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PRINCIPLES OF MACROECONOMICS:
A
G U I D E D
T O U R
PART ONE: INTRODUCTION
Chapter 1
Ten Principles of Economics
The study of economics is guided by a few big ideas.
Chapter 2
Thinking Like an Economist
Economists view the world as both scientists and policymakers.
Chapter 3
Interdependence and the Gains
from Trade
The theory of comparative advantage explains how people benefit
from economic interdependence.
PART TWO: SUPPLY AND DEMAND: HOW MARKETS WORK
Chapter 4
The Market Forces of Supply
and Demand
How does the economy coordinate interdependent economic
actors? Through the market forces of supply and demand.
PART THREE: THE DATA OF MACROECONOMICS
Chapter 5
Measuring a Nation’s Income
Chapter 6
Measuring the Cost of Living
The overall quantity of production and the overall price level are
used to monitor developments in the economy as a whole.
PART FOUR: THE REAL ECONOMY IN THE LONG RUN
Chapter 7
Production and Growth
Chapter 8
Saving, Investment, and the
Financial System
Chapter 9
Unemployment and
Its Natural Rate
These chapters describe the forces that, in the long run,
determine key real variables, including growth in GDP, saving,
investment, real interest rates, and unemployment.
PART FIVE: MONEY AND PRICES IN THE LONG RUN
Chapter 10
The Monetary System
Chapter 11
Money Growth and Inflation
The monetary system is crucial in determining the long-run
behaviour of the price level, the inflation rate, and other nominal
variables.
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PART SIX: THE MACROECONOMICS OF OPEN ECONOMIES
Chapter 12
Chapter 13
Open-Economy Macroeconomics:
Basic Concepts
A Macroeconomic Theory of
the Open Economy
A nation’s economic interactions with other nations are described
by its trade balance, net foreign investment, and exchange rate.
A long-run model of the open economy explains the determinants
of the trade balance, the real exchange rate, and other variables.
PART SEVEN: SHORT-RUN ECONOMIC FLUCTUATIONS
Chapter 14
Aggregate Demand and
Aggregate Supply
Chapter 15
The Influence of Monetary
and Fiscal Policy on Aggregate
Demand
Chapter 16
The Short-Run Tradeoff between
Inflation and Unemployment
The model of aggregate demand and aggregate supply explains
short-run economic fluctuations, the short-run effects of
monetary and fiscal policy, and the short-run linkage between
real and nominal variables.
PART EIGHT: FINAL THOUGHTS
Chapter 17
Five Debates over
Macroeconomic Policy
A capstone chapter presents both sides of five major debates over
economic policy.
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PRINCIPLES
OF
MACROECONOMICS
FIFTH CANADIAN EDITION
N . G R E G O RY M A N K I W
H A RVA R D U N I V E R S I T Y
RONALD D. KNEEBONE
U N I V E R S I T Y O F C A L G A RY
KENNETH J. McKENZIE
U N I V E R S I T Y O F C A L G A RY
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Principles of Macroeconomics, Fifth Canadian Edition
by N. Gregory Mankiw, Ronald D. Kneebone, and Kenneth J. McKenzie
Vice President,
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Evelyn Veitch
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COPYRIGHT © 2011, 2008 by
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Adapted from Principles of Macroeconomics, Fifth Edition, by
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For more information contact
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II. McKenzie, Kenneth J. (Kenneth
James), 1959– III. Title.
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Mankiw, N. Gregory
Principles of macroeconomics /
N. Gregory Mankiw, Ronald D.
Kneebone, Kenneth J.
McKenzie. — 5th Canadian ed.
Includes index.
ISBN 978-0-17-650242-3
HB172.5.M363 2010
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ISBN-10: 0-17-650242-4
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Page v
To Catherine, Nicholas, and Peter,
my other contributions to the next generation
To our parents
and
Cindy,
Kathleen, and Janetta
Thanks for your support and patience
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B R I E F
C O N T E N T S
PART 1
INTRODUCTION
CHAPTER 1
CHAPTER 2
Ten Principles of Economics 3
Thinking Like an Economist 21
Appendix Graphing: A Brief Review 42
Interdependence and the Gains
from Trade 51
CHAPTER 3
1
PART 6
THE MACROECONOMICS OF OPEN
ECONOMIES 267
CHAPTER 12
Open-Economy Macroeconomics: Basic
Concepts 269
A Macroeconomic Theory of the Open
Economy 297
CHAPTER 13
PART 2
SUPPLY AND DEMAND: HOW MARKETS
WORK 67
PART 7
SHORT-RUN ECONOMIC
FLUCTUATIONS 323
CHAPTER 4
The Market Forces of Supply
and Demand 69
CHAPTER 14
Aggregate Demand and Aggregate
Supply 325
The Influence of Monetary and Fiscal
Policy on Aggregate Demand 365
The Short-Run Tradeoff between Inflation
and Unemployment 407
CHAPTER 15
PART 3
THE DATA OF MACROECONOMICS
CHAPTER 5
CHAPTER 6
Measuring a Nation’s Income 97
Measuring the Cost of Living 121
PART 4
THE REAL ECONOMY IN THE
LONG RUN 137
CHAPTER 7
CHAPTER 8
Production and Growth 139
Saving, Investment, and the Financial
System 165
Unemployment and Its Natural Rate 191
CHAPTER 9
PART 5
MONEY AND PRICES IN THE
LONG RUN 217
CHAPTER 10
CHAPTER 11
The Monetary System 219
Money Growth and Inflation 241
95
CHAPTER 16
PART 8
FINAL THOUGHTS
CHAPTER 17
Five Debates over Macroeconomic
Policy 439
437
Glossary 459
Index
463
NEL
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T A B L E
O F
Tupungato/Shutterstock.com
Preface xvii
How the Book Is Organized xvii
Walk-Through xx
New in This Fifth Canadian Edition xxiii
Supplements xxiv
About the Authors xxvii
Acknowledgments xxviii
PART 1
INTRODUCTION
Learning Objectives
How the Economy as a Whole Works 13
Principle #8: A Country’s Standard of Living
Depends on Its Ability to Produce Goods
and Services 13
Principle #9: Prices Rise When the Government
Prints Too Much Money 14
Principle #10: Society Faces a Short-Run Tradeoff
between Inflation and Unemployment 15
FYI: How to Read This Book 16
Conclusion 17
Summary 17
Key Concepts 17
Questions for Review 18
Problems and Applications 18
CHAPTER 2
THINKING LIKE AN ECONOMIST
1
CHAPTER 1
TEN PRINCIPLES OF ECONOMICS
C O N T E N T S
3
3
How People Make Decisions 4
Principle #1: People Face Tradeoffs 4
Principle #2: The Cost of Something
Is What You Give Up to Get It 5
IN THE NEWS: Using Opportunity Cost to Sell 6
Principle #3: Rational People Think at the Margin 8
Principle #4: People Respond to Incentives 9
How People Interact 10
Principle #5: Trade Can Make Everyone Better Off 10
Principle #6: Markets Are Usually a Good Way to
Organize Economic Activity 10
FYI: Adam Smith and the Invisible Hand 12
Principle #7: Governments Can Sometimes Improve
Market Outcomes 12
Learning Objectives
21
21
The Economist as Scientist 22
The Scientific Method: Observation, Theory,
and More Observation 22
The Role of Assumptions 23
Economic Models 24
Our First Model: The Circular-Flow Diagram 24
Our Second Model: The Production Possibilities
Frontier 26
Microeconomics and Macroeconomics 28
The Economist as Policy Adviser 30
Positive versus Normative Analysis 30
Economists in Ottawa 31
IN THE NEWS: Super Bowl Economics 33
CASE STUDY: Mr. Mankiw Goes to Washington
Why Economists Disagree 35
Differences in Scientific Judgments
Differences in Values 36
Perception versus Reality 36
34
35
NEL
viii
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ix
IN THE NEWS: Environmental Economists 37
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Let’s Get Going 38
Summary 39
Key Concepts 39
Questions for Review 39
Problems and Applications 40
Appendix Graphing: A Brief Review 42
Graphs of a Single Variable 42
Graphs of Two Variables: The Coordinate
System 42
Curves in the Coordinate System 43
Slope 47
Cause and Effect 48
PART 2
SUPPLY AND DEMAND:
HOW MARKETS WORK 67
CHAPTER 3
INTERDEPENDENCE AND THE GAINS FROM TRADE
Learning Objectives
51
51
A Parable for the Modern Economy
Production Possibilities 52
Specialization and Trade 54
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
Learning Objectives
52
Comparative Advantage: The Driving Force
of Specialization 56
Absolute Advantage 57
Opportunity Cost and Comparative Advantage 57
Comparative Advantage and Trade 58
FYI: The Legacy of Adam Smith and David Ricardo 59
The Price of Trade 59
IN THE NEWS: How Committed Is Canada to Free
Trade? 60
Applications of Comparative Advantage 61
Should Mike Weir Mow His Own Lawn? 61
Should Canada Trade with Other Countries? 62
Conclusion 63
Summary 63
Key Concepts 63
Questions for Review 63
Problems and Applications 64
69
69
Markets and Competition 70
What Is a Market? 70
What Is Competition? 70
Demand 71
The Demand Curve: The Relationship between
Price and Quantity Demanded 71
Market Demand versus Individual Demand 72
Shifts in the Demand Curve 73
CASE STUDY: Two Ways to Reduce the Quantity of
Smoking Demanded 76
Supply 77
The Supply Curve: The Relationship between
Price and Quantity Supplied 77
Market Supply versus Individual Supply 79
Shifts in the Supply Curve 79
Supply and Demand Together 81
Equilibrium 81
Three Steps to Analyzing Changes in Equilibrium 83
IN THE NEWS: Supply, Demand, and Technology 88
Conclusion: How Prices Allocate Resources 89
Summary 90
Key Concepts 91
Questions for Review 91
Problems and Applications 91
NEL
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PART 3
THE DATA OF MACROECONOMICS
95
GDP and Economic Well-Being 113
CASE STUDY: International Differences in GDP and the
Quality of Life 114
Conclusion
115
IN THE NEWS: Does GDP Measure Well-Being? 116
Summary 117
Key Concepts 118
Questions for Review 118
Problems and Applications 119
CHAPTER 6
MEASURING THE COST OF LIVING
Learning Objectives
121
121
CHAPTER 5
MEASURING A NATION’S INCOME
Learning Objectives
97
97
The Economy’s Income and Expenditure 98
The Measurement of Gross Domestic Product 100
“GDP Is the Market Value . . .” 100
“. . . Of All . . .” 100
“. . . Final . . .” 101
“. . . Goods and Services . . .” 101
“. . . Produced . . .” 101
“. . . Within a Country . . .” 101
“. . . In a Given Period of Time” 102
FYI: Other Measures of Income 102
The Components of GDP 103
Consumption 103
Investment 104
Government Purchases 104
Net Exports 104
CASE STUDY: The Components of Canadian GDP 105
The Consumer Price Index 122
How the Consumer Price Index Is Calculated 122
FYI: What Is in the CPI’s Basket? 124
Problems in Measuring the Cost of Living 125
The GDP Deflator versus the Consumer Price Index
126
Correcting Economic Variables for the Effects
of Inflation 128
Dollar Figures from Different Times 128
FYI: The Bank of Canada’s Inflation Calculator 129
CASE STUDY: Mr. Index Goes to Hollywood 129
Indexation 129
Real and Nominal Interest Rates 130
CASE STUDY: Interest Rates in the Canadian Economy 131
Conclusion 132
Summary 133
Key Concepts 134
Questions for Review 134
Problems and Applications 134
Real versus Nominal GDP 106
A Numerical Example 106
The GDP Deflator 108
CASE STUDY: Real GDP over Recent History 109
CASE STUDY: Measuring Economic Well-Being in
Canada 110
CASE STUDY: GDP, GNP, and Foreign Ownership 111
NEL
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TABLE OF CONTENTS
CHAPTER 8
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SAVING, INVESTMENT, AND THE FINANCIAL SYSTEM
PART 4
THE REAL ECONOMY
IN THE LONG RUN 137
CHAPTER 7
PRODUCTION AND GROWTH
Learning Objectives
139
139
Economic Growth around the World 140
FYI: Are You Richer Than the Richest American? 142
Productivity: Its Role and Determinants 142
Why Productivity Is So Important 142
How Productivity Is Determined 143
FYI: The Production Function 145
CASE STUDY: Are Natural Resources a Limit to
Growth? 146
Economic Growth and Public Policy 147
The Importance of Saving and Investment 147
Diminishing Returns and the Catch-Up Effect 147
Investment from Abroad 149
Education 150
Health and Nutrition 151
