ECONOMICS Stephen Ison and Stuart Wall fourth edition ECONOMICS Visit the Economics, fourth edition Companion Website at www.pearsoned.co.uk/ison to find valuable student learning material including: ● Answers to mini case studies throughout the chapters of the book ● Responses to the pause for thought boxes throughout the chapters of the book ● Answers to end of chapter progress and review questions ● Suggested outlines to essay questions We work with leading authors to develop the strongest educational materials 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 Fourth Edition Stephen Ison Loughborough University Stuart Wall Anglia Ruskin University 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 Fourth edition published 2007 © Pearson Education Limited 2007 The rights of Stephen Ison and Stuart Wall to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. ISBN-13: 978-0-273-68107-6 ISBN-10: 0-273-68107-9 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Ison, Stephen. Economics / Stephen Ison, Stuart Wall. — 4th ed. p. cm. Includes bibliographical references and index. ISBN-13: 978-0-273-68107-6 ISBN-10: 0-273-68107-9 1. Economics—Textbooks. I. Wall, Stuart, 1946– II. Title. HB171.5.I84 2006 330— dc22 2006047252 10987654321 10 09 08 07 06 Typeset in 10/12pt Minion by 35 Printed and bound in Great Britain by Ashford Colour Press, Hampshire The publisher’s policy is to use paper manufactured from sustainable forests. Contents Preface xvii Acknowledgements xix Publisher Acknowledgements xx Chapter 1 The nature of economics 1 Learning objectives 1 1 Introduction 1 2 Defining economics 2 2.1 The ways in which an economist thinks 2 2.2 The use of tables and diagrams 2 2.3 The economic problem 4 2.4 Opportunity cost 5 2.5 The production possibility frontier (PPF) 5 2.6 The PPF and opportunity cost 7 3 Economic systems 9 4 The market economy 10 4.1 Advantages of the market economy 11 4.2 Disadvantages of the market economy 11 5 The planned economy 13 5.1 Advantages of the planned economy 13 5.2 Disadvantages of the planned economy 13 6 The mixed economy 15 7 Positive and normative economics 15 8 Micro- and macreconomics 16 Key points 16 Further reading 17 Web references 17 Progress and review questions 17 Part One MICROECONOMICS Chapter 2 Demand, supply and market equilibrium 23 Learning objectives 23 1 Introduction 23 2 The market 23 3 Demand 24 3.1 What is demand? 24 3.2 Factors influencing demand 24 3.3 ‘Movements along’ and ‘shifts in’ the demand curve 29 3.4 The derivation of market demand 30 vi CONTENTS 4 Supply 32 4.1 What is supply? 32 4.2 Factors influencing supply 32 4.3 The derivation of market supply 35 4.4 ‘Movements along’ and ‘shifts in’ the supply curve 36 5 Market equilibrium 36 5.1 The equilibrium market price 36 5.2 Changes in the equilibrium market price 37 Key points 39 Further reading 39 Web references 40 Progress and review questions 40 Chapter 3 Elasticity 45 Learning objectives 45 1 Introduction 45 2 Price elasticity of demand (PED) 45 2.1 What is price elasticity of demand? 45 2.2 Price elasticity of demand and total revenue 49 2.3 Factors determining price elasticity of demand 50 3 Income elasticity of demand (YED) 52 3.1 What is income elasticity of demand? 52 3.2 Types of income elasticity of demand 53 4 Cross elasticity of demand (CED) 55 4.1 What is cross elasticity of demand? 55 5 Price elasticity of supply (PES) 57 5.1 What is price elasticity of supply? 57 5.2 Factors determining price elasticity of supply 58 6 The importance of the elasticity concept 60 7 Applications of demand and supply 60 Key points 63 Further reading 64 Web references 64 Progress and review questions 65 Chapter 4 Consumer theory 69 Learning objectives 69 1 Introduction 69 2 Marginal utility theory 69 2.1 What is marginal utility theory? 69 2.2 Total utility 70 2.3 Marginal utility 70 2.4 The law of diminishing marginal utility 70 2.5 The consumer equilibrium 72 2.6 Derivation of the demand curve 74 3 Indifference curve analysis 74 3.1 What is indifference curve analysis? 