Contents Preface xxxi
AN INTRODUCTION TO ECONOMICS Part 1 Economics: The Science of Scarcity chapter
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economics 24/7 24 3 Why LeBron James Isn’t in College 6 The Costs and Benefits of Attending Class 7 Why Did the British Soldiers Wear Red Uniforms? 11
What Economics Is About 1 A Definition of Economics 2 Goods and Bads 2
Resources 2
Scarcity and a Definition of Economics 2
Key Concepts in Economics 5 Opportunity Cost 5 Benefits and Costs 6 Unintended Effects 10 Exchange 11
Decisions Made at the Margin 8
Efficiency 8
Economic Categories 12 Positive and Normative Economics 12
Microeconomics and Macroeconomics 13
A Reader Asks 13 Analyzing the Scene 14 Chapter Summary 15 Key Terms and Concepts 16 Questions and Problems 16 Appendix A: Working with Diagrams 17 Two-Variable Diagrams 17 Slope of a Line 18 Slope of a Line Is Constant 18 Slope of a Curve 20 The 45° Line 20 Pie Charts 21 Bar Graphs 21 Line Graphs 21 Appendix Summary 24 Questions and Problems 24 Appendix B: Should You Major in Economics? 25 Five Myths about Economics and an Economics Major 26 What Awaits You as an Economics Major? 28 What Do Economists Do? 29 Places to Find More Information 30 Concluding Remarks 30
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economics 24/7 Can Technology on the Farm Affect the Number of Lawyers in the City? 37 Liberals, Conservatives, and the PPF 39 Jerry Seinfeld, the Doorman, and Adam Smith 44
Economic Activities: Producing and Trading 31 The Production Possibilities Frontier 32 The Straight-Line PPF: Constant Opportunity Costs 32 The Bowed-Outward (ConcaveDownward) PPF: Increasing Opportunity Costs 33 Law of Increasing Opportunity Costs 34 Economic Concepts within a PPF Framework 35
Exchange or Trade 38 Periods Relevant to Trade 39 Trade and the Terms of Trade 40 Trades and Third-Party Effects 42
Costs of Trades 40
Production, Trade, and Specialization 42 Producing and Trading 42 Profit and a Lower Cost of Living 45 and All-Knowing Dictator Versus the Invisible Hand 45
A Benevolent
A Reader Asks 46 Analyzing the Scene 47 Chapter Summary 47 Key Terms and Concepts 48 Questions and Problems 48 Working with Numbers and Graphs 49
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economics 24/7 Ticket Prices at Disney World 54 Overbooking and the Airlines 69 Ticket Scalping 75
Supply and Demand: Theory 50 A Note about Theories 51 What Is Demand? 51 The Law of Demand 52 What Does Ceteris Paribus Mean? 52 Four Ways to Represent the Law of Demand 52 Two Prices: Absolute and Relative 53 Why Does Quantity Demanded Go Down as Price Goes Up? 53 Individual Demand Curve and Market Demand Curve 54 A Change in Quantity Demanded Versus a Change in Demand 55 What Factors Cause the Demand Curve to Shift? 57 Movement Factors and Shift Factors 59
Supply 60 The Law of Supply 61 Why Most Supply Curves Are Upward Sloping 61 Changes in Supply Mean Shifts in Supply Curves 62 What Factors Cause the Supply Curve to Shift? 63 A Change in Supply Versus a Change in Quantity Supplied 64
The Market: Putting Supply and Demand Together 65 Supply and Demand at Work at an Auction 65 The Language of Supply and Demand: A Few Important Terms 66 Moving to Equilibrium: What Happens to Price When There Is a Surplus or a Shortage? 67 Speed of Moving to Equilibrium 68 Moving to Equilibrium: Maximum and Minimum Prices 68 Equilibrium in Terms of Consumers’ and Producers’ Surplus 70 What Can Change Equilibrium Price and Quantity? 71
Price Controls 73 Price Ceiling: Definition and Effects 73 Price Floor: Definition and Effects 76
A Reader Asks 77
Do Buyers Prefer Lower Prices to Higher Prices? 76
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Analyzing the Scene 78 Chapter Summary 78 Key Terms and Concepts 79 Questions and Problems 80 Working with Numbers and Graphs 80
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Supply and Demand: Practice 82 Application 1: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes of Admission? 83 Application 2: What Will Happen to the Price of Marijuana If the Purchase and Sale of Marijuana Are Legalized? 84 Application 3: Where Did You Get That Music? 85 Application 4: Television Shows During the Olympics 86 Application 5: Who Feeds Cleveland? 86 Application 6: The Minimum Wage Law 87 Application 7: Loud Talking at a Restaurant 88 Application 8: Price Ceiling in the Kidney Market 89 Application 9: Healthcare and the Right to Sue Your HMO 91 Application 10: Being Late to Class 92 Application 11: If Gold Prices Are the Same Everywhere, Then Why Aren’t House Prices? 93 Application 12: Do You Pay for Good Weather? 94 Application 13: Paying All Professors the Same Salary 94 Application 14: Price Floors and Winners and Losers 96 Application 15: College Superathletes 97 Application 16: Supply and Demand on a Freeway 99 Application 17: What Does Price Have to Do with Getting to Class on Time? 101 Application 18: The Space Within Space 102 Application 19: 10 A.M. Classes in College 102 Application 20: Who Pays the Tax? 103 A Reader Asks 105 Analyzing the Scene 105 Chapter Summary 106 Key Terms and Concepts 107 Questions and Problems 108 Working with Numbers and Graphs 109
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MACROECONOMICS Part 2 Macroeconomic Fundamentals chapter
