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Ⅰ INTRODUCTION: THINKINGLIKE AN ECONOMIST4

1. Economics and Economic Reasoning4

Appendix A: Graphish: The Language of Graphs20

2. The Economic Organization of Society27

Appendix A: The History of Economic Systems49

3. The U.S. Economy in a Global Setting55

Appendix A: Valuing Stocks and Bonds77

4. Supply and Demand82

5. Using Supply and Demand103

Appendix A: Algebraic Representation of Supply,Demand, and Equilibrium124

Ⅱ MICROECONOMICS132

I MICROECONOMICS: THE BASICS132

6. Describing Supply and Demand: Elasticities132

7. Taxation and Government Intervention156

Ⅱ FOUNDATIONS OF SUPPLY AND DEMAND176

8. The Logic of Individual Choice: The Foundationof Supply and Demand176

Appendix A: Indifference Curve Analysis194

9. Production and Cost Analysis Ⅰ200

10. Production and Cost Analysis Ⅱ217

Appendix A: Isocost/Isoquant Analysis233

Ⅲ MARKET STRUCTURE AND POLICY238

11. Perfect Competition238

12. Monopoly261

Appendix A: The Algebra of Competitive andMonopolistic Firms280

13. Monopolistic Competition, Oligopoly, and Strategic Pricing282

14. Globalization, Technology, and Real-World Competition305

Ⅳ APPLYING ECONOMIC REASONING TO POLICY326

15. Government Policy and MarketFailures326

16. Antitrust Policy and Regulation346

17. Microeconomic Policy, Economic Reasoning,and Beyond371

V POLICY ISSUES IN DEPTH390

18. Politics and Economics: The Case ofAgricultural Markets390

19. International Trade Policy405

Appendix A: The Geomet of Absolute Advantageand Comparative Advantage422

Ⅵ FACTOR MARKETS428

20. Who Gets What? The Distribution of Income428

21. Work and the Labor Market451

Appendix A: Derived Demand474

Appendix B: Nonwage Income and PropertyRights479

Ⅲ MACROECONOMICS484

Ⅰ MACROECONOMIC PROBLEMS484

22. Economic Growth, Business Cycles,Unemployment, and Inflation484

23. National Income Accounting512

Ⅱ THE MACROECONOMIC FRAMEWORK533

24. Growth, Productivity, and the Wealthof Nations533

25. Aggregate Demand, Aggregate Supply,and Modern Macroeconomics566

26. The Multiplier Model580

Appendix A: An Algebraic Presentation of theExpanded Multiplier Model600

Appendix B: The Multiplier Model and the AS/ADModel601

Ⅲ POLICY ISSUES604

27. Demand Management Policy604

28. Politics, Surpluses, Deficits, and Debt626

29. Money, Banking, and the Financial Sector647

Appendix A: A Closer Look at Financial Institutionsand Financial Markets667

Appendix B: Creation of MoneyUsing T -Accounts677

30. Monetary Policy and the Debate aboutMacro Policy680

Appendix A: The Effect of Monetary PolicyUsing T-Accounts700

31. Inflation and Its Relationship to Unemploymentand Growth702

Ⅳ INTERNATIONAL POLICY ISSUES724

32. Open Economy Macro: Exchange Rate andTrade Policy724

Appendix A: History of Exchange Rate Systems747

33. International Dimensions of Monetary and FiscalPolicies750

V COMBINING THE FRAMEWORK WITH POLICY766

34. Tools, Rules, and Policy766

Ⅰ INTRODUCTION: THINKINGLIKE AN ECONOMIST4

1. ECONOMICS AND ECONOMICREASONING4

What Economics Is5

A Guide to Economic Reasoning6

Marginal Costs and Marginal Benefits6

KNOWING THE TOOLS: Economic Knowledge inOne Sentence: TANSTAAFL7

Economics and Passion8

Opportunity Cost8

Economic and Market Forces9

BEYOND THE TOOLS: Economics in Perspective10

Economic Terminology12

Economic Insights12

The Invisible Hand Theory12

APPLYING THE TOOLS: Winston Churchill andLady Astor13

Economic Theory and Stories13

KNOWING THE TOOLS: Dealing withMath Anxiety14

Microeconomics and Macroeconomics14

Economic Institutions15

Economic Policy Options15

Objective Policy Analysis16

Policy and Social and Political Forces17

Conclusion17

Chapter Summary18

Key Terms18

Questions for Thought and Review18

Problems and Exercises19

Web Questions19

Answers to Margin Questions20

Appendix A: Graphish: The Language of Graphs20

2. THE ECONOMIC ORGANIZATION OFSOCIETY27

Capitalism28

Reliance on the Market28

What's Good about the Market?29

Socialism29

Socialism in Theory30

Socialism in Practice30

Evolving Economic Systems30

APPLYING THE TOOLS: Tradition and Today'sEconomy31

BEYOND THE TOOLS: The Rise of Markets inPerspective32

The Need for Coordination in an Economic System32

Evolutionary Changes within Systems33

A Blurring of the Distinction between Capitalism andSocialism33

The Production Possibility Curve and EconomicReasoning33

The Production Possibility Table34

The Production Possibility Curve34

KNOWING THE TOOLS: Production PossibiliCurves37

Some Examples of Shifts in the Production PossibilityCurve39

The Production Possibili Curve and EconomicSystems40

The Production Possibili Curve andTough Choices41

Comparative Advantage, Specialization, and Trade42

