(BQ) Part 2 book Economic has contents: The economics of environmental protection; taxation and public expenditure, trade policy; inflation and disinflation; output and prices in the short run; from the short run to the long run - The adjustment of factor prices,...and other contents.
The Economics of Environmental Protection In almost everything we do, we are subject to some form of government regulation The system of criminal law regulates our interactions with people and property Local zoning laws regulate the ways in which the land that we own or occupy may be used Regulatory commissions set rates for electricity, natural gas, local telephone service, and a host of other goods and services Seat belts, brake lights, turn signals, air bags, internal door panels, bumpers, and catalytic converters are compulsory and regulated in quality all in a single industry The list goes on and on A good case can be made that various governments in Canada have more effect on the economy through regulation than through taxing and spending The focus in this chapter is on a specific type of government regulation, one that has become increasingly important in recent years In particular, we examine the negative externalities that lead to environmental degradation and the various government policies designed to address them As we will see, policies intended to protect the environment not always so in an efficient manner One of the central themes in this chapter is that the information available to the regulatory agencies, especially regarding firms technologies for reducing pollution, is generally incomplete This lack of good information leads to the result that market-based environmental regulations are usually more successful than methods based on the government s direct control The chapter concludes with a discussion of a specific environmental challenge that has become a crucial policy issue We examine the issue of how greenhouse-gas emissions are contributing to global climate change, the technical challenges associated with reducing these emissions, and policies designed to address this enormous challenge 17 L LEARNING OBJECTIVES In this chapter you will learn how an externality can be internalized, and how this can lead to allocative efficiency why direct pollution controls are often inefficient how market-based policies, such as emissions taxes and tradable pollution permits, can improve economic efficiency some basic facts about greenhouse gases and how they relate to the growing problem of global climate change 418 PA RT : G O V E R N M E N T I N T H E M A R K E T E C O N O M Y 17.1 The Economic Rationale for Regulating Pollution For information about the Canadian Environmental Protection Act, see Pollution is a negative externality As a consequence of producing or consuming goods and services, bads are produced as well Steel plants produce smoke in addition to steel Farms produce chemical runoff as well as food Logging leads to soil erosion that contaminates fish breeding grounds Cars, trucks, and factories, by burning carbonrich fossil fuels, such as coal, oil, and natural gas, produce carbon dioxide and other greenhouse gases that contribute to global climate change Households produce human waste and garbage as they consume goods and services In all of these cases, the technology of production and consumption automatically generates pollution Indeed, few human endeavours not have negative pollution externalities Environment Canada s website: www.ec.gc.ca Practise with Study Guide Chapter 17, Exercise FIGURE 17-1 A Pollution Externality in a Competitive Market MC S = MC P + MEC Price, Costs MC P p* MEC = marginal external cost pc D = MB Q Qc Quantity A negative externality implies that a competitive free market will produce more output than the allocatively efficient level If the externality can be internalized, allocative efficiency can be achieved A competitive free market will produce where the demand and supply curves intersect that is, at Qc and pc If each unit of output of this good also generates an external cost of MEC, then social marginal cost is greater than private marginal cost by this amount The allocatively efficient level of output is where marginal benefit equals social marginal cost that is, at Q* The competitive free market therefore produces too much output If firms in this industry are now required to pay a tax of $MEC per unit of output, the private marginal cost curve, MCP, shifts up to MCS The externality will thus be internalized because firms will now be forced to pay the full social cost of their production The new competitive equilibrium will be p*, Q*, and allocative efficiency will be achieved Pollution as an Externality Polluting firms who are profit maximizers not regard a clean environment as a scarce resource and therefore fail to consider the full costs of using this resource when producing their product When a paper mill produces newsprint for the world s newspapers, more people are affected than just its suppliers, employees, and customers Its water-discharged effluent hurts the fishing boats that ply nearby waters, and its smog makes many resort areas less attractive, thereby reducing the tourist revenues that local motel operators and boat renters can expect The profit-maximizing paper mill neglects these external effects of its actions because its profits are not directly affected by them As shown in Figure 17-1, allocative efficiency requires that the price (the value that consumers place on the marginal unit of output) be just equal to the marginal social cost (the value of the resources that society gives up to produce the marginal unit of output) When there are negative externalities, social marginal cost exceeds private marginal cost because the act of production generates costs for society that are not faced by the producer By producing where price equals private marginal cost and thereby ignoring the externality, the firms are maximizing profits but producing too much output The price that consumers pay just covers the private marginal cost but does not pay for the external damage The social benefit of the last unit of output (the market price) is less than the social cost (private marginal cost plus the extra cost to society from the externality) Reducing output by one unit would increase allocative efficiency and thus make society as a whole better off C H A P T E R : T H E E C O N O M I C S O F E N V I R O N M E N TA L P R O T E C T I O N Making polluting firms bear the entire social cost of their production is called internalizing the externality This leads them to produce a lower level of output, as shown in Figure 17-1 Indeed, at the optimal level of output, where the externality is completely internalized, consumer prices would just cover the social marginal cost of production We would have the familiar condition for allocative efficiency that marginal benefits to consumers are just equal to the marginal (social) cost of producing these benefits 419 internalizing the externality A process that results in a producer or consumer taking account of a previously external effect The socially optimal level of output is at the quantity for which all marginal costs, private plus external, equal the marginal benefit to society In order to internalize the externality successfully, it is necessary to measure its size accurately Looking at Figure 17-1, we must be able to measure the magnitude of the marginal external cost, MEC In practice, however, external costs are quite difficult to measure This measurement is especially difficult in the case of air pollution, where the damage is often spread over hundreds of thousands of square kilometres and can affect millions of people Notice from Figure 17-1 that the allocatively efficient outcome still has some pollution being generated This is because the production of each unit of output in Figure 17-1 generates some pollution It is simply impossible to produce goods and services without generating some environmental damage The economic problem is then to determine how much environmental damage to allow or, equivalently, how much pollution abatement (reduction) to implement In general, it is not optimal to eliminate all pollution Zero environmental damage is generally not allocatively efficient FIGURE 17-2 The Optimal Amount of Pollution Abatement MC Dollars per Unit The Optimal Amount of Pollution Abatement The socially optimal amount of pollution abatement implies a positive amount of pollution MB Q* 100% Pollution Abatement The economics of determining how much pollution to prohibit, and therefore how much to allow, is summarized in Figure 17-2, which depicts the marginal benefits and marginal costs of pollution abatement The analysis might be thought of as applying, for example, to water pollution in a specific watershed It is drawn from the perspective of a public authority whose mandate is to maximize social welfare Note that the figure is drawn in terms of the amount of pollution that is prevented (or abated) rather than in terms of the total amount of pollution produced We this because pollution abatement (rather than pollution itself) is a good of economic value, and we are more familiar with applying the concepts of supply and demand for goods with positive The optimal amount of pollution abatement occurs where the marginal cost of reducing pollution is just equal to the marginal benefits from doing so MB represents the marginal benefit of reducing pollution by one unit MC represents the marginal cost of reducing pollution by one unit The optimal level of pollution abatement is Q*, where MB * MC Notice that not all pollution is eliminated For each unit up to Q*, the marginal benefit derived from pollution abatement exceeds the marginal cost The total net benefit from the optimal amount of pollution abatement is given by the shaded area the sum of the difference between marginal benefit and marginal cost at each level of abatement Any further efforts to reduce pollution beyond Q* would add more to social costs than to social benefits 420 PA RT : G O V E R N M E N T I N T H E M A R K E T E C O N O M Y values If no pollution is abated, the watershed will be subjected to the amount of pollution that would occur in an unregulated market The greater the amount of pollution abated, the smaller the amount of pollution that remains Thus, as we move to the right along the horizontal axis, there is more pollution abatement and therefore less remaining pollution On the vertical axis, measured in dollars per unit, we show the marginal benefit and marginal cost of pollution abatement The marginal cost of abating pollution is often small at low levels of abatement but rises steeply after some point This is the upward-sloping line shown in Figure 17-2 There are two reasons for believing that this shape is accurate First is the familiar logic behind increasing marginal costs Because some antipollution measures can be taken fairly Pollution is an externality Unless they are required by easily, the first units of pollution abatement will be cheap law to so, most firms not take the social costs of relative to later units In addition, it is likely that pollution their pollution into account when they make their private prevention of any degree will be easier for some firms than profit-maximizing decisions for others New facilities are likely to run more cleanly than old ones, for example Pollution abatement in a factory that was designed in the era of environmental concern may be much easier than obtaining similar abatement in an older factory After some point, however, the easy fixes are exhausted, and the marginal cost of further pollution abatement rises steeply The downward-sloping curve in Figure 17-2 is the demand for pollution abatement and reflects the marginal benefit of pollution reduction The curve slopes downward for much the same reason that the typical demand curve slopes downward Starting at any level of pollution, people will derive some benefit from reducing the level of pollution, but the marginal benefit from a given amount of abatement will be lower, the lower the level of remaining pollution (or the higher the level of abatement) Put another way, in a very dirty environment, a little cleanliness will be much prized, but in a very clean environment, a little more cleanliness will be of only small additional value The optimal amount of pollution abatement occurs where the marginal benefit is equal to the marginal cost where supply and demand in Figure 17-2 intersect Since the optimal amount of abatement is usually not 100 percent, some pollution will likely exist at the optimal outcome As we said earlier, zero pollution is generally not allocatively efficient In trying to reach this optimum, the pollution-control authority faces three serious problems First, although Figure 17-2 looks like a supply demand diagram, we have already seen that the private sector will not by itself create a market in pollution control Hence, the government must intervene in private-sector markets if the optimal level of control shown in Figure 17-2 is to be attained The second problem is that the optimal level of pollution abatement is not easily known because the marginal benefit and the marginal cost curves shown in Figure 17-2 are not usually observable In practice, the government can only estimate these curves, and