SalvatoreMicroeconomics, 5th edition Web Examples

Salvatore/Microeconomics, 5th edition /Web Examples WEB SITE CONTENTS Chapter 1: Fewer Guns Means a Lot More Butter Chapter 1: Even the IBM PC and the Boeing 777 Are Not All American! Chapter 2: Changes in Supply and Demand Cause Large Swings in Copper Prices Chapter 3: Happiness and Life Satisfaction over Time in the U.S and the U.K Chapter 4: The Human Development Index—A Better Measure of the Standard of Living Chapter 5: Estimation of the Demand for Oranges by Market Experiment Chapter 6: Returns on U.S Asssets Are Higher for More Risky Investments Chapter 7: How Motorola Stumbled and Failed to Avoid Diseconomies of Scale Chapter 8: To Reduce Costs, Firms Often Look Far Afield Chapter 9: The Russian Wheat Deal and U.S Wheat Prices Chapter 10: Restrictions on Competition in the Pricing of Milk in New York City and the Nation Chapter 11: The Monopolistically Competitive Restaurant Market Chapter 12: The Objective and Strategy of Firms in the Cigarette Industry Chapter 13: Transfer Pricing Chapter 14: The Glut of Lawyers and Doctors in the United States Chapter 15: Change in the Occupational Distribution of the U.S Labor Force: 1990–1999 Chapter 16: Rates of Return on U.S and Foreign Share Price Chapter 17: Exchange in POW Camps Chapter 18: The Fable of the Apples and the Bees Chapter 19: Information and the Limits to Workers Privacy =============================================================== Web Example 1-1 Fewer Guns Means a Lot More Butter With the collapse of communism in the former Soviet Union and its virtual removal as a military threat, the United States reaped a sizable “peace dividend”; that is, U.S military expenditures (which in 1990 were 26% of the government’s total budget) were reduced sharply and redirected toward the private sector and other forms of government spending Over a decade, the savings from military expenditures amounted to as much as $150 billion per year Growth was also stimulated by gradually redeploying toward civilian uses the 30% of all scientists and engineers previously employed in defense-related research and production There were many conflicting claims on such a peace dividend Some wanted to use the money to help the Eastern European countries and the former Soviet republics restructure their economies to promote democracy Others wanted to use it to improve health, education, and infrastructure in this country Still others wanted to use it to reduce the immense federal deficit; this would reduce public borrowing, lower interest rates, and stimulate housing and other private investments Some thought that using of the peace dividend to improve health, education, and infrastructure would increase long-term national growth considerably For example, a billion dollars could provide comprehensive prenatal care to an additional 1.5 million poor pregnant women or add 400,000 children to the Head Start program It has been estimated that each dollar spent on Head Start saves almost $5 in welfare, remedial education, and other costs later Improving infrastructure would also be productive According to the Federal Transportation Department, urban areas waste billion hours a year on highway delays Flight delays at 21 primary airports amount to 20,000 hours per year As it turned out, the peace dividend was in fact used to a little of all the above The same type of heated discussion arose during the 2000 Presidential election and afterwards on how to use the huge budget surplus that was developing when the American economy was growing very rapidly With sharp and unexpected decline in the growth of the U.S economy in 2001 and the huge tax cuts pushed by the newly elected Bush Administration, the budget surplus all but vanished—and so did the discussion of what to with it What did occur, however, was a major shift in budget priorities: Whereas in 1956 60% of federal spending went for defense and 22% for social security and other payments to individuals, in 2006 60% went for the latter and 20% for the former Source: “$150 Billion a Year—How to Spend It,” New York Times, March 9, 1990, p 34; “The Defense Whizzes Making It in Civvies,” Business Week, September 7, 1992, pp 88-90; Allen Schick, “How the Federal Surplus Happened,” Brookings Review, Winter 2000, pp 36–39; “President’s Signature Turns Broad Tax Cut, and a Campaign Promise, Into a Law,” New York Times, June 6, 2001, p 24; “Bush Projections in Budget Surplus,” New York Times, August 23, 2001, p 1; and “The Stubborn Welfare State,” Newsweek, February 19, 2007, p 39 =============================================================== =============================================================== Web Example 1-2 Even the IBM PC and the Boeing 777 Are Not All American! The following table shows that of the total manufacturing cost of $860 for the IBM PC in 1985, $625 was for parts and components made abroad (of which, $230 was from U.S.owned plants) Even though all the parts made overseas could be manufactured domestically, they would have cost more and would have led to higher PC prices in the United States (and reduced competitiveness of IBM PCs in international markets) In fact, at the end of 2004, IBM sold its PC business to China’s Lenovo Similarly, only 13 of the 33 major components of the new Boeing 777 jetliner are made in the United States, are made in Japan, and another 13 in other countries (Australia, Canada, England, France, Italy, and South Korea) Distribution of Manufacturing Costs for the IBM PC in the United States and Abroad Total manufacturing cost: Portion made abroad: in U.S.-owned plants in foreign-owned plants Distribution of manufacturing costs: Monochrome monitor Semiconductors Semiconductors Power supply Graphic printer Floppy disk drives Assembly of disk drives Keyboard Case and final assembly $860 $625 $230 $395 (Korea) (Japan) (U.S.) (Japan) (Japan) (Singapore) (U.S.) (Japan) (U.S.) $ 85 105 105 60 160 165 25 50 105 $860 _ _ Sources: “America’s High Tech Crisis,” Business Week, March 11, 1985, pp 56–67; Boeing news release 1998; and “IBM Strikes a Deal with Rival Lenovo,” Wall Street Journal, December 9, 2004, p A3 =============================================================== =============================================================== Web Example 2-1 Changes in Supply and Demand Cause Large Swings in Copper Prices Copper is an important mineral with a large variety of industrial uses, ranging from electrical wires, electrical appliances, and computers, and it is used in the construction of automobiles, homes and offices In terms of quantities consumed, copper is third