Principles of Economics

Cover......Page 1
Title Page......Page 4
Copyright Page......Page 5
Dedication......Page 6
About the Authors......Page 7
Preface......Page 8
Acknowledgments......Page 12
Brief Contents......Page 21
Contents......Page 22
Chapter 1 Thinking Like an Economist......Page 32
Economics: Studying Choice in a World of Scarcity......Page 33
Applying the Cost-Benefit Principle......Page 34
Opportunity Cost......Page 35
The Role of Economic Models......Page 36
Pitfall 1: Measuring Costs and Benefits as Proportions rather than Absolute Dollar Amounts......Page 37
Pitfall 2: Ignoring Implicit Costs......Page 38
Pitfall 3: Failure to Think at the Margin......Page 39
Economics: Micro and Macro......Page 44
Economic Naturalism......Page 45
THE ECONOMIC NATURALIST 1.1......Page 46
THE ECONOMIC NATURALIST 1.3......Page 47
Core Principles......Page 48
Problems......Page 49
Answers to Concept Checks......Page 51
Appendix: Working with Equations, Graphs, and Tables......Page 52
Chapter 2 Comparative Advantage......Page 64
Exchange and Opportunity Cost......Page 65
The Principle of Comparative Advantage......Page 66
THE ECONOMIC NATURALIST 2.1......Page 68
Sources of Comparative Advantage......Page 69
The Production Possibilities Curve......Page 70
How Individual Productivity Affects the Slope and Position of the PPC......Page 73
The Gains from Specialization and Exchange......Page 75
A Production Possibilities Curve for a Many-Person Economy......Page 76
Factors That Shift the Economy’s Production Possibilities Curve......Page 78
Why Have Some Countries Been Slow to Specialize?......Page 80
Can We Have Too Much Specialization?......Page 81
Outsourcing......Page 82
THE ECONOMIC NATURALIST 2.4......Page 83
Key Terms......Page 85
Problems......Page 86
Answers to Concept Checks......Page 87
Chapter 3 Supply and Demand......Page 90
What, How, and for Whom? Central Planning versus the Market......Page 92
Buyers and Sellers in Markets......Page 93
The Demand Curve......Page 94
The Supply Curve......Page 95
Market Equilibrium......Page 97
Rent Controls Reconsidered......Page 100
Pizza Price Controls?......Page 102
Predicting and Explaining Changes in Prices and Quantities......Page 103
Shifts in Demand......Page 104
THE ECONOMIC NATURALIST 3.1......Page 106
Shifts in the Supply Curve......Page 107
THE ECONOMIC NATURALIST 3.2......Page 110
Four Simple Rules......Page 111
THE ECONOMIC NATURALIST 3.3......Page 113
Cash on the Table......Page 114
Smart for One, Dumb for All......Page 115
Summary......Page 117
Problems......Page 118
Answers to Concept Checks......Page 120
Appendix: The Algebra of Supply and Demand......Page 122
Chapter 4 Elasticity......Page 124
Price Elasticity Defined......Page 125
Time......Page 127
Some Representative Elasticity Estimates......Page 128
THE ECONOMIC NATURALIST 4.2......Page 129
A Graphical Interpretation of Price Elasticity......Page 130
Price Elasticity Changes along a Straight-Line Demand Curve......Page 132
Two Special Cases......Page 133
Elasticity and Total Expenditure......Page 134
Income Elasticity and Cross-Price Elasticity of Demand......Page 138
The Price Elasticity of Supply......Page 139
Determinants of Supply Elasticity......Page 141
Time......Page 142
THE ECONOMIC NATURALIST 4.3......Page 143
Summary......Page 145
Review Questions......Page 146
Problems......Page 147
Answers to Concept Checks......Page 149
Appendix: The Midpoint Formula......Page 150
Chapter 5 Demand......Page 152
The Origins of Demand......Page 153
THE ECONOMIC NATURALIST 5.1......Page 154
Measuring Wants: The Concept of Utility......Page 155
Allocating a Fixed Income between Two Goods......Page 158
Income and Substitution Effects Revisited......Page 162
Applying the Rational Spending Rule......Page 164
THE ECONOMIC NATURALIST 5.3......Page 165
THE ECONOMIC NATURALIST 5.5......Page 167
Horizontal Addition......Page 168
Calculating Consumer Surplus......Page 169
Summary......Page 172
Problems......Page 173
Answers to Concept Checks......Page 175
Chapter 6 Perfectly Competitive Supply......Page 178
Thinking about Supply: The Importance of Opportunity Cost......Page 179
Individual and Market Supply Curves......Page 181
Profit-Maximizing Firms in Perfectly Competitive Markets......Page 182
The Demand Curve Facing a Perfectly Competitive Firm......Page 183
