PART I 1
GETTING ACQUAINTED WITH ECONOMICS 1
1 What Is Economics? 3
2 The U.S. Economy: Myth and Reality 25
3 Scarcity and Choice: The Economic Problem 49
4 Supply and Demand: An Initial Look 67
PART II 93
ESSENTIALS OFMICROECONOMICS:CONSUMERS AND FIRMS 93
5 Consumer Choice: The Demand Side of the Market 95
6 Demand and Elasticity 125
7 Production, Inputs, and Cost: Building Blocks for Supply Analysis 147
8 Output, Price, and Profit:The Importance of Marginal Analysis 181
PART III 207
THE MARKET SYSTEM: VIRTUES AND VICES 207
9 The Firm and the Industry under Perfect Competition 209
10 The Price System and the Case for Laissez-Faire 233
11 Monopoly 255
12 Between Competition and Monopoly 275
13 The Market Mechanism: Shortcomings and Remedies 301
14 Real Firms and Their Financing: Stocks and Bonds 325
PART IV 349
THE DISTRIBUTION OF INCOME 349
15 Pricing the Factors of Production 351
16 Labor: The Human Input 377
17 Poverty, Inequality, and Discrimination 403
PART V 429
THE GOVERNMENT AND THE ECONOMY 429
18 Limiting Market Power: Regulation of Industry 431
19 Limiting Market Power: Antitrust Policy 451
20 Taxation and Resource Allocation 469
21 Environmental Protection and Resource Conservation: The Economist's Approach 491
PART VI 515
THE MACROECONOMY:AGGRSGATE SUPPLY AND OEMAND 515
22 The Realm of Macroeconomics 517
23 Unemployment and Inflation: The Twin Evils of Macroeconomics 537
24 Income and Spending: The Powerful Consumer 563
25 Demand-Side Equilibrium: Unemployment or Inflation? 587
26 Changes on the Demand Side: Multiplier Analysis 609
27 Supply-Side Equilibrium: Unemployment and Inflation? 627
PART VII 647
FISCAL AND MONETARY POLICY 647
28 Managing Aggregate Demand: Fiscal Policy 649
29 Money and the Banking System 671
30 Monetary Policy and the National Economy 695
31 The Debate over Monetary Policy 717
32 Budget Deficits and the National Debt: Fact and Fiction 745
33 The Trade-off between Inflation and Unemployment 769
PART VIII 795
THE UNITED STAES IN THE WORLD ECONOMY 795
34 International Trade and Comparative Advantage 797
35 The International Monetary System: Order or Disorder? 821
36 Macroeconomics in a World Economy 845
37 Productivity and Growth in the Wealth of Nations 865
38 Comparative Economic Systems: What Are the Choices? 897
ACQUAINTED WITH ECONOMICS 1
CHAPTER 1 WHAT IS ECONOMICS? 3
Ideas for Beyond the Final Exam 3
Idea 1: Mutual Gains from Voluntary Exchange 4
Idea 2: Rational Choice and True Economic Costs: The Role of Opportunity Cost 4
Idea 3: Attempts to Repeal the Laws of Supply and Demand: The Market Strikes Back 5
Idea 4: The Importance of Marginal Analysis 5
Idea 5: Externalities: A Shortcoming of the Market Cured by Market Methods 6
Idea 6: The Cost Disease of the Personal Services 6
Idea 7: The Trade-off between Output and Equality 7
Idea 8: The Trade-off between Inflation and Unemployment 7
Idea 9: The Illusion of High Interest Rates 8
Idea 10: Do Budget Deficits Burden Future Generations? 8
Idea 11: The Overwhelming Importance of Productivity Growth in the Long Run 9
Idea I2: The Surprising Principle of Comparative Advantage 9
Inside the Economist's Tool Kit 10
Economics as a Discipline 10
The Need for Abstraction 10
The Role of Economic Theory 13
What Is an Economic "Model" 15
Reasons for Disagreements: Imperfect Information and Value Judgments 16
Last World: Common Sense Is Not Always Reliable 17
Summary 17
Key Terms 17
Questions for Review 18
Appendix: The Graphs Used in Economic Analysis 18
Two-Variable Diagrams 18
The Definition and Measurement of Slope 19
Rays through the Origin and 45？ Lines 22
Squeezing Three Dimensions into Two: Contour Maps 23
Summary 24
Key Terms 24
Questions for Review 24
CHAPTER 2 The U.S. Economy: MYTH AND REAUTY 25
The American Economy:A Thumbnail Sketch 25
A Growing Economy...but with Inflation 28
The Inputs:Labor and Capital 32
The Outputs:What America Produce? 34
Public Opinion on Profits 35
The Central Role of Business Firms 35
Is That an American Company? 36
What's Missing from the picture Government 36
Conclusion:The Mixed Economy 40
Summary 41
Key Terms 41
Questions for Review 41
Appendix:Further Perils in the Interpretation of Graphs 42
Distorting Trends by Choice of the Time Period 42
