Ebook Economics (7th edition): Part 1

(BQ) Part 1 book Economics has contents: Introducing economics, supply and demand, markets in action, background to demand, background to supply, profit maximising under perfect competition and monopoly, alternative theories of the firm.

John Sloman • Alison Wride

Academy Economics Network is based at the University of Bristol John is also Visiting Professor at the

University of the West of England, Bristol.

Economics.

“The book has been written and revised in successive editions with a dedicated focus on the needs of

students.”

Roy Bailey, University of Essex

“A key strength of the book is the student-friendly writing style The author defi nitely takes a student point of

view with respect to discussion and explanation.”

Pam Siler, University of Abertay, Dundee

“There are a number of key strengths in the Sloman book First, the clarity of the written style is outstanding

Second, the learning features are exceptional Third, the way in which the subject is tackled using logical

ideas, graphical representation as well as the algebra gives students confi dence in their own ability to learn

diffi cult topics Fourth, the delivery of material across multi-media platforms is innovative and shows much

creativity.”

Ian Jackson, Staffordshire University

Go to www.pearsoned.co.uk/sloman, your gateway

to all the online resources for this new edition, including:

• A new regularly updated Economics in the News site with accompanying podcasts

• A new student revision centre with a wealth

of resources such as self-testing interactive questions and answers, revision cards, audio animations and hints and tips to help you do well

in your exams

• A new edition of MyEconLab Redeem your access

code included with this textbook to gain access to

an unrivalled online study and testing resource, providing you with personalised practice exactly where you need it most

See Getting Started with MyEconLab on page xxii for more details

Economics has never been so exciting to learn,

The seventh edition of Economics contains the most up-to-the-minute coverage and uses the latest data to

track and analyse the impact of the global financial crisis on our economy

Just like the economy, Economics has also been

through a thorough overhaul While retaining its

classic features and clear and engaging writing

style, it has many new features, including:

• New co-author Alison Wride from the University of

Exeter.

• New Part D on Microeconomic Policy with

separate chapters on government policies

towards the environment, big business and

inequality.

• Expanded section on Game Theory covering

multiple move and single shot games.

• The most exhaustive revision to date of the

fi nancial crisis, banking collapse and subsequent

recession on fi scal and monetary policy is

explored in detail, as is the role of securitisation

and issues of liquidity and risk.

ONCE OPENED THIS PACK CANNOT BE RETURNED FOR A REFUND

Visit the Sloman website at www.pearsoned.co.uk/sloman to find valuable student learning

material including:

• a new, searchable economic news blog, with news items, analysis and accompanying

podcasts added several times per month and referenced to the relevant chapter in this book;

• a new student revision centre with an online revision guide to help you prepare for your

economics exam, self-assessment questions to test your knowledge, an online glossary,revision flashcards and hints and tips for doing well in exams;

• hotlinks to over 200 sites;

• links to the book’s MyEconLab site.

With your purchase of a new copy of this textbook, you received a Student Access Kit to

MyEconLab for Economics, Seventh Edition Follow the instructions on the card to register

successfully and start making the most of the online resources

MyEconLab provides a variety of tools to enable students to assess and progress their own

learning, including questions and tests for each chapter of the book A personalised Study Planidentifies areas to concentrate on to improve grades Specific tools are provided to each student

to direct their studies in the most efficient way MyEconLab also includes:

• a highly interactive online workbook;

• guided solutions that break problems into component steps and guide you through themwith hints;

• extra case studies with questions: several per chapter;

• maths cases with exercises, related to the Looking at the Maths boxes in the book;

• answers to all in-chapter questions;

• a comprehensive glossary with flashcards to check students’ knowledge;

• animations of key models with audio explanations

See Getting Started with MyEconLab on page xxii for more details.

To activate your registration go to www.pearsoned.co.uk/sloman, click on the Economics,

Seventh Edition cover, select MyEconLab registration, log-in and follow the instructions on-screen to register as a new user

We work with leading authors to develop thestrongest educational materials in economics,bringing cutting-edge thinking and best learningpractice to a global market.

Under a range of well-known imprints, includingFinancial Times Prentice Hall, we craft high-qualityprint and electronic publications which help readers

to understand and apply their content, whetherstudying or at work

To find out more about the complete range of ourpublishing, please visit us on the World Wide Web atwww.pearsoned.co.uk

Pearson Education Limited

Edinburgh Gate

Harlow

Essex CM20 2JE

England

and Associated Companies throughout the world

Visit us on the World Wide Web at:

www.pearsoned.co.uk

First edition published 1991

Second edition published 1994

Updated second edition published 1995

Third edition published 1997

Updated third edition published 1998

Fourth edition published 2000

Fifth edition published 2003

Sixth edition published 2006

Seventh edition published 2009

© John Sloman 1991

© John Sloman, Alison Bird and Mark Sutcliffe 1994, 1997

© John Sloman, Alison Sloman and Mark Sutcliffe 2000, 2003

© John Sloman 2006

© John Sloman, Alison Wride 2009

The rights of John Sloman and Alison Wride to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.

All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or

otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the

United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6 –10 Kirby Street, London EC1N 8TS.

All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any

affiliation with or endorsement of this book by such owners ISBN 978-0-273-71562-7

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library

Library of Congress Cataloguing-in-Publication Data

Typeset in 8/12pt Stone Serif by 35

Printed and bound by Rotolito Lombarda, Italy

The publisher’s policy is to use paper manufactured from sustainable

John Sloman is Director of

the Economics Network (www

economicsnetwork.ac.uk) of the

UK Higher Education Academy

The Economics Network is based

at the University of Bristol andprovides a range of servicesdesigned to promote and sharegood practice in learning andteaching economics The Net-work is one of 24 subject centres covering the range of dis-

ciplines taught in UK Higher Education The HE Academy

is backed by grants from the four UK higher education

funding councils

John is also visiting professor at the University of theWest of England, Bristol where, from 1992 to 1999, he was

Head of School of Economics He taught at UWE until 2007

John has taught a range of courses, including economic

principles on social science and business studies degrees,

development economics, comparative economic systems,

intermediate macroeconomics and managerial economics

He has also taught economics on various professional

courses

He is also the author of Essentials of Economics (Pearson Education, 4th edition 2007) and Economics and the Business

Environment (2nd edition 2008) He is also co-author, with

Kevin Hinde from the University of Durham, of Economics

for Business (Pearson Education, 4th edition 2007) and

with Peter Smith from the University of Southampton of

the Economics Workbook designed to accompany Economics

7th edition Translations or editions of the various booksare available for a number of different countries with thehelp of co-authors around the world

John is very interested in promoting new methods ofteaching economics, including group exercises, experiments,role playing, computer-aided learning and the use of audi-ence response systems and podcasting in teaching He hasorganised and spoken at conferences for both lecturers andstudents of economics throughout the UK and in manyother countries

As part of his work with the Economics Network he has contributed to its two sites for students and prospec-tive students of economics: Study Economics (www.studyeconomics.org) and Why Study Economics? (www.whystudyeconomics.ac.uk)

From March to June 1997, John was a visiting lecturer atthe University of Western Australia In July and August

2000, he was again a visiting lecturer at the University ofWestern Australia and also at Murdoch University in Perth

In 2007, John received a Lifetime Achievement Award as

‘outstanding teacher and ambassador of economics’prsented jointly by the Higher Education Academy, theGovernment Economic Service and the Scottish EconomicSociety

Alison Wride is Deputy Director

of the University of ExeterBusiness School and an AssociateProfessor in Economics Prior toher appointment as Deputy Head,she was Head of UndergraduateStudies within the School

Her areas of interest includethe student experience and therelationship between skills, em-ployability and education She is acknowledged as having

expertise in understanding the factors that influence

stud-ent satisfaction, particularly relevant given the School’s

position as number one business school in the UK for 2006,

2007 and 2008

In 2006 Alison received the Student Nominated Awardfor Teaching Excellence from the Economics Network ofthe UK Higher Education Academy This was followed

by the University of Exeter Vice Chancellor’s Award forExcellence in 2007, in recognition of both her role in lead-ing on the transformation of the student experience in theBusiness School and her own teaching Her work in thisarea has lead to requests for talks at a number of confer-ences and other events

Alison has taught economics at a variety of levels: Alevel, undergraduate and MBA Her teaching ethos is based

on enthusing students and bringing economics to life andsetting the theory in context She still believes that ‘thebest decision I ever made – in terms of my career – waschoosing to take A level economics I fell in love with the

About the Authors

subject within an hour and that was entirely due to the

excellence and enthusiasm of my teacher.’

Alison’s external interests include work with the

Treasury and Government Economic Service on economics

training for non-economists working in Government;

she is currently involved in a similar initiative with the

Scottish Government This work focuses on furnishingthose at the cutting edge of developing policy with thetools and economic understanding to ensure that both the formulation of aims and the choice of methods result in coherent strategies that enhance efficiency and equity

Brief Contents

Part E FOUNDATIONS OF MACROECONOMICS

Custom Publishing xv

1.1 What’s the latest economics news? 5 1.2 Looking at macroeconomic data 7 1.3 The opportunity costs of studying 11 1.4 Scarcity and abundance 13 1.5 The rise and fall of planning in the former

1.6 Adam Smith and the ‘invisible hand’ of the market 22

2.3 Price and output determination 42

3.1 Advertising and its effect on demand curves 62 3.2 Pricing on the buses 63

*3.3 Using calculus to calculate the price elasticity

3.5 Dealing in futures markets 76 3.6 A moral dilemma of tobacco taxes 79 3.7 The fallacy of composition 84

*4.1 Using calculus to derive a marginal utility

4.2 The marginal utility revolution 102 4.3 Is economics the study of selfish behaviour? 103 4.4 Taking account of time 104 4.5 Problems with insurance markets 108

*4.7 Consumer theory: characteristics theory 120

5.1 The short-run theory of production 1245.2 Costs in the short run 1305.3 The long-run theory of production 136

*5.4 The relationship between TPP, MPP and APP 130 5.5 The fallacy of using historic costs 131 5.6 Cost curves in practice 135

Contents

*5.7 The Cobb–Douglas production function 141

5.8 Minimum efficient scale 150

*5.9 Using calculus to find the maximum

5.10 The logic of logistics 160

6 Profit Maximising under Perfect

6.1 Alternative market structures 164

6.3 E-commerce and perfect competition 170

6.4 Breaking Sky’s monopoly on live football

6.6 Airline deregulation in the USA and Europe 180

7 Profit Maximising under Imperfect

7.1 Selling ice cream as a student 187

7.2 Is beer becoming more concentrated? 191

7.4 The prisoners’ dilemma 203

7.5 What’s the train fare to London? 207

7.7 Price discrimination in the cinema 209

8.1 Problems with traditional theory 214

8.2 Alternative maximising theories 218

Boxes

8.1 The organisational structure of firms 214

8.2 What do you maximise? 217

8.3 When is a theory not a theory? 219

8.6 Stakeholder power? 229

8.7 How do companies set prices? 232

9.1 Wage determination under perfect competition 237

9.2 Wage determination in imperfect markets 246

Boxes

9.1 Labour as a factor of production 238

*9.2 Using indifference curve analysis to derive the individual’s supply curve of labour 240 9.3 Immigration and the UK labour market 241 9.4 Monopsony in Victorian times 247 9.5 The rise and decline of the labour movement

9.6 How useful is marginal productivity theory? 251 9.7 Equal pay for equal work? 252 9.8 Flexible labour markets and the flexible firm 254

9.10 The economics of non-renewable resources 269

10 Inequality, Poverty and Policies to

*10.5 Tax cuts and incentives 298

11.1 Efficiency under perfect competition 30511.2 The case for government intervention 31311.3 Forms of government intervention 323

*11.4 Cost–benefit analysis 32911.5 Government failure and the case for

Boxes

11.1 The police as a public service 316 11.2 A commons solution 318 11.3 Should health-care provision be left to the

11.4 Deadweight loss from taxes on goods and

*11.5 What price a human life? 332

*11.6 Meeting the Kyoto Protocol 334 11.7 Mises, Hayek and the Mont Pelerin Society 338

12.1 Economics of the environment 34212.2 Policies to tackle pollution and its effects 34712.3 The economics of traffic congestion 35612.4 Urban transport policies 361

