Table of Contents

Preface ix

Chapter 1 Introduction to Economics 1

What Is Economics? 1

Economics and Scarcity 2

Scarcity and Choice 3

Efficiency and Equity 5

Application 1.1: To Work or Not to Work 6

Factors of Production 7

Factors and Income 8

Scarce Resources 8

Application 1.2: Does Money Buy Happiness? 9

Economic Theory and Policy 9

Economic Theory 10

Application 1.3: Ok, What Are They? 12

Economic Policy 13

Up for Debate: Should St. Louis County, Missouri, Impose Mandatory Trash Pickup and Recycling? 14

Tools of the Economist 15

Words, Graphs, and Mathematical Equations 15

Scarcity, Model Building, and Graphs 16

Modeling Scarcity 16

Interpreting the Model 17

Test Your Understanding: Production Possibilities 19

Macroeconomics and Microeconomics 19

Critical Thinking Case 1: Difficult Choices in the Extreme 24

Chapter 1 Appendix 25

Graphing 25

Constructing a Graph 25

Direct and Inverse Relationships 26

Chapter 2 Economic Decision Making and Economic Systems 29

Scarcity, the Basic Economic Decisions, and Economic Systems 29

Economic Systems and the Basic Economic Decisions 30

Traditional Economies 31

Market Economies 32

The Operation of a Market Economy 32

Economic Decisions in a Market Economy 33

Application 2.1: Saying No! 34

Evaluating Market Economies 36

Government Intervention in a Market Economy: A Mixed Economy 37

Planned Economies 37

Economic Decisions in a Planned Economy 38

Evaluating Planned Economies 38

Mixed Economies 39

Test Your Understanding: Economic Decision Making and the Circular Flow 40

Changing Economic Systems 41

The U.S. Economic System 41

The British Foundations of the U.S. Economy 41

Application 2.2: The People’s Republic of China 42

Application 2.3: The Factory Girl’s Last Day 43

Historical Highlights in the Development of the U.S. Economy 44

Up for Debate: Are U.S. and Western European Economic Institutions Appropriate for Other Nations? 46

Critical Thinking Case 2: Judging Economies 51

Chapter 3 Demand, Supply, and Price Determination 53

Demand and Supply 54

Demand: The Buyer’s Side 54

Supply: The Seller’s Side 55

Market Demand, Market Supply, and Price Setting 58

Market Demand and Market Supply 58

Markets and Price Setting 58

Application 3.1: The Laws of Demand and Supply 59

Equilibrium Price and Equilibrium Quantity 60

Changes in Quantity Demanded and Quantity Supplied 62

Changes in Demand and Supply 62

Changes in Demand 63

Changes in Supply 65

Changes in Quantity Demanded or Supplied and Changes in Demand or Supply: A Crucial Distinction 67

Application 3.2: Fads: Some In, Some Out 67

Changes in Equilibrium Price and Equilibrium Quantity 69

Effect of Increases and Decreases in Demand 69

Effect of Increases and Decreases in Supply 70

Effect of Changes in Both Demand and Supply 71

Test Your Understanding: Changes in Demand and Supply 72

Limiting Price Movements 73

Price Ceilings 73

Price Floors 73

Price Elasticity of Demand and Supply 75

Application 3.3: Is Rent Control a Good Thing or a Bad Thing? 76

Price Elasticity of Demand 76

Up for Debate: Is It a Mistake to Raise the Minimum Wage? 77

Application 3.4: Peanut Butter: A Yummy Staple 79

Price Elasticity of Supply 79

Critical Thinking Case 3: How Do Supply and Demand Work in Health Care? 84

Chapter 4 Goals and Problems of the Macroeconomy: Employment, Prices, and Production 85

Unemployment and Full Employment 86

Consequences of Unemployment 86

Types of Unemployment 86

Application 4.1: What’s at Stake When a Job is Lost? 87

Employment and Unemployment Measures and Statistics 88

Interpreting Unemployment Statistics 92

The Goal of Full Employment 93

Inflation and Stable Prices 94

Consequences of Inflation 94

Causes of Inflationary Pressure 96

Application 4.2: The $4 Summer of 2008 98

Measures of Inflation 99

Deflation and Disinflation 103

Production 103

Full Production and Economic Growth 103

Up for Debate: Will Policies to Protect the Environment Slow Economic Growth? 105