Dangers of Omitting the Origin 43
Unreliability of Steepness and Choice of Units 44
Summary 47
Questions for Review 47
CHAPTER 3 SCARCITY AND CHOICE: THE ECONOMIC PROBLEM 49
Problem:The"indispensable Necessity"Syndrome 50
Scarcity,Choice,and Opportunity cost 50
Scarcity and Choice for a Single Firm 52
The Principle of Increasing Costs 54
Scarcity and Choice for the Entire Society 55
A Military-Civilian Output Trade-off in Reality 55
Scarcity and Choice Elsewhere the Economy 57
The Concept of Efficiency 59
The Three Coordination Tasks of Any Economy 60
Specialization,Division of Labor,and Exchange 60
Adam Smith (1723--1790) 61
Markets,prices,and the Three Coordination Tasks 62
Liberal and Conservative Goals Can Both Be Served by the Market Mechanism 63
Summary 64
Key Terms 65
Questions for Review 65
CHAPTER 4 SUPPLY AND DEMAND:AN INITIAL LOOK 67
Fighting the Invisible Hand 68
Price COntrols at Valley Forge 68
Demand and the Quantity Demanded 69
Supply and the Quantity Supplied 71
Equilibrium of Supply and Demand 73
Shifts of the Demand Curve 75
Shifts of the Supply Curve 79
Restraining the Market Mechanism:Price Ceilings 83
Policy Debate: Economic Aspects of the War on Drugs 84
Restraining the Market Mechanism:Price Floors 86
A Can of Worms 87
A Simple but Powerful Lesson 89
Summary 89
Key Terms 90
Questions for Review 90
PART II ESSENTIALS OF MICROECONOMICS:CONSUMERS AND FIRMS 93
CHAPTER 5 CONSUMER CHOICE: THE DEMAND SIDE OF THE MARKET 95
A Paradox: Should Water Be Worth More Than Diamonds? 96
Scarcity and Demand 96
Total ond Marginal Utility 97
Do Consumers Really Behave "Rationally" and Maximize Utility? 101
From Marginal Utility to the Demand Curve 103
Consumer Choice as a Trade-off Opportunity Cost 104
Consumer Surplus: The Net Gain from a Purchase 105
Resolving the Diamond-Water Paradox 107
Price, Income, and Quantity Demanded 107
From Individual Demand Curves to Market Demand Curves 110
The "Law" of Demand 111
Summary 112
Key Terms 113
Questions for Review 113
Appendix: Indifference Curve Analysis 114
Geometry of Available Choices: The Budget Line 114
What the Consumer Prefers: The Indifference Curve 116
The Slopes of Indifference Curves and Budget Lines 118
The Consumer's Choice 119
Consequences of Income Changes: Inferior Goods 121
Consequences of Price Changes: Deriving the Demand Curve 121
Summary 123
Key Terms 123
Questions for Review 124
CHAPTER 6 DEMAND AND ELASTICITY 125
Two Illustrative Cases 125
Example I: The Revenue Effect of a Sales-Tax Cut 125
Example II: Polaroid v.Kodak 126
Elasticity: The Measure of Responsiveness 127
Price Elasticity of Demand and the Shapes of Demand Curves 130
The Relationship between Elasticity.ond Slope 132
Price Elasticity of Demand and Total Expenditure 133
What Determines Elasticity of Demand? 135
Price Elasticity:Ignore It at Your Peril 136
Elasticity as a General Concept 137
Cross Elasticify of Demand: Substitutes and Complements 137
How Large Is a Firm's Market share? Cross Elasticity as a Test 139
Shifts of the Demand Curve: Advertising, Income, and the Prices of Complements and Substitutes 139
The Time Dimension of the Demand Curve and Economic Decision Making 141
Two Illustrative Applications of Elasticity Analysis 142
Summary 143
Key Terms 143
Questions for Review 143
Appendix: Statistical Analysis of Demand Relationships 144
An Illustration: Did the Advertising Program Work? 146
CHAPTER 7 PRODUCTION, INPUTS, AND COST BUILDING BLOCKS FOR SUPPLY ANALYSIS 147
Application: Are Larger Firms More Efficient? 148
Production, Input Choice, and Cost with One Variable Input 149
The "law" of Diminishing Marginal Returns 151
The Optimal Quantity of an Input and Diminishing Returns 152
cost Curves and Input Quantities 153
Fixed Costs and Variable Costs 156
Long-Run versus Short-Run Costs 159
The Average Cost Curve in the Short and Long Run 160
Multiple Input Decisions:The Choice of Optimal Input Substitutability: The Choice of Input Proportions 162
The Marginal Rule for Optimal Input Proportions 164
The Production Function and the Firm's Cost Curves 165
Input Substitution in the Forest 165
Economies of Stale 167
Policy Debate: Should Water Be Provided to Western Farmers at Subsidized Prices? 167
The "law" of Diminishing Marginal Returns and Returns to Scale 169