The Division of Labor44

Markets, Specialization, and Growth44

Conclusion45

Chapter Summary45

Key Terms46

Questions for Thought and Review46

Problems and Exercises46

Web Questions47

Answers to Margin Questions47

Appendix A: The History of Economic Systems49

3. THE U.S. ECONOMY IN A GLOBALSETTING55

The U.S. Economy56

Business57

Consumer Sovereignty and Business57

Forms of Business57

BEYOND THE TOOLS: Is the United States aPostindustrial Society?58

KNOWING THE TOOLS: The Stock Market60

Finance and Business60

E-Commerce and the Digital Economy61

Households61

The Power of Households62

Suppliers of Labor62

Government62

Government as an Actor63

Government as a Referee63

The Global Setting64

Global Corporations65

International Trade66

APPLYING THE TOOLS: A World EconomicGeography Quiz67

How International Trade Differs from Domestic Trade69

BEYOND THE TOOLS: International Issues inPerspective70

KNOWING THE TOOLS: Our InternationalCompetitors71

Institutions Supporting Free Trade72

Free Trade Organizations73

International Economic Policy Organizations73

Conclusion74

Chapter Summary74

Key Terms75

Questions for Thought and Review75

Problems and Exercises76

Web Questions76

Answers to Margin Questions76

Appendix A: Valuing Stocks and Bonds77

4 SUPPLY AND DEMAND82

Demand83

The Law of Demand83

The Demand Curve84

Shifts in Demand versus Movements along a DemandCurve84

Shift Factors of Demand85

A Review86

The Demand Table86

From a Demand Table to a Demand Curve87

Individual and Market Demand Curves88

KNOWING THE TOOLS: Six Things to RememberWhen Considering a Demand Curve89

Supply89

The Law of Supply90

The Supply Curve90

Shifts in Supply versus Movements along a SupplyCurve91

Shift Factors of Supply91

Shift in Supply versus a Movement along a SupplyCurve92

A Review93

The Supply Table93

KNOWING THE TOOLS: Six Things to RememberWhen Considering a Supply Curve94

From a Supply Table to a Supply Curve94

Individual and Market Supply Curves94

The Marriage of Supply and Demand95

Excess Supply95

Excess Demand95

Price Adjusts95

The Graphical Marriage of Supply and Demand96

Equilibrium97

What Equilibrium Is97

What Equilibrium Isn't97

Desirable Characteristics of Supply/DemandEquilibrium97

APPLYING THE TOOLS: The Supply and Demand forChildren99

Conclusion99

Chapter Summary99

Key Terms100

Questions for Thought and Review100

Problems and Exercises101

Web Questions102

Answers to Margin Questions102

5. USING SUPPLY AND DEMAND103

The Power of Supply and Demand103

Six Real-World Examples105

KNOWING THE TOOLS: Supply andDemand in Action108

A Review108

Government Interferences: Price Ceilings and Floors110

Price Ceilings110

Price Floors111

Government Interferences: Taxes, Tariffs, and Quotas113

Excise Taxes and Tariffs113

Quotas114

The Relationship between a Quota and a Tariff115

The Limitations of Supply and Demand Analysis115

Other Things Don't Remain Constant115

The Fallacy of Composition116

The Roles of Government116

BEYOND THE TOOLS: Laissez-Faire Is NotAnarchy117

Provide a Stable Set of Institutions and Rules117

Promote Effective and Workable Competition117

Correct for Externalities118

Ensure Economic Stability and Growth118

Provide for Public Goods119

Adjust for Undesired Market Results119

Market Failures and Government Failures120

Conclusion120

Chapter Summary120

Key Terms121

Questions for Thought and Review121

Problems and Exercises121

Web Questions122

Answers to Margin Questions123

Appendix A: Algebraic Representation of Supply, Demand,and Equilibrium124

Ⅱ MICROECONOMICS132

Ⅰ MICROECONOMICS: THE BASICS132

6 DESCRIBING SUPPLY AND DEMAND:ELASTICITIES132

Price Elasticity133

Classifying Demand and Supply as Elastic or Inelastic133

What Information Price Elasticity Provides134

Elasticity Is Independent of Units134

Calculating Elasticities135

The End-Point Problem135

The Arc Convention136

KNOWING THE TOOLS: Calculating Elasticity at a Point137

Elasticity and Supply and Demand Curves137

Elasticity Is Not the Same as Slope137

Elasticity Changes along Straight-Line Curves139

Substitution and Elasticity139

KNOWING THE TOOLS: Geometric Tricks forEstimating Price Elasticity140

Substitution and Demand140

Substitution and Supply141

How Substitution Factors Affect Specific Decisions142

Empirical Estimates of Elasticities142

Elasticity, Total Revenue, and Demand144

Total Revenue along a Demand Curve145

Elasticity of Individual and Market Demand146

Other Elasticity Concepts146

APPLYING THE TOOLS: Empirically MeasuringElasticities147

Income Elasticity of Demand147

Cross-Price Elasticity of Demand148

KNOWING THE TOOLS: A Review of the AlternativeElasticity Terms149

Some Examples150

The Power of Supply and Demand Analysis150

