Economics: Principles, Applications, and Tools / Edition 8

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Overview

For Principles of Economics courses.

Questions that drive interest, applications that illustrate concepts, and the tools to test and solidify comprehension.

Students come into their first Economics course thinking they will gain a better understanding of the economy around them. Unfortunately, they often leave with many unanswered questions. To ensure students actively internalize economics, O'Sullivan/Sheffrin/Perez use chapter-opening questions to spark interest on important economic concepts, applications that vividly illustrate those concepts, and chapter-ending tools that test and solidify understanding.

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Product Details

  • ISBN-13: 9780132949330
  • Publisher: Prentice Hall
  • Publication date: 1/18/2013
  • Edition description: New Edition
  • Edition number: 8
  • Pages: 800
  • Sales rank: 619,287
  • Product dimensions: 8.70 (w) x 10.90 (h) x 1.30 (d)

Meet the Author

ARTHUR O’SULLIVAN

is a professor of economics at Lewis and Clark College in Portland, Oregon. After receiving his B.S.

in economics at the University of Oregon, he spent two years in the Peace Corps, working with city

planners in the Philippines. He received his Ph.D. in economics from Princeton University in 1981

and has taught at the University of California, Davis, and Oregon State University, winning teaching

awards at both schools. He is the author of the best-selling textbook Urban Economics, currently in its

seventh edition.

Professor O’Sullivan’s research explores economic issues concerning urban land use, environmental

protection, and public policy. His articles have appeared in many economics journals, including the

Journal of Urban Economics, Journal of Environmental Economics and Management, National Tax Journal,

Journal of Public Economics, and Journal of Law and Economics.

Professor O’Sullivan lives with his family in Portland, Oregon. For recreation, he enjoys hiking,

kiteboarding, and squash.

STEVEN M. SHEFFRIN

is professor of economics and executive director of the Murphy Institute at Tulane University. Prior to

joining Tulane in 2010, he was a faculty member at the University of California, Davis, and served as

department chairman of economics and dean of social sciences. He has been a visiting professor at

Princeton University, Oxford University, London School of Economics, and Nanyang Technological

University, and he has served as a financial economist with the Office of Tax Analysis of the United

States Department of the Treasury. He received his B.A. from Wesleyan University and his Ph.D. in

economics from the Massachusetts Institute of Technology.

Professor Sheffrin is the author of 10 other books and monographs and over 100 articles in the

fields of macroeconomics, public finance, and international economics. His most recent books

include Rational Expectations (second edition) and Property Taxes and Tax Revolts: The Legacy of

Proposition 13 (with Arthur O’Sullivan and Terri Sexton).

Professor Sheffrin has taught macroeconomics and public finance at all levels, from general introduction

to principles classes (enrollments of 400) to graduate classes for doctoral students. He is the

recipient of the Thomas Mayer Distinguished Teaching Award in economics.

He lives with his wife Anjali (also an economist) in New Orleans, Louisiana, and has two daughters

who have studied economics. In addition to a passion for current affairs and travel, he plays a

tough game of tennis.

STEPHEN J. PEREZ

is a professor of economics and NCAA faculty athletics representative at California State University,

Sacramento. After receiving his B.A. in economics at the University of California, San Diego, he was

awarded his Ph.D. in economics from the University of California, Davis, in 1994. He taught economics

at Virginia Commonwealth University and Washington State University before coming to California

State University, Sacramento, in 2001. He teaches macroeconomics at all levels as well as econometrics,

sports economics, labor economics, and mathematics for economists.

Professor Perez’s research explores most macroeconomic topics. In particular, he is interested

in evaluating the ability of econometric techniques to discover the truth, issues of causality in

macroeconomics, and sports economics. His articles have appeared in many economics journals,

including the Journal of Monetary Economics; Econometrics Journal; Economics Letters; Journal of

Economic Methodology; Public Finance and Management; Journal of Economics and Business; Oxford

Bulletin of Economics and Statistics; Journal of Money, Credit, and Banking; Applied Economics; and

Journal of Macroeconomics.

