Shifts In The Market Labor Supply Curve

A change in the wage rate causes a movement along a labor supply curve, as in the move from point C to point D in Figure 8(a). But labor supply curves can (and of 6 What happens if the market wage exceeds your reservation wage in more than one market at the same time As long as preferences are rational (Chapter 5), this will never happen, for it would mean that you cannot decide which job-income combination is more attractive. For example, suppose the market wage for egg-cleaning jobs was 25...

General Versus Specific Human Capital

Economists classify human capital into two categories, according to how broadly it can be applied in the workplace. Human capital that makes you more produc- ceneral human capital KnoWledge tive at many different firms is called general human capital. If you study engineer- education, or training that is bluing at college, for example, your knowledge will help you at any of thousands of able at many different firms. types of human capital necessary to be a successful aerospace engineer at...

Cooperative Behavior In Oligopoly

In the real world, oligopolists will usually get more than one chance to choose their prices. Pepsi and Coca-Cola have been rivals in the soft drink market for most of this century, as have Ford, DaimlerChrysler, and GM in the automobile market and Kellogg, Post (Kraft Foods), Quaker, and General Mills in the breakfast cereal market. These firms can change their prices based on the past responses of their rivals. The equilibrium in a game with repeated plays may be very different from the...

Sources Of Bias In The

There are several reasons for the upward bias in the CPI. Substitution Bias. Until recently, the CPI almost completely ignored a general principle of consumer behavior People tend to substitute goods that have become 4 See Toward a More Accurate Measure of the Cost of Living, Report to the Senate Finance Committee from the Advisory Commission to Study the Consumer Price Index, December 1996. relatively cheaper in place of those that have become relatively more expensive. For example, in the...

Verdict The Classical Model Cannot Explain Economic Fluctuations

In earlier chapters, we stressed that the classical model works well in explaining the movements of the economy in the longer run. Now, we see that it does a rather poor job of explaining the economy in the short run. Why is this Largely because the classical model involves assumptions about the economy that make sense in the longer run, but not in the short run. Chief among these is the assumption that the labor market clears that is, that the labor market operates at the point of intersection...

The Costs Of Unemployment

Why are we so concerned about achieving a low rate of unemployment What are the costs of unemployment to our society We can identify two different types of costs economic costs those that can be readily measured in dollar terms and noneconomic costs those that are difficult or impossible to measure in dollars, but still affect us in important ways. Economic Costs. The chief economic cost of unemployment is the opportunity cost of lost output the goods and services the jobless would produce if...

Why Monopolies Often Earn Zero Economic Profit

The title of this section might puzzle you. We've just seen that in the long run a monopoly can earn economic profit and should never stay in business if it suffers a loss. Then how can it be that monopolies often earn zero profit in the real world Is it just a coincidence The answer is no. There are two forces tending to cut monopoly profits. 1. Government regulation. As discussed earlier, in many cases of natural monopoly, a firm is granted a government franchise to be the sole seller in a...

Monopolistic Competition And Oligopoly

The Concept of Imperfect Competition Short Run Monopolistic Competition in the Long Run Excess Capacity Under Monopolistic Competition Nonprice Competition Oligopoly in the Real World Why Oligopolies Exist Oligopoly Behavior Cooperative Behavior in Oligopoly The Limits to Oligopoly Using the Theory Advertising in Monopolistic Competition and Oligopoly Advertising and Market Equilibrium Under Monopolistic Competition Advertising and Collusion in Oligopoly The Four Market Structures A Postscript...

Compensating Differentials

In our imaginary world, all jobs were equally attractive to all workers. But in the real world, jobs differ in hundreds of ways that matter to workers. When one job is intrinsically more or less attractive than another, we can expect their wages to differ by a compensating wage differential A compensating wage differential is the difference in wage rates that makes two jobs equally attractive to workers. To see how compensating wage differentials come about, let's consider some of the important...

Labor Shortages And Surpluses

We sometimes hear about a shortage or a surplus of labor in some profession or trade In the early 1990s there was a surplus of scientists, in the mid-1990s a short-Labor shortage The quantity of la- age of software developers. Economists define a labor shortage as an excess demand bor demanded exceeds the quantity for labor a situation in which the quantity of workers demanded in a market is supplied at the prevailing wage rate. greater than the quantity supplied at the prevailing wage rate....

The Marginal Revenue And Marginal Cost Approach

There is another way to find the profit-maximizing level of output. This approach, which uses marginal concepts, gives us some powerful insights into the firm's decision-making process. Recall that marginal cost is the change in total cost from producing one more unit of output. Now, let's consider a similar concept for revenue. Marginal revenue (MR) is the change in total revenue from producing one more unit of output. Mathematically, MR is calculated by dividing the change in total revenue...

Back to the Money Market

Look back at Figure 5, and let's recap what you've learned so far. If the interest rate were 9 percent, there would be an excess supply of money, and therefore an excess demand for bonds. The public would try to buy bonds, and the price of bonds would rise. Now we can complete the story. As you've just learned, a rise in the price of bonds means a decrease in the interest rate. The complete sequence of events is We've shown that when the money market is not in equilibrium, the public tries to...

