Con The Central Bank Should Not Aim For Zero Inflation

Although price stability may be desirable, the benefits of zero inflation compared to moderate inflation are small, whereas the costs of reaching zero inflation are large. Estimates of the sacrifice ratio suggest that reducing inflation by 1 percentage point requires giving up about 5 percent of one year's output. Reducing inflation from, say, 4 percent to zero requires a loss of 20 percent of a year's output. At the current level of gross domestic product of about 9 trillion, this cost...

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Labor-Force Participation Rates for Men and Women since 1950. This figure shows the percentage of adult men and women who are members of the labor force. It shows that over the past several decades, women have entered the labor force, and men have left it. 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 '98 Labor-Force Participation Rates for Men and Women since 1950. This figure shows the percentage of adult men and women who are members of the labor force. It shows that over the past...

The Theory Of Liquidity Preference

Theory Demand

In his classic book, The General Theory of Employment, Interest, and Money, John Maynard Keynes proposed the theory of liquidity preference to explain what factors determine the economy's interest rate. The theory is, in essence, just an application of supply and demand. According to Keynes, the interest rate adjusts to balance the supply and demand for money. You may recall from Chapter 11 that economists distinguish between two interest rates The nominal interest rate is the interest rate as...

Unemployment Insurance

One government program that increases the amount of frictional unemployment, without intending to do so, is unemployment insurance. This program is designed to offer workers partial protection against job loss. The unemployed who quit their jobs, were fired for cause, or just entered the labor force are not eligible. Benefits are paid only to the unemployed who were laid off because their previous employers no longer needed their skills. Although the terms of the program vary over time and...

The Functions Of Money

Money has three functions in the economy It is a medium of exchange, a unit of account, and a store of value. These three functions together distinguish money from other assets, such as stocks, bonds, real estate, art, and even baseball cards. Let's examine each of these functions of money in turn. A medium of exchange is an item that buyers give to sellers when they purchase goods and services. When you buy a shirt at a clothing store, the store gives you the shirt, and you give the store your...

Some Important Identities

Recall that gross domestic product (GDP) is both total income in an economy and the total expenditure on the economy's output of goods and services. GDP But wait. There is a big difference. Profits grow over time. If that dividend should increase with profits, say at a rate of 5 percent annually, then, by the 30th year, your annual dividend payment will be over 800, or one-third more than the bond is yielding. The price of the stock almost certainly will have risen as well. By this simple...

Public Policy And Job Search

Even if some frictional unemployment is inevitable, the precise amount is not. The faster information spreads about job openings and worker availability, the more rapidly the economy can match workers and firms. The Internet, for instance, may help facilitate job search and reduce frictional unemployment. In addition, public policy may play a role. If policy can reduce the time it takes unemployed workers to find new jobs, it can reduce the economy's natural rate of unemployment. Government...

Job Search

One reason why economies always experience some unemployment is job search. Job search is the process of matching workers with appropriate jobs. If all workers and all jobs were the same, so that all workers were equally well suited for all jobs, job search would not be a problem. Laid-off workers would quickly find new jobs that were well suited for them. But, in fact, workers differ in their tastes and skills, jobs differ in their attributes, and information about job candidates and job the...

And The Freesilver Debate

As a child, you probably saw the movie The Wizard of Oz, based on a children's book written in 1900. The movie and book tell the story of a young girl, Dorothy, who finds herself lost in a strange land far from home. You probably did not know, however, that the story is actually an allegory about U.S. monetary policy in the late nineteenth century. From 1880 to 1896, the price level in the U.S. economy fell by 23 percent. Because this event was unanticipated, it led to a major redistribution of...

Measuring The Cost Of Living

Learn how the consumer price index (CPI) is constructed Consider why the CPI is an imperfect measure of the cost of living Compare the CPI and the GDP deflator as measures of the overall price level In 1931, as the U.S. economy was suffering through the Great Depression, famed baseball player Babe Ruth earned 80,000. At the time, this salary was extraordinary, even among the stars of baseball. According to one story, a reporter asked Ruth whether he thought it was right that he made more than...

Pro The Tax Laws Should Be Reformed To Encourage Saving

A nation's saving rate is a key determinant of its long-run economic prosperity. When the saving rate is higher, more resources are available for investment in new plant and equipment. A larger stock of plant and equipment, in turn, raises labor productivity, wages, and incomes. It is, therefore, no surprise that international data show a strong correlation between national saving rates and measures of economic well-being. Another of the Ten Principles of Economics presented in Chapter 1 is...