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Table of Contents


Preface
Introduction and Key Principles
Introduction: What Is Economics?     2
What Is Economics?     4
Positive Versus Normative Analysis     5
The Three Key Economic Questions: What, How, and Who?     6
Economic Models     6
Economic Analysis and Modern Problems     7
Economic View of Traffic Congestion     7
Economic View of Poverty in Africa     7
Economic View of Japan's Economic Problems     8
The Economic Way of Thinking     9
Use Assumptions to Simplify     9
Isolate Variables-Ceteris Paribus     9
Think at the Margin     10
Rational People Respond to Incentives     10
Pedaling for Television Time     11
Preview of Coming Attractions: Macroeconomics     11
To Understand Why Economies Grow     11
Application London Solves Its Congestion Problem     12
To Understand Economic Fluctuations     13
To Make Informed Business Decisions     13
Preview of Coming Attractions: Microeconomics     13
To Understand Markets and Predict Changes     13
To Make Personal and Managerial Decisions     14
To Evaluate Public Policies     14
Summary     15
Key Terms     15
Exercises     15
Appendix: Using Graphs and Percentages     17
Using Graphs     17
Computing Percentage Changes and Using Equations     24
The Key Principles of Economics     28
The Principle of Opportunity Cost     30
The Cost of College     30
The Opportunity Costs of Time and Invested Funds     31
Opportunity Cost and the Production Possibilities Curve     31
The Marginal Principle     33
The Opportunity Cost of Military Spending     34
How Many Movie Sequels?     35
Renting College Facilities     36
Automobile Emissions Standards     36
Continental Airlines Uses the Marginal Principle     37
The Principle of Voluntary Exchange     37
Exchange and Markets     37
Online Games and Market Exchange     38
The Principle of Diminishing Returns     38
Tiger Woods and Weeds     39
Diminishing Returns from Sharing a Production Facility     39
Fertilizer and Crop Yields     40
The Real-Nominal Principle     40
The Declining Real Minimum Wage      41
Repaying Student Loans     42
Summary     43
Key Terms     43
Exercises     43
Economic Experiment     47
Exchange and Markets     48
Comparative Advantage and Exchange     50
Specialization and the Gains from Trade     50
Comparative Advantage Versus Absolute Advantage     52
The Division of Labor and Exchange     52
Comparative Advantage and International Trade     53
Moving Jobs to Different States and Different Countries     54
Movie Exports     54
Candy Cane Makers Move to Mexico for Cheap Sugar     55
Markets     56
Virtues of Markets     56
Markets in a Prisoner of War Camp     57
Market Failure and the Role of Government     58
Government Enforces the Rules of Exchange     59
Government Can Reduce Economic Uncertainty     60
Summary     61
Key Terms     61
Exercises     61
Demand, Supply, and Market Equilibrium     66
The Demand Curve     68
The Individual Demand Curve and the Law of Demand     68
From Individual Demand to Market Demand      69
The Supply Curve     70
The Individual Supply Curve and the Law of Supply     71
Why Is the Individual Supply Curve Positively Sloped?     72
From Individual Supply to Market Supply     73
Why Is the Market Supply Curve Positively Sloped?     74
Market Equilibrium: Bringing Demand and Supply Together     74
Excess Demand Causes the Price to Rise     75
Excess Supply Causes the Price to Drop     76
Market Effects of Changes in Demand     76
Change in Quantity Demanded Versus Change in Demand     76
Increases in Demand Shift the Demand Curve     77
Decreases in Demand Shift the Demand Curve     78
A Decrease in Demand Decreases the Equilibrium Price     80
Market Effects of Changes in Supply     80
Change in Quantity Supplied Versus Change in Supply     80
Increases in Supply Shift the Supply Curve     81
An Increase in Supply Decreases the Equilibrium Price     82
Decreases in Supply Shift the Supply Curve     83
A Decrease in Supply Increases the Equilibrium Price     83
Simultaneous Changes in Demand and Supply     84
Predicting and Explaining Market Changes     85
Applications of Demand and Supply      86
Hurricane Katrina and Baton Rouge Housing Prices     86
Ted Koppel Tries to Explain Lower Drug Prices     87
Electricity from the Wind     88
The Bouncing Price of Vanilla Beans     89
Platinum, Jewelry, Catalytic Converters     90
Summary     91
Key Terms     91
Exercises     91
Economic Experiment     96
The Basic Concepts in Macroeconomics
Measuring a Nation's Production and Income     98
The "Flip" Sides of Macroeconomic Activity: Production and Income     100
The Circular Flow of Production and Income     101
The Production Approach: Measuring a Nation's Macroeconomic Activity Using Gross Domestic Product     102
The Components of GDP     103
Putting It All Together: The GDP Equation     107
The Income Approach: Measuring a Nation's Macroeconomic Activity Using National Income     107
