixed economy An economic system than answers the What, How, and For Whom questions through a mixture of traditional, command, and market systems Model A simplified description of reality used to understand and predict the relationship between variables Monetarism The theory that changes in the money supply directly determine changes in prices, real GDP, and employment Monetary Control Act A law, formally titled the Depository Institutions Deregulation and Monetary Control Act of 1980, that gave the Federal Reserve System greater control over nonmember banks and made all financial institutions more competitive Monetary policy The Federal Reserve’s use of open market operations, changes in the discount rate, and changes in the required reserve ratio to change the money supply (M1) Money Anything that serves as a medium of exchange, unit of account, and store of value Money multiplier The maximum change in the money supply (checkable deposits) due to an initial change in the excess reserves banks hold The money multiplier is equal to divided by the required reserve ratio Monopolistic competition A market structure characterized by (1) many small sellers, (2) a differentiated product, and (3) easy market entry and exit Monopoly A market structure characterized by (1) a single seller, (2) a unique product, and (3) impossible entry into the market Net public debt National debt minus all government interagency borrowing Network good A good that increases in value to each user as the total number of users increases As a result, a firm can achieve economies of scale Examples include Facebook and Match.com Nominal GDP The value of all final goods based on the prices existing during the time period of production Nominal income The actual number of dollars received over a period of time Nominal interest rate The actual rate of interest without adjustment for the inflation rate Nonprice competition The situation in which a firm competes using advertising, packaging, product development, better quality, and better service, rather than lower prices Normal good Any good for which there is a direct relationship between changes in income and its demand curve Normal profit The minimum profit necessary to keep a firm in operation A firm that earns normal profits earns total revenue equal to its total opportunity cost Normative economics An analysis based on value judgment O Offshoring Work for a company performed by the company’s employees located in another country Oligopoly A market structure characterized by (1) few sellers, (2) either a homogeneous or a differentiated product, and (3) difficult market entry Open market operations The buying and selling of government securities by the Federal Reserve System Opportunity cost The best alternative sacrificed for a chosen alternative Outsourcing The practice of a company having its work done by another company in another country www.downloadslide.com GLOSSARY P Peak The phase of the business cycle in which real GDP reaches its maximum after rising during a recovery Perfect competition A market structure characterized by (1) a large number of small firms, (2) a homogeneous product, and (3) very easy entry into or exit from the market Perfect competition is also referred to as pure competition 555 produce in a given period of time with its available resources and technology Progressive tax A tax that charges a higher percentage of income as income rises Proportional tax A tax that charges the same percentage of income, regardless of the size of income Also called a flat-rate tax or simply a flat tax Perfectly competitive firm’s short-run supply curve The firm’s marginal cost curve above the minimum point on its average variable cost curve Protectionism The government’s use of embargoes, tariffs, quotas, and other restrictions to protect domestic producers from foreign competition Perfectly competitive industry’s short-run supply curve The supply curve derived from the horizontal summation of the marginal cost curves of all firms above the minimum point of each firm’s average variable cost curve Public choice theory The analysis of the government’s decisionmaking process for allocating resources Perfectly elastic demand A condition in which a small percentage change in price brings about an infinite percentage change in quantity demanded Perfectly inelastic demand A condition in which the quantity demanded does not change as the price changes Personal income (PI) The total income received by households that is available for consumption, saving, and payment of personal taxes Positive economics An analysis limited to statements that are verifiable Poverty line The level of income below which a person or a family is considered to be poor Precautionary demand for money The stock of money people hold to pay unpredictable expenses Price ceiling A legally established maximum price a seller can charge Price discrimination The practice of charging different prices for the same product that are not justified by cost differences Price elasticity of demand The ratio of the percentage change in the quantity demanded of a product to a percentage change in its price Price floor A legally established minimum price a seller can be paid Price leadership A pricing strategy in which a dominant firm sets the price for an industry and the other firms follow Price maker A firm that faces a downward-sloping demand curve and can therefore choose among price and output combinations along the demand curve Price system A mechanism that uses the forces of supply and demand to create an equilibrium through rising and falling prices Price taker A seller that has no control over the price of the product it sells Privatization The process of turning a government enterprise into a private enterprise Product differentiation The process of creating real or apparent differences between goods and services Production function The relationship between the maximum amounts of output that a firm can produce and various quantities of inputs Production possibilities curve A curve that shows the maximum combinations of two outputs an economy can Public good A good or service with two properties: (1) users collectively consume benefits, and (2) there is no way to bar people who not pay (free riders) from consuming such a good or service Q Quantity theory of money The theory that changes in the money supply are directly related to changes in the price level Quota A limit on the quantity of a good that may be imported in a given time period R Rational ignorance The voter’s choice to remain uninformed because the marginal cost of obtaining information is higher than the marginal benefit from knowing it Real balances effect The impact on total spending (real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value Real GDP The value of all final goods produced during a given time period based on the prices existing in a selected base year Real income The actual number of dollars received (nominal income) adjusted for changes in the CPI Real interest rate The nominal