Economics for Business Dermot McAleese Competition, Macro-stability and Globalisation third edition Specially tailored for a business-oriented audience, this text provides a complete introduction to economics for business programmes. With its non-technical and down-to-earth style this book will help make the economics module on your business or professional programme a more instructive and enjoyable experience. Economics for Business is especially suitable for MBA and other executive programmes, as well as for post-experience conversion courses. Dermot McAleese is Whately Professor of Political Economy, and Dean of the Faculty of Business, Economics and Social Studies, at Trinity College Dublin. He has served on the Board of the Central Bank of Ireland and was visiting professor at the World Bank. He lectures on MBA and executive courses in Trinity College and he is a member of the visiting faculty of the Irish Management Institute and of the ENPC School of International Management (Paris). He has written extensively on economic policy and international economics. "I have used Economics for Business as a key text on my Managerial Economics module in the Warwick MBA programme for a number of years. The book possesses the rare quality of being both accessible and rigorous. It is comprehensive, yet admirably succinct. The new material on international issues - such as trade agreements, currency crises and the Euro debate - in the latest edition will be greatly appreciated by teachers and students alike." Professor Robin Naylor, University of Warwick " Economics for Business is an excellent text, which is very well written and demonstrates the wealth of knowledge possessed by its author." Professor Steve Bradley, Lancaster University Competition, Macro-stability and Globalisation Features • Full coverage of central issues in business-oriented economics courses e.g. interest rates and determinants of exchange rates. • Focuses on the increased openness and globalisation of the economy. • Coverage of both macro and micro topics. • Strikes a balance between theory and application. • Sets economic ideas in their historical and social context. • New! Material on China in the WTO, deflation, Argentina’s currency crisis, the pros and cons of joining the Euro. • New! Even more exercises and questions for discussion. an imprint of www.pearson-books.com Economics for Business third edition McAleese mcaleese a/w 27/7/05 2:43 PM Page 1 Economics for Business We work with leading authors to develop the strongest educational material in economics, bringing cutting-edge thinking and best learning practice to a global market. Under a range of well-known imprints, including Financial Times Prentice Hall, we craft high quality print and electronic publications which help readers to understand and apply their content, whether studying or at work. To find out more about the complete range of our publishing please visit us on the World Wide Web at: www.pearsoned.co.uk Economics for Business Competition, Macro-stability and Globalisation Dermot McAleese Trinity College Dublin Third Edition Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk First published under the Prentice Hall Europe imprint 1997 Second edition 2001 Third edition published 2004 © Dermot McAleese 1997, 2004 The right of Dermot McAleese to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without either the prior written permission of the Publishers or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. ISBN 0 273 68398 5 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing-in-Publication Data McAleese, Dermot. Economics for business: competition, macro-stability, and globalisation / Dermot McAleese.–– 3rd ed. p. cm. Includes bibliographical references and index. ISBN 0-273-68398-5 1. Managerial economics. I. Title. HD30.22.M29 2004 330’.024’658––dc22 2004043237 10 98765432 09 08 07 06 05 Typeset in 9.5/12pt Stone Serif by 25 Printed and bound in Great Britain by Ashford Colour Press Ltd, Gosport The publisher’s policy is to use paper manufactured from sustainable forests. List of boxes xiv Preface to the third edition xvii Acknowledgements xxi 1 The economic policy consensus 1 2What makes nations grow? 13 Part I The market system and competition 43 3 The market system in action 47 4Market demand and the pricing decision 72 5 The firm in a competitive market 95 6 The economics of market power 125 7 Competition policy, privatisation and regulation 155 8 Government intervention and the market system 180 9 Business and the environment 206 10 Hiring labour and the investment decision 227 Part II The macroeconomic framework 243 11 Aggregate supply, aggregate demand and the price level 246 12 Price stability and central banks 276 13 Understanding interest rates and monetary policy 305 14 Unemployment and the labour market 336 15 Fiscal policy, budget deficits and government debt 370 16 Business fluctuations and forecasting 401 Part III The global economy 421 17 Foreign trade: patterns and policy 424 18 Capital flows and foreign investment 462 19 Labour migration 488 20 The balance of payments: what it is and why it matters 501 21 Coping with exchange rates 528 22 Exchange rate regimes and the euro 561 Index 595 v Brief contents List of boxes xiv Preface to the third edition xvii Acknowledgements xxi 1 The economic policy consensus 1 Introduction 1 1.1 The economic policy consensus 2 1.2 Why policy changed 5 1.3 Implications for the future 6 1.4 Criticisms of the new consensus 7 1.5 Will the consensus last? 9 Summary 11 Questions for discussion 11 Exercises 11 Further reading 12 2 What makes nations grow? 13 Introduction 13 2.1 Trends in economic growth 14 2.2 Growth theories 17 2.3 Human welfare and sustainable growth 26 2.4 Policy prescriptions for growth 33 2.5 Conclusions 36 Summary 37 Questions for discussion 38 Exercises 39 Further reading 40 Appendix 2.1 The economics of the new economy 40 Introduction to Part I 44 3 The market system in action 47 Introduction 47 3.1 The market system 48 vii Contents Part I The market system and competition 3.2 The role of prices 53 3.3 Movements in demand and supply 56 3.4 The role of traders and arbitrage 61 3.5 The efficiency of the market system 63 3.6 The free market system in social context 65 3.7 Conclusions 67 Summary 68 Questions for discussion 69 Exercises 70 Further reading 71 4 Market demand and the pricing decision 72 Introduction 72 4.1 What is a ‘rational’ consumer? 