Chapter 34 Summary

A. The Economic Consequences of the Debt 1. Budgets are systems used by governments and organizations to plan and control expenditures and revenues. Budgets are in surplus (or deficit) when the government has revenues greater (or less) than its expenditures. Macroeconomic policy depends upon fiscal policy, comprised of the overall stance of spending and taxes. 2. Economists separate the actual budget into its structural and cyclical components. The structural budget calculates how much the government would collect and spend if the economy were operating at potential output. The cyclical budget accounts for the impact of the business cycle on tax revenues, expenditures, and the deficit. To assess fiscal policy, we should pay close attention to the structural deficit; changes in the cyclical deficit are a result of changes in the economy, while structural deficits are a cause of changes in the economy. 3. The government debt represents the accumulated borrowings from the public. It is the sum of past deficits. A useful measure of the size of the debt is the debt-GDP ratio, which for the United States has tended to rise during wartime and fall during peacetime. The 1980s were an exception, for the debt-GDP ratio rose sharply during this period. 4. In the short run, economists worry that structural government deficits crowd out investment. The extent of crowding out depends upon financial markets and international linkages, the determinants of investment, and how deficits are financed. The best bet today is that, outside of deep recessions, national investment (both domestic and foreign) will be significantly crowded out by government spending. 5. To the degree that we borrow from abroad for consumption and pledge posterity to pay back the interest and principal on such external debt, our descendants will indeed find themselves sacrificing consumption to service this debt. If we leave future generations an internal debt but no change in capital stock, there are various internal effects. The process of taxing Peter to pay Paula, or taxing Paula to pay Paula, can involve various distortions of productivity and efficiency but should not be confused with owing money to another country. 6. Economic growth may slow if the public debt displaces capital. This syndrome occurs when people substitute public debt for capital or private assets, thereby reducing the economy's private capital stock. In the long run, a larger government debt may slow the growth of potential output and consumption because of the costs of servicing an external debt, the inefficiencies that arise from taxing to pay the interest on the debt, and the diminished capital accumulation that comes from capital displacement. B. Stabilizing the Economy 7. Nations face two considerations in setting monetary and fiscal policies: the appropriate level of aggregate demand and the best monetary-fiscal mix. The mix of fiscal and monetary policies helps determine the composition of GDP. A high-investment strategy would call for a budget surplus along with low real interest rates. 8. After the Keynesian revolution, many economists had high hopes for countercyclical stabilization policy. In practice, fiscal policy has proved a cumbersome policy, particularly because of the difficulty of raising taxes and cutting expenditures during inflationary periods. Consequently, the United States today relies almost entirely upon monetary policy to stabilize the economy. 9. Should governments follow fixed rules or discretion? The answer involves both positive economics and normative values. Conservatives often espouse rules, while liberals often advocate active fine-tuning to attain economic goals. More basic is the question of whether active and discretionary policies stabilize or destabilize the economy. Economists often stress the need for credible policies, whether credibility is generated by rigid rules or by wise leadership. A recent trend among countries is inflation targeting for monetary policy, which is a flexible rule-based system that sets a medium-term inflation target while allowing short-run flexibility when economic shocks make attaining a rigid inflation target too costly. C. Economic Prospects in the New Century 10. Remember the dictum: "Productivity isn't everything, but in the long run it is almost everything." A country's ability to improve its living standards over time depends almost entirely on its ability to improve the technologies and capital used by the work force. 11. Promoting economic growth entails advancing technology. The major role of government is to ensure free markets, protect strong intellectual property rights, promote vigorous competition, and support basic science and technology.

Chapter 33 Summary

A. Classical Stirrings and Keynesian Revolution 1. Classical economists relied upon Say's Law of Markets, which holds that "supply creates its own demand." In modern language, the classical approach means that flexible wages and prices quickly erase any excess supply or demand and quickly reestablish full employment and full utilization of capacity. In a classical system, macroeconomic policy has no role to play in stabilizing the real economy, although it will still determine the path of prices. 2. The Keynesian revolution postulated inflexibility of prices and wages, so output and unemployment are determined by the interaction of supply and demand forces. The Keynesian AS curve is upward-sloping rather than classically vertical, and monetary or fiscal policies therefore affect both prices and real output. There is no automatic self-correcting price mechanism, and the economy can therefore experience prolonged periods of depression or inflation. 3. In the modern Keynesian view, monetary and fiscal policies can substitute for flexible wages and prices, stimulating the economy during recessions and slowing aggregate demand during booms to forestall inflationary tendencies. B. The Monetarist Approach 4. Monetarism holds that the money supply is the primary determinant of short-run movements in both real and nominal GDP as well as of long-run movements in nominal GDP. 5. Monetarism relies upon the analysis of trends in the velocity of money to understand the impact of money on the economy. The income velocity of circulation of money (V) is defined as the ratio of the dollar GDP flow to the stock of M: V = PQ/M = GDP/M While V is definitely not a constant - if only because it rises with interest rates - monetarists count on its movements being regular and predictable. 6. From velocity's definition comes the quantity theory of prices: P = kM where k = V/Q The quantity theory of prices regards P as almost strictly proportional to M. This view is useful for understanding hyperinflations and certain long-term trends, but it should not be taken literally. 7. The monetarist school holds to three major propositions: (a) The growth of the money supply is the major systematic determinant of nominal GDP growth; (b) prices and wages are relatively flexible; and (c) the private economy is stable. These propositions suggest that macroeconomic fluctuations arise primarily from erratic money-supply growth. 8. Monetarism is generally associated with a laissez-faire and anti-big-government political philosophy. Because of a desire to avoid active government and a belief in the inherent stability of the private sector, monetarists often propose that the money supply grow at a fixed rate of 3 or 5 percent annually. Some monetarists believe that this will produce steady growth with stable prices in the long run. 9. The Federal Reserve conducted a full-scale monetarist experiment from 1979 to 1982. The experience from this period convinced remaining skeptics that money is a powerful determinant of aggregate demand and that most of the short-run effects of money changes are on output rather than on prices. However, as suggested by the Lucas critique, velocity may become quite unstable when a monetarist approach is followed. C. New Classical Macroeconomics 10. New classical macroeconomics rests on two fundamental hypotheses: People's expectations are formed efficiently and rationally, and prices and wages are flexible. It follows from these assumptions in a new classical economy that unemployment is voluntary. Further, the Phillips curve is vertical in the short run, even though it may appear otherwise. The theory of the real business cycle points to supply-side technological disturbances and labor market shifts as the clue to business-cycle fluctuations. 11. The policy ineffectiveness theorem holds that predictable government policies cannot affect real output and unemployment. The new classical theory states that, while we may observe a downward-sloping short-run Phillips curve, we cannot exploit the slope for the purposes of lowering unemployment. If economic policymakers systematically attempt to increase output and decrease unemployment, people will soon come to understand and to anticipate the policy. Fixed policy rules will produce better economic outcomes. 12. Critics of new classical macroeconomics argue that prices and wages are inflexible in the short run. And the predictions - particularly that business cycles are caused by misperceptions and that cyclical unemployment comes when confused people quit their jobs - seem farfetched as an explanation of serious downturns, like those of the 1930s or early 1980s in the United States and of the 1990s in Europe. 13. Study the interim appraisal for the current mainstream synthesis of the warring schools of macroeconomics.

