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Micro Econ 6 Principles of Microeconomics 6Th Edition William A Mceachern Full Chapter
Micro Econ 6 Principles of Microeconomics 6Th Edition William A Mceachern Full Chapter
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micro
william a. M c Eachern
University of Connecticut
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Micro ECON6 © 2019, 2017 Cengage Learning, Inc.
Will McEachern Unless otherwise noted, all content is © Cengage.
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M cE ac h e r n
ECONMICRO
6 Brief
Contents
Part 1 Introduction to Economics
1 The Art and Science of Economic Analysis 2
2 Economic Tools and Economic Systems 24
3 Economic Decision Makers 40
4 Demand, Supply, and Markets 56
Index 380
iv CONTENTS
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5 Elasticity of Demand and Supply 74 8 Perfect Competition 120
5-1 Price Elasticity of Demand 75 8-1 An Introduction to Perfect
5-2 Determinants of the Price Elasticity of Demand 80 Competition 121
9 Monopoly 142
6-4 Final Word 102
Part 3
9-6 Price Discrimination 155
9-7 Final Word 158
Competition 176
10-5 Final Word 177
CONTENTS v
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13-6 Corporate Finance 228
Part 4 13-7 Final Word 232
Part 5
11 Resource Markets 180 Market Failure and
11-1 The Once-Over 181
11-2 Demand and Supply of Resources 182
Public Policy
11-3 Temporary and Permanent Resource
Price Differences 184
11-4 Opportunity Cost and Economic
Zhao jian kang/Shutterstock.com
Rent 185
11-5 A Closer Look at Resource Demand 188
11-6 Final Word 193
12 LUnions
abor Markets and Labor
196
12-1 Labor Supply 197
12-2 Why Wages Differ 202 15 Eand
conomic Regulation
Antitrust Policy 252
12-3 Unions and Collective Bargaining 205
12- 4 Union Wages and Employment 207 15-1 Types of Government Regulation 253
12-5 Final Word 213 15-2 Regulating a Natural Monopoly 254
15-3 Alternative Theories of Economic Regulation 256
13 and
Capital, Interest, E ntrepreneurship,
Corporate Finance 216
15-4 Antitrust Law and Enforcement 258
15-5 Competitive Trends in the U.S. Economy 264
15-6 Final Word 266
13-1 The Role of Time in Production
16 PChoice
and Consumption 217
13-2 The Market for Loanable Funds 221 ublic Goods and Public
13-3 Why Interest Rates Differ 222 268
13-4 Present Value and Discounting 224 16-1 Public Goods 269
13-5 Entrepreneurship 226 16-2 Public Choice in Representative Democracy 272
vi CONTENTS
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19
16-3 Exploiting Government versus Avoiding
Government 277 International Trade 324
16-4 Bureaucracy and Representative Democracy 279 19-1 The Gains from Trade 325
16-5 Final Word 281 19-2 Trade Restrictions and Welfare Loss 332
17
19-3 Efforts to Reduce Trade Barriers 336
Externalities and the 19-4 Arguments for Trade Restrictions 338
Environment 284 19-5 Final Word 341
17-1 Externalities and the Common-Pool Problem 285
17-2 Optimal Level of Pollution 287
17-3 Environmental Protection 293
20 International Finance 344
20-1 Balance of Payments 345
17-4 Positive Externalities 298
20-2 Foreign Exchange Rates and Markets 350
17-5 Final Word 299
20-3 Other Factors Influencing Foreign Exchange
Markets 353
18 Poverty and Redistribution 304 20-4 International Monetary System 355
20-5 Final Word 357
18-1 The Distribution of Household Income 305
21
18-2 Redistribution Programs 310
18-3 Who Are the Poor 315 Economic Development 360
18-4 Some Unintended Consequences of Income 21-1 Worlds Apart 361
Assistance 318
21-2 Productivity: Key to Development 366
18-5 Welfare Reforms 319
21-3 International Trade and Development 372
18-6 Final Word 321
21-4 Foreign Aid and Economic Development 374
21-5 Final Word 378
International Economics
iStockphoto.com/Rafael Ramirez
CONTENTS vii
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Part 1
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▸▸ Why are comic strip and TV characters like those ▸▸ Why is a good theory like a closet organizer?
in Adventure Time, The Simpsons, and Family Guy ▸▸ What’s the big idea with economics?
missing a finger on each hand?
Finally, how can it be said that in economics “what goes
▸▸ Which college majors pay the most? around comes around”? These and other questions are
▸▸ In what way are people who pound on vending answered in this chapter, which introduces the art and
machines r elying on theory? science of economic analysis.
Y
ou have been reading and hearing about or off campus, take a course in accounting or
economic issues for years—unemployment, one in history, get married or stay single, pack
inflation, poverty, recessions, federal defi- a lunch or buy a sandwich. You already know
cits, college tuition, airfares, stock prices, com- much more about economics than you realize.
puter prices, smartphone prices, and gas prices. You bring to the subject a rich personal experi-
When explanations of such issues go into any ence, an experience that will be tapped through-
depth, your eyes may glaze over and you may out the book to reinforce your understanding of
tune out, the same way you do when a weather the basic ideas.
forecaster tries to explain high-pressure fronts
colliding with moisture carried in from the coast.
What many people fail to realize is that
economics is livelier than the dry accounts
offered by the news media. Economics is about
“ Why are comic strip and TV
characters like those in Adventure
making choices, and you make economic choices Time, The Simpsons, and Family Guy
every day—choices about whether to get a part-
time job or focus on your studies, live in a dorm
missing a finger on each hand?
”
1-1 THE ECONOMIC PROBLEM: unlimited wants exists to a greater or lesser extent for
each of the 7.5 billion people on earth. Everybody—
SCARCE RESOURCES, cab driver, farmer, brain surgeon, dictator, shepherd,
student, politician—faces the problem. For example, a
UNLIMITED WANTS cab driver uses time and other scarce resources, such
as the taxi, knowledge of the city, driving skills, and
Would you like a new car, a nicer home, a smarter phone, gasoline, to earn income. That income, in turn, buys
tastier meals, more free time, a more interesting social housing, groceries, clothing, trips to Disney World, and
life, more spending money, more leisure, more sleep? thousands of other goods and services that help satisfy
Who wouldn’t? But even if you can satisfy some of these some of the driver’s unlimited wants. Economics exam-
desires, others keep popping up. The problem is that ines how people use their scarce resources to satisfy
although your wants, or desires, are virtually unlimited, their unlimited wants. Let’s pick apart the definition,
the resources available to satisfy these wants are scarce. b eginning with resources,
A resource is scarce when it is not freely available—that then goods and services, and
is, when its price exceeds zero. Because resources are finally focus on the heart economics The study of
how people use their scarce
scarce, you must choose from among your many wants, of the matter—economic
resources to satisfy their
and whenever you choose, you must forgo satisfying choice, which results from unlimited wants
some other wants. The problem of scarce resources but scarcity.
