CONTENTS 1
PART I 1
INTR0DUCTION 1
CHAPTER 1 TEN PRINCIPLES OF ECON0MICS 3
How People Make Decisions 4
Principle #1: People Face Tradeoffs 4
Principle #2: The Cost of SOmething ls What You Give Up to Get It 5
Principle #3: Rational People Think at the Margin 6
Principle #4: People Respond to Incentives 7
How People Interact 8
Principle #5: Trade Can Make Everyone Better Off 8
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity 9
Principle #7: Governments Can Sometimes Improve Market Outcomes 10
How the Economy as a Whole works 10
Principle #8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services 11
Principle #9: Prices Rise When the Government Prints Too Much Money 12
Principle #10: Society Faces a Short Run Tradeoff between Inflation and Unemployment 13
Conclusion 13
Summary 14
Key Concepts 14
Questions for Review 15
Problems and Applications 15
CHAPTER 2 THINKING LIKE AN EC0NOMIST 17
The Economist as Scientist 18
The Scientific Method: Observation, Theory and More Observation 19
The Role of Assumptions 19
Economic Models 20
Our First Model: The Circular-Flow Diagram 21
Our Second Model: The Production Possibilities Frontier 22
Microeconomics and Macroeconomics 25
The Economist as Policymaker 26
Positive versus Normative Analysis 26
EconomistS in Washington 27
Why Economists Disagree 28
Differences in Scientific Judgments 28
Differences in Values 29
Charlatans and Cranks 29
Perception versus Reality 30
Let's Get Going 31
Summary 32
Key Concepts 32
Questions for Review 32
Problems and Applications 33
Graphs of Two Variables: The Coordinate System 34
Graph5 of a Single Variable 34
Appendix: Graphing--A Brief Review 34
Curves in the Coordinate System 36
Slope and Elasticity 39
Cause and Effect 41
Omitted Variables 41
Reverse Causality 42
CHAPTER 3 INTERDEPENDENCE AND THE GAINS FR0M TRADE 45
A Parable for the Modem Economy 46
Production Possibilities 46
Specialization and Trade 48
The Principle of Comparative Advantage 50
Absolute Advantage 51
Opportunity Cost and Comparative Advantage 51
Comparative Advantage and Trade 52
Should Michael Jordan Mow His Own Lawn? 53
Applications of Comparative Advantage 53
FYI: The Legacy of Adam Smith and David Ricardo 54
Should the United States Trade with Other Countries? 54
Conclusion 55
Summary 55
Key Concepts 56
Questions for Review 56
Problems and Applications 56
PART II 57
SUPPLY AND DEMAND I:HOW MARKETS W0RK 59
CHAPTER 4 THE MARKET F0RCES OF SUPPLY AND DEMAND 61
Markets and Competition 62
Competitive Markets 62
Competition: Perfect and Otherwise 62
Price 63
Demand 63
The Determinants of Individual Demand 63
Income 64
Prices of Related Goods 64
Tastes 64
Expectations 64
The Demand Schedule and the Demand Curve 64
Ceteris Paribus 66
Market Demand versus Individual Demand 66
Shifts in the Demand Curve 68
CASE STUDY: Two Ways to Reduce the Quantity of Smoking Demanded 69
Supply 70
The Supply Schedule and the Supply Curve 71
Expectations 71
Technology 71
Input Prices 71
Price 71
The Determinants of Individual Supply 71
Market Supply versus Individual Supply 72
Shifts in the Supply Curve 73
Supply and Demand Together 74
Equilibrium 76
Three Steps to Analyzing Changes in Equilibrium 78
Example: A Change in Demand 78
Shifts in Curves versus Movements along Curves 80
Example: A Change in Supply 80
Example:A Change in Both Supply and Demand 81
Conclusion: How Prices Allocate Resources 81
lN THE NEWS: Supply, Demand, and the Price of Paper--Pulp Reality 83
Summary 84
Key Concepts 85
Questions for Review 85
Problems and Applications 85
CHAPTER 5 ELASTICITY AND ITS APPUCATI0N 89
The Elasticity of Demand 90
The Price Elasticity of Demand and Its Determinants 90
Necessities versus Luxuries 90
Availability of Close Substitutes 90
Definition of the Market 90
Time Horizon 91
Computing the Price Elasticity of Demand 91
FYI: Calculating E1asticities Using the Midpoint Method 92
The Variety of Demand Curves 92
Total Revenue and the Price Elasticity of Demand 94
The Income Elasticity of Demand 96
CASE STUDY: Pricing Admission to a Museum 96
FYI: Elasticity and Total Revenue along a Linear Demand Curve 97
IN THE NEWS: On the Road with Elasticity--For Whom the Booth Tolls, Price Really Does Matter 98
The Elasticity of Supply 99
The Price Elasticity of Supply and Its Determinants 99
Computing the Price Elasticity of Supply 99
The Variety of Supply Curves 100
Three Applications of Supply, Demand, and Elasticity 102
Can Good News fOr Farming Be Bad News fOr Farmers? 103
Why Did OPEC Fail to Keep the Price of Oil High? 105
Does Drug Interdiction Increase or Decrease Drug-Related Crime? 106
Conclusion 108
Summary 108
Problems and Applications 109
Questions for Review 109
Key Concepts 109
CHAPTER 6 SUPPLY DEMAND, AND GOVERNMENT POLICIES 111
Controls on Prices 112
How Price Ceilings Affect Market Outcomes 112
CASE STUOY: Lines at the Gas Pump 113
CASE STUDY: Rent Control in the Short Run and Long Run 115
IN THE NEWS: Rent Control in New York City--Home Free: Some Rich and Famous of New York City Bask in Shelter of Rent Law 116
How Price Floors Affect Market Outcomes 117
CASE STUDY: The Minimum Wage 118
Evaluating Price Controls 120
Taxes 121
How Taxes on Buyers Affect Market Outcomes 122
How Taxes on Sellers Affect Market Outcomes 123
CASE STU0Y: Can Congress Distribute the Burden of a Payroll Tax? 124
Elasticity and Tax Incidence 125
CASE STUDY: Who Pays the Luxury Tax? 127
Conclusion 128
Key Concepts 128
Questions for Review 128
Summary 128
Problems and Applications 129
PART III 129
SUPPLY AND DEMAND II:MARKETS AND WELFARE 131
CHAPTER 7 CONSUMERS, PRODUCERS, AND THE EFFICIENCY 0F MARKETS 133
Willingness to Pay 134
Consumer Surplus 134
Using the Demand Curve to Measure Consumer Surplus 135
How a Lower Price Raises Consumer Surplus 138
What Does Consumer Surplus Measure? 138
Producer Surplus 140
Cost and the Willingness to Sell 140
Using the Supply Curve to Measure Producer Surplus 141
How a Higher Price Raises Producer Surplus 143
The Benevolent Social Planner 144
Market Efficiency 144
FYI: The Invisible Hand of the Marketplace 145
Evaluating the Market Equilibrium 146
lN THE NEWS: Ticket Scalping--Tickets? Supply Meets Demand on Sidewalk 148
Conclusion: Market Efficiency and Market Failure 150
Summary 151
Key Concepts 151
Questions for Review 151
Problems and Applications 151
CHAPTER 8 APPLICATI0N: THE COSTS 0F TAXATION 155
How a Tax Affects Market Participants 156
The Deadweight Loss of Taxation 156
Welfare without a Tax 157
Welfare with a Tax 158
Changes in Welfare 158
Deadweight Losses and the Gains from Trade 159
The Determinants of the Deadweight Loss 160
CASE STUDY: The Deadweight Loss of Taxes on Labor 162
CASE STUDY: Henry George and the Tax on Land 163
Deadweight Loss and Tax Revenue as Taxes vary 164
CASE STUDY: The Laffer Curve and Supply-Side Economics 166
Conclusion 168
IN THE NEWS: Should Ukraine Cut Tax Rates to Raise Tax Revenue?--A Big Tax Cut to Lyt the Economy-Not Her, in Ukraine 169
PrOblems and Applications 170
Questions for Review 170
Key Concepts 170
Summary 170
CHAPTER 9 APPLICATION: INTERNATIONAL TRADE 173
The Determinants of Trade 174
The Equilibrium without Trade 174
The World Price and Comparative Advantage 175
FYI: Comparing Prices and Comparative Advantage 175
The Winners and Losers frOm Trade 176
The Gains and Losses of an Exporting Country 176
The Gains and Losses of an ImPOrting Country 179
The Effects of a Tariff 181
The Effects of an IMport Quota 182
The Lessons for Trade Policy 185
The Arguments for Restricting Trade 186
The Jobs Argument 186
The Infant-Industry Argumen 187
The National-Security Argument 187
President Wins Tomato Accord for Flaridians: Mexico Agrees to End Low-Price Shipments 188
IN THE NEWS: NAFTA and Mexican Tomatoes- 188
The Unfair-Competition Argument 189
The Protection-as-a-Bargaining-Chip Argument 189
CASE STUDY: GATT and the Multilateral Approach to Free Trade 189
IN THE NEWS: A Chicken Invasion--U.S. Chicken in Every Pot? Nyet! Russians Cry Foul 190
Conclusion 191
Summary 192
Key Concepts 192
Questions for Review 193
Problems and Applications 193
PART IV 197
THE ECONOMICS OF THE PUBLIC SECT0R 197
CHAPTER 10 EXTERNALITIES 199
Welfare Economics:A Recap 201
Externalities and Market Inefficiency 201
Negative Externalities in Production 202
Positive Externalities in Production 203
CASE STUDY: The Debate over Technology Policy 204
Externalities in Consumption 205
Private Solutions to Externalities 207
The Types of Private Solutions 207
IN THE NEWS: An Outraged Citizen Speaks Out-Smokers, Pick UP Your Butts 208
The Coase Theorem 208
Why Private Solutions DO NOt Always Work 209
Public POlicies toward Externalities 210
Regulation 210
Pigovian Taxes and Subsidies 211
Tradable Pollution Permits 212