Macroeconomics 14th Edition by Michael Parkin - Global Edition Textbook

GLOBAL EDITION MACROECONOMICS 14th Edition Michael Parkin MACROECONOMICS FOURTEENTH EDITION GLOBAL EDITION ◆ MICHAEL PARKIN University of Western Ontario A01_PARK3608_14_GE_FM.indd 1 1/29/22 9:24 PM Please contact https://support.pearson.com/getsupport/s/contactsupport with any queries on this content. Acknowledgments of third-party content appear on the appropriate page within the text. Pearson Education Limited KAO Two KAO Park Hockham Way Harlow Essex CM17 9SR United Kingdom and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsonglobaleditions.com © Pearson Education Limited 2023 The rights of Michael Parkin to be identified as the authors of this work, have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. Macroeconomics, 14th Edition, ISBN 978-0-137-47082-2 by Michael Parkin published by Pearson Education © 2023 All rights reserved. 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A01_PARK3608_14_GE_FM.indd 3 1/29/22 9:24 PM TO ROBIN A01_PARK3608_14_GE_FM.indd 4 1/29/22 9:24 PM ◆ ABOUT THE AUTHOR Michael Parkin is Professor Emeritus in the Department of Economics at the University of Western Ontario, Canada. Professor Parkin has held faculty appointments at Brown University, the University of Manchester, the University of Essex, and Bond University. He is a past president of the Canadian Economics Association and has served on the editorial boards of the American Economic Review and the Journal of Monetary Economics and as managing editor of the Canadian Journal of Economics. Professor Parkin’s research on macroeconomics, monetary economics, and international economics has resulted in over 160 publications in journals and edited volumes, including the American Economic Review, the Journal of Political Economy, the Review of Economic Studies, the Journal of Monetary Economics, and the Journal of Money, Credit and Banking. He became most visible to the public with his work on inflation that discredited the use of wage and price controls. Michael Parkin also spearheaded the movement toward European monetary union. Professor Parkin is an experienced and dedicated teacher of introductory economics. 5 A01_PARK3608_14_GE_FM.indd 5 1/29/22 9:24 PM This page intentionally left blank A01_PARK3608_14_GE_FM.indd 6 1/29/22 9:24 PM ◆ BRIEF CONTENTS PART ONE INTRODUCTION 29 CHAPTER CHAPTER CHAPTER 1 What Is Economics? 29 2 The Economic Problem 61 3 Demand and Supply 85 PART TWO MACROECONOMIC DATA 115 CHAPTER 4 Measuring the Value of Production: CHAPTER GDP 115 5 Monitoring Jobs and Inflation 139 PART THREE MACROECONOMIC TRENDS 163 CHAPTER CHAPTER CHAPTER 6 Economic Growth 163 7 Finance, Saving, and Investment 191 8 Money, the Price Level, and CHAPTER 9 The Exchange Rate and the Balance of Payments 243 PART FOUR MACROECONOMIC FLUCTUATIONS 273 CHAPTER 10 Aggregate Supply and Aggregate Demand 273 11 Expenditure Multipliers 297 CHAPTER 12 The Business Cycle, Inflation, and CHAPTER Deflation 327 PART FIVE MACROECONOMIC POLICY 353 13 Fiscal Policy 353 CHAPTER 14 Monetary Policy 379 CHAPTER 15 International Trade Policy 405 CHAPTER Inflation 213 7 A01_PARK3608_14_GE_FM.indd 7 1/29/22 9:24 PM ◆ ALTERNATIVE PATHWAYS THROUGH THE CHAPTERS Macro Flexibility Chapter 1 Chapter 6 What Is Economics? Economic Growth Chapter 2 Chapter 7 Chapter 13 The Economic Problem Finance, Saving, and Investment Fiscal Policy Chapter 10 Chapter 12 Aggregate Supply and Aggregate Demand The Business Cycle, Inflation, and Deflation Chapter 3 Chapter 4 Demand and Supply Measuring the Value of Production: GDP Chapter 15 Chapter 5 International Trade Policy Monitoring Jobs and Inflation Chapter 7 Finance, Saving, and Investment Chapter 14 Monetary Policy Chapter 8 Money, the Price Level, and Inflation Chapter 9 The Exchange Rate and the Balance of Payments Chapter 11 Expenditure Multipliers Start here ... … then jump to any of these … … and jump to any of these after doing the prerequisites indicated 8 A01_PARK3608_14_GE_FM.indd 8 25/02/22 8:58 PM ◆ DETAILED CONTENTS PART ONE INTRODUCTION 29 CHAPTER 1 ◆ WHAT IS ECONOMICS? 29 Definition of Economics 30 Two Big Economic Questions 31 What, How, and For Whom? 31 Do Choices Made in the Pursuit of Self-Interest also Promote the Social Interest? 33 The Economic Way of Thinking 37 A Choice Is a Tradeoff 37 Making a Rational Choice 37 Benefit: What You Gain 37 Cost: What You Must Give Up 37 How Much? Choosing at the Margin 38 Choices Respond to Incentives 38 Economics as Social Science and Policy Tool 39 Economist as Social Scientist 39 Economist as Policy Adviser 39 Economists in the Economy 40 Jobs for an Economics Major 40 Will Jobs for Economics Majors Grow? 40 Earnings of Economics Majors 41 Skills Needed for Economics Jobs 41 A Diversity Challenge in the Economics Profession 41 APPENDIX Graphs in Economics 45 Graphing Data 45 Graphing Economic Data 46 Scatter Diagrams 46 Graphs Used in Economic Models 48 Variables That Move in the Same Direction 48 Variables That Move in Opposite Directions 49 Variables That Have a Maximum or a Minimum 50 Variables That Are Unrelated 51 The Slope of a Relationship 52 The Slope of a Straight Line 52 The Slope of a Curved Line 53 Graphing Relationships Among More Than Two Variables 54 Ceteris Paribus 54 When Other Things Change 55 MATHEMATICAL NOTE Equations of Straight Lines 56 ■ AT ISSUE, 36 ■ ECONOMICS IN THE NEWS, 34 Worked Problem, Summary (Key Points and Key Terms), Problems and Applications, and Additional Problems and Applications appear at the end of each chapter. 9 A01_PARK3608_14_GE_FM.indd 9 1/29/22 9:24 PM 10 DETAILED CONTENTS CHAPTER 2 ◆ THE ECONOMIC PROBLEM 61 CHAPTER 3 ◆ DEMAND AND SUPPLY 85 Production Possibilities and Opportunity Cost 62 Production Possibilities Frontier 62 Production Efficiency 63 Tradeoff Along the PPF 63 Opportunity Cost 63 Markets and Prices 86 Using Resources Efficiently 65 The PPF and Marginal Cost 65 Preferences and Marginal Benefit 66 Allocative Efficiency 67 Gains from Trade 68 Comparative Advantage and Absolute Advantage 68 Achieving the Gains from Trade 70 The Liz–Joe Economy and Its PPF 72 Economic Growth 73 The Cost of Economic Growth 73 A Nation’s Economic Growth 74 Changes in What We Produce 74 Economic Coordination 76 Firms 76 Markets 76 Property Rights 76 Money 76 Circular Flows Through Markets 76 Coordinating Decisions 77 ■■ ECONOMICS IN ACTION, 74 ■■ ECONOMICS IN THE NEWS, 64, 78 Demand 87 The Law of Demand 87 Demand Curve and Demand Schedule 87 A Change in Demand 88 A Change in the Quantity Demanded Versus a Change in Demand 90 Supply 92 The Law of Supply 92 Supply Curve and Supply Schedule 92 A Change in Supply 93 A Change in the Quantity Supplied Versus a Change in Supply 94 Market Equilibrium 96 Price as a Regulator 96 Price Adjustments 97 Predicting Changes in Price and Quantity 98 An Increase in Demand 98 A Decrease in Demand 98 An Increase in Supply 100 A Decrease in Supply 100 Changes in Both Demand and Supply 102 MATHEMATICAL NOTE Demand, Supply, and Equilibrium 106 ■■ ECONOMICS IN THE NEWS, 99, 101, 104 PART ONE WRAP-UP ◆ Understanding the Scope of Economics Your Economic Revolution 113 Talking with Esther Duflo 114 A01_PARK3608_14_GE_FM.indd 10 1/29/22 9:24 PM DETAILED CONTENTS PART TWO MACROECONOMIC DATA 115 CHAPTER 4 ◆ MEASURING THE VALUE OF PRODUCTION: GDP 115 Gross Domestic Product 116 GDP Defined 116 GDP and the Circular Flow of Expenditure and Income 116 Why “Domestic” and Why “Gross”? 118 Measuring U.S. GDP 119 The Expenditure Approach 119 The Income Approach 120 Nominal GDP and Real GDP 121 Calculating Real GDP 121 The Uses and Limitations of Real GDP 122 The Standard of Living Over Time 122 The Standard of Living Across Countries 124 Limitations of GDP 125 APPENDIX Graphs in Macroeconomics 130 The Time-Series Graph 130 Making a Time-Series Graph 130 Reading a Time-Series Graph 130 Ratio Scale Reveals Trend 131 A Time-Series with a Trend 131 Using a Ratio Scale 131 MATHEMATICAL NOTE Chained-Dollar Real GDP 132 ■ ECONOMICS IN ACTION, 127 ■ AT ISSUE, 126 ■ ECONOMICS IN THE NEWS, 128 11 CHAPTER 5 ◆ MONITORING JOBS AND INFLATION 139 Employment and Unemployment 140 Why Unemployment Is a Problem 140 Current Population Survey 141 Three Labor Market Indicators 141 Other Definitions of Unemployment 143 Most Costly Unemployment 144 Alternative Measures of Unemployment 144 Unemployment and Full Employment 145 Frictional Unemployment 145 Structural Unemployment 145 Cyclical Unemployment 145 “Natural” Unemployment 145 Real GDP and Unemployment over the Cycle 146 The Price Level, Inflation, and Deflation 148 Why Inflation and Deflation Are Problems 148 The Consumer Price Index 149 Reading the CPI Numbers 149 Constructing the CPI 149 Measuring the Inflation Rate 150 Distinguishing High Inflation from a High Price Level 151 The Biased CPI 151 Consequences and Magnitude of Bias 152 Alternative Price Indexes 152 Core Inflation 153 ■ ECONOMICS IN ACTION, 140, 147 ■ ECONOMICS IN THE NEWS, 154 PART TWO WRAP-UP ◆ Monitoring Macroeconomic Performance The Big Picture 161 Talking with Dave Donaldson 162 A01_PARK3608_14_GE_FM.indd 11 1/29/22 9:24 PM 12 DETAILED CONTENTS PART THREE MACROECONOMIC TRENDS 163 CHAPTER 6 ◆ ECONOMIC GROWTH 163 The Basics of Economic Growth 164 Calculating Growth Rates 164 Economic Growth Versus Business Cycle Expansion 164 The Magic of Sustained Growth 165 Applying the Rule of 70 166 Long-Term Growth Trends 167 Long-Term Growth in the U.S. Economy 167 Real GDP Growth in the World Economy 168 How Potential GDP Grows 170 What Determines Potential GDP? 170 What Makes Potential GDP Grow? 172 Why Labor Productivity Grows 175 Preconditions for Labor Productivity Growth 175 Physical Capital Growth 175 Human Capital Growth 176 Technological Advances 176 Is Economic Growth Sustainable? Theories, Evidence, and Policies 179 Classical Growth Theory 179 Neoclassical Growth Theory 179 New Growth Theory 180 New Growth Theory Versus Malthusian Theory 182 Sorting Out the Theories 182 The Empirical Evidence on the Causes of Economic Growth 182 Policies for Achieving Faster Growth 182 CHAPTER 7 ◆ FINANCE, SAVING, AND INVESTMENT 191 Financial Markets and Financial Institutions 192 Finance and Money 192 Capital and Financial Capital 192 Capital and Investment 192 Wealth and Saving 192 Financial Capital Markets 193 Financial Institutions 194 Funds That Finance Investment 196 Financial Decisions and Risks 198 The Time Value of Money 198 Net Present Value 198 The Decision Rule 198 Financial Risk: Insolvency and Illiquidity 198 Market Risk: Interest Rates and Asset Prices 199 Getting Real 199 The Loanable Funds Market 200 The Demand for Loanable Funds 200 The Supply of Loanable Funds 200 Equilibrium in the Loanable Funds Market 201 Changes in Demand and Supply 202 Government in the Loanable Funds Market 204 A Government Budget Surplus 204 A Government Budget Deficit 204 ■ ECONOMICS IN ACTION, 194, 197, 202 ■ ECONOMICS IN THE NEWS, 206 ■ ECONOMICS IN ACTION, 169, 176, 177 ■ ECONOMICS IN THE NEWS, 178, 184 A01_PARK3608_14_GE_FM.indd 12 1/29/22 9:24 PM DETAILED CONTENTS 13 CHAPTER 8 ◆ MONEY, THE PRICE LEVEL, AND INFLATION 213 What Is Money? 214 Medium of Exchange 214 Unit of Account 214 Store of Value 215 Money in the United States Today 215 Depository Institutions 217 Types of Depository Institutions 217 What Depository Institutions Do 217 Economic Benefits Provided by Depository Institutions 218 How Depository Institutions Are Regulated 218 Financial Technology 220 The Federal Reserve System 221 The Structure of the Fed 221 The Fed’s Balance Sheet 222 The Fed’s Policy Tools 222 How Banks Create Money 224 Creating Deposits by Making Loans 224 The Money Creation Process 225 The Money Multiplier 226 The Money Market 228 The Demand for Money 228 Changes in the Demand for Money 228 The Supply of Money 229 Money Market Equilibrium 230 The Quantity Theory of Money 232 MATHEMATICAL NOTE The Money Multiplier 236 ■■ ECONOMICS IN ACTION, 215, 220, 223, 226, 232 ■■ AT ISSUE, 219 ■■ ECONOMICS IN THE NEWS, 227, 234 CHAPTER 9 ◆ THE EXCHANGE RATE AND THE BALANCE OF PAYMENTS 243 The Foreign Exchange Market 244 Trading Currencies 244 Exchange Rates 244 Questions About the U.S. Dollar Exchange Rate 244 An Exchange Rate Is a Price 244 The Demand for One Money Is the Supply of Another Money 245 Demand in the Foreign Exchange Market 245 Demand Curve for U.S. Dollars 246 Supply in the Foreign Exchange Market 247 Supply Curve for U.S. Dollars 247 Market Equilibrium 248 Changes in the Demand for U.S. Dollars 248 Changes in the Supply of U.S. Dollars 249 Changes in the Exchange Rate 250 Arbitrage, Speculation, and Market Fundamentals 252 Arbitrage 252 Speculation 253 Market Fundamentals 254 Exchange Rate Policy 255 Flexible Exchange Rate 255 Fixed Exchange Rate 255 Crawling Peg 256 Financing International Trade 258 Balance of Payments Accounts 258 Borrowers and Lenders 260 The Global Loanable Funds Market 260 Debtors and Creditors 261 Is U.S. Borrowing for Consumption? 261 Current Account Balance 262 Net Exports 262 Where Is the Exchange Rate? 263 ■■ ECONOMICS IN ACTION, 245, 251, 253, 256, 259, 263 ■■ ECONOMICS IN THE NEWS, 264 PART THREE WRAP-UP ◆ Understanding Macroeconomic Trends Expanding the Frontier 271 Talking with Xavier Sala-i-Martin 272 A01_PARK3608_14_GE_FM.indd 13 1/29/22 9:24 PM 14 DETAILED CONTENTS PART FOUR MACROECONOMIC FLUCTUATIONS 273 CHAPTER 10 ◆ AGGREGATE SUPPLY AND AGGREGATE DEMAND 273 Aggregate Supply 274 Quantity Supplied and Supply 274 Long-Run Aggregate Supply 274 Short-Run Aggregate Supply 275 Changes in Aggregate Supply 276 Aggregate Demand 278 The Aggregate Demand Curve 278 Changes in Aggregate Demand 279 Explaining Macroeconomic Trends and Fluctuations 282 Short-Run Macroeconomic Equilibrium 282 Long-Run Macroeconomic Equilibrium 282 Economic Growth and Inflation in the AS-AD Model 283 The Business Cycle in the AS-AD Model 284 Fluctuations in Aggregate Demand 286 Fluctuations in Aggregate Supply 287 Macroeconomic Schools of Thought 288 The Classical View 288 The Keynesian View 288 The Monetarist View 289 The Way Ahead 289 ■ ECONOMICS IN ACTION, 280, 283, 284 ■ ECONOMICS IN THE NEWS, 290 CHAPTER 11 ◆ EXPENDITURE MULTIPLIERS 297 Fixed Prices and Expenditure Plans 298 Expenditure Plans 298 Consumption and Saving Plans 298 Marginal Propensities to Consume and Save 300 Slopes and Marginal Propensities 300 Consumption as a Function of Real GDP 301 Import Function 301 Real GDP with a Fixed Price Level 302 Aggregate Planned Expenditure 302 Actual Expenditure, Planned Expenditure, and Real GDP 303 Equilibrium Expenditure 304 Convergence to Equilibrium 305 The Multiplier 306 The Basic Idea of the Multiplier 306 The Multiplier Effect 306 Why Is the Multiplier Greater Than 1? 307 The Size of the Multiplier 307 The Multiplier and the Slope of the AE Curve 308 Imports and Income Taxes 309 The Multiplier Process 309 Business Cycle Turning Points 310 The Multiplier and the Price Level 311 Adjusting Quantities and Prices 311 Aggregate Expenditure and Aggregate Demand 311 Deriving the Aggregate Demand Curve 311 Changes in Aggregate Expenditure and Aggregate Demand 312 Equilibrium Real GDP and the Price Level 313 MATHEMATICAL NOTE The Algebra of the Keynesian Model 318 ■ ECONOMICS IN ACTION, 301, 310 ■ ECONOMICS IN THE NEWS, 316 A01_PARK3608_14_GE_FM.indd 14 1/29/22 9:24 PM DETAILED CONTENTS CHAPTER 12 ◆ THE BUSINESS CYCLE, INFLATION, AND DEFLATION 327 The Business Cycle 328 Mainstream Business Cycle Theory 328 Real Business Cycle Theory 329 Inflation Cycles 333 Demand-Pull Inflation 333 Cost-Push Inflation 335 Expected Inflation 337 Forecasting Inflation 338 Inflation and the Business Cycle 338 Deflation 339 What Causes Deflation? 339 What Are the Consequences of Deflation? 341 How Can Deflation Be Ended? 341 The Phillips Curve 342 The Short-Run Phillips Curve 342 The Long-Run Phillips Curve 342 ■ ECONOMICS IN ACTION, 330, 340, 343 ■ ECONOMICS IN THE NEWS, 344 PART FOUR WRAP-UP ◆ Understanding Macroeconomic Fluctuations Boom and Bust 351 Talking with Emi Nakamura 352 A01_PARK3608_14_GE_FM.indd 15 15 PART FIVE MACROECONOMIC POLICY 353 CHAPTER 13 ◆ FISCAL POLICY 353 The Federal Budget 354 The Institutions and Laws 354 Highlights of the 2022 Budget 355 The Budget in Historical Perspective 356 Budget Balance and Debt 358 State and Local Budgets 359 Supply-Side Effects of Fiscal Policy 360 Full Employment and Potential GDP 360 The Effects of the Income Tax 360 Taxes on Expenditure and the Tax Wedge 361 Taxes and the Incentive to Save and Invest 362 Tax Revenues and the Laffer Curve 363 The Supply-Side Debate 363 Generational Effects of Fiscal Policy 364 Generational Accounting and Present Value 364 The Social Security Time Bomb 364 Generational Imbalance 365 International Debt 365 Fiscal Stimulus 366 Automatic Fiscal Policy and Cyclical and Structural Budget Balances 366 Discretionary Fiscal Stimulus 369 ■ ECONOMICS IN ACTION, 359, 361, 368, 370 ■ ECONOMICS IN THE NEWS, 372 1/29/22 9:24 PM 16 DETAILED CONTENTS CHAPTER 14 ◆ MONETARY POLICY 379 Monetary Policy Objectives and Framework 380 Monetary Policy Objectives 380 Operational “Stable Prices” Goal 381 Operational “Maximum Employment” Goal 381 Responsibility for Monetary Policy 382 The Conduct of Monetary Policy 382 The Monetary Policy Instruments 382 Monetary Policy Decisions 383 Hitting the Federal Funds Rate Target 385 Monetary Policy Transmission 387 Quick Overview 387 Changes in Interest Rates 388 Changes in Money and Loans 388 Changes in Real GDP, Unemployment, and Inflation 389 The Change in Aggregate Demand, Real GDP, and the Price Level 389 The Fed Fights Recession 390 The Fed Fights Inflation 392 Loose Links and Long and Variable Lags 393 Policy Strategies and Clarity 394 Financial Crisis: Cure and Prevention 396 The Anatomy of the Financial Crisis 396 The Fed’s Policy Actions in Crisis 396 Congress’s Policy Actions in Crisis 396 Macroprudential Regulation 397 ■■ ECONOMICS IN ACTION, 394 ■■ AT ISSUE, 386 ■■ ECONOMICS IN THE NEWS, 398 CHAPTER 15 ◆ INTERNATIONAL TRADE POLICY 405 How Global Markets Work 406 International Trade Today 406 What Drives International Trade? 406 Why the United States Imports T-Shirts 407 Why the United States Exports Airplanes 408 Winners, Losers, and the Net Gain from Trade 409 Gains and Losses from Imports 409 Gains and Losses from Exports 409 Gains for All 409 International Trade Restrictions 410 Tariffs 410 Import Quotas 412 Other Import Barriers 415 Export Subsidies 415 The Case Against Protection 416 Helps an Infant Industry Grow 416 Counteracts Dumping 416 Saves Domestic Jobs 416 Allows Us to Compete with Cheap Foreign Labor 416 Penalizes Lax Environmental Standards 417 Prevents Rich Countries from Exploiting Developing Countries 417 Reduces Offshore Outsourcing That Sends Good U.S. Jobs to Other Countries 417 Avoiding Trade Wars 418 Why Is International Trade Restricted? 418 Compensating Losers 419 ■■ ECONOMICS IN ACTION, 406, 411, 412 ■■ AT ISSUE, 418 ■■ ECONOMICS IN THE NEWS, 414, 420 PART FIVE WRAP-UP ◆ Understanding Macroeconomic Policy Tradeoffs and Free Lunches 427 Talking with Stephanie Schmitt-Grohé 428 Glossary G-1 Index I-1 Credits C-1 A01_PARK3608_14_GE_FM.indd 16 1/29/22 9:24 PM ECONOMICS 14th Edition Making economics real, showing the action and telling the story, learning interactively. Making Economics Real Economics in the News, Economics in Action, and Talking With focus on real-world issues and events. ECONOMICS IN THE NEWS Quantity of vanilla bean Price of vanilla bean Year (thousands of tons per year) (dollars per pound) 2015 2017 7.5 4.5 30 270 THE QUESTIONS ■ What does the data table tell us? Why did the price of vanilla bean rise? Was it because the demand for vanilla bean changed or the supply changed. In which direction did it change? ■ ■ THE ANSWERS ■ Singapore PPF in 2020 U.S. PPF in 2020 ■ D ■ Singapore PPF in 1980 ■ B C A ■ U.S. PPF in 1980 0 Consumption goods (per person) ■ Economic Growth in the United States and Singapore If such high economic growth rates are maintained, these other Asian countries will close the gap and overtake the United States, as Singapore has done. ■ The data table tells us that from 2015 to 2017, the quantity of vanilla bean produced decreased and the price of vanilla bean increased sharply. An increase in demand brings an increase in the quantity and a rise in the price. A decrease in supply brings a decrease in the quantity and a rise in the price. Because the quantity of vanilla bean decreased and the price of vanilla bean increased, there must have been a decrease in the supply of vanilla bean. The news clip says a cyclone hit Madagascar, which decreased production and brought a decrease in the supply of vanilla bean. The figure illustrates the market for vanilla bean in 2015 and 2017. The demand curve D shows the demand for vanilla bean. In 2015, the supply curve was S15, the price was $30 a pound, and the quantity of vanilla bean traded was 7.5 thousand tons. In 2017, the decreased production in Madagascar decreased the supply of vanilla bean to S17. The price rose to $270 a pound and the quantity traded decreased to 4.5 thousand tons The higher price brought a decrease in the quantity of vanilla bean demanded, which is shown by the movement along the demand cur ve. Price (dollars per pound) Capital goods (per person) In 1980, the production possibilities per person in the United States were 40 percent higher than those in Singapore (see the figure). The United States devoted one fifth of its resources to accumulating capital, and in 1980, was at point A on its PPF. By 2020, U.S. production possibilities had doubled and production was at point B. In 1980, Singapore devoted 45 percent of its resources to accumulating capital and was at point C on its PPF. By 1992, Singapore’s real GDP per person had grown to equal that of the United States, and by 2020 to exceed it by 50 percent at point D on its 2020 PPF. If Singapore continues to devote more resources to accumulating capital than the United States does it will continue to grow more rapidly. But if Singapore decreases its capital accumulation, then its rate of economic growth will slow. Singapore is typical of the fast-growing Asian economies, which include Taiwan, Thailand, South Korea, and China. Production possibilities expand in these countries by between 5 percent and sometimes almost 10 percent a year. ESTHER DUFLO is the Abdul Latif Jameel Professor of Poverty Alleviation and Development Economics at the Massachusetts Institute of Technology. Among her many honors are the 2010 John Bates Clark Medal for the best economist under 40 and the Financial Times and Goldman Sachs Business Book of the Year Award in 2011 for her book (with Abhijit Banerjee) Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty. Professor Duflo’s research seeks to advance our understanding of the economic choices of the extremely poor by conducting massive real-world experiments. Professor Duflo was an undergraduate student of history and economics at École Normale Supérieure and completed a master’s degree at DELTA in Paris before moving to the United States. She earned her PhD in Economics at MIT in 1999. Michael Parkin talked with her about her work , which advances our understanding of the economic choices and condition of the very poor. THE DATA ■ Singapore Overtakes the United States 400 S17 Professor Duflo, what’s the story about how you became an economist and in particular the architect of experiments designed to understand the economic choices of the very poor? When I was a kid, I was exposed to many stories Cyclone decreases supply of vanilla bean … S15 300 ... the price rises ... accident, I discovered that economics was the way in which I could actually be useful: While spending a year in Russia teaching French and studying History, D 4.5 7.5 Quantity (thousands of tons per year) The Market for Vanilla Bean in 2015–2017 Price (dollars per ton) D2021 1,800 ... the price of cocoa has risen ... D2018 4.6 4.8 Quantity (millions of tons per year) 0 The Market for Cocoa Beans ECONOMICS IN THE NEWS WORKED PROBLEM 4. Sellers expect a higher price next weekend, so they decrease the quantity supplied this weekend by Quantity supplied Questions 1. If the price of a rose is $6, describe the situation in the rose market. Explain how the price adjusts. 2. If the price of a rose is $9, describe the situation in the rose market. Explain how the price adjusts. 3. What is the market equilibrium? 4. Rose sellers know that Mother’s Day is next weekend and they expect the price to be higher, so they withhold 60 roses from the market this weekend. What is the price this weekend? 5. On Mother’s Day, demand increases by 160 roses. What is the price of a rose on Mother’s Day? Solutions 1. At $6 a rose, the quantity demanded is 150 demanded exceeds the quantity supplied and there is a shortage of 90 roses. With people lining up Key Point: When a shortage exists, the price rises. 2. At $9 a rose, the quantity demanded is 50 and the quantity supplied is 150. The quantity supplied exceeds the quantity demanded and there is a surplus of 100 roses. With slow sales of roses and a surplus, the price falls to below $9 a rose. Key Point: When a surplus exists, the price falls. 3. Market equilibrium occurs at the price at which the quantity demanded equals the quantity supplied. That price is $7 a rose. The market equilibrium is a price of $7 a rose and 100 roses a week bought and sold, point A on the figure. Key Point: At market equilibrium, there is no shortage or surplus. A01_PARK3608_14_GE_FM.indd 17 (dollars per rose) Quantity supplied (roses per week) 6.00 150 0 7.00 100 40 8.00 70 70 9.00 50 90 At $7 a rose, there is a shortage of 60 roses, so the price rises to $8 a rose, where the quantity demanded equals the quantity supplied. (Point B) Key Point: When supply decreases, the price rises. 5. Demand increases by 160 roses. Sellers plan to increase the normal supply by the 60 roses withheld last weekend. Create the new table: Quantity demanded Price (dollars per rose) Quantity supplied (roses per week) 6.00 310 120 7.00 260 160 8.00 230 190 9.00 210 210 At $7 a rose, there is a shortage of 100 roses, demanded equals the quantity supplied. The price on Mother’s Day is $9 a rose. (Point C) Key Point: When demand increases by more than supply, the price rises. Key Figure Price (dollars per rose) 60 100 130 150 Quantity demanded Price (roses per week) 10 S1 9 8 5 0 S0 C B DM A 7 6 SM Before Mother's Day 50 70 100 Mother's Day Normal D0 150 210 Quantity (roses per week) The Markets for Chocolate and Cocoa We’re Heading for a Chocolate Crisis The world is running out of chocolate, and if we don’t take some significant action soon, we’ll be dealing with a major chocolate shortage in less than a decade. Chocolate is made from cocoa and a cocoa shortage is becoming more and more imminent, with prices rising. Source: ZME Science, Febr uary 1, 2021 THE DATA Quantity of cocoa Price of cocoa Year (millions of tons per year) (dollars per ton) 2018 2021 4.6 4.8 1,800 2,800 THE QUESTIONS ■ What does the data tell us? ■ Why did the price of cocoa increase? Was it because the demand for cocoa changed, or the supply changed? In which direction was the change? THE ANSWERS ■ The data table tells us that from 2018 to 2021, both the quantity of cocoa produced and the price of cocoa increased. ■ An increase in demand brings an increase in the quantity and a rise in the price. ■ An increase in supply brings an increase in the quantity and a fall in the price. ■ Because both the quantity of cocoa and the price of cocoa increased, there must have been in increase in the demand for cocoa. ■ The cocoa is used to produce chocolate, which is a normal good, so the demand for chocolate and cocoa increases when incomes increase. ■ Incomes are increasing, especially in fast-growing China and other Asian countries, so the demand for chocolate has increased, which has increased the demand for cocoa. ■ he figure illustrates the market for cocoa in 2018 T and 2021. The supply curve S shows the supply of cocoa. I■n 2018, the demand cur ve was D2018, the price was $1,800 per ton, and the quantity of cocoa traded was 4.6 million tons. ■ y 2021, the higher incomes in China and other B countries had increased the demand for cocoa to D2021. ■ he price rose to $2,800 per ton and the quantity T traded increased to 4.8 million tons. ■ he higher price brought an increase in the quantity T of cocoa supplied, which is shown by the movement upward along the supply cur ve. Price (dollars per ton) The table sets out the demand and supply schedules for roses on a normal weekend. 