Economics, Thirteenth Edition
By Roger A. Arnold
Content
An Introduction to Economics
Part 1 Economics: The Science of Scarcity
CHAPTER 1: What Economics is About 1
Your Life, 2019–2029 1
A Definition of Economics 2
Goods and Bads 2 Resources 2 Scarcity and a Definition of Economics 2
Key Concepts in Economics 4
Opportunity Cost 4 Opportunity Cost and Behavior 6 Benefits and Costs 6
Decisions Made at the Margin 7 Efficiency 9
Does It Matter to You . . . If You Are Efficient or Not? 11
Economics Is About Incentives 12 Unintended Effects 13 Exchange 14
Ceteris Paribus and Theory 16
Ceteris Paribus Thinking 16 What Is a Theory? 17
Hear What and How the Economist Thinks . . . About Theories 19
Economic Categories 20
Positive Economics and Normative Economics 20 Microeconomics and
Macroeconomics 20
Chapter Summary 22
Key Terms and Concepts 23
Questions and Problems 23
Working with Numbers and Graphs 24
Appendix A: WORKING WITH DIAGRAMS 25
Slope of a Line 26
Slope of a Line Is Constant 27
Slope of a Curve 27
The 45-Degree Line 27
Pie Charts 29
Bar Graphs 29
Line Graphs 30
Appendix Summary 32
Key Terms and Concepts 32
Questions and Problems 32
Appendix B: SHOULD YOU MAJOR IN ECONOMICS? 34
Five Myths About Economics and Being an Economics Major 35
What Awaits You as an Economics Major? 37
What Do Economists Do? 38
Places to Find More Information 40
Concluding Remarks 40
CHAPTER 2: PRODUCTION POSSIBILITIES FRONTIER FRAMEWORK 41
The Production Possibilities Frontier 41
The Straight-Line PPF: Constant Opportunity Costs 41 The Bowed-Outward
(Concave-Downward) PPF: Increasing Opportunity Costs 42
Does It Matter to You . . . If the Economy Is at One Point on the PPF Instead of Another? 44
Law of Increasing Opportunity Costs 45 Economic Concepts in a Production Possibilities
Specialization and Trade Can Move Us Beyond Our Ppf 51
A Simple Two-Person PPF Model 51 On or Beyond the PPF? 52
Hear What and How the Economist Thinks . . . About Manufacturing Jobs 53
Chapter Summary 56
Key Terms and Concepts 57
Questions and Problems 57
Working with Numbers and Graphs 57
CHAPTER 3: SUPPLY AND DEMAND: THEORY 59
What Is Demand? 59
The Law of Demand 60 Four Ways to Represent the Law of Demand 60 Why Does
Quantity Demanded Go Down as Price Goes Up? 61 Individual Demand Curve and
Market Demand Curve 62 A Change in Quantity Demanded Versus a Change in
Demand 63 What Factors Cause the Demand Curve to Shift? 66 Movement Factors
and Shift Factors 68
Supply 69
The Law of Supply 69 Why Most Supply Curves Are Upward Sloping 70 Changes in
Supply Mean Shifts in Supply Curves 72 What Factors Cause the Supply Curve to Shift? 72
A Change in Supply Versus a Change in Quantity Supplied 74
The Market: Putting Supply and Demand Together 75
Supply and Demand at Work at an Auction 75 The Language of Supply and Demand: A
Few Important Terms 76 Moving to Equilibrium: What Happens to Price When There Is
a Surplus or a Shortage? 76 Speed of Moving to Equilibrium 76
Hear What and How the Economist Thinks . . . About Higher Prices and Buying More 78
Moving to Equilibrium: Maximum and Minimum Prices 79 The Connection Between
Equilibrium and Predictions 80 Equilibrium in Terms of Consumers’ and Producers’
Surplus 81
Does It Matter to You . . . If You Pay Equilibrium Prices or Not? 83
What Can Change Equilibrium Price and Quantity? 83 It Is Important to Know Why
the Price Changed: Back to Substitutes and Complements 86 Epilogue: Who Feeds Cleveland? 87
Chapter Summary 91
Key Terms and Concepts 91
Questions and Problems 92
Working with Numbers and Graphs 93
CHAPTER 4: PRICES: FREE, CONTROLLED, AND RELATIVE 95
Price 95
Price as a Rationing Device 95 Price as a Transmitter of Information 96
Price Controls 97
Price Ceiling 97
Hear What and How the Economist Thinks . . . About Price Ceilings and the Value of Money 102
Price Floor: Definition and Effects 103
Does It Matter to You . . . If the Demand Curve for Unskilled Labor Is Steep or Not? 105
Two Prices: Absolute and Relative 109
Absolute (Money) Price and Relative Price 109 Taxes on Specific Goods and Relative Price Changes 110
Does It Matter to You . . . If Something You Buy Is Taxed or Subsidized? 112
Chapter Summary 114
Key Terms and Concepts 114
Questions and Problems 114
Working with Numbers and Graphs 115
CHAPTER 5: SUPPLY, DEMAND, AND PRICE: APPLICATIONS 116
Application 1: U-Haul Rates and Demand 116
Application 2: Subsidizing the Consumption
of Anything Can Raise its Price 117
Application 3: 10 a.m. Classes in College 119
Application 4: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes of Admission? 121
Application 5: Why is Medical Care So Expensive? 122
Application 6: Do You Pay for Good Weather? 124
Application 7: The Price of an Aisle Seat 126
Application 8: College Superathletes 127
Application 9: Easier-to-Obtain Loans and Higher Housing Prices 129
Application 10: Speculators, Price Variability, and Patterns 130
Application 11: Supply and Demand on a Freeway 131
Application 12: Are Renters Better Off? 132
Chapter Summary 135
Questions and Problems 136
Working with Numbers and Graphs 137
Macroeconomics
Part 2 Macroeconomic Fundamentals
CHAPTER 6: MACROECONOMIC MEASUREMENTS,
PART I: PRICES AND UNEMPLOYMENT 138
Measuring The Price Level 138
Using the CPI to Compute the Price Level 138 Inflation and the CPI 140 The Core PCE Index 141
Does It Matter to You . . . If Prices Rise or Fall? 142
Converting Dollars from One Year to Another 143
Hear What and How the Economist Thinks . . . About House Prices in the Past 145
Measuring Unemployment 146
Who Are the Unemployed? 146 The Unemployment Rate and the Employment
Rate 147 Common Misconceptions about the Unemployment and Employment
Rates 147 Reasons for Unemployment 148 Discouraged Workers 148 Types of
Unemployment 149 The Natural Unemployment Rate and Full Employment 150
Cyclical Unemployment 151
Chapter Summary 154
Key Terms and Concepts 154
Questions and Problems 154
Working with Numbers and Graphs 155
CHAPTER 7: MACROECONOMIC MEASUREMENTS,
PART II: GDP AND REAL GDP 156
Gross Domestic Product 156
Calculating GDP 156 Final Goods and Intermediate Goods 157 What GDP Omits 157
GDP Is Not Adjusted for Bads Generated in the Production of Goods 158 Per-Capita GDP 158
The Expenditure Approach to Computing GDP for a Real-World Economy 162
Using the Expenditure Approach to Compute GDP 163 Common Misconceptions about Increases in GDP 165
The Income Approach to Computing GDP for a Real-World Economy 165
Computing National Income 167 From National Income to GDP: Making
Some Adjustments 168 Other National Income Accounting Measurements 170
Net Domestic Product 170 Personal Income 170 Disposable Income 170
Real GDP 171
Why We Need Real GDP 171 Computing Real GDP 171 The General Equation for
Real GDP 172 What Does It Mean if Real GDP Is Higher in One Year Than in Another?
172 Real GDP, Economic Growth, and Business Cycles 172
Does It Matter to You . . . In Which Phase of the Business Cycle You Search for a Job? 174
Hear What and How the Economist Thinks . . . About Economic Growth and
Real GDP 175
Chapter Summary 177
Key Terms and Concepts 178
Questions and Problems 178
Working with Numbers and Graphs 179
Part 3 Macroeconomic Stability, Instability, and Fiscal Policy
CHAPTER 8: AGGREGATE DEMAND AND AGGREGATE SUPPLY 181
A Way to View the Economy 181
Aggregate Demand 182
Why Does the Aggregate Demand Curve Slope Downward? 183 An Important Word on
the Three Effects 186 A Change in Quantity Demanded of Real GDP Versus a Change
in Aggregate Demand 186 Changes in Aggregate Demand: Shifts in the AD Curve 187
How Spending Components Affect Aggregate Demand 188 Why Is There More Total
Spending? 189 Factors That Can Change C, I, G, and NX (EX – IM) and Therefore
Can Change AD (Shift the AD Curve) 189 Can a Change in the Money Supply Change
Aggregate Demand? 194 If Consumption Rises, Does Some Other Spending Component
Have to Decline? 194
Does It Matter to You . . . If Velocity Falls? 196
Hear What and How the Economist Thinks . . . About Total Spending, the Money Supply,
and Velocity 197
Short-Run Aggregate Supply 197
Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping 197 What
Puts the “Short Run” in the SRAS Curve? 199 Changes in Short-Run Aggregate Supply:
Shifts in the SRAS Curve 200 Something More to Come: Peoples’ Expectations 201
Putting AD And Sras Together: Short-Run Equilibrium 202
How Short-Run Equilibrium in the Economy Is Achieved 202 Thinking in Terms of
Short-Run Equilibrium Changes in the Economy 203 An Important Exhibit 207
Long-Run Aggregate Supply 207
Going from the Short Run to the Long Run 207 Short-Run Equilibrium, Long-Run
Equilibrium, and Disequilibrium 209
Chapter Summary 211
Key Terms and Concepts 212
Questions and Problems 212
Working with Numbers and Graphs 213
CHAPTER 9: CLASSICAL MACROECONOMICS
AND THE SELF-REGULATING ECONOMY 215
The Classical View 215
Classical Economists and Say’s Law 215 Classical Economists and Interest Rate Flexibility 216
Does It Matter to You . . . How Much People Save? 218
Classical Economists on Prices and Wages: Both Are Flexible 219
Three States of the Economy 220
Real GDP and Natural Real GDP: Three Possibilities 220 The Labor Market and the
Three States of the Economy 222 Common Misconceptions About the Unemployment
Rate and the Natural Unemployment Rate 223
The Self-Regulating Economy 226
What Happens If a Self-Regulating Economy Is in a Recessionary Gap? 226 What’s the
Connection Between a Slow Recovery and How Quickly or Slowly Wages Adjust? 227
What Happens If the Economy Is In an Inflationary Gap? 228 The Self-Regulating
Economy: A Recap 228
Hear What and How the Economist Thinks . . . About Laissez-Faire and the
Self-Regulating Economy 231 Policy Implication of Believing That the Economy Is Self-Regulating 231 Changes
in a Self-Regulating Economy: Short Run and Long Run 232 A Recap of Classical
Macroeconomics and a Self-Regulating Economy 234 Business-Cycle Macroeconomics
and Economic-Growth Macroeconomics 234
Chapter Summary 238
Key Terms and Concepts 238
Questions and Problems 239
Working with Numbers and Graphs 239
CHAPTER 10: KEYNESIAN MACROECONOMICS AND ECONOMIC
INSTABILITY: A CRITIQUE OF THE SELF-REGULATING ECONOMY 241
Questioning the Classical Position and the Self-Regulating Economy 241
Keynes’s Criticism of Say’s Law in a Money Economy 242 Keynes on Wage Rates 243
Different Markets, Different Rates of Adjustment 244 Keynes on Prices 247 Is It a
Question of the Time It Takes for Wages and Prices to Adjust? 248
The Simple Keynesian Model 251
Assumptions 251 The Consumption Function 251 Consumption and Saving 253
The Multiplier 254 The Multiplier and Reality 255
Does It Matter to You . . . How Much Spring Breakers Spend, the Value of the MPC, or Both? 256
The Simple Keynesian Model in the AD–AS Framework 257
Shifts in the Aggregate Demand Curve 257 The Keynesian Aggregate
Supply Curve 257 The Economy in a Recessionary Gap 259 Government’s Role
in the Economy 260 The Theme of the Simple Keynesian Model 260
Hear What and How the Economist Thinks . . . About Why Not All Economists Agree on How the Economy Works 261
The Simple Keynesian Model in the TE–TP Framework 262
Deriving a Total Expenditures (TE) Curve 263 Where the Consumption Curve and
the Total Expenditures Curve Cut the Vertical Axis: More on Exhibit 12 264 What Will
Shift the TE Curve? 265 Comparing Total Expenditures (TE) and Total Production (TP)
265 Moving from Disequilibrium to Equilibrium 266 The Economy in a Recessionary
Gap and the Role of Government 268 Equilibrium in the Economy 269 The Theme of
the Simple Keynesian Model 269
Chapter Summary 271
Key Terms and Concepts 271
Questions and Problems 272
Working with Numbers and Graphs 273
CHAPTER 11: FISCAL POLICY AND THE FEDERAL BUDGET 274
The Federal Budget 274
Government Expenditures 274 Government Tax Revenues 275 Budget Projections 276
Budget Deficit, Surplus, or Balance 277 Structural and Cyclical Deficits 278 The Public
Debt 279 Valued-Added Tax 279 Tax Deductions Versus Subsidies 282
Fiscal Policy 283
Some Relevant Fiscal Policy Terms 283 Two Important Notes 283
Demand-Side Fiscal Policy 283
Shifting the Aggregate Demand Curve 283 Fiscal Policy: Keynesian Perspective (Economy
Is Not Self-Regulating) 284 Crowding Out: Questioning Expansionary Fiscal Policy 285
Lags and Fiscal Policy 287 Crowding Out, Lags, and the Effectiveness of Fiscal Policy 289
Democracy in Deficit 289
Hear What and How the Economist Thinks . . . About the Deficit as a Percentage
of GDP 292
Supply-Side Fiscal Policy 292
Marginal Tax Rates and Aggregate Supply 293 The Laffer Curve: Tax Rates and Tax Revenues 293
Does It Matter to You . . . If the Economy Is on the Upward-Sloping or
Downward-Sloping Portion of the Laffer Curve? 295
Fiscal Policy and Expectations 296
Chapter Summary 298
Key Terms and Concepts 299
Questions and Problems 299
Working with Numbers and Graphs 300
Part 4 Money, the Economy, and Monetary Policy
CHAPTER 12: MONEY, BANKING, AND THE FINANCIAL SYSTEM 301
Money: What Is It and How Did It Come To Be? 301
Money: A Definition 301 Three Functions of Money 302 From a Barter Economy to
a Money Economy: The Origins of Money 302
Does It Matter to You . . . If You Live in a Barter or Money Economy? 304
Money, Leisure, and Output 304
Defining the Money Supply 305
M1 305 Money Is More Than Currency 306 M2 306 Where Do Credit Cards Fit In? 306
Hear What and How the Economist Thinks . . . About Money and Gold 307
How Banking Developed 308
The Early Bankers 308 The Bank’s Reserves and More 310
The Financial System 311
Direct and Indirect Finance 312 Adverse Selection Problems and Moral Hazard
Problems 312 The Bank’s Balance Sheet 313 A Bank’s Business: Turning Liabilities into Assets 313
Chapter Summary 315
Key Terms and Concepts 316
Questions and Problems 316
Working with Numbers and Graphs 317
CHAPTER 13: THE FEDERAL RESERVE SYSTEM 318
The Structure and Functions of the Federal Reserve System (The Fed) 318
The Structure of the Fed 318 Functions of the Fed 319 Common Misconceptions
About the U.S. Treasury and the Fed 321
The Money Supply Expansion Process 323
A Quick Review of Reserves, Required Reserves, and Excess Reserves 323 The Money Supply Expansion Process 323
Hear What and How the Economist Thinks . . . About Money and Currency 327
The Money Supply Contraction Process 327
Does It Matter to You . . . If Banks Are Reserve Deficient or Not? 329
Other Fed Tools and Recent Fed Actions 329
The Required Reserve Ratio 330 The Discount Window and the Federal Funds
Market 330 The Fed and the Federal Funds Rate Target 331 What Is Free Banking? 331