Measures of Production 106

Does GDP Tell the Whole Story? 108

Test Your Understanding: Calculating Price Indexes and GDP 109

Application 4.3: A Tale of Two Families 110

Productivity 110

A Possible Policy Problem 111

Critical Thinking Case 4: Statistics and Decision Making 117

Chapter 5 Foundations of the Macroeconomy 119

Changes in Macroeconomic Activity 119

Business Cycles 121

Causes of Economic Fluctuations 122

Total Spending and Macroeconomic Activity 123

Application 5.1: What’s Causing the Economy to Change? 124

The Household Sector 124

The Business Sector 127

Up for Debate: Is Saving a Healthy Habit? 128

Application 5.2: Interest Rates and Investment Spending 130

The Government Sector 132

The Foreign Sector 135

Summary of Aggregate Spending, Leakages, and Injections 136

The Multiplier Effect 138

Application 5.3: Ripples through the Economy 141

Inflation, Expectations, and Macroeconomic Policies 141

A Word about Inflation 141

A Word about Expectations 142

Macroeconomic Predictors and Policies 142

Test Your Understanding: Changes in Economic Activity 143

Application 5.4: Unconventional Indicators of Economic Health 144

Critical Thinking Case 5: Getting Smarter 149

Chapter 6 The Role of Government in the Macroeconomy 151

Government Expenditures and Revenues 152

Government Expenditures 152

Government Revenues 154

Taxes: Types and Reform 156

Progressive, Proportional, and Regressive Taxes 156

Tax Reform and Issues 156

Up for Debate: Should the Federal Income Tax Be Changed to a Flat Tax? 157

Application 6.1: A Chronology of Federal Income Tax Policies 158

Fiscal Policy 159

The Mechanics of Fiscal Policy 159

Discretionary and Automatic Fiscal Policy 160

Government Budgets 161

Types of Budgets 162

The Budget and Fiscal Policy: Tying Them Together 164

Application 6.2: How Much Do We Love Granny? 165

Test Your Understanding: Government’s Impact on the Macroeconomy 166

The Realities of Fiscal Policy and the Federal Budget 166

The National Debt 167

Financing and Assessing the National Debt 167

Application 6.3: U.S. Treasury Securities 168

Crowding Out 171

Critical Thinking Case 6: Nimby (Not in My Backyard) 175

Chapter 7 Money, Financial Institutions, and the Federal Reserve 177

Money 178

The Definition and Functions of Money 178

Application 7.1: Fixed Assets, Or: Why a Loan in Yap is Hard to Roll Over 180

The U.S. Money Supply 180

Monetary Standards 183

Financial Depository Institutions 184

Commercial Banks 185

Other Financial Depository Institutions 186

Application 7.2: What Do I Do? 187

The Federal Reserve System 187

Organization of the Federal Reserve System 188

Functions of the Federal Reserve Banks 189

Test Your Understanding: Changes in a Bank’s Reserve Account 192

Recent Trends in Financial Institutions 192

Legislative Changes 192

Structural Changes 193

The Financial Crisis of 2007–2009 195

Application 7.3: Ben Bernanke’s Reflections on the Financial Crisis 196

Up for Debate: Should Congress Enact More Stringent Regulations over the Banking System? 197

Critical Thinking Case 7: Cigarette Money 202

Chapter 8 Money Creation, Monetary Theory, and Monetary Policy 203

The Money Supply and the Level of Economic Activity 204

The Equation of Exchange 204

Money Creation 205

The Process of Money Creation 206

The Multiple Expansion of Money 207

Application 8.1: Questions and Answers about Reserves and Loans 208

Excess Reserves, Interest Rates, and the Level of Spending 210

Determining Interest Rates on Loans 212

Application 8.2: An Interest Rate Primer 215

The Federal Reserve and Monetary Policy 215

Monetary Policy Tools 216

Test Your Understanding: Financial Depository Institution Calculations 220

Application 8.3: Who Really Is the Most Powerful Person in the United States? 221