Chapter 32 Summary

A. Nature and Impacts of Inflation 1. Recall that inflation occurs when the general level of prices is rising. The rate of inflation is the percentage change in a price index from one period to the next. The major price indexes are the consumer price index (CPI) and the GDP deflator. 2. Like diseases, inflations come in different strains. We generally see low inflation in the United States (a few percentage points annually). Sometimes, galloping inflation produces price rises of 50 or 100 or 200 percent each year. Hyperinflation takes over when the printing presses spew out currency and prices start rising many times each month. Historically, hyperinflations have almost always been associated with war and revolution. 3. Inflation affects the economy by redistributing income and wealth and by impairing efficiency. Unanticipated inflation usually favors debtors, profit seekers, and risk-taking speculators. It hurts creditors, fixed-income classes, and timid investors. Inflation leads to distortions in relative prices, tax rates, and real interest rates. People take more trips to the bank, taxes may creep up, and measured income may become distorted. And when central banks take steps to lower inflation, the real costs of such steps in terms of lower output and employment can be painful. B. Modern Inflation Theory 4. At any time, an economy has a given inertial or expected inflation rate. This is the rate that people have come to anticipate and that is built into labor contracts and other agreements. The inertial rate of inflation is a short-run equilibrium and persists until the economy is shocked. 5. In reality, the economy receives incessant price shocks. The major kinds of shocks that propel inflation away from its inertial rate are demand-pull and cost-push. Demand-pull inflation results from too much spending chasing too few goods, causing the aggregate demand curve to shift up and to the right. Wages and prices are then bid up in markets. Cost-push inflation is a new phenomenon of modern industrial economies and occurs when the costs of production rise even in periods of high unemployment and idle capacity. 6. The Phillips curve shows the relationship between inflation and unemployment. In the short run, lowering one rate means raising the other. But the short-run Phillips curve tends to shift over time as expected inflation and other factors change. If policymakers attempt to hold unemployment below the NAIRU for long periods, inflation will tend to spiral upward. 7. Modern inflation theory relies on the concept of the nonaccelerating inflation rate of unemployment, or NAIRU, which is the lowest NAIRU that the nation can enjoy without risking an upward spiral of inflation. It represents the level of unemployment of resources at which labor and product markets are in inflationary balance. Under the NAIRU theory, there is no permanent tradeoff between unemployment and inflation, and the long-run Phillips curve is vertical. C. Dilemmas of Anti-inflation Policy 8. A central concern for policymakers is the cost of reducing inertial inflation. Current estimates indicate that a substantial recession is necessary to slow inertial inflation. 9. Economists have put forth many proposals for lowering the NAIRU; notable proposals include improving labor market information, improving education and training programs, and refashioning government programs so that workers have greater incentives to work. Sober analysis of politically viable proposals leads most economists to expect only small improvements from such labor market reforms. 10. Because of the high costs of reducing inflation through recessions, nations have often looked for other approaches. These are incomes policies such as wage-price controls and voluntary guidelines, tax-based approaches, and market-strengthening strategies.

Chapter 31 Summary

A. The Foundations of Aggregate Supply 1. Aggregate supply describes the relationship between the output that businesses willingly produce and the overall price level, other things being constant. The factors underlying aggregate supply are (a) potential output, determined by the inputs of labor, capital, and natural resources available to an economy, along with the technology or efficiency with which these inputs are used, and (b) input costs, such as wages, energy prices, and import prices. Changes in these underlying factors will shift the AS curve. 2. Two major approaches to output determination are the classical and Keynesian views. The classical view holds that prices and wages are flexible; any excess supply or demand is quickly extinguished and full employment is established after AD or AS shocks. The classical view is represented by a vertical AS curve. The Keynesian view holds that prices and wages are sticky in the short run due to contractual rigidities such as labor-union agreements. In this kind of economy, output responds positively to higher levels of aggregate demand because the AS curve is relatively flat, particularly at low levels of output. In a Keynesian variant, the economy can experience long periods of persistent unemployment because wages and prices adjust slowly to shocks and equilibration toward full employment is slow. 3. A synthesis of classical and Keynesian views distinguishes the long run from the short run. In the short term, because wages and prices do not have time to adjust fully, the AS curve is upward-sloping, showing that businesses will supply more output at a higher price level. By contrast, in the long run, wages and prices have time to adjust fully to shocks, so we treat the long-run AS curve as vertical or classical. Hence, in the long run, output will be determined by a nation's potential output, and the evolution of aggregate demand will affect prices rather than output. B. Unemployment 4. The government gathers monthly statistics on unemployment, employment, and the labor force in a sample survey of the population. People with jobs are categorized as employed; people without jobs who are looking for work are said to be unemployed; people without jobs who are not looking for work are considered outside the labor force. Over the last decade, 66 percent of the population over 16 was in the labor force, while 6 percent of the labor force was unemployed. 5. There is a clear connection between movements in output and the unemployment rate over the business cycle. According to Okun's Law, for every 2 percent that actual GDP declines relative to potential GDP, the unemployment rate rises 1 percentage point. This rule is useful in translating cyclical movements of GDP into their effects on unemployment. 6. Recessions and the associated high unemployment are extremely costly to the economy. Major periods of slack like the 1970s and early 1980s cost the nation hundreds of billions of dollars and have great social costs as well. Yet, even though unemployment has plagued capitalism since the Industrial Revolution, understanding its causes and costs has been possible only with the rise of modern macroeconomic theory. 7. Economists divide unemployment into three groups: (a) frictional unemployment, in which workers are between jobs or moving in and out of the labor force; (b) structural unemployment, consisting of workers who are in regions or industries that are in a persistent slump because of labor market imbalances or high real wages; and (c) cyclical unemployment, pertaining to workers laid off when the overall economy suffers a downturn. 8. Understanding the causes of unemployment has proved to be one of the major challenges of modern macroeconomics. Some unemployment (often called voluntary) would occur in a flexible-wage, perfectly competitive economy when qualified people chose not to work at the going wage rate. Voluntary unemployment might be the efficient outcome of competitive markets. 9. The theory of sticky wages and involuntary unemployment holds that the slow adjustment of wages produces surpluses and shortages in individual labor markets. This theory holds that the cyclical unemployment occurs because wages are inflexible, failing to adjust quickly to labor surpluses or shortages. If wages are above market-clearing levels, some workers are employed but other qualified workers cannot find jobs. Such unemployment is involuntary and also inefficient in that both workers and firms could benefit from an appropriate use of monetary and fiscal policies. 10. Labor markets fail to clear partly because of costs involved in administering the compensation system. Frequent adjustment of compensation for market conditions would command too large a share of management time, would upset workers' perceptions of fairness, and would undermine worker morale and productivity. In the long run, wages tend to adjust and remove abnormal levels of unemployment or job vacancies. But the slow pace of wage adjustment means that societies may suffer prolonged periods of unemployment. 11. A careful look at the unemployment statistics reveals several regularities: a. Recessions hit all groups in roughly proportional fashion - that is, all groups see their unemployment rates go up and down in proportion to the overall unemployment rate. b. A very substantial part of U.S. unemployment is short-term. In low-unemployment years (such as 1999) about 85 percent of unemployed workers are unemployed less than 26 weeks. The average duration of unemployment rises sharply in deep and prolonged recessions. c. In most years, a substantial amount of unemployment is due to simple turnover, or frictional causes, as people enter the labor force for the first time or reenter it. Only during recessions is the pool of unemployed composed primarily of job losers. d. The persistent unemployment in Europe appears to arise from a combination of weak aggregate demand and inflexible labor market institutions.

