Ebook Economics principles and policy (11th edition): Part 2

(BQ) Part 2 book Economics principles and policy has contents: Pricing the factors of production; poverty, inequality, and discrimination; an introduction to macroeconomics; aggregate demand and the powerful consumer; money and the banking system; budget deficits in the short and long run,...and other contents.

Find more at www.downloadslide.com Part The Distribution of Income I n Part 5, we examine how a market economy distributes its income, using the price mechanism, with the prices of the inputs to the production process determined by supply and demand; that is, we investigate what determines the share of total output that goes to workers, to landowners, to investors, etc We will see that the market assigns a central role to the marginal productivity of each of these recipients—how much of a marginal contribution each makes to the economy’s total output In Chapter 19, we will study the payments made for the use of capital (interest), land (rent), and the reward to entrepreneurs (profits) Because most people earn their incomes primarily from wages and salaries, and because these payments constitute nearly threequarters of U.S national income, our analysis of the payments to labor (wages) merits a separate chapter (Chapter 20) In Chapter 21, we turn to some important problems in the distribution of income—poverty, inequality, and discrimination C H A P T E R S 19 | Pricing the Factors of Production 21 | Poverty, Inequality, and Discrimination 20 | Labor and Entrepreneurship: The Human Inputs Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Pricing the Factors of Production Rent is that portion of the produce of the earth which is paid to the landlord for use of the original and indestructible powers of the soil DAVI D RI CARD O ( 1772– 1823) I n Chapter 15, we noted that the market mechanism cannot be counted on to distribute income in accord with ethical notions of fairness, and we listed this as one of the market’s shortcomings But there is much more to say about how income is distributed in a market economy The market mechanism distributes income through its payments to the factors of production Everyone owns some potentially usable factors of production—the inputs used in the production process Many of us have only our own labor; but some of us also have funds that we can lend, land that we can rent, or natural resources that we can sell at prices determined by supply and demand The distribution of income in a market economy is determined by the prices of the factors of production and by the amounts that are employed For example, if wages are low and unequal and unemployment is high, obviously many people will be poor Factors of production are the broad categories— land, labor, capital, exhaustible natural resources, and entrepreneurship—into which we classify the economy’s different productive inputs C O N T E N T S PUZZLE: WHY DOES A HIGHER RETURN TO SAVINGS REDUCE THE AMOUNTS SOME PEOPLE SAVE? THE PRINCIPLE OF MARGINAL PRODUCTIVITY INPUTS AND THEIR DERIVED DEMAND CURVES INVESTMENT, CAPITAL, AND INTEREST The Demand for Funds The Downward-Sloping Demand Curve for Funds PUZZLE RESOLVED: THE SUPPLY OF FUNDS The Issue of Usury Laws: Are Interest Rates Too High? THE DETERMINATION OF RENT Land Rents: Further Analysis Generalization: Economic Rent Seeking Rent as a Component of an Input’s Compensation An Application of Rent Theory: Salaries of Professional Athletes Rent Controls: The Misplaced Analogy PAYMENTS TO BUSINESS OWNERS: ARE PROFITS TOO HIGH OR TOO LOW? What Accounts for Profits? Taxing Profits CRITICISMS OF MARGINAL PRODUCTIVITY THEORY | APPENDIX | Discounting and Present Value Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 398 Part The Distribution of Income PUZZLE: Entrepreneurship is the act of starting new firms, introducing new products and technological innovations, and, in general, taking the risks that are necessary to seek out business opportunities WHY DOES A HIGHER RETURN TO SAVINGS REDUCE THE AMOUNTS SOME PEOPLE SAVE? The rate of interest is the price one obtains by saving some money and lending it to others—for example, lending the money to a bank (by depositing the money into a bank account) or lending the money to a corporation (by buying its bonds) We normally expect that a rise in the price of a loan (like the price of anything else) will reduce the quantity demanded and increase the quantity supplied In fact, many people who save their money and lend it to others the opposite—they reduce the amount they lend when the rate of interest goes up How can that make sense? The same puzzle affects other factors of production For example, when wages, the price of labor, rise, workers often decide to work less, perhaps taking longer vacations Why don’t they work more when pay is better? The explanation will be discussed later in the chapter It is useful to group the factors of production into five broad categories: land, labor, capital, exhaustible natural resources, and a rather mysterious input called entrepreneurship In this chapter, we will look at two of them—the interest paid to capital and the rent of land But first, because there is a great deal of misperception about the distribution of income among workers, suppliers of capital, and landlords, let’s see how much these three groups actually earn Of all the payments made to factors of production in the United States in 2006, interest payments accounted for about 4.5 percent; land rents were minuscule, making up only 0.7 percent; corporate profits accounted for 15 percent; and income of other business proprietors made up 9.4 percent In total, the payments to all the factors of production that we deal with in this chapter amounted to about 30 percent of national factor income Where did the rest of it go? The answer is that 70 percent of 2006 national factor income consisted of employee compensation—that is, wages and salaries.1 There are many other serious misunderstandings about the nature of income distribution and about what government can to influence it, and discussions of the subject are often emotional That’s because the distribution of income is the one area in economics in which any one individual’s interests almost inevitably conflict with the interests of someone else By definition, if I get a larger slice of the total income pie, then you end up with a smaller slice Still, as we will see in the next chapter, it is possible to get more for oneself by increasing the size of the pie, and then everyone can benefit THE PRINCIPLE OF MARGINAL PRODUCTIVITY The marginal physical product (MPP) of an input is the increase in output that results from a one-unit increase in the use of the input, holding the amounts of all other inputs constant The marginal revenue product (MRP) of an input is the money value of the additional sales that a firm obtains by selling the marginal physical product of that input By now it should not surprise you that supply and demand determine the prices of inputs as well as the prices of goods and services The supply sides of the markets for the various factors differ enormously, so we must discuss each factor market separately We can use one basic principle, the principle of marginal productivity, to explain how much of any input a profit-maximizing firm will demand, given the price of that input To review the principle, we must first recall two concepts from Chapter 7: marginal physical product (MPP) and marginal revenue product (MRP) Table helps us review these two concepts in terms of Naomi’s Natural Farm, which has to decide how much organic corn, priced at $10 per bag, to feed its chickens The marginal National Income and Product Accounts, U.S Department of Commerce, Bureau of Economic Analysis, available at http://www.bea.gov (Note: This calculation consists of the Bureau of Economic Analysis categories, Compensation of Employees, Proprietors’ Income with IVA and CCAdj., Rental Income of Persons with CCAdj., Corporate Profits with IVA and CCAdj., and Net Interest and Miscellaneous Payments, all as a percentage of Net National Factor Income.) Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Chapter 19 physical product (MPP) column tells us how many additional pounds of chicken each additional bag of corn will yield For example, according to the table, the fourth bag increases output by 34 pounds The marginal revenue product (MRP) column tells us how many dollars this marginal physical product is worth In Table 1, we assume Naomi’s prized, natural chickens sell at $0.75 per pound, so the MRP of the fourth bag of corn is $0.75 per pound times 34 pounds, or $25.50 (last column of the table) The marginal productivity principle states that in competitive factor markets, the profit-maximizing firm will hire or buy the quantity of any input at which the marginal revenue product equals the price of the input 399 Pricing the Factors of Production TABLE Naomi’s Natural Farm Schedules for TPP, MPP, APP, and MRP of Corn (1) (2) (3) Corn Input (Bags) TPP: Total Physical Product (chicken, lbs) MPP: Marginal Physical Product per Bag 10 11 12 0.0 lbs 14.0 36.0 66.0 100.0 130.0 156.0 175.0 184.0 185.4 180.0 165.0 144.0 14.0 lbs 22.0 30.0 34.0 30.0 26.0 19.0 9.0 1.4 25.4 215.0 221.0 The basic logic behind this principle is simple, as we saw before We know that the firm’s profit from acquiring an additional unit of an input is the input’s marginal revenue product minus its marginal cost (which is the price of the additional unit of input) If the input’s marginal revenue product is greater than its price, it will pay the profit-seeking firm to acquire more of that input because an additional unit of input brings the firm revenue that exceeds its cost The firm should purchase that input up to the amount at which diminishing returns reduce the MRP to the level of the input’s price, so that further expansion yields zero further addition to profit By similar reasoning, if MRP is less than price, then the firm is using too much of the input We see in Table that about seven bags is the optimal amount of corn for Naomi to use each week, because an eighth bag brings in a marginal revenue product of only $6.75, which is less than the $10 cost of buying the bag One corollary of the principle of marginal productivity is obvious: The quantity of any input demanded depends on its price The lower the price of corn, the more it pays the farm to buy In our example, it pays Naomi to use between seven and eight bags when the price per bag is $10 But if corn were more expensive—say, $20 per bag—that high price would exceed the value of the marginal product of either the sixth or seventh bag It would, therefore, pay the firm to stop at five bags of corn Thus, marginal productivity analysis shows that the quantity demanded of an input normally declines as the input price rises The “law” of demand applies to inputs just as it applies to consumer goods (4) APP: Average Physical Product per Bag (5) MRP: Marginal Revenue Product per Bag 0.0 lbs $10.50 14.0 16.50 18.0 22.50 22.0 25.50 25.0 22.50 26.0 19.50 26.0 14.25 25.0 6.75 23.0 1.05 20.6 24.05 18.0 211.25 15.0 215.75 12.0 INPUTS AND THEIR DERIVED DEMAND CURVES We can, in fact, be much more specific about how much of each input a profit-maximizing firm will demand That’s because the marginal productivity principle tells us precisely how to derive the demand curve for any input from its marginal revenue product (MRP) curve Figure graphs the MRP schedule from Table 1, showing the marginal revenue product for corn (MRPc) rising and then declining as Naomi feeds more and more corn to her chickens In the figure, we focus on three possible prices for a bag of corn: $20, $15, and $10 As we have just seen, the optimal purchase rule requires Naomi to keep increasing her use of corn until her MRP begins to fall and eventually is reduced to the price of corn At a price of $20 per bag, we see that the quantity demanded is about 5.6 bags of corn per week (point A); at that point, MRP equals price Similarly, if the price of corn is $15 per bag, quantity demanded is about 6.8 bags per week (point B) Finally, at a price of $10 per bag, the quantity demanded would be about 7.7 bags per week (point C) Points A, B, and C are therefore three points on the demand curve for corn By repeating this exercise for any other price, we learn that because the Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com MRP per Bag of Corn per Week 400 The Distribution of Income Part $26 24 22 20 18 16 14 12 10 –2 –4 –6 –8 –10 –12 –14 –16 profit-maximizing purchase of an input occurs at the point where the MRP has fallen down to the level of the input price, A D The demand curve for any input is the downward-sloping portion of its marginal revenue product curve.2 B C Bags of Corn per Week F I GURE Marginal Revenue Product Graph for Naomi’s Natural Farm MRP per Bag of Corn The derived demand for an input is the demand for the input by producers as determined by the demand for the final product that the input is used to produce $50 40 30 20 10 10 11 12 The demand for corn or labor (or for any other input) is called a derived demand because it is derived from the underlying demand for the final product (poultry in this case) For example, suppose that a surge in demand drives organic chicken prices to $1.50 per pound Then, at each level of corn usage, the marginal revenue product will be twice as large as when poultry brought $0.75 per pound This effect appears in Figure as an upward shift of the (derived) demand curve for corn, from D0D0 to D1D1, even though the marginal physical product curves have not changed Thus, an outward shift in demand for poultry leads to an outward shift in the demand for corn.3 We conclude that, in general: An outward shift in the demand curve for any commodity causes an outward shift of the derived demand curve for all factors utilized in the production of that commodity Similarly, an inward shift in the demand curve for a commodity leads to inward shifts in the demand curves for factors used in producing that commodity This completes our discussion of the demand side of the analysis of input pricing The most noteworthy feature of the discussion is the fact that the same marginal productivity principle serves as the foundation for the demand schedule for each and every type of input In particular, as we will see in Chapter 20, the marginal productivity principle serves as the basis for the deD1 termination of the demand for labor—that crucial input whose financial reward plays so important a role in an economy’s standard of living On the demand side, one analysis fits almost all D0 The supply side for each input, however, entails a very different story Here we must deal with each of the main production factors individually We must D0 D1 so because, as we will see, the supply relationships of 10 the different inputs vary considerably We begin with interest payments, or the return on capital First, we Bags of Corn per Week must define a few key terms F I GURE A Shift in the Demand Curve for Corn Why is the demand curve restricted to only the downward-sloping portion of the MRP curve? The logic of the marginal productivity principle dictates this constraint For example, if the price of corn were $15.00 per bag, Figure shows that MRP P at two input quantities: (approximately) 1.75 bags (point D) and 6.8 bags (point B) Point D cannot be the optimal stopping point, however, because the MRP of a second bag ($16.50) is greater than the cost of the third bag ($15.00); that is, the firm makes more money by expanding its input use beyond 1.5 bags per week A similar profitable opportunity for expansion occurs anytime P MRP and the MRP curve slopes upward at the current price This must be so, because then an increase in the quantity of input used by the firm will raise MRP above the input’s price It follows that a profit-maximizing firm will always demand an input quantity that is in the range where MRP is diminishing To make Figure easier to read, the (irrelevant) upward-sloping portion and the negative portion of each curve have been omitted Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Chapter 19 401 Pricing the Factors of Production INVESTMENT, CAPITAL, AND INTEREST Although people sometimes use the words investment and capital as if they were interchangeable, it is important to distinguish between them Economists define capital as the inventory (or stock) of plant, equipment, and other productive resources owned by a business firm, an individual, or some other organization Investment is the amount by which capital grows A warehouse owned by a firm is part of its capital Expansion of the warehouse by adding a new area to the building is an investment So, when economists use the word investment, they not mean just the transfer of money The higher the level of investment, the faster the amount of capital that the investor possesses grows The relation between investment and capital is often explained by the analogy of filling a bathtub: The accumulated water in the tub is analogous to the stock of capital, whereas the flow of water from the faucet (which adds to the tub’s water) is like the flow of investment Just as the faucet must be turned on for more water to accumulate, the capital stock increases only when investment continues If investment ceases, the capital stock stops growing (but does not disappear) In other words, if investment is zero, the capital stock does not fall to zero but remains constant (just as when you turn off the faucet the tub doesn’t suddenly empty, but rather the level of the water stays the same) The process of building up capital by investing and then using this capital in production can be divided into five steps, listed below and summarized in Figure 3: Investment is the flow of resources into the production of new capital It is the labor, steel, and other inputs devoted to the construction of factories, warehouses, railroads, and other pieces of capital during some period of time SOURCE: © The New Yorker Collection 1995, Robert Mankoff from cartoonbank.com All Rights Reserved Step The firm decides to enlarge its stock of capital Step The firm raises the funds to finance its expansion, either by tapping outside sources such as banks or by holding onto some of its own earnings rather than paying them out to company owners Step The firm uses these funds to hire the inputs needed to build factories, warehouses, and the like This step is the act of investment Step After the investment is completed, the firm ends up with a larger stock of capital Step The firm uses the capital (along with other inputs) either to expand production or to reduce costs At this point, the firm starts earning returns on its investment Capital refers to an inventory (stock) of plant, equipment, and other (generally durable) productive resources held by a business firm, an individual, or some other organization “I can’t sleep I just got this incredible craving for capital.” Notice that investors put money into the investment process—either their own or funds borrowed from others Then, through a series of steps, firms transform the funds into physical inputs suitable for production use If investors borrow the funds, they must FIGU R E The Investment Production Process Decide to increase the capital stock Raise funds Investment flow: Buy inputs, use them to build up capital stock Added capital stock Other inputs Production Initial capital stock Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 402 Part The Distribution of Income Interest is the payment for the use of funds employed in the production of capital; it is measured as the percent per year of the value of the funds tied up in the capital someday return those amounts to the lender with some payment for their use This payment is called interest, and it is calculated as an annual percentage of the amount borrowed For example, if an investor borrows $1,000 at an interest rate of 12 percent per year, the annual interest payment is $120 The Demand for Funds The rate of interest is the price at which funds can be rented (borrowed) Just like other factor prices, interest rates are determined by supply and demand On the demand side of the market for loans are borrowers—people or institutions that, for one reason or another, wish to spend more than they currently have Individuals or families borrow to buy homes or automobiles or other expensive products Sometimes, as we know, they borrow because they want to consume more than they can afford, which can get them into financial trouble But often, borrowing makes good sense as a way to manage their finances when they experience a temporary drop in income It also makes sense to borrow money to buy an item such as a home that will be used for many years This long product life makes it appropriate for people to pay for the item as it is used, rather than all at once when it is purchased Businesses use loans primarily to finance investment To the business executive who borrows funds to finance an investment and pays interest in return, the funds really represent an intermediate step toward the acquisition of the machines, buildings, inventories, and other forms of physical capital that the firm will purchase The marginal productivity principle governs the quantity of funds demanded, just as it governs the quantity of corn demanded for chicken feed Specifically: Firms will demand the quantity of borrowed funds that makes the marginal revenue product of the investment financed by the funds just equal to the interest payment charged for borrowing One noteworthy feature of capital distinguishes it from other inputs, such as corn When Naomi feeds corn to her chickens, the input is used once and then it is gone But a blast furnace, which is part of a steel company’s capital, normally lasts many years The furnace is a durable good; because it is durable, it contributes not only to today’s production but also to future production This fact makes calculation of the marginal revenue product more complex for a capital good than for other inputs To determine whether the MRP of a capital good is greater than the cost of financing it (that is, to decide whether an investment is profitable), we need a way to compare money values received at different times For, other things being equal, a dollar to be received in 2011 is worth less than a dollar in 2010 because the recipient of the 2010 dollar has an additional year in which to use it to earn more money; for example, he can lend it out for an additional year and earn the additional interest To make such comparisons between money obtained at different dates, economists and businesspeople use a calculation procedure called discounting We will explain discounting in detail in the appendix to this chapter, but it is not necessary to master this technique in an introductory course There are really only two important attributes of discounting to learn here: • A sum of money received at a future date is worth less than the same sum of money received today • This difference in values between money today and money in the future is greater when the rate of interest is higher We can easily understand why this is so To illustrate our first point, consider what you could with a dollar that you received today rather than a year from today If the annual rate of interest were 10 percent, you could lend it out (for example, by putting it in a savings account) and receive $1.10 in a year’s time—your original $1.00 plus $0.10 interest For this reason, money received today is worth more than the same number of dollars received later Now for our second point Suppose the annual rate of interest is 15 percent rather than the 10 percent in the previous example In this case, $1.00 invested today would grow to Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Chapter 19 403 Pricing the Factors of Production $1.15 (rather than $1.10) in a year’s time, which means that $1.15 received a year from today would be equivalent to $1.00 received today, and so, when the interest rate is 15 percent, $1.10 a year in the future must now be worth less than $1.00 today In contrast, when the interest rate is only 10 percent per year, $1.10 to be received a year from today is equivalent to $1 of today’s money, as we have seen This illustrates the second of our two points The rate of interest is a crucial determinant of the economy’s level of investment It strongly influences the amount of current consumption that consumers will choose to forgo in order to use the resources to build machines and factories that can increase the output of consumers’ goods in the future The interest rate is crucial in determining the allocation of society’s resources between present and future—an issue that we discussed in Chapter 15 (pages 318–319) Let us see, then, how the market sets interest rates The Downward-Sloping Demand Curve for Funds A rise in the price of borrowed funds, like a rise in the price of any item, usually decreases quantity demanded But when the money is used for investment by the firm the situation is a little more complicated than the relation between price and a consumers’ good The two attributes of discounting discussed above help to explain the special reasons why the demand curve for funds has a negative slope Recall that the demand for borrowed funds, like the demand for all inputs, is a derived demand, derived from the desire to invest in capital goods But firms will receive part— perhaps all—of a machine or factory’s marginal revenue product in the future Hence, the value of the MRP in terms of today’s money shrinks as the interest rate rises Why? Because a given future return on investment in a machine or factory becomes worth less (it must be discounted more) when the rate of interest rises, as our illustration of the second point about discounting showed As a consequence of this shrinkage, a machine that appears to be a good investment when the interest rate is 10 percent may look like a terrible investment if interest rates rise to 15 percent; that is, the higher the interest rate, the fewer machines a firm will demand That is so because investing in the machines would use up money that could earn more interest in a savings account Thus, the demand curve for machines and other forms of capital will have a negative slope—the higher the interest rate, the smaller the quantity that firms will demand As the interest rate on borrowing rises, more and more investments that previously looked profitable start to look unprofitable The demand for borrowing for investment purposes, therefore, is lower at higher rates of interest The higher the interest rate, the less people and firms will want to borrow to finance their investments The Derived Demand Curve for Loans D Rate of Interest in Percent per Year Note that, although this analysis clearly applies to a firm’s purchase of capital goods such as plant and equipment, it may also apply to the company’s land and labor purchases Firms often finance both of these expenditures via borrowed funds, and these inputs’ marginal revenue products may accrue only months or even years after the inputs have been bought and put to work (For example, it may take quite some time before newly acquired agricultural land will yield a marketable crop.) Thus, just as in the case of capital investments, a rise in the interest rate will reduce the quantity demanded of investment goods such as land and labor, just as it cuts the derived demand for investment in plant and equipment Figure depicts a derived demand schedule for loans, with the interest rate on the vertical axis as the loan’s cost to a borrower Its negative slope illustrates the conclusion we have just stated: FI GURE D Dollars Demanded per Year Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 404 Part The Distribution of Income PUZZLE RESOLVED: F I GURE Equilibrium in the Market for Loans Rate of Interest in Percent per Year D 7.5% A 5.5 S THE SUPPLY OF FUNDS Somewhat different relationships arise on the supply side of the market for funds—where the suppliers or lenders are consumers, banks, and other business firms Funds lent out are usually returned to the owner (with interest) only over a period of time Loans will look better to lenders when they bear higher interest rates, so the supply schedule for loans rather naturally may be expected to slope upward—at higher rates of interest, lenders supply more funds Such a supply schedule appears as the curve SS in Figure 5, where we also reproduce the demand curve, DD, from Figure Here, the free-market interest rate is 7.5 percent However, not all supply curves for funds slope uphill to the right like curve SS As we stated in the puzzle at the beginning of the chapter, sometimes a rise in the interest rate (the price of loans that is the financial reward for saving) will lead people to save less, rather than more An example will help to explain the reason for this apparently curious behavior, which, as we will see, can sometimes be sensible behavior Say Jim is saving to buy a $10,000 used tractor in three years If he lends money out at interest in the interim, suppose Jim must save $3,100 per year to reach his goal If interest rates were higher, he could get away with saving less than $3,100 per year and still reach his $10,000 goal because every year, with the higher interest, he would get larger interest payments on his savings Thus, Jim’s saving S (and lending) may decline as a result of the rise in interest rate This argument applies fully only to savers, like Jim, with a fixed accumulation goal, but similar considE erations affect the calculations of other savers So when the rate of interest rises, some people save more but some save less B Generally, we expect the quantity of loans supplied to rise at least somewhat when the interest reward rises, so the supply curve will have a positive slope, like SS in Figure However, for reasons similar to those indicated in Jim’s example, the increase in the economy’s D saving that results from a rise in the interest rate is usually quite small That is why we have drawn the supply curve to be so steep The rise in the amount supplied by some lenders is partially offset by a decline in the amounts lent by savers with fixed goals (like Jim, who is putting money away to buy a tractor, or Jasmine, who Dollars Lent per Year is saving for an expensive camera) Having examined the relevant demand and supply curves, we are now in a position to discuss the determination of the equilibrium rate of interest This is summed up in Figure 5, in which the equilibrium is, as always, at point E, where quantity supplied equals quantity demanded We conclude, again, that the equilibrium interest rate on loans is 7.5 percent in the example in the graph The Issue of Usury Laws: Are Interest Rates Too High? People have often been dissatisfied with the market mechanism’s determination of interest rates Fears that interest rates, if left unregulated, would climb to exorbitant levels have made usury laws (which place upper limits on money-lending rates) quite popular in many times and places Attempts to control interest payments date back to biblical days, and in the Middle Ages the influence of the church even led to total prohibition of interest payments in much of Europe The same is true today in Moslem countries In the United Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Chapter 19 405 Pricing the Factors of Production States, the patchwork of state usury laws was mostly dismantled during the 1980s when the banking industry was deregulated Unscrupulous lenders often manage to evade usury laws, charging interest rates even higher than the free-market equilibrium rate Even when usury laws are effective, they interfere with the operation of supply and demand and, as we will demonstrate, they may harm economic efficiency Look at Figure again but, this time, assume it depicts the supply of bank loans to consumers Consider what happens if a usury law prohibits interest rates higher than 5.5 percent per year on consumer loans At 5.5 percent, the quantity supplied (point A in Figure 5) falls short of the quantity demanded (point B) This means that many applicants for consumer loans are being turned down even though banks consider them to be creditworthy Who gains and who loses from this usury law? The gainers are the lucky consumers who get loans at 5.5 percent even though they would have been willing to pay 7.5 percent The losers are found on both the supply side and the demand side: the consumers who would have been willing and able to get credit at 7.5 percent but who are turned down at 5.5 percent, and the banks that could have made profitable loans at rates of up to 7.5 percent if there were no interest-rate ceiling This analysis explains why usury laws can be politically popular Few people sympathize with bank stockholders, and the consumers who get loans at lower rates are, naturally, pleased with the result of usury laws Other consumers, who would like to borrow at 5.5 percent but cannot because quantity supplied is less than quantity demanded, are likely to blame the bank for refusing to lend, rather than blaming the government for outlawing mutually beneficial transactions Concern over high interest rates can be rational It may, for example, be appropriate to combat homelessness by making financing of housing cheaper for poor people Of course, it may be much more rational for the government to subsidize the interest on housing for the poor rather than to declare high interest rates illegal, in effect pretending that those costs can simply be legislated away, as a usury ceiling tries to do.4 THE DETERMINATION OF RENT Annual Rent per Acre The factor of production we will discuss next is land Rent, the payment for the use of land, is another price that, when left to the market, often seems to settle at politically unpopular levels Rent controls are a frequent solution We discussed the effects of rent controls in Chapter (pages 72–73), and we will say a bit more about them later in this chapter Our main focus here is the determination of rents by free markets S D The market for land is characterized by a special feature on the supply side Land is a factor of production whose total quantity supplied is (roughly) unchanging and virtually unchangeable: The same quantity is available at every possible price Indeed, classical economists used this notion as E $2,000 the working definition of land, and the definition seems to fit, at least approximately Although people may drain swamps, clear forests, fertilize fields, build skyscrapers, or convert land from one use (a farm) to another (a housing development), human effort cannot change the total supply S of land by very much 1,000 What does this fact tell us about how the market determines land rents? Figure helps to provide an answer Acres of Land The vertical supply curve SS means that no matter what D FI GURE The law also sometimes concerns itself with discrimination in lending against women or members of ethnic minority groups Strong evidence suggests the existence of sex and race discrimination in lending For example, as late as the nineteenth century, married women were often denied loans without the explicit permission of their husbands, even when the women had substantial independent incomes Determination of Land Rent in Littleville Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 828 Index Demand curve consumer preferences and income, 59–60 definition, 58 downward-sloping, 90–92 for funds, 402–404 graphical representation, 14–15 from historical statistics, 122–125 individual, 96–97 infinitely elastic, 111 and inputs, 399–400 kinked, 247–250 for labor, 421–424, 428 marginal utility, 90–92 and monopoly, 157, 221 under perfect competition, 199–200 price and quantity, 157–158 shifts in, 58–60, 66–67 straight-line, 112 time period of, 116, 118–120 unit-elastic, 112–113 Demand elasticity determinants of, 115–116 effect on total revenue and total expenditure, 113–115 elasticity as general concept, 116–118 elasticity as measure of responsiveness, 108–113 perfectly elastic, 111 perfectly inelastic, 112 Polaroid vs Kodak, 120 price elasticity of demand, 109, 111–113 time period of demand curve, 116, 118–120 unit elasticity, 112–113 Demand inflation, 594–595 Demand law, 97–98 Demand schedule, 58, 90 Demand-side equilibrium, 559–581 see also Equilibrium aggregate demand curve, 564–566 equilibrium GDP, 560–561, 565, 574, 607 and full employment, 566–567 income determination, 562–564, 577–578 multiplier analysis, 569–573, 574–575, 577–581 saving and investment coordination, 567–568 Demand-side fluctuations, 597–598 Demand-side inflation, 702 Demarcation line, between macroeconomics and microeconomics, 469 Denmark, 431 Depletable resource pricing, 369–371 Depletability, 317 Deposit creation, 636–640 Deposit destruction, 640 Deposit insurance, 634 Depositors, safety of, 626 Depreciate (currency), 746 see also Exchange rates Depreciation, 555 Depressions, 560 see also Great Depression Deregulation, 279–282 Derivatives, 188 Derived demand, 399–400, 403, 422–423 Detrimental externality, 312, 314, 315, 356 Devaluation (currency), 747, 754 Developing countries, 531–533 Development assistance, 531 Diamond, Gary, 633 Diamond-water puzzle, 84, 95 Diminishing marginal productivity, 140–141 Diminishing marginal returns, 131–134 Diminishing marginal utility, 86–87 Diminishing returns, 135, 143–144 Dioccletian, 56 Direct controls, 364–366 Direct taxes, 379 Dirty float, 758 Discount rate, 654 Discounting, 417–418 Discouraged workers, 498 Discrimination see Economic discrimination Discriminatory pricing, 437–438 Disposable income, 539, 541–544, 545–548 Distribution, 50–52, 292, 294–295 Division of labor, 48–49, 50 Doe, Jane, 784 Doha Round (tariff reductions), 732, 733 Dollar, U.S., 746, 758–759, 760, 764, 775 see also Exchange rates Dominant strategy, 250–252 Donne, John, 763, 774 Double coincidence of wants, 627 “Double taxation,” 180 Dough, John, 784 Dow Jones Industrial Average, 187 Downsizing trend, 431 Drucker, Peter F., 344 Drugs, 71 Dumping, 737–740 Duopoly, 250–251 Dupont Cellophane decision, 107, 119 E Earned Income Tax Credit (EITC), 457 Earnings, 29–30, 420–421, 439 Earnings, retained, 182–183 Eastern Europe, 70, 167, 305, 330, 358 Eastman-Kodak, 120, 226 ECB (European Central Bank), 787 Economic analysis, graphs in, 14 Economic decision making, 118–120, 292–299 Economic discrimination economic theory of, 461–463 by employers, 461 by fellow workers, 461 as inefficiency, 47 and labor force participation, 425 policies to combat, 458–459 productivity, 452–453 roles of market and government, 462 statistical, 462 wages, 462 Economic forecasts, 613, 676 Economic growth see Growth Economic model, 12 Economic policy, and politics, 324 Economic profit, 158–163, 207, 209–210, 412–414 see also Profits Economic rent, 406, 408–409, 411 see also Rent Economic theory of discrimination, 461–463 see also Economic discrimination Economics, 3–19 abstraction, 8–11, 468 of America’s 2010 healthcare reform, 328 as discipline, graphs, 14–19 imperfect information and value judgments, 12–13 models, 12 theory, role of, 11–12 Economics of Welfare, The (Pigou), 356 Economies of large size, 278–279 Economies of scale AT&T example, 128, 145–146 and average costs, 211 cost minimization, 136, 146, 151–152 definition, 142, 264 historical costs vs analytical cost curves, 144, 146 “law” of diminishing returns, 135, 143–144 and monopoly, 220 and perfect competition, 211 and regulation, 274 Economies of scope, 274 Economist, The, 187, 524, 724, 752 Economy, U.S see U.S economy Ecuador, 758 Edifice complex, 360 Edison, Thomas, 338, 344, 348, 420 Education and training and demand for labor, 422–423 in developing countries, 532 and growth, 524–526 and income inequality, 451 on-the-job training, 422, 425, 525–526 and poverty, 455 to reduce natural rate of unemployment, 715–716 spending on, 34 Education policy, 525 Educational services, 28 EEOC (Equal Employment Opportunity Commission), 458 Efficiency, 47, 128 vs equality, 7, 453–454, 458–459 vs growth, 305 innovation incentives, 277–278 of large firms, 128 and monopoly power, 264, 412 and perfect competition, 211–212, 299–301 of resource allocation, 288–291, 311–312 scarcity and choice, 47 self-correcting mechanism, 709–710 and taxation, 385–387, 391–392 Efficient allocation of resources, 288–291, 311–312 Einstein, Albert, 491 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Index Eisenhower, Dwight, 92 EITC (Earned Income Tax Credit), 457 Elastic demand curve, 112–113 Elasticity, 108–113, 116–118 see also Demand elasticity Elasticity of demand, 109, 438 see also Demand elasticity Electricity industry, 281 Electricity prices, 60 Electronic calculators, and output selection, 293 Emission taxes see Pollution charges Emissions permits, 366–367 Employment sectors, 28–29 Energy conservation, 386 Energy prices, 60, 528, 529 Engels, Friedrich, 197, 199 ENIAC (Electronic Numerical Integrator and Computer), 343 Enron, 187 Entrepreneurs discriminatory pricing of innovative product, 437–438 earnings of, 420–421, 439 fixed costs and public good attributes, 437 and growth, 435–440 innovation, 338–340, 435–441 and inputs, 435–441 and institutions, 440–441 negative financial rewards, 439–440 prices and profits of, 436 Entrepreneurship, 398, 413, 436 see also Entrepreneurs Entry to market, and deregulation, 280 Environmental policy approaches to, 363–367 costs excluded from GDP, 475 direct controls, 364–366 economics of, 356–368 emissions permits, 366–367 and externalities, 356–363 pollution charges, 356, 364–366 voluntarism, 363–364 Environmental Protection Agency (EPA), 315, 357, 362, 364, 367, 368 Equal Employment Opportunity Commission (EEOC), 458 Equality, vs efficiency, 7, 453–454, 458–459 Equal-marginal-revenue rule, 228 Equation of exchange, 662 Equilibrium see also Demand-side equilibrium of aggregate supply and demand, 587–588 definition, 65, 560 industry, 205–206 industry and firm in long run, 206–209 of interest rates, 404 long-run, 239 and perfect competition, 200–201 in perfectly competitive firm, 201 and real GDP, 596–597 short run, 200–201 of supply and demand, 64–70 Equilibrium GDP, 560–561, 565, 574, 607 Equilibrium price, 742–743 Equilibrium wage, 428 Equity, horizontal, 384 Escalator clause, 716 Euro, 759–760 Europe, 26, 30 see also European Union; individual nations European Central Bank (ECB), 669, 787 European Union, 294, 379, 449, 648, 737, 759–760 Excess burden, 386–387 Excess capacity theorem, 239–240, 257 Excess reserves, 636, 653 Exchange rates and aggregate demand, 765–767 and aggregate supply, 766 appreciate/depreciate, 746 Argentina, 745, 753, 756, 757, 758 Brazil, 745, 757, 758 Canada, 746, 747 China, 753, 757 and deficit reduction, 770–772 determination of, 747–752 devaluation, 747, 754 dollar, value of, 746, 764, 775 and economic activity, 750 effect of supply and demand, 747–752 effects of changes in, 765–766 European Union, 759–760 fiscal expansion, 769 fixed, 753–754, 756–757 floating, 747 Indonesia, 745, 774 inflation, 751–752, 756 interest rates, 749–750, 756 international trade, 726, 764–766 Japan, 747, 767 macroeconomic effects of, 767–768 Mexico, 747, 757, 758 price ratios, 730 purchasing power parity theory, 750–752 and relative prices, 549–550 revaluation, 747, 754 in Russia, 745, 758 in South Korea, 774 and trade deficit, 766, 772–774 of various currencies, 747 Excise tax, 379, 381, 383, 389–390, 619 Excludability, 317 Expansion path, 151–152 Expected inflation, 504–505, 716 Expenditure, consumer, 538–539 Expenditure schedule, 562–563 Expenditures, government, 34 Experience, 422, 452, 715–716 Export subsidy, 733 Exports, 23–24, 579–580, 765 see also Net exports Externalities, 6, 334 beneficial, 312, 314, 315, 350–351, 356 Coase theorem, 316 detrimental, 312, 314, 315, 356 government policy, 315–316 and inefficiency, 47, 312–314 as shortcoming of market mechanism, 312–316, 356–363 Exxon Mobil Corp., 69, 179 829 F Factors of production definition, 22 inputs and their derived demand curves, 399–400 investment, capital and interest, 401–405 marginal productivity, 140–141, 398–399, 414–415 profits, 411–414 rent determination, 405–411 Famines, 335 Farm sector, 29 Farming advertising, 236 economics, 204 price supports, 73–74 and water prices, 147 Fastow, Andrew, 187 Favoritism, 75 FCC (Federal Communications Commission), 256 FDIC (Federal Deposit Insurance Corporation), 634, 790 “Fed.” see Federal Reserve System Federal budget, 40 Federal Communications Commission (FCC), 256 Federal Deposit Insurance Corporation (FDIC), 634, 790 Federal Energy Regulatory Commission, 60 Federal funds rate, 650 Federal Open Market Committee (FOMC), 647–648, 649 Federal Reserve Board, 319, 481–484, 646, 701 Federal Reserve System and Bernanke, 646 budget deficits, 770–771 central bank independence, 648–649 control debate (money supply or interest rates), 668–671 financial crisis, 788, 789 monetary policy, 647–649 origins and structure of, 647 and recessions, 674 Federal tax system see Taxation Federal Trade Commission, 267 Federal Trade Commission Act, 266 Fiat money, 630 FIB (Friendly Investment Bank), 786 Final goods and services, 473, 553, 554, 555–556 Financial crisis, 779 of 2007–2008, 646, 653 to Great Recession, 788–791 hitting bottom and recovering, 791–792 housing price bubble, 784–785, 786–787 lessons, 792–793 leverage, 782–784 roots, 780–782 subprime mortgage crisis, 784, 785 profits, 782–784 risk, 782–784 Finland, 450 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 830 Index Fiscal federalism, 384 Fiscal policy aggregate demand, 605–623, 698 aggregate demand shifts, 657 algebraic treatment, 622–623 contractionary, 611, 667, 698 definition, 479–480, 605 difficulties, 612–613 expansionary, 610, 612, 665–667, 708, 756, 769 of George W Bush, 612 graphical representation, 619–621 income taxes and consumption schedule, 606–607 and interest rates, 665–667 international capital flows, 769 to limit economic fluctuations, vs monetary policy, 654, 667–668, 685 and the multiplier, 607–610 in open economy, 768–770 and recessionary gap, 611 Republican Party, 612 spending policy vs tax policy, 611–612 supply-side tax cuts, 613–617 and taxation, 619–623 time lags, 613 trade deficit, 766, 771–774 and unemployment, 483–484, 708 and velocity, 662–667 Fitzgerald, F Scott, 531 Fixed consumption function, 565, 572 Fixed costs and entrepreneurs, 437 and profit-maximizing price, 168–169 vs variable, 129–130 Fixed exchange rates, 753, 756–757 Fixed taxes, 619–620 Floating exchange rates, 747 Fluctuations, economic during 1990s, 705–706 aggregate demand curve, 703 Clintonomics, 481–482 demand-side, 597–598 in George W Bush economy, 477, 482–483 Great Depression, 478–479 Great Stagflation (1973–1980), 480 growth, 24–25, 475–477 inflation and deflation, 477–478 limiting, Phillips curve, 703–704 Reaganomics, 481 supply-side inflation, 598–599, 702–703, 705–706 World War II to 1973, 25–26, 479–480 Flypaper theory of tax incidence, 387–388, 390 FMOC (Federal Open Market Committee), 647–648, 649 Food stamps, 456, 457 Foreclosure, 785 Ford Motor Co., 31, 32, 241 Forecasts, economic, 613, 676 Foreign aid, 531 Foreign direct investment, 531–532 Fractional reserve banking, 632 France, 22, 26, 35, 434, 497, 725, 747 Franklin, Benjamin, 368, 489, 723 Frederick the Great, 336 Free markets see also Free trade; Market system; Price system exchange rates, 747–752 growth vs efficiency, 305 imperfect information, 320, 321 innovation, 338–349 moral hazard, 320, 634 Poland‘s transition to, 294, 358 productivity, 330 research and development spending, 349–351 shortcomings, 309–332 externalities, 312–316, 356–363 government failure, 323–330 imperfect information, 320–321 increasing costs of vital services, 324–330 list of, 310 moral hazard, 320, 634 principal-agent problem, 321–323 provision of public goods, 316–318, 348, 437 rent seeking, 320 resource allocation between present and future, 318–319 Free trade, 735, 738 see also Free markets Freedman, Audrey, 463 Free-rider problem, 317 Frictional unemployment, 498 Friedman, Milton, 666, 670 Friendly Investment Bank (FIB), 786 Fuel crisis, history, 370 see also Oil Full employment, 499, 566–567, 613 Funds, 402–404 Future, 343, 549 Future income expectations, and consumption function, 547–548 G Galbraith, John Kenneth, 645 Game theory, 250–253, 256 Gasoline distribution, 291 Gasoline tax, 69–70 Gates, Bill, 344, 439, 451 GDP see Gross Domestic Product (GDP) GDP deflator, 513 Gender, workforce composition, 27 General Electric, 267, 468 General Motors, 31, 129, 179, 277, 468, 585 General Theory of Employment, Interest, and Money, The (Keynes), 479, 552, 566 Geography, as problem for developing countries, 532–533 George, Henry, 406 Germany currency, 747 GDP of, 22 hyperinflation, 507–508, 666 investment in, 528 labor strikes, 434 labor union membership, 431 openness of economy, 24 taxes in, 35 unemployment, 26, 497 Gilman, Mark, 68–69 Global financial meltdown, 789 Global warming, 315, 360, 361 Globalization, 723, 724 see also International trade GNP (Gross national product), 555 Gold standard, 754–755 Goods, inferior, 96, 104–105 Goods, intermediate, 473, 554, 555–556 Goods, nature of, 115 Goods and services, future of, 327–328 Google, 185 Gore, Al, 377, 616 Gough, William, 633 Governance, in developing countries, 533 Government budget, and investment, 667 and economic discrimination, 462 as employment sector, 28–29 expenditures, 34 failures, 323–330 and fixed exchange rates, 753–754 intervention, 673–675 policy, 315–316, 677 and pollution, 360 as redistributor, 35 as referee, 33 regulation, 33–34, 211 role of, 32–35 size of, 612, 676–677 spending surge under George W Bush, 697 taxes see Taxation transfer payments, 35, 541, 609–610, 716 Government purchases, 539 Graphs average curves, 174 comparative advantage, 728–731 contour maps, 18–19 demand curve, 14–15 economics, 14–19 fiscal policy, 619–621 marginal curves, 174 rays through origin and 458 lines, 17–18 short-run profit, 201–202 slope, definition and measurement, 15–17 two-variable diagrams, 14–15 Grasso, Dick, 187 Great Boom of 1990s, 760 Great Britain see United Kingdom Great Depression and banking system, 642 economic fluctuations during, 478–479 gold standard, 754–755 Keynes on, 566 and labor, 420 price supports, 73 savings during, 541 and self-correcting mechanism, 592 stock prices during, 183 unemployment, 25–26, 496–497 unemployment insurance, 500 Great Lakes region, 357 Great Recession, 779 financial crisis to, 788–791 Great Stagflation (1973–1980), 480 Greenspan, Alan, 178, 671, 677 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Index Gross Domestic Product (GDP) see also Potential GDP; Real GDP; Real GDP per capita components, 472–474 definition, 23, 337 equilibrium, 560–561, 565, 574, 607 exceptions to the rules, 552–553 and labor costs, 420, 725 limitation of, 474–475 in macroeconomics, 471–475 national debt relative to, 688 and national income, 537–539 nominal GDP, 472, 476 real GDP see Real GDP as sum of all factor payments, 553–555 as sum of final goods and services, 553 as sum of values added, 555–556 and taxation, 378–379 in various nations, 22 Gross national income, 540 Gross national product (GNP), 555 Gross private domestic investment, 553 Growth in Africa, 522 of aggregate demand, 702 aggregate demand as determinant of, 686 of aggregate supply, 686 aggregate supply-demand model, 471, 596–600, 613–614 in China, 517, 522, 531, 739 convergence hypothesis, 520–522 of demand, 523 in developing countries, 531–533 as economic goal, 490–495 vs efficiency, 305 and entrepreneurs, 435–440 investment, 686 long run vs short run, 533 under market system, 334–338 in Mexico, 522 national debt, 695–696 as part of economic fluctuations, 24–25, 475–477 of potential GDP, 493–494 production capacity, 492–493 productivity growth, 8, 490–491, 518–520, 529 productivity rates, 527–531 rate of, 25, 476–477, 492, 493–495, 520–522 and real GDP, 476 in Russia, 517, 522 slow down (1973–1995), 527–528 slow down, 2006–2007, 468 trade deficit, 766, 771–774 Growth policy capital formation, 522–524, 526 definition, 490, 517 education and training, 524–526 technological change, 526–527 H Haiti, 522 Hamilton, Alexander, 736, 781 Hammurabi, 56 Hardman, Sasha, 427 Harrington, Michael, 446–447 Head tax, 379 Health, in developing countries, 533 Health care costs, 34, 310, 325–326, 328, 329–320 Healthcare reform 2010, of America, 328 Health services, 28 Heinz‘s Pet Products Company, 114 Hemingway, Ernest, 531 Herfindahl-Hirschman Index (HHI), 267–268, 269 Heron of Alexandria, 435, 440 Herrnstein, Richard, 451 Heywood, John, 235 HHI (Herfindahl-Hirschman Index), 267–268, 269 Highmark, Inc., 272 High-tech industries, 340–343 see also Technology Highway congestion, 291 Hirsch, Yale, 191 Hispanic workers, labor force participation, 425 Home mortgage, 781 Hong Kong, 520 Hoover, Herbert, 478, 683 “Hooverville,” 478 Horizontal equity, 384 Horses, and pollution, 359 Hot money, 749 Housing bubble, 482, 635, 784–785 Hub-and-spoke system, 280 Hugo, Victor, 467 Human capital, 422–423, 451, 520 Human capital theory, 429 Human Genome Project, 527 Hungary, 507 Hurricane Katrina, 429 Hyperinflation, 507–508, 666 Hypothesis, 11 I IBM (International Business Machines), 220, 267, 352, 532, 750 IMF (International Monetary Fund), 508, 758 Imperfect information, 320, 321 Imperial Food Products, 432 Imports, 23–24, 578–581, 737–740, 765 see also International trade Incidence of a tax, 387–391 Incidental cost, 313 Incidental damage, 357 Income and circular flow, 539–541 and consumer spending, 541–544 determinants of, 562–564, 577–578 disposable, 539, 541–544, 545–548 distribution, 304–305, 398, 445, 449–450, 615 future expectations of, 547–548 inequality of, 450–452 and inflation, 504 median, 452 vs money, 646 national, 537–539, 541, 549, 554 per capita, 334 831 and quantity demanded, 95–96 real consumer income, 564–565 taxation, 379, 380–381, 457, 572, 606–609, 614, 619 vs wealth, 564–565 Income effect, 426, 427 Income elasticity of demand, 116 Income gap, 421 Income security programs, 34 Income-expenditure diagram, 563–564 Incomplete specialization, 731 Increasing costs, principle of, 44 Increasing returns to scale, 142–146 Index fund, 184 Index number, 511 Indexing, 716–717 India, 522, 524, 532, 739 Indifference curve, 102 Indifference curve analysis budget line, 100–101, 150 properties of, 101–103 slope of, 103–106 Indirect taxes, 379 Individual demand curve, 96–97 Individual Retirement Accounts (IRA), 547 Indonesia, 745, 774 Induced increase in consumption, 572 Induced investment, 562–563, 695 Industrial Revolution, 335, 336 Industry and competition, 31 concentration of, 267 equilibrium in long-run, 206–209 equilibrium in short-run, 205–206 long-run supply curve, 210–212 perfect competition, 205–211 protection for particular, 734–735 short-run supply curve, 204, 205 size, and shifts in supply curve, 62–63 Inefficiency, 47, 312–314 see also Efficiency Inelastic curve, 112–113, 438 Inequality, 446, 449–452, 457–458 Infant-industry argument, 736–737 Inferior goods, 96, 104–105 Infinite slope, 15 Infinitely elastic demand curves, 111 Inflation see also Inflationary gap in 1960s and 1970s, 480 aggregate demand curve, 588–589 aggregate supply curve, 588–589, 657 average level of, 507 and budget deficits, 692–694 combating, 484 Consumer Price Index (CPI), 512 as coordination failure, 568–569 costs of, 506–508, 709 deficit spending, 693 definition, 471 and deflation, 477–478, 591–593 of demand, 594–595 demand-side, 702 demand-side vs supply-side, 702 distortions of, 505–506 and economic fluctuations, 477–478 as economic goal to keep low, 500–509 effect on bondholders, 181 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 832 Index exchange rates, 751–752, 756 expectations and the Phillips curve, 710–712 expected rate of, 504–505, 716 hyperinflation, 507–508, 666 and income, 504 index numbers for, 511 and monetary policy, 657 and money growth, 666 and the multiplier, 588–589 myths, 501–504, 509 predictable, 507 pure, 503 real vs nominal interest rates, 504–505 and real wages, 501–502 real world, 503 as redistributor of income and wealth, 504 and relative prices, 503–504 statistical measurements of, 511–513 supply-side, 598–599, 702–703, 705–706 unemployment, 7–8, 583, 708 unemployment trade-off, 701–717 unexpected, 504–505 unpredictable, 507 using price index to measure, 512–513 variability of, 507 Inflation premium, 716 Inflation targeting, 481, 484, 677, 709–710 Inflationary gap, 567–568, 589–591, 593–595, 611, 706–707 Information Age, 29, 529 Information technology (IT), 528–529 Infrastructure, public, 34 Inherited wealth, 452 Innovation “arms race,” 342–343, 345–346 “assembly lines,” 340–343 as beneficial externality, 350–351 and collaboration, 353 definition, 413–414, 526–527 demand, stimulation of, 339 dissemination of new technology, 351–353 effect of price on, 348–349 effect on outputs, 348–349 entrepreneurs, 338–340, 435–441 financing of, 345–346 as free market accomplishment, 338–349 incentives for, 277–278 kinked revenue curve model of spending, 346–348 labor, 423 licensing of, 351 in market system, 338–349 and monopoly, 227 and monopoly power, 264 natural resource increases, 373 and oligopolistic firms, 340–349 process, 349 product, 348–349 as public good, 348 scale required for, 279 Schumpeter‘s model, 343–344 Innovative entrepreneurship, 413, 436 Input-output analysis, 295–297 Inputs, 32, 42, 489 capital, 30 combinations of, 150–151 and demand curve, 399–400 derived demand curves, 399–400 entrepreneurs, 435–441 labor see Labor opportunity cost, 137 optimal combination of, 133–137 optimal quantity, 132–133 price changes in, 63, 136–137 production and cost with one variable, 130–133 production capacity, 492–493 quantities, 137–139 scarcity and monopoly, 219 substitutability, 134–135 variability, 128–130 Insolvent, 783 Institutions, and entrepreneurs, 440–441 Interdependence, 84, 236, 242–243, 245 Interest, 34, 402 see also Interest rates Interest rate differentials, 749–750 Interest rate spreads, 780, 781 Interest rates behavior of, 1979–1985, 671 and bond prices, 181–182 compounding, 491 cuts, 482–483 debt, 687–689, 694–695 and demand for funds, 402–404 equilibrium of, 404 exchange rates, 749–750, 756 Federal Reserve System, 668–671 fiscal policy, 665–667 history of, 56 international capital flows, 768–770 monetary policy, 655 monetization, 693–694 multiplier, 666–667 open-market operations, 652 opportunity cost, 318–319 real, 504–506, 522–523, 546–547 resource allocation, 318–319 risk and reward in, 781 role of in resource allocation, 318–319 usury laws, 404–405 velocity, 662–667 Intermediate goods, 473, 554, 555–556 International Business Machines (IBM), 220, 267, 352, 532, 750 International capital flows, 768–770 International Energy Agency, 244 International Ladies Garment Workers‘ Union, 432 International Monetary Fund (IMF), 508, 758 International monetary system, 745–761 adjustment mechanisms, 756 balance of payments, 753–754, 756 Bretton Woods system, 755 current “nonsystem,” 757–760 euro, 759–760 exchange rates see Exchange rates gold standard, 754–755 International Monetary Fund (IMF), 508, 758 volatile dollar, 758–759 International trade see also Imports “cheap foreign labor,” 723–724, 731–732, 738 and comparative advantage, 727–732 deficit, 766, 771–774 dumping, 737–740 and exchange rates, 726, 764–766 gains from, 729–730 globalization, 723–724 vs intranational trade, 726–727 multiplier, 579–580 mutual gains, 725–726 political factors, 726 prices, 742–744 and real GDP, 765 reasons for, 725–726 reasons to inhibit, 734–737 and recessions, 764 supply, demand, and pricing, 742–744 tariffs and quotas, 732–737, 743–744 unfair foreign competition, 739 Internet, 529 Internet bubble, 449, 760 Intimate Bookshop, Inc., 272 Intranational trade, 726–727 Invention, 338, 340, 413–414, 440, 526–527 Inventory, 401, 552 Investment see also Bonds; Stocks business, 655 capital and interest, 401–405 coordination with savings, 567–568 as factor of production, 401–405 foreign direct, 531–532 in Germany, 528 in government budget, 667 growth, 522–524, 686 in housing, 655 induced, 562–563, 695 lagging, 528 monetary policy, 655–656 and savings, 567–568 surge in, 528–529 trade deficit, 766, 771–774 variability of, 548–549 Investment banks, 187–188 Investment in human capital, 422–423, 429, 451, 520 Investment spending, 539, 548–549 Investor protection, 524 Invisible hand, 56, 70, 211–212, 257, 292, 303, 309 iPhone, 339 IQ tests, 451 IRA (Individual Retirement Accounts), 547 Iran, 736 Iraq, 595, 736 Ireland, 290 Iron ore, 356 “Irrational exuberance,” 178 Irreversible decisions, 319 Isoquant see Production indifference curves IT (Information technology), 528–529 Italy currency, 747 educational attainment in, 532 GDP of, 22 investor protection, 524 labor strikes, 434 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Index taxes in, 35 unemployment, 26, 497 It‘s a Wonderful Life (Capra), 633 Ivory trade, 76 J Jackson, Andrew, 629 January barometer stock market predictor, 191 Japan central bank of, 648 deflation, 593 educational attainment in, 532 exchange rates, 747, 767 GDP of, 22 investment in, 528 investor protection, 524 labor, 520, 725 labor strikes, 434 living standards, 731–732 openness of economy, 24 productivity, 490–491 taxation, 35 trade with U.S., 549–550, 727–729, 730–731, 772 unemployment rates, 26 wages, 725 Jefferson, Thomas, 34 Job market for college graduates, 595 Job placement, 715–716 Jobs, Steven, 344 Johnson, Lyndon, 447 Justice, Department of, 267, 270 K Kahn, Alfred, 324 Kansas City, 359 Kelly, Richard, 55 Kennedy, John F., 499, 605 Kenya, 76 Kerry, John, 377, 616 Keynes, John Maynard, 537, 549, 559 Bretton Woods system, 755 on coordination failure, 568 on equilibrium GDP, 560 The General Theory of Employment, Interest, and Money, 479, 552, 566 on Great Depression, 566 on stock market behavior, 192 Keynesian model aggregate demand curve, 657–658 monetary policy, 656–658, 665 money and price level in, 656–658 recessions, 714–715 theory, 11, 12 King, Martin Luther, Jr., 497 Kinked demand curve, 247–250 Kinked revenue curve model, 346–348 Kodak, 120, 226 Kohn, Donald, 787 Kozlowski, Dennis, 187 Krueger, Alan, 499 Kydland, Finn, 678 L Labor bilateral monopoly, 433 costs of, 420, 725 demand for, 421–424, 428 division of, 48–49, 50 during Great Depression, 420 human capital theory, 429 increase in labor force participation, 424–425 and innovation, 423 as input, 26–30 mobility impediments, 726–727 monopsony, 433 quality of, 520 supply of, 424–427, 429, 586–587 supply of and leisure time, 425–427 teenagers, 429–430 unions and collective bargaining, 430–434 wage determination in competitive markets, 421–424 wage differences, 428–430, 450–452 working conditions, 432 Labor force, 492–493 Labor force participation, 424–425 Labor productivity, 327, 491, 493–494, 530 Labor Statistics, Bureau of, 497–498 Labor union, 280, 424, 430–434 Lags, 613, 667–668, 675–679 Laissez-faire, 293 Lake Erie, 357 Lake Karachay, 359 Lake Superior, 364 Land, 405–408 see also Rent Latin America, and property rights, 524 Law of conservation of matter and energy, 361–363 Law of demand see Demand law Law of diminishing marginal productivity see Diminishing marginal productivity Law of diminishing marginal returns see Diminishing marginal returns Law of diminishing marginal utility see Diminishing marginal utility Law of diminishing returns see Diminishing returns Law of supply and demand see Supply and demand Leeson, Nicholas, 188 Leisure time, and labor supply, 425–427 Lemons, 321 Leontief, Wassily, 296 Leverage, 782–784 Liability, 635–636 Limit order, 183–184 Limited liability, 180 Lincoln, Abraham, 435 Liquid Crystal Display (LCD), 353 Liquidity, 631 Living conditions, 336 Living standards, 731–732 Local services, and deregulation, 280 Lockouts, 434 London, fogs of, 357 London School of Economics, 12 Long run, 129, 142–143, 239 Longfellow, Henry Wadsworth, 309 Longfield, Mountifort, 290 Long-run average cost (LRAC), 210–213 Long-run supply curve, 210–212 Long-Term Capital Management, 188 833 Los Angeles Summer Olympic Games, 363–364 Louisiana Pacific Corporation, 364–365 LRAC (Long-run average cost), 210–213 Lucas, Robert E., Jr., 517 Luxembourg Income Study, 450 Luxury goods, 115 M M1, 630–631 see also Money M2, 631 see also Money Maastricht Treaty, 648 Macroeconomic policy, goals of, 489–514 economic growth, 490–495 low inflation, 500–509 low unemployment, 495–500 Macroeconomics, 467–485 see also specific topics and aggregate demand, 489–490 and aggregate supply, 489 and aggregation, 468–469 exchange rates see Exchange rates fluctuations, economic see Fluctuations, economic gross domestic product, 471–475 vs microeconomics, 468–469 stabilization policy, 483–485 supply and demand in, 469–471 ‘Magic box,’ 413 Managed float, 758 Manufacturing, 28, 30, 423, 431, 724–725 Manure, and pollution, 359 Maps, 9–11, 18–19, 149 Marginal analysis to achieve optimal output, 167, 301–306 importance of, 155–156 logic of, 168–170 marginal costs in, 170–171, 302 maximization of total profit, 156, 161–167 optimal purchase rule, 87–90, 92, 135–136, 509 role of, 170–171 selling below costs, 169–170 Marginal cost curves, 137–139 Marginal costs (MC) vs average cost pricing, 276–277 compared to average costs, 6, 173–174 in marginal analysis, 170–171, 302 optimization, 165–167 perfect competition, 200 public goods, 317 vs total and average costs, 161, 211 Marginal curves, graphical representation of, 174 Marginal fixed costs, 139 Marginal land, 407 Marginal physical products (MPP), 130–132, 398, 428 Marginal private benefit (MPB), 313 Marginal private cost (MPC), 313–314 Marginal productivity, 140–141, 398–399, 414–415 Marginal productivity theory of distribution, 414–415 Marginal profit, 163–165 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 834 Index Marginal propensity to consume (MPC), 544–545 Marginal returns, 131–134 Marginal revenue (MR), 159–160, 165–167, 173–174, 200 Marginal revenue product (MRP), 132–133, 398–400 Marginal revenue product of labor (MRPL), 422 Marginal social benefit (MSB), 313 Marginal social cost (MSC), 313–314 Marginal tax rate, 379, 392 Marginal utility, 86–92, 95, 302 see also Utility analysis Market demand curve, 96–97 Market economy, 48, 167 see also Free markets; Free trade; Price system Market exchange, 50 Market failure see Free markets Market order purchase, 183 Market power, 267–269, 274 see also Antitrust laws; Recession Market price, 41 Market share, 119 Market system in China, 167 definition, 50–52 depletable resource pricing, 369–371 dissemination of new technology, 351–353 externalities, 356–363 growth, 334–338 innovation, 338–349 overview, 330 research and development, 349–351 Market value of time, 42 Markets, 32 see also Free markets Marshall, Alfred, 583 Marshall, Steve, 69 Marx, Karl, 35, 52, 305 Maximization, logic of, 163–170 Maximization of profits, 156, 161–167 Maximum criterion, 252–253 Mayak industrial complex, 359 Mazda, 32 MBS (mortgage-backed securities), 786 McCain, John, 392, 446, 616 McCullough, Robert, 60 McDonnell-Douglas, 733 Medicaid/Medicare, 34, 381, 456 Medium of exchange, 628 see also Money Mercantilism, 732 Mexico central bank of, 649 currency, 747, 757, 758 educational attainment in, 532 growth, 522 investor protection, 524 labor costs, 725 openness of economy, 24 trade with U.S., 730 wages, 724–725 Microeconomics, vs macroeconomics, 468–469 see also specific topics Microsoft, 220, 222, 267, 270–271, 451 Military spending, 45 Milk consumption, 67 Mill, John Stuart, 625 Minimum wage, 499 Misallocation of resources, 75–76, 311 see also Resource allocation Mixed economy, 36 Mobility impediments, 726–727 Monetarism, 661, 665, 666, 670–671 Monetary control see Monetary policy Monetary policy aggregate demand, influence on, 656, 685 aggregate supply, 657 changing reserve requirements, 654 contractionary, 654 definition, 645–646 expansionary, 652, 654, 656–657, 693–694, 698, 708, 756 Federal Reserve System, 647–649 vs fiscal policy, 654, 667–668, 685 inflation, 657 inflation targeting, 481, 484, 677, 709–710 and inflationary effects of deficit spending, 693 interest rates, 655 international capital flows, 768–770 investment, 655–656 Keynesian model, 656–658, 665 lending to banks, 653–654 methods of monetary control, 652–654 money vs income, 646 multiplier, 656 need for, 643 in open economy, 768–770 open-market operations, 649–652 policy debates, 658 total expenditure, 655–656 trade deficit, 766, 771–774 unemployment, 708 workings of, 654–656 Monetary union, 759 Monetizing the deficit, 693–694 Money, 50 see also Money supply anticounterfeiting features, 629 vs barter, 627–628 creation of, 636–642 limits by single bank, 636–638 oversimplified formula, 642 by a series of banks, 638–640 full-bodied paper money, 630 growth of, and inflation, 666 vs income, 646 inflationary expectations, 710–712 M1/M2, 630–631 measurements of, 630–632 as medium of exchange, 628 nature of, 626–630 objects used as, 628–630 and price level in Keynesian model, 656–658 primitive forms of, 628 quantity theory of, 662–665 redesigning bills, 629 Money cost, 41–42, 658 Money market deposit accounts, 631 Money market mutual funds, 631 Money multiplier, 640 Money profit, 43 Money revenue, 132–133 Money supply, 630–632 see also Money bank discretion over, 632–633 contractions of, 640–642 and Federal Reserve System, 668–671 origins of, 635–636 Money-fixed asset, 546, 564 Monopolistic competition attributes of, 258–259 characteristics of, 236–238 excess capacity theorem and resource allocation, 239–240, 257 price and output determination, 238 and public welfare, 257–258 Monopoly, 157, 217–232 see also Antitrust laws Adam Smith on, 217 anticompetitive practices, 270–271 benefits of, 226–227 bilateral, 433 cost curves, 226 definition, 218–221 demand curve, 157, 221 demand shift, 225–226 economies of scale, 220 and innovation, 227 license, 409 natural monopoly, 218, 220–222, 227 and outputs, 224–225 vs perfect competition, 224–225 power, 264, 412 price discrimination under, 227–230 profits, 224, 345–346 public welfare, 264–265 pure monopoly, 195, 218, 258–259 regulation, 211, 220–221 resemblance of vigorous competition, 269–270 resource allocation by, 225 scarcity of inputs, 219 sources of, 219–220 supply decision, 221–226 Monopoly license, 409 Monopoly power, 264, 412 Monopoly profits, 224, 345–346 Monopsony, 433 Moore‘s law, 343 Moral hazard, 320, 634 Morgenstern, Oskar, 250 Morris, Robert, 449 Mortgage-backed securities (MBS), 786 Mozambique, 524 MPB (Marginal private benefit), 313 MPC (Marginal private cost), 313–314 MPC (Marginal propensity to consume), 544–545 MPP (Marginal physical products), 130–132, 398, 428 MR (Marginal revenue), 159–160, 165–167, 173–174, 200 MRP (Marginal revenue product), 132–133, 398–400 MRPL (Marginal revenue product of labor), 422 MSB (Marginal social benefit), 313 MSC (Marginal social cost), 313–314 Mugabe, Robert, 508 Multinational corporations, 31–32, 531–532 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Index Multiplier aggregate demand curve, 574–575 algebraic statement, 571–573 and automatic stabilizers, 609 definition, 569–570 and demand-side equilibrium, 569–573, 574–575, 577–581 effect on equilibrium GDP, 607 as general concept, 573–574 and government transfer payments, 35, 541, 609–610, 716 illustration of, 570–571 and income determination, 577–578 inflation, 588–589 interest rates, 666–667 and international trade, 579–580 monetary policy, 656 overstatement of, 608 spending chain, 571 taxes, 607–610, 621 variability of, 613 with variable imports, 578–581 Municipal bonds, 380 Murray, Charles, 451 Mutual fund, 184 N NAAQS (National ambient air quality standards), 357 NAFTA (North American Free Trade Agreement), 724, 732 NASA (National Aeronautics and Space Administration), 527 NASDAQ stock market, 178, 186 Nash, John, 253 Nash equilibrium, 253 National Aeronautics and Space Administration (NASA), 527 National ambient air quality standards (NAAQS), 357 National debt as a burden, 691–692 contributors, 696 definition, 687 facts, 687–689 foreign holders of, 692 interest on, 34 relative to GDP, 688 and slow growth, 695–696 National defense, 34, 735–736 National income, 537–539, 541, 549, 554 National income accounting, 552–556 National Institutes of Health (NIH), 527 National Science Foundation (NSF), 527 Natural monopoly, 218, 220–222, 227 Natural rate of unemployment, 707, 715–716 Natural resources allocation of, 319 economics of, 368–375 actual prices in 20th century, 371–374 depletable resource pricing, 369–371 interferences with price patterns, 372–374 and innovation, 373 price controls, 56–57, 329, 373–374, 480 reserves, 372–373, 375 supply of, 356 Near moneys, 631 Necessities, 115 Negative financial rewards, 439–440 Negative income tax (NIT), 456–457, 610 Negative slope, 15 Net exports, 539, 549–550, 579, 764 see also Exports Net national product (NNP), 554 Net of transfers, 541 Net taxes, 541 Net utility, 88 Net worth, 636 Netherlands, 24, 35, 365, 450 Network externalities, 270 “New Economy,” 481–482, 702 New Orleans, 429 New York City, rent controls in, 72–73 New York Stock Exchange (NYSE), 185–189 New York Times, 76 New York Yankees, 411 Newman, Pauline, 432 NIH (National Institutes of Health), 527 NINJA loans, 781 Nippon Steel Co., 69 Nissan, 32 Nixon, Richard, 374, 480, 755 NNP (Net national product), 554 No Child Left Behind, 525 Nobel Prize winners Finn Kydland, 678 Robert E Lucas, Jr., 517 Edward Prescott, 678 Robert M Solow, Nominal GDP, 472, 476 Nominal rate of interest, 504–506 Nominal wage, 502, 585–586, 591–592 Nonconsumption uses, as portion of GDP, 31 Nonmonetary attractiveness, 429 Nordhaus, William, 421, 439 Normal goods, 96 North American Free Trade Agreement (NAFTA), 724, 732 North Korea, and central planning, 295 Northern Rock (bank), 626, 633 Northern Telecom, 32 Northwest Airlines, 245 Norway, 450 NSF (National Science Foundation), 527 NTT, 32 O Obama, Barack, 46, 606, 612, 616, 684, 724, 780, 787, 791, 792 Official deficit, 690 Offshoring, 724–725 Oglala Sioux, and poverty, 447 Oil, 56, 68–69, 373, 595–596, 600, 705–706 see also Fuel crisis, history Okun, Arthur, 454 Oligopoly, 195, 211, 241–256 advertising, 236, 241 attributes of, 258–259 behavior analysis, 242 behavior models, 242–246 game theory, 250–253, 256 games with dominant strategy, 250–252 835 and innovation, 340–349 kinked demand curve, 247–250 Nash equilibrium, 253 public welfare, 257–258 repeated games, 254–256 sales maximization, 246–247 zero-sum game, 253–254 Olympic Games (Los Angeles), 363–364 On-the-job training, 422, 425, 525–526 OPEC (Organization of Petroleum Exporting Countries), 243, 244, 374–375, 480, 528, 595, 600 Open economy, 23–24, 763 aggregate supply in, 766 fiscal and monetary policy, 768–770 fiscal expansion, 769 Open-market operations, 649–652 bank reserves market, 649–650 bond prices, 652 contractionary, 669 expansionary, 669–670 interest rates, 652 mechanics of, 650–652 Opportunity cost of capital, 209–210 and comparative advantage, 49 and consumer choice, 92–96 definition, 4–5 of inputs, 137 interest rates, 318–319 money cost, 41–42, 658 nature of, 45 and production possibilities frontier, 44 rent, 409 scarcity and choice, 40–42 subsidized water prices, 147 Optimal decision, 42, 119, 156, 158–164 Optimal output, 167, 301–306 Optimal purchase quantity, 88 Optimal purchase rule, 87–90, 92, 135–136, 509 Optimal tax, 391–392 Optimization, 165–167 Orange County, California, 188, 291 Organization of Petroleum Exporting Countries (OPEC), 243, 244, 374–375, 480, 528, 595, 600 Origin, 14 Other America, The (Harrington), 446–447 Outputs, 30–31, 32, 42, 489 cost, 137–142 distribution of, 50–52 effect of innovation on, 348–349 electronic calculator example, 293 under monopolistic competition, 238 optimal, 167, 301–306 optimal decision, 164 perfect competition, 301–306 production capacity, 492–493 restricted by monopoly, 224–225 selection of, 292, 293, 302 value of, 541 Overproduction, 264 Ozone, 359 P Panama, 758 Paper money see Money Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 836 Index Parmalat, 187 Patents, 120, 219, 440 Paulson, Henry, 790, 791 “Pay-as-you-go” system, 382 “Pay-as-you-throw” programs, 362 Payoff matrix, 250 Payroll tax, 381, 390–391 “Peak, off-peak pricing,” 304–305 Pell Grants, 46 Pensions, 34 Per-capita income, 334 Perfect competition, 195, 197–214 attributes of, 258–259 in business firms, 199–204 definition, 198–199 demand curve under, 199–200 efficiency, 211–212, 299–301 government regulation, 33–34, 211 industry, 205–211 industry equilibrium, 205–206 long-run industry supply curve, 210–212 marginal costs, 200 vs monopoly, 224–225 optimal output, 167, 301–306 short-run equilibrium, 200–201 short-run supply curve, 204, 205 short-term losses, 202 shutdown and break-even analysis, 202–204 zero economic profit, 209–210, 224 Perfectly contestable, 257–258 Perfectly elastic demand curves, 111 Perfectly inelastic demand curves, 112 Perot, Ross, 732 Personal income tax, 379, 380–381, 457, 614 Personal services, cost disease of, 324–330, 530–531 Peru, 522 Philip Morris, 114 Phillips, A.W., 12, 703 Phillips curve, 12, 701 definition, 706–708 and inflation targeting, 677, 709–710 inflationary expectations, 710–712 origins of, 703–704 short-run, 708, 709, 711 supply-side inflation, 598–599, 702–703, 705–706 vertical long-run, 707, 711–712 Physical assets, 539 Physical resources, 40 Pigou, Arthur C., 319, 356 Pigs, and pollution, 359 Pine Ridge, South Dakota, and poverty, 447 Pizza Hut, 242 Plowback, 182–183 Poland, 294, 358 Polaroid, 120 Political business cycles, 677–678 Political stability, 524 Politics budget deficits, 698 business cycles, 677–678 economic policy, 324 Pollution see also Environmental policy; Pollution charges and allocation of resources, 319, 324 and animals, 359 in centrally planned economies, 358 in China, 358 as detrimental externality, 315 and George W Bush, 367 history of, 357–360 law of conservation of matter and energy, 361–363 reduction of, 198 role of individuals and governments, 360 and taxation, 212–213 Pollution charges, 356, 364–366 Polo, Marco, 629 Popular Mechanics, 343 Population, and shifts in demand curve, 59 Portfolio, 184–185 Portfolio diversification, 184–185 Positive slope, 15 Post office, 23 Potato famine, 290 Potential GDP, 492–496, 533, 537, 566, 589, 694 Poverty, 446–449 absolute vs relative, 448–449 and education, 455 measurements of, 447–448 negative income tax, 456–457 Pine Ridge, South Dakota, 447 policies to combat, 454–457 “War on Poverty,” 447–448 welfare debate, 455–456 Poverty line, 447–449 PPF (Production possibilities frontier), 43–44, 45, 311, 522, 731 Practical policy, vs theory, 11 Predatory pricing, 270 Predictable inflation, 507 Prescott, Edward, 678 Present value, 417–418 Presidential campaigns, and supply-side economics, 616 Price advantage for domestic firms, 734 and aggregate demand curve, 612 consequences of changes, 105–106 cuts, 114 of depletable resources, 369–371 and deregulation, 279–280 discriminatory, 437–438 effect of innovation on, 348–349 of energy, 60, 528–529 of entrepreneurs, 436 equilibrium, 742–743 fixed costs, 168–169 gasoline distribution, 291 and income distribution, 304–305, 398, 445, 449–450, 615–616 increases, 114 increases and public interest, 290–291 infrequency of changes, 236 innovation, effect on, 348–349 of inputs, 63, 136–137 interference, 372–374 international trade, 742–744 long-run, 225 mechanism, 297–299, 303, 306 under monopolistic competition, 238 monopoly power, 264, 412 of natural resources, 372–374 optimal, 167 “peak, off-peak pricing,” 304–305 predatory, 270 price ratios and exchange rates, 730 profit maximizing, 168–169 and quantity, 157–158 and recessionary gap, 591–592 regulation, 273, 275–277, 282 of related outputs, 64 relative, 503–504, 549–550, 765 San Francisco bridges example, 288, 289–290, 306 short-run, 224–225 sticky, 247–249, 347 subsidized, 147 supports during Great Depression, 73 Price caps, 277, 278 Price ceilings, 70–71 Price controls, 56–57, 329, 373–374, 480 Price discrimination, 227–230 Price elasticity of demand, 109, 111–115 Price elasticity of supply, 117 Price fixing, 245 Price floors, 73 Price index, 512–513 Price leadership, 244–246 Price level, 546, 596–597 Price maker, 221 Price system efficiency, 299–301 optimal output, 167, 301–306 resource allocation, 288–291 scarcity and coordinated decisions, 292–299 Smith on, 56, 288, 732 Price taker, 199, 201, 204 Price war, 245–246 Priceline.com, 178 Princess Palatine, 336 Princeton University, 170–171, 427 Principal-agent problem, 321–323 Principals, 321–323 Principle of increasing costs, 44 Priorities, 40 Prism, Miss, 745 Private goods, 317 Private-enterprise economy, 23 Process innovations, 349 Procter & Gamble, 236, 333, 341 Producer‘s surplus, 299–301 Product differentiation, 242 Product innovation, 348–349 see also Innovation Product quality, and deregulation, 280 Production capacity, 492–493 circular flow, 539–541 input choice and cost with one variable, 130–133 measurements of, 554–555 planning, 293–294 underproduction/overproduction, 264 Production function, 492–493 Production indifference curves, 149–152 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Index Production indifference maps, 19, 149 Production possibilities frontier (PPF), 43–44, 45, 311, 522, 731 Productivity aggregate supply curve, 586 and capital, 519 definition, 334 discrimination, 452 and free markets, 330–331 growth, 8, 490–491, 518–520, 529 of labor, 327, 491, 493–494, 530 labor quality, 520 levels of, 520–522 marginal, 140–141, 398–399, 414–415 rate of, 527–531 slow down (1973–1995), 527–528 specialization, 48, 50, 725, 728, 731–732 speed-up (1995–?), 528–529 technology, 519 Professional athlete salaries, 410, 411 Profits, 174 corporate, 31 deregulation, 281 economic, 158–163, 207, 209–210, 412–414 of entrepreneurs, 436 excessive, 277 as factor of production, 411–414 marginal, 163–165 maximization, 156, 161–167 monopoly, 224, 345–346 monopoly power, 264, 412 in new market economies, 167 public opinion on, 31 returns to innovation, 413–414 risk bearing, 412–413 selling below costs, 157, 169–170 short run, 201–202 taxation of, 414 total, 158, 161–167 Progressive tax, 379 Progressive taxation, 35 Property rights, 524 Property tax, 379, 383–384 Proportional tax, 35, 379 Protectionism infant-industry argument, 736–737 national defense, 34, 735–736 noneconomic considerations, 735–736 for particular industries, 734–735 popularity of, 736 price advantage for domestic firms, 734 Safire on, 738 satire, 739 strategic trade policy, 737 trade deficit, 766, 771–774 Prudhoe Bay, 68–69 Public debt see National debt Public facilities, user charges, 305 Public goods, 316–318, 348, 437 Public infrastructure, 34 Public interest see Public welfare Public school financing, 383–384 Public utilities, 220–221 Public welfare, 257–258, 264–265, 290–291, 362 Publilius Syrus, 83 Purchasing power, 476, 501–502 Purchasing power parity theory, 750–752 Pure inflation, 503 Pure monopoly, 195, 218, 258–259 Putin, Vladimir, 305 Q Quantity, and price, 157–158 Quantity demanded, 57–61, 95–96 Quantity supplied, 61–64 Quantity theory of money, 662–665 Quota, 732–737, 743–744 Qwest, 187 R Radioactive pollutants, 358–359 Random walks, 190–192 Ratchet, 348 Rate averaging, 275 Rational expectations, 712–714 Ray through the origin, 17–18 Rays, 17–18 RBC (Risky Bank Corporation), 786 Ready, Jeff, 413 Reagan, Ronald budget deficits, 40 election of, 25, 477 fiscal policy, 612 quotation, 377 Reaganomics, 481 regulation, 34 supply-side economics, 613–617 tax cuts, 691 Real consumer income, 564–565 Real GDP and aggregate demand curve, 584, 612 definition, 23–25, 472 equilibrium, 596–597 and growth, 476 international trade, 765 Real GDP per capita, 476 Real rate of interest, 504–506, 522–523, 546–547 Real wage rate, 501–502 Real wages, 420, 530 Real-world inflation, 503 Rebates, tax, 538, 547–548 Recapitalize, 790 Recession of 1973–1980, 480–481 of 2001, 698 and budget deficits, 698 definition, 24–25, 471, 533 Federal Reserve System, 674 international trade, 764 Keynesian model, 714–715 national debt, 696 transmission of across borders, 574 unemployment, 471, 480, 560 Recessionary gap adjustment to, 591–593 definition, 566–568, 583, 589–591 fiscal policy, 611 and prices, 591–592 Recycling, 362 Redistributive policies, 453 837 Regressive tax, 379 Regulation of banking system, 626, 634–635 definition, 273 deregulation, 279–282 economies of scale, 274 efficiency and innovation incentives, 277–278 government, 33–34, 211 marginal vs average cost pricing, 276–277 of monopolies, 211, 220–221 objectives of, 274–275 prices, 273, 275–276, 282 of stock market, 186–187 Reich, Robert, 32 Related goods, prices and availability of, 60–61 Related outputs, prices of, 64 Relative poverty, 448–449 Relative prices, 503–504, 549–550, 765 Rent, 405–411 as a component of an input‘s compensation, 409–410 controls, 72–73, 410–411 economic rent, 406, 408–409, 411 land rents, 405–408 opportunity cost, 409 professional athlete salaries, 410–411 Rent seeking, 320 Repeated games, 254–256 Report on Manufacturers (Hamilton), 736 Research and development (R&D), 279, 340–341, 345–346, 349–351, 437, 526–527 Research and Experimentation Tax Credit, 527 Reserve Mining Company, 364 Reserve requirements, 635 Resource allocation as coordination task, 47–49 efficiency, 288–291, 311–312 and excess capacity theorem, 239–240, 257 interest rates, 318–319 misallocation, 75–76, 311 by monopoly, 225 and monopoly power, 264 in practice, 319 between present and future, 318–319 Resources, 40 see also Resource allocation Restricted grants, 384 Retail sector, 28, 236, 240 Retained earnings, 182–183 Returns to a single input, 143–144 Returns to innovation, 413–414 Returns to scale, 142–146 Revaluation (currency), 747, 754 Revenue, average, 159–160, 173–174 Revenue, marginal, 159–160, 165–167, 173–174, 200 Revenue, money, 132–133 Revenue, total, 113–115, 159–160, 202 Ricardo, David, 49, 397, 406, 727–728, 732, 738 Rigas, John, 187 Risk bearing, 412–413 Risk premium, 780, 781 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 838 Index Risk sharing, 328 Risk taking, 451 Risky Bank Corporation (RBC), 786 Rite Aid, 187 Riverside Freeway, 291 Robinson, Joan, 236–237 Robinson-Patman Act, 266 Rodriguez, Alex, 411 Roodman, David Malin, 355 Roosevelt, Franklin, 755 Royal Caribbean Cruises Ltd., 365 Ruhr River basin, and pollution charges, 364 Rules-versus-discretion debate, 675–679 Run on a bank, 626, 633 Russia, 24, 517, 522, 524, 745, 758 S Safety, and deregulation, 280–281 Safire, William, 263, 738 Sales maximization, 246–247 Sales tax, 379, 619 San Francisco bridges, and price, 288, 289–290, 306 Savings, 398, 541, 547, 567–568, 773 Savings account, 631 Securitization, 786 Scandals, corporate, 188 Scarcity, 39–52 and choice efficiency, 47 for entire society, 45–46 money cost, 41–42, 658 opportunity cost, 40–42 optimal decision, 42 principle of increasing costs, 44 production possibilities frontier, 43–44 real-world examples, 46 for a single firm, 42–44 coordinated decisions, 292–299 and demand, 84–85 depletable resource pricing, 369–371 input-output analysis, 295–297 in monopoly, 219 price mechanism, 297–299, 303, 306 utility, 95 Scatter diagrams, 542–544 Schor, Juliet, 475 Schultze, Charles, 615 Schumpeter, Joseph, 343–344, 436–438 Schumpeter‘s model, 343–344 Securities and Exchange Commission (SEC), 182, 186 Securities firms, 653 Self-correcting mechanism, 592–593, 611, 675–678, 706, 708–710 Self-employment, 29 September 11 terrorist attacks, 392, 474, 610, 676, 760 Service economy, 29, 423–424, 431 Service industry, 28–29 Shakespeare, William, 419 Sharp Corporation, 353 Shaw, George Bernard, 419, 479, 661 Sherman Act, 266, 268 Shift in demand curve, 58–60, 66–67 Short run, 129 Shortage, 65 Short-run profit, graphical representation, 201–202 Short-run supply curve, 204–205 Short-term losses, 202 Shubik, Martin, 177 Shutdown, and break-even analysis, 202–204 Siemens, 532 Sierra Leone, 522 Simon, Herbert, 156 Singapore, 520, 524 Singer, Elias, 420 Sitting Bull, 445 Slope, definition and measurement, 15–17 Slope of a curved line, 16–17 Slope of a straight line, 15 Slope of an indifference curve, 103–106 Slope of the budget line, 103–106 Slow down (1973–1995), 527–528 Slow down (2006–2007), 468 Smith, Adam diamond-water puzzle, 95 on division of labor, 48–49, 50 invisible hand, 257, 292, 309 on monopoly, 217 on perfect competition, 199, 211–212 on price system, 56, 288, 732 University of Glasgow lecture, 84 on voluntary exchange, 726 Social Security System, 34, 381–383, 541, 691 Socialism, 35 Software industry, 222 Solow, Robert M., Sony Corporation, 353 Soto, Hernando de, 524 South Korea, 520, 532, 725, 774 Southeast Asia, 745, 757, 758 Soviet Union, 35, 48, 70, 338, 358, 525 Spain, 725 Specialization, 48, 50, 725, 728, 731–732 Speculation, 189, 193 Speculators, currency, 757 Spending, 30–31, 539–544, 547–549, 613, 697 Spending chain, 571 Spending policy, 611–612 Stabilization policy and aggregate supply curve, 671–673 automatic stabilizers, 609 criticism of, 662, 674 definition, 517 disagreements about, 714–715 effectiveness, 484–485 and full employment, 566 lags in, 667–668, 676 in macroeconomics, 483–485 role of, 600 Stagflation, 480, 583, 584, 594–596, 600 Standard Oil, 267 State and local government expenditures, 34 State and local tax system see Taxation Statistics, historical, 122–125 Steam engine, 435–436, 440 Steel industry, 69 Stewart, Jimmy, 633 Sticky prices, 247–249, 347 Stock exchanges, 185–189 Stock market 1987 crash, 187 booms and busts, 178, 192 bubble, 192 regulation, 186–187 unpredictability of, 178–179 Stock option, 322–323 Stock options scandals, 321–323 Stock price index, 184 Stocks, 180–185, 190–192 Store of value, 628 Straight-line demand curve, 112 Strategic argument for protection, 737 Strategic interaction, 243 Strategic trade policy, 737 Strategy, 250 Strikes, 433–434 Structural budget deficit, 689–690 Structural budget surplus, 689–690 Structural unemployment, 498 Studying, 134 Subprime mortgage crisis, 633, 635, 763, 781, 784, 785 Subsidies, 212–213, 733 Substitutability, 134–135 Substitutes, 115–118 Substitution effect, 426 Sudan, 532 Sugar industry, 73–74 Sullivan, Scott, 187 Sunk costs, 219–220 Super Bowl stock market predictor, 191 Supply analysis, 127 Supply and demand, 55–76 see also Demand; Demand curve demand schedule, 58, 90 demand shifts and supply-demand equilibrium, 66–67 effect on exchange rates, 747–752 equilibrium, 64–70 farm price supports, 73–74 gasoline tax analysis, 69–70 international trade, 742–744 invisible hand see Invisible hand and labor see Labor law of, 5, 66 in macroeconomics, 469–471 price ceilings, 70–71 price elasticity, 117 price floors, 73 quantity demanded, 57–61, 95–96 quantity supplied, 61–64 rent controls, 72–73, 410–411 supply schedule, 61–62 supply shifts and supply-demand equilibrium, 67–70 Supply curve, 61–64, 124, 204–205, 210–212 Supply curve of a firm, 204 Supply curve of an industry, 205 Supply curve of the perfectly competitive firm, 204 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Index Supply curve of the perfectly competitive industry, 205–206 Supply decision, monopoly firm, 221–226 Supply schedule, 61–62 Supply shock, 595–596, 600, 705–706 Supply-demand analysis, 69–70, 369–371 Supply-demand diagrams, 64–66 Supply-demand equilibrium, 64–70 Supply-side economics, 613–617 Supply-side fluctuations, 598–599 Supply-side inflation, 598–599, 702–703, 705–706 Supply-side tax cuts, 613–617 Supreme Court, 268, 459 Surplus, 65, 73 SUVs, 386–389 Swartz, Mark, 187 Swaziland, 524 Sweden, 26, 35, 434, 450, 524, 747 Swiss Alps, and global warming, 360 Switzerland, 35, 747 Sysco, 204 T Tacit collusion, 244–246, 253–254 Taiwan, 520, 725 Takeover, 188 TANF (Temporary Assistance to Needy Families), 455 Tangency, point of, 151 Tangency conditions, 104 Tangent, 16, 239 Tanner, Bill, 69 Tariff, 732–737, 743–744 TARP (Troubled Assets Relief Program), 790, 791 Tax deductions, 380–381 Tax exempt, 380 Tax incidence, 387–391 Tax loopholes, 380, 386–387 Tax Reform Act of 1986, 387 Tax shifting, 389 Taxation, 377–392 antitax sentiment, 377 average tax rate, 379 benefits principle of taxation, 385 burden of, 386 and capital formation, 522–524 on cigarettes, 108, 114–115 and consumption schedule, 606–607, 619 corporate income tax, 380–381, 614 criticism of, 506 cuts, 378, 392, 446, 482–483, 538, 606, 610, 612, 676–677, 685, 689, 691, 697 cuts and consumer spending, 547–548 death duties, 457–458 direct, 379 “double taxation,” 180 efficiency in, 385–387, 391–392 to encourage savings, 547 equity in, 384–385 excise tax, 381, 383, 389–390 federal tax system, 379–383 fiscal federalism, 384 fiscal policy, 619–623 fixed taxes, 619–620 gasoline, 69–70 and GDP, 378–379 and government size, 612, 676–677 head tax, 379 homeowner benefits, 380–381 incidence of a tax, 387–391 on income, 379, 380–381, 457, 572, 606–609, 614, 619 indirect, 379 levels and types of, 378–379 loopholes and excess burden, 380, 386–387 marginal tax rates, 379, 392 and the multiplier, 607–610, 621 negative income tax, 456–457, 610 net taxes, 541 optimal tax, 391–392 payroll tax, 381, 390–391 and pollution, 212–213 on profits, 414 progressive, 35, 379 property tax, 379, 383–384 proportional, 35, 379 rebates, 538, 547–548 regressive, 379 sales and excise tax, 379, 381, 383, 389–390, 619 sales tax, 379, 619 share of under George W Bush, 35 Social Security System, 381–383 vs spending policy, 611–612 state and local tax system, 383–384 supply-and-demand analysis, 69–70, 369–371 and supply-side cuts, 613–617 variable, 619–620 in various nations, 35, 684–685 Taylor, John, 677 “Taylor rule,” 677 TC (Total costs), 137–138, 161, 202 Teamsters, 280, 433 Technical superiority, and monopoly, 220 Technological progress, and shifts in supply curve, 63 Technology and aggregate supply curve, 586 in Asia, 532 and capital formation, 523, 526 in developing countries, 532 dissemination of, 351–353 and economies of scale see Economies of scale and education, 526 growth policy, 526–527 and production capacity, 492–493 and productivity growth, 519 spurring change, 526–527 Technology trading, 351 Teenagers, 27–28, 108, 114–115, 429–430, 497 Telephone service, 128, 218, 230–231, 275 Temporary Assistance to Needy Families (TANF), 455 Tennessee Valley Authority, 23 Terrorism, 482 see also September 11 terrorist attacks Terry, Letha, 432 839 Texas Rangers, 411 TFC (Total fixed costs), 139 Thailand, 774 Thames River, 357 TheGroceryGame.com, 204 Theory, 11–12 Third World see Developing countries Time, market value of, 42 Time inconsistency, 678 Time magazine, 432 Time period, and demand elasticity, 118–120 Tin, 356 Total cost curves, 137–139 Total costs (TC), 137–138, 161, 202 Total expenditure, effect of price elasticity of demand, 113–115 Total fixed costs (TFC), 139 Total monetary utility, 86 Total physical products (TPP), 130–131 Total profit, 158, 161–167 Total profit curve, 163, 164 Total revenue (TR), 113–115, 159–160, 202 Total utility, 86 Total variable cost (TVC), 202 Toyota, 31, 241, 532 TPP (Total physical products), 130–131 TR (Total revenue), 113–115, 159–160, 202 Trade see International trade see Intranational trade Trade, as win-win situation, 5–6 Trade adjustment assistance, 735 Trade deficit, 766, 771–774 see also International trade Trade protection see Protectionism Trade war, 732, 734 Transactions, limitation on volume, 75 Transfer in kind, 456 Transfer payments, 35, 541, 609–610, 716 Treasury, 790 Treasury bills, 649–650 Treaty of Maastricht, 759 Triangle Shirtwaist Factory fire, 432 “Trickle-down economics.” see Supplyside economics Troubled Assets Relief Program (TARP), 790, 791 Trotsky, Leon, 287, 288 Tru-Blu Cooperative, 204 Tucker, Sophie, 494 Tuition, 518, 530–531 Tullock, Gordon, 409 Tundra travel season, 361 Turkey, 745, 758 TVC (Total variable cost), 202 Two-variable diagrams, 14–15 Tyco, 187 U Ukraine, 522 Unlevered bank, 783 Underproduction, 264 Unemployment African Americans, 497 and aggregate demand, 483–484 among teenagers, 497 as automatic stabilizer, 609 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com 840 Index benefits, 381 combating, 483–484 compensation, 34 computation of, 497–498 as coordination failure, 569 costs of, 495, 709 cyclical, 498, 591 economic goal to keep low, 495–500 and efficiency, 47 fighting with fiscal and monetary policy, 483–484, 708 fiscal policy, 483–484, 708 frictional, 498 full employment, 499, 566–567, 613 during Great Depression, 25–26, 496–497 and growth policy, 490 human costs of, 496–497 and inflation, 7–8, 583, 708 inflation trade-off, 701–717 and the market, 560 and minimum wage, 499 monetary policy, 708 natural rate of, 707, 715–716 and recession, 471, 480, 560 and recessionary gap, 591–593 structural, 498 types of, 498 in various nations, 26, 497 Unemployment insurance, 497, 499–500, 541 Unemployment rate, 25–26, 495 Unenforceability, 75 Unexpected inflation, 504–505 Unions see Labor union Unit elasticity, 112–113 Unit of account, 628 United Auto Workers (UAW), 433, 585 United Kingdom currency, 747 educational attainment in, 532 GDP of, 22 inflation targeting, 677 investor protection, 524 labor costs, 725 labor strikes, 434 market economy of, 167 openness of economy, 24 peak, off-peak pricing, 304–305 Phillips curve, 703–704 productivity, 490–491 taxes in, 35 unemployment rates, 26 wages, 725 United States see also specific topics Canada, trade with, 729 China, trade with, 730 Japan, trade with, 549–550, 727–729, 730–731, 772 labor strikes, 434 Mexico, trade with, 730 openness of economy, 24 share of GDP, 22 taxes in see Taxation trade deficit, 772 unemployment rates, 25–26, 495 Unit-elastic demand curve, 112–113 Universal service, 275 University of Glasgow, 84 University of Pittsburgh Medical Center (UPMC), 272 Unpredictable inflation, 507 Uruguay Round (tariff reductions), 732 U.S dollar, 746, 758–759, 760, 764, 775 U.S economy, 21–36 aggregate supply-demand model, 471, 596–600, 613–614 bank failures, 627 budget deficits, 40, 46 closed economy, 23–24, 768–769 federal budget, 691 fluctuations see Fluctuations, economic government intervention, 673–675 growth of see Growth inflationary gap, 594–595 inputs see Inputs overview, 22–25 private-enterprise economy, 23 stagflation, 480, 583, 584, 594–595, 600 U.S Postal Service, 219, 275 U.S Steel Corp., 69, 245, 267 User charges for public facilities, 305 Usury laws, 404–405 Utilities, public, 220–221 Utility, marginal, 86–92, 95, 302 Utility analysis, 85–92 diminishing marginal utility, 86–87 downward-sloping demand curves, 90–92 optimal purchase rule, 35–36, 87–90, 92, 509 purpose of, 85–86 and scarcity, 95 total vs marginal utility, 86 water vs diamonds, 84, 95 V Valley Forge, 57 Value added, 555–556 Value-added tax (VAT), 379 Variable costs, 129–130, 138, 202 Variable taxes, 619–620 Variables, 14–15 Velocity, 662–667 Vertical equity, 384–385 Vertical long-run Phillips curve, 707, 711–712 Vietnam War, 480 Vital services, increasing costs of, 324–329 Volatility, 60 Volcker, Paul, 481, 671 Voluntarism, as environmental policy, 363–364 Voluntary exchange, 726 Von Neumann, John, 250 W Wage premium, for college graduates, 525 Wages, 29–30 construction wages in New Orleans, 429 and deregulation, 281 determination in competitive markets, 421–424 differences in, 428–430, 450–452 discrimination, 462 equilibrium, 428 in Europe, 30 inflationary expectations, 710–712 minimum, 499 nominal, 502, 585–586, 591–592 rate of change, 703 real wage rate, 501–502 real wages, 420, 530 in various nations, 724–725 Wal-Mart, 28, 179 “War on Poverty,” 447–448 Washington, George, 57 Waste disposal, 362 Water, subsidized prices for, 147 Watson, Thomas J., 343 Watt, James, 420, 435–436 Wealth, 452, 504, 546, 564–565 Wealth of Nations, The (Smith), 48 Welfare debate, 455–456 West Penn Allegheny Health Systems, Inc., 272 Whitney, Eli, 420 Wilde, Oscar, 359, 745 Wilhelmina, 336 Women, 27, 170–171, 424–425, 463 Work incentives, and negative income tax, 457 Work slowdowns, 434 Workers, 428, 498 Workforce, American, 27–30, 520, 528 Working conditions, 432 Working population see Workforce, American Workweek, length of, 475 World Bank, 517, 524, 531 World Trade Organization (WTO), 733, 734 World War II economic fluctuations, 25–26, 479–480 financing of, 696 and labor, 420 production capacity during, 492 and taxation, 378, 380 WorldCom, 187 Wright brothers, 420 WTO (World Trade Organization), 733, 734 X Xerox, 187 X-intercept, 17 Y Y-intercept, 17 Z Zacharakis, Andrew, 413 Zambia, 71 Zero economic profit, 209–210, 224 Zero slope, 15 Zero-sum game, 253–254 Zimbabwe, 508 Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Table of Contents PART I: GETTING ACQUAINTED WITH ECONOMICS What is Economics? The Economy: Myth and Reality The Fundamental Economic Problem: Scarcity and Choice Supply and Demand: An Initial Look PART II: THE BUILDING BLOCKS OF DEMAND AND SUPPLY Consumer Choice: Individual and Market Demand Demand and Elasticity Production, Inputs, and Cost: Building Blocks for Supply Analysis Output, Price, and Profit: The Importance of Marginal Analysis The Economics of the Stock Market PART III: MARKETS AND THE PRICE SYSTEM 10 The Firm and the Industry Under Perfect Competition 11 Monopoly 12 Between Competition and Monopoly 13 Limiting Market Power: Regulation and Antitrust PART VII: FISCAL AND MONETARY POLICY 28 Managing Aggregate Demand: Fiscal Policy 29 Money and the Banking System 30 Managing Aggregate Demand: Monetary Policy 31 The Debate Over Monetary and Fiscal Policy 32 Fiscal Policy, Monetary Policy, and Growth 33 The Trade-off Between Inflation and Unemployment PART VIII: THE UNITED STATES IN THE WORLD ECONOMY 34 International Trade and Comparative Advantage 35 The International Monetary System: Order or Disorder? 36 Exchange Rates and the Macroeconomy PART IX: POSTSCRIPT: THE FINANCIAL CRISIS OF 2007-2009 37 The Financial Crisis and the Great Recession Ideas for Beyond the Final Exam PART IV: THE VIRTUES AND LIMITATIONS OF MARKETS 14 The Case for Free Markets I: The Price System 15 The Shortcomings of Free Markets 16 The Market’s Prime Achievement: Innovation and Growth 17 Externalities, the Environment and Natural Resources 18 Taxation and Resource Allocation PART V: THE DISTRIBUTION OF INCOME 19 Pricing the Factors of Production 20 Labor and Entrepreneurship: The Human Inputs 21 Poverty, Inequality, and Discrimination PART VI: THE MACROECONOMY: AGGREGATE SUPPLY AND DEMAND 22 An Introduction to Macroeconomics 23 The Goals of Macroeconomic Policy 24 Economic Growth: Theory and Policy 25 Aggregate Demand and the Powerful Consumer 26 Demand-Side Equilibrium: Unemployment or Inflation? 27 Bringing in the Supply Side: Unemployment and Inflation? 1: 2: 3: 4: 5: 6: 7: 8: 9: 10: How Much Does it Really Cost? Attempts to Repeal the Laws of Supply and Demand — The Market Strikes Back The Surprising Principle of Comparative Advantage Trade is a Win-Win Situation The Importance of Thinking at the Margin Externalities — A Shortcoming of the Market Cured by Market Methods The Trade-Off Between Efficiency and Equality Government Policies Can Limit Economic Fluctuations — But Don’t Always Succeed The Short-Run Trade-Off Between Inflation and Unemployment Productivity Growth is (Almost) Everything in the Long Run Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Find more at www.downloadslide.com Selected U.S Macroeconomic Data, 1929-2009 Year (1) (2) (3) Gross Domestic Product Personal Consumption Expenditure (4) Gross Private Domestic Government Investment Purchases (5) (6) Net Exports Gross Domestic Product (7) (8) Gross Personal Private Consumption Domestic Expenditure Investment (9) Government Purchases (10) Net Exports Real GDP per capita (In chained 2000 dollars) (in billions of chained 2000 dollars)a (in billions of dollars) (11) (12) (13) Price Level Chained Consumer GDP Price Price Index Index (2000 = 100) (1982-1984 = 100) (14) Real Average Hourly Earnings (1982 dollars) (15) (16) Labor Population Forceb (millions) (17) Civilian Unemployment Rate (percent) (18) (19) Money Supply M1 M2 (in December) (billions of dollars) (20) (21) Interest Rates Treasury Corp Bills Bondsc (percent) (22) (23) Exchange Value of U.S Dollard (January 1997 = 100) Federal Budget Surplus (+) or Deficit (–)e (billions of dollars) 1929 103.6 77.4 16.5 9.4 0.4 977.0 736.6 101.7 146.5 –9.4 8,016 10.6 17.1 —— 121.9 49.2 3.2 —— —— —— 4.73 —— 2.6 1933 1939 56.4 92.2 45.9 67.2 1.7 9.3 8.7 14.8 0.1 0.8 716.4 1072.8 601.1 811.1 18.9 86.2 157.2 238.6 –10.2 –4.7 5,700 8,188 7.9 8.6 13.0 13.9 —— —— 125.7 131.0 51.6 55.2 24.9 17.2 —— —— —— —— —— —— 4.49 3.01 —— —— -0.5 -0.1 1945 223.0 120.0 10.8 93.0 -0.8 2012.4 1001.4 74.7 1402.2 –26.8 14,382 11.1 18.0 —— 139.9 53.9 1.9 —— —— —— 2.62 —— -27.3 1950 1955 293.7 414.7 192.2 258.8 54.1 69.0 46.7 86.4 0.7 0.5 2006.0 2500.3 1283.3 1544.5 253.2 285.0 492.4 779.3 –9.0 –14.3 13,225 15,128 14.6 16.6 24.1 26.8 —— —— 151.7 165.3 62.2 65.0 5.3 4.4 —— —— —— —— —— 1.72 2.62 3.06 —— —— 6.9 9.2 1960 1965 526.4 719.1 331.8 443.8 78.9 118.2 111.5 151.4 4.2 5.6 2830.9 3610.1 1784.4 2241.8 296.5 437.3 871.0 1048.7 –12.7 –18.9 15,661 18,576 18.6 19.9 29.6 31.5 —— 8.04 180.8 194.3 69.6 74.5 5.5 4.5 140.7 167.8 312.4 459.2 2.87 3.95 4.41 4.49 —— —— 11.4 9.8 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1038.3 1126.8 1237.9 1382.3 1499.5 1637.7 1824.6 2030.1 2293.8 2562.2 648.3 701.6 770.2 852.0 932.9 1033.8 1151.3 1277.8 1427.6 1591.2 152.4 178.2 207.6 244.5 249.4 230.2 292.0 361.3 438.0 492.9 233.7 246.4 263.4 281.7 317.9 357.7 383.0 414.1 453.6 500.7 4.0 0.6 -3.4 4.1 -0.8 16.0 -1.6 -23.1 -25.4 -22.5 4269.9 4413.3 4647.7 4917.0 4889.9 4879.5 5141.3 5377.7 5677.6 5855.0 2740.2 2844.6 3019.5 3169.1 3142.8 3214.1 3393.1 3535.9 3691.8 3779.5 475.1 529.3 591.9 661.3 612.6 504.1 605.9 697.4 781.5 806.4 1233.7 1206.9 1198.1 1193.9 1224.0 1251.6 1257.2 1271.0 1308.4 1332.8 –52.0 –60.6 –73.5 –51.9 –29.4 –2.4 –37.0 –61.1 –61.9 –41.0 20,820 21,249 22,140 23,200 22,861 22,592 23,575 24,412 25,503 26,010 24.3 25.5 26.6 28.1 30.7 33.6 35.5 37.8 40.4 43.8 38.8 40.5 41.8 44.4 49.3 53.8 56.9 60.6 65.2 72.6 8.46 8.64 8.99 8.98 8.65 8.48 8.58 8.66 8.69 8.41 205.1 207.7 209.9 211.9 213.9 216.0 218.1 220.3 222.6 225.1 82.8 84.4 87.0 89.4 91.9 93.8 96.2 99.0 102.3 105.0 4.9 5.9 5.6 4.9 5.6 8.5 7.7 7.1 6.1 5.8 214.4 228.3 249.2 262.9 274.2 287.1 306.2 330.9 357.3 381.8 626.5 710.3 802.3 855.5 902.1 1016.2 1152.0 1270.3 1366.0 1473.7 6.39 4.33 4.06 7.04 7.85 5.79 4.98 5.26 7.18 10.05 8.04 7.39 7.21 7.44 8.57 8.83 8.43 8.02 8.73 9.63 —— —— —— 31.7 32.6 33.7 35.8 36.9 35.1 35.4 -8.4 -22.2 -9.3 3.9 -5.2 -68.2 -46.3 -33.0 -10.2 -1.0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 2788.1 3126.8 3253.2 3534.6 3930.9 4217.5 4460.1 4736.4 5100.4 5482.1 1755.8 1939.5 2075.5 2288.6 2501.1 2717.6 2896.7 3097.0 3350.1 3594.5 479.3 572.4 517.2 564.3 735.6 736.2 746.5 785.0 821.6 874.9 566.1 627.5 680.4 733.4 796.9 878.9 949.3 999.4 1038.9 1100.6 -13.1 -12.5 -20.0 -51.7 -102.7 -115.2 -132.5 -145.0 -110.1 -87.9 5839.0 5987.2 5870.9 6136.2 6577.1 6849.3 7086.5 7313.3 7613.9 7885.9 3766.2 3823.3 3876.7 4098.3 4315.6 4540.4 4724.5 4870.3 5066.6 5209.9 717.9 782.4 672.8 735.5 952.1 943.3 936.9 965.7 988.5 1028.1 1358.8 1371.2 1395.3 1446.3 1494.9 1599.0 1696.2 1737.1 1758.9 1806.8 12.6 8.3 –12.6 –60.2 –122.4 –141.5 –156.3 –148.4 –106.8 –79.2 25,640 26,030 25,282 26,186 27,823 28,717 29,443 30,115 31,069 31,877 47.8 52.3 55.5 57.7 59.8 61.6 63.0 64.8 67.0 69.5 82.4 90.9 96.5 99.6 103.9 107.6 109.6 113.6 118.3 124.0 8.00 7.89 7.87 7.96 7.96 7.92 7.97 7.87 7.82 7.75 227.7 230.0 232.2 234.3 236.4 238.5 240.7 242.8 245.1 247.4 106.9 108.7 110.2 111.6 113.5 115.5 117.8 119.9 121.7 123.9 7.1 7.6 9.7 9.6 7.5 7.2 7.0 6.2 5.5 5.3 408.5 436.7 474.8 521.4 551.6 619.8 724.7 750.2 786.7 792.9 1599.8 1755.5 1909.3 2125.7 2308.8 2494.6 2731.4 2830.8 2993.9 3158.4 11.39 14.04 10.60 8.62 9.54 7.47 5.97 5.78 6.67 8.11 11.94 14.17 13.79 12.04 12.71 11.37 9.02 9.38 9.71 9.26 36.4 40.3 46.8 52.8 60.1 67.2 62.4 60.4 60.9 66.9 -47.8 -49.2 -137.5 -171.4 -147.5 -156.3 -173.9 -137.4 -121.2 -113.8 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 5800.5 5992.1 6342.3 6667.4 7085.2 7414.7 7838.5 8332.4 8793.5 9353.5 3835.5 3980.1 4236.9 4483.6 4750.8 4987.3 5273.6 5570.6 5918.5 6342.8 861.0 802.9 864.8 953.3 1097.3 1144.0 1240.2 1388.7 1510.8 1641.5 1181.7 1236.1 1273.5 1294.8 1329.8 1374.0 1421.0 1474.4 1526.1 1631.3 -77.6 -27.0 -32.8 -64.4 -92.7 -90.7 -96.3 -101.4 -161.8 -262.1 8033.9 8015.1 8287.1 8523.4 8870.7 9093.7 9433.9 9854.3 10283.5 10779.8 5316.2 5324.2 5505.7 5701.2 5918.9 6079.0 6291.2 6523.4 6865.5 7240.9 993.5 912.7 986.7 1074.8 1220.9 1258.9 1370.3 1540.8 1695.1 1844.3 1864.0 1884.4 1893.2 1878.2 1878.0 1888.9 1907.9 1943.8 1985.0 2056.1 –54.7 –14.6 –15.9 –52.1 –79.4 -98.8 -110.7 -139.8 -252.6 -356.6 32,112 31,614 32,255 32,747 33,671 34,112 34,977 36,102 37,238 38,592 72.2 74.8 76.5 78.2 79.9 81.5 83.1 84.6 85.5 86.8 130.7 136.2 140.3 144.5 148.2 152.4 156.9 160.5 163.0 166.6 7.66 7.59 7.55 7.54 7.54 7.54 7.57 7.69 7.89 8.01 250.2 253.5 256.9 260.3 263.5 266.6 269.7 273.0 276.2 279.3 125.8 126.3 128.1 129.2 131.1 132.3 133.9 136.3 137.7 139.4 5.6 6.8 7.5 6.9 6.1 5.6 5.4 4.9 4.5 4.2 824.7 897.0 1024.9 1129.6 1150.7 1127.4 1081.6 1072.7 1095.8 1122.6 3276.8 3377.0 3430.3 3480.9 3496.7 3640.7 3820.1 4033.3 4377.3 4635.0 7.50 5.38 3.43 3.00 4.25 5.49 5.01 5.06 4.78 4.64 9.32 8.77 8.14 7.22 7.97 7.59 7.37 7.27 6.53 7.05 71.4 74.4 76.9 83.8 90.9 92.7 97.5 104.4 115.9 116.0 -170.3 -224.2 -303.9 -281.2 -212.2 -197.0 -125.3 -23.8 80.5 140.6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 9951.5 10286.2 10642.3 11142.1 11867.8 12638.4 13398.9 14077.6 14441.4 14256.0 6830.4 7148.8 7439.2 7804.0 8285.1 8819.0 9322.7 9826.4 10129.9 10089.0 1772.2 1661.9 1647.0 1729.7 1968.6 2172.2 2327.2 2288.5 2136.1 1628.8 1731.0 1846.4 1983.3 2112.6 2232.8 2369.9 2518.4 2676.5 2883.2 2930.7 -382.1 -371.0 -427.2 -504.1 -618.7 -722.7 -769.3 -713.8 -707.8 -392.4 11226.0 11347.2 11553.0 11840.7 12263.8 12638.4 12976.2 13254.1 13312.2 12987.4 7608.1 7813.9 8021.9 8247.6 8532.7 8819.0 9073.5 9313.9 9290.9 9235.1 1970.3 1831.9 1807.0 1871.6 2058.2 2172.2 2230.4 2146.2 1989.4 1541.5 2097.8 2178.3 2279.6 2330.5 2362.0 2369.9 2402.1 2443.1 2518.1 2564.6 -451.6 -472.1 -548.8 -603.9 -688.0 -722.7 -729.2 -647.7 -494.3 -355.6 39,750 39,774 40,107 40,728 41,806 42,692 43,425 43,926 43,714 42,238 88.6 90.7 92.1 94.1 96.8 100.0 103.3 106.2 108.5 109.7 172.2 177.1 179.9 184.0 188.9 195.3 201.6 207.3 215.3 214.5 8.04 8.12 8.25 8.28 8.24 8.18 8.24 8.33 8.30 8.60 282.4 285.3 288.1 290.7 293.3 296.0 298.8 301.7 304.5 307.5 142.6 143.7 144.9 146.5 147.4 149.3 151.4 153.1 154.3 154.1 4.0 4.7 5.8 6.0 5.5 5.1 4.6 4.6 5.8 9.3 1087.7 1182.3 1220.4 1306.8 1376.4 1374.2 1365.6 1373.0 1595.2 1693.4 4917.2 5431.2 5784.7 6071.6 6412.2 6674.1 7085.3 7438.8 8155.9 8524.5 5.82 3.40 1.61 1.01 1.37 3.15 4.73 4.36 1.37 0.16 7.62 7.08 6.49 5.66 5.63 5.23 5.59 5.56 5.63 5.31 119.5 125.9 126.7 119.1 113.6 110.7 108.5 103.4 99.8 105.9 226.5 24.6 -306.9 -415.2 -387.8 -257.1 -152.7 -214.8 -682.7 -1224.7 a Components not add up to GDP due to chain method of deflation b Persons 14 years and older for 1920-1945; thereafter, persons 16 years and older c Moody’s Aaa rating d Trade-weighted average of broad group of U.S trading partners e National income and product accounts basis; calendar years Copyright 2011 Cengage Learning, Inc All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part ... lbs $10.50 14.0 16.50 18.0 22 .50 22 .0 25 .50 25 .0 22 .50 26 .0 19.50 26 .0 14 .25 25 .0 6.75 23 .0 1.05 20 .6 24 .05 18.0 21 1 .25 15.0 21 5.75 12. 0 INPUTS AND THEIR DERIVED DEMAND CURVES We can, in fact,... square foot in 20 08 SOURCE: Matt Woolsey, “World’s Most Valuable Addresses,” Forbes, December 22 , 20 08, http://www.forbes.com /20 08/ 12/ 22/ most-valuable-addresses-forbeslife-cx_ mw_ 122 2realestate.html... duplicated, in whole or in part Find more at www.downloadslide.com MRP per Bag of Corn per Week 400 The Distribution of Income Part $26 24 22 20 18 16 14 12 10 2 –4 –6 –8 –10 – 12 –14 –16 profit-maximizing