accurate estimates are often difficult to obtain, especially when the technology of pollution abatement is changing rapidly and the health consequences and other costs associated with various pollutants are not known An excellent recent example of our ignorance regarding the marginal costs and benefits of pollution abatement is related to the effects of greenhouse-gas emissions on global warming Though there is now a broad consensus among scientists (with some notable exceptions) that humankind s emissions of greenhouse gases are contributing to global warming, the estimates of the magnitude of the effects of Earth s warming vary considerably C H A P T E R : T H E E C O N O M I C S O F E N V I R O N M E N TA L P R O T E C T I O N 421 The third problem is that the available techniques for regulating pollution are themselves imperfect Even if the optimal level of pollution abatement were known with precision, there are both technical and legal impediments to achieving that level through regulation This brings us to a discussion of the various policies that governments can use to reduce pollution As we will see, some policies are more effective than others 17.2 Pollution-Control Policies We examine three different types of policies designed to bring about the optimal amount of pollution abatement (or the optimal amount of pollution) These are direct controls, emissions taxes, and tradable pollution permits Direct Controls Direct control is the form of environmental regulation that is used most often in Canada and the United States, although it is often invisible to consumers (Policies of direct control are sometimes referred to as command-and-control policies.) Automobile emissions standards are one example The standards must be met by all new cars that are sold in Canada They require that emissions per kilometre of a number of smog-producing pollutants be less than certain specified amounts The standards are the same no matter where the car is driven The marginal benefit of reducing carbon monoxide emissions in rural Saskatchewan, where there is relatively little smog, is certainly much less than the marginal benefit in downtown Montreal, where there is already a good deal of smog Yet the standard is the same in both places Direct controls often require that specific techniques be used to reduce pollution For example, coal-fired electric plants are sometimes required to use devices called scrubbers to reduce sulphur dioxide emissions, even in cases where other techniques could have achieved the same level of pollution abatement at lower cost Another form of direct control is the simple prohibition of certain polluting behaviours For example, many cities and towns prohibit the private burning of leaves and other trash because of the air pollution problem (as well as the fire dangers) that the burning would cause A number of communities have banned the use of wood-burning stoves for the same reason Some provinces outlaw the use of weed-control products because of the contamination they cause in the ground water Similarly, the Canadian federal government gradually reduced the amount of lead allowed in leaded gasoline and then eliminated leaded gasoline altogether Problems with Direct Controls The government can legislate a certain amount of pollution abatement through direct controls, and assuming that the legislation can be enforced, this amount of abatement will be achieved An important problem with direct controls, however, is not with the amount of pollution abated, but rather with the total cost of achieving the given amount of abatement In the terminology of Chapter 12, direct pollution controls are not productively efficient because the total cost of achieving a given amount of pollution abatement is not minimized Pollution is being abated efficiently when the marginal cost of pollution abatement is the same for all firms Practise with Study Guide Chapter 17, Exercise 422 FIGURE 17-3 PA RT : G O V E R N M E N T I N T H E M A R K E T E C O N O M Y The Inefficiency of Direct Pollution Controls MCB Dollars per Unit MCA CB CA QR Pollution Abatement Requiring equal amounts of pollution abatement from different polluters is inefficient when the different polluters have different technologies of pollution abatement Firm A is able to reduce its emissions according to the marginal cost curve MCA Firm B has a different abatement technology and has a higher marginal cost of abatement, MCB Suppose a regulatory authority requires that the two firms reduce pollution by the same amount, QR Firm A will have a marginal cost of pollution abatement of CA, whereas Firm B s marginal cost will be CB, which is larger than CA To see that this outcome is inefficient, consider what happens if Firm A increases its pollution abatement by one unit while Firm B decreases its abatement by one unit Total pollution remains the same, but total costs fall When firms are required to abide by direct pollution controls, however, the marginal cost of pollution abatement is usually not equated across firms To see this, consider two firms that have different technologies and thus face different marginal costs of pollution abatement, as shown in Figure 17-3 These firms may be in the same industry, producing similar products, or they may be in different industries altogether In either case, they are assumed to have different abilities to abate pollution Suppose that, for any level of pollution abatement, Firm As marginal costs of abatement are lower than those for Firm B In this situation, consider a system of direct pollution controls that requires Firm A and Firm B each to reduce pollution by a given amount, say QR As shown in Figure 17-3, Firm As marginal cost at QR (CA) is less than Firm B s marginal cost (CB) As long as CA is less than CB, it is possible to reduce the total cost of this amount of pollution abatement by reallocating it between the two firms For example, suppose CA is $10 and CB is $18 If Firm A abated one more unit of pollution, its costs would rise by $10; if Firm B abated one less unit of pollution, its costs would fall by $18 By reallocating one unit of pollution abatement from Firm B to Firm A, total pollution abatement would be unaffected, but the total cost of the abatement would be reduced by $8 As long as the two firms marginal costs of abatement are not equal, it is possible to reduce total costs further by further redistributing the abatement between the firms Only when marginal costs are equal across the two firms is the given level of pollution abatement being achieved at the lowest possible cost Direct pollution controls are usually inefficient because they not minimize the total cost of a given amount of pollution abatement Direct controls are also expensive to monitor and to enforce The regulatory agency has to check factory by factory, farm by farm how many pollutants of what kinds are being emitted It then also needs a mechanism for penalizing offenders Accurate monitoring of all potential sources of pollution requires a level of resources that is much greater than has ever been made available to the relevant regulatory agencies Moreover, the existing system of fines and penalties, in the view of many critics, is not nearly harsh enough to have much effect A potential polluter, required to limit emissions of a pollutant to so many kilograms or litres per day, will take into account the cost of meeting the standard, the probability of being caught, and the severity of the penalty before deciding how to behave If the chances of being caught and the penalties are small, the direct controls may have little effect Monitoring and enforcement of direct pollution controls are costly, and this costliness reduces the effectiveness of the controls C H A P T E R : T H E E C O N O M I C S O F E N V I R O N M E N TA L P R O T E C T I O N 423 Finally, some direct controls can have undesirable effects For example, automobile manufacturers in the United States are required to achieve an average level of fuel efficiency on the entire fleet of cars they produce Cars that could burn either gasoline or E85, a blend of 85 percent ethanol and 15 percent gasoline, were first produced in 1997 When operating with E85, only the amount of gasoline in the fuel is used to compute the car s fuel efficiency, and so a car with the capacity to operate with E85 is deemed to be far more fuel efficient than a car operating with gasoline However, because very few service stations sold ethanol, owners of these new cars soon turned to fuelling their cars with ordinary gasoline But the regulations still counted these vehicles as fuel-efficient ethanol-burning cars even though they were, in practice, no more efficient than normal gasoline-burning cars As a result, the manufacturers were able to produce more gasoline-guzzling SUVs and still achieve, at least on paper, their overall fuel-efficiency standards Thus, the mere existence of cars that were able to (but didn t actually) burn ethanol contributed to an increase in the average per-vehicle consumption of gasoline Emissions Taxes FIGURE 17-4 The Efficiency of Emissions Taxes Emissions tax equals marginal benefit of pollution abatement Dollars per Unit An alternative method of pollution control is to levy a tax on emissions at the source The advantage of such a procedure is that it internalizes the pollution externality so that decentralized decisions can lead to allocatively efficient outcomes Again, suppose Firm A can reduce emissions cheaply, while it is more expensive for Firm B to reduce emissions And further suppose that all firms are required to pay a tax equal to $t per unit of pollution emitted Since firms must pay $t for every unit of pollution they produce, they will save $t for every unit of pollution they not produce It follows that the emissions tax of $t is each firm s marginal benefit of pollution abatement The goal of profit maximization will then lead firms to reduce emissions to the point where the marginal cost of further reduction is just equal to $t Firm A will reduce emissions much more than Firm B and both will then have the same marginal cost of further abatement, which is required in order to minimize the cost of a given total amount of pollution abatement Such a situation is illustrated in Figure 17-4 Note that if the regulatory agency is able to obtain a good estimate of the marginal damage done by pollution, it could set the tax rate just equal to that amount In such a case, polluters would be forced by the tax to internalize the full pollution externality and allocative efficiency would be achieved In terms of Figure 17-1, each firm s private marginal cost curve would shift up by the full amount of the tax (set to equal the marginal external cost, MEC) and thus the allocatively efficient level of output (and pollution) would be produced MCB MCA t QB QA Pollution Abatement Emission taxes can lead to efficient pollution abatement As in Figure 17-3, Firm A faces a lower marginal cost of pollution abatement than does Firm B Suppose the regulatory authority imposes a tax of t dollars per unit of pollution emitted Since each firm would then save t dollars for each unit of pollution it does not produce, t can be viewed as each firm s marginal benefit of pollution abatement Firm A chooses to reduce its pollution by QA Up to this point, the tax saved (marginal benefit) from reducing pollution exceeds the marginal cost of reducing pollution Firm B chooses to abate only a small amount of pollution, QB Since the marginal cost of abatement is equated across firms, the total amount of pollution abatement (QA * QB) is achieved at minimum cost This is efficient pollution abatement 424 Practise with Study Guide Chapter 17, Exercise and Extension Exercise E1 PA RT : G O V E R N M E N T I N T H E M A R K E T E C O N O M Y A second advantage of using emissions taxes is that regulators are not required to specify anything about how polluters should abate pollution and thus are not required to have expertise about the firms technologies Rather, polluters themselves can be left to find the most efficient abatement techniques The profit motive will lead them to so because they will want to avoid paying the tax Emissions taxes can internalize pollution externalities so that profit-maximizing firms will produce the allocatively efficient amount of pollution abatement Problems with Emissions Taxes Practise with Study Guide Chapter 17, Short-Answer Question Emissions taxes can work only if it is possible to measure emissions with reasonable accuracy For some kinds of pollution-creating activities, this does not pose much of a problem, but for many other types of pollution, good measuring devices that can be installed at reasonable cost not exist In these cases, emissions taxes cannot work, and direct controls are the only feasible approach When there is good reason to prohibit a pollutant completely, direct controls are obviously better than taxes Municipal bans on the burning of leaves fall in this category, as the occasional emergency bans on some kinds of pollution that are invoked during an air-pollution crisis in such cities as Los Angeles, Toronto, and Vancouver Another problem with emissions taxes involves setting the tax rate Ideally, the regulatory agency would obtain an estimate of the marginal social damage caused per unit of each pollutant and set the