Economics 8e by arnold

Analyzing the Scene 148Chapter Summary 149Key Terms and Concepts 150Questions and Problems 150Working with Numbers and Graphs 151Depression, and Scrabble 169 Reality Can Be Messy, and Co

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8e

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8e Roger A.Arnold

California State University San Marcos

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Thomson South-Western, a part of

The Thomson Corporation.Thomson,

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trademarks used herein under license

Printed in the United States of America

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To Sheila, Daniel, and David

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Preface xxxi

A N I NTR O D U CTI O N TO E C O N O M I C S

Part 1 Economics: The Science of Scarcity

Chapter 1 What Economics Is About 1

Appendix A Working with Diagrams 17

Appendix B Should You Major in Economics? 25

Chapter 2 Economic Activities: Producing and

Trading 31

Chapter 3 Supply and Demand: Theory 50

Chapter 4 Supply and Demand: Practice 82

M A C R O E C O N O M I C S

Part 2 Macroeconomic Fundamentals

Chapter 5 Macroeconomic Measurements, Part I:

Prices and Unemployment 111

Chapter 6 Macroeconomic Measurements, Part II:

GDP and Real GDP 131

Part 3 Macroeconomic Stability, Instability,

and Fiscal Policy

Chapter 7 Aggregate Demand and Aggregate

Supply 152

Chapter 8 The Self-Regulating Economy 177

Chapter 9 Economic Instability: A Critique of the

Chapter 11 Money and Banking 241

Chapter 12 The Federal Reserve System 260

Chapter 13 Money and the Economy 272

Chapter 14 Monetary Policy 298

Part 5 Expectations and Growth

Chapter 15 Expectations Theory and the

Chapter 18 Consumer Choice: Maximizing Utility

and Behavioral Economics 380

Appendix C: Budget Constraint Analysis and

Indifference Curve Analysis 396

Chapter 19 Production and Costs 405

Part 7 Product Markets and Policies

Chapter 20 Perfect Competition 435 Chapter 21 Monopoly 461

Chapter 22 Monopolistic Competition, Oligopoly,

and Game Theory 482

Chapter 23 Government and Product Markets:

Antitrust and Regulation 508

Part 8 Factor Markets and Related Issues

Chapter 24 Factor Markets: With Emphasis on the

Labor Market 531

Chapter 25 Wages, Unions, and Labor 554 Chapter 26 The Distribution of Income and

Poverty 572

Chapter 27 Interest, Rent, and Profit 592

Part 9 Market Failure and Public Choice

Chapter 28 Market Failure: Externalities, Public

Goods, and Asymmetric Information 609

Chapter 29 Public Choice: Economic Theory

Applied to Politics 636

TH E G L O B A L E C O N O MY

Part 10 International Economics and

Globalization Chapter 30 International Trade 657 Chapter 31 International Finance 674 Chapter 32 Globalization 702

P R A CTI C A L E C O N O M I C S

Part 11 Financial Matters

Chapter 33 Stocks, Bonds, Futures, and

Options 719

W E B C H A P TE R S

Part 12 Web Chapters

Chapter 34 Agriculture: Farmers’ Problems,

Government Policies, and Unintended Effects 741

Chapter 35 International Impacts on the

Economy 753

Self-Test Appendix 741 Glossary 765

Index 777

Brief Contents

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Preface xxxi

AN I NTRODUCTION TO ECONOM ICS

Part 1 Economics: The Science of Scarcity

What Economics Is About 1

A Definition of Economics 2

Goods and Bads 2 Resources 2 Scarcity and a Definition of Economics 2

Key Concepts in Economics 5

Opportunity Cost 5 Benefits and Costs 6 Decisions Made at the Margin 8 Efficiency 8

Economic Categories 12

Positive and Normative Economics 12 Microeconomics and Macroeconomics 13

A Reader Asks 13Analyzing the Scene 14Chapter Summary 15Key Terms and Concepts 16Questions and Problems 16

Appendix A: Working with Diagrams 17

Two-Variable Diagrams 17Slope of a Line 18Slope of a Line Is Constant 18Slope of a Curve 20

The 45° Line 20Pie Charts 21Bar Graphs 21Line Graphs 21Appendix Summary 24Questions and Problems 24

Appendix B: Should You Major in Economics? 25

Five Myths about Economics and an Economics Major 26What Awaits You as an Economics Major? 28

What Do Economists Do? 29Places to Find More Information 30Concluding Remarks 30

1

f e a t u r e s

economics24/7

24 3 Why LeBron James

Isn’t in College

6 The Costs and Benefits

of Attending Class

7 Why Did the British Soldiers

Wear Red Uniforms?

11

c h a p t e r

Contents

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Supply and Demand: Theory 50

A Note about Theories 51What Is Demand? 51

the Law of Demand 52 Two Prices: Absolute and Relative 53 Why Does Quantity

Factors Cause the Demand Curve to Shift? 57 Movement Factors and Shift Factors 59

Supply 60

Supply Mean Shifts in Supply Curves 62 What Factors Cause the Supply Curve

to Shift? 63 A Change in Supply Versus a Change in Quantity Supplied 64

The Market: Putting Supply and Demand Together 65

Supply and Demand at Work at an Auction 65 The Language of Supply and Demand: A Few Important Terms 66 Moving to Equilibrium: What Happens to Price When There Is a Surplus

or a Shortage? 67 Speed of Moving to Equilibrium 68 Moving to Equilibrium: Maximum and Minimum Prices 68 Equilibrium in Terms of Consumers’ and Producers’ Surplus 70 What Can Change Equilibrium Price and Quantity? 71

Can Technology on the Farm

Affect the Number of Lawyers

in the City?

37 Liberals, Conservatives,

and the PPF

39 Jerry Seinfeld, the Doorman,

and Adam Smith

69 Ticket Scalping

75

3

c h a p t e r

2

c h a p t e r Economic Activities: Producing and Trading 31

The Production Possibilities Frontier 32

The Straight-Line PPF: Constant Opportunity Costs 32 The Bowed-Outward Downward) PPF: Increasing Opportunity Costs 33 Law of Increasing Opportunity Costs 34 Economic Concepts within a PPF Framework 35

(Concave-Exchange or Trade 38

Periods Relevant to Trade 39 Trade and the Terms of Trade 40 Costs of Trades 40 Trades and Third-Party Effects 42

Production, Trade, and Specialization 42

Producing and Trading 42 Profit and a Lower Cost of Living 45 A Benevolent and All-Knowing Dictator Versus the Invisible Hand 45

A Reader Asks 46Analyzing the Scene 47Chapter Summary 47Key Terms and Concepts 48Questions and Problems 48Working with Numbers and Graphs 49

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Contents xi

4

c h a p t e r Supply and Demand: Practice 82

Application 1: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes ofAdmission? 83

Application 2: What Will Happen to the Price of Marijuana If the Purchase and Sale

of Marijuana Are Legalized? 84Application 3: Where Did You Get That Music? 85Application 4: Television Shows During the Olympics 86Application 5: Who Feeds Cleveland? 86

Application 6: The Minimum Wage Law 87Application 7: Loud Talking at a Restaurant 88Application 8: Price Ceiling in the Kidney Market 89Application 9: Healthcare and the Right to Sue Your HMO 91Application 10: Being Late to Class 92

Application 11: If Gold Prices Are the Same Everywhere, Then Why Aren’t HousePrices? 93

Application 12: Do You Pay for Good Weather? 94Application 13: Paying All Professors the Same Salary 94Application 14: Price Floors and Winners and Losers 96Application 15: College Superathletes 97

Application 16: Supply and Demand on a Freeway 99Application 17: What Does Price Have to Do with Getting to Class on Time? 101Application 18: The Space Within Space 102

Application 19: 10 A.M Classes in College 102Application 20: Who Pays the Tax? 103

Analyzing the Scene 78Chapter Summary 78Key Terms and Concepts 79Questions and Problems 80Working with Numbers and Graphs 80

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f e a t u r e s

economics24/7

Did President Kennedy Earn

More Than Today’s President?

118 What Was a Penny Worth?

120 Economics at the Movies

121 National Public Radio and

Unemployment Figures

124 What Explains the Increasing

Part 2 Macroeconomic Fundamentals

Macroeconomic Measurements, Part I: Prices and Unemployment 111

How to Approach the Study of Macroeconomics 112

Policies 113 Different Views of How the Economy Works 113

Three Macroeconomic Organizational Categories 113Macroeconomic Measures 115

Measuring Prices Using the CPI 115 Inflation and the CPI 117 The Substitution Bias

in Fixed-Weighted Measures 118 GDP Implicit Price Deflator 119 Converting Dollars from One Year to Another 119

Measuring Unemployment 120

Is Full Employment? 125 Cyclical Unemployment 125

f e a t u r e s

economics24/7

Happiness and the Economist

135 GDP: Proceed with Caution

137 Per Capita GDP in 1820

140

6

c h a p t e r Macroeconomic Measurements, Part II: GDP and Real GDP 131

Gross Domestic Product 132

Generated in the Production of Goods 134 Per Capita GDP 134 Is Either GDP or Per Capita GDP a Measure of Happiness or Well-Being? 134

The Expenditure Approach to Computing GDP for a Real-World Economy 136

Expenditures in a Real-World Economy 136 Computing GDP Using the Expenditure Approach 137

The Income Approach to Computing GDP for a Real-World Economy 138

Computing National Income 141 From National Income to GDP: Making Some Adjustments 141

Other National Income Accounting Measurements 143

Real GDP 144

GDP 145 What Does It Mean If Real GDP Is Higher in One Year Than in Another Year?

A Reader Asks 148

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Analyzing the Scene 148Chapter Summary 149Key Terms and Concepts 150Questions and Problems 150Working with Numbers and Graphs 151

Depression, and Scrabble

169 Reality Can Be Messy,

and Correct Predictions

Can Be Difficult to Make

171

7

c h a p t e r

Part 3 Macroeconomic Stability, Instability, and Fiscal Policy

Aggregate Demand and Aggregate Supply 152

The Two Sides to an Economy 153Aggregate Demand 153

Why Does the Aggregate Demand Curve Slope Downward? 153 A Change in the Quantity

Demand: Shifts in the AD Curve 156 How Spending Components Affect Aggregate Demand

157 Factors That Can Change C, I, G, and NX (EX – IM) and Therefore Can Change AD

Short-Run Aggregate Supply 162

Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping 162 What Puts the “Short Run” in SRAS? 163 Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve 163

Putting AD and SRAS Together: Short-Run Equilibrium 165

How Short-Run Equilibrium in the Economy Is Achieved 166 Thinking in Terms of Short-Run Equilibrium Changes in the Economy 167 An Important Exhibit 169