13.2 Privatisation and regulation 375Boxes

13.1 A lift to profits? 371 13.2 School fees in the UK 372 13.3 What price for peace of mind? 374 13.4 Selling power to the people 380

14.1 The scope of macroeconomics 38814.2 The circular flow of income 39014.3 Measuring national income and output 39314.4 Short-term economic growth and the

14.5 Long-term economic growth 403Appendix: Calculating GDP 409Boxes

14.1 Which country is better off? 396 14.2 How big is the underground economy? 397

14.4 Is stability always desirable? 402 14.5 Theories of growth 405 14.6 The costs of economic growth 406 14.7 When higher GDP can lead to lower welfare 410

15 Macroeconomic Issues and Analysis:

15.1 The costs of unemployment 420

15.3 Cost-push illusion 433 15.4 Is inflation dead? 434 15.5 The Phillips curve 436 15.6 Dealing in foreign exchange 445 15.7 The political business cycle (Part I) 448

16.1 Setting the scene: three key issues 45416.2 Classical macroeconomics 45616.3 The Keynesian revolution 46216.4 The monetarist–Keynesian debate 46616.5 The current position: an emerging consensus? 469Boxes

16.1 Balance the budget at all costs 460 16.2 The crowding-out effect 461 16.3 Will wage cuts cure unemployment? 463

17.1 Background to the theory 47517.2 The determination of national income 48617.3 The simple Keynesian analysis of

unemployment and inflation 49217.4 The Keynesian analysis of the business cycle 495Boxes

*17.1 Using calculus to derive the MPC 479 17.2 Consumption and saving in practice 480 17.3 Business expectations and their effect on

17.4 Deriving the multiplier formula 490 17.5 The paradox of thrift 492 17.6 Has there been an accelerator effect over

the past thirty years? 498

18.1 The meaning and functions of money 503

*18.5 Calculating the money multiplier 523 18.6 Are the days of cash numbered? 527

19 The Relationship between the Money

19.1 The effects of monetary changes on national

19.2 The monetary effects of changes in the goods

*19.3 ISLM analysis: the integration of the goods and

19.4 Taking inflation into account 556

19.1 Choosing the exchange rate or the money

19.2 The stability of the velocity of circulation 542

19.3 Crowding out in an open economy 546

*19.4 Environmentally sustainable macroeconomic

*20.3 ISLM analysis of fiscal and monetary policy 589

20.4 Fiscal and monetary policy in the UK 591

20.5 Rules versus discretion 601

Boxes

20.1 Managing the US economy 566

20.2 Riding a switchback 570

20.3 Following the golden rule 572

20.4 The operation of monetary policy in The UK 578

20.5 Central banking and monetary policy in the USA 580

20.6 Monetary policy in the eurozone 582

20.8 Using interest rates to control both aggregate

demand and the exchange rate 587 20.9 Quantitative easing 588

20.10 Inflation targeting 602

20.11 Interest rate responses and the financial

*20.12 How do inflation targets work in practice? 606

21 Aggregate Supply, Unemployment

21.2 The expectations-augmented Phillips curve 619

21.3 Inflation and unemployment: the new classical

21.1 Cost-push inflation and supply shocks 617

*21.2 Analysing demand-pull and cost-push inflation

using the ADI/ASI model 618

*21.3 Basing expectations on the past 622

21.4 The political business cycle (Part II) 625

21.5 The rational expectations revolution 628

21.6 Forecasting the weather 629

21.7 The boy who cried ‘Wolf’ 631

22.1 Long-run economic growth in industrialised

23.1 Supply-side policies and the macroeconomy 65123.2 Approaches to supply-side policy 65223.3 Market-orientated supply-side policies 65423.4 Interventionist supply-side policy 661Boxes

23.1 The supply-side revolution in the USA 655

*24.5 The optimum tariff or export tax 687 24.6 Giving trade a bad name 688 24.7 The Doha development agenda 690 24.8 Mutual recognition 699 24.9 Features of the single market 701 24.10 The Internal Market Scoreboard 702

25 The Balance of Payments and

25.1 Alternative exchange rate regimes 706

25.3 Free-floating exchange rates 72025.4 Exchange rate systems in practice 729

Appendix: The open economy and ISLM

Boxes

25.1 Balance of trade and the public finances 708 25.2 The UK’s balance of payments deficit 711 25.3 The effectiveness of fiscal and monetary policies under fixed exchange rates 718 25.4 The price of a Big Mac 722 25.5 The euro/dollar seesaw 724 25.6 The effectiveness of monetary and fiscal policies under floating exchange rates 728 25.7 How significant are inflation differentials? 733

26 Global and Regional Interdependence 742

26.1 Globalisation and the problem of instability 74326.2 European economic and monetary union (EMU) 74826.3 Achieving greater currency stability 755Boxes

26.1 Globalisation and the US trade imbalance 744 26.2 Attempts at harmonisation: the G8 748 26.3 Optimal currency areas 754

27.1 The problem of underdevelopment 76227.2 International trade and development 76627.3 Structural problems within developing

*27.4 Unemployment in developing countries 780 27.5 The building BRICs of development 782 27.6 Argentina in crisis 784 27.7 Debt and the environment 786

Postscript: The Castaways or Vote for Caliban 792Appendix 1: Some Techniques of Economic Analysis A:1

Threshold Concepts and Key Ideas T:1

Supporting Resources

Visit www.pearsoned.co.uk/sloman click on the Economics, Seventh Edition cover at the top of the page, select

MyEconLab registration and log-in to access MyEconLab

MyEconlab for students

MyEconLab for Economics, Seventh Edition enables you to assess your learning and provides you with a

per-sonalised Study Plan, which identifies areas you need to concentrate on to improve your grades Specific tools areprovided to direct your study in the most efficient way Access to MyEconLab is provided with every new purchase

of the main text

MyEconLab contains the following resources:

• a personalised Study Plan, with extensive self-testing material and homework that can be set by your tutor;

• a complete online workbook for use alongside the textbook as you learn;

• multiple choice questions to test your learning;

• extra case studies with questions per chapter;

• maths cases with exercises, related to the Looking at the Maths boxes in the book;

• answers to all in-chapter questions;

• an economics news blog updated several times per month Each news item has an introduction, links to a range

of news articles, questions and references to the relevant chapter of the book;

• animations of all key models with audio explanations These can be downloaded to your iPod or MP4 player;

• extensive annotated Hotlinks to relevant sites on the Internet, regularly updated;

• an online glossary to explain key terms with flashcards to test your knowledge

MyEconLab for lecturers

• MyEconLab’s gradebook automatically records each student’s time spent and performance on the tests andStudy Plan and generates reports you can use to monitor your students’ progress

• You can use MyEconLab to build your own tests, quizzes and homework assignments from the question baseprovided to set for your students’ assessment

• Questions are generated algorithmically so that they use different values each time they are used

• If you want to devote the time, you can create your own exercises by using the econ exercise builder

For lecturers wanting more information about the MyEconLab product, please contact your local Pearson

Education sales representative at www.pearsoned.co.uk/replocator or visit www.myeconlab.com.

Additional lecturer resources:

• tutor guide to using chapters and discussion of learning/teaching issues;

• customisable testbank of question material;

• customisable lecture plans in PowerPoint with questions for use in lectures with or without an audienceresponse system;

• key models animated as full-colour PowerPoint slide shows;

• downloadable PowerPoint slides of all figures and tables from the book;

• a range of teaching and learning case studies;

• workshops with answers;

• answers to end-of-chapter questions;

• answers to the case studies found in MyEconLab

These lecturer resources can be downloaded from the lecturer website at www.pearsoned.co.uk/sloman Click

on the Economics, Seventh Edition cover and select lecturer resources Most are open access, but answers are

password protected

The lecturer resources are also available on a memory stick from your Pearson Education sales representative

Custom Publishing

Custom publishing allows academics to pick and choose content from one or more textbooks for their course and combine

it into a definitive course text

Here are some common examples of custom solutions which have helped over 1000 courses across Europe:

• different chapters from across our publishing imprints combined into one book;

• lecturer’s own material combined together with textbook chapters or published in a separate booklet;

• third-party cases and articles that you are keen for your students to read as part of the course;

• any combination of the above

The Pearson Education custom text published for your course is professionally produced and bound – just as you wouldexpect from any Pearson Education text Since many of our titles have online resources accompanying them we can evenbuild a Custom website that matches your course text

If you are teaching a first year Economics course you may have a large teaching team with different lecturers teaching themicro and macroeconomics sections Do you find that it can be difficult to agree on one textbook? If you do, you might findcombining the macro and micro halves from different Pearson textbooks, either in one volume or two separate volumes, auseful solution If you like to spend slightly longer on any one topic, you might like to provide some additional chapters asfurther reading online for your students

Custom publishing has enabled adopters of this text to employ these different solutions

If, once you have had time to review this title, you feel Custom publishing might benefit you and your course, please do get

in contact However minor, or major the change – we can help you out

For more details on how to make your chapter selection for your course please go to www.pearsoned.co.uk/sloman and select the custom publishing link.

You can contact us at: www.pearsoncustom.co.uk or via your local representative at: www.pearsoned.co.uk/replocator.

Guided Tour

The book is divided into seven parts, each with a full page

introduction and part map to help you navigate around the

In Chapter 10 we look at policies that address the distribution of income In Chapter 11 we examine the

we turn to government policies with respect to the environment and business.

Full page chapter openers provide an overview of the topics to

be covered in each chapter, and a map of all chapter sectionsand sub-sections These overviews, as well as full learningobjectives per chapter, can be found in MyEconLab

Money and Interest Rates

18.1 The meaning and functions of money 503

The functions of money 503 What should count as money? 504

18.2 The financial system 504

The role of the financial sector 504 The banking system 505 Deposit taking and lending 506 Liquidity and profitability 509 The central bank 511 The role of the money market 515

18.3 The supply of money 520

Definitions of the money supply 520 The creation of credit: the simplest case 520 The creation of credit: the real world 522 What causes money supply to rise? 524 The flow-of-funds equation 525 The relationship between money supply and the rate of interest 526

18.4 The demand for money 527

The motives for holding money 527 The transactions plus precautionary demand

for money: L1 528

The speculative (or assets) demand for money: L2 529

The total demand for money: L1+ L2 530

But why do changes in the money supply affect the economy? The answer is that the supply of money and

the demand for money between them determine the rate

demand and the performance of the economy generally.

In section 18.5 we shall see just how this process works First we define what is meant by money and examine its operation of the financial sector of the economy and its come in for considerable scrutiny in recent times follow- crunch’ of the 2007–9.

We then turn to look at the demand for money Here we answer to that would probably be ‘as much as possible’! they want to hold in the form of money?

Finally, we put supply and demand together to see how

we will see how the central bank intervenes in money markets to alter interest rates.

C H A P T E R M A P

NAVIGATION AND SETTING THE SCENE

Questions throughout the text enable you to test your understanding

of what you have just read Answers appear in MyEconLab

Let us assume that the market rate of interest is 10 per cent (i.e 0.1) Then according to the formula, a purchaser would be prepared to pay

= £10 000

Why should this be so? If a person deposits £10 000 in the bank, with an interest rate of 10 per cent this will earn

guaranteed to earn a rent of £1000 per year, then provided

than putting money in the bank The competition between

reaches £10 000.

This is just another example of equilibrium being where marginal cost equals marginal benefit This can be demon- strated by rearranging equation (1) to give

Pi = R

Remember that the equilibrium price of the land (P) is

£10 000 and that the rate of interest (i) is 0.1 If you borrow

in interest payments (i.e Pi) This is your annual marginal

will earn from the land.

1 What price would the same piece of land sell for if it still earned £1000 rent per year, but if the rate of interest were now (a) 5 per cent; (b) 20 per cent?

2 What does this tell us about the relationship between the price of an asset (like land) and the rate of interest?

Who are the poor? Who are the rich?

We have been building up an answer to these questions as

concerns the ownership of land and capital Many people

earn no profit, rent or interest.

For those who are fortunate enough to own productive assets, their income from them will depend on (a) the quantity they own and (b) their rental value.

?