150 100 70 50 S .. and the quantity of cocoa beans supplied has increased 2,800 Worked Problem, and new Economics in the News video series with linked exercises promote active learning. Quantity demanded All told, you really have to imagine living on An increase in incomes has increased the demand for chocolate and cocoa beans, ... Learning Interactively Price about 3 times what it is in the United States. So the poverty line we use for India is 33 cents per day, not intervene in the world while keeping enough sanity to analyze it. I thought this would be ideal for me and I have never regretted it. I have the best job in the world. Graphs with realistic values; consistent use of color with blended arrows that show action; boxed notes that tell the story; and captions that make each diagram a self-contained object for study and review. 6.00 7.00 8.00 9.00 (e.g., a haircut) is cheaper. For example, in India, the purchasing power of sufficient discomfort that I knew 30 0 For defining the poverty line, we don’t include the cost of housing. The poor also get free goods, sometimes of bad quality (education, healthcare) and the value of those is also not included. Other than that, Moreover, you have to realize this is everything, stories about children living all around the world. taking into account the fact that I remember asking myself how life is much cheaper in many I could justify my luck of being … imagine living on under a dollar born where I was. I had a very a day after your rent is paid in exaggerated idea of what it was Seattle or Denver. Not easy! ... and the quantity demanded decreases 200 100 The ver y poor whom you study are people who live on $1 a day or $2 a day. … Is $1 a day a true measure engagement as a doctor in a small NGO dealing 270 Showing the Action and Telling the Story (dollars per rose) Esther Duflo Crop Uncertainty Drives Vanilla Price Back to Record Level The price of vanilla soared to a record $270 a pound last year after a cyclone hit the Madagascar. Source: Financial Times, March 25, 2018 ■ ECONOMICS IN ACTION TALKING WITH The Market for Vanilla Bean An increase in incomes has increased the demand for chocolate and cocoa beans, ... 1,800 S .. and the quantity of cocoa beans supplied has increased 2,800 D2021 ... the price of cocoa has risen ... D2018 0 4.6 4.8 Quantity (millions of tons per year) The Market for Cocoa Beans 1/29/22 9:24 PM This page intentionally left blank A01_PARK3608_14_GE_FM.indd 18 1/29/22 9:24 PM ◆ PREFACE ◆ What’s New in This Edition New in this fourteenth edition revision are: Fine-tuning the content; several notable changes; and an applications video series. Fine-Tuning the Content This revision is driven by the drama of the extraordinary period of economic history in which we are living and its rich display of events and forces through which students can be motivated to discover the power of economic models and the economic way of thinking. Chief among these events is the Covid pandemic, its impacts on markets and resource allocation, and the extraordinary fiscal policy and monetary policy responses it has brought. But Covid isn’t an isolated shock in an otherwise tranquil world. Persistent slow economic growth; increasing concentration of wealth; ongoing tensions arising from the loss of American jobs to offshore outsourcing and the political popularity of trade protection; a slowing pace of China’s expansion; enhanced concern about carbon emission and climate change; relentless pressure on the federal budget from the demands of an aging population and a sometimes dysfunctional Congress with its associated rising government debt; the dilemma posed by slow, more than decadelong recovery from a global financial crisis and recession and the related question, magnified by Covid, of when and how fast to exit an era of extreme monetary stimulus. All of these events feature at the appropriate points in this new edition. Every chapter contains many small changes, all designed to enhance clarity, currency, and relevancy and the text and examples are all updated to reflect the most recently available data and events. Notable Content Changes Chapter 1, What Is Economics?, has a new section on the diversity challenge in economics. Women and minorities are under-represented in economics at every level: in undergraduate programs, graduate school, faculty appointments, and the broader private and public sector jobs. Under-representation in economics is more persistent and greater than in other subjects that use similar skills. All the chapters are updated to include the latest data on: the national accounts in Chapter 4; the labor market and price indexes, Chapter 5; economic growth, Chapter 6; interest rates and loanable funds, Chapter 7; banks and the money market, Chapter 8; the exchange rate and balance of payments, Chapter 9; the short-run Phillips curve tradeoff, Chapter 12; fiscal policy, Chapter 13; and monetary policy, Chapter 14. Ten chapters have an analysis of news reports about the macroeconomic effects of Covid and the policy responses it triggered. These include the effects of the pandemic on the production possibilities frontier, Chapter 2, demand and supply in the hand sanitizer market, Chapter 3, nowcasting GDP in the pandemic, Chapter 4; measuring unemployment, Chapter 5; massive bond buying by the Federal Reserve, Chapter 8; the Covid recession viewed through the lens of the AS-AD model, Chapter 10; inventories in the Covid recession, Chapter 11; post-Covid inflation fears in Chapter 12; and the effects of fiscal and monetary stimulus in the Covid recession in Chapters 13 and 14. Other changes include an explanation of the Fed’s new operating procedures with ample reserves, Chapter 14; a look at China’s slowing growth rate, Chapter 6; the growth of “fintec”’ in financial markets, Chapter 7; and currency manipulation, Chapter 9. 19 A01_PARK3608_14_GE_FM.indd 19 1/29/22 9:24 PM 20 PREFACE Notable New Videos Thirty videos based on Economics in the News and Economics in Action boxes provide a lively alternative way of applying economic principles to real-world issues and events. Each video runs for around two minutes and is accompanied by a short quiz. Examples of items included in this video series are the rising price of chocolate, the the UN Human Development Index (HDI), unemployment in the Covid recession, money and interest rates, China’s currency manipulation, aggregate demand and aggregate supply in action, and the fiscal policy and monetary policy responses to Covid. ◆ THE VISION To change the way students see the world: this is my goal in teaching economics and in writing this book. Three facts about students are my guiding principles. First, students want to learn, but they are overwhelmed by the volume of claims on their time and energy. So, they must see the relevance to their lives and future careers of what they are being asked to learn. Second, students want to get it, and get it quickly. So, they must be presented with clear and succinct explanations. Third, students want to make sense of today’s world and be better prepared for life after school. So, they must be shown how to apply the timeless principles of economics and its models to illuminate and provide a guide to understanding today’s events and issues, and the future challenges they are likely to encounter. The organization, structure, and features of this text arise directly from the three guiding principles, and I will describe them by placing them in four groups: Making economics real Showing the action and telling the story ■■ Learning interactively—learning by doing ■■ Developing employability and citizenship skills ■■ ■■ Making Economics Real The student needs to see economics as a lens that sharpens the focus on real-world issues and events, and not as a series of logical exercises with no real purpose. Economics in the News, At Issue, and Economics in Action are designed to achieve this goal. Each chapter ends with an Economics in the News application that helps students to think like economists by connecting the chapter tools and concepts to the world around them. In many chapters, an additional briefer Economics in the News presents a short news clip, supplemented by data where needed, that poses some questions and walks through the answers. Four At Issue boxes engage the student in debate and controversy. An At Issue box introduces an issue and then presents two opposing views. It leaves the matter unsettled so that students and the instructor can continue the argument in class and reach their own conclusions. Economics in Action boxes make economics real by providing data and information that links models to real-world economic activity. Some of the issues covered in these boxes include the the HDI versus GDP; the fast-growing Asian economies; the home price bubble; banks flush with reserves; and the size of the fiscal stimulus multipliers. A01_PARK3608_14_GE_FM.indd 20 1/29/22 9:24 PM PREFACE 21 Interviews with leading economist, whose work correlates to what the student is learning, are the final component of making economics real. These interviews explore the education and research of prominent economists and their advice for those who want to continue studying the subject. This edition has new interviews with Emi Nakamura and Dave Donaldson, two outstanding economists recognized by being awarded the American Economic Association’s highest honor for economists under the age of 40. Showing the Action and Telling the Story Through the past twelve editions, this book has set the standard of clarity in its diagrams; the thirteenth edition continues to uphold this tradition. My goal is to show “where the economic action is.” The diagrams in this book continue to generate an enormously positive response, which confirms my view that graphical analysis is the most powerful tool available for teaching and learning economics at the principles level. Recognizing that some students find graphs hard to work with, I have developed the entire art program with the study and review needs of the student in mind. The diagrams feature Axes that measure and display concrete real-world data, and where possible and relevant, the most recent data ■■ Graphs paired with data tables from which curves are plotted ■■ Original curves consistently shown in blue ■■ Shifted curves, equilibrium points, and other important features highlighted in red ■■ Color-blended arrows to indicate movement ■■ Diagrams labeled with boxed notes that tell the story ■■ Extended captions that make each diagram and its caption a self-contained object for study and review ■■ Learning Interactively—Learning by Doing Every chapter section closes with a Review Quiz, which invites the student to rework the section with questions that cover the key ideas. As part of the chapter review, the student is presented with a Worked Problem, a multi-part problem that covers the core content of the chapter and consists of questions, solutions, key points, and a key figure. This feature increases the incentive for the student to learn-by-doing and review the chapter actively. Developing Employability and Citizenship Skills The economic way of thinking is a foundational skill for career and citizenship. Every feature of the text helps the student develop this skill, repeatedly using its central ideas of tradeoff; opportunity cost; the margin; incentives; the gains from voluntary exchange; the forces of demand, supply, and equilibrium; the pursuit of economic rent; and the tension between self-interest and the social interest. The section of Chapter 1, “Economists in the Economy”, identifies a further five general skills that are crucial for getting a job and developing a successful career. This text lays the foundation for effective citizenship by explaining the principles of welfare economics and the competing ideas about fairness, and repeatedly applying these principles to a comprehensive range of public choice problems. A01_PARK3608_14_GE_FM.indd 21 1/29/22 9:24 PM 22 PREFACE ◆ Organization I have organized the sequence of topics and chapters in what I think is the most natural order in which to cover the material. But I recognize that there are alternative views on the best order. I have kept this fact and the need for flexibility firmly in mind throughout the text. Many alternative sequences work, and the Flexibility Chart on p. 8 explains the alternative pathways through the chapters. In using the flexibility information, keep in mind that the best sequence is the one in which I present the topics. And even chapters that the flexibility chart identifies as strictly optional are better covered than omitted. ◆ Teaching Resources Parkin teaching resources include an Instructor’s Manual, Solutions Manual, Test Bank, and PowerPoint. Instructors can download these