Long-Run Aggregate Supply 170

Going from the Short Run to the Long Run 170 Short-Run Equilibrium, Long-Run Equilibrium, and Disequilibrium 172

8

c h a p t e r The Self-Regulating Economy 177

The Classical View 178

Classical Economists and Say’s Law 178 Classical Economists and Interest Rate Flexibility

178 Classical Economists on Prices and Wages 180

Three States of the Economy 181

Real GDP and Natural Real GDP: Three Possibilities 181 The Labor Market and the Three States of the Economy 182 One Nagging Question: How Can the Unemployment Rate Be Less Than the Natural Unemployment Rate? 184

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The Self-Regulating Economy 185

What Happens If the Economy Is in a Recessionary Gap? 185 What Happens If the Economy Is in an Inflationary Gap? 186 The Self-Regulating Economy: A Recap 188 Policy Implication of Believing the Economy Is Self-Regulating 189 Changes in a Self- Regulating Economy: Short Run and Long Run 189

House Wealth

208

9

c h a p t e r Economic Instability: A Critique of the Self-Regulating Economy 195

Questioning the Classical Position 196

Keynes’s Criticism of Say’s Law in a Money Economy 196 Keynes on Wage Rates 198 New Keynesians and Wage Rates 198 Keynes on Prices 199 Is It a Question of the Time

It Takes for Wages and Prices to Adjust? 200

The Simple Keynesian Model 201

The Multiplier 203 The Multiplier and Reality 205

The Simple Keynesian Model in the AD-AS Framework 206

Shifts in the Aggregate Demand Curve 206 The Keynesian Aggregate Supply Curve 206

Theme of the Simple Keynesian Model 209

The Simple Keynesian Model in the TE-TP Framework 210

Deriving a Total Expenditures (TE) Curve 210 What Will Shift the TE Curve? 211 Comparing Total Expenditures (TE) and Total Production (TP) 212 Moving from Disequilibrium to Equilibrium 212 The Graphical Representation of the Three States of the Economy in the TE-TP Framework 213 The Economy in a Recessionary Gap and the Role

of Government 214 The Theme of the Simple Keynesian Model 216

10

c h a p t e r The Federal Budget and Fiscal Policy 221

The Federal Budget 222

Government Expenditures 222 Government Tax Revenues 223 Budget Deficit, Surplus,

or Balance 225 Structural and Cyclical Deficits 226 The Public Debt 226

Fiscal Policy 226

Some Relevant Fiscal Policy Terms 227 Two Important Notes 227

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Demand-Side Fiscal Policy 227

Shifting the Aggregate Demand Curve 227 Fiscal Policy: A Keynesian Perspective 228 Crowding Out: Questioning Expansionary Fiscal Policy 229 Lags and Fiscal Policy 232 Crowding Out, Lags, and the Effectiveness of Fiscal Policy 233

Supply-Side Fiscal Policy 233

Marginal Tax Rates and Aggregate Supply 233 The Laffer Curve: Tax Rates and Tax Revenues 234

f e a t u r e s

economics24/7

Two Plumbers, New Year’s

Eve, and Progressive Taxation

224 JFK and the 1964 Tax Cut

229 Star Wars: Episode III—

Revenge of the Sith

245 Economics on the Yellow

Brick Road 248 eBay and Match.com

250

11

c h a p t e r

Part 4 Money, the Economy, and Monetary Policy

Money and Banking 241

Money: What Is It and How Did It Come to Be? 242

Money: A Definition 242 Three Functions of Money 242 From a Barter to a Money

Leisure, and Output 244 What Gives Money Its Value? 245

Defining the Money Supply 246

How Banking Developed 249

The Early Bankers 249 The Federal Reserve System 249

The Money Creation Process 249

The Bank’s Reserves and More 250 The Banking System and the Money Expansion

Who Created What? 254 It Works in Reverse: The “Money Destruction” Process 255

We Change Our Example 256

12

c h a p t e r The Federal Reserve System 260

The Structure and Functions of the Fed 261

The Structure of the Fed 261 The Functions of the Fed 262

Fed Tools for Controlling the Money Supply 264

Open Market Operations 264 The Required Reserve Ratio 267 The Discount Rate 267

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f e a t u r e s

economics24/7

Some History of the Fed

262 Flying in with the Money

286

13

c h a p t e r Money and the Economy 272

Money and the Price Level 273

The Equation of Exchange 273 From the Equation of Exchange to the Simple Quantity Theory

of Money 274 The Simple Quantity Theory of Money in an AD-AS Framework 275 Dropping the Assumptions That V and Q Are Constant 277

Monetarism 278

Monetarist Views 278 Monetarism and AD-AS 279 The Monetarist View of the Economy 281

Inflation 281

One-Shot Inflation 282 Continued Inflation 284

Money and Interest Rates 287

What Economic Variables Are Affected by a Change in the Money Supply? 287 The Money Supply, the Loanable Funds Market, and Interest Rates 288 So What Happens to the Interest Rate as the Money Supply Changes? 292 The Nominal and Real Interest Rates 292

14

c h a p t e r Monetary Policy 298

The Money Market 299

The Demand for Money 299 The Supply of Money 300 Equilibrium in the Money Market 300

Nonactivist Monetary Proposals 312

The Fed and the Taylor Rule 313 Inflation Targeting 314

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Contents xvii

f e a t u r e s

economics24/7

If You’re So Smart, Then

Why Aren’t You Rich?