among metals after iron and aluminum It is its properties of high thermal and electrical conductivity, malleability, and resistance to corrosion that make a readily available supply of copper crucial for modern industrial production, and its price is an important part of the cost of many products There are, however, substitutes and a change in the price of copper in relation to the price of its substitutes can lead to the switching from one mineral to others in production of many products Changes in Demand and Supply can explain the sharp decline in the world’s price of copper from about $1.20 per pound in mid-1997 to $0.62 per pound in mid-2001 The decline in copper prices during the second half of 1997 was triggered by the serious financial and economic crisis in South-East Asia (South Korea, Thailand, Malaysia, Indonesia, and the Philippines), which reduced the world demand for copper By the beginning of 1999, the price of copper had reached a low of $0.61 per pound From then until the fall of 2000, the price of copper rallied to $0.89 per pound, as the demand for copper increased with the end of the crisis in South-East Asia and as a result of rapid growth in the United States (then the world’s largest user of copper) From fall 2000 until fall 2001, however, copper declined to $0.62 as a result of flat world consumption (because of the world economic slowdown) in the face of large increases in supply (rightward shift in the world supply curve) as several new large copper mines in South America (especially Chile—the largest copper producer in the world) and in Asia started production Since then, however, copper prices increased sharply and exceeded $3.50 per pound in fall 2006 as a result of production problems in various producing countries and sharply increased demand (especially from China, which has now the largest user, accounting for about 20% of world consumption) Despite the recent sharp increase in the price of copper, U.S mining companies are facing increasing pressure due to their high production costs, lower-quality copper ore, and more stringent environmental regulations In recent years, U.S Mining companies have reduced costs by implementing new and cheaper smelting (refining) techniques and by mergers (so as to eliminate excess capacity) Despite these efforts, U.S copper production declined from 2,140 metric tons in 1998 to 1,220 metric tons in 2006, while most other copper producing countries increased theirs (the United States, however, still remains the world’s second copper producer with percent of world output after Chile, which has 35 percent of the world market) Source: “Tough Times in Copper Pits,” New York Times, September 11, 1999, p C1 and Daniel E Eldstein, “Copper,” U.S Geological Survey Mineral Yearbook (Washington, D.C.: U.S Government Printing Office, 2006) See also: http://minerals.usgs.gov/minerals/pubs/commodity/copper/coppemcs07.pdf =============================================================== =============================================================== Web Example 3-1 Happiness and Life Satisfaction Over Time in the U.S and the U.K The following table shows the proportions of people giving different happiness answers in the United States and in the United Kingdom over the 1972–1998 period Happiness and Life Satisfaction: Averages for Different Periods a) The proportions of people giving different happiness answers in the United States 1972–98 1972–1976 All - not too happy All - pretty happy All - very happy 1977–1982 1982–1987 1988–1993 1994–1998 14% 52 34 12 54 34 12 56 32 10 58 33 12 58 30 Male - not too happy Male - pretty happy Male - very happy 14 54 32 12 56 32 13 57 30 58 34 11 58 31 Female - not too happy Female - pretty happy Female - very happy 13 51 36 12 53 35 12 56 33 11 57 32 13 59 29 White - not too happy White - pretty happy White - very happy 12 52 36 11 54 35 11 56 33 57 34 11 59 31 Black - not too happy Black - pretty happy Black - very happy 26 54 20 23 54 23 21 58 21 18 60 22 21 58 20 (Continued on the next page) (Continued from the previous page) b) The proportions of people giving different life-satisfaction answers in Great Britain 1973–98 1972–1976 1977–1982 1983–1987 1988–1993 1994–1998 All - not at all All - not very All - fairly All - very 4% 11 54 31 10 54 32 10 55 31 10 55 31 10 57 31 Male - not at all Male - not very Male - fairly Male - very 11 55 30 10 55 31 10 57 29 10 57 29 10 58 29 Female - not at all Female - not very Female - fairly Female - very 12 53 32 10 53 34 10 54 32 11 54 32 55 32 Source: D Blanchflower and A Oswald, “Well-Being Over Time in Britain and the USA,” NBER Working Paper 7487, January 2000, p 19 =============================================================== =============================================================== Web Example 4-1 The Human Development Index—A Better Measure the Standard of Living The United Nations has recently devised a broader and better measure of a nation’s standard of living than just comparing per capita incomes, called the Human Development Index (HDI) The HDI is a weighted average of life expectancy (as a measure of the general health conditions in the nation), an educational index (which includes the adult literacy rate and student enrolment ratio in the nation), and real per capita income adjusted for differences in the purchasing power of the dollar (PPP—defined in Example 4–8) The table below shows the three components of the HDI, as well as the HDI itself for the same 13 countries included in Table 4.3 in Example 4–8 Note that the PPP per capita incomes shown in the table below are different than those shown in Table 4.3 because of different methods of adjustment The table shows that Canada has the highest HDI, followed by Japan, France, United States, United Kingdom, Italy, and Germany among the developed countries, and Mexico, South Korea, Russia, Brazil, China and India among developing countries Note also that the difference in the HDI among developed and developing countries is much less than if we compare only their PPP per capita incomes Life Expectancy, Education Index, PPP Per Capita Income, and Human Development Index: Selected Developed and Developing Countries, 2005 Life Human Expectancy Education Per Capita Development Country at Birth Index Income Index (years) (PPP US $) (HDI) Canada Japan France United States United Kingdom Italy Germany 80.3 82.3 80.2 77.9 79.0 80.3 79.1 0.99 0.95 0.98 0.97 0.97 0.96 0.95 $33,375 31,267 30,386 41,890 33,238 28,529 29,461 0.961 0.953 0.952 0.951 0.946 0.941 0.935 Mexico 75.6 0.86 10,751 0.829 S Korea 77.9 0.98 22,029 0.921 10 Russia 65.0 0.96 