New to this edition is the inclusion of international applications, examples and case studies, providing fully for the needs of modern students of introductory economics. The book is intended for 1st-year undergraduates taking an introduction to economics or principles of economics course. View via Publisher. Save to Library Save. Create Alert Alert. Share This Paper. Background Citations. Methods Citations. Results Citations. Citation Type.
Has PDF. Publication Type. More Filters. This paper explores possible reasons for the long and enduring dominance of neoclassical theory over the undergraduate microeconomics textbook.
It proposes that those very attributes of neoclassical … Expand. The first of these essays was written for a happy occasion — my acceptance of honorary membership in the European Society for the History of Economic Thought. The second marked an altogether sadder … Expand. View 2 excerpts, cites results. Successes and failures in the transformation of economics.
While acknowledging the successes of modern economics, this paper concentrates on some shortcomings. Many are traced to a single source: the great insights of economics are all qualitative. A cut in the rate of interest will increase investment and consumption spending, and will increase net exports.
As shown in Figure Monetary policy has a much shorter decision lag than fiscal policy. Fiscal policy tools to control inflation involve either the government spending less, or increasing tax rates, or both. Government spending is extremely difficult to reduce at short notice so is not particularly useful when a government wishes to control inflation. Although it may require some time for tax rates to be changed this may nevertheless be a more effective way of reducing AD.
Increases in the interest rate may be used to control inflation, again by causing a reduction in AD, principally by reducing investment spending. As people buy bonds money flows into the central bank and the money supply is reduced. If this action is sufficient to control the money supply then it will help control inflation.
Monetary policy is probably most effective as a way of controlling inflation when the intentions of the monetary authorities over the long run are clearly understood, and unwavering.
When fiscal policy is used as a stimulus to the economy, i. However scope for increasing a budget deficit may be constrained. A reduction in interest rates would also increase aggregate spending in normal circumstances, though not when there was a liquidity trap. As the rate of interest rises, the level of investment falls, AE is lower, and the equilibrium level of GDP falls. Thus there is a negative relationship between the price level and equilibrium GDP, giving the AD curve a negative slope.
In this case a rise in the price level leads to a reduction in the real money supply, which shifts the LM curve to the left, leading to a higher rate of interest and lower GDP. Since the AD curve is determined by the intersection of the IS and LM curves, any factor which affects the slope of either of these will affect the slope of AD.
The slope of the IS curve depends on the interest elasticity of investment and on the size of the multiplier. The slope of the LM curve depends on the elasticities of the demand for money with respect to the rate of interest and to GDP. Any factor which changes any constituent part of AD will cause AD to shift. This would be a good question for a brainstorming session in a class, or perhaps for a competition in which the group with the most correct suggestions wins.
This is a logical start in that it provides some basic facts and identifies key terms. The object is to familiarize students with the meaning and significance of the major categories which they are likely to encounter in everyday discussion.
The accounts are set out in the format introduced in the UK in , which conforms to the international standard format. Credits, debits, and balances are shown, giving a clearer overall picture, and some terminology changed.
The last part of the first section explores some common misconceptions about the balance of payments. These phrases usually refer to the balance of payments on current account and may betray an old-fashioned mercantilist view of trade. It deals with the new mercantilist idea that only the balance of trade matters and makes the key distinction between the volume and the balance of trade as sources of the gains from trade.
The second section focuses on the market for foreign exchange, first defining the exchange rate and explaining why foreign exchange transactions are necessary in a world with foreign trade and country-specific currencies. The text then discusses the demand for foreign currency and the supply of foreign currency in the foreign exchange market.
This material is consistently linked to the discussion of the balance of payments accounts found earlier in the chapter. The third section, on the determination of exchange rates, will be much easier for students who have studied demand and supply at some length, but it can be handled with only Chapter 3. Although the theory is nothing but another application of the competitive theory of price, students tend to find it difficult, because of the necessary chains of reasoning, to link shifts in the demand for and supply of goods and services to shifts in the demand for and supply of foreign exchange and, thence, to changes in free-market exchange rates.
After the concept of equilibrium in the foreign exchange market is introduced, the distinction between fixed and flexible exchange rates is made in terms of whether or not the monetary authorities intervene in the foreign exchange market. Managed floats are also briefly discussed. The problems associated with fixed exchange rates may be seen as a further example of the difficulties of price intervention, first met in Chapter 3.
The rest of the chapter focuses on flexible exchange rates, looking first at some of the more important causes of the shifts in demand and supply that lead to changes in exchange rates. The major payoff for students is found in the review, at the end of the chapter, of the behaviour of exchange rates since the arrival of floating in the early s.
There are two key topics. One is purchasing power parity PPP , which is discussed in detail in both the short term and the long term. Despite the logic of the law of one price, applying this logic to price indices can be dangerous, and as a result there are good reasons to expect PPP not to hold.
A discussion of the links between the interest rate and the exchange rate leads to an acknowledgement of the significance of the exchange rate as an element of the monetary transmission mechanism, and points the reader towards Chapter The first case study discusses the links between global imbalances and the financial crisis which is first raised in Box Both cases are new to this edition. The second case study on balance of payments adjustment is also new.
The French asset the house is balanced by the French debt the loan provided by a French bank. Subsequent loan repayments, if made out of UK income, would appear in the current account as a debit under goods and services, on the services line.
If the airline were British, the cost of the ticket would not appear in the balance of payments accounts. The idea of a balance of payments crisis is also strong, at least among an older generation in the UK which lived under a fixed exchange rate regime and saw governments lose elections because of such crises.
This makes domestic goods and services less competitive and leads to a reduction in exports. At the same time imported goods and services become cheaper, so imports rise.
The fall in demand for home-produced goods and services may lead to a recessionary gap, other things being equal. In the UK a strong currency has been associated with a decline in the manufacturing sector as export markets were lost while growth in the service sector was strong. This changed pattern of the economy is not just the result of a strong currency however. Beneficiaries of a strong exchange rate include those who holiday abroad.
The discussion of overshooting on pages looks at the implications for the UK economy in the last three decades of having periods when the pound was overvalued. Such markets are highly speculative as buyers and sellers seek to maximize their returns. They react swiftly to relative changes in interest rates.
As investors rush into a currency they push its exchange rate above its PPP level where it will stay until investors calculate that a future depreciation of an overvalued currency is not compensated by the interest differential which first triggered their purchase of that currency.
See the discussion of exchange rate overshooting starting on page Not so in the seminar room, however. If the statement is taken to mean outflows per se, then in a developed economy such outflows are likely to be at a roughly similar level to capital inflows, with the difference between the two relatively very small—see the data for the UK in Table A poor country dependent on foreign aid would present a different picture.
On the other hand, if the statement refers to net outflows on the capital account, then those outflows will be balanced by a surplus on the current account of the balance of payments and will represent an increase in domestically owned foreign assets which would be expected to generate a stream of income in the future. While a capital outflow might create employment overseas, so too might the future income received in the domestic economy. The current account measures the payments for goods and services, income, and transfers.
A current account surplus is balanced by a capital account deficit, which means that total spending in the economy is lower than total income so that there is a capital outflow. Purchasing power parity is a long-run concept, based on the relative purchasing power of two currencies and is influenced by changes in the price level. Many teachers skip this chapter in a first-year course and some others use it in the second year.
The macroeconomic model developed over the previous chapters is extended to include the role of external influences such as the exchange rate regime and international financial capital flows, so that it provides a much more appropriate tool for analysing the modern economy. The student will recognize the world in which we live. The chapter is divided into three main sections, but the longest by far is the middle section on macroeconomic policy in a world with perfect capital mobility.
The first section gives three reasons why the analysis found later is necessary. Although the net exports function has already been discussed the model has so far ignored the repercussions of changes in the balance of trade.
These repercussions are influenced by the degree of mobility of international financial capital, while the behaviour of capital flows is affected by the exchange rate regime. The text deals next with the results of monetary and fiscal policy changes under, first, a fixed exchange rate regime: monetary policy is shown to be ineffective while expansionary fiscal policy will, in the long run, increase both domestic prices and the trade deficit.
Second, the analysis is developed with floating exchange rates. The exploration of the effect of fiscal policy changes takes into account both a fixed money stock and, alternatively, a fixed interest rate. The section finishes by reworking the analysis, but this time starting from a position of disequilibrium after a negative aggregate demand shock—the usual circumstance in which expansionary policy is used.
The preceding discussion started from an equilibrium position. By the end, the student should have a feel for both the flexibility and the relevance of the macro model developed over the preceding chapters and culminating here. The chapter serves as a review of much of the material in the macroeconomic half of the book.
At the end of the chapter are a couple of pages in which the authors point out the implications of the preceding discussion for the transmission of monetary policy and for the effectiveness of fiscal policy, in a world where capital flows are unchecked and exchange rates float.
This is a thought-provoking end to a stimulating chapter. The first case study examines the linkages in financial markets that helped spread the global banking crisis. The second case study looks at the Asian crisis of These all add international dimensions to the crisis discussions of the previous three chapters and thus help to build a fuller picture.
Notes for users of the previous edition The pattern in earlier chapters of having a news story in a box early on is broken in this chapter and for the rest of the book. Applied material comes early from Box This is all intended to balance the fact that the core of this chapter is some hard theory that is as tough as it gets in the Macro half of the book. Sterling would be expected to depreciate.
The differential in nominal interest rates will equal the expected rate of change of the exchange rate, so that expected returns would be equal on dollar and sterling assets. Thus sterling would appreciate in relation to the euro during the year. A pound would buy more euros at the end of the year than at the beginning. Expansionary policy reduces the interest rate and expands the money stock but any possible effect will be negated by selling of the currency on the foreign exchange market. The central bank will have to buy the domestic currency in the foreign exchange market to maintain the fixed exchange rate, thus reducing the domestic money stock and causing interest rates to rise.
Neither GDP nor the price level are affected by all this. Expansionary fiscal policy will lead to an increase in GDP in the short run only, a higher price level in the long run, and an increase in the trade deficit. Expansionary monetary policy will lead to an increase in GDP in the short run only, and to a higher price level in the long run. However its impact on the balance of payments account is quite different from that of fiscal policy in Question 4. In the short run the lower interest rate leads to a lower real exchange rate, a surplus on the current account, capital outflows to balance the trade surplus, and thus an increase in net foreign assets.
In the long run these changes cease as equilibrium is regained. The results of expansionary fiscal policy depend on whether the monetary authority holds the money stock or the interest rate fixed. Essentially, with a fixed stock of money, a growing budget deficit is matched by a growing trade deficit and fiscal policy has little or no effect on GDP.
This expansion in the money stock leads to a short-run increase in GDP and upward pressure on the price level, much as in Figure In the process, higher prices lead to a reduction of net exports so in the long run a current account deficit occurs, financed by borrowing from abroad.
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