(BQ) Part 2 book Economics hass contents: Topics for further study, the data of macroeconomics, the real economy in the long run, the real economy in the long run, the macroeconomics of open economies, short run economic fluctuations, topics in international finance and macroeconomics, final thoughts.
www.downloadslide.com TOPICS FOR FURTHER STUDY For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com 21 THE THEORY OF CONSUMER CHOICE hen you walk into a shop, you are confronted with thousands of goods that you might buy Of course, because your financial resources are limited, you cannot buy everything that you want The assumption is, therefore, that you consider the prices of the various goods being offered for sale and buy a bundle of goods that, given your resources, best suits your needs and desires In this chapter we develop the theory that describes how consumers make decisions about what to buy So far throughout this book we have summarized consumers’ decisions with the demand curve As we discussed in Chapters through to 7, the demand curve for a good reflects consumers’ willingness to pay for it When the price of a good rises, consumers are willing to pay for fewer units, so the quantity demanded falls We now look more deeply at the decisions that lie behind the demand curve The theory of consumer choice presented in this chapter provides a more complete understanding of demand, just as the theory of the competitive firm in Chapter 14 provides a more complete understanding of supply We will look at the traditional analysis of consumer behaviour and also introduce some ideas that have arisen as a result of more recent research in psychology, which is increasingly being looked at with interest by economists One of the Ten Principles of Economics discussed in Chapter is that people face trade-offs The theory of consumer choice examines the trade-offs that people face in their role as consumers When a consumer buys more of one good, he can afford less of other goods When he spends more time enjoying leisure and less time working, he has lower income and can afford less consumption When 438 © JEFF GINIEWICZ / ISTOCK W For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com Chapter 21 The Theory of Consumer Choice 439 he spends more of his income in the present and saves less of it, he must accept a lower level of consumption in the future The theory of consumer choice examines how consumers facing these trade-offs make decisions and how they respond to changes in their environment After developing the basic theory of consumer choice, we apply it to three questions about household decisions In particular, we ask: • Do all demand curves slope downward? • How wages affect labour supply? • How interest rates affect household saving? At first, these questions might seem unrelated But, as we will see, we can use the theory of consumer choice to address each of them THE BUDGET CONSTRAINT: WHAT THE CONSUMER CAN AFFORD Most people would like to increase the quantity or quality of the goods they consume – to take longer holidays, drive fancier cars or eat at better restaurants People consume less than they desire because their spending is constrained, or limited, by their income We begin our study of consumer choice by examining this link between income and spending To keep things simple, we use a model which examines the decisions facing a consumer who buys only two goods: cola and pizza Of course, real people buy thousands of different kinds of goods Yet using this model greatly simplifies the problem without altering the basic insights about consumer choice We first consider how the consumer’s income constrains the amount he spends on cola and pizza Suppose that the consumer has an income of €1 000 per month and that he spends his entire income each month on cola and pizza The price of a litre of cola is €2 and the price of a pizza is €10 The table in Figure 21.1 shows some of the many combinations of Cola and pizza that the consumer can buy The first line in the table shows that if the consumer spends all his income on pizza, he can eat 100 pizzas during the month, but he would not be able to buy any cola at all The second line shows another possible consumption bundle: 90 pizzas and 50 litres of cola And so on Each consumption bundle in the table costs exactly €1 000 The graph in Figure 21.1 illustrates the consumption bundles that the consumer can choose The vertical axis measures the number of litres of cola, and the horizontal axis measures the number of pizzas Three points are marked on this figure At point A, the consumer buys no cola and consumes 100 pizzas At point B, the consumer buys no pizza and consumes 500 litres of cola At point C, the consumer buys 50 pizzas and 250 litres of cola Point C, which is exactly at the middle of the line from A to B, is the point at which the consumer spends an equal amount (€500) on cola and pizza Of course, these are only three of the many combinations of cola and pizza that the consumer can choose All the points on the line from A to B are possible This line, called the budget constraint, shows the consumption bundles that the consumer can afford In this case, it shows the trade-off between cola and pizza that the consumer faces The slope of the budget constraint measures the rate at which the consumer can trade one good for the other Recall from the appendix to Chapter that the slope between two points is calculated as the change in the vertical distance divided by the change in the horizontal distance (‘rise over run’) From point A to point B, the vertical distance is 500 litres, and the horizontal distance is budget constraint the limit on the consumption bundles that a consumer can afford For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 440 Part www.downloadslide.com Topics for Further Study FIGURE 21.1 The Consumer’s Budget Constraint The budget constraint shows the various bundles of goods that the consumer can afford for a given income Here the consumer buys bundles of cola and pizza The table and graph show what the consumer can afford if his income is €1 000, the price of cola is €2 and the price of pizza is €10 Litres of cola Number of pizzas Spending on cola Spending on pizza Total spending 100 €0 €1 000 €1 000 50 90 100 900 000 100 80 200 800 000 150 70 300 700 000 200 60 400 600 000 250 50 500 500 000 300 40 600 400 000 350 30 700 300 000 400 20 800 200 000 450 10 900 100 000 500 000 000 Quantity of cola 500 250 B C Consumer’s budget constraint A 50 100 Quantity of pizza 100 pizzas Because the budget constraint slopes downward, the slope is a negative number – this reflects the fact that to get one extra pizza, the consumer has to reduce his consumption of cola by five litres In fact, the slope of the budget constraint (ignoring the minus sign) equals the relative price of the two goods – the price of one good compared to the price of the other A pizza costs times as much as a litre of cola, so the opportunity cost of a pizza is litres of cola The budget constraint’s slope of reflects the trade-off the market is offering the consumer: pizza for litres of cola Quick Quiz Draw the budget constraint for a person with income of €1 000 if the price of cola is €5 and the price of pizza is €10 What is the slope of this budget constraint? PREFERENCES: WHAT THE CONSUMER WANTS Our goal in this chapter is to see how consumers make choices There are two key assumptions that are made about consumers One is that they have limited incomes but unlimited wants and the second is that they prefer to have more than less These basic assumptions allow us to investigate behaviour in relation to how a consumer allocates limited income among different preferences The budget constraint is one piece of the analysis: it shows what combination of goods the consumer can afford given his income and the prices of the goods The consumer’s choices, however, depend not only on his budget constraint but also on his preferences regarding the two goods Therefore, the consumer’s preferences are the next piece of our analysis For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com Chapter 21 The Theory of Consumer Choice 441 Representing Preferences with Indifference Curves The consumer’s preferences allow him to choose among different bundles of cola and pizza If you offer the consumer two different bundles, he chooses the bundle that best suits his tastes If the two bundles suit his tastes equally well, we say that the consumer is indifferent between the two bundles Just as we have represented the consumer’s budget constraint graphically, we can also represent his preferences graphically We this with indifference curves An indifference curve shows the bundles of consumption that make the consumer equally happy In this case, the indifference curves show the combinations of cola and pizza with which the consumer is equally satisfied Figure 21.2 shows two of the consumer’s many indifference curves The consumer is indifferent among combinations A, B and C, because they are all on the same curve Not surprisingly, if the consumer’s consumption of pizza is reduced, say from point A to point B, consumption of cola must increase to keep him equally happy If consumption of pizza is reduced again, from point B to point C, the amount of cola consumed must increase yet again The slope at any point on an indifference curve equals the rate at which the consumer is willing to substitute one good for the other This rate is called the marginal rate of substitution (MRS) In this case, the marginal rate of substitution measures how much cola the consumer requires in order to be compensated for a one-unit reduction in pizza consumption Notice that because the indifference curves are