Principles of Economics: a Guided Tour

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The study of economics is guided by a few big ideas.

Economists view the world as both scientists and policymakers.

The theory of comparative advantage explains how people benefit from economic interdependence.

IntroductIon

1 Ten Principles of Economics

2 Thinking Like an Economist

3 Interdependence and the Gains from Trade

FIrm BehavIor and the organIzatIon oF Industry

13 The Costs of Production

14 Firms in Competitive Markets

15 Monopoly

16 Monopolistic Competition

17 Oligopoly

The theory of the firm sheds light on the decisions that lie behind supply in competitive markets.

Firms with market power can cause market outcomes to be inefficient.

how markets work

4 The Market Forces of Supply and Demand

5 Elasticity and Its Application

6 Supply, Demand, and Government Policies

How does the economy coordinate interdependent economic actors? Through the market forces of supply and demand.

The tools of supply and demand are put to work to examine the effects of various government policies.

markets and welFare

7 Consumers, Producers, and the Efficiency of Markets

8 Application: The Costs of Taxation

9 Application: International Trade

Why is the equilibrium of supply and demand desirable for society as a whole? The concepts of consumer and producer surplus explain the efficiency of markets, the costs of taxation, and the benefits of international trade.

the economIcs oF the PuBlIc sector

10 Externalities

11 Public Goods and Common Resources

12 The Design of the Tax System

Market outcomes are not always efficient, and governments can sometimes remedy market failure.

To fund programs, governments raise revenue through their tax systems, which are designed with an eye toward balancing efficiency and equity.

Principles of Economics:a Guided Tour

FInal thoughts

36 Six Debates over Macroeconomic Policy A capstone chapter presents both sides of six major debates over economic policy.

money and PrIces In the long run

29 The Monetary System

30 Money Growth and Inflation

The monetary system is crucial in determining the long-run behavior of the price level, the inflation rate, and other nominal variables.

the real economy In the long run

25 Production and Growth

26 Saving, Investment, and the Financial System

27 The Basic Tools of Finance

28 Unemployment

These chapters describe the forces that in the long run determine key real variables, including GDP growth, saving, investment, real interest rates, and unemployment.

The overall quantity of production and the overall price level are used to monitor developments in the economy as a whole.

the data oF macroeconomIcs

23 Measuring a Nation’s Income

24 Measuring the Cost of Living

the macroeconomIcs oF oPen economIes

31 Open-Economy Macroeconomics: Basic Concepts

32 A Macroeconomic Theory of the Open Economy

A nation’s economic interactions with other nations are described by its trade balance, net foreign investment, and exchange rate.

A long-run model of the open economy explains the determinants of the trade balance, the real exchange rate, and other real variables.

the economIcs oF laBor markets

18 The Markets for the Factors of Production

19 Earnings and Discrimination

20 Income Inequality and Poverty

These chapters examine the special features of labor markets, in which most people earn most of their income.

toPIcs For Further study

21 The Theory of Consumer Choice

22 Frontiers of Microeconomics

Additional topics in microeconomics include household decision making, asymmetric information, political economy, and behavioral economics.

short-run economIc FluctuatIons

33 Aggregate Demand and Aggregate Supply

34 The Influence of Monetary and Fiscal Policy on Aggregate Demand

35 The Short-Run Trade-off betweenInflation and Unemployment

The model of aggregate demand and aggregate supply explains short-run economic fluctuations, the short-run effects of monetary and fiscal policy, and the short-run linkage between real and nominal variables.

PrinciPles of

EconomicsNiNth EditioN

N. GrEGory MaNkiwHarvard University

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Principles of Economics, Ninth EditionN. Gregory Mankiw

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Printed in the United States of America Print Number: 01 Print Year: 2019


To Catherine, Nicholas, and Peter, my other contributions to the next generation


iv

Aboutthe Author

N. Gregory Mankiw is the Robert M. Beren Professor ofEconomics at Harvard University. As a student, he stud-ied economics at Princeton University and MIT. As ateacher, he has taught macroeconomics, microeconomics,statistics, and principles of economics. He even spentone summer long ago as a sailing instructor on LongBeach Island.

Professor Mankiw is a prolific writer and a regularparticipant in academic and policy debates. His workhas been published in scholarly journals, such as theAmerican Economic Review, Journal of Political Economy,and Quarterly Journal of Economics, and in more popu-lar forums, such as the New York Times and The WallStreet Journal. He is also author of the best-sellingintermediate-level textbook Macroeconomics (WorthPublishers).

In addition to his teaching, research, and writing,Professor Mankiw has been a research associate of theNational Bureau of Economic Research, an adviserto the Congressional Budget Office and the FederalReserve Banks of Boston and New York, a trustee of theUrban Institute, and a member of the ETS test develop-ment committee for the Advanced Placement exam ineconomics. From 2003 to 2005, he served as chairman ofthe President’s Council of Economic Advisers.

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

vv

Preface: Tothe instructor

during my 20-year career as a student, the course that excited me mostwas the two-semester sequence on the principles of economics that I tookduring my freshman year in college. It is no exaggeration to say that it

changed my life.I had grown up in a family that often discussed politics over the dinner table.

The pros and cons of various solutions to society’s problems generated ferventdebate. But in school, I had been drawn to the sciences. Whereas politics seemedvague, rambling, and subjective, science was analytic, systematic, and objective.While political debate continued without end, science made progress.

My freshman course on the principles of economics opened my eyes to anew way of thinking. Economics combines the virtues of politics and science.It is, truly, a social science. Its subject matter is society—how people choose tolead their lives and how they interact with one another—but it approaches the subject with the dispassion of a science. By bringing the methods of science tothe questions of politics, economics tries to make progress on the challenges thatall societies face.

I was drawn to write this book in the hope that I could convey some of theexcitement about economics that I felt as a student in my first economics course.Economics is a subject in which a little knowledge goes a long way. (The samecannot be said, for instance, of the study of physics or the Chinese language.)Economists have a unique way of viewing the world, much of which can be taughtin one or two semesters. My goal in this book is to transmit this way of thinkingto the widest possible audience and to convince readers that it illuminates muchabout the world around them.

I believe that everyone should study the fundamental ideas that economics hasto offer. One purpose of general education is to inform people about the world andthereby make them better citizens. The study of economics, as much as any disci-pline, serves this goal. Writing an economics textbook is, therefore, a great honorand a great responsibility. It is one way that economists can help promote bettergovernment and a more prosperous future. As the great economist Paul Samuelsonput it, “I don’t care who writes a nation’s laws, or crafts its advanced treaties,if I can write its economics textbooks.”

What’s new in the ninth edition?Economics is fundamentally about understanding the world in which we live.Most chapters of this book include Case Studies illustrating how the principlesof economics can be applied. In addition, In the News boxes offer excerpts fromnewspapers, magazines, and online news sources showing how economic ideasshed light on current issues facing society. After students finish their first course



Preface: To The InsTrucTorvi

in economics, they should think about news stories from a new perspective andwith greater insight. To keep the study of economics fresh and relevant for eachnew cohort of students, I update each edition of this text to keep pace with theever-changing world.

The new applications in this ninth edition are too numerous to list in theirentirety, but here is a sample of the topics covered (and the chapters in which theyappear):

• Technology companies are increasingly using economists to better run theirbusinesses. (Chapter 2)

• The hit Broadway show Hamilton has brought renewed attention to the issueof ticket reselling. (Chapter 7)

• President Trump has taken a new and controversial approach to internationaltrade. (Chapter 9)

• A carbon tax and dividend plan has become a focal policy in the debateabout global climate change. (Chapter 10)

• Social media share many features, along with many of the problems,associated with common resources. (Chapter 11)

• The Supreme Court hears a case about international price discrimination.(Chapter 15)

• Amazon looks like it might be the next target for antitrust regulators.(Chapter 17)

• The winners and losers from immigration have become a major issue in thepolitical debate. (Chapter 18)

• Research on tax data shows by how much the super-rich have gotten evenricher. (Chapter 20)

• Some economists suggest that, despite little change in the official povertyrate, we are winning the war on poverty. (Chapter 20)

• The theory of economic growth can help explain why so many of the world’spoorest nations are in sub-Saharan Africa. (Chapter 25)

• Economist Martin Feldstein explains why the United States is so prosperous.(Chapter 25)

• Cryptocurrencies may be the money of the future, or they may be a passingfad. (Chapter 29)

• Living during a hyperinflation, such as the recent situation in Venezuela, is asurreal experience. (Chapter 30)

• Recent discussion of trade deficits has included a lot of misinformation.(Chapter 32)

• The Federal Reserve has started to reassess what it means to target aninflation rate of 2 percent. (Chapter 36)

In addition to updating the book, I have refined its coverage and pedagogy withinput from many users of the previous edition. There are numerous changes, largeand small, aimed at making the book clearer and more student-friendly.