Production in the Short Run......Page 184
Some Important Cost Concepts......Page 185
Choosing Output to Maximize Profit......Page 186
A Graphical Approach to Profit Maximization......Page 188
Price = Marginal Cost: The Maximum-Profit Condition......Page 190
The “Law” of Supply......Page 192
Input Prices......Page 193
THE ECONOMIC NATURALIST 6.1......Page 194
Calculating Producer Surplus......Page 197
Summary......Page 199
Problems......Page 200
Answers to Concept Checks......Page 203
Chapter 7 Efficiency, Exchange, and the Invisible Hand in Action......Page 206
Three Types of Profit......Page 207
Responses to Profits and Losses......Page 211
The Importance of Free Entry and Exit......Page 217
Economic Rent versus Economic Profit......Page 218
THE ECONOMIC NATURALIST 7.1......Page 220
The Invisible Hand and Cost-Saving Innovations......Page 221
Smart for One, Dumb for All......Page 222
Market Equilibrium and Efficiency......Page 223
Efficiency Is Not the Only Goal......Page 226
Price Ceilings......Page 227
Price Subsidies......Page 231
Summary......Page 233
Review Questions......Page 234
Problems......Page 235
Answers to Concept Checks......Page 237
Chapter 8 Monopoly, Oligopoly, and Monopolistic Competition......Page 240
Monopolistic Competition......Page 241
Oligopoly......Page 242
The Essential Difference between Perfectly and Imperfectly Competitive Firms......Page 243
Government Licenses or Franchises......Page 244
Network Economies......Page 245
Economies of Scale and the Importance of Start-Up Costs......Page 246
THE ECONOMIC NATURALIST 8.1......Page 248
Profit Maximization for the Monopolist......Page 249
Marginal Revenue for the Monopolist......Page 250
The Monopolist’s Profit-Maximizing Decision Rule......Page 252
Being a Monopolist Doesn’t Guarantee an Economic Profit......Page 253
Why the Invisible Hand Breaks Down under Monopoly......Page 254
Price Discrimination Defined......Page 256
How Price Discrimination Affects Output......Page 257
The Hurdle Method of Price Discrimination......Page 260
Is Price Discrimination a Bad Thing?......Page 262
Examples of Price Discrimination......Page 263
THE ECONOMIC NATURALIST 8.3......Page 264
State Ownership and Management......Page 265
Exclusive Contracting for Natural Monopoly......Page 266
Vigorous Enforcement of Antitrust Laws......Page 267
Summary......Page 268
Problems......Page 269
Answers to Concept Checks......Page 272
Appendix: The Algebra of Monopoly Profit Maximization......Page 274
Chapter 9 Games and Strategic Behavior......Page 276
The Three Elements of a Game......Page 277
Nash Equilibrium......Page 279
The Original Prisoner’s Dilemma......Page 281
THE ECONOMIC NATURALIST 9.1......Page 282
Tit-for-Tat and the Repeated Prisoner’s Dilemma......Page 285
THE ECONOMIC NATURALIST 9.2......Page 286
THE ECONOMIC NATURALIST 9.3......Page 287
Games in Which Timing Matters......Page 288
Credible Threats and Promises......Page 290
Monopolistic Competition When Location Matters......Page 291
THE ECONOMIC NATURALIST 9.4......Page 292
Commitment Problems......Page 293
Solving Commitment Problems with Psychological Incentives......Page 295
Preferences as Solutions to Commitment Problems......Page 296
Review Questions......Page 298
Problems......Page 299
Answers to Concept Checks......Page 302
External Costs and Benefits......Page 304
How Externalities Affect Resource Allocation......Page 305
How Do Externalities Affect Supply and Demand?......Page 306
The Coase Theorem......Page 308
Laws and Regulations......Page 312
THE ECONOMIC NATURALIST 10.1......Page 313
Compensatory Taxes and Subsidies......Page 314
Property Rights and the Tragedy of the Commons......Page 316
The Problem of Unpriced Resources......Page 317
The Effect of Private Ownership......Page 319
THE ECONOMIC NATURALIST 10.3......Page 320
Controlling Multinational Environmental Pollution......Page 321
THE ECONOMIC NATURALIST 10.5......Page 322
Positional Arms Races and Positional Arms Control Agreements......Page 323
Social Norms as Positional Arms Control Agreements......Page 324
Norms of Taste......Page 325
Norms against Vanity......Page 326
Summary......Page 327
Problems......Page 328
Answers to Concept Checks......Page 331
Chapter 11 The Economics of Information......Page 332
How the Middleman Adds Value......Page 333
The Cost-Benefit Test......Page 335