10,845 0.802 10 Brazil 71.7 0.88 8,402 0.800 11 China 75.9 0.84 6,757 0.777 12 India 63.7 0.62 3,452 0.619 Source: United Nations Development Program, Human Development Report New York: Oxford University Press, 2007/2008, pp 229–232 ==================================================================== =============================================================== Web Example 5-1 Estimation of the Demand for Oranges by Market Experiment Researchers at the University of Florida conducted a market experiment in Grand Rapids, Michigan, in 1962 to determine the price elasticity and the cross-price elasticity of demand for three types of Valencia oranges: those from the Indian River district of Florida, those from the interior district of Florida, and those from California Grand Rapids was chosen as the site for the market experiment because its size, demographic characteristics, and economic base were representative of other midwestern markets for oranges Nine supermarkets participated in the experiment, which involved changing the price of the three types of oranges, each day, for 31 consecutive days and recording the quantity sold of each variety The price changes ranged within 16 cents, in 4-cent increments, around the price of oranges that prevailed in the market at the time of the study More than 9,250 dozen oranges were sold in the nine supermarkets during the 31 days of the experiment Each of the participating supermarkets was provided with an adequate supply of each type of orange so that supply effects could be ignored The length of the experiment was also sufficiently short so as to ensure no change in tastes, incomes, population, the rate of inflation, and determinants of demand other than price The results, summarized in the following table, indicate that the price elasticity of demand for all three types of oranges was fairly high (the boldface numbers in the main diagonal of the table) For example, the price elasticity of demand for the Indian River oranges of -3.07 indicates that a percent increase in their price leads to a 3.07 percent decline in their quantity demanded More interestingly, the off-diagonal entries in the table show that while the cross-price elasticities of demand between the two types of Florida oranges were larger than 1, they were close to zero with respect to the California oranges In other words, while consumers regarded the two types of Florida oranges as close substitutes, they did not view the California oranges as such In pricing their oranges, therefore, producers of each of the two Florida varieties would have to carefully consider the price of the other (as consumers switch readily among them as a result of price changes) but need not be much concerned about the price of California oranges Price Elasticity and Cross Price Elasticity of Demand for Oranges Florida Type of Orange Indian River Florida Interior California Florida Indian River -3.07 +1.56 +0.01 Florida Interior +1.16 -3.01 +0.14 California +0.18 +0.09 -2.76 Source: M B Godwin, W F Chapman, and W T Hanley, “Competition between Florida and and California Valencia Oranges in the Fruit Market,” Bulletin 704 (Gainesville: University of Florida, December 1965) =============================================================== =============================================================== Web Example 6-1 Returns on U.S Assets Are Higher for More Risky Investments The following table shows the average annual return and standard deviation of the returns on U.S stocks, U.S Treasury bonds, U.S Treasury bills, gold and silver holdings, as well as the average annual rate inflation over the period 1990 to 1999 The table shows that U.S stocks had the highest average annual return but also the highest variability of returns or risk, as measured by the standard deviation U.S Treasury bonds and bills had much lower average annual returns but also faced much lower risk because the probability that the U.S government goes out of business is practically nill U.S Treasury bills offer lower returns than U.S Treasury bonds because the former are more liquid (i.e., mature in less than one year, most commonly three months, while U.S Treasury bonds have a maturity of one year or more) With the annual rate of inflation of 3.2 percent, this means that the average annual real rate of return on U.S stocks was 6.8 percent (10.0%–3.2%) over the period 1990– 1999 On the other hand, the average annual real rate of return on U.S Treasury bonds and U.S Treasury bills was, respectively, 1.4 percent and 0.9 percent over the same period The average real rate of return on holding gold and silver, however, was negative (-0.6 and–1.0, respectively) Thus, despite the claims often made that precious metals (particularly gold) offer the best protection against inflation, their price increased at a slower rate than the rate of inflation and so their real return was actually negative of the last decade Average Annual Rate of Return and Standard Deviation on U.S Assets and Rate of Inflation, 1990–1999 _ Asset Annual Rate of Return Standard Deviation _ Stocks 10.0 1.95 Treasury bonds 4.6 0.37 Treasury bills 4.1 0.11 Gold holdings 2.6 0.49 Silver holdings 2.2 0.73 Inflation rate 3.2 0.16 _ Source: The Foresight Saga,” The Economist, December 18, 1999, pp 59-61 =============================================================== ========================================== ===================== Web Example 7-1 How Motorola Stumbled and Failed to Avoid Diseconomies of Scale Motorola, a leader in the worldwide revolution in wireless communications, grew by leaps and bounds from the mid-1980s to the mid-1990s In 1995, its revenues were $27 billion (with profits of $1.8 billion), propelling it to the twenty-fourth spot on the Fortune 500 list In fact, Motorola had been doubling in size every five years (its sales were $10 billion in 1989) The question in 1996 was “Can Motorola keep avoiding excessive bureaucracy, complacency, and diseconomies of scale as it grows larger and larger?” That question was answered in the second half of the decade, when Motorola stumbled In 2000, Motorola revenues had grown only to $37 billion (with profits of $1.3 billion) and it had slipped to 109th place in the Fortune 500 list Until 1996, Motorola was considered by many to be the best-managed company in the world It was described as an icon of innovation, a pioneer of self-directed teams, and a prince of profits; it wrote the book on decentralization, job training, and promoting cooperation between labor and management Motorola was regarded as simply the best in the world in almost everything it did—including