All the changes that I made, and the many others that I considered, were evalu-ated in light of the benefits of brevity. Like most things that we study in economics,a student’s time is a scarce resource. I always keep in mind a dictum from the greatnovelist Robertson Davies: “One of the most important things about writing is toboil it down and not bore the hell out of everybody.”



viiPreface: To The InsTrucTor

How is This Book organized?The organization of this book was designed to make economics as student-friendlyas possible. What follows is a whirlwind tour of this text. The tour will, I hope, giveinstructors some sense of how the pieces fit together.

introductory materialChapter 1, “Ten Principles of Economics,” introduces students to the economist’sview of the world. It previews some of the big ideas that recur throughout econom-ics, such as opportunity cost, marginal decision making, the role of incentives, thegains from trade, and the efficiency of market allocations. Throughout the book,I refer regularly to the Ten Principles of Economics introduced in Chapter 1 to remindstudents that these ideas are the foundation for all economics.

Chapter 2, “Thinking Like an Economist,” examines how economists approachtheir field of study. It discusses the role of assumptions in developing a theory andintroduces the concept of an economic model. It also explores the role of economistsin making policy. This chapter’s appendix offers a brief refresher course on howgraphs are used, as well as how they can be abused.

Chapter 3, “Interdependence and the Gains from Trade,” presents the theoryof comparative advantage. This theory explains why individuals trade with theirneighbors, as well as why nations trade with other nations. Much of economics isabout how market forces coordinate many individual production and consump-tion decisions. As a starting point for this analysis, students see in this chapter whyspecialization, interdependence, and trade can benefit everyone.

The Fundamental Tools of supply and DemandThe next three chapters introduce the basic tools of supply and demand. Chapter 4,“The Market Forces of Supply and Demand,” develops the supply curve, the demandcurve, and the notion of market equilibrium. Chapter 5, “Elasticity and Its Application,”introduces the concept of elasticity and uses it to analyze events in three different mar-kets. Chapter 6, “Supply, Demand, and Government Policies,” uses these tools to exam-ine price controls, such as rent-control and minimum-wage laws, and tax incidence.

Chapter 7, “Consumers, Producers, and the Efficiency of Markets,” extends theanalysis of supply and demand using the concepts of consumer surplus and pro-ducer surplus. It begins by developing the link between consumers’ willingnessto pay and the demand curve and the link between producers’ costs of produc-tion and the supply curve. It then shows that the market equilibrium maximizesthe sum of the producer and consumer surplus. Thus, students learn early about theefficiency of market allocations.

The next two chapters apply the concepts of producer and consumer surplus toquestions of policy. Chapter 8, “Application: The Costs of Taxation,” shows whytaxation results in deadweight losses and what determines the size of those losses.Chapter 9, “Application: International Trade,” considers who wins and who losesfrom international trade and presents the debate over protectionist trade policies.

more microeconomicsHaving examined why market allocations are often desirable, the book thenconsiders how the government can sometimes improve on them. Chapter 10,“Externalities,” explains how external effects such as pollution can render market



Preface: To The InsTrucTorviii

outcomes inefficient and discusses the possible public and private solutions tothose inefficiencies. Chapter 11, “Public Goods and Common Resources,” considersthe problems that arise when goods, such as national defense, have no market price.Chapter 12, “The Design of the Tax System,” describes how the government raisesthe revenue necessary to pay for public goods. It presents some institutional back-ground about the U.S. tax system and then discusses how the goals of efficiencyand equity come into play when designing a tax system.

The next five chapters examine firm behavior and industrial organization.Chapter 13, “The Costs of Production,” discusses what to include in a firm’s costs,and it introduces cost curves. Chapter 14, “Firms in Competitive Markets,” analyzesthe behavior of price-taking firms and derives the market supply curve. Chapter 15,“Monopoly,” discusses the behavior of a firm that is the sole seller in its market.It examines the inefficiency of monopoly pricing, the possible policy responses,and the attempts by monopolies to price discriminate. Chapter 16, “MonopolisticCompetition,” looks at behavior in a market in which many sellers offer similar butdifferentiated products. It also discusses the debate over the effects of advertising.Chapter 17, “Oligopoly,” covers markets in which there are only a few sellers, usingthe prisoners’ dilemma as the model for examining strategic interaction.

The next three chapters present issues related to labor markets. Chapter 18, “TheMarkets for the Factors of Production,” emphasizes the link between factor pricesand marginal productivity. Chapter 19, “Earnings and Discrimination,” discussesthe determinants of equilibrium wages, including compensating differentials,human capital, and discrimination. Chapter 20, “Income Inequality and Poverty,”examines the degree of inequality in U.S. society, alternative views about the government’s role in changing the distribution of income, and various policiesaimed at helping society’s poorest members.

The next two chapters present optional material. Chapter 21, “The Theory ofConsumer Choice,” analyzes individual decision making using budget constraintsand indifference curves. Chapter 22, “Frontiers of Microeconomics,” introducesthe topics of asymmetric information, political economy, and behavioral econom-ics. Some instructors may skip all or some of this material, but these chapters areuseful in motivating and preparing students for future courses in microeconomics.Instructors who cover these topics may assign these chapters earlier than they arepresented in the book, and I have written them to facilitate this flexibility.

macroeconomicsMy overall approach to teaching macroeconomics is to examine the economy inthe long run (when prices are flexible) before examining the economy in the shortrun (when prices are sticky). I believe that this organization simplifies learningmacroeconomics for several reasons. First, the classical assumption of price flex-ibility is more closely linked to the basic lessons of supply and demand, whichstudents have already mastered. Second, the classical dichotomy allows the studyof the long run to be broken up into several easily digested pieces. Third, becausethe business cycle represents a transitory deviation from the economy’s long-rungrowth path, studying the transitory deviations is more natural after the long-runequilibrium is understood. Fourth, the macroeconomic theory of the long run isless controversial among economists than is the macroeconomic theory of theshort run. For these reasons, most upper-level courses in macroeconomics nowfollow this long-run-before-short-run approach; my goal is to offer introductorystudents the same advantage.



ixPreface: To The InsTrucTor

I start the coverage of macroeconomics with issues of measurement. Chapter 23,“Measuring a Nation’s Income,” discusses the meaning of gross domestic productand related statistics from the national income accounts. Chapter 24, “Measuring theCost of Living,” examines the measurement and use of the consumer price index.

The next four chapters describe the behavior of the real economy in the longrun. Chapter 25, “Production and Growth,” examines the determinants of the largevariation in living standards over time and across countries. Chapter 26, “Saving,Investment, and the Financial System,” discusses the types of financial institu-tions in our economy and examines their role in allocating resources. Chapter 27,“The Basic Tools of Finance,” introduces present value, risk management, and assetpricing. Chapter 28, “Unemployment,” considers the long-run determinants of theunemployment rate, including job search, minimum-wage laws, the market powerof unions, and efficiency wages.

Having described the long-run behavior of the real economy, the book then turnsto the long-run behavior of money and prices. Chapter 29, “The Monetary System,”introduces the economist’s concept of money and the role of the central bank in controlling the quantity of money. Chapter 30, “Money Growth and Inflation,”develops the classical theory of inflation and discusses the costs that inflationimposes on a society.

The next two chapters present the macroeconomics of open economies, maintain-ing the long-run assumptions of price flexibility and full employment. Chapter 31,“Open-Economy Macroeconomics: Basic Concepts,” explains the relationshipamong saving, investment, and the trade balance, the distinction between the nomi-nal and real exchange rate, and the theory of purchasing-power parity. Chapter 32,“A Macroeconomic Theory of the Open Economy,” presents a classical modelof the international flow of goods and capital. The model sheds light on variousissues, including the link between budget deficits and trade deficits and themacroeconomic effects of trade policies. Because instructors differ in theiremphasis on this material, these chapters are written so they can be used in differentways. Some may choose to cover Chapter 31 but not Chapter 32; others may skipboth chapters; and still others may choose to defer the analysis of open-economymacroeconomics until the end of their courses.