THE ECONOMIC NATURALIST 11.2......Page 336
Two Guidelines for Rational Search......Page 337
The Gamble Inherent in Search......Page 338
The Commitment Problem When Search Is Costly......Page 339
Asymmetric Information......Page 340
The Lemons Model......Page 341
The Credibility Problem in Trading......Page 343
THE ECONOMIC NATURALIST 11.3......Page 344
Conspicuous Consumption as a Signal of Ability......Page 345
Statistical Discrimination......Page 346
THE ECONOMIC NATURALIST 11.6......Page 347
Moral Hazard......Page 348
THE ECONOMIC NATURALIST 11.7......Page 349
THE ECONOMIC NATURALIST 11.8......Page 350
Review Questions......Page 352
Problems......Page 353
Answers to Concepts Checks......Page 354
Chapter 12 Labor Markets, Poverty, and Income Distribution......Page 356
The Economic Value of Work......Page 357
The Supply Curve of Labor......Page 360
Market Shifts......Page 361
Human Capital Theory......Page 362
Labor Unions......Page 363
THE ECONOMIC NATURALIST 12.1......Page 364
THE ECONOMIC NATURALIST 12.2......Page 365
Discrimination by Others......Page 366
Other Sources of the Wage Gap......Page 367
THE ECONOMIC NATURALIST 12.3......Page 368
Recent Trends in Inequality......Page 369
Is Income Inequality a Moral Problem?......Page 370
Means-Tested Benefit Programs......Page 372
The Negative Income Tax......Page 373
Minimum Wages......Page 374
The Earned-Income Tax Credit......Page 375
A Combination of Methods......Page 377
Summary......Page 378
Problems......Page 379
Answers to Concept Checks......Page 382
Chapter 13 The Environment, Health, and Safety......Page 384
Applying the Cost-Benefit Criterion......Page 385
Designing a Solution......Page 387
The HMO Revolution......Page 388
THE ECONOMIC NATURALIST 13.1......Page 389
The Problem with Health Care Provision through Private Insurance......Page 390
The Affordable Care Act of 2010......Page 391
Taxing Pollution......Page 392
Auctioning Pollution Permits......Page 394
Climate Change and Carbon Taxes......Page 395
Workplace Safety Regulation......Page 397
Public Health and Security......Page 401
THE ECONOMIC NATURALIST 13.3......Page 402
THE ECONOMIC NATURALIST 13.4......Page 403
Summary......Page 404
Problems......Page 405
Answers to Concept Checks......Page 407
Chapter 14 Public Goods and Tax Policy......Page 410
Public Goods versus Private Goods......Page 411
Paying for Public Goods......Page 413
THE ECONOMIC NATURALIST 14.1......Page 415
The Demand Curve for a Public Good......Page 416
Private Provision of Public Goods......Page 418
THE ECONOMIC NATURALIST 14.2......Page 419
Local, State, or Federal?......Page 422
Pork Barrel Legislation......Page 423
THE ECONOMIC NATURALIST 14.4......Page 424
Rent-Seeking......Page 425
Starve the Government?......Page 427
What Should We Tax?......Page 428
Key Terms......Page 430
Problems......Page 431
Answers to Concept Checks......Page 433
Chapter 15 Spending, Income, and GDP......Page 436
Market Value......Page 437
Final Goods and Services......Page 438
Produced within a Country during a Given Period......Page 441
The Expenditure Method for Measuring GDP......Page 442
GDP and the Incomes of Capital and Labor......Page 446
Nominal GDP versus Real GDP......Page 447
THE ECONOMIC NATURALIST 15.1......Page 449
Leisure Time......Page 450
Nonmarket Economic Activities......Page 451
Poverty and Economic Inequality......Page 452
Health and Education......Page 453
THE ECONOMIC NATURALIST 15.3......Page 454
Summary......Page 455
Problems......Page 456
Answers to Concept Checks......Page 458
Chapter 16 Inflation and the Price Level......Page 460
The Consumer Price Index and Inflation......Page 461
Inflation......Page 463
Adjusting for Inflation......Page 465
Deflating a Nominal Quantity......Page 466
Indexing to Maintain Buying Power......Page 468
Does the CPI Measure “True” Inflation?......Page 469
The Costs of Inflation: Not What You Think......Page 472
“Noise” in the Price System......Page 473
Distortions of the Tax System......Page 474
Unexpected Redistributions of Wealth......Page 475
Interference with Long-Term Planning......Page 476
Hyperinflation......Page 477
Inflation and the Real Interest Rate......Page 478
The Fisher Effect......Page 481
Key Terms......Page 482
Problems......Page 483
Answers to Concept Checks......Page 485
Chapter 17 Wages and Unemployment......Page 488
