Economics, 13th Edition PDF by Roger A. Arnold


Economics, Thirteenth Edition

By Roger A. Arnold

Economics, 13th Edition


An Introduction to Economics

Part 1 Economics: The Science of Scarcity

CHAPTER 1: What Economics is About 1

Your Life, 2019–2029 1

A Definition of Economics 2

Goods and Bads 2 Resources 2 Scarcity and a Definition of Economics 2

Key Concepts in Economics 4

Opportunity Cost 4 Opportunity Cost and Behavior 6 Benefits and Costs 6

Decisions Made at the Margin 7 Efficiency 9

Does It Matter to You . . . If You Are Efficient or Not? 11

Economics Is About Incentives 12 Unintended Effects 13 Exchange 14

Ceteris Paribus and Theory 16

Ceteris Paribus Thinking 16 What Is a Theory? 17

Hear What and How the Economist Thinks . . . About Theories 19

Economic Categories 20

Positive Economics and Normative Economics 20 Microeconomics and

Macroeconomics 20

Chapter Summary 22

Key Terms and Concepts 23

Questions and Problems 23

Working with Numbers and Graphs 24


Slope of a Line 26

Slope of a Line Is Constant 27

Slope of a Curve 27

The 45-Degree Line 27

Pie Charts 29

Bar Graphs 29

Line Graphs 30

Appendix Summary 32

Key Terms and Concepts 32

Questions and Problems 32


Five Myths About Economics and Being an Economics Major 35

What Awaits You as an Economics Major? 37

What Do Economists Do? 38

Places to Find More Information 40

Concluding Remarks 40


The Production Possibilities Frontier 41

The Straight-Line PPF: Constant Opportunity Costs 41 The Bowed-Outward

(Concave-Downward) PPF: Increasing Opportunity Costs 42

Does It Matter to You . . . If the Economy Is at One Point on the PPF Instead of Another? 44

Law of Increasing Opportunity Costs 45 Economic Concepts in a Production Possibilities

Frontier Framework 46

Specialization and Trade Can Move Us Beyond Our Ppf 51

A Simple Two-Person PPF Model 51 On or Beyond the PPF? 52

Hear What and How the Economist Thinks . . . About Manufacturing Jobs 53

Chapter Summary 56

Key Terms and Concepts 57

Questions and Problems 57

Working with Numbers and Graphs 57


What Is Demand? 59

The Law of Demand 60 Four Ways to Represent the Law of Demand 60 Why Does

Quantity Demanded Go Down as Price Goes Up? 61 Individual Demand Curve and

Market Demand Curve 62 A Change in Quantity Demanded Versus a Change in

Demand 63 What Factors Cause the Demand Curve to Shift? 66 Movement Factors

and Shift Factors 68

Supply 69

The Law of Supply 69 Why Most Supply Curves Are Upward Sloping 70 Changes in

Supply Mean Shifts in Supply Curves 72 What Factors Cause the Supply Curve to Shift? 72

A Change in Supply Versus a Change in Quantity Supplied 74

The Market: Putting Supply and Demand Together 75

Supply and Demand at Work at an Auction 75 The Language of Supply and Demand: A

Few Important Terms 76 Moving to Equilibrium: What Happens to Price When There Is

a Surplus or a Shortage? 76 Speed of Moving to Equilibrium 76

Hear What and How the Economist Thinks . . . About Higher Prices and Buying More 78

Moving to Equilibrium: Maximum and Minimum Prices 79 The Connection Between

Equilibrium and Predictions 80 Equilibrium in Terms of Consumers’ and Producers’

Surplus 81

Does It Matter to You . . . If You Pay Equilibrium Prices or Not? 83

What Can Change Equilibrium Price and Quantity? 83 It Is Important to Know Why

the Price Changed: Back to Substitutes and Complements 86 Epilogue: Who Feeds Cleveland? 87

Chapter Summary 91

Key Terms and Concepts 91

Questions and Problems 92

Working with Numbers and Graphs 93


Price 95

Price as a Rationing Device 95 Price as a Transmitter of Information 96

Price Controls 97

Price Ceiling 97

Hear What and How the Economist Thinks . . . About Price Ceilings and the Value of Money 102

Price Floor: Definition and Effects 103

Does It Matter to You . . . If the Demand Curve for Unskilled Labor Is Steep or Not? 105

Two Prices: Absolute and Relative 109

Absolute (Money) Price and Relative Price 109 Taxes on Specific Goods and Relative Price Changes 110

Does It Matter to You . . . If Something You Buy Is Taxed or Subsidized? 112

Chapter Summary 114

Key Terms and Concepts 114

Questions and Problems 114

Working with Numbers and Graphs 115


Application 1: U-Haul Rates and Demand 116

Application 2: Subsidizing the Consumption

of Anything Can Raise its Price 117

Application 3: 10 a.m. Classes in College 119

Application 4: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes of Admission? 121