IN THE NEWS: Promoting Human Capital 152
Property Rights and Political Stability 153
Free Trade 154
Research and Development 154
IN THE NEWS: Rich Farmers versus the World’s
Poor 155
CASE STUDY: Productivity Slowdowns and
Speedups 157
Population Growth 158
Conclusion: The Importance of Long-Run Growth 161
Summary 161
Key Concepts 162
Questions for Review 162
Problems and Applications 162
Learning Objectives
165
165
Financial Institutions in the Canadian Economy 166
Financial Markets 167
FYI: How to Read the Newspaper’s Stock Tables 169
Financial Intermediaries 170
Summing Up 171
Saving and Investment in the National Income
Accounts 171
FYI: Financial Institutions in Crisis 172
Some Important Identities 173
The Meaning of Saving and Investment 174
The Market for Loanable Funds 175
Supply and Demand for Loanable Funds 175
Policy 1: Saving Incentives 177
Policy 2: Investment Incentives 179
Policy 3: Government Budget Deficits and Surpluses 180
CASE STUDY: The Accumulation of Government
Debt in Canada 183
CASE STUDY: The Debate over Budget Imbalances 185
Conclusion 186
Summary 187
Key Concepts 187
Questions for Review 187
Problems and Applications 188
CHAPTER 9
UNEMPLOYMENT AND ITS NATURAL RATE
Learning Objectives
191
191
Identifying Unemployment 192
How Is Unemployment Measured? 192
CASE STUDY: Labour-Force Participation of Men
and Women in the Canadian Economy 196
Does the Unemployment Rate Measure
What We Want It To? 197
How Long Are the Unemployed without Work? 198
Why Are There Always Some People Unemployed? 199
FYI: A Tale of Two Recessions 200
Job Search 201
Why Some Frictional Unemployment Is Inevitable 201
Public Policy and Job Search 202
Employment Insurance 203
NEL
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TABLE OF CONTENTS
The Bank of Canada 226
The Bank of Canada Act
Monetary Policy 228
Minimum-Wage Laws 205
Unions and Collective Bargaining 206
FYI: Who Earns the Minimum Wage? 207
The Economics of Unions 208
Are Unions Good or Bad for the Economy? 209
226
Commercial Banks and the Money Supply 228
The Simple Case of 100 Percent-Reserve Banking 228
Money Creation with Fractional-Reserve Banking 229
The Money Multiplier 230
The Bank of Canada’s Tools of Monetary Control 232
Problems in Controlling the Money Supply 235
FYI: The Bank of Canada’s Response to the 2007–09
Financial Crisis 236
CASE STUDY: Bank Runs and the Money Supply 237
Conclusion 238
Summary 238
Key Concepts 238
Questions for Review 239
Problems and Applications 239
The Theory of Efficiency Wages 209
Worker Health 210
Worker Turnover 210
Worker Effort 210
Worker Quality 211
CASE STUDY: Henry Ford and the Very Generous
$5-a-Day Wage 211
Conclusion 212
Summary 213
Key Concepts 213
Questions for Review 213
Problems and Applications 214
CHAPTER 11
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MONEY GROWTH AND INFLATION
PART 5
MONEY AND PRICES
IN THE LONG RUN 217
CHAPTER 10
THE MONETARY SYSTEM
Learning Objectives
219
219
The Meaning of Money 220
The Functions of Money 221
The Kinds of Money 221
IN THE NEWS: The History of Money 222
Money in the Canadian Economy 223
FYI: Credit Cards, Debit Cards, and Money 224
CASE STUDY: Where Is All the Currency? 225
Learning Objectives
241
241
The Classical Theory of Inflation 242
The Level of Prices and the Value of Money 242
Money Supply, Money Demand, and Monetary
Equilibrium 243
The Effects of a Monetary Injection 244
A Brief Look at the Adjustment Process 246
The Classical Dichotomy and Monetary Neutrality 247
Velocity and the Quantity Equation 248
CASE STUDY: Money and Prices during Four
Hyperinflations 250
The Inflation Tax 252
The Fisher Effect 252
IN THE NEWS: A Recipe for Economic Disaster 253
The Costs of Inflation 256
A Fall in Purchasing Power? The Inflation Fallacy 256
Shoeleather Costs 256
Menu Costs 257
Relative-Price Variability and the Misallocation
of Resources 258
Inflation-Induced Tax Distortions 258
Confusion and Inconvenience 260
A Special Cost of Unexpected Inflation: Arbitrary
Redistributions of Wealth 260
CASE STUDY: Money Growth, Inflation, and the Bank of
Canada 261
NEL
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TABLE OF CONTENTS
Conclusion 263
Summary 263
Key Concepts 264
Questions for Review 264
Problems and Applications 264
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A First Theory of Exchange-Rate Determination:
Purchasing-Power Parity 286
The Basic Logic of Purchasing-Power Parity 286
Implications of Purchasing-Power Parity 287
CASE STUDY: The Nominal Exchange Rate during a
Hyperinflation 288
Limitations of Purchasing-Power Parity 289
CASE STUDY: The Hamburger Standard 290
PART 6
THE MACROECONOMICS
OF OPEN ECONOMIES 267
Interest Rate Determination in a Small Open Economy with
Perfect Capital Mobility 291
A Small Open Economy 292
Perfect Capital Mobility 292
Limitations to Interest Rate Parity 293
Conclusion 294
Summary 294
Key Concepts 295
Questions for Review 295
Problems and Applications 295
CHAPTER 13
A MACROECONOMIC THEORY OF THE
OPEN ECONOMY 297
CHAPTER 12
OPEN-ECONOMY MACROECONOMICS:
BASIC CONCEPTS 269
Learning Objectives
269
The International Flows of Goods and Capital 270
The Flow of Goods: Exports, Imports, and
Net Exports 270
CASE STUDY: The Increasing Openness of the Canadian
Economy 271
IN THE NEWS: Breaking Up the Chain of Production 273
The Flow of Financial Resources: Net Capital
Outflow 274
The Equality of Net Exports and Net Capital Outflow 275
FYI: The Current Account Balance 277
Saving, Investment, and Their Relationship to the
International Flows 277
Summing Up 279
CASE STUDY: Saving, Investment, and Net Capital
Outflow of Canada 279
The Prices for International Transactions:
Real and Nominal Exchange Rates 282
Nominal Exchange Rates 282
Real Exchange Rates 283
FYI: The Value of the Canadian Dollar 283
FYI: The Euro 286
xiii
Learning Objectives
297
Supply and Demand for Loanable Funds and
for Foreign-Currency Exchange 298
The Market for Loanable Funds 298
The Market for Foreign-Currency Exchange 302
FYI: Purchasing-Power Parity as a Special Case 304
Equilibrium in the Open Economy 305
Net Capital Outflow: The Link between the
Two Markets 305
Simultaneous Equilibrium in Two Markets 306
How Policies and Events Affect an Open Economy 308
Increase in World Interest Rates 308
FYI: Negative Values of Net Capital Outflow 308
Government Budget Deficits and Surpluses 310
Trade Policy 312
Political Instability and Capital Flight 314
Conclusion 318
Summary 318
Key Concepts 319
Questions for Review 319
Problems and Applications 320
NEL
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PART 7
SHORT-RUN ECONOMIC
FLUCTUATIONS 323
CHAPTER 14
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Learning Objectives
325
325
Three Key Facts about Economic Fluctuations 326
Fact 1: Economic Fluctuations Are Irregular
and Unpredictable 326
Fact 2: Most Macroeconomic Quantities Fluctuate
Together 326
Fact 3: As Output Falls, Unemployment Rises 328
Explaining Short-Run Economic Fluctuations 328
The Assumptions of Classical Economics 328
The Reality of Short-Run Fluctuations 329
The Model of Aggregate Demand and Aggregate
Supply 330
The Aggregate-Demand Curve 331
Why the Aggregate-Demand Curve Slopes
Downward 332
Why the Aggregate-Demand Curve Might Shift 334
CASE STUDY: Housing Wealth 334
The Aggregate-Supply Curve 337
Why the Aggregate-Supply Curve Is Vertical in the
Long Run 338
Why the Long-Run Aggregate-Supply Curve Might
Shift 339
Using Aggregate Demand and Aggregate Supply
to Depict Long-Run Growth and Inflation 340
Why the Aggregate-Supply Curve Slopes Upward
in the Short Run 342
Why the Short-Run Aggregate-Supply Curve
Might Shift 345
Two Causes of Economic Fluctuations 347
The Effects of a Shift in Aggregate Demand 347
FYI: Monetary Neutrality Revisited 350
CASE STUDY: Big Shifts in Aggregate Demand: Two
Depressions and World War II 351
CASE STUDY: The Recession of 2008–09 354
The Effects of a Shift in Aggregate Supply 355
CASE STUDY: Oil and the Economy 358
FYI: The Origins of Aggregate Demand and Aggregate
Supply 359
Conclusion 361
Summary 361
Key Concepts 362
Questions for Review 362
Problems and Applications 362
CHAPTER 15
THE INFLUENCE OF MONETARY AND
FISCAL POLICY ON AGGREGATE DEMAND
Learning Objectives
365
365
How Monetary Policy Influences Aggregate Demand 366
The Theory of Liquidity Preference 367
The Downward Slope of the Aggregate-Demand
Curve 372
Changes in the Money Supply 373
Open-Economy Considerations 374
CASE STUDY: Why Central Banks Watch the Stock
Market (and Vice Versa) 379
How Fiscal Policy Influences Aggregate Demand 380
Changes in Government Purchases 380
The Multiplier Effect 381
A Formula for the Spending Multiplier 382
Other Applications of the Multiplier Effect 384
The Crowding-Out Effect on Investment 384
Open-Economy Considerations 386
Changes in Taxes 392
Deficit Reduction 393
FYI: How Fiscal Policy Might Affect Aggregate
Supply 393
Using Policy to Stabilize the Economy 394
The Case for Active Stabilization Policy 394
The Case against Active Stabilization Policy 395
Automatic Stabilizers 395
A Flexible Exchange Rate as an Automatic Stabilizer 396
CASE STUDY: The Recession of 2008–09 (Again) 397
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A Quick Summary 399
FYI: Interest Rates in the Long Run and the Short
Run 401
Conclusion 402
Summary 403
Key Concepts
404
Questions for Review 404
Problems and Applications 404
PART 8
FINAL THOUGHTS
CHAPTER 16
THE SHORT-RUN TRADEOFF BETWEEN INFLATION
AND UNEMPLOYMENT 407
Learning Objectives
xv
437
407
The Phillips Curve 408
Origins of the Phillips Curve 408
Aggregate Demand, Aggregate Supply, and the
Phillips Curve 409
Shifts in the Phillips Curve: The Role of Expectations 411
The Long-Run Phillips Curve 411
The Meaning of “Natural” 414
Reconciling Theory and Evidence 414
The Short-Run Phillips Curve 415
The Natural Experiment for the Natural-Rate
Hypothesis 417
Shifts in the Phillips Curve: The Role of Supply
Shocks 418
The Cost of Reducing Inflation 422
The Sacrifice Ratio 422
Rational Expectations and the Possibility of Costless
Disinflation 424
Disinflation in the 1980s 425
IN THE NEWS: How to Keep Expected Inflation Low 427
The Zero-Inflation Target 428
Anchored Expectations 430
Looking Ahead 431
Recovering from the 2008–09 Recession . . .
. . . and Beyond 432
Conclusion 433
Summary 434
Key Concepts 434
Questions for Review 434
Problems and Applications 434
431
CHAPTER 17
FIVE DEBATES OVER MACROECONOMIC POLICY
Learning Objectives
439
439
Should Monetary and Fiscal Policymakers Try to
Stabilize the Economy? 439
Pro: Policymakers Should Try to Stabilize the
Economy 440
Con: Policymakers Should Not Try to Stabilize the
Economy 440
Should Monetary Policy Be Made by an Independent
Central Bank? 441
Pro: Monetary Policy Should Be Made by an
Independent Central Bank 442
Con: Monetary Policy Should Not Be Made by an
Independent Central Bank 443
Should the Central Bank Aim for Zero Inflation? 444
Pro: The Central Bank Should Aim for Zero Inflation 444
Con: The Central Bank Should Not Aim for Zero
Inflation 445
Should Governments Balance Their Budgets? 447
Pro: Governments Should Balance Their Budgets 448
Con: Governments Should Not Balance Their
Budgets 449
Should the Tax Laws Be Reformed to Encourage
Saving? 451
Pro: The Tax Laws Should Be Reformed to Encourage
Saving 451
Con: The Tax Laws Should Not Be Reformed to
Encourage Saving 453
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Conclusion 454
Summary 454
Questions for Review 455
Problems and Applications 455
Glossary 459
Index 463
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P R E FA C E
As soon as we got our hands on the first U.S. edition of Principles of Macroeconomics, it was clear to us that “this one is different.” If other first-year economics
textbooks are encyclopedias, Gregory Mankiw’s was, and still is, a handbook.
