Economics principles, applications, and tools

769 Pages·2018·28.06 MB·English

by  O’Sullivan, Arthur, Perez, Stephen J., Sheffrin, Steven M.

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Economics
PrinciPlES, APPlicAtiOnS, And tOOlS
ninth EditiOn
GlObAl EditiOn
Arthur O’Sullivan
Lewis and Clark College
Steven M. Sheffrin
Tulane University
Stephen J. Perez
California State University, Sacramento
A01_OSUL5592_09_GE_FM.indd 1 3/17/17 5:48 PM
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ISBN 10: 1-292-16559-6
ISBN 13: 978-1-292-16559-2
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About the Authors
Arthur O’SullivAn
is a professor of economics at Lewis and Clark College in Portland, Oregon. After receiving his
B.S. in economics at the University of Oregon, he spent two years in the Peace Corps, work-
ing with city planners in the Philippines. He received his Ph.D. in economics from Princeton
University in 1981 and has taught at the University of California, Davis, and Oregon State
University, winning teaching awards at both schools. He is the author of the best-selling text-
book Urban Economics, currently in its eighth edition, with translations into Russian, Chinese,
Korean, and Greek.
Professor O’Sullivan’s research explores economic issues concerning urban land use,
environmental protection, and public policy. His articles have appeared in many econom-
ics journals, including the Journal of Urban Economics, Journal of Environmental Economics
and Management, National Tax Journal, Journal of Public Economics, and Journal of Law and
Economics.
Professor O’Sullivan lives with his family in Portland, Oregon. For recreation, he enjoys
hiking, kiteboarding, and squash.
StEvEn M. ShEffrin
is professor of economics and executive director of the Murphy Institute at Tulane University.
Prior to joining Tulane in 2010, he was a faculty member at the University of California, Davis,
and served as department chairman of economics and dean of social sciences. He has been a
visiting professor at Princeton University, Oxford University, London School of Economics, and
Nanyang Technological University, and he has served as a financial economist with the Office
of Tax Analysis of the United States Department of the Treasury. He received his B.A. from
Wesleyan University and his Ph.D. in economics from the Massachusetts Institute of Technology.
Professor Sheffrin is the author of 10 other books and monographs and over 100 articles
in the fields of macroeconomics, public finance, and international economics. His most recent
books include Rational Expectations (second edition) and Property Taxes and Tax Revolts: The
Legacy of Proposition 13 (with Arthur O’Sullivan and Terri Sexton).
Professor Sheffrin has taught macroeconomics and public finance at all levels, from gen-
eral introduction to principles classes (enrollments of 400) to graduate classes for doctoral
students. He is the recipient of the Thomas Mayer Distinguished Teaching Award in economics.
He lives with his wife Anjali (also an economist) in New Orleans, Louisiana, and has two
daughters who have studied economics. In addition to a passion for current affairs and travel,
he plays a tough game of tennis.
StEPhEn J. PErEz
is a professor of economics and NCAA faculty athletics representative at California State
University, Sacramento. After receiving his B.A. in economics at the University of California,
San Diego, he was awarded his Ph.D. in economics from the University of California, Davis,
in 1994. He taught economics at Virginia Commonwealth University and Washington State
University before coming to California State University, Sacramento, in 2001. He teaches mac-
roeconomics at all levels as well as econometrics, sports economics, labor economics, and
mathematics for economists.
Professor Perez’s research explores most macroeconomic topics. In particular, he is inter-
ested in evaluating the ability of econometric techniques to discover the truth, issues of causal-
ity in macroeconomics, and sports economics. His articles have appeared in many economics
journals, including the Journal of Monetary Economics; Econometrics Journal; Economics
Letters; Journal of Economic Methodology; Public Finance and Management; Journal of
Economics and Business; Oxford Bulletin of Economics and Statistics; Journal of Money,
Credit, and Banking; Applied Economics; and Journal of Macroeconomics.
3
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contents
Preface 20 Using Macroeconomics to Make Informed
Business Decisions 42
PArt 1
Preview of Coming Attractions:
introduction and Key Principles Microeconomics 42
Using Microeconomics to Understand Markets
and Predict Changes 42
1 Introduction: What Is Economics? 32
Using Microeconomics to Make Personal and
Managerial Decisions 42
What Is Economics? 33
Using Microeconomics to Evaluate Public
Positive versus Normative Analysis 34
Policies 43
The Three Key Economic Questions: What, How,
* SuMMAry 43 * KEy tErMS 43
and Who? 35
* ExErciSES 44
Economic Models 35
APPEndix: using Graphs and Percentages 45
Economic Analysis and Modern Problems 36
uSinG GrAPhS 45
Economic View of Traffic Congestion 36 cOMPutinG PErcEntAGE chAnGES And uSinG
EquAtiOnS 53
Economic View of Poverty in Africa 36
APPