Principles of Economics, A Streamlined Approach, Fourth Edition
By Robert H. Frank, Ben S. Bernanke, Kate Antonovics and Ori Heffetz
Contents:
Part- 1 Introduction
Chapter-1 Thinking Like an Economist 1
Economics: Studying Choice in a World of Scarcity 2
Applying the Cost-Benefit Principle 3
Economic Surplus 4
Opportunity Cost 4
The Role of Economic Models 5
Three Important Decision Pitfalls 6
Pitfall 1: Measuring Costs and Benefits as Proportions
Rather than Absolute Dollar Amounts 6
Pitfall 2: Ignoring Implicit Costs 7
Pitfall 3: Failing to Think at the Margin 8
Normative Economics versus Positive Economics 13
Economics: Micro and Macro 13
The Approach of This Text 14
Economic Naturalism 14
THE ECONOMIC NATURALIST 1.1 15
THE ECONOMIC NATURALIST 1.2 15
THE ECONOMIC NATURALIST 1.3 16
Summary 17 • Key Terms 17 • Review Questions 17 •
Problems 18 • Answers to Self-tests 19 • Appendix: Working
with Equations, Graphs, and Tables 21
Chapter-2 Supply and Demand 31
What, How, and for Whom? Central Planning versus the Market 33
Buyers and Sellers in Markets 34
The Demand Curve 35
The Supply Curve 36
Market Equilibrium 38
Rent Controls Reconsidered 41
Pizza Price Controls? 43
Predicting and Explaining Changes in Prices and Quantities 44
Shifts in Demand 45
THE ECONOMIC NATURALIST 2.1 47
Shifts in the Supply Curve 48
THE ECONOMIC NATURALIST 2.2 51
Four Simple Rules 51
THE ECONOMIC NATURALIST 2.3 54
Efficiency and Equilibrium 54
Cash on the Table 55
Smart for One, Dumb for All 56
THE ECONOMIC NATURALIST 2.4 57
Summary 58 • Key Terms 59 • Review Questions 59 •
Problems 59 • Answers to Self-tests 60 • Appendix: The
Algebra of Supply and Demand 63
Part- 2 Competition and the Invisible Hand
Chapter- 3 Demand and Elasticity 65
The Law of Demand 66
The Origins of Demand 66
Needs versus Wants 67
THE ECONOMIC NATURALIST 3.1 67
Applying the Law of Demand 68
Substitution at Work 68
THE ECONOMIC NATURALIST 3.2 68
THE ECONOMIC NATURALIST 3.3 69
THE ECONOMIC NATURALIST 3.4 70
The Importance of Income Differences 70
THE ECONOMIC NATURALIST 3.5 71
Individual and Market Demand Curves 7
Horizontal Addition 71
Elasticity 73
Price Elasticity of Demand 73
Price Elasticity Defined 73
Determinants of Price Elasticity of Demand 75
some representative elasticity estimates 76
Using Price Elasticity of Demand 77
The Economic Naturalist 3.6 77
The Economic Naturalist 3.7 77
A Graphical Interpretation of Price Elasticity 78
Price Elasticity Changes along a Straight-Line Demand Curve 80
Two Special Cases 81
Elasticity and Total Expenditure 82
Income Elasticity and Cross-Price Elasticity of Demand 86
Summary 87 • Key Terms 87 • Review Questions 88 •
Problems 88 • Answers to Self-tests 89
Chapter- 4 Perfectly Competitive Supply 91
Thinking about Supply: The Importance of Opportunity Cost 92
Individual and Market Supply Curves 94
Profit-Maximizing Firms in Perfectly
Competitive Markets 95
Profit Maximization 95
The Demand Curve Facing a Perfectly Competitive Firm 96
Production in the Short Run 97
Choosing Output to Maximize Profit 98
Price Equals Marginal Cost: The Seller’s Supply Rule 101
Graphing Marginal Cost 101
The “Law” of Supply 103
Applying the Theory of Supply 104
The Economic Naturalist 4.1 104
Determinants of Supply Revisited 107
Technology 107
Input Prices 107
The Number of Suppliers 107
Expectations 108
Changes in Prices of Other Products 108
The Price Elasticity of Supply 108
Determinants of Supply Elasticity 111
The Economic Naturalist 4.2 112
Unique and Essential Inputs: The Ultimate Supply Bottleneck 114
Summary 115 • Key Terms 116 • Review Questions 116 •
Problems 116 • Answers to Self-tests 117
Chapter- 5 Efficiency, Exchange, and the Invisible Hand in Action 119
The Central Role of Economic Profit 120
Three Types of Profit 120
The Invisible Hand Theory 123
Two Functions of Price 123
Responses to Profits and Losses 123
The Effect of Market Forces on Economic Profit 125