Chapter 30 Summary

A. Foreign Trade and Economic Activity 1. An open economy is one that engages in international exchange of goods, services, and investments. Exports are goods and services sold to buyers outside the country, while imports are those purchased from foreigners. The difference between exports and imports of goods and services is called net exports. 2. When foreign trade is introduced, domestic demand can differ from national output. Domestic demand comprises consumption, investment, and government purchases (C + I + G). To obtain GDP, exports Ex) must be added and imports (Im) subtracted, so GDP = C + I + G + X where X = net exports = Ex - Im. Imports are determined by domestic income and output along with the prices of domestic goods relative to those of foreign goods; exports are the mirror image, determined by foreign income and output along with relative prices. The dollar increase of imports for each dollar increase in GDP is called the marginal propensity to import (MPm). 3. Foreign trade has an effect on GDP similar to that of investment or government purchases. As net exports rise, there is an increase in aggregate demand for domestic output. Net exports hence have a multiplier effect on output. But the expenditure multiplier in an open economy will be smaller than that in a closed economy because of leakages from spending into imports. The multiplier is Open-economy multiplier = 1/(MPS + MPm) Clearly, other things equal, the open-economy multiplier is smaller than the closed-economy multiplier, where MPm = 0. 4. The operation of monetary policy has new implications in an open economy. An important example involves the operation of monetary policy in a small open economy that has a high degree of capital mobility. Such a country must align its interest rates with those in the countries to whom it pegs its exchange rate. This means that countries operating on a fixed exchange rate essentially lose monetary policy as an independent instrument of macroeconomic policy. Fiscal policy, by contrast, becomes a powerful instrument of policy because fiscal stimulus is not offset by changes in interest rates. 5. An open economy operating with flexible exchange rates can use monetary policy for macroeconomic stabilization which operates independently of other countries. In this case, the international link adds another powerful channel to the domestic monetary mechanism. A monetary tightening leads to higher interest rates, attracting foreign financial capital and leading to a rise (or appreciation) of the exchange rate. The exchange-rate appreciation tends to depress net exports, so this impact reinforces the contractionary impact of higher interest rates on domestic investment. 6. The international monetary mechanism was an important factor in changing the U.S. investment pattern in the 1980s. Loose fiscal policy and tight money reduced net exports and shifted the composition of GDP away from tradeable goods to nontradeable goods. B. Interdependence in the Global Economy 7. In the longer run, operating in the global marketplace provides new constraints and opportunities for countries to improve their economic growth. Perhaps the most important element concerns saving and investment, which are highly mobile and respond to incentives and the investment climate in different countries. 8. The foreign sector provides another source for saving and another outlet for investment. Higher domestic saving - whether through private saving or government fiscal surpluses - will increase the sum of domestic investment and net exports. Recall the identity: X = S + (T - G) - I or Net exports = Private saving + Government saving - Domestic Investment In the long run, a country's trade position primarily reflects its national saving and investment rates. Reducing a trade deficit requires changing domestic saving and investment. One important mechanism for bringing trade flows in line with domestic saving and investment is through the exchange rate. 9. Besides promoting high saving and investment, countries increase their growth through a wide array of policies and institutions. Important considerations are a stable macroeconomic climate, strong property rights for both tangible investments and intellectual property, a convertible currency with few restrictions on financial flows, and political and economic stability. C. International Economic Issues at Century's End 10. Popular analysis looks at large trade deficits and sees "deindustrialization." But this analysis overlooks the important distinction between productivity and competitiveness. Competitiveness refers to how well a nation's goods can compete in the global marketplace and is determined primarily by relative prices. Productivity denotes the level of output per unit of input. Real incomes and living standards depend primarily upon productivity, whereas the trade and current-account positions depend upon competitiveness. There is no close linkage between competitiveness and productivity. 11. Fixed exchange rates are a source of instability in a world of highly mobile financial capital and cite the fundamental contradiction of fixed exchange rates: A country cannot simultaneously have a fixed but adjustable exchange rate, free capital and financial movements, and an independent domestic monetary policy. 12. European countries chose to move to the "super-hard" fixed exchange rates in a common currency and a unitary central bank. A common currency is appropriate when a region forms an optimal currency area. Advocates of European monetary union point to the improved predictability, lower transactions costs, and potential for better capital allocation. Skeptics worry that a common currency - like any irrevocably fixed-exchange-rate system - will require flexible wages and prices to promote adjustment to macroeconomic shocks. In an area with relatively low labor mobility, monetary union may doom major regions or countries to long periods of slow growth and high unemployment.

Chapter 29

A. The Balance of International Payments 1. The balance of international payments is the set of accounts that measures all the economic transactions between a nation and the rest of the world. It includes exports and imports of goods, services, and financial instruments. Exports are credit items, while imports are debits. More generally, a country's credit items are transactions that make foreign currencies available to it; debit items are ones that reduce its holdings of foreign currencies. 2. The major components of the balance of payments are: I. Current account (merchandise trade, services, investment income, transfers) II. Financial account (private, government, and official-reserve changes) The fundamental rule of balance-of-payments accounting is that the sum of all items must equal zero: I + II = 0. 3. Historically, countries tend to go through stages of the balance of payments: from the young debtor borrowing for economic development, through mature debtor and young creditor, to mature creditor nation living off earnings from past investments. In the 1980s, the United States moved to a different stage where low domestic saving and attractive investment opportunities again led it to borrow heavily abroad and become a debtor nation. B. The Determination of Foreign Exchange Rates 4. International trade involves the new element of different national currencies, which are linked by relative prices called foreign exchange rates. When Americans import Japanese goods, they ultimately need to pay in Japanese yen. In the foreign exchange market, Japanese yen might trade at ¥100/$ (or reciprocally, ¥1 would trade for $0.01). This price is called the foreign exchange rate. 5. In a foreign exchange market involving only two countries, the supply of U.S. dollars comes from Americans who want to purchase goods, services, and investments from Japan; the demand for U.S. dollars comes from Japanese who want to import commodities or financial assets from America. The interaction of these supplies and demands determines the foreign exchange rate. More generally, foreign exchange rates are determined by the complex interplay of many countries buying and selling among themselves. When trade or financial flows change, supply and demand shift and the equilibrium exchange rate changes. 6. A fall in the market price of a currency is a depreciation; a rise in a currency's value is called an appreciation. In a system where governments announce official foreign exchange rates, a decrease in the official exchange rate is called a devaluation, while an increase is a revaluation. 7. According to the purchasing-power parity (PPP) theory of exchange rates, exchange rates tend to move with changes in relative price levels of different countries. The PPP theory applies better to the long run than the short run. When this theory is applied to measure the purchasing power of incomes in different countries, it raises the per capita outputs of low-income countries. C. The International Monetary System 8. A well-functioning international economy requires a smoothly operating exchange-rate system, which denotes the institutions that govern financial transactions among nations. Three important exchange-rate systems are (a) the flexible exchange rates, in which a country's foreign exchange rate is determined by market forces of supply and demand; (b) fixed exchange rates, such as the gold standard or the Bretton Woods system, in which countries set and defend a given structure of exchange rates; and (c) managed exchange rates, in which government interventions and market forces interact to determine the level of exchange rates. 9. Classical economists like David Hume explained international adjustments to trade imbalances by the gold-flow mechanism. Under this process, gold movements would change the money supply and the price level. For example, a trade deficit would lead to a gold outflow and a decline in domestic prices that would (a) raise exports and (b) curb imports of the gold-losing country while (c) reducing exports and (d) raising imports of the gold-gaining country. This mechanism shows that under fixed exchange rates, countries which have balance-of-payments problems must adjust through changes in domestic price and output levels. 10. After World War II, countries created a group of international economic institutions to organize international trade and finance. Under the Bretton Woods system, countries "pegged" their currencies to the dollar and to gold, providing fixed but adjustable exchange rates. When official parities deviated too far from fundamentals, countries could adjust parities and achieve a new equilibrium without incurring the hardships of inflation or recession. 11. When the Bretton Woods system broke down in 1971, it was replaced by today's hybrid system. Today, the major economic regions (the U.S., Euroland, and Japan) have currencies that float relative to each other. Most small countries peg their currencies to the dollar or to other currencies.

