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introduction to EconomicsPartiEconomics: The Science of Scarcity

Chapter 1 What Economics Is About 1Appendix A Working with Diagrams 23Appendix B Should You Major in Economics 32Chapter 2 Economic Activities: Producing and Trading 39Chapter 3 Supply and Demand: Theory 63

MacroeconomicsPart 2

Macroeconomic Fundamentals

Chapter 4 Macroeconomic Measurements 95

Part 3Macroeconbmic Stability and Instability

Chapter 5 Aggregate Demand and Aggregate Supply 119Chapters The Self-Regulating Economy 145Chapter 7 Economic Instability: A Critique of the Self-

Regulating Economy 164

Part 4Money and Banking, Fiscal Policy, Monetary Policy

Chapter 8 Money, Banking, and the Federal Reserve 190Chapter 9 Money, the Price Level, and Interest Rates 213Chapter 10 Monetary Policy and Fiscal Policy 233

Part 5Expectations and Growth

Chapter 11 Expectations Theory and the Economy 258Chapter 12 Economic Growth 278

MicroeconomicsPart 6Microeconomic Fundamentals

Chapter 13 Elasticity 295Chapter 14 Consumer Choice: Maximizing Utility and

Behavioral Economics 319Chapter 15 Production and Costs 338

Part 7Product Markets

Chapter 16 Perfect Competition 361Chapter 17 Monopoly 385Chapter 18 Monopolistic Competition and Oligopoly 405

Part 8Factor Markets and Related Issues

Chapter 19 Factor Markets 430Chapter 20 Interest, Rent, and Profit 452Chapter 21 The Distribution of Income and Poverty 469

Part 9Market Failure and Public Choice

Chapter 22 Market Failure: Externalities and Public Goods 490Chapter 23 Public Choice 511

Part 10International Economics: Theory and Policy

Chapter 24 International Trade and Finance 527

Self-Test Appendix 559Glossary 573Index 581

Brief Contents vii

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FEATURES

Economics in Everyday Life:Blogging 8Economics in Popular Culture:Why LeBron James Isn't in College 9

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Positive and Normative Ecpnqmics,;3^^Microeconomics and Macroeconomics 3

Key Concepts in Economics 4 •

Thinking in Terms of Scarcity arid its Effects 4 Thinking in Terms of Opportunity Cost 6

Thinking in Terms of Costs.ana< Benefits' 8 < Thinking in Terms of Efficiency 10

Thinking in Terms of Unintended Effects 12.', Thinking in Terms of Equilibrium 13

^Thinking in Terms.of, the Ceteris Paribus Assumption 14 Thinking in Terms of the Difference

I-.V, T.', Between Association 'and Causation .15 Thinking in Terms of the Difference Between the

lif.Group_and Individual ,15~ r~-,'^•••••-' ••< ' "' "'•y'>'''1 "lh'-;

.^Economists Build, and Test (Theories {1.6. :;..,;• . , . . ! •- ' " , - , , . . . .<. ' -v f ; • .,• =.••

What Is a Theory? 16 Building and Testing.a Theory 17

t A Reader Asks 19/- ... ,,, , . - 0 •,.•..,\ rf;v _-• , . -

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Key Terms and Concepts- 21 j »« • i,> •"',. Questions and Problems.21 .. .. .,,(.-, .,, ... x. ..

Appendix A: Working with Diagrams 23

Two-Variable Diagrams.23,, ;..Pi,. w,,i-rilo

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•. Slope of a'LineMs C6nstantr:241 t'.» z>A;^:\'r\ . .

Slope of a Curve 26 . -'".:>:...;• C -.•• , , , , , . , . . ,

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Bar Graphs 27 " • ' ' ' ':;.' s,,.-./>, v>L-.;.-.' •.

Line Graphs 28 •'•'. •;\i:tr:';\iw:;iin..,,0

A p p e n d i x S u m m a r y 30 ; ; * ' i - : - ~ r - x - "" ".'-'• "• ' > ; l • . ,Ques t ions a n d Prob lems 3 O ' r / ! r i ( ' l ! •">~'?\; r,•.?••-'•' • •• • ' • • . , , •

Appendix B: Should You Major in Economics? 32

Five Myths About Economics and,an Economics Major 33 .

