deutschs zentralbibliothek essentials of economics

Deutschs Zentralbibliothekfur Wirtschaftswissenschaften

-£&, -g

ESSENTIALS OF ECONOMICS:

Table of Contents

Preface: To the Student vii

PARTIINTRODUCTION 1

CHAPTER 1TEN PRINCIPLES OF ECONOMICS 3

How People Make Decisions 4Principle 1: People Face Trade-offs 4Principle 2: The Cost of Something Is What You Give

Up to Get It 5Principle 3: Rational People Think at the Margin 6Principle 4: People Respond to Incentives 7

How People Interact 8Principle 5: Trade Can Make Everyone Better Off 8Principle 6: Markets Are Usually a Good Way to

Organize Economic Activity 8IN THE NEWS Incentive Pay 9Principle 7: Governments Can Sometimes Improve

Market Outcomes 10FYI Adam Smith and the Invisible Hand 11

How the Economy as a Whole Works 12

Principle 8: A Country's Standard of Living Dependson Its Ability to Produce Goods and Services 12

Principle 9: Prices Rise When the Government Prints TooMuch Money 13

IN THE NEWS Why You Should Study Economics 14

Principle 10: Society Faces a Short-Run Trade-off betweenInflation and Unemployment 14

Conclusion 15FYI How to Read This Book 16

Summary 17Key Concepts 17Questions for Review 18Problems and Applications 18

CHAPTER 2THINKING LIKE AN ECONOMIST 21

The Economist as Scientist 22The Scientific Method: Observation, Theory, and

More Observation 22The Role of Assumptions 23Economic Models 23Our First Model: The Circular-Flow Diagram 24Our Second Model: The Production Possibilities

Frontier 25Microeconomics and Macroeconomics 28FYI Who Studies Economics? 29

The Economist as Policy Adviser 30Positive versus Normative Analysis 30Economists in Washington 31IN THE NEWS Football Economics 32

Why Economists' Advice Is Not Always Followed 32

Why Economists Disagree 34

TABLE OF CONTENTS xv

Differences in Scientific Judgments 34Differences in Values 34Perception versus Reality 35

Let's Get Going 36IN THE NEWS Environmental Economics 37


APPENDIX Graphing: A Brief Review 40Graphs of a Single Variable 40Graphs of Two Variables: The Coordinate System 41Curves in the Coordinate System 42Slope 44Cause and Effect 46

CHAPTER 3INTERDEPENDENCE AND THE GAINS FROMTRADE 49

A Parable for the Modern Economy 50Production Possibilities 50Specialization and Trade 52

Comparative Advantage: The Driving Force ofSpecialization 54Absolute Advantage 54Opportunity Cost and Comparative Advantage 54Comparative Advantage and Trade 55The Price of the Trade 56

Applications of Comparative Advantage 57FYI The Legacy of Adam Smith and David RicardoShould Tiger Woods Mow His Own Lawn? 58Should the United States Trade with Other

Countries? 58IN THE NEWS The Changing Face of International

Trade 59

Conclusion 60Summary 60Key Concepts 60Questions for Review 61Problems and Applications 61

57

PART IIHOW MARKETS WORK 63

CHAPTER 4THE MARKET FORCES OF SUPPLYAND DEMAND 65

Markets and Competition 66What Is a Market? 66What Is Competition? 66

Demand 67The Demand Curve: The Relationship between Price

and Quantity Demanded 67Market Demand versus Individual Demand 68Shifts in the Demand Curve 69CASE STUDY Two Ways to Reduce the Quantity of

Smoking Demanded 71

Supply 73The Supply Curve: The Relationship between Price

and Quantity Supplied 73Market Supply versus Individual Supply 73Shifts in the Supply Curve 74

Supply and Demand Together 77Equilibrium 77Three Steps to Analyzing Changes in Equilibrium

Conclusion: How Prices Allocate Resources 83IN THE NEWS The Helium Market 83IN THE NEWS Price Increases after Natural

Disasters 84

79

xvi TABLE OF CONTENTS


CHAPTER 5ELASTICITY AND ITS APPLICATION 89

The Elasticity of Demand 90The Price Elasticity of Demand and Its Determinants 90Computing the Price Elasticity of Demand 91The Midpoint Method: A Better Way to Calculate

Percentage Changes and Elasticities 91The Variety of Demand Curves 92Total Revenue and the Price Elasticity of Demand 94Elasticity and Total Revenue along a Linear Demand

Curve 95Other Demand Elasticities 97IN THE NEWS Energy Demand 98

The Elasticity of Supply 99The Price Elasticity of Supply and Its Determinants 99Computing the Price Elasticity of Supply 100The Variety of Supply Curves 100

