Brief Contents
PART I Introduction To Economics1
1
The Scope and Method of Economics1
Why Study Economics?2
To Learn a Way ofThinking2
To Understand Society4
To Understand Global Affairs5
To Be an Informed Citizen5
ECONOMICS IN PRACTICE iPod and the World6
The Scope of Economics6
Microeconomics and Macroeconomics6
The Diverse Fields ofEconomics7
ECONOMICS IN PRACTICE Trust and Gender9
The Method of Economics9
Descriptive Economics and Economic Theory10
Theories and Models10
Economic Policy13
An Invitation15
Summary15Review Terms and Concepts16Problems16
Appendix: How to Read and Understand Graphs17
2
The Economic Problem: Scarcity and Choice25
Scarcity, Choice, and Opportunity Cost26
Scarcity and Choice in a One-Person Economy26
Scarcity and Choice in an Economy ofTwo or More27
ECONOMICS IN PRACTICE Frozen Foods and Opportunity Costs28
The Production Possibility Frontier33
The Economic Problem38
ECONOMICS IN PRACTICE Trade-Offs among the Rich and Poor39
Economic Systems and the Role of Government 39
Command Economies40
Laissez-Faire Economies:The Free Market40
Mixed Systems,Markets,and Governments42
Looking Ahead42
Summary43Review Terms and Concepts43Problems44
3 Demand, Supply, and Market Equilibrium47
Firms and Households: The Basic DecisionMaking Units47
Input Markets and Output Markets: The Circular Flow48
Demand in Product/Output Markets50
Changes in Quantity Demanded versus Changes in Demand51
Price and Quantity Demanded:The Law of Demand51
Other Determinants ofHousehold Demand54
ECONOMICS IN PRACTICE Kindle in the College Market?55
Shift ofDemand versus Movement Along a Demand Curve56
From Household Demand to Market Demand58
Supply in Product/Output Markets60
Price and Quantity Supplied:The Law of Supply61
Other Determinants ofSupply62
Shift ofSupply versus Movement Along a Supply Curve63
From Individual Supply to Market Supply65
Market Equilibrium66
Excess Demand66
Excess Supply68
Changes in Equilibrium69
ECONOMICS IN PRACTICE High Prices for Tomatoes70
Demand and Supply in Product Markets: A Review72
Looking Ahead: Markets and the Allocation of Resources72
ECONOMICS IN PRACTICE Why Do the Prices of Newspapers Rise?73
Summary74Review Terms and Concepts75Problems76
4 Demand and Supply Applications79
The Price System: Rationing and Allocating Resources79
Price Rationing79
ECONOMICS IN PRACTICE Prices and Total Expenditure: A Lesson From the Lobster Industry in 2008–200981
Constraints on the Market and Alternative Rationing Mechanisms82
Prices and the Allocation ofResources86
Price Floor86
Supply and Demand Analysis: An Oil Import Fee86
ECONOMICS IN PRACTICE The Price Mechanism at Work for Shakespeare87
Supply and Demand and Market Efficiency89
Consumer Surplus89
Producer Surplus90
Competitive Markets Maximize the Sum of Producer and Consumer Surplus91
Potential Causes ofDeadweight Loss From Underand Overproduction92
Looking Ahead93
Summary93Review Terms and Concepts94Problems94
5 Elasticity97
Price Elasticity of Demand98
Slope and Elasticity98
Types ofElasticity99
Calculating Elasticities100
Calculating Percentage Changes100
Elasticity Is a Ratio ofPercentages101
The Midpoint Formula101
Elasticity Changes Along a Straight-Line Demand Curve103
Elasticity and Total Revenue105
The Determinants of Demand Elasticity107
Availability ofSubstitutes107
The Importance ofBeing Unimportant107
ECONOMICS IN PRACTICE Who Are the Elastic Smokers?108
The Time Dimension108
ECONOMICS IN PRACTICE Elasticities at a Delicatessen in the Short Run and Long Run109
Other Important Elasticities109
Income Elasticity ofDemand110
Cross-Price Elasticity ofDemand110 Elasticity ofSupply111
Looking Ahead111
Summary112Review Terms and Concepts112Problems113
Appendix: Point Elasticity (Optional)115
PART II The Market System: Choices Made by Households and Firms117
6 Household Behavior and Consumer Choice121
Household Choice in Output Markets121
The Determinants ofHousehold Demand122
The Budget Constraint122
The Equation ofthe Budget Constraint125
The Basis of Choice: Utility126
Diminishing Marginal Utility126
Allocating Income to Maximize Utility127
The Utility-Maximizing Rule129
Diminishing Marginal Utility and DownwardSloping Demand129
Income and Substitution Effects130
The Income Effect130
The Substitution Effect131
Household Choice in Input Markets132
The Labor Supply Decision132
ECONOMICS IN PRACTICE Substitution and Market Baskets133
The Price ofLeisure134
Income and Substitution Effects ofa Wage Change134
Saving and Borrowing:Present versus Future Consumption135
ECONOMICS IN PRACTICE What Happens When the Cost of Self-Discovery Falls?136
A Review: Households in Output and Input Markets137
Summary138Review Terms and Concepts138Problems138 Appendix: Indifference Curves141
7 The Production Process: The Behavior of Profit-Maximizing Firms147
The Behavior of Profit-Maximizing Firms148
Profits and Economic Costs148
Short-Run versus Long-Run Decisions150
The Bases ofDecisions:Market Price ofOutputs, Available Technology,and Input Prices151
The Production Process152
Production Functions:Total Product,Marginal Product,and Average Product152
Production Functions with Two Variable Factors of Production155
ECONOMICS IN PRACTICE Learning about Growing Pineapples in Ghana156
Choice of Technology156
ECONOMICS IN PRACTICE How Fast Should a Truck Driver Go?157
Looking Ahead: Cost and Supply158
Summary158Review Terms and Concepts159Problems159
Appendix: Isoquants and Isocosts162
8
Short-Run Costs and Output Decisions167
Costs in the Short Run168
