PRINCIPLES OF ECONOMICS - N. GREGORY MANKIW Eighth edition ISBN 13: 978-1-305-58512-6 ISBN 10: 1-305-58512-7 Brief Contents PART I Introduction 1 1 Ten Principles of Economics 3 2 Thinking Like an Economist 19 3 Interdependence and the Gains from Trade 47 PART II How Markets Work 63 4 The Market Forces of Supply and Demand 65 5 Elasticity and Its Application 89 6 Supply, Demand, and Government Policies 111 PART III Markets and Welfare 131 7 Consumers, Producers, and the Efficiency of Markets 133 8 Application: The Costs of Taxation 153 9 Application: International Trade 167 PART IV The Economics of the Public Sector 187 10 Externalities 189 11 Public Goods and Common Resources 211 12 The Design of the Tax System 227 PART V Firm Behavior and the Organization of Industry 245 13 The Costs of Production 247 14 Firms in Competitive Markets 267 15 Monopoly 289 16 Monopolistic Competition 319 17 Oligopoly 337 PART VI The Economics of Labor Markets 359 18 The Markets for the Factors of Production 361 19 Earnings and Discrimination 383 20 Income Inequality and Poverty 401 PART VII Topics for Further Study 423 21 The Theory of Consumer Choice 425 22 Frontiers of Microeconomics 451 PART VIII The Data of Macroeconomics 471 23 Measuring a Nation’s Income 473 24 Measuring the Cost of Living 495 PART IX The Real Economy in the Long Run 513 25 Production and Growth 515 26 Saving, Investment, and the Financial System 541 27 The Basic Tools of Finance 563 28 Unemployment 577 PART X Money and Prices in the Long Run 601 29 The Monetary System 603 30 Money Growth and Inflation 627 PART XI The Macroeconomics of Open Economies 651 31 Open-Economy Macroeconomics: Basic Concepts 653 32 A Macroeconomic Theory of the Open Economy 677 PART XII Short-Run Economic Fluctuations 699 33 Aggregate Demand and Aggregate Supply 701 34 The Influence of Monetary and Fiscal Policy on Aggregate Demand 737 35 The Short-Run Trade-off between Inflation and Unemployment 763 PART XIII Final Thoughts 787 36 Six Debates over Macroeconomic Policy 789 Contents PART I Introduction 1 CHAPTER 1 Ten Principles of Economics 3 1-1 How People Make Decisions 4 1-1a Principle 1: People Face Trade-offs 4 1-1b Principle 2: The Cost of Something Is What You Give Up to Get It 5 1-1c Principle 3: Rational People Think at the Margin 6 1-1d Principle 4: People Respond to Incentives 7 1-2 How People Interact 8 1-2a Principle 5: Trade Can Make Everyone Better Off 8 1-2b Principle 6: Markets Are Usually a Good Way to Organize Economic Activity 9 FYI: Adam Smith and the Invisible Hand 10 CASE STUDY: Adam Smith Would Have Loved Uber 11 1-2c Principle 7: Governments Can Sometimes Improve Market Outcomes 11 1-3 How the Economy as a Whole Works 13 1-3a Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services 13 1-3b Principle 9: Prices Rise When the Government Prints Too Much Money 13 1-3c Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment 14 1-4 Conclusion 15 Summary 16 Key Concepts 16 Questions for Review 16 Problems and Applications 17 CHAPTER 2 Thinking Like an Economist 19 2-1 The Economist as Scientist 20 2-1a The Scientific Method: Observation, Theory, and More Observation 20 2-1b The Role of Assumptions 21 2-1c Economic Models 22 2-1d Our First Model: The Circular-Flow Diagram 22 2-1e Our Second Model: The Production Possibilities Frontier 2-1f Microeconomics and Macroeconomics 26 2-2 The Economist as Policy Adviser 27 2-2a Positive versus Normative Analysis 27 2-2b Economists in Washington 28 2-2c Why Economists’ Advice Is Not Always Followed 29 2-3 Why Economists Disagree 30 2-3a Differences in Scientific Judgments 30 2-3b Differences in Values 30 2-3c Perception versus Reality 31 ASK THE EXPERTS: Ticket Resale 32 2-4 Let’s Get Going 32 IN THE NEWS: Why You Should Study Economics 33 Summary 34 Key Concepts 34 Questions for Review 35 Problems and Applications 35 Appendix Graphing: A Brief Review 37 CHAPTER 3 Interdependence and the Gains from Trade 47 3-1 A Parable for the Modern Economy 3-1a Production Possibilities 49 3-1b Specialization and Trade 50 3-2 Comparative Advantage: The Driving Force of Specialization 52 3-2a Absolute Advantage 52 3-2b Opportunity Cost and Comparative Advantage 52 3-2c Comparative Advantage and Trade 53 3-2d The Price of the Trade 54 FYI: The Legacy of Adam Smith and David Ricardo 55 3-3 Applications of Comparative Advantage 55 3-3a Should Serena Williams Mow Her Own Lawn? 55 IN THE NEWS: Economics within a Marriage 56 3-3b Should the United States Trade with Other Countries? 56 ASK THE EXPERTS: Trade between China and the United States 58 3-4 Conclusion 58 Summary 59 Key Concepts 59 Questions for Review 60 Problems and Applications 60 PART II How Markets Work 63 CHAPTER 4 The Market Forces of Supply and Demand 65 4-1 Markets and Competition 66 4-1a What Is a Market? 