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This page intentionally left blank MACROECONOMICS TENTH EDITION MICHAEL PARKIN University of Western Ontario Editor in Chief Donna Battista Senior Acquisitions Editor Adrienne D’Ambrosio Development Editor Deepa Chungi Managing Editor Nancy Fenton Assistant Editor Jill Kolongowski Photo Researcher Angel Chavez Production Coordinator Alison Eusden Director of Media Susan Schoenberg Senior Media Producer Melissa Honig Executive Marketing Manager Lori DeShazo Rights and Permissions Advisor Jill Dougan Senior Manufacturing Buyer Carol Melville Senior Media Buyer Ginny Michaud Copyeditor Catherine Baum Art Director and Cover Designer Jonathan Boylan Technical Illustrator Richard Parkin Text Design, Project Management and Page Make-up Integra Software Services, Inc. Cover Image: Medioimages/PhotoDisc/Getty Images Photo credits appear on page C-1, which constitutes a continuation of the copyright page. Copyright © 2012, 2010, 2008, 2005, 2003 Pearson Education, Inc. All rights reserved. No part of this publica- tion may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. For information on obtaining permission for use of material in this work, please submit a written request to Pearson Education, Inc., Rights and Contracts Department, 501 Boylston Street, Suite 900, Boston, MA 02116, fax your request to 617-671-3447, or e-mail at http://www.pearsoned.com/legal/ permissions.htm. Library of Congress Cataloging-in-Publication Data Parkin, Michael, 1939– Macroeconomics/Michael Parkin. — 10th ed. p. cm. Includes index. ISBN 978-0-13-139445-2 (alk. paper) 1. Economics. I. Title. HB171.5.P313 2010 330—dc22 2010045760 1 2 3 4 5 6 7 8 10—CRK—14 13 12 11 10 ISBN 10: 0-13-139445-2 ISBN 13: 978-0-13-139445-2 TO ROBIN ABOUT THE AUTHOR Michael Parkin is Professor Emeritus in the Department of Economics at the University of Western Ontario, Canada. Professor Parkin has held faculty appointments at Brown University, the University of Manchester, the University of Essex, and Bond University. He is a past president of the Canadian Economics Association and has served on the editorial boards of the American Economic Review and the Journal of Monetary Economics and as managing editor of the Canadian Journal of Economics. Professor Parkin’s research on macroeconomics, monetary economics, and international economics has resulted in over 160 publications in journals and edited volumes, including the American Economic Review, the Journal of Political Economy, the Review of Economic Studies, the Journal of Monetary Economics, and the Journal of Money, Credit and Banking. He became most visible to the public with his work on inflation that discredited the use of wage and price controls. Michael Parkin also spearheaded the movement toward European monetary union. Professor Parkin is an experienced and dedicated teacher of introductory economics. iv BRIEF CONTENTS PART ONE PART FOUR INTRODUCTION 1 MACROECONOMIC FLUCTUATIONS 241 CHAPTER 1 What Is Economics? 1 CHAPTER 10 Aggregate Supply and Aggregate CHAPTER 2 The Economic Problem 29 Demand 241 CHAPTER 3 Demand and Supply 51 CHAPTER 11 Expenditure Multipliers: The Keynesian Model 265 PART TWO CHAPTER 12 U.S. Inflation, Unemployment, and MONITORING MACROECONOMIC Business Cycle 295 PERFORMANCE 83 PART FIVE CHAPTER 4 Measuring GDP and Economic MACROECONOMIC POLICY 321 Growth 83 CHAPTER 13 321 CHAPTER 5 Monitoring Jobs and Inflation 107 Fiscal Policy CHAPTER 14 Monetary Policy 347 PART THREE CHAPTER 15 International Trade Policy 371 MACROECONOMIC TRENDS 133 CHAPTER 6 Economic Growth 133 CHAPTER 7 Finance, Saving, and Investment 159 CHAPTER 8 Money, the Price Level, and Inflation 183 CHAPTER 9 The Exchange Rate and the Balance of Payments 211 v This page intentionally left blank ALTERNATIVE PATHWAYS THROUGH THE CHAPTERS Macro Flexibility Chapter 1 What is Economics Chapter 6 Economic Growth Chapter 2 The Economic Problem Chapter 7 Chapter 13 Finance, Saving, Fiscal Policy and Investment Chapter 3 Chapter 4 Demand and Supply Measuring GDP and Economic Growth Chapter 12 Chapter 10 U.S. Inflation, Aggregate Supply and Unemployment, and Aggregate Demand Chapter 15 Chapter 5 Business Cycle International Monitoring Jobs Trade Policy and Inflation Chapter 8 Chapter 14 Money, the Price Level, Monetary Policy and Inflation Chapter 9 The Exchange Rate and the Balance of Payments Chapter 11 Expenditure Multipliers: The Keynesian Model Start here ... … then jump to … and jump to any of these after any of these … doing the pre-requisites indicated vii TABLE OF CONTENTS PART ONE APPENDIX Graphs in Economics 13 INTRODUCTION 1 Graphing Data 13 Scatter Diagrams 14 ◆ CHAPTER 1 WHAT IS ECONOMICS? 