£1000 0.1

2709 THE THEORY OF DISTRIBUTION OF INCOME

The quantity of assets owned

This will depend on the following:

• Inheritance Some people have rich parents who leave them substantial amounts of land and capital.

• Past income and savings If people have high incomes and save a large proportion of them, this helps them to build up a stock of assets.

• Skill in investment (entrepreneurial skill) The more ful people are in investing and in organising produc- tion, the more rapidly will their stock of assets grow.

skil-• Luck When people open up a business, there are usually substantial risks The business might flourish or fail.

The rental value

This is the income earned per unit of land and capital

It will depend on the following:

• The level of demand for the factor This depends on

the factor’s MRP, which in turn depends on its physical productivity (MPP) and the demand for the good it pro- duces and hence the good’s MR.

• The elasticity of demand for the good The greater the monopoly power that capital owners have in the goods

uct and the greater will be the supernormal returns they can earn on their capital.

• The elasticity of supply of the factor The less elastic its supply, the more factor owners can gain from a high

of economic rent that the factor will earn.

• The total factor supply by other factor owners The ther to the left the total factor supply curve, the higher

fur-can earn for any given level of demand.

Thus if you are lucky enough to have rich parents who leave you a lot of money when you are relatively young; if

portion of your earnings; if you own assets that few other

then you may end up very rich.

If you have no assets, you will have no property income

at all If at the same time you are on a low wage or are unemployed, then you may be very poor indeed.

Its supply is totally inelastic (or nearly so) Its demand

curve is downward sloping and will equal the MRP of

land.

2 The price of land depends on its potential rental value (its marginal benefit) and the repayment costs of

borrowing to pay for the land (its marginal cost).

Equilibrium is where the two are equal.

3 People’s income depends not only on their wages but

on whether they own any land or capital, and, if they

do, the rental value of these assets This is the final element in determining the distribution of income in the economy.

End-of-chapter questions can be used for

self-testing or in class

Take the Chapter Tests in MyEconLab to generate a personalised Study Plan.

You will then be directed to specific resources in MyEconLab to help youfocus your studies and improve your grades For details on how to accessMyEconLab, see the access card that is packaged with every new copy ofthis book

END OF CHAPTER QUESTIONS271

END OF CHAPTER QUESTIONS

1 The wage rate that a firm has to pay and the output it (all figures are hourly):

Number of workers 1 3 5 7

Wage rate ( ACL ) (£) 3 5 7 9 10

Assume that output sells at £2 per unit.

(a) Copy the table and add additional rows for TCL ,

MCL, TRPLand MRPL Put the figures for MCL and

MRPL in the spaces between the columns.

(b) How many workers will the firm employ in order to maximise profits?

(c) What will be its hourly wage bill at this level of employment?

(d) How much hourly revenue will it earn at this level

of employment?

(e) Assuming that the firm faces other (fixed) costs of

£30 per hour, how much hourly profit will it make?

(f) Assume that the workers now formed a union and that the firm agreed to pay the negotiated wage rate to all employees What is the maximum to which the hourly wage rate could rise without causing the firm to try to reduce employment below the level of (b) above? (See Figure 9.10.) (g) What would be the firm’s hourly profit now?

2 If a firm faces a shortage of workers with very specific skills, it may decide to undertake the necessary

training itself If, on the other hand, it faces a shortage

of unskilled workers, it may well offer a small wage increase in order to obtain the extra labour In the first case, it is responding to an increase in demand for labour by attempting to shift the supply curve In the the supply curve Use a demand and supply diagram to illustrate each case Given that elasticity of supply is different in each case, do you think that these are the best policies for the firm to follow? What would happen

to wages and economic rent if it used the second policy

in the first case?

3 Why does the marginal revenue product differ between workers in different jobs?

4 For what reasons is the average gross weekly pay of women only 76.4 per cent of that of men in the UK?

5 Given the analysis of bilateral monopoly, if the passing

of minimum wage legislation forces employers to pay higher wage rates to low-paid employees, will this necessarily cause a reduction in employment?

6 Using a diagram like Figure 9.13, demonstrate what will happen under perfect competition when there is

an increase in the productivity of a particular type of capital Consider the effects on the demand, price (rental rate) and quantity supplied of the services of this type of capital.

7 What factors could cause a rise in the market rate of interest?

8 How is the market price of land related to its productivity?

Online resources

Additional case studies in MyEconLab

9.1 Economic rent and transfer earnings This examines a way of classifying the earnings of a factor of production and

shows how these earnings depend on the elasticity of supply of the factor.

9.2 Telecommuters This case study looks at the rise of telecommuting, whereby people are able to work from home

utilising modern technology.

9.3 Other labour market imperfections This looks at the three imperfections identified on page 255: namely,

imperfect information, persistent disequilibria in labour markets and non-maximising behaviour by firms or workers.

9.4 Ethnic minorities in the UK labour market This case study looks at differences in income and employment between

different ethnic groups in the UK.

9.5 Profit sharing An examination of the case for and against profit sharing as a means of rewarding workers.

Maths Case 9.1 Calculating the long-run cost of supplying additional equipment for rent A worked example.

Maths Case 9.2 Calculating the internal rate of return A worked example.

Websites relevant to this chapter

See sites listed at the end of Chapter 10 on page 303.

PRACTISING AND TESTING YOUR LEARNING

A printed Workbook is available for purchase

(from www.pearson-books.com, ISBN 978-0-273-72916-7), which contains over 1500 questions of various types, carefullymatched to the content of the main text

Graphical problems help you explore economic concepts visually.

Introducing Economics

production involves using various resources or factors of

production.

Q3 It is normal to group factors of production into

three broad categories These are:

1 .

2 .

3 .

Q4 Which one of the following would not be

classified as a factor of production?

A.Jim Bodget, a bricklayer for a local construction firm.

B.The cement mixer Jim uses.

C.The cement Jim puts in the mixer.

D.The building site Jim works on.

E.The wage Jim gets paid at the end of the week.

1.1 What do economists study?

(Page 4) Economists study many issues, but all of them stem

occurs because there are not enough resources (labour, land and capital) to produce everything that people would like.

Q1 The problem of scarcity is directly relevant:

A.only to those times when rationing has been enforced.

B.only to developing countries low in resources.

C.only to those on low incomes.

D.only to those periods of history before mass production.

E.to all countries and all individuals.

Q2 The problem of scarcity will eventually disappear

with the development of new technology and resulting higher levels of production. True/False ( Page 4) In order to tackle the problem of scarcity, societies

REVIEW

In this first chapter we start by looking at the subject matter of economics What is it that

economists study? How is the subject divided up? What makes a problem an economic one?

Although all countries face economic problems, they nevertheless tackle them in different ways In some countries the government plays a major role in economic decision making In others decisions are left much more to individuals Section 1.2 examines how these different types of economy operate.

We then turn to examine types of reasoning employed by economists Do economists proceed

like natural scientists, or does being a social science make economics different from subjects like making Can economists tell governments what they ought to do?

A

Multiple choice Written answer Delete wrong word Diagram / table manipulation Calculation Matching/ordering

AIDING YOUR UNDERSTANDING

Threshold Concept boxes cover the fundamental concepts

that you need to grasp in order to think like an economist

An icon appears in the margin when these concepts are

referred to later in the text, and highlights the links between

different parts of the subject

• What goods and services are going to be produced and

in what quantities, since there are not enough resources

how much wheat, how much insurance, how many video games etc will be produced?

• How are things going to be produced? What resources

are going to be used and in what quantities? What

tech-be produced by robots or by assembly line workers?

Will electricity be produced from coal, oil, gas, nuclear fission, renewable resources or a mixture of these?

• For whom are things going to be produced? In other

words, how will the nation’s income be distributed?

sume of the nation’s output What will be the wages of

How much will pensioners receive? How much of the nation’s income will go to shareholders or landowners?

All societies have to make these choices, whether they are made by individuals, groups or the government These

81 INTRODUCING ECONOMICS

choices can be seen as microeconomic choices, since they

put, but with the individual goods and services that make it

incomes to buy them.

Choice and opportunity cost

Choice involves sacrifice The more food you choose to

The more food a nation produces the fewer resources will

production or consumption of one thing involves the sacrifice of alternatives This sacrifice of alternatives in the production (or consumption) of a good is known as

its opportunity cost.

The opportunity cost of any activity is the sacrifice

made to do it It is the best thing that could have been done as an alternative.

KEY IDEA 2

We thus have to make decisions between alternatives To make sensible decisions we must weigh up the benefits

of doing something against its opportunity cost This is another of our threshold concepts (no 8): see page 100.

1 Think of three things you did last week What was the opportunity cost of each one?

2 Assume that a supermarket has some fish that has reached its sell-by date It was originally priced at £10, but yesterday was marked down to £5 ‘for quick sale’.

It is now the end of the day and it still has not been sold The supermarket is about to close and there is

no one in the store who wants fish What is the opportunity cost for the store of throwing the fish away?

?

Scarcity, as we have seen, is at the heart of economics.

We face scarcity as individuals Each of us has a limited limited lifespan So even if we had the money, we would consume or take part in every possible activity.

The same applies to nations A country has limited would like So too with the world Our planet has finite exploit these resources are also limited.

We thus have to make choices In fact, virtually every time natives If you choose to spend your time staying in and buy a DVD for £10, you are choosing not to spend that £10

on something else Likewise, if a nation devotes more

of its resources to producing manufactured goods, there will be less to devote to the provision of services or the production of agricultural goods If we devote more have to produce less of the material goods that people want to consume.

What we give up in order to do something is known as its something measured in terms of the best alternative for- time or money if you had not made the choice you did

This is one of the most fundamental concepts in importance, it affects the way you look at economic prob-

eco-Section Summaries allow you to recap on your learning at

frequent intervals and provide an important revision tool

1.3 THE NATURE OF ECONOMIC REASONING25 Section summary

1 The economic systems of different countries vary according to the extent to which they rely on the market

or the government to allocate resources.

2 At the one extreme, in a command economy, the state makes all the economic decisions It plans amounts of resources to allocate for present consumption and amounts for investment for future output It plans the will use and the amount of resources it will be allocated.

It plans the distribution of output between consumers.

3 A command economy has the advantage of being able

to address directly various national economic goals, such as rapid growth and the avoidance of unemployment and inequality A command economy, however, is likely to be inefficient: a large bureaucracy will be needed to collect and process information;

prices and the choice of production methods are likely

to be arbitrary; incentives may be inappropriate;

shortages and surpluses may result.

4 At the other extreme is the free-market economy

In this economy, decisions are made by the interaction of demand and supply Price changes act as the mechanism whereby demand and supply are balanced If there is a shortage, price will rise until the shortage is eliminated If there is a surplus, price will fall until that is eliminated.

5 A free-market economy functions automatically and if there is plenty of competition between producers this can help to protect consumers’ interests In practice, however, competition may be limited; there may be great inequality; there may be adverse social and environmental consequences; there may be macroeconomic instability.

6 In practice, all economies are some mixture of the market and government intervention It is the degree and form of government intervention that distinguishes one type of economy from another.

Economics is one of the social sciences So in what sense is

astronomy? What is the significance of the word ‘social’ in

role in helping governments devise economic policy?

Economics as a science

The methodology employed by economists has a lot in

attempt to construct theories or models which are then

constructs models of planetary movements to explain why

tion in the future.

Models in economics

In order to explain and predict, the economist constructs

models show simplified relationships between various economic phenomena For example, a model of a market

price Although most models can be described verbally,

phical or mathematical form.

Building models

Models are constructed by making general hypotheses

that consumer demand will rise when consumer incomes

rise These hypotheses will often be based on observations.

observations is known as induction.

Using models

caused: what the causes of inflation are, why workers in some industries earn more than others, and so on.

forecasts: for example, inflation will be below 5 per cent

then ’ variety: for example, if demand for good x rises,

models is known as deduction.

When making such deductions it has to be assumed that nothing else that can influence the outcome has changed

its price will rise assuming the cost of producing good x has

1.3 THE NATURE OF ECONOMIC REASONING

Economic model A formal presentation of an

You can use your personalised MyEconLab Study Plan to assess

how well you are doing, and areas you need to concentrate on toimprove

Extra resources such as animated graphs with audioexplanations are provided to further explain the topics youneed to focus on improving your grades For details on how

to access MyEconLab, see the access card that is packaged with every new copy of this book

All economic terms are printed in bold where they first

appear in the text, and definitions of them are given

at the bottom of the page All terms also appear in the

comprehensive glossary that appears at the back of

the book and in MyEconLab

5.3 THE LONG-RUN THEORY OF PRODUCTION137

of scale if costs per unit of output fall as the scale of

produc-to scale from its facproduc-tors of production, then as it produces

per unit of output Other things being equal, this means that it will be producing at a lower unit cost.

There are several reasons why firms are likely to ence economies of scale Some are due to increasing returns

experi-to scale; some are not.

workers can do more simple, repetitive jobs With this

spe-workers can become highly efficient in their particular job, especially with long production runs; there is less time lost in workers switching from one operation to another;

employed who have specific skills in specific areas.

are indivisible The most obvious example is machinery.

could not make full use of one They only become

econom-problem of indivisibilities is made worse when different

are of a different size For example, if there are two types of

aging 4 units a day, a minimum of 12 units would have

to be produced, involving two production machines and

utilised.

con-tains things (blast furnaces, oil tankers, pipes, vats, etc.)

reason has to do with the relationship between a

contain-largely on the materials used to build it and hence roughly

Large containers have a bigger volume relative to surface

with a bottom, top and four sides, with each side

measur-area of 6 square metres (six surfaces of 1 square metre

each) If each side were now to be doubled in length to

surface area 24 square metres (six surfaces of 4 square

been gained at only a fourfold increase in the container’s

in cost.

more efficient in the sense that more output can be gained

may be required to operate a machine whether it be large or

raw materials.

be sufficient waste products to enable some by-product or by-products to be made.

product through several stages in its manufacture This

from one firm or factory to another For example, a large

or waste paper into cardboard and then into cardboard boxes in a continuous sequence.

All the above are examples of plant economies of scale.

machine being large There are other economies of scale,

however, that are associated with the firm being large –

perhaps with many factories.

plants can specialise in particular functions There can also

be centralised administration of the firm; for example, one human resources department could administer all the

be made by rationalising their activities in this way.

only when the firm is large: for example, research and

research laboratory This is another example of

indivisibil-Specialisation and division of labour Where production

tasks, thus allowing workers to acquire a high degree of efficiency.

Indivisibility The impossibility of dividing a factor into

smaller units.

Plant economies of scale Economies of scale that arise

because of the large size of a factory.

Rationalisation The reorganising of production (often

after a merger) so as to cut out waste and duplication and generally to reduce costs.

Definitions

The Key Ideas in an economist’s toolkit are

highlighted and explained where they firstappear Again, an icon appears in the marginwhenever they recur later in the book

3.1 ELASTICITY67

between two points on the curve, or at a specific point.

arc method Calculating elasticity at a point will involve

supply curves as for demand curves: the formulae are the

rather than quantity demanded.

Given the following supply schedule:

(b) Using the arc method, calculate price elasticity

of supply (i) between P = 2 and P = 4; (ii) between P = 8

(e) What would be the answer to (d) if the supply curve were

a straight line but intersecting the horizontal axis to the right of the origin?

Income elasticity of demand (YD )

So far we have looked at the responsiveness of demand and

determinants of demand and supply In theory, we could

in any one of their determinants We could have a whole

range of different types of elasticity of demand and supply.

Elasticity The responsiveness of one variable

(e.g demand) to a change in another (e.g price).

This concept is fundamental to understanding how markets work The more elastic variables are, the more responsive is the market to changing circumstances.

In practice there are just two other elasticities that are particularly useful to us, and both are demand elasticities.

The first is the income elasticity of demand (YD) This

measures the responsiveness of demand to a change in

consumer incomes (Y) It enables us to predict how much

The formula for the income elasticity of demand is: the

by the percentage (or proportionate) change in income.

Putting this in symbols gives

YD = %ΔQ D

%ΔY

KEY IDEA 9

?

Figure 3.9 Unit elastic supply curves

*LOOKING AT THE MATHS

We can use a supply equation to demonstrate why a straight-line supply curve through the origin has an elasticity equal to 1 Assume that the supply equation is

Qs= a + bP (1)

If the supply curve passes through the origin, the value of

a= 0 Thus:

The point elasticity formula for price elasticity of supply

is similar to that for price elasticity of demand (see pages 63–64) and is given by

Income elasticity of demand The responsiveness of

demand to a change in consumer incomes.

Formula for income elasticity of demand (YD ) The

percentage (or proportionate) change in demand divided

by the percentage (or proportionate) change in income:

%ΔQ D ÷ %ΔY.

Definitions

APPLYING ECONOMICS TO THE REAL WORD

Case Studies and Applications boxes include

examples, data and scenarios from the real world

to show you why this subject really matters in

everyday life

56620 FISCAL AND MONETARY POLICY

BOX 20.1 MANAGING THE US ECONOMY

To fiscally stimulate or not to fiscally stimulate, that is the question

CASE STUDIES AND APPLICATIONS

to 2006, many people defaulted on their mortgages and other debt Banks found themselves in a liquidity crisis as sub-prime debt They cut back on loans in what became known as the ‘credit crunch’.

By the end of 2007, the US economy seemed to be heading for recession and by the final quarter or the year, annual economic growth had become negative (−0.2 per cent) In January 2008, President Bush announced an emergency $154 billion stimulus package of tax rebates, worth 1.1 per cent of GDP The effect was to boost consumer spending, and recession seemed to have been averted By the second quarter of 2008, the economy was growing at an annual rate of 3.3 per cent.

But the effect was short-lived Once the tax rebates had been spent, the growth in consumer spending ceased By the end of 2008, GDP was declining; the country was in recession.

On coming to office in January 2009, President Obama announced a major fiscal stimulus package, worth $819 billion – his ‘Recovery and Investment Plan’ This was in addition to monetary policies designed to increase the flow of credit (see Box 20.5) The aim of the fiscal stimulus was to create 3 million jobs and reverse the collapse in The package included a $1000 tax cut for some 95 per cent of working families, but the main feature was targeted increases in government expenditure to improve infrastructure: doubling the production of renewable energy, modernising some 75 per cent of government buildings to save energy, and large-scale investment in schools, colleges and public universities, in nationwide broadband, in science, research and technology.

The measures would bring the US budget deficit for

2009 to between $1.2 and $1.6 trillion, or between 8 and cent for Germany, 3.8 per cent for Italy, 6.2 per cent for Spain and 8.8 per cent for the UK.

Whether such measures would work to revive the economy would depend on their effects on consumer behaviour and business confidence Would the tax cuts, for example, encourage people to go out and spend? Or would people simply save the tax cuts for fear of losing their jobs in the deepening recession? What would be the multiplier and accelerator effects of the increased government expenditure? Would it stimulate further consumer spending and hence increased investment,

or would the effects be offset by falling consumer expenditure and thus reduced investment as firms cut back on capacity?

Which is likely to give a bigger boost to aggregate demand: tax cuts of a given amount targeted to (a) the rich, or (b) the poor?

?

Response to the slowdown in 2001

Since the start of 2001, the US Federal Reserve, led by

Alan Greenspan, had been fighting a sharp slowdown in

the US economy Interest rates had been cut seven times

from their level of 6.5 per cent at the beginning of the

year to 3.5 per cent in August By September 2001,

the economy seemed to be starting to recover.

The terrorist attacks on 11 September brought this

modest recovery to an abrupt halt At this point, many

analysts were suggesting that it might be necessary to

lower rates close to zero in order to kick-start the

economy Even then the success of such a strategy

was not guaranteed.

At this point, it was decided that a measure of

discretionary fiscal policy was required in order to help

reduce pressure on the Federal Reserve and its use of

interest rates to pump-prime the economy.

Following a meeting at the end of September 2001,

Alan Greenspan advised Congress that a fiscal stimulus

of $100 billion, or almost 1 per cent of US GDP, was

advisable The Stimulus Bill proposed cutting personal

taxation from 27 to 25 per cent, and offering tax

exemption to business for new investment The

Democrats were opposed to the personal tax cuts,

which would go largely to the rich A compromise was

reached in March 2002 when a stimulus package of

incentives to business.

Such was the delay in passing the Stimulus Bill that

recovery began to occur without it With continued

reductions in interest rates, which by December 2001

had been cut eleven times and, at 1.75 per cent, were at

in the 1960s, the economy seemed to be bouncing back.

Economic growth was 1.6 per cent in 2002, 2.5 per cent

in 2003 and 3.6 per cent in 2004.

But it was not just the Stimulus Bill and the interest

rate cuts that were boosting the economy Fiscal policy

generally was becoming more and more expansionary as

over $650 billion were given between 2001 and 2004

(71.7 per cent of which went to the richest 20 per cent,

26.4 per cent to the richest 1 per cent and just 0.2 per cent

to the poorest 20 per cent) In 2000, there was a budget

surplus of 2.4 per cent of GDP By 2004, the total tax cuts

during the period had transformed this into a deficit of

3.6 per cent.

Another dose of medicine

In 2007, the US economy once more seemed to be heading

for recession As we saw in Box 18.2 on pages 572–3,

many large mortgages had been given to people with low

credit ratings (sub-prime mortgages) when interest rates

had been low With interest rates rising steeply from 2004

Websites relevant to each chapter are listed at the

end of the chapter and are linked to the chapter

resources area of MyEconLab

2127 PROFIT MAXIMISING UNDER IMPERFECT COMPETITION

Online resources

Additional case studies in MyEconLab

7.1 The motor vehicle repair and servicing industry A case study of monopolistic competition.

7.2 The corner shop and the hypermarket A case study in non-price competition: how the corner shop can survive

competition from the big supermarkets.

7.3 Curry wars Monopolistic competition in the take-away food market.

7.4 Bakeries: oligopoly or monopolistic competition A case study on the bread industry, showing that small-scale local

bakeries can exist alongside giant national bakeries.

7.5 ‘Rip-off Britain’ This examines the evidence for oligopolistic collusion in the car, supermarket and banking

industries.

7.6 Fair wars in the skies? The effect of the entry of low-cost airlines on air fares.

7.7 A product’s life cycle How market conditions vary at different stages in a product’s life.

7.8 Advertising and the public interest Does the consumer benefit from advertising?

Maths Case 7.1 Calculating the profit-maximising price of a price leader Using equations for demand, revenue and cost

curves.

Maths Case 7.2 Deriving the Cournot equilibrium An algebraic example.

Maths Case 7.3 Calculating the profit-maximising prices under third-degree price discrimination Using calculus to find

the profit-maximising output and price in each market and to compare the profit with and without price discrimination.

Websites relevant to Chapters 6 and 7

Numbers and sections refer to websites listed in the Web Appendix and hotlinked from this book’s website at

www.pearsoned.co.uk/sloman.

• For news articles relevant to this and the previous chapter, see the Economics News Articles link from the book’s

website.

• For general news on companies and markets, see websites in section A, and particularly A2, 3, 4, 5, 8, 9, 18, 24, 25,

26, 36 See also A38, 39, 40, 43 and 44 for links to newspapers worldwide; and A41 and 42 for links to economics

news articles from newspapers worldwide.

• For sites that look at competition and market power, see B2 (third link); E4, 10, 18; G7, 8 See also links in I 7, 11, 14

and 17.

• For information on OPEC (Box 7.3), see site H6.

• For a site on game theory, see A40 including its home page See also D4; C20; I 17 and 4 (in the EconDirectory section).

• For a site that contains a number of open-access computer-based games on oligopoly and game theory that can be

played between students, see site C24.

• For a simulation of running a farm (under perfect competition), see site D12.

• For a simulation on third-degree price discrimination, see site D3.

Additional Case Studies relevant to each chapter can be found in

MyEconLab These cases are listed at the end of each chapter

A news blog site New items are added several times per month These

link to articles in the press and there are questions on each news itemand references to the book There is also a powerful search featurethat lets you search for articles by chapter of the book, by topic or

by month

FLEXIBLE LEARNING

Starred sections contain optional, more advanced material.

These can be omitted without interrupting the flow of the

argument

54819 THE RELATIONSHIP BETWEEN THE MONEY AND GOODS MARKETS

The goods and money markets

In this chapter, we have shown that there are two key

mar-these two markets interact The first is the goods market;

has been analysed by using a model.