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Macroeconomic Measurements, Part I: Prices and Unemployment 111 How to Approach the Study of Macroeconomics 112 Macroeconomic Problems 112 Macroeconomic Theories 112 Macroeconomic Policies 113 Different Views of How the Economy Works 113
Three Macroeconomic Organizational Categories 113 Macroeconomic Measures 115
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economics 24/7 Did President Kennedy Earn More Than Today’s President? 118 What Was a Penny Worth? 120 Economics at the Movies 121 National Public Radio and Unemployment Figures 124 What Explains the Increasing Percentage of Women in the Labor Force? 126
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economics 24/7 Happiness and the Economist 135 GDP: Proceed with Caution 137 Per Capita GDP in 1820 140
Measuring Prices Using the CPI 115 Inflation and the CPI 117 The Substitution Bias in Fixed-Weighted Measures 118 GDP Implicit Price Deflator 119 Converting Dollars from One Year to Another 119
Measuring Unemployment 120 Who Are the Unemployed? 121 The Unemployment and Employment Rates 122 Reasons for Unemployment 123 Discouraged Workers 123 Types of Unemployment 123 What Is Full Employment? 125 Cyclical Unemployment 125
A Reader Asks 127 Analyzing the Scene 127 Chapter Summary 128 Key Terms and Concepts 129 Questions and Problems 129 Working with Numbers and Graphs 129 Macroeconomic Measurements, Part II: GDP and Real GDP 131 Gross Domestic Product 132 Three Ways to Compute GDP 132 What GDP Omits 133 GDP Is Not Adjusted for Bads Generated in the Production of Goods 134 Per Capita GDP 134 Is Either GDP or Per Capita GDP a Measure of Happiness or Well-Being? 134
The Expenditure Approach to Computing GDP for a Real-World Economy 136 Expenditures in a Real-World Economy 136 Approach 137
Computing GDP Using the Expenditure
The Income Approach to Computing GDP for a Real-World Economy 138 Computing National Income 141 Adjustments 141
From National Income to GDP: Making Some
Other National Income Accounting Measurements 143 Net Domestic Product 143
Personal Income 143
Disposable Income 144
Real GDP 144 Why We Need Real GDP 144 Computing Real GDP 145 The General Equation for Real GDP 145 What Does It Mean If Real GDP Is Higher in One Year Than in Another Year? 145 Real GDP, Economic Growth, and Business Cycles 146
A Reader Asks 148
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Analyzing the Scene 148 Chapter Summary 149 Key Terms and Concepts 150 Questions and Problems 150 Working with Numbers and Graphs 151
Part 3 Macroeconomic Stability, Instability, and Fiscal Policy chapter
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economics 24/7 The Vietnam War and AD-SRAS 166 Aggregate Demand, the Great Depression, and Scrabble 169 Reality Can Be Messy, and Correct Predictions Can Be Difficult to Make 171
Aggregate Demand and Aggregate Supply 152 The Two Sides to an Economy 153 Aggregate Demand 153 Why Does the Aggregate Demand Curve Slope Downward? 153 A Change in the Quantity Demanded of Real GDP Versus a Change in Aggregate Demand 156 Changes in Aggregate Demand: Shifts in the AD Curve 156 How Spending Components Affect Aggregate Demand 157 Factors That Can Change C, I, G, and NX (EX – IM) and Therefore Can Change AD 158 Can a Change in the Money Supply Change Aggregate Demand? 161
Short-Run Aggregate Supply 162 Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping 162 What Puts the “Short Run” in SRAS? 163 Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve 163
Putting AD and SRAS Together: Short-Run Equilibrium 165 How Short-Run Equilibrium in the Economy Is Achieved 166 Thinking in Terms of Short-Run Equilibrium Changes in the Economy 167 An Important Exhibit 169
Long-Run Aggregate Supply 170 Going from the Short Run to the Long Run 170 Equilibrium, and Disequilibrium 172
Short-Run Equilibrium, Long-Run
A Reader Asks 173 Analyzing the Scene 173 Chapter Summary 174 Key Terms and Concepts 175 Questions and Problems 175 Working with Numbers and Graphs 176
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The Self-Regulating Economy 177 The Classical View 178 Classical Economists and Say’s Law 178 Classical Economists and Interest Rate Flexibility 178 Classical Economists on Prices and Wages 180
Three States of the Economy 181 Real GDP and Natural Real GDP: Three Possibilities 181 The Labor Market and the Three States of the Economy 182 One Nagging Question: How Can the Unemployment Rate Be Less Than the Natural Unemployment Rate? 184
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economics 24/7 Hurricane Katrina and the Economy 187
The Self-Regulating Economy 185 What Happens If the Economy Is in a Recessionary Gap? 185 What Happens If the Economy Is in an Inflationary Gap? 186 The Self-Regulating Economy: A Recap 188 Policy Implication of Believing the Economy Is Self-Regulating 189 Changes in a SelfRegulating Economy: Short Run and Long Run 189
A Reader Asks 191 Analyzing the Scene 191 Chapter Summary 192 Key Terms and Concepts 193 Questions and Problems 193 Working with Numbers and Graphs 194
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economics 24/7 The Multiplier Goes on Spring Break 205 Negative Savings and House Wealth 208