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clean seawater have become scarce. Goods and
an
nisms by which buyers and nu
o
Pr
d
e e
se
sellers communicate, such
rv
tu
ice
di
as classified ads, radio and en
s
Exp
t
ro fi
Lab entre
,p
or,
nt
bought and sold in product
ca pren
re
pit
t,
co
es
In
m nt
,i
es
tu e
na
rc
ia ral u
l a re Wa so
markets. The most impor- bil so Re
ity urc
tant resource market is the es, Resource
markets
labor, or job, market. Think
about your own experience
looking for a job, and you’ll
already have some idea of
that market.
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supply of resources come together in resource m
arkets to 1-2a Rational Self-Interest
determine what firms pay for resources. These resource
prices—wages, interest, rent, and profit—flow as income A key economic assumption is that individuals, in mak-
to households. The demand and supply of products ing choices, rationally select what they perceive to be in
come together in product markets to determine what their best interests. By rational, economists mean sim-
households pay for goods and services. These expen- ply that people try to make the best choices they can,
ditures on goods and services flow as revenue to firms. given the available time and information. People may not
Resources and products flow in one direction—in this know with certainty which alternative will turn out to be
case, counterclockwise—and the corresponding pay- the best. They simply select the alternatives they expect
ments flow in the other direction—clockwise. What goes will yield the most satisfaction and happiness. In general,
around comes around. Take a little time now to trace the rational self-interest means that each individual tries
logic of the circular flows. to maximize the expected benefit achieved with a given
cost or to minimize the expected cost of achieving a given
benefit. Thus, economists begin with the assumption that
1-2 THE ART OF ECONOMIC ANALYSIS people look out for their self-
interest. For example, a phy- rational self-interest
sician who owns a pharmacy Each individual tries to
An economy results as millions of individuals attempt to prescribes 8 percent more maximize the expected benefit
satisfy their unlimited wants. Because their choices lie at achieved with a given cost or to
drugs on average than a phy-
minimize the expected cost of
the heart of the economic problem—coping with scarce sician who does not own a achieving a given benefit
resources but unlimited wants—these choices deserve a pharmacy.1
closer look. Learning about the forces that shape eco-
nomic choices is the first step toward understanding the 1. Brian Chen, Paul Gertler, and Chuh-Yuh Yang, “Moral Hazard and Econo-
mies of Scope in Physician Ownership of Complementary Medical Services,”
art of economic analysis. NBER Working Paper 19622 (November 2013).
Jeff Schultes/Shutterstock.com
Source: Matthew Kotchen and Matthew Potoski, “Conflicts of Interest Distort Public Evaluations: Evidence from the Top 25 Ballots of NCAA Football
Coaches,” Journal of Economic Behavior & Organization, 107 (November 2014): 51–63.
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term. You just finished lunch and are deciding whether the choices of various decision makers. Microeconomics
to order dessert. explains how price and quantity are determined in indi-
Economic choice is based on a comparison of the vidual markets—the market for breakfast cereal, sports
expected marginal benefit and the expected marginal equipment, or used cars, for instance.
cost of the action under consideration. Marginal means You have probably given little thought to what influ-
incremental, additional, or extra. Marginal refers to a ences your own economic choices. You have likely given
change in an economic variable, a change in the status even less thought to how your choices link up with those
quo. A rational decision maker changes the status quo if made by millions of others in the U.S. economy to deter-
the expected marginal benefit from the change exceeds mine economy-wide measures such as total production,
the expected marginal cost. For example, Amazon.com employment, and economic growth. Macroeconomics
compares the marginal benefit expected from adding a studies the performance of the economy as a whole.
new line of products (the additional sales revenue) with Whereas microeconomics studies the individual pieces of
the marginal cost (the additional cost of the resources the economic puzzle, as reflected in particular markets,
required). Likewise, you compare the marginal benefit macroeconomics puts all the pieces together to focus on
you expect from eating dessert (the additional pleasure or the big picture. Macroeconomics sees the forest, not the
satisfaction) with its marginal cost (the additional money, trees; the beach, not the grains of sand; and the Rose
time, and calories). Bowl parade float, not the individual flowers that shape
Typically, the change under consideration is small, and color that float.
but a marginal choice can involve a major economic The national economy usually grows over time,
adjustment, as in the decision to quit school and find a but along the way it sometimes stumbles, experiencing
job. For a firm, a marginal choice might mean building a recessions in economic activity, as reflected by a decline
plant in Mexico or even filing for bankruptcy. By focus- in production, employment, and other aggregate mea-
ing on the effect of a marginal adjustment to the status sures. Economic fluctuations are the rise and fall of
quo, the economist is able to cut the analysis of economic economic activity relative to the long-term growth trend
choice down to a manageable size. Rather than confront of the economy. These fluctuations, or business cycles,
a bewildering economic reality head-on, the economist vary in length and intensity, but they usually involve the
begins with a marginal choice to see how this choice entire nation and often other nations too. For exam-
affects a particular market and shapes the economic sys- ple, the U.S. economy now
tem as a whole. Incidentally, to the noneconomist, mar- produces more than four marginal Incremental,
ginal usually means relatively inferior, as in “a movie of times as much as it did in additional, or extra; used
marginal quality.” Forget that meaning for this course and 1960, despite experiencing to describe a change in an
instead think of marginal as meaning incremental, addi- eight recessions since then, economic variable
macroeconomics The
Although you have made thousands of economic how people use their scarce
study of the economic behavior
choices, you probably seldom think about your own resources in an attempt to of entire economies, as
economic behavior. For example, why are you reading satisfy their unlimited wants. measured, for example, by total
this book right now rather than doing something else? Rational self-interest guides production and employment
Microeconomics is the study of your economic behavior individual choice. Choice economic fluctuations
and the economic behavior of others who make choices requires time and informa- The rise and fall of economic
about such matters as how much to study and how much tion and involves a compari- activity relative to the long-term
growth trend of the economy;
to party, how much to borrow and how much to save, son of the expected marginal
also called business cycles
what to buy and what to sell. Microeconomics examines benefit and the expected
individual economic choices and how markets coordinate marginal cost of alternative
simplify the human form (some even lack arms and heads).