Unemployment And Its Natural Rate

Learn about the data used to measure the amount of unemployment Consider how unemployment arises from the process of job search Losing a job can be the most distressing economic event in a person's life. Most people rely on their labor earnings to maintain their standard of living, and many people get from their work not only income but also a sense of personal accomplishment. A job loss means a lower living standard in the present, anxiety about the future, and reduced self-esteem. It is not...

The Link Between The Two Markets

We begin by recapping what we've learned so far in this chapter. We have been discussing how the economy coordinates four important macroeconomic variables national saving (S), domestic investment (I), net foreign investment (NFI), and net exports (NX). Keep in mind the following identities In the market for loanable funds, supply comes from national saving, demand comes from domestic investment and net foreign investment, and the real interest rate balances supply and demand. In the market for...

The Effects Of An Import Quota

Import Quota

The Isolandian economists next consider the effects of an import quota a limit on the quantity of imports. In particular, imagine that the Isolandian government distributes a limited number of import licenses. Each license gives the license holder the right to import 1 ton of steel into Isoland from abroad. The Isolandian economists want to compare welfare under a policy of free trade and welfare with the addition of this import quota. Figure 9-7 shows how an import quota affects the Isolandian...

The Fisher Effect

Inflation Fisher Effect

According to the principle of monetary neutrality, an increase in the rate of money growth raises the rate of inflation but does not affect any real variable. An important application of this principle concerns the effect of money on interest rates. Interest rates are important variables for macroeconomists to understand because they link the economy of the present and the economy of the future through their effects on saving and investment. To understand the relationship between money,...

Aggregate Demand Aggregate Supply And The Phillips Curve

Aggregate Demand And Supply Models

The model of aggregate demand and aggregate supply provides an easy explanation for the menu of possible outcomes described by the Phillips curve. The Phillips curve simply shows the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate-demand curve move the economy along the short-run aggregate-supply curve. As we saw in Chapter 19, an increase in the aggregate demand for goods and services leads, in the short run, to a larger output of goods and...

E2

Increase Supply Loanable Funds

An increase in net foreign investment . a The Market for Loanable Funds in Mexico 1. An increase in net foreign investment . 3. . . . which increases the interest rate. 2____increases the demand Quantity of for loanable funds . . . Loanable Funds 4. At the same time, the increase in net foreign investment increases the supply of pesos . . 4. At the same time, the increase in net foreign investment increases the supply of pesos . . c The Market for Foreign-Currency Exchange The Effects of...

Aggregate Surplus

Imports Consumer Surplus

Our story about the steel industry and the debate over trade policy in Isoland is just a parable. Or is it Our story about the steel industry and the debate over trade policy in Isoland is just a parable. Or is it Clinton Warns U.S. Will Fight Cheap Imports By David E. Sanger President Clinton said for the first time today that the United States would not tolerate the flooding of our markets with low-cost goods from Asia and Russia, particularly steel, that are threatening the jobs of American...

In The N Ews

The Case for Unilateral Disarmament in the Trade Wars Economist Jagdish Bhagwati argues that the United States should lower its trade barriers unilaterally. By Jagdish Bhagwati President Clinton and 17 other Asian-Pacific leaders are meeting today in Vancouver. Rather than the convivial photo-op they'd planned, however, they must contend with worrisome trade news. A spate of Asian currency devaluations has raised the specter of renewed protectionism around the world. South America's Mercosur...

The Shortrun Tradeoff Between Inflation And Unemployment

Two closely watched indicators of economic performance are inflation and unemployment. When the Bureau of Labor Statistics releases data on these variables each month, policymakers are eager to hear the news. Some commentators have added together the inflation rate and the unemployment rate to produce a misery index, which purports to measure the health of the economy. How are these two measures of economic performance related to each other Earlier in the book we discussed the long-run...

Illustrate The Effect Of This Tax On Equilbrium Price And Quantity In The Sock Market

What happens to consumer and producer surplus when 3. the sale of a good is taxed How does the change in consumer and producer surplus compare to the tax 4 revenue Explain. 2. Draw a supply-and-demand diagram with a tax on the 5 sale of the good. Show the deadweight loss. Show the How do the elasticities of supply and demand affect the deadweight loss of a tax Why do they have this effect Why do experts disagree about whether labor taxes have small or large deadweight losses What happens to...

