Baumol & Blinder MACROECONOMICS (11th ed)

LICENSED TO:

CHAPTER 9:

Demand-Side Equilibrium:

Unemployment or Inflation?

1.

The original equilibrium GDP is at Y 5 3,800, where spending equals output. This is shown by the intersection of the lower of the two expenditure lines in the graph above with the 45° line. The MPC calculated from the data is 0.90, so the multiplier is 10. If investment spending rises by $20 (to $260) the equilibrium GDP will increase by $20 3 10 5 $200, which is represented by a vertical shift (by $20) to the upper expenditure function in the diagram.

3.

FIGURE 2

GDP

At lower prices, the real value of money and other assets that are denominated in money terms is higher. Since wealth influences consumption, at lower prices consumption is higher.

5.Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 300 1 0.75DI

C 5 300 1 0.75(Y 2 1,200) C 5 300 1 0.75Y 2 900

C 5 2600 1 0.75Y

Y 5 2600 1 0.75Y 1 1,100 1 1,300 2 100 Y 5 0.75Y 1 1,700

0.25Y 5 1,700

Y 5 4 3 1,700 5 6,800

This algebraic model yields the same equilibrium GDP as Table 3 and Figure 10 in the chapter.

Compared to the answer to Test Yourself Question 4, we find $800 more in GDP from a $200 increase in I. Thus this question demonstrates that the multiplier of 4 applies to changes in I as well as to changes in C.

7.

FIGURE 3

The graph above indicates that equilibrium GDP rises from 1,320 to 1,440, or by 120. The oversimplified multiplier formula can be used in this case. The marginal propensity to consume can be calculated between any two income levels. The numbers in the table above show that each $60 of additional income leads to $40 more in consumer spending, so the MPC is 40/60 5 2/3, and the multiplier is 1/[1 2 (2/3)] 5 3. So a shift in consumption of 40 should raise equilibrium GDP by 120, which it does.

Answers to Appendix A Questions

1.Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 150 1 0.75(Y 2 400)

C 5 150 1 0.75Y 2 300

C 5 2150 1 0.75Y

Y 5 2150 1 0.75Y 1 300 1 400 2 50

Y 5 0.75Y 1 500 0.25Y 5 500

Y 5 4 3 500 5 2,000

3.Saving is equal to disposable income minus consumption. In Question 1: S 5 (Y 2 T) 2 C

S 5 (2,000 2 400) 2 [2150 1 0.75(2000)]

S 5 1,600 2 (2150 1 1,500)

S 5 1,600 2 1,350

S 5 250

S is not equal to I. (In Question 2, S is equal to I. The difference is that X and IM are equal in Question 2 but unequal in Question 1.

5.(a) Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 100 1 0.8(Y 2 500)

C 5 100 1 0.8Y 2 400

C 5 2300 1 0.8Y

Y 5 2300 1 0.8Y 1 700 1 500 1 0

Y 5 0.8Y 1 900 0.2Y 5 900

Y 5 5 3 900 5 4,500

(b)S 5 (Y 2 T ) 2 C

S 5 (4,500 2 500) 2 [2300 1 0.8(4,500)]

S 5 4,300 2 3,600 5 700, which is equal to investment, so S 5 I.

(c)Now X 2 IM 5 100, so the last four lines of 5(a) above are replaced by

Y 5 2300 1 0.8Y 1 700 1 500 1 100

Y 5 0.8Y 1 1,000 0.2Y 5 1,000

Y 5 5 3 1,000 5 5,000

S 5 (Y 2 T) 2 C

S 5 (5,000 2 500) 2 [2300 1 0.8(5,000)]

S 5 4,800 2 4,000 5 800 Now, S is not equal to I.

Answers to Appendix B Questions

1.

FIGURE 4

3. In Figure 4, the intersection of the upper expenditure line with the 45° line shows an equilibrium GDP of 4,500. (The lower expenditure line shows the solution to Test Yourself Question 2, with a GDP of 4,000.) Exports have risen by 250, and GDP has risen by 500, so the multiplier is 2.

LICENSED TO:

CHAPTER 10:

Supply-Side Equilibrium:

Unemployment AND Inflation?

1.

FIGURE 1

Full employment

Equilibrium real output is $3,000, while the price level is 100. Since full employment is at $2,800 billion, there is an inflationary gap of 200.

