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∂ECONOMICS
F O U R T H E D I T I O N
Joseph E. StiglitzC O L U M B I A U N I V E R S I T Y
Carl E.WalshU N I V E R S I T Y O F C A L I F O R N I A , S A N TA C R U Z
∂ECONOMICS
F O U R T H E D I T I O N
BW. W. NORTON & COMPANY
NEW YORK • LONDON
BCopyright © 2006, 2002, 1997, 1993 by W. W. Norton & Company, Inc.
All rights reserved
Printed in the United States of America
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Library of Congress Cataloging-in Publication Data
Stiglitz, Joseph E.
Economics / Joseph E. Stiglitz, Carl E. Walsh.—4th ed.
p. cm.
Includes index.
ISBN 0-393-92622-2
1. Economics. I. Walsh, Carl E. II. Title
HB171.5.S884 2005
330—dc22
2005055518
W. W. Norton & Company, Inc., 500 Fifth Avenue, New York, N. Y. 10110
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ABOUT THE AUTHORS
Joseph E. Stiglitz is professor of economics, business, and international andpublic affairs at Columbia University. Before joining the Columbia faculty, he heldappointments at Yale, Oxford, Princeton, and Stanford. Internationally recognizedas one of the leading economists of his generation, Professor Stiglitz has made impor-tant contributions to virtually all of the major subfields of economics, in particularthe economics of information, one of the key topics highlighted in this text. He wasa co-recipient of the Nobel Prize in Economic Science in 2001, and earlier in hiscareer received the American Economic Association’s John Bates Clark Medal,which is given every two years to the most outstanding economist under the age offorty. Professor Stiglitz is the author and editor of hundreds of scholarly articlesand books, including the best-selling undergraduate textbook Economics of the Public
Sector (Norton) and, with Anthony Atkinson, the classic graduate textbook Lectures
in Public Economics. He is the author of two influential popular books as well:Globalization and Its Discontents and The Roaring Nineties. In addition, he was thefounding editor of the Journal of Economic Perspectives. Professor Stiglitz has alsoplayed a prominent role at the highest levels of economic policy making. He was amember and chairman of President Clinton’s Council of Economic Advisers andlater served as Senior Vice President and Chief Economist of the World Bank.
Carl E.Walsh is professor of economics at the University of California, SantaCruz, where he teaches principles of economics. He previously held faculty appoint-ments at Princeton and the University of Auckland, New Zealand, and has been a vis-iting professor at Stanford. He is widely known for his research in monetary economicsand is the author of a leading graduate text, Monetary Theory and Policy (MIT Press).Before joining the Santa Cruz faculty, Professor Walsh was senior economist at theFederal Reserve Bank of San Francisco, where he continues to serve as a visitingscholar. He has also been a visiting scholar at the Federal Reserve Banks of KansasCity, Philadelphia, and at the Board of Governors. He has taught courses in mone-tary economics to the research department and staff economists at the central banksof Hong Kong, Norway, Portugal, Spain, and the United Kingdom, and at theInternational Monetary Fund. He is a past member of the board of editors of theAmerican Economic Review and is currently an associate editor of the Journal of
Money, Credit, and Banking and the Journal of Economics and Business. He is also onthe editorial board of the Journal of Macroeconomics.