Economic Instability: A Critique of the Self-Regulating Economy 195 Questioning the Classical Position 196 Keynes’s Criticism of Say’s Law in a Money Economy 196 Keynes on Wage Rates 198 New Keynesians and Wage Rates 198 Keynes on Prices 199 Is It a Question of the Time It Takes for Wages and Prices to Adjust? 200
The Simple Keynesian Model 201 Assumptions 201 The Consumption Function 201 The Multiplier 203 The Multiplier and Reality 205
Consumption and Saving 203
The Simple Keynesian Model in the AD-AS Framework 206 Shifts in the Aggregate Demand Curve 206 The Keynesian Aggregate Supply Curve 206 The Economy in a Recessionary Gap 208 Government’s Role in the Economy 209 The Theme of the Simple Keynesian Model 209
The Simple Keynesian Model in the TE-TP Framework 210 Deriving a Total Expenditures (TE) Curve 210 What Will Shift the TE Curve? 211 Comparing Total Expenditures (TE) and Total Production (TP) 212 Moving from Disequilibrium to Equilibrium 212 The Graphical Representation of the Three States of the Economy in the TE-TP Framework 213 The Economy in a Recessionary Gap and the Role of Government 214 The Theme of the Simple Keynesian Model 216
A Reader Asks 216 Analyzing the Scene 217 Chapter Summary 218 Key Terms and Concepts 219 Questions and Problems 219 Working with Numbers and Graphs 220
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The Federal Budget and Fiscal Policy 221 The Federal Budget 222 Government Expenditures 222 Government Tax Revenues 223 Budget Deficit, Surplus, or Balance 225 Structural and Cyclical Deficits 226 The Public Debt 226
Fiscal Policy 226 Some Relevant Fiscal Policy Terms 227
Two Important Notes 227
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economics 24/7 Two Plumbers, New Year’s Eve, and Progressive Taxation 224 JFK and the 1964 Tax Cut 229 Star Wars: Episode III— Revenge of the Sith 235
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Demand-Side Fiscal Policy 227 Shifting the Aggregate Demand Curve 227 Fiscal Policy: A Keynesian Perspective 228 Crowding Out: Questioning Expansionary Fiscal Policy 229 Lags and Fiscal Policy 232 Crowding Out, Lags, and the Effectiveness of Fiscal Policy 233
Supply-Side Fiscal Policy 233 Marginal Tax Rates and Aggregate Supply 233 Revenues 234
The Laffer Curve: Tax Rates and Tax
A Reader Asks 237 Analyzing the Scene 238 Chapter Summary 238 Key Terms and Concepts 239 Questions and Problems 240 Working with Numbers and Graphs 240
Part 4 Money, the Economy, and Monetary Policy chapter
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economics 24/7 Is Money the Best Gift? 243 English and Money 245 Economics on the Yellow Brick Road 248 eBay and Match.com 250
Money and Banking 241 Money: What Is It and How Did It Come to Be? 242 Money: A Definition 242 Three Functions of Money 242 From a Barter to a Money Economy: The Origins of Money 243 Money in a Prisoner of War Camp 244 Money, Leisure, and Output 244 What Gives Money Its Value? 245
Defining the Money Supply 246 M1 246
M2 246
Where Do Credit Cards Fit In? 247
How Banking Developed 249 The Early Bankers 249
The Federal Reserve System 249
The Money Creation Process 249 The Bank’s Reserves and More 250 The Banking System and the Money Expansion Process 251 Why Maximum? Answer: No Cash Leakages and Zero Excess Reserves 254 Who Created What? 254 It Works in Reverse: The “Money Destruction” Process 255 We Change Our Example 256
A Reader Asks 257 Analyzing the Scene 257 Chapter Summary 258 Key Terms and Concepts 258 Questions and Problems 259 Working with Numbers and Graphs 259
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The Federal Reserve System 260 The Structure and Functions of the Fed 261 The Structure of the Fed 261
The Functions of the Fed 262
Fed Tools for Controlling the Money Supply 264 Open Market Operations 264
The Required Reserve Ratio 267
The Discount Rate 267
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economics 24/7 Some History of the Fed 262 Flying in with the Money 266
A Reader Asks 269 Analyzing the Scene 270 Chapter Summary 270 Key Terms and Concepts 270 Questions and Problems 271 Working with Numbers and Graphs 271
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economics 24/7 The California Gold Rush, or an Apple for $72 276 Grade Inflation: It’s All Relative 286
Money and the Economy 272 Money and the Price Level 273 The Equation of Exchange 273 From the Equation of Exchange to the Simple Quantity Theory of Money 274 The Simple Quantity Theory of Money in an AD-AS Framework 275 Dropping the Assumptions That V and Q Are Constant 277
Monetarism 278 Monetarist Views 278
Monetarism and AD-AS 279
The Monetarist View of the Economy 281
Inflation 281 One-Shot Inflation 282 Continued Inflation 284
Money and Interest Rates 287 What Economic Variables Are Affected by a Change in the Money Supply? 287 The Money Supply, the Loanable Funds Market, and Interest Rates 288 So What Happens to the Interest Rate as the Money Supply Changes? 292 The Nominal and Real Interest Rates 292
A Reader Asks 293 Analyzing the Scene 294 Chapter Summary 295 Key Terms and Concepts 296 Questions and Problems 296 Working with Numbers and Graphs 297
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Monetary Policy 298 The Money Market 299 The Demand for Money 299