rate of interest minus the inflation rate Recession A downturn in the business cycle during which real GDP declines; also called a contraction Regressive tax A tax that charges a lower percentage of income as income rises Required reserve ratio The percentage of deposits that the Federal Reserve requires a bank to hold in vault cash or on deposit with the Fed Required reserves The minimum balance that the Federal Reserve requires a bank to hold in vault cash or on deposit with the Fed Resources The basic categories of inputs used to produce goods and services Resources are also called factors of production Economists divide resources into three categories: land, labor, and capital S Scarcity The condition in which human wants are forever greater than the available supply of time, goods, and resources www.downloadslide.com 556 GLOSSARY Short run A period of time so short that there is at least one fixed input Total cost (TC) The sum of total fixed cost and total variable cost at each level of output Short-run aggregate supply curve (SRAS) The curve that shows the level of real GDP produced at different possible price levels during a time period in which nominal incomes not change in response to changes in the price level Total fixed cost (TFC) Costs that not vary as output varies and that must be paid even if output is zero These are payments that the firm must make in the short run, regardless of the level of output Shortage A market condition existing at any price where the quantity supplied is less than the quantity demanded Total revenue (TR) The total number of dollars a firm earns from the sale of a good or service, which is equal to its price multiplied by the quantity demanded Slope The ratio of change in the variable on the vertical axis (the rise or fall) to change in the variable on the horizontal axis (the run) Socialism An economic system characterized by government ownership of resources and centralized decision making Speculative demand for money The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other nonmoney financial assets Spending multiplier (SM) The change in aggregate demand (total spending) resulting from an initial change in any component of aggregate demand, including consumption, investment, government purchases, and net exports As a formula, the spending multiplier equals 1/(1-MPC) Stagflation The condition that occurs when an economy experiences the twin maladies of high unemployment and rapid inflation simultaneously Store of value The ability of money to hold value over time Structural unemployment Unemployment caused by a mismatch of the skills of workers out of work and the skills required for existing job opportunities Subprime mortgage loan A home loan made to borrowers with an above-average risk of default Substitute good A good that competes with another good for consumer purchases As a result, there is a direct relationship between a price change for one good and the demand for its “competitor” good Supply A curve or schedule showing the various quantities of a product sellers are willing to produce and offer for sale at possible prices during a specified period of time, ceteris paribus Supply curve of labor A curve showing the different quantities of labor workers are willing to offer employers at different wage rates in a given time period, ceteris paribus Supply-side fiscal policy A fiscal policy that emphasizes government policies that increase aggregate supply in order to achieve long-run growth in real output, full employment, and a lower price level Total variable cost (TVC) Costs that are zero when output is zero and vary as output varies Traditional economy An economic system that answers the What, How, and For Whom questions the way they always have been answered Transactions demand for money The stock of money people hold to pay everyday predictable expenses Transfer payment A government payment to individuals not in exchange for goods or services currently produced Trough The phase of the business cycle in which real GDP reaches its minimum after falling during a recession U Unemployment rate The percentage of people in the civilian labor force who are without jobs and are actively seeking jobs Unit of account The function of money to provide a common measurement of the relative value of goods and services Unitary elastic demand A condition in which the percentage change in quantity demanded is equal to the percentage change in price V Variable input Any resource for which the quantity can change during the period of time under consideration Velocity of money The average number of times per year a dollar of the money supply is spent on final goods and services Vicious circle of poverty The trap in which countries are poor because they cannot afford to save and invest, but they cannot save and invest because they are poor W Surplus A market condition existing at any price where the quantity supplied is greater than the quantity demanded Wage-price spiral A situation that occurs when increases in nominal wage rates are passed on in higher prices, which, in turn, result in even higher nominal wage rates and prices T Wealth The value of the stock of assets owned at some point in time Tariff A tax on an import Tax multiplier (TM) The change in aggregate demand (total spending) resulting from an initial change in taxes As a formula, the tax multiplier equals − spending multiplier Technology The body of knowledge and skills applied to how goods are produced World Bank The lending agency that makes long-term lowinterest loans and provides technical assistance to less-developed countries World Trade Organization (WTO) An international organization of member countries that oversees international trade agreements and rules on trade disputes www.downloadslide.com index A Ability-to-pay principle, 351 Absolute advantage, 466 Accounting profit, 113–114 AD See Aggregate demand curve Ad valorem, 467 AD-AS model See Aggregate demandAggregate supply model Adjustable-rate mortgages (ARMs), 280, 441 Advertising, 178 AFC See Average fixed cost African Americans, discrimination against, 213–215 Agency for International Development (AID), 523–524 Aggregate demand changes in macroeconomic equilibrium, 298–301 effect of decreases in, 302 effect of expansionary monetary policy on, 436 impact of decrease in, 318–321 impact of increase in, 315–317 macroeconomic equilibrium, 297–298 nonprice-level determinants of, 292–293, 303 Aggregate demand curve (AD), 289–290 increase in, 306–308, 320–321 reasons for downward slope of, 290–291 reasons for downward sloping, 291 rightward shift in, 306 shift in, 292 Aggregate demand-Aggregate supply model classical range of, 299–301 cost-push and demand-pull inflation and, 304–306 equilibrium in self-correcting, 315 during Great Recession (2008–2009), 301 intermediate range of, 299–301 Keynesian range of, 299–301 self-correcting, 313–321, 451–453 Aggregate supply changes in macroeconomic equilibrium, 298–301 classical view of, 294–296 Keynesian view of, 293–294 macroeconomic equilibrium, 