Measuring National Income     108
Measuring National Income Through Value Added     109
An Expanded Circular Flow     109
Using Value Added to Measure the True Size of Wal-Mart     110
A Closer Examination of Nominal and Real GDP     111
Measuring Real Versus Nominal GDP      111
How to Use the GDP Deflator     112
Fluctuations in GDP     113
GDP as a Measure of Welfare     114
Shortcomings of GDP as a Measure of Welfare     114
The NBER and the 2001 Recession     115
The Links Between Self-Reported Happiness and GDP     117
Summary     118
Key Terms     118
Exercises     118
Unemployment and Inflation     122
Examining Unemployment     124
How Is Unemployment Defined and Measured?     124
After Growing Sharply, Women's Labor Force Participation Has Leveled Off     125
Alternative Measures of Unemployment and Why They're Important     126
NEETs Are the New Discouraged Workers in Japan     127
Who Are the Unemployed?     128
Categories of Unemployment     128
Types of Unemployment: Cyclical, Frictional, and Structural     129
The Natural Rate of Unemployment     130
The Costs of Unemployment     130
Finding the Optimal Level of Unemployment Insurance     131
The Consumer Price Index and The Cost of Living     132
The CPI Versus the Chain Index for GDP     133
Problems in Measuring Changes in Prices      133
Inflation     134
Historical U.S. Inflation Rates     135
Using the CPI to Adjust Social Security Benefits     136
The Perils of Deflation     136
The Costs of Inflation     137
Anticipated Inflation     137
Unanticipated Inflation     137
Summary     138
Key Terms     139
Exercises     139
The Economy in the Long Run
The Economy at Full Employment     142
Wage and Price Flexibility and Full Employment     144
Understanding Full Employment     144
The Production Function     144
Wages and the Demand and Supply for Labor     147
Labor Market Equilibrium     147
Changes in Demand and Supply     147
Immigration Affects Both the Demand and Supply for Labor     149
Labor Market Equilibrium and Full Employment     149
Labor Supply Varies Across Countries and Time     151
Using the Full-Employment Model     151
Taxes and Potential Output     151
A Nobel Laureate Explains Why Europeans Work Less Than Americans or the Japanese     153
Real Business Cycle Theory     153
Dividing Output Among Competing Demands for GDP at Full Employment     155
International Comparisons     155
Crowding Out in a Closed Economy     156
Crowding Out in an Open Economy     158
Crowding In     158
Summary     158
Key Terms     159
Exercises     159
Why Do Economies Grow?     162
Economic Growth Rates     164
Measuring Economic Growth     164
Comparing the Growth Rates of Various Countries     166
Increased Growth Leads to Less Child Labor in Developing Countries     167
Are Poor Countries Catching Up?     167
Capital Deepening     168
Saving and Investment     169
Growth Need Not Cause Increased Inequality     170
How Do Population Growth, Government, and Trade Affect Capital Deepening?     171
Limits to Capital Deepening     172
The Key Role of Technological Progress     172
How Do We Measure Technological Progress?     173
Using Growth Accounting     173
How Growth in Singapore and Hong Kong Differed     174
Worldwide Factors Slowed U.S. Productivity Growth     174
The Internet and Information Technology Raised Productivity Throughout the Economy      176
What Causes Technological Progress?     176
Research and Development Funding     177
Monopolies That Spur Innovation     177
The Scale of the Market     178
Induced Innovations     178
Education, Human Capital, and the Accumulation of Knowledge     178
A Virtuous Circle: GDP and Health     179
New Growth Theory     180
A Key Governmental Role: Providing the Correct Incentives and Property Rights     180
Lack of Property Rights Hinders Growth in Peru     181
Summary     182
Key Terms     182
Exercises     183
Appendix: A Model of Capital Deepening     186
Economic Fluctuations
Aggregate Demand and Aggregate Supply     190
Sticky Prices and Their Macroeconomic Consequences     192
Price Stickiness in Retail Catalogs     194
Understanding Aggregate Demand     194
What Is the Aggregate Demand Curve?     194
The Components of Aggregate Demand     195
Why the Aggregate Demand Curve Slopes Downward     195
Shifts in the Aggregate Demand Curve     196
How the Multiplier Makes the Shift Bigger     198
Understanding Aggregate Supply      200
The Long-Run Aggregate Supply Curve     201
The Short-Run Aggregate Supply Curve     202
Business Investment, Net Exports, and the 2001 Recession     203
Supply Shocks     204
How the U.S. Economy Has Coped with Oil Price Fluctuations     205
From the Short Run to the Long Run     205
Looking Ahead     207
Summary     207
Key Terms     207
Exercises     208
Fiscal Policy     210
The Role of Fiscal Policy     212
Fiscal Policy and Aggregate Demand     212
The Fiscal Multiplier     213
The Limits to Stabilization Policy     214