3.

FIGURE 2

(a)In Chapter 9, Test Yourself Question 2, the marginal propensity to consume was 0.9, and the (oversimplified) multiplier was therefore 10. The table in this question confirms that when investment rises by 20, from 240 to 260, aggregate demand rises by 200 at any given price level. For example, at a price level of 105, aggregate demand rises from 3,770 to 3,970.

(b)Initial equilibrium: P 5 100, Y 5 3,800. Eventual equilibrium: P 5 110, Y 5 3,940. The multiplier, taking account of price increases, is 140/20 5 7, which is less than 10.

CHAPTER 11:

Managing Aggregate Demand: Fiscal

Policy

1.

FIGURE 1

Equilibrium GDP is 1,720 (see diagram). The marginal propensity to consume is 0.75 and the multiplier is 4. If government purchases fall by 60, and the price level is unchanged, GDP would fall by 4 3 60 5 240, that is, to 1,480.

3.At each level of GDP, G is now higher by 120, while C is lower by 3⁄4 of 120, or 90. Therefore, there is a net increase in total expenditure of 30 at each level of GDP, as shown in the following table:

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400 APPENDIX

Equilibrium GDP is now 1,840, which is 120 more than in Test Yourself Question 1.

5.The answer to Test Yourself Question 2 is 1,720. So you want to increase GDP by 120 (raising it to 1,840). Because the marginal propensity to consume is 0.75, and the marginal tax rate is 1⁄3, the multiplier is 2. Therefore, you must take some action that will have the initial effect of raising expenditure by 60. You may raise government spending on GDP by 60, or you may lower taxes or raise transfer payments by 80 (since 3⁄4 of 80 is 60).

Answers to Appendix A Questions

1.(a) variable tax (as GDP rises, people drive more);

(b)variable tax; (c) fixed tax; (d) variable tax

3.The higher fixed tax reduces consumer spending, but the lower income-tax rate increases consumer spending. The question is: which effect is larger? The answer is found by seeing which tax change is larger, since C

depends on DI 5 Y 2 T. At a GDP of Y 5 10,000 billion, a two percentage point cut in the income-tax rate reduces tax receipts by $200 billion, which is larger than the

$100 billion fixed-tax increase. So C, and hence equilibrium GDP on the demand side, rises.

Answers to Appendix B Questions

1.Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 120 1 0.8DI DI 5 Y 2 T

DI 5 Y 2 (200 1 0.25Y)

DI 5 0.75Y 2 200

C 5 120 1 0.8(0.75Y 2 200)

C 5 120 1 0.6Y 2 160

C 5 0.6Y 2 40

Y 5 0.6Y 2 40 1 320 1 480 2 80

Y 5 0.6Y 1 680 0.4Y 5 680

Y 5 (1/0.4) 3 680

Y 5 2.5 3 680 5 1,700 Equilibrium GDP is 1,700.

There are three different ways to find the multipliers, any one of which is correct.

for government purchases:

1.Note from the preceding equations that equilibrium GDP is 2.5 times all autonomous spending. Since G is autonomous spending, the multiplier for G is 2.5.

2.Raise G from 480 to 481. Working through the algebra above, this comes to 0.4Y 5 681, which implies that Y 5 1,702.5. So the increase in G of 1 has raised Y by 2.5, and the multiplier is 2.5.

3.From the formula in the appendix, the multiplier is 1/1 2b(12t) 5 1/[1 20.8(1 20.25)] 5 1/[1 20.8(0.75)]

5 1/(1 2 0.6) 5 1/0.4 5 2.5

for fixed taxes:

1.Note that a rise in fixed taxes decreases GDP (so the sign of the multiplier is negative) and that it increases

spending in the first round by the marginal propensity to consume times the tax reduction. So the tax multiplier is the multiplier found above, multiplied by (minus) the MPC, or 2.5 3 (20.8) 5 22.

2.Raise fixed taxes in the model from 200 to 201. Working through the algebra, this comes to

0.4Y 5 679.2, or Y 5 1,698. So an increase in taxes of

1has reduced GDP by 2, and the multiplier is 22.

