Limits, Alternatives, · 2015-01-28 · Present Choices & Future Possibilities Goods for the Present re re Goods for the Present Presentville Futureville P F Current Curve Current

Copyright 2008 The McGraw-Hill Companies 1-1

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

1 Limits,

Alternatives,

and Choices


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives

• Economics Defined

–Economic Perspective

• Role of Economic Theory

• Microeconomics and Macroeconomics

• Scarce Resources

–The Economizing Problem

• Production Possibilities

O 1.1

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Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Economic Perspective

• Scarcity and Choice

–Opportunity Cost

• Purposeful Behavior

–Utility

• Marginal Analysis

–Marginal Benefits

–Marginal Costs

O 1.2

O 1.3






Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Theories Principles and Models

• The Scientific Method

• Economic Principle

–Generalizations

–Other-Things-Equal Assumption (ceteris paribus)

–Graphical Expression

O 1.4




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Macro and Microeconomics

• Macroeconomics

–Aggregate

• Microeconomics

–Individual Units

• Positive Economics

• Normative Economics


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Individual’s Economizing Problem

• Limited Income

• Unlimited Wants

• A Budget Line

• Attainable and Unattainable Combinations

• Tradeoffs & Opportunity Costs

• Choice

• Income Change

O 1.5

W 1.1



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Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Average Income, Selected Nations

Per Capita Income 2004

Switzerland

United States

Japan

France

South Korea

Mexico

Brazil

China

Pakistan

Nigeria

Rwanda

Liberia Source: World Bank

$48,230

41,400

37,180

30,090

13,980

6,770

3,090

1,290

600

390

220

110

Country

GLOBAL PERSPECTIVE


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


6

5

4

3

2

1

0

0

2

4

6

8

10

12

DVDs $20

Books $10

12

10

8

6

4

2

0 2 4 6 8 10 12 14

$120 Budget

Income = $120

Pdvd = $20 = 6

Income = $120

Pb = $10 = 12

Attainable

Unattainable

Quantity of Books

Qu

an

tity

of

DV

Ds


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Society’s Economizing Problem

• Scarce Resources

• Resource Categories –Land

–Labor

–Capital • Investment

–Entrepreneurial Ability

• Factors of Production


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Production Possibilities Model

• Full Employment

• Fixed Resources

• Fixed Technology

• Two Goods

–Consumer Goods (Pizzas)

–Capital Goods (Industrial Robots)


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Production Possibilities Table

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot Points to Create Graph…


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Pizzas

Ind

ustr

ial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

A

B

C

D

E

Economic

Growth

Now Attainable

A’

B’

C’

D’

E’

Production Possibilities Curve

G 1.1

http://highered.mcgraw-hill.com/sites/0073126632/student_view0/chapter1/interactive_graphs.html



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Pizzas

Ind

ustr

ial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

A

B

C

D

E

Law of Increasing

Opportunity Cost

A’

B’

C’

D’

E’


Shape of

the Curve

W 1.2




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Pizzas

Ind

ustr

ial

Ro

bo

ts

Under or

Unemployment

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

A’

B’

C’

D’

E’


U


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


15

10

5

0 1 2 3

a

b

c

d

e

MB = MC

MC

MB

Optimal Allocation of Resources

Quantity of Pizza

Marg

inal B

en

efi

t &

Marg

inal

Co

st


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment Growth

and the Future • A Growing Economy

• Economic Growth

–Increasing Resource

Supplies

–Increasing Resource

Quality

–Technological Advances


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Present Choices & Future Possibilities

Goods for the Present

Goods for

the F

utu

re

Goods for

the F

utu

re

Goods for the Present

Presentville Futureville

P

F

Current

Curve

Current

Curve

Future

Curve Future

Curve

Compare Two Hypothetical Economies

Implications of International Trade

G 1.2




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Pitfalls to Sound Economic

Reasoning

• Biases

• Loaded Terminology

• Fallacy of Composition

• Post Hoc Fallacy

• Correlation but not

Causation


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms • economics

• economic perspective

• opportunity cost

• utility

• marginal analysis

• scientific method

• economic principle

• other-things-equal assumption

• macroeconomics

• aggregate

• microeconomics

• positive economics

• normative economics

• economizing problem

• budget line

• economic resources

• land

• labor

• capital

• investment

• entrepreneurial ability

• factors of production

• consumer goods

• capital goods

• production possibilities curve

• law of increasing opportunity costs

• economic growth


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Next Chapter Preview…

The Market

System and the

Circular Flow


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

1

Graphs and

Their Meaning

Appendix


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Graphs and Their Meaning

Table Graph Income Consumption Point

$ 0

100

200

300

400

$ 50

100

150

200

250

a

b

c

d

e

Consum

ption (

C)

$400

300

200

100

0

Income (Y)

$100 200 300 400

a

b

c

d

e

Plot Data Points to Create Graph


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Direct and Inverse Relationships

Direct Relationship

Inverse Relationship

Both Variables Move Up or Down Together

Variables Move Opposite Each Other


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Dependent and Independent Variables

• Independent Variable

–The Cause or Source of Change

• Dependent Variable

–The Effect or Result of the Change in the Independent Variable

• Other Things Equal Assumption


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

200

150

100

50

0

Slope of a Line Positive Slope of a Straight Line

Slope = Vertical Change

Horizontal Change

+50

+100 = .5 = =

1

2

50 100 150 200

50

100 Horizontal Change

Vertical

Change


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

50

40

30

20

10

0

Slope of a Line Negative Slope of a Straight Line

Slope = Vertical Change

Horizontal Change

-10

+4 = =

1

2

4 8 12 16 20

-10

4

Horizontal Change

Vertical

Change

-2


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Slope of a Line • Slopes and Measurement

Units

• Slopes and Marginal Analysis

• Infinite and Zero Slopes

Pri

ces o

f B

an

an

as

Purchases of Watches Divorce Rate

Co

nsu

mp

tio

n

Slope = Zero Slope =

Infinite


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

50

40

30

20

10

0

Slope of a Line Equation of a Straight Line

y = a + bx

4 8 12 16 20

-10

4

Horizontal Change

Vertical

Change

Vertical Intercept (a)

Slope (b)

Independent Variable (x)

Dep

en

den

t V

ari

ab

le (y

)


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

50

40

30

20

10

0

Slope of a Line Equation of a Straight Line

4 8 12 16 20

-10

4

Horizontal Change

Vertical

Change

Dependent Variable (Q)

Ind

ep

en

den

t V

ari

ab

le (P

)

Economists Put Independent

Variable on Vertical Axis

y = a + bx

P = 50 – 2.5Q Becomes


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

20

15

10

5

0

Slope of a Nonlinear Curve

Slope is a Tangent Straight Line

5 10 15 20

A

B

b

b

a

a

Tangent at A is the Slope of Line a-a

Tangent at B is the Slope of Line b-b


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms Page

• horizontal axis

• vertical axis

• direct relationship

• inverse relationship

• independent variable

• dependent variable

• slope of a straight line

• vertical intercept


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


The Market

System and the

Circular Flow


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Market

System and the

Circular Flow 2 C H A P T E R


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

PROPERTY RESOURCES

1. LAND

2. CAPITAL

HUMAN RESOURCES

3. LABOR

4. ENTREPRENEURIAL ABILITY

SCARCE RESOURCES

ECONOMIC RESOURCES


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Resource payments: correspond to

resource categories

RENTAL

INCOME

INTEREST

INCOME

WAGES

PROFIT &

LOSS

PROPERTY RESOURCES

LAND

CAPITAL

HUMAN RESOURCES

LABOR

ENTREPRENEUR


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Macroeconomics Starts Here


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Economic Systems

• Definition: A particular set of

institutional arrangements and a

coordinating mechanism to

respond to the economizing

problem.

• Economic systems differ as to:

1) who owns the factors of

production

2) the method used to motivate,

coordinate, and direct economic

activity.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Command System

• The government owns most

property resources and economic

decision making occur through a

central economic plan.

• The central planning board

determines production goals for

each firm and resources to be

allocated.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Market System

• There is private ownership of

resources.

• Markets and prices coordinate

and direct economic activity.

• Each participant acts in its own

self-interest.

• In pure capitalism the

government plays a very limited

role.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Characteristics of the Market

System • Private Property.

• Freedom of firms to choose.