Fixed Costs168
Variable Costs169
Total Costs175
Short-Run Costs:A Review177
ECONOMICS IN PRACTICE Average and Marginal Costs at a College178
Output Decisions: Revenues, Costs, and Profit
Maximization179
Perfect Competition179
Total Revenueand Marginal Revenue 180
Comparing Costs and Revenues to Maximize Profit180
ECONOMICS IN PRACTICE Case Study in Marginal Analysis: An Ice Cream Parlor182
The Short-Run Supply Curve184 Looking Ahead185
Summary185Review Terms and Concepts186Problems186
9
Long-Run Costs and Output Decisions189
Short-Run Conditions and Long-Run Directions190
Maximizing Profits190
Minimizing Losses192
The Short-Run Industry Supply Curve194
Long-Run Directions:A Review194
Long-Run Costs: Economies and Diseconomies of Scale195
Increasing Returns to Scale196
ECONOMICS IN PRACTICE Economies of Scale in the World Marketplace197
ECONOMICS IN PRACTICE Economies of Scale in Solar198
Constant Returns to Scale199
Decreasing Returns to Scale200
U-Shaped Long-Run Average Costs200
Long-Run Adjustments to Short-Run Conditions200
ECONOMICS IN PRACTICE The Long-Run Average Cost Curve: Flat or U-Shaped?201
Short-Run Profits:Moves In and Out of Equilibrium201
ECONOMICS IN PRACTICE The Fortunes of the Auto Industry204
The Long-Run Adjustment Mechanism:Investment Flows Toward Profit Opportunities204
ECONOMICS IN PRACTICE Why Are Hot Dogs So Expensive in Central Park?205
Output Markets: A Final Word206
Summary206Review Terms and Concepts207Problems207
Appendix: External Economies and Diseconomies and the Long-Run Industry Supply Curve210
10 Input Demand: The Labor and Land Markets215
Input Markets: Basic Concepts215
Demand for Inputs:A Derived Demand215
Inputs:Complementary and Substitutable216 Diminishing Returns216
ECONOMICS IN PRACTICE Sometimes Workers Play Hooky!217
Marginal Revenue Product217
Labor Markets219
A Firm Using Only One Variable Factor of Production:Labor219
A Firm Employing Two Variable Factors of Production in the Short and Long Run222
ECONOMICS IN PRACTICE What is Denzel Washington’s Marginal Revenue Product in Broadway’s Fences?223
Many Labor Markets224
Land Markets224
Rent and the Value ofOutput Produced on Land225
ECONOMICS IN PRACTICE Time Is Money: European High-Speed Trains226
The Firm’s Profit-Maximizing Condition in Input Markets226
Input Demand Curves227
Shifts in Factor Demand Curves227
Looking Ahead228
Summary229Review Terms and Concepts230Problems230
11
Input Demand: The Capital Market and the Investment Decision233
Capital, Investment, and Depreciation233
Capital233
ECONOMICS IN PRACTICE Investment Banking, IPOs, and Electric Cars235
Investment and Depreciation235
The Capital Market236
Capital Income:Interest and Profits237
Financial Markets in Action239
Mortgages and the Mortgage Market240
ECONOMICS IN PRACTICE Who Owns Stocks in the United States?241
Capital Accumulation and Allocation241
The Demand for New Capital and the Investment Decision241
Forming Expectations242
ECONOMICS IN PRACTICE Chinese Wind Power243
Comparing Costs and Expected Return243
A Final Word on Capital245
Summary246Review Terms and Concepts246Problems247
Appendix: Calculating Present Value248
12 General Equilibrium and the Efficiency of Perfect Competition253
Market Adjustment to Changes in Demand254
Allocative Efficiency and Competitive
Equilibrium256
Pareto Efficiency256
ECONOMICS IN PRACTICE Ethanol and Land Prices257
Revisiting Consumer and Producer Surplus258
The Efficiency ofPerfect Competition259
Perfect Competition versus Real Markets262
The Sources of Market Failure262
Imperfect Markets262
Public Goods263
Externalities263
Imperfect Information264
Evaluating the Market Mechanism264
Summary264Review Terms and Concepts265Problems265
PART III Market Imperfections and the Role of Government269
13
Monopoly and Antitrust Policy269
Imperfect Competition and Market Power: Core Concepts269
Forms ofImperfect Competition and Market Boundaries270
Price and Output Decisions in Pure Monopoly Markets271
Demand in Monopoly Markets271
Perfect Competition and Monopoly Compared276
Monopoly in the Long Run:Barriers to Entry277
ECONOMICS IN PRACTICE Managing the Cable Monopoly280
The Social Costs of Monopoly281
Inefficiency and Consumer Loss281
Rent-Seeking Behavior282
Price Discrimination283
Examples ofPrice Discrimination285
Remedies for Monopoly: Antitrust Policy285
Major Antitrust Legislation285
ECONOMICS IN PRACTICE Antitrust Rules Cover the NFL287
Imperfect Markets: A Review and a Look Ahead287
Summary288Review Terms and Concepts289Problems289
14
Oligopoly293
Market Structure in an Oligopoly294
ECONOMICS IN PRACTICE Why Are Record Labels Losing Key Stars Like Madonna?296
Oligopoly Models297
The Collusion Model297
The Price-Leadership Model298
The Cournot Model299
Game Theory300
Repeated Games303
A Game with Many Players:Collective Action Can Be Blocked by a Prisoner’s Dilemma304
ECONOMICS IN PRACTICE Price Fixing in Digital Music306
Oligopoly and Economic Performance306
Industrial Concentration and Technological Change307
The Role of Government307
Regulation ofMergers308
A Proper Role?310
Summary310Review Terms and Concepts311Problems311
15 Monopolistic Competition313
Industry Characteristics314
Product Differentiation and Advertising315
How Many Varieties?315
How Do Firms Differentiate Products?316
ECONOMICS IN PRACTICE An Economist Makes Tea318 Advertising318
ECONOMICS IN PRACTICE Can Information Reduce Obesity?321
Price and Output Determination in Monopolistic Competition322
