Download Circular flow of economic activity through a simple market economy

Examples of Microeconomic and Macroeconomic Concerns
DIVISION OF
PRODUCTION
PRICES
ECONOMICS
INCOME
EMPLOYMENT
Microeconomics
Production/output in
individual industries
and businesses
How much steel
How much office
space
How many cars
Distribution of
Price of individual
income and wealth
goods and services
Wages in the auto
Price of medical care
industry
Price of gasoline
Minimum wage
Food prices
Executive salaries
Apartment rents
Poverty
Employment by
individual businesses
and industries
Jobs in the steel
industry
Number of
employees in a firm
Number of
accountants
Macroeconomics
National
production/output
Total industrial
output
Gross domestic
product
Growth of output
National income
Aggregate price level
Total wages and
Consumer prices
salaries
Producer prices
Total corporate
Rate of inflation
profits
Employment and
unemployment in the
economy
Total number of jobs
Unemployment rate
The Three Basic Questions
Scarcity and the Production Possibilities Curve: The production possibilities curve (or frontier) illustrates the
notion of scarcity: With a given amount of resources, an increase in farm goods comes at the expense of factory
goods. The curve is bowed outward because resources are not perfectly adaptable to the production of the two
goods.
Shifting the Production Possibilities Curve: The production possibilities curve will shift outward as a result of an
increase in the economy’s resources (natural resources, labor, physical capital, human capital, and
entrepreneurship) or a technological innovation that increases the output from a given amount of resources.
The Marginal Principle and TV Time: If the opportunity cost of TV time is $0.35 per hour and pedaling is not
required for TV time, the marginal principle is satisfied at point n, and the child will watch 20 hours of TV per
week. If pedaling is required and the discomfort of pedaling is $0.85 per hour, the marginal cost of TV time is
$1.20 (equal to $0.35 + $0.85), and the marginal principle is satisfied at point m, with only 3 hours of TV time
per week.
Diminishing Returns for Pizza
Number of workers
1
2
3
Total product: pizzas produced
Marginal product
12
18
21
12
6
3
4
22
1
Total Product Curve and Diminishing Returns: As the number of workers increases, the number of pizzas
produced per hour increases but at a decreasing rate. The second worker increases output by 6 pizzas (from 12
pizzas to 18 pizzas), but the fourth worker increases output by only 1 pizza (from 21 pizzas to 22 pizzas).
Diminishing returns occur because workers share a pizza oven.
Production per Hour and Opportunity Cost
Bread produced per hour
Shirts produced per hour
Opportunity cost of one loaf of bread
Opportunity cost of one shirt
Brenda
Sam
6
2
1/3 shirt
3 loaves of bread
1
1
1 shirt
1 loaf of bread
The Individual Demand Curve: According to the law of demand, the higher the price, the smaller the quantity
demanded, everything else being equal. Therefore, the demand curve is negatively sloped: When the price
increases from $6 to $8, the quantity demanded decreases from 7 pizzas per month (point d) to 4 pizzas per
month (point c).
From Individual to Market Demand: The market demand equals the sum of the demands of all consumers. In this
case there are only two consumers, so at each price, the market quantity demanded equals the quantity demanded
by Al plus the quantity demanded by Bea. At a price of $8, Al’s quantity is 4 pizzas (point c) and Bea’s quantity
is 2 pizzas (point g), so the market quantity demanded is 6 pizzas (point j). Each consumer obeys the law of
demand, so the market demand curve is negatively sloped.
The Marginal Principle and the Output Decision: The marginal benefit curve is horizontal at the market price. To
satisfy the marginal principle, the firm produces the quantity at which the marginal benefit equals the marginal
cost. An increase in the price shifts the marginal-benefit curve upward and increases the quantity at which the
marginal benefit equals the marginal cost.
Nora’s Supply Schedule for Pizza
Price ($)
4
6
8
10
12
Quantity of pizzas per month
100
200
300
400
500
Individual and Market Supply Curve:
(A) Supply of individual firm. Nora supplies 300 pizzas at a price of $8 (point p) but 400 pizzas at a price of
$10 (point q).
(B) Market supply. There are 100 identical pizzerias, so the market quantity equals 100 times the quantity
supplied by Nora’s, the typical pizzeria. At a price of $8, Nora supplies 300 pizzas (point p), so the market
quantity supplied is 30,000 pizzas (point u).
Supply, Demand, and Market Equilibrium: At the market equilibrium (point e, with price = $8 and quantity =
30,000), the quantity supplied equals the quantity demanded. At a price lower than the equilibrium price ($6),
there is excess demand (the quantity demanded exceeds the quantity supplied). At a price above the equilibrium
price ($12), there is excess supply (the quantity supplied exceeds the quantity demanded).
Market Effects of an Increase in Demand: An increase in demand shifts the demand curve to the right: At each
price, the quantity demanded increases. At the initial price ($8), the shift of the demand curve causes excess
demand, causing the price to rise. Equilibrium is restored at point n, with a higher equilibrium price ($10, up
from $8) and a larger equilibrium quantity (40,000 pizzas, up from 30,000 pizzas).
Changes in Demand Shift the Demand Curve
An increase in demand shifts the demand curve to the
A decrease in demand shifts the demand curve to the
right when
left when
The good is normal and income increases
The good is normal and income decreases
The good is inferior and income decreases
The good is inferior and income increases
The price of a substitute good increases
The price of a substitute good decreases
The price of a complementary good decreases
The price of a complementary good increases
Population increases
Population decreases
Consumer tastes shift in favor of the product
Consumer tastes shift away from the product
Favorable advertising
Unfavorable publicity
Consumers expect a higher price in the future
Consumers expect a lower price in the future
Market Effects of a Decrease in Demand: A decrease in demand shifts the demand curve to the left: At each
price, the quantity demanded decreases. At the initial price ($8), the leftward shift of the demand curve causes
excess supply, causing the price to fall. Equilibrium is restored at point n, with a lower equilibrium price ($6,
down from $8) and a smaller equilibrium quantity (20,000 pizzas, down from 30,000 pizzas).
Decrease in income. A decrease in income means that consumers have less to spend, so they buy a smaller
quantity of each normal good.
Decrease in price of a substitute good. A decrease in the price of a substitute good such as tacos makes pizza
more expensive relative to tacos, causing consumers to demand less pizza.
Increase in price of a complementary good. An increase in the price of a complementary good such as beer
increases the cost of a beer and pizza meal, decreasing the demand for pizza.
Decrease in population. A decrease in the number of people means that there are fewer pizza consumers, so the
market demand for pizza decreases.
Shift in consumer tastes. When consumers’ preferences shift away from pizza in favor of other products, the
demand for pizza decreases.
Expectations of lower future prices. If consumers think next month’s pizza price will be lower than they had
initially expected, they may buy a smaller quantity today, meaning the demand for pizza today will decrease.

The market moves downward along the supply curve to a smaller quantity supplied.

The market moves downward along the new demand curve to a larger quantity demanded.
The supply curve intersects the new demand curve at point n, so the new equilibrium price is $6 (down from $8),
and the new equilibrium quantity is 20,000 pizzas (down from 30,000 pizzas).
Market Effects of an Increase in Supply: An increase in supply shifts the supply curve to the right: At each price,
the quantity supplied increases. At the initial price ($8), the rightward shift of the supply curve causes excess
supply, causing the price to drop. Equilibrium is restored at point n, with a lower equilibrium price ($6, down
from $8) and a larger equilibrium quantity (36,000 pizzas, up from 30,000 pizzas).
Changes in Supply Shift the Supply Curve
An increase in supply shifts the supply curve to the right
when
The cost of an input decreases
A technological advance decreases production costs
The number of firms increases
Producers expect a lower price in the future
Subsidy
A decrease in supply shifts the supply curve to the left
when
The cost of an input increases
The number of firms decreases
Producers expect a higher price in the future
Tax
Market Effects of a Decrease in Supply: A decrease in supply shifts the supply curve to the left: At each price,
the quantity supplied decreases. At the initial price ($8), the leftward shift of the supply curve causes excess
demand, causing the price to rise. Equilibrium is restored at point n, with a higher equilibrium price ($10, up
from $8) and a smaller equilibrium quantity (23,000 pizzas, down from 30,000 pizzas).
Increase in input costs. A increase in the cost of labor or some other input will make pizza production more
costly and less profitable at a given price, so producers will supply less.
A decrease in the number of producers. The market supply is the sum of the supplies of all producers, so a
decrease in the number of producers decreases supply.
Expectations of higher future prices. If firms think next month’s pizza price will be higher than they had initially
expected, they may be willing to sell a smaller quantity today (and a larger quantity next month). That means
that the supply of pizza today will decrease.
Tax. If the government imposes a tax on producers (a firm pays the government some amount for each unit
produced), the tax will make the product more costly and less profitable, so firms will supply less.
Market Effects of Simultaneous Changes in Supply and Demand: (A) Larger increase in demand. If the
increase in demand is larger than the increase in supply (if the shift of the demand curve is larger than the shift of
the supply curve), both the equilibrium price and the equilibrium quantity will increase.
(B) Larger increase in supply. If the increase in supply is larger than the increase in demand (if the shift of the
supply curve is larger than the shift of the demand curve), the equilibrium price will decrease and the equilibrium
quantity will increase.
Market Effects of Changes in Demand or Supply
Change in Demand or Supply
Increase in demand
Decrease in demand
Increase in supply
Decrease in supply
Change in Price
Change in Quantity
Increase
Decrease
Decrease
Increase
Increase
Decrease
Increase
Decrease
University Enrolment and Apartment Rent: An increase in university enrolment will increase the demand for
apartments in the university town, shifting the demand curve to the right. Equilibrium is restored at point n, with
a higher price ($600, up from $400) and a larger quantity (4,000 apartments, up from 3,000 apartments).
Market Effects of Pesticide Residue: A report of pesticide residue on apples decreases the demand for apples,
shifting the demand curve to the left. Equilibrium is restored at point n, with a lower price ($0.50, down from
$0.60) and a smaller quantity (20,000 pounds, down from 26,000 pounds).
