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PART I1

GETTING ACQUAINTED WITH ECONOMICS1

1 What Is Economics?3

2 The U.S. Economy: Myth and Reality25

3 Scarcity and Choice: The Economic Problem49

4 Supply and Demand: An Initial Look67

PART II93

ESSENTIALS OFMICROECONOMICS:CONSUMERS AND FIRMS93

5 Consumer Choice: The Demand Side of the Market95

6 Demand and Elasticity125

7 Production, Inputs, and Cost: Building Blocks for Supply Analysis147

8 Output, Price, and Profit:The Importance of Marginal Analysis181

PART III207

THE MARKET SYSTEM: VIRTUES AND VICES207

9 The Firm and the Industry under Perfect Competition209

10 The Price System and the Case for Laissez-Faire233

11 Monopoly255

12 Between Competition and Monopoly275

13 The Market Mechanism: Shortcomings and Remedies301

14 Real Firms and Their Financing: Stocks and Bonds325

PART IV349

THE DISTRIBUTION OF INCOME349

15 Pricing the Factors of Production351

16 Labor: The Human Input377

17 Poverty, Inequality, and Discrimination403

PART V429

THE GOVERNMENT AND THE ECONOMY429

18 Limiting Market Power: Regulation of Industry431

19 Limiting Market Power: Antitrust Policy451

20 Taxation and Resource Allocation469

21 Environmental Protection and Resource Conservation: The Economist's Approach491

PART VI515

THE MACROECONOMY:AGGRSGATE SUPPLY AND OEMAND515

22 The Realm of Macroeconomics517

23 Unemployment and Inflation: The Twin Evils of Macroeconomics537

24 Income and Spending: The Powerful Consumer563

25 Demand-Side Equilibrium: Unemployment or Inflation?587

26 Changes on the Demand Side: Multiplier Analysis609

27 Supply-Side Equilibrium: Unemployment and Inflation?627

PART VII647

FISCAL AND MONETARY POLICY647

28 Managing Aggregate Demand: Fiscal Policy649

29 Money and the Banking System671

30 Monetary Policy and the National Economy695

31 The Debate over Monetary Policy717

32 Budget Deficits and the National Debt: Fact and Fiction745

33 The Trade-off between Inflation and Unemployment769

PART VIII795

THE UNITED STAES IN THE WORLD ECONOMY795

34 International Trade and Comparative Advantage797

35 The International Monetary System: Order or Disorder?821

36 Macroeconomics in a World Economy845

37 Productivity and Growth in the Wealth of Nations865

38 Comparative Economic Systems: What Are the Choices?897

ACQUAINTED WITH ECONOMICS1

CHAPTER 1 WHAT IS ECONOMICS?3

Ideas for Beyond the Final Exam3

Idea 1: Mutual Gains from Voluntary Exchange4

Idea 2: Rational Choice and True Economic Costs: The Role of Opportunity Cost4

Idea 3: Attempts to Repeal the Laws of Supply and Demand: The Market Strikes Back5

Idea 4: The Importance of Marginal Analysis5

Idea 5: Externalities: A Shortcoming of the Market Cured by Market Methods6

Idea 6: The Cost Disease of the Personal Services6

Idea 7: The Trade-off between Output and Equality7

Idea 8: The Trade-off between Inflation and Unemployment7

Idea 9: The Illusion of High Interest Rates8

Idea 10: Do Budget Deficits Burden Future Generations?8

Idea 11: The Overwhelming Importance of Productivity Growth in the Long Run9

Idea I2: The Surprising Principle of Comparative Advantage9

Inside the Economist's Tool Kit10

Economics as a Discipline10

The Need for Abstraction10

The Role of Economic Theory13

What Is an Economic "Model"15

Reasons for Disagreements: Imperfect Information and Value Judgments16

Last World: Common Sense Is Not Always Reliable17

Summary17

Key Terms17

Questions for Review18

Appendix: The Graphs Used in Economic Analysis18

Two-Variable Diagrams18

The Definition and Measurement of Slope19

Rays through the Origin and 45？ Lines22

Squeezing Three Dimensions into Two: Contour Maps23

Summary24

Key Terms24

Questions for Review24

CHAPTER 2 The U.S. Economy: MYTH AND REAUTY25

The American Economy:A Thumbnail Sketch25

A Growing Economy...but with Inflation28

The Inputs:Labor and Capital32

The Outputs:What America Produce?34

Public Opinion on Profits35

The Central Role of Business Firms35

Is That an American Company?36

What's Missing from the picture Government36

Conclusion:The Mixed Economy40

Summary41

Key Terms41

Questions for Review41

Appendix:Further Perils in the Interpretation of Graphs42

Distorting Trends by Choice of the Time Period42

Dangers of Omitting the Origin43

Unreliability of Steepness and Choice of Units44

Summary47

Questions for Review47

CHAPTER 3 SCARCITY AND CHOICE: THE ECONOMIC PROBLEM49

Problem:The"indispensable Necessity"Syndrome50

Scarcity,Choice,and Opportunity cost50

Scarcity and Choice for a Single Firm52

The Principle of Increasing Costs54

Scarcity and Choice for the Entire Society55

A Military-Civilian Output Trade-off in Reality55

Scarcity and Choice Elsewhere the Economy57

The Concept of Efficiency59

The Three Coordination Tasks of Any Economy60

Specialization,Division of Labor,and Exchange60

Adam Smith (1723--1790)61

Markets,prices,and the Three Coordination Tasks62

Liberal and Conservative Goals Can Both Be Served by the Market Mechanism63

Summary64

Key Terms65

Questions for Review65

CHAPTER 4 SUPPLY AND DEMAND:AN INITIAL LOOK67

Fighting the Invisible Hand68

Price COntrols at Valley Forge68

Demand and the Quantity Demanded69

Supply and the Quantity Supplied71

Equilibrium of Supply and Demand73

Shifts of the Demand Curve75

Shifts of the Supply Curve79

Restraining the Market Mechanism:Price Ceilings83

Policy Debate: Economic Aspects of the War on Drugs84

Restraining the Market Mechanism:Price Floors86

A Can of Worms87

A Simple but Powerful Lesson89

Summary89

Key Terms90

Questions for Review90

PART II ESSENTIALS OF MICROECONOMICS:CONSUMERS AND FIRMS93

CHAPTER 5 CONSUMER CHOICE: THE DEMAND SIDE OF THE MARKET95

A Paradox: Should Water Be Worth More Than Diamonds?96

Scarcity and Demand96

Total ond Marginal Utility97

Do Consumers Really Behave "Rationally" and Maximize Utility?101

From Marginal Utility to the Demand Curve103

Consumer Choice as a Trade-off Opportunity Cost104

Consumer Surplus: The Net Gain from a Purchase105

Resolving the Diamond-Water Paradox107

Price, Income, and Quantity Demanded107

From Individual Demand Curves to Market Demand Curves110

The "Law" of Demand111

Summary112

Key Terms113

Questions for Review113

Appendix: Indifference Curve Analysis114

Geometry of Available Choices: The Budget Line114

What the Consumer Prefers: The Indifference Curve116

The Slopes of Indifference Curves and Budget Lines118

The Consumer's Choice119

Consequences of Income Changes: Inferior Goods121

Consequences of Price Changes: Deriving the Demand Curve121

Summary123

Key Terms123

Questions for Review124

CHAPTER 6 DEMAND AND ELASTICITY125

Two Illustrative Cases125

Example I: The Revenue Effect of a Sales-Tax Cut125

Example II: Polaroid v.Kodak126

Elasticity: The Measure of Responsiveness127

Price Elasticity of Demand and the Shapes of Demand Curves130

The Relationship between Elasticity.ond Slope132

Price Elasticity of Demand and Total Expenditure133

What Determines Elasticity of Demand?135

Price Elasticity:Ignore It at Your Peril136

Elasticity as a General Concept137

Cross Elasticify of Demand: Substitutes and Complements137

How Large Is a Firm's Market share? Cross Elasticity as a Test139

Shifts of the Demand Curve: Advertising, Income, and the Prices of Complements and Substitutes139

The Time Dimension of the Demand Curve and Economic Decision Making141

Two Illustrative Applications of Elasticity Analysis142

Summary143

Key Terms143

Questions for Review143

Appendix: Statistical Analysis of Demand Relationships144

An Illustration: Did the Advertising Program Work?146

CHAPTER 7 PRODUCTION, INPUTS, AND COST BUILDING BLOCKS FOR SUPPLY ANALYSIS147

Application: Are Larger Firms More Efficient?148

Production, Input Choice, and Cost with One Variable Input149

The "law" of Diminishing Marginal Returns151

The Optimal Quantity of an Input and Diminishing Returns152

cost Curves and Input Quantities153

Fixed Costs and Variable Costs156

Long-Run versus Short-Run Costs159

The Average Cost Curve in the Short and Long Run160

Multiple Input Decisions:The Choice of Optimal Input Substitutability: The Choice of Input Proportions162