tax equal to this amount This ideal tax rate would perfectly internalize the pollution externality However, the information that is needed to determine the marginal external cost (MEC) shown in Figure 17-1 is often difficult to obtain If the regulatory agency sets the tax rate too high, too many resources will be devoted to pollution control If the tax is set too low, there will be too little pollution abatement and thus too much pollution A disadvantage with emissions taxes is that information necessary to determine the optimal tax rate is often unavailable ADDI T I ONA L T OPI C S We usually think of emissions taxes as applying to air or water pollution But a different example of the same principle is becoming more common in Canadian and U.S cities For more information, look for Charging for Garbage by the Bag in the Additional Topics section of this book s MyEconLab w w w m y e c o n l a b c o m Tradable Pollution Permits: Cap and Trade The third general policy approach to pollution reduction is often referred to as a system of cap and trade This system comprises two fundamental parts First, the government mandates a limit (or cap ) on the total amount of pollution of some specific type Second, the government distributes permits to firms (either by granting or auctioning) C H A P T E R : T H E E C O N O M I C S O F E N V I R O N M E N TA L P R O T E C T I O N allowing the firms to emit a specified amount of pollution These permits can be traded among the firms at prices determined in a free market For example, the government might issue permits for a total of 10 000 megatonnes of annual sulphur dioxide emissions and distribute to each of 20 firms a permit for 500 megatonnes In any given year, a firm is restricted to emitting an amount of sulphur dioxide no greater than the amount allowed by the permits it holds Firms can then trade the permits freely among themselves and a market-determined price will be established For obvious reasons, a capand-trade system is also referred to as a system of tradable pollution permits Like emissions taxes, tradable pollution permits can minimize the cost of a given amount of pollution abatement To see this, consider starting from a situation similar to that with direct pollution controls In Figure 17-5, both firms are abating pollution by QR units (The inefficiency of this initial situation is reflected by the differential in marginal costs of the two firms.) Now suppose the government issues permits for a total amount of emissions consistent with the same total amount of pollution abatement (* + QR in the figure) What should each of the firms do? Should they abate more pollution, or less? Note that at QR units of pollution abatement, the marginal costs for Firm B exceed the marginal costs for Firm A pollution abatement is more difficult for Firm B than for Firm A Suppose the two firms could agree on a price p* at which to buy and sell permits Who would buy, and who would sell? Firm B, the high-abatement-cost firm, would rather buy permits at p* and avoid having to reduce pollution at high marginal costs By buying X pollution permits from Firm A, Firm B ends up abating QB units of pollution and reduces its costs by the red-shaded area Firm A, the low-abatement-cost firm, would rather sell its permits at p* and abate more pollution at low marginal cost By selling X permits to Firm B, Firm A ends up abating QA units of pollution and increases its profits by the blue-shaded area Therefore, with low-abatement-cost firms selling pollution permits to high-abatementcost firms, both types of firms are better off than when they are subject to direct pollution controls even though the total amount of pollution abatement is unchanged Since FIGURE 17-5 tradable pollution permits Rights to emit specific amounts of specified pollutants that private firms may buy and sell among themselves The total quantity of permits is set by government policy Practise with Study Guide Chapter 17, Exercise and Short-Answer Question The Efficiency of Tradable Pollution Permits ( Cap and Trade ) MCB MCA Dollars per Unit 425 MCB p* MCA X permits X permits QB QR Pollution Abatement QA A cap-and-trade system is an efficient way to achieve a given amount of pollution abatement As in Figure 17-3 and Figure 17-4, Firm A has lower marginal costs of pollution abatement than does Firm B If each firm abates pollution by Q R units, the firms marginal costs are not equated and the pollution abatement is inefficient All firms can be better off if they are issued tradable pollution permits even though total pollution abatement remains unchanged The price of the permits reflects firms marginal benefit of pollution abatement If the price is p*, Firm A would sell X permits to Firm B Firm B would reduce its abatement to QB and reduce its costs by the red area, while Firm A would increase its abatement to QA and increase its earnings by the blue area Since the marginal costs of abatement are equated across firms, this is efficient pollution abatement 426 FIGURE 17-6 PA RT : G O V E R N M E N T I N T H E M A R K E T E C O N O M Y the marginal cost of abatement is now equal across firms, we know from our earlier discussion that the given amount of pollution abatement is being achieved at the lowest possible cost The Market for Tradable Pollution Permits Price of Permits S With tradable pollution permits, profit-maximizing firms will reduce pollution until their marginal abatement costs equal the price of pollution permits The costs of a given amount of pollution abatement will be minimized The demand for pollution permits depends on firms costs of pollution abatement p* Government policy sets the cap on pollution and thus the total number of permits D QS Number of Pollution Permits The equilibrium price in the market for pollution permits is determined by government policy and by firms technology of pollution abatement The government sets the total quantity of pollution permits at QS This is the vertical supply curve At a lower price for permits (the marginal benefit of abatement) firms decide to abate less pollution and they therefore require more pollution permits The demand curve for permits is therefore downward sloping At the equilibrium price, the quantity of permits demanded by firms is equal to the number issued by the government What determines the equilibrium market price for pollution permits? The total supply of pollution permits is determined by the government policy the governmentmandated cap on pollution Let this amount be QS it is represented by a vertical supply curve in Figure 17-6 The demand for pollution permits comes from firms and depends on their costs of pollution abatement For every unit of pollution that a firm abates, the firm requires one fewer pollution permit The price of the pollution permit is therefore the firms marginal benefit of abatement As the price of the permit increases, each firm decides to abate more pollution and therefore demand fewer pollution permits Thus, the demand curve for pollution permits is downward sloping, as shown in Figure 17-6 At the equilibrium price for pollution permits, p*, the number of permits demanded by firms will exactly equal the number of permits issued by the government In the market for pollution permits, the quantity is set by government policy Given that quantity, the equilibrium price is determined by firms demand for pollution permits Technological Change We said earlier that one problem with direct pollution controls is that they tend, like much government regulation, to respond only slowly to changes in technology or market conditions In contrast, tradable pollution permits, because they are a market-based method of pollution control, maintain their efficiency even in the midst of frequent and substantial changes in technology As technological advances occur that reduce firms costs of pollution abatement, firms demands for pollution permits will fall The result will be a reduction in the equilibrium price of pollution permits But whatever the market price for permits, profit-maximizing firms will equate the price to their marginal abatement costs, thus minimizing the total cost of a given amount of pollution abatement Improvements in abatement technology will lead to a reduction in the demand for emissions permits and thus a reduction in their equilibrium price The total cost of a given amount of pollution abatement will still be minimized I 10 INDEX The General Theory of Employment, Interest and Money (Keynes), 583, 605n, 798n Germany, hyperinflation in, 674 Giffen, Robert, 128 Giffen goods, 128 129 global climate change, 429 439 global collective environmental action, 431 433 global economy See international economy global supply chains, 860 861 global warming, 664 globalization Canadian economy, effect on, 254 causes of, 13 and choice, 13 debate, 14 described, 13 investment and saving in globalized financial markets, 375 nature of globalization, 254 and structural change, 809 globalization protests, 14 goals of firms, 152 153 gold standard, 677 good jobs bad jobs debate, 349 352 goods, complements in consumption, 55 conspicuous consumption goods, 130 durable goods, 526 excludable, 392, 393 395 final goods, 498 Giffen goods, 128 129 government purchases of goods, 458 inferior goods, 54, 93, 128 intermediate goods, 498 non-durable goods, 526 non-excludable, 392 396 non-rivalrous goods, 392 396 non-traded goods, 919 normal goods, 54, 93 private goods, 392 public goods, 19 20, 395 396, 396f rivalrous, 392 substitutes in consumption, 54 55 use of, Goods and Services Tax (GST), 447, 449 451, 452f goods markets described, 10 and factor markets, 307 Gore, Al, 429, 430f government basic functions of, 384 385 bonds, 571n budget deficit See budget deficit budget surplus See budget surplus debt, 548 as decision makers, 10 declining industries, response to, 219 duty of, 152 evaluation of role of, 467 469 expenditure See government expenditure failure, 407 411 Government of Canada, 404, 682 intervention See government intervention in mixed economy, 19 20 as monopolist, 410 411 monopoly of violence, 384 385 municipal governments, 548 net tax revenue, 819 policy See government policy program spending, 820 provincial governments, 548 public vs private sector, 468 scope of government activity, 468 469 in short-run macroeconomic model (simple model), 547 549 support of industry, and job creation, 318 taxes See taxation government debt, 819 in Canada, 821 822 causes of, 827 debt-to-GDP ratio, 825 827 economic policy, effect on, 830 832 effects of, 827 834 federal government, 821 822, 821f, 822f foreign-held debt, 833 long-term burden of government debt, 829 830 provincial governments, 822 government expenditure in Canada, 457 467 Canadian fiscal federalism, 458 460 Canadian social programs, 460 467 deficit-financed, 610 611 discretionary expenditure, 820 equalization payments, 459, 460 expenditures by Canadian governments, 2008, 458f vs government purchases, 503 intergovernmental transfers, 459 460 transfer payments, 458, 459t, 503, 547, 560 561 government failure, 407 411 government intervention agriculture and the farm problem, 115 amount of intervention, 411 412 competition policy, 298 300 compliance costs, 406 407 cost-benefit analysis, 404 costs of, 405 407 democracy, and inefficient public choices, 409 410 direct costs, 406 economic growth, 403 government failure, 407 411 income distribution, 400 indirect costs, 406 407 and inefficiency, 115 116 mix of market and government intervention, 384 paternalism, 402 prices See price controls production costs, changes in, 406 protection of individuals from others, 402 public choice theory, 408 409 public provision, 405 public provision, preferences for, 400 402 redistribution programs, 405 regulations, 405 rent seeking, 407 social goals, 399 403 social responsibility, 402 403 subsidies See subsidies tools of, 404 405 Government of Canada, 404, 682 government policy allocative efficiency, 291 competition policy, 298 300 desired saving, increasing, 374 economic regulation, 291 297 evolution of, 469 fiscal policy See fiscal policy investment, encouragement of, 375 and labour-market flexibility, 809 810 labour markets, and adaptation to changes, 806 minimum wages, 103, 115, 342 344 monetary policy See monetary policy natural monopoly, 292 294 oligopolies, 295 297 pay equity, 323 324 short-run vs long-run macroeconomics, 632 634 trade policy See trade policy government purchases, 503 changes in, 560 cost vs market value, 503 of goods and services, 458, 547 vs government expenditure, 503, 547 increases in, 614 616 graphing concave to the origin, cross-sectional data, 35 demand curve, 64n economic data, 35 37 economic theories, 37 43 functional forms, 39 functional relation, 38, 39 42 functions, 38 39 functions with minimum or maximum, 42, 43f introduction to graphing, 6, 37 market, graphical analysis of, 62 64 non-linear functions, 40 42 scatter diagram, 36 37, 37f slope of a straight line, 40 supply curve, 64n time-series data, 35 36 utility, 122, 122f The Great Canadian Disinflation (Robson and Laidler), 752n Great Depression, 479, 609, 610 611, 744 745, 746 747, 770, 874 Green, C., 435n greenhouse-gas emissions, 430 431, 433 436, 664 665 Gresham, Thomas, 675 Gresham s law, 675 676 gross domestic product (GDP), 501 actual GDP, 626f consumption expenditure, 501 debt-to-GDP ratio, 825 827 