Principles Of Economics, Eighth Edition
By Robert H. Frank, Ben S. Bernanke, Kate Antonovics and Ori Heffetz
Contents:
PART I Introduction
Chapter 1 Thinking Like an Economist 1
Economics: Studying Choice in a World of Scarcity 2
Applying the Cost-Benefit Principle 3
Economic Surplus 4
Opportunity Cost 4
The Role of Economic Models 5
Three Important Decision Pitfalls 6
Pitfall 1: Measuring Costs and Benefits as
Proportions rather than Absolute Dollar
Amounts 6
Pitfall 2: Ignoring Implicit Costs 7
Pitfall 3: Failing to Think at the Margin 8
Normative Economics versus Positive Economics 13
Economics: Micro and Macro 13
The Approach of This Text 14
Economic Naturalism 14
THE ECONOMIC NATURALIST 1.1 15
THE ECONOMIC NATURALIST 1.2 15
THE ECONOMIC NATURALIST 1.3 16
Summary 17 • Core Principles 17 • Key Terms 17
- Review Questions 18 • Problems 18 • Answers to
Self-Tests 19 • Appendix: Working with Equations,
Graphs, and Tables 20
Chapter 2 Comparative Advantage 31
Exchange and Opportunity Cost 32
The Principle of Comparative Advantage 33
THE ECONOMIC NATURALIST 2.1 35
Sources of Comparative Advantage 36
THE ECONOMIC NATURALIST 2.2 36
Comparative Advantage and Production Possibilities 37
The Production Possibilities Curve 37
How Individual Productivity Affects the Slope and
Position of the PPC 40
The Gains from Specialization and Exchange 41
A Production Possibilities Curve for a Many-Person
Economy 43
A Note on the Logic of the Fruit Picker’s Rule 44
Factors That Shift the Economy’s Production
Possibilities Curve 45
Why Have Some Countries Been Slow to Specialize? 46
Can We Have Too Much Specialization? 47
Comparative Advantage and Outsourcing 48
THE ECONOMIC NATURALIST 2.3 48
Outsourcing 48
THE ECONOMIC NATURALIST 2.4 49
Summary 51 • Core Principles 51
- Key Terms 51 • Review Questions 52
- Problems 52 • Answers to Self-Tests 53
Chapter 3 Supply and Demand 55
What, How, and for Whom? Central Planning
versus the Market 57
Buyers and Sellers in Markets 58
The Demand Curve 59
The Supply Curve 60
Market Equilibrium 62
Rent Controls Reconsidered 65
Pizza Price Controls? 67
Predicting and Explaining Changes in Prices
and Quantities 68
Shifts in Demand 69
THE ECONOMIC NATURALIST 3.1 71
Shifts in the Supply Curve 72
THE ECONOMIC NATURALIST 3.2 75
Four Simple Rules 75
THE ECONOMIC NATURALIST 3.3 78
Efficiency and Equilibrium 78
Cash on the Table 79
Smart for One, Dumb for All 80
THE ECONOMIC NATURALIST 3.4 81
Summary 82 • Core Principles 83
- Key Terms 83 • Review Questions 83
- Problems 83 • Answers to Self-Tests 85
- Appendix: The Algebra of Supply and Demand 86
PART 2 Competition and the Invisible Hand
Chapter 4 Elasticity 89
Price Elasticity of Demand 90
Price Elasticity Defined 90
Determinants of Price Elasticity of Demand 92
Substitution Possibilities 92
Budget Share 92
Time 92
Some Representative Elasticity Estimates 93
Using Price Elasticity of Demand 94
THE ECONOMIC NATURALIST 4.1 94
THE ECONOMIC NATURALIST 4.2 94
A Graphical Interpretation of Price Elasticity 95
Price Elasticity Changes along a Straight-Line
Demand Curve 97
Two Special Cases 98
Elasticity and Total Expenditure 99
Income Elasticity and Cross-Price Elasticity of Demand 103
The Price Elasticity of Supply 104
Determinants of Supply Elasticity 106
Flexibility of Inputs 107
Mobility of Inputs 107
Ability to Produce Substitute Inputs 107
Time 107
THE ECONOMIC NATURALIST 4.3 108
Unique and Essential Inputs: The Ultimate
