Fluent Essays

Check file for questions 1. Which of the following is not a consequence of the Industrial Revolution? A. Similar and sustained growth for all countries B. Increasing inequality among countries C. Increasing specialization and labor productivity D. Migration of peasants to urban environments 2. One of the main factors for economic growth is labor productivity. If you were to advise a government in how to increase labor productivity, which policy suggestion would be more likely to be successful? A. Invest in education, which will likely decrease human capital B. Promote the immediate free use of all new innovations C. Invest in education, which will likely increase human capital D. Provide disincentives for invention 3. Analyze the following graph, which shows the average annual rates of productivity growth for the United States in different time periods, as measured by the change in output per hour worked. Which of the statements is incorrect? 4. One straight-forward way of measuring the components of economic growth is to utilize an aggregate production function. Which of the following conclusions regarding the results of those studies for the United States is incorrect? A. Investment in physical capital has proven to be more important than investment in human capital B. Physical capital, human capital and technology typically work together to promote economic growth C. Growth in human capital and physical capital often explains only half or less than half of the economic growth that occurs D. A big portion of economic growth is left unexplained by physical and human capital, meaning that technology plays a major role in that process 5. One of the arguments favoring the convergence hypothesis is the existence of diminishing marginal returns. What that does that argument implies? A. High-income economies and low-income economies will never invest the same amount in physical and human capital B. If high-income economies and low-income economies invest the same amount in physical and human capital, both economies will grow at the same rate C. If high-income economies and low-income economies invest the same amount in physical and human capital, the former will grow less than the later because the returns for those investments will be smaller D. If high-income economies and low-income economies invest the same amount in physical and human capital, the former will grow faster than the later because they already have larger stocks of capital 6. 6. 7. Which of the following sentences is true about the relationship between labor productivity, capital deepening, and technology? A. Improvements in technology are always accompanied by increasing labor productivity and capital deepening B. Improvements in technology can be a way of avoiding decreasing marginal returns in output per capita C. It is impossible to increase labor productivity without capital deepening D. When there’s no technological advancement, labor productivity remains constant Principles of Macroeconomics 2e SENIOR CONTRIBUTING AUTHORS STEVEN A. GREENLAW, UNIVERSITY OF MARY WASHINGTON DAVID SHAPIRO, PENNSYLVANIA STATE UNIVERSITY Based on the 2nd edition of Principles of Economics, Economics and the Economy, 2e by Timothy Taylor, published in 2011. OpenStax Rice University 6100 Main Street MS-375 Houston, Texas 77005 To learn more about OpenStax, visit https://openstax.org. Individual print copies and bulk orders can be purchased through our website. ©2018 Rice University. Textbook content produced by OpenStax is licensed under a Creative Commons Attribution 4.0 International License (CC BY 4.0). 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Get started at openstax.org/details/books/principles-macroeconomics-2e Table of Contents Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Chapter 1: Welcome to Economics! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1.1 What Is Economics, and Why Is It Important? . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1.2 Microeconomics and Macroeconomics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 1.3 How Economists Use Theories and Models to Understand Economic Issues . . . . . . . . . . 15 1.4 How To Organize Economies: An Overview of Economic Systems . . . . . . . . . . . . . . . 18 Chapter 2: Choice in a World of Scarcity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 2.1 How Individuals Make Choices Based on Their Budget Constraint . . . . . . . . . . . . . . . 28 2.2 The Production Possibilities Frontier and Social Choices . . . . . . . . . . . . . . . . . . . . 33 2.3 Confronting Objections to the Economic Approach . . . . . . . . . . . . . . . . . . . . . . . 38 Chapter 3: Demand and Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 3.1 Demand, Supply, and Equilibrium in Markets for Goods and Services . . . . . . . . . . . . . 46 3.2 Shifts in Demand and Supply for Goods and Services . . . . . . . . . . . . . . . . . . . . . 51 3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process . . . . . . . . . . . . . . 61 3.4 Price Ceilings and Price Floors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 3.5 Demand, Supply, and Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Chapter 4: Labor and Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 4.1 Demand and Supply at Work in Labor Markets . . . . . . . . . . . . . . . . . . . . . . . . . 84 4.2 Demand and Supply in Financial Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 4.3 The Market System as an Efficient Mechanism for Information . . . . . . . . . . . . . . . . . 