contemporary economics - gbv · 2010-12-28 · contemporary economics an applications approach 6th...

CONTEMPORARY

ECONOMICSAN APPLICATIONS APPROACH

6 T H E D I T I O N

ROBERT J. CARBAUGH

(fM.E.SharpeArmonk, New YorkLondon, England

Note on Electronic Materials xviii

Preface xix

P A Introduction 11 Scarcity and Choice 2

P A R T The Microeconomy 272 Market Transactions: Demand and Supply Analysis

3 Demand and Supply Applications 55

4 Production and the Costs of Production 75

5 Competition and Monopoly: Virtues and Vices 97

6 Imperfect Competition 127

7 Labor Markets 151

8 Government and Markets 173

28

P A R T The Macroeconomy 1959 The Mixed Economy of the United States 196

10 Gross Domestic Product and Economic Growth 221

11 The Business Cycle, Unemployment, and Inflation 245

12 Macroeconomic Instability: Aggregate Demand

and Aggregate Supply 275

13 Fiscal Policy and the Federal Budget 297

14 Money and the Banking System 321

15 The Federal Reserve and Monetary Policy 345

P A R T The International Economy 36916 The United States and the Global Economy 370

17 International Finance 391

18 Economic Systems and Developing Countries 411

Glossary 429

Index 441

Note on Electronic Materials xviiiPreface xix

P A R T Introduction 1

C H A P T E R 1

Scarcity and Choice 2What Is Economics? 3

Microeconomics 4

Macroeconomics 4

The Economic Way of Thinking 4

Every Choice Has a Cost 4

People Make Better Choices by Thinking at the Margin 5

Rational Self-Interest 5

Economic Models 5

Positive versus Normative Economics 5

Scarcity 6

Scarcity and Opportunity Cost 7

The Opportunity Cost of Attending College 8

Opportunity Costs and Choices 9

The Production Possibilities Curve and Opportunity Cost 10

Economic Inefficiency 11

Law of Increasing Opportunity Cost 12

Economic Growth 13

Economic Decline 14

Economic Growth: Trade-Offs between Current

and Future Consumption 15

Production Possibilities Applications 16

Opportunity Cost of National Security 16

Economic Sanctions and Economic Decline 17

Chapter Summary 19

Key Terms and Concepts 20

Self-Test: Multiple-Choice Questions 20

Study Questions and Problems 22

Contents vii

P A R T

Exploring Further 1.1: A Primer on Tables and Graphs 23

Movements along the Study Time-Grade Line 23

Slope of the Study Time-Grade Line 24

Shifts in the Study Time-Grade Line 24

The Microeconomy 27

C H A P T E R 2

Market Transactions: -Demand and Supply Analysis 28Markets 29

Demand 29

The Demand Curve and the Law of Demand 30

What Explains the Law of Demand? 31

Changes in Demand: Demand Shifters 32

Supply 34

The Supply Curve and the Law of Supply 35

Oil Firms Squeeze More Crude from Wells 36

Changes in Supply: Supply Shifters 37

Demand, Supply, and Equilibrium 39

Shifts in Demand and Supply 41

Contemporary Applications of Demand and Supply 43

Bike Competition Puts the Brakes on Schwinn 43

Rising Health Care Costs Cripple Households 44

Coping with America's Thirst for Oil 46

Chapter Summary 49




C H A P T E R 3

Demand and Supply Applications 55Price Elasticity of Demand 56

Determinants of Price Elasticity of Demand 58

Availability of Substitutes 58

Proportion of Income 59

Time 59

Airlines Fail to Pass on Full 10-Percent Ticket Tax to Passengers 59

Price Elasticity of Demand and Total Revenue 61

viii Contents

Applications of Price Elasticity of Demand and Total Revenue 62

State Governments Increase Cigarette Tax to Raise Revenue 62

Colleges Hike Tuition to Offset Cutbacks in State Aid

to Higher Education 62

Pittsburgh Pirates Underestimate Fan Reaction:

Ticket Price Hike Was Wrong 63

U.S. Postal Service Boosts Rates to Increase Revenue 64

Price Ceilings and Price Floors 65

Rent Controls Make Housing More Affordable 65

Should Federal Interest-Rate Ceilings Be Imposed

on MasterCard and Visa? 67

U.S. Farmers Reap High Subsidies from the Government 68

Chapter Summary 69




C H A P T E R 4

Production and the Costs of Production 75The Short Run versus the Long Run 76

The Production Function 77

Short-Run Production 77

Improvements in Technology and Work Rules

Shift Product Curves Upward 79

Short-Run Production Costs 80

Total Fixed, Total Variable, and Total Costs 82

Average Costs 83

Marginal Cost 84

Long-Run Production Costs 85

Economies of Scale 85

Diseconomies of Scale 87

Shifts in Cost Curves 88

Foreign Competition Forces Cost Adjustments for U.S. Steelmakers 89

Costs and Profit 89

Explicit Costs and Implicit Costs 91

Accounting Profit and Economic Profit 91

Chapter Summary 92




Contents ix

C H A P T E R 5

Competition and Monopoly:Virtues and Vices 97Perfect Competition 98

The Perfectly Competitive Firm as a Price Taker 99

Perfect Competition: Profit Maximization in the Short Run 101

Marginal Revenue Equals Marginal Cost Rule 101

Profit Maximization 101

Perfect Competition: Long-Run Adjustments and Economic Efficiency 102

Effects of Market En try 104

Effects of Market Exit 104

Will Online Music Start-ups Be Singing the Blues? 104

Monopoly 106

Barriers to Entry 106

Legal Barriers 106

Control over Essential Inputs 107

Economies of Scale 107

Cable Television: Why Rates Are So High 108

De Beers: The "Gift of Love" 109

Profit Maximization for a Monopoly 110

Price and Marginal Revenue 110

Maximizing Profits 112

Continuing Monopoly Profits 114

The Case against Monopoly 114

The U.S. Postal Service as a Legal Monopoly 115

Reducing Monopoly Power: Generic Drugs Compete

against Brand-Name Drugs 117

Chapter Summary 118




Exploring Further 5.1: Loss Minimization and the Shut-Down Rule 124

C H A P T E R 6

Imperfect Competition 127Concentration Ratios 128

Monopolistic Competition 130

Profit Maximization in the Short Run 131

The Long Run: Normal Profit and Excess Capacity 132

Despite Competition from Starbucks, Most Independent

Coffeehouses Survive 133

Contents

Advertising 134

Price Discrimination 136

Oligopoly 138

Rivalry in the Soft Drink Industry 138

Game Theory and Oligopoly Behavior 139

Competitive Oligopoly and Low Prices 139

Cooperative Behavior and Cheating 140

Airbus and Boeing Rival for Supremacy in the Jetliner Industry 141

Collusion and Cartels 143

Mergers and Oligopoly 144

Chapter Summary 146




C H A P T E R 7

Labor Markets 151Labor Market Equilibrium 152

Do Minimum Wage Laws Help Workers? 155

Are Workers Better Off with Labor Unions? 157

Increasing Union Wages 158

What Gives a Union Strength? 161

Outsourcing of Jobs: Threat or Opportunity for U.S. Workers? 162

What Prevents U.S. Jobs from Being Outsourced Abroad? 162

The Effects of Outsourcing 163

Do Liberal Immigration Laws Harm American Workers? 164

Chapter Summary 166