resources at www.pearsonglobaleditions.com. The Instructor’s Manual, authored by Mark Rush, University of Florida, contains chapter-by-chapter overviews; a list of what’s new in the fourteenth edition; and ready-to-use lecture notes. The Solution Manual, authored by Mark Rush, University of Florida, contains solutions to all Review Quizzes; End-of-chapter Problems; and End-of-chapter Additional Problems and Applications. The Test Bank contains 6,000 questions, authored by Svitlana Malsymenko, Uni versity of Pittsburgh, and James K. Self, Lee College and reviewed by Mark Rush, University of Florida to ensure clarity and consistency. The four types of questions are: multiple-choice, short-answer, graphing, and essay. Each question is classified by the term or concept it supports, its level of difficulty: 1 for straight recall, 2 for some analysis, 3 for complex analysis, and its AACSB category. The Association to Advance Collegiate Schools of Business (AACSB) Guidelines propose learning experiences in the following categories of Assurance of Learning Standards: Written and Oral Communication; Ethical Understanding and Reasoning; Analytical Thin king; Interpersonal Relations and Teamwork; Diverse and Multicultural Work Environments; Reflective Thinking; Application of Knowledge; and Integration of Real-World Business Experiences. The Computerized TestGen allows instructors to customize, save, and generate tests; edit, add, or delete questions from the Test Bank; analyze test results; and organize a database of tests and student results. TestGen offers many options for organizing and displaying tests, along with search and sort features. Instructors can download the software and the Test Bank at www.pearsonglobaleditions.com. The Instructor’s PowerPoint contains ready-made lectures with text figures and tables animated, along with speaking notes from the Instructor’s Manual. Large versions of all figures are available for instructors to use in creating their own lectures. A01_PARK3608_14_GE_FM.indd 22 1/29/22 9:24 PM PREFACE 23 ◆ Acknowledgments I thank my current and former colleagues and friends at the University of Western Ontario who have taught me so much. They are Jim Davies, Jeremy Greenwood, Ig Horstmann, Peter Howitt, Greg Huffman, David Laidler, Phil Reny, Chris Robinson, and John Whalley. I also thank Doug McTaggart and Christopher Findlay, co-authors of an Australian edition, and Melanie Powell and Kent Matthews, co-authors of the European edition. Suggestions arising from their adaptations of earlier editions have been helpful to me in preparing this edition. I thank the several thousand students whom I have been privileged to teach. The instant response that comes from the look of puzzlement or enlightenment has taught me how to teach economics. It is a special joy to thank the many outstanding people at Pearsonwho contribut ed to the concerted publishing effort that brought this edition to completion. Christopher DeJohn, Content Manager Quantitative Business, and Samantha Lewis, Product Manager, provided direction and overall management of the project. Thomas Hay ward, Senior Content Analyst, provided helpful guidance on the priorities for this revision and enthusiastic support. Elaine Page, Senior Content Producer, Economics, managed the production process, and drawing on her earlier career as a development editor gave good advice on the new way news items are presented. Noel Lotz, Digital Content Manager, and Melissa Honig, Digital Studio Producer, directed the production of MyLab content and the eText and ensured that all our media assets were correctly assembled. Ashley DePace, Product Marketing Manager, provided inspired marketing strategy and direction, and Kristin Jobe and Gina Linko, Content Project Managers, kept the project on track on a tight schedule. I thank all of these wonderful people. It has been inspiring to work with them and to share in creating what I believe is a truly outstanding e ducational tool. I thank Catherine Baum, who provided a careful, consistent, and intelligent copy edit and accuracy check. I especially thank Mark Rush, who yet again played a crucial role in creating another edition of this text and package. Mark has been a constant source of good advice and good humor. I thank the many exceptional reviewers who have shared their insights through the various editions of this book. Their contribution has been invaluable. I thank the people who work directly with me. Jeannie Shearer provided outstanding research assistance on many topics, including finding news articles and creating MyLab exercises. Richard Parkin created the electronic art files and offered many ideas that improved the figures in this book. Evan Sauve wrote scripts and worked with Liam Winckel and Richard to make the videos and associated exercises that are new in this edition. As with the previous editions, this one owes an enormous debt to Robin Bade. I dedicate this book to her and again thank her for her work. I could not have written this book without the tireless and selfless help she has given me. My thanks to her are unbounded. Classroom experience will test the value of this book. I would appreciate hear ing from instructors and students about how I can continue to improve it in future editions. Michael Parkin London, Ontario, Canada michael.parkin@uwo.ca A01_PARK3608_14_GE_FM.indd 23 1/29/22 9:24 PM 24 PREFACE ◆ Reviewers Eric Abrams, Hawaii Pacific University Christopher Adams, Federal Trade Commission John T. 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Hoffman, Arizona State University Paul Hohenberg, Rensselaer Polytechnic Institute Jim H. Holcomb, University of Texas, El Paso Robert Holland, Purdue University Harry Holzer, Georgetown University Linda Hooks, Washington and Lee University Gary Hoover, University of Oklahoma Jim Horner, Cameron University Djehane Hosni, University of Central Florida Harold Hotelling, Jr., Lawrence Technical University Calvin Hoy, County College of Morris Ing-Wei Huang, Assumption University, Thailand Julie Hunsaker, Wayne State University Beth Ingram, University of Iowa Jayvanth Ishwaran, Stephen F. Austin State University Michael Jacobs, Lehman College S. Hussain Ali Jafri, Tarleton State University Dennis Jansen, Texas A&M University Andrea Jao, University of Pennsylvania Barbara John, University of Dayton Barry Jones, Binghamton University Garrett Jones, Southern Florida University Frederick Jungman, Northwestern Oklahoma State University Paul Junk, University of Minnesota, Duluth Leo Kahane, California State University, Hayward Veronica Kalich, Baldwin-Wallace College John Kane, State University of New York, Oswego Eungmin Kang, St. Cloud State University Arthur Kartman, San Diego State University Theresa Kauffman, Chattahoochee Technical College Gurmit Kaur, Universiti Teknologi (Malaysia) Louise Keely, University of Wisconsin, Madison Manfred W. Keil, Claremont McKenna College Elizabeth Sawyer Kelly, University of Wisconsin, Madison Rose Kilburn, Modesto Junior College 1/29/22 9:24 PM 26 PREFACE Amanda King, Georgia Southern University John King, Georgia Southern University Robert Kirk, Indiana University-Purdue University, Indianapolis Norman Kleinberg, City University of New York, Baruch College Robert Kleinhenz, California State University, Fullerton Barry Kotlove, Edmonds Community College John Krantz, University of Utah Joseph Kreitzer, University of St. Thomas Patricia Kuzyk, Washington State University David Lages, Southwest Missouri State University W. J. Lane, University of New Orleans Leonard Lardaro, University of Rhode Island Kathryn Larson, Elon College Luther D. Lawson, University of North Carolina, Wilmington Elroy M. Leach, Chicago State University Jim Lee, Texas A & M, Corpus Christi Sang Lee, Southeastern Louisiana University Robert Lemke, Florida International University Mary Lesser, Iona College Philip K. 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Young, Riverside Community College Michael Youngblood, Rock Valley College Peter Zaleski, Villanova University 1/29/22 9:24 PM 28 PREFACE Tianwei Zhang, University of Georgia Jason Zimmerman, South Dakota State University David Zucker, Martha Stewart Living Omnimedia Supplements Authors Luke Armstrong, Lee College Sue Bartlett, University of South Florida Kelly Blanchard, Purdue University James Cobbe, Florida State University Carol Dole, Jacksonville University Karen Gebhardt, Colorado State University John Graham, Rutgers University Jill Herndon, University of Florida Gary Hoover, University of Alabama Patricia Kuzyk, Washington State University Sang Lee, Southeastern Louisiana University Svitlana Maksymenko, University of Pittsburgh Robert Martel, University of Connecticut Katherine McClain, University of Georgia Russ McCullough, Iowa State University Barbara Moore, University of Central Florida James Morley, Washington University in St. Louis William Mosher, Clark University Alexandra Nica, University of Iowa Constantin Ogloblin, Georgia Southern University Edward Price, Oklahoma State University Mark Rush, University of Florida James K. Self, University of Indiana, Bloomington Rebecca Stein, University of Pennsylvania Michael Stroup, Stephen F. Austin State University Della Lee Sue, Marist College Nora Underwood, University of Central Florida Laura A. Wolff, Southern Illinois University, Edwardsville ◆ Global Edition Acknowledgments Contributor Eliane Haykal teaches Economics at Notre Dame University and the University of Balamand, Lebanon. Her work and research is focused on international trade with the objective of examining the comparative advantage of Lebanon. Reviewers We are deeply grateful to the following reviewers, who provided invaluable insights that helped further develop the content. Merve Burnazoglu, Utrecht University Natalie Chen, University of Warwick Simeon Coleman, Loughborough University Carsten Küchler, Lucerne School of Business Eddie Cheung Chi Leung, The Open University of Hong Kong Joyce Chai Hui Ming, Temasek Polytechnic Malatji Moye, University of South Africa Mario Pezzino, University of Manchester Heng Kiat Sing, Swinburne University Subidey Togan, Bilkent University A01_PARK3608_14_GE_FM.indd 28 1/29/22 9:24 PM PArT ONE INTRODUCTION 1 WHAT IS ECONOMICS? After studying this chapter, you will be able to: ◆ Define economics and distinguish between microeconomics and macroeconomics ◆ Explain the two big questions of economics ◆ Explain the key ideas that define the economic way of thinking ◆ Explain how economists go about their work as social scientists and policy advisers ◆ Describe the jobs available to a graduate with a major in economics ◆ Is economics about money: How people make it and spend it? Is it about business, government, and jobs? Is it about why some people and some nations are rich and others poor? Economics is about all these things. But its core is the study of choices and their consequences. Your life will be shaped by the choices that you make and the challenges that you face. To face those challenges and seize the opportunities they present, you must understand the powerful forces at play. The economics that you’re about to learn will become your most reliable guide. This chapter gets you started by describing the questions that economists try to answer and looking at how economists think as they search for the answers. 29 M01_PARK3608_14_GE_C01.indd 29 07/01/22 4:05 PM 30 ChAPTEr 1 What Is Economics? ◆ Definition of Economics A fundamental fact dominates our lives: We want more than we can get. Our inability to get everything we want is called scarcity. Scarcity is universal. It confronts all living things. Even parrots face scarcity! Because we can’t get everything we want, we must make choices. You can’t afford both a laptop and an iPhone, so you must choose which one to buy. You can’t spend tonight both studying for your next test and going to the movies, so again, you must choose which one to do. Governments can’t spend a tax dollar on both national defense and environmental protection, so they must choose how to spend that dollar. Your choices must somehow be made consistent with the choices of others. If you choose to buy a laptop, someone else must choose to sell it. Incentives reconcile choices. An incentive is a reward that encourages an action, or a penalty that discourages one. Prices act as incentives. If the price of a laptop is too high, more will be offered for sale than people want to buy. And if the price is too low, fewer will be offered for sale than people want to buy. But there is a price at which choices to buy and sell are consistent. Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that inﬂuence and reconcile those choices. Not only do I want a cracker—we all want a cracker! © The New Yorker Collection 1985 Frank Modell from cartoonbank.com. All rights reserved. Think about the things that you want and the scarcity that you face. You want to go to a good school, college, or university. You want to live in a well-equipped, spacious, and comfortable home. You want the latest smartphone and the fastest Internet connection for your laptop or tablet. You want some sports and recreational gear—perhaps some new running shoes, or a new bike. You want much more time than is available to go to class, do your homework, play sports and games, read novels, go to the movies, listen to music, travel, and hang out with your friends. And you want to live a long and healthy life. What you can afford to buy is limited by your income and by the prices you must pay. And your time is limited by the fact that your day has 24 hours. You want some other things that only governments provide. You want to live in a safe neighborhood in a peaceful and secure world, and enjoy the benefits of clean air, lakes, rivers, and oceans. What governments can afford is limited by the taxes they collect. Taxes lower people’s incomes and compete with the other things they want to buy. What everyone can get—what society can get—is limited by the productive resources available. These resources are the gifts of nature, human labor and ingenuity, and all the previously produced tools and equipment. M01_PARK3608_14_GE_C01.indd 30 The subject has two parts: Microeconomics Macroeconomics ■ ■ Microeconomics is the study of the choices that individuals and businesses make, the way these choices interact in markets, and the influence of governments. Some examples of microeconomic questions are: Why are people streaming more movies? How would a tax on on-line shopping affect Amazon? Macroeconomics is the study of the performance of the national economy and the global economy. Some examples of macroeconomic questions are: Why does the U.S. unemployment rate fluctuate? Can the Federal Reserve make the unemployment rate fall by keeping interest rates low? REVIEW QUIZ List some examples of the scarcity that you face. Find examples of scarcity in today’s headlines. 