Principles of Economics, 10th Edition PDF by N Gregory Mankiw


Principles of Economics, 10th Edition

By N. Gregory Mankiw

Principles of Economics, 10th Edition


Preface: To the Instructor v

Preface: To the Student xxix

Part I Introduction 1

Chapter 1

Ten Principles of Economics 1

1-1 How People Make Decisions 2

1-1a Principle 1: People Face Trade-Offs 2

1-1b Principle 2: The Cost of Something Is What You

Give Up to Get It 3

1-1c Principle 3: Rational People Think at the Margin 4

1-1d Principle 4: People Respond to Incentives 5

1-2 How People Interact 6

1-2a Principle 5: Trade Can Make Everyone Better Off 6

1-2b Principle 6: Markets Are Usually a Good Way

to Organize Economic Activity 7

FYI: Adam Smith and the Invisible Hand 8

Case Study: Adam Smith Would Have Loved Uber 8

1-2c Principle 7: Governments Can Sometimes

Improve Market Outcomes 9

1-3 How the Economy as a Whole Works 11

1-3a Principle 8: A Country’s Standard of Living Depends

on Its Ability to Produce Goods and Services 11

1-3b Principle 9: Prices Rise When the Government Prints

Too Much Money 11

1-3c Principle 10: Society Faces a Short-Run Trade-Off

between Inflation and Unemployment 12

1-4 Conclusion 13

Chapter in a Nutshell 14

Key Concepts 14

Questions for Review 14

Problems and Applications 14

Quick Quiz Answers 15

Chapter 2

Thinking Like an Economist 17

2-1 The Economist as Scientist 18

2-1a The Scientific Method: Observation, Theory,

and More Observation 18

2-1b The Role of Assumptions 19

2-1c Economic Models 19

2-1d Our First Model: The Circular-Flow Diagram 20

2-1e Our Second Model: The Production

Possibilities Frontier 22

2-1f Microeconomics and Macroeconomics 24

2-2 The Economist as Policy Adviser 25

In the News: Why Tech Companies Hire Economists 26

2-2a Positive versus Normative Analysis 26

2-2b Economists in Washington 28

2-2c Why Economists’ Advice Is Often Not Followed 29

2-3 Why Economists Disagree 30

2-3a Differences in Scientific Judgments 30

2-3b Differences in Values 30

2-3c Perception versus Reality 31

Ask the Experts: Ticket Resale 31

2-4 Let’s Get Going 32

Chapter in a Nutshell 32

Key Concepts 33

Questions for Review 33

Problems and Applications 33

Quick Quiz Answers 34

APPENDIX Graphing: A Brief Review 35

Graphs of a Single Variable 35

Graphs of Two Variables: The Coordinate System 36

Curves in the Coordinate System 37

Slope 39

Cause and Effect 41

Chapter 3

Interdependence and the Gains

from Trade 45

3-1 A Parable for the Modern Economy 46

3-1a Production Possibilities 46

3-1b Specialization and Trade 48

3-2 Comparative Advantage: The Driving Force

of Specialization 50

3-2a Absolute Advantage 50

3-2b Opportunity Cost and Comparative Advantage 50

3-2c Comparative Advantage and Trade 52

3-2d The Price of the Trade 52

FYI: The Legacy of Adam Smith and David Ricardo 53

3-3 Applications of Comparative Advantage 53

Preface: To the Instructor v

Preface: To the Student xxix


Contents xvii

3-3a Should Naomi Osaka Mow Her Own Lawn? 54

3-3b Should the United States Trade

with Other Countries? 54

3-4 Conclusion 55

Ask the Experts: Trade between China and the

United States 55

In the News: Economics within a Marriage 56

Chapter in a Nutshell 56

Key Concepts 57

Questions for Review 57

Problems and Applications 58

Quick Quiz Answers 59

Part II How Markets Work 61

Chapter 4

The Market Forces of Supply and

Demand 61

4-1 Markets and Competition 62

4-1a What Is a Market? 62

4-1b What Is Competition? 62

4-2 Demand 63

4-2a The Demand Curve: The Relationship between

Price and Quantity Demanded 63

4-2b Market Demand versus Individual Demand 64

4-2c Shifts in the Demand Curve 65

Case Study: Two Ways to Reduce Smoking 68

4-3 Supply 69

4-3a The Supply Curve: The Relationship between

Price and Quantity Supplied 69

4-3b Market Supply versus Individual Supply 70

4-3c Shifts in the Supply Curve 70

4-4 Supply and Demand Together 73

4-4a Equilibrium 73

4-4b Three Steps to Analyzing Changes in Equilibrium 75

In the News: Price Increases after Disasters 80

4-5 Conclusion: How Prices Allocate Resources 82

Ask the Experts: Price Gouging 82

Chapter in a Nutshell 83

Key Concepts 83

Questions for Review 84

Problems and Applications 84

Quick Quiz Answers 85

Chapter 5

Elasticity and Its Application 87

5-1 The Elasticity of Demand 88

5-1a The Price Elasticity of Demand and Its Determinants 88

5-1b The Price Elasticity of Demand, with Numbers 89

5-1c The Midpoint Method: A Better Way to Calculate

Percentage Changes and Elasticities 89

5-1d The Variety of Demand Curves 90

5-1e Total Revenue and the Price Elasticity of Demand 91

FYI: A Few Elasticities from the Real World 91

5-1f Elasticity and Total Revenue along

a Linear Demand Curve 94

5-1g Other Demand Elasticities 96

5-2 The Elasticity of Supply 97

5-2a The Price Elasticity of Supply and Its Determinants 97

5-2b The Price Elasticity of Supply, with Numbers 98

5-2c The Variety of Supply Curves 98

5-3 Three Applications of Supply, Demand, and Elasticity 100

5-3a Can Good News for Farming Be Bad News

for Farmers? 101

5-3b Why Has OPEC Failed to Keep the Price of

Oil High? 103

5-3c Does Drug Interdiction Increase or Decrease

Drug-Related Crime? 104

In the News: Elasticity of Supply and Demand

in the Ride-share Market 106

5-4 Conclusion 108

Chapter in a Nutshell 108

Key Concepts 108

Questions for Review 108

Problems and Applications 109

Quick Quiz Answers 110

Chapter 6

Supply, Demand, and Government

Policies 111

6-1 The Surprising Effects of Price Controls 112

6-1a How Price Ceilings Affect Market Outcomes 112

Case Study: How to Create Long Lines

at the Gas Pump 114

Case Study: Why Rent Control Causes Housing Shortages,

Especially in the Long Run 115

Ask the Experts: Rent Control 116

6-1b How Price Floors Affect Market Outcomes 116

Case Study: Controversies over the Minimum Wage 118

Ask the Experts: The Minimum Wage 120

6-1c Evaluating Price Controls 120

6-2 The Surprising Study of Tax Incidence 121

6-2a How Taxes on Sellers Affect Market Outcomes 121

In the News: Should the Minimum Wage

Be $15 an Hour? 122

6-2b How Taxes on Buyers Affect Market Outcomes 124

Case Study: Can Congress Distribute the Burden

of a Payroll Tax? 126

6-2c Elasticity and Tax Incidence 127

Case Study: Who Pays the Luxury Tax? 128

6-3 Conclusion 129

xviii Contents

Chapter in a Nutshell 129

Key Concepts 130

Questions for Review 130

Problems and Applications 130

Quick Quiz Answers 131

Part III Markets and

Welfare 133

Chapter 7

Consumers, Producers, and the

Efficiency of Markets 133

7-1 Consumer Surplus 134

7-1a Willingness to Pay 134

7-1b Using the Demand Curve to Measure

Consumer Surplus 135

7-1c How a Lower Price Raises Consumer Surplus 137

7-1d What Does Consumer Surplus Measure? 138

7-2 Producer Surplus 139

7-2a Cost and the Willingness to Sell 139

7-2b Using the Supply Curve to Measure Producer Surplus 140

7-2c How a Higher Price Raises Producer Surplus 141

7-3 Market Efficiency 143

7-3a Benevolent Social Planners 143

7-3b Evaluating the Market Equilibrium 144

Ask the Experts: Supplying Kidneys 146

Case Study: Should There Be a Market for Organs? 146

7-4 Conclusion: Market Efficiency and Market Failure 147

In the News: How Ticket Resellers Help Allocate

Scarce Resources 148

Chapter in a Nutshell 150

Key Concepts 150

Questions for Review 150

Problems and Applications 150

Quick Quiz Answers 152

Chapter 8

Application: The Costs of Taxation 153

8-1 The Deadweight Loss of Taxation 154

8-1a How a Tax Affects Market Participants 154

8-1b Deadweight Losses and the Gains from Trade 157

8-2 The Determinants of the Deadweight Loss 158

Case Study: The Deadweight Loss Debate 160

8-3 Deadweight Loss and Tax Revenue as Taxes Vary 162

Case Study: The Laffer Curve and Supply-Side

Economics 163

Ask the Experts: The Laffer Curve 164

8-4 Conclusion 165

Chapter in a Nutshell 165

Key Concept 166

Questions for Review 166

Problems and Applications 166

Quick Quiz Answers 167

Chapter 9

Application: International Trade 169

9-1 The Determinants of Trade 170

9-1a The Equilibrium without Trade 170

9-1b The World Price and Comparative Advantage 171

9-2 The Winners and Losers from Trade 171

9-2a The Gains and Losses of an Exporting Country 172

9-2b The Gains and Losses of an Importing Country 173

9-2c The Effects of a Tariff 175

FYI: Import Quotas: Another Way to Restrict Trade 177

9-2d The Lessons for Trade Policy 177

9-2e Other Benefits of International Trade 178

9-3 The Arguments for Restricting Trade 179

9-3a The Jobs Argument 180

9-3b The National-Security Argument 180

9-3c The Infant-Industry Argument 180

9-3d The Unfair-Competition Argument 181

9-3e The Protection-as-a-Bargaining-Chip Argument 181

Case Study: Trade Agreements and the World Trade

Organization 181

Ask the Experts: Trade Deals and Tariffs 181

In the News: Trade as a Tool for Economic Development 182

9-4 Conclusion 184

Chapter in a Nutshell 185

Key Concepts 185

Questions for Review 185

Problems and Applications 186

Quick Quiz Answers 187

Part IV The Economics

of the Public Sector 189

Chapter 10

Externalities 189

10-1 Externalities and Market Inefficiency 191

10-1a Welfare Economics: A Recap 191

10-1b Negative Externalities 192

10-1c Positive Externalities 193

Case Study: Technology Spillovers, Industrial Policy,

and Patent Protection 194

10-2 Public Policies toward Externalities 195

10-2a Command-and-Control Policies: Regulation 195

Ask the Experts: Covid Vaccines 196

10-2b Market-Based Policy 1: Corrective Taxes

and Subsidies 196

Case Study: Why Is Gasoline Taxed So Heavily? 197

10-2c Market-Based Policy 2: Tradable Pollution Permits 199

10-2d Objections to the Economic Analysis of Pollution 201

Contents xix

Case Study: Climate Change and Carbon Taxes 201

Ask the Experts: Carbon Taxes 202

10-3 Private Solutions to Externalities 203

10-3a The Types of Private Solutions 203

10-3b The Coase Theorem 204

10-3c Why Private Solutions Do Not Always Work 205

In the News: The Coase Theorem in Action 206

10-4 Conclusion 206

Chapter in a Nutshell 207

Key Concepts 208

Questions for Review 208

Problems and Applications 208

Quick Quiz Answers 209

Chapter 11

Public Goods and Common

Resources 211

11-1 The Different Kinds of Goods 212

11-2 Public Goods 214

11-2a The Free-Rider Problem 214

11-2b Some Important Public Goods 214

Case Study: Are Lighthouses Public Goods? 216

11-2c The Difficult Job of Cost–Benefit Analysis 217

Case Study: How Much Is a Life Worth? 217

11-3 Common Resources 218

11-3a The Tragedy of the Commons 218

11-3b Some Important Common Resources 219

Ask the Experts: Congestion Pricing 220

Case Study: Why the Cow Is Not Extinct 221

In the News: Road Pricing 222

11-4 Conclusion: Property Rights and Government Action 222

Chapter in a Nutshell 224

Key Concepts 224

Questions for Review 224

Problems and Applications 224

Quick Quiz Answers 226

Chapter 12

The Economics of Healthcare 227

12-1 The Special Characteristics of the Market

for Healthcare 228

12-1a Externalities Galore 229

Case Study: Vaccine Hesitancy 230

12-1b The Difficulty of Monitoring Quality 230

12-1c The Insurance Market and Its Imperfections 231

12-1d Healthcare as a Right 233