Chapter Summary 334
Key Terms and Concepts 334
Questions and Problems 335
Working with Numbers and Graphs 335
Appendix C: The Market For Reserves (or The Federal Funds Market) 337
The Demand for Reserves 337
The Supply of Reserves 338
Two Different Supply Curves for Reserves 338
The Corridor and Changing the Federal Funds Rate 340
CHAPTER 14: MONEY AND THE ECONOMY 341
Money and the Price Level 341
The Equation of Exchange 341 From the Equation of Exchange to the Simple
Quantity Theory of Money 343 The Simple Quantity Theory of Money in an AD–AS Framework 344
Hear What and How the Economist Thinks . . . About More Money and Inflation 346
Dropping the Assumptions that V and Q Are Constant 348 Monetarism 349
The Four Monetarist Positions 349 Monetarism and AD–AS 349
Does It Matter to You . . . If the AS Curve Is Vertical or Upward-Sloping? 352
The Monetarist View of the Economy 352 Inflation 353
One-Shot Inflation 353 Continued Inflation 357 Can You Get Rid of Inflation with Price Controls? 360
Money and Interest Rates 360
Which Economic Variables Does a Change in the Money Supply Affect? 360 The Money
Supply, the Loanable Funds Market, and Interest Rates 361 What Happens to the
Interest Rate as the Money Supply Changes? 365 The Nominal and Real Interest
Rates 366
Chapter Summary 367
Key Terms and Concepts 368
Questions and Problems 368
Working with Numbers and Graphs 369
CHAPTER 15: MONETARY POLICY 371
Transmission Mechanisms 371
The Money Market in the Keynesian Transmission Mechanism 371 The Keynesian
Transmission Mechanism: Indirect 373 The Keynesian Mechanism May Get
Blocked 374 The Monetarist Transmission Mechanism: Direct 377
Monetary Policy and the Problem of Inflationary and Recessionary Gaps 378
A Different View of the Economy: Patterns of Sustainable Specialization and Trade (PSST) 380
Monetary Policy and the Activist–Nonactivist Debate 381
The Case for Activist (or Discretionary) Monetary Policy 382 The Case for Nonactivist (or Rules-Based) Monetary
Policy 382 Nonactivist Monetary Proposals 385
The Constant-Money-Growth-Rate Rule 386 The Predetermined-Money-Growth-Rate
Rule 386 The Fed and the Taylor Rule 386 Inflation Targeting 387 Nominal GDP Targeting 387
Does It Matter to You . . . How Much of a Change There Is in the Money Supply? 388
A Gold Standard as Monetary Policy and the Value of the Dollar 389
Hear What and How the Economist Thinks . . . About Predicting Gold Prices 391
Chapter Summary 393
Key Terms and Concepts 394
Questions and Problems 394
Working with Numbers and Graphs 395
Appendix D: Bond Prices and the Interest Rate 396
Appendix Summary 398
Questions and Problems 398
Part 5 Expectations and Growth
CHAPTER 18: Debates in Macroeconomics Over the Role and Effects of Government 443
Macroeconomics and Government: The Debate 443
Tax Cuts, Tax Revenue, and Budget Deficits 444
The Economy: Self-Regulating or Not? 445
More Government Spending or a Cut in Taxes: Which Gives a Bigger Bang for the Buck? 445
More Government Spending or a Cut in Taxes: The Size and Scope of Government 447
The Degree of Crowding Out 448
The Politics of Government Spending 449
Hear What and How the Economist Thinks . . . About the Economics of a Hurricane 450
Monetary Policy: Rules Versus Discretion 451
Bailouts 451
Demand-Side and Supply-Side Views of the Economy and Government Tools
for Changing Real GDP 452
Chapter Summary 456
Key Terms and Concepts 457
Questions and Problems 457
Working with Numbers and Graphs 458
MICROECONOMICS
Part 7 Microeconomic Fundamentals
CHAPTER 19: ELASTICITY 459
Elasticity: Part 1 459
Price Elasticity of Demand 459 Elasticity Is Not Slope 461 From Perfectly Elastic to
Perfectly Inelastic Demand 461 Price Elasticity of Demand and Total Revenue (Total
Expenditure) 464 Elastic Demand and Total Revenue 465
Elasticity: Part 2 470
Price Elasticity of Demand Along a Straight-Line Demand Curve 470 Determinants of
Price Elasticity of Demand 471
Hear What and How the Economist Thinks . . . About the Prevalence of Elasticity 474
Other Elasticity Concepts 475
Cross Elasticity of Demand 475 Income Elasticity of Demand 476 Price Elasticity of
Supply 477 Price Elasticity of Supply and Time 478
The Relationship Between Taxes and Elasticity 481
Who Pays the Tax? 481 Elasticity and the Tax 482
Does It Matter to You . . . If There Are Few or Many Substitutes for the Goods
You Buy? 483
Degree of Elasticity and Tax Revenue 484
Chapter Summary 486
Key Terms and Concepts 487
Questions and Problems 487
Working with Numbers and Graphs 488
CHAPTER 20: CONSUMER CHOICE: MAXIMIZING UTILITY
AND BEHAVIORAL ECONOMICS 489
Utility Theory 489
Utility: Total and Marginal 489 Law of Diminishing Marginal Utility 490
The Solution to the Diamond–Water Paradox 492
Consumer Equilibrium and Demand 494
Equating Marginal Utilities per Dollar 494 Maximizing Utility and the Law of Demand