∂ v
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CONTENTS IN BRIEF
∂ vii
PART 1 INTRODUCTION 1Chapter 1 Modern Economics • 3Chapter 2 Thinking Like an Economist • 25
PART 2 PERFECT MARKETS 51Chapter 3 Demand, Supply, and Price • 53Chapter 4 Using Demand and Supply • 77Chapter 5 The Consumption Decision • 101Chapter 6 The Firm’s Costs • 131Chapter 7 The Competitive Firm • 155Chapter 8 Labor Markets • 175Chapter 9 Capital Markets • 191Chapter 10 The Efficiency of Competitive Markets • 215
PART 3 IMPERFECT MARKETS 237Chapter 11 Introduction to Imperfect Markets • 239Chapter 12 Monopoly, Monopolistic Competition, and Oligopoly • 261Chapter 13 Government Policies Toward Competition • 289Chapter 14 Strategic Behavior • 311Chapter 15 Imperfect Information in the Product Market • 333Chapter 16 Imperfections in the Labor Market • 355
PART 4 ISSUES IN PUBLIC POLICY 373Chapter 17 The Public Sector • 375Chapter 18 Environmental Economics • 405Chapter 19 International Trade and Trade Policy • 423Chapter 20 Technological Change • 453
PART 5 INTRODUCTION TO MACROECONOMICS 471Chapter 21 Macroeconomics and the Economic Perspective • 473Chapter 22 Measuring Output and Unemployment • 485Chapter 23 The Cost of Living and Inflation • 509
PART 6 FULL-EMPLOYMENT MACROECONOMICS 523Chapter 24 The Full-Employment Model • 525Chapter 25 Government Finance at Full Employment • 547Chapter 26 The Open Economy at Full Employment • 567Chapter 27 Growth and Productivity • 585Chapter 28 Money, the Price Level, and the Federal Reserve • 605
PART 7 MACROECONOMIC FLUCTUATIONS 635Chapter 29 Introduction to Macroeconomic Fluctuations • 637Chapter 30 Aggregate Expenditures and Income • 661Chapter 31 Aggregate Demand and Inflation • 689Chapter 32 The Federal Reserve and Interest Rates • 715Chapter 33 The Role of Macroeconomic Policy • 727
PART 8 THE GLOBAL ECONOMY 755Chapter 34 The International Financial System • 757Chapter 35 Policy in the Open Economy • 779Chapter 36 Development and Transition • 793
PART 9 FURTHER TOPICS IN MACROECONOMICS 817Chapter 37 Inflation and Unemployment • 819Chapter 38 Controversies in Macroeconomic Policy • 837Chapter 39 A Student’s Guide to Investing • 865
viii ∂
CONTENTS ∂ ix
CONTENTS
PREFACE XXXV
PART 1 INTRODUCTION 1
CHAPTER 1 MODERN ECONOMICS 3INTERNET CONNECTION: Tracking the Digital
Economy 6
What Is Economics? 6
Trade-offs 7
Incentives 8
THINKING LIKE AN ECONOMIST: Incentives and
the Price of AOL 9
Exchange 10
INTERNET CONNECTION: Auction Sites 11
Information 13
Distribution 14
The Three Major Markets 15
Keeping Track of Tricky Terms 16
Microeconomics and Macroeconomics: The Two
Branches of Economics 17
The Science of Economics 18
Discovering and Interpreting Relationships 18
Causation and Correlation 19
Why Economists Disagree 19
REVIEW AND PRACTICE 21
CHAPTER 2 THINKING LIKE AN ECONOMIST 25The Basic Competitive Model 25
Rational Consumers and Profit-Maximizing Firms 26
Competitive Markets 27
e-INSIGHT: Markets, Exchange, and e-Commerce 27
Efficiency and Distribution in the Basic Competitive
Model 28
The Basic Competitive Model as a Benchmark 28
Incentives and Information: Prices, Property Rights, and
Profits 29
Incentives Versus Equality 31
When Property Rights Fail 31
Alternatives to the Price System 32
Opportunity Sets and Trade-Offs 34
Budget and Time Constraints 34
The Production Possibilities Curve 35
Costs 37
Opportunity Costs 38
THINKING LIKE AN ECONOMIST: Trade-Offs 39
INTERNET CONNECTION: Internet Resources for
Economists 40
CASE IN POINT: The Opportunity Cost of Attending
College 40
Sunk Costs 42
Marginal Costs 43
INTERNET CONNECTION: The Economists’ Voice
43
REVIEW AND PRACTICE 45
APPENDIX: Reading Graphs 47
Slope 48
Interpreting Curves 49
PART 2 PERFECT MARKETS 51
CHAPTER 3 DEMAND, SUPPLY, AND PRICE 53The Role of Prices 53
Demand 54
The Individual Demand Curve 54
The Market Demand Curve 55
Shifts in Demand Curves 57
x ∂ CONTENTS
Sources of Shifts in Demand Curves 57
CASE IN POINT: Gasoline Prices and the Demand for
SUVs 59
Shifts in a Demand Curve Versus Movements along a
Demand Curve 60
FUNDAMENTALS OF DEMAND, SUPPLY, AND
PRICE 1: Demand Declines as Price Rises 61
Supply 61
e-INSIGHT: The Demand for Computers and
