Principles of Economics

Economics is a social science that examines how people choose among the alternatives available to them.

The fact that gravity is holding you to the earth does not mean that your neighbor is forced to drift up into space!

Opportunity cost is the value of the best alternative forgone in making any choice.

The oily sand is then hauled off in two-story dump trucks which, when filled, weigh more than a Boeing 747.

“You see a lot of the land dug up, a lot of the boreal forest struck down and it’s upsetting, it fills me with rage,” he says.

A rainy day could change the opportunity cost of reading a good book; we might expect more reading to get done in bad than in good weather.

The margin is the current level of an activity. Think of it as the edge from which a choice is to be made.

Why do tickets to the best concerts cost so much? How does the threat of global warming affect real estate prices in coastal areas? Why do women end up doing most of the housework?

In rankings for all three years, economics majors recorded the highest scores.

What is your opportunity cost of pursuing study of economics? Does studying more economics serve your interests and will doing so maximize your satisfaction level?

This finding lends some credence to the notion that the marketplace rewards training in the economic way of thinking.

An economist would add the value of the best alternative use of the additional time that will be required for the child.

There is always a possibility that someone may find a case that invalidates the hypothesis. That possibility means that nothing in economics, or in any other social science, or in any science, can ever be p r o v e n true.

A model of the real world cannot b e the real world.

We cannot ask the world to stand still while we conduct experiments in economic phenomena.

Because no test exists for these values, these two economists will continue to disagree, unless one persuades the other to adopt a different set of values.

The data are consistent with the hypothesis, but it is never possible to prove that a hypothesis is correct.

What if the quantity of time were increased, say to 48 hours per day, and everyone still lived as many days as before. Would time still be scarce?

Ultimately, then, an economy’s factors of production create utility; they serve the interests of people.

Pennsylvania farmers in the eighteenth century who found oil oozing up through their soil were dismayed, not delighted.

We can dispute whether all the changes have made our lives better. What we cannot dispute is that they have made our lives different.

The name Mars reflects its otherworld appearance—it extends 300 feet above the water’s surface and has steel tendons that reach 3,000 feet to the floor of the gulf.

An untapped deposit of natural gas is a natural resource. Once extracted and put in a storage tank, natural gas is capital.

The negative slope of the production possibilities curve reflects the scarcity of the plant’s capital and labor.

The greater the absolute value of the slope of the production possibilities curve, the greater the opportunity cost will be.

Comparative advantage thus can stem from a lack of efficiency in the production of an alternative good rather than a special proficiency in the production of the first good.

Notice that this production possibilities curve, which is made up of linear segments from each assembly plant, has a bowed-out shape; the absolute value of its slope increases as Alpine Sports produces more and more snowboards.

Scarcity implies that a production possibilities curve is downward sloping; the law of increasing opportunity cost implies that it will be bowed out, or concave, in shape.

In this section, we shall assume that the economy operates on its production possibilities curve so that an increase in the production of one good in the model implies a reduction in the production of the other.

Of course, an economy cannot really produce security; it can only attempt to provide it.

Some workers are without jobs, some buildings are without occupants, some fields are without crops.

Inefficient production implies that the economy could be producing more goods without using any additional labor, capital, or natural resources.

Imagine that you are suddenly completely cut off from the rest of the economy. You must produce everything you consume; you obtain nothing from anyone else.

In material terms, the forgone output represented a greater cost than the United States would ultimately spend in World War II.

A failure to allocate resources in this way means that world production falls inside the production possibilities curve; more of each good could be produced by relying on comparative advantage.

Of course, this idealized example would have all of South America’s computer experts becoming farmers while all of Europe’s farmers become computer geeks!

The development of modern information technology—including computers, software, and communications equipment—that seemed to proceed at breathtaking pace especially during the final years of the last century and continuing to the present has transformed the way we live and work.

In the most recent period, 1995–2002, however, these percentages are essentially reversed, with a little less than 30% explained by increases in quantities of the factors of production and a whopping 70% explained by improvements in factor quality and technology.

When Stone Age people fashioned the first tools, they were spending time building capital rather than engaging in consumption.

No economy represents a pure case of either market capitalism or command socialism.

If she were operating under a command socialist system, she would not be the owner of the plants and thus would be unlikely to profit from their efficient use.

North Korea received the dubious distinction of being the least free.

The proposal for cooperation between two countries that had been the most bitter of enemies was a revolutionary one.

Just as the U.S. Constitution prohibits states from restricting trade with other states, the European Union has dismantled all forms of restrictions that countries within the Union used to impose on one another.

Producing each additional unit of the good on the horizontal axis requires a greater sacrifice of the good on the vertical axis than did the previous units produced.

Suppose blue-eyed people were banned from working. How would this affect a nation’s production possibilities curve?

How many pizzas will people eat this year? How many doctor visits will people make? How many houses will people buy?

The quantity demanded of a good or service is the quantity buyers are willing and able to buy at a particular price during a particular period, all other things unchanged.

When a store finds itself with an overstock of some item, such as running shoes or tomatoes, and needs to sell these items quickly, what does it do?

A shift in a demand curve is called a change in demand.

A good for which demand increases when income increases is called a normal good. A good for which demand decreases when income increases is called an inferior good.

If people expect gasoline prices to rise tomorrow, they will fill up their tanks today to try to beat the price increase.

Indeed, according to Clark Kerr, a former president of the University of California system, a university is best understood as a group of people “held together by a common grievance over parking.”

The latter may be the case for some families, since staying at home and watching DVDs is a cheaper form of entertainment than taking the family to the movies.

Goods that cannot be produced, such as additional land on the corner of Park Avenue and 56th Street in Manhattan, are fixed in supply—a higher price cannot induce an increase in the quantity supplied.

