Full text of "Principles Of Economics"
Tenth Edition
Principles of ECONOMICS
N. GREGORY MIANIKIW
Introduction
1 Ten Principles of Economics
2 Thinking Like an Economist
3 Interdependence and the Gains from Trade
How Markets Work
4 The Market Forces of Supply and Demand ——\
5 Elasticity and Its Application
6 Supply, Demand, and Government Policies
Markets and Welfare
7 Consumers, Producers, and the Efficiency
of Markets
8 Application: The Costs of Taxation
9 Application: International Trade
The Economics of the Public Sector
10 Externalities
11 Public Goods and Common Resources
12 The Economics of Healthcare
13 The Design of the Tax System
Firm Behavior and the Organization of Industry
14 The Costs of Production
15 Firms in Competitive Markets
16 Monopoly
17 Monopolistic Competition —
18 Oligopoly
===
Principles of Economics: a Guided Tour
====
The study of economics is guided by a few big ideas.
Economists view the world as both scientists and policymakers.
The theory of comparative advantage explains how people
benefit from economic interdependence.
How does the economy coordinate interdependent economic
actors? Through the market forces of supply and demand.
The tools of supply and demand are put to work to examine
the effects of various government policies.
Why is the equilibrium of supply and demand desirable for
society as a whole? The concepts of consumer and producer
surplus explain the efficiency of markets, the costs of taxation,
and the benefits of international trade.
Market outcomes are not always efficient, and governments
can sometimes remedy market failure.
To fund programs, governments raise revenue through their
tax systems, which are designed with an eye toward balancing
efficiency and equity.
The theory of the firm sheds light on the decisions that lie
behind supply in competitive markets.
Firms with market power can cause market outcomes
to be inefficient.
The Economics of Labor Markets
19
20
21
The Markets for the Factors of Production ——
Earnings and Discrimination
Income Inequality and Poverty
Topics for Further Study
22
23
The Theory of Consumer Choice
Frontiers of Microeconomics
The Data of Macroeconomics
24
25
Measuring a Nation’s Income
Measuring the Cost of Living
The Real Economy in the Long Run
26
27
28
29
Production and Growth
Saving, Investment, and the Financial System
The Basic Tools of Finance
Unemployment
Money and Prices in the Long Run
30
31
The Monetary System
Money Growth and Inflation
The Macroeconomics of Open Economies
32
33
Open-Economy Macroeconomics:
Basic Concepts
A Macroeconomic Theory of the
Open Economy
Short-Run Economic Fluctuations
34
35
36
Aggregate Demand and Aggregate Supply ——
The Influence of Monetary and Fiscal Policy
on Aggregate Demand i—
The Short-Run Trade-off between
Inflation and Unemployment
Final Thoughts
37
38
Six Debates over Macroeconomic Policy
Appendix: How Economists Use Data
These chapters examine the special features of labor markets,
in which most people earn most of their income.
Additional topics in microeconomics include household decision
making, asymmetric information, political economy, and
behavioral economics.
The overall quantity of production and the overall price level
are used to monitor developments in the economy as a whole.
These chapters describe the forces that in the long run determine
key real variables, including GDP growth, saving, investment,
real interest rates, and unemployment.
The monetary system is crucial in determining the long-run
behavior of the price level, the inflation rate, and other
nominal variables.
A nation’s economic interactions with other nations are described
by its trade balance, net foreign investment, and exchange rate.
A long-run model of the open economy explains the determinants
of the trade balance, the real exchange rate, and other real vari-
ables.
The model of aggregate demand and aggregate supply explains
short-run economic fluctuations, the short-run effects of
monetary and fiscal policy, and the short-run linkage between
real and nominal variables.
A capstone chapter presents both sides of six major debates
over economic policy.
The analysis of data to test theories and estimate parameters is
central to the science of economics.
If you enjoyed the economics course that
you just finished, you might like to read more
about economic issues in the following books.
Abhijit V. Banerjee and Esther Duflo
Good Economics for Hard Times
(New York: PublicAffairs, 2019)
Two prominent economists—winners of the Nobel prize in
2019—offer their ideas about how to build a better world.
Yoram Bauman and Grady Klein
The Cartoon Introduction to Economics
(New York: Hill and Wang, 2010)
Basic economic principles, with humor.
Bryan Caplan
The Myth of the Rational Voter: Why Democracies
Choose Bad Policies
(Princeton, NJ: Princeton University Press, 2008)
An economist asks why elected leaders often fail to follow the
policies that economists recommend.
Kimberly Clausing
Open: The Progressive Case for Free Trade,
Immigration, and Global Capital
(Cambridge, MA: Harvard University Press, 2019)
An economist explains why Americans benefit from interacting
with the rest of the world.
Avinash K. Dixit and Barry J. Nalebuff
The Art of Strategy: A Game Theorist’s Guide to Success
in Business and Life
(New York: Norton, 2008)
This introduction to game theory discusses how all people—
from arrested criminals to corporate executives—should, and
do, make strategic decisions.
Mihir Desai
The Wisdom of Finance: Discovering Humanity in the
World of Risk and Return
(Boston: Houghton Mifflin Harcourt, 2017)
A charming look at how the insights of finance inform our lives.