Comic strips and cartoons simplify a character’s anatomy—
leaving out fingers (in the case of Adventure Time, The
Simpsons, and Family Guy) or a mouth (in the case of Dil-
bert), for instance. You might think of economic theory as a A good theory can act like a closet organizer for
stripped-down, or streamlined, version of economic reality. your mind, helping you understand a messy and
A good theory helps us understand a messy and confusing world.
confusing world. Lacking a theory of how things work,
our thinking can become cluttered with facts, one piled
on another, as in a messy closet. You could think of a good
theory as a closet organizer for the mind. A good theory understood. Someone who pounds on the Pepsi machine
offers a helpful guide to sorting, saving, and understand- that just ate a quarter has a crude theory about how that
ing information. machine works. One version of that theory might be, “The
quarter drops through a series of whatchamacallits, but
1-3a The Role of Theory sometimes it gets stuck. If I pound on the machine, then I
can free up the quarter and send it on its way.” Evidently,
Most people don’t understand the role of theory. Perhaps this theory is widespread enough that people continue to
you have heard, “Oh, that’s fine in theory, but in practice pound on machines that fail to perform (a real problem
it’s another matter.” The implication is that the theory in for the vending machine industry and one reason newer
question provides little aid in practical matters. People who machines are fronted with glass). Yet, if you were to ask
say this fail to realize that they are merely substituting their these mad pounders to explain their “theory” about how the
own theory for a theory they machine works, they would look at you as if you were crazy.
economic theory, or either do not believe or do not
economic model, A understand. They are really say-
simplification of reality used ing, “I have my own theory that
1-3b The Scientific Method
to make predictions about
works better.” To study economic problems, economists employ a pro-
cause and effect in the real
world All of us employ theories, cess called the scientific method, which consists of four
however poorly defined or steps, as outlined in Exhibit 1.2.
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be, “What is the relationship between
Exhibit 1.2 the price of Pepsi and the quantity of
The Scientific Method: Step-by-Step Pepsi purchased?” In this case, the rel-
The steps of the scientific method are designed to develop and test evant variables are price and quantity. A
hypotheses about how the world works. The objective is a theory that variable is a measure that can take on
predicts outcomes more accurately than the best alternative theory.
A hypothesis is rejected if it does not predict as accurately as the best different values at different times. The
alternative. A rejected hypothesis can be modified or reworked in light variables of concern become the ele-
of the test results. ments of the theory, so they must be
selected with care.
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may behave in an unpredictable way. But the unpredict- Can we conclude that physicians cause cancer? No. To
able actions of numerous individuals tend to cancel one assume that event A caused event B simply because the
another out, so the average behavior of groups can be pre- two are associated in time is to commit the association-
dicted more accurately. For example, if the federal gov- is-causation fallacy, a common error. The fact that
ernment cuts personal income taxes, certain households one event precedes another or that the two events occur
might save the entire tax cut. On average, however, house- simultaneously does not necessarily mean that one causes
hold spending would increase. Likewise, if Burger King the other. Remember: Association is not necessarily
cuts the price of Whoppers, the manager can better pre- causation.
dict how much sales will increase than how a specific cus-
tomer coming through the door will respond. The random The Fallacy of Composition
actions of individuals tend to offset one another, so the
Perhaps you have been to a rock concert where every-
average behavior of a large group can be predicted more
one stands to get a better view. At some concerts, most
accurately than the behavior of a particular individual.
people even stand on their chairs. But even stand-
Consequently, economists tend to focus on the average,
ing on chairs does not improve your view if others do
or typical, behavior of people in groups—for example,
the same, unless you are quite tall. Likewise, arriving
as average taxpayers or average Whopper consumers—
early to buy concert tickets does not work if many
rather than on the behavior of a specific individual.
have the same idea. Earning a college degree to get
a better job does not work as well if everyone earns a
1-4 SOME PITFALLS OF FAULTY college degree. These are examples of the fallacy of
composition, which is an erroneous belief that what is
ECONOMIC ANALYSIS true for the individual, or the part, is also true for the
group, or the whole.
Economic analysis, like other forms of scientific inquiry, is
subject to common mistakes in reasoning that can lead to The Mistake of Ignoring
faulty conclusions. Here are three sources of confusion. the Secondary Effects
In many cities, public officials have imposed rent con-
The Fallacy That A
ssociation trols on apartments. The primary effect of this policy,
Is Causation the effect that policy makers focus on, is to keep rents
In the past two decades, the number of physicians spe- from rising. Over time, however, fewer new apart-
cializing in cancer treatment increased sharply. At the ments get built because renting them becomes less
same time, the incidence of some cancers increased. profitable. Moreover, existing rental units deteriorate
because owners have plenty of customers anyway.
Thus, the quantity and quality of housing may decline
as a result of what appears to be a reasonable mea-
sure to keep rents from
rising. The mistake was association-is-causation
to ignore the secondary fallacy The incorrect idea
effects, or the unintended that if two variables are associ-
ated in time, one must necessar-
consequences, of the
ily cause the other
policy. Economic actions
have secondary effects that fallacy of composition
Anna Omelchenko/Fotolia LLC
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Exhibit 1.3
Median Annual Pay by College Major (with Bachelor’s Degree Only)
Computer Engineering
Electrical Engineering
Mechanical Engineering
Computer Science
Civil Engineering Nursing
Economics
Finance
Mathematics
Accounting
Chemistry
Marketing & Management
Political Science
Agriculture
Biology
History
English
Sociology
Psychology 0–5 Years' Experience
Criminal Justice 10–20 Years' Experience
Elementary Education
0 20 40 60 80 100 120
Thousands of Dollars
Sources: Median pay data for 2015 were found at https://www.payscale.com/best-colleges/degrees.asp. For a survey of
e mployment opportunities,go to the U.S. Labor Department’s Occupational Outlook Handbook at https://www.bls.gov/oco/.