Product Differentiation and Demand Elasticity323
Price/Output Determination in the Short Run323
Price/Output Determination in the Long Run324
Economic Efficiency and Resource Allocation326
Summary326Review Terms and Concepts327Problems327
16 Externalities, Public Goods, and Social Choice329
Externalities and Environmental Economics329
Marginal Social Cost and Marginal-Cost Pricing330
ECONOMICS IN PRACTICE Ban on Oil Drillers332
Private Choices and External Effects333
Internalizing Externalities334
ECONOMICS IN PRACTICE Externalities Are All Around Us338
ECONOMICS IN PRACTICE Climate Change341
Public (Social) Goods341
The Characteristics ofPublic Goods341
Public Provision ofPublic Goods342
Optimal Provision ofPublic Goods343
Local Provision ofPublic Goods:Tiebout
Hypothesis345
Social Choice346
The Voting Paradox346
Government Inefficiency:Theory ofPublic Choice348
Rent-Seeking Revisited348 Government and the Market349
Summary349Review Terms and Concepts350Problems350
17 Uncertainty and Asymmetric Information353
Decision Making Under Uncertainty: The Tools353
Expected Value354
Expected Utility354
Attitudes Toward Risk356
Asymmetric Information357
Adverse Selection358
ECONOMICS IN PRACTICE Adverse Selection in the Health Care Market360 Market Signaling360
ECONOMICS IN PRACTICE How to Read Advertisements361
Moral Hazard362 Incentives363
Labor Market Incentives363
Summary364Review Terms and Concepts365Problems365
18
Income Distribution and Poverty367
The Sources of Household Income367 Wages and Salaries367
Income from Property369
Income from the Government:Transfer Payments370
The Distribution of Income370
Income Inequality in the United States370 The World Distribution ofIncome372
ECONOMICS IN PRACTICE The New Rich Work!373 Causes ofIncreased Inequality373 Poverty375
The Distribution ofWealth376
The Utility Possibilities Frontier376 The Redistribution Debate377
Arguments Against Redistribution378
Arguments in Favor ofRedistribution378
Redistribution Programs and Policies380
Financing Redistribution Programs:Taxes380
Expenditure Programs381
ECONOMICS IN PRACTICE Does Price Matter in Charitable Giving?384 Government or the Market? A Review385
Summary385Review Terms and Concepts386Problems386
19
Public Finance: The Economics of Taxation389
The Economics of Taxation389
Taxes:Basic Concepts389
ECONOMICS IN PRACTICE Calculating Taxes392
Tax Equity392
What Is the “Best”Tax Base?393
ECONOMICS IN PRACTICE The Yankees and the Estate Tax396
The Gift and Estate Tax396
Tax Incidence: Who Pays?396
The Incidence ofPayroll Taxes397
The Incidence ofCorporate Profits Taxes400
The Overall Incidence ofTaxes in the United States: Empirical Evidence402
Excess Burdens and the Principle of Neutrality402
How Do Excess Burdens Arise?402
Measuring Excess Burdens403
Excess Burdens and the Degree ofDistortion404
The Principle of Second Best405
Optimal Taxation406
Summary406Review Terms and Concepts407Problems407
PART IV Concepts and Problems in Macroeconomics409
20 Introduction to Macroeconomics409
Macroeconomic Concerns410
Output Growth 410
Unemployment411
Inflation and Deflation412
The Components of the Macroeconomy412
The Circular Flow Diagram413
The Three Market Arenas414
The Role ofthe Government in the Macroeconomy415
A Brief History of Macroeconomics415
ECONOMICS IN PRACTICE Macroeconomics in Literature417
The U.S. Economy Since 1970417
ECONOMICS IN PRACTICE John Maynard Keynes419
Summary420Review Terms and Concepts421Problems421
21
Measuring National Output and National Income423
Gross Domestic Product423
Final Goods and Services424
Exclusion ofUsed Goods and Paper
Transactions424
Exclusion ofOutput Produced Abroad by Domestically Owned Factors ofProduction425
Calculating GDP425
The Expenditure Approach426
ECONOMICS IN PRACTICE Where Does eBay Get Counted? 427
The Income Approach429
ECONOMICS IN PRACTICE GDP: One of the Great Inventions of the 20th Century 431
Nominal versus Real GDP432
Calculating Real GDP432
Calculating the GDP Deflator434
The Problems ofFixed Weights434
Limitations of the GDP Concept435
GDP and Social Welfare435
The Underground Economy436
Gross National Income per Capita436
Looking Ahead437
Summary437Review Terms and Concepts438Problems439
22 Unemployment, Inflation, and Long-Run Growth441
Unemployment441
Measuring Unemployment441
Components ofthe Unemployment Rate443
ECONOMICS IN PRACTICE A Quiet Revolution: Women Join the Labor Force445
The Costs ofUnemployment446
Inflation447
The Consumer Price Index448
The Costs ofInflation449
ECONOMICS IN PRACTICE The Politics of Cost-ofLiving Adjustments450
Long-Run Growth452
Output and Productivity Growth452
Looking Ahead454
Summary455Review Terms and Concepts455Problems455
PART V The Core of Macroeconomic Theory457
23 Aggregate Expenditure and Equilibrium Output459
The Keynesian Theory of Consumption460
Other Determinants ofConsumption463
ECONOMICS IN PRACTICE Behavioral Biases in Saving Behavior464
Planned Investment (I)464
The Determination of Equilibrium Output (Income)465
The Saving/Investment Approach to Equilibrium468
Adjustment to Equilibrium469
The Multiplier469
The Multiplier Equation471
ECONOMICS IN PRACTICE The Paradox of Thrift472
The Size ofthe Multiplier in the Real World473 Looking Ahead473
Summary474Review Terms and Concepts474Problems474
Appendix: Deriving the Multiplier Algebraically476
24
The Government and Fiscal Policy477
Government in the Economy478
Government Purchases (G),Net Taxes (T),and Disposable Income (Yd)478
The Determination ofEquilibrium Output (Income) 480
