As we grow up, we are told about the virtues of thrift. Those who spend all their income are condemned to end up poor. Those who save are promised a happy life. Similarly, governments tell us, an economy that saves is an economy that will grow strong and prosper! The model we have seen in this chapter, however, tells a different and surprising story.
Read MoreIf a higher inflation rate meant just a faster but proportional increase in all prices and wages—a case called pure inflation—inflation would be only a minor inconvenience because relative prices would be unaffected.
Read MoreEconomists care about unemployment for two reasons. First, they care about unemployment because of its direct effect on the welfare of the unemployed. Although unemployment benefits are more generous today than they were during the Great Depression, unemployment is still associated with financial and psychological suffering. The extent of suffering depends on the nature of unemployment.
Read MoreFact 1: Economic Fluctuations Are Irregular and Unpredictable
Fluctuations in the economy are often called the business cycle. As this term suggests, economic fluctuations correspond to changes in business conditions. When real GDP grows rapidly, business is good. During such periods of economic expansion, most firms find that customers are plentiful and that profits are growing. When real GDP falls during recessions, businesses have trouble. During such periods of economic contraction, most firms experience declining sales and dwindling profits.
TRADE POLICY
A trade policy is a government policy that directly influences the quantity of goods and services that a country imports or exports. Trade policy takes various forms, usually with the purpose of supporting a particular domestic industry. One common trade policy is a tariff, a tax on imported goods. Another is an import quota, a limit on the quantity of a good produced abroad that can be sold domestically.
Read MoreGOVERNMENT BUDGET DEFICITS
A government budget deficit represents a negative public saving, it reduces national saving (the sum of public and private saving). Thus, a government budget deficit reduces the supply of loanable funds, drives up the interest rate, and crowds out investment.
Read MoreWe have been discussing how the economy coordinates four important macroeconomic variables: national saving (S), domestic investment (I), net capital outflow (NCO), and net exports (NX).
Keep in mind the following identities:
Read MoreTo understand the market for foreign-currency exchange, we begin with another identity from the previous topic:
NCO = NX
Net capital outflow = Net exports
Our model of the open economy treats the two sides of this identity as representing the two sides of the market for foreign-currency exchange. Net capital outflow represents the quantity of dollars supplied for the purpose of buying foreign assets. For example, when a U.S. mutual fund wants to buy a Japanese government bond, it needs to change dollars into yen, so it supplies dollars in the market for foreign-currency exchange. Net exports represent the quantity of dollars demanded for the purpose of buying U.S. net exports of goods and services. For example, when a Japanese airline wants to buy a plane made by Boeing, it needs to change its yen into dollars, so it demands dollars in the market for foreign-currency exchange.
Read MoreWe made the simplifying assumption that the financial system consists of only one market, called the market for loanable funds. All savers go to this market to deposit their saving, and all borrowers go to this market to get their loans. In this market, there is one interest rate, which is both the return to saving and the cost of borrowing.
Read MoreThe theory of purchasing-power parity is based on a principle called the law of one price. This law asserts that a good must sell for the same price in all locations. Otherwise, there would be opportunities for profit left unexploited. For example, suppose that coffee beans sold for less in Seattle than in Boston. A person could buy coffee in Seattle for, say, $4 a pound and then sell it in Boston for $5 a pound, making a profit of $1 per pound from the difference in price. The process of taking advantage of price differences for the same item in different markets is called arbitrage. In our example, as people took advantage of this arbitrage opportunity, they would increase the demand for coffee in Seattle and increase the supply in Boston. The price of coffee would rise in Seattle (in response to greater demand) and fall in Boston (in response to greater supply). This process would continue until, eventually, the prices were the same in the two markets.
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