When Should a Supplier Not Raise Price?150

Elasticity and Shifting Supply and Demand151

Conclusion152

Chapter Summary152

Key Terms153

Questions for Thought and Review153

Problems and Exercises154

Web Questions155

Answers to Margin Questions155

7. TAXATION AND GOVERNMENTINTERVENTION156

Taxation and Government156

How Much Should Government Tax?157

KNOWING THE TOOLS: Consumer and ProducerSurplus158

Two Principles of Taxation160

Who Bears the Burden of a Tax?161

APPLYING THE TOOLS: What Goods Should BeTaxed?163

Tax Incidence and Current Policy Debates163

Government Intervention164

Government Intervention as Implicit Taxation164

Rent Seeking, Politics, and Elasticities167

KNOWING THE TOOLS: Elasticity and Whether aPrice Increase Is Significant169

Conclusion171

Chapter Summary172

Key Terms172

Questions for Thought and Review172

Problems and Exercises173

Web Questions174

Answers to Margin Questions174

Ⅱ FOUNDATIONS OF SUPPLY ANDDEMAND176

8. THE LOGIC OF INDIVIDUAL CHOICE:THE FOUNDATION OF SUPPLY ANDDEMAND176

Utility Theory and Individual Choice177

Measuring Pleasure177

Total Utility and Marginal Utility178

Diminishing Marginal Utility179

Rational Choice and Marginal Utility180

Some Choices180

The Principle of Rational Choice181

Simultaneous Decisions181

Maximizing Utility and Equilibrium182

An Example of Maximizing Utility182

Extending the Principle of Rational Choice184

Rational Choice and the Laws of Demand and Supply184

KNOWING THE TOOLS: Income and SubstitutionEffects185

The Law of Supply186

Opportunity Cost187

Applying Economists' Theo of Choice to theReal World188

The Cost of Decision Making188

Given Tastes189

Tastes and Individual Choice189

APPLYING THE TOOLS: Making Stupid Decisions190

Conclusion190

Chapter Summary191

Key Terms191

Questions for Thought and Review192

Problems and Exercises192

Web Questions193

Answers to Margin Questions193

Appendix A: Indifference Curve Analysis194

9. PRODUCTION AND COSTANALYSIS Ⅰ200

The Role of the Firm201

The Firm and the Market201

APPLYING THE TOOLS: Value Added and theCalculation of Total Production202

Firms Maximize Profit202

The Production Process203

The Long Run and the Short Run203

Production Tables and Production Functions204

The Law of Diminishing Marginal Productivity204

The Costs of Production206

Fixed Costs, Variable Costs, and Total Costs206

Average Total Cost, Average Fixed Cost, and AverageVariable Cost207

Marginal Cost207

Graphing Cost Curves208

Total Cost Curves208

Average and Marginal Cost Curves208

Downward-Sloping Shape of the Average FixedCost Curve208

The U Shape of the Average and MarginalCost Curves209

The Relationship between the Marginal Productivityand Marginal Cost Curves210

The Relationship between the Marginal Cost andAverage Cost Curves211

KNOWING THE TOOLS: Review of Costs212

Intermission213

Chapter Summary213

Key Terms213

Questions for Thought and Review214

Problems and Exercises214

Web Questions215

Answers to Margin Questions215

10. PRODUCTION AND COSTANALYSIS Ⅱ217

Making Long-Run Production Decisions217

Technical Efficiency and Economic Efficiency218

APPLYING THE TOOLS: Producing the MazdaMiata219

Determinants of the Shape of the Long-RunCost Curve219

Economies of Scale219

Diseconomies of Scale221

Constant Returns to Scale221

KNOWING THE TOOLS: Distinguishing Diseconomiesof Scale from Diminishing Marginal Productivity222

The Importance of Economies and Diseconomies ofScale222

Envelope Relationship223

APPLYING THE TOOLS: Why Are TextbooksSo Long?224

Entrepreneurial Activity and the Supply Decision224

Using Cost Analysis in the Real World225

Economies of Scope225

Learning by Doing and Technological Change226

Many Dimensions229

Unmeasured Costs229

APPLYING THE TOOLS: New Approaches in CostAnalysis230

The Standard Model as a Framework230

Conclusion and a Look Ahead230

Chapter Summary231

Key Terms231

Questions for Thought and Review231

Problems and Exercises232

Web Questions232

Answers to Margin Questions233

Appendix A: Isocost/Isoquant Analysis233

Ⅲ MARKET STRUCTURE AND POLICY238

11. PERFECT COMPETITION238

A Perfectly Competitive Market239

The Necessa Conditions for Perfect Competition239

The Definition of Supply and Perfect Competition240

APPLYING THE TOOLS: The Internet and thePerfectly Competitive Model241

Demand Curves for the Firm and the Industry241

The Profit-Maximizing Level of Output242

Marginal Revenue242

Marginal Cost243

Profit Maximization: MC = MR244

The Marginal Cost Curve Is the Supply Curve244

Firms Maximize Total Profit245

Profit Maximization Using Total Revenueand Total Cost245

APPLYING THE TOOLS: The Broader Importance ofthe MR = MC Equilibrium Condition246