Three Important Labor Market Trends......Page 489
Wages and the Demand for Labor......Page 490
Shifts in the Demand for Labor......Page 493
The Supply of Labor......Page 496
Shifts in the Supply of Labor......Page 497
Why Have Real Wages Increased by So Much in the Industrialized Countries?......Page 498
Since the 1970s, Real Wage Growth in the United States Has Stagnated, Even Though Employment Growth Has Been Rapid......Page 499
Increasing Wage Inequality: The Effects of Globalization......Page 500
Increasing Wage Inequality: Technological Change......Page 502
Unemployment and the Unemployment Rate......Page 505
The Costs of Unemployment......Page 507
The Duration of Unemployment......Page 508
Frictional Unemployment......Page 509
Structural Unemployment......Page 510
Minimum Wage Laws......Page 511
Labor Unions......Page 512
Other Government Regulations......Page 513
Summary......Page 514
Problems......Page 515
Answers to Concept Checks......Page 517
Chapter 18 Economic Growth......Page 520
The Remarkable Rise in Living Standards: The Record......Page 521
Why “Small” Differences in Growth Rates Matter......Page 523
Why Nations Become Rich: The Crucial Role of Average Labor Productivity......Page 525
Human Capital......Page 527
Physical Capital......Page 529
Technology......Page 532
Entrepreneurship and Management......Page 533
THE ECONOMIC NATURALIST 18.1......Page 534
The Political and Legal Environment......Page 535
Promoting Economic Growth......Page 537
Policies That Promote Saving and Investment......Page 538
The Poorest Countries: A Special Case?......Page 539
Thinking about the Costs of Economic Growth......Page 540
Are There Limits to Growth?......Page 541
Review Questions......Page 544
Problems......Page 545
Answers to Concept Checks......Page 547
Chapter 19 Saving, Capital Formation, and Financial Markets......Page 550
Saving and Wealth......Page 551
Stocks and Flows......Page 552
Capital Gains and Losses......Page 553
The Measurement of National Saving......Page 555
Private and Public Components of National Saving......Page 556
Public Saving and the Government Budget......Page 558
Why Do People Save?......Page 560
Saving and the Real Interest Rate......Page 562
Saving, Self-Control, and Demonstration Effects......Page 563
Investment and Capital Formation......Page 565
THE ECONOMIC NATURALIST 19.1......Page 568
Bonds......Page 569
Stocks......Page 571
The Informational Role of Bond and Stock Markets......Page 573
Risk Sharing and Diversification......Page 574
Saving, Investment, and Financial Markets......Page 575
Summary......Page 580
Problems......Page 581
Answers to Concept Checks......Page 585
Chapter 20 Money, Prices, and Financial Intermediaries......Page 586
The Banking System and the Allocation of Saving to Productive Uses......Page 587
Money and Its Uses......Page 589
Measuring Money......Page 591
Commercial Banks and the Creation of Money......Page 593
The Money Supply with Both Currency and Deposits......Page 596
Controlling the Money Supply with Open-Market Operations......Page 598
Money and Prices......Page 599
Velocity......Page 600
Money and Inflation in the Long Run......Page 601
Review Questions......Page 603
Problems......Page 604
Answers to Concept Checks......Page 605
Chapter 21 Short-Term Economic Fluctuations......Page 606
Recessions and Expansions......Page 607
Some Facts about Short-Term Economic Fluctuations......Page 610
Potential Output......Page 612
The Output Gap......Page 614
The Natural Rate of Unemployment and Cyclical Unemployment......Page 615
Okun’s Law......Page 617
Why Do Short-Term Fluctuations Occur? A Preview and a Parable......Page 619
Al’s Ice Cream Store: A Tale about Short-Run Fluctuations......Page 620
THE ECONOMIC NATURALIST 21.1......Page 621
Summary......Page 622
Problems......Page 623
Answer to Concept Check......Page 624
Chapter 22 Spending, Output, and Fiscal Policy......Page 626
The Keynesian Model’s Crucial Assumption: Firms Meet Demand at Preset Prices......Page 627
Planned Spending versus Actual Spending......Page 629
Consumer Spending and the Economy......Page 631
Planned Aggregate Expenditure and Output......Page 633
Short-Run Equilibrium Output......Page 636
Finding Short-Run Equilibrium Output: Numerical Approach......Page 637
Finding Short-Run Equilibrium Output: Graphical Approach......Page 638