Exploring Further 7.1: A Firm's Hiring Decision 170

C H A P T E R 8

Government and Markets 173Market Failure 174

Monopoly Power 175

Antitrust Policy 175

Economic Regulation and Deregulation 176

Public-Utility Regulation 177

Peak-Load Pricing: Buying Power by the Hour 179

Contents xi

P A R T

Spillover Effects 180

Spillover Costs 180

Cap and Trade Emission Certificates Clear Skies of Acid Rain 182

Spillover Benefits 183

Should Government Subsidize Professional Sports? 184

Social Regulation 185

Do Corporate Fuel Economy Standards Promote

Fuel Conservation? 186

Public Goods 187

Inadequate Information 188

Economic Inequality 189

Chapter Summary 190




The Macroeconomy 195

C H A P T E R 9

The Mixed Economy of the United States 196Households as Income Receivers 197

Sources of Income Inequality 198

Households as Spenders 199

The Business Sector 200

Government in the Mixed Economy 201

Social Security 203

Should Social Security Be Privatized? 205

Government Finance 205

Taxation Principles: Benefits Received versus Ability to Pay 208

Progressive, Regressive, and Proportional Taxes 208

The U.S. Tax Structure 210

Federal Personal Income Tax 210

Federal Corporate Income Tax 211

Social Security Tax 211

Sales, Excise, and Property Taxes 211

Overall U.S. Tax System 212

Should the U.S. Tax System Be Reformed? 213

Flat-Rate Income Tax 213

Value-Added Tax 214

National Sales Tax 215

xii Contents

Chapter Summary 216




C H A P T E R 10

Gross Domestic Product and Economic Growth 221Measuring an Economy's Output 222

Gross Domestic Product 223

The Components of GDP' 224

A Formula for GDP 225

What GDP Does Not Measure 226

Real GDP versus Nominal GDP 227

Long-Run Economic Growth 229

The Rate of Economic Growth 229

What Determines Economic Growth? 231

Natural Resources 232

Physical Capital 232

Human Capital 233

Productivity 233

The Significance of Technological Innovation 236

The Role of Government 236

Theories of Economic Growth 237

Is Economic Growth Desirable? 239

Chapter Summary 240




C H A P T E R 11

The Business Cycle, Unemployment,and Inflation 245The Business Cycle 246

Phases of the Business Cycle 246

Theories of the Business Cycle 250

Do Economic Expansions Die of Old Age? 250

Unemployment 251

Measuring Unemployment 251

Three Kinds of Unemploymen t 252

Mitigating the Costs of Unemploymen t 253

What Is Full Employment? 254

The Recession of2007-2009 254

Contents

Bursting of Housing Bubble Triggers Recession 255

Inflexible Labor Markets Cost Jobs 257

The Productivity-Jobs Connection 259

Inflation 261

Measuring Inflation: The Consumer Price Index 262

Who Benefits from and Who Is Hurt by Inflation? 264

Inflation and the Purchasing Power of Income 265

Redistribution of Wealth from Lenders to Borrowers 265

Inflation and Real Interest Rates 266

Inflation and Taxpayers 267

Home Ownership as a Hedge against Inflation 267

Effects of Severe Inflation 269

Causes of Inflation 269

Chapter Summary 270




C H A P T E R 12

Macroeconomic Instability: Aggregate Demandand Aggregate Supply 275The Stability of the Macroeconomy 276

The Classical View 277

The Great Depression 277

The Keynesian View 278

Aggregate Demand and Aggregate Supply 279

Aggregate Demand 280

Movements along the Aggregate Demand Curve 280

Shifts in the Aggrega re Demand Curve 281

The Multiplier Effect 281

Aggregate Supply 282

Movements along the Aggregate Supply Curve 282

Shifts in the Aggregate Supply Curve 283

The Origins of Recession 284

Decreases in Aggregate Demand 284

Decreases in Aggregate Supply 287

The Origins of Inflation Revisited 287

Demand-Pull Inflation 287

Cost-Push Inflation 290

Chapter Summary 290

xiv Contents




Exploring Further 12.1: The Nature and Operation

of the Multiplier Effect 294

Calculating the Value of the Multiplier 295

Graphical Illustration of the Multiplier Effect 296

C H A P T E R 1 3

Fiscal Policy and the Federal Budget 297Fiscal Policy 298

Fiscal Policy and Aggregate Demand 299

Combating Recession 299

Combating Inflation 302

Fiscal Policy in Action 302

Automatic Stabilizers 304

Problems of Fiscal Policy 306

Timing Lags 306

Crowding-Out Effect 307

Fiscal Policy and Aggregate Supply: Long-Run Growth 308

Supply-Side Effects of Changes in Taxes 308

Do Tax Cuts Cause Tax Revenues to Rise (Fall)? 309

The Federal Deficit and Federal Debt 311

Sales and Ownership of Federal Debt 312

U.S. Fiscal Policy: Does the Federal Debt Cheat Future Generations? 313

Should There Be a Balanced-Budget Amendment? 314

Chapter Summary 314




Exploring Further 13.1: Fiscal Policy and the Multiplier 319

C H A P T E R 14

Money and the Banking System 321The Meaning of Money 322

Medium of Exchange 323

Unit of Account 323

Store of Value 323

Are Credit Cards Money? 324

Shopping for a Credit Card 324

The U.S. Money Supply 325

Contents xv

Coins 326

Paper Money 326

Checking Accounts 327

Special Types of Checks 328

Check Processing and Collection 330

What Backs the Money Supply? 332

Measuring the Money Supply: The M1 Money Supply 333

How Your Money Grows Over Time: Compound Interest 334

The Business of Banking 336

A Bank's Balance Sheet 336

The Reserve Requirement 337

The Process of Money Creation 338

The Federal Deposit Insurance Corporation 339

Chapter Summary 340




C H A P T E R 15

The Federal Reserve and Monetary Policy 345The Federal Reserve System 346

Structure of the Federal Reserve System 346

The Independence of the Fed 348

The Functions of the Federal Reserve System 349

Monetary Policy 349

Open Market Operations 350

The Discount Rate 352

The Reserve Requirement 352

Term Auction Facility 353

Shifting Aggregate Demand 354

Expansionary Policy 355

Restrictive Policy 355

The Federal Reserve and Economic Stabilization 357

The Recession of 2007-2009 357

2001A ttack on America 358

Monetary Policy: Advantages and Disadvantages 359

Advantages of Monetary Policy 359

Disadvantages of Monetary Policy 360

Discretion or Rules: Fixed-Money Rule or Inflation Targeting? 361

Should Congress Reduce the Independence of the Federal Reserve? 362

Chapter Summary 363

xvi Contents

P A




R T A T n e International Economy 369

C H A P T E R 1 6

The United States and the Global Economy 370The United States as an Open Economy 371

The Advantages of Specialization and Trade 372

Comparative Advantage and International Trade 374

Production and Consumption without Specialization and Trade 375

Production and Consumption with Specialization and Trade 375

Comparative Advantage 376

Why Are Free Trade and Globalization Controversial? 378

Limiting Foreign Competition: Tariffs 379

Arguments for Trade Restrictions 381

Job Protection 381

Protection against Cheap Foreign Labor 382

Fairness in Trade: A Level Playing Field 383

Infant Industry 383

Noneconomic Arguments 383

Pursuing Trade Liberalization 384

World Trade Organization 384

From NAFTA to CAFTA 385

Chapter Summary 386




C H A P T E R 17

International Finance 391The Balance of Payments 392

The Current Account 392

The Capital and Financial Account 393

What Does a Current Account Deficit (Surplus) Mean? 393

The U.S. Balance of Payments 394

Are U.S. Current Account Deficits Bad? 395

The Foreign Exchange Market 396

A Weak Dollar Is a Bonanza for European Tourists 398

Contents

Exchange Rate Determination 398

Long-Run Determinants of Exchange Rates 400

Short-Run Determinants of Exchange Rates 400

Exchange Rate Systems 401

Floating Exchange Rates 401

Fixed Exchange Rates 401

Monetary Integration in Europe and the United States 402

The Euro: A Common Currency for Europe 402

The Dollar: A Common Currency for the Americas? 403

Chapter Summary 404




C H A P T E R 18

Economic Systems and Developing Countries 411Economic Systems and the Fundamental Economic Questions 412

The Market Economy 413

The Command Economy 414

The Mixed Economy 415

Transition Economies 416

Eastern Europe 416

China 416

India 417

The Economics of Developing Countries 418

Obstacles to Economic Development 418

Tensions between Developing Countries and Advanced Countries 421

Economic Growth Strategies 422

Aid to Developing Countries 423

World Bank 423

International Monetary Fund 423

Generalized System of Preferences 424

Chapter Summary 425




Glossary 429

Index 441

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