cellular phones, pagers, two-way radios, semiconductors, and other electronic gadgets In 1995, Motorola had an incredible 85 percent share of the world market in pagers, a 45 percent share of the world market for cellular phones, and $6 billion in semiconductor sales (making it the world’s number chip producer, after Intel and NEC), and it generated more than half of its revenues abroad Contrary to many other large U.S firms at the time, this was a large company that sizzled From a slowly declining electronics company in the 1970s, Motorola had become a world technological leader, beating the best of its Japanese competitors—and in the process becoming an industrial legend and management-books case study By 1998, however, it was clear that Motorola had slipped very badly First, it failed to anticipate the rapid move to digital technology and so it lost market leadership in cellular telephones, not only around the world but also on its home turf, to a relative new comer, Nokia of Finland Then, came its leadership crisis after its respected chief executive, George Fisher, left to head Eastman Kodak and Chris Galvin, the unseasoned and less than brilliant third-generation member of his family to run the company, took over Finally, came its ill-fated move into Iridium, the ambitious new satellite world-wide telephone service, which failed to take off and filed for bankruptcy in August of 1999 The question is, How could this have happened to a company that until a few years earlier had been regarded as one of the best companies in the world? In a nutshell, Motorola simply seemed to have lost its way during the second half of the 1990s It had grown arrogant with success, became self-satisfied, and became sluggish in execution, in a world that had become increasingly competitive and fast Motorola’s renowned “warring tribes” culture, which pitted one division against the other, backfired and became a stumbling block to change and renewal Since 1998, Motorola has tried to turn the company around by merging into one unit the cellular, paging, and the two-way radio (Continued on the next page) ========================================== ===================== ========================================== ===================== Web Example 9-1 The Russian Wheat Deal and U.S Wheat Prices In July 1982, the then Soviet Union announced that it would purchase 400 million bushels of winter wheat from the United States This was approximately one-quarter of the total U.S annual production With the short-run supply curve for winter wheat fairly price inelastic, the increased demand for American wheat led to a sharp rise in the price of wheat in the United States—from about $1.60 per bushel at the end of June 1982 to about $2.25 by the end of September The size of the Russian wheat deal caught many farmers by surprise and angered those who had sold their wheat just before the wheat deal was announced The increase in demand for American wheat led to an increase in the price of wheat, exactly as predicted by our model (see the right panel of Figure 9-8 in the text) Furthermore, since the supply curve for American (winter) wheat was fairly price inelastic, the price increase was sharp In the face of continued difficulties in Russian agriculture and in the expectation of continued purchases of American wheat by the Soviet Union and high wheat prices in the United States, American farmers increased their wheat output in 1983 and 1989 (also as predicted by our model) The same occurred with corn in 1989 During the 1990s, the demand for U.S wheat increased as a result of U.S aid to Russia to purchase American food after the fall of communism and as a result of the subsidies that the U.S government gave for exporting American wheat to counter European subsidies By increasing the demand for American wheat, these measures also tended to keep wheat prices and production in the United States above what they would have been Agricultural production and prices, however, depend even more on the vagaries of the weather Source: B Luttrell, “Grain Export Agreements,” Federal Reserve Bank of St Louis Review, August/September 1981; “Signs of Big Soviet Purchase Push Corn Prices Higher,” New York Times, October 20, 1989, p D3; “U.S Offers Russia Aid in Buying Food,” New York Times, September 15, 1992, p 6; “U.S Wheat Subsidies Are Message to Europe,” New York Times, September 3, 1992, p D2; “Weathering the Weather Market,” Business Week, August 21, 1995, p 31; “Drought in Texas and Oklahoma Stunting Crops and Economies,” New York Times, August 12, 1998, p 1; Strong Harvest Set to Restrain Wheat Price Rise,” Financial Times, January 27, 2000, p 34; “Wheat Forecast Slashed Again, Financial Times, October 31, 2007, p ================================================================ Web Example 10-1 Restrictions on Competition in the Pricing of Milk in New York City and the Nation Retail milk prices in New York State have been kept artificially high by an antiquated law passed during the Great Depression of the 1930s that required milk dealers to obtain a license to operate in any local market in the state The commissioner of agriculture, appointed by the governor, had the responsibility of granting these licenses, except when they led to “destructive competition in a market already adequately served.” In practice, however, commissioners did not issue licenses if these threatened the profits of established local dairies The result was that retail milk prices in New York State were about 20 percent higher than in neighboring New Jersey In 1986, the commissioner finally allowed a New Jersey dairy firm to sell milk in Staten Island (a borough of New York City), and immediately the price of milk in the borough declined by 20 percent The commissioner, however, under strong pressure from local dairies (which contended that they could not tolerate more competition because their costs are higher), rejected the application for a license from the same New Jersey dairy firm to sell milk in two other boroughs of New York City These state regulations are in addition to federal regulations that have set minimum prices for fluid milk since the time of the Great Depression with the intent of stabilizing milk prices, thereby ensuring reliable supplies across the country Under federal law, the country was divided into 31 regions, with the U.S Department of Agriculture setting the minimum price that farmers in each region could charge for milk each month Minimum prices were set higher the farther the region is from Eau Claire, Wisconsin, historically the center of the dairy industry Then, the 