The Federal Budget     216
Federal Spending     216
Increasing Life Expectancy and Aging Populations Spur Costs of Entitlement Programs     218
Federal Revenues     219
The Federal Deficit and Fiscal Policy     220
Automatic Stabilizers     220
How Governments Use Budget Baselines to Forecast Deficits     221
Are Deficits Bad?     222
Fiscal Policy in U.S. History     222
The Depression Era     223
The Kennedy Administration     223
The Vietnam War Era     223
The Reagan Administration     224
The Clinton and George W. Bush Administrations     224
Surveys Show Much of the 2001 Tax Cuts Were Saved     225
Summary     226
Key Terms     227
Exercises     227
The Income-Expenditure Model     230
A Simple Income-Expenditure Model     232
Equilibrium Output     233
Adjusting to Equilibrium Output     234
The Consumption Function     235
Consumer Spending and Income     235
Changes in the Consumption Function     236
Rising Home Equity, the Wealth Effect, and Increased Consumer Spending     237
Equilibrium Output and the Consumption Function     238
Saving and Investment     239
Understanding the Multiplier     240
Increased Investment Spending Raises GDP After Natural Disasters     241
Government Spending and Taxation     242
Fiscal Multipliers     242
Using Fiscal Multipliers     244
John Maynard Keynes: A World Intellectual     246
Understanding Automatic Stabilizers     247
Exports and Imports     249
The Locomotive Effect: How Foreign Demand Affects a Country's Output     251
The Income-Expenditure Model and the Aggregate Demand Curve     252
Summary     253
Key Terms     254
Exercises     254
Economic Experiment     256
Appendix: Formulas for Equilibrium Income and the Multiplier     257
Investment and Financial Markets     262
An Investment: A Plunge into the Unknown     264
Evaluating the Future     265
Energy Price Uncertainty Reduces Investment Spending     266
Understanding Present Value     266
Options for a Lottery Winner     268
Real and Nominal Interest Rates     269
Interest Rates Vary by Risk and Length of Loan     270
Understanding Investment Decisions     271
Investment and the Stock Market     272
How Financial Intermediaries Facilitate Investment     274
When Financial Intermediaries Malfunction     275
Fannie Mae and Freddie Mac Facilitate Homeownership: But Do They Increase Risk?     276
Summary     277
Key Terms     277
Exercises     278
Economic Experiment     279
Money, Banking, and Monetary Policy
Money and the Banking System      280
What Is Money?     282
Three Properties of Money     282
Different Types of Monetary Systems     283
Measuring Money in the U.S. Economy     284
More Than Half of U.S. Currency Is Held Overseas     285
How Banks Create Money     286
A Bank's Balance Sheet: Where the Money Comes From and Where It Goes     286
How Banks Create Money     287
How the Money Multiplier Works     288
How the Money Multiplier Works in Reverse     289
A Banker's Bank: The Federal Reserve     290
The Structure of the Federal Reserve     290
Two Recent Major Leaders of the Federal Reserve Board     292
The Independence of the Federal Reserve     293
What the Federal Reserve does During a Financial Crisis     293
Coping with a Stock Market Crash; Black Monday, 1987     293
The Financial System Under Stress: September 11, 2001     294
Summary     295
Key Terms     295
Exercises     295
Economic Experiment     298
Appendix: Formula for Deposit Creation     299
The Federal Reserve and Monetary Policy     300
The Money Market     302
The Demand for Money     302
How the Federal Reserve Can Change the Money Supply     304
Open Market Operations     305
Other Tools of the Fed     305
How Interest Rates Are Determined: Combining the Demand and Supply of Money     306
Interest Rates and Bond Prices     307
Rising Interest Rates During an Economic Recovery     308
Interest Rates and How They Change Investment and Output (GDP)     310
Monetary Policy and International Trade     312
Monetary Policy Challenges for the Fed     313
Lags in Monetary Policy     313
The Effectiveness of Committees     314
Influencing Market Expectations: From the Federal Funds Rate to Interest Rates on Long-Term Bonds     315
Making the Federal Reserve More Transparent     316
Looking Ahead: From the Short Run to the Long Run     316
Summary     317
Key Terms     317
Exercises     317
Inflation, Unemployment, and Economic Policy
Modern Macroeconomics: From the Short Run to the Long Run     320
Linking the Short Run and the Long Run     322
The Difference Between the Short and Long Run     322
Wages and Prices and Their Adjustment over Time      322
How Wage and Price Changes Move the Economy Naturally Back to Full Employment     323
Returning to Full Employment from a Recession     324
Returning to Full Employment from a Boom     325
Economic Policy and the Speed of Adjustment     325
Liquidity Traps     327
Japan's Lost Decade     327
Political Business Cycles     328