Technological Innovation and the Computer Market: Technological innovation decreases production costs,
increasing supply and shifting the supply curve to the right. The equilibrium price decreases, and the equilibrium
quantity increases.
Bad Weather and the Coffee Market: Bad weather decreases the supply of coffee beans, shifting the supply curve
to the left. Equilibrium is restored at point n, with a higher price ($0.72, up from $0.60) and a smaller quantity
(22 million pounds, down from 30 million pounds).
The Mystery of Increasing Poultry Consumption: Because the price of poultry decreased at the same time the
quantity of poultry consumed increased, we know that the increase in consumption resulted from an increase in
supply, not an increase in demand. Innovations in poultry processing decreased production costs, shifting the
supply curve to the right.
The Mystery of Lower Drug Prices: Because the quantity of cocaine consumed decreased at the same time the
price of cocaine decreased, we know that the decrease in price resulted from a decrease in demand, not an
increase in supply. A decrease in the demand for cocaine decreased the price and decreased the quantity
consumed.
The Mystery of the Tobacco Money: The tobacco settlement increases the price of cigarettes from $3.00 to
$3.40, causing movement upward along the original demand curve from point i to point p, decreasing the
quantity consumed from 80 million to 72 million packs. The reduction in advertising and marketing shifts the
demand curve to the left, reducing the quantity demanded at the new price ($3.40) from 72 million (point p) to
50 million packs (point n).
Using Data to Draw a Demand Curve
The following table shows data on gasoline prices and gasoline consumption in a particular city. Is it possible to
use these data to draw a demand curve? If so, draw the demand curve. If not, why not?
Gasoline Price
Quantity Consumed
Year
(per gallon)
(millions of gallons)
1999
2000
2001
1.20
1.40
1.60
400
300
360
Circular flow of economic activity through a simple market economy. Note that the flow reflects the direction in
which goods and services flow through input and output markets.
Name circular flow diagram. Here, goods and services flow clockwise: Labor services supplied by households
flow to firms, and goods and services produced by firms flow to households. Money (not pictured here) flows in
the opposite (counterclockwise) direction: Payment for goods and services flows from households to firms, and
payment for labor services flows from firms to households.
Composition of U.S. GDP, Second Quarter 2000 (billions of dollars expressed at annual rates)
Consumption
Private Investment
Government
Net
GDP
Expenditures
Expenditures
Purchases
Exports
9,945
6,706
1,852
U.S. Trade Balance as a Share of GDP, 1960–2000
1,742
–355
Trade Balance as a Percent of GDP, 2000
From GDP to National Income, Second Quarter 2000 (billions of dollars)
Gross domestic product plus net income from abroad =
Gross national product minus depreciation =
Net national product minus indirect taxes (and other adjustments) =
National income
Composition of U.S. National Income, Second Quarter of 2000 (billions of dollars)
National income
Compensation of employees
Corporate profits
Rental income
Proprietor’s income
Net interest
GDP Data for a Simple Economy
Quantity Produced
9,945
9,937
8,693
7,983
7,983
5,603
964
141
709
566
Price
Year
Cars
Computers
Cars
Computers
2004
2005
4
5
1
3
$10,000
12,000
$5,000
5,000
The Core of Macroeconomic Theory
In this business cycle, the economy is expanding as it moves through point A from the trough to the peak. When
the economy moves from a peak down to a trough, through point B, the economy is in recession.
Life-Cycle Theory of Consumption: In their early working years, people consume more than they earn. This is
also true in the retirement years. In between, people save (consume less than they earn) to pay off debts from
borrowing and to accumulate savings for retirement.
Real GDP in the United States since 1970 has risen overall, but there have been three recessionary periods: 1974
I-1975 IV, 1980 II-1983 I, and 1990 III-1991 I.
The U.S. unemployment rate since 1970 shows wide variations. The three recessionary reference periods show
increases in the unemployment rate.
The percentage change in the GDP price index measures the overall rate of inflation. Since 1970, inflation has
been high in two periods: 1973 IV-1975 IV and 1979 I-1981 IV. Inflation between 1983 and 1992 was moderate.
Since 1992, it has been fairly low.
Unemployment Data, 2001
Selected U.S. Unemployment Statistics, Unemployment Rates for May 2001 (in percent)
Total
4.4
Males 20 years and older
3.9
Females 20 years and older
3.8
Both sexes, 16–19 years
13.6
White
3.8
African American
8.0
White, 16–19 years
11.8
African American, 16–19 years
25.1
Married men
2.6
Married women
2.9
Women maintaining families
6.2
Relationship Between Labor and Output with Fixed Capital: With capital fixed, output increases with labor input
but at a decreasing rate.
Increase in the Stock of Capital: When capital increases from K * to K** the production function shifts up. At any
level of labor input, the level of output increases.
Demand for and Supply of Labor
Shifts in Demand and Supply
Determining Full Employment Output: Panel B determines the equilibrium level of employment at L* and the
real wage rate at W*. Full employment output in panel A is Y*.
Effects of Employment Taxes
Alternative Uses of GDP for 1998 (percent of total GDP)
Consumptio
Investment
n
Japan
United States
France
Singapore
Germany
61
67
55
37
58
27
20
19
33
22
Government
Net Export
purchases
10
14
23
10
19
2
–1
3
20
1
Effects of an Adverse Technology Shock: An adverse shock to the economy shifts the labor demand curve to the
left and leads to lower wages, reduced employment, and reduced output.
Components of the CPI (consumer price index)
Increased Government Spending Crowds Out Consumption
Increased Government Spending Also Crowds Out Investment
Components of GDP, 2001: The Expenditure Approach
BILLIONS
OF DOLLARS
Total gross domestic product
Personal consumption expenditures (C)
Durable goods
Nondurable goods
Services
Gross private domestic investment (I)
Nonresidential
Residential
Change in business inventories
Government consumption and gross investment (G)
Federal
State and local
Net exports (EX - IM)
Exports (EX)
Imports (IM)
Note: Numbers may not add exactly because of rounding.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
PERCENTAGE
OF GDP
10,205.6
7,063.5
858.2
2,055.0
4,150.2
1,634.0
1,246.6
446.1
-58.6
1,839.3
615.7
1,223.6
-331.2
1,049.4
1,380.7
100.0
69.2
8.4
20.1
40.7
16.0
12.2
4.4
-0.6
18.0
6.0
12.0
-3.2
10.3
13.5
Components of GDP, 2001: The Income Approach
BILLIONS
OF DOLLARS
Gross domestic product
National income
Compensation of employees
Proprietors' income
Corporate profits
Net interest
Rental income
Depreciation
Indirect taxes minus subsidies
Net factor payments to the rest of the world
Other
PERCENTAGE
OF GDP
10,205.6
8,199.9
6,010.0
943.5
748.9
554.8
142.7
1,351.3
739.4
11.1
-96.1
GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal Income, 2001
100.0
80.3
58.9
7.3
7.3
5.4
1.4
13.2
7.2
0.1
-0.9
DOLLARS
(BILLIONS
)
10,205.6
+342.1
-353.2
10,194.5
-1,351.3
8,843.2
-643.3
8,199.9
-332.6
-731.2
+439.1
1,148.7
8,723.9
-1,306.2
7,417.7
GDP
Plus: receipts of factor income from the rest of the world
Less: payments of factor income to the rest of the world
Equals: GNP
Less: depreciation
Equals: net national product (NNP)
Less: indirect taxes minus subsidies plus other
Equals: national income
Less: corporate profits minus dividends
Less: social insurance payments
Plus: personal interest income received from the government and consumers
Plus: transfer payments to persons
Equals: personal income
Less: personal taxes
Equals: disposable personal income
Disposable Personal Income and Personal Saving, 2001
DOLLARS
(BILLIONS)
7,417.7
Disposable personal income
Less:
Personal consumption expenditures
Interest paid by consumers to business
Personal transfer payments to foreigners
Equals: personal saving
Personal saving as a percentage of disposable personal income:
-7,063.5
-204.3
-31.3
118.6
1.6%
A Three-Good Economy
Good A
Good B
Good C
Total
PRODUCTION
YEAR 1
YEAR 2
Q1
Q2
6
11
7
4
10
12
PRICE PER UNIT
YEAR 1
YEAR 2
P1
P2
$ .50
$ .40
.30
1.00
.70
.90
Per Capita GNP for Selected Countries, 1998
COUNTRY
U.S. DOLLARS
Switzerland
40,080
Norway
34,330
Denmark
33,260
Japan
32,380
United States
29,340
Austria
26,850
Germany
25,850
Sweden
25,620
Belgium
25,380
France
24,940
Netherlands
24,760
Finland
24,110
GDP IN
YEAR 1
IN YEAR
1
PRICES
P 1 × Q1
$3.00
2.10
7.00
$12.10
Nominal
GDP
in year 1
COUNTRY
Portugal
Argentina
South Korea
Czech Republic
Brazil
Mexico
Turkey
South Africa
Colombia
Jordan
Romania
Phillipines
GDP IN
YEAR 2
IN YEAR
1
PRICES
P 1 × Q2
$5.50
1.20
8.40
$15.10
GDP IN
YEAR 1
IN YEAR
2
PRICES
P 2 × Q1
$2.40
7.00
9.00
$18.40
GDP IN
YEAR 2
IN YEAR
2
PRICES
P 2 × Q2
$ 4.40
4.00
10.80
$19.20
Nominal
GDP
in year 2
U.S. DOLLARS
10,690
8,970
7,970
5,040
4,570
3,970
3,160
2,880
2,600
1,520
1,390
1,050
United Kingdom
21,400
Australia
20,300
Italy
20,250
Canada
20,020
Ireland
18,340
Israel
15,940
Spain
14,080
Greece
11,650
Countries with Lower Income in 1870 Grew Faster
China
Indonesia
Pakistan
India
Rwanda
Nepal
Ethiopia
750
680
480
430
230
210
100
Increase in the Supply of Capital: An increase in the supply of capital will shift the production function upward
and increase the demand for labor. Real wages will increase from W* to W**, and potential output will increase
from Y* to Y**.
