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TWENTIETH EDITION
Economics
Today
The Micro View
@ Pearson
Dedication For Sabine,
Courage has always been your strong suit.
And I continue to admire it greatly.
R.L.M.
Copyright© 2021, 2018, 2016 by Pearson Education, Inc. or its affiliates, 221 River Street, H oboken, NJ 07030. Al l Rights Reserved.
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Preface xi
PART 1 Introduction
1 The Nature of Economics
2 Scarcity and the World of Trade-Otts 26
3 Demand and Supply 48
4 Extensions of Demand and Supply Analysis 73
5 Public Spending and Public Choice 98
6 Funding the Public Sector 120
iii
CONTENTS
Preface xi
PART 1 Introduction
Al-DECISION MAKING
THROUGH DATA 1 The Nature of Economics 1
Microeconomic and Macroeconomic The Power of Economic Analysis 2 • The Three Basic Economic Questions and Two
Applications 4 Opposing Sets of Answers 4 • The Economic Approach: Systematic Decisions 6
EXAMPLE • Economics as a Science 8
The Altered Incentives Confronting WHAT HAPPENS WHEN ... people's actual reactions to incentives differ from how they
Prospective College Students 7 claim they would respond in answers to survey questions? 9
Getting Directions 8 Positive versus Normative Economics 10
BEHAVIORAL EXAMPLE ECONOMICS IN YOUR LIFE Government Involvement Enables a Private U.S. Housing
Assessing Whether Charitable Dona- Finance Company to Provide "Cheap" Loans 12
tions Reflect Caring for Others or for
Oneself 7
ISSUES & APPLICATIONS Why Fewer Men in Manufacturing Jobs Helps to Explain Why
Fewer Women Are Married 12
Summary: What You Should Know 13 • Problems 14 • References 16
APPENDIX A Reading and Working with Graphs 17
Direct and Inverse Relationships 17 • Constructing a Graph 18 • Graphing
N umbers in a Table 19 • The Slope of a Line (A Linear Curve) 21 • What You
Should Know 24 • Problems 25
iv
CONTENTS V
INTERNATIONAL EXAMPLE ECONOMICS IN YOUR LIFE Space-Constrained Restaurants Discover That Customers Care
In China, Lower-Priced Solar Energy abo ut Quality-Adjusted Lunch Prices 67
Puts a Damper on the Demand for
ISSUES & APPLICATIONS Explaining a Consumption Shift from Soft Drinks to Bottled
Coal 56
Water: Tastes versus Relative Prices 67
A British Vegetable Shortage Has
Predictable Effects on Vegetable Summary: What You Should Know 69 • Problems 70 • References 72
Prices 66
Al-DECISION MAKING
THROUGH DATA
The Global Tourism Industry 58
EXAMPLE WHAT HAPPENS WHEN . .. the New York City government effectively raises the legal
minimum price of cigarettes within the city's boundaries to almost twice the average U.S.
The Effects of a Simultaneous
Decrease in the Supply of and an price? 81
Increase in the Demand for Vinyl Price Floors and Quantity Restrictions 83
Records 78 ECONOMICS IN YOUR LIFE A Mayor Favors the Minimum Wage until Confronting Its
"99-Seat Th eaters" in Los Angeles Consequences 87
Adapt to a Minimum Wage
Requirement 86 ISSUES & APPLICATIONS Why Shortages of Some Pharmaceuticals Generate Higher
Prices for Other Drugs 88
INTERNATIONAL EXAMPLE
Summary: What You Should Know 89 • Problems 90 • References 93
Customers of eWater Prefer Price
Rationing over First Come, First APPENDIX B Consumer Surplus, Producer Surplus , and Gains from Trade within a Price
Served at a Zero Price 79 System 94
BEHAVIORAL EXAMPLE Consumer Surplus 94 • Producer Surplus 95 • Gains from Trade within a Price
Experimental Evidence Verifies Predic- System 96 • Price Controls and Gains from Trade 97
tions about the Effects of Imposing a
Price Floor in a Labor Market 87
Al-DECISION MAKING WHAT HAPPENS WHEN ... governments require everyone to purchase health
THROUGH DATA insu rance? 102
Contemplating Big Data as a Public The Other Economic Functions of Government 103 • T he Political Functions
Good 105 of Government 106 • Public Spending and Transfer Programs 107 • Collective
Decision Making: The Theory of Public Choice 111
POLICY EXAMPLE
Government Sponsorship Keeps Light ECONOMICS IN YOUR LIFE Fake "Service Pets" Create Exte rnal Costs on Airline
Rail Systems in Operation 106 Flights 114
Private Space Firms Recycle Rocket ISSUES & APPLICATIONS Residents of Wisconsin Learn That Services Provided by State
Boosters and Capsules That the Parks Are Not Public Goods 114
Government Regards as
Summary: What You Should Know 115 • Problems 116 • References 119
Throwaways 113
BEHAVIORAL EXAMPLE
To Inhibit Nicotine Consumption, Should
the Government Assume That All
Consumers Behave the Same? 107
POLICY EXAMPLE 6 Funding the Public Sector 120
State Governments Confront Higher
Debt Repayment Expenses 121 Paying for the Public Sector: Systems of Taxation 121 •The Most Important Federal
Taxes 123
Al-DECISION MAKING
THROUGH DATA WHAT HAPPENS WHEN ... the government raises the tax rate on capital gains derived
fro m sales of financial assets? 125