Information Technology 62
Market Supply 64
Shifts in Supply Curves 65
Sources of Shifts in Supply Curves 65
Shifts in a Supply Curve Versus Movements along a
Supply Curve 67
FUNDAMENTALS OF DEMAND, SUPPLY, AND
PRICE 2: Supply Increases as Price Rises 67
Law of Supply and Demand 67
Using Demand and Supply Curves 69
Consensus on the Determination of Prices 70
FUNDAMENTALS OF DEMAND, SUPPLY, AND
PRICE 3: The Market Clears at the Equilibrium
Price 71
Price, Value, and Cost 70
INTERNET CONNECTION: The Demand and Supply
in the Oil Market 71
REVIEW AND PRACTICE 72
CHAPTER 4 USING DEMAND AND SUPPLY 77The Price Elasticity of Demand 77
Price Elasticity and Revenues 79
The Determinants of the Elasticity of Demand 80
The Price Elasticity of Supply 82
INTERNATIONAL PERSPECTIVE: Comparing
Reactions to the Oil Price Shock of 2000 83
Using Demand and Supply Elasticities 85
Shortages and Surpluses 88
Interfering with the Law of Supply and Demand 90
THINKING LIKE AN ECONOMIST: Incentives and
the Window Tax 90
Price Ceilings 91
CASE IN POINT: Rent Control in New York City 93
CONTENTS ∂ xi
Price Floors 93
INTERNET CONNECTION: Flawed Deregulation 94
Alternative Solutions 94
REVIEW AND PRACTICE 96
APPENDIX: Elasticity and Slope 98
CHAPTER 5 THE CONSUMPTION DECISION 101The Basic Problem of Consumer Choice 101
The Budget Constraint 102
Choosing a Point on the Budget Constraint: Individual
Preferences 104
What Happens to Consumption When Income Changes?
105
CASE IN POINT: The Fate of the BTU Tax 107
INTERNET CONNECTION: What We Consume 109
A Closer Look at the Demand Curve 109
Deriving Demand Curves 110
The Importance of Distinguishing Between Income and
Substitution Effects 111
THINKING LIKE AN ECONOMIST: Incentives,
Income Effects, and Substitution Effects 112
Utility and the Description of Preferences 113
Consumer Surplus 117
Looking Beyond the Basic Model 118
How Well Do the Underlying Assumptions Match Reality?
118
Behavioral Economics 119
REVIEW AND PRACTICE 122
APPENDIX: Indifference Curves and the Consumption
Decision 124
Using Indifference Curves to Illustrate Consumer Choices
124
Indifference Curves and Marginal Rates of Substitution
126
Using Indifference Curves to Illustrate Choices 127
Using Indifference Curves to Derive Demand Curves 128
Substitution and Income Effects 128
CHAPTER 6 THE FIRM’S COSTS 131Profits, Costs, and Factors of Production 132
Production with One Variable Input 132
Types of Costs and Cost Curves 135
xii ∂ CONTENTS
Short-Run and Long-Run Cost Curves 141
Short-Run Cost Curves 142
Long-Run Cost Curves 142
INTERNET CONNECTION: Economic Definitions
146
Production with Many Factors 146
Cost Minimization 147
The Principle of Substitution 147
CASE IN POINT: The Principle of Substitution and
Global Warming 148
Economies of Scope 150
REVIEW AND PRACTICE 151
CHAPTER 7 THE COMPETITIVE FIRM 155Revenue 155
Costs 156
INTERNET CONNECTION: Firms’ Profit-and-Loss
Statements 157
Basic Conditions of Competitive Supply 158
Entry, Exit, and Market Supply 160
Sunk Costs and Exit 161
The Firm’s Supply Curve 162
The Market Supply Curve 163
Long-Run Versus Short-Run Supply 164
e-INSIGHT: The 2001 Recession: Cutbacks Versus
Shutdowns 165
Accounting Profits and Economic Profits 166
Opportunity Costs 166
Economic Rent 168
CASE IN POINT: Entering the Painting Business and
Opportunity Costs 169
The Theory of the Competitive Firm 171
REVIEW AND PRACTICE 172
CHAPTER 8 LABOR MARKETS 175The Labor Supply Decision 175
INTERNET CONNECTION: Labor Force Data 176
The Choice Between Leisure and Consumption 176
Labor Force Participation 179
THINKING LIKE AN ECONOMIST: Trade-Offs 179
Firms and the Demand for Labor 181
Factor Demand 182
CONTENTS ∂ xiii
From the Firm’s Factor Demand to the Market’s Factor
Demand 184
Labor Supply, Demand, and the Equilibrium Wage 184
REVIEW AND PRACTICE 186
APPENDIX: Indifference Curves and the Labor Supply
Decision 188
Deciding Whether to Work 188
CHAPTER 9 CAPITAL MARKETS 191Supply in the Capital Market 191
The Household Decision to Save 192
THINKING LIKE AN ECONOMIST: Wealth
Distribution and Interest Rates 197
INTERNET CONNECTION: Household Saving 198
CASE IN POINT: Why is the U.S. Saving Rate So Low?