1996 Freedom to Farm Act instructed the secretary of agriculture to develop a more market-oriented dairy system by 1999 In July 1997, the Northeast Interstate Dairy Compact (a cartel) was allowed to set a minimum wholesale price for milk above the federal minimum price in the six Northeastern states Five other Atlantic states (New York State, New Jersey, Pennsylvania, Delaware, and Maryland) also applied to join the Northeast Interstate Dairy Compact and Southern states indicated their intent to form a dairy cartel of their own In spring 2002, however, Congress refused to extend the law allowing the Dairy Compact to exist but included a new subsidy program in the Farm Bill signed into law The new Farm Bill provides farmers a subsidy when the market price of milk falls below the price that the Dairy Compact would have set But taxpayers, instead of consumers, now foot the bill and the new program is administered by the U.S Department of Agriculture rather than by the Dairy Compact in the affected States The dairy industry is but one clear case in which government regulations (both state and federal) restricted entry and competition and led to higher prices for consumers and profits for firms in the industry Source: “The Price of Monopoly Milk,” The New York Times, February 10, 1986, p 22; “The Milk Cartel,” The New York Times, September 1, 1987, p 22; “The OPEC of Milk,” The Wall Street Journal, June 20, 2001, p A18; “Reversing Course, Bush Signs Bill Raising Farm Subsidies,” New York Times, May 14, 2002, p 16; “Senate Panel Extends Milk Subsidies Amid Farm Cuts,” Wall Street Journal, October 20, 2007, p A4; for updates, see: http://www.cato.org/pub_display.php?pub_id=8479 and http://www.dairycompact.org ================================================================ ========================================== ===================== Web Example 11-1 The Monopolistically Competitive Restaurant Market The restaurant market in any city has all the characteristics of monopolistic competition There are usually thousands of restaurants in any large city, catering to all types of foods, tastes, incomes, and sectors Some restaurants are very luxurious and expensive, while others are simple and inexpensive Some restaurants provide entertainment, while others not Some are located in the theater district and serve pre-theater dinner and aftertheater supper, while others are located in residential areas of the city and cater to the family business In one block in mid-Manhattan, the author recently counted 19 restaurants: Italian, French, Chinese, and Brazilian, Indian, Japanese, Korean, Mexican, Pakistani, and Spanish In a recent issue of New York Magazin,e more than 100 restaurants of all types were advertised, and these are only a very small fraction of the restaurants located in the city Entry into the restaurant business is also relatively easy (witness the hundreds of new restaurants that open each year and the about equal number that close in any large city during the same year) Since each restaurant offers a somewhat differentiated product, many advertise their existence, location, and menu, together with the usual claim (which no one really takes seriously) of superiority over all other restaurants in the same class Source: The New York, January 2008 =============================================================== ========================================== ===================== Web Example 12-1 The Objective and Strategy of Firms in the Cigarette Industry Until the rash of recent legal suits and court rulings on the health damages of cigarette smoking, the objective of firms in the cigarette industry seemed to be the maximization of long-run profits or firm value, as postulated by the theory of the firm Different firms, however, pursued these goals differently The doubling of the federal excise tax on each pack of cigarettes on January 1, 1983, as well as the rise in other state taxes since then, resulted in a sharp increase in cigarette prices and a reduction in consumption In order to lure customers from rivals and maintain profit levels, the weaker three of the nation’s six major producers introduced generic cigarettes These contain cheaper tobacco, come in plain black-and-white packages, are advertised very little, and sell at less than half the price of name brands The other three major producers, instead, followed the more traditional marketing strategy of brand proliferation That is, they introduced a large number of new brands to appeal to every conceivable taste or consumer group and spent hundreds of millions of dollars on advertising They resisted the introduction of generic cigarettes because these cigarettes have very low profit margins But as sales of generic cigarettes rose, these other major producers responded with the introduction of discounts—brand-name cigarettes that cost more than generics but less than the traditional brands Then on Friday, April 2, 1993 (which became known as the infamous Marlboro Friday), Philip Morris took the unusual step of cutting the price of Marlboro cigarettes (one of the world’s best-known and profitable brands) and its other premium brands by 20 percent (about 40 cents per pack) in an effort to contain continued loss of market share to generic cigarettes RJR Nabisco, Philip Morris’s main competitor, quickly matched the price cut At the same time, both groups of cigarette producers greatly expanded sales abroad With the antismoking campaign going global, however, and with a Worldwide AntiSmoking Treaty singed in February 2004 severely restricting advertising and marketing practices, international sales of American cigarettes also slowed down In recent years and as a result of the rash of lawsuits on the harmful health effects of smoking, cigarette companies have been forced to change their strategy to that of containing potential financial losses from adverse court rulings Thus, in November 1998, they agreed to pay $246 billion over 25 years to settle the high-profile national effort on the part of 46 states to recoup public-health costs linked to smoking This added 42.5 cents to each pack sold by Big Tobacco and resulted in their loss of market share to the three Minors (that were not part of the settlement) from 99.6 percent to 91.9 percent In 2005, the U.S Justice Department also asked for a $10 billion penalty from tobacco companies (scaled down from $130 billion recommended by a government witness) to finance a stop-smoking campaign at the conclusion of a long-run case filed in 1999 that charged them conspiracy to promote smoking and misleading to public on the dangers of smoking (Continued on the next page) (Continued from the previous page) Source: “Big Tobacco’s Toughest Road,” U.S News & World Report (April 17, 1989), p 26; “Philip Morris Cuts Cigarette Prices, Stunning Market,” New York Times, April 3, 1993, p 1; “Cigarette Makers and States Draft a $206 Billion Deal,” New York Times, November 14, 1998, p 1; “Major Makers of Cigarettes Raise Prices,” Wall Street Journal, August 31, 1999, p A3; “Worldwide Anti-Tobacco Treaty Takes Effect,” New York Times, February 28, 2004, p 8; “Tobacco Trustbuster,” Forbes, February 28, 2005, pp 86–89; “The High Cost of Nicotine Withdrawal,” Newsweek, May 23, 2005, p 40; and “Limit for Award in Tobacco Case Sets Off Protests,” New York Times, June 9, 2005, p =============================================================== =========================================== ===================== Web Example 13-1 Transfer Pricing The U.S Internal Revenue Service, bolstered by new Auditing powers, is investigating many American Subsidiaries of foreign firms on the suspicion that they have underpaid U.S corporate income taxes by as much as $12 billion Indirect evidence of this is given by the fact that the ratio of income tax payments to total receipts of foreign-controlled U.S corporations was less than half that of U.S corporations Even more incredible is the fact that of the nearly 37,000 foreign-owned companies filing returns in 1986, more than half reported no taxable income! In 1991, the IRS adopted an “advance pricing agreement” with an increasing number of multinational corporations on the range of prices at which to value the various products that these multinationals import to the United States, so as to avoid transfer pricing disputes But such disputes continue In 1993, Nissan had to pay $144 million to the U.S Internal Revenue Service to settle claims arising from transfer pricing; in 1996, Japan filed claims for nearly $500 million in back taxes for transfer pricing against more than 50 multinational corporations; in 2000 DailmerChrysler had to pay an extra $46 million in taxes to Japan because of transfer pricing, and in the same year Nissan also had to pay extra taxes to the United Kingdom for the same reason The foreign profits of the six largest U.S drug companies rose from 38 percent of their overall income in 1994 to more than 65 percent in 2003 even though the share of overseas sales grew only slightly As a result, taxes on corporate profits for those companies fell from the 31 percent rate on domestic profits to the 17.5 percent rate on foreign profits By far the largest transfer pricing case to date was the one which the IRS brought against the pharmaceutical group GlaxoSmithKline (GSK) in 2006 which was settled by GSK paying $3.4 billion without going to trial Still pending is a 2006 case in which the IRS is seeking to recoup $2.3 billion from Merck for unpaid taxes on profits transferred to Bermuda Since 2002, the United States began to aggressively crack down on a new type of transfer pricing used by U.S and foreign computer and pharmaceutical companies arising from their transfer of intellectual property (such as trademarks and patents) to tax havens to avoid paying taxes on the income generated from those properties Source: “I.R.S Investigating Foreign Companies for Tax Cheating,” New York Times, February 10, 1990, p 1; “Big Japan Concern Reaches an Accord on Paying U.S Tax,” New York Times, November 11, 1992, p 1; “Why Do Foreign Companies Report Such Low Profits on Their U.S Operations?” Wall Street Journal, November 2, 1994, p A1; “Japan’s Tax Man Leans on Foreign Firms,” Wall Street Journal, November 25, 1966, p C21; “DaimlerChrysler Japan Forced to Pay More Tax,” Financial Times, October 10, 2000, p 22; “Nissan’s U.K Arm Hit by Tax Charges,” Financial Times, November 8, 2000, p 27; “A New Twist in Tax Avoidance: Firms Send Best Ideas Abroad,” Wall Street Journal, June 24, 2002, p A1; “Treasury Cracks Down on Companies Shifting Profits to Low-Tax Jurisdictions,” Financial Times, August 25, 2005, p 1; and “How Merck Saved $1.5 Billion Paying Itself for Drug Patents,” Wall Street Journal, April 28, 2006, p A1 ================================================================ === ============================================= ================ Web Example 14-1 The Glut of Lawyers and Doctors in the United States There are more than one million lawyers in the United States in 1981—up from 355,000 in 1971 and spending on legal services increased from $10 billion to more than $100 billion from 1950 to 1980 Although some increase in the number of lawyers was justified by population growth, the proliferation of laws and regulations, and the greater propensity on the part of citizens to bring legal action, 70% of the members of the American Bar Association believe that the boom has gotten out of hand and that something must be done to limit their number As predicted by economic theory, the larger increase in the supply, relative to the demand, of law services resulted in a reduction in the price of many law services, such as for uncontested divorces, wills, small personal injury cases, and nonbusiness bankruptcy cases (It is primarily in large corporate disputes that costs are rising sharply and multimillion dollar fees are becoming the rule rather than the exception.) Competition for business has resulted in attorneys setting up legal clinics, often in drugstores and shopping malls, to handle simple cases at cut-rate prices Lawyers’ search for business has also been blamed by some for the rash of lawsuits in recent years In their search for business, lawyers have also increasingly turned to advertising since 1977, when the U.S Supreme Court abolished state prohibitions against advertising Things were not much changed in 2007! An oversupply of doctors also seemed to exist in the United States in the 1980s and 1990s when the ratio of doctors to patients nationwide was about 250 per 100,000, well above the ratio of 150 to 100,000 that many experts consider optimum The prediction was that if the number of doctors continued to grow as the past rate, the ratio would have grown to 290 per 100,000 by the turn of the century, greatly increasing the oversupply This led the American Medical Association (AMA) to call for cutbacks of 20 to 25 percent in medical school enrollment (in the face of increasing applications) and limits on the number of foreign physicians entering the country The Federal Trade Commission, however, however, ruled (and its ruling has been upheld by the Supreme Court) that the AMA, as any other professional group, is subject to the antitrust laws