12-1e The Rules Governing the Healthcare Marketplace 233

12-2 Key Facts about the U.S. Healthcare System 235

12-2a People Are Living Longer 235

12-2b Healthcare Spending Is a Growing

Share of the Economy 236

Ask the Experts: Baumol’s Cost Disease 238

12-2c Healthcare Spending Is Especially High

in the United States 238

12-2d Out-of-Pocket Spending Is a Declining Share

of Health Expenditure 239

Ask the Experts: Cadillac Tax 240

12-3 Conclusion: The Policy Debate over Healthcare 241

In the News: Lessons from the Pandemic of 2020 242

Chapter in a Nutshell 244

Key Concepts 244

Questions for Review 244

Problems and Applications 244

Quick Quiz Answers 245

Chapter 13

The Design of the Tax System 247

13-1 U.S. Taxation: The Big Picture 248

13-1a Taxes Collected by the Federal Government 249

13-1b Taxes Collected by State and Local Governments 251

13-2 Taxes and Efficiency 252

13-2a Deadweight Losses 253

Case Study: Should Income or Consumption Be Taxed? 253

13-2b Administrative Burden 254

13-2c Marginal Tax Rates versus Average Tax Rates 255

13-2d Lump-Sum Taxes 255

Ask the Experts: Top Marginal Tax Rates 255

13-3 Taxes and Equity 256

13-3a The Benefits Principle 257

13-3b The Ability-to-Pay Principle 257

Case Study: How the Tax Burden Is Distributed 258

13-3c Tax Incidence and Tax Equity 260

Case Study: Who Pays the Corporate Income Tax? 260

13-4 Conclusion: The Trade-Off between Equity and Efficiency 261

In the News: The Value-Added Tax 262

Chapter in a Nutshell 264

Key Concepts 264

Questions for Review 264

Problems and Applications 264

Quick Quiz Answers 265

Part V Firm Behavior and the

Organization of Industry 267

Chapter 14

The Costs of Production 267

14-1 What Are Costs? 268

14-1a Total Revenue, Total Cost, and Profit 268

14-1b Why Opportunity Costs Matter 268

14-1c The Cost of Capital Is an Opportunity Cost 269

14-1d Economists and Accountants Measure Profit

Differently 269

xx Contents

14-2 Production and Costs 271

14-2a The Production Function 271

14-2b From the Production Function

to the Total-Cost Curve 273

14-3 The Many Measures of Cost 274

14-3a Fixed and Variable Costs 275

14-3b Average and Marginal Cost 275

14-3c Cost Curves and Their Shapes 276

14-3d Typical Cost Curves 278

14-4 Costs in the Short Run and in the Long Run 280

14-4a The Relationship between Short-Run and Long-Run

Average Total Cost 280

14-4b Economies and Diseconomies of Scale 281

FYI: Lessons from a Pin Factory 281

14-5 Conclusion 282

Chapter in a Nutshell 283

Key Concepts 283

Questions for Review 283

Problems and Applications 284

Quick Quiz Answers 285

Chapter 15

Firms in Competitive Markets 287

15-1 What Is a Competitive Market? 288

15-1a The Meaning of Competition 288

15-1b The Revenue of a Competitive Firm 288

15-2 Profit Maximization and the Competitive

Firm’s Supply Curve 290

15-2a A Simple Example of Profit Maximization 290

15-2b The Marginal-Cost Curve and the Firm’s Supply

Decision 292

15-2c The Firm’s Short-Run Decision to Shut Down 294

15-2d Spilt Milk and Other Sunk Costs 295

Case Study: Near-Empty Restaurants and Off-Season

Miniature Golf 296

15-2e The Firm’s Long-Run Decision to Exit

or Enter a Market 297

15-2f Measuring Profit in Our Graph for the

Competitive Firm 297

15-2g A Brief Recap 299

15-3 The Supply Curve in a Competitive Market 300

15-3a The Short Run: Market Supply with a Fixed

Number of Firms 300

15-3b The Long Run: Market Supply with Entry and Exit 300

15-3c Why Do Competitive Firms Stay in Business If They

Make Zero Profit? 302

15-3d A Shift in Demand in the Short Run and Long

Run 303

15-3e Why the Long-Run Supply Curve Might Slope

Upward 303

15-4 Conclusion: Behind the Supply Curve 305

Chapter in a Nutshell 306

Key Concepts 306

Questions for Review 306

Problems and Applications 307

Quick Quiz Answers 309

Chapter 16

Monopoly 311

16-1 Why Monopolies Arise 312

16-1a Monopoly Resources 313

16-1b Government-Created Monopolies 313

16-1c Natural Monopolies 314

16-2 How Monopolies Make Production and Pricing

Decisions 315

16-2a Monopoly versus Competition 315

16-2b A Monopoly’s Revenue 316

16-2c Profit Maximization 318

FYI: Why a Monopoly Does Not Have a Supply Curve 320

16-2d A Monopoly’s Profit 320

Case Study: Monopoly Drugs versus Generic Drugs 321

16-3 The Welfare Cost of Monopolies 323

16-3a The Deadweight Loss 323

16-3b The Monopoly’s Profit: A Social Cost? 325

16-4 Price Discrimination 326

16-4a A Parable about Pricing 326

16-4b The Moral of the Story 327

16-4c The Analytics of Price Discrimination 328

16-4d Examples of Price Discrimination 329

16-5 Public Policy toward Monopolies 330

16-5a Increasing Competition with Antitrust Laws 331

16-5b Regulation 331

Ask the Experts: Mergers and Competition 332

16-5c Public Ownership 333

16-5d Above All, Do No Harm 333

In the News: Will the Biden Administration Expand the Scope

of Antitrust Policy? 334

16-6 Conclusion: The Prevalence of Monopolies 334

Chapter in a Nutshell 336

Key Concepts 337

Questions for Review 337

Problems and Applications 337

Quick Quiz Answers 340

Chapter 17

Monopolistic Competition 341

17-1 Between Monopoly and Perfect Competition 342

17-2 Competition with Differentiated Products 344

17-2a The Monopolistically Competitive Firm

in the Short Run 344

17-2b The Long-Run Equilibrium 346

17-2c Monopolistic versus Perfect Competition 347

17-2d Monopolistic Competition and the Welfare of Society 348

17-3 Advertising 350

17-3a The Debate over Advertising 350

Contents xxi

Case Study: How Advertising Affects Prices 351

17-3b Advertising as a Signal of Quality 352

