Page 199 - Krugmans Economics for AP Text Book_Neat

section 4

Module 16 Income and Expenditure
Module 18 Aggregate Supply: Introduction and National Income
Module 17 Aggregate Demand: Introduction
and Determinants

Determinants
Module 19 Equilibrium in the Aggregate
Demand–Aggregate Supply Model and Price
Module 20 Economic Policy and the Aggregate
Demand–Aggregate Supply Model
Module 21 Fiscal Policy and the Multiplier Determination
Economics by Example:
“How Much Debt Is Too Much?”

FROM BOOM TO BUST

Ft. Myers, Florida, was a boom town in 2003, 2004, and most The abrupt collapse of the housing market pulled the
of 2005. Jobs were plentiful: by 2005 the unemployment rate local economy down with it, as the process that had created
was less than 3%. The shopping malls were humming, and the earlier boom operated in reverse.
new stores were opening everywhere. The boom and bust in Ft. Myers illustrates, on a small
But then the boom went bust. Jobs became scarce, and by scale, the way booms and busts often happen for the econ-
2009 the unemployment rate had reached 14%. Stores had omy as a whole. The business cycle is often driven by ups
few customers, and many were closing. One new business or downs in investment spending—either residential in-
was flourishing, however. Marc Joseph, a real estate agent, vestment spending (that is, spending on home construc-
began offering “foreclosure tours”: visits to homes that had tion) or nonresidential investment spending (such as
been seized by banks after the owners were unable to make spending on construction of office buildings, factories,
mortgage payments. and shopping malls). Changes in investment spending, in
What happened? Ft. Myers boomed from 2003 to 2005 be- turn, indirectly lead to changes in consumer spending,
cause of a surge in home construction, fueled in part by specu- which magnify—or multiply—the effect of the investment
lators who bought houses not to live in, but because they spending changes on the economy as a whole.
believed they could resell those houses at much higher prices. In this section we’ll study how this process works on
Home construction gave jobs to construction workers, electri- a grand scale. As a first step, we introduce multiplier analy-
cians, real estate agents, and others. And these workers, in turn, sis and show how it helps us understand the business
spent money locally, creating jobs for sales workers, waiters, cycle. In Module 17 we explain aggregate demand and its two
gardeners, pool cleaners, and more. These workers also spent most important components, consumer spending and
money locally, creating further expansion, and so on. investment spending. Module 18 introduces aggregate sup-
The boom turned into a bust when home construction ply, the other half of the model used to analyze economic
came to a virtual halt. It fluctuations. We will
turned out that specula- then be ready to explore
tion had been feeding on how aggregate supply
itself: people were buy- and aggregate demand
ing houses as invest- determine the levels
ments, then selling them of prices and real out-
to other people who put in an economy.
were also buying houses Finally, we will use
as investments, and the the aggregate demand-
prices had risen to levels aggregate supply model
far beyond what people Courtesy of the Dallas Morning News to visualize the state
who actually wanted to of the economy and
live in houses were will- examine the effects of
ing to pay. economic policy.

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