• Self interest.

• Competition.

• Markets and prices.

• Technology and capital goods.

• Specialization.

• Use of money.

• Active, but limited government.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Circular Flow Model

• There are two groups of decision makers

in the private economy: households

(resource owners) and businesses

(resource users)

• The market system (resource markets

and product markets) coordinates these

decisions.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

What happens in the resource markets?

a. Households sell resources directly or indirectly (through ownership of corporations) to businesses.

b. Businesses buy resources in order to produce goods and services.

c. Interaction of these sellers and buyers determines the price of each resource, which in turn provides income for the owner of that resource.

d. Flow of payments from businesses for the resources constitutes business costs and resource owners’ incomes.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

What happens in the product markets?

a. Households are on the buying side of these

markets, purchasing goods and services.

b. Businesses are on the selling side of these

markets, offering products for sale.

c. Interaction of these buyers and sellers

determines the price of each product.

d. Flow of consumer expenditures constitutes

sales receipts for businesses.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS

RESOURCE

MARKET

PRODUCT

MARKET



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


RESOURCE

MARKET

RESOURCES INPUTS

PRODUCT

MARKET

CIRCULAR FLOW MODEL



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


RESOURCE

MARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

GOODS &

SERVICES

GOODS &

SERVICES

PRODUCT

MARKET

CIRCULAR FLOW MODEL



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


RESOURCE

MARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCT

MARKET

GOODS &

SERVICES

GOODS &

SERVICES

CIRCULAR FLOW MODEL



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


RESOURCE

MARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCT

MARKET

GOODS &

SERVICES

GOODS &

SERVICES

$ CONSUMPTION $ REVENUE

CIRCULAR FLOW MODEL



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

CIRCULAR FLOW MODEL


RESOURCE

MARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCT

MARKET

GOODS &

SERVICES

GOODS &

SERVICES

$ CONSUMPTION $ REVENUE



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

More Realistic Circular Flow


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Macroeconomic Policies


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Limitations of the model:

1. Does not depict transactions between households and between businesses (inter-businesses).

2. Ignores government and the “rest of the world” in the decision-making process (we will take care of them later on).

3. Does not explain how prices of products and resources are actually determined.


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

6 Measuring

Domestic Output

and National

Income


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • How GDP is Defined and

Measured

• Relationships Between GDP, Net Domestic Product, National Income, Personal Income, and Disposable Income

• The Nature and Function of a GDP Price Index

• The Difference Between Nominal GDP and Real GDP

• Some Limitations of the GDP Measure


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Assessing Economy’s Performance

• National Income Accounting

• Bureau of Economic Analysis

• Gross Domestic Product

(GDP)

–A Monetary Measure

–Avoid Multiple Counting

• Intermediate Goods

• Final Goods

• Value Added

–Exclude Nonproduction

Transactions


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Assessing Economy’s Performance

• Financial Transactions

Excluded –Public Transfer

Payments

–Private Transfer

Payments

–Stock (and Bond) Market

Transactions

• Second Hand Sales


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Two Approaches to GDP

• Income Approach –Wages

–Rental Incomes

–Interest Incomes

–Profits

• Expenditure Approach –Final-Product or Value-

Added

–The Sum of the Money

Spent to Buy the Output


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Two Approaches to GDP Expenditure

Approach Income

Approach

G

D

P

= =

+ Consumption by

Households

Investment by

Businesses

Government

Purchases

Expenditures

By Foreigners

+

+

+ +

+

Wages

Rents

Interest

Profits

Statistical

Adjustments

+


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Expenditure Approach Personal Consumption Expenditures

• Durable Consumer Goods

• Nondurable Consumer Goods

• Consumer Expenditures for

Services

Gross Private Domestic Investment

• Machinery, Equipment, and Tools

• All Construction

• Changes in Inventories

• Noninvestment Transactions

C

Ig


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Expenditure Approach

January 1 Year’s GDP December 31

Consumption & Government

Spending

Depreciation

Net Investment

Gross Investment

Stock of Capital

Increased

Stock of Capital

Gross Investment Depreciation

Net Investment

- =


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Expenditure Approach Government Purchases

• Expenditures for Goods and

Services

• Expenditures for Social

Capital

Net Exports

Xn = Exports (X) – Imports (M)

Putting It All Together:

GDP = C + I + G + Xn GDP= $8,746 + 2,105 + 2,363 - 727 = $12,487

in 2005

G

Xn


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

GDP Approaches Compared

Compensation

Rents

Interest

Proprietor’s Income

Corporate Profits

Taxes on Production and

Imports

National Income

Net Foreign Factor Income

Statistical Discrepancy

Consumption of Fixed

Capital

Gross Domestic Product

$ 7125

73

498

939

1352

917

$10,904

-34

43

1574

$ 12,487

Personal Consumption (C)

Gross Private Domestic

Investment (Ig)

Government Purchases (G)

Net Exports (Xn)

Gross Domestic Product

Accounting Statement for the U.S. Economy, 2005 in Billions

Receipts Expenditures Approach

Allocations Income Approach

$ 8746

2105

2363

-727

$ 12,487


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Comparative GDPs

Source: World Bank

Select Nations GDPs - 2005

United States Japan

Germany China

United Kingdom France

Italy Spain

Canada Brazil

Korea, Rep. India

Mexico Russian Fed.

Australia

0 1 2 3 4 5 6 7 8 9 10 12

$12.4

$4.5 $2.8

$2.2

$2.2

$2.1

$1.7

$1.1

$1.1 $.79

$.79

$.78

$.77 $.76 $.70

GDP in Trillions of Dollars

GLOBAL PERSPECTIVE


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Income Approach

• Compensation of Employees

• Rents

• Interest

• Proprietor’s Income

• Corporate Profits

–Corporate Income Taxes

–Dividends

–Undistributed Corporate Profits

–Taxes on Production and

Imports


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Income Approach

• From National Income to GDP

–Net Foreign Factor Income

–Statistical Discrepancy

–Consumption of Fixed Capital

• Other National Accounts

–Net Domestic Product (NDP)

–National Income (NI)

–Personal Income (PI)

–Disposable Income (DI)

DI = C + S W 6.1




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Income Approach

Gross Domestic Product (GDP)

Consumption of Fixed Capital

Net Domestic Profit (NDP)

Statistical Discrepancy

Net Foreign Factor Income

National Income (NI)

Taxes on Production and Imports

Social Security Contributions

Corporate Income Taxes

Undistributed Corporate Profits

Transfer Payments

Personal Income (PI)

Personal Taxes

Disposable Income (DI)

$ 12,487

-1,574

$ 10,913

-43

34

$ 10,904

-917

-871

-378

-460

+1,970

$ 10,248

-1,210

$ 9,038

Income Relationships – United States, 2005


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Circular Flow Revisited U.S. Domestic Output and the Flows of Expenditure and Income


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Nominal Versus Real GDP

• Nominal GDP

• Real GDP

• Price Index

• GDP Price Index Price Index In Given Year

= x 100

Price of Market Basket In Specific Year

Price of Same Basket In Base Year

Real GDP =

Nominal GDP

Price Index (in hundredths)

O 6.1

W 6.2






Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Shortcomings of GDP

• Nonmarket Activities

• Leisure

• Improved Product Quality

• The Underground Economy

• GDP and the Environment

• Composition and Distribution

of the Output

• Noneconomic Sources of

Well-Being


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Shortcomings of GDP

Source: Journal of Economic Literature

Underground Economy as a Percentage

of GDP - Select Nations

Greece

Italy

Spain

Portugal

Belgium

Sweden

Germany

France

Holland

United Kingdom

Japan

United States

Switzerland

0 5 10 15 20 25 30 Percentage of GDP

GLOBAL PERSPECTIVE


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Magical Mystery Tour

• Consumption – Census Bureau’s Retail Trade Survey

– Census Bureau’s Survey of Manufacturers

– Census Bureau’s Service Survey

• Investment – All Consumption Data Sources

– Survey of Manufacturers

– Service Survey

– Industry Sources

– Census Bureau’s Housing Starts Survey and Housing Sales Survey

– Retail Trade Survey

– Wholesale Trade Survey

– Survey of Manufacturing

BEA Sources of Data for Analysis


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Magical Mystery Tour

• Government Purchases

– Office of Personnel Management

– Construction Surveys

– Census Bureau’s Survey of

Government Finance

• Net Exports

– U.S. Customs Service

– BEA Surveys and Analysis


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms • national income

accounting

• gross domestic product

• intermediate goods

• final goods

• multiple counting

• value added

• expenditures approach

• income approach

• personal consumption expenditures (C)

• gross private domestic investment (Ig)

• net private domestic investment

• government purchases

• net exports (Xn)

• taxes on production and imports

• national income

• consumption of fixed capital

• net domestic product (NDP)

• personal income (PI)

• disposable income (DI)

• nominal GDP

• real GDP

• price index


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Introduction to

Economic Growth,

Unemployment,

and Inflation


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

7 Introduction to Economic Growth and Instability


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • The Business Cycle and its

Primary Phases

• How Economic Growth is Measured and Why is it Important

• How Unemployment and Inflation are Measured

• The Types of Unemployment and Inflation and their Various Economic Impacts


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Economic Growth

• Increase in Real GDP

• Increase in Real GDP Per

Capita

• Growth as a Goal

• Arithmetic of Growth

–Rule of 70

Approximate

number of years

required to double

real GDP

= 70

annual percentage rate

of growth

W 7.1




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Economic Growth

• Main Sources of Growth • Increases in Inputs • Increases in Resource

Productivity • Productivity Defined • Productivity in the United

States – Improved Products and

Services –Added Leisure –Other Impacts


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Selected Growth Rates

Source: Economic Report of the President, 2006

-4

-2

0

2

4

6

U.S.

Germany

France

Japan

U.K.

Italy

1997 1999 2001 2003 2005

Perc

en

tag

e C

han

ge (

an

nu

al

rate

)

GLOBAL PERSPECTIVE


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Business Cycle

Level

of

Real O

utp

ut

Time

Peak

Peak

Peak

Trough

Trough

O 7.1 Phases of the Business Cycle

Cyclical Impact: Durables and Nondurables




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment

• Twin Problems of the Business

Cycle – Unemployment

– Inflation

• Measurement of Unemployment

• Labor Force

• Unemployment Rate – Part-Time Employment

– Discouraged Workers

Unemployment Rate Unemployed

Labor Force = x 100

W 7.2




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment

Under 16 And/or

Institutionalized (70.5 Million)

Labor Force, Employment, and Unemployment, 2005

Total

Population

(296.6 Million)

Not in Labor Force (76.8 Million)

Employed (141.7 Million)

Labor

Force

(149.3 Million)

Unemployed (7.6 Million)


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment

• Types of Unemployment –Frictional Unemployment

–Structural Unemployment

–Cyclical Unemployment

• Full Employment Defined

• Full-Employment Rate of

Unemployment

• Natural Rate of

Unemployment (NRU)


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment

• Economic Cost of

Unemployment

• Potential Output

• GDP Gap and Okun’s Law

GDP Gap Actual GDP Potential GDP = -

W 7.3




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment Actual and Potential GDP and the Unemployment Rate

5,000

6,000

7,000

8,000

9,000

10,000

11,000

12,000

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

The GDP Gap 12,000

11,000

10,000

9,000

8,000

7,000

6,000

5,000 GD

P (

bil

lio

ns

of

19

96

do

lla

rs)

0

2

4

6

8

10

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

The Unemployment Rate 10

8

6

4

2

0

Un

em

plo

ym

en

t (p

erc

en

t o

f c

ivil

ian

L

ab

or

forc

e)

Source: Congressional Budget Office & Bureau of Economic Analysis

GDP gap (positive)

GDP gap (negative)

Potential GDP

Actual GDP


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment

• Unequal Burdens –Occupation

–Age

–Race and Ethnicity

–Gender

–Education

–Duration

• Noneconomic Costs


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Unemployment

Source: Bureau of Labor Statistics

0

5

10

15

U.S.

Germany

Italy

Japan

France

1995 2000 2005

Un

em

plo

ym

en

t R

ate

(p

erc

en

t)

Unemployment Rates in Five Industrial Nations,

1995-2005

GLOBAL PERSPECTIVE


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation • Inflation Defined

• Measurement of

Inflation

–Consumer Price Index

CPI

Price of the Most Recent Market

Basket in the Particular Year

Price of the Same Market

Basket in 1982-1984

= x 100


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation Annual Inflation Rates in the United States,

1960-2005

0

5

10

15

1960 1970 1980 1990 2000

Inflation R

ate

(perc

ent)



Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation


-1

0

1

2

3

4

5

6

U.S.

Germany

Italy

Japan

France

1995 2000 2005

Infl

ati

on

Rate

(p

erc

en

t)

Inflation Rates in Five Industrial Nations,

1995-2005

GLOBAL PERSPECTIVE


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation • Types of Inflation –Demand Pull Inflation –Cost-Push Inflation •Per Unit Production Costs

• Redistributive Effects –Nominal and Real

Income –Anticipations •Anticipated Inflation •Unanticipated Inflation


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation • Who is Hurt by Inflation? –Fixed-Income Receivers

–Savers

–Creditors

• Who is Unaffected or Hurt

by Inflation? –Flexible-Income Receivers

• Cost-of-Living Adjustments

(COLAs)

–Debtors

W 7.4




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation • Anticipated Inflation –Nominal Interest Rate

–Real Interest Rate

–Inflation Premium

Nominal Interest

Rate

Real Interest

Rate

Inflation Premium

11%

5%

6%

= +

O 7.2




Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Inflation • Deflation

• Mixed Effects

• Arbitrariness

• Cost-Push Inflation and

Real Output

• Demand-Pull Inflation and

Real Output

• Hyperinflation


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Stock Market and the Economy

• Supply and Demand in the Stock Market

• Collective Expectations of Future Profits

and Losses

• Dow Jones Industrial Average (DJIA)

• Volatility of the Stock Market

• Wealth Effect

• Investment Effect

• Studies Show Consumption and Investment

Unaffected

• Little Impact on Macroeconomy

• Stock Market Bubbles Do Have an Impact

• Stock Price Cycle Predictions

• Index of Leading Indicators

• Stock Prices Not a Reliable Predictor Alone

Do Stock Prices Affect Macroeconomic Instability?


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms • economic growth

• real GDP per capita

• rule of 70

• productivity

• business cycle

• peak

• recession

• trough

• expansion

• labor force

• unemployment rate

• discouraged workers

• frictional unemployment

• structural unemployment

• cyclical unemployment

• full-employment rate of unemployment

• natural rate of unemployment (NRU)

• potential output

• GDP gap

• Okun’s law

• inflation

• Consumer Price Index (CPI)

• demand-pull inflation

• cost-push inflation

• per-unit production costs

• nominal income

• real income

• anticipated inflation

• unanticipated inflation

• cost-of-living adjustments (COLAs)

• real interest rate

• nominal interest rate

• deflation

• hyperinflation


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Basic Macroeconomic Relationships


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

8 Basic

Macroeconomic

Relationships


Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • How Changes in Income Affect

Consumption (and Saving)

• About Factors Other Than Income That Can Affect Consumption

• How Changes in Real Interest Rates Affect Investment

• About Factors Other Than the Real Interest Rate That Can Affect Investment

• Why Changes in Investment Increase or Decrease Real GDP by a Multiple Amount

Copyright 2008 The McGraw-Hill Companies 1-

100

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Basic Relationships

• Income-Consumption

• Income-Saving

• 45° Line

• C = DI on the Line

• S = DI - C


101

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Income and Consumption

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

0 2000 4000 6000 8000 10000

Co

nsu

mp

tio

n (

bil

lio

ns o

f d

oll

ars

)

Disposable Income (billions of dollars)

Consumption and Disposable Income, 1983-2005

45° Reference Line C=DI

83

86 85

84

88 89

91 90

87

92 93

94 95

01

97 96

99

98

00

02

05

03

04

Consumption In 1992

Saving In 1992

45°

C


102

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Consumption and Saving

• The Consumption Schedule

• The Saving Schedule • Break-Even Income • Average Propensity to

Consume (APC) • Average Propensity to

Save (APS)

O 8.1

APS = Saving

Income APC =

Consumption

Income




103

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Marginal Propensity to Consume (MPC)

• Marginal Propensity to Save (MPS)

MPC = Change in Consumption

Change in Income

MPS = Change in Saving

Change in Income


104

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


(1) Level of Output

And Income

(GDP=DI)

(2) Consump-

tion (C)

(3) Saving (S)

(1-2)

(4) Average

Propensity to Consume

(APC) (2)/(1)

(5) Average

Propensity to Save (APS) (3)/(1)

(6) Marginal

Propensity to Consume

(MPC) Δ(2)/Δ(1)

(7) Marginal

Propensity to Save (MPS)

Δ(3)/Δ(1)

(1) $370

(2) 390

(3) 410

(4) 430

(5) 450

(6) 470

(7) 490

(8) 510

(9) 530

(10) 550

$375

390

405

420

435

450

465

480

495

510

$-5

0

5

10

15

20

25

30

35

40

1.01

1.00

.99

.98

.97

.96

.95

.94

.93

.93

-.01

.00

.01

.02

.03

.04

.05

.06

.07

.07

.75

.75

.75

.75

.75

.75

.75

.75

.75

.25

.25

.25

.25

.25

.25

.25

.25

.25


105

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

500

475

450

425

400

375

45°


50

25

0

370 390 410 430 450 470 490 510 530 550

370 390 410 430 450 470 490 510 530 550

Consumption and Saving Schedules

C

S

Consumption Schedule

Saving Schedule

Saving $5 Billion

Dissaving $5 Billion

Dissaving $5 Billion

Saving $5 Billion


Co

ns

um

pti

on

(b

illi

on

s o

f d

oll

ars

)

Sa

vin

g

(bil

lio

ns

of

do

lla

rs)


106

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

GLOBAL PERSPECTIVE


Source: Statistical Abstract of the United States, 2006

Average Propensities to Consume Select Nations GDPs

United States

Canada

United Kingdom

Japan

Germany

Netherlands

Italy

France

.80 .85 .90 .95 1.00

.963

.958

.953

.942

.896

.893

.840

.833

Average Propensities to Consume


107

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• MPC + MPS = 1

• MPC and MPS as Slopes

• Nonincome Determinants of Consumption and Saving

–Wealth Effect

–Expectations

–Real Interest Rates

–Household Debt

W 8.1




108

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Other Important

Considerations

• Changes Along Schedules

• Switch to Real GDP

• Schedule Shifts

• Stability

• Taxation

G 8.1




109

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

45°

Consumption and Saving Consumption and Saving Schedules

C0

S0


Co

ns

um

pti

on

(b

illi

on

s o

f d

oll

ars

)

Sa

vin

g

(bil

lio

ns

of

do

lla

rs)

C2

C1

S1

S2


110

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Interest Rate and Investment

• Expected Rate of Return (r)

• The Real Interest Rate (i)

• Meaning of r = i

• Investment Demand Curve

O 8.2

G 8.2






111

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Expected Rate of

Return (r)

Cumulative Amount of Investment Having This

Rate of Return or Higher

(i)

16%

14%

12%

10%

8%

6%

4%

2%

0%

$ 0

5

10

15

20

25

30

35

40

r a

nd

i (

pe

rce

nt)

16

14

12

10

8

6

4

2

0

5 10 15 20 25 30 35 40

Investment (billions of dollars)

The Investment Demand Curve

ID


112

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Shifts of the Investment

Demand Curve

–Acquisition, Maintenance,

and Operating Costs

–Business Taxes

–Technological Change

–Stock of Capital Goods on

Hand

–Expectations


113

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


r a

nd

i (

pe

rce

nt)

0


Shifts in the Investment Demand Curve

ID0 ID1 ID2

Increase in

Investment Demand

Decrease in

Investment Demand


114

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Instability of Investment

–Durability

–Irregularity of Innovation

–Variability of Profits

–Variability of Expectations


115

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

GLOBAL PERSPECTIVE


Source: World Bank

Gross Investment Expenditures as a Percent of GDP, Select Nations

South Korea

Japan

Mexico

Canada

France

United States

Germany

United Kingdom

Sweden

0 10 20 30

Percent of GDP, 2004


116

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


-30

-20

-10

0

10

20

30

40

1971 1975 1979 1983 1987 1991 1995 1999 2003

GDP

Gross Investment

The Volatility of Investment

Pe

rce

nta

ge

Ch

an

ge

Year


117

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Multiplier Effect

Multiplier = Change in Real GDP

Initial Change in Spending

The Multiplier and the Marginal Propensities

Multiplier = 1

1 - MPC

Multiplier = 1

MPS

-or-

Graphically…

W 8.2




118

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Multiplier Effect

(1)

Change in

Income

(2)

Change in

Consumption

(MPC = .75)

(3)

Change in

Saving

(MPC = .25) Increase in Investment of $5 Second Round Third Round Fourth Round Fifth Round All other rounds Total

$ 5.00 3.75 2.81 2.11 1.58 4.75

$ 20.00

$ 3.75 2.81 2.11 1.58 1.19 3.56

$ 15.00

$ 1.25 .94 .70 .53 .39

1.19 $ 5.00

Tabular and Graphical Views

Rounds of Spending 1 2 3 4 5 All

$20.00

15.25

13.67

11.56

8.75

5.00 $5.00

$3.75

$2.81

$2.11 $1.58

$4.75

ΔI= $5 billion


119

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Multiplier Effect The MPC and the Multiplier

10

5

4

3

2 .5

.67

.75

.8

.9

MPC Multiplier


120

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Squaring the Economic Circle

• Humorist Art Buchwald and the

Multiplier

• One Person Can’t Buy a Product

• Others Subsequently Impacted

and Cannot Buy Other Items

• Multiple Effects Impact Psyche

• Ultimately Causes Multiple Step

Impact Upon the Economy as a

Whole


121

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms

• 45° (degree) line

• consumption schedule

• saving schedule

• break-even income

• average propensity to consume (APC)

• average propensity to save (APS)

• marginal propensity to consume (MPC)

• marginal propensity to save (MPS)

• wealth effect

• expected rate of return

• investment demand curve

• multiplier


122

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


The Aggregate

Expenditures Model


123

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

9 The Aggregate

Expenditures

Model O 9.1




124

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • Economists Combine Consumption and

Investment to Depict an Aggregate Expenditures Schedule for a Private Closed Economy

• Three Characteristics of the Equilibrium Level of Real GDP in a Private Closed Economy – AE = Output

– Saving = Investment

– No Unplanned Changes in Inventories

• How Changes in Equilibrium Real GDP Occur and Relate to Multiplier

• Integrate Government and Foreign Sectors into AE

• Recessionary and Expansionary Expenditure Gaps


125

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Consumption and Investment • Simplifications –Private Closed Economy

–Planned Investment

–Investment Schedule

r a

nd

i (

pe

rce

nt)


ID

20

8

Real GDP (billions of dollars)

20

Inve

stm

en

t (b

illio

ns

of

do

lla

rs)

Ig

Investment Demand Curve Investment Schedule

20 20

Investment

Demand

Curve

Investment

Schedule


126

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Consumption and Investment

• Equilibrium GDP:

C + Ig = GDP

• Real Domestic Output

• Aggregate Expenditures

–Aggregate Expenditures Schedule

• Equilibrium GDP

• Disequilibrium W 9.1




127

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Consumption and Investment

(1) 40

(2) 45

(3) 50

(4) 55

(5) 60

(6) 65

(7) 70

(8) 75

(9) 80

(10) 85

$375

390

405

420

435

450

465

480

495

510

$-5

0

5

10

15

20

25

30

35

40

20

20

20

20

20

20

20

20

20

20

$395

410

425

440

455

470

485

500

515

530

$-25

-20

-15

-10

-5

0

+5

+10

+15

+20

Increase

Increase

Increase

Increase

Increase

Equilibrium

Decrease

Decrease

Decrease

Decrease

$370

390

410

430

450

470

490

510

530

550

(2) Real

Domestic Output

(and Income)

(GDP=DI)

(3) Con-

sump- tion (C)

(4) Saving (S)

(1-2)

(5) Investment

(Ig)

(6) Aggregate

Expenditures (C+Ig)

(7) Unplanned Changes in Inventories

(+ or -)

(8) Tendency of Employment Output and

Income

(1) Employ-

ment

Graphically…

…in Billions of Dollars


128

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

530

510

490

470

450

430

410

390

370

45°

370 390 410 430 450 470 490 510 530 550


Co

nsu

mp

tio

n (

billio

ns o

f d

ollars

)

Consumption and Investment Equilibrium GDP

C

Ig = $20 Billion

Aggregate

Expenditures

C = $450 Billion

C + Ig (C + Ig = GDP)

Equilibrium Point

G 9.1




129

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Equilibrium GDP

• Other Features…

–Saving Equals

Planned Investment

•Leakage

• Injection

–No Unplanned

Changes in Inventories


130

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

510

490

470

450

430

45°

430 450 470 490 510


Ag

gre

gate

Exp

en

dit

ure

s (

billio

ns o

f d

ollars

)

Changes in Equilibrium GDP …and the Multiplier

Increase in

Investment

(C + Ig)0

Decrease in

Investment

(C + Ig)2

(C + Ig)1


131

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

International Trade • Net Exports and Aggregate

Expenditures • Net Exports Schedule • Net Exports and Equilibrium

GDP –Positive Net Exports –Negative Net Exports

• International Economic Linkages –Prosperity Abroad –Tariffs –Exchange Rates


132

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Real GDP

+5

0

-5

Net

Exp

ort

s X

n

(billio

ns o

f D

ollars

)


Ag

gre

gate

Exp

en

dit

ure

s

(billio

ns o

f d

ollars

)

510

490

470

450

430

45° 430 450 470 490 510

International Trade Net Exports and Equilibrium GDP

Aggregate

Expenditures

with Positive

Net Exports

C + Ig

Aggregate

Expenditures

with Negative

Net Exports

C + Ig+Xn2

C + Ig+Xn1

Xn1

Xn2

Positive Net Exports

Negative Net Exports

450 470 490


133

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show -700 200 150 100 50 0 50 100 150 200 250

International Trade

Net Exports of Goods - Select Nations, 2004

Positive Net Exports Negative Net Exports

Canada

France

Germany

Italy

Japan

United Kingdom

United States

+37

+195

+111

-17

-2

-117

-707

Source: World Trade Organization

GLOBAL PERSPECTIVE


134

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Adding the Public Sector

(1) $370

(2) 390

(3) 410

(4) 430

(5) 450

(6) 470

(7) 490

(8) 510

(9) 530

(10) 550

$375

390

405

420

435

450

465

480

495

510

$-5

0

5

10

15

20

25

30

35

40

$20

20

20

20

20

20

20

20

20

20

10

10

10

10

10

10

10

10

10

10

20

20

20

20

20

20

20

20

20

20

$415

430

445

460

475

490

505

520

535

550

10

10

10

10

10

10

10

10

10

10

(1) Level of Output

and Income

(GDP=DI)

(2) Consump-

tion (C)

(3) Saving (S)

(4) Investment

(Ig)

(5) Net Exports

(Xn) (6)

Government (G)

(7) Aggregate

Expenditures (C+Ig+Xn+G) (2)+(4)+(5)+(6)

Exports

(X)

Imports

(M)

Government Purchases and GDP

…in Billions of Dollars


135

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

45°

470 550


Ag

gre

gate

Exp

en

dit

ure

s (

billio

ns o

f d

ollars

)

Adding the Public Sector Government Spending and GDP

C

Government

Spending of

$20 Billion

C + Ig + Xn

C + Ig + Xn + G

$20 Billion Increase

in Government

Spending Yields an


In GDP


136

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

45°

490 550


Ag

gre

gate

Exp

en

dit

ure

s (

billio

ns o

f d

ollars

)

Adding the Public Sector Lump-Sum Tax Increase and GDP

$15 Billion Decrease

In Consumption From

a $20 Billion (MPC=.75)

Increase in

Taxes

Cd + Ig + Xn + G

C + Ig + Xn + G


in Taxes Yields a

$60 Billion Decrease

In GDP


137

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Adding the Public Sector

Cd + Ig + Xn + G = GDP

• Leakages

• Injections

• No Planned Inventory

Changes

Sd + M + T = Ig + X + G G 9.2

W 9.2






138

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Equilibrium Versus Full-Employment GDP

Recessionary Expenditure Gap


Ag

gre

gate

Exp

en

dit

ure

s

(billio

ns o

f d

ollars

) 550

530

510

490

470

45° 490 510 530

AE0

AE1

Full Employment

Recessionary Expenditure Gap = $5 Billion

$5 Billion

Gap Yields

$20 Billion

GDP

Change


139

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Inflationary Expenditure Gap


Ag

gre

gate

Exp

en

dit

ure

s

(billio

ns o

f d

ollars

) 550

530

510

490

470

45° 490 510 530

AE0

AE2

Full Employment

Inflationary Expenditure Gap = $5 Billion $5 Billion

Gap Yields

$20 Billion

GDP

Change


140

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Application: –U.S. Recession of 2001

• Inflationary Expenditure Gap

–U.S. Inflation in the Late

1980s

–Full-Employment Output

with Large Negative Net

Exports • Negative Net Exports

W 9.3




141

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Limitations of the Model –Does Not Show Price Level

Changes

– Ignores Premature Demand-Pull Inflation

–Limits Real GDP to the Full-Employment Level of Output

–Does Not Deal with Cost-Push Inflation

–Does Not Allow for “Self-Correction”


142

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Say’s Law - The Great Depression and Keynes

• Classical School – Automatic Self-Adjustment to Full Employment – Mill, Ricardo

• Views Based Upon “Say’s Law” - J.B. Say (1767-1832) – Supply Creates its Own Demand

• Great Depression Caused Questions

• Keynes Answered in his General Theory of Employment, Interest, and Money

• Income and Saving Discrepancies

• Volatility in Investment Spending

• Cyclical Unemployment Can Occur

• Government Should Be Active in the Recovery Process

O 9.2




143

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms

• planned investment

• investment schedule

• aggregate expenditures schedule

• equilibrium GDP

• leakage

• injection

• unplanned changes in inventories

• net exports

• lump-sum tax

• recessionary-expenditure gap

• inflationary-expenditure gap


144

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Aggregate Demand and

Aggregate Supply


145

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

10 Aggregate Demand and Aggregate Supply


146

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • Aggregate Demand and the

Factors That Cause it to Change

• Aggregate Supply and the Factors That Cause it to Change

• How AD and AS Determine an Economy’s Equilibrium Price Level and the Level of Real GDP

• How the AD-AS Model Explains Periods of Demand-Pull Inflation, Cost-Push Inflation, and Recession


147

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

AD – AS Model

• Aggregate Demand-

Aggregate Supply Model

(AD-AS Model)

• Aggregate Demand

• Why the Downward Slope?

–Real-Balances Effect

–Interest-Rate Effect

–Foreign Purchases Effect

O 10.1




148

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

AD – AS Model

Real Domestic Output, GDP

Pri

ce

Level

AD

Aggregate

Demand

Aggregate Demand Curve

Click to Link to Appendix 10: Relationship of AD to the AE Model


149

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Changes in Aggregate Demand

• Determinants of Aggregate

Demand and Multiplier Effect

• Changes in:

–Consumer Spending

–Consumer Wealth

–Consumer Expectations

–Household Debt

–Personal Taxes

– Investment Spending

–Real Interest Rates


150

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


–Expected Returns

• About Future Business

Conditions

• Technology

• Degree of Excess Capacity

• Business Taxes

–Government Spending

–Net Export Spending

–National Income Abroad

• Exchange Rates


151

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD1

Increase in

Aggregate

Demand

Changes in Aggregate Demand Curve

AD3

AD2 Decrease in

Aggregate

Demand


152

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Aggregate Supply Aggregate Supply in the Long Run


Pri

ce L

evel

ASLR

Long Run

Aggregate

Supply


153

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Aggregate Supply Aggregate Supply in the Short Run

Per-Unit Production Cost

Total Input Cost

Units of Output =


Pri

ce L

eve

l

0 Qf

Aggregate Supply

(Short Run)

W 10.1




154

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Changes in Aggregate Supply

• Determinants of Aggregate

Supply

• Changes in: – Input Prices

–Domestic Resource Prices

–Prices of Imported Resources

–Market Power

–Productivity

–Legal-Institutional Environment

–Business Taxes and Subsidies

–Government Regulation


155

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Understanding Productivity

Productivity Total Output

Total Inputs =

Total Output

Total Inputs = =

10

5 2

G 10.1




156

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AS1

Increase in

Aggregate

Supply

Changes in Aggregate Demand Curve

AS3

AS2 Decrease in

Aggregate

Supply


157

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Equilibrium and Changes in Equilibrium

Real Output

Demanded

(Billions)

Price Level

(Index Number)

Real Output

Supplied

(Billions)

$506

508

510

512

514

108

104

100

96

92

$513

512

510

507

502

Tabular View…

Equilibrium Price Level and

Equilibrium Price Level


158

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Real Domestic Output, GDP (Billions of Dollars)

Pri

ce L

evel

100

92

502 510 514

a b

AD

AS

Equilibrium


159

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD

AS

P1

P2

Q2 Q1 Qf

AD1

Increase in Aggregate Demand

Demand-Pull

Inflation


160

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD1

AS

P1

P2

Q1 Q2 Qf

AD2

Decrease in Aggregate Demand

Creates a

Recession

a

c

b


161

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

• Recession and Cyclical Unemployment

• Deflation • Downward Price Inflexibility

Due to: –Fear of Price Wars –Menu Costs –Wage Contracts –Morale, Effort, and Productivity

• Efficiency Wages

–Minimum Wage


O 10.2




162

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD

AS

P1

P2

Q1 Qf

Decrease in Aggregate Supply

Cost-Push

Inflation

AS1

a

b


163

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD1

AS2

P1

P2

Q2 Q1

Increases in Aggregate Supply – Full-Employment With Price-Level Stability

AS1

b

AD2

c

P3

Q3

a


164

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Has the Impact of Oil Prices Diminished?

• Several Aggregate Supply Shocks

• Shifts in Aggregate Supply

• Significant Changes in Oil Prices Brought Rapid Cost-Push Inflation

• Rising Unemployment

• Recent Fears of Reoccurrence

• Core Inflation Rate Remaining Steady


165

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Has the Impact of Oil Prices Diminished?

• Lower Production Costs and High Productivity are Compensating for Oil Prices

• Aggregate Supply Did Not Decline

• Productivity Impact: – 14,000 Btus per $1 of GDP in 1970

– 7,000 Btus per $1 of GDP in 2005

• Result is 33% Less Sensitive to Oil Price Fluctuations

• Federal Reserve Vigilance in Managing Price Stability


166

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms

• aggregate demand-

aggregate supply

(AD-AS) model

• aggregate demand

• real-balances effect

• interest-rate effect

• foreign purchases

effect

• determinants of

aggregate demand

• aggregate supply

• long-run aggregate

supply curve

• short-run aggregate

supply curve

• determinants of

aggregate supply

• productivity

• equilibrium price

level

• equilibrium real

output

• menu costs

• efficiency wages


167

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Fiscal Policy, Deficits, and Debt

Click to Link to Appendix 10: Relationship of AD to the AE Model


168

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

10 The Relationship of the Aggregate Demand Curve to the Aggregate Expenditures Model

Appendix

Return to Chapter 10


169

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Deriving the AD Curve

Pri

ce L

evel

Ag

gre

gate

Exp

en

dit

ure

s

(billio

ns o

f d

ollars

)

45°

AE2 (at P2 )

AE3 (at P3 )

AE1 (at P1 )

Q1 Q2 Q3

Real Domestic Product, GDP

AD

P3

P2

P1

As Price Levels

Increase…

Real GDP

Declines



170

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Pri

ce L

evel

Ag

gre

gate

Exp

en

dit

ure

s

45°


AE2 (at P1 )

AE1 (at P1 )

Q1 Q2

AD1

P1

Increase in

Aggregate

Expenditures

Increase in

Aggregate

Demand

AD2



171

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Pri

ce L

evel

Ag

gre

gate

Exp

en

dit

ure

s

45°


AE2 (at P1 )

AE1 (at P1 )

Q1 Q2

AD1

P1

AD2

The Shift in the

Aggregate Demand

Curve is a Multiple

of the initial Change

in Aggregate

Expenditures



172

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Fiscal Policy, Deficits, and Debt



173

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

11 Fiscal Policy,

Deficits, and

Debt O 11.1




174

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • Purposes, Tools, and

Limitations of Fiscal Policy

• Role of Built-In Stabilizers in Moderating Business Cycles

• How the Standardized Budget Reveals the Status of U.S. Fiscal Policy

• The Size, Composition, and Consequences of the U.S. Public Debt


175

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Fiscal Policy and the AD-AS Model

• Fiscal Policy

• Council of Economic Advisers (CEA)

• Discretionary Fiscal Policy

• Nondiscretionary Fiscal Policy

–Passive or Automatic


176

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Expansionary Fiscal Policy

–Increased Government Spending

–Tax Reductions

–Some Combination of the Two

• Budget Deficit


177

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD2

Recessions Decrease Aggregate Demand

AD1

$5 Billion Additional Spending

Full $20 Billion Increase in

Aggregate Demand

AS

$490 $510

P1

Expansionary Fiscal Policy


178

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


• Contractionary Fiscal Policy

–Decreased Government Spending

–Increased Taxes

–Some Combination of the Two

• Budget Surplus

• Policy Options: G or T?

G 11.1




179

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show



Pri

ce L

evel

AD3

Recessions Decrease Aggregate Demand

AD4

$5 Billion Initial Decrease

In Spending

Full $20 Billion Decrease in

Aggregate Demand

AS

$510 $522

P1

Contractionary Fiscal Policy


180

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Built-In Stability

• Automatic or Built-In

Stabilizers

• Economic Importance

• Tax Progressivity

–Progressive Tax System

–Proportional Tax System

–Regressive Tax System


181

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Built-In Stability

G

T

Deficit

Surplus

GDP1 GDP2 GDP3


Go

vern

men

t E

xp

en

ses, G

an

d T

ax R

even

ues,

T


182

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Evaluating Fiscal Policy

• Standardized Budget (Full-

Employment Budget)

• Cyclical Deficit

• Recent U.S. Fiscal Policy

• Budget Deficits and

Projections

• Social Security

Considerations


183

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


G

T

GDP2 GDP1


Go

vern

men

t E

xp

en

ses, G

an

d T

ax R

even

ues,

T

(Year 2) (Year 1)

$500

$450

a b

c


184

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


G

T1

GDP4 GDP3


Go

vern

men

t E

xp

en

ses, G

an

d T

ax R

even

ues,

T

(Year 4) (Year 3)

$500

$450

d e

f

$475

$425 g

T2

h


185

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

(1) Year

(2) Actual

Deficit (-) or Surplus (+)

(3) Standardized Deficit (-) or Surplus (+)

Recent U.S. Fiscal Policy

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

-3.9% -4.4% -4.5% -3.8% -2.9% -2.2% -1.4% -0.3% +0.8% +1.4% +2.5% +1.3% -1.5% -3.4% -3.5% -2.6%

-2.2% -2.5% -2.9% -2.9% -2.1% -2.0% -1.2% -1.0% -0.4% +0.1% +1.1% +1.1% -1.1% -2.7% -2.4% -1.8%

Federal Deficits and Surpluses – 1990 - 2005 as a Percentage of Potential GDP

Source: Congressional Budget Office


186

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

GLOBAL PERSPECTIVE

Recent U.S. Fiscal Policy

Full-Employment Budget Deficits or Surpluses as a Percentage of Potential GDP, 2005

Source: Organization for Economic Cooperation and Development

New Zealand

Denmark

Canada

Ireland

France

Norway

United Kingdom

United States

Japan

-6 -4 -2 0 2 4 6 Deficits Surpluses

+4.6

+3.1

+1.2

-1.3

-2.4

-3.0

-3.0

-3.6

-6.3


187

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Recent U.S. Fiscal Policy Federal Budget Deficits and Surpluses Actual and Projected, Fiscal 1992-2012

Source: Congressional Budget Office

$300

200

100

0

-100

-200

-300

-400

-500

Bu

dg

et

Defi

cit

(-)

or

Su

rplu

s,

Billio

ns

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Actual Projected (as of March 2006)


188

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

• Problems of Timing – Recognition Lag – Administrative Lag – Operational Lag

• Political Considerations – Political Business Cycle

• Future Policy Reversals • Offsetting State and Local

Finance • Crowding-Out Effect • Current Thinking on Fiscal

Policy

Recent U.S. Fiscal Policy Problems, Criticisms, and Complications

O 11.2




189

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Public Debt • National or Public Debt

$7.96 Trillion • Ownership –U.S. Securities –42% Owned by Federal

Government and Federal Reserve

–58% Held Outside the Federal Government and Federal Reserve

Graphically…


190

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Public Debt Debt Held by the

Federal Government

and Federal

Reserve (51%)

Debt Held Outside

The Federal

Government

and Federal

Reserve (49%)

Federal

Reserve

U.S.