98 Chapter 5: Elasticity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 5.1 Price Elasticity of Demand and Price Elasticity of Supply . . . . . . . . . . . . . . . . . . . 108 5.2 Polar Cases of Elasticity and Constant Elasticity . . . . . . . . . . . . . . . . . . . . . . . 113 5.3 Elasticity and Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 5.4 Elasticity in Areas Other Than Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 Chapter 6: The Macroeconomic Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 6.1 Measuring the Size of the Economy: Gross Domestic Product . . . . . . . . . . . . . . . . 135 6.2 Adjusting Nominal Values to Real Values . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 6.3 Tracking Real GDP over Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 6.4 Comparing GDP among Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 6.5 How Well GDP Measures the Well-Being of Society . . . . . . . . . . . . . . . . . . . . . . 155 Chapter 7: Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163 7.1 The Relatively Recent Arrival of Economic Growth . . . . . . . . . . . . . . . . . . . . . . 164 7.2 Labor Productivity and Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 7.3 Components of Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174 7.4 Economic Convergence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 178 Chapter 8: Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 8.1 How Economists Define and Compute Unemployment Rate . . . . . . . . . . . . . . . . . 190 8.2 Patterns of Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 8.3 What Causes Changes in Unemployment over the Short Run . . . . . . . . . . . . . . . . 200 8.4 What Causes Changes in Unemployment over the Long Run . . . . . . . . . . . . . . . . . 204 Chapter 9: Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 9.1 Tracking Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218 9.2 How to Measure Changes in the Cost of Living . . . . . . . . . . . . . . . . . . . . . . . . 222 9.3 How the U.S. and Other Countries Experience Inflation . . . . . . . . . . . . . . . . . . . . 227 9.4 The Confusion Over Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 9.5 Indexing and Its Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Chapter 10: The International Trade and Capital Flows . . . . . . . . . . . . . . . . . . . . . . . 245 10.1 Measuring Trade Balances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246 10.2 Trade Balances in Historical and International Context . . . . . . . . . . . . . . . . . . . . 250 10.3 Trade Balances and Flows of Financial Capital . . . . . . . . . . . . . . . . . . . . . . . 252 10.4 The National Saving and Investment Identity . . . . . . . . . . . . . . . . . . . . . . . . . 255 10.5 The Pros and Cons of Trade Deficits and Surpluses . . . . . . . . . . . . . . . . . . . . . 259 10.6 The Difference between Level of Trade and the Trade Balance . . . . . . . . . . . . . . . 261 Chapter 11: The Aggregate Demand/Aggregate Supply Model . . . . . . . . . . . . . . . . . . . 269 11.1 Macroeconomic Perspectives on Demand and Supply . . . . . . . . . . . . . . . . . . . . 271 11.2 Building a Model of Aggregate Demand and Aggregate Supply . . . . . . . . . . . . . . . 272 11.3 Shifts in Aggregate Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278 11.4 Shifts in Aggregate Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280 11.5 How the AD/AS Model Incorporates Growth, Unemployment, and Inflation . . . . . . . . . 284 11.6 Keynes’ Law and Say’s Law in the AD/AS Model . . . . . . . . . . . . . . . . . . . . . . 287 Chapter 12: The Keynesian Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 12.1 Aggregate Demand in Keynesian Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 298 12.2 The Building Blocks of Keynesian Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 302 12.3 The Phillips Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305 12.4 The Keynesian Perspective on Market Forces . . . . . . . . . . . . . . . . . . . . . . . . 309 Chapter 13: The Neoclassical Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 13.1 The Building Blocks of Neoclassical Analysis . . . . . . . . . . . . . . . . . . . . . . . . 317 13.2 The Policy Implications of the Neoclassical Perspective . . . . . . . . . . . . . . . . . . . 322 13.3 Balancing Keynesian and Neoclassical Models . . . . . . . . . . . . . . . . . . . . . . . 329 Chapter 14: Money and Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335 14.1 Defining Money by Its Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 336 14.2 Measuring Money: Currency, M1, and M2 . . . . . . . . . . . . . . . . . . . . . . . . . . 338 14.3 The Role of Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 341 14.4 How Banks Create Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 346 Chapter 15: Monetary Policy and Bank Regulation . . . . . . . . . . . . . . . . . . . . . . . . . 355 15.1 The Federal Reserve Banking System and Central Banks . . . . . . . . . . . . . . . . . . 356 15.2 Bank Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359 15.3 How a Central Bank Executes Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . 362 15.4 Monetary Policy and Economic Outcomes . . . . . . . . . . . . . . . . . . . . . . . . . . 365 15.5 Pitfalls for Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370 Chapter 16: Exchange Rates and International Capital Flows . . . . . . . . . . . . . . . . . . . . 