The deadweight loss debate

Supply, demand, elasticity, deadweight loss all this economic theory i enough to make your head spin. But believe it or not, these ideas go to the heart of a profound political question How big should the government be The debate hinges on these concepts because the larger the deadweight loss of taxation, the larger the cost of any government program. If taxation entails large deadweight losses, then these losses are a strong argument for a leaner government that does less and taxes less. But...

Why The Fed Watches The Stock Market And Vice Versa

Irr.itvon.il exuberance.' Th.it was how Federal Reserve Chairman Alan Greenspan once described the booming stock market of the late 1990s. He was right that the market was exuberant Average tuck prices increased about fourfold during this decade And perhaps it was even irrational In the first few years of the following decade, the stock market took back some of these large gains, as stock prices experienced a pronounced decline, falling by about 40 percent from 20(10 to 2003. How should the Fed...

Con Monetary Policy Should Not Be Made by Rule

There may be pitfalls with discretionary monetary policy, but there is also an important advantage to it flexibility. The Fed has to confront various circumstances, not all of which can be foreseen. In the 1930s, banks failed in record numbers. In the 1970s, the price of oil skyrocketed around the world. In October 1987, the stock market fell by 22 percent in a single day. In 2007 and 2008, house prices dropped, and home foreclosures soared. The Fed must decide how to respond to these shocks to...

Why Monopolies Arise

Monopoly a firm that is the sotc seller of * product without close ttJbstitute* A firm is a monopoly i it is the sole seller of its product and if its product dries not have close substitutes. The fundamental cause of monopoly is terriers to entry A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it. Barriers to entry, in turn, have three main sources Monopoly mirrors A key resource required for production is owned by a single firm....

Info

Coeipurativ ddvanlag and, 55-56 economic growth and, 567 um inxn. is* Gains from trade international. 5 r International trade Tt de restrict KteiaJtzotton and, 52-54 Trade balance, 692 Iraiie polkk* and, 72 -7 30 Trade dcfi.it, W3,700 ((t'tul Hiving y.lul and, 726-727 of United Stales, 700-702.726-727 TrodtoHi. 4-5 Si* Philip cuit* polky cfoitoon and, 31 production posst.il.tics tnanttai and. 27 between work and kwure, 399 Trade policy. 728 m open economies, 728-7X1 Trade re-.trfctfc i effects...

The Case against Active Stabilization Policy

Some economists argue that the government should avoid active use of monetary and fiscal polky to try to stabilize Ihe economy. They claim that these policy instruments should be set to achieve long-run goals. Such as rapid economk growth and low inflation, and that the economy should be left to deal with short-run fluctuatkmson its own. Although these economists may admit that monetary and fiscal polky can stabilize the economy in theory, they doubt whether it can do so in practice. The...

The Cost Of Reducing Inflation

In October 1979, a OPEC was imposing adverse supply shocks on the world's economics for the second time in a decode. Fed Chairman Paul Volcker decided that the time for action had come. Volcker had been appointed chairman by President Carter only two months earlier, and he had taken the job knowing that inflation had reached unacceptable lex-els. As guardian of the nation's monetary system, he felt he had little choice but to pursue a policy of disinflation a reduction in the rate of inflation....

Income Inequality and Poverty

He only difference between the rich and other people, Mary Colum once said to Ernest Hemingway, is that the rich have more money. Maybe so Hut this claim leaves many questions unanswered The gap between rich and poor is a fascinating and important topic of study for the comfortable rich, for the struggling poor, and for the aspiring and worried middle class. From the previous two chapters, you should have some understanding about why different people have different incomes. A person's earnings...

The Role op Interest Rate Targets in Fed Policy

How docs the Federal Reserve affect the economy Our discussion here and earlier in the book has treated the money supply as the Fed's policy instrument. When the Fed buys government bonds in open-market operations, it increases the money supply and expands aggregate demand. When the Fed sells government bonds in open-market operations, it decreases the money supply and contracts aggregate demand. Discussions Ot Fed policy often treat the interest rate, rather than the money supply, as the Fed's...

Supply And Demand For Loanable Funds And For Foreigncurrency Exchange

To understand the forces at work in an open economy, we focus on supply and demand in two markets. The First is the market for loanable funds, which coordinates the economy's saving, investment, and flow of loanable funds abroad (called the nel capital outflow). The second is the market for foreign-currency exchange, which coordinates people who want to exchange the domestic currency for the currency of other countries. In this sect ion, we discuss supply and demand in each of these markets. In...

Questions For Review

What is moral hazard I ist three things an employer might do to reduce the severity of this problem. 2. What is adverse selection Give an example of a market in which adverse selection might be a problem. 3. Define sijttirfr> fg and screening and give an example of each. 4. What unusual property of voting did Condorcet notice7 5- Explain why majority rule respects the preferences of the median voter rather than the average voter. 6. Describe the ultimatum game. What outcome from this game...

The Monetary System

When you walk into a restaurant to buy a meal, you get something of value a full stomach. To pay for this service, you might hand the restaurateur several worn-out pieces of greenish paper decorated with strange symbols, government buildings, and the portraits of famous dead Americans- Or you might hand him a single piece of paper with the name of a bank and your signature. Whether you pay by cash or check, the restaurateur is liappy to work hard to satisfy your gastronomical desires 111...

Frifa WH0 Pays The Corporate Income Tax

The corporate income tax provides a good example of the importance of tax incidence for lax pol icy. The corporate ta x is popu lar among voters. After all, corporations are not people. Voters are always eager to have their taxes reduced and have some impersonal corporation pick up the tab. Ijfr But before deciding that the corporate income tax is a good way for the government to raise revenue, we should consider who bears the burden of the corporate I.' tax. This is a difficult question on...

The Gains and Losses of an Exporting Country

Figure 2 shows the lsolandian textile market when the domestic equilibrium price before trade is below the world price. Once trade is allowed, the domestic price rises to equal the world price. No seller of textiles would accept less than the world price, and tu> buyer would pay more than the world price. After the domestic price has risen to equal the world price, the domestic quantity supplied differ from the domestic quantity demanded. The supply curve shows the quantity of textiles...

Consumer Surplus

We begin our study of welfare economics by looking at the benefits buyers receive from participating in a market. Imagine lhat you own a mint-condition recording of Elvis Presley's first album. Because you are not an Elvis Presley fan, you decide to sell it. One way to do so is to hold an auction- Four Elvis fans show up for your auclion John, Paul, George, and Ringo. Each of them would like to own the album, but thenr is a limit to the amount that each is willing to pay for it. Table 1 shows...

G U R E 1

Recall that economistsdistinguish between the real interest rate and the nominal interest rate. The nominal interest rate is the interest rate as usually reported the monetary return to saving and the monetary cost of borrowing. The real interest rate is the nominal interest rate corrected for inflation it equals the nominal interest rale minus the inflation rate. Because inflation erodes the value of money over time, the real interest rate more accurately reflects the real return to saving and...

An Alternative View of Education Signaling

Earlier we discussed the human-capital view of education, according to whkh school ing raises workers' wages becausc it makes them more productive- Although this view is widely accepted, some economists have proposed an alternative theory, which emphasizes that firms use educational attainment as a way of sorting between high-ability and low-ability workers. According to this alternative view, when people earn a college degree, for instance, thev do not become more productive, but they do...

Markets With Only A Few Sellers

Because an oligopolistic market has only a small group of sellers, a key feature of oligopoly is the tension between cooperation and self-interest. The group of oligopolists is best off cooperating and acting like a monopolist producing a small quantity of output ami charging a price above margin. cost. Vet because each oligopolist cares only about its own profit, there are powerful incentives at work that hinder a group of firms from maintaining the monopoly outcome. To understand the behavior...

The Theory of Consumer Choice

When you walk into a store, you are confronted with thousands of goods that you might buy. Because your financial resources are limited, however, you cannot buy everything that you want. You therefore consider the prices of the various goods offered for sale and buy a bundle of goods that, given your resources, best suits your needs and desires. In this chapter, we develop a theory thai describes how consumers make decisions about what to buy. Thus far in this book, we have summarized...

The Budget Constraint What The Consumer Can Afford

Budget constant the limit on the consumption bundles that o consumer can eHord Most people would like to increase the quantity or quality of the goods they consume to take longer vacatk> ns, drive fanck'r cars, or eat at better restaurants. People consume less than they desire because their spending is constrained, or limited, by their income- We begin our study of consumer choke by examining this link between income and spending. To keep tilings simple, we examine the decision facing a...

Advertising

II is nearly impossible to go through a typical day in a modern economy without being bombarded with adv ertising. Whether you are reading a newspaper, watching television, or driving down the highway, some tlrm will try to convince you to buy its product. Such behavior is a natural feature of monopolistic competition (as well as some oligopolistic industries). When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise to attract more...

