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Cengage Learning
Principles of Economics / Edition 4

Principles of Economics / Edition 4

by N. Gregory Mankiw
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That is how Alfred Marshall, the great 19th century economist, defined economics in his classic textbook, Principles of Economics. The text you have in your hand continues that tradition, from the cover image to the last page. The cover of this and previous editions shows a market scene. It reminds us that economics is about people as they go about their lives. Economics is about buying, selling, setting prices, competing for customers, looking for jobs, and earning a living. It is about why markets so often succeed as a way to run a society and why they sometimes fail. When the Mankiw text was first published, The Economist wrote, "Mr. Mankiw's book sets a new standard for clarity and liveliness." USA Today called it "a grand success." Since then, the book has indeed become the new standard for introducing economics to students like you around the world. It has been translated into twenty languages, and more than a million copies have been sold. Thomson South-Western is pleased to bring you this Fourth Edition.

Product Details

ISBN-13: 9780324224726
Publisher: Cengage Learning
Publication date: 02/15/2006
Series: Available Titles CengageNOW Series
Edition description: 4TH
Pages: 936
Product dimensions: 8.60(w) x 10.10(h) x 1.50(d)

About the Author

N. Gregory Mankiw is Robert M. Beren Professor of Economics at Harvard University. He studied economics at Princeton University and MIT. Dr. Mankiw is a prolific writer and a regular participant in academic and policy debates. His research includes work on price adjustment, consumer behavior, financial markets, monetary and fiscal policy, and economic growth. His published articles have appeared in academic journals, such as the American Economic Review, Journal of Political Economy, and Quarterly Journal of Economics, and in more widely accessible forums, including The New York Times, The Washington Post, The Wall Street Journal, and Fortune. Dr. Mankiw has been a research associate of the National Bureau of Economic Research, an adviser to the Federal Reserve Bank of Boston and the Congressional Budget Office, and a member of the ETS test development committee for the advanced placement exam in economics. From 2003 to 2005, he served as chairman of the President's Council of Economic Advisers.

Table of Contents

Preface: To the Instructor     vii
Preface: To the Student     xix
Introduction     1
Ten Principles of Economics     3
How People Make Decisions     4
People Face Trade-offs     4
The Cost of Something Is What You Give Up to Get It     5
Rational People Think at the Margin     6
People Respond to Incentives     7
How People Interact     8
Trade Can Make Everyone Better Off     8
Markets Are Usually a Good Way to Organize Economic Activity     9
Governments Can Sometimes Improve Market Outcomes     10
FYI: Adam Smith and the Invisible Hand     10
How the Economy as a Whole Works     11
A Country's Standard of Living Depends on Its Ability to Produce Goods and Services     12
Prices Rise When the Government Prints Too Much Money     12
Society Faces a Short-Run Trade-off between Inflation and Unemployment     13
FYI: How to Read This Book     14
Conclusion     14
Summary     15
Key Concepts     15
Questions for Review     16
Problems and Applications     16
Thinking Like an Economist     19
TheEconomist as Scientist     20
The Scientific Method: Observation, Theory and More Observation     20
The Role of Assumptions     21
Economic Models     22
Our First Model: The Circular-Flow Diagram     22
Our Second Model: The Production Possibilities Frontier     24
Microeconomics and Macroeconomics     26
FYI: Who Studies Economics?     27
The Economist as Policy Adviser     28
Positive versus Normative Analysis     28
Economists in Washington     29
In the News: Super Bowl Economics     30
Case Study: Mr. Mankiw Goes to Washington     31
Why Economists Disagree     32
Differences in Scientific Judgments     32
Differences in Values     33
Perception versus Reality     33
Let's Get Going     34
In the News: Why You Should Study Economics     35
Summary     36
Key Concepts     36
Questions for Review     36
Problems and Applications     36
Graphing: A Brief Review     38
Graphs of a Single Variable     38
Graphs of Two Variables: The Coordinate System     39
Curves in the Coordinate System     40
Slope     42
Cause and Effect     44
Interdependence and the Gains From Trade     47
A Parable for the Modern Economy     48
Production Possibilities     48
Specialization and Trade     50
Comparative Advantage: The Driving Force of Specialization     52