Chapter 28 Summary

A. Economic Growth in Poor Countries 1. Most of the world's population live in developing countries, which have relatively low per capita incomes. Such countries often exhibit rapid population growth and low literacy and have a high proportion of their population living and working on farms. 2. The key to development lies in four fundamental factors: human resources, natural resources, capital formation, and technology. Population causes problems of explosive growth as the Malthusian prediction of diminishing returns haunts the poorest countries. On the constructive agenda, improving the population's health, education, and technical training has high priority. 3. Investment and saving rates in poor countries are low because incomes are so depressed that little can be saved for the future. International finance of investment in poor countries has witnessed many crises over the last two centuries. The most recent cycle came in 1997-98 when many East Asian countries borrowed heavily and were unable to repay their loans. 4. Technological change is often associated with investment and new machinery. It offers much hope to the developing nations because they can adopt the more productive technologies of advanced nations. This requires entrepreneurship. One task of development is to spur internal growth of the scarce entrepreneurial spirit. 5. Numerous theories of economic development help explain why the four fundamental factors are present or absent at a particular time. Geography and climate, custom, religious and business attitudes, class conflicts and political systems - each affects economic development. But none does so in a simple and invariable way. Development economists today emphasize the growth advantage of relative backwardness, the need to respect the role of agriculture, and the art of finding the proper boundary between state and market. The most recent consensus is on the advantages of openness. B. Alternative Models for Development 6. Other approaches have competed with the mixed market economy as models for economic development. Alternative strategies include the managed-market approach of the East Asian countries, socialism, and the Soviet-style command economy. 7. The managed-market approach of Japan and the Asian dragons, such as South Korea, Hong Kong, Taiwan, and Singapore, have proved remarkably successful over the last quarter-century. Among the key ingredients are macroeconomic stability, high investment rates, a sound financial system, rapid improvements in education, and an outward orientation in trade and technology policies. 8. Socialism is a middle ground between capitalism and communism, stressing government ownership of the means of production, planning by the state, income redistribution, and peaceful transition to a more egalitarian world. 9. Historically, Marxism took its deepest roots in semifeudal Russia. A study of resource allocation in the Soviet-style command economy shows great central planning of broad elements of resource allocation, particularly the emphasis on heavy industry. The Soviet economy grew rapidly in its early decades, but stagnation and collapse have today put Russia and other formerly communist countries at income levels far below those of North America, Japan, and Western Europe. 10. Faced with slowing economic growth and the desire for economic reform, Russia and other formerly communist countries are making the difficult transition to market economies. Transition raises many obstacles, such as soft budget constraints, frozen and distorted prices, and an inadequate legal framework. Two major transition strategies are the shock-therapy approach of multiple simultaneous measures and the more cautious step-by-step approach, in which reforms are sequenced to prevent disruption. The lessons of the transition are broadly applicable to countries hoping to cast off government controls for a market-oriented system.

Chapter 27 Summary

A. Theories of Economic Growth 1. The analysis of economic growth examines the factors that lead to the growth of potential output over the long run. The growth in output per capita is an important objective of government because it is associated with rising average real incomes and living standards. 2. Reviewing the experience of nations over space and time, we see that the economy rides on the four wheels of economic growth: (a) the quantity and quality of its labor force; (b) the abundance of its land and other natural resources; (c) the stock of accumulated capital; and, perhaps most important, (d) the technological change and innovation that allow greater output to be produced with the same inputs. There is no unique combination of these four ingredients, however; the United States, Europe, and Asian countries have followed different paths to economic success. 3. The classical models of Smith and Malthus describe economic development in terms of land and population. In the absence of technological change, increasing population ultimately exhausts the supply of free land. The resulting increase in population density triggers the law of diminishing returns, so growth produces higher land rents with lower competitive wages. The Malthusian equilibrium is attained when the wage has fallen to the subsistence level, below which population cannot sustain itself. In reality, however, technological change has kept economic development progressing in industrial countries by continually shifting the productivity curve of labor upward. 4. Concerns about limitations of natural resources and increasing environmental spillovers from economic activity have led many to question whether economic growth at present rates can long continue. One set of worries based on limited supplies of land, energy, and mineral resources has receded with continuing new discoveries and resource-saving technological change. Global environmental constraints may lead to costly environmental damages or the need for expensive preventive measures. 5. Capital accumulation with complementary labor forms the core of modern growth theory in the neoclassical growth model. This approach uses a tool known as the aggregate production function, which relates inputs and technology to total potential GDP. In the absence of technological change and innovation, an increase in capital per worker (capital deepening) would not be matched by a proportional increase in output per worker because of diminishing returns to capital. Hence, capital deepening would lower the rate of return on capital (equal to the real interest rate under risk-free competition) while raising real wages. 6. Technological change increases the output producible with a given bundle of inputs. This pushes upward the aggregate production function, making more output available with the same inputs of labor and capital. Recent analysis in the "new growth theory" seeks to uncover the processes which generate technological change. This approach emphasizes (a) that technological change is an output of the economic system, (b) that technology is a public or nonrival good that can be used simultaneously by many people, and (c) that new inventions are expensive to produce but inexpensive to reproduce. These features mean that governments must pay careful attention to ensuring that inventors have adequate incentives, through strong intellectual property rights, to engage in research and development. B. The Patterns of Growth in the United States 7. Numerous trends of economic growth are seen in data for this century. Among the key findings are that real wages and output per hour worked have risen steadily, although there has been a marked slowdown since the 1970s; that the real interest rate has shown no major trend; and that the capital-output ratio has declined. The major trends are consistent with the neoclassical growth model augmented by technological advance. Thus economic theory confirms what economic history tells us - that technological advance increases the productivity of inputs and improves wages and living standards. 8. The last trend, continual growth in potential output over the twentieth century, raises the important question of the sources of economic growth. Applying quantitative techniques, economists have used growth accounting to determine that "residual" sources - such as technological change and education - outweigh capital deepening in their impact on GDP growth or labor productivity. 9. After 1970, productivity growth slowed under the weight of energy price increases, increasing environmental regulation, and other structural changes. In the late 1990s, however, the explosion of productivity and investment in computers along with improved measurement have led to a sharp upturn in productivity growth.

SCRIPT FORMAT

 

Chapter 26 Summary

A. Central Banking and the Federal Reserve System 1. The Federal Reserve System is a central bank, a bank for bankers. Its objectives are to allow sustainable economic growth, maintain a high level of employment, ensure orderly financial markets, and above all to preserve reasonable price stability. 2. The Federal Reserve System (or "Fed") was created in 1913 to control the nation's money and credit and to act as the "lender of last resort." It is run by the Board of Governors and the Federal Open Market Committee (FOMC). The Fed acts as an independent government agency and has great discretion in determining monetary policy. 3. The Fed has three major policy instruments: (a) open-market operations, (b) the discount rate on bank borrowing, and (c) legal reserve requirements on depository institutions. Using these instruments, the Fed affects intermediate targets, such as the level of bank reserves, market interest rates, and the money supply. All these operations aim to improve the economy's performance with respect to the ultimate objectives of monetary policy: achieving the best combination of low inflation, low unemployment, rapid GDP growth, and orderly financial markets. In addition, the Fed along with other federal agencies must backstop the domestic and international financial system in times of crisis. 4. The most important instrument of monetary policy is the Fed's open-market operations. Sales by the Fed of government securities in the open market reduce the Fed's assets and liabilities and thereby reduce the reserves of banks. The effect is a decrease in banks' reserve base for deposits. People end up with less M and more government bonds. Open-market purchases do the opposite, ultimately expanding M by increasing bank reserves. 5. Outflows of international reserves can reduce reserves and M unless offset by sterilization though open-market purchases of bonds. Inflows have the opposite effects unless offset. In recent years, the Fed has routinely sterilized international reserve movements. In open economies with fixed exchange rates, monetary policies must be closely aligned with those in other countries. B. The Effects of Money on Output and Prices 6. If the Fed desires to slow the growth of output, the five-step sequence goes thus: a. The Fed reduces bank reserves through open-market operations. b. Each dollar reduction of bank reserves produces a multiple contraction of bank money and the money supply. c. In the money market, a reduction in the money supply moves along an unchanged money demand schedule, raising interest rates, restricting the amount and terms of credit, and tightening money. d. Tight money reduces investment and other interest-sensitive items of spending like consumer durables or net exports. e. The reduction in investment and other spending reduces aggregate demand by the familiar multiplier mechanism. The lower level of aggregate demand lowers output and the price level or inflation. The sequence is summarized by R down M down i up I, C, X down AD down real GDP down and inflation down 7. Although the monetary mechanism is often explained in terms of money affecting "investment," in fact the monetary mechanism is an extremely rich and complex process whereby changes in interest rates and asset prices influence a wide variety of elements of spending. These sectors include housing, affected by changing mortgage interest rates and housing prices; business investment, affected by changing interest rates and stock prices; spending on consumer durables, influenced by interest rates and credit availability; state and local capital spending, affected by interest rates; and net exports, determined by the effects of interest rates upon foreign exchange rates. 8. In an open economy, the international-trade linkage reinforces the domestic impacts of monetary policy. In a regime of flexible exchange rates, changes in monetary policy affect the exchange rate and net exports, adding yet another facet to the monetary mechanism. The trade link tends to reinforce the impact of monetary policy, operating in the same direction on net exports as it does on domestic investment. 9. Monetary policy may have different effects in the short run and the long run. In the short run, with a relatively flat AS curve, most of the change in AD will affect output and only a small part will affect prices. In the longer run, as the AS curve becomes more nearly vertical, monetary shifts lead predominantly to changes in the price level and much less to output changes. In the polar case where money-supply changes affect only nominal variables and have no effects on real variables, we say money is neutral. Most real-world monetary shifts have left real economic effects in their wake.