Regulation And Deregulation The Airlines

The airline industry provides many examples of actual and proposed policies for improving efficiency and correcting market failures. Early in the development of air travel in the 1930s the federal government decided that the airline market was sufficiently important, and was performing sufficiently poorly, that regulation was needed. A regulatory agency, the Civil Aeronautics Board (CAB), was created to determine which airlines would be allowed to operate, where and when they could fly, and how...

Figure

Initially, the baht is fixed at the equilibrium rate of 0.04. When the supply and demand curves shift to D2 and S2, the equilibrium exchange rate falls to 0.02. If Thailand continues to fix the rate at 0.04, it will have to buy up the excess supply of 300 million baht per month, using dollars. As its dollar reserves dwindle, traders will anticipate a drop in the value of the baht, shifting the curves out further, as indicated by the heavy arrows. vent the excess supply from driving the exchange...

Changes In The Online Retail Market

Panel (a) of Figure 2 shows what is happening in the online market. In this diagram, we are using the quantity of CDs as our measure of retail services on the horizontal axis, and the average markup as our measure of the price of retail services on the vertical axis. The demand curve D1 shows the demand for online retail services. The product market effects of growth in internet retailing Panel (a) depicts the market for CDs sold on line. Initially, the supply and demand curves intersect at...

Income Elasticity Of Demand

Recall from Chapter 3 that a change in average household income in a market will shift the demand curve. An income elasticity tells us how sensitive demand is to changes in income. More specifically, Income elasticity of demand The the income elasticity of demand is the percentage change in quantity de- percentage change in entity de- manded divided by the percentage change in income, with all other influences manded caused by a l-percent on demand remaining constant. where I is income in the...

Monopolistic Competition In The Short

The individual monopolistic competitor behaves very much like a monopoly. Its constraints are its given technology of production, the prices it must pay for its inputs, and the downward-sloping demand curve that it faces. And, like any other firm, its goal is to maximize profit by producing where MR MC. The result may be economic profit or loss in the short run. The key difference is this While a monopoly is the only seller in its market, a monopolistic competitor is one of many sellers. When a...

Health Insurance And The Market For Health Care

In 1990, health-related expenditures in the United States amounted to about 700 billion, or 12.2 percent of Gross Domestic Product (GDP). By the end of the decade, the figure had risen to about 1.3 trillion, or 14.3 percent of GDP. With this rapid rise in spending, the U.S. found itself devoting a larger share of its resources to health care than any other nation in the world. Why such rapid growth with no end in sight A variety of explanations have been offered. On the supply side, scientific...

Elasticity And Total Expenditure

When the price of a good increases, the law of demand tells us that people will demand less of it. But this does not necessarily mean that they will spend less on it. After the price rises, fewer units will be purchased, but each unit will cost more. It turns out that whether total spending on the good rises or falls depends entirely on the price elasticity of demand for the good. To see this more formally, note that the total expenditure (TE) on a good is defined as where P is the price per...

Goals And Constraints Of The Competitive Firm

Small Time, like any business firm, strives to maximize profit. And, like any firm, it faces constraints. For example, it must use some given production technology to produce its output, and must pay some given prices for its inputs. As a result, Small Time firm faces a familiar cost constraint, just like Spotless Car Wash in Chapter 6 and Ned's Beds in Chapter 7, Small Time Gold Mines faces a total cost of production for any level of output it might want to produce. In addition to total cost,...

Responding To Supply Shocks

So far in this chapter, you've seen that demand shocks, in general, present the Fed with easy policy choices. By sticking to its interest rate target, it can neutralize any demand shocks that arise from shifts in money demand. And by changing its interest rate target from time to time, it can deal with demand shocks caused by changes in spending. In each of these cases, the very policy that maintains a stable price level also helps to maintain full employment. But adverse or negative supply...

Side Payments And Pareto Improvements

The examples of Pareto improvements we have considered so far involve easily arranged transactions, in which one person trades with another and both come out ahead. Since both parties benefit, they have every incentive to find each other and trade. But there are more complicated situations, involving groups of people, in which a Pareto improvement will come about only if one side makes a special kind of payment to the Economic efficiency A situation in which every Pareto improvement has...

Using The Theory The Collapse Of Communism

Economic efficiency can be a powerful tool to help us understand the economic changes that shook the world in the late 1980s and early 1990s. It can also help us understand the changes that are continuing to take place in China in the year 2000 and beyond, and may in the future take place in such holdouts as Cuba, Belarus, and North Korea as well. Simply put, the system that these nations had in place for decades centrally planned socialism was economically inefficient. True, the...

The Fed In Action

When the Fed tries to achieve a macroeconomic goal by controlling or manipulating the money supply, it is conducting monetary policy. During periods of economic calm, such as 1993 through 1999, the Fed's monetary policy tends to be stable, and the interest rate remains at about the same level from year to year. Occasionally, however, the Fed sees the need to act dramatically to adjust the money stock aggressively and engineer large changes in interest rates. Such an episode occurred in the...

The Production Possibilities Frontier

Points along a production possibilities frontier show combinations of two goods here, lives saved and other goods' that can be produced using available resources and technology. At point A, all resources are used to produce other goods, and no lives are saved. At point F, 500,000 lives are saved, but no other goods are produced. The concave, bowed-out shape of the frontier reflects the law of increasing opportunity cost. other goods we're producing. In Figure 1, the quantity of other goods is...