What Awaits You as an Economics Major? 35 • • -

.What Do Economists Dp? 36. :

Places to Find More Information 37 . •:••••

Concluding Remarks 38

Contents ix

2FEATURES

Economics in Everyday Life:Liberals, Conservatives, and the PPF 46Economics in Popular Culture:Elvis, Comparative Advantage, andSpecialization 53Economics in Popular Culture:Jerry Seinfeld, the Doorman, and AdamSmith 54

3FEATURES

Economics in the World:U4E (((H))) *5Yours Forever, Big Hug, High Five 67Economics in Everyday Life:Getting to Class on Time 73Economics in Everyday Life:Supply and Demand on a Freeway 89

Economic Activities: Producing and Trading 39

The Production Possibilities Frontier 40

The Straight-Line PPF: Constant Opportunity Costs 40 The Bowed-Outward(Concave-Downward) PPF: Increasing Opportunity Costs 41 Law of Increasing OpportunityCosts 42 Economic Concepts Within a PPF Framework 43

Trade or Exchange 47

The Purpose of Trade 47 Periods Relevant to Trade 47 Trade and the Terms of Trade 48Costs of Trades 48

Production, Trade, and Specialization 50

Producing and Trading 50 Profit and a Lower Cost of Living 52

Producing, Trading, and Economic Systems 55Property Rights 58A Reader Asks 60Chapter Summary 60Key Terms and Concepts 61Questions and Problems 61Working With Numbers and Graphs 62

Supply and Demand: Theory 63

A Note About Theory 64

Demand 64

The Law of Demand 64 Four Ways to Represent the Law of Demand 65 Absolute andRelative Price 66 Why Quantity Demanded Goes Down as Price Goes Up 66Individual Demand Curve and Market Demand Curve 67 A Change in Quality DemandedVersus a Change in Demand 68 What Factors Cause the Demand Curve to Shift 70

Supply 73

The Law of Supply 74 Why Most Supply Curves Are Upward-Sloping 74 The Market SupplyCurve 75 Changes in Supply Mean Shifts in Supply Curves 75 What Factors Cause theSupply Curve to Shift? 75

The Market: Putting Supply and Demand Together 79

Supply and Demand at Work at an Auction 79 The Language of Supply and Demand:A Few Important Terms 80 Moving to Equilibrium: What Happens to Price When There Isa Surplus or Shortage 80 Speed of Moving to Equilibrium 80 Moving to Equilibrium:Maximum and Minimum Prices 82 Equilibrium in Terms of Consumers' and Producers'Surplus 83 What Can Change Equilibrium Price and Quanity? 84

Price Controls 86

Price Ceiling: Definition and Effects 86 Do Buyers Prefer Lower Prices to HigherPrices? 89 Price Floor: Definition and Effects 90 Surpluses 90 Fewer Exchanges 90

A Reader Asks 91Chapter Summary 91Key Terms and Concepts 92Questions and Problems 92Working With Numbers and Graphs 93

Contents

4FEATURES

Economics in Popular Culture:Who Earned More as President:John F. Kennedy or George W. Bush? 101Economics in the World:What Explains the Increasing Percentage ofWomen in the Labor Force? 103Economics in Everyday Life:Does the State of the Economy InfluenceHow People Vote? 112

5FEATURES

Economics in Everyday Life:Looking at Consumption 125Economics in Popular Culture:Aggregate Demand, the Great Depression,and Scrabble 137

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Part 2: Macroeconbmic Fundamentals

Macroeconomic Measurements 95

Macroeconomic Measurements 96

Measuring Prices 96

Measuring Prices Using the CPI 96 Inflation and the CPI 98 GDP Implicit Price

Deflator 99 Converting Dollars From One Year to Another 99

Measuring Unemployment 100

Who Are the Unemployed? 100 The Unemployment and Employment Rates 102 Types ofUnemployment 104 What Is Full Employment? 104 Cyclical Unemployment 105