297–298 nonprice-level determinants of, 301–303 Aggregate supply curve (AS), 293–294 classical range of, 297 classical vertical, 295 increase in, 306–308, 320–321 intermediate range of, 297 Keynesian horizontal, 294 Keynesian range of, 297 long-run, 315 ranges of, 296–298 rightward shift in, 303, 306 short-run, 313–315 Agricultural price supports, 81 AID See Agency for International Development Aid, foreign, 523–524 AIDS vaccinations, 86 Airline fares, 105 Alligator farming, 146 Amtrak, 505 Anti-Inflation theories, 453 Antipoverty programs, 209–213 Anti-recession theories, 452 APEC See Asian-Pacific Economic Cooperation Apple Computer Company, 126 Appreciation of currency, 480 Arbitrage, 164 Arc elasticity formula See Midpoints formula ARMs See Adjustable-rate mortgages AS See Aggregate supply curve Asian-Pacific Economic Cooperation (APEC), 472 Assets, 411 Association, 8–9 ATC See Average total cost ATS accounts See Automatic transfer of savings accounts Automatic stabilizers, 333–335 Automatic transfer of savings (ATS) accounts, 398 AVC See Average variable cost Average cost curves, 119–120 Average fixed cost (AFC), 119 Average profit per unit, 137 Average tax rate, 352 Average total cost (ATC), 119, 137 Average variable cost (AVC), 119, 137 B Balance of payments, 473 Balance of trade, 473–476, 485 See also Trade Banana imports, 471 Bank failures, 399, 403, 405 Bank One Investment Advisors, Banks/banking See also Federal Reserve System bookkeeping, 410–411 fractional reserve, 410–414 goldsmiths and, 410 money creation by, 410–414 money supply and, 415 multiplier expansion of money by system, 414–416 reserves, 411 revolution, 404 supervision and regulation of, 403 top ten in United States, 402 Barriers to entry, 132, 177, 183 Barter, 393 Base year, 272 Base-year prices, 272 BEA See Budget Enforcement Act of 1990 Benefit-cost analysis, 357–358 Benefits-received principle, 351 Bernanke, Ben S., 400 Bilateral loans, 524 Black market, 78 Board of Governors of Federal Reserve System, 400 Boston Snow Index (BSI), Bottlenecks, 299 Brain drain, 516 Break-even point, 134 Breakfast cereal market, 187 Bretton Woods agreement, 484 British East India Company, 156 Bryan, Jennings William, 484 Buchanan, James, 356–357 Budget deficit, 333–334, 367, 368–369, 370, 371, 379 Budget Enforcement Act (BEA) of 1990, 368 Budget resolution, 365 Budget surplus, 333, 367, 368, 370, 371, 372 Budgets See also Federal budget capital, 379 financing government, 349–450 operating, 379 share spent on product, 107 surpluses and deficits in other countries, 370 Bureau of Consumer Financial Protection (CFPB), 403 Bureau of Economic Analysis (BEA), 237 Bureau of Engraving and Printing, 403 Bureau of Labor Statistics (BLS), 256, 271 Bureaucracy, inefficiency of, 359 Bureaucratic inefficiency, 359 Bush, George W., 325, 345, 372, 400 Business Conditions Digest, 252 Business cycles, 249–256 economic growth and, 251 historical record in United States, 252 hypothetical and actual, 249 indicators, 252–254 phases of, 249–251 real GDP growth rates in other countries, 252 roller coaster, 252 total spending and, 254–256 Business inventories, 233 Buyers expectations of, 54, 281 for health care, 96 number of, 52–53 C CAFTA See Central American Free Trade Agreement California, electricity market in, 79 Canada, 463, 472, 502 Capital accumulation of, 517 budget, 379 definition of, efficiency of, 124 human, 198, 319, 516–517 Capital account, 476 Capital budget, 379 Capital flight, 517 Capital formation, 37 Capital goods, 233 Capitalism, 498 Carlson, Chester, 35 Cartels, 183–185 Cash transfer programs, 211 Causation, 8–9 Cause-and-effect relationships, 8–9 Caviar, 156 CBO See Congressional Budget Office Central American Free Trade Agreement (CAFTA), 473 Central banks, 399 See also Federal Reserve System Centralization, 501 Certificates of deposit (CDs), 399 Ceteris paribus assumption change in quantity demanded and, 51 change in quantity supplied and, 59, 60 definition of, equilibrium and, 65 law of demand and, 49, 50 law of supply and, 56 prices of related goods and, 54 CFPB See Bureau of Consumer Financial Protection Chan, Anthony, Change in demand, 51–52 Change in quantity demanded, 51–52 557 www.downloadslide.com 558 INDEX Change in quantity supplied, 59–60 Change in supply, 59–60 Chavez, Hugo, 505 Cheap foreign labor argument, 469 Check clearing, 413–414 Checkable deposits, 398, 411 China See People’s Republic of China Choice, 5–6, 29 Churchill, Winston, 491 Cigarette smoking, 107 Circular flow model, 230–231 Civilian labor force, 256 Classical economics, 442–443, 451–453 Classical range, 299–301 Clinton, Bill, 325, 345 Coca-Cola, Coincident indicators, 254 Coins, 396–398 Collective bargaining, 200–201 College education price index, 276 College tuition policies, 164 Command economy, 492–495 Command socialism, 499 Commodity money, 396 Common Market, 472–473 Communism, 500 Communist Manifesto (Marx & Engels), 500 Comparable worth, 214, 215 Comparative advantage, 466–467 Competition characteristics of, 132–133 lack of, 83 nonprice, 176, 183 perfect, 131–151 Complementary goods, 54 Computers market rigging and, 83, 84 prices, 62 Congressional Budget Office (CBO), 365 Constant dollar GDP See Real GDP Constant returns to scale, 124 Consulting business, 114 Consumer price index (CPI) calculating, 271–273 cost-of-laughing index and, 274–275 criticisms, 277 definition of, 271 GDP chain price index and, 241 inflation rates and, 273 Consumer sovereignty, 498–499 Consumers changes in demand by, 260 tastes and preferences, 53, 96 Consumption possibilities, 464 Continuing resolutions, 366 Contractionary fiscal policy, 326, 331–333, 452–453 Copyrights, 154 Corporate income taxes, 349, 352 Cost curves average, 119 long-run average, 121–123, 144–145 long-run supply, 144–145 short run, 120, 122 total, 117–119 Costa Rica, 473 Cost-of-laughing index, 274–275 Cost-of-living adjustment (COLA), 278 Cost-of-living index, 271 Cost-push inflation, 281–282, 304–306 Costs explicit/implicit, 113 external, 84 formulas, 117–121 long-run production, 121–123 minimizing in natural monopoly, 155 opportunity, 28–29, 32–34, 78 profit and, 113–114 short-run production, 115–117 Counterfeiting, 395–396 CPI See Consumer price index Credit, 394 Credit cards, 394–395 Crowding-in effect, 378 Crowding-out effect, 377–379 Cuba, 503 Currency appreciation of, 480 definition of, 397 depreciation of, 480 Euro, 472–473 maintaining and circulating, 403 Current account, 473–476 Current money GDP, 240 Current-dollar GDP, 240 Current-year prices, 272 Curves See also Aggregate demand curve; Aggregate supply curve; Demand curve; Supply curve cost, 117–123 demand for money, 430–431 investment demand, 435, 436, 443, 445 Laffer, 339 movements along/shifts in, 21 production possibilities, 30–32 Cyclical unemployment, 261–262 D Dairy price supports, 85 Das Kapital (Marx), 500 DeBeers, 156 Debit cards, 395 Debt See also National debt ceiling, 370 external, 476 international, 476–477 net public, 367 Decision making, centralized, 501 Deficit Reduction Act, 