In the case of the goods market, the model is the Keynesian injections/withdrawals model Any change in

change For example, a rise in government expenditure

national income In other words, an increase in the

the output of goods and services (assuming that there are sufficient idle resources).

In the case of the money market, the model is the one

showing the demand for money (L) and the supply of

in the supply or demand for money will cause the

equilib-directly in this market, either by affecting the supply of money or by operating on interest rates.

What we have shown in this chapter is that the two

markets interact: that changes in one market cause changes

has a direct effect in the goods markets, but also an indirect

The goods market effect was shown in Figure 19.8(a) The

rise in injections led to a multiplied rise in income to Y2 The money market effect was shown in Figure 19.8(b) The

money and a resulting rise in interest rates to r2 This in turn had an effect back in the goods market, with a higher

somewhat and reducing the final rise in income.

The effect of a rise in money supply in the two markets was shown in Figures 19.1, 19.2 and 19.7 (on pages 537 and 540) The rise in money supply reduces interest rates.

This then, via an increase in investment (or a reduction

and a reduction in imports), leads to a multiplied rise in

in the money market, with a higher income leading to a

rates.

The trouble with our analysis so far is that we have needed at least two diagrams What we are going to look

at in this section is a model which combines these two

mar-model is known as the ISLM mar-model.

The model allows us to examine the effects of changes

originating in one of the two markets on both national

will be in both the goods and the money markets

simul-curves: an IS curve and an LM curve The IS curve is based

on equilibrium in the money market.

Let us examine these two curves in turn.

The IS curve

Deriving the IS curve

To explain how the IS curve is derived, let us examine

part shows the familiar Keynesian injections and

with-assuming that saving is the only withdrawal from the

cir-Thus in equilibrium I = S (i.e J = W) The bottom part of Figure 19.11 shows the IS curve This shows all the various

curves I1and S1 Equilibrium national income will be where

I = S, i.e at Y1 Thus in the lower part of Figure 19.11, an

interest rate of r1will give a level of national income of Y1

Thus point a is one point on the IS curve At an interest rate of r1 the goods market will be in equilibrium at an

income of Y1 Now what will happen if the rate of interest changes?

Let us assume that it falls to r2 This will cause a rise in investment and a fall in saving A rise in investment is

investment line to I2 Likewise a fall in saving is shown by a

shift in the saving curve to S2 This will lead to a multiplied

rise in income to Y2(where I2= S2 ) This corresponds to

point b in the lower diagram, which therefore gives a ond point on the IS curve.

sec-*19.3 ISLM ANALYSIS: THE INTEGRATION OF THE GOODS AND

MONEY MARKET MODELS

ISLM model A model showing simultaneous

equilibrium in the goods market (I= S) and the money market (L= M).

Definition

Optional Looking at the Maths boxes are designed for students

on more rigorous courses, which make use of maths Theyexpress mathematically what is also covered in words orgraphically Most link to Maths Cases with worked mathematicalexamples and numerical questions that can be found inMyEconLab

cost curves, sales revenue maximisation will tend to lead to a higher output and a lower price than profit maximisation.

Draw a diagram with MC and MR curves Mark the output (a) at which profits are maximised; (b) at which sales revenue is maximised.

The firm will still have to make sufficient profits, ever, to keep the shareholders happy Thus firms can be

how-satisficers.

The effect of this profit constraint is illustrated in Figure

8.2 The diagram shows a total profit (TΠ ) curve (This is

found by simply taking the difference between TR and TC

profit is Π (whatever the output) Any output greater than

Q3 will give a profit less than Π Thus the sales revenue

maximiser who is also a profit satisficer will produce Q3 , not

Q1 Note, however, that this output is still greater than the

profit-maximising output Q2

?

2208 ALTERNATIVE THEORIES OF THE FIRM

If the firm could maximise sales revenue and still make more than the minimum acceptable profit, it would prob- ably spend this surplus profit on advertising to increase revenue further This would have the effect of shifting

ing costs money).

*LOOKING AT THE MATHS

We can express sales revenue maximisation algebraically.

We start with the situation with no profit constraint.

Unconstrained sales revenue maximisation

Assume that the total revenue function is given by

TR = bQ − cQ2 (1)

This will give a straight-line MR function given by

MR= = b − 2cQ Total revenue is maximised where MR= 0, since, when

total revenue is maximised, any increase in output will give a zero rise in total revenue In other words, at the top

of the total revenue curve in Figures 8.1 and 8.2, the slope Thus:

Constrained sales revenue maximisation

If there is a profit constraint, we can write the objective

function as Max TR, subject to TR− TC ≥ TΠ* where TΠ * is the minimum profit that must be achieved Assume that

the TR and TC functions are given by

We can use this to solve for Q An example of this is given

in Maths Case 8.1 in MyEconLab.

Figure 8.2 Sales revenue maximising with a profit constraint

Figure 8.1 Sales revenue maximising output

See Suggestions for Shorter or Less Advanced Courses in the Preface for different ideas of how best to

use the book for different courses

• ‘Looking at the maths’ sections These short sections express a topic mathematically Some use calculus; some

courses and go further than other textbooks at

introduc-courses Most refer students to worked examples in Maths

equations; some use simple unconstrained optimisation

both substitution and Lagrange multipliers The ‘Looking

students on non-mathematical courses without any loss

of continuity.

• An open learning approach, with questions ated into the text so as to test and reinforce students’

incorpor-much more active process.

• End-of-chapter questions These can be set as work for students to do in class or at home Alternatively, stud-

at the end of a topic.

• Summaries given at the end of each section, thus viding a point for reflection and checking on compre- hension at reasonably frequent intervals.

pro-• An even micro/macro split.

• The book is divided into seven parts This makes the structure transparent and makes it easier for the student

to navigate.

Despite retaining these popular features, there have been many changes to this seventh edition.

Extensive revision

Economics (seventh edition) uses a lot of applied material,

ject alive for students by relating it to contemporary issues.

the book has had to be rewritten to reflect contemporary issues Specifically this means that:

• Many of the boxes are new or extensively revised.

• There are many new examples given in the text.

• All policy sections reflect the changes that have taken place in the last three years For example, changes in

discussed in the new Chapters 12 and 13; previously

impact of the extensive turmoil experienced in the

been covered, as has been the subsequent recession,

tary and fiscal policy, particularly in an updated and expanded Chapter 20.

• All tables and charts have been updated, as have factual references in the text.

• Theoretical coverage has been strengthened at various points of the books For example, there is an expanded

includes discussion of the multiple move games The

tions on the links between money and goods markets

the collapse of the banking system in 2008/9 Particular

the issues of capital adequacy liquidity and risk.

Most importantly, every single section and every single sentence of the book has been carefully considered, and if

contemporary relevance The result, we hope, is a text that

world.

The book is designed to be used on a number of different

inclusion of a lot of optional material and the

self-can be used very flexibly.

It is suitable for one-year principles courses at first-year degree level, two-year economics courses on non-economics

highly suitable for single-semester courses, either with a

subject.

The following suggests chapters which are appropriate

to different types of course and gives some guidance on chapters that can be omitted while retaining continuity:

Alternative 1: Less advanced but comprehensive courses

Omit all starred sections, starred sub-sections and starred boxes.

Example of a comprehensive course, omitting some of these chapters: Chapters 1–7, 9, 11–13, 14, 15, 17–22, 24–25.

Alternative 2: Economics for Business courses

Chapters 1–3, 5 –9, 12 –15, 18, 20, 23 – 6.

Example of an Economics for Business course, omitting some of these chapters: Chapters 1–3, 5 –9, 13, 14, 15, 18,

20, 24 –25.

SUGGESTIONS FOR SHORTER OR LESS ADVANCED COURSES

PREFACExxvii xxviiiPREFACE

Alternative 3: Introduction to microeconomics

Chapters 1–13, 24 The level of difficulty can be varied by

these chapters.

Example of an Introduction to Microeconomics course, omitting some of these chapters: Chapters 1–7, 9, 11–13, 24.

Alternative 4: Introduction to macroeconomics

Chapters 1, 2, 14 –26 The level of difficulty can be varied

Omit boxes at will.

Alternative 6: Courses with a theory bias

Chapters 1, 2, 4 –9, 11, 14 –19, 21, 22, 24, 25 The level of

sections and boxes from these chapters.

Alternative 7: Courses with a policy bias (and only basic theory)

Chapters 1–3, 5, 6, 10–15, (17), 20, 23 – 6.

Student Workbook, Seventh Edition (by John Sloman and Peter Smith)

A new edition of the Student Workbook has been designed

matches a chapter of Economics and consists of four sections.

questions and goes through all the key material in the

text-true/false, either/or, filling in blank words or phrases,

written answers and brief calculations Each type of question is clearly marked with an appropriate symbol.

B Problems, exercises and projects This section includes multiple-part calculations and exercises, and student

playing and questionnaires).

C Discussion topics and essays This includes various thought-provoking questions that can be used for class discussion and more traditional essay questions.

D Answers and comments This includes answers to

and comments on all questions in section A of each

chapter (answers to section B questions are given on the memory stick and in the lecturer’s resources at

www.pearsoned.co.uk/sloman).

MyEconLab (for students)

MyEconLab is a comprehensive set of online resources

provided with every new purchase of this text MyEconLab provides a variety of tools to enable students to assess their own learning, including exercises, quizzes and tests

A personalised Study Plan identifies areas to concentrate on

to improve grades, and specific tools are provided to each student to direct their studies in the most efficient way.

In addition, a large range of other resources are available

in MyEconLab, including:

• A highly interactive online workbook;

• Animations of key models with audio explanations;

• A news blog with news items added several times each month;

• A comprehensive glossary with flashcards to check dents’ knowledge;

stu-• 154 case studies with questions for self study, ordered chapter by chapter and referred to in the text;

• Maths cases with exercises, related to the ‘Looking at the Maths’ sections in the book;

• 20 self-test questions per chapter;

• Updated list of over 260 hotlinks to sites of use for economics;

• Answers to all in-chapter questions;

• Profiles of famous historical economists;

• Learning objectives for each chapter written in friendly’ language.

‘student-Note that the news blog and hotlinks can also be accessed

directly from www.pearsoned.co.uk/sloman.

See Guided Tour (pages xvi– xxi) for more details.

For lecturers

MyEconLab

MyEconLab can be set up by you as a complete virtual

Blackboard, WebCT or Moodle You can customise its look

COMPANION BOOKS AND MATERIALS

We understand that no student learns or teacher teaches in the same way Hence, with this seventh edition, we have endeavoured tomake the book and its accompanying resources as flexible as possible to use The in-text features and accompanying online resourcesallow you to study at your own pace and focus on topics where you need the most help

The seventh edition of Economics comes with a new,

improved and updated version of MyEconLab MyEconLab

is personalised and innovative online study and testing

resource that provides a variety of tools to enable you to

assess and progress your own learning In addition to the

exercises interspersed in the text, which you are

encour-aged to tackle as you go along, you should log-on to this

new online tool and practise further

To get started, take out your access kit included inside

this book to register online

Registration and log-in

Go to www.pearsoned.co.uk/sloman and click on the

Economics, Seventh Edition cover, select MyEconLab

regis-tration and log-in and follow the instructions on-screen

using the code inside your access kit, which will look like

this:

Getting Started with MyEconLab

Now you should be registered with your own passwordready to log-in directly to your own course

When you log-in to your course for the first time, thecourse home page will look like this:

The log-in screen will look like this:

Sample tests (two for each chapter) enable you to test self to see how much you already know about a particulartopic and identify the areas in which you need more prac-tice Click on the Study Plan button in the menu and take

your-sample test a for the chapter you are studying Once you

have completed a chapter, go back and take sample test b

to see how much you have learned

Now follow the steps below for the chapter you arestudying

Step 1: Take a sample test

Step 2: Review your study plan Step 4: Use the e-book and additional

multimedia tools found in Textbook Resources to help you further

Use the online workbook for an interactive way to reviewwhat you have learned in the text and to practise furtherwith additional support before you attempt the questions

in MyEconlab

If you are struggling with a question, you can click on thetextbook icon to read the relevant part of your textbookagain

You can also click on the animation icon to help youvisualise and improve your understanding of key concepts

Good luck getting started with MyEconLab.

For an online tour go to www.myeconlab.com.

For any help and advice contact the 24-hour online support

at www.myeconlab.com and click on student support.

To help you make the most efficient use of your self-study

time, the results of the sample tests you have taken will be

incorporated into your Study Plan showing you what

sec-tions you have mastered and what secsec-tions you need to

study further

Step 3: Have a go at an exercise

From the Study Plan, click on the section of the book

you are studying and have a go at the series of interactive

Exercises (Exercises with page references are based on

end-of-chapter questions in the book.)

When required, use the Grapher on the right-hand side

to select the graphing tools you need to complete the

ques-tion For help using the grapher click on the question icon

Additional study tools such as Guided Solutions and

Examples break the question down step-by-step to help

you to complete the exercises successfully You can try

the same exercises over and over again, and each time the

values will change, giving you unlimited practice

Economics affects all our lives As consumers we try to

make the best of our limited incomes As workers – or

future workers! – we take our place in the job market As

citizens of a country our lives are affected by the decisions

of our government: decisions over taxes, decisions over

spending on health and education, decisions on interest

rates, decisions that affect unemployment, inflation and

growth As dwellers on the planet Earth we are affected by

the economic decisions of each other: the air we breathe,

the water we drink and the environment we leave to our

children are all affected by the economic decisions taken by

the human race

Economics thus deals with some of the most ing issues we face It is this that still excites the authors

challeng-about economics after many years of teaching the subject

We hope that some of this excitement rubs off on you

The first six editions of Economics have been widely used

in Britain and throughout the world Like them, this new

edition is suitable for all students of economics at first-year

degree level, A level or on various professional courses

where a broad grounding in both principles and

applica-tions is required It is structured to be easily understood by

those of you who are new to the subject, with various

sec-tions and boxes that can be left out on first reading or on

shorter courses; yet it also has sufficient depth to challenge

those of you who have studied the subject before, with

starred sections (*) and case studies that will provide much

that is new There are also optional short mathematical

sec-tions for those of you studying a more rigorous course

The book gives a self-contained introduction to theworld of economics and is thus ideal for those who will not

study the subject beyond introductory level But by

care-fully laying a comprehensive foundation and by the

inclu-sion of certain materials in starred sections that bridge the

gap between introductory and second-level economics, it

provides the necessary coverage for those of you going on

to specialise in economics

The book is designed with one overriding aim: to makethis exciting and highly relevant subject as clear to under-

stand as possible To this end the book has a number of

important features (see also the Guided Tour):

• A full and consistent colour design is used to guide youthrough the text and make the structure easy to follow

• The text is written in a direct and straightforward style,with short paragraphs to aid rapid comprehension

• Key ideas are highlighted and explained where they firstappear These ideas are key elements in the economist’s

‘toolkit’ and whenever they recur later in the book, anicon appears in the margin and you are referred back tothe page where they are defined and explained

• Fifteen ‘threshold concepts’ are presented and explained

in separate panels Grasping these fundamental cepts that recur throughout the subject will help you to

con-‘think like an economist’ Like the key ideas, an icon isused to refer to them whenever they occur

• Full-page chapter introductions raise the key issues ofthe chapter and also give a map to help you ‘navigate’through the contents of the various sections

• Numerous examples from around the world are given:some serious, some lighthearted

• Summaries appear at the end of each section (ratherthan each chapter)

• Definitions of all economic terms can be found at thebottom of the page where they first appear

• A comprehensive index is provided, including reference

to all defined terms

• Through the text, questions (typically one or two perpage) are posed to test comprehension and stimulatethought while you are learning Answers to all thesequestions are in MyEconLab

• Questions at the end of each chapter can be used foreither individual or class use

• Boxes provide case studies, institutional material, newsitems, contemporary and historical debates and issues,anecdotes and advanced topics

• Advanced material in starred sections/boxes is included,which can be omitted without affecting the flow ofargument

• Additional case studies, which are listed at the end ofeach chapter, can be accessed in MyEconLab

• Many issues are examined in their historical as well ascontemporary context

Preface

TO THE STUDENT

• ‘Looking at the maths’ sections are designed for

stud-ents on more rigorous courses that make use of

math-ematics These sections express things mathematically

that have just been covered in words and/or graphically

Most of them link to Maths Cases on the book’s website

These cases give worked mathematical examples and

also include one or more numerical questions for you to

work through, either at home or in class

• Extensive website references are given at the end of each

chapter These refer you to the websites listed at the end

of the book in Appendix 2 These can all be accessed

directly from MyEconLab at www.coursecompass.com

All these features are designed to make your studies

more interesting and to help you learn in a deeper and

more active way

The book looks at the world of the early 21st century

Despite huge advances in technology and despite the

com-fortable lives led by many people in the industrialised

world, we still suffer from unemployment, poverty and

inequality, and in many countries (the UK included) the

gap between rich and poor has grown much wider; our

environment is polluted; our economy still goes through

periodic recessions; conflict and disagreement often

domin-ate over peace and harmony

What is more, the world order has been changing With

a growing interdependence of the economies of the world;

with an inexorable process of ‘globalisation’, which links us

all through a web of telecommunications and internationaltrade into a world of Coca-Cola, Nike trainers, Microsoft,football and American chat shows; with repeated bouts ofturmoil on international financial markets culminating inthe banking crisis of 2008/9; with evidence that economicproblems have spread like a contagion around the world,resulting in what might prove to be a paralysing recession;with Chinese economic growth increasingly becoming thepowerhouse of the global economy; with the move awayfrom the ideological simplicity of a ‘free-market’ solution

to all economic problems; with a powerful but ally sluggish ‘eurozone’ and a rapidly evolving EuropeanUnion with new members; with an uncertain future for the USA with its ever-growing level of debt; and with anever deepening crisis for many developing countries; sothere are many new economic challenges that face us.Economists are called on to offer solutions

economic-But despite our changing environment, there are certaineconomic fundamentals that do not change Despite dis-agreements among economists – and there are plenty –there is a wide measure of agreement on how to analysethese fundamentals

We hope that this book will give you an enjoyable duction to the economist’s world and that it will equip youwith the tools to understand and criticise the economicpolicies that others pursue

intro-Good luck and have fun

This new edition retains many of the popular features of

the previous edition (see also the Guided Tour):

• A style that is direct and to the point, with the aim all

the time to provide maximum clarity There are

numer-ous examples to aid comprehension

• All economic terms highlighted in the text where

they first appear and defined at the foot of that page

Each term is also highlighted in the index, so that the

student can simply look up a given definition as

required By defining them on the page where they

appear, the student can also see the terms used in

con-text in the con-text

• Key ideas highlighted and explained when they first

appear There are 38 of these ideas, which are

funda-mental to the study of economics Students can see

them recurring throughout the book, and an icon

appears in the margin to refer back to the page where

the idea first appears

• Fifteen ‘threshold concepts’ Understanding and being

able to relate and apply these core economic concepts

helps students to ‘think like an economist’ and to relate

the different parts of the subject to each other

• A wealth of applied material in boxes (176 in all), making learning more interesting for students and, byrelating economics to the real world, bringing the subject alive The boxes allow the book to be compre-hensive without the text becoming daunting and allowmore advanced material to be introduced where appro-priate Many of the boxes can be used as class exercisesand virtually all have questions at the end

• Full-page chapter introductions These set the scene forthe chapter by introducing the students to the topicscovered and relating them to the everyday world Theintroductions also include a ‘chapter map’ This pro-vides a detailed contents listing, helping students to see how the chapter is structured and how the varioustopics relate to each other

• A consistent use of colour in graphs and diagrams, withexplanations in panels where appropriate These featuresmake them easier to comprehend and more appealing

• Starred sections and boxes for more advanced material.These can be omitted without interrupting the flow ofthe argument This allows the book to be used by stu-dents with different abilities and experience, and oncourses of different levels of difficulty

TO LECTURERS AND TUTORS

• ‘Looking at the maths’ sections These short sections

express a topic mathematically Some use calculus; some

do not They are designed to be used on more rigorouscourses and go further than other textbooks at introduc-tory level in meeting the needs of students on suchcourses Most refer students to worked examples in MathsCases in MyEconLab Some of these use simultaneousequations; some use simple unconstrained optimisationtechniques; others use constrained optimisation, usingboth substitution and Lagrange multipliers The ‘Looking

at the maths’ sections are short and can be omitted bystudents on non-mathematical courses without any loss

of continuity

• An open learning approach, with questions

incorpor-ated into the text so as to test and reinforce students’

understanding as they progress This makes learning amuch more active process

• End-of-chapter questions These can be set as work for

students to do in class or at home Alternatively, ents can simply use them to check their comprehension

stud-at the end of a topic

• Summaries given at the end of each section, thus

pro-viding a point for reflection and checking on hension at reasonably frequent intervals

compre-• An even micro/macro split

• The book is divided into seven parts This makes the

structure transparent and makes it easier for the student

to navigate

Despite retaining these popular features, there havebeen many changes to this seventh edition

Extensive revision

Economics (seventh edition) uses a lot of applied material,

both to illustrate theory and policy, and to bring the

sub-ject alive for students by relating it to contemporary issues.This has meant that, as with the previous edition, much ofthe book has had to be rewritten to reflect contemporaryissues Specifically this means that:

• Many of the boxes are new or extensively revised

• There are many new examples given in the text

• All policy sections reflect the changes that have takenplace in the last three years For example, changes inenvironmental policy and competition policy are fullydiscussed in the new Chapters 12 and 13; previouslythese were brought together in a single chapter Theimpact of the extensive turmoil experienced in thefinancial markets and the banking sector in 2008/9 hasbeen covered, as has been the subsequent recession,allowing us to consider fully the implications for mone-tary and fiscal policy, particularly in an updated andexpanded Chapter 20

• All tables and charts have been updated, as have factualreferences in the text

• Theoretical coverage has been strengthened at variouspoints of the books For example, there is an expandedsection on game theory in Chapter 7, which nowincludes discussion of the multiple move games Thechapter on money and interest rates and further sec-tions on the links between money and goods marketshave been expanded and strengthened in the light ofthe collapse of the banking system in 2008/9 Particularattention has been paid to the role of securitisation andthe issues of capital adequacy liquidity and risk.Most importantly, every single section and every singlesentence of the book has been carefully considered, and ifnecessary redrafted, to ensure both maximum clarity andcontemporary relevance The result, we hope, is a text thatyour students will find exciting and relevant to today’sworld

The book is designed to be used on a number of different

types of course Because of its comprehensive nature, the

inclusion of a lot of optional material and the

self-contained nature of many of the chapters and sections, it

can be used very flexibly

It is suitable for one-year principles courses at first-yeardegree level, two-year economics courses on non-economics

degrees, A level, HND and professional courses It is also

highly suitable for single-semester courses, either with a

micro or a macro focus, or giving a broad outline of the

subject

The following suggests chapters which are appropriate

to different types of course and gives some guidance on

chapters that can be omitted while retaining continuity:

Alternative 1: Less advanced but comprehensive courses

Omit all starred sections, starred sub-sections and starredboxes

Example of a comprehensive course, omitting some ofthese chapters: Chapters 1–7, 9, 11–13, 14, 15, 17–22, 24–25

Alternative 2: Economics for Business courses

Alternative 3: Introduction to

microeconomics

Chapters 1–13, 24 The level of difficulty can be varied by

including or omitting starred sections and boxes from

these chapters

Example of an Introduction to Microeconomics course,

omitting some of these chapters: Chapters 1–7, 9, 11–13,

24

Alternative 4: Introduction to

macroeconomics

Chapters 1, 2, 14 –26 The level of difficulty can be varied

by including or omitting starred sections and boxes from

these chapters

Example of an Introduction to Macroeconomics course,

omitting some of these chapters: Chapters 1, 2, (If

micro-economics has not previously been covered) 14, 15, 17–

23, 25

Alternative 5: Outline courses

Chapters 1, 2, 5, 6, 14, 15, 17, 18, 24, 25 (section 25.1).Omit boxes at will

Alternative 6: Courses with a theory bias

Chapters 1, 2, 4 –9, 11, 14 –19, 21, 22, 24, 25 The level ofdifficulty can be varied by including or omitting starredsections and boxes from these chapters

Alternative 7: Courses with a policy bias (and only basic theory)

Chapters 1–3, 5, 6, 10–15, (17), 20, 23 – 6

Student Workbook, Seventh Edition

(by John Sloman and Peter Smith)

A new edition of the Student Workbook has been designed

to accompany this text Each chapter of the workbook

matches a chapter of Economics and consists of four sections.