Elections, Political Parties, and Voter Expectations     328
Understanding the Economics of the Adjustment Process     329
The Long-Run Neutrality of Money     330
Crowding Out in the Long Run     332
An Unfortunate Gamble     333
Classical Economics in Historical Perspective     334
Say's Law     334
Keynesian and Classical Debates     334
Summary     335
Key Terms     335
Exercises     336
The Dynamics of Inflation and Unemployment     338
Money Growth, Inflation, and Interest Rates     340
Inflation in a Steady State     340
How Changes in the Growth Rate of Money Affect the Steady State     341
Understanding the Expectations Phillips Curve: The Relationship Between Unemployment and Inflation     342
Are the Public's Expectations About Inflation Rational?     343
U.S. Inflation and Unemployment in the 1980s     344
Shifts in the Natural Rate of Unemployment in the 1990s     345
Regional Differences in Unemployment Increase the Natural Rate     346
How the Credibility of a Nation's Central Bank Affects Inflation     347
Increased Political Independence for the Bank of England Lowered Inflation Expectations     349
Inflation and the Velocity of Money     349
Inflation-Indexed Bonds in the United States     350
Hyperinflation     352
How Budget Deficits Lead to Hyperinflation     353
Summary     354
Key Terms     354
Exercises     355
Economic Experiment     357
Macroeconomic Policy Debates     358
Should We Balance the Federal Budget?     360
The Budget in Recent Decades     360
The Budget and Social Security     361
Five Debates About Deficits     362
New Methods to Measure the Long-Term Fiscal Imbalances for the United States     365
Should the Fed Target Inflation?     366
Two Debates About Inflation Targeting     367
Bernanke on Inflation Targeting     368
Should We Tax Consumption Rather Than Income?     369
Two Debates About Consumption Taxation     370
The Flat Tax Is a Tax on Consumption     372
Summary     373
Key Terms     373
Exercises     373
The International Economy
International Trade and Public Policy     376
Benefits from Specialization and Trade     378
Production Possibilities Curve     378
Comparative Advantage and the Terms of Trade     379
The Consumption Possibilities Curve     380
How Free Trade Affects Employment     381
Protectionist Policies     382
Import Bans     382
Quotas and Voluntary Export Restraints     382
Responses to Protectionist Policies     384
The Impact of Tariffs on the Poor     384
What Are the Rationales for Protectionist Policies?     385
To Shield Workers from Foreign Competition     385
To Nurture Infant Industries     385
Measuring the Costs of Protecting Jobs     386
To Help Domestic Firms Establish Monopolies in World Markets     386
Protection for Candle Makers     387
A Brief History of International Tariff and Trade Agreements     388
Ongoing Trade Negotiations     389
Recent Policy Debates and Trade Agreements     389
Are Foreign Producers Dumping Their Products?     389
Do Trade Laws Inhibit Environmental Protection?     390
Do Outsourcing and Trade Cause Inequality?     391
Why Do People Protest Against Free Trade?     392
Summary     393
Key Terms     393
Exercises     393
The World of International Finance     396
How Exchange Rates Are Determined     398
What Are Exchange Rates?     398
How Demand and Supply Determine Exchange Rates     399
Changes in Demand or Supply     400
Real Exchange Rates and Purchasing Power Parity     401
The Current Account, the Financial Account, and the Capital Account     403
Big Macs and Purchasing Power Parity     404
Rules for Calculating the Current, Financial, and Capital Accounts     405
Fixed and Flexible Exchange Rates     407
Fixing the Exchange Rate     407
World Savings and U.S. Current Account Deficits     408
Fixed Versus Flexible Exchange Rates     408
The U.S. Experience with Fixed and Flexible Exchange Rates     410
Exchange Rate Systems Today      411
The First Decade of the Euro     411
Managing Financial Crises     412
The Argentinean Financial Crisis     413
Summary     414
Key Terms     414
Exercises     415
Economic Experiment     416
A Closer Look at Demand and Supply
Elasticity: A Measure of Responsiveness     418
The Price Elasticity of Demand     420
Computing Percentage Changes and Elasticities     420
Price Elasticity and the Demand Curve     422
Elasticity and the Availability of Substitutes     422
Other Determinants of the Price Elasticity of Demand     425
Using Price Elasticity to Predict Changes in Quantity     425
Beer Taxes and Highway Deaths     426
Subsidized Medical Care in Cote d'Ivoire and Peru     427
Price Elasticity and Total Revenue     427
How to Cut Teen Smoking by 60 Percent     428
Elastic Versus Inelastic Demand     429
Market Elasticity Versus Elasticity for a Firm     430
Transit Fares and Deficits     430
A Bumper Crop Is Bad News for Farmers     431
Drug Prices and Property Crime     432
Elasticity and Total Revenue for a Linear Demand Curve      432