Supply Bottleneck 110
Summary 110 • Key Terms 111 • Review
Questions 111 • Problems 112 • Answers to
Self-Tests 113 • Appendix: The Midpoint Formula 114
Chapter 5 Demand 115
The Law of Demand 116
The Origins of Demand 116
Needs versus Wants 117
THE ECONOMIC NATURALIST 5.1 117
Translating Wants into Demand 118
Measuring Wants: The Concept of Utility 118
Allocating a Fixed Income between Two Goods 121
The Rational Spending Rule 125
Income and Substitution Effects Revisited 125
Applying the Rational Spending Rule 127
Substitution at Work 127
THE ECONOMIC NATURALIST 5.2 128
THE ECONOMIC NATURALIST 5.3 128
THE ECONOMIC NATURALIST 5.4 129
The Importance of Income Differences 129
THE ECONOMIC NATURALIST 5.5 130
Individual and Market Demand Curves 130
Horizontal Addition 130
Demand and Consumer Surplus 132
Calculating Consumer Surplus 132
Summary 135 • Key Terms 135 • Review
Questions 135 • Problems 135 • Answers to
Self-Tests 137 • Appendix: Indifference Curves 138
Chapter 6 Perfectly Competitive Supply 151
Thinking about Supply: The Importance of
Opportunity Cost 152
Individual and Market Supply Curves 154
Profit-Maximizing Firms in Perfectly Competitive Markets 155
Profit Maximization 155
The Demand Curve Facing a Perfectly
Competitive Firm 156
Production in the Short Run 157
Some Important Cost Concepts 158
Choosing Output to Maximize Profit 159
A Note on the Firm’s Shutdown Condition 160
Average Variable Cost and Average Total Cost 161
A Graphical Approach to Profit Maximization 161
Price = Marginal Cost: The Maximum-Profit
Condition 163
The “Law” of Supply 164
Determinants of Supply Revisited 166
Technology 166
Input Prices 166
The Number of Suppliers 166
Expectations 166
Changes in Prices of Other Products 166
Applying the Theory of Supply 167
THE ECONOMIC NATURALIST 6.1 167
Supply and Producer Surplus 170
Calculating Producer Surplus 170
Summary 171 • Key Terms 172 • Review Questions 172
- Problems 172 • Answers to Self-Tests 174
Chapter 7 Efficiency, Exchange, and the Invisible
Hand in Action 175
The Central Role of Economic Profit 176
Three Types of Profit 176
The Invisible Hand Theory 179
Two Functions of Price 179
Responses to Profits and Losses 179
The Importance of Free Entry and Exit 185
Economic Rent versus Economic Profit 186
The Invisible Hand in Action 188
The Invisible Hand at the Supermarket and on the
Freeway 188
THE ECONOMIC NATURALIST 7.1 188
The Invisible Hand and Cost-Saving Innovations 188
The Distinction between an Equilibrium and a
Social Optimum 189
Smart for One, Dumb for All 190
THE ECONOMIC NATURALIST 7.2 190
Market Equilibrium and Efficiency 191
Efficiency Is Not the Only Goal 193
Why Efficiency Should Be the First Goal 194
The Cost of Preventing Price Adjustments 195
Price Ceilings 195
Price Subsidies 198
Summary 200 • Key Terms 201 • Review Questions 201
- Problems 201 • Answers to Self-Tests 203
PART 3 Market Imperfections
Chapter 8 Monopoly, Oligopoly, and
Monopolistic Competition 205
Perfect and Imperfect Competition 206
Different Forms of Imperfect Competition 206
Monopolistic Competition 206
Oligopoly 207
The Essential Difference between Perfectly and
Imperfectly Competitive Firms 208
Five Sources of Market Power 209
Exclusive Control over Important Inputs 209
Patents and Copyrights 209
Government Licenses or Franchises 209
Economies of Scale and Natural Monopolies 210
Network Economies 210
Economies of Scale and the Importance of