Application 5: Why is Medical Care So Expensive? 122

Application 6: Do You Pay for Good Weather? 124

Application 7: The Price of an Aisle Seat 126

Application 8: College Superathletes 127

Application 9: Easier-to-Obtain Loans and Higher Housing Prices 129

Application 10: Speculators, Price Variability, and Patterns 130

Application 11: Supply and Demand on a Freeway 131

Application 12: Are Renters Better Off? 132

Chapter Summary 135

Questions and Problems 136

Working with Numbers and Graphs 137


Part 2 Macroeconomic Fundamentals



Measuring The Price Level 138

Using the CPI to Compute the Price Level 138 Inflation and the CPI 140 The Core PCE Index 141

Does It Matter to You . . . If Prices Rise or Fall? 142

Converting Dollars from One Year to Another 143

Hear What and How the Economist Thinks . . . About House Prices in the Past 145

Measuring Unemployment 146

Who Are the Unemployed? 146 The Unemployment Rate and the Employment

Rate 147 Common Misconceptions about the Unemployment and Employment

Rates 147 Reasons for Unemployment 148 Discouraged Workers 148 Types of

Unemployment 149 The Natural Unemployment Rate and Full Employment 150

Cyclical Unemployment 151

Chapter Summary 154

Key Terms and Concepts 154

Questions and Problems 154

Working with Numbers and Graphs 155



Gross Domestic Product 156

Calculating GDP 156 Final Goods and Intermediate Goods 157 What GDP Omits 157

GDP Is Not Adjusted for Bads Generated in the Production of Goods 158 Per-Capita GDP 158

The Expenditure Approach to Computing GDP for a Real-World Economy 162

Using the Expenditure Approach to Compute GDP 163 Common Misconceptions about Increases in GDP 165

The Income Approach to Computing GDP for a Real-World Economy 165

Computing National Income 167 From National Income to GDP: Making

Some Adjustments 168 Other National Income Accounting Measurements 170

Net Domestic Product 170 Personal Income 170 Disposable Income 170

Real GDP 171

Why We Need Real GDP 171 Computing Real GDP 171 The General Equation for

Real GDP 172 What Does It Mean if Real GDP Is Higher in One Year Than in Another?

172 Real GDP, Economic Growth, and Business Cycles 172

Does It Matter to You . . . In Which Phase of the Business Cycle You Search for a Job? 174

Hear What and How the Economist Thinks . . . About Economic Growth and

Real GDP 175

Chapter Summary 177

Key Terms and Concepts 178

Questions and Problems 178

Working with Numbers and Graphs 179

Part 3 Macroeconomic Stability, Instability, and Fiscal Policy


A Way to View the Economy 181

Aggregate Demand 182

Why Does the Aggregate Demand Curve Slope Downward? 183 An Important Word on

the Three Effects 186 A Change in Quantity Demanded of Real GDP Versus a Change

in Aggregate Demand 186 Changes in Aggregate Demand: Shifts in the AD Curve 187

How Spending Components Affect Aggregate Demand 188 Why Is There More Total

Spending? 189 Factors That Can Change C, I, G, and NX (EX – IM) and Therefore

Can Change AD (Shift the AD Curve) 189 Can a Change in the Money Supply Change

Aggregate Demand? 194 If Consumption Rises, Does Some Other Spending Component

Have to Decline? 194

Does It Matter to You . . . If Velocity Falls? 196

Hear What and How the Economist Thinks . . . About Total Spending, the Money Supply,

and Velocity 197

Short-Run Aggregate Supply 197

Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping 197 What

Puts the “Short Run” in the SRAS Curve? 199 Changes in Short-Run Aggregate Supply:

Shifts in the SRAS Curve 200 Something More to Come: Peoples’ Expectations 201

Putting AD And Sras Together: Short-Run Equilibrium 202

How Short-Run Equilibrium in the Economy Is Achieved 202 Thinking in Terms of

Short-Run Equilibrium Changes in the Economy 203 An Important Exhibit 207

Long-Run Aggregate Supply 207

Going from the Short Run to the Long Run 207 Short-Run Equilibrium, Long-Run

Equilibrium, and Disequilibrium 209

Chapter Summary 211

Key Terms and Concepts 212

Questions and Problems 212

Working with Numbers and Graphs 213



The Classical View 215

Classical Economists and Say’s Law 215 Classical Economists and Interest Rate Flexibility 216

Does It Matter to You . . . How Much People Save? 218

Classical Economists on Prices and Wages: Both Are Flexible 219

Three States of the Economy 220

Real GDP and Natural Real GDP: Three Possibilities 220 The Labor Market and the

Three States of the Economy 222 Common Misconceptions About the Unemployment

Rate and the Natural Unemployment Rate 223

The Self-Regulating Economy 226

What Happens If a Self-Regulating Economy Is in a Recessionary Gap? 226 What’s the

