Brief Contents. An Introduction to Demand and Supply 48. Money, Banking, and Monetary Policy 671. Macroeconomic Problems and Policies 762

Transcription

1 Brief Contents PART 1 What Is Economics? 1 Chapter 1 Economic Issues and Concepts 1 Chapter 2 Economic Theories, Data, and Graphs 24 PART 2 An Introduction to Demand and Supply 48 Chapter 3 Demand, Supply, and Price 48 Chapter 4 Elasticity 75 Chapter 5 Markets in Action 98 PART 3 Consumers and Producers 120 Chapter 6 Consumer Behaviour 120 Chapter 7 Producers in the Short Run 149 Chapter 8 Producers in the Long Run 174 PART 4 Market Structure and Efficiency 197 Chapter 9 Competitive Markets 197 Chapter 10 Monopoly, Cartels, and Price Discrimination 225 Chapter 11 Imperfect Competition and Strategic Behaviour 251 Chapter 12 Economic Efficiency and Public Policy 279 PART 5 Factor Markets 305 Chapter 13 How Factor Markets Work 305 Chapter 14 Labour Markets 333 Chapter 15 Interest Rates and the Capital Market 357 PART 6 Government in the Market Economy 383 Chapter 16 Market Failures and Government Intervention 383 Chapter 17 The Economics of Environmental Protection 417 Chapter 18 Taxation and Public Expenditure 446 PART 8 The Economy in the Short Run 518 Chapter 21 The Simplest Short-Run Macro Model 518 Chapter 22 Adding Government and Trade to the Simple Macro Model 546 Chapter 23 Output and Prices in the Short Run 569 PART 9 The Economy in the Long Run 591 Chapter 24 From the Short Run to the Long Run: The Adjustment of Factor Prices 591 Chapter 25 The Difference Between Short-Run and Long-Run Macroeconomics 622 Chapter 26 Long-Run Economic Growth 637 PART 10 Money, Banking, and Monetary Policy 671 Chapter 27 Money and Banking 671 Chapter 28 Money, Interest Rates, and Economic Activity 700 Chapter 29 Monetary Policy in Canada 728 PART 11 Macroeconomic Problems and Policies 762 Chapter 30 Inflation and Disinflation 762 Chapter 31 Unemployment Fluctuations and the NAIRU 790 Chapter 32 Government Debt and Deficits 818 PART 12 Canada in the Global Economy 842 Chapter 33 The Gains from International Trade 842 Chapter 34 Trade Policy 867 Chapter 35 Exchange Rates and the Balance of Payments 892 MYECONLAB CHAPTER 931 Chapter 36W Challenges Facing the Developing Countries 931 PART 7 Chapter 19 Chapter 20 An Introduction to Macroeconomics 474 What Macroeconomics Is All About 474 The Measurement of National Income 497 Mathematical Notes M-1 Photo Credits P-1 Timeline of Great Economists T-1 Index I-1

2 Contents To the Instructor To the Student Features of This Edition Supplements Acknowledgments xix xxvii xxviii xxx xxxii PART 1 What Is Economics? 1 Chapter 1 Economic Issues and Concepts The Complexity of the Modern Economy 2 The Self-Organizing Economy 2 Efficient Organization 3 Main Characteristics of Market Economies Scarcity, Choice, and Opportunity Cost 4 Resources 4 Scarcity and Choice 4 Four Key Economic Problems Who Makes the Choices and How? 10 The Flow of Income and Expenditure 10 The Complexity of Production 11 Markets and Money 12 Globalization Is There an Alternative to the Market Economy? 15 Types of Economic Systems 15 The Great Debate 16 Government in the Modern Mixed Economy 19 Summary 20 Key Concepts 21 Study Exercises 21 Discussion Questions 23 Chapter 2 Economic Theories, Data, and Graphs Positive and Normative Advice 25 Disagreements Among Economists Economic Theories 27 Theories 27 Models Testing Theories 29 Rejection Versus Confirmation 30 Statistical Analysis 31 Correlation Versus Causation Economic Data 32 Index Numbers 32 Graphing Economic Data Graphing Economic Theories 37 Functions 38 Graphing Functional Relations 39 A Final Word 43 Summary 44 Key Concepts 45 Study Exercises 45 Discussion Questions 47 PART 2 An Introduction to Demand and Supply 48 Chapter 3 Demand, Supply, and Price Demand 49 Quantity Demanded 49 Quantity Demanded and Price 51 Demand Schedules and Demand Curves Supply 57 Quantity Supplied 57 Quantity Supplied and Price 58 Supply Schedules and Supply Curves The Determination of Price 62 The Concept of a Market 62 Graphical Analysis of a Market 62 Changes in Market Prices 64 Relative Prices and Inflation 68 Summary 70 Key Concepts 71 Study Exercises 71 Discussion Questions 74 Chapter 4 Elasticity Price Elasticity of Demand 76 The Measurement of Price Elasticity 77 What Determines Elasticity of Demand? 81 Elasticity and Total Expenditure Price Elasticity of Supply 84 Determinants of Supply Elasticity An Important Example Where Elasticity Matters Other Demand Elasticities 91 Income Elasticity of Demand 91 Cross Elasticity of Demand 93 Summary 94 Key Concepts 95 Study Exercises 95 Discussion Questions 97