The Relationship Between Average And Marginal Costs

Although marginal cost and average cost are not the same, there is an important relationship between them. Look again at Figure 6 and notice that all three curves MC, AVC, and ATC first fall and then rise, but not all at the same time. The MC curve bottoms out before either the AVC or ATC curve. Further, the MC curve intersects each of the average curves at their lowest points. These graphical features of Figure 6 are no accident indeed, they follow from the laws of mathematics. To understand...

Units of Output

If long-run total cost rises proportionately less than output, production reflects economies of scale, and LRATC slopes downward. If cost rises proportionately more than output, there are diseconomies of scale, and LRATC slopes upward. Between those regions, cost and output rise proportionately, yielding constant returns to scale. output (Q) can be accomplished with less than a doubling of costs, then the ratio LRTC Q LRATC will decline, and voila economies of scale. When long-run total cost...

Deriving The Demand Curve

In panel (a), a decrease in the price of concerts causes Max's budget lines to rotate outward. At 30 per concert, he maximizes utility at point D in both panels and attends 3 concerts. If the price falls to 10 per concert, he increases his consumption to 4 concerts per month, at point J. At a price of 5 each, he attends 6 concerts, shown at point K. Max's demand curve in panel (b) is obtained by connecting3 points such as D, J, and K. Substitution effect As the price of a good falls, the...

Assumptions Of The Classical Model

Remember from Chapter 1 that all models begin with assumptions about the world. The classical model is no exception. Many of the assumptions are merely simplify-ing they make the model more manageable, enabling us to see the broad outlines of economic behavior without getting lost in the details. Typically, these assumptions involve aggregation, such as ignoring the many different interest rates in the economy and instead referring to a single interest rate, or ignoring the many different types...

Challengeq U E S T I

Suppose Douglas and Ziffel have properties that adjoin the farm of Mr. Haney. The current zoning law permits Haney to use the farm for any purpose. Haney has decided to raise pigs (the best use of the land). A pig farm will earn 50,000 per year, forever. a. Assuming the interest rate is 10 percent per year, what is Haney's pig farm worth (Hint Use the special discounting formula of Chapter 13.) b. Suppose the next-best use of Haney's property is residential, where it could earn 20,000 per year....

The Redistributive Cost Of Inflation

One cost of inflation is that it often redistributes purchasing power within society. But because the winners and losers are chosen haphazardly rather than by conscious social policy the redistribution of purchasing power is not generally desirable. In some cases, the shift in purchasing power is downright perverse harming the needy and helping those who are already well off. How does inflation sometimes redistribute real income An increase in the price level reduces the purchasing power of any...

Putting Supply And Demand Together

What happens when buyers and sellers, each having the desire and the ability to trade, come together in a market The two sides of the market certainly have different agendas. Buyers would like to pay the lowest possible price, while sellers would like to charge the highest possible price. Is there chaos when they meet, with Try your hand at a Java-based supply and demand simulation. You can find it at http www. openteach.com javaapplets econ.html. Equilibrium A state of rest a situation that,...

Total Spending In A Very Simple Economy

Imagine a world much simpler than our own, a world with just two types of economic units households and business firms. In this world, households spend all of their income on goods and services. They do not save any of their income, nor do they pay taxes. Such an economy is illustrated in the circular flow diagram of Figure 3. The arrows on the right-hand side show that resources labor, land, and capital are supplied by households, and purchased by firms, in factor markets. In return,...

The Loanable Funds Market And Says

In Figure 4 (flip back 6 pages), you saw that total spending will equal total output if and only if total leakages in the economy (saving plus net taxes) are equal to total injections (planned investment plus government purchases). Now we can see how this requirement is satisfied automatically. Because the loanable funds market clears, we know that the interest rate the price in this market will rise or fall until the quantities of funds supplied (saving) and funds demanded (investment plus the...

Shifts In The Market Labor Demand Curve

Labor markets, like other markets in the economy, are undergoing constant change, in part caused by shifts in labor demand curves. As we'll see in the second half of this chapter, these shifts can have dramatic effects on workers, increasing or decreasing their wage rates, or causing some to lose their jobs entirely. We've already seen that a change in the wage rate will cause us to move along a labor demand curve, as in the move from point A to point B in Figure 3 (p. 315). But when something...

How Ongoing Inflation Arises

The best way to begin our analysis of ongoing inflation is to explore how it arises in an economy. We can do this by revisiting the 1960s, when the inflation rate rose steadily, and ongoing inflation first became a public concern. What was special about the economy in the 1960s First, it was a period of exuberance and optimism, for both businesses and households. Business spending on plant and equipment rose, and household spending on new homes and automobiles rose as well. At the same time,...

Production And Cost In The Long

Most of the business firms you have contact with such as your supermarket, the stores where you buy new clothes, your telephone company, and your internet service provider plan to be around for quite some time. They have a long-term planning horizon, as well as a short-term one. But so far, we've considered the behavior of costs only in the short run. In the long run, costs behave differently, because the firm can adjust all of its inputs in any way it wants In the long run, there are no fixed...

The inefficiency of imperfect competition

An imperfectly competitive firm, such as Kellogg, faces a downward-sloping demand curve and maximizes profit by producing q* boxes of cornflakes. At that output, the benefit of another box to some consumer ( 3) exceeds the marginal cost of producing it ( 1). That is economically inefficient. consumers better off a Pareto improvement. However, this will not happen as long as firms behave as shown in Figure 5. Thus, from the point of view of efficiency, monopoly and imperfectly competitive...

Detour Entry And Economic Profit

In Figure 2, the supply curve shifts rightward because of entry of new firms. Does that make sense So far in this text, we've assumed that entry occurs when firms that are already in the industry are enjoying economic profit. We've even identified profit as one of the major forces that help to allocate resources in a market economy Profit attracts new firms, while losses cause exit. But that is certainly not what is happening in online retailing. After all, almost all online retailers have...

Person

What is the market demand schedule for this cereal (Assume that these three people are the only buyers.) Draw the market demand curve. b. Why might the three people have different demand schedules 7. Larsen E. Pulp, head of Pulp Fiction Publishing Co., just got some bad news The price of paper, the company's most important input, has increased. a. On a supply demand diagram, show what will happen to the price of Pulp's output (novels). b. Explain the resulting substitution and income effects...

Problems And Exercises

With a three-panel diagram one panel showing the money market, one showing the aggregate expenditure diagram, and one showing the AD curve show how a decrease in the money supply shifts the AD curve leftward. 2. Using a diagram showing the aggregate expenditure line, the money market, and the AD curve, describe how an increase in taxes affects the interest rate, real aggregate expenditure, and the aggregate demand curve. (Assume that the price level does not change.) What other changes would...

A Shock To The Economy And The Stock Market The 1990s

The 1990s especially the second half of the 1990s saw a dramatic rise in stock prices. Both the Dow Jones Industrial Average and the Standard & Poor's 500 more than quadrupled over the period, and the NASDAQ increased almost ninefold. The 1990s were also a period of rapid expansion, especially the period from 1995 to 1999, in which economic growth averaged 4.2 percent per year much faster than in previous decades. In part, the economic expansion and the rise in stock prices were reinforcing...

Macroeconomic Controversies

Macroeconomics is full of disputes and disagreements. Indeed, modern macroeco-nomics which began with the publication of The General Theory of Employment, Interest, and Money, by British economist John Maynard Keynes in 1936 originated in controversy. Keynes was taking on the conventional wisdom of his time classical economics which held that the macroeconomy worked very well on its own, and the best policy for the government to follow was laissez faire leave it alone. As he was working on The...

Shifts In Labor Demand

One idea, studied by a number of economists, is that a recession might be caused by a leftward shift of the labor demand curve. This possibility is illustrated in Figure 3, in which a leftward shift in the labor demand curve would move us down and to the Can the Classical Model Explain Economic Fluctuations a recession caused by declining labor demand If a recession were caused by a leftward shift of the labor demand curve, both employment and the real wage would fall as in the movement from...

Internet Entrepreneurs Get Rich An Increase In Demand

Since shifts in supply and demand work the same way in any market, let's leave Maple syrup for now and look at a different market housing in San Francisco. In this market, something remarkable has happened recently The average price of a single-family home1 increased from 250,450 in mid-1995 to 373,750 in mid-1999. In just three and one-half year, the price almost doubled What explains this dramatic rise in in San Francisco housing prices Supply and demand can give us the answer. First, let's...

The Recession Of 19901991

Our most recent recession began in the second half of 1990 and continued into 1991. Table 6 tells the story. The second column shows real GDP in 1996 dollars in each of several quarters. For example, 1990 2 denotes the second quarter of 1990, and during that three-month period, GDP was 6,705 billion at an annual rate. (That is, if we had continued producing that quarter's GDP for an entire year, we would have produced a total of 6,705 billion worth of goods and services in the year 1990.) As...

The Very Short Run Hot Money

Banks and other large financial institutions collectively have trillions of dollars worth of funds that they can move from one type of investment to another at very short notice. These funds are often called hot money. If those who manage hot money perceive even a tiny advantage in moving funds to a different country's assets say, because its interest rate is slightly higher they will do so. Often, decisions to move billions of dollars are made in split seconds, by traders watching computer...

The Demand Deposit Multiplier

By how much will demand deposits increase in total If you look back at the balance sheet changes we've analyzed, you'll see that each bank creates less in demand deposits than the bank before. When Salomon Brothers deposited its 1,000 check from the Fed at First National, 1,000 in demand deposits was created. This led to an additional 900 in demand deposits created by Second Federal, another 810 created by Third State, and so on. In each round, a bank lent 90 percent of the deposit it received....

The Demand Curve

The downward-sloping demand curve, D, shows the quantity of maple syrup that would be purchased at each price, holding constant all other variables affecting demand. At 4.00 per bottle, 4,000 bottles of syrup are demanded (point A). At 2.00 per bottle, 6,000 bottles are demanded (point B). connect all of these points with a line, we obtain the famous demand curve, labeled with a D in the figure. The market demand curve (or just demand curve) shows the relationship between the price of a good...

Math Jargon And Other Concerns

Economists often express their ideas using mathematical concepts and a special vocabulary. Why Because these tools enable economists to express themselves more precisely than with ordinary language. For example, someone who has never studied economics might say, When used textbooks are available, students won't buy new textbooks. That statement might not bother you right now. But once you've finished your first economics course, you'll be saying it something like this When the price of used...

The Expenditure Approach To

The Commerce Department's Bureau of Economic Analysis (BEA) the agency responsible for gathering, reporting, and analyzing movements in the nation's output calculates GDP in several different ways. The most important of these is the expenditure approach. Because this method of measuring GDP tells us so much about the structure of our economy, we'll spend the next several pages on it. In the expenditure approach, we divide output into four categories according to which group in the economy...

The Assumption Of Profit Maximization

From the preceding discussion, it might seem that the profit-maximizing assumption underlying most of this chapter is somewhat naive. After all, because of the principal-agent problem, the firm may not always maximize profits, even though that is what the owners want. Why, then, did we base our theory of firm behavior on such a simple assumption Why not go back and view the firm in light of the principal-agent problem For one very good reason The assumption of profit maximization, while not...

Oligopoly Behavior

Of the market structures you have studied in this book, oligopoly presents the greatest challenge to economists. In the other types of markets perfect competition, monopoly, and monopolistic competition each firm acts independently, without worrying about the reactions of other firms. Its task is a simple one to select an output level along its demand curve that gives it maximum profit. But this approach doesn't describe an oligopolist. The essence of oligopoly, remember, is strategic...

Getting It Right The Success Of Continental Airlines

Continental Airlines was doing something that seemed like a horrible mistake. All other airlines at the time were following a simple rule They would only offer a flight if, on average, 65 percent of the seats could be filled with paying passengers, since only then could the flight break even. Continental, however, was flying jets filled to just 50 percent of capacity and was actually expanding flights on many routes. When word of Continental's policy leaked out, its stockholders were angry, and...

The Natural Rate Of Unemployment

Finally, we come to the most controversial information problem facing the Fed uncertainty over the natural rate of unemployment. While there is wide agreement that the natural rate rose in the 1970s and has fallen since the late 1980s, economists remain uncertain about its value during any given period. Many economists believe that today the natural rate is between 4 and 4.5 percent, but no one is really sure. Why is this a problem It's very much like the two mountain climbers who become lost....

Managing Expectations

Changes in interest rates due to changes in expectations can have important consequences. First, fortunes can be won and lost depending on how people bet on the future. For example, suppose you believe the interest rate is about to drop, so you buy bonds, thinking their price is about to rise. But suppose the interest rate actually rises instead. Then your bonds will immediately drop in price and be worth less than what you paid for them. In fact, it is not unusual for major bondholders such as...

The Relationship Between Longrun And Shortrun Costs

If you compare Table 6 (long run) with Table 3 (short run), you will see something important For some output levels, LRTC is smaller than TC. For example, Spotless can wash 185 cars for an LRTC of 390. But earlier, we saw that in the short run, the TC of washing these same 185 cars was 435. To understand the reason for this difference, look back at Table 5, which lists the four different ways of washing 185 cars per day. In the short run, the firm is stuck with just one automated line, so its...

Societys Choice Of

The title of this section might seem absurd How can we say that society chooses its level of GDP Wouldn't the citizens of any nation want their GDP to be as large as possible and certainly larger than it currently is The answer is yes. After all, GDP is certainly important to our economic well-being. Few of us would want to live at the levels of output per capita that prevailed 100, 50, or even 25 years ago. Increased output of medical care, restaurant meals, entertainment, transportation...

The Future Of The

In the past, the CPI has mostly tracked the cost of a fixed basket of goods, and it has done a reasonably good job of doing so. But it has not done a good job tracking what many people call the cost of living the number of dollars a person must pay in order to enjoy a given level of economic satisfaction. When people substitute cheaper goods, take advantage of new technologies, and enjoy quality improvements, they are trying to get more satisfaction for a given cost, or else trying to Over 10...

Soviet Production The Reality

Newly privatized Russian firms have been operating in the region of diseconomies of scale at levels like Q2. If they reduce output in the short run to Q3, they will find average costs rising along ATC. Today, many of these huge Russian firms are in a serious jam. Since free trade has opened up, they must compete with Western firms, which can produce at substantially lower costs per unit. One recent study has found that the average Russian industrial firm requires five times the labor, raw...

The Decline Of Monopoly

The past century was not kind to monopolies. In the first half of the century, vigorous antitrust legislation and enforcement broke up many long-standing monopolies, such as Standard Oil in 1911, and Alcoa in 1945. For the rest of the century, many monopolies and would-be monopolies came under the scrutiny of government regulators, and were unable to fully maximize profit. Today, monopolies face a different threat the relentless advance of technology. Consider, for example, the natural monopoly...

Other Demand Elasticities

In Chapter 3, we saw that other variables besides price influence quantity demanded. We can measure the sensitivity of demand to each of these variables by defining other types of demand elasticities. In general, the term elasticity measures the percentage change in one variable caused by a 1-percent change in some other variable. But whereas the price elasticity told us about relative movements along the demand curve, these other elasticities give us information about how the demand curve...

Changes In The Budget Line

In panel a , an increase in income leads to a rightward, parallel shift of the budget line. In panel b , a decrease in the price of a movie causes the budget line to rotate upward the horizontal intercept is unaffected. In panel c , a decrease in the price of a concert leads to a rightward rotation of the budget line. Since the ratio Pconcert Pmovie has not changed, the spending trade-off between movies and concerts remains the same. Thus, An increase in income will shift the budget line upward...

Deriving The Aggregate Supply Curve

Figure 5 summarizes our discussion about the effect of output on the price level in the short run. Suppose the economy begins at point A, with output at 10 trillion 2 This simplifying assumption is not entirely realistic. In some industries, wages will respond to changes in output, at least somewhat, even in the short run. However, assuming that the nominal wage remains constant in the short run makes our model much simpler, without affecting any of our essential conclusions. Beginning at point...

Anticipating A Price Change

In the late 1980s, many East Coast colleges purchased expensive equipment that would enable them to switch rapidly from oil to natural gas as a source of heat. The idea was to protect the colleges from a sudden rise in oil prices, like the one they had suffered in the 1970s. Finally, an event occurred that gave the colleges a change to put their new equipment to use In the fall of 1990, Iraq invaded Kuwait. As oil prices skyrocketed, the colleges switched from burning oil to burning natural...

Equilibrium Gdp And Employment

Now that you've learned how to find the economy's equilibrium GDP in the short run, a question may have occurred to you When the economy operates at equilibrium, will it also be operating at full employment The answer is not necessarily. Let's see why. If you look back over the two methods we've employed to find equilibrium GDP using columns of numbers as in Table 4, and using a graph as in Figure 8 you will see that in both cases we've asked only one question How much will households,...

Opportunity Cost For Individuals

Virtually every action we take as individuals uses up scarce money, scarce time, or both. Hence, every action we choose requires us to sacrifice other enjoyable goods and activities for which we could have used our money and time. For example, it took a substantial amount of the authors' time to write this textbook. Suppose that the time devoted to writing the book could instead have been used by one of the authors to either 1 go to law school, 2 write a novel, or 3 start a profitable business....

Full Employment

Full employment means that unemployment is at normal levels. But what, exactly, is a normal amount of employment Recall that there are different types of unemployment. Some of the unemployed in any given month will find jobs after only a short time of searching. This frictional unemployment is part of the normal working of the labor market, and is not a serious social problem. Other job seekers will spend many months or years out of work because they lack the skills that employers require, or...

How Economic Fluctuations Affect Spending Taxes And The Federal Budget

Economic fluctuations affect both transfer payments and tax revenues. In a recession, in which many people lose their jobs, the federal government contributes larger amounts to state-run unemployment insurance systems and pays more in transfers to the poor, since more families qualify for these types of assistance. Thus, a recession causes transfer payments to rise. Recessions also cause a drop in tax revenue, because household income and corporate profits two important sources of tax revenue...

R Eview Questions

What causal relationship does the aggregate demand curve describe Why does the AD curve slope downward What does each point on the AD curve represent 2. Only spending shocks can shift the aggregate demand curve. True or false Explain. 3. List three reasons why a change in output affects unit costs and subsequently the price level. 4. What causal relationship does the aggregate supply curve describe Why does the AS curve slope upward 5. Why does equilibrium occur only where the AD and AS...

The Bright Budgetary Future How Certain

Try your hand at managing the budget by using the National Budget Simulation http socrates. berkeley.edu 3333 budget budget.html . of Congress, not to take positions in political debates. Although some of the CBO's studies have been controversial, its research methods and conclusions are on the whole widely used and widely respected by both Democrats and Republicans. However, just because the CBO's projections are honest does not mean they are reliable. Projections especially those made over...

Changes In Technology

Perfect competition, while it does wonders for society as a whole, is hard on the individual firm. We have seen that economic profit when it occurs exists only fleetingly before being eliminated by the entry of other firms. Similarly, economic loss is eliminated by exit a rather clinical term for thousands of painful business failures each year. But these features of competition make it a powerful engine for satisfying our material desires. In this section, we look at another way in which...

Understanding The Market For Collegeeducated Labor

Students have many motives for attending college, but one of the most important motives is to invest in their own human capital. Put very simply, going to college will enable you to earn a higher income than you would otherwise be able to earn. How much higher In 1998, the average high school graduate aged 25 or older earned 19,735 per year, while the average college graduate earned 36,708.9 The college wage premium is the percentage by which the average college graduate's income exceeds the...

Improving Education

So far in this chapter, we've considered the problem of a consumer trying to maximize utility by selecting the best combination of goods and services. But consumer theory can be extended to consider almost any decision between two alternatives. Economists use the model of consumer theory to understand how people choose between work and leisure, between spending now and investing for the future, and even between honest work and criminal activities. In this section, we apply the insights of...

Bank Failures And Banking Panics

A bank failure occurs when a bank is unable to meet the requests of its depositors to withdraw their funds. Typically, the failure occurs when depositors begin to worry about the bank's financial health. They may believe that their bank has made unsound loans that will not be repaid, so that it does not have enough assets to cover its demand deposit liabilities. In that case, everyone will want to be first in Using the Theory Banks Failures and Banking Panics line to withdraw cash, since banks...

Economic Growth In The Lessdeveloped Countries

In most countries, Malthus's dire predictions have not come true. An important part of the reason is that increases in the capital stock have raised productivity and increased the average standard of living. Increases in the capital stock are even more important in the less-developed countries LDCs , which have relatively little capital to begin with and where even small increases in capital formation can have dramatic effects on living standards. But how does a nation go about increasing its...

Physical Capital And The Firms Investment Decision

The concept of capital was introduced in the first chapter of this book. There, you learned that capital is one of society's resources, along with land and labor. More specifically, capital is any long-lasting tool that people use to produce goods and services. You also learned that we can classify capital into two categories physical capital, such as the plant and equipment owned by business firms, and human capital the skills and training of the labor force. In this section, we'll focus on...

Time To Take A Break

By now, your mind may be swimming with concepts and terms total, average, and marginal cost curves fixed and variable costs explicit and implicit costs. . . . We are covering a lot of ground here and still have a bit more to cover production and cost in the long run. As difficult as it may seem to keep these concepts straight, they will become increasingly easy to handle as you use them in the chapters to come. But it's best not to overload your brain with too much new material at one time. So...

Ongoing Inflation And The Phillips Curve

Shifting Phillips Curve

Ongoing inflation changes our analysis of monetary policy. For one thing, it forces us to recognize a subtle, but important, change in the Fed's objectives While the Fed still desires full employment, its other goal price stability is not zero inflation, but rather a low and stable inflation rate. Another difference is in the graphs we use to illustrate the Fed's policy choices. Instead of continuing to analyze the economy with AS and AD graphs, when there is ongoing inflation, we usually use...

Net capital flows into the united states as a percent of gdp

Is just what has happened to the United States that the U.S. trade deficit has been caused by the desire of foreigners to invest in the United States. The result was a massive capital inflow and trade deficit that arose in the early 1980s, as illustrated in Figure 10. That capital inflow was unprecedented in size and duration, and it reversed a long-standing pattern of ownership between the United States and other countries. For decades, American holdings of foreign assets far exceeded foreign...

The Four Market Structures A Postscript

You have now been introduced to the four different market structures perfect competition, monopoly, monopolistic competition, and oligopoly. Each has different characteristics, and each leads to different predictions about pricing, profit, non-price competition, and firms' responses to changes in their environments. Table 1 summarizes some of the assumptions and predictions associated with each of the four market structures. While the table is a useful review of the models we have studied, it...

How The Cpi Is Used

The CPI is one of the most important measures of the performance of the economy. It is used in three major ways As a Policy Target. In the introductory macroeconomics chapter, we saw that price stability or a low inflation rate is one of the nation's important macro-economic goals. The measure most often used to gauge our success in achieving low inflation is the CPI. To Index Payments. A payment is indexed when it is set by a formula so that it rises and falls proportionately with a price...

The Classical Model A Summary

You've just completed a first tour of the classical model, our framework for understanding the economy in the long run. Before we begin to use this model, this is a good time to go back and review what we've done. We began with a critical assumption All markets clear. We then used the first three Key Steps of our four-step procedure to organize our thinking about the economy. First, we focused on an important market the labor market and identified the buyers and sellers in that market. We...

Shifts In The Consumptionincome Line

As you've learned, consumption spending depends positively on income If income increases and taxes remain unchanged, disposable income will rise, and consumption spending will rise along with it. The chain of causation can be represented this way In Figure 4, this change in consumption spending would be represented by a movement along the consumption-income line. For example, a rise in income from 7,000 billion to 8,000 billion would cause consumption spending to increase from 5,000 billion to...

The Resource Cost Of Inflation

In addition to its possible redistribution of income, inflation imposes another cost upon society. To cope with inflation, we are forced to use up time and other resources as we go about our daily economic activities shopping, selling, saving that we could otherwise have devoted to productive activities. Thus, inflation imposes an opportunity cost on society as a whole and on each of its members When people must spend time and other resources coping with inflation, they pay an opportunity cost...

How The Stock Market Affects The Economy

What do households do when their wealth increases Typically, they increase their spending. In our short-run macro model, we would classify this is an increase in autonomous consumption an increase in consumption spending at any level of disposable income. The link between stock prices and consumer spending is an important one, so economists have given it a name the wealth effect. And the wealth effect works in both directions Just as an increase in stock prices increases autonomous consumption,...

Bilateral arbitrage

Millions of British Pounds per Month Millions of British Pounds per Month Initially, the price of the pound is 1.20 in New York panel a and 1.80 in London panel b . Traders take advantage of this exchange rate differential by buying pounds in New York and simultaneously selling them in London. As they do so, the demand curve shifts rightward in New York, and the supply curve shifts rightward in London. Arbitrage continues until the exchange rate attains the same value 1.50 per pound in both...

The effect of higher stock prices on the economy

Higher stock prices have a wealth effect on spending, increasing consumption spending at any level of real GDP. In panel a , the wealth effect of higher stock prices shifts the aggregate expenditure line upward, raising equilibrium GDP from Y, to Y2. Panel b shows a more complete way of illustrating the wealth effect Higher stock prices shift the aggregate demand curve rightward, increasing both equilibrium real GDP and the price level. any change in government policy this shift of the AD curve...

Why The Fed Allows Ongoing Inflation

Since the Fed can choose any rate of inflation it wants, and since inflation is costly to society, we might think that the Fed would aim for an inflation rate of zero. But a look back at panel a of Figure 1 shows that this is not what the Fed has chosen to do. In recent years, with unemployment very close to its natural rate, the Fed has maintained annual inflation at around 2 or 3 percent. Why doesn't the Fed eliminate inflation from the economy entirely One reason is a widespread belief that...

S U M M A R Y

The model of supply and demand is a powerful tool for understanding all sorts of economic events. For example, governments often intervene in markets either by creating price ceilings or price floors, or by imposing taxes or subsidies. Supply and demand enables us to predict how these interventions affect the price of a good and the quantity exchanged. Another powerful tool is the price elasticity of demand, defined as the percentage change in quantity demanded divided by the percentage change...

Using Price Elasticity Of Demand

Supply Curve After Excise Tax

Knowing the price elasticity of demand for a good and understanding the link between elasticity and total expenditure or revenue is helpful in many different contexts. For example, producers of goods and services doctors, bakers, theater owners, manufacturers, and others can use price elasticity of demand to predict how a price change will affect their total sales revenue. And government policy makers can and do use demand elasticities to price many government services, to make tax policy, and...

Price Floors

Supply Loanable Funds Curve

Sometimes, governments try to help sellers of a good by establishing a price floor a minimum amount below which the price is not permitted to fall. The most common use of price floors around the world has been to raise prices or prevent prices from falling in agricultural markets. Price floors for agricultural goods are commonly called price support programs. In the United States, price support programs began during the Great Depression, after farm prices fell by more than 50 between 1929 and...

Are We Saving Lives Efficiently

Brief physician antismoking intervention Single personal warning from physician to stop smoking Sickle cell screening and treatment for African-American newborns Intensive physician anti-smoking intervention Physician identification of smokers among their patients 3 physician counseling sessions 2 further sessions with smoking-cessation specialists and materials nicotine patch or nicotine gum Mammograms Once every 3 years, for ages 50-64 Mammograms Annually, for ages 50-64 Exercise...

Crossprice Elasticity Of Demand

A cross-price elasticity relates the change in quantity demanded for one good to a price change in another. More formally, we define the cross-price elasticity of demand between good X and good Y as The percentage change in the quantity demanded of one good caused by a 1-percent change in the price of another good. A cross-price elasticity of demand tells us the percentage change in quantity demanded of a good for each 1-percent increase in the price of some other good, all other influences on...

How To Study Economics

As you read this book or listen to your instructor, you may find yourself nodding along and thinking that everything makes perfect sense. Economics may even seem easy. Indeed, it is rather easy to follow economics, since it's based so heavily on simple logic. But following and learning are two different things. You will eventually discover preferably before your first exam that economics must be studied actively, not passively. If you are reading these words lying back on a comfortable couch, a...

Profit Maximization Using Graphs

Both approaches to maximizing profit using totals or using marginals can be seen even more clearly when we use graphs. In Figure 2 a and b , the data from Table 1 have been plotted the TC and TR curves in the left panel, and the MC and MR curves in the right one. Note the important relationship between the MR and TR curves. MR tells us the change in total revenue as output increases. Thus, as long as the MR curve lies above the horizontal axis MR gt 0 , TR must be increasing, and the TR curve...

Scarcity And Individual Choice

Think for a moment about your own life your daily activities, the possessions you enjoy, the surroundings in which you live. Is there anything you don't have right now that you'd like to have Anything that you already have but that you would like more of If your answer is no, congratulations Either you are well advanced on the path of Zen self-denial, or else you are a close relative of Bill Gates. The rest of us, however, feel the pinch of limits to our material standard of living. This simple...

An Imaginary World

To understand why wages differ in the real world, let's start by imagining an unreal world, with three features 1. Except for differences in wages, all jobs are equally attractive to all workers. 2. All workers are equally able to do any job. 3. All labor markets are perfectly competitive. In such a world, we would expect every worker to earn an identical wage in the long run. Let's see why. Figure 1 shows two different labor markets that, initially, have different wages. Panel a shows a local...

The Market For Day Care Changes In Both Supply And Demand

So far, we've considered the consequences of a change in a single variable only. But what happens to the market equilibrium when two or more variables change simultaneously Figure 11 illustrates how we would analyze such a situation, using the market for day care services. SIMULTANEOUS SHIFTS OF SUPPLY AND DEMAND As more young mothers sought day care, the demand curve shifted right from D1990 to D2000. Simultaneously, more firms entered the market, increasing sup- P y from 5,990to s2000. As a...

Change In Labor Supply

Shifts in labor supply typically happen slowly. A look back at Table 4 shows why. While tastes for different jobs can and do change, the changes are usually very gradual. The cost of acquiring human capital can change more rapidly, but this will not shift a labor supply curve until some time later. For example, a drop in the price of going to law school will shift the labor supply curve rightward three years later when those who enter law school now finally get their degrees and begin to enter...