prohibiting restraints of trade To be sure, not all medical specialties were equally affected For example, a “shortage” of psychiatrists (especially child psychiatrists) was developing, but a major “surplus” of surgeons, obstetricians, pediatricians, cardiologists, and diagnostic radiologists was expected While doctors were not unemployed, some are having trouble getting enough patients and were recommending more unnecessary treatment Economic theory predicts that, under these circumstances, a completely free market would result in lower (or less rapidly rising) prices for medical services and physicians’ incomes The situation seemed to have completely reversed during the present decade While in 1994 the Journal of the American Medical Association predicted a surplus of 165,000 doctors by 2000, the prediction in 2005 was that because it takes 10 years to train a doctor, the nation will have a shortage of 85,000 to 200,000 doctors in 2020 unless action is taken soon It is not that the number of doctors declined during the past decade (in fact the number of active physicians in the United States increased from 500,000 in 1985 to 800,000 in 2005) but, instead, that the demand for doctors’ services increased even more Sources: “A Glut of Lawyers—Impact on U.S.,” U.S News & World Report, December 19, 1983, pp 59-61; “The Legal Profession,” The Economist, July 18, 1992, pp 3-18; “A.M.A Board Studies Ways to Curb Supply of Physicians,’’ New York Times, June 16, 1986, p 1; “Rising Supply of Doctors May Be Bad for Health Costs,” Wall Street Journal, May 8, 1991, p B1; “Medical Schools Are Urged to Cut Admissions,” New York Times, November 17, 1995 p D2; “Hard Case: Job Market Wanes for U.S Lawyers,” Wall Street Journal, September 24, 2007, p A1; http://www.usatoday.com/news/health/2005–03–02-doctor-shortage_x.htm; and http://www.larouchepub.com/other/2007/3401dr_nrs_shortage.html ================================================================ ========================================== ===================== Web Example 15-1 Change in the Occupational Distribution of the U.S Labor Force: 1990–1999 The following table shows the very large change in the male and female occupational distribution of the U.S labor force in the century between 1900 and 1999 In 1900, most males and a very large proportion of the females labor force were in agriculture By 1999, agriculture accounted for the smallest proportion of the males and female labor force among the six occupational categories specified in the table There was a sharp increase in the percentage of professional males and especially females in the labor force For females, there was a sharp switch away from service, manufacturing and agriculture in favor of professional, clerical and sales over the century For males, the switch was primarily from agriculture to professional, sales and service _ Change in the Occupational Distribution of the U.S Labor Force Between 1900 and 1999 1900 1999 Male Female Difference Male Female Difference Professional 10.2% 9.6% 0.6 31.5% 35.9% -4.4 Clerical 2.8 4.0 -1.2 5.5 23.4 -17.9 Sales 4.6 4.3 0.3 11.3 13.0 -1.7 Manufacturing 37.6 27.7 9.9 37.9 9.2 28.7 Service 3.1 35.5 -32.4 9.9 17.4 -7.5 Agricultural 41.7 19.0 22.7 3.8 1.1 2.7 _ _ _ Source: “From Mill Town to Board Room: The Rise of Women’s Paid Labor,” Journal of Economic Perspectives, Fall 2000, pp 101–122 =============================================================== ============================================== ======================= Web Example 16-1 Rates of Return on U.S and Foreign Share Price The following table shows the average rate of return in dollar terms on share price indices in the United States and in a selected number of the 83 countries for which this data were collected from October 9, 2002 (when the American Stock market hit bottom) to October 2007 The respectable average return in the U.S S&P 500 of 15% shown in the table ranked only 79th among the 83 countries The highest return was in Peru (88%); Brazil ranked th with an average return of 74%, while the lowest return among the 83 countries was in Costa Rica (8%) To be noted, however, is that since the returns were measured in dollars, the returns in local currency were much less for those countries whose currency appreciated with respect to the dollar over the past five years For example, of the 34 percent returns in Germany, 23 percent (this is how much the euro appreciated with respect to the dollar from October 2002 to October 2007) was due to the appreciation of the euro with respect to the dollar and only 11 percent was the return in terms of the local currency (the euro) Rates of Return on Share Price Indices in U.S Dollars in a Selected Group of Countries, October 2002 to October 2007 _ Country Average Country Average _Return Return_ Peru (1) 88% Canada (47) 32 Brazil (4) 74 Spain (49) 32 Turkey (9) 55 Australia (51) 30 Poland (11) 51 Singapore (59) 28 India (12) 50 Thailand (60) 27 Argentina (18) 47 Hong Kong (62) 26 Russia (21) 44 France (63) 26 Mexico (31) 39 Italy (60) 23 South Africa (33) 38 Britain (74) 20 South Korea (37) 35 Japan (78) 16 Germany (39) 34 United States (79) 15 China (46) 33 Costa Rica (83) _ Source: “Strong Gains in the U.S., Except by Comparison,” Wall Street Journal, October 13, 2007, p C3 ============================================== ======================= ============================================== ======================= Web Example 17-1 Exchange in POW Camps Prisoner-of-war (POW) camps during World War II provide an example of pure exchange In these camps, little or no production took place, but prisoners received rations of many products from the detaining power, from the Red Cross, and from private parcels The products included canned milk, sugar, butter, chocolates, cookies, cigarettes, razor blades, and writing paper Soon after receiving rations, prisoners voluntarily began to exchange the received products among themselves, in order to end up with a bundle of goods that better fit their different tastes Individuals who did not smoke exchanged some of their ration of cigarettes for cookies, chocolates, or other products with other prisoners People who did not care much for chocolate exchanged much of it for other products, and so on Since exchange was voluntary, the strong presumption is that all parties to the exchange benefited Equilibrium would be reached and exchange would come to an end when the marginal rate of substitution between all pairs of products was more or less equal for all prisoners consuming each pair of products Source: R.A Radford, “The Economic Organization of a