(BQ) Part 2 book Economics - A contemporary introduction has contents: Introduction to macroeconomics, productivity and growth, measuring the economy and the circular flow, aggregate expenditure components, aggregate expenditure and aggregate demand, international macroeconomics,...and other contents.
402 C H A P T E R C H A P T E R © Gary Conner/Index Stock Imagery 19 International Trade T his morning you pulled on your Levi’s jeans from Mexico, pulled over your Benetton sweater from Italy, and laced up your Timberland boots from Thai- land After a breakfast that included bananas from Honduras and coffee from Brazil, you climbed into your Volvo from Sweden fueled by Venezuelan oil and headed for a lecture by a visiting professor from Hungary If the United States is such a rich and productive country, why we import so many goods and services? Why don’t we produce everything ourselves? And why some groups try to restrict foreign trade? Answers to these and other questions are addressed in this chapter The world is a giant shopping mall, and Americans are big spenders Americans buy Japanese cars, French wine, Chinese kitchen gadgets, European vacations, and thousands of other goods and services from around the globe But foreigners buy Use Homework Xpress! for economic application, graphing, videos, and more American products too—grain, personal computers, aircraft, movies, trips to New Chapter 19 International Trade York City, and thousands of other goods and services In this chapter, we examine the gains from international trade and the effects of trade restrictions on the allocation of resources The analysis is based on the familiar tools of demand and supply Topics discussed include: • Gains from trade • Import quotas • Absolute and comparative • Welfare loss from trade advantage revisited • Tariffs restrictions • Arguments for trade restrictions The Gains from Trade A family from Virginia that sits down for a meal of Kansas prime rib, Idaho potatoes, and California string beans, with Georgia peach cobbler for dessert, is benefiting from interstate trade.You already understand why the residents of one state trade with those of another Back in Chapter 2, you learned about the gains arising from specialization and exchange You may recall how you and your roommate could maximize output when you each specialized.The law of comparative advantage says that the individual with the lowest opportunity cost of producing a particular good should specialize in producing that good Just as individuals benefit from specialization and exchange, so states and, indeed, nations.To reap the gains that arise from specialization, countries engage in international trade With trade, each country specializes in the goods that it produces at the lowest opportunity cost A Profile of Exports and Imports Just as some states are more involved in interstate trade than others, some nations are more involved in international trade than others For example, exports account for about onequarter of the gross domestic product (GDP) in Canada and the United Kingdom; about one-third of GDP in Germany, Sweden, and Switzerland; and about half of GDP in the Netherlands Despite the perception that Japan has a huge export sector, exports make up only about one-seventh of its GDP U.S Exports In the United States, exports of goods and services amounted to about 10 percent of GDP in 2003 Although small relative to GDP, exports play a growing role in the U.S economy.The left panel of Exhibit shows the composition of U.S merchandise exports by major category Capital goods account for 41 percent of all exports Capital goods include high-tech products, such as computers and jet aircraft Next most important are industrial supplies and materials, at 24 percent of the total.Together, capital goods and industrial supplies and materials make up 65 percent, or nearly two-thirds, of U.S exports.Thus, most U.S exports help foreign manufacturers make stuff Consumer goods (except food, which is included in another category) account for only 13 percent of exports.This category includes entertainment products, such as movies and recorded music U.S Imports U.S imports of goods and services were 14 percent relative to GDP in 2003.The right panel of Exhibit shows the composition of U.S merchandise imports.Whereas consumer goods accounted for only 13 percent of U.S exports, they are the largest category of imports at 27 percent of the total Imported consumer goods include electronics from Taiwan, shoes from Brazil, and kitchen gadgets from China.The next most important category of imports, at 403 404 Part International Microeconomics E X H I B I T Composition of U.S Merchandise Exports and Imports in 2003 Other 3% Foods, feeds, and beverages 8% Consumer goods 13% Automotive vehicles 11% Industrial supplies and materials 24% Capital goods 41% Exports Other 4% Consumer goods 27% Foods, feeds, and beverages 4% Industrial supplies and materials 25% Automotive vehicles 17% Capital goods 23% Imports Source: Based on government figures reported by Christopher Bach, “U.S International Transactions, 2003,” Survey of Current Business (April 2004), Table D, p 63 25 percent, is industrial supplies and materials, such as crude oil from Venezuela and the Middle East and raw metals, including lead, zinc, and copper, from around the world Ranked third is capital goods, at 23 percent, such as printing presses from Germany Note that automotive vehicles are only 11 percent of exports but 17 percent of imports Raw Materials Let’s focus just on raw materials Exhibit shows, for 12 key commodities, U.S production as a percentage of U.S consumption If production falls short of consumption, the United States imports the difference For example, because America grows coffee only in Hawaii, U.S production is only percent of U.S consumption, so nearly all coffee is imported.The exhibit also shows that U.S production falls short of consumption for oil and metals such as lead, zinc, copper, and aluminum If production exceeds consumption, the United States exports the difference For example, U.S.-grown wheat amounts to 184 percent of U.S wheat consumption, so nearly half of U.S.-grown wheat is exported U.S production also exceeds consumption for other crops, including cotton, oil seeds (soybeans, sunflower seeds, canola), and coarse grains (corn, barley, oats) In short, when it comes to basic commodities, the United States is a net importer of oil and metals and a net exporter of crops Trading Partners To give you some feel for America’s trading partners in 2003, here are the top 10 destinations for U.S goods in order of importance: Canada, Mexico, Japan, Great Britain, Germany, 405 Chapter 19 International Trade E X H I B I T Coffee Lead Oil U.S Production as a Percentage of U.S Consumption for Various Commodities Zinc Aluminum Copper If U.S production is less than U.S consumption, then production is less than 100 percent of consumption, and imports make up the difference If U.S production exceeds U.S consumption, then the amount by which production exceeds 100 percent of consumption is exported Sugar Coal Coarse grains Cotton Oil seeds Wheat 20 40 60 80 100 120 140 160 180 200 Percent Source: Based on annual figures from The Economist World in Figures: 2001 Edition (London: Profile Books, 2001) China, South Korea, France, the Netherlands, and Taiwan The top 10 sources of U.S imports consist of Canada, China, Mexico, Japan, Germany, Great Britain, South Korea, Taiwan, France, and Italy China makes the biggest jump in the ranks, going from sixth as a destination for U.S exports to second as a source of U.S imports Production Possibilities Without Trade The rationale behind most international trade is obvious.The United States grows little coffee because our climate is not suited to coffee More revealing, however, are the gains from trade where the comparative advantage is not so obvious Suppose that just two goods— food and clothing—are produced and consumed and that there are only two countries in the world—the United States, with a labor force of 100 million workers, and the mythical country of Izodia, with 200 million workers The conclusions derived from this simple model have general relevance for international trade Exhibit presents production possibilities tables for each country, based on the size of the labor force and the productivity of workers in each country.The exhibit assumes that each country has a given technology and labor is fully and efficiently employed If no trade occurs between countries, Exhibit presents each country’s consumption possibilities table as well.The production numbers imply that each worker in the United States can produce either units of food or units of clothing per day If all 100 million U.S workers are in the food industry, they produce 600 million units per day, as shown in column U1 in panel (a) If all U.S workers make clothing, they turn out 300 million units per day, as shown in column U6 The columns in between show some workers making food and some making clothing Because a U.S worker can produce either units of food or units of clothing, the opportunity cost of more unit of food is 1⁄2 unit of clothing 406 Part International Microeconomics E X H I B I T (a) United States Production Possibilities with 100 Million Workers (millions of units per day) Production Possibilities Schedules for the United States and Izodia Food Clothing U1 U2 U3 U4 U5 U6 600 480 360 240 120 0 60 120 180 240 300 (b) Izodia Production Possibilities with 200 Million Workers (millions of units per day) Food Clothing AUTARKY A situation of national selfsufficiency; there is no economic interaction with foreigners I1 I2 I3 I4 I5 I6 200 160 120 80 40 0 80 160 240 320 400 Suppose Izodian workers are less educated, work with less capital, and farm less-fertile soil than U.S workers (think of China), so each can produce only unit of food or units of clothing per day If all 200 million Izodian workers specialize in food, they can produce 200 million units of food per day, as shown in column I1 in panel (b) of Exhibit If they all make clothing, total output is 400 million units of clothing per day, as shown in column I6 Some intermediate production possibilities are also listed in the exhibit Because an Izodian worker can produce either unit of food or units of clothing, the opportunity cost of more unit of food is units of clothing We can convert the data in Exhibit to a production possibilities frontier for each country, as shown in Exhibit In each diagram, the amount of food produced is measured on the vertical axis and the amount of clothing on the horizontal axis U.S combinations are shown in the left panel by U1, U2, and so on; Izodian combinations are shown in the right panel by I1, I2, and so on Because we assume that resources are perfectly adaptable to the production of each commodity, each production possibilities curve is a straight line reflecting a constant opportunity cost Exhibit illustrates the possible combinations of food and clothing that residents of each country can produce and consume if all resources are fully and efficiently employed and there is no trade between the two countries Autarky is the situation of national self-sufficiency, in which there is no economic interaction with foreign producers or consumers Suppose that U.S producers maximize profit and U.S consumers maximize utility with the combination of 240 million units of food and 180 million units of clothing—combination U4.This will be called the autarky equilibrium Suppose also that Izodians are in autarky equilibrium, identified as combination I3, of 120 million units of food and 160 million units of clothing Consumption Possibilities Based on Comparative Advantage In our example, each U.S worker can produce more clothing and more food per day than can each Izodian worker, so Americans have an absolute advantage in the production of both goods Recall from Chapter that having an absolute advantage means being able to produce something using fewer re- 407 Chapter 19 International Trade (a) United States Food 500 400 300 200 100 U1 Production Possibilities Frontiers for the United States and Izodia Without Trade (millions of units per day) 500 U2 U3 U4 400 300 200 U5 100 U6 E X H I B I T 600 Food 600 (b) Izodia 100 200 300 400 Clothing I1 I2 I3 I4 I5 I6 100 200 300 400 Clothing sources than other producers require Should the U.S economy remain in autarky—that is, self-sufficient in both food and clothing productions—or could there be gains from trade? As long as the opportunity cost of production differs between the two countries, there are gains from specialization and trade.The opportunity cost of producing more unit of food is 1⁄2 unit of clothing in the United States compared with units of clothing in Izodia According to the law of comparative advantage, each country should specialize in producing the good with the lower opportunity cost Because the opportunity cost of producing food is lower in the United States than in Izodia, both countries will gain if the United States specializes in food and exports some to Izodia, and Izodia specializes in clothing and exports some to the United States Before countries can trade, they must somehow agree on how much of one good exchanges for another—that is, they must establish the terms of trade As long as Americans can get more than 1⁄2 unit of clothing for each unit of food, and as long as Izodians can get more than 1⁄2 unit of food for each unit of clothing, both countries will be better off by specialization and exchange rather than autarky Suppose that market forces shape the terms of trade so that unit of clothing exchanges for unit of food.Americans thus trade unit of food to Izodians for unit of clothing.To produce unit of clothing themselves,Americans would have to sacrifice units of food Likewise, Izodians trade unit of clothing to Americans for unit of food, which is only half what Izodians would sacrifice to produce unit of food themselves Exhibit shows that with unit of food trading for unit of clothing, Americans and Izodians can consume anywhere along their blue consumption possibilities frontiers The consumption possibilities frontier shows a nation’s possible combinations of goods available as a result of production and foreign trade (Note that the U.S consumption possibilities curve does not extend to the right of 400 million units of clothing, because that’s the most Izodians can produce.) The amount each country actually consumes will depend on the relative preferences for food and clothing Suppose Americans select combination U in panel (a) and Izodians select point I in panel (b) Without trade, the United States produces and consumes 240 million units of food and 180 million units of clothing.With trade, the United States specializes in food by producing Panel (a) shows the U.S production possibilities curve; its slope indicates that the opportunity cost of an additional unit of food is 1⁄2 unit of clothing Panel (b) shows production possibilities in Izodia; an additional unit of food costs units of clothing Food is produced at a lower opportunity cost in the United States TERMS OF TRADE How much of one good exchanges for a unit of another good 408 Part International Microeconomics E X H I B I T (b) Izodia (a) United States 600 If Izodia and the United States can trade at the rate of unit of clothing for unit of food, both can benefit Consumption possibilities at these terms of trade are shown by the blue lines The United States was previously producing and consuming U4 By trading with Izodia, it can produce only food and still consume combination U, which has more food and more clothing than U4 Likewise, Izodia can attain preferred combination I by trading its clothing for U.S food Both countries are better off as a result of international trade 600 500 U 400 300 200 U4 100 Food 500 Food Production (and Consumption) Possibility Frontiers with Trade (millions of units per day) 400 300 I 200 100 100 200 300 400 Clothing I3 100 200 300 400 Clothing 600 million units; Americans eat 400 million units and exchange the rest for 200 million units of Izodian clothing.This consumption combination is reflected by point U.Through exchange,Americans increase their consumption of both food and clothing Without trade, Izodians produce and consume 120 million units of food and 160 million units of clothing.With trade, Izodians specialize to produce 400 million units of clothing; they wear 200 million units and exchange the rest for 200 million units of U.S food.This consumption combination is shown by point I.Through trade, Izodians, like Americans, are able to increase their consumption of both goods How is this possible? Because Americans are more efficient in the production of food and Izodians more efficient in the production of clothing, total output increases when each specializes.Without specialization, total world production was 360 million units of food and 340 million units of clothing.With specialization, food increases to 600 million units and clothing to 400 million units.Thus, both countries increase consumption with trade Although the United States has an absolute advantage in both goods, differences in the opportunity cost of production between the two nations ensure that specialization and exchange result in mutual gains Remember that comparative advantage, not absolute advantage, creates gains from specialization and trade.The only constraint on trade is that, for each good, total world production must equal total world consumption We simplified trade relations in our example to highlight the gains from specialization and exchange.We assumed that each country would completely specialize in producing a particular good, that resources were equally adaptable to the production of either good, that the costs of transporting goods from one country to another were inconsequential, and that there were no problems in arriving at the terms of trade.The world is not that simple For example, we don’t expect a country to produce just one good Regardless, the law of comparative advantage still leads to gains from trade Reasons for International Specialization Countries trade with one another—or, more precisely, people and firms in one country trade with those in another—because each side expects to gain from exchange How we know what each country should produce and what each should trade? Chapter 19 International Trade 409 Differences in Resource Endowments Trade is often prompted by differences in resource endowment that results in differences in the opportunity cost of production across countries Some countries are blessed with an abundance of fertile land and favorable growing seasons.The United States, for example, has been called the “breadbasket of the world” because of its rich farmland ideal for growing corn Coffee grows best in the climate and elevation of Colombia, Brazil, and Jamaica Honduras has the ideal climate for growing bananas.Thus, the United States exports corn and imports coffee and bananas Differences in the seasons across countries also serve as a basis for trade For example, during the winter, Americans import fruit from Chile, and Canadians travel to Florida for sun and fun During the summer, Americans export fruit to Chile, and Americans travel to Canada for camping and hiking Mineral resources are often concentrated in particular countries: oil in Saudi Arabia, bauxite in Jamaica, diamonds in South Africa.The United States has abundant coal supplies, but not enough oil to satisfy domestic demand.Thus, the United States exports coal and imports oil More generally, countries export products they can produce more cheaply in return for those that are unavailable domestically or are more costly to produce than to buy from other countries Remember, trade is based on comparative advantage, which is the ability to produce something at a lower opportunity cost than other producers face Economies of Scale If production is subject to economies of scale—that is, if long-run average cost falls as a firm expands its scale of operation—countries can gain from trade if each nation specializes Such specialization allows firms in each nation to produce more, which reduces average costs.The primary reason for establishing the single integrated market of the European Union was to offer producers there a large, open market of over 450 million consumers so that producers could achieve economies of scale, and thereby produce at a lower opportunity cost than faced by foreign producers Firms and countries producing at the lowest opportunity costs are most competitive in international markets Differences in Tastes Even if all countries had identical resource endowments and combined those resources with equal efficiency, each country would still gain from trade as long as tastes differed among countries Consumption patterns differ across countries and some of this likely results from differences in tastes For example, the Czechs and Irish drink three times as much beer per capita as the Swiss and Swedes.The French drink three times as much wine as Australians.The Danes eat twice as much pork as Americans Americans eat twice as much chicken as Hungarians Soft drinks are four times more popular in the United States than in Europe.The English like tea; Americans, coffee Algeria has an ideal climate for growing grapes, but its large Muslim population abstains from alcohol; thus,Algeria exports wine Trade Restrictions and Welfare Loss Despite the benefits of international trade, nearly all countries at one time or another erect trade barriers.Trade restrictions usually benefit some domestic producers but harm some other domestic producers and all domestic consumers In this section, we will consider the effects of restrictions and the reasons they are imposed N e t Bookmark What goods and services does the United States trade? With whom? Who are the United States’ largest trading partners? Answers to these and many other trade-related questions can be found by cruising through the U.S Census Bureau’s Trade Data Web site at http://www.census.gov/ foreign-trade/www/statistics html 410 Part International Microeconomics Tariffs A tariff, a term first introduced in Chapter 3, is a tax on imports (Tariffs can apply to exports, too, but we will focus on import tariffs.) A tariff can be either specific, such as a tariff of $5 per barrel of oil, or ad valorem, such as 10 percent on the import price of jeans Consider the effects of a specific tariff on a particular good In Exhibit 6, D is the U.S demand for sugar and S is the supply of sugar from U.S growers (there were about 10,000 U.S sugarcane growers in 2004) Suppose that the world price of sugar is $0.10 per pound, as it was recently.The world price is determined by the world supply and demand for a product It is the price at which any supplier can sell output on the world market and at which any demander can purchase output on the world market With free trade, U.S consumers can buy any amount desired at the world price of $0.10 per pound, so the quantity demanded is 70 million pounds per month, of which U.S producers supply 20 million pounds and 50 million pounds are imported Because U.S buyers can purchase sugar at the world price, U.S producers can’t charge more than that Now WORLD PRICE The price at which a good is traded on the world market; determined by the world supply and world demand for the good Effect of a Tariff At a world price of $0.10 per pound, U.S consumers demand 70 million pounds of sugar per month, and U.S producers supply 20 million pounds per month; the difference is imported After the imposition of a $0.05 per pound tariff, the U.S price rises to $0.15 per pound U.S producers increase production to 30 million pounds, and U.S consumers cut back to 60 million pounds Imports fall to 30 million pounds At the higher U.S price, consumers are worse off; their loss of consumer surplus is the sum of areas a, b, c, and d Area a represents an increase in producer surplus; this area is transferred from consumers to producers Area b reflects the higher marginal cost of domestically producing sugar that could have been produced more cheaply abroad; thus b is a net U.S welfare loss Area c shows government revenue from the tariff Area d reflects the loss of consumer surplus resulting from the drop in consumption The net welfare loss to the U.S economy consists of areas b and d S Price per pound E X H I B I T $0.15 a c b 0.10 d f D 20 30 60 70 Sugar (millions of pounds per month) Chapter 19 International Trade suppose that a specific tariff of $0.05 is imposed on each pound of imported sugar, raising its price from $0.10 to $0.15 per pound U.S producers can therefore raise their own price to $0.15 per pound as well without losing customers to imports At the higher price, the quantity supplied by U.S producers increases to 30 million pounds, but the quantity demanded by U.S consumers declines to 60 million pounds Because quantity demanded has declined and quantity supplied by U.S producers has increased, U.S imports fall from 50 million to 30 million pounds Because the price is higher after the tariff, consumers are worse off.Their loss in consumer surplus is identified in Exhibit by the combination of the blue- and pink-shaded areas Because both the U.S price and the quantity supplied by U.S producers have increased, U.S producers’ total revenue increases by the areas a plus b plus f But only area a represents an increase in producer surplus.The increased revenue represented by the areas f plus b merely offsets the higher marginal cost of expanding U.S sugar production from 20 million to 30 million pounds per month.Area b represents part of the net welfare loss to the domestic economy because those 10 million pounds could have been imported for $0.10 per pound rather than produced domestically at a higher marginal cost Government revenue from the tariff is identified by area c, which equals the tariff of $0.05 per pound multiplied by the 30 million pounds that are imported, or $1.5 million per month.Tariff revenue represents a loss to consumers, but because the tariff goes to the government, it can be used to lower taxes or to increase public services, so it’s not a loss to society Area d shows a loss in consumer surplus because less sugar is consumed at the higher price.This loss is not redistributed to anyone else, so area d reflects part of the net welfare loss of the tariff.Therefore, areas b and d show the domestic economy’s net welfare loss of the tariff; the two triangles measure a loss in consumer surplus that is not offset by a gain to anyone in the domestic economy In summary: Of the total loss in U.S consumer surplus (areas a, b, c, and d ) resulting from the tariff, area a is redistributed to U.S producers, area c becomes government revenue, and areas b and d are net losses in domestic social welfare because of the tariff Import Quotas An import quota is a legal limit on the amount of a particular commodity that can be imported Quotas usually target imports from certain countries For example, a quota may limit automobiles from Japan or shoes from Brazil.To have an impact on the domestic market, a quota must be less than would be imported under free trade Consider a quota on the U.S market for sugar In panel (a) of Exhibit 7, D is the U.S demand curve and S is the supply curve of U.S sugar producers Suppose again that the world price of sugar is $0.10 per pound.With free trade, that price would prevail in the U.S market as well, and a total of 70 million pounds would be demanded U.S producers would supply 20 million pounds and importers, 50 million pounds.With a quota of 50 million pounds or more per month, the U.S price would remain the same as the world price of $0.10 per pound, and quantity would be 70 million pounds per month In short, a quota of at least 50 million pounds would not raise the U.S price above the world price A more stringent quota, however, would reduce imports, which, as we’ll see, would raise the U.S price Suppose U.S trade officials impose an import quota of 30 million pounds per month.As long as the U.S price is at or above the world price of $0.10 per pound, foreign producers supply 30 million pounds So at prices at or above $0.10 per pound, the total supply of sugar to the U.S market is found by adding 30 million pounds of imported sugar to the amount supplied by U.S producers U.S and foreign producers would never sell for less than $0.10 per 411 752 Index diamonds-water paradox, 121–122 diminishing nature of, 117 free medical care example, 127–128 and law of demand, 122, 124 and marginal valuation, 124 work, 261–262 marginal valuation, and consumer surpluses, 124 mark (German currency), 718 market behavior consumer information searches, 306–307 impacts of asymmetric information, 308 market competition defined, over time, 329, 331 market demand See also demand curves and consumer expectations, 69 and consumer income, 68 and consumer tastes, 70 defined, 68 and prices of related good, 68–69 for private goods, 340–341 for public goods, 341 and population changes, 70 versus individual demand, 68 market equilibrium experiments studying, 187–188 and short-run economic profit, 176 techniques for reaching, 177–178 market exchange advantages of, 301 and minimum efficient scale, 302 market interest rates, 286 determinants, 288 administration costs, 290 loan duration, 289 risk, 289 tax treatments, 290 discounted value of loan payments, 291 present value of annuities, 292–294 present value of loan payments, 290–292 prime rate, 289 market power, 218, 318 market price in perfectly competitive markets, 169 and short-run losses and profits, 171–172, 176 versus opportunity cost, 52 market purchases multiple suppliers, 304 quality control, 302–303 versus internal production, 301 market supply defined, 72 in long-run equilibrium, 179 and number of producers, 73 and prices of alternative goods, 72 and prices of relevant resources, 72 and producer expectations, 73 and technological change, 72 market system, markets See also demand; supply adjustment process, long-run, 182–183 agricultural, and income and price elasticity, 105–106 capital, 284 defined, 4, 74 demand and supply, 64 curves for, 182 effects of demand changes, 179–182 equilibrium, 75–79 National Basketball Association example, 80 shortages, 74 surpluses, 74 disequilibrium, 81 price ceilings, 81–82 price floors, 81 toy business, 83 effects on transaction costs, 74 firms corporations, 50–51 partnerships, 50 sole proprietorships, 50 foreign exchange markets, 60 government role, 54 dealing with externalities, 55 enforcing contracts, 54 equalizing income distribution, 55 fostering a healthy economy, 55 preventing failures, 54 promoting competition, 54 providing public goods, 54–55 regulating natural monopolies, 54 households, 47 incentives of, 41 and industries, 166 international trade, 59 balance of payments, 59 currency and exchange rates, 60 merchandise trade balance, 59 trade restrictions, 60 labor markets, supply curves, 48–49, 260 loanable funds market, 288–294 monopolies, 193 monopolistic competition, 217 nonprofit institutions, 52 oligopoly, 224 perfectly competitive markets, 166 benefits to consumers and producers, 185–187 demand, 167 examples of, 166 price determinants, 166 political markets, 55–56 product markets, resource markets, role in modified command systems, 41 securities exchanges, 295–296 supply curves, 71 underpricing of public output, 56 versus command systems, 41 market wage, 262–263 market work, 260 net utility, 261 supply curves, 262–263 utility maximization, 261–262 maturity date (bonds), 295 maximizing profits, 50, 143 calculations for, 168–160 golden rule for, 170 isoquants and isocost lines, 163 long-run, 178–179 adjusting to decreased demand, 181–182 adjusting to increased demand, 179–181 monopolies graphing marginal curves, 202 graphing total curves, 203 long-run perspective, 204 marginal approach, 201 and output, 201 total approach, 201 monopolistic competition long-run profit, 220–221 marginal analysis, 219 short-run profit, 220 oligopolistic markets cartels, 228–229 price leadership, 229 and price discrimination, 209–212 resource costs and marginal revenue product, 250–251 short-run, 171, 176 versus maximizing utility, 241 and wages, 266 maximizing utility, 47 consumer equilibrium formula, 120–121 consuming goods and services, 260 and costs, 119 equilibrium, 120 and indifference curves, 136–137 and price changes, 137 work and leisure, 260–263 MC (marginal cost), 147 calculating, 147 impact on total cost curve, 147 importance of, 147 monopolies and profit maximization, 201 McCain-Feingold measure, 349 McDonald’s Big Mac price index, 714–715 economies and diseconomies of scale, 154–155 franchise characteristics, 312–313 McDowell County,WV, unemployment in, 495–496 means-tested programs, 388 cash transfer programs Supplemental Security Income (SSI), 388 Temporary Assistance for Needy Families (TANF), 388 in-kind transfer programs food stamps, 389 Medicaid, 388–389 varieties of, 389 measurement units, 22–23 for utility, 117–118 median income, 384 and ability and education, 385 two-earner households versus no-earner households, 384 median voter model, 342–343 median wage, 382–383 mediators, mediation, 271 Medicaid, 388–389 medical care, free, marginal value, 127–128 Medicare, 387–388 funding for, 57 impact on federal budgets, 687 origins of, 693 reforming, 694 spending on, 56, 685 medium of exchange, 427, 599 See also currency; money and demand for money, 643 men, labor force participation rate, 492 mercantilism, 428, 468 merchandise trade balance, 59, 705–706 merchandise traded, 470 Mercosur free trade area, 416 mergers banks, 613 conglomerates, 328 horizontal, 325, 327–328 hostile takeovers, 328 legislation affecting, 325 753 Index non-horizontal, 327 public policy and, 326–327 vertical, 325, 328 waves of, 327–329 Merrill Lynch, outsourcing by, 304 metals as money, quality control issues, 600 precious, and mercantilism, 428 U.S imports of, 404 Mexico Mexico City air pollution in, 369 national economy, 426 North American Free Trade Agreement (NAFTA), 416 microchip technology, impact on production, 53 microeconomics defined, relationship between income and consumption, 513 microprinting, 622 Microsoft, antitrust case against, 331 Middle East, U.S imports from, 404 milk, price floors for, 81 minimizing loss monopolies, and average variable cost, 204 short-run marginal analysis, 172, 174 monopolistic competition, 219 producing at a loss, 171–172 shutting down production, 174–175 minimum efficient scale, 154, 302 minimum wage impact on resource demand, 253–254 laws governing, 387 mining industry, unemployment rates, 495–496 Minnesota, welfare reform, 397 Mitchell,Wesley C., 428 mixed economic systems, 41 mobile technologies and virtual offices, 53 mobility of resources, pricing impacts, 244 models, economic circular-flow model, defined, PPF (production possibilities frontier), 34–35 and capital stock, 37 importance of, 37–38 and opportunity costs, 35–36 and resources, 36–37 and technological innovation, 37 role in analysis, modified capitalism, 40 modified command systems, 41 monetary policy, 55 anticipating, 670–671 defined, 55 effectiveness of and credibility of policy makers, 671 and expectations, 669 time-inconsistency policy, 670 and federal funds rate, 635 federal funds rate targets, 648–650 open-market operations, 608 and Phillips curves, 675–676 and price stability, 672–673 responsibility of Federal Reserve for, 608 short-run versus long-run focus, 655–657 supply regulation, 608 and velocity of money supply, 654 versus monetary theory, 642 money, 597, 599 See also banks; currency; income aggregates, 621 cash transfer payments, 49 in circular-flow model, coins, 600–601 commodity money, 599 currency and exchange rates, 60 demand for, 642 and interest rates, 643–644 reasons, 642–643 desirable features, 600 evolution of, 598–599 exporting, restrictions on, 708 fiat money, 602–603 financial intermediaries for, 605 banks, 610–613, 616 commercial banks, 605 depository institutions, 605 Federal Deposit Insurance Corporation (FDIC), 609 Federal Reserve System, 606–608, 610 national banks, 606 state banks, 605 thrift institutions, thrifts, 605 foreign exchange, 709 Bretton Woods agreement, 717–718 exchange rates, 710–716 gold standard, 716–717 managed float system, 718–719 markets for, 710 sources, 709 the euro, 710 functions as medium of exchange, 32, 599, 650 role in national economies, 427 as store of value, 599, 603 as unit of account, 599 holding, opportunity costs, 643 hyperinflation of, 603–605 income and revenue, 5, 66 international trade in, 708 liquidity of, 643 loanable funds market, 288 in opportunity cost calculations, 30 quantity theory of, 651 velocity determinants, 652 velocity stability, 652 real value and consumption, 518–519 representative money, 602 as stock variable, 599 token money, 601 bank notes, 602 representative money, 602 value of, and export expenditures, 527, 532 velocity of, 650–651 money market mutual funds, 610 money multiplier, 631–632 money policy impact on aggregate demand long-run effects, 650 short-run effects, 645–646 impact on aggregate supply long-run effects, 650–651 short-run effects, 646–648 money supply See also income and counterfeit money, 622–623 and credit cards, 624 checkable deposits, 621 components, 603 contraction of, 632–633 and economy, 642 excessive, and hyperinflation, 604–605 Federal Reserve control tools, 634–636 focus of monetary policy on, 655–657 government regulation of, 55 increases in, impact on inflation, 654 money aggregates M1, 621, 624 M2, 623 M3, 623 money creation, role of excess reserves, 628–631 money multiplier, 631–632 predicting quantity theory of money, 651–652 and stability of money velocity, 652 versus demand, and equilibrium interest rates, 644–645 monopolies allocative inefficiency, 207 attraction of competitors, 197 behavior of, 318 consumer surplus, 206–207 deadweight loss, 207–208 defined, 54, 193–194 disadvantages of, 318 economic profits and, 317 entry barriers, 194 control of essential resources, 195–197 economies of scale, 195 legal restrictions, 194 government regulation of, 54, 318 innovation by, 209 lack of competition in, 318 local, 197 losses, short-run, and shutdown decisions, 204 marginal revenue, 198 monopolistic advantage, 318 natural, 54, 195, 318, 320 perfectly discriminating monopolists, 211–212 as price makers, 201 price and output, 206 319–321 price discrimination, 209 profit maximization, 319 and limiting output, 201 graphing marginal curves, 202 graphing total curves, 203 long-run, 204 marginal approach, 201 total approach, 201 profit versus price, 204 public utilities, 319 regulating, 320 revenue schedules, 199 subsidizing, 320–321 U.S Post Office example, 208–209 versus perfectly competitive firms, 197–198, 201, 204 monopolistic competition, 217–221 versus oligopoly, 224 versus perfectly competitive markets, 222–223 monopolists, perfectly discriminating, 211 monthly earnings, moral hazards, 310 bank loans, 611 mortgage loans and bank failures, 610 movement along a demand curve, 70 movement along a supply curve, 74 754 Index Movielink, 222 movies, movie theaters economies and diseconomies of scale, 153 winner-take-all labor markets, 268–269 MPC (marginal propensity to consume), 515–516 and spending multiplier calculations, 541 MPS (marginal propensity to save), 515, 517 and spending multiplier calculations, 541 MR (marginal revenue) and economic profit farm example, 169 short-run profits, 171 monopolies calculating, 199 and profit maximization, 201 MRS (marginal rate of substitution) calculating, 134 and consumer equilibrium, 136–137 defined, 134 law of diminishing marginal rate of substitution, 134 MRTS (marginal rate of technical substitution), 161–163 multilateral trade agreements common markets, 416 General Agreement on Tariffs and Trade (GATT), 414 multipliers, multiplier effects autonomous spending, 554 balanced budget, 594 government purchase multiplier, 578 money multipliers, 631 limits on expansion, 632 simple, 631 net tax multiplier, 594 planned spending changes airline industry example, 542 decreased spending, 541–543 effects on aggregate demand, 545–547 increased spending, 539–541 spending increases, 541 price level changes, 543 price decreases, 545 price increases, 543–544 simple tax multiplier, 580 spending factors that reduce, 595 and fiscal policy, 583 and net exports, 552 mutual funds, money market, 610 N NAFTA (North American Free Trade Agreement), 416 Nasdaq, 178 National Banking Act of 1863, 605 national banks, 606, 626 National Basketball Association (NBA) case study, 80 National Bureau of Economic Research (NBER), 428 national debt debt held by public, 696 foreign-owned, 699 gross debt, 696 impact on future generations, 698–700 impacts of paying off, 700–701 interest payments, 697–698 net debt, 697 relative to GDP, 696 and supply-side fiscal policies, 588 versus federal deficits, 695–696 national defense as argument for trade restrictions, 417 outlays on, 685 national economies aggregate demand, 432–434 aggregate output, 432 aggregate supply, 434 balance-of-payments accounts, 707–708 body analogy, 427, 468 capital accounts, 708 circular flow, 427 currency, 427 economic cycles, 429–430 fluctuations coincident economic indicators, 432 depression, 428 expansion, 429 inflation, 428 lagging economic indicators, 432 leading economic indicators, 432 recession, 428, 432 full employment, defined, 497–498 inflation anticipated versus unanticipated inflation, 503 Brazil hyperinflation example, 500 historical trends, 502–503 impacts of, 507–508 local and regional variability, 504 measuring, 500 and relative price changes, 504 sources, 501 unpopularity of, 507 variable, transaction costs, 503 international trade balance of payments, 705–707 current account balances, 708 unilateral transfers, 707–708 investment demand curves, 522–524 measuring, gross domestic product (GDP), 426 national income, 486–488 net exports, 526–527, 532 performance measurements, 468 circular flow approach, 468 expenditure-based GDP, 469–470, 473 GDP (gross domestic product), 468 income-based GDP, 470–471, 473 national income accounting system, 468–471, 473–475 net domestic product, 476 precious metal stocks, 468 U.S government statistics, 475–476 unemployment costs of, 490 international comparisons, 498–499 measuring, 490–493 sources, 496–497 unemployment benefits, 498 United States, history, 435–441 variability in size of, 426 national economy defined, 426 importance of, 426 national income See also GDP (gross domestic product accounting system for, 468–471, 473–475 calculating, 486–488 National InterBank, 633 natural abilities, and specialization of labor, 33 natural market forces for closing gaps, 662–664 impact on economies, 662, 673 and rational expectations, 674–675 rationale for, 674 natural monopolies defined, 54, 195 government regulation of, 318–321 profit maximization by, 319 subsidizing, 320–321 natural rate hypotheses, 679 natural rate of output, 558 natural rate of unemployment, 558 challenges of identifying, 664–665 and discretionary fiscal policies, 586 hysteresis, 571–572 and short-run aggregate supply curve, 560 natural resources defined, exhaustible resources, households as source of, in circular-flow model, productivity of, 448 renewable resources, rent for, NBA (National Basketball Association) case study, 80 NBC, costs of broadcasting Olympics, 308 NBER (National Bureau of Economic Research), 428 necessities, 104 needs and scarcity of resources, versus demand and wants, 65 negative (inverse) variable relations, 22 negative externalities, 55, 357 Coase theorem, 365–366 electricity market and, 360 impact on GDP, 476 pollution, 360–361, 363 prices and, 358 rainforest destruction, 364–365 net debt, 697 net domestic product, 476, 486–487 net export function, 526–527, 532 and disposable income, 532 nonincome determinants, 527 net exports, 470, 707 and aggregate expenditures, 536 in circular-flow model, 473 and income on, 551–552 spending multiplier effects, 552 variable, 595 net imports, and real GDP demanded, 555 net interest in national income calculations, 487 net investment, 476 net taxes (NT) and aggregate demand-side equilibrium calculations, 594 and aggregate expenditures, 535 in circular flow model, 474 defined, 526 and disposable income, 526 and government transfer payments, 526 multiplier effect, calculating, 594 and real GDP demanded, 578–580 755 Index net unilateral transfers, 707–708 net wealth, 517–518 net worth, 626–627 Netherlands, gross domestic product (GDP), 403 new industry entries approaches to discouraging, 207 and oligopolistic markets, 229 New York Stock Exchange, 178, 295 New Zealand, inflation, 673 Nigeria economic challenges, 462 1990 presidential election, 589 Nixon, Richard, administration, 438 nominal GDP (gross domestic product) and changes in money supply, 651 deflating, 477 in GDP price index, 480 nominal interest rate, 506 nominal wages, 557 and inflation, 507 versus real wages, 557 wage flexibility, 565, 567–568 noncash transfers, 385 nondurable goods, 49, 469 nonexclusive goods, 54, 340 non-horizontal mergers, 327 nonmarket work, 260 gathering consumer information, 306 net utility, 261 supply curves job experience, 265 nonwage income sources, 264 working conditions, 264–265 utility maximization, 261–262 non-monetary labor components job experience, 265 and minimum wage requirements, 254 and permanent resource price differences, 244 work tastes, 265 working conditions, 265 nonperforming loans, 616 non-profit institutions, 52 nonrenewable resources See exhaustible resources; resources nonrival goods, 54, 339–340 nonunion sector, and union wages on, 272 Nordhaus,William, 589 normal goods, 68, 104 normal profit, 142 in perfectly competitive markets, 179 normative economic statements, 10 North American Free-Trade Agreement (NAFTA), 369, 416 North Korea command economy, 41 per-capita production, 41 notes, Federal Reserve, 621 counterfeiting of, 622–623 profits from, 636 NT (net taxes), 473–474 number of producers, impact on supply curve, 73 O occupation, impact on unemployment rate, 493 offices, virtual, 53 officials, government, spending decisions, 56 oil as exhaustible resource, U.S imports of, 404 oligopolistic markets, oligopolies, 224 analysis of using game theory, 230–233 and barriers to entry, 224–226 cartels, 227–229 collusion, 227 defined, 224 differentiated, 224 price leadership, 229 price wars, 227, 232 product differentiation, 224 undifferentiated, 224 versus monopolistic competition, 224 versus perfectly competitive markets, 234 Olympics, broadcasting costs, 308 one-parent households See single-parent households one-shot games (game theory), 233 online banking, 633–634 OPEC (Organization of Petroleum Exporting Countries), 227, 438 allocation schemes, 228–229 open-access goods, 339–340, 358 open-market activities, 608 controlling money supply using, 634–635 purchases and sales, 635 operating budgets, 688 operating expenditures, 687 opportunity costs of attending college, 262 calculating attending college example, 28–29 effect of circumstances, 30 information constraints, 30 subjectivity of, 29–30 time constraints, 30 defined, 28, 141 differences in, and advantages of international trade, 406–408 explicit costs, 141 of holding money, 643 impact on PPF (production possibilities frontier), 35–36 implicit costs, 141 of increased production, 283 and international trade, 59, 405, 409 law of comparative advantage, 31–32 of money, 600 payment exceeding, 348 and PPF (production possibilities frontier), 35–37 and profit calculations, 142 of resources, 244–245 time costs, 128 versus economic rent, 245 versus market price, 52 optimal search, defined, 306 Oregon, welfare reform, 398–399 Organization of Petroleum Exporting Countries (OPEC), 227–229, 438 organizations, tax-exempt, 52 organized labor, labor unions, 270 collective bargaining, 271 mediation and arbitration, 271 strikes, 271 wages and employment, 270–271 origin (graphs), 20 other-things-constant assumption, outlays, government, 525, 685 See also national debt in circular-flow model, 473 government purchase function, 526 ratio to GDP, 56 transfer payments, 526 output aggregate, 432 and decreased resources, 570–571 and increased resources, 568–570 and labor supply, 557 and price levels, 432 allocation decisions, 39 average costs, 148 below potential, long-run impacts, 563–565 as component of productivity, 448 demand for, impact on resources, 252–253 exceeding potential inflationary pressure, 562–563 long-run impacts, 561–563 excess, costs of, 559 and labor supplies natural rate of employment, 558 potential output, 558 wage agreements, 558 long-run aggregate supply (LRAS) curve, 565, 567–568 long-run costs average cost curves, 151–152 diseconomies of scale, 153, 155 economies of scale, 152–154 long-run market adjustments constant-cost industries, 182 handling decreases in demand, 181–182 handling increases in demand, 179–181 increasing-cost industries, 183 loss-minimizing marginal analysis for, 172, 174 producing at a loss, 171–172 shutting down production, 174–175 and marginal cost, 147 minimum efficient scale, 154 modeling production, 34 monopolies demand curves, 197 and profit maximization, 201–204 relationship to price, 206 oligopolistic markets, cartels, 228–229 per worker production function, 449 perfectly competitive markets allocative efficiency, 185 productive efficiency, 185 relationship to price, 205–206 potential, 558 and short-run aggregate supply (SRAS) curve, 560 and contractionary fiscal policy, 582 and expansionary fiscal policy, 580–581 and price level changes, 558–560 production decisions PPF (production possibilities frontier), 35 production decisions, 39 production function, 160 profit-maximizing calculating, 168–169 and market equilibrium price and quantity, 176 short-run profit, 171 756 Index public, pricing of, 56 rate of, and resource use, 143–144 recessions, and labor productivity, 456 restrictions on, 318 and short-run supply curves, 175 and specialization on, 32 technologically efficient production, 160 expansion paths, 163–164 isocost lines, 162–163 isoquants, 160–161 and total cost, 147 total product, 143 U.S economy, 428 versus spending plans, 537 output gaps and wage flexibility, 565, 567–568 output per capita, 456–457 output, potential, challenges of identifying, 664–665 outsourcing, 304 problems associated with, 305 and unionization, 278 owners of corporations, 50 owner’s equity, 294 property rights, 39–40 resources, P packaging, differentiating products using, 217 PACS (political action committees) 348 palm dates, as money, 599 panda supply, China’s control over, 196 Panic of 1907, 606 paper money, 601–603 partners, trading, 404 partnerships, 50 passive policy approaches closing contractionary gaps, 662–664 closing expansionary gaps, 664 dependence on rules, 673 effectiveness of, 674–675 impact on economies, 662 rationale for, 674 underlying assumptions, 667–668 patents, 194, 287 enforcement problems, 287 entry restrictions associated with, 194 paths, expansion, 163–164 payments transfer, personal income from, 48–49 use of money for, 603 payoff matrix (game theory), 230 cola war game, 232–233 duopoly price-setting game, 231–232 payroll taxes, 57–58 payscales, and demand and supply, 80 pegged exchange rates, 716 pension payments, including in personal income, 486 per capita output, and standard of living, 456 per se illegal, 326 per-worker production function, 449–450 perfect competition, 166 and long-run profits, 179 perfectly competitive firms, 168 perfectly competitive markets, 166 benefits to consumers and producers, 185–187 capital, 284–285 consumer surplus, 206 demand, 167 efficiency, 185 examples of, 166 marginal revenue and market price, 169 price determinants, 166 price and output, 205–206 price takers, 201 products, 217 versus monopolies, 197–198, 201, 204 versus monopolistic competition, 222–223 versus oligopolistic markets, 234 perfect discrimination, 211 perfectly elastic demand curve, 94 perfectly elastic supply curve, 101–102 perfectly inelastic demand curve, 94–95 perfectly inelastic supply curve, 102 performance (national economies), measuring circular flow approach, 468 expenditure-based GDP, 469–470, 473 GDP (gross domestic product), 468 income-based GDP, 470–471, 473 national income accounting system, 468–471, 473–475 net domestic product, 476 precious metal stocks, 468 U.S government statistics, 475–476 permanent income, 587 personal consumption expenditures, 469 personal income, 486–487 sources of, 48–49 personal preferences, and specialization of labor, 33 Phillips curves, 675–676 evidence supporting, 679–680 long-run, 677, 679 natural rate hypothesis, 679 short-run, 677 Phillips,A.W., 675 physical capital, 2, 449, 469 physical differentiation (products), 217 pirating, 287 planned aggregate expenditure below GDP, 538 decreases in, impacts on economy, 541–543 in excess of real GDP, 538 increases in, i539–541 and price level changes, 543–544 and real GDP demanded, 537 planned investment and aggregate expenditures, 536 decreases in impact on economy, 541–543 and price level changes, 543–544 nonincome determinants, 523––524 versus actual investment, 536 planned spending changes in, 541–547 and net exports, 551–552 and prices, 543–544 planning curves, 151 planning horizon, 150 plant level economies and diseconomies of scale, 154 policies, public efforts to influence, 208 fiscal policy,55 discretionary fiscal policy, 585–589 and Keynes on, 584 income taxes, 584–585 unemployment insurance, 585 welfare transfer payments, 585 laissez-faire, 583 monetary, 55 open-market operations, 608 responsibility of Federal Reserve for, 608 policy, industrial, 462 political action committees (PACs), 348 political business cycle, 589 political markets (U.S.) complexity of jurisdictions, 56 enforcement of decisions, 56 pricing of public output, 56 and vote maximization, 56 politics, politicians campaign finance reform, 349–350 and discretionary fiscal policy, 589 and federal budgeting process, 687 and persistence of federal deficits, 690 special interests and, 343–344 pollution air, 368–369, 371 external costs of, 360–363 hazardous wastes, 371–372 impacts on GDP, 476 as negative externality, 55 optimal level of, 360–361, 363 pollution rights, 366–368 solid waste, 372–373 water, 371 poor families antipoverty programs, 387 single-parent households, 381 sources of poverty age, 389–390 gender, 390–392 racial discrimination, 392–394 population changes impact on demand curves, 70 and job creation, 440 populist legislation, 345 pork-barrel spending, 344 portability of money, 600 positive (direct) variable relations, 22 positive economic statements, 10 positive externalities, 55, 358, 373, 375–376 positive rate of time preference, 284 positive statements, 10 posted-offer pricing, 188 potential GDP and fiscal policy contractionary policies, 582 expansionary policies, 580–581 long-run aggregate supply and decreased resources, 570–571 and increased resources, 568–570 and lower than expected output, 563–565 wage flexibility, 565, 567–568 potential output, 558, 560 challenges of identifying, 664–665 costs of exceeding, 559 757 Index failure to meet, costs, 560 and short-run aggregate supply, 560 poverty, poverty rate and age, 389–390 changes over time, 385–386 and gender, 390–392 measuring, 385–386 and racial and ethnic discrimination, 392–394 and unemployment rate, 387 U.S official poverty level, 385 World Bank international poverty line, 386 PPF (production possibilities frontier) defined, 35 and economic growth, 446–447 and capital investments, 448 importance of, as model, 37–38 and technology, 447–448 PPP (purchasing power parity) theory, 714–715 precious metals accumulation of, 428 stocks of, 468 predatory dumping, 418 predatory pricing, 326 predetermined rules, and passive approaches to public policy, 673 prediction, as goal of theory, 12 preferences, consumer, 116 present value, 291 of annuities, 292–294 of loan payments, 290–292 president, U.S presidential elections, influence of fiscal policies, 589 role in budget process, 686 price ceilings, 81–82 changes impact on demand curve, 70 income effect, 66, 115, 137–139 and consumption, and utility, 119 and demand, 65, 67 discrimination defined, 325 and profit maximization, 209–212 of goods, and demand for resources, 242 marginal cost and, 319–321 at market equilibrium, 176–178 monopolies and maximizing profit, 204 relationship to average and marginal revenue, 198 relationship to average revenue, 198 relationship to output, 206 monopolistic competition, 222 perfectly competitive markets, 166–169, 205–206, 222 price level, 433 substitution effect, 66, 115, 137–139 price elasticity of demand (ED), 90 constant-elasticity demand perfectly elastic demand curves, 94–95 perfectly inelastic demand curves, 94 defined, 90 determinants availability of substitutes, 96–97 length of adjustment period, 97–98 price expectations, 69 size of consumer’s budget, 97 effects on total revenue, 92, 94 estimating Chevrolet example, 98 cigarette example, 98–100 electricity example, 98 formula for, 90–92 inelastic demand, 92 linear demand curve, 93–94 monopolistic competition, 218 and price discrimination, 209 and tax incidence, 112–113 unit-elastic demand, 92, 94 price elasticity of supply (ES), 100 constant-elasticity supply, 101–102 defined, 100 determinants, 103–104 elastic supply, 101 formula for, 100 inelastic supply, 101 and tax incidence, 113 price floors, 81 price indexes base year, 477–478 chain-weighted systems, 480–481 constructing, 478 consumer price index (CPI), 478–480 GDP price index, 480 uses for, 433 price inelasticity and agricultural markets, 105–106 constant-elasticity supply, unitelastic curves, 102 price leaders, 229, 233 price levels and aggregate supply, 434 and labor supplies, 557 impacts of fiscal policy, 581–582 base year, 433 and consumption, 518–519 at equilibrium, 434 expectations for and effectiveness of monetary policy, 669 higher than expected price, 558–559 natural rate of unemployment, 558 lower than expected prices, 560 potential output, 558 foreign exchange rates, 714–715 greater than expected output, 561–563 index number, 432 long-run aggregate supply curve, 565, 567–568 and lower than expected output, 563–565 and planned spending, 543–545 and purchasing power, 557, 603 and real GDP, 434, 440–441 and short-run aggregate supply curve, 560 and wage agreements, 558 price makers, 201, 217 price stability and central bank independence, 672–673 government role in fostering, 55 price takers, 168, 201 price wars, 232 price-output combinations, monopolies, 319–321 price-setting game (game theory) theory), 231–232 prices alternative goods, 72 artificially low, 207 and consumer searches on, 307 diamonds-water paradox, 121–122 and disequilibrium, and real income, 66 effects on total revenue, 92 equilibrium price, 75–76 factors that impact, 76–79 and inflation cost-push inflation, 501 demand-pull inflation, 501 and GDP calculations, 477 historical trends, 502–503 hyperinflation, 500 interest rates, 505–507 international variability, 504 local and regional variability, 504 measuring inflation rates, 500 and relative price changes, 504 international trade import quotas, 60–61, 411–413 tariffs, 60–61, 411, 413 maximum settings (price ceilings), 81–82 minimum settings (price floors), 81 monopolistic competition and long-run profits, 220–221 video industry example, 221–222 oligopolistic markets cartels, 228–229 collusion and cartels, 227–229 price leadership, 229 perfectly competitive versus oligopolistic markets, 234 posted-offer pricing, 188 predatory, 326 for public output in political markets, 56 and real income, 66 relative, 68–69 of resources constant-cost industries, 182 and demand and supply, 239 increasing-cost industries, 183 permanent differences in, 244 and resource market supply curve, 242–243 temporary differences in, 244 and shortages, 4, 74–75, 81 and supplies, 71, 242 and surpluses, 74–75, 81 world price determinants, 410 primary versus secondary effects, 13 prime rate, 289 principal, 309 principal-agent problem, 309 prisoner’s dilemma (game theory) cola war game, 232–233 dominant-strategy equilibrium, 230 duopoly price-setting game, 231–232 payoff matrix, 230 price-setting game, 231 strategy, 230 private domestic investment, gross, 469 private goods defined, 54 demand for, 340–341 features of, 339 versus public goods, 54 private investment demand curve, 522–523 gross domestic investment, 520 758 Index private property rights, 39–40, 358–359 privatization and growth in output per capita, 457 producers benefits of market exchange, 185–187 channeling of savings to, 283 impacts on supply curve, 71, 73 interests of, and government regulations, 322 producer surplus, 187 economic rent , 245 resource suppliers, 244 product differentiation, costs of, 226 product, marginal and increasing marginal returns, 144 and labor demand, 247–249 product markets asymmetric information, 308–309 defined, resources, demanders and suppliers, 241 production and aggregate income and expenditure, 474 aggregate supply, 434 and decreased resources, 570–571 and increased resources, 568–570 allocative efficiency, 185 below potential, long-run impacts, 563–565 costs complex inputs, 300–301 fixed costs, 146 long-run, 150–155 and minimizing short-run losses, 171–172, 174 monopolies, and deadweight losses, 207–208 role of firms in minimizing, 301 short-run, 146–147, 149–150 and supply curves, 71–72 technologically efficient production, 163–164 total cost estimates, 162–163 variable costs, 146 cottage industry system, 49 decentralized, 53 defined, 448 economies of scope, 305 of electricity, 195 and excess output, 559 inflationary pressure, 562–563 long-run impacts, 561–563, 565 of goods and services, decisions about, 39 household the electronic cottage, 53 exclusion from GDP calculations, 474 factors that influence, 52 internal and quality control, 302–303 versus market purchases, 301 long-run aggregate supply curve, 565, 567–568 long-run market adjustments, 179–183 marginal product, 143 marginal revenue, 284 market purchases advantages of, 301 and minimum efficient scale, 302 and multiple suppliers, 304 and quality control, 302–303 minimum efficient scale, 302 modeling, 34 monopoly, and allocative inefficiency, 207 and need for firms, 300 negative costs, impact on GDP, 476–477 oligopoly and economies of scale, 225–226 organizing efficiently, 313 PPF (production possibilities frontier) efficient production, 35 and increased capital stock, 37 and increased resources, 36–37 and technological innovation, 37 impacts of opportunity costs, 35–36 inefficient and unattainable production, 35 and price level changes, 558–560 production factors capital, entrepreneurial ability, labor, natural resources, resource payments, time dimension, resources, productive efficiency, 185 protecting, negative implications, 419 public vs private, 353 roundabout, and capital accumulation, 283 and saving, 283 and short-run shut-down decisions, 174 shut-down decisions using long-run supply curves, 182 using short-run supply curves, 174–175 specialization of, and need for monetary exchange, 32 substitution in, 242 supplies for, 304 total product, 143 transaction costs, 49 and unplanned inventory buildups, reductions, 538 versus spending, 537 production function, 143, 160 technological efficient production, 160–161 expansion paths, 163–164 isocost lines, 162–163 isoquants, 161 per worker, and technological change, 450 production possibilities and autarky equilibrium, 406 and international trade, analysis of advantages, 406–408 production possibilities frontier (PPF) and capital investments, 448 defined, 35, 446 and economic growth, 447 and technology, 447–448 importance of, as model, 37–38 productive efficiency, 185 productivity and computers, 455 defined, 448 and division of labor, 33 fluctuations in growth of, 454 growth during recessions, 456 household, 52 human capital, 452–453 and international trade, 405–406 labor, 448 capital deepening, 449 and output per capita, 456 per-worker production function, 449 versus labor costs, 650 versus physical capital, 449 market versus command systems, 41 measuring, 448 rules of the game, 451 and standards of living, 451–452 and technological change, 450–451 of union labor, 275 U.S productivity history, 453–454 products as basis of profits, 141 in circular-flow model, demand for, 252 improvements in, exclusion from GDP calculations, 475 information searches about, 306–307 new, and market disequilibrium, 83 in perfectly competitive markets, 217 product differentiation, 217–218, 224 professional workers economists, 13–14 unemployment rates, 493 profit accounting profit, 142 banks, 614, 625–628 defined, economic profit, 143 calculating, 168–169 long-run, 178–179 adjusting to decreased demand, 181–182 adjusting to increased demand, 179–181 short-run, 171, 176 economic profit, 142 Federal Reserve notes, 636 finance companies, 625 formula for, 3, 50 and investment decisions, 522 maximizing, 50, 143, 168 as goal of firms, 141 golden rule for, 170 and short-run price decreases, 560 and short-run price increases, 558–559 using isoquants and isocost lines, 163 versus maximizing utility, 241 monopolies graphing marginal curves, 202 graphing total curves, 203 long-run perspective, 204 marginal approach, 201 and output, 201 source of, 207 total approach, 201 monopolistic competition long-run profit, 220–221 marginal analysis, 219 perfectly discriminating monopolists, 211–212 short-run profit, 220 normal profit, 142 oligopolistic markets, 234 cartels, 228–229 price leadership, 229 759 Index perfectly competitive markets, 234 and price discrimination, 209–210 reinvesting, 295 and resource costs, 250–251 unregulated profits, 319 and wages, 266 progressive taxation, 58, 384, 584–585 property rights, 39–40 externalities and, 357–359 intellectual property rights, 287 proportional taxation, 57 and aggregate demand-side equilibrium calculations, 594–595 defined, 57 and spending multiplier, 595 proprietor’s income, in national income calculations, 487 See also sole proprietors protectionism See trade restrictions pubic debt, 696 public assistance, welfare-to-work programs, 499 public capital, 699 public choices in democracies, 342–345, 348, 350 distribution of costs and benefits of, 344–345 median voter model, 342–343 pollution rights and, 367–368 special interests and, 343–344 public debt, 696–697 public goods, 339 defined, 54 demand for, 341 features of, 339 government provision of, 54–55 market for, 341 optimal provision of, 340–341 paying for, 342 public-goods legislation, 344–345 production incentives, 40 versus private goods, 54 public policy approaches dependence on rules, 673 and rational expectations, 674–675 rationale for, 674 effectiveness of role of anticipation, 670–671 role of credibility, 671 role of expectations, 668–670 efforts to influence, 208 impact on U.S economy, 662 active approach, 662, 667–668 active versus passive approaches, 661, 664–665 closing contractionary gaps, 662–664 closing expansionary gaps, 664 passive approach, 667–668 implementation time lags, 665–666 mergers and, 326–327 Phillips curves, 675–676 evidence supporting, 679–680 long-run curves, 677, 679 natural rate hypothesis, 679 short-run curves, 677 public sector, expenditures, 694–695 public utilities, 319 purchases, market advantages of, 301 demand, 65 by government, 469, 525–526, 577–578 intermediate goods and services, 469 and minimum efficient scale, 302 multiple suppliers, 304 open-market, impacts on money supply, 635 role of money as medium of exchange, 599 as store of value, 599, 603 as unit of account, 599 quality control, 302–303 and specialization of products, 33–34 versus internal production, 301 purchasing power and inflation, 507 and price levels, 557 purchasing power parity (PPP) theory, 714–715 role of money, 599, 603 pure capitalism, 39–40 pure command systems, 40–41 purely competitive markets, 248 purity requirements, 414 Q Qn (isoquants), 160–162 Quaker Oats, Snapple spin-off, 305 qualifications, communicating reliably about,312 quality of capital impact on productivity and growth, 450–451 and technological change, 450 quality control, 302–303 quality, uniform, of money, 600–601 of resources, and permanent price differences, 244 quantity (Q) long-term market adjustments constant-cost industries, 182 handling decreased demand, 181–182 handling increased demand, 179–181 increasing-cost industries, 183 at market equilibrium Dutch auctions, 177 online auctions, 178 and short-run profits, 176 stock markets, 178 monopolies, and profit maximization, 201 in perfectly competitive markets, 201 quantity demanded, 67 quantity supplied, 72 relationship to price (demand curve), 67 of resources and demand and supply, 239 maintaining supplies of, 304 of savings, impact on loanable funds supply, 288 quantity theory of money, 651–652 quasi-public goods, 339340 Quesnay, Franỗois, 468 Quicken WillMaker software, 252 quintiles, income-based, 381 quota defined, 60 on imports, 60, 411–412 Japanese car example, 61 quota rights, 413 versus tariffs, 413 R racial discrimination affirmative action programs, 393–394 impact on poverty rates, 392–393 radio leases, auctioning of, 307–308 rainforest destruction, 364–365 R&D (research and development), 302 applied, 459 basic, 459 and economic growth, 459–460 and economies of scope, 305 rates inflation, 500 interest and consumption, 519 and of inflation, 505–507 and net export expenditure, 527 nominal, 506 and planned investment, 524 real, 506 of labor force participation, 492, 521–522 of return and demand for investment, 520 marginal rate of return, 285–286 of unemployment changes over time, 492 and age and ethnicity, 493 and occupation, 493 international comparisons, 498–499 limitations, 499 measuring, 490–492 regional variability, 493 taxes, marginal tax rate, 58 rational choice, 6–7 rational expectations and passive policy approaches, 674–675 and policy effectiveness, 668–669 rational self-interest, 6, rationality, bounded, 302 raw materials accumulation of, and mercantilism, 428 availability of, 409 U.S imports of, 404 Reagan, Ronald, administration, 689 and inflation, 507 public policy approaches, 668 tax cut, 588 real estate prices, 244, 253 real GDP (gross domestic product), 428, 433, 535 and aggregate demand curves, 434 and aggregate supply curves, 434 at equilibrium, 434 in excess of spending plans, 538 in GDP price index, 480 and net exports, 551–552 and output per capita, 456 per capita, 441 and price levels, 440–441 relationship of output and spending, 537 relationship of spending plans and production, 538 and simple spending multiplier calculations, 541 and supply-side economics, 439 real GDP demanded and autonomous spending changes, 552–553 760 Index and decreased planned spending, 541–543 equilibrium calculations, 594–595 and government purchases, 577–578 and net taxes, 578–580 and price level changes, 543–544 relationship with aggregate expenditure, 537 underlying algebra, 554–555 real GDP supplied long-run aggregate supply, 561–563 short-run aggregate supply curve, 560 short-run impacts of excess output, 559 short-run impacts of price levels, 558–560 real GNP (gross national product), 432 real income, 66 real interest rate, 506 real wages and price levels, 558 purchasing power, 557 wage flexibility, 565, 567–568 realized capital gain, 51 reallocation of resources, and wage changes, 244 rebounds, economic, 454 recalling currency, 623 receipts, relationship to spending, 650 recession, 428 and cyclical unemployment, 497 and decrease in money supply, 657 during the early 1990s, 588 impact on poverty rate, 385–386 indicators of, 432 regional impacts, 429 recognition lags, 666 relationship to spending, Japan example, 547 recycling, 373 redistribution of income, 55 regional trade agreements, 416–417 regions specialization of labor, 33 variable and economic fluctuations, 429 regressive taxation, 58 regulation government, of natural monopolies, 54 as industrial policy, 462 in mixed economic systems, 41 relative price, 66, 68–69 relevant resources, 72 religion, impact on economic systems, 41 renewable resources, 3, 358 rent, economic, 3, 244 rent seeking, 208, 348–349 costs, 420 rental income imputed, 475 in national income calculations, 488 repetitive games (game theory), 233 reported income, 384 representative money, 602 Republicans, economic policies, 589 research and development (R&D), 302 applied, 459 basic, 459 and economic growth, 459–460 and economies of scope, 305 reserve accounts (banks), 606 controlling money supply using, 636 excess reserves, 627 money creation process, 628–631 money multiplier, 631–632 money supply contraction, 632–633 fractional reserve banking systems, 602 liquidity versus profitability, 627–628 required ratio, 602, 627, 635 residential construction, 469 residents, 705 residual accounts, trade balances, 708–709 resolutions, congressional, 686 resource complements, 251 resource demand, 239 costs versus revenues, 240 demand shifts architects example, 252–253 and demand for final output, 252 and prices of resources, 251 and technological innovation, 252 derived demand, 241–242 labor demands and marginal resource costs, 249–251 marginal revenue product, 248–249 total and marginal product, 247–248 and marginal revenue product, 253 and minimum wage, 253–254 for money, 642–643 and supply, 239–240, 242–243 resource markets, resources, allocation of under modified capitalism, 40 under pure capitalism, 39–40 under pure command system, 40–41 buying and selling, capital, intellectual property, 287 loanable funds market, 288 marginal rate of return on investment, 285–286 marginal resource cost, 285 marginal revenue product, 284 and resource demand, 240 in circular-flow model, combining, 12 expansion paths, 163–164 production function, 160 technologically efficient production, 160–163 complements, 251 complexity of, and input costs, 300–301 controlling, 195–197 coordinating, 152 costs of constant-cost industries, 182 fixed versus variable, 146 increasing-cost industries, 183 long-run average cost, 150–151, 153 marginal resource costs, 249–251 opportunity costs, 141, 244–245 and profit, short-run average cost, 148–150 total versus marginal, 146–147 defined, 2, economic rent, 244–245 entrepreneurial ability, exhaustible, 358 explicit costs, 141 fixed resources, 143 implicit costs, 141 and international specialization and trade, 409 labor, and complexity of resource markets, 301–302 demand and supply, 240, 260, 434, 558–560, 565 and discretionary fiscal policies, 587 full employment, 497–498 human capital, 449 labor force participation rate, 492 low-skilled, 383 output, per capita, 456 output, potential, 558 and production variability, 561–565 productivity of, in U.S., 448, 53–456 and supply-side fiscal policies, 588–589 underemployment, 499 unemployment, 260, 387, 490–493, 496–499, 558 utility maximization, 260 versus physical capital, 449 wage agreements, 558 wage flexibility, 565, 567–568 wages, 241, 266–267 wages, real, 557 natural resources, outsourcing, 304 ownership of, 3–4, 39 household-owned, 48–49, 245 permanent versus temporary price differences, 244 and production, 36–37, 301, 448 relevant, impact on supply curves, 72 renewable, 358 substitutes for, 251 supplies aggregate supply, 557 adverse supply shocks, 570–571 beneficial supply shocks, 569–570 capital stock, 569 institutional causes, 569 labor supplies, 568 and monetary policy, 646–648 multiple suppliers, 304 quality control, 302–303 scarcity of, 2–3 time, using and absolute advantage, 32 decisions about, 39 economies and diseconomies of scale, 152–155 efficient, 35–36, 185 law of comparative advantage, 32 and output rate, 143–144 restrictions on, 359 short-run versus long-run, 143 transforming into products, 141 variable versus fixed resources, 143 761 Index responsiveness to changes See price elasticity restrictions, trade, 60, 409 arguments in favor of antidumping argument, 417–418 declining industries argument, 419 infant industry argument, 417 jobs and income argument, 418–419 national defense argument, 417 domestic content requirements, 414 entry barriers licenses, 194 patents, invention incentives, 194 export subsidies, 413 import substitution strategy, 421 loans to foreign buyers, 413 overall impact, 414 problems associated with, 419–420 purity requirements, 414 quotas, import, 411–413 tariffs, 410–411, 413 restructuring, 155 retail stores, posted-offer pricing, 188 retained earnings, 295 retraining programs, 497 return on investments, 285–286, 520 revaluation of currency, 716 revenue, See also income; profits average, 171, 197–198 from capital, 284 in circular-flow model, as component of profit, federal, from taxes, 692 marginal and economic profit, 169 marginal revenue product, 248 of monopolists, 198, 201 per-unit, 171 revenue curves and profit maximization, 202–203 relationship to demand and marginal revenue, 199 and resource demand, 240 revenue schedules, 199 sources, 57, 381 total, 168, 201 rice as money, 599 richest households, 381 right-to-work states, 276 rights, property, 39 risks bank loans, 626 of global trade, 155 and market interest rates, 289 and wages, 269 rival goods, 54, 339–340 Robinson, Joan, 217 Roosevelt, Franklin D., 608 roundabout production, 283 rule of reason, 326 rules, economic predetermined, and passive approaches to public policy, 673 and rational expectations, 674–675 rules of the game, 429, 446, 451 rules of the marketplace, 54 S S corporations, 51 salaries See income; wages sales and business type, 51 open-market, 635 salt as money, 599 savings accumulation of capital, 283 and capital investments, 448 channeling to borrowers, 625–626 in circular-flow model, 474 and disposable income, 535 formula for, 513 in GDP calculations, 473 household expenditures for, 49 flow to financial markets, 473 impact on loanable funds market, 288 incentives for, 284 and interest rates, 284 life-cycle model, 519–520 marginal propensity to save, 515, 517 from postponed consumption, 284 and production, 283 saving function, 517 slope, 517 savings banks, 605 deposits, 623 failures among, 610–612 scale diseconomies of, 152 approaches to handling, 155 and long-run costs, 152 McDonald’s example, 155 movie theater example, 153 economies of as barriers to entry, 195 and long-run costs, 152 McDonald’s example, 154 movie theater example, 153 oligopoly, 225–226 minimum efficient, 154, 302 of operations, and profit, 151, 178–182 utility, 117–118 scarcity defined, 2–3 and demand, 65–66 of goods and services, impact on choices, school lunch programs, 389 Schumpter, Joseph, 333 scientific method, 8–10 scope, economies of, 305 screening job applicants, 312 searches for consumer information, 306–307 seasonal unemployment, 496 Seattle,WA, 1999 demonstrations, 415–416 seawater, clean, scarcity of, secondary effects, 13 secondary market (securities), 295 secondhand securities, 295 securities corporate bonds, 295 corporate stocks, 294–295 liquidity, 295 secondhand, 295 securities exchanges, 295–296 security concerns adverse supply shocks from, 570–571 impacts on economic growth, 451 seigniorage, 601 selection, adverse, 309 self-correcting forces, 436 for closing contractionary gaps, 662–664 for closing expansionary gaps, 664 self-employed individuals Social Security taxes, 58 sole proprietorships, 50 self-interest, rational, sellers markets for, monopolistic competition, 217 serrations on coins, 601 service, differentiating products using, 218 services, allocation decisions, 39 consuming, 260 defined, demand for, 642–643 free, 3–4 household expenditures for, 49 markets for, outsourcing, 304 prices, producing choosing production methods, 39 choosing what to produce, 39 transaction costs, 49 scarcity of, in U.S trade surpluses, 707 versus goods, 3, 59 set-aside programs, 394 severance pay, 572 shares bank, 626 stock, 294 Shepherd,William G., 329, 331 Sherman Antitrust Act of 1890, 325 shift of a demand curve, 70 shift of a supply curve, 74 shipping, outsourcing of, 304 short-run, 558 benefits, perfectly competitive markets, 185 consumer and producer surpluses, 186–187 costs average, 148–149 and law of diminishing returns, 150 marginal, 147, 150 total, 146–147 defined, 143, 558 equilibrium, 562 as focus of monetary policy, 655–657 maximizing profits, 168–169, 171, 176, 181, 219 monopolistic competition, 220 losses minimizing, 171–172, 174–175 shutdown decisions, 204 price change adjustments, 98 production law of diminishing marginal returns, 144 producer surpluses, 187 profit maximization, 181 output exceeding potential, 562–563 Phillips curves, 677, 679–680 resource use, 143 supply curves, 175 aggregate supply, 557–558, 560 for firms and industries, 175 shortages defined, 74 effects on prices, 75 factors that cause, 74 impact on prices, 81 shut-down decisions and long-run market adjustments, 181–182 monopolies, 204 pros and cons, 174–175 762 Index and short-run market adjustments, 174–175 shutdown point, 175 signaling, 312 simple money multiplier, 631–632 simple spending multiplier, 541 and investment decreases, 541–543 and price level changes, 543–545 simple tax multiplier, 580 single-parent families, 381 poverty rates, 391–392 size efficient, and oligopoly, 153, 225–226 of U.S government, measuring, 56 skills development costs, 244 differences in, and wages, 266–267 as human capital, slope of a line budget lines, 135 curved lines formula for, 22 marginal analysis using, 23 measuring, 22–25 negative and positive slopes, 24 demand curves, 67 linear, 92–94 perfectly elastic, 94 perfectly inelastic, 94 unit-elastic, 95 isocost lines, 162–163 isoquants, 161 straight lines, 24 supply curves, 101–102 slowdowns, economic, 454 Smith,Adam, 40, 74, 121, 436 Smith,Vernon, 187–188 smoking reduction programs, 387–388, 100 social regulation, 318 Social Security, 387 as cash transfer payment, 49 COLAs (cost-of-living adjustments), 508 federal outlays for, 685, 687 and income, 526 origins of, 498, 693 reforming, 694 spending on, by U.S government, 56 taxes for, 57–58, 486 Social Security Act (1935), 498 social welfare, 187 domestic, and tariffs, 411 expenditures on, 387 income assistance programs, 388–389 and quota rights, 413 social insurance programs, 387–388 soft landings, 664 soft money, 349 soil productivity, 448 sole proprietorships, 48, 50 solid waste disposal, 372–373 South Korea, per-capita production, 41 Southern African Customs Union, 416 Spain inflation, 673 unemployment rates, 571 spatial differentiation (products), 218 special interests campaign finance reform and, 349–350 elected officials and, 343–344 PACs, 348 regulations and, 322 rent seeking, 348–349 special-interest legislation, 344–345 specialization and capital, 284 and core competencies, 304 division of labor, 33–34 economies of scale, 152 and international trade, 59–60, 403, 408–409 and interstate trade, 403 and market exchange, 49, 301 and need for money, 32 opportunity costs, 31–32 specific tariffs, 410 speculators, 713 currency speculation, 718– 719 spending aggregate, 470 and national income, 488 autonomous in circular-flow model, impact on real GDP demanded, 552–553 multiplier effects, 554 consumer, 587 and demand for money, 642–643 government federal outlays, 685 as fiscal policy, 55 history of, 583–584 and national debt, 695, 697–700 and reductions in, 693 and real GDP, 5, 473, 577–578, 694–69 rationales for, 688–689 and income distribution, 384 and money supply, 650–651 relationship to receipts, 650 unilateral transfers, 707–708 spending multiplier, 539–541 airline industry example, 542–543 factors that reduce, 595 and fiscal policy, 583 and net exports, 552 spending plans and programs, 576 below real GDP, 538 changes in, impacts of, 545–547 in excess of real GDP, 538 and net exports, 470, 551–552 versus output, 537 spin-offs, 155 sporadic dumping, 418 sports markets, 268–269 as monopolies, 196 SRAS (short-run aggregate supply) curve, 560 SSI (Supplemental Security Income), 388 stabilizers, automatic income taxes, 577, 584–585 unemployment insurance, 585 welfare transfer payments, 585 stagflation, 585, 676 conditions leading to, 438 Standard Oil, 326 standard of living developing countries, 452 and government deficits, 699 industrial market countries, 451 international differences, 426, 451 measuring, 441, 446 output per capita, 456 start-up costs, 226 state banks, 605 charters, 626 states (U.S.) General Assistance aid, 388 government responsibilities, 55 poverty rates, 392 trade among, 403 unemployment rates, 493 statistical discrepancy account, 708–709 steel industry, U.S., 420 Steinbeck, John, 490 Stigler, George, 322 Stigler search model, 307 stock, corporate dividends, 295 markets, 178 shares, 50, 294 versus capital investment, 469 stock variables, 427 defined, 599 government debt, 439 net wealth, 517 stocks of goods, 469 of precious metals, 468 Stone Mountain Accessories, 304 store of value, 599, 603 strategy (game theory) cola war game, 232–233 dominant-strategy equilibrium, 230 duopoly price-setting game, 231–232 one-shot versus repetitive games, 233 tit-for-tat games, 233 strikes, 271, 277 structural unemployment, 497 subjective factors consumer tastes and preferences, 116 and demand, 65 and utility scales, 118 subsidies export, 413 as industrial policy, 462 for natural monopolies, 320–321 substitute resources, 251 substitutes availability of and prices, 96–97, 107 bottled versus tap water example, 122 defined, 69 import substitution, 421 MRS (marginal rate of substitution), 134 MRTS (marginal rate of technical substitution), 161–163 in production, 242 resource substitutes, 251 substitution effect of price changes, 66, 115, 137–139 of wage increases, 263 sugar quotas, 413 sunk cost, 30–31 Super Bowl advertising costs, 64 Superfund, 371–372 supernote, 622–623 Supplemental Security Income (SSI), 388 supplies control over by monopolists, 196 defined, 70 equilibrium price and quantity, 75–79 individual, 72 industrial imports and exports, 403 loanable funds, 288 maintaining quantities of, 304 market, 72 money checkable deposits, 621 components, 603 contraction of, 632–633 763 Index counterfeit money, 622–623 and equilibrium interest rate, 644–645 Federal Reserve Control tools, 634–636 focus of monetary policy on, 655–657 and increases in, 654 limits on expansion, 632 M1 aggregate, 621, 624 M2 aggregate, 623 M3 aggregate, 623 money multiplier, 631–632 predicting, 651–652 role of banks, 628–631 in perfectly competitive markets, 166 price elasticity of elastic supply, 101 formula for, 100 impact on tax incidence, 113 inelastic supply, 101 and price elasticity of demand, 91 unit-elastic supply, 101 and shortages, 74 and surpluses, 74 resource markets, 240 effect of elasticity, 245 impact on price and quantity, 239 suppliers monopolists, 194 outsourcing, 304 supply curves, 71 versus quantity supplied, 72 supply curves (Sx), 71 aggregate, 557 curves for, 434 and discretionary fiscal policy, 587–588 impact on spending multiplier, 595 labor supplies, 557–558 and long-run Phillips curves, 677, 679 and money policy, 650–651 and natural rate of unemployment, 558 and potential output, 558 and price level decreases, 560 and price level increases, 558–559 and price levels, 558 and short-run Phillips curves, 677 and supply-side fiscal policies, 588–589 defined, 71 elasticity, 101–102, 245 individual workers, 260 backward-bending, 263 and flexibility of hours worked, 263 income effect of wage increase, 263 nonwage factors, 264–265 substitution effect of wage increase, 263 and utility maximization, 260 wages, 262–263 inelastic supply, 101 labor markets, 265 and unions, 273–278 wages, 266 loanable funds market, 288 long-run for industries, 182 long-run equilibrium, 179 money, 650–651 monopolies, 204 monopolistic competition, 219 movement along versus shifts in, 74 perfectly competitive markets, 205 and prices, 71 resources, 242–244 shifts in, 72–73, 77–79 short-run break-even point, 175 for firms, 174–175 for industries, 175 shutdown point, 175 and tax incidence, 113 temporal factors, 103–104 supply schedule, 71 supply shocks, 568–569 adverse, 570–571 beneficial, 569 supply-side economics, 439, 689 supply-side fiscal policies, 588–589 support, differentiating products using, 218 surpluses consumer, 124, 185–187 free medical care example, 127–128 market demand curves, 125–126 defined, 74 effects on prices, 75 factors that cause, 74 federal budget, 590, 692–693 in foreign exchange, 709 impact on prices, 81 producer, 187 producer surplus, 187 resources, economic rent, 244 in trade balances, 706–707 Sweden, export levels, 403 Switzerland export levels, 403 inflation, 673 systems, economic allocation of goods and services, 39 centrally planned, 40–41 and custom and religion, 41 defined, 39 market systems, 40 mixed systems, 41 modified capitalism, 40 modified command system, 41 production of goods and services, 39 pure capitalism, 39–40 pure command system, 40–41 T Taiwan productivity, 41 U.S imports from, 403 TANF (Temporary Assistance for Needy Families), 388, 396 tangent defined, 24–25 measuring, 24 tariffs, 60, 410–411 defined, 60 U.S., on steel, 420 versus import quotas, 413 tastes, 116 cultural differences, 409 defined, 70 impact on demand curves, 70 job preferences, 265 representing using indifference maps, 134–135 stability of, 116 taxable income, 142 earned-income tax credit, 388 taxes, taxation ability-to-pay principle, 57 avoidance and evasion of, 350 benefits-received tax principle, 57 on corporate income, 51 effects of, 350 as fiscal policy, 55, 576 automatic stabilizers, 577, 584–585 permanent income effects, 587 tax cuts, 577, 579, 588, 664 tax increases, 692 government revenue from, 57, 692 and government transfer payments, 526 household expenditures for, 49 and household production, 52 on imports, 60 as industrial policy, 462 marginal tax rate, 58, 342 and market interest rates, 290 net (NT), 473, 535 impact on disposable income, 526 impact on real GDP demanded, 578–580 in aggregate demand-side equilibrium calculations, 594 multiplier effect, 594 payroll taxes, 57 on public goods, 55 progressive systems, 384, 584–585 proportional systems, 594–595 regressive taxation, 58 richest households, 381, 590 S corporations, 51 and supply-side economics, 439 tax incidence defined, 57, 112 and demand elasticity on, 112–113 and supply elasticity on, 113 tax-exempt organizations, 52 in Western Europe, 572 TC (total cost) calculating, 162 curve for, 147 and monopoly profits, 201 tea as money, 599 technical substitution, 161–162 technical workers, unemployment rates, 493 technological innovation, change and agricultural markets, 106 and capital, 450–451 and demand curves, 72 and growth, 447–448 and household productivity, 52 and industrial policy, 462 and monopolies, 208–209 and productivity, 455 research and development, 459–460 and resource demand, 252–253 and structural unemployment, 497 and unemployment, 459 technical substitution, 161–162 technologically efficient production expansion paths, 163–164 isocost lines, 162–163 isoquants, 160–161 teenagers pregnancy and poverty rates, 391 unemployment rates, 492–493 telecommuting, 53 telephone companies, price discrimination, 210 Temporary Assistance for Needy Families (TANF), 388, 396 term structure of interest rates, 289–290 terms of trade, 407 terrorism adverse supply shocks, 570–571 764 Index impact on economic growth, 590 impact on global economies, 431 impact on money supply, 634 impacts on rules of the game, 451 and international firms, 155 spending multiplier effects, 542–543 Thailand, currency speculation, 718–719 Thatcher, Margaret, 456 theory, economic defined, goal of, 12 role in analysis, verification or refutation of, 10 Thompson,Tommy, 398 thrift institutions, thrifts, 605 timber as renewable resource, time, temporal factors, See also long-run; short-run adjustment periods and price elasticity of demand, 97–98 and price elasticity of supply, 103–104 allocating, 261–262 costs of, 128 in demand analyses, 128 hours worked, 263 and interest rates, 285 and opportunity costs, 30 and rational choice, as resource, and resource use, 143 and savings, 284 time lags and discretionary fiscal policy, 586 for implementing public policy, 665–666 and utility maximization, 260–261 time deposits, 623 time-inconsistency problem, 670 time-series graph, 20 tips, as indicator of performance, 311 tit-for-tat games (game theory), 233 tobacco as money, 599 token money, 601–602 Tokyo Round (GATT), 414 total cost (TC), 146–147 calculating marginal cost factors, 147 monthly production costs, 162 and economic profit, 168 monopolies intersection with revenue curves, 203 and profit maximization, 201 total product curve for, 143–144 and labor demand, 247–248 total revenue (TR), 92 and demand elasticity 92, 94 and economic profit, 168 formula for, 92 monopolies calculating, 199 intersection with cost curves, 203 and profit maximization, 201 total utility defined, 117 and law of demand, 122, 124 maximizing, 118–121 measuring, 118 toxic waste, 371–372 trade barriers, 714 and barter, 598 role of money, 598–99 as store of value, 599, 603 as unit of account, 599 as unit of exchange, 599 trade wars, 420 Trade Agreements Act of 1979, 418 trade, international, 59, 334 advantages of, 405–408 and autarky, 406 auto industry example, 60–61 balance of payments, 59, balance on goods and services, 707 double-entry bookkeeping for, 705 as flow variable, 705 merchandise trade balance, 705–706 statistical discrepancy account, 708–709 balances current account, 708 factors that affect, 706 and foreign exchange, 709 statistical discrepancy accounts, 708–709 surpluses and debits, 706 capital account, 708 common markets, 416 free trade areas, 416 North American Free Trade Agreement (NAFTA), 416 constraints, 408 currency and exchange rates, 60 deficits, 532, 704, 706 and federal budget deficits, 691, 719 exports capital goods, 403 consumer goods, 403 promotion of, 421 factors contributing to consumer differences, 409 economies of scale, 409 resource endowments, 409 foreign exchange, 709 import substitution, 421 merchandise trade balance, 59 multilateral trade agreements, 414–416 restrictions on, 60, 409 arguments in factor of, 417–419 domestic content requirements, 414 export subsidies, 413 import quotas, 411–413 low-interest loans to foreign buyers, 413 overall impact, 414 problems associated with, 419–420 purity requirements, 414 tariffs, 410–411 tariffs versus quotas, 413 surpluses, 706–707 U.S trading partners, 404 unilateral transfers, 707–708 trade, interstate, 403 trademarks, 218, 287 tradition, impact on economic systems, 41 training on-the-job, 254 and wage differences, 266–267 transaction costs, 49 bank loans, 625–626 barter, 598 commodity money, 600 defined, 74 effects of markets on, 74 and household production on, 52 and Internet on, 53 role of firms in minimizing, 301 unanticipated inflation, 503 transfer payments, 526 as automatic stabilizer, 585 and income redistribution, 55 defined, 49 personal income from, 48–49 transfers, unilateral, 707 transmission of electricity, 195 transport costs, 324 travel industry, 543 traveler’s checks, 621 treaties, trade, 414 treble damage suits, 333 trial lawyers, 348 tropical rainforest destruction, 364–365 Truman, Harry, on unemployment, 490 trusts, 325 two-earner households, 381, 384 tying contracts, 325 U UAW (United Auto Workers), 275 unanticipated inflation effects of, 503 impacts of, 508 transaction costs, 503 uncertainty, 284 underemployment, 499 underground economy, 350, 474, 499 underpricing of public output, 56 undifferentiated oligopoly, 224 unemployment combined with inflation, 585 economic costs, 490 expected, 669 and long-run aggregate supply (LRAS) curve, 565 measuring, 387, 490–493, 498–499 natural rate, 558, 679 challenges of identifying, 664–665 and discretionary fiscal policies, 586 hysteresis, 571–572 and output, 558 and short-run aggregate supply curve, 560 personal costs, 490 sources, 496 cyclical unemployment, 497 frictional unemployment, 496 seasonal unemployment, 496 structural unemployment, 497 and supply-side fiscal policies, 588–589 and technological change, 459 unemployment benefits, 498 versus inflation, 675–677, 679–680 and wage flexibility, 565, 567–568 unemployment compensation, 49, 498, 526 unemployment insurance, 388, 585 unemployment rate, 387 and age and ethnicity, 493 changes over time, 492 defined, 491 international comparisons, limitations, 499 measuring, 490–492 and occupation, 493 regional variability, 493 unfair business practices, 54 765 Index uniform quality of money, 600–601 unilateral transfers, 707–708 unintended consequences, 13 unions collective bargaining, 271 craft, 270, 273–274 demand for, 274–275 efforts to organize IT workers, 277 featherbedding, 275 industrial, 270–272 labor collective bargaining, 271 history, 270 impact on wage, 382 mediation and arbitration, 271 strikes, 271 wages and employment, 270–271 membership, 275–278 strikes, 271 unit elastic demand, 92, 94–95 unit elastic supply, 101–102 unit of account, 599 United Auto Workers (UAW), 275 United Kingdom (UK) export levels, 403 government outlays, 56 output per capita, 456 relationship with US economy, 430 United States economy, 426 See also Federal Reserve System; trade, international active public policy, 661–662, 664–668 body analogy, 427 budget deficits and currency values, 691 history, 689–690 and interest rates, 691 persistence, 690 rationale for, 688–689 budget philosophies, 689 budget surpluses, 692 economic impacts, 700–701 reasons for, 692–693 reversal of, 693 competition, 329, 331–332 as common market, 416 currency, 621–623 exports, 403 federal budget budget process, 686 budget process criticisms, 686–687 national debt, 695 outlays, 685 reforming entitlement programs, 693–694 suggestions for reform, 687–688 federal system of government, 55 financial intermediaries, 605 banks, banking, 610–613 depository institutions, 605 Federal Deposit Insurance Corporation (FDIC), 609 Federal Reserve System, 606–608, 610 state banks, 605 fluctuations, 428 depression, 428 economic cycles, 429 expansion, 429 inflation, 428 recession, 428, 432 foreign ownership of assets, 708 history the Great Depression, 435–436 Keynesian economics, 436–437 real GDP and price levels, 440–441 stagflation, 438 supply-side economics, 439 government size and outlays, 56, 694–695 gross domestic product (GDP), 426 imports, 403–404 inflation and central bank independence, 673 comparisons with other countries, 504 labor productivity, 453–454 mixed economic system, 41 money supply control mechanisms, 634–636 national income, 486–488 North American Free Trade Agreement (NAFTA), 416 passive policy approaches,661, 667–668, 673–675 physical capital, 449 savings in, 520 standards of living, 451 steel tariffs, impacts, 420 official poverty level, 385 output gaps in, 567–568 per capita, comparisons with other countries, 456–457 performance statistics, 475–476 productivity , 454– 456 public policy impacts, 662 expansionary and contractionary gaps, 662–664 role of anticipation, 670–671 role of credibility, 671 role of expectations, 668–670 R&D expenditures, 460–461 regional variability in unemployment rates, 493 trade deficits, 704, 706 unemployment rates, 498–499 units of exchange, commodity money, 599 units of measurement, for slopes, 22–23 units of utility, 117–118 Universal Studios price discrimination, 211 unlimited liability, 50 unmarried mothers, poverty rates, 391–392 unplanned inventory adjustments and aggregate expenditure, 536 unplanned buildups and reductions, 538 unrelated (independent) variables, 22 unrelated goods, 69 unreported income, 350 Untied Parcel Service (UPS), 208 UPS (United Parcel Service), 208 Uruguay Round (GATT), 414, 416 U.S Bureau of Engraving and Printing, 621 Uruguay Round (GATT), 414, 416 U.S Census Bureau income measurements, 381 poverty level calculations, 385–386 U.S Commerce Department statistics, 475–476 U.S Department of Agriculture, poverty level calculations, 385 U.S Patent and Trademark Office, 194, 218 U.S Postal Service history, 208 license to deliver mail, 195 monopoly status, 208–209 U.S Steel, 326 U-shaped curve, 25 utility from consuming, 260 defined, 47, 116 and demand, 122, 124 free medical care example, 127–128 indifference curves, 133–134, 136–137 and leisure, 260 marginal utility, 117 marginal valuation, 124 maximizing, 47 equilibrium, 120–121 and costs, 118–119 versus maximizing profit, 241 measuring, 117–118 subjectivity of, 116 time costs, 128 total utility, 117 and work, 261–263 V valuation, marginal, 124 value of commodities, 599 of goods and services, 599, 603 of resources, 241–242 store of value, 599 unit of account, 599 value added, 470–471 value judgments, 10 variable costs (VC), 146 and short-run losses, 171–172, 174–175 and total cost, 146–147 variable inflation international variability, 504 local/regional variability, 504 relative price changes, 504 transaction costs, 503 variable resources, 143–144 variable technology, 361–363 variables coincident economic indicators, 432 defined, dependent, 20, 515 federal budget deficit, 437 flow, 427 budget deficits, 437 consumption and income, 517 functional relationships, 20 in graphs, 20–21 independent (unrelated), 20, 22 lagging economic indicators, 432 leading economic indicators, 432 line shifts, 25 negative (inverse), 22 positive (direct), 22 stock variables, 427 government debt, 439 net wealth, 517 velocity of money, 650 determinants of, 652 quantity theory of money, 651 stability of, 652 vending machines, in Japan, 11–12 Venezuela, U.S imports from, 404 vertical axis (graph), 20 vertical demand curves, 95 vertical integration defined, 301 bounded rationality of managers, 302 market purchases versus internal production, 301–302 766 Index minimum efficient scale, 302 multiple suppliers, 304 outsourcing, 304 vertical mergers, 325, 328 vertical supply curves, 102 video industry, 221–222 virtual offices, 53 VirtualBank, 633 Volcker, Paul, 657, 675 voters and political spending, 56 rational ignorance of, 344 W wages and aggregate supplies, 434, 560, 565, 567–568 defined, and derived demand, 241–242 economic rent versus opportunity costs, 244–245 efficiency wages, 311 expectations for, 669 factors that affect geographic differences, 270 individual differences, 266–267 job discrimination, 270 job risks, 269 marginal analysis, 266 union membership, 270–275 winner-take-all markets, 268–269 increases in backward-bending labor supply curves, 263 income effect, 263 substitution effect, 263 and inflation, 507 in-kind wages, 475 international differences, 715 and labor supply, 262–263 and labor unions, 382 median, 382–383 minimum, 253–254, 387 and monetary policy, 646–648 nominal, 557 and non-monetary job components, 244 personal income from, 48 price impacts, 244 and production, 561–565 real, 557 and resource supply, 240, 242 and total costs, 162 and trade restrictions, 418–419 wage agreements, 557–558 Wal-Mart, 65 Walton, Sam,Wal-Mart, 65 wants and scarcity of resources, versus demand and needs, 65 water consumption, marginal utility, 117 diamonds-water paradox, 121–122 measuring, 117–118 water pollution, 371 Wealth of Nations,The (Smith), 436 wealth, net impact on consumption, 517–518 and real GDP, 434 welfare programs as automatic stabilizer, 585 as cash transfer payment, 49, 526 means-tested programs, 388–389 spending on, by U.S government, 56, 685 welfare dependency, 395 welfare reform, 395–399, 499 welfare, social, 187 Wells Fargo online banking services, 633 West Virginia unemployment rates, 495–496 Western Europe euro, 710 inflation in, 504 standards of living, 451 unemployment rates, 498–499, 571–572 wheat, U.S exports of, 404 willingness to produce, 70–71 willingness to purchase, 65, 136 WillMaker software (Quicken), 252 winner’s curse, 307–308 winner-take-all labor markets, 268–269 Wisconsin welfare reform, 397 women labor force participation rate, 492 poverty rates among, 390–392 work See also labor; resources; unemployment rates; workers and leisure time, 261 market, 260 nonmarket, 260, 306 and utility, 261 work participation programs (welfare-to-work), 396–399 workers absolute advantage, 406 affirmative action programs, 393–394 discouraged, 491 education, 452–453 employment levels, 558 full employment, 497–498 labor force participation rate, 492 low-skilled, 383 marginal product, 143 output per capita, 456 and technological change, 459 underemployed, 499 unemployed cyclical unemployment, 497 frictional unemployment, 496 and age and ethnicity, 493 and occupation, 493 international comparisons, 498–499 measuring, 491–492 natural rate of, 558 reasons for, 496 regional variability, 493 seasonal unemployment, 496 structural unemployment, 497 unemployment benefits, 498 wages and price level, 558 purchasing power, 557 wage agreements, 557 wage inflexibility, 568 worker-population ratio, 456 workers’ compensation, 388 working conditions international conditions, 415 and labor supplies, 264–265 World Bank, international poverty line, 386 world economies, 426 See also trade, international competition and, 332 money supply and inflation, 654 and tariffs, 411 world price, 410 World Trade Organization (WTO), 414–416 and regional trade agreements, 417 ruling on U.S steel tariffs, 420 World War II and government outlays, 56 impact on U.S economy, 437 production levels, 559 unemployment during, 492 WTO (World Trade Organization), 414–416 and regional trade agreements, 417 ruling on U.S steel tariffs, 420 XYZ zero economic profit, 179 Zimbabwe, hyperinflation, 500 zombie banks, 611, 616 ... Americans export fruit to Chile, and Americans travel to Canada for camping and hiking Mineral resources are often concentrated in particular countries: oil in Saudi Arabia, bauxite in Jamaica, diamonds... specialization and exchange result in mutual gains Remember that comparative advantage, not absolute advantage, creates gains from specialization and trade.The only constraint on trade is that, for each... Trade Agreement, or CAFTA A half dozen Latin American countries form Mercosur, the association of Southeast Asian nations make up ASEAN, and South Africa and its four neighboring countries make