Gross Domestic Product 105

Three Ways to Compute GDP 105 What GDP Omits 107 Is Either GDP or Per Capita GDPa Measure of Happiness or Well-Being? 108

The Expenditure Approach To Computing GDP For A Real-World Economy 109

Expenditures in a Real-World Economy 109 Computing GDP Using the ExpenditureApproach 110

Real GDP 111

Why We Need Real GDP 111 Computing Real GDP 111 The General Equation for RealGDP 113 What Does It Mean if Real GDP Is Higher in One Year Than in Another Year? 113Real GDP, Economic Growth, and Business Cycles 113


Part 3: Macroeconomic Stability and Instability

Aggregate Demand and Aggregate Supply 119

The Two Sides to an Economy 120

Aggregate Demand 120

Why Does the Aggregate Demand Curve Slope Downward? 120 A Change in the QuantityDemanded of Real GDP Versus a Change in Aggregate Demand 121 Changes in AggregateDemand—Shifts in the AD Curve 122 How Spending Components Affect AggregateDemand 122 Factors That Can Change C, I, G, and Therefore Can Change AD 123The Interest Rate and the Loanable Funds Market 127 Can a Change in the Money SupplyChange Aggregate Demand? 130

Short-Run Aggregate Supply 130

Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward-Sloping 131 What Putsthe "Short-Run" In SRAS? 132 Changes in Short-Run Aggregate Supply—Shifts in the SRASCurve 132

Putting AD and SRAS Together: Short-Run Equilibrium 134

How Short-Run Equilibrium In the Economy Is Achieved 134 The Unemployment Rate in theShort Run 135 Thinking in Terms of Short-Run Equilibrium Changes in the Economy 138

Long-Run Aggregate Supply 139

Going From the Short Run to the Long Run 139 Short-Run Equilibrium, Long-RunEquilibrium, and Disequilibrium 140

Contents xi

6FEATURES

Economics in Technology:

The Natural Unemployment Rate,Technology, and Policy Errors 158

7Economics in Popular Culture:

The Multiplier Goes on Spring Break 175


The Self-Regulating Economy 145

The Classical View 146

Classical Economists and Say's Law 146 Classical Economists and Interest RateFlexibility 147 Classical Economists on Prices and Wages 149

Three States of the Economy 149

Real GDP and Natural Real GDP: Three Possibilities 150 The Labor Market and the ThreeStates of the Economy 151 One Nagging Question: How Can the Unemployment Rate BeLess Than the Natural Unemployment Rate? 153

The Self-Regulating Economy 154

What Happens if the Economy Is in a Recessionary Gap? 154 What Happens if the EconomyIs in an Inflationary Gap? 155 The Self-Regulating Economy: A Recap 156 PolicyImplication of Believing the Economy Is Self-Regulating 157 Changes in a Self-RegulatingEconomy: Short Run and Long Run 158


Economic Instability: A Critique of the Self-Regulating Economy 164

Questioning the Classical Position 165

Keynes's Criticism of Say's Law in a Money Economy 165 Keynes on Wage Rates 166New Keynesians and Wage Rates 167 Keynes on Prices 168 Is It a Question of the Time ItTakes for Wages and Prices to Adjust? 169

The Simple Keynesian Model 170

Assumptions 170 The Consumption Function 171 Consumption and Saving 172The Multiplier 173 The Multiplier and Reality 175

The Simple Keynesian Model in the AD-AS Framework 176

Shifts in the Aggregate Demand Curve 176 The Keynesian Aggregate Supply Curve 176The Economy in a Recessionary Gap 178 Government's Role in the Economy 178The Theme of the Simple Keynesian Model 179

The Simple Keynesian Model in the TE-TP Framework 180

Deriving a Total Expenditures (TE) Curve 180 What Will Shift the TE Curve? 180 ComparingTotal Expenditures (TE) and Total Production (TP) 180 Moving From Disequilibrium toEquilibrium 182 The Graphical Representation of the Three States of Economy in the TE-TPFramework 183 The Economy in a Recessionary Gap and the Role of Government 184The Theme of the Simple Keynesian Model 185


xii Contents

8FEATURES

Economics in Everyday Life:English and Money 193Economics in the World:Is Money the Best Gift? 194Economics in Popular Culture:Economics on the Yellow Brick Road 196