The Importance of Free Entry and Exit 126
The Invisible Hand in Action 127
The Economic Naturalist 5.1 127
Economic Rent versus Economic Profit 129
The Distinction between an Equilibrium and a Social Optimum 130
Smart for One, Dumb for All 131
The Economic Naturalist 5.2 131
Market Equilibrium and Efficiency 132
The Cost of Preventing Price Adjustments 136
Summary 138 • Key Terms 139 • Review Questions 139 •
Problems 139 • Answers to Self-tests 140
Part- 3 Market Imperfections
Chapter- 6 Monopoly, Oligopoly, and Monopolistic Competition 141
Perfect and Imperfect Competition 142
Different forms of Imperfect Competition 142
The Essential Difference between Perfectly and Imperfectly Competitive Firms 144
Five Sources of Market Power 145
Exclusive Control over Important Inputs 145
Patents and Copyrights 145
Government Licenses or Franchises 145
Economies of Scale and Natural Monopolies 146
Network Economies 146
Economies of scale and the importance of start-Up costs 147
The Economic Naturalist 6.1 150
Profit Maximization for the Monopolist 150
Marginal Revenue for the Monopolist 150
The Monopolist’s Profit-Maximizing Decision Rule 152
Being a Monopolist Doesn’t Guarantee an Economic Profit 154
Why the Invisible Hand Breaks Down under Monopoly 155
Using Discounts to Expand the Market 156
Price Discrimination Defined 157
The Economic Naturalist 6.2 157
How Price Discrimination Affects Output 157
The Hurdle Method of Price Discrimination 160
Is Price Discrimination a Bad Thing? 163
Examples of Price Discrimination 163
The Economic Naturalist 6.3 164
Summary 165 • Key Terms 166 • Review Questions 166 •
Problems 166 • Answers to Self-tests 168
Chapter- 7 Games and Strategic Behavior 169
Using Game Theory to Analyze Strategic Decisions 170
The Three Elements of a Game 170
Nash Equilibrium 172
The Prisoner’s Dilemma 174
The Original Prisoner’s Dilemma 174
The Economics of Cartels 175
The Economic Naturalist 7.1 175
Tit-for-Tat and the Repeated Prisoner’s Dilemma 177
The Economic Naturalist 7.2 178
The Economic Naturalist 7.3 179
Games in Which Timing Matters 180
Credible Threats and Promises 182
Monopolistic Competition When Location Matters 184
The Economic Naturalist 7.4 184
Commitment Problems 186
Solving Commitment Problems with Psychological Incentives 188
Summary 190 • Key Terms 190 • Review Questions 191 •
Problems 191 • Answers to Self-tests 194
Chapter- 8 An Introduction to Behavioral Economics 195
Judgmental Heuristics or Rules of Thumb 196
Availability 196
Representativeness 197
Regression to the Mean 198
The Economic Naturalist 8.1 198
Anchoring and Adjustment 199
Misinterpretation of Contextual Clues 200
The Psychophysics of Perception 200
The Difficulty of Actually Deciding 200
Impulse-Control Problems 202
The Economic Naturalist 8.2 203
Loss Aversion and Status Quo Bias 205
The Economic Naturalist 8.3 206
Concerns about Relative Position 207
The Economic Naturalist 8.4 210
The Economic Naturalist 8.5 211
Summary 214 • Key Terms 215 • Review Questions 215 •
Problems 215 • Answers to Self-tests 216
Chapter- 9 Externalities and Property Rights 217
External Costs and Benefits 217
How Externalities Affect Resource Allocation 218
The Coase Theorem 219
Remedies for Externalities 223
Laws and Regulations 223
The Economic Naturalist 9.1 225
The Optimal Amount of Negative Externalities Is Not Zero 225
Compensatory Taxes and Subsidies 226
The Economic Naturalist 9.2 226
Property Rights and the Tragedy of the Commons 227
The Problem of Unpriced Resources 227
The Effect of Private Ownership 229
When Private Ownership Is Impractical 230
The Economic Naturalist 9.3 230
The Economic Naturalist 9.4 231
Positional Externalities 232
Payoffs That Depend on Relative Performance 232
The Economic Naturalist 9.5 232
Positional Arms Races and Positional Arms Control Agreements 234
Social Norms as Positional Arms Control Agreements 235