Between us, we have many years of experience teaching first-year economics.
Like many instructors, we found it harder and harder to teach with each new edition of the thick, standard texts. It was simply impossible to cover all of the material. Of course, we could have skipped sections, features, or whole chapters, but
then, apart from the sheer hassle of telling students which bits to read and not to
read, and worries about the consistencies and completeness of the remaining
material, we ran the risk of leaving students with the philosophy that what matters is only what’s on the exam.
We do not believe that the writers of these other books set out with the intention of cramming so much material into them. It is a difficult task to put together
the perfect textbook—one that all instructors would approve of and that all students would enjoy using. Therefore, to please all potential users, most of the
books end up covering a wide range of topics. And so the books grow and grow.
Professor Mankiw made a fresh start in the first U.S. edition. He included all
the important topics and presented them in order of importance. And in the fifth
U.S. edition, he has resisted the temptation to add more and more material. We
have, in adapting the text for Canadian students, taken a minimalist approach: “If
it isn’t broken, don’t fix it!” While the book is easily recognizable as Mankiw’s,
we have made changes that increase its relevance to Canadian students. Some of
these changes reflect important differences between the Canadian and U.S.
economies. For example, the Canadian economy is much smaller and more open
than the U.S. economy, and this fact is explicitly recognized in this edition. Other
changes reflect important institutional differences between the two countries,
including the structure of the tax system and the nature of competition policy.
Finally, the Canadian edition focuses on issues and includes examples that are
more familiar and relevant to a Canadian audience.
We would not have agreed to participate in the Canadian edition if we were
not extremely impressed with the U.S. edition. Professor Mankiw has done an
outstanding job of identifying the key concepts and principles that every firstyear student should learn.
It was truly a pleasure to work with such a well-thought-out and well-written
book. We have enjoyed teaching from the earlier Canadian editions and we look
forward to using the fifth Canadian edition. We hope you do, too.
Finally, we want to acknowledge the contributions of our friend and colleague
Nick Rowe of Carleton University. We began our work adapting Professor
Mankiw’s book with Nick, and while he decided to leave the project with this edition, his contributions to the book remain and we acknowledge his help and advice.
HOW THE BOOK IS ORGANIZED
To write a brief and student-friendly book, Mankiw considered new ways to
organize familiar material. What follows is a whirlwind tour of this text. This
tour, we hope, will give you a sense of how the pieces fit together.
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Introductory Material
Chapter 1, “Ten Principles of Economics,” introduces students to the economist’s
view of the world. It previews some of the big ideas that recur throughout
economics, such as opportunity costs, marginal decision making, the role of
incentives, the gain from trade, and the efficiency of market allocations.
Throughout the text an effort is made to relate the discussion back to the ten principles of economics introduced in Chapter 1. The interconnections of the material
with the ten principles are clearly identified throughout the text.
Chapter 2, “Thinking Like an Economist,” examines how economists approach
their field of study, discussing the role of assumptions in developing a theory and
introducing the concepts of an economic model. It also discusses the role of economists in making policy. The appendix to this chapter offers a brief refresher
course on how graphs are used and how they can be abused.
Chapter 3, “Interdependence and the Gains from Trade,” presents the theory of
comparative advantage. This theory explains why individuals trade with their
neighbours, as well as why nations trade with other nations. Much of economics
is about how market forces coordinate many individual production and consumption decisions. As a starting point for this analysis, students see in this
chapter why specialization, interdependence, and trade can benefit everyone.
The Fundamental Tools of Supply and Demand
The next chapter introduces the basic tools of supply and demand. Chapter 4,
“The Market Forces of Supply and Demand,” develops the supply curve, the
demand curve, and the notion of market equilibrium.
More Macroeconomics
Our overall approach to teaching macroeconomics is to examine the economy in
the long run (when prices are flexible) before examining the economy in the short
run (when prices are sticky). We believe that this organization simplifies learning
macroeconomics for several reasons. First, the classical assumption of price flexibility is more closely linked to the basic lessons of supply and demand, which
students have already mastered. Second, the classical dichotomy allows the study
of the long run to be broken up into several, more easily digested pieces.
Third, because the business cycle represents a transitory deviation from the
economy’s long-run growth path, studying the transitory deviations is more
natural after the long-run equilibrium is understood. Fourth, the macroeconomic
theory of the short run is more controversial among economists than the macroeconomic theory of the long run. For these reasons, most upper-level courses in
macroeconomics now follow this long-run-before-short-run approach; our goal is
to offer introductory students the same advantage.
Returning to the detailed organization, we start the coverage of macroeconomics with issues of measurement. Chapter 5, “Measuring a Nation’s Income,”
discusses the meaning of gross domestic product and related statistics from the
national income accounts. Chapter 6, “Measuring the Cost of Living,” discusses
the measurement and use of the consumer price index.
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PREFACE
The next three chapters describe the behaviour of the real economy in the long
run. Chapter 7, “Production and Growth,” examines the determinants of the large
variation in living standards over time and across countries. Chapter 8, “Saving,
Investment, and the Financial System,” discusses the types of financial institutions in our economy and examines their role in allocating resources. Chapter 9,
“Unemployment and Its Natural Rate,” considers the long-run determinants of
the unemployment rate, including job search, minimum-wage laws, the market
power of unions, and efficiency wages.
Having described the long-run behaviour of the real economy, the book then
turns to the long-run behaviour of money and prices. Chapter 10, “The Monetary
System,” introduces the economist’s concept of money and the role of the central
bank in controlling the quantity of money. Chapter 11, “Money Growth and Inflation,” develops the classical theory of inflation and discusses the costs that
inflation imposes on a society.
The next two chapters present the macroeconomics of open economies, maintaining the long-run assumptions of price flexibility and full employment.
Chapter 12, “Open-Economy Macroeconomics: Basic Concepts,” explains the
relationship among saving, investment, and the trade balance; the distinction
between the nominal and real exchange rate; and the theory of purchasing-power
parity. Chapter 13, “A Macroeconomic Theory of the Open Economy,” presents a
classical model of the international flow of goods and capital. The model sheds
light on various issues, including the link between budget deficits and trade
deficits and the macroeconomic effects of trade policies. Because instructors differ
their emphasis on this material, these chapters are written so that they can be
used in different ways. Some may choose to cover Chapter 12 but not Chapter 13,
others may skip both chapters, and still others may choose to defer the analysis of
open-economy macroeconomics until the end of their courses.
After fully developing the long-run theory of the economy in Chapters 5
through 13, the book turns to explaining short-run fluctuations around the longrun trend. This organization simplifies teaching the theory of short-run fluctuations because, at this point in the course, students have a good grounding in
many basic macroeconomic concepts. Chapter 14, “Aggregate Demand and
Aggregate Supply,” begins with some facts about the business cycle and then
introduces the model of aggregate demand and aggregate supply. Chapter 15,
“The Influence of Monetary and Fiscal Policy on Aggregate Demand,” explains
how policymakers can use the tools at their disposal to shift the aggregatedemand curve. Chapter 16, “The Short-Run Tradeoff between Inflation and
Unemployment,” explains why policymakers who control aggregate demand
face a tradeoff between inflation and unemployment. It examines why this
tradeoff exists in the short run, why it shifts over time, and why it does not exist
in the long run.
The book concludes with Chapter 17, “Five Debates over Macroeconomic
Policy.” This capstone chapter considers controversial issues facing policymakers: the proper degree of policy activism in response to the business cycle,
the choice between rules and discretion in the conduct of monetary policy, the
desirability of reaching zero inflation, the importance of reducing the government’s debt, and the need for tax reform to encourage saving. For each issue, the
chapter presents both sides of the debate and encourages students to make their
own judgments.
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WALK-THROUGH
The purpose of this text is to help students learn the fundamental lessons of economics and to show how such lessons can be applied to the world in which they
live. Toward that end, various learning tools recur throughout the book.
Chapter Openers
Welldesigned chapter openers act as
previews that summarize the
major concepts to be learned in
each chapter.
Case Studies Economic theory is useful and interesting only if
it can be applied to understanding actual events and policies.
Updated or replaced with more current Canadian examples, this
book therefore contains numerous case studies that apply the
theory that has just been developed.
Figures and Tables
Colourful and eye-catching visuals are
used to make important economic points and to clarify
Canadian and other key economic concepts. These have also
proved to be valuable and memorable teaching aids.
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PREFACE
Updated Canadian “In the News” Features
One benefit that students gain from studying
economics is a new perspective and greater
understanding about news from Canada and
around the world. To highlight this benefit, there
are excerpts from many Canadian news articles,
some of which are opinion columns written by
prominent economists. These articles show how
basic economic theory can be applied.
“FYI” Features
These features provide
additional material “for your information.” Some
of them offer a glimpse into the history of
economic thought. Others clarify technical issues.
Still others discuss supplementary topics that
instructors might choose either to discuss or skip
in their lectures.
Key Concept Definitions
When key concepts
are introduced in the chapter, they are presented in
bold typeface. In addition, their definitions are
placed in the margin and in the “Glossary” at the
back of the book. This treatment should aid
students in learning and reviewing the material.
QuickQuizzes After each major section,
students are offered a quick quiz to check their
comprehension of what they have just learned. If
students cannot readily answer these quizzes, they
should stop and reread the material before
continuing.
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Chapter Summaries
Each chapter ends with a
brief summary that reminds students of the most
important lessons that they have just learned. Later in
their study, it offers an efficient way to review for
exams.
List of Key Concepts
A list of key concepts at the
end of each chapter offers students a way to test their
understanding of the new terms that have been
introduced. Page references are included so that
students can review the terms they do not
understand.
Questions for Review At the end of each
chapter are questions for review that cover the
chapter’s primary lessons. Students can use these
questions to check their comprehension and to
prepare for exams.
Problems and Applications Each chapter also
contains a variety of problems and applications that
ask students to apply the material they have learned.
Some instructors may use these questions for
homework assignments. Others may use them as a
starting point for classroom discussion.
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PREFACE
NEW IN THIS FIFTH CANADIAN EDITION
Chapter 6
A new “FYI” feature on the Bank of Canada’s Inflation Calculator
has been added. The feature shows how students can calculate the rate of inflation
over any time period and determine the level of prices in any year since 1914,
using the Inflation Calculator provided on the Bank of Canada’s website.
Chapter 8
A new “FYI” feature, “Financial Institutions in Crisis,” has been added
that explains the source of the financial crisis that struck the world’s economies in
2007–09 and discusses the importance of financial market regulations. Our existing
“Case Study” on the debate over government budgets has been modified to reflect
the return to deficits following the 2007–09 financial crisis.
Chapter 9 A new “FYI” feature has been added comparing the labour market
effects of the latest recession to that in 1990–91. It shows that not all recessions
affect all parts of Canada the same. Another new “FYI” feature has been added,
examining who earns the minimum wage.
Chapter 10
A new “FYI” feature has been added explaining how the Bank of
Canada responded to the world financial crisis of 2007–09.
Chapter 14
A new “Case Study” on housing wealth presents and discusses
data on the boom and bust in house prices over the period 1993–2009 and what role
that may have played in the financial crisis of 2007–09. Another new “Case Study”
studies the recession Canada suffered in 2008–09 and makes comparisons to the
Great Depression of the 1930s.
Chapter 15
A new “Case Study” on the recession of 2008–09 evaluates the
response of Canadian policymakers.
Clear Explanations
In Chapter 3, we have expanded our discussion of
comparative advantage to better enable students to understand and appreciate this
key concept. In Chapter 5, we expand our discussion of how inflation is measured.