Total Profit at the Profit-Maximizing Level of Output247

Determining Profit from a Table of Costsand Revenue247

Determining Profit from a Graph248

APPLYING THE TOOLS: Profit Maximization andReal-World Firms250

The Shutdown Point250

Short-Run Market Supply and Demand251

KNOWING THE TOOLS: Finding Price, Output,and Profit252

Long-Run Competitive Equilibrium252

APPLYING THE TOOLS: The Shutdown Decision andthe Relevant Costs253

Adjustment from the Short Run to the Long Run253

An Increase in Demand253

Long-Run Market Supply254

KNOWING THE TOOLS: A Summary of a PerfectlyCompetitive Industry255

An Example in the Real World255

Conclusion256

Chapter Summary256

Key Terms257

Questions for Thought and Review257

Problems and Exercises258

Web Questions259

Answers to Margin Questions259

12. MONOPOLY261

The Key Difference between a Monopolist and a PerfectCompetitor262

A Model of Monopoly263

Determining the Monopolist's Price and OutputNumerically263

KNOWING THE TOOLS: A Trick in Graphing theMarginal Revenue Curve264

Determining the Monopolist's Price and OutputGraphically264

Comparing Monopoly and Perfect Competition266

An Example of Finding Output and Price266

Profits and Monopoly267

A Monopolist Making a Profit267

A Monopolist Breaking Even and Making a Loss268

KNOWING THE TOOLS: Finding a Monopolist'sOutput, Price, and Profit269

The Price-Discriminating Monopolist269

BEYOND THE TOOLS: Monopsony270

The Welfare Loss from Monopoly270

Barriers to Entryand Monopoly271

Natural Ability271

APPLYING THE TOOLS: Can Price Controls IncreaseOutput and Lower Market Price?272

Economies of Scale272

Government-Created Monopolies274

Normative Views of Monopoly274

Government Policy and Monopoly: AIDS Drugs275

Conclusion276

Chapter Summary276

Key Terms277

Questions for Thought and Review277

Problems and Exercises277

Web Questions278

Answers to Margin Questions279

Appendix A: The Algebra of Competitive and MonopolisticFirms280

13. MONOPOLISTIC COMPETITION, OLIGO-POLY, AND STRATEGIC PRICING282

The Problems of Determining Industry Structure283

Classifying Industries283

Determining Industry Structure284

Conglomerate Firms and Bigness285

The Importance of Classifying Indust Structure285

APPLYING THE TOOLS: Foreign CompetitiveOligopolies286

Characteristics of Monopolistic Competition286

Many Sellers286

Product Differentiation287

Multiple Dimensions of Competition287

Ease of Entry of New Firms in the Long Run287

Output, Price, and Profit of a MonopolisticCompetitor288

Comparing Monopolistic Competition with PerfectCompetition289

Comparing Monopolistic Competition with Monopoly290

Advertising and Monopolistic Competition290

Characteristics of Oligopoly291

Models of Oligopoly Behavior292

The Cartel Model292

The Contestable Market Model294

Comparison of the Contestable Market Model and theCartel Model294

Strategic Pricing and Oligopoly295

Game Theory, Oligopoly, and StrategicDecision Making296

Prisoner's Dilemma and a Duopoly Example296

Duopoly and a Payoff Matrix298

BEYOND THE TOOLS: Game Theory andExperimental Economics299

Oligopoly Models, Structure, and Performance299

KNOWING THE TOOLS: A Comparison of VariousMarket Stctures300

Conclusion301

Chapter Summary301

Key Terms302

Questions for Thought and Review302

Problems and Exercises302

Web Questions303

Answers to Margin Questions304

14. GLOBALIZATION, TECHNOLOGY, ANDREAL-WORLD COMPETITION305

The Goals of Real-World Firms and the Monitoring Problem306

Short-Run versus Long-Run Profit306

The Problem with Profit Maximization306

What Do Real-World Firms Maximize?308

The Lazy Monopolist and X-Inefficiency308

How Competition Limits the Lazy Monopolist308

Motivations for Efficiency other than theProfit Incentive309

The Fight between Competitive and MonopolisticForces310

How Monopolistic Forces Affect PerfectCompetition310

Economic Insights and Real-World Competition311

How Competitive Forces Affect Monopoly311

Competition and Natural Monopoly312

How Firms Protect Their Monopolies314

Cost-Benefit Analysis of Creating and MaintainingMonopolies314

Establishing Market Position315

Driving Forces in Today's Economy315

Globalization315

Technology318

Technology, Efficiency, and Market Structure318

Perfect Competition and Technology319

Monopolistic Competition and Technology319

Monopoly and Technology319

Oligopoly and Technology319

Network Externalities, Standards, and TechnologicalLock-In320

Conclusion322

Chapter Summary322

Key Terms322

Questions for Thought and Review323

Problems and Exercises323

Web Questions324

Answers to Margin Questions324

Ⅳ APPLYING ECONOMIC REASONINGTO POLICY326

15. GOVERNMENT POLICY AND MARKETFAILURES326

KNOWING THE TOOLS: Pareto Optimality and thePerfectly Competitive Benchmark327

Market Failures327

Externalities328

A Negative Externality Example328

A Positive Externality Example329

APPLYING THE TOOLS: Common Resources and theTragedy of the Commons330

Alternative Methods of Dealing with Externalities330

Direct Regulation330

Incentive Policies330

Voluntary Reductions332

APPLYING THE TOOLS: Marketable Permits forPollution333

The Optimal Policy333

Public Goods334

Informational Problems336

Policies to Deal with Informational Problems337

A Market in Information337

Licensing of Doctors337

The Informational Alternative to Licensure339

Government Failure and Market Failures341

Conclusion342

Chapter Summary342

Key Terms342

Questions for Thought and Review343

Problems and Exercises343

Web Questions344

Answers to Margin Questions344

16. ANTITRUST POLICY ANDREGULATION346

Antitrust Policy: Judgment by Performanceor Structure?347

History of U.S. Antitrust Laws347

The Sherman Antitrust Act348

The Standard Oil and American Tobacco Cases:Judging Market Competitiveness byPerformance349

