CONTEMPORARY ECONOMICS AN APPLICATIONS APPROACH 5TH EDITION ROBERT ]. CARBAUGH ^M.E.Sharpe Armonk, New York London, England
& Preface xix p A R T i Introduction 1 C H A P T E R 1 Scarcity and Choice 2 What Is Economics? 3 Microeconomics 4 Macroeconomics 4 The Economic Way of Thinking 4 Every Choice Has a Cost 4 People Make Better Choices by Thinking at the Margin 5 Rational Self-interest 5 Economic Models 5 Positive versus Normative Economics 5 Scarcity 6 Scarcity and Opportunity Cost 7 The Opportunity Cost of A ttending College 8 Opportunity Costs and Choices 9 The Production Possibilities Curve and Opportunity Cost 10 Economic Inefficiency 11 Law of Increasing Opportunity Cost 12 Economic Growth 13 Economic Decline 14 Economic Growth: Trade-Offs between Current and Future Consumption 15 Production Possibilities Applications 16 Opportunity Cost of National Security 16 Economic Sanctions and Economic Decline 17 Chapter Summary 20 Key Terms and Concepts 20 Self-Test: Multiple-Choice Questions 21 Study Questions and Problems 22
Exploring Further 1.1: A Primer on Tables and Graphs 23 Movements along the Study Time-Grade Line 24 Slope of the Study Time-Grade Line 24 Shifts in the Study Time-Grade Line 25 p A R T o) The Microeconomy 27 CHAPTER 2 Market Transactions: Demand and Supply Analysis 28 Markets 29 Demand 30 The Demand Curve and the Law of Demand 30 What Explains the Law of Demand? 31 Changes in Demand: Demand Shifters 32 Supply 34 The Supply Curve and the La w of Supply 35 Oil Firms Squeeze More Crude from Wells 36 Changes in Supply: Supply Shifters 36 Demand, Supply, and Equilibrium 38 Shifts in Demand and Supply 40 Contemporary Applications of Demand and Supply 43 Bike Competition Puts the Brakes on Schwinn 43 Rising Health Care Costs Cripple Households 43 Coping with America's Thirst for Oil 46 Chapter Summary 48 Key Terms and Concepts 49 Self-Test: Multiple-Choice Questions 49 Study Questions and Problems 51 CHAPTER 3 Demand and Supply Applications 53 Price Elasticity of Demand 54 Determinants of Price Elasticity of Demand - 56 Availability of Substitutes 56 Proportion of Income 57 Time 57 Airlines Fail to Pass on the Full 10-Percent Ticket Tax to Passengers 57 Price Elasticity of Demand and Total Revenue 59
viii Contents Applications of Price Elasticity of Demand and Total Revenue 60 Colleges Hike Tuition to Offset Cutbacks in State Aid to Higher Education 60 Pittsburgh Pirates Underestimate Fan Reaction: Ticket Price Hike Was Wrong 60 U.S. Postal Service Boosts Rates to Increase Revenue 61 Price Ceilings and Price Floors 63 Rent Controls Make Housing More Affordable 63 Should Federal Interest-Rate Ceilings Be Imposed on MasterCard and Visa? 64 U.S. Farmers Reap High Subsidies from the Government 65 Chapter Summary. 67 Key Terms and Concepts 68 Self-Test: Multiple-Choice Questions 68 Study Questions and Problems 69 CHAPTER 4 Production and the Costs of Production 73 The Short Run versus the Long Run 74 The Production Function 75 Short-Run Production 75 Improvements in Technology and Work Rules Shift Product Curves Upward 77 Short-Run Production Costs 78 Total Fixed, Total Variable, and Total Costs 80 Average Costs 81 Marginal Cost 82 Long-Run Production Costs 83 Economies of Scale 83 Diseconomies of Scale 85 Shifts in Cost Curves 86 Foreign Competition Forces Cost Adjustments for U.S. Steelmakers 87 Costs and Profit 88 Explicit Costs and Implicit Costs 89 Accoun ting Profit and Economic Profit 89 Chapter Summary 90 Key Terms and Concepts 91 Self-Test: Multiple-Choice Questions 91 Study Questions and Problems 93
CHAPTER 5 Competition and Monopoly: Virtues and Vices 95 Perfect Competition 96 The Perfectly Competitive Firm as a Price Taker 97 Perfect Competition: Profit Maximization in the Short Run 99 Marginal Revenue Equals Marginal Cost Rule 99 Profit Maximization 99 Perfect Competition: Long-Run Adjustments and Economic Efficiency 100 Will Online Music Start-ups Be Singing the Blues? 102 Monopoly 103 Barriers to Entry 104 Legal Barriers 104 Control over Essential Inputs 105 Economies of Scale 105 Cable Television: Why Rates Are So High 106 De Beers: The "Gift of Love" 107 Profit Maximization for a Monopoly 108 Price and Marginal Revenue 108 Maximizing Profits 109 Continuing Monopoly Profits 111 The Case against Monopoly 112 The U.S. Postal Service as a Legal Monopoly 113 Reducing Monopoly Power: Generic Drugs Compete against Brand-Name Drugs 114 Chapter Summary 116 Key Terms and Concepts 116 Self-Test: Multiple-Choice Questions 116 Study Questions and Problems 118 Exploring Further 5.1: Loss Minimization and the Shut-Down Rule 120 CHAPTER 6 Imperfect Competition 123 Concentration Ratios 124 Monopolistic Competition 126 Profit Maximization in the Short Run 127 The Long Run: Normal Profit and Excess Capacity 127 Despite Competition from Starbucks, Most Independent Coffeehouses Survive 128 Advertising 130 Price Discrimination 132
Oligopoly 133 Rivalry in the Soft Drink Industry 134 Game Theory and Oligopoly Behavior 134 Competitive Oligopoly and Low Prices 135 Cooperative Behavior and Cheating 136 Airbus and Boeing Rival for Supremacy in the Jetliner Industry 137 Collusion and Cartels 138 Mergers and Oligopoly 139 Chapter Summary 140 Key Terms and Concepts 141 Self-Test: Multiple-Choice Questions 141 Study Questions and Problems 143 CHAPTER 7 Labor Markets 145 Labor Market Equilibrium 146 Do Minimum Wage Laws Help Workers? 149 Are Workers Better Off with Labor Unions? 152 Increasing Union Wages 153 What Gives a Union Strength? 155 Outsourcing of Jobs: Threat or Opportunity for U.S. Workers? 156 What Prevents U.S. Jobs from Being Outsourced Abroad? 157 The Effects of Outsourcing 157 Do Liberal Immigration Laws Harm American Workers? 158 Chapter Summary 160 Key Terms and Concepts 161 Self-Test: Multiple-Choice Questions 161 Study Questions and Problems 163 Exploring Further 7.1: A Firm's Hiring Decision 164 CHAPTER 8 Government and Markets 167 Market Failure 168 Monopoly Power 169 ^ Antitrust Policy 169 The Music Industry Pays Millions for Price Fixing 170 Economic Regulation and Deregulation 170 Public-Utility Regulation 171 Partial Deregulation of Electricity Shocks Californians 172 Peak-Load Pricing: Buying Power by the Hour 174
xi Spillover Effects 175 Spillover Costs 175 Trading Emission Certificates Clears the Skies of Acid Rain 177 Spillover Benefits 177 Should Government Subsidize Professional Sports? 178 Social Regulation 180 Do Corporate Fuel Economy Standards Promote Fuel Conservation? 181 Public Goods 182 Inadequate Information 183 Economic Inequality 183 Chapter Summary 184 Key Terms and Concepts 185 Self-Test: Multiple-Choice Questions 186 Study Questions and Problems 187 PART - fl The Macroeconomy 189 CHAPTER 9 The Mixed Economy of the United States 190 Households as Income Receivers 191 Sources of Income Inequality 192 Households as Spenders 193 The Business Sector 194 Government in the Mixed Economy 195 Social Security 197 Should Social Security Be Priva tized? 199 Government Finance 199 Taxation Principles: Benefits Received versus Ability to Pay 202 Progressive, Regressive, and Proportional Taxes 202 The U.S. Tax Structure 204 Federal Personal Income Tax 204 Federal Corporate Income Tax 205 Social Security Tax 205 Sales, Excise, and Property Taxes 205 Overall U.S. Tax System 206 Should the U.S. Tax System Be Reformed? 207 Flat-Rate Income Tax 207 Value-Added Tax 209 National Sales Tax 209
Chapter Summary 210 Key Terms and Concepts 211 Self-Test: Multiple-Choice Questions 211 Study Questions and Problems 213 CHAPTER 10 Gross Domestic Product and Economic Growth 215 Measuring an Economy's Output 216 Gross Domestic Product 217 The Components of GDP 218 A Formula for GDP 219 What GDP Does Not Measure 220 Real GDP versus Nominal GDP 221 Long-Run Economic Growth 223 The Rate of Economic Growth 223 What Determines Economic Growth? 225 Natural Resources 226 Physical Capital 226 Human Capital 227 Productivity 227 The Significance of Technological Innovation 230 The Role of Government 230 Theories of Economic Growth 231 Is Economic Growth Desirable? 233 Chapter Summary 234 Key Terms and Concepts 235 Self-Test: Multiple-Choice Questions 235 Study Questions and Problems 237 CHAPTER 11 The Business Cycle, Unemployment, and Inflation 239 ^ The Business Cycle 240 Phases of the Business Cycle 240 Theories of the Business Cycle 244 Do Economic Expansions Die of Old Age? 244 Unemployment 245 Measuring Unemployment 245 Three Kinds of Unemployment 247 Mitigating the Costs of Unemployment 247 What Is Full Employment? 248 Inflexible Labor Markets Cost Jobs 248
xiii Jobless Expansions: The Productivity-Jobs Connection 251 Inflation 253 Measuring Inflation: The Consumer Price Index 254 Who Benefits From and Who Is Hurt by Inflation? 255 Inflation and the Purchasing Power of Income 255 Redistribution of Wealth from Lenders to Borrowers 257 Inflation and Real Interest Rates 257 Inflation and Taxpayers 258 Home Ownership as a Hedge against Inflation 258 Effects of Severe Inflation 260 Causes of Inflation 260 Chapter Summary 261 Key Terms and Concepts 262 Self-Test: Multiple-Choice Questions 262 Study Questions and Problems 264 CHAPTER 12 Macroeconomic Instability: Aggregate Demand and Aggregate Supply 265 The Stability of the Macroeconomy 266 The Classical View 267 The Great Depression 267 The Keynesian View 268 Aggregate Demand and Aggregate Supply 269 Aggregate Demand 270 Movemen ts along the Aggrega te Demand Curve 270 Shifts in the Aggregate Demand Curve 271 The Multiplier Effect 271 Aggregate Supply 272 Movemen ts along the Aggregate Supply Curve 272 Shifts in the Aggregate Supply Curve 273 The Origins of Recession 274 Decreases in Aggregate Demand 274 Decreases in Aggregate Supply 276 The Origins of Inflation Revisited 276 Demand-Pull Inflation 276 Cost-Push Inflation 278 Chapter Summary 278 Key Terms and Concepts 280 Self-Test: Multiple-Choice Questions 280
xiv Contents Study Questions and Problems 282 Exploring Further 12.1: The Nature and Operation of the Multiplier Effect 283 Calculating the Value of the Multiplier 284 Graphical Illustration of the Multiplier Effect 285 CHAPTER 13 Fiscal Policy and the Federal Budget 287 Fiscal Policy 288 Fiscal Policy and Aggregate Demand 289 Combating Recession 289 Combating Inflation 292 Fiscal Policy in Action 292 Automatic Stabilizers 294 Problems of Fiscal Policy 296 Timing Lags 296 Crowding-Out Effect 297 Fiscal Policy and Aggregate Supply: Long-Run Growth 298 Supply-Side Effects of Changes in Taxes 298 Do Tax Cuts Cause Tax Revenues to Rise (Fall)? 299 The Federal Deficit and Federal Debt 301 Sales and Ownership of Federal Debt 302 Is the Federal Debt Good or Bad? 303 Should There Be a Balanced-Budget Amendment? 304 Chapter Summary 304 Key Terms and Concepts 305 Self-Test: Multiple-Choice Questions 306 Study Questions and Problems 307 Exploring Further 13.1: Fiscal Policy and the Multiplier 309 CHAPTER 14 Money and the Banking System 311 The Meaning of Money 312 Medium of Exchange 313 Unit of Account 313 Store of Value 313 Are Credit Cards Money? 314 Shopping for a Credit Card 314 The U.S. Money Supply 315 Coins 316 Paper Money 316
Checking Accounts 317 Special Types of Checks 318 Check Processing and Collection: The Federal Reserve 320 What Backs the Money Supply? 322 Measuring the Money Supply: The M1 Money Supply 322 How Your Money Grows Over Time: Compound Interest 324 The Business of Banking 325 A Bank's Balance Sheet 325 The Reserve Requirement 327 The Process of Money Creation 327 The Federal Deposit Insurance Corporation 329 Chapter Summary 330 Key-Terms and Concepts 330 Self-Test: Multiple-Choice Questions 331 Study Questions and Problems 332 CHAPTER 15 The Federal Reserve and Monetary Policy 335 The Federal Reserve System 336 Structure of the Federal Reserve System 336 The Independence of the Fed 338 The Functions of the Federal Reserve System 339 Monetary Policy 339 Open Market Operations 340 The Discount Rate 342 The Reserve Requirement 342 Shifting Aggregate Demand 343 Expansionary Policy 343 Restrictive Policy 346 The Recession of 2001 and the Federal Reserve 346 Attack on America: How the Fed Defended the Financial System 348 Monetary Policy: Advantages and Disadvantages 349 Advantages of Monetary Policy 349 Disadvantages of Monetary Policy 349 Discretion or Rules: Fixed-Money Rule or Inflation Targeting? 350 Should Congress Reduce the Independence of the Federal Reserve? 351 Chapter Summary 352 Key Terms and Concepts 352 Self-Test: Multiple-Choice Questions 353 Study Questions and Problems 354
A R T A The International Economy 357 CHAPTER 16 The United States and the Global Economy 358 The United States as an Open Economy 359 The Advantages of Specialization and Trade 360 Comparative Advantage and International Trade 362 Production and Consumption without Specialization and Trade 363 Production and Consumption with Specialization and Trade 363 Comparative Advantage 364 Why Are Free Trade and Globalization Controversial? 366 Limiting Foreign Competition: Tariffs 367 Arguments for Trade Restrictions 369 Job Protection 369 Protection against Cheap Foreign Labor 370 Fairness in Trade: A Level Playing Field 371 Infant Industry 371 Noneconomic Arguments 371 Pursuing Trade Liberalization 372 World Trade Organization 372 From NAFTA to CAFTA 373 Chapter Summary 374 Key Terms and Concepts 374 Self-Test: Multiple-Choice Questions 375 Study Questions and Problems 376 CHAPTER 17 International Finance 379 The Balance of Payments 380 The Current Account 380 The Capital and Financial Account 381 What Does a Current Account Deficit (Surplus) Mean? 381 The U.S. Balance of Payments 382 Are U.S. Current Account Deficits Bad? 383 The Foreign Exchange Market 384 A Weak Dollar Is a Bonanza for European Tourists 386 Exchange Rate Determination 386 Long-Run Determinants of Exchange Rates 388 Short-Run Determinants of Exchange Rates 388
xvii Exchange Rate Systems 389 Floating Exchange Rates 389 Fixed Exchange Rates 389 Monetary Integration for Europe and the United States 390 The Euro: A Common Currency for Europe 390 The Dollar: A Common Currency for the Americas? 391 Chapter Summary 392 Key Terms and Concepts 393 Self-Test: Multiple-Choice Questions 394 Study Questions and Problems 395 CHAPTER 18 Economic Systems and Developing Countries 399 Economic Systems and the Fundamental Economic Questions 400 The Market Economy 401 The Command Economy 402 The Mixed Economy 403 Transition Economies 404 Eastern Europe 404 China 404 The Economics of Developing Countries 405 Obstacles to Economic Development 406 Tensions between Developing Countries and Advanced Countries 408 Economic Growth Strategies 409 Aid to Developing Countries 410 World Bank 410 International Monetary Fund 411 Generalized System of Preferences 411 Chapter Summary 412 Key Terms and Concepts 413 Self-Test: Multiple-Choice Questions 413 Study Questions and Problems 414 Glossary 415 Index 427