2 Suppose The Government Borrows 20 Billion More Next Year Than This Year. A Use A Supply-and-demand Diagram To Analyze

What is the role of the financial system Name and describe two markets that are part of the financial system in our economy. Name and describe two financial intermediaries. 2. Why is it important for people who own stocks and bonds to diversify their holdings What type of financial institution makes diversification easier 3. What is national saving What is private saving What is public saving How are these three variables related 4. What is investment How is it related to national saving 5....

Elasticity And Tax Incidence

Tax Revenue Supply Demand Curve

When a good is taxed, buyers and sellers of the good share the burden of the tax. But how exactly is the tax burden divided Only rarely will it be shared equally. To see how the burden is divided, consider the impact of taxation in the two markets in Figure 6-9. In both cases, the figure shows the initial demand curve, the initial supply curve, and a tax that drives a wedge between the amount paid by buyers and the amount received by sellers. Not drawn in either panel of the figure is the new...

Imagine That Winemakers In The State Of Washington Petitioned The State Government To Tax Wines Imported From

The United States represents a small part of the world orange market. a. Draw a diagram depicting the equilibrium in the U.S. orange market without international trade. Identify the equilibrium price, equilibrium quantity, consumer surplus, and producer surplus. b. Suppose that the world orange price is below the U.S. price before trade, and that the U.S. orange market is now opened to trade. Identify the new equilibrium price, quantity consumed, quantity produced domestically, and quantity...

Evaluating Price Controls

One of the Ten Principles of Economics discussed in Chapter 1 is that markets are usually a good way to organize economic activity. This principle explains why economists usually oppose price ceilings and price floors. To economists, prices are not the outcome of some haphazard process. Prices, they contend, are the result of the millions of business and consumer decisions that lie behind the supply and demand curves. Prices have the crucial job of balancing supply and demand and, thereby,...

Economists In Washington

Enforce Anti Trust Laws

President Harry Truman once said that he wanted to find a one-armed economist. When he asked his economists for advice, they always answered, On the one hand, . . . . On the other hand, . . . . Truman was right in realizing that economists' advice is not always straightforward. This tendency is rooted in one of the Ten Principles of Economics in Chapter 1 People face tradeoffs. Economists are aware that tradeoffs are involved in most policy decisions. A policy might increase efficiency at the...

Opportunity Cost And Comparative Advantage

There is another way to look at the cost of producing potatoes. Rather than comparing inputs required, we can compare the opportunity costs. Recall from Chapter 1 that the opportunity cost of some item is what we give up to get that item. In our example, we assumed that the farmer and the rancher each spend 40 hours a week working. Time spent producing potatoes, therefore, takes away from time available for producing meat. As the rancher and farmer change their allocations of time between...

Case Study Rent Control In The Short Run And Long

Rent Control Economics

One common example of a price ceiling is rent control. In some cities, the local government places a ceiling on rents that landlords may charge their tenants. The goal of this policy is to help the poor by making housing more affordable. Economists often criticize rent control, arguing that it is a highly inefficient way to help the poor raise their standard of living. One economist called rent control the best way to destroy a city, other than bombing. The adverse effects of rent control are...

In The N

Price System Allocate Resources

Mother Nature Shifts the Supply Curve According to our analysis, a natural disaster that reduces supply reduces the quantity sold and raises the price. Here's a recent example. 4-Day Cold Spell Slams California Crops Devastated By Todd S. Purdum A brutal four-day freeze has destroyed more than a third of California's annual citrus crop, inflicting upwards of a halfbillion dollars in damage and raising the prospect of tripled orange prices in supermarkets by next week. Throughout the Golden...

Two Ways To Reduce The Quantity Of Smoking Demanded

Supply For Cigarettes Graph

Public policymakers often want to reduce the amount that people smoke. There are two ways that policy can attempt to achieve this goal. One way to reduce smoking is to shift the demand curve for cigarettes and other tobacco products. Public service announcements, mandatory health warnings on cigarette packages, and the prohibition of cigarette advertising on television are all policies aimed at reducing the quantity of cigarettes demanded at any given price. If successful, these policies shift...