demand-determined real GDP, 583 INDEX disposable personal income, 508 economic bads, 512 513 energy intensity of GDP, 434 435 equilibrium GDP, 571 572 factor incomes, 504 505 GDP accounting, 626 632 GDP deflator, 509 510 GDP on the expenditure side, 501 504 GDP on the income side, 501, 504 506, 506t government purchases, 502 503 vs gross national product (GNP), 507 508 growth and fluctuations in real GDP, 1965 2008, 478f growth rate of, 560n home production, 512 illegal activities, 510 511 investment expenditure, 502 and living standards, 513 514 measurement of, 477 net exports, 503 504 nominal GDP, 509 510, 509t, 510n, 511 non-factor payments, 505 506 non-market activities, 512 omissions from, 510 513 per capita GDP, 638 potential GDP, 479, 480f, 626f real GDP, 509 510, 509t, 511, 708 reducing global GDP, 434 short-term fluctuations, 477 three sources of changes in, 631f total expenditures, 504 total national income, 506 underground economy, 512 world GDP, energy use, and greenhouse-gas emissions, 433 436 gross investment, 502 gross national product (GNP), 507 508 gross tuning, 614 growth economic growth See economic growth and free markets, 387 388 population growth See population productivity growth, 628 social costs of economic growth, 643 Guaranteed Income Supplement (GIS), 467 H happiness, 125, 514, 643 Harper, Stephen, 349 health care cost containment, 462 market, 105 private sector, role of, 462 463 public expenditure, 462 463 reform, 463 Heckscher, Eli, 852 Heckscher-Ohlin model, 852 853 historical perspective Asian crisis, and Canadian economy, 585 Canadian monetary history, 749 756 central planning, failure of, 18 19 creative destruction, 234 David Ricardo, and economic rent, 325 development of unions in Canada, 347 explicit cooperation in OPEC, 268 269 fiscal policy in the Great Depression, 610 hyperinflation, and the value of money, 674 ice storms, hurricanes, and economics, 66 Jacob Viner and the clever draftsman, 182 mercantilism, 913 money, and the Great Depression, 746 747 real-world weather shocks, 66 67 trade protection and recession, 874 unions, development of, 347 workers, and technological change, 656 A History of the Canadian Dollar (Powell), 678n Hobbes, Thomas, 384 hold-up of capital, 348 home production, 512 homogeneous product, 199 horizontal equity, 453 hours per person, 316 households reasons for holding money, 706 707 stocks and bonds, purchase of, 358 wealth, change in, 525 housing collapse, 359, 684 housing shortages, 106 107 human capital, 335 336, 357, 643, 652 653, 853 854 Human Resources and Social Development, 342, 805 Hume, David, 842 hunter-gatherer societies, 11 hurdle pricing, 244 245 Hurricane Katrina, 66 67 hyperinflation, 484, 673, 674 675 hypotheses, 28 hysteresis, 718, 719, 808 809 I ice storms, 66 ideas, 660 661 idle capital equipment, 168 idle resources, illegal activities, 510 511 illustrative abstraction, 28 29 imperfect competition, 254 257 choice of prices, 255 256 choice of products, 255 differentiated products, 255 innovation and, 290 monopolistic competition, 257 260 non-price competition, 256 oligopoly, 261 273 vs perfect competition, 256 wage differentials, 339 342 implicit costs, 155 156, 155n import duty See tariffs import quota, 876, 877f imports, 503 Canadian imports, 1970 2008, 492f Canadian imports, by industry, 843f comparative advantage, 857, 857f and gross domestic product (GDP), 503 504 as key macroeconomic variable, 491 marginal propensity to import, 549 multiplier with taxes and imports, 556 557 rise in foreign price of, 906 907 improved inputs, 185 incentives described, misplaced incentives, 19 income break-even level of income, 465 change in, and consumer s reaction, 144 circular flow of income and expenditure, 10 11, 10f I 11 and consumption, 38f current income, and saving, 369 and demand, 54 disposable income in Canada, 1981 2008, 521f disposable personal income, 508 distribution of income See distribution of income earned income, 465 education, and employment income, 335f expected future income, and saving, 369 factor incomes, 504 505 foreign income, 550 growth, effect of, 373, 374 375 and inferior goods, 93 as key macroeconomic variable, 476 480 national income See national income net domestic income, 505 real income, 127, 513 scatter diagram of household income and saving, 37f total national income, 506 income effect, 128 indifference theory, 146 147 interest rate, 370n of price change, 147f and price changes, 126 131 and taxation, 130 131 income-elastic, 91 income elasticity of demand, 91 93 income-inelastic, 91 income-support programs, 463 466 income taxes, 447, 448 449, 456 457 income-tested benefits, 460 An Incomplete Truth (Gore), 429 increasing returns (to scale), 179 incremental utility, 121n index numbers, 32 35, 33t indifference curves budget line, 141 143 consumer s utility-maximizing choices, 143 144 demand curve, deriving, 144 147, 145f described, 139 141 diminishing marginal rate of substitution, 140 141 income effect, 146 147 indifference map, 141, 141f substitution effect, 146 147 I 12 INDEX indifference map, 141, 141f indirect costs, 406 407 indirect taxes, 499n, 505 induced expenditure, 519 industrial concentration, 253 254 industrial unions, 347 industrialized countries See developed countries industry government support of industry, and job creation, 318, 812 industrial concentration, 253 254 industries with a few large firms, 252 253 industries with many small firms, 252 industry supply curve, 207, 208f interindustry wage differentials, 344 long-run industry supply curve, 220 and monopolists, 230 symmetric vs asymmetric, 259n unionization rates, by industry, 346t Industry Canada, 253 inefficiency see also efficiency democracy, and inefficient public choices, 409 410 of direct controls, 421 422, 422f examples of, 280 externalities, and allocative inefficiency, 391, 391f and government intervention, 115 116 monopoly, 230, 230f output quotas, 114 115, 114f reallocation of production, 281 inelastic demand, 77, 79, 89 inelastic supply, 89 infant industry argument, 870 871 inferior goods, 54, 93, 128 inflation, 485, 763 accelerating inflation, 774 775, 776 777 anticipated inflation, 487, 763, 767 in Canada, 673 causes of, 775 776 conclusion, 777 consequences of, 776 constant inflation, 768 769, 768f continually increasing rate of, 775 CPI and core inflation, 742f CPI inflation, 1965 2009, 763f deflation, 769, 770 demand inflation, 770 disinflation, 751 752, 780 784 expectations, 764, 765 766, 768 high inflation, costs of, 764 hyperinflation, 484, 673, 674 675 Inflation Calculator, 486, 763 and interest rate, 372, 488, 623 624 international perspective, 719f as key macroeconomic variable, 484 487 in macroeconomic model, 764 769 meaning of, 372 as monetary phenomenon, 775 779 and monetary policy, 740f NAIRU See NAIRU (nonaccelerating inflation rate of unemployment) output-gap inflation, 767 and price, 767 768 and price level, 372 purchasing power of money, 486 recent history, 486 487, 487f reducing inflation, 779 784 and relative prices, 68 70 rising inflation, 1987 1990, 750 751 significance of, 489 stagflation, 603, 780, 781 783 supply inflation, 771 sustained inflation, 739, 778, 782f targeting See inflation targeting too low inflation, 756 unanticipated inflation, 487, 738, 763 uncertainty and, 738 wages, changes in, 764 767 inflation targeting and automatic stabilizers, 741 complications, 741 744 described, 623 exchange rate and monetary policy, 743 744 formal systems of, 739 output gap, role of, 739 740, 740f overall success of, 739 reasons for targeting inflation, 738 739 recent periods of, 752 755 as stabilizing policy, 740 741 volatile food and energy prices, 741 743 inflationary gap, 478, 594, 597, 608, 608f information asymmetric information, 396 398 as public good, 396 inherited skills, 334 335 innovation, 267, 272 273, 290, 294 295, 387 388, 655, 658 659 inputs economies of scale, 179 fixed factors, 157 improved inputs, 185 input prices, changes in, 577 578 prices of, and supply, 59 60 and production, 154 variable factors, 157 Inside the Black Box (Rosenberg), 657 installed capital, 348 institution building, 385 institutions financial institutions, 683 684 and market economies, mixed economy, 19 integrated tax system, 449 intensity of preferences, 409 interaction among markets, 99 100 interbank activities, 685 interest, 151, 505, 505n see also interest rate interest rate, 488 bank rate, 732 on bond, 367 and bond yields, 704 705 change in, 526 as cost of borrowing, 526 and credit flows, 488 489 and demand for money, 708 determination, in market for financial capital, 371, 371f discounting by, 360, 361n endogenous, 371 equilibrium interest rate, 371f, 712 713, 712f exogenous, 371 and extraction of natural resources, 377 income effect, 370n and inflation, 372, 488, 623 624 and investment demand, 367 368, 368f as key macroeconomic variable, 487 489 liquidity preference theory of interest, 711 market interest rate, 704 vs money supply, 729 731 nominal interest rate, 371, 372, 488, 489f, 708n, 714n overnight interest rate, 732 734, 733f and present value, 701 703 as price of financial capital, 370 real interest rate, 371, 372, 376f, 488, 489f, 528 529, 708n reduction in, and firm s optimal capital stock, 366 and saving, 370 short-term interest rates, 1975 2009, 749f significance of, 489 and slope of the AD curve, 716 substitution effect, 370n targeting the interest rate, 731 intergovernmental transfers, 459 460 intermediate goods, 498 intermediate products, 154 internalizing the externality, 419 international borrowing, 913 914 international economy depreciation and appreciation, 490 491 exchange rate, 490 inflation and money growth, 719f investment and saving in globalized financial markets, 375, 649 and macroeconomic variables, 490 Marshall-Lerner condition, 902n International Labour Organization, 882 International Monetary Fund (IMF), 14, 895, 904 INDEX international trade Canada s trading partners, 844 comparative advantage See comparative advantage economic profits in foreign markets, 871 872 exports See exports foreign income, changes in, 550 and free trade agreements, 491 gains from trade, 844 855 global supply chains, 860 861 growth in world trade, 843f imports See imports international relative prices, 550 552 intra-industry trade, 844, 851 law of one price, 855 856 marginal propensity to import, 549 meaning of, 842 net export function, 550 552, 550f, 551f pattern of trade, 855 862 in short-run macroeconomic model, 549 552 terms of trade, 859 862, 859f, 862f, 870 trade policy See trade policy transaction costs, 922 923 and uncertainty, 922 923 volume of trade vs balance of trade, 843 844 interpersonal trade, 844 interregional trade, 845 intra-industry trade, 844, 851 inventories, 502 changes in, 502, 528 529 and real interest rate, 528 529 investment and aggregate expenditure, 520 and capital market, 371 377 changes in desired investment, 713 714 in closed economies, 828 829 crowding out, 828, 829f demand for investment See investment demand desired saving vs desired investment, 534 direct investment, 894 encouragement of, 375 expenditure See investment expenditure fixed investment, 502 flow, 375, 376f in globalized financial markets, 375, 649 gross investment, 502 in industrialized countries, 648 649, 649f net investment, 502 portfolio investment, 894 and saving, in long-run, 645 649, 646f volatility of investment, 1981 2008, 528f investment demand economy s demand for investment, 368 firm s demand for capital, 364 368 increases in, 647f, 648 and interest rate, 367 368, 368f investment expenditure, 502 autonomous expenditure, 530, 530f business confidence, 530 changes in sales, 529 530 desired investment expenditure, 527 530 real interest rate, 528 529 invisible hand, involuntary unemployment, 805 isocost lines, 194, 194f isoquant analysis, 192 196, 193f, 194f, 195f isoquant map, 193, 194f isoquants, 192 193, 193f J Jaccard, Mark, 437, 438n Japanese economy, 624 625 job creation, 318, 792, 812, 873 874 job destruction, 792 job security, 345 346 K key economic problems idle resources, productive capacity, growth in, what is consumed and by whom, what is produced and how, Keynes, John Maynard, 523, 583, 605n, 720, 798n Keynesian AS curve, 582, 583 Keynesian consumption function, 523 Keynesians, 720 722, 744 745 knowledge, 660 661 knowledge-driven growth, 661 knowledge transfer, 658 Krueger, Alan, 344 Kuhn, Peter, 349n Kyoto Protocol, 432 433, 433t L labour described, 4, 154 division of labour, 12, 161 hours per person, 316 marginal product, 650, 797 mobility of labour, 317 318 non-monetary considerations, 318, 324 population, variations in, 315 real wages, changes in, 316 specialization of labour, 11 13 supply of, 315 316, 628 variable labour, 164t wage differentials, 321, 323 324 labour force, 481 growth of, 643, 652 as key macroeconomic variable, 480 483 labour-force participation rate, 315 316, 628 protection against low-wage foreign labour, 872 873 recent history, 482f labour-force participation rate, 315 316, 628 labour market adaptation to changes, 806 bilateral monopoly, 341 342, 342f competitive labour markets, 343 discrimination, 336 339, 337f flexibility, and policy, 809 810 flows in, 792 793, 794 795 good jobs bad jobs debate, 349 352 legislated minimum wages, 342 344, 343f monopsony, 340 342 New Classical labour market, 798f paradox of value, 135 stocks, 794 795 union