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MACROECONOMICS
Principles and Policy
Eleventh Edition
MACROECONOMICS
Principles and Policy
Eleventh Edition


William J. Baumol
New York University and Princeton University




Alan S. Blinder
Princeton University




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About the Authors


WILLIAM J. BAUMOL
William J. Baumol was born in New York City and received his BSS at the
College of the City of New York and his Ph.D. at the University of London.
He is the Harold Price Professor of Entrepreneurship and Academic Director
of the Berkley Center for Entrepreneurial Studies at New York University,
where he teaches a course in introductory microeconomics, and the Joseph
Douglas Green, 1895, Professor of Economics Emeritus and Senior Economist
at Princeton University. He is a frequent consultant to the management of
major firms in a wide variety of industries in the United States and other coun-
tries as well as to a number of governmental agencies. In several fields, includ-
ing the telecommunications and electric utility industries, current regulatory
policy is based on his explicit recommendations. Among his many
contributions to economics are research on the theory of the firm, the contesta-
bility of markets, the economics of the arts and other services”the “cost dis-
ease of the services” is often referred to as “Baumol™s disease“”and economic
growth, entrepreneurship, and innovation. In addition to economics, he taught
a course in wood sculpture at Princeton for about 20 years and is an accom-
Alan Blinder and Will Baumol
plished painter (you may view some of his paintings at
http://pages.stern.nyu.edu/˜wbaumol/).
Professor Baumol has been president of the American Economic Association and
three other professional societies. He is an elected member of the National Academy of
Sciences, created by the U.S. Congress, and of the American Philosophical Society,
founded by Benjamin Franklin. He is also on the board of trustees of the National Council
on Economic Education and of the Theater Development Fund. He is the recipient of
11 honorary degrees.
Baumol is the author of more than 35 books and hundreds of journal and newspaper
articles. His writings have been translated into more than a dozen languages.


ALAN S. BLINDER
Alan S. Blinder was born in New York City and attended Princeton University, where
one of his teachers was William Baumol. After earning a master™s degree at the London
School of Economics and a Ph.D. at MIT, Blinder returned to Princeton, where he has
taught since 1971, including teaching introductory macroeconomics since 1977. He is
currently the Gordon S. Rentschler Memorial Professor of Economics and co-director of
Princeton™s Center for Economic Policy Studies, which he founded.
In January 1993, Blinder went to Washington as part of President Clinton™s first Coun-
cil of Economic Advisers. Then, from June 1994 through January 1996, he served as vice
chairman of the Federal Reserve Board. He thus played a role in formulating both the
fiscal and monetary policies of the 1990s, topics discussed extensively in this book. He
has also advised several presidential campaigns.
Blinder has consulted for a number of the world™s largest financial institutions, testi-
fied dozens of times before congressional committees, and been involved in several entre-
preneurial start-ups. For many years, he has written newspaper and magazine articles on
economic policy, and he currently has a regular column in the New York Times Sunday
Business Section. In addition, Blinder™s op-ed pieces still appear periodically in other
newspapers. He also appears frequently on PBS, CNN, CNBC, and Bloomberg TV.

v
About the Authors
vi



Blinder has served as president of the Eastern Economic Association and vice presi-
dent of the American Economic Association and is a member of the American Philosophi-
cal Society, the American Academy of Arts and Sciences, and the Council on Foreign
Relations. He has two grown sons, two grandsons, and lives in Princeton with his wife,
where he plays tennis as often as he can.
Brief Contents


PART 1 GETTING ACQUAINTED WITH ECONOMICS
Chapter 1 What Is Economics? 3
Chapter 2 The Economy: Myth and Reality 21
Chapter 3 The Fundamental Economic Problem: Scarcity and Choice 39
Chapter 4 Supply and Demand: An Initial Look 55

PART 2 THE MACROECONOMY: AGGREGATE SUPPLY AND DEMAND
Chapter 5 An Introduction to Macroeconomics 83
Chapter 6 The Goals of Macroeconomic Policy 105
Chapter 7 Economic Growth: Theory and Policy 133
Chapter 8 Aggregate Demand and the Powerful Consumer 153
Chapter 9 Demand-Side Equilibrium: Unemployment or Inflation? 175
Bringing in the Supply-Side: Unemployment and Inflation? 199
Chapter 10