74 3.2 Indifference curves 75 3.3 The budget line 78 CONTENTS vii 4 The consumer equilibrium under indifference curve analysis 80 4.1 A change in income 81 4.2 A change in price 81 5 The substitution and income effect 82 6 Inferior product or good 84 7 Giffen good 85 8 Derivation of the demand curve 85 Key points 86 Further reading 87 Web references 87 Progress and review questions 88 Chapter 5 Production and costs 94 Learning objectives 94 1 Introduction 94 2 Types of business enterprise 95 2.1 Sole trader 95 2.2 Partnership 95 2.3 Joint stock company 95 2.4 Public sector companies 96 3 The growth of firms 96 3.1 Why do firms wish to grow? 96 3.2 Internal growth 98 3.3 External growth 98 4 The factors of production 100 4.1 What are the factors of production? 100 4.2 Land 100 4.3 Labour 100 4.4 Capital 100 5 Production 100 5.1 Production function 100 5.2 Production in the short run: law of diminishing returns 101 5.3 The average and marginal concept 102 5.4 Production in the long run 103 6 Isoquants 104 7 Isocost 106 8 The least-cost process of production 108 9 The expansion path 108 10 Costs 109 10.1 What are costs? 109 10.2 Short-run and long-run costs 110 10.3 Total, average and marginal cost 111 10.4 Long-run average cost (LRAC) and economies of scale 113 10.5 Sources of economies of scale 114 10.6 Economies of scope 116 10.7 Diseconomies of scale 116 Key points 117 Further reading 118 Web references 118 Progress and review questions 118 viii CONTENTS Chapter 6 Theory of the firm: perfect competition and monopoly 123 Learning objectives 123 1 Introduction 123 2 Revenue, costs and profit 124 2.1 Revenue 124 2.2 Profit maximisation 127 3 Perfect competition 128 3.1 What is perfect competition? 128 3.2 Short-run equilibrium in perfect competition 129 3.3 Long-run equilibrium in perfect competition 131 3.4 Allocative and productive efficiency 132 3.5 Contestable market theory 133 4 Monopoly 134 4.1 What is monopoly? 134 4.2 Barriers to entry 135 4.3 Advantages of a monopoly 136 4.4 Disadvantages of a monopoly 137 5 Price discrimination 138 5.1 Consumer surplus 138 5.2 First degree price discrimination 139 5.3 Second degree price discrimination 140 5.4 Third degree price discrimination 140 Key points 142 Further reading 142 Web references 142 Progress and review questions 143 Chapter 7 Theory of the firm: monopolistic competition and oligopoly 147 Learning objectives 147 1 Introduction 147 2 Monopolistic competition 147 2.1 What is monopolistic competition? 147 2.2 Short-run equilibrium in monopolistic competition 148 2.3 Long-run equilibrium in monopolistic competition 149 3 Oligopoly: non-collusive 150 3.1 What is oligopoly? 150 3.2 The kinked demand curve and price rigidity 150 3.3 Other pricing strategies 152 3.4 Non-price competition 152 4 Oligopoly: collusion 153 4.1 Methods of collusion 154 4.2 Cartels 154 4.3 Price-leadership models 155 5 Game theory 157 5.1 Zero sum games 157 5.2 Non-zero sum games 159 CONTENTS ix 6 Contestable markets 160 Key points 161 Further reading 162 Web references 162 Progress and review questions 162 Chapter 8 Wages, rent and profit 166 Learning objectives 166 1 Introduction 166 2 Marginal productivity theory of wages 166 2.1 Perfectly competitive product and labour market 167 2.2 The firm’s demand curve for labour 168 3 The supply of labour 169 4 The labour market equilibrium 170 4.1 Labour demand and imperfect product markets 172 5 A monopsony market for labour 173 6 Trade unions and the market for labour 175 6.1 Impacts of trade unions 175 6.2 The bargaining strength of trade unions 176 7 Economic rent and transfer earnings 178 7.1 Economic rent 178 7.2 Transfer earnings 178 7.3 Economic rent versus transfer earnings 178 8 Profit 180 8.1 What is profit? 180 8.2 Profit as a cost of production 181 8.3 The function of profit 181 8.4 Determination of profit 181 Key points 182 Further reading 182 Web references 182 Progress and review questions 183 Chapter 9 Regulation, deregulation and competition 187 Learning objectives 187 1 Introduction 187 2 Regulation 187 2.1 Types of regulation 187 2.2 Reasons for deregulation 188 2.3 Deregulation and public interest theory 189 3 Privatisation 190 3.1 The case for privatisation 190 3.2 The case against privatisation 192 3.3 ‘Natural monopoly’ argument 193 4 Regulation of privatised companies 194 4.1 Objectives of regulators 194 5 UK competition policy 194 5.1 The key institutions in UK merger policy 194 [...]... is that most economies are mixed economies? 