496 Should the Government Provide the Necessities of Life for Free? 496
Hear What and How the Economist Thinks . . . About Towns, Pollution Standards, and
Making the Invisible, Visible 498
Behavioral Economics 499
Are People Willing to Reduce Others’ Incomes? 499 Is One Dollar Always One
Dollar? 500 Coffee Mugs and the Endowment Effect 501 Does the Endowment
Effect Hold Only for New Traders? 503
Does It Matter to You . . . If You Are Subject to the Endowment Effect? 503
The Ultimatum Game—and Facebook, YouTube, and Wikipedia 504
Framing 507 Neuroeconomics 508
Chapter Summary 510
Key Terms and Concepts 511
Questions and Problems 511
Working with Numbers and Graphs 512
APPEnDIx E: BUDGET CONSTRAINT AND INDIFFERENCE
CURVE ANALYSIS 513
The Budget Constraint 513
What Will Change the Budget Constraint? 513
Indifference Curves 514
Constructing an Indifference Curve 515
The Indifference Map and the Budget Constraint Come Together 518
From Indifference Curves to a Demand Curve 519
Appendix Summary 520
Key Terms and Concepts 520
Questions and Problems 520
CHAPTER 21: PRODUCTION AND COSTS 521
Why Firms Exist 521
The Market and the Firm: Invisible Hand Versus Visible Hand 521 The Alchian-and-
Demsetz Answer 522 Shirking on a Team 522 Ronald Coase on Why Firms Exist 523
Markets: Outside and Inside the Firm 524
Two Sides to Every Business Firm 524
More on Total Cost 525 Accounting Profit Versus Economic Profit 525
Does It Matter to You . . . If You Think in Terms of Only Accounting Profit? 526
Zero Economic Profit Is Not as Bad as It Sounds 527
Hear What and How the Economist Thinks . . . About Maximizing Revenue
and Profit 528
Production 529
Common Misconception About the Short Run and Long Run 529 Production in the
Short Run 529 Whose Marginal Productivity Are We Talking About? 531 Marginal
Physical Product and Marginal Cost 531 Average Productivity 534
Costs of Production: Total, Average, Marginal 536
The AVC and ATC Curves in Relation to the MC Curve 538 Tying Short-Run
Production to Costs 541 One More Cost Concept: Sunk Cost 542
Production and Costs in the Long Run 546
Long-Run Average Total Cost Curve 547 Economies of Scale, Diseconomies of Scale,
and Constant Returns to Scale 548 Why Economies of Scale? 549 Why Diseconomies
of Scale? 549 Minimum Efficient Scale and Number of Firms in an Industry 549
Shifts In Cost Curves 550
Taxes 550 Input Prices 550 Technology 550
Chapter Summary 551
Key Terms and Concepts 552
Questions and Problems 553
Working with Numbers and Graphs 554
Part 8 Product Markets and Policies
CHAPTER 22: PERFECT COMPETITION 555
The Theory of Perfect Competition 555
A Perfectly Competitive Firm Is a Price Taker 556 The Demand Curve for a Perfectly
Competitive Firm Is Horizontal 556 Common Misconceptions about Demand
Curves 557 The Marginal Revenue Curve of a Perfectly Competitive Firm Is the Same
as Its Demand Curve 558 Theory and Real-World Markets 559
Perfect Competition in the Short Run 560
What Level of Output Does the Profit-Maximizing Firm Produce? 560 The Perfectly
Competitive Firm and Resource Allocative Efficiency 560 To Produce or Not to Produce:
That Is the Question 561 Common Misconceptions over the Shutdown Decision 564
The Perfectly Competitive Firm’s Short-Run Supply Curve 565 From Firm Supply Curve
to Market (Industry) Supply Curve 565 Why Is the Market Supply Curve Upward
Sloping? 568
Perfect Competition in the Long Run 568
The Conditions of Long-Run Competitive Equilibrium 569 The Perfectly Competitive
Firm and Productive Efficiency 570 Industry Adjustment to an Increase in Demand 571
Profit from Two Perspectives 574
Does It Matter to You . . . If There Is Easy Entry into a Market? 575
Industry Adjustment to a Decrease in Demand 576 Differences in Costs, Differences in
Profits: Now You See It, Now You Don’t 576
Hear What and How the Economist Thinks . . . About Buyers and Sellers 577
Profit and Discrimination 578
Topics for Analysis in the Theory of Perfect Competition 579
Do Higher Costs Mean Higher Prices? 579 Will the Perfectly Competitive Firm
Advertise? 579 Supplier-Set Price Versus Market-Determined Price: Collusion or
Competition? 580
Chapter Summary 581
Key Terms and Concepts 582
Questions and Problems 582
Working with Numbers and Graphs 583
CHAPTER 23: MONOPOLY 585
The Theory of Monopoly 585
Barriers to Entry: A Key to Understanding Monopoly 586 What Is the Difference
Between a Government Monopoly and a Market Monopoly? 586
Monopoly Pricing and Output Decisions 587
The Monopolist’s Demand and Marginal Revenue 588 The Monopolist’s Demand Curve
and Marginal Revenue
Curve Are Not the Same 589 Price and Output for a Profit-
Maximizing Monopolist 589 Comparing the Demand Curve in Perfect Competition
with the Demand Curve in Monopoly 591 If a Firm Maximizes Revenue, Does It
Automatically Maximize Profit Too? 591
Perfect Competition and Monopoly 592