Sources of Real GDP Growth, 1929–1982 (average annual percentage rates)
Due to capital growth
Due to labor growth
+ technological progress
Output growth
0.56
1.34
1.02
2.92
Percentage Contributions to Real GDP Growth
Long vs. short run
Output per Worker Hour (Productivity), 1952-2001
The Economy in the Short Run: In the short run, the economy produces at y0, which exceeds potential output y p
Adjusting to the Long Run: With output exceeding potential, the AS curve shifts upwards as depicted by the
dotted lines. The economy adjusts to the long-run equilibrium at E1.
The Keynesian Cross: At equilibrium output y*, total demand Ey* equals output 0y*.
Equilibrium Output: Equilibrium output (y*) is determined at E, where demand intersects the 45° line. If output
were higher (y1), it would exceed demand and production would fall. If output were lower (y2), it would fall short
of demand and production would rise.
Adjustments to Equilibrium Output
C+I
Production
100
100
100
80
120
100
Inventories
Depletion of inventories of 20
Excess of inventories of 20
No change
Direction of Output
Output increases
Output decreases
Output stays constant
Consumption Function: The consumption function relates desired consumer spending to the level of income.
Determining GDP: GDP is determined where the C + I line intersects the 45° line. At that level of output, y *,
desired spending equals output.
Multiplier: When investment increases by +I from l 0 to l 1, equilibrium output increases by +y from y 0 to y 1.
The change in output (+y) is greater than the change in investment (+l).
The Multiplier in Action
Round of
Increase in
Spending
Demand
1
2
3
4
5
.
.
.
Total
$10
8
6.4
5.12
4.096
.
.
.
50 million
Increase in
GDP and Income
Increase in
Consumption
$10
8
6.4
5.12
4.096
.
.
.
50 million
$8
6.4
5.12
4.096
3.277
.
.
.
40 million
Keynesian Fiscal Policy
Increase In Tax Rates: An increase in tax rates decreases the slope of the C + I + G line. This lowers output and
reduces the multiplier.
Increase in Exports and Imports
Capital per Worker, 1952-2001
Real GDP and Unemployment Rates, 1929-1933 and 1980-1982
THE EARLY PART OF THE GREAT DEPRESSION, 1929-1933
PERCENTAGE CHANGE IN
UNEMPLOYME NUMBER OF UNEMPLOYED
REAL GDP
NT RATE
(MILLIONS)
1929
3.2
1.5
1930
-8.6
8.9
4.3
1931
-6.4
16.3
8.0
1932
-13.0
24.1
12.1
1933
-1.4
25.2
12.8
Note: Percentage fall in real GDP between 1929 and 1933 was 26.6 percent.
THE RECESSION OF 1980-1982
PERCENTAGE
NUMBER OF
CAPACITY
CHANGE
UNEMPLOYMENT
UNEMPLOYED
UTILIZATION
IN REAL
RATE
(MILLIONS)
(PERCENTAGE)
GDP
1979
5.8
6.1
85.2
1980
-0.2
7.1
7.6
80.9
1981
2.5
7.6
8.3
79.9
1982
-2.0
9.7
10.7
72.1
Note: Percentage increase in real GDP between 1979 and 1982 was 0.1 percent.
Sources: Historical Statistics of the United States and U.S. Department of Commerce, Bureau of Economic
Analysis.
Employed, Unemployed, and the Labor Force, 1953-2001
(1)
(2)
(3)
POPULATION
16 YEARS
LABOR
OLD OR OVER
FORCE
EMPLOYED
(MILLIONS)
(MILLIONS) (MILLIONS)
1953
107.1
63.0
61.2
1960
117.2
69.6
65.8
1970
137.1
82.8
78.7
1980
167.7
106.9
99.3
1982
172.3
110.2
99.5
1990
189.2
125.8
118.8
2001
211.9
141.8
135.1
Note: Figures are civilian only (military excluded).
Source: Economic Report of the President, 2002, Table B-35
(4)
(5)
UNEMPLOYED
(MILLIONS)
1.8
3.9
4.1
7.6
10.7
7.0
6.7
(6)
LABORFORCE
PARTICIPATION
RATE
58.9
59.4
60.4
63.8
64.0
66.5
66.9
UNEMPLO
YMENT
RATE
2.9
5.5
4.9
7.1
9.7
5.6
4.7
Unemployment Rates by Demographic Group, 1982 and 2000
YEARS
Total
NOV.
1982
JULY
2000
10.8
4.2
White
Men
20+
16-19
20+
16-19
Women
9.6
9.0
22.7
8.1
19.7
African-American
Men
20.2
20+
19.3
16-19
52.4
Women
20+
16.5
16-19
46.3
Source: U.S. Department of Labor, Bureau of Labor Statistics. Data are not seasonally adjusted.
Regional Differences in Unemployment, 1975, 1982, and 1991
1975
1982
U.S. avg.
8.5
Cal.
9.9
Fla.
10.7
Ill.
7.1
Mass.
11.2
Mich.
12.5
N.J.
10.2
N.Y.
9.5
N.C.
8.6
Ohio
9.1
Tex.
5.6
Sources: Statistical Abstract of the United States, various editions.
Average Duration of Unemployment, 1979-2001
WEEKS
1979
10.8
1980
11.9
1981
13.7
1982
15.6
1983
20.0
1984
18.2
1985
15.6
1986
15.0
1987
14.5
1988
13.5
1989
11.9
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
3.6
2.6
11.7
3.5
10.2
8.6
7.1
28.5
7.0
27.2
1991
9.7
9.9
8.2
11.3
7.9
15.5
9.0
8.6
9.0
12.5
6.9
WEEKS
12.0
13.7
17.7
18.0
18.8
16.6
16.7
15.8
14.5
14.4
6.7
7.5
7.3
7.1
9.0
9.2
6.6
7.2
5.8
6.4
6.6
Inflation During Three Expansions
1972
1973
1974
INFLATION RATE
3.2
6.2
11.0
1976
1977
1978
1979
1980
5.8
6.5
7.6
11.3
13.5
1984
1985
1986
1987
1988
1989
4.3
3.6
1.9
3.6
4.1
4.8
The Consumer Price Index, 1950-2001
PERCENTAGE CHANGE
IN CPI
1950
1.3
1951
7.9
1952
1.9
1953
0.8
1954
0.7
1955
-0.4
1956
1.5
1957
3.3
1958
2.8
1959
0.7
CPI
24.1
26.0
26.5
26.7
26.9
26.8
27.2
28.1
28.9
29.1
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
PERCENTAGE CHANGE
IN CPI
5.8
6.5
7.6
11.3
13.5
10.3
6.2
3.2
4.3
3.6
CPI
56.9
60.6
65.2
72.6
82.4
90.9
96.5
99.6
103.9
107.6
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1.7
1.0
1.0
1.3
1.3
1.6
2.9
3.1
4.2
5.5
5.7
4.4
3.2
6.2
11.0
9.1
29.6
29.9
30.2
30.6
31.0
31.5
32.4
33.4
34.8
36.7
38.8
40.5
41.8
44.4
49.3
53.8
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
1.9
3.6
4.1
4.8
5.4
4.2
3.0
3.0
2.6
2.8
3.0
2.3
1.6
2.2
3.4
2.8
109.6
113.6
118.3
124.0
130.7
136.2
140.3
144.5
148.2
152.4
156.9
160.5
163.0
166.6
172.2
177.1
Saving = Aggregate Income – Consumption
All income is either spent on consumption or saved in an economy in which there are no taxes. Thus, S =Y – C.
AGGREGATE INCOME, Y
(BILLIONS OF DOLLARS)
0
80
100
200
400
600
800
1,000
AGGREGATE CONSUMPTION, C
(BILLIONS OF DOLLARS)
100
160
175
250
400
550
700
850
An Aggregate Consumption Function Derived from the Equation C = 100 + .75Y
Deriving a Saving Function from a Consumption Function
Y
AGGREGATE
INCOME
(BILLIONS OF DOLLARS)
0
80
100
200
400
600
800
1,000
The Planned Investment Function
–C
AGGREGATE
CONSUMPTION
(BILLIONS OF DOLLARS)
100
160
175
250
400
550
700
850
=
S
AGGREGATE
SAVING
(Billions OF Dollars)
–100
–80
–75
–50
0
50
100
150
For the time being, we will assume that planned investment is fixed. It does not change when income changes, so
its graph is just a horizontal line.
Deriving the Planned Aggregate Expenditure Schedule and Finding Equilibrium (All Figures in Billions of
Dollars) The Figures in Column 2 Are Based on the Equation C = 100 + .75Y.
(1)
(2)
(3)
(4)
(5)
(6)
EQUIL
PLANNED
UNPLANNED
AGGREGATE
AGGREGATE
PLANNED
IBRIU
AGGREGATE
INVENTORY
OUTPUT
CONSUMPTIO INVESTMEN
M?
EXPENDITURE (AE)
CHANGE
(INCOME) (Y)
N (C)
T (I)
(Y =
C+I
Y – (C + I)
AE?)
100
175
25
200
−100
No
200
250
25
275
−75
No
400
400
25
425
−25
No
500
475
25
500
0
Yes
600
550
25
575
+25
No
800
700
25
725
+75
No
1,000
850
25
875
+125
No
Equilibrium Aggregate Output: Equilibrium occurs when planned aggregate expenditure and aggregate output
are equal. Planned aggregate expenditure is the sum of consumption spending and planned investment spending.
Planned Aggregate Expenditure and Aggregate Output (Income): Saving is a leakage out of the spending stream.
If planned investment is exactly equal to saving, then planned aggregate expenditure is exactly equal to
aggregate output, and there is equilibrium.
The S = I Approach to Equilibrium: Aggregate output will be equal to planned aggregate expenditure only when
saving equals planned investment (S = I). Saving and planned investment are equal at Y = 500.
The Multiplier as Seen in the Planned Aggregate Expenditure Diagram: At point A, the economy is in
equilibrium at Y = 500. When I increases by 25, planned aggregate expenditure is initially greater than aggregate
output. As output rises in response, additional consumption is generated, pushing equilibrium output up by a
multiple of the initial increase in I. The new equilibrium is found at point B, where Y = 600. Equilibrium output
has increased by 100 (600 – 500), or four times the amount of the increase in planned investment.