Start-Up Costs 211
THE ECONOMIC NATURALIST 8.1 213
Profit Maximization for the Monopolist 214
Marginal Revenue for the Monopolist 214
The Monopolist’s Profit-Maximizing
Decision Rule 216
Being a Monopolist Doesn’t Guarantee
an Economic Profit 218
Why the Invisible Hand Breaks Down under
Monopoly 218
Using Discounts to Expand the Market 220
Price Discrimination Defined 220
THE ECONOMIC NATURALIST 8.2 221
How Price Discrimination Affects Output 221
The Hurdle Method of Price Discrimination 224
Is Price Discrimination a Bad Thing? 226
Examples of Price Discrimination 227
THE ECONOMIC NATURALIST 8.3 228
Public Policy toward Natural Monopoly 228
State Ownership and Management 229
State Regulation of Private Monopolies 229
Exclusive Contracting for Natural Monopoly 230
Vigorous Enforcement of Antitrust Laws 230
Summary 232 • Key Terms 232 • Review
Questions 233 • Problems 233 • Answers to
Self-Tests 235 • Appendix: The Algebra of
Monopoly Profit Maximization 236
Chapter 9 Games and Strategic Behavior 239
Using Game Theory to Analyze Strategic Decisions 240
The Three Elements of a Game 240
Nash Equilibrium 242
The Prisoner’s Dilemma 244
The Original Prisoner’s Dilemma 244
The Economics of Cartels 245
THE ECONOMIC NATURALIST 9.1 245
Tit-for-Tat and the Repeated Prisoner’s
Dilemma 247
THE ECONOMIC NATURALIST 9.2 248
THE ECONOMIC NATURALIST 9.3 249
Games in Which Timing Matters 250
Credible Threats and Promises 252
Monopolistic Competition When Location Matters 254
THE ECONOMIC NATURALIST 9.4 254
Commitment Problems 256
Solving Commitment Problems with Psychological
Incentives 258
Are People Fundamentally Selfish? 259
Preferences as Solutions to Commitment
Problems 259
Summary 260 • Key Terms 260 • Review
Questions 261 • Problems 261 • Answers to
Self-Tests 264
Chapter 10 An Introduction to Behavioral
Economics 265
Judgmental Heuristics or Rules of Thumb 267
Availability 267
Representativeness 267
Regression to the Mean 268
THE ECONOMIC NATURALIST 10.1 269
Anchoring and Adjustment 269
Misinterpretation of Contextual Clues 270
The Psychophysics of Perception 270
The Difficulty of Actually Deciding 271
Impulse-Control Problems 272
THE ECONOMIC NATURALIST 10.2 273
Loss Aversion and Status Quo Bias 275
THE ECONOMIC NATURALIST 10.3 276
Beyond Narrow Self-Interest 277
The Present-Aim Standard of Rationality 278
The Adaptive Rationality Standard 278
Concerns about Fairness 281
Concerns about Relative Position 282
THE ECONOMIC NATURALIST 10.4 285
THE ECONOMIC NATURALIST 10.5 286
Summary 289 • Key Terms 290 • Review
Questions 290 • Problems 290 • Answers to
Self-Tests 291
Chapter 11 Externalities, Property Rights,
and the Environment 293
External Costs and Benefits 294
How Externalities Affect Resource Allocation 294
How Do Externalities Affect Supply
and Demand? 295
The Coase Theorem 297
Remedies for Externalities 302
Laws and Regulations 302
THE ECONOMIC NATURALIST 11.1 303
THE ECONOMIC NATURALIST 11.2 303
The Optimal Amount of Negative Externalities
Is Not Zero 304
Compensatory Taxes and Subsidies 304
THE ECONOMIC NATURALIST 11.3 306
Property Rights and the Tragedy of the Commons 306
The Problem of Unpriced Resources 306
The Effect of Private Ownership 309
When Private Ownership Is Impractical 310
THE ECONOMIC NATURALIST 11.4 310
THE ECONOMIC NATURALIST 11.5 310
Harvesting Timber on Remote Public Land 311
Harvesting Whales in International Waters 311
Controlling Multinational Environmental
Pollution 311
Positional Externalities 311
Payoffs That Depend on Relative
Performance 312
THE ECONOMIC NATURALIST 11.6 312
Positional Arms Races and Positional Arms
Control Agreements 313
Campaign Spending Limits 313
Roster Limits 314
Arbitration Agreements 314
Mandatory Starting Dates for Kindergarten 314
Social Norms as Positional Arms Control
Agreements 314
Nerd Norms 314
Fashion Norms 314
Norms of Taste 315
Norms against Vanity 315
Using Price Incentives in Environmental
Regulation 316
Taxing Pollution 316
Auctioning Pollution Permits 318
Climate Change and Carbon Taxes 319
Summary 321 • Key Terms 322 • Review
Questions 322 • Problems 322 • Answers to
Self-Tests 324
PART 4 Economics of Public Policy
Chapter 12 The Economics of Information 325
How the Middleman Adds Value 326
The Optimal Amount of Information 328
The Cost-Benefit Test 328
The Free-Rider Problem 328
THE ECONOMIC NATURALIST 12.1 329
THE ECONOMIC NATURALIST 12.2 329
Two Guidelines for Rational Search 330
The Gamble Inherent in Search 331
The Commitment Problem When Search Is Costly 332
Asymmetric Information 333
The Lemons Model 333
The Credibility Problem in Trading 335
The Costly-to-Fake Principle 336
THE ECONOMIC NATURALIST 12.3 336
THE ECONOMIC NATURALIST 12.4 337
Conspicuous Consumption as a Signal
of Ability 337
THE ECONOMIC NATURALIST 12.5 338
Statistical Discrimination 339
THE ECONOMIC NATURALIST 12.6 339
Disappearing Political Discourse 340
THE ECONOMIC NATURALIST 12.7 340
THE ECONOMIC NATURALIST 12.8 342
Insurance 343
Adverse Selection 343
Moral Hazard 344
The Problem with Health Care Provision through
Private Insurance 344
The Affordable Care Act of 2010 345
Summary 346 • Key Terms 347
- Review Questions 347 • Problems 347
- Answers to Self-Tests 348
Chapter 13 Labor Markets, Poverty, and
Income Distribution 349
The Economic Value of Work 350
The Equilibrium Wage and Employment Levels 353
The Demand Curve for Labor 353
The Supply Curve of Labor 353
Market Shifts 354
Explaining Differences in Earnings 355
Human Capital Theory 355
Labor Unions 355
THE ECONOMIC NATURALIST 13.1 357
Compensating Wage Differentials 357
THE ECONOMIC NATURALIST 13.2 358
Discrimination in the Labor Market 358
Discrimination by Employers 358
Discrimination by Others 359
Other Sources of the Wage Gap 359
Winner-Take-All Markets 360
THE ECONOMIC NATURALIST 13.3 360
Recent Trends in Inequality 361
Is Income Inequality a Moral Problem? 362
Methods of Income Redistribution 363
Welfare Payments and In-Kind Transfers 364
Means-Tested Benefit Programs 364
The Negative Income Tax 365
Minimum Wages 365
The Earned-Income Tax Credit 366
Public Employment for the Poor 368
A Combination of Methods 369
Summary 370 • Key Terms 370 • Review
Questions 370 • Problems 371 • Answers to
Self-Tests 372
Chapter 14 Public Goods and Tax Policy 373
Government Provision of Public Goods 374
Public Goods versus Private Goods 374
Paying for Public Goods 376
THE ECONOMIC NATURALIST 14.1 378
The Optimal Quantity of a Public Good 379
The Demand Curve for a Public Good 379
Private Provision of Public Goods 380
Funding by Donation 381
Development of New Means to Exclude
Nonpayers 381
Private Contracting 381
Sale of By-Products 381
THE ECONOMIC NATURALIST 14.2 381
Laws, Regulations, and the Question of
Centralization 384
Externalities and Property Rights 384
Local, State, or Federal? 384
Sources of Inefficiency in the Political Process 385
Pork Barrel Legislation 385
THE ECONOMIC NATURALIST 14.3 386
THE ECONOMIC NATURALIST 14.4 386
Rent-Seeking 387
Starve the Government? 389
What Should We Tax? 390
Summary 392 • Key Terms 392 • Review
Questions 393 • Problems 393 • Answers to
Self-Tests 395
PART 5 International Trade
Chapter 15 International Trade and
Trade Policy 397
Comparative Advantage as a Basis for Trade 398
Production and Consumption Possibilities and
the Benefits of Trade 399
The Two-Worker Production Possibilities
Curve 399
The Many-Worker Production Possibilities
Curve 402
Consumption Possibilities with and without
International Trade 404
A Supply and Demand Perspective on Trade 407
Winners and Losers from Trade 410
THE ECONOMIC NATURALIST 15.1 410
Protectionist Policies: Tariffs and Quotas 412
Tariffs 412
Quotas 414
THE ECONOMIC NATURALIST 15.2 416
The Inefficiency of Protectionism 417
THE ECONOMIC NATURALIST 15.3 417
Summary 418 • Key Terms 419 • Review
Questions 419 • Problems 420 • Answers to
Self-Tests 421 • Chapter 15 Appendix: An Algebraic
Approach to Trade Analysis (included at the back of the book)
PART 6 Macroeconomic: Issues and Data
Chapter 16 Macroeconomics: The Bird’s-Eye View
of the Economy 423
The Major Macroeconomic Issues 425
Economic Growth and Living Standards 425
Productivity 427
Recessions and Expansions 428
Unemployment 428
Inflation 430
Economic Interdependence among Nations 431
Macroeconomic Policy 432
Types of Macroeconomic Policy 432
Positive versus Normative Analyses of
Macroeconomic Policy 433
Aggregation 434
Studying Macroeconomics: A Preview 437
Summary 438 • Key Terms 438 • Review
Questions 438 • Problems 439 • Answers to
Self-Tests 439
Chapter 17 Measuring Economic Activity:
GDP and Unemployment 441
Gross Domestic Product: Measuring the
Nation’s Output 442
Market Value 443
Final Goods and Services 445
Produced in a Country during a Given
Period 448
Methods for Measuring GDP 449
The Expenditure Method for Measuring GDP 449
GDP and the Incomes of Capital and Labor 452
Nominal GDP versus Real GDP 455
THE ECONOMIC NATURALIST 17.1 457
Real GDP and Economic Well-Being 457
Why Real GDP Isn’t the Same as Economic
Well-Being 458
Leisure Time 458
THE ECONOMIC NATURALIST 17.2 458
Nonmarket Economic Activities 459
Environmental Quality and Resource Depletion 459
Quality of Life 459
Poverty and Economic Inequality 460
But GDP Is Related to Economic Well-Being 460
Availability of Goods and Services 460
Health and Education 461
THE ECONOMIC NATURALIST 17.3 462
Unemployment and the Unemployment Rate 463
Measuring Unemployment 463
The Costs of Unemployment 465
The Duration of Unemployment 466
The Unemployment Rate versus “True”
Unemployment 466
Summary 467 • Key Terms 468 • Review
Questions 468 • Problems 468 • Answers to
Self-Tests 470
Chapter 18 Measuring the Price Level
and Inflation 471
The Consumer Price Index and Inflation 472
Inflation 475
Adjusting for Inflation 476
Deflating a Nominal Quantity 476
Indexing to Maintain Buying Power 479
THE ECONOMIC NATURALIST 18.1 480
Does the CPI Measure “True” Inflation? 481
The Costs of Inflation: Not What You Think 483
The True Costs of Inflation 484
“Noise” in the Price System 484
Distortions of the Tax System 485
“Shoe-Leather” Costs 486
Unexpected Redistributions of Wealth 486
Interference with Long-Term Planning 487
Hyperinflation 487
Inflation and Interest Rates 489
Inflation and the Real Interest Rate 489
The Fisher Effect 492
Summary 493 • Key Terms 493 • Review
Questions 494 • Problems 494 • Answers to
Self-Tests 495
PART 7 The Economy in the Long Run
Chapter 19 Economic Growth, Productivity,
and Living Standards 497
The Remarkable Rise in Living Standards:
The Record 499
Why “Small” Differences in Growth Rates
Matter 501
Why Nations Become Rich: The Crucial Role of Average
Labor Productivity 503
The Determinants of Average Labor Productivity 505
Human Capital 505
THE ECONOMIC NATURALIST 19.1 506
Physical Capital 507
Land and Other Natural Resources 509
Technology 510
THE ECONOMIC NATURALIST 19.2 511
Entrepreneurship and Management 512
THE ECONOMIC NATURALIST 19.3 513
The Political and Legal Environment 513
The Costs of Economic Growth 515
Promoting Economic Growth 515
Policies to Increase Human Capital 516
THE ECONOMIC NATURALIST 19.4 516
Policies That Promote Saving and
Investment 516
Policies That Support Research and
Development 517
The Legal and Political Framework 517
The Poorest Countries: A Special Case? 517
Are There Limits to Growth? 518
Summary 520 • Key Terms 521 • Review
Questions 521 • Problems 521 • Answers to
Self-Tests 523
Chapter 20 The Labor Market: Workers, Wages,
and Unemployment 525
Five Important Labor Market Trends 526
Trends in Real Wages 526
Trends in Employment and
Unemployment 527
Supply and Demand in the Labor Market 528
Wages and the Demand for Labor 528
Shifts in the Demand for Labor 530
THE ECONOMIC NATURALIST 20.1 534
The Supply of Labor 534
Shifts in the Supply of Labor 536
Explaining the Trends in Real Wages
and Employment 536
Large Increases in Real Wages in
Industrialized Countries 537
Real Wage Growth in the United States Has
Stagnated since the Early 1970s, while Employment
Growth Has Been Rapid 537
Increasing Wage Inequality: The Effects of
Globalization and Technological Change 539
Globalization 539
Technological Change 541
THE ECONOMIC NATURALIST 20.2 543
Unemployment 544
Types of Unemployment and Their Costs 545
Frictional Unemployment 545
Structural Unemployment 546
Cyclical Unemployment 546
Impediments to Full Employment 546
Summary 549 • Key Terms 549 • Review
Questions 550 • Problems 550 • Answers to
Self-Tests 551
Chapter 21 Saving and Capital Formation 553
Saving and Wealth 554
Stocks and Flows 555
Capital Gains and Losses 556
THE ECONOMIC NATURALIST 21.1 557
Why Do People Save? 559
THE ECONOMIC NATURALIST 21.2 559
Saving and the Real Interest Rate 560
Saving, Self-Control, and Demonstration Effects 562
THE ECONOMIC NATURALIST 21.3 563
National Saving and Its Components 565
The Measurement of National Saving 565
Private and Public Components of
National Saving 567
Public Saving and the Government Budget 568
Is Low Household Saving a Problem? 570
Investment and Capital Formation 571
Saving, Investment, and Financial Markets 573
THE ECONOMIC NATURALIST 21.4 576
Summary 578 • Key Terms 578 • Review
Questions 579 • Problems 579 • Answers to
Self-Tests 580
Chapter 22 Money, Prices, and
the Federal Reserve 583
Money and Its Uses 584
THE ECONOMIC NATURALIST 22.1 585
Measuring Money 586
Commercial Banks and the Creation of Money 587
The Money Supply with Both Currency and
Deposits 590
The Federal Reserve System 592
The History and Structure of the Federal
Reserve System 593
Controlling the Money Supply: Open-Market
Operations 593
The Fed’s Role in Stabilizing Financial Markets: Banking Panics 595
THE ECONOMIC NATURALIST 22.2 595
Money and Prices 598
Velocity 598