After developing the long-run theory of the economy in Chapters 25 through 32, thebook turns to explaining short-run fluctuations around the long-run trend. Chapter 33,“Aggregate Demand and Aggregate Supply,” begins with some facts about the busi-ness cycle and then introduces the model of aggregate demand and aggregate supply.Chapter 34, “The Influence of Monetary and Fiscal Policy on Aggregate Demand,”explains how policymakers can use the tools at their disposal to shift the aggregate-demand curve. Chapter 35, “The Short-Run Trade-Off between Inflation andUnemployment,” explains why policymakers who control aggregate demand face atrade-off between inflation and unemployment. It examines why this trade-off existsin the short run, why it shifts over time, and why it does not exist in the long run.

The book concludes with Chapter 36, “Six Debates over Macroeconomic Policy.”This capstone chapter considers six controversial issues facing policymakers: theproper degree of policy activism in response to the business cycle, the relativeefficacy of government spending hikes and tax cuts to fight recessions, the choicebetween rules and discretion in the conduct of monetary policy, the desirability ofreaching zero inflation, the importance of balancing the government’s budget, andthe need for tax reform to encourage saving. For each issue, the chapter presentsboth sides of the debate and encourages students to make their own judgments.



Preface: To The InsTrucTorx

learning ToolsThe purpose of this book is to help students learn the fundamental lessons of economics and to show how they can apply these lessons to their lives and theworld in which they live. Toward that end, I have used various learning tools thatrecur throughout the book.

case studiesEconomic theory is useful and interesting only if it can be applied to understandingactual events and policies. This book, therefore, contains numerous case studiesthat apply the theory that has just been developed.

in the news BoxesOne benefit that students gain from studying economics is a new perspective andgreater understanding about news from around the world. To highlight this benefit,I have included excerpts from many newspaper and magazine articles, some ofwhich are opinion columns written by prominent economists. These articles,together with my brief introductions, show how basic economic theory can beapplied. Most of these boxes are new to this edition. And for the first time in thisedition, each news article ends with “Questions to Discuss,” which can be used tostart a dialogue in the classroom.

FYi BoxesThese boxes provide additional material “for your information.” Some of themoffer a glimpse into the history of economic thought. Others clarify technical issues.Still others discuss supplementary topics that instructors might choose either todiscuss or skip in their lectures.

Ask the Experts BoxesThis feature summarizes results from the IGM Economics Experts Panel, an ongoing survey of several dozen prominent economists. Every few weeks,these experts are offered a statement and then asked whether they agree with it,disagree with it, or are uncertain about it. The survey results appear in the chaptersnear the coverage of the relevant topic. They give students a sense of wheneco nomists are united, when they are divided, and when they just don’t knowwhat to think.

Definitions of Key conceptsWhen key concepts are introduced in the chapter, they are presented in bold type-face. In addition, their definitions are placed in the margins. This treatment shouldaid students in learning and reviewing the material.

Quick QuizzesAfter each major section in a chapter, students are offered a brief multiple-choiceQuick Quiz to check their comprehension of what they have just learned. If studentscannot readily answer these quizzes, they should stop and review material beforecontinuing. The answers to all Quick Quizzes are available at the end of each chapter.



xiPreface: To The InsTrucTor

chapter in a nutshellEach chapter concludes with a brief summary that reminds students of the mostimportant lessons that they have learned. Later in their study, it offers an efficientway to review for exams.

List of Key conceptsA list of key concepts at the end of each chapter offers students a way to test theirunderstanding of the new terms that have been introduced. Page references areincluded so that students can review the terms they do not understand.

Questions for ReviewLocated at the end of each chapter, questions for review cover the chapter’s primarylessons. Students can use these questions to check their comprehension and preparefor exams.

Problems and ApplicationsEach chapter also contains a variety of problems and applications asking studentsto apply the material that they have learned. Some instructors may use thesequestions for homework assignments. Others may use them as a starting point forclassroom discussions.

Alternative Versions of the BookThe book you are now holding is one of five versions of this text that are availablefor introducing students to economics. Cengage and I offer this menu of booksbecause instructors differ in how much time they have and what topics they chooseto cover. Here is a brief description of each:

• Principles of Economics. This complete version of the book contains all36 chapters. It is designed for two-semester introductory courses that coverboth microeconomics and macroeconomics.

• Principles of Microeconomics. This version contains 22 chapters and is designedfor one-semester courses in introductory microeconomics.

• Principles of Macroeconomics. This version contains 23 chapters and isdesigned for one-semester courses in introductory macroeconomics.It contains a full development of the theory of supply and demand.

• Brief Principles of Macroeconomics. This shortened macro version of 18 chapterscontains only one chapter on the basics of supply and demand. It is designedfor instructors who want to jump to the core topics of macroeconomics morequickly.

• Essentials of Economics. This version of the book contains 24 chapters.It is designed for one-semester survey courses that cover the basics ofboth microeconomics and macroeconomics.

The accompanying table shows precisely which chapters are included in each book.Instructors who want more information about these alternative versions shouldcontact their local Cengage representative.



Preface: To The InsTrucTorxii

Table 1

The Five Versions of This Book

Principles of EconomicsPrinciples of

MicroeconomicsPrinciples of

Macroeconomics

BriefPrinciples of

MacroeconomicsEssentials ofEconomics

1 Ten Principles of Economics X X X X

2 Thinking Like an Economist X X X X

3 interdependence and the Gains from Trade X X X X

4 The Market Forces of Supply and demand X X X X

5 Elasticity and its application X X X

6 Supply, demand, and Government Policies X X X

7 Consumers, Producers, and the Efficiency ofMarkets

X X X

8 application: The Costs of Taxation X X X

9 application: international Trade X X X

10 Externalities X X

11 Public Goods and Common resources X X

12 The design of the Tax System X

13 The Costs of Production X X

14 Firms in Competitive Markets X X

15 Monopoly X X

16 Monopolistic Competition X

17 oligopoly X

18 The Markets for the Factors of Production X

19 Earnings and discrimination X

20 income inequality and Poverty X

21 The Theory of Consumer Choice X

22 Frontiers of Microeconomics X

23 Measuring a Nation’s income X X X

24 Measuring the Cost of Living X X X

25 Production and Growth X X X

26 Saving, investment, and the Financial System X X X

27 The basic Tools of Finance X X X

28 Unemployment X X X

29 The Monetary System X X X

30 Money Growth and inflation X X X

31 open-Economy Macroeconomics: basic Concepts X X

32 a Macroeconomic Theory of the open Economy X X

33 aggregate demand and aggregate Supply X X X

34 The influence of Monetary and Fiscal Policy onaggregate demand

X X X

35 The Short-run Trade-off between inflation andUnemployment

X X

36 Six debates over Macroeconomic Policy X X



xiiiPreface: To The InsTrucTor

supplementsCengage offers various supplements for instructors and students who use thisbook. These resources make teaching the principles of economics easy for theinstructor and learning them easy for the student. David R. Hakes of the Universityof Northern Iowa, a dedicated teacher and economist, supervised the developmentof the supplements for this edition. A complete list of available supplements followsthis Preface.

ModulesI have written four modules, or mini-chapters, with optional material that instructors can include in their courses. For instructors using the digital versionof the book, these modules can be added with a few mouse clicks. As of now, thereare modules on The Economics of Healthcare, The European Union,The KeynesianCross, and How Economists Use Data. I expect to add more modules to the libraryavailable to instructors in the years to come.

Translations and AdaptationsI am delighted that versions of this book are (or will soon be) available in many ofthe world’s languages. Currently scheduled translations include Azeri, Chinese (inboth standard and simplified characters), Croatian, Czech, Dutch, French, Georgian,German, Greek, Indonesian, Italian, Japanese, Korean, Macedonian, Montenegrin,Portuguese, Romanian, Russian, Serbian, and Spanish. In addition, adaptations ofthe book for Australian, Canadian, European, and New Zealand students are alsoavailable. Instructors who would like more information about these books shouldcontact Cengage.

AcknowledgmentsIn writing this book, I benefited from the input of many talented people. Indeed,the list of people who have contributed to this project is so long, and their contri-butions so valuable, that it seems an injustice that only a single name appears onthe cover.

Let me begin with my colleagues in the economics profession. The many editionsof this text and its supplemental materials have benefited enormously from theirinput. In reviews and surveys, they have offered suggestions, identified challenges,and shared ideas from their own classroom experience. I am indebted to them forthe perspectives they have brought to the text. Unfortunately, the list has becometoo long to thank those who contributed to previous editions, even though studentsreading the current edition are still benefiting from their insights.