304 How Far Does Monetary

Policy Reach? Or Monetary

Policy and Blue Eyes

310 Asset-Price Inflation

(and the Townspeople with

Rational Expectations)

332

15

c h a p t e r

Part 5 Expectations and Growth

Expectations Theory and the Economy 319

Phillips Curve Analysis 320

The Phillips Curve 320 Samuelson and Solow: The Phillips Curve Is Americanized 320

The Controversy Begins: Are There Really Two Phillips Curves? 321

Things Aren’t Always as We Thought 321 Friedman and the Natural Rate Theory 321 How Do People Form Their Expectations? 324

Rational Expectations and New Classical Theory 326

Rational Expectations 326 Do People Anticipate Policy? 326 New Classical Theory: The Effects of Unanticipated and Anticipated Policy 327 Policy Ineffectiveness Proposition (PIP)

328 Rational Expectations and Incorrectly Anticipated Policy 329 How to Fall into a Recession Without Really Trying 330

New Keynesians and Rational Expectations 332Looking at Things from the Supply Side: Real Business Cycle Theorists 333

16

c h a p t e r Economic Growth 339

A Few Basics About Economic Growth 340

Do Economic Growth Rates Matter? 340 Growth Rates in Selected Countries 340 Two Types of Economic Growth 342 Economic Growth and the Price Level 343

What Causes Economic Growth? 344

Trade as Technology 346 Property Rights Structure 346 Economic Freedom 347 Policies to Promote Economic Growth 348 Economic Growth and Special Interest Groups 349

New Growth Theory 350

What Was Wrong with the Old Theory? Or What’s New with New Growth Theory? 350 Discovery, Ideas, and Institutions 352 Expanding Our Horizons 352

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f e a t u r e s

economics24/7

Growth and Morality

341 How Economizing on

Time Can Promote

Economic Growth

344 Religious Beliefs and

Economic Growth

347 Professors, Students,

and Ideas 351

f e a t u r e s

economics24/7

Drug Busts and Crime

365 Will High Taxes on Cigarettes

Reduce Smoking?

366 Why Do Companies

Hire Celebrities?

369 Are Children Substitutes

How to Approach the Study of Microeconomics 358

Elasticity: Part 1 359

Price Elasticity of Demand 359 Elasticity Is Not Slope 361 From Perfectly Elastic to Perfectly Inelastic Demand 361 Price Elasticity of Demand and Total Revenue (Total Expenditure) 363

Elasticity: Part 2 367

Price Elasticity of Demand Along a Straight-Line Demand Curve 367 Determinants of Price Elasticity of Demand 368

Other Elasticity Concepts 371

Cross Elasticity of Demand 371 Income Elasticity of Demand 373 Price Elasticity of Supply 373 Price Elasticity of Supply and Time 375

Consumer Equilibrium and Demand 385

Equating Marginal Utilities per Dollar 385 Maximizing Utility and the Law of Demand 386 Should the Government Provide the Necessities of Life for Free? 386

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Behavioral Economics 388

Are People Willing to Reduce Others’ Incomes? 388 Is $1 Always $1? 389 Coffee Mugs and the Endowment Effect 390 Does the Endowment Effect Hold Only for New Traders? 391

Appendix C: Budget Constraint and Indifference Curve Analysis 396

The Budget Constraint 396

Slope of the Budget Constraint 396 What Will Change the Budget Constraint? 397

Indifference Curves 397Constructing an Indifference Curve 398

Characteristics of Indifference Curves 398

The Indifference Map and the Budget Constraint Come Together 401From Indifference Curves to a Demand Curve 402

Appendix Summary 403Questions and Problems 404

for Good Weather

387

f e a t u r e s

economics24/7

Do Secretaries Who

Work for Investment Banks

Earn More Than Secretaries

Who Work for Hotels?

409 High School Students,

Staying Out Late, and More

417 What Matters to Global

c h a p t e r Production and Costs 405

Why Firms Exist 406

The Market and the Firm: Invisible Hand Versus Visible Hand 406 The Alchian and Demsetz

Outside and Inside the Firm 408

The Firm’s Objective: Maximizing Profit 408

Accounting Profit Versus Economic Profit 410 Zero Economic Profit Is Not as Bad as It Sounds 411

Production 411

Production in the Short Run 412 Marginal Physical Product and Marginal Cost 414 Average Productivity 416

Costs of Production: Total, Average, Marginal 417

The AVC and ATC Curves in Relation to the MC Curve 419 Tying Short-Run Production to

Production and Costs in the Long Run 426

Long-Run Average Total Cost Curve 426 Economies of Scale, Diseconomies of Scale, and

Scale? 428 Minimum Efficient Scale and Number of Firms in an Industry 428

Shifts in Cost Curves 429

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f e a t u r e s

economics24/7

Amazon: There May Not Be

Any Cappuccino, but There

Are Millions of Books

437

Do Churches Compete?