Other notable economics majors include former Hewlett- whole story, and economic factors are not always the most
Packard president (and billionaire) Meg Whitman, former important. But economic considerations have important
head of Microsoft (and billionaire) Steve Ballmer, CNN and predictable effects on individual choices, and these
founder (and billionaire) Ted Turner, financial guru (and choices affect the way we live.
billionaire) Warren Buffett, Walmart founder (and bil- Yes, economics is a challenging discipline, but it is
lionaire) Sam Walton, and (non-billionaire) Scott Adams, also an exciting and rewarding one. The good news is
creator of Dilbert, the mouthless wonder. that you already know a lot about economics. To use this
knowledge, however, you must cultivate the art and sci-
ence of economic analysis. You must be able to simplify
1-6 FINAL WORD the world to formulate questions, isolate the relevant
variables, and then tell a persuasive story about how these
variables relate.
This textbook describes how economic factors affect indi- An economic relation can be expressed in words, rep-
vidual choices and how all these choices come together resented as a table of quantities, described by a mathemat-
to shape the economic system. Economics is not the ical equation, or illustrated as a graph. The appendix to this
STUDY
TOOLS 1
READY TO STUDY? IN THE BOOK, YOU CAN:
◻ Work the problems at the end of the chapter.
◻ Rip out the chapter review card for a handy summary of the chapter and key terms.
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CHAPTER 1 PROBLEMS
Your instructor can access the answers to these problems online at https://cengagebrain.com.
Vertical axis
15 a
y measured along the vertical axis increases as you move
north of the origin. Mark off this line from 0 to 20, in
increments of 5 units each. 10
Within the space framed by the two axes, you can
plot possible combinations of the variables measured 5 b
along each axis. Each point identifies a value measured
along the horizontal, or x, axis and a value measured along
0
the vertical, or y, axis. For example, place point a in your
Origin 5 10 15 20 x
graph to reflect the combination where x equals 5 units
Horizontal axis
and y equals 15 units. Likewise, place point b in your
graph to reflect 10 units of x and 5 units of y. Now com-
pare your results with points shown in Exhibit A-1.
A graph is a picture showing how variables relate,
and a picture can be worth a thousand words. Take a look the year, the price of a product
origin on a graph
at Exhibit A-2, which shows the U.S. annual unemploy- and the quantity demanded, or depicting two-dimensional
ment rate since 1900. The year is measured along the the price of production and the space, the zero point
horizontal axis and the unemployment rate is measured quantity supplied. Because we
horizontal axis line on
as a percentage along the vertical axis. Exhibit A-2 is a focus on just two variables at a graph that begins at the
time-series graph, which shows the value of a variable, in a time, we usually assume that origin and goes to the right
this case the percent of the labor force unemployed, over other relevant variables remain and left; sometimes called
time. If you had to describe the information presented in constant. the x axis
Exhibit A-2, the explanation could take many words. The One variable often depends vertical axis line on
picture shows not only how one year compares to the next on another. The time it takes a graph that begins at the
origin and goes up and
but also how one decade compares to another and how you to drive home depends on
down; sometimes called
the unemployment rate trends over time. The sharply your average speed. Your weight the y axis
higher unemployment rate during the Great Depression depends on how much you eat.
graph a picture showing
of the 1930s is unmistakable. Graphs convey information The amount of Pepsi you buy how variables relate in two-
in a compact and efficient way. depends on the price. A func- dimensional space; one vari-
This appendix shows how graphs express a variety tional relation exists between able is measured along the
of possible relations among variables. Most graphs of two variables when the value horizontal axis and the other
along the vertical axis
interest in this book reflect the relationship between two of one variable depends on the
economic variables, such as the unemployment rate and value of another variable.
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Exhibit A-2
U.S. Unemployment Rate Since 1900
A time-series graph depicts the behavior of some economic variable over time. Shown here are U.S. unemployment rates since 1900.
Unemployment rate (percent)
25
20
15
10
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
Year
Source: Historical Statistics of the United States, 1970; and Economic Report of the President, January 2017.
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Exhibit A-5
Alternative Slopes for Straight Lines
The slope of a line indicates how much the vertically measured variable changes for a given increase in the variable measured
along the horizontal axis. Panel (a) shows a positive relation between two variables; the slope is 0.5, a positive number. Panel
(b) depicts a negative, or inverse, relation. When the x variable increases, the y variable decreases; the slope is 20.7, a nega-
tive number. Panels (c) and (d) represent situations in which two variables are unrelated. In panel (c), the y variable always
takes on the same value; the slope is 0. In panel (d), the x variable always takes on the same value; the slope is mathematically
undefined but we simplify by assuming the slope is infinite.
20 5 20 7
Slope = 10 = 0.5 Slope = – = –0.7
10
15
5
10 10
10
–7
3
10
0 10 20 x 0 10 20 x
10
20 20 Slope = 0 = `
0
Slope = 10 = 0 10
10 10
10
0 10 20 x 0 10 x
same but units are measured not in feet but in yards, output, measured along the horizontal axis. For example,
the relation between total cost and quantity purchased is in panel (a) of Exhibit A-6, the marginal cost of another
as depicted in panel (b). Now total cost increases by $3 foot of copper tubing is $1, which also equals the slope
for each 1-yard increase in output, so the slope equals of the line. In panel (b), the marginal cost of another
3/1, or 3. Because different units are used to measure yard of tubing is $3, which again is the slope of that line.
the copper tubing, the two panels reflect different slopes, Because of its applicability to marginal analysis, the slope
even though the cost is $1 per foot in each panel. Keep has special relevance in economics.
in mind that the slope depends in part on the units of
measurement. A1-1d The Slopes of Curved
Economic analysis usually involves marginal analy-
sis, such as the marginal cost of one more unit of output.
Lines
The slope is a convenient device for measuring marginal The slope of a straight line is the same everywhere along
effects because it reflects the change in total cost, mea- the line, but the slope of a curved line differs along the
sured along the vertical axis, for each 1-unit change in curve, as shown in Exhibit A-7. To find the slope of a
CHAPTER 1: The Art and Science of Economic Analysis 21
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Exhibit A-6
Slope Depends on the Unit of Measure
The value of the slope depends on the units of measure. In panel (a), output is measured in feet of copper
tubing; in panel (b), output is measured in yards. Although the cost is $1 per foot in each panel, the slope is
different in the two panels because copper tubing is measured using different units.
