We now use the tools developed in Part I to analyze specific economic issues. While Part I has a strong theoretical focus, here we incorporate more data. For most applications, we begin by reviewing the data relevant to the topic and then present leading theories that are used to understand these facts.

The data show that for most consumers their level of consumption is very sensitive to changes in income and insensitive to changes in interest rates. The basic theory of consumption presented in Part I has the opposite prediction. This chapter therefore presents a richer model of consumption that better aligns with the facts.

How much do people work, and who works how much? How do these features vary across time and space? This chapter presents a basic theory of consumption and labor choice that can rationalize the observations.

There has been steady income growth in advanced economies since the Industrial Revolution and there are now large differences in average income across countries. These facts have huge importance to human welfare, what explains them? A first set of explanations hinges on the accumulation of more materials and tools and working harder. The chapter explains that these forces can only explain a small part of the facts. The accumulation of knowledge is key and the chapter presents the standard framework for modeling investments in knowledge.

This chapter introduces facts on business cycle fluctuations and presents theories used to analyze business cycles. Here we focus on those theories that assume perfect adjustment of prices and defer our discussion of Keynesian theories to a later chapter.

To this point the book has said little about the role of government in the economy despite the fact that governments control a large fraction of the resources in many economies. This chapter describes the tradeoffs governments face when raising tax revenues and describes the theory of optimal taxation.

On the whole, the volatility of asset prices is surprisingly high and even despite this the average returns to risky assets exceeds those on safe assets by a surprisingly large amount. This chapter introduces the core theories of asset pricing and explains how they relate to these patterns in the data.

This chapter discusses the explanations for why money has value and how inflation is related to the value of money.

Empirically, changes in the money supply lead to changes in the level of economic activity. In this chapter we develop the workhorse New
Keynesian model of business cycles that is used to understand the effects of monetary policy and its use as a stabilization tool.

Large collapses in economic activity, such as the Great Depression or the Global Financial Crisis of 2008, are often associated with problems in credit markets. This chapter extends our analysis of the economy to incorporate frictions in borrowing and lending relationships, which allows us to understand how credit market problems degrade economic performance.

One of the most-often cited macroeconomic statistics is the unemployment rate. Moreover, unemployment spells can have important consequences for the welfare of individual workers. Understanding this important topic requires moving beyond the frictionless labor market model we started from in order to explain why some individuals are able and willing to work yet remain unemployed.

Households are vastly different in their levels of income, wealth, and consumption. What explains these differences? This chapter presents the main explanations of economic inequality.

Much like households are heterogeneous, firms too are vastly different in the number of workers they employee and the amount of capital they control. This chapter presents facts on the distribution of firms and discusses the reasons that this heterogeneity among firms may or may not matter for the performance of the aggregate economy.

This chapter explains how two or more economies interact with each other by trading goods and financial assets. How much do countries borrow from one another? What determines the exchange rate between their currencies and between their purchasing powers?

This chapter explains how the circumstances and economic performance of emerging economies differs from advanced economies. Emerging economies face particular challenges and opportunities including a different sets of government institutions, greater difficulty in borrowing abroad, and perhaps greater exposure to volatile commodity prices. The chapter pays particular attention to understanding the causes and consequences of sovereign default.

Climate change could very likely be the most consequential macroeconomic issue of the twenty-first century. This chapter presents facts on carbon emissions and warming and then introduces a macroeconomic model that draws a link from economic activities to carbon emissions to warming. Such a model allows for the analysis of public policies aimed at reducing emissions.