Connection Between a Slow Recovery and How Quickly or Slowly Wages Adjust? 227

What Happens If the Economy Is In an Inflationary Gap? 228 The Self-Regulating

Economy: A Recap 228

Hear What and How the Economist Thinks . . . About Laissez-Faire and the

Self-Regulating Economy 231 Policy Implication of Believing That the Economy Is Self-Regulating 231 Changes

in a Self-Regulating Economy: Short Run and Long Run 232 A Recap of Classical

Macroeconomics and a Self-Regulating Economy 234 Business-Cycle Macroeconomics

and Economic-Growth Macroeconomics 234

Chapter Summary 238

Key Terms and Concepts 238

Questions and Problems 239

Working with Numbers and Graphs 239



Questioning the Classical Position and the Self-Regulating Economy 241

Keynes’s Criticism of Say’s Law in a Money Economy 242 Keynes on Wage Rates 243

Different Markets, Different Rates of Adjustment 244 Keynes on Prices 247 Is It a

Question of the Time It Takes for Wages and Prices to Adjust? 248

The Simple Keynesian Model 251

Assumptions 251 The Consumption Function 251 Consumption and Saving 253

The Multiplier 254 The Multiplier and Reality 255

Does It Matter to You . . . How Much Spring Breakers Spend, the Value of the MPC, or Both? 256

The Simple Keynesian Model in the AD–AS Framework 257

Shifts in the Aggregate Demand Curve 257 The Keynesian Aggregate

Supply Curve 257 The Economy in a Recessionary Gap 259 Government’s Role

in the Economy 260 The Theme of the Simple Keynesian Model 260

Hear What and How the Economist Thinks . . . About Why Not All Economists Agree on How the Economy Works 261

The Simple Keynesian Model in the TE–TP Framework 262

Deriving a Total Expenditures (TE) Curve 263 Where the Consumption Curve and

the Total Expenditures Curve Cut the Vertical Axis: More on Exhibit 12 264 What Will

Shift the TE Curve? 265 Comparing Total Expenditures (TE) and Total Production (TP)

265 Moving from Disequilibrium to Equilibrium 266 The Economy in a Recessionary

Gap and the Role of Government 268 Equilibrium in the Economy 269 The Theme of

the Simple Keynesian Model 269

Chapter Summary 271

Key Terms and Concepts 271

Questions and Problems 272

Working with Numbers and Graphs 273


The Federal Budget 274

Government Expenditures 274 Government Tax Revenues 275 Budget Projections 276

Budget Deficit, Surplus, or Balance 277 Structural and Cyclical Deficits 278 The Public

Debt 279 Valued-Added Tax 279 Tax Deductions Versus Subsidies 282

Fiscal Policy 283

Some Relevant Fiscal Policy Terms 283 Two Important Notes 283

Demand-Side Fiscal Policy 283

Shifting the Aggregate Demand Curve 283 Fiscal Policy: Keynesian Perspective (Economy

Is Not Self-Regulating) 284 Crowding Out: Questioning Expansionary Fiscal Policy 285

Lags and Fiscal Policy 287 Crowding Out, Lags, and the Effectiveness of Fiscal Policy 289

Democracy in Deficit 289

Hear What and How the Economist Thinks . . . About the Deficit as a Percentage

of GDP 292

Supply-Side Fiscal Policy 292

Marginal Tax Rates and Aggregate Supply 293 The Laffer Curve: Tax Rates and Tax Revenues 293

Does It Matter to You . . . If the Economy Is on the Upward-Sloping or

Downward-Sloping Portion of the Laffer Curve? 295

Fiscal Policy and Expectations 296

Chapter Summary 298

Key Terms and Concepts 299

Questions and Problems 299

Working with Numbers and Graphs 300

Part 4 Money, the Economy, and Monetary Policy


Money: What Is It and How Did It Come To Be? 301

Money: A Definition 301 Three Functions of Money 302 From a Barter Economy to

a Money Economy: The Origins of Money 302

Does It Matter to You . . . If You Live in a Barter or Money Economy? 304

Money, Leisure, and Output 304

Defining the Money Supply 305

M1 305 Money Is More Than Currency 306 M2 306 Where Do Credit Cards Fit In? 306

Hear What and How the Economist Thinks . . . About Money and Gold 307

How Banking Developed 308

The Early Bankers 308 The Bank’s Reserves and More 310

The Financial System 311

Direct and Indirect Finance 312 Adverse Selection Problems and Moral Hazard

Problems 312 The Bank’s Balance Sheet 313 A Bank’s Business: Turning Liabilities into Assets 313

Chapter Summary 315

Key Terms and Concepts 316

Questions and Problems 316

Working with Numbers and Graphs 317


The Structure and Functions of the Federal Reserve System (The Fed) 318

The Structure of the Fed 318 Functions of the Fed 319 Common Misconceptions

About the U.S. Treasury and the Fed 321

The Money Supply Expansion Process 323

A Quick Review of Reserves, Required Reserves, and Excess Reserves 323 The Money Supply Expansion Process 323

Hear What and How the Economist Thinks . . . About Money and Currency 327

The Money Supply Contraction Process 327

Does It Matter to You . . . If Banks Are Reserve Deficient or Not? 329

Other Fed Tools and Recent Fed Actions 329

The Required Reserve Ratio 330 The Discount Window and the Federal Funds

Market 330 The Fed and the Federal Funds Rate Target 331 What Is Free Banking? 331

Chapter Summary 334

Key Terms and Concepts 334

Questions and Problems 335

Working with Numbers and Graphs 335

Appendix C: The Market For Reserves (or The Federal Funds Market) 337

The Demand for Reserves 337

The Supply of Reserves 338

Two Different Supply Curves for Reserves 338

The Corridor and Changing the Federal Funds Rate 340


Money and the Price Level 341

The Equation of Exchange 341 From the Equation of Exchange to the Simple

Quantity Theory of Money 343 The Simple Quantity Theory of Money in an AD–AS Framework 344

Hear What and How the Economist Thinks . . . About More Money and Inflation 346

Dropping the Assumptions that V and Q Are Constant 348 Monetarism 349

The Four Monetarist Positions 349 Monetarism and AD–AS 349

Does It Matter to You . . . If the AS Curve Is Vertical or Upward-Sloping? 352

The Monetarist View of the Economy 352 Inflation 353

One-Shot Inflation 353 Continued Inflation 357 Can You Get Rid of Inflation with Price Controls? 360

Money and Interest Rates 360

Which Economic Variables Does a Change in the Money Supply Affect? 360 The Money

Supply, the Loanable Funds Market, and Interest Rates 361 What Happens to the

Interest Rate as the Money Supply Changes? 365 The Nominal and Real Interest

Rates 366

Chapter Summary 367

Key Terms and Concepts 368

Questions and Problems 368

Working with Numbers and Graphs 369


Transmission Mechanisms 371

The Money Market in the Keynesian Transmission Mechanism 371 The Keynesian

Transmission Mechanism: Indirect 373 The Keynesian Mechanism May Get

Blocked 374 The Monetarist Transmission Mechanism: Direct 377

Monetary Policy and the Problem of Inflationary and Recessionary Gaps 378

A Different View of the Economy: Patterns of Sustainable Specialization and Trade (PSST) 380

Monetary Policy and the Activist–Nonactivist Debate 381

The Case for Activist (or Discretionary) Monetary Policy 382 The Case for Nonactivist (or Rules-Based) Monetary

Policy 382 Nonactivist Monetary Proposals 385

The Constant-Money-Growth-Rate Rule 386 The Predetermined-Money-Growth-Rate

Rule 386 The Fed and the Taylor Rule 386 Inflation Targeting 387 Nominal GDP Targeting 387

Does It Matter to You . . . How Much of a Change There Is in the Money Supply? 388

A Gold Standard as Monetary Policy and the Value of the Dollar 389

Hear What and How the Economist Thinks . . . About Predicting Gold Prices 391

Chapter Summary 393

Key Terms and Concepts 394

Questions and Problems 394

Working with Numbers and Graphs 395

Appendix D: Bond Prices and the Interest Rate 396

Appendix Summary 398

Questions and Problems 398

Part 5 Expectations and Growth

CHAPTER 18: Debates in Macroeconomics Over the Role and Effects of Government 443

Macroeconomics and Government: The Debate 443

Tax Cuts, Tax Revenue, and Budget Deficits 444

The Economy: Self-Regulating or Not? 445

More Government Spending or a Cut in Taxes: Which Gives a Bigger Bang for the Buck? 445

More Government Spending or a Cut in Taxes: The Size and Scope of Government 447

The Degree of Crowding Out 448

The Politics of Government Spending 449

Hear What and How the Economist Thinks . . . About the Economics of a Hurricane 450

Monetary Policy: Rules Versus Discretion 451

Bailouts 451

Demand-Side and Supply-Side Views of the Economy and Government Tools

for Changing Real GDP 452

Chapter Summary 456

Key Terms and Concepts 457

Questions and Problems 457

Working with Numbers and Graphs 458


Part 7 Microeconomic Fundamentals


Elasticity: Part 1 459

Price Elasticity of Demand 459 Elasticity Is Not Slope 461 From Perfectly Elastic to

Perfectly Inelastic Demand 461 Price Elasticity of Demand and Total Revenue (Total

Expenditure) 464 Elastic Demand and Total Revenue 465

Elasticity: Part 2 470

Price Elasticity of Demand Along a Straight-Line Demand Curve 470 Determinants of

Price Elasticity of Demand 471

Hear What and How the Economist Thinks . . . About the Prevalence of Elasticity 474

Other Elasticity Concepts 475

Cross Elasticity of Demand 475 Income Elasticity of Demand 476 Price Elasticity of

Supply 477 Price Elasticity of Supply and Time 478

The Relationship Between Taxes and Elasticity 481

Who Pays the Tax? 481 Elasticity and the Tax 482

Does It Matter to You . . . If There Are Few or Many Substitutes for the Goods

You Buy? 483

Degree of Elasticity and Tax Revenue 484

Chapter Summary 486

Key Terms and Concepts 487

Questions and Problems 487

Working with Numbers and Graphs 488



Utility Theory 489

Utility: Total and Marginal 489 Law of Diminishing Marginal Utility 490

The Solution to the Diamond–Water Paradox 492

Consumer Equilibrium and Demand 494

Equating Marginal Utilities per Dollar 494 Maximizing Utility and the Law of Demand

496 Should the Government Provide the Necessities of Life for Free? 496

Hear What and How the Economist Thinks . . . About Towns, Pollution Standards, and

Making the Invisible, Visible 498

Behavioral Economics 499

Are People Willing to Reduce Others’ Incomes? 499 Is One Dollar Always One

Dollar? 500 Coffee Mugs and the Endowment Effect 501 Does the Endowment

Effect Hold Only for New Traders? 503

Does It Matter to You . . . If You Are Subject to the Endowment Effect? 503

The Ultimatum Game—and Facebook, YouTube, and Wikipedia 504

Framing 507 Neuroeconomics 508

Chapter Summary 510

Key Terms and Concepts 511

Questions and Problems 511

Working with Numbers and Graphs 512



The Budget Constraint 513

What Will Change the Budget Constraint? 513

Indifference Curves 514

Constructing an Indifference Curve 515

The Indifference Map and the Budget Constraint Come Together 518

From Indifference Curves to a Demand Curve 519

Appendix Summary 520

Key Terms and Concepts 520

Questions and Problems 520


Why Firms Exist 521

The Market and the Firm: Invisible Hand Versus Visible Hand 521 The Alchian-and-

Demsetz Answer 522 Shirking on a Team 522 Ronald Coase on Why Firms Exist 523

Markets: Outside and Inside the Firm 524

Two Sides to Every Business Firm 524

More on Total Cost 525 Accounting Profit Versus Economic Profit 525

Does It Matter to You . . . If You Think in Terms of Only Accounting Profit? 526

Zero Economic Profit Is Not as Bad as It Sounds 527

Hear What and How the Economist Thinks . . . About Maximizing Revenue

and Profit 528

Production 529

Common Misconception About the Short Run and Long Run 529 Production in the

Short Run 529 Whose Marginal Productivity Are We Talking About? 531 Marginal

Physical Product and Marginal Cost 531 Average Productivity 534

Costs of Production: Total, Average, Marginal 536

The AVC and ATC Curves in Relation to the MC Curve 538 Tying Short-Run

Production to Costs 541 One More Cost Concept: Sunk Cost 542

Production and Costs in the Long Run 546

Long-Run Average Total Cost Curve 547 Economies of Scale, Diseconomies of Scale,

and Constant Returns to Scale 548 Why Economies of Scale? 549 Why Diseconomies

of Scale? 549 Minimum Efficient Scale and Number of Firms in an Industry 549

Shifts In Cost Curves 550

Taxes 550 Input Prices 550 Technology 550

Chapter Summary 551

Key Terms and Concepts 552

Questions and Problems 553

Working with Numbers and Graphs 554

Part 8 Product Markets and Policies


The Theory of Perfect Competition 555

A Perfectly Competitive Firm Is a Price Taker 556 The Demand Curve for a Perfectly

Competitive Firm Is Horizontal 556 Common Misconceptions about Demand

Curves 557 The Marginal Revenue Curve of a Perfectly Competitive Firm Is the Same

as Its Demand Curve 558 Theory and Real-World Markets 559

Perfect Competition in the Short Run 560

What Level of Output Does the Profit-Maximizing Firm Produce? 560 The Perfectly

Competitive Firm and Resource Allocative Efficiency 560 To Produce or Not to Produce:

That Is the Question 561 Common Misconceptions over the Shutdown Decision 564

The Perfectly Competitive Firm’s Short-Run Supply Curve 565 From Firm Supply Curve

to Market (Industry) Supply Curve 565 Why Is the Market Supply Curve Upward

Sloping? 568

Perfect Competition in the Long Run 568

The Conditions of Long-Run Competitive Equilibrium 569 The Perfectly Competitive

Firm and Productive Efficiency 570 Industry Adjustment to an Increase in Demand 571

Profit from Two Perspectives 574

Does It Matter to You . . . If There Is Easy Entry into a Market? 575

Industry Adjustment to a Decrease in Demand 576 Differences in Costs, Differences in

Profits: Now You See It, Now You Don’t 576

Hear What and How the Economist Thinks . . . About Buyers and Sellers 577

Profit and Discrimination 578

Topics for Analysis in the Theory of Perfect Competition 579

Do Higher Costs Mean Higher Prices? 579 Will the Perfectly Competitive Firm

Advertise? 579 Supplier-Set Price Versus Market-Determined Price: Collusion or

Competition? 580

Chapter Summary 581

Key Terms and Concepts 582

Questions and Problems 582

Working with Numbers and Graphs 583


The Theory of Monopoly 585

Barriers to Entry: A Key to Understanding Monopoly 586 What Is the Difference

Between a Government Monopoly and a Market Monopoly? 586

Monopoly Pricing and Output Decisions 587

The Monopolist’s Demand and Marginal Revenue 588 The Monopolist’s Demand Curve

and Marginal Revenue

Curve Are Not the Same 589 Price and Output for a Profit-

Maximizing Monopolist 589 Comparing the Demand Curve in Perfect Competition

with the Demand Curve in Monopoly 591 If a Firm Maximizes Revenue, Does It

Automatically Maximize Profit Too? 591

Perfect Competition and Monopoly 592

Price, Marginal Revenue, and Marginal Cost 592 Monopoly, Perfect Competition,

and Consumers’ Surplus 592 Monopoly or Nothing? 594

The Case Against Monopoly 595

The Deadweight Loss of Monopoly 595

Does It Matter to You . . . If There Is a Deadweight Loss of Monopoly Triangle? 596

Rent Seeking 596 X-Inefficiency 597

Price Discrimination 598

Types of Price Discrimination 599 Why a Monopolist Wants to Price Discriminate 599

Conditions of Price Discrimination 599

Hear What and How the Economist Thinks . . . About Price Discrimination 600

Moving to P 5 MC Through Price Discrimination 601 Coupons and Price

Discrimination 603

Chapter Summary 605

Key Terms and Concepts 606

Questions and Problems 606

Working with Numbers and Graphs 607



The Theory of Monopolistic Competition 608

The Monopolistic Competitor’s Demand Curve 609 The Relationship between Price and

Marginal Revenue for a Monopolistic Competitor 609 Output, Price, and

Marginal Cost for the Monopolistic Competitor 609 Will There Be Profits in

the Long Run? 609 Excess Capacity: What Is It, and Is It “Good” or “Bad”? 610

The Monopolistic Competitor and Two Types of Efficiency 612

Oligopoly: Assumptions and Real-World Behavior 613

The Concentration Ratio 613

Price and Output Under the Cartel Theory 614

The Cartel Theory 614

Game Theory, Oligopoly, and Contestable Markets 617

Prisoner’s Dilemma 618 Oligopoly Firms’ Cartels and the Prisoner’s Dilemma 620

Are Markets Contestable? 621 Necessary and Sufficient Conditions and Efficiency 622

A Review of Market Structures 622

Applications of Game Theory 623

Grades and Partying 623

Hear What and How the Economist Thinks . . . About Grade Inflation 625

The Arms Race 626 Speed Limit Laws 626

Chapter Summary 628

Key Terms and Concepts 629

Questions and Problems 629

Working with Numbers and Graphs 629




Antitrust 630

Antitrust Acts 631 Unsettled Points in Antitrust Policy 633 Antitrust and Mergers 635

Common Misconceptions about Antitrust Policy 636 Network Monopolies 636

Regulation 639

The Case of Natural Monopoly 639 Regulating the Natural Monopoly 641 Regulating

Industries That Are Not Natural Monopolies 643 Theories of Regulation 643

Hear What and How the Economist Thinks . . .About Regulation 644

The Costs and Benefits of Regulation 645

Does It Matter to You . . . If People Are Aware of Both the Costs and the Benefits of

Regulation? 645

Chapter Summary 647

Key Terms and Concepts 648

Questions and Problems 648

Working with Numbers and Graphs 649

Part 9 Factor Markets and Related Issues



Factor Markets 650

The Demand for a Factor 650 Marginal Revenue Product: Two Ways to Calculate It 651

The MRP Curve Is the Firm’s Factor Demand Curve 651 Value Marginal Product 652

An Important Question: Is MRP 5 VMP ? 653 Marginal Factor Cost: The Firm’s Factor

Supply Curve 654 How Many Units of a Factor Should a Firm Buy? 655 When There

Is More Than One Factor, How Much of Each Factor Should the Firm Buy? 655

The Labor Market 657

Shifts in a Firm’s MRP, or Factor Demand, Curve 657 Market Demand for Labor 659

The Elasticity of Demand for Labor 660

Hear What and How the Economist Thinks . . . About the Debate Over the Minimum

Wage 660

Does It Matter to You . . . If the Elasticity of Demand for the Good or Service You

Produce Is High or Low? 662

Market Supply of Labor 662 An Individual’s Supply of Labor 663 Shifts in the Labor

Supply Curve 664 Putting Supply and Demand Together 665 Why Do Wage Rates

Differ? 666 Why Demand and Supply Differ among Labor Markets 667 Why Did You

Choose Your Major? 667 Marginal Productivity Theory 668

Labor Markets and Information 670

Screening Potential Employees 670 Promoting from Within 671 Discrimination or an

Information Problem? 671

Chapter Summary 672

Key Terms and Concepts 673

Questions and Problems 673

Working with Numbers and Graphs 674


Objectives of Labor Unions 675

Employment for All Members 675 Maximizing the Total Wage Bill 676 Maximizing

Income for a Limited Number of Union Members 676 Wage–Employment Trade-Off 676

Practices of Labor Unions 677

Affecting the Elasticity of Demand for Union Labor 677

Hear What and How the Economist Thinks . . .About Unions and Wages 678

Affecting the Demand for Union Labor 679 Affecting the Supply of Union Labor 679

Affecting Wages Directly: Collective Bargaining 680 Strikes 682

Effects of Labor Unions 682

The Case of Monopsony 682 Unions’ Effects on Wages 684

Does It Matter to You . . . If Things Are Different in the Short-Run Than

in the Long Run? 686

Unions’ Effects on Prices 686 Unions’ Effects on Productivity and Efficiency: Two Views 686

Chapter Summary 689

Key Terms and Concepts 690

Questions and Problems 690

Working with Numbers and Graphs 691


Some Facts About Income Distribution 692

Who Are the Rich and How Rich Are They? 692 The Effect of Age on the Income

Distribution 693 A Simple Equation 695

Does It Matter to You . . . What Your Educational Attainment Level Is? 697

Measuring Income Equality 697

The Lorenz Curve 697 The Gini Coefficient 699 A Limitation of the Gini

Coefficient 700 Common Misconceptions about Income Inequality 700

Why Income Inequality Exists 701

Factors Contributing to Income Inequality 702 Income Differences: Some Are

Voluntary, Some Are Not 703

Poverty 704

What Is Poverty? 704 Limitations of the Official Poverty Income Statistics 704 Who

Are the Poor? 705 What Is the Justification for Government Redistributing Income? 705

Chapter Summary 707

Key Terms and Concepts 708

Questions and Problems 708

Working with Numbers and Graphs 708


Interest 709

Loanable Funds: Demand and Supply 709 The Price for Loanable Funds and the

Return on Capital Goods Tend to Equality 711 Why Do Interest Rates Differ? 712

Nominal and Real Interest Rates 712 Present Value: What Is Something Tomorrow

Worth Today? 713 Rent 716 David Ricardo, the Price of Grain, and Land Rent 716

The Supply Curve of Land Can Be Upward Sloping 718 Economic Rent and Other

Factors of Production 719 Economic Rent and Baseball Players: Perspective Matters 719

Does It Matter to You . . . If People Compete for Artificial Rents as Opposed to Real

Rents? 720

Competing for Artificial and Real Rents 720

Profit 721

Theories of Profit 721 Profit and Loss as Signals 722

Hear What and How the Economist Thinks . . . About Profit 723

The Entrepreneur 724

A Market 724 How Can the Entrepreneur Increase Trade? 724 Turning Potential

Trades into Actual Trades 725 A Necessary Condition: Turn Potential Trades into Actual

Trades in a Way Acceptable to Consumers 725 Can Increasing Trades in One Area

Reduce Trades in Another? 725 Uncertainty and the Entrepreneur 725

Chapter Summary 727

Key Terms and Concepts 727

Questions and Problems 728

Working with Numbers and Graphs 728

Part 10 Market Failure, Public Choice, and Special-Interest Group Politics



Externalities 729

Costs and Benefits of Activities 729 Marginal Costs and Benefits of Activities 730

Social Optimality, or Efficiency, Conditions 731 Three Categories of Activities 731

Externalities in Consumption and in Production 731 Diagram of a Negative

Externality 731 Diagram of a Positive Externality 734

Internalizing Externalities 735

Persuasion 735 Taxes and Subsidies 736 Assigning Property Rights 736

Hear What and How the Economist Thinks . . . About Coming to Class Late 737

Voluntary Agreements 737 Combining Property Rights Assignments and Voluntary

Agreements 738 Beyond Internalizing: Setting Regulations 739

Environmental Policy 740

Method 1: Government Regulation, or Command and Control 741 Method 2: Emission

Taxes 741 Method 3: Tradable Pollution Permits (Cap and Trade) 742 Similarities and

Differences Between Emission Taxes and Tradable Pollution Permits 743

Public Goods: Excludable and Nonexcludable 744

Goods 744 The Free Rider 745

Does It Matter to You . . . If There Is a Free-Rider Problem? 746

Nonexcludable Versus Nonrivalrous 746

Asymmetric Information 748

Asymmetric Information in a Product Market 748 Asymmetric Information in a Factor

Market 749 Is There Market Failure? 749 Adverse Selection 750 Moral Hazard 751

Chapter Summary 754

Key Terms and Concepts 755

Questions and Problems 756

Working with Numbers and Graphs 757



Public Choice Theory 758

The Political Market 759

Moving Toward the Middle: The Median Voter Model 759 What Does the Theory

Predict? 760

Voters and Rational Ignorance 763

The Costs and Benefits of Voting 763

Does It Matter to You . . . If You Do Not Vote? 764

Rational Ignorance 764

Hear What and How the Economist Thinks . . . About Rational Ignorance 766

More About Voting 767

Example 1: Voting for a Nonexcludable Public Good 767 Example 2: Voting and

Efficiency 768

Special-Interest Groups 769

Information and Lobbying 769 Congressional Districts as Special-Interest Groups 770

Public-Interest Talk, Special-Interest Legislation 770 Rent Seeking 771 Bringing About

Transfers 772 Information, Rational Ignorance, and Seeking Transfers 772

Constitutional Economics 774

Chapter Summary 776

Key Terms and Concepts 777

Questions and Problems 777

Working with Numbers and Graphs 778

Part 11 Economic Theory-Building and Everyday Life



A Different Kind of Chapter 779

The Process 780

Observation/Thought 1: The Birthrates in Various Countries are Different 781

The Question 781 The Theory 781 The Predictions 781

A Detour: The Issue of Falsifiability (Refutability) 782

Hear What and How the Economist Thinks . . . About Theories 782

Observation/Thought 2: The Ethical Code of People Who Live in a Small Town is

Different from that of People Who Live in a Large City 783

The Question 784 The Theory 784 The Predictions 784

Observation/Thought 3: The Closer the Dollar Tuition the Student Pays is to the

Equilibrium Tuition, the More on Time and Responsive University Instructors Will Be for

Office Hours 786

The Question 786 The Theory 786 The Predictions 788

Observation/Thought 4: Criminals Are Not Rational 788

The Question 788 The Theory 788 The Predictions 789 A Detour: Does

Evidence Prove a Theory Correct? 789 Another Detour: After You Have One Theory

That Explains and Predicts, Search for Another 790 A Final Detour: Why Prediction Is

So Important, Or Why Good-Sounding Stories Are Not Enough 791

Observation/Thought 5: More Students Wear Baseball Caps in Class on Exam Days

Than on Other Days 792

The Question 792 The Theory 792 The Predictions 793

Observation/Thought 6: Houses in “Good” School Districts Are Often More Expensive

than Comparable Houses in “Bad” School Districts 795

The Question 795 The Theory 795 The Predictions 795

Observation/Thought 7: Are People Better Off With or Without Health Care

Vouchers? 796

The Question 796 The Theory 796 The Predictions 797

Observation/Thought 8: People Who Give to Others Often Complain That They

End Up Giving Too Much 797

The Question 797 The Theory 798 The Predictions 800

Does It Matter to You . . . If and How You Are in Someone Else’s Utility Function? 801

Chapter Summary 802

Questions and Problems 804

Working with Numbers and Graphs 804

The Global Economy

Part 12 International Economics and Globalization


International Trade Theory 805

How Countries Know What to Trade 806

Does It Matter to You . . . If There Is Always Someone Who Can Do Something Better

Than You? 808

A Common Misconception about How Much We Can Consume 809 How Countries

Know When They Have a Comparative Advantage 809

Hear What and How the Economist Thinks . . . About Common Sense 811

Trade Restrictions 811

The Distributional Effects of International Trade 812 Consumers’ and Producers’

Surpluses 812 The Benefits and Costs of Trade Restrictions 813 Why Nations

Sometimes Restrict Trade 817

Chapter Summary 821

Key Terms and Concepts 822

Questions and Problems 822

Working with Numbers and Graphs 823


The Foreign Exchange Market 824

The Demand for Goods 825 The Demand for, and Supply of, Currencies 825

Flexible Exchange Rates 826

The Equilibrium Exchange Rate 826

Does It Matter to You . . . If the Dollar Depreciates? 827

Changes in the Equilibrium Exchange Rate 827 Factors That Affect the Equilibrium

Exchange Rate 828

Fixed Exchange Rates 831

Fixed Exchange Rates and Overvalued or Undervalued Currency 832 What Is So

Bad about an Overvalued Dollar? 834 Government Involvement in a Fixed Exchange

Rate System 835 Options Under a Fixed Exchange Rate System 835

Fixed Exchange Rates Versus Flexible Exchange Rates 837

Promoting International Trade 837 Optimal Currency Areas 837

Chapter Summary 840

Key Terms and Concepts 841

Questions and Problems 841

Working with Numbers and Graphs 842

Web Chapters

CHAPTER 35: The Economic Case for and Against

Government: Five Topics Considered 843

Economics and Government 843

The Economic Case for Government 844

Government Can Remove Individuals from a Prisoner’s Dilemma Setting 844

Externalities 848 Nonexcludable Public Goods 849 The Case for Smaller or Larger

Government 851

The Economic Case Against Government 852

Unintended Effects of Government Actions 852 Government as Transfer Mechanism 853

Economic Growth Versus Transfers 855 Following the Leader in Pushing for Transfers 856

Divisive Society: A Nonexcludable Public Bad 858

Chapter Summary 859

Key Terms and Concepts 860

Questions and Problems 860

Working with Numbers and Graphs 861


Financial Markets 862

Stocks 863

Where Are Stocks Bought and Sold? 863 The Dow Jones Industrial Average (DJIA) 864

How the Stock Market Works 865 Why Do People Buy Stock? 866 How to Buy

and Sell Stock 866 Buying Stocks or Buying the Market 867 How to Read the Stock

Market Page 868

Bonds 870

The Components of a Bond 870 Bond Ratings 871 Bond Prices and Yields

(or Interest Rates) 871 Common Misconceptions about the Coupon Rate and Yield

(Interest Rate) 872 Types of Bonds 873 How to Read the Bond Market Page 873

Risk and Return 875

Futures and Options 875

Futures 875 Options 876

Chapter Summary 879

Key Terms and Concepts 879

Questions and Problems 879

Working with Numbers and Graphs 880

Self-Test Appendix 843

Glossary 869

Index 881

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