Preserving National Tax Bases 122
Tax Rates and Tax Revenues 127 •Taxation from the Point of View of Producers and
EXAMPLE Consumers 130
Average Federal Income Tax Rates and
U.S. Income Tax Progressivity 123 ECONOMICS IN YOUR LIFE The Connecticut Govern ment Decides to Avoid Striking Out on
Its Income Tax Policy 132
Vi CONTENTS
POLICY EXAMPLE ISSUES & APPLICATIONS What Would It Take to Save Social Security as We Know It? 132
If You Generate Sales from Moving Summary: What You Should Know 133 •Problems 134 •References 136
Items from Ou r State to Outer Space,
Pay Up ! 128
BEHAVIORAL EXAMPLE
Increases in Complex Sales Taxes
Generate Predictable Dynamic
Responses by Consumers 129
POLICY EXAMPLE 21 Rents, Profits, and the Financial Environment of Business 450
State Governments Discover That a
Change in the Interest Rate Affects
Economic Rent 451 • Firms and Profits 452
Discounted Present Value 460 WHAT HAPPENS WHEN .. . factors of production that a producer al ready owns could be
INTERNATIONAL POLICY leased to other firms at a higher price than previously? 455
EXAMPLE Interest 458 • Corporate Financing Methods 461
A Government Bond Designed for a ECONOMICS IN YOUR LIFE What New Microwave Towers Have to Do with Modern
Generation of Smartphone Users 462 Financial Markets 465
Al-DECISION MAKING ISSUES & APPLICATIONS Explaining the Growth in the Number of Widely Used "Stock
THROUGH DATA Indexes" 465
Supplementing or Replacing Human Summary: What You Should Know 466 • Problems 467 • References 469
Financial Trading 463
EXAMPLE
Why Trying to Induce Companies to
"Do the Right Thing" by "Punishing"
Their Stocks Often Fails 464
CONTENTS Vii
INTERNATIONAL POLICY WHAT HAPPENS WHEN . . . U.S. spending on merchandise imports increases during the
EXAMPLE same year that foreign expenditures on U.S. merchan dise exports decrease, other things being
equal? 697
African Governments with Dollar-
Denominated Debts Confront Foreign Deriving the Demand for and Supply of Foreign Exchange 697 •Determining
Exchange Depreciations 707 Foreign Exchange Rates 701 • Fixed Versus Floating Exchange Rates 704
Al-DECISION MAKING ECONOMICS IN YOUR LIFE The Hong Ko ng Monetary Authority Acts to Keep Its Cur-
THROUGH DATA rency's Exchange Rate Fixed 708
Foreign Exchange Markets Involving ISSUES & APPLICATIONS How Chang ing a Fixed Exchange Rate to Try to Absorb Shocks
Really Big Data 707 Eventually Can Cause Shocks 709
Summary: What You Should Know 710 • Problems 710 • References 712
Glossary 715
Index 727
PREFACE
I have modified the learning and teaching package for this 20th edition of Economics
Today to make learning more efficient for your students. At the same time, the hall-
mark of each previous edition has been maintained-teaching and learning through
examples.
xi
Xii PREFACE
Thomas Elliot, Columbia College Margaret McDaniel, Community College ofAllegheny County
Maria Giuili, Diablo Valley College Kevin McWoodson, Moraine Valley Community College
Sanja Grubacic, Southern Connecticut State University Alex Obiya, San Diego City College
Ronald Halcrow, Antelope Valley College Jeff Salavitabar, Delaware County Community College
Timothy Hamilton, Columbia College James Sondgeroth, Austin Community College
Samuel Imarhiagbe, Collin College Alan Traverse, Columbia College
Ninos Malek, San Jose State University and De Anza College Ricardo Vicente, BYU-Hawaii
xiii
xiv ACKNOWLEDGMENTS
Peng Huang, James Hubert, George Hughes, Joseph W Hunt Jr. , Scott Hunt, John Ifediora, R. Jack
Inch, Christopher Inya, Tomotaka Ishimine, E. E. Jarvis, Ricot Jean, Parvis Jenab, Allan Jenkins, John
Jensel, Mark Jensen, S. D. J evremovic, ]. Paul Jewell, Nancy Jianakoplos, Frederick Johnson, David
Jones, Lamar B. Jones, Paul A. Joray, Daniel A. Joseph, Craig Justice, M. James Kahiga, Septimus
Kaikai, Michael Kaluya, Lillian Kamal, Mohammad Kasraian, D evajyoti Kataky, Timothy R. Keely,
Ziad Keilany, Norman F. Keiser, Michele Kegley, Sukanya Kemp, Brian Kench, Randall G. Kesselring,
Alan Kessler, E. D. Key, Saleem Khan, M. Barbara Killen, Bruce Kimzey, Terrence Kina!, Philip
G. King, E. R. Kittrell , David Klingman, Charles Knapp, Jerry Knarr, Tori Knight, Faik Koray, Janet
Koscianski, Dennis Lee Kovach, Marie Kratochvil, Richard W Kreissle, Peter Kressler, Paul ]. Kubik,
Michael Kupilik, Margaret Landman, Richard LaNear, Larry Landrum, Keith Langford, Theresa
Laughlin, James M. Leaman, Anthony T. Lee, Jim Lee, Loren Lee, Bozena Leven, Donald Lien,
George Lieu, Stephen E. Lile, Jane Lopus, Lawrence W Lovick, Marty Ludlum, William Kent Lutz,
Brian Lynch, Brian Madie, Michael Machiorlatti, Laura Maghoney, G. Dirk Mateer, John McArthur,
Robert McAuliffe, James C. McBrearty, Howard J. McBride, Bruce McClung, Jeremy McCracken, John
McDowell, E. S. McKuskey, James ]. McLain, Kevin McWoodson, John L. Madden, Mary Lou