368 Deflation, 271 Demand See also Aggregate demand; Price elasticity of demand analysis to health care, 94–97 change in, 51–52, 74–75 change in quantity demanded, 51–52 changes in consumer, 260 definition of, 50 derived, 196, 200 for dollars, 480–481, 482, 483 elastic, 100–101 for foreign exchange, 478–479 for health care, 96 inelastic, 101 labor, 195–197, 203 law of, 49–50 market, 50–51, 64–66 for money, 429 for money curve, 430–431 nonprice determinants of, 52–56, 62 perfectly elastic, 102–103 perfectly inelastic, 103 precautionary, 429 speculative, 429 transactions, 429 unitary elastic, 102 Demand curve See also Aggregate demand curve for dollars, 481 for health care, 94, 96 impact of changes in nonprice determinants of demand on, 55–56 for labor, 196, 201 market, 50–51 movement along, 52 price elasticity of demand variations along, 103–105 Demand curve for labor, 196 Demand deposits, 398, 421 Demand for money curve, 430–431 Demand shifters, 51, 52–56 Demand-pull inflation, 281, 304–306, 335 Demand-side fiscal policy, 335, 336 Deng Xiaoping, 504 Deposit insurance, 403, 405 Deposit multiplier See Money multiplier Depository Institutions Deregulation and Monetary Control Act of 1980 See Monetary Control Act Deposits certificates of, 399 checkable, 398, 411 demand, 398 new, 412 savings, 398–399 time, 399 Depreciation of currency, 480 Depression, 249 See also Great Depression Derived demand, 196, 200 Difficult entry, 183 Digital cash, 393 Diminishing returns, law of, 115–117, 196 Direct relationship, 17–18 Discount rate, 419–420 Discount window, 420 Discouraged workers, 258 Discretionary fiscal policy, 326–333, 451–453 Discrimination, 213–215 Diseconomies of scale, 125 Disinflation, 273 Disposable personal income (DI), 239–240 Distribution, 235–236 Dollars, 480–481, 482, 483 Domestic production, 229 Dominican Republic., 473 Double counting, 229–230 E Earned-Income Tax Credit (EITC), 211 Easy entry and exit, 177 Economic bads, 236–237 Economic development, 514–521 Economic efficiency, 499 Economic freedom, 499 Economic growth, 251 categories that determine, 522 definition of, 34 development around the world and, 514–521 sources of, 34–36 Economic indicators, Economic models, Economic profit, 113–114 Economic systems classification of, 502 comparison of, 502–503 forms of, 498–502 privatization versus nationalization, 505–507 types of, 492–498 Economic way of thinking, 2–26 www.downloadslide.com INDEX Economics See also International economics; Keynesian economics; Macroeconomics applying graphs to, 17–26 careers in, 12–13 classical, 442–443 definition of, methodology of, 6–7 normative, 10–11 positive, 10 three fundamental questions of, 28 Economies in transition, 503–505 Economies of scale, 123, 154, 183 Economists, disagreements among, 10–12 Economy command, 492–495 market, 495–497 measures of macro, 239 mixed, 497–498 traditional, 492 underground, 236 Education, 28, 260, 346 EEC See European Economic Community Efficiency of capital, 124 El Salvador, 473 Elastic demand, 100–101 Elasticity coefficient, 99, 100, 101, 103, 106 Electricity prices, 79 Embargo, 467 Employees, labor unions and, 200–203 Employment See also Unemployment effect of monetary policy on, 434–435 full, 262–263, 281 Employment Act of 1946, 256 EMU See European Economic and Monetary Union Engels, Friedrich, 500 Entitlement programs, 210 Entrepreneurship, 4, 34–36 Entry barriers, 132, 177, 183 Environmental Protection Agency (EPA), 237 EPA See Equal Pay Act Equal Credit Opportunity Act, 403 Equal Employment Opportunity Commission (EEOC), 214 Equal Pay Act (EPA), 214 Equation of exchange, 437 Equilibrium in AD-AS macroeconomic, 297–301 definition of, 65 long-run, 144–145 market, 74 in self-correcting AD-AS model, 315 short-run, 142–144 trend of macro, 320 Equilibrium interest rate, 431–432 Equilibrium price, 65, 74–77, 81, 85, 133–134, 142–144 Equilibrium wage rate, 198–199 Ethanol fuel, 76 EU See European Union Euro, 472–473 European Economic and Monetary Union (EMU), 472 European Economic Community (EEC), 472 European Union (EU), 471, 472 Excess capacity, 181 Excess reserves, 411 Exchange equation of, 437 rates, 477–485 Excise taxes, 353 Expansion, 249 Expansionary fiscal policy, 326, 331, 436, 451–452 Expectations, 59, 61, 281 Expenditure approach, 231–232 Explicit costs, 113 Exports, net, 233–234 External debt, 476 External national debt, 375–376 Externalities, 83–86, 236–237 F Factor markets, 230 Factors of production See Resources Fair Labor Standards Act (1938), 11 FDIC See Federal Deposit Insurance Corporation Featherbedding, 200 Federal Advisory Council, 401 Federal budget balancing act, 365–370 debate on surplus, 372 debt ceiling, 370 federal expenditures, revenues, and deficits as percentage of GDP, 369 financing, 349–350 financing the national debt, 366–368 government surpluses and deficits as a percentage of GDP, 371 process, 365–366 rise and fall of surpluses and deficits, 368–370 surpluses and deficits, 367 Federal Communications Commission (FCC), 154 Federal debt See National debt Federal Deposit Insurance Corporation (FDIC), 403, 406 Federal funds market, 420 Federal funds rate, 420 Federal Insurance Contribution Act (FICA), 211 Federal Open Market Committee (FOMC), 400–401, 423 Federal Reserve Act, 399 Federal Reserve Bank of New York, 418 Federal Reserve System, 399–401 See also Banks/banking Board of Governors, 400 control of money definition, 422 controlling money supply and, 402 districts of, 400 Federal Open Market Committee, 400–401 functions of, 401–404 Great Recession and, 441 organizational chart of, 399–401 Federal Savings and Loan Insurance Corporation (FSLIC), 406 Federal Tax Code, 355 FedEx, 36 Few sellers, 182 Fiat money, 397 FICA See Federal Insurance Contribution Act FICA tax, 354 Final goods, 229–230 Finance, international balance of payments, 473–477 exchange rates, 477–485 Financial capital, Financial Services Modernization Act, 405 Fiscal policy, 325–344 automatic stabilizers, 333–335 contractionary, 326 definition of, 326 discretionary, 326–333 expansionary, 326, 331, 436, 451–452 labor markets and, 337 vs monetary policy, 422 supply-side, 335–338 using to combat inflation, 331–333 Fixed exchange rates, 479, 482, 484 559 Fixed input, 115 Fixed investment, 232–233 Fixed money target, 439 Fixed resources, 30 Fixed-wage contracts, 314 Fixed-weight price index, 271 Flat-tax, 354, 356 FOMC See Federal Open Market Committee FOMC directives, 401 Food stamps, 92, 212–213 Ford, Henry, 35, 124 Foreign aid, 523–524 Foreign exchange relative incomes and, 480 shifts in supply and demand for, 479 supply and demand for, 478–479 tastes and preferences and, 479–480 Foreign loans, 524 Foreign private investment, 522–523 Four Tigers, 513 Fractional reserve banking, 410–414 Franklin cent, 397 Free enterprise system See Capitalism Free to Choose (Friedman & Friedman), 88 Free trade, 467–469 Free trade agreements, 472–473 Free Trade Area of the Americas (FTAA), 472 Freeconomics, 128 Freemiums, 128 Frictional unemployment, 259–260 Friedman, Milton, 88, 439, 443 