A Review questions This section is a mixture of narrative and

questions and goes through all the key material in the

text-book chapter Questions are a mixture of multiple choice,

true/false, either/or, filling in blank words or phrases,

matching a series of answers to a series of questions, short

written answers and brief calculations Each type of

question is clearly marked with an appropriate symbol

B Problems, exercises and projects This section includes

multiple-part calculations and exercises, and student

projects (including data search exercises, games, role

playing and questionnaires)

C Discussion topics and essays This includes various

thought-provoking questions that can be used for class

discussion and more traditional essay questions

D Answers and comments This includes answers to

and comments on all questions in section A of each

chapter (answers to section B questions are given on

the memory stick and in the lecturer’s resources at

www.pearsoned.co.uk/sloman).

MyEconLab (for students)

MyEconLab is a comprehensive set of online resources

developed for the seventh edition of Economics Access is

provided with every new purchase of this text MyEconLab

provides a variety of tools to enable students to assess

their own learning, including exercises, quizzes and tests

A personalised Study Plan identifies areas to concentrate on

to improve grades, and specific tools are provided to eachstudent to direct their studies in the most efficient way

In addition, a large range of other resources are available

in MyEconLab, including:

• A highly interactive online workbook;

• Animations of key models with audio explanations;

• A news blog with news items added several times eachmonth;

• A comprehensive glossary with flashcards to check dents’ knowledge;

stu-• 154 case studies with questions for self study, orderedchapter by chapter and referred to in the text;

• Maths cases with exercises, related to the ‘Looking at theMaths’ sections in the book;

• 20 self-test questions per chapter;

• Updated list of over 260 hotlinks to sites of use for economics;

• Answers to all in-chapter questions;

• Profiles of famous historical economists;

• Learning objectives for each chapter written in friendly’ language

‘student-Note that the news blog and hotlinks can also be accessed

directly from www.pearsoned.co.uk/sloman.

See Guided Tour (pages xvi– xxi) for more details

For lecturers

MyEconLab

MyEconLab can be set up by you as a complete virtuallearning environment for your course or embedded intoBlackboard, WebCT or Moodle You can customise its look

COMPANION BOOKS AND MATERIALS

and feel and its availability to students You can use it to

provide support to your students in the following ways:

• MyEconLab’s gradebook automatically records each

stu-dent’s time spent and performance on the tests andStudy Plan It also generates reports you can use to mon-itor your students’ progress

• You can use MyEconLab to build your own tests, quizzes

and homework assignments from the question base vided to set for your students’ assessment

pro-• Questions are generated algorithmically so that they use

different values each time they are used

• You can create your own exercises by using the econ

exercise builder

Memory stick

The CD produced for tutors using the 6th edition of

Economics proved very popular The materials on the CD

have been updated, revised and extended for the 7th

edi-tion and are now available on a memory stick, free of

charge from Pearson Education to tutors using the book as

a course text The memory stick contains the following:

• PowerPoint®slide shows in full colour for use with a

data projector in lectures and classes These can also bemade available to students by loading them on to a localnetwork The memory stick contains several types ofthese slide shows:

– All figures from the book and most of the tables Eachfigure is built up in a logical sequence, thereby allow-ing tutors to show them in lectures in an animatedform They are also available in a simple version suit-able for printing onto acetate for OHPs

– A range of models There are 39 files, each containingone of the key models from the book, developed in

an animated sequence of between 20 and 80 screens

– Customisable lecture plans These are a series of bullet-point lecture plans There is one for each chap-ter of the book Each one can be easily edited, withpoints added, deleted or moved, so as to suit particu-lar lectures A consistent use of colour is made toshow how the points tie together They come in vari-ous versions:

• Lecture plans with integrated diagrams These lecture plans include animated diagrams andcharts at the appropriate points

• Lecture plans with integrated diagrams and tions These allow lectures to become more interact-ive and can be used with or without an audienceresponse system (ARS) ARS versions are availablefor InterWrite PRS®and for TurningPoint®

ques-• Lecture plans are also without the diagrams sothat you can construct your own on the black-board or whiteboard or use an OHP

• Tutor’s Guide in Word® This contains the following features:

– Answers to all questions in Economics (7th edition):

i.e questions embedded in the text, box questionsand end-of-chapter questions These can be edited asdesired and distributed to students

– Answers to the case studies and maths cases found inMyEconLab

– Suggestions on how to use the text

– Learning objectives that can be used for syllabusdesign and course planning

• Multiple-choice questions This test bank have beenrevised and contains many new questions It is flexibleand easy to use

• Case studies These, also available in MyEconLab, can

be reproduced and used for classroom exercises or forstudent assignments Answers are also provided

• Workshops There are 20 of these (10 micro and 10macro/international) They are in Word®and can bereproduced for use with large groups of students (up to200) Suggestions for use are given on the memory stick.Answers to all workshop questions are given in separateWord®files

• Teaching/learning case studies These examine variousways to improve student learning of introductory economics

Lecturer website

All the materials on the memory stick are available

to download from the lecturer section of the website

(www.pearsoned.co.uk/sloman) Click on the book image

to take you to the link to the lecturer site Most of the materials are open access, but all answers are in a securepassword protected area of the site

The site is regularly updated

WinEcon (Sloman version)

The widely acclaimed WinEcon software, produced and

authored by the Economics Consortium of the Teachingand Learning Technology Programme (TLTP) and designed

to support courses in introductory economics, is now available to download in a version specially designed for

Economics (7th edition).

There is a separate chapter in the Sloman version of

WinEcon to correspond with the relevant chapter in the

book The software is highly interactive and is attractive touse and is regularly updated It has been redesigned in anew attractive format

For details of WinEcon and how to download a copy, go

to www.winecon.com/sloman-economics.

As with previous editions, we owe a debt to various people.

The whole team from Pearson has, as always, been very

help-ful and supportive Thanks in particular to Ellen Morgan,

who has been of tremendous help at every stage of

revis-ing the book and to Joe Vella who has steered the book

smoothly through production Thanks also to Margaret

Christie, who meticulously copy-edited the manuscript,

Joan Dale Lace, proofreader and Isobel McLean who

pre-pared the Index

Particular thanks go to two colleagues who have

con-tributed to this edition and its supplements The first is

Dean Garratt from Nottingham Trent University He has

provided material for some of the macro chapters and we

really appreciate his input in this time of rapid change in

banking and finance and in macroeconomic policy The

second in Elizabeth Jones from Exeter University She has

contributed towards the Online Workbook and also is a

regular blogger on the Sloman Economics News site Her

ideas and input have been really valuable

Thanks too to colleagues and students from many

uni-versities who have been helpful and encouraging and, as in

previous editions, have made useful suggestions for

im-provement We have attempted to incorporate their ideas

wherever possible Please do write or email if you have any

suggestions Especially we should like to thank the

follow-ing reviewers of the previous editions Their analysis and

comments have helped to shape this new edition

Dr Christopher J Gerry, University College London SSESS, UK

David Ho

Ian Jackson, Staffordshire University, UK

Lars Bach, The International Business Academy,

Roy Bailey, University of Essex, UKStuart Sayer, University of Edinburgh, UKProfessor Sue Bowden, University of York, UKTony McGough, Course Director, Cass Business School,City University London, UK

Walter Vanthielen, Hasselt University, BelgiumWilfried Pauwels, University of Antwerp, Belgium

A special thanks to Peter Smith from the University ofSouthampton who has revised the Workbook to accom-pany this edition of the book and has contributed to theTutor Guide and the MyEconLab online course It’s great tohave his input and ideas for improvements to the booksand supplements

A special thanks too to Mark Sutcliffe from the CardiffSchool of Management Mark provided considerable help and support on earlier editions and it’s still muchappreciated

John: My biggest thanks go to my family, and especially

to Alison, my wife and soulmate, and our daughter Ellie Asalways they have been patient and supportive, despite mylong hours at the computer

Alison: I’d like to offer thanks to my husband, Chris,without his support and love none of this would have beenpossible

Acknowledgements

Enterprise and Regulatory Reform, 2007; Figure 24.7

adapted from The Competitive Advantage of Nations, The Free

Press (Porter M E., 1998) p 127, Reprinted with the sion of The Free Press, a Division of Simon & Schuster, Inc.,copyright © 1990, 1998 by Michael E Porter All rightsreserved; and figure on page 782 after Forecast by Morgan

permis-Stanley, The Economist, 5 June 2008, copyright © The

Economist 2008

Tables

Tables on page 7, 396, 484 and tables 15.5, 20.1, 22.1, 22.2,

23.1, 24.1 adapted from Statistical Annex of the European Economy, Commission of the European Communities, 2007; Table on page 166 after United Kingdom Input-Output Analyses, 2006 Edition, National Statistics, 2006, Table 8.31,

© Crown copyright 2008 Published with the permission ofthe Office for Public Sector Information (OPSI); Tables on

page 232 from “How do UK companies set prices?”, Bank of England Quarterly, May, Table D, p 188, 189 (Hall, S.,

Walsh, M and Yates, T., 1996), copyright © The Bank of

England; Tables on page 252 after Annual Survey of Hours and Earnings, National Statistics © Crown copyright 2008.

Published with the permission of the Office for Public

Sector Information (OPSI); Table 10.1 after Family Spending,

National Statistics, 2008, © Crown copyright 2008.Published with the permission of the Office for PublicSector Information (OPSI); Table 10.2 adapted from Based

on HMRC personal wealth statistics www.hmrc.gov.uk/stats/personal_wealth/menu.htm, Table 13.5 HMRevenue & Customs, © Crown copyright 2008; Tables on

page 334, 335 after The costs and benefits of lowering the sulphur content of petrol and diesel to less than 10 ppm,

Commission of the European Communities, DG

Environment, 2001 Tables 4, 5 and 9; Table 12.1 after OECD Environmental Outlook, Organisation for Economic Co- operation and Development, 2002; Table 12.3 after Transport Statistics of Great Britain, 2007, Department for Transport,

2007, Crown Copyright material is reproduced with mission under the terms of the Click-Use License; Table

per-on page 410 from An Index of Sustainable Ecper-onomic Welfare for the UK 1950–96, Centre for Environmental Strategy,

University of Surrey (Jackson, T., Marks, N., Ralls, J and

Stymne, S.); Table A14.1 after United Kingdom National Accounts: The Blue Book 2008 Edition, National Statistics,

2008, www.statistics.gov.uk Crown copyright material is

We are grateful to the following for permission to reproduce

copyright material:

Figures

Figure on page 254 adapted from Flexibility, Uncertainty

and Manpower Management, IMS Report No 89, Institute

of Manpower Studies (Atkinson, J., 1984), Institute for

Employment Studies (IES); Figure 10.1 adapted from ‘T he

effects of taxes and benefits on household income’

2006/07, Economic & Labour Market Review, July, National

Statistics, 2008, © Crown copyright 2008 Published with

the permission of the Office for Public Sector Information

(OPSI); Figures 10.5, 10.7, 10.8, 12.4 after Family Spending,

National Statistics, 2008, © Crown Copyright 2008

Pub-lished with the permission of the Office for Public Sector

Information (OPSI); Figures 10.14a, 10.14b after Eurostat,

Statistics in Focus http://epp.eurostat.ec.europa.eu,

Commis-sion of the European Communities, 2008; Figure on page

344 from Stern Review on the Economics of Climate Change,

Office of Climate Change (OCC) Stern Review, 2006,

Executive Summary, Figure 1, based on data drawn from

World Resources Institute Climate Analysis Indicators Tool

(CAIT) online database version 3.0., © Crown copyright

2006; Figure on page 380 after ‘Electricity supply:

reorgan-isation and privatreorgan-isation’, The Economic Review, March,

Vol 7, No 4 (Green, R., 1991), Reprinted by permission

of Philip Allan Updates; Figures A14.1, A14.2 after United

Kingdom National Accounts: The Blue Book 2008 Edition,

National Statistics, 2008, www.statistics.gov.uk Crown

copyright material is reproduced with the permission of

the Controller Office of Public Sector Information (OPSI);