Madden, John Marangos, Dan Marburger, G len Marston, John M. Martin, Paul]. Mascotti, James
D. Mason, Paul M. Mason, Tom Mathew, Warren Matthews, Akbar Marvasti, Pete Mavrokordatos,
Fred May, G. Hartley Mellish, Mike Melvin, Diego Mendez-Carbajo, Dan C. Messerschmidt, Michael
Metzger, Charles Meyrick, Herbert C. Milikien, Joel C. Millonzi, Glenn Milner, Ida Mirzaie, D aniel
Mizak, Khan Mohabbat, Thomas Molloy, William H. Moon, Margaret D. Moore, William E. Morgan,
Stephen Morrell, Irving Morrissett, James W. Moser, T haddeaus Mounkurai, Kevin Murphy, Martin
F. Murray, Dense! L. Myers, George L. Nagy, Solomon Namala, Ronald M. Nate, Jerome Neadly,
James E. Needham, Claron Nelson, Douglas Nettleton, William Nook, Gerald T. O'Boyle, Greg
Okoro, Dr. Larry Olanrewaju, Richard E. O'Neill, Lucian T. Orlowski, Diane S. Osborne, Joan
Osborne, Melissa A. Osborne, James O 'Toole, Tomi Ovaska, Lawrence Overlan, Benny E. Overton, Jan
Palmer, Zuohong Pan, Gerald Parker, Ginger Parker, Randall E. Parker, Mohammed Partapurwala,
Kenneth Parzych, Elizabeth Patch, Joseph Patton, Norm Paul, Teddi Paulson, Wesley Payne, Raymond
A. Pepin, Martin M. Perline, Timothy Perri, Jerry Petr, Maurice Pfannesteil, Van Thi Hong Pham,
Chris Phillips, James Phillips, Raymond]. Phillips, I. James Pickl, Bruce Pietrykowski, D ennis Placone,
Mannie Poen, W illiam L. Polvent, Robert Posatko, Greg Pratt, Leila]. Pratt, Steven Pressman, Rick
Pretzsch, Renee Prim, Robert E. Pulsinelli, Rod D. Raehsler, Kambriz Raffiee, Sandra Rahman,
Jaishankar Raman, John Rapp, Richard Rawlins, Gautam Raychaudhuri, Kenneth Rebeck, Ron Reddall,
Mitchell Redlo, Annette Redmon, Charles Reichhelu, Robert S. Rippey, Charles Roberts, Ray
C. Roberts, Leila Angelica Rodemann, Richard Romano, Judy Roobian-Mohr, Duane Rosa, Richard
Rosenberg, Larry Ross, Barbara Ross-Pfeiffer, Marina Rosser, Philip Rothman, John Roufagalas,
Stephen Rubb, Henry Ryder, Lewis Sage, Basel Saleh, Patricia Sanderson, Thomas N. Schaap, William
A. Schaeffer, William Schamoe, David Schauer, A. C. Schlenker, David Schlow, Paul Schoofs, Scott
]. Schroeder, Bill Schweizer, William Scott, Dan Segebarth, Paul Seidenstat, Swapan Sen, Augustus
Shackelford, Richard Sherman Jr., Liang-rong Shiau, Gail Shields, Jeff Shmidl, David Shorow, Vishwa
Shukla, R.]. Sidwell, Jonathan Silberman, David E. Sisk, Alden Smith, Garvin Smith, Howard
F. Smith, Lynn A. Smith, Phil Smith, William Doyle Smith, Brian Sommer, Lee Spector, George Spiva,
Richard L. Sprinkle, Alan Stafford, Amanda Stallings-Wood, Herbert F. Steeper, Diane L. Stehman,
Columbus Stephens, William Stine, Allen D. Stone, Daniel Strang, Jialu Streeter, Osman Suliman,
]. M. Sullivan, Rebecca Summary, Terry Sutton, Joseph L. Swaffar, Thomas Swanke, Manjuri Talukdar,
Frank D. Taylor, Ian Taylor, Daniel Teferra, Lea Templer, Gary Theige, Dave Thiessen, Robert
P. Thomas, Deborah Thorsen, Richard Trieff, George Troxler, William T. Trulove, William
N . Trumbull, Patricia Turco, Arianne K. Turner, Kay Unger, Anthony Uremovic, Ezgi U zel, John
Vahaly, Jim Van Beek, David Van Hoose, Lee]. Van Scyoc, Roy Van Ti!, Reuben Veliz, Sharmila
Vishwasrao, Craig Walker, Robert F. Wallace, Henry C. Wallich, J acqueline Ward, Milledge Weathers,
Ethel C. Weeks, Roger E. Wehr, Don Weimer, Robert G . Welch, Terence West, James Wetzel, Wylie
Whalthall, James H . Wheeler, Everett E. White, Michael D . White, Oxana Wieland, Mark
A. Wilkening, Raburn M . Williams, James W illis, George W ilson, Travis Wilson, Mark Wohar, Ken
Woodward, Tim Wulf, Peter R. Wyman, Whitney Yamamura, Donald Yankovic, Alex Yguado, Paul
Young, Shik Young, Michael Youngblood, Mohammed Zaheer, Ed Zajicek, Charles Zalonka, Sourushe
Zandvakili, Paul Zarembka, Erik Zemljic, George K. Zestos, William J . Zimmer, Jr.
ACKNOWLEDGMENTS XV
For this 20th edition of Economics Today, I was fortunate to again h ave production management
masterfully managed by Kathy Smith, working for SPi Global. She remains at the top of her field by
making sure that every correction is made, every graph is perfect, and every table remains error free.
I 'm also thankful for the impact of the following: Shweta Jain, content producer; C hris De] ohn, content
strategy manager; Thomas Hayward, content strategy analyst; Samantha Lewis, product manager; and
Adrienne D'Ambrosio, director of product management. I'd also like to thank Ashley DePace and Nayke
Heine on their work on the marketing plans.
To my faithful, long-standing, and amazingly accurate "super reviewer,'' Professor Dan Benjamin, a
heartfelt thank you from me. I am sure that those of you reading this text will recognize h ow error-free
it is, and Professor Benjamin is largely responsible for that level of detail. To my assistant, Sue Jasin, who
was responsible for the many drafts of all of the updated revisions, thank you for "burning the midnight
oil."
I welcome ideas and criticisms from both professors and students alike.
R.L.M.
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1 The Nature of Economics
LEARNING OBJECTIVES
I
n 1950, t he typica l woman who married did so at
age 20. Now, however, she is wa it ing until age 27.
After reading this chapter, you should be Furthermore, a larger number of women are choosing
able to: not to marry at all. Contributing to delayed marriages
m Define econom ics and discuss t he
difference between microeconom ics and
and nonmarriages is t he fact that fewer women are
agreeing to marry non-co llege-ed ucated men emp loyed
macroeconomics by or seeking to work in manufact uring industries. In
m Ident ify the t hree basic economic
quest ions and the two opposing set s of
t his chapter, you wil l learn that dimin ished prospects
for male employment by ma nufacturing firms and
answers
decreased male earn ings at these companies have
m Eval uate t he role that rat ional self-i nterest
plays in economic analysis
provided women wit h economic incentives t hat reduce
1
2 PART 1 I INTRODUCTION
more than one out of every fou r vehicles on Russian roads is equipped with a dashboard camera? Russian resi-
dents likely are no more tech savvy than residents of many other nations, but they have stronger incentives to
document auto accidents that may occur while they are driving. Russia's Arctic winter conditions and poor
maintenance of many of its roads contribute to large numbers of accidents that drivers might wish to document
in case thei r insurers question whether they or other drivers were at fault. In addition, Russian Highway Patrol
officers commonly stop drivers who have committed no driving offenses and threaten them with tickets unless
they pay bribes. Furthermore, criminal organizations commonly stage accidents or provide damaged vehicles as
evidence for fil ing insurance claims against motorists. Taken together, the prevalence of icy roads, police cor-
ruption, and faked accident claims gives drivers in Russia particularly strong incentives to install dashboa rd
cameras and compile video documentation of every second their veh icles spend on the road.
Incentives In th is chapter, you will learn why contemplating the nature of self-interested responses to incentives is
Rewards or penalties for engaging in the starting point for analyzing choices peop le make in all walks of life. After all, how much time you devote
a particular activity. to studying economics in th is introductory course depends in part on the incentives established by your
instructor's grading system. As you will see, self-interest and incentives are the underpinnings for all the
decisions you and others around you make each day.
Defining Economics
Economics Economics is part of the social sciences and, as such, seeks explanations of real events.
The study of how people allocate their All social sciences analyze human behavior, as opposed to the physical sciences, which
limited resources to satisfy their generally analyze the behavior of electrons, atoms, and other nonhuman phenomena.
unlimited wants.
Economics is the st.udy of how people allocate their limited resources in an
attempt to satisfY their unlimited wants. As such, economics is the st.udy ofhow
Resources people make choices.
Things used to produce goods and services
to satisfy people's wants. To understand this definition fully, two other words need explaining: resources and
Wants wants. Resources are things that have value and, more specifically, are used to pro-
What people would buy if their incomes duce goods and services that satisfy people's wants. Wants are all of the items that
were unlimited. people would purchase if they had unlimited income.
CHAPTER 1 I The Nature of Economics 3
Whenever an individual, a business, or a nation faces alternatives, a choice must be
made, and economics helps us study how those choices are made. For example, you
have to choose how to spend your limited income. You also have to choose how to
spend your limited time. You may have to choose how many of your company's limited
resources to allocate to advertising and how many to allocate to new-product research.
In economics, we examine situations in which individuals choose how to do things,
when to do things, and with whom to do them. Ultimately, the purpose of economics
is to explain choices.
Microeconomic analysis, for example, is concerned with the effects of changes in the
price of gasoline relative to that of other energy sources. It examines the effects of new
taxes on a specific product or industry. If the government establishes new health care
regulations, how individual firms and consumers will react to those regulations would
be in the realm of microeconomics. The effects of higher wages brought about by an
effective union strike would also be analyzed using the tools of microeconomics.
In contrast, issues such as the rate of inflation, the amount of economywide unem-
ployment, and the yearly growth in the output of goods and services in the nation all
fall into the realm of macroeconomic analysis. In other words, macroeconomics deals
with aggregates, or totals-such as total output in an economy. Aggregates
Be aware, however, of the blending of microeconomics and macroeconomics in Total amounts or quantities. Aggregate
modern economic theory. Modern economists are increasingly using microeconomic demand, for example, is total pla nned
expenditures throughout a nation.
analysis- the study of decision making by individuals and by firms- as the basis of
macroeconomic analysis. They do this because even though macroeconomic analysis
focuses on aggregates, those aggregates are the result of choices made by individuals
and firms.
Recent technological developments have contributed further to the theoretical
blending of microeconomics and macroeconomics. Increasingly, businesses, govern-
ments, and even individuals are turning to artificial intelligence (AI) technologies, Artificial intelligence (Al) technologies
which are digital-app-based or -assisted tools utilized in making and implementing The development and implementation of
decisions. AI technologies often implement sophisticated and typically automated methods of utilizing automated data-
analytics techn iques, mach ine learning, or
data-analytics methods for working with very substantial volumes of information, com-
virtual- or augmented-reality techniques to
monly known as big data, to reveal previously hidden relationships. In the past, people examine and evaluate information in an
applied their skills in using basic statistical techniques to examine and learn from large effort to help consumers, businesses, and
sets of data. To a growing extent, however, people now have adopted machine learning, governments to make decisions.
or the application of simple or sophisticated AI-guided programming of digital devices,
to search through massive bodies of data that human minds might struggle to compre-
hend. Increasingly, AI technologies also entail the use of virtual-reality techniques, which
allow people to view or perceive fully artificial environments, or augmented-reality
methods, which enable individuals to observe virtual overlays of information alongside
real images. With such AI technologies, businesses, governments, and consumers can
make more informed decisions. Furthermore, a growing number of economists also
are employing AI technologies to examine people's decision making and choices.