Adding Net Taxes (T) and Government Purchases (G) to the Circular Flow of Income.
Finding Equilibrium for I = 100, G = 100, and T = 100 (All Figures in Billions of Dollars)
(1)
(2) (3)
Y
T
300
500
700
900
1,10
0
1,30
0
1,50
0
10
0
10
0
10
0
10
0
10
0
10
0
10
0
(4)
(5)
YdY - T (C = 100 + .75 Yd)
(6) (7) (8)
S
I
(Yd - C)
200
250
-50
400
400
0
600
550
50
800
700
100
1,000
850
150
1,200
1,000
200
1,400
1,150
250
Y = Output (Income)
T = Net Taxes
Yd - T = Disposable Income
(C = 100 + .75 Yd) = Consumption Spending
S (Yd - C) = Saving
10
0
10
0
10
0
10
0
10
0
10
0
10
0
G
10
0
10
0
10
0
10
0
10
0
10
0
10
0
(9)
(10)
ADJUSTMENT TO
DISEQUILIBRIUM
C + I + G Y - (C + I + G)
450
-150
Output↑
600
-100
Output↑
750
-50
Output↑
900
0
Equilibrium
1,050
+50
Output↓
1,200
+100
Output↓
1,350
+150
Output↓
I = Planned Investment Spending
G = Government Purchases
C + I + G = Planned Aggregate
Expenditure
Y - (C + I + G) = Unplanned Inventory
Change
Finding Equilibrium Output/Income Graphically: Because G and I are both fixed at 100, the aggregate
expenditure function is the new consumption function displaced upward by I + G = 200. Equilibrium occurs at Y
= C + I + G = 900.
Finding Equilibrium After a $50 Billion Government Spending Increase (All Figures in Billions of Dollars; G
Has Increased from 100 in Table 9.1 to 150 Here)
1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
ADJUST
MENT
TO
(C = 100 S
Y - (C + I
Y
T
YdY - T
I
G
C+I+G
DISEQUI
+ .75 Yd) (Yd - C)
+ G)
LIBRIU
M
300
100
200
250
−50
100
150
500
−200 Output↑
500
100
400
400
0
100
150
650
−150 Output↑
700
100
600
550
50
100
150
800
−100 Output↑
900
100
800
700
100
100
150
950
−50 Output↑
Equilibriu
1,100
100
1,000
850
150
100
150
1,100
0
m
1,300
100
1,200
1,000
200
100
150
1,250
+50 Output↓
Y = Output (Income)
T = Net Taxes
Yd - T = Disposable Income
(C = 100 + .75 Yd) = Consumption Spending
S (Yd - C) = Saving
I = Planned Investment Spending
G = Government Purchases
C + I + G = Planned Aggregate
Expenditure
Y - (C + I + G) = Unplanned Inventory
Change
The Government Spending Multiplier: Increasing government spending by 50 shifts the AE function up by 50.
As Y rises in response, additional consumption is generated. Overall, the equilibrium level of Y increases by 200,
from 900 to 1,100.
Finding Equilibrium After a $200-Billion Balanced-Budget Increase in G and T (All Figures in Billions of
Dollars; Both G and T Have Increased from 100 in Table 9.1 to 300 Here)
1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
ADJUSTM
Yd
(C = 100
Y - (C + I + ENT TO
Y
T
I
G
C+I+G
Y-T
+ .75 Yd)
G)
DISEQUILIBRIUM
500
300
200
250
100
300
650
-150
Output↑
700
300
400
400
100
300
800
-100
Output↑
900
300
600
550
100
300
950
-50
Output↑
1,100
300
800
700
100
300
1,100
0 Equilibrium
1,300
300
1,000
850
100
300
1,250
+50
Output↓
1,500
300
1,200
1,000
100
300
1,400
+100
Output↓
Y = Output (Income)
T = Net Taxes
Yd - T = Disposable Income
I = Planned Investment Spending
G = Government Purchases
(C = 100 + .75 Yd) = Consumption Spending
Y - (C + I + G) = Unplanned Inventory Change
Summary of Fiscal Policy Multipliers
POLICY STIMULUS
C + I + G = Planned Aggregate Expenditure
MULTIP FINAL IMPACT ON
LIER
EQUILIBRIUM Y
GovernmentIncrease or decrease in the level of government purchases:
spending
G
multiplier
1/MPS
+G*1/MPS
Tax
multiplier
MPC/MP
S
+T*MPC/MPS
1
+G
Increase or decrease in the level of net taxes: T
BalancedSimultaneous balanced-budget increase or decrease in the
budget
1evel of government purchases and net taxes: = T
multiplier
+ is an increase
Federal Government Receipts and Expenditures, 2001 (Billions of Dollars)
PERCENT
AGE
AMOU
OF TOTAL
NT
Receipts
Personal taxes
Corporate taxes
Indirect business taxes
Contributions for social insurance
Total
Current expenditures
Consumption
Transfer payments
Grants-in-aid to state and local governments
Net interest payments
Net subsidies of government enterprises
Total
Current surplus (+) or deficit (−) (receipts − current expenditures)
1,010.1
193.2
111.0
720.6
2,034.9
49.6
9.5
5.5
35.4
100.0
514.1
831.9
274.2
236.9
52.5
1,909.6
+125.3
26.9
43.6
14.4
12.4
2.7
100.0
The Federal Government Surplus (1) or Deficit (2) as a Percentage of GDP, 1970 I-2001 IV: The deficits in the
1980s were particularly large by historical standards.
The Federal Government Debt as a Percentage of GDP, 1970 I-2001 IV: The federal government debt increased
dramatically in the 1980s as a result of the large deficits. The percentage began to fall in the mid-1990s.
A Decrease in the Required Reserve Ratio From 20 Percent to 12.5 Percent Increases the Supply of Money (All
Figures in Billions of Dollars)
PANEL 1: REQUIRED RESERVE RATIO = 20%
Federal Reserve
Commercial Banks
Assets
Liabilities
Assets
Liabilities
Government
$200
$100
Reserves
Reserves
$100
$500
Deposits
securities
$100
Currency
Loans
$400
Note: Money supply (M1) = Currency + Deposits = $600.
PANEL 2: REQUIRED RESERVE RATIO = 12.5%
Federal Reserve
Commercial Banks
Assets
Liabilities
Assets
Liabilities
Government
$200
$100
Reserves
Reserves
$100
$800
Deposits
securities
(+$100)
$100
Currency
Loans
$700
(+$300)
The Effect On the Money Supply of Commercial Bank Borrowing from the Fed (All Figures in Billions of
Dollars)
PANEL 1: No commercial bank borrowing from the fed
Federal Reserve
Commercial Banks
Assets
Liabilities
Assets
Liabilities
Securities
$160
$80
Reserves
Reserves
$80
$400
Deposits
$80
Currency
Loans
$320
Note: Money supply (M1) = Currency + Deposits = $600.
PANEL 2: commercial bank borrowing $20 from the fed
Federal Reserve
Commercial Banks
Assets
Liabilities
Assets
Liabilities
Securities
$160
$100
Reserves
Reserves
$100
$500
Deposits
(+$20)
(+$20)
(+$300)
Loans
$20
$80
Currency
Loans
(+$100)
$420
$20
Amount owed
to Fed (+$20)
Open Market Operations (The Numbers in Parentheses in Panels 2 and 3 Show the Differences Between Those
Panels and Panel 1. All Figures in Billions of Dollars)
PANEL 1
Federal Reserve
Commercial Banks
Jane Q. Public
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Securities
$100 $20
Reserves Reserves $20 $100 Deposits Deposits
$5
$0
Debts
Currency Loans
$80
$5
Net Worth
Note: Money supply (M1) = Currency + Deposits = $180.
PANEL 2
Federal Reserve
Commercial Banks
Jane Q. Public
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Securities
$95 $15
Reserves Reserves $15 $95
Deposits Deposits
$0
$0
Debts
(–$5)
(–$5)
(–$5)
(–$5)
(–$5)
$80
Currency Loans
$80
Securities
$5
$5
Net Worth
(+$5)
Note: Money supply (M1) = Currency + Deposits = $175.
PANEL 3
Federal Reserve
Commercial Banks
Jane Q. Public
Assets
Liabilities
Assets
Liabilities
Assets
Liabilities
Securities
$95 $15
Reserves Reserves $15 $75
Deposits Deposits
$0
$0
Debts
(–$5)
(–$5)
(–$25)
(–$5)
$80
Currency Loans
$60
Securities
$5
$5
Net Worth
(–$20)
(+$5)
Note: Money supply (M1) = Currency + Deposits = $155.
The Nonsynchronization of Income and Spending: Income arrives only once a month, but spending takes place
continuously.
Jim's Monthly Checking Account Balances: Strategy 1: Jim could decide to deposit his entire paycheck ($1,200)
into his checking account at the start of the month and run his balance down to zero by the end of the month. In
this case, his average balance would be $600.
Jim's Monthly Checking Account Balances: Strategy 2: Jim could also choose to put one half of his paycheck
into his checking account and buy a bond with the other half of his income. At mid-month, Jim would sell the
bond and deposit the $600 into his checking account to pay the second half of the month's bills. Following this
strategy, Jim's average money holdings would be $300.
The Demand Curve for Money Balances: The quantity of money demanded (the amount of money households
and firms wish to hold) is a function of the interest rate. Because the interest rate is the opportunity cost of
holding money balances, increases in the interest rate will reduce the quantity of money that firms and
households want to hold, and decreases in the interest rate will increase the quantity of money that firms and
households want to hold.
An Increase in Aggregate Output (Income) (Y) Will Shift the Money Demand Curve to the Right: An increase in
Y means there is more economic activity. Firms are producing and selling more, and households are earning
more income and buying more. There are more transactions, for which money is needed. As a result, both firms
and households are likely to increase their holdings of money balances at a given interest rate.