Most important in this process has been David Hakes (University of NorthernIowa). David has served as a reliable sounding board for ideas and a hardworkingpartner with me in putting together the superb package of supplements. I am alsograteful to Stephanie Thomas (Cornell University), who helped in the planningprocess for this new edition.



Preface: To The InsTrucTorxiv

Anil Aba, University of UtahMark Abajian, San Diego Mesa

CollegeDorian Abreu, Hunter CollegeGoncalo Alves Pina, Santa Clara

UniversityBob Barnes, Loyola University

ChicagoJames Bathgate, Western Nevada

CollegeNicole Bissessar, Southern New

Hampshire UniversityJoseph Brignone, Brigham Young

UniversityWilliam Byrd, Troy UniversitySamantha Cakir, Macalester CollegeJohn Carter, Modesto Junior CollegeAvik Chakrabarti, University of

Wisconsin–MilwaukeeYong Chao, University of LouisvilleDavid Chaplin, Northwest

Nazarene UniversityMitch Charkiewicz, Central

Connecticut State UniversityLaPorchia Collins, Tulane

UniversityAndrew Crawley, University of

MaineMaria DaCosta, University of

Wisconsin–Eau ClaireDennis Debrecht, Carroll

UniversityAmrita Dhar, University of Mary

WashingtonLynne Elkes, Loyola University

MarylandElena Ermolenko, Oakton

Community CollegeSarah Estelle, Hope CollegeJohn Flanders, Central Methodist

UniversityGary Gray, Umpqua Community

CollegeJessica Hennessey, Furman

UniversityAlexander Hill, Arizona State

University

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The following reviewers of the eighth edition provided suggestions for refiningthe content, organization, and approach in the ninth.



xvPreface: To The InsTrucTor

Paul Stock, University of MaryHardin Baylor

Yang Su, University ofWashington

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The team of editors who worked on this book improved it tremendously.Jane Tufts, developmental editor, provided truly spectacular editing—as shealways does. Jason Fremder, economics Product Director, and Christopher Rader,Product Manager, did a splendid job of overseeing the many people involvedin such a large project. Sarah Keeling, Senior Learning Designer, was crucial inassembling an extensive and thoughtful group of reviewers to give me feedbackon the previous edition and shape up the new edition. Anita Verma, SeniorContent Manager, was crucial in putting together an excellent team to revise thesupplements and with Beth Asselin and Phil Scott, project managers at SPi Global,had the patience and dedication necessary to turn my manuscript into this book.Bethany Bourgeois, Senior Designer, gave this book its clean, friendly look. IrwinZucker, copyeditor, refined my prose, and Val Colligo, indexer, prepared a carefuland thorough index. John Carey, Executive Marketing Manager, worked longhours getting the word out to potential users of this book. The rest of the Cengageteam has, as always, been consistently professional, enthusiastic, and dedicated.

We have a top team of veterans who have worked across multiple editions producing the supplements that accompany this book. Working with those atCengage, the following have been relentless in making sure that the suite ofancillary materials is unmatched in both quantity and quality. No other textcomes close.

PowerPoint: Andreea Chiritescu (Eastern Illinois University).Test Bank: Shannon Aucoin, Eugenia Belova, Ethan Crist, Kasie Jean, and Brian

Rodriguez (in-house Subject Matter Experts).Instructor manual: David Hakes (University of Northern Iowa).

I am grateful also to Rohan Shah and Rohit Goyal, two star undergraduates atHarvard and Yale, respectively, who helped me refine the manuscript and checkthe page proofs for this edition.

As always, I must thank my “in-house” editor Deborah Mankiw. As the firstreader of most things I write, she continued to offer just the right mix of criticismand encouragement.

Finally, I should mention my three children Catherine, Nicholas, and Peter. Theircontribution to this book was putting up with a father spending too many hoursin his study. The four of us have much in common—not least of which is our loveof ice cream (which becomes apparent in Chapter 4).

N. Gregory MankiwMay 2019



xviixvii

Brief contents

Part I introduction 11 Ten Principles of economics 12 Thinking like an economist 173 interdependence and the Gains from Trade 45

Part II How Markets Work 614 The Market forces of supply and Demand 615 elasticity and its Application 876 supply, Demand, and Government Policies 109

Part III Markets and Welfare 1317 consumers, Producers, and the efficiency of

Markets 1318 Application: The costs of Taxation 1519 Application: international Trade 167

Part IV The economics of the Public sector 18710 externalities 18711 Public Goods and common resources 20912 The Design of the Tax system 225

Part V firm Behavior and the organization ofindustry 243

13 The costs of Production 24314 firms in competitive Markets 26315 Monopoly 28716 Monopolistic competition 31717 oligopoly 335

Part VI The economics of labor Markets 35718 The Markets for the factors of

Production 35719 earnings and Discrimination 37920 income inequality and Poverty 397

Part VII Topics for further study 41921 The Theory of consumer choice 41922 frontiers of Microeconomics 447

Part VIII The Data of Macroeconomics 46723 Measuring a nation’s income 46724 Measuring the cost of living 487

Part IX The real economy in the long run 50525 Production and Growth 50526 saving, investment, and the financial system 52927 The Basic Tools of finance 55128 Unemployment 567

Part X Money and Prices in the long run 58929 The Monetary system 58930 Money Growth and inflation 613

Part XI The Macroeconomics of open economies 63931 open-economy Macroeconomics: Basic

concepts 63932 A Macroeconomic Theory of the

open economy 661

Part XII short-run economic fluctuations 68333 Aggregate Demand and Aggregate supply 68334 The influence of Monetary and fiscal Policy on

Aggregate Demand 71935 The short-run Trade-off between inflation and

Unemployment 745

Part XIII final Thoughts 76936 six Debates over Macroeconomic Policy 769



xviii

ParT I Introduction 1ChaPTer 1

Ten Principles of Economics 11-1 How People Make Decisions 2

1-1a Principle 1: People Face Trade-Offs 21-1b Principle 2: The Cost of Something Is What You Give

Up to Get It 31-1c Principle 3: Rational People Think at the Margin 41-1d Principle 4: People Respond to Incentives 5

1-2 How People Interact 61-2a Principle 5: Trade Can Make Everyone Better Off 71-2b Principle 6: Markets Are Usually a Good Way to

Organize Economic Activity 7fYI: Adam Smith and the Invisible Hand 8case sTudY: Adam Smith Would Have Loved Uber 91-2c Principle 7: Governments Can Sometimes Improve

Market Outcomes 9

1-3 How the Economy as a Whole Works 111-3a Principle 8: A Country’s Standard of Living Depends

on Its Ability to Produce Goods and Services 111-3b Principle 9: Prices Rise When the Government Prints

Too Much Money 111-3c Principle 10: Society Faces a Short-Run Trade-Off

between Inflation and Unemployment 12

1-4 Conclusion 13Chapter in a Nutshell 14Key Concepts 14Questions for Review 14Problems and Applications 14Quick Quiz Answers 15

ChaPTer 2Thinking Like an Economist 172-1 The Economist as Scientist 18

2-1a The Scientific Method: Observation, Theory, andMore Observation 18

2-1b The Role of Assumptions 192-1c Economic Models 19

Preface: To the Instructor v

Preface: To the Student xxxi

2-1d Our First Model: The Circular-Flow Diagram 202-1e Our Second Model: The Production Possibilities

Frontier 212-1f Microeconomics and Macroeconomics 24

2-2 The Economist as Policy Adviser 252-2a Positive versus Normative Analysis 25In The news: Why Tech Companies Hire Economists 262-2b Economists in Washington 272-2c Why Economists’ Advice Is Not Always Followed 28

2-3 Why Economists Disagree 292-3a Differences in Scientific Judgments 292-3b Differences in Values 302-3c Perception versus Reality 30ask The exPerTs: Ticket Resale 32

2-4 Let’s Get Going 32Chapter in a Nutshell 33Key Concepts 33Questions for Review 33Problems and Applications 34Quick Quiz Answers 34

APPENDIX Graphing: A Brief Review 35Graphs of a Single Variable 35Graphs of Two Variables: The Coordinate System 36Curves in the Coordinate System 37Slope 39Cause and Effect 41

ChaPTer 3interdependence and the Gainsfrom Trade 453-1 A Parable for the Modern Economy 46

3-1a Production Possibilities 463-1b Specialization and Trade 48

3-2 Comparative Advantage: The Driving Force ofSpecialization 50

3-2a Absolute Advantage 503-2b Opportunity Cost and Comparative Advantage 503-2c Comparative Advantage and Trade 523-2d The Price of the Trade 52fYI: The Legacy of Adam Smith and David Ricardo 53

