table of
contents FYI: Adam Smith and the Invisible Hand 12
Preface: To the Student ix
How the Economy as a Whole Works 13 Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services 13 In The News: Why You Should Study Economics 14 Principle 9: Prices Rise When the Government Prints Too Much Money 15 Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment 16 FYI: How to Read This Book 17
Acknowledgments xii
Conclusion 17
Chapter 2
thinking Like an Economist 21
I Introduction
Part
1
Chapter 1
ten Principles of Economics 3 How People Make Decisions 4 Principle 1: People Face Trade-offs 4 Principle 2: The Cost of Something Is What You Give Up to Get It 5 Principle 3: Rational People Think at the Margin 6 Principle 4: People Respond to Incentives 7 Case Study: The Incentive Effects of Gasoline Prices 8 In The News: Incentive Pay 9 How People Interact 10 Principle 5: Trade Can Make Everyone Better Off 10 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity 10 Principle 7: Governments Can Sometimes Improve Market Outcomes 11
The Economist as Scientist 22 The Scientific Method: Observation, Theory, and More Observation 22 The Role of Assumptions 23 Economic Models 24 Our First Model: The Circular-Flow Diagram 24 Our Second Model: The Production Possibilities Frontier 26 Microeconomics and Macroeconomics 29 The Economist as Policy Adviser 29 FYI: Who Studies Economics? 30 Positive versus Normative Analysis 30 Economists in Washington 31 In The News: The Economics of President Obama 32 Why Economists’ Advice Is Not Always Followed 32 Why Economists Disagree 34 Differences in Scientific Judgments 34 Differences in Values 34 Perception versus Reality 35 Let’s Get Going 35 In The News: Environmental Economics 37 APPENDIX Graphing: A Brief Review 40 Graphs of a Single Variable 40 Graphs of Two Variables: The Coordinate System 41 Curves in the Coordinate System 42 Slope 44 Cause and Effect 46
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CONTENTS
Chapter 3
Interdependence and the Gains from trade 49 A Parable for the Modern Economy 50 Production Possibilities 50 Specialization and Trade 52 Comparative Advantage: The Driving Force of Specialization 54 Absolute Advantage 54 Opportunity Cost and Comparative Advantage 54 Comparative Advantage and Trade 55 The Price of the Trade 56 FYI: The Legacy of Adam Smith and David Ricardo 57 Applications of Comparative Advantage 57 Should Tom Brady Mow His Own Lawn? 57 Should the United States Trade with Other Countries? 58 In The News: The Changing Face of International Trade 59 Conclusion 59
xix
Market Demand versus Individual Demand 68 Shifts in the Demand Curve 69 Case Study: Two Ways to Reduce the Quantity of Smoking Demanded 71 Supply 73 The Supply Curve: The Relationship between Price and Quantity Supplied 73 Market Supply versus Individual Supply 73 Shifts in the Supply Curve 74 Supply and Demand Together 77 Equilibrium 77 Three Steps to Analyzing Changes in Equilibrium 79 In The News: Price Increases after Disasters 82 Conclusion: How Prices Allocate Resources 84
Chapter 5
Elasticity and Its application 89 The Elasticity of Demand 90 The Price Elasticity of Demand and Its Determinants 90 Computing the Price Elasticity of Demand 91 The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities 91 The Variety of Demand Curves 92 FYI: A Few Elasticities from the Real World 94 Total Revenue and the Price Elasticity of Demand 94 Elasticity and Total Revenue along a Linear Demand Curve 96 Other Demand Elasticities 97 The Elasticity of Supply 98 The Price Elasticity of Supply and Its Determinants 98 Computing the Price Elasticity of Supply 98 The Variety of Supply Curves 99 Three Applications of Supply, Demand, and Elasticity 101 Can Good News for Farming Be Bad News for Farmers? 101 Why Did OPEC Fail to Keep the Price of Oil High? 103 Does Drug Interdiction Increase or Decrease Drug-Related Crime? 105
II How Markets Work
Part
63
Chapter 4
the Market Forces of Supply and Demand 65 Markets and Competition 66 What Is a Market? 66 What Is Competition? 66 Demand 67 The Demand Curve: The Relationship between Price and Quantity Demanded 67
Conclusion 106
Chapter 6
Supply, Demand, and Government Policies 111 Controls on Prices 112 How Price Ceilings Affect Market Outcomes 112 Case Study: Lines at the Gas Pump 114 Case Study: Rent Control in the Short Run and the Long Run 115 How Price Floors Affect Market Outcomes 116 Case Study: The Minimum Wage 117 Evaluating Price Controls 119 In The News: Should Unpaid Internships Be Allowed? 120 Taxes 121 How Taxes on Sellers Affect Market Outcomes 121
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xx
CONTENTS
How Taxes on Buyers Affect Market Outcomes 123 Case Study: Can Congress Distribute the Burden of a Payroll Tax? 124 Elasticity and Tax Incidence 125 Case Study: Who Pays the Luxury Tax? 127 Conclusion 128
The Deadweight Loss of Taxation 156 How a Tax Affects Market Participants 157 Deadweight Losses and the Gains from Trade 159 The Determinants of the Deadweight Loss 160 Case Study: The Deadweight Loss Debate 162 Deadweight Loss and Tax Revenue as Taxes Vary 163 Case Study: The Laffer Curve and Supply-Side Economics 165 In The News: New Research on Taxation 166 Conclusion 166
Chapter 9
application: International trade 171 The Determinants of Trade 172 The Equilibrium without Trade 172 The World Price and Comparative Advantage 173
and III Markets Welfare
Part
133
Chapter 7
Consumers, Producers, and the Efficiency of Markets 135 Consumer Surplus 136 Willingness to Pay 136 Using the Demand Curve to Measure Consumer Surplus 137 How a Lower Price Raises Consumer Surplus 138 What Does Consumer Surplus Measure? 140
The Winners and Losers from Trade 174 The Gains and Losses of an Exporting Country 174 The Gains and Losses of an Importing Country 175 The Effects of a Tariff 177 FYI: Import Quotas: Another Way to Restrict Trade 179 The Lessons for Trade Policy 179 Other Benefits of International Trade 180 In The News: Trade Skirmishes 181 The Arguments for Restricting Trade 182 The Jobs Argument 182 In The News: Should the Winners from Free Trade Compensate the Losers? 183 The National-Security Argument 184 In The News: Second Thoughts about Free Trade 184 The Infant-Industry Argument 185 The Unfair-Competition Argument 186 The Protection-as-a-Bargaining-Chip Argument 186 Case Study: Trade Agreements and the World Trade Organization 186 Conclusion 187
Producer Surplus 141 Cost and the Willingness to Sell 141 Using the Supply Curve to Measure Producer Surplus 142 How a Higher Price Raises Producer Surplus 144 Market Efficiency 145 The Benevolent Social Planner 145 Evaluating the Market Equilibrium 146 In The News: Ticket Scalping 148 Case Study: Should There Be a Market in Organs? 149 Conclusion: Market Efficiency and Market Failure 150
Chapter 8
application: the Costs of taxation 155 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
CONTENTS
Economics IV the of the Public
Part
Sector
193
Chapter 10
Externalities 195
xxi
Chapter 12
the Design of the tax System 233 A Financial Overview of the U.S. Government 234 The Federal Government 235 Case Study: The Fiscal Challenge Ahead 238 State and Local Government 240
Externalities and Market Inefficiency 197 Welfare Economics: A Recap 197 Negative Externalities 198 Positive Externalities 199 In The News: The Externalities of Country Living 200 Case Study: Technology Spillovers, Industrial Policy, and Patent Protection 201
Taxes and Efficiency 242 Deadweight Losses 242 Case Study: Should Income or Consumption Be Taxed? 243 In The News: The Temporarily Disappearing Estate Tax 244 Administrative Burden 244 Marginal Tax Rates versus Average Tax Rates 245 Lump-Sum Taxes 245
Public Policies toward Externalities 202 Command-and-Control Policies: Regulation 203 Market-Based Policy 1: Corrective Taxes and Subsidies 203 Case Study: Why Is Gasoline Taxed So Heavily? 204 Market-Based Policy 2: Tradable Pollution Permits 205 Objections to the Economic Analysis of Pollution 207 In The News: Cap and Trade 208
Taxes and Equity 246 The Benefits Principle 246 The Ability-to-Pay Principle 247 Case Study: How the Tax Burden Is Distributed 248 Tax Incidence and Tax Equity 249 Case Study: Who Pays the Corporate Income Tax? 250 In The News: The Value-Added Tax 250
Private Solutions to Externalities 209 The Types of Private Solutions 210 The Coase Theorem 210 Why Private Solutions Do Not Always Work 211
Conclusion: The Trade-off between Equity and Efficiency 252
Conclusion 212
Chapter 11
Public Goods and Common resources 217 The Different Kinds of Goods 218 Public Goods 220 The Free-Rider Problem 220 Some Important Public Goods 220 Case Study: Are Lighthouses Public Goods? 222 The Difficult Job of Cost–Benefit Analysis 223 Case Study: How Much Is a Life Worth? 223 Common Resources 224 The Tragedy of the Commons 224 Some Important Common Resources 225 In The News: The Case for Toll Roads 226 Case Study: Why the Cow Is Not Extinct 228 Conclusion: The Importance of Property Rights 229
V Firm Behavior and the Organization
Part
of Industry
257
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xxii
contents
Chapter 13
Chapter 15
The Costs of Production 259
Monopoly 299
What Are Costs? 260 Total Revenue, Total Cost, and Profit 260 Costs as Opportunity Costs 260 The Cost of Capital as an Opportunity Cost 261 Economic Profit versus Accounting Profit 262
Why Monopolies Arise 300 Monopoly Resources 301 Government-Created Monopolies 301 Natural Monopolies 302
Production and Costs 263 The Production Function 263 From the Production Function to the Total-Cost Curve 265 The Various Measures of Cost 265 Fixed and Variable Costs 266 Average and Marginal Cost 267 Cost Curves and Their Shapes 268 Typical Cost Curves 270 Costs in the Short Run and in the Long Run 271 The Relationship between Short-Run and Long-Run Average Total Cost 271 Economies and Diseconomies of Scale 272 FYI: Lessons from a Pin Factory 273 Conclusion 274
Chapter 14
Firms in Competitive Markets 279 What Is a Competitive Market? 280 The Meaning of Competition 280 The Revenue of a Competitive Firm 280 Profit Maximization and the Competitive Firm’s Supply Curve 282 A Simple Example of Profit Maximization 282 The Marginal-Cost Curve and the Firm’s Supply Decision 283 The Firm’s Short-Run Decision to Shut Down 285 Spilt Milk and Other Sunk Costs 286 Case Study: Near-Empty Restaurants and Off-Season Miniature Golf 287 The Firm’s Long-Run Decision to Exit or Enter a Market 288 Measuring Profit in Our Graph for the Competitive Firm 288 The Supply Curve in a Competitive Market 289 The Short Run: Market Supply with a Fixed Number of Firms 290 The Long Run: Market Supply with Entry and Exit 290 Why Do Competitive Firms Stay in Business If They Make Zero Profit? 292 A Shift in Demand in the Short Run and Long Run 293 Why the Long-Run Supply Curve Might Slope Upward 293 Conclusion: Behind the Supply Curve 295
How Monopolies Make Production and Pricing Decisions 303 Monopoly versus Competition 303 A Monopoly’s Revenue 304 Profit Maximization 306 A Monopoly’s Profit 308 FYI: Why a Monopoly Does Not Have a Supply Curve 308 Case Study: Monopoly Drugs versus Generic Drugs 309 The Welfare Cost of Monopolies 310 The Deadweight Loss 311 The Monopoly’s Profit: A Social Cost? 313 Price Discrimination 314 A Parable about Pricing 314 The Moral of the Story 315 The Analytics of Price Discrimination 315 Examples of Price Discrimination 317 Public Policy toward Monopolies 318 In The News: TKTS and Other Schemes 318 Increasing Competition with Antitrust Laws 319 In The News: President Obama’s Antitrust Policy 320 Regulation 321 Public Ownership 323 Doing Nothing 323 Conclusion: The Prevalence of Monopolies 323
Chapter 16
Monopolistic Competition 329 Between Monopoly and Perfect Competition 330 Competition with Differentiated Products 332 The Monopolistically Competitive Firm in the Short Run 332 The Long-Run Equilibrium 332 Monopolistic versus Perfect Competition 335 Monopolistic Competition and the Welfare of Society 336 In The News: Insufficient Variety as a Market Failure 338 Advertising 338 The Debate over Advertising 340 Case Study: Advertising and the Price of Eyeglasses 340 Advertising as a Signal of Quality 341 FYI: Galbraith versus Hayek 342 Brand Names 343 Conclusion 344
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CONTENTS xxiii
Chapter 17
Oligopoly 349 Markets with Only a Few Sellers 350 A Duopoly Example 350 Competition, Monopolies, and Cartels 351 In The News: Public Price Fixing 352 The Equilibrium for an Oligopoly 353 How the Size of an Oligopoly Affects the Market Outcome 354 The Economics of Cooperation 355 The Prisoners’ Dilemma 355 Oligopolies as a Prisoners’ Dilemma 357 Case Study: OPEC and the World Oil Market 358 Other Examples of the Prisoners’ Dilemma 358 The Prisoners’ Dilemma and the Welfare of Society 360 Why People Sometimes Cooperate 360 Case Study: The Prisoners’ Dilemma Tournament 361 Public Policy toward Oligopolies 362 Restraint of Trade and the Antitrust Laws 362 Case Study: An Illegal Phone Call 363 Controversies over Antitrust Policy 363 Case Study: The Microsoft Case 365
The Demand for Labor 376 The Competitive Profit-Maximizing Firm 377 The Production Function and the Marginal Product of Labor 377 The Value of the Marginal Product and the Demand for Labor 379 What Causes the Labor-Demand Curve to Shift? 380 FYI: Input Demand and Output Supply: Two Sides of the Same Coin 381 FYI: The Luddite Revolt 382 The Supply of Labor 383 The Trade-off between Work and Leisure 383 What Causes the Labor-Supply Curve to Shift? 383 Equilibrium in the Labor Market 384 Shifts in Labor Supply 385 In The News: The Economics of Immigration 386 Shifts in Labor Demand 386 Case Study: Productivity and Wages 387 FYI: Monopsony 389 The Other Factors of Production: Land and Capital 389 Equilibrium in the Markets for Land and Capital 390 FYI: What Is Capital Income? 391 Linkages among the Factors of Production 391 Case Study: The Economics of the Black Death 392
Conclusion 366 In The News: The Next Big Antitrust Target? 367
Conclusion 393
Chapter 19
Earnings and Discrimination 397 Some Determinants of Equilibrium Wages 398 Compensating Differentials 398 Human Capital 398 Case Study: The Increasing Value of Skills 399 Ability, Effort, and Chance 400 Case Study: The Benefits of Beauty 401 An Alternative View of Education: Signaling 402 The Superstar Phenomenon 402 In The News: The Human Capital of Terrorists 403 Above-Equilibrium Wages: Minimum-Wage Laws, Unions, and Efficiency Wages 404
VI the Economics of Labor Markets
Part
Chapter 18
the Markets for the Factors of Production 375
373
The Economics of Discrimination 405 Measuring Labor-Market Discrimination 405 Case Study: Is Emily More Employable than Lakisha? 407 Discrimination by Employers 407 Case Study: Segregated Streetcars and the Profit Motive 408 Discrimination by Customers and Governments 408 Case Study: Discrimination in Sports 409 In The News: Gender Differences 410 Conclusion 411
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xxiv CONTENTS
Chapter 20
Income Inequality and Poverty 415 The Measurement of Inequality 416 U.S. Income Inequality 416 Inequality around the World 417 The Poverty Rate 419 Problems in Measuring Inequality 420 Case Study: Alternative Measures of Inequality 421 In The News: What’s Wrong with the Poverty Rate? 422 Economic Mobility 423 The Political Philosophy of Redistributing Income 424 Utilitarianism 424 Liberalism 425 Libertarianism 427 Policies to Reduce Poverty 427 Minimum-Wage Laws 428 Welfare 428 Negative Income Tax 429 In-Kind Transfers 430 In The News: The Root Cause of a Financial Crisis 430 Antipoverty Programs and Work Incentives 431 Conclusion 432
Preferences: What the Consumer Wants 441 Representing Preferences with Indifference Curves 442 Four Properties of Indifference Curves 443 Two Extreme Examples of Indifference Curves 444 Optimization: What the Consumer Chooses 446 The Consumer’s Optimal Choices 446 FYI: Utility: An Alternative Way to Describe Preferences and Optimization 447 How Changes in Income Affect the Consumer’s Choices 448 How Changes in Prices Affect the Consumer’s Choices 449 Income and Substitution Effects 450 Deriving the Demand Curve 452 Three Applications 453 Do All Demand Curves Slope Downward? 453 Case Study: The Search for Giffen Goods 454 How Do Wages Affect Labor Supply? 454 Case Study: Income Effects on Labor Supply: Historical Trends, Lottery Winners, and the Carnegie Conjecture 457 In The News: Backward-sloping Labor Supply in Kiribati 458 How Do Interest Rates Affect Household Saving? 459 Conclusion: Do People Really Think This Way? 461
Chapter 22
Frontiers of Microeconomics 467 Asymmetric Information 468 Hidden Actions: Principals, Agents, and Moral Hazard 468 FYI: Corporate Management 469 Hidden Characteristics: Adverse Selection and the Lemons Problem 470 Signaling to Convey Private Information 471 Case Study: Gifts as Signals 471 Screening to Uncover Private Information 472 Asymmetric Information and Public Policy 473
VII topics for Further Study
Part
437
Chapter 21
Political Economy 473 The Condorcet Voting Paradox 474 Arrow’s Impossibility Theorem 475 In The News: Arrow’s Problem in Practice 476 The Median Voter Is King 478 Politicians Are People Too 479 Behavioral Economics 480 People Aren’t Always Rational 480 People Care about Fairness 481 In The News: Sin Taxes 482 People Are Inconsistent over Time 484
the theory of Consumer Choice 439
Conclusion 485
The Budget Constraint: What the Consumer Can Afford 440
Glossary 489 Index 493
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