3 During the Covid pandemic, what incentives did you face and how did you respond? 4 Find an example of the distinction between microeconomics and macroeconomics in today’s headlines. 1 2 07/01/22 4:05 PM Two Big Economic Questions 31 ◆ Two Big Economic Questions Two big questions summarize the scope of economics: How do choices end up determining what, how, and for whom goods and services are produced? ■■ Do choices made in the pursuit of self-interest also promote the social interest? FIGURE 1.1 What Three Countries Produce United States ■■ What, How, and For Whom? Goods and services are the objects that people value and produce to satisfy wants. Goods are physical objects such as smartphones and automobiles. Services are tasks performed for people such as wireless service and auto-repair service. What? What we produce varies across countries and changes over time. In the United States today, agri culture accounts for 1 percent of total production, industry (manufactured goods) for 11 percent, and services (retail and wholesale trade, healthcare, and education are the biggest ones) for 80 percent. In contrast, in low-income Ethiopia, agriculture accounts for 35 percent of total production, industry for 22 percent, and services for 44 percent. Figure 1.1 shows these numbers and also the percentages for China, which fall between those for the United States and Ethiopia. What determines these patterns of production? How do choices end up determining the quantities of smartphones, automobiles, wireless service, auto-repair service, and the millions of other items that are produced in the United States and around the world? How? How we produce is described by the technolo- gies and resources that we use. The resources used to produce goods and services are called factors of production, which are grouped into four categories: Land Labor ■■ Capital ■■ Entrepreneurship ■■ ■■ Land The “gifts of nature” that we use to produce goods and services are called land. In economics, land is what in everyday language we call natural resources. It includes land in the everyday sense M01_PARK3608_14_GE_C01.indd 31 China Ethiopia 0 20 40 60 Percentage of production Agriculture Industry 80 100 Services Agriculture and industry are small percentages of production in rich countries such as the United States and large percentages of production in poor countries such as Ethiopia. Most of what is produced in the United States is services. The numbers for China fall between poor countries and rich countries. Source of data: The World Bank Group: Data of World Bank 2021. together with minerals, oil, gas, coal, water, air, forests, and fish. Our land surface and water resources are renewable and some of our mineral resources can be recy cled. But the resources that we use to create energy are nonrenewable—they can be used only once. Labor The work time and work effort that people devote to producing goods and services is called labor. Labor includes the physical and mental efforts of all the people who work on farms and construction sites and in factories, shops, and offices. The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work expe rience. You are building your own human capital right now as you work on your economics course, and your human capital will continue to grow as you gain work experience. Human capital expands over time. Today, 91 percent of the adult population of the United States have completed high school and 38 percent have a college or university degree. Figure 1.2 shows these measures of human capital in the United States and its growth since 1900. 07/01/22 4:05 PM 32 Chapter 1 What Is Economics? incomes have fewer options and can afford a smaller range of goods and services. People earn their incomes by selling the services of the factors of production they own: FIGURE 1.2 A Measure of Human Capital 100 Less than 5 years elementary school Land earns rent. Labor earns wages. ■■ Capital earns interest. ■■ Entrepreneurship earns profit. ■■ ■■ 75 Some high school Completed high school 50 1 to 3 years of college 25 4 years or more of college 0 1900 Year 1920 1940 1960 1980 2000 2020 In 2020, 38 percent of the population aged 25 and older had 4 years or more of college, up from 2 percent in 1900. A further 53 percent had completed high school, up from 12 percent in 1900. Source of data: U.S. Census Bureau, 2021. Capital The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are called capital. In everyday language, we talk about money, stocks, and bonds as being “capital.” These items are financial capital. Financial capital plays an important role in enabling businesses to borrow the funds that they use to buy physical capital. But financial capital is not used to produce goods and services and it is not a factor of production. Entrepreneurship The human resource that organizes labor, land, and capital is called entrepreneurship. Entrepreneurs are the drivers of economic progress. They develop new ideas about what and how to produce, make business decisions, and bear the risks that arise from these decisions. What determines how the factors of production are used to produce each good and service? For Whom? Who consumes the goods and services that are produced depends on the incomes that peo ple earn. People with large incomes can buy a wide range of goods and services. People with small M01_PARK3608_14_GE_C01.indd 32 Which factor of production earns the most income? The answer is labor. In 2020, wages were 55 percent of total income and the incomes from land, capital, and entrepreneurship totaled 45 percent. Labor’s share has fallen slightly over the past 20 years. Knowing how income is shared among the factors of production doesn’t tell us how it is shared among individuals. And the distribution of income among individuals is extremely unequal. You know of some people who earn very large incomes. In 2019, Stephen Curry earned $74.4 million and LeBron James earned $88.2 million. LeBron joined the Los Angeles Lakers in 2018 under a four-year $153 million contract. You know of even more people who earn very small incomes. Servers at McDonald’s average around $11.50 an hour; checkout clerks, cleaners, and textile and leather workers all earn less than $15 an hour. You probably know about other persistent differences in the incomes people earn. Men, on average, earn more than women; whites earn more than minorities; college graduates earn more than high-school graduates. We can get a good sense of who consumes the goods and services produced by looking at the percentages of total income earned by different groups of people. The 20 percent of people with the lowest incomes earn about 5 percent of total income, while the richest 20 percent earn close to 50 percent of total income. So on average, people in the richest 20 percent earn more than 10 times the incomes of those in the poorest 20 percent. There is even huge inequality within the richest 20 percent and the top 1 percent earns almost 15 percent of total income. Why is the distribution of income so unequal? Economics provides some answers to all these questions about what, how, and for whom goods and services are produced and much of the rest of this book will help you to understand those answers. We’re now going to look at the second big question of economics: Do choices made in the pursuit of self-interest also promote the social interest? 07/01/22 4:05 PM Two Big Economic Questions 33 Do Choices Made in the Pursuit of SelfInterest also Promote the Social Interest? Every day, you and 328 million other Americans, along with 7.9 billion people in the rest of the world, make economic choices that result in what, how, and for whom goods and services are produced. These choices are made by people who are pursuing their self-interest. Self-Interest You make a choice in your self-interest if you think that choice is the best one available for you. All the choices that people make about how to use their time and other resources are made in the pursuit of self-interest. When you allocate your time or your budget, you do what makes the most sense to you. You might think about how your choices affect other people and take into account how you feel about that, but it is how you feel that influences your choice. You order a home-delivery pizza because you’re hungry, not because the delivery person needs a job. And when the pizza delivery person shows up at your door, he’s not doing you a favor. He’s pursuing his self-interest and hoping for a tip and another call next week. The big question is: Is it possible that all the choices that each one of us makes in the pursuit of self-interest could end up achieving an outcome that is best for everyone? Social Interest An outcome is in the social interest if it is best for society as a whole. It is easy to see how you decide what is in your self-interest. But how do we decide if something is in the social interest? To help you answer this question, imagine a scene like that in Economics in the News on p. 34. Ted, an entrepreneur, creates a new business. He hires a thousand workers and pays them $20 an hour, $1 an hour more than they earned in their old jobs. Ted’s business is extremely profitable and his own earnings increase by $1 million per week. You can see that Ted’s decision to create the business is in his self-interest—he gains $1 million a week. You can also see that for Ted’s employees, their decisions to work for Ted are in their self-interest— they gain $1 an hour (say $40 a week). And the decisions of Ted’s customers must be in their self-interest, otherwise they wouldn’t buy from him. But is this outcome in the social interest? The economist’s answer is “Yes.” It is in the social interest because it makes everyone better off. There are no losers. M01_PARK3608_14_GE_C01.indd 33 Efficiency and the Social Interest Economists use the everyday word “efficient” to describe a situation that can’t be improved upon. Resource use is efficient if it is not possible to make someone better off without making someone else worse off. If it is possible to make someone better off without making anyone worse off, society can be made better off and the situation is not efficient. In the Ted story everyone is better off, so it improves efficiency and the outcome is in the social interest. But notice that it would also have been effi cient if the workers and customers had gained nothing and Ted had gained even more than $1 million a week. But would that efficient outcome be in the so cial interest? Many people have trouble seeing the outcome in which Ted is the only winner as being in the social interest. They say that the social interest requires Ted to share some of his gain either with his workers in higher wages or with his customers in lower prices, or with both groups. Fair Shares and the Social Interest The idea that the social interest requires “fair shares” is a deeply held one. Think about what you regard as a fair share. To help you, imagine the following game. I put $100 on the table and tell someone you don’t know and who doesn’t know you to propose a share of the money between the two of you. If you accept the proposed share, you each get the agreed upon shares. If you don’t accept the proposed share, you both get nothing. It would be efficient—you would both be better off—if the proposer offered to take $99 and leave you with $1 and you accepted that offer. But would you accept the $1? If you are like most people, the idea that the other person gets 99 times as much as you is just too much to stomach. “No way,” you say and the $100 disappears. That outcome is inefficient. You have both given up something. When the game I’ve just described is played in a classroom experiment, about half of the players reject offers of below $30. So fair shares matter. But what is fair? There isn’t a crisp definition of fairness to match that of effi ciency. Reasonable people have a variety of views about it. Almost everyone agrees that too much inequality is unfair. But how much is too much? And inequality of what: income, wealth, or the opportunity to work, earn an income, and accumulate wealth? You will examine efficiency again in Chapter 2 and efficiency and fairness in Chapter 5. 