PART 3 FISCAL AND MONETARY POLICY
Chapter 11 Managing Aggregate Demand: Fiscal Policy 221
Chapter 12 Money and the Banking System 241
Chapter 13 Managing Aggregate Demand: Monetary Policy 261
Chapter 14 The Debate over Monetary and Fiscal Policy 277
Chapter 15 Budget Deficits in the short and long run 299
Chapter 16 The Trade-Off Between Inflation and Unemployment 317

PART 4 THE UNITED STATES IN THE WORLD ECONOMY
Chapter 17 International Trade and Comparative Advantage 339
Chapter 18 The International Monetary System: Order or Disorder? 361
Chapter 19 Exchange Rates and the Macroeconomy 379




vii
Table of Contents

Preface xix


PART 1 GETTING ACQUAINTED WITH ECONOMICS 1

Chapter 1 What Is Economics? 3
IDEAS FOR BEYOND THE FINAL EXAM 4
Idea 1: How Much Does It Really Cost? 4
Idea 2: Attempts to Repeal the Laws of Supply and Demand”The Market Strikes Back 5
Idea 3: The Surprising Principle of Comparative Advantage 5
Idea 4: Trade Is a Win-Win Situation 5
Idea 5: Government Policies Can Limit Economic Fluctuations”But Don™t Always Succeed 6
Idea 6: The Short-Run Trade-Off between Inflation and Unemployment 6
Idea 7: Productivity Growth Is (Almost) Everything in the Long Run 6
Epilogue 7
INSIDE THE ECONOMIST™S TOOL KIT 7
Economics as a Discipline 7
The Need for Abstraction 7
The Role of Economic Theory 9
What Is an Economic Model? 10
Reasons for Disagreements: Imperfect Information and Value Judgments 11
Summary 12
Key Terms 12
Discussion Questions 12
APPENDIX: USING GRAPHS: A REVIEW 13
Graphs Used in Economic Analysis 13
Two-Variable Diagrams 13
The Definition and Measurement of Slope 14
Rays Through the Origin and 45° Lines 16
Squeezing Three Dimensions into Two: Contour Maps 17
Summary 18
Key Terms 18
Test Yourself 18

Chapter 2 The Economy: Myth and Reality 21
THE AMERICAN ECONOMY: A THUMBNAIL SKETCH 22
A Private-Enterprise Economy 23
A Relatively “Closed” Economy 23
A Growing Economy . . . 24
But with Bumps along the Growth Path 24
THE INPUTS: LABOR AND CAPITAL 26
The American Workforce: Who Is in It? 27
The American Workforce: What Does It Do? 28
The American Workforce: What It Earns 29
Capital and Its Earnings 30
THE OUTPUTS: WHAT DOES AMERICA PRODUCE? 30
THE CENTRAL ROLE OF BUSINESS FIRMS 31
WHAT™S MISSING FROM THE PICTURE? GOVERNMENT 32
The Government as Referee 33
The Government as Business Regulator 33
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Contents
x



Government Expenditures 34
Taxes in America 35
The Government as Redistributor 36
CONCLUSION: IT™S A MIXED ECONOMY 36
Summary 36
Key Terms 37
Discussion Questions 37

Chapter 3 The Fundamental Economic Problem: Scarcity and Choice 39
ISSUE: WHAT TO DO ABOUT THE BUDGET DEFICIT? 40
SCARCITY, CHOICE, AND OPPORTUNITY COST 40
Opportunity Cost and Money Cost 41
Optimal Choice: Not Just Any Choice 42
SCARCITY AND CHOICE FOR A SINGLE FIRM 42
The Production Possibilities Frontier 43
The Principle of Increasing Costs 44
SCARCITY AND CHOICE FOR THE ENTIRE SOCIETY 45
Scarcity and Choice Elsewhere in the Economy 45
ISSUE REVISITED: COPING WITH THE BUDGET DEFICIT 46
THE CONCEPT OF EFFICIENCY 47
THE THREE COORDINATION TASKS OF ANY ECONOMY 48
SPECIALIZATION FOSTERS EFFICIENT RESOURCE ALLOCATION 48
The Wonders of the Division of Labor 48
The Amazing Principle of Comparative Advantage 49
SPECIALIZATION LEADS TO EXCHANGE 50
MARKETS, PRICES, AND THE THREE COORDINATION TASKS 50
LAST WORD: DON™T CONFUSE ENDS WITH MEANS 52
Summary 52
Key Terms 53
Test Yourself 53
Discussion Questions 53

Chapter 4 Supply and Demand: An Initial Look 55

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