Chapter 25 Summary

A. Money and Interest Rates 1. Money is anything that serves as a commonly accepted medium of exchange or means of payment. Money also functions as a unit of account and a store of value. Before money came into use, people exchanged goods for goods in a process called barter. Money arose to facilitate trade. Early money consisted of commodities, which were superseded by paper money and then bank money. Unlike other economic goods, money is valued because of social convention. We value money indirectly for what it buys, not for its direct utility. 2. Two definitions of money are commonly used today. The first is narrow (or transactions) money (M1) - made up of currency and checking deposits. The second important concept is broad money (M2), which includes M1 plus highly liquid near-monies like savings accounts. The definitions of the M's have changed over the last two decades as a result of rapid innovation in financial markets. 3. Interest rates are the prices paid for borrowing money; they are measured in dollars per year paid back per dollar borrowed or in percent per year. People willingly pay interest because borrowed funds allow them to buy goods and services to satisfy consumption needs or make profitable investments. 4. We observe a wide variety of interest rates. These rates vary because of many factors such as the term or maturity of loans, the risk and liquidity of investments, and the tax treatment of the interest. 5. Nominal or money interest rates generally rise during inflationary periods, reflecting the fact that the purchasing power of money declines as prices rise. To calculate the interest yield in terms of real goods and services, we use the real interest rate, which equals the nominal or money interest rate minus the rate of inflation. The U.S. government recently issued inflation-indexed bonds, which guarantee a fixed real return on investments. 6. The demand for money differs from that for other commodities. Money is held for its indirect rather than its direct value. But money holdings are limited because keeping funds in money rather than in other assets has an opportunity cost: we sacrifice interest earnings when we hold money. 7. People hold money primarily because they need it to pay bills or buy goods. Such transactions needs are met by M1 and are chiefly related to the value of transactions or to nominal GDP. Economic theory predicts, and empirical studies confirm, that the demand for money is sensitive to interest rates; higher interest rates lead to a lower demand for M. B. Banking and the Supply of Money 8. Banks are commercial enterprises that seek to earn profits for their owners. One major function of banks is to provide checking accounts to customers. Modern banks gradually evolved from the old goldsmith establishments in which money and valuables were stored. Eventually it became general practice for goldsmiths to hold less than 100 percent reserves against deposits; this was the beginning of fractional-reserve banking. 9. If banks kept 100 percent cash reserves against all deposits, there would be no creation of money when new reserves were injected by the central bank into the system. There would be only a 1-to-1 exchange of one kind of money for another kind of money. 10. Today, banks are legally required to keep reserves on their checking deposits. These can be in the form of cash on hand or of non-interest-bearing deposits at the Federal Reserve. For illustrative purposes, we examined a required reserve ratio of 10 percent. In this case, the banking system as a whole - together with public or private borrowers and the depositing public - creates bank money 10 to 1 for each new dollar of reserves created by the Fed and deposited somewhere in the banking system. 11. Each small bank is limited in its ability to expand its loans and investments. It cannot lend or invest more than it has received from depositors; it can lend only about nine-tenths as much. Although no bank alone can expand its reserves 10 to 1, the banking system as a whole can. Each bank receiving $1000 of new deposits lends nine-tenths of its newly acquired cash on loans and investments. If we follow through the successive groups of banks in the dwindling, never-ending chain, we find for the system as a whole new deposits of $1000 + $900 + $810 + $729 + ... = $1000 × [1 + 9/10 + (9/10)2 + (9/10)3 + @ @ @ ] = $1000(1/(1 - 9/10)) = $1000(1/0.1) = $10,000 More generally: Money-supply multiplier = (change of money)/(change of reserves) = 1/(required reserve ratio) 12. There may be some leakage of new cash reserves of the banking system into circulation outside the banks and into assets other than checking accounts. When some of the new reserves leak into assets other than checking deposits, the relationship of money creation to new reserves may depart from the 10-to-1 formula given by the money-supply multiplier. C. A Tour of Wall Street 13. Households own a variety of financial assets. The most important are money, savings accounts, government securities, equities, and pension funds. 14. Assets have different characteristics, the most important being the rate of return and the risk. The rate of return is the total dollar gain from a security. Risk refers to the variability of the returns on an investment. Because people are risk-averse, they require higher returns to induce them to buy riskier assets. 15. Stock markets, of which the New York Stock Exchange is the most important, are places where titles of ownership to the largest companies are bought and sold. The history of stock prices is filled with violent gyrations, such as the Great Crash of 1929. Trends are tracked by the use of stock-price indexes, such as the Standard and Poor's 500 or the familiar Dow-Jones Industrial Average. 16. Modern economic theories of stock prices generally focus on the role of efficient markets. An efficient market is one in which all information is quickly absorbed by speculators and is immediately built into market prices. In efficient markets, there are no easy profits; looking at yesterday's news or past patterns of prices or elections or business cycles will not help predict future price movements. Thus, in efficient markets, prices respond to surprises. Because surprises are inherently random, stock prices and other speculative prices move erratically, as in a random walk. 17. Implant the five rules of personal finance firmly in your long-term memory: (a) Know thy investments. (b) Diversify, diversify, that is the rule of the prophets of finance. (c) Consider common-stock index funds. (d) Minimize unnecessary costs and taxes. (e) Match your investments to your risk preference.

Samuelson's book Summary Chapter 24

Chapter 24 Summary

A. The Basic Multiplier Model 1. The multiplier model provides a simple way to understand the impact of aggregate demand on the level of output. In the simplest approach, household consumption is a function of disposable income while investment is fixed. People's desire to consume and the willingness of businesses to invest are brought into balance by adjustments in output. The equilibrium level of national output must be at the intersection of the saving and investment schedules, SS and II. We can also see this using the expenditure-output approach in which equilibrium output comes at the intersection of the consumption-plus-investment schedule, C + I, with the 45E line. 2. If output is temporarily above its equilibrium level, businesses find output higher than sales, with inventories piling up involuntarily and profits plummeting. Firms therefore cut production and employment back toward the equilibrium level. The only sustainable level of output comes when buyers voluntarily purchase exactly as much as businesses desire to produce. 3. Thus, for the simplified Keynesian multiplier model, investment calls the tune and consumption dances to the music. Investment determines output, while saving responds passively to income changes. Output rises or falls until planned saving has adjusted to the level of planned investment. 4. Investment has a multiplied effect on output. When investment changes, output will at first rise by an equal amount. But as the income receivers in the capital-goods industries get more income, they set in motion a whole chain of additional secondary consumption spending and employment. If people always spend r of each extra dollar of income on consumption, the total of the multiplier chain will be 1 + r + r^2 + ... = 1/(1 - r) = 1/(1 - MPC) = 1/MPS The simplest multiplier is numerically equal to the reciprocal of the MPS or, equivalently, to 1/(1 - MPC). The multiplier works in either direction, amplifying either increases or decreases in investment. This result occurs because it always takes more than a dollar of increased income to increase saving by a dollar. 5. Key points to remember are (a) the basic multiplier model emphasizes the importance of shifts in aggregate demand in affecting output and income and (b) it is primarily applicable for situations with unemployed resources. B. Fiscal Policy in the Multiplier Model 6. The analysis of fiscal policy elaborates the Keynesian multiplier model. It shows that an increase in government purchases-taken by itself, with taxes and investment unchanged-has an expansionary effect on national output much like that of investment. The schedule of C + I + G shifts upward to a higher equilibrium intersection with the 45E line. 7. A decrease in taxes - taken by itself, with investment and government purchases unchanged - raises the equilibrium level of national output. The CC schedule of consumption plotted against GDP is shifted upward and leftward by a tax cut. But since extra dollars of disposable income go partly into saving, the dollar increase in consumption will not be quite so great as the dollars of new disposable income. Therefore, the tax multiplier is smaller than the government expenditure multiplier. 8. Using statistical techniques and macroeconomic theory, economists have developed realistic models to estimate expenditure multipliers. For mainstream approaches, these tend to show multipliers of between 1 and 1½ for periods of up to 4 years.