Historical Costs versus Analytical Cost Curves 170
Resolving the Economies of Stale Puzzle 170
Cost Minimization in Theory and Practice 172
Summary 173
Key Terms 173
Questions for Review 174
Appendix: Production Indifference Curves 174
Characteristics of the Production Indifference Curves 175
The Choice of Input Combinations 176
Cost Minimization, Expansion Path, and Cost Curves 177
Effects of Changes in Input Prices 178
Summary 179
Key Terms 179
Questions for Review 179
CHAPTER 8 OUTPUT, PRICE, AND PROFIT: THE IMPORTANCE OF MARGINAL ANALYSIS 181
Two Illustrative Cases 182
Case 1: Making Profits by Selling Below Costs 182
Case 2: Pricing a Six-Pack 182
Price and Quantity: One Decision, Not Two 182
Do Firms Really Maximize Profits? 184
Total Profit: Keep Your Eye on the Goal 185
Maximization of Total Profit 189
Marginal Analysis and Maximization of Total Profit 191
Marginal Revenue and Marginal Cost: Guides to an Optimum 192
Polity Debate: Profit and the New Market Economies 195
Generalization:The Logic of Marginal Analysis and Maximization 196
Application: Fixed Cost and the Profit Maximization 196
Marginal Analysis in Real Decision Problems 198
Conclusion: The Fundamental Role of Marginal Analysis 200
The Theory and Reality:A Word of Caution 201
Summary 202
Key Terms 202
Questions for Review 202
Appendix:The Relationships among Total,Average,and Marginal Data 203
Graphical Representation of Marginal and Average Curves 204
Questions for Review 205
PART III 207
THE MARKET SYSTEM: VIRTUES AND VICES 207
CHAPTER 9 THE FIRM AND THE INDUSTRY UNDER PERFECT COMPETITION 209
Two Practical Puzzles 209
Issue 1: Pollution-Reduction Incentives That Increase Pollution 210
Issue 2: Can Firms Shift the Burden of Taxation to Consumers 210
Varieties of Market Structre: A Sneak Proview 210
Perfect Competition Defined 211
The Competitive Firm and Its Demand Curve 212
Short-Run Equilibrium of the Perfectly Competitive Firm 213
Short-Run Profit:graphic Representation 215
The Case of Short-Term Losses 215
Shutdown and Break-Even Analysis 216
The Short-Run Supply Curve of the Competitive Firm 218
The Short-Run Supply Curve of the Competitive Industry 218
Industry Equilibrium in the Short Run 220
Industry and Firm Equilibrium in the Long Run 221
The Long-Run Industry Supply Curve 224
Zero Economic Profit: The Opportunity Cost of Capital 225
Perfect Competition and Economic Efficiency 226
Policy Debate: Should Perfect Competition Be Used as a Guide by Government Regulators? 227
Our Two Puzzles Resolved 228
Summary 230
Key Terms 231
Questions for Review 231
CHAPTER 10 THE PRICE SYSTEM AND THE CASE FOR LASSEZ-FAIRE 233
Puzzle: San Francisco Bay Bridge Pricing 234
Efficient Resource Allocation: The Concept 234
Pricing to Promote Efficiency: An Example 235
Earthquake, Bridge Congestion, and Route Substitution 237
Con Price Increases Ever Serve the Public Interest? 237
Scarcity and the Need to Coordinate Economic Decisions 239
Economic Shock Therapy in Poland 240
Three Coordination Tasks in the Economy 240
Input-Output Analysis: The Near Impossibility of Perfect Central Planning 243
Input-Output Equations: An Example 245
How Perfect Competition Achieves Efficiency: What to Produce 245
Other Roles of Prices: Income Distribution and Fairness 248
San Francisco Bridge Pricing Revisited 249
Toward Assessment of the Price Mechanism 230
Another Look at the Market's Achievement:Growth versus Efficiency 250
Policy Debate: User Charges for Public Facilities 251
Summary 252
Key Terms 252
Questions for Review 252
CHAPTER 11 MONOPOLY 255
Application: Monopoly and Pollution Charges 255
Monopoly Defined 256
Causes of Monopoly: Barriers to Entry and Cosi Advantages 257
Natural Monopoly 258
The Monopolist's Supply Decision 259
Determining the Profit -Maximizing Output 261
Comparison of Monopoly and Perfect Competition 263
Con Anything Good Be Said about Monopoly? 265
Price Discrimination under Monopoly 267
Monopoly ond the Shifting of Pollution Charges 270
Summary 272
Key Terms 273
Questions for Review 273
CHAPTER 12 BETWEEN COMPETITION AND MONOPOLY 275
Some Puzzling Observations 276
Monopolistic Competition 276
Price and Output Determination under Monopolistic Competition 218
The Excess Capacity Theorem and Resource Allocation 280