Determinants of Money Demand
1. The interest rate: r (negative effect)
2. The dollar volume of transactions (positive effect)
a. Aggregate output (income): Y (positive effect)
b. The price level: P (positive effect)
Adjustments in the Money Market: Equilibrium exists in the money market when the supply of money is equal
to the demand for money: Md = Ms. At r1, the quantity of money supplied exceeds the quantity of money
demanded, and the interest rate will fall. At r2, the quantity demanded exceeds the quantity supplied, and the
interest rate will rise. Only at r* is equilibrium achieved.
The Effect of an Increase in the Supply of Money on the Interest Rate: An increase in the supply of money from
to lowers the rate of interest from 14 percent to 7 percent.
The Effect of an Increase in Income on the Interest Rate: An increase in aggregate output (income) shifts the
money demand curve from to which raises the equilibrium interest rate from 7 percent to 14 percent.
The Impact of an Increase in the Price Level on the Economy—Assuming No Changes in G, T, and M s
The Aggregate Demand (AD) Curve: At all points along the AD curve, both the goods market and the money
market are in equilibrium.
The Effect of an Increase in Money Supply on the AD Curve: An increase in the money supply (M s) causes the
aggregate demand curve to shift to the right, from AD0 to AD1. This shift occurs because the increase in M s
lowers the interest rate, which increases planned investment (and thus planned aggregate expenditure). The final
result is an increase in output at each possible price level.
The Effect of an Increase in Government Purchases or a Decrease in Net Taxes on the AD Curve: An increase in
government purchases (G) or a decrease in net taxes (T) causes the aggregate demand curve to shift to the right,
from AD0 to AD1. The increase in G increases planned aggregate expenditure, which leads to an increase in
output at each possible price level. A decrease in T causes consumption to rise. The higher consumption then
increases planned aggregate expenditure, which leads to an increase in output at each possible price level.
Shifts in the Aggregate Demand Curve: A Summary
The Short-Run Aggregate Supply Curve: In the short run, the aggregate supply curve (the price/output response
curve) has a positive slope. At low levels of aggregate output, the curve is fairly flat. As the economy approaches
capacity, the curve becomes nearly vertical. At capacity, the curve is vertical.
Shifts of the Aggregate Supply Curve
Factors That Shift the Aggregate Supply Curve
The Equilibrium Price Level: At each point along the AD curve, both the money market and the goods market
are in equilibrium. Each point on the AS curve represents the price/output decisions of all the firms in the
economy. P0 and Y0 correspond to equilibrium in the goods market and the money market and to a set of
price/output decisions on the part of all the firms in the economy.
The Long-Run Aggregate Supply Curve: When the AD curve shifts from AD0 to AD1, the equilibrium price level
initially rises from P0 to P1 and output rises from Y0 to Y1. Costs respond in the longer run, shifting the AS curve
from AS0 to AS1. If costs ultimately increase by the same percentage as the price level, the quantity supplied.
A Shift of the Aggregate Demand Curve When the Economy Is on the Nearly Flat Part of the AS Curve:
Aggregate demand can shift to the right for a number of reasons, including an increase in the money supply, a
tax cut, or an increase in government spending. If the shift occurs when the economy is on the nearly flat portion
of the AS curve, the result will be an increase in output with little increase in the price level.
A Shift of the Aggregate Demand Curve When the Economy Is Operating at or Near Maximum Capacity: If a
shift of aggregate demand occurs while the economy is operating near full capacity, the result will be an increase
in the price level with little increase in output..
Cost-Push, or Supply-Side Inflation: An increase in costs shifts the AS curve to the left. By assuming the
government does not react to this shift, the AD curve does not shift, the price level rises, and output falls..
Cost Shocks Are Bad News for Policy Makers: A cost shock with no change in monetary or fiscal policy would
shift the aggregate supply curve from AS0 to AS1, lower output from Y0 to Y1, and raise the price level from P0 to
P1. Monetary or fiscal policy could be changed enough to have the AD curve shift from AD0 to AD1. This would
prevent output from falling, but it would raise the price level further, to P2.
Sustained Inflation from an Initial Increase in G and Fed Accommodation: An increase in G with the money
supply constant shifts the AD curve from AD0 to AD1. Although not shown in the figure, this leads to an increase
in the interest rate and crowding out of planned investment. If the Fed tries to keep the interest rate unchanged by
increasing the money supply, the AD curve will shift farther and farther to the right. The result is a sustained
inflation, perhaps hyperinflation.
Costs of Inflation
Anticipated Inflation
Unanticipated Inflation
Institutions do not adjust
Institutions adjust
Distortions in the tax system,
problems in financial markets
Cost of changing prices,
shoe-leather costs
Unfair redistributions
Institutional disintegration
The Classical Labor Market: Classical economists believe that the labor market always clears. If the demand for
labor shifts from D0 to D1, the equilibrium wage will fall from W0 to W*. Everyone who wants a job at W* will
have one
Sticky Wages: If wages "stick'' at W0 instead of fall to the new equilibrium wage of W* following a shift of
demand from D0 to D1, the result will be unemployment equal to L0 − L1.
The Aggregate Supply Curve: The AS curve shows a positive relationship between the price level (P) and
aggregate output (income) (Y).
The Relationship Between the Price Level and the Unemployment Rate: This curve shows a negative
relationship between the price level (P) and the unemployment rate (U). As the unemployment rate declines in
response to the economy's moving closer and closer to capacity output, the price level rises more and more.
The Phillips Curve: The Phillips Curve shows the relationship between the inflation rate and the unemployment
rate.
Unemployment and Inflation, 1960–1969: During the 1960s there seemed to be an obvious trade-off between
inflation and unemployment. Policy debates during the period revolved around this apparent trade-off.
Unemployment and Inflation, 1970–2001: During the 1970s and 1980s, it became clear that the relationship
between unemployment and inflation was anything but simple.
Changes in the Price Level and Aggregate Output Depend on Both Shifts in Aggregate Demand and Shifts in
Aggregate Supply
The Price of Imports, 1960 I–2001 IV: The price of imports changed very little in the 1960s and early 1970s. It
increased substantially in 1974 and again in 1979–1980. Since 1981, the price of imports has changed very little.
The Long-Run Phillips Curve: The Natural Rate of Unemployment: If the AS curve is vertical in the long run, so
is the Phillips Curve. In the long run, the Phillips Curve corresponds to the natural rate of unemployment—that
is, the unemployment rate that is consistent with the notion of a fixed long-run output at potential GDP. U* is the
natural rate of unemployment.
The NAIRU Diagram: To the left of the NAIRU the price level is accelerating (positive changes in the inflation
rate), and to the right of the NAIRU the price level is decelerating (negative changes in the inflation rate). Only
when the unemployment rate is equal to the NAIRU is the price level changing at a constant rate (no change in
the inflation rate).
The Fed's Response to Low Output/Low Inflation: During periods of low output/low inflation, the economy is on
the relatively flat portion of the AS curve. In this case, the Fed is likely to expand the money supply. This will
shift the AD curve to the right, from AD0 to AD1, and lead to an increase in output with very little increase in the
price level.
The Fed's Response to High Output/High Inflation: During periods of high output/high inflation, the economy is
on the relatively steep portion of the AS curve. In this case, the Fed is likely to contract the money supply. This
will shift the AD curve to the left, from AD0 to AD1, and lead to a decrease in the price level with very little
decrease in output.
Data for Selected Variables for the 1989–2001 Period
Real GDP
AAA
Federal
Qua
Unemploymen Inflation
Three-Month
Surplu
Growth Rate
Bond
Government
rter
t Rate (%)
Rate (%)
T-Bill Rate
s/GDP
(%)
Rate
Surplus
1989
5.0
5.2
4.3
8.5
9.7
-108.8 -0.020
I
II
2.2
5.2
4.0
8.4
9.5
-127.3 -0.023
III
1.9
5.3
2.9
7.9
9.0
-140.6 -0.025
IV
1.4
5.4
3.1
7.6
8.9
-143.4 -0.026
1990
5.1
5.3
4.5
7.8
9.2
-172.1 -0.030
I
II
0.9
5.3
4.7
7.8
9.4
-171.2 -0.030
III
-0.7
5.7
3.9
7.5
9.4
-164.6 -0.028
IV
-3.2
6.1
3.5
7.0
9.3
-184.0 -0.031
1991
-2.0
6.6
4.7
6.1
8.9
-160.1 -0.027
I
II
2.3
6.8
2.9
5.6
8.9
-213.4 -0.036
III
1.0
6.9
2.5
5.4
8.8
-234.7 -0.039
IV
2.2
7.1
2.3
4.6
8.4
-253.1 -0.042
1992
3.8
7.4
3.1
3.9
8.3
-288.3 -0.047
I
II
3.8
7.6
2.2
3.7
8.3
-291.8 -0.046
III
3.1
7.6
1.3
3.1
8.0
-316.5 -0.050
IV
5.4
7.4
2.5
3.1
8.0
-293.5 -0.045
1993
-0.1
7.2
3.4
3.0
7.7
-300.9 -0.046
I
II
2.5
7.1
2.2
3.0
7.4
-267.3 -0.041
III
1.8
6.8
1.8
3.0
6.9
-275.5 -0.041
IV
6.2
6.6
2.3
3.1
6.8
-253.0 -0.037
1994
3.4
6.6
2.0
3.3
7.2
-237.5 -0.034
I
II
5.7
6.2
1.8
4.0
7.9
-190.6 -0.027
III
2.2
6.0
2.4
4.5
8.2
-211.8 -0.030
IV
5.0
5.6
1.9
5.3
8.6
-209.2 -0.029
1995
1.5
5.5
3.0
5.8
8.3
-208.2 -0.029
I
II
0.8
5.7
1.7
5.6
III
3.1
5.7
1.8
5.4
IV
3.2
5.6
2.0
5.3
1996
2.9
5.6
2.5
5.0
I
II
6.8
5.5
1.4
5.0
III
2.0
5.3
1.9
5.1
IV
4.6
5.3
1.6
5.0
1997
4.4
5.3
2.9
5.1
I
II
5.9
5.0
1.9
5.1
III
4.2
4.8
1.2
5.1
IV
2.8
4.7
1.4
5.1
1998
6.5
4.7
1.0
5.1
I
II
2.9
4.4
1.2
5.0
III
3.4
4.5
1.5
4.8
IV
5.6
4.4
1.1
4.3
1999
3.5
4.3
2.3
4.4
I
II
2.5
4.3
1.4
4.5
III
5.7
4.2
0.9
4.7
IV
8.3
4.1
1.3
5.0
2000
4.8
4.1
3.3
5.5
I
II
5.2
4.0
2.5
5.7
III
1.3
4.1
1.9
6.0
IV
1.9
4.0
1.7
6.0
2001
1.3
4.2
3.3
4.8
I
II
0.3
4.5
2.1
3.7
III
-1.3
4.8
2.2
3.2
IV
1.4
5.6
-0.3
1.9
Note: The inflation rate is the percentage change in the GDP price index
7.7
7.4
7.0
-189.0
-197.5
-173.1
-0.026
-0.027
-0.023
7.0
-176.4
-0.023
7.6
7.6
7.2
-137.0
-130.1
-103.9
-0.018
-0.017
-0.013
7.4
-86.5
-0.011
7.6
7.2
6.9
-68.2
-33.8
-25.0
-0.008
-0.004
-0.003
6.7
26.0
0.003
6.6
6.5
6.3
41.9
72.1
56.4
0.005
0.008
0.006
6.4
89.8
0.010
6.9
7.3
7.5
117.4
147.3
143.4
0.013
0.016
0.015
7.7
236.0
0.024
7.8
7.6
7.4
244.9
229.9
222.4
0.025
0.023
0.022
7.1
205.4
0.020
7.2
7.1
6.9
186.7
-13.6
105.4
0.018
-0.001
0.010
Two Time Paths for GDP: Path A is less stable—it varies more over time—than path B. Other things being
equal, society prefers path B to path A.