3 CONTENTS vii Chapter 5 Markets in Action The Interaction Among Markets Government-Controlled Prices 100 Disequilibrium Prices 101 Price Floors 101 Price Ceilings Rent Controls: A Case Study of Price Ceilings 105 The Predicted Effects of Rent Controls 106 Who Gains and Who Loses? 107 Policy Alternatives An Introduction to Market Efficiency 109 Demand as Value and Supply as Cost 109 Economic Surplus and Market Efficiency 111 Market Efficiency and Price Controls 112 One Final Application: Output Quotas 114 A Cautionary Word 115 Summary 116 Key Concepts 117 Study Exercises 117 Discussion Questions 119 PART 3 Consumers and Producers 120 Chapter 6 Consumer Behaviour Marginal Utility and Consumer Choice 121 Diminishing Marginal Utility 121 Utility Schedules and Graphs 122 Maximizing Utility 123 The Consumer s Demand Curve Income and Substitution Effects of Price Changes 126 The Substitution Effect 127 The Income Effect 127 The Slope of the Demand Curve 128 An Interesting Application to Taxation Consumer Surplus 131 The Concept 131 The Paradox of Value 133 Summary 135 Key Concepts 136 Study Exercises 136 Discussion Questions 138 Appendix to Chapter 6 Indifference Curves 139 6A.1 Indifference Curves 139 Diminishing Marginal Rate of Substitution 140 The Indifference Map 141 6A.2 The Budget Line 141 Properties of the Budget Line 142 The Slope of the Budget Line 142 6A.3 The Consumer s Utility-Maximizing Choices 143 The Consumer s Reaction to a Change in Income 144 The Consumer s Reaction to a Change in Price 144 6A.4 Deriving the Demand Curve 144 Income and Substitution Effects 146 Study Exercises 147 Chapter 7 Producers in the Short Run What Are Firms? 150 Organization of Firms 150 Financing of Firms 151 Goals of Firms Production, Costs, and Profits 154 Production 154 Costs and Profits 154 Profit-Maximizing Output 157 Time Horizons for Decision Making Production in the Short Run 158 Total, Average, and Marginal Products 159 Diminishing Marginal Product 160 The Average Marginal Relationship Costs in the Short Run 163 Defining Short-Run Costs 163 Short-Run Cost Curves 164 Capacity 167 Shifts in Short-Run Cost Curves 168 Summary 169 Key Concepts 170 Study Exercises 170 Discussion Questions 173 Chapter 8 Producers in the Long Run The Long Run: No Fixed Factors 175 Profit Maximization and Cost Minimization 175 Long-Run Cost Curves 178 Shifts in LRAC Curves The Very Long Run: Changes in Technology 182 Technological Change 183 Firms Choices in the Very Long Run 186 Summary 188 Key Concepts 188 Study Exercises 189 Discussion Questions 191 Appendix to Chapter 8 Isoquant Analysis 192

4 viii CONTENTS 8A.1 Isoquants 192 An Isoquant Map 193 8A.2 Cost Minimization 194 The Principle of Substitution 195 PART 4 Market Structure and Efficiency 197 Chapter 9 Competitive Markets Market Structure and Firm Behaviour 198 Competitive Market Structure 198 Competitive Behaviour 198 The Significance of Market Structure The Theory of Perfect Competition 199 The Assumptions of Perfect Competition 199 The Demand Curve for a Perfectly Competitive Firm 200 Total, Average, and Marginal Revenue Short-Run Decisions 203 Should the Firm Produce at All? 203 How Much Should the Firm Produce? 205 Short-Run Supply Curves 206 Short-Run Equilibrium in a Competitive Market Long-Run Decisions 212 Entry and Exit 212 Long-Run Equilibrium 215 Changes in Technology 217 Declining Industries 219 Summary 220 Key Concepts 221 Study Exercises 221 Discussion Questions 224 Chapter 10 Monopoly, Cartels, and Price Discrimination A Single-Price Monopolist 226 Revenue Concepts for a Monopolist 226 Short-Run Profit Maximization 228 Entry Barriers and Long-Run Equilibrium 231 The Very Long Run and Creative Destruction Cartels as Monopolies 235 The Effects of Cartelization 236 Problems That Cartels Face Price Discrimination 239 When Is Price Discrimination Possible? 240 Different Forms of Price Discrimination 240 The Consequences of Price Discrimination 245 Summary 246 Key Concepts 247 Study Exercises 247 Discussion Questions 250 Chapter 11 Imperfect Competition and Strategic Behaviour The Structure of the Canadian Economy 252 Industries with Many Small Firms 252 Industries with a Few Large Firms 252 Industrial Concentration What Is Imperfect Competition? 254 Firms Choose Their Products 255 Firms Choose Their Prices 255 Non-price Competition 256 Two Market Structures Monopolistic Competition 257 The Assumptions of Monopolistic Competition 257 Predictions of the Theory 258 Empirical Relevance of Monopolistic Competition Oligopoly and Game Theory 261 The Basic Dilemma of Oligopoly 261 Some Simple Game Theory Oligopoly in Practice 265 Types of Cooperative Behaviour 265 Types of Competitive Behaviour 266 The Importance of Entry Barriers 267 Oligopoly and the Economy 272 Summary 273 Key Concepts 275 Study Exercises 275 Discussion Questions 278 Chapter 12 Economic Efficiency and Public Policy Productive and Allocative Efficiency 280 Productive Efficiency 281 Allocative Efficiency 282 Which Market Structures Are Efficient? 285 Allocative Efficiency and Total Surplus 287 Allocative Efficiency and Market Failure Economic Regulation to Promote Efficiency 291 Regulation of Natural Monopolies 292 Regulation of Oligopolies 295 Financial Crisis and Recession Canadian Competition Policy 298 The Evolution of Canadian Policy 299 Current Reforms 299 Summary 300 Key Concepts 301 Study Exercises 301 Discussion Questions 304

5 CONTENTS ix PART 5 Factor Markets 305 Chapter 13 How Factor Markets Work Income Distribution 306 A Glimpse of the Theory Ahead The Demand for Factors 308 The Firm s Marginal Decision on Factor Use 308 The Firm s Demand Curve for a Factor 310 Elasticity of Factor Demand 311 The Market Demand Curve for a Factor 313 Shifts of the Market Factor Demand Curve The Supply of Factors 314 The Supply of Factors to the Economy 315 The Supply of Factors to a Particular Industry 316 The Supply of Factors to a Particular Firm The Operation of Factor Markets 319 Differentials in Factor Prices 320 Policies to Promote Pay Equity 323 Economic Rent 324 A Final Word 328 Summary 328 Key Concepts 329 Study Exercises 330 Discussion Questions 332 Chapter 14 Labour Markets Wage Differentials 334 Wage Differentials in Competitive Markets 334 Wage Differentials in Non-competitive Markets 339 Legislated Minimum Wages Labour Unions 345 Collective Bargaining 345 Unanswered Questions The Good Jobs Bad Jobs Debate 349 Six Observations 350 A Mixed Blessing? 352 Summary 352 Key Concepts 353 Study Exercises 353 Discussion Questions 356 Chapter 15 Interest Rates and the Capital Market A Brief Overview of the Capital Market Present Value 360 The Present Value of a Single Future Payment 360 The Present Value of a Stream of Future Payments 362 Conclusions Investment Demand 364 The Firm s Demand for Capital 364 The Economy s Demand for Investment The Supply of Saving 368 Saving and Current Income 369 Saving and Expected Future Income 369 Saving and the Interest Rate 370 The Economy s Supply of Saving Investment, Saving, and the Interest Rate 371 Changes in the Capital-Market Equilibrium 373 Summary 378 Key Concepts 379 Study Exercises 379 Discussion Questions 381 PART 6 Chapter 16 Government in the Market Economy 383 Market Failures and Government Intervention Basic Functions of Government The Case for Free Markets 386 Automatic Coordination 386 Innovation and Growth 387 Decentralization of Power Market Failures 389 Market Power 389 Externalities 390 Non-rivalrous and Non-excludable Goods 392 Asymmetric Information 396 Summary Broader Social Goals 399 Income Distribution 400 Preferences for Public Provision 400 Protecting Individuals from Others 402 Paternalism 402 Social Responsibility 402 Economic Growth 403 A General Principle Government Intervention 404 The Tools of Government Intervention 404 The Costs of Government Intervention 405 Government Failure 407 How Much Should Government Intervene? 411 Summary 412 Key Concepts 414

6 x CONTENTS Study Exercises 414 Discussion Questions 416 PART 7 An Introduction to Macroeconomics 474 Chapter 17 The Economics of Environmental Protection The Economic Rationale for Regulating Pollution 418 Pollution as an Externality 418 The Optimal Amount of Pollution Abatement Pollution-Control Policies 421 Direct Controls 421 Emissions Taxes 423 Problems with Emissions Taxes 424 Tradable Pollution Permits: Cap and Trade 424 Uncertainty and the Choice Between Emissions Taxes and Cap and Trade The Economic Challenge of Global Climate Change 429 The Basics About Greenhouse-Gas Emissions 430 The Case for Global Collective Action 431 Energy Use, GDP, and Greenhouse-Gas Emissions 433 Significant Policy Challenges 436 Summary 439 Summary 442 Key Concepts 442 Study Exercises 443 Discussion Questions 445 Chapter 18 Taxation and Public Expenditure Taxation in Canada 447 Progressive Taxes 447 The Canadian Tax System Evaluating the Tax System 452 Taxation and Equity 452 Taxation and Efficiency Public Expenditure in Canada 457 Canadian Fiscal Federalism 458 Canadian Social Programs Evaluating the Role of Government 467 Public Versus Private Sector 468 Scope of Government Activity 468 Evolution of Policy 469 Summary 469 Key Concepts 470 Study Exercises 471 Discussion Questions 473 Chapter 19 What Macroeconomics Is All About Key Macroeconomic Variables 476 Output and Income 476 Employment, Unemployment, and the Labour Force 480 Productivity 483 Inflation and the Price Level 484 Interest Rates 487 The International Economy Growth Versus Fluctuations 491 Long-Term Economic Growth 492 Short-Term Fluctuations 493 What Lies Ahead? 493 Summary 494 Key Concepts 494 Study Exercises 494 Discussion Questions 496 Chapter 20 The Measurement of National Income National Output and Value Added National Income Accounting: The Basics 500 GDP from the Expenditure Side 501 GDP from the Income Side National Income Accounting: Some Further Issues 507 GDP and GNP 507 Real and Nominal GDP 509 Omissions from GDP 510 GDP and Living Standards 513 Summary 514 Key Concepts 515 Study Exercises 515 Discussion Questions 517 PART 8 The Economy in the Short Run 518 Chapter 21 The Simplest Short-Run Macro Model Desired Aggregate Expenditure 519 Desired Consumption Expenditure 520 Desired Investment Expenditure 527 The Aggregate Expenditure Function Equilibrium National Income Changes in Equilibrium National Income 535 Shifts of the AE Function 535 The Multiplier 537

7 CONTENTS xi Economic Fluctuations as Self-Fulfilling Prophecies 540 Summary 541 Key Concepts 542 Study Exercises 542 Discussion Questions 544 Chapter 22 Adding Government and Trade to the Simple Macro Model Introducing Government 547 Government Purchases 547 Net Tax Revenues 547 The Budget Balance 548 Provincial and Municipal Governments 548 Summary Introducing Foreign Trade 549 Net Exports 549 Shifts in the Net Export Function 550 Summary Equilibrium National Income 552 Desired Consumption and National Income 552 The AE Function 553 Equilibrium National Income Changes in Equilibrium National Income 556 The Multiplier with Taxes and Imports 556 Net Exports 557 Fiscal Policy Demand-Determined Output 561 Summary 562 Key Concepts 563 Study Exercises 564 Discussion Questions 566 Appendix to Chapter 22 An Algebraic Exposition of the Simple Macro Model 567 The Algebra Illustrated 568 Chapter 23 Output and Prices in the Short Run The Demand Side of the Economy 570 Exogenous Changes in the Price Level 570 Changes in Equilibrium GDP 571 The Aggregate Demand Curve The Supply Side of the Economy 575 The Aggregate Supply Curve 575 Shifts in the Aggregate Supply Curve Macroeconomic Equilibrium 578 Changes in the Macroeconomic Equilibrium 579 Aggregate Demand Shocks 580 Aggregate Supply Shocks 582 A Word of Warning 584 Summary 586 Key Concepts 587 Study Exercises 587 Discussion Questions 590 PART 9 The Economy in the Long Run 591 Chapter 24 From the Short Run to the Long Run: The Adjustment of Factor Prices 591 The Short Run 592 The Adjustment of Factor Prices 592 The Long Run 592 Summary The Adjustment Process 594 Potential Output and the Output Gap 594 Factor Prices and the Output Gap 594 Potential Output as an Anchor Aggregate Demand and Supply Shocks 599 Expansionary AD Shocks 600 Contractionary AD Shocks 601 Aggregate Supply Shocks 602 Long-Run Equilibrium Fiscal Stabilization Policy 606 The Basic Theory of Fiscal Stabilization 606 Practical Limitations of Discretionary Fiscal Policy 613 Fiscal Policy and Growth 614 Summary 617 Key Concepts 618 Study Exercises 618 Discussion Questions 620 Chapter 25 The Difference Between Short-Run and Long-Run Macroeconomics Two Examples from Recent History 623 Inflation and Interest Rates in Canada 623 Saving and Growth in Japan 624 A Need to Think Differently Accounting for Changes in GDP 626 GDP Accounting: The Basic Principle 627 GDP Accounting: An Application 630 Summing Up Policy Implications 632 Looking Ahead 634 Summary 634 Key Concepts 635 Study Exercises 635 Discussion Questions 636

8 xii CONTENTS Chapter 26 Long-Run Economic Growth The Nature of Economic Growth 638 Benefits of Economic Growth 639 Costs of Economic Growth 641 Sources of Economic Growth Established Theories of Economic Growth 644 Focus on the Long Run 644 Investment, Saving, and Growth 645 Neoclassical Growth Theory New Growth Theories 657 Endogenous Technological Change 657 Increasing Marginal Returns Are There Limits to Growth? 661 Resource Exhaustion 661 Environmental Degradation 663 Conclusion 664 Summary 666 Key Concepts 667 Study Exercises 667 Discussion Questions 669 PART 10 Money, Banking, and Monetary Policy 671 Chapter 27 Money and Banking The Nature of Money 672 What Is Money? 672 The Origins of Money 673 Modern Money: Deposit Money The Canadian Banking System 679 The Bank of Canada 680 Commercial Banks in Canada 683 Reserves Money Creation by the Banking System 688 Some Simplifying Assumptions 688 The Creation of Deposit Money 688 Excess Reserves and Cash Drains The Money Supply 692 Kinds of Deposits 693 Definitions of the Money Supply 693 Near Money and Money Substitutes 694 Choosing a Measure 694 The Role of the Bank of Canada 695 Summary 695 Key Concepts 696 Study Exercises 696 Discussion Questions 698 Chapter 28 Money, Interest Rates, and Economic Activity Understanding Bonds 701 Present Value and the Interest Rate 701 Present Value and Market Price 703 Interest Rates, Market Prices, and Bond Yields 704 Bond Riskiness The Demand for Money 705 Three Reasons for Holding Money 706 The Determinants of Money Demand 707 Money Demand: Summing Up Monetary Equilibrium and National Income 710 Monetary Equilibrium 710 The Monetary Transmission Mechanism 712 An Open-Economy Modification 714 The Slope of the AD Curve The Strength of Monetary Forces 717 Long-Run Neutrality of Money 717 Short-Run Non-neutrality of Money 719 Summary 722 Key Concepts 723 Study Exercises 724 Discussion Questions 726 Chapter 29 Monetary Policy in Canada How the Bank of Canada Implements Monetary Policy 729 Money Supply Versus the Interest Rate 729 The Bank of Canada and the Overnight Interest Rate 732 The Money Supply Is Endogenous 734 Expansionary and Contractionary Monetary Policies Inflation Targeting 738 Why Target Inflation? 738 The Role of the Output Gap 739 Inflation Targeting as a Stabilizing Policy 740 Complications in Inflation Targeting Long and Variable Lags 744 What Are the Lags in Monetary Policy? 745 Destabilizing Policy? 746 Political Difficulties Thirty Years of Canadian Monetary Policy 749 Economic Recovery: Rising Inflation: Disinflation: Inflation Targeting I: Inflation Targeting II: Financial Crisis and Recession: 2007 Present 755 Summary 757 Key Concepts 758 Study Exercises 758 Discussion Questions 760

9 CONTENTS xiii PART 11 Macroeconomic Problems and Policies 762 Chapter 30 Inflation and Disinflation Adding Inflation to the Model 764 Why Wages Change 764 From Wages to Prices 767 Constant Inflation Shocks and Policy Responses 769 Demand Shocks 770 Supply Shocks 771 Accelerating Inflation 774 Inflation as a Monetary Phenomenon Reducing Inflation 779 The Process of Disinflation 780 The Cost of Disinflation 783 Conclusion 784 Summary 785 Key Concepts 785 Study Exercises 786 Discussion Questions 788 Chapter 31 Unemployment Fluctuations and the NAIRU Employment and Unemployment 791 Changes in Employment 791 Changes in Unemployment 792 Flows in the Labour Market 792 Consequences of Unemployment Unemployment Fluctuations 796 New Classical Theories 797 New Keynesian Theories 798 Convergence of Theories? What Determines the NAIRU? 804 Frictional Unemployment 804 Structural Unemployment 804 The Frictional Structural Distinction 806 Why Does the NAIRU Change? Reducing Unemployment 810 Cyclical Unemployment 810 Frictional Unemployment 810 Structural Unemployment 811 Conclusion 813 Summary 813 Key Concepts 814 Study Exercises 814 Discussion Questions 816 Chapter 32 Government Debt and Deficits Facts and Definitions 819 The Government s Budget Constraint 819 Deficits and Debt in Canada Two Analytical Issues 822 The Stance of Fiscal Policy 823 Changes in the Debt-to-GDP Ratio The Effects of Government Debt and Deficits 827 Do Deficits Crowd Out Private Activity? 828 Do Deficits Harm Future Generations? 829 Does Government Debt Hamper Economic Policy? 830 Recent Budget Surpluses Formal Fiscal Rules? 834 Annually Balanced Budgets? 835 Cyclically Balanced Budgets? 835 Allowing for Growth 836 Summary 837 Key Concepts 838 Study Exercises 838 Discussion Questions 841 PART 12 Canada in the Global Economy 842 Chapter 33 The Gains from International Trade The Gains from Trade 844 Interpersonal, Interregional, and International Trade 844 Illustrating the Gains from Trade 845 The Gains from Trade with Variable Costs 848 Sources of Comparative Advantage The Determination of Trade Patterns 855 The Law of One Price 855 The Pattern of Foreign Trade 856 Is Comparative Advantage Obsolete? 858 The Terms of Trade 859 Summary 863 Key Concepts 863 Study Exercises 864 Discussion Questions 866 Chapter 34 Trade Policy Free Trade or Protection? 868 The Case for Free Trade 868 The Case for Protection 869 Fallacious Arguments for Protection Methods of Protection 875 Tariffs 875 Quotas and Voluntary Export Restrictions (VERs) 876 Tariffs Versus Quotas? 877 Trade-Remedy Laws and Non-tariff Barriers 878

10 xiv CONTENTS 34.3 Current Trade Policy 880 The GATT and the WTO 880 Regional Trade Agreements 883 Trade Creation and Trade Diversion 884 The North American Free Trade Agreement 885 Summary 888 Key Concepts 888 Study Exercises 889 Discussion Questions 891 Chapter 35 Exchange Rates and the Balance of Payments The Balance of Payments 893 The Current Account 893 The Capital Account 893 The Balance of Payments Must Balance 894 A Balance of Payments Deficit? 896 Summary The Foreign-Exchange Market 898 The Supply of Foreign Exchange 899 The Demand for Foreign Exchange The Determination of Exchange Rates 902 Flexible Exchange Rates 903 Fixed Exchange Rates 904 Changes in Flexible Exchange Rates 904 Structural Changes 908 The Volatility of Exchange Rates Three Policy Issues 910 Current Account Deficits and Surpluses 910 Is There a Correct Value for the Canadian Dollar? 916 Should Canada Have a Fixed Exchange Rate? 919 Summing Up 924 Summary 924 Key Concepts 926 Study Exercises 926 Discussion Questions 928 MYECONLAB CHAPTER 931 Chapter 36W Challenges Facing the Developing Countries W.1 The Uneven Pattern of Development 36W.2 Impediments to Economic Development Natural Resources Inefficiency Human Capital and Health Agriculture Population Growth Cultural Barriers Domestic Saving Infrastructure Institutions Foreign Debt 36W.3 Development Policies The Older View The Rise of a New View The Washington Consensus Debate Beyond the Washington Consensus Conclusion Summary Key Concepts Study Exercises Discussion Questions Mathematical Notes M-1 Photo Credits P-1 Timeline of Great Economists T-1 Index I-1

11 List of Boxes Applying Economic Concepts 1-1 The Opportunity Cost of Your University Degree The Globalization Debate Minimum Wages and Unemployment Is It Socially Responsible to Maximize Profits? Three Examples of Diminishing Returns The Significance of Productivity Growth Substitution and Innovation with Automated Teller Machines (ATMs) Why Small Firms Are Price Takers The Parable of the Seaside Inn Entry Barriers for Irish Pubs During the Booming 1990s The Capital Market and Macroeconomics The World s Endangered Fish Used Cars and the Market for Lemons An Open Letter to the Leaders of Canada s Federal Political Parties Poverty Traps and the Negative Income Tax The Terminology of Business Cycles How the CPI Is Constructed Value Added Through Stages of Production Calculating Nominal and Real GDP The Multiplier: A Numerical Example How Large Is Canada s Simple Multiplier? Canada s Fiscal Response to the Recession An Open Letter from a Supporter of the Growth Is Good School An Open Letter from a Supporter of the Growth Is Bad School Climate Change and Economic Growth Understanding Bond Prices and Bond Yields Unconventional Monetary Policy During the Financial Crisis What Determines the Amount of Currency in Circulation? How Do People Form Their Expectations? Is Deflation a Problem? Stocks and Flows in the Canadian Labour Market Is Foreign-Held Debt a Problem? Two Examples of Absolute and Comparative Advantage Comparative Advantage and Global Supply Chains Should the WTO Be Abolished? Canadian Wine: A Free-Trade Success Story A Student s Balance of Payments with the Rest of the World Managing Fixed Exchange Rates News and the Exchange Rate 911 Lessons from History 1-1 The Failure of Central Planning Ice Storms, Hurricanes, and Economics Jacob Viner and the Clever Draftsman Creative Destruction Through History Explicit Cooperation in OPEC David Ricardo and Economic Rent The Development of Unions in Canada The Asian Crisis and the Canadian Economy Fiscal Policy in the Great Depression Should Workers Be Afraid of Technological Change? Hyperinflation and the Value of Money Two Views on the Role of Money in the Great Depression Trade Protection and Recession Mercantilism, Then and Now 913

12 xvi LIST OF BOXES Extensions in Theory 3-1 The Distinction Between Stocks and Flows The Algebra of Market Equilibrium The Algebra of Tax Incidence The Terminology of Elasticity Market and Individual Demand Curves Idle Capital Equipment and Flat Cost Curves The Prisoners Dilemma Allocative Efficiency and the Distribution of Income Innovation and Imperfect Competition Inflation and Interest Rates Arthur Okun s Leaky Bucket A Problem with Democracy Who Really Pays the Corporate Income Tax? Arbitrary Decisions in National Income Accounting The Theory of the Consumption Function The Algebra of the Simple Multiplier The Keynesian AS Curve The Phillips Curve and the Adjustment Process The Business Cycle: Additional Pressures for Adjustment The Phillips Curve and Accelerating Inflation Is the NAIRU Like a Razor s Edge? A Closer Look at New Classical Theory Voluntary Versus Involuntary Unemployment Changes in the Debt-to-GDP Ratio The Gains from Trade More Generally 849

13 Additional Topics on MyEconLab ( Chapter 1 A Brief Introduction to Graphing Challenges Facing the Developing Countries Chapter 15 The U.S. Housing Collapse and the Financial Crisis of A Beginner s Guide to the Stock Market Chapter 2 How Economists Choose Their Theories Investment and Saving in Globalized Financial Markets Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 What the S&P/TSX Really Measures A Brief Introduction to Graphing Economic Data and the Identification Problem A Primer on the Market for Crude Oil Some Further Details About Demand Elasticity Who Really Pays for Payroll Taxes? Linkages Between Markets When Rent Controls Work and When They Don t Agriculture and the Farm Problem What Makes People Happy? Do Taxes Discourage Work Effort and Saving? Multinational Enterprises and Foreign Direct Investment Do Firms Really Maximize Profits? Explaining Different Concepts of Efficiency Understanding and Addressing Canada s Productivity Challenges An Example of Loss Minimization as Profit Maximization The Long-Run Industry Supply Curve The Battle Over Online Prescription Drugs The Nature of Globalization A Sequential Game in Fibre Optics Oligopoly and Contestable Markets Ontario s Troubled Electricity Sector Does Government Support of Specific Industries Really Create Jobs? Chapter 16 Chapter 17 Chapter 18 Chapter 20 Chapter 21 Chapter 22 Chapter 23 Chapter 24 Chapter 25 Chapter 26 Interest Rates and the Extraction of Natural Resources Externalities and the Coase Theorem How Excessive Regulation Hobbles Development Charging for Garbage by the Bag A Market for SO 2 Emissions in the United States The Politics of Market-Based Environmental Policies Debate More Healthy than Health Care Who Are Canada s Poor? The Economic and Fiscal Challenges of Population Aging Growth in Canada and Other G7 Countries What Makes People Happy? The Consumption Function in Canada Investment, Saving, and Equilibrium GDP The Saving Investment Approach to Equilibrium in an Open Economy with Government What Is the Balanced Budget Multiplier? Oil Prices and the Canadian Economy Several Measures of Economic Fluctuations in Canada Understanding and Addressing Canada s Productivity Challenges What Makes People Happy? Investment and Saving in Globalized Financial Markets The Economic and Fiscal Challenges of Population Aging Chapter 14 The Puzzle of Interindustry Wage Differentials in Canada Challenges Facing the Developing Countries

14 xviii ADDITIONAL TOPICS ON MYECONLAB Chapter 27 Chapter 28 Chapter 29 Chapter 30 Chapter 31 A Quick Introduction to Financial Assets The U.S. Housing Collapse and the Financial Crisis of The Costs and Benefits of Deposit Insurance A Beginner s Guide to the Stock Market Interest Rates and the Slope of the AD Curve Monetary Policy and the Exchange Rate in Canada Can Inflation Be Too Low? The Costs of High Inflation Understanding the Canada U.S. Unemployment Gap Does Government Support of Specific Industries Really Create Jobs? Chapter 32 What Caused the Build-Up of Canada s Public Debt? Budget Deficits and National Saving Chapter 33 Who Are Canada s Trading Partners? Does Third-World Growth Harm First-World Prosperity? Chapter 34 The Continuing Saga of Softwood Lumber Farm Subsidies and the World Trade Organization Chapter 35 Expectations and Exchange-Rate Overshooting What Is an Optimal Currency Area? Chapter 36W Challenges Facing the Developing Countries

15 To the Instructor Economics is a living discipline, changing and evolving in response to developments in the world economy and in response to the research of many thousands of economists throughout the world. Through thirteen editions, Economics has evolved with the discipline. Our purpose in this edition, as in the previous twelve, is to provide students with an introduction to the major issues facing the world s economies, to the methods that economists use to study those issues, and to the policy problems that those issues create. Our treatment is everywhere guided by three important principles: 1. Economics is scientific, in the sense that it progresses through the systematic confrontation of theory by evidence. Neither theory nor data alone can tell us much about the world, but combined they tell us a great deal. 22. Economics is useful and it should be seen by students to be so. An understanding of economic theory combined with knowledge about the economy produces many important insights about economic policy. Although we stress these insights, we are also careful to point out cases where too little is known to support strong statements about public policy. Appreciating what is not known is as important as learning what is known. 3. We strive always to be honest with our readers. Although we know that economics is not always easy, we do not approve of glossing over difficult bits of analysis without letting readers see what is happening and what has been assumed. We take whatever space is needed to explain why economists draw their conclusions, rather than just asserting the conclusions. We also take pains to avoid simplifying matters so much that students would have to unlearn what they have been taught if they continue their study beyond the introductory course. In short, we have tried to follow Albert Einstein s advice: Everything should be made as simple as possible, but not simpler. Current Economic Issues In writing the thirteenth edition of Economics, we have tried to reflect the major economic issues that we face in the early twenty-first century. Living Standards and Economic Growth One of the most fundamental economic issues is the determination of overall living standards. Adam Smith wondered why some countries become wealthy while others remain poor. Though we have learned much about this topic in the past 235 years since Adam Smith s landmark work, economists recognize that there is still much we do not know. The importance of technological change in determining increases in overall living standards is a theme that permeates both the microeconomics and macroeconomics halves of this book. Chapter 8 explores how firms deal with technological change at the micro level, and how changes in their economic environment lead them to create new products and new production processes. Chapters 11 and 12 discuss how imperfectly competitive firms often compete through their innovative practices, and the importance for policymakers of designing competition policy to keep these practices as energetic as possible. Technological change also plays a central role in our discussions of long-run economic growth in Chapters 25 and 26. We explore not only the traditional channels of saving, investment, and population growth, but also the more recent economic theories that emphasize the importance of increasing returns and endogenous growth. We are convinced that no other introductory economics textbook places as much emphasis on technological change and economic growth as we do in this book. Given the importance of continuing growth in living standards and understanding where that growth comes from, we believe this emphasis is appropriate. We hope you agree.

16 xx TO THE INSTRUCTOR Financial Crisis and Recession The collapse of U.S. housing prices in 2007 led to a global financial crisis the likes of which had not been witnessed in a century, and perhaps longer. A deep recession, experienced in many countries, followed quickly on its heels. These dramatic events re-awakened many people to two essential facts about economics. First, modern economies can and do go into recession. This essential fact had perhaps been forgotten by many who had become complacent after more than two decades of economic prosperity. Second, financial markets are crucial to the operation of modern economies. Like an electricity system, the details of financial markets are a mystery to most people, and the system itself is often ignored when it is functioning properly. But when financial markets cease to work smoothly, and interest rates rise while credit flows decline, we are all reminded of their importance. In this sense, the financial crisis of was like a global power failure for the world economy. The financial crisis had micro causes and macro consequences. The challenges of appropriate regulation, for financial and non-financial firms, are explored in Chapters 12 and 16. The market for financial capital and the determination of interest rates are examined in Chapter 15. And debates regarding the appropriate role of the government in a market economy occur throughout the book, including Chapters 1, 5, 16, and 18. On the macro side, the financial crisis affected the Canadian banking system, discussed in Chapter 27, and led to some unconventional actions by the Bank of Canada, as discussed in Chapter 29. Moreover, as the global financial crisis led to a deep recession worldwide, Canadian fiscal policy was forced to respond, as we review in Chapters 24 and 32. Finally, as has happened several times throughout history, the recession raised the threat of protectionist policies, as we examine in Chapter 34. Globalization Enormous changes have occurred throughout the world over the last few decades. Flows of trade and investment between countries have risen so dramatically that it is now common to speak of the globalization of the world economy. Today it is no longer possible to study any economy without taking into account developments in the rest of the world. Throughout its history, Canada has been a trading nation, and our policies relating to international trade have often been at the centre of political debates. International trade shows up in many parts of this textbook, but it is the focus of two chapters. Chapter 33 discusses the theory of the gains from trade; Chapter 34 explores trade policy, with an emphasis on NAFTA and the WTO, especially its round of negotiations that began in Doha. Included under the label of globalization is the mobility of labour and capital. How mobile is labour across international borders? Does such labour mobility imply that Canada s policies cannot diverge significantly from those in other countries? We explore these issues at various points throughout the book, especially in Chapters 13, 14, and 18. With globalization and the international trade of goods and assets come fluctuations in exchange rates. In recent years there have been substantial changes in the Canada U.S. exchange rate a 15- percent depreciation followed the Asian economic crisis in , and an even greater appreciation occurred in the period. Such volatility in exchange rates complicates the conduct of economic policy. In Chapters 28 and 29 we explore how the exchange rate fits into the design and operation of Canada s monetary policy. In Chapter 35 we examine the debate between fixed and flexible exchange rates. The forces of globalization are with us to stay. In this thirteenth edition of Economics, we have done our best to ensure that students are made aware of the world outside Canada and how events elsewhere in the world affect the Canadian economy. The Role of Government Between 1980 and 2008, the political winds had shifted in Canada, the United States, and many other countries. Political parties that previously had advocated a greater role for government in the economy began to argue the benefits of limited government. But the political winds shifted again with the arrival of the financial crisis and global recession in 2008, which led governments the world over to take some unprecedented actions. Many soon argued that we were observing the end of laissez-faire and witnessing the return of big government. But was that really true?

17 TO THE INSTRUCTOR xxi Has the fundamental role of government changed significantly over the past 30 years? In order to understand the role of government in the economy, students must understand the benefits of free markets as well as the situations that cause markets to fail. They must also understand that governments often intervene in the economy for reasons related more to equity than to efficiency. In this thirteenth edition of Economics, we continue to incorporate the discussion of government policy as often as possible. Here are but a few of the many examples that we explore: tax incidence (in Chapter 4) the effects of minimum wages and rent controls (in Chapter 5) economic regulation and competition policy (in Chapter 12) pay equity policy (in Chapter 13) environmental policies (in Chapter 17) the disincentive effects of income taxes (in Chapter 18) fiscal policy (in Chapters 22 and 24) policies related to the economy s long-run growth rate (in Chapter 26) monetary policy (in Chapters 28, 29, and 30) policies that affect the economy s long-run unemployment rate (in Chapter 31) the importance of debt and deficits (in Chapter 32) trade policies (in Chapter 34) policies related to the exchange rate (in Chapter 35) The Book Economic growth, financial crisis and recession, globalization, and the role of government are pressing issues of the day. Much of our study of economic principles and the Canadian economy has been shaped by these issues. In addition to specific coverage of growth and internationally oriented topics, growth and globalization appear naturally throughout the book in the treatment of many topics once thought to be entirely domestic. Most chapters of Economics contain some discussion of economic policy. We have two main goals in mind when we present these discussions: 1. We aim to give students practice in using economic theory, because applying theory is both a wonderfully effective teaching method and a reliable test of students grasp of theory. 2. We want to introduce students to the major policy issues of the day and to let them discover that few policy debates are as black and white as they often appear in the press. Both goals reflect our view that students should see economics as useful in helping us to understand and deal with the world around us. The choice of whether to study macro first or micro first is partly a personal one that cannot be decided solely by objective criteria. We believe that there are excellent reasons for preferring the micro macro order, and we have organized the book accordingly. For those who prefer the macro micro order, we have attempted to make reversibility easy. The first three chapters provide a solid foundation for first studying either microeconomics (Chapters 4 18) or macroeconomics (Chapters and 36W). Microeconomics: Structure and Coverage To open Part 1, Chapter 1 presents the market as an instrument of coordination. We introduce the issues of scarcity and choice and then briefly discuss alternative economic systems. Comparisons with command economies help to establish what a market economy is by showing what it is not. Chapter 2 makes the important distinction between positive and normative inquiries and goes on to an introductory discussion of the construction and testing of economic theories. We also discuss graphing in detail. Part 2 deals with demand and supply. After introducing price determination and elasticity in Chapters 3 and 4, we apply these tools in Chapter 5. The case studies are designed to provide practice in applying the tools rather than a full coverage of each case. Chapter 5 also has an intuitive and thorough treatment of economic value and market efficiency. Part 3 presents the foundations of demand and supply. The theory of consumer behaviour is developed via marginal utility theory in Chapter 6, which also provides an introduction to consumer surplus and an intuitive discussion of income and substitution effects. The Appendix to Chapter 6 covers indifference curves, budget lines, and the derivation of demand curves using indifference theory. Chapter 7 introduces the firm as an institution and develops

18 xxii TO THE INSTRUCTOR short-run costs. Chapter 8 covers long-run costs and the principle of substitution, and goes on to consider shifts in cost curves due to technological change. The latter topic is seldom, if ever, covered in the micro part of elementary textbooks, yet applied work on firms responses to changing economic signals shows it to be extremely important. The first two chapters of Part 4, Chapters 9 and 10, present the standard theories of perfect competition and monopoly with a thorough discussion of price discrimination and some treatment of international cartels. Chapter 11 deals with monopolistic competition and oligopoly, which are the market structures most commonly found in Canadian industries. Strategic behaviour plays a central part in the analysis of this chapter. The first half of Chapter 12 deals with the efficiency of competition and the inefficiency of monopoly. The last half of the chapter deals with regulation and competition policy. Part 5 begins in Chapter 13 by discussing the general principles of factor pricing and how factor prices are influenced by factor mobility. Chapter 14 then examines the operation of labour markets, addressing issues such as wage differentials, discrimination, labour unions, and the good jobs bad jobs debate. Chapter 15 discusses investment in physical capital, the role of the interest rate, and the overall functioning of capital markets. The first chapter of Part 6 (Chapter 16) provides a general discussion of market success and market failure, and outlines the arguments for and against government intervention in a market economy. Chapter 17 deals with environmental regulation, with a detailed discussion of market-based policies and an introduction to the issue of global climate change. Chapter 18 analyzes taxes, public expenditure, and the main elements of Canadian social policy. These three chapters expand on the basics of microeconomic analysis by providing current illustrations of the relevance of economic theory to contemporary policy situations. Macroeconomics: Structure and Coverage Our treatment of macroeconomics is divided into six parts. We make a clear distinction between the economy in the short run and the economy in the long run, and we get quickly to the material on long-run economic growth. Students are confronted with issues of long-run economic growth before they are introduced to issues of money and banking. Given the importance of economic growth in driving overall living standards, we feel this is an appropriate ordering of the material; but for those who prefer to discuss money before thinking about economic growth, the ordering can be easily switched without any loss of continuity. The first macro chapter, Chapter 19, introduces readers to the central macro variables, what they mean, and why they are important. The discussion of national income accounting in Chapter 20 provides a thorough treatment of the distinction between real and nominal GDP, the distinction between GDP and GNP, and a discussion of what measures of national income do not measure. Part 8 develops the core short-run model of the macro economy, beginning with the fixed-price (Keynesian Cross) model in Chapters 21 and 22 and then moving on to the AD/AS model in Chapter 23. Chapter 21 uses a closed economy model with no government to explain the process of nationalincome determination and the nature of the multiplier. Chapter 22 extends the setting to include international trade and government spending and taxation. Chapter 23 rounds out our discussion of the short run with the AD/AS framework, discussing the importance of both aggregate demand and aggregate supply shocks. We place the Keynesian Cross before the AD/AS model to show that there is no mystery as to where the AD curve comes from and why it is downward sloping; the AD curve is derived directly from the Keynesian Cross model. In contrast, books that begin their analysis with the AD/AS model are inevitably less clear about where the model comes from. We lament the growing tendency to omit the Keynesian Cross from introductory macroeconomics textbooks; we believe the model has much to offer students in terms of economic insights. Part 9 begins in Chapter 24 by showing how the short-run model evolves toward the long run through the adjustment of factor prices what we often call the Phillips curve. We introduce potential output as an anchor to which real GDP returns following AD or AS shocks. This chapter also addresses issues in fiscal policy, including the important distinction between automatic stabilizers and discretionary fiscal stabilization policy. Chapter 25 is a short chapter that contrasts short-run with long-run macroeconomics, emphasizing the different typical causes of output changes over the two time spans. Using Canadian data, we show that long-run changes in GDP have