17-3c Brand Names 353

17-4 Conclusion 354

Chapter in a Nutshell 355

Key Concepts 356

Questions for Review 356

Problems and Applications 356

Quick Quiz Answers 357

Chapter 18

Oligopoly 359

18-1 Markets with Only a Few Sellers 360

18-1a A Duopoly Example 360

18-1b Competition, Monopolies, and Cartels 360

18-1c The Equilibrium for an Oligopoly 362

18-1d How the Size of an Oligopoly Affects

the Market Outcome 363

Ask the Experts: Market Share and Market Power 364

18-2 The Economics of Cooperation 364

18-2a The Prisoners’ Dilemma 365

18-2b Oligopolies as a Prisoners’ Dilemma 366

Case Study: OPEC and the World Oil Market 367

18-2c Other Examples of the Prisoners’ Dilemma 368

18-2d The Prisoners’ Dilemma and the Welfare of Society 369

18-2e Why People Sometimes Cooperate 370

Case Study: The Prisoners’ Dilemma Tournament 370

18-3 Public Policy toward Oligopolies 371

18-3a Restraint of Trade and the Antitrust Laws 371

Case Study: An Illegal Phone Call 372

18-3b Controversies over Antitrust Policy 373

Ask the Experts: Antitrust in the Digital Economy 374

Case Study: The Microsoft Case 375

In the News: Amazon in the Crosshairs 376

18-4 Conclusion 377

Chapter in a Nutshell 378

Key Concepts 378

Questions for Review 378

Problems and Applications 378

Quick Quiz Answers 380

Part VI The Economics of

Labor Markets 381

Chapter 19

The Markets for the Factors of

Production 381

19-1 The Demand for Labor 382

19-1a The Competitive, Profit-Maximizing Firm 382

19-1b The Production Function and the Marginal

Product of Labor 383

19-1c The Value of the Marginal Product and the

Demand for Labor 385

19-1d What Causes the Labor-Demand Curve to Shift? 386

FYI: Input Demand and Output Supply: Two Sides

of the Same Coin 387

19-2 The Supply of Labor 388

19-2a The Trade-Off between Work and Leisure 388

19-2b What Causes the Labor-Supply Curve to Shift? 389

Ask the Experts: Immigration 390

19-3 Equilibrium in the Labor Market 390

19-3a Shifts in Labor Supply 390

Case Study: The Immigration Debate 392

19-3b Shifts in Labor Demand 393

Case Study: Productivity and Wages 393

19-4 The Other Factors of Production: Land and Capital 395

19-4a Equilibrium in the Markets for Land and Capital 395

FYI: What Is Capital Income? 396

19-4b Linkages among the Factors of Production 396

Case Study: The Economics of the Black Death 397

19-5 Conclusion 398

Chapter in a Nutshell 398

Key Concepts 399

Questions for Review 399

Problems and Applications 399

Quick Quiz Answers 401

Chapter 20

Earnings and Discrimination 403

20-1 What Determines Wages? 404

20-1a Compensating Differentials 404

20-1b Human Capital 404

Case Study: The Increasing Value of Skills 405

Ask the Experts: Inequality and Skills 406

20-1c Ability, Effort, and Chance 406

Case Study: The Benefits of Beauty 407

20-1d An Alternative View of Education: Signaling 407

20-1e The Superstar Phenomenon 408

20-1f Below-Equilibrium Wages: Monopsony 409

Ask the Experts: Competition in Labor Markets 409

In the News: The Aftereffects of the Covid Pandemic 410

20-1g Above-Equilibrium Wages: Minimum-Wage Laws,

Unions, and Efficiency Wages 410

20-2 The Economics of Discrimination 412

20-2a Measuring Labor-Market Discrimination 412

Case Study: Is Emily More Employable Than Lakisha? 413

20-2b Discrimination by Employers 414

Case Study: Segregated Streetcars

and the Profit Motive 415

20-2c Discrimination by Customers and Governments 415

Case Study: Discrimination in Sports 416

20-2d Statistical Discrimination 417

20-3 Conclusion 418

Chapter in a Nutshell 418

xxii Contents

Key Concepts 418

Questions for Review 419

Problems and Applications 419

Quick Quiz Answers 420

Chapter 21

Income Inequality and Poverty 421

21-1 Measuring Inequality 422

21-1a U.S. Income Inequality 422

21-1b Inequality around the World 423

FYI: Incomes of the Super-Rich 424

21-1c The Poverty Rate 424

21-1d Problems in Measuring Inequality 427

21-1e Economic Mobility 428

Case Study: A Lifetime Perspective

on Income Inequality 429

21-2 The Political Philosophy of Redistributing Income 430

21-2a The Utilitarian Tradition 430

21-2b The Liberal Contractarian Tradition 431

21-2c The Libertarian Tradition 432

21-3 Policies to Reduce Poverty 434

21-3a Minimum-Wage Laws 434

21-3b Welfare 434

21-3c Negative Income Tax 435

21-3d In-Kind Transfers 436

In the News: Poverty during the Pandemic 436

21-3e Antipoverty Programs and Work Incentives 437

21-4 Conclusion 439

Chapter in a Nutshell 439

Key Concepts 440

Questions for Review 440

Problems and Applications 440

Quick Quiz Answers 441

Part VII Topics for Further

Study 443

Chapter 22

The Theory of Consumer Choice 443

22-1 The Budget Constraint: What a Consumer Can Afford 444

22-1a Representing Consumption Opportunities

in a Graph 444

22-1b Shifts in the Budget Constraint 445

22-2 Preferences: What a Consumer Wants 447

22-2a Representing Preferences with Indifference Curves 447

22-2b Four Properties of Indifference Curves 448

22-2c Two Extreme Examples of Indifference Curves 450

22-3 Optimization: What a Consumer Chooses 452

22-3a The Consumer’s Optimal Choices 452

FYI: Utility: An Alternative Way to Describe Preferences

and Optimization 453

22-3b How Changes in Income Affect

the Consumer’s Choices 453

22-3c How Changes in Prices Affect

the Consumer’s Choices 455

22-3d Income and Substitution Effects 455

22-3e Deriving the Demand Curve 457

22-4 Three Applications 458

22-4a Do All Demand Curves Slope Downward? 458

Case Study: The Search for Giffen Goods 460

22-4b How Do Wages Affect Labor Supply? 460

Case Study: Income Effects on Labor Supply:

Historical Trends, Lottery Winners, and the

Carnegie Conjecture 463

22-4c How Do Interest Rates Affect

Household Saving? 464

22-5 Conclusion: Do People Really Think This Way? 467

Chapter in a Nutshell 467

Key Concepts 468

Questions for Review 468

Problems and Applications 468

Quick Quiz Answers 469

Chapter 23

Frontiers of Microeconomics 471

23-1 Asymmetric Information 472

23-1a Hidden Actions: Principals, Agents,

and Moral Hazard 472

FYI: Corporate Management 473

23-1b Hidden Characteristics: Adverse Selection and the

Lemons Problem 474

23-1c Signaling to Convey Private Information 474

Case Study: Gifts as Signals 475

23-1d Screening to Uncover Private Information 476

23-1e Asymmetric Information and Public Policy 476

23-2 Political Economy 477

23-2a The Condorcet Voting Paradox 478

23-2b Arrow’s Impossibility Theorem 479

23-2c The Median Voter Is King 480

23-2d Politicians Are People Too 481

23-3 Behavioral Economics 482

23-3a People Aren’t Always Rational 482

23-3b People Care about Fairness 484

23-3c People Are Inconsistent over Time 485

Ask the Experts: Behavioral Economics 485

In the News: Faults in Risk Assessment 486

23-4 Conclusion 487

Chapter in a Nutshell 488

Key Concepts 488

Questions for Review 488

Problems and Applications 488

Quick Quiz Answers 489

Contents xxiii

Part VIII The Data of

Macroeconomics 491

Chapter 24

Measuring a Nation’s Income 491

24-1 The Economy’s Income and Expenditure 492

24-2 The Measurement of GDP 494

24-2a “GDP Is the Market Value . . .” 494

24-2b “. . . of All . . .” 494

24-2c “. . . Final . . .” 495

24-2d “. . . Goods and Services . . .” 495

24-2e “. . . Produced . . .” 495

24-2f “. . . Within a Country . . .” 495

24-2g “. . . In a Given Period.” 495

FYI: Other Measures of Income 496

24-3 The Components of GDP 497

24-3a Consumption 497

24-3b Investment 497

24-3c Government Purchases 498

24-3d Net Exports 498

Case Study: The Components of U.S. GDP 499

24-4 Real versus Nominal GDP 500

24-4a A Numerical Example 500

24-4b The GDP Deflator 501

Case Study: A Half Century of Real GDP 502

24-5 Is GDP a Good Measure of Economic Well-Being? 504

Case Study: International Differences in GDP and the

Quality of Life 505

In the News: Sex, Drugs, and GDP 506

24-6 Conclusion 507

Chapter in a Nutshell 508

Key Concepts 508

Questions for Review 508

Problems and Applications 508

Quick Quiz Answers 510

Chapter 25

Measuring the Cost of Living 511

25-1 The Consumer Price Index 512

25-1a How the CPI Is Calculated 512

FYI: What’s in the CPI’s Basket? 514

25-1b Problems in Measuring the Cost of Living 515

25-1c The GDP Deflator versus the Consumer Price

Index 516

25-2 Correcting Economic Variables for the

Effects of Inflation 518

25-2a Dollar Figures from Different Times 518

FYI: Mr. Index Goes to Hollywood 519

Case Study: Regional Differences in the Cost of

Living 519

25-2b Indexation 521

25-2c Real and Nominal Interest Rates 521

Case Study: Interest Rates in the U.S. Economy 522

25-3 Conclusion 524

Chapter in a Nutshell 525

Key Concepts 525

Questions for Review 525

Problems and Applications 526

Quick Quiz Answers 527

Part IX The Real Economy

in the Long Run 529

Chapter 26

Production and Growth 529

26-1 Economic Growth around the World 530

FYI: Are You Richer Than the Richest American? 532

26-2 Productivity: Its Role and Determinants 532

26-2a Why Productivity Is So Important 533

26-2b How Productivity Is Determined 533

FYI: The Production Function 535

Case Study: Are Natural Resources a Limit

to Growth? 536

26-3 Economic Growth and Public Policy 537

26-3a Saving and Investment 537

26-3b Diminishing Returns and the Catch-Up Effect 537

26-3c Investment from Abroad 539

26-3d Education 540

26-3e Health and Nutrition 540

26-3f Property Rights and Political Stability 541

26-3g Free Trade 542

26-3h Research and Development 542

26-3i Population Growth 543

Ask the Experts: Innovation and Growth 543

Case Study: Why Is So Much of Africa Poor? 545

In the News: The Secret Sauce of American Prosperity 548

26-4 Conclusion: The Importance of Long-Run Growth 548

Chapter in a Nutshell 549

Key Concepts 550

Questions for Review 550

Problems and Applications 550

Quick Quiz Answers 551

Chapter 27

Saving, Investment, and the Financial

System 553

27-1 Financial Institutions in the U.S. Economy 554

27-1a Financial Markets 554

27-1b Financial Intermediaries 556

27-1c Summing Up 558

xxiv Contents

27-2 Saving and Investment in the National Income Accounts 558

27-2a Some Important Identities 559

27-2b The Meaning of Saving and Investment 560

27-3 The Market for Loanable Funds 561

27-3a Supply and Demand for Loanable Funds 561

27-3b Policy 1: Saving Incentives 563

27-3c Policy 2: Investment Incentives 565

Case Study: The Decline in Real Interest Rates

from 1984 to 2020 566

27-3d Policy 3: Government Budget Deficits and Surpluses 567

Case Study: The History of U.S. Government Debt 569

Ask the Experts: Fiscal Policy and Saving 569

FYI: Financial Crises 571

27-4 Conclusion 572

Chapter in a Nutshell 572

Key Concepts 572

Questions for Review 573

Problems and Applications 573

Quick Quiz Answers 574

Chapter 28

The Basic Tools of Finance 575

28-1 Present Value: Measuring the Time Value of Money 576

FYI: The Magic of Compounding and the Rule of 70 578

28-2 Managing Risk 578

28-2a Risk Aversion 579

28-2b The Markets for Insurance 579

28-2c Diversification of Firm-Specific Risk 580

28-2d The Trade-Off between Risk and Return 581

28-3 Asset Valuation 583

28-3a Fundamental Analysis 583

FYI: Key Numbers for Stock Watchers 584

28-3b The Efficient Markets Hypothesis 584

Case Study: Random Walks and Index Funds 585

Ask the Experts: Diversified Investing 586

In the News: The Perils of Investing with

a Y Chromosome 586

28-3c Market Irrationality 587

28-4 Conclusion 588

Chapter in a Nutshell 589

Key Concepts 589

Questions for Review 589

Problems and Applications 589

Quick Quiz Answers 590

Chapter 29

Unemployment 591

29-1 Identifying Unemployment 592

29-1a How Is Unemployment Measured? 592

Case Study: Labor-Force Participation of Women

and Men in the U.S. Economy 595

29-1b Does the Unemployment Rate Measure What

We Want It to Measure? 596

29-1c How Long Are the Unemployed without Work? 596

29-1d Why Are There Always Some People

Unemployed? 598

FYI: The Jobs Number 598

29-2 Job Search 599

29-2a Why Some Frictional Unemployment Is Inevitable 599

29-2b Public Policy and Job Search 600

29-2c Unemployment Insurance 600

29-3 Minimum-Wage Laws 602

Case Study: Who Earns the Federal Minimum Wage? 603

29-4 Unions and Collective Bargaining 604

29-4a The Economics of Unions 604

29-4b Are Unions Good or Bad for the Economy? 605

FYI: Mismatch as a Source of Structural Unemployment 606

29-5 The Theory of Efficiency Wages 607

29-5a Worker Health 607

29-5b Worker Turnover 607

29-5c Worker Quality 607

29-5d Worker Effort 608

29-5e Worker Morale 608

Case Study: Henry Ford and the Amazing

$5-a-Day Wage 608

In the News: Efficiency Wages in Practice 610

29-6 Conclusion 610

Chapter in a Nutshell 611

Key Concepts 612

Questions for Review 612

Problems and Applications 612

Quick Quiz Answers 613

Part X Money and Prices in

the Long Run 615

Chapter 30

The Monetary System 615

30-1 The Meaning of Money 616

30-1a The Functions of Money 616

30-1b The Kinds of Money 617

FYI: Cryptocurrencies: A Fad or the Future? 618

30-1c Money in the U.S. Economy 618

FYI: Why Credit Cards Aren’t Money 619

Case Study: Where Is All the Currency? 620

30-2 The Federal Reserve System 620

30-2a The Fed’s Organization 620

30-2b The Federal Open Market Committee 621

30-3 Banks and the Money Supply 622

30-3a The Simple Case of 100-Percent-Reserve Banking 622

30-3b Money Creation with Fractional-

Reserve Banking 623

Contents xxv

30-3c The Money Multiplier 624

30-3d Bank Capital, Leverage, and the Financial Crisis

of 2008–2009 625

30-4 The Fed’s Tools of Monetary Control 627

30-4a How the Fed Influences the Quantity

of Reserves 628

30-4b How the Fed Influences the Reserve Ratio 629

30-4c Problems in Controlling the Money Supply 630

Case Study: Bank Runs and the Money Supply 631

30-4d The Federal Funds Rate 632

In the News: A Trip to Jekyll Island 632

30-5 Conclusion 634

Chapter in a Nutshell 635

Key Concepts 635

Questions for Review 635

Problems and Applications 636

Quick Quiz Answers 637

Chapter 31

Money Growth and Inflation 639

31-1 The Classical Theory of Inflation 640

31-1a The Level of Prices and the Value of Money 641

31-1b Money Supply, Money Demand, and Monetary

Equilibrium 641

31-1c The Effects of a Monetary Injection 642

31-1d A Brief Look at the Adjustment Process 643

31-1e The Classical Dichotomy and Monetary

Neutrality 645

31-1f Velocity and the Quantity Equation 646

Case Study: Money and Prices during Four

Hyperinflations 648

31-1g The Inflation Tax 649

31-1h The Fisher Effect 650

31-2 The Costs of Inflation 652

31-2a A Fall in Purchasing Power? The Inflation Fallacy 652

31-2b Shoeleather Costs 653

31-2c Menu Costs 654

31-2d Relative-Price Variability and the Misallocation of

Resources 654

31-2e Inflation-Induced Tax Distortions 655

31-2f Confusion and Inconvenience 656

31-2g A Special Cost of Unexpected Inflation: Arbitrary

Redistributions of Wealth 657

31-2h Inflation Is Bad, but Deflation May Be Worse 657

Case Study: The Wizard of Oz and the Free-Silver

Debate 658

In the News: Life during Hyperinflation 660

31-3 Conclusion 660

Chapter in a Nutshell 662

Key Concepts 662

Questions for Review 662

Problems and Applications 662

Quick Quiz Answers 663

Part XI The Macroeconomics

of Open Economies 665

Chapter 32

Open-Economy Macroeconomics:

Basic Concepts 665

32-1 The International Flows of Goods and Capital 666

32-1a The Flow of Goods: Exports, Imports,

and Net Exports 666

Case Study: The Increasing Openness of the

U.S. Economy 667

32-1b The Flow of Financial Resources:

Net Capital Outflow 668

32-1c The Equality of Net Exports and

Net Capital Outflow 669

32-1d Saving, Investment, and Their Relationship

to International Flows 671

32-1e Summing Up 672

Case Study: Is the U.S. Trade Deficit a

National Problem? 673

Ask the Experts: Trade Balances and

Trade Negotiations 675

32-2 The Prices for International Transactions:

Real and Nominal Exchange Rates 676

32-2a Nominal Exchange Rates 676

FYI: The Euro 677

32-2b Real Exchange Rates 677

32-3 A First Theory of Exchange-Rate Determination:

Purchasing-Power Parity 679

32-3a The Basic Logic of Purchasing-Power Parity 679

32-3b Implications of Purchasing-Power Parity 680

Case Study: The Nominal Exchange Rate during a

Hyperinflation 681

32-3c Limitations of Purchasing-Power Parity 682

Case Study: The Hamburger Standard 683

32-4 Conclusion 684

Chapter in a Nutshell 684

Key Concepts 685

Questions for Review 685

Problems and Applications 685

Quick Quiz Answers 686

Chapter 33

A Macroeconomic Theory of the

Open Economy 687

33-1 Supply and Demand for Loanable Funds and for

Foreign-Currency Exchange 688

33-1a The Market for Loanable Funds 688

33-1b The Market for Foreign-Currency Exchange 690

FYI: Purchasing-Power Parity as a Special Case 692

xxvi Contents

33-2 Equilibrium in the Open Economy 693

33-2a Net Capital Outflow: The Link between the Two

Markets 693

33-2b Simultaneous Equilibrium in Two Markets 694

FYI: Disentangling Supply and Demand 696

33-3 How Policies and Events Affect an Open Economy 696

33-3a Government Budget Deficits 696

33-3b Trade Policy 698

Ask the Experts: Deficits 699

33-3c Political Instability and Capital Flight 701

Case Study: Capital Flows from China 703

In the News: Separating Fact from Fiction 704

Ask the Experts: Currency Manipulation 704

33-4 Conclusion 706

Chapter in a Nutshell 706

Key Concepts 706

Questions for Review 707

Problems and Applications 707

Quick Quiz Answers 708

Part XII Short-Run Economic

Fluctuations 709

Chapter 34

Aggregate Demand and Aggregate

Supply 709

34-1 Three Key Facts about Economic Fluctuations 710

34-1a Fact 1: Economic Fluctuations Are Irregular

and Unpredictable 710

34-1b Fact 2: Most Macroeconomic Quantities

Fluctuate Together 712

34-1c Fact 3: As Output Falls, Unemployment Rises 712

34-2 Explaining Short-Run Economic Fluctuations 713

34-2a The Assumptions of Classical Economics 713

34-2b The Reality of Short-Run Fluctuations 713

34-2c The Model of Aggregate Demand and Aggregate

Supply 714

34-3 The Aggregate-Demand Curve 715

34-3a Why the Aggregate-Demand Curve

Slopes Downward 715

34-3b Why the Aggregate-Demand Curve Might Shift 718

34-4 The Aggregate-Supply Curve 720

34-4a Why the Aggregate-Supply Curve Is Vertical in

the Long Run 721

34-4b Why the Long-Run Aggregate-Supply

Curve Might Shift 722

34-4c Using Aggregate Demand and Aggregate Supply to

Depict Long-Run Growth and Inflation 723

34-4d Why the Aggregate-Supply Curve Slopes Upward in

the Short Run 724

34-4e Why the Short-Run Aggregate-Supply

Curve Might Shift 728

34-5 Two Causes of Economic Fluctuations 729

34-5a The Effects of a Shift in Aggregate Demand 730

FYI: Monetary Neutrality Revisited 733

Case Study: Two Big Shifts in Aggregate Demand: The Great

Depression and World War II 733

Case Study: The Great Recession of 2008–2009 734

34-5b The Effects of a Shift in Aggregate Supply 736

Case Study: Oil and the Economy 738

FYI: The Origins of the Model of Aggregate Demand and

Aggregate Supply 739

Case Study: The Covid Recession of 2020 740

In the News: The Strange Downturn of 2020 740

34-6 Conclusion 743

Chapter in a Nutshell 743

Key Concepts 744

Questions for Review 744

Problems and Applications 744

Quick Quiz Answers 746

Chapter 35

The Influence of Monetary and Fiscal

Policy on Aggregate Demand 747

35-1 How Monetary Policy Influences Aggregate Demand 748

35-1a The Theory of Liquidity Preference 749

FYI: Interest Rates in the Long Run and

the Short Run 751

35-1b The Downward Slope of the Aggregate-Demand

Curve 752

35-1c Changes in the Money Supply 753

35-1d The Role of Interest-Rate Targets in Fed Policy 754

Case Study: Why the Fed Watches the Stock Market (and

Vice Versa) 755

35-1e The Zero Lower Bound 756

35-2 How Fiscal Policy Influences Aggregate Demand 757

35-2a Changes in Government Purchases 757

35-2b The Multiplier Effect 758

35-2c A Formula for the Spending Multiplier 758

35-2d Other Applications of the Multiplier Effect 760

