Principles of Economics Book

Preface: To the Instructor     vii
Preface: To the Student     xix
Introduction     1
Ten Principles of Economics     3
How People Make Decisions     4
People Face Trade-offs     4
The Cost of Something Is What You Give Up to Get It     5
Rational People Think at the Margin     6
People Respond to Incentives     7
How People Interact     8
Trade Can Make Everyone Better Off     8
Markets Are Usually a Good Way to Organize Economic Activity     9
Governments Can Sometimes Improve Market Outcomes     10
FYI: Adam Smith and the Invisible Hand     10
How the Economy as a Whole Works     11
A Country's Standard of Living Depends on Its Ability to Produce Goods and Services     12
Prices Rise When the Government Prints Too Much Money     12
Society Faces a Short-Run Trade-off between Inflation and Unemployment     13
FYI: How to Read This Book     14
Conclusion     14
Summary     15
Key Concepts     15
Questions for Review     16
Problems and Applications     16
Thinking Like an Economist     19
TheEconomist as Scientist     20
The Scientific Method: Observation, Theory and More Observation     20
The Role of Assumptions     21
Economic Models     22
Our First Model: The Circular-Flow Diagram     22
Our Second Model: The Production Possibilities Frontier     24
Microeconomics and Macroeconomics     26
FYI: Who Studies Economics?     27
The Economist as Policy Adviser     28
Positive versus Normative Analysis     28
Economists in Washington     29
In the News: Super Bowl Economics     30
Case Study: Mr. Mankiw Goes to Washington     31
Why Economists Disagree     32
Differences in Scientific Judgments     32
Differences in Values     33
Perception versus Reality     33
Let's Get Going     34
In the News: Why You Should Study Economics     35
Summary     36
Key Concepts     36
Questions for Review     36
Problems and Applications     36
Graphing: A Brief Review     38
Graphs of a Single Variable     38
Graphs of Two Variables: The Coordinate System     39
Curves in the Coordinate System     40
Slope     42
Cause and Effect     44
Interdependence and the Gains From Trade     47
A Parable for the Modern Economy     48
Production Possibilities     48
Specialization and Trade     50
Comparative Advantage: The Driving Force of Specialization     52
Absolute Advantage     52
Opportunity Cost and Comparative Advantage     52
Comparative Advantage and Trade     54
FYI: The Legacy of Adam Smith and David Ricardo     55
Applications of Comparative Advantage     55
Should Tiger Woods Mow His Own Lawn?     55
In the News: Evolution and Economics     56
Should the United States Trade with Other Countries?     56
Conclusion     58
Summary     58
Key Concepts     59
Questions for Review     59
Problems and Applications     59
How Markets Work     61
The Market Forces of Supply and Demand     63
Markets and Competition     64
What Is a Market?     64
What Is Competition?     64
Demand     65
The Demand Curve: The Relationship between Price and Quantity Demanded     65
Market Demand versus Individual Demand     66
Shifts in the Demand Curve     67
Case Study: Two Ways to Reduce the Quantity of Smoking Demanded     69
Supply     71
The Supply Curve: The Relationship between Price and Quantity Supplied     71
Market Supply versus Individual Supply     71
Shifts in the Supply Curve     72
Supply and Demand Together     75
Equilibrium     75
Three Steps to Analyzing Changes in Equilibrium     77
In the News: Political Unrest Shifts the Supply Curve     81
Conclusion: How Prices Allocate Resources     82
Summary     84
Key Concepts     84
Questions for Review     85
Problems and Applications     85
Elasticity and its Application     89
The Elasticity of Demand     90
The Price Elasticity of Demand and Its Determinants     90
Computing the Price Elasticity of Demand     91
The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities     92
The Variety of Demand Curves     93
Total Revenue and the Price Elasticity of Demand     93
Elasticity and Total Revenue along a Linear Demand Curve     95
In the News: On the Road with Elasticity     98
Other Demand Elasticities     98
The Elasticity of Supply     99
The Price Elasticity of Supply and Its Determinants     100
Computing the Price Elasticity of Supply     100
The Variety of Supply Curves     100
Three Applications of Supply, Demand, and Elasticity     103
Can Good News for Farming Be Bad News for Farmers?     103
Why Did OPEC Fail to Keep the Price of Oil High?     105
Does Drug Interdiction Increase or Decrease Drug-Related Crime?     107
Conclusion     108
Summary     109
Key Concepts     109
Questions for Review     109
Problems and Applications     110
Supply, Demand, and Government Policies     113
Controls on Prices     114
How Price Ceilings Affect Market Outcomes     114
Case Study: Lines at the Gas Pump     116
Case Study: Rent Control in the Short Run and Long Run     117
How Price Floors Affect Market Outcomes     118
In the News: Rent Control in New York     120
Case Study: The Minimum Wage     120
Evaluating Price Controls      123
Taxes     124
How Taxes on Buyers Affect Market Outcomes     124
How Taxes on Sellers Affect Market Outcomes     126
Case Study: Can Congress Distribute the Burden of a Payroll Tax?     128
Elasticity and Tax Incidence     129
Case Study: Who Pays the Luxury Tax?     129
Conclusion     131
Summary     131
Key Concepts     132
Questions for Review     132
Problems and Applications     132
Markets and Welfare     135
Consumers, Producers, and the Efficiency of Markets     137
Consumer Surplus     138
Willingness to Pay     138
Using the Demand Curve to Measure Consumer Surplus     139
How a Lower Price Raises Consumer Surplus     140
What Does Consumer Surplus Measure?     142
Producer Surplus     143
Cost and the Willingness to Sell     143
Using the Supply Curve to Measure Producer Surplus     144
How a Higher Price Raises Producer Surplus     146
Market Efficiency     147
The Benevolent Social Planner     147
Evaluating the Market Equilibrium     148
In the News: Ticket Scalping      151
Case Study: Should There Be a Market in Organs?     152
In the News: The Miracle of the Market     153
Conclusion: Market Efficiency and Market Failure     154
Summary     155
Key Concepts     155
Questions for Review     155
Problems and Applications     156
Application: The Costs of Taxation     159
The Deadweight Loss of Taxation     160
How a Tax Affects Market Participants     161
Deadweight Losses and the Gains from Trade     163
The Determinants of the Deadweight Loss     165
Case Study: The Deadweight Loss Debate     165
Deadweight Loss and Tax Revenue as Taxes Vary     167
FYI: Henry George and the Land Tax     169
Case Study: The Laffer Curve and Supply-Side Economics     170
In the News: On the Way to France     171
Conclusion     172
Summary     173
Key Concept     173
Questions for Review     173
Problems and Applications     173
Application: International Trade     177
The Determinants of Trade     178
The Equilibrium without Trade     178
The World Price and Comparative Advantage     179
The Winners and Losers from Trade     179
The Gains and Losses of an Exporting Country     180
The Gains and Losses of an Importing Country     181
In the News: Cheap Clothes from China     183
The Effects of a Tariff     184
FYI: Import Quotas: Another Way to Restrict Trade     186
The Lessons for Trade Policy     186
The Arguments for Restricting Trade     187
FYI: Other Benefits of International Trade     188
The Jobs Argument     188
In the News: Offshore Outsourcing     189
The National-Security Argument     190
The Infant-Industry Argument     190
The Unfair-Competition Argument     191
The Protection-as-a-Bargaining-Chip Argument     191
Case Study: Trade Agreements and the World Trade Organization     192
In the News: Globalization     193
Conclusion     194
Summary     195
Key Concepts     195
Questions for Review     196
Problems and Applications     196
The Economics of the Public Sector     201
Externalities     203
Externalities and Market Inefficiency      204
Welfare Economics: A Recap     205
Negative Externalities     206
Positive Externalities     207
Case Study: Technology Spillovers, Industrial Policy, and Patent Protection     208
Private Solutions to Externalities     209
The Types of Private Solutions     209
The Coase Theorem     210
Why Private Solutions Do Not Always Work     211
Public Policies toward Externalities     212
Command-and-Control Policies: Regulation     212
Market-Based Policy 1: Corrective Taxes and Subsidies     213
In the News: Conserving Fuel     214
Case Study: Why Is Gasoline Taxed So Heavily?     215
Market-Based Policy 2: Tradable Pollution Permits     216
In the News: Controlling Carbon     218
Objections to the Economic Analysis of Pollution     219
Conclusion     219
Summary     220
Key Concepts     220
Questions for Review     220
Problems and Applications     221
Public Goods and Common Resources     223
The Different Kinds of Goods     224
Public Goods     225
The Free-Rider Problem     226
Some Important Public Goods     226
Case Study: Are Lighthouses Public Goods?     228
The Difficult Job of Cost-Benefit Analysis     229
Case Study: How Much Is a Life Worth?     230
Common Resources     231
The Tragedy of the Commons     231
Some Important Common Resources     232
In the News: A Solution to City Congestion     233
Case Study: Why the Cow Is Not Extinct     234
In the News: Should Yellowstone Charge as Much as Disney World?     235
Conclusion: The Importance of Property Rights     236
Summary     236
Key Concepts     237
Questions for Review     237
Problems and Applications     237
The Design of the Tax System     241
A Financial Overview of the U.S. Government     242
The Federal Government     242
Case Study: The Fiscal Challenge Ahead     246
State and Local Government     248
Taxes and Efficiency     249
Deadweight Losses     250
Case Study: Should Income or Consumption Be Taxed?     250
Administrative Burden     251
Marginal Tax Rates versus Average Tax Rates     252
Case Study: Iceland's Natural Experiment     252
Lump-Sum Taxes     253
Taxes and Equity     253
The Benefits Principle     254
The Ability-to-Pay Principle     254
Case Study: How the Tax Burden Is Distributed     255
In the News: Tax Reform around the World     257
Case Study: Horizontal Equity and the Marriage Tax     257
Tax Incidence and Tax Equity     259
Case Study: Who Pays the Corporate Income Tax?     259
Conclusion: The Trade-off between Equity and Efficiency     260
Summary     261
Key Concepts     261
Questions for Review     261
Problems and Applications     262
Firm Behavior and the Organization of Industry     265
The Costs of Production     267
What Are Costs?     268
Total Revenue, Total Cost, and Profit     268
Costs as Opportunity Costs     268
The Cost of Capital as an Opportunity Cost     269
Economic Profit versus Accounting Profit     270
Production and Costs     271
The Production Function     271
From the Production Function to the Total-Cost Curve     273
The Various Measures of Cost      274
Fixed and Variable Costs     275
Average and Marginal Cost     276
Cost Curves and Their Shapes     277
Typical Cost Curves     278
Costs in the Short Run and in the Long Run     280
The Relationship between Short-Run and Long-Run Average Total Cost     280
Economies and Diseconomies of Scale     281
FYI: Lessons from a Pin Factory     282
Conclusion     282
Summary     283
Key Concepts     284
Questions for Review     284
Problems and Applications     285
Firms in Competitive Markets     289
What Is a Competitive Market?     290
The Meaning of Competition     290
The Revenue of a Competitive Firm     290
Profit Maximization and the Competitive Firm's Supply Curve     292
A Simple Example of Profit Maximization     292
The Marginal-Cost Curve and the Firm's Supply Decision     293
The Firm's Short-Run Decision to Shut Down     295
Spilt Milk and Other Sunk Costs     297
Case Study: Near-Empty Restaurants and Off-season Miniature Golf     298
The Firm's Long-Run Decision to Exit or Enter a Market     298
Measuring Profit in Our Graph for the Competitive Firm     299
The Supply Curve in a Competitive Market     301
The Short Run: Market Supply with a Fixed Number of Firms     301
The Long Run: Market Supply with Entry and Exit     302
Why Do Competitive Firms Stay in Business If They Make Zero Profit?     303
A Shift in Demand in the Short Run and Long Run     304
Why the Long-Run Supply Curve Might Slope Upward     304
Conclusion: Behind the Supply Curve     306
Summary     307
Key Concepts     307
Questions for Review     307
Problems and Applications     308
Monopoly     311
Why Monopolies Arise     312
Monopoly Resources     313
Case Study: The DeBeers Diamond Monopoly     313
Government-Created Monopolies     313
Natural Monopolies     314
How Monopolies Make Production and Pricing Decisions     315
Monopoly versus Competition     316
A Monopoly's Revenue     317
Profit Maximization     318
A Monopoly's Profit     320
FYI: Why a Monopoly Does Not Have a Supply Curve     321
Case Study: Monopoly Drugs versus Generic Drugs     322
The Welfare Cost of Monopoly     323
The Deadweight Loss     323
The Monopoly's Profit: A Social Cost?     325
Public Policy toward Monopolies     326
Increasing Competition with Antitrust Laws     326
Regulation     327
Public Ownership     328
Doing Nothing     329
Price Discrimination     329
In the News: Public Transport and Private Enterprise     330
A Parable about Pricing     330
The Moral of the Story     332
The Analytics of Price Discrimination     333
Examples of Price Discrimination     334
Conclusion: The Prevalence of Monopoly     335
In the News: TKTS and Other Schemes     336
Summary     338
Key Concepts     339
Questions for Review     339
Problems and Applications     340
Oligopoly     345
Between Monopoly and Perfect Competition     346
Markets with Only a Few Sellers     347
In the News: The Growth of Oligopoly     348
A Duopoly Example     348
Competition, Monopolies, and Cartels     349
The Equilibrium for an Oligopoly     350
In the News: The Global Fight against Cartels     351
How the Size of an Oligopoly Affects the Market Outcome     352
Game Theory and the Economics of Cooperation     353
The Prisoners' Dilemma     354
Oligopolies as a Prisoners' Dilemma     355
Case Study: OPEC and the World Oil Market     356
Other Examples of the Prisoners' Dilemma     357
The Prisoners' Dilemma and the Welfare of Society     359
Why People Sometimes Cooperate     359
Case Study: The Prisoners' Dilemma Tournament     360
Public Policy toward Oligopolies     360
Restraint of Trade and the Antitrust Laws     361
Case Study: An Illegal Phone Call     361
Controversies over Antitrust Policy     362
Case Study: The Microsoft Case     364
Conclusion     365
In the News: Antitrust in the New Economy     366
Summary     367
Key Concepts     367
Questions for Review     367
Problems and Applications     368
Monopolistic Competition     373
Competition with Differentiated Products     374
The Monopolistically Competitive Firm in the Short Run     374
The Long-Run Equilibrium      375
Monopolistic versus Perfect Competition     377
Monopolistic Competition and the Welfare of Society     379
FYI: Is Excess Capacity a Social Problem?     380
Advertising     380
The Debate over Advertising     381
Case Study: Advertising and the Price of Eyeglasses     382
Advertising as a Signal of Quality     382
FYI: Galbraith versus Hayek     383
Brand Names     384
Conclusion     386
Summary     387
Key Concept     387
Questions for Review     387
Problems and Applications     388
The Economics of Labor Markets     391
The Markets for the Factors of Production     393
The Demand for Labor     394
The Competitive Profit-Maximizing Firm     394
The Production Function and the Marginal Product of Labor     395
The Value of the Marginal Product and the Demand for Labor     397
What Causes the Labor-Demand Curve to Shift?     398
FYI: Input Demand and Output Supply: Two Sides of the Same Coin     399
FYI: The Luddite Revolt     400
The Supply of Labor     401
The Trade-off between Work and Leisure      401
What Causes the Labor-Supply Curve to Shift?     401
Equilibrium in the Labor Market     402
Shifts in Labor Supply     402
Shifts in Labor Demand     404
Case Study: Productivity and Wages     405
FYI: Monopsony     406
The