Price, Marginal Revenue, and Marginal Cost 592 Monopoly, Perfect Competition,
and Consumers’ Surplus 592 Monopoly or Nothing? 594
The Case Against Monopoly 595
The Deadweight Loss of Monopoly 595
Does It Matter to You . . . If There Is a Deadweight Loss of Monopoly Triangle? 596
Rent Seeking 596 X-Inefficiency 597
Price Discrimination 598
Types of Price Discrimination 599 Why a Monopolist Wants to Price Discriminate 599
Conditions of Price Discrimination 599
Hear What and How the Economist Thinks . . . About Price Discrimination 600
Moving to P 5 MC Through Price Discrimination 601 Coupons and Price
Discrimination 603
Chapter Summary 605
Key Terms and Concepts 606
Questions and Problems 606
Working with Numbers and Graphs 607
CHAPTER 24: MONOPOLISTIC COMPETITION, OLIGOPOLY,
AND GAME THEORY 608
The Theory of Monopolistic Competition 608
The Monopolistic Competitor’s Demand Curve 609 The Relationship between Price and
Marginal Revenue for a Monopolistic Competitor 609 Output, Price, and
Marginal Cost for the Monopolistic Competitor 609 Will There Be Profits in
the Long Run? 609 Excess Capacity: What Is It, and Is It “Good” or “Bad”? 610
The Monopolistic Competitor and Two Types of Efficiency 612
Oligopoly: Assumptions and Real-World Behavior 613
The Concentration Ratio 613
Price and Output Under the Cartel Theory 614
The Cartel Theory 614
Game Theory, Oligopoly, and Contestable Markets 617
Prisoner’s Dilemma 618 Oligopoly Firms’ Cartels and the Prisoner’s Dilemma 620
Are Markets Contestable? 621 Necessary and Sufficient Conditions and Efficiency 622
A Review of Market Structures 622
Applications of Game Theory 623
Grades and Partying 623
Hear What and How the Economist Thinks . . . About Grade Inflation 625
The Arms Race 626 Speed Limit Laws 626
Chapter Summary 628
Key Terms and Concepts 629
Questions and Problems 629
Working with Numbers and Graphs 629
CHAPTER 25: GOVERNMENT AND PRODUCT
MARKETS:
ANTITRUST AND REGULATION 630
Antitrust 630
Antitrust Acts 631 Unsettled Points in Antitrust Policy 633 Antitrust and Mergers 635
Common Misconceptions about Antitrust Policy 636 Network Monopolies 636
Regulation 639
The Case of Natural Monopoly 639 Regulating the Natural Monopoly 641 Regulating
Industries That Are Not Natural Monopolies 643 Theories of Regulation 643
Hear What and How the Economist Thinks . . .About Regulation 644
The Costs and Benefits of Regulation 645
Does It Matter to You . . . If People Are Aware of Both the Costs and the Benefits of
Regulation? 645
Chapter Summary 647
Key Terms and Concepts 648
Questions and Problems 648
Working with Numbers and Graphs 649
Part 9 Factor Markets and Related Issues
CHAPTER 26: FACTOR MARKETS: WITH EMPHASIS
ON THE LABOR MARKET 650
Factor Markets 650
The Demand for a Factor 650 Marginal Revenue Product: Two Ways to Calculate It 651
The MRP Curve Is the Firm’s Factor Demand Curve 651 Value Marginal Product 652
An Important Question: Is MRP 5 VMP ? 653 Marginal Factor Cost: The Firm’s Factor
Supply Curve 654 How Many Units of a Factor Should a Firm Buy? 655 When There
Is More Than One Factor, How Much of Each Factor Should the Firm Buy? 655
The Labor Market 657
Shifts in a Firm’s MRP, or Factor Demand, Curve 657 Market Demand for Labor 659
The Elasticity of Demand for Labor 660
Hear What and How the Economist Thinks . . . About the Debate Over the Minimum
Wage 660
Does It Matter to You . . . If the Elasticity of Demand for the Good or Service You
Produce Is High or Low? 662
Market Supply of Labor 662 An Individual’s Supply of Labor 663 Shifts in the Labor
Supply Curve 664 Putting Supply and Demand Together 665 Why Do Wage Rates
Differ? 666 Why Demand and Supply Differ among Labor Markets 667 Why Did You
Choose Your Major? 667 Marginal Productivity Theory 668
Labor Markets and Information 670
Screening Potential Employees 670 Promoting from Within 671 Discrimination or an
Information Problem? 671
Chapter Summary 672
Key Terms and Concepts 673
Questions and Problems 673
Working with Numbers and Graphs 674
CHAPTER 27: WAGES, UNIONS, AND LABOR 675
Objectives of Labor Unions 675
Employment for All Members 675 Maximizing the Total Wage Bill 676 Maximizing
Income for a Limited Number of Union Members 676 Wage–Employment Trade-Off 676
Practices of Labor Unions 677
Affecting the Elasticity of Demand for Union Labor 677
Hear What and How the Economist Thinks . . .About Unions and Wages 678
Affecting the Demand for Union Labor 679 Affecting the Supply of Union Labor 679
Affecting Wages Directly: Collective Bargaining 680 Strikes 682
Effects of Labor Unions 682
The Case of Monopsony 682 Unions’ Effects on Wages 684
Does It Matter to You . . . If Things Are Different in the Short-Run Than
in the Long Run? 686
Unions’ Effects on Prices 686 Unions’ Effects on Productivity and Efficiency: Two Views 686
Chapter Summary 689
Key Terms and Concepts 690
Questions and Problems 690