7 Positive economics Seeks to make statements that can be checked by reference to facts and avoids value judgements Normative economics Proposes action based on value judgements POSITIVE AND NORMATIVE ECONOMICS At this point it is useful to distinguish between positive and normative economics Positive economics is concerned with issues such as how individuals... central to economics, will also be covered in this chapter, together with an explanation of the free market, which is the main mechanism by which resources are allocated throughout the world The use of a free market is an attempt by nations and the global economy to address this central economic problem of scarcity and choice 2 ECONOMICS 2 DEFINING ECONOMICS There is no one definition of economics, ... Education for extracts adapted from Economics for Business and Management 2005 by Griffiths and Wall In some cases we have been unable to trace the owners of copyright material and we would appreciate any information that would enable us to do so CHAPTER The nature of economics 1 Learning objectives By the end of this chapter you should be able to: Define what is meant by economics ● Outline the ways in... 8) Moreover, there is the problem of resource utilisation, ensuring that all the available resources are used effectively This is the subject matter of macroeconomics and is dealt with in Part Two 2.4 Opportunity cost Macroeconomics An area of economics that concentrates on the economic behaviour of the economy as a whole, dealing with issues such as inflation and unemployment Opportunity cost The best... market economy ● Outline the differences between a market economy and a planned economy ● Define what is meant by ‘public goods’ ● Distinguish between positive and normative economics ● 1 ● Distinguish between microeconomics and macroeconomics INTRODUCTION What determines the demand for a good or service? What happens to the demand for a good if its price rises or falls? Why do firms supply goods? How can... Robbins as long ago as 1932 He defined economics as ‘the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses’ At first reading this may appear a difficult definition to understand; however, if it is studied in more detail it can be seen to offer a useful insight We can dissect the definition as follows: (a) Economics is a ‘social science’ in that... involving the allocation of scarce resources among alternative uses to achieve given ends Economics is also concerned with the distribution of resources between different groups in society So, in addition to the problem of what gets produced (allocation), there is the problem of who gets what CHAPTER 1 · THE NATURE OF ECONOMICS 5 is produced (see Chapter 8) Moreover, there is the problem of resource utilisation,... distinction is sometimes rather arbitrary The book is aimed primarily at those students who are new to economics, taking the subject as part of a first year degree or degree equivalent programme or on professional courses The book may also be useful to the more serious students engaged on A level economics and business studies courses There are certain topic areas which progress the subject beyond the... on education has also been protected up to 2007 2.5 The production possibility frontier (PPF) The central problem in economics of scarcity, choice, opportunity cost and resource allocation can be analysed by using a production possibility frontier or curve as shown in Figure 1.2 6 ECONOMICS Figure 1.2 The production possibility frontier AF represents the boundary between the goods and services which... selected Mini Case Studies and Progress and Review Questions 488 Index 528 Preface This fourth edition of Economics is somewhat of a departure from the previous editions in that it involves Stuart Wall as a co-author who has vast experience in terms of writing, editing and publishing in the area of economics and business management His involvement in the revision of this book has substantially enhanced . ECONOMICS Stephen Ison and Stuart Wall fourth edition ECONOMICS Visit the Economics, . normative economics 15 8 Micro- and macreconomics 16 Key points 16 Further reading 17 Web references 17 Progress and review questions 17 Part One MICROECONOMICS Chapter