Why does the application of big data analytics potentially have microeconomic and
macroeconomic implications?
4 PART 1 I INTRODUCTION
I!) Id entify the th ree The Three Basic Economic Questions and
basic eco nom ic questions
and the two oppos ing sets Two Opposing Sets of Answers
of answers
In every nation, three fundamental questions must be addressed irrespective of the
form of its government or who h eads that government, how rich or how poor th e
Economic system n ation may be, or wh at type of economic system-the institutional mechanism
A society's institutional mechanism for through which resources are utilized to satisfy human wants-has been chosen.
determini ng th e way scarce resou rces are
used to satisfy human desires.
The Three Basic Questions
The three fundamental questions of economics concern the problem of how to allo-
cate society's scarce resources:
1. What and how much will be produced? Some mechanism must exist for determining
which items will be produced while others remain inventors' pipe dreams or indi-
viduals' unfulfilled desires.
2. How will items be produced? T here are many ways to produce a desired item. It is
possible to use more labor and fewer m achines, or vice versa. It is possible, for
instan ce, to produce an item with an aim to maximize th e number of people
employed. Alternatively, an item may be produced with an aim to minimize the
total expenses that members of society incur. Somehow, a decision must be made
about the mix of resources used in production, the way in which they are organized,
ECONOMICS IN YOUR LIFE and how they are brought together at a particular location .
To contemplate a recent example
from U.S. housing finance regarding 3. For whom will items be produced? Once an item is produced, who should be able to
choosing among answers to the obtain it? People use scarce resources to produce any item, so typically people value
three basic economic questions, access to that item. T hus, determining a mechanism for distributing produced
take a look at Government
items is a crucial issue for any society.
Involvement Enables a Private
U.S. Housing Finance Company to
Provide " Cheap" Loans on page 12. Now that you know the questions an economic system must answer, how do cur-
rent systems actually an swer them?
CHAPTER 1 I The Nature of Economics 5
Two Opposing Sets of Answers
At any point in time, every nation has its own economic system. How a nation's resi-
dents go about answering the three basic economic questions depends on that nation's
economic system.
Centralized Command and Control Throughout history, one common type of eco-
nomic system has been command and control (also called central planning). Such a system
is operated by a centralized authority, such as a king or queen, a dictator, a central
government, or some other type of authority. Such an entity assumes responsibility
for addressing fundamental economic issues. Under command and control, this
authority decides what items to produce and how many, determines how the scarce
resources will be organized in the items' production, and identifies who will be able to
obtain the items.
For instance, in a command-and-control economic system, a government
might decide that particular types of automobiles ought to be produced in certain
numbers. The government might issue specific rules for how to manage the pro-
duction of these vehicles, or it might even establish ownership over those resources
so that it can make all such resource allocation decisions directly. Finally, the
government may then decide who will be authorized to purchase or otherwise
utilize the vehicles.
The Price System The alternative to command and control is the price system (also
called a market system), which is a shorthand term describing an economic system that
answers the three basic economic questions via decentralized decision making. Under
a pure price system, individuals and families own all of the scarce resources used in
production. Consequently, choices about what and how many items to produce are
left to private parties to determine on their own initiative, as are decisions about how
to go about producing those items. Furthermore, individuals and families choose how
to allocate their own incomes to obtain the produced items at prices established via
privately organized mechanisms.
In the price system, which you will learn about in considerable detail in later
chapters, prices define the terms under which people agree to make exchanges. Prices
signal to everyone within a price system which resources are relatively scarce and
which are relatively abundant. This signaling aspect of the price system provides infor-
mation to individual buyers and sellers about what and h ow many items should be
produced, how production of items should be organized, and who will choose to buy
the produced items.
Thus, in a price system, individuals and families own the facilities used to produce
automobiles. They decide which types of automobiles to produce, how many of them
to produce, and how to bring labor and machines together within their facilities to
generate the desired production. Other individuals and families decide how much of
their earnings they wish to spend on automobiles.
Mixed Economic Systems By and large, the economic systems of the world's nations
are mixed economic systems that incorporate aspects of both centralized command
and control and a decentralized price system. At any given time, some nations lean
toward centralized mechanisms of command and control and allow relatively little
scope for decentralized decision making. At the same time, other nations limit the
extent to which a central authority dictates answers to the three basic economic ques-
tions, leaving people mostly free to utilize a decentralized price system to generate
their own answers.
A given country may reach different decisions at different times about how much to
rely on command and control versus a price system to answer its three basic economic
questions. Until 2008, for instance, U.S. residents preferred to rely mainly on a decen-
tralized price system to decide which and how many financial services to produce and
6 PART 1 I INTRODUCTION
how to produce them. During some years since then, the U.S. government has owned
substantial fractions of financial firms and hence has exerted considerable command-
and-control authority over production of financial services.
The distinction here is between what people may think-the realm of psychology
and psychiatry and perhaps sociology-and what they do . Economics does not
involve itself in analyzing individual or group thought processes. Economics looks at
what people actually do in life with their limited resources . It does little good to
criticize the rationality assumption by stating, "Nobody thinks that way" or "I never
think that way" or "How unrealistic! That's as irrational as anyone can get!" In a
world in which people can be atypical in countless ways, economists find it useful to
concentrate on discovering the baseline. Knowing what happens on average is a
good place to start. In this way, we avoid building our thinking on exceptions rather
than on reality.
Take the example of driving. When you consider passing another car on a two-lane
highway with oncoming traffic, you have to make very quick decisions: You must esti-
mate the speed of the car that you are going to pass, the speed of the oncoming cars,
the distance between your car and the oncoming cars, and your car's potential rate of
acceleration. If we were to apply a model to your behavior, we would use the rules of
calculus. In actual fact, you and most other drivers in such a situation do not actually
think of using the rules of calculus, but to predict your behavior, we could make the
prediction as if you understood those rules.
Responding to Incentives
If it can be assumed that individuals never intentionally make decisions that would
leave them worse off, then they will respond to changes in incentives. Indeed, much of
human behavior can be explained in terms of how individuals respond to changing
incentives over time.
Schoolchildren are motivated to do better by a variety of incentive systems, rang-
ing from gold stars and certificates of achievement when they are young, to better
grades with accompanying promises of a "better life" as they get older. Of course,
negative incentives affect our behavior, too. Penalties, punishments, and other
forms of negative incentives can raise the total cost of engaging in various
activities.
How have earnings-based and tuition-expense-related incentives of pursuing a col-
lege degree changed in recent years?
CHAPTER 1 I The Nature of Economics 7
EXAMPLE
The Altered Incentives Confronting Prospective College Students
In 1975, an individual considering enrolling in a college and success- $29,500 per year. Accompanying thi s 11 percent decrease in the antici-
fully completing about four years of coursework required for a bachelor's pated earnings payoff from a college degree has been an inflation-
degree cou ld anticipate an inflation-adjusted an nual payoff of about adjusted increase in average tuition and fees of 75 percent over the
$20,000 every year following graduation. By 2000, this inflation- same interval. Thus, today's dollars-and-cents incentives to pu rsue a
adjusted annual earnings incentive to earn a co llege degree had college degree are much weaker than was true a generation ago.
increased to about $33,000. This substantial jump in average annual
income helps to explain why the percentage of U.S. adults holding col- REAL APPLICATION
lege degrees stead ily increased from 13 percent in 1975 to 33 percent Sometimes adults tell young people to "get all the education you can
today. get. " Does that mean you should necessarily obtain an advanced degree?
Since 2000, however, the average inflation-adjusted annual earn-
ings ga in from obta ining a college degree has dropped to about Sources are listed at the end of this chapter.
Defining Self-Interest
Self-interest does not always mean increasing one's wealth measured in dollars and
cents. We assume that individuals seek many goals, not just increased wealth measured
in monetary terms. Thus, the self-interest part of our economic-person assumption
includes goals relating to prestige, friendship, love, power, helping others, creating
works of art, and many other matters. We can also think in terms of enlightened self-
interest, whereby individuals, in the pursuit of what makes them better off, also
achieve the betterment of others around them. In brief, individuals are assumed to
want the ability to further their goals by making decisions about how items around
them are used. The head of a charitable organization usually will not turn down an
additional contribution, because accepting the funds yields control over how they are
used, even though their use is for other people's benefit.
Does the fact that many people donate to charity necessarily imply that the donors
only wish to help others?
BEHAVIORAL EXAMPLE
Assessing Whether Charitable Donations Reflect Caring for Others or for Oneself
When contemplating making a charitable donation, people often consider and additional donations to earthquake-stricken municipalities. Yet
two motivations. The first is a desireto help others. The second is the pos- directed taxes and donations to regions whose governments offered gifts
sibility of benefiting from incentives that governments provide to those were more than six times larger than those that taxpayers directed to areas
who make donations, such as certain tax deductions granted to charitable in which governments offered no gifts. Theresearchers conclude that allow-
donors by tax authorities. ing governments unaffected by the earthquake to offer reciprocal gifts
Three behavioral economists- Eiji Yamamura of Seinan Gaku in Univer- reduced directed taxes and donations to governments of regions damaged
sity, Yoshiro Tsutsui of Kanan University, and Furnia Ohtake of Osaka by the quake. Thus, in the absence of governmental reciprocal gifts to
University-have studied how these motivations interacted in Japan during donors, even more funds would have reached parts of Japan that suffered
the years following an unusually damaging ea rthquake in the eastern part the greatest harm from the earthquake.
of the country. Under Japan's tax laws, people were allowed to respond to
the earthquake by directing portions of their local tax payments, potentially
supplemented with extra donations, to municipalities that suffered most FOR CRITICAL THINKING
from the quake. At the same time, however, municipal governments in How might the fact that the U.S. government allows larger tax deductions
Japan could compete for directed tax payments and donations by offering for some charitable donations than for others affect U.S. taxpayers' incen-
donors reciprocal gifts, including gift cards, digital devices, home appli- tives about how much to donate and to whom they direct their
ances, jewelry, and even gold or si lver. donations?
The researchers find evidence that Japan's taxpayers definitely
responded to the earthquake in a caring manner by directing more taxes Sources are listed at the end of this chapter.
8 PART 1 I INTRODUCTION
Assumptions
Every model, or theory, must be based on a set of assumptions. Assumptions define
the array of circumstances in which our model is most likely to be applicable. When
some people predicted that sailing ships would fall off the edge of the earth, they used
the assumption that the earth was flat. Columbus did not accept the implications of
such a model because h e did not accept its assumptions. He assumed that the world
was round. The real-world test of his own model refuted the flat-earth model.
Indirectly, then, it was a test of the assumption of the flat-earth model.
Is it possible to use our knowledge about assumptions to understand why driving
directions sometimes contain very few details?
EXAMPLE
Getting Directions
Assumptions are a shorthand for rea lity. Imagine that you have decided yo u wi ll t rave l- Oceanside , San Clemente, Irvine, Anaheim , Los
to drive from your home in San Diego to downtown San Francisco. Angeles, Bakersfie ld, Modesto, and so on-with the ind ividual
Because you have never driven this route, you dec ide to use a trave l- maps show ing you exactly how the freeway th reads through each of
planner device such as global-position ing-system equipment. these cities. You would get a nearly complete descript ion of real ity
When you ask for directions, the electronic trave l planne r co uld because the GPS travel planner will not have used many simp lifying
give yo u a set of detailed maps that shows eac h city through which assumptions. It is more likely, however, that t he travel planne r will
CHAPTER 1 I The Nature of Economics 9
simply say, "Get on Interstate 5 going north. Stay on it for about 500 miles. Francisco-they focus on what is relevant to the problem at hand
Follow t he signs for San Francisco. After crossing the toll bridge, and omit what is not.
take any exit marked 'Downtown. " ' By omitti ng al l of the trivia l
details, the travel plan ner has told you all that you real ly need and FOR CRITICAL THINKING
want to know. The mode ls you wi ll be using in this text are sim ilar to In what way do small talk and gossip represent the use of simplifying
the simpl ified directions on how to drive from San Diego to San assumptions?
The Ceteris Paribus Assumption: All Other Things Being Equal Everything in the world
seems to relate in some way to everything else in the world. It would be impossible to
isolate the effects of changes in one variable on another variable if we always had to
worry about the many other variables that might also enter the analysis. Similar to
other sciences, economics uses the ceteris paribus assumption. Ceteris paribus means Ceteris paribus [KAY-ter-us
"other things constant" or "other things equal." PEAR-uh-bus] assumption
Consider an example taken from economics. One of the most important determi- The assumption that nothing changes
except the fa ctor or factors bei ng studied.
nants of how much of a particular product a family buys is how expensive that product
is relative to other products. We know that in addition to relative prices, other factors
influence decisions about making purchases. Some of them have to do with income,
others with tastes, and yet others with custom and religious beliefs. Whatever these
other factors are, we hold them constant when we look at the relationship between
changes in prices and changes in how much of a given product people will purchase.
m Distinguish between
posit ive and normat ive
Positive versus Normative Economics
econom ics Economics uses positive analysis, a value-free approach to inquiry. No subjective or
\.
moral judgments enter into the analysis. Positive analysis relates to statements such as
"If A, then B." For example, "If the price of gasoline goes up relative to all other
prices, then the amount of it that people buy will fall." That is a positive economic
statement. It is a statement of what is. It is not a statement of anyone's value judgment
or subjective feelings.
CHAPTER 1 I The Nature of Economics 11
Distinguishing between Positive and Normative Economics
For many problems analyzed in the "hard" sciences such as physics and chemistry, the
analyses are considered to be virtually value-free. After all, how can someone's values
enter into a theory of molecular behavior? Economists, however, face a different
problem. They deal with the behavior of individuals, not molecules. That makes it
more difficult to stick to what we consider to be value-free or positive economics Positive economics
without reference to our feelings . Analysis that is strictly limited to making
When our values are interjected into the analysis, we enter the realm of normative either purely descriptive statements or
scientific predictions. For example, "If A,
economics, involving normative analysis. A positive economic statement is "If the
then B." A statement of what is.
price of gas rises, people will buy less." If we add to that analysis the statement "so we
should not allow the price to go up," we have entered the realm of normative economics- Normative economics
we have expressed a value judgment. In fact, any time you see the word should, you will Analysis involving value judgments about
economic policies; relates to whether
know that values are entering into the discussion. Just remember that positive state- outcomes are good or bad. Astatement of
ments are concerned with what is, whereas normative statements are concerned with what ought to be.
what ought to be.
Each of us has a desire for different things. That means we have different values.
When we express a value judgment, we are simply saying what we prefer, like, or
desire. Because individual values are diverse, we expect-and indeed observe-that
people express widely varying value judgments about how the world ought to be.
They sat on opposite sides of a table, the food and dishes not yet
cleared away after their supper. A cheap kerosene lamp lit the room
insufficiently. The smoke from a ragged wick had entirely blackened
one side of the glass chimney. One of the men had cunningly utilized
this to throw the face of his companion into the light while his own
remained in shadow. His bleached eyes watched the emotions come
and go as they registered on the twisted, wolfish countenance of this
criminal on the dodge. He was playing on his evil instincts as a
musician does upon the strings of a violin.
“Me, I said right away, soon as I seen you, ‘This Cig’s no quitter; he’ll
go through.’ So I tied up with you. Game, an’ no mollycoddle. Tha’s
how I sized you up.”
“You got me right, Prowers. I’ll say so.”
The little man with the leathery face watched his victim. In the back
of his mind a dreadful thought had lodged and become fixed. He
would use for his purpose this vain and shallow crook, then blot him
out of life before he turned upon him.
“Don’t I know it? Cig ain’t roostin’ up here for his health, I says to
myself. Not none, by jiminy by jinks. He’s got business.”
“Business is right,” agreed the New Yorker. “An’ soon as it’s done, I
ain’t stickin’ around dis dump no more. I’m duckin’ for ’Frisco. But get
it straight, Prowers. I taken all de chances I’m gonna take alone.
See? An’ it’ll cost you two hundred iron men for my share of de job.”
“Not that much, Cig. We’ve both got our reasons for wantin’ to pull
this off. Clint Reed an’ his foreman ain’t exactly friends of yours. You
got yore own account to settle. But I’ll dig up a hundred. That’ll take
you to ’Frisco.”
Cig looked at his mild vis-à-vis sullenly. This harmless-looking old
fellow was his master in villainy, more thorough, more ruthless.
There were times when his bleached eyes became ice-coated, when
the New Yorker had sensed back of them the crouched threat of the
coiled rattlesnake. If he had known what Prowers was thinking now,
he would have shuddered.
“Some generous guy, youse are,” he sneered. “An’ how do I know
youse won’t rap on me—t’row me down when de rubes make de big
holler after de job?”
The old cattleman was at his suave mildest. No malignity showed in
his smile. “I don’t reckon I can give no written guarantee, Cig, but I
never sawed off trouble yet on a fellow takin’ the trail with me. Those
who have rode with me could tell you that.”