The Clayton Act and the Federal Trade CommissionAct349

The ALCOA Case: Judging Market Competitivenessby Structure350

Judging Markets by Structure and Performance:The Reality350

APPLYING THE TOOLS: Wal-Mart, State Laws, andCompetition351

Recent Antitrust Enforcement352

APPLYING THE TOOLS: Nefarious BusinessPractices353

Three Recent Antitrust Cases353

The IBM Case353

The AT&T Case354

The Microsoft Case356

Assessment of Antitrust Policy359

Mergers, Acquisitions, and Takeovers359

Acquisitions and Takeovers359

Mergers360

BEYOND THE TOOLS: White Knights and GoldenParachutes361

Recent Merger Activity and Deacquisitions362

Assessment of Mergers and Acquisitions363

International Competition and Antitrust Policy in OtherCountries363

APPLYING THE TOOLS: Antitrust Agencies in SomeOther Countries364

Regulation, Government Ownership, and IndustrialPolicies365

Regulation365

Government Ownership365

Industrial Policies367

Conclusion367

Chapter Summary368

Key Terms368

Questions for Thought and Review368

Problems and Exercises369

Web Questions369

Answers to Margin Questions370

17. MICROECONOMIC POLICY, ECONOMICREASONING, AND BEYOND371

Economists' Differing Views about Social Policy372

How Economists' Value Judgments Creep into PolicyProposals372

The Need for a Worldview374

Agreement among Economists about Social Policy374

Economists' Cost/Benefit Approach to GovernmentRegulation375

The Value of Life375

Comparing Costs and Benefits of DifferentDimensions377

Putting Cost/Benefit Analysis in Perspective378

The Problem of Other Things Changing378

The Cost/Benefit Approach in Context378

KNOWING THE TOOLS: Economic Efficiency and theGoals of Society379

Failure of Market Outcomes379

Distribution380

Examples of Distributional Issues380

BEYOND THE TOOLS: The Ambiguity of TotalSurplus381

Consumer Sovereignty and Rationality Problems382

Inalienable Rights382

APPLYING THE TOOLS: Elasticity and Taxation toChange Behavior383

Government Failure384

APPLYING THE TOOLS: The Conventional PolicyWisdom among Economists385

Politics and Economic Policy385

Conclusion386

Chapter Summary386

Key Terms387

Questions for Thought and Review387

Problems and Exercises387

Web Questions388

Answers to Margin Questions389

V POLICY ISSUES IN DEPTH390

18. POLITICS AND ECONOMICS: THE CASEOF AGRICULTURAL MARKETS390

APPLYING THE TOOLS: The Cost of a Box ofWheaties391

The Nature of Agricultural Markets391

The Good/Bad Paradox in Agriculture392

The Long-Run Decline of Farming392

The Short-Run Cyclical Problem Facing Farmers393

The Difficulty of Coordinating Farm Production393

Ways around the Good/Bad Paradox393

The General Rule of Political Economy394

Four Price Support Options394

Supporting the Price by Regulato Measures395

Providing Economic Incentives to Reduce Supply397

Subsidizing the Sale of the Good398

Buying Up and Storing, Giving Away, or Destroyingthe Good398

Which Group Prefers Which Option?399

Economics, Politics, and Real-World Policies399

Interest Groups399

APPLYING THE TOOLS: Changes in U.S. AgriculturalPolicy400

International Issues400

Conclusion401

Chapter Summary401

Key Terms402

Questions for Thought and Review402

Problems and Exercises402

Web Questions403

Answers to Margin Questions403

19. INTERNATIONAL TRADE POLICY405

APPLYING THE TOOLS: The Gains to InternationalTraders406

The Principle of Comparative Advantage406

The Gains from Trade406

BEYOND THE TOOLS: International Issues inPerspective407

Dividing Up the Gains from Trade407

Reasons for Trade Restrictions408

Unequal Internal Distribution of the Gains fromTrade409

Haggling by Companies over the Gains from Trade410

Haggling by Countries over Trade Restrictions411

Specialized Production411

Macroeconomic Aspects of Trade412

National Security413

International Politics413

Increased Revenue Brought In by Tariffs413

Why Economists Generally Oppose TradeRestrictions413

Varieties of Trade Restrictions414

Tariffs415

Quotas416

Voluntary Restraint Agreements417

Embargoes417

Regulatory Trade Restrictions417

APPLYING THE TOOLS: Hormones andEconomics418

Nationalistic Appeals418

Free Trade Associations418

APPLYING THE TOOLS: Dumping419

Conclusion419

Chapter Summary420

Key Terms420

Questions for Thought and Review420

Problems and Exercises421

Web Questions422

Answers to Margin Questions422

Appendix A: The Geometry of Absolute Advantage andComparative Advantage422

Ⅵ FACTOR MARKETS428

20. WHO GETS WHAT? THE DISTRIBUTIONOF INCOME428

Ways of Considering the Distribution of Income429

The Share Distribution of Income430

The Lorenz Curve430

U.S. Income Distribution over Time431

Defining Poverty432

The Official Definition of Poverty432

Debates about the Definition of Poverty433

The Costs of Poverty434

International Dimensions of Income Inequality434

Comparing U.S. Income Distribution with That inOther Countries434

KNOWING THE TOOLS: The Gini Coefficient435

Income Distribution among Countries436

The Total Amount of Income in VariousCountries436

The Distribution of Wealth436

A Lorenz Curve of the Distribution of Wealth437