198
Demand in the Capital Market 200
A Behavioral Perspective on Saving 202
Education and Human Capital 203
e-INSIGHT: Financing the New Economy 205
Education and Economic Trade-Offs 206
The Basic Competitive Model 206
REVIEW AND PRACTICE 207
APPENDIX A: Indifference Curves and the Saving
Decision 209
Deciding How Much to Save 209
Changing the Interest Rate 210
APPENDIX B: Calculating Present Discounted Value 211
CHAPTER 10 THE EFFICIENCY OF COMPETITIVEMARKETS 215Competitive Markets and Economic Efficiency 216
Consumer and Producer Surplus 217
FUNDAMENTALS OF COMPETITIVE MARKETS 1:
Households and Firms are Price Takers 218
FUNDAMENTALS OF COMPETITIVE MARKETS 2:
The Equilibrium Price Maximizes Consumer Plus
Producer Surplus 219
INTERNET CONNECTION: Digital Economist 219
Taxes and Efficiency 220
Efficiency 221
Pareto Efficiency 222
xiv ∂ CONTENTS
Conditions for the Pareto Efficiency of the Market
Economy 222
THINKING LIKE AN ECONOMIST: Exchange and
Distribution 224
Competitive Markets and Pareto Efficiency 225
FUNDAMENTALS OF COMPETITIVE MARKETS 3:
The Competitive Market Economy is Pareto
Efficient 225
Competitive Markets and Income Distribution 225
General Equilibrium Analysis 227
The Basic Competitive Equilibrium Model 227
THINKING LIKE AN ECONOMIST: Indirect Trade-
Offs and Air Safety for Children 228
CASE IN POINT: The Labor Market and the Widening
Wage Gap 230
CASE IN POINT: The Minimum Wage and General
Equilibrium 231
General Equilibrium Over Time 232
When Partial Equilibrium Analysis Will Do 234
Looking Beyond the Basic Model 234
REVIEW AND PRACTICE 235
PART 3 IMPERFECT MARKETS 237
CHAPTER 11 INTRODUCTION TO IMPERFECTMARKETS 239Extending the Basic Competitive Model 240
FUNDAMENTALS OF IMPERFECT MARKETS 1:
Imperfect Markets Lead to Market Failures 242
Imperfect Competition and Market Structure 242
Price and Quantity with Imperfect Competition 244
Government Policies 245
INTERNET CONNECTION: The Federal Trade
Commission 245
INTERNATIONAL PERSPECTIVE: Trade and
Competition 246
FUNDAMENTALS OF IMPERFECT MARKETS 2:
Imperfect Competition 246
Imperfect Information 247
The Information Problem 247
How Big a Problem? 247
CONTENTS ∂ xv
How Prices Convey Information 248
Markets for Information 249
e-INSIGHT: Information, Competition, and the Internet
249
Government Policies 250
FUNDAMENTALS OF IMPERFECT MARKETS 3:
Imperfect Information 251
Externalities 252
Government Policies Toward Externalities 252
THINKING LIKE AN ECONOMIST: Incentives and
the Environment 253
FUNDAMENTALS OF IMPERFECT MARKETS 4:
Externalities 254
Public Goods 254
FUNDAMENTALS OF IMPERFECT MARKETS 5:
Public Goods 255
Looking Ahead 256
REVIEW AND PRACTICE 257
CHAPTER 12 MONOPOLY, MONOPOLISTICCOMPETITION, AND OLIGOPOLY261Monopoly Output 261
An Example: The ABC-ment Company 264
Monopoly Profits 265
Price Discrimination 266
Economies of Scale and Natural Monopolies 267
INTERNATIONAL PERSPECTIVE: South Africa,
AIDS, and Price Discrimination 268
Assessing the Degree of Competition 270
Number of Firms in the Industry 270
Product Differentiation 271
e-INSIGHT: Network Externalities, the New Economy,
and Monopoly Power 272
Equilibrium with Monopolistic Competition 273
Oligopolies 274
Collusion 275
Restrictive Practices 279
Entry Deterrence 281
INTERNET CONNECTION: Keeping Track of
Oligopolies 281
xvi ∂ CONTENTS
THINKING LIKE AN ECONOMIST: Trade-Offs,
American Airlines, and Predation 283
The Importance of Imperfections in Competition 284
REVIEW AND PRACTICE 285
CHAPTER 13 GOVERNMENT POLICIES TOWARDCOMPETITION 289The Drawbacks of Monopolies and Limited Competition
289
Restricted Output 289
Managerial Slack 291
Reduced Research and Development 291
Rent Seeking 292
Further Drawbacks of Limited Competition 292
e-INSIGHT: Using the Internet to Enhance Price
Discrimination 293
Policies Toward Natural Monopolies 293
Public Ownership 294
Regulation 295
Encouraging Competition 296
INTERNATIONAL PERSPECTIVE: The Darker Side of
Privatization 296
CASE IN POINT: California Electricity Deregulation
298
Antitrust Policies 299
Limiting Market Domination 300
Defining Markets 301
INTERNET CONNECTION: U.S. Department of
Justice and Antitrust Laws 301
THINKING LIKE AN ECONOMIST: Incentives and
the Remedy to the Microsoft Monopoly Problem
302
Curbing Restrictive Practices 304
Enforcing the Antitrust Laws 305
CASE IN POINT: Coke and Pepsi Play Merger 306
REVIEW AND PRACTICE 308
CHAPTER 14 STRATEGIC BEHAVIOR 311Review of the Prisoner’s Dilemma 312
Dominant Strategies 313
CONTENTS ∂ xvii
Nash Equilibrium 313
Strategic Behavior in More General Games 316
Games With Only One Dominant Strategy 316
INTERNATIONAL PERSPECTIVE: Beggar-Thy-
Neighbor Tariff Policies 317
Games Without Dominant Strategies 318
INTERNET CONNECTION: The Zero-Sum Game
Solver 319
Repeated Games 320
Reputations 321
Tit for Tat 321
INTERNET CONNECTION: The Prisoner’s Dilemma
321
Institutions 322
CASE IN POINT: Banking Panics 322
Sequential Moves 324
THINKING LIKE AN ECONOMIST: Information and
Thinking Strategically 326
Time Inconsistency 326
Commitment 327
REVIEW AND PRACTICE 329
CHAPTER 15 IMPERFECT INFORMATION IN THEPRODUCT MARKET 333The Market for Lemons and Adverse Selection 333
Signaling 335
Judging Quality by Price 336
The Incentive Problem 337
Market Solutions 337
Contract Solutions 338
Reputation Solutions 339
The Market for Health Insurance 340
CASE IN POINT: Buying Health Insurance 341
The Search Problem 342
THINKING LIKE AN ECONOMIST: Incentive and
Information Problems in the Housing Market
343
e-INSIGHT: Information Technology and Middlemen
344
INTERNET CONNECTION: Job Search 345
Search and Imperfect Competition 345
Search and the Labor Market 346
xviii ∂ CONTENTS
Search and Information Intermediaries 346
Advertising 347
Advertising and Competition 348
Advertising and Profits 348
The Importance of Imperfect Information 350
REVIEW AND PRACTICE 351
CHAPTER 16 IMPERFECTIONS IN THE LABOR MARKET 355Labor Unions 355
A Brief History 356
INTERNET CONNECTION: Unions on the Internet
358
Economic Effects 359
Limits on Union Power 360
Wage Differentials 362
Discrimination 363
Motivating Workers 364
Piece Rates and Incentives 365
Efficiency Wages 366
CASE IN POINT: Minimum Wages 367
Other Incentives 368
Compensating Workers 368
e-INSIGHT: Labor Markets and the Internet 369
REVIEW AND PRACTICE 371
PART 4 ISSUES IN PUBLIC POLICY373
CHAPTER 17 THE PUBLIC SECTOR 375Why Does the Government Intervene in the Economy?