not straight lines, the marginal rate of substitution is not the same at all points on a given indifference curve The rate at which a consumer is willing to trade one good for the other depends on the amounts of the goods he is already consuming That is, the rate at which a consumer is willing to trade pizza for cola depends on whether he is hungrier or thirstier, which in turn depends on how much pizza and cola he has The consumer is equally happy at all points on any given indifference curve, but he prefers some indifference curves to others We assume that consumers would rather have more of a good than less of it Because he prefers more consumption to less, higher indifference curves are preferred to lower ones In Figure 21.2, any point on curve I2 is preferred to any point on curve I1 indifference curve a curve that shows consumption bundles that give the consumer the same level of satisfaction marginal rate of substitution the rate at which a consumer is willing to trade one good for another FIGURE 21.2 The Consumer’s Preferences The consumer’s preferences are represented with indifference curves, which show the combinations of cola and pizza that make the consumer equally satisfied Because the consumer prefers more of a good, points on a higher indifference curve (I2 here) are preferred to points on a lower indifference curve (I1) The marginal rate of substitution (MRS) shows the rate at which the consumer is willing to trade cola for pizza Quantity of cola C B MRS D I2 A Indifference curve, I1 Quantity of pizza For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 442 Part www.downloadslide.com Topics for Further Study A consumer’s set of indifference curves gives a complete ranking of the consumer’s preferences That is, we can use the indifference curves to rank any two bundles of goods For example, the indifference curves tell us that point D is preferred to point A because point D is on a higher indifference curve than point A (That conclusion may be obvious, however, because point D offers the consumer both more pizza and more cola.) The indifference curves also tell us that point D is preferred to point C because point D is on a higher indifference curve Even though point D has less cola than point C, it has more than enough extra pizza to make the consumer prefer it By seeing which point is on the higher indifference curve, we can use the set of indifference curves to rank any combinations of cola and pizza Four Properties of Indifference Curves Because indifference curves represent a consumer’s preferences, they have certain properties that reflect those preferences Here we consider four properties that describe most indifference curves: • Property 1: Higher indifference curves are preferred to lower ones Consumers usually prefer more of something to less of it This preference for greater quantities is reflected in the indifference curves As Figure 21.2 shows, higher indifference curves represent larger quantities of goods than lower indifference curves Thus, the consumer prefers being on higher indifference curves • Property 2: Indifference curves are downward sloping The slope of an indifference curve reflects the rate at which the consumer is willing to substitute one good for the other In most cases, the consumer likes both goods Therefore, if the quantity of one good is reduced, the quantity of the other good must increase in order for the consumer to be equally happy For this reason, most indifference curves slope downward • Property 3: Indifference curves not cross To see why this is true, suppose that two indifference curves did cross, as in Figure 21.3 Then, because point A is FIGURE 21.3 The Impossibility of Intersecting Indifference Curves A situation like this can never happen According to these indifference curves, the consumer would be equally satisfied at points A, B and C, even though point C has more of both goods than point A Quantity of cola C A B Quantity of pizza For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com Chapter 21 The Theory of Consumer Choice 443 on the same indifference curve as point B, the two points would make the consumer equally happy In addition, because point B is on the same indifference curve as point C, these two points would make the consumer equally happy But these conclusions imply that points A and C would also make the consumer equally happy, even though point C has more of both goods This contradicts our assumption that the consumer always prefers more of both goods to less This is called the ‘axiom of transitivity’– given any three baskets of goods, if A is preferred to B and B to C then A must be preferred to C Thus, indifference curves cannot cross • Property 4: Indifference curves are bowed inward The slope of an indifference curve is the marginal rate of substitution – the rate at which the consumer is willing to trade off one good for the other The marginal rate of substitution (MRS) usually depends on the amount of each good the consumer is currently consuming In particular, because people are more willing to trade away goods that they have in abundance and less willing to trade away goods of which they have little, the indifference curves are bowed inward As an example, consider Figure 21.4 At point A, because the consumer has a lot of cola and only a little pizza, he is very hungry but not very thirsty To induce the consumer to give up pizza, the consumer has to be given litres of cola: the marginal rate of substitution is litres per pizza By contrast, at point B, the consumer has little cola and a lot of pizza, so he is very thirsty but not very hungry At this point, he would be willing to give up pizza to get litre of cola: the marginal rate of substitution is litre per pizza Thus, the bowed shape of the indifference curve reflects the consumer’s greater willingness to give up a good that he already has in large quantity FIGURE 21.4 Bowed Indifference Curves Indifference curves are usually bowed inward This shape implies that the marginal rate of substitution (MRS) depends on the quantity of the two goods the consumer is consuming At point A, the consumer has little pizza and much cola, so he requires a lot of extra cola to induce him to give up one of the pizzas: the marginal rate of substitution is litres of cola per pizza At point B, the consumer has much pizza and little cola, so he requires only a little extra cola to induce him to give up one of the pizzas: the marginal rate of substitution is litre of cola per pizza Quantity of cola 14 MRS = A B MRS = 1 Indifference curve Quantity of pizza For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 444 Part www.downloadslide.com Topics for Further Study Two Extreme Examples of Indifference Curves The shape of an indifference curve tells us about the consumer’s willingness to trade one good for the other When the goods are easy to substitute for each other, the indifference curves are less bowed; when the goods are hard to substitute, the indifference curves are very bowed To see why this is true, let’s consider the extreme cases Perfect Substitutes Suppose that someone offered you bundles of 50 cent coins and 10 cent coins How would you rank the different bundles? Most probably, you would care only about the total monetary value of each bundle If so, you would judge a bundle based on the number of 50 cent coins plus five times the number of 10 cent coins In other words, you would always be willing to trade 50 cent coin for 10 cent coins, regardless of the number of coins in either bundle Your marginal rate of substitution between 10 cent coins and 50 cent coins would be a fixed number: We can represent your preferences over 50 cent coins and 10 cent coins with the indifference curves in panel (a) of Figure 21.5 Because the marginal rate of substitution is constant, the indifference curves are straight lines In this extreme case of straight indifference curves, we say that the two goods are perfect substitutes perfect substitutes two goods with straight-line indifference curves Perfect Complements Suppose now that someone offered you bundles of shoes Some of the shoes fit your left foot, others your right foot How would you rank these different bundles? In this case, you might care only about the number of pairs of shoes In other words, you would judge a bundle based on the number of pairs you could assemble from it A bundle of left shoes and right shoes yields only pairs Getting more right shoe has no value if there is no left shoe to go with it FIGURE 21.5 Perfect Substitutes and Perfect Complements When two goods are easily substitutable, such as 50 cent and 10 cent coins, the indifference curves are straight lines, as shown in panel (a) When two goods are strongly complementary, such as left shoes and right shoes, the indifference curves are right angles, as shown in panel (b) (a) Perfect substitutes (b) Perfect complements 10 cent Left shoes 15 10 I1 I2 I2 I1 I3 50 cent Right shoes For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com Chapter 21 We can represent your preferences for right and left shoes with the indifference curves in panel (b) of Figure 21.5 In this case, a bundle with left shoes and right shoes is just as good as a bundle with left shoes and right shoes It is also just as good as a bundle with left shoes and right shoes The indifference curves, therefore, are right angles In this extreme case of right-angle indifference curves, we say that the two goods are perfect complements In the real world, of course, most goods are neither perfect substitutes (like coins of different denominations) nor perfect complements (like right shoes and left shoes) More typically, the indifference curves are bowed inward, but not so bowed as to become