The Marginal Rule for Optimal Input Proportions164

The Production Function and the Firm's Cost Curves165

Input Substitution in the Forest165

Economies of Stale167

Policy Debate: Should Water Be Provided to Western Farmers at Subsidized Prices?167

The "law" of Diminishing Marginal Returns and Returns to Scale169

Historical Costs versus Analytical Cost Curves170

Resolving the Economies of Stale Puzzle170

Cost Minimization in Theory and Practice172

Summary173

Key Terms173

Questions for Review174

Appendix: Production Indifference Curves174

Characteristics of the Production Indifference Curves175

The Choice of Input Combinations176

Cost Minimization, Expansion Path, and Cost Curves177

Effects of Changes in Input Prices178

Summary179

Key Terms179

Questions for Review179

CHAPTER 8 OUTPUT, PRICE, AND PROFIT: THE IMPORTANCE OF MARGINAL ANALYSIS181

Two Illustrative Cases182

Case 1: Making Profits by Selling Below Costs182

Case 2: Pricing a Six-Pack182

Price and Quantity: One Decision, Not Two182

Do Firms Really Maximize Profits?184

Total Profit: Keep Your Eye on the Goal185

Maximization of Total Profit189

Marginal Analysis and Maximization of Total Profit191

Marginal Revenue and Marginal Cost: Guides to an Optimum192

Polity Debate: Profit and the New Market Economies195

Generalization:The Logic of Marginal Analysis and Maximization196

Application: Fixed Cost and the Profit Maximization196

Marginal Analysis in Real Decision Problems198

Conclusion: The Fundamental Role of Marginal Analysis200

The Theory and Reality:A Word of Caution201

Summary202

Key Terms202

Questions for Review202

Appendix:The Relationships among Total,Average,and Marginal Data203

Graphical Representation of Marginal and Average Curves204

Questions for Review205

PART III207

THE MARKET SYSTEM: VIRTUES AND VICES207

CHAPTER 9 THE FIRM AND THE INDUSTRY UNDER PERFECT COMPETITION209

Two Practical Puzzles209

Issue 1: Pollution-Reduction Incentives That Increase Pollution210

Issue 2: Can Firms Shift the Burden of Taxation to Consumers210

Varieties of Market Structre: A Sneak Proview210

Perfect Competition Defined211

The Competitive Firm and Its Demand Curve212

Short-Run Equilibrium of the Perfectly Competitive Firm213

Short-Run Profit:graphic Representation215

The Case of Short-Term Losses215

Shutdown and Break-Even Analysis216

The Short-Run Supply Curve of the Competitive Firm218

The Short-Run Supply Curve of the Competitive Industry218

Industry Equilibrium in the Short Run220

Industry and Firm Equilibrium in the Long Run221

The Long-Run Industry Supply Curve224

Zero Economic Profit: The Opportunity Cost of Capital225

Perfect Competition and Economic Efficiency226

Policy Debate: Should Perfect Competition Be Used as a Guide by Government Regulators?227

