Chapter 1. A Brief Economic History of the United States

Learning Tips for Chapter 1

Figure 1 (on page 11) combines two types of charts: a time series graph and a time line. Both types of charts depict a series of dates on one axis, usually the horizontal axis. A time line places historical events in sequence along a consistent scale measuring time on the horizontal axis. For example, Figure 1 shows us when major events (such as World War I and the postwar recessions) took place. The point of a time line is to spatially represent how far apart events took place and how long in duration they were. A time series graph is a line chart composed of points measuring a quantitative variable on the vertical axis. Time series line charts visually show patterns in the measured variable over time, such as increases and decreases. In Figure 1, the quantitative variable is "percent growth in output." The line rises and falls to represent increases and decreases in the growth rate.

WWhen you are creating this kind of chart, the scale for time must be consistent. Notice that in Figure 1 the years defining each decade are precisely the same distance apart. As with any chart, if you change the length of either the vertical or the horizontal axis, you can change the look of the graph—even though the data stays the same. If you doubled the width of every decade, for example, the line chart would look flatter, and the ups and downs would resemble the shape of business cycles, as we will see later in Chapter 10.

Chapter 2. Resource Utilization

Learning Tips for Chapter 2

To help understand what the Production Possibilities Frontier or (Production Possibilities Curve) is meant to represent, start with the every-day usage of the word "frontier." When you hear the word "frontier," you might come up with images of pioneers in covered wagons settling the old West. A frontier is an outer boundary. As the pioneers moved west, the boundary of the portion of North America settled by European Americans shifted. The frontier was the farthest point the settlers could go, given their technology (e.g. covered wagons), information (e.g. maps), and resources (e.g. food supplies for the journey). The Production Possibilities Frontier is a visual representation of the outer limit of what an economy can produce at a particular point in time, given the current state of its technology, information, and resources.

Just as lots of people lived further east than the frontier, most countries do not produce at the production possibilities frontier. That is, most countries do not successfully maximize their production. So pay attention to the space inside this curve as well as the curve itself.

On a Production Possibilities Curve, guns and butter are excellent representations of military goods and civilian goods for any country across the globe. But we can graph the trade-off between any two types of goods or services within any country. We would still have a downward-sloping Production Possibilities Curve, though its shape would be affected by how well endowed the selected economy is with its four economic resources.

For an economy such as the United States, try graphing the Production Possibilities Curve for automobiles versus diamonds using the same hypothetical units as Figure 1 on page 31. The units could be millions of automobiles versus pounds of mined diamonds. Even though the U.S. is "auto-rich" and "diamond-poor," and that is reflected by the shape of the curve, the law of increasing costs still holds: the more diamonds we want to produce, the more and more cars we must sacrifice. Now try graphing the same two products (automobiles and diamonds) for South Africa, and show the law of increasing costs. How do the shapes of your two PPCs differ?

Chapter 3. Supply and Demand

Learning Tips for Chapter 3

When the demand curve shifts to the left, it is moving closer to the origin, or zero, where the two axes (P and Q) meet. Therefore, it is easier for us to recognize that demand has "gone down," or decreased. When the supply curve shifts to the left by a lot, the curve can look like it is moving closer to the sky. So spatially, you may be tempted to say that supply is "going up." But increases and decreases in supply and demand are in relation to the origin. If you can remember that "right is up" and "left is down," you will not mistake a shift that is upward (an increase) or downward (a decrease).

Placing price ceilings and price floors on a two-dimensional set of axes can be confusing because the ceiling and the floor are not where we are used to seeing them! This is another case where our spatial sense is different than our economic meaning. In other words, on supply and demand graphs, floors are near the top (above equilibrium) while ceilings are near the bottom (below equilibrium). Remember that price ceilings and floors are the opposite of building ceilings and floors.