3.From the formula in the appendix, the tax multiplier is

2b/1 2 b (1 2 t) 5 20.8/[1 2 0.8(1 2 0.25)] 5 20.8/[1

20.8(0.75)] 5 20.8/(1 2 0.6) 5 20.8/0.4 = 22

To raise GDP by 100, the government can (a) raise G by 40, and the multiplier of 2.5 will do the rest, or (b) lower taxes or raise transfer payments by 50, and the multiplier of –2 will do the rest.

3.(a) Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 0.9(Y 2 T)

C 5 0.9[Y 2 ( 1⁄3 )Y]

C 5 0.9[( 2⁄3 )Y]

C 5 0.6Y

Y 5 0.6Y 1 100 1 540 2 40

Y 5 0.6Y 1 600 0.4Y 5 600

Y 5 (1/0.4) 3 600

Y 5 2.5 3 600 5 1,500 Budget deficit 5 G 2 T

5 540 2 [( 1⁄3 ) 3 1500]

5 540 2 500

5 40

(b)Since the budget deficit in part a is 40, the government would reduce its purchases by 40, to 500. Repeating the steps above, but now with G 5 500:

Y 5 0.6Y 1 100 1 500 2 40

Y 5 0.6Y 1 560 0.4Y 5 560

Y 5 (1/0.4) 3 560

Y 5 2.5 3 560 5 1,400 Budget deficit 5 G 2 T

5 500 2 [( 1⁄3 ) 3 1,400]

5 500 2 4662⁄3

5 331⁄3

GDP falls by 100, to 1,400. That drop reduces tax receipts, which are one-third of GDP, by 331⁄3 (to 4662⁄3). So in the new equilibrium, the deficit has fallen by only 62⁄3 (to 331⁄3), not by the full 40 in lower spending. Although G fell by the amount of the deficit, this in turn caused Y to fall, which in turn lowered taxes, and the deficit persisted.

CHAPTER 12:

Money and the Banking System

1.Under those conditions, the money multiplier is 1/.10, or 10, so an infusion of $12 million into reserves will support an increase in money of $120 million.

The Fed simply creates the $5 billion (in the form of bank reserves) to buy the bonds. In the long run, it makes no difference whether the Fed buys the bonds from a bank or from an individual. In this case, Bank of America’s $5 billion in new reserves are offset by $5 billion in new deposits, so that not all of the new reserves are excess reserves, whereas if the Fed had bought the bonds from Bank of America directly there would have been no change in deposits, and all the new reserves would have been excess. In the long run, however, the new reserves of $5 billion will support the same increase in deposits. Why? Because in this case, the original transaction between the Fed and Bill Gates already creates $5 billion in new deposits.

CHAPTER 14:

The Debate over Monetary and Fiscal Policy

1.Based on recent data, the velocity of money in the United States, for M1, is about 9.5–10. Students will probably calculate a much higher velocity for themselves.

3.In Figure 1, M0S0 is the initial money supply. The demand for money falls from M0D0 to M1D1; as a consequence, the quantity of money in the economy falls from

M0 to M1, and the interest rate falls from r0 to r1. The Fed has three choices.

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402APPENDIX

(a)It can accept the new money supply and interest rate.

(b)It can restore the previous interest rate, r0, by lowering the money supply curve to M1S1. This will further reduce the quantity of money to M2.

(c)If it follows a monetarist policy, it can restore the

original quantity of money, M0, by increasing the supply curve to M2S2. This will have the effect of reducing the interest rate still further, to r2.

public holds in currency (zero in part (a), 0.2D in part (b)). In part (a), the monetary base (B 5 R 1 C ) and bank reserves are identical because C 5 0. So all $10 billion in new monetary base goes into bank reserves, where it supports $50 billion in new deposits. But in part (b), half of the new $10 billion in monetary base gets absorbed by currency holdings, leaving an increase of only $5 billion in bank reserves—which supports only $25 billion in new deposits.

FIGURE 1

5.(a) Since people hold no currency, M 5 D. Both M and D will therefore be (1/0.2) 3 $50 billion 5 5 3 $50 billion 5 $250 billion. If the Fed increases reserves to $60 billion, M and D will rise to $300 billion instead. The money multiplier is therefore $50/$10 5 5.

(b)Now, since people hold currency, M 5 C 1 D 5 1.2D, because C 5 0.2D. The $50 billion monetary base (B 5 50) must now serve two purposes: bank reserves plus currency, B 5 R 1 C. Since R 5 0.2D (reserve requirements) and C 5 0.2D (currency holdings), this means B 5 0.4D. With B 5 50, D 5 125 now. But now people also hold 0.2 3 $125 5 $25 billion in currency, so the money supply is M 5 D 1 C 5 $150. Notice that the money supply is much less than in part (a). The reason is that half of the monetary base is now used as currency rather than as bank reserves. (Notice that required reserves are 0.2 3 $125 5 $25 billion and cash holdings are also $25 billion.)

When the Fed increases the monetary base to $60 billion, the equation B 5 R 1 C now becomes 60 5 .4D, so deposits rise to D 5 $150 billion ($60/0.4). With an additional C 5 $30 billion in cash in circulation (0.2 3 $150), the money supply will rise to M 5 D 1 C 5 $150 1 $30 5 $180. So the money multiplier is just $30/$10 5 3 now.

(c)As the monetary base increases, the money supply M increases as well. However, the size of the increase in the money supply depends both on the required reserve ratio (0.2) in the example and how much the

CHAPTER 15:

Budget Deficits in the Short and

Long Run

1.The budget deficit is an annual-flow concept. It is the excess of government expenditures over government revenues in a given year. The national debt is an accumulated stock of debt. It is increased each year by the deficit or reduced by the surplus. If the deficit becomes a surplus, the debt will fall (although the accumulated debt may still be very large).

3.Expansionary monetary policy will raise GDP, and this will raise tax receipts. The lower interest rates will also decrease the government’s interest payments. Both changes will reduce the government’s budget deficit. If the government tries to counteract the Fed’s positive effect on aggregate demand, it will institute a more contractionary fiscal policy by decreasing government spending or raising taxes, or both. The deficit will shrink still more.

CHAPTER 16:

The Trade-Off between Inflation and Unemployment

1.Figure 1 shows that when the aggregate supply curve is vertical, shifting aggregate demand curves change only the price level, not output.

FIGURE 1

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CHAPTER 17:

International Trade and

Comparative Advantage

1.(a) In the absence of trade, 1 barrel of wine costs 4 yards of cloth in England.

(b)In the absence of trade, 1 barrel of wine costs 2 yards of cloth in Portugal.

(c)

FIGURE 1

(d)Portugal has the absolute advantage in the production of both goods, and the comparative advantage in wine. England has the comparative advantage in cloth.

(e)When trade opens, England will specialize in cloth and export it to Portugal, which in turn will specialize in wine and export it to England.

(f)In the international market, the price of a barrel of wine will wind up somewhere between 4 yards and 2 yards of cloth, perhaps 3. Stated another way, the price of 1 yard of cloth will be between 1⁄2 gallon of wine and 1⁄4 gallon of wine.

Answers to Appendix Questions

1. (a)

FIGURE 3

(b)If there is no trade, in the United States the equilibrium price is $5,000 and the equilibrium quantity is 50,000 units. In Japan, the price is $1,000 and the quantity is 50,000.

(c)The new world price will be $3,000 because, at that price, world quantity demanded is 100,000 units (70,000 plus 30,000) and world quantity supplied is also 100,000 units (40,000 plus 60,000). The price of computers has fallen in the United States and risen in Japan. (Note: To arrive at the answer graphically, construct world demand and supply curves. The equilibrium will be found at a world price of $3,000.)

(d)Japan will export 30,000 computers.

(e)In the United States, computer production falls from 50,000 to 40,000, and therefore employment in the computer industry falls. In Japan, computer production rises from 50,000 to 60,000, with a consequent increase in employment. Initially, American consumers and Japanese computer producers (both employers and employees) are helped by free trade, while American computer producers and Japanese consumers are hurt.

CHAPTER 18:

The International Monetary System: Order or Disorder?

1.One can use supply and demand curves for either the yen or the dollar. If one chooses the market for dollars, then the exchange rate measured on the vertical axis is the price of a dollar in yen:

(a)Japanese imports increase and U.S. exports increase. So the demand for dollars rises, and the dollar therefore appreciates.

(b)Because Japanese stocks are less attractive, there is less capital outflow from the United States to Japan to buy stocks. The supply of dollars decreases, and the dollar therefore appreciates.

(c)With lower interest rates, American financial assets become less attractive. So capital flows out of the United States (or less flows in). This increases the supply of dollars, leading to a depreciation of the dollar.

(d)The increase in foreign aid increases the supply of dollars and leads to a depreciation of the dollar.

(e)Because the Japanese economy booms and the U.S. economy is in a recession, Japanese imports increase while U.S. imports fall. Japanese demand for dollars therefore increases, while US supply of dollars decreases. So the dollar appreciates.

(f ) At any given exchange rate, higher U.S. inflation causes an increase in imports and a decrease in exports. This leads to consequent increases in the supply of dollars and decreases in the demand for dollars. Therefore, the dollar depreciates.

3.Items (a) and (c) would lead to a depreciation of the dollar. Items (b) and (e) would lead to an appreciation. Item

(d) would have no effect on the value of the dollar because it is purely a domestic transaction.

404 APPENDIX

CHAPTER 19:

Exchange Rates and the Macroeconomy

1.In Figure 1, the economy begins at A, with price P0 and output Y0, resulting from aggregate demand D0 and aggregate supply S0. The currency appreciation leads to a decrease in exports and therefore a decrease in aggregate

demand to D1. Because imported inputs become less expensive, it also leads to an increase in aggregate sup-

ply to S1. The price level will definitely fall, to P1 in the diagram. Whether output falls or rises depends on the relative strength of the aggregate demand and aggregate supply effects, but since the aggregate demand shift is probably greater, output is likely to decrease, as shown in the diagram, to Y1.

FIGURE 1

D0

S0

S1

P0

LevelPrice

P1

D0

S0

S1

D1

Y1 Y0

GDP

3. (a)

Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 150 1 .75DI

C 5 150 1 .75(.8)Y

C 5 150 1 .6Y

I 5 300 1 .2Y 2 50(r)

I 5 300 1 .2Y 2 50(8)

I 5 .2Y 2 100

(X 2 IM) 5 300 2 (250 1 .2Y) (X 2 IM) 5 50 2 .2Y

Y 5 150 1 .6Y 1 .2Y 2 100 1 800 1 50 2 .2Y Y 5 900 1 .6Y

.4Y 5 900

Y 5 2.5(900)

Y 5 2,250

G 2 T 5 800 2 .2(2,250)

G 2 T 5 800 2 450

G 2 T 5 350

X 2 IM 5 50 2 .2(2,250)

X 2 IM 5 50 2 450

X 2 IM 5 2400

(b)

Y 5 C 1 I 1 G 1 (X 2 IM)

C 5 150 1 .75DI

C 5 150 1 .75(.8)Y

C 5 150 1 .6Y

I 5 300 1 .2Y 2 50(r)

I 5 300 1 .2Y 2 50(8)

I 5 .2Y 2 100

(X 2 IM) 5 250 2 (.2Y)

(X 2 IM) 5 250 2 .2Y

Y 5 150 1 .6Y 1 .2Y 2 100 1 800 1 250 2 .2Y Y 5 1,100 1 .6Y

.4Y 5 1,100

Y 5 2.5(1,100)

Y 5 2,750

G 2 T 5 800 2 .2(2,750)

G 2 T 5 800 2 55

G 2 T 5 250

X 2 IM 5 250 2 .2(2,750)

X 2 IM 5 250 2 550

X 2 IM 5 2300

Absolute advantage One country is said to have an absolute advantage over another in the production of a particular good if it can produce that good using smaller quantities of resources than can the other country. (p. 343)

Abstraction Abstraction means ignoring many details so as to focus on the most important elements of a problem. (p. 8)

Aggregate demand Aggregate demand is the total amount that all consumers, business firms, and government agencies spend on final goods and services. (p. 154)

Aggregate demand curve The aggregate demand curve shows the quantity of domestic product that is demanded at each possible value of the price level. (pp. 86, 180)

Aggregate supply curve The aggregate supply curve shows, for each possible price level, the quantity of goods and services that all the nation’s businesses are willing to produce during a specified period of time, holding all other determinants of aggregate quantity supplied constant. (pp. 86, 200)

Aggregation Aggregation means combining many individual markets into one overall market. (p. 84)