Working with Numbers and Graphs 691
CHAPTER 28: THE DISTRIBUTION OF INCOME AND POVERTY 692
Some Facts About Income Distribution 692
Who Are the Rich and How Rich Are They? 692 The Effect of Age on the Income
Distribution 693 A Simple Equation 695
Does It Matter to You . . . What Your Educational Attainment Level Is? 697
Measuring Income Equality 697
The Lorenz Curve 697 The Gini Coefficient 699 A Limitation of the Gini
Coefficient 700 Common Misconceptions about Income Inequality 700
Why Income Inequality Exists 701
Factors Contributing to Income Inequality 702 Income Differences: Some Are
Voluntary, Some Are Not 703
Poverty 704
What Is Poverty? 704 Limitations of the Official Poverty Income Statistics 704 Who
Are the Poor? 705 What Is the Justification for Government Redistributing Income? 705
Chapter Summary 707
Key Terms and Concepts 708
Questions and Problems 708
Working with Numbers and Graphs 708
CHAPTER 29: INTEREST, RENT, AND PROFIT 709
Interest 709
Loanable Funds: Demand and Supply 709 The Price for Loanable Funds and the
Return on Capital Goods Tend to Equality 711 Why Do Interest Rates Differ? 712
Nominal and Real Interest Rates 712 Present Value: What Is Something Tomorrow
Worth Today? 713 Rent 716 David Ricardo, the Price of Grain, and Land Rent 716
The Supply Curve of Land Can Be Upward Sloping 718 Economic Rent and Other
Factors of Production 719 Economic Rent and Baseball Players: Perspective Matters 719
Does It Matter to You . . . If People Compete for Artificial Rents as Opposed to Real
Rents? 720
Competing for Artificial and Real Rents 720
Profit 721
Theories of Profit 721 Profit and Loss as Signals 722
Hear What and How the Economist Thinks . . . About Profit 723
The Entrepreneur 724
A Market 724 How Can the Entrepreneur Increase Trade? 724 Turning Potential
Trades into Actual Trades 725 A Necessary Condition: Turn Potential Trades into Actual
Trades in a Way Acceptable to Consumers 725 Can Increasing Trades in One Area
Reduce Trades in Another? 725 Uncertainty and the Entrepreneur 725
Chapter Summary 727
Key Terms and Concepts 727
Questions and Problems 728
Working with Numbers and Graphs 728
Part 10 Market Failure, Public Choice, and Special-Interest Group Politics
CHAPTER 30: MARKET FAILURE: EXTERNALITIES, PUBLIC GOODS,
AND ASYMMETRIC INFORMATION 729
Externalities 729
Costs and Benefits of Activities 729 Marginal Costs and Benefits of Activities 730
Social Optimality, or Efficiency, Conditions 731 Three Categories of Activities 731
Externalities in Consumption and in Production 731 Diagram of a Negative
Externality 731 Diagram of a Positive Externality 734
Internalizing Externalities 735
Persuasion 735 Taxes and Subsidies 736 Assigning Property Rights 736
Hear What and How the Economist Thinks . . . About Coming to Class Late 737
Voluntary Agreements 737 Combining Property Rights Assignments and Voluntary
Agreements 738 Beyond Internalizing: Setting Regulations 739
Environmental Policy 740
Method 1: Government Regulation, or Command and Control 741 Method 2: Emission
Taxes 741 Method 3: Tradable Pollution Permits (Cap and Trade) 742 Similarities and
Differences Between Emission Taxes and Tradable Pollution Permits 743
Public Goods: Excludable and Nonexcludable 744
Goods 744 The Free Rider 745
Does It Matter to You . . . If There Is a Free-Rider Problem? 746
Nonexcludable Versus Nonrivalrous 746
Asymmetric Information 748
Asymmetric Information in a Product Market 748 Asymmetric Information in a Factor
Market 749 Is There Market Failure? 749 Adverse Selection 750 Moral Hazard 751
Chapter Summary 754
Key Terms and Concepts 755
Questions and Problems 756
Working with Numbers and Graphs 757
CHAPTER 31: PUBLIC CHOICE AND SPECIAL-INTEREST
GROUP POLITICS 758
Public Choice Theory 758
The Political Market 759
Moving Toward the Middle: The Median Voter Model 759 What Does the Theory
Predict? 760
Voters and Rational Ignorance 763
The Costs and Benefits of Voting 763
Does It Matter to You . . . If You Do Not Vote? 764
Rational Ignorance 764
Hear What and How the Economist Thinks . . . About Rational Ignorance 766
More About Voting 767
Example 1: Voting for a Nonexcludable Public Good 767 Example 2: Voting and
Efficiency 768
Special-Interest Groups 769
Information and Lobbying 769 Congressional Districts as Special-Interest Groups 770
Public-Interest Talk, Special-Interest Legislation 770 Rent Seeking 771 Bringing About
Transfers 772 Information, Rational Ignorance, and Seeking Transfers 772
Constitutional Economics 774
Chapter Summary 776
Key Terms and Concepts 777
Questions and Problems 777
Working with Numbers and Graphs 778
Part 11 Economic Theory-Building and Everyday Life
CHAPTER 32: BUILDING THEORIES TO EXPLAIN EVERYDAY LIFE: FROM
OBSERVATIONS TO QUESTIONS TO THEORIES TO PREDICTIONS 779
A Different Kind of Chapter 779
The Process 780
Observation/Thought 1: The Birthrates in Various Countries are Different 781
The Question 781 The Theory 781 The Predictions 781
A Detour: The Issue of Falsifiability (Refutability) 782
Hear What and How the Economist Thinks . . . About Theories 782
Observation/Thought 2: The Ethical Code of People Who Live in a Small Town is
Different from that of People Who Live in a Large City 783
The Question 784 The Theory 784 The Predictions 784
Observation/Thought 3: The Closer the Dollar Tuition the Student Pays is to the
Equilibrium Tuition, the More on Time and Responsive University Instructors Will Be for
Office Hours 786
The Question 786 The Theory 786 The Predictions 788
Observation/Thought 4: Criminals Are Not Rational 788
The Question 788 The Theory 788 The Predictions 789 A Detour: Does
Evidence Prove a Theory Correct? 789 Another Detour: After You Have One Theory
That Explains and Predicts, Search for Another 790 A Final Detour: Why Prediction Is
So Important, Or Why Good-Sounding Stories Are Not Enough 791
Observation/Thought 5: More Students Wear Baseball Caps in Class on Exam Days
Than on Other Days 792
The Question 792 The Theory 792 The Predictions 793
Observation/Thought 6: Houses in “Good” School Districts Are Often More Expensive
than Comparable Houses in “Bad” School Districts 795
The Question 795 The Theory 795 The Predictions 795
Observation/Thought 7: Are People Better Off With or Without Health Care
Vouchers? 796
The Question 796 The Theory 796 The Predictions 797
Observation/Thought 8: People Who Give to Others Often Complain That They
End Up Giving Too Much 797
The Question 797 The Theory 798 The Predictions 800
Does It Matter to You . . . If and How You Are in Someone Else’s Utility Function? 801
Chapter Summary 802
Questions and Problems 804
Working with Numbers and Graphs 804
The Global Economy
Part 12 International Economics and Globalization
CHAPTER 33: INTERNATIONAL TRADE 805
International Trade Theory 805
How Countries Know What to Trade 806
Does It Matter to You . . . If There Is Always Someone Who Can Do Something Better
Than You? 808
A Common Misconception about How Much We Can Consume 809 How Countries
Know When They Have a Comparative Advantage 809
Hear What and How the Economist Thinks . . . About Common Sense 811
Trade Restrictions 811
The Distributional Effects of International Trade 812 Consumers’ and Producers’
Surpluses 812 The Benefits and Costs of Trade Restrictions 813 Why Nations
Sometimes Restrict Trade 817
Chapter Summary 821
Key Terms and Concepts 822
Questions and Problems 822
Working with Numbers and Graphs 823
CHAPTER 34: INTERNATIONAL FINANCE 824
The Foreign Exchange Market 824
The Demand for Goods 825 The Demand for, and Supply of, Currencies 825
Flexible Exchange Rates 826
The Equilibrium Exchange Rate 826
Does It Matter to You . . . If the Dollar Depreciates? 827
Changes in the Equilibrium Exchange Rate 827 Factors That Affect the Equilibrium
Exchange Rate 828
Fixed Exchange Rates 831
Fixed Exchange Rates and Overvalued or Undervalued Currency 832 What Is So
Bad about an Overvalued Dollar? 834 Government Involvement in a Fixed Exchange
Rate System 835 Options Under a Fixed Exchange Rate System 835
Fixed Exchange Rates Versus Flexible Exchange Rates 837
Promoting International Trade 837 Optimal Currency Areas 837
Chapter Summary 840
Key Terms and Concepts 841
Questions and Problems 841
Working with Numbers and Graphs 842
Web Chapters
CHAPTER 35: The Economic Case for and Against
Government: Five Topics Considered 843
Economics and Government 843
The Economic Case for Government 844
Government Can Remove Individuals from a Prisoner’s Dilemma Setting 844
Externalities 848 Nonexcludable Public Goods 849 The Case for Smaller or Larger
Government 851
The Economic Case Against Government 852
Unintended Effects of Government Actions 852 Government as Transfer Mechanism 853
Economic Growth Versus Transfers 855 Following the Leader in Pushing for Transfers 856
Divisive Society: A Nonexcludable Public Bad 858
Chapter Summary 859
Key Terms and Concepts 860
Questions and Problems 860
Working with Numbers and Graphs 861
CHAPTER 36: STOCKS, BONDS, FUTURES, AND OPTIONS 862
Financial Markets 862
Stocks 863
Where Are Stocks Bought and Sold? 863 The Dow Jones Industrial Average (DJIA) 864
How the Stock Market Works 865 Why Do People Buy Stock? 866 How to Buy
and Sell Stock 866 Buying Stocks or Buying the Market 867 How to Read the Stock
Market Page 868
Bonds 870
The Components of a Bond 870 Bond Ratings 871 Bond Prices and Yields
(or Interest Rates) 871 Common Misconceptions about the Coupon Rate and Yield
(Interest Rate) 872 Types of Bonds 873 How to Read the Bond Market Page 873
Risk and Return 875
Futures and Options 875
Futures 875 Options 876
Chapter Summary 879
Key Terms and Concepts 879
Questions and Problems 879
Working with Numbers and Graphs 880
Self-Test Appendix 843
Glossary 869
Index 881