POW Camp,” Economica, November 1945, pp 189–201 =============================================================== =============================================================== Web Example 18-1 The Fable of the Apples and the Bees For decades, economists have used the tale of the apples and the bees as a classic example of externalities That is, the owner of beehives receives an external benefit, in the form of free nectar, which his or her bees extract from the neighbor’s apple blossoms to produce honey At the same time, the apple grower receives an external benefit in the form of free pollinating services for his or her apple blossoms from the neighbor’s bees, which increase crops Both the apple grower and the owner of the beehives receive external (i.e., unpaid) benefits from the other At least so it was thought, until Steven Cheung took the time to investigate the case in the state of Washington He found that apple growers and bee keepers were quite aware of the external benefits that each conferred on the others and routinely attempted to internalize (i.e., extract a payment for) the benefits they provided This was done by contracts for the placement of beehives on the farms These contracts specified the number of beehives, the average number of bees in each, the dispersion of the hives throughout the farm, the time period, and even bee protection against insecticides When honey production was large, bee keepers paid farmers (i.e., signed apiary leases) for the right to place hives on the farm On the other hand, when honey production was very little, farmers paid bee keepers to have hives placed on their farm for pollinating purposes (i.e., signed pollinating contracts) Indeed in many localities one can find the entry “pollinating services” in the yellow pages The amount of actual payment in one direction or the other also depends on the size of the net external benefits received by one of the two parties By doing so, externalities were, for the most part, internalized Note that by inventing the fable of the apples and the bees in order to provide an example of externalities, it seems that economists have themselves created an external cost by theorizing without adequate empirical investigation As pointed out in section 1.6 of the text, theoretical speculation (in the form of the hypotheses) and empirical verification should go hand in hand In recent years, honeybees seems to be vanishing and scientists are racing to find the reasons and reverse the process Source: Steven N.S Cheung, “The Fable of the Bees: An Empirical Investigation,” Journal of Law and Economics, April 1973, pp 11–33; “America’s Beekeepers: Hives for Hire,” National Geographic, May 1993, pp 73–93; “Honeybees, Gone with the Wind Leave Crops and Keepers in Peril,” New York Times, February 2, 2007, p 1; and “Bees Vanish; Scientists Race for Reasons,” New York Times, September 24, 2007, p F1 ================================================================ =============================================================== Web Example 19-1 Information and the Limits to Workers Privacy You find out that a co-worker driving an 18-wheeler for the company is having a new bout with alcoholism Do you tell the boss? The question was posed to 4,000 human resource managers at a recent conference The audience voted nearly five-to-one in favor of telling the company One participant expressed the sentiments of the vast majority of those present by saying “no way would I let this driver on the road, to kill people.” The result was different on the next question Do you tell Jack’s girlfriend that Jack tested positive on H.I.V.? The vast majority of the audience answered no to this question Why? The reason given was that while both the driver and the person infected with H.I.V could cause another person’s death, the first could so while at work and using a company’s vehicle, whereas the other could so privately and after work While in these two situations, there was agreement among the vast majority of the participants as to what to do, there is in general a great deal of confusion about the rights to privacy of employees and the actions that a company might want to take to gather information about employees behavior and the action to take when potentially harmful onthe-job behavior is uncovered Confusion is not likely to be dispelled by referring to the 188-page book on worker privacy from the Bureau of National Affairs, a nonprofit organization that monitors government rulings on this problem A Federal rule on alcohol abuse reported in this volume states: “Any disclosure made whether with or without the patient consent, shall be limited to information necessary in the light of the need or purpose for the disclosure.” Not much help! One way to overcome some of this confusion is to have clear company behavioral guidelines For example, a worker at IBM dated a co-worker who then went to work for a competitor The worker was told to break the relationship and when she refused she was fired She sued IBM and won The reason was not that IBM or any other company has no right to regulate such relationships, but because IBM guidelines did not specifically forbid such relationships In general, when misconduct significantly affects work performance, and the company has clear guidelines, the company has the right to fire an employee who disregards the guidelines if the misconduct continues after the employees has been warned However, overdrinking on weekends that does not affect the employee’s performance on Monday should not be punishable, even if such behavior increases long-run health insurance costs Source: “The New Ethics Enforcer,” Business Week, February 13, 2006, pp 76–77; “Ethics: This Time Is Personal,” Financial Times, March 24, 2005, p 7; “The Limits to Worker Privacy,” New York Times, December 20, 1990, p F13; “Charting a Course to Ethical Profits,” New York Times, February 8, 1998, Section 3, p.1 ================================================================ ...=============================================================== Web Example 1-1 Fewer Guns Means a Lot More Butter With the collapse of communism in the former... =============================================================== =============================================================== Web Example 1-2 Even the IBM PC and the Boeing 777 Are Not All American! The following table shows... =============================================================== =============================================================== Web Example 2-1 Changes in Supply and Demand Cause Large Swings in Copper Prices Copper is an important