Mankiw Principles of Economics (3rd ed)

2.Why is it important for people who own stocks and bonds to diversify their holdings? What type of financial institution makes diversification easier?

3.What is national saving? What is private saving? What is public saving? How are these three variables related?

4.What is investment? How is it saving?

5.Describe a change in the tax code that might increase private saving. If this policy were implemented, how would it affect the market for loanable funds?

6.What is a government budget deficit? How does it affect interest rates, investment, and economic growth?

1.For each of the following pairs, which bond would you expect to pay a higher interest rate? Explain.

a.a bond of the U.S. government or a bond of an eastern European government

b.a bond that repays the principal in 2005 or a bond that repays the principal in 2025

c.a bond from Coca-Cola or a bond from a software company you run in your garage

d.a bond issued by the federal government or a bond issued by New York State

2.Look up in a newspaper the stock of two companies you know something about (perhaps as a customer). What is the price–earnings ratio for each company? Why do you think they differ? If you were to buy one of these stocks, which would you choose? Why?

3.Theodore Roosevelt once said, “There is no moral difference between gambling at cards or in lotteries or on the race track and gambling in the stock market.” What social purpose do you think is served by the existence of the stock market?

4.Use the Internet to look at the Web site for a mutual fund company, such as Vanguard (www.vanguard.com). Compare the return on an actively managed mutual fund with the return on an index fund. What explains the difference in these returns?

5.Declines in stock prices are sometimes viewed as harbingers of future declines in real GDP. Why do you suppose that might be true?

6.When the Russian government defaulted on its debt to foreigners in 1998, interest rates rose on bonds issued by many other developing countries. Why do you suppose this happened?

7.Many workers hold large amounts of stock issued by the firms at which they work. Why do you suppose companies encourage this behavior? Why might a person not want to hold stock in the company where he works?

8.Your roommate says that he buys stock only in companies that everyone believes will experience big increases in profits in the future. How do you suppose the price–earnings ratio of these companies compares to the price–earnings ratio of other companies? What might be the disadvantage of buying stock in these companies?

9.Explain the difference between saving and investment as defined by a macroeconomist. Which of the following situations represent investment? Saving? Explain.

a.Your family takes out a mortgage and buys a new house.

b.You use your $200 paycheck to buy stock in AT&T.

c.Your roommate earns $100 and deposits it in her account at a bank.

d.You borrow $1,000 from a bank to buy a car to use in your pizza delivery business.

10.Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public saving is $0.2 trillion. Assuming this economy is closed, calculate consumption, government purchases, national saving, and investment.

11.Suppose that Intel is considering building a new chipmaking factory.

a.Assuming that Intel needs to borrow money in the bond market, why would an increase in interest rates affect Intel’s decision about whether to build the factory?

b.If Intel has enough of its own funds to finance the new factory without borrowing, would an increase in interest rates still affect Intel’s decision about whether to build the factory? Explain.

12.Suppose the government borrows $20 billion more next year than this year.

a.Use a supply-and-demand diagram to analyze this policy. Does the interest rate rise or fall?

b.What happens to investment? To private saving? To public saving? To national saving? Compare the

size of the changes to the $20 billion of extra government borrowing.

c.How does the elasticity of supply of loanable funds affect the size of these changes? (Hint: See Chapter 5 to review the definition of elasticity.)

d.How does the elasticity of demand for loanable funds affect the size of these changes?

e.Suppose households believe that greater government borrowing today implies higher taxes to pay off the government debt in the future. What does this belief do to private saving and the supply of loanable funds today? Does it increase or decrease the effects you discussed in parts

(a) and (b)?

13.Over the past ten years, new computer technology has enabled firms to reduce substantially the amount of inventories they hold for each dollar of sales. Illustrate the effect of this change on the market for loanable

funds. (Hint: Expenditure on inventories is a type of investment.) What do you think has been the effect on investment in factories and equipment?

14.“Some economists worry that the aging populations of industrial countries are going to start running down their savings just when the investment appetite of emerging economies is growing” (Economist, May 6, 1995). Illustrate the effect of these phenomena on the world market for loanable funds.

15.This chapter explains that investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit.

a.Why is it difficult to implement both of these policies at the same time?

b.What would you need to know about private saving in order to judge which of these two policies would be a more effective way to raise investment?

U N E M P L O Y M E N T

A N D I T S N A T U R A L R A T E

Losing a job can be the most distressing economic event in a person’s life. Most people rely on their labor earnings to maintain their standard of living, and many people get from their work not only income but also a sense of personal accomplishment. A job loss means a lower living standard in the present, anxiety about the future, and reduced self-esteem. It is not surprising, therefore, that politicians campaigning for office often speak about how their proposed policies will help create jobs.

In the preceding two chapters we have seen some of the forces that determine the level and growth of a country’s standard of living. A country that saves and invests a high fraction of its income, for instance, enjoys more rapid growth in its capital stock and its GDP than a similar country that saves and invests less. An even more obvious determinant of a country’s standard of living is the amount of unemployment it typically experiences. People who would like to work but cannot

IN THIS CHAPTER YOU WILL . . .

Lear n about the data used to measur e the amount of unemployment

Consider how unemployment arises fr om the pr ocess of job sear ch

Consider how unemployment can r esult fr om minimum - wage laws

See how unemployment can arise fr om

bar gaining between fir ms and unions

Examine how unemployment

r esults when fir ms choose to pay

ef ficiency wages

length of the average workweek, and the duration of unemployment. These data come from a regular survey of about 60,000 households, called the Current Population Survey.

Based on the answers to survey questions, the BLS places each adult (aged sixteen and older) in each surveyed household into one of three categories:

Employed

Unemployed

Not in the labor force

A person is considered employed if he or she spent most of the previous week working at a paid job. A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job. A person who fits neither of the first two categories, such as a full-time student, homemaker, or retiree, is not in the labor force. Figure 26-1 shows this breakdown for 1998.

Once the BLS has placed all the individuals covered by the survey in a category, it computes various statistics to summarize the state of the labor market. The BLS defines the labor force as the sum of the employed and the unemployed:

Labor force Number employed number of unemployed

labor force

the total number of workers, including both the employed and the unemployed

Employed (131.5 million)

Labor force (137.7 million)

Adult population (205.2 million)

Figur e 26-1

THE BREAKDOWN OF THE

POPULATION IN 1998. The

Bureau of Labor Statistics divides the adult population into three categories: employed, unemployed, and not in the labor force.

SOURCE: Bureau of Labor Statistics.

unemployment rate

the percentage of the labor force that is unemployed

labor-force

par ticipation rate the percentage of the adult

population that is in the labor force

natural rate of unemployment

the normal rate of unemployment around which the unemployment rate fluctuates

The BLS defines the unemployment rate as the percentage of the labor force that is unemployed:

Unemployment rate Number of unemployed 100.

The BLS computes unemployment rates for the entire adult population and for more narrow groups—blacks, whites, men, women, and so on.

The BLS uses the same survey to produce data on labor-force participation. The labor-force participation rate measures the percentage of the total adult population of the United States that is in the labor force:

Labor-force participation rate Adult population 100.

This statistic tells us the fraction of the population that has chosen to participate in the labor market. The labor-force participation rate, like the unemployment rate, is computed both for the entire adult population and for more narrow groups.

To see how these data are computed, consider the figures for 1998. In that year, 131.5 million people were employed, and 6.2 million people were unemployed. The labor force was

Labor force 131.5 6.2 137.7 million.

The unemployment rate was

Unemployment rate (6.2/137.7) 100 4.5 percent.

Because the adult population was 205.2 million, the labor-force participation rate was

Labor-force participation rate (137.7/205.2) 100 67.1 percent.

Hence, in 1998, two-thirds of the U.S. adult population were participating in the labor market, and 4.5 percent of those labor-market participants were without work.

Table 26-1 shows the statistics on unemployment and labor-force participation for various groups within the U.S. population. Three comparisons are most apparent. First, women have lower rates of labor-force participation than men, but once in the labor force, women have similar rates of unemployment. Second, blacks have similar rates of labor-force participation as whites, and they have much higher rates of unemployment. Third, teenagers have lower rates of labor-force participation and much higher rates of unemployment than the overall population. More generally, these data show that labor-market experiences vary widely among groups within the economy.

The BLS data on the labor market also allow economists and policymakers to monitor changes in the economy over time. Figure 26-2 shows the unemployment rate in the United States since 1960. The figure shows that the economy always has some unemployment and that the amount changes from year to year. The normal rate of unemployment around which the unemployment rate fluctuates is called the natural rate of unemployment, and the deviation of unemployment from its

Table 26-1

THE LABOR-MARKET

EXPERIENCES OF VARIOUS

DEMOGRAPHIC GROUPS.

This table shows the unemployment rate and the labor-force participation rate of various groups in the U.S. population for 1998.

UNEMPLOYMENT RATE SINCE 1960. This graph uses annual data on the unemployment rate to show the fraction of the labor force without a job.

Source: U.S. Department of Labor.

natural rate is called cyclical unemployment. In the figure, the natural rate is shown as a horizontal line at 5.5 percent, which is a rough estimate of the natural rate for the U.S. economy during this period. Later in this book we discuss

Figur e 26-2

cyclical unemployment

the deviation of unemployment from its natural rate

Labor-Force

Participation

Rate (in percent)

Figur e 26-3

LABOR-FORCE PARTICIPATION

RATES FOR MEN AND WOMEN

SINCE 1950. This figure shows the percentage of adult men and women who are members of the labor force. It shows that over the past several decades, women have entered the labor force, and men have left it.

SOURCE: U.S. Department of Labor.