72 4.2 Deriving the market demand curve 75 4.3 Elasticities of demand 75 4.4 Estimating the demand function 82 4.5 Price elasticities and the pricing decision 88 4.6 Conclusions 90 Summary 91 Questions for discussion 92 Exercises 93 Further reading 94 5 The firm in a competitive market 95 Introduction 95 5.1 Profit maximisation 96 5.2 Rules for maximising profit 101 5.3 Cost structure of the firm 107 5.4 The transaction costs approach 115 5.5 From cost structure to supply curve 119 5.6 Conclusions 119 Summary 120 Questions for discussion 121 Exercises 122 Further reading 124 6 The economics of market power 125 Introduction 125 6.1 Firm size 126 6.2 The economics of market power 133 6.3 How to sustain monopoly power 141 6.4 Market power with few firms – the case of oligopoly 142 6.5 Conclusions 146 Contents viii Summary 147 Questions for discussion 148 Exercises 149 Further reading 150 Case study 6.1: The diamond cartel 151 7 Competition policy, privatisation and regulation 155 Introduction 155 7.1 The case for competition 156 7.2 Competition policy 159 7.3 Privatisation 169 7.4 Regulation 171 7.5 Conclusions 175 Summary 176 Questions for discussion 177 Exercises 177 Further reading 179 8 Government intervention and the market system 180 Introduction 180 8.1 Income distribution and the equity–efficiency trade-off 182 8.2 Market failures 187 8.3 Government intervention 193 8.4 Government failure 198 8.5 Conclusions 202 Summary 203 Questions for discussion 204 Exercises 205 Further reading 205 9 Business and the environment 206 Introduction 206 9.1 Economic growth and the environment 208 9.2 Environmental policies 211 9.3 Policy instruments: design and effects 214 9.4 Impact on business 219 9.5 Conclusions 222 Summary 223 Questions for discussion 224 Exercises 224 Further reading 226 10 Hiring labour and the investment decision 227 Introduction 227 Contents ix [...]... examining economics from a business perspective We focus on concepts and information which are helpful in understanding economic performance and policy The book is especially concerned with the interaction between business and practical economic problems We pay attention to points of overlap and contrast between economics and other business subjects such as accountancy, strategic management and marketing... government support to business has become more targeted and results-oriented Within this context, the book aims to provide a comprehensive overview of the three branches of economics essential to business: the economics of the market system and competition, macroeconomics, and globalisation Managerial economics textbooks cover microeconomic aspects, and some textbooks address macroeconomic issues from... multiplier–accelerator model Top-down forecast of demand for personal computers The World Trade Organisation (WTO) Comparative advantage in action The Uruguay Round and beyond Adam Smith’s argument for protection Job losses and imports Why is inward foreign direct investment to Japan so low? Why do firms invest abroad? Transfer pricing Incentives and foreign direct investment Migrants and government finances How... several economics modules, as do professional courses in banking, insurance, actuarial science and information technology Economics for Business has been written to provide a considered, comprehensive, yet accessible introduction to economics to accompany such courses Although there are many good introductory economics texts, I found that none quite matched the needs of the many MBA and economics for. .. deal to colleagues in the economics department and business school at Trinity College Dublin, and elsewhere, and to interactions and conversations with business people in Ireland and abroad Also, I continue to be indebted to John Martin (OECD) for sharing his encyclopedic knowledge of economics policy issues with me This book has grown out of lectures to the Trinity MBA programme and to other executive... fluctuations and forecasting 401 Introduction 16.1 Business fluctuations – the facts 16.2 What causes fluctuations? 16.3 Business fluctuations and growth 401 403 407 411 xi Contents 16.4 Forecasting the business cycle 16.5 Macro-forecasts and the firm 16.6 Conclusions Summary Questions for discussion Exercises Further reading Part III The global economy Introduction to Part III 17 Foreign trade: patterns and. .. source of inspiration to me for many years The staff at Pearson Education, in particular acquisitions editor, Paula Harris, and production editor, Anita Atkinson, and her team, including the anonymous readers, were unfailingly helpful and a source of many improvements Finally, my continuing thanks to Camilla for editorial advice and unfailing support, and to Emma and Susannah for tolerating the intrusions... reform package in the early 1990s which focused on a more intensive use of market incentives in domestic labour and product markets, openness to trade and foreign investment, and fiscal stability China too has become more conscious of the need to use market mechanisms Throughout Eastern Europe and the former Soviet Union, policy-makers have turned away from economic planning and price controls, and. .. office, the US has espoused and promulgated the new economic doctrines 2 The new economic policy regime has important implications for business It has tended to bring lower taxes and a more supportive, pro-business and proentrepreneurial climate On the negative side, from the point of view of the individual firm, it has also meant greater exposure to domestic and foreign competition, and less security Individuals,... Cohen, The Wealth of the World and the Poverty of Nations (Cambridge, MA: MIT Press, 1998) The literature on this topic continues to grow For a controversial and somewhat selfindulgent critique of globalisation and new consensus policies, by a former chief economist of the World Bank, see J Stiglitz, Globalisation and its Discontents (New York: W.W Norton, 2002) The case for the consensus view is well . of the three branches of economics essential to business: the economics of the market system and competition, macroeconomics, and globalisation. Managerial. Economics for Business Dermot McAleese Competition, Macro-stability and Globalisation third edition Specially tailored for a business-oriented