"The Fool in the Shower"—How Government Policy Can Make Matters Worse: Attempts to stabilize the
economy can prove destabilizing because of time lags. An expansionary policy that should have begun to take
effect at point A does not actually begin to have an impact until point D, when the economy is already on an
upswing. Hence the policy pushes the economy to points F′ and G′ (instead of points F and G). Income varies
more widely than it would have if no policy had been implemented.
Deficit Reduction Targets under Gramm-Rudman-Hollings: The GRH legislation, passed in 1986, set out to
lower the federal deficit by $36 billion per year. If the plan had worked, a zero deficit would have been achieved
by 1991.
Deficit Targeting as an Automatic Destabilizer: Deficit targeting changes the way the economy responds to
negative demand shocks because it does not allow the deficit to increase. The result is a smaller deficit, but a
larger decline in income than would have otherwise occurred.
Data for Selected Variables for Six Countries, 1980–1999
GDP Growth Rate
Inflation Rate
United Kingdom
1980
-1.6
1981
-1.3
1982
1.5
1983
3.6
1984
2.5
1985
3.5
1986
4.4
1987
4.8
1988
5.0
1989
2.1
1990
0.6
1991
-1.5
1992
0.1
1993
2.3
1994
4.4
1995
2.8
1996
2.6
1997
3.5
1998
2.2
1999
1.7
France
1980
1.3
1981
0.6
1982
2.2
1983
0.8
1984
1.3
1985
1.8
1986
2.4
1987
2.2
1988
4.2
1989
4.1
1990
2.6
1991
1.0
1992
1.5
1993
-1.0
1994
2.0
1995
1.7
1996
1.1
1997
2.0
1998
3.3
1999
2.4
Germany
1980
1.0
1981
0.1
1982
-0.9
1983
1.8
1984
2.8
1985
2.0
Unemployment Rate
Short-Term Interest Rate
18.8
11.4
7.8
5.3
4.4
5.9
3.2
5.0
6.1
7.4
7.6
6.7
4.0
2.8
1.5
2.5
3.3
2.9
3.2
1.6
NA
NA
10.3
11.1
11.2
11.5
11.6
10.6
8.7
7.3
7.1
8.9
10.0
10.5
9.6
8.7
8.2
7.0
6.3
6.1
15.2
13.0
11.5
9.6
9.3
11.6
10.4
9.3
9.8
13.1
14.1
11.0
8.9
5.2
5.2
6.3
5.8
6.5
6.8
5.0
11.7
12.0
12.1
9.6
7.5
5.8
5.3
3.0
3.1
3.2
2.9
3.0
2.0
2.4
1.8
1.7
1.4
1.4
0.8
0.6
NA
NA
7.7
8.1
9.7
10.1
10.2
10.4
9.8
9.3
9.0
9.5
10.4
11.7
12.3
11.7
12.4
12.3
11.8
11.3
11.9
15.3
14.9
12.5
11.7
9.9
7.7
8.0
7.5
9.1
9.9
9.5
10.4
8.8
5.7
6.4
3.7
3.2
3.4
2.7
5.0
4.2
4.4
3.2
2.1
2.1
2.6
4.0
5.7
6.9
7.1
7.2
7.9
10.4
8.3
5.6
5.9
5.0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2.3
1.5
3.7
3.6
5.7
5.1
2.2
-1.1
1.2
2.9
0.8
1.5
2.2
1.3
GDP Growth Rate
Spain
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Italy
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
3.2
1.9
1.5
2.4
3.2
3.9
5.0
3.7
3.7
0.8
1.0
0.8
1.0
0.6
Inflation Rate
6.5
6.3
6.2
5.6
4.8
4.2
4.5
7.9
8.4
8.2
8.9
9.9
9.4
8.7
Unemployment Rate
3.9
3.3
3.6
6.3
8.1
8.3
8.3
6.2
5.1
4.4
3.4
3.3
3.4
2.9
Short-Term Interest Rate
2.2
-0.1
1.5
2.2
1.5
1.7
2
6
2
7
7
3
0.7
-1.2
3
7
3
8
0
7
13.4
12.6
13.9
11.8
11.6
7.7
11.1
5.8
5.7
7.1
7.3
7.1
6.9
4.3
4.0
4.8
3.4
2.1
2.3
2.5
NA
NA
14.9
17.5
20.3
21.7
21.2
20.6
19.5
17.2
16.2
16.4
18.4
22.7
24.1
22.9
22.2
20.8
18.8
15.9
15.7
15.8
15.7
19.8
13.4
10.9
8.6
8.0
10.8
13.6
14.2
12.5
12.4
10.5
8.1
9.8
7.2
5.0
3.8
3.0
3.5
0.5
0.5
2
6
8
8
1
9
9
0
4
20.9
19.1
17.0
15.1
11.6
9.0
7.8
6.1
6.8
6.5
8.2
7.6
NA
NA
6.4
7.5
8.0
8.3
9.0
9.8
9.8
9.8
9.0
8.6
15.9
19.7
19.4
17.9
15.4
13.7
11.4
10.7
11.1
12.6
12.4
12.5
1992
0.8
4.5
8.8
1993
-0.9
3.9
10.3
1994
2
3.5
11.2
1995
9
5.0
11.6
1996
0.9
5.2
11.7
1997
5
2.6
12.0
1998
3
2.8
11.9
1999
0
1.7
11.3
Japan
1980
2.8
5.4
2.0
1981
2
4.1
2.2
1982
1
1.8
2.4
1983
3
1.8
2.7
1984
9
2.6
2.7
1985
4
2.1
2.6
1986
9
1.7
2.8
1987
2
0.1
2.8
1988
2
0.7
2.5
1989
8
2.0
2.3
1990
1
2.3
2.1
1991
8
2.7
2.1
1992
0
1.7
2.2
1993
0.3
0.6
2.5
1994
0.6
0.2
2.9
1995
5
-0.6
3.1
1996
0
-1.4
3.4
1997
4
0.1
3.4
1998
-2.8
0.3
4.1
1999
4
0.0
4.7
Source: Organization for Economic Cooperation and Development (OECD) and IMF.
14.3
10.6
9.2
10.9
8.5
6.3
4.6
2.9
10.9
7.4
6.9
6.4
6.1
6.5
4.8
3.5
3.6
4.9
7.2
7.5
4.6
3.1
2.2
1.2
0.5
0.5
0.4
0.1
The Effects of Government on Household Consumption and Labor Supply
INCOME TAX RATES
TRANSFER PAYMENTS
Increase
Decrease
Increase
Decrease
Effect on consumption
Negative
Positive
Positive
Negative
Effect on labor supply
Negative*
Positive*
Negative
Positive
*If the substitution effect dominates.
Note: The effects are larger if they are expected to be permanent instead of temporary.
Consumption Expenditures, 1970 I–2001 IV: Over time, expenditures on services and nondurable goods are
"smoother" than expenditures on durable goods.
Housing Investment of the Household Sector, 1970 I–2001 IV: Housing investment fell sharply during the four
recessionary periods since 1970. Like expenditures for durable goods, expenditures for housing investment are
postponable.
Labor-Force Participation Rates for Men 25 to 54, Women 25 to 54, and All Others 16 and Over, 1970 I–2001
IV: Since 1970, the labor-force participation rate for prime-age men has been decreasing slightly. The rate for
prime-age women has been increasing dramatically. The rate for all others 16 and over has been declining since
1979 and shows a tendency to fall during recessions (the discouraged-worker effect).
Plant and Equipment Investment of the Firm Sector, 1970 I–2001 IV: Over all, plant and equipment investment
declined in the four recessionary periods since 1970.
Employment in the Firm Sector, 1970 I–2001 IV: Growth in employment was generally negative in the four
recessions the U.S. economy has experienced since 1970.
Inventory Investment of the Firm Sector and the Inventory/Sales Ratio, 1970 I–2001 IV: The inventory/sales
ratio is the ratio of the firm sector's stock of inventories to the level of sales. Inventory investment is very
volatile.
Employment and Output over the Business Cycle: In general, employment does not fluctuate as much as output
over the business cycle. As a result, measured productivity (the output-to-labor ratio) tends to rise during
expansionary periods and decline during contractionary periods.
Economic Growth Shifts Society's Production Possibility Frontier Up and to the Right: The production
possibility frontier shows all the combinations of output that can be produced if all society's scarce resources are
fully and efficiently employed. Economic growth expands society's production possibilities, shifting the ppf up
and to the right.e.