Three Applications of Supply, Demand, andElasticity 102Can Good News for Farming Be Bad News for

Farmers? 103Why Did OPEC Fail to Keep the Price of Oil High? 105Does Drug Interdiction Increase or Decrease

Drug-Related Crime? 106


CHAPTER 6SUPPLY, DEMAND, AND GOVERNMENTPOLICIES 113

Controls on Prices 114How Price Ceilings Affect Market OutcomesCASE STUDY Lines at the Gas Pump 116

114

CASE STUDY Rent Control in the Short Run and theLong Run 117

How Price Floors Affect Market Outcomes 118.CASE STUDY The Minimum Wage 119Evaluating Price Controls 121IN THE NEWS President Chavez versus the

Market 122

Taxes 123How Taxes on Sellers Affect Market Outcomes 124How Taxes on Buyers Affect Market Outcomes 125CASE STUDY Can Congress Distribute the Burden

of a Payroll Tax? 127Elasticity and Tax Incidence 128CASE STUDY Who Pays the Luxury Tax? 130


PART IIIMARKETS AND WELFARE 135

CHAPTER 7CONSUMERS, PRODUCERS, AND THE EFFICIENCYOF MARKETS 137

Consumer Surplus 138Willingness to Pay 138Using the Demand Curve to Measure Consumer

Surplus 139

TABLE OF CONTENTS xvii

How a Lower Price Raises Consumer SurplusWhat Does Consumer Surplus Measure? 141

140

Producer Surplus 143Cost and the Willingness to Sell 143Using the Supply Curve to Measure Producer

Surplus 144How a Higher Price Raises Producer Surplus 145

Market Efficiency 147The Benevolent Social Planner 147Evaluating the Market Equilibrium 148CASE STUDY Should There Be a Market in

Organs? 150

, IN THE NEWS Ticket Scalping 151

Conclusion: Market Efficiency and Market Failure 152IN THE NEWS The Miracle of the Market 153


CHAPTER 8APPLICATION: THE COSTS OF TAXATION 159

The Deadweight Loss of Taxation 160How a Tax Affects Market Participants 161Deadweight Losses and the Gains from Trade 163

The Determinants of the Deadweight Loss 164

CASE STUDY The Deadweight Loss Debate 166

Deadweight Loss and Tax Revenue as Taxes VaryFYI Henry George and the Land Tax 169CASE STUDY The Laffer Curve and Suppiy-Side

Economics 169IN THE NEWS On the Way to France 170

Conclusion 172Summary 172

167

Key Concepts 173Questions for Review 173Problems and Applications 173

CHAPTER 9APPLICATION: INTERNATIONAL TRADE 177

The Determinants of Trade 178The Equilibrium without Trade 178The World Price and Comparative Advantage 179

The Winners and Losers from Trade 180The Gains and Losses of an Exporting Country 180The Gains and Losses of an Importing Country 181The Effects of a Tariff 183The Lessons for Trade Policy 185FYI Import Quotas: Another Way to Restrict

Trade 185Other Benefits of International Trade 186IN THE NEWS Should the Winners from Free Trade

Compensate the Losers? 187

The Arguments for Restricting Trade 188The Jobs Argument 188IN THE NEWS Offshore Outsourcing 189

The National-Security Argument 190The Infant-Industry Argument 190The Unfair-Competition Argument 191The Protection-as-a-Bargaining-Chip Argument 191IN THE NEWS Second Thoughts about Free

Trade 192CASE STUDY Trade Agreements and the World Trade

Organization 192


xviii TABLE OF CONTENTS

PART IVTHE ECONOMICS OF THE PUBLICSECTOR 201

CHAPTER 10EXTERNALITIES 203

Externalities and Market Inefficiency 204Welfare Economics: A Recap 205Negative Externalities 205Positive Externalities 207CASE STUDY Technology Spillovers, Industrial Policy,. and Patent Protection 208

Public Policies toward Externalities 209Command-and-Control Policies: Regulation 209Market-Based Policy 1: Corrective Taxes and

Subsidies 210CASE STUDY Why Is Gasoline Taxed So Heavily? 211Market-Based Policy 2: Tradable Pollution Permits 212Objections to the Economic Analysis of Pollution 214

Private Solutions to Externalities 215The Types of Private Solutions 215IN THE NEWS The Case for Taxing Carbon 216The Coase Theorem 217Why Private Solutions Do Not Always Work 218


