Ebook Economics (9th edition): Part 1 - Roger A. Arnold

(BQ) Part 1 book Economics has contents: What economics is about; economic activities - producing and trading; supply and demand - theory; supply and demand - applications; macroeconomic measurements, part i - prices and unemployment; the federal reserve system; money and the economy; money and the economy,...and other contents:

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To Sheila, Daniel, and David

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May we suggest one of these titles?

Teaching an economics course other than Principles?

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Brief Contents

v

Preface xxv

An Introduction to Economics

Chapter 1 What Economics Is About 1

Appendix A Working with Diagrams 19

Appendix B Should You Major in Economics? 27

Chapter 2 Economic Activities: Producing and Trading 33

Chapter 3 Supply and Demand: Theory 53

Chapter 4 Supply and Demand: Applications 91

Macroeconomics

Chapter 5 Macroeconomic Measurements, Part I: Prices and

Unemployment 113

Chapter 6 Macroeconomic Measurements, Part II: GDP and Real

GDP 133

and Fiscal Policy

Chapter 7 Aggregate Demand and Aggregate Supply 156

Chapter 8 The Self-Regulating Economy 184

Chapter 9 Economic Instability: A Critique of the Self-Regulating

Economy 203

Chapter 10 Fiscal Policy and the Federal Budget 229

Chapter 11 Money and Banking 250

Chapter 12 The Federal Reserve System 270

Chapter 13 Money and the Economy 284

Chapter 14 Monetary Policy 311

Chapter 15 Expectations Theory and the Economy 333

Chapter 16 Economic Growth 354

Chapter 20 Perfect Competition 458 Chapter 21 Monopoly 485

Chapter 22 Monopolistic Competition, Oligopoly, and Game

Theory 508 Chapter 23 Government and Product Markets: Antitrust and

Regulation 534

Chapter 24 Factor Markets: With Emphasis on the Labor

Market 557 Chapter 25 Wages, Unions, and Labor 582 Chapter 26 The Distribution of Income and Poverty 601 Chapter 27 Interest, Rent, and Profit 623

Chapter 28 Market Failure: Externalities, Public Goods, and

Asymmetric Information 642 Chapter 29 Public Choice: Economic Theory Applied to

Politics 668

The Global Economy

Chapter 30 International Trade 689 Chapter 31 International Finance 708 Chapter 32 Globalization and International Impacts on the

Economy 737

Practical Economics

Chapter 33 Stocks, Bonds, Futures, and Options 765

Web Chapter

Chapter 34 Agriculture: Problems, Policies, and Unintended

Effects 786

Self-Test Appendix 786 Glossary 806

Index 816

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vii

Preface xxv

A n I n t r o d u c t i o n t o E c o n o m i c s

Part  Economics: The Science of Scarcity

CHAPTER  WHAT ECONOMICS IS ABOUT 1

A Definition of Economics 1

Goods and Bads 1 Resources 2 Scarcity and a Definition of Economics 2

Key Concepts in Economics 5

Opportunity Cost 5 Opportunity Cost and Behavior 6 Benefits and Costs 7 Decisions Made at the Margin 8 Efficiency 8 Unintended Effects 10 Exchange 11

Economic Categories 13

Positive and Normative Economics 13 Microeconomics and Macroeconomics 14

A Reader Asks 16 Chapter Summary 16 Key Terms and Concepts 17 Questions and Problems 17

APPENDIX A: WORKING WITH DIAGRAMS 19

Two-Variable Diagrams 19 Slope of a Line 20

Slope of a Line Is Constant 22 Slope of a Curve 22

The 45-Degree Line 22 Pie Charts 23

Bar Graphs 23 Line Graphs 24 Appendix Summary 26 Questions and Problems 26

APPENDIX B: SHOULD YOU MAJOR IN ECONOMICS? 27

Five Myths About Economics and an Economics Major 28

Myth 1: Economics Is All Mathematics and Statistics 28 Myth 2: Economics Is Only About Inflation, Interest Rates, Unemployment, and Other Such Things 28 Myth 3: People Become

“I Don’t Believe That

Every Time a Person Does

Something, He Compares

the Marginal Benefits

and Costs”

15

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Economists Only if They Want to “Make Money” 29 Myth 4: Economics Wasn’t Very Interesting in High School, So It’s Not Going to Be Very Interesting in College 30 Myth 5: Economics Is a Lot Like Business, But Business Is More Marketable 30

What Awaits You as an Economics Major? 30 What Do Economists Do? 31

Places to Find More Information 32 Concluding Remarks 32

CHAPTER  ECONOMIC ACTIVITIES: PRODUCING AND TRADING 33

The Production Possibilities Frontier 33

The Straight-Line PPF: Constant Opportunity Costs 33 The Bowed-Outward Downward) PPF: Increasing Opportunity Costs 34 Law of Increasing Opportunity Costs 36 Economic Concepts Within a PPF Framework 37

(Concave-Exchange or Trade 39

Periods Relevant to Trade 39 Trade and the Terms of Trade 41 Costs of Trades 42 Trades and Third-Party Effects 44

Production, Trade, and Specialization 44

Producing and Trading 44 Profit and a Lower Cost of Living 47 A Benevolent and Knowing Dictator Versus the Invisible Hand 48

All-A Reader All-Asks 50 Chapter Summary 50 Key Terms and Concepts 51 Questions and Problems 51 Working with Numbers and Graphs 52

CHAPTER  SUPPLY AND DEMAND: THEORY 53

A Note About Theories 53 What Is Demand? 54

The Law of Demand 54 What Does Ceteris Paribus Mean? 55 Four Ways to Represent

the Law of Demand 56 Two Prices: Absolute and Relative 56 Why Does Quantity Demanded Go Down as Price Goes Up? 57 Individual Demand Curve and Market Demand Curve 58 A Change in Quantity Demanded Versus a Change in Demand 59 What Factors Cause the Demand Curve to Shift? 62 Movement Factors and Shift Factors 65

Supply 66

The Law of Supply 66 Why Most Supply Curves Are Upward Sloping 67 Changes

in Supply Mean Shifts in Supply Curves 68 What Factors Cause the Supply Curve to Shift? 69 A Change in Supply Versus a Change in Quantity Supplied 70

The Market: Putting Supply and Demand Together 71

Supply and Demand at Work at an Auction 71 The Language of Supply and Demand: A Few Important Terms 72 Moving to Equilibrium: What Happens to Price when There Is

a Surplus or a Shortage? 72 Speed of Moving to Equilibrium 74 Moving to Equilibrium: Maximum and Minimum Prices 75 Equilibrium in Terms of Consumers’ and Producers’ Surplus 76 What Can Change Equilibrium Price and Quantity? 78

Demand and Supply as Equations 81 Price Controls 82

Price Ceiling: Definition and Effects 82 Price Floor: Definition and Effects 85

A Reader Asks 87 Chapter Summary 87 Key Terms and Concepts 88

“I Thought Prices Equaled

Costs Plus 10 Percent”

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Questions and Problems 88 Working with Numbers and Graphs 90

CHAPTER  SUPPLY AND DEMAND: APPLICATIONS 91

Application 1: Why Is Medical Care So Expensive? 91 Application 2: Where Will House Prices Change the Most? 94 Application 3: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes of

Admission? 95 Application 4: Supply and Demand on a Freeway 96 Application 5: Price Ceilings in the Kidney Market 97 Application 6: The Minimum Wage Law 99

Application 7: Price Floors and Winners and Losers 101 Application 8: Are Renters Better Off? 102

Application 9: Do You Pay for Good Weather? 104 Application 10: College Superathletes 105

Application 11: 10 a.m Classes in College 107 Application 12: What will Happen to the Price of Marijuana if the Purchase and Sale

of Marijuana Are Legalized? 108

A Reader Asks 110 Chapter Summary 110 Key Terms and Concepts 111 Questions and Problems 111 Working with Numbers and Graphs 112

M a c r o e c o n o m i c s

Part  Macroeconomic Fundamentals

CHAPTER  MACROECONOMIC MEASUREMENTS, PART I: PRICES AND

UNEMPLOYMENT 113

How to Approach the Study of Macroeconomics 113

Macroeconomic Problems 113 Macroeconomic Theories 114 Macroeconomic Policies 115 Different Views of How the Economy Works 115

Three Macroeconomic Organizational Categories 115 Macroeconomic Measures 117

Measuring Prices Using the CPI 117 Inflation and the CPI 119 The Substitution Bias in Fixed-Weighted Measures 121 GDP Implicit Price Deflator 122 Converting Dollars from One Year to Another 122

Measuring Unemployment 124

Who Are the Unemployed? 124 The Unemployment and Employment Rates 125 Reasons for Unemployment 126 Discouraged Workers 126 Types of Unemployment 127 Cyclical Unemployment 128

O F F I C E H O U R S

“Doesn’t High Demand

Mean High Quantity

“Is There More Than One

Reason the Unemployment

Rate Will Fall?”