Samuelson's book Summary Chapter 23

Chapter 23 Summary

A. Business Fluctuations 1. Business cycles or fluctuations are swings in total national output, income, and employment, marked by widespread expansion or contraction in many sectors of the economy. They occur in all advanced market economies. We distinguish the phases of expansion, peak, recession, and trough. 2. Many business cycles occur when shifts in aggregate demand cause sharp changes in output, employment, and prices. Aggregate demand shifts when changes in spending by consumers, businesses, or governments change total spending relative to the economy's productive capacity. A decline in aggregate demand leads to recessions or depressions. An upturn in economic activity can lead to inflation. 3. Business-cycle theories differ in their emphasis on exogenous and internal factors. Importance is often attached to fluctuations in such exogenous factors as technology, elections, wars, exchange-rate movements, or oil-price shocks. Most theories emphasize that these exogenous shocks interact with internal mechanisms, such as the multiplier and investment-demand shifts, to produce cyclical behavior. Just as people suffer from different diseases, so do business-cycle ailments vary in different times and countries. B. Foundations of Aggregate Demand 4. Ancient societies suffered when harvest failures produced famines. The modern market economy can suffer from poverty amidst plenty when insufficient aggregate demand leads to deteriorating business conditions and soaring unemployment. At other times, excessive reliance on the monetary printing press leads to runaway inflation. Understanding the forces that affect aggregate demand, including government fiscal and monetary policies, can help economists and policymakers design steps to smooth out the cycle of boom and bust. 5. Aggregate demand represents the total quantity of output willingly bought at a given price level, other things held constant. Components of spending include (a) consumption, which depends primarily upon disposable income; (b) investment, which depends upon present and expected future output and upon interest rates and taxes; (c) government purchases of goods and services; and (d) net exports, which depend upon foreign and domestic outputs and prices and upon foreign exchange rates. 6. Aggregate demand curves differ from demand curves used in microeconomic analysis. The AD curves relate overall spending on all components of output to the overall price level, with policy and exogenous variables held constant. The aggregate demand curve is downward_sloping primarily because of the money-supply effect, which occurs when a rise in the price level, with the nominal money supply constant, reduces the real money supply. A lower real money supply raises interest rates, tightens credit, and reduces total real spending. This represents a movement along an unchanged AD curve. 7. Factors that change aggregate demand include (a) macroeconomic policies, such as monetary and fiscal policies, and (b) exogenous variables, such as foreign economic activity, technological advances, and shifts in asset markets. When these variables change, they shift the AD curve.

Samuelson's book Summary Chapter 22

Chapter 22 Summary

A. Consumption and Saving 1. Disposable income is an important determinant of consumption and saving. The consumption function is the schedule relating total consumption to total disposable income. Because each dollar of disposable income is either saved or consumed, the saving function is the other side or mirror image of the consumption function. 2. Recall the major features of consumption and saving functions: a. The consumption (or saving) function relates the level of consumption (or saving) to the level of disposable income. b. The marginal propensity to consume (MPC) is the amount of extra consumption generated by an extra dollar of disposable income. c. The marginal propensity to save (MPS) is the extra saving generated by an extra dollar of disposable income. d. Graphically, the MPC and the MPS are the slopes of the consumption and saving schedules, respectively. e. MPS / 1 - MPC. 3. Adding together individual consumption functions gives us the national consumption function. In simplest form, it shows total consumption expenditures as a function of disposable income. Other variables, such as permanent income or the life-cycle effect, wealth, and age also have a significant impact on consumption patterns. 4. The personal saving rate has declined sharply in the last two decades. To explain this decline, economists point to social security and government health programs, changes in capital markets, and the rapid rise in personal wealth due to the stock-market boom of the 1990s. Declining saving hurts the economy because personal saving is a major component of national saving and investment. While people feel richer because of the booming stock market, the nation's true wealth increases only when its productive tangible and intangible assets increase. B. Investment 5. The second major component of spending is gross private domestic investment in housing, plant, software, and equipment. Firms invest to earn profits. The major economic forces that determine investment are therefore the revenues produced by investment (primarily influenced by the state of the business cycle), the cost of investment (determined by interest rates and tax policy), and the state of expectations about the future. Because the determinants of investment depend on highly unpredictable future events, investment is the most volatile component of aggregate spending. 6. An important relationship is the investment demand schedule, which connects the level of investment spending to the interest rate. Because the profitability of investment varies inversely with the interest rate, which affects the cost of capital, we can derive a downward-sloping investment demand curve. As the interest rate declines, more investment projects become profitable, showing why the investment demand schedule slopes downward.

Samuelson's book Summary Chapter 21

Chapter 21 Summary

1. The national income and product accounts contain the major measures of income and product for a country. The gross domestic product (GDP) is the most comprehensive measure of a nation's production of goods and services. It comprises the dollar value of consumption (C), gross private domestic investment (I), government purchases (G), and net exports (X) produced within a nation during a given year. Recall the formula: GDP = C + I + G + X This will sometimes be simplified by combining private domestic investment and net exports into total gross national investment (IT = I + X): GDP = C + IT + G 2. Because of the way we define residual profit, we can match the upper-loop, flow-of-product measurement of GDP with the lower-loop, flow-of-cost measurement, as shown in Figure 21.1. The flow-of-cost approach uses factor earnings and carefully computes value added to eliminate double counting of intermediate products. And after summing up all (before-tax) wage, interest, rent, depreciation, and profit income, it adds to this total all indirect tax costs of business. GDP does not include transfer items such as interest on government bonds or welfare payments. 3. By use of a price index, we can "deflate" nominal GDP (GDP in current dollars) to arrive at a more accurate measure of real GDP (GDP expressed in dollars of some base year's purchasing power). Use of such a price index corrects for the "rubber yardstick" implied by changing levels of prices. 4. Net investment is positive when the nation is producing more capital goods than are currently being used up in the form of depreciation. Since depreciation is hard to estimate accurately, statisticians have more confidence in their measures of gross investment than in those of net investment. 5. National income and disposable income are two additional official measurements. Disposable income (DI) is what people actually have left - after all tax payments, corporate saving of undistributed profits, and transfer adjustments have been made - to spend on consumption or to save. 6. Using the rules of the national accounts, measured saving must exactly equal measured investment. This is easily seen in a hypothetical economy with nothing but households. In a complete economy, private saving and government surplus equal domestic investment plus net foreign investment. The identity between saving and investment is just that: Saving must equal investment no matter whether the economy is in boom or recession, war or peace. It is a consequence of the definitions of national income accounting. 7. Gross domestic product and even net domestic product are imperfect measures of genuine economic welfare. In recent years, statisticians have started correcting for nonmarket measures such as unpaid work at home and environmental externalities. 8. Inflation occurs when the general level of prices is rising (and deflation occurs when it is falling). We measure the overall price level and rate of inflation using price indexes - weighted averages of the prices of thousands of individual products. The most important price index is the consumer price index (CPI), which traditionally measured the cost of a fixed market basket of consumer goods and services relative to the cost of that bundle during a particular base year. Recent studies indicate that the CPI trend has a major upward bias because of index-number problems and omission of new and improved goods, and the government has undertaken steps to correct some of this bias.

Samuelson's book Summary Chapter 20

Chapter 20 Summary

A. Key Concepts of Macroeconomics

1. Macroeconomics is the study of the behavior of the entire economy: it analyzes long-run growth as well as the cyclical movements in total output, unemployment and inflation, the money supply and the budget deficit, and international trade and finance. This contrasts with microeconomics, which studies the behavior of individual markets, prices, and outputs.

