Case Study The Deadweight Loss Debate

Supply, demand, elasticity, deadweight loss all this economic theory is 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 reason the debate hinges on these concepts is that the larger the deadweight loss of taxation, the larger the cost of any government program. If taxation entails very large deadweight losses, then these losses are a strong argument for a leaner government that does less and...

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Do you agree with the following statements Why or why not a. The benefits of Pigovian taxes as a way to reduce pollution have to be weighed against the deadweight losses that these taxes cause. b. A negative production externality calls for a Pigovian tax on producers, whereas a negative consumption externality calls for a Pigovian tax on consumers. 2. Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities in consumption b. Draw a graph of the...

The Effects Of A Shift In Aggregate Demand

Suppose that for some reason a wave of pessimism suddenly overtakes the economy. The cause might be a scandal in the White House, a crash in the stock market, or the outbreak of a war overseas. Because of this event, many people lose confidence in the future and alter their plans. Households cut back on their spending and delay major purchases, and firms put off buying new equipment. What is the impact of such a wave of pessimism on the economy Such an event reduces the aggregate demand for...

The Federal Government

The U.S. federal government collects about two-thirds of the taxes in our economy. It raises this money in a number of ways, and it finds even more ways to spend it. Receipts Table 12-2 shows the receipts of the federal government in 1999. Total receipts in this year were 1,806 billion, a number so large that it is hard to comprehend. To bring this astronomical number down to earth, we can divide it by the size of the U.S. population, which was about 272 million in 1999. We then find that the...

The Jobs Argument

Opponents of free trade often argue that trade with other countries destroys domestic jobs. In our example, free trade in steel would cause the price of steel to fall, reducing the quantity of steel produced in Isoland and thus reducing employment in the Isolandian steel industry. Some Isolandian steelworkers would lose their jobs. Yet free trade creates jobs at the same time that it destroys them. When Iso-landians buy steel from other countries, those countries obtain the resources to buy...

The Lessons For Trade Policy

The team of Isolandian economists can now write to the new president You asked us three questions about opening up trade. After much hard work, we have the answers. Question If the government allowed Isolandians to import and export steel, what would happen to the price of steel and the quantity of steel sold in the domestic steel market Answer Once trade is allowed, the Isolandian price of steel would be driven to equal the price prevailing around the world. If the world price is now higher...

The Meaning Of Money

The set of assets in an economy that people regularly use to buy goods and services from other people What is money This might seem like an odd question. When you read that billionaire Bill Gates has a lot of money, you know what that means He is so rich that he can buy almost anything he wants. In this sense, the term money is used to mean wealth. Economists, however, use the word in a more specific sense Money is the set of assets in the economy that people regularly use to buy goods and...

The Nationalsecurity Argument

When an industry is threatened with competition from other countries, opponents of free trade often argue that the industry is vital for national security. In our example, Isolandian steel companies might point out that steel is used to make guns and tanks. Free trade would allow Isoland to become dependent on foreign countries to supply steel. If a war later broke out, Isoland might be unable to produce enough steel and weapons to defend itself. Economists acknowledge that protecting key...

The Price Level and Investment The Interest Rate Effect

As we discussed in Chapter 28, the price level is one determinant of the quantity of money demanded. The lower the price level, the less money households need to hold to buy the goods and services they want. When the price level falls, therefore, households try to reduce their holdings of money by lending some of it out. For instance, a household might use its excess money to buy interest-bearing bonds. Or it might deposit its excess money in an interest-bearing savings account, and the bank...

Three Steps To Analyzing Changes In Equilibrium

So far we have seen how supply and demand together determine a market's equilibrium, which in turn determines the price of the good and the amount of the good that buyers purchase and sellers produce. Of course, the equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts one of these curves, the equilibrium in the market changes. The analysis of such a change is called comparative statics because it involves comparing two static situations...

Why The Aggregatedemand Curve Might Shift

The downward slope of the aggregate-demand curve shows that a fall in the price level raises the overall quantity of goods and services demanded. Many other factors, however, affect the quantity of goods and services demanded at a given price level. When one of these other factors changes, the aggregate-demand curve shifts. Let's consider some examples of events that shift aggregate demand. We can categorize them according to which component of spending is most directly affected. Shifts Arising...

Why The Aggregatesupply Curve Slopes Upward In The Short

We now come to the key difference between the economy in the short run and in the long run the behavior of aggregate supply. As we have already discussed, the long-run aggregate-supply curve is vertical. By contrast, in the short run, the aggregate-supply curve is upward sloping, as shown in Figure 31-6. 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 goods and services supplied, and a decrease in the level of...