439 What Do Audrey Hepburn,

Lucille Ball, and Bugs Bunny

A Perfectly Competitive Firm Is a Price Taker 437 The Demand Curve for a Perfectly Competitive Firm Is Horizontal 438 The Marginal Revenue Curve of a Perfectly Competitive Firm Is the Same as Its Demand Curve 439 Theory and Real-World Markets 440

Perfect Competition in the Short Run 441

What Level of Output Does the Profit-Maximizing Firm Produce? 441 The Perfectly Competitive Firm and Resource Allocative Efficiency 442 To Produce or Not to Produce: That Is the Question 443 The Perfectly Competitive Firm’s Short-Run Supply Curve 445 From Firm to Market (Industry) Supply Curve 445 Why Is the Market Supply Curve Upward Sloping? 446

Perfect Competition in the Long Run 448

The Conditions of Long-Run Competitive Equilibrium 448 The Perfectly Competitive Firm and Productive Efficiency 449 Industry Adjustment to an Increase in Demand 449 What Happens as Firms Enter an Industry in Search of Profits? 452 Industry Adjustment to a Decrease in Demand 453 Differences in Costs, Differences in Profits: Now You See It, Now You Don’t 453 Profit and Discrimination 454

Topics for Analysis Within the Theory of Perfect Competition 455

Do Higher Costs Mean Higher Prices? 455 Will the Perfectly Competitive Firm Advertise?

455 Supplier-Set Price Versus Market-Determined Price: Collusion or Competition? 456

21

c h a p t e r Monopoly 461

The Theory of Monopoly 462

Barriers to Entry: A Key to Understanding Monopoly 462 What Is the Difference Between

a Government Monopoly and a Market Monopoly? 464

Monopoly Pricing and Output Decisions 464

The Monopolist’s Demand and Marginal Revenue 464 The Monopolist’s Demand and Marginal Revenue Curves Are Not the Same: Why Not? 465 Price and Output for a Profit-

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Maximizing Monopolist 466 If a Firm Maximizes Revenue, Does It Automatically Maximize Profit Too? 466

Perfect Competition and Monopoly 468

Price, Marginal Revenue, and Marginal Cost 468 Monopoly, Perfect Competition, and

The Case Against Monopoly 470

The Deadweight Loss of Monopoly 470 Rent Seeking 471 X-Inefficiency 472

Price Discrimination 472

Types of Price Discrimination 473 Why a Monopolist Wants to Price Discriminate 473 Conditions of Price Discrimination 473 Moving to P ⫽ MC Through Price Discrimination 474 You Can Have the Comics, Just Give Me the Coupons 475

f e a t u r e s

economics24/7

Monopoly and the

Boston Tea Party

463 Amazon and Price

Discrimination

475 Why Do District Attorneys

Plea-Bargain?

476

f e a t u r e s

economics24/7

How Is a New Year’s

Resolution Like a Cartel

c h a p t e r Monopolistic Competition, Oligopoly, and Game Theory 482

The Theory of Monopolistic Competition 483

The Monopolistic Competitor’s Demand Curve 483 The Relationship Between Price and Marginal Revenue for a Monopolistic Competitor 483 Output, Price, and Marginal Cost for the Monopolistic Competitor 483 Will There Be Profits in the Long Run? 484 Excess Capacity: What Is It, and Is It “Good” or “Bad”? 485 The Monopolistic Competitor and Two Types of Efficiency 487 Advertising and Designer Labels 487

Oligopoly: Assumptions and Real-World Behavior 487Price and Output Under Three Oligopoly Theories 488

The Cartel Theory 488 The Kinked Demand Curve Theory 491 The Price Leadership Theory 493

Game Theory, Oligopoly, and Contestable Markets 494

Prisoner’s Dilemma 495 Oligopoly Firms’ Cartels and the Prisoner’s Dilemma 497 Are Markets Contestable? 499

A Review of Market Structures 500Applications of Game Theory 500

as an Enforcement Mechanism 503

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and Expensive Mini-Bars

f e a t u r e s

economics24/7

Why Jobs Don’t Always Move

to the Low-Wage Country

538 How May Crime, Outsourcing,

and Multitasking Be Related?

542 What Is the Wage Rate

for a Street-Level Pusher

in a Drug Gang?

546

24

c h a p t e r

Part 8 Factor Markets and Related Isues

Factor Markets: With Emphasis on the Labor Market 531

Factor Markets 532

The Demand for a Factor 532 Marginal Revenue Product: Two Ways to Calculate It 532 The MRP Curve Is the Firm’s Factor Demand Curve 533 Value Marginal Product 534 An Important Question: Is MRP ⫽ VMP? 534 Marginal Factor Cost: The Firm’s Factor Supply Curve 534 How Many Units of a Factor Should a Firm Buy? 535 When There Is More Than One Factor, How Much of Each Factor Should the Firm Buy? 536

The Labor Market 537

Shifts in a Firm’s MRP, or Factor Demand, Curve 537 Market Demand for Labor 539 The Elasticity of Demand for Labor 540 Market Supply of Labor 541 An Individual’s Supply of Labor 543 Shifts in the Labor Supply Curve 543 Putting Supply and Demand Together

543 Why Do Wage Rates Differ? 544 Why Demand and Supply Differ in Different Labor Markets 545 Why Did You Choose the Major That You Chose? 546 Marginal Productivity Theory 547

Labor Markets and Information 548

Screening Potential Employees 548 Promoting from Within 549 Is It Discrimination

or Is It an Information Problem? 549

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Contents xxiii

f e a t u r e s

economics24/7

Technology, the Price of

Competing Factors, and

Displaced Workers

561 What Are College

Professors’ Objectives?

562

“Are You Ready

for Some Football?”