right angles The Theory of Consumer Choice 445 perfect complements two goods with right-angle indifference curves Quick Quiz Draw some indifference curves for cola and pizza Explain the four properties of these indifference curves OPTIMIZATION: WHAT THE CONSUMER CHOOSES The goal of this chapter is to understand how a consumer makes choices We have the two pieces necessary for this analysis: the consumer’s budget constraint and the consumer’s preferences Now we put these two pieces together and consider the consumer’s decision about what to buy The Consumer’s Optimal Choices Consider once again our cola and pizza example The consumer would like to end up with the best possible combination of cola and pizza – that is, the combination on the highest possible indifference curve But the consumer must also end up on or below his budget constraint, which measures the total resources available to him Figure 21.6 shows the consumer’s budget constraint and three of his many indifference curves The highest indifference curve that the consumer can reach (I2 in the figure) is the one that just barely touches the budget constraint The point at which this indifference curve and the budget constraint touch is called the optimum The consumer would prefer point A, but he cannot afford that point because it lies above his budget constraint The consumer can afford point B, but that point is on a lower indifference curve and, therefore, provides the consumer less satisfaction The optimum represents the best combination of consumption of cola and pizza available to the consumer Notice that, at the optimum, the slope of the indifference curve equals the slope of the budget constraint We say that the indifference curve is tangent to the budget constraint The slope of the indifference curve is the marginal rate of substitution between cola and pizza, and the slope of the budget constraint is the relative price of cola and pizza Thus, the consumer chooses consumption of the two goods so that the marginal rate of substitution equals the relative price In Chapter we saw how market prices reflect the marginal value that consumers place on goods This analysis of consumer choice shows the same result in another way In making his consumption choices, the consumer takes as given the relative price of the two goods and then chooses an optimum at which his marginal rate of substitution equals this relative price The relative price is the rate at which the market is willing to trade one good for the other, whereas the marginal rate of substitution is the rate at which the consumer is willing to For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 446 Part www.downloadslide.com Topics for Further Study FIGURE 21.6 The Consumer’s Optimum The consumer chooses the point on his budget constraint that lies on the highest indifference curve At this point, called the optimum, the marginal rate of substitution equals the relative price of the two goods Here the highest indifference curve the consumer can reach is I2 The consumer prefers point A, which lies on indifference curve I3, but the consumer cannot afford this bundle of cola and pizza In contrast, point B is affordable, but because it lies on a lower indifference curve, the consumer does not prefer it Quantity of cola Optimum B A I3 I2 I1 Budget constraint Quantity of pizza trade one good for the other At the consumer’s optimum, the consumer’s valuation of the two goods (as measured by the marginal rate of substitution) equals the market’s valuation (as measured by the relative price) As a result of this consumer optimization, market prices of different goods reflect the value that consumers place on those goods How Changes in Income Affect the Consumer’s Choices Now that we have seen how the consumer makes the consumption decision, let’s examine how consumption responds to changes in income To be specific, suppose that income increases With higher income, the consumer can afford more of both goods The increase in income, therefore, shifts the budget constraint outward, as in Figure 21.7 Because the relative price of the two goods has not changed, the slope of the new budget constraint is the same as the slope of the initial budget constraint That is, an increase in income leads to a parallel shift in the budget constraint The expanded budget constraint allows the consumer to choose a better combination of cola and pizza In other words, the consumer can now reach a higher indifference curve Given the shift in the budget constraint and the consumer’s preferences as represented by his indifference curves, the consumer’s optimum moves from the point labelled ‘initial optimum’ to the point labelled ‘new optimum’ Notice that in Figure 21.7 the consumer chooses to consume more cola and more pizza Although the logic of the model does not require increased consumption of both goods in response to increased income, this situation is the most common one As you may recall from Chapter 4, if a consumer wants For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com trade policy a government policy that directly influences the quantity of goods and services that a country imports or exports trade surplus imports an excess of exports over Tragedy of the Commons a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole transaction costs the costs that parties incur in the process of agreeing and following through on a bargain transfer payment a payment for which no good or service is exchanged unemployment insurance a government programme that partially protects workers’ incomes when they become unemployed Glossary 889 unemployment rate the percentage of the labour force that is unemployed velocity of money the rate at which money changes hands union a worker association that bargains with employers over wages and working conditions vertical equity the idea that taxpayers with a greater ability to pay taxes should pay larger amounts unit of account the yardstick people use to post prices and record debts welfare economics the study of how the allocation of resources affects economic well-being utilitarianism the political philosophy according to which the government should choose policies to maximize the total utility of everyone in society well-being happiness or satisfaction with life as reported by individuals utility a measure of happiness or satisfaction willingness to pay the maximum amount that a buyer will pay for a good value of the marginal product the marginal product of an input times the price of the output world price the price of a good that prevails in the world market for that good variable costs costs that are dependent on the quantity of output produced For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com INDEX A ability, and wages, 405–6 ability-to-pay principle, 255 abnormal profit, 302 above-equilibrium wages, 409–10, 600 absolute advantage, 57 absolute poverty, 423 accelerator principle, 709–10 accountability of policy, 876 accountants, 267 accounting profit, 267 actual spending, saving or investment, 707 adverse selection, 467, 468, 576 advertising, 344–50 brand names, 348–50 critique of, 345–6 debate over, 345–7 defence of, 346 as prisoners’ dilemma, 368, 370 as sign of quality, 347–8 what it does, 346–7 agent, 467 aggregate demand contraction in, 749 effects of shift in, 748–50 influence of fiscal policy on, 768–9, 771 influence of monetary policy on, 758–66 and IS-LM model, 720–3 and the Phillips curve, 783–5 rate of change, 709–10 stabilization of, 766 see also model of aggregate demand and aggregate supply aggregate demand curve, 733, 734–5, 739 and consumption, 737 and government purchases, 738 and investment, 737 and long-run growth and inflation, 742 and net exports, 738 shifts in as cause of economic fluctuations, 736–8 slope of, 735–6, 762–3 and tax changes, 771 aggregate risk, 579 aggregate supply adverse shift, 750, 751 effect of fiscal policy on, 772 effects of shift in, 750–2 and the Phillips curve, 783–5 see also model of aggregate demand and aggregate supply aggregate supply curve, 733 and long-run growth and inflation, 742 and shift in consumer preferences, 846 shifts in the long-run, 741–2 shifts in the short-run, 746–7 upward slope in the short-run, 742–6 vertical in the long-run, 738–40 AIG, 824 airline industry, 327 Akerlof, George, 469 allocative efficiency, 139 alternative opportunities, and shift in labour supply curve, 389 anti-poverty policies, and work incentives, 430, 433 anti-trust laws, 328 appreciation, 673 arbitrage, 325 arms race, as prisoners’ dilemma, 368 Arrow, Kenneth, 475 Arrow’s impossibility theorem, 475 Ashenfelter, Orley, 229 Asset Purchasing Facility (APF), 623 asset valuation, 582–8 efficient markets hypothesis, 583–7 fundamental analysis, 583 market irrationality, 587–8 asset-backed securities (ABS), 819 assumptions, 23 asymmetric information, 466, 467–73, 820–2 and adverse selection, 468–9 hidden actions, 467–8 hidden characteristics, 468–9 and moral hazard, 467–8 and public policy, 472–3 screening to induce information revelation, 472 signalling to convey private information, 469–70 Aumann, Robert J., 369–70 automatic stabilizers, 777–8 autonomous expenditure, 711 average fixed cost, 273 average revenue, 290 average tax rate, 253 average total cost (ATC), 273 and profit, 299 relationship between short-run and long-run, 278–9 relationship with marginal cost, 275–6 U-shaped, 275 average variable cost, 273 B balanced budget, 778, 872–4 balanced trade, 667 Bank of England, 33, 625–6, 678, 767, 770, 796–7, 817, 822, 825, 826, 827, 828–9 see also banks; central bank(s); European Central Bank (ECB); Federal Reserve System (Fed) Banking Commission (UK), 626 banks, 553, 555 100-per cent reserve banking, 627–8 bonus culture