How Much Wealth Do the Wealthy Have?437

Socioeconomic Dimensions of Income Inequality438

Income Distribution according to SocioeconomicCharacteristics438

Income Distribution according to Class439

Income Distribution and Fairness440

Philosophical Debates about Equality andFairness440

Fairness and Equality441

Fairness as Equality of Opportunity442

The Problems of Redistributing Income442

Three Important Side Effects of RedistributivePrograms442

Politics, Income Redistribution, and Fairness443

Income Redistribution Policies443

Taxation to Redistribute Income443

Expenditure Programs to Redistribute Income445

How Successful Have Income Redistribution ProgramsBeen?446

Conclusion447

Chapter Summary448

Key Terms448

Questions for Thought and Review448

Problems and Exercises449

Web Questions449

Answers to Margin Questions450

21. WORK AND THE LABOR MARKET451

The Supply of Labor452

Real Wages and the Opportunity Cost of Work453

KNOWING THE TOOLS: Income and SubstitutionEffects454

The Supply of Labor and Nonmarket Activities454

Income Taxation, Work, and Leisure455

The Elasticity of the Supply of Labor455

Immigration and the International Supplyof Labor456

The Derived Demand for Labor456

Factors Influencing the Elasticity of Demandfor Labor457

Labor as a Factor of Production458

Shift Factors of Demand458

The Role of Other Forces in Wage Determination460

Imperfect Competition and the Labor Market461

Monopsony461

Union Monopoly Power462

Bilateral Monopoly462

Downsizing, Upsizing, and X-Inefficiency462

Political and Social Forces and the Labor Market463

Fairness and the Labor Market463

Job Discrimination and the Labor Market464

BEYOND THE TOOLS: Democracy in theWorkplace465

The Evolution of Labor Markets467

Conclusion: The Labor Market and You469

Chapter Summary471

Key Terms471

Questions for Thought and Review471

Problems and Exercises472

Web Questions473

Answers to Margin Questions473

Appendix A: Derived Demand474

APPLYING THE TOOLS: Difficulties in DeterminingMarginal Productivities476

Appendix B: Nonwage Income and Property Rights479

Ⅲ MACROECONOMICS484

Ⅰ MACROECONOMIC PROBLEMS484

22. ECONOMIC GROWTH, BUSINESSCYCLES, UNEMPLOYMENT, ANDINFLATION484

Two Frameworks: The Long Run and the Short Run484

Growth485

KNOWING THE TOOLS: Your Consumption andAverage Consumption486

Global Experiences with Growth486

The Benefits and Costs of Growth487

Business Cycles488

The Phases of the Business Cycle489

Why Do Business Cycles Occur?490

Leading Indicators491

Unemployment492

Unemployment as a Social Problem492

Unemployment as Government's Problem493

Why the Target Rate of Unemployment Changed493

BEYOND THE TOOLS: From Full Employment to theTarget Rate of Unemployment494

Whose Responsibility Is Unemployment?494

APPLYING THE TOOLS: Categories ofUnemployment495

How Is Unemployment Measured?496

Unemployment and Potential Output498

Microeconomic Categories of Unemployment499

Inflation500

Measurement of Inflation501

KNOWING THE TOOLS: Measurement Problems withthe Consumer Price Index502

Real and Nominal Concepts504

Expected and Unexpected Inflation504

Costs of Inflation505

Conclusion506

Chapter Summary506

Key Terms507

Questions for Thought and Review507

Problems and Exercises507

Web Questions508

Answers to Margin Questions508

Appendix A: Nonmainstream Approaches to Macro509

23. NATIONAL INCOME ACCOUNTING512

National Income Accounting513

Measuring Total Economic Output of Goods andServices513

Calculating GDP514

BEYOND THE TOOLS: Is GDP Biased againstWomen?518

Two Methods of Calculating GDP518

The National Income Accounting Identity518

The Expenditures Approach518

The Income Approach521

Equality of Income and Expenditure522

Other National Income Terms523

Using GDP Figures524

Comparing GDP among Countries524

Economic Welfare over Time525

Real and Nominal GDP525

Some Limitations of National Income Accounting526

GDP Measures Market Activity, Not Welfare526

APPLYING THE TOOLS: The Colander HappinessIndex527

Measurement Errors527

Misinterpretation of Subcategories528

Genuine Progress Indicator528

APPLYING THE TOOLS: The UndergroundEconomy529

Conclusion529

Chapter Summary530

Key Terms531

Questions for Thought and Review531

Problems and Exercises531

Web Questions532

Answers to Margin Questions532

Ⅱ THE MACROECONOMIC FRAMEWORK533

24. GROWTH, PRODUCTIVITY, AND THEWEALTH OF NATIONS533

General Observations about Growth534

Growth and the Economy's Potential Output534

The Importance of Growth for Living Standards534

BEYOND THE TOOLS: Is Growth Good?535

Markets, Specialization, and Growth536

Economic Growth, Distribution, and Markets536

Per Capita Growth537

The Sources of Growth538

Investment and Accumulated Capital538

Available Resources539

Growth-Compatible Institutions539

Technological Development540

Entrepreneurship540

Turning the Sources of Growth into Growth541

The Production Function and Theories of Growth541

The Standard Theory of Growth—the ClassicalGrowth Model542

APPLYING THE TOOLS: Is the 21st Centu the Age ofTechnology or One of Many Ages of Technology?544