9FEATURES

Economics in the World:Money and Inflation 217Economics in Popular Culture:The California Gold Rush, or an Apple for$72 219

10FEATURES

Economics in Everyday Life:JFK and the 1964 Tax Cut 246Economics in Everyday Life:How Far Does Monetary Policy Reach? Or,Monetary Policy and Blue Eyes 248Economics in Everyday Life:Asset-Price Inflation 253

Part 4: Money and Banking, Fiscal Policy, Monetary Policy

Money, Banking, and the Federal Reserve 190

Money: What Is It And How Did It Come To Be? 191

Money: A Definition .191 Three Functions of Money 191 From a Barter to a MoneyEconomy: The Origins of Money 192

Defining the Money Supply 194

M1 194 M2 195 Where Do Credit Cards Fit In? 195

The Money Creation Process 197

The Federal Reserve System 197 The Bank's Reserves and More 197 The Banking Systemand the Money Expansion Process 198 Why Maximum? Answer: No Cash Leakages andZero Excess Reserves 201 Who Created What? 201 It Works In Reverse: The "MoneyDestruction" Process 202

The Federal Reserve System 204

Open Market Operations 204 The Required Reserve Ratio 206 The Discount Rate 207


Money, the Price Level, and Interest Rates 213

Money and the Price Level 214

The Equation of Exchange 214 From the Equation of Exchange to the Simple QuantityTheory of Money 215 The Simple Quantity Theory of Money in an AD-AS Framework 216Dropping the Assumptions That V and Q Are Constant 219

Monetarism 220

Monetarist Views 220 Monetarism and AD-AS 221 The Monetarist View ofthe Economy 223

Money and Interest Rates 224

What Economic Variables Are Affected by a Change in the Money Supply? 224 The MoneySupply, the Loanable Funds Market, and Interest Rates 225 So, What Happens to the InterestRate as the Money Supply Changes? 228 The Nominal and Real Interest Rates 229


Monetary Policy and Fiscal Policy 233

Government Policies and the Economy 234

Fiscal Policy 234

Some Relevant Fiscal Policy Terms 234 Two Important Notes 234

Demand-Side Fiscal Policy 234

Shifting the Aggregate Demand Curve 235 Fiscal Policy: A Keynesian Perspective 235Crowding Out: Questioning Expansionary Fiscal Policy 236 The New Classical View of FiscalPolicy 238 Lags and Fiscal Policy 240 Crowding Out, Lags, and the Effectiveness of FiscalPolicy 242

Contents xiii

• I • I •

11FEATURES

Economics in Technology:Turning the Unanticipated into theAnticipated 267Economics in Everyday Life:Rational Expectations in the CollegeClassroom 271Economics in Popular Culture:The Boy Who Cried Wolf(And the Townspeople With RationalExpectations) 273

12FEATURES

Economics in Technology:How Economizing on Time Can PromoteEconomic Growth 285Economics in Everyday Life:Religious Beliefs and Economic Growth288Economics in Everyday Life:Professors, Students, and Ideas 291

Supply-Side Fiscal Policy 242

Marginal Tax Rates and Aggregate Supply 242 The Laffer Curve: Tax Rates andTax Revenues 243

j

Monetary Policy 245

Monetary Policy and the Problem of Inflationary and Recessionary Gaps 245

Monetary Policy and the Activist-Nonactivist Debate 247

The Case for Activist (or Discretionary) Monetary Policy 249 The Case for Nonactivist (orRules-Based) Monetary Policy 249

Nonactivist Monetary Proposals 251

A Constant-Money-Growth-Rate Rule 251 A Predetermined-Money-Growth-Rate Rule 252The Fed and the Taylor Rule 252


Part 5: Expectations and Growth

Expectations Theory and the Economy 258

Phillips Curve Analysis 259

The Phillips Curve 259 Samuelson and Solow: The Phillips Curve Is Americanized 260

The Controversy Begins: Are There Really Two Phillips Curves? 260

Things Aren't Always as We Thought 260 Friedman and the Natural Rate Theory 260How Do People Form Their Expectations? 263

i

Rational Expectations and New Classical Theory 265

Rational Expectations 265 Do People Anticipate Policy? 265 New Classical Theory:The Effects of Unanticipated and Anticipated Policy 266 Policy IneffectivenessProposition (PIP) 268 Rational Expectations and Incorrectly Anticipated Policy 268How To Fall Into a Recession Without Really Trying 269

New Keynesians and Rational Expectations 271

Looking At Things From The Supply Side: Real Business Cycle Theorists 272


Economic Growth 278

A Few Basics About Economic Growth 279

Do Economic Growth Rates Matter? 279 Growth Rates In Selected Countries 279Two Types of Economic Growth 280 Economic Growth and the Price Level 282

What Causes Economic Growth? 282

Natural Resources 283 Labor 283 Capital 283 Technological Advances 284 Free Tradeas Technology 284 Property Rights Structure 285 Economic Freedom 285 Policies toPromote Economic Growth 286 Economic Growth and Special Interest Groups 287

New Growth Theory 289

What Was Wrong With the Old Theory? Or, What's New With New Growth Theory? 289Discovery, Ideas, and Institutions 290 Expanding Our Horizons 290

xiv Contents

13FEATURES

Economics in Everyday Life:Drug Busts and Crime 302Economics in Everyday Life:Will High Taxes on Cigarettes ReduceSmoking? 304Economics in Popular Culture:Why Do Companies Hire Celebrities? 309

14FEATURES

Economics in the World:Cuban Cigars 323Economics in Everyday Life:How You Pay for Good Weather 328

A Reader Asks 292Chapter Summary 292Key Terms and Concepts 293Quest ions and Problems 293Working Wi th Numbers and Graphs 294

Part 6: Microeconomic Fundamentals

Elasticity 295

Elasticity: Part 1 296

Price Elasticity of Demand 296 Elasticity Is Not Slope 297 From Perfectly Elastic toPerfectly Inelastic Demand 298 Price Elasticity of Demand and Total Revenue (TotalExpenditure) 300

Elasticity: Part 2 303

Price Elasticity of Demand Along a Straight-Line Demand Curve 303 Determinants of PriceElasticity of Demand 305

Other Elasticity Concepts 308

Cross Elasticity of Demand 308 Income Elasticity of Demand 310 Price Elasticity ofSupply 311 Price Elasticity of Supply and Time 312 The Relationship Between Taxesand Elasticity 313

A Reader Asks 316Chapter Summary 316 ^Key Terms and Concepts 317Questions and Problems 317Working With Numbers and Graphs 318

Consumer Choice: Maximizing Utility and Behavioral Economics 319

Utility Theory 320

Utility, Total and Marginal 320 Law of Diminishing Marginal Utility 320 The Millionaire andthe Pauper: What Law Says and Doesn't Say 323 The Solution to the Diamond-WaterParadox 324 Is Gambling Worth the Effort? 324

Consumer Equil ibr ium and Demand 325

Equating Marginal Utilities per Dollar 325 Consumer Equilibrium and the Law of Demand 326Income and Substitution Effects 327 Should the Government Provide the Necessities of Lifefor Free? 329

Behavioral Economics 331

Are People Willing to Reduce Others' Incomes? 331 Is $1 Always $1? 332 Coffee Mugsand the Endowment Effect 333 Does the Endowment Effect Hold Only for New Traders? 334

A Reader Asks 335Chapter Summary 335 •>Key Terms and Concepts 336Quest ions and Problems 336Working Wi th Numbers and Graphs 337

Contents xv

15FEATURES

Economics in Everyday Life:High School Students and Staying OutLate, and More 347Economics in the World:What Matters to GlobalCompetitiveness? 353

16FEATURES

Economics in Popular Culture:What Do Audrey Hepburn, Lucille Ball, andBugs Bunny Have in Common? 374Economics in Everyday Life:Do Churches Compete? 375

Production and Costs 338

The Firm's Objective: Maximizing Profit 339

Accounting Profit Versus Economic Profit 339 Zero Economic Profit Is Not so Bad as ItSounds 340

Production 341

Production in the Short Run 342 Marginal Physical Product and Marginal Cost 343Average Productivity 346

Costs of Production: Total, Average, Marginal 346

The AVC and ATC Curves in Relation to the MC Curve 349 Tying Short-Run Production toCosts 351 One More Cost Concept: Sunk Cost 351

Production and Costs in the Long Run 355

Long-Run Average Total Cost Curve 355 Economics of Scale, Diseconomies of Scale, andConstant Returns to Scale 356 Why Economies of Scale? 357 Why Diseconomies ofScale? 357

Shifts in Cost Curves 357

Taxes 357 Input Prices 357 Technology 358


Part 7: Product Markets

Perfect Competition 361

Market Structures 362

The Theory of Perfect Competition 362

A Perfectly Competitive Firm Is a Price Taker 362 The Demand Curve for a PerfectlyCompetitive Firm is Horizontal 363 The Marginal Revenue Curve of a Perfectly CompetitiveFirm Is the Same as Its Demand Curve 364 Theory and Real-World Markets 365

Perfect Competition in the Short Run 366

What Level of Output Does the Profit-Maximizing Firm Produce? 366 The PerfectlyCompetitive Firm and Resource Allocative Efficiency 367 To Produce or Not to Produce:That Is the Question 368 The Perfectly Competitive Firm's Short-Run Supply Curve 371From Firm to Market (Industry) Supply Curve 371 Why Is the Market Supply Curve Upward-Sloping? 371

Perfect Competition in the Long Run 373

The Conditions of Long-Run Competitive Equilibrium 373 The Pertectly Competitive Firm andProductive Efficiency 375 Industry Adjustment to an Increase in Demand 375 WhatHappens as Firms Enter an Industry in Search of Profits? 378 Industry Adjustment to aDecrease in Demand 379 Differences in Cost, Differences in Profits: Now You See It, NowYou Don't 380 Profit and Discrimination 381


xvi Contents

17FEATURES

Economics in Everyday Life:Monopoly and the Boston Tea Party 388Economics in Everyday Life:Amazon and Price Discrimination 400Economics in Everyday Life:Why Do District Attorneys PleaBargain? 402

18FEATURES

Economics in Everyday Life:How Is a New Year's Resolution Like aCartel Agreement? 414Economics in Everyday Life:An Economic Theory of the Mafia 421Economics in Technology:The Industry Standard Path toMonopoly 422

The Theory of Monopoly 386

Barriers to Entry: A Key to Understanding Monopoly 386 What Is the Difference Between aGovernment Monopoly and a Market Monopoly? 387

Monopoly Pricing and Output Decisions 388

The Monopolist's Demand and Marginal Revenue 388 The Monopolist's Demand andMarginal Revenue Curves Are Not the Same: Why Not? 390 Price and Output for a Profit-Maximizing Monopolist 390 If a Firm1 Maximizes Revenue, Does It Automatically MaximizeProfit Too? 391

Perfect Competition and Monopoly 393

Price, Marginal Revenue, and Marginal Cost 393 Monopoly, Perfect Competition, andConsumers'Surplus 393 Monopoly or Nothing 394

The Case Against Monopoly 395

The Deadweight Loss of Monopoly 395 Rent Seeking 396 X-lnefficiency 397

Price Discrimination 398

Types of Price Discrimination 398 Why a Monopolist Wants to Price Discriminate 398Conditions of Price Discrimination 399 Moving to P5MC Through Price Discrimination 399You Can Have the Comics, Just Give Me the Coupons 401


Monopolistic Competition and Oligopoly 405

The Theory of Monopolistic Competition 406

The Monopolistic Competitor's Demand Curve 406 The Relationship Between Price andMarginal Revenue for a Monopolistic Competitor 406 Output, Price, and Marginal Cost for theMonopolistic Competitor 406 Will There Be Profits in the Long Run? 407 Excess Capacity:What Is It, and Is It "Good" or "Bad"? 408 The Monopolist Competitor and Two Types ofEfficiency 409 Advertising and Designer Labels 409

Oligopoly: Assumptions and Real-World Behavior 410

Price and Output Under Three Oligopoly Theories 411

The Cartel Theory 411 The Kinked Demand Curve Theory 413 The Price LeadershipTheory 415

Game Theory, Oligopoly, and Contestable Markets 417

Prisoner's Dilemma 417 Oligopoly Firms, Cartels, and Prisoner's Dilemma 419 Are Markets

Contestable? 420

A Review of Market Structures 423

Applications of Game Theory 424

Grades and Partying 424 The Arms Race 425 Speed Limit Laws 426


Contents xvii

• I l l

FEATURES

Economics in the World:Why Jobs Don't Always Move to the Low-Wage Country 440Economics in Technology:How May Crime, Outsourcing, andMultitasking Be Related? 441Economics in Everyday Life:What Is the Wage Rate for a Street-LevelPusher in a Drug Gang? 446

20FEATURES

Economics in Popular Culture:Lotteries, Art, and Old Age 459Economics in Everyday Life:Is the Car Worth Buying? 460Economics in Everyday Life:What Does Present Value Have to DoWith a Divorce? 461

Part 8: Factor Markets and Related Issues

Factor Markets 430

Factor Markets 431

The Demand fora Factor 431 Marginal Revenue Product: Two Ways to Calculate It 431The MRP Curve Is the Firm's Factor Demand Curve 432 Value Marginal Product 433An Important Question: Is MRP =VMP? 433 Marginal Factor Cost 433 How Many Units ofa Factor Should a Firm Buy? 435 When There Is More Than One Factor, How Much of EachFactor Should the Firm Buy? 436

The Labor Market 437

Shifts In a Firm's MRP, or Factor Demand, Curve 437 Market Demand for Labor 438 MarketSupply of Labor 442 An Individual's Supply of Labor 442 Shifts In the Labor Supply Curve443 Putting Supply and Demand Together 443 Why Do Wage Rates Differ? 444 WhyDemand and Supply Differ In Different Labor Markets 445 Why Did You Choose the MajorThat You Chose? 446

Labor Markets and Information 447

Screening Potential Employees 447 Promoting From Within 448 Is It Discrimination or Is Itan Information Problem? 448


Interest, Rent, and Profit 452

Interest 453

Loanable Funds: Demand and Supply 453 The Price for Loanable Funds and the Return onCapital Goods Tend to Equality 455 Why Do Interest Rates Differ? 455 Nominal and RealInterest Rates 456 Present Value: What Is Something Tomorrow Worth Today? 457Deciding Whether or Not to Purchase a Capital Good 458

Rent 459

David Ricardo, the Price of Grain, and Land Rent 460 The Supply Curve of Land Can BeUpward-Sloping 461 Economic Rent and Other Factors of Production 462 Economic Rentand Baseball Players: The Perspective from Which the Factor Is Viewed Matters 462Competing for Artificial and Real Rents 463 Do People Overestimate Their Worth to Others,or Are They Simply Seeking Economic Rent? 463

Profit 464

Theories of Profit 464 What Is Entrepreneurship? 465 What Do a Microwave Oven and anErrand Runner Have in Common? 465 Profit and Loss as Signals 466


xviii Contents

I • I I

21FEATURES

Economics in Everyday Life:Winner-Take-All Markets 480Economics in Popular Culture:Monks, Blessings, and Free Riders 486

22FEATURES

Economics in Technology:Software, Switching Costs and Benefits,and Market Failure 500Economics in Everyday Life:Finding Economics in College Life 502

The Distribution of Income and Poverty 469

Some Facts About Income Distribution 470

Who Are the Rich and How Rich Are They? 470 Adjusting the Income Distribution 470The Effect of Age on the Income Distribution 472 A Simple Equation 473