and risk, 820–2 central bank’s tools of monetary control, 630–3 changed nature of, 633–7 collapse of, 824 financial crisis, 468 money creation with fractional-reserve banking, 628–9 and money multiplier, 629–30 and money supply, 627–37 and moral hazard, 467 and off-balance sheet loans, 634–5 and problems in controlling money supply, 633 see also Bank of England; central bank(s); European Central Bank (ECB); Federal Reserve System (Fed) bar graph, 43 bargaining, argument for restricting trade, 190 Bear Stearns, 820, 824 beauty, economic benefits of, 406 Becker, Gary, 413–14 behavioural economics, 466–7, 477–81 deviations from rationality, 477–9 and fairness, 479–80 inconsistency over time, 480–1 benefits principle, 254–5 benevolent social planner (BSP), 147–8 Bentham, Jeremy, 424 Bernanke, Ben, 826, 827 Big Mac Index, 682–3 binding constraint, 118 Black Death, economics of, 398 Black Swan event, 869–70 bonds, 551–2 below investment grade, 552 credit risk, 552 date of maturity, 551 debt finance, 552 default, 552 and financial crisis, 824 gilt-edged, 552 issued by SPV, 635 junk, 552 perpetuity, 552 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk 891 Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 892 www.downloadslide.com Index bonds (Continued ) principal, 551 term, 552 bonus culture, 820–2 brand names, 348–50 branding, 348–50 brewing industry, 351–2, 357 British Bankers’ Association, 636 bubbles, 817, 819, 820, 822–4, 875–6 Budd, Alan, 37–8 budget, balancing of, 778, 872–4 budget constraint, 439–40 budget deficit, 245, 566–7, 826, 872–4 and global recessions, 567–8 government policy, 694–6 Budget Responsibility Committee (BRC), 870 budget surplus, 245, 566–7 Bundesbank, 33 Bush, George W., 37, 184, 189 business cycle, 15, 727, 729–31 business-stealing externality, 344 buyers incentives, 119 influences on, 74 C Canada, average annual income per capita, 12 capital, 395 equilibrium in markets for, 396–7 flow of, 539 international flows, 667–72 mobility, 850–1, 854–5 shifts in long-run aggregate supply curve, 741 capital flight, 699 effects of, 700 and political instability, 698–700 capital income, 397 capital stock, 544 carbon trading permits, 216 Carnegie conjecture, 457–8 cartel, 358–9, 363 catch-up effect, 537–8 cause and effect, 49 omitted variables, 49–50 reverse causality, 50–1 CDS market, 820, 822, 823, 824 central bank(s), 622 conduct of monetary policy in financial crisis, 826–32 European, 624–5 and interest rates, 764–5 and long-run vertical Phillips curve as argument for independence, 793–7 and money supply, 759–64 price stability vs financial stability, 831 and quantitative easing, 623–4 response to financial crisis, 827–32 role of, 622–3 and the stock market, 766–8 tools of monetary control, 630–3 see also Bank of England; banks; European Central Bank (ECB); Federal Reserve System (Fed) chance, and wages, 405–6 change in quantity demanded, 72 cheques, 616–17 child labour, 432–3 chocolate industry, 355–6 cinema tickets, 327 circular-flow diagram, 27–8, 488 claimant count, 594 classical dichotomy, 647–8 close substitutes, 95 closed economy, 666 Coase theorem, 207–8 collateralized debt obligations (CDOs), 557, 581, 819–20 collective bargaining, 607 collusion, 359 command-and-control policies, 210 commodity money, 618 common currency area, 678, 840 benefits of single currency, 844–5 costs of single currency, 845–7 and fiscal policy, 857–60 see also optimum currency area; single currency common resources, 223, 229, 231–3 clean air and water, 232 congested roads, 232–3 fish, whales and other wildlife, 233 and prisoners’ dilemma, 370–1 Tragedy of the Commons, 231–2 comparative advantage, 57, 58 absolute advantage, 57 applications, 61–2 changing, 63–4 opportunity cost, 57–8 and trade, 60–1 comparative statics, 83 compensating differential, 404 competition controversies over policy, 374–6 definition, 288–9 with differentiated products, 339–44 imperfect, 356 monopolistic vs perfect, 342–3 perfect, 69–70 unfair, 190 vs monopoly, 313–14, 333 competition law, 328–9, 332, 374 competitive firm measuring profit, 298–9 profit-maximizing, 383–4 revenue, 289–90 short-run supply curve, 295 staying in business with zero profit, 302 competitive market, 69 definition, 288–90 supply curve in, 299–305 complements, 74 compounding, 573 concentration ratio, 357 Condorcet paradox, 474 constant returns to scale, 279 construction industry, 367–8 consumer choice, 438–9 and budget constraint, 439–40 and demand curves, 453–4 interest rates and household saving, 458–60 and neuroeconomics, 461–3 optimization of, 445–52 and preferences, 440–5 wages and labour supply, 454–7 consumer preferences, 846–8 consumer prices index (CPI), 507, 822, 830 calculation of, 507–9 harmonized index of consumer prices and RPI, 512–13 measuring the cost of living, 509–12 vs GDP deflator, 513–14, 515 Consumer Protection and Markets Authority (UK), 626 consumer surplus, 139–43, 140 measuring using demand curve, 140–1 raising by lowering prices, 141–2 and subsidies, 149–51 what it measures, 142–3 willingness to pay, 139–40 consumption, 492 and price level, 735 shifts in aggregate demand, 737 and Value-added tax (VAT), 737–8 consumption-saving decision, 458, 481 contestable markets, 349 cooperation economics of, 364–6, 368, 370–3 reasons why, 372–3 see also prisoners’ dilemma coordinate system, 43–5 curves in, 45–7 cost curve marginal, 291–3 shapes, 274–6 total, 271, 272 typical, 276–8 cost of living and introduction of new goods, 509–10 problems in measuring, 509–12 and relevance of inflation, 511–12 and substitution bias, 509 and unmeasured quality change, 510–11 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com cost-benefit analysis, 226 cost-of-living allowance (COLA), 517 cost(s), 144 average, 273–4 of capital, 266 fixed, 273 of inflation, 653–9 marginal, 273–4 measures of, 271–8 and production, 267–71 of reducing inflation, 799, 802–5 short-run and long-run, 278–82 of single currency, 845–7 total, 265 variable, 273 welfare cost of monopoly, 320–3 see also opportunity cost council tax, 243 credit card, 616–17, 619–21, 817 credit crunch, 637 credit default swaps (CDS), 556–7 credit market, 825, 827 credit rating, 821, 835 credit risk, 552 cross-border shopping, 674 cross-price elasticity of demand, 104 crowding in, 770 crowding out, 567, 770 crowding-out effect, 768–9, 771 currency, 619 appreciation and depreciation of, 673 local, 620 market for foreign exchange, 689–90 nominal exchange rates for, 674 as worthless, 658–9 currency union, 840 customer discrimination, 414–15 customs union, 192 cyclical deficit, 870 cyclical unemployment, 596 D dark pools, 558 deadweight loss, 321–3 pricing parable, 324–6 and quotas, 183, 185, 186 and tariffs, 182–3, 188 and welfare economics, 186 debit card, 616–17, 619–21 debt crisis, 701–2 debt finance, 552 decisions, consumption-saving, 458, 481 economists as decision-makers, 38–9 and improvement in data, 520–1 incentives, 7–8 marginal changes, 6–7 mistakes in, 478–9 opportunity cost, 5–6 trade-offs, 4–5 decrease (or increase) in demand, 72, 73 defence spending, 244–5 deficits, 870–1 deflation, 641, 660–1 deflationary gap, 708 demand, 68, 70–6 applications, 108–13 change in, 84–5 decrease or increase in, 72, 73 elasticity, 95–104 excess, 82 inelastic, 95 market vs individual, 71–2 perfectly (in)elastic, 98 shifts, 302–4 demand curve, 71 causes of shift, 387–8 deriving, 451–2 downward sloping, 453–4 linear, 101–2 measuring consumer surplus, 140–1 shifts, 72–5 shifts vs movements, 72 variety of, 97–8 demand deposits, 621 demand for labour see labour demand demand schedule, 70 depreciation, 491, 673 depression, 726 deregulation, 817 Deutsche Bank, 820 diminishing marginal product, 270 diminishing marginal utility, 425, 447 diminishing returns, 536–7 direct tax, 243 discount coupons, 327 discount rate, 632 discrimination, 410 by customers and governments, 414–15 by employers, 412–13 economics of, 410–15 labour market measurement, 410–12 diseconomies of scale, 279 disinflation costless, 804 and Phillips curve, 803 Thatcher, 804–5 disposable personal income, 491 distribution of income see income diversification, 578 dividend, 554 dominant strategy, 365 double coincidence of wants, 617 Dow Jones Industrial Average, 553 drugs monopoly vs generic, 318–20 prohibition and crime, 111–13 trade-offs in new treatments, 245 duopoly, 358 Index 893 E earnings per share, 554 economic activity, 726 Economic Crime Agency (UK), 626 economic fluctuations basic model, 733–4 causes, 747–52 difference between short run and long run, 733 as irregular and unpredictable, 727 most macroeconomic quantities fluctuate together, 727, 729, 732 as output falls, unemployment rises, 732 and shift in aggregate demand, 748–50 and shift in aggregate supply, 750–2 short-run explanation, 732–4 economic forecasting, 869–70 economic growth, 12, 524–5 around the world, 526–30 compounding and rule of, 70, 574 diminishing returns and catch-up effect, 535–8 and education, 539 in Euro Area, 855 and free trade, 541–2 health and nutrition, 540 and inflation in the model of aggregate demand and aggregate supply, 742, 743 and investment from abroad, 538–9 long-run, 547 natural resources as limit to, 533–5 and population growth, 543–4, 546–7 property rights, political stability and good governance, 540–1 and public policy, 534–44, 546–7 research and development, 542–3 saving and investment, 534–5 underestimation of, 527 economic life cycle, 421–2 economic mobility, 423 economic models, 25–30 economic profit, 266–7 economic stabilization see stabilization policy economic variables, correcting for effects of inflation, 516–19 economic well-being, 498–9, 501–2 economics, 2–3 developing theories in, 34–5 of discrimination, 410–15 and efficient markets