567

25

c h a p t e r Wages, Unions, and Labor 554

The Facts and Figures of Labor Unions 555

Types of Unions 555 Union Membership: The United States and Abroad 555

Objectives of Labor Unions 555

Employment for All Members 556 Maximizing the Total Wage Bill 556 Maximizing Income for a Limited Number of Union Members 556 Wage-Employment Tradeoff 556

Practices of Labor Unions 558

Affecting Elasticity of Demand for Union Labor 558 Affecting the Demand for Union Labor 558 Affecting the Supply of Union Labor 559 Affecting Wages Directly:

Collective Bargaining 559 Strikes 560

Effects of Labor Unions 561

The Case of Monopsony 561 Unions’ Effects on Wages 565 Unions’ Effects on Prices

566 Unions’ Effects on Productivity and Efficiency: Two Views 566

f e a t u r e s

economics24/7

Winner-Take-All Markets

580 Monks, Blessings,

and Free Riders

588

26

c h a p t e r The Distribution of Income and Poverty 572

Some Facts About Income Distribution 573

Who Are the Rich and How Rich Are They? 573 The Effect of Age on the Income Distribution 575 A Simple Equation 575

Measuring Income Equality 576

The Lorenz Curve 576 The Gini Coefficient 577 A Limitation of the Gini Coefficient 578

Why Income Inequality Exists 579

Factors Contributing to Income Inequality 579 Income Differences: Some Are Voluntary, Some Are Not 582

Normative Standards of Income Distribution 583

The Marginal Productivity Normative Standard 583 The Absolute Income Equality Normative

Poverty 586

What Is Poverty? 586 Limitations of the Official Poverty Income Statistics 587 Who Are the Poor? 587 What Is the Justification for Government Redistributing Income? 587

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f e a t u r e s

economics24/7

Is the Car Worth Buying?

597 Loans for the Poorest

of the Poor 600 Insuring Oneself Against

Terrorism 605

Rent 599

David Ricardo, the Price of Grain, and Land Rent 599 The Supply Curve of Land Can Be Upward Sloping 599 Economic Rent and Other Factors of Production 600 Economic Rent and Baseball Players: The Perspective from Which the Factor Is Viewed Matters 601 Competing for Artificial and Real Rents 601 Do People Overestimate Their Worth to Others,

or Are They Simply Seeking Economic Rent? 602

Profit 602

Theories of Profit 602 What Is Entrepreneurship? 603 What Do a Microwave Oven and

an Errand Runner Have in Common? 604 Profit and Loss as Signals 605

f e a t u r e s

economics24/7

Software, Switching

Costs and Benefits,

and Market Failure

613 Telemarketers and Efficiency

620 The Right Quantity and

Quality of a Nonexcludable

Public Good

626 Finding Economics

in College Life

630

28

c h a p t e r

Part 9 Market Failure and Public Choice

Market Failure: Externalities, Public Goods, and Asymmetric Information 609

Market Failure 610Externalities 610

Costs and Benefits of Activities 610 Marginal Costs and Benefits of Activities 611 Social Optimality, or Efficiency, Conditions 611 Three Categories of Activities 611 Externalities in Consumption and in Production 612 Diagram of a Negative Externality 612 Diagram of a Positive Externality 614

Internalizing Externalities 616

Persuasion 616 Taxes and Subsidies 617 Assigning Property Rights 617 Voluntary Agreements 618 Combining Property Rights Assignments and Voluntary Agreements 618 Beyond Internalizing: Setting Regulations 620

Dealing with a Negative Externality in the Environment 621

Is No Pollution Worse Than Some Pollution? 621 Two Methods to Reduce Air Pollution 622

Public Goods: Excludable and Nonexcludable 624

Asymmetric Information 626

Asymmetric Information in a Product Market 627 Asymmetric Information in a Factor

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f e a t u r e s

economics24/7

Simple Majority Voting Rule:

The Case of the Statue

in the Public Square

640 Are You Rationally Ignorant?

642 Inheritance, Heirs,

and Why the Firstborn

Became King or Queen

648

29

c h a p t e r Public Choice: Economic Theory Applied to Politics 636

Public Choice Theory 637The Political Market 637

Moving Toward the Middle: The Median Voter Model 637 What Does the Theory Predict? 638

Voters and Rational Ignorance 641

The Costs and Benefits of Voting 641 Rational Ignorance 642

More About Voting 643

Example 1: Voting for a Nonexcludable Public Good 643 Example 2: Voting and Efficiency 644

Special Interest Groups 645

Information and Lobbying Efforts 646 Congressional Districts as Special Interest Groups 646 Public Interest Talk, Special Interest Legislation 647 Special Interest Groups and Rent Seeking 647

Government Bureaucracy 650

A View of Government 651

International Trade Theory 658

Comparative Advantage? 660

Trade Restrictions 662

The Distributional Effects of International Trade 662 Consumers’ and Producers’ Surplus 662 The Benefits and Costs of Trade Restrictions 663 If Free Trade Results in Net Gain, Why Do Nations Sometimes Restrict Trade? 666

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The World Trade Organization (WTO) 669

f e a t u r e s

economics24/7

Dividing Up the Work

661 Offshore Outsourcing, or

Offshoring 667

f e a t u r e s

economics24/7

The Nobel Prize in

Economics and Foreign

Exchange Markets

683 Back to the Futures

685 Big Macs and Exchange Rates

691

31

c h a p t e r International Finance 674

The Balance of Payments 675

Current Account 676 Capital Account 679 Official Reserve Account 679 Statistical Discrepancy 679 What the Balance of Payments Equals 680