The Supply of Money 300
Equilibrium in the Money Market 300
Transmission Mechanisms 300 The Keynesian Transmission Mechanism: Indirect 301 The Keynesian Mechanism May Get Blocked 301 The Monetarist Transmission Mechanism: Direct 305
Monetary Policy and the Problem of Inflationary and Recessionary Gaps 306 Monetary Policy and the Activist-Nonactivist Debate 308 The Case for Activist (or Discretionary) Monetary Policy 309 Rules-Based) Monetary Policy 309
The Case for Nonactivist (or
Nonactivist Monetary Proposals 312 A Constant-Money-Growth-Rate Rule 312 A Predetermined-Money-Growth-Rate Rule 312 The Fed and the Taylor Rule 313 Inflation Targeting 314
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economics 24/7 If You’re So Smart, Then Why Aren’t You Rich? 304 How Far Does Monetary Policy Reach? Or Monetary Policy and Blue Eyes 310 Asset-Price Inflation 313
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economics 24/7 Rational Expectations in the College Classroom 329 The Boy Who Cried Wolf (and the Townspeople with Rational Expectations) 332
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A Reader Asks 315 Analyzing the Scene 316 Chapter Summary 316 Key Terms and Concepts 317 Questions and Problems 317 Working with Numbers and Graphs 318
Part 5 Expectations and Growth Expectations Theory and the Economy 319 Phillips Curve Analysis 320 The Phillips Curve 320
Samuelson and Solow: The Phillips Curve Is Americanized 320
The Controversy Begins: Are There Really Two Phillips Curves? 321 Things Aren’t Always as We Thought 321 Friedman and the Natural Rate Theory 321 How Do People Form Their Expectations? 324
Rational Expectations and New Classical Theory 326 Rational Expectations 326 Do People Anticipate Policy? 326 New Classical Theory: The Effects of Unanticipated and Anticipated Policy 327 Policy Ineffectiveness Proposition (PIP) 328 Rational Expectations and Incorrectly Anticipated Policy 329 How to Fall into a Recession Without Really Trying 330
New Keynesians and Rational Expectations 332 Looking at Things from the Supply Side: Real Business Cycle Theorists 333 A Reader Asks 335 Analyzing the Scene 335 Chapter Summary 336 Key Terms and Concepts 337 Questions and Problems 337 Working with Numbers and Graphs 338
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Economic Growth 339 A Few Basics About Economic Growth 340 Do Economic Growth Rates Matter? 340 Growth Rates in Selected Countries 340 Two Types of Economic Growth 342 Economic Growth and the Price Level 343
What Causes Economic Growth? 344 Natural Resources 344 Labor 345 Capital 345 Technological Advances 345 Free Trade as Technology 346 Property Rights Structure 346 Economic Freedom 347 Policies to Promote Economic Growth 348 Economic Growth and Special Interest Groups 349
New Growth Theory 350 What Was Wrong with the Old Theory? Or What’s New with New Growth Theory? 350 Discovery, Ideas, and Institutions 352 Expanding Our Horizons 352
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economics 24/7 Growth and Morality 341 How Economizing on Time Can Promote Economic Growth 344
A Reader Asks 353 Analyzing the Scene 353 Chapter Summary 354 Key Terms and Concepts 355 Questions and Problems 355 Working with Numbers and Graphs 355
Religious Beliefs and Economic Growth 347 Professors, Students, and Ideas 351
MICROECONOMICS Part 6 Microeconomic Fundamentals
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economics 24/7 Drug Busts and Crime 365 Will High Taxes on Cigarettes Reduce Smoking? 366 Why Do Companies Hire Celebrities? 369 Are Children Substitutes or Complements? 372
Elasticity 357 How to Approach the Study of Microeconomics 358 Consumers 358 Firms 358 359 Recap 359
Factor Owners 359
Choices Are Made in Market Settings
Elasticity: Part 1 359 Price Elasticity of Demand 359 Elasticity Is Not Slope 361 From Perfectly Elastic to Perfectly Inelastic Demand 361 Price Elasticity of Demand and Total Revenue (Total Expenditure) 363
Elasticity: Part 2 367 Price Elasticity of Demand Along a Straight-Line Demand Curve 367 Elasticity of Demand 368
Determinants of Price
Other Elasticity Concepts 371 Cross Elasticity of Demand 371 Income Elasticity of Demand 373 Supply 373 Price Elasticity of Supply and Time 375
Price Elasticity of
A Reader Asks 376 Analyzing the Scene 376 Chapter Summary 377 Key Terms and Concepts 378 Questions and Problems 378 Working with Numbers and Graphs 379
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Consumer Choice: Maximizing Utility and Behavioral Economics 380 Utility Theory 381 Utility: Total and Marginal 381 Diamond-Water Paradox 384
Law of Diminishing Marginal Utility 381
The Solution to the
Consumer Equilibrium and Demand 385 Equating Marginal Utilities per Dollar 385 Maximizing Utility and the Law of Demand 386 Should the Government Provide the Necessities of Life for Free? 386
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economics 24/7 Cuban Cigars, Chilean Grapes 383 How You Pay for Good Weather 387
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Behavioral Economics 388 Are People Willing to Reduce Others’ Incomes? 388 Is $1 Always $1? 389 Coffee Mugs and the Endowment Effect 390 Does the Endowment Effect Hold Only for New Traders? 391