Absolute Advantage     52
Opportunity Cost and Comparative Advantage     52
Comparative Advantage and Trade     54
FYI: The Legacy of Adam Smith and David Ricardo     55
Applications of Comparative Advantage     55
Should Tiger Woods Mow His Own Lawn?     55
In the News: Evolution and Economics     56
Should the United States Trade with Other Countries?     56
Conclusion     58
Summary     58
Key Concepts     59
Questions for Review     59
Problems and Applications     59
How Markets Work     61
The Market Forces of Supply and Demand     63
Markets and Competition     64
What Is a Market?     64
What Is Competition?     64
Demand     65
The Demand Curve: The Relationship between Price and Quantity Demanded     65
Market Demand versus Individual Demand     66
Shifts in the Demand Curve     67
Case Study: Two Ways to Reduce the Quantity of Smoking Demanded     69
Supply     71
The Supply Curve: The Relationship between Price and Quantity Supplied     71
Market Supply versus Individual Supply     71
Shifts in the Supply Curve     72
Supply and Demand Together     75
Equilibrium     75
Three Steps to Analyzing Changes in Equilibrium     77
In the News: Political Unrest Shifts the Supply Curve     81
Conclusion: How Prices Allocate Resources     82
Summary     84
Key Concepts     84
Questions for Review     85
Problems and Applications     85
Elasticity and its Application     89
The Elasticity of Demand     90
The Price Elasticity of Demand and Its Determinants     90
Computing the Price Elasticity of Demand     91
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities     92
The Variety of Demand Curves     93
Total Revenue and the Price Elasticity of Demand     93
Elasticity and Total Revenue along a Linear Demand Curve     95
In the News: On the Road with Elasticity     98
Other Demand Elasticities     98
The Elasticity of Supply     99
The Price Elasticity of Supply and Its Determinants     100
Computing the Price Elasticity of Supply     100
The Variety of Supply Curves     100
Three Applications of Supply, Demand, and Elasticity     103
Can Good News for Farming Be Bad News for Farmers?     103
Why Did OPEC Fail to Keep the Price of Oil High?     105
Does Drug Interdiction Increase or Decrease Drug-Related Crime?     107
Conclusion     108
Summary     109
Key Concepts     109
Questions for Review     109
Problems and Applications     110
Supply, Demand, and Government Policies     113
Controls on Prices     114
How Price Ceilings Affect Market Outcomes     114
Case Study: Lines at the Gas Pump     116
Case Study: Rent Control in the Short Run and Long Run     117
How Price Floors Affect Market Outcomes     118
In the News: Rent Control in New York     120
Case Study: The Minimum Wage     120
Evaluating Price Controls      123
Taxes     124
How Taxes on Buyers Affect Market Outcomes     124
How Taxes on Sellers Affect Market Outcomes     126
Case Study: Can Congress Distribute the Burden of a Payroll Tax?     128
Elasticity and Tax Incidence     129
Case Study: Who Pays the Luxury Tax?     129
Conclusion     131
Summary     131
Key Concepts     132
Questions for Review     132
Problems and Applications     132
Markets and Welfare     135
Consumers, Producers, and the Efficiency of Markets     137
Consumer Surplus     138
Willingness to Pay     138
Using the Demand Curve to Measure Consumer Surplus     139
How a Lower Price Raises Consumer Surplus     140
What Does Consumer Surplus Measure?     142
Producer Surplus     143
Cost and the Willingness to Sell     143
Using the Supply Curve to Measure Producer Surplus     144
How a Higher Price Raises Producer Surplus     146
Market Efficiency     147
The Benevolent Social Planner     147
Evaluating the Market Equilibrium     148
In the News: Ticket Scalping      151
Case Study: Should There Be a Market in Organs?     152
In the News: The Miracle of the Market     153
Conclusion: Market Efficiency and Market Failure     154
Summary     155
Key Concepts     155
Questions for Review     155
Problems and Applications     156
Application: The Costs of Taxation     159
The Deadweight Loss of Taxation     160
How a Tax Affects Market Participants     161
Deadweight Losses and the Gains from Trade     163
The Determinants of the Deadweight Loss     165
Case Study: The Deadweight Loss Debate     165
Deadweight Loss and Tax Revenue as Taxes Vary     167
FYI: Henry George and the Land Tax     169
Case Study: The Laffer Curve and Supply-Side Economics     170
In the News: On the Way to France     171
Conclusion     172
Summary     173
Key Concept     173
Questions for Review     173
Problems and Applications     173
Application: International Trade     177
The Determinants of Trade     178
The Equilibrium without Trade     178