Fiscal Policy at Work: Multiplier Effects482
The Government Spending Multiplier482
The Tax Multiplier484
The Balanced-Budget Multiplier486
The Federal Budget487
The Budget in 2009488
Fiscal Policy Since 1993:The Clinton,Bush,and Obama Administrations 489
The Federal Government Debt491
The Economy’s Influence on the Government Budget492
Automatic Stabilizers and Destabilizers492
ECONOMICS IN PRACTICE Governments Disagree on How Much More Spending Is Needed493
Full-Employment Budget493
Looking Ahead494
Summary494Review Terms and Concepts495Problems495
Appendix A: Deriving the Fiscal Policy Multipliers497
Appendix B: The Case in Which Tax Revenues Depend on Income497
25
The Money Supply and the Federal Reserve System501
An Overview of Money501
What Is Money?501
Commodity and Fiat Monies502
ECONOMICS IN PRACTICE Dolphin Teeth as Currency503
Measuring the Supply ofMoney in the United States504
The Private Banking System505
How Banks Create Money505
A Historical Perspective:Goldsmiths506
The Modern Banking System507
The Creation ofMoney508
The Money Multiplier510
The Federal Reserve System511
Functions ofthe Federal Reserve512
Expanded Fed Activities Beginning in 2008513
The Federal Reserve Balance Sheet513
How the Federal Reserve Controls the Money Supply515
The Required Reserve Ratio515
The Discount Rate516
Open Market Operations517
Excess Reserves and the Supply Curve for Money520
Looking Ahead521
Summary521Review Terms and Concepts521Problems522
26
Money Demand and the Equilibrium Interest Rate525
Interest Rates and Bond Prices525
ECONOMICS IN PRACTICE Professor Serebryakov Makes an Economic Error526
The Demand for Money526
The Transaction Motive527
The Speculation Motive530
The Total Demand for Money530
ECONOMICS IN PRACTICE ATMs and the Demand for Money531
The Effect ofNominal Income on the Demand for Money531
The Equilibrium Interest Rate532
Supply and Demand in the Money Market532
Changing the Money Supply to Affect the Interest Rate534
Increases in P•Y and Shifts in the Money Demand Curve534
Zero Interest Rate Bound535
Looking Ahead: The Federal Reserve and Monetary Policy535
Summary535Review Terms and Concepts536Problems536
Appendix A: The Various Interest Rates in the U.S. Economy 537
Appendix B: The Demand For Money: A Numerical Example539
27
Aggregate Demand in the Goods and Money Markets 541
Planned Investment and the Interest Rate542
Other Determinants ofPlanned Investment542
ECONOMICS IN PRACTICE Small Business and the Credit Crunch543
Planned Aggregate Expenditure and the Interest Rate543
Equilibrium in Both the Goods and Money Markets: The IS-LM Model544
Policy Effects in the Goods and Money Markets545
Expansionary Policy Effects545
Contractionary Policy Effects547
The Macroeconomic Policy Mix548
The Aggregate Demand (AD) Curve549
The Aggregate Demand Curve:A Warning549
Other Reasons for a Downward-Sloping Aggregate Demand Curve551
Shifts ofthe Aggregate Demand Curve from Policy Variables551
Looking Ahead: Determining the Price Level553
Summary553Review Terms and Concepts554Problems554
Appendix: The IS-LM Model 555
28
Aggregate Supply and the Equilibrium Price Level559
The Aggregate Supply Curve559
The Aggregate Supply Curve:A Warning559
Aggregate Supply in the Short Run560
Shifts ofthe Short-Run Aggregate Supply Curve561
The Equilibrium Price Level562
The Long-Run Aggregate Supply Curve563
ECONOMICS IN PRACTICE The Simple “Keynesian” Aggregate Supply Curve564
Potential GDP564
Monetary and Fiscal Policy Effects565
Long-Run Aggregate Supply and Policy Effects567
Causes of Inflation567
Demand-Pull Inflation567
Cost-Push,or Supply-Side,Inflation568
Expectations and Inflation568
Money and Inflation569
ECONOMICS IN PRACTICE Inflationary Expectations in China570
Sustained Inflation as a Purely Monetary Phenomenon571
The Behavior of the Fed571
Targeting the Interest Rate571
The Fed’s Response to the State ofthe Economy572
ECONOMICS IN PRACTICE Markets Watch the Fed573
Fed Behavior Since 1970 574
Interest Rates Near Zero 575
Inflation Targeting576
Looking Ahead576
Summary576Review Terms and Concepts577Problems577
29
The Labor Market In the
Macroeconomy581
The Labor Market: Basic Concepts581
The Classical View of the Labor Market582
The Classical Labor Market and the Aggregate Supply Curve583
The Unemployment Rate and the Classical View583
Explaining the Existence of Unemployment584
Sticky Wages584
Efficiency Wage Theory585
ECONOMICS IN PRACTICE Does Unemployment Insurance Increase Unemployment or Only Protect the Unemployed?586
Imperfect Information587
Minimum Wage Laws587
An Open Question587
The Short-Run Relationship Between the Unemployment Rate and Inflation588
The Phillips Curve:A Historical Perspective589
Aggregate Supply and Aggregate Demand Analysis and the Phillips Curve590
Expectations and the Phillips Curve592
Inflation and Aggregate Demand592
The Long-Run Aggregate Supply Curve, Potential Output, and the Natural Rate of Unemployment593
The Nonaccelerating Inflation Rate of Unemployment (NAIRU)594
Looking Ahead595
Summary595Review Terms and Concepts596Problems596
PART VI Further Macroeconomics Issues599
30
Financial Crises, Stabilization, and Deficits599
The Stock Market, the Housing Market, and Financial Crises600
Stocks and Bonds600
Determining the Price ofa Stock600
The Stock Market Since 1948601
ECONOMICS IN PRACTICE Bubbles or Rational Investors?603
Housing Prices Since 1952604
Household Wealth Effects on the Economy604
Financial Crises and the 2008 Bailout604