3-3 Applications of Comparative Advantage 543-3a Should LeBron James Mow His Own Lawn? 543-3b Should the United States Trade with

Other Countries? 54

contents



xixconTenTs

3-4 Conclusion 55ask The exPerTs: Trade between China and the

United States 55In The news: Economics within a Marriage 56

Chapter in a Nutshell 56Key Concepts 57Questions for Review 57Problems and Applications 58Quick Quiz Answers 59

ParT II How Markets Work 61ChaPTer 4

The market Forces of supplyand Demand 614-1 Markets and Competition 62

4-1a What Is a Market? 624-1b What Is Competition? 62

4-2 Demand 634-2a The Demand Curve: The Relationship between

Price and Quantity Demanded 634-2b Market Demand versus Individual Demand 644-2c Shifts in the Demand Curve 65case sTudY: Two Ways to Reduce Smoking 68

4-3 Supply 694-3a The Supply Curve: The Relationship between

Price and Quantity Supplied 694-3b Market Supply versus Individual Supply 704-3c Shifts in the Supply Curve 71

4-4 Supply and Demand Together 734-4a Equilibrium 734-4b Three Steps to Analyzing Changes in Equilibrium 75In The news: Price Increases after Disasters 80

4-5 Conclusion: How Prices Allocate Resources 81ask The exPerTs: Price Gouging 82

Chapter in a Nutshell 82Key Concepts 83Questions for Review 83Problems and Applications 84Quick Quiz Answers 85

ChaPTer 5Elasticity and its Application 875-1 The Elasticity of Demand 88

5-1a The Price Elasticity of Demand and Its Determinants 885-1b Computing the Price Elasticity of Demand 895-1c The Midpoint Method: A Better Way to Calculate

Percentage Changes and Elasticities 905-1d The Variety of Demand Curves 91

fYI: A Few Elasticities from the Real World 915-1e Total Revenue and the Price Elasticity of Demand 935-1f Elasticity and Total Revenue along a Linear

Demand Curve 945-1g Other Demand Elasticities 96

5-2 The Elasticity of Supply 975-2a The Price Elasticity of Supply and

Its Determinants 975-2b Computing the Price Elasticity of Supply 985-2c The Variety of Supply Curves 98

5-3 Three Applications of Supply, Demand, and Elasticity 1005-3a Can Good News for Farming Be Bad News

for Farmers? 1015-3b Why Did OPEC Fail to Keep the Price

of Oil High? 1035-3c Does Drug Interdiction Increase or Decrease

Drug-Related Crime? 104


ChaPTer 6supply, Demand, and GovernmentPolicies 1096-1 Controls on Prices 110

6-1a How Price Ceilings Affect Market Outcomes 110case sTudY: Lines at the Gas Pump 112case sTudY: Rent Control in the Short Run and

the Long Run 113ask The exPerTs: Rent Control 1146-1b How Price Floors Affect Market Outcomes 114case sTudY: The Minimum Wage 116ask The exPerTs: The Minimum Wage 1176-1c Evaluating Price Controls 118

6-2 Taxes 1196-2a How Taxes on Sellers Affect Market Outcomes 119In The news: Should the Minimum Wage

Be $15 an Hour? 1206-2b How Taxes on Buyers Affect Market Outcomes 122case sTudY: Can Congress Distribute the Burden of a

Payroll Tax? 1246-2c Elasticity and Tax Incidence 125case sTudY: Who Pays the Luxury Tax? 126




xx conTenTs

ParT III Markets andWelfare 131

ChaPTer 7

consumers, Producers, and theEfficiency of markets 1317-1 Consumer Surplus 132

7-1a Willingness to Pay 1327-1b Using the Demand Curve to Measure

Consumer Surplus 1337-1c How a Lower Price Raises Consumer Surplus 1347-1d What Does Consumer Surplus Measure? 135

7-2 Producer Surplus 1377-2a Cost and the Willingness to Sell 1377-2b Using the Supply Curve to Measure Producer

Surplus 1387-2c How a Higher Price Raises Producer Surplus 140

7-3 Market Efficiency 1417-3a The Benevolent Social Planner 1417-3b Evaluating the Market Equilibrium 142case sTudY: Should There Be a Market

for Organs? 145ask The exPerTs: Supplying Kidneys 145In The news: How Ticket Resellers Help Allocate

Scarce Resources 146

7-4 Conclusion: Market Efficiency and Market Failure 147Chapter in a Nutshell 148Key Concepts 148Questions for Review 149Problems and Applications 149Quick Quiz Answers 150

ChaPTer 8Application: The costs of Taxation 1518-1 The Deadweight Loss of Taxation 152

8-1a How a Tax Affects Market Participants 1528-1b Deadweight Losses and the Gains from Trade 155

8-2 The Determinants of the Deadweight Loss 157case sTudY: The Deadweight Loss Debate 158

8-3 Deadweight Loss and Tax Revenue as Taxes Vary 160case sTudY: The Laffer Curve and Supply-Side

Economics 161ask The exPerTs: The Laffer Curve 162

8-4 Conclusion 163Chapter in a Nutshell 163Key Concept 164Questions for Review 164Problems and Applications 164Quick Quiz Answers 165

ChaPTer 9Application: international Trade 1679-1 The Determinants of Trade 168

9-1a The Equilibrium without Trade 1689-1b The World Price and Comparative Advantage 169

9-2 The Winners and Losers from Trade 1709-2a The Gains and Losses of an Exporting Country 1709-2b The Gains and Losses of an Importing Country 1719-2c The Effects of a Tariff 173fYI: Import Quotas: Another Way to Restrict Trade 1759-2d The Lessons for Trade Policy 1759-2e Other Benefits of International Trade 176In The news: Trade as a Tool for Economic

Development 178

9-3 The Arguments for Restricting Trade 1789-3a The Jobs Argument 1789-3b The National-Security Argument 1799-3c The Infant-Industry Argument 1809-3d The Unfair-Competition Argument 1809-3e The Protection-as-a-Bargaining-Chip Argument 180case sTudY: Trade Agreements and the World Trade

Organization 181ask The exPerTs: Tariffs and Trade Deals 181In The news: The Trade Policies of

President Trump 182


ParT Iv The Economics of thePublic Sector 187

ChaPTer 10

Externalities 18710-1 Externalities and Market Inefficiency 189

10-1a Welfare Economics: A Recap 18910-1b Negative Externalities 19010-1c Positive Externalities 191case sTudY: Technology Spillovers, Industrial Policy,

and Patent Protection 192

10-2 Public Policies toward Externalities 19310-2a Command-and-Control Policies: Regulation 193ask The exPerTs: Vaccines 19410-2b Market-Based Policy 1: Corrective Taxes

and Subsidies 194case sTudY: Why Is Gasoline Taxed So Heavily? 19510-2c Market-Based Policy 2: Tradable Pollution Permits 197



xxiconTenTs

In The news: What Should We Do aboutClimate Change? 198

ask The exPerTs: Carbon Taxes 20010-2d Objections to the Economic Analysis

of Pollution 200

10-3 Private Solutions to Externalities 20110-3a The Types of Private Solutions 20110-3b The Coase Theorem 20210-3c Why Private Solutions Do Not Always Work 203In The news: The Coase Theorem in Action 204


ChaPTer 11Public Goods and commonResources 20911-1 The Different Kinds of Goods 210

11-2 Public Goods 21211-2a The Free-Rider Problem 21211-2b Some Important Public Goods 213case sTudY: Are Lighthouses Public Goods? 21411-2c The Difficult Job of Cost–Benefit Analysis 215case sTudY: How Much Is a Life Worth? 215

11-3 Common Resources 21711-3a The Tragedy of the Commons 21711-3b Some Important Common Resources 218ask The exPerTs: Congestion Pricing 218case sTudY: Why the Cow Is Not Extinct 219In The news: Social Media as a Common Resource 220

11-4 Conclusion: The Importance of Property Rights 221Chapter in a Nutshell 222Key Concepts 222Questions for Review 222Problems and Applications 223Quick Quiz Answers 224

ChaPTer 12The Design of the Tax system 22512-1 An Overview of U.S. Taxation 226

12-1a Taxes Collected by the Federal Government 22712-1b Taxes Collected by State and Local Governments 229

12-2 Taxes and Efficiency 23012-2a Deadweight Losses 231case sTudY: Should Income or Consumption