Economic Growth from an Increase in Labor—More Output but Diminishing Returns and Lower Labor
Productivity
QUANTITY
QUANTITY
TOTAL
MEASURED
OF LABOR
OF CAPITAL
OUTPUT
LABOR
L
K
Y
PRODUCTIVITY
PERIOD
(HOURS)
(UNITS)
(UNITS)
Y/L
1
100
100
300
3.0
2
110
100
320
2.9
3
120
100
339
2.8
4
130
100
357
2.7
Employment, Labor Force, and Population Growth, 1947–2001
CIVILIAN
CIVILIAN LABOR FORCE
NONINSTITUTIONAL
Percentage of
POPULATION OVER 16
Number (Millions)
Population
YEARS OLD (MILLIONS)
1947
1960
101.8
117.3
59.4
69.6
58.3
59.3
EMPLO
YMENT
(MILLI
ONS)
57.0
65.8
1970
1980
1990
2001
Percentage change,
1947–2001
Annual rate
137.1
167.7
189.2
211.9
82.8
106.9
125.8
141.8
60.4
63.7
66.5
66.9
78.7
99.3
118.8
135.1
+108.2
+138.7
+137.0
+1.3%
+1.6%
+1.6%
Economic Growth from an Increase in Capital—More Output, Diminishing Returns to Added Capital, Higher
Measured Labor Productivity
QUANTITY
QUANTITY
TOTAL
MEASURED
OF LABOR
OF CAPITAL
OUTPUT
LABOR
L
K
Y
PRODUCTIVITY
PERIOD
(HOURS)
(UNITS)
(UNITS)
Y/L
1
100
100
300
3.0
2
100
110
310
3.1
3
100
120
319
3.2
4
100
130
327
3.3
Fixed Private Nonresidential Net Capital Stock, 1960–2000 (Billions of 1996 Dollars)
EQUIPMENT
STRUCTURES
1960
672.7
2,015.7
1970
1,154.8
2,744.2
1980
1,989.8
3,589.1
1990
2,722.5
4,703.5
2000
4,359.6
5,541.2
Percentage change,
+548.1%
+174.9%
1960–2000
Annual rate
+4.7%
+2.5%
Years of School Completed by People Over 25 Years Old, 1940–2000
PERCENTAGE WITH LESS
THAN 5 YEARS OF SCHOOL
19
13.7
40
19
11.1
50
19
8.3
60
19
5.5
70
19
3.6
80
19
NA
90
20
NA
00
NA = not available.
PERCENTAGE WITH 4 YEARS
OF HIGH SCHOOL OR MORE
PERCENTAGE WITH 4
YEARS OF COLLEGE OR
MORE
24.5
4.6
34.3
6.2
41.1
7.7
52.3
10.7
66.5
16.2
77.6
21.3
84.1
25.6
Growth of Real GDP in the United States, 1871–2000
AVERAGE
PERIOD
GROWTH RATE PER YEAR
1871–1889
5.5
1889–1909
4.0
1909–1929
2.8
1929–1940
1.6
1940–1950
5.6
PERIOD
1950–1960
1960–1970
1970–1980
1980–1990
1990–2000
AVERAGE
GROWTH RATE PER YEAR
3.5
4.2
3.2
3.2
3.2
Growth of Real GDP in the United States and Other Countries, 1981–1998
AVERAGE GROWTH
COUNTRY
RATE PER YEAR
United States
3.1
Japan
2.8
Germany
2.1
France
2.0
Italy
1.8
United Kingdom
2.4
Canada
2.5
Africa
2.5
Asia (excluding Japan)
7.3
Sources of Growth in the United States, 1929–1982
PERCENT OF GROWTH ATTRIBUTABLE TO EACH SOURCE
1929–1982
1929–1948
1948–1973
1973–1979
Increases in inputs
53
49
45
94
Labor
20
26
14
47
Capital
14
3
16
29
Education (human capital)
19
20
15
18
Increases in productivity
47
51
55
6
Advances in knowledge
31
30
39
8
a
Other factors
16
21
16
-2
Annual growth rate in
2.8
2.4
3.6
2.6
real national income
a
Economies of scale, weather, pollution abatement, worker safety and health, crime, labor disputes, and so forth.
Output per Worker Hour (Productivity), 1952–2001
The Velocity of Money, 1960 I–2001 IV: Velocity has not been constant over the period from 1960 to 2001.
There is a long-term trend—velocity has been rising. There are also fluctuations, some of them quite large.
The Laffer Curve: The Laffer curve shows the amount of revenue the government collects is a function of the tax
rate. It shows that when tax rates are very high, an increase in the tax rate could cause tax revenues to fall.
Similarly, under the same circumstances, a cut in the tax rate could generate enough additional economic activity
to cause revenues to rise.
U.S. Balance of Trade (Exports Minus Imports), 1929–2001 (Billions of Dollars)
EXPORTS MINUS IMPORTS
1929
+ 0.4
1933
+ 0.1
1945
– 0.9
1955
+ 0.4
1960
+ 2.4
1965
+ 3.9
1970
+ 1.2
1975
+ 13.6
1976
– 2.3
1977
– 23.7
1978
– 26.1
1979
– 24.0
1980
– 14.9
1981
– 15.0
1982
– 20.5
1983
– 51.7
1984
– 102.0
1985
– 114.2
1986
– 131.9
1987
– 142.3
1988
– 106.3
1989
– 80.7
1990
– 71.4
1991
– 20.7
1992
– 27.9
1993
– 60.5
1994
– 87.1
1995
– 84.3
1996
– 89.0
1997
– 89.3
1998
– 151.5
1999
– 250.3
2000
– 364.0
2001
– 331.2
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
Yield Per Acre of Wheat and Cotton
NEW ZEALAND
Wheat
6 bushels
Cotton
2 bales
AUSTRALIA
2 bushels
6 bales
Total Production of Wheat and Cotton Assuming No Trade, Mutual Absolute Advantage, and 100 Available
Acres
NEW ZEALAND
AUSTRALIA
Wheat
25 acres × 6 bushels/acre
75 acres × 2 bushels/acre
150 bushels
150 bushels
Cotton
75 acres × 2 bales/acre
25 acres × 6 bales/acre
150 bales
150 bales
Production Possibility Frontiers for Australia and New Zealand before Trade: Without trade, countries are
constrained by their own resources and productivity.
Production Possibility Frontiers for Australia and New Zealand before Trade: Without trade, countries are
constrained by their own resources and productivity.
Production and Consumption of Wheat and Cotton after Specialization
PRODUCTION
New Zealand
100 acres × 6 bushels/acre
600 bushels
0 acres
Cotton
0
Wheat
CONSUMPTION
New
Australia
Zealand
Australia
0 acres
0
100 acres × 6 bales/acre
600 bales
Wheat
Cotton
300 bushels
300 bushels
300 bales
300 bales
Expanded Possibilities after Trade: Trade enables both countries to move beyond their own resource
constraints—beyond their individual production possibility frontiers.
Yield Per Acre of Wheat and Cotton
NEW ZEALAND
Wheat
6 bushels
Cotton
6 bales
AUSTRALIA
1 bushel
3 bales
Realizing a Gain from Trade When One Country Has a Double Absolute Advantage
STAGE 1
New Zealand
Australia
50 acres × 6 bushels/acre
0 acres
Wheat
300 bushels
0
50 acres × 6 bales/acre
100 acres × 3 bales/acre
Cotton
300 bales
300 bales
STAGE 2
New Zealand
Australia
Wheat
75 acres × 6 bushels/acre
0 acres
450 bushels
0
Cotton
100 acres × 3 bales/acre
300 bales
Wheat
25 acres × 6 bales/acre
150 bales
STAGE 3
New Zealand
100 bushels (trade)
100 bushels
Cotton
350 bushels
(after trade)
200 bales (trade)
350 bales
(after trade)
100 bales
Australia
Comparative Advantage Means Lower Opportunity Cost: The real cost of cotton is the wheat sacrificed to obtain
it. The cost of 3 bales of cotton in New Zealand is 3 bushels of wheat (a half acre of land must be transferred
from wheat to cotton—refer to Table 16.5). However, the cost of 3 bales of cotton in Australia is only 1 bushel
of wheat. Australia has a comparative advantage over New Zealand in cotton production, and New Zealand has a
comparative advantage over Australia in wheat production.
Domestic Prices of Timber (Per Foot) and Rolled Steel (Per Meter) in the United States and Brazil
UNITED STATES
BRAZIL
Timber
$1
3 Reals
Rolled steel
$2
4 Reals
Trade Flows Determined by Exchange Rates
EXCHANGE
PRICE
RESULT
RATE
OF REAL
$1 = 1 R
$ 1.00
Brazil imports timber and steel
$1 = 2 R
.50
Brazil imports timber
$1 = 2.1 R
.48
Brazil imports timber; United States imports steel
$1 = 2.9 R
.34
Brazil imports timber; United States imports steel
$1 = 3 R
.33
United States imports steel
$1 = 4 R
.25
United States imports timber and steel
The Gains from Trade and Losses from the Imposition of a Tariff: A tariff of $1 increases the market price
facing consumers from $2 per yard to $3 per yard. The government collects revenues equal to the gray-shaded
area. The loss of efficiency has two components. First, consumers must pay a higher price for goods that could
be produced at lower cost. Second, marginal producers are drawn into textiles and away from other goods,
resulting in inefficient domestic production.
United States Balance of Payments, 2000
All transactions that bring foreign exchange into the United States are credited (1) to the current account; all
transactions that cause the United States to lose foreign exchange are debited (2) to the current account.