New Growth Theory545

Economic Policies to Encourage Per Capita Growth547

Policies to Encourage Saving and Investment548

Policies to Control Population Growth549

Policies to Increase the Level of Education549

Policies to Create Institutions That EncourageTechnological Innovation550

Policies to Provide Funding for Basic Research551

Policies to Increase the Economy's Openness toTrade552

Conclusion552

Chapter Summary553

Key Terms553

Questions for Thought and Review553

Problems and Exercises554

Web Questions554

Answers to Margin Questions555

25. AGGREGATE DEMAND, AGGREGATESUPPLY, AND MODERNMACROECONOMICS556

The Historical Development of Modem Macro557

From Classical to Keynesian Economics557

Classical Economists558

The Layperson's Explanation for Unemployment558

The Essence of Keynesian Economics558

KNOWING THE TOOLS: In the Long Run, We're AllDead558

The AS/AD Model560

The Aggregate Demand Curve561

The Slope of the AD Curve561

Shifts in the AD Curve563

The Aggregate Supply Curve565

The Slope of the AS Curve566

Shifts in the AS Curve566

The Potential Output Curve567

Equilibrium in the Aggregate Economy567

KNOWING THE TOOLS: Why Are PricesInflexible?568

Short-Run Equilibrium569

Long-Run Equilibrium569

Integrating the Short-Run and Long-RunFrameworks569

KNOWING THE TOOLS: A Review of the AS/ADModel571

Some Additional Policy Examples572

Why Macro Policy Is More Complicated Than theAS/AD Model Makes It Look573

Three Policy Ranges573

The Problem of Estimating Potential Output574

Some Real-World Examples575

Debates about Potential Output576

Conclusion576

Chapter Summary576

Key Terms577

Questions for Thought and Review577

Problems and Exercises577

Web Questions578

Answers to Margin Questions578

26. THE MULTIPLIER MODEL580

BEYOND THE TOOLS: Econometric Models581

The Multiplier Model581

BEYOND THE TOOLS: History of the MultiplierModel582

Aggregate Production582

Aggregate Expenditures583

Determining the Level of Aggregate Income587

KNOWING THE TOOLS: Solving for EquilibriumIncome Algebraically588

The Multiplier Equation588

The Multiplier Process589

The Circular Flow Model and the Intuition behind theMultiplier Process590

The Multiplier Model in Action591

The Steps of the Multiplier Process592

Examples of the Effects of Shifts in AggregateExpenditures593

KNOWING THE TOOLS: Determinants of the AECurve595

Limitations of the Multiplier Model595

The Multiplier Model Is Not a Complete Model of theEconomy595

Shifts Are Not as Great as Intuition Suggests595

The Price Level Will Often Change in Response toShifts in Demand596

People's Forward-Looking Expectations Make theAdjustment Process Much More Complicated596

Shifts in Expenditures Might Reflect Desired Shifts inSupply and Demand596

Expenditures Depend on Much More Than CurrentIncome597

Conclusion597

Chapter Summary597

Key Terms598

Questions for Thought and Review598

Problems and Exercises598

Web Questions599

Answers to Margin Questions599

Appendix A: An Algebraic Presentation of the ExpandedMultiplier Model600

Appendix B: The Multiplier Model and the AS/ADModel601

Ⅲ POLICY ISSUES604

27. DEMAND MANAGEMENT POLICY604

The Story of Fiscal Policy605

Aggregate Demand Management605

BEYOND THE TOOLS: Keynes and Fiscal Policy606

Fighting Recession: Expansionary Fiscal Policy606

Fighting Inflation: Contractionary Fiscal Policy609

The Questionable Effectiveness of Fiscal Policy609

APPLYING THE TOOLS: Using Taxes Rather ThanExpenditures as the Tool of Fiscal Policy610

Alternatives to Fiscal Policy610

Directed Investment Policies: Policy AffectingExpectations611

KNOWING THE TOOLS: Government DemandManagement Policies612

Trade Policy and Export-Led Growth612

Autonomous Consumption Policy613

Real-World Examples614

Fiscal Policy in World War Ⅱ614

Recent Fiscal Policy615

Problems with Fiscal and Other Activist Policies615

1. Financing the Deficit Doesn't Have OffsettingEffects616

2. Knowing What the Situation Is618

3. Knowing the Level of Potential Income618

4. The Government's Flexibility in Changing Taxesand Spending619

APPLYING THE TOOLS: Fighting Vietnam WarInflation620

5. Size of the Government Debt Doesn't Matter620

6. Fiscal Policy Doesn't Negatively Affect OtherGovernment Goals620

Summaryof the Problems620

Building Fiscal Policies into Institutions621

Conclusion621

Chapter Summary622

Key Terms623

Questions for Thought and Review623

Problems and Exercises623

Web Questions624

Answers to Margin Questions624

28. POLITICS, SURPLUSES, DEFICITS, ANDDEBT626

Defining Surpluses and Deficits627

Financing the Deficit627

Arbitrariness of Defining Surpluses and Deficits628

Many Right Definitions628

Surpluses and Deficits as Summary Measures628

Nominal and Real Surpluses and Deficits629

Structural and Passive Surpluses and Deficits630

The Definition of Debt and Assets631

Debt Management631

Difference between Individual and GovernmentDebt633

U.S. Government Deficits and Debt: The HistoricalRecord634

The Debt Burden635

U.S. Debt Relative to Other Countries635

Interest Rates and Debt Burden636

The Modern Debate about the Surplus636

Why Did the Surplus Come About?637

KNOWING THE TOOLS: Four Important Points aboutDeficits and Debt638

What Should the Government Do with the Surplus?638

Implications of the Government's Cash FlowAccounting System638

The Social Security System638

Why the Surplus Is Not As Large As It Looks641

The Real Problem and the Real Solution641

BEYOND THE TOOLS: The Stock Market Crash of2014?643

Conclusion644

Chapter Summary644

Key Terms644

Questions for Thought and Review645

Problems and Exercises645

Web Questions646

Answers to Margin Questions646

29. MONEY, BANKING, AND THEFINANCIAL SECTOR647

Why Is the Financial Sector Important to Macro?648

The Role of Interest Rates in the Financial Sector649

Saving That Escapes the Circular Flow650

The Definitions and Functions of Money650

The U.S. Central Bank: The Fed650

Functions of Money651

Alternative Measures of Money653

M1653

KNOWING THE TOOLS: Characteristics of a GoodMoney654

Mz654

Beyond M2: L654

Distinguishing between Money and Credit655

APPLYING THE TOOLS: NOW Accounts and MoneyMarket Accounts656

Banks and the Creation of Money656

How Banks Create Money656

The Money Multiplier658

Faith as the Backing of Our Money Supply661

APPLYING THE TOOLS: The Real-World MoneyMultiplier and Recent Reforms in Banking662

