Economics For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization, and adaptation from the North American version Global edition Global edition Global edition SIXth edition Hubbard • O’Brien Economics This is a special edition of an established title widely used by colleges and universities throughout the world Pearson published this exclusive edition for the benefit of students outside the United States and Canada If you purchased this book within the United States or Canada, you should be aware that it has been imported without the approval of the Publisher or Author SIXth edition R Glenn Hubbard • Anthony Patrick O’Brien Pearson Global Edition Hubbard_06_1292159928_Final.indd 01/04/16 4:32 PM đ Practice, Engage, and Assess with MyEconLab ã P earson eText—The Pearson eText gives students access to their textbook anytime, anywhere In addition to notetaking, highlighting, and bookmarking, the Pearson eText offers interactive and sharing features Students actively read and learn, through embedded and auto-graded practice, real-time data-graphs, animations, author videos, and more Instructors can share comments or highlights, and students can add their own, for a tight community of learners in any class • P ractice—Algorithmically generated homework and study plan exercises with instant feedback ensure varied and productive practice, helping students improve their understanding and prepare for quizzes and tests Draw-graph exercises encourage students to practice the language of economics • L earning Resources—Personalized learning aids such as Help Me Solve This problem walkthroughs, Teach Me explanations of the underlying concept, and figure Animations provide on-demand help when 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interactive and sharing features Students actively read and learn, through embedded and auto-graded practice, real-time data-graphs, animations, author videos, and more Instructors can share comments or highlights, and students can add their own, for a tight community of learners in any class • P ractice—Algorithmically generated homework and study plan exercises with instant feedback ensure varied and productive practice, helping students improve their understanding and prepare for quizzes and tests Draw-graph exercises encourage students to practice the language of economics • L earning Resources—Personalized learning aids such as Help Me Solve This problem walkthroughs, Teach Me explanations of the underlying concept, and figure Animations provide on-demand help when students need it most • A daptive Study Plan—Monitors each student’s progress and offers a continuously personalized study plan based on his or her own homework, quiz, and test results Includes unlimited practice exercises and the opportunity to prove mastery through quizzes based on recommended learning objectives • Dynamic Study Modules—With a focus on key topics, these modules work by continuously assessing student performance and activity in real time and, using data and analytics, provide personalized content to reinforce concepts that target each student’s particular strengths and weaknesses • D igital Interactives—Focused on a single core topic and organized in progressive levels, each interactive immerses students in an assignable and auto-graded activity Digital Interactives are also engaging lecture tools for traditional, online, and hybrid courses, many incorporating real-time data, data displays, and analysis tools for rich classroom discussions Hubbard_06_1292159928_ifc_Final.indd ® Practice, Engage, and Assess with MyEconLab • L earning Catalytics—Generates classroom discussion, guides lectures, and promotes peer-to-peer learning with real-time analytics Students can use any device to interact in the classroom, engage with content, and even draw and share graphs • R eal-Time Data Analysis Exercises—Using current macro data to help students understand the impact of changes in economic variables, Real-Time Data Analysis Exercises communicate directly with the Federal Reserve Bank of St Louis’s FRED® site and update as new data are available • C urrent News Exercises—Every week, current microeconomic and macroeconomic news stories, with accompanying exercises, are posted to MyEconLab Assignable and auto-graded, these multi-part exercises ask students to recognize and apply economic concepts to real-world events • E xperiments—Flexible, easy-to-assign, auto-graded, and available in Single and Multiplayer versions, Experiments in MyEconLab make learning fun and engaging • R eporting Dashboard—View, analyze, and report learning outcomes clearly and easily Available via the Gradebook and fully mobile-ready, the Reporting Dashboard presents student performance data at the class, section, and program levels in an accessible, visual manner • L MS Integration—Link from any LMS platform to access assignments, rosters, and resources, and synchronize MyLab grades with your LMS gradebook For students, new direct, single sign-on provides access to all the personalized learning MyLab resources that make studying more efficient and effective • M obile Ready—Students and instructors can access multimedia resources and complete assessments right at their fingertips, on any mobile device 01/04/16 4:33 PM Economics A01_HUB9928_06_SE_FM.indd 11/04/16 1:33 PM Th e P ear son Series in Economics Abel/Bernanke/Croushore Macroeconomics* Fort Sports Economics Acemoglu/Laibson/List Economics* Froyen Macroeconomics Bade/Parkin Foundations of Economics* Fusfeld The Age of the Economist Berck/Helfand The Economics of the Environment Gerber International Economics* Bierman/Fernandez Game Theory with Economic Applications González-Rivera Forecasting for Economics and Business Blanchard Macroeconomics* Gordon Macroeconomics* Blau/Ferber/Winkler The Economics of Women, Men, and Work Greene Econometric Analysis Boardman/Greenberg/Vining/ Weimer Cost-Benefit Analysis Boyer Principles of Transportation Economics Gregory Essentials of Economics Gregory/Stuart Russian and Soviet Economic Performance and Structure Klein Mathematical Methods for Economics Krugman/Obstfeld/Melitz International Economics: Theory & Policy* Laidler The Demand for Money Leeds/von Allmen The Economics of Sports Leeds/von Allmen/Schiming Economics* Lynn Economic Development: Theory and Practice for a Divided World Miller Economics Today* Understanding Modern Economics Miller/Benjamin The Economics of Macro Issues Miller/Benjamin/North The Economics of Public Issues Branson Macroeconomic Theory and Policy Hartwick/Olewiler The Economics of Natural Resource Use Bruce Public Finance and the American Economy Heilbroner/Milberg The Making of the Economic Society Mishkin The Economics of Money, Banking, and Financial Markets* Carlton/Perloff Modern Industrial Organization Heyne/Boettke/Prychitko The Economic Way of Thinking Case/Fair/Oster Principles of Economics* Holt Markets, Games, and Strategic Behavior The Economics of Money, Banking, and Financial Markets, Business School Edition* Chapman Environmental Economics: Theory, Application, and Policy Hubbard/O’Brien Economics* Cooter/Ulen Law & Economics Money, Banking, and the Financial System* Daniels/VanHoose International Monetary & Financial Economics Hubbard/O’Brien/Rafferty Macroeconomics* Downs An Economic Theory of Democracy Ehrenberg/Smith Modern Labor Economics Farnham Economics for Managers Folland/Goodman/Stano The Economics of Health and Health Care *denotes MyEconLab titles A01_HUB9928_06_SE_FM.indd Hughes/Cain American Economic History Husted/Melvin International Economics Jehle/Reny Advanced Microeconomic Theory Mills/Hamilton Urban Economics Macroeconomics: Policy and Practice* Murray Econometrics: 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intentionally left blank 561590_MILL_MICRO_FM_ppi-xxvi.indd 24/11/14 5:26 PM www.freebookslides.com About the Authors Glenn Hubbard, policymaker, professor, and researcher R Glenn Hubbard is the dean and Russell L Carson Professor of Finance and Economics in the Graduate School of Business at Columbia University and professor of economics in Columbia’s Faculty of Arts and Sciences He is also a research associate of the National Bureau of Economic Research and a director of Automatic Data Processing, Black Rock Closed-End Funds, and MetLife He received his Ph.D in economics from Harvard University in 1983 From 2001 to 2003, he served as chairman of the White House Council of Economic Advisers and chairman of the OECD Economic Policy Committee, and from 1991 to 1993, he was deputy assistant secretary of the U.S Treasury Department He currently serves as co-chair of the nonpartisan Committee on Capital Markets Regulation Hubbard’s fields of specialization are public economics, financial markets and institutions, corporate finance, macroeconomics, industrial organization, and public policy He is the author of more than 100 articles in leading journals, including American Economic Review, Brookings Papers on Economic Activity, Journal of Finance, Journal of Financial Economics, Journal of Money, Credit, and Banking, Journal of Political Economy, Journal of Public Economics, Quarterly Journal of Economics, RAND Journal of Economics, and Review of Economics and Statistics His research has been supported by grants from the National Science Foundation, the National Bureau of Economic Research, and numerous private foundations Tony O’Brien, award-winning professor and researcher Anthony Patrick O’Brien is a professor of economics at Lehigh University He received his Ph.D from the University of California, Berkeley, in 1987 He has taught principles of economics for more than 20 years, in both large sections and small honors classes He received the Lehigh University Award for Distinguished Teaching He was formerly the director of the Diamond Center for Economic Education and was named a Dana Foundation Faculty Fellow and Lehigh Class of 1961 Professor of Economics He has been a visiting professor at the University of California, Santa Barbara, and the Graduate School of Industrial Administration at Carnegie Mellon University O’Brien’s research has dealt with issues such as the evolution of the U.S automobile industry, the sources of U.S economic competitiveness, the development of U.S trade policy, the causes of the Great Depression, and the causes of black–white income differences His research has been published in leading journals, including American Economic Review, Quarterly Journal of Economics, Journal of Money, Credit, and Banking, Industrial Relations, Journal of Economic History, and Explorations in Economic History His research has been supported by grants from government agencies and private foundations A01_HUB9928_06_SE_FM.indd 11/04/16 1:33 PM www.freebookslides.com Chapter Summary and Problems 1.3 83 Economic Models, pages 70–75 LEARNING OBJECTIVE: Describe the role of models in economic analysis Summary An economic variable is something measurable that can have different values, such as the wages of software programmers Economists rely on economic models when they apply economic ideas to real-world problems Economic models are simplified versions of reality used to analyze real-world economic situations Economists accept and use an economic model if it leads to hypotheses that are confirmed by statistical analysis In many cases, the acceptance is tentative, however, pending the gathering of new data or further statistical analysis Economics is a social science because it applies the scientific method to the study of the interactions among individuals Economics is concerned with positive analysis rather than normative analysis Positive analysis is concerned with what is Normative analysis is concerned with what ought to be As a social science, economics considers human behavior in every context of decision making, not just in business MyEconLab Visit www.myeconlab.com to complete select exercises online and get instant feedback Review Questions 3.1 What is the relationship between economic models and economic data? 3.2 Explain why it is important for an economic model to yield testable hypotheses 3.3 What is the difference between normative analysis and positive analysis? Is economics concerned mainly with normative analysis or positive analysis? Briefly explain Problems and Applications 3.4 Suppose an economist develops an economic model and finds that “it works great in theory, but it fails in practice.” What should the economist next? 3.5 Dr Strangelove’s theory is that the price of mushrooms is determined by the activity of subatomic particles that exist in another universe parallel to ours When the subatomic particles are emitted in profusion, the price of mushrooms is high When subatomic particle emissions are low, the price of mushrooms is also low How would you go about testing Dr Strangelove’s theory? Discuss whether this theory is useful 3.6 [Related to the Don’t Let This Happen to You on page 73] Briefly explain which of the following statements represent positive analysis and which represent normative analysis a A 50-cent-per-pack tax on cigarettes will lead to a 12 percent reduction in smoking by teenagers b The federal government should spend more on AIDS research c Rising wheat prices will increase bread prices d The price of coffee at Starbucks is too high 3.7 [Related to the Don’t Let This Happen to You on page 73] The Living Wage Foundation in the United Kingdom aims to persuade employers and politicians of the importance of a living wage rather than a nationally agreed minimum wage The living wage is based on the amount of income M01_HUB9928_06_SE_CH01.indd 83 that an individual needs to earn to cover the basic costs of living and lead a “decent life.” The living wage is an informal benchmark calculated by the Centre for Research in Social Policy at Loughborough University, while the national minimum wage is set by the government Living costs in London in particular are significantly higher than in the rest of the country The Living Wage Foundation has obtained support in principle from the main political parties and has so far accredited about 1,000 employers who have decided to offer a living wage Do you think it is the role of the government to make sure that people who work have enough income to live a “decent life”? Source: What is the living wage?”, bbc.com, November 2, 2014; and Living Wage Foundation, http://www.livingwage.org.uk/ 3.8 [Related to the Making the Connection on page 74] The Making the Connection feature explains that there are both positive and normative elements to the debate over whether medical schools should charge tuition and whether hospitals should continue to pay residents who pursue primary care but not residents who specialize What economic statistics would be most useful in evaluating the positive elements in this debate? Assuming that these statistics are available or could be gathered, are they likely to resolve the normative issues in this debate? 3.9 [Related to the Chapter Opener on page 61] An article in the Wall Street Journal discussing Sanadu’s prospects for successfully selling its home medical devices observes, “Another challenge will be getting doctors on board with the idea of patients bringing them information from home.” What economic incentives doctors have to accept this information? What economic incentives they have not to accept it? Source: Timothy Hay, “Gadgets Bring Diagnostics into the Home,” Wall Street Journal, April 27, 2015 3.10 Suppose you were building an economic model to forecast the number of physicians and physician’s assistants likely to be needed in 2020 Should your model take into account the growth of the home medical device industry? Briefly explain 3.11 The occupation of a gas engineer in the United Kingdom is regulated To obtain licenses, individuals need to have qualifications in areas of gas work and join the Gas Safety Register In addition, European Union (EU) citizens who want to operate as gas engineers in the United Kingdom will also need to be registered with the Gas Safety Register a How does this system help protect consumers? b How might this system protect the financial interests of plumbers and gas engineers more than the well-being of consumers? c Briefly explain whether you consider this system to be good or bad Is your conclusion an example of normative economics or of positive economics? Explain the reasons for your answer Sources: Maria Koumenta, Amy Humphris, Morris Kleiner, and Mario Pagliero, “Occupational Regulation in the EU and UK: Prevalence and Labour Market Impacts,” July 2014, Final Report; and Gas Safe Register, http://www.gassaferegister.co.uk/ 08/04/16 1:43 PM www.freebookslides.com 84 1.4 C h a p t er Economics: Foundations and Models Microeconomics and Macroeconomics, page 75 LEARNING OBJECTIVE: Distinguish between microeconomics and macroeconomics Summary Problems and Applications Microeconomics is the study of how households and f irms make choices, how they interact in markets, and how the government attempts to influence their choices Macroeconomics is the study of the economy as a whole, including topics such as inflation, unemployment, and economic growth 4.3 Briefly explain whether each of the following is primarily a microeconomic issue or a macroeconomic issue a The effect of higher cigarette taxes on the quantity of cigarettes sold b The effect of higher income taxes on the total amount of consumer spending c The reasons the economies of East Asian countries grow faster than the economies of sub-Saharan African countries d The reasons for low rates of profit in the airline industry 4.4 Briefly explain whether you agree with the following assertion: “Microeconomics is concerned with things that happen in one particular place, such as the unemployment rate in one city In contrast, macroeconomics is concerned with things that affect the country as a whole, such as how the rate of teenage smoking in the United States would be affected by an increase in the tax on cigarettes.” MyEconLab Visit www.myeconlab.com to complete select exercises online and get instant feedback Review Question 4.1 Briefly discuss the difference between microeconomics and macroeconomics 4.2 Would the term “investment” be regarded as a microeconomic or a macroeconomic issue? Briefly explain 1.5 A Preview of Important Economic Terms, pages 75–77 LEARNING OBJECTIVE: Define important economic terms Summary Becoming familiar with important terms is a necessary step in learning economics These important economic terms include M01_HUB9928_06_SE_CH01.indd 84 capital, entrepreneur, factors of production, firm, goods, household, human capital, innovation, profit, revenue, services, and technology 08/04/16 1:43 PM www.freebookslides.com Appendix Using Graphs and Formulas Learning objective: Use graphs and formulas to analyze economic situations Graphs are used to illustrate key economic ideas Graphs appear not just in economics textbooks but also on Web sites and in newspaper and magazine articles that discuss events in business and economics Graphs serve two useful purposes: (1) They simplify economic ideas, and (2) they make the ideas more concrete so they can be applied to real-world problems Economic and business issues can be complicated, but a graph can help cut through complications and highlight the key relationships needed to understand the issue In that sense, a graph can be like a street map Suppose you take a bus to New York City to see the Empire State Building After arriving at the Port Authority Bus Terminal, you will probably use a map similar to this one to find your way to the Empire State Building Maps are simplified versions of reality This map shows the streets in this part of New York City and some of the most important buildings The map does not show stores, most buildings, or the names, addresses, and telephone numbers of the people who live and work in the area In fact, the map shows almost nothing about the messy reality of life in this section of New York City, except how the streets are laid out, which is the essential information you need to get from the Port Authority Bus Terminal to the Empire State Building Street map of New York City Copyright © 2011 City Maps Inc Reprinted by permission M01_HUB9928_06_SE_CH01.indd 85 08/04/16 1:43 PM www.freebookslides.com 86 C h a p t er Economics: Foundations and Models Think about someone who says, “I know how to get around in the city, but I just can’t figure out how to read a map.” It certainly is possible to find your destination in a city without a map, but it’s a lot easier with one The same is true of using graphs in economics It is possible to arrive at a solution to a real-world problem in economics and business without using graphs, but it is usually a lot easier if you use them With practice, you will become familiar with the graphs and formulas in this text, and you will know how to use them to analyze problems that would otherwise seem very difficult What follows is a brief review of how graphs and formulas are used Graphs of One Variable Figure 1A.1 displays values for market shares in the U.S automobile market, using two common types of graphs Market shares show the percentage of industry sales accounted for by different firms In this case, the information is for groups of firms: the “Big Three”—Ford, General Motors, and Chrysler—as well as Japanese, European, and Korean firms Panel (a) displays the information about market shares as a bar graph, where the market share of each group of firms is represented by the height of its bar Panel (b) displays the same information as a pie chart, where the market share of each group of firms is represented by the size of its slice of the pie Information about an economic variable is also often displayed in a time-series graph, which shows on a coordinate grid how the values of a variable change over time In a coordinate grid, we can measure the value of one variable along the vertical axis (or y-axis) and the value of another variable along the horizontal axis (or x-axis) The point where the vertical axis intersects the horizontal axis is called the origin At the origin, the value of both variables is zero The points on a coordinate grid represent values of the two variables In Figure 1A.2, we measure the number of automobiles and trucks sold worldwide by Ford Motor Company on the vertical axis, and we measure time on the horizontal axis In time-series graphs, the height of the line at each date shows the value of the Shares of the U.S automobile market 50% Korean firms 8.0% 45.4% 45 European firms 9.2% 37.3% 40 35 30 25 Japanese firms 37.3% 20 15 9.2% 10 Big Three 45.4% 8.0% Big Three Japanese firms European firms Korean firms (a) Bar Graphs (b) Pie Chart Figure 1A.1 Bar Graphs and Pie Charts Values for an economic variable are often displayed as a bar graph or a pie chart In this case, panel (a) shows market share data for the U.S automobile industry as a bar graph, where the market share of each group of firms is represented by the height of its bar Panel (b) displays the same M01_HUB9928_06_SE_CH01.indd 86 information as a pie chart, where the market share of each group of firms is represented by the size of its slice of the pie Source: “Auto Sales,” Wall Street Journal, May 21, 2015 08/04/16 1:43 PM www.freebookslides.com Appendix Using Graphs and Formulas Sales 8.0 (millions of automobiles) 7.0 87 Sales 7.5 (millions of automobiles) 7.0 6.0 6.5 5.0 6.0 4.0 5.5 3.0 2.0 5.0 1.0 4.5 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 The slashes (//) indicate that the scale on the vertical axis is truncated, which means that some numbers are omitted The numbers on the vertical axis jump from to 4.5 (a) Time-series graph where the scale is not truncated (b) Time-series graph with truncated scale MyEconLab Animation Figure 1A.2 Time-Series Graphs Both panels present time-series graphs of Ford Motor Company’s worldwide sales during each year from 2003 to 2014 In panel (a), the vertical axis starts at 0, and the distance between each pair of values shown is the same In panel (b), the scale on the vertical axis is truncated, which means that although it starts at 0, it then jumps to 4.5 million As a result, the fluctuations in Ford’s sales appear smaller in panel (a) than in panel (b) Source: Ford Motor Company, Annual Report, various years variable measured on the vertical axis Both panels of Figure 1A.2 show Ford’s worldwide sales during each year from 2003 to 2014 The difference between panel (a) and panel (b) illustrates the importance of the scale used in a time-series graph In panel (a), the vertical axis starts at 0, and the distance between each pair of values shown is the same In this panel, the decline in Ford’s sales during 2008 and 2009 appears relatively small In panel (b), the scale on the vertical axis is truncated, which means that although it starts at zero, it jumps to 4.5 million As a result, the distance on the vertical axis from to 4.5 million is much smaller than the distance from 4.5 million to 5.0 million The slashes (//) near the bottom of the axis indicate that the scale is truncated In panel (b), the decline in Ford’s sales during 2008 and 2009 appears much larger than in panel (a) (Technically, the horizontal axis in both panels is also truncated because we start with 2003, not 0.) MyEconLab Concept Check Graphs of Two Variables We often use graphs to show the relationship between two variables Suppose you are interested in the relationship between the price of a cheese pizza and the quantity of pizzas sold per week in the town of Statesboro, Georgia A graph showing the relationship between the price of a good and the quantity of the good demanded at each price is called a demand curve (As we will discuss later, in drawing a demand curve for a good, we have to hold constant any variables other than price that might affect the willingness of consumers to buy the good.) Figure 1A.3 shows the data collected on price and quantity The figure shows a two-dimensional grid on which we measure the price of pizza along the y-axis and the quantity of pizza sold per week along the x-axis Each point on the grid represents one of the price and quantity combinations listed in the table We can connect the points to form the demand curve for pizza in Statesboro, Georgia Notice that the scales on both axes in the graph are truncated In this case, truncating the axes allows the graph to illustrate more clearly the relationship between price and quantity by excluding low prices and quantities M01_HUB9928_06_SE_CH01.indd 87 08/04/16 1:43 PM www.freebookslides.com 88 C h a p t er Economics: Foundations and Models MyEconLab Concept Animation Figure 1A.3 Price (dollars per pizza) Quantity (pizzas per week) $15 50 A 14 55 B 13 60 C 12 65 D 11 70 E Plotting Price and Quantity Points in a Graph The figure shows a two-dimensional grid on which we measure the price of pizza along the vertical axis (or y-axis) and the quantity of pizza sold per week along the horizontal axis (or x-axis) Each point on the grid represents one of the price and quantity combinations listed in the table By connecting the points with a line, we can better illustrate the relationship between the two variables Price $16 (dollars per pizza) 15 Points A B 14 C 13 D 12 E 11 Demand curve 50 55 60 65 70 75 Quantity (pizzas per week) As we saw in Figure 1A.2, the slashes (//) indicate that the scales on the axes are truncated, which means that numbers are omitted: On the horizontal axis numbers jump from to 50, and on the vertical axis numbers jump from to 11 Slopes of Lines Once you have plotted the data in Figure 1A.3, you may be interested in how much the quantity of pizza sold increases as the price decreases The slope of a line tells us how much the variable we are measuring on the y-axis changes as the variable we are measuring on the x-axis changes We can use the Greek letter delta (Δ) to stand for the change in a variable The slope is sometimes referred to as the rise over the run So, we have several ways of expressing slope: Slope = Change in value on the vertical axis Change in value on the horizontal axis = ∆y ∆x = Rise Run Figure 1A.4 reproduces the graph from Figure 1A.3 Because the slope of a straight line is the same at any point, we can use any two points in the figure to calculate the slope of the line For example, when the price of pizza decreases from $14 to $12, the quantity of pizza sold increases from 55 per week to 65 per week Therefore, the slope is: Slope = ∆Price of pizza 1+12 - +142 -2 = = = - 0.2 ∆Quantity of pizza 165 - 552 10 The slope of this line shows us how responsive consumers in Statesboro, Georgia, are to changes in the price of pizza The larger the value of the slope (ignoring the negative sign), the steeper the line will be, which indicates that not many additional pizzas are sold when the price falls The smaller the value of the slope, the flatter the line will be, which indicates a greater increase in pizzas sold when the price falls MyEconLab Concept Check Taking into Account More Than Two Variables on a Graph The demand curve graph in Figure 1A.4 shows the relationship between the price of pizza and the quantity of pizza demanded, but we know that the quantity of any good demanded depends on more than just the price of the good For example, the quantity of pizza demanded in a given week in Statesboro, Georgia, can be affected by other M01_HUB9928_06_SE_CH01.indd 88 08/04/16 1:43 PM www.freebookslides.com 89 Appendix Using Graphs and Formulas MyEconLab Animation Price $16 (dollars per pizza) 15 Figure 1A.4 Calculating the Slope of a Line (55, 14) 14 12 13 14 = We can calculate the slope of a line as the change in the value of the variable on the y-axis divided by the change in the value of the variable on the x-axis Because the slope of a straight line is constant, we can use any two points in the figure to calculate the slope of the line For example, when the price of pizza decreases from $14 to $12, the quantity of pizza demanded increases from 55 per week to 65 per week So, the slope of this line equals −2 divided by 10, or −0.2 (65, 12) 12 65 55 = 10 11 Demand curve 50 55 60 65 70 75 Quantity (pizzas per week) variables—the price of hamburgers, whether an advertising campaign by local pizza parlors has begun that week, and so on Allowing the values of any other variables to change will cause the position of the demand curve in the graph to change Suppose that the demand curve in Figure 1A.4 were drawn holding the price of hamburgers constant, at $1.50 If the price of hamburgers rises to $2.00, some consumers will switch from buying hamburgers to buying pizza, and more pizzas will be demanded at every price The result on the graph will be to shift the line representing the demand curve to the right Similarly, if the price of hamburgers falls from $1.50 to $1.00, some consumers will switch from buying pizza to buying hamburgers, and fewer pizzas will be demanded at every price The result on the graph will be to shift the line representing the demand curve to the left The table in Figure 1A.5 shows the effect of a change in the price of hamburgers on the quantity of pizza demanded On the graph, suppose that at first we are on the line labeled Demand curve1 If the price of pizza is $14 (point A), an increase in the price of MyEconLab Animation Quantity (pizzas per week) Price (dollars per pizza) When the Price of Hamburgers = $1.00 When the Price of Hamburgers = $1.50 When the Price of Hamburgers = $2.00 $15 45 50 55 14 50 55 60 13 55 60 65 12 60 65 70 11 65 70 75 A B 13 C 12 D 11 Demand curve3 10 Demand curve1 Showing Three Variables on a Graph The demand curve for pizza shows the relationship between the price of pizzas and the quantity of pizzas demanded, holding constant other factors that might affect the willingness of consumers to buy pizza If the price of pizza is $14 (point A), an increase in the price of hamburgers from $1.50 to $2.00 increases the quantity of pizzas demanded from 55 to 60 per week (point B) and shifts us to Demand curve2 Or, if we start on Demand curve1 and the price of pizza is $12 (point C), a decrease in the price of hamburgers from $1.50 to $1.00 decreases the quantity of pizza demanded from 65 to 60 per week (point D) and shifts us to Demand curve3 Price $16 (dollars per pizza) 15 14 Figure 1A.5 Demand curve2 45 50 55 60 65 70 75 80 Quantity (pizzas per week) M01_HUB9928_06_SE_CH01.indd 89 08/04/16 1:43 PM www.freebookslides.com 90 C h a p t er Economics: Foundations and Models MyEconLab Animation Figure 1A.6 Graphing the Positive Relationship between Income and Consumption In a positive relationship between two economic variables, as one variable increases, the other variable also increases This figure shows the positive relationship between disposable personal income and consumption spending As disposable personal income in the United States has increased, so has consumption spending Source: U.S Department of Commerce, Bureau of Economic Analysis Year Disposable Personal Income (billions of dollars) Consumption Spending (billions of dollars) 2011 $11,801 $10,689 2012 12,384 11,083 2013 12,505 11,484 2014 12,986 11,930 Consumption $12,500 spending (billions of 12,000 dollars) 2014 2013 11,500 11,000 2011 2012 10,500 10,000 $11,000 11,500 12,000 12,500 13,000 13,500 Disposable personal income (billions of dollars) hamburgers from $1.50 to $2.00 increases the quantity of pizzas demanded from 55 to 60 per week (point B) and shifts us to Demand curve2 Or, if we start on Demand curve1 and the price of pizza is $12 (point C), a decrease in the price of hamburgers from $1.50 to $1.00 decreases the quantity of pizzas demanded from 65 to 60 per week (point D) and shifts us to Demand curve3 By shifting the demand curve, we have taken into account the effect of changes in the value of a third variable—the price of hamburgers We will use this technique of shifting curves to allow for the effects of additional variables many times in this book MyEconLab Concept Check Positive and Negative Relationships We can use graphs to show the relationships between any two variables Sometimes the relationship between the variables is negative, meaning that as one variable increases in value, the other variable decreases in value This was the case with the price of pizza and the quantity of pizzas demanded The relationship between two variables can also be positive, meaning that the values of both variables increase or decrease together For example, when the level of total income—or disposable personal income—received by households in the United States increases, the level of total consumption spending, which is spending by households on goods and services, also increases The table in Figure 1A.6 shows the values (in billions of dollars) for income and consumption spending for 2011–2014 The graph plots the data from the table, with disposable personal income measured along the horizontal axis and consumption spending measured along the vertical axis Notice that the points for 2012 and 2013 not all fall exactly on the line To examine the relationship between two variables, economists often use the straight line that best fits the data MyEconLab Concept Check Determining Cause and Effect When we graph the relationship between two variables, we usually want to draw conclusions about whether changes in one variable are causing changes in the other variable Doing so can, however, lead to mistakes Suppose over the course of a year you graph the number of homes in a neighborhood that have a fire burning in the fireplace and the number of leaves on trees in the neighborhood You would get a relationship like that shown in panel (a) of Figure 1A.7: The more fireplaces in use in the neighborhood, the fewer leaves the trees have Can we draw the conclusion from this graph that M01_HUB9928_06_SE_CH01.indd 90 08/04/16 1:43 PM www.freebookslides.com Appendix Using Graphs and Formulas Number of leaves on trees 91 Rate at which grass grows Number of fires in fireplaces (a) Problem of omitted variables Number of lawn mowers being used (b) Problem of reverse causality MyEconLab Animation Figure 1A.7 Determining Cause and Effect Using graphs to draw conclusions about cause and effect can be hazardous In panel (a), we see that there are fewer leaves on the trees in a neighborhood when many homes have fires burning in their fireplaces We cannot draw the conclusion that using fireplaces causes the leaves to fall because we have an omitted variable—the season of the year In panel (b), we see that more lawn mowers are used in a neighborhood during times when the grass grows rapidly and fewer lawn mowers are used when the grass grows slowly Concluding that using lawn mowers causes the grass to grow faster would be making the error of reverse causality using a fireplace causes trees to lose their leaves? We know, of course, that such a conclusion is incorrect In spring and summer, there are relatively few fireplaces being used, and the trees are full of leaves In the fall, as trees begin to lose their leaves, fireplaces are used more frequently And in winter, many fireplaces are being used and many trees have lost all their leaves The reason that the graph in Figure 1A.7 is misleading about cause and effect is that there is obviously an omitted variable in the analysis—the season of the year An omitted variable is one that affects other variables, and its omission can lead to false conclusions about cause and effect Although in our example the omitted variable is obvious, there are many debates about cause and effect where the existence of an omitted variable has not been clear For instance, it has been known for many years that people who smoke cigarettes suffer from higher rates of lung cancer than nonsmokers For some time, tobacco companies and some scientists argued that there was an omitted variable—perhaps failure to exercise or poor diet—that made some people more likely to smoke and more likely to develop lung cancer If this omitted variable existed, then the finding that smokers were more likely to develop lung cancer would not have been evidence that smoking caused lung cancer In this case, however, nearly all scientists eventually concluded that the omitted variable did not exist and that, in fact, smoking does cause lung cancer A related problem in determining cause and effect is known as reverse causality The error of reverse causality occurs when we conclude that changes in variable X cause changes in variable Y when, in fact, it is actually changes in variable Y that cause changes in variable X For example, panel (b) of Figure 1A.7 plots the number of lawn mowers being used in a neighborhood against the rate at which grass on lawns in the neighborhood is growing We could conclude from this graph that using lawn mowers causes the grass to grow faster We know, however, that in reality, the causality is in the other direction Rapidly growing grass during the spring and summer causes the increased use of lawn mowers Slowly growing grass in the fall or winter or during periods of low rainfall causes the decreased use of lawn mowers Once again, in our example, the potential error of reverse causality is obvious In many economic debates, however, cause and effect can be more difficult to determine M01_HUB9928_06_SE_CH01.indd 91 08/04/16 1:43 PM www.freebookslides.com 92 C h a p t er Economics: Foundations and Models For example, changes in the money supply, or the total amount of money in the economy, tend to occur at the same time as changes in the total amount of income people in the economy earn A famous debate in economics was about whether the changes in the money supply caused the changes in total income or whether the changes in total income caused the changes in the money supply Each side in the debate accused the other side of committing the error of reverse causality MyEconLab Concept Check Are Graphs of Economic Relationships Always Straight Lines? The graphs of relationships between two economic variables that we have drawn so far have been straight lines The relationship between two variables is linear when it can be represented by a straight line Few economic relationships are actually linear For example, if we carefully plot data on the price of a product and the quantity demanded at each price, holding constant other variables that affect the quantity demanded, we will usually find a curved—or nonlinear—relationship rather than a linear relationship In practice, however, it is often useful to approximate a nonlinear relationship with a linear relationship If the relationship is reasonably close to being linear, the analysis is not significantly affected In addition, it is easier to calculate the slope of a straight line, and it is also easier to calculate the area under a straight line So, in this textbook, we often assume that the relationship between two economic variables is linear, even when we know that this assumption is not precisely correct MyEconLab Concept Check Slopes of Nonlinear Curves In some situations, we need to take into account the nonlinear nature of an economic relationship For example, panel (a) of Figure 1A.8 shows the hypothetical relationship between Apple’s total cost of producing smartwatches and the quantity of smartwatches produced The relationship is curved rather than linear In this case, the cost of production is increasing at an increasing rate, which often happens in manufacturing In other words, as we move up the curve, its slope becomes larger (Remember that with a straight line, the slope is always constant.) To see why, first remember that we calculate the slope of a curve by dividing the change in the variable on the y-axis by the change in the variable on the x-axis As we move from point A to point B, the quantity produced increases by million smartwatches, while the total cost of production increases by $50 million Farther up the curve, as we move from point C to point D, the change in quantity is the same—1million smartwatches—but the change in the total cost of production is now much larger—$250 million Because the change in the y variable has increased, while the change in the x variable has remained the same, we know that the slope has increased To measure the slope of a nonlinear curve at a particular point, we measure the slope of the line that is tangent to that curve at that point This tangent line will touch the curve only at that point We can measure the slope of the tangent line just as we would measure the slope of any other straight line In panel (b), the tangent line at point B has a slope equal to: ∆ Cost 75 = = 75 ∆ Quantity The tangent line at point C has a slope equal to: ∆ Cost 150 = = 150 ∆ Quantity Once again, we see that the slope of the curve is larger at point C than at point B MyEconLab Concept Check Formulas We have just seen that graphs are an important economic tool In this section, we will review several useful formulas and show how to use them to summarize data and calculate important relationships M01_HUB9928_06_SE_CH01.indd 92 08/04/16 1:43 PM www.freebookslides.com 93 Appendix Using Graphs and Formulas Total cost of production (millions of dollars) Total cost of production (millions of dollars) Total cost $1,000 Total cost D Dy = 250 $900 Dy = 150 C 750 B 350 A 300 Dy = 50 Dx = B 350 Dy = 75 275 Dx = C 750 Dx = Dx = Quantity produced (millions per month) (a) The slope of a nonlinear curve is not constant Quantity produced (millions per month) (b) The slope of a nonlinear curve is measured by the slope of the tangent line MyEconLab Animation Figure 1A.8 The Slope of a Nonlinear Curve The relationship between the quantity of Apple Watches produced and the total cost of production is curved rather than linear In panel (a), when we move from point A to point B, the quantity produced increases by million Apple Watches, while the total cost of production increases by $50 million Farther up the curve, as we move from point C to point D, the change in quantity is the same—1 million Apple Watches—but the change in the total cost of production is now much larger—$250 million Because the change in the y variable has increased, while the change in the x variable has remained the same, we know that the slope has increased In panel (b), we measure the slope of the curve at a particular point by calculating the slope of the tangent line at that point The slope of the tangent line at point B is 75, and the slope of the tangent line at point C is 150 Formula for a Percentage Change The percentage change is the change in some economic variable, usually from one period to the next, expressed as a percentage A key macroeconomic measure is the real gross domestic product (GDP) GDP is the value of all the final goods and services produced in a country during a year “Real” GDP is corrected for the effects of inflation When economists say that the U.S economy grew 2.4 percent during 2014, they mean that real GDP was 2.4 percent higher in 2014 than it was in 2013 The formula for making this calculation is: a GDP2014 - GDP2013 b * 100 GDP2013 or, more generally, for any two periods: Percentage change = a M01_HUB9928_06_SE_CH01.indd 93 Value in the second period - Value in the first period b * 100 Value in the first period 08/04/16 1:43 PM www.freebookslides.com 94 C h a p t er Economics: Foundations and Models In this case, real GDP was $15,710 billion in 2013 and $16,086 billion in 2014 So, the growth rate of the U.S economy during 2014 was: a +16,086 - +15,710 b * 100 = 2.4% +15,710 Notice that it doesn’t matter that in using the formula, we ignored the fact that GDP is measured in billions of dollars In fact, when calculating percentage changes, the units don’t matter The percentage increase from $15,710 billion to $16,086 billion is exactly the same as the percentage