66 4-1b What Is Competition? 66 4-2 Demand 67 4-2a The Demand Curve: The Relationship between Price and Quantity Demanded 67 4-2b Market Demand versus Individual Demand 68 4-2c Shifts in the Demand Curve 69 CASE STUDY: Two Ways to Reduce the Quantity of Smoking Demanded 71 4-3 Supply 73 4-3a The Supply Curve: The Relationship between Price and Quantity Supplied 73 4-3b Market Supply versus Individual Supply 74 4-3c Shifts in the Supply Curve 75 4-4 Supply and Demand Together 76 4-4a Equilibrium 76 4-4b Three Steps to Analyzing Changes in Equilibrium 78 4-5 Conclusion: How Prices Allocate Resources 83 ASK THE EXPERTS: Price Gouging 83 IN THE NEWS: Price Increases after Disasters 84 Summary 86 Key Concepts 86 Questions for Review 87 Problems and Applications 87 CHAPTER 5 Elasticity and Its Application 89 5-1 The Elasticity of Demand 90 5-1a The Price Elasticity of Demand and Its Determinants 90 5-1b Computing the Price Elasticity of Demand 91 5-1c The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities 92 5-1d The Variety of Demand Curves 93 FYI: A Few Elasticities from the Real World 93 5-1e Total Revenue and the Price Elasticity of Demand 95 5-1f Elasticity and Total Revenue along a Linear Demand Curve 96 5-1g Other Demand Elasticities 98 5-2 The Elasticity of Supply 99 5-2a The Price Elasticity of Supply and Its Determinants 99 5-2b Computing the Price Elasticity of Supply 99 5-2c The Variety of Supply Curves 100 5-3 Three Applications of Supply, Demand, and Elasticity 102 5-3a Can Good News for Farming Be Bad News for Farmers? 102 5-3b Why Did OPEC Fail to Keep the Price of Oil High? 104 5-3c Does Drug Interdiction Increase or Decrease Drug-Related Crime? 105 5-4 Conclusion 107 Summary 108 Key Concepts 108 Questions for Review 109 Problems and Applications 109 CHAPTER 6 Supply, Demand, and Government Policies 111 6-1 Controls on Prices 112 6-1a How Price Ceilings Affect Market Outcomes 112 CASE STUDY: Lines at the Gas Pump 114 CASE STUDY: Rent Control in the Short Run and the Long Run 115 6-1b How Price Floors Affect Market Outcomes 116 ASK THE EXPERTS: Rent Control 116 CASE STUDY: The Minimum Wage 118 ASK THE EXPERTS: The Minimum Wage 119 6-1c Evaluating Price Controls 120 6-2 Taxes 120 6-2a How Taxes on Sellers Affect Market Outcomes 121 6-2b How Taxes on Buyers Affect Market Outcomes 122 CASE STUDY: Can Congress Distribute the Burden of a Payroll Tax? 124 6-2c Elasticity and Tax Incidence 124 CASE STUDY: Who Pays the Luxury Tax? 126 6-3 Conclusion 127 Summary 128 Key Concepts 128 Questions for Review 128 Problems and Applications 129 PART III Markets and Welfare 131 CHAPTER 7 Consumers, Producers, and the Efficiency of Markets 133 7-1 Consumer Surplus 134 7-1a Willingness to Pay 134 7-1b Using the Demand Curve to Measure Consumer Surplus 135 7-1c How a Lower Price Raises Consumer Surplus 136 7-1d What Does Consumer Surplus Measure? 137 7-2 Producer Surplus 139 7-2a Cost and the Willingness to Sell 139 7-2b Using the Supply Curve to Measure Producer Surplus 140 7-2c How a Higher Price Raises Producer Surplus 141 7-3 Market Efficiency 142 7-3a The Benevolent Social Planner 143 7-3b Evaluating the Market Equilibrium 144 IN THE NEWS: The Invisible Hand Can Park Your Car 146 CASE STUDY: Should There Be a Market for Organs? 147 ASK THE EXPERTS: Supplying Kidneys 148 7-4 Conclusion: Market Efficiency and Market Failure 148 Summary 150 Key Concepts 150 Questions for Review 150 Problems and Applications 150 CHAPTER 8 Application: The Costs of Taxation 153 8-1 The Deadweight Loss of Taxation 154 8-1a How a Tax Affects Market Participants 155 8-1b Deadweight Losses and the Gains from Trade 157 8-2 The Determinants of the Deadweight Loss 158 CASE STUDY: The Deadweight Loss Debate 160 8-3 Deadweight Loss and Tax Revenue as Taxes Vary 161 CASE STUDY: The Laffer Curve and Supply-Side Economics 162 ASK THE EXPERTS: The Laffer Curve 163 8-4 Conclusion 164 Summary 165 Key Concept 165 Questions for Review 165 Problems and Applications 165 CHAPTER 9 Application: International Trade 167 9-1 The Determinants of Trade 168 9-1a The Equilibrium without Trade 168 9-1b The World Price and Comparative Advantage 169 9-2 The Winners and Losers from Trade 170 9-2a The Gains and Losses of an Exporting Country 170 9-2b The Gains and Losses of an Importing Country 171 9-2c Effects of a Tariff 173 FYI: Import Quotas: Another Way to Restrict Trade 175 9-2d The Lessons for Trade Policy 175 9-2e Other Benefits of International Trade 176 IN THE NEWS: Trade as a Tool for Economic Development 177 9-3 The Arguments for Restricting Trade 178 9-3a The Jobs Argument 178 IN THE NEWS: Should the Winners from Free Trade Compensate the Losers? 