William Easterly
The Tyranny of Experts: Economists, Dictators, and the
Forgotten Rights of the Poor
(New York: Basic Books, 2013)
A former World Bank economist examines the many attempts
to help the world’s poorest nations and why these attempts have
often failed.
Milton Friedman
Capitalism and Freedom
(Chicago: University of Chicago Press, 1962)
One of the most important economists of the 20th century
argues that society should rely less on the government and more
on the free market.
Robert L. Heilbroner
The Worldly Philosophers
(New York: Touchstone, 1953, revised 1999)
A classic introduction to the lives, times, and ideas of the great
economic thinkers, including Adam Smith, David Ricardo, and
John Maynard Keynes.
Steven E. Landsburg
The Armchair Economist: Economics and Everyday Life
(New York: Free Press, 2012)
Why does popcorn cost so much at movie theaters? Steven
Landsburg discusses this and other puzzles of economic life.
Steven D. Levitt and Stephen J. Dubner
Freakonomics: A Rogue Economist Explores the Hidden
Side of Everything
(New York: Morrow, 2005)
Economic principles and clever data analysis applied to a wide
range of offbeat topics, including drug dealing, online dating,
and sumo wrestling.
Roger Lowenstein
America’s Bank: The Epic Struggle to Create the Federal
Reserve
(New York: Penguin Press, 2015)
A history of the founding of one of the most important
policymaking institutions in the United States.
Annie Lowrey
Give People Money: How a Universal Basic Income
Would End Poverty, Revolutionize Work, and Remake
the World
(New York: Crown, 2018)
‘The case for a substantial rethinking of the social safety net.
Burton G. Malkiel
A Random Walk Down Wall Street: The Time-Tested
Strategy for Successful Investing
(New York: Norton, 2019)
This introduction to stocks, bonds, and financial economics is
not a “get rich quick” book, but it might help you get rich slowly.
Deirdre McCloskey and Art Carden
Leave Me Alone and I’ll Make You Rich: How the
Bourgeois Deal Enriched the World
(Chicago: University of Chicago Press, 2020)
An overview of economic history that asks why most modern
societies have, over the past two centuries, escaped the grinding
poverty that previously characterized most of human existence.
John McMillan
Reinventing the Bazaar: A Natural History of Markets
(New York: Norton, 2002)
A deep and nuanced, yet still very readable, analysis of how
society can make the best use of market mechanisms.
Branko Milanovic
Capitalism, Alone: The Future of the System that Rules
the World
(Cambridge, MA: Harvard University Press, 2019)
A look at how capitalism manifests itself in different ways in
different countries.
Sendhil Mullainathan and Eldar Shafir
Scarcity: Why Having Too Little Means So Much
(New York: Times Books, 2013)
An economist and psychologist team up to examine the causes
and consequences of our limited cognitive abilities.
Sylvia Nasar
Grand Pursuit: The Story of Economic Genius
(New York: Simon and Schuster, 2011)
A sweeping narrative that tells the story of economic discovery.
William D. Nordhaus
The Spirit of Green: The Economics of Collisions and
Contagions in a Crowded World
(Princeton, NJ: Princeton University Press, 2021)
The 2018 Nobel laureate in economics examines how to best
address critical externalities, such as the carbon emissions that
lead to global climate change.
Roger W. Spencer and David A. Macpherson
Lives of the Laureates
(Cambridge, MA: MIT Press, 2014)
Twenty-three winners of the Nobel Prize in Economics offer
autobiographical essays about their lives and work.
Tenth Edition
Principles of
ECONOMICS
N. GREGORY MANKIW
HARVARD UNIVERSITY
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Principles of Economics, 10e
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JORDI CABRE
N. Gregory Mankiw is the Robert M. Beren Professor
of Economics at Harvard University. As a student, he
studied economics at Princeton University and MIT. As
a teacher, he has taught macroeconomics, microeconom-
ics, statistics, and principles of economics. He even spent
one summer long ago as a sailing instructor on Long
Beach Island.
Professor Mankiw is a prolific writer and regular
participant in academic and policy debates. His work
has been published in scholarly journals such as the
American Economic Review, Journal of Political Economy,
and Quarterly Journal of Economics and in more popu-
lar forums, such as the New York Times and The Wall
Street Journal. He is also the author of the best-selling
intermediate-level textbook Macroeconomics (Worth
Publishers).
In addition to his teaching, research, and writing,
Professor Mankiw has been a research associate of the
National Bureau of Economic Research, a member of
the Brookings Panel on Economic Activity, an adviser
to the Congressional Budget Office and the Federal
Reserve Banks of Boston and New York, a trustee of the
Urban Institute and the Economic Club of New York,
and a member of the ETS test development committee
for the Advanced Placement exam in economics. From
2003 to 2005, he served as chairman of the President’s
Council of Economic Advisers.
Pretace: To the Instructor
the two-semester sequence on the principles of economics that I took during
my first year in college. It is no exaggeration to say that it changed my life.
I had grown up ina family that often discussed politics over the dinner table.
The pros and cons of various solutions to society’s problems generated fervent
debate. But in school, I had been drawn to the sciences. While politics seemed vague,
rambling, and subjective, science was analytic, systematic, and objective. Political
debate continued without end, but scientific research made progress.
My freshman course on the principles of economics opened my eyes to a new
way of thinking. Economics combines the virtues of politics and science. It is, truly,
a social science. Its subject matter is society—how people choose to lead their lives
and how they interact with one another—but it approaches the subject with the
dispassion of a science. By bringing the methods of science to the questions of
politics, economics aims to make progress on the challenges that all societies face.
I wrote this book with the hope that I could convey some of the excitement about
economics that I felt as a student in my first economics course. Economics is a subject
in which a little knowledge goes a long way. (The same cannot be said, for instance,
of the study of physics or the Chinese language.) Economists have a unique world-
view, much of which can be taught in one or two semesters. My goal in this book
is to transmit this way of thinking to the widest possible audience and to convince
readers that it illuminates much about their lives and the world around them.
I believe that everyone should study the fundamental ideas that economics has
to offer. One purpose of general education is to teach people about the world and
thereby make them better citizens. The study of economics, as much as any disci-
pline, serves this goal. Writing an economics textbook is, therefore, a great honor
and a great responsibility. It is one way that economists can help promote better
government and a more prosperous future. As the great economist Paul Samuelson
put it, “I don’t care who writes a nation’s laws, or crafts its advanced treaties, if I
can write its economics textbooks.”
D uring my 20-year career as a student, the course that excited me most was
What’s New in the Tenth Edition?
Economics aims to understand the world in which we live. Most chapters of this
book include Case Studies that illustrate how the principles of economics can be
applied. In the News boxes offer excerpts from newspapers, magazines, and online
news sources to show how economic ideas shed light on current issues facing soci-
ety. After students finish their first course in economics, they should think about
news reports from a new perspective and with greater insight. To keep the study of
economics fresh and relevant for each new cohort of students, I update each edition
to keep pace with the ever-changing world.
vi Preface: To the Instructor
The new applications in this tenth edition are too numerous to list in their entirety,
but here is a sample of the topics covered (and the chapters in which they appear):
e Shortages during the coronavirus pandemic renewed the debate over
whether it is fair for businesses to increase prices during a crisis. (Chapter 4)
e The future of the ride-share market hinges on the elasticities of supply and
demand. (Chapter 5)
e The minimum wage remains a contentious topic. (Chapter 6)
e Acarbon tax is a versatile tool to combat global climate change. (Chapter 10)
e Putting a price on road use gets renewed attention as the United States
embarks on building new infrastructure. (Chapter 11)
e The pandemic of 2020 taught some lessons about why it’s hard to cut
wasteful medical spending. (Chapter 12)
e The value-added tax might be a policy for the United States to consider.
(Chapter 13)
e The Biden administration looked to expand the scope of antitrust policy.
(Chapter 16)
e Amazon found itself in the crosshairs of antitrust enforcers. (Chapter 18)
e¢ Immigration policy creates winners and losers in the labor market.
(Chapter 19)
e The forgone schooling during the coronavirus pandemic might have long-
lasting effects on earnings. (Chapter 20)
e New research takes a lifetime perspective on measuring inequality. (Chapter 21)
¢ Robust expansions of the social safety net reduced poverty during the coro-
navirus pandemic. (Chapter 21)
¢ People are not good at rationally responding to small-probability events.
(Chapter 23)
e Research has shed light on how the aftermath of the slave trade affects mod-
ern Africa. (Chapter 26)
The four-decade decline in real interest rates is puzzling. (Chapter 27)
Women are generally better investors than men. (Chapter 28)
New research has examined the use of efficiency wages. (Chapter 29)
The recession caused by the coronavirus pandemic was unusual in several
ways. (Chapter 34)
e The monetary and fiscal response during the pandemic caused some economists
to worry about a resurgence in inflation. (Chapter 36)
e The Federal Reserve is asked to expand its set of economic goals. (Chapter 37)
This edition also includes two new chapters. Chapter 12 examines the econom-
ics of healthcare. As this sector’s share of the economy has increased, its distinc-
tive features, problems, and policy challenges have become more important for
students to understand. Chapter 38 is an optional appendix chapter that discusses
how economists use data. In recent years, economic research has grown increas-
ingly empirical, and some instructors want to introduce students to the statistical
methods that economists use. Instructors who teach this chapter can move it earlier
in the course.
As always, I have carefully gone through every chapter to refine the book’s
coverage and pedagogy. There are numerous changes, large and small, to ensure
that the book is clear, accurate, and up-to-date.
All the changes that I made, and the many others that I considered, were evalu-
ated in light of the benefits of brevity. Like most things studied in economics, a
student's time is a scarce resource. I always keep in mind a dictum from the novel-
ist Robertson Davies: “One of the most important things about writing is to boil it
down and not bore the hell out of everybody.”
How Is This Book Organized?
This book is organized to make economics as student-friendly as possible. What
follows is a whirlwind tour, which will, I hope, give instructors some sense of how
the pieces fit together.
Introductory Material
Chapter 1, “Ten Principles of Economics,” introduces students to the economist’s
view of the world. It previews the big ideas that recur in economics, such as oppor-
tunity cost, marginal decision making, the role of incentives, the gains from trade,
and the efficiency of market allocations. Throughout the book, I refer regularly to
the Ten Principles of Economics in Chapter 1 to remind students that these ideas
are the foundation for all economics.
Chapter 2, “Thinking Like an Economist,” examines how economists approach
their subject. It discusses the role of assumptions in developing a theory and intro-
duces the concept of an economic model. It also explores the role of economists in
making policy. This chapter’s appendix offers a brief refresher course on how graphs
are used as well as how they can be abused.
Chapter 3, “Interdependence and the Gains from Trade,” presents the theory of
comparative advantage. This theory explains why individuals trade with their neigh-
bors and why nations trade with other nations. Much of economics is about how
market forces coordinate many individual production and consumption decisions.
As a starting point for this analysis, students see in this chapter why specialization,
interdependence, and trade can benefit everyone.
The Fundamental Tools of Supply and Demand
The next three chapters introduce the basic tools of supply and demand.
Chapter 4,
“The Market Forces of Supply and Demand,” develops the supply curve, the
demand curve, and the notion of market equilibrium. Chapter 5, “Elasticity and
Its Application,” introduces the concept of elasticity and uses it to analyze events
in three different markets.
Chapter 6, “Supply, Demand, and Government Policies,”
uses these tools to examine price controls, such as rent-control and minimum-wage
laws, and tax incidence.
Chapter 7, “Consumers, Producers, and the Efficiency of Markets,” extends the
analysis of supply and demand using the concepts of consumer surplus and pro-
ducer surplus. It begins by developing the link between consumers’ willingness to
pay and the demand curve and the link between producers’ costs of production
and the supply curve. It then shows that the market equilibrium maximizes the
sum of the producer and consumer surplus. Thus, students learn early about the
efficiency of market allocations.
The next two chapters apply the concepts of producer and consumer surplus
to policy questions.
Chapter 8, “Application: The Costs of Taxation,” shows
why taxation results in deadweight losses and what determines the size of those
losses. Chapter 9, “Application: International Trade,” considers who wins and
who loses from international trade and presents the debate over protectionist
trade policies.
Preface: To the Instructor
vii
viii
Preface: To the Instructor
More Microeconomics
Having examined why market allocations are often desirable, the book then considers
how the government can sometimes improve on them.
Chapter 10, “Externalities,”
explains how external effects such as pollution can render market outcomes inef-
ficient and discusses the possible public and private solutions to those inefficien-
cies.
Chapter 11, “Public Goods and Common Resources,” considers the problems
that arise when goods, such as national defense, have no market price.
Chapter 12,
“The Economics of Healthcare,” examines the distinctive features, problems, and
policy challenges of an increasingly important sector of the economy.
Chapter 13,
“The Design of the Tax System,” describes how the government raises the revenue
necessary to pay for public goods. It presents some institutional background about
the U.S. tax system and then discusses how the goals of efficiency and equity come
into play when designing a tax system.
The next five chapters examine firm behavior and industrial organization.
Chapter 14, “The Costs of Production,” discusses what to include in a firm’s
costs, and it introduces cost curves. Chapter 15, “Firms in Competitive Markets,”
analyzes the behavior of price-taking firms and derives the market supply curve.
Chapter 16, “Monopoly,” discusses the behavior of a firm that is the sole seller in
its market. It examines the inefficiency of monopoly pricing, the possible policy
responses, and the attempts by monopolies to price discriminate.
Chapter 17,
“Monopolistic Competition,” looks at behavior in a market in which many sell-
ers offer similar but differentiated products. It also discusses the debate over the
effects of advertising.
Chapter 18, “Oligopoly,” covers markets in which there
are only a few sellers, using the prisoners’ dilemma as the model for examining
strategic interaction.
The next three chapters present issues related to labor markets.
Chapter 19, “The
Markets for the Factors of Production,” emphasizes the link between factor prices
and marginal productivity.
Chapter 20, “Earnings and Discrimination,” discusses the
determinants of equilibrium wages, including compensating differentials, human
capital, and discrimination.
Chapter 21, “Income Inequality and Poverty,” examines
the degree of inequality in U.S. society, alternative views about the government's
role in changing the distribution of income, and various policies aimed at helping
members of society experiencing poverty.
The next two chapters present optional material. Chapter 22, “The Theory
of Consumer Choice,” analyzes individual decision making using budget con-
straints and indifference curves. Chapter 23, “Frontiers of Microeconomics,”
introduces the topics of asymmetric information, political economy, and behav-
ioral economics. Some instructors may skip all or some of this material, but these
chapters are useful in motivating and preparing students for future courses in
microeconomics. Instructors who cover these topics may assign these chapters
earlier than they are presented in the book, and I have written them to facilitate
this flexibility.
Macroeconomics
My overall approach to teaching macroeconomics is to examine the economy in the
long run (when prices are flexible) before examining the economy in the short run
(when prices are sticky). I believe that this organization simplifies learning macroeco-
nomics for several reasons. First, the classical assumption of price flexibility is more
closely linked to the basic lessons of supply and demand, which students have already
mastered. Second, the classical dichotomy allows the study of the long run to be broken
up into several easily digested pieces. Third, because the business cycle represents a
transitory deviation from the economy’s long-run growth path, studying the transitory
deviations is more natural after the long-run equilibrium is understood. Fourth, the
macroeconomic theory of the long run is less controversial among economists than
is the macroeconomic theory of the short run. For these reasons, most upper-level
courses in macroeconomics now follow this long-run-before-short-run approach; my
goal is to offer introductory students the same advantage.
I start the coverage of macroeconomics with issues of measurement. Chapter 24,
“Measuring a Nation’s Income,” discusses the meaning of gross domestic product
and related statistics from the national income accounts. Chapter 25, “Measuring the
Cost of Living,” examines the measurement and use of the consumer price index.
The next four chapters describe the behavior of the real economy in the long
run. Chapter 26, “Production and Growth,” examines the determinants of the large
variation in living standards over time and across countries. Chapter 27, “Saving,
Investment, and the Financial System,” discusses the types of financial institutions
in our economy and examines their role in allocating resources. Chapter 28, “The
Basic Tools of Finance,” introduces present value, risk management, and asset pric-
ing. Chapter 29, “Unemployment,” considers the long-run determinants of the
unemployment rate, including job search, minimum-wage laws, the market power
of unions, and efficiency wages.
Having described the long-run behavior of the real economy, the book then
turns to the long-run behavior of money and prices. Chapter 30, “The Monetary
System,” introduces the economist’s concept of money and the role of the cen-
tral bank in controlling the quantity of money. Chapter 31, “Money Growth and
Inflation,” develops the classical theory of inflation and discusses the costs that
inflation imposes on a society.
The next two chapters present the macroeconomics of open economies, maintain-
ing the long-run assumptions of price flexibility and full employment. Chapter 32,
“Open-Economy Macroeconomics: Basic Concepts,” explains the relationship among
saving, investment, and the trade balance, the distinction between the nominal
and real exchange rate, and the theory of purchasing-power parity. Chapter 33, “A
Macroeconomic Theory of the Open Economy,” presents a classical model of the
international flow of goods and capital. The model sheds light on various issues,
including the link between budget deficits and trade deficits and the macroeconomic
effects of trade policies. Because instructors differ in their emphasis on this material,
these chapters are written so they can be used in different ways. Some may choose
to cover Chapter 32 but not Chapter 33, others may skip both chapters, and still
others may choose to defer the analysis of open-economy macroeconomics until
the end of their courses.
After developing the long-run theory of the economy in Chapters 26 through
33, the book turns to explaining short-run fluctuations around the long-run trend.
Chapter 34, “Aggregate Demand and Aggregate Supply,” begins with some facts about
the business cycle and then introduces the model of aggregate demand and aggre-
gate supply. Chapter 35, “The Influence of Monetary and Fiscal Policy on Aggregate
Demand,” explains how policymakers can use the tools at their disposal to shift the
aggregate-demand curve. Chapter 36, “The Short-Run Trade-Off between Inflation
and Unemployment,” explains why policymakers who control aggregate demand
face a trade-off between inflation and unemployment. It examines why this trade-off
exists in the short run, why it shifts over time, and why it does not exist in the long run.
The discussion of macroeconomics concludes with Chapter 37, “Six Debates
over Macroeconomic Policy.” This capstone chapter considers six controversial
issues facing policymakers: the proper degree of policy activism in response to the
Preface: To the Instructor
ix
x
Preface: To the Instructor
business cycle, the relative efficacy of government spending hikes and tax cuts to
fight recessions, the choice between rules and discretion in the conduct of monetary
policy, the desirability of reaching zero inflation, the importance of balancing the
government's budget, and the need for tax reform to encourage saving. For each
issue, the chapter presents both sides of the debate and encourages students to
make their own judgments.
The final chapter in the book is Chapter 38, “Appendix: How Economists Use
Data.” This chapter introduces students to the statistical methods that economists
use to test and apply their theories. Instructors who teach it may choose to move
it earlier in the course.
Learning Tools
The purpose of this book is to help students learn the fundamental lessons of eco-
nomics and to show how they can apply these lessons to their lives and the world
in which they live. Toward that end, I have used various learning tools that recur
throughout the book.
Case Studies
Economic theory is useful and interesting only if it can be applied to understanding
actual events and policies. This book, therefore, contains numerous case studies that
apply the theory that has just been developed.
In the News Boxes
One benefit that students gain from studying economics is a new perspective and
greater understanding of news from around the world. To highlight this benefit, Ihave
included excerpts from many newspaper and magazine articles, some of which are
opinion columns written by prominent economists. These articles, together with my
brief introductions, show how basic economic theory can be applied. Most of these
boxes are new to this edition. Each news article ends with “Questions to Discuss,”
which can be used to start a dialogue in the classroom.
FYI Boxes
These boxes provide additional material “for your information.” Some of them offer
a glimpse into the history of economic thought. Others clarify technical issues. Still
others discuss supplementary topics that instructors might choose to either discuss
or skip in their lectures.
Ask the Experts Boxes
This feature summarizes results from the IGM Economic Experts Panel, an ongo-
ing survey of several dozen prominent economists. Every few weeks, these
experts are offered a statement and then asked whether they agree with it,
disagree with it, or are uncertain about it. The survey results appear in the
chapters near the coverage of the relevant topic. They give students a sense of
when economists are united, when they are divided, and when they just don’t
know what to think.
Definitions of Key Concepts
When key concepts are introduced in the chapter, they are presented in blue type-
face. In addition, their definitions are placed in the margins. This treatment should
aid students in learning and reviewing the material.
Quick Quizzes
After each major section in a chapter, students are offered a brief multiple-choice
Quick Quiz to check their comprehension of what they have just learned. If students
cannot readily answer these quizzes, they should stop and review the material before
continuing. The answers to all Quick Quizzes are available at the end of each chapter.
Chapter in a Nutshell
Each chapter concludes with a brief summary that reminds students of the most
important lessons they have learned. Later in their study, it offers an efficient way
to review for exams.
List of Key Concepts
A list of key concepts at the end of each chapter offers students a way to test their
understanding of the new terms that have been introduced. Page references are
included, so students can review the terms they do not understand.
Questions for Review
Located at the end of each chapter, questions for review cover the chapter’s pri-
mary lessons. Students can use these questions to check their comprehension and
prepare for exams.
Problems and Applications
Each chapter also contains a variety of problems and applications that ask students to
apply the material they have learned. Some instructors may use these questions for home-
work assignments. Others may use them as a starting point for classroom discussions.
Alternative Versions of the Book
The book you are now holding is one of five versions of this text that are available
for introducing students to economics. Cengage and I offer this menu of books
because instructors differ in how much time they have and what topics they choose
to cover. Here is a brief description of each:
e Principles of Economics. This complete version of the book contains all 38
chapters. It is designed for two-semester introductory courses that cover both
microeconomics and macroeconomics.
e Principles of Microeconomics. This version contains 24 chapters and is designed
for one-semester courses in introductory microeconomics.
e Principles of Macroeconomics. This version contains 24 chapters and is
designed for one-semester courses in introductory macroeconomics. It con-
tains a full development of the theory of supply and demand.
e Brief Principles of Macroeconomics. This shortened macro version of 19 chapters
contains only one chapter on the basics of supply and demand. It is designed for
instructors who want to jump to the core topics of macroeconomics more quickly.
e Essentials of Economics. This version of the book contains 24 chapters. It is
designed for one-semester survey courses that cover the basics of both micro-
economics and macroeconomics.
Table 1 shows which chapters are included in each book. Instructors who want more
information about these alternative versions should contact their local Cengage
representative.
Preface: To the Instructor
xi
xii Preface: To the Instructor
Table 1
The Five Versions of This Book
Principles of | Principles of Principles of elt Essentials of
Principles of
é Economics
Macroeconomics
Economics Microeconomics Macroeconomics
Ten Principles of Economics 1 il 1 il il
Thinking Like an Economist 2 2 2 2 2
Interdependence and the Gains from Trade 3 3 3 3 3}
The Market Forces of Supply and Demand 4 4 4 4 4
Elasticity and Its Application 5 5 5) 5
Supply, Demand, and Government Policies 6 6 6 6
Consumers, Producers, and the Efficiency of Markets 7 I I 7
Application: The Costs of Taxation 8 8 8 8
Application: International Trade 9 9 ) 9
Externalities 0) 0) 10
Public Goods and Common Resources 1 11 ill
The Economics of Healthcare 2 12
The Design of the Tax System 3} 13
The Costs of Production 4 4 12
Firms in Competitive Markets 5) 15 ils)
Monopoly 6 16 14
Monopolistic Competition 7 17
Oligopoly 8 8
The Markets for the Factors of Production ©) 19
Earnings and Discrimination 20 20
Income Inequality and Poverty 21 21
The Theory of Consumer Choice 22 22
Frontiers of Microeconomics 23 28
Measuring a Nation’s Income 24 10 5 15
Measuring the Cost of Living 25 ill 6 16
Production and Growth 26 12 7 17
Saving, Investment, and the Financial System 2] 18} 8 18
The Basic Tools of Finance 28 4 9 19
Unemployment 29 15 10 20
The Monetary System 30 16 11 21
Money Growth and Inflation 31 17 12 ED
Open-Economy Macroeconomics: Basic Concepts 32 18 13
A Macroeconomic Theory of the Open Economy 33 19 14
Aggregate Demand and Aggregate Supply 34 20 15 23
The Influence of Monetary and Fiscal Policy on Aggregate Demand 85 21 16 24
The Short-Run Trade-off between Inflation and Unemployment 36 22 17
Six Debates over Macroeconomic Policy 37 BS 18
Appendix: How Economists Use Data 38 24 24 19
Supplements
Cengage offers various supplements for instructors and students who use this book.
These resources make teaching the principles of economics easy for the instructor
and learning them easy for the student. David R. Hakes of the University of Northern
Iowa, a dedicated teacher and economist, supervised the development of the supple-
ments for this edition. A complete list of available supplements follows this Preface.
Optional Online Chapter on the Keynesian Cross
Ihave written a brief chapter on the Keynesian Cross (sometimes called the income-
expenditure model) that complements the material on aggregate demand and aggre-
gate supply. Instructors who want to teach this model can add this chapter to their
students’ e-books for no additional cost.
Translations and Adaptations
I am delighted that versions of this book are (or will soon be) available in many of
the world’s languages. Currently scheduled translations include Azeri, Chinese (in
both standard and simplified characters), Croatian, Czech, Dutch, French, Georgian,
German, Greek, Indonesian, Italian, Japanese, Korean, Macedonian, Montenegrin,
Portuguese, Romanian, Russian, Serbian, and Spanish. In addition, adaptations of
the book for Australian, Canadian, European, and New Zealand students are also
available. Instructors who would like more information about these books should
contact Cengage.
Acknowledgments
In writing this book, I benefited from the input of many talented people. Indeed,
the list of people who have contributed to this project is so long, and their con-
tributions so valuable, that it seems an injustice that only a single name appears
on the cover.
Let me begin with my colleagues in the economics profession. The many editions
of this text and its supplemental materials have benefited enormously from their
input. In reviews and surveys, they have offered suggestions, identified challenges,
and shared ideas from their own classroom experience. I am indebted to them for
the perspectives they have brought to the text. Unfortunately, the list has become
too long to thank those who contributed to previous editions, even though students
reading the current edition are still benefiting from their insights.
Most important in this process has been David Hakes (University of Northern
Iowa). David has served as a reliable sounding board for ideas and a hardworking
partner with me in putting together the superb package of supplements.
A special thanks to my friend Jeff Sommer. For many years, Jeff was my edi-
tor at the New York Times. For this edition, he graciously read through the entire
book, offering numerous suggestions for improvement. I am deeply grateful for
his input.
The publishing team who worked on the book improved it tremendously. Jane Tufts,
developmental editor, provided truly spectacular editing—as she always does. Joe
Sabatino, economics Product Director, and Christopher Rader, Senior Product Manager,
Preface: To the Instructor
xiii
xiv
Preface: To the Instructor
did a splendid job of overseeing the many people involved in such a large project.
Colleen Farmer, Allison Janneck, and Anita Verma, Senior Content Managers, were
crucial in managing the whole project and putting together an excellent team to revise
the supplements and, with Pradhiba Kannaiyan, project manager at MPS Limited, had
the patience and dedication necessary to turn my manuscript into this book. Erin Griffin,
Senior Designer, gave this book its clean, friendly look and designed the wonderful
cover. Tiffany Lee, copyeditor, refined my prose, and Vikas Makkar, indexer, prepared
a careful and thorough index. John Carey, Executive Marketing Manager, worked long
hours getting the word out to potential users of this book. The rest of the Cengage team
has, as always, been consistently professional, enthusiastic, and dedicated.
We have a top team of veterans who have worked across multiple editions produc-
ing the supplements that accompany this book. Working with those at Cengage, the
following have been relentless in making sure that the suite of ancillary materials
is unmatched in both quantity and quality. No other text comes close.
PowerPoint: Andreea Chiritescu (Eastern Illinois University)
Test Bank: Shannon Aucoin, Eugenia Belova, and Alex Lewis (in-house Subject
Matter Experts)
Instructor manual: David Hakes (University of Northern Iowa)
I am also grateful to Sarah Lao and Nathan Sun, two star undergraduates at
Harvard, who helped me check the page proofs for this edition.
As always, I must thank my “in-house” editor Deborah Mankiw. As the first
reader of most things I write, she continued to offer just the right mix of criticism
and encouragement.
Finally, [should mention my three children, Catherine, Nicholas, and Peter. Their
contribution to this book was putting up with a father spending too many hours in
his study. The four of us have much in common—not least of which is our love of
ice cream (which becomes apparent in Chapter 4).
N. Gregory Mankiw
May 2022
Brief Contents
Part! Introduction 1
1 Ten Principles of Economics 1
2 Thinking Like an Economist 17
3 Interdependence and the Gains from Trade 45
Part Il How Markets Work 61
4 The Market Forces of Supply and Demand 61
5 Elasticity and Its Application 87
6 Supply, Demand, and Government Policies 111
Part Ill Markets and Welfare 133
7 Consumers, Producers, and the Efficiency of
Markets 133
8 Application: The Costs of Taxation 153
9 Application: International Trade 169
Part IV The Economics of the Public Sector 189
10 Externalities 189
11 Public Goods and Common Resources 211
12 The Economics of Healthcare 227
13 The Design of the Tax System 247
Part V Firm Behavior and the Organization
of Industry 267
14 The Costs of Production 267
15 Firms in Competitive Markets 287
16 Monopoly 311
17 Monopolistic Competition 341
18 Oligopoly 359
Part VI The Economics of Labor Markets 381
19 The Markets for the Factors of Production 381
20 Earnings and Discrimination 403
21 Income Inequality and Poverty 421
Part VII Topics for Further Study 443
22 The Theory of Consumer Choice 443
23 Frontiers of Microeconomics 471
Part VIII The Data of Macroeconomics 491
24 Measuring a Nation’s Income 491
25 Measuring the Cost of Living 511
Part IX The Real Economy in the Long Run 529
26 Production and Growth 529
27 Saving, Investment, and the Financial System 553
28 The Basic Tools of Finance 575
29 Unemployment 591
Part X Money and Prices in the Long Run 615
30 The Monetary System 615
31 Money Growth and Inflation 639
Part XI The Macroeconomics of
Open Economies 665
32 Open-Economy Macroeconomics:
Basic Concepts 665
33 A Macroeconomic Theory of the
Open Economy 687
Part XII Short-Run Economic Fluctuations 709
34 Aggregate Demand and Aggregate Supply 709
35 The Influence of Monetary and Fiscal Policy
on Aggregate Demand 747
36 The Short-Run Trade-Off between Inflation and
Unemployment 771
Part XIIl Final Thoughts 797
37 Six Debates over Macroeconomic Policy 797
38 Appendix: How Economists Use Data 819
XV
Contents
Preface: To the Instructor v
Preface: To the Student xxix
Part | 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
xvi
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
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 Il 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
Contents
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
xvii
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
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
100
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 Ill 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
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
Externalities
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
Contents = xix
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: CadillacTax 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
15-2¢ 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
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
Contents = xxi
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
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
19
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
ina 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
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
24-29”... 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
Contents = xxiii
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
aY 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
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
31-1fVelocity 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
31-2¢ 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
Contents
Part Xl 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
1c The Equality of Net Exports and
Net Capital Outflow 669
32-1d Saving, Investment, and Their Relationship
o 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
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
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 XIll 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
Contents xxvii
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
Preface: To
the Student
wrote Alfred Marshall, the great 19th-century economist, in his textbook,
Principles of Economics. Knowledge about the economy has advanced
substantially since Marshall’s time, but this definition of economics is as true
today as it was in 1890, when the first edition of his text was published.
Why should you, as a student in the 21st century, embark on the study of eco-
nomics? There are three reasons.
The first reason to study economics is that it will help you understand the world
in which you live. Many questions about the economy might spark your curiosity.
Why are apartments so hard to find in New York City? Why do airlines charge less
for a round-trip ticket if the traveler stays over a Saturday night? Why is Scarlett
Johansson paid so much to perform in movies? Why are living standards so meager
in many African countries? Why do some countries have high rates of inflation while
others have stable prices? Why are jobs easy to find in some years and hard to find
in others? These are just a few of the questions that a course or two in economics
will help you answer.
The second reason to study economics is that it will make you a more astute par-
ticipant in the economy. Throughout your life, you'll make many economic decisions.
As a student, you decide how many years to remain in school. Once you take a job,
you'll decide how much of your income to spend, how much to save, and how to
invest your savings. Someday you may find yourself running a small business or a
large corporation, and you will decide how many workers to hire and what prices
to charge for your products. Studying economics will give you a new perspective
on how best to make these decisions. The insights explored in the coming chapters
will not, by themselves, make you rich, but they may help in that endeavor.
The third reason to study economics is that it will help you understand the poten-
tial and limits of economic policy. Economic questions are always on the minds of
policymakers in mayors’ offices, governors’ mansions, and the White House. What
are the burdens of alternative forms of taxation? What are the effects of free trade
with other countries? What is the best way to protect the environment? How does
a government budget deficit affect growth? As a voter, you help choose the policies
that guide the allocation of society’s resources. An understanding of economics will
help you carry out that responsibility. And who knows: Someday, you may end up
as one of those policymakers yourself.
The principles of economics can be applied in many of life’s situations. Whether
the future finds you following the news, running a business, or sitting in the Oval
Office, you will be glad that you studied economics.
4A cen is a study of mankind in the ordinary business of life.” So
N. Gregory Mankiw
May 2022
Xxix
Whe word economy comes from the Greek word oikonomos,
| which means “one who manages a household.” At first, the
H connection between households and economies may seem
obscure. But in fact, they have much in common.
No matter how you picture a modern household, its members
face endless decisions. Somehow, they must decide which members
1 1 do which tasks and what each receives in return. Who cooks din-
Ten Principles ner? Who gets some extra dessert? Who cleans the bathroom? Who
': gets to drive the car? Whether a household’s income is high, low,
of Economics or somewhere in between, its resources (time, dessert, car mileage)
must be allocated among alternative uses.
Like a household, a society faces countless decisions. It must
find some way to decide what jobs will be done and who will do
them. Society needs people to grow food, make clothing, and design
software. Once society has allocated people (as well as land, build-
ings, and machines) to various jobs, it must distribute the goods
and services they produce. It must decide who will eat potatoes
and who will eat caviar, who will live in a grand manor and who
will live in a fifth-floor walk-up.
==
Part | Introduction
scarcity
the limited nature of
society’s resources
economics
the study of how society
manages its scarce
resources
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