35-2e The Crowding-Out Effect 760

35-2f Changes in Taxes 762

FYI: How Fiscal Policy Might Affect Aggregate Supply 763

35-3 Using Policy to Stabilize the Economy 763

35-3a The Case for Active Stabilization Policy 764

Case Study: Keynesians in the White House 765

35-3b The Case against Active Stabilization Policy 765

Ask the Experts: Economic Stimulus 765

35-3c Automatic Stabilizers 767

35-4 Conclusion 768

Chapter in a Nutshell 768

Key Concepts 768

Questions for Review 769

Problems and Applications 769

Quick Quiz Answers 770

Contents xxvii

Chapter 36

The Short-Run Trade-Off between

Inflation and Unemployment 771

36-1 The Phillips Curve 772

36-1a Origins of the Phillips Curve 772

36-1b Aggregate Demand, Aggregate Supply,

and the Phillips Curve 773

36-2 Shifts in the Phillips Curve: The Role of

Expectations 775

36-2a The Long-Run Phillips Curve 775

36-2b The Meaning of “Natural” 777

36-2c Reconciling Theory and Evidence 778

36-2d The Short-Run Phillips Curve 779

36-2e The Natural Experiment for the Natural-Rate

Hypothesis 780

36-3 Shifts in the Phillips Curve: The Role

of Supply Shocks 782

36-4 The Cost of Reducing Inflation 785

36-4a The Sacrifice Ratio 785

36-4b Rational Expectations and the Possibility

of Costless Disinflation 787

36-4c The Volcker Disinflation 787

36-5 Recent History 789

36-5a The Greenspan Era 789

36-5b The Great Recession 790

Ask the Experts: The Inflation of 2021–2022 792

36-5c The Pandemic 792

36-6 Conclusion 793

Chapter in a Nutshell 793

Key Concepts 794

Questions for Review 794

Problems and Applications 794

Quick Quiz Answers 795

Part XIII Final Thoughts 797

Chapter 37

Six Debates over Macroeconomic

Policy 797

37-1 How Actively Should Policymakers Try to Stabilize

the Economy? 798

37-1a The Case for Robust Stabilization Policy 798

37-1b The Case for Modest Stabilization Policy 798

37-2 Should the Government Fight Recessions with Spending

Hikes or Tax Cuts? 800

37-2a The Case for Fighting Recessions with Spending

Hikes 800

37-2b The Case for Fighting Recessions with Tax Cuts 801

37-3 Should Monetary Policy Be Made by Rule

or Discretion? 803

37-3a The Case for Rule-based Monetary Policy 803

37-3b The Case for Discretionary Monetary Policy 804

FYI: Inflation Targeting 805

37-4 Should the Central Bank Aim for an Inflation

Rate Near Zero? 806

37-4a The Case for Near-Zero Inflation 806

37-4b The Case for Living with Moderate Inflation 807

In the News: The Goals of Monetary Policy 808

37-5 Should the Government Balance Its Budget? 810

37-5a The Case for a Balanced Budget 810

37-5b The Case against a Balanced Budget 811

37-6 Should the Tax Laws Be Reformed

to Encourage Saving? 812

37-6a The Case for Promoting Saving through

Tax Reform 812

Ask the Experts: Taxing Capital and Labor 814

37-6b The Case against Promoting Saving through

Tax Reform 814

37-7 Conclusion: Economic Policy and Shades of Gray 815

Chapter in a Nutshell 816

Questions for Review 816

Problems and Applications 817

Quick Quiz Answers 817

Chapter 38

Appendix: How Economists Use

Data 819

38-1 The Data That Economists Gather and Study 820

38-1a Experimental Data 820

Case Study: The Moving to Opportunity Program 821

38-1b Observational Data 821

38-1c Three Types of Data 822

38-2 What Economists Do with Data 823

38-2a Describing the Economy 823

38-2b Quantifying Relationships 823

38-2c Testing Hypotheses 824

38-2d Predicting the Future 824

Case Study: The FRB/US Model 825

38-3 The Methods of Data Analysis 826

38-3a Finding the Best Estimate 826

38-3b Gauging Uncertainty 828

38-3c Accounting for Confounding Variables 830

38-3d Establishing Causal Effects 832

Case Study: How Military Service Affects Civilian

Earnings 833

38-4 Conclusion 834

Chapter in a Nutshell 835

Key Concepts 835

Questions for Review 835

Problems and Applications 835

Quick Quiz Answers 836

Glossary 837

Index 844

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