How Taxes On Buyers Affect Market Outcomes

Tax Levied Buyers

We first consider a tax levied on buyers of a good. Suppose, for instance, that our local government passes a law requiring buyers of ice-cream cones to send 0.50 to the government for each ice-cream cone they buy. How does this law affect the buyers and sellers of ice cream To answer this question, we can follow the three steps in Chapter 4 for analyzing supply and demand 1 We decide whether the law affects the supply curve or demand curve. 2 We decide which way the curve shifts. 3 We examine...

Should Tiger Woods Mow His Own Lawn

Tiger Woods spends a lot of time walking around on grass. One of the most talented golfers of all time, he can hit a drive and sink a putt in a way that most casual golfers only dream of doing. Most likely, he is talented at other activities too. For example, let's imagine that Woods can mow his lawn faster than anyone else. But just because he can mow his lawn fast, does this mean he should To answer this question, we can use the concepts of opportunity cost and comparative advantage. Let's...

Principle 1 People Face Tradeoffs

The first lesson about making decisions is summarized in the adage There is no such thing as a free lunch. To get one thing that we like, we usually have to give up another thing that we like. Making decisions requires trading off one goal against another. Consider a student who must decide how to allocate her most valuable resource her time. She can spend all of her time studying economics she can spend all of her time studying psychology or she can divide her time between the two fields. For...

Beer And Pizza Are Complements Because They

Market, p. 66 competitive market, p. 66 quantity demanded, p. 67 law of demand, p. 68 normal good, p. 68 inferior good, p. 68 substitutes, p. 68 complements, p. 68 demand schedule, p. 69 demand curve, p. 70 ceteris paribus, p. 70 quantity supplied, p. 75 law of supply, p. 75 supply schedule, p. 76 supply curve, p. 76 equilibrium, p. 80 equilibrium price, p. 80 equilibrium quantity, p. 80 surplus, p. 81 shortage, p. 81 1. What is a competitive market Briefly describe the types of markets other...

Principle 7 Governments Can Sometimes Improve Market Outcomes

Although markets are usually a good way to organize economic activity, this rule has some important exceptions. There are two broad reasons for a government to intervene in the economy to promote efficiency and to promote equity. That is, most policies aim either to enlarge the economic pie or to change how the pie is divided. The invisible hand usually leads markets to allocate resources efficiently. Nonetheless, for various reasons, the invisible hand sometimes does not work. Economists use...

When The Weather Turns Warm In New England Every Summer The Prices Of Hotel Rooms In Caribbean Resorts Plummet.

Explain each of the following statements using supply- a. When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country. b. When the weather turns warm in New England every summer, the prices of hotel rooms in Caribbean resorts plummet. c. When a war breaks out in the Middle East, the price of gasoline rises, while the price of a used Cadillac falls. 2. An increase in the demand for notebooks raises the quantity of notebooks demanded, but not the...

Principle 2 The Cost Of Something Is What You Give Up To Get It

Because people face tradeoffs, making decisions requires comparing the costs and benefits of alternative courses of action. In many cases, however, the cost of some action is not as obvious as it might first appear. Consider, for example, the decision whether to go to college. The benefit is intellectual enrichment and a lifetime of better job opportunities. But what is the cost To answer this question, you might be tempted to add up the money you spend on tuition, books, room, and board. Yet...

Three Steps To Analyzing Changes In Equilibrium

Ice Cream Market Demand And Supply

So far we have seen how supply and demand together determine a market's equilibrium, which in turn determines the price of the good and the amount of the good that buyers purchase and sellers produce. Of course, the equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts one of these curves, the equilibrium in the market changes. The analysis of such a change is called comparative statics because it involves comparing two static situations...

Principle 6 Markets Are Usually A Good Way To Organize Economic Activity

For 5 a week you can watch baseball without being nagged to cut the grass For 5 a week you can watch baseball without being nagged to cut the grass The collapse of communism in the Soviet Union and Eastern Europe may be the most important change in the world during the past half century. Communist countries worked on the premise that central planners in the government were in the best position to guide economic activity. These planners decided what goods and services were produced, how much was...

Principle 4 People Respond To Incentives

Cost Benefit Analysis Seat Belts

Because people make decisions by comparing costs and benefits, their behavior may change when the costs or benefits change. That is, people respond to incentives. When the price of an apple rises, for instance, people decide to eat more pears and fewer apples, because the cost of buying an apple is higher. At the same time, apple orchards decide to hire more workers and harvest more apples, because the benefit of selling an apple is also higher. As we will see, the effect of price on the...