The World Price and Comparative Advantage     179
The Winners and Losers from Trade     179
The Gains and Losses of an Exporting Country     180
The Gains and Losses of an Importing Country     181
In the News: Cheap Clothes from China     183
The Effects of a Tariff     184
FYI: Import Quotas: Another Way to Restrict Trade     186
The Lessons for Trade Policy     186
The Arguments for Restricting Trade     187
FYI: Other Benefits of International Trade     188
The Jobs Argument     188
In the News: Offshore Outsourcing     189
The National-Security Argument     190
The Infant-Industry Argument     190
The Unfair-Competition Argument     191
The Protection-as-a-Bargaining-Chip Argument     191
Case Study: Trade Agreements and the World Trade Organization     192
In the News: Globalization     193
Conclusion     194
Summary     195
Key Concepts     195
Questions for Review     196
Problems and Applications     196
The Economics of the Public Sector     201
Externalities     203
Externalities and Market Inefficiency      204
Welfare Economics: A Recap     205
Negative Externalities     206
Positive Externalities     207
Case Study: Technology Spillovers, Industrial Policy, and Patent Protection     208
Private Solutions to Externalities     209
The Types of Private Solutions     209
The Coase Theorem     210
Why Private Solutions Do Not Always Work     211
Public Policies toward Externalities     212
Command-and-Control Policies: Regulation     212
Market-Based Policy 1: Corrective Taxes and Subsidies     213
In the News: Conserving Fuel     214
Case Study: Why Is Gasoline Taxed So Heavily?     215
Market-Based Policy 2: Tradable Pollution Permits     216
In the News: Controlling Carbon     218
Objections to the Economic Analysis of Pollution     219
Conclusion     219
Summary     220
Key Concepts     220
Questions for Review     220
Problems and Applications     221
Public Goods and Common Resources     223
The Different Kinds of Goods     224
Public Goods     225
The Free-Rider Problem     226
Some Important Public Goods     226
Case Study: Are Lighthouses Public Goods?     228
The Difficult Job of Cost-Benefit Analysis     229
Case Study: How Much Is a Life Worth?     230
Common Resources     231
The Tragedy of the Commons     231
Some Important Common Resources     232
In the News: A Solution to City Congestion     233
Case Study: Why the Cow Is Not Extinct     234
In the News: Should Yellowstone Charge as Much as Disney World?     235
Conclusion: The Importance of Property Rights     236
Summary     236
Key Concepts     237
Questions for Review     237
Problems and Applications     237
The Design of the Tax System     241
A Financial Overview of the U.S. Government     242
The Federal Government     242
Case Study: The Fiscal Challenge Ahead     246
State and Local Government     248
Taxes and Efficiency     249
Deadweight Losses     250
Case Study: Should Income or Consumption Be Taxed?     250
Administrative Burden     251
Marginal Tax Rates versus Average Tax Rates     252
Case Study: Iceland's Natural Experiment     252
Lump-Sum Taxes     253
Taxes and Equity     253
The Benefits Principle     254
The Ability-to-Pay Principle     254
Case Study: How the Tax Burden Is Distributed     255
In the News: Tax Reform around the World     257
Case Study: Horizontal Equity and the Marriage Tax     257
Tax Incidence and Tax Equity     259
Case Study: Who Pays the Corporate Income Tax?     259
Conclusion: The Trade-off between Equity and Efficiency     260
Summary     261
Key Concepts     261
Questions for Review     261
Problems and Applications     262
Firm Behavior and the Organization of Industry     265
The Costs of Production     267
What Are Costs?     268
Total Revenue, Total Cost, and Profit     268
Costs as Opportunity Costs     268
The Cost of Capital as an Opportunity Cost     269
Economic Profit versus Accounting Profit     270
Production and Costs     271
The Production Function     271
From the Production Function to the Total-Cost Curve     273
The Various Measures of Cost      274
Fixed and Variable Costs     275
Average and Marginal Cost     276
Cost Curves and Their Shapes     277
Typical Cost Curves     278
Costs in the Short Run and in the Long Run     280
The Relationship between Short-Run and Long-Run Average Total Cost     280
Economies and Diseconomies of Scale     281
FYI: Lessons from a Pin Factory     282
Conclusion     282
Summary     283
Key Concepts     284
Questions for Review     284
Problems and Applications     285
Firms in Competitive Markets     289
What Is a Competitive Market?     290
The Meaning of Competition     290
The Revenue of a Competitive Firm     290
Profit Maximization and the Competitive Firm's Supply Curve     292
A Simple Example of Profit Maximization     292
The Marginal-Cost Curve and the Firm's Supply Decision     293
The Firm's Short-Run Decision to Shut Down     295
Spilt Milk and Other Sunk Costs     297
Case Study: Near-Empty Restaurants and Off-season Miniature Golf     298
The Firm's Long-Run Decision to Exit or Enter a Market     298
Measuring Profit in Our Graph for the Competitive Firm     299
The Supply Curve in a Competitive Market     301
The Short Run: Market Supply with a Fixed Number of Firms     301
The Long Run: Market Supply with Entry and Exit     302
Why Do Competitive Firms Stay in Business If They Make Zero Profit?     303
A Shift in Demand in the Short Run and Long Run     304
Why the Long-Run Supply Curve Might Slope Upward     304
Conclusion: Behind the Supply Curve     306
Summary     307
Key Concepts     307
Questions for Review     307
Problems and Applications     308
Monopoly     311
Why Monopolies Arise     312
Monopoly Resources     313
Case Study: The DeBeers Diamond Monopoly     313
Government-Created Monopolies     313
Natural Monopolies     314
How Monopolies Make Production and Pricing Decisions     315
Monopoly versus Competition     316
A Monopoly's Revenue     317
Profit Maximization     318
A Monopoly's Profit     320
FYI: Why a Monopoly Does Not Have a Supply Curve     321
Case Study: Monopoly Drugs versus Generic Drugs     322
The Welfare Cost of Monopoly     323
The Deadweight Loss     323
The Monopoly's Profit: A Social Cost?     325
Public Policy toward Monopolies     326
Increasing Competition with Antitrust Laws     326
Regulation     327
Public Ownership     328
Doing Nothing     329
Price Discrimination     329
In the News: Public Transport and Private Enterprise     330
A Parable about Pricing     330
The Moral of the Story     332
The Analytics of Price Discrimination     333
Examples of Price Discrimination     334
Conclusion: The Prevalence of Monopoly     335
In the News: TKTS and Other Schemes     336
Summary     338
Key Concepts     339
Questions for Review     339
Problems and Applications     340
Oligopoly     345
Between Monopoly and Perfect Competition     346
Markets with Only a Few Sellers     347
In the News: The Growth of Oligopoly     348
A Duopoly Example     348
Competition, Monopolies, and Cartels     349
The Equilibrium for an Oligopoly     350
In the News: The Global Fight against Cartels     351
How the Size of an Oligopoly Affects the Market Outcome     352
Game Theory and the Economics of Cooperation     353
The Prisoners' Dilemma     354
Oligopolies as a Prisoners' Dilemma     355
Case Study: OPEC and the World Oil Market     356
Other Examples of the Prisoners' Dilemma     357
The Prisoners' Dilemma and the Welfare of Society     359
Why People Sometimes Cooperate     359
Case Study: The Prisoners' Dilemma Tournament     360
Public Policy toward Oligopolies     360
Restraint of Trade and the Antitrust Laws     361
Case Study: An Illegal Phone Call     361
Controversies over Antitrust Policy     362
Case Study: The Microsoft Case     364
Conclusion     365
In the News: Antitrust in the New Economy     366
Summary     367
Key Concepts     367
Questions for Review     367
Problems and Applications     368
Monopolistic Competition     373
Competition with Differentiated Products     374
The Monopolistically Competitive Firm in the Short Run     374
The Long-Run Equilibrium      375
Monopolistic versus Perfect Competition     377
Monopolistic Competition and the Welfare of Society     379
FYI: Is Excess Capacity a Social Problem?     380
Advertising     380
The Debate over Advertising     381
Case Study: Advertising and the Price of Eyeglasses     382
Advertising as a Signal of Quality     382
FYI: Galbraith versus Hayek     383
Brand Names     384
Conclusion     386
Summary     387
Key Concept     387
Questions for Review     387
Problems and Applications     388
The Economics of Labor Markets     391
The Markets for the Factors of Production     393
The Demand for Labor     394
The Competitive Profit-Maximizing Firm     394
The Production Function and the Marginal Product of Labor     395
The Value of the Marginal Product and the Demand for Labor     397
What Causes the Labor-Demand Curve to Shift?     398
FYI: Input Demand and Output Supply: Two Sides of the Same Coin     399
FYI: The Luddite Revolt     400
The Supply of Labor     401
The Trade-off between Work and Leisure      401
What Causes the Labor-Supply Curve to Shift?     401
Equilibrium in the Labor Market     402
Shifts in Labor Supply     402
Shifts in Labor Demand     404
Case Study: Productivity and Wages     405
FYI: Monopsony     406
The Other Factors of Production: Land and Capital     406
Equilibrium in the Markets for Land and Capital     407
FYI: What Is Capital Income?     408
Linkages among the Factors of Production     408
Case Study: The Economics of the Black Death     409
Conclusion     410
Summary     410
Key Concepts     410
Questions for Review     411
Problems and Applications     411
Earnings and Discrimination     413
Some Determinants of Equilibrium Wages     414
Compensating Differentials     414
Human Capital     414
Case Study: The Increasing Value of Skills     415
Ability Effort, and Chance     416
In the News: The Loss of Manufacturing Jobs     417
Case Study: The Benefits of Beauty     418
An Alternative View of Education: Signaling     419
The Superstar Phenomenon      419
In the News: Are Elite Colleges Worth the Cost?     420
Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and Efficiency Wages     421
The Economics of Discrimination     422
Measuring Labor-Market Discrimination     422
Case Study: Is Emily More Employable than Lakisha?     424
Discrimination by Employers     424
Case Study: Segregated Streetcars and the Profit Motive     425
Discrimination by Customers and Governments     426
Case Study: Discrimination in Sports     426
Conclusion     427
Summary     428
Key Concepts     428
Questions for Review     428
Problems and Applications     429
Income Inequality and Poverty     431
The Measurement of Inequality     432
U.S. Income Inequality     432
Inequality around the World     433
The Poverty Rate     434
In the News: The Global Distribution of Income     435
Problems in Measuring Inequality     437
Economic Mobility     438
The Political Philosophy of Redistributing Income     439
Utilitarianism     439
Liberalism     440
Libertarianism      441
Policies to Reduce Poverty     442
Minimum-Wage Laws     442
Welfare     443
In the News: Hurricane Katrina and Its Aftermath     444
Negative Income Tax     444
In-Kind Transfers     445
In the News: Child Labor     446
Antipoverty Programs and Work Incentives     447
Conclusion     449
Summary     450
Key Concepts     450
Questions for Review     450
Problems and Applications     451
Topics for Further Study     453
The Theory of Consumer Choice     455
The Budget Constraint: What the Consumer Can Afford     456
Preferences: What the Consumer Wants     457
Representing Preferences with Indifference Curves     458
Four Properties of Indifference Curves     459
Two Extreme Examples of Indifference Curves     460
Optimization: What the Consumer Chooses     462
The Consumer's Optimal Choices     462
FYI: Utility: An Alternative Way to Describe Preferences and Optimization     463
How Changes in Income Affect the Consumer's Choices     464
How Changes in Prices Affect the Consumer's Choices      465
Income and Substitution Effects     466
Deriving the Demand Curve     468
Three Applications     469
Do All Demand Curves Slope Downward?     469
How Do Wages Affect Labor Supply?     471
Case Study: Income Effects on Labor Supply: Historical Trends, Lottery Winners, and the Carnegie Conjecture     472
How Do Interest Rates Affect Household Saving?     474
Conclusion: Do People Really Think This Way?     477
Summary     478
Key Concepts     478
Questions for Review     478
Problems and Applications     479
Frontiers of Microeconomics     483
Asymmetric Information     484
Hidden Actions: Principals, Agents, and Moral Hazard     484
Case Study: Corporate Management     485
Hidden Characteristics: Adverse Selection and the Lemons Problem     486
In the News: The Fruits of Moral Hazard     487
Signaling to Convey Private Information     487
Case Study: Gifts as Signals     488
Screening to Induce Information Revelation     489
Asymmetric Information and Public Policy     489
Political Economy     490
The Condorcet Voting Paradox      490
Arrow's Impossibility Theorem     491
The Median Voter Is King     492
In the News: Farm Policy and Politics     494
Politicians Are People Too     494
Behavioral Economics     496
People Aren't Always Rational     496
People Care about Fairness     497
People Are Inconsistent over Time     498
Conclusion     499
In the News: The Psychology of Saving     500
Summary     501
Key Concepts     501
Questions for Review     501
Problems and Applications     501
The Data of Macroeconomics     505
Measuring a Nation's Income     507
The Economy's Income and Expenditure     508
The Measurement of Gross Domestic Product     510
"GDP Is the Market Value..."     510
"...Of All..."     510
"...Final..."     511
"...Goods and Services..."     511
"...Produced..."     511
"...Within a Country..."     511
"...In a Given Period of Time"     511
The Components of GDP     512
Consumption     512
FYI: Other Measures of Income      513
Investment     513
Government Purchases     514
Net Exports     514
Case Study: The Components of U.S. GDP     515
Real versus Nominal GDP     515
A Numerical Example     516
The GDP Deflator     517
Case Study: Real GDP over Recent History     518
In the News: GDP Lightens Up     519
In the News: The Underground Economy     520
Is GDP a Good Measure of Economic Well-Being?     520
Case Study: International Differences in GDP and the Quality of Life     522
Case Study: Who Wins at the Olympics?     523
Conclusion     524
Summary     525
Key Concepts     525
Questions for Review     525
Problems and Applications     526
Measuring the Cost of Living     529
The Consumer Price Index     530
How the Consumer Price Index Is Calculated     530
Problems in Measuring the Cost of Living     532
FYI: What Is in the CPI's Basket?     533
In the News: Accounting for Quality Change     534
The GDP Deflator versus the Consumer Price Index     536
Correcting Economic Variables for the Effects of Inflation      538
Dollar Figures from Different Times     538
Case Study: Mr. Index Goes to Hollywood     539
Indexation     539
Real and Nominal Interest Rates     540
Case Study: Interest Rates in the U.S. Economy     541
Conclusion     542
Summary     543
Key Concepts     544
Questions for Review     544
Problems and Applications     544
The Real Economy in the Long Run     547
Production and Growth     549
Economic Growth around the World     550
FYI: A Picture Is Worth a Thousand Statistics     552
FYI: Are You Richer Than the Richest American?     554
Productivity: Its Role and Determinants     554
Why Productivity Is So Important     554
How Productivity Is Determined     555
FYI: The Production Function     557
Case Study: Are Natural Resources a Limit to Growth?     557
Economic Growth and Public Policy     558
Saving and Investment     559
Diminishing Returns and the Catch-Up Effect     559
Investment from Abroad     561
Education     562
Health and Nutrition      562
In the News: Promoting Human Capital     563
Property Rights and Political Stability     564
Free Trade     565
Research and Development     566
Population Growth     566
In the News: Rich Farmers versus the World's Poor     567
In the News: Foreign Aid     568
Conclusion: The Importance of Long-Run Growth     571
Summary     571
Key Concepts     572
Questions for Review     572
Problems and Applications     572
Saving, Investment, and the Financial System     575
Financial Institutions in the U.S. Economy     576
Financial Markets     576
Financial Intermediaries     578
FYI: How to Read the Newspaper's Stock Tables     579
Summing Up     581
Saving and Investment in the National Income Accounts     581
Some Important Identities     582
The Meaning of Saving and Investment     583
The Market for Loanable Funds     584
Supply and Demand for Loanable Funds     584
Saving Incentives     586
Investment Incentives     587
Government Budget Deficits and Surpluses     588
Case Study: The History of U.S. Government Debt     590
Conclusion     592
Summary     593
Key Concepts     593
Questions for Review     593
Problems and Applications     594
The Basic Tools of Finance     597
Present Value: Measuring the Time Value of Money     598
FYI: The Magic of Compounding and the Rule of 70     600
Managing Risk     600
Risk Aversion     600
The Markets for Insurance     601
FYI: The Peculiarities of Health Insurance     602
Diversification of Firm-Specific Risk     603
The Trade-off between Risk and Return     604
Asset Valuation     605
Fundamental Analysis     606
The Efficient Markets Hypothesis     606
Case Study: Random Walks and Index Funds     607
In the News: Nobel Caliber Investment Advice     608
Market Irrationality     609
Conclusion     609
Summary     610
Key Concepts     610
Questions for Review     610
Problems and Applications     611
Unemployment     613
Identifying Unemployment     614
How Is Unemployment Measured?     614
Case Study: Labor-Force Participation of Men and Women in the U.S. Economy     617
Does the Unemployment Rate Measure What We Want It To?     618
In the News: The Rise of Adult Male Joblessness     620
How Long Are the Unemployed without Work?     620
Why Are There Always Some People Unemployed?     622
Job Search     623
Why Some Frictional Unemployment Is Inevitable     623
Public Policy and Job Search     623
In the News: German Unemployment     624
Unemployment Insurance     626
Minimum-Wage Laws     627
FYI: Who Earns the Minimum Wage?     628
Unions and Collective Bargaining     629
The Economics of Unions     629
Are Unions Good or Bad for the Economy?     630
In the News: Should You Join a Union?     631
The Theory of Efficiency Wages     632
Worker Health     632
Worker Turnover     632
Worker Quality     633
Worker Effort     633
Case Study: Henry Ford and the Very Generous {dollar}5-a-Day Wage     634
Conclusion     634
Summary     635
Key Concepts      635
Questions for Review     636
Problems and Applications     636
Money and Prices in the Long Run     639
The Monetary System     641
The Meaning of Money     642
The Functions of Money     642
The Kinds of Money     643
In the News: The History of Money     644
Money in the U.S. Economy     645
FYI: Credit Cards, Debit Cards, and Money     647
Case Study: Where Is All the Currency?     647
The Federal Reserve System     648
The Fed's Organization     648
The Federal Open Market Committee     649
Banks and the Money Supply     650
The Simple Case of 100-Percent-Reserve Banking     650
Money Creation with Fractional-Reserve Banking     651
The Money Multiplier     652
The Fed's Tools of Monetary Control     653
Problems in Controlling the Money Supply     655
Case Study: Bank Runs and the Money Supply     655
FYI: The Federal Funds Rate     656
Conclusion     657
Summary     657
Key Concepts     658
Questions for Review     658
Problems and Applications      658
Money Growth and Inflation     661
The Classical Theory of Inflation     662
The Level of Prices and the Value of Money     662
Money Supply, Money Demand, and Monetary Equilibrium     663
The Effects of a Monetary Injection     664
A Brief Look at the Adjustment Process     665
The Classical Dichotomy and Monetary Neutrality     667
Velocity and the Quantity Equation     668
Case Study: Money and Prices during Four Hyperinflations     670
The Inflation Tax     671
In the News: The German Hyperinflation     672
The Fisher Effect     673
The Costs of Inflation     675
A Fall in Purchasing Power? The Inflation Fallacy     676
Shoeleather Costs     676
Menu Costs     677
Relative-Price Variability and the Misallocation of Resources     678
Inflation-Induced Tax Distortions     678
Confusion and Inconvenience     680
A Special Cost of Unexpected Inflation: Arbitrary Redistributions of Wealth     680
Case Study: The Wizard of Oz and the Free-Silver Debate     681
In the News: How to Protect Your Savings from Inflation     682
Conclusion      684
Summary     685
Key Concepts     685
Questions for Review     685
Problems and Applications     686
The Macroeconomics of Open Economies     689
Open-Economy Macroeconomics: Basic Concepts     691
The International Flows of Goods and Capital     692
The Flow of Goods: Exports, Imports, and Net Exports     692
Case Study: The Increasing Openness of the U.S. Economy     693
The Flow of Financial Resources: Net Capital Outflow     694
The Equality of Net Exports and Net Capital Outflow     695
Saving, Investment, and Their Relationship to the International Flows     696
In the News: Americans Rely on Capital Flows from Abroad     697
Summing Up     698
Case Study: Is the U.S. Trade Deficit a National Problem?     699
The Prices for International Transactions: Real and Nominal Exchange Rates     701
Nominal Exchange Rates     701
Real Exchange Rates     702
FYI: The Euro     703
A First Theory of Exchange-Rate Determination: Purchasing-Power Parity     704
The Basic Logic of Purchasing-Power Parity     705
Implications of Purchasing-Power Parity     705
Case Study: The Nominal Exchange Rate during a Hyperinflation     707
In the News: The Starbucks Index     708
Limitations of Purchasing-Power Parity     708
Case Study: The Hamburger Standard     710
Conclusion     711
Summary     711
Key Concepts     711
Questions for Review     712
Problems and Applications     712
A Macroeconomic Theory of the Open Economy     715
Supply and Demand for Loanable Funds and for Foreign-Currency Exchange     716
The Market for Loanable Funds     716
The Market for Foreign-Currency Exchange     718
FYI: Purchasing-Power Parity as a Special Case     720
Equilibrium in the Open Economy     720
Net Capital Outflow: The Link between the Two Markets     720
Simultaneous Equilibrium in Two Markets     721
FYI: Disentangling Supply and Demand     723
How Policies and Events Affect an Open Economy     724
Government Budget Deficits     724
In the News: The U.S. Trade Deficit     726
Trade Policy     727
Political Instability and Capital Flight     729
Case Study: Could Capital Flee from the United States?     731
Conclusion      732
Summary     733
Key Concepts     733
Questions for Review     734
Problems and Application     734
Short-Run Economic Fluctuations     737
Aggregate Demand and Aggregate Supply     739
Three Key Facts about Economic Fluctuations     740
Economic Fluctuations Are Irregular and Unpredictable     740
Most Macroeconomic Quantities Fluctuate Together     740
As Output Falls, Unemployment Rises     742
Explaining Short-Run Economic Fluctuations     742
The Assumptions of Classical Economics     742
In the News: Offbeat Indicators     743
The Reality of Short-Run Fluctuations     744
The Model of Aggregate Demand and Aggregate Supply     744
The Aggregate-Demand Curve     746
Why the Aggregate-Demand Curve Slopes Downward     746
Why the Aggregate-Demand Curve Might Shift     749
The Aggregate-Supply Curve     750
Why the Aggregate-Supply Curve Is Vertical in the Long Run     751
Why the Long-Run Aggregate-Supply Curve Might Shift     752
Using Aggregate Demand and Aggregate Supply to Depict Long-Run Growth and Inflation     754
Why the Aggregate-Supply Curve Slopes Upward in the Short Run      755
Why the Short-Run Aggregate-Supply Curve Might Shift     758
Two Causes of Economic Fluctuations     760
The Effects of a Shift in Aggregate Demand     761
FYI: Monetary Neutrality Revisited     763
Case Study: Two Big Shifts in Aggregate Demand: The Great Depression and World War II     764
Case Study: The Recession of 2001     765
FYI: The Origins of Aggregate Demand and Aggregate Supply     766
The Effects of a Shift in Aggregate Supply     767
Case Study: Oil and the Economy     769
FYI: The Macroeconomic Impact of Hurricane Katrina     770
Conclusion     771
Summary     771
Key Concepts     772
Questions for Review     772
Problems and Applications     773
The Influence of Monetary and Fiscal Policy on Aggregate Demand     777
How Monetary Policy Influences Aggregate Demand     778
The Theory of Liquidity Preference     779
The Downward Slope of the Aggregate-Demand Curve     781
FYI: Interest Rates in the Long Run and the Short Run     782
Changes in the Money Supply     784
The Role of Interest-Rate Targets in Fed Policy     785
Case Study: Why the Fed Watches the Stock Market (and Vice Versa)     786
How Fiscal Policy Influences Aggregate Demand     787
Changes in Government Purchases     787
The Multiplier Effect     787
A Formula for the Spending Multiplier     788
Other Applications of the Multiplier Effect     789
The Crowding-Out Effect     790
Changes in Taxes     791
FYI: How Fiscal Policy Might Affect Aggregate Supply     792
Using Policy to Stabilize the Economy     793
The Case for Active Stabilization Policy     793
Case Study: Keynesians in the White House     794
The Case against Active Stabilization Policy     795
Automatic Stabilizers     796
Conclusion     796
Summary     797
Key Concepts     797
Questions for Review     798
Problems and Applications     798
The Short-Run Trade-Off Between Inflation and Unemployment     801
The Phillips Curve     802
Origins of the Phillips Curve     802
Aggregate Demand, Aggregate Supply, and the Phillips Curve     803
Shifts in the Phillips Curve: The Role of Expectations     805
The Long-Run Phillips Curve      805
The Meaning of "Natural"     808
Reconciling Theory and Evidence     808
The Short-Run Phillips Curve     809
The Natural Experiment for the Natural-Rate Hypothesis     811
In the News: How to Keep Expected Inflation Low     813
Shifts in the Phillips Curve: The Role of Supply Shocks     814
The Cost of Reducing Inflation     816
The Sacrifice Ratio     817
Rational Expectations and the Possibility of Costless Disinflation     818
The Volcker Disinflation     819
The Greenspan Era     821
In the News: The Case for Inflation Targeting     822
Case Study: Why Were Inflation and Unemployment So Low at the End of the 1990s?     822
Conclusion     824
Summary     825
Key Concepts     826
Questions for Review     826
Problems and Applications     827
Final Thoughts     831
Five Debates Over Macroeconomic Policy     833
Should Monetary and Fiscal Policymakers Try to Stabilize the Economy?     834
Pro: Policymakers Should Try to Stabilize the Economy     834
Con: Policymakers Should Not Try to Stabilize the Economy     834
In the News: The Fine-Tuning of George W. Bush     836
Should Monetary Policy Be Made by Rule Rather Than by Discretion?     836
Pro: Monetary Policy Should Be Made by Rule     837
In the News: Inflation Targeting as a Rule for Monetary Policy     838
Con: Monetary Policy Should Not Be Made by Rule     840
Should the Central Bank Aim for Zero Inflation?     841
Pro: The Central Bank Should Aim for Zero Inflation     841
Con: The Central Bank Should Not Aim for Zero Inflation     842
In the News: The Optimal Rate of Inflation     843
Should the Government Balance Its Budget?     844
Pro: The Government Should Balance Its Budget     844
Con: The Government Should Not Balance Its Budget     845
In the News: Dealing with Deficits     846
Should the Tax Laws Be Reformed to Encourage Saving?     848
Pro: The Tax Laws Should Be Reformed to Encourage Saving     848
In the News: Tax Reform     850
Con: The Tax Laws Should Not Be Reformed to Encourage Saving     850
Conclusion     851
Summary     852
Questions for Review     853
Problems and Applications     853
Quick Quiz Answers     857
Glossary     873
Index      879

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