Chapter 7 extends our discussion of the source of productivity speedups and
slowdowns. In Chapter 9, we have further developed our discussion of the concept
of efficiency wages. In Chapter 12, we discuss the terms “strong” and “weak” as
applied to the value of a currency and emphasize the importance of interpreting
these terms appropriately. In Chapter 14, we have significantly updated our
discussion of how changes in oil prices impact the economy. Finally, in Chapter 16,
we have modified our discussion of the future of the inflation–unemployment
tradeoff to reflect what occurred during the world financial crisis of 2007–09.
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SUPPLEMENTS
For the Instructor
The Nelson Education Teaching Advantage (NETA) program delivers researchbased resources that promote student engagement and higher-order thinking and
enable the success of Canadian students and educators.
The primary NETA components are NETA Engagement and NETA
Assessment.
NETA Engagement The foundational principles underlying NETA
Engagement are student-centred learning, deep learning, active learning, and
creating positive classroom environments. The NETA Instructor’s Guide to
Classroom Engagement (NETA IGCE) provides an overview of the research
underlying these principles. The structure of the Classroom Engagement
Activities was created by Dr. Roger Fisher and validated by an interdisciplinary
editorial advisory board of scholars of teaching and learning.
Editorial Advisory Board:
Norman Althouse, Haskayne School of Business, University of Calgary
Brenda Chant-Smith, Department of Psychology, Trent University
Scott Follows, Manning School of Business Administration, Acadia University
Glen Loppnow, Department of Chemistry, University of Alberta
Tanya Noel, Department of Biology, York University
Gary Poole, Director, Centre for Teaching and Academic Growth and School of
Population and Public Health, University of British Columbia
Dan Pratt, Department of Educational Studies, University of British Columbia
The Classroom Engagement Activities for Principles of Macroeconomics, Fifth
Canadian Edition, were written by Professor Oliver Franke at Concordia University
College of Alberta.
NETA Assessment Recognizing the importance of multiple-choice testing in
today’s classroom and in response to instructors’ concerns, Nelson Education has
created the NETA Assessment program. NETA Assessment is a research-based
program that improves the quality of our test banks by ensuring our test banks
measure not just recall (as is typical with test banks) but higher-level thinking skills
as well.
The NETA Assessment program was created in partnership with David
DiBattista, a 3M National Teaching Fellow, professor of psychology at Brock University, and researcher in the area of multiple-choice testing.
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PREFACE
All NETA test banks include Professor DiBattista’s guide for instructors, Multiple
Choice Tests: Getting Beyond Remembering. This guide has been designed to assist you
in using Nelson test banks to achieve the desired outcomes in your course.
Instructor’s Resource CD Managing classroom resources is now easier for
instructors. The new Instructor’s Resource CD contains all key supplements:
Instructor’s Manual, NETA Classroom Engagement Activities, NETA Test Bank,
ExamView Computerized Test Bank, Microsoft® PowerPoint® slides, and Image
Library. ISBN 978-0-17-644179-1.
Computerized Test Bank The ExamView Computerized Testing Software
contains all the questions in the NETA test bank. Technically checked and
copyedited for this new edition, the program is an easy-to-use test-creation
software application that is compatible with Microsoft Windows. Instructors can
add or edit questions, instructions, and answers, and can select questions by
previewing them on the screen, selecting them randomly, or selecting them by
number. Instructors can also create and administer quizzes online, whether over
the Internet, a local area network (LAN), or a wide area network (WAN). The
Principles of Macroeconomics Fifth Canadian Edition Test Bank was updated and
revised by Professor Constantin Colonescu at Grant MacEwan University. The
Principles of Microeconomics Fifth Canadian Edition Test Bank was updated and
revised by Professor Hannah Holmes at McMaster University. The Test Banks
reside on the Instructor’s Resource CD and as a downloadable from the
instructor’s area of the text’s website (www.mankiw5e.nelson.com).
Microsoft® PowerPoint® Lecture and Exhibit Slides
Available on the
Instructor’s Resource CD and downloadable from the text’s website
(http://www.mankiw5e.nelson.com) are two versions of the PowerPoint
presentation. Revised by Professor Marc Prud’Homme at the University of Ottawa,
to save instructors valuable time as they prepare for class using this comprehensive
lecture presentation, this supplement covers all the essential topics presented in
each chapter of the book. Graphs, tables, lists, and concepts are developed
sequentially, much as one might develop them on a chalkboard. Additional
examples and applications are used to reinforce major lessons. A separate exhibit
presentation provides instructors with all of the tables and graphs from the main
text.
Aplia For instructors, Aplia offers high-quality, auto-graded assignments,
which ensure that students put forth effort on a regular basis throughout the term.
Contact your Nelson sales representative for more information.
Ten Principles Video Set Ken Witty, a talented documentary filmmaker,
has produced a video series to illustrate the ten principles of economics
introduced in Chapter 1 of both the fifth Canadian edition and the fifth U.S.
edition texts. Instructors can show these videos as an interesting and visually
appealing introduction to topics discussed throughout the textbook.
ISBN 978-0-324-17395-6.
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PREFACE
For the Student
Study Guide Written by Professors Peter Fortura at Algonquin College and
Shahram Manouchehri at Grant MacEwan University, this study guide was
prepared to enhance student success. Each chapter of the study guide includes
learning objectives, a description of the chapter’s context and purpose, a chapter
review, key terms and definitions, advanced critical thinking questions, and
helpful hints for understanding difficult concepts. Students can develop their
understanding by doing the practice problems and short-answer questions, and
then assess theory mastery of the key concepts with the self-test, which includes
true/false and multiple-choice questions. Solutions to all problems are included
in the study guide.
Principles of Macroeconomics Study Guide:
ISBN 978-0-17-644187-6.
Principles of Microeconomics Study Guide:
ISBN 978-0-17-647135-4.
Aplia For students, Aplia offers a way to stay on top of course work with
regularly scheduled homework assignments. Interactive tools and content further
increase engagement and understanding. Students, ask your instructor about
Aplia.
Principles of Macroeconomics Website Valuable resources for students
can be found on the Internet at the Principles of Macroeconomics textbook support
site: http://www.mankiw5e.nelson.com. Students will find more true/false,
multiple-choice, and short-answer questions (updated and revised by Eric Moon
at the University of Toronto); links to economics-related Internet sites; PowerPoint
slides for their review; a graphics workshop for appropriate chapters; and much
more.
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A B O U T
T H E
A U T H O R S
Jordi Cabré
N. Gregory Mankiw is Professor of Economics at Harvard
University. As a student, he studied economics at
Princeton University and MIT. As a teacher, he has taught
macroeconomics, microeconomics, statistics, and principles of economics. He even spent one summer long ago as
a sailing instructor on Long Beach Island.
Professor Mankiw is a prolific writer and a regular participant in academic and policy debates. His work has been
published in scholarly journals such as the American Economic Review, Journal of Political Economy, and Quarterly
Journal of Economics, and in more popular forums such as The
New York Times, The Financial Times, The Wall Street Journal, and Fortune. He is also
author of the best-selling intermediate-level textbook Macroeconomics (Worth Publishing). In addition to his teaching, research, and writing, Professor Mankiw has
been a research associate of the National Bureau of Economic Research, an adviser to
the Federal Reserve Bank of Boston and the Congressional Budget Office, and a
member of the Educational Testing Service (ETS) test development committee for
the advanced placement exam in economics. From 2003 to 2005, he served as
Chairman of the President’s Council of Economic Advisers.
Ronald D. Kneebone is Professor of Economics at the University of Calgary. He received his Ph.D. from McMaster
University. Professor Kneebone has taught courses in
public finance and in macroeconomics from principles
through to the Ph.D. level, and he is a two-time winner of
the Faculty of Social Sciences Distinguished Teacher Award
at the University of Calgary. His research interests are primarily in the areas of public sector finances and fiscal federalism. He shared with Ken McKenzie the Douglas Purvis
Memorial Prize for the best published work in Canadian
public policy in 1999. Since 2008, he has been Director of
Economic and Social Policy Research in The School of Public Policy at the University of Calgary.
Kenneth J. McKenzie is Professor of Economics at the University of Calgary. He received his Ph.D. from Queen’s
University. Specializing in public economics with an
emphasis on taxation and political economy, Professor
McKenzie has published extensively in these areas. He is
the winner of the 1996 Harry Johnson Prize (with University of Calgary colleague Herb Emery) for the best article in
the Canadian Journal of Economics, the 1999 Douglas Purvis
Memorial Prize (with Ron Kneebone) for a published work
relating to Canadian public policy, and the 2000 Faculty of
Social Sciences Distinguished Researcher Award at the University of Calgary. Professor McKenzie has taught microeconomics and public
economics from the principles to the graduate level, and has received several
departmental teaching awards.
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A C K N O W L E D G M E N T S
The success of each Canadian edition of Principles of Macroeconomics and Principles
of Microeconomics has been due, in part, to the reviewers who
helped us shape this text, edition after edition. We have benefited enormously
from their advice and suggestions.
Collins Ayoo,
Carleton University
James Wishart,
College of the Rockies
Menouar Boulahfa,
Dawson College
Weili Ding,
Queen’s University
Steven Lehrer,
Queen’s University
Kien Tran,
University of Lethbridge
David Gray,
University of Ottawa
Maurice Tugwell,
Acadia University
Kevin Clinton,
Bank of Canada
Keith Baxter,
Bishop’s University
Nancy Churchman,
Carleton University
Aurelia Best,
Centennial College
Bogdan Buduru,
Concordia University
Stephen Rakocsy,
Humber College
Byron Eastman,
Chris McDonnell,
Malaspina University-College
Martin Dooley,
McMaster University
Peter McCabe,
McMaster University
Ernie Jacobson,
Northern Alberta Institute of Technology
Ugurhan G. Berkok,
Queen’s University
Gregor Smith,
Queen’s University
Ibrahim Hayania,
Seneca College
Ather H. Akbari,
St. Mary’s University
Herb Emery,
University of Calgary
Costas Nicolau,
University of Manitoba
Robin Neill,
University of Prince Edward Island and
Carleton University
Pierre Fortin,
University of Quebec at Montreal
Michael Hare,
University of Toronto
Hannah Holmes,
McMaster University
Laurentian University
Special thanks go to Bill Scarth of McMaster University, who offered invaluable advice regarding the structure and emphasis of the Canadian editions. Dr.
Scarth is an award-winning teacher and author, and to ignore his advice would
have been perilous indeed. His extensive comments were instrumental in helping
us formulate our approach to the Canadian editions.
We would also like to thank our colleagues at the University of Calgary who
provided invaluable informal input and useful examples and applications. We, of
course, bear full responsibility for any misinterpretations and errors.
Canadianizing this book has been a team effort from the very start. We would
like to acknowledge the editorial, production, and marketing teams at Nelson for
their professionalism, advice, and encouragement throughout the process.
Deserving special attention are senior acquisitions editor Craig Dyer and the
team at My Editor for helping to ensure the timely completion of our work.
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ACKNOWLEDGMENTS
Finally, we are grateful to our families for their indulgence and encouragement
throughout the research and writing process. Their patience and understanding
are greatly appreciated.
Ronald D. Kneebone
Kenneth J. McKenzie
October 2010
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G L O S S A RY
absolute advantage the comparison among
producers of a good according to their
productivity
aggregate-demand curve a curve that
shows the quantity of goods and services that
households, firms, and the government want
to buy at each price level
aggregate-supply curve a curve that shows
the quantity of goods and services that firms
choose to produce and sell at each price level
appreciation an increase in the value of a
currency as measured by the amount of
foreign currency it can buy
automatic stabilizers changes in fiscal
policy that stimulate aggregate demand
when the economy goes into a recession,
without policymakers having to take any
deliberate action
balanced trade
equal imports
Bank of Canada
commodity money money that takes the
form of a commodity with intrinsic value
comparative advantage the comparison
among producers of a good according to their
opportunity cost
competitive market a market in which
there are many buyers and many sellers so
that each has a negligible impact on the
market price
complements two goods for which an
increase in the price of one leads to a decrease
in the demand for the other
consumer price index (CPI) a measure of
the overall cost of the goods and services
bought by a typical consumer
consumption spending by households on
goods and services, with the exception of
purchases of new housing
a situation in which exports
core inflation the measure of the underlying
trend of inflation
the central bank of Canada
crowding out a decrease in investment that
results from government borrowing
bank rate the interest rate charged by the
Bank of Canada on loans to the commercial
banks
bond a certificate of indebtedness
budget deficit a shortfall of tax revenue
from government spending
budget surplus an excess of tax revenue
over government spending
business cycle fluctuations in economic
activity, such as employment and production
capital flight a large and sudden reduction in the demand for assets located in
a country
catch-up effect the property whereby
countries that start off poor tend to grow
more rapidly than countries that start off rich
crowding-out effect on investment the
offset in aggregate demand that results when
expansionary fiscal policy raises the interest
rate and thereby reduces investment spending
crowding-out effect on net exports the
offset in aggregate demand that results when
expansionary fiscal policy in a small open
economy with a flexible exchange rate raises
the real exchange rate and thereby reduces
net exports
currency the paper bills and coins in the
hands of the public
cyclical unemployment the deviation of
unemployment from its natural rate
demand curve a graph of the relationship
between the price of a good and the quantity
demanded
central bank an institution designed to regulate the quantity of money in the economy
demand deposits balances in bank accounts
that depositors can access on demand by
writing a cheque or using a debit card
circular-flow diagram a visual model of the
economy that shows how dollars flow through
markets among households and firms
demand schedule a table that shows the
relationship between the price of a good and
the quantity demanded
classical dichotomy the theoretical separation of nominal and real variables
depreciation a decrease in the value of a
currency as measured by the amount of foreign currency it can buy
closed economy an economy that does not
interact with other economies in the world
collective bargaining the process by
which unions and firms agree on the terms
of employment
discouraged searchers individuals who
would like to work but have given up
looking for a job
economics the study of how society
manages its scarce resources
efficiency the property of society getting
the most it can from its scarce resources
efficiency wages above-equilibrium wages
paid by firms in order to increase worker
productivity
Employment Insurance a government
program that partially protects workers’
incomes when they become unemployed
equilibrium a situation in which the
price has reached the level where quantity
supplied equals quantity demanded
equilibrium price the price that balances
quantity supplied and quantity demanded
equilibrium quantity the quantity
supplied and the quantity demanded at the
equilibrium price
equity the property of distributing
economic prosperity fairly among the
members of society
exports goods and services that are
produced domestically and sold abroad
externality the impact of one person’s
actions on the well-being of a bystander
fiat money money without intrinsic value
that is used as money because of government
decree
financial intermediaries financial
institutions through which savers can
indirectly provide funds to borrowers
financial markets financial institutions
through which savers can directly provide
funds to borrowers
financial system the group of institutions in
the economy that help to match one person’s
saving with another person’s investment
fiscal policy the setting of the level of
government spending and taxation by
government policymakers
Fisher effect the one-for-one adjustment of
the nominal interest rate to the inflation rate
depression a severe recession
foreign exchange market operations the
purchase or sale of foreign money by the
Bank of Canada
diminishing returns the property whereby
the benefit from an extra unit of an input
declines as the quantity of the input increases
fractional-reserve banking a banking
system in which banks hold only a fraction of
deposits as reserves
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GLOSSARY
job search the process by which workers
find appropriate jobs given their tastes and
skills
model of aggregate demand and aggregate
supply the model that most economists use
to explain short-run fluctuations in economic
activity around its long-run trend
labour force the total number of workers,
including both the employed and the
unemployed
monetary neutrality the proposition that
changes in the money supply do not affect
real variables
government debt the sum of all past
budget deficits and surpluses
labour-force participation rate the percentage of the adult population that is in the
labour force
monetary policy the setting of the money
supply by policymakers in the central bank
government net debt the difference
between the value of government financial
liabilities and financial assets
law of demand the claim that, other things
equal, the quantity demanded of a good falls
when the price of the good rises
government purchases spending on goods
and services by local, territorial, provincial,
and federal governments
law of supply the claim that, other things
equal, the quantity supplied of a good rises
when the price of the good rises
gross domestic product (GDP) the market
value of all final goods and services
produced within a country in a given period
of time
law of supply and demand the claim
that the price of any good adjusts to bring
the quantity supplied and the quantity
demanded for that good into balance
frictional unemployment unemployment
that results because it takes time for workers
to search for the jobs that best suit their tastes
and skills
GDP deflator a measure of the price level
calculated as the ratio of nominal GDP to real
GDP times 100
human capital the knowledge and skills
that workers acquire through education,
training, and experience
import quota a limit on the quantity of a
good that is produced abroad and sold
domestically
imports goods and services that are
produced abroad and sold domestically
incentive
to act
something that induces a person
indexation the automatic correction of a
dollar amount for the effects of inflation by
law or contract
inferior good a good for which, other
things equal, an increase in income leads
to a decrease in demand
inflation an increase in the overall level
of prices in the economy
inflation rate the percentage change
in the price index from the preceding
period
inflation tax the revenue the government
raises by creating money
interest rate parity a theory of interest rate
determination whereby the real interest rate
on comparable financial assets should be the
same in all economies with full access to
world financial markets
investment spending on capital equipment,
inventories, and structures, including household purchases of new housing
liquidity the ease with which an asset can
be converted into the economy’s medium of
exchange
macroeconomics the study of economywide phenomena, including inflation,
unemployment, and economic growth
marginal changes small incremental
adjustments to a plan of action
market a group of buyers and sellers
of a particular good or service
market economy an economy that
allocates resources through the decentralized
decisions of many firms and households
as they interact in markets for goods and
services
money the set of assets in an economy
that people regularly use to buy goods and
services from other people
money multiplier the amount of money the
banking system generates with each dollar of
reserves
money supply the quantity of money
available in the economy
multiplier effect the additional shifts in
aggregate demand that result when expansionary fiscal policy increases income and
thereby increases consumer spending
mutual fund an institution that sells shares
to the public and uses the proceeds to buy
a portfolio of stocks and bonds
national saving (saving) the total income in
the economy that remains after paying for
consumption and government purchases
natural-rate hypothesis the claim that
unemployment eventually returns to its
normal, or natural, rate, regardless of the
rate of inflation
natural rate of output the production of
goods and services that an economy achieves
in the long run when unemployment is at its
normal rate
market failure a situation in which a
market left on its own fails to allocate
resources efficiently
natural rate of unemployment the rate of
unemployment to which the economy tends
to return in the long run
market for loanable funds the market in
which those who want to save supply funds
and those who want to borrow to invest
demand funds
natural resources the inputs into the
production of goods and services that are
provided by nature, such as land, rivers,
and mineral deposits
market power the ability of a single
economic actor (or small group of actors) to
have a substantial influence on market prices
net capital outflow the purchase of
foreign assets by domestic residents minus
the purchase of domestic assets by
foreigners
medium of exchange an item that buyers
give to sellers when they want to purchase
goods or services
menu costs the costs of changing prices
net exports the value of a nation’s exports
minus the value of its imports; also called the
trade balance
microeconomics the study of how households and firms make decisions and how
they interact in markets
nominal exchange rate the rate at which a
person can trade the currency of one country
for the currency of another
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GLOSSARY
461
nominal GDP the production of goods and
services valued at current prices
public saving the tax revenue that the government has left after paying for its spending
scarcity the limited nature of society’s
resources
nominal interest rate the interest rate as
usually reported without a correction for the
effects of inflation
purchasing-power parity a theory of
exchange rates whereby a unit of any given
currency should be able to buy the same
quantity of goods in all countries
shoeleather costs the resources wasted
when inflation encourages people to reduce
their money holdings
quantity demanded the amount of a good
that buyers are willing and able to purchase
small open economy an economy that
trades goods and services with other
economies and, by itself, has a negligible
effect on world prices and interest rates
nominal variables variables measured in
monetary units
normal good a good for which, other things
equal, an increase in income leads to an
increase in demand
normative statements claims that attempt
to prescribe how the world should be
quantity equation the equation M ⫻ V ⫽
P ⫻ Y, which relates the quantity of money,
the velocity of money, and the dollar value
of the economy’s output of goods and
services
Okun’s law the number of percentage
points the unemployment rate increases
when GDP falls by 1 percentage point
quantity supplied the amount of a good
that sellers are willing and able to sell
open economy an economy that interacts
freely with other economies around the
world
open-market operations the purchase or
sale of Government of Canada bonds by the
Bank of Canada
opportunity cost whatever must be given
up to obtain some item
overnight rate the interest rate on very
short-term loans between commercial
banks
perfect capital mobility full access to world
financial markets
Phillips curve a curve that shows the
short-run tradeoff between inflation and
unemployment
physical capital the stock of equipment
and structures that are used to produce
goods and services
quantity theory of money a theory
asserting that the quantity of money available
determines the price level and that the
growth rate in the quantity of money
available determines the inflation rate
rational expectations the theory according
to which people optimally use all the information they have, including information
about government policies, when forecasting
the future
rational people people who systematically
and purposefully do the best they can to
achieve their objectives
real exchange rate the rate at which a
person can trade the goods and services of
one country for the goods and services of
another
real GDP the production of goods and
services valued at constant prices
real interest rate the interest rate corrected
for the effects of inflation
positive statements claims that attempt to
describe the world as it is
real variables variables measured in
physical units
private saving the income that households have left after paying for taxes and
consumption
recession a period of declining real incomes
and rising unemployment
production possibilities frontier a graph
that shows the combinations of output that
the economy can possibly produce given the
available factors of production and the
available production technology
reserve ratio the fraction of deposits that
banks hold as reserves
reserve requirements regulations on the
minimum amount of reserves that banks
must hold against deposits
shortage a situation in which quantity
demanded is greater than quantity supplied
stagflation a period of falling output and
rising prices
sterilization the process of offsetting
foreign exchange market operations with
open-market operations, so that the effect
on the money supply is cancelled out
stock a claim to partial ownership in a firm
store of value an item that people can
use to transfer purchasing power from the
present to the future
strike the organized withdrawal of labour
from a firm by a union
structural unemployment unemployment
that results because the number of jobs
available in some labour markets is
insufficient to provide a job for everyone
who wants one
substitutes two goods for which an
increase in the price of one leads to an
increase in the demand for the other
supply curve a graph of the relationship
between the price of a good and the quantity
supplied
supply schedule a table that shows the
relationship between the price of a good and
the quantity supplied
supply shock an event that directly alters
firms’ costs and prices, shifting the
economy’s aggregate-supply curve and thus
the Phillips curve
surplus a situation in which quantity
supplied is greater than quantity demanded
tariff a tax on goods produced abroad and
sold domestically
productivity the quantity of goods and
services produced from each hour of a
worker’s time
reserves deposits that banks have received
but have not loaned out
technological knowledge society’s understanding of the best ways to produce goods
and services
property rights the ability of an individual
to own and exercise control over scarce
resources
sacrifice ratio the number of percentage
points of one year’s output lost in the process
of reducing inflation by 1 percentage point
theory of liquidity preference Keynes’s
theory that the interest rate adjusts to bring
money supply and money demand into
balance
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GLOSSARY
trade balance the value of a nation’s
exports minus the value of its imports;
also called net exports
union a worker association that bargains
with employers over wages and working
conditions
revenue and higher spending on incomesupport programs, and the result can be
even higher budget deficits
trade deficit an excess of imports over
exports
unit of account the yardstick people use
to post prices and record debts
trade policy a government policy that
directly influences the quantity of goods and
services that a country imports or exports
velocity of money the rate at which money
changes hands
virtuous circle cycle that results when
surpluses increase the supply of loanable
funds, reduce interest rates, stimulate
investment, and result in faster economic
growth; faster growth leads to higher tax
revenue and lower spending on incomesupport programs, and the result can be
even higher budget surpluses
trade surplus an excess of exports over
imports
unemployment rate the percentage of the
labour force that is unemployed
vicious circle cycle that results when
deficits reduce the supply of loanable funds,
increase interest rates, discourage
investment, and result in slower economic
growth; slower growth leads to lower tax
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INDEX
Note: Page numbers in boldface refer to
pages where key terms are defined. Page
numbers followed by “f” or “t” refer to
figures or tables.
A
Absolute advantage, 57
Accounting, 173
Aggregate demand
case study, 351–354
contraction in, 349f
fiscal policy and, 380–394
monetary policy and, 366–379
money supply changes, 373–374
multiplier effect, 382–384
open economy considerations, 374–379
Phillips curve, 409–411
shifts in, 347–355
theory of liquidity preference, 367–372
See also Model of aggregate demand and
aggregate supply
Aggregate-demand curve, 330, 331–337, 331f
case study, 334–336
downward sloping, 332–334, 372–373,
372f
expansionary policies, 400f
shifting of, 334–337
summary, 337t
Aggregate supply
case study, 358–360
fiscal policy and, 393
Phillips curve, 409–411
shifts in, 355–360, 356f, 357f
shocks to, 418–422, 420f
See also Model of aggregate demand and
aggregate supply
Aggregate-supply curve, 330, 337–347
long-run, 338–342
shifting of, 339–340, 345–346
short-run, 342–346, 342f, 347t
upward sloping, 342–345
vertical direction of, 338–339, 338f
Akerlof, George, 408
American Stock Exchange, 168
Anderson, Kym, 156
Apple iPod, 273–274
Appreciation, 282
Arbitrage, 287
Argentina, 317
Ashraf, Nava, 155–156
Ashworth, Laurence, 7
Assumptions, 23–24
B
Balanced trade, 270
Bangladesh, 13
Bank of Canada, 166, 172, 226, 226–228
consumer price index, 126
Currency Museum, 222
establishment of, 226
financial crisis (2007–09), 236
functions, 227
government in relation to, 226–227
inflation, 261–262, 412–433
inflation calculator, 129
monetary control, 232–235, 367–368,
377–379
monetary policy, 228, 261–262, 441–444
Bank of Canada Act, 226–227
Bank of Montreal, 227
Bank of Nova Scotia, 227
Bank rate, 234, 368
Bank runs, 237–238
Banks. See Commercial banks
Bar graphs, 42, 43f
Barro, Robert, 424
Barter, 220
Basket of goods and services, for CPI, 122–127
Belichick, Bill, 33
Berra, Yogi, 132
Big 5 banks, 227
Big Macs, 290–291
Birdsall, Nancy, 152
Blinder, Alan, 444–445
Bolivia, 257
Bond, 167
Bond market, 167–168
Bouey, Gerald, 261
Brain drain, 150–151
Brazil, 152
Broadcom, 274
Budget deficit, 174
Budget surplus, 174
Bush, George W., 34
Business cycles, 15, 326. See also Economic
fluctuations; Political business cycle
Buyers, variables influencing, 74–75, 76t
C
Canada
as small open economy, 291–292
average income, 13
brain drain, 151
capital flight, 317
currency outstanding in, 225–226
dollar, value of, 283, 284f
economic fluctuations, 351–354
economists as policy advisers, 31–32
financial crisis (2007–09), 172, 354–355,
397–399
financial institutions, 166–171
foreign ownership in, 111–113
free trade, 60–61
GNP vs. GDP, 111–113
government debt, 183–185, 448–451
Great Depression, 237, 351–353
house prices (1993–2009), 335f
inflation, 14
interest rates, 131–132
international flows, 271–273, 271f, 279–281
money, 223–225, 225f, 283, 284f
net capital outflow, 279–281, 299, 306, 308
oil production and prices, 358–360,
418–422
personal saving, 177
real GDP, 109–110, 352f
recession (2008–09), 354–355, 397–399
research and development, 155–156
unemployment rates, 194–195, 195f, 200,
200t, 417–418, 418f
union membership, 206–207
vicious circle, 182
See also Bank of Canada
Canada Deposit Insurance Corporation
(CDIC), 237–238
Canada Pension Plan (CPP), 450
Canada–U.S. Auto Pact, 272
Canada–U.S. Free Trade Agreement, 272
Canadian Imperial Bank of Commerce, 227
Capital
aggregate-supply curve, 339–340
dilution of, 159
outflow, 274–276
perfect capital mobility, 292
productivity and, 143
See also Human capital
Capital flight, 314–317, 315, 315f
Capital gains, taxes on, 258–259
Carney, Mark, 226, 427
Cartels, 358
Case studies
aggregate demand, 351–354
aggregate-demand curve, 334–336
aggregate supply, 358–360
central banks and the stock market, 379–380
consumer price index, 129
currency, 225–226
economic fluctuations, 351–355, 358–360
economic well-being in Canada,
110–111, 111f
exchange rates, 288–289
foreign ownership, 111–113
GDP components, 105–106
government budget imbalances, 185–186
government debt, 183–185
hyperinflation, 250–252, 288–289
inflation, 261–262
interest rates, 131–132
international differences in GDP and
well-being, 114–115
international flows, 271–273, 279–281
labour-force participation, 196–197
money supply, 237–238
natural resources and economic growth, 146
recession (2008–09), 354–355, 397–399
smoking demand, 76–77
wages, 211–212
NEL
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Catch-up effect, 148, 148–149
Cause and effect, graphs for illustrating,
48–50
Central banks, 226, 379–380, 441–442
Central planning, 11
Chain of production, 273–274
Chaundy, David, 88
Circular-flow diagram, 24, 24–26, 25f, 99f
Classical dichotomy, 247, 247–248, 329
Classical economics
assumptions of, 328–329
Keynes's criticism of, 359
propositions of, 401
Clean Air Act, 38
Cline, William, 156
Closed economy, 173, 270, 375f
Coins, 223
Collective bargaining, 208
Commercial banks, 170, 227, 228–236
Commission on the Measurement of
Economic Performance and Social
Progress, 116–117
Commodity money, 221
Commodity substitution bias, 125
Communism, 11
Company towns, 209
Comparative advantage, 56–62, 58
applications of, 61–62
opportunity costs, 57–58
trade and, 58
Comparative statics, 84
Competitive markets, 70, 70–71
Complements, 75
Constant returns to scale, 145
Consumer price index (CPI), 122, 122–128
basket for, 122–127
calculation of, 122–125
case study, 129
GDP deflator versus, 126–128, 127f
problems with, 125–126
Consumption, 103, 103–104, 334
Consumption taxes, 178
Continental Congress (U.S.), 252
Coordinate system, 42–43, 44f
Core inflation, 125
Cost of living, 121–133
consumer price index, 122–128
inflation effects, 128–131
problems in measuring, 125–126
Cost-of-living allowance (COLA), 130
Costs, 5–7
Coyne, James, 391–392
CPI. See Consumer price index (CPI)
Credit cards, 224
Credit risk, 167–168
Crow, John, 428
Crowding out, 181
Crowding-out effect on investment, 384,
384–386, 385f
Crowding-out effect on net exports, 388
Currency, 224
case study, 225–226
strong vs. weak, 282
Currency Museum, Ottawa, 222
Current account balance, 277
Cyclical unemployment, 191–192, 201
D
Daily volume, 169
Date of maturity, 167
Davies, Kart, 38
Debit cards, 224
Debt finance, 168
Decision making, 4–10
costs, 5–7
incentives, 9–10
rationality and marginal changes, 8
tradeoffs, 4–5
Declaration of Independence, 12
Dedrick, Jason, 273
Default, 167
Default risk, 293
Deflation, 241
Defoe, Daniel, Robinson Crusoe, 142
Demand, 71–77
case study, 76–77
demand curve, 71–72
excess, 82
market versus individual, 72–73
shifts in demand curve, 73–76
See also Supply and demand
Demand curve, 44–47, 45f, 71–76, 72,
72f, 77f
Demand deposits, 224
Demand schedule, 71, 72f
Denmark, 207
Department of Finance Canada, 166
Depreciation, 282
Depression, 325. See also Great Depression
Diminishing returns, 147, 147–149
Discouraged searchers, 197
Disinflation, 422–433, 423f
anchored expectations, 430–431
in 1980s, 425–427, 425f
rational expectations, 424–425
sacrifice ratio, 422–424
zero-inflation target, 428–430
Dividends
net flow of, 277
in stock tables, 169
Dividend yield, 169
Domestic interest rate, 299
Dominion Experimental Farms, 155
Double coincidence of wants, 220
Dow Jones Industrial Average, 168, 170
E
Earnings per share, 169
Economic fluctuations, 325–362, 327f
aggregate-demand curve, 331–337
aggregate demand shifts, 347–355
aggregate-supply curve, 337–347
aggregate supply shifts, 355–360
analyzing, 348t
case studies, 351–355, 358–360
causes, 347–360
classical economics, assumptions of,
328–329
long-run, 338–342
model of aggregate demand and aggregate
supply, 330–331, 340–342, 359
properties of, 326, 328
short-run, 328–331, 342–346
unemployment and, 327f, 328
Economic growth
factors in, 147–160
international comparison, 140–141, 141t
natural resources, 146
productivity, 142–145
public policy, 147–161
Economics, 4
assumptions, 23–24
disagreements in, 35–38
macroeconomics, 28–30
microeconomics, 28–30
models, 24–28
principles generally agreed upon, 36t
principles of, 16t
scientific approach to, 22–30
Economic well-being, 110–117, 111f
Economists
agreement among, 36t
characteristics of, 38
disagreements among, 35–38
environmental, 36–37
as policy advisers, 30–35
as scientists, 22–30
Economy
income and expenditure, 98–100
models, 24–28, 52–56
operation of, 13–16
standard of living, 13–14
Education, 150–152
Efficiency, 5
government intervention for, 13
production possibilities frontier, 27
Efficiency wages, 209, 209–211
Einstein, Albert, 22
Eisenhower, Dwight, 7
Employment Insurance (EI), 203,
203–205, 398
Environmental Defense, 38
Environmental economists, 36–37
Environmental Protection Agency, 38
Equilibrium
changes in, 83–87
long-run, 348f
in money market, 370–372, 371f
open economy, 305–307
small open economy, 307f
NEL
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supply and demand, 81, 81–83,
82f, 83f
in two markets, 306–307
Equilibrium interest rate, 370–371
Equilibrium price, 81, 81–82
Equilibrium price level, 244–249, 245f
Equilibrium quantity, 81
Equilibrium real exchange rate, 305
Equity, 5, 13
Equity finance, 168
Euro, 286
European Central Bank (ECB), 286
Excess demand, 82
Excess reserves, 230
Excess supply, 82
Exchange rates, 282–291
case study, 288–289
determining, 286–288
fixed, 388–390, 389f
flexible, 387–388, 387f, 396–397
models of, 286–291, 302–305
nominal, 282–283
real, 283–285, 333–334
See also Foreign-currency exchange
market
Expectations
anchored, 430–431
demand affected by, 75
inflation and, 411–418, 427
rational, 424–425
supply affected by, 80
Expected inflation, 415, 416f
Expenditures, national, 98–100
Exports, 62, 270. See also Net exports
Externalities, 13, 150
F
Factors of production, 24, 144
Farmers, aid to, 155–156
Farm subsidies, 155–156
Federal Home Loan Mortgage Corporation
(Freddie Mac), 172
Fiat money, 222, 222–223
Final goods, 101
Financial intermediaries, 170, 170–171
Financial markets, 167, 167–168, 170
bond market, 167–168
stock market, 168
Financial system, 166
Canadian, 166–171
crisis in, 172
financial intermediaries, 170–171
financial markets, 167–168, 170
Fiscal policy, 380
aggregate-demand curve, 400f
aggregate demand influenced by, 380–394
aggregate supply influenced by, 393
crowding-out effect on investment,
384–386
deficit reduction, 393–394
government purchases, 380
monetary policy and, 390–392
multiplier effect, 381–384
open economy considerations, 386–392,
387f
stabilization of economy, 394–399,
439–441
summary, 391t
tax changes, 392–393
Fisher, Irving, 254
Fisher effect, 254, 254–255
Fleming, Donald, 392
Flinders Island, 160
Flows. See International flows
Fluctuations. See Economic fluctuations
Fogel, Robert, 151
Football, 33
Ford, Henry, 211–212
Ford Motor Company, 211–212
Foreign-currency exchange market,
302–305, 303f. See also Exchange rates
Foreign direct investment, 149, 275
Foreign exchange market operations, 233,
367–368
Foreign investment, 149–150
Foreign Investment Review Act (FIRA), 112
Foreign ownership, 111–113
Foreign portfolio investment, 149, 275
Fractional-reserve banking, 229, 229–230
France, 61
Frederick, Shane, 6–7
Free trade
Canada, 60–61
comparative advantage, 59
economic growth, 154
Frictional unemployment, 201, 201–202
Friedman, Milton, 242, 245, 262, 411–412,
414–418
G
Gates, Bill, 142
GDP. See Gross domestic product (GDP)
GDP deflator, 108, 108–109, 126–128, 127f
General Motors, 172
Germany
hyperinflation, 289
inflation, 14–15
personal saving, 177
Gold standard, 222
Gone with the Wind (film), 129
Gono, Gideon, 254
Goods and Services Tax (GST), 178, 452
Goulden, Lawrence, 37
Government
budget deficits and surpluses, 180–183,
181f, 185–186, 310–312, 311f, 393–394,
447–451
intervention in market by, 12–13
money supply, 14–15
purchases, 336, 380
465
spending, 396
See also Fiscal policy
Government debt, 180, 183–185
Government net debt, 183, 184f
Government purchases, 104
Graphing, 42–50
cause and effect, 48–50
curves, 43–47
single variable, 42
slope, 47–48
two variables, 42–43
types of, 42, 43f
Gray, David, 205
Great Depression, 226, 237, 351–353
Greenpeace, 38
Greenspan, Alan, 34, 379
Gross domestic product (GDP), 100
case studies, 105–106, 109–110, 111–113,
114–115
components of, 103–106
defined, 100–103
GNP versus, 111–113
income equal to expenditure in, 98–99
international comparison, 140–141, 141t
measurement of, 100–103
real versus nominal, 106–110, 107t
well-being measures, 113–117
Gross national product (GNP), 102, 111–113
H
Hamburger standard, 290–291
Hanson Lecture (Crow), 428
Health and nutrition, 151–153, 210
History, experimental value of, 23
House prices, 335f
Human capital, 144
education, 150–152
population growth, 159
productivity, 144, 150
technological knowledge versus, 145
Human Resources and Skills Development
Canada (HRSDC), 204
Hume, David, 242, 247, 248, 329
Hyperinflation, 242, 250–254, 251f, 257,
288–289
I
Identities (mathematics), 173–174
Import quotas, 312, 312–314, 313f
Imports, 62, 270
Incentives, 9, 9–10
Income, national
GDP as measure of, 98–100
other measures of, 102
Income, personal
demand in relation to, 74–75
disposable, 102
measurement of, 102
Income effect, 453
Indexation, 129, 129–130
NEL
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Index funds, 171
Individual demand, 72
Individual supply, 79
Indonesia, 317
Inferior goods, 74
Inflation, 14, 241–263
case studies, 250–252, 261–262, 288–289
cause of, 15
classical theory, 242–250
core inflation, 125
correcting measurements for effects
of, 128–131
costs, 256–261, 444–445
defined, 109
disinflation, 422–433
expectations, 411–418, 427
expected, 415, 416f
historical overview, 241–242
hyper-, 242, 250–254, 257, 288–289
public policy, 411–433
unemployment and, 15, 407–433
volatility of, 261
zero, 428–430, 444–447
Zimbabwe, 253–254
Inflation fallacy, 256
Inflation rate, 109, 124, 255f
Inflation tax, 252, 256–257
Infrastructure spending, 398
Input prices, 80
Interactions. See Personal interactions
Interest income, taxes on, 259
Interest payments, net flow of, 277
Interest rate parity, 293, 293–294
Interest rates
aggregate-demand curve, 332–333, 366–379
case study, 131–132
determining, 291–294, 401
domestic, 299
equilibrium, 370–371
loans and, 176–177
long vs. short run, 401
money supply and, 254
real vs. nominal, 130–132, 177, 253,
259, 367
theory of liquidity preference, 367–372
world, 292, 294, 299, 306, 308–310, 316
Intermediate goods, 101
International flows, 270–281
capital, 274–276
case studies, 271–273, 279–281
goods, 270–271
saving/investment and, 277–281
summary, 279t
See also Open economies
International Monetary Fund, 150
Intrinsic value, 221
Investment, 104
aggregate-demand curve, 336
crowding-out effect, 384–386, 385f
economic growth, 147
GDP, 104
incentives, 179–180
international flows, 277–281
savings vs., 174–175
Investment tax credit, 179
Invisible hand, 11, 12, 90
Inward-oriented policies, 154
J
Jagger, Mick, 9
Japan
export restrictions, 312
personal saving, 177
protectionism, 61
Job search, 201, 201–205
Employment Insurance, 203–205
frictional unemployment, 201–202
public policy, 202–203
Junk bonds, 168
K
Kennedy, Robert, 113
Keynes, John Maynard, 32, 38, 359, 367
The General Theory of Employment, Interest,
and Money, 367, 394
Kraemer, Kenneth L., 273
Kremer, Michael, 160
L
Labour, and aggregate-supply curve, 339
Labour force, 193
Labour-force participation, case study in,
196–197
Labour-force participation rate, 193, 193–194,
194t, 196f
Labour Force Survey, 192
Labour underutilization, 198t
Laidler, David, 426
Lamy, Pascal, 60
Law of demand, 71
Law of one price, 286–287
Law of supply, 78
Law of supply and demand, 83
Linden, Greg, 273
Lipsey, Richard, 408, 414
Liquidity, 221, 369
Liquidity preference, theory of, 367, 367–372
Loanable funds
defined, 175, 182
market for, 175–183, 298–302, 301f
supply and demand, 175–177, 178f, 180f,
298–302
Long-run growth. See Economic growth
Lucas, Robert, 140, 424
M
Macroeconomics, 28–30, 29, 98
basic concepts, 269–295
Malthus, Thomas Robert, 158–159
Mancession, 194
Mankiw, Gregory, 34–35
Marginal benefits, 8
Marginal changes, 8
Marginal costs, 8
Marginal propensity to consume (MPC),
382–383
Marginal propensity to import (MPI), 383–384
Market-clearing price, 82
Market demand, 72–73, 73f
Market economy, 11
Market failure, 13
Market for foreign-currency exchange,
302–305, 303f
Market for loanable funds, 175, 175–183, 176f,
298–302, 301f
government budget deficits and surpluses,
180–183
investment incentives, 179–180
saving incentives, 177–179
supply and demand, 175–177, 178f, 180f
Market power, 13
Markets, 70
benefits of, 10–11
competitive, 70–71
government intervention in, 12–13
Market supply, 79, 79f
Marple, James, 427
Martin, Will, 156
Masters, William, 156
McCalla, Alex, 156
McDonald's, 290–291
McMillan, Margaret, 155–156
Medium of exchange, 170, 221
Men, labour-force participation of, 194,
196–197
Menu costs, 257–258, 344
Mexico
average income, 13
political instability, 314–316, 315f
Microeconomics, 28–30, 29, 98
Middle East, oil production in, 358–360,
419–422
Miller, Richard, 33
Minimum-wage laws, 205–206
Minimum wages, 207
Misperceptions theory, 344–345
Model of aggregate demand and aggregate
supply, 330, 330–331, 330f, 359
long-run growth and inflation, 340–342, 341f
Phillips curve, 409–411, 410f, 413f
Models, 24–28
circular-flow diagram, 24–26
production possibilities frontier, 26–28
use and value of, 24
Monetarism, 261–262
Monetary control, 232–236
open-market operations, 232–233
overnight rate, 234–235
problems, 235–236
reserve requirements, 233–234
NEL
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Monetary gradualism, 261
Monetary injection, 244–245, 246f, 375–379,
375f, 376f, 378t
Monetary neutrality, 248, 329, 350, 412
Monetary policy, 227, 228
aggregate-demand curve, 372–373, 400f
aggregate demand influenced by, 366–379
central banks vs. politicians, 441–444
fiscal policy and, 390–392
money supply changes, 373–374
open economy considerations, 374–379
stabilization of economy, 394–399, 439–441
theory of liquidity preference, 367–372
Money, 220
in Canadian economy, 223–225, 225f
creation of, 229–232
functions, 221
injection of, 244–245, 246f
kinds of, 221–223
meaning of, 220–225
quantity theory of, 15, 242–250
social custom of, 219–220, 222–223
value of, 242–244
Money demand, 243–244, 369–370, 369f,
372f
Money multiplier, 230–232, 231
Money stock, 223
Money supply, 227, 368f
aggregate demand influenced by, 373–374
Bank of Canada and, 227–228, 232–235,
243, 261–262, 367–368
bank runs, 237–238
case study, 237–238
commercial banks and, 228–236
increase in, 244–245, 246f
inflation, 15
interest rates and, 254
prices in relation to, 14–15
problems, 235–236
theory of liquidity preference, 367–369
Monopolies, 71
Movements along a curve, 46
Mugabe, Robert, 253–254
Multiplier effect, 381, 381–384, 381f
Mutual funds, 170, 170–171
N
Nader, Ralph, 9
NASDAQ, 168
National Energy Program (NEP), 358
National saving (saving), 174
National War Labour Order, 208
Natural-rate hypothesis, 417, 417–418
Natural rate of output, 339
Natural rate of unemployment, 191–192, 199,
199–201, 199f, 412, 414–418
Natural resources, 144
aggregate-supply curve, 340
case study, 146
productivity and, 144, 146
Negative correlation, 43
Net capital outflow, 274–277, 275, 279–281,
305–306, 308
Net exports, 104, 104–105, 270, 275–276,
313–314, 336, 388
Net foreign investment, 275
Net national product (NNP), 102
Newton, Isaac, 22
New York Stock Exchange, 168
Nominal exchange rates, 282, 282–283
Nominal gross domestic product, 106–109,
107, 250f
Nominal interest rates, 130–132, 131, 132f,
177, 253–255, 255f, 259, 367
Nominal variables, 247, 247–248
Normal goods, 74
Normative statements, 30, 30–31
North American Free Trade Agreement
(NAFTA), 272, 273
Nutrition. See Health and nutrition
O
Obama, Barack, 7
Office of the Superintendent of Financial
Institutions (OSFI), 166, 172, 237
Oil, 358–360
Okun's law, 423
Omitted variables, 48–49, 49f
100 percent-reserve banking, 228–229
Open economies, 173, 270
aggregate demand, 374–379
budget deficits and surpluses, 310–312,
311f
equilibrium, 305–307
fiscal policy, 386–392, 387f
foreign-currency exchange supply and
demand, 302–305
loanable funds supply and demand,
298–302
macroeconomic theory of, 298–319
monetary injection, 376f
policies and events affecting, 308–317
political instability, 314–317
small open economy, 291–293
world interest rates, 308–310
See also International flows
Open-market operations, 232, 232–233, 367
Opportunity costs, 7, 57
comparative advantage, 57–58
explained, 6–7
price of trade, 59–60
production possibilities frontier,
27–28
Ordered pairs, 42
Organization of the Petroleum Exporting
Countries (OPEC), 358–360, 419–422
Origin, in graphing, 43
Osberg, Lars, 110
Outward-oriented policies, 154
Overnight rate, 234, 234–235
467
P
Panagariya, Arvind, 155, 156
Paper money, 223
Patent system, 156–157
Peltzman, Sam, 9–10
Perfect capital mobility, 292
Perfect competition, 70–71
Perpetuity, 167
Personal interactions, 10–11
governments and markets, 12–13
markets, 10–11
trade, 10
Perspectives on Labour and Income (Statistics
Canada), 207
Phelps, Edmund, 411–412, 414–418
Phillips, A. W., 408, 414
Phillips curve, 408, 408–433, 409f, 416f
breakdown of, 419f
disinflation, 422–431
expectations, 411–418
long-run, 411–415, 413f
model of aggregate demand and aggregate
supply, 409–411, 410f, 413f
in 1950s and 1960s, 418f
origins of, 408–409
predictions for future, 431–433
shifts in, 411–422
short-run, 415–417
supply shocks, 418–422
Physical capital, 143, 143–144
Pie charts, 42, 43f
Political business cycle, 442
Political stability/instability, 153,
314–317
Population growth, 158–160
PortalPlayer, 274
Porter, Douglas, 427
Portfolio, 170
Positive correlation, 43
Positive statements, 30, 30–31
Price/earnings ratio (P/E), 169
Prices
aggregate-supply curve, 343–344
demand curve, 71–72
input prices, 80
international transactions, 282–286
levels of, 242–244, 245f, 332–333
markets directed by, 11
money supply and, 14–15
relative, 258
resource allocation, 89
in stock tables, 169
supply curve, 77–78
trade and, 59–60
Price takers, 70
Principal, 167
Private saving, 174
Production chains, 273–274
Production function, 145, 148f
NEL
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Production possibilities frontier, 26, 26–28,
27f, 29f, 52–54, 53f
Productivity, 14, 143
determinants, 143–145
importance of, 142–143, 161
slowdowns and speedups, 157–158
standard of living determined by, 14
Property rights
economic growth, 153
significance of, 12, 12
Protectionism, 155–156
Public policy
economic growth, 147–161
economists as advisers to, 30–35
employment, 15, 202–203
incentives, 9–10
inflation, 14–15, 411–433
job search, 202–203
open economy affected by, 308–317
political factors, 13
positive vs. normative analysis, 30–31
productivity and living standards, 14
role and scope of, 12–13
shifts in demand, 76–77
stabilization of economy, 394–399
time inconsistency of, 442