Price Elasticity Along a Linear Demand Curve     432
Elasticity and Total Revenue for a Linear Demand Curve     434
Other Elasticities of Demand     434
Income Elasticity of Demand     435
Cross-Price Elasticity of Demand     435
The Price Elasticity of Supply     436
What Determines the Price Elasticity of Supply?     437
The Role of Time: Short-Run Versus Long-Run Supply Elasticity     437
Extreme Cases: Perfectly Inelastic Supply and Perfectly Elastic Supply     438
Predicting Changes in Quantity Supplied     439
Using Elasticities to Predict Changes in Equilibrium Price     439
The Price Effects of a Change in Demand     439
The Price Effects of a Change in Supply     441
Metropolitan Growth and Housing Prices     441
An Import Ban and Shoe Prices     443
Summary     443
Key Terms     444
Exercises     444
Market Efficiency and Government Intervention     448
Consumer Surplus and Producer Surplus     450
The Demand Curve and Consumer Surplus     451
The Supply Curve and Producer Surplus     451
Market Equilibrium and Efficiency      452
Total Surplus Is Lower with a Price Below the Equilibrium Price     453
Total Surplus Is Lower with a Price Above the Equilibrium Price     454
Efficiency and the Invisible Hand     454
Government Intervention in Efficient Markets     455
Controlling Prices-Maximum and Minimum Prices     455
Setting Maximum Prices     455
Rent Control     456
Milk Mountains     458
Setting Minimum Prices     458
Controlling Quantities-Licensing and Import Restrictions     458
Taxi Medallions     459
Licensing and Market Efficiency     459
Winners and Losers from Licensing     460
Import Restrictions     460
U.S. and European Consumers Pay for Import Restrictions     462
Who Really Pays Taxes?     462
Tax Shifting: Forward and Backward     462
Supply and Demand for Human Organs     463
Tax Shifting and the Price Elasticity of Demand     464
Cigarette Taxes and Tobacco Land     465
Tax Burden and Deadweight Loss     465
Boat Workers and the Tax on Luxury Boats     465
Taxes and December Babies     467
Summary     467
Key Terms      468
Exercises     468
Economic Experiment     471
Consumer Choice Using Utility Theory     472
Total and Marginal Utility     474
Consumer Choice     475
Consumer Constraints: The Budget Line     475
Making Choices Using the Equimarginal Rule     476
New Zealand's Tax on Light Spirits     477
Online Music Stores and Piracy     478
The Individual Demand Curve     479
The Income and Substitution Effects of a Price Change     479
Points on the Demand Curve     480
The Substitution Effect of a Gas Tax Decreases Gas Consumption     481
Applications of Consumer Choice     482
Inflation Doesn't Change Consumption or Utility     482
Television Versus Radio Advertising     483
Summary     484
Key Terms     484
Exercises     484
Appendix: Consumer Choice with Indifference Curves     488
Consumer Constraints and Preferences     488
Maximizing Utility     491
What's Your MRS?     492
Online Music and Piracy     493
Inflation Doesn't Change Consumption or Utility     494
Drawing the Individual Demand Curve     495
The Substitution Effect of a Gas Tax Decreases Gas Consumption     498
Summary     499
Key Terms     500
Exercises     500
Market Structures and Pricing
Production Technology and Cost     504
Economic Cost and Economic Profit     506
A Firm with a Fixed Production Facility: Short-Run Costs     507
Production and Marginal Product     507
Short-Run Total Cost     508
Short-Run Average Costs     510
Short-Run Marginal Cost     511
The Relationship Between Marginal Cost and Average Cost     512
Production and Cost in the Long Run     513
Expansion and Replication     513
Reducing Output with Indivisible Inputs     515
Scaling Down and Labor Specialization     515
Economies of Scale     516
Diseconomies of Scale     516
Actual Long-Run Average-Cost Curves     516
Short-Run Versus Long-Run Average Cost     517
Applications of Production Cost     518
The Production Cost of an iPod Nano     518
Indivisible Inputs and the Cost of Fake Killer Whales     519
Scale Economies in Wind Power      520
Information Goods and First-Copy Cost     520
The Average Cost of Producing Airplanes     521
Summary     522
Key Terms     523
Exercises     523
Perfect Competition     526
Preview of the Four Market Structures     528
The Firm's Short-Run Output Decision     530
The Total Approach: Computing Total Revenue and Total Cost     530
The Marginal Approach     531
Economic Profit and the Break-Even Price     533
The Firm's Shut-Down Decision     533
Total Revenue, Variable Cost, and the Shut-Down Decision     533
The Shut-Down Price     535
Fixed Costs and Sunk Costs     535
The Break-Even Price for a Corn Farmer     536
Short-Run Supply Curves     536
The Firm's Short-Run Supply Curve     536
The Short-Run Market Supply Curve     537
Market Equilibrium     538
Wireless Women in Pakistan     539
The Long-Run Supply Curve for an Increasing-Cost Industry     539