Figure on page 411 after Quality of Life Briefing, New

Economics Foundation/Friends of the Earth (Mayo, E.,

MacGillivray, A and McLaren, D., 1998), copyright © The

New Economics Foundation; Figure on page 430 from

Yugoslavian banknote, 1994, copyright © National Bank

of Serbia, Treasury Department; Figure on page 485 after

Business and Consumer Surveys Commission of the European

Communities, 2008; Figure on page 573 after Pre-Budget

Report 2008 H M Treasury, 2005; Figure on page 606 after

Inflation Report, November, Bank of England, 2008, copyright

© The Bank of England; Figure 21.16 after Budget Report

2008 H.M Treasury, 2008, Chart 2.1; Figure on page 646

after Productivity in the UK: 7, Securing long-term prosperity,

November, HM Treasury and Department for Business

Publishers Acknowledgements

reproduced with the permission of the Controller Office

of Public Sector Information (OPSI); Table A14.2 after

UK National Income and Expenditure, National Statistics,

2008, www.statistics.gov.uk Crown copyright material is

reproduced with the permission of the Controller Office of

Public Sector Information (OPSI); Table on page 431 after

Based on data in IMF International Financial Statistics (IFS)

database www.imfstatistics.org International Monetary

Fund; Tables 15.2, 15.3 after Economic and Labour Market

Review National Statistics, © Crown copyright 2008

Pub-lished with the permission of the Office for Public Sector

Information (OPSI); Table 15.4 after Eurostat, Statistics

in Focus http://epp.eurostat.ec.europa.eu Commission of

the European Communities, 2008; Tables 15.7, 15.8 after

Based on data in the Statistical Interactive Database www

bankofengland.co.uk/mfsd/iadb/NewIntermed.asp Bank of

England, copyright © The Bank of England; Table on page

484 after Business and Consumer Surveys Commission of the

European Communities, DG for Financial and Economic

Affairs, 2007; Tables on page 520, 18.2 and 18.7 adapted

from Bankstats, Bank of England, 2008 Table in A and B:

money and lending, and Table B1.1.1, copyright © The

Bank of England; Table 20.6 after From the National

Statistics website www.statistics.gov.uk National Statistics,

© Crown copyright Reproduced with the permission of the

Controller Office of Public Sector Information (OPSI); Table

24.5 adapted from The competition effects of the single

market in Europe, Economic Policy (Allen, C., Gasiorek, M.

and Smith, A., 1998), copyright © Wiley-Blackwell; Table

25.2 after Based on data in the IMF International Financial

Statistics (IFS) database www.imfstatistics.org International

Monetary Fund; Table 26.1 after OECD Economic Outlook,

Organisation for Economic Co-operation and

Develop-ment, 2007; Table 27.1 after World Development Statistics, World Bank, 2005; Table on page 765 adapted from UNDP Human Development Report 2007/2008, United Nations

Development Program, published 2007, reproduced withpermission of Palgrave Macmillan; Tables 27.4, 27.5 after

Global Development Finance World Bank, 2008; Tables 2.1, 2.2 after Times Series Data, National Statistics, 2008, ©

Crown copyright Reproduced with the permission of theController Office of Public Sector Information (OPSI); Table

2.3 after The effects of taxes and benefits on household income, 2006/07 National Statistics, 2008, © Crown copyright 2008.

Published with the permission of the Office for Public

Sector Information (OPSI); Table 2.5 after Economic Trends

National Statistics, © Crown copyright 2006 Publishedwith the permission of the Controller of Her Majesty’sStationery Office (HMSO)

Text

Box 19.4 after A proposal for greening of textbook macro:

‘IS-LM-EE’, Royal Holloway College, University of London,

Working Paper (Heyes, A., 1998); Extract on page 665 from

Intricate workings, The Economist, 17 June 2006, copyright

© The Economist 2006; and Poetry on page 792 “TheCastaways or Vote for Caliban” by Adrian Mitchell from

Greatest Hits copyright © Adrian Mitchell 1991 Reproduced

by permission of PFD www.pfd.co.uk on behalf of theestate of Adrian Mitchell

In some instances we have been unable to trace the owners

of copyright material, and we would appreciate any mation that would enable us to do so

Economics contains some core ideas These ideas are simple, but can be applied to a wide range of nomic problems We start examining these ideas in Chapter 1.

1 Ch

Introducing Economics

Illustrating economic issues: the production

Illustrating economic issues: the circular flow

The classification of economic systems 16

Assessment of the command economy 19

Assessment of the free-market economy 23

Economics as a social science 26

You may never have studied economics before, and yet when you open a newspaper what do you read? – a report from ‘our economics correspondent’ Turn on the television news and what do you see? – an item on the state of the economy Talk to friends and often the topic will turn to the price of this or that product, or whether you have got enough money to afford to do this or that.

The fact is that economics affects our daily lives We are continually being made aware of local, national and inter- national economic issues, whether price increases, interest rate changes, fluctuations in exchange rates, unemploy- ment, economic recessions or the effects of globalisation.

We are also continually faced with economic problems and decisions of our own What should I buy in the supermarket? Should I save up for a summer holiday, or spend more on day-to-day living? Should I go to university, or should I try to find a job now? If I go to university, should I work part time?

So just what is economics about? In this chapter we will attempt to answer this question and give you some insights into the subject that you will be studying We will see how the subject is divided up, and in particular we will distinguish between the two major branches of eco- nomics: microeconomics and macroeconomics.

We will also look at the ways in which different types of economy operate, from the centrally planned economies

of the former communist countries to the largely market economies of most of the world today We will ask just how ‘markets’ work.

free-C H A P T E R M A P

Many people think that economics is about money Well, to

some extent this is true Economics has a lot to do with

money: with how much money people are paid; how much

they spend; what it costs to buy various items; how much

money firms earn; how much money there is in total in the

economy But as we will see later in the book, money is

only important because of what it allows us to do; money is

a tool and economics is more than just the study of money

It is concerned with the following:

• The production of goods and services: how much the

economy produces, both in total and of individual

items; how much each firm or person produces; what

techniques of production are used; how many people

are employed

• The consumption of goods and services: how much the

population as a whole spends (and how much it saves);

what the pattern of consumption is in the economy;

how much people buy of particular items; what

particu-lar individuals choose to buy; how people’s

consump-tion is affected by prices, advertising, fashion and other

factors

Could production and consumption take place

without money? If you think they could, give some

examples.

But we still have not quite got to the bottom of what

economics is about What is the crucial ingredient that

makes a problem an economic one? The answer is that

there is one central problem faced by all individuals and

all societies From this one problem stem all the other

economic problems we shall be looking at throughout this

book

This central economic problem is the problem of

scarcity This applies not only in countries like Ethiopia

and the Sudan, but also in the UK, the USA, Japan, France

and all other countries of the world For an economist,

scarcity has a very specific definition

?

Before reading on, how would you define ‘scarcity’? Must goods be at least temporarily unattainable to

be scarce?

The problem of scarcity

Ask people if they would like more money, and the vastmajority would answer ‘Yes’ They want more money sothat they can buy more goods and services; and this applies not only to poor people but also to most wealthypeople too The point is that human wants are virtuallyunlimited

Yet the means of fulfilling human wants are limited Atany one time the world can only produce a limited amount

of goods and services This is because the world only has

a limited amount of resources These resources, or factors

of production as they are often called, are of three broad

types:

• Human resources: labour The labour force is limited in

number, but also in skills This limits the productivity oflabour

• Natural resources: land and raw materials The world’s

land area is limited, as are its raw materials

• Manufactured resources: capital Capital consists of all

those inputs that have each had to be produced in thefirst place The world has a limited stock of capital: alimited supply of factories, machines, transportationand other equipment The productivity of capital is lim-ited by the state of technology

Could each of these types of resources be increased

in quantity or quality? Is there a time dimension to your answer?

So here is the reason for scarcity: human wants are virtually unlimited, whereas the resources available to sat-isfy these wants are limited We can thus define scarcity as follows:

?

?

Production The transformation of inputs into outputs by

firms in order to earn profit (or to meet some other

objective)

Consumption The act of using goods and services to satisfy

wants This will normally involve purchasing the goods and

services

Factors of production (or resources) The inputs into the

production of goods and services: labour, land and raw

materials, and capital

Labour All forms of human input, both physical and

mental, into current production

Land and raw materials Inputs into production that are

provided by nature: e.g unimproved land and mineraldeposits in the ground

Capital All inputs into production that have

themselves been produced: e.g factories, machines and tools

Definitions

Scarcity is the excess of human wants over what

can actually be produced Because of scarcity,various choices have to be made betweenalternatives

If we would all like more money, why does the government not print a lot more? Could it not thereby solve the problem

of scarcity ‘at a stroke’?

Of course, we do not all face the problem of scarcity tothe same degree A poor person unable to afford enough to

eat or a decent place to live will hardly see it as a ‘problem’

that a rich person cannot afford a second BMW But

economists do not claim that we all face an equal problem

of scarcity In fact this is one of the major issues economists

study: how resources are distributed, whether between

different individuals, different regions of a country or

dif-ferent countries of the world

But given that people, both rich and poor, want morethan they can have, this makes them behave in certain

ways Economics studies that behaviour It studies people

at work, producing the goods that people want It studies

people as consumers, buying the goods that they

them-selves want It studies governments influencing the level

and pattern of production and consumption In short, it

studies anything to do with the process of satisfying

human wants

?

KEY IDEA

1

Demand and supply

We said that economics is concerned with consumptionand production Another way of looking at this is in terms

of demand and supply In fact, demand and supply and the

relationship between them lie at the very centre of nomics But what do we mean by the terms, and what istheir relationship with the problem of scarcity?

eco-Demand is related to wants If goods and services were

free, people would simply demand whatever they wanted.Such wants are virtually boundless, perhaps only limited by

people’s imagination Supply, on the other hand, is limited.

It is related to resources The amount that firms can supplydepends on the resources and technology available

Given the problem of scarcity, given that human wants

exceed what can actually be produced, potential demands will exceed potential supplies Society therefore has to find

some way of dealing with this problem, to try to matchdemand with supply This applies at the level of the eco-

nomy overall: aggregate demand will need to be balanced against aggregate supply In other words, total spending in

the economy should balance total production It alsoapplies at the level of individual goods and services Thedemand and supply of cabbages should balance, and soshould the demand and supply of digital cameras, cars,houses and package holidays

But if potential demand exceeds potential supply, how

are actual demand and supply to be made equal? Either

demand has to be curtailed, or supply has to be increased,

or a combination of the two Economics studies this cess It studies how demand adjusts to available supplies,and how supply adjusts to consumer demands

pro-Dividing up the subject

Economics is traditionally divided into two main branches

– macroeconomics and microeconomics, where ‘macro’ means

big and ‘micro’ means small

KI 1 p5

• Unemployment increases: consumer spending falls

• Increased expenditure on primary and secondaryeducation is announced while tuition fees foruniversity degrees are increased The governmentclaims that this will help reduce poverty and increaseproductivity Opponents claim that students from low-income households will be priced out of highereducation

• Oil prices hit a record high level: Shell’s share pricerises, while those of Ford Motor Company fall

• Banking crisis: lack of credit triggers recession

What is it that makes each one of the above news items an economics item?

?

• Budget news: Chancellor cuts 2p off the basic rate ofincome tax while abolishing the lowest 10p band Theresulting reaction from MPs and the public requires arethink on tax allowances

• Mortgage companies require housebuyers to pay largerdeposits: impact on the housing market is expected toresult in lower house prices

• Despite predictions of a recession, cinemas andtakeaway pizza chains report record turnover

• Smoking banned in public places: pubs and cafesconcerned about the impact on trade

• Food prices soar across the world: an increase inmortality in developing countries is predicted

• Prices rise: unions demand higher wages tocompensate

Scarcity The excess of human wants over what can

actually be produced to fulfil these wants

Definition