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Contents
Preface
xxi
PA R T 1
Introduction: Scarcity and the Economic System
CHAPTER 1
The Study of Economics
1
3
The Economic Problem 4
Cost-Benefit Analysis and Opportunity Cost
5
USE YOUR ECONOMIC REASONING: Researcher Suggests Why Lean Times May Be Good
for You 6
The Production Possibilities Curve
8
Opportunity Costs along the Curve 10 The Law of Increasing Costs
Economic Growth and the Benefits of Trade 11
The Three Fundamental Questions
What to Produce
14
10
14
How to Produce
14
For Whom to Produce
14
Five Economic Goals 15
Conflicts and Trade-Offs 17
Full Employment versus Stable Prices 17 Economic Growth versus
Environmental Protection 18 Equality versus Efficiency 18
Choosing between Objectives 18
Economic Theory and Policy
19
Theory in Everyday Life 19 Lessons from the Production Possibilities
Model 20 A Theory of Cigarette Consumption 20 Policies and
Predictions 21
USE YOUR ECONOMIC REASONING: Children Smart Enough to Get into Elite Schools
May Not Need to Bother
22
Economists and Conclusions 24
The Organization of the Text 25
Summary 26 Key Terms 27
Study Questions 27 Answer Key
APPENDIX: Working with Graphs
30
31
ix
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Contents
CHAPTER 2
Economic Systems
35
The Model of Pure Capitalism
36
Elements of Capitalism 36 The Circular-Flow Model 38 How Capitalism
Answers the Three Fundamental Questions 41 Capitalism: Strengths and
Weaknesses 43
The Model of Pure Command Socialism
44
Elements of Command Socialism 44 The Pyramid Model 45
How Command Socialism Answers the Three Fundamental Questions
Command Socialism: Strengths and Weaknesses 47
Mixed Economies: The Real-World Solution
The U.S. Economic System
48
46
48
The Rest of the World
52
USE YOUR ECONOMIC REASONING: In a Deep Crisis, Germany Begins to Revamp Its
Vast Welfare State
54
Summary 58 Key Terms 60
Study Questions 60 Answer Key
63
PA R T 2
Microeconomics: Markets, Prices,
and the Role of Competition 65
CHAPTER 3
Demand and Supply: Price Determination in Competitive
Markets 67
Demand
68
Demand Curves
69
The Law of Demand 70
Determinants of Demand
70
Income 71 Tastes and Preferences 72 Expectations about Prices 72
Price of Related Goods 72 The Number of Consumers in the Market 73
Change in Quantity Demanded versus Change in Demand
Supply 74
73
USE YOUR ECONOMIC REASONING: Faster Track to the American Dream: Falling Interest
Rates Give Younger Buyers a Chance to Own Home
The Supply Curve
The Law of Supply 77
Determinants of Supply
Technology 78
Market 79
76
76
78
Resource Prices
79
The Number of Producers in the
Change in Supply versus Change in Quantity Supplied
The Process of Price Determination 81
USE YOUR ECONOMIC REASONING: Price Is Right
Equilibrium Price and Quantity
of Prices 86
84
Changes in the Equilibrium Price
87
80
82
The Rationing and Motivating Functions
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CONTENTS
The Impact of a Change in Demand 87 The Impact of a Change in
Supply 89 The Impact of Simultaneous Changes in Demand and Supply
Economic Efficiency and the Role of Prices
USE YOUR ECONOMIC REASONING: The “Bargain” Jaguar
Summary 94 Key Terms 96
Study Questions 96 Answer Key
CHAPTER 4
Price Supports 101
Excise Taxes 107
Elasticity of Demand
93
99
Applications Using Demand and Supply
Government Intervention in Pricing
90
92
100
101
Price Ceilings
103
Subsidies
105
109
The Coefficient of Demand Elasticity 110 Degrees of Elasticity 111
Elasticity along a Straight-Line Demand Curve 112 Elasticity and Total
Revenue 113 The Determinants of Elasticity 115 Looking Back: Excise
Taxes and the Elasticity of Demand 117
$2 Federal Cigarette Tax Hike Sought