How A Tax Affects Market Participants

Now let's use the tools of welfare economics to measure the gains and losses from a tax on a good. To do this, we must take into account how the tax affects buyers, sellers, and the government. The benefit received by buyers in a market is measured by consumer surplus the amount buyers are willing to pay for the good minus the amount they actually pay for it. The benefit received by sellers in a market is measured by producer surplus the amount sellers receive for the good minus their costs....

Unemployment And Its Natural Rate

Learn about the data used to measure the amount of unemployment Consider how unemployment arises from the process of job search Losing a job can be the most distressing economic event in a person's life. Most people rely on their labor earnings to maintain their standard of living, and many people get from their work not only income but also a sense of personal accomplishment. A job loss means a lower living standard in the present, anxiety about the future, and reduced self-esteem. It is not...

Some Important Public Goods

There are many examples of public goods. Here we consider three of the most important. Nati onal Defense The defense of the country from foreign aggressors is a classic example of a public good. It is also one of the most expensive. In 1999 the U.S. federal government spent a total of 277 billion on national defense, or about 1,018 per person. People disagree about whether this amount is too small or too large, but almost no one doubts that some government spending for national defense is...

Should Tiger Woods Mow His Own Lawn

Tiger Woods spends a lot of time walking around on grass. One of the most talented golfers of all time, he can hit a drive and sink a putt in a way that most casual golfers only dream of doing. Most likely, he is talented at other activities too. For example, let's imagine that Woods can mow his lawn faster than anyone else. But just because he can mow his lawn fast, does this mean he should To answer this question, we can use the concepts of opportunity cost and comparative advantage. Let's...

Measuring The Cost Of Living

Learn how the consumer price index (CPI) is constructed Consider why the CPI is an imperfect measure of the cost of living Compare the CPI and the GDP deflator as measures of the overall price level In 1931, as the U.S. economy was suffering through the Great Depression, famed baseball player Babe Ruth earned 80,000. At the time, this salary was extraordinary, even among the stars of baseball. According to one story, a reporter asked Ruth whether he thought it was right that he made more than...

Costs As Opportunity Costs

When measuring costs at Hungry Helen's Cookie Factory or any other firm, it is important to keep in mind one of the Ten Principles of Economics from Chapter 1 The cost of something is what you give up to get it. Recall that the opportunity cost of an item refers to all those things that must be forgone to acquire that item. When economists speak of a firm's cost of production, they include all the opportunity costs of making its output of goods and services. A firm's opportunity costs of...

Case Study The Laffer Curve And Supplyside Economics

One day in 1974, economist Arthur Laffer sat in a Washington restaurant with some prominent journalists and politicians. He took out a napkin and drew a figure on it to show how tax rates affect tax revenue. It looked much like panel (b) of our Figure 8-7. Laffer then suggested that the United States was on the downward-sloping side of this curve. Tax rates were so high, he argued, that reducing them would actually raise tax revenue. Most economists were skeptical of Laffer's suggestion. The...

Case Study Discrimination In Sports

As we have seen, measuring discrimination is often difficult. To determine whether one group of workers is discriminated against, a researcher must correct for differences in the productivity between that group and other workers in the economy. Yet, in most firms, it is difficult to measure a particular worker's contribution to the production of goods and services. One type of firm in which such corrections are easier is the sports team. Professional teams have many objective measures of...

Con Policymakers Should Not Try To Stabilize The Economy

Although monetary and fiscal policy can be used to stabilize the economy in theory, there are substantial obstacles to the use of such policies in practice. One problem is that monetary and fiscal policy do not affect the economy immediately but instead work with a long lag. Monetary policy affects aggregate demand by changing interest rates, which in turn affect spending, especially residential and business investment. But many households and firms set their spending plans in advance. As a...

Negative Externalities In Production

Now let's suppose that aluminum factories emit pollution For each unit of aluminum produced, a certain amount of smoke enters the atmosphere. Because this smoke creates a health risk for those who breathe the air, it is a negative externality. How does this externality affect the efficiency of the market outcome Because of the externality, the cost to society of producing aluminum is larger than the cost to the aluminum producers. For each unit of aluminum produced, the social cost includes the...

The Shortrun Tradeoff Between Inflation And Unemployment

Learn why policymakers face a short-run tradeoff between inflation and unemployment Consider why the inflation-unemployment tradeoff disappears in the long run See how supply shocks can shift the inflation-unemployment tradeoff Two 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 and...

The Costs Of Production

Learn the meaning of average total cost and marginal cost and how they are related The economy is made up of thousands of firms that produce the goods and services you enjoy every day General Motors produces automobiles, General Electric produces lightbulbs, and General Mills produces breakfast cereals. Some firms, such as these three, are large they employ thousands of workers and have thousands of stockholders who share in the firms' profits. Other firms, such as the local barbershop or candy...

Public Policy And Job Search

Even if some frictional unemployment is inevitable, the precise amount is not. The faster information spreads about job openings and worker availability, the more rapidly the economy can match workers and firms. The Internet, for instance, may help facilitate job search and reduce frictional unemployment. In addition, public policy may play a role. If policy can reduce the time it takes unemployed workers to find new jobs, it can reduce the economy's natural rate of unemployment. Government...

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What is the role of the financial system Name and describe two markets that are part of the financial system in our economy. Name and describe two financial intermediaries. 2. Why is it important for people who own stocks and bonds to diversify their holdings What type of financial institution makes diversification easier 3. What is national saving What is private saving What is public saving How are these three variables related 4. What is investment How is it related to national saving 5....

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Japan generally runs a significant trade surplus. Do you think this is most related to high foreign demand for Japanese goods, low Japanese demand for foreign goods, a high Japanese saving rate relative to Japanese investment, or structural barriers against imports into Japan Explain your answer. 2. An article in The New York Times Apr. 14, 1995 regarding a decline in the value of the dollar reported that the president was clearly determined to signal that the United States remains solidly...

Case Study Two Ways To Reduce The Quantity Of Smoking Demanded

Two Ways Demand Curve

Public policymakers often want to reduce the amount that people smoke. There are two ways that policy can attempt to achieve this goal. One way to reduce smoking is to shift the demand curve for cigarettes and other tobacco products. Public service announcements, mandatory health warnings on cigarette packages, and the prohibition of cigarette advertising on television are all policies aimed at reducing the quantity of cigarettes demanded at any given price. If successful, these policies shift...

The Effects Of A Shift In Aggregate Supply

Short Run Aggregate Supply Curve Shifts

Imagine once again an economy in its long-run equilibrium. Now suppose that suddenly some firms experience an increase in their costs of production. For example, bad weather in farm states might destroy some crops, driving up the cost An Adverse Shift in Aggregate Supply. When some event increases firms' costs, the short-run aggregate-supply curve shifts to the left from AS to AS2. The economy moves from point A to point B. The result is stagflation Output falls from Y1 to Y2, and the price...

Political Instability And Capital Flight

Capital Flight Impact Interest Rates

In 1994 political instability in Mexico, including the assassination of a prominent political leader, made world financial markets nervous. People began to view Mexico as a much less stable country than they had previously thought. They decided to pull some of their assets out of Mexico in order to move these funds to the United States and other safe havens. Such a large and sudden movement of funds out of a country is called capital flight. To see the implications of capital flight for the...

Hint The Government Took Such An Action In The 1980s

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 c. If the government were to build the bridge, what price should it charge d. Should the government build the bridge Explain. 9. The Placebo Drug Company holds a patent on one of its discoveries. a. Assuming that the production of the drug...

Conclusion The Origins Of Aggregate Demand And Aggregate Supply

First, we have discussed some of the important facts about short-run fluctuations in economic activity. Second, we have introduced a basic model to explain those fluctuations, called the model of aggregate demand and aggregate supply. In the next two chapters we look at each piece of this model in more detail in order to understand more fully what causes fluctuations in the economy and how policymakers might respond to these fluctuations. Now that we have a...

The Cost Of Producing Stereo Systems Has Fallen Over The Past Several Decades

An early freeze in California sours the lemon crop. What happens to consumer surplus in the market for lemons What happens to consumer surplus in the market for lemonade Illustrate your answers with diagrams. 2. Suppose the demand for French bread rises. What happens to producer surplus in the market for French bread What happens to producer surplus in the market for flour Illustrate your answer with diagrams. 3. It is a hot day, and Bert is very thirsty. Here is the value he places on a...

The Various Measures Of Cost

Thirsty Thelma Lemonade Stand

Our analysis of Hungry Helen's Cookie Factory demonstrated how a firm's total cost reflects its production function. From data on a firm's total cost, we can derive several related measures of cost, which will turn out to be useful when we analyze production and pricing decisions in future chapters. To see how these related measures are derived, we consider the example in Table 13-2. This table presents cost data on Helen's neighbor Thirsty Thelma's Lemonade Stand. The first column of the table...

Catherines Demand Curve

Catherine Demand Curve

The demand schedule shows the quantity demanded at each price. Catherine's Demand Curve. This demand curve, which graphs the demand schedule in Table 4-1, shows how the quantity demanded of the good changes as its price varies. Because a lower price increases the quantity demanded, the demand curve slopes downward. a graph of the relationship between the price of a good and the quantity demanded a Latin phrase, translated as other things being equal, used as a...

In The N Ews

If an economy is to allocate its scarce resources efficiently, goods must get to those consumers who value them most highly. Ticket scalping is one example of how markets reach efficient outcomes. Scalpers buy tickets to plays, concerts, and sports events and then sell the tickets at a price above their original cost. By charging the highest price the market will bear, scalpers help ensure that consumers with the greatest willingness to pay for the tickets actually do get them. In some places,...

The Effects Of An Import Quota

Deadweight Loss Imports

The Isolandian economists next consider the effects of an import quota a limit on the quantity of imports. In particular, imagine that the Isolandian government distributes a limited number of import licenses. Each license gives the license holder the right to import 1 ton of steel into Isoland from abroad. The Isolandian economists want to compare welfare under a policy of free trade and welfare with the addition of this import quota. Figure 9-7 shows how an import quota affects the Isolandian...

Shifts In The Demand Curve

Shifts The Demand Curve

Suppose that the American Medical Association suddenly announces a new discovery People who regularly eat ice cream live longer, healthier lives. How does this announcement affect the market for ice cream The discovery changes people's tastes and raises the demand for ice cream. At any given price, buyers now want to purchase a larger quantity of ice cream, and the demand curve for ice cream shifts to the right. Whenever any determinant of demand changes, other than the good's price, the demand...

Pat And Kris Are Roommates. They Spend Most Of Their Time Studying Of Course But They Leave Some Time For Their

Will a nation tend to export or import goods for which it has a comparative advantage Explain. Why do economists oppose policies that restrict trade among nations 1. Consider the farmer and the rancher from our example in this chapter. Explain why the farmer's opportunity cost of producing 1 pound of meat is 2 pounds of potatoes. Explain why the rancher's opportunity cost of producing 1 pound of meat is 1 8 pound of potatoes. 2. Maria can read 20 pages of economics in an hour. She can also read...

Little Kona Is A Small Coffee Company That Is Considering Entering A Market Dominated By Big Brew

The New York Times Nov. 30, 1993 reported that the inability of OPEC to agree last week to cut production has sent the oil market into turmoil . . . leading to the lowest price for domestic crude oil since June 1990. a. Why were the members of OPEC trying to agree to cut production b. Why do you suppose OPEC was unable to agree on cutting production Why did the oil market go into turmoil as a result c. The newspaper also noted OPEC's view that producing nations outside the organization, like...

What Happen To Popeye S Demand Curve

Market, p. 66 competitive market, p. 66 quantity demanded, p. 67 law of demand, p. 68 normal good, p. 68 inferior good, p. 68 substitutes, p. 68 complements, p. 68 demand schedule, p. 69 demand curve, p. 70 ceteris paribus, p. 70 quantity supplied, p. 75 law of supply, p. 75 supply schedule, p. 76 supply curve, p. 76 equilibrium, p. 80 equilibrium price, p. 80 equilibrium quantity, p. 80 surplus, p. 81 shortage, p. 81 1. What is a competitive market Briefly describe the types of markets other...

Case Study Monopoly Drugs Versus Generic Drugs

According to our analysis, prices are determined quite differently in monopolized markets from the way they are in competitive markets. A natural place to test this theory is the market for pharmaceutical drugs because this market takes on both market structures. When a firm discovers a new drug, patent laws give the firm a monopoly on the sale of that drug. But eventually the firm's patent runs out, and any company can make and sell the drug. At that time, the market switches from being...

If You Were Johnny S Agent What Recording Fee Would You Advise

100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 900,000 1,000,000 The author is paid 2 million to write the book, and the marginal cost of publishing the book is a constant 10 per book. a. Compute total revenue, total cost, and profit at each quantity. What quantity would a profit-maximizing publisher choose What price would it charge b. Compute marginal revenue. Recall that MR ATR AQ. How does marginal revenue compare to the price Explain. c. Graph the marginal-revenue,...

You Were Planning To Spend Saturday Working

Describe some of the tradeoffs faced by the following a. a family deciding whether to buy a new car b. a member of Congress deciding how much to spend on national parks c. a company president deciding whether to open a new factory d. a professor deciding how much to prepare for class 2. You are trying to decide whether to take a vacation. Most of the costs of the vacation airfare, hotel, forgone wages are measured in dollars, but the benefits of the vacation are psychological. How can you...

Hi-tech Printing Company Invents A New Process That Sharply Reduces The Cost Of Printing Books. What Happens To Hi-tech

How much should the firm produce to maximize profit b. Calculate marginal revenue and marginal cost for each quantity. Graph them. Hint Put the points between whole numbers. For example, the marginal cost between 2 and 3 should be graphed at 2 1 2. At what quantity do these curves cross How does this relate to your answer to part a c. Can you tell whether this firm is in a competitive industry If so, can you tell whether the industry is in a long-run...

Case Study Rent Control In The Short Run And Long

Partial Rent Control Quantities

One common example of a price ceiling is rent control. In some cities, the local 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...

Externalities In Consumption

Positive Consumption

The externalities we have discussed so far are associated with the production of goods. Some externalities, however, are associated with consumption. The consumption of alcohol, for instance, yields negative externalities if consumers are more likely to drive under its influence and risk the lives of others. Similarly, the consumption of education yields positive externalities because a more educated population leads to better government, which benefits everyone. The analysis of consumption...

Case Study Are Lighthouses Public Goods

Lighthouses Free

Some goods can switch between being public goods and being private goods depending on the circumstances. For example, a fireworks display is a public good if performed in a town with many residents. Yet if performed at a private amusement park, such as Walt Disney World, a fireworks display is more like a private good because visitors to the park pay for admission. Another example is a lighthouse. Economists have long used lighthouses as examples of a public good. Lighthouses are used to mark...

Recent Study Found That The Demand And Supply Schedules For Frisbees Are As Follows

Lovers of classical music persuade Congress to impose a price ceiling of 40 per ticket. Does this policy get more or fewer people to attend classical music concerts The government has decided that the free-market price of cheese is too low. a. Suppose the government imposes a binding price floor in the cheese market. Use a supply-and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese b. Farmers...

Our Second Model The Production Possibilities Frontier

Quantity Computers Produced

Most economic models, unlike the circular-flow diagram, are built using the tools of mathematics. Here we consider one of the simplest such models, called the production possibilities frontier, and see how this model illustrates some basic economic ideas. Although real economies produce thousands of goods and services, let's imagine an economy that produces only two goods cars and computers. Together the car industry and the computer industry use all of the economy's factors of production. The...

Principle 6 Markets Are Usually A Good Way To Organize Economic Activity

For 5 a week you can watch baseball without being nagged to cut the grass For 5 a week you can watch baseball without being nagged to cut the grass The collapse of communism in the Soviet Union and Eastern Europe may be the most important change in the world during the past half century. Communist countries worked on the premise that central planners in the government were in the best position to guide economic activity. These planners decided what goods and services were produced, how much was...

Case Study Why The Cow Is Not Extinct

Throughout history, many species of animals have been threatened with extinction. When Europeans first arrived in North America, more than 60 million buffalo roamed the continent. Yet hunting the buffalo was so popular during the nineteenth century that by 1900 the animal's population fell to about 400 before the government stepped in to protect the species. In some African countries today, the elephant faces a similar challenge, as poachers kill the animals for the ivory in their tusks. Yet...

The Market For Pizza Has The Following Demand And Supply Schedules

Explain each of the following statements using supply- a. When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country. b. When the weather turns warm in New England every summer, the prices of hotel rooms in Caribbean resorts plummet. c. When a war breaks out in the Middle East, the price of gasoline rises, while the price of a used Cadillac falls. 2. An increase in the demand for notebooks raises the quantity of notebooks demanded, but not the...

Ten Principles Of Economics

Learn the meaning of opportunity cost See how to use marginal reasoning when making decisions Discuss how incentives affect people's behavior The word economy comes from the Greek word for one who manages a household. At first, this origin might seem peculiar. But, in fact, households and economies have much in common. A household faces many decisions. It must decide which members of the household do which tasks and what each member gets in return Who cooks dinner Who does the laundry Who gets...