hypothesis, 878–9 Nobel Prize for, 361, 369–70, 413, 467, 469, 474, 525, 540, 642 and return to Keynesianism, 877–8 economics, ten principles government, 11 incentives, 7–8 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 894 www.downloadslide.com Index economics, ten principles (Continued ) inflation, 14–15 inflation-unemployment trade-off, 15–16 marginal change, 6–7 markets, 9–11 opportunity cost, 5–6 standard of living, 12–13 trade, 8–9 trade-offs, 4–5 economies of scale, 279 as cause of monopoly, 312 implications of, 280–2 economists as decision-makers, 38–9 disagreements among, 35–9 getting it wrong, 876–9 knowledge of, 38 as mathematician, 39 as policy advisors, 31–5 as scientists, 22–31 vs accountants, 267 economy, 27 etymology, and monetary adjustment process, 646–7 education, 244 and human capital, 405, 539 race/gender discrimination in, 411–12 signalling theory of, 406–7 value of, 408–9 efficiency, 5, 148, 155, 878–9 allocative, 147–53 market equilibrium, 151–3 and taxes, 250–1 trade-off with equity, 260 efficiency wages, 409–10, 468 theory of, 609–11 worker effort, 610 worker health, 609 worker quality, 610–11 worker turnover, 609–10 efficient level of output, 321 efficient markets hypothesis, 583–7, 878–9 efficient scale, 275 effort, and wages, 405–6 elasticity, 95 applications, 108–13 and tax incidence, 130 elasticity of supply, 104–8 computing, 105 determinants, 104–5 perfectly (in)elastic, 105 variety, 105–7 employer discrimination, 412–14 employer taste model, 413–14 employers labour market discrimination, 412–13 and moral hazard, 468 equilibrium, 81 for an oligopoly, 359–60 evaluating, 151–3 in labour market, 390–3 long-run, 340–2, 746 in markets for land and capital, 396–7 in money market, 760 in open economy, 691–4 simultaneous in two markets, 692–4 without trade, 175–6 equilibrium price, 81 equilibrium quantity, 81 equilibrium wages, 404–10 ability, effort and chance, 405–6 above-equilibrium wages, 409–10 compensating differentials, 404 education, 406–7 human capital, 404–5 superstar phenomenon, 407–8 equity, 5, 148, 552–3 finance, 552 and taxes, 254–7 trade-off with efficiency, 260 euro, 625, 678, 701–2, 841–4 Euro Area, 846 growth rates in, 855 Europe, as optimum currency area, 851–7 European Central Bank (ECB), 33, 624–5, 632, 678, 796–7, 823, 825, 827 see also Bank of England; banks; central bank(s); Federal Reserve System (Fed) European Commission, 374, 411 European Competition Network (ECN), 329 European Economic Community (EEC), 842 European Economic and Monetary Union (EMU), 841 European System of Central Banks (ESCB), 841 European Trading Scheme (ETS), 216 European Union (EU), 16–17, 192, 216, 374, 411, 420, 512, 524, 598, 770, 842 Eurosystem, 625 excess capacity, 342–3 excess demand, 82 excess supply, 81 exchange rate effect, 758 Exchange Rate Mechanism (ERM), 806–7 exchange rates flexible, 848 nominal, 674, 677–8 price level and net exports, 736 and purchasing power parity, 676–81 real, 674–6 reduction in foreign variability, 845 targeting, 807–8 excludability, 222 exit, 293–4, 296–7, 300–2 expectations, 74, 79 and long-run Phillips curve, 786–8 and short-run Phillips curve, 789–90 expected inflation, 789 expenditure, 487–8 explicit costs, 265 exports, 62, 667–8 gains and losses of exporting countries, 177–9 see also international flows; international trade; net exports external growth, 312–13 externality, 11, 155, 198–200 business-stealing, 344 and market inefficiency, 200–5 negative, 200–3 positive, 203–4 private solutions, 205–10 product-variety, 344 public policies towards, 210–14 public/private policies, 215, 217 F factors of production, 383, 388 demand for labour, 383–8 equilibrium in labour market, 390–3 land and capital, 395–8 linkages among, 397–8 supply of labour, 389–90 fair trade, 374–5 Federal Open Market Committee (FOMC), 776 Federal Reserve System (Fed), 33, 626–7, 678, 767, 770, 797, 817, 822, 825, 826, 828 see also Bank of England; banks; central bank(s); European Central Bank (ECB) fiat money, 619 films, most popular, 516–17 final good, 490 finance, 572 financial capital mobility, 854–5 financial crisis, 816–17, 870, 876–9 asymmetric information, 820–2 banking collapse, 824 bonus culture and risk, 820–2 bubble bursts, 822–4 bubbles and speculation, 817, 819 causes, 825, 879 conduct of monetary policy, 826–32 global problems, 823 moral hazard, 823 path to global recession, 824–5 response of central banks, 827–31 role of regulators, 832–5 securitization, 819–20 sub-prime market, 819 summary, 825 financial institutions, 561–3, 565–6 and macroprudential policy, 875 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com financial intermediaries, 553 financial markets, 551 deregulation, 817 Financial Policy Committee (UK), 626 financial resources, flow of, 669–70 Financial Services Authority (FSA), 826, 830 financial stability, 831 Financial Stability Forum (FSF), 834 financial system, 550 firms delayed payment, 468 long-run decision to exit or enter a market, 296–7 market supply, 300 short-run decision to shut down, 293–4 supply decision, 291–3 fiscal federalism, 858 fiscal policy, 718, 757–8 and common currency areas, 857–60 effect on aggregate supply, 772 example of, 774–5 influence on aggregate demand, 768–9, 771 lags in, 777 and stabilization of economy, 772–3, 775–8 fiscal stimulus, 770–1 Fisher effect, 652 Fisher, Irving, 652 fixed costs, 273 flat (or proportional) tax, 255 flexible exchange rates, 848 flows of goods and services see exports; import(s); international flows; international trade; net exports fluctuations see economic fluctuations Fogel, Robert, 540 foreign currency exchange, market for, 689–90 foreign direct investment (FDI), 538–9, 669 foreign exchange rate variability, reduction in, 845 foreign portfolio investment, 670 fractional-reserve banking, 628 France average annual income per capita, 12 competition law in, 328 and currency union, 846 growth rates in, 855 free rider, 224, 858–60 free trade and economic growth, 541–2 effect on welfare on exporting country, 178 multilateral approach, 192–3 opponents of, 189 rethinking, 191–2 unilateral approach, 192 frictional unemployment, 600, 601–2 Friedman, Milton, 642, 786–92 full-employment output, 741 fundamental analysis, 583 future value, 573 G game theory, 364 and economics of cooperation, 364–6, 368, 370–3 GDP deflator, 497, 513–14 gender labour force participation in EU, 598–9 labour market discrimination, 411–12 General Agreement on Tariffs and Trade (GATT), 192 general equilibrium, 714–17 using IS-LM model, 717–20 General Theory of Employment, Interest and Money (Keynes), 706, 759, 773 Germany average annual income per capita, 12 competition law in, 328 and currency union, 846 earnings in, 411, 418 exchange rates, 676–7 growth rates in, 855 inflation in, 14, 641–2, 658, 679 tax overview, 249–50 Giffen good, 454 gift-giving, 470–1 gilt-edged bonds, 552 gilt-edged stock, 553 global recession, 567–8, 770–1, 823 path to, 824–5 gold standard, 618 goods, 490 common resources, 223, 229, 231–3 different kinds, 222–3 excludable, 222 inferior, 73 international flows, 667–72 natural monopoly, 223 normal, 73 private, 222 public, 222–6 rival, 222 substitutes, 73, 95 Google, 332 government, 309–10 benefits of, 11 budget deficits, 694–6 creation of monopolies, 310–11 debt, 566–7 discrimination by, 414–15 distribution of payroll tax, 129–30 and good governance, 540–1 and inflation, 14–15 institutions, 32–3 pros and cons of balancing its budget, 872–4 see also public policy Index 895 government purchases, 493, 768 and shift in aggregate demand curve, 738 government stock, 553 graphs cause and effect, 49–51 overview, 42–3 positive correlation, 46 scatterplot, 46 single variable, 43 slope, 47–9 two variables, 43–7 Greece budget deficit in, 567–8 capital flight from, 701–2 debt crisis in, 861–2 Greenspan, Alan, 587, 766, 817, 826 gross domestic product (GDP), 486, 487– 8, 489, 525, 538, 559–60, 671 components, 492–4 definition, 489 deflator, 497 and economic well-being, 498–9, 501–2 exclusions, 489 government borrowing as percentage of, 770 income and expenditure, 487–8 international differences and quality of life, 500 life expectancy and literacy, 500 measurement of, 489–91, 498 real vs nominal, 494–7 and world economy, 668–9 gross domestic product per head, 12 gross national product (GNP), 491, 538 Group of Seven (G7), 239 growth see economic growth H Halifax Bank of Scotland (HBOS), 824 happiness, 501–2 Harmonized Index of Consumer Prices (HICP), 512–13 HBOS, 829–30 health, 540 hedonics, 520–1 heuristics, 478–9 anchoring, 478–9 availability, 479 representativeness, 479 Honarvar, A., 149–51 horizontal equity, 255, 256 Household International, 820 housing market, 817 boom in, 820 negative equity in, 822–3 prices, 818, 820 sub-prime, 636–7 see also mortgage market HSBC, 820 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 896 www.downloadslide.com Index human capital, 405, 531–2 and education, 405, 539 health expenditures, 540 role of, 411 and wage discrimination, 411–12 human life, 226–9 Hume, David, 642, 648 hyperinflation, 642, 657–8 example of, 658–9 money and prices during, 649–51 nominal exchange rate during, 678–9 I ice cream, price of, 659 Iceland, 253–4 Icelandic banks, 823, 824 identity equation, 492, 670 idiosyncratic risk, 579 IKEA, 61–2 immigration, 390 imperfect competition, 70, 356 implicit costs, 265 import quota, 183–6, 696 effects of, 697 imports, 62, 667–8 international trade in an importing country, 179–81 in-kind transfers, 430 incentives, 7–8, 16–17 investment, 565–6 saving, 563–5 income, 73, 487–8 changes affecting consumer choice, 446–9 disposable personal, 491 distribution of, 418–19 increase in, 448 measurement of inequality, 419–23 national, 491 personal, 491 