Our Two Puzzles Resolved228

Summary230

Key Terms231

Questions for Review231

CHAPTER 10 THE PRICE SYSTEM AND THE CASE FOR LASSEZ-FAIRE233

Puzzle: San Francisco Bay Bridge Pricing234

Efficient Resource Allocation: The Concept234

Pricing to Promote Efficiency: An Example235

Earthquake, Bridge Congestion, and Route Substitution237

Con Price Increases Ever Serve the Public Interest?237

Scarcity and the Need to Coordinate Economic Decisions239

Economic Shock Therapy in Poland240

Three Coordination Tasks in the Economy240

Input-Output Analysis: The Near Impossibility of Perfect Central Planning243

Input-Output Equations: An Example245

How Perfect Competition Achieves Efficiency: What to Produce245

Other Roles of Prices: Income Distribution and Fairness248

San Francisco Bridge Pricing Revisited249

Toward Assessment of the Price Mechanism230

Another Look at the Market's Achievement:Growth versus Efficiency250

Policy Debate: User Charges for Public Facilities251

Summary252

Key Terms252

Questions for Review252

CHAPTER 11 MONOPOLY255

Application: Monopoly and Pollution Charges255

Monopoly Defined256

Causes of Monopoly: Barriers to Entry and Cosi Advantages257

Natural Monopoly258

The Monopolist's Supply Decision259

Determining the Profit -Maximizing Output261

Comparison of Monopoly and Perfect Competition263

Con Anything Good Be Said about Monopoly?265

Price Discrimination under Monopoly267

Monopoly ond the Shifting of Pollution Charges270

Summary272

Key Terms273

Questions for Review273

CHAPTER 12 BETWEEN COMPETITION AND MONOPOLY275

Some Puzzling Observations276

Monopolistic Competition276

Price and Output Determination under Monopolistic Competition218

The Excess Capacity Theorem and Resource Allocation280

Oligopoly281

A Shopping List283

OPEC Keeps the Ceiling on Oil Output285

Policy Debate: Acting on Recognized InterdePendence versus "Tacit Collusion"286

The Kinked Demand Curve Model288

The Game-Theory Approach290

Monopolistic Competition, Oligopoly, and Public Welfare294

Billion-Dollar APPlication: Game Theory and the FCC Auction295

A Glance Backward: Comparison of the Four Market Forms296

Summary297

Key Terms298

Questions for Review298

CHAPTER 13 THE MARKET MECHANISM: SHORTCOMINGS ANO REMEDIES301

Puzzle: Rising Health-Care Costs in Canada302

What Does the Market Do Poorly?302

Efficient Resource Allocation: A Review302

Externalities:Getting the Prices Wrong304

Provision of Public Goods309

Allocation of Resources between Present and Future311

Some Other Sources of Market Failure313

Asymmetric Information, Lemons, and Agents314

Market Failure and Government Failure315

The Politics of Economic Policy316

The Cost Disease of the Service Sector316

Evaluative Comments321

Epilogue:The Unforgiving Market, Its Gift of Abundance, and Its Dangerous Friends322