A Reader Asks 392 Analyzing the Scene 393 Chapter Summary 393 Key Terms and Concepts 394 Questions and Problems 394 Working with Numbers and Graphs 395 Appendix C: Budget Constraint and Indifference Curve Analysis 396 The Budget Constraint 396 Slope of the Budget Constraint 396
What Will Change the Budget Constraint? 397
Indifference Curves 397 Constructing an Indifference Curve 398 Characteristics of Indifference Curves 398
The Indifference Map and the Budget Constraint Come Together 401 From Indifference Curves to a Demand Curve 402 Appendix Summary 403 Questions and Problems 404
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economics 24/7 Do Secretaries Who Work for Investment Banks Earn More Than Secretaries Who Work for Hotels? 409 High School Students, Staying Out Late, and More 417 What Matters to Global Competitiveness? 421 “I Have to Become an Accountant” 424
Production and Costs 405 Why Firms Exist 406 The Market and the Firm: Invisible Hand Versus Visible Hand 406 The Alchian and Demsetz Answer 406 Shirking in a Team 406 Ronald Coase on Why Firms Exist 407 Markets: Outside and Inside the Firm 408
The Firm’s Objective: Maximizing Profit 408 Accounting Profit Versus Economic Profit 410 Sounds 411
Zero Economic Profit Is Not as Bad as It
Production 411 Production in the Short Run 412 Average Productivity 416
Marginal Physical Product and Marginal Cost 414
Costs of Production: Total, Average, Marginal 417 The AVC and ATC Curves in Relation to the MC Curve 419 Costs 422 One More Cost Concept: Sunk Cost 422
Tying Short-Run Production to
Production and Costs in the Long Run 426 Long-Run Average Total Cost Curve 426 Economies of Scale, Diseconomies of Scale, and Constant Returns to Scale 427 Why Economies of Scale? 428 Why Diseconomies of Scale? 428 Minimum Efficient Scale and Number of Firms in an Industry 428
Shifts in Cost Curves 429 Taxes 429 Input Prices 429
Technology 429
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A Reader Asks 430 Analyzing the Scene 430 Chapter Summary 431 Key Terms and Concepts 432 Questions and Problems 432 Working with Numbers and Graphs 433
Part 7 Product Markets and Policies chapter
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economics 24/7 Amazon: There May Not Be Any Cappuccino, but There Are Millions of Books 437 Do Churches Compete? 439 What Do Audrey Hepburn, Lucille Ball, and Bugs Bunny Have in Common? 447
Perfect Competition 435 Market Structures 436 The Theory of Perfect Competition 436 A Perfectly Competitive Firm Is a Price Taker 437 The Demand Curve for a Perfectly Competitive Firm Is Horizontal 438 The Marginal Revenue Curve of a Perfectly Competitive Firm Is the Same as Its Demand Curve 439 Theory and Real-World Markets 440
Perfect Competition in the Short Run 441 What Level of Output Does the Profit-Maximizing Firm Produce? 441 The Perfectly Competitive Firm and Resource Allocative Efficiency 442 To Produce or Not to Produce: That Is the Question 443 The Perfectly Competitive Firm’s Short-Run Supply Curve 445 From Firm to Market (Industry) Supply Curve 445 Why Is the Market Supply Curve Upward Sloping? 446
Perfect Competition in the Long Run 448 The Conditions of Long-Run Competitive Equilibrium 448 The Perfectly Competitive Firm and Productive Efficiency 449 Industry Adjustment to an Increase in Demand 449 What Happens as Firms Enter an Industry in Search of Profits? 452 Industry Adjustment to a Decrease in Demand 453 Differences in Costs, Differences in Profits: Now You See It, Now You Don’t 453 Profit and Discrimination 454
Topics for Analysis Within the Theory of Perfect Competition 455 Do Higher Costs Mean Higher Prices? 455 Will the Perfectly Competitive Firm Advertise? 455 Supplier-Set Price Versus Market-Determined Price: Collusion or Competition? 456
A Reader Asks 456 Analyzing the Scene 457 Chapter Summary 458 Key Terms and Concepts 459 Questions and Problems 459 Working with Numbers and Graphs 460
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Monopoly 461 The Theory of Monopoly 462 Barriers to Entry: A Key to Understanding Monopoly 462 a Government Monopoly and a Market Monopoly? 464
What Is the Difference Between
Monopoly Pricing and Output Decisions 464 The Monopolist’s Demand and Marginal Revenue 464 The Monopolist’s Demand and Marginal Revenue Curves Are Not the Same: Why Not? 465 Price and Output for a Profit-
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economics 24/7 Monopoly and the Boston Tea Party 463 Amazon and Price Discrimination 475 Why Do District Attorneys Plea-Bargain? 476
Maximizing Monopolist 466 Profit Too? 466
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If a Firm Maximizes Revenue, Does It Automatically Maximize
Perfect Competition and Monopoly 468 Price, Marginal Revenue, and Marginal Cost 468 Monopoly, Perfect Competition, and Consumers’ Surplus 468 Monopoly or Nothing? 469
The Case Against Monopoly 470 The Deadweight Loss of Monopoly 470
Rent Seeking 471
X-Inefficiency 472
Price Discrimination 472 Types of Price Discrimination 473 Why a Monopolist Wants to Price Discriminate 473 Conditions of Price Discrimination 473 Moving to P ⫽ MC Through Price Discrimination 474 You Can Have the Comics, Just Give Me the Coupons 475
A Reader Asks 478 Analyzing the Scene 478 Chapter Summary 480 Key Terms and Concepts 480 Questions and Problems 480 Working with Numbers and Graphs 481