See also Fiscal policy; Monetary policy
Public saving, 174
Public Service Staff Relations Act, 208
Purchasing power, 256
Purchasing-power parity, 286
exchange rate determination, 286–291, 304
hamburger standard, 290–291
implications, 287–288
limitations, 289–290
logic of, 286–287
Q
Quantity demanded, 71
Quantity equation, 249
Quantity supplied, 77
Quantity theory of money, 15, 242–250,
245, 250f
R
Rational expectations, 424–425
Rational people, 8
Real exchange rates, 283, 283–285,
333–334, 373
Real gross domestic product, 106–110, 107,
352f
Real interest rates, 130–132, 131, 132f, 177,
253, 259, 367
Real variables, 247, 247–248
Recessions, 110, 325
of 2008–09, 354–355, 397–399, 431–432
Registered retirement savings plans (RRSPs),
178, 452
Relative prices, 258
Research and development, 154–157
Reserve ratio, 229, 231
Reserve requirements, 229–230, 233,
233–234
Reserves, 229
Resource allocation, 89
Retained earnings, 169
Reverse causality, 48–50, 50f
Ricardo, David, 59
Risk premium, 316
Robertson, John, 254
Robson, William, 426
Rockefeller, John D., 142
Romer, David, 33
Royal Bank, 227
Russia, 317
S
S&P/TSX Composite Index, 170
Sacrifice ratio, 423, 423–425, 432
Samuelson, Paul, 408–409
Sargent, Thomas, 424–425
Sarkozy, Nicolas, 116
Saving, 174–175
economic growth, 147
incentives, 177–179, 451–453
international flows, 277–281
tax reform and, 451–453
Scarcity, 4
Scatterplots, 43
Science, economics as, 22–30
assumptions, 23–24
disagreements, 35
micro- and macroeconomics, 28–30
models, 24–28
scientific method, 22–23
Scientific method, 22–23
Seasonal adjustment, 103
Sectoral shifts, 202
Self-interest, 12
Sellers, variables influencing, 80–81,
81t
Shakespeare, William, Hamlet, 186
Sharpe, Andrew, 110
Shaw, George Bernard, 35
Shifts of a curve, 46
Shoeleather costs, 257
Shortages, 82
Slope, 47–48, 47f
Small open economy, 292
equilibrium, 307f
interest rate determination, 291–293
Smith, Adam, 59, 90
The Wealth of Nations, 11, 12
Snow, John, 34
Solow, Robert, 408–409
South Korea
capital flight, 317
economic growth, 149
protectionism, 61
Specialization, trade and, 54–56
Stabilization of economy, policy interventions
for, 394–399
automatic stabilizers, 395, 395–397
pros and cons, 394–395, 439–441
Stagflation, 356, 419–421
Standard of living, 13–14
Statistics Canada, 122–126, 192–193, 207
Sterilization, 233
Sticky-price theory, 343–344
Sticky-wage theory, 343
Stiglitz, Joseph, 116
Stock, 168
Stock indexes, 168, 170
Stock market, 168, 379–380
Stock tables, 169
Store of value, 170, 221
Stricker, Laura, 7
Strikes, 208
Strong currency, 282
Structural unemployment, 201, 205–206
Substitutes, 75
Substitution effect, 453
Supply, 77–81
excess, 82
market vs. individual, 79
shifts in supply, 79–81
supply curve, 77–78
See also Supply and demand
Supply and demand, 81–88
changes in equilibrium, 83–88
equilibrium, 81–83
foreign-currency exchange, 302–305
law of, 83
loanable funds, 298–302
money, 243–244, 245f
Supply curve, 77–78, 78, 78f, 80f
Supply schedule, 78, 78f
Supply shocks, 418–422, 419, 421f
Supply-siders, 393
Surplus, 82
Sweden, 207
T
T-account, 229
Tariffs, 312
Tastes, 75, 88
Taxes
as automatic economic stabilizer, 396
changes in, 392–393
consumption taxes, 178
fiscal policy, 392–393
inflation-induced distortions, 258–260,
259t
inflation tax, 252, 256–257
saving and, 451–453
Tax-free savings accounts (TFSAs), 178, 452
Technological knowledge, 144
aggregate-supply curve, 340
human capital versus, 145
productivity and, 144–145
NEL
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INDEX
Technology
population growth and, 160
supply affected by, 80
supply and demand affected by, 88
Term, 167
Thailand, 317
Theory of liquidity preference, 367, 367–372
equilibrium in money market, 370–372
money demand, 369–370
money supply, 367–369
Time inconsistency of policy, 442
Time-series graphs, 42, 43f
Toronto-Dominion Bank, 227
Toronto Stock Exchange (TSX), 74, 168
Toshiba, 274
Trade
benefits of, 10
comparative advantage, 58
geography, 154
price of, 59–60
specialization, 54–56
See also International flows; Open economies
Trade balance, 270
Trade deficit, 270
Tradeoffs, 4–5
inflation and unemployment, 407–433
production possibilities frontier, 27–28
Trade policy, 312, 312–314
Trade surplus, 270
Truman, Harry, 31
TSX Venture Exchange, 168
Turnover, worker, 210
U
Unemployment, 191–213
cyclical, 191–192, 201
economic fluctuations and, 327f, 328
efficiency wages, 209–211
frictional, 201–202
inflation and, 15, 407–433
job search, 201–205
measurement of, 192–198
minimum-wage laws, 205–206
natural rate of, 191–192, 199–201, 199f, 412,
414–418
personal impact of, 191
reasons for, 198–201
structural, 201
unions, 206–209
Unemployment rate, 193, 193–194,
194t, 195f
Unions, 206, 206–209
economic impact, 208–209
membership, 206–207
United States
capital flight, 317
currency outstanding in, 226
financial crisis (2007–09), 172, 354
Great Depression, 237
interest rates, 291, 293, 309
personal saving, 177
stock market, 379
trade with, 271f, 272–273, 297
union membership, 207
Unit of account, 221
U.S. Council of Economic Advisers, 34
W
V
Yale School of Management, 6
Valdes, Alberto, 156
Values, 36
Velocity of money, 249, 250f
Vicious circle, 182
Virtuous circle, 182
Volume, in stock table, 169
469
Wages
aggregate-supply curve, 343
case study, 211–212
efficiency wages, 209–211
minimum wages, 205–207
Weak currency, 282
Wealth
money and, 220, 221
redistribution of, due to inflation/
deflation, 260–261
Wealth effect, 74–75, 332
Well-being. See Economic well-being
West Texas Intermediate, 360
Wolfowitz, Paul, 155
Women, labour-force participation of, 194,
196–197
Workers
effort, 210–211
health, 210
quality, 211
turnover, 210
World Bank, 150
World interest rates, 292, 294, 299, 306,
308–310, 309f, 316
World Trade Organization, 273
World War II, 353
Y
Z
Zero-inflation target, 428–430, 429f,
444–447
Zimbabwe, 253–254
Zwane, Alix Peterson, 155–156
NEL
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S U G G E S T I O N S
F O R
S U M M E R
R E A D I N G
IF YOU ENJOYED THE ECONOMICS COURSE THAT YOU HAVE JUST FINISHED, YOU MIGHT LIKE
TO READ ABOUT ECONOMIC ISSUES IN THE FOLLOWING BOOKS:
PAUL BLUSTEIN
The Chastening: Inside the Crisis That Rocked the Global
Financial System and Humbled the IMF
New York: Public Affairs, 2001
WILLIAM EASTERLY
The Elusive Quest for Growth: Economists’ Adventures and
Misadventures in the Tropics
Cambridge, MA: MIT Press, 2001
A journalist tells the story of how economic policymakers
around the world muddled through the financial crisis of the
late 1990s.
A World Bank economist examines the many attempts to
help the world’s poorest nations and why they have so often
failed.
WILLIAM BREIT AND BARRY T. HIRSCH
MILTON AND ROSE FRIEDMAN
Lives of the Laureates
Cambridge, MA: MIT Press, 2004
Free to Choose
New York: Harcourt Brace, 1979
Eighteen winners of the Nobel prize in economics offer
autobiographical essays about their life and work.
Two economists argue that society should rely less on the
government and more on the free market.
DIANE COYLE
ROBERT L. HEILBRONER
Sex, Drugs, and Economics
New York: Texere, 2002
Basic economics applied to a wide range of sometimes
unconventional topics.
The Worldly Philosophers
New York: Touchstone, 1953; revised 1999
A classic introduction to the lives, times, and ideas of the
great economic thinkers, including Adam Smith, David
Ricardo, and John Maynard Keynes.
JOHN CROW
Making Money: An Insider’s Perspective on Finance,
Politics, and Canada’s Central Bank
Etobicoke, ON: John Wiley & Sons, 2002
JOHN HELLIWELL
Globalization and Well-Being
Vancouver: UBC Press, 2003
Part memoir, part history, part analysis of major monetary
policy issues, Making Money brings to life the inner workings
and the politics of the Bank of Canada.
This text is essential reading for all those trying to think their
way through the welter of conflicting assertions about what
is left for national policies in today’s world.
AVINASH DIXIT AND BARRY NALEBUFF
DOUGLAS A. IRWIN
Thinking Strategically: A Competitive Edge in Business,
Politics and Everyday Life
New York: Norton, 1991
This introduction to game theory discusses how all people—
from corporate executives to criminals under arrest—should,
and do, make strategic decisions.
Free Trade under Fire
Princeton, NJ: Princeton University Press, 2005
An economist sheds some light on the debate over
globalization.
PAUL KRUGMAN
Peddling Prosperity
New York: Norton, 1994
A survey of the evolution of economic ideas and policy, with
an emphasis on macroeconomics and international trade.
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STEVEN E. LANDSBURG
The Armchair Economist: Economics and Everyday Life
New York: Free Press, 1993
Why does popcorn cost so much at movie theatres? Steven
Landsburg discusses this and other puzzles of economic life.
STEVEN D. LEVITT AND STEPHEN J. DUBNER
Freakonomics: A Rogue Economist Explores the Hidden Side
of Everything
New York: Morrow, 2005
Economic principles and clever date analysis applied to a
wide range of offbeat topics, including drug dealing, online
dating, and sumo wrestling.
CHRISTOPHER RAGAN AND WILLIAM WATSON
Is the Debt War Over? Dispatches from Canada’s Fiscal
Frontline
Montreal: McGill-Queen’s University Press, 2004
Is the current rather modest pace of debt reduction enough?
Or does more have to be done? To put things more
dramatically, is the debt war over? Questions asked and
answered.
RAGHURAM G. RAJAN AND LUIGI ZINGALES
Saving Capitalism from the Capitalists
Princeton, NJ: Princeton University Press, 2003
Two economists explain how society can use financial
markets to create wealth and spread economic opportunity.
BURTON G. MALKIEL
A Random Walk down Wall Street
New York: Norton, 2004
This introduction to stocks, bonds, and financial economics is
not a “get rich quick” book, but it might help you get rich
slowly.
THOMAS SOWELL
Applied Economics: Thinking beyond Stage One
New York: Basic Books, 2004
A nontechnical application of economics to a wide range of
policy issues, including housing, medical care,
discrimination, and economic development.
JOHN MCMILLAN
Reinventing the Bazaar: A Natural History of Markets
New York: Norton, 2002
A deep and nuanced, yet still very readable, analysis of how
society can make the best use of market mechanisms.
JACK MINTZ
Most Favored Nation: Building a Framework for Smart
Economic Policy
C. D. Howe Institute, Policy Study 36, 2001
This study makes a compelling case for new policies to lower
the cost of doing business in Canada, spur growth, and raise
Canadians’ standard of living.
WILLIAM WATSON
Globalization and the Meaning of Canadian Life
Toronto: University of Toronto Press, 1998
This vigorously argued book offers much new insight and
corrects many current misperceptions about Canadian
affairs. Readers will welcome its lively mix of historical and
contemporary perspectives.
THE ECONOMIST
Weekly newsmagazine. Not being a book, this item doesn’t
really fit on this list, but it is the best place to go if you want
solid economic analysis of current events.
P.J. O’ROURKE
Eat the Rich: A Treatise on Economics
New York: Atlantic Monthly Press, 1998
A humorist asks why some nations prosper while other
don’t. He answers with a world tour that takes the reader
from Albania to the New York Stock Exchange.
Copyright 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.