When these other variables change, the all-other-things-unchanged conditions behind the original supply curve no longer hold.

If a change in the international political climate leads many owners to expect that oil prices will rise in the future, they may decide to leave their oil in the ground, planning to sell it later when the price is higher.

Students sometimes make the mistake of thinking of such a shift as a shift “down” and therefore as a reduction in supply.

“The chickens didn’t stop laying eggs on Sunday,” Father Joseph chuckles. “When we shifted to cookies we could take Sundays off. We weren’t hemmed in the way we were with the chickens.”

An increase in the price of DVD rentals does not shift the supply curve at all; rather, it corresponds to a movement upward to the right along the supply curve.

The equilibrium price in any market is the price at which quantity demanded equals quantity supplied.

With unsold coffee on the market, sellers will begin to reduce their prices to clear out unsold coffee.

Notice that the supply curve does not shift; rather, there is a movement along the supply curve.

Suppose you are told that an invasion of pod-crunching insects has gobbled up half the crop of fresh peas, and you are asked to use demand and supply analysis to predict what will happen to the price and quantity of peas demanded and supplied.

Whether the equilibrium price is higher, lower, or unchanged depends on the extent to which each curve shifts.

If prices did not adjust, this balance could not be maintained.

The circular flow model shows that goods and services that households demand are supplied by firms in product markets.

Obesity appears to have a stronger association with the occurrence of chronic medical conditions, reduced physical health-related quality of life and increased health care and medication expenditures than smoking or problem drinking.

What more apt picture of our sedentary life style is there than spending the afternoon watching a ballgame on TV, while eating chips and salsa, followed by a dinner of a lavishly topped, take-out pizza?

Usually, market surpluses and shortages are short-lived.

I think the gas companies just use any excuse to jack up prices, and they’re doing it again now.

If the demand curve shifts as in problem 13 and the supply curve shifts as in problem 14, without drawing a graph or consulting the data, can you predict whether equilibrium price increases or decreases?

In 1984, just 8.2% of U.S. households owned a personal computer. By 2007, Google estimates that 78% did.

Higher oil prices also increase the cost of producing virtually every good or service, as at a minimum, the production of most goods requires transportation.

General Motors owns its assembly plants, and Wal-Mart owns its stores; these firms therefore own their capital.

The process through which shares of stock are bought and sold can seem chaotic.

At the equilibrium price, the number of shares supplied by people who think holding the stock no longer makes sense just balances the number of shares demanded by people who think it does.

The attacks on 9/11 provoked fear and uncertainty—two things that are certain to bring stock prices down, at least until other events and more information cause expectations to change again in this very responsive market.

Surpluses and shortages of goods are short-lived as prices adjust to equate quantity demanded with quantity supplied.

While such price reductions have been celebrated in computer markets, farmers have successfully lobbied for government programs aimed at keeping their prices from falling.

Prices received by farmers plunged nearly two-thirds from 1930 to 1933.

However, since farm aid has generally been allotted on the basis of how much farms produce rather than on a per-farm basis, most federal farm support has gone to the largest farms.

Even though an aerial photograph of a city would show apartments to be fixed at a point in time, owners of those properties will decide how many to rent depending on the amount of rent they anticipate.

The monthly rent is $500 and the key price is $3,000.

Filling the 25-gallon tank of an SUV with pure ethanol requires over 450 pounds of corn—which contains enough calories to feed one person for a year.

Nonetheless, it is clear that corn-based ethanol is no free lunch.

When you get a cold, do you go to the doctor? Probably not, if it is a minor cold. But if you feel like you are dying, or wish you were, you probably head for the doctor.

In markets with third-party payers, an equilibrium is achieved, but it is not at the intersection of the demand and supply curves.

The decision turned out to be a painful one; the first year, a seven-year-old boy with leukemia, who might have been saved with a bone marrow transplant, died.

More than 90,000 people queued up, hoping to be lucky winners.

We saw that interfering with the market mechanism may solve one problem but often creates other problems at the same time.

The Internal Revenue Service went along with this and ruled that employer-financed retirement plans were not taxable income.

We know from the law of demand how the quantity demanded will respond to a price change: it will change in the opposite direction. But how much will it change?

Be careful not to confuse elasticity with slope.

The arc elasticity method has the advantage that it yields the same elasticity whether we go from point A to point B or from point B to point A.

By using the average quantity and average price to calculate percentage changes, the arc elasticity approach avoids the necessity to specify the direction of the change.

As we move down the demand curve, equal changes in quantity represent smaller and smaller percentage changes, whereas equal changes in price represent larger and larger percentage changes, and the absolute value of the elasticity measure declines.

Even though people consume less gasoline at $4.25 than at $4.00, total revenue rises because the higher price more than makes up for the drop in consumption.

Total revenue will move in the direction of the variable that changes by the larger percentage.

Notice that the area gained in moving to the rectangle at B is greater than the area lost; total revenue rises to $42,000.

A diabetic will not consume more insulin as its price falls but, over some price range, will consume the amount needed to control the disease.

A change in pencil prices, in contrast, might lead to very little reduction in quantity demanded simply because pencils are not likely to loom large in household budgets.

Your only hope is to increase revenue. Would a fare increase boost revenue?

We can think of driving through red lights as an activity for which there is a demand—after all, ignoring a red light speeds up one’s trip.

Total revenue falls after a few years, since demand changes and becomes price elastic.

A reduction in the price of salsa, for example, would increase the demand for chips, suggesting that salsa is a complement of chips.

A 10 per cent increase in the price of local radio advertising led to a 10 per cent increase in demand for local television advertising.

Teens tend to underestimate the danger of smoking and to overestimate their likely ability to quit smoking when they choose to do so.