129

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CHAPTER  MACROECONOMIC MEASUREMENTS, PART II: GDP

AND REAL GDP 133

Gross Domestic Product 133

Three Ways to Compute GDP 133 What GDP Omits 136 GDP Is Not Adjusted for Bads Generated in the Production of Goods 137 Per Capita GDP 137 Is Either GDP or Per Capita GDP a Measure of Happiness or Well-Being? 137

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

Expenditures in a Real-World Economy 138 Computing GDP Using the Expenditure Approach 140

The Income Approach to Computing GDP for a Real-World Economy 142

Computing National Income 143 From National Income to GDP: Making Some Adjustments 144

Other National Income Accounting Measurements 146

Net Domestic Product 147 Personal Income 147 Disposable Income 147

Real GDP 148

Why We Need Real GDP 148 Computing Real GDP 148 The General Equation for Real GDP 149 What Does It Mean if Real GDP Is Higher in One Year Than in Another Year? 149 Real GDP, Economic Growth, and Business Cycles 149

Part  Macroeconomic Stability, Instability, and

Fiscal Policy

CHAPTER  AGGREGATE DEMAND AND AGGREGATE SUPPLY 156

The Two Sides to an Economy 156 Aggregate Demand 156

Why Does the Aggregate Demand Curve Slope Downward? 157 A Change in the Quantity Demanded of Real GDP Versus a Change in Aggregate Demand 160 Changes in Aggregate

Demand: Shifts in the AD Curve 161 How Spending Components Affect Aggregate

Demand 161 Factors That Can Change C, I, G, and NX (EX – IM) and Therefore Can

Change AD 162 Can a Change in the Money Supply Change Aggregate Demand? 167

Short-Run Aggregate Supply 167

Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping 167 What Puts the “Short Run” in SRAS? 169 Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve 169 Something More to Come: People’s Expectations 170

Putting AD and SRAS Together: Short-Run Equilibrium 172

How Run Equilibrium in the Economy Is Achieved 172 Thinking in Terms of Run Equilibrium Changes in the Economy 173 An Important Exhibit 175

Short-Long-Run Aggregate Supply 176

Going from the Short Run to the Long Run 176 Short-Run Equilibrium, Long-Run Equilibrium, and Disequilibrium 177 Something More to Come: Shifts in the LRAS

Reality Can Be Messy, and

Correct Predictions Can Be

Difficult to Make

177

“What Purpose Does the

AD-AS Framework Serve?”

179

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CHAPTER  THE SELF-REGULATING ECONOMY 184

The Classical View 184

Classical Economists and Say’s Law 184 Classical Economists and Interest Rate Flexibility 185 Classical Economists on Prices and Wages 187

Three States of the Economy 187

Real GDP and Natural Real GDP: Three Possibilities 187 The Labor Market and the Three States of the Economy 189

The Self-Regulating Economy 192

What Happens if the Economy Is in a Recessionary Gap? 193 What Happens if the Economy

Is in an Inflationary Gap? 194 The Self-Regulating Economy: A Recap 195 Policy Implication of Believing the Economy Is Self-Regulating 196 Changes in a Self-Regulating Economy: Short Run and Long Run 196

CHAPTER  ECONOMIC INSTABILITY: A CRITIQUE OF THE

SELF-REGULATING ECONOMY 203

Questioning the Classical Position 203

Keynes’s Criticism of Say’s Law in a Money Economy 204 Keynes on Wage Rates 205 New Keynesians and Wage Rates 206 Keynes on Prices 206 Is It a Question of the Time It Takes for Wages and Prices to Adjust? 207

The Simple Keynesian Model 208

Assumptions 208 The Consumption Function 208 Consumption and Saving 211 The Multiplier 212 The Multiplier and Reality 213

The Simple Keynesian Model in the AD-AS Framework 215

Shifts in the Aggregate Demand Curve 215 The Keynesian Aggregate Supply Curve 215 The Economy in a Recessionary Gap 216 Government’s Role in the Economy 217 The Theme of the Simple Keynesian Model 218

The Simple Keynesian Model in the TE-TP Framework 218

Deriving a Total Expenditures (TE ) Curve 218 What Will Shift the TE

Curve? 220 Comparing Total Expenditures (TE) and Total Production (TP) 220 Moving

from Disequilibrium to Equilibrium 221 The Graphical Representation of the Three States

of the Economy in the TE-TP Framework 221 The Economy in a Recessionary Gap and the

Role of Government 223 The Theme of the Simple Keynesian Model 223

E C O N O M I C S 2 4 / 7

Natural Disasters and the

Economy

194

The Story Behind the

Curves on the Blackboard

198

“Do Economists Really

Know What the Natural

“Does a Lot Depend

on Whether Wages Are

Flexible or Inflexible?”

225

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CHAPTER  FISCAL POLICY AND THE FEDERAL BUDGET 229

The Federal Budget 229

Government Expenditures 229 Government Tax Revenues 230 Budget Deficit, Surplus, or Balance 233 Structural and Cyclical Deficits 233 The Public Debt 233

Fiscal Policy 235

Some Relevant Fiscal Policy Terms 235 Two Important Notes 235

Demand-Side Fiscal Policy 236

Shifting the Aggregate Demand Curve 236 Fiscal Policy: Keynesian Perspective (Economy Is Not Self-Regulating) 236 Crowding Out: Questioning Expansionary Fiscal Policy 238 Lags and Fiscal Policy 241 Crowding Out, Lags, and the Effectiveness of Fiscal Policy 242

Supply-Side Fiscal Policy 242

Marginal Tax Rates and Aggregate Supply 243 The Laffer Curve: Tax Rates and Tax Revenues 243

Part  Money, the Economy, and Monetary Policy

CHAPTER  MONEY AND BANKING 250

Money: What Is It and How Did It Come to Be? 250

Money: A Definition 250 Three Functions of Money 251 From a Barter to a Money Economy: The Origins of Money 251 Money, Leisure, and Output 253

Defining the Money Supply 254

M1 254 M2 256 Where Do Credit Cards Fit in? 257

How Banking Developed 257

The Early Bankers 257 The Federal Reserve System 258

The Money Creation Process 258

The Bank’s Reserves and More 258 The Banking System and the Money Expansion Process 259 Why Maximum? Answer: No Cash Leakages and Zero Excess

Reserves 262 Who Created What? 263 It Works in Reverse: The Money Destruction Process 264 We Change Our Example 265

E C O N O M I C S 2 4 / 7

Two Plumbers, New

Year’s Eve, and Progressive

Movie Crowding Out: The

Case of The Dark Knight

“Can Something I Do End

Up Changing the Money

Supply?”

