1416 Krugman Essentials of Economics 4E

Essentials of ECONOMICS

Copyright ©2016 Worth Publishers. Distributed by Worth Publishers. Not for redistribution. KrugESS4e_FM_pp_i_xxviii.indd i 15/07/16 2:05 PM Copyright ©2016 Worth Publishers. Distributed by Worth Publishers. Not for redistribution. KrugESS4e_FM_pp_i_xxviii.indd ii 15/07/16 2:05 PM Essentials of ECONOMICS FOURTH EDITION

Paul Krugman Graduate Center of the City University of New York

Robin Wells

New York

Copyright ©2016 Worth Publishers. Distributed by Worth Publishers. Not for redistribution. KrugESS4e_FM_pp_i_xxviii.indd iii 15/07/16 2:05 PM To beginning students everywhere, which we all were at one time.

Vice President, Social Science: Charles Linsmeier Publisher: Shani Fisher Marketing Manager: Tom Digiano Marketing Assistant: Morgan Ratner Executive Development Editor: Sharon Balbos Consultant: Ryan Herzog Senior Media Editor: Lukia Kliossis Editorial Assistant: Courtney Lindwall Director, Content Management Enhancement: Tracey Kuehn Managing Editor: Lisa Kinne Project Editor: Martha Emry Director of Design, Content Management: Diana Blume Interior and Cover Designer: Vicki Tomaselli Photo Editor: Cecilia Varas Photo Researchers: Elyse Rieder and Cecilia Varas Senior Production Supervisor: Stacey B. Alexander Senior Media Producer: Chris Efstratiou Media Producers: Andrew Vaccaro and Daniel Comstock Composition and Illustrations: MPS Ltd. Printing and Binding: RR Donnelley

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ISBN-13: 978-1-4641-8665-3 ISBN-10: 1-4641-8665-0

Library of Congress Control Number: 2016936479

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PAUL KRUGMAN, recipient of the 2008 Nobel Memorial Prize in Economic Sciences, taught at Princeton University for 14 years. In 2015, he joined the faculty of the Graduate Center of the City University of New York, associated with the Luxembourg Income Study, which tracks and analyzes income inequality around the world. He received his BA from Yale and his PhD from MIT. Before Princeton, he taught at Yale, Stanford, and MIT. He also spent a year on the staff of the Council of Economic Advisers in 1982–1983. His research has included pathbreaking work on international trade, economic geography, and currency crises. In 1991, Krugman received the American Economic Association’s John Bates Clark medal. In addition to his teaching and academic research, Krugman writes extensively for nontechnical audiences. He is a regular op-ed columnist for the New York Times. His best-selling trade books include End This Depression Now!, The Return of Depression Economics and the Crisis of 2008, a history of recent economic troubles and their implications for economic policy, and The Conscience of a Liberal, a study of the political economy of economic inequality and its relationship with political polarization from the Gilded Age to the present. His earlier books, Ligaya Franklin Peddling Prosperity and The Age of Diminished Expectations, have become modern classics.

ROBIN WELLS was a Lecturer and Researcher in Economics at Princeton University. She received her BA from the University of Chicago and her PhD from the University of California at Berkeley; she then did postdoctoral work at MIT. She has taught at the University of Michigan, the University of Southampton (United Kingdom), Stanford, and MIT.

This is a book about economics as the study of what people do and how they interact, a study very much informed by real-world experience.

Dear Students and Instructors,

These words, this spirit, have served as a guiding We also include pedagogical features that reinforce principle for us in every edition. While we were learning. For example, each major section ends driven to write this book by many small ideas about with three related elements devised with the student particular aspects of economics, we also had one big in mind: (1) the Economics in Action: a real- idea: an economics textbook should be built around world application to help students achieve a fuller narratives, many of them pulled from real life, and it understanding of concepts they just read about; (2) a should never lose sight of the fact that economics is, in Quick Review of key ideas in list form; and (3) Check the end, a set of stories about what people do. Your Understanding self-test questions with answers at back of book. Our thought-provoking end-of-chapter Many of the stories economists tell take the form of problems are another strong feature. And we are pleased models—for whatever else they are, economic models to introduce the new Work It Out feature: one end-of- are stories about how the world works. But we believe chapter problem in each chapter that students solve that student understanding of and appreciation for with the help of an interactive tutorial. An overview of models are greatly enhanced if they are presented, as the text’s tools for learning are on p. ix. much as possible, in the context of stories about the real world that both illustrate economic concepts and Students also benefit from the impressive set of online touch on the concerns we all face living in a world resources in that are linked to specific shaped by economic forces. chapter content. These include adaptive quizzing, tutorials, interactive activities, and much more. You’ll find a rich array of stories in every chapter, All have been devised with the goal of supporting in the chapter openers, Economics in Actions, For instructor teaching and student learning in the one- Inquiring Minds, Global Comparisons, and the end-of- semester introductory course. part Business Cases. As always, we include many new stories and update others. We also integrate an We hope that your experience with this text is a international perspective throughout, and most visibly, good one. Thank you for introducing Essentials of in our Global Comparison feature. An overview of the Economics into your classroom. narrative-based features in the text is on p. viii.

Paul Krugman Robin Wells

We are committed to the belief that students learn best from a textbook built around narratives, steeped in real life and current events, with a strong emphasis on global matters, and accompanied by proven technology that supports student success.

Narrative Approach Technology That Builds Success This is a book built around narratives and stories, many Developed alongside chapters and designed for seamless pulled from real life. In every chapter, stories are used to integration with the book, for Essentials of teach core concepts and motivate learning. We believe Economics, Fourth Edition, provides students access to that the best way to introduce concepts and reinforce an extensive collection of proven learning tools: adaptive them is through memorable, real-world stories; students quizzing, tutorials, videos, activities, and a comprehen- simply relate more easily to them. sive review of math and graphing. The goals for these LD V R IE O W resources are the same as the text’s: student engagement, W Global Focus mastery of the material, and success in the course. We have thoroughly integrated an international perspective into the text, in the many applications, cases, To find activities that correspond to the interactive activity and stories, and, of course, in the data-based Global text, look for this icon: Comparison feature. This book is unrivaled in the attention paid to global matters.

What’s New in the Fourth Edition? An important and timely new chapter on poverty Many new and updated stories, applications, and inequality New Chapter 11 looks at the problem and cases keep the text fresh and engaging. of poverty, the issue of income inequality, and the U.S. The new stories cover a broad range of topics, many welfare state and its philosophical foundations. Health reflecting current events—for example, sustainability, care economics is also covered, along with a detailed the impact of technology, the economic situation in examination of the Affordable Care Act. Europe, and today’s policy debates. A listing of new examples appears on p. xiii. New coverage of price discrimination and game theory, and a newly separate Chapter 8 on Expanded and updated offerings in monopoly In response to feedback from users, we’ve These include a new math and graphing review, an carved out a separate chapter on monopoly and array of new activities designed to motivate learning added coverage of price discrimination to it. We also and encourage success in the course, and enhanced added a full section on game theory to Chapter 9, on integration between and in-text content. oligopoly and monopolistic competition. Our hope is that these additions will resonate with students and make teaching these topics more meaningful and fun.

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Engaging Students with a Narrative Approach

b To engage students, every chapter begins with CHAPTER 3 Supply and Demand a compelling story.

LD V R IE

O W ▲ W ECONOMICS in Action ▲ What You Will Learn A NATURAL GAS BOOM in This Chapter interactive activity Smart Grid Economics • What a competitive market is and how it is described by the f you are a night owl who likes to listen to music, write term papers, or do laun- supply and demand model dry in the middle of the night, your local electricity grid would like to thank you. Why? Because you are using electricity when it is least costly to generate. • What the demand curve and the I supply curve are The problem is that energy cannot be stored efficiently on a large scale. So power plant operators maintain both the main power stations that are designed • The difference between movements along a curve and to run continuously, as well as smaller power plants that operate only during shifts of a curve periods of peak demand—such as during daytime working hours or periods of • How the supply and demand extreme outside temperatures. curves determine a market’s These smaller power plants are more expensive to operate, incurring higher equilibrium price and equilibrium marginal cost per kilowatt generated than the average cost of generating a quantity kilowatt (that is, cost averaged over kilowatts generated by the large and small • In the case of a shortage or plants). According to the U.S. Government Accountability Office, it can cost surplus, how price moves the AP Photo/Andrew Rush Spencer Platt/Getty Images up to 10 times more to generate electricity during a summer market back to equilibrium TheTh adoptiond ti off new ddrillingilli ttechnologiesh l i lleadsd tto cheaperh naturalt l gas andd vigorousi afternoon (when air conditioners are running at maximum protests. interactive activity capacity) compared to nighttime. But consumers typically aren’t aware that the marginal RESIDENT OBAMA GOT A VIVID quadrupling from 2002 to 2006? There “game changer” was how energy experts cost of electricity varies over the course of a day or according illustration of American free speech were two principal factors—one reflecting described the impact of these technolo- to the weather. Instead, consumers see prices on their electric- P in action while touring upstate New the demand for natural gas, the other the gies on oil and natural gas production ity bills based on the average cost of electricity generation. As a York on August 23, 2013. The president supply of natural gas. and prices. To illustrate, the United States result, electricity demand is inefficient—too high during high was greeted by more than 500 chanting First, the demand side. In 2002, the produced 10.37 trillion cubic feet of natu- marginal cost periods and too low during low marginal cost and sign-toting supporters and opponents. U.S. economy was mired in recession; ral gas from shale deposits in 2012, nearly periods. In the end, consumers end up paying more than they Why the ruckus? Because upstate New with economic activity low and job losses doubling the total from 2010. That total should for their electricity, as utility companies must eventu- York is a key battleground over the adop- high, people and businesses cut back increased again in 2014, to 13.45 trillion ally raise their prices to cover production costs. tion of a relatively new method of produc- their energy consumption. For example, cubic feet of natural gas, making the To solve this inefficiency, utility companies, appliance man- to save money, homeowners turned down United States the world’s largest producer ing energy supplies. Hydraulic fractur- ufacturers, and the federal government are working together to ing, or fracking, is a method of extracting their thermostats in winter and turned of both oil and natural gas—overtaking develop SMART Grid technologies—that help consumers adjust natural gas (and to a lesser extent, oil) from them up in the summer. But by 2006, the both Russia and Saudia Arabia. their usage according to the true marginal cost of a kilowatt deposits trapped between layers of shale U.S. economy came roaring back, and The benefits of much lower natural gas Caiaimage/Getty Images rock thousands of feet underground— natural gas consumption rose. Second, prices have not only led to lower heat- WithWithSMARTGidt SMART Grid technology, h l consumers save money byb in real time. “Smart” meters have been developed for home using powerful jets of chemical-laden the supply side. In 2005, Hurricane ing costs for American consumers, they basing their demand for electricity on marginal cost rather use, which allow the price to the consumer to vary according water to release the gas. While it has been Katrina devastated the American Gulf have also cascaded through American than average cost. to the true marginal cost—which the consumer can see. And known for almost a century that the United Coast, site of most of the country’s natu- industries, particularly power generation States contains vast deposits of natural ral gas production at the time. So by and transportation. Electricity-generating gas within these shale formations, they lay 2006 the demand for natural gas had power plants are switching from coal to untapped because drilling for them was surged while the supply of natural gas natural gas, and mass-transit vehicles are considered too difficult. had been severely curtailed. As a result, switching from gasoline to natural gas. (You m So students can immediately see economic Until recently, that is. A few decades in 2006 natural gas prices peaked at can even buy an inexpensive kit to convert ago, new drilling technologies were devel- around $14 per thousand cubic feet, up your car from gasoline to natural gas.) The oped that made it possible to reach these from around $2 in 2002. effect has been so significant that many KrugESS4e_CH06_pp_175_201.indd concepts 190 applied in the real world, Economics in 24/05/16 3:08 PM deeply embedded deposits. But what Fast-forward to 2015: natural gas pric- European manufacturers, paying four times finally pushed energy companies to invest es once again fell to $2 per thousand more for gas than their U.S. rivals, have Action applications appear throughout chapters. in and adopt these new extraction tech- cubic feet. But this time it wasn’t a slow been forced to relocate plants to American nologies was the high price of natural economy that was the principal expla- soil to survive. In addition, the revived U.S. gas over the last decade. What account- nation, it was the use of the new tech- natural gas industry has directly created ed for these high natural gas prices—a nologies. “Boom,” “supply shock,” and tens of thousands of new jobs. BUSINESS An Uber Way to Get a Ride CASE

n a densely populated city like New York City, finding a taxi is a relatively easy task on most days—stand on a corner, put out your arm and, usually, before long I an available cab stops to pick you up. And even before you step into the car you will know approximately how much it will cost to get to your destination, because KrugESS4e_CH03_pp_066_100.indd 66 24/05/16 2:18 PM taxi meter rates are set by city regulators and posted for riders. But at times it is not so easy to find a taxi—on rainy days, during GLOBAL rush hour, and at crowded locations where many people are looking for COMPARISION What’s the Matter with Italy? a taxi at the same time. At such times, you could wait a very long while before finding an available cab. As you wait, you will probably notice empty taxis passing you by—drivers who have quit working for the day ome countries have been much more successful at mak- Unfortunately, Italy’s troubles aren’t just economic: it also and are headed home or back to the garage. There will be drivers who ing use of new technologies than others. suffers from chronic political weakness, which has left suc- might stop, but then won’t pick you up because they find your destina- S tion inconvenient. Moreover, there are times when it is simply impos- In the early stages of the information technology, or IT, cessive governments with little ability to take strong action sible to hail a taxi—for example, during a snowstorm or on New Year’s revolution, it seemed that the United States was pulling on any front. Eve when the demand for taxis far exceeds the supply. In 2009 two young entrepreneurs, Garrett Camp and Travis Kalanick, ahead of Europe. That’s less clear now: some European founded Uber, a company that they believe offers a better way to get a countries have moved forward rapidly in broadband, the ride. Using a smartphone app, Uber serves as a clearinghouse connect- Total factor ing people who want a ride to drivers with cars who are registered with wireless internet, and more. But one major European productivity, Uber. Confirm your location using the Uber app and you’ll be shown the nation is clearly lagging on all fronts: Italy. available cars in your vicinity. Tap “book” and you receive a text say- 2000 = 100 ing your car—typically a spotless Lincoln Town Car—is on its way. At The accompanying figure shows estimates of total Germany the end of your trip, fare plus tip are automatically deducted from your 110 © Mark Avery/ZUMA Wire/Alamy factor productivity growth since 2000 in three countries: credit card. As of 2014 Uber operates in 60 countries and more than 300 cities and booked $10 billion in rides in 2015. the United States, Germany (Europe’s largest economy), 105 Given that Uber provides personalized service and better quality cars, their and Italy. The United States and Germany have been fares are somewhat higher than regular taxi fares during normal driving hours—a situation that customers seem happy with. However, the qualification during nor- roughly keeping pace. But Italy seems, remarkably, to 100 United States mal driving hours is an important one because at other times Uber’s rates fluctu- have actually been slipping backwards. ate. When a lot of people are looking for a car—such as during a snowstorm or on New Year’s Eve—Uber uses what it calls surge pricing, setting the rate higher until This may be, in part, a consequence of the continu- 95 everyone who wants a car at the going price can get one. So during a recent New ing economic slump in Europe. But researchers studying Italy York snowstorm, rides cost up to 8.25 times the standard price. Enraged, some of Italian business argue that a variety of institutional factors, 90 Uber’s customers have accused them of price gouging. But according to Kalanick, the algorithm that Uber uses to determine the ranging from rigid labor markets to poor management, surge price is set to leave as few people as possible without a ride, and he’s just have prevented Italy from taking advantage of the oppor- doing what is necessary to keep customers happy. As he explains, “We do not own cars nor do we employ drivers. Higher prices are required in order to get cars on tunities new technology has to offer. 2001 2003 2005 2007 2009 2011 2013 the road and keep them on the road during the busiest times.” This explanation It’s a troubling picture, and one that surely should was confirmed by one Uber driver who said, “If I don’t have anything to do and Year see a surge price, I get out there.” be addressed with a variety of economic reforms.

QUESTIONS FOR THOUGHT Data from: The Conference Board Total Economy Database™, January 2014, http://www.conference-board.org/data/economydatabase/. 1. Before Uber, how were prices set in the market for rides in New York City? Was it a competitive market? 2. What accounts for the fact that during good weather there are typically enough taxis m for everyone who wants one, but during snowstorms there typically aren’t enough? To provide students with an international 3. How does Uber’s surge pricing solve the problem described in the previous question? Assess Kalanick’s claim that the price is set to leave as few people possible without a perspective, the Global Comparison feature uses ride. data and graphs to illustrate why countries reach m So students can see key economic principles different economic outcomes. applied to real-life business situations, each major

KrugESS4e_CH05_pp_137_174.inddpart concludes 172 with Business Cases. 24/05/16 3:04 PM

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KrugESS4e_CH15_pp_407_438.indd 421 24/05/16 4:51 PM Engaging Students with Effective Tools for Learning

b To reinforce learning, sections within chapters ▲ ECONOMICS in Action conclude with three tools for learning: (1) an interactive activity Moving Along the Aggregrate Demand Curve, 1979–1980 application of key concepts in the Economics in hen looking at data, it’s often hard to distinguish between changes in spending that represent movements along the aggregate demand curve Action; (2) a quick review of key concepts; and Wand shifts of the aggregate demand curve. One telling exception, however, is what happened right after the oil crisis of 1979, which we mentioned in this chapter’s opening story. Faced (3) a comprehension check with Check Your with a sharp increase in the aggregate price level—the rate of consumer price inflation reached 14.8% in March Understanding Questions (solutions are at back of 1980—the Federal Reserve stuck to a policy of increas- ing the quantity of money slowly. The aggregate price level of book). was rising steeply, but the quantity of money circulating in the economy was growing slowly. The net result was that the purchasing power of the quantity of money in

Glow Images/SuperStock circulation fell. TheTh interest i t t rate t effect ff t of f a rise i iin ththe aggregate t price i llevel l leads l d This led to an increase in the demand for borrowing to a drop in consumer and investment spending. and a surge in interest rates. The prime rate, which is the interest rate banks charge their best customers, climbed above 20%. High interest rates, in turn, caused both consumer spending and investment spending to fall: in 1980 purchases of durable consumer goods like cars fell by 5.3% and real Quick Review investment spending fell by 8.9%. • The aggregate demand curve In other words, in 1979–1980 the economy responded just as we’d expect if it is downward sloping because of were moving upward along the aggregate demand curve from right to left: due the wealth effect of a change in to the wealth effect and the interest rate effect of a change in the aggregate price the aggregate price level and the level, the quantity of aggregate output demanded fell as the aggregate price level interest rate effect of a change rose. This does not explain, of course, why the aggregate price level rose. But as in the aggregate price level. we’ll see in the upcoming section on the AD–AS model, the answer to that ques- SOLVED PROBLEM Sugar, Sugar • Changes in consumer spending tion lies in the behavior of the short-run aggregate supply curve. caused by changes in wealth and “U.S. Sugar Soars Above World Prices.” So read the headline in the Wall Street Jour- expectations about the future nal in December 2014. Although the price for sugar on the international market shift the aggregate demand curve. for interactive tutorials with step-by-step Changes in investment spending was $0.15 per pound at the time, American buyers were paying 50% more, nearly guidance on how to solve problems caused by changes in expectations Check Your Understanding 16-1 $0.25 per pound. The impact was felt by candy companies like PEZ Candy, which and by the size of the existing purchases 75,000 pounds of sugar each week. Why was there a 1. Determine the effect on aggregate demand of each of the following events. Explain stock of physical capital also shift disparity in price? Quantity of sugar (millions of tons) the aggregate demand curve. whether it represents a movement along the aggregate demand curve (up or down) To protect sugar farmers, the U.S. government limits the Price of sugar Quantity Quantity or a shift of the curve (leftward or rightward). (per pound) demanded supplied • Fiscal policy affects aggregate quantity of sugar that domestic buyers, like PEZ Candy, can pur- a. A rise in the interest rate caused by a change in monetary policy demand directly through chase from international suppliers. These restrictions leave U.S. $0.45 1.6 2.8 b. A fall in the real value of money in the economy due to a higher aggregate buyers with virtually no other choice; they have to purchase the government purchases and 0.35 1.8 2.4 indirectly through changes in price level higher-priced sugar from domestic suppliers. taxes or government transfers. c. News of a worse-than-expected job market next year The table is a hypothetical supply and demand schedule for 0.25 2.0 2.0 Monetary policy affects aggregate d. A fall in tax rates the U.S. sugar market. 0.15 2.2 1.6 e. A rise in the real value of assets in the economy due to a lower aggregate price level demand indirectly through Use a supply and demand graph to ﬁ nd the equilibrium quan- 0.05 2.4 1.2 changes in the interest rate. f. A rise in the real value of assets in the economy due to a surge in real estate values tity and price for sugar in the United States. Show how a short- Solutions appear at back of book. age would occur if U.S. sugar farmers were forced to set prices equal to the world price of $0.15 per pound. Price of sugar (per pound) STEP 1 Draw and label supply and demand curves. 0.45 S Find the equilibrium quantity demanded. Review pages 68–70, 78–79 and 85–88. 0.35 The equilibrium quantity demanded is at point E, the point E 0.25 KrugESS4e_CH16_pp_439_474.indd 446 24/05/16 4:57at PMwhich quantity supplied equals quantity demanded. As shown both in the supply and demand schedule and in the figure, this occurs at an equilibrium quantity of 2.0 billion 0.15 pounds and an equilibrium price of $0.25. 0.05 D STEP 2 Calculate the shortage of sugar that would occur at a price of $0.15. 0 1.2 1.6 2 2.82.4 Review pages 85–88. Quantity of sugar (billions of pounds) As shown in the upcoming graph, a price of $0.15 corresponds to point A on the supply curve. The quantity supplied at a price of 0.15 can be found by starting at point A, following the dotted line down WORK IT OUT interactive activity to the horizontal axis, and observing that the quantity supplied by U.S. sugar farmers is 1.6 billion pounds. Similarly, a price of $0.15 corresponds to point B on the demand curve. The quantity demanded at a price of $0.15 can be found by starting 17. Consider an industry with the demand curve (D) and a. If the industry is perfectly competitive, what will be the at point B, following the dotted line down to the horizontal axis, and observing that marginal cost curve (MC) shown in the accompanying total quantity produced? At what price? diagram. There is no fixed cost. If the industry is a single- b. Which area reflects consumer surplus under perfect price monopoly, the monopolist’s marginal revenue curve competition? would be MR. Answer the following questions by naming c. If the industry is a single-price monopoly, what quantity the appropriate points or areas. will the monopolist produce? Which price will it charge? m Price d. Which area reflects the single-price monopolist’s A profit? End-of-chapter worked-out problems, called Solved

e. Which area reflects consumer surplus under single-KrugESS4e_CH03_pp_066_100.indd 95 24/05/16 2:18 PM F JN price monopoly? Problem, and new interactive activities on , B K C G O f. Which area reflects the deadweight loss to society from single-price monopoly? b called Work It Out, guide students, step by step, H L R E MC g. If the monopolist can price-discriminate perfectly, what quantity will the perfectly price-discriminating through solving problems. D monopolist produce? ISTM Quantity MR

b Pitfalls teach students to identify PITFALLS and avoid common CEILINGS, FLOORS, AND and sold, doesn’t a price floor increase sellers don’t want to sell as much as QUANTITIES the quantity? buyers want to buy, it’s the sellers who misconceptions about A price ceiling pushes the price of a No, it doesn’t. In fact, both floors determine the actual quantity sold, KrugESS4e_CH08_pp_231_261.indd 261 24/05/16 3:22 PM economic concepts. good down. A price floor pushes the and ceilings reduce the quantity bought because buyers can’t force unwilling price of a good up. So it’s easy to and sold. Why? When the quantity of a sellers to sell. If buyers don’t want to assume that the effects of a price floor good supplied isn’t equal to the quantity buy as much as sellers want to sell, it’s are the opposite of the effects of a price demanded, the actual quantity sold is the buyers who determine the actual ceiling. In particular, if a price ceiling determined by the “short side” of the quantity sold, because sellers can’t force reduces the quantity of a good bought market—whichever quantity is less. If unwilling buyers to buy.

KrugESS4e_CH04_pp_101_136.indd 119 24/05/16 2:58 PM

This edition is accompanied by technology that, like the textbook, has been developed to spark student engagement and improve outcomes while offering instructors flexible, high-quality, research-based tools for teaching this course.

LAUNCHPADWORKS.COM

Built from the ground up alongside Essentials of Economics, features the most author-driven and text-specifi c content of any integrated homework system available. In this edition you will fi nd exciting changes to , including a collection of new activities designed to augment in-chapter content and features to support student learning. for Essentials of Economics Includes

c The Complete Essentials of Economics e-Book

c Pre-built units offer instructors and students ready-made units for study with LearningCurve quizzes, e-Book pages, tutorials, and graded homework for every chapter. Units are fl exible and easy to adapt or expand to suit individual preferences.

b Adaptive Quizzing Embraced by students and instructors alike, this incredibly popular and effective adaptive quizzing engine offers individualized question sets and feedback tailored to each student based on correct and incorrect responses. Questions are hyperlinked to relevant e-Book sections, encouraging students to read and use the resources at hand to enrich their understanding.

NEW! Math and Graphing Review c This is a critically important new resource created by a team of instructors for students who would benefi t from a review of basic math and graphing—skills needed to do well in an introductory economics course. It is organized as a series of activities, each with a pre-test question, an animation with patient and clear explanations, and fi ve concluding questions to test comprehension.

Copyright ©2016 Worth Publishers. Distributed by Worth Publishers. Not for redistribution. KrugESS4e_FM_pp_i_xxviii.indd x 15/07/16 2:06 PM NEW! Student-Centered Activities We have added three new types of activities to that are designed to help students practice and master economic concepts.

NEW! Work It Out c These skill-building activities are tutorials that walk students through each step of solving an end-of-chapter problem using choice-specifi c feedback and video explanations. They are an extension of the end-of-chapter Solved Problems in the textbook, and they have allowed us to double the number of worked-out problems in this edition.

b NEW! Economics in Action Activities Like the in-text feature of the same name, these activities engage students in learning through real- world applications of key economic concepts. In , the feature is enhanced with assessment and links to outside sources with related data. They also help students apply the concepts they’ve learned and become more comfortable working with data.

c NEW! Video Activities A curated collection of video clips from PBS NewsHour are linked to specifi c chapters and accompanied by multiple-choice assessment questions.

Provides Instructors with These Resources

FOR ASSESSMENT ADDITIONAL RESOURCES

Test Bank Fully revised for the Fourth Edition, the Test A Gradebook This useful resource offers clear feedback to Bank contains multiple-choice and short-answer questions students and instructors on individual assignments and on to help instructors assess students’ comprehension, inter- performance in the course. pretation, and ability to synthesize. LMS integration Included so that is easily inte- Graphing Questions Another question bank for instruc- grated into a school’s learning management system and that tors building assignments and tests. These are electroni- an instructor’s Gradebook and roster are always in sync. cally gradable graphing questions that use our own graph- Instructor’s Resource Manual Offers instructors teaching engine. Students are asked to draw graphs in response ing materials and tips to enhance the classroom experience, to a question; their graphs are automatically graded by the along with chapter objectives, outlines, and other ideas. software. Solutions Manual Prepared by the authors of the text, this End-of-Chapter Problems The in-text end-of-chapter manual offers detailed solutions to all of the text’s end-of- problems have been converted to a multiple-choice format chapter problems and the Business Case questions. accompanied by answer-specific feedback. Interactive Presentation Slides These brief, interactive, Graded Homework Assignments Each unit and visually interesting slides are designed to hold students’ concludes with a pre-built assignment, providing instruc- attention in class. The slides include graphics and anima- tors with a curated set of multiple-choice and graphing tions that demonstrate key concepts, real-world examples, questions that are easily assigned for graded assessment. hyperlinks to relevant outside sources (including videos), and many opportunities for active learning.

Also available for instructors and students, to be used with any text or homework system:

FlipItEcon.com

FlipIt gets students actively involved in learning economics in a fresh way. This resource was developed by two pioneers in active- learning methods—Eric Chiang, Florida Atlantic University, and José Vazquez, University of Illinois at Urbana-Champaign. Students watch Pre-Lectures and complete Bridge Question assessments before class—helping them prepare so they can be fully engaged in class, and giving instructors data about student comprehension that can inform their lecture preparation.

Saplinglearning.com

Sapling Learning is an online homework system that helps students get better grades with targeted instructional feedback tailored to each individual’s responses. It also helps instructors spend less time preparing for and managing a course by providing personalized classroom support from a PhD- or Master’s-level colleague fully trained in Sapling’s system.

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Copyright ©2016 Worth Publishers. Distributed by Worth Publishers. Not for redistribution. KrugESS4e_FM_pp_i_xxviii.indd xii 15/07/16 2:06 PM What’s New in This Edition? A New Chapter Chapter 11, Poverty, Inequality, and the Welfare State

A New Feature Work It Out problems in every chapter

2 Major New Sections Price Discrimination in Chapter 8, Monopoly Game Theory in Chapter 9, Oligopoly and Monopolistic Competition

To teach students about the 9 New Opening Stories realities of resource scarcity and A Natural Gas Boom, 66 the need to make choices, we Deck the Halls, 202 use fracking and its effects on The Coming of Obamacare, 315 the market for natural gas as the The Pain in Spain*, 343 subject of the opening story for Hitting the Breaking Point, 377 Chapter 3, on supply and demand. Airpocalypse Now*, 407 Funny Money*, 506 The Most Powerful Person in Government, 541 In other cases we pay particular The Everywhere Phone*, 569 attention to how changes in technology are transforming the 10 New Business Cases economic landscape—discussing An Uber Way to Get a Ride, 172 the rise of Uber to illustrate Shopping Apps, Showrooming, and the Challenges Facing Brick-and- market equilibrium, and the use of Mortar Retailers, 230 Smart Grid technology to show the Amazon and Hachette Go to War, 284 Hunting Endangered Animals to Save Them, 341 importance of measuring cost. Welfare State Entrepreneurs*, 342 The Business Cycle and the Decline of Montgomery Ward, 404 Example topics illustrate important Day Labor in the Information Age, 406 policy debates, such as the How Boeing Got Better, 473 introduction of the Affordable Care Slow Steaming*, 474 Act and the environmental trade- Here Comes the Sun, 566 offs of coal-fired versus natural 18 New Economics in Action Applications gas-fired power plants. And as Take the Keys, Please, 107 always, we integrate a global Price Controls in Venezuela*, 116 perspective. Crabbing, Quotas, and Saving Lives in Alaska, 128 Smart Grid Economics, 190 Farmers Move Up Their Supply Curves, 216 Why Is Your Broadband So Slow? And Why Does It Cost So Much?*, 249 How Much Does Your Electricity Really Cost?, 291 Long-Term Trends in Income Inequality in the United States, 323 Programs and Poverty in the Great Recession, 327 What Medicaid Does, 334 French Family Values*, 337 Spain’s Costly Surplus*, 356 Is the End of Economic Growth in Sight?*, 418 Why Did Britain Fall Behind?*, 423 The Cost of Limiting Carbon*, 432 Austerity and the Multiplier, 486 Are We Greece?*, 498 How Hong Kong Lost Its Shirts*, 578 *indicates a global example.

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Our deep appreciation and heartfelt thanks go out to Ryan Herzog, Gonzaga University, for his hard work and extensive contributions during every stage of this revision. Ryan’s creativity and insights helped us make this fourth edition possible.

A special thanks to Doris Bennett, Jacksonville State University, for her contributions to the test bank and for her helpful accuracy reviews. Thank you to Kathryn Graddy, Brandeis University, for her hard work on the second and third editions of this text.

Thank you, as well, to the instructors who offered invaluable input on this fourth edition.

Gbenga Ajilore, University of Toledo Ryan Herzog, Gonzaga University Doris Bennett, Jacksonville State University Nicholas Karatjas, Indiana University of Pennsylvania McKinley Blackburn, University of South Carolina Solina Lindahl, California Polytechnic University, San Luis Obispo Amy Boswell, Anne Arundel Community College Mike Martell, Franklin and Marshall College Elizabeth Breitbach, University of South Carolina Iordanis Petsas, University of Scranton Satyajit Ghosh, University of Scranton Elizabeth Sawyer-Kelly, University of Wisconsin, Madison Chris Gingrich, Eastern Mennonite University Leonore Taga, Rider University George Greenlee, St. Petersburg College, Clearwater

Thank you to all the instructors who reviewed past editions of this text.

Carlos Aguilar, El Paso Community College Richard Langlois, University of Connecticut Irma T. Alonso, Florida International University Frances F. Lea, Germanna Community College Jack Amariglio, Merrimack College Noreen E. Lephardt, Marquette University Clive Belﬁ eld, Queens College, CUNY Stephen Lile, Western Kentucky University Rob Catlett, Emporia State University Parul Mathur, Simpson College Semih Emre Cekin, Texas Tech University Dennis C. McCornac, Anne Arundel Community College Eric Chiang, Florida Atlantic University Chris N. McGrew, Purdue University Norman R. Cloutier, University of Wisconsin–Parkside Mary Helen McSweeney-Feld, Iona College Michael Coon, University of Wisconsin–Milwaukee Marshall Medoff, California State University, Long Beach Tom Creahan, Morehead State University Diego Mendez-Carbajo, Illinois Wesleyan University Abel Embaye, University of Arkansas Garrett Milam, University of Puget Sound Jose Esteban, Palomar College Ellen Mutari, Richard Stockton College of New Jersey Randall Filer, Hunter College, CUNY Kevin O’Brien, Bradley University Todd Gabe, University of Maine Inge O’Connor, Syracuse University Seth Gitter, Towson University John Perry, Centre College Devra Golbe, Hunter College H. Mikael Sandberg, University of Florida Patricia Graham, University of Northern Colorado Elizabeth Sawyer-Kelly, University of Wisconsin–Madison Thomas Hardin, Mater Dei Catholic High School Amy Scott, DeSales University Terence Hunady, Bowling Green State University Chace Stiehl, Bellevue College Arthur Janssen, Emporia State University Abdulhamid Sukar, Cameron University Matthew Jaremski, Colgate University Patrick Taylor, Millsaps College Nicholas Karatjas, Indiana University of Pennsylvania Robert Teitelbaum, State University of New York, Empire State College Susan Kask, Warren Wilson College Theo Thedford, Shorter University Hisaya Kitaoka, Franklin College Jose J. Vazquez-Cognet, University of Illinois at Urbana-Champaign Katie Kontak, Bowling Green State University Matt Warning, University of Puget Sound Andrew F. Kozak, St. Mary’s College of Maryland Thomas Watkins, Eastern Kentucky University

We must also thank the many people at Worth Publishers for their work on this edition: Shani Fisher, Sharon Balbos, Lukia Kliossis, and Courtney Lindwall in editorial. We thank Tom Digiano and Tom Acox for their enthusiastic and tireless advocacy of this book. Many thanks to the incredible production, design, photo, and media teams: Tracey Kuehn, Lisa Kinne, Stacey Alexander, Martha Emry, Vicki Tomaselli, Deb Heimann, Cecilia Varas, Elyse Rieder, Chris Efstratiou, Andrew Vaccaro, and Daniel Comstock.

And lastly, to all of you who have introduced our books to your students and colleagues, and who continue to shape our experience as textbook authors, we thank you and encourage your feedback.

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Part 1 WHAT IS ECONOMICS? 1 First Principles / 1 2 Economic Models: Trade-offs and Trade / 23 Appendix: Graphs in Economics / 47 Part 2 SUPPLY AND DEMAND 3 Supply and Demand / 66 4 Price Controls and Quotas: Meddling with Markets / 101 5 Elasticity and Taxation / 137 Part 3 THE PRODUCTION DECISION 6 Behind the Supply Curve: Inputs and Costs / 175 7 Perfect Competition and the Supply Curve / 202 Part 4 BEYOND PERFECT COMPETITION 8 Monopoly / 231 9 Oligopoly and Monopolistic Competition / 262 Part 5 MICROECONOMICS AND PUBLIC POLICY 10 Externalities and Public Goods / 286 11 Poverty, Inequality, and the Welfare State / 315 Part 6 INTRODUCTION TO MACROECONOMICS 12 Macroeconomics: The Big Picture / 343 13 GDP and the CPI: Tracking the Macroeconomy / 360 14 Unemployment and Inflation / 377 Part 7 ECONOMIC GROWTH AND FLUCTUATIONS 15 Long-Run Economic Growth / 407 16 Aggregate Demand and Aggregate Supply / 439 Part 8 STABILIZATION POLICY 17 Fiscal Policy / 475 18 Money, Banking, and the Federal Reserve System / 506 19 Monetary Policy / 541 Part 9 THE INTERNATIONAL ECONOMY 20 International Trade, Capital Flows, and Exchange Rates / 569

Solutions to Check Your Understanding Questions / S-1 Glossary / G-1 Index / I-1

Preface vi

Part 1 WHAT IS ECONOMICS?

Chapter 1 ECONOMICS IN ACTION Adventures in First Principles / 1 Babysitting 18

Common Ground 1 Chapter 2 The Ordinary Business of Life 2 Economic Models: Trade-offs and Trade / 23 My Benefi t, Your Cost 3 From Kitty Hawk to Dreamliner 23 Good Times, Bad Times 3 Models in Economics: Some Important Onward and Upward 4 Examples 24 Principles That Underlie Individual Choice: The Core of Economics 4 Trade-offs: The Production Possibility Frontier 25 Comparative Advantage and Gains from Trade 30 Principle #1: Choices Are Necessary Because Resources Comparative Advantage and International Trade, in Are Scarce 4 Reality 33 Principle #2: The True Cost of Something Is Its Opportunity Cost 5 Global Comparison Pajama Republics 34 Principle #3: “How Much” Is a Decision at the Margin 6 Transactions: The Circular-Flow Diagram 34 Principle #4: People Usually Respond to Incentives, Exploiting ECONOMICS IN ACTION Rich Nation, Poor Nation 36 Opportunities to Make Themselves Better Off 7 Using Models 37 ECONOMICS IN ACTION Boy or Girl? It Depends on Positive versus Normative Economics 37 the Cost 9 When and Why Economists Disagree 38 Interaction: How Economies Work 10 ECONOMICS IN ACTION Economists, Beyond the Principle #5: There Are Gains from Trade 11 Ivory Tower 39 Principle #6: Markets Move Toward Equilibrium 12 Solved Problem Heavy Metal and High Protein 41 Principle #7: Resources Should Be Used Effi ciently to Achieve Society’s Goals 13 Chapter 2 Principle #8: Markets Usually Lead to Effi ciency 14 Principle #9: When Markets Don’t Achieve Effi ciency, Appendix: Graphs in Economics / 47 Government Intervention Can Improve Society’s Welfare 15 Getting the Picture 47 ECONOMICS IN ACTION Restoring Equilibrium on the Graphs, Variables, and Economic Models 47 Freeways 15 How Graphs Work 47 Economy-Wide Interactions 16 Two-Variable Graphs 47 Principle #10: One Person’s Spending Is Another Person’s Curves on a Graph 49 Income 17 A Key Concept: The Slope of a Curve 50 Principle #11: Overall Spending Sometimes Gets Out of Line The Slope of a Linear Curve 50 with the Economy’s Productive Capacity 17 Horizontal and Vertical Curves and Their Slopes 51 Principle #12: Government Policies Can Change Spending 18 The Slope of a Nonlinear Curve 52 Calculating the Slope Along a Nonlinear Curve 52

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Maximum and Minimum Points 54 Part 1 BUSINESS CASES 64 Calculating the Area Below or Above a Curve 55 • How Priceline.com Revolutionized the Travel Graphs That Depict Numerical Information 56 Industry 64 Types of Numerical Graphs 56 • Effi ciency, Opportunity Cost, and the Logic of Lean Problems in Interpreting Numerical Graphs 58 Production 65 Solved Problem Working with Graphs 60

Part 2 SUPPLY AND DEMAND

Chapter 3 Competitive Markets—and Others 94 Supply and Demand / 66 Solved Problem Sugar, Sugar 95

A Natural Gas Boom 66 Chapter 4 Supply and Demand: A Model of a Competitive Price Controls and Quotas: Meddling with Market 67 Markets / 101 The Demand Curve 68 Big City, Not-So-Bright Ideas 101 The Demand Schedule and the Demand Curve 68 Shifts of the Demand Curve 69 Consumer Surplus and the Demand Curve 102 Global Comparison Pay More, Pump Less 70 Willingness to Pay and the Demand Curve 102 Understanding Shifts of the Demand Curve 72 Willingness to Pay and Consumer Surplus 102 ECONOMICS IN ACTION Beating the Traffi c 77 Producer Surplus and the Supply Curve 104 Cost and Producer Surplus 104 The Supply Curve 78 The Gains from Trade 106 The Supply Schedule and the Supply Curve 78 Shifts of the Supply Curve 79 ECONOMICS IN ACTION Take the Keys, Understanding Shifts of the Supply Curve 80 Please 107 ECONOMICS IN ACTION Only Creatures Small and Why Governments Control Prices 108 Pampered 84 Price Ceilings 109 Supply, Demand, and Equilibrium 85 Modeling a Price Ceiling 109 Finding the Equilibrium Price and Quantity 85 How a Price Ceiling Causes Inefﬁ ciency 111 Why Do All Sales and Purchases in a Market Take Place at So Why Are There Price Ceilings? 115 the Same Price? 86 ECONOMICS IN ACTION Price Controls in Venezuela: Why Does the Market Price Fall If It Is Above the Equilibrium “You Buy What They Have” 116 Price? 87 Why Does the Market Price Rise If It Is Below the Equilibrium Price Floors 117 Price? 87 How a Price Floor Causes Inefﬁ ciency 119 Using Equilibrium to Describe Markets 88 So Why Are There Price Floors? 121 ECONOMICS IN ACTION The Price of Admission 88 Global Comparison Check Out Our Low, Low Wages! 122 Changes in Supply and Demand 89 ECONOMICS IN ACTION The Rise and Fall of the Unpaid Intern 122 What Happens When the Demand Curve Shifts 90 What Happens When the Supply Curve Shifts 91 Controlling Quantities 124 Simultaneous Shifts of Supply and Demand Curves 92 The Anatomy of Quantity Controls 124 ECONOMICS IN ACTION The Cotton Panic and The Costs of Quantity Controls 127 Crash of 2011 93

ECONOMICS IN ACTION Crabbing, Quotas, and Global Comparison Food’s Bite in World Budgets 152 Saving Lives in Alaska 128 ECONOMICS IN ACTION Spending It 152 Solved Problem The World’s Second Most Expensive City 130 The Price Elasticity of Supply 153 Chapter 5 Measuring the Price Elasticity of Supply 153 Elasticity and Taxation / 137 What Factors Determine the Price Elasticity of Supply? 154 ECONOMICS IN ACTION European Farm Taken for a Ride 137 Surpluses 155 Deﬁ ning and Measuring Elasticity 138 An Elasticity Menagerie 156 Calculating the Price Elasticity of Demand 138 The Beneﬁ ts and Costs of Taxation 157 An Alternative Way to Calculate Elasticities: The Midpoint The Revenue from an Excise Tax 157 Method 140 Tax Rates and Revenue 158 ECONOMICS IN ACTION Estimating Elasticities 141 The Costs of Taxation 160 Interpreting the Price Elasticity of Demand 142 Elasticities and the Deadweight Loss of a Tax 162 How Elastic Is Elastic? 142 ECONOMICS IN ACTION Taxing the Marlboro Man 164

Price Elasticity Along the Demand Curve 147 Solved Problem Drive We Must 165 What Factors Determine the Price Elasticity of Demand? 148 ECONOMICS IN ACTION Responding to Your Part 2 BUSINESS CASES 172 Tuition Bill 149 • An Uber Way to Get a Ride 172 Other Demand Elasticities 150 • Medallion Financial: Cruising Right Along 173 The Cross-Price Elasticity of Demand 150 • The Airline Industry: Fly Less, Charge More 174 The Income Elasticity of Demand 151

Part 3 THE PRODUCTION DECISION

Chapter 6 Summing Up Costs: The Short and Long of It 195 Behind the Supply Curve: Inputs and Costs / 175 ECONOMICS IN ACTION There’s No Business Like Snow Business 196 The Farmer’s Margin 175 Solved Problem Production Challenges for Tesla: The Production Function 176 The Model X 197 Inputs and Output 176 Global Comparison Wheat Yields Around the World 178 Chapter 7 From the Production Function to Cost Curves 180 Perfect Competition and the Supply Curve / 202 ECONOMICS IN ACTION The Mythical Man-Month 182 Deck the Halls 202 Two Key Concepts: Marginal Cost and Average Perfect Competition 203 Cost 183 Defi ning Perfect Competition 203 Marginal Cost 183 Two Necessary Conditions for Perfect Competition 203 Average Total Cost 185 Free Entry and Exit 204 Minimum Average Total Cost 188 ECONOMICS IN ACTION Paid to Delay 205 Does the Marginal Cost Curve Always Slope Upward? 189 ECONOMICS IN ACTION Smart Grid Economics 190 Production and Profi ts 206 Using Marginal Analysis to Choose the Profi t-Maximizing Short-Run versus Long-Run Costs 191 Quantity of Output 206 Returns to Scale 194 When Is Production Profi table? 209 The Short-Run Production Decision 212

Changing Fixed Cost 215 ECONOMICS IN ACTION From Global Wine Glut to Summing Up: The Perfectly Competitive Firm’s Proﬁ tability and Shortage 223 Production Conditions 215 Solved Problem Is There a Catch? 224 ECONOMICS IN ACTION Farmers Move Up Their Supply Curves 216 Part 3 BUSINESS CASES 229 The Industry Supply Curve 217 • Kiva Systems’ Robots versus Humans: The Challenge The Short-Run Industry Supply Curve 217 of Holiday Order Fulfi llment 229 The Long-Run Industry Supply Curve 218 • Shopping Apps, Showrooming, and the Challenges The Cost of Production and Efﬁ ciency in Long-Run Facing Brick-and-Mortar Retailers 230 Equilibrium 222

Part 4 BEYOND PERFECT COMPETITION

Chapter 8 ECONOMICS IN ACTION Sales, Factory Outlets, and Monopoly / 231 Ghost Cities 255 Solved Problem Painkiller Pricing 256 Everybody Must Get Stones 231 Types of Market Structure 232 Chapter 9 The Meaning of Monopoly 233 Oligopoly and Monopolistic Competition / 262

Monopoly: Our First Departure from Perfect Caught in the Act 262 Competition 233 What Monopolists Do 233 The Meaning of Oligopoly 263 Why Do Monopolies Exist? 235 Understanding Oligopoly 263 ECONOMICS IN ACTION Newly Emerging Markets: Oligopoly in Practice 266 A Diamond Monopolist’s Best Friend 237 ECONOMICS IN ACTION Bitter Chocolate? 268 How a Monopolist Maximizes Proﬁ t 239 Games Oligopolists Play 270 The Monopolist’s Demand Curve and Marginal The Prisoners’ Dilemma 270 Revenue 239 Repeated Interaction and Tacit Collusion 272 The Monopolist’s Proﬁ t-Maximizing Output and Price 242 ECONOMICS IN ACTION The Rise and Fall and Rise Monopoly versus Perfect Competition 242 of OPEC 273 Monopoly: The General Picture 244 The Meaning of Monopolistic Competition 275 ECONOMICS IN ACTION Shocked by the High Price of Electricity 244 Large Numbers 276 Free Entry and Exit in the Long Run 276 Monopoly and Public Policy 246 Differentiated Products 276 Welfare Effects of Monopoly 246 ECONOMICS IN ACTION Any Color, So Long as It’s Preventing Monopoly 247 Black 278 Dealing with Natural Monopoly 248 Solved Problem The Ups (and Downs) of Oil Prices 278 ECONOMICS IN ACTION Why Is Your Broadband So Slow? And Why Does It Cost So Much? 249 Part 4 BUSINESS CASES 284 Price Discrimination 251 • Amazon and Hachette Go to War 284 The Logic of Price Discrimination 251 • Virgin Atlantic Blows the Whistle . . . or Blows It? 285 Perfect Price Discrimination 253

Part 5 MICROECONOMICS AND PUBLIC POLICY

Chapter 10 Chapter 11 Externalities and Public Goods / 286 Poverty, Inequality, and the Welfare State / 315

The Great Stink 286 The Coming of Obamacare 315 Externalities 287 Poverty, Inequality, and Public Policy 316 Pollution: An External Cost 287 The Logic of the Welfare State 316 The Socially Optimal Quantity of Pollution 288 The Problem of Poverty 317 Why a Market Economy Produces Too Much Pollution 289 Economic Inequality 320 Private Solutions to Externalities 290 Global Comparison Income, Redistribution, and Inequality in Rich ECONOMICS IN ACTION How Much Does Your Countries 321 Electricity Really Cost? 291 Economic Insecurity 322 Policies Toward Pollution 293 ECONOMICS IN ACTION Long-term Trends in Income Inequality in the United States 323 Environmental Standards 293 Emissions Taxes 293 The U.S. Welfare State 325 Global Comparison Economic Growth and Greenhouse Gases in Means-Tested Programs 325 Six Countries 294 Social Security and Unemployment Insurance 326 Tradable Emissions Permits 295 The Effects of the Welfare State on Poverty and Inequality 326 Comparing Environmental Policies with an Example 296 ECONOMICS IN ACTION Welfare State Programs and ECONOMICS IN ACTION Cap and Trade 297 Poverty Rates in the Great Recession, 2007–2010 327 Positive Externalities 298 The Economics of Health Care 328 Preserved Farmland: An External Benefi t 299 The Need for Health Insurance 328 Positive Externalities in Today’s Economy 300 Government Health Insurance 330 Health Care in Other Countries 331 ECONOMICS IN ACTION The Impeccable Economic The Affordable Care Act 332 Logic of Early-Childhood Intervention Programs 301 ECONOMICS IN ACTION What Medicaid Does 334 Public Goods 301 The Debate over the Welfare State 335 Characteristics of Goods 302 Why Markets Can Supply Only Private Goods Effi ciently 303 Problems with the Welfare State 335 Providing Public Goods 304 The Politics of the Welfare State 336 How Much of a Public Good Should Be Provided? 305 ECONOMICS IN ACTION French Family Values 337 Cost-Benefi t Analysis 307 ECONOMICS IN ACTION Old Man River 308 Part 5 BUSINESS CASES 341 Solved Problem The Not So Sweet Smell of • Hunting Endangered Animals to Save Them 341 Success 309 • Welfare State Entrepreneurs 342

Part 6 INTRODUCTION TO MACROECONOMICS

Chapter 12 The Nature of Macroeconomics 344 Macroeconomics: The Big Picture / 343 Macroeconomic Questions 344 Macroeconomics: The Whole Is Greater Than the Sum of Its The Pain in Spain 343 Parts 345

Macroeconomics: Theory and Policy 345 ECONOMICS IN ACTION Indexing to the CPI 372 ECONOMICS IN ACTION Fending Off Depression 346 Solved Problem A Change in Fortune? 373 The Business Cycle 347 Chapter 14 Charting the Business Cycle 348 The Pain of Recession 349 Unemployment and Infl ation / 377 Taming the Business Cycle 349 Hitting the Braking Point 377 ECONOMICS IN ACTION Comparing Recessions 350 The Unemployment Rate 378 Long-Run Economic Growth 351 Defi ning and Measuring Unemployment 378 ECONOMICS IN ACTION A Tale of Two Countries 353 The Signifi cance of the Unemployment Rate 379 Growth and Unemployment 381 Infl ation and Defl ation 353 ECONOMICS IN ACTION Failure to Launch 383 The Causes of Infl ation and Defl ation 354 The Pain of Infl ation and Defl ation 354 The Natural Rate of Unemployment 384 ECONOMICS IN ACTION A Fast (Food) Measure of Job Creation and Job Destruction 384 Infl ation 355 Frictional Unemployment 385 Structural Unemployment 386 International Imbalances 355 The Natural Rate of Unemployment 389 ECONOMICS IN ACTION Spain’s Costly Surplus 356 Changes in the Natural Rate of Unemployment 389 Chapter 13 ECONOMICS IN ACTION Structural Unemployment in East Germany 391 GDP and the CPI: Tracking the Macroeconomy / 360 Infl ation and Defl ation 392 The Level of Prices Doesn’t Matter . . . 392 The New #2 360 . . . But the Rate of Change of Prices Does 393 Measuring the Macroeconomy 361 Winners and Losers from Infl ation 396 Infl ation Is Easy; Disinfl ation Is Hard 397 Gross Domestic Product 361 Calculating GDP 361 ECONOMICS IN ACTION Israel’s Experience with What GDP Tells Us 364 Infl ation 397 ECONOMICS IN ACTION Creating the National Solved Problem The Current Population Survey 399 Accounts 364 Real GDP: A Measure of Aggregate Output 365 Part 6 BUSINESS CASES 404 Calculating Real GDP 365 • The Business Cycle and the Decline of Montgomery What Real GDP Doesn’t Measure 367 Ward 404 ECONOMICS IN ACTION Miracle in Venezuela? 367 • Getting a Jump on GDP 405 • Day Labor in the Information Age 406 Price Indexes and the Aggregate Price Level 368 Market Baskets and Price Indexes 368 The Consumer Price Index 369 Other Price Measures 371

Part 7 ECONOMIC GROWTH AND FLUCTUATIONS

Chapter 15 Comparing Economies Across Time and Long-Run Economic Growth / 407 Space 408 Real GDP per Capita 408 Airpocalypse Now 407 Growth Rates 410

ECONOMICS IN ACTION India Takes Off 411 Shifts of the Aggregate Demand Curve 442 Government Policies and Aggregate Demand 445 The Sources of Long-Run Growth 412 ECONOMICS IN ACTION Moving Along the Aggregate The Crucial Importance of Productivity 412 Demand Curve, 1979–1980 446 Explaining Growth in Productivity 413 Accounting for Growth: The Aggregate Production Aggregate Supply 447 Function 413 The Short-Run Aggregate Supply Curve 447 What About Natural Resources? 417 Shifts of the Short-Run Aggregate Supply Curve 449 ECONOMICS IN ACTION Is the End of Economic The Long-Run Aggregate Supply Curve 451 Growth in Sight? 418 From the Short Run to the Long Run 453 Why Growth Rates Differ 419 ECONOMICS IN ACTION Sticky Wages in the Great Explaining Differences in Growth Rates 419 Recession 455 Global Comparison What’s the Matter with Italy? 421 The AD–AS Model 456 The Role of Government in Promoting Economic Growth 421 Short-Run Macroeconomic Equilibrium 457 ECONOMICS IN ACTION Why Did Britain Fall Shifts of Aggregate Demand: Short-Run Effects 458 Behind? 423 Shifts of the SRAS Curve 458 Success, Disappointment, and Failure 424 Global Comparison Supply Shocks of the Twenty-ﬁ rst Century 460 East Asia’s Miracle 424 Long-Run Macroeconomic Equilibrium 460 Latin America’s Disappointment 426 Africa’s Troubles and Promise 426 ECONOMICS IN ACTION Supply Shocks versus Demand Shocks in Practice 463 ECONOMICS IN ACTION Are Economies Converging? 427 Macroeconomic Policy 464 Is World Growth Sustainable? 429 Policy in the Face of Demand Shocks 465 Natural Resources and Growth, Revisited 429 Responding to Supply Shocks 466 Economic Growth and the Environment 430 ECONOMICS IN ACTION Is Stabilization Policy ECONOMICS IN ACTION The Cost of Limiting Stabilizing? 466 Carbon 432 Solved Problem A Shocking Analysis 467 Solved Problem Tracking India’s Economic Growth 433 Part 7 BUSINESS CASES 473 Chapter 16 • How Boeing Got Better 473 Aggregate Demand and Aggregate Supply / 439 • Slow Steaming 474

What Kind of Shock? 439 Aggregate Demand 440 Why Is the Aggregate Demand Curve Downward Sloping? 441

Part 8 STABILIZATION POLICY

Chapter 17 Taxes, Purchases of Goods and Services, Government Transfers, and Borrowing 476 Fiscal Policy / 475 The Government Budget and Total Spending 477 How Big Is Big Enough? 475 Expansionary and Contractionary Fiscal Policy 478 Can Expansionary Fiscal Policy Actually Work? 480 Fiscal Policy: The Basics 476 A Cautionary Note: Lags in Fiscal Policy 481

ECONOMICS IN ACTION What Was in the Recovery Determining the Money Supply 517 Act? 482 How Banks Create Money 517 Fiscal Policy and the Multiplier 483 Reserves, Bank Deposits, and the Money Multiplier 518 The Money Multiplier in Reality 519 Multiplier Effects of an Increase in Government Purchases of Goods and Services 483 ECONOMICS IN ACTION Multiplying Money Multiplier Effects of Changes in Government Transfers and Down 521 Taxes 484 The Federal Reserve System 521 How Taxes Affect the Multiplier 485 The Structure of the Fed 522 ECONOMICS IN ACTION Austerity and the What the Fed Does: Reserve Requirements and the Discount Multiplier 486 Rate 523 The Budget Balance 487 Open-Market Operations 523 The Budget Balance as a Measure of Fiscal Policy 488 The European Central Bank 525 The Business Cycle and the Cyclically Adjusted Budget ECONOMICS IN ACTION The Fed’s Balance Sheet, Balance 488 Normal and Abnormal 526 Should the Budget Be Balanced? 490 The Evolution of the American Banking ECONOMICS IN ACTION Europe’s Search for a System 528 Fiscal Rule 491 The Crisis in American Banking in the Early Twentieth Long-Run Implications of Fiscal Policy 492 Century 528 Defi cits, Surpluses, and Debt 493 Responding to Banking Crises: The Creation of the Federal Reserve 529 Global Comparison The American Way of Debt 494 The Savings and Loan Crisis of the 1980s 530 Problems Posed by Rising Government Debt 494 Back to the Future: The Financial Crisis of 2008 531 Defi cits and Debt in Practice 495 ECONOMICS IN ACTION Regulation After the 2008 Implicit Liabilities 497 Crisis 534 ECONOMICS IN ACTION Are We Greece? 498 Solved Problem Multiplying Money 535 Solved Problem Mind the Gap 500 Chapter 19 Chapter 18 Monetary Policy / 541 Money, Banking, and the Federal Reserve System / 506 The Most Powerful Person in Government 541 The Demand for Money 542 Funny Money 506 The Opportunity Cost of Holding Money 542 The Meaning of Money 507 The Money Demand Curve 544 What Is Money? 507 Shifts of the Money Demand Curve 545 Roles of Money 508 ECONOMICS IN ACTION A Yen for Cash 546 Global Comparison The Big Moneys 508 Money and Interest Rates 547 Types of Money 509 Measuring the Money Supply 510 The Equilibrium Interest Rate 547 Monetary Policy and the Interest Rate 549 ECONOMICS IN ACTION The History of the Dollar 511 Long-Term Interest Rates 550 ECONOMICS IN ACTION The Fed Reverses The Monetary Role of Banks 512 Course 551 What Banks Do 513 Monetary Policy and Aggregate Demand 552 The Problem of Bank Runs 514 Bank Regulation 515 Expansionary and Contractionary Monetary Policy 552 Monetary Policy in Practice 553 ECONOMICS IN ACTION It’s a Wonderful Banking System 516 The Taylor Rule Method of Setting Monetary Policy 554 Infl ation Targeting 554

Global Comparison Inﬂ ation Targets 555 ECONOMICS IN ACTION International Evidence of The Zero Lower Bound Problem 556 Monetary Neutrality 560

ECONOMICS IN ACTION What the Fed Wants, the Solved Problem The Great Mistake of 1937 561 Fed Gets 556 Money, Output, and Prices in the Long Run 557 Part 8 BUSINESS CASES 566 Short-Run and Long-Run Effects of an Increase in the Money • Here Comes the Sun 566 Supply 558 • The Perfect Gift: Cash or a Gift Card? 567 Monetary Neutrality 559 • PIMCO Bets on Cheap Money 568 Changes in the Money Supply and the Interest Rate in the Long Run 559

Part 9 THE INTERNATIONAL ECONOMY

Chapter 20 The Effects of a Tariff 585 International Trade, Capital Flows, and The Effects of an Import Quota 587 Exchange Rates / 569 ECONOMICS IN ACTION Trade Protection in the United States 588 The Everywhere Phone 569 Capital Flows and the Balance of Payments 588 Comparative Advantage and International Balance of Payments Accounts 589 Trade 570 Underlying Determinants of International Capital Flows 592 Production Possibilities and Comparative Advantage, Global Comparison Big Surpluses 593 Revisited 571 Two-Way Capital Flows 593 The Gains from International Trade 572 Comparative Advantage versus Absolute Advantage 574 ECONOMICS IN ACTION The Golden Age of Capital Flows 594 Global Comparison Productivity and Wages Around the World 575 The Role of the Exchange Rate 595 Sources of Comparative Advantage 576 Understanding Exchange Rates 595 ECONOMICS IN ACTION How Hong Kong Lost Its The Equilibrium Exchange Rate 596 Shirts 578 Inﬂ ation and Real Exchange Rates 599 Purchasing Power Parity 601 Supply, Demand, and International Trade 579 The Effects of Imports 579 ECONOMICS IN ACTION Low-Cost America 602 The Effects of Exports 581 Solved Problem Trade Is Sweet 604 International Trade and Wages 583 ECONOMICS IN ACTION Trade, Wages, and Land Part 9 BUSINESS CASE 609 Prices in the Nineteenth Century 584 • Li & Fung: From Guangzhou to You 609 The Effects of Trade Protection 585

Solutions to Check Your Understanding Questions S-1 Glossary G-1 Index I-1

Cover Photo Credits First Row (left to right): Female Korean factory worker: Image Source/Getty Images; Market food: Izzy Schwartz/Getty Images; High gas prices in Fremont, California: Mpiotti/ Getty Images

Second Row: Red sports car: Shutterstock; View of smoking coal power plant: iStockphoto/Thinkstock; Lab technician using microscope: Jim Arbogast/Getty Images

Fourth Row: Set of colored fl ags of many nations of the world: © FC_Italy/Alamy; Stack of cargo containers at sunrise in an intermodal yard: Shutterstock; Depression era photo of man holding sign: The Image Works

Fifth Row: Stock market quotes from a computer screen: Stephen VanHorn/Shutterstock; Portrait of a college student on campus: pkchai/Shutterstock; Peaches: Stockbyte/Photodisc

Sixth Row: Rear view of people window shopping: Thinkstock; Power plant pipes: Corbis; Power lines: Brand X Pictures; Three students taking a test: © Royalty-Free/Corbis; Paper money: Shutterstock

Seventh Row: Woman from the Sacred Valley of the Incas: hadynyah/Getty Images; Paint buckets with various colored paint, Shutterstock; Close up of hands, woman using her cell phone: Shutterstock; Paper money: Shutterstock

Eighth Row: Cows: Stockbyte/Photodisc; Wind turbine farm over sunset: Ted Nad/ Shutterstock; Wall Street sign: Thinkstock; Busy shopping street Center Gai, Shibuya, Tokyo: Tom Bonaventure/Photographer’s Choice RF/Getty Images; Paper money: Shutterstock

Ninth/Tenth Row: Waiter in Panjim: Steven Miric/Getty Images; Group of friends carrying shopping bags on city street: Monkey Business Images/Shutterstock; Set of colored fl ags of many nations of the world: © FC_Italy/Alamy; Soy bean fi eld: Fotokostic/Shutterstock; Drilling rig workers: iStockphoto; Tropical fi sh and hard corals in the Red Sea, Egypt: Vlad61/Shutterstock; Modern train on platform: Shutterstock

Eleventh/Twelfth Row: Paper money: Shutterstock; View of smoking coal power plant: iStockphoto/Thinkstock; Welder: Tristan Savatier/Getty Images; Container ship: EvrenKalinbacak/Shutterstock; Market food: Izzy Schwartz/Getty Images; Modern train on platform: Shutterstock

Thirteenth Row: Printing U.S. dollar banknotes: Thinkstock

Back Cover Photo: Professor giving a lecture: Izabela Habur/iStockphoto

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