2. The United States proclaimed its macroeconomic goals in the Employment Act of 1946, which declared that federal policy was "to promote maximum employment, production, and purchasing power." Since then, the nation's priorities among these three goals have shifted. But all market economies still face three central macroeconomic questions: (a) Why do output and employment sometimes fall, and how can unemployment be reduced? (b) What are the sources of price inflation, and how can it be kept under control? (c) How can a nation increase its rate of economic growth?

3. In addition to these perplexing questions is the hard fact that there are inevitable conflicts or trade-offs among these goals: Rapid growth in future living standards may mean reducing consumption today, and curbing inflation may involve a temporary period of high unemployment.

4. Economists evaluate the success of an economy's overall performance by how well it attains these objectives: (a) high levels and rapid growth of output and consumption [output is usually measured by the gross domestic product (GDP), which is the total value of all final goods and services produced in a given year; also, GDP should be close to potential GDP, the maximum sustainable or high-employment level of output]; (b) low unemployment rate and high employment, with an ample supply of good jobs; (c) price-level stability (or low inflation).

5. Before the science of macroeconomics was developed, countries tended to drift around in the shifting macroeconomic currents without a rudder. Today, there are numerous instruments with which governments can steer the economy: (a) Fiscal policy (government spending and taxation) helps determine the allocation of resources between private and collective goods, affects people's incomes and consumption, and provides incentives for investment and other economic decisions. (b) Monetary policy (particularly central-bank regulation of the money supply to influence interest rates and credit conditions) affects sectors in the economy that are interest-sensitive. The most affected sectors are housing, business investment, and net exports.

6. The nation is but a small part of an increasingly integrated global economy in which countries are linked together through trade of goods and services and through financial flows. A smoothly running international economic system contributes to rapid economic growth, but the international economy can throw sand in the engine of growth when trade flows are interrupted or the international financial mechanism breaks down. Dealing with international trade and finance is high on the agenda of all countries.

B. Aggregate Supply and Demand

7. The central concepts for understanding the determination of national output and the price level are aggregate supply (AS) and aggregate demand (AD). Aggregate demand consists of the total spending in an economy by households, businesses, governments, and foreigners. It represents the total output that would be willingly bought at each price level, given the monetary and fiscal policies and other factors affecting demand. Aggregate supply describes how much output businesses would willingly produce and sell given prices, costs, and market conditions.

8. AS and AD curves have the same shapes as the familiar supply and demand curves analyzed in microeconomics. The downward-sloping AD curve shows the amount that consumers, firms, and other purchasers would buy at each level of prices, with other factors held constant. The AS curve depicts the amount that businesses would willingly produce and sell at each price level, other things held constant. (But beware of potential confusions of microeconomic and aggregate supply and demand.)

9. The overall macroeconomic equilibrium, determining both aggregate price and output, comes where the AS and AD curves intersect. At the equilibrium price level, purchasers willingly buy what businesses willingly sell. Equilibrium output can depart from full employment or potential output.

10. Recent American history shows an irregular cycle of aggregate demand and supply shocks and policy reactions. In the mid-1960s, war-bloated deficits plus easy money led to a rapid increase in aggregate demand. The result was a sharp upturn in prices and inflation. In 1973 and again in 1979, adverse supply shocks led to an upward shift in aggregate supply. This led to stagflation, with a simultaneous rise in unemployment and inflation. At the end of the 1970s, economic policymakers reacted to the rising inflation by tightening monetary policy and raising interest rates. The result lowered spending on interest-sensitive demands such as housing, investment, and net exports. The period of austerity in the early 1980s ushered in a long period of macroeconomic stability.

11. Over the long run of the entire century, the growth of potential output has increased aggregate supply enormously and led to continual growth in output and living standards.

Samuelson's book Summary Chapter 19

Chapter 19 Summary

A. The Sources of Inequality 1. In the last century, the classical economists believed that inequality was a universal constant, unchangeable by public policy. This view does not stand up to scrutiny. Poverty made a glacial retreat over the early part of this century, and absolute incomes for those in the bottom part of the income distribution rose sharply. Since the early 1970s, this trend has reversed, and inequality has increased. 2. The Lorenz curve is a convenient device for measuring the spreads or inequalities of income distribution. It shows what percentage of total income goes to the poorest 1 percent of the population, to the poorest 10 percent, to the poorest 95 percent, and so forth. 3. Poverty is essentially a relative notion. In the United States, poverty was defined in terms of the adequacy of incomes in the early 1960s. By this standard of measured income, little progress in reducing inequality has been made in the last decade. 4. The distribution of American income today appears to be less unequal than in the early part of this century or than in less developed countries now. But it still shows a considerable measure of inequality and increasing inequality over the last quarter-century. Wealth is even more unequally distributed than is income, both in the United States and in other capitalist economies. 5. To explain the inequality in income distribution, we can look separately at labor income and property income. Labor earnings vary because of differences in abilities and in intensities of work (both hours and effort) and because occupational earnings differ, due to divergent amounts of human capital, among other factors. 6. Property incomes are more unevenly distributed than labor earnings, largely because of the great disparities in wealth. Inheritance helps the children of the wealthy begin ahead of the average person; only a small fraction of America's wealth can be accounted for by life_cycle savings. B. Antipoverty Policies 7. Political philosophers write of three types of equality: (a) equality of political rights, such as the right to vote; (b) equality of opportunity, providing equal access to jobs, education, and other social systems; and (c) equality of outcome, whereby people are guaranteed equal incomes or consumptions. Whereas the first two types of equality are increasingly accepted in most advanced democracies like the United States, equality of outcome is generally rejected as impractical and too harmful to economic efficiency. 8. Equality has costs as well as benefits; the costs show up as drains from Okun's "leaky bucket." That is, attempts to reduce income inequality by progressive taxation or transfer payments may harm economic incentives to work or save and may thereby reduce the size of national output. Potential leakages are administrative costs and reduced hours of work or savings rates. 9. Major programs to alleviate poverty are welfare payments, food stamps, Medicaid, and a group of smaller or less targeted programs. As a whole, these programs are criticized because they impose high benefit-reduction rates (or marginal "tax" rates) on low-income families when families begin to earn wages or other income. 10. People are divided on how to improve the current income-support system. One proposal, called the negative income tax, would consolidate current programs into a unified cash income supplement. The supplement would be reduced (that is, income would be "taxed") at a moderate rate (say, one-third or one-half), so that low-income families would have a significant incentive to seek market employment. The United States has adopted a variant known as the earned-income tax credit, which provides a wage supplement to families with low earnings. C. Health Care: The Problem That Won't Go Away 11. Health care is one of the largest and most rapidly growing sectors of the economy. It is characterized by multiple market failures that lead governments to intervene heavily. Health systems have major externalities, which include preventing communicable diseases and discovering new biomedical knowledge. In addition, there are market failures such as the asymmetric information between doctors and patients and between patients and insurance companies. These asymmetries lead to adverse selection in the purchase of insurance and to moral hazard (or the third-party payment syndrome) in excessive consumption of medical services. Finally, because health is so important to human welfare and to labor productivity, governments strive to provide a minimum standard of health care to the population. 12. Dissatisfaction with the health-care system - over rising costs, a growing number of uninsured, and lagging health status, particularly of poor and minority groups - has prompted proposals for reform. Few advocate returning to a pure-market system because of hardships on the poor and adverse effects on public health and on the generation of new biomedical knowledge. A nationalized system would provide universal coverage but ration health care by long waits for services. The predominant organization of the private health system in the United States today is managed care; this system provides a package of benefits for workers or those who can afford to buy care, but the provider limits access to curb costs.