The crook from the East was uneasy. He did not know why. His
restlessness drove him to the door of the cabin from which he looked
out upon a cynical moon riding high above the tops of the pines. He
shivered. This bleak world of white appalled his city-cramped spirit. It
had been bad enough in summer. Now it was infinitely worse.
“Looks like there’s a hoodoo on me,” he growled. “It’s de Gawd-
forsaken country that puts a jinx on me. I’m losin’ me noive. Every
job I tackle is a flivver. After dis one, it’s me for de bright lights.”
“That’s right. A getaway for you, pronto.”
“When do we get busy?”
“To-night,” Prowers answered. “Merrick has left two watchmen at the
dam. One of ’em lives at Wild Horse. His wife’s sick. He got a call
half an hour ago sayin’ she was worse. He’s hittin’ the trail for town.”
“Leavin’ one guy on de job. Do we bump him off?”
“Not necessary. A quart of bootleg whiskey reached him this
afternoon. Time we get there, he’ll be dead to the world.”
“You sent de booze?”
“Merrick didn’t,” Prowers answered, with his impish grin.
“Sure he ain’t on de wagon?”
“Dead sure. He can’t leave it alone.”
“Looks like a lead pipe,” Cig admitted. “But de jinx on me—When I
gunned dat Tug Hollister I’d ’a’ swore I got him good. Nothin’ works.”
Jake could not quite forbear sarcasm. “You’d ought to take one o’
these here correspondence courses in efficiency. It’ll be different to-
night, though. I ain’t used to fallin’ down on anything I go after.”
“Meanin’ that I do?” Cig demanded sourly out of the corner of a
drooping mouth.
“Meanin’ you ain’t been lucky lately. Let it go at that.”
Prowers moved about making his preparations. The dynamite and
the fuses already made ready were put in a gunny-sack. The tools
were packed. Beneath his coat Jake put on a gaberdine vest, for it
was possible that the weather might turn cold.
Presently both men were ready. The cattleman blew out the light and
they passed from the cabin into the starry night.
They did not go direct to the dam. Prowers had in him too much of
the fox for that. He would not leave tracks in the snow that might
later take him to the penitentiary. Their footsteps followed the beaten
trail that ran from the cabin to a road meandering down into Paradise
Valley by the line of least resistance.
Half a mile from the point where they struck it, another road
deflected from this one, leading to Merrick’s camp at the Sweetwater
Dam. Into this they turned. The snow had been beaten down by
scores of passing feet. The top crust did not break beneath their
weights, so that no evidence would be left written there as to who
had made this midnight trip of destruction.
Cig’s eye took in the ghostly white hills and he shivered. “Gawd,
what a dump!” he groaned. His vocabulary was as limited as his
emotions. He could never get used to the barren grandeur of the
Rockies. They awed and oppressed him. They were too stark and
clean for him. He struggled with a sense of doom. In cities he never
thought of death, but premonitions of it had several times shaken his
ratlike courage since he had been here. Twice he had dreamed that
he was being buried in these hills and had wakened in a cold sweat
of horror. He made up his mind to “beat it” for the Pacific coast at
once.
They came down into the bowl where the dam was, skirting the edge
of the timber to attract as little attention as possible in case a
watchman should be on his beat. No sign of life disturbed the
stillness. They crept to the tents and made a hurried survey. In one
of them a man lay on a cot asleep. He was fully dressed. His arms
were outflung and he was breathing stertorously. A bottle, one third
full, stood on a small table close to the cot.
“Like I said, dead to the world,” Prowers commented.
He turned away. Cig swiftly snatched the bottle and slipped it inside
his coat. He wanted a drink or two pretty badly, and, like enough,
Prowers wouldn’t let him have them if he knew.
The two men crossed the dam-head to the gates.
“It’ll be here,” the cowman said as he put down the gunny-sack.
Before they set to work, Cig concealed his bottle, but in the course of
the hours that followed he made frequent visits to the spot where he
had hidden it. Since Prowers was neither blind nor a fool he became
aware of what the other was trying to keep from him. He said
nothing. The bulk of the work fell on him. No complaint came from
his lips. There was a curious smile on them, ironic, cruel, and
unhuman.
Cig was in turn gay, talkative, maudlin, and drowsy. His boastings
died away. He propped himself against the cement wall close to the
gates and swayed sleepily. Once or twice he cat-napped for a few
moments.
The old man continued to prepare the charges. Once, watching his
accomplice, he broke into a cackle of mocking mirth, so sinister that
Cig would have shuddered if he had been alive to impressions.
The tramp slid down to a sitting posture.
“Done up. Shleep a li’l’ ’f you don’ min’,” he murmured.
Presently he was in a drunken slumber.
Prowers finished his work and lit the fuses. He looked at the weak
and vicious instrument he had been using, a horrible grin on his
leathery, wrinkled face.
“You comin’ or stayin’?” he asked squeakily.
The doomed man snored.
“Suit yoreself,” the little devil-man said. “Well, if I don’t see you
again, good-bye. I got to be hittin’ the trail right lively.”
He moved briskly along the great wall of the dam, climbed the steps
at the far end, and followed the road leading out of the basin. Once
he turned to look at the deep lake lying placidly behind the rampart
Merrick had built to hold it.
A great flash and roar filled the night. Even where Prowers stood, he
felt the shake of the earth. Masses of torn concrete, of rock and
sand, were flung into the air. The echoes of the explosion died, but
another sound reached the anarchist on the hillside. He listened,
with the diabolical grin on his lips, to a murmur of rushing waters.
The Sweetwater Dam was going out.
“The Flat Tops are liable to be irrigated good an’ plenty, looks like,”
he murmured. “Well, this is no place for sight-seers.”
He shuffled along the trail, the Satanic smile still on his leathery face.
It would have vanished promptly if he had known that a pair of eyes
were looking down on him from the shadow of a pine above the
road.
CHAPTER XXXVI
A STORMY SEA