The Foreign Exchange Market 680

The Demand for Goods 681 The Demand for and Supply of Currencies 681

Flexible Exchange Rates 683

The Equilibrium Exchange Rate 683 Changes in the Equilibrium Exchange Rate 684 Factors That Affect the Equilibrium Exchange Rate 684

Fixed Exchange Rates 687

Fixed Exchange Rates and Overvalued/Undervalued Currency 688 What Is So Bad About

an Overvalued Dollar? 689 Government Involvement in a Fixed Exchange Rate System 690 Options Under a Fixed Exchange Rate System 690 The Gold Standard 692

Fixed Exchange Rates Versus Flexible Exchange Rates 694

Promoting International Trade 694 Optimal Currency Areas 695

The Current International Monetary System 696

32

c h a p t e r Globalization 702

What Is Globalization? 703

Two Ways to “See” Globalization 704

No Barriers 704 A Union of States 704

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Globalization Facts 704

International Trade 705 Foreign Exchange Trading 705 Foreign Direct Investment 705 Personal Investments 707 The World Trade Organization 707 Business Practices 707

Movement Toward Globalization 707

Benefits and Costs of Globalization 710

The Continuing Globalization Debate 713More or Less Globalization: A Tug of War? 714

Less Globalization 714 More Globalization 715

A Reader Asks 716Analyzing the Scene 716Chapter Summary 717Key Terms and Concepts 717Questions and Problems 718

the Sound of Music?

709 Should You Leave a Tip?

712

f e a t u r e s

economics24/7

Is There Genius When It

Comes to Picking Stocks?

721 Are Some Economists

P RACTICAL ECONOM ICS

Part 11 Financial Matters

Stocks, Bonds, Futures, and Options 719

Financial Markets 720Stocks 720

Where Are Stocks Bought and Sold? 720 The Dow Jones Industrial Average (DJIA) 722

Sell Stock 726 Buying Stocks or Buying the Market 726 How to Read the Stock Market Page 728

Bonds 730

The Components of a Bond 730 Bond Ratings 730 Bond Prices and Yields (or Interest

Return 733

Futures and Options 734

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Part 12 Web Chapters

Agriculture: Farmers’ Problems, Government Policies, and Unintended Effects 741

Agriculture: The Issues 742

A Few Facts 742 Agriculture and Income Inelasticity 743 Agriculture and Price Inelasticity 743 Price Variability and Futures Contracts 744 Can Bad Weather Be Good for Farmers? 745

f e a t u r e s

economics24/7

Proper Business Etiquette

Around the World

762

35

c h a p t e r International Impacts on the Economy 753

International Factors and Aggregate Demand 754

International Factors and Aggregate Supply 756

Foreign Input Prices 756 Why Do Foreign Input Prices Change? 757

Factors That Affect Both Aggregate Demand and Aggregate Supply 757

The Exchange Rate 757 What Role Do Interest Rates Play? 758

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Deficits: International Effects and Domestic Feedback 759

The Budget Deficit and Expansionary Fiscal Policy 759 The Budget Deficit and

Contractionary Fiscal Policy 760 The Effects of Monetary Policy 761

A Reader Asks 763

Analyzing the Scene 764

Chapter Summary 764

Key Terms and Concepts 765

Questions and Problems 765

Working with Numbers and Graphs 766

Self-Test Appendix 741

Glossary 765

Index 777

Contents xxix

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Arnold continues to set the standard for clear, balanced, and thorough coverage of principles of economics thattruly engages students.With four new chapters, easy customization, and fully integrated digital and course man-

agement options, Economics, 8e is the perfect solution for your classroom Packed with intriguing pop culture

examples to which students relate, the text bolsters student interest in economics by describing the pected places economics occurs, illustrating how economic forces link events around the world to their lives,and demonstrating how economics can be used as a tool in understanding the world In addition, the eighthedition is integrated with such powerful resources as ThomsonNOW™, Aplia™, and the Tomlinson Videos

unex-NEWMacro & Micro Themes: A new organizing feature in the 8th edition is the use ofMacro and Micro themes to help students understand the big questions that macro-and microeconomists seek to answer Framing the content through these major themeshelps readers to see how the themes and policies are interconnected Macroeconomics

is organized into understanding price level and GDP, economics stability vs instability, andpolicy efficacy Microeconomics themes are objectives of the individual or firm, con-straints on the individual or firm, and choices made given the objectives and constraints

NEW Chapters: Arnold continues to set the standard for clear, current, and topicaleconomic coverage All-new chapters on globalization and financial markets cover twoareas of increasing importance to readers as they try to understand the implications

of news stories they hear and see on these issues In addition, innovative online ters cover agriculture and international impacts of macroeconomics, giving instructors flex-ibility in tailoring courses to topics they want to cover

chap-Economics 24/7: Illustrating the practical relevance of economic concepts, this ing feature explores anything and everything that can be better explained through eco-

intrigu-nomic analysis For example, why is Fox’s series 24 so suspenseful? Why are airlines so

often overbooked? How does supply and demand work on the highway? Economics24/7 trains readers to look for economic forces at work everywhere around them—and understand the principles behind them