$6 $6
1
5
3
1
1 3
Slope = = 1 3 Slope = =3
1 1
1
0 5 6 0 1 2
Feet of copper tubing Yards of copper tubing
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Exhibit A-8 Exhibit A-9
Curves with Both Positive and Negative Slopes Shift of Line Relating Distance Traveled
Some curves have both positive and negative slopes. The to Hours Driven
hill-shaped curve (in red) has a positive slope to the left of Line T appeared originally in Exhibit A-5 to show the rela-
point a, a slope of 0 at point a, and a negative slope to the tion between hours driven and distance traveled per day,
right of that point. The U-shaped curve (in blue) starts off assuming an average speed of 50 miles per hour. If the
with a negative slope, has a slope of 0 at point b, and has a speed averages only 40 miles per hour, the entire relation
positive slope to the right of that point. shifts to the right to T9, indicating that any given distance
traveled requires more driving time. For example, 200 miles
y traveled takes 4 hours at 50 miles per hour but 5 hours at
40 miles per hour. This figure shows how a change in
assumptions, in this case, the average speed, can shift the
a entire relationship between two variables.
0 x 150
100
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
▸▸ Why are you reading this book right now rather ▸▸ Why is there no point crying over spilled milk?
Q uthan
e sdoing
t i osomething
ns else? ▸▸ Why does common ownership often lead to
▸▸ What is college costing you? common neglect?
▸▸ Why will you eventually major in one subject rather ▸▸ These and other questions are addressed in this
than continue to take courses in various subjects? chapter, which introduces some tools of economic
▸▸ Why is fast food so fast? analysis—some tools of the trade.
C
hapter 1 introduced the idea that scarcity that different economies must answer—questions
forces us to make choices, but the chap- about what goods and services to produce, how to
ter said little about how to make economic produce them, and for whom to produce them.
choices. This chapter develops a framework for
evaluating economic alternatives. First, we con-
“Why is there
sider the cost involved in selecting one alternative
over others. Next, we develop tools to explore the
no point crying over
choices available to individuals and to the econ-
omy as a whole. Finally, we examine the questions
spilled milk?
”
2-1 CHOICE AND OPPORTUNITY COST other possible alternative. You are reading this chapter
right now because you have nothing better to do. In fact,
you are attending college for the same reason: College
Think about a choice you just made: the decision to begin
appears more attractive than your best alternative.
reading this chapter right now rather than use your time to
study for another course, play sports, watch TV, play video
games, go online, get some sleep, hang with friends, or do 2-1b Opportunity Cost
something else. Suppose it’s late and your best alternative Is Subjective
to reading right now is getting some sleep. The cost of
reading is passing up the opportunity of sleep. Because of Like beauty, opportunity cost is in the eye of the beholder.
scarcity, whenever you make a choice, you must pass up It is subjective. Only the individual making the choice can
another opportunity; you must incur an opportunity cost. identify the most attractive alternative. But the chooser
seldom knows the actual value of what was passed up
because that alternative is “the road not taken.” If you
2-1a Opportunity Cost give up an evening of pizza and conversation with friends
What do we mean when we talk about the cost of some- to work on a research paper, you will never know exactly
thing? Isn’t it what we must give up—must forgo—to get what you gave up. You know only what you expected. Evi-
that thing? The opportunity cost of the chosen item or dently, you expected the benefit of working on that paper
activity is the value of the best alternative that is forgone. to exceed the benefit of the best alternative. (Incidentally,
You can think of opportunity cost as the opportunity lost. focusing on the best alternative forgone makes all other
Sometimes opportunity cost can be measured in terms of alternatives irrelevant.)
money, although, as we shall see, money is usually only
part of opportunity cost.
Calculating Opportunity Cost
How many times have you heard people say they Requires Time and Information
did something because they “had nothing better to do”? Economists assume that
They actually mean they had nothing else going on. Yet, people rationally choose the opportunity cost The
value of the best alternative for-
according to the idea of opportunity cost, people always most valued alternative. This
gone when an item or activity
do what they do because they have nothing better to do. does not mean you exhaus- is chosen
The choice selected seems, at the time, preferable to any tively assess the value of all
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
which is a cost that has already been incurred and can-
not be recovered, regardless of what you do next. You
should ignore sunk costs in making economic choices.
Hence, you should switch lines. Economic decision mak-
SPECIALIZATION, AND both papers and your roommate irons 12 shirts. As a result
of specialization, total output increases by nine shirts! You
EXCHANGE strike a deal to exchange your typing for your roommate’s
ironing, so you each end up with a typed paper and six
ironed shirts. Thus, each of you is better off as a result of
Suppose you live in a dormitory (and also either go to col-
specialization and exchange. By specializing in the task that
lege in the 1950s or are a very dedicated hipster). You and
you each do better, you rely on the law of comparative
your roommate have such tight schedules that you each
advantage, which states that the individual with the lower
can spare only about an hour a week for mundane tasks
opportunity cost of producing a particular output should
like ironing shirts and typing papers (granted, in reality
specialize in that output. You face a lower opportunity cost
you may not iron shirts or type papers, but this example
of typing than does your roommate, because in the time it
will help you understand some important principles).
takes to type a paper, you could iron 3 shirts whereas your
Each of you must turn in a typed three-page paper every
roommate could iron 12 shirts. Moreover, if you face a
week, and you each prefer ironed shirts when you have
lower opportunity cost of typing, your roommate must face
the time. Let’s say it takes you a half hour to type a hand-
a lower opportunity cost of ironing (try working that out).
written paper. Your roommate is from the hunt-and-peck
school and takes about an hour. But your roommate is a
talented ironer and can iron a shirt in 5 minutes flat (or 2-2bAbsolute Advantage
should that be, iron it flat in 5 minutes?). You take twice Versus Comparative
as long, or 10 minutes, to iron a shirt.
During the hour set aside each week for typing and
Advantage
ironing, typing takes priority. If you each do your own The gains from specializa-
typing and ironing, you type your paper in a half hour tion and exchange so far are law of comparative
and iron three shirts in the remaining half hour. Your obvious. A more interesting advantage The individual,
roommate spends the entire hour typing the paper, leav- case arises if you are faster firm, region, or country with the
lowest opportunity cost of pro-
ing no time for ironing. Thus, if you each do your own at both tasks. Suppose the
ducing a particular good should
tasks, the combined output is two typed papers and three example changes only in specialize in that good
ironed shirts. one respect: Your roommate
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one you could make yourself? Why is
Exhibit 2.1 fast food so fast? McDonald’s takes
Specialization in the Production of Cotton Shirts advantage of the gains resulting from
the division of labor. Each worker,
rather than preparing an entire meal,
specializes in separate tasks. This divi-
sion of labor allows the group to pro-
duce much more.