377
INTERNATIONAL PERSPECTIVE:The Size of
Government in Different Countries 377
Equity-Efficiency Trade-Offs 380
e-INSIGHT: The New Economy and Inequality 381
The U.S. Tax System in Practice 381
CONTENTS ∂ xix
Characteristics of a Good Tax System 382
The Scope of the U.S. Tax System 383
Grading the U.S. Tax System 383
Transfers 386
Welfare 387
Housing 388
Social Insurance 389
Designing Government Programs 390
Government Failures 391
Incentives and Constraints 392
Budgeting and Spending Procedures 393
Imperfections of Information 393
Collective Decision Making 394
Current and Recent Controversies in the Economics of
the Public Sector 395
Dealing With the Deficit 395
Social Security 396
Health Care 398
INTERNET CONNECTION: Policy Analysis 400
REVIEW AND PRACTICE 401
CHAPTER 18 ENVIRONMENTAL ECONOMICS 405Negative Externalities and Oversupply 405
Policy Responses to Problems in the Environment 407
Property Rights Responses 407
INTERNATIONAL PERSPECTIVE: Global Warming
408
THINKING LIKE AN ECONOMIST: Environmental
and Economic Trade-Offs 410
Regulation 410
Taxes and Subsidies 412
The Marketable Permit Response 413
CASE IN POINT: Reducing Acid Rain 414
Weighing the Alternative Approaches 415
Natural Resources 416
INTERNET CONNECTION: The National Center for
Environmental Economics 416
e-INSIGHT: Information and the Environment 418
Merit Goods and the Environment 418
REVIEW AND PRACTICE 419
xx ∂ CONTENTS
CHAPTER 19 INTERNATIONAL TRADE AND TRADEPOLICY 423Trade Between Countries 423
Interdependence in the Product Market 424
Interdependence in the Labor Market 424
Interdependence in the Capital Market 425
Multilateral Trade 425
Comparative Advantage 426
INTERNET CONNECTION: David Ricardo 427
Production Possibilities Curves and Comparative
Advantage 427
Comparative Advantage and Specialization 428
e-INSIGHT: The United States’ Comparative Advantage
in the Internet Age 429
What Determines Comparative Advantage? 430
The Perceived Costs of International Interdependence
432
THINKING LIKE AN ECONOMIST: Exchange and
the Globalization Controversy 432
Trade Policies 434
Commercial Policy 434
Tariffs 435
Quotas 436
Voluntary Export Restraints 436
Other Nontariff Barriers 437
“Fair Trade” Laws 437
INTERNATIONAL PERSPECTIVE: Surrogate
Countries and Canadian Golf Carts 438
Political and Economic Rationale for Protection 439
Displaced Firms and Workers 440
Beggar-Thy-Neighbor Policies 441
Wages in Affected Sectors 442
Increased Competition 442
THINKING LIKE AN ECONOMIST: Distribution and
Trade Liberalization 443
The Infant Industry Argument 443
e-INSIGHT: Trade Liberalization in Information
Technology and Financial Services 444
Strategic Trade Theory 445
International Cooperation 445
GATT and the WTO 445
CONTENTS ∂ xxi
The Growing Protest Against the WTO 446
CASE IN POINT: The Banana War 447
Regional Trading Blocs 448
INTERNET CONNECTION: The World Trade
Organization 449
REVIEW AND PRACTICE 450
CHAPTER 20 TECHNOLOGICAL CHANGE 453Links Between Technological Change and Imperfect
Competition 454
e-INSIGHT: The New Economy and Innovation 455
Patents and the Production of Ideas 455
THINKING LIKE AN ECONOMIST: Intellectual
Property Rights and Distribution 456
The Trade-Off Between Short-term Efficiency and
Innovation 457
CASE IN POINT: Eli Whitney and the Cotton Gin 460
R & D as a Fixed Cost 460
Learning by Doing 461
Access to Capital Markets 462
Schumpeterian Competition 463
Basic Research as a Public Good 464
Government Promotion of Technological Progress 465
Subsidies 465
Protection 466
Relaxing Antitrust Policies 466
INTERNET CONNECTION: Competitiveness 468
Technological Change and Economic Growth 468
REVIEW AND PRACTICE 469