ThomsonNOW™ Teaching Tools: Part of the text’s fully integrated course managementsystem, this time-saving suite of online tools offers unrivaled course planning andmanagement tools, enabling instructors to pinpoint how well students master key con-cepts Instructors can assign personalized study plans (a pre- and post-assessment ofstudent knowledge with resources to reinforce concepts), view results in their gradebook,and then gear lectures around student needs With its proven ease of use and efficientpaths to success, it delivers the results instructors want—NOW ThomsonNOW™ can

be integrated with WebCT®and Blackboard®

xxx

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Personalizing Your Economics, 8e… with Custom and Tomlinson

Thomson Custom Solutions develops personalized solutions to meetyour economics education needs Match your learning materials toyour syllabus and create the perfect learning solution Consider thefollowing when looking at your customization options for any Thomson Economics texts:

• Remove chapters you do not cover, or rearrange theirorder to create a streamlined and efficient text that stu-dents will appreciate

• Add your own material to cover new topics or tion, saving you time and providing students a fully inte-grated course resource

informa-• Include contemporary economic issues from ourEconomic Issues Collection, found on our custom web-site Many of these issues are brief and applied, ideallysuited for the introductory Principles of Economicscourse

Thomson Custom Solutions offers the fastest and easiest way

to create unique customized learning materials delivered theway you want Our custom solutions also include: accessing on-demand cases from

leading business case providers such as Harvard Business School Publishing, Ivey, Darden

and NACRA, building a tailored text online withwww.textchoice2.com, and publishing

your original materials For more information about custom publishing options, visit

www.thomsoncustom.comor contact your local Thomson representative

Thomson South-Western isexcited to announce threenew video lecture productsfeaturing award-winning teacher and professional communicator Steven Tomlinson

(Ph.D, Stanford) These new web-based lecture videos—

Economics with Steven Tomlinson, Economic JumpStart ® , and

Economic LearningPath ®—are sure to engage your students, while

reinforcing the economic concepts they need to know

Visit www.thomsonedu.com/economics for more details

about this new video series!

Preface xxxi

Custom

Tomlinson Economics Videos

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xxxii

ThomsonNOW™ is the most reliable, flexible, andeasy-to-use online suite of services and resources.ThomsonNOW™for Economics, 8e takes the best of current technology tools including

online homework management; a fully customizable test bank; and course support rials such as online quizzing, videos, and tutorials to support your course goals and saveyou significant preparation and grading time!

mate-This powerful, fully integrated online teaching andlearning system provides you with the ultimate inflexibility, ease of use, and efficient paths to success

to deliver the results you want—NOW!

• Plan student assignments with easy onlinehomework management

• Manage your grade book with ease

• Teach today’s student using valuable coursesupport materials

• Reinforce student comprehension with personalized learning paths

• Test with a customizable test bank

• Grade automatically for seamless, immediate results

Find Out More!

We are confident that you will find that ThomsonNOW™ for Economics is themost reliable, easy-to-use, online suite of services and resources ever developed Formore information, visit www.thomsonedu.com/thomsonnow or contact your localThomson South-Western representative today!

ThomsonNOW

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Preface xxxiii

Thomson is proud to continue our partnership with Aplia™ Inc.!

Created by Paul Romer, one of the nation’s leading economists, Apliaenhances teaching and learning by providing online interactive toolsand experiments that help economics students become

“active learners.” Our partnership allows a tight content

correlation between Economics, 8e and Aplia’s online tools.

Students Come to Class Prepared

It is a proven fact that students do better in their course

work if they come to class prepared Aplia’s activities are

engaging and based on discovery learning, requiring

students to take an active role in the learning process

When assigned online homework, students are more apt to read the text, come to class

better prepared to participate in discussions, and are more able to relate to the economic

concepts and theories presented

Learning by doing helps studentsfeel involved, gain confidence inthe materials, and see importantconcepts come to life

Assign Homework in an Effective and Efficient WayNow you can assign homeworkwithout increasing your workload!

Together, Economics and Aplia

provide the best text and ogy resources to give you multi-ple teaching and learning solu-tions Through Aplia, you canassign problem sets and online activities that automatically give feedback and are tracked

technol-and graded, all without requiring additional effort Since Aplia’s assignments are closely

integrated with Economics, 8e, your students are applying what they have learned from

the text to their homework

Contact your local Thomson South-Western Representative to find out how you can

incorporate this exciting technology into your course.www.aplia.com/thomson

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First Edition Reviewers

East Texas Baptist University

This book could not have been written and published without the generous expert assistance of many people.Adeep debt of gratitude is owed to the reviewers of the first through seventh editions and to the reviewers of thisedition, the eighth

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Second Edition Reviewers

Kansas State University

Charles Van Eaton

Hillsdale College

Mark Wheeler

Bowling Green State University

Thomas Wyrick

Southwest Missouri State University

Third Edition ReviewersCarlos Aguilar

University of Texas, El Paso

Rebecca Ann Benakis

New Mexico State University

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University of Hawaii at Manoa

Fourth Edition Reviewers

University of North Texas

Mary Ann Hendryson

Western Washington University

Southwest Missouri State University

Fifth Edition ReviewersKari Battaglia

University of North Texas

The University of Vermont

Mary Ann Hendryson

Western Washington University

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Sixth Edition Reviewers

Hendrikus J.E.M Brand

Lee Van Scyoc

University of Wisconsin, Oshkosh

Seventh Edition Reviewers

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