How is this increase in produc-
tivity possible? First, the manager
can assign tasks according to indi-
vidual preferences and abilities—that
is, according to the law of compara-
tive advantage. The worker with the
friendly smile and pleasant personality
can handle the customers up front; the
one with the strong back but few social
graces can handle the heavy lifting out
back. Second, a worker who performs
the same task again and again gets better at
of labor within a single industry by watching the cred- it (experience is a good teacher). The worker filling orders
its roll at the end of a movie. The credits list scores of at the drive-through, for example, learns to deal with spe-
specialists—from gaffer (lighting electrician) to assistant cial problems that arise. As another example, consider the
location scout. The production of movies and TV shows experience gained by someone screening bags at airport
often requires hundreds of specialists. security. Experience helps the screener distinguish the
Some specialties may seem odd. For example, harmful from the harmless. Third, specialization means
professional mourners in Taiwan are hired by grieving no time is lost moving from one task to another. Finally,
families to scream, wail, and otherwise demonstrate the and perhaps most importantly, the specialization of
deep grief befitting a proper funeral. The sharp degree labor allows for the introduction of more sophisticated
of specialization is perhaps most obvious online, where production techniques—techniques that would not make
the pool of potential customers is so vast that individual sense on a smaller scale. For example, McDonald’s large
sites become finely focused. For example, you can find shake machine would be impractical in the home. Spe-
sites specializing in musical bowls, tongue studs, toe cialized machines make each worker more productive.
rings, brass knuckles, mouth harps, ferret toys, and cat To summarize: The specialization of labor (a) takes
bandanas—just to name a few of the hundreds of thou- advantage of individual preferences and natural abilities,
sands of specialty sites. You won’t find such precise spe- (b) allows workers to develop more experience at a par-
cialization at the mall. Adam Smith (1723–1790), who ticular task, (c) reduces the need to shift among different
is considered the father of economics, said the degree tasks, and (d) permits the introduction of labor-saving
of specialization is limited by the extent of the market. machinery. Specialization and the division of labor occur
Online sellers draw on the broadest customer base in the not only among individuals but also among firms, regions,
world to find a market niche. and, indeed, entire countries. The cotton shirt mentioned
earlier might involve growing cotton in one country, turn-
ing it into cloth in another, making the shirt in a third, and
2-2dDivision of Labor and selling it in a fourth.
We should also acknowl-
Gains from Specialization edge the downside of special- division of labor Break-
ing down the production of a
Picture a visit to McDonald’s: “Let’s see, I’ll have a Big ization. Doing the same thing good into separate tasks
Mac, an order of fries, and a chocolate shake.” In minutes all day can become tedious.
your order is ready. It would take you much longer to make Consider, for example, the specialization of labor
Focusing work effort on a par-
a homemade version of this meal. Why is the McDonald’s assembly line worker whose ticular product or a single task
meal faster, cheaper, and—for some people—tastier than sole task is to tighten a
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
point along the PPF between C and E, such as
Exhibit 2.2 D, yields both more consumer goods and more
The Economy’s Production Possibilities Frontier capital goods than I. Hence, combination I is
If the economy uses its available resources and its technology and inefficient. By using resources more efficiently,
know-how efficiently to produce consumer goods and capital goods, the economy can produce more of at least one
that economy is on its production possibilities frontier, AF. The PPF
is bowed out to reflect the law of increasing opportunity cost; the good without reducing the production of the
economy must sacrifice more and more units of consumer goods to other good. Points outside the PPF, such as U in
produce each additional increment of capital goods. Note that more Exhibit 2.2, identify unattainable combinations,
consumer goods must be given up in moving from E to F than in mov-
ing from A to B, although in each case the gain in capital goods is 10
given the availability of resources, technology
million units. Points inside the PPF, such as I, represent inefficient use and know-how, and rules of the game. Thus, the
of resources. Points outside the PPF, such as U, represent unattainable PPF not only shows efficient combinations of pro-
combinations.
duction but also serves as the boundary between
inefficient combinations inside the frontier and
unattainable combinations outside the frontier.
Consumer goods (millions of units per year)
50
48
A
B 2-3c The Shape
43 C
U
of the PPF
40
Unattainable
Any movement along the PPF involves producing
34 D less of one good to produce more of the other.
30 Movements down along the curve indicate that
Inefficient
the opportunity cost of more capital goods is fewer
I
20 E consumer goods. For example, moving from point
A to point B increases capital production from
10 none to 10 million units but reduces consumer
units from 50 million to 48 million. Increasing cap-
F ital goods by 10 million reduces consumer goods
0
only a little. Capital production initially employs
10 20 30 40 50
resources (such as heavy machinery used to build
Capital goods (millions of units per year) factories) that produce few consumer goods but
are quite productive in making capital.
As shown by the dashed lines in Exhibit 2.2,
each additional 10 million units of capital produced
The economy’s PPF for consumer goods and capital reduce consumer goods by successively larger amounts.
goods is shown by the curve AF in Exhibit 2.2. Point A The resources used to produce more capital are increas-
identifies the amount produced per year if all the economy’s ingly better suited to producing consumer goods. The
resources are used efficiently to produce consumer goods. opportunity cost of making more capital goods increases,
Point F identifies the amount produced per year if all the because not all resources in the economy are perfectly
economy’s resources are used efficiently to produce capital adaptable to the production of both types of goods. The
goods. Points along the curve between A and F identify pos- shape of the production possibilities frontier reflects the
sible combinations of the two goods that can be produced law of increasing opportunity cost. If the economy
when all the economy’s resources are used efficiently. uses resources efficiently, the law of increasing opportu-
nity cost states that each additional increment of one good
2-3bInefficient and requires the economy to sacrifice successively larger and
larger increments of the other good.
Unattainable Production The PPF derives its
Points inside the PPF, such as I in Exhibit 2.2, identify bowed-out shape from the law of increasing
combinations that do not employ resources efficiently. law of increasing opportunity opportunity cost To pro-
duce more of one good, a suc-
Note that C yields more consumer goods and no fewer cost. For example, whereas
cessively larger amount of the
capital goods than I. Moreover, E yields more capital the first 10 million units of other good must be sacrificed
goods and no fewer consumer goods than I. Indeed, any capital have an opportunity
CHAPTER 2: Economic Tools and Economic Systems 31
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
cost of only 2 million consumer units, the final 10 million
units of capital—that is, the increase from E to F—have
an opportunity cost of 20 million consumer units. Notice
that the slope of the PPF shows the opportunity cost of
an increment of capital. As the economy moves down the
curve, the curve becomes steeper, reflecting the higher
opportunity cost of capital goods in terms of forgone
Angela Harburn/Shutterstock.com
consumer goods. The law of increasing opportunity cost
also applies when moving from capital goods to consumer
goods. Incidentally, if resources were perfectly adaptable
to the production of both consumer goods and capital
goods, the PPF would be a straight line, reflecting a con-
stant opportunity cost along the PPF.
the PPF?