PART 5 INTRODUCTION TOMACROECONOMICS 471
CHAPTER 21 MACROECONOMICS AND THEECONOMIC PERSPECTIVE 473The Commitment to Full Employment and Growth 474
Getting the Country Moving Again 477
Stagflation 477
The Conquest of Inflation 478
xxii ∂ CONTENTS
Government Deficits and Trade Deficits 479
Getting the Economy Moving (Again) 479
New Challenges 480
The Three Key Goals of Macroeconomic Performance 481
A Look Ahead 482
REVIEW AND PRACTICE 483
CHAPTER 22 MEASURING OUTPUT ANDUNEMPLOYMENT 485Measuring Output and Growth 485
Gross Domestic Product 486
Measuring GDP: The Value of Output 489
INTERNET CONNECTION: The Bureau of Economic
Analysis 489
CASE IN POINT: Is Software a Final Good or an
Intermediate Good? 491
Potential GDP 494
INTERNATIONAL PERSPECTIVE: What Gets
Measured in the GDP? 495
Problems in Measuring Output 496
Measuring the Standard of Living 497
A Green GDP 497
Unemployment 498
Unemployment Statistics 499
Forms of Unemployment 500
Output Gaps and the Natural Rate of Unemployment 503
Flows and Stocks 505
REVIEW AND PRACTICE 506
CHAPTER 23 THE COST OF LIVING AND INFLATION 509The Costs of Inflation 509
Who Suffers from Inflation 510
The Economy 511
The Costs of Deflation 512
CASE IN POINT: Hyperinflation in Germany in the
1920s 512
Measuring Inflation 514
INTERNET CONNECTION: Improving Our Measure
of the CPI 516
CASE IN POINT: The Price Index Makes a Difference
516
CONTENTS ∂ xxiii
Alternative Measures of Inflation 517
INTERNET CONNECTION: The Inflation Calculator
517
e-INSIGHT: Measuring the Price and Quantity of
Software 518
The American Experience with Inflation 519
REVIEW AND PRACTICE 521
PART 6 FULL-EMPLOYMENTMACROECONOMICS 523
CHAPTER 24 THE FULL-EMPLOYMENT MODEL 525Macroeconomic Equilibrium 526
The Labor Market 527
Shifts in the Demand and Supply of Labor 529
CASE IN POINT: Mass Migration in the Nineteenth
Century 531
e-INSIGHT: Labor Markets and the Internet 532
The Product Market 532
Potential GDP 533
Demand and Equilibrium Output 534
The Capital Market 536
Household Saving 536
Investment 537
Equilibrium in the Capital Market 538
The General Equilibrium Model 540
Using the General Equilibrium Model 541
REVIEW AND PRACTICE 543
CHAPTER 25 GOVERNMENT FINANCE AT FULLEMPLOYMENT 547The Composition of Spending and Taxes 548
Extending the Basic Full-Employment Model 548
Adding the Government 549
The Government and the Capital Market 549
Leakages and Injections 554
INTERNATIONAL PERSPECTIVE: Deficits in Other
Countries 555
THINKING LIKE AN ECONOMIST: Distribution,
Deficits and Intergenerational Transfers 556
xxiv ∂ CONTENTS
Evaluating Government Deficits and Surpluses 557
Government Deficits and Surpluses: Our Recent
Experiences 558
Factors Affecting the Federal Budget 561
Risk Factors for the Federal Budget 562
REVIEW AND PRACTICE 563
CHAPTER 26 THE OPEN ECONOMY AT FULLEMPLOYMENT 567The Open Economy 568
The Capital Market in the Open Economy 568
The Basic Trade Identity 572
INTERNET CONNECTION: U.S. Trade Data 573
CASE IN POINT: The Trade Deficit 574
e-INSIGHT: High-Tech Exports and Imports 576
Exchange Rates 577
THINKING LIKE AN ECONOMIST: Net Exports and
the Exchange Rate 579
Is the Trade Deficit a Problem? 580
REVIEW AND PRACTICE 583
CHAPTER 27 GROWTH AND PRODUCTIVITY 585Rising Standards of Living 586
Explaining Productivity 589
INTERNET CONNECTION: How Fast Is Modern
Economic Growth? 590
The Capital Stock and the Role of Saving and Investment
590
The Quality of the Labor Force 592
The Reallocation of Resources from Low- to High-
Productivity Sectors 592
Technological Change and the Role of Ideas 593
Total Factor Productivity: Measuring the Sources of
Growth 596