Chapter 5. The Household-Consumption Sector

Learning Tips for Chapter 5

A word about graph selection is in order. Figure 1 on page 97 depicts savings as a percentage of disposable personal income as a time series line chart. The same information could also be presented as a bar chart, with vertical bars every four years, the years 1960 to 2000, written on the horizontal axis. But Professor Slavin selected a line chart for a very important reason: he wanted to show the data points for each year, between the 4-year intervals depicted on the horizontal axis. If you want to graph or chart the subtle changes for a variable that jumps around quite a bit over time, a line chart is a better choice than an almost arbitrary selection of years in a bar chart.

Chapter 6. The Business-Investment Sector

Learning Tips for Chapter 6

When individuals buy stocks or bonds, we commonly speak of them as "investing" their money. This is another case, like "capital," in which an economist's definition of a term is different than the meaning you may be used to. With both of these terms, economists are less interested in money than in the productive uses to which money is put. Economic investment involves the purchase of capital goods (plants and equipment) by businesses in order produce more output or to produce output more efficiently. A quick way to remember how to speak like an economist: instead of talking about "investing capital," economists talk about "investing in capital."

Inventories (unsold goods) are also counted as an economic investment because they will generate future sales and profits. Inventories are a tricky component of business investment. More investment is generally good economic news. It shows that businesses are confident about future sales and are replacing or expanding their capital equipment in order to boost production. Rising inventories can send the same signal, that businesses are optimistically producing goods, anticipating strong sales. But inventories piling up can also mean just the opposite. When the economy slows down, businesses that are slow to react may overproduce, leaving themselves with high inventories. (We will return to this issue in chapter 11.)

The third component of investment—residential housing—may also surprise you. The title of chapter 6 refers to the Business-Investment Sector, yet residential housing is purchased by households. Buying a house or apartment is different than the consumption activities that households generally engage in. While you may enjoy your home, most buyers also view home ownership as—here's that word again—an investment. That is, homes, unlike most of the goods and services we buy, often increase in value over time. Homeowners generally make a profit when they resell their homes. For this reason, economists classify residential housing as an investment good.

Once again, the three components of investment are: (1) capital goods such as plants and equipment; (2) inventories; and (3) residential housing.

Chapter 7. The Government Sector

Learning Tips for Chapter 7

Once again, the three components of investment are: (1) capital goods such as plants and equipment; (2) inventories; and (3) residential housing.

Chapter 9. Gross Domestic Product

Learning Tips for Chapter 9

"Final means final!" How many times have we heard that phrase? The same is true with measuring GDP. In adding up the value of all the goods and services produced and sold within a nation's boundaries in a year, we must avoid multiple counting or double counting. That's why we only count final goods and services. Things are only counted once, when they are end-products for consumers. If you are calculating GDP, always tell yourself: "Final means final!" Consider oranges and orange juice, for instance. If you are buying an orange to eat it with lunch, the orange is the final product. If Tropicana is buying oranges from Florida growers to make juice, and you buy a half gallon of juice at the grocery store, then the final product is juice. Leave out the value of the oranges, as these are intermediate products on their way to becoming juice. Think of other examples of intermediate versus final goods, and remember only the latter count towards GDP.

Chapter 10. Economic Fluctuations, Unemployment, and Inflation

Learning Tips for Chapter 10

The terms "deflation" and "disinflation" can often be confused. If you think about trying to blow up a large balloon or a small air mattress (with your mouth and not an automatic air pump!), it may help to distinguish the two. Disinflation is when you are huffing and puffing to blow up a balloon or air mattress by mouth. Your first few breaths fill the balloon quite a bit. But with each succeeding breath, you get more and more tired. So each attempt at blowing produced less and less air in the balloon. You have slowed down! You are adding air to the balloon at a lower rate with each breath. Applied to prices, disinflation is when the price level (like the air level in a balloon) is rising, but just not as fast as it was before. So the rate of the price increase is slowing down. Prices are rising at a decreasing rate, or the rate of inflation is falling. On the other hand, deflation is when the air seeps out of the balloon or air mattress. The level of air is falling. Once again, applied to prices, deflation is when prices in general are falling.