Government

Agencies U.S.

Individuals

Foreign

Ownership

U.S. Banks

And other

Financial

Institutions

Other – Including

State and Local

Governments

Source: U.S. Treasury

9%

8%

25%

8% 8%

42%

Total Debt $7.96 Trillion


191

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Debt and GDP Federal Debt Held by the Public as a

Percentage of GDP, 1970 - 2005

Source: Economic Report of the President, 2006

Perc

en

t o

f G

DP

Year

50

45

40

35

30

25

20

15

10

5

0

1970 1975 1980 1985 1990 1995 2000 2005


192

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

GLOBAL PERSPECTIVE

Debt and GDP

Publicly Held Debt: International Comparisons

As a Percentage of GDP - 2005

Italy

Belgium

Japan

Germany

France

United States

Hungary

Netherlands

United Kingdom

Spain

Canada

Poland

0 20 40 60 80 100

101.3

86.3

80.9

39.6

58.8

46.5

45.7

39.3

39.1

26.4

17.0

28.7

Source: Organization for Economic Cooperation and Development


193

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Debt and GDP

• Interest Charges

• False Concerns

–Bankruptcy

–Refinancing

–Taxation

–Burdening Future

Generations


194

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Debt and GDP

• Substantive Issues

–Income Distribution

–Incentives

–Foreign-Owned Public

Debt

–Crowding-Out Effect

Revisited

Graphically…


195

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Debt and GDP The Investment Demand Curve and the Crowding-Out Effect

5 10 15 20 25 30 35 40 0

2

4

6

8

10

12

14

16

Re

al In

tere

st

Ra

te (

Pe

rce

nt)

Investment Demand (Billions of Dollars)

ID1

ID2

a

b c

Interest Rate

Rise Will

Decrease

Investment

a to b

Crowding-

Out Effect

A Large Public Debt to Finance Public Investment Will Cause…

If Public Spending

Spurs More Private

Investment Will

Increase to ID2


196

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Debt and GDP

• Public Investments and

Public-Private

Complementarities

• Public Investments

–Public Goods Spending

–Human Capital Spending

–Reduction on Crowding-

Out Effect


197

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Leading Indicators

1. Average Workweek 2. Initial Claims for Unemployment

Insurance 3. New Orders for Consumer

Goods 4. Vendor Performance 5. New Orders for Capital Goods 6. Building Permits for Houses 7. Stock Prices 8. Money Supply 9. Interest-Rate Spread 10.Consumer Expectations

Source: The Conference Board


198

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms • fiscal policy

• Council of Economic Advisers (CEA)

• expansionary fiscal policy

• budget deficit

• contractionary fiscal policy

• budget surplus

• built-in stabilizer

• progressive tax system

• proportional tax system

• regressive tax system

• standardized budget

• cyclical deficit

• political business cycle

• crowding-out effect

• public debt

• U.S. Securities

• external public debt

• public investments


199

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Money and Banking


200

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

12 Money and

Banking


201

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • The Functions of Money and

the Components of the U.S. Money Supply

• What “Backs” the Money Supply, Making Us Willing to Accept It?

• The Makeup of the Federal Reserve and the U.S. Banking System

• The Functions and Responsibilities of the Federal Reserve


202

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Defined • The Functions of Money –Medium of Exchange

–Unit of Account

–Store of Value

• Components of the Money Supply –Currency

–Checkable Deposits

–Other Liquid Savings Deposits


203

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Defined • Currency –Coins and Paper Money –Token Money –Federal Reserve Notes

• Checkable Deposits –Commercial Banks –Thrift Institutions

• A Qualification –Government, Federal

Reserve, and Banks Excluded from M1


204

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Defined • M1 –Currency –Checkable Deposits

• M2 –Near-Monies –Savings Deposits Including

Money Market Deposit Accounts (MMDA)

–Small Time Deposits –Money Market Mutual Funds

(MMMF)


205

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Defined M1 M2

54%

46%

M1 20%

Savings Deposits

Including Money Market

Deposit Accounts (MMDA)

Small Time Deposits

Money Market Mutual

Funds Held By Individuals

(MMMF)

Currency

Checkable Deposits

15%

11%

54%

$1,375 Billion

$6,758 Billion

February 2006

Totals

+ +

+

+

+


206

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Defined • Money Definition MZM

–Money Zero Maturity

– Immediately Available

–From M2 Subtract Small Time Deposits

–Add Back Money Market Mutual Funds Owned by Businesses (MMMF)

–Slightly Larger than M2

–February 2005 M2 was $6,758 Billion and MZM was $6,934 Billion


207

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Supply • Are Credit Cards Money?

• What “Backs” the Money

Supply?

• Stable Value of Money

• Money as Debt

–Acceptability

–Legal Tender

–Relative Scarcity


208

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Supply • Money and Prices

–Purchasing Power of the Dollar

$V = 1/P

– Inflation and Acceptability

• Stabilizing Money’s

Purchasing Power

– Intelligent Management of the

Money Supply – Monetary Policy

–Appropriate Fiscal Policy


209

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Federal Reserve System

• The Federal Reserve

and the Banking System

–Historical Background

–Board of Governors

–Federal Open Market

Committee (FOMC)

•Open Market Operations


210

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Federal Reserve System Fed Functions and the Money Supply • Issuing Currency

• Setting Reserve Requirements

and Holding Reserves

• Lending Money to Banks and

Thrifts

–Discount Rate

• Check Collection

• Fiscal Agent for U.S.

• Supervising Banks

• Controlling the Money Supply


211

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Federal Reserve System Fed Functions and the Money Supply • Federal Reserve Independence

• Recent Developments –Relative Decline of Banks and

Thrifts

–Consolidation Among Banks and

Thrifts

–Convergence of Services

Provided by Financial Institutions

–Globalization of Financial

Markets

–Electronic Payments


212

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Financial Institutions

• Commercial Banks

• Thrifts

• Insurance Companies

• Mutual Fund Companies

• Pension Funds

• Securities Firms

Major U.S. Financial Institutions


213

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Global Greenback

• U.S. Currency Circulating Abroad – Russians $40 Billion

– Argentineans $7 Billion

– Polish $6 Billion

• U.S. Profits from Dollars Leaving

• Black Markets and Illegal Activities

• Seeking Stable Purchasing Power – Soviet Union Collapse

– Brazil Inflation Issues

– Asian Market Exchanges


214

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Global Greenback

• Financial Risks

–Exchange-Rate Risk

–Upside Opportunity

• Global Greenback a Positive Economic Force

• Results in Increased Output and Income Globally


215

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms • medium of exchange

• unit of account

• store of value

• M1

• token money

• Federal Reserve Notes

• checkable deposits

• commercial banks

• thrift institutions

• near-monies

• M2

• savings account

• money market deposit account (MMDA)

• time deposits

• money market mutual fund (MMMF)

• MZM

• legal tender

• Federal Reserve System

• Board of Governors

• Federal Reserve Banks

• Federal Open Market Committee (FOMC)

• financial services industry

• electronic payments


216

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Money Creation


217

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

13

Money

Creation


218

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • Why the U.S. Banking System is

Called a “Fractional Reserve” System

• Distinction Between a Bank’s Actual Reserves and Its Required Reserves

• How a Bank Can Create Money Through Granting Loans

• The Multiple Expansion of Loans and Money by the Entire Banking System

• The Monetary Multiplier and How to Calculate it


219

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Fractional Reserve System

• Balance Sheet

Assets = Liabilities + Net Worth

• Transactions Needed to

Enable Banks to Create

Money Through Lending

As Follows…


220

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Creating a Bank

• Control

–Banking Regulators

• Asset and Liability

–Transactions are Both

Transaction 4:

Excess Reserves

Excess

Reserves = -

Actual

Reserves

Required

Reserves


221

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Money Creating Transactions

Profits, Liquidity, and the Federal Funds Market

• Profit –Loans

–Securities

• Liquidity –Impact Upon Reserves

• Overnight Bank Loans

• Federal Funds Market –Federal Funds Rate


222

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Banking System

• Multiple-Deposit Expansion

• The Banking System’s Lending Potential

• Assumptions:

–20% Required Reserves

–All Banks “Loaned Up”

–Banks Lend All of Excess Reserves


223

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Banking System

Bank A

Bank B

Bank C

Bank D

Bank E

Bank F

Bank G

Bank H

Bank I

Bank J

Bank K

Bank L

Bank M

Bank N

Other Banks

Bank

(1) Acquired Reserves

and Deposits

(2) Required Reserves (Reserve

Ratio = .2)

(3) Excess

Reserves (1)-(2)

(4) Amount Bank Can Lend; New Money

Created = (3)

$100.00

80.00

64.00

51.20

40.96

32.77

26.21

20.97

16.78

13.42

10.74

8.59

6.87

5.50

21.99

$20.00

16.00

12.80

10.24

8.19

6.55

5.24

4.20

3.36

2.68

2.15

1.72

1.37

1.10

4.40

$80.00

64.00

51.20

40.96

32.77

26.21

20.97

16.78

13.42

10.74

8.59

6.87

5.50

4.40

17.59

$80.00

64.00

51.20

40.96

32.77

26.21

20.97

16.78

13.42

10.74

8.59

6.87

5.50

4.40

17.59

$400.00


224

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Monetary Multiplier Monetary Multiplier or Checkable-

Deposit Multiplier

Monetary

Multiplier =

1

Required Reserve Ratio

or in Symbols… m = 1

R New Reserves

$100

$20

Required

Reserves

$80

Excess

Reserves

$100

Initial

Deposit

$400

Bank System Lending

Money Created

Graphic

Example


225

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

The Monetary Multiplier

• Reversibility

–Making Loans Creates

Money

–Loan Repayment Destroys

Money

–Multiple Step Money

Expansion

–Multiple Step Destruction of

Money

W 13.2




226

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Bank Panics of 1930-1933

• Series of Bank Panics

• Before Deposit Insurance

• Mass Withdrawals From Fear

• Move to Cash Reduced Money Supply Through Reduction in Loans

• Multiple Contraction Slowed Lending and the Economy

• 1933 National Bank Holiday for One Week

• Resulted in FDIC and 25% Drop in Money Supply

• Contributed to the Great Depression

• Regulation Protects the System Today


227

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms

• fractional reserve banking

system

• balance sheet

• vault cash

• required reserves

• reserve ratio

• excess reserves

• actual reserves

• Federal funds rate

• monetary multiplier


228

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Interest Rates and Monetary Policy


229

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

14

Interest Rates and

Monetary Policy


230

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Chapter Objectives • How the Equilibrium Interest

Rate is Determined in the Market for Money

• The Goals and Tools of Monetary Policy

• The Federal Funds Rate and How the Fed Controls It

• The Mechanisms by Which Monetary Policy Affects GDP and the Price Level

• Effectiveness of Monetary Policy and its Shortcomings


231

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Interest Rates • Defined as the Price

Paid for the Use of Money

• Demand for Money

–Transactions Demand, D1

–Asset Demand, D2

–Total Money Demand, Dm

…Graphically

O 14.1

W 14.1






232

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Interest Rates Demand for Money and the Money Market

Rate

of

Inte

res

t, I p

erc

en

t

10

7.5

5

2.5

0 50 100 150 200 50 100 150 200 50 100 150 200 250 300

Amount of Money

Demanded

(Billions of Dollars)

Amount of Money

Demanded


Amount of Money

Demanded and Supplied


= +

(a) Transactions Demand for Money, Dt

(b) Asset

Demand for Money, Da

(c) Total

Demand for Money, Dm

And Supply

Dt Da Dm

Sm

5


233

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Interest Rates • Equilibrium Interest Rate

• Interest Rates and Bond Prices

–Bond Prices Fall When Interest Rates Rise

–Bond Prices Rise When Interest Rates Fall

–Inverse Relationship Between Interest Rates and Bond Prices

W 14.2

G 14.1






234

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Consolidated Balance Sheet Federal Reserve Banks

• Assets

–Securities

–Loans to Commercial Banks

• Liabilities

–Reserves of Commercial Banks

–Treasury Deposits

–Federal Reserve Notes Outstanding


235

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Tools of Monetary Policy • Open Market Operations –Buying Securities

• From Commercial Banks

• From the Public

–Selling Securities • To Commercial Banks

• To the Public

• When the Fed Sells Securities, Commercial Bank Reserves are Reduced

O 14.2

W 14.3






236

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Tools of Monetary Policy

New Reserves $1000

$5000

Bank System Lending

Total Increase in the Money Supply, ($5,000)

Fed Buys $1,000 Bond from

a Commercial Bank

$1000

Excess

Reserves


237

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Tools of Monetary Policy

Check is Deposited

New Reserves

$1000

Total Increase in the Money Supply, ($5000)

Fed Buys $1,000 Bond from

the Public

$200

Required

Reserves

$800

Excess

Reserves

$1000 Initial

Checkable Deposit

$4000

Bank System Lending


238

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Tools of Monetary Policy • The Reserve Ratio

–Raising the Reserve Ratio

–Lowering the Reserve Ratio

• The Discount Rate

–Borrowing from the Fed by Banks Increases Reserves and Enhances Lending Ability

• Relative Importance of Each


239

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Targeting the Federal Funds Rate

• Federal Funds Rate

Defined

• Expansionary Monetary

Policy (Easy Money)

–Prime Interest Rate

• Restrictive Monetary

Policy (Tight Money)

• The Taylor Rule W 14.4




240

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Monetary Policy • Cause-Effect Chain

• Market for Money

• Investment

• Equilibrium GDP

• Effects of an Expansionary

Monetary Policy

• Effects of a Restrictive

Monetary Policy

G 14.2




241

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Monetary Policy Expansionary Monetary Policy Problem: Unemployment and Recession

Fed Buys Bonds, Lowers Reserve Ratio, or Lowers the Discount Rate

Excess Reserves Increase

Federal Funds Rate Falls

Money Supply Rises

Interest Rate Falls

Investment Spending Increases

Aggregate Demand Increases

Real GDP Rises

CA

US

E-E

FF

EC

T C

HA

IN


242

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Monetary Policy Restrictive Monetary Policy Problem: Inflation

Fed Sells Bonds, Increases Reserve Ratio, or Increases the Discount Rate

Excess Reserves Decrease

Federal Funds Rate Rises

Money Supply Falls

Interest Rate Rises

Investment Spending Decreases

Aggregate Demand Decreases

Inflation Declines

CA

US

E-E

FF

EC

T C

HA

IN


243

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Monetary Policy • Evaluation and Issues –Speed and Flexibility –Isolation From Political

Pressure

• Recent U.S. Monetary Policy

• Problems and Complications –Recognition Lag –Administrative Lag –Operational Lag


244

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

AD-AS Theory of Price Level - Real Output and Stabilization Policy

Levels of

Output,

Employment,

Income, and

Prices

Aggregate

Demand

Aggregate

Supply

Input

Resources

With Prices

Productivity

Sources

Legal-

Institutional

Environment

Consumption

(Cd)

Investment

(Ig)

Net Export

Spending

(Xn)

Government

Spending

(G)


245

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

For the Fed - Life is a Metaphor

• The Fed as Mechanic

• The Fed as Warrior

• The Fed as the Fall Guy

• The Fed as Cosmic Force

• Really Concerned About Money


246

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show

Key Terms

• monetary policy

• transaction demand

• asset demand

• total demand for money

• reserve ratio

• discount rate

• Federal funds rate

• expansionary monetary policy

• Taylor rule

• cyclical asymmetry

• inflation targeting


247

Chapter Objectives

Economic

Perspective

Theories

Principles and

Models

Macro and

Microeconomics

Individual’s

Economizing

Problem

Society’s

Economizing

Problem

Production

Possibilities Model

Unemployment,

Growth, and the

Future

Last Word

Key Terms

End Show


Extending The Analysis of Aggregate Supply

Documents

Limits, Alternatives, · 2015-01-28 · Present Choices & Future Possibilities Goods for the Present re re Goods for the Present Presentville Futureville P F Current Curve Current