Any production possibilities frontier assumes the economy’s
resources, technology and know-how, and rules of the game consumer goods axis, as shown in panel (c). Panel (d)
are fixed during the period under consideration. Over time, shows the effect of an increase in a resource such as con-
however, the PPF may shift if resources, technology, and struction equipment that is suited only to capital goods.
know-how, or the rules of the game change. Economic
growth is an expansion in the economy’s production pos- Increases in the Capital Stock
sibilities as reflected by an outward shift of the PPF. An economy’s PPF depends in part on the stock of human
and physical capital. The more capital an economy pro-
Changes in Resource Availability duces in one period, the more output can be produced in
If people decide to work longer hours, the PPF shifts the next period. Thus, producing more capital goods during
outward, as shown in panel (a) of Exhibit 2.3. An increase this period (e.g., more machines in the case of physical capi-
in the size or health of the labor force, an increase in the tal or more education in the case of human capital) shifts
skills of the labor force, or an increase in the availability the economy’s PPF outward in the next period.
of other resources, such as new oil discoveries, also shifts
the PPF outward. In contrast, a decrease of resources Technological Change and More
shifts the PPF inward, as depicted in panel (b). For Know-How
example, in 1990 Iraq invaded Kuwait, setting oil fields A technological discovery that employs resources more
ablaze and destroying much of Kuwait’s physical capi- efficiently could shift the economy’s PPF outward.
tal. In West Africa, the encroaching sands of the Sahara Some discoveries enhance the production of both con-
destroy thousands of square miles of farmland each year. sumer goods and capital goods, as shown in panel (a) of
And in northwest China, a rising tide of wind-blown sand Exhibit 2.3. For example, the Internet has increased each
has claimed grasslands, lakes, and forests, and swallowed firm’s ability to find available resources. A technological
entire villages, forcing tens of thousands of people to flee. discovery that benefits consumer goods only, such as
The new PPFs in panels (a) and (b) appear to be paral- more disease-resistant crops, is reflected by a rotation
lel to the original ones, indicating that the resources that outward of the PPF along the consumer goods axis, as
changed could produce both capital goods and consumer shown in panel (c). Note that point F remains unchanged
goods. For example, an increase because the breakthrough does not affect the production
in electrical power can enhance of capital goods. Panel (d) shows a technological advance
economic growth An
increase in the economy’s the production of both, as shown in the production of capital goods, such as better software
ability to produce goods and in panel (a). If a resource such as for designing heavy machinery. But even for a given level
services; reflected by an out- farmland benefits just consumer of technology and a given number of workers, output can
ward shift of the economy’s
goods, then increased availability increase over time with more know-how. For example,
production possibilities
frontier or productivity of that resource researchers have documented that steel production dou-
shifts the PPF more along the bled at a mini-mill even though the technology did not
32 PART ONE: Introduction to Economics
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Exhibit 2.3
Shifts of the Economy’s Production Possibilities Frontier
When the resources available to an economy change, the PPF shifts. If more resources become available,
if technology and know-how improve, or if the rules of the game create greater stability, the PPF shifts
outward, as in panel (a), indicating that more output can be produced. A decrease in available resources or
an upheaval in the rules causes the PPF to shift inward, as in panel (b). Panel (c) shows a change affecting
consumer goods. More consumer goods can now be produced at any given level of capital goods. Panel (d)
shows a change affecting capital goods.
A'
A A
Consumer goods
Consumer goods
A''
F F' F '' F
Capital goods Capital goods
A'
A
Consumer goods
Consumer goods
F F F'
Capital goods Capital goods
change nor did the number of workers. Through experi- underpinnings that encourage people to pursue pro-
mentation, workers developed more know-how.1 ductive activity. A more stable political environment
and more reliable property rights increase the incen-
Improvements in the Rules of the Game tive to work and to invest, and thus help the economy
The rules of the game are the formal and informal grow. For example, people have more incentive to work
institutions that support the economy—the laws, cus- if taxes claim less of their paychecks. People have more
toms, manners, conventions, and other institutional incentive to invest if they are confident that their invest-
ment will not be appropriated by government, stolen by
1. Igal Hendel and Yossi Spiegel, “Small Steps for Workers, a Giant Leap for thieves, destroyed by civil unrest, or blown up by ter-
Productivity.” American Economic Journal: Applied Economics, 6 February
2014: 73–90. rorists. Greater certainty and stability in the rules of the
CHAPTER 2: Economic Tools and Economic Systems 33
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Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
game shift the economy’s PPF outward. On the other efficiently and how the economy selects the most pre-
hand, greater uncertainty about the rules of the game ferred combination depends on the decision-making
reduces the economy’s productive capacity, as reflected rules employed. But regardless of how decisions are
by an inward shift of the PPF. For example, during the made, each economy must answer three fundamental
Great Recession of 2007–2009, trust in U.S. institutions questions.
such as banks, newspapers, Congress, and big corpora-
tions declined and this reduced the economy’s productive
ability.2 2-4aThree Questions Every
Economic System Must
2-3eWhat We Learn from Answer
the PPF What goods and services are to be produced? How are
The PPF demonstrates several ideas introduced so they to be produced? And for whom are they to be pro-
far. The first is efficiency: The PPF describes efficient duced? An economic system is the set of mechanisms
combinations of output, given the economy’s resources, and institutions that resolve the what, how, and for whom
technology and know-how, and rules of the game. The questions. Some criteria used to distinguish among eco-
second idea is scarcity: Given the resources, technol- nomic systems are (1) who owns the resources, (2) what
ogy and know-how, and rules of the game, the economy decision-making process is used to allocate resources
can produce only so much output per period. The PPF and products, and (3) what types of incentives guide eco-
slopes downward, because more of one good means less nomic decision makers.
of the other good, thus demonstrating opportunity cost.