Summary323

Key Terms324

Questions for Review324

CHAPTER 14 REAL FIRMS AND THEIR FINANCING: STOCKS AND BONDS325

Puzzle: The Stock Market's Unpredictability325

Firms in the United States326

Proprietorships326

Partnerships327

Corporations328

Stocks and Bonds330

Financing Corporate Activity332

Corporate Choice between Stocks and Bonds333

Buying Stocks and Bonds334

Selecting a portfolio:Diversification334

Following a Portfolio's Performance335

Stock Exchanges and Their Functions337

You Are There: An Event on the Trading Floor of the New York Stock Exchange338

Regulation of the Stock Market338

Stock Exchanges and Corporate Capital Needs339

The Recent Surge in Takeover Battles340

The lssue of Speculation341

How to Lose a Billion Dollars in One Easy Step: The Derivatives Craze342

Stock Prices as Random Walks343

Football and Financial Forecasting344

Summary346

Key Terms346

Questions for Review347

PART IV349

THE DISTRIBUTION OF INCOME349

CHAPTER 15 PRICING THE FACTORS OF PRODUCTION351

The Principle of Marginal Productivity352

The Derived Demand Curve for an Input353

Investment, Capital, and Interest355

The Determination of Rent:Simple Version361

Japanese Land Prices363

The Rent of Land: Some Complications364

Generalization:What Determines Shoquille O'Neal's Salary?365

Rent Seeking366

Rent Controls:The Misplaced Analogy368

Issue:Are Profits Too High or Too Low?369

What Accounts for Profits?370

EntrepreneurshiP in Poland371

Criticisms of Marginal Productivity Theory372

Summary373

Key Terms374

Questions for Review374

Appendix: Discounting and Present Value315

Summary376

Key Terms376

Questions for Review376

CHAPTER l6 LABOR: THE HUMAN INPUT317

ISSUE: Lagging Wages and Growing Inequality311

Competitive Labor Markets378

The Supply of Labor319

The Demand for Labor and the Determination of Wages381

Why Wages Differ382

Ability and Earnings:The Rent Component of Wages383

Investment in Human Capital384

Education and Earnings:Dissenting Views385

The Effects of Minimum Wage Legislation387

Unions and collective Bargaining388

The Development of Unionism in America390

The Way It Was391

Union as Labor Monopolies392

Monopsony and Bilateral Monopoly395

Collective Bargaining and Strikes396

The 1994--1995 Baseball Strike397

Recent Developments in the u.s.Labor Market399

Summary401

Key Terms401

Questions for Review402

CHAPTER 17 POVERTY, INEQUALITY,AND DISCRIMINATION403

Issue:Welfare Reform and the Trade-off between Equality and Efficiency403

The Facts:Poverty404

The Poorest Place in America406

The Facts:Inequality407

Depicting Income Distributions:The Lorenz Curve409

Some Reasons for Unequal Incomes410

How Important Is the Bell Curve?411

The Facts: Discrimination412

The Economic Theory of DIscrimination413

Are Women Better Workers?415

The Optimal Amount of Inequality416

The Trade-off between Equality and Efficiency417

Policies to Combat Poverty419

The Negative Income421

The Personal Income Tax423

Death Duties and Other Taxes424

Policies to Combat Discrimination424

Has Affirmative Action Outlived Its Usefulness?425

Postscript on the Distribution of Income425

Summary426

Key Terms426

Questions for Review427

PART V429

THE GOVERNMENT AND THE ECONOMY429

CHAPTER 18 LIMITING MARKET POWER:REGULATION OF INDUSTAY431

puzzle: Industry Opposition to Deregulation431

Monopoly,Regulation,and Nationalization432

What Is Regulated?BY Whom?432

A Brief History of Regulation433

Why Regulation?434

Why Regulators Sometimes Raise Prices436

A Problem of Marginal-Cost Prices438

Economic Theory in an ICC Coal Rate Decision440

Regulation of Profit and Incentives for Efficiency441

Price Caps as Incentives for Efficiency442

Pricing of Access to "Bottleneck" Services443

The Privy Council Approves Parity-Principle Access Pricing444

Some Effects of Deregulation445

Consequences of Deregulation:General Comments446

A Word on Privatization447

Industry Opposition to Deregulation--The Puzzle Revisited449

Summary449

Key Terms450

Questions for Review450

CHAPTER 19 LIMITING MRKET POWER: ANTITRUST POLICY451

The Public Image of Business When the Antitrust Laws Were Born452

Can Antitrust Law Be Used to Prevent Competition?453

The Antitrust Laws454

Protection of Competition, Not Protection of Competitors456

Merger Policy458

You Are There:An Antitrust Trial459

Issues in Concentration of Industry460

Evidence on Concentration in Industry462

The Pros and Cons of Bigness463

Other Government Programs Related to Bigness465

Issues in Antitrust Policy465

Summary467

Key Terms468

Questions for Review468

CHAPTER 20 TAXATION AND RESOURCE ALLOCATION469

Issue: Should We Flatten the Income Tax?470

The Level and Types of Taxation470

The Payroll Tax and the Social Security System474

The State and Local Tax System475

The Concept of Equity in Taxation476

The Concept of Efficiency in Taxation478

Excess Burden and Mr.Figg480

Tax Loopholes and Excess Burden481

Shifting the Burden of Taxation: Tax Incidence481

The Incidence of Excise Taxes482

The Incidence of the Payroll Tax484

When Taxation Con Improve Efficiency485

Equity,Efficiency,and the Optimal Tax486

Conclusion:The Virtues and Vices of a Flat Tax486

Summary487

Key Terms488

Questions for Review488

CHAPTER 21 ENVIRONMENTAL PROTECTION AND RESOURCE CONSERVATION:THE ECONOMIST'S APPROACH491

Part 1: The Economics of Environmental Protection492

The Facts: Is Everything Really Getting Steadily Worse?491

The Law of Conservation of Matter and Energy495

Governments and Individuals as Damagers of the Environment496

Environmental Damage as an Externality496

Supply-Demand Analysis of Environmental Externalities497

Basic Approaches to Environmental Policy498

Emissions Taxes versus Direct Controls500

Other Financial Devices to Profect the Environment: Emissions Permits502

A Market Approach to Cutting Environmental Protectiotn Costs503

Two Cheers for the Market504

Part 2: The Economics of Energy and Natural Resources504

The Permanent Fuel Crisis505

The Free Market and Pricing of Depletable Resources505

Resource Prices in the 20th Century508

On the Virtues of Rising Prices511

Growing Reserves of Exhaustible Resources: Our Puzzle Revisited512

Summary512

Key Terms513

Questions for Review513

PART VI515

THE MACROECONOMY:AGGREGATE SUPPLY AND DEMAND515

CHAPTER 22 THE REALM MACROECONOMICS517

Drawing o Line between Macroeconomics and Microeconomics517

Supply and Demand in Macroeconomics519

Gross Domestic Product521

Limitations of the GDP: What GDP Is Not523

Are Americans Working More?525

The Economy on o Roller Coaster525

"Green" GDP526

Life in "Hooverville"529

From World War 11 to 1973529

John Maynard Keynes (1883--1946)530

The Great Stagflation,1973--1980531

Reaganomics and Its Aftermath531

Clintonomics: Deficit Reduction and the Resumption of Growth532

The Problem of Macroeconomic Stabilization:A Sneak Preview532

Summary535

Key Terms535

Questions for Review536

CHAPTER 23 UNEMPLOYMENT AND INFLATION: THE TWON EVILS OF MACROECONOMICS537

The Costs of Unemployment538

The Economic Costs of High Unemployment539

Counting the Unemployed: The official Statistics541

Types of Unemployment542

How Much Employment Is "Full Employment"?543

Policy Debate: Does the Minimum Wage Cause Unemployment?544

Unemployment Insurance: The Invaluable Cushion544

Unemployment Insurance and the Costs of Unemployment545

The Costs of Inflation546

Inflationt The Myth and the Reality546

Inflation as a Redistributor of Income and Wealth549

Real versus Nominal Interest Rates550

Inflation and the Tax System551

Interest Rate Ceilings and Other Impediments553

Other Costs of Inflation554

The Costs of Low versus High Inflation554

Hyperinflation and the Piggy Bank556

Summary557

Key Terms558

Questions for Review558

Appendix: How Statisticians Measure Inflation558

Index Numbers for Inflation558

The Consumer Price Index559

How to Use a Price Index to "Deflate" Monetary Figures560

The GDP Deflator560

Your Personal CPI561

Summary561

Key Terms562

Questions for Review562

CHAPTER 24 INCOME AND SPENDING: THE POWERFUL CONSUMER563

A Puzzle: Demand Management and the Ornery Consumer564

Case 1: The 1964 Tax Cut564

Case 2: The 1975 Tax Cut564

Case 3: The 1981--1984 Tax Cuts564

Aggregate Demand, Domestic Product, and National Income565

The Cirtular Flow of Spending, Production, and Income566

Consumer SPending and Income: The Important Relationship568

The Consumption Function and the Marginal Propensity to Consume571

Movements along versus Shifts of the Consumption Function573

Other Determinants of Consumer Spending574

Policy Debate: Using the Tax Code to Spur Saving576

Why Tax Policy Failed in 1975576

The Predictability of Consumer Behavior578

Summary578

Key Terms579

Questions for Review579

Appendix: National Income Accounting580

Defining GDP: Exceptions to the Rules580

GDP as the Sum of Final Goods and Services581

GDP as the Sum of All Factor Payments581

GDP as the Sum of Values Added584

Summary585

Key Terms586

Questions for Review586

CHAPTER 25 DEMAND-SIDE EQUILIBRIUM: UNEMPLOYMENT OR INFLATION?587

Puzzle: Why Does the Market Permit Unemployment?588

The Extreme Variability of Investment588

The Investment Boom of the Nineties589

The Determinants of Net Exports591

The Meaning of Equilibrium GDP592

Equilibrium on the Demand Side of the Economy594

Constructing the Expenditure schedule594

The Mechanics of Income Determination596

The Aggregate Demand Curve598

Demand-side Equilibrium and Full Employment600

The Coordination of saving and Investment602

Unemployment and Inflation as Coordination Failures604

Summary605

Key Terms605

Questions for Review606

Appendix:The Simple Algebra of Income Determination607