Allocation of resources Allocation of resources refers to the society’s decisions on how to divide up its scarce input resources among the different outputs produced in the economy and among the different firms or other organizations that produce those outputs. (p. 47)

Appreciate A nation’s currency is said to appreciate when exchange rates change so that a unit of its currency can buy more units of foreign currency. (pp. 362, 381)

Asset An asset of an individual or business firm is an item of value that the individual or firm owns. (p. 251)

Automatic stabilizer An automatic stabilizer is a feature of the economy that reduces its sensitivity to shocks, such as sharp increases or decreases in spending. (p. 225)

Autonomous increase in consumption

An autonomous increase in consumption is an increase in consumer spending

without any increase in consumer incomes. It is represented on a graph as a shift of the entire consumption function. (p. 189)

Balance of payments deficit The balance of payments deficit is the amount by which the quantity supplied of a country’s currency (per year) exceeds the quantity demanded. Balance of payments deficits arise whenever the exchange rate is pegged at an artificially high level. (p. 369)

Balance of payments surplus The balance of payments surplus is the amount by which the quantity demanded of a country’s currency (per year) exceeds the quantity supplied. Balance of payments surpluses arise whenever the exchange rate is pegged at an artificially low level. (p. 369)

Balance sheet A balance sheet is an accounting statement listing the values of all assets on the left side and the values of all liabilities and net worth on the right side. (p. 252)

Barter Barter is a system of exchange in which people directly trade one good for another, without using money as an intermediate step. (p. 243)

Budget deficit The budget deficit is the amount by which the government’s expenditures exceed its receipts during a specified period of time, usually a year. If receipts exceed expenditures, it is called a budget surplus instead. (pp. 303, 387)

Budget surplus The budget surplus is the amount by which the government’s receipts exceed its expenditures during a specified period of time, usually a year. If expenditures exceed receipts, it is called a budget deficit instead. (p. 303)

Capital A nation’s capital is its available supply of plant, equipment, and software. It is the result of past decisions to make investments in these items. (pp. 138)

Capital account The capital account balance includes purchases and sales of financial assets to and from citizens and companies of other countries. (p. 370)

Capital formation Capital formation is synonymous with investment. It refers to the process of building up the capital stock. (p. 138)

Capital gain A capital gain is the difference between the price at which an asset is sold and the price at which it was bought. (p. 122)

Central bank A central bank is a bank for banks. The United States’ central bank is the Federal Reserve System. (p. 263)

Central bank independence Central bank independence refers to the central bank’s ability to make decisions without political interference. (p. 264)

Closed economy A closed economy is one that does not trade with other nations in either goods or assets. (pp. 24, 385)

Commodity money Commodity money is an object in use as a medium of exchange, but that also has a substantial value in alternative (nonmonetary) uses. (p. 245)

Comparative advantage One country is said to have a comparative advantage over another in the production of a particular good relative to other goods if it produces that good less inefficiently as compared with the other country. (pp. 49, 343)

Consumer expenditure Consumer expenditure (C) is the total amount spent by consumers on newly produced goods and services (excluding purchases of new homes, which are considered investment goods). (p. 154)

Consumer Price Index (CPI) The Consumer Price Index (CPI) is measured by pricing the items on a list representative of a typical urban household budget. (p. 128)

Consumption function The consumption function shows the relationship between total consumer expenditures and total disposable income in the economy, holding all other determinants of consumer spending constant. (p. 160)

Convergence hypothesis The convergence hypothesis holds that nations with low levels of productivity tend to have high productivity growth rates, so that international productivity differences shrink over time. (p. 137)

Coordination failure A coordination failure occurs when party A would like to change his behavior if party B would

405

change hers, and vice versa, and yet the two changes do not take place because the decisions of A and B are not coordinated. (p. 184)

Correlated Two variables are said to be correlated if they tend to go up or down together. Correlation need not imply causation. (p. 10)

Cost disease of the personal services

The cost disease of the personal services is the tendency of the costs and prices of these services to rise persistently faster than those of the average output in the economy. (p. 146)

Crowding in Crowding in occurs when government spending, by raising real GDP, induces increases in private investment spending. (p. 311)

Crowding out Crowding out occurs when deficit spending by the government forces private investment spending to contract. (p. 310)

