List of Figures page ix
List of Tables xii
Preface xv
Foreword xix
1 GDP and Inflation 1
Objectives of this Chapter 2
1.1 GDP 3
1.1.1 Definition of GDP 3
1.1.2 GDP andWelfare 9
1.1.3 Historical Behavior of Nominal and Real GDP 11
1.1.4 Caveats 15
1.2 Components of GDP 15
1.2.1 Private Consumption 16
1.2.2 Private Investment 20
1.2.3 Government Spending 22
1.2.4 Net Exports 25
1.2.5 Miscellany 27
1.3 More GDP Accounting 28
1.4 Inflation 31
Further Reading 37
Homework 38
2 Firms and Growth 43
Objectives of this Chapter 44
2.1 Cobb–Douglas Production

2.1.1 Constant Returns to Scale 46
2.1.2 Declining Marginal Products 47
2.2 Profit Maximization 48
2.2.1 Optimal Capital 49
2.2.2 Optimal Labor 51
2.2.3 Optimal Profits 51
2.3 Growth Accounting 52
2.3.1 Growth in Developed Countries 55
2.3.2 Balanced Growth 56
2.3.3 Growth in Developing Countries 58
2.3.4 Barriers to Growth 60
2.4 Measurement of Kt , Lt, and zt 68
2.4.1 Measurement of the Capital Stock 68
2.4.2 Measurement of the Labor Input 76
2.4.3 Measurement of Technology 80
Further Reading 83
Homework 84
3 Households and Asset Pricing 89
Objectives of this Chapter 90
3.1 Optimal Labor Supply with No Saving 93
3.2 Optimal Consumption and Investment 97
3.2.1 A Two-PeriodModel 97
3.2.2 Mathematics of the Solution 99
3.2.3 Reinterpreting the Household Budget Constraint 101
3.2.4 Intertemporal Elasticity of Substitution 102
3.2.5 Discussion of Assumptions 104
3.2.6 Discussion of Uncertainty 106
3.3 Saving and Investment in Multiple Assets 109
3.3.1 Stocks and Bonds: The Equity Premium Puzzle 109
3.3.2 Housing

vii
3.4 Optimal Labor, Consumption, Investment 129
3.4.1 Model 129
3.4.2 Calibration 133
Further Reading 134
Homework 136
4 Trade 141
Objectives of this Chapter 142
4.1 Trade of Goods for Goods 144
4.2 Current and Capital Accounts 148
4.3 Data on Current and Capital Accounts 150
4.4 Trade of Goods for Assets 152
4.5 Factor Prices and Trade 159
4.6 Topics in Exchange Rates 161
4.6.1 Covered Interest Parity 161
4.6.2 Purchasing Power Parity 162
4.6.3 Fisher Equation 163
Further Reading 164
Homework 165
5 Business Cycles 167
Objectives of this Chapter 168
5.1 Business Cycle Dates 169
5.2 Trends and Cycles 169
5.3 Business Cycle Statistics 178
5.4 The Theory of Business Cycles 184
Further Reading 186
Homework 189

6 Monetary Policy 191
Objectives of this Chapter 192
6.1 A Very Brief History of the Federal Reserve 192
6.2 The Taylor Rule 196
6.3 Monetary Policy and Inflation 201
Further Reading 205
Homework 207
Appendix: Math 209
Objectives of this Appendix 209
A.1 Derivatives 209
A.1.1 Derivative of Polynomials 210
A.1.2 Derivative of the Natural Logarithm Function 212
A.1.3 Derivative Approximation to the Natural
Logarithm Function 213
A.2 Constrained Optimization: Econ 1 Revealed 214
A.2.1 Writing Down and Solving the Problem 215
A.2.2 Notes on the Lagrange Multiplier (λ) and
Expenditure Shares 217
Bibliography 219
Index

1.1 Annual log real GDP and “trend” log real GDP,
1929–2007 page 13
1.2 Annual log real GDP and trend log real GDP,
1973–2007 14
1.3 Annual log real GDP and log nominal GDP,
1929–2007 14
1.4 Ratio of annual nominal consumption (excluding
durables) to annual nominal GDP, 1929–2007 18
1.5 Detrended log real consumption (excluding durables)
and log real GDP, 1929–2007 19
1.6 Detrended log real consumption (excluding durables)
and log real GDP, 1973–2007 19
1.7 Ratio of annual nominal gross private domestic
investment to annual nominal GDP, 1929–2007 21
1.8 Detrended log real gross private domestic investment
and detrended log real GDP, 1973–2007 22
1.9 Bureau of Economic Analysis National Income and
Product Accounts Table 1.10: Gross domestic income
by type of income 29
1.10 Capital’s share of income (α), 1929–2007 31
1.11 Annual inflation rate, all consumption and
consumption excl. food and energy, 1930–2007 33
1.12 Annual inflation rate, all consumption and
consumption excl. food and energy, 1997–2007 34
1.13 Annual inflation rate, investment in equipment and
software, 1930–2007

1.14 Annual inflation rate, owner-occupied housing
(from www.ofheo.gov), 1975–2007 36
2.1 Bureau of Economic Analysis Fixed Asset Table 1.1:
Current-cost net stock of fixed assets and consumer
durable goods 70
2.2 Bureau of Economic Analysis National Income and
Product Accounts Table 1.1.5: Gross domestic product 71
2.3 Bureau of Economic Analysis National Income and
Product Accounts Table 2.3.5: Personal consumption
expenditures by major type of product 72
2.4 The ratio of the nominal value of capital to nominal
annual output, 1929–2006 73
2.5 The depreciation rate of capital, δ, 1930–2006 74
2.6 Per-capita hours worked per week, 1949–2006 78
2.7 ln (zt ) and its trend, with ln (zt ) rescaled to 0.0 in
1949, 1949–2006 81
2.8 Deviations of ln (zt ) from trend, 1949–2006 82
3.1 Realized values of t+1, 1949–2007 115
3.2 Ratio of annual rents to house prices (percent),
1960:1–2007:4 127
3.3 Nominal interest rate on 10-year Treasury Bonds,
1995–2007 128
4.1 Net exports, exports, and imports as a percentage of
nominal GDP, 1929–2007 151
5.1 Quarterly change in log real GDP and dates of NBER
contractions, 1949:1–2007:4 170
5.2 Log real GDP, 1949:1–2007:4 172
5.3 Trend log real GDP, trend computed using the
HP-Filter and a straight line, 1949:1–2007:4 173
5.4 Log real GDP less trend, trend computed using the
HP-Filter and a straight line, 1949:1–2007:4

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