Questions for Review607

CHAPTER 26 CHANGES ON THE DEMAND SIDE:MULTIPLIER ANALYSIS609

Case Study: How Did Kansas Do It?609

The Magic of the Multiplier610

Demystifying the Multiplier:How it Works611

Algebraic Statement of the Multiplier614

We Multiplier Effect of Consumer Spending615

The Multiplier Effect of Government Purchase616

The Multiplier Effect of Net Exports617

The Multiplier in Reverse618

The Paradox of Thrift519

The Multiplier and the Aggregate Demand Curve619

Summary621

Key Terms621

Questions for Review621

Appendix A:The simple Algebra of the Multipler622

Appendix B:The Multiplier with Variable Imports622

Summary626

Questions for Review626

CHAPTER 27 SUPPLY-SIDE EQUILIBRIUM:UNEMPLOYMENT AND INFLATION?627

Debate:Two Sides to the Supply Side627

The Aggregate Supply Curve628

Shifts of the Aggregate Supply Curve630

Equilibrium of Aggregate Demand and Supply632

Recessionary and Inflationary Gaps Revisited633

Adjusting to a Recessionary Gap:Deflation or Unemployment?635

An Example from Recent History:Disinflation in the 1990s638

Adjusting to an inflationary Gap:Inflation638

Tight Labor Markets in 1995639

Demand Inflation and Stagflation640

Stagflation from Supply shifts641

Inflation and the Multiplier642

A Role for Stabilization policy645

Summary645

Key Terms645

Questions for Review646

PART VII647

FISCAL AND MONETARY POLICY647

CHAPTER 28 MANAGING AGGREGA DEMAND:FISCAL POLICY AOOR.GALUCY649

Issue:How Quickly Should We Balance the Budget?649

Income Taxes and the Consumption Schedule650

The Multiplier Revisited654

Multipliers for Ta Policy655

Government Transfer Payments657

Planning Expansive Fiscal Policy657

Planning Restrictive Fiscal Policy658

The Choice between Spending Policy and Tax Policy659

Some Harsh Realities660

The Idea behind Supply-Side Tax Cuts661

Some Files in the Ointment663

Toward Assessment of Supply-Side Economics664

Clintonomics and Supply-Side Economics665

Summary665

Key Terms666

Questions for Review666

Appendix:Algebraic Treatment of Fiscal Policy and Aggregate Demand667

Questions for Review669

CHAPTER 29 MONEY AND THE BANKING SYSTEM671

Issue: To Regulate or to Deregulate?That is the Question671

Barter Versus Monetary Exchange672

The Conceptual Definition of Money674

What Serves as Money?674

How the Quantity of Money is Measured676

How Banking Began678

Is There a Smart Card in Your Future?679

Principles of Band Management:profits versus Safety680

Bank Regulation680

The Savings and Loan Crisis: Over at Last681

How Bankers Keep Books681

Policy Debate: Abolish the Community Reinvestment Act?682

The Limits to Money Creation by a Single Bank683

Multiple Money Creation by a Series of Banks685

The Process in Reverse:Multiple Contractions of the Money Supply688

Why the Deposit Creation Formula is Oversimplified690

The Need for Monetary Policy691

Summary691

Key Terms692

Questions for Review692

CHAPTER 30 MONETARY POLICY AND THE NATIONAL ECONOMY695

Money and Income:The Important Difference695

The Federal Reserve System:Origins and Structure696

The Independence of the Fed691

You Are There: The FOMC Meets698

Policy Debate: How Independent Should the Central Bank Be?699

Controlling the Money Supply: Open-Market Operations699

Open-Market Operations,Bond Prices,and Interest Rates701

Controlling the Money Supply:Lending to Banks702

Controlling the Money Supply:Reserve REquirements703

The Money Supply Mechanism704

The Demand for Money705

Equilibrium in the Money Market706

Interest Rates and Total Expenditures708

Monetary Policy and Aggregate Demand709

Money and the Price Level in the Keynesian Model711

From Models to Policy Debates713

Summary713

Key Terms714

Questions for Review714

CHAPTER 31 THE DEBATE OVER MONETARY POLICY717

Issue: Should We Forsake Stabilization Policy?717

Velocity and the Quantity Theory of Money718

The Determinants of Velocity720

Monetarism:The Quantity Theory Modernized722

Fiscal Policy, Interest Rates, and Velocity724

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 Curve730

Debate:Should the Government Intervene?733

Debate:Rules or Discretion?736

Techniques of Economic Forecasting737

The Accuracy of Economic Forecasts739

Other Dimensions of the Rules-Versus-Discretion Debate739

Conclusion:What Should be Done?741

Summary742

Key Terms743

Questions for Review743

CHAPTER 32 BUDGET DEFICITS AND THE NATIONAL DEBT: FACT AND FICTION745

Puzzle:Are Smaller Deficits Good or Bad for Growth?746

Should the Budget Be Balanced?746

Deficits and Debt:Some Terminology747

Some Facts about the National Debt748

Interpreting the Budget Deficit750

Inflation Accounting for Interest Payments752

Bogus Arguments about the Burden of Burden of the Debt756

Budget Deficits and Inflation757

Deficits,INterest Rates, and Crowding Out761

POlicy Debate: A Balanced-Budget Amendment to the Constitution?762