Summary 237 • Key Terms 237 • Review Questions 237 •
Problems 238 • Answers to Self-tests 239
Part- 4 Economics of Public Policy
Chapter- 10 Using Economics to Make Better Policy Choices 241
The Economics of Health Care 242
The Case for Mandatory Immunization Laws 242
Explaining Rising Health Care Costs 243
Designing a Solution 244
The HMO Revolution 245
The Economic Naturalist 10.1 245
The Problem with Health Care Provision through Private Insurance 246
The Affordable Care Act of 2010 247
Using Price Incentives in Environmental Regulation 248
Taxing Pollution 248
Auctioning Pollution Permits 250
Climate Change and Carbon Taxes 252
Methods of Income Redistribution 253
Welfare Payments and In-Kind Transfers 254
Means-Tested Benefit Programs 254
The Negative Income Tax 255
Minimum Wages 255
The Earned-Income Tax Credit 256
Public Employment for the Poor 256
A Combination of Methods 256
Summary 258 • Key Terms 258 • Review Questions 258 •
Problems 258 • Answers to Self-tests 259
Part-5 International Trade
Chapter- 11 International Trade and Trade Policy 261
Comparative Advantage as a Basis for Trade 262
A Supply and Demand Perspective on Trade 266
Winners and Losers from Trade 268
The Economic Naturalist 11.1 269
Protectionist policies: tariffs and quotas 270
Tariffs 270
Quotas 272
The Economic Naturalist 11.2 275
The Inefficiency of Protectionism 276
The Economic Naturalist 11.3 276
Summary 277 • Key Terms 278 • Review Questions 278 •
Problems 278 • Answers to Self-tests 280
Part- 6 Macroeconomics: Issues and Data
Chapter- 12 Macroeconomics: The Bird’s-Eye View of the Economy 281
The Major Macroeconomic Issues 283
Economic Growth and Living Standards 283
Productivity 285
Recessions and Expansions 286
Unemployment 286
Inflation 288
Economic Interdependence among Nations 289
Macroeconomic Policy 290
Types of Macroeconomic Policy 290
Positive versus Normative Analyses of Macroeconomic Policy 291
Aggregation 293
Studying Macroeconomics: A Preview 295
Summary 296 • Key Terms 296 • Review Questions 296 •
Problems 297 • Answers to Self-tests 297
Chapter- 13 Measuring Economic Activity: GDP,
Unemployment, and Inflation 299
Gross Domestic Product: Measuring the Nation’s Output 300
Market Value 301
Final Goods and Services 303
Produced in a Country during a Given Period 306
Methods for Measuring GDP 307
The Expenditure Method for Measuring GDP 307
GDP and the Incomes of Capital and Labor 310
Nominal GDP versus Real GDP 313
The Economic Naturalist 13.1 315
Real Gdp, Economic Growth, and Economic Well-Being 315
Unemployment and the Unemployment Rate 316
Measuring Unemployment 316
The Costs of Unemployment 318
The Duration of Unemployment 319
The Unemployment Rate versus “True” Unemployment 320
The Consumer Price Index and Inflation 320
Inflation 323
Adjusting for Inflation 324
Deflating a Nominal Quantity 324
Indexing to Maintain Buying Power 326
The Economic Naturalist 13.2 327
Inflation Measurement and Quality Change 328
The Costs of Inflation: Not What You Think 329
The True Costs of Inflation 330
Summary 333 • Key Terms 334 • Review Questions 334 •
Problems 334 • Answers to Self-tests 336
Part-7 The Economy in the Long Run
Chapter- 14 Economic Growth, Productivity, and Living Standards 339
The Remarkable Rise in Living Standards: The Record 340
Why “Small” Differences in Growth Rates Matter 343
Why Nations Become Rich: The Crucial Role of Average
Labor Productivity 345
The Determinants of Average Labor Productivity 347
Human Capital 348
The Economic Naturalist 14.1 349
Physical Capital 350
Land and Other Natural Resources 351
Technology 352
The Economic Naturalist 14.2 353
Entrepreneurship and Management 354
The Economic Naturalist 14.3 354
The Political and Legal Environment 355
Real Gdp and Economic Well-Being 357
Why Real gdp Isn’t the Same as Economic Well-Being 357
The Economic Naturalist 14.4 357
But Gdp Is Related to Economic Well-Being 359
The Economic Naturalist 14.5 361