Assessing Monetary Policy 221

Government Deficits and Monetary Policy 221

Advantages and Disadvantages of Monetary Policy 223

Up for Debate: Should the Federal Reserve Be Placed Under the Direct Control of Congress? 225

Critical Thinking Case 8: The Fed and the Great Depression of the 1930s 230

Chapter 9 Macroeconomic Viewpoints and Models 233

Macroeconomic Model Building 234

A Warning 234

Application 9.1: Paying Close Attention to Models: It’s Worth the Effort 235

Classical Economics 236

Application 9.2: The Academic Scribblers 238

Keynesian Economics 239

Equilibrium in the Macroeconomy 239

Keynesian Policy Prescriptions 242

New Classical Economics 243

The New Classical Model 244

Test Your Understanding: Classical, Keynesian, and New Classical Models 247

Additional Macroeconomic Models 248

New Keynesian Economics 248

Monetarism 248

Supply‐Side Economics 248

Up for Debate: Should Government’s Role in Influencing Economic Activity Be Reduced? 249

A Final Word on Macroeconomic Viewpoints 249

Application 9.3: The World According to . . . 250

Critical Thinking Case 9: Does Anyone Care What Economists Think? 255

Chapter 10 Households and Businesses: An Overview 257

Overview of Households 258

Household Income and Expenditures 258

Goals and Decision Making by Individuals 260

Maximizing Economic Well‐Being 260

Application 10.1: Family Gossip 262

Application 10.2: You Decide 263

Overview of Business 264

Legal Forms of Business 265

Test Your Understanding: The Price of Stock Shares 267

Numbers and Sizes of Businesses 267

Business Ownership of Business 268

Goals and Decisions of Business Firms 269

Application 10.3: Two Profiles: Starbucks and Kraft Foods 270

Up for Debate: Should Profitable Businesses Be Expected to Actively Participate in Improving Their Communities? 271

Critical Thinking Case 10: Time to Maximize 275

Chapter 11 Benefits, Costs, and Maximization 277

Balancing Benefits and Costs: the Individual 278

Defining Benefits and Costs 278

Measuring Benefits and Costs 279

Maximizing Satisfaction 282

Application 11.1: Do It Yourself 285

Graphing Costs, Benefits, and Net Benefit 285

Balancing Benefits and Costs: The Business 287

Defining Benefits and Costs 287

Measuring Revenues and Costs 288

Application 11.2: You Need an Economist 289

Maximizing Profit 290

Graphing Costs, Revenues, and Profit 292

Social Benefits and Costs 292

Test Your Understanding: Maximizing Profit 294

Application 11.3: The Real Cost of Smoking 295

Maximizing Society’s Net Benefit 295

Public Choice 297

Up for Debate: Should Drivers Be Banned from Using Cell Phones While Operating a Vehicle? 298

Maximizing Behavior and the Voting Process 298

Critical Thinking Case 11: A Spoonful of Sugar 304

Chapter 12 Production and the Costs of Production 307

Production Basics 308

Sectors and Industries 308

Methods of Production 309

Economic Time, Production, and the Costs of Production 311

Application 12.1: Do You Know a Modern‐Day Luddite? 312

Up for Debate: Should the Same Cost Measures Used by Businesses Apply to Government and Nonprofits? 313

Short‐Run Costs 314

Total Costs 314

Unit Costs 315

The Pattern of Short‐Run Costs 316

The Law of Diminishing Returns 319

Test Your Understanding: Calculating Costs and Averages 320

Application 12.2: Are Wellness Programs Cost Effective? 322

Long‐Run Costs 322

Economies of Scale, Diseconomies of Scale, and Constant Returns to Scale 323

Application 12.3: Too Big to Help 325

Critical Thinking Case 12: The Human Factor 330

Chapter 13 Competition and Market Structures 331

Defining a Market 332

The Market Structures 333

Pure Competition 334

Characteristics of Pure Competition 334

Behavior of a Firm in Pure Competition 334

Application 13.1: The Farmers’ Almanac: It’s a Necessity 338

Is There Pure Competition? 340

Monopolistic Competition 342

Characteristics of Monopolistic Competition 342

Behavior of a Firm in Monopolistic Competition 342

Up for Debate: Does Nonprice Competition Waste Resources? 346

Oligopoly 347

Characteristics of Oligopoly 347

Behavior of a Firm in an Oligopolistic Market 347

Test Your Understanding: Purely Competitive and Monopolistically Competitive Markets 348