Asset Markets and Policy Makers605
ECONOMICS IN PRACTICE Financial Reform
Bill606
Time Lags Regarding Monetary and Fiscal Policy606
Stabilization607
Recognition Lags608
Implementation Lags608
Response Lags608
Summary609
Government Deficit Issues610
Deficit Targeting610
Summary612Review Terms and Concepts613Problems613
31
Household and Firm Behavior in the Macroeconomy: A Further Look615
Households: Consumption and Labor Supply
Decisions615
The Life-Cycle Theory ofConsumption615
The Labor Supply Decision617
Interest Rate Effects on Consumption619
Government Effects on Consumption and Labor Supply:Taxes and Transfers619
A Possible Employment Constraint on Households620
A Summary ofHousehold Behavior621
The Household Sector Since 1970621
ECONOMICS IN PRACTICE Household Reactions to Winning the Lottery622
Firms: Investment and Employment Decisions624
Expectations and Animal Spirits624
Excess Labor and Excess Capital Effects625
Inventory Investment625
A Summary ofFirm Behavior627
The Firm Sector Since 1970627
Productivity and the Business Cycle629
The Short-Run Relationship Between Output and Unemployment630
The Size of the Multiplier631
Summary632Review Terms and Concepts633Problems633
32
Long-Run Growth635
The Growth Process: From Agriculture to Industry636
Sources of Economic Growth637
Increase in Labor Supply638
Increase in Physical Capital639
Increase in the Quality ofthe Labor Supply (Human Capital)640
ECONOMICS IN PRACTICE Education and Skills in the United Kingdom641
Increase in the Quality ofCapital (Embodied Technical Change)641
Disembodied Technical Change642
More on Technical Change642
U.S.Labor Productivity:1952 I–2010 I643
Growth and the Environment and Issues of Sustainability644
Summary646Review Terms and Concepts647Problems647
33 Alternative Views in Macroeconomics649
Keynesian Economics649 Monetarism650
The Velocity ofMoney650
The Quantity Theory ofMoney650
Inflation as a Purely Monetary Phenomenon652
The Keynesian/Monetarist Debate653
Supply-Side Economics653
The Laffer Curve654
Evaluating Supply-Side Economics654
New Classical Macroeconomics655
The Development ofNew Classical Macroeconomics655
Rational Expectations656
ECONOMICS IN PRACTICE How Are Expectations Formed?657
Real Business Cycle Theory and New Keynesian Economics658
Evaluating the Rational Expectations
Assumption659
Testing Alternative Macroeconomic Models660
Summary660Review Terms and Concepts661Problems661
PART VII The World Economy663
34 International Trade, Comparative Advantage, and Protectionism663
Trade Surpluses and Deficits664
The Economic Basis for Trade: Comparative Advantage665
Absolute Advantage versus Comparative Advantage665
Terms ofTrade669
Exchange Rates670
The Sources of Comparative Advantage672
The Heckscher-Ohlin Theorem672
Other Explanations for Observed Trade Flows673
Trade Barriers: Tariffs, Export Subsidies, and Quotas673
U.S.Trade Policies,GATT,and the WTO674
ECONOMICS IN PRACTICE Tariff Wars676
Free Trade or Protection?676
The Case for Free Trade676
The Case for Protection678
ECONOMICS IN PRACTICE A Petition679
An Economic Consensus682
Summary682Review Terms and Concepts683Problems683
35 Open-Economy Macroeconomics: The Balance of Payments and Exchange Rates687
The Balance of Payments688
The Current Account688
The Capital Account690
ECONOMICS IN PRACTICE The Composition of Trade Gaps691
The United States as a Debtor Nation691
Equilibrium Output (Income) in an Open Economy692
The International Sector and Planned Aggregate
Expenditure692
Imports and Exports and the Trade Feedback Effect694
ECONOMICS IN PRACTICE The Recession Takes Its Toll on Trade695
Import and Export Prices and the Price Feedback Effect695
The Open Economy with Flexible Exchange Rates696
The Market for Foreign Exchange696 Factors That Affect Exchange Rates699
The Effects ofExchange Rates on the Economy701
ECONOMICS IN PRACTICE China’s Increased Flexibility702
ECONOMICS IN PRACTICE Losing Monetary Policy Control704
An Interdependent World Economy705
Summary705Review Terms and Concepts706Problems707
Appendix: World Monetary Systems Since 1900708
36
Economic Growth in Developing and Transitional Economies713
Life in the Developing Nations: Population and Poverty714
Economic Development: Sources and Strategies715
The Sources ofEconomic Development716
ECONOMICS IN PRACTICE Corruption718 Strategies for Economic Development719
ECONOMICS IN PRACTICE Cell Phones Increase Profits for Fishermen in India722
Two Examples ofDevelopment:China and India723
Development Interventions723
Random and Natural Experiments:Some New Techniques in Economic Development723
Education Ideas724
Health Improvements725
Population Issues726
The Transition to a Market Economy727
Six Basic Requirements for Successful Transition727 Summary731Review Terms and Concepts732Problems733
Glossary735
Index751
Photo Credits781
Preface
Our goal in the 10th edition,as it was in the first edition,is to instill in students a fascination with both the functioning ofthe economy and the power and breadth ofeconomics.The first line ofevery edition ofour book has been “The study ofeconomics should begin with a sense ofwonder.”We hope that readers come away from our book with a basic understanding ofhow market economies function,an appreciation for the things they do well,and a sense ofthe things they do poorly.We also hope that readers begin to learn the art and science ofeconomic thinking and begin to look at some policy and even personal decisions in a different way.
What’s New in This Edition?
The years 2008–2009 became the fifth recession in the United States since 1970.One of the new features ofthis edition is a discussion ofthis recession in the context ofthe overall history ofthe U.S.economy.This most recent recession,however,required more than the usual revisions,both because ofits severity and because ofthe unusual nature ofboth the events leading up to it and some ofthe remedies employed by the government to deal with it.
In June 2010,the balance sheet ofthe Federal Reserve had assets of$2.3 billion.Ofthese assets,half,or just over $1.1 billion,was held in the form ofmortgage-backed securities. In 2007,the Fed held no mortgage-backed securities.In June 2010,commercial banks in the United States held more than $900 billion in excess reserves at the Fed.In the past, banks have held almost no excess reserves.These extraordinary changes at the Fed follow on the heels ofinterventions by the federal government in financial operations of numerous private banks like J.P.Morgan and Goldman Sachs,as well as in companies like AIG and General Motors.These extraordinary actions required substantial changes throughout the macroeconomic chapters ofthis book.New material describing these interventions appear in a number ofchapters,both in the text itselfand in the Economics in Practice boxes.Revisions were also necessary in the background discussions ofmonetary policy,since the existence ofexcess reserves considerably complicates the usual workings ofmonetary policy.
In the microeconomics area,there has been a good deal ofexciting new work in the areas ofeconomic development,behavioral economics,and experimental economics.This edition has added material in various places throughout the microeconomics chapters that describe this work.A particular highlight is Chapter 36,which carefully lays out the methodological approach used by researchers doing randomized experiments in the economic development area and describes some ofthe results ofthat work.
This edition has augmented the current research focus ofmany ofthe Economics in Practice boxes.Historically,the boxes have focused principally on newspaper excerpts related to the subject ofthe chapter.Beginning last edition and pushed through more strongly this edition,we have added boxes that we hope will demonstrate more clearly the ideas that lie at the heart ofeconomic thinking.Thus,two thirds ofthe boxes in the microeconomics and macroeconomics chapters relate an economic principle either to a personal observation (why does Denzel Washington get paid what he does?) or to a recent piece ofeconomic research (new work by Emmanuel Saez on the fact that much ofmodern wealth comes from wages rather than interest,Carola Frydman’s work on executive compensation,and Rachel Croson’s work on gender and trust).When possible,we focus on work by younger scholars and on more recent research.It is our hope that new students will be inspired by the wide breadth and exciting nature ofthe research currently going on in economics as they read these boxes.
A number ofthe chapters have been reworked to improve their readability.On the microeconomics side,Chapters 9,12,and 18 have been most affected.On the macroeconomics side,the growth chapter,Chapter 32,has been completely rewritten.The other major changes concern the new discussion needed for the 2008–2009 recession and the new policy initiatives.
We have added many new problems in the end-of-chapter materials,aiming for more text-specific questions.
Economics is a social science.Its value is measured in part in terms ofits ability to help us understand the world around us and to grapple with some ofthe social issues ofthe times:How do markets work,and why are they so powerful? Why do firms earn profits,and how are wages determined? Does it matter to consumers ifthere are many firms in an industry or only one? In 2006,the top 20 percent ofthe households in the United States earned 48 percent ofall income generated.Why do we see this income inequality,and why has it been growing? There is enormous poverty in many parts ofthe world.Are there ways to intervene,either at the country level or the individual level? In almost any marketplace in the United States we see goods that were produced in countries from all over the world.U.S. goods also travel to far corners ofthe world to be sold to consumers in Europe,Asia,and Latin America.Why do we see the pattern we do? Across the globe,people are increasingly worried about global warming.What tools can an economist bring to the table in helping to solve this complex problem? These questions are microeconomic questions.To answer them,we need to learn how households and firms make decisions and how those decisions are interconnected.As we begin to see the way in which market outcomes—like prices,profits,industry growth,and the like—emerge from the interplay ofdecisions made by a legion ofhouseholds and firms,acting largely in their own interests,we hope that the reader’s sense ofwonder will grow.
As we go to press in 2010,the U.S.economy is slowly recovering from a very difficult downturn,with many people still unsuccessfully seeking work.What causes an economy to falter and unemployment rates to grow? More generally,how do we measure and understand economic growth? Are there government policies that can help prevent downturns or at least reduce their severity? In 2010,in the United States we hear increasing worries about the growing size ofthe government debt.Where did this debt come from,and are people right to be worried? These question are macroeconomic questions.The years 2008–2010 have been very challenging years in the macroeconomy for most ofthe world.In the United States the government has used policies never used before,and we have all—macroeconomists and policy makers alike—struggled to figure out what works and what does not.For someone studying macroeconomics,we are in the middle ofan enormously exciting time.
The Foundation
The themes of Principles ofEconomics,10th edition,are the same themes ofthe first nine editions.The purposes ofthis book are to introduce the discipline ofeconomics and to provide a basic understanding ofhow economies function.This requires a blend ofeconomic theory, institutional material,and real-world applications.We have maintained a balance between these ingredients in every chapter.The hallmark features ofour book are its:
1. Three-tiered explanations ofkey concepts (stories-graphs-equations)
2. Intuitive and accessible structure
3. International coverage
Three-Tiered Explanations: Stories-Graphs-Equations
Professors who teach principles ofeconomics are faced with a classroom ofstudents with different abilities,backgrounds,and learning styles.For some students,analytical material is difficult no matter how it is presented;for others,graphs and equations seem to come naturally.The problem facing instructors and textbook authors is how to convey the core principles ofthe discipline to as many students as possible without selling the
better students short.Our approach to this problem is to present most core concepts in the following three ways:
First,we present each concept in the context ofa simple intuitive story or example in words often followed by a table.Second,we use a graph in most cases to illustrate the story or example.And finally,in many cases where appropriate,we use an equation to present the concept with a mathematical formula.
Microeconomic Structure
The organization ofthe microeconomic chapters continues to reflect our beliefthat the best way to understand how market economies operate—and the best way to understand basic economic theory—is to work through the perfectly competitive model first,including discussions ofoutput markets (goods and services) and input markets (land,labor,and capital),and the connections between them before turning to noncompetitive market structures such as monopoly and oligopoly.When students understand how a simple,perfectly competitive system works,they can start thinking about how the pieces ofthe economy “fit together.”We think this is a better approach to teaching economics than some ofthe more traditional approaches,which encourage students to think ofeconomics as a series ofdisconnected alternative market models.
Learning perfect competition first also enables students to see the power ofthe market system.It is impossible for students to discuss the efficiency ofmarkets as well as the problems that arise from markets until they have seen how a simple,perfectly competitive market system produces and distributes goods and services.This is our purpose in Chapter 6through 11.
Chapter 12,“General Equilibrium and the Efficiency ofPerfect Competition,”is a pivotal chapter that links simple,perfectly competitive markets with a discussion ofmarket imperfections and the role ofgovernment.Chapter 13through 15 cover three noncompetitive market structures—monopoly,monopolistic competition,and oligopoly.Chapter 16 covers externalities,public goods,and social choice.Chapter 17,which is new to this edition, covers uncertainty and asymmetric information.Chapters 18 and 19 cover income distribution as well as taxation and government finance.The visual at the top ofthe next page (Figure II.2 from page 118),gives you an overview ofour structure.
Macroeconomic Structure
We remain committed to the view that it is a mistake simply to throw aggregate demand and aggregate supply curves at students in the first few chapters ofa principles book.To understand the AS and AD curves,students need to know about the functioning ofboth the goods market and the money market.The logic behind the simple demand curve is wrong when it is applied to the relationship between aggregate demand and the price level.Similarly,the logic behind the simple supply curve is wrong when it is applied to the relationship between aggregate supply and the price level.
Part ofteaching economics is teaching economic reasoning.Our discipline is built around deductive logic.Once we teach students a pattern oflogic,we want and expect them to apply it to new circumstances.When they apply the logic ofa simple demand curve or a simple supply curve to the aggregate demand or aggregate supply curve,the logic does not fit.We believe that the best way to teach the reasoning embodied in the aggregate demand and aggregate supply curves without creating confusion for students is to build up to those topics carefully.
In Chapter 23,“Aggregate Expenditure and Equilibrium Output,”and Chapter 24, “The Government and Fiscal Policy,”we examine the market for goods and services.In Chapter 25,“The Money Supply and the Federal Reserve System,”and Chapter 26,“Money Demand and the Equilibrium Interest Rate,”we examine the money market.We bring the two markets together in Chapter 27,“Aggregate Demand in the Goods and Money Markets,”which explains the links between aggregate output ( Y) and the interest rate (r) and derives the AD curve.In Chapter 28,“Aggregate Supply and the Equilibrium Price Level,”we introduce the AS curve and determine the equilibrium price level (P).We then explain in Chapter 29,“The Labor Market in the Macroeconomy,”how the labor markets
CHAPTER 6
Perfectly Competitive MarketsMarket Imperfections and the Role of Government
Household Behavior
• Demand in output markets
• Supply in input markets
CHAPTERS 8–9
Equilibrium in Competitive Output Markets
• Output prices
• Short run
• Long run
CHAPTERS 7–8
Firm Behavior
• Choice of technology
• Supply in output markets
• Demand in input markets
CHAPTERS 10–11
Competitive Input Markets
• Labor/land
- Wages/rents
• Capital/Investment
- Interest/profits
CHAPTER 12
The Competitive Market System
• General equilibrium and efficiency
CHAPTERS 13–19
Market
Imperfections and the Role of Government
• Imperfect market structures
- Monopoly
- Monopolistic competition
- Oligopoly
• Externalities, public goods, imperfect information, social choice
• Income distribution and poverty
• Public finance: the economics of taxation
FIGURE II.2 Understanding the Microeconomy and the Role of Government
fits into this macroeconomic picture.The figure at the top ofthe next page (Figure V.1 from page 457) gives you an overview ofthis structure.
One ofthe big issues in the organization ofthe macroeconomic material is whether long-run growth issues should be taught before short-run chapters on the determination of national income and countercyclical policy.In the last three editions,we moved a significant discussion ofgrowth to Chapter 22,“Unemployment,Inflation,and Long-Run Growth,”and highlighted it.However,while we wrote Chapter 32,the major chapter on long-run growth, so that it can be taught before or after the short-run chapters,we remain convinced that it is easier for students to understand the growth issue once they have come to grips with the logic and controversies ofshort-run cycles,inflation,and unemployment.
International Coverage
As in previous editions,we continue to integrate international examples and applications throughout the text.This probably goes without saying:The days in which an introductory economics text could be written with a closed economy in mind have long since gone.
Tools for Learning
As authors and teachers,we understand the challenges ofthe principles ofeconomics course. Our pedagogical features are designed to illustrate and reinforce key economic concepts through real-world examples and applications.
Economics in Practice
As described earlier,the Economics in Practice feature presents a real-world personal observation,current research work,or a news article that supports the key concept ofthe chapter and helps students think critically about how economics is a part oftheir daily lives.The
CHAPTERS 23–24
The Goods-and-Services Market
• Planned aggregate expenditure Consumption (C) Planned investment (I) Government (G)
• Aggregate output (income) (Y)
CHAPTERS 25–26
The Money Market
• The supply of money
• The demand for money
• Interest rate (r)
Connections between the goods-and-services market and the money market
Aggregate Demand
• Aggregate demand curve
CHAPTER 28
Aggregate Supply
• Aggregate supply curve
• Equilibrium interest rate (r*)
• Equilibrium output (income) (Y*)
• Equilibrium price level (P*)
end-of-chapter problem sets include a question specific to each Economics in Practice feature. Students can visit www.myeconlab.com for additional updated news articles and related exercises.
Graphs
Reading and interpreting graphs is a key part ofunderstanding economic concepts.The Chapter 1Appendix,“How to Read and Understand Graphs,”shows readers how to interpret the 200-plus graphs featured in this book.We use red curves to illustrate the behavior of firms and blue curves to show the behavior ofhouseholds.We use a different shade ofred and blue to signify a shift in a curve.
CHAPTER 29
The Labor Market
• The supply of labor
• The demand for labor
• Employment and unemployment
FIGURE 3.9 Excess
Demand, or Shortage
At a price of $1.75 per bushel, quantity demanded exceeds quantity supplied. When excess demand exists, there is a tendency for price to rise. When quantity demanded equals quantity supplied, excess demand is eliminated and the market is in equilibrium. Here the equilibrium price is $2.50 and the equilibrium quantity is 35,000 bushels.
FIGURE V.1 The Core of Macroeconomic Theory
Problems and Solutions
Each chapter and appendix ends with a problem set that asks students to think about and apply what they’ve learned in the chapter.These problems are not simple memorization questions.Rather,they ask students to perform graphical analysis or to apply economics to a real-world situation or policy decision.More challenging problems are indicated by an asterisk.Additional questions specific to the Economics in Practice feature have been added. Several problems have been updated.The solutions to all ofthe problems are available in the Instructor’s Manuals.Instructors can provide the solutions to their students so they can check their understanding and progress.
MyEconLab
Both the text and supplement package provide ways for instructors and students to assess their knowledge and progress through the course.MyEconLab,the new standard in personalized online learning,is a key part ofCase,Fair,and Oster’s integrated learning package for the 10th edition.
For the Instructor
MyEconLab is an online course management,testing, and tutorial resource. Instructors can choose how much or how little time to spend setting up and using MyEconLab.Each chapter contains two Sample Tests, Study Plan Exercises,and Tutorial Resources.Student use ofthese materials requires no initial setup by their instructor.The online Gradebook records each student’s performance and time spent on the Tests and Study Plan and generates reports by student or by chapter. Instructors can assign tests,quizzes,and homework in MyEconLab using four resources:
Preloaded Sample Tests
Problems similar to the end-of-chapter problems
Test Item File questions
Self-authored questions using Econ Exercise Builder
Exercises use multiple-choice,graph drawing,and free-response items,many ofwhich are generated algorithmically so that each time a student works them,a different variation is presented.MyEconLab grades every problem,even those with graphs.When working homework exercises,students receive immediate feedback with links to additional learning tools. Customization and Communication MyEconLab in CourseCompass™ provides additional optional customization and communication tools.Instructors who teach distance learning courses or very large lecture sections find the CourseCompass format useful because they can upload course documents and assignments,customize the order ofchapters,and use communication features such as Digital Drop Box and Discussion Board.
Experiments in MyEconLab
Experiments are a fun and engaging way to promote active learning and mastery ofimportant economic concepts.Pearson’s experiments program is flexible and easy for instructors and students to use.
Single-player experiments allow your students to play an experiment against virtual players from anywhere at anytime with an Internet connection.
Multiplayer experiments allow you to assign and manage a real-time experiment with your class.In both cases,pre- and post-questions for each experiment are available for assignment in MyEconLab.
For the Student
MyEconLab puts students in control oftheir learning through a collection oftests,practice,and study tools tied to the online interactive version ofthe textbook,as well as other media resources. Within MyEconLab’s structured environment,students practice what they learn,test their understanding,and pursue a personalized Study Plan generated from their performance on Sample Tests and tests set by their instructors.At the core ofMyEconLab are the following features:
Sample Tests,two per chapter
Personal Study Plan
Tutorial Instruction
Graphing Tool
Sample Tests Two Sample Tests for each chapter are preloaded in MyEconLab,enabling students to practice what they have learned,test their understanding,and identify areas in which they need further work.Students can study on their own,or they can complete assignments created by their instructor.
Personal Study Plan Based on a student’s performance on tests,MyEconLab generates a personal Study Plan that shows where the student needs further study.The Study Plan consists ofa series ofadditional practice exercises with detailed feedback and guided solutions that are keyed to other tutorial resources.
Tutorial Instruction Launched from many ofthe exercises in the Study Plan,MyEconLab provides tutorial instruction in the form ofstep-by-step solutions and other media-based explanations.
Graphing Tool A graphing tool is integrated into the Tests and Study Plan exercises to enable students to make and manipulate graphs.This feature helps students understand how concepts,numbers,and graphs connect.
Additional MyEconLab Tools MyEconLab includes the following additional features:
1.Economics in the News—This feature provides weekly updates during the school year ofnews items with links to sources for further reading and discussion questions.
2.eText—While students are working in the Study Plan or completing homework assignments,one ofthe tutorial resources available is a direct link to the relevant page ofthe text so that students can review the appropriate material to help them complete the exercise.
3.Glossary—This searchable version ofthe textbook glossary provides additional examples and links to related terms.
4.Glossary Flashcards—Every key term is available as a flashcard,allowing students to quiz themselves on vocabulary from one or more chapters at a time.
5.Research Navigator (CourseCompass™ version only)—This feature offers extensive help on the research process and provides four exclusive databases ofcredible and reliable source material,including the New York Times,the Financial Times,and peer-reviewed journals. MyEconLab content has been created through the efforts of: Charles Baum,Middle Tennessee State University;Sarah Ghosh,University ofScranton; Russell Kellogg,University ofColorado–Denver;Bert G.Wheeler,Cedarville University;and Noel Lotz and Douglas A.Ruby,Pearson Education