Current Account
Goods exports
772.2
Goods imports
-1,224.4
(1) Net export of goods
-452.2
Exports of services
293.5
Imports of services
-217.0
(2) Net export of services
76.5
Income received on investments
352.9
Income payments on investments
-367.7
(3) Net investment income
-14.8
(4) Net transfer payments
-54.1
(5) Balance on current account (1 + 2 + 3 + 4)
-444.6
Capital Account
(6) Change in private U.S. assets abroad (increase is -)
-579.7
(7) Change in foreign private assets in the United States
986.6
(8) Change in U.S. government assets abroad (increase is -)
-1.2
(9) Change in foreign government assets in the United States
37.6
(10) Balance on capital account (6 + 7 + 8 + 9)
443.3
(11) Statistical discrepancy
1.3
(12) Balance of Payments (5 + 10 + 11)
0
Determining Equilibrium Output in an Open Economy: In a, planned investment spending (I), government
spending (G), and total exports (EX) are added to consumption (C) to arrive at planned aggregate expenditure.
However, C + I + G + EX includes spending on imports because imports are part of planned aggregate
expenditure. In b, the amount imported at every level of income is subtracted from planned aggregate
expenditure. Equilibrium output occurs at Y* = 200, the point at which planned domestic aggregate expenditure
crosses the 45-degree line.
Some Private Buyers and Sellers in International Exchange Markets: United
States and Great Britain
THE DEMAND FOR POUNDS (SUPPLY OF DOLLARS)
1. Firms, households, or governments that import British goods into the United States or wish to buy
British-made goods and services
2.
U.S. citizens traveling in Great Britain
3.
Holders of dollars who want to buy British stocks, bonds, or other financial instruments
4.
U.S. companies that want to invest in Great Britain
5. Speculators who anticipate a decline in the value of the dollar relative to the pound
THE SUPPLY OF POUNDS (DEMAND FOR DOLLARS)
1. Firms, households, or governments that import U.S. goods into Great Britain or wish to buy U.S.-made
goods and services
2.
British citizens traveling in the United States
3.
Holders of pounds who want to buy stocks, bonds, or other financial instruments in the United States
4.
British companies that want to invest in the United States
5.
Speculators who anticipate a rise in the value of the dollar relative to the pound
The Demand for Pounds in the Foreign Exchange Market: When the price of pounds falls, British-made goods
and services appear less expensive to U.S. buyers. If British prices are constant, U.S. buyers will buy more
British goods and services, and the quantity of pounds demanded will rise.
The Equilibrium Exchange Rate: When exchange rates are allowed to float, they are determined by the forces of
supply and demand. An excess demand for pounds will cause the pound to appreciate against the dollar. An
excess supply of pounds will lead to a depreciating pound.
Exchange Rates Respond to Changes in Relative Prices: The higher price level in the United States makes
imports relatively less expensive. U.S. citizens are likely to increase their spending on imports from Britain,
shifting the demand for pounds to the right, from D to D′. At the same time, the British see U.S. goods getting
more expensive and reduce their demand for exports from the United States. The supply of pounds shifts to the
left, from S to S′. The result is an increase in the price of pounds. The pound appreciates and the dollar is worth
less.
Exchange Rates Respond to Changes in Relative Interest Rates: If U.S. interest rates rise relative to British
interest rates, British citizens holding pounds may be attracted into the U.S. securities market. To buy bonds in
the United States, British buyers must exchange pounds for dollars. The supply of pounds shifts to the right,
from S to S′. However, U.S. citizens are less likely to be interested in British securities, because interest rates are
higher at home. The demand for pounds shifts to the left, from D to D′. The result is a depreciated pound and a
stronger dollar.
The Effect of a Depreciation on the Balance of Trade (the J Curve): Initially, a depreciation of a country's
currency may worsen its balance of trade. The negative effect on the price of imports may initially dominate the
positive effects of an increase in exports and a decrease in imports.
Indicators of Economic Development
Populatio GDP per
n
Capita,
(Millions) 1998
Country Group
1998
(Dollars)
Life
Expectancy Infant Mortality, 1998
, 1998
(Deaths Before Age One
(Years)
per 1,000 Births)
Percentage of
Population in
Urban Areas,
1998
Low-income
(e.g., China,
Ethiopia,
Haiti, India)
3,536
520
63
68
30
886
1,740
68
35
58
588
4,870
71
26
77
25,480
78
6
77
Lower middleincome
(e.g.,
Guatemala,
Poland,
Philippines,
Thailand)
Upper middleincome
(e.g., Brazil,
Malaysia,
Mexico)
Industrial market
economies
(e.g., Japan,
886
Germany,
New Zealand,
United States)
Source: World Bank, World Development Indicators, 2000. Note that all numbers refer to weighted averages for
each country group, where the weights equal the populations of each nation in a specific country group.
Income Distribution in Some Developing Countries
SRI
LANKA
Per Capita GDP 1995
$29,240
$810
Bottom 20%
5.2
8.0
Second 20%
10.5
11.8
Third 20%
15.6
15.8
Fourth 20%
22.4
21.5
Top 20%
46.4
42.8
Top 10%
30.5
28.0
Source: World Bank, World Development Report, 2000.
UNITED STATES
BRAZI
L
$4,630
2.5
5.5
10.0
18.3
63.8
47.6
PAKISTA
N
$470
9.5
12.9
16.0
20.5
41.1
27.6
INDONESI
A
$640
8.0
11.3
15.1
20.8
44.9
30.3
KEN
YA
$350
5.0
9.7
14.2
20.9
50.2
34.9
The Structure of Production in Selected Developed and Developing Economies, 1998
PERCENTAGE OF GROSS DOMESTIC PRODUCT
COUNTRY
PER CAPITA INCOME
AGRICULTURE INDUSTRY
SERVICES
Tanzania
$ 220
46
15
39
Bangladesh
350
22
28
50
China
750
18
49
33
Thailand
2,160
11
41
48
Colombia
2,470
13
Brazil
4,630
8
Korea (Rep.)
8,600
5
United States
29,240
2
Japan
32,350
2
Source: World Bank, World Development Report, 2000.
25
29
43
26
37
61
63
52
72
61
The Growth of World Population, Projected to 2020 a.d.: For thousands of years, population grew slowly. From
1 a.d. until the mid-1600s, population grew at about .04 percent per year. Since the Industrial Revolution,
population growth has occurred at an unprecedented rate.
Total (Public and Private) External Debt for Selected Countries, 1998 (Billions of Dollars)
TOTAL EXTERNAL
COUNTRY
TOTAL DEBTAS A PERCENTAGE OF GDP
DEBT
Guinea-Bissau
1.0
363
Nicaragua
6.0
295
Angola
12.7
280
Sudan
16.8
172
Indonesia
150.9
169
Thailand
86.2
76
Russian Federation
183.6
62
Peru
32.4
55
Argentina
144.0
52
Turkey
102.1
49
Mexico
159.9
41
Brazil
232.0
29
India
98.2
20
China
154.6
14
Source: World Bank, World Development Indicators, 2000.
Major Trading Partners of the United States, 1999. Source: Statistical Abstract of the United States 2001
(Washington, DC: U.S. Government Printing Office, 2001).
Exchange Rates in July 2001
Nation
Australia
Brazil
Britain
Canada
France
Germany
Hong Kong
Ireland
Israel
Japan
Mexico
Saudi Arabia
Currency
Dollar
Real
Pound sterling
Dollar
Franc
Mark
Dollar
Punt
Shekel
Yen
Peso
Rial
Percentages of Government Spending on Various Programs
Value in Dollars
(U.S. $ equivalent)
0.51
0.41
1.41
0.66
0.1291
0.4332
0.1282
1.07
0.24
0.0079
0.1095
0.27
Units per Dollar
(Currency per U.S. $)
1.96
2.41
0.71
1.51
7.74
2.3079
7.799
0.92
4.19
125.75
9.12
3.75
Percentages of Government Spending on Various Programs
Percentages of Government Revenue from Different Sources
Microeconomic implications
Mortgage, Corporate, and Government Interest Rates
Typical Investments: A typical investment, in which a cost of $100 incurred today yields a return of $104 next
year.
Returns on Investment
Investment
Cost
Return
A
B
C
D
E
$100
$100
$100
$100
$100
$101
$103
$105
$107
$109
Interest Rates and Investment: As the real interest rate declines, investment spending in the economy increases.
Savers and Investors
Components of M1, January 2001
Currency held by the public
Demand deposits
Other checkable deposits
Travelers’ checks
Total of M1
Balance Sheet for a Bank
$ 534 billion
$ 316 billion
$ 242 billion
$ 8 billion
$1100 billion
Process of Deposit Creation: Changes in Balance Sheets
Structure of the Federal Reserve
Open Market Purchase: An open market purchase increases the supply of money, decreases interest rates, and
increases the level of output.
Possible Pitfalls in Stabilization Policy
Share of Capital Gains by Income
Income Class
$10,000–20,000
$20,000–30,000
$30,000–40,000
$40,000–50,000
$50,000–75,000
$75,000–100,000
$100,000–200,000
$200,000 and over
Share of Capital Gains
2.6%
2.9%
4.4%
3.4%
9.0%
8.5%
15.7%
56.8%
Cost per Ton of Paper with Varying Amounts of Pollution
Waste per Ton
Average Production Cost
(Gallons)
per Ton
5
4
3
2
1
0
$ 60
$ 61
$ 64
$ 71
$ 86
$116
$20
$16
$12
$8
$4
$0
Tax Cost
per Ton
Average Total Cost
per Ton with Tax
$ 80
$ 77
$ 76
$ 79
$ 90
$116
Market Effects of a Pollution Tax: The pollution tax increases the cost of producing paper, shifting the market
supply curve to the left. The equilibrium moves from point i to point f. The tax increases the equilibrium price
from $60 to $68 per ton and decreases the equilibrium quantity from 100 to 80 tons per day.
Market Effects of Command and Control: The command-and-control policy increases the cost of producing
paper, shifting the market supply curve to the left. The equilibrium price increases to $74 per ton, and the
equilibrium quantity decreases to 70 tons per day. Compared to the pollution-tax policy, the command-andcontrol policy leads to a higher price and a smaller quantity.
Abatement Costs: Low-Cost Firm Versus High-Cost Firm
Production Cost per Ton:
Waste per Ton
Firm with Low
(Gallons)
Abatement Cost
5
4
3
2
1
0
$ 60
$ 61
$ 64
$ 71
$ 86
$116
Production Cost per Ton:
Firm with High
Abatement Cost
$ 60
$ 67
$ 82
$112
$172
$300