Measuring Income Equality 474

The Lorenz Curve 474 The Gini Coefficient 476 A Limitation of the Gini Coefficient 477

Why Income Inequality Exists 478

Factors Contributing to Income Inequality 478 Income Differences: Some Are Voluntary,Some Are Not 479

Normative Standards of Income Distribution 481

The Marginal Productivity Normative Standard 481 The Absolute Income Equality NormativeStandard 483 The Rawislan Normative Standard 483 Size of the Income Pies 484

Poverty 484

What Is Poverty? 484 Limitations of the Official Poverty Income Statistics 485 Who Are ThePoor? 485 What Is the Justification for Government Redistributing Income? 485


Part 9: Market Failure and Public Choice

Market Failure: Externalities and Public Goods 490

Market Failure 491 s

Externalities 491

Cost and Benefits of Activities 491 Marginal Costs and Benefits of Activities 492 SocialOptimality of Efficiency Conditions 492 Three Categories of Activities 492 Externalities inConsumption and in Production 493 Diagram of a Negative Externality 493 Diagram of aPositive Externality 495

Internalizing Externalities 497

Persuasion 497 Taxes and Subsidies 497 Assigning Property Rights 498 VoluntaryAgreements 499 Combining Property Rights Assignments and Voluntary Agreements 499Beyond Internalizing: Setting Regulations 501

Dealing With a Negative Externality in the Environment 501

Is No Pollution Worse Than Some Pollution? 503 Two Methods to Reduce Air Pollution 503

Public Goods: Excludable and Nonexcludable 505

Goods 505 The Free Rider 506 Nonexcludable Versus Nonrivalrous 507


Contents xix

• I l l

FEATURES

Economics in Everyday Life:Are You Rationally Ignorant? 518Economics in Everyday Life:Inheritance, Heirs, and Why the FirstbornBecame King or Queen 522

24Economics in Everyday Life:Dividing Up the Work 532Economics in Popular Culture:Offshore Outsourcing or Offshoring 537

Public Choice 511

Public Choice Theory 512

The Political Market 512

Moving Toward the Middle: The Median Voter Model 512 What Does the Theory Predict? 513

Voters and Rational Ignorance 514

The Costs and Benefits of Voting 514 Rational Ignorance 516

Special Interest Groups 517

Information and Lobbying Efforts 517 Congressional Districts as Special Interest Groups 519Public Interest Talk, Special Interest Legislation 519 Special Interest Groups and RentSeeking 520

Government Bureaucracy 523A View of Government 524A Reader Asks 524Chapter Summary 525Key Terms and Concepts 525Questions and Problems 525Working With Numbers and Graphs 526

Part 10: International Economics: Theory and Policy

International Trade and Finance 527

International Trade Theory 528

How Do Countries Know What to Trade? 528 How Do Countries Know When They Have aComparative Advantage? 531

Trade Restrictions 531

The Distributional Effects of International Trade 531 Consumers' and Producers' Surplus 533The Benefits and Costs of Trade Restrictions 534 If Free Trade Results in Net Gain, Why DoNations Sometimes Restrict Trade? 537 The Saving-Domestic-Jobs Argument 539

The Foreign Exchange Market 540

The Demand for and Supply of Currencies 541

Flexible Exchange Rates 543

The Equilibrium Exchange Rate 543 Changes in the Equilibrium Exchange Rate 543Factors That Affect the Equilibrium Exchange Rates 544

Fixed Exchanged Rates 546

Fixed Exchanged Rates and Overvalued/Undervalued Currency 546 What Is so Bad About anOvervalued Dollar? 548 Government Involvement in a Fixed Exchange Rate System 549Options Under a Fixed Exchanged Rate System 549 The Gold Standard 550

Fixed Exchange Rates Versus Flexible Exchange Rates 552

Promoting International Trade 552

A Reader Asks 555Chapter Summary 555Key Terms and Concepts 556Questions and Problems 557

Working With Numbers and Graphs 557

Self-Test Appendix 559

Glossary 573

Index 581

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^k - gbv · the market: putting supply and demand together 79 supply and demand at work at an...

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