266

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CHAPTER  THE FEDERAL RESERVE SYSTEM 270

The Structure and Functions of the Federal Reserve System (the Fed) 270

The Structure of the Fed 270 Functions of the Fed 271

Fed Tools for Controlling the Money Supply 274

Open Market Operations 274 The Required Reserve Ratio 276 The Discount Rate 278 Term Auction Facility (TAF) Program: One More Monetary Tool 278

CHAPTER  MONEY AND THE ECONOMY 284

Money and the Price Level 284

The Equation of Exchange 284 From the Equation of Exchange to the Simple Quantity Theory of Money 285 The Simple Quantity Theory of Money in an AD-AS

Framework 288 Dropping the Assumptions That V and Q Are Constant 289

Monetarism 290

Monetarist Views 290 Monetarism and AD-AS 291 The Monetarist View of the

Economy 293

Inflation 294

One-Shot Inflation 294 Continued Inflation 298

Money and Interest Rates 301

What Economic Variables Are Affected by a Change in the Money Supply? 301 The Money Supply, the Loanable Funds Market, and Interest Rates 302 What Happens to the Interest Rate as the Money Supply Changes? 305 The Nominal and Real Interest Rates 306

“In the Press Talk Is About

Interest Rates, Not the

Money Supply”

280

E C O N O M I C S 2 4 / 7

The California Gold Rush,

or Really Expensive Apples

“Do Changes in the Money

Supply Affect Real GDP?”

307

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CHAPTER  MONETARY POLICY 311

The Money Market 311

The Demand for Money 311 The Supply of Money 312 Equilibrium in the Money Market 312

Nonactivist Monetary Proposals 326

Constant-Money-Growth-Rate Rule 326 Predetermined-Money-Growth-Rate Rule 326 The Fed and the Taylor Rule 327 Inflation Targeting 328

Part  Expectations and Growth

CHAPTER  EXPECTATIONS THEORY AND THE ECONOMY 333

Phillips Curve Analysis 333

The Phillips Curve 333 Samuelson and Solow: The Americanization of the Phillips Curve 334

The Controversy Begins: Are There Really Two Phillips Curves? 334

Things Aren’t Always as We Thought 334 Friedman and the Natural Rate Theory 335 How Do People Form Their Expectations? 338

Rational Expectations and New Classical Theory 339

Rational Expectations 340 Do People Really Anticipate Policy? 340 New Classical Theory: The Effects of Unanticipated and Anticipated Policy 341 Policy Ineffectiveness Proposition (PIP) 342 Rational Expectations and Incorrectly Anticipated Policy 343 How to Fall into a Recession Without Really Trying 345

New Keynesians and Rational Expectations 347 Looking at Things from the Supply Side: Real Business Cycle Theorists 348

E C O N O M I C S 2 4 / 7

Rational Expectations in

the College Classroom

344

Rational Expectations and

the Boy Who Cried Wolf

346

“Does New Classical

Theory Call the Effects of

Fiscal and Monetary Policy

into Question?”

350

E C O N O M I C S 2 4 / 7

If You’re So Smart, Then

Why Aren’t You Rich?

318

Who Gets the Money First

and What Happens to

“Does Monetary Policy

Always Have the Same

Effects?”

329

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CHAPTER  ECONOMIC GROWTH 354

A Few Basics About Economic Growth 354

Do Economic Growth Rates Matter? 355 Growth Rates in Selected Countries 355 Two Types of Economic Growth 357 Economic Growth and the Price Level 359

What Causes Economic Growth? 359

Natural Resources 359 Labor 360 Capital 360 Technological Advances 360 Free Trade as Technology 361 Property Rights Structure 361 Economic Freedom 362 Policies

to Promote Economic Growth 363 Economic Growth and Special Interest Groups 365 Worries over Economic Growth 366

New Growth Theory 367

What’s New About New Growth Theory? 367 Discovery, Ideas, and Institutions 368 Expanding Our Horizons 368

Shifts in Three Curves at Once: AD, SRAS, and LRAS 369

M i c r o e c o n o m i c s

Part  Microeconomic Fundamentals

CHAPTER  ELASTICITY 375

How to Approach the Study of Microeconomics 375

Consumers 376 Firms 376 Factor Owners 376 The Choices Made in Market Settings 376 Recap 377

Elasticity: Part 1 377

Price Elasticity of Demand 377 Elasticity Is Not Slope 378 From Perfectly Elastic

to Perfectly Inelastic Demand 379 Price Elasticity of Demand and Total Revenue (Total Expenditure) 381

Elasticity: Part 2 385

Price Elasticity of Demand Along a Straight-Line Demand Curve 385 Determinants of Price Elasticity of Demand 386

Other Elasticity Concepts 388

Cross Elasticity of Demand 389 Income Elasticity of Demand 389 Price Elasticity of Supply 392 Price Elasticity of Supply and Time 393

The Relationship Between Taxes and Elasticity 394

Who Pays the Tax? 394 Elasticity and the Tax 395 Degree of Elasticity and Tax Revenue 396

E C O N O M I C S 2 4 / 7

How Economizing on Time

Can Promote Economic

“What Is the Difference

Between Business Cycle

Will High Taxes on

Cigarettes Reduce Smoking?

“What Is the Relationship

Between Different Price

Elasticities of Demand and

Total Revenue?”

398

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CHAPTER  CONSUMER CHOICE: MAXIMIZING UTILITY AND

BEHAVIORAL ECONOMICS 402

Utility Theory 402

Utility: Total and Marginal 402 Law of Diminishing Marginal Utility 403 The Solution to the Diamond-Water Paradox 406

Consumer Equilibrium and Demand 407

Equating Marginal Utilities per Dollar 407 Maximizing Utility and the Law of Demand 408 Should the Government Provide the Necessities of Life for Free? 410

Behavioral Economics 411

Are People Willing to Reduce Others’ Incomes? 411 Is $1 Always $1? 412 Coffee Mugs and the Endowment Effect 413 Does the Endowment Effect Hold Only for New Traders? 415

APPENDIX C: BUDGET CONSTRAINT AND INDIFFERENCE CURVE ANALYSIS 420

The Budget Constraint 420

Slope of the Budget Constraint 420 What Will Change the Budget Constraint? 420

Indifference Curves 421 Constructing an Indifference Curve 421

Characteristics of Indifference Curves 422

The Indifference Map and the Budget Constraint Come Together 425 From Indifference Curves to a Demand Curve 425

Appendix Summary 426 Questions and Problems 427

Which Is Better: A Tax

Rebate or a Tax Bonus?

“Is There an Indirect

Way of Proving the Law

of Diminishing Marginal

Utility?”

416

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CHAPTER  PRODUCTION AND COSTS 428

Why Firms Exist 428

The Market and the Firm: Invisible Hand Versus Visible Hand 428 The Alchian and Demsetz Answer 429 Shirking in a Team 429 Ronald Coase on Why Firms Exist 430 Markets: Outside and Inside the Firm 431

The Firm’s Objective: Maximizing Profit 431

Accounting Profit Versus Economic Profit 432 Zero Economic Profit Is Not as Bad as It Sounds 433

Production 434

Production in the Short Run 434 Marginal Physical Product and Marginal Cost 436 Average Productivity 439

Costs of Production: Total, Average, Marginal 441

The AVC and ATC Curves in Relation to the MC Curve 442 Tying Short-Run Production to

Costs 445 One More Cost Concept: Sunk Cost 446

Production and Costs in the Long Run 450

Long-Run Average Total Cost Curve 450 Economies of Scale, Diseconomies of Scale, and Constant Returns to Scale 451 Why Economies of Scale? 452 Why Diseconomies of Scale? 452 Minimum Efficient Scale and Number of Firms in an Industry 452

Shifts in Cost Curves 452

Taxes 453 Input Prices 453 Technology 453

Part  Product Markets and Policies

CHAPTER  PERFECT COMPETITION 458

The Theory of Perfect Competition 458

A Perfectly Competitive Firm Is a Price Taker 459 The Demand Curve for a Perfectly Competitive Firm Is Horizontal 459 The Marginal Revenue Curve of a Perfectly Competitive Firm Is the Same as Its Demand Curve 462 Theory and Real-World Markets 463