Promoting Economic Growth 363
Policies to Increase Human Capital 363
The Economic Naturalist 14.6 363
Policies That Promote Saving and Investment 364
Policies That Support Research and Development 364
The Legal and Political Framework 365
The Poorest Countries: A Special Case? 365
Are There Limits to Growth? 366
Summary 368 • Key Terms 368 • Review Questions 369 •
Problems 369 • Answers to Self-tests 371
Chapter- 15 The Labor Market: Workers, Wages, and Unemployment 373
Five Important Labor Market Trends 374
Trends in Real Wages 374
Trends in Employment and Unemployment 375
Supply and Demand in the Labor Market 376
Wages and the Demand for Labor 376
Shifts in the Demand for Labor 379
The Economic Naturalist 15.1 382
The Supply of Labor 383
Shifts in the Supply of Labor 384
Explaining the Trends in Real Wages and Employment 385
Large Increases in Real Wages in Industrialized Countries 385
Real Wage Growth in the United States Has Stagnated since
the Early 1970s, While Employment Growth Has Been Rapid 386
Increasing Wage Inequality: The Effects of
Globalization and Technological Change 388
The Economic Naturalist 15.2 392
Unemployment 394
Types of Unemployment and Their Costs 394
Impediments to Full Employment 395
Summary 398 • Key Terms 399 • Review Questions 399 •
Problems 399 • Answers to Self-tests 401
Chapter- 16 Saving and Capital Formation 403
Saving and Wealth 404
Stocks and Flows 405
Capital Gains and Losses 406
The Economic Naturalist 16.1 407
The Economic Naturalist 16.2 409
Why Do People Save? 410
The Economic Naturalist 16.3 411
Saving and the Real Interest Rate 412
Saving, Self-Control, and Demonstration Effects 414
The Economic Naturalist 16.4 415
National Saving and Its Components 417
The Measurement of National Saving 417
Private and Public Components of National Saving 419
Public Saving and the Government Budget 420
Is Low Household Saving a Problem? 422
Investment and Capital Formation 423
Saving, Investment, and Financial Markets 425
The Economic Naturalist 16.5 428
Summary 430 • Key Terms 430 • Review Questions 431 •
Problems 431 • Answers to Self-tests 433
Chapter- 17 Money, the Federal Reserve, and Global Financial Markets 435
Money and its Uses 436
The Economic Naturalist 17.1 437
Measuring Money 438
Commercial Banks and the Creation of Money 439
The Money Supply with Both Currency and Deposits 442
The Federal Reserve System 444
The History and Structure of the Federal Reserve System 445
Controlling the Money Supply: Open-Market Operations 445
The Fed’s Role in Stabilizing Financial Markets: Banking Panics 447
The Economic Naturalist 17.2 447
The Financial System and the Allocation of Saving to
Productive Uses 450
The Banking System 450
The Economic Naturalist 17.3 451
Bonds and Stocks 452
Bond Markets, Stock Markets, and the Allocation of Savings 457
The Informational Role of Bond and Stock Markets 457
Risk Sharing and Diversification 457
The Economic Naturalist 17.4 458
International Capital Flows 460
Capital Flows and the Balance of Trade 461
The Determinants of International Capital Flows 462
Saving, Investment, and Capital Inflows 464
The Saving Rate and the Trade Deficit 465
The Economic Naturalist 17.5 466
Summary 468 • Key Terms 470 • Review Questions 470 •
Problems 470 • Answers to Self-tests 472
Part-8 The Economy in the Short Run
Chapter- 18 Short-Term Economic Fluctuations and Fiscal Policy 475
The Economic Naturalist 18.1 476
Recessions and Expansions 477
The Economic Naturalist 18.2 480
Some Facts about Short-Term Economic Fluctuations 481
Output Gaps and Cyclical Unemployment 483
Potential Output 483
The Output Gap 484
The Natural Rate of Unemployment and Cyclical Unemployment 485
The Economic Naturalist 18.3 486
Why Do Short-Term Fluctuations Occur? A Preview and a Tale 487
Alice’s Ice Cream Store: A Tale about Short-Run Fluctuations 488
Recessions and Proposed Solutions: Keynes’s Analysis 490