1 Graphs Used in Economic Models 16 Definition of Economics 2 Variables That Move in the Same Direction 16 Variables That Move in Opposite Directions 17 Two Big Economic Questions 3 Variables That Have a Maximum or a What, How, and For Whom? 3 Minimum 18 Can the Pursuit of Self-Interest Promote the Variables That Are Unrelated 19 Social Interest? 5 The Slope of a Relationship 20 The Economic Way of Thinking 8 The Slope of a Straight Line 20 A Choice Is a Tradeoff 8 The Slope of a Curved Line 21 Making a Rational Choice 8 Graphing Relationships Among More Than Benefit: What You Gain 8 Two Variables 22 Cost: What You Must Give Up 8 How Much? Choosing at the Margin 9 Ceteris Paribus 22 Choices Respond to Incentives 9 When Other Things Change 23 Economics as Social Science and MATHEMATICAL NOTE Policy Tool 10 Equations of Straight Lines 24 Economist as Social Scientist 10 Economist as Policy Adviser 10 Summary (Key Points and Key Terms), Study Plan Problems and Applications, and Additional Problems and Applications appear at the end of each chapter. viii Contents ix CHAPTER 2 ◆ THE ECONOMIC PROBLEM 29 CHAPTER 3 ◆ DEMAND AND SUPPLY 51 Production Possibilities and Opportunity Markets and Prices 52 Cost 30 Demand 53 Production Possibilities Frontier 30 The Law of Demand 53 Production Efficiency 31 Demand Curve and Demand Schedule 53 Tradeoff Along the PPF 31 A Change in Demand 54 Opportunity Cost 31 A Change in the Quantity Demanded Versus a Using Resources Efficiently 33 Change in Demand 56 The PPF and Marginal Cost 33 Supply 58 Preferences and Marginal Benefit 34 The Law of Supply 58 Allocative Efficiency 35 Supply Curve and Supply Schedule 58 Economic Growth 36 A Change in Supply 59 The Cost of Economic Growth 36 A Change in the Quantity Supplied Versus a A Nation’s Economic Growth 37 Change in Supply 60 Gains from Trade 38 Market Equilibrium 62 Comparative Advantage and Absolute Price as a Regulator 62 Advantage 38 Price Adjustments 63 Achieving the Gains from Trade 39 Predicting Changes in Price and Quantity 64 Economic Coordination 41 An Increase in Demand 64 Firms 41 A Decrease in Demand 64 Markets 42 An Increase in Supply 66 Property Rights 42 A Decrease in Supply 66 Money 42 All the Possible Changes in Demand and Circular Flows Through Markets 42 Supply 68 Coordinating Decisions 42 READING BETWEEN THE LINES READING BETWEEN THE LINES Demand and Supply: The Price of Coffee 70 The Rising Opportunity Cost of Food 44 MATHEMATICAL NOTE Demand, Supply, and Equilibrium 72 PART ONE WRAP-UP ◆ Understanding the Scope of Economics Your Economic Revolution 79 Talking with Jagdish Bhagwati 80 x Contents ◆ PART TWO CHAPTER 5 MONITORING JOBS AND MONITORING MACROECONOMIC INFLATION 107 PERFORMANCE 83 Employment and Unemployment 108 Why Unemployment Is a Problem 108 CHAPTER 4 ◆ MEASURING GDP AND Current Population Survey 109 Three Labor Market Indicators 109 ECONOMIC GROWTH 83 Other Definitions of Unemployment 111 Gross Domestic Product 84 Most Costly Unemployment 112 GDP Defined 84 Alternative Measure of Unemployment 112 GDP and the Circular Flow of Expenditure Unemployment and Full Employment 113 and Income 85 Frictional Unemployment 113 Why Is Domestic Product “Gross”? 86 Structural Unemployment 113 Measuring U.S. GDP 87 Cyclical Unemployment 113 The Expenditure Approach 87 “Natural” Unemployment 113 The Income Approach 87 Real GDP and Unemployment Over the Nominal GDP and Real GDP 89 Cycle 114 Calculating Real GDP 89 The Price Level, Inflation, and Deflation 116 The Uses and Limitations of Real GDP 90 Why Inflation and Deflation are Problems 116 The Standard of Living Over Time 90 The Consumer Price Index 117 The Standard of Living Across Countries 92 Reading the CPI Numbers 117 Limitations of Real GDP 93 Constructing the CPI 117 Measuring the Inflation Rate 118 READING BETWEEN THE LINES Distinguishing High Inflation from a High Price Real GDP Forecasts in the Uncertain Economy Level 119 of 2010 96 The Biased CPI 119 120 APPENDIX Graphs in Macroeconomics 98 The Magnitude of the Bias Some Consequences of the Bias 120 MATHEMATICAL NOTE Alternative Price Indexes 120 Chained-Dollar Real GDP 100 Core CPI Inflation 121 The Real Variables in Macroeconomics 121 READING BETWEEN THE LINES Jobs Growth Lags Recovery 122 PART TWO WRAP-UP ◆ Monitoring Macroeconomic Performance The Big Picture 129 Talking with Richard Clarida 130 Contents xi ◆ PART THREE CHAPTER 7 FINANCE, SAVING, AND MACROECONOMIC TRENDS 133 INVESTMENT 159 Financial Institutions and Financial Markets 160 CHAPTER 6 ◆ ECONOMIC GROWTH 133 Finance and Money 160 Physical Capital and Financial Capital 160 The Basics of Economic Growth 134 Capital and Investment 160 Calculating Growth Rates 134 Wealth and Saving