Friedman, Rose, 88 FSLIC See Federal Savings and Loan Insurance Corporation FTAA See Free Trade Area of the Americas Full employment, 262–263, 281 Full Employment and Balanced Growth Act of 1978, 256 Fully employed resources, 30 Future production capacity, 36 G Galbraith, John Kenneth, 168 Game theory, 185–187 Gasoline prices, 56, 79–80, 279 GATT See General Agreement on Tariffs and Trade GDP See Gross domestic product GDP chain price index, 241–242, 271 GDP gap, 263–266 GDP per capita, 511–513 Gender discrimination laws, 215 General Agreement on Tariffs and Trade (GATT), 468, 519 General Motors (GM), 507 General Theory of Employment, Interest, and Money, The (Keynes), 293, 307, 429, 443 Globalization, 261 GM See General Motors Gold, 404, 410, 484 Goldsmiths, 410 Goods capital, 233 complementary, 54 final, 229–230 inferior, 54 intermediate, 230 network, 154–155 normal goods, 54 prices of other, 62 prices of related, 54 private, 88 public, 86–88 substitute, 54, 96, 105–106 www.downloadslide.com 560 INDEX Gosplan, 493–494 Government expenditures, 233, 346–348 automatic stabilizers and, 333–335 crowding-out effect and, 377–379 federal, 347 growth as a percentage of GDP, 346 increasing to combat recession, 326–328 in other countries, 348 patterns, 347–348 revenues, and deficits as percentage of GDP, 369 Government securities, 416–417 Governments, intervention in markets by, 83–87 Graphs applying to economics, 17–26 direct relationship between variables, 17–18 independent relationship between variables, 20, 21 inverse relationship between variables, 18–19 Great Depression, 249, 288 compared to Great Recession, 444 cyclical unemployment and, 261 Keynesian expansionary fiscal policy and, 331 monetary policy during, 443 paper money and, 396 real GDP during, 443 stock market crashes and, 255 unemployment rate and, 256–257, 258 unions and, 202 Great Recession aggregate demand-aggregate supply model for, 301 compared to Great Depression, 444 economic growth and, 251 effect of decreases in aggregate demand during, 302 Federal Reserve System and, 441 government deficit and, 372 as influence affecting recent federal budget surpluses and deficits, 368 Keynesian management of the economy in, 289 in phase of business cycle, 249, 252 unemployment rate in, 257 Greenhouse effect, 308 Greenspan, Alan, 372, 441 Gross domestic product (GDP), 228–242 actual and potential, 264 definition of, 229 domestic production and, 229 federal expenditures, revenues, and deficits as percentage of, 369 federal net interest as a percentage of, 375 final goods and, 229–330 formula for, 234 government surpluses and deficits as a percentage of, 371 growth of government expenditures as a percentage of, 346 growth rates in other countries, 252 international comparison of, 235 measuring, 230–234, 243 money value and, 394 national debt as percentage of, 375 nominal, 240–241 in other countries, 234 real, 240–241 real GDP growth rate in China, 504 shortcomings, 234–237 taxes as percentage of, 350 Gross investment, 233 Gross private domestic investment, 232–233 Gross public debt See National debt Guatemala, 473 H Hamburger University, 124 Hayek, Friedrich, 499 Health care, 94–97 Health insurance, 94–95 Hicks, John, 169 Hitler, Adolph, 428 Homogeneous products, 132, 182 Honduras, 473 Hong Kong, 472, 502, 519, 520–521 Hoogewerft, Rupert, 506 Housing and Economic Recovery Act, 441 Housing assistance, 213 Housing market bubble, 441 Hu Jintao, 506 Huckabee, Mike, 356 Human capital, 198, 319, 516–517 Human resources, 516–517 Humor index, 274–275 Hurun Report, 506 Hyperinflation, 282–283 I IACs See Industrially advanced countries IMF See International Monetary Fund Implicit costs, 113 Impossible entry, 153 Income demand and, 54 disposable personal, 239–240 division of total annual money, 206 health care and, 96 inequality, 87 inflation and, 278–279 median family, 207 median money, 206 national, 237–238 nominal, 278 personal, 238–239 real, 278 relative, 480 relative price levels, 480–481 taxes, 354–355 Income disparity, 511–514 Income distribution, 204–207 Income inequality, 87, 205–207 Income security, 347 Incomplete knowledge, 313 Independent relationship, 20, 21 Indicators, business-cycle, 252–254 Individual demand, 50 Industrially advanced countries (IACs) comparing less-developed and, 511–514 definition of, 512 growth and development around the world of, 514–521 helping hand of, 521–525 Inelastic demand, 101 Inequality, income, 87, 205–207 Infant industry argument, 469 Inferior goods, 54 Infinite geometric series, 328–329 Inflation, 270–287 consequences of, 277–281 cost-push, 281–282 definition of, 271 demand-pull, 281 hyperinflation, 282–283 income and, 278–279 meaning and measurement of, 271–277 in other countries, 282–284 psychosis, 282 rates, 276–277 real interest rate and, 280–281 using fiscal policy to combat, 331–333 wealth and, 279–280 Infrastructure, 517, 519 In-kind transfers, 208, 211 Inside lags, 422 Interest payments, on national debt, 366–367 Interest rates affect of monetary policy on, 433–434 discount rate, 419–420 equilibrium, 431–432 investment spending and, 434 nominal, 280 real, 280 relative real, 481–482 speculative demand for money and, 429 Interest-rate effect, 291 Intermediate goods, 230 Intermediate range, 299 Internal national debt, 375 International Air Transport Association (IATA), 184 International debt, 476–477 International economics cartels, 183–185 development around the world and, 514–521 exchange rates, 477–485 GDP growth rates, 252 government expenditures, 348 inflation, 282–284 labor union membership, 202–204 national debt, 476–477 tax burden, 349, 350 International finance balance of payments, 473–477 exchange rates, 477–485 International Monetary Fund (IMF), 484, 524–525 International Telecommunications Union (ITU), 184 International trade, 463–473, 519–521 absolute and comparative advantage in, 465–467 arguments for protection, 469–471 free trade agreements, 472–473 free trade vs protectionism, 467–469 need for, 463–465 Invention, 34 Inverse relationship, 18–19 Investment definition of, 37 fixed, 232–233 foreign private, 522–523 future production possibilities curve and, 36–37 government expenditures and, 346 gross, 233 gross private domestic, 232–233 investment in, 516–517 Investment demand curve, 435, 436, 443, 445 Invisible hand, 131, 496 J Jackson, Andrew, 364 Japan, 463, 472, 479–481, 498, 502, 519 Job discrimination, 213–214 Jobs, Steven, 126 www.downloadslide.com INDEX K Keating, Charles, Jr., 405 Kentucky Fried Chicken, 504 Keynes, John Maynard, 288–289, 293, 307, 429, 443 Keynesian economics, 331 classical views of contractionary policy vs., 452–453 classical views of expansionary policy vs., 451–452 demand-side versus supply-side effects, 336 horizontal aggregate supply curve, 294 monetary policy transmission mechanism of, 434 overview of, 443–445 range in AD-AS macroeconomic equilibrium, 299 ranges of the aggregate supply curve, 297–298 supply-side effects vs demand-side effects of tax cuts, 338 supply-side fiscal policy and, 335 view of aggregate supply, 