The Keynesian Model’s Crucial Assumption: Firms Meet
Demand at Preset Prices 490
The Economic Naturalist 18.4 491
Aggregate Output and Spending 492
Hey Big Spender! Consumer Spending and the Economy 492
The Multiplier 494
Stabilizing Spending: The Role of Fiscal Policy 495
Government Purchases and Spending 496
THE ECONOMIC NATURALIST 18.5 497
Taxes, Transfers, and Aggregate Spending 498
The Economic Naturalist 18.6 499
Fiscal Policy as a Stabilization Tool: Three Qualifications 500
Fiscal Policy and the Supply Side 501
The Problem of Deficits 501
The Relative Inflexibility of Fiscal Policy 502
Summary 503 • Key Terms 504 • Review Questions 504 •
Problems 505 • Answers to Self-tests 506
Chapter-19 Stabilizing the Economy: The Role of the Fed 507
The Federal Reserve and Interest Rates: The Basic Model 508
The Demand for Money 509
Macroeconomic Factors That Affect the Demand for Money 512
The Money Demand Curve 513
The Economic Naturalist 19.1 514
The Supply of Money and Money Market Equilibrium 516
How the Fed Controls the Nominal Interest Rate 517
The Role of the Federal Funds Rate in Monetary Policy 519
Can the Fed Control the Real Interest Rate? 520
The Federal Reserve and Interest Rates: A Closer Look 521
Can the Fed Fully Control the Money Supply? 522
Do Interest Rates Always Move Together? 525
The Effects of Federal Reserve Actions on the Economy 528
Aggregate Expenditure and the Real Interest Rate 528
The Fed Fights a Recession 531
The Economic Naturalist 19.2 532
The Fed Fights Inflation 533
The Economic Naturalist 19.3 533
The Economic Naturalist 19.4 534
The Economic Naturalist 19.5 534
The Fed’s Policy Reaction Function 536
The Economic Naturalist 19.6 536
Monetary Policy making: Art or Science? 539
Summary 539 • Key Terms 541 • Review Questions 541 •
Problems 541 • Answers to Self-tests 543
Chapter-20 Aggregate Demand, Aggregate Supply, and Inflation 545
Inflation, Spending, and Output: The Aggregate Demand Curve 546
Inflation, the Fed, and Why the AD Curve Slopes Downward 547
Other Reasons for the Downward Slope of the AD Curve 548
Factors That Shift the Aggregate Demand Curve 548
Shifts of the AD Curve versus Movements along the AD Curve 551
Inflation and Aggregate Supply 552
Inflation Inertia 553
The Output Gap and Inflation 555
The Aggregate Demand–Aggregate Supply Diagram 557
The Self-Correcting Economy 559
Sources of Inflation 560
Excessive Aggregate Spending 560
The Economic Naturalist 20.1 562
Inflation Shocks 563
The Economic Naturalist 20.2 564
Shocks to Potential Output 566
The Economic Naturalist 20.3 567
Controlling Inflation 569
The Economic Naturalist 20.4 571
The Economic Naturalist 20.5 572
Summary 574 • Key Terms 575 • Review Questions 575 •
Problems 576 • Answers to Self-tests 577
Part- 9 The International Economy
Chapter- 21 Exchange Rates and the Open Economy 579
Exchange Rates 581
Nominal Exchange Rates 581
Flexible versus Fixed Exchange Rates 583
The Real Exchange Rate 583
The Economic Naturalist 21.1 586
The Determination of the Exchange Rate in the Long Run 587
A Simple Theory of Exchange Rates: Purchasing Power Parity (PPP) 587
Shortcomings of the PPP Theory 589
The Determination of the Exchange Rate in the Short Run 590
The Foreign Exchange Market: A Supply and Demand Analysis 591
Changes in the Supply of Dollars 593
Changes in the Demand for Dollars 594
The Economic Naturalist 21.2 594
Monetary Policy and the Exchange Rate 595
The Economic Naturalist 21.3 596
The Exchange Rate as a Tool of Monetary Policy 597
Fixed Exchange Rates 597
How to Fix an Exchange Rate 598
Monetary Policy and the Fixed Exchange Rate 602
The Economic Naturalist 21.4 603
The Economic Naturalist 21.5 604
The Economic Naturalist 21.6 605
Should Exchange Rates Be Fixed or Flexible? 606
The Economic Naturalist 21.7 607
Summary 608 • Key Terms 609 • Review Questions 610 •
Problems 610 • Answers to Self-tests 611
Glossary G-1
Index I-1