381 16.1 How the Foreign Exchange Market Works . . . . . . . . . . . . . . . . . . . . . . . . . . 382 16.2 Demand and Supply Shifts in Foreign Exchange Markets . . . . . . . . . . . . . . . . . . 390 16.3 Macroeconomic Effects of Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . 395 16.4 Exchange Rate Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397 Chapter 17: Government Budgets and Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . 409 17.1 Government Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410 17.2 Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413 17.3 Federal Deficits and the National Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415 17.4 Using Fiscal Policy to Fight Recession, Unemployment, and Inflation . . . . . . . . . . . . 418 17.5 Automatic Stabilizers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 421 17.6 Practical Problems with Discretionary Fiscal Policy . . . . . . . . . . . . . . . . . . . . . 423 17.7 The Question of a Balanced Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 427 Chapter 18: The Impacts of Government Borrowing . . . . . . . . . . . . . . . . . . . . . . . . . 435 18.1 How Government Borrowing Affects Investment and the Trade Balance . . . . . . . . . . 436 18.2 Fiscal Policy and the Trade Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439 18.3 How Government Borrowing Affects Private Saving . . . . . . . . . . . . . . . . . . . . . 442 18.4 Fiscal Policy, Investment, and Economic Growth . . . . . . . . . . . . . . . . . . . . . . . 444 Chapter 19: Macroeconomic Policy Around the World . . . . . . . . . . . . . . . . . . . . . . . 453 19.1 The Diversity of Countries and Economies across the World . . . . . . . . . . . . . . . . 455 19.2 Improving Countries’ Standards of Living . . . . . . . . . . . . . . . . . . . . . . . . . . . 458 19.3 Causes of Unemployment around the World . . . . . . . . . . . . . . . . . . . . . . . . . 463 19.4 Causes of Inflation in Various Countries and Regions . . . . . . . . . . . . . . . . . . . . 464 19.5 Balance of Trade Concerns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465 Chapter 20: International Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475 20.1 Absolute and Comparative Advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . 476 20.2 What Happens When a Country Has an Absolute Advantage in All Goods . . . . . . . . . 482 20.3 Intra-industry Trade between Similar Economies . . . . . . . . . . . . . . . . . . . . . . . 486 20.4 The Benefits of Reducing Barriers to International Trade . . . . . . . . . . . . . . . . . . 490 This OpenStax book is available for free at http://cnx.org/content/col12190/1.4 Chapter 21: Globalization and Protectionism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497 21.1 Protectionism: An Indirect Subsidy from Consumers to Producers . . . . . . . . . . . . . . 498 21.2 International Trade and Its Effects on Jobs, Wages, and Working Conditions . . . . . . . . 505 21.3 Arguments in Support of Restricting Imports . . . . . . . . . . . . . . . . . . . . . . . . . 508 21.4 How Governments Enact Trade Policy: Globally, Regionally, and Nationally . . . . . . . . 514 21.5 The Tradeoffs of Trade Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 517 A | The Use of Mathematics in Principles of Economics . . . . . . . . . . . . . . . . . . . . . . . 525 B | The Expenditure-Output Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 541 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 603 This OpenStax book is available for free at http://cnx.org/content/col12190/1.4 PREFACE Welcome to Principles of Macroeconomics 2e (2nd Edition), an OpenStax resource. This textbook was written to increase student access to high-quality learning materials, maintaining highest standards of academic rigor at little to no cost. About OpenStax OpenStax is a nonprofit based at Rice University, and it’s our mission to improve student access to education. Our first openly licensed college textbook was published in 2012, and our library has since scaled to over 25 books for college and AP® courses used by hundreds of thousands of students. OpenStax Tutor, our low-cost personalized learning tool, is being used in college courses throughout the country. Through our partnerships with philanthropic foundations and our alliance with other educational resource organizations, OpenStax is breaking down the most common barriers to learning and empowering students and instructors to succeed. About OpenStax resources Customization Principles of Macroeconomics 2e is licensed under a Creative Commons Attribution 4.0 International (CC BY) license, which means that you can distribute, remix, and build upon the content, as long as you provide attribution to OpenStax and its content contributors. Because our books are openly licensed, you are free to use the entire book or pick and choose the sections that are most relevant to the needs of your course. Feel free to remix the content by assigning your students certain chapters and sections in your syllabus, in the order that you prefer. You can even provide a direct link in your syllabus to the sections in the web view of your book. Instructors also have the option of creating a customized version of their OpenStax book. The custom version can be made available to students in low-cost print or digital form through their campus bookstore. Visit the Instructor Resources section of your book page on OpenStax.org for more information. Errata All OpenStax textbooks undergo a rigorous review process. However, like any professional-grade textbook, errors sometimes occur. Since our books are web based, we can make updates periodically when deemed pedagogically necessary. If you have a correction to suggest, submit it through the link on your book page on OpenStax.org. Subject matter experts review all errata suggestions. OpenStax is committed to remaining transparent about all updates, so you will also find a list of past errata changes on your book page on OpenStax.org. Format You can access this textbook for free in web view or PDF through OpenStax.org, and for a low cost in print. About Principles of Macroeconomics 2e Principles of Macroeconomics 2e (2nd edition) covers the scope and sequence requirements of most introductory macroeconomics courses. The text includes many current examples, which are handled in a politically equitable way. The outcome is a balanced approach to both Keynesian and classical views, and to the theory and application of economics concepts. The second edition has been thoroughly revised to increase clarity, update data and current event impacts, and incorporate the feedback from many reviewers and adopters. Coverage and scope To develop the first edition of Principles of Macroeconomics, we acquired the rights to Timothy Taylor’s Principles of Economics and solicited ideas from economics instructors at all levels of higher education, from community colleges to PhD-granting universities. For the second edition, we received even more expansive and actionable feedback from hundreds of adopters who had used the book for several academic terms. These knowledgeable instructors informed the pedagogical courses, learning objective development and fulfillment, and the chapter arrangements. Faculty who taught from the material provided critical and detailed commentary. Preface 1 The result is a book that covers the breadth of economics topics and also provides the necessary depth to ensure the course is manageable for instructors and students alike. We strove to balance theory and application, as well as the amount of calculation and mathematical examples. The book is organized into seven main parts: What is Economics? The first two chapters introduce students to the study of economics with a focus on making choices in a world of scarce resources. Supply and Demand, Chapters 3 and 4, introduces and explains the first analytical model in economics: supply, demand, and equilibrium, before showing applications in the markets for labor and finance. Elasticity and Price, Chapter 5, introduces and explains elasticity and price, two key concepts in economics. The Macroeconomic Perspective and Goals, Chapters 6 through 10, introduces a number of key concepts in macro: economic growth, unemployment and inflation, and international trade and capital flows. A Framework for Macroeconomic Analysis, Chapters 11 through 13, introduces the principal analytic model in macro, namely the aggregate demand/aggregate supply Model. The model is then applied to the Keynesian and Neoclassical perspectives. The expenditure-output model is fully explained in a stand-alone appendix. Monetary and Fiscal Policy, Chapters 14 through 18, explains the role of money and the banking system, as well as monetary policy and financial regulation. Then the discussion switches to government deficits and fiscal policy. International Economics, Chapters 19 through 21, the final part of the text, introduces the international dimensions of economics, including international trade and protectionism. Alternate Sequencing Principles of Macroeconomics 2e was conceived and written to fit a particular topical sequence, but it can be used flexibly to accommodate other course structures. One such potential structure, which will fit reasonably well with the textbook content, is provided below. Please consider, however, that the chapters were not written to be completely independent, and that the proposed alternate sequence should be carefully considered for student preparation and textual consistency. Chapter 1 Welcome to Economics! Chapter 2 Choice in a World of Scarcity Chapter 3 Demand and Supply Chapter 4 Labor and Financial Markets Chapter 5 Elasticity Chapter 20 International Trade Chapter 6 The Macroeconomic Perspective Chapter 7 Economic Growth Chapter 8 Unemployment Chapter 9 Inflation Chapter 10 The International Trade and Capital Flows Chapter 12 The Keynesian Perspective Chapter 13 The Neoclassical Perspective Chapter 14 Money and Banking Chapter 15 Monetary Policy and Bank Regulation Chapter 16 Exchange Rates and International Capital Flows Chapter 17 Government Budgets and Fiscal Policy Chapter 11 The Aggregate Demand/Aggregate Supply Model Chapter 18 The Impacts of Government Borrowing Chapter 19 Macroeconomic Policy Around the World Chapter 21 Globalization and Protectionism Appendix A The Use of Mathematics in Principles of Economics Appendix B The Expenditure-Output Model 2 Preface This OpenStax book is available for free at http://cnx.org/content/col12190/1.4 Changes to the second edition OpenStax only undertakes revisions when significant modifications to a text are necessary. In the case of Principles of Macroeconomics, we received a wealth of constructive feedback. Many of the book’s users felt that consequential movement in economic data, coupled with the impacts of national and global events, warranted a full revision. We also took advantage of the opportunity to improve the writing and sequencing of the text, as well as many of the calculation examples. The major changes …