CASE IN POINT: Calculating Total Factor Productivity
in the 1990s 597
e-INSIGHT: Computers and Increased Productivity
Growth 598
FUNDAMENTALS OF GROWTH: Growth in the
Economy’s Labor Force, Growth in the Economy’s
Capital Stock, Technological Change 599
CONTENTS ∂ xxv
Are There Limits to Economic Growth? 600
THINKING LIKE AN ECONOMIST: Trade-Offs and
the Costs of Economic Growth 601
REVIEW AND PRACTICE 602
CHAPTER 28 MONEY, THE PRICE LEVEL, AND THEFEDERAL RESERVE 605Prices and Inflation 606
Money Demand 607
Money Supply 609
The Price Level 609
INTERNET CONNECTION: How Much Cash Do We
Hold? 610
The Financial System in Modern Economies 612
CASE IN POINT: When Atlanta Printed Money 614
Creating Money in Modern Economies 615
Money Is What Money Does 615
Measuring the Money Supply 617
Money and Credit 618
CASE IN POINT: “Boggs Bills” and the Meaning of
Money 619
The Money Supply and the Bank’s Balance Sheet 620
THINKING LIKE AN ECONOMIST: Exchange,
Money, and the Internet 620
How Banks Create Money 622
e-INSIGHT: Electronic Cash 623
The Federal Reserve 626
How the Fed Affects the Money Supply 628
INTERNET CONNECTION: The Federal Reserve
Banks and International Central Banks 629
The Stability of the U.S. Banking System 630
Reducing the Threat of Bank Runs 631
REVIEW AND PRACTICE 633
xxvi ∂ CONTENTS
PART 7 MACROECONOMICFLUCTUATIONS 635
CHAPTER 29 INTRODUCTION TOMACROECONOMIC FLUCTUATIONS637Economic Fluctuations 638
INTERNET CONNECTION: Dating Business Cycle
Peaks and Troughs 642
CASE IN POINT: Estimating the Output Costs of a
Recession 642
THINKING LIKE AN ECONOMIST: Employment
Fluctuations and Trade-Offs 643
Why Economies Experience Fluctuations 643
Nominal Versus Real Wages 645
The Slow Adjustment of Nominal Wages 645
The Slow Adjustment of Prices 645
THINKING LIKE AN ECONOMIST: Information and
Measuring the Business Cycle 647
Understanding Macroeconomic Fluctuations: Key
Concepts 648
Sticky Wages 649
FUNDAMENTALS OF FLUCTUATIONS 1: Sticky
Wages 649
Sticky Prices 649
e-INSIGHT: Cyclical and Structural Productivity 650
FUNDAMENTALS OF FLUCTUATIONS 2: Sticky
Prices 651
Inflation and Adjustment 652
FUNDAMENTALS OF FLUCTUATIONS 3: Short-Run
Inflation-Unemployment Trade-Off 653
Inflation, Monetary Policy, and Spending 653
FUNDAMENTALS OF FLUCTUATIONS 4: Inflation,
Monetary Policy, and Spending 655
CASE IN POINT: Inflation Targeting 655
Linking the Four Key Concepts 656
REVIEW AND PRACTICE 657
CONTENTS ∂ xxvii
CHAPTER 30 AGGREGATE EXPENDITURES ANDINCOME 661Income-Expenditure Analysis 661
The National Income-Output Identity 663
Equilibrium Output 663
Shifts in the Aggregate Expenditures Schedule 664
Mathematical Formulation 665
A Look Forward 666
Consumption 667
Disposable Income 667
Expectations of Future Income 671
Wealth 671
Investment 672
Investment and the Real Interest Rate 673
Inventory Investment 674
Macroeconomic Implications of Investment 675
Government Purchases 676
Net Exports 676
Exports 678
Imports 678
Macroeconomic Implications 679
Putting International Trade into the Equation 680
Calculating Equilibrium Output 681
Aggregate Expenditures and the Real Interest Rate
683
THINKING LIKE AN ECONOMIST: Incentives and
the Real After-Tax Rate of Interest 684
REVIEW AND PRACTICE 685
CHAPTER 31 AGGREGATE DEMAND ANDINFLATION 689The Real Interest Rate and the Capital Market 690
The Aggregate Demand–Inflation Curve 691
The Fed’s Policy Rule 692
What Can Shift the ADI Curve? 694
INTERNATIONAL PERSPECTIVE: How Do Other
Central Banks React to Inflation? 696
Other Factors That Can Shift the ADI Curve 696
Using the ADI Curve 697
Output Effects of a Shift in the ADI Curve 698
CASE IN POINT: The Volcker Disinflation 700
xxviii ∂ CONTENTS