Planned Spending and the Output Gap......Page 639
The Multiplier......Page 644
Government Purchases and Planned Spending......Page 645
Taxes, Transfers, and Aggregate Spending......Page 648
Fiscal Policy and the Supply Side......Page 651
The Relative Inflexibility of Fiscal Policy......Page 652
Summary......Page 653
Review Questions......Page 654
Problems......Page 655
Answers to Concept Checks......Page 657
Appendix: The Multiplier in the Basic Keynesian Model......Page 660
Chapter 23 Monetary Policy and the Federal Reserve......Page 662
The History and Structure of the Federal Reserve System......Page 663
The Fed’s Role in Stabilizing Financial Markets: Banking Panics......Page 664
Can the Fed Control the Real Interest Rate?......Page 667
The Role of the Federal Funds Rate in Monetary Policy......Page 668
Planned Aggregate Expenditure and the Real Interest Rate......Page 669
The Fed Fights a Recession......Page 672
The Fed Fights Inflation......Page 674
THE ECONOMIC NATURALIST 23.1......Page 676
Should the Federal Reserve Respond to Changes in Asset Prices?......Page 677
The Federal Reserve and Interest Rates......Page 678
The Demand for Money......Page 679
Macroeconomic Factors That Affect the Demand for Money......Page 680
The Money Demand Curve......Page 681
THE ECONOMIC NATURALIST 23.2......Page 682
The Supply of Money and Money Market Equilibrium......Page 683
Open-Market Operations......Page 685
Reserve Requirements......Page 687
Unconventional Monetary Policy......Page 688
Summary......Page 689
Problems......Page 690
Answers to Concept Checks......Page 692
Chapter 24 Aggregate Demand, Aggregate Supply, and Business Cycles......Page 694
The Aggregate Demand–Aggregate Supply Model: A Brief Overview......Page 695
The Aggregate Demand Curve......Page 696
The Fed’s Monetary Policy Rule......Page 697
Demand Shocks......Page 698
Stabilization Policy......Page 700
The Aggregate Supply Curve......Page 701
Inflation Inertia......Page 702
Deriving the AS Curve: Graphical Analysis......Page 705
What Causes the AS Curve to Shift?......Page 706
Changes in Inflation Expectations......Page 707
Inflation Shocks......Page 708
Demand Shocks: Shifts in the AD Curve......Page 709
Inflation Shocks: Shifts in the AS Curve......Page 710
Using AD-AS to Analyze the Great Recession......Page 711
The Self-Correcting Economy......Page 713
A Recessionary Gap......Page 714
A Role for Stabilization Policy?......Page 715
Review Questions......Page 716
Answers to Concept Checks......Page 717
Chapter 25 Macroeconomic Policy......Page 720
What Is the Role of Stabilization Policy?......Page 721
Stabilization Policy and Demand Shocks......Page 722
Stabilization Policy and Inflation Shocks......Page 723
THE ECONOMIC NATURALIST 25.1......Page 725
THE ECONOMIC NATURALIST 25.2......Page 726
Inflationary Expectations and Credibility......Page 727
Central Bank Independence......Page 728
Announcing a Numerical Inflation Target......Page 729
Fiscal Policy and the Supply Side......Page 731
THE ECONOMIC NATURALIST 25.3......Page 734
Policymaking: Art or Science?......Page 736
Review Questions......Page 738
Problems......Page 739
Answer to Concept Check......Page 740
Chapter 26 Exchange Rates, International Trade, and Capital Flows......Page 742
Exchange Rates......Page 743
Nominal Exchange Rates......Page 744
Should Exchange Rates Be Fixed or Flexible?......Page 746
The Euro: A Common Currency for Europe......Page 747
A Supply and Demand Analysis......Page 748
The Supply of Dollars......Page 749
The Demand for Dollars......Page 750
Changes in the Supply of Dollars......Page 751
Does a Strong Currency Imply a Strong Economy?......Page 752
Monetary Policy and the Exchange Rate......Page 753
The Exchange Rate as a Tool of Monetary Policy......Page 754
The Real Exchange Rate......Page 755
A Simple Theory of Exchange Rates: Purchasing Power Parity (PPP)......Page 757
Shortcomings of the PPP Theory......Page 760
International Capital Flows and the Balance of Trade......Page 761
International Capital Flows......Page 762
The Determinants of International Capital Flows......Page 763
Saving, Investment, and Capital Inflows......Page 764
The Saving Rate and the Trade Deficit......Page 767
Summary......Page 770
Problems......Page 771
Answers to Concept Checks......Page 773
Glossary......Page 774
Index......Page 782