Current account The current account balance includes international purchases and sales of goods and services, crossborder interest and dividend payments, and cross-border gifts to and from both private individuals and governments. It is approximately the same as net exports. (p. 370)

Cyclical unemployment Cyclical unemployment is the portion of unemployment that is attributable to a decline in the economy’s total production. Cyclical unemploymentrises during recessions and falls as prosperity is restored. (p. 114)

Deflating Deflating is the process of finding the real value of some monetary magnitude by dividing by some appropriate price index. (p. 129)

Deflation Deflation refers to a sustained decrease in the general price level. (p. 93)

Demand curve A demand curve is a graphical depiction of a demand schedule. It shows how the quantity demanded of some product will change as the price of that product changes during a specified period of time, holding all other determinants of quantity demanded constant. (p. 58)

Demand schedule A demand schedule is a table showing how the quantity demanded of some product during a specified period of time changes as the price of that product changes, holding all other determinants of quantity demanded constant. (p. 58)

Demand-side inflation Demand-side inflation is a rise in the price level caused by rapid growth of aggregate demand. (p. 318)

Deposit creation Deposit creation refers to the process by which a fractional reserve banking system turns $1 of bank reserves into several dollars of bank deposits. (p. 252)

Deposit insurance Deposit insurance is a system that guarantees that depositors will not lose money even if their bank goes bankrupt. (p. 250)

Depreciate A nation’s currency is said to depreciate when exchange rates change so that a unit of its currency can buy fewer units of foreign currency. (p. 362)

Depreciation Depreciation is the value of the portion of the nation’s capital equipment that is used up within the year. It tells us how much output is needed just to maintain the economy’s capital stock. (pp. 171, 381)

Devaluation A devaluation is a reduction in the official value of a currency. (p. 363)

Development assistance Development assistance (“foreign aid”) refers to outright grants and low-interest loans to poor countries from both rich countries and multinational institutions like the World Bank. The purpose is to spur economic development. (p. 147)

Discount rate The discount rate is the interest rate the Fed charges on loans that it makes to banks. (p. 270)

Discouraged worker A discouraged worker is an unemployed person who gives up looking for work and is therefore no longer counted as part of the labor force. (p. 114)

Disposable income Disposable income (DI) is the sum of the incomes of all individuals in the economy after all taxes have been deducted and all transfer payments have been added. (p. 155)

Division of labor Division of labor means breaking up a task into a number of smaller, more specialized tasks so that each worker can become more adept at a particular job. (p. 48)

Dumping Dumping means selling goods in a foreign market at lower prices than those charged in the home market. (p. 353)

Economic model An economic model is a simplified, small-scale version of some

aspect of the economy. Economic models are often expressed in equations, by graphs, or in words. (p. 10)

Efficiency A set of outputs is said to be produced efficiently if, given current technological knowledge, there is no way one can produce larger amounts of any output without using larger input amounts or giving up some quantity of another output. (p. 47)

Equation of exchange The equation of exchange states that the money value of GDP transactions must be equal to the product of the average stock of money times velocity. That is: M 3 V 5 P 3 Y (p. 278)

Equilibrium An equilibrium is a situation in which there are no inherent forces that produce change. Changes away from an equilibrium position will occur only as a result of “outside events” that disturb the status quo. (pp. 65, 176)

Excess reserves Excess reserves are any reserves held in excess of the legal minimum. (p. 252)

Exchange rate The exchange rate states the price, in terms of one currency, at which another currency can be bought. (pp. 362, 381)

Expenditure schedule An expenditure schedule shows the relationship between national income (GDP) and total spending. (p. 179)

Export subsidy An export subsidy is a payment by the government to exporters to permit them to reduce the selling prices of their goods so they can compete more effectively in foreign markets. (p. 349)

Factors of production Inputs or factors of production are the labor, machinery, buildings, and natural resources used to make outputs. (p. 22)

Federal funds rate The federal funds rate is the interest rates that banks pay and receive when they borrow reserves from one another. (p. 266)

Fiat money Fiat money is money that is decreed as such by the government. It is of little value as a commodity, but it maintains its value as a medium of exchange because people have faith that the issuer will stand behind the pieces of printed paper and limit their production. (p. 246)

Final goods and services Final goods and services are those that are purchased by their ultimate users. (p. 89)