179 9-3b The National-Security Argument 180 9-3c The Infant-Industry Argument 180 9-3d The Unfair-Competition Argument 181 9-3e The Protection-as-a-Bargaining-Chip Argument 181 CASE STUDY: Trade Agreements and the World Trade Organization 181 ASK THE EXPERTS: Trade Deals 182 9-4 Conclusion 182 Summary 184 Key Concepts 184 Questions for Review 184 Problems and Applications 185 PART IV The Economics of the Public Sector 187 CHAPTER 10 Externalities 189 10-1 Externalities and Market Inefficiency 191 10-1a Welfare Economics: A Recap 191 10-1b Negative Externalities 192 10-1c Positive Externalities 193 CASE STUDY: Technology Spillovers, Industrial Policy, and Patent Protection 194 10-2 Public Policies toward Externalities 195 10-2a Command-and-Control Policies: Regulation 195 10-2b Market-Based Policy 1: Corrective Taxes and Subsidies 196 ASK THE EXPERTS: Vaccines 196 CASE STUDY: Why Is Gasoline Taxed So Heavily? 197 IN THE NEWS: What Should We Do about Climate Change? 199 10-2c Market-Based Policy 2: Tradable Pollution Permits 200 ASK THE EXPERTS: Carbon Taxes 200 10-2d Objections to the Economic Analysis of Pollution 202 10-3 Private Solutions to Externalities 202 10-3a The Types of Private Solutions 202 10-3b The Coase Theorem 203 10-3c Why Private Solutions Do Not Always Work 204 IN THE NEWS: The Coase Theorem in Action 205 10-4 Conclusion 206 Summary 207 Key Concepts 207 Questions for Review 207 Problems and Applications 208 CHAPTER 11 Public Goods and Common Resources 211 11-1 The Different Kinds of Goods 212 11-2 Public Goods 214 11-2a The Free-Rider Problem 214 11-2b Some Important Public Goods 214 CASE STUDY: Are Lighthouses Public Goods? 216 11-2c The Difficult Job of Cost–Benefit Analysis 216 CASE STUDY: How Much Is a Life Worth? 217 11-3 Common Resources 218 11-3a The Tragedy of the Commons 218 11-3b Some Important Common Resources 219 ASK THE EXPERTS: Congesting Pricing 219 IN THE NEWS: The Case for Toll Roads 220 CASE STUDY: Why the Cow Is Not Extinct 222 11-4 Conclusion: The Importance of Property Rights Summary 224 Key Concepts 224 Questions for Review 224 Problems and Applications 224 CHAPTER 12 The Design of the Tax System 227 12-1 An Overview of U.S. Taxation 228 12-1a Taxes Collected by the Federal Government 228 12-1b Taxes Collected by State and Local Governments 231 12-2 Taxes and Efficiency 232 12-2a Deadweight Losses 232 CASE STUDY: Should Income or Consumption Be Taxed? 233 12-2b Administrative Burden 234 12-2c Marginal Tax Rates versus Average Tax Rates 235 12-2d Lump-Sum Taxes 235 12-3 Taxes and Equity 236 12-3a The Benefits Principle 236 12-3b The Ability-to-Pay Principle 237 CASE STUDY: How the Tax Burden Is Distributed 238 12-3c Tax Incidence and Tax Equity 239 IN THE NEWS: Tax Expenditures 240 CASE STUDY: Who Pays the Corporate Income Tax? 240 12-4 Conclusion: The Trade-off between Equity and Efficiency 242 Summary 243 Key Concepts 243 Questions for Review 244 Problems and Applications 244 PART V Firm Behavior and the Organization of Industry 245 CHAPTER 13 The Costs of Production 247 13-1 What Are Costs? 248 13-1a Total Revenue, Total Cost, and Profit 248 13-1b Costs as Opportunity Costs 249 13-1c The Cost of Capital as an Opportunity Cost 249 13-1d Economic Profit versus Accounting Profit 250 13-2 Production and Costs 251 13-2a The Production Function 251 13-2b From the Production Function to the Total-Cost Curve 253 13-3 The Various Measures of Cost 254 13-3a Fixed and Variable Costs 255 13-3b Average and Marginal Cost 255 13-3c Cost Curves and Their Shapes 256 13-3d Typical Cost Curves 258 13-4 Costs in the Short Run and in the Long Run 259 13-4a The Relationship between Short-Run and Long-Run Average Total Cost 260 13-4b Economies and Diseconomies of Scale 261 FYI: Lessons from a Pin Factory 261 13-5 Conclusion 262 Summary 263 Key Concepts 264 Questions for Review 264 Problems and Applications 264 CHAPTER 14 Firms in Competitive Markets 267 14-1 What Is a Competitive Market? 268 14-1a The Meaning of Competition 268 14-1b The Revenue of a Competitive Firm 269 14-2 Profit Maximization and the Competitive Firm’s Supply Curve 270 14-2a A Simple Example of Profit Maximization 270 14-2b The Marginal-Cost Curve and the Firm’s Supply Decision 271 14-2c The Firm’s Short-Run Decision to Shut Down 273 14-2d Spilt Milk and Other Sunk Costs 275 CASE STUDY: Near-Empty Restaurants and Off-Season Miniature Golf 275 14-2e The Firm’s Long-Run Decision to Exit or Enter a Market 276 14-2f Measuring Profit in Our Graph for the Competitive Firm 277 14-3 The Supply Curve in a Competitive Market 279 14-3a The Short Run: Market Supply with a Fixed Number of Firms 279 14-3b The Long Run: Market Supply with Entry and Exit 279 14-3c Why Do Competitive Firms Stay in Business If They Make Zero Profit? 