Money and Inflation in the Long Run 599
Summary 601 • Key Terms 602 • Review
Questions 602 • Problems 602 • Answers to
Self-Tests 603
Chapter 23 Financial Markets and International
Capital Flows 605
The Financial System and the Allocation of Saving
to Productive Uses 606
The Banking System 607
THE ECONOMIC NATURALIST 23.1 608
Bonds and Stocks 608
Bonds 609
Stocks 610
Bond Markets, Stock Markets, and the Allocation of Savings 613
The Informational Role of Bond and
Stock Markets 613
Risk Sharing and Diversification 614
THE ECONOMIC NATURALIST 23.2 615
International Capital Flows 616
Capital Flows and the Balance of Trade 617
The Determinants of International
Capital Flows 619
Saving, Investment, and Capital Inflows 620
The Saving Rate and the Trade Deficit 622
THE ECONOMIC NATURALIST 23.3 623
Summary 625 • Key Terms 625 • Review
Questions 625 • Problems 626 • Answers to Self-Tests 627
PART 8 The Economy in the Short Run
Chapter 24 Short-Term Economic Fluctuations: An Introduction 629
THE ECONOMIC NATURALIST 24.1 630
Recessions and Expansions 631
THE ECONOMIC NATURALIST 24.2 633
Some Facts about Short-Term Economic Fluctuations 634
Output Gaps and Cyclical Unemployment 637
Potential Output 637
The Output Gap 638
The Natural Rate of Unemployment and Cyclical Unemployment 639
THE ECONOMIC NATURALIST 24.3 640
Okun’s Law 642
THE ECONOMIC NATURALIST 24.4 643
Why Do Short-Term Fluctuations Occur? A Preview
and a Tale 644
Alice’s Ice Cream Store: A Tale about Short-Run
Fluctuations 645
Summary 646 • Key Terms 647 • Review
Questions 647 • Problems 647 • Answers to
Self-Tests 648
Chapter 25 Spending and Output in the
Short Run 649
The Keynesian Model’s Crucial Assumption: Firms Meet
Demand at Preset Prices 651
THE ECONOMIC NATURALIST 25.1 652
Planned Aggregate Expenditure 653
Planned Spending versus Actual Spending 653
Consumer Spending and the Economy 655
THE ECONOMIC NATURALIST 25.2 656
Planned Aggregate Expenditure and Output 657
Short-Run Equilibrium Output 660
Finding Short-Run Equilibrium Output: Numerical Approach 661
Finding Short-Run Equilibrium Output: Graphical Approach 662
Planned Spending and the Output Gap 664
THE ECONOMIC NATURALIST 25.3 666
The Multiplier 667
Stabilizing Planned Spending: The Role of Fiscal Policy 668
Government Purchases and Planned Spending 668
THE ECONOMIC NATURALIST 25.4 670
Taxes, Transfers, and Aggregate Spending 671
THE ECONOMIC NATURALIST 25.5 673
Fiscal Policy as a Stabilization Tool: Three Qualifications 674
Fiscal Policy and the Supply Side 675
The Problem of Deficits 675
The Relative Inflexibility of Fiscal Policy 675
Summary 676 • Key Terms 677 • Review
Questions 678 • Problems 678 • Answers to
Self-Tests 679 • Appendix A: An Algebraic
Solution of the Basic Keynesian Model 681 • Appendix B:
The Multiplier in the Basic Keynesian Model 684
Chapter 26 Stabilizing the Economy: The Role of
the Fed 687
The Federal Reserve and Interest Rates:
The Basic Model 688
The Demand for Money 689
Macroeconomic Factors That Affect the Demand
for Money 692
The Money Demand Curve 693
THE ECONOMIC NATURALIST 26.1 694
The Supply of Money and Money Market Equilibrium 696
How the Fed Controls the Nominal Interest Rate 697
The Role of the Federal Funds Rate in Monetary Policy 699
Can the Fed Control the Real Interest Rate? 700
The Federal Reserve and Interest Rates: A Closer Look 701
Can the Fed Fully Control the Money Supply? 701
Affecting Bank Reserves through Open-Market Operations 702
Affecting Bank Reserves through Discount Window Lending 702
Setting and Changing Reserve Requirements 702
Excess Reserves: The Norm since 2008 703
Do Interest Rates Always Move Together? 704
The Zero Lower Bound and the Need for
“Unconventional” Monetary Policy 705
Quantitative Easing 705
Forward Guidance 705
Interest on Reserves and the New Tools of
Monetary Policy 706
The Effects of Federal Reserve Actions on the
Economy 708
Planned Aggregate Expenditure and the Real
Interest Rate 708
The Fed Fights a Recession 711
THE ECONOMIC NATURALIST 26.2 712
The Fed Fights Inflation 713
THE ECONOMIC NATURALIST 26.3 714
THE ECONOMIC NATURALIST 26.4 715
THE ECONOMIC NATURALIST 26.5 715
The Feds Policy Reaction Function 717
THE ECONOMIC NATURALIST 26.6 717
Monetary Policymaking: Art or Science? 720
Summary 720 • Key Terms 722 • Review
Questions 722 • Problems 722 • Answers to
Self-Tests 724 • Appendix: Monetary Policy in the Basic Keynesian Model 725
Chapter 27 Aggregate Demand, Aggregate Supply, and Inflation 727
Inflation, Spending, and Output: The Aggregate
Demand Curve 728
Inflation, the Fed, and Why the AD Curve Slopes
Downward 729
Other Reasons for the Downward Slope of
the AD Curve 730
Factors That Shift the Aggregate Demand
Curve 730
Changes in Spending 731
Changes in the Fed’s Policy Reaction Function 732
Shifts of the AD Curve versus Movements along the AD Curve 732
Inflation and Aggregate Supply 734
Inflation Inertia 735
Inflation Expectations 735
Long-Term Wage and Price Contracts 736
The Output Gap and Inflation 737
No Output Gap: Y = Y* 738
Expansionary Gap: Y > Y* 738
Recessionary Gap: Y < Y* 738
The Aggregate Demand–Aggregate Supply Diagram 739
The Self-Correcting Economy 741
Sources of Inflation 742
Excessive Aggregate Spending 742
THE ECONOMIC NATURALIST 27.1 744
Inflation Shocks 745
THE ECONOMIC NATURALIST 27.2 746
Shocks to Potential Output 748
THE ECONOMIC NATURALIST 27.3 749
Controlling Inflation 751
THE ECONOMIC NATURALIST 27.4 753
THE ECONOMIC NATURALIST 27.5 754
Summary 756 • Key Terms 757 • Review
Questions 757 • Problems 758 • Answer to
Self-Test 759 • Appendix: The Algebra of
Aggregate Demand and Aggregate Supply 762
PART 9 The International Economy
Chapter 28 Exchange Rates and the Open
Economy 765
Exchange Rates 767
Nominal Exchange Rates 767
Flexible versus Fixed Exchange Rates 769
The Real Exchange Rate 769
THE ECONOMIC NATURALIST 28.1 772
The Determination of the Exchange Rate in the Long Run 773
A Simple Theory of Exchange Rates: Purchasing Power Parity (PPP) 773
Shortcomings of the PPP Theory 775
The Determination of the Exchange Rate in the Short Run 776
The Foreign Exchange Market: A Supply and Demand Analysis 777
The Supply of Dollars 777
The Demand for Dollars 778
The Equilibrium Value of the Dollar 778
Changes in the Supply of Dollars 779
Changes in the Demand for
Dollars 780
THE ECONOMIC NATURALIST 28.2 780
Monetary Policy and the Exchange Rate 781
THE ECONOMIC NATURALIST 28.3 782
The Exchange Rate as a Tool of Monetary
Policy 783
How to Fix an Exchange Rate 784
Speculative Attacks 787
Monetary Policy and the Fixed Exchange Rate 788
THE ECONOMIC NATURALIST 28.4 789
THE ECONOMIC NATURALIST 28.5 790
THE ECONOMIC NATURALIST 28.6 790
Should Exchange Rates Be Fixed or
Flexible? 792
THE ECONOMIC NATURALIST 28.7 793
Summary 794 • Key Terms 795 • Review
Questions 795 • Problems 796 • Answers to
Self-Tests 797
Glossary G-1
Index I-1