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economics 24/7 How Is a New Year’s Resolution Like a Cartel Agreement? 490 An Economic Theory of the Mafia 498
Monopolistic Competition, Oligopoly, and Game Theory 482 The Theory of Monopolistic Competition 483 The Monopolistic Competitor’s Demand Curve 483 The Relationship Between Price and Marginal Revenue for a Monopolistic Competitor 483 Output, Price, and Marginal Cost for the Monopolistic Competitor 483 Will There Be Profits in the Long Run? 484 Excess Capacity: What Is It, and Is It “Good” or “Bad”? 485 The Monopolistic Competitor and Two Types of Efficiency 487 Advertising and Designer Labels 487
Oligopoly: Assumptions and Real-World Behavior 487 Price and Output Under Three Oligopoly Theories 488 The Cartel Theory 488 Theory 493
The Kinked Demand Curve Theory 491
The Price Leadership
Game Theory, Oligopoly, and Contestable Markets 494 Prisoner’s Dilemma 495 Oligopoly Firms’ Cartels and the Prisoner’s Dilemma 497 Are Markets Contestable? 499
A Review of Market Structures 500 Applications of Game Theory 500 Grades and Partying 500 The Arms Race 502 as an Enforcement Mechanism 503
A Reader Asks 504 Analyzing the Scene 505 Chapter Summary 505 Key Terms and Concepts 506 Questions and Problems 506 Working with Numbers and Graphs 507
Speed Limit Laws 502
The Fear of Guilt
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economics 24/7 Thomas Edison and Hollywood 512 High-Priced Ink Cartridges and Expensive Mini-Bars 515 “Why Am I Always Flying to Dallas?” 525
Government and Product Markets: Antitrust and Regulation 508 Antitrust 509 Antitrust Acts 509 Unsettled Points in Antitrust Policy 510 Antitrust and Mergers 513 Seven Antitrust Cases and Actions 514 Network Monopolies 517 Civil Action No. 981232 518
Regulation 519 The Case of Natural Monopoly 519 Regulating the Natural Monopoly 521 Regulating Industries That Are Not Natural Monopolies 523 Theories of Regulation 523 The Costs and Benefits of Regulation 524 Some Effects of Regulation Are Unintended 524 Deregulation 525
A Reader Asks 526 Analyzing the Scene 527 Chapter Summary 528 Key Terms and Concepts 528 Questions and Problems 528 Working with Numbers and Graphs 529
Part 8 Factor Markets and Related Isues chapter
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economics 24/7 Why Jobs Don’t Always Move to the Low-Wage Country 538 How May Crime, Outsourcing, and Multitasking Be Related? 542 What Is the Wage Rate for a Street-Level Pusher in a Drug Gang? 546
Factor Markets: With Emphasis on the Labor Market 531 Factor Markets 532 The Demand for a Factor 532 Marginal Revenue Product: Two Ways to Calculate It 532 The MRP Curve Is the Firm’s Factor Demand Curve 533 Value Marginal Product 534 An Important Question: Is MRP ⫽ VMP? 534 Marginal Factor Cost: The Firm’s Factor Supply Curve 534 How Many Units of a Factor Should a Firm Buy? 535 When There Is More Than One Factor, How Much of Each Factor Should the Firm Buy? 536
The Labor Market 537 Shifts in a Firm’s MRP, or Factor Demand, Curve 537 Market Demand for Labor 539 The Elasticity of Demand for Labor 540 Market Supply of Labor 541 An Individual’s Supply of Labor 543 Shifts in the Labor Supply Curve 543 Putting Supply and Demand Together 543 Why Do Wage Rates Differ? 544 Why Demand and Supply Differ in Different Labor Markets 545 Why Did You Choose the Major That You Chose? 546 Marginal Productivity Theory 547
Labor Markets and Information 548 Screening Potential Employees 548 Promoting from Within 549 or Is It an Information Problem? 549
A Reader Asks 550 Analyzing the Scene 550 Chapter Summary 551 Key Terms and Concepts 552 Questions and Problems 552 Working with Numbers and Graphs 553
Is It Discrimination
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economics 24/7 Technology, the Price of Competing Factors, and Displaced Workers 561 What Are College Professors’ Objectives? 562 “Are You Ready for Some Football?” 567
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Wages, Unions, and Labor 554 The Facts and Figures of Labor Unions 555 Types of Unions 555
Union Membership: The United States and Abroad 555
Objectives of Labor Unions 555 Employment for All Members 556 Maximizing the Total Wage Bill 556 Maximizing Income for a Limited Number of Union Members 556 Wage-Employment Tradeoff 556
Practices of Labor Unions 558 Affecting Elasticity of Demand for Union Labor 558 Affecting the Demand for Union Labor 558 Affecting the Supply of Union Labor 559 Affecting Wages Directly: Collective Bargaining 559 Strikes 560
Effects of Labor Unions 561 The Case of Monopsony 561 Unions’ Effects on Wages 565 Unions’ Effects on Prices 566 Unions’ Effects on Productivity and Efficiency: Two Views 566
A Reader Asks 568 Analyzing the Scene 569 Chapter Summary 569 Key Terms and Concepts 570 Questions and Problems 570 Working with Numbers and Graphs 571
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economics 24/7 Winner-Take-All Markets 580 Monks, Blessings, and Free Riders 588
The Distribution of Income and Poverty 572 Some Facts About Income Distribution 573 Who Are the Rich and How Rich Are They? 573 Distribution 575 A Simple Equation 575
The Effect of Age on the Income
Measuring Income Equality 576 The Lorenz Curve 576