Production Cost and Industry Size     540
Drawing the Long-Run Market Supply Curve     540
Wolfram Miners Obey the Law of Supply     541
The Worldwide Supply of Sugar     542
Short-Run and Long-Run Effects of Changes in Demand     542
The Short-Run Response to an Increase in Demand     542
The Long-Run Response to an Increase in Demand     543
Zoning, Land Prices, and the Supply Curve for Apartments     544
Long-Run Supply for a Constant-Cost Industry     545
Long-Run Supply Curve for a Constant-Cost Industry     545
Hurricane Andrew and the Price of Ice     545
Summary     547
Key Terms     547
Exercises     547
Monopoly and Price Discrimination     552
The Monopolist's Output Decision     554
Total Revenue and Marginal Revenue     555
A Formula for Marginal Revenue     556
Using the Marginal Principle     556
The Social Cost of Monopoly     559
Deadweight Loss from Monopoly     559
Rent Seeking: Using Resources to Get Monopoly Power     561
Monopoly and Public Policy     561
Ending the Monopoly on Internet Registration     562
Patents and Monopoly Power     562
Incentives for Innovation     562
Trade-Offs from Patents     563
Price Discrimination      563
Bribing the Makers of Generic Drugs     564
Senior Discounts in Restaurants     565
Price Discrimination and the Elasticity of Demand     566
Paying for a Cold Soft Drink on a Hot Day     566
The Pricing of Movie Admission and Popcorn     567
Hardback Books Are Relatively Expensive     568
Summary     568
Key Terms     569
Exercises     569
Economic Experiment     572
Market Entry and Monopolistic Competition     574
The Effects of Market Entry     576
Entry Squeezes Profits from Three Sides     577
Woofer, Tweeter, and the Stereo Business     578
Deregulation and Entry in Trucking     578
Name Brands Versus Store Brands     579
Monopolistic Competition     579
When Entry Stops: Long-Run Equilibrium     580
Differentiation by Location     581
Trade-Offs with Entry and Monopolistic Competition     581
Average Cost and Variety     581
Opening a Dunkin' Donuts Shop     582
Monopolistic Competition Versus Perfect Competition     583
Advertising for Product Differentiation     584
Celebrity Endorsements and Signaling      584
Advertising and Movie Buzz     585
Summary     586
Key Terms     586
Exercises     586
Economic Experiment     589
Oligopoly and Strategic Behavior     590
What Is an Oligopoly?     592
Cartel Pricing and the Duopolists' Dilemma     593
Price-Fixing and the Game Tree     595
Equilibrium of the Price-Fixing Game     596
Nash Equilibrium     597
Overcoming the Duopolists' Dilemma     597
Low-Price Guarantees     597
Vitamin Inc. Gets Busted     598
Repeated Pricing Games with Retaliation for Underpricing     599
Low-Price Guarantees and Empty Promises     600
Price-Fixing and the Law     601
Alternative Models of Oligopoly Pricing     602
Price Leadership     602
The Kinked Demand Curve Model     602
Simultaneous Decision Making and the Payoff Matrix     603
Simultaneous Price-Fixing Game     603
The Prisoners' Dilemma     604
The Insecure Monopolist and Entry Deterrence     605
The Passive Approach     605
Entry Deterrence and Limit Pricing     606
Legal and Illegal Entry Deterrence     608
Examples: Microsoft Windows and Campus Bookstores     608
Entry Deterrence and Contestable Markets     609
When Is the Passive Approach Better?     609
The Advertisers' Dilemma     609
Reynolds International Takes the Money Leaves the Market     610
Summary     612
Key Terms     612
Exercises     612
Economic Experiment     617
Controlling Market Power: Antitrust and Regulation     618
Natural Monopoly     620
Picking an Output Level     620
Will a Second Firm Enter?     621
Price Controls for a Natural Monopoly     622
XM and Sirius Satellite Radio     623
A Decrease in Demand Increases The Price of Cable TV     624
Antitrust Policy     624
Breaking Up Monopolies     624
Blocking Mergers     625
Merger Remedy for Wonder Bread     626
Heinz and Beech-Nut Battie for Second Place     627
Regulating Business Practices: Price-Fixing, Tying, and Cooperative Agreements     628
Xidex Recovers Its Acquisition Cost in Two Years     629
The Microsoft Cases     629
A Brief History of U.S. Antitrust Policy     629
Deregulation: Airlines, Telecommunications, and Electricity     630
Deregulation of Airlines     630
Deregulation of Telecommunication Services     631
Deregulation of Electricity     631
Electricity Deregulation in California     632
Electricity Deregulation in Other U.S. States     633
Summary     633
Key Terms     633
Exercises     633
Externalities and Information
Imperfect Information: Adverse Selection and Moral Hazard     636
The Lemons Problem     638
Uninformed Buyers and Knowledgeable Sellers     638
Equilibrium with All Low-Quality Goods     639
A Thin Market: Equilibrium with Some High-Quality Goods     640
Responding to the Lemons Problem     642
Buyers Invest in Information     642
Consumer Satisfaction Scores from ValueStar and eBay     642