Chapter 11. Classical and Keynesian Economics

Learning Tips for Chapter 11

What's the difference between Aggregate Demand and Aggregate Expenditure? These two terms sound awfully similar, so it is easy to confuse them. Understanding the difference is the key to understanding the Keynesian model of macroeconomic equilibrium (shown graphically on page 262).

Aggregate Demand was defined (on page 255) as the total value of real GDP that all sectors of the economy are willing to purchase at various price levels. These sectors include households that consume, business firms that invest, government spending, and net exports. Aggregate Expenditure, in contrast, refers to planned spending by consumers, business firms, government, and foreigners.

What's the difference between what the economic sectors are willing to spend and what they plan to spend? Not much. There is one type of "spending" that is unplanned: business inventories. In chapter 6, we saw that the business investment (I) counted in Real GDP (and in Aggregate Demand) includes spending on capital goods (which are planned) and inventories. Businesses cannot control the level of their unsold inventories. They can plan to have a certain amount of their product left over at the end of the year, but actual inventories depend on the level of sales.

For example, suppose you open a restaurant specializing in homemade soups. You make several huge pots of soup that you plan to sell. But you don't get enough customers. Some of the soup is left over for the next day. What would you do the next morning? Would you make the same amount of soup again? Of course not! You would make less soup.

Suppose word gets out that your soup is fantastic. You run out of soup in the middle of the lunch hour rush. What would you do the next day? Make more soup!

Multiply this story by thousands and thousands of business throughout the economy. The aggregate level of demand is affected by factors such as consumers' income (rather than the reputation of a specific product such as soup). If sales are low, business firms will wind up with excess inventories. Actual investment (counted in Real GDP on the horizontal axis of the graph on page 262) will be greater than planned investment (as part of Aggregate Expenditure on the vertical axis). Businesses will respond by lowering their planned investment for the following production cycle. If sales are brisk, inventories run lower than planned. In this case, businesses will respond by increasing their level of planned investment for the next production cycle.

Keynesian equilibrium occurs when planned inventories equal actual inventories. Business firms will keep producing at the same level because the market sent them a signal that they correctly estimated the level of demand for goods and services. But they may have correctly estimated a low level of demand, so this might not be at the level of production needed to sustain full employment. Keynesian equilibrium can occur at any point where (planned) Aggregate Expenditure equals Real GDP, at any point on the 45-degree line on the graph.

Chapter 12. Fiscal Policy and the National Debt

Learning Tips for Chapter 12

One way to try to understand how fiscal policy was used to aid the economy during recessions has to do with the GDP equation from Chapter 9, the expenditure approach:

GDP = C + I + G + X_n

If GDP = C + I + G + X_n, and during the Great Depression, C, I and X_n were falling, the only component of GDP left is G. To grow the economy, we need to increase G (government spending).

Chapter 13. Money and Banking

Learning Tips for Chapter 13

When I ask students at the beginning of the semester what economics is about, they often bring up money. But it has taken us until Chapter 13 to actually talk about money. That's because economists view money as a useful tool, but not an end in itself. We measure the strength of the economy in terms of output (GDP), jobs, and price stability—not the amount of money or gold held in locked vaults. While some individuals seem to prize money as a goal, most of us want money in order to buy things that we hope will make us happy or at least more secure. If you were washed up on a deserted island (like Tom Hanks in the movie Castaway), money would not be much help. Money is a social creation and it is only meaningful in a social context.

So what is money good for? Economists argue that money does four things. Let's review them:

1. Medium of exchange: Money as grease. Think of the phrase "greasing the wheels of commerce." Money, like grease, helps things move smoothly. If we just relied on bartering for all of our transactions, the machinery could jam. My local grocer might not want a lesson in economics, but since you do and the college pays me, I don't have to worry about offering something of direct value to the grocer.
2. Standard of value: Money as a yardstick. How much better is the sound and picture of a movie on a DVD than a video tape? One way to express the relative value is their relative price. If I buy a DVD that costs twice as much as the same movie on video, I must think it is twice as good. Some movies are worth paying full price in a movie theater. Others I would wait to rent because it costs less, and some I would only watch when they show up on cable at no extra cost. The relative cost of different objects is one way of comparing how valuable we think they are. (Not the only way, of course.)
3. Store of value: Money as a storage container. A farmer sells a bunch of crops in the summer and fall, saving the money earned to use during the winter. Retailers earn the majority of their profits in the December buying frenzy, then use this income to pay their costs for the rest of the year. One reason money works better than barter is that we can get money now and use it later. At least in the short run, money is a way of holding onto "value" until we need it.
4. Standard of deferred payment: Money lets us "Buy now, pay later." Money stores value, but it is a leaky storage container. Inflation erodes the value of money. That's OK, though, because we can use money as a yardstick to compare the value of $1,000 now to $1,000 twenty years from now. Because the money you use to pay off your mortgage will be worth less by the time you finish paying the bank, you have to pay the bank extra money—called interest.

A quick note about Figure 2: The time series graph on page 307 shows the annual percentage change in the money supply. Notice that it is the rate of change that is depicted on the vertical axis. Interpreting this graph can be tricky. Between 1985 and 1989, the line on the graph is mostly sloping downward. Does this mean that the money supply was shrinking? No! The rate of growth was lower but still more than 0; the money supply was still increasing but at a slower rate. What was the first year on the graph that the money supply actually decreased? 1995, the first time the rate of change is a negative number.

Chapter 14. The Federal Reserve and Monetary Policy

Learning Tips for Chapter 14

Here's a quick summary of the prescriptions associated with the three tools of monetary policy:

• Recession: Lower, Lower, Buy
• Inflation: Increase, Increase, Sell

Translation:

• To fight a recession, the Fed lowers the discount rate, lowers the reserve requirements, or buys bonds.
• To fight inflation, the Fed raises the discount rate, raises the reserve requirements, or sells bonds.

Chapter 16. Economic Growth and Productivity

Learning Tips for Chapter 16

Productivity is defined as output per unit of input. Measuring output should be easy for you by now. Economists generally use real GDP to measure output. But how do we measure input? For example, labor productivity could be measured as the amount of output per person in the population or per member of the labor market. As Chapter 16 points out, however, people in different countries have very different average workweeks and different numbers of holidays. Therefore, Figure 3 on page 388 focuses on GDP per hour worked in selected countries. This measure of input enables us to compare countries on a more level playing field.

Chapter 18. The Elasticities of Demand and Supply

Learning Tips for Chapter 18

Here is a helpful hint that will help you remember how to graph relatively elastic versus relatively inelastic demand and supply curves. The trick involves how you write the letter "E" in Elastic and the letter "I" in Inelastic. Try writing the two terms in the following way to help "jog your memory":

To calculate who bears the burden of a tax, it is best done in three logical steps:

Step 1. Find the tax (T), or the vertical distance between the supply curve before the tax and after the tax, or tax increase;

Step 2. Find the buyer burden (BB), or the difference in price, (P2 – P1); and

Step 3. Find the Seller Burden (SB) as the difference between Steps 1 and 2, or (T – BB)

Chapter 19. Theory of Consumer Behavior

Learning Tips for Chapter 19

The definition of consumer surplus is the difference between what you pay for some good or service and what you would have been willing to pay. The word "difference" is a clue that calculating consumer surplus involves subtraction. Here is a quick formula to help you remember how to calculate consumer surplus:

Consumer Surplus = Total Utility – (Price x Quantity)

Remember to stay on the same row of the utility schedule, so that you are comparing the Total Utility for the same number of units as the "Q" in Price × Quantity.

Chapter 20. Cost

Learning Tips for Chapter 20

Graphing all of the cost curves and getting everything to intersect correctly is difficult. AVC and ATC must cross MC at their minimum points. The easiest way to do this is to always graph the costs curves in the following order:

1. Marginal Cost (MC)
2. Average Variable Cost (AVC)
3. Average Total Cost (ATC)

That way you can ensure that AVC falls, reaches a minimum when it crosses MC, then rises again; the same is true with ATC. Keep in mind that the AVC is always flatter and more gradual than the ATC.

Chapter 21. Profit, Loss, and Perfect Competition

Learning Tips for Chapter 21

A short rhyme (or rap) can help you remember the rule that firms use to set output (or Q*) in order to maximize profit. For the profit maximizing level of output, Q*, pronounce Q* as "Q star." Here's the rhyme:

"Firms set Q* where MC = MR."

It sounds silly, but if you say this aloud a few times, you are more likely to remember the rule.

Another rhyme that may help you is that a perfectly competitive firm is a "price taker, not a price maker."

Zero economic profit is a confusing concept. What it really means is that accounting profits tend to equalize in a truly competitive market economy. It also helps to remember that it is the profit rate (the percentage return on a business' outlays for fixed and variable costs), not the absolute value of profits, that will equalize. Any time a firm or industry is especially profitable, this will attract more competitors, increasing supply and driving down the profit rate.

Chapter 22. Monopoly

Learning Tips for Chapter 22

Here is another tip on drawing graphs. Draw the curves on the monopoly graph in this order:

1. Demand Curve
2. Marginal Revenue (MR)
3. Marginal Cost (MC) (then label Q* and P*)
4. Average Total Cost (ATC)
5. Find the profit rectangle

This same order will help you draw the graph for monopolistic competition in chapter 23.

Chapter 23. Monopolistic Competition

Learning Tips for Chapter 23

The term "monopolistic competition" sounds like a mouthful. When you think about it, it also sounds contradictory. Monopolies dominate markets and have no competitors; competitive markets have many firms, not monopolies.

The term is meant to sound contradictory. Monopolistically competitive markets have some of the characteristics of markets dominated by one firm and some of the characteristics of perfectly competitive markets:

• The monopoly aspect comes from product differentiation. For a consumer who is loyal to a particular brand or firm, the market feels like a monopoly. There are no equivalent substitutes. Demand is relatively inelastic (see page 561).
• The competitive aspect comes from the low barriers to entering the market. Firms, even those with loyal customers, do have competitors and will lose some market share when new firms enter the market.

Put them both together and you get monopolistic competition.

Chapter 24. Oligopoly

Learning Tips for Chapter 24

Note that the demand curve for an oligopoly operating under cutthroat competition is kinked, not kinky! The noun "kink" is defined in Webster's dictionary as "a twist or curl, as in a thread, rope, or hair, caused by its doubling or bending upon itself." The word "kink" can also refer to a sore muscle or an imperfection in a machine, but that is not the sense in which it is being used here. It is the bend in the demand curve that provides it's name.

The bend or kink of the demand curve is positioned at the current price. Remember the tip from chapter 18 about how to draw elastic versus inelastic curves. One part of the demand curve (above the current price) is flat. If a firm raises their price, demand is elastic. The other part (below the current price) is steep. If the firm lowers their price, demand is inelastic.

Chapter 26. Demand in the Factor Market

Learning Tips for Chapter 26

During the first part of your course, you have gotten used to thinking of consumers in households on the demand side of markets and business firms on the supply side. Now, when you get to factor markets, this gets reversed. Business firms demand labor and other factors of production. People in households are now the suppliers of labor.

Chapter 30. Income Distribution and Poverty

Learning Tips for Chapter 30

It is easy to make mistakes trying to translate the relative percentage information in Table 2 into the cumulative percentages you need to draw a Lorenz curve. Rather than doing the addition in your head, it helps to add an extra column to your table; this column should list the cumulative percentage of income for each of the quintiles. For example, Table 2 on page 694 has room to insert an extra, cumulative percentage column to the right of the column of 1968 data. You could add another cumulative column for the 2002 data.

Remember that the word "cumulative" refers to addition. Your "cumulative GPA" is the grade point average for all the courses you have taken so far. Similarly, the cumulative percentage of total income is the percentage of income earned by a quintile plus all the lower quintiles. The cumulative percentage of the last category should always equal 100% (or close to 100% due to rounding).

What is the difference between income and wealth? The textbook lists wages, salaries, interest payments, dividends, profits, rent, and government transfer payments as forms of income. What each of these has in common is that they flow to the recipient over time. You might be paid an hourly wage or a weekly salary or quarterly interest on a savings account, or an annual dividend because of stock ownership. That is why each of these forms of income was part of the circular flow diagram (see chapter 4).

Wealth, on the other hand, is a stable or fixed asset. You own your house, the contents of your checking or savings account, a certificate of deposit, or shares of stock—at least until you choose to sell them. Of course, even though ownership of the asset is relatively fixed, their market value may vary over time. For example, your house might be worth more today than when you purchased it.

Even though income and wealth are different, each can reinforce the other. The accumulation of income is one way of building wealth. For example, you might put aside some savings from your salary to purchase a house or buy some stock for your retirement account. And wealth can generate income. A savings account pays out interest. Owning stocks provides dividends. Property ownership can generate rent. This mutual reinforcement tends to concentrate wealth in a few hands. Also, wealth can be passed on from generation to generation, generating income for the heirs.

Notice, in fact, that wealth is more concentrated than income. We learned in chapter 30 that the top quintile (20 percent) of families earned 47.7% of all income in 2001 (see Figure 2). But the top 1 percent of the population (a much smaller group) held around 40% of wealth in the late 1990s.

Chapter 31. International Trade

Learning Tips for Chapter 31

Puzzled over how to calculate the Domestic Exchange Equations? They are based on calculating the slopes of the Production Possibilities Curves. You may (or may not) remember from your algebra classes that the slope formula is "rise over run" or the change between two points as measured on the vertical axis divided by the change between the same two points as measured on the horizontal axis. Let's apply this formula to the example in Figure 3A, the trade-off between photocopier and VCR production in the United States.

Focus on points B and C. We can write the coordinates for these two points as (10, 60) and (20, 40). Remember that the first number is read from the horizontal (or x) axis and the second number is read from the vertical (or y) axis. The change in photocopier production as we move from point B to point C is 40 – 60 or -20. The change in VCR production as we move from point B to point C is 20 – 10 or 10. The U.S. must give up 20 photocopiers to produce an additional 10 VCRs. This leads to the equation that you see on page 724: 2 photocopiers = 1 VCR.

The slope would be calculated as -20/10 or -2. The reason for using straight-line PPCs in this chapter, rather than PPCs with increasing opportunity costs, is because the straight lines have constant slopes, and therefore the Domestic Exchange Equations are constant. This simplifying assumption makes it easier to point out the advantages to specialization and trade.

Chapter 32. International Finance

Learning Tips for Chapter 32

Strong dollar or weak dollar? Which is better? The answer to this question, as with so many questions in economics, is: It depends! Stronger is not always better.

Under a system of floating exchange rates, a "strong dollar" means that the value of the dollar is relatively high, compared with other currencies. Each dollar buys more euros, pesos, yen, rubles, etc. This is great news if you are an American consumer who wants to buy imported goods—Japanese electronics, Swiss watches, or sneakers that are made in the Philippines.

But a strong dollar makes U.S.-made goods more expensive overseas. It takes more euros, pesos, yen, rubles, etc. to purchase U.S.-made cars, wheat, or DVDs. As our exports decline, so does GDP. Jobs are lost in export-oriented industries. That's why U.S. policy makers have been encouraging some of our trading partners to weaken the value of the dollar.

Remember:

• "Strong" dollar means the value of the dollar (measured against other currencies) is high. This benefits U.S. consumers who purchase imports more cheaply, but hurts export-oriented industries. A strong dollar contributes to the trade deficit (exports – imports).
• "Weak" dollar means the value of the dollar (measured against other currencies) is low. This hurts U.S. consumers by making imported goods more expensive. But it makes U.S. exports cheaper for consumers overseas, reducing the trade deficit.