The PPF’s bowed-out shape reflects the law of increasing What Goods and Services
opportunity cost, which arises because some resources Are to Be Produced?
are not perfectly adaptable to the production of each type Most of us take for granted the incredible number of
of good. Moreover, a shift outward in the PPF reflects choices that go into deciding what gets produced—
economic growth. everything from which new kitchen appliances are intro-
Finally, because society must somehow select a duced and which roads get built, to which of the 10,000
specific combination of output—a single point—along movie scripts purchased by U.S. studios each year get to
the PPF, the PPF also underscores the need for choice. be among the 650 or so movies made. Although different
Selecting a particular combination determines not economies resolve these and millions of other questions
only the consumer goods available in this period, but using different decision-making rules and mechanisms,
also the capital stock available in the next period. One all economies must somehow make such choices.
thing the PPF does not tell us is which combination
to choose. The PPF tells us only about the costs, not How Are Goods and Services
the benefits, of the two goods. To make a selection, to Be Produced?
we need to know about both costs and benefits. How The economic system must determine how output gets
society goes about choosing a particular combination produced. Which resources should be used, and how
depends on the nature of the economic system, as you should they be combined to make stuff? How much labor
will see next. should be used and at what skill levels? What kinds of
machines should be used? What new technology should
be incorporated into the latest video games? Should the
2-4 ECONOMIC SYSTEMS office complex be built in the city or closer to the inter-
state highway? Millions of individual decisions determine
which resources are employed and how these resources
Each point along the economy’s production possi-
are combined.
bilities frontier is an efficient combination of outputs.
Whether the economy produces For Whom Are Goods and Services
economic system The
set of mechanisms and to Be Produced?
institutions that resolve the 2. Betsey Stevenson and Justin
Wolfers, “Trust in Public Institutions Who will actually consume the goods and services pro-
what, how, and for whom Over the Business Cycle,” American
questions duced? The economic system must determine how to allo-
Economic Review, 101 (May 2011):
281–287. cate the fruits of production among the population. Should
34 PART ONE: Introduction to Economics
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Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
everyone receive equal shares? Should the weak and the harnesses the pursuit of self-interest to direct resources
sick get more? Should it be “first come, first served,” so that where they earn the greatest reward. According to Smith,
those willing to wait in line get more? Should goods be allo- although each individual pursues his or her self-interest,
cated according to height? Weight? Religion? Age? Gender? the “invisible hand” of market forces promotes the general
Race? Looks? Strength? Political connections? Lottery? welfare. Capitalism is sometimes called laissez-faire; trans-
Majority rule? The value of resources supplied? The ques- lated from the French, this phrase means “to let do,” or to
tion “For whom are goods and services to be produced?” is let people do as they choose without government interven-
often referred to as the distribution question. tion. Thus, under capitalism, voluntary choices based on
Although the three economic questions were dis- rational self-interest are made in unrestricted markets to
cussed separately, they are closely related. The answer to answer the questions what, how, and for whom.
one depends on the answers to the others. For example, As we will see in later chapters, pure capitalism has
an economy that distributes goods and services uniformly its flaws. The most notable market failures are these:
to everyone will, no doubt, answer the what-will-be-
1. No central authority protects property rights,
produced question differently than an economy that
enforces contracts, and otherwise ensures that the
somehow allows more personal choice. As we have seen,
rules of the game are followed.
laws about resource ownership and the role of govern-
ment determine the “rules of the game”—the set of con- 2. People with no resources to sell could starve.
ditions that shape individual incentives and constraints. 3. Some producers may try to monopolize markets by
Along a spectrum ranging from the freest to the most regi- eliminating the competition.
mented types of economic systems, pure capitalism would 4. The production or consumption of some goods
be at one end and the pure command system at the other. involves side effects that can harm or benefit people
not involved in the market transaction.
2-4b Pure Capitalism 5. Firms have no incentive to produce the so-called
public goods, such as national defense, because pri-
Under pure capitalism, there is no government. The rules
vate firms cannot prevent nonpayers from enjoying
of the game include the private ownership of resources and
the benefits of public goods.
the market distribution of products. Owners have property
rights to the use of their resources and are therefore free 6. Market economies experience economic fluctua-
to supply those resources to the highest bidder. Private tions, which are alternating periods of expansions
property rights allow individual owners to use resources and recessions in their level of economic activity,
or to charge others for their use. Any income from sup- especially in employment and production.
plying labor, capital, natural resources, or entrepreneurial Because of these limitations, countries have modified
ability goes to the individual resource owners. Producers pure capitalism to allow some role for government. Even
are free to make and sell whatever they think will be profit- Adam Smith believed government should play a role.
able. Consumers are free to buy whatever goods they can The United States is among the most market-oriented
afford. All this voluntary buying and selling is coordinated economies in the world today.
by unrestricted markets, where buyers and sellers make
their intentions known. Market prices guide resources to
their most productive use and channel goods and services 2-4cPure
to the consumers who value them the most. Command pure capitalism An eco-
nomic system characterized
Under pure capitalism, markets answer the what,
how, and for whom questions. That’s why capitalism is
System by the private ownership of
resources and the use of prices
also referred to as a market system. Markets transmit In a pure command sys- to coordinate economic activity
information about relative scarcity, provide individual tem, resources are directed in unregulated markets
incentives, and distribute income among resource sup- and production is coordi- private property rights
pliers. No individual or small group coordinates these nated not by market forces An owner’s right to use, rent, or
activities. Rather, it is the voluntary choices of many buy- but by the “command,” or sell resources or property
ers and sellers responding only to their individual incen- central plan, of government. pure command system
tives and constraints that direct resources and products In theory at least, instead An economic system character-
ized by the public ownership
to those who value them the most. of private property, there is
of resources and centralized
According to Adam Smith, market forces allocate public, or communal, owner- planning
resources as if by an “invisible hand”—an unseen force that ship of property. That’s why
CHAPTER 2: Economic Tools and Economic Systems 35
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Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Another random document with
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There were titters from the younger members of the much
interested audience and even unconcealed laughter from the older
boys, and Elk’s dark countenance took on a deeper and more angry
red as he thrust it close to Laurie’s.
“That’ll be about all for you,” he growled. “You’re one of these
funny guys, aren’t you? Must have your little joke, eh? Well, see how
you like this one!”
Elk raised his right hand, unclenched but formidable. An expectant
hush filled the little store. Polly, with troubled eyes fixed on the
drama, deluged a pineapple ice-cream with soda until it dripped on
the counter below. Laurie continued to smile.
CHAPTER II
KEWPIE STATES HIS CASE