political philosophy of redistribution, 424–30, 433 proportion devoted to the product, 96 transitory vs permanent, 422–3 income effect, 450 income elasticity of demand, 103–4 income inequality European, 419–20 gender and race, 411–12 measurement of, 419–23 measurement problems, 420–3 political philosophy of redistribution, 424–30, 433 income tax negative, 429–30 and nominal interest, 656 vs consumption tax, 251–2 increase (or decrease) in demand, 72, 73 indexation, 517 indifference curve, 441, 447 bowed, 443 extreme examples, 444–5 impossibility of intersecting, 442 properties, 442–3 representing preferences with, 441–2 indirect tax, 243 individual demand, 71–2 induced expenditure, 711 industrial policy, 203–4 inelastic demand, 95 infant industry, argument for restricting trade, 189–90 inferior good, 73, 448 inflation, 14–15, 507, 641 accurate and reliable data, 520–1 classical theory of, 643–9 confusion and inconvenience, 657 correcting economic variables for effects of, 516–19 cost of reducing, 799, 802–5 costs of, 653–9 expected, 789 fallacy, 653–4 ice cream example, 659 level of prices and the value of money, 643–4 link with money, 622–3 and long-run growth in the model of aggregate demand and aggregate supply, 742, 743 and long-run Phillips curve, 786–9 measures of, 515 and menu costs, 654–5 money supply, money demand and monetary equilibrium, 644–5 overestimated, 527 path from monetary targets to inflation target, 806–7 relative price variability and misallocation of resources, 655 relevance of, 511–12 and shoeleather costs, 654 and short-run Phillips curve, 789–90 targeting, 805–8 and tax distortions, 655–7 unexpected, 657–8 see also unemployment-inflation tradeoff inflation rate, 507, 508, 653 inflation tax, 651 inflationary gap, 708 information and economic forecasting, 869–70 importance of, 868–9 and making accurate decisions, 869 private, 469–70 revelation, 472 see also asymmetric information informationally efficient, 584 Innis & Gunn, 351–2 input demand, 388 input prices, 79 insurance and adverse selection, 469, 576 markets for, 575–6, 578 and moral hazard, 467 unemployment, 602–5 interactions governments, 11 markets, 9–11 trade, 8–9 interest rate effect, 758 interest rates, 651–2, 759 effect on household saving, 458–60 in long run and short run, 761 maintaining constant following rise in IS curve, 720 and net capital outflow, 692 price level and investment, 735–6 real and nominal, 518–19 role of, 764–5 and theory of liquidity preference, 759–62 intermediate good, 490 internalizing an externality, 203 international flows equality of net exports and net capital outflow, 670–1 exports, imports and net exports, 667–8 financial resources, 669–70 prices for, 673–6 saving and investment, 671–2 see also exports; international trade; net exports; trade International Monetary Fund (IMF), 33, 539, 808–10 international trade benefits of, 188 determinants, 175–6 effect of oligopoly on, 362–3 effects of a tariff, 181–3 equilibrium without, 175–6 gains and losses of an exporting country, 177–9 gains and losses of an importing country, 179–81 import quota, 183, 185–6 trade restrictions, 189–90 and world price, 176 see also exports; international flows; net exports; trade intrinsic value, 618 investment, 492 and economic growth, 534–5 from abroad, 538–9 and global recession, 771 incentives, 565–6 and international flows, 671–2 meaning of, 560–1 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com in national income accounts, 558–61 and price level, 735–6 rate of change, 709–10 risk-free, 816 shifts in aggregate demand, 737 investment fund, 555 invisible hand, 10–11, 419 inward-oriented policies, 541–2 Ireland, economic growth rates in, 856 IS-LM curves, 714–17 IS-LM model, 713 and aggregate demand, 720–3 and general equilibrium, 717–20 IS-MP model, 722–3 Italy, competition law in, 328–9 J Japan, 660–1, 677, 770, 817 job search, 601 and public policy, 602 jobs, argument for restricting trade, 189 JP Morgan, 820 junk bonds, 552 K Kamprad, Ingvar, 61–2 Kellogg, 347–8 Keynes, John Maynard, 33, 588–9, 706–7, 713, 721, 759, 773, 877, 878–9 Keynesianism, 707–8, 713, 877–8 King, Mervyn, 826, 827, 828 Kremer, Michael, 544, 546–7 Krugman, Paul, 770–1 Kydland, Finn E., 729–31 L labour demand, 383–8 causes of shift in curve, 387–8 shifts in, 392–3 and value of marginal product, 386–7 labour force, 596 gender participation in EU economy, 598–9 labour force participation rate (or economic activity rate), 596 labour force surveys, 594–8 labour market and adverse selection, 469 equilibrium, 390–3 ethnic breakdown of, 597 measuring discrimination, 410–12 microeconomic model, 801 minimum wage, 123–5 mobility in, 423 labour mobility, 849–50, 854 labour productivity, 399 labour supply, 389–90 causes of labour-supply curve shift, 389–90 effect of wages on, 454–7 shifts in, 391–2 shifts in long-run aggregate supply curve, 741 trade-off between work and leisure, 389 laissez-faire, 153 land, equilibrium in markets for, 396–7 law of demand, 70, 453 law of supply, 76 law of supply and demand, 81 Lehman Brothers, 822, 824 lemons problem, 469 Li, David, 580–1 liberalism, 425 libertarian paternalism, 427 libertarianism, 426–7 life cycle, 421 linear demand curve, 101–2 liquidity, 618 liquidity preferences see theory of liquidity preferences liquidity trap, 723, 731–2, 770 living standards, 12–13, 542 loanable funds see market for loanable funds London Stock Exchange (LSE) 553, 766 long run, 268 aggregate supply curve shift in, 741–2 aggregate supply curve vertical in, 739–40 and demand for money, 644–5 depictions of growth and inflation, 742 differences with short-run, 733 equilibrium, 340–2, 746 firm’s decision to exit or enter a market, 296–7 importance of growth, 547 interest rates in, 761 Keynesian, 706 market supply with entry and exit, 300–2 Phillips curve, 786–8 relationship with short-run average total cost, 278–9 shift in demand, 302–4 shutdowns in, 297–8 supply curve sloping upward, 304–5 lottery winners, 457–8 lump-sum tax, 254 luxuries vs necessities, 95 M macroeconomic policy debates, 868–79 balancing the budget, 872–4 and failure of economists, 876–9 importance of information, 868–70 and macroprudential policy as missing ingredient from current policy framework, 874–6 structural deficits as real or not, 870–1 macroeconomics, 31, 486–7 Index 897 development of theory, 734 and macroprudential policy, 875 quantity fluctuations, 727, 729, 732 reassessment of policy, 808–10 symmetric shocks, 851 macroprudential policy fine in theory but practicalities are overwhelming, 875–6 helps bridge gap between macroeconomic policy and regulation of individual institutions, 875 as missing ingredient from current policy framework, 874–6 Malthus, Thomas Robert, 543–7 marginal benefits, marginal changes, marginal cost, 6, 273 mark-up over, 343 relationship with average total cost, 275–6 rising, 275 marginal cost curve, 291–3 marginal cost pricing, 330 marginal firm, 304 marginal product, 269 marginal product of labour, 384–6, 385 marginal propensity to consume (MPC), 712 marginal propensity to save (MPS), 712 marginal rate of substitution, 441 marginal revenue, 290, 315 marginal tax rate, 253 marginal utility, 447 market, 68 in action, 89 and adverse selection, 469 concentrated, 357–63 definition, 95–6 exit or enter decisions, 296–7 for factors of production, 27 for goods and services, 27 market economy, 9–11 market efficiency see efficiency market equilibrium see equilibrium market failure, 11, 155 market forces, 80 market for foreign currency exchange, 689–90 market inefficiency, 200–5 market irrationality, 587–8 market for loanable funds, 561 supply and demand for, 561–3, 687–90 market outcomes effect of oligopoly on, 360, 362–3 effect of price ceilings on, 118–20 effect of price floors on, 121–3 effect of subsidies on, 132–3 effect of taxes on sellers, 127–9 market power, 11, 155, 308–9 market structure, 356–7 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 898 www.downloadslide.com Index market supply with entry and exit, 300–2 with fixed number of firms, 300 market value, 489 market-based policies, 210–11 market-clearing price, 81 maximin criterion, 426 median voter theorem, 475 medium of exchange, 555, 618 menu costs, 655 Merrill Lynch, 820 microeconomics, 31, 486 model of labour market, 801 Microsoft, 308–10, 332 minimum wage, 123–5 legislation, 409–10, 428–9, 605–6 set above equilibrium wage level, 801 misperception theory, 745 model of aggregate demand and aggregate supply, 727, 733, 752–3 see also aggregate demand; aggregate supply monetary control, central bank’s tools, 630–3 monetary equilibrium, and inflation, 644–5 monetary injection, 645–6, 764 monetary neutrality, 648 classical dichotomy, 647–8 monetary policy, 622, 718–20, 757–8 conduct of, 826–32 influences on aggregate demand, 758–66, 777 lags in, 777 path from monetary targets to inflation target, 806–7 and stabilization of economy, 772–3, 775–8 Monetary Policy Committee (UK), 626 monetary union, 840 money, 617 creation with fractional-reserve banking, 628–9 in the economy, 619–22 functions of, 618 and hyperinflation, 649–51 kinds of, 618–19 link with inflation, 622–3 measures of euro area stock, 621 measuring time value of, 573–5 printing too much, 14–15 problems in controlling, 633 money demand and monetary equilibrium, 644–5 and theory of liquidity preference, 760–2 money market, 631 equilibrium in, 760 and slope of aggregate demand curve, 763 money multiplier, 629–30 money supply, 622 adjustment process, 646–7 and banking system, 627–37 changes in, 763–4 classical dichotomy, 647–8 increase in, 646 and monetary equilibrium, 644–5 problems in controlling, 633 targeting, 807–8 and theory of liquidity preference, 759–60 monopolistic competition, 70, 338–9 