Regulation of Banks and the Financial Sector662

Financial Panics662

Anatomy of a Financial Panic663

Government Policy to Prevent Panic663

The Benefits and Problems of Guarantees663

The Savings and Loan Bailout664

Conclusion665

Chapter Summary665

Key Terms665

Questions for Thought and Review666

Problems and Exercises666

Web Questions667

Answers to Margin Questions667

Appendix A: A Closer Look at Financial Institutions andFinancial Markets667

KNOWING THE TOOLS: Do Financial Assets MakeSociety Richer?670

Appendix B: Creation of Money Using T-Accounts677

30. MONETARY POLICY AND THE DEBATEABOUT MACRO POLICY680

Duties and Structure of the Fed682

Structure of the Fed682

APPLYING THE TOOLS: Central Banks in OtherCountries684

Duties of the Fed684

BEYOND THE TOOLS: Histoof the U.S. BankingSystem685

The Importance of MonetaPolicy685

The Conduct of Monetary Policy686

Tools of Moneta Policy686

Changing the Reserve Requirement686

APPLYING THE TOOLS: Three Letters687

Changing the Discount Rate688

KNOWING THE TOOLS: Fancy Lingo689

Executing Open Market Operations689

Monetary Policy in the AS/AD Model692

Monetary Policy in the Circular Flow693

The Emphasis on the Interest Rate693

Real and Nominal Interest Rates693

Real and Nominal Interest Rates and MonetaryPolicy695

Problems in the Conduct of Monetary Policy695

Knowing What Policy to Use695

Understanding the Policy You're Using696

Lags in Monetary Policy696

Political Pressure696

Conflicting International Goals696

Conclusion697

Chapter Summary697

Key Terms697

Questions for Thought and Review698

Problems and Exercises698

Web Questions699

Answers to Margin Questions699

Appendix A: The Effect of Monetary Policy UsingT-Accounts700

31. INFLATION AND ITS RELATIONSHIP TOUNEMPLOYMENT AND GROWTH702

Some Basics about Inflation703

The Distributional Effects of Inflation703

Expectations of Inflation703

Productivity, Inflation, and Wages704

Theories of Inflation704

The Quantity Theory of Money and Inflation704

KNOWING THE TOOLS: Demand-Pull and Cost-PushInflation705

BEYOND THE TOOLS: The Keeper of the ClassicalFaith: Milton Friedman709

The Institutional Theory of Inflation710

KNOWING THE TOOLS: Dieting and FightingInflation713

Inflation and Unemployment: The Phillips Curve713

History of the Phillips Curve714

The Breakdown of the Short-Run Phillips Curve715

The Long-Run and Short-Run Phillips Curves715

Stagflation and the Phillips Curve717

The New Economy: The Late 1990s and Early2000s717

The Relationship between Inflation and Growth718

Quantity Theoryand the Inflation/GrowthTrade-Off719

Institutional Theory and the Inflation/GrowthTrade-Off719

Conclusion720

Chapter Summary720

Key Terms720

Questions for Thought and Review721

Problems and Exercises721

Web Questions722

Answers to Margin Questions722

Ⅳ INTERNATIONAL POLICY ISSUES724

32. OPEN ECONOMY MACRO: EXCHANGE724

RATE AND TRADE POLICY724

The Balance of Payments725

The Current Account726

The Capital Account727

The Official Transactions Account728

Exchange Rates728

Exchange Rates and the Balance of Payments730

Fundamental Forces Determining Exchange Rates730

Why Exchange Rate Determination Is MoreComplicated Than Supply/Demand Analysis MakesIt Seem731

International Trade Problems from Shifting Values ofCurrencies731

How a Fixed Exchange Rate System Works731

KNOWING THE TOOLS: Exchange Rates Set by Law:Nonconvertible Currencies and Capital Controls732

APPLYING THE TOOLS: Determining the Causes andFluctuations in the Dollar's Value734

Advantages and Disadvantages of Alternative ExchangeRate Systems736

Fixed Exchange Rates736

Flexible Exchange Rates737

Partially Flexible Exchange Rates738

Which View Is Right?738

APPLYING THE TOOLS: The Euro739

Adjusting the Economy to the Exchange Rate via TradePolicy739

Varieties of Trade Restrictions739

Economists' Dislike of Trade RestrictionPolicies742

Strategic Trade Policies742

Conclusion743

Chapter Summary743

Key Terms744

Questions for Thought and Review744

Problems and Exercises745

Web Questions745

Answers to Margin Questions746

Appendix A: History of Exchange Rate Systems747

33. INTERNATIONAL DIMENSIONS OFMONETARY AND FISCAL POLICIES750

The Ambiguous Inteational Goals of MacroeconomicPolicy751

The Exchange Rate Goal751

The Trade Balance Goal751

APPLYING THE TOOLS: The U.S. Trade Deficit752

International versus Domestic Goals752

Monetary and Fiscal Policy with Fixed ExchangeRates753

Increase the Private Demand for Francs viaContractionary Monetary Policy753

Decrease the Private Supply of Francs viaContractionary Monetary and Fiscal Policy754

Monetary and Fiscal Policy with Flexible or PartiallyFlexible Exchange Rate Regimes754

Monetary Policy's Effect on Exchange Rates754

Monetary Policy's Effect on the Trade Balance756

Fiscal Policy's Effect on Exchange Rates758

Fiscal Policy's Effect on the Trade Deficit759

International Phenomena and Domestic Goals760

International Monetary and Fiscal Coordination760

KNOWING THE TOOLS: Monetary and Fiscal Policy'sEffect on International Goals761

Coordination Is a Two-Way Street761

Crowding Out and International Considerations761

Conclusion762

Chapter Summary763

Questions for Thought and Review763

Problems and Exercises764

Web Questions764

Answers to Margin Questions764

V COMBINING THE FRAMEWORK WITHPOLICY766

34. TOOLS, RULES, AND POLICY766

Models767

Micro Models767

Macro Models769

KNOWING THE TOOLS: Key Models in IntroductoMacroeconomics773

Using Models to Understand and Discuss Policy773

Policies and Institutions773

Worldviews and Policy775

Keynesian and Classical Policy Views776

Monetaryand Fiscal Policy776

Policy Process and Credibility779

Has the Economy Entered a New Era?781

BEYOND THE TOOLS: The Stock Market Boom andthe Economy783

Conclusion784

Chapter Summary784

Key Terms785

Questions for Thought and Review785

Problems and Exercises785

Web Questions786

Answers to Margin Questions786