Evaluating the Market Equilibrium

Figure 7 shows consumer ami prtxlucvr surplus when a market reaches the equilibrium of supply and demand. Recall that consumer surplus equals the area above the price and under the demand curve and producer surplus equals the area below the price and above the supply curve. Thus, the total area between the supply and demand curves up to the point of equilibrium represents the total surplus in this market. Is this equilibrium allocation of resources efficient Thai is, does it maximize total...

Market Based Policy 2 Tradable Pollution Permits

Returning to our example of the paper mill and the steel mill, lei us suppose that, despite the advice of its economists, the EPA adopts the regulation and requires each factory to reduce its pollution to 300 tons of glop per year. Then one day, after the regulation is in place and both mills have complied, the two firms go to the EPA with a proposal. The steel mill wants to increase its emission of glop by 11)1) tons. The paper mill has agreed to reduce its emission by the same amount if the...

How The Economy As A Whole Works

Westarted by discussing how individuals make decisions and then looked at how people interact with one another. All these decisions and interactions together make up Ik economy. The last Ihree principles concern the workings of Ihe economy as a whole- Principle 8 A Country's Standard of Living Depends on Its Ability to Produce Goods and Services The differences in living standards around the world are staggering. In 2006, the average American had an income of about 44,260. In the same year, the...

The Economics Of Cooperation

As we have seen, oligopolies would like to reach the monopoly outcome, but doing so requires cooperation, which at time b difficult to establish and maintain. In thb section we look more closely at the problems that arise when cooperation among actors b desirable but difficult. To analyze the economics of cooperation, we need to leam a little about game theory. In particular, we focus on an important game called the prisoners' dilemma Thb game provides insight into why cooperation is difficult....

The Unfair Competition Argument

A common argument is that free trade is desirable only if .ill countries play by the same rules. If firms in different countries are subject to different laws and regulations, then it is unfair (the argument goes) to expect the firms to compete in the international marketplace. For instance, suppose that the government of Neighborland subsidizes its textile industry by giving textile companies large tax breaks. The Isolandian textile industry might argue that it should be protected from this...

Thf Difficult Job of Cost Bpnffit Analysis

- So far we have seen that the government provides public goods because the pri-5 vate market on its own will not produce an efficient quantity. Yet deciding that the government must play a role is only the first step. The government must then wnat ns ooi> o ims determine what kinds of public goods to provide and in what quantities. Suppose that the government is considering a public project, such is build ing a new highway. To judge whether to build the highway, it must compare the total...

Aggregate Demand Aggregate Supply and the Phillips Curve

The model of aggregate demand and aggregate supply provides an easy explanation for the menu of possible outcomes described by the Phillips curve. The Phillips cum- shell's the combinations of'inflation and unemployment that arise in the short run as shifts m the aggregate-demand curtv moi< e the economy along the shorl-run aggregate-supply cunr. As we saw in the preceding two chapters, an increase in the aggregate demand for goods and services leads, in the short run, to a larger output of...

Why Economists Disagree

If all economists were laid end to end, the)' would not reach a conclusion. This quip from George Bernard Shaw is revealing. Economists as a group are often criticized for giving conflicting advice to policymaker . President Ronald Reagan onoc joked that if the game Trivial Pursuit were designed for economists, it would have 100 questions and 3,IXX> answers Why do economists so often appear to give conflicting advice to policymakers There are two basic reason* Economist may disagree about the...

A Linear Demand Curve

Let's examine how elasticity varies along a linear demand curve, as shown in Figure 4. We know that a straight line has a constant slope. Slope is defined as rise over run, which here is the ralio of the change in price (rise) to the change in quantity (run)- This particular demand curve's slope is constant because each increase in price causes the same two-unit decrease in the quantity demanded- Even though the slope of a linear demand curve is constant, the elasticity is not. This is true...

The Markets for the Factors of Production

When you finish school, your income will be determined largely by what kind of job you take. If you become a computer programmer, you will earn more than if you become a gas station attendant. This fact is not surprising, hut it is not obvious why it is true. No law requires that computer programmers be paid more than gas station attendants. No ethical principle says that programmers are more deserving. What then determines which job will pay you the higher wage Your income, of course, is a...

Should Monetary And Fiscal Policymakers Try To Stabilize The Economy

In the preceding three chapters, we saw how changes in aggregate demand and aggregate supply can lead to short-run fluctuations in production and employment. We also saw how monetary and fiscal policy can shift aggregate demand and, thereby, influence these fluctuations. But even if policymakers can influence short-run economic fluctuations, does that mean they should Our first debate concerns whether monetary and fiscal policymakers should use the tools at their disposal in an attempt to...