CHAPTER 11PUBLIC GOODS AND COMMONRESOURCES 225

The Different Kinds of Goods 226

Public Goods 227The Free-Rider Problem 228Some Important Public Goods 228CASE STUDY Are Lighthouses Public Goods? 230The Difficult Job of Cost-Benefit Analysis 230CASE STUDY How Much Is a Life Worth? 231

Common Resources 232The Tragedy of the Commons 232Some Important Common Resources 233IN THE NEWS The Bloomberg Plan 234CASE STUDY Why the Cow Is Not Extinct 236

Conclusion: The Importance of Property RightsSummary 238Key Concepts 238Questions for Review 238Problems and Applications 238

237

PARTVFIRM BEHAVIOR ANDTHE ORGANIZATION OFINDUSTRY 241

CHAPTER 12THE COSTS OF PRODUCTION 243

What Are Costs? 244Total Revenue, Total Cost, and Profit 244

TABLE OF CONTENTS xix

Costs as Opportunity Costs 244The Cost of Capital as an Opportunity Cost 245Economic Profit versus Accounting Profit 246

Production and Costs 247The Production Function 247From the Production Function to the total-Cost

Curve 249

The Various Measures of Cost 250Fixed and Variable Costs 250Average and Marginal Cost 251Cost Curves and Their Shapes 252Typical Cost Curves 254

Costs in the Short Run and in the Long Run 256The Relationship between Short-Run and Long-Run

Average Total Cost 256Economies and Diseconomies of Scale 257FYI Lessons from a Pin Factory 258


CHAPTER 13FIRMS IN COMPETITIVE MARKETS 265

What Is a Competitive Market? 266The Meaning of Competition 266The Revenue of a Competitive Firm 266

Profit Maximization and the Competitive Firm's SupplyCurve 268A Simple Example of Profit Maximization 268The Marginal-Cost Curve and the Firm's Supply

Decision 269The Firm's Short-Run Decision to Shut Down 271Spilt Milk and Other Sunk Costs 272CASE STUDY Near-Empty Restaurants and Off-Season

Miniature Golf 273The Firm's Long-Run Decision to Exit or Enter a

Market 274

Measuring Profit in Our Graph for the CompetitiveFirm 275

The Supply Curve in a Competitive Market 277The Short Run: Market Supply with a Fixed Number

of Firms 277The Long Run: Market Supply with Entry and Exit 278Why Do Competitive Firms Stay in Business If They

Make Zero Profit? 279A Shift in Demand in the Short Run and Long Run 280Why the Long-Run Supply Curve Might Slope

Upward 280

Conclusion: Behind the Supply CurveSummary 283Key Concepts 283Questions for Review 283Problems and Applications 284

CHAPTER 14MONOPOLY 287

282

Why Monopolies Arise 288Monopoly Resources 289Government-Created MonopoliesNatural Monopolies 290

289

How Monopolies Make Production and PricingDecisions 291Monopoly versus Competition 291A Monopoly's Revenue 292Profit Maximization 295FYI Why a Monopoly Does Not Have a Supply

Curve 296

A Monopoly's Profit 296CASE STUDY Monopoly Drugs versus Generic

Drugs 297

The Welfare Cost of Monopolies 298The Deadweight Loss 299The Monopoly's Profit: A Social Cost? 301

Price Discrimination 302A Parable about Pricing 302The Moral of the Story 303The Analytics of Price Discrimination 304

xx TABLE OF CONTENTS

Examples of Price Discrimination 305IN THE NEWS TKTS and Other Schemes 306

Public Policy toward Monopolies 308Increasing Competition with Antitrust LawsRegulation 309IN THE NEWS Airline Mergers 309IN THE NEWS Public Transport and Private

Enterprise 310Public Ownership 312Doing Nothing 313

308

Conclusion: The Prevalence of MonopoliesSummary 314Key Concepts 315Questions for Review 315Problems and Applications 316

314

PART VITHE DATA OFMACROECONOMICS 321

CHAPTER 15

MEASURING A NATION'S INCOME 323

The Economy's Income and Expenditure 324

The Measurement of Gross Domestic Product 326

"GDP Is the Market Value . . ." 326". . . of All . . ." 326". . . Final..." 327". . . Goods and Services . . ." 327". . . Produced..." 327

". . . Within a Country . . ." 327".. . In a Given Period of Time."