The Gini Coefficient 577
A Limitation of the Gini Coefficient 578
Why Income Inequality Exists 579 Factors Contributing to Income Inequality 579 Some Are Not 582
Income Differences: Some Are Voluntary,
Normative Standards of Income Distribution 583 The Marginal Productivity Normative Standard 583 The Absolute Income Equality Normative Standard 584 The Rawlsian Normative Standard 585
Poverty 586 What Is Poverty? 586 Limitations of the Official Poverty Income Statistics 587 Who Are the Poor? 587 What Is the Justification for Government Redistributing Income? 587
A Reader Asks 589 Analyzing the Scene 590 Chapter Summary 590 Key Terms and Concepts 591 Questions and Problems 591 Working with Numbers and Graphs 591
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Interest, Rent, and Profit 592 Interest 593 Loanable Funds: Demand and Supply 593 The Price for Loanable Funds and the Return on Capital Goods Tend to Equality 595 Why Do Interest Rates Differ? 595 Nominal and Real Interest Rates 596 Present Value: What Is Something Tomorrow Worth Today? 597 Deciding Whether or Not to Purchase a Capital Good 598
Rent 599 features
economics 24/7 Is the Car Worth Buying? 597 Loans for the Poorest of the Poor 600 Insuring Oneself Against Terrorism 605
David Ricardo, the Price of Grain, and Land Rent 599 The Supply Curve of Land Can Be Upward Sloping 599 Economic Rent and Other Factors of Production 600 Economic Rent and Baseball Players: The Perspective from Which the Factor Is Viewed Matters 601 Competing for Artificial and Real Rents 601 Do People Overestimate Their Worth to Others, or Are They Simply Seeking Economic Rent? 602
Profit 602 Theories of Profit 602 What Is Entrepreneurship? 603 What Do a Microwave Oven and an Errand Runner Have in Common? 604 Profit and Loss as Signals 605
A Reader Asks 606 Analyzing the Scene 607 Chapter Summary 607 Key Terms and Concepts 608 Questions and Problems 608 Working with Numbers and Graphs 608
Part 9 Market Failure and Public Choice chapter
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economics 24/7 Software, Switching Costs and Benefits, and Market Failure 613 Telemarketers and Efficiency 620 The Right Quantity and Quality of a Nonexcludable Public Good 626 Finding Economics in College Life 630
Market Failure: Externalities, Public Goods, and Asymmetric Information 609 Market Failure 610 Externalities 610 Costs and Benefits of Activities 610 Marginal Costs and Benefits of Activities 611 Social Optimality, or Efficiency, Conditions 611 Three Categories of Activities 611 Externalities in Consumption and in Production 612 Diagram of a Negative Externality 612 Diagram of a Positive Externality 614
Internalizing Externalities 616 Persuasion 616 Taxes and Subsidies 617 Assigning Property Rights 617 Voluntary Agreements 618 Combining Property Rights Assignments and Voluntary Agreements 618 Beyond Internalizing: Setting Regulations 620
Dealing with a Negative Externality in the Environment 621 Is No Pollution Worse Than Some Pollution? 621
Two Methods to Reduce Air Pollution 622
Public Goods: Excludable and Nonexcludable 624 Goods 624
The Free Rider 624
Nonexcludable Versus Nonrivalrous 625
Asymmetric Information 626 Asymmetric Information in a Product Market 627 Asymmetric Information in a Factor Market 628 Is There Market Failure? 628 Adverse Selection 629 Moral Hazard 631
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A Reader Asks 632 Analyzing the Scene 633 Chapter Summary 633 Key Terms and Concepts 634 Questions and Problems 634 Working with Numbers and Graphs 635
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Public Choice: Economic Theory Applied to Politics 636 Public Choice Theory 637 The Political Market 637 Moving Toward the Middle: The Median Voter Model 637
Voters and Rational Ignorance 641 The Costs and Benefits of Voting 641
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economics 24/7 Simple Majority Voting Rule: The Case of the Statue in the Public Square 640 Are You Rationally Ignorant? 642 Inheritance, Heirs, and Why the Firstborn Became King or Queen 648
What Does the Theory Predict? 638
Rational Ignorance 642
More About Voting 643 Example 1: Voting for a Nonexcludable Public Good 643
Example 2: Voting and Efficiency 644
Special Interest Groups 645 Information and Lobbying Efforts 646 Congressional Districts as Special Interest Groups 646 Public Interest Talk, Special Interest Legislation 647 Special Interest Groups and Rent Seeking 647
Government Bureaucracy 650 A View of Government 651 A Reader Asks 652 Analyzing the Scene 653 Chapter Summary 653 Key Terms and Concepts 654 Questions and Problems 654 Working with Numbers and Graphs 655
THE GLOBAL ECONOMY Part 10 International Economics and Globalization chapter
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International Trade 657 International Trade Theory 658 How Do Countries Know What to Trade? 658 Comparative Advantage? 660
How Do Countries Know When They Have a
Trade Restrictions 662 The Distributional Effects of International Trade 662 Consumers’ and Producers’ Surplus 662 The Benefits and Costs of Trade Restrictions 663 If Free Trade Results in Net Gain, Why Do Nations Sometimes Restrict Trade? 666
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economics 24/7 Dividing Up the Work 661 Offshore Outsourcing, or Offshoring 667