Gifts As Signals

A tnail is debating what to give his girlfriend for her birthday. I know, he says to himself, III give Iter cash. After all, I don't know her tastes as well as he does, and with cash, she can buy anything she wants. But when he hands her the money, she is offended. Convinced he doesn't really love her. she breaks off the relationship. What's the economics behind this story In some ways, gift giving is 1 strange custom. As the man in our story suggests, people typically know their own...

How Price Ceilings Affect Market Outcomes

When the government, moved by he complaint and campaign contributions of the Ice-Cream Eaters, imposes a price ceiling on the market for ice cream, two outcomes are possible. In panel (a) of Figure 1, the government imposes a prke ceiling of -1 per cone. In thb case, because the prke that balances supply and demand ( 3) is below the ceiling, he prke ceiling is n > f binding. Market forces naturally move the economy to the equilibrium, and the price ceiling has no effect on the price or the...

Nearempty Restaurants And Offseason Miniature Golf

Have you ever walked into a restaurant for lunch and found it almost empty Why, you might have asked, does the restaurant even bother to stay open It might seem that the revenue from the few customers could not possibly cover the cost of running the restaurant. STAHMCI CPtN cjw tr Hgm-AA , EVW WH MAN T4BIES OUTTY. In making he decision whether to open tor lunch, a restaurant owner must keep in mind the distinctkm between fixed and variable costs. Many of a restaurant's costs the rent, kitchen...

Frontiers of Microeconomics

Economics is a study of the choices th.it people make and the resulting interactions they have with one another This study has many facets, as we have seen in the preceding chapters. Yet it would be a mistake to think that all the facets we have seen make up a finished jewel, perfect and unchanging. Like all scientists, economists are always on the lookout for new areas to study and new phenomena to explain. This final chapter on microeconomics offers an assortment of throe topic at the...

Problems And Applications

Many small Ixxits are made of fiberglass, which is derived from crude oil. Suppose that the price of oil rises. a. Using diagrams, show what happens to the cost curves of an individual boat-making firm and to the market supply curve. b. What happens to the profits of boat makers in the short run What happens to the number of boat makers in the king run 2. You go out to the best restaurant in town and order a lobster dinner for 40. After eating half of the lobster, you realize that you are quite...

Problems and applicatio

Table 2 shows that income inequality in the United States has increased since 1970. Some factors contributing to this increase were discussed in Chapter 19. What are they 2. Table 3 shows that the percentage of children in families with income below the poverty line far exceeds the percentage of the elderly in such families. How might the allocation of government money across different social programs have contributed to this phenomenon (Hint See Chapter 12.1 3. Economists often view life cycle...

Asymmetric Information

This statement is a common taunt among children, but it also conveys a deep truth about how people sometimes interact with one another. Many times in life, one person knows more about what is going on than another. A difference in access to relevant knowledge is called an in oroiii* lion iisymtwrtry. Examples abound. A worker knows more than his employer about how much effort he puts into his Job. A seller of a used car knows more than lite buyer about the car's...

M Rent Control In The Short Run rh And The Long Run

One common example of a price ceiling is rent control. In many cities, the kval government places a ceiling on rents that landlords may charge their tenants. The goal of this policy is to help the poor by making housing more affordable. Economists often criticize rent control, arguing that it is a highly inefficient way to help the poor raise their standard of living. One economist called rent control the best way to destroy a city, other than bombing. The adverse effects of rent control are...

Reconciling Theory and Evidence

At first, the conclusion of Friedman and Phelps that there is no long-run trade-off between inflation and unemployment might not seem persuasive. Their argument was based on an appeal to theory, specifically classical theory's prediction of monetary neutrality. By contrast, the negative correlation between inflation and unemployment documented by Phillips, Samuelson. and So low was based on actual evidence from the real world- Why should anyone believe that policymakers faced a vertical...

Typical Cost Curves

In the examples we have studied so far. the firms exhibit diminishing marginal product and, therefore, rising marginal cost at all levels of output. This simplifying assumption was useful because it allowed us to focus on the key features of cost curves that will prove useful in analyzing firm behavior. Yet actual firms are usually more complicated than this. In many firms, marginal product does not start to fall immediately after the first worker is hired. Depending on the production process,...

Should Monetary Policy Be Made By Rule Rather Than By Discretion

As we learned in the chapter on the monetary system, the Federal Open Market Committee sets monetary policy in the United States. The committee meets about every six weeks to evaluate the state of the economy. Based on this evaluation and forecasts of future economic conditions, it chooses whether to raise, lower, or leave unchanged the level of short-term interest rates. The Fed then adjusts the money supply to reach that interest-rate target, which will normally remain unchanged until the...

Total Revenue Total Cost and Profit

To understand the decisions a firm make , we must understand what it is trying to do. It is conceivable that Caroline started her firm because of an altruistic desire to provide the world with cookies or, perhaps, out of love for the cookie business. More likely, Caroline started her business to make money. Economists normally assume that the goal of a firm is to maximize profit, and they find that this assumption works ss-ell in most can's. What is a firm's...

Financial Overview Of The Us Government

How much of the nation's income does the government take as taxes Figure 1 shows government revenue, including federal, state, and local governments, as a percentage of total income for tlx.- US. economy. It shows that the role of government has grown substantially over the past century. In 1V I2, the government collected 7 percent of total income in recent years, government has collected about 2k percent. In other words, as the economy's income has grown, the government's revenue from taxation...

The Design of the Tax System

I Scaitface Capone, the notorious 1920s gangster and crime boss, was never convicted for his many violent crimes. Yet eventually, he did go to jail for tax evasion. He had neglected to heed Ben Franklin's observation that in this world nothing is certain but death and taxes- When Franklin made this claim in 1789, the average American paid less than 5 percent of his income in taxes, and that remained true for the next hundred years. Over the course of the 20th century, however, taxes became ever...

What i r Make of Rising Inequality

An economist offers his perspective on the rise in U.S. income iooquafrty. Incomes and Inequality What the Numbers Don't Tell Us Dw grating regualty m wvdth and Income has led many propfc to gwtOon sOKti the contemporary American econ orny is rigged m Uwoi ot the rich. Able there Is I tile cbubt thit the gap between ihe wakhy and e er gt t fy el has widened in recent years. The siuatton net as unfair as some ol the numbers seemtoirrpy Much of the measured growth in irenme meqwlry has resuted...

Would Banning Negext Increase Or Decrease Welfare

The government wants to reduce pollution to 120 units, so it gives each firm 40 tradable pollution permits. a. Who sells permits and how many do they sell Who buys permits and how many do they buy Briefly explain why the sellers ami buyers are each willing to do so. What is the total cost of pollution reduction in this situation b. How much higher would tlx costs of pollution reduction be if the permits could not be traded 13. The market for a particular chemical, called Negext. is described by...

Cost and the Willingness to Sell

Imagine now that you are a homeowner and you want to get your house painted. You turn to four sellers of painting services Mary, Frida, Georgia, and Grandma, Each painter is willing to do the work for you if the price is righl. You decide to take bids from the four painters and auction off the job to the painter who will do the work for the lowest price- Each painter is willing to take the job if the price she would receive exceeds her cost of doing Ihe work. Here the term cost should be...

Your Enterprising Uncle Opens A Sandwich Shop

In what kind of market structure does the firm sell its output How can you tdl b. In what kind of market structure does the firm rent robots How can you tell C- Calculate the marginal product and the value of the marginal product for each additional robot. d. How many robots should the firm rent Explain. 5. Your enterprising uncle opens a sandwich shop that employs 7 people. The employees are paid S6 per hour, and a sandwich sells for M. If your undo is maximizing his profit, what is the...

The City Goverment Considering Two

The marginal cost pet dozen pizzas using the information on variable cost. What is the relationship between these sets of numbers Comment. 7. You are thinking about setting up a lemonade stand. The stand itself costs S2CO. The ingredients for each cup of lemonade cost 0.50. a. What is your fixed cost of doin gt business What is your variable cost per cup b. Construct a table showing your total cost, average total cost, and marginal cost for output levels varying from 0 to 111 gallons- Hint...

Co

To maximize profit, what price would you charge tor an adult ticket For a child's ticket How much profit do you make b. The city council passes a law prohibiting you from charging different prices to different customers. What price do you set for a ticket now How much profit do you make c. Who is worse off because of the law prohibiting price discrimination Who is better off If you can, quantify the changes in welfare. d. If tile fixed cost of the play were 2,5ft gt rather than 2,000. how...

The Downward Slope of the Aggregate Demand Curve

Having seen how the theory of Ikjtiidity preference explains the economy's equilibrium interest rate, we now consider the theory's implications for the aggregate demand for goods and services. As a warm-up exercise, let's begin by using the theory to reexamine a topic we already understand the interest-rate effect and Ihe downward slope of the aggregate-demand curve. In particular, suppose that the overall level of prices in the economy rises. What happens to the interest rate that balances the...

The Volcker Disinflation

As we have seen, when Paul Volcker faced the prospect of reducing inflation from its peak of about 10 percent, the economics profession offered two conflicting predictions. One group of economists offered estimates of the sacrifke ratio and concluded that reducing inflation would have great cost in terms of lost output and high unemployment. Another group offered the theory of rational expeclatums and concluded that reducing inflation could be much less costly and, perhaps, could even have no...

Five Debates over Macroeconomic Policy

It is hard to open up the newspaper without finding some politician or editorial writer advocating a change in economic policy. The president should raise taxes to reduce the budget deficit, or he should stop worrying about the budget deficit. I he Federal Reserve should cut interest rates to stimulate a flagging economy, or it should avoid such moves in order not to risk higher inflation, Congress should reform the tax system to promote faster economic growth, or it should reform the tax...

The Theory Of Efficiency Wages

A fourth reason economies always experience some unemployment in addition to job search, minimum-wage laws, and unions is suggested by the theory of efficiency wages According to this theory, firms operate more efficiently if wages are above the equilibrium level. Therefore, it may be profitable for firms to keep wages high even in the presence of a surplus of labor. In some ways, the unemployment that arises from efficiency wages is similar to the unemployment that arises from minimum-wage...

Identifying Unemployment

Let's start by examining more precisely what the term unemployment means- Measuring unemployment is the job of the Bureau of Labor Statistics BLS . which is part of the Department of Labor. Every month, the BLS produces data on unemployment and on other aspects of the labor market, including types of employment, length of the average workweek, and the duration of unemployment. These data come from a regular survey of about 60 XX households, called the Current Population Survey. Based on the...

The Classical Theory Of Inflation

We begin our study of inflation by developing the quantity theory of money. This theory is often called 'classical because it was developed by some of the earliest economic thinkers. Most economists today rely on this theory to explain the long-run determinants of the price level and the inflatk gt n rate. The Level of Prices and the Value or Money Suppose we observe over some period of time the price of an ice-cream cone rising from a nickel to a dollar. What conclusion should we draw from the...

The Short Run Tradeoff between Inflation and Unemployment

Wo closely watched indicators of economic performance are inflation and unemployment When the Bureau of Labor Statistics releases data on these variables each month, policymakers are eager to hear the news. Some commentators have added together the inflation rate anil the unemployment rate to produce a misery index, which purports to measure the health of the economy. How an- these two measures of economic performance related to each other liarlier in the book, we discusscd the long-run...

Igure 2

Natural Rate Unemployment

Rali in the United States since 1MW . The figure shows that the economy always has some unemployment and that the amount changes from year to year, The normal rate of unemployment around which the unemployment rate fluctuates is called the natural rate of unemployment, anil the deviation of unemployment from its natural rate is called cyclical unemployment, The natural rate of unemployment shown in the figure is a series estimated by economists at the Congressional Budget Office. For 2007, they...

Financial Institutions In The Us Economy

At the broadest level, the financial system moves the economy's scarce resources from savers people who spend less than they earn to borrowers people who spend more than they earn . Savers save for various reasons to put a child through college in several years or to retire comfortably in several decades Similarly, borrowers borrow for various reasons to buy a house in which to live or to start a business with which to make a living. Savers supply their money to the financial system with the...

Two Causes Of Economic Fluctuations

Now that we have introduced the model of aggregate demand and aggregate supply. we have the basic tools we need to analyze fluctuations in economic activity. In particular, we can use what we have learned about aggregate demand and aggregate supply to examine the two basic causes of short-run fluctuations shifts in aggregate demand and shifts in aggregate supply. To keep things simple, we assume the economy begins in long-run equilibrium, .1 shown in Figure 7. Output and the price level are...

Why Is Gasoline Taxed So Heavily

In many nations, gasoline is among the most heavily taxed goods The gas lax can be viewed as a corrective tax aimed at three negative externalities associated with driving CiHtges jiw 'f you have ever been stuck in bumper-to-bumper traffic, you have probably wished that there were fewer cars on lite road. A gasoline tax keeps congestion down by encouraging people to take public transportation, carpool more often, and live closer to work. Accidents Whenever people buy large cars or sport-utility...

Con The Central Bank Should Not Aim for Zero Inflation

Price stability may be desirable, but the benefits of zero inflation compared to moderate inflation are small, whereas the costs of reaching zero inflation are large. Estimates of the sacrifice ratio suggest that reducing inflation by 1 percentage point requires giving up about 5 percent of one year's output. Reducing inflation from, say, 4 percent to zero requires a loss of 20 percent of a year's output. People might dislike inflation of 4 percent, but it is not at all clear that they would or...

Con Thf Tax Laws Should Not Be Reformed to Encourage Saving

Increasing saving may be desirable, but it is not the only goal of tax policy. Policymakers also must be sure to distribute the tax burden fairly. The problem with proposals to increase the incentive to save is that they increase the tax burden on tho who can least afford it. It is undeniable that high-income households save a greater fraction of their income than low-income households. As a result, any tax change that favors people who save will also tend to favor people with high income....

Should The Tax Laws Be Reformed To Encourage Saving

A nation's standard of living depends on its ability to produce goods and services. This was one of the Ten PrincipleS of Economics in Chapter 1. As we saw in the chapter on produclkm and growth, a nation's productive capability, in turn, is determined largely by how much it saves and invests for the future. Our fifth debate is whether policymakers should reform the tax laws to encourage greater saving and investment. Pro The Tax Laws Should Bl Reformed to Encourage Saving A nation's swing rate...

The Case for Active Stabilization Policy

Let's return to the question that began this chapter When the president and Congress raise taxes, how should the Federal Reserve respond As we have seen, the level of taxation b one determinant of the position of the aggregate-demand curve. When the government raise taxes, aggregate demand will fall, depressing production and employment in the short run. If the Federal Reserve wants to prevent this adverse cffcct of the fiscal policy, it can expand aggregate demand by increasing the money...

Laborforce Participation Of Men And Women In The Us Economy

Natural rote of unemployment the normal rate of unemployment around which the unemployment rate fluctuates cyclical unemployment the deviation of uncm ptoyment from its natural rate Women's role in American society has changed dramatically over the past century. Social commentators have pointed to many causes for this change. In part, it is attributable to new tochnologks, such as the washing machine, duthes dryer, refrigerator, freezer, and dishwasher, which have reduced the amount of time...

Firm Behavior Anp The Organization Qf Industry 265

Total Cost, and it'i' I '.-ib Vi'ri iIIi ti t IIIM_jal I iV t i-' III gt . .i -'l.il - in ' .'ili.'ri. t .-_ail 11-.- I'rril ii linn rim. Iiii_2Zi. luv -. jn.l V.-ifi.iMr lt - I-._21 Avi'.v.t'y iiiiil Miifr.in.r '. i i_-- urna and_bail'-. iv 1 gt j -1 gt ,i t .- ' in the Shim Kun J nil in the linn Run_2SU 1,1' Si nI .- Villi, I- .vi ' -lii'il K.ri 1 l.'.yti'.'ni.-.-- ,ii gt .1 Pi .v. '.'nn - -A gt iiv_2 amp 1 FT .cason rgr a Pin Fa-itary_222

Three Key Facts About Economic Fluctuations

Short-run fluctuations in economic activity occur in all countries throughout history. As a starting point for understanding these year-to-year fluctuations, let's discuss some of their most important properties. Fact 1 Economic Fluctuations Are Irregular and Unpredictable Fluctuations in the economy are often called the business cycle. As this term suggests, economic fluctuations correspond to changes in business conditions. When real CDP grows rapidly, business is good. During such periods of...

Why the Aggregate Supply Curve Slopes Upward in the Short

The key difference between the economy in the short run and in the long run is the behavior of aggregate supply. The le gt ng-run aggregate-supply curve is vertical because, in the long run, the overall level of prices does not affect the economy's ability to produce goods and services. By contrast, in the short run, the price level dots affect the economy's output. That is, over a period of a year or two, an increase in the overall level of prices in the economy tends to raise the quantity of...

How Taxes on Buyers Affect Market Outcomes

Now consider a tax levied on buyers of a good. Suppose that our local government passes a law requiring buyers of ice-cream cones to send 50.50 to the government for each ice-cream cone they buy. What are the effects of this law Again, we apply our three steps. Step One The initial impact of the tax is on the demand for ice cream. The supply curve is not affected because, fur any given price of icecream, sellers have the same incentive to provide ice cream to the market. By contrast, buyers now...

Larry Curly And Moe Run The Only Saloon In Town

If the company were to build the bridge, what would be its profit-maximizing price Would that be the efficient level of output Why or why not b. If the company is interested in maximizing profit, should it build the bridge What would be its profit or loss e. If the government were to build the bridge, what price should it charge d. Should the government build the bridge Explain. 7. Larry, Curly, and Moe run the only saloon in town. Larry wants to sell as many drinks as possible without...

The Village Of Ectenia Has Ten Residents

Within the dorm room, is the showing of a movie a publk g lt x gt d Why or why not b. If it costs f gt 8 to rent a movie, how many movies should the roommates rent to maximize total surplus c. If they choose the optimal number from part b and then split the cost of renting the movies equally, how much surplus does each person obtain from watching the movies d. Is there any way to split the cost to ensure that everyone benefits What practical problems does this solution raise e. Suppose they...

The Economist As Policy Adviser

Often, economists are asked to explain the causes of economic events. Why, for example, is unemployment higher for teenagers than for older workers Sometimes, economists are asked to recommend policies to improve economic outcomes. What, for instance, should the government do to improve the economic well-being of teenagers When economists are trying to explain the world, they are scientists. When they are trying to help improve it, they are policy advisers. positive statomonts claim- that...

Market Based Policy 1 Corrective Taxes and Subsidies

Instead of regulating behavior in response to an externality, the government can use market-based policies to align private incentives with social efficiency. For instance, as we saw earlier, the government can internalize the externality by taxing activities that have negative externalities and subsidizing activities that have positive externalities. Taxes enacted to deal with the effects of negative externalities are called corrective taxes. They are also called Pigovimt taxes after economist...

Welfare Economics A Recap

We begin by recalling the key lessons of welfare economics from Chapter 7. To make our analysis concrete, we consider a specific market the market for aluminum. Figure 1 shows the supply and demand curves in the market for aluminum. As you should recall from Chapter 7. the supply and demand curves contain important information about costs arvd benefits. The demand curve for aluminum reflects the value of aluminum to consumers, as measured by the prices they arc willing to pay. At any given...

Why Did OPEC Fail to Keep the Price op On High

Many of the most disruptive events for the world's economies over the past several decades have originated in the world market for oil. In the 1970s, members of the Organization of Petroleum Exporting Countries OPEC decided to raise the world price of oil to increase their incomes. These countries accomplished this goal by jointly reducing the amount of oil they supplied. From 1973 to 1974, the price of oil adjusted for overall inflation rose more tluin 50 percent. Then, a few years later, OPEC...

F

In writing this book, I benefited from the input of many talented people. Indeed, the list of people who have contributed to this project is so long, and their contributions so valuable, th.it it seems an injustice th.it only a single name appears on the cover Let me begin with my colleagues in the economics profession. The four editions of this text and its supplemental materials have benefited enormously from their input. In reviews and surveys, they have offered suggestions, identified...

Graphs of Two Variables The Coordinate System

Although the three graphs in Figure A-l are useful in showing how a variable changes over time or across individuals, such graphs are limited in how much they can tell us. These graphs display information only on a single variable. Economists an- often concerned with the relationships between variable . Thus, they need to display two variables on a single graph. The coordinate system makes thb possible. Suppose you want to examine the relationship between study time and grade point average. For...

1

Economics is a study of mankind in the ordinary business of life. So wrote Alfred Marshall, the great 19th-century economist, in his textbook, Principles 0 Eavumte. Although wc have learned much about the cconomy since Marshall's time, this definition of economics is as true today as it was in 1890, when the first edition of his text was published. Why should you, as a student at the beginning of the 21st century, embark on the study of economics I here are three reasons. The first reason to...

The Shortrun Tradeoff Between Inflation And Unemployment 801

Aggregate tX-m.ind, Aggregate Supply, and the Phillips Curve 803 Shifts in the Phillips Curve The Role of Expectations 905 The Long-Run Phillips Cum 805 The Meaning of 'Natural 837 Rcconcilmg Th lt x gt ry and F. vtdenccr NiH Tho Short-Run Phillips Curv e 809 I V Natural Experiment for the Natural-Kate Hypothesis 610 ShifK in thr Phillips I u.vi- The Role of Supply Shocks 812 IN THE NEWS Will Stagflation Return 815 Rational F-vpectationa and the Pauibility of Costles Disinflation 817 I - Wli...