328

327

The Components of GDPConsumption 329Investment 329FYI Other Measures of Income 329Government Purchases 330Net Exports 330CASE STUDY The Components of U.S. GDP 331

Real versus Nominal GDP 331A Numerical Example 332The GDP Deflator 333CASE STUDY Real GDP Over Recent History 334

Is GDP a Good Measure of Economic Weil-Being? 335IN THE NEWS The Underground Economy 336CASE STUDY International Differences in GDP and the

Quality of Life 338

Conclusion 339FYI Who Wins at the Olympics? 340


CHAPTER 16MEASURING THE COST OF LIVING 345

The Consumer Price Index 346How the Consumer Price Index Is Calculated 346Problems in Measuring the Cost of Living 348FYI What Is In the CPI's Basket? 349

IN THE NEWS Accounting for Quality Change 350The GDP Deflator versus the Consumer Price Index 352

Correcting Economic Variables for the Effects ofInflation 353Dollar Figures from Different Times 354Indexation 354Real and Nominal Interest Rates 355FYI Mr. Index Goes to Hollywood 355

TABLE OF CONTENTS xxi

CASE STUDY Interest Rates in the U.S. Economy 357


PART VIITHE REAL ECONOMY INTHE LONG RUN 363

CHAPTER 17PRODUCTION AND GROWTH 365

Economic Growth around the World 366FYI A Picture Is Worth a Thousand Statistics 368FYI Are You Richer Than the Richest American? 370

Productivity: Its Role and Determinants 370Why Productivity Is So Important 370How Productivity Is Determined 371FYI The Production Function 373IN THE NEWS Measuring Capital 374CASE STUDY Are Natural Resources a Limit to

Growth? 374

Economic Growth and Public Policy 376Saving and Investment 376Diminishing Returns and the Catch-Up Effect 377Investment from Abroad 378Education 379

IN THE NEWS Promoting Hu man Capital 380Health and Nutrition 381Property Rights and Political Stability 382Free Trade 383Research and Development 384Population Growth 384IN THE NEWS Escape from Malthus 386

Conclusion: The Importance of Long-Run Growth 388Summary 389Key Concepts 389Questions for Review 389Problems and Applications 390

CHAPTER 18SAVING, INVESTMENT, AND THE FINANCIALSYSTEM 391

Financial Institutions in the U.S. Economy 392Financial Markets 392Financial Intermediaries 394FYI Key Numbers for Stock Watchers 395Summing Up 396

Saving and Investment in the National IncomeAccounts 397Some Important Identities 397The Meaning of Saving and Investment 399

The Market for Loanable Funds 399Supply and Demand for Loanable Funds 400Policy 1: Saving Incentives 402Policy 2: Investment Incentives 403IN THE NEWS In Praise of Misers 404Policy 3: Government Budget Deficits and

Surpluses 405CASE STUDY The History of U.S. Government

Debt 407


xxii TABLE OF CONTENTS

CHAPTER 19THE BASIC TOOLS OF FINANCE 413

Present Value: Measuring the Time Value of Money 414

FYI The Magic of Compounding and the Rule

of 70 416

Managing Risk 416Risk Aversion 417The Markets for Insurance 417FYI The Peculiarities of Health Insurance 418Diversification of Firm-Specific Risk 419The Trade-off between Risk and Return 420

Asset Valuation 422Fundamental Analysis 422CASE STUDY Random Walks and Index FundsThe Efficient Markets Hypothesis 422IN THE NEWS Neurofinance 424Market Irrationality 425

Conclusion 426Summary 427Key Concepts 427Questions for Review 427Problems and Applications

423

427

CHAPTER 20UNEMPLOYMENT 429

Identifying Unemployment 430How Is Unemployment Measured? 430CASE STUDY Labor-Force Participation of Men and

Women in the U.S. Economy 433IN THE NEWS The Rise of Adult Male

Joblessness 434Does the Unemployment Rate Measure What We

Want It To? 435How Long Are the Unemployed without Work? 437Why Are There Always Some People Unemployed? 438

Job Search 439Why Some Frictional Unemployment Is InevitableFYI The Jobs Number 439Public Policy and Job Search 440

439

Unemployment Insurance 441IN THE NEWS Unemployment Policy At Home

and Abroad 442

Minimum-Wage Laws 443

Unions and Collective Bargaining 445FYI Who Earns the Minimum Wage? 445The Economics of Unions 446Are Unions Good or Bad for the Economy? 447

The Theory of Efficiency Wages 448Worker Health 448Worker Turnover 448Worker Quality 449Worker Effort 449CASE STUDY Henry Ford and the Very Generous

$5-A-Day Wage 450


PART VIIIMONEY AND PRICES INTHE LONG RUN 455

CHAPTER 21THE MONETARY SYSTEM 457

The Meaning of Money 458The Functions of Money 458

TABLE OF CONTENTS xxiii

The Kinds of Money 459IN THE NEWS Monetary Lessons from Iraq 460Money in the U.S. Economy 461FYI Credit Cards, Debit Cards, and Money 463

CASE STUDY Where Is All the Currency? 463

The Federal Reserve System 464The Fed's Organization 464The Federal Open Market Committee 464

Banks and the Money Supply 465The Simple Case of 100-Percent-Reserve Banking 466Money Creation with Fractional-Reserve Banking 466The Money Multiplier 467The Fed's Tools of Monetary Control 469IN THE NEWS The Financial Crisis of 2008 470Problems in Controlling the Money Supply 472CASE STUDY Bank Runs and the Money Supply 473The Federal Funds Rate 473


CHAPTER 22MONEY GROWTH AND INFLATION 479

The Classical Theory of Inflation 480The Level of Prices and the Value of Money 480Money Supply, Money Demand, and Monetary

Equilibrium 481The Effects of a Monetary Injection 482A Brief Look at the Adjustment Process 483The Classical Dichotomy and Monetary Neutrality 485Velocity and the Quantity Equation 486CASE STUDY Money and Prices During Four

Hyperinflations 488The Inflation Tax 489

• The Fisher Effect 490IN THE NEWS A Recipe for Economic Disaster 491

The Costs of Inflation 492A Fall in Purchasing Power? The Inflation Fallacy 493Shoeleather Costs 494

Menu Costs 495Relative-Price Variability and the Misallocation of

Resources 495Inflation-Induced Tax Distortions 496Confusion and Inconvenience 497A Special Cost of Unexpected Inflation: Arbitrary

Redistributions of Wealth 498CASE STUDY The Wizard of Oz and the Free-Silver

Debate 498


PART IXSHORT-RUN ECONOMICFLUCTUATIONS 505

CHAPTER 23AGGREGATE DEMAND AND AGGREGATESUPPLY 507

Three Key Facts about Economic Fluctuations 508Fact 1: Economic Fluctuations Are Irregular and

Unpredictable 508Fact 2: Most Macroeconomic Quantities Fluctuate

Together 508Fact 3: As Output Falls, Unemployment Rises 510

Explaining Short-Run Economic Fluctuations 510The Assumptions of Classical Economics 510IN THE NEWS Offbeat Indicators 511

xxiv TABLE OF CONTENTS

The Reality of Short-Run Fluctuations 512The Model of Aggregate Demand and Aggregate

Supply 513

The Aggregate-Demand Curve 514Why the Aggregate-Demand Curve Slopes

Downward 514 - - 'Why the Aggregate-Demand Curve Might Shift 517IN THE NEWS The 2008 Fiscal Stimulus 518

The Aggregate-Supply Curve 519Why the Aggregate-Supply Curve Is Vertical in the

Long Run 520Why the Long-Run Aggregate-Supply Curve Might

Shift 521Using Aggregate Demand and Aggregate Supply to

Depict Long-Run Growth and Inflation 523Why the Aggregate-Supply Curve Slopes Upward

in the Short Run 523Why the Short-Run Aggregate-Supply Curve Might

Shift 528

Two Causes of Economic Fluctuations 529The Effects of a Shift in Aggregate Demand 530FYI Monetary Neutrality Revisited 532CASE STUDY Two Big Shifts in Aggregate Demand:

The Great Depression and World War II 533CASE STUDY The Recession of 2001 535The Effects of a Shift in Aggregate Supply 535FYI The Origins of Aggregate Demand and Aggregate

Supply 538CASE STUDY Oil and the Economy 538


CHAPTER 24THE INFLUENCE OF MONETARY AND FISCALPOLICY ON AGGREGATE DEMAND 545

How Monetary Policy Influences Aggregate Demand 546The Theory of Liquidity Preference 547The Downward Slope of the Aggregate-Demand

Curve 549FYI Interest Rates in the Long Run and the Short

Run 550Changes in the Money Supply 551The Role of Interest-Rate Targets in Fed Policy 553IN THE NEWS The FOMC Explains Itself 554CASE STUDY Why the Fed Watches the Stock Market

(and Vice Versa) 554

How Fiscal Policy Influences Aggregate Demand 555Changes in Government Purchases 555The Multiplier Effect 556A Formula for the Spending Multiplier 556Other Applications of the Multiplier Effect 558The Crowding-Out Effect 559Changes in Taxes 560

Using Policy to Stabilize the Economy 561FYI How Fiscal Policy Might Affect Aggregate

Supply 561The Case for Active Stabilization Policy 562CASE STUDY Keynesians in the White House 563The Case against Active Stabilization Policy 563Automatic Stabilizers 565


Glossary 569Index 574

deutschs zentralbibliothek essentials of economics

Documents