Monopoly 350

Characteristics of Monopoly 350

Behavior of a Monopolist 351

Application 13.2: Take Me Out to the Ball Game 353

Application 13.3: Patents Work—For a While 354

Market Structures, The Consumer, and Efficiency 354

Critical Thinking Case 13: The $800 Haircut 360

Chapter 14 Government and the Markets 361

Antitrust Enforcement 362

The Antitrust Laws 363

Application 14.1: Cases Involving the Sherman Act 366

Application 14.2: Cases Involving the Clayton Act and Its Amendments 369

Government Regulation 370

Application 14.3: Antitrust Enforcement Up Close and Personal 371

The Structure of Regulation 371

Industry Regulation 375

Social Regulation 377

Test Your Understanding: Government and Business 379

The Performance of Regulation 379

Up for Debate: Is Government Intervention Reaching Too Far? 380

Critical Thinking Case 14: Eminent Domain: In the Public Interest or Not? 383

Chapter 15 Labor Markets, Unions, and the Distribution of Income 385

Labor Markets: Demand 386

The Demand for Labor 387

Labor Markets: Supply 390

Test Your Understanding: A Small Business Determines Its Demand for Employees 392

Changes and Modifications in Labor Markets 392

Changes in Labor Demand and Supply 392

Application 15.1: Go Green 395

Modifications of the Labor Demand and Supply Model 396

Labor Unions 399

Types of Unions and Union Membership 399

Collective Bargaining 399

Collective Bargaining and the Law 400

The Distribution of Income 401

Differences in Income 402

Application 15.2: Making the Most of Intellectual Capital 404

Poverty 404

Application 15.3: Young and Homeless 407

Up for Debate: Should There Be a Work Requirement for Those Seeking Public Assistance? 407

Critical Thinking Case 15: Income Distribution: Are the Shares of the Pie Fair? 412

Chapter 16 International Trade 413

An Overview of U.S. International Trade 414

The Size and Composition of U.S. Trade 414

Application 16.1: A Sad Story 417

Comparative Advantage and International Trade 418

Scarcity and Specialization 418

The Principle of Comparative Advantage 418

Free Trade and Protectionism 420

Test Your Understanding: Comparative Advantage 421

Trade-Restricting Policies 421

Free Trade Arguments 423

Protectionist Arguments 423

The Real World of International Trade: Policies and Agreements 424

Application 16.2: Gloria Flunks the Professor 425

Up for Debate: Should Trade Be Restricted if It Results in Environmental Damage? 427

Critical Thinking Case 16: A Petition (by Frederic Bastiat, 1801–1850) 431

Chapter 17 International Finance 433

Exchanging Currencies 434

Exchange Rates 434

The Determination of Exchange Rates 434

Understanding Foreign Exchange

Markets 437

Application 17.1: Foreign Exchange Markets 438

Application 17.2: Does a Lower‐Valued Dollar Help the Economy? 439

Test Your Understanding: Changes in Exchange Rates 441

International Financial Transactions and Balances 442

The Current Account 442

Application 17.3: A Prized Export 444

The Financial Account 445

Challenges to the International Financial System 445

External Debt Issues 445

Monetary Integration in Europe 446

Up for Debate: Euro‐Dreams 447

Critical Thinking Case 17: Helping Poor Countries 451

Glossary 453

Answers to “Test Your Understanding” 461

Index 469

About the Author

Patrick J. Welch and Gerry F. Welch are the authors of Economics: Theory and Practice, Binder Ready Version, 11th Edition, published by Wiley.