The World Trade Organization (WTO) 669 A Reader Asks 670 Analyzing the Scene 670 Chapter Summary 671 Key Terms and Concepts 672 Questions and Problems 672 Working with Numbers and Graphs 673
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economics 24/7 The Nobel Prize in Economics and Foreign Exchange Markets 683 Back to the Futures 685 Big Macs and Exchange Rates 691
International Finance 674 The Balance of Payments 675 Current Account 676 Capital Account 679 Official Reserve Account 679 Discrepancy 679 What the Balance of Payments Equals 680
The Foreign Exchange Market 680 The Demand for Goods 681
The Demand for and Supply of Currencies 681
Flexible Exchange Rates 683 The Equilibrium Exchange Rate 683 Changes in the Equilibrium Exchange Rate 684 Factors That Affect the Equilibrium Exchange Rate 684
Fixed Exchange Rates 687 Fixed Exchange Rates and Overvalued/Undervalued Currency 688 What Is So Bad About an Overvalued Dollar? 689 Government Involvement in a Fixed Exchange Rate System 690 Options Under a Fixed Exchange Rate System 690 The Gold Standard 692
Fixed Exchange Rates Versus Flexible Exchange Rates 694 Promoting International Trade 694
Optimal Currency Areas 695
The Current International Monetary System 696 A Reader Asks 698 Analyzing the Scene 699 Chapter Summary 699 Key Terms and Concepts 700 Questions and Problems 700 Working with Numbers and Graphs 701
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Statistical
Globalization 702 What Is Globalization? 703 A Smaller World 703
A World Economy 703
Two Ways to “See� Globalization 704 No Barriers 704
A Union of States 704
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economics 24/7 How Hard Will It Be to Get into Harvard in 2025? 706 Will Globalization Change the Sound of Music? 709 Should You Leave a Tip? 712
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Globalization Facts 704 International Trade 705 Foreign Exchange Trading 705 Foreign Direct Investment 705 Personal Investments 707 The World Trade Organization 707 Business Practices 707
Movement Toward Globalization 707 The End of the Cold War 707
Advancing Technology 708
Policy Changes 708
Benefits and Costs of Globalization 710 The Benefits 710
The Costs 712
The Continuing Globalization Debate 713 More or Less Globalization: A Tug of War? 714 Less Globalization 714
More Globalization 715
A Reader Asks 716 Analyzing the Scene 716 Chapter Summary 717 Key Terms and Concepts 717 Questions and Problems 718
PRACTICAL ECONOMICS Part 11 Financial Matters chapter
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economics 24/7 Is There Genius When It Comes to Picking Stocks? 721 Are Some Economists Poor Investors? 724 $1.3 Quadrillion 727
Stocks, Bonds, Futures, and Options 719 Financial Markets 720 Stocks 720 Where Are Stocks Bought and Sold? 720 The Dow Jones Industrial Average (DJIA) 722 How the Stock Market Works 723 Why Do People Buy Stock? 725 How to Buy and Sell Stock 726 Buying Stocks or Buying the Market 726 How to Read the Stock Market Page 728
Bonds 730 The Components of a Bond 730 Bond Ratings 730 Bond Prices and Yields (or Interest Rates) 731 Types of Bonds 731 How to Read the Bond Market Page 732 Risk and Return 733
Futures and Options 734 Futures 734
Options 736
A Reader Asks 738 Analyzing the Scene 738 Chapter Summary 739 Key Terms and Concepts 739 Questions and Problems 739 Working with Numbers and Graphs 740
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WEB CHAPTERS Part 12 Web Chapters chapter
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economics 24/7 The Politics of Agriculture 747
Agriculture: Farmers’ Problems, Government Policies, and Unintended Effects 741 Agriculture: The Issues 742 A Few Facts 742 Agriculture and Income Inelasticity 743 Agriculture and Price Inelasticity 743 Price Variability and Futures Contracts 744 Can Bad Weather Be Good for Farmers? 745
Agricultural Policies 746 Price Supports 746 Restricting Supply 746 Target Prices and Deficiency Payments 748 Production Flexibility Contract Payments, (Fixed) Direct Payments, and Countercyclical Payments 749 Nonrecourse Commodity Loans 749
A Reader Asks 750 Analyzing the Scene 751 Chapter Summary 751 Key Terms and Concepts 751 Questions and Problems 752 Working with Numbers and Graphs 753
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International Impacts on the Economy 753 International Factors and Aggregate Demand 754 Net Exports 754
The J-Curve 755
International Factors and Aggregate Supply 756 Foreign Input Prices 756
Why Do Foreign Input Prices Change? 757
Factors That Affect Both Aggregate Demand and Aggregate Supply 757 features
economics 24/7 Proper Business Etiquette Around the World 762
The Exchange Rate 757
What Role Do Interest Rates Play? 758
Contents
Deficits: International Effects and Domestic Feedback 759 The Budget Deficit and Expansionary Fiscal Policy 759 The Budget Deficit and Contractionary Fiscal Policy 760 The Effects of Monetary Policy 761
A Reader Asks 763 Analyzing the Scene 764 Chapter Summary 764 Key Terms and Concepts 765 Questions and Problems 765 Working with Numbers and Graphs 766 Self-Test Appendix 741 Glossary 765 Index 777
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