It is estimated that for young males the cross price elasticity of smokeless tobacco with respect to the price of cigarettes is 1.2—a 10% increase in cigarette prices leads to a 12% increase in young males using smokeless tobacco.

The supply of Beatles’ songs is perfectly inelastic because the band no longer exists.

What makes this case interesting is that it has sometimes been found that the measured elasticity is negative, that is, that an increase in the wage rate is associated with a reduction in the quantity of labor supplied.

In some very high-paying professions, the labor supply curve may have a negative slope, which leads to a negative price elasticity of supply.

Thus, for this sample of physicians, increases in wages have little or no effect on the amount the primary care doctors work, while a 10% increase in wages for specialists reduces their quantity of labor supplied by about 3%.

Elasticity is a measure of the degree to which a dependent variable responds to a change in an independent variable.

Total revenue moves in the direction of the quantity change if demand is price elastic, it moves in the direction of the price change if demand is price inelastic, and it does not change if demand is unit price elastic.

Economist David Romer found that in introductory economics classes a 10% increase in class attendance is associated with a 4% increase in course grade.

People may not consciously seek to maximize anything, but they behave as though they do.

The rule basically says this: If the additional benefit of one more unit exceeds the extra cost, do it; if not, do not.

Notice that the total benefit curve rises, but by smaller and smaller amounts, as she studies more and more.

Economists do not assume that people have numerical scales in their heads with which to draw marginal benefit and marginal cost curves. They merely assume that people act as if they did.

This rule says that, to maximize the net benefit of an activity, a decision maker should increase an activity up to the point at which marginal benefit equals marginal cost.

Suppose, instead of thinking in intervals of whole hours, we think in terms of smaller intervals, say, of 12 minutes.

The loss in net benefits resulting from a failure to carry out an activity at the efficient level is called a deadweight loss.

It is easy to make the mistake of assuming that if an activity is carried out up to the point where marginal benefit equals marginal cost, then net benefits must be zero.

The only way to prevent oil spills completely is to stop shipping oil. That is a cost few people would accept.

He said resources would be guided, as if by an “invisible hand,” to their best uses.

If it were the case for all grocery items, there would not be grocery stores at all.

This marginal cost is considered in the economic sense—other goods and services worth $1.50 were not produced in order to make an additional pound of tomatoes available.

Exchanges in the marketplace have a remarkable property: Both buyers and sellers expect to emerge from the transaction better off.

For example, if 1% of the population controls virtually all the income, then the market will efficiently allocate virtually all its production to those same people.

The tusks from a single animal could be sold for $2,000 in the black market—nearly double the annual per capita income in Kenya.

A good for which the cost of exclusion is prohibitive and for which the marginal cost of an additional user is zero is a public good.

Recognizing the opportunity to consume the good without paying for it, most would be free riders.

The fact that these goods are produced by a government agency does not make them a public good.

By the time a child who spends the average amount of time watching television finishes elementary school, he or she will have seen 100,000 acts of violence, including 8,000 murders.

A person who turns his or her front yard into a garbage dump may be ordered to clean it up.

Anyone who cut back on hunting in order to help to preserve the herd would lose income—and face the likelihood that other hunters would go on hunting at the same rate as before.

In an important way, however, smokers also generate external benefits. They contribute to retirement programs and to Social Security, then die sooner than nonsmokers.

The efficiency condition is not met; the price is lower and the quantity greater than would be efficient.

If a village in Botswana is granted several licenses to kill elephants, how does this give it an incentive to preserve elephants and increase the size of the herd?

From moment to moment the hedonimeter varies; the delicate index now flickering with the flutter of passions, now steadied by intellectual activity, now sunk whole hours in the neighborhood of zero, or momentarily springing up towards infinity.

The total utility curve shows that when Mr. Higgins attends no movies during a month, his total utility from attending movies is zero.

Failure of marginal utility to diminish would thus lead to extraordinary levels of consumption of a single good to the exclusion of all others.

To achieve the maximum total utility from movies, Mr. Higgins would have to exceed his entertainment budget.

The law of diminishing marginal utility tells us that the marginal utility of good X will fall as the consumer consumes more of it; the marginal utility of good Y will rise as the consumer consumes less of it.

Even a small purchase, such as an ice cream bar, fails the strict test of being divisible; grocers generally frown on requests to purchase one-half of a $2 ice cream bar if the consumer wants to spend an additional dollar on ice cream.

“Isn’t it worth a couple of dollars to spend an extra half-hour with your family?”

The lower price of apples increases the marginal utility of each $1 Ms. Andrews spends on apples, so that at her current level of consumption of apples and oranges Ms. Andrews will respond by purchasing more apples.

This method of adding amounts along the horizontal axis of a graph is referred to as summing horizontally.

In effect, the price reduction for apples was equivalent to handing her a $5 bill, thereby increasing her purchasing power.

After the price reduction, it cost her just $15 to buy what cost her $20 before. She has, in effect, $5 more than she did before.

As their incomes rise and they can afford something they like better, they consume less of the inferior good.

The income effect of a price change works in a direction o p p o s i t e to that of the substitution effect in the case of an inferior good, whereas it reinforces the substitution effect in the case of a normal good.

In order to subsist, the poor reduce consumption of other goods so they can buy more of the staple.

Because the income effect reinforces the substitution effect, CDs are a normal good for her and her demand curve is similar to that shown in Figure 7.6.

Combinations above and to the right of the budget line are beyond the reach of her budget.

Price is not the variable that is shown on the two axes. The axes show the quantities of the two goods.

The collection of indifference curves for a consumer constitutes a kind of map illustrating a consumer’s preferences.

At the point of utility maximization, then, the rate at which the consumer is willing to exchange one good for another equals the rate at which the goods can be exchanged in the market.

The observation of that rule would lead a consumer to the highest indifference curve possible for a given budget.

The market asked her to give up only one; she got her extra day of riding at a bargain!

When the price of horseback riding (the good on the horizontal axis) goes down, the budget line becomes flatter.

Prices of goods tended to be quoted in terms of cigarettes.

Utility is a conceptual measure of satisfaction; it is not actually measurable.

Marie is content to watch the entire program, while John continually switches channels in favor of possible alternatives.

Explain how this demand curve illustrates the law of demand.

The planning period over which a firm can consider all factors of production as variable is called the long run.

Beyond the seventh tailor, production begins to decline and the curve slopes downward.

What happens to your GPA when you get a grade that is higher than your previous average? It rises.

After the seventh unit of labor, Acme’s fixed plant becomes so crowded that adding another worker actually reduces output.

Then you could grow an unlimited quantity of food on your small plot—enough to feed the entire world!

Even if the firm cuts production to zero, it must still pay $200 per day in the short run.

Beyond the seventh jacket, the curve becomes steeper and steeper.

The marginal cost (MC) curve (from Figure 8.7) intersects the ATC and AVC curves at the lowest points on both curves.

The marginal cost curve intersects the average total cost and average variable cost curves at their lowest points.

Should it choose a production process with lots of labor and not much capital, like the street sweepers in China?

The firm achieves a net gain of 2 units of output, without any change in cost, by transferring $1 from capital to labor.

China thus finds it cheaper to clean streets with lots of people using brooms, while the United States finds it efficient to clean streets with large machines and relatively less labor.

Again, notice that the U-shaped LRAC curve is an envelope curve that surrounds the various short-run ATC curves.

Eventually, the diseconomies of management overwhelm any gains the firm might be achieving by operating with a larger scale of plant, and long-run average costs begin rising.

The firm is thus limited to a small scale of operation even though this might involve higher unit costs.

Finally, an outage damages a company’s reputation and inevitably results in dissatisfied customers—some of whom may switch to other companies.

The size of operations necessary to reach the lowest point on the LRAC curve has a great deal to do with determining the relative sizes of firms in an industry.

What was the error in the director’s recommendation?

Shade the regions corresponding to economies of scale, constant returns to scale, and diseconomies of scale.

A price-taking firm or consumer is like an individual who is buying or selling stocks. He or she looks up the market price and buys or sells at that price.

If entry is easy, then the promise of high economic profits will quickly attract new firms.

The notion that firms must sit back and let the market determine price seems to fly in the face of what we know about most real firms, which is that firms customarily do set prices.

He told The Wall Street Journal, “This was very bad for them, but it was good for me.”

For perfectly competitive firms, the price is very much like the weather: they may complain about it, but in perfect competition there is nothing any of them can do about it.

For a perfectly competitive firm, the marginal revenue curve is a horizontal line at the market price.

How many pounds of radishes will he sell if he charges a price that exceeds the market price? None.

Notice that a line drawn tangent to the total cost curve at that quantity has the same slope as the total revenue curve.

Students sometimes make the mistake of calculating economic profit as the difference between the price and the lowest point on the ATC curve.

The firm may close its doors, but it must continue to pay its fixed costs.

We can even think of a firm’s decision to close at the end of the day as a kind of shutdown point; the firm makes this choice because it does not anticipate that it will be able to cover its variable cost overnight.

The lowest point on the average variable cost curve is called the shutdown point.

The 66 satellites were poised to start falling from the sky.

The existence of economic profits in a particular industry attracts new firms to the industry in the long run.

The process of firms leaving Industry B and entering A will continue until firms in both industries are earning zero economic profit.

New firms enter as long as there are economic profits to be made—as long as price exceeds ATC.

An industry in which production costs fall as firms enter in the long run is a decreasing-cost industry.

Having determined how the profit-maximizing firms of the model would respond, we can then predict firms’ responses to similar changes in the real world.

The supply curve in Panel (a) shifts to S, driving the price down in the long run to the original level of $1.70 per bushel and returning economic profits to zero in long-run equilibrium.

Any change in marginal cost produces a similar change in industry supply, since it is found by adding up marginal cost curves for individual firms.

The message of long-run equilibrium in a competitive market is a profound one. The ultimate beneficiaries of the innovative efforts of firms are consumers.

And, as the model of perfect competition predicts, entry has driven prices down, benefiting consumers to the tune of tens of billions of dollars each year.

The equilibrium level of economic profits in the long run is zero.

Who benefits from the fact that they pollute the air? Now suppose the government requires them to reduce their pollution. Who will pay for the cleanup?

What level of output should the firm produce? Should it shut down? Should it exit the industry? Explain.

A monopoly does not take the market price as given; it determines its own price.

By cutting its price below the minimum average total cost of the smaller plants, the larger firm could drive the smaller ones out of business.

Network effects arise in situations where products become more useful the larger the number of users of the product.

He will not even allow inspectors from the government of the United States to set foot on his bridge.

Because it is the only supplier in the industry, the monopolist faces the downward-sloping market demand curve alone.

In this section, we shall see why a monopoly firm will always select a price in the elastic region of its demand curve.

A monopoly firm will never choose a price and output in the inelastic range of the demand curve.

The marginal revenue of the third unit is the $7 the firm receives for that unit minus the $1 reduction in revenue for each of the first two units.

Because there are no rivals selling the products of monopoly firms, they can charge whatever they want.

It cannot just “charge whatever it wants.” And if it charges “all the market will bear,” it will sell either 0 or, at most, 1 unit of output.

“It’s clear that these teams are very sophisticated in their use of pricing to maximize profits,” Mr. Ferguson said.

The higher price charged by a monopoly firm may allow it a profit—in large part at the expense of consumers, whose reduced options may give them little say in the matter.

The fact that society suffers a deadweight loss due to monopoly is an efficiency problem. But the transfer of a portion of consumer surplus to the monopolist is an equity issue.

Graft and corruption may be the result, claim these critics.

Potential rivals are always beating at the door and thereby making the monopoly’s fragile market contestable—that is, open to

Forces that limit the power of monopoly firms are the constant effort by other firms to capture some of the monopoly firm’s profits and technological change that erodes monopoly power.

The turmoil that has followed illustrates the fragility of monopoly power.

Because a typical monopolist holds market price above marginal cost, the major impact of monopoly is a reduction in efficiency.

People often blame the high prices for events such as professional football and basketball and baseball games on the high salaries of professional athletes.

In fact, differentiated markets imply that the notion of a single “market price” is meaningless.

To sell more pizzas, Mama’s must lower its price, and that means its marginal revenue from additional pizzas will be less than price.

Such comings and goings are typical of monopolistic competition.

The inefficiency of monopolistic competition may be a small price to pay for a wide range of product choices.

If you haven’t had very many choices, and all of a sudden you get choices—especially if those choices involve a lot of flavor and quality—it’s hard to go back.

Some firms will exit as competitors win customers away from them.

In an oligopoly, the fourth and final market structure that we will study, the market is dominated by a few firms, each of which recognizes that its own actions will produce a response from its rivals and that those responses will affect it.

The concrete industry appears to be highly competitive. But concrete is produced in local markets—it is too expensive to ship it very far—and many of these local markets are dominated by a handful of firms.

Uncertainty about the interaction of rival firms makes specification of a single model of oligopoly impossible.

Any one firm might calculate that it could charge slightly less than the cartel price and thus capture a larger share of the market for itself.

The outcome of a strategic decision is called a payoff. In general, the payoff in an oligopoly game is the change in economic profit to each firm.

But because the prisoners cannot communicate, each is likely to make a strategic choice that results in a more costly outcome.

An oligopoly game is a bit like a baseball game with an unlimited number of innings—one firm may come out ahead after one round, but another will emerge on top another day.

As crazy as it seemed, however, it worked. For 40 years, the two nations did not go to war.

In the end, though, the purchasers of their products paid in the form of higher prices or less memory.

One legal cartel is the NCAA, which many economists regard as a successful device through which member firms (colleges and universities) collude on a wide range of rules through which they produce sports.

Hearing that “Pepsi is the right one, baby” or “Tide gets your clothes whiter than white” may not be among the most edifying lessons consumers could learn.

Advertising is thus a two-edged sword.

As long as a firm faces a downward-sloping demand curve and thus has some degree of monopoly power, it may be able to engage in price discrimination.

Resale may be particularly difficult for certain services, such as dental checkups.

A grocery store does not charge a higher price for vegetables to vegetarians, whose demand is likely to be less elastic than that of its omnivorous customers.

The $10 fee to foreigners would permit the country to exploit its monopoly power in permitting people to visit the parks.

Each oligopolist is aware of its interdependence with other firms in the industry and is constantly aware of the behavior of its rivals.

Why do these professors not worry that the students will get together and collude in such a way as to keep the high score in the class equal to a very low total?

If the extra output that is produced by hiring one more unit of labor adds more to total revenue than it adds to total cost, the firm will increase profit by increasing its use of labor.

With two accountants, a degree of specialization is possible if each accountant takes calls dealing with questions about which he or she has particular expertise.

It may seem counterintuitive that firms do not operate in the range of increasing returns, which would correspond to the upward-sloping portion of the marginal revenue product curve.

These two marginal decision rules are really just two ways of saying the same thing: one rule is in terms of quantity of output and the other in terms of the quantity of factors required to produce that quantity of output.

Because the demand for factors that produce a product depends on the demand for the product itself, factor demand is said to be derived demand.

Office automation and organizational restructuring have led secretaries to assume a wide range of new responsibilities once reserved for managerial and professional staff.

The more leisure people demand, the less labor they supply.

What is the price of an extra hour of leisure? It is the wage W that the individual forgoes by not working for an hour.

With the substitution and income effects working in opposite directions, it is not clear whether a wage increase will increase or decrease the quantity of labor supplied—or leave it unchanged.

The supply curve for labor can thus slope upward over part of its range, become vertical, and then bend backward as the income effect of higher wages begins to dominate the substitution effect.

Financial planners have, in recent years, sought the introduction of tougher licensing requirements, which would reduce the supply of financial planners.

The effects of these two changes pull the quantity of labor supplied in opposite directions.

When total compensation drops by more than 50% it is difficult to keep your financial head above water no matter how well you have budgeted.

Because each firm is a price taker, it faces a horizontal supply curve for labor at the market wage.

The plague killed about one-third of the people of Europe within a few years, shifting the supply curve for labor sharply to the left.

The market is an extremely powerful mechanism for moving resources to the areas of highest demand. At the same time, however, changes in technology seem to be leaving less educated workers behind.

In contrast, the twentieth century has been characterized by skill-biased technical change because the rapid increase in the supply of skilled workers has induced the development of skill-complementary technologies.

For example, the gap between the wages of high school-educated and college-educated workers widened in hospitals, and they aren’t affected by foreign production.

It is possible that, above some wage, the income effect more than offsets the substitution effect. At or above that wage, an individual’s supply curve for labor is backward bending.

“I love my work; the wage I’m paid has nothing to do with the amount of work I want to do.”

“I’m sorry, kids, but now that I’m earning more, I just can’t afford to come home early in the afternoon, so I won’t be there when you get home from school.”

Time, the saying goes, is nature’s way of keeping everything from happening all at once.

Aunt Carmen is offering you $1,000 if you will pass up the $10,000 today.

The longer the time period before a payment is to be made, the lower its present value.

Given the alternative of claiming the $220.3 million jackpot in 30 annual payments of $7.4 million or taking $125.3 million in a lump sum, he chose the latter.

From the buyer’s point of view, a speedy death is desirable, because it means the investor will collect quickly on the purchase of a patient’s policy.

Increases in capital increase the marginal product of labor and boost wages at the same time they boost total output.

A negative NPV implies that the funds for the asset would yield a higher return if used to purchase an interest-bearing asset.

At an interest rate of 7%, the NPV is positive. At an interest rate of 8%, the NPV would be negative.

Economists say that the demand for a factor is a “derived” demand—derived, that is, from the demand for what the factor produces.

The interest rate is determined in a market in the same way that the price of potatoes is determined in a market: by the forces of demand and supply.

Will higher interest rates encourage the behavior they reward? The answer is a resounding “maybe.”

Because changes in interest rates produce substitution and income effects that pull saving in opposite directions, we cannot be sure what will happen to saving if interest rates change.

A change in the quantity of capital that firms demand can begin with a change in the demand for capital or with a change in the demand or supply of loanable funds.

For the most part, there is scant evidence that the MBA credential, particularly from non-elite schools…are related to either salary or the attainment of higher level positions in organizations.

In the absence of government intervention, natural resources that are common property may be destroyed.

With oil prices expected to rise 15% per year, the dollar value of your oil will increase faster if you leave it in the ground than if you pump it out, sell it, and purchase an interest-earning asset.

In short, why do prices of natural resources fluctuate as they do? Should the process of continuing to “exhaust” them just drive their prices up over time?

The market simply will not allow us to “run out” of exhaustible natural resources.

While this solution may be efficient, the resource will not be sustained over time at current levels.

If he earns $30 million per year now but could earn $100,000 in a best alternative occupation, then $29.9 million of his salary is economic rent.

Khurais, however, is no Ghawar. Not only is its expected yield much smaller, but it is going to be far more difficult to exploit.

What we face, he told The Wall Street Journal in 2008, is a grim future of depleting oil resources and rising prices.

In general, economic rent is return to a resource in excess of the minimum price necessary to make that resource available.

Explain why higher interest rates tend to increase the current use of natural resources.

Assuming your goal is to maximize your revenue from the wine, at what point will you sell it?

Monopsony is the buyer’s counterpart of monopoly. Monopoly means a single seller; monopsony means a single buyer.

The quantity of labor used by the monopsony firm is less than would be used in a competitive market; the wage paid is lower than would be paid in a competitive labor market.

As New York Yankees owner George Steinbrenner once put it, “You measure the value of a ballplayer by how many fannies he puts in the seats.”

Before 1977, for example, professional baseball players in the United States played under the terms of the “reserve clause,” which specified that a player was “owned” by his team.

A university hiring a local accountant to teach a section of accounting does not have to worry that that person will go to another state to find a better offer as a part-time instructor.

For average and star-quality players, salaries fell far below net MRP, just as the theory of monopsony suggests.

But, the economic lesson remains clear: any weakening of the monopsony power of teams results in gains in player salaries.

The firm thus increases its employment of labor in response to the minimum wage.

Economist Alan Manning notes that the competitive model implies that a firm that pays a penny less than the market equilibrium wage will have zero employees.

Evidence that casts doubt on the proposition that higher minimum wages reduce employment does not remove many economists’ doubt that higher minimum wages would be a good policy.

To strengthen its position, a union may threaten a strike—a refusal by union members to work—unless its demands are met.

Impressive economy-wide wage gains over the last two centuries may be one reason why the attraction of unions has remained weak.

The model of bilateral monopoly does not tell us the wage that will emerge; whether the final wage will be closer to what the union seeks or closer to what the employer seeks will depend on the bargaining strength of the union and of the employer.

The AMA has been very successful in limiting the number of physicians, thus maintaining higher salaries than would otherwise exist.

By forming a cooperative, farmers could counter the monopsony power of a processor with monopoly power of their own, creating a bilateral monopoly.

A demoralized labor force produced dramatic reductions in the quality of service, and Continental was back in bankruptcy in 1991.

The key to success seems to lie in the establishment of workplace culture that rewards good teamwork and efforts to enhance productivity.

A bilateral monopoly results in a kind of price-setters’ standoff, in which the firm seeks a low wage and the union a high one.

Now suppose the firm is required to pay a minimum wage of $48 per day. Show what will happen to the quantity of labor the firm will hire and the wage it will pay.

In 1929, government expenditures at all levels were less than 10% of the nation’s total output; in the current century, that share has more than tripled.

That rather rosy forecast was set aside after September 11, 2001.

In addition to governments that spend more, people in the United States have clearly chosen governments that do more.

In most cases, we expect that markets will come close to achieving this result—that is the important lesson of Adam Smith’s idea of the market as an invisible hand, guiding the economy’s scarce factors of production to their best uses.

Consequently, each consumer has an incentive to be a free rider in consuming the good, and the firms providing a public good do not get a signal from consumers that reflects their benefit of consuming the good.

An imperfectly competitive private market will produce less of a good than is efficient.

If the public sector finds a way to confront producers with the social cost of their production, then the supply curve shifts to S, and production falls to the efficient level Q.

Stigler’s point was that even though the market is often an inefficient allocator of resources, so is the government likely to be.

If 5% of the people receive 95% of the income, it might be efficient to allocate roughly 95% of the goods and services produced to them.

The fact that most transfer payments in the United States are not means-tested leads to something of a paradox: some transfer payments involve taxing people whose incomes are relatively low to give to people whose incomes are relatively high.

But, in an economy in which angry voters wield considerable influence, trying to fix rising gasoline prices can turn into a task from which a wise politician does not shrink.

But, the public sector consists of people, and when those people become angry, the urge for intervention can become unstoppable.

The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.

A flat tax with an income exemption would thus be a progressive tax.

It is hard to imagine anything that has not been taxed at one time or another. Windows, closets, buttons, junk food, salt, death—all have been singled out for special taxes.

It is that $5,950 that the individual will weigh against the opportunity cost in forgone leisure in deciding whether to do the extra work.

The important thing to see is that the tax drives a $2 per pound “wedge” between the price buyers pay and the price sellers receive.

We insert this tax wedge between the demand and supply curves.

The study assigned taxes on the basis of who bears the burden, not on who pays the tax.

Overall, they found that a pattern of marginal rates for various ages and income levels could be described in a single word: “bizarre.”

No one designed these marginal incentives. They simply emerge from the bewildering mix of welfare and tax programs households face.

Public choice theory discards the notion that people in the public sector seek to maximize net benefits to society as a whole.

The probability that any statewide election will be decided by a single vote is, effectively, zero.

In the real world, it is not individual voters who count but well-organized groups that can deliver the support of voters to a candidate.

If candidates did not need to seek funding from special interests, the influence of these groups would wane.

The recounting process proved to be one of the most bizarre chapters in American political history.

The second approach to the analysis of the public sector is public choice theory, which assumes utility-maximizing and rent-seeking behavior on the part of participants in the public sector and those trying to influence it.

V.I. Lenin, founder of the former Soviet Union, wrote that “the State is a machine for the oppression of one class by another.”

These businesses were led by entrepreneurs who, rightly or wrongly, have come to be thought of as “robber barons” out to crush their competitors, monopolize their markets, and gouge their customers.

The Court recognized that lower shoe prices would have benefited consumers, but chose to protect competitors instead.

The Clayton Act (1914) clarifies the illegal per se provision of the Sherman Act by prohibiting the purchase of a rival firm if the purchase would substantially decrease competition, and outlawing interlocking directorates, in which there are the same people sitting on the boards of directors of competing firms.

If a firm is more efficient than its competitors, why should it be punished?

The typical antitrust case is an almost impudent exercise in economic gerrymandering.

The Court prevented the merger on grounds the new company would be able to charge a lower price than its rivals!

In the proposed merger between United Shoe Machinery and Brown Shoe, the court clearly chose to protect the welfare of firms in the industry rather than the welfare of consumers.

In an antitrust context, joint ventures refer to cooperative arrangements between two or more firms that otherwise would violate antitrust laws.

Mergers that create substantial monopoly power in Japan are not typically prosecuted by the government.

This legislation opened the door for U.S. competitors to use antitrust laws to prevent competition from foreigners, quite the opposite of the laws’ original purpose.

U.S. firms that have been “undersold” by foreign firms can charge those firms with “dumping.”

The policy difference is fundamental. Americans argue that they seek to protect competition, while the EU protects competitors—even if consumers suffer as a result.

Another consideration is that technological change in this industry is occurring so rapidly that competitors can emerge from anywhere.

In the case of natural monopolies, regulation is viewed as necessary to lower prices and increase output.

The regulators get “captured” by the very firms they are supposed to be regulating.

In some cases, then, the behavioral changes attributed to consumer protection laws may actually worsen the problem the laws seek to correct.

Many airlines, unused to the demands of a competitive, unprotected, and unregulated environment, went bankrupt or were taken over by other airlines.

Consumer protection efforts may sometimes be useful, but they tend to produce behavioral responses that often negate the effort at protection.

Mr. Viscusi says that the tragic result is a dramatic increase in the number of children poisoned each year.

Another believes that much current regulation protects regulated firms from competitive market forces and that the regulators are captured by the firms they are supposed to regulate.

DuPont argued that the definition of the market should be changed to include all wrapping paper. Why is this issue of market definition important?

To model the effects of trade, we begin by looking at a hypothetical country that does not engage in trade and then see how its production and consumption change when it does engage in trade.

As the law of increasing opportunity costs predicts, in order to produce more boats, Roadway must give up more and more trucks for each additional boat.

Despite the fact that Roadway can produce more of both goods, it can still gain from trade with Seaside—and Seaside can gain from trade with Roadway.

The fact that the opportunity costs differ between the two countries suggests the possibility for mutually advantageous trade.

Once trade opens between the two countries, truck producers in Roadway will rush to export trucks to Seaside.

Notice that each country produces on its production possibilities curve, but international trade allows both countries to consume a combination of goods they would be incapable of producing!

Trade allows countries to consume combinations of goods and services they would be unable to produce.

Doomsayers suggest that our comparative advantage in the twenty-first century will lie in flipping hamburgers and sweeping the floors around Japanese computers.

Distinguish between one-way trade and two-way trade.

Such adjustments are likely to be faster and less painful for labor and for the owners of the capital and natural resources involved.

Whether the differences in brands of water are perceived or real, it may not be too long before restaurants develop water lists next to their beer and wine lists.

The U.S. price of sugar is almost triple the world price of sugar, thus reducing the quantity consumed in the United States.

In defining cost, the government agency invariably includes a specification of a “normal” profit. That normal profit can be absurdly high.

The United States once imposed size restrictions to “protect” U.S. consumers from small tomatoes.

After only a few Concordes had been produced, it became obvious that the aircraft was a financially losing proposition and production was halted.

Estimates of the cost of saving one job in the steel industry through restrictions on steel imports, for example, go as high as $800,000 per year.

In effect, a poor country’s lower demand for environmental quality gives it a comparative advantage in production of goods that generate a great deal of pollution.

Voluntary export restrictions are another means of protection; they are rarely voluntary.

Thus, with the phenomena of complementarity, increases in scale, and increases of scope, each job outsourced led to almost two additional jobs in the United States.

Free trade allows nations to consume goods beyond their domestic production possibilities curves.

They argue that if a good can be produced more cheaply abroad than at home, tariffs should be imposed on the good so that the costs of producing it are the same everywhere.

Explain why pollution can be said to have benefits as well as costs and describe the nature of these benefits and costs.

The difficulty with pollution problems is that decision makers experience the benefits of their own choices to pollute the environment, but the costs spill over to everyone who breathes the air or consumes the water.

Fresh air has become scarce, and pollution has become an economic problem.

Mary and Jane will pollute up to the point that the marginal benefit of additional pollution to them has reached zero—that is, up to the point where the marginal benefit matches their marginal cost.

The notion that too little pollution could be inefficient may strike you as strange.

The proposition that if property rights are well defined and if bargaining is costless, the private market can achieve an efficient outcome regardless of which of the affected parties holds the property rights is known as the Coase theorem.

In effect, Mr. Coase insists that the harm cannot be attributed to one party or another.

It is always the case that there are several potential ways of mitigating the effects of airport operations; the economic problem is to select the most efficient from among those alternatives.

We can thus think of the marginal benefit of an additional unit of pollution as the added cost of not emitting it.

The marginal cost curve of the first few units of emissions is zero and then rises once emissions begin to harm people. That is the point at which the air becomes a scarce resource.

To economists, such an ostrich-like approach of sticking one’s head in the sand would be unacceptable.

The existence of pollution implies that an environmental resource has alternative uses and is thus scarce.

A house closer to a hazardous waste site is cheaper; people take advantage of the lower price of such sites to purchase larger houses.

Pleas that people refrain from driving on certain days when pollution is very great, for example, achieve virtually no compliance.

Although it may seem fair to require equal reductions by the two firms, this approach is likely to generate excessive costs.

Suppose, for example, that labor were allocated according to a command-and-control mechanism. Rather than leaving labor allocation to the marketplace, suppose that firms were simply told how much labor to use.

Environmental groups went to federal court, charging that the taxes constituted a “license to pollute.”

As long as their marginal benefits of pollution differ, the firms can profit from exchange.

Economists have long argued that as pollution-control authorities replace command-and-control strategies with incentive approaches, society will reap huge savings.

The exchange of pollution rights can achieve a given reduction in emissions at the lowest cost possible.

Multiplying that extra slowing by the number of cars behind you gives the marginal delay of adding your own car to an already congested highway.

The paper mill will reduce its pollution until the marginal benefit of polluting equals the tax.

These environmentalists insist that pollution is wrong, and that no one should be able to buy the right to pollute the environment.

What is the price elasticity of house prices with respect to proximity to a hazardous waste site?

The gap between the average annual incomes of high school graduates and those with a bachelor’s degree increased by nearly a factor of five between 1975 and 2006.

The closer a Lorenz curve lies to the 45-degree line, the more equal the distribution. The more bowed out the curve, the less equal the distribution.

The researchers further comment that, for the 1990s, moving across quintiles has become harder to achieve precisely because of the increased income inequality.

The use of production teams, for example, shifts decision-making authority to small groups of assembly-line workers.

Whether these changes increased or decreased fairness in the society is ultimately a normative question.

Equilibrium in a society in which people think incomes are a result of luck, connections, and corruption turns out to be precisely that.

How can a nation that is so rich have so many people who are poor?

The first is an absolute income test, which sets a specific income level and defines a person as poor if his or her income falls below that level.

Still, the poverty rate in the United States is greater than that of any other industrialized nation.

The average poor person in the United States has more living space than the average person in London, Paris, Vienna, or Athens.

The incidence of poverty soars when several of these demographic factors associated with poverty are combined.

The poor are not likely to be successful competitors in the contest to be at the receiving end of public sector income redistribution efforts; most redistribution goes to people who are not poor.

If a typical household would prefer, say, $515 in cash to $515 in food stamps, then $515 worth of food stamps is not valued at $515 in cash.

Clearly, the United States is the least aggressive in seeking to eliminate poverty among the eight countries shown.

Cash programs might reduce the degree of poverty, but might not affect a family’s income enough to actually move that family above the poverty line.

Prime Minister Blair promised to 'make welfare popular again.'

In the real world, we know that on average women and members of racial minorities receive different wages from white male workers, even though they may have similar qualifications and backgrounds.

To the extent that discrimination exists, a country will not be allocating resources efficiently; the economy will be operating inside its production possibilities curve.

If the market is at least somewhat competitive, firms who continue to discriminate may be driven out of business.

The wages of white women were about 65% of those of white men in 1955, and fell to about 60% from the mid-1960s to the late 1970s.

Most federal activity was directed toward the South, and the civil rights effort shattered an entire way of life that had subjugated black Americans and had separated them from mainstream life.

However, it may be a long time before discrimination disappears from the labor market, not only due to remaining discriminatory preferences but also because the human capital and work characteristics that people bring to the labor market are decades in the making.

By the age of eight, differences in learning abilities are essentially fixed.

The long-term impact on poverty is still under investigation.

Suppose you were an entrepreneur who knew that the common belief was wrong. What could you do to enhance your profits?

Suppose Professor Heckman’s recommendation for early intervention for low income children is followed and that it has the impact he predicts.

The market value of all final goods and services produced can rise even if total output falls.

The committee typically determines that a recession has happened long after it has actually begun and sometimes ended!

The story of the business cycle is the story of progress and plenty, of failure and sacrifice.

Third quarter, 2002 35.7

Predicting business cycle turning points has always been a tricky business.

Inflation and deflation refer to changes in the average level of prices, not to changes in particular prices.

If you are a borrower, unexpected inflation is a good thing—it reduces the value of money that you must repay.

In Yugoslavia in 1993 there was a report of a shop owner barring the entrance to his store with a mop while he changed his prices.

A price index is a number whose movement reflects movement in the average level of prices.