Samuelson's book Summary Chapter 18

Chapter 18 Summary

A. Population and Resource Limitations 1. Malthus's theory of population rests on the law of diminishing returns. He contended that population, if unchecked, would tend to grow at a geometric (or exponential) rate, doubling every generation or so. But each member of the growing population would have less land and natural resources to work with. Because of diminishing returns, income could grow at an arithmetic rate at best; output per person would tend to fall so low as to stabilize population at a subsistence level of near-starvation. 2. Over the last century and a half, Malthus and his followers have been criticized on several grounds. Among the major criticisms are that Malthusians ignored the possibility of technological advance and overlooked the significance of birth control as a force in lowering population growth. 3. Studies of the relationship between pollution, population, and income have determined that the demand for environmental quality rises rapidly with per capita income, so for most indicators environmental quality improves rather than deteriorates as per capita income rises. B. Natural-Resource Economics 4. Natural resources are nonrenewable when they are essentially fixed in supply and cannot regenerate quickly. Renewable resources are ones whose services are replenished regularly and which, if properly managed, can yield useful services indefinitely. 5. From an economic point of view, the crucial distinction is between appropriable and inappropriable resources. Natural resources are appropriable when firms or consumers can capture the full benefits of their services; examples include vineyards or oil fields. Natural resources are inappropriable when their costs or benefits do not accrue to the owners; in other words, they involve externalities. Examples include air quality and climate, which have externalities that are affected by such activities as the burning of fossil fuels. 6. Important examples of appropriable, nonrenewable natural resources are fossil fuels such as oil, gas, and coal. Economists argue that because private markets can efficiently price and allocate their services, such natural resources should be treated the same as any other capital asset. C. Curbing Externalities: Environmental Economics 7. A major market failure that is increasing in importance is externalities. These occur when the costs (or benefits) of an activity spill over to other people, without those other people being paid (or paying) for the costs (or benefits) incurred (or received). 8. The most clear-cut example of an externality is the case of public goods, like defense, where all consumers in a group share equally in the consumption and cannot be excluded. Less obvious examples like public health, inventions, parks, and dams also possess public-good properties. These contrast with private goods, like bread, which can be divided and provided to a single individual. 9. Environmental problems arise because of externalities that stem from production or consumption. An unregulated market economy will produce too much pollution and too little pollution abatement. Unregulated firms decide on abatement (and other public goods) by comparing the marginal private benefits with the marginal private costs. Efficiency requires that marginal social benefits equal marginal social abatement costs. 10. There are numerous steps by which governments can internalize or correct the inefficiencies arising from externalities. Alternatives include decentralized solutions (such as negotiations or legal liability rules) and government-imposed approaches (such as pollution-emission standards or emissions taxes). Experience indicates that no approach is ideal in all circumstances, but many economists believe that greater use of market-oriented approaches would improve the efficiency of regulatory systems. 11. Global public goods, like slowing climate change, present the thorniest problems, which often cannot be solved by either markets or national governments. Nations must devise new tools to forge international agreements when global environmental trends threaten our living standards or ecosystems.

Samuelson's book Summary Chapter 17

Chapter 17 Summary

A. Business Regulation: Theory and Practice 1. Regulation consists of government rules commanding firms to alter their business conduct. Economic regulation involves the control of prices, production, entry and exit conditions, and standards of service in a particular industry; social regulation consists of rules aimed at correcting information failures and externalities, particularly those that impinge on health and safety and the environment. 2. The normative view of regulation is that government intervention is appropriate when there are major market failures. These include excess market power in an industry, inadequate supply of information to consumers and workers, and externalities such as pollution. Economists have developed a positive theory of regulation in which regulation often serves the purpose of actually benefitting regulated firms, whose interests are furthered by exclusion of potential rivals. 3. The strongest case for economic regulation comes in regard to natural monopolies. Natural monopoly occurs when average costs are falling for every level of output, so the most efficient organization of the industry requires production by a single firm. Few industries come close to this condition today - perhaps only local utilities like water and electricity. 4. In conditions of natural monopoly, governments regulate the price and service of private companies. Traditionally, government regulation of monopoly has required that price be set at the average cost of production. The ideal regulation would require price to be set equal to marginal cost, but this approach is impractical because it requires that government subsidize the monopolist. A new approach is performance-based regulation, such as price caps, which provides superior incentives to regulated firms to reduce costs and improve productivity. 5. Given the strength of competitive forces, particularly from the global marketplace, the case for economic regulation holds for few industries today. The deregulation movement of the 1970s reduced the extent of economic regulation markedly, producing gains in industries such as the airlines. B. Antitrust Policy 6. Antitrust policy, prohibiting anticompetitive conduct and preventing monopolistic structures, is the primary way that public policy limits abuses of market power by large firms. This policy grew out of legislation like the Sherman Act (1890) and the Clayton Act (1914). The primary purposes of antitrust are (a) to prohibit anticompetitive activities (which include agreements to fix prices or divide up territories, price discrimination, and tie-in agreements) and (b) to break up monopoly structures. In today's legal theory, such structures are those that have excessive market power (a large share of the market) and also engage in anticompetitive acts. 7. In addition to limiting the behavior of existing firms, antitrust law prevents mergers that would lessen competition. Today, horizontal mergers (between firms in the same industry) are the main source of concern, while vertical and conglomerate mergers tend to be tolerated. 8. Antitrust policy has been significantly influenced by economic thinking during the last three decades. As a result, antitrust policy now focuses almost exclusively on improving efficiency and ignores earlier populist concerns with bigness itself. Moreover, in today's economy - with intense competition from foreign producers and deregulated rivals - many believe that antitrust policy should concentrate primarily on preventing collusive agreements like price fixing.

Samuelson's book Summary Chapter 16

Chapter 16 Summary

A. Government Control of the Economy 1. The economic role of government has increased sharply over the last century. The government influences and controls private economic activity by using taxes, expenditures, and direct regulation. 2. A modern welfare state performs four economic functions: (a) It remedies market failures; (b) it redistributes income and resources; (c) it establishes macroeconomic stabilization policy to stabilize the business cycle and promote long-term economic growth; and (d) it manages international economic affairs. 3. Public-choice theory analyzes how governments actually behave. Just as the invisible hand can break down, so there are government failures, in which government interventions lead to waste or redistribute income in an undesirable fashion. B. Government Expenditures 4. The American system of public finance is one of fiscal federalism. The federal government concentrates its spending on issues of national concern - on national public goods like defense and space exploration. States and localities generally focus on local public goods - those whose benefits are largely confined within state or city boundaries. 5. Government spending and taxation today take approximately one-third of total national output. Of this total, 70 percent is spent at the federal level, and the balance is divided between state and local governments. Only a tiny fraction of government outlays is devoted to traditional functions like police and the courts. C. Economic Aspects of Taxation 6. Notions of "benefits" and "ability to pay" are two principal theories of taxation. A tax is progressive, proportional, or regressive as it takes a larger, equal, or smaller fraction of income from rich families than it does from poor families. Direct and progressive taxes on incomes are in contrast to indirect and regressive sales and excise taxes. 7. More than half of federal revenues come from personal and corporation income taxes. The rest comes from taxes on payrolls or consumption goods. Local governments raise most of their revenue from property taxes, while sales taxes are most important for states. 8. The individual income tax is levied on "income from whatever source derived," less certain exemptions and deductions. The marginal tax rate, denoting the fraction paid in taxes for every dollar of additional income, is key to determining the impact of taxes on incentives to work and save. Marginal tax rates were lowered sharply during the 1980s, but top rates were then raised in President Clinton's fiscal package of 1993. 9. The fastest-growing federal tax is the payroll tax, used to finance social security. This is an "earmarked" levy, with funds going to provide public pensions and health and disability benefits. Because there are visible benefits at the end of the stream of payments, the payroll tax has elements of a benefit tax. 10. Economists point to the Ramsey tax rule, which emphasizes that efficiency will be promoted when taxes are levied more heavily on those activities that are relatively price-inelastic. A new approach is green taxes, which levy fees on environmental externalities, reducing harmful activities while raising revenues that would otherwise be levied on goods or productive inputs. But in all taxes, equity and political acceptability are severe constraints. 11. The incidence of a tax refers to its ultimate economic burden and to its total effect on prices, outputs, and other economic magnitudes. Those who pay a tax can often pass its burden forward to consumers or backward to factors of production. The current U.S. tax and transfer system is moderately progressive.