free entry, 339 many sellers, 339 product differentiation, 339 short run, 339–40 vs perfect competition, 342–3, 351 and the welfare of society, 343–4 monopoly, 69, 308–10, 358–9 economies of scale, 312 government-created, 310–11 inefficiency of, 322 lack of supply curve, 318 natural, 311–12 prevalence of, 333 production and pricing decisions, 313–20 profit, 318, 323 public ownership, 331 public policy towards, 328–31 regulation, 329–31 resources, 310 revenue, 314–16 vs competition, 313–14, 333 welfare cost of, 320–3 monopoly firms, 309 monopoly power, 332 monopsony, 395 moral hazard, 467–8 and financial crisis, 823 and MPs expenses, 481–2 Morgan Stanley, 820 mortgage market, 817 defaults in, 822–3 sub-prime, 636–7 variable or adjustable rates, 636 see also housing market MPs expenses, 481–2 salaries, 516 standard of living, 506–7 multiplier effect, 709, 771 applications, 711–13 formula for spending multiplier, 710–11 N Nash equilibrium, 360, 796 Nash, John, 361–2 National Health Service (NHS) (UK), 243, 245 national income, 491 saving and investment, 558–61 National Insurance Contribution (NIC), 241–2 national saving (saving), 560 national security, argument for restricting trade, 189 natural monopoly, 311–12 natural rate of output, 741 natural rate of unemployment, 596 natural resources, 532 as limit to growth, 533–5 shifts in long-run aggregate supply curve, 741 stretching, 543 natural-rate hypothesis, 791 natural/social factors, 80 necessities vs luxuries, 95 negative externalities, 200–3 negative income tax, 429–30 Nestlé, 347–8 net capital outflow, 669–70 dependent on interest rate, 692 link between two markets, 691–2 and net exports, 670–1 net exports, 493, 667–8, 671 and net capital outflow, 670–1 and price level, 736 see also exports net national product (NNP), 491 neuroeconomics, 461–3 New York Stock Exchange (NYSE), 553 NIKKEI Index, 553 nominal exchange rate, 673, 674, 677–8 during hyperinflation, 678–9 nominal GDP, 494–7, 496 nominal interest rate, 518, 652, 653, 656, 759 nominal variables, 647, 648 normal good, 73 normal profit, 302 normative statements, 32 North American Free Trade Agreement (NAFTA), 192 Northern Rock, 824, 827 Nozick, Robert, 427 nudges, 427, 604–5 nutrition, 540 O Office for Budgetary Responsibility (OBR), 869 oligopoly, 70, 356, 357–8 effect of size on market outcome, 360, 362–3 equilibrium for, 359–60 game, 366 public policy towards, 373–6 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com open economy, 667, 686–7 effect of policies and events on, 694–700 equilibrium in, 691–4 supply and demand for loanable funds and for foreign currency exchange, 687–91 open-market operations, 622, 630–1 opportunity cost, 6, 265–6 and comparative advantage, 57–8 see also cost(s) optimization and changes in income effect, 446–9 and changes in prices, 449–50 and consumer’s optimal choices, 445–6 deriving demand curve, 451–2 income and substitution effects, 450–1 optimum, 445 optimum currency area, 849 Europe as, 851–7 theory of, 849–51 see also common currency area; single currency output, 761 effect, 315, 362 efficient level of, 321 falls in, 732 price, 387 supply, 388 outright open-market operations, 631 outward-oriented policies, 542 over the counter transactions, 822 P parity see purchasing power parity perception vs reality, 36–8 perfect competition, 69 vs monopolistic competition, 342–3, 351 perfect complements, 444–5 perfect price discrimination, 326 perfect substitutes, 444 perfectly competitive market, 288–9 permanent income, 422 personal income, 491 petrol tax, 212–13 Phelps, Edmund, 786–92 Phillips, A.W., 783 Phillips curve, 15, 783 aggregate demand and aggregate supply, 783–5 breakdown of, 793 and central bank independence, 793 long-run, 786–8, 793–7, 799 origins of, 783 reconciling theory and evidence, 788–9 and role of expectations, 785–93 and sacrifice ratio, 802–3 shifts in, 785–93, 797–8, 802 short-run, 789–90 and supply shocks, 785–94 and unemployment-inflation trade-off, 791–2 physical capital, 531 pie chart, 43 Pigovian tax, 211–12 petrol, 212–13 and tradable pollution permits, 213–14 planned spending, saving or planned investment, 707 Poland, average annual income per capita, 12 policy transparency and accountability, 876 political economy, 466, 473–7 Arrow’s impossibility theorem, 474–5 Condorcet voting paradox, 473–4 median voter is king, 475–6 political behaviour, 477 political (in)stability, 540–1 and capital flight, 698–700 pollution objections to economic analysis of, 217 and Pigovian taxes, 214 and social optimum, 202 tradable permits, 213–14 population growth, 543–7 size and structure of, 74 portfolio management, 819–20 positive externalities, 203–4 positive statements, 32 potential output, 741 poverty and child labour, 432–3 in-kind transfers, 430 minimum wage laws, 428–9 negative income tax, 429–30 perspectives on, 431 policies to reduce, 428 social security, 429 and work incentives, 430, 433 see also income inequality poverty line, 423 poverty rate, 423 predatory pricing, 375 preferences, 440–5 with indifference curves, 441–2 Prescott, Edward C., 729–31 present value, 573 price ceiling, 118 effect on market outcomes, 118–20 price controls, 118–25 evaluating, 125 price discrimination, 323–4, 325–6 analytics of, 326–7 examples, 327–8 parable concerning, 324–6 reduction of, 844–5 price earnings (P/E) ratio, 554 Index 899 price effect, 315, 362 price elasticity of demand, 95–6 computing, 96–7 midpoint method, 97 and total expenditure, 98, 101 and total revenue, 98, 101, 108 price elasticity of supply, 104–5 price floor, 118 in action, 126–7 effect on market outcomes, 121–3 price level, 742, 761 and consumption, 735 and investment, 735–6 and net exports, 736 price maker, 308 price stability, 831 price taker, 69, 308 price-fixing, 367–8, 374 price(s) allocation of resources, 89–90 changes affecting consumer choice, 449–50 cutting, 113–14 decisions made by monopolies, 313–20 during hyperinflation, 649–51 input, 79 for international transactions, 673–6 lowering by raising consumer surplus, 141–2 predatory, 375 and profit, 299 raising producer surplus by highering, 146–7 of related goods, 73–4 relative variability, 655 and risk, 577–8 as signals, 83 and sticky wages, 721 stock, 554 principal, 467 prisoners’ dilemma, 364–5 oligopolies as, 365–6 and welfare of society, 371–2 see also cooperation, economics of private goods, 222 private information, 469–70 private saving, 560 private solutions, 205 Coase theorem, 207–8 reasons for not working, 209–10 types of, 205–7 producer price index, 509 producer surplus, 143–7, 144 cost and willingness to sell, 144 measuring using supply curve, 144–6 raising by higher prices, 146–7 product differentiation, 339–44 product, proportion of income devoted to, 96 product-variety externality, 344 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 900 www.downloadslide.com Index production decisions made by monopolies, 313–20 factors of, 395–8 potential output (or full-employment output), 741 production function, 269–71, 384–6, 533 production possibilities frontier, 28–30, 53–5 productivity, 12, 525 determinants, 531–3 importance of, 530–1 role, 530–3 and wages, 393 profit, 265 interpreting, 268–9 measuring, 298–9 monopoly, 318, 323 zero, 302 profit maximization, 290–1, 292, 316–17 competitive firm, 383–4 progressive tax, 255 property rights, 205, 215, 217 and economic growth, 540–1 importance of, 234–5 proportional (or flat) tax, 255 protection as bargaining chip, argument for restricting trade, 190 Prudential Regulatory Authority (UK), 626 public choice theory, 187 public goods, 222–3 public order and safety spending, 244 public ownership, 331 public policy and economic growth, 534–44, 546–7 and job search, 602 towards externalities, 210–14 towards monopolies, 328–31 towards oligopolies, 373–6 see also government public saving, 560 public sector debt, 246 purchasing power, and inflation, 653–4 purchasing power parity, 676 basic logic, 676–7 example, 681 and exchange rates, 676–81 implications of, 677–8 limitations of, 680–1law, of, one, price, 676–7 as special case, 691 purchasing power standard (PPS), 680 Q quality of life, 500 quantitative easing, 623–4 quantity demanded, 70 quantity discounts, 328 quantity equation, 649 quantity supplied, 76 quantity theory of money, 646 quants, 580–1 quotas, 183, 185, 186 R racial discrimination and education, 411–12 and labour market, 410–11 random walk, 584 rational expectations, 804 Rawls, John, 425–6 real exchange rate, 674–6 real GDP, 494–7, 496, 727, 729, 732 real interest rate, 518, 652, 759 real money balances, 713 real variables, 647, 648 real wage flexibility, 849, 853–4 reality vs perception, 36–8 recession, 399, 726, 731–2, 770–1, 877 refinancing rate, 631–3, 632 regressive tax, 255 regulation and financial crisis, 832–5 and monopolies, 329–31 and moral hazard, 468 towards externalities, 211 regulators, 832–5 relative poverty, 423 relative price variability, 655 rent seeking, 771 repurchase agreement (repo), 631 resale price maintenance, 374–5 research and development, 542–3 reserve ratio, 628 reserve requirements, 632 reserves, 627 resource allocation by price, 89–90 market equilibrium, 151–2 relative price variability and misallocation of, 655 resources financial, 669–70 misallocation of, 655 monopoly, 310 natural, 532, 533–5, 543 restricting trade, 189–90 infant industry argument, 189–90 jobs argument, 189 national security argument, 189 protection as bargaining argument, 190 unfair competition argument, 190 Retail Price Index (RPI), 393, 512–13 retained earnings, 554 reticular activation system (RAS), 478 reverse causality, 50–1 Riccardo, David, 59 rising marginal cost, 275 risk aggregate, 579 aversion, 575 and bank lending, 634–7 and banking crisis, 820–2 diversification