theory and applications of economics

Theory and Applications of Economics v 1.0 This is the book Theory and Applications of Economics (v 1.0) This book is licensed under a Creative Commons by-nc-sa 3.0 (http://creativecommons.org/licenses/by-nc-sa/ 3.0/) license See the license for more details, but that basically means you can share this book as long as you credit the author (but see below), don't make money from it, and make it available to everyone else under the same terms This book was accessible as of December 29, 2012, and it was downloaded then by Andy Schmitz (http://lardbucket.org) in an effort to preserve the availability of this book Normally, the author and publisher would be credited here However, the publisher has asked for the customary Creative Commons attribution to the original publisher, authors, title, and book URI to be removed Additionally, per the publisher's request, their name has been removed in some passages More information is available on this project's attribution page (http://2012books.lardbucket.org/attribution.html?utm_source=header) For more information on the source of this book, or why it is available for free, please see the project's home page (http://2012books.lardbucket.org/) You can browse or download additional books there ii Table of Contents About the Authors Acknowledgments Dedications Preface Chapter 1: What Is Economics? Microeconomics in a Fast-Food Restaurant Macroeconomics in a Fast-Food Restaurant 13 What Is Economics, Really? 16 End-of-Chapter Material 18 Chapter 2: Microeconomics in Action 20 Four Examples of Microeconomics 21 The Microeconomic Approach 27 End-of-Chapter Material 34 Chapter 3: Macroeconomics in Action 36 Behind the Screens 43 Between News and Policy: The Framework of Macroeconomics 51 End-of-Chapter Material 56 Chapter 4: Everyday Decisions 58 Individual Decision Making: How You Spend Your Income 60 Individual Demand 80 Individual Decision Making: How You Spend Your Time 100 End-of-Chapter Material 111 Chapter 5: Life Decisions 116 Consumption and Saving 118 Using Discounted Present Values 143 Avoiding Risk 155 Embracing Risk 167 End-of-Chapter Material 173 iii Chapter 6: eBay and craigslist 178 craigslist and the Gains from Trade 183 eBay 193 Supply and Demand 202 Production Possibilities 215 End-of-Chapter Material 233 Chapter 7: Where Do Prices Come From? 237 The Goal of a Firm 239 The Revenues of a Firm 245 The Costs of a Firm 266 Markup Pricing: Combining Marginal Revenue and Marginal Cost 272 The Supply Curve of a Competitive Firm 281 End-of-Chapter Material 287 Chapter 8: Why Do Prices Change? 291 Market Supply and Market Demand 296 Using the Supply-and-Demand Framework 307 Another Perspective on Changing Prices 319 Three Important Markets 329 Beyond Perfect Competition 339 End-of-Chapter Material 346 Appendix: Algebraic Presentation of Supply and Demand 349 Chapter 9: Growing Jobs 352 How Do Firms Decide How Many Hours of Labor to Hire? 357 Entry and Exit 379 Search 390 Government Policies 398 End-of-Chapter Material 402 Chapter 10: Making and Losing Money on Wall Street 406 A Walk Down Wall Street 410 The Value of an Asset 420 Asset Markets and Asset Prices 429 Efficient Markets 438 End-of-Chapter Material 450 Appendix: A General Formulation of Discounted Present Value 454 iv Chapter 11: Raising the Wage Floor 456 Nominal Wages and Real Wages 461 The Effects of a Minimum Wage 470 Minimum Wage Changes 478 The Minimum Wage and the Distribution of Income 484 Empirical Evidence on Minimum Wages 492 End-of-Chapter Material 502 Chapter 12: Barriers to Trade and the Underground Economy 507 How the Government Controls What You Buy and Sell 511 Limits on Trade across Borders 534 Government and the Labor Market 542 End-of-Chapter Material 548 Chapter 13: Superstars 552 Facts about Inequality 556 The Sources of Inequality 570 Distributive Justice 581 Government Policy 592 End-of-Chapter Material 597 Chapter 14: Cleaning Up the Air and Using Up the Oil 601 The Economics of Clean Air 607 Externalities 619 Renewable, Nonrenewable, and Accumulable Resources 634 End-of-Chapter Material 646 Appendix: An Example of the Hotelling Rule in Operation 649 Chapter 15: Busting Up Monopolies 651 Market Power and Monopoly 654 Patents and Copyright 667 Markets with a Small Number of Sellers 677 End-of-Chapter Material 694 Chapter 16: A Healthy Economy 699 Supply and Demand in Health-Care Markets 704 Health Insurance 719 Government Policy 730 End-of-Chapter Material 737 v Chapter 17: Cars 742 The Demand for Automobiles 745 Supply of Cars 760 Market Outcomes in the Automobile Industry 768 Policy Issues 774 End-of-Chapter Material 780 Chapter 18: The State of the Economy 783 Measuring Economic Activity 787 Measuring Prices and Inflation 802 The Circular Flow of Income 813 The Meaning of Real GDP 825 End-of-Chapter Material 834 Chapter 19: The Interconnected Economy 838 Housing Supply and Demand 844 Comparative Statics: Changes in the Price of Housing 853 Three Important Markets 858 Linkages across Markets 876 End-of-Chapter Material 888 Chapter 20: Globalization and Competitiveness 892 The Production of Real GDP 900 Labor in the Aggregate Production Function 912 Physical Capital in the Aggregate Production Function 921 Other Inputs in the Aggregate Production Function 929 Accounting for Changes in GDP 936 Globalization and Competitiveness Revisited 943 End-of-Chapter Material 951 Chapter 21: Global Prosperity and Global Poverty 957 The Single-Person Economy 963 Four Reasons Why GDP Varies across Countries 975 The Accumulation of Physical Capital 982 Balanced Growth 994 The Role of International Institutions in Promoting Growth 1007 End-of-Chapter Material 1013 vi Chapter 22: The Great Depression 1019 What Happened during the Great Depression? 1024 The Great Depression: A Decrease in Potential Output? 