USE YOUR ECONOMIC REASONING:
Summary 119 Key Terms 121
Study Questions 121 Answer Key
APPENDIX: The Elasticity of Supply
CHAPTER 5
Costs and Decision Making
124
125
131
Explaining Human Behavior: The Role of Assumptions
The Pursuit of Self-Interest
118
132
132
Comparing Costs and Benefits
133
The Importance of Marginal Analysis 133
The Improper Estimation of Costs 135
Ignoring Implicit Costs
Sunk Costs 137
135
Failing to Ignore Fixed and
Business Decision Making and the Pursuit of Profit
Short-Run Costs of Production 140
139
Total Costs: Fixed and Variable 140 Average Costs: Fixed, Variable,
and Total 142 Marginal Cost 143
The Cost Curves 145
Selecting the Profit-Maximizing Level of Output
147
Marginal Revenue Is the Marginal Benefit 148 Using the Decision Rule:
Comparing Marginal Revenue and Marginal Cost 148 Graphing and Profit
Maximization 150 Wise Decisions Don’t Always Lead to Profits 151
Gas Stations, Fast Food, and the All-Night Grocery Store
152
Whatever Happened to Gas Stations? 152 Why Is Breakfast
Everywhere? 153 Sale! Buy Below Cost! 154 Late-Night Movies
and Empty Airplanes 155
Summary 156 Key Terms 158
Study Questions 158 Answer Key 162
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Contents
CHAPTER 6
Price Taking: The Purely Competitive Firm
163
The Nature of Pure Competition 164
The Firm under Pure Competition 165
Profit Maximization in the Short Run 166
Determining the Profit-Maximizing Output 167
Supply 168 Evaluating Profit or Loss 169
Profit Maximization in the Long Run
Marginal Cost and Firm
174
Setting the Stage: The Short-Run Picture 175 The Entrance of
Firms: Attraction of Profits 175 The Exit of Firms: Looking for
Greener Pastures 177
The Benefits of Pure Competition
Production Efficiency
177
USE YOUR ECONOMIC REASONING:
Profits
177
Allocative Efficiency
180
Summary 182 Key Terms 184
Study Questions 184 Answer Key
CHAPTER 7
178
Organic Produce Helps Local Farmers Grow
188
Price Searching: The Firm with Market Power 189
The Acquisition of Market Power
190
Product Differentiation as a Source of Market Power
as a Source of Market Power 191
190
Control over Supply
USE YOUR ECONOMIC REASONING: As Its Members Flout Oil Quotas, OPEC Considers
New Approach
192
Price Searching
195
The Price Searcher’s Demand Curve
The Profit-Maximization Rule
195
196
Calculating Marginal Revenue 197 The Profit-Maximizing Price and
Quantity 197 A Digression on Price Discrimination 200
USE YOUR ECONOMIC REASONING: What Price Fairness?
202
Evaluating the Short-Run Profit or Loss 204
Barriers to Entry and Long-Run Profits 205
Price Searchers and Resource Allocation 206
Price Searchers and Economies of Scale 208
Summary 211 Key Terms 213
Study Questions 213 Answer Key
APPENDIX: Pricing in Practice
CHAPTER 8
216
217
Industry Structure and Public Policy 223
Industry Structure and Market Power
Pure Competition 225
Monopolistic Competition 225
224
Monopolistic Competition and Market Power
Competition 227
226
Evaluating Monopolistic
USE YOUR ECONOMIC REASONING: Quality with Freshness Is Portas Pizza’s Niche:
Customers Watch Meal Being Made, Bake It at Home 228
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CONTENTS
Oligopoly
230
Oligopolists and Market Power 230 Mutual Interdependence and Game
Theory 231 Tactics for Cooperating 235 Factors Limiting
Cooperation 236
Monopoly
237
USE YOUR ECONOMIC REASONING: Schick Seeks New Edge with Four-Blade Razor
Monopoly and Market Power
240
Monopoly and Profit Maximization
The Consequences of Monopoly or Oligopoly
243
The Problems of Misallocation of Resources and Redistribution of Income
The Possible Benefits of Size 244
Antitrust and Regulation
243
245
Antitrust Enforcement 245 Criticisms of Antitrust
Regulation 250
Summary 252 Key Terms 254
Study Questions 254 Answer Key 257
CHAPTER 9
238
241
249
Industry
Market Failure 258
Market Power Revisited 259
Externalities as a Source of Market Failure
Externalities: The Case of External Costs
External Benefits 268
USE YOUR ECONOMIC REASONING:
260
260
Externalities: The Case of
A Great Leap Forward
Market Failure and the Provision of Public Goods
270
273
USE YOUR ECONOMIC REASONING: Rare but Deadly Ailment Catches College Freshman
Unprepared
274
Private Goods versus Public Goods
276
The Free-Rider Problem
Poverty, Equality, and Trends in the Income Distribution
Government Failure: The Theory of Public Choice 279
Summary 281 Key Terms 283
Study Questions 283 Answer Key
276
277
287
PA R T 3
Macroeconomics: The Economy as a Whole
CHAPTER 10 Measuring Aggregate Performance
Measuring Unemployment
289
291
292
Counting the Unemployed 292 Types of Unemployment 294
Full Employment versus Zero Unemployment 297 A Closer Look at
Unemployment Rates 297 Unemployment Rates: A Word of Caution
Measuring Inflation
298
299
Unanticipated Inflation and Income Redistribution
299
USE YOUR ECONOMIC REASONING: Jobless Workers Switch Fields to Find Relief
300
When Inflation Is Anticipated 303 Calculating a Price Index 303 The
Consumer Price Index 305 The Producer Price Index and the Implicit Price
Deflator 307
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Contents
Measuring Total Output
308
Calculating GDP: A Sneak Preview 308 GDP and the Circular Flow
The Expenditures Approach 309 The Income Approach 312
Interpreting GDP Statistics 313
USE YOUR ECONOMIC REASONING: What Price for the Environment?
Summary 317 Key Terms 318
Study Questions 318 Answer Key
CHAPTER 11
308
314
321
Aggregate Demand and Supply: The Model of the
Self-Correcting Economy 322
Aggregate Demand
323
The Real Balance Effect 324 The Interest Rate Effect
International Trade Effect 326
Changes in Aggregate Demand
USE YOUR ECONOMIC REASONING:
Aggregate Supply
330
The
326
Household and Business Expectations
Government Policy
324
327
Aggregate Wealth
Home Truths
327
328
Foreign Incomes and Prices
330
331
The Short-Run AS Curve: A Closer Look
Changes in Aggregate Supply
332
334
Wage Rates and Other Resource Prices 334 Technology and the Productivity
of Labor 335 Supplies of Labor and Capital 335
The Equilibrium Output and Price Level 336
The Impact of Changes in Aggregate Demand or Supply
The Model of the Self-Correcting Economy 339
337
USE YOUR ECONOMIC REASONING: High Natural Gas Prices Resonating: Analysts Fear
Economic Damage
340
Adjustments to an Increase in Aggregate Demand 341 Adjustments to a
Decrease in Aggregate Demand 343 Shifts in the Long-Run Aggregate
Supply Curve 344
Summary 345 Key Terms 347
Study Questions 347 Answer Key 350
CHAPTER 12 Fiscal Policy
351
The Federal Budget
Tax Revenues
352
353
Government Expenditures
353
Classical Economics, the Great Depression, and John Maynard Keynes 354
The Existence of Unemployment or Inflation 356
Discretionary Fiscal Policy: Combating Unemployment or Inflation 357
Automatic Fiscal Policy: The Economy’s Automatic Stabilizers 359
Fiscal Policy and the Federal Budget 360
Planned and Unplanned Deficits and Surpluses
Federal Budget 361
Issues Related to Fiscal Policy
Crowding Out
363
362
361
Unemployment and the
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CONTENTS
USE YOUR ECONOMIC REASONING: Dizzying Dive to Red Ink Poses Stark Choices for
Washington
364
The Expansionary Bias
The Public Debt
364
Time Lags
366
367
Concerns about the Public Debt 367 Concluding Comments on the Public
Debt 370
Summary 371 Key Terms 374
Study Questions 374 Answer Key 378
CHAPTER 13 Money, Banking, and Monetary Policy
What Is Money?
379
380
Money and Near Money 380 Credit Cards and Debit Cards
Definitions of the Money Supply 382
How Depository Institutions Create Money
381
383
A Bank’s Balance Sheet 384 The Creation of Checkable Deposits 385
The Multiple Expansion of Loans and Deposits 388 The Deposit
Multiplier 389 The Destruction of Checkable Deposits 390
The Federal Reserve System
391
The Origin of the Federal Reserve
Federal Reserve System 392
392
Monetary Policy and the Federal Reserve
The Organization and Functions of the
394
Open-Market Operations 395 Changing the Reserve Requirement
Changing the Discount Rate 396
Money, Interest Rates, and the Level of Economic Activity
Interest Rate Determination
Activity 399
The Limits to Monetary Policy
Time Lags
395
397
397 Monetary Policy and the Level of Economic
401
401
USE YOUR ECONOMIC REASONING: Fed Cuts Key Rate by One-Half Point in Aggressive
Move
402
Uneven Effectiveness 402
Summary 404 Key Terms 406
Study Questions 406 Answer Key
CHAPTER 14 The Activist–Nonactivist Debate
409
410
The Activist Position: Keynes Revisited 411
The Nonactivist Position: The Monetarists 412
Fiscal Policy and Crowding Out 412 Monetary Policy and the Monetary
Rule 413 Policy Lags and the Self-Correcting Economy 414 Monetarism:
Concluding Points 415 Criticisms of Monetarism 415
The Nonactivist Position: The New Classical Economists
Wage/Price Flexibility and Full Employment
416
416
USE YOUR ECONOMIC REASONING: Greenspan Argues Against Strict Rules For Fed
418
Rational Expectations and Discretionary Policy 419 The Need for Policy
Rules 422 Criticisms of the New Classical Economics 422
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A Different Form of Activism: Managing Aggregate Supply
Supply-Side Economics
423
423
The Reagan Supply-Side Experiment
Summing Up: Final Thoughts on Policy Activism
Summary 428 Key Terms 429
Study Questions 429 Answer Key
432
CHAPTER 15 Economic Growth: The Importance of the Long Run
Economic Growth and Why It Matters
425
427
433
433
Economic Growth and the Standard of Living 434 Per Capita GDP: The
United States’ Experience 434 The Rule of Seventy-Two: Why the Growth
Rate Matters 437
Sources of Economic Growth
438
Growth in the Stock of Natural Resources 439 Growth in the Labor Supply
439 Growth in the Capital Stock 440 Technological Advances 441
Policies to Promote Growth
442
Promoting Capital Investment
Progress 447
443
Promoting Technological
USE YOUR ECONOMIC REASONING: Bad Debt: Why Bush’s Deficits Will Slow America’s
Growth
448
Debates about Growth Policy
453
The Devil Is in the Details: Debates about How to Stimulate Growth
Will Economic Growth Harm the Environment? 454
Summary 455 Key Terms 457
Study Questions 457 Answer Key 460
453
PA R T 4
International Economics: Trade, Exchange Rates,
and the Balance of Payments 461
CHAPTER 16 International Trade
463
Interdependent Economies and U.S. Trade
Import and Export Patterns
Trade 465
464
The Basis for International Trade
464
Interdependence and Attitudes Toward
466
The Opportunity Cost of Domestic Production 466 The Principle of
Comparative Advantage 467 Comparative Advantage as a Basis for
Trade 468
The Benefits of Trade
469
The Production Possibilities Curve and the Gains from Trade 470 The
Transition to Greater Specialization: Winners and Losers 472 Lower Prices
through International Competition 473
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CONTENTS
Types of Barriers to Trade
Tariffs
475
Quotas
474
476
Other Restrictions
476
USE YOUR ECONOMIC REASONING: U.S.-EU Crop Fight Flares
Trade Barriers and Consumer Welfare 480
Common Arguments for Protection 481
Reducing Barriers: The Role of Trade Agreements
483
International Trade Agreements: GATT and the WTO
Agreements: NAFTA 485
USE YOUR ECONOMIC REASONING:
483
Regional Trade
U.S. Farm Policy Sows Ire in Africa
The Case for Trade Adjustment Assistance
Summary 489 Key Terms 491
Study Questions 491 Answer Key
CHAPTER 17 International Finance
478
486
488
494
495
The Meaning of Exchange Rates 496
Exchange Rate Systems: Flexible Exchange Rates
497
The Equilibrium Exchange Rate 498 Changes in the Equilibrium Exchange
Rate 499 The Impact of Changes in Exchange Rates 502
USE YOUR ECONOMIC REASONING: Dollar Buying Less European Goods: Slump Could
Mean a U.S. Market Boost
504
Exchange Rate Systems: Fixed Exchange Rates
506
Fixed Exchange Rates and the Balance of Payments
507
The Current System: The Managed Float 510
The U.S. Balance of Payments Accounts 511
USE YOUR ECONOMIC REASONING: Japan Is Spending Heavily to Pursue a Weak-Yen
Policy
512
The Current Account 512 The Capital Account 515 Statistical
Discrepancy 515 Official Reserve Transactions 516
Summary 517 Key Terms 518
Study Questions 518 Answer Key 521
Glossary 523
Photo Credits 534
Index 535
ROHL.8354.FM.i-xxvi 4/2/04 2:02 PM Page xviii
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Use Your Economic Reasoning News
Articles
PART ONE Introduction: Scarcity and the Economic System
1
Chapter 1
The Study of Economics 3
The Associated Press: Researcher Suggests Why Lean Times May Be Good
for You 6
New York Times: Children Smart Enough to Get into Elite Schools May Not
Need to Bother 22
Chapter 2
Economic Systems 35
Wall-Street Journal: In a Deep Crisis, Germany Begins to Revamp Its Vast
Welfare State 54
PART TWO Microeconomics: Markets, Prices, and the Role of
Competition 65
Chapter 3
Demand and Supply: Price Determination in Competitive
Markets 67
Boston Globe: Faster Track to the American Dream: Falling Interest Rates Give
Younger Buyers a Chance to Own Home 76
New Republic: Price Is Right 82
Wall Street Journal: The “Bargain” Jaguar 93
Chapter 4
Applications Using Demand and Supply 100
The Washington Post: $2 Federal Cigarette Tax Hike Sought
Chapter 6
118
Price Taking: The Purely Competitive Firm 163
The Associated Press: Organic Produce Helps Local Farmers Grow Profits
Chapter 7
Price Searching: The Firm with Market Power 189
New York Times: As Its Members Flout Oil Quotas, OPEC Considers New
Approach 192
New York Times: What Price Fairness? 202
Chapter 8
Industry Structure and Public Policy 223
St. Louis Dispatch: Quality with Freshness Is Portas Pizza’s Niche 228
Wall Street Journal: Schick Seeks New Edge with Four-Blade Razor 238
Chapter 9
Market Failure 258
The Economist: A Great Leap Forward 270
New York Times: Rare but Deadly Ailment Catches College Freshmen
Unprepared 274
180
xix
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xx
Use Your Economic Reasoning News Articles
PART THREE Macroeconomics: The Economy as a Whole
Chapter 10
289
Measuring Aggregate Performance 291
Wall-Street Journal: Jobless Workers Switch Fields to Find Relief
New Straits Times: What Price for the Environment? 314
300
Chapter 11
Aggregate Demand and Supply: The Model of the Self-Correcting
Economy 322
The Economist: Home Truths 328
The Houston Chronicle: High Natural Gas Prices Resonating 340
Chapter 12
Fiscal Policy 351
New York Times: Dizzying Dive to Red Ink Poses Stark Choices for
Washington 364
Chapter 13
Money, Banking, and Monetary Policy 379
New York Times: Fed Cuts Key Rate by One-Half Point in Aggressive Move 402
Chapter 14
The Activist–Nonactivist Debate 410
New York Times: Greenspan Argues Against Strict Rules for Fed
Chapter 15
418
Economic Growth: The Importance of the Long Run 433
Boston Globe: Bad Debt: Why Bush’s Deficits Will Slow America’s
Growth 448
PART FOUR International Economics: Trade, Exchange Rates,
and the Balance of Payments 461
Chapter 16
Chapter 17
International Trade 463
Wall Street Journal: U.S.-EU Crop Fight Flares 478
The Washington Times: U.S. Farm Policy Sows Ire in Africa
486
International Finance 495
The Boston Herald: Dollar Buying Less European Goods: Slump Could Mean a
U.S. Market Boost 504
New York Times: Japan Is Spending Heavily to Pursue a Weak-Yen Policy 512