Perfect Competition in the Short Run 463

What Level of Output Does the Profit-Maximizing Firm Produce? 464 The Perfectly Competitive Firm and Resource Allocative Efficiency 465 To Produce or Not to Produce: That Is the Question 465 The Perfectly Competitive Firm’s Short-Run Supply Curve 468 From Firm to Market (Industry) Supply Curve 469 Why Is the Market Supply Curve Upward Sloping? 470

Perfect Competition in the Long Run 471

The Conditions of Long-Run Competitive Equilibrium 471 The Perfectly Competitive Firm and Productive Efficiency 473 Industry Adjustment to an Increase in Demand 473 Industry Adjustment to a Decrease in Demand 477 Differences in Costs, Differences in Profits: Now You See It, Now You Don’t 477 Profit and Discrimination 478

Topics for Analysis Within the Theory of Perfect Competition 479

Do Higher Costs Mean Higher Prices? 479 Will the Perfectly Competitive Firm Advertise? 479 Supplier-Set Price Versus Market-Determined Price: Collusion or Competition? 480

A Reader Asks 482

E C O N O M I C S 2 4 / 7

High School Students,

Staying Out Late, and

“What Is the Difference

Between the Law of

Frank Sinatra, Sugar

Ray Robinson, and the

Trang 20

Chapter Summary 482 Key Terms and Concepts 483 Questions and Problems 483 Working with Numbers and Graphs 484

CHAPTER  MONOPOLY 485

The Theory of Monopoly 485

Barriers to Entry: A Key to Understanding Monopoly 485 What Is the Difference Between a Government Monopoly and a Market Monopoly? 487

Monopoly Pricing and Output Decisions 488

The Monopolist’s Demand and Marginal Revenue 488 The Monopolist’s Demand and Marginal Revenue Curves Are Not the Same 489 Price and Output for a Profit-Maximizing Monopolist 490 If a Firm Maximizes Revenue, Does It Automatically Maximize Profit Too? 490

Perfect Competition and Monopoly 492

Price, Marginal Revenue, and Marginal Cost 493 Monopoly, Perfect Competition, and Consumers’ Surplus 493 Monopoly or Nothing? 494

The Case Against Monopoly 495

The Deadweight Loss of Monopoly 495 Rent Seeking 496 X-Inefficiency 498

CHAPTER  MONOPOLISTIC COMPETITION, OLIGOPOLY, AND

GAME THEORY 508

The Theory of Monopolistic Competition 508

The Monopolistic Competitor’s Demand Curve 508 The Relationship Between Price and Marginal Revenue for a Monopolistic Competitor 509 Output, Price, and Marginal Cost for the Monopolistic Competitor 509 Will There Be Profits in the Long Run? 509 Excess Capacity: What Is It, and Is It “Good” or “Bad”? 510 The Monopolistic Competitor and Two Types of Efficiency 512

Oligopoly: Assumptions and Real-World Behavior 512

The Concentration Ratio 513

Price and Output Under Three Oligopoly Theories 513

The Cartel Theory 513 The Kinked Demand Curve Theory 517 The Price Leadership Theory 518

Game Theory, Oligopoly, and Contestable Markets 520

Prisoner’s Dilemma 520 Oligopoly Firms’ Cartels and the Prisoner’s Dilemma 522 Are Markets Contestable? 524

A Review of Market Structures 525 Applications of Game Theory 525

Grades and Partying 525 The Arms Race 527 Speed Limit Laws 528 The Fear of Guilt

as an Enforcement Mechanism 528

A Reader Asks 531 Chapter Summary 532

E C O N O M I C S 2 4 / 7

The People Wear Prada

512

How Is a New Year’s

Resolution Like a Cartel

“Are Firms (as Sellers) Price

Takers or Price Searchers?”

“Does the Single-Price

Monopolist Lower Price Only

on the Additional Unit?”

504

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Key Terms and Concepts 532 Questions and Problems 533 Working with Numbers and Graphs 533

CHAPTER  GOVERNMENT AND PRODUCT MARKETS: ANTITRUST AND

REGULATION 534

Antitrust 534

Antitrust Acts 535 Unsettled Points in Antitrust Policy 537 Antitrust and Mergers 539 Seven Antitrust Cases and Actions 539 Network Monopolies 542 Civil Action No 98-1232 543

Regulation 546

The Case of Natural Monopoly 546 Regulating the Natural Monopoly 547 Regulating Industries That Are Not Natural Monopolies 549 Theories of Regulation 550 The Costs and Benefits of Regulation 550 Some Effects of Regulation Are

Unintended 551 Deregulation 552

Part  Factor Markets and Related Issues

CHAPTER  FACTOR MARKETS: WITH EMPHASIS ON THE LABOR

MARKET 557

Factor Markets 557

The Demand for a Factor 557 Marginal Revenue Product: Two Ways to Calculate

It 558 The MRP Curve Is the Firm’s Factor Demand Curve 559 Value Marginal

Product 560 An Important Question: Is MRP ⫽ VMP? 560 Marginal Factor Cost:

The Firm’s Factor Supply Curve 561 How Many Units of a Factor Should a Firm Buy? 562 When There Is More Than One Factor, How Much of Each Factor Should the Firm Buy? 563

The Labor Market 564

Shifts in a Firm’s MRP, or Factor Demand, Curve 564 Market Demand for Labor 566 The

Elasticity of Demand for Labor 567 Market Supply of Labor 568 An Individual’s Supply of Labor 569 Shifts in the Labor Supply Curve 570 Putting Supply and Demand Together 571 Why Do Wage Rates Differ? 571 Why Demand and Supply Differ Among Labor Markets 572 Why Did You Choose Your Major? 573 Marginal Productivity Theory 574

Labor Markets and Information 576

Screening Potential Employees 576 Promoting from Within 577 Discrimination or an Information Problem? 577

E C O N O M I C S 2 4 / 7

Thomas Edison and

Hollywood

536

High-Priced Ink Cartridges

and Expensive Minibars

543

Macs, PCs, and People

Who Are Different

“What Is the Advantage of

the Herfindahl Index?”

553

E C O N O M I C S 2 4 / 7

Why Jobs Don’t Always

Move to the Low-Wage

Country

566

How Crime, Outsourcing,

and Multitasking Might Be

Related

569

The Wage Rate for a

Street-Level Pusher in a Drug

Trang 22

CHAPTER  WAGES, UNIONS, AND LABOR 582

The Facts and Figures of Labor Unions 582

Types of Unions 582 Union Membership: The United States and Abroad 583

Objectives of Labor Unions 583

Employment for All Members 583 Maximizing the Total Wage Bill 584 Maximizing Income for a Limited Number of Union Members 584 Wage-Employment Trade-Off 584

Practices of Labor Unions 585

Affecting Elasticity of Demand for Union Labor 585 Affecting the Demand for Union Labor 586 Affecting the Supply of Union Labor 587 Affecting Wages Directly: Collective Bargaining 587 Strikes 588

Effects of Labor Unions 589

The Case of Monopsony 589 Unions’ Effects on Wages 592 Unions’ Effects on Prices 594 Unions’ Effects on Productivity and Efficiency: Two Views 595

CHAPTER  THE DISTRIBUTION OF INCOME AND POVERTY 601

Some Facts About Income Distribution 601

Who Are the Rich and How Rich Are They? 601 The Effect of Age on the Income Distribution 603 A Simple Equation 604

Measuring Income Equality 606

The Lorenz Curve 606 The Gini Coefficient 607 A Limitation of the Gini Coefficient 608

Why Income Inequality Exists 609

Factors Contributing to Income Inequality 609 Income Differences: Some Are Voluntary, Some Are Not 611

Normative Standards of Income Distribution 612

The Marginal Productivity Normative Standard 612 The Absolute Income Equality Normative Standard 615 The Rawlsian Normative Standard 615

Poverty 616

What Is Poverty? 616 Limitations of the Official Poverty Income Statistics 617 Who Are the Poor? 617 What Is the Justification for Government Redistributing Income? 618

E C O N O M I C S 2 4 / 7

Statistics Can Mislead if

You Don’t Know How

They Are Made

“Are the Number of Persons

in Each Fifth the Same?”