1032 The Components of GDP during the Great Depression 1039 The Great Depression: A Decrease in Aggregate Spending? 1048 Policy Interventions and the Great Depression 1069 End-of-Chapter Material 1075 Chapter 23: Jobs in the Macroeconomy 1080 Unemployment 1085 Job and Worker Flows 1095 Hours Worked 1108 The Government and the Labor Market 1116 End-of-Chapter Material 1123 Chapter 24: Money: A User’s Guide 1128 What Is Money? 1132 Using Money to Buy Goods and Services 1141 Using Money to Buy Other Monies: Exchange Rates 1145 Using Money to Buy Assets: Interest Rates 1165 End-of-Chapter Material 1181 Chapter 25: Understanding the Fed 1186 Central Banks 1192 The Monetary Transmission Mechanism 1198 Monetary Policy, Prices, and Inflation 1214 Monetary Policy in the Open Economy 1225 The Tools of the Fed 1229 The Fed in Action 1238 End-of-Chapter Material 1247 Chapter 26: Inflations Big and Small 1251 The Quantity Theory of Money 1254 Facts about Inflation and Money Growth 1263 The Causes of Inflation 1275 The Costs of Inflation 1284 Policy Remedies 1288 End-of-Chapter Material 1295 vii Chapter 27: Income Taxes 1299 Basic Concepts of Taxation 1302 The Kennedy Tax Cut of 1964 1309 Income Taxes and Saving 1330 The Reagan Tax Cut 1333 End-of-Chapter Material 1343 Chapter 28: Social Security 1348 Individual and Government Perspectives on Social Security 1352 A Model of Consumption 1363 Social Security in Crisis? 1372 The Benefits and Costs of a Social Security System 1383 Social Security in the Real World 1388 End-of-Chapter Material 1395 Chapter 29: Balancing the Budget 1399 Deficits and Debt 1403 The Causes of Budget Deficits 1419 The Benefits of Deficits 1432 The Costs of Deficits 1438 The Ricardian Perspective 1446 End-of-Chapter Material 1456 Chapter 30: The Global Financial Crisis 1462 The Financial Crisis in the United States 1466 From Financial Crisis to Recession 1481 The Crisis in Europe and the Rest of the World 1490 Currency Crises 1508 End-of-Chapter Material 1511 viii Chapter 31: Toolkit 1514 Individual Demand 1516 Elasticity 1520 The Labor Market 1522 Choices over Time 1524 Discounted Present Value 1526 The Credit Market 1529 Expected Value 1531 Correcting for Inflation 1533 Supply and Demand 1536 Buyer Surplus and Seller Surplus 1540 Efficiency and Deadweight Loss 1543 Production Possibilities Frontier 1546 Comparative Advantage 1548 Costs of Production 1550 Pricing with Market Power 1553 Comparative Statics 1556 Production Function 1559 Nash Equilibrium 1562 Externalities and Public Goods 1565 Foreign Exchange Market 1567 Growth Rates 1570 Mean and Variance 1573 Correlation and Causality 1576 The Credit (Loan) Market (Macro) 1579 The Fisher Equation: Nominal and Real Interest Rates 1582 The Aggregate Production Function 1584 The Circular Flow of Income 1588 Growth Accounting 1594 The Solow Growth Model 1596 The Aggregate Expenditure Model 1604 Price Adjustment 1609 Consumption and Saving 1611 The Government Budget Constraint 1615 The Life-Cycle Model of Consumption 1618 Aggregate Supply and Aggregate Demand 1620 The IS-LM Model 1623 ix About the Authors Russell Cooper Dr Russell Cooper is a professor of economics at the European University Institute in Florence, Italy He has held positions at the University of Texas, Boston University, the University of Iowa, and Yale University as well as numerous visiting positions in Asia, Europe, North America, and South America He has taught principles of economics at many of these universities as well as numerous courses to PhD students Cooper’s research has focused on macroeconomics, labor economics, monetary policy, and industrial organization He received his PhD from the University of Pennsylvania in 1982 He was elected Fellow of the Econometric Society in 1997 A Andrew John Andrew John is an associate professor of economics at Melbourne Business School, Melbourne, Australia He received his undergraduate degree in economics from the University of Dublin, Trinity College, in 1981 and his PhD in economics from Yale University in 1988 He has held academic appointments at Michigan State University, the University of Virginia, and INSEAD He has also held visiting appointments at the University of Michigan, the Helsinki School of Economics and Business Administration, and the University of Texas at Austin He joined Melbourne Business School in January 2009 Andrew has consulting experience in the areas of marketing, economics, and strategy He has worked with clients in Australia, Europe, and throughout the AsiaPacific region He has extensive experience in the pharmaceutical industry and has also worked with firms in the consumer goods and consulting sectors Andrew has taught economics to undergraduates, PhD students, MBA students, and executives His research interests include state-dependent pricing models, environmental economics, coordination games, and consumer boycotts His published research has appeared in top economics and business journals, including American Economic Review, Quarterly Journal of Economics, Journal of Monetary Economics, Economic Journal, Journal of Public Economics, Management Science, Sloan Management Review, and Journal of Marketing His work is widely cited in economics journals ... decisions, and the employment and career choices of firms and workers—are examples of what we study in the part of economics called microeconomics1 Microeconomics is about the behavior of individuals and. .. about economics that every educated individual should know Applications ahead of Theory We present all the theory that is standard in books on the principles of economics But by beginning with applications, ... author for microeconomics and another for macroeconomics Both of us have researched and taught both microeconomic and macroeconomic topics, and we have worked together on all aspects of the book