Oligopoly 281
A Shopping List 283
OPEC Keeps the Ceiling on Oil Output 285
Policy Debate: Acting on Recognized InterdePendence versus "Tacit Collusion" 286
The Kinked Demand Curve Model 288
The Game-Theory Approach 290
Monopolistic Competition, Oligopoly, and Public Welfare 294
Billion-Dollar APPlication: Game Theory and the FCC Auction 295
A Glance Backward: Comparison of the Four Market Forms 296
Summary 297
Key Terms 298
Questions for Review 298
CHAPTER 13 THE MARKET MECHANISM: SHORTCOMINGS ANO REMEDIES 301
Puzzle: Rising Health-Care Costs in Canada 302
What Does the Market Do Poorly? 302
Efficient Resource Allocation: A Review 302
Externalities:Getting the Prices Wrong 304
Provision of Public Goods 309
Allocation of Resources between Present and Future 311
Some Other Sources of Market Failure 313
Asymmetric Information, Lemons, and Agents 314
Market Failure and Government Failure 315
The Politics of Economic Policy 316
The Cost Disease of the Service Sector 316
Evaluative Comments 321
Epilogue:The Unforgiving Market, Its Gift of Abundance, and Its Dangerous Friends 322
Summary 323
Key Terms 324
Questions for Review 324
CHAPTER 14 REAL FIRMS AND THEIR FINANCING: STOCKS AND BONDS 325
Puzzle: The Stock Market's Unpredictability 325
Firms in the United States 326
Proprietorships 326
Partnerships 327
Corporations 328
Stocks and Bonds 330
Financing Corporate Activity 332
Corporate Choice between Stocks and Bonds 333
Buying Stocks and Bonds 334
Selecting a portfolio:Diversification 334
Following a Portfolio's Performance 335
Stock Exchanges and Their Functions 337
You Are There: An Event on the Trading Floor of the New York Stock Exchange 338
Regulation of the Stock Market 338
Stock Exchanges and Corporate Capital Needs 339
The Recent Surge in Takeover Battles 340
The lssue of Speculation 341
How to Lose a Billion Dollars in One Easy Step: The Derivatives Craze 342
Stock Prices as Random Walks 343
Football and Financial Forecasting 344
Summary 346
Key Terms 346
Questions for Review 347
PART IV 349
THE DISTRIBUTION OF INCOME 349
CHAPTER 15 PRICING THE FACTORS OF PRODUCTION 351
The Principle of Marginal Productivity 352
The Derived Demand Curve for an Input 353
Investment, Capital, and Interest 355
The Determination of Rent:Simple Version 361
Japanese Land Prices 363
The Rent of Land: Some Complications 364
Generalization:What Determines Shoquille O'Neal's Salary? 365
Rent Seeking 366
Rent Controls:The Misplaced Analogy 368
Issue:Are Profits Too High or Too Low? 369
What Accounts for Profits? 370
EntrepreneurshiP in Poland 371
Criticisms of Marginal Productivity Theory 372
Summary 373
Key Terms 374
Questions for Review 374
Appendix: Discounting and Present Value 315
Summary 376
Key Terms 376
Questions for Review 376
CHAPTER l6 LABOR: THE HUMAN INPUT 317
ISSUE: Lagging Wages and Growing Inequality 311
Competitive Labor Markets 378
The Supply of Labor 319
The Demand for Labor and the Determination of Wages 381
Why Wages Differ 382
Ability and Earnings:The Rent Component of Wages 383
Investment in Human Capital 384
Education and Earnings:Dissenting Views 385
The Effects of Minimum Wage Legislation 387
Unions and collective Bargaining 388
The Development of Unionism in America 390
The Way It Was 391
Union as Labor Monopolies 392
Monopsony and Bilateral Monopoly 395
Collective Bargaining and Strikes 396
The 1994--1995 Baseball Strike 397
Recent Developments in the u.s.Labor Market 399
Summary 401
Key Terms 401
Questions for Review 402
CHAPTER 17 POVERTY, INEQUALITY,AND DISCRIMINATION 403
Issue:Welfare Reform and the Trade-off between Equality and Efficiency 403
The Facts:Poverty 404
The Poorest Place in America 406
The Facts:Inequality 407
Depicting Income Distributions:The Lorenz Curve 409
Some Reasons for Unequal Incomes 410
How Important Is the Bell Curve? 411
The Facts: Discrimination 412
The Economic Theory of DIscrimination 413
Are Women Better Workers? 415
The Optimal Amount of Inequality 416
The Trade-off between Equality and Efficiency 417
Policies to Combat Poverty 419
The Negative Income 421
The Personal Income Tax 423
Death Duties and Other Taxes 424
Policies to Combat Discrimination 424
Has Affirmative Action Outlived Its Usefulness? 425
Postscript on the Distribution of Income 425
Summary 426
Key Terms 426
Questions for Review 427
PART V 429
THE GOVERNMENT AND THE ECONOMY 429
CHAPTER 18 LIMITING MARKET POWER:REGULATION OF INDUSTAY 431
puzzle: Industry Opposition to Deregulation 431
Monopoly,Regulation,and Nationalization 432
What Is Regulated?BY Whom? 432
A Brief History of Regulation 433
Why Regulation? 434
Why Regulators Sometimes Raise Prices 436
A Problem of Marginal-Cost Prices 438
Economic Theory in an ICC Coal Rate Decision 440
Regulation of Profit and Incentives for Efficiency 441
Price Caps as Incentives for Efficiency 442
Pricing of Access to "Bottleneck" Services 443
The Privy Council Approves Parity-Principle Access Pricing 444
Some Effects of Deregulation 445
Consequences of Deregulation:General Comments 446
A Word on Privatization 447
Industry Opposition to Deregulation--The Puzzle Revisited 449
Summary 449
Key Terms 450
Questions for Review 450
CHAPTER 19 LIMITING MRKET POWER: ANTITRUST POLICY 451
The Public Image of Business When the Antitrust Laws Were Born 452
Can Antitrust Law Be Used to Prevent Competition? 453
The Antitrust Laws 454
Protection of Competition, Not Protection of Competitors 456
Merger Policy 458
You Are There:An Antitrust Trial 459
Issues in Concentration of Industry 460
Evidence on Concentration in Industry 462
The Pros and Cons of Bigness 463
Other Government Programs Related to Bigness 465
Issues in Antitrust Policy 465
Summary 467
Key Terms 468
Questions for Review 468
CHAPTER 20 TAXATION AND RESOURCE ALLOCATION 469
Issue: Should We Flatten the Income Tax? 470
The Level and Types of Taxation 470
The Payroll Tax and the Social Security System 474
The State and Local Tax System 475
The Concept of Equity in Taxation 476
The Concept of Efficiency in Taxation 478
Excess Burden and Mr.Figg 480
Tax Loopholes and Excess Burden 481
Shifting the Burden of Taxation: Tax Incidence 481
The Incidence of Excise Taxes 482
The Incidence of the Payroll Tax 484
When Taxation Con Improve Efficiency 485
Equity,Efficiency,and the Optimal Tax 486
Conclusion:The Virtues and Vices of a Flat Tax 486
Summary 487
Key Terms 488
Questions for Review 488
CHAPTER 21 ENVIRONMENTAL PROTECTION AND RESOURCE CONSERVATION:THE ECONOMIST'S APPROACH 491
Part 1: The Economics of Environmental Protection 492
The Facts: Is Everything Really Getting Steadily Worse? 491
The Law of Conservation of Matter and Energy 495
Governments and Individuals as Damagers of the Environment 496
Environmental Damage as an Externality 496
Supply-Demand Analysis of Environmental Externalities 497
Basic Approaches to Environmental Policy 498
Emissions Taxes versus Direct Controls 500
Other Financial Devices to Profect the Environment: Emissions Permits 502
A Market Approach to Cutting Environmental Protectiotn Costs 503
Two Cheers for the Market 504
Part 2: The Economics of Energy and Natural Resources 504
The Permanent Fuel Crisis 505
The Free Market and Pricing of Depletable Resources 505
Resource Prices in the 20th Century 508
On the Virtues of Rising Prices 511
Growing Reserves of Exhaustible Resources: Our Puzzle Revisited 512
Summary 512
Key Terms 513
Questions for Review 513
PART VI 515
THE MACROECONOMY:AGGREGATE SUPPLY AND DEMAND 515
CHAPTER 22 THE REALM MACROECONOMICS 517
Drawing o Line between Macroeconomics and Microeconomics 517
Supply and Demand in Macroeconomics 519
Gross Domestic Product 521
Limitations of the GDP: What GDP Is Not 523
Are Americans Working More? 525
The Economy on o Roller Coaster 525
"Green" GDP 526
Life in "Hooverville" 529
From World War 11 to 1973 529
John Maynard Keynes (1883--1946) 530
The Great Stagflation,1973--1980 531
Reaganomics and Its Aftermath 531
Clintonomics: Deficit Reduction and the Resumption of Growth 532
The Problem of Macroeconomic Stabilization:A Sneak Preview 532
Summary 535
Key Terms 535
Questions for Review 536
CHAPTER 23 UNEMPLOYMENT AND INFLATION: THE TWON EVILS OF MACROECONOMICS 537
The Costs of Unemployment 538
The Economic Costs of High Unemployment 539
Counting the Unemployed: The official Statistics 541
Types of Unemployment 542
How Much Employment Is "Full Employment"? 543
Policy Debate: Does the Minimum Wage Cause Unemployment? 544
Unemployment Insurance: The Invaluable Cushion 544
Unemployment Insurance and the Costs of Unemployment 545
The Costs of Inflation 546
Inflationt The Myth and the Reality 546
Inflation as a Redistributor of Income and Wealth 549
Real versus Nominal Interest Rates 550
Inflation and the Tax System 551
Interest Rate Ceilings and Other Impediments 553
Other Costs of Inflation 554
The Costs of Low versus High Inflation 554
Hyperinflation and the Piggy Bank 556
Summary 557
Key Terms 558
Questions for Review 558
Appendix: How Statisticians Measure Inflation 558
Index Numbers for Inflation 558
The Consumer Price Index 559
How to Use a Price Index to "Deflate" Monetary Figures 560
The GDP Deflator 560
Your Personal CPI 561
Summary 561
Key Terms 562
Questions for Review 562
CHAPTER 24 INCOME AND SPENDING: THE POWERFUL CONSUMER 563
A Puzzle: Demand Management and the Ornery Consumer 564
Case 1: The 1964 Tax Cut 564
Case 2: The 1975 Tax Cut 564
Case 3: The 1981--1984 Tax Cuts 564
Aggregate Demand, Domestic Product, and National Income 565
The Cirtular Flow of Spending, Production, and Income 566
Consumer SPending and Income: The Important Relationship 568
The Consumption Function and the Marginal Propensity to Consume 571
Movements along versus Shifts of the Consumption Function 573
Other Determinants of Consumer Spending 574
Policy Debate: Using the Tax Code to Spur Saving 576
Why Tax Policy Failed in 1975 576
The Predictability of Consumer Behavior 578
Summary 578
Key Terms 579
Questions for Review 579
Appendix: National Income Accounting 580
Defining GDP: Exceptions to the Rules 580
GDP as the Sum of Final Goods and Services 581
GDP as the Sum of All Factor Payments 581
GDP as the Sum of Values Added 584
Summary 585
Key Terms 586
Questions for Review 586
CHAPTER 25 DEMAND-SIDE EQUILIBRIUM: UNEMPLOYMENT OR INFLATION? 587
Puzzle: Why Does the Market Permit Unemployment? 588
The Extreme Variability of Investment 588
The Investment Boom of the Nineties 589
The Determinants of Net Exports 591
The Meaning of Equilibrium GDP 592
Equilibrium on the Demand Side of the Economy 594
Constructing the Expenditure schedule 594
The Mechanics of Income Determination 596
The Aggregate Demand Curve 598
Demand-side Equilibrium and Full Employment 600
The Coordination of saving and Investment 602
Unemployment and Inflation as Coordination Failures 604
Summary 605
Key Terms 605
Questions for Review 606
Appendix:The Simple Algebra of Income Determination 607
Questions for Review 607
CHAPTER 26 CHANGES ON THE DEMAND SIDE:MULTIPLIER ANALYSIS 609
Case Study: How Did Kansas Do It? 609
The Magic of the Multiplier 610
Demystifying the Multiplier:How it Works 611
Algebraic Statement of the Multiplier 614
We Multiplier Effect of Consumer Spending 615
The Multiplier Effect of Government Purchase 616
The Multiplier Effect of Net Exports 617
The Multiplier in Reverse 618
The Paradox of Thrift 519
The Multiplier and the Aggregate Demand Curve 619
Summary 621
Key Terms 621
Questions for Review 621
Appendix A:The simple Algebra of the Multipler 622
Appendix B:The Multiplier with Variable Imports 622
Summary 626
Questions for Review 626
CHAPTER 27 SUPPLY-SIDE EQUILIBRIUM:UNEMPLOYMENT AND INFLATION? 627
Debate:Two Sides to the Supply Side 627
The Aggregate Supply Curve 628
Shifts of the Aggregate Supply Curve 630
Equilibrium of Aggregate Demand and Supply 632
Recessionary and Inflationary Gaps Revisited 633
Adjusting to a Recessionary Gap:Deflation or Unemployment? 635
An Example from Recent History:Disinflation in the 1990s 638
Adjusting to an inflationary Gap:Inflation 638
Tight Labor Markets in 1995 639
Demand Inflation and Stagflation 640
Stagflation from Supply shifts 641
Inflation and the Multiplier 642
A Role for Stabilization policy 645
Summary 645
Key Terms 645
Questions for Review 646
PART VII 647
FISCAL AND MONETARY POLICY 647
CHAPTER 28 MANAGING AGGREGA DEMAND:FISCAL POLICY AOOR.GALUCY 649
Issue:How Quickly Should We Balance the Budget? 649
Income Taxes and the Consumption Schedule 650
The Multiplier Revisited 654
Multipliers for Ta Policy 655
Government Transfer Payments 657
Planning Expansive Fiscal Policy 657
Planning Restrictive Fiscal Policy 658
The Choice between Spending Policy and Tax Policy 659
Some Harsh Realities 660
The Idea behind Supply-Side Tax Cuts 661
Some Files in the Ointment 663
Toward Assessment of Supply-Side Economics 664
Clintonomics and Supply-Side Economics 665
Summary 665
Key Terms 666
Questions for Review 666
Appendix:Algebraic Treatment of Fiscal Policy and Aggregate Demand 667
Questions for Review 669
CHAPTER 29 MONEY AND THE BANKING SYSTEM 671
Issue: To Regulate or to Deregulate?That is the Question 671
Barter Versus Monetary Exchange 672
The Conceptual Definition of Money 674
What Serves as Money? 674
How the Quantity of Money is Measured 676
How Banking Began 678
Is There a Smart Card in Your Future? 679
Principles of Band Management:profits versus Safety 680
Bank Regulation 680
The Savings and Loan Crisis: Over at Last 681
How Bankers Keep Books 681
Policy Debate: Abolish the Community Reinvestment Act? 682
The Limits to Money Creation by a Single Bank 683
Multiple Money Creation by a Series of Banks 685
The Process in Reverse:Multiple Contractions of the Money Supply 688
Why the Deposit Creation Formula is Oversimplified 690
The Need for Monetary Policy 691
Summary 691
Key Terms 692
Questions for Review 692
CHAPTER 30 MONETARY POLICY AND THE NATIONAL ECONOMY 695
Money and Income:The Important Difference 695
The Federal Reserve System:Origins and Structure 696
The Independence of the Fed 691
You Are There: The FOMC Meets 698
Policy Debate: How Independent Should the Central Bank Be? 699
Controlling the Money Supply: Open-Market Operations 699
Open-Market Operations,Bond Prices,and Interest Rates 701
Controlling the Money Supply:Lending to Banks 702
Controlling the Money Supply:Reserve REquirements 703
The Money Supply Mechanism 704
The Demand for Money 705
Equilibrium in the Money Market 706
Interest Rates and Total Expenditures 708
Monetary Policy and Aggregate Demand 709
Money and the Price Level in the Keynesian Model 711
From Models to Policy Debates 713
Summary 713
Key Terms 714
Questions for Review 714
CHAPTER 31 THE DEBATE OVER MONETARY POLICY 717
Issue: Should We Forsake Stabilization Policy? 717
Velocity and the Quantity Theory of Money 718
The Determinants of Velocity 720
Monetarism:The Quantity Theory Modernized 722
Fiscal Policy, Interest Rates, and Velocity 724
Debate:Should Stabilization Policy Rely on Fiscal or Monetary Policy? 725
Debate:Should the Fed Control the Money Supply or control Interest Rates? 727
Debate:The Shape of the Aggregate Supply Curve 730
Debate:Should the Government Intervene? 733
Debate:Rules or Discretion? 736
Techniques of Economic Forecasting 737
The Accuracy of Economic Forecasts 739
Other Dimensions of the Rules-Versus-Discretion Debate 739
Conclusion:What Should be Done? 741
Summary 742
Key Terms 743
Questions for Review 743
CHAPTER 32 BUDGET DEFICITS AND THE NATIONAL DEBT: FACT AND FICTION 745
Puzzle:Are Smaller Deficits Good or Bad for Growth? 746
Should the Budget Be Balanced? 746
Deficits and Debt:Some Terminology 747
Some Facts about the National Debt 748
Interpreting the Budget Deficit 750
Inflation Accounting for Interest Payments 752
Bogus Arguments about the Burden of Burden of the Debt 756
Budget Deficits and Inflation 757
Deficits,INterest Rates, and Crowding Out 761
POlicy Debate: A Balanced-Budget Amendment to the Constitution? 762
The True Burden of the National Debt 763
Deficit Reduction and Growth:Puzzle Resolved 764
Conclusion:The Economics and Politics of the Budget Deficit 765
America speaks: How to Reduce the Budget Deficit 766
Summary 767
Key Terms 768
Questions for Review 768
CHAPTER 33 THE TRADE-OFF BETWEN INFLATION AND UNEMPLOYMENT 769
Demand-Side Inflation Versus Supply-Side Inflation:A Review 770
Applying the Model to a Growing Economy 771
Demand-Side Inflation and the Phillips Curve 773
Supply-Side Inflation and the Collapse of the Phillip Curve 777
What the Phillips Curve is Not 778
Fighting Unemployment with Fiscal and Monetary Policy 781
What Should Be Done? 782
Inflationary Expectations and the Phillips Curve 783
The Theory of Rational Expectations 786
Why Economists(and Politicians)Disagree 788
The Dilemma of Demand Management 789
Attempts to Reduce the Natural Rate of Unemployment 789
Policy Debate:Should the Fed Concentrate Only on Reducing Inflation? 790
Wage-Price Controls 190
Indexing 191
Summary 792
Key Terms 793
Questions for Review 793