620

E C O N O M I C S 2 4 / 7

Technology, the Price of

Competing Factors, and

Trang 23

CHAPTER  INTEREST, RENT, AND PROFIT 623

Interest 623

Loanable Funds: Demand and Supply 623 The Price for Loanable Funds and the Return

on Capital Goods Tend to Equality 626 Why Do Interest Rates Differ? 626 Nominal and Real Interest Rates 627 Present Value: What Is Something Tomorrow Worth Today? 628 Deciding Whether or Not to Purchase a Capital Good 629

Rent 631

David Ricardo, the Price of Grain, and Land Rent 631 The Supply Curve of Land Can Be Upward Sloping 632 Economic Rent and Other Factors of Production 632 Economic Rent and Baseball Players: The Perspective from Which the Factor Is Viewed

Matters 633 Competing for Artificial and Real Rents 633 Do People Overestimate Their Worth to Others, or Are They Simply Seeking Economic Rent? 633

Profit 634

Theories of Profit 634 What Is Entrepreneurship? 636 What a Microwave Oven and an Errand Runner Have in Common 636 Profit and Loss as Signals 637

Part  Market Failure and Public Choice

CHAPTER  MARKET FAILURE: EXTERNALITIES, PUBLIC GOODS, AND

Agreements 651 Beyond Internalizing: Setting Regulations 652

Dealing with a Negative Externality in the Environment 653

Is No Pollution Worse Than Some Pollution? 654 Two Methods to Reduce Air Pollution 654

Public Goods: Excludable and Nonexcludable Goods 656

Goods 656 The Free Rider 657 Nonexcludable Versus Nonrivalrous 657

Asymmetric Information 659

Asymmetric Information in a Product Market 659 Asymmetric Information in a Factor Market 660 Is There Market Failure? 660 Adverse Selection 661 Moral Hazard 662

“How Is Present Value

Used in the Courtroom?”

638

E C O N O M I C S 2 4 / 7

Switching Costs and

Market Failure (Maybe)

645

Want to Lease a Rainforest

for $1.6 Million per Year?

Arriving Late to Class,

Grading on a Curve, and

Studying Together for the

Midterm

662

“It Seems Wrong to Let

Some Business Firms Pay to

Pollute”

664

Trang 24

CHAPTER  PUBLIC CHOICE: ECONOMIC THEORY APPLIED TO

Voters and Rational Ignorance 672

The Costs and Benefits of Voting 673 Rational Ignorance 674

More About Voting 676

Example 1: Voting for a Nonexcludable Public Good 676 Example 2: Voting and Efficiency 677

Special Interest Groups 678

Information and Lobbying Efforts 678 Congressional Districts as Special Interest Groups 679 Public Interest Talk, Special Interest Legislation 679 Special Interest Groups and Rent Seeking 680

Government Bureaucracy 682

A View of Government 684

T h e G l o b a l E c o n o m y

Part  International Economics and Globalization

CHAPTER  INTERNATIONAL TRADE 689

International Trade Theory 689

How Countries Know What to Trade 690 How Countries Know when They Have a Comparative Advantage 692

Trade Restrictions 694

The Distributional Effects of International Trade 694 Consumers’ and Producers’

Surpluses 694 The Benefits and Costs of Trade Restrictions 697 Why Nations Sometimes Restrict Trade 700

World Trade Organization (WTO) 703

E C O N O M I C S 2 4 / 7

Dividing the Work

693

You’re Getting Better

Because Others Are Getting

“Should We Impose Tariffs

if They Impose Tariffs?”

704

E C O N O M I C S 2 4 / 7

A Simple Majority Voting

Rule: The Case of the

Statue in the Public Square

Inheritance, Heirs, and

Why the Firstborn Became

King or Queen

682

“Doesn’t Public Choice

Paint a Bleak Picture of

Politics and Government?”

685

Trang 25

CHAPTER  INTERNATIONAL FINANCE 708

The Balance of Payments 708

Current Account 709 Capital Account 712 Official Reserve Account 713 Statistical Discrepancy 713 What the Balance of Payments Equals 713

The Foreign Exchange Market 715

The Demand for Goods 715 The Demand for and Supply of Currencies 716

Flexible Exchange Rates 718

The Equilibrium Exchange Rate 718 Changes in the Equilibrium Exchange Rate 719 Factors That Affect the Equilibrium Exchange Rate 719

Fixed Exchange Rates 722

Fixed Exchange Rates and Overvalued/Undervalued Currency 722 What Is So Bad About an Overvalued Dollar? 723 Government Involvement in a Fixed Exchange Rate System 724 Options Under a Fixed Exchange Rate System 726 The Gold Standard 727

Fixed Exchange Rates Versus Flexible Exchange Rates 728

Promoting International Trade 728 Optimal Currency Areas 729

The Current International Monetary System 731

CHAPTER  GLOBALIZATION AND INTERNATIONAL IMPACTS

ON THE ECONOMY 737

What Is Globalization? 737

A Smaller World 737 A World Economy 738

Two Ways to See Globalization 739

No Barriers 739 A Union of States 740

Globalization Facts 740

International Trade 740 Foreign Exchange Trading 741 Foreign Direct Investment 741 Personal Investments 741 The World Trade Organization 742 Business Practices 742

Movement Toward Globalization 742

The End of the Cold War 743 Advancing Technology 744 Policy Changes 744

Benefits and Costs of Globalization 745

The Benefits 745 The Costs 746

The Continuing Globalization Debate 748 More or Less Globalization: A Tug of War? 749

Less Globalization 749 More Globalization 749

International Factors and Aggregate Demand 750

Net Exports 750 The J-Curve 751

International Factors and Aggregate Supply 754

Foreign Input Prices 754 Why Foreign Input Prices Change 754

Factors That Affect Both Aggregate Demand and Aggregate Supply 754

The Exchange Rate 755 The Role That Interest Rates Play 755

Deficits: International Effects and Domestic Feedback 756

The Budget Deficit and Expansionary Fiscal Policy 757 The Budget Deficit and Contractionary Fiscal Policy 758 The Effects of Monetary Policy 759

A Reader Asks 762 Chapter Summary 762

E C O N O M I C S 2 4 / 7

Should You Leave a Tip?

739

Proper Business Etiquette

Around the World

743

Will Globalization Change

the Sound of Music?

748

How Hard Will It Be to

Get into Harvard in 2025?

752

“Why Do Some People

Favor Globalization and

“Why Is the Depreciation

of One Currency Tied to

the Appreciation of Another

Currency?”

733

Trang 26

Key Terms and Concepts 763 Questions and Problems 763 Working with Numbers and Graphs 764

P r a c t i c a l E c o n o m i c s

Part  Financial Matters

CHAPTER  STOCKS, BONDS, FUTURES, AND OPTIONS 765

Financial Markets 765 Stocks 766

Where Are Stocks Bought and Sold? 766 The Dow Jones Industrial Average (DJIA) 767 How the Stock Market Works 768 Why Do People Buy Stock? 770 How to Buy and Sell Stock 771 Buying Stocks or Buying the Market 771 How to Read the Stock Market Page 772

W e b C h a p t e r

Part  Web Chapter

CHAPTER  AGRICULTURE: PROBLEMS, POLICIES, AND UNINTENDED

EFFECTS 786

Agriculture: The Issues 786

A Few Facts 786 Agriculture and Income Inelasticity 787 Agriculture and Price Inelasticity 788 Price Variability and Futures Contracts 789 Can Bad Weather Be Good for Farmers? 789

Agricultural Policies 790

Price Supports 791 Restricting Supply 791 Target Prices and Deficiency Payments 792 Production Flexibility Contract Payments, (Fixed) Direct Payments, and Countercyclical Payments 792 Nonrecourse Commodity Loans 793

“Why Don’t Farmers Agree

to Cut Back Output?”

795

Trang 27

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www.cengage.com/economics/arnold

C H A P T E R 2 Economic Activities: Producing and Trading 39

Suppose an advance in technology allows more military goods and more civilian goods

to be produced with the same quantity of resources As a result, the PPF in Exhibit 6 shifts

outward from PPF1 to PPF2 The outcome is the same as when the quantity of resources

is increased.

F i n d i n g E c o n o m i c s

In an Attorney’s Ofﬁ ce

A n attorney is sitting in his office working Where is the economics?

Let’s back up and first talk about farmers and a change in technology During the twentieth century,

many farmers left farming because farming experienced major technological advances Where

farm-ers once farmed with minimal capital equipment, today they use computfarm-ers, tractors, pesticides,

cellular phones, and much more In 1910, the United States had 32.1 million farmers; today there are

around 4.8 million farmers Where did all the farmers go?

Because of technological advancements, fewer farmers were needed to produce food and so many

began to produce cars, airplanes, television sets, and computers They became attorneys,

accoun-tants, and police officers

What we learn here is that a technological advancement in one sector of the economy can have

ripple effects throughout the economy We also learn that a technological advancement can affect

the composition of employment

S E L F - T E S T

(Answers to Self-Test questions are in the Self-Test Appendix.)

1 What does a straight-line production possibilities frontier (PPF) represent? What does a

bowed-outward PPF represent?

2 What does the law of increasing costs have to do with a bowed-outward PPF?

3 A politician says, “If you elect me, we can get more of everything we want.” Under what

condition(s) is the politician telling the truth?

4 In an economy, only one combination of goods is productive efficient True or false? Explain your answer.

E XCHANGE OR T RADE

Exchange (trade) is the process of giving up one thing for something else Usually, money

is traded for goods and services Trade is all around us; we are involved with it every day

Few of us, however, have considered the full extent of trade.

Periods Relevant to Trade

There are three time periods relevant to the trading process We discuss these relevant

time periods next.

Exchange (Trade)

The process of giving up one thing

for something else.

Exchange (Trade)

The process of giving up one thing

for something else.

PPF2 PPF1

Economic growth shifts

an advance in technology can

bilities of an economy, leading

Instructor:

One purpose is to ground us in reality For example, the frontier (or boundary) of the PPF represents scarcity, which is a fact of life In other words, the frontier of the PPF is essentially saying, “Here is scarcity

Work with it.” One of the important effects of acknowledging this fact

is that we come to understand what is and what is not possible For example, if the economy is currently on the frontier of its PPF, producing 100 units of X and 200 units of Y, it follows that it’s possible to get more of X, but it’s impossible to get more of X without getting less of

Y In other words, the frontier of the PPF grounds us in reality: More of one thing means less of something else

Student:

I’ve also heard that the PPF can show us what is necessary before the

“average person” in a country can become richer Is this true? And what kind of richer do we mean here?

Instructor:

We are talking about becoming richer in terms of having more goods through economic growth In other words, the average person in society becomes richer if the PPF shifts rightward by more than the population grows To illustrate, suppose that a 100-person economy is currently producing 100 units of X and 200 units of Y It follows that

the average person can have 1 unit of X and 2 units of Y Now pose there is economic growth (shifting the PPF to the right) and the

sup-200 units of X and 400 units of Y If the population has not changed (if it is still 100 people), then the average person can now have 2 units

of X and 4 units of Y The average person is richer in terms of two goods, X and Y If we change things, and let the population grow from

100 persons to, say, 125 persons, it is still possible for the average person to have more through economic growth With a population of economy grows by a greater percentage than the population, it is possible for the average person to become richer (in terms of goods and services)

Student:

Just because the economy is producing more of both goods (X and Y),

it doesn’t necessarily follow that the average person is better off in terms of goods and services, does it? Can’t all the extra output end up

in the hands of only a few people instead of being evenly distributed across the entire population?

Points to Remember

1 The production possibilities frontier (PPF) grounds us in reality

It tells us what is and what is not possible in terms of producing various combinations of goods and services

2 The PPF tells us that when we have efficiency (we are at a point

on the frontier itself), more of one thing means less of something else In other words, the PPF tells us there are trade-offs in life

3 If the PPF shifts rightward and the population does not change, then output per capita rises

49

95425_02_ch02_033-052.indd 49 9/29/08 1:57:49 PM

Y ou have your own PPF, you just may not know it Suppose you are studying for two upcoming exams You have only a total of eight hours before you have to take the first exam, after which you exam Time spent studying for the first exam (in economics) takes away from time that could be spent studying for the second exam

is a resource in the production of a good grade; less time studying for the ation may look as it does in Exhibit 7(a) We have identified four points

in the exhibit (1–4) corresponding

to the four combinations of two grades (one grade in economics and one grade in English).

You will notice also that each grade comes with a certain amount of time studying This time

is specified under the grade

Given the resources you currently have (your labor and time) you can achieve any of the four combinations For example, you can spend six hours studying for economics and get a B (point 1), but this means you study math for zero hours and get an F in that course

Or you can spend four hours studying for economics and get a C (point 2), leaving you two hours to study for math, in which you get a D

What do you need to get a higher grade

in one course without getting a lower grade in the other course? You need more

If you have eight hours to study, your PPF shifts rightward, as in Exhibit 7(b) Now point 5 is possible (whereas it was not possible before you got more time) At point 5, you can get a C in economics and in math, which was an impossible combination of grades when you had less time (a PPF closer to the origin)

THE PPF AND YOUR GRADES

40

exhibit 7

A (6 hrs.) C (4 hrs.) D (2 hrs.) F (0 hr.) F (0 hr.) (2 hrs.) D

PPF1

C (4 hrs.) (6 hrs.) B A 1 3 1 3 4

Grade in Math and Time Spent

to Earn the Grade

(a)

A (8 hrs.) B (6 hrs.) C (4 hrs.) D (2 hrs.) F (0 hr.) F (0 hr.) (2 hrs.) D

PPF1

C (4 hrs.) (6 hrs.) B (8 hrs.) A 5 4

Grade in Math and Time Spent

to Earn the Grade

Trang 28

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Trang 29

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Trang 30

Arnold’s Study Guide –

Your Partner for Success

Study Guide

Written and updated by Roger Arnold, this thorough Study Guide

helps you to gain a solid understanding of chapter material The

Study Guide reinforces learning with a list of key concepts and

terms, review questions and problems, short-answer exercises asking

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Trang 31

University of Southern Mississippi

This book could not have been written and published without the generous expert assistance of many people A deep debt of

gratitude is owed to the reviewers of the first through eighth editions and to the reviewers of this edition, the ninth

Trang 32

Southwest Missouri State University

Second Edition Reviewers

Kansas State University

Charles Van Eaton

Hillsdale College

Mark Wheeler

Bowling Green State University

Thomas Wyrick

Third Edition Reviewers

Carlos Aguilar

University of Texas, El Paso

Rebecca Ann Benakis

New Mexico State University

Trang 33

University of Hawaii at Manoa

Fourth Edition Reviewers

University of North Texas

Mary Ann Hendryson

Western Washington University

Fifth Edition Reviewers

The University of Vermont

Mary Ann Hendryson

Western Washington University

Texas Tech University

Sixth Edition Reviewers

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University of Wisconsin, Oshkosh

Seventh Edition Reviewers

Trang 34

Eighth Edition Reviewers

Oklahoma Wesleyan University

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Northwestern State University

I would like to thank Peggy Crane of Southwestern College, who revised the Test Bank, and Jane Himarios of the University

of Texas at Arlington, who revised the Instructor’s Manual I owe a dept of gratitude to all the fine and creative people I worked with at South-Western/Cengage Learning These persons include Jack Calhoun; Alex von Rosenberg; Michael Worls, Executive Editor for Economics; Jennifer Thomas, Senior Developmental Editor; Kim Kusnerak, Senior Content Project Manager; John Carey, Senior Marketing Manager; Michelle Kunkler, Senior Art Director; and Sandee Milewski, Senior Frontlist Buyer

My deepest debt of gratitude goes to my wife, Sheila, and to my two sons, David, eighteen years old, and Daniel, twenty one years old They continue to make all my days happy ones

Roger A Arnold

Trang 35

Introduction You are about to begin your study of economics Before

we start discussing particular topics in economics, we think it best to give you

an overview of what economics is and of some of the key concepts in economics

These key concepts can be compared to musical notes: just as musical notes

repeat themselves in any song (you hear the musical note G over and over again),

so do the key concepts in economics repeat themselves Some of the key concepts

we discuss include scarcity, opportunity cost, efficiency, marginal decision

making, and exchange

In this section, we discuss a few key economic concepts; then we incorporate knowledge

of these concepts into a definition of economics

Goods and Bads

Economists talk about goods and bads A good is anything that gives a person utility or

satisfaction Here is a partial list of some goods: a computer, a car, a watch, a television

set, friendship, and love You will notice from our list that a good can be either tangible

or intangible A computer is a tangible good; friendship is an intangible good Simply

put, for something to be a good (whether tangible or intangible), it simply has to give you

utility or satisfaction

A bad is something that gives a person disutility or dissatisfaction If the flu gives you

disutility or dissatisfaction, then it is a bad If the constant nagging of an acquaintance is

something that gives you disutility or dissatisfaction, then it is a bad

People want goods and they do not want bads In fact, they will pay to get goods

(“Here is $1,000 for the computer”), and they will pay to get rid of bads they currently

have (“I’d be willing to pay you, doctor, if you can prescribe something that will shorten

the time I have the flu”)

Trang 36

Can something be a good for one person and a bad for another person? Well, because

a good is something that gives one utility and a bad is something that gives one ity, this question is simply asking whether something can give utility to one person and disutility to another Can you identify such a thing? What about cigarette smoking? For some people, smoking cigarettes gives them utility; for other people, it gives them disu-tility We conclude that smoking cigarettes can be a good for some people and a bad for others This must be why the wife tells her husband, “If you want to smoke, you should

disutil-do it outside.” In other words, get those bads away from me.

Resources

Goods do not just appear before us when we snap our fingers It takes resources to duce goods (Sometimes resources are referred to as inputs or factors of production.)

pro-Generally, economists divide resources into four broad categories: land, labor, capital,

and entrepreneurship Land includes natural resources, such as minerals, forests, water, and unimproved land For example, oil, wood, and animals fall into this category (Sometimes economists refer to this category simply as natural resources.)

Labor consists of the physical and mental talents people contribute to the production process For example, a person building a house is using his or her own labor

Capital consists of produced goods that can be used as inputs for further production Factories, machinery, tools, computers, and buildings are examples of capital One coun-try might have more capital than another This means that it has more factories, machin-ery, tools, and so on

Entrepreneurship refers to the particular talent that some people have for organizing the resources of land, labor, and capital to produce goods, seek new business opportuni-ties, and develop new ways of doing things

Scarcity and a Definition of Economics

We are now ready to define a key concept in economics: scarcity Scarcity is the condition

in which our wants (for goods) are greater than the limited resources (land, labor, capital, and entrepreneurship) available to satisfy those wants In other words, we want goods, but there are just not enough resources available to provide us with all the goods we want.Look at it this way: Our wants (for goods) are infinite, but our resources (which we need to produce the goods) are finite Scarcity is our infinite wants hitting up against finite resources.Many economists say that if scarcity didn’t exist, neither would economics In other words, if our wants weren’t greater than the limited resources available to satisfy them, there would be no field of study called economics This is similar to saying that if matter and motion didn’t exist, neither would physics or that if living things didn’t exist, neither would biology For this reason, we define economics in this text as the science of scarcity More completely, economics is the science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.

T h i n k i n g l i k e A n E c o n o m i s t

Scarcity Affects Everyone

Everyone in the world has to face scarcity, even billionaires Take, for example, Bill Gates, the cofounder of Microsoft and one of the richest people in the world He may be able to satisfy more of his wants for tangible goods (houses, cars) than most people, but this doesn’t mean he has the resources to satisfy all his wants His wants might include more time with his children, more friendship, no disease in the world, peace on earth, and a hundred other things that he does not have the resources to “produce.”

Land

All natural resources, such as

minerals, forests, water, and

unimproved land.

Labor

The physical and mental talents

people contribute to the production

process.

Capital

Produced goods that can be used as

inputs for further production, such as

factories, machinery, tools,

comput-ers, and buildings.

Entrepreneurship

The particular talent that some

people have for organizing the

resources of land, labor, and capital

to produce goods, seek new business

opportunities, and develop new ways

of doing things.

Scarcity

The condition in which our wants are

greater than the limited resources

available to satisfy those wants.

Economics

The science of scarcity; the science

of how individuals and societies deal

with the fact that wants are greater

than the limited resources available

to satisfy those wants.

Land

All natural resources, such as

minerals, forests, water, and

unimproved land.

Labor

The physical and mental talents

people contribute to the production

process.

Capital

Produced goods that can be used as

inputs for further production, such as

factories, machinery, tools,

comput-ers, and buildings.

Entrepreneurship

The particular talent that some

people have for organizing the

resources of land, labor, and capital

to produce goods, seek new business

opportunities, and develop new ways

of doing things.

Scarcity

The condition in which our wants are

greater than the limited resources

available to satisfy those wants.

Economics

The science of scarcity; the science

of how individuals and societies deal

with the fact that wants are greater

than the limited resources available

to satisfy those wants.

Trang 37

THINKING IN TERMS OF SCARCITY’S EFFECTS Scarcity has effects Here are

three: (1) the need to make choices, (2) the need for a rationing device, and (3)

competi-tion We describe each

are greater than our limited resources, some wants must go unsatisfied We must choose

which wants we will satisfy and which we will not Jeremy asks: Do I go to Hawaii or do I

pay off my car loan earlier? Ellen asks: Do I buy the new sweater or two new shirts?

Lost is an ABC television series; the

pilot for the show aired on

Septem-ber 22, 2004 The show is about

people who have survived a plane crash

(Oceanic flight 815) and now inhabit a

mys-terious tropical island

The tropical island is unlike any island

any-one has ever seen or visited before We’ll

show you just how later, but before we do,

let’s return to our discussion of scarcity,

goods, and resources We know that scarcity is a condition where our

wants for goods are greater than the resources available to satisfy

those wants

Now ask: If you didn’t need resources to produce goods—if you didn’t

need anything to produce goods—would you have overcome scarcity?

Would you have defeated scarcity?

The answer is yes Obviously the only reason you cannot have all the

goods you want is because resources are needed to produce goods,

and there are a finite number of resources in the world Wood is

needed to produce a chair, labor is needed to produce a computer, and

capital is needed to produce a car If you didn’t need wood, labor, or

capital to produce any good—if you didn’t need anything to produce

goods—then you could have all the goods you desire And if you could

have all the goods you desire, you would have defeated or overcome

scarcity Make sense?

With this as background, listen to the words of Ben, one of the

char-acters on Lost In the third season of Lost, Episode 13 (“The Man from

Tallahassee”), he speaks the following words to John Locke, one of the

survivors of the plane crash

I can show you things Things I know you want to see very badly Let me put it so you’ll understand Picture a box You know something about boxes, don’t you John? What if I told you that somewhere on this island there’s a very large box and whatever you imagined whatever you wanted to be in it when you opened that box, there it would be What would you say about that, John?

They key words are, “there’s a very large box and whatever you imagined whatever you wanted to be in

it when you opened that box, there it would be.” In other words,

if you wish for a good—any good—there it will be You do not have

to produce the good, you do not need any resources before you can produce the good All you have to do is wish for it and “there it would be.”

In other words, the box on the Lost island is all anyone needs, and then with that box, anything you wish for will be yours That is a setting

in which scarcity is no more And because scarcity is no more, neither

is choice, which is one of the effects of scarcity There is no need to decide between good X and Y, you can have both And what about the cost of these goods? Is there a cost to them? Certainly not, for if you don’t have to give up one thing to get something else (which is the case in real life), the opportunity cost of what you get is zero Wishing for X at 10:05 doesn’t mean you have given up the chance to get Y, because with a magic box, you can wish for Y at 10:05 and one second

In conclusion, the Lost island is truly an unusual and very different island It is an island where for some people scarcity, choices, and costs are no more You just might say that it is a make-believe island

LOST

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Need for a Rationing Device A rationing device is a means of deciding who gets what

It is scarcity that implies the need for a rationing device If people have infinite wants for goods and there are only limited resources to produce the goods, then a rationing device must be used to decide who gets the available quantity of goods Dollar price is a ration-ing device For example, there are 100 cars on the lot and everyone wants a new car How

do we decide who gets what quantity of the new cars? The answer is “use the rationing device dollar price.” Those people who pay the dollar price for the new car end up with

a new car

Is dollar price a fair rationing device? Doesn’t it discriminate against the poor? After all, the poor have fewer dollars than the rich, so the rich can get more of what they want than can the poor True, dollar price does discriminate against the poor But then, as the economist knows, every rationing device discriminates against someone

Suppose that dollar price could not be used as a rationing device tomorrow Some rationing device would still be necessary because scarcity would still exist How would we ration gas at the gasoline station, food in the grocery store, or tickets for the Super Bowl? Let’s consider some alternatives to dollar price as a rationing device

Suppose first come, first served is the rationing device For example, suppose there are only 40,000 Super Bowl tickets If you are one of the first 40,000 in line for a Super Bowl ticket, then you get a ticket If you are person number 40,001 in line, you don’t Such a method discriminates against those who can’t get in line quickly What about slow walk-ers or people with a disability? What about people without cars who can’t drive to where the tickets are distributed?

Or suppose brute force is the rationing device For example, if there are 40,000 Super Bowl tickets, then as long as you can take a ticket away from someone who has a ticket, the ticket is yours Who does this rationing method discriminate against? Obviously, it discriminates against the weak and non-aggressive

Or suppose beauty is the rationing device The more beautiful you are, the better your chance of getting a Super Bowl ticket Again, the rationing device discriminates against someone

These and many other alternatives to dollar price could be used as a rationing device However, each discriminates against someone, and none is clearly superior to dollar price

In addition, if first come, first served, brute force, beauty, or another alternative to dollar price is the rationing device, what incentive would the producer of a good have to produce the good? With dollar price as a rationing device, a person produces computers and sells them for money He then takes the money and buys what he wants But if the rationing device were, say, brute force, he would not have an incentive to produce Why produce anything when someone will end up taking it away from you? In short, in a world where dollar price isn’t the rationing device, people are likely to produce much less than

in a world where dollar price is the rationing device

competing for jobs? Are states and cities competing for businesses? Are students ing for grades? The answer to all these questions is yes The economist wants to know why this competition exists and what form it takes First, the economist concludes, competition exists because of scarcity If there were enough resources to satisfy all our seem-

compet-ingly unlimited wants, people would not have to compete for the available but limited resources

Second, the economist sees that competition takes the form of people trying to get more of the rationing device If dollar price is the rationing device, people will compete

to earn dollars Look at your own case You are a college student working for a degree One reason (but perhaps not the only reason) you are attending college is to earn a higher

Rationing Device

A means for deciding who gets what

of available resources and goods.

Rationing Device

A means for deciding who gets what

of available resources and goods.

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income after graduation But why do you want a higher income? You want it because it

will allow you to satisfy more of your wants

Suppose muscular strength (measured by lifting weights) were the rationing device

instead of dollar price People with more muscular strength would receive more resources

and goods than people with less muscular strength would receive In this situation, people

would compete for muscular strength (Would they spend more time at the gym lifting

weights?) The lesson is simple: Whatever the rationing device, people will compete for it.

F i n d i n g E c o n o m i c s

At the Campus Book Store

To learn economics well, you must practice what you learn One of the ways of “practicing

economics” is to find economics in everyday scenes of life With this in mind, consider the

following scene: You are in the campus book store buying a book for your computer science course

You are currently handing over $65 to the cashier Can you find the economics in this simple scene?

Before you read on, think about it for a minute

Let’s work backward to find the economics You are currently handing the cashier $65 We know

that dollar price is a rationing device But let’s now ask ourselves why we would need a rationing

device to get the book The answer is scarcity In other words, scarcity is casting its long shadow

there in the book store when you buy a book We have found one of the key economic concepts—

scarcity—in the campus book store (If you also said that a book is a good, then you have found

even more economics in the book store Can you find more than scarcity and a good?)

S E L F - T E S T

(Answers to Self-Test questions are in the Self-Test Appendix.)

1 Scarcity is the condition of finite resources True or false? Explain your answer.

2 How does competition arise out of scarcity?

3 How does choice arise out of scarcity?

There are numerous key concepts in economics—concepts that define the field We

dis-cuss a few of these concepts next

Opportunity Cost

So far we have established the fact that people must make choices because scarcity exists

In other words, because our seemingly unlimited wants push up against limited resources,

some wants must go unsatisfied We must therefore choose which wants we will satisfy

and which we will not The most highly valued opportunity or alternative forfeited when

a choice is made is known as opportunity cost Every time you make a choice, you incur

an opportunity cost For example, you have chosen to read this chapter In making this

choice, you denied yourself the benefits of doing something else You could have watched

television, emailed a friend, taken a nap, eaten a few slices of pizza, read a novel, shopped

for a new computer, and so on Whatever you would have chosen to do had you decided

not to read this chapter is the opportunity cost of your reading this chapter For example,

The most highly valued opportunity

or alternative forfeited when a choice

is made.

The most highly valued opportunity

or alternative forfeited when a choice

is made.

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if you would have watched television had you chosen not to read this chapter—if this was your next best alternative—then the opportunity cost of reading this chapter is watching television.

Think “No Free Lunch”

Economists are fond of saying that there is no such thing as a free lunch This catchy phrase expresses the idea that opportunity costs are incurred when choices are made Perhaps this

is an obvious point, but consider how often people mistakenly assume there is a free lunch For example, some parents think education is free because they do not pay tuition for their children to attend public elementary school Sorry, but that is a misconception Free implies no sacrifice and no opportunities forfeited, which is not true in regard to elementary school education Resources that could be used for other things are used to provide elementary school education.

Consider the people who speak about free medical care, free housing, free bridges (“there is no charge to cross it”), and free parks Sorry, again, but free medical care, free housing, free bridges, and free parks are misconceptions The resources that provide medical care, housing, bridges, and parks could have been used in other ways.

Opportunity Cost and Behavior

Economists believe that a change in opportunity cost can change a person’s behavior For example, consider Ryan, who is a sophomore at Cornell University in Ithaca, New York

He attends classes Monday through Thursday of every week Every time he chooses to

go to class, he gives up the opportunity to do something else, such as the opportunity to earn $10 an hour working at a job The opportunity cost of Ryan spending an hour in class is $10

Now let’s raise the opportunity cost of attending class On Tuesday, we offer Ryan

$70 to skip his economics class He knows that if he attends his economics class, he will forfeit $70 What will Ryan do? An economist would predict that as the opportunity cost

of attending class increases relative to the benefits of attending class, Ryan is less likely to attend class

This is how economists think about behavior, whether it is Ryan’s or your own The higher the opportunity cost of doing something, the less likely it will be done This is part of the

economic way of thinking

Before you continue, look at Exhibit 1, which summarizes some of the things about scarcity, choice, and opportunity cost up to this point

exhibit 1

Scarcity and Related Concepts

Because of scarcity, a rationing device is needed.

Whatever the rationing device, people will compete for it Scarcity and competition are linked.

Because of scarcity, people must make choices.

When choices are made, opportunity costs are incurred.

Changes in opportunity cost affect behavior.

Scarcity

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