280 14-3d A Shift in Demand in the Short Run and Long Run 281 14-3e Why the Long-Run Supply Curve Might Slope Upward 282 14-4 Conclusion: Behind the Supply Curve 284 Summary 285 Key Concepts 285 Questions for Review 285 Problems and Applications 286 CHAPTER 15 Monopoly 289 15-1 Why Monopolies Arise 290 15-1a Monopoly Resources 291 15-1b Government-Created Monopolies 291 15-1c Natural Monopolies 292 15-2 How Monopolies Make Production and Pricing Decisions 293 15-2a Monopoly versus Competition 293 15-2b A Monopoly’s Revenue 294 15-2c Profit Maximization 296 15-2d A Monopoly’s Profit 298 FYI: Why a Monopoly Does Not Have a Supply Curve 298 CASE STUDY: Monopoly Drugs versus Generic Drugs 299 15-3 The Welfare Cost of Monopolies 300 15-3a The Deadweight Loss 301 15-3b The Monopoly’s Profit: A Social Cost? 303 15-4 Price Discrimination 303 15-4a A Parable about Pricing 304 15-4b The Moral of the Story 305 15-4c The Analytics of Price Discrimination 305 15-4d Examples of Price Discrimination 306 IN THE NEWS: Price Discrimination in Higher Education 308 15-5 Public Policy toward Monopolies 308 15-5a Increasing Competition with Antitrust Laws 308 15-5b Regulation 309 ASK THE EXPERTS: Airline Mergers 309 15-5c Public Ownership 310 15-5d Doing Nothing 311 15-6 Conclusion: The Prevalence of Monopolies 311 Summary 313 Key Concepts 313 Questions for Review 314 Problems and Applications 314 CHAPTER 16 Monopolistic Competition 319 16-1 Between Monopoly and Perfect Competition 320 16-2 Competition with Differentiated Products 322 16-2a The Monopolistically Competitive Firm in the Short Run 322 16-2b The Long-Run Equilibrium 323 16-2c Monopolistic versus Perfect Competition 324 16-2d Monopolistic Competition and the Welfare of Society 327 16-3 Advertising 328 16-3a The Debate over Advertising 328 CASE STUDY: Advertising and the Price of Eyeglasses 329 16-3b Advertising as a Signal of Quality 330 16-3c Brand Names 331 16-4 Conclusion 332 Summary 333 Key Concepts 334 Questions for Review 334 Problems and Applications 334 CHAPTER 17 Oligopoly 337 17-1 Markets with Only a Few Sellers 338 17-1a A Duopoly Example 338 17-1b Competition, Monopolies, and Cartels 339 17-1c The Equilibrium for an Oligopoly 340 17-1d How the Size of an Oligopoly Affects the Market Outcome 341 ASK THE EXPERTS: Nash Equilibrium 341 17-2 The Economics of Cooperation 342 17-2a The Prisoners’ Dilemma 343 17-2b Oligopolies as a Prisoners’ Dilemma 344 CASE STUDY: OPEC and the World Oil Market 345 17-2c Other Examples of the Prisoners’ Dilemma 346 17-2d The Prisoners’ Dilemma and the Welfare of Society 347 17-2e Why People Sometimes Cooperate 348 CASE STUDY: The Prisoners’ Dilemma Tournament 348 17-3 Public Policy toward Oligopolies 349 17-3a Restraint of Trade and the Antitrust Laws 349 CASE STUDY: An Illegal Phone Call 350 17-3b Controversies over Antitrust Policy 350 CASE STUDY: The Microsoft Case 352 IN THE NEWS: Europe versus Google 354 17-4 Conclusion 354 Summary 355 Key Concepts 356 Questions for Review 356 Problems and Applications 356 PART VI The Economics of Labor Markets 359 CHAPTER 18 The Markets for the Factors of Production 361 18-1 The Demand for Labor 362 18-1a The Competitive Profit-Maximizing Firm 363 18-1b The Production Function and the Marginal Product of Labor 363 18-1c The Value of the Marginal Product and the Demand for Labor 365 18-1d What Causes the Labor-Demand Curve to Shift? 366 FYI: Input Demand and Output Supply: Two Sides of the Same Coin 367 18-2 The Supply of Labor 368 18-2a The Trade-off between Work and Leisure 368 18-2b What Causes the Labor-Supply Curve to Shift? 368 ASK THE EXPERTS: Immigration 369 18-3 Equilibrium in the Labor Market 369 18-3a Shifts in Labor Supply 370 18-3b Shifts in Labor Demand 371 IN THE NEWS: The Economics of Immigration 372 CASE STUDY: Productivity and Wages 373 FYI: Monopsony 374 18-4 The Other Factors of Production: Land and Capital 375 18-4a Equilibrium in the Markets for Land and Capital 375 FYI: What Is Capital Income? 376 18-4b Linkages among the Factors of Production 377 CASE STUDY: The Economics of the Black Death 377 18-5 Conclusion 378 Summary 379 Key Concepts 379 Questions for Review 379 Problems and Applications 380 CHAPTER 19 Earnings and Discrimination 383 19-1 Some Determinants of Equilibrium Wages 384 19-1a Compensating Differentials 384 19-1b Human Capital 385 CASE STUDY: The Increasing Value of Skills 385 ASK THE EXPERTS: Inequality and Skills 386 IN THE NEWS: Schooling as a Public Investment 387 19-1c Ability, Effort, and Chance 388 CASE STUDY: The Benefits of Beauty 388 19-1d An Alternative View of Education: Signaling 389 19-1e The Superstar Phenomenon 390 19-1f Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and Efficiency Wages 390 19-2 The Economics of Discrimination 391 19-2a Measuring Labor-Market Discrimination 391 CASE STUDY: Is Emily More Employable than Lakisha? 