Guarantees and Lemons Laws     642
Evidence of the Lemons Effect     643
The Resale Value of a Week-Old Car     643
Used Pickup Trucks     644
Regulation of the California Kiwifruit Market     644
Baseball Pitchers Are Like Used Cars      645
Uninformed Sellers and Knowledgeable Buyers: Insurance     646
Health Insurance     646
Equilibrium with All High-Cost Consumers     646
Responding to Adverse Selection in Insurance: Group Insurance     648
The Uninsured     648
Genetic Testing Benefits Low-Risk People     649
Other Types of Insurance     650
Insurance and Moral Hazard     650
Deposit Insurance for Savings & Loans     651
People with Insurance Take More Risks     651
Summary     652
Key Terms     652
Exercises     652
Economic Experiments     656
Public Goods and Public Choice     658
External Benefits and Public Goods     660
Public Goods and the Free-Rider Problem     661
Free Riders and the Three-Clock Tower     663
Overcoming the Free-Rider Problem     663
Paying Landowners to Host Wolves     664
Asteroid Diversion as a Public Good     664
Private Goods with External Benefits     665
External Benefits from Education     665
External Benefits and the Marginal Principle     665
Other Private Goods That Generate External Benefits      666
External Benefits from Lojack     667
Public Choice     667
Voting and the Median-Voter Rule     667
Alternative Models of Government: Self-Interest and Special Interests     669
Politicians Are Like Ice-Cream Sellers     670
Which Theory Is Correct?     671
Summary     671
Key Terms     671
Exercises     671
Economic Experiment     673
External Costs and Environmental Policy     674
The Optimal Level of Pollution     676
Using the Marginal Principle     676
The Optimal Level of Sulfur Dioxide Emissions     677
Taxing Pollution     678
A Firm's Response to a Pollution Tax     678
The Market Effects of a Pollution Tax     678
Traditional Regulation     680
Uniform Abatement with Permits     680
The Effects of a Carbon Tax     681
Command and Control     682
Market Effects of Pollution Regulations     682
Marketable Pollution Permits     682
Dear Abby and Environmental Policy     683
Voluntary Exchange and Marketable Permits     684
Supply, Demand, and the Price of Marketable Permits      684
External Costs from Automobiles     685
External Costs from Pollution     685
Marketable Permits for Sulfur Dioxide     686
Chicago Climate Exchange     687
External Costs from Congestion     688
External Costs from Collisions     689
Young Drivers and Collisions     689
Summary     690
Key Terms     690
Exercises     690
Economic Experiment     693
The Labor Market and Income Distribution
The Labor Market, Income, and Poverty     694
The Demand for Labor     696
Labor Demand by an Individual Firm in the Short Run     696
Market Demand for Labor in the Short Run     699
Labor Demand in the Long Run     699
Short-Run Versus Long-Run Demand     699
The Supply of Labor     700
The Individual Labor-Supply Decision: How Many Hours?     700
Different Responses to a Higher Wage     701
The Market Supply Curve for Labor     701
Labor Market Equilibrium     702
Changes in Demand and Supply     702
The Market Effects of the Minimum Wage     703
Codes of Conduct and Living Wages      704
Trade-Offs from Immigration     705
Explaining Differences in Wages and Income     705
Why Do Wages Differ Across Occupations?     706
The Gender Pay Gap     706
Wage Premiums for Dangerous Jobs     707
Racial Discrimination     708
Why Do College Graduates Earn Higher Wages?     708
Lakisha Washington Versus Emily Walsh     709
The Distribution of Income     710
Income Distribution Facts     710
Recent Changes in the Distribution of Income     711
Changes in the Top End of Income Distribution: 1920-1998     712
Poverty and Public Policy     713
Poverty Rates for Different Groups     713
Redistribution Programs for the Poor     714
Welfare Reform and TANF     714
Welfare and Work Incentives     715
Summary     716
Key Terms     716
Exercises     716
Unions, Monopsony, and Imperfect Information     720
Labor Unions     722
A Brief History of Labor Unions in the United States     722
Labor Unions and Wages     723
Truckers Trade Off Wages and Jobs     724
Market Structure and the Wage-Jobs Trade-Off     725
The Effects of Unions on Worker Productivity and Turnover     725
Competition Reduces Trucker Wages     726
Monopsony Power     726
Marginal Labor Cost Exceeds the Wage     727
Picking a Quantity of Labor and a Wage     727
Monopsony Versus Perfect Competition     728
Monopsony and a Minimum Wage     729
Monopsony and the Real World     730
Pubs and the Labor-Supply Curve     731
Imperfect Information and Efficiency Wages     731
The Mixed Market for Labor     731
Efficiency Wages at Ford Motor Company     733
Summary     734
Key Terms     734
Exercises     734
Glossary     737
Photo Credits     747
Index     749
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