07/01/22 4:05 PM 34 ChAPTEr 1 What Is Economics? multinational firms that produce in low-cost regions and sell in high-price regions. But is globalization in the self-interest of the low-wage worker in Malaysia who sews your new running shoes and the displaced shoemaker in Atlanta? Is it in the social interest? Questions about the social interest are hard ones to answer and they generate discussion, debate, and disagreement. Four issues in today’s world put some flesh on these questions. The issues are: Globalization Information-age monopolies ■ Climate change ■ The Covid pandemic ■ ■ Globalization The term globalization means the expansion of international trade, borrowing and lending, and investment. When Nike produces sports shoes, people in Malaysia get work; and when China Airlines buys new airplanes, Americans who work at Boeing in Seattle build them. While globalization brings expanded production and job opportunities for some workers, it destroys many American jobs. Workers across the manufacturing industries must learn new skills, take service jobs, which often pay less, or retire earlier than previously planned. Globalization is in the self-interest of those consumers who buy low-cost goods and services produced in other countries; and it is in the self-interest of the ECONOMICS IN ThE NEWS The Invisible Hand THE QUESTIONS From Brewer to Bio-Tech Entrepreneur Kiran Mazumdar-Shaw trained to become a master brewer and learned about enzymes, the stuff from which bio-pharmaceuticals are made. Discovering it was impossible for a woman in India to become a master brewer, the 25-year-old Kiran decided to create a bio-pharmaceutical business. Kiran’s firm, Biocon, employed uneducated workers who loved their jobs and the living conditions made possible by their high wages. But when a labor union entered the scene and unionized the workers, a furious Kiran fired the workers, automated their jobs, and hired a smaller number of educated workers. Biocon continued to grow and today, Kiran’s wealth exceeds $1 billion. Kiran has become wealthy by developing and producing bio-pharmaceuticals that improve people’s lives. But Kiran is sharing her wealth in creative ways. She has opened a cancer treatment center to help thousands of patients who are too poor to pay and created a health insurance scheme. ■ Source: Ariel Levy, “Drug Test,” The New Yorker, January 2, 2012 M01_PARK3608_14_GE_C01.indd 34 ■ ■ Whose decisions in the story were taken in selfinterest? Whose decisions turned out to be in the social interest? Did any of the decisions harm the social interest? THE ANSWERS ■ ■ ■ All the decisions—Kiran’s, the workers’, the union’s, and the firm’s customers’—are taken in the pursuit of self-interest. Kiran’s decisions serve the social interest: She creates jobs that benefit her workers and products that benefit her customers. And her charitable work brings yet further social benefits. The labor union’s decision might have harmed the social interest because it destroyed the jobs of uneducated workers. Kiran Mazumdar-Shaw, founder and CEO of Biocon 07/01/22 4:05 PM Two Big Economic Questions Information-Age Monopolies The technological change of the past forty years has been called the Information Revolution. Bill Gates, a co-founder of Microsoft, held a privileged position in this revolution. For many years, Windows was the only available operating system for the PC. The PC and Mac competed, but the PC had a huge market share. An absence of competition gave Microsoft the power to sell Windows at prices far above the cost of production. With lower prices, many more people would have been able to afford and buy a computer. The information revolution has clearly served your self-interest: It has provided your smartphone, laptop, loads of handy applications, and the Internet. It has also served the self-interest of Bill Gates who has seen his wealth soar. But did the information revolution best serve the social interest? Did Microsoft produce the best possible Windows operating system and sell it at a price that was in the social interest? Or was the quality too low and the price too high? Climate Change Burning fossil fuels to generate electricity and to power airplanes, automobiles, and trucks pours a staggering 28 billion tons—4 tons per person—of carbon dioxide into the atmosphere each year. These carbon emissions, two thirds of which come from the United States, China, the European Union, Russia, and India, bring global warming and climate change. Every day, when you make self-interested choices to use electricity and gasoline, you leave your carbon footprint. You can lessen this footprint by walking, riding a bike, taking a cold shower, or planting a tree. But can each one of us be relied upon to make decisions that affect the Earth’s carbon-dioxide concentration in the social interest? Must governments change the incentives we face so that our selfinterested choices are also in the social interest? How M01_PARK3608_14_GE_C01.indd 35 35 can governments change incentives? How can we encourage the use of wind and solar power to replace the burning of fossil fuels that brings climate change? The Covid Pandemic Covid-19 spreads through close contact and social interaction. Without some degree of social isolation, one infected person infects more than one other person, each of whom in turn infect more than one other person, leading to an exponential spread of the disease. A person who socially isolates avoids infection, but also avoids infecting others. People choose their degree of social isolation in their self-interest. But do individual choices serve the social interest? Most likely not. To control the spread of the virus and ease the pressure on healthcare services, governments, working with economists and epidemiologists, set the rules to best serve the social interest. What are the best rules, and when should they be eased? We’ve looked at four topics and asked many questions that illustrate the potential conflict between the pursuit of self-interest and the social interest. We’ve asked questions but not answered them because we’ve not yet explained the economic principles needed to do so. We will answer these questions in future chapters. REVIEW QUIZ Describe the broad facts about what, how, and for whom goods and services are produced. 2 Give some examples to illustrate the potential for conflict between self-interest and the social interest during the Covid pandemic. 1 07/01/22 4:05 PM 36 ChAPTEr 1 What Is Economics? AT ISSUE The Protest Against Market Capitalism Market capitalism is an economic system in which individuals own land and capital and are free to buy and sell land, capital, and goods and services in markets. Markets for goods and services, along with markets for land and capital, coordinate billions of self-interested choices, which determine what, how, and for whom goods and services are produced. A few people earn enormous incomes, many times the average income. There is no supreme planner guiding the use of scarce resources and the outcome is unintended and unforeseeable. Centrally planned socialism is an economic system in which the government owns all the land and capital, directs workers to jobs, and decides what, how, and for whom to produce. The Soviet Union, several Eastern European countries, and China have used this system in the past but have now abandoned it. Only Cuba and North Korea use this system today. A few bureaucrats in positions of great power receive huge incomes, many times that of an average person. Our economy today is a mixed economy, which is market capitalism with government regulation. The Protest The Economist’s Response The protest against market capitalism takes many forms. Historically, Karl Marx and other communist and socialist thinkers wanted to replace it with socialism and central planning. Today, thousands of people who feel let down by the economic system want less market capitalism and more government regulation. The Occupy Wall Street movement, with its focus on the large incomes of the top 1 percent, is a visible example of today’s protest. Protesters say: Economists agree that market capitalism isn’t perfect. But they argue that it is the best system available and while some government intervention and regulation can help, government attempts to serve the social interest often end up harming it. Adam Smith (see p. 85), who gave the first systematic account of how market capitalism works, says: ■ ■ ■ ■ ■ Big corporations (especially big banks) have too much power and influence on governments. Democratically elected governments can do a better job of allocating resources and distributing income than uncoordinated markets. More regulation in the social interest is needed— to serve “human need, not corporate greed.” In a market, for every winner, there is a loser. Big corporations are the winners. Workers and unemployed people are the losers. ■ ■ ■ ■ The self-interest of big corporations is maximum profit. But an invisible hand leads production decisions made in pursuit of self-interest to unintentionally promote the social interest. Politicians are ill-equipped to regulate corporations or to intervene in markets, and those who think they can improve on the market outcome are most likely wrong. In a market, buyers get what they want for less than they would be willing to pay and sellers earn a profit. Both buyers and sellers gain. A market transaction is a “win-win” event. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” The Wealth of Nations, 1776 A Protest against Capitalism M01_PARK3608_14_GE_C01.indd 36 Adam Smith 07/01/22 4:05 PM The Economic Way of Thinking 37 ◆ The Economic Way of Thinking The questions that economics tries to answer tell us about the scope of economics, but they don’t tell us how economists think and go about seeking answers to these questions. You’re now going to see how economists go about their work. We’re going to look at six key ideas that define the economic way of thinking. These ideas are A choice is a tradeoff. People make rational choices by comparing benefits and costs. ■■ Benefit is what you gain from something. ■■ Cost is what you must give up to get something. ■■ Most choices are “how-much” choices made at the margin. ■■ Choices respond to incentives. ■■ ■■ A Choice Is a Tradeoff Because we face scarcity, we must make choices. And when we make a choice, we select from the available alternatives. For example, you can spend Saturday night studying for your next economics test or having fun with your friends, but you can’t do both of these activities at the same time. You must choose how much time to devote to each. Whatever choice you make, you could have chosen something else. You can think about your choices as tradeoffs. A tradeoff is an exchange—giving up one thing to get something else. When you choose how to spend your Saturday night, you face a tradeoff between studying and hanging out with your friends. Making a Rational Choice Economists view the choices that people make as rational. A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice. Only the wants of the person making a choice are relevant to determine its rationality. For example, you might like your coffee black and strong but your friend prefers his milky and sweet. So it is rational for you to choose espresso and for your friend to choose cappuccino. The idea of rational choice provides an answer to the first question: What goods and services will be M01_PARK3608_14_GE_C01.indd 37 produced and in what quantities? The answer is those that people rationally choose to buy! But how do people choose rationally? Why do more people choose an iPad rather than a Microsoft Surface? Why has the U.S. government chosen to build an interstate highway system and not an interstate high-speed railroad system? The answers turn on comparing benefits and costs. Benefit: What You Gain The benefit of something is the gain or pleasure that it brings and is determined by preferences—by what a person likes and dislikes and the intensity of those feelings. If you get a huge kick out of “League of Legends,” that video game brings you a large benefit. If you have little interest in listening to Yo-Yo Ma playing a Vivaldi cello concerto, that activity brings you a small benefit. Some benefits are large and easy to identify, such as the benefit that you get from being in school. A big piece of that benefit is the goods and services that you will be able to enjoy with the boost to your earning power when you graduate. Some benefits are small, such as the benefit you get from a slice of pizza. Economists measure benefit as the most that a person is willing to give up to get something. You are willing to give up a lot to be in school. But you would give up only an iTunes download for a slice of pizza. Cost: What You Must Give Up The opportunity cost of something is the highestvalued alternative that must be given up to get it. To make the idea of opportunity cost concrete, think about your opportunity cost of being in school. It has two components: the things you can’t afford to buy and the things you can’t do with your time. Start with the things you can’t afford to buy. You’ve spent all your income on tuition, residence fees, books, and a laptop. If you weren’t in school, you would have spent this money on tickets to ball games and movies and all the other things that you enjoy. But that’s only the start of your opportunity cost. You’ve also given up the opportunity to get a job. Suppose that the best job you could get if you weren’t in school is working at Citibank as a teller earning $25,000 a year. Another part of your opportunity cost of being in school is all the things that you could buy with the extra $25,000 you would have. 07/01/22 4:05 PM 38 ChAPTEr 1 What Is Economics? As you well know, being a student eats up many hours in class time, doing homework assignments, preparing for tests, and so on. To do all these school activities, you must give up many hours of what would otherwise be leisure time spent with your friends. So the opportunity cost of being in school is all the good things that you can’t afford and don’t have the spare time to enjoy. You might want to put a dollar value on that cost or you might just list all the items that make up the opportunity