393 19-2b Discrimination by Employers 393 CASE STUDY: Segregated Streetcars and the Profit Motive 394 19-2c Discrimination by Customers and Governments 395 CASE STUDY: Discrimination in Sports 395 19-3 Conclusion 396 Summary 397 Key Concepts 398 Questions for Review 398 Problems and Applications 398 CHAPTER 20 Income Inequality and Poverty 401 20-1 The Measurement of Inequality 402 20-1a U.S. Income Inequality 402 20-1b Inequality around the World 403 IN THE NEWS: A Worldwide View of the Income Distribution 405 20-1c The Poverty Rate 406 20-1d Problems in Measuring Inequality 407 CASE STUDY: Alternative Measures of Inequality 408 20-1e Economic Mobility 409 20-2 The Political Philosophy of Redistributing Income 409 20-2a Utilitarianism 410 20-2b Liberalism 411 20-2c Libertarianism 412 20-3 Policies to Reduce Poverty 413 20-3a Minimum-Wage Laws 413 20-3b Welfare 414 20-3c Negative Income Tax 414 20-3d In-Kind Transfers 415 20-3e Antipoverty Programs and Work Incentives 415 IN THE NEWS: International Differences in Income Redistribution 416 20-4 Conclusion 418 Summary 419 Key Concepts 420 Questions for Review 420 Problems and Applications 420 PART VII Topics for Further Study 423 CHAPTER 21 The Theory of Consumer Choice 425 21-1 The Budget Constraint: What the Consumer Can Afford 426 21-2 Preferences: What the Consumer Wants 428 21-2a Representing Preferences with Indifference Curves 428 21-2b Four Properties of Indifference Curves 429 21-2c Two Extreme Examples of Indifference Curves 430 21-3 Optimization: What the Consumer Chooses 432 21-3a The Consumer’s Optimal Choices 432 FYI: Utility: An Alternative Way to Describe Preferences and Optimization 433 21-3b How Changes in Income Affect the Consumer’s Choices 434 21-3c How Changes in Prices Affect the Consumer’s Choices 435 21-3d Income and Substitution Effects 436 21-3e Deriving the Demand Curve 438 21-4 Three Applications 439 21-4a Do All Demand Curves Slope Downward? 439 CASE STUDY: The Search for Giffen Goods 440 21-4b How Do Wages Affect Labor Supply? 440 CASE STUDY: Income Effects on Labor Supply: Historical Trends, Lottery Winners, and the Carnegie Conjecture 443 21-4c How Do Interest Rates Affect Household Saving? 444 21-5 Conclusion: Do People Really Think This Way? 446 Summary 447 Key Concepts 448 Questions for Review 448 Problems and Applications 448 CHAPTER 22 Frontiers of Microeconomics 451 22-1 Asymmetric Information 452 22-1a Hidden Actions: Principals, Agents, and Moral Hazard 452 FYI: Corporate Management 453 22-1b Hidden Characteristics: Adverse Selection and the Lemons Problem 454 22-1c Signaling to Convey Private Information 455 CASE STUDY: Gifts as Signals 455 22-1d Screening to Uncover Private Information 456 22-1e Asymmetric Information and Public Policy 456 22-2 Political Economy 457 22-2a The Condorcet Voting Paradox 457 22-2b Arrow’s Impossibility Theorem 458 22-2c The Median Voter Is King 459 22-2d Politicians Are People Too 461 22-3 Behavioral Economics 461 22-3a People Aren’t Always Rational 462 22-3b People Care about Fairness 463 IN THE NEWS: Using Deviations from Rationality 464 22-3c People Are Inconsistent over Time 466 22-4 Conclusion 467 Summary 468 Key Concepts 468 Questions for Review 468 Problems and Applications 468 PART VIII The Data of Macroeconomics 471 CHAPTER 23 Measuring a Nation’s Income 473 23-1 The Economy’s Income and Expenditure 474 23-2 The Measurement of GDP 476 23-2a “GDP Is the Market Value . . .” 476 23-2b “. . . of All . . .” 476 23-2c “. . . Final . . .” 476 23-2d “. . . Goods and Services . . .” 477 23-2e “. . . Produced . . .” 477 23-2f “. . . Within a Country . . .” 477 23-2g “. . . In a Given Period of Time.” 477 FYI: Other Measures of Income 478 23-3 The Components of GDP 479 23-3a Consumption 479 23-3b Investment 479 IN THE NEWS: Sex, Drugs, and GDP 480 23-3c Government Purchases 480 23-3d Net Exports 480 CASE STUDY: The Components of U.S. GDP 481 23-4 Real versus Nominal GDP 482 23-4a A Numerical Example 482 23-4b The GDP Deflator 484 CASE STUDY: A Half Century of Real GDP 485 IN THE NEWS: Gauging the High-Tech Economy 486 23-5 Is GDP a Good Measure of Economic Well-Being? 486 IN THE NEWS: Measuring Macroeconomic Well-Being 488 CASE STUDY: International Differences in GDP and the Quality of Life 490 23-6 Conclusion 491 Summary 492 Key Concepts 492 Questions for Review 492 Problems and Applications 493 CHAPTER 24 Measuring the Cost of Living 495 24-1 The Consumer Price Index 496 24-1a How the CPI Is Calculated 496 FYI: What’s in the CPI’s Basket? 