increase from $15,710 to $16,086 MyEconLab Concept Check Formulas for the Areas of a Rectangle and a Triangle Areas that form rectangles and triangles on graphs can have important economic meaning For example, Figure 1A.9 shows the demand curve for Pepsi Suppose that the price is currently $2.00 and that 125,000 bottles of Pepsi are sold at that price A firm’s total revenue is equal to the amount it receives from selling its product, or the quantity sold multiplied by the price In this case, total revenue will equal 125,000 bottles times $2.00 per bottle, or $250,000 The formula for the area of a rectangle is: Area of a rectangle = Base * Height In Figure 1A.9, the shaded rectangle also represents the f irm’s total revenue because its area is given by the base of 125,000 bottles multiplied by the price of $2.00 per bottle We will see in later chapters that areas that are triangles can also have economic significance The formula for the area of a triangle is: Area of a triangle = MyEconLab Study Plan MyEconLab Animation Figure 1A.9 Showing a Firm’s Total Revenue on a Graph The area of a rectangle is equal to its base multiplied by its height Total revenue is equal to quantity multiplied by price Here, total revenue is equal to the quantity of 125,000 bottles times the price of $2.00 per bottle, or $250,000 The area of the shaded rectangle shows the firm’s total revenue The shaded area in Figure 1A.10 is a triangle The base equals 150,000 - 125,000, or 25,000 Its height equals +2.00 - +1.50, or +0.50 Therefore, its area equals 1>2 * 25,000 * +0.50, or +6,250 Notice that the shaded area is a triangle only if the demand curve is a straight line, or linear Not all demand curves are linear However, the formula for the area of a triangle will usually still give a good approximation, even if the demand curve is not linear MyEconLab Concept Check Price of Pepsi (dollars per bottle) $2.00 Total revenue Demand curve for Pepsi M01_HUB9928_06_SE_CH01.indd 94 * Base * Height 125,000 Quantity (bottles per month) 08/04/16 1:43 PM www.freebookslides.com 95 Appendix Using Graphs and Formulas MyEconLab Animation Price of Pepsi (dollars per bottle) Figure 1A.10 The Area of a Triangle Area = 1/2 x Base x Height = 1/2 x 25,000 x $0.50 = $6,250 The area of a triangle is equal to 1/2 multiplied by its base multiplied by its height The area of the shaded triangle has a base equal to 150,000 - 125,000, or 25,000, and a height equal to +2.00 - +1.50, or +0.50 Therefore, its area is equal to 1>2 * 25,000 * +0.50, or +6,250 $2.00 1.50 Demand curve for Pepsi 125,000 150,000 Quantity (bottles per month) Summary of Using Formulas You will encounter several other formulas in this book Whenever you use a formula, you should follow these steps: Make sure you understand the economic concept the formula represents Make sure you are using the correct formula for the problem you are solving Make sure the number you calculate using the formula is economically reasonable For example, if you are using a formula to calculate a firm’s revenue and your answer is a negative number, you know you made a mistake somewhere MyEconLab Concept Check 1a MyEconLab Study Plan Using Graphs and Formulas, pages 27–37 LEARNING OBJECTIVE: Use graphs and formulas to analyze economic situations MyEconLab Visit www.myeconlab.com to complete select exercises online and get instant feedback 1A.2 The following table gives information about the quantity of glasses of lemonade demanded on sunny and overcast days: Problems and Applications Price (dollars per glass) Quantity (glasses of lemonade per day) $0.80 30 Sunny 0.80 10 Overcast 0.70 40 Sunny Week 0.70 20 Overcast 50 Sunny 1A.1 The following table shows the relationship between the price of custard pies and the number of pies Jacob buys per week: Price (dollars per pie) Quantity of pies Weather $3.00 July 0.60 2.00 July 0.60 30 Overcast 60 Sunny 40 Overcast 5.00 July 16 0.50 6.00 July 23 0.50 1.00 July 30 4.00 August a Is the relationship between the price of pies and the number of pies Jacob buys a positive relationship or a negative relationship? b Plot the data from the table on a graph similar to Figure 1A.3 on page 88 Draw a straight line that best fits the points c Calculate the slope of the line M01_HUB9928_06_SE_CH01.indd 95 Plot the data from the table on a graph similar to Figure 1A.5 on page 89 Draw two straight lines representing the two demand curves—one for sunny days and one for overcast days 1A.3 Using the information in Figure 1A.2 on page 87, calculate the percentage change in Ford’s auto sales from one year to the next During which year did sales fall at the highest rate? 09/04/16 3:29 PM www.freebookslides.com 96 C h a p t er Economics: Foundations and Models 1A.4 Real GDP in 2012 was $15,369 billion Real GDP in 2013 was $15,710 billion What was the percentage change in real GDP from 2012 to 2013? What economists call the percentage change in real GDP from one year to the next? 1A.5 Assume that the demand curve for Pepsi passes through the following two points: Price per bottle of Pepsi (in dollars) Number of bottles demanded $2.50 100,000 1.25 200,000 a Draw a graph with a linear demand curve that passes through these two points b Show on the graph the areas representing total revenue at each price Give the value for total revenue at each price 1A.6 What is the area of the triangle shown in the following figure? 1A.7 Calculate the slope of the total cost curve at point A and at point B in the following figure Total cost of production (millions of dollars) Total cost $900 B 700 A 300 175 Price of Pepsi (dollars per two-liter bottle) 14 12 Quantity produced (millions per month) $2.25 1.50 Demand curve for Pepsi M01_HUB9928_06_SE_CH01.indd 96 115,000 175,000 Quantity (bottles per month) 08/04/16 1:43 PM www.freebookslides.com This page intentionally left blank 561590_MILL_MICRO_FM_ppi-xxvi.indd 24/11/14 5:26 PM ... Benefits from a Weak Yen The Real Exchange Rate 10 74 10 75 10 76 10 76 10 77 10 78 10 79 10 79 10 80 10 81 10 81 1082 10 83 10 85 10 85 10 85 10 87 10 87 10 88 11 /04 /16 1: 33 PM www.freebookslides.com 24 C o n te n... Woods System 11 24 11 24 11 24 11 25 11 26 Glossary 11 31 Company Index 11 39 Subject Index 11 42 Credits 11 63 11 /04 /16 1: 33 PM www.freebookslides.com This page intentionally left blank 5 615 90_MILL_MICRO_FM_ppi-xxvi.indd... the Federal Reserve System 909 909 910 910 910 911 914 915 916 916 917 918 919 919 920 9 21 9 21 922 922 922 923 924 924 926 928 929 929 9 31 932 932 11 /04 /16 1: 33 PM www.freebookslides.com 22 C