cost. The examples of opportunity cost that we’ve just considered are all-or-nothing costs—you’re either in school or not in school. Most situations are not like this one. They involve choosing how much of an activity to do. How Much? Choosing at the Margin You can allocate the next hour between studying and chatting online with your friends, but the choice is not all or nothing. You must decide how many minutes to allocate to each activity. To make this decision, you compare the benefit of a little bit more study time with its cost—you make your choice at the margin. The benefit that arises from an increase in an activity is called marginal benefit. For example, your marginal benefit from one more night of study before a test is the boost it gives to your grade. Your marginal benefit doesn’t include the grade you’re already achieving without that extra night of work. The opportunity cost of an increase in an activity is called marginal cost. For you, the marginal cost of studying one more night is the cost of not spending that night on your favorite leisure activity. To make your decisions, you compare marginal benefit and marginal cost. If the marginal benefit from an extra night of study exceeds its marginal cost, you study the extra night. If the marginal cost exceeds the marginal benefit, you don’t study the extra night. Choices Respond to Incentives Economists take human nature as given and view people as acting in their self-interest. All people— you, other consumers, producers, politicians, and public servants—pursue their self-interest. Self-interested actions are not necessarily selfish actions. You might decide to use your resources in ways that bring pleasure to others as well as to yourself. But a self-interested act gets the most benefit for you based on your view about benefit. M01_PARK3608_14_GE_C01.indd 38 The central idea of economics is that we can predict the self-interested choices that people make by looking at the incentives they face. People undertake those activities for which marginal benefit exceeds marginal cost; they reject options for which marginal cost exceeds marginal benefit. For example, your economics instructor gives you a problem set and tells you these problems will be on the next test. Your marginal benefit from working these problems is large, so you diligently work them. In contrast, your math instructor gives you a problem set on a topic that she says will never be on a test. You get little marginal benefit from working these problems, so you decide to skip most of them. Economists see incentives as the key to reconciling self-interest and social interest. When our choices are not in the social interest, it is because of the incentives we face. One of the challenges for economists is to figure out the incentives that result in self-interested choices being in the social interest. Economists emphasize the crucial role that institutions play in influencing the incentives that people face as they pursue their self-interest. Laws that protect private property and markets that enable voluntary exchange are the fundamental institutions. You will learn as you progress with your study of economics that where these institutions exist, self-interest can indeed promote the social interest. REVIEW QUIZ Explain the idea of a tradeoff and think of three tradeoffs that you made today. 2 Explain what economists mean by rational choice and think of three choices that you’ve made today that are rational. 3 Explain why opportunity cost is the best forgone alternative and provide examples of some opportunity costs that you have faced during the last week. 4 Explain what it means to choose at the margin and illustrate with three choices at the margin that you have made today. 5 Explain why choices you made during the Covid pandemic were in your self-interest. Why might your choices not have been in the social interest? 1 07/01/22 4:05 PM Economics as Social Science and Policy Tool ◆ Economics as Social Science and Policy Tool Economics is both a social science and a toolkit for advising on policy decisions. Economist as Social Scientist As social scientists, economists seek to discover how the economic world works. In pursuit of this goal, like all scientists, economists distinguish between positive and normative statements. Positive Statements A positive statement is about what is. It says what is currently believed about the way the world operates. A positive statement might be right or wrong, but we can test it by checking it against the facts. “Our planet is warming because of the amount of coal that we’re burning” is a positive statement. We can test whether it is right or wrong. A central task of economists is to test positive statements about how the economic world works and to weed out those that are wrong. Economics first got off the ground in the late 1700s, so it is a young science compared with, for example, physics, and much remains to be discovered. Normative Statements A normative statement is about what ought to be. It depends on values and cannot be tested. Policy goals are normative statements. For example, “We ought to cut our use of coal by 50 percent” is a normative policy statement. You may agree or disagree with it, but you can’t test it. It doesn’t assert a fact that can be checked. Unscrambling Cause and Effect Economists are par- ticularly interested in positive statements about cause and effect. Are computers getting cheaper because people are buying them in greater quantities? Or are people buying computers in greater quantities because they are getting cheaper? Or is some third factor causing both the price of a computer to fall and the quantity of computers bought to increase? To answer such questions, economists create and test economic models. An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand. For example, an economic model of a wireless network might include features such as the prices of calls, the number of smartphone users, and the volume of calls. But the model would ignore smartphone colors and ringtones. M01_PARK3608_14_GE_C01.indd 39 39 A model is tested by comparing its predictions with the facts. But testing an economic model is difficult because we observe the outcomes of the simultaneous change of many factors. To cope with this problem, economists look for natural experiments (situations in the ordinary course of economic life in which the one factor of interest is different and other things are equal or similar); conduct statistical investigations to find correlations; and perform economic experiments by putting people in decision-making situations and varying the influence of one factor at a time to discover how they respond. Economist as Policy Adviser Economics is useful. It is a toolkit for advising governments and businesses and for making personal decisions. Some of the most famous economists work partly as policy advisers. Carmen M. Reinhart at the John F. Kennedy School of Government, Harvard University, has written widely on policy issues arising from government debt and international capital markets. Gita Gopinath of Harvard University is currently on leave from her academic job and is serving as Chief Economist at the International Monetary Fund. And Cecilia Elena Rouse of Princeton University is serving as Chief Economic Adviser to President Biden. All the policy questions on which economists provide advice involve a blend of the positive and the normative. Economics can’t help with the normative part—the policy goal. But it can help to clarify the goal. And for a given goal, economics provides the tools for evaluating alternative solutions—comparing marginal benefits and marginal costs and finding the solution that makes the best use of the available resources. REVIEW QUIZ Distinguish between a positive statement and a normative statement and provide examples associated with the Covid-19 vaccine rollout. 2 What is a model? Can you think of a model that you might use in your everyday life? 3 How do economists try to disentangle cause and effect? 4 How is economics used as a policy tool? 1 07/01/22 4:05 PM 40 Chapter 1 What Is Economics? ◆ Economists in the Economy What are the jobs available to an economics major? Is the number of economics jobs expected to grow or shrink? How much do economics graduates earn? And what are the skills needed for an economics job? FIGURE 1.3 Economics Jobs Market research analyst 57% Economist 2% Budget analyst 4% Jobs for an Economics Major A major in economics opens the door to the pursuit of a master’s or Ph.D. and a career as an economist. Relatively few people take this path, but for those who do, the challenges are exciting and job satisfaction is high. Economists work in private firms, government, and international organizations. The work of economists varies enormously but can generally be described as collecting and analyzing data on the production and use of resources, goods, and services; predicting future trends; and studying ways of using resources more efficiently. Writing reports and giving talks are a big part of the job of an economist. An economics major also opens the door to a range of jobs that have the word “analyst” in the title. Three of these jobs, that between them employ almost one million people, are market research analyst, financial analyst, and budget analyst. A market research analyst works with data on buying patterns and tries to forecast the likely success of a product and the price that buyers are willing to pay for it. A financial analyst studies trends and fluctuations in interest rates and stock and bond prices and tries to predict the cost of borrowing and the returns on investments. A budget analyst keeps track of an organization’s cash flow—its receipts and payments—and prepares budget plans that incorporate predictions of future cash flows. Figure 1.3 shows the scale and distribution of employment across the jobs for an economics major. Will Jobs for Economics Majors Grow? The future is always uncertain and things rarely turn out as expected. But we can’t avoid trying to peer into the future when we make choices that commit to a long-term plan, and economists at the Bureau of Labor Statistics (the BLS) have done their best to provide some forecasts. M01_PARK3608_14_GE_C01.indd 40 Financial analyst 37% Employment in 2020 Economist Budget analyst Financial analyst Market research analyst Total jobs 20,500 55,400 487,800 738,100 1,301,800 The pie chart shows the relative number of jobs for economists and analysts that use economic ideas and tools. Most of the jobs for an economics major are in market research (57 percent) and finance (37 percent). Source of data: Bureau of Labor Statistics. The BLS has provided forecasts of employment growth from 2019 to 2029 for a large range of jobs and says average job growth will be 3 percent—for every 100 jobs in 2019, there will be 103 in 2029. Jobs for those with a Ph.D. in economics are forecasted to grow by 14 percent. This growth is much higher than for jobs on average and reflects the fact that economists are valued by private firms as data analysts. Amazon for example employs 150 Ph.D. economists and Uber 30. Google employs about 300 economists and statisticians. Other firms with large economics teams include Facebook, Microsoft, eBay, Airbnb, and Deliveroo. Budget analyst jobs are expected to grow by a slow 3 percent because this job is easy to replace with artifi cial intelligence. But jobs for financial analysts are ex pected to grow by 5 percent and for market research analysts by 18 percent. These forecasts imply a bright future for people who choose to major in economics. 07/01/22 4:05 PM Economists in the Economy 41 Earnings of Economics Majors Earnings of economics majors vary a lot depending on the job and the level of qualifications. The Web resource payscale.com reports a pay range for economists of all types from $56,500 to $139,600, with a median of $105,100. A person who majors in economics and goes on to complete a Ph.D. and gets a job as an economist would expect to earn about $150,000 a year by midcareer. Economists working in finance, insurance, and government jobs earn more than the average. Pay in “analyst” jobs is lower and ranges from an average of $55,000 a year for market research analysts to $82,000 a year for financial analysts. These rates of pay put economics graduates near but not at the top of the distribution as you can see in Fig. 1.4. Only graduates who majored in petroleum engineering and operations research have average pay that exceeds that of economists. FIGURE 1.4 Earnings of College Majors College Major Petroleum engineering Operations research Applied economics and management Quantitative business analysis Actuarial mathematics Chemical engineering Actuarial science Aeronautical engineering Political economy Nuclear engineering Skills Needed for Economics Jobs What are the skills that an employer looks for in a candidate for an economics related job? Five skill requirments stand out. They are: Critical-thinking skills Analytical skills ■■ Math skills ■■ Writing skills ■■ Oral communication skills ■■ ■■ 0 45 90 135 180 Earnings (thousands of dollars per year) Starting salary Increase by mid-career Economics majors are not the highest earners—petroleum engineers and operations research scientists earn more—but at $140,000 a year in mid-career, economists earn more than most other majors. Source of data: American Economics Association. Critical-Thinking Skills The ability to clarify and solve problems using logic and relevant evidence Analytical Skills The use of economic ideas and tools to examine data, notice patterns, and reach a logical conclusion Math Skills The ability to use mathematical and statistical tools to analyze data and reach valid conclusions Writing Skills The ability to present ideas, conclusions, and reasons in succinct written reports appropriate for the target audience Oral Communication Skills The ability to explain ideas, conclusions, and reasons to people with a limited background in economics. M01_PARK3608_14_GE_C01.indd 41 A Diversity Challenge in the Economics Profession You’ve seen that an economics major opens a wide range of well-paid jobs and the outlook for job growth and pay is above average. But there is unequal access to these jobs. The economics profession lacks diversity. We close this account of economists in the economy by looking at the diversity challenge in the economics profession. We begin by looking at some numbers that describe the degree of underrepresentation of women and racial and ethnic minorities. We then look at research that seeks to understand the reasons for the lack of diversity. And we close with a brief account of the efforts that some economists are making to achieve a more diverse profession. 