Ebook Macroeconomics (3rd edition): Part 1
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Macroeconomics
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Macroeconomics
Third Edition
R. Glenn Hubbard
Columbia University
Anthony Patrick O'Brien
Lehigh University
Prentice Hall
Boston
Amsterdam
Delhi
Columbus
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Indianapolis
Dubai
New York
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Library of Congress Cataloging-in-Publication Data
Hubbard, R. Glenn.
Macroeconomics/R. Glenn Hubbard. Anthony Patrick O'Brien. - 3rd ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-13-602182-7
ISBN-IO: 0-13-602182-4
1. Macroeconomics I. O'Brien, Anthony Patrick. II. Title.
HBI72.5.H86 2009
339-dc22
2009033429
10 9 8 7 6 5 4 3 2 1
Prentice Hall
is an imprint of
ISBN-IO:
0-13-602182-4
www.pe.rsonhighered.comISBN-13: 978-0-13-602182-7
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For Constance, Raph, and Will
-R. Glenn Hubbard
For Cindy, MaHhew, Andrew, and Daniel
-Anthony Patrick O'Brien
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Glenn Hubbard, policymaker, professor, and
researcher. R. Glenn Hubbard is the dean and Russell L.
Carson Professor of Finance and Economics in the Graduate
School of Business at Columbia University and professor of
economics in Columbia's Faculty of Arts and Sciences. He is also a
research associate of the National Bureau of Economic Research and
a director of Automatic Data Processing, Black Rock Closed-End
Funds, KKR Financial Corporation, and MetLife. He was formerly
a director of Capmark Financial, Duke Realty, Information
Services Group, and Ripplewood Holdings. He received his Ph.D.
in economics from Harvard University in 1983. From 2001 to 2003, he served as chairman
of the White House Council of Economic Advisers and chairman of the OECD Economy
Policy Committee, and from 1991 to 1993, he was deputy assistant secretary of the U.S.
Treasury Department. He currently serves as co-chair of the nonpartisan Committee on
Capital Markets Regulation. Hubbard's fields of specialization are public economics,
financial markets and institutions, corporate finance, macroeconomics, industrial
organization, and public policy. He is the author of more than 100 articles in leading
journals, including American Economic Review, Brookings Papers on Economic Activity,
Journal ofFinance, Journal of Financial Economics, Journal ofMoney, Credit, and Banking,
Journal of Political Economy, Journal of Public Economics, Quarterly Journal of Economics,
RAND Journal ofEconomics, and Review ofEconomics and Statistics. His research has been
supported by grants from the National Science Foundation, the National Bureau of
Economic Research, and numerous private foundations.
Tony O'Brien, award-winning professor and
researcher. Anthony Patrick O'Brien is a professor of
economics at Lehigh University. He received his Ph.D. from the
University of California, Berkeley, in 1987. He has taught principles
of economics for more than 15 years, in both large sections and
small honors classes. He received the Lehigh University Award for
Distinguished Teaching. He was formerly the director of the
Diamond Center for Economic Education and was named a Dana
Foundation Faculty Fellow and Lehigh Class of 196 1 Professor of
Economics. He has been a visiting professor at the University of
California, Santa Barbara, and the Graduate School of Industrial Administration at
Carnegie Mellon University. O'Brien's research has dealt with such issues as the evolution of
the U.S. automobile industry, sources of U.S. economic competitiveness, the development of
U.S. trade policy, the causes of the Great Depression, and the causes of black-white income
differences. His research has been published in leading journals, including American
Economic Review, Quarterly Journal of Economics, Journal of Money, Credit, and Banking,
Industrial Relations, Journal of Economic History, and Explorations in Economic History. His
research has been supported by grants from government agencies and private foundations.
In addition to teaching and writing, O'Brien also serves on the editorial board of the
Journal ofSocio-Economics.
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Preface
Acknowledgments
xx
xxxvi
PART 4: Short-Run Fluctuations
Chapter 1 1 : Aggregate Expenditure and Output
in the Short Run
PART 1 : Introduction
Chapter 1 : Economics: Foundations and Models
Chapter 1 Appendix: Using Graphs and Formulas
Macroeconomic Equilibrium
24
36
PART 5: Monetary and Fiscal Policy
96
Chapter 4 Appendix: Quantitative Demand
and Supply Analysis
Chapter 1 3: Money, Banks, and the Federal
Reserve System
127
PART 2: Firms in the Domestic
and International Economies
420
Chapter 1 4: Monetary Policy
454
Chapter 1 5: Fiscal Policy
494
Chapter 1 5 Appendix: A Closer Look at the
Multiplier
Chapter 5: Firms. the Stock Market, and Corporate
Governance
416
64
Chapter 4: Economic Efficiency. Government
Price Setting. and Taxes
382
Chapter 1 2 Appendix: Macroeconomic Schools
of Thought
Chapter 3: Where Prices Come From: The
Interaction of Demand and Supply
380
Chapter 1 2: Aggregate Demand and Aggregate
Supply Analysis
Chapter 2: Trade-offs. Comparative Advantage.
and the Market System
338
Chapter 1 1 Appendix: The Algebra of
132
535
Chapter 1 6: Inflation, Unemployment, and
Federal Reserve Policy
542
Chapter 5 Appendix: Tools to Analyze Firms'
Financial Information
157
Chapter 6: Comparative Advantage and the
PART 6: The International Economy
Gains from International Trade
166
Chapter 1 7 : Macroeconomics in an Open Economy
574
Chapter 6 Appendix: Multinational Firms
202
Chapter 1 8: The International Financial System
60 4
Chapter 1 8 Appendix: The Gold Standard and
PART 3: Macroeconomic Foundations
and Long-Run Growth
the Bretton Woods System
629
GLOSSARY
G-I
Chapter 7: GDP: Measuring Total Production
COMPANY INDEX
SUBJECT INDEX
and Income
208
Chapter 8: Unemployment and Inflation
234
Chapter 9: Economic Growth, the Financial System,
and Business Cycles
270
Chapter 1 0: Long-Run Economic Growth: Sources
and Policies
viii
302
CREDITS
I-I
1-3
C-I
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xx
Preface
Acknowledgments
PART 1 :
xxxvi
Introduction
CHAPTER 1: Economics: Foundations
and Models
MICROSOFT VERSUS THE U.S. CONGRESS ON WORKER VISAS
Three Key Economic Ideas
People Are Rational
People Respond to Economic Incentives
Making the Connection: Will Women Have More
Babies if the Government Pays Them To?
Optimal Decisions Are Made at the Margin
Solved Problem 1-1: Apple Computer Makes
a Decision at the Margin
Formulas
2
3
4
5
6
Economic Models
The Role of Assumptions in Economic Models
Forming and Testing Hypotheses in Economic
Models
Normative and Positive Analysis
Don't Let This Happen to You! Don't Confuse
Positive Analysis with Normative Analysis
Economics as a Social Science
Making the Connection: Should the Federal
Government Have Increased Restrictions on
the Immigration of Skilled Workers?
Microeconomics and Macroeconomics
A Preview of Important Economic Terms
Conclusion
An Inside Look at Policy:
Do Immigrants Displace
or Complement Domestic Workers?
to
II
II
12
13
13
13
14
IS
16
18
Key Terms, Summary. Review Questions, Problems
and Applications
20
24
Graphs of One Variable
25
Slopes of Lines
Taking into Account More Than Two
Variables on a Graph
Positive and Negative Relationships
31
32
32
Problems and Applications
34
CHAPTER 2: Trade-offs, Comparative
Advantage, and the Market System
MANAGERS MAKING CHOICES AT BMW
36
37
Production Possibilities Frontiers
and Opportunity Costs
Specialization and Gains from Trade
Absolute Advantage versus Comparative Advantage
Comparative Advantage and the Gains from Trade
Don't Let This Happen to Youl Don't Confuse
Absolute Advantage and Comparative
Advantage
Solved Problem 2-2: Comparative Advantage
and the Gains from Trade
The Market System
The Circular Flow of Income
The Gains from Free Markets
The Market Mechanism
Making the Connection: A Story of the Market
System in Action: How Do You Make an iPod?
The Role of the Entrepreneur
The Legal Basis of a Successful Market System
Making the Connection: Property Rights in
Cyberspace: YouTube, Facebook, and MySpace
Conclusion
38
38
40
41
42
43
44
44
46
47
47
48
49
50
50
52
52
53
53
54
55
An Inside Look:
CHAPTER 1 Appendix: Using Graphs
and Formulas
Graphs of Two Variables
31
33
34
Comparative Advantage and Trade
II
29
Formula for a Percentage Change
Formulas for the Areas of a Rectangle
and a Triangle
Summary of Using Formulas
Graphing the Production Possibilities Frontier
Solved Problem 2-1: Drawing a Production
Possibilities Frontier for Rosie's Boston Bakery
Making the Connection: Facing the Trade-offs in
Health Care Spending
Increasing Marginal Opportunity Costs
Economic Growth
The Economic Problem That Every Society Must Solve
What Goods and Services Will Be Produced?
How Will the Goods and Services Be Produced?
Who Will Receive the Goods and Services Produced?
Centrally Planned Economies versus Market
Economies
The Modern "Mixed" Economy
Efficiency and Equity
Determining Cause and Effect
Are Graphs of Economic Relationships
Always Straight Lines?
Slopes of Nonlinear Curves
26
26
Detroit Challenges Hybrids
with New Technology
56
Key Terms, Summory, Review Questions, Problems
and Applications
CHAPTER 3: Where Prices Come From:
The Interaction of Demand and Supply
28
RED BULL AND THE MARKET fOR ENERGY DRINKS
29
The Demand Side of the Market
58
64
85
66
ix
x
CONTENT S
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Demand Schedules and Demand Curves
The Law of Demand
What Explains the Law of Demand?
Holding Everything Else Constant:
The Ceteris Paribus Condition
Variables That Shift Market Demand
Making the Connection: Are Big Macs an
Inferior Good?
Making the Connection: The Aging of the Baby
Boom Generation
A Change in Demand versus a Change
in Quantity Demanded
Making the Connection: Red Bull and the Future
Demand for Energy Drinks
The Supply Side of the Market
Supply Schedules and Supply Curves
The Law of Supply
Variables That Shift Market Supply
A Change in Supply versus a Change
in Quantity Supplied
66
67
67
68
68
Floors and Price Ceilings
69
70
71
73
74
74
75
75
76
Market Equilibrium: Putting Demand
and Supply Together
How Markets Eliminate Surpluses and Shortages
Demand and Supply Both Count
Solved Problem 3-3: Demand and Supply Both
Count: A Tale of Two Letters
78
78
79
80
The Effect of Demand and Supply Shifts on Equilibrium 8 1
The Effect of Shifts in Supply on Equilibrium
Making the Connection: The Falling Price of LCD
Televisions
The Effect of Shifts in Demand on Equilibrium
The Effect of Shifts in Demand and Supply
over Time
Solved Problem 3-4: High Demand and Low
Prices in the Lobster Market?
Don't Let This Happen to You! Remember:
A Change in a Good's Price Does Not Cause
the Demand or Supply Curve to Shift
Shifts in a Curve versus Movements along a Curve
Conclusion
An Inside Look:
How Does Advertising Help Red
Bull Increase Demand for Its Energy Drink?
81
81
83
83
CHAPTER 4: Economic Efficiency,
Government Price Setting, and Taxes
SHOULD THE GOVERNMENT CONTROL APARTMENT RENTS?
Consumer Surplus and Producer Surplus
Consumer Surplus
The Consumer
Surplus from Broadband Internet Service
Producer Surplus
What Consumer Surplus and Producer
Surplus Measure
84
The Economic Impact of Taxes
The Effect of Taxes on Economic Efficiency
Tax Incidence: Who Actually Pays a Tax?
Solved Problem 4-4: When Do Consumers
Pay All of a Sales Tax Increase?
Making the Connection: Is the Burden of the Social
Security Tax Really Shared Equally between
Workers and Firms?
An Inside Look at Policy:
Is Rent Control a
Lifeline or Stranglehold?
103
103
104
105
105
105
106
108
109
109
109
llO
III
III
1 12
112
113
114
liS
1 17
118
Key Terms, Summary, Review Questions, Problems
86
87
87
88
90
and Applications
CHAPTER 4 Appendix: Quantitative
Demand and Supply Analysis
Demand and Supply Equations
Calculating Consumer Surplus and Producer Surplus
Review Questions
Problems and Applications
96
97
98
120
127
127
128
130
130
PART 2: Firms in the Domestic
and International Economies
98
Making the Connection:
The Efficiency of Competitive Markets
Price Floors: Government Policy in
Agricultural Markets
Making the Connection: Price Floors in Labor
Markets: The Debate over Minimum
Wage Policy
Price Ceilings: Government Rent Control
Policy in Housing Markets
Don't Let This Happen to You! Don't Confuse
"Scarcity" with a "Shortage"
Black Markets
Solved Problem 4-3: What's the Economic
Effect of a Black Market for Apartments?
Making the Connection: Does Holiday Gift
Giving Have a Deadweight Loss?
The Results of Government Price Controls:
Winners, Losers, and Inefficiency
Positive and Normative Analysis of Price
Ceilings and Price Floors
Conclusion
Key Terms, Summary, Review Questions, Problems
and Applications
Marginal Benefit Equals Marginal Cost
in Competitive Equilibrium
Economic Surplus
Deadweight Loss
Economic Surplus and Economic Efficiency
Government Intervention in the Market: Price
100
101
CHAPTER 5: Firms. the Stock Market.
and Corporate Governance
FACEBOOK: FROM DORM ROOM TO WALL STREET
102
102
1YPes of Firms
Who Is Liable? Limited and Unlimited Liability
132
1 33
134
134
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Corporations Earn the Majority of
Revenue and Profits
Making the Connection: How Important Are
Small Businesses to the U. S. Economy?
Corporate Structure and Corporate Governance
Solved Problem 5-2: Does the Principal-Agent
Problem Apply to the Relationship between
Managers and Workers?
How Firms Raise Funds
Sources of External Funds
Stock and Bond Markets Provide
Capital-and Information
Don't Let This Happen to You! When Google
Shares Change Hands, Google Doesn't Get
the Money
Why Do Stock Prices Fluctuate So Much?
Making the Connection: Following Abercrombie
& Fitch's Stock Price in the Financial Pages
Using Financial Statements to Evaluate a Corporation
The Income Statement
The Balance Sheet
Corporate Governance Policy
The Accounting Scandals of the Early 2000s
Solved Problem 5-5: What Makes a Good Board
of Directors?
The Financial Meltdown of the Late 2000s
Making the Connection: Was the Principal-Agent
Problem at the Heart of the Financial Crisis?
Conclusion
An Inside Look: The Principal-Agent Problem
at Facebook
CHAPTER 5 Appendix: Tools to Analyze
Firms' Financial Information
Using Present Value to Make Investment Decisions
136
136
137
137
138
138
140
140
141
Going Deeper into Financial Statements
International Trade
145
Measuring the Economic Effect of the Sugar Quota
145
146
147
148
149
152
157
157
159
160
160
161
162
164
Solved Problem 6-4: Measuring the Economic
Effect of a Quota
The High Cost of Preserving Jobs with
Tariffs and Quotas
Gains from Unilateral Elimination of
Tariffs and Quotas
Other Barriers to Trade
Why Do Some People Oppose the
World Trade Organization?
Making the Connection: The Unintended
Consequences of Banning Goods Made
with Child Labor
Dumping
Positive versus Normative Analysis (Once Again)
Making the Connection: The Obama Administration
Develops a Trade Policy
Conclusion
An Inside Look at Policy: Caterpillar and Other
Exporters Oppose "Buy American" Provision
170
171
171
172
173
173
174
176
176
176
177
178
178
179
180
181
182
183
184
185
185
185
186
187
189
189
190
191
192
Key Terms, Summary, Review Questions, Problems
and Applications
CHAPTER 6 Appendix: Multinational Firms
A BRIEF HISTORY OF MULTINATIONAL ENTERPRISES
194
202
202
Strategic Factors in Moving from
166
IS A GOVERNMENT "BUY AMERICAN" POLICY
The Importance of Trade to the U. S. Economy
U. S. International Trade in a World Context
Tariffs
Quotas and Voluntary Export Restraints
The Arguments Over 'frade Policies and Globalization
150
Key Terms, Review QuesHons, Problems and Applications
The United States in the International Economy
Increasing Consumption through Trade
Solved Problem 6-3: The Gains from Trade
Why Don't We See Complete Specialization?
Does Anyone Lose as a Result of International
Trade?
Don't Let This Happen to You! Remember That
Trade Creates Both Winners and Losers
Where Does Comparative Advantage Come From?
Making the Connection: Why Is Dalton, Georgia,
the Carpet-Making Capital of the World?
Comparative Advantage Over Time: The
Rise and Fall-and Rise-of the U. S.
Consumer Electronics Industry
143
144
145
162
163
A GOOD IDEA FOR U.S. FIRMS LIKE CATERPILLAR?
How Countries Gain from International Trade
Government Policies That Restrict
Analyzing Income Statements
Analyzing Balance Sheets
CHAPTER 6: Comparative Advantage
and the Gains from International Trade
A Brief Review of Comparative Advantage
Comparative Advantage in International Trade
142
Solved Problem SA-I: How to Receive Your
Contest Winnings
Using Present Value to Calculate Bond Prices
Using Present Value to Calculate Stock Prices
A Simple Formula for Calculating Stock Prices
on International Trade
Comparative Advantage in International Trade
Key Terms, Summary, Review Questions, Problems
and Applications
xi
Making the Connection: How Caterpillar Depends
135
The Structure of Corporations and the
Principal-Agent Problem
CONTENT S
1 67
Domestic to Foreign Markets
203
Making the Connection: Have Multinational
Corporations Reduced Employment and
Lowered Wages in the United States?
205
168
Challenges to U.S. Firms in Foreign Markets
168
169
206
Competitive Advantages of U.S. Firms
Key Terms, Review Questions, Problems and Applications
207
206
xii
CONTENT S
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PART 3: Macroeconomic Foundations
and Long-Run Growth
CHAPTER 7: GOP: Measuring Total
Production and Income
208
FORD MOTOR COMPANY FEELS THE EFFECTS
OF THE RECESSION
Gross Domestic Product Measures Total Production
209
211
Measuring Total Production: Gross
211
Domestic Product
212
Solved Problem 7-1: Calculating GDP
Production, Income, and the Circular-Flow Diagram 212
Components of GDP
214
Don't Let This Happen to You! Remember What
215
Economists Mean by Investment
215
An Equation for GDP and Some Actual Values
Making the Connection: Will U. S.
216
Consumers Be Spending Less?
218
Measuring GDP by the Value-Added Method
Does GDP Measure What We Want It to Measure?
Shortcomings in GDP as a Measure of
Total Production
Making the Connection: Why Do Many
Developing Countries Have Such Large
Underground Economies?
Shortcomings of GDP as a Measure of Well-being
Making the Connection: Did World War II
Bring Prosperity?
Real GDP Versus Nominal GDP
Calculating Real GDP
Solved Problem 7-3: Calculating Real GDP
Comparing Real GDP and Nominal GDP
The GDP Deflator
Other Measures of Total Production and Total Income
Gross National Product (GNP)
National Income
Personal Income
Disposable Personal Income
The Division of Income
Conclusion
An Inside Look at Policy: Falling Auto Purchases
Lead to Lower GDP
219
219
220
220
221
222
222
223
224
224
225
225
226
226
226
226
227
228
Key Terms, Summary, Review Questions, Problems
and Appllcotlons
CHAPTER 8: Unemployment and Inflation
THE SEArrLE POST·INTELLIGENCER STOPS
THE PRESSES, CAUSING MORE JOB LOSSES
230
234
235
Measuring the Unemployment Rate and the Labor
Force Participation Rate
The Household Survey
Solved Problem 8-1: What Happens if You
Include the Military?
Problems with Measuring the Unemployment Rate
Trends in Labor Force Participation
Unemployment Rates for Demographic Groups
Unemployment So High During the
Recent Recession?
How Long Are People Typically Unemployed?
The Establishment Survey: Another Measure
of Employment
Job Creation and Job Destruction over Time
1YPes of Unemployment
Frictional Unemployment and Job Search
Structural Unemployment
Cyclical Unemployment
Full Employment
Making the Connection: How Should We
Categorize the Unemployment at the Seattle
Post-Intelligencer and Other Newspapers?
Explaining Unemployment
Government Policies and the Unemployment Rate
Labor Unions
Efficiency Wages
Making the Connection: Why Does Costco
Pay Its Workers So Much More Than
Wal-Mart Does?
Measuring Inflation
The Consumer Price Index
Is the CPI Accurate?
240
242
242
243
244
244
245
245
245
246
247
247
249
249
249
250
251
252
Don't Let This Happen to You! Don't Miscalculate
the Inflation Rate
The Producer Price Index
252
253
Using Price Indexes to Adjust for the Effects
of Inflation
254
Solved Problem 8-5: Calculating Real
Average Hourly Earnings
Real versus Nominal Interest Rates
254
255
Does Inflation Impose Costs on the Economy?
257
Inflation Affects the Distribution of Income
The Problem with Anticipated Inflation
The Problem with Unanticipated Inflation
Making the Connection: What's So Bad
about Falling Prices?
257
258
258
Conclusion
An Inside Look: Newspaper Layoffs Add to Rising
Unemployment in 2009
259
261
262
Key Terms, Summory, Review Questions, Problems
and Applications
CHAPTER 9: Economic Growth,
the Financial System. and Business Cycles
GROWTH AND THE BUSINESS CYCLE AT BOEING
Long-Run Economic Growth
236
Making the Connection: The Connection
238
238
239
between Economic Prosperity and Health
Calculating Growth Rates and the Rule of 70
What Determines the Rate of Long-Run Growth?
Solved Problem 9-1: The Role of Technological
Change in Growth
236
240
Making the Connection: Why Was Male
264
270
271
272
273
275
275
276
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Making the Connection: What Explains Rapid
Economic Growth in Botswana?
Potential GDP
Saving, Investment, and the Financial System
An Overview of the Financial System
The Macroeconomics of Saving and Investment
The Market for Loanable Funds
Making the Connection: Ebenezer Scrooge:
Accidental Promoter of Economic Growth?
Solved Problem 9-2: How Would a Consumption
Tax Affect Saving, Investment, the Interest
Rate, and Economic Growth?
The Business Cycle
Some Basic Business Cycle Definitions
How Do We Know When the Economy
Is in a Recession?
Making the Connection: Can a Recession Be
a Good Time for a Business to Expand?
What Happens during a Business Cycle?
Don't Let This Happen to You! Don't Confuse
the Price Level and the Inflation Rate
Will the U. S. Economy Return to Stability?
Conclusion
An Inside Look: Airlines Face the Business Cycle
and Long-Run Growth
277
279
279
280
281
282
283
New Growth Theory
Joseph Schumpeter and Creative Destruction
Economic Growth in the United States
Economic Growth in the United States since 1950
What Caused the Productivity Slowdown
of 1973-1994?
Has the "New Economy" Increased Productivity?
Why Has Productivity Growth Been Faster
in the United States than in Other Countries?
Why Isn't the Whole World Rich?
286
287
287
288
289
290
Catch-up: Sometimes, but Not Always
Solved Problem 10-4: The Economic Growth
Model's Prediction of Catch-up
Why Don't More Low-Income Countries
Experience Rapid Growth?
Making the Connection: What Do Parking Tickets
in New York City Have to Do With Poverty
in the Developing World?
The Benefits of Globalization
Growth Policies
291
294
295
296
Key Terms, Summary, Review Questions, Problems
and Applications
CONTENT S
Enhancing Property Rights and the Rule of Law
Improving Health and Education
Policies that Promote Technological Change
Policies that Promote Saving and Investment
Is Economic Growth Good or Bad?
Conclusion
298
An Inside Look at Policy: Investment Spurs
China's Growth
CHAPTER 10: Long-Run Economic Growth:
Sources ond Policies
GOOGLE'S DILEMMA IN CHINA
Economic Growth over Time and around the World
Economic Growth from 1,000,000 B.C.
to the Present
Making the Connection: Why Did the Industrial
Revolution Begin in England?
Small Differences in Growth Rates Are Important
Why Do Growth Rates Matter?
Don't Let This Happen to You! Don't Confuse
the Average Annual Percentage Change
with the Total Percentage Change
Making the Connection: The Benefits of an Earlier
Start: Standards of Living in China
and Japan
"The Rich Get Richer and . . ."
What Determines How Fast Economies Grow?
The Per-Worker Production Function
Which Is More Important for Economic
Growth: More Capital or Technological Change?
Technological Change: The Key to
Sustaining Economic Growth
Making the Connection: What Explains the
Economic Failure of the Soviet Union?
Solved Problem 10-2: Using the Economic
Growth Model to Analyze the Failure
of the Soviet Union's Economy
xiii
313
315
3 15
316
316
317
317
3 19
319
321
322
323
325
326
326
327
327
327
328
329
330
Key Terms, Summary, Review Questions, Problems
302
303
304
304
and Applications
PART 4:
Short-Run Fluctuations
CHAPTER 1 1: Aggregate Expenditure
and Output in the Short Run
FLUCTUATING DEMAND AT INTEL
305
306
306
307
332
The Aggr egate Expenditure Model
Aggregate Expenditure
The Difference between Planned
Investment and Actual Investment
Macroeconomic Equilibrium
Adjustments to Macroeconomic Equilibrium
338
339
340
340
341
341
342
Determining the Level of Aggregate Expenditure
307
308
308
309
310
311
311
312
in the Economy
343
Consumption
343
Making the Connection: Do Changes in Housing
Wealth Affect Consumption Spending?
The Relationship between Consumption
and National Income
Income, Consumption, and Saving
Solved Problem 11-2: Calculating the Marginal
Propensity to Consume and the Marginal
Propensity to Save
Planned Investment
Making the Connection: Intel Tries to Jump
Off the Roller Coaster of Information
Technology Spending
345
348
349
350
351
352
xiv
CONTENT S
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Government Purchases
Net Exports
Graphing Macroeconomic Equilibrium
Showing a Recession on the 45'-Line Diagram
The Important Role of Inventories
A Numerical Example of Macroeconomic
Equilibrium
Don't Let This Happen to You! Don't Confuse
Aggregate Expenditure with Consumption
Spending
Solved Problem 11-3: Determining Macroeconomic
Equilibrium
The Multiplier Effect
353
354
356
358
359
360
361
362
363
The Great Depression of the 1930s
365
A Formula for the Multiplier
366
Summarizing the Multiplier Effect
367
Solved Problem 11-4: Using the Multiplier Formula 368
The Paradox of Thrift
369
Conclusion
An Inside Look: Falling PC Sales Signal Further
Decline in the Economy
369
37 1
CHAPTER 1 1 Appendix: The Algebra
of Macroeconomic Equilibrium
Problems and Applications
CHAPTER 1 2: Aggregate Demand
and Aggregate Supply Analysis
THE FORTUNES OF FEDEX FOLLOW THE BUSINESS CYCLE
Aggregate Demand
Why Is the Aggregate Demand Curve
Downward Sloping?
Shifts of the Aggregate Demand Curve
versus Movements along It
The Variables That Shift the Aggregate
Demand Curve
Making the Connection: Should Germany
Reduce Its Reliance on Exports?
Don't Let This Happen to You! Understand Why
the Aggregate Demand Curve Is Downward
Sloping
Solved Problem 12-1: Movements along the
Aggregate Demand Curve versus Shifts
of the Aggregate Demand Curve
Aggregate Supply
The Long-Run Aggregate Supply Curve
The Short-Run Aggregate Supply Curve
Shifts of the Short-Run Aggregate Supply Curve
versus Movements along It
Variables That Shift the Short-Run Aggregate
Supply Curve
Recessions, Expansions, and Supply Shocks
Making the Connection: Does It Matter
What Causes a Decline in Aggregate Demand?
Making the Connection: How Long Does It
Take to Return to Potential GDP? A View
from the Obama Administration
Supply Model
What Is the Usual Cause of Inflation?
The Recession of 2007-2009
Solved Problem 12-4: Showing the Oil Shock
of 1974-1975 on a Dynamic Aggregate
Demand and Aggregate Supply Graph
Conclusion
An Inside Look:
Smaller Freight Volumes
Signal Continued Economic Troubles
396
396
398
400
and Applications
CHAPTER 12 Appendix: Macroeconomic
Schools of Thought
374
The Monetarist Model
The New Classical Model
The Real Business Cycle Model
380
Capitalism's Severest Critic
382
PART 5:
383
CHAPTER 13: Money, Banks, and the
Federal Reserve System
385
COCA·COLA DRIES UP AS MONEY FLOODS ZIMBABWE
387
Barter and the Invention of Money
The Functions of Money
What Can Serve as Money?
Making the Connection: The Mackerel
Economy in the Federal Prison System
How Is Money Measured in the United States Today!
388
389
390
390
392
Ml: The Narrowest Definition of the Money Supply
Makingthe Connection: Do We Still Need the Penny?
M2: A Broader Definition of Money
Don't Let This Happen to You! Don't Confuse
Money with Income or Wealth
Solved Problem 13-2: The Definitions of Ml
and M2
What about Credit Cards and Debit Cards?
How Do Banks Create Money!
393
393
405
407
408
4 10
416
416
417
417
418
Monetary and Fiscal Policy
What Is Money, and Why Do We Need It?
386
403
4 18
Key Terms
386
403
Making the Connection: Karl Marx:
381
384
40 1
Key Terms, Summary, Review Questions, Problems
372
Key Terms, Summary, Review Questions, Problems
and Applications
and the Short Run
A Dynamic Aggregate Demand and Aggregate
Making the Connection: The Multiplier in Reverse:
The Aggregate Demand Curve
Macroeconomic Equilibrium in the Long Run
Bank Balance Sheets
Using T-Accounts to Show How a Bank Can
Create Money
420
421
422
422
423
424
425
425
426
427
428
428
429
429
429
429
430
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The Simple Deposit Multiplier
432
Don't Let This Happen to You! Don't Confuse
Assets and Liabilities
433
Showing How Banks
Create Money
434
The Simple Deposit Multiplier versus the Real-World
Deposit Multiplier
436
Solved Problem 13-3:
The Federal Reserve System
437
The Establishment of the Federal Reserve System
437
How the Federal Reserve Manages the Money Supply 438
The "Shadow Banking System" and the Financial
Crisis of 2007-2009
439
The Quantity Theory of Money
Connecting Money and Prices: The Quantity
Equation
The Quantity Theory Explanation of Inflation
High Rates of Inflation
Making the Connection: The German Hyperinflation
of the Early 1920s
Conclusion
An Inside Look at Policy: Less Lending Lowers
Money Supply Growth
442
442
443
443
444
445
CHAPTER 14: Monetory Policy
448
454
MONETARY POLICY, TOLL BROTHERS,
AND THE HOUSING MARKET
What Is Monetary Policy?
The Goals of Monetary Policy
455
Monetary Policy Targets
The Demand for Money
Shifts in the Money Demand Curve
How the Fed Manages the Money Supply:
A Quick Review
Equilibrium in the Money Market
A Tale of Two Interest Rates
Choosing a Monetary Policy Target
The Importance of the Federal Funds Rate
Monetary Policy and Economic Activity
How Interest Rates Affect Aggregate Demand
The Effects of Monetary Policy on Real GDP
and the Price Level
Making the Connection: Too Low for Zero:
The Fed Tries "Quantitative Easing"
Can the Fed Eliminate Recessions?
A Summary of How Monetary Policy Works
Don't Let This Happen to You! Remember That
with Monetary Policy, It's the Interest RatesNot the Money-That Counts
The Effects of Monetary Policy on Real GDP
and the Price Level: A More Complete Account
Should the Fed Target the Money Supply?
Why Doesn't the Fed Target Both the Money Supply
and the Interest Rate?
The Taylor Rule
Should the Fed Target Inflation?
Making the Connection: How Does the Fed
Measure Inflation?
Fed Policies During the 2007-2009 Recession
The Inflation and Deflation of the Housing
Market "Bubble"
The Changing Mortgage Market
The Role of Investment Banks
Making the Connection: The Wonderful World
of Leverage
The Fed and the Treasury Department Respond
An Inside Look at Policy: Housing Market
Affects the United States and
Europe Differently
CHAPTER 15: Fiscal Policy
What Is Fiscal Policy?
458
458
459
459
460
461
462
462
463
463
470
471
473
473
474
474
475
476
477
477
479
479
480
481
483
484
Key Terms, Summary, Review Questions, Problems
and Applications
456
What Fiscal Policy Is and What It Isn't
Automatic Stabilizers versus Discretionary
Fiscal Policy
An Overview of Government Spending and Taxes
Making the Connection: Is Spending on Social
Security and Medicare a Fiscal Time Bomb?
486
494
495
496
496
496
497
499
The Effects of Fiscal Policy on Real GDP
and the Price Level
Expansionary and Contractionary Fiscal Policy
A Summary of How Fiscal Policy Affects
Aggregate Demand
Don't Let This Happen to You! Don't Confuse
Fiscal Policy and Monetary Policy
500
500
502
502
Fiscal Policy in the Dyoamic Aggregate Demand
464
and Aggregate Supply Model
The Government Purchases and Tax Multipliers
465
467
468
468
Monetary Policy in the Dyoamic Aggregate Demand
and Aggregate Supply Model
Policy Targets
A BOON FOR Ha.R BLOCK
458
xv
A Closer Look at the Fed's Setting of Monetary
456
The Money Market and the Fed's Choice of Monetary
Policy Targets
Using Monetary Policy to Fight Inflation
Solved Problem 14-4: The Effects of Monetary
Policy
Conclusion
446
Key Terms, Summary, Review Questions, Problems
and Applications
CONTENT S
469
469
The Effect of Changes in Tax Rates
Taking into Account the Effects of
Aggregate Supply
The Multipliers Work in Both Directions
Fiscal Policy in Action: The Obama Administration
Faces the Recession of 2007-2009
Solved Problem 15-4: Fiscal Policy Multipliers
Making the Connection: Economists in the Obama
Administration Estimate the Size
of the Multiplier
503
504
507
507
508
508
510
511
xvi
CONTENT S
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The Limits of Using Fiscal Policy to Stabilize
the Economy
Does Government Spending Reduce
Private Spending?
Crowding Out in the Short Run
Crowding Out in the Long Run
Making the Connection: Is Losing Your Job
Good for Your Health?
Deficits, Surpluses, and Federal Government Debt
How the Federal Budget Can Serve
as an Automatic Stabilizer
Making the Connection: Did Fiscal Policy
Fail during the Great Depression?
Solved Problem 15-6: The Effect of Economic
Fluctuations on the Budget Deficit
Should the Federal Budget Always Be Balanced?
The Federal Government Debt
Is Government Debt a Problem?
The Effects of Fiscal Policy in the Long Run
The Long-Run Effects of Tax Policy
Tax Simplification
Making the Connection: Should the United States
Adopt the "Flat Tax"?
The Economic Effect of Tax Reform
How Large Are Supply-Side Effects?
Conclusion
An Inside Look at Policy: Obama Uses Fiscal
Policy to Stimulate the Economy
511
512
512
513
514
515
516
517
518
518
519
520
520
520
521
522
523
524
525
CHAPTER 15 Appendix: A Closer Look
at the Multiplier
An Expression for Equilibrium Real GDP
A Formula for the Government Purchases Multiplier
A Formula for the Tax Multiplier
The «Balanced Budget" Multiplier
The Effects of Changes in Tax Rates on the Multiplier
The Multiplier in an Open Economy
Problems and Applications
CHAPTER 16: Inflation, Unemployment,
and Federal Reserve Policy
535
535
536
537
537
538
539
540
542
543
The Discovery of the Short-Run '!rade-off
between Unemployment and Inflation
Explaining the Phillips Curve with Aggregate
Demand and Aggregate Supply Curves
Is the Phillips Curve a Policy Menu?
Is the Short-Run Phillips Curve Stable?
The Long-Run Phillips Curve
The Role of Expectations of Future Inflation
Making the Connection: Do Workers
Understand Inflation?
The Short-Run and Long-Run Phillips Curves
550
552
552
The Effect of Rational Expectations
on Monetary Policy
Is the Short-Run Phillips Curve Really Vertical?
Real Business Cycle Models
Fed Policy From the 1970s to the Present
The Effect of a Supply Shock on the Phillips Curve
Paul Voleker and Disinflation
Don't Let This Happen to You! Don't Confuse
Disinflation with Deflation
Solved Problem 16-4: Using Monetary Policy
to Lower the Inflation Rate
554
555
555
556
556
557
558
559
Alan Greenspan, Ben Bernanke, and the Crisis
in Monetary Policy
Conclusion
An Inside Look at Policy: The Fed Faces
the Phillips Curve Once Again
560
563
565
566
Key Terms, Summary, Review Questians, Problems
and Applications
568
526
528
WHY DOES SUMMITVILLE TILES CARE ABOUT
MONETARY POLICY?
550
Expectations of the Inflation Rate and Monetary Policy 553
Has the Fed Lost It's Independence?
Key Terms, Summary, Review Questions, Problems
and Applications
Shifts in the Short-Run Phillips Curve
How Does a Vertical Long-Run Phillips Curve
Affect Monetary Policy?
Making the Connection: Does the Natural Rate
of Unemployment Ever Change?
Solved Problem 16-2: Changing Views
of the Phillips Curve
S44
545
546
546
546
547
548
549
PART 6:
The International Economy
CHAPTER 1 7: Macroeconomics
in an Open Economy
STRONG DOLLAR HURTS MCDONALD'S PROFITS
574
575
The Balance of Payments: Linking the United States
to the International Economy
576
The Current Account
The Financial Account
The Capital Account
Why Is the Balance of Payments Always Zero?
Don't Let This Happen to You! Don't Confuse
the Balance of Trade, the Current Account
Balance, and the Balance of Payments
Solved Problem 17-1: Understanding
the Arithmetic of Open Economies
576
577
578
579
The Foreign Exchange Market and Exchange Rates
58 1
Making the Connection: Exchange Rate Listings
581
582
Equilibrium in the Market for Foreign Exchange
How Do Shifts in Demand and Supply Affect
the Exchange Rate?
Making the Connection: What Explains the Fall
and Rise and Fall of the Dollar?
Some Exchange Rates Are Not Determined
by the Market
How Movements in the Exchange Rate Affect
Exports and Imports
579
580
583
585
586
586
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587
587
588
The International Sector and National
Saving and Investment
Net Exports Equal Net Foreign Investment
Domestic Saving, Domestic Investment,
and Net Foreign Investment
Solved Problem 17-3: Arriving at the Saving
and Investment Equation
588
589
590
591
The Effect of a Government Budget
Deficit on Investment
592
593
Monetary Policy and Fiscal Policy in an Open Economy 594
Monetary Policy in an Open Economy
Fiscal Policy in an Open Economy
Conclusion
An Inside Look at Policy: Financial Crisis
Contributes to a Strong Dollar
594
595
595
596
Key Terms, Summary, Review Questions, Problems
and Applications
CHAPTER 18: The International
Financial System
598
EXCHANGE RATES
Don't Let This Happen to You! Remember
That Modern Currencies Are Fiat Money
The Current Exchange Rate System
The Floating Dollar
Conclusion
An Inside Look at Policy: Can Tariffs Offset
the Effect of Overvaluation?
and Applications
605
606
607
607
607
610
610
612
613
614
618
619
62 1
622
624
CHAPTER 18 Appendix: The Gold Standard
629
and the Bretton Woods System
The Gold Standard
The End of the Gold Standard
The Collapse of the Bretton Woods System
604
608
608
Key Terms, Summary, Review Questions, Problems
The Bretton Woods System
MOLSON COORS DEALS WITH FLUCTUATING
Exchange Rate Systems
Gain from the Rising Value of the Canadian
Dollar
What Determines Exchange Rates in the Long Run?
Making the Connection: The Big Mac Theory
of Exchange Rates
Solved Problem 18-2: Calculating Purchasing
Power Parity Exchange Rates Using Big Macs
The Euro
Making the Connection: Can the Euro Survive
the 2007-2009 Recession?
Pegging against the Dollar
Making the Connection: Crisis and Recovery
in South Korea
International Capital Markets
Making the Connection: Why Is the United States
Called the "World's Largest Debtor"?
xvii
Making the Connection: The Toronto Blue Jays
Don't Let This Happen to You! Don't Confuse
What Happens When a Currency Appreciates
with What Happens When it Depreciates
Solved Problem 17-2: The Effect of Changing
Exchange Rates on the Prices of Imports
and Exports
The Real Exchange Rate
CONTENT S
Key Terms, Summary, Review Questions, Problems
and Applications
GLOSSARY
COMPANY INDEX
SUBJECT INDEX
CREDITS
629
629
630
63 1
633
G-l
1-1
1-3
C-l
xviii
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F LEX I B I L I T Y C H A R T
F L E X I B I L I TY C H A R T
The following chart helps you organize your syllabus based on your teaching preferences and objectives:
Core
Optional
CHAPTER 1 : Economics:
CHAPTER 1 Appendix: Using
Foundations and Models
Po l i cy
Graphs and Formulas
CHAPTER 2: Trade-offs,
Comparative Advantage,
and the Market System
CHAPTER 3: Where Prices Come
From: The Interaction of Demand
and Supply
CHAPTER 4 Appendix:
Quantitative Demand
and Supply Analysis
CHAPTER 5: Firms, the Stock
Market, and Corporate
Governance
CHAPTER 5 Appendix: Tools to
Analyze Firms' Financial
Information
CHAPTER 6: Comparative
Advantage and the Gains from
International Trade
CHAPTER 6 Appendix:
M u ltinational Firms
CHAPTER 7: GOP: Measuring
Total Production and Income
CHAPTER 8: Unemployment
and Inflation
CHAPTER 9: Economic Growth,
the Financial System, and
Business Cycles
CHAPTER 1 0: long-Run Economic
Growth: Sources and Policies
CHAPTER 1 1 : Aggregate
Expenditure and Output In the
Short Run
This chapter uses the Keynesian 45"-line aggregate
expenditure model to introduce students to the short
run relarionship between spending and production.
The discussion of monetary and fisCAl policy in later
chapters uses only the aggregate demand and
aggregate supply model. which allows instructors to
omit Chapter II.
CHAPTER 4: Economic
Efficiency, Government Price
Setting, and Taxes
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F LEX I B I L I T Y C H A R T
Core
Optional
Po l i cy
CHAPTER 1 1 Appendix: The
Algebra of M acroeconomic
Equilibrium
CHAPTER 1 2: Aggregate
Demand and Aggregate Supply
Analysis
This chapter carefully develops the AD-AS
modeJ and then makes the model dynamic to
better account for actual movements in real
GDP and the price leveL The dynamic AD-AS
modeJ is covered in an optional section. which
instrudors can omit without loss of continuity.
CHAPTER 1 2 Appendix:
Macroeconomic Schools of
Thought
CHAPTER 1 3: Money, Banks, and
the Federal Reserve System
CHAPTER 1 4: Monetary Policy
CHAPTER 1 5: Fiscal Policy
CHAPTER 1 6: Inflation,
Unemployment, and Federal
Reserve Policy
CHAPTER 1 7 : M acroeconomics
in an Open Economy
CHAPTER 1 8: The International
Financial System
xix
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When George Lucas was asked why he made
Star Wars, he replied, "It's the kind of movie I
like to see, but no one seemed to be making them. So, I decided to make one." We realized
that no one seemed to be writing the kind of textbook we wanted to use in our classes. So,
after years of supplementing texts with fresh, lively, real-world examples from newspapers,
magazines, and professional journals, we decided to write an economics text that delivers
complete economics coverage with many real-world business examples. Our goal was to
keep our classes "widget free."
N EW TO TH E TH IRD EDITION
Much has happened i n the economy during the last few years. The financial meltdown
that began in the summer of 2007 led to the most severe recession since the Great Depression
of the 1930s. In response to these problems, Congress, the president, and the Federal Reserve
enacted dramatic new policies. Our approach in the first two editions of this text has been to
put applications at the forefront of the discussion. We believe that students find the study of
economics more interesting and easier to master when they see economic analysis applied to
the real-world issues that concern them. Given how much has happened recently in the
economy, we believe that this new edition will provide students with a better understanding
of recent economic events and the policy responses to them. The new material in this edition
has taken us into areas-such as investment banking and mortgage-backed securities-not
often dealt with in principles texts. We believe, though, that a basic background in these
issues is necessary for students to understand the economic problems of recent years and the
responses of policymakers.
Here is a summary of our changes. Please see the next section for details on each change:
New coverage of the recession and financial crisis of 2007-2009.
New coverage of initiatives by the Federal Reserve.
New coverage of fiscal policy, including President Obama's stimulus program.
Reorganized presentation of the dynamic aggregate demand and aggregate supply
model in the monetary policy chapter and fiscal policy chapter.
All GDP data are now on a 2005 base year basis.
All figures, tables, and graphs have been carefully updated.
All companies in the chapter openers have been either replaced with new companies or
updated with current information.
All chapters include new An Inside Look newspaper articles and analyses to help students
apply economic thinking to current events and policy debates.
There are 24 new Making the Connection features to help students tie economic concepts
to current events and policy issues.
We have taken the opportunity of this new edition to make many changes throughout
the text, while concentrating on three key areas:
The financial crisis and recession of2007-2009. The financial crisis and resulting recession
were the worst since the Great Depression of the 1930s. We discuss the recession throughout
the book, including a detailed discussion of its origins in Chapter 12, "Aggregate Demand
and Aggregate Supply Analysis." Chapter 12 also includes a discussion of the particular sever
ity of recessions caused by financial crises and contains a new discussion of how long it takes
the economy to return to potential GDP. The housing bust and subprime crisis are discussed
xx
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in Chapter 13, "Money, Banks, and the Federal Reserve System," and Chapter 14, "Monetary
Policy." Chapter 7, "GDP: Measuring Total Production and Income:' has a new Making the
Connedion on the decline in consumption spending and increase in saving during the reces
sion. Chapter 8, "Unemployment and Inflation" has a new Making the Connection on the sur
prising increase in male unemployment relative to female unemployment during the reces
sion. Chapter 9, "Economic Growth, the Financial System, and Business Cycles," has a new
Making the Connedion on firms that decide to expand even as their sales fall during a reces
sion. Chapter I I , "Aggregate Expenditure and Output in the Short Run," contains a new sec
tion on the "paradox of thrift." Chapter 18, "The International Financial System," has a new
Making the Connection on the debate over whether the euro helped or hurt Europe in dealing
with the recession.
New initiatives by the Federal Reserve. During 2008, the Fed dramatically broke with
precedent by setting up a number of new "lending facilities," and by participating in
actions such as the purchase of Bear Stearns by JP Morgan Chase. In this new edition, we
provide students with a basic background on investment banks, the process of securitiza
tion-including a new explanatory figure-and the mortgage-backed securities market
including the roles of Fannie Mae and Freddie Mac-and the debate among economists
concerning the Fed's new policies. Chapter 13 contains an important new section on the
rise of the "shadow banking" system and a new supporting figure to explain securitization.
Chapter 15 has a new Making the
Connection on the role leverage played in the financial
crisis. Chapter 16, "Inflation, Unemployment, and Federal Reserve Policy," covers the debate
over Alan Greenspan's culpability in bringing on the financial crisis, the consequences of the
Fed's intervention to save long-term capital management, and the questions raised by the
Fed's close collaboration with the Treasury during the latest crisis, particularly the question
of whether the Fed's independence has been undermined.
Fiscal policy, includingPresident Obama's stimulus program. The stimulus package enacted in
early 2009 was the largest fiscal policy action in U. S. history. We examine the package in detail
in Chapter 15, "Fiscal Policy," which also has a figure setting out the components of the pack
age. Chapter 15 has a new Making the Connedion on the debate over the size of the government
spending multiplier. In discussing the tax cuts in the stimulus program we include a new sec
tion on the different effects temporary and permanent tax changes have on consumption
spending.
Here are other significant changes to
Macroeconomics Third Edition:
Many instructors have found our dynamic aggregate demand and aggregate supply
model to be an important improvement on the usual static model. We understand, how
ever, that some instructors would prefer to concentrate on the basic model. So, in the
third edition, our discussion of the dynamic model appears in one entirely self-contained
section in each of Chapters 12, 14, and 15. These sections can be omitted with no loss of
continuity because knowledge of the dynamic model is not presumed in any of the dis
cussion outside of these sections.
Al! GDP data are now on a 2005 base year basis. As of publication, ours is the only text
that has 2005 base year data, which was first released by the U. S. Bureau of Economic
Analysis in late summer 2009.
All figures, tables, and graphs have been carefully updated, so they reflect such recent
events as the explosion in the federal budget deficit and the increase in government debt
as a percentage of GDP.
All companies in the chapter openers have been either replaced with new companies or
updated with current information.
Al! chapters include new An Inside Look newspaper articles and analyses to help students
apply economic thinking to current events and policy debates.
P RE F A CE
xxi
xxii
P RE F A CE
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Finally, we have gone over rhe text literally line-by-line, tightening the discussion,
rewriting unclear points, and making many orher small changes. We are grateful to rhe
many instructors and students who made suggestions for improvements in rhe previous
edition. We have done our best to incorporate as many of these suggestions as possible.
T h e Fou n d a ti o n :
Contextual Learning and Modern Organization
Students come to study macroeconomics with a strong interest in understanding events and
developments in the economy. We try to capture that interest and develop students' eco
nomic intuition and understanding in this text. We present macroeconomics in a way that is
modern and based in rhe real world of business and economic policy. And we believe we
achieve this presentation without making the analysis more difficult. We avoid the recent
trend of using simplified versions of intermediate models, which are often more detailed and
more complex than what students need to understand the basic macroeconomic issues.
Instead, we usc a more realistic version of the familiar aggregate demand and aggregate sup
ply model to analyze short-run fluctuations and monetary and fiscal policy. We also avoid
rhe "dueling schools of rhought" approach often used to teach macroeconomics at rhe prin
ciples level. We emphasize rhe many areas of macroeconomics where most economists agree.
And we present rhroughout real business and policy situations to develop students' intuition.
Here are a few highlights of our approach to macroeconomics:
A BROAD DISCUSSION OF MACRO STATISTICS. Many students pay at least some
attention to rhe financial news and know rhat rhe release of statistics by federal agencies
can cause movements in stock and bond prices. A background in macroeconomic statis
tics helps clarify some of rhe policy issues encountered in later chapters. In Chapter 7,
"GDP: Measuring Total Production and Income," and Chapter 8, "Unemployment and
Inflation," we provide students with an understanding of the uses and potential short
comings of rhe key macroeconomic statistics, without getting bogged down in the
minutiae of how the statistics are constructed. So, for instance, we discuss the important
differences between rhe payroll survey and rhe household survey for understanding con
ditions in rhe labor market. We explain why rhe financial markets react more strongly to
news from the payroll survey. Chapter 14,"Monetary Policy," discusses why rhe Federal
Reserve prefers to measure inflation using rhe personal consumption expenditures price
index rather than the consumer price index.
EARLY COVERAGE OF LONG· RUN TOP ICS. We place key macroeconomic issues in
rheir long-run context in Chapter 9, "Economic Growth, the Financial System, and
Business Cycles," and Chapter 10, "Long-Run Economic Growth: Sources and Policies:)
Chapter 9 puts rhe business cycle in rhe context of underlying long-run growrh and dis
cusses what actually happens during the phases of the business cycle. We believe rhis
material is important if students are to have the understanding of business cycles rhey
will need to interpret economic events, yet rhis material is often discussed only briefly or
omitted entirely in orher books. We know rhat many instructors prefer to have a short
run orientation to their macro courses, wirh a strong emphasis on policy. Accordingly, we
have structured Chapter 9 so rhat its discussion of long-run growrh would be sufficient
for instructors who want to move quickly to short-run analysis. Chapter 10 uses a simple
neoclassical growth model to explain important growth issues. We apply rhe model to
topics such as rhe decline of rhe Soviet economy, rhe surprisingly strong growrh perfor
mance of Botswana, and rhe failure of many developing countries to sustain high growrh
rates. And we challenge students with rhe discussion "Why Isn't rhe Whole World Rich?"
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xxiii
A DYNAMIC MODEL OF AGGREGATE DEMAND
AND AGGREGATE SUP P LY. We take a fresh approach
to the standard aggregate demand and aggregate supply
model. We realize there is no good, simple alternative to
using the AD-AS model when explaining movements in
the price level and in real GDP. But we know that more
instructors are dissatisfied with the AD-AS model than
with any other aspect of the macro principles course.
The key problem, of course, is that
AD-AS is a static
model that attempts to account for dynamic changes in
real GDP and the price level. Our approach retains the
basics of the AD-AS model but makes it more accurate
and useful by making it more dynamic. We emphasize
two points: First, changes in the position of the short
Figure 12-8
A ornarnc � DernaIcI _ AogNocM "" NodeI
run (upward-sloping) aggregate supply curve depend
mainly on the state of expectations of the inflation rate.
Second, the existence of growth in the economy means
that the long-run (vertical) aggregate supply curve shifrs
The first acetate overlay adds the shifts in the long·run and short-run
aggregate supply curves
to the right every year. This "dynamic" AD-AS model
t
provides students with a more accurate understanding
of the causes and consequences of fluctuations in real
GDP and the price level. Chapter 12 includes a three
layer, full-color acetate for the key introductory dynamic
AD-AS graph (Figure 12-8, "A Dynamic Aggregate
Demand and Aggregate Supply Model;' on page 402 and
reproduced on the right).We created this acetate to help
students see how the graph builds step by step and to
help make the graph easier for instructors to present.
The acetate will help instructors who want to use
dynamic AD-AS in class but believe the model needs to
be developed carefully.
We introduce this model in Chapter 12, "Aggregate
Demand and Aggregate Supply Aoalysis," and use it to
discuss monetary policy in Chapter 14,"Monetary
Policy;' and fiscal policy in Chapter 15, "Fiscal Policy."
Instructors may safely omit the sections on the dynamic
......wiIlIdotbo>i< ...... 4
W.
1oa,-
The second acetate overlay adds the shift in the aggregate demand curve
to complete the dynamic model
AD-AS model without any loss in continuity to the dis
cussion of macroeconomic theory and policy.
EXTENSIVE COVERAGE OF MONETARY P OLICY.
Because of the central role monetary policy plays in the
economy and in students' curiosity about business and
financial news, we devote two chapters-Chapters 14,
"Monetary Policy," and 16, "Inflation, Unemployment,
and Federal Reserve Policy"-to the topic. We empha
size the issues involved in the Fed's choice of monetary
policy targets, and we include coverage of the Taylor
rule. The third edition includes coverage of the Fed's
new policies aimed at dealing with the housing crisis
and its effects on financial markets.
COVERAGE OF BOTH THE DEMAND-SIDE AND SU P P LY- SIDE EF FECTS OF
FISCAL P OLICY. Our discussion of fiscal policy in Chapter 15, "Fiscal Policy;' carefully
distinguishes between automatic stabilizers and discretionary fiscal policy. We also pro
vide significant coverage of the supply-side effects of fiscal policy.
t
xxiv
P RE F A CE
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A SElF-CONTAINED BUT TH OROUGH D ISCUSSION OF THE KEYNESIAN
INCOME-EXP END ITURE
A P P ROAC H .
The
Keynesian
income-expenditure
approach (the "45'-line diagram," or "Keynesian cross") is useful for introducing stu
dents to the short-run relationship between spending and production. Many instruc
tors, however, prefer to omit this material. Therefore, we use the 45'-line diagram only
in Chapter I I , "Aggregate Expenditure and Output in the Short Run." The discussion of
monetary and fiscal policy in later chapters uses only the AD-AS model, making it pos
sible to omit Chapter I I .
EXTENSIVE INTERNATIONAL COVERAGE. We include three chapters devoted to
international topics: Chapter 6, "Comparative Advantage and the Gains from
International Trade," Chapter 17, "Macroeconomics in an Open Economy," and Chapter
18, "The International Financial System." Having a good understanding of the interna
tional trading and financial systems is essential to understanding the macroeconomy and
to satisfying students' curiosiry about the economic world around them. In addition to
the material in our three international chapters, we weave international comparisons into
the narratives of several chapters, including our discussion of labor market policies in
Chapter 16, "Inflation, Unemployment, and Federal Reserve Policy," and central banking
in Chapter 13,"Money, Banks, and the Federal Reserve System."
FLEXIBLE CHA P TER ORGANIZATION. Because we realize that there are a variery of
approaches to teaching principles of macroeconomics, we have structured our chapters
for maximum flexibility. For example, our discussion of long-run economic growth in
Chapter 9, "Economic Growth, the Financial System, and Business Cycles;' makes it pos
sible for instructors to omit the more thorough discussion of these issues in Chapter 10,
"Long-Run Economic Growth: Sources and Policies." Our discussion of the Keynesian
45'-line diagram is confined to Chapter I I so that instructors who do not use this
approach can proceed directly to aggregate demand and aggregate supply analysis in
Chapter 12, "Aggregate Demand and Aggregate Supply Analysis." While we devote two
chapters to monetary policy, the first of these-Chapter 14, "Monetary Policy" -is a self
contained discussion, so instructors may safely omit the material in Chapter 16,
"Inflation, Unemployment, and Federal Reserve Policy;' if they choose to. Finally, instruc
tors may choose to omit all three of the international chapters (Chapter 6, "Comparative
Advantage and the Gains from International Trade," Chapter 17, "Macroeconomics in an
Open Economy," and Chapter 18, "The International Financial System"), cover just
Chapter 6 on international trade; cover just Chapter 17; or cover Chapter 17 and Chapter
18, while omitting Chapter 6. Please refer to the flexibiliry chart on pages xviii-xix to help
select the chapters and order best suited to your classroom needs.
S p e c i a l Featu res :
A Rea l-Wo r l d , H a n d s-o n A p p ro a c h
t o Le a r n i n g E c o n o m ics
Business Cases a n d A n Inside Look News Articles
Each chapter-opening case provides a real-world context for learning, sparks students' inter
est in economics, and helps to unify the chapter. The case describes an actual company facing
a real situation. The company is integrated in the narrative, graphs, and pedagogical features
of the chapter. Many of the chapter openers focus on the role of entrepreneurs in developing
new products and bringing them to the market. For example, Chapter 3 covers Dietrich
Mateschitz of Red Bull, Chapter 5 covers Mark Zuckerberg of Facebook, Chapter 10 covers
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Larry Page and Sergey Brin of Google. Here are a few examples of companies we explore in
the chapter openers in this new edition:
Red Bull (Chapter 3, "Where Prices Come From: The Interaction of Demand and
Supply")
Ford Motor Company (Chapter 7, "GOP: Measuring Total Production and Income")
FedEx (Chapter 12, ''Aggregate Demand and Aggregate Supply Analysis")
An Inside Look is a two-page feature that shows students how to apply the concepts from
the chapter to the analysis of a news article. Select articles deal with policy issues and are
titled An Inside Look at Policy. Articles are from sources such as the Wall Street Journal, The
Economist, and BusinessWeek. The An Inside Look feature presents an excerpt from an article,
analysis of the article, a graph(s), and critical-thinking questions.
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