in a competitive labour market, 339 340, 340f wage differentials, 334 344 labour productivity, 483, 484f labour union, 339 I 13 bargaining, and New Keynesian theory, 802 collective bargaining, 341, 345 348 in competitive labour market, 339 340, 340f craft unions, 347 development of unions in Canada, 347 employment effects of, 346 348, 348f featherbedding, 347 348 industrial unions, 347 influence on economic outcomes, 348 349 job security, 345 346 monopsony, 341 342 national unions, 347 statistics, 345 union membership in Canada, 345f union wage premium, 346, 348f unionization rates, by industry, 346t wage levels, and size of union, 346 wages vs employment, 345 346 Laffer, Arthur, 457 Laffer curve, 457, 457f Lafrance, R., 917n lags decision lags, 613 execution lag, 613 time lags, in monetary policy, 744 749 Laidler, David, 752n land described, 4, 154 mobility of land, 317 supply of, 315 law of diminishing marginal returns, 311, 650 651, 651f law of diminishing marginal utility, 121, 126 law of diminishing returns, 160, 162, 576 law of one price, 855 856 leaky bucket analogy, 401 lean production, 12 learning by doing, 12, 657 658, 851 852, 852f lender of last resort, 682 Lewis, William, 659 life-cycle theory, 523 limited partnership, 150 The Limits to Growth (Club of Rome), 661 I 14 INDEX linear consumption function, 39 linearly related, 40 liquidity preference theory of interest, 711 living standards See standard of living long run, 158 capital, supply of, 628 capital market, trends in, 375 377 cost minimization, 175 177 decisions, in competitive market, 212 219 entry and exit, 212 215 factor supply, 628 focus on, 644 645 investment, and natural monopoly, 294 labour supply, 628 long-run cost curves, 178 182 macroeconomic model See long-run macroeconomic model macroeconomics vs microeconomics, 625n monopolistic competition, 259 monopoly, 231 232 national income, 625 principle of substitution, 177 178 productivity, 628 629 profit maximization, and cost minimization, 175 181 long-run aggregate supply curve, 605 long-run average cost (LRAC) curve, 178 constant costs, 180 decreasing costs, 179 180 increasing costs, 180 shape of, 178 180, 179f shifts in, 181 182 and short-run cost curves, 180 181, 181f long-run cost curves, 178 182 long-run demand curve, 82 long-run economic growth, 477, 492 493 long-run equilibrium, 83f, 86f, 215 216, 217f, 231 232, 259, 604 605, 605f long-run industry supply curve, 220 long-run macroeconomic model aggregate demand and supply shocks, 599 605 defining characteristics, 592 593 inflation, 764 769 long-run equilibrium, 604 605, 605f short-run vs long-run macroeconomics See short-run vs long-run macroeconomics long-run neutrality of money, 717 719, 717f long-run supply curve long-run industry supply curve, 220 price elasticity of supply, 86 rent controls, 106, 106f long-term burden of government debt, 829 830 long-term capital movements, 908 Lorenz curve, 306, 308f loss minimization, 210, 213 losses deadweight loss See deadweight loss economic losses, 156 157 exit caused by, 214f loss minimization, 210 low-income cutoff, 463 lump-sum tax, 447 luxuries, 92 93 M M1, 693 M2, 693 M2+, 693 MacKenzie King, William Lyon, 874 macroeconomic equilibrium, 578 586, 579f aggregate demand shock, 580f aggregate demand shocks, 580 582 aggregate supply shocks, 582 584, 584f changes in, 579 580 negative shock, 579 positive shock, 579 macroeconomic states, 593t macroeconomic variables depreciation and appreciation, 490 491 employment, 480 483 exchange rate, 490 exports and imports, 491 income, 476 480 inflation, 484 487 interest rates, 487 489 labour force, 480 483 output, 476 480 price level, 484 487 productivity, 483 484 unemployment, 480 483 macroeconomics, 9, 475 and capital market, 377 key macroeconomic variables, 476 491 Malthus, Thomas, 161, 184, 605n managed float, 902 margin of dumping, 878 marginal benefit, 11 marginal cost (MC), 164 of abating pollution, 420 described, 10 11 equality of MR and MC, and profit maximization, 205 206 increasing, 41 marginal cost (MC) curve, 165, 166f marginal-cost pricing, 293 marginal decisions, 10 11 marginal product (MP), 160 change in factor s marginal product, 313 314 diminishing marginal product, 160 161 firm s demand curve for a factor, 310 labour, 650, 797 in the short run, 159f marginal propensity to consume (MPC), 524 marginal propensity to import, 549 marginal propensity to save (MPS), 525 marginal propensity to spend, 531 532 marginal propensity to tax, 548 marginal rate of substitution (MRS), 140 marginal rate of technical substitution, 192 marginal response, diminishing, 41 marginal returns, increasing, 659 661 marginal revenue (MR), 202 change in firm s marginal revenue, 314 equality of MR and MC, and profit maximization, 205 206 firm s demand curve for a factor, 310 monopolists, 226 228, 228f in perfect competition, 202 marginal revenue product (MRP), 309 marginal tax rate, 448 marginal utility, 121 and consumer choice, 121 126 and consumption, 122f fundamental equation, 124 law of diminishing marginal utility, 121, 126 market, 62 capital market See capital market changes in market prices, 64 67 and choice, 12 13 competitive market See competitive market concept of a market, 62 crude oil market, 70 defining the market, 254 described, 12 efficiency See market efficiency feedback effects, 99 100 financial markets, 683 general-equilibrium analysis, 100 government-controlled prices, 100 108 graphical analysis, 62 64 interaction among markets, 99 100 interest rate, 704 labour market See labour market for lemons, 399 linkages between markets, 100 mix of market and government intervention, 384 paradox of value, 133 135, 134f partial-equilibrium analysis, 99 100 perfectly competitive markets, 62 and price, 3, 62 67 for tradable pollution permits, 426f market-clearing price See equilibrium price market demand curve described, 51n, 126f for a factor, 313 314 market-development costs, 659 660 market economy see also free-market economies alternative to, 15 20 INDEX case for free markets, 386 389 defined, 12 efficient organization, first-come, first-served, 104 main characteristics, self-organizing economy, market efficiency, 109 116 see also allocative efficiency demand as value, 109 111 and economic surplus, 111 112, 112f output quotas, inefficiency of, 114 115, 114f and price controls, 112 114, 113f and price discrimination, 245 246 supply as cost, 109 111 market failures, 389 adverse selection, 397 398 and allocative efficiency, 289 291 asymmetric information, 396 398 described, 19 20 externalities, 390 392 market power, 389 390 moral hazard, 397 non-rivalrous and nonexcludable goods, 392 396 The Market for Lemons (Akerlof), 399 market inefficiency, 113, 113f market power, 198 allocative efficiency vs economic growth, 390 degree of market power, 200 inevitability of, 389 390 market segments, identification of, 242 and price discrimination, 240 market price and bond yields, 704 705 and economic rent, 326 and present value, 703 704 market segments, price discrimination among, 241 242 market share, 266 267 market structures, 198 competitive market structure See competitive market efficiency and, 285 291 imperfect competition, 254 257 and innovation, 658 659 monopolistic competition, 252, 257 260 monopoly See monopoly oligopoly, 253, 261 273 perfect competition See perfect competition review of, 280t significance of, 199 market value, vs cost, 503 Marshall, Alfred, 4, 51, 64n, 797n Marshall-Lerner condition, 902n Marx, Karl, 16, 17f, 306 mass production, 12 mathematical equation, 38 mathematics See algebra maximization of net advantage, 321 maximizers, 10 maximum of a function, 42 McJobs, 349 medium of exchange, 672 menu costs, 801 mercantilism, 912, 913 metallic money, 673 675 micro demand curve, 572 574 microeconomic foundations, 475 microeconomics, 9, 625n military service, 403 Mill, John Stuart, 605n milling, 674 minimum efficient scale (MES), 180, 216, 231, 232 minimum of a function, 42 minimum wages, 103, 115, 342 344, 343f mixed economy, 16 government in, 19 20 rent seeking, 407 mobility of factors, 314 315 mobility of financial capital, 715 model See economic model Modigliani, Franco, 523 Monetarists, 720 722, 721n, 744 monetary equilibrium, 710 711, 711f monetary policy see also Bank of Canada and business cycles, 493 contractionary monetary policy, 737 credit easing, 735 destabilizing policy, 746 748 disinflation, 751 752 economic recovery, 1983 1987, 750 effectiveness of, 720 and exchange rate, 743 744 expansionary monetary policy, 737 financial crisis and recession, 2007 to present, 755 756 fine tuning, 614 flexible vs fixed exchange rates, 923 924 forward-looking monetary policy, 748f government debt, effect of, 830 831 gross tuning, 614 implementation of, 729 737, 730f inflation targeting, 738 744 inflation targeting, 1991 2000, 752 754 inflation targeting, 2001 2007, 754 755 Keynesians vs Monetarists, 720 722, 721n monetary validation, 771, 772f, 773 774, 775, 780 781 policy instrument, 732, 736 political difficulties, 748 749 pre-emptive monetary policy, 748 quantitative easing, 735 recent Canadian monetary history, 749 756 rising inflation, 1987 1990, 750 751 shocks and policy responses, 769 779 short-run level of GDP, 633 time lags, 744 749 unconventional during 2007 2008 financial crisis, 735 monetary transmission mechanism, 712 714, 715f, 716f, 737f monetary validation, 771, 772f, 773 774, 775, 780 781 money bank notes, 676 and choice, 13 coins, 673 674 creation, by banking system, 688 692 defined, 672 demand for money, 705 710 deposit money, 678 679, 688 690 fiat money, 677 678 fractionally backed paper money, 677 gold standard, 677 I 15 and the Great Depression, 746 747 Gresham s law, 675 676 growth, across many countries, 719f hyperinflation, and value of money, 674 675 long-run neutrality of money, 717 719, 717f as medium of exchange, 672 metallic money, 673 675 nature of money, 672 679 and neutrality, 624 opportunity cost of holding money, 708, 708n origins of money, 673 678 paper money, 676 677 purchasing power of money, 486, 513 real value of money, 487 reasons for holding money, 706 707 short-run non-neutrality of money, 719 722 and specialization, 13 as store of value, 672 673 strength of monetary forces, 717 722, 721f supply See money supply and trade, 13 as unit of account, 673 money demand See demand for money money market deposit accounts, 693 money market mutual funds, 693 money neutrality, 718 money price, 68 money substitutes, 693 694 money supply, 692 aggregate demand, effect on, 714, 714f Bank of Canada, as regulator, 682 683 Bank of Canada, role of, 695 changes in, and desired investment expenditure, 713 choosing a measure, 694 695 currency, amount in circulation, 736 definitions of money supply, 693 endogenous money supply, 734 vs interest rate, 729 731 kinds of deposits, 693 M1, 693 M2, 693 I 16 INDEX money supply (continued) M2+, 693 money substitutes, 693 694 near money, 693 694 targeting the money supply, 729 731 three measures of, 694f monopolist, 225, 226 see also monopoly average revenue, 226, 228f firm and industry, 230 government as, 410 411 marginal revenue, 226 228, 228f negatively sloped demand curve, 226 no supply curve, 229 revenue concepts, 226 228, 228f short-run profit maximization, 228 230, 229f single-price monopolist, 226 235 monopolistic competition, 257 assumptions of, 257 258 development of, 252 differentiated product, 258, 260 and efficiency, 286 empirical relevance, 260 excess-capacity theorem, 259 260 long-run equilibrium of the industry, 259 predictions of the theory, 258 260 profit maximization, 258f review of, 280t short-run decision of the firm, 258 monopolistic practices, 287 monopoly, 225, 226 see also monopolist allocative efficiency, 285 286, 289, 289f bilateral monopoly, 341 342 cartels, 235 238 vs competition, 230 creative destruction, 232 235 deadweight loss, 289, 289f economic regulation, 292 295 and efficiency, 285 286 entry barriers, 231 232, 233 inefficiency of, 230, 230f long-run equilibrium, 231 232 natural monopoly, 231, 292 295 vs perfect competition, 230 and price discrimination, 239 review of, 280t in very long run, 232 235 monopoly of violence, 384 385 monopoly practices, 291 monopsony, 340, 341f and minimum wages, 343 with a union, 341 342 without a union, 340 341 Monster.ca, 811 moral hazard, 397 motives, 27 multinational enterprises (MNEs), 150, 151 multiplier and automatic stabilizers, 612n balanced budget multiplier, 561 described, 537 numerical example, 538 process, and time, 745 simple multiplier, 537f, 538 540, 539f, 558, 561 562, 574f, 575 with taxes and imports, 556 557 when price level varies, 580 582, 581f municipal governments, 548 N NAIRU (non-accelerating inflation rate of unemployment) causes of changes in, 807 810 demographic shifts, 807, 808f described, 765 determinants of, 804 810 frictional or structural causes, 797 frictional-structural distinction, 806 807 frictional unemployment, 804 globalization and structural change, 809 hysteresis, 808 809 and non-accelerating rate of inflation, 775 policy and labour-market flexibility, 809 810 razor s edge, 778 779 structural unemployment, 804 806 and unemployment fluctuations, 802 803 Nash, John, 263 Nash equilibrium, 263 265 national defence, 395 national income see also national income accounting actual national income, 478n constant-dollar national income, 477 current-dollar national income, 477 demand-determined national income, 625 equilibrium national income, 532 535, 533t, 534f equilibrium national income, changes in, 535 541 in long run, 625 marginal propensity to spend, 531 532 maximization of, and protectionism, 870 872 monetary equilibrium, 710 711 national output, 498 499 and national product, 500f nominal national income, 477, 478n potential national income, 478n real national income, 477, 478n recent history, 477 significance of, 479 480 simple model See short-run macroeconomic model (simple model) use of term, 476 value added, 498 499 national income accounting arbitrary decisions in, 507 basics of, 500 507 further issues, 507 514 GDP and living standards, 513 514 GDP on the expenditure side, 501 504 GDP on the income side, 501, 504 506, 506t GDP vs GNP, 507 508 interest, treatment of, 505n nominal GDP, 509 510 omissions from GDP, 510 513 real GDP, 509 510 total national income, 506 National Income and Expenditure Accounts (NIEA), 500 national output, 498 499 National Policy of 1876, 871 national price indices See price index national product, 500f national saving, 645 646, 647 648, 647f, 828 national treatment, 885 natural entry barriers, 231 natural gas prices, 61 natural monopoly, 231, 292 295, 293f natural rate of unemployment, 630 natural resources, 377, 650n near money, 693 694 necessities, 92 93 negative aggregate demand shock, 585, 601f negative aggregate supply shocks, 583 584, 584f, 603f negative externalities, 391, 431 negative income tax (NIT), 465 negative profits, 204, 204t negative shock, 579 negatively related, 39 neoclassical economics, 605n neoclassical growth theory, 649 656 aggregate production function, 649 652 balanced growth with constant technology, 653 constant returns to scale, 652 economic growth, 652 653 human capital accumulation, 652 653 labour-force growth, 652 law of diminishing marginal returns, 650 651 physical capital accumulation, 652 653 technological change, 654 656 net domestic income, 505 net export function, 550 552, 550f, 551f, 557 net exports, 504 Canadian net exports, 1970 2008, 492f changes in, and exogenous changes in price level, 571 and gross domestic product (GDP), 503 504 in open economies, 829 in short-run macroeconomic model, 549 550 net investment, 502 net tax rate, 548 net tax revenue, 819 net taxes, 547 neutrality of money, 717 719, 717f New Classical economists, 797 INDEX New Classical labour market, 798f New Classical theories of unemployment, 797 798, 799, 803t new deposit, 688 689 new growth theories, 657 661 New Keynesian theories of unemployment, 798 802, 803t New Keynesians, 796, 797 new plant and equipment, 502, 529 new products, 185 186, 659 660 new residential housing, 502 new techniques, 185 newly built plants, 217 no fixed factors, 175 182 Nobel laureates, 722 nominal GDP, 509 510, 509t, 510n, 511 nominal interest rate, 371, 372, 488, 489f, 708n, 714n nominal national income, 477, 478n nominal wages, 596n, 772n non-chequable deposits, 693 non-cooperative behaviour, 261 non-cooperative outcome, 262, 263 non-durable goods, 526 non-excludable, 392 396 non-factor payments, 505 506 non-governmental organizations (NGOs), 153 non-linear consumption function, 39 non-linear functions, 40 42 non-market activities, 512 non-neutrality of money, 719 722 non-price competition, 256 non-profit organizations, 150 non-rivalrous goods, 392 396 non-strategic behaviour, 261 non-sunk costs, 214 non-tariff barriers (NTBs), 868, 878 880 non-traded goods, 919 normal goods, 54, 93 normative judgments, 115 normative statements, 25 26, 25t North American Free Trade Agreement (NAFTA), 491, 805, 851, 867, 883 884, 885 886 Northwest Territories, 238 numbers in square brackets, 40n O Office of the Superintendent of Financial Institutions, 291 292 official financing account, 894 Ohlin, Bertil, 852 oil crude oil market, 70 prices, 61, 81, 82n, 83 prices, and Canadian economy, 586 oil shocks, 82n Okun, Arthur, 401 Old Age Security (OAS), 466 467 oligopoly, 261 basic dilemma of, 261 262, 262f collusion, 265 competition for market share, 266 267 competitive behaviour, types of, 266 267 contestable markets, 271 cooperative behaviour, types of, 265 266 cooperative (collusive) outcome, 261 262 cooperative outcome, 263 deregulation and privatization, 297 described, 253 direct control, 296 duopoly, 262 and economic growth, 296 economic regulation, 295 297 and the economy, 272 273 and efficiency, 286 entry barriers, importance of, 267 271 explicit collusion, 265 266 game theory, 262 265 innovation, 267, 272 273 market adjustment, 272 Nash equilibrium, 263 265 non-cooperative outcome, 262, 263 payoff matrix, 262 263, 262f in practice, 265 273 prisoners dilemma, 263, 264 profits under oligopoly, 272 protection from competition, 296 review of, 280t sequential game, 265 strategic behaviour, 263 265 tacit collusion, 266 online prescription drugs, 244 on-the-job training, 336 Ontario, electricity sector in, 297 open economy, 555, 714 716, 829, 844 open-economy monetary transmission mechanism, 714 716, 716f open-market operations, 729, 734 opportunity cost, and budget line, 143 of capital, 155 156 and choice, and comparative advantage, 846, 846t described, economic growth, 642 643, 642f gains from trade, 848f of holding money, 708, 708n interest rate on bond, 367 and production possibilities boundary, of time, 155 of university degree, optimal capital stock, 365 366, 366f optimal currency area, 919 optimism, 526 optimizers, 475 ordinary partnership, 150 organization of firms, 150 Organization of Petroleum Exporting Countries (OPEC), 81, 82n, 83, 235 238, 266, 268 269, 773 other things being equal, 51 output see also production above potential, 595 596 aggregated total output, 477 below potential, 596 cartels, and output restrictions, 236 238 constant returns (to scale), 180 and costs, 575 576 decreasing returns (to scale), 180 demand-determined output, 532, 537n, 561 562 factor demand elasticity, 312 full-employment output, 478 increasing returns (to scale), 179 as key macroeconomic variable, 476 480 lost output, 793 796 I 17 minimum efficient scale (MES), 180, 216 national output, 498 499 output gap See output gap output quotas, inefficiency of, 114 115, 114f potential output, 477 479, 594, 597 598, 633 and price discrimination, 245 246 price discrimination among units of output, 240 241, 241f and prices, 576 profit as function of, 43f profit-maximizing output, 157 varied output, and costs, 85 output gap, 478, 480f described, 477 479 factor prices, 594 597 and inflation targeting, 739 740, 740f in short run, 595f and wages, 765 output-gap inflation, 767 overfishing, 393, 394 overnight interest rate, 732 734, 733f overt collusion, 265 own-price elasticity of demand, 78 P paper money, 676 677 parable of the Seaside Inn, 211 paradox of thrift, 608 610 paradox of value, 133 135, 134f Pareto, Vilfredo, 283 Pareto efficient, 283 partial-equilibrium analysis, 99 100 partnership, 150 paternalism, 402 pattern of trade, 855 862 pay equity, 323 324 payoff matrix, 262 263, 262f payroll taxes, 91 pegged exchange rates, 585 perfect competition, 199 see also competitive market allocative efficiency, 288 289, 288f assumptions of, 199 200 average revenue (AR), 202 demand curve for perfectly competitive firm, 200 202, 201f described, 62, 198 I 18 INDEX perfect competition (continued) and efficiency, 285 entry and exit, 212 215 vs imperfect competition, 256 industry supply curve, 207, 208f marginal revenue (MR), 202 vs monopoly, 230 output level, adjustments in, 206 price equals marginal revenue, 202 price taker, 200 productive efficiency, 285 review of, 280t short-run equilibrium, 208 210, 209f short-run supply curves, 206 207, 207f total revenue (TR), 202 perfect price discrimination, 241 perfectly competitive markets See perfect competition permanent-income theory, 523 permanent tax changes, 613 614 personal income taxes, 448 449 pessimism, 526 Phillips, A.W., 597, 598, 776 Phillips curve, 597, 598 599, 765, 776 777 physical capital, 315, 357, 644, 652 653 planned expenditure See desired aggregate expenditure (AE) point of diminishing average productivity, 160 point of diminishing marginal productivity, 160 policy See government policy political assistance, 385 political difficulties, and monetary policy, 748 749 political marketplace, 19 pollution cap and trade, 424 427, 425f control, and diminishing returns, 162 direct controls, 421 423, 422f economic rationale for regulation, 418 421 emissions taxes, 423 424, 423f as externality, 418 419, 418f marginal change, 40 41 optimal amount of pollution abatement, 419 421, 419f pollution-control policies, 421 424 tradable pollution permits, 424 427, 425f, 426f uncertainty, and choice of policy, 427 429, 428f population and demand, 55 economic and fiscal challenges of population aging, 656 growth, and demand for financial capital, 374 375 growth, and supply of financial capital, 374 variations in, 315 portfolio balance, 711 portfolio diversification, and diminishing returns, 162 portfolio investment, 894 positive aggregate supply shocks, 584, 585 positive analysis, 115 116 positive externalities, 391 positive investment, 367n positive shock, 579 positive statements, 25 26, 25t, 389 positively related, 39 post-Kyoto agreement, 436 437 post-secondary education, 461 462 potential GDP, 479, 480f, 626f potential national income, 478n potential output, 477 479, 478, 594, 597 598, 633 poverty as absolute concept, 463 464 alleviation of, 640 641 estimate of, 463 464 measurement of, 464 negative income tax (NIT), 465 as relative concept, 463 464 poverty line, 463 poverty traps, 464, 465 Powell, James, 678n The Power of Productivity (Lewis), 659 PPP exchange rate, 917, 918f precautionary demand, 706 predatory pricing, 271 predictions, 28 preferences allocation by sellers preferences, 104 intensity of preferences, 409 regional differences in preferences, 459 sellers preferences, 104 prescription drugs, online, 244 present value (PV), 360, 701 and the interest rate, 701 703 and market price, 703 704 one period in the future, 360 361 sequence of future payments, 702 703 several periods in the future, 361 of single future payment, 360 361, 361t, 362t single payment one year hence, 701 702 of stream of future payments, 362 363, 363t summary of findings, 364 price absolute price, 68 average-cost pricing, 293 294 average housing prices, 2009, 36f average price, and price elasticity of demand, 78 79 base-period prices, 509 bond prices, 706 707 break-even price, 215 changes in See price changes consumer price, 87 determination of price, 62 70 disequilibrium price See disequilibrium price entry-attracting price, 212 equilibrium price See equilibrium price excess demand, effect of, 63 excess supply, effect of, 63 exit-inducing price, 213 factor prices See factor prices firms choice of prices, 255 256 government-controlled prices, 100 108 hurdle pricing, 244 245 and inflation, 767 768 input prices, changes in, 577 578 of inputs, and supply, 59 60 international relative prices, 550 552 marginal-cost pricing, 293 and marginal revenue, 202 market prices, 3, 62 67 market prices, and economic rent, 326 money price, 68 of other goods, and demand, 54 55 of other products, and supply, 61 and output, 576 predatory pricing, 271 and quantity demanded, 51 52 and quantity supplied, 58 relative prices, and inflation, 68 70 shut-down price, 205 snob appeal, 130 of substitutes, 81 volatile food and energy prices, 741 743 wage-price spiral, 773 price ceilings described, 102 105 rent controls, 105 108 price changes and consumer behaviour, 125 consumer s reaction to, 144 effect of, 51 factor prices See factor prices income effect, 126 131, 129f, 147f market prices, 64 67 price reductions, and quantity demanded, 77t, 128 substitution effect, 126 131, 129f, 147f price-consumption line, 145f, 146 price controls, 100 108 binding price ceilings, 102 binding price floor, 101 102, 102f black market, 104 105, 104f deadweight loss, 113 described, 100 101 disequilibrium prices, 101 excess demand, 102 104 excess supply, 102 and market efficiency, 112 114, 113f price ceilings, 102 105 price floors, 101 102 rent controls, 105 108 price discrimination, 239 among market segments, 241 242 among units of output, 240 241, 241f conditions for successful price discrimination, 240 consequences of, 245 246 and consumer welfare, 246 and downward-sloping demand curve, 239 and firm profits, 245 forms of, 240 245 hurdle pricing, 244 245 identification of consumers different valuations, 240 INDEX and market efficiency, 245 246 market power, 240 no arbitrage, 240 and output, 245 246 perfect price discrimination, 241 profitable price discrimination, 243f reasons for, 239 240 services, vs goods, 244 price elasticity of demand, 76 83, 78 along a linear demand curve, 80f average price and quantity, use of, 78 79 calculation of, 78t determinants, 81 82 importance of, 76, 76f long-run demand curve, 81 82 measurement of, 77 80 numerical elasticities, interpretation of, 79 80 own-price elasticity of demand, 78 short-run demand curve, 81 82 terminology of, 92 and total expenditure, 82 83 price elasticity of supply, 84 87 computation of, 85 determinants of, 85 87 long-run supply curve, 86 production costs, 85 87 short-run supply curve, 86 substitution, 85 87 price floors, 101 102 price index, 485, 486, 918 price level, 484 485 changes in, and exchange rate, 907 deflation, 769, 770 and demand for money, 709 and desired aggregate expenditure (AE), 570 571, 571f exogenous changes, 570 571 and inflation, 372 as key macroeconomic variable, 484 487 and multiplier, 580 582, 581f recent history, 487f price setter, 255, 562, 576 price stickiness, 801 price taker, 200, 201, 203, 576 primary budget deficit, 820 primary schools, 461 principal, 151, 529 principle of substitution, 177 178, 195 196, 311 Principles of Economics (Marshall), 64n prisoners dilemma, 263, 264 private benefit, 390 private cost, 390 private goods, 392 private saving, 645 private sector, 468 privatization, 297, 401 process innovation, 185 producer surplus, 287, 288f producers agricultural sector, 115 as decision makers, 10 as maximizers, 10, 11 product average product (AP), 159 160 choice of products, 255 differentiated product, 255, 257, 258, 259n, 260, 851 diminishing average product, 167 diminishing marginal product, 160 161, 167 homogeneous product, 199 intermediate products, 154 marginal product (MP), 160 marginal revenue product (MRP), 309 total product (TP), 159, 159f types of products, 393t product definition, 81 product differentiation See differentiated product product innovation, 185 186 production, see also output complements in production, 61 complexity of, 11 12 de-materialization of, 662 fixed production, 849 flow, 154n home production, 512 how much to produce, 205 206 inputs, 154 mass production, 12 methods, changes in, 177 option of producing nothing, 203 205 profit-maximizing output, 157 quotas, inefficiency of, 114 115, 114f in the short run, 158 162 substitutes in production, 61 value added, 499 variable production, 849 what is produced and how, production costs changes in, 406 increasing, 42f and supply elasticity, 85 87 production function, 154 production possibilities boundary, and allocative efficiency, 283 284, 284f concave to the origin, economic growth, effect of, 9f graphical depiction, 8f and productive efficiency, 282, 283f shape of, variable production, 849, 849f productive capacity, growth in, productive efficiency, 281 282, 283f direct controls, 421 perfect competition, 285 productive efficiency for the industry, 281, 281f productivity Canada s productivity challenges, 183, 632 changes in, 578 growth, significance of, 184 as key macroeconomic variable, 483 484 labour productivity, 483 in long run, 628 629 measure of, 627 point of diminishing average productivity, 160 point of diminishing marginal productivity, 160 recent history, 483 484 significance of, 484 productivity growth, 628 profit accounting profits, 155, 156, 450 451 business profits, 505 and choice, 10 and commercial banks, 685 economic profits, 155 156, 450 as function of output, 43f making profit, 154 155 maximization of See profit maximization negative profits, and shutdown decision, 204, 204t oligopoly, 272 positive profits, and new entrants, 213f and price discrimination, 245 pure profit, 155 156 I 19 and resource allocation, 156 157 profit maximization as assumption, 28 for competitive firm, 205 206, 206f and cost minimization, 175 181 equality of MR and MC, 205 206 and factors of production, 309 firms and, 153 loss minimization as, 210 monopolistic competition, 258f monopolists, and short-run profit maximization, 228 230, 229f optimal capital stock, 365 366, 366f price discrimination, 243f principle of substitution, 177 178 profit-maximizing output, 157 quantities of factors, adjustments of, 177 short-run vs long-run, for competitive firm, 216f and social responsibility, 152 153 progressive tax, 447 448 property taxes, 451 452 proportional tax, 447 protection from competition, 296 protectionism, 867, 868 case for protection, 869 875 countervailing duties, 879 880 diversification, 869 dumping, 878 879 economic profits in foreign markets, 871 872 fallacious arguments for protection, 872 875 vs free trade, 868 875 historical perspective, 874 infant industry argument, 870 871 maximization of national income, 870 872 methods of protection, 875 880 non-tariff barriers, 878 880 objectives other than maximizing national income, 869 870 quotas, 876 877 I 20 INDEX protectionism (continued) specific groups, protection of, 869 870 tariffs, 875 876 terms of trade, improvement of, 870 trade-remedy laws, 878 880 voluntary export restriction (VER), 876 877 provincial governments, 548, 822 public choice theory, 408 409 public expenditure See government expenditure public goods, 19 20, 395 396, 396f public policy See government policy public provision, 400 402, 405 public saving, 645 public sector, 468 purchasing power of money, 486, 513 purchasing power parity (PPP), 916 919 pure profit, 155 156 Q quality, and command economies, 19 quantitative easing, 735 quantity average quantity, and price elasticity of demand, 78 79 market quantities, quantity demanded, 49 change in quantity demanded, 56 described, 49 51 as flow of purchases, 49 and inferior goods, 93 and price, 51 52 and price reductions, 77t, 128 and total expenditure, 84f quantity supplied, 57 change in quantity supplied, 61 described, 57 58 and price, 58 Quebec ice storm, 66 quotas, 876 877 R Rasminsky, Louis, 680, 681n ration, 104 rational expectations, 766 rational ignorance, 409 re-engineering, 180 real GDP, 509 510, 509t, 511, 708 real income, 127, 513 real interest rate, 371, 372, 376f, 488, 489f, 528 529, 708n real national income, 477, 478n real value of money, 487 real wages, changes in, 316 recession, 297 298, 479, 624, 753n, 755 756, 874 recessionary gap, 478, 594, 597, 607, 607f recovery, 479, 783 red tape, 406, 407 redemption date, 151 redistribution programs, 405 refundable tax credit, 465 regional differences in preferences, 459 regional trade agreements, 883 886 Registered Pension Plans (RPPs), 467 Registered Retirement Savings Plans (RRSPs), 374, 467 regressive tax, 447 regulation compliance costs, 406 407 described, 405 and development, 407 economic regulation, 291 297 environmental protection See environmental protection minimum wages, 103, 115, 342 344 natural monopoly, 292 294 oligopolies, 295 297 pay equity, 323 324 rejection, vs confirmation, 30 31 relative price, 68 70 rent controls, 105 108, 106f rent seeking, 407 reputation effects, 271 reserve currency, 900 reserve ratio, 687 reserves excess reserves, 687 688, 691 fractional-reserve system, 687 requirements for, 686 688 reserve ratio, 687 target reserve ratio, 688 target reserves, 687 688 residential construction, 529 resource allocation, leaky bucket analogy, 401 and profits, 156 157 resource efficiency, 662 resources common-property resource, 392 393 described, exhaustion of, 661 663 as factors of production, idle resources, interest rates, and extraction of natural resources, 377 limited resources, effect of, 5f retained earnings, 151, 358, 505 retirement benefits, 466 467 retirement income-support programs, 466 467 revenue average revenue (AR), 202 marginal revenue (MR), 202 monopolists, 226 228, 228f for price-taking firm, 203 total revenue (TR), 202 reverse causality, 32 Ricardo, David, 306, 325, 605n, 797n, 842, 868 riskiness of a bond, 705 rivalrous, 392 Robson, William, 752n Rosenberg, Nathan, 657 Royal Bank, 683, 835 royalties, 326 rules of origin, 883 S sacrifice ratio, 784, 784f salaries, 504 sales, changes in, 529 530 sales taxes, 449 451, 452f saving, 520 and current income, 369 desired saving vs desired investment, 534 and expected future income, 369 in globalized financial markets, 375, 649 and growth in Japan, 624 625 income and substitution effects, 130 and the interest rate, 370 and investment, in long-run, 645 649, 646f national saving, 645 646, 647 648, 647f, 828 policies to increase desired saving, 374 private saving, 645 public saving, 645 scatter diagram of household income and saving, 37f supply of saving, 368 370, 370f taxes and, 130 saving function average propensity to save (APS), 525 described, 524 525 graph, 522f marginal propensity to save (MPS), 525 saving investment approach, 555 savings deposits, 693 scarcity and choice, in economics, limited resources, effect of, 5f and production possibilities boundary, resource allocation, resources, scatter diagram, 36 37, 37f schedule, 38 Schelling, Thomas, 387, 387n Schembri, L., 917n schools, funding for, 461 Schumpeter, Joseph, 233 235, 267, 273, 290, 657 scientific approach, 29 Seaside Inn, parable of, 211 seasonal fluctuations in unemployment, 482 secondary schools, 461 securitization, 683 self-fulfilling prophecies, 540 541 self-interest, self-organizing economy, seller price, 87 sellers preferences, 104 sequential game, 265 Service Canada, 812 services, excludable, 392 flow of, 360 geographic scope of, 459 government purchases of services, 458 rivalrous, 392 service-sector employment, 349 352, 350t use of, shocks aggregate demand shock, 574, 580 582, 580f, 600 602, 600f, 601f aggregate supply shocks, 577 578, 582 584, 584f, 602 604, 603f contractionary aggregate demand shocks, 601 602 demand shocks, 770 771, 772f INDEX expansionary aggregate demand shocks, 600 hurricanes, 66 67 ice storms, 66 and innovation, 659 negative aggregate demand shock, 585, 601f negative aggregate supply shocks, 583 584, 584f, 603f negative shock, 579 oil shocks, 82n and policy responses, 769 779 positive aggregate supply shocks, 584, 585 positive shock, 579 supply shocks, 771 774, 772f, 773f weather shocks, 67 short run, 157 average-marginal relationship, 161 162 average product (AP), 159 160 capacity, 167 cost curves, 164 167 costs, 163 169 decisions, and competitive market, 203 210 diminishing marginal product, 160 161 factor utilization, 629 630 macroeconomic model See short-run macroeconomic model (expanded); shortrun macroeconomic model (simple model) macroeconomics vs microeconomics, 625n marginal product (MP), 159f, 160 monopolistic competition, 258 monopoly, 228 230 output gaps, 595f price and output, in natural monopoly, 292 294 production, 158 162 profit maximization, and monopolists, 228 230, 229f total product (TP), 159, 159f short-run average total cost (SRATC) curve, 180 181, 181f, 182 short-run cost curves average cost curves, 165 described, 164 167 factor prices, changes in, 168 169 fixed factor, changes in amount of, 169 and idle capital equipment, 168 and long-run cost curves, 180 181, 181f marginal cost curve, 165 shifts in, 168 169 short-run average total cost (SRATC) curve, 180 181, 181f, 182 U-shaped cost curve, 165 167 short-run costs average fixed cost (AFC), 163 164 average total cost (ATC), 163 average variable cost (AVC), 164 defining, 163 164 fixed capital, 164t and long-run costs, 180 181, 181f marginal cost (MC), 164 short-run cost curves, 164 167 total costs (TC), 163 total fixed cost (TFC), 163 total variable cost (TVC), 163 variable labour, 164t short-run demand curve, 82 short-run equilibrium, 83f, 86f, 208 210, 209f short-run macroeconomic model (expanded) see also short-run macroeconomic model (simple model) aggregate demand (AD) curve, 572 575 aggregate demand and supply shocks, 599 605 aggregate supply (AS) curve, 575 578 defining characteristics, 592 demand side of the economy, 570 575 equilibrium GDP, 571 572 exogenous changes in price level, 570 571 factor prices, adjustment of, 592 inflation, 764 769 macroeconomic equilibrium, 578 586 short-run vs long-run macroeconomics See short-run vs long-run macroeconomics supply side of the economy, 575 578 short-run macroeconomic model (simple model) see also short-run macroeconomic model (expanded) algebraic exposition, 567 568 budget balance, 548 closed economy, 520 demand-determined output, 561 562 desired aggregate expenditure, 519 532 desired consumption and national income, 552 553 desired consumption expenditure, 520 527 desired investment expenditure, 527 530 equilibrium condition, 533 equilibrium national income, 532 535, 552 555 equilibrium national income, changes in, 535 541, 556 561 fiscal policy, 557 561 foreign trade, introduction of, 549 552 general propositions, 536 government, introduction of, 547 549 government purchases, 547 multiplier with taxes and imports, 556 557 net export function, shifts in, 550 552, 550f, 551f net exports, 549 550, 557 net tax revenues, 547 548 provincial and municipal governments, 548 short-run non-neutrality of money, 719 722 short-run supply curve industry supply curve, 207, 208f and perfectly competitive firm, 206 207, 207f price elasticity of supply, 86 rent controls, 106, 106f short-run vs long-run macroeconomics capital supply, in long run, 628 factor supply, in long run, 628 factor utilization, in short run, 629 630 GDP accounting, 626 632 I 21 inflation and interest rates in Canada, 623 624 labour supply, in long run, 628 policy implications, 632 634 productivity, in long run, 628 629 saving and growth in Japan, 624 625 short-term capital movements, 908 shut-down decision, 204, 204t shut-down price, 205 simple model See short-run macroeconomic model (simple model) simple multiplier, 537f, 538 540, 539f, 558, 561 562, 574f, 575 single-price monopolist, 226 235 single proprietorship, 150 size distribution of income, 306 slope of aggregate demand (AD) curve, 716 of aggregate supply (AS) curve, 575 577, 576 577, 577f of budget line, 142 143 of consumption function, 524 of a curved line, 42 of demand curve, 77 of demand curve, and income and substitution effects, 128 129, 129f of a straight line, 40 slump, 479 Slutsky effect, 127n small open economy, 901n Smith, Adam, 3, 11, 16, 306, 322, 385, 385n, 386, 605n, 797n, 842, 844, 868 Smoot-Hawley Tariff Act, 874 snob appeal, 130 social benefit, 390, 418 social class, 306 social cost, 390 social costs of economic growth, 643 social goals economic growth, 403 income distribution, 400 paternalism, 402 protection of individuals from others, 402 public provision, preferences for, 400 402 social responsibility, 402 403 social programs, 460 467 I 22 INDEX social responsibility and broader social goals, 402 403 military service, 403 and profit maximization, 152 153 softwood lumber dispute, 878 sole proprietorship, 150 Solow, Robert, 655 Solow residual, 655 Southeast Asia, financial crisis in, 585, 753, 920 921 Soviet Union, 17, 18 19 S&P/TSX, 35, 35f specialization comparative advantage, 847 gains from, 847t of labour, 11 13 and money, 13 and trade, 12 specialization of labour, 11 13 speculative demand, 707 sport fishing, and diminishing returns, 162 spreading overhead, 164 stabilization policy, 557 561, 559f, 606 616 see also fiscal policy stagflation, 603, 780, 781 783 standard deviation, 162 standard of living and freer trade, 14 and gross domestic product (GDP), 513 514 rising average material living standards, 639 640 state-owned enterprise, 150 statistical analysis, 31 statistical discrepancy, 506 Statistics Canada, 32, 453, 461, 463, 482, 500, 793, 855 Stern, Nicolas, 430n sticky wages See wage stickiness Stigler, George, 296 stock market, 370, 701 stocks accumulated capital stock, 375 of capital, 360 vs flow, 49, 50, 366 367 greenhouse gas emissions, 430 issue of, 358 in labour market, 794 795 optimal capital stock, 365 366, 366f value at a point in time, 50 store of value, 672 673 strategic behaviour, 261 competitive behaviour, 266 267 cooperative behaviour, 265 266 cooperative outcome, 263 non-cooperative outcome, 263 oligopoly, 261, 263 265 strategic trade policy, 871 structural change, 809 structural changes, 908 909 structural deficit, 824 structural unemployment, 481 482, 804 806, 811 812 subsidies farm subsidies, 882 and gross domestic product (GDP), 505 and supply, 61 subsistence economies, 11 substitutes availability of, 81 in consumption, 54 55 and cross elasticities, 94 diminishing marginal rate of substitution, 140 141 marginal rate of technical substitution, 192 money substitutes, 693 694 price of, 81 principle of substitution, 177 178, 311 in production, 61 and supply elasticity, 85 87 substitutes in consumption, 54 55 substitution approach, 435 436 substitution between factors, 311 312 substitution effect, 127 indifference theory, 146 147 interest rate, 370n of price change, 147f and price changes, 126 131 Slutsky effect, 127n and taxation, 130 131 sunk costs, 213 215 suppliers, number of, 61 supply, 59 of capital, 628 change in quantity supplied, 61 change in supply, 61 as cost, 109 111 excess supply, 63, 102, 629 factor supply, 314 319 of financial capital, 358, 373 374 of foreign exchange, 899 901 inelastic supply, 89 and long-run equilibrium, 83f of money See money supply of national saving, 647 648, 647f and number of suppliers, 61 price elasticity of supply See price elasticity of supply and prices of inputs, 59 60 prices of other products, 61 quantity supplied, 57 58 of saving, 368 370, 370f shifts in, and demand curves, 76f and short-run equilibrium, 83f supply curve See supply curve supply schedule, 58 taxes or subsidies, 61 and technology, 60 supply chains, global, 860 861 supply curve, 58 foreign exchange, 900 901 graph, 64n industry supply curve, 207, 208f long-run supply curve See long-run supply curve and monopolists, 229 movements along vs shifts of whole curve, 61 62 price, and additional cost, 110f, 111 shifts in, 59 61, 65 66, 65f short-run supply curve See short-run supply curve supply elasticity, 84 87 supply inflation, 771 supply schedule, 58 supply shock aggregate supply shocks, 577 578, 582 584, 584f, 602 604, 603f hurricanes, 66 67 monetary validation, 773 774 negative aggregate supply shocks, 583 584, 584f, 603f no monetary validation, 772, 773f policy responses to, 771 774, 772f, 773f positive aggregate supply shocks, 584, 585 supply side of the economy, 575 578 surplus budget surplus, 548, 820, 834 consumer surplus, 131 135, 133f, 287, 288f current account surpluses, 910 915 economic surplus See economic surplus producer surplus, 287, 288f total surplus, and allocative efficiency, 287 289 sustainable growth, 665 sustained inflation, 739, 778, 782f T tacit collusion, 265, 266 tangency solution, 259 target reserve ratio, 688 tariffs, 868 deadweight loss of, 875f described, 875 and public choice theory, 409 vs quotas, 877 878 tastes, and demand, 55 tax-assisted saving plans, 467 tax bracket, 448 Tax-Free Saving Accounts (TFSAs), 374, 467 tax incidence, 87 90 taxation ability-to-pay principle, 452 453 adjustment of tax systems, 405 average tax rate, 448 benefit principle, 453 in Canada, 447 452 Canadian tax system, 448 452, 453 454 corporate income taxes, 449, 450 451 deadweight loss, 454 differences in tax bases, 458 459 direct burden, 454 456, 455f, 456f disincentive effects of income taxes, 456 457 and efficiency, 454 456 and equity, 452 454 evaluation of tax system, 452 457 excess burden, 454 456, 455f, 456f excise tax, 87 90, 88f, 449 451 Goods and Services Tax (GST), 447, 449 451, 452f income and substitution effects, 130 131 income taxes, 447, 448 449, 456 457 indirect taxes, 499n, 505 INDEX integrated tax system, 449 Laffer curve, 457, 457f lump-sum tax, 447 marginal propensity to tax, 548 marginal tax rate, 448 multiplier with taxes and imports, 556 557 negative income tax (NIT), 465 net tax rate, 548 net tax revenue, 819 net taxes, 547 payroll taxes, 91 personal income taxes, 448 449 progressive taxes, 447 448 property taxes, 451 452 proportional tax, 447 reductions in taxes, 616 refundable tax credit, 465 regressive tax, 447 sales taxes, 449 451, 452f and supply, 61 tax incidence, 87 90 tax rates, changes in, 560, 560f tax revenues of Canadian governments, 2008, 447t taxes as user charges, 453 temporary vs permanent tax changes, 613 614 two burdens of taxation, 454 456 technical efficiency, 175 technological changes, 183 and capital market, 676 in competitive market, 217 219 creative destruction, 232 235 and demand for financial capital, 375 economic growth, 644 embodied technical change, 654 endogenous technological change, 657 659 improved inputs, 185 knowledge transfer, 658 measurement of, 655 656 and neoclassical growth theory, 654 656 new products, 185 186 new techniques, 185 and optimal capital stock, 366 and tradable pollution permits, 426 and the very long run, 182 188 workers and, 656 technology, and supply, 60 temporary factor-price differentials, 321, 322f, 336 temporary tax changes, 613 614 term, 151 term deposit, 693 terms of trade, 859 862, 859f, 862f, 870 testing theories, 29 32 theories, 27 28 see also economic theories The Theory of Monopolistic Competition (Chamberlin), 257 The Theory of the Leisure Class (Veblen), 130 theory of the second best, 284n Thiessen, Gordon, 623, 680, 752, 753, 831, 831n Thinking Strategically (Dixit and Nalebuff), 264 third-party effects, 390 time, opportunity cost of, 155 time horizons for decision making, 157 158 time-series data, 35 36, 35f tools of government intervention, 404 405 total cost curves, 166f total costs (TC), 163 total expenditure at any point on demand curve, 83 and elasticity, 82 83 and quantity demanded, 84f total fixed cost (TFC), 163 total product (TP), 159, 159f total revenue (TR), 202 total surplus, and allocative efficiency, 287 289 total utility, 121, 122f total variable cost (TVC), 163 Towers, Graham, 680 tradable pollution permits, 424 427, 425, 425f, 426f trade see also international trade barter, 12 and money, 13 and specialization, 12 trade account, 893 trade balance, 491 trade creation, 884 trade diversion, 884 trade policy, 867, 868 current trade policy, 880 892 free trade vs protectionism, 868 875 non-tariff barriers, 878 880 protectionist policies, 875 880 quotas, 876 877 regional trade agreements, 883 886 strategic trade policy, 871 tariffs, 875 876 trade-remedy laws, 878 880 voluntary export restriction (VER), 876 877 trade-remedy laws, 878 880 trade-weighted exchange rate, 490 traditional economy, 15 transaction costs, 922 923 transactions demand, 706 transfer earnings, 324 transfer payments, 458, 459t, 503, 547, 560 561 transnational corporations (TNCs), 13 treasury bills, 701 two-part tariff, 293 U U-shaped cost curves, 165 167 unanticipated inflation, 487, 738, 763 uncertainty, and international trade, 922 923 uncontrolled experiments, 31 underground economy, 512 unemployment, 481 assisting adjustment, 812 Canada U.S unemployment gap, 793 changes in, 792 consequences of, 793 796 convergence of theories, 802 803 cyclical unemployment, 481 482, 796, 810 fluctuations, 796 803 frictional unemployment, 481 482, 795, 804, 810 811 as key macroeconomic variable, 480 483 and lost output, 793 796 and minimum wages, 103, 344 New Classical theories, 797 798, 799, 803t New Keynesian theories, 798 802, 803t personal costs of, 796 recent history, 482, 482f reducing unemployment, 810 813 resistance to change, 811 seasonal fluctuations, 482 significance of, 483 I 23 structural unemployment, 481 482, 804 806, 811 812 voluntary vs involuntary unemployment, 805 and wage stickiness, 800f unemployment rate, 481 Canada, 1976 2009, 791f Canada, 1978 to 2009, 35 36, 36f by demographic groups, 808f NAIRU See NAIRU (nonaccelerating inflation rate of unemployment) natural rate of unemployment, 630 union See labour union union wage premium, 346, 348f unit cost, 575 unit of account, 673 United Kingdom, 297 United Nations, 661 United States Canada U.S unemployment gap, 793 Canadian U.S dollar exchange rate, 490, 491f Clean Air Act (U.S.), 427 deregulation, 297 financial crisis, 297 298, 359, 412, 684 housing collapse, 359, 684 short-term interest rates, 1975 2009, 749f SO2 emissions, 427 softwood lumber dispute, 878 Universal Child Care Benefit, 466 university degree, opportunity cost of, Uruguay Round, 880 881 used cars, and market for lemons, 399 user charges, 453 utility, 121 choice and, 10 and the consumer s decision, 123 125 graphs, 122, 122f incremental utility, 121n marginal utility See marginal utility maximization, 121, 123 125, 143 144 measurement of, 125 schedules, 122 total utility, 121, 122f utility-maximizing choice, 143 144, 143f I 24 INDEX V value costs vs market value, 503 demand as value, 109 111 paradox of value, 133 135, 134f value added, 498 499 variable, 27 endogenous variable, 27, 64 exogenous variable, 27, 64 linearly related, 40 negatively related, 39 positively related, 39 variable costs, 848 851 variable factors, 157 variable labour, 164t variable production, 849 Veblen, Thorstein, 130 verbal statement, 38 vertical equity, 452 453 very long run, 158 automated teller machines (ATMs), 187 creative destruction, 232 235 firms choices, 186 188 innovation, and natural monopoly, 294 295 monopoly, 232 235 technological changes, 182 188 Viner, Jacob, 182, 884 violence, monopoly of, 384 385 volatility of exchange rate, 909 910 of food and energy prices, 741 743 of investment, 1981 2008, 528f voluntary export restriction (VER), 876 877 voluntary market transaction, 101 voluntary unemployment, 805 voting, 11 W wage contracts, 801 wage differentials in competitive markets, 334 339 discrimination, 336 339, 337f equilibrium wage differentials, 323 324, 334, 336 formal education, 335 human capital, 335 336 and inherited skills, 334 335 interindustry wage differentials, 344 legislated minimum wages, 342 344, 343f monopsony, 340 342 non-competitive markets, 339 342 on-the-job training, 336 temporary differentials, 321, 336 union in a competitive labour market, 339 340, 340f and working conditions, 334 wage-price spiral, 773 wage stickiness, 596 597, 602, 602n, 800f wages differentials in See wage differentials efficiency wages, 801 vs employment, 345 346 and expected inflation, 765 766 flexible wages, 601 and gross domestic product (GDP), 504 in New Classical labour market, 798f nominal wages, 596n, 772n and output gap, 765 real wages, 765 reason for changes in, 764 767 union wage premium, 346, 348f wage-price spiral, 773 wage stickiness, 596 597, 602, 602n Watts, George, 681n wealth changes in, in long run, 710n household wealth, change in, 525 The Wealth of Nations (Smith), 3f, 842 weather shocks, 67 weighted average, 35 welfare, 464 465 wheat market, 83 women discrimination, and wage differentials, 336 339, 337f and labour force participation, 315 work effort income and substitution effects, 130 taxes and, 130 working conditions, 334 Working Income Tax Benefit (WITB), 465 Workopolis.ca, 811 World Bank, 14 world trade See international trade World Trade Organization (WTO), 14, 843, 867, 872, 880 883 ... reduced its Canada 598.9 758.1 26 .6 +6 emissions, but this reduction again reflects France 567.1 5 62. 6 +0.8 the economic collapse that occurred in Germany 22 6.3 015.3 +17 .2 +21 the former East Germany... (million tonnes CO2e) Percentage annual emissions, with Canada s increase Country 1990 20 04 Change emissions) being especially large France had a very Australia 423 .1 529 .2 25.1 slight decline... after the two Italy 519.6 5 82. 5 12. 1 +6.5 Germanys were unified in the early 1990s Japan 27 2.1 355 .2 6.5 +6 The overall pattern from Table 17-1 is Poland 564.4 388.1 +31 .2 +6 therefore one of a few