Be Taxed? 23112-2b Administrative Burden 232

12-2c Marginal Tax Rates versus Average Tax Rates 23312-2d Lump-Sum Taxes 233ask The exPerTs: Top Marginal Tax Rates 233

12-3 Taxes and Equity 23412-3a The Benefits Principle 23512-3b The Ability-to-Pay Principle 235case sTudY: How the Tax Burden Is Distributed 23612-3c Tax Incidence and Tax Equity 238case sTudY: Who Pays the Corporate

Income Tax? 238

12-4 Conclusion: The Trade-Off between Equityand Efficiency 239Chapter in a Nutshell 240Key Concepts 240Questions for Review 240Problems and Applications 241Quick Quiz Answers 241

ParT v Firm Behavior andthe Organization ofIndustry 243

ChaPTer 13

The costs of Production 24313-1 What Are Costs? 244

13-1a Total Revenue, Total Cost, and Profit 24413-1b Costs as Opportunity Costs 24413-1c The Cost of Capital as an Opportunity Cost 24513-1d Economic Profit versus Accounting Profit 246

13-2 Production and Costs 24713-2a The Production Function 24713-2b From the Production Function to the

Total-Cost Curve 249

13-3 The Various Measures of Cost 25013-3a Fixed and Variable Costs 25113-3b Average and Marginal Cost 25113-3c Cost Curves and Their Shapes 25213-3d Typical Cost Curves 254

13-4 Costs in the Short Run and in the Long Run 25613-4a The Relationship between Short-Run and Long-Run

Average Total Cost 25613-4b Economies and Diseconomies of Scale 257fYI: Lessons from a Pin Factory 258




xxii conTenTs

ChaPTer 14Firms in competitive markets 26314-1 What Is a Competitive Market? 264

14-1a The Meaning of Competition 26414-1b The Revenue of a Competitive Firm 264

14-2 Profit Maximization and the Competitive Firm’sSupply Curve 266

14-2a A Simple Example of Profit Maximization 26614-2b The Marginal-Cost Curve and the Firm’s

Supply Decision 26814-2c The Firm’s Short-Run Decision to Shut Down 27014-2d Spilt Milk and Other Sunk Costs 271case sTudY: Near-Empty Restaurants and Off-Season

Miniature Golf 27214-2e The Firm’s Long-Run Decision to Exit or Enter

a Market 27214-2f Measuring Profit in Our Graph for the

Competitive Firm 27414-2g A Brief Recap 275

14-3 The Supply Curve in a Competitive Market 27614-3a The Short Run: Market Supply with a Fixed Number

of Firms 27614-3b The Long Run: Market Supply with Entry and Exit 27614-3c Why Do Competitive Firms Stay in Business If They

Make Zero Profit? 27814-3d A Shift in Demand in the Short Run and Long Run 27914-3e Why the Long-Run Supply Curve Might

Slope Upward 279

14-4 Conclusion: Behind the Supply Curve 281Chapter in a Nutshell 282Key Concepts 282Questions for Review 282Problems and Applications 283Quick Quiz Answers 285

ChaPTer 15monopoly 28715-1 Why Monopolies Arise 288

15-1a Monopoly Resources 28915-1b Government-Created Monopolies 28915-1c Natural Monopolies 290

15-2 How Monopolies Make Production and PricingDecisions 291

15-2a Monopoly versus Competition 29115-2b A Monopoly’s Revenue 29215-2c Profit Maximization 29415-2d A Monopoly’s Profit 296fYI: Why a Monopoly Does Not Have a Supply Curve 297case sTudY: Monopoly Drugs versus Generic Drugs 297

15-3 The Welfare Cost of Monopolies 29915-3a The Deadweight Loss 29915-3b The Monopoly’s Profit: A Social Cost? 301

15-4 Price Discrimination 30215-4a A Parable about Pricing 30215-4b The Moral of the Story 30315-4c The Analytics of Price Discrimination 30415-4d Examples of Price Discrimination 305In The news: Price Discrimination Reaches

the Supreme Court 306

15-5 Public Policy toward Monopolies 30815-5a Increasing Competition with Antitrust Laws 30815-5b Regulation 309ask The exPerTs: Mergers 31015-5c Public Ownership 31015-5d Doing Nothing 311

15-6 Conclusion: The Prevalence of Monopolies 311Chapter in a Nutshell 312Key Concepts 313Questions for Review 313Problems and Applications 313Quick Quiz Answers 316

ChaPTer 16monopolistic competition 31716-1 Between Monopoly and Perfect Competition 318

16-2 Competition with Differentiated Products 32016-2a The Monopolistically Competitive Firm in the

Short Run 32016-2b The Long-Run Equilibrium 32216-2c Monopolistic versus Perfect Competition 32316-2d Monopolistic Competition and the Welfare

of Society 324

16-3 Advertising 32616-3a The Debate over Advertising 326case sTudY: How Advertising Affects Prices 32716-3b Advertising as a Signal of Quality 32816-3c Brand Names 329


ChaPTer 17oligopoly 33517-1 Markets with Only a Few Sellers 336

17-1a A Duopoly Example 33617-1b Competition, Monopolies, and Cartels 33617-1c The Equilibrium for an Oligopoly 33817-1d How the Size of an Oligopoly Affects the Market

Outcome 339ask The exPerTs: Market Share and Market Power 340



xxiiiconTenTs

17-2 The Economics of Cooperation 34117-2a The Prisoners’ Dilemma 34117-2b Oligopolies as a Prisoners’ Dilemma 342case sTudY: OPEC and the World Oil Market 34317-2c Other Examples of the Prisoners’ Dilemma 34417-2d The Prisoners’ Dilemma and the Welfare of Society 34517-2e Why People Sometimes Cooperate 346case sTudY: The Prisoners’ Dilemma Tournament 346

17-3 Public Policy toward Oligopolies 34717-3a Restraint of Trade and the Antitrust Laws 347case sTudY: An Illegal Phone Call 34817-3b Controversies over Antitrust Policy 349case sTudY: The Microsoft Case 351In The news: Is Amazon the Next Antitrust Target? 352


ParT vI The Economics ofLabor Markets 357

ChaPTer 18

The markets for the Factors ofProduction 35718-1 The Demand for Labor 358

18-1a The Competitive Profit-Maximizing Firm 35818-1b The Production Function and the Marginal Product

of Labor 35918-1c The Value of the Marginal Product and the Demand

for Labor 36118-1d What Causes the Labor-Demand Curve to Shift? 362fYI: Input Demand and Output Supply: Two Sides of the

Same Coin 363

18-2 The Supply of Labor 36418-2a The Trade-Off between Work and Leisure 36418-2b What Causes the Labor-Supply Curve to Shift? 365

18-3 Equilibrium in the Labor Market 366ask The exPerTs: Immigration 36618-3a Shifts in Labor Supply 36618-3b Shifts in Labor Demand 368case sTudY: Productivity and Wages 369fYI: Monopsony 370

18-4 The Other Factors of Production: Land and Capital 37018-4a Equilibrium in the Markets for Land and Capital 371fYI: What Is Capital Income? 37218-4b Linkages among the Factors of Production 372case sTudY: The Economics of the Black Death 373In The news: The Winners and Losers from

Immigration 374


ChaPTer 19Earnings and Discrimination 37919-1 Some Determinants of Equilibrium Wages 380

19-1a Compensating Differentials 38019-1b Human Capital 380case sTudY: The Increasing Value of Skills 381ask The exPerTs: Inequality and Skills 38219-1c Ability, Effort, and Chance 382case sTudY: The Benefits of Beauty 38319-1d An Alternative View of Education: Signaling 38319-1e The Superstar Phenomenon 38419-1f Above-Equilibrium Wages: Minimum-Wage Laws,

Unions, and Efficiency Wages 385In The news: Schooling as a Public Investment 386

19-2 The Economics of Discrimination 38719-2a Measuring Labor-Market Discrimination 387case sTudY: Is Emily More Employable than Lakisha? 38919-2b Discrimination by Employers 389case sTudY: Segregated Streetcars and the Profit Motive 39019-2c Discrimination by Customers and Governments 391case sTudY: Discrimination in Sports 39119-2d Statistical Discrimination 392


ChaPTer 20income inequality and Poverty 39720-1 Measuring Inequality 398

20-1a U.S. Income Inequality 39820-1b Inequality Around the World 399fYI: Incomes of the Super-Rich 40020-1c The Poverty Rate 40020-1d Problems in Measuring Inequality 403In The news: Are We Winning the War on Poverty? 404case sTudY: Alternative Measures of Inequality 40420-1e Economic Mobility 405

20-2 The Political Philosophy of Redistributing Income 40620-2a Utilitarianism 40720-2b Liberalism 40820-2c Libertarianism 409



xxiv conTenTs

20-3 Policies to Reduce Poverty 41020-3a Minimum-Wage Laws 41020-3b Welfare 41120-3c Negative Income Tax 41120-3d In-Kind Transfers 41220-3e Antipoverty Programs and Work Incentives 413In The news: International Differences in Income

Redistribution 414


ParT vII Topics for FurtherStudy 419

ChaPTer 21

The Theory of consumer choice 41921-1 The Budget Constraint: What a Consumer Can Afford 420

21-1a Representing Consumption Opportunitiesin a Graph 420

21-1b Shifts in the Budget Constraint 421

21-2 Preferences: What a Consumer Wants 42321-2a Representing Preferences with Indifference Curves 42321-2b Four Properties of Indifference Curves 42421-2c Two Extreme Examples of Indifference Curves 426

21-3 Optimization: What a Consumer Chooses 42821-3a The Consumer’s Optimal Choices 42821-3b How Changes in Income Affect the

Consumer’s Choices 429fYI: Utility: An Alternative Way to Describe Preferences

and Optimization 43021-3c How Changes in Prices Affect the Consumer’s

Choices 43021-3d Income and Substitution Effects 43221-3e Deriving the Demand Curve 433

21-4 Three Applications 43521-4a Do All Demand Curves Slope Downward? 435case sTudY: The Search for Giffen Goods 43621-4b How Do Wages Affect Labor Supply? 436case sTudY: Income Effects on Labor Supply: Historical

Trends, Lottery Winners, and the CarnegieConjecture 439

21-4c How Do Interest Rates Affect Household Saving? 440

21-5 Conclusion: Do People Really Think This Way? 443Chapter in a Nutshell 443Key Concepts 444Questions for Review 444Problems and Applications 444Quick Quiz Answers 445

ChaPTer 22Frontiers of microeconomics 44722-1 Asymmetric Information 448

22-1a Hidden Actions: Principals, Agents, and Moral Hazard 448fYI: Corporate Management 44922-1b Hidden Characteristics: Adverse Selection and the

Lemons Problem 45022-1c Signaling to Convey Private Information 450case sTudY: Gifts as Signals 45122-1d Screening to Uncover Private Information 45222-1e Asymmetric Information and Public Policy 452

22-2 Political Economy 45322-2a The Condorcet Voting Paradox 45322-2b Arrow’s Impossibility Theorem 45422-2c The Median Voter Is King 45522-2d Politicians Are People Too 457

22-3 Behavioral Economics 45822-3a People Aren’t Always Rational 45822-3b People Care about Fairness 45922-3c People Are Inconsistent over Time 460ask The exPerTs: Behavioral Economics 461In The news: Using Deviations from Rationality 462


ParT vIII The Data ofMacroeconomics 467

ChaPTer 23

measuring a nation’s income 46723-1 The Economy’s Income and Expenditure 468

23-2 The Measurement of GDP 47023-2a “GDP Is the Market Value . . .” 47023-2b “. . . of All . . . ” 47023-2c “. . . Final . . . ” 47123-2d “. . . Goods and Services . . . ” 47123-2e “. . . Produced . . . ” 47123-2f “. . . Within a Country . . . ” 47123-2g “. . . In a Given Period of Time.” 471fYI: Other Measures of Income 472

23-3 The Components of GDP 47323-3a Consumption 47323-3b Investment 47323-3c Government Purchases 47423-3d Net Exports 474case sTudY: The Components of U.S. GDP 475



xxvconTenTs

23-4 Real versus Nominal GDP 47623-4a A Numerical Example 47623-4b The GDP Deflator 477case sTudY: A Half Century of Real GDP 478

23-5 Is GDP a Good Measure of Economic Well-Being? 480case sTudY: International Differences in GDP and the

Quality of Life 481In The news: Sex, Drugs, and GDP 482


ChaPTer 24measuring the cost of Living 48724-1 The Consumer Price Index 488

24-1a How the CPI Is Calculated 488fYI: What’s in the CPI’s Basket? 49024-1b Problems in Measuring the Cost of Living 49124-1c The GDP Deflator versus the Consumer Price Index 492

24-2 Correcting Economic Variables for the Effectsof Inflation 494

24-2a Dollar Figures from Different Times 494fYI: Mr. Index Goes to Hollywood 495case sTudY: Regional Differences in the Cost of Living 49524-2b Indexation 49724-2c Real and Nominal Interest Rates 497case sTudY: Interest Rates in the U.S. Economy 499


ParT Ix The Real Economyin the Long Run 505

ChaPTer 25

Production and Growth 50525-1 Economic Growth around the World 506

fYI: Are You Richer Than the Richest American? 508

25-2 Productivity: Its Role and Determinants 50825-2a Why Productivity Is So Important 50925-2b How Productivity Is Determined 509fYI: The Production Function 511case sTudY: Are Natural Resources a Limit

to Growth? 512

25-3 Economic Growth and Public Policy 51325-3a Saving and Investment 51325-3b Diminishing Returns and the Catch-Up Effect 51325-3c Investment from Abroad 51525-3d Education 51625-3e Health and Nutrition 51625-3f Property Rights and Political Stability 51725-3g Free Trade 51825-3h Research and Development 519ask The exPerTs: Innovation and Growth 51925-3i Population Growth 519case sTudY: Why Is So Much of Africa Poor? 521In The news: The Secret Sauce of American

Prosperity 524

25-4 Conclusion: The Importance of Long-Run Growth 524Chapter in a Nutshell 525Key Concepts 526Questions for Review 526Problems and Applications 526Quick Quiz Answers 527

ChaPTer 26saving, investment, and theFinancial system 52926-1 Financial Institutions in the U.S. Economy 530

26-1a Financial Markets 53026-1b Financial Intermediaries 53226-1c Summing Up 534

26-2 Saving and Investment in the National Income Accounts 53426-2a Some Important Identities 53526-2b The Meaning of Saving and Investment 536

26-3 The Market for Loanable Funds 53726-3a Supply and Demand for Loanable Funds 53726-3b Policy 1: Saving Incentives 53926-3c Policy 2: Investment Incentives 54126-3d Policy 3: Government Budget Deficits and

Surpluses 542ask The exPerTs: Fiscal Policy and Saving 543case sTudY: The History of U.S. Government Debt 544fYI: Financial Crises 546


ChaPTer 27The Basic Tools of Finance 55127-1 Present Value: Measuring the Time Value of Money 552

fYI: The Magic of Compounding and the Rule of 70 554



xxvi conTenTs

27-2 Managing Risk 55427-2a Risk Aversion 55527-2b The Markets for Insurance 55527-2c Diversification of Firm-Specific Risk 55627-2d The Trade-Off between Risk and Return 557

27-3 Asset Valuation 55927-3a Fundamental Analysis 559fYI: Key Numbers for Stock Watchers 56027-3b The Efficient Markets Hypothesis 560case sTudY: Random Walks and Index Funds 561ask The exPerTs: Diversified Investing 56227-3c Market Irrationality 562


ChaPTer 28Unemployment 56728-1 Identifying Unemployment 568

28-1a How Is Unemployment Measured? 568case sTudY: Labor-Force Participation of Men and

Women in the U.S. Economy 57128-1b Does the Unemployment Rate Measure What We

Want It to Measure? 57228-1c How Long Are the Unemployed without Work? 57428-1d Why Are There Always Some People Unemployed? 574fYI: The Jobs Number 575

28-2 Job Search 57628-2a Why Some Frictional Unemployment

Is Inevitable 57628-2b Public Policy and Job Search 57628-2c Unemployment Insurance 577

28-3 Minimum-Wage Laws 578case sTudY: Who Earns the Minimum Wage? 579

28-4 Unions and Collective Bargaining 58128-4a The Economics of Unions 58128-4b Are Unions Good or Bad for the Economy? 582

28-5 The Theory of Efficiency Wages 58328-5a Worker Health 58328-5b Worker Turnover 58428-5c Worker Quality 58428-5d Worker Effort 584case sTudY: Henry Ford and the Very Generous

$5-a-Day Wage 585


ParT x Money and Pricesin the Long Run 589

ChaPTer 29

The monetary system 58929-1 The Meaning of Money 590

29-1a The Functions of Money 59029-1b The Kinds of Money 591fYI: Cryptocurrencies: A Fad or the Future? 59229-1c Money in the U.S. Economy 593fYI: Why Credit Cards Aren’t Money 594case sTudY: Where Is All the Currency? 594

29-2 The Federal Reserve System 59529-2a The Fed’s Organization 59529-2b The Federal Open Market Committee 596

29-3 Banks and the Money Supply 59729-3a The Simple Case of 100-Percent-Reserve

Banking 59729-3b Money Creation with Fractional-Reserve

Banking 59829-3c The Money Multiplier 59929-3d Bank Capital, Leverage, and the Financial Crisis of

2008–2009 600

29-4 The Fed’s Tools of Monetary Control 60229-4a How the Fed Influences the Quantity of Reserves 60229-4b How the Fed Influences the Reserve Ratio 60429-4c Problems in Controlling the Money Supply 604case sTudY: Bank Runs and the Money Supply 605In The news: A Trip to Jekyll Island 60629-4d The Federal Funds Rate 606


ChaPTer 30money Growth and inflation 61330-1 The Classical Theory of Inflation 614

30-1a The Level of Prices and the Value of Money 61530-1b Money Supply, Money Demand, and Monetary

Equilibrium 61530-1c The Effects of a Monetary Injection 61730-1d A Brief Look at the Adjustment Process 61830-1e The Classical Dichotomy and Monetary Neutrality 61930-1f Velocity and the Quantity Equation 620case sTudY: Money and Prices during Four

Hyperinflations 62230-1g The Inflation Tax 62230-1h The Fisher Effect 624



xxviiconTenTs

30-2 The Costs of Inflation 62630-2a A Fall in Purchasing Power? The Inflation Fallacy 62630-2b Shoeleather Costs 62730-2c Menu Costs 62830-2d Relative-Price Variability and the Misallocation of

Resources 62830-2e Inflation-Induced Tax Distortions 62930-2f Confusion and Inconvenience 63030-2g A Special Cost of Unexpected Inflation: Arbitrary

Redistributions of Wealth 63130-2h Inflation Is Bad, but Deflation May Be Worse 631case sTudY: The Wizard of Oz and the Free-Silver

Debate 632In The news: Life During Hyperinflation 634


ParT xI The Macroeconomicsof OpenEconomies 639

ChaPTer 31open-Economy macroeconomics:Basic concepts 63931-1 The International Flows of Goods and Capital 640

31-1a The Flow of Goods: Exports, Imports, andNet Exports 640

case sTudY: The Increasing Openness of theU.S. Economy 641

31-1b The Flow of Financial Resources: Net Capital Outflow 64231-1c The Equality of Net Exports and Net Capital Outflow 64331-1d Saving, Investment, and Their Relationship to the

International Flows 64531-1e Summing Up 646case sTudY: Is the U.S. Trade Deficit a National Problem? 647ask The exPerTs: Trade Balances and Trade

Negotiations 648

31-2 The Prices for International Transactions: Real andNominal Exchange Rates 649

31-2a Nominal Exchange Rates 64931-2b Real Exchange Rates 650fYI: The Euro 651

31-3 A First Theory of Exchange-Rate Determination:Purchasing-Power Parity 652

31-3a The Basic Logic of Purchasing-Power Parity 65331-3b Implications of Purchasing-Power Parity 653case sTudY: The Nominal Exchange Rate during a

Hyperinflation 655

31-3c Limitations of Purchasing-Power Parity 656case sTudY: The Hamburger Standard 656


ChaPTer 32A macroeconomic Theory of theopen Economy 66132-1 Supply and Demand for Loanable Funds and forForeign-Currency Exchange 662

32-1a The Market for Loanable Funds 66232-1b The Market for Foreign-Currency Exchange 664fYI: Purchasing-Power Parity as a Special Case 666

32-2 Equilibrium in the Open Economy 66732-2a Net Capital Outflow: The Link between the

Two Markets 66732-2b Simultaneous Equilibrium in Two Markets 668fYI: Disentangling Supply and Demand 670

32-3 How Policies and Events Affect anOpen Economy 670

32-3a Government Budget Deficits 67132-3b Trade Policy 673ask The exPerTs: Deficits 67332-3c Political Instability and Capital Flight 675case sTudY: Capital Flows from China 677In The news: Separating Fact from Fiction 678ask The exPerTs: Currency Manipulation 678


ParT xII Short-Run EconomicFluctuations 683

ChaPTer 33

Aggregate Demand and Aggregatesupply 68333-1 Three Key Facts about Economic Fluctuations 684

33-1a Fact 1: Economic Fluctuations Are Irregularand Unpredictable 684

33-1b Fact 2: Most Macroeconomic Quantities FluctuateTogether 686

33-1c Fact 3: As Output Falls, Unemployment Rises 686



xxviii conTenTs

33-2 Explaining Short-Run Economic Fluctuations 68733-2a The Assumptions of Classical Economics 68733-2b The Reality of Short-Run Fluctuations 68733-2c The Model of Aggregate Demand and Aggregate Supply 688

33-3 The Aggregate-Demand Curve 68933-3a Why the Aggregate-Demand Curve Slopes

Downward 68933-3b Why the Aggregate-Demand Curve Might Shift 692

33-4 The Aggregate-Supply Curve 69533-4a Why the Aggregate-Supply Curve Is Vertical in

the Long Run 69533-4b Why the Long-Run Aggregate-Supply Curve

Might Shift 69633-4c Using Aggregate Demand and Aggregate Supply

to Depict Long-Run Growth and Inflation 69733-4d Why the Aggregate-Supply Curve Slopes Upward

in the Short Run 69933-4e Why the Short-Run Aggregate-Supply Curve

Might Shift 702

33-5 Two Causes of Economic Fluctuations 70433-5a The Effects of a Shift in Aggregate Demand 705fYI: Monetary Neutrality Revisited 707case sTudY: Two Big Shifts in Aggregate Demand: The

Great Depression and World War II 707case sTudY: The Great Recession of 2008–2009 70933-5b The Effects of a Shift in Aggregate Supply 711case sTudY: Oil and the Economy 713fYI: The Origins of the Model of Aggregate Demand and

Aggregate Supply 714


ChaPTer 34The influence of monetary and FiscalPolicy on Aggregate Demand 71934-1 How Monetary Policy Influences Aggregate Demand 720

34-1a The Theory of Liquidity Preference 72134-1b The Downward Slope of the Aggregate-Demand Curve 723fYI: Interest Rates in the Long Run and the Short Run 72434-1c Changes in the Money Supply 72534-1d The Role of Interest-Rate Targets in Fed Policy 727case sTudY: Why the Fed Watches the Stock Market

(and Vice Versa) 72734-1e The Zero Lower Bound 728

34-2 How Fiscal Policy Influences Aggregate Demand 73034-2a Changes in Government Purchases 73034-2b The Multiplier Effect 73034-2c A Formula for the Spending Multiplier 731

34-2d Other Applications of the Multiplier Effect 73234-2e The Crowding-Out Effect 73334-2f Changes in Taxes 734fYI: How Fiscal Policy Might Affect

Aggregate Supply 735

34-3 Using Policy to Stabilize the Economy 73634-3a The Case for Active Stabilization Policy 736case sTudY: Keynesians in the White House 737ask The exPerTs: Economic Stimulus 737In The news: How Large Is the Fiscal

Policy Multiplier? 73834-3b The Case against Active Stabilization Policy 73934-3c Automatic Stabilizers 741


ChaPTer 35The short-Run Trade-off betweeninflation and Unemployment 74535-1 The Phillips Curve 746

35-1a Origins of the Phillips Curve 74635-1b Aggregate Demand, Aggregate Supply, and the

Phillips Curve 747

35-2 Shifts in the Phillips Curve: The Roleof Expectations 749

35-2a The Long-Run Phillips Curve 74935-2b The Meaning of “Natural” 75135-2c Reconciling Theory and Evidence 75235-2d The Short-Run Phillips Curve 75335-2e The Natural Experiment for the Natural-Rate

Hypothesis 754

35-3 Shifts in the Phillips Curve: The Role ofSupply Shocks 756

35-4 The Cost of Reducing Inflation 75935-4a The Sacrifice Ratio 75935-4b Rational Expectations and the Possibility of Costless

Disinflation 76135-4c The Volcker Disinflation 76235-4d The Greenspan Era 76335-4e A Financial Crisis Takes Us for a Ride along the

Phillips Curve 764




Principles of Economics: a Guided Tour

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