PART VIII 795
THE UNITED STAES IN THE WORLO ECONOMY 795
CHAPTER 34 INTERNATIONAL AND COMPARATIVE ADVANTAGE 797
Puzzle: How Can Americans Compete with"Cheap Foreign Labor"? 797
Why Trade? 798
Mutual Gains from Trade 799
International Versus Intranational Trade 800
The Law of Comparative Advantage 801
David Ricardo(1772--1823) 802
The Arithmetic of Comparative Advantage 802
The Graphics of Comparative Advantage 803
Comparative Advantage and Competition of "Cheap Foreign Labor" 806
Supply-Demand Equilibrium and Pricing in World Trade 807
Tariffs, Quotas, and other Interferences with Trade 808
How Tariffs and Quotas Work 809
How Sweet It Is:The U.S.Sugar Quota 810
Tariffs versus Quotas 811
Why Inhibit Trade? 812
Other Arguments for Protection 814
Can Protectionism save Free Trade? 816
Con Cheap Imports Be Bad for a Country 817
Conclusion:A Last Look at the "Cheap Foreign Labor"Argument 817
Unfair Foreign Competition 818
Summary 818
Key Terms 819
Questions for Review 819
CHAPTER 35 THE INTERNATIONAL MONTARY SYSTEM:ORDER OR DISORDER? 821
Puzzle: Whatever Happened to Mexico? 821
What Are Exchange Rates? 822
Exchange Rate Determination in a Free Market 823
The Purchasing-Power Parity Theory:The Long Rum 826
Economic Activity and Exchange Rates:The Medium Rum 827
Purchasing-Power Parity and the Big Mac 828
Interest Rates and Exchange Rates:The Short Run 829
Market Determination of Exchange Rates:Summary 830
Fixed Exchange Rates and the Balance of Payments 830
Defining the Balance of Payments in Practice 833
A Bit of History:The Gold Standard 834
The Bretton Woods System and the International Monetary Fund 835
Adiustment Mechanisms under Fixed Exchange Rates 836
Why Try to Fix Exchange Rates? 838
The Current Mixed System 839
The volatile Dollar 839
The European Exchang Rate Mechanism 841
Summary 842
Key Terms 842
Questions for Review 843
CHAPTER 36 MACROECONOMICS IN A WORLD ECONOMY 845
Issue:Deficit Reduction and the Dollar 845
International Trade and Aggregate Demand:A Quick Review 846
Relative Prices,Exports,and Imports 847
The Effects of Changes in Exchange Rates 847
Aggregate Supply in an Open Economy 849
The Macroeconomic Effects of Exchange Rates 850
Interest Rates and International Capital Flows 851
Fiscal Policy in an Open Economy 852
Monetary Policy in an Open Economy 854
International Aspects of Deficit Deficit Reduction 855
The Link Between the Budget Deficit and the trade Deficit 857
Is the Trade Deficit a Problem? 858
On Curing the Trade Deficit 862
Summary 862
Key Terms 863
Questions for Review 863
CHAPTER 31 PRODUCTIVITY AND GROWTH IN THE WEALTH OF NATIONS 865
Part 1: Growth in the United States and Other Industrial Countries 865
Life in the "Good Old Days" 865
The Magnitude of Productivity Growth 867
The Second Major Development:Convergence 871
The U.S. Productivity Slowdown:Is American Economic Leadership Doomed? 873
Productivity and the Deindustrialization Thesis 875
Unemployment and Productivity Growth 877
The Real Costs of Lagging Productivity:Lagging Wages and Living Standards 878
Requirements for Increased Growth 879
Growth without Sacrificing Consumption:Something for Nothing? 880
On Growth in population:Is Less Realty More? 880
Is More Growth Really Better? 883
Part 2: Problems of the Less Developed Countries 884
Recent Trends 886
Impediments to Development in the LDC： 887
Help from Industrialized Economies 891
Con LDC： Break Away from Poverty? 893
Summary 893
Key Terms 894
Questions for Review 895
CHAPTER 38 COMPARATIVE ECONOMIC SYSTEMS: WHAT ARE THE CHOICES? 897
Economic Systems:Two Important Distinctions 898
The Market or the Plan?Some Issues 899
The Market or the Plan:The Scoreboard 900
Capitalism of Socialism? 901
Socialism,Planning,and Freedom 902
The Administrative Command Economy:The Old Soviet Union 903
Economies in Transition: Russia and Her Neighbors 905
A Tale of Two Countries 907
China under Mao: Revolutionary Communism 908
China since Mao: Explosive Growth 909
Japan's Unique Brand of Capitalism 910
U.S.-Japanese Trade: Is Everyone Playing Fair? 911
Is Japan a Planned Economy? 912
Can America Import Japanese Manufacturing Methods? 913
What Can the United States born from (and Teach)Japan? 913
Summary 914
Key Terms 915
Questions for Review 915