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Unformatted text preview: Macroeconomics Principles v. 1.0 This is the book Macroeconomics Principles (v. 1.0). This book is licensed under a Creative Commons by-nc-sa 3.0 ( 3.0/) license. See the license for more details, but that basically means you can share this book as long as you credit the author (but see below), don't make money from it, and do make it available to everyone else under the same terms. This book was accessible as of December 29, 2012, and it was downloaded then by Andy Schmitz ( ) in an effort to preserve the availability of this book. Normally, the author and publisher would be credited here. However, the publisher has asked for the customary Creative Commons attribution to the original publisher, authors, title, and book URI to be removed. Additionally, per the publisher's request, their name has been removed in some passages. More information is available on this project's attribution page ( ). For more information on the source of this book, or why it is available for free, please see the project's home page ( ). You can browse or download additional books there. ii Table of Contents About the Authors................................................................................................................. 1 Acknowledgments................................................................................................................. 3 Preface..................................................................................................................................... 6 Chapter 1: Economics: The Study of Choice .................................................................... 9 Defining Economics ..................................................................................................................................... 10 The Field of Economics................................................................................................................................ 18 The Economists’ Tool Kit............................................................................................................................. 30 Review and Practice..................................................................................................................................... 38 Chapter 2: Confronting Scarcity: Choices in Production ........................................... 42 Factors of Production .................................................................................................................................. 44 The Production Possibilities Curve ............................................................................................................ 52 Applications of the Production Possibilities Model ................................................................................. 71 Review and Practice..................................................................................................................................... 86 Chapter 3: Demand and Supply........................................................................................ 95 Demand ......................................................................................................................................................... 97 Supply.......................................................................................................................................................... 111 Demand, Supply, and Equilibrium............................................................................................................ 123 Review and Practice................................................................................................................................... 141 Chapter 4: Applications of Demand and Supply......................................................... 149 Putting Demand and Supply to Work ...................................................................................................... 151 Government Intervention in Market Prices: Price Floors and Price Ceilings ..................................... 163 The Market for Health-Care Services ...................................................................................................... 173 Review and Practice................................................................................................................................... 182 Chapter 5: Macroeconomics: The Big Picture ............................................................. 187 Growth of Real GDP and Business Cycles................................................................................................. 190 Price-Level Changes................................................................................................................................... 200 Unemployment........................................................................................................................................... 216 Review and Practice................................................................................................................................... 227 Chapter 6: Measuring Total Output and Income........................................................ 232 Measuring Total Output ............................................................................................................................ 234 Measuring Total Income............................................................................................................................ 251 GDP and Economic Well-Being ................................................................................................................. 260 Review and Practice................................................................................................................................... 270 iii Chapter 7: Aggregate Demand and Aggregate Supply .............................................. 276 Aggregate Demand..................................................................................................................................... 278 Aggregate Demand and Aggregate Supply: The Long Run and the Short Run.................................... 290 Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium ............................. 304 Review and Practice................................................................................................................................... 317 Chapter 8: Economic Growth .......................................................................................... 324 The Significance of Economic Growth ..................................................................................................... 326 Growth and the Long-Run Aggregate Supply Curve .............................................................................. 336 Determinants of Economic Growth .......................................................................................................... 346 Review and Practice................................................................................................................................... 353 Chapter 9: The Nature and Creation of Money........................................................... 359 What Is Money? .......................................................................................................................................... 361 The Banking System and Money Creation .............................................................................................. 371 The Federal Reserve System ..................................................................................................................... 386 Review and Practice................................................................................................................................... 395 Chapter 10: Financial Markets and the Economy ...................................................... 401 The Bond and Foreign Exchange Markets............................................................................................... 403 Demand, Supply, and Equilibrium in the Money Market ...................................................................... 414 Review and Practice................................................................................................................................... 431 Chapter 11: Monetary Policy and the Fed.................................................................... 437 Monetary Policy in the United States ...................................................................................................... 439 Problems and Controversies of Monetary Policy ................................................................................... 451 Monetary Policy and the Equation of Exchange ..................................................................................... 464 Review and Practice................................................................................................................................... 475 Chapter 12: Government and Fiscal Policy.................................................................. 482 Government and the Economy ................................................................................................................. 484 The Use of Fiscal Policy to Stabilize the Economy.................................................................................. 496 Issues in Fiscal Policy................................................................................................................................. 507 Review and Practice................................................................................................................................... 515 Chapter 13: Consumption and the Aggregate Expenditures Model ....................... 521 Determining the Level of Consumption................................................................................................... 522 The Aggregate Expenditures Model......................................................................................................... 535 Aggregate Expenditures and Aggregate Demand................................................................................... 558 Review and Practice................................................................................................................................... 566 iv Chapter 14: Investment and Economic Activity ......................................................... 573 The Role and Nature of Investment ......................................................................................................... 575 Determinants of Investment..................................................................................................................... 584 Investment and the Economy ................................................................................................................... 595 Review and Practice................................................................................................................................... 600 Chapter 15: Net Exports and International Finance.................................................. 606 The International Sector: An Introduction ............................................................................................. 608 International Finance ................................................................................................................................ 620 Exchange Rate Systems ............................................................................................................................. 632 Review and Practice................................................................................................................................... 643 Chapter 16: Inflation and Unemployment ................................................................... 649 Relating Inflation and Unemployment .................................................................................................... 651 Explaining Inflation–Unemployment Relationships .............................................................................. 660 Inflation and Unemployment in the Long Run ....................................................................................... 669 Review and Practice................................................................................................................................... 682 Chapter 17: A Brief History of Macroeconomic Thought and Policy ..................... 689 The Great Depression and Keynesian Economics ................................................................................... 691 Keynesian Economics in the 1960s and 1970s ......................................................................................... 701 An Emerging Consensus: Macroeconomics for the Twenty-First Century .......................................... 715 Review and Practice................................................................................................................................... 728 Chapter 18: Inequality, Poverty, and Discrimination ............................................... 732 Income Inequality ...................................................................................................................................... 735 The Economics of Poverty......................................................................................................................... 746 The Economics of Discrimination ............................................................................................................ 762 Review and Practice................................................................................................................................... 771 Chapter 19: Economic Development ............................................................................. 777 The Nature and Challenge of Economic Development........................................................................... 780 Population Growth and Economic Development.................................................................................... 795 Keys to Economic Development ............................................................................................................... 805 Review and Practice................................................................................................................................... 815 Chapter 20: Socialist Economies in Transition ........................................................... 818 The Theory and Practice of Socialism...................................................................................................... 820 Socialist Systems in Action ....................................................................................................................... 828 Economies in Transition: China and Russia ............................................................................................ 837 Review and Practice................................................................................................................................... 851 v Appendix A: Graphs in Economics................................................................................. 853 How to Construct and Interpret Graphs.................................................................................................. 854 Nonlinear Relationships and Graphs without Numbers ........................................................................ 870 Using Graphs and Charts to Show Values of Variables .......................................................................... 878 Appendix B: Extensions of the Aggregate Expenditures Model.............................. 890 The Algebra of Equilibrium....................................................................................................................... 891 The Aggregate Expenditures Model and Fiscal Policy ........................................................................... 895 Review and Practice................................................................................................................................... 901 vi About the Authors Libby Rittenberg Libby Rittenberg has been a Professor of Economics at Colorado College in Colorado Springs since 1989. She teaches principles of economics, intermediate macroeconomic theory, comparative economic systems, and international political economy. She received her B. A. in economics-mathematics and Spanish from Simmons College and her Ph.D. in economics from Rutgers University. Prior to joining the faculty at Colorado College, she taught at Lafayette College and at the Rutgers University Graduate School of Management. She served as a Fulbright Scholar in Istanbul, Turkey, and as a research economist at Mathematica, Inc. in Princeton, New Jersey. Dr. Rittenberg specializes in the internationally oriented areas of economics, with numerous articles in journals and books on comparative and development economics. Much of her work focuses on transition issues and on the Turkish economy. She has been very involved in study abroad education and has directed programs in central Europe and Turkey. Tim Tregarthen There is one word that captures the essence of Dr. Timothy Tregarthen—inspiring. Tim was first diagnosed with multiple sclerosis (MS) in 1975. Yet, he continued a remarkable academic career of teaching and research. In 1996, he published the first edition of his principles of economics textbook to great acclaim, and it became widely used in colleges around the country. That same year, MS made him wheelchair-bound. The disease forced his retirement from teaching at the University of Colorado at Colorado Springs in 1998. He lost the use of his arms in 2001 and has been quadriplegic ever since. In 2002, Tim’s doctor expected him to die. 1 About the Authors He was placed in the Pikes Peak Hospice program and was twice given his last rites by his priest. UCCS Chancellor Shockley-Zalabak says, “I really thought that Tim would die in hospice. That’s what the doctors told me, and I really believed that. I remember one day they called me and told me to try to come see him. They didn't expect him to live through the night.” Not only did he live through the night, but he eventually recovered to the point that he moved from hospice to a long-term care facility. There, he never let his disease get him down. In fact, he turned back to his love of writing and teaching for inspiration. He obtained a voice-activated computer, recruited a coauthor, Libby Rittenberg of Colorado College, and turned his attention to revising his principles of economics book. Unnamed Publisher is honored to publish a new, first edition relaunch of this wonderful book, and proud to bring Tim’s incredible talents as a teacher back to life for future generations of students to learn from. In addition to completing the rewrite of his textbook, Tim recently completed an autobiography about the thirty-two years he has had MS, titled Suffering, Faith, and Wildflowers. He is nearing completion of a novel, Cool Luck, based on the life of a friend. It is the story of a young couple facing the husband’s diagnosis of ALS—Lou Gehrig’s disease. Remarkably, in 2007, he was able to return to the classroom at UCCS, where he had taught economics for twenty-seven years. In January of 2009, Tim married Dinora Montenegro (now Dinora Tregarthen); the couple lives in San Gabriel, California. Perhaps Tim’s approach to life is best summed up by an observation by UCCS English Professor Thomas Naperierkowski: “One of the remarkable things is, heck, I can wake up with a headache and be a pretty grouchy character, but given his physical trials, which he faces every minute of his life these days, I’ve never seen him grouchy, I’ve never seen him cranky.” Carry on, Tim. 2 Acknowledgments The authors would like to thank to the following individuals who reviewed t...
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