The True Burden of the National Debt763

Deficit Reduction and Growth:Puzzle Resolved764

Conclusion:The Economics and Politics of the Budget Deficit765

America speaks: How to Reduce the Budget Deficit766

Summary767

Key Terms768

Questions for Review768

CHAPTER 33 THE TRADE-OFF BETWEN INFLATION AND UNEMPLOYMENT769

Demand-Side Inflation Versus Supply-Side Inflation:A Review770

Applying the Model to a Growing Economy771

Demand-Side Inflation and the Phillips Curve773

Supply-Side Inflation and the Collapse of the Phillip Curve777

What the Phillips Curve is Not778

Fighting Unemployment with Fiscal and Monetary Policy781

What Should Be Done?782

Inflationary Expectations and the Phillips Curve783

The Theory of Rational Expectations786

Why Economists(and Politicians)Disagree788

The Dilemma of Demand Management789

Attempts to Reduce the Natural Rate of Unemployment789

Policy Debate:Should the Fed Concentrate Only on Reducing Inflation?790

Wage-Price Controls190

Indexing191

Summary792

Key Terms793

Questions for Review793

PART VIII795

THE UNITED STAES IN THE WORLO ECONOMY795

CHAPTER 34 INTERNATIONAL AND COMPARATIVE ADVANTAGE797

Puzzle: How Can Americans Compete with"Cheap Foreign Labor"?797

Why Trade?798

Mutual Gains from Trade799

International Versus Intranational Trade800

The Law of Comparative Advantage801

David Ricardo(1772--1823)802

The Arithmetic of Comparative Advantage802

The Graphics of Comparative Advantage803

Comparative Advantage and Competition of "Cheap Foreign Labor"806

Supply-Demand Equilibrium and Pricing in World Trade807

Tariffs, Quotas, and other Interferences with Trade808

How Tariffs and Quotas Work809

How Sweet It Is:The U.S.Sugar Quota810

Tariffs versus Quotas811

Why Inhibit Trade?812

Other Arguments for Protection814

Can Protectionism save Free Trade?816

Con Cheap Imports Be Bad for a Country817

Conclusion:A Last Look at the "Cheap Foreign Labor"Argument817

Unfair Foreign Competition818

Summary818

Key Terms819

Questions for Review819

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 Market823

The Purchasing-Power Parity Theory:The Long Rum826

Economic Activity and Exchange Rates:The Medium Rum827

Purchasing-Power Parity and the Big Mac828

Interest Rates and Exchange Rates:The Short Run829

Market Determination of Exchange Rates:Summary830

Fixed Exchange Rates and the Balance of Payments830

Defining the Balance of Payments in Practice833

A Bit of History:The Gold Standard834

The Bretton Woods System and the International Monetary Fund835

Adiustment Mechanisms under Fixed Exchange Rates836

Why Try to Fix Exchange Rates?838

The Current Mixed System839

The volatile Dollar839

The European Exchang Rate Mechanism841

Summary842

Key Terms842

Questions for Review843

CHAPTER 36 MACROECONOMICS IN A WORLD ECONOMY845

Issue:Deficit Reduction and the Dollar845

International Trade and Aggregate Demand:A Quick Review846

Relative Prices,Exports,and Imports847

The Effects of Changes in Exchange Rates847

Aggregate Supply in an Open Economy849

The Macroeconomic Effects of Exchange Rates850

Interest Rates and International Capital Flows851

Fiscal Policy in an Open Economy852

Monetary Policy in an Open Economy854

International Aspects of Deficit Deficit Reduction855

The Link Between the Budget Deficit and the trade Deficit857

Is the Trade Deficit a Problem?858

On Curing the Trade Deficit862

Summary862

Key Terms863

Questions for Review863

CHAPTER 31 PRODUCTIVITY AND GROWTH IN THE WEALTH OF NATIONS865

Part 1: Growth in the United States and Other Industrial Countries865

Life in the "Good Old Days"865

The Magnitude of Productivity Growth867

The Second Major Development:Convergence871

The U.S. Productivity Slowdown:Is American Economic Leadership Doomed?873

Productivity and the Deindustrialization Thesis875

Unemployment and Productivity Growth877

The Real Costs of Lagging Productivity:Lagging Wages and Living Standards878

Requirements for Increased Growth879

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 Countries884

Recent Trends886

Impediments to Development in the LDC：887

Help from Industrialized Economies891

Con LDC： Break Away from Poverty?893

Summary893

Key Terms894

Questions for Review895

CHAPTER 38 COMPARATIVE ECONOMIC SYSTEMS: WHAT ARE THE CHOICES?897

Economic Systems:Two Important Distinctions898

The Market or the Plan?Some Issues899

The Market or the Plan:The Scoreboard900

Capitalism of Socialism?901

Socialism,Planning,and Freedom902

The Administrative Command Economy:The Old Soviet Union903

Economies in Transition: Russia and Her Neighbors905

A Tale of Two Countries907

China under Mao: Revolutionary Communism908

China since Mao: Explosive Growth909

Japan's Unique Brand of Capitalism910

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

Summary914

Key Terms915

Questions for Review915