07/01/22 4:05 PM 42 ChAPTEr 1 What Is Economics? Measuring Underrepresentation With equal representation, 50 percent of economics degrees would go to women and 30 percent to racial and ethnic minorities. In recent years, 30 percent of economics bachelor’s and doctorate degrees were awarded to women and 9 percent of doctorates and 15 percent of bachelor’s degrees to Blacks, Hispanics, and Native Americans. Swarthmore economist Amanda Bayer, a leading researcher on diversity in the economics profession, and Princeton University economist Cecilia Rouse, appointed President Biden’s chief economic adviser in 2021, have surveyed a very large body of research on the scale and sources of underrepresentation. Figure 1.5 provides a view of some of what they found. Underrepresentation runs back from doctorate numbers to undergraduate degrees. And minorities and women are less represented in the economics profession than in several other disciplines, most notably in science, technology, engineering and math, the STEM disciplines. Economics has less diversity than STEM, and while STEM has become increasingly diverse, the lack of diversity in economics has barely changed. Understanding Underrepresentation Measuring the degree of underrepresentation is easy. Understanding the reasons for a lack of diversity is hard. Partly it is an economics topic, a “what, how, and for whom” question. And economists are working on research projects to better understand the choices and incentives that lead to underrepresentation. But it is also an interdisciplinary topic that draws on the full range of the social sciences. The most likely main reason for underrepresentation is gender and racial implicit bias in selecting doctoral students and faculty. Low representation at the top of the profession leads to a lack of role models to inspire undergraduate economics students, which translates to low representation in bachelor’s degrees. Improving Representation Most economists believe that a more diverse profession would be not only fairer but also more efficient. It would improve the quality of economic research and policy advice. University of Oklahoma Professor Gary Hoover and Yale Professor Ebonya Washington, co-chairs of an American Economic Association (AEA) committee charged with increasing the representation of minority students in economics, have introduced an undergraduate essay prize, a travel grant, and other programs to better incentivize students. Similar programs seek to increase the representation of women in undergraduate economics. M01_PARK3608_14_GE_C01.indd 42 FIGURE 1.5 Degrees Awarded to Women and Minorities in Economics and STEM Doctorate degrees Economics STEM Bachelor's degrees Economics STEM 30 40 50 0 10 20 Percentage of degrees awarded to women 1995 60 2015 (a) Women Doctorate degrees Economics STEM Bachelor's degrees Economics STEM 0 5 10 15 Percentage of degrees awarded to minorities 1995 20 2015 (b) Underrepresented Minorities In part (a), a constant fewer than 30 percent of economics degrees are awarded to women compared with more than 50 percent of STEM degrees. In part (b), fewer than 10 percent of minorities get an economics doctorate degree, and fewer than 15 percent of minorities get an economics bachelor’s degree. Source of data: Amanda Bayer and Cecilia Elena rouse, “Diversity in the Economics Profession: A New Attack on an Old Problem”, Journal of Economic Perspectives, Fall 2016. REVIEW QUIZ What types of jobs do economists do? What are the skills needed for an economics job? 3 What is the range and median salary of economists? How do they compare to other college majors? 4 Why is the underrepresentation of women and minorities in economics an economic problem? 1 2 07/01/22 4:05 PM Summary 43 SUMMARY Definition of Economics (p. 30) All economic questions arise from scarcity—from the fact that wants exceed the resources available to satisfy them. ■ Economics is the social science that studies the choices that people make as they cope with scarcity. ■ The subject divides into microeconomics and macroeconomics. ■ Two Big Economic Questions (pp. 31–36) ■ Cost—opportunity cost—is what you must give up to get something. ■ Most choices are “how much” choices made at the margin by comparing marginal benefit and marginal cost. ■ Choices respond to incentives. ■ Key Points Two big questions summarize the scope of economics: 1. How do choices end up determining what, how, and for whom goods and services are produced? 2. When do choices made in the pursuit of selfinterest also promote the social interest? The Economic Way of Thinking (pp. 37–38) Every choice is a tradeoff—exchanging more of something for less of something else. ■ People make rational choices by comparing benefit and cost. ■ Economics as Social Science and Policy Tool (p. 39) Economists distinguish between positive statements—what is—and normative statements— what ought to be. ■ To explain the economic world, economists create and test economic models. ■ Economics is a toolkit used to provide advice on government, business, and personal economic decisions. ■ Economists in the Economy (pp. 40–42) Economics majors work in a wide range of jobs as economists and analysts. ■ The job growth outlook for economics majors is good and pay is above average. ■ Economics has a diversity problem with a significant and persistent underrepresentation of women and minorities. ■ Key Terms Benefit , 37 Capital, 32 Economic model, 39 Economics, 30 Efficient , 33 Entrepreneurship, 32 Factors of production, 31 Goods and services, 31 human capital, 31 Incentive, 30 M01_PARK3608_14_GE_C01.indd 43 Interest , 32 Labor, 31 Land, 31 Macroeconomics, 30 Margin, 38 Marginal benefit , 38 Marginal cost , 38 Microeconomics, 30 Opportunity cost , 37 Preferences, 37 Profit , 32 rational choice, 37 rent , 32 Scarcity, 30 Self-interest , 33 Social interest , 33 Tradeoff, 37 Wages, 32 07/01/22 4:05 PM 44 ChAPTEr 1 What Is Economics? PROBLEMS AND APPLICATIONS Definition of Economics 1. Apple Inc. decides to make iTunes freely available in unlimited quantities. a. Does Apple’s decision change the incentives that people face? b. Is Apple’s decision an example of a microeconomic or a macroeconomic issue? Two Big Economic Questions 2. Which of the following pairs does not match? a. Labor and wages b. Land and rent c. Entrepreneurship and profit d. Capital and profit 3. Explain how the following news headlines concern self-interest and the social interest. a. Starbucks Expands in China b. McDonald’s Moves into Online Ordering c. Food Must Be Labeled with Nutrition Data The Economic Way of Thinking 4. The night before an economics test, you decided to go to the movies instead of studying for your test. Your test grade was 50 percent, lower than your usual 70 percent score. a. Did you face a tradeoff ? b. What was the opportunity cost of your evening at the movies? 5. Olympics Could Cost More Than $26 Billion Japanese media estimate that overall spending on Japan’s new expensive national venues is between $26 billion and $28 billion. Source: Los AngelesTimes, December 20, 2019 What is Japan’s opportunity cost of hosting the Olympic Games? Explain your answer. Economics as Social Science and Policy Tool 6. Which of these statements is positive, which is normative, and why? a. The United States should cut its imports. b. China imports U.S. pork and soybean. c. If the iPhone price rises, iPhone sales will fall. Economists in the Economy 7. What are the five basic skills needed for an economics job? 8. How is the AEA trying to encourage more women and minorities to study economics? 9. How does the BLS expect jobs for economists to grow in the next decade? ADDITIONAL PROBLEMS AND APPLICATIONS Definition of Economics 10. Swifties, Rejoice! Taylor Swift Will Perform a Free JamFest Source: USA Today, November 8, 2019 When Taylor Swift performs at JamFest, what is free and what is scarce? Explain your answer. Two Big Economic Questions 11. How does the creation of a successful movie influence what, how, and for whom goods and services are produced? 12. How does a successful movie illustrate self-interested choices that are also in the social interest? The Economic Way of Thinking 13. Before starring in Guardians of the Galaxy, Chris Pratt had appeared in 11 movies that grossed an average of $7 million on the opening weekend. Guardians of the Galaxy grossed $94 million. a. How will the success of Guardians of the Galaxy M01_PARK3608_14_GE_C01.indd 44 influence the opportunity cost of hiring Chris Pratt? b. How have the incentives for a movie producer to hire Chris Pratt changed? 14. What might be an incentive for you to take a class in summer school? List some of the benefits and costs involved in your decision. Would your choice be rational? Economics as Social Science and Policy Tool 15. Look at today’s Wall Street Journal. What is the leading economic news story? Which big economic questions and tradeoffs does it discuss or imply? 16. Provide two microeconomic and two macroeconomic statements. Classify them as positive or normative, and explain your classifications. Economists in the Economy 17. What might be an incentive for economics students to do a Ph.D.? What would be the opportunty cost of doing a Ph.D.? 07/01/22 4:05 PM Appendix: Graphs in Economics 45 ◆◆ Make and interpret a scatter diagram ◆◆ Identify linear and nonlinear relationships and relationships that have a maximum and a minimum Above sea level Graphs in Economics After studying this appendix, you will be able to: A graph represents a quantity as a distance on a line. In Fig. A1.1, a distance on the horizontal line represents temperature, measured in degrees Fahrenheit. A movement from left to right shows an increase in temperature. The point 0 represents zero degrees Fahrenheit. To the right of 0, the temperature is positive. To the left of 0, the temperature is negative (as indicated by the minus sign). A distance on the vertical line represents height above sea level, measured in thousands of feet. The point 0 represents sea level. Points above 0 represent feet above sea level. Points below 0 represent feet below sea level (indicated by a minus sign). In Fig. A1.1, the two scale lines are perpendicular to each other and are called axes. The vertical line is the y-axis, and the horizontal line is the x-axis. Each axis has a zero point, which is shared by the two axes and called the origin. To make a two-variable graph, we need two pieces of information: the value of the variable x and the value of the variable y. Think about a concrete example. Off the coast of Alaska, the temperature is 32 degrees—the value of x. A fishing boat is located at 0 feet above sea level—the value of y. These two bits of information appear as point A in Fig. A1.1. A climber at the top of Mount McKinley on a cold day is 20,320 feet above sea level in a zero-degree gale. These two pieces of information appear as point B. On a warmer day, a climber might be at the peak of Mt. McKinley when the temperature is 32 degrees, at point C. M01_PARK3608_14_GE_C01.indd 45 0ºF and 20,320 ft 25 20 B C 32ºF and 20,320 ft 15 10 Origin –60 Below sea level ◆ Graphing Data y 32ºF and 0 ft 5 ◆◆ Define and calculate the slope of a line ◆◆ Graph relationships among more than two variables Making a Graph FIGURE A1.1 Height (thousands of feet) APPENDIX –30 A 0 –5 Negative 30 60 90 120 Temperature (degrees F) x Positive –10 Graphs have axes that measure quantities as distances. Here, the horizontal axis (x-axis) measures temperature, and the vertical axis (y-axis) measures height. Point A represents a fishing boat at sea level (0 on the y-axis) on a day when the temperature is 32°F. Point B represents a climber at the top of Mt. McKinley, 20,320 feet above sea level at a temperature of 0°F. Point C represents a climber at the top of Mt. McKinley, 20,320 feet above sea level at a temperature of 32°F. We can draw two lines, called coordinates, from point C. One, called the x-coordinate, runs from C to the vertical axis. This line is called “the x-coordinate” because its length is the same as the value marked off on the x-axis. The other, called the y-coordinate, runs from C to the horizontal axis. This line is called “the y-coordinate” because its length is the same as the value marked off on the y-axis. We describe a point on a graph by the values of its x-coordinate and its y-coordinate, in that order. For example, at point C, x is 32 degrees and y is 20,320 feet above sea level. A graph like that in Fig. A1.1 can be made using any quantitative data on two variables. The graph can show just a few points like Fig. A1.1, or many points. Before we look at graphs with many points, let’s reinforce what you’ve just learned by looking at a graph made with economic data. 07/01/22 4:05 PM

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