293–294 view of role of money, 429–432 Kind, 235–236 Kushner, Malcolm, 274 Kuznets, Simon, 228 L Labor, demand curve for, 196, 201 demand for, 195–197, 203 marginal product of, 195 supply curve of, 197–198, 202 supply of, 197–199, 203 surplus, 81 unions and, 200 Labor markets under perfect competition, 195–200 supply-side fiscal policies and, 337 Labor productivity, 467 Labor unions employee power, 200–203 membership, 202–204 Laffer, Arthur, 339 Laffer curve, 339 Lagging indicators, 254 Lags, in fiscal and monetary policy, 422 Laissez-faire, 294–295, 496, 520 Land, 3–4 Law and order, 519 Law of demand, 49–50, 56 Law of diminishing returns, 115–117, 196 Law of increasing opportunity costs, 32–34, 463 Law of supply, 56–58 LDCs See Less-developed countries Leading indicators, 253 Legal barriers, 153–154 Leisure time, 236 Lenin, Vladimir, 428, 504 Less-developed countries (LDCs) comparing developed and, 511–514 definition of, 512 growth and development around the world of, 514–521 helping hand of advanced countries and, 521–525 Levi Strauss Company, Liabilities, 411 Lincoln, Abraham, 364 Lincoln Savings and Loan, 405 Liquidity, 394 Loans, 412–413, 524 Logrolling, 358 Long run, 115, 162, 178–179 Long-run aggregate supply curve (LRAS), 315, 319, 320–321 Long-run average cost curve, 121–123, 144–145 Long-run equilibrium, 144–145 Long-run production costs, 121–123 Long-run supply curves, 144–145 Loss, short-run, 137–141, 162 LRAS See Long-run aggregate supply curve M M1, 397, 412–418, 422 M2, 398–399, 422 Macro equilibrium price, 320 Macroeconomic equilibrium, 297–301 Macroeconomics comparison of views, 442–446 definition of, formula for GDP in, 234 Macroeconomy impact of monetary policy on, 434–435 measures of, 239 Majority-rule problem, 357–358 Mao Zedong, 504, 506 Marginal analysis, 30, 134–137 Marginal cost (MC), 120, 134–137 Marginal product, 115–117 Marginal product of labor, 195 Marginal propensity to consume (MPC), 328, 329 Marginal revenue equals marginal cost method, 134–137, 158–161 Marginal revenue (MR), 134–137, 155–158 Marginal revenue product (MRP), 196 Marginal tax rate, 352 Market clearing, 65 Market demand, 50–51, 64–66 See also Demand Market demand curve, 50–51 Market economy, 48, 495–497 Market efficiency, 83 Market equilibrium, 74–77 Market failure, 83–87 Market rigging, 83, 84 Market structure comparison of, 187–188 definition of, 132 monopolistic competition, 176–177 monopoly, 153–155 oligopoly, 182–187 perfect competition, 131–134 Market supply, 58, 64–66 See also Supply Markets barriers to entry, 132, 177, 183 definition of, 64 difficult entry to, 183 easy entry and exit from, 177 factor, 230 government intervention in, 77–82 impossible entry to, 153 monopolistically competitive, 177 product, 230 Marshall, Alfred, 65 Marx, Karl, 500–501, 504 McCain, John, 356 McDonald’s, 124, 504 McKinley, William, 484 Means test, 209–210 Measures, quality-of-life, 513–514 Median money income, 206 Medicaid, 212 Medicare, 211–212 561 Medium of exchange, 393 Mercantilism, 496 METI See Ministry of Economy, Trade and Industry Mexico, 463, 472, 476, 485 Microeconomics, 5–6, 65–66 Midpoints formula, 99–100 Milk price supports, 82 Minimum wage, 11, 80–81, 525 Ministry of Economy, Trade and Industry (METI), 498 Mixed economy, 497–498 Model development, Model-building process, Models, Monetarism, 435–440, 445 Monetary Control Act, 398, 404–406 Monetary History of the United States, A (Friedman & Schwartz), 443 Monetary policy comparison of macroeconomic views and, 442–445 definition of, 416 discount rate, 419–420 disputes over, 451–453 effect of expansionary policy on aggregate demand, 436 effect on interest rate of, 433–434 effect on prices, output, and employment, 434–435 vs fiscal policy, 422 during Great Depression, 443 impact by using AD-AS model, 435 Keynesian transmission mechanism, 434 Keynesian view of role of money in, 429–432 monetarist transmission mechanism, 435–440 monetarist view of role of money in, 435–441 money creation and, 416–421 money supply and, 416–421 open market operations, 416–419 required reserve ratio, 420–421 shortcomings of, 422 Monetary rule, 439 Money behind, 396–397 commodity, 396 counterfeit, 395–396 credit cards and, 394–395 demand for, 429 as divisible, 396 fixed, 439 functions of, 393 history of, 396–397 as medium of exchange, 393 monetarist view of, 435–440 near, 398 as portable, 396 precautionary demand for, 429 properties of, 395–396 quantity theory of, 438 speculative demand for, 429 as store of value, 394 transactions demand for, 429 uniformity of, 396 as unit of account, 394 velocity of, 437, 439–440 Money creation, 409–427 banks and, 410–414 beginning of, 410 monetary policy and, 416–421 monetary policy shortcomings and, 422 multiplier expansion of money by system, 414–416 www.downloadslide.com 562 INDEX Money curve, demand for, 430–431 Money income, 278 Money multiplier, 415–416, 422 Money supply controlling, 402 decreasing, 434 definitions, 397–399 expansion of, 415 Federal Reserve System and, 402 increasing, 433–434 M1, 397, 412–418, 422 M2, 398–399, 422 monetary policy and, 416–421 Monopolistic competition comparing perfect competition and, 179–182 less output for more and, 180–182 in long run, 178–179 market structure, 176–177 in short run, 177–178 Monopolistically competitive firm in long run, 180 price and output decisions for, 177–179 as price maker, 177 in short run, 179 Monopoly, 152–174 case against and for, 168–169 compared with perfect competition, 166–168 long run, 162 market structure, 153–155 natural, 154 in other countries, 156 price and output decisions, 155–162 price discrimination, 162–165 Mortgages, 280, 441 Motel rental rates, 141 MPC See Marginal propensity to consume MR = MC rule, 137 Mutual interdependence, 182 N NAFTA See North American Free Trade Agreement NASA See National Aeronautics and Space Administration National Aeronautics and Space Administration (NASA), 499 National Association for Business Economics (NABE), 255 National debt bankruptcy and, 371–372 burden to future generations, 375–377 crowding-out effect and, 377–379 external, 375–376 federal net interest as a percentage of GDP, 375 financing, 366–368 global perspective on, 374 internal, 375 ownership of, 376 reasons to worry about, 370–379 National income accounting method See Expenditure approach National income (NI), 237–238 National Industrial Recovery Act (NIRA) of 1933, 202 National Labor Relations Act (NLRA) of 1935, 202 National Metal Industries, National retail sales tax, 356 National security argument, 469 Nationalization, 505–507 Natural monopoly, 154 Natural rate of unemployment, 262–263 Natural resources, 3–4 endowment of, 516 Near money, 398 Negative externalities, 84, 236–237 Negotiable order of withdrawal (NOW) accounts, 398 Neighborhood effects See Externalities Net exports, 233–234 Net exports effect, 291 Net public debt, 367 Network good, 154–155 New York Federal Reserve Bank, 401 New York taxicabs, 168 Newly industrialized economies, 513, 520–521 Nicaragua, 473 NIRA See National Industrial Recovery Act of 1933 Nixon, Richard M., 79, 484 NLRA See National Labor Relations Act of 1935 Nominal GDP, 240–241 Nominal income, 278 Nominal interest rates, 280 Nondiscretionary fiscal policy See Automatic stabilizers Nonmarket transactions, 234–235 Nonprice competition, 176, 183 Nonprice determinants of aggregate demand, 292–293, 303 of aggregate supply, 301–303 of demand, 51, 52–56 of supply, 59, 61–63 terminology for changes in, 60 Nonprice-level determinants, 292–293, 301–303 Nonproductive financial transactions, 229 Nonrenewable resources, Normal goods, 54 Normal profit, 114, 178 Normative economics, 10–11 North American Free Trade Agreement (NAFTA), 472, 485, 519 North Korea, 503 NOW accounts See Negotiable order of withdrawal accounts O Obama, Barack, 325, 368 Office of Management and Budget (OMB), 372 Offshoring, 261 Oil prices, 58 Okun, Arthur, 278 Old Age, Survivors, and Disability Health Insurance (OASDHI), 211 Oligopoly, 182–187 OMB See Office of Management and Budget Open market operations, 416–419 Operating budget, 379 Opportunity cost, 28–29, 32–34, 78, 429 Organ shortages, 67 Organization of Petroleum Exporting Countries (OPEC), 184, 281, 302 Ostrich farming, 131 Output affect of monetary policy on, 434–435 decisions for monopolistically competitive firm, 177–179 decisions for monopoly, 155–162 decisions for oligopoly, 183–187 for monopolistic competition, 180–182 for perfect competition, 167 Outside lags, 422 Outsourcing, 261 Overpopulation, 516–517 Ownership, 153 P Panic of 1907, 399 Paper money, 396, 397 Patents, 154 Pay discrimination, 214 PayGo law, 368 Payoff matrix, 185, 186 Payroll taxes, 354 Peak, 249 People’s Republic of China, 463, 472, 476, 504–505, 506 Per capita energy consumption, 514 Perfect competition, 131–151 compared with monopoly, 166–168 long-run supply curves under, 144–145 more output for less and, 167 short-run supply curves under, 141–144 Perfectly competitive firm facing short-run loss, 138–140 long-run equilibrium for, 144–145 as price taker, 133–134 short-run equilibrium for, 142–144 short-run loss minimization, 137–141 short-run profit maximization for, 134–137 short-run supply curve, 141 shutting down, 140–141 Perfectly competitive industry short-run supply curve, 141–142 Perfectly elastic demand, 102–103 Perfectly inelastic demand, 103 Personal computers (PCs) market rigging and, 83, 84 prices of, 62 Personal consumption expenditures, 232 Personal income (PI), 238–239 Petrossian Company, 156 Plastic money, 394–395 Political environment, 519 Pollution, 84–86 Pollution taxes, 85–86 Popcorn prices, 165 Population growth, 517 Positive economics, 10 Positive externalities, 84 Poverty, 207–209, 517 Poverty line, 208 Precautionary demand for money, 429 Preferences, 53, 96, 479–480 Present investment, future production possibilities curve and, 36–37 Price ceilings, 77–80 Price controls, 77–82 Price discrimination, 162–165 Price elasticity of demand, 98–111 cigarette smoking, 107 determinants of, 105–108 elastic demand, 100–101 inelastic demand, 101 midpoints formula, 99–100 in monopoly, 155–158 perfectly elastic demand, 102–103 perfectly inelastic demand, 103 terminology, 103 total revenue test of, 100 unitary elastic demand, 102 variations along demand curve, 103–105 Price floors, 80–82 Price leadership, 183 www.downloadslide.com INDEX Price levels, relative, 480–481 Price maker, 155, 177 Price supports, 82 Price system, 65–66, 67 Price taker, 133–134, 155 Prices See also Equilibrium price adjustment to change over time, 107–108 base-year, 272 Central planners fixing, 495 current-year, 272 decisions for monopolistically competitive firm, 177–179 decisions for monopoly, 155–162 decisions for oligopoly, 183–187 effect of monetary policy on, 434–435 market demand, 50–51 of other goods firm could produce, 62 personal computers, 62 of related goods, 54 relative price levels, 480–481 resource, 59, 61, 97 of substitutes, 96 terminology for changes in, 60 trend in, 76–77 Private goods, 88 Private interest, 501 Private ownership, 498 Private property, 501 Privatization, 505–507 Problem identification, Producers, expectations of, 61 Product differentiation, 176, 182 Product markets, 230 Production domestic, 229 monopolist as a resource misallocator and, 166 scales of, 123–126 Production costs, 112–130 long run, 121–123 short run, 115–117 short-run cost formulas, 117–121 Production function, 115, 195 Production possibilities curve, 30–32 alpha’s and beta’s present and future, 518 effect of external financing on an LDC’s, 523 effect of public capital on, 38 international trade and, 463–464 outward shift of, 35 present investment and, 36–38 technological change and, 35 Productivity, 467, 470 Products decisions about production of, 28 homogeneous, 132, 182 quality of, 235–236 unique, 153 Profit costs and, 113–114 definition of, 113 economic and accounting, 113–114 normal, 114, 178 Profit maximization, short-run, 134–137, 158–161 Profit motive, 496 Progressive taxes, 352–353 Property taxes, 354 Proportional taxes, 354 Protectionism arguments for, 469–471 definition of, 467 free trade vs., 467–469 Public choice theory, 356–360 bureaucratic inefficiency, 359 majority-rule problem, 357–358 rational voter ignorance, 358–359 shortsightedness effect, 359 special-interest group effect, 358 Public goods, 86–88, 351 Public interest, 499, 501 Public ownership, 506 Public sector, 345–363 art of taxation, 351–356 financing government budgets, 349–350 government size and growth, 346–348 public choice theory, 356–360 Q Quality of products, 235–236 Quality-of-life measures, 513–514 Quantity, equilibrium, 51–52 Quantity theory of money, 438 Quota, 469 R Racial discrimination, 199, 213–214 Rational ignorance, 359 Rational voter ignorance, 358–359 Rationing, 65 Reagan, Ronald, 325, 345, 368, 372 Real balances effect, 290–291 Real GDP, 240–241 changes in potential, 319–320 during Great Depression, 443 growth rates in other countries, 252 international comparison of, 253 Real income, 278 Real interest rates, 280 Real median family income, 207 Recession cutting taxes to combat, 330–331 definition of, 249 increasing government spending to combat, 326–328 opposing anti-recession theories, 452 severity of Post–World War II, 251 stock market crashes and, 255 Recovery, 249 Regressive taxes, 353–354 Regulation, 85, 86 Relative incomes, 480 Relative price levels, 480–481 Relative real interest rates, 481–482 Renewable resources, Rent control, 77–79 Rent Your Own Storage Center, 145 Required reserve ratio, 411, 420–421 Required reserves, 411 Resolution Trust Corporation (RTC), 406, 506 Resource misallocation, 166, 180 Resource prices, 59, 61, 97 Resources categories of, 3–4 changes in, 34 fixed, 30 fully employed, 30 natural, 3–4 ownership of, 153, 498 scarce, Retail sales tax, 356 Revenue, 155–158 marginal, 134–137, 155–158 total, 100–101 Road to Serfdom, The (Hayek), 499 Robot musicians, 263 Rockefeller, John D., 168 563 Roosevelt, Franklin D., 202, 210, 368, 484 RTC See Resolution Trust Corporation Russia, 472, 503–504 S Sales tax, 353, 356 Savings and Loans crisis, 405–406 Savings deposits, 398–399 Scales of production, 123–126 Scarcity choice and, 5–6, 29 money and, 395–396 price system and, 67 problem of, 3, 28 School vouchers, 88 Schumpeter, Joseph, 168 Schwartz, Anna, 443 Search unemployment, 260 Secondhand transactions, 229 Securitization, 441 Self-correcting AD-AS model, 315, 316, 451–453 Self-sufficiency, 464–465 Sellers few, 182 many small, 176 number of, 61, 96–97 single, 153 September 11, 200, 255 Short run, 115, 177–178 Short run cost curves, 120, 122 Shortage, 64 Short-run aggregate supply curve (SRAS), 313–315, 452–453 Short-run cost formulas, 117–121 Short-run equilibrium, 142–144 Short-run loss, 137–141, 162 Short-run loss minimization, 137–141, 163 Short-run production costs, 115–117 Short-run profit maximization, 134–137, 158–161 Short-run supply curves, 141–144 Shortsightedness effect, 359 Shutdown point, 140 Silver, 396, 397 Singapore, 513, 519, 520 Single seller, 153 Sixteenth Amendment, 354 Slope, 20 Small time deposits, 399 Smith, Adam, 83, 123, 131, 294, 357, 443, 495–497, 500, 520 Smith, Frederick W., 36 Social insurance taxes, 349 Social networking sites, 178 Social Security, 210, 211, 346 Social Security Administration (SSA), 367 Social Security trust fund, 210, 367 Socialism, 499–502 South Korea, 513, 519, 520 Soviet Union, 492, 494, 500, 501, 503 Special-interest group effect, 358 Specialization, 464–465 Speculative demand for money, 429 Spending multiplier (SM) arithmetic, 328–329 definition of, 327 effect, 329 relationship between MPC and, 329 Spillover effects See Externalities SRAS See Short-run aggregate supply curve SSA See Social Security Administration Stagflation, 304, 335 Standard Oil, 164 www.downloadslide.com 564 INDEX Standex International Corporation, Steel industry, 84, 468 Stock market crashes, 255 Stone money, 395 Store of value, 394 Structural unemployment, 260 Subprime mortgage loans, 441 Subsidies, 59, 61, 86 Substitute goods, 54, 96, 105–106 Supply See also Aggregate supply analysis to health care, 94–97 change in, 59–60, 75–76 change in quantity supplied, 59–60 definition of, 56 for foreign exchange, 479 of health care, 96–97 labor, 197–199, 203 law of, 56–58 market, 58 nonprice determinants of, 61–63 Supply curve See also Aggregate supply curve for dollars, 481 of labor, 197–198 long run, 144–145 movement along, 59 nonprice determinants of supply on, 59, 63 short run, 141–144 Supply shifters, 59 Supply-side fiscal policy, 335–338 Surplus, 64 T T-accounts, 410 Taiwan, 513, 519, 520 Tariffs, 467–469 TARP See Troubled Assets Recovery Program Tastes, 53, 96, 479–480 Tax multiplier (TM), 330–331, 336 Tax rates, 352 Tax Reform Act of 1986, 355 Taxable income, 352, 353 Taxes/taxation ability-to-pay principle, 351 benefits-received principle, 351 cuts, 325, 336–338, 345 cutting to combat recession, 330–331 excise, 353 FICA, 354 flat, 356 growth as a percentage of GDP, 350 income, 354–355 national retail sales, 356 as nonprice determinant, 59, 61 in other countries, 349, 350 payroll, 354 pollution, 85–86 progressive, 352–353 property, 354 proportional, 354 reform, 354–356 regressive, 353–354 retail sales, 356 sales, 353 social insurance, 349 supply-side cuts, 337–338 supply-side effects vs demand-side effects of cuts in, 338 tariffs, 467–469 value-added, 356 Taxicabs, 168 T-bills See Treasury bills Technological change, 34–35 Technological progress, 518–519 Technology, 30, 61, 261, 319 Temporary Assistance to Needy Families (TANF), 211 Tennessee Valley Authority (TVA), 499 Testable, 10 Theories, Third parties, 84 Three-variable relationship, 20–22 Thrift Bailout Bill, 406 Thrifts, 404, 405 Ticket prices, 98 Ticket scalping, 82 Time deposits, 399 Tit-for-tat strategy, 186 Total cost curves, 117–119 Total cost (TC), 119, 134–137 Total fixed cost (TFC), 117–118 Total revenue, 100–101, 155–158 Total revenue-total cost method, 134–137, 158, 160 Total spending, 254–256, 281 Total variable cost (TVC), 118 Trade balance of, 473–476, 485 embargoes, 467 free trade vs protectionism, 467–469 specialization with, 465 specialization without, 464–465 U.S trading partners, 463 Trade deficits, 474 Trade sanctions, 106 Traditional economy, 492 Transactions demand for money, 429 Transfer payments, 229, 233, 346 Transitional unemployment, 260 Treasury bills (T-bills), 366, 378, 416, 417, 423 Trillion-dollar person, Troubled Assets Recovery Program (TARP), 441 Trough, 249 Truman, Harry, 10 Tuition policies, 164 TVA See Tennessee Valley Authority U Underemployment, 258 Underground economy, 236 Unemployment, 256–266 cyclical, 261–262 frictional, 259–260 natural rate of, 262–263 nonmonetary and demographic consequences, 265–266 in other countries, 257 robot musicians and, 263 structural, 260 types of, 259–262 Unemployment compensation, 92, 211, 346 Unemployment rate criticisms, 257–258 definition of, 256–357 in Great Depression, 256–257, 258 by selected demographic groups, 265 for selected nations, 259 in United States, 258 Unilateral transfers, 475 Unions See Labor unions Unique products, 153 Unit of account, 394 Unitary elastic demand, 102 United States, 476–477, 502 balance of trade, 473–476, 485 business cycles, 252 international debt of, 476–477 trade deficit, 474, 475 trading partners, 463 unemployment rate, 258 Upshaw, David L., Uruguay round, 468 U.S dollar, 480–481 U.S mints, 403 U.S Postal Service, 499 U.S Treasury, 366–367, 372, 377, 396, 399, 400, 403, 404 V Value-added tax (VAT), 356 Variable input, 115 Variables direct relationship between, 17–18 independent relationship between, 20, 21 inverse relationship between variables, 18–19 VAT See Value-added tax Velocity of money, 437, 439–440 Vicious circle of poverty, 517 Voters, rational ignorance of, 358–359 W Wage rates, equilibrium, 198–199 Wage-price spiral, 284 Wages collective bargaining and, 200–201, 203 comparable worth and, 214, 215 minimum, 11, 80–81 Wagner Act (1935), 202 Wall Street Journal, 339 Wampum, 393, 396 War on drugs, 87 War on terrorism, 36 Wealth, 279–280 Wealth of Nations, The (Smith), 83, 123, 443, 495, 496, 500, 520 Welfare payments, 346 Welfare reform, 212 Wilson, Woodrow, 399 Working poor, 11 World Bank, 510, 524, 525 World trade See International trade World Trade Organization (WTO), 468, 471, 504, 519 World War II, 346, 368, 370, 371, 376–377 WTO See World Trade Organization X Xerox Corporation, 35 Y Yap, 395, 404 Yen-per-dollar exchange rate, 480 Z Zandi, Mark, 331 Zero economic profit, 114, 134 ... 3 02 PART • The Macroeconomy and Fiscal Policy E XH I BI T 14.9 Effect of Decreases in Aggregate Demand During 20 08 20 09 of the Great Recession AS E1 Price level 21 9 (CPI) 21 2 E3 E2 AD1 AD3 AD2... XH I BI T 14.5 29 5 The Classical Vertical Aggregate Supply Curve AS 400 Price level (CPI) Surplus 300 E1 E′ E2 20 0 AD1 100 AD2 Full employment 12 16 20 24 Real GDP (trillions of dollars per year)... and E2 caused by the aggregate demand curve decreasing from AD1 to AD2 along the intermediate range of the aggregate supply curve AS At E2 in the fourth quarter of 20 08, the CPI dropped to 21 2,