498 24-1b Problems in Measuring the Cost of Living 499 IN THE NEWS: Monitoring Inflation in the Internet Age 500 24-1c The GDP Deflator versus the Consumer Price Index 502 24-2 Correcting Economic Variables for the Effects of Inflation 503 24-2a Dollar Figures from Different Times 503 FYI: Mr. Index Goes to Hollywood 504 CASE STUDY: Regional Differences in the Cost of Living 505 24-2b Indexation 506 24-2c Real and Nominal Interest Rates 506 CASE STUDY: Interest Rates in the U.S. Economy 508 24-3 Conclusion 508 Summary 510 Key Concepts 510 Questions for Review 510 Problems and Applications 511 PART IX The Real Economy in the Long Run 513 CHAPTER 25 Production and Growth 515 25-1 Economic Growth around the World 516 25-2 Productivity: Its Role and Determinants 518 25-2a Why Productivity Is So Important 518 FYI: Are You Richer Than the Richest American? 518 25-2b How Productivity Is Determined 519 FYI: A Picture Is Worth a Thousand Statistics 520 FYI: The Production Function 523 CASE STUDY: Are Natural Resources a Limit to Growth? 524 25-3 Economic Growth and Public Policy 525 25-3a Saving and Investment 525 25-3b Diminishing Returns and the Catch-Up Effect 525 25-3c Investment from Abroad 527 25-3d Education 528 25-3e Health and Nutrition 528 25-3f Property Rights and Political Stability 529 25-3g Free Trade 530 25-3h Research and Development 531 ASK THE EXPERTS: Innovation and Growth 531 IN THE NEWS: Curmudgeon versus Optimist 532 25-3i Population Growth 534 IN THE NEWS: Using Experiments to Evaluate Aid 536 25-4 Conclusion: The Importance of Long-Run Growth 538 Summary 539 Key Concepts 539 Questions for Review 539 Problems and Applications 540 CHAPTER 26 Saving, Investment, and the Financial System 541 26-1 Financial Institutions in the U.S. Economy 542 26-1a Financial Markets 542 26-1b Financial Intermediaries 544 FYI: Key Numbers for Stock Watchers 545 26-1c Summing Up 546 26-2 Saving and Investment in the National Income Accounts 547 26-2a Some Important Identities 547 26-2b The Meaning of Saving and Investment 549 26-3 The Market for Loanable Funds 549 26-3a Supply and Demand for Loanable Funds 550 26-3b Policy 1: Saving Incentives 551 26-3c Policy 2: Investment Incentives 553 26-3d Policy 3: Government Budget Deficits and Surpluses 554 ASK THE EXPERTS: Fiscal Policy and Saving 555 CASE STUDY: The History of U.S. Government Debt 556 FYI: Financial Crises 558 26-4 Conclusion 558 Summary 559 Key Concepts 560 Questions for Review 560 Problems and Applications 560 CHAPTER 27 The Basic Tools of Finance 563 27-1 Present Value: Measuring the Time Value of Money 564 FYI: The Magic of Compounding and the Rule of 70 566 27-2 Managing Risk 566 27-2a Risk Aversion 566 27-2b The Markets for Insurance 567 27-2c Diversification of Firm-Specific Risk 568 27-2d The Trade-off between Risk and Return 569 27-3 Asset Valuation 571 27-3a Fundamental Analysis 571 27-3b The Efficient Markets Hypothesis 571 CASE STUDY: Random Walks and Index Funds 572 ASK THE EXPERTS: Diversification 573 27-3c Market Irrationality 573 27-4 Conclusion 574 Summary 575 Key Concepts 575 Questions for Review 575 Problems and Applications 576 CHAPTER 28 Unemployment 577 28-1 Identifying Unemployment 578 28-1a How Is Unemployment Measured? 578 CASE STUDY: Labor-Force Participation of Men and Women in the U.S. Economy 581 28-1b Does the Unemployment Rate Measure What We Want It To? 582 28-1c How Long Are the Unemployed without Work? 584 28-1d Why Are There Always Some People Unemployed? 584 FYI: The Jobs Number 585 28-2 Job Search 586 28-2a Why Some Frictional Unemployment Is Inevitable 586 28-2b Public Policy and Job Search 586 28-2c Unemployment Insurance 587 28-3 Minimum-Wage Laws 588 CASE STUDY: Who Earns the Minimum Wage? 589 IN THE NEWS: Should the Minimum Wage Be Raised to $15 an Hour? 590 28-4 Unions and Collective Bargaining 592 28-4a The Economics of Unions 592 28-4b Are Unions Good or Bad for the Economy? 593 28-5 The Theory of Efficiency Wages 594 28-5a Worker Health 594 28-5b Worker Turnover 594 28-5c Worker Quality 595 28-5d Worker Effort 595 CASE STUDY: Henry Ford and the Very Generous $5-a-Day Wage 595 28-6 Conclusion 596 Summary 597 Key Concepts 598 Questions for Review 598 Problems and Applications 598 PART X Money and Prices in the Long Run 601 CHAPTER 29 The Monetary System 603 29-1 The Meaning of Money 604 29-1a The Functions of Money 605 29-1b The Kinds of Money 605 IN THE NEWS: Why Gold? 606 29-1c Money in the U.S. Economy 607 CASE STUDY: Where Is All the Currency? 608 FYI: Why Credit Cards Aren’t Money 609 29-2 The Federal Reserve System 609 29-2a The Fed’s Organization 609 29-2b The Federal Open Market Committee 610 29-3 Banks and the Money Supply 611 29-3a The Simple Case of 100-Percent-Reserve Banking 611 29-3b Money Creation with Fractional-Reserve Banking 612 29-3c The Money Multiplier 613 29-3d Bank Capital, Leverage, and the Financial Crisis of 2008–2009 615 29-4 The Fed’s Tools of Monetary Control 616 29-4a How the Fed Influences the Quantity of Reserves 617 29-4b How the Fed Influences the Reserve Ratio 618 29-4c Problems in Controlling the Money Supply 619 CASE STUDY: Bank Runs and the Money Supply 619 IN THE NEWS: A Trip to Jekyll Island 620 29-4d The Federal Funds Rate 621 29-5 Conclusion 622 Summary 623 Key Concepts 624 Questions for Review 624 Problems and Applications 624 CHAPTER 30 Money Growth and Inflation 627 30-1 The Classical Theory of Inflation 629 30-1a The Level of Prices and the Value of Money 629 30-1b Money Supply, Money Demand, and Monetary Equilibrium 630 30-1c The Effects of a Monetary Injection 631 30-1d A Brief Look at the Adjustment Process 632 30-1e The Classical Dichotomy and Monetary Neutrality 633 30-1f Velocity and the Quantity Equation 634 CASE STUDY: Money and Prices during Four Hyperinflations 636 30-1g The Inflation Tax 637 FYI: Hyperinflation in Zimbabwe 638 30-1h The Fisher Effect 639 30-2 The Costs of Inflation 640 30-2a A Fall in Purchasing Power? The Inflation Fallacy 641 30-2b Shoeleather Costs 641 30-2c Menu Costs 642 30-2d Relative-Price Variability and the Misallocation of Resources 642 30-2e Inflation-Induced Tax Distortions 643 30-2f Confusion and Inconvenience 644 30-2g A Special Cost of Unexpected Inflation: Arbitrary Redistributions of Wealth 645 30-2h Inflation Is Bad, but Deflation May Be Worse 646 CASE STUDY: The Wizard of Oz and the Free-Silver Debate 646 30-3 Conclusion 647 Summary 649 Key Concepts 649 Questions for Review 649 Problems and Applications 649 PART XI The Macroeconomics of Open Economies 651 CHAPTER 31 Open-Economy Macroeconomics: Basic Concepts 653 31-1 The International Flows of Goods and Capital 654 31-1a The Flow of Goods: Exports, Imports, and Net Exports 654 CASE STUDY: The Increasing Openness of the U.S. Economy 655 IN THE NEWS: The Complicated Politics of Trade Agreements 656 31-1b The Flow of Financial Resources: Net Capital Outflow 658 31-1c The Equality of Net Exports and Net Capital Outflow 659 31-1d Saving, Investment, and Their Relationship to the International Flows 660 31-1e Summing Up 661 CASE STUDY: Is the U.S. Trade Deficit a National Problem? 662 ASK THE EXPERTS: Trade Balances and Trade Negotiations 664 31-2 The Prices for International Transactions: Real and Nominal Exchange Rates 664 31-2a Nominal Exchange Rates 665 31-2b Real Exchange Rates 665 FYI: The Euro 666 31-3 A First Theory of Exchange-Rate Determination: Purchasing-Power Parity 667 31-3a The Basic Logic of Purchasing-Power Parity 668 31-3b Implications of Purchasing-Power Parity 668 CASE STUDY: The Nominal Exchange Rate during a Hyperinflation 670 31-3c Limitations of Purchasing-Power Parity 671 CASE STUDY: The Hamburger Standard 671 31-4 Conclusion 672 Summary 673 Key Concepts 673 Questions for Review 674 Problems and Applications 674 CHAPTER 32 A Macroeconomic Theory of the Open Economy 677 32-1 Supply and Demand for Loanable Funds and for Foreign-Currency Exchange 678 32-1a The Market for Loanable Funds 678 32-1b The Market for Foreign-Currency Exchange 680 FYI: Purchasing-Power Parity as a Special Case 682 32-2 Equilibrium in the Open Economy 683 32-2a Net Capital Outflow: The Link between the Two Markets 683 32-2b Simultaneous Equilibrium in Two Markets 684 FYI: Disentangling Supply and Demand 685 32-3 How Policies and Events Affect an Open Economy 686 32-3a Government Budget Deficits 686 32-3b Trade Policy 688 32-3c Political Instability and Capital Flight 690 IN THE NEWS: Is a Strong Currency Always in a Nation’s Interest? 692 CASE STUDY: Capital Flows from China 694 ASK THE EXPERTS: Currency Manipulation 695 32-4 Conclusion 695 Summary 696 Key Concepts 696 Questions for Review 696 Problems and Applications 697 PART XII Short-Run Economic Fluctuations 699 CHAPTER 33 Aggregate Demand and Aggregate Supply 701 33-1 Three Key Facts about Economic Fluctuations 702 33-1a Fact 1: Economic Fluctuations Are Irregular and Unpredictable 702 33-1b Fact 2: Most Macroeconomic Quantities Fluctuate Together 704 33-1c Fact 3: As Output Falls, Unemployment Rises 704 33-2 Explaining Short-Run Economic Fluctuations 33-2a The Assumptions of Classical Economics 705 33-2b The Reality of Short-Run Fluctuations 705 33-2c The Model of Aggregate Demand and Aggregate Supply 706 33-3 The Aggregate-Demand Curve 707 33-3a Why the Aggregate-Demand Curve Slopes Downward 707 33-3b Why the Aggregate-Demand Curve Might Shift 710 33-4 The Aggregate-Supply Curve 712 33-4a Why the Aggregate-Supply Curve Is Vertical in the Long Run 712 33-4b Why the Long-Run Aggregate-Supply Curve Might Shift 713 33-4c Using Aggregate Demand and Aggregate Supply to Depict Long-Run Growth and Inflation 715 33-4d Why the Aggregate-Supply Curve Slopes Upward in the Short Run 716 33-4e Why the Short-Run Aggregate-Supply Curve Might Shift 720 33-5 Two Causes of Economic Fluctuations 721 33-5a The Effects of a Shift in Aggregate Demand 722 FYI: Monetary Neutrality Revisited 724 CASE STUDY: Two Big Shifts in Aggregate Demand: The Great Depression and World War II 725 CASE STUDY: The Great Recession of 2008–2009 726 IN THE NEWS: What Have We Learned? 728 33-5b The Effects of a Shift in Aggregate Supply 728 CASE STUDY: Oil and the Economy 731 FYI: The Origins of the Model of Aggregate Demand and Aggregate Supply 732 33-6 Conclusion 733 Summary 734 Key Concepts 734 Questions for Review 735 Problems and Applications 735 CHAPTER 34 The Influence of Monetary and Fiscal Policy on Aggregate Demand 737 34-1 How Monetary Policy Influences Aggregate Demand 738 34-1a The Theory of Liquidity Preference 739 34-1b The Downward Slope of the Aggregate-Demand Curve 741 FYI: Interest Rates in the Long Run and the Short Run 742 34-1c Changes in the Money Supply 743 34-1d The Role of Interest-Rate Targets in Fed Policy 745 CASE STUDY: Why the Fed Watches the Stock Market (and Vice Versa) 745 34-1e The Zero Lower Bound 746 34-2 How Fiscal Policy Influences Aggregate Demand 747 34-2a Changes in Government Purchases 747 34-2b The Multiplier Effect 748 34-2c A Formula for the Spending Multiplier 748 34-2d Other Applications of the Multiplier Effect 750 34-2e The Crowding-Out Effect 750 34-2f Changes in Taxes 752 FYI: How Fiscal Policy Might Affect Aggregate Supply 752 34-3 Using Policy to Stabilize the Economy 753 34-3a The Case for Active Stabilization Policy 753 IN THE NEWS: How Large Is the Fiscal Policy Multiplier? 754 CASE STUDY: Keynesians in the White House 756 ASK THE EXPERTS: Economic Stimulus 756 34-3b The Case against Active Stabilization Policy 756 34-3c Automatic Stabilizers 758 34-4 Conclusion 758 Summary 759 Key Concepts 760 Questions for Review 760 Problems and Applications 760 CHAPTER 35 The Short-Run Trade-off between Inflation and Unemployment 763 35-1 The Phillips Curve 764 35-1a Origins of the Phillips Curve 764 35-1b Aggregate Demand, Aggregate Supply, and the Phillips Curve 765 35-2 Shifts in the Phillips Curve: The Role of Expectations 767 35-2a The Long-Run Phillips Curve 767 35-2b The Meaning of “Natural” 769 35-2c Reconciling Theory and Evidence 770 35-2d The Short-Run Phillips Curve 771 35-2e The Natural Experiment for the Natural-Rate Hypothesis 772 35-3 Shifts in the Phillips Curve: The Role of Supply Shocks 773 35-4 The Cost of Reducing Inflation 776 35-4a The Sacrifice Ratio 777 35-4b Rational Expectations and the Possibility of Costless Disinflation 778 35-4c The Volcker Disinflation 779 35-4d The Greenspan Era 780 35-4e A Financial Crisis Takes Us for a Ride along the Phillips Curve 781 35-5 Conclusion 782 Summary 784 Key Concepts 784 Questions for Review 784 Problems and Applications 784 PART XIII Final Thoughts 787 CHAPTER 36 Six Debates over Macroeconomic Policy 789 36-1 Should Monetary and Fiscal Policymakers Try to Stabilize the Economy? 790 36-1a Pro: Policymakers Should Try to Stabilize the Economy 790 36-1b Con: Policymakers Should Not Try to Stabilize the Economy 790 36-2 Should the Government Fight Recessions with Spending Hikes Rather Than Tax Cuts? 792 36-2a Pro: The Government Should Fight Recessions with Spending Hikes 792 36-2b Con: The Government Should Fight Recessions with Tax Cuts 793 36-3 Should Monetary Policy Be Made by Rule Rather Than by Discretion? 794 36-3a Pro: Monetary Policy Should Be Made by Rule 795 36-3b Con: Monetary Policy Should Not Be Made by Rule 796 FYI: Inflation Targeting 797 36-4 Should the Central Bank Aim for Zero Inflation? 797 36-4a Pro: The Central Bank Should Aim for Zero Inflation 798 36-4b Con: The Central Bank Should Not Aim for Zero Inflation 799 IN THE NEWS: On Kiwis and Currencies 800 36-5 Should the Government Balance Its Budget? 802 36-5a Pro: The Government Should Balance Its Budget 802 36-5b Con: The Government Should Not Balance Its Budget 803 36-6 Should the Tax Laws Be Reformed to Encourage Saving? 805 36-6a Pro: The Tax Laws Should Be Reformed to Encourage Saving 805 ASK THE EXPERTS: Taxing Capital and Labor 806 36-6b Con: The Tax Laws Should Not Be Reformed to Encourage Saving 806 36-7 Conclusion 807 Summary 808 Questions for Review 809 Problems and Applications 809 Glossary 811 Index 819