reduces risk, 579 idiosyncratic, 578–9 insurance markets, 575–6, 578 managing, 575–82 pricing, 577–8 trade-off between risk and return, 581–2 zero, 580–1 risk averse, 575 rivalry, 222 Rockefeller, John D., 527 Royal Bank of Scotland (RBS), 824 rule of, 70, 574 S sacrifice ratio, 802–3 safety systems, 230–1 Saha, David, 770 Samuelson, Paul, 783 saving and economic growth, 534–5 incentives, 563–5 and interest rates, 458–60 and international flows, 671–2 meaning of, 560–1 in national income accounts, 558–61 scarcity, Schelling, Thomas C., 369–70 scientific jundgement, 35–6 scientific method, 22–3 screening, 472 Securities and Exchange Commission (SEC), 826 securitization, 819 sellers number of, 80, 357–63 taxes on, 127–9 services, 490 international flows, 667–72 Shahmoradi, A., 149–51 shares, 552–3 Sherman Anti-trust Act, 328 shifts of curves, 46–7, 387–8 Shiller, Robert, 587–8 shoeleather costs, 654 short run, 268 aggregate supply curve sloping upward in, 742–6 causes of fluctuations in, 726–7 competitive firm’s supply curve in, 295 and demand for money, 645 differences with long-run, 733 economic fluctuations, 726, 732–4 firm’s decision to shut down, 293–4 interest rates in, 761 Keynesian, 706 market supply with fixed number of firms, 300 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com monopolistically competitive firm, 339–40 Phillips curve, 789–90 reasons for aggregate supply curve shift, 746–7 relationship with long-run average total cost, 278–9 shift in demand, 302–4 shutdowns in, 297–8 short-selling, 829–30 shortage, 81 shutdown, 293–4 in short-run and long-run, 297–8 signalling, 470 Simon, Herbert, 478 single currency characteristics that increase benefits of, 851 characteristics that reduce costs of, 849–51 Single European Market, 841–4, 843 skiing, 110–11 slope, 47–9 budget constraint, 439–40 downward demand curve, 453–4, 735–6, 762–3 expenditure, 714 upward supply curve, 304–5, 742–6 Smith, Adam, 10, 59 social (or external) cost, 201 social security, 243, 429 social/natural factors, 80 Solow, Robert, 783 South Africa cement cartels in, 363 fiscal policy in, 774–5 tax overview, 247–9 Spain, average annual income per capita, 12 special purpose vehicle (SPV), 635 specialization, 55–7 speculation, 817, 819 spending multiplier formula, 710–11 spilt milk, 294–5 Stability and Growth Pact (SGP), 860–1 stabilization policy arguments against, 775–7 arguments for, 772–3, 775 and automatic stabilizers, 777–8 stagflation, 751 standard of living, 12 labour productivity and recession, 399 worldwide differences, 528–9 sticky price theory, 721–3, 744–5 sticky wage theory, 721–3, 743–4 Stigler, George, 331 stock index, 553 stock markets, 552–3, 588–9, 877 and central banks, 766–8 stock (or share or equity), 552 store of value, 618 strike, 410 structural deficits as myth, 871 policy makers need to eradicate, 870–1 as real or not, 870–1 structural unemployment, 600 sub-prime market, 636–7, 819, 825, 827 subsidies, 211–12 subsidy, 118 and consumer surplus, 149–51 effect on market outcomes, 132–3 substitutes, 73, 95 substitution effect, 450 sunk cost, 294–5 Sunstein, Cass R., 427 superstar phenomenon, 407–8 supply, 68, 76–80 applications, 108–13 change in, 85 excess, 81 firm’s decisions on, 291–3 increase or decrease in, 77–8 market vs individual, 77 supply curve, 76 in competitive firm, 293 in competitive market, 299–305 measuring producer surplus, 144–6 and monopolies, 318 price vs quantity, 76 shifts in, 78–80 shifts vs movements along, 77–8 short run, 295 upward sloping, 304–5 supply and demand changes in equilibrium, 82–8 equilibrium, 80–2 for foreign currency exchange, 687–90 for loanable funds, 561–3, 687–90 versatility of, 384 supply of labour see labour supply supply schedule, 76 supply shock, 797 role of, 797–9 supra-governmental institutions, 32–3 surplus, 81 Sweden earnings in, 418 state-owned monopolies, 311 symmetric demand shocks, 855–6 symmetric macroeconomic shocks, 851 synergies, 329 T Taleb, Nassim Nicholas, 478 targeting inflation, 805–8 of money supply and exchange rate, 807–8 Index 901 path from monetary to inflation target, 806–7 tariff, 181, 696 and Bush administration, 37 deadweight loss, 182–3 tastes, 74, 389 tax incidence, 127 and elasticity, 130 tax(es), 127–33, 237–8 administrative burden, 252–3 capital, 243 capital gains, 248 changes and marginal propensities, 712 company, 243 corporation, 248, 250, 257 council, 243 deadweight losses, 251 direct, 243 and efficiency, 250–1 and equity, 254–7 fair or foul policy, 258–60 German overview, 249–50 income vs consumption, 251–2 indirect, 243 inflation-induced distortions, 655–7 level of, 771 lump-sum, 254 marginal vs average rates, 253 payroll, 129–30 sellers effect on market outcomes, 127–9 South African overview, 247–9 UK overview, 238–47 VAT, 242–3, 250 Taylor, John, 776 Taylor rule, 776 technological change, 387–8 technological knowledge, 532–3 shifts in long-run aggregate supply curve, 741–2 technological progress, promoting, 544, 546–7 technology, 79 technology spillovers, 203–4 temporary earnings replacement accounts (TERA), 604–5 Thaler, Richard H., 427 Thatcher disinflation, 804–5 theory of liquidity preference, 758–60 and money demand, 760–2 and money supply, 759–60, 763–4 ticket touts, 153–4 time horizon, 96 time-series graph, 43 Tobin tax, 836–7 total cost, 265 total cost curve, 271, 272 total expenditure, 98 total revenue, 98, 265 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 902 www.downloadslide.com Index total surplus, 148 total utility, 447 toxic debt, 636–7 tradable pollution permits, 213–14 trade and comparative advantage, 60–1 determinants of, 175–6 restraint of, 374 restricting, 189–90 and specialization, 55–7 winners and losers, 177–88 see also exports; international flows; international trade; net exports trade balance, 667 trade deficit, 667 trade integration and benefits of single currency, 852–3 high degree of, 851 trade policy, 186–8, 696–8 trade surplus, 667 trade-offs, 4–5, 8–9, 245 between inflation and unemployment, 791–2 between risk and return, 581–2 efficiency vs equity, 260 work and leisure, 389 Tragedy of the Commons, 231–2 tranches, 635–6 transaction costs, 209 elimination of, 844 transfer payment, 493 transparency of policy, 876 transport spending, 244 Trichet, Jean Claude, 826 two markets net capital outflow and link between, 691–2 simultaneous equilibrium, 692–4 tying, 375–6 U U-shaped average total cost, 275 ultimatum game, 479–80 unemployment, 592–611 cyclical, 592–3 definition, 593–4 duration, 599–600 frictional, 600, 601–2 identifying, 593–601 as inevitable, 601–2 and long-run Phillips curve, 786–9 measurement of, 594–8 natural rate of, 592, 593 reasons for, 600–1 rises due to falls in output, 732 and short-run Phillips curve, 789–90 structural, 600 unemployment insurance, 602–5 unemployment rate, 596 unemployment-inflation trade-off, 15–16, 791–2see also inflation unfair competition, argument for restricting trade, 190 union, 409–10, 607 economics of, 607–8 as good or bad for the economy, 608 unit of account, 618 unit elasticity, 98 United Kingdom advertising in, 345 anti-trust laws, 328 average annual income per capita, 12, 524 breakdown of adult population, 595 changing prices in, 659 competition law in, 328, 329 distribution of income in, 419–20 earnings in, 403, 410–11, 418 financial crisis in, 817 financial overview, 238–47 financial regulation in, 626 GDP in, 238, 239, 245–7, 493–4 inflation in, 14, 643, 653, 798 living standards in, 542 local currency in, 620 monetary policy, 678 parliament in, 506–7 price measurement in, 512 unemployment rate, 597 VAT in, 737–8 United States anti-trust laws, 328 average annual income per capita, 12 earnings in, 403, 410, 411 GDP in, 495 minimum wage in, 123 monetary policy, 678 race/gender discrimination in, 411–12 stock market crash, 767 unemployment in, 601 US Federal Reserve see Federal Reserve System (Fed) utilitarianism, 424–5 utility, 424–5, 447 utility function, 576 values, differences among economists, 36 variable costs, 273 velocity of money, 648–9 vertical equity, 255 Volcker rule, 831–2 volume of shares, 554 V X value of the marginal product, 386 Value-added tax (VAT), 242–3, 250 and consumption, 737–8 zero elasticity, 98 zero risk, 580–1 Zimbabwe, inflation in, 14, 642, 658–9 W wage curve theory, 800–2 wages above-equilibrium, 409–10, 600 and adverse selection, 469 effect on labour supply, 454–7 efficiency, 409–10, 468 equilibrium, 404–10 minimum, 123–5, 409–10, 428–9, 605–6 and productivity, 393 and real-wage flexibility, 849 sticky, 721 wealth, 618 arbitrary redistributions of, 657–8 and riches, 527 wealth effect, 735, 758 Weizsäcker, Jakob von, 770 welfare economics, 138, 155, 200 and cost of monopoly, 320–3 without price discrimination, 326 welfare of society effect of free trade in an exporting country, 178–9 and monopolistic competition, 343–4 and prisoners’ dilemma, 371–2 well-being, 138–9 willingness to pay, 139 work incentives, and anti-poverty policies, 430, 433 work-leisure trade-off, 389 workers effort, 610 health, 609 quality, 610–11 turnover, 609–10 World Bank, 539 world economy, 668–9 world price, 176 World Trade Organization (WTO), 192–3 Y yield, 554 For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it www.downloadslide.com For more Cengage Learning textbooks, visit www.cengagebrain.co.uk Copyright 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it ... 000 150 70 300 700 000 20 0 60 400 600 000 25 0 50 500 500 000 300 40 600 400 000 350 30 700 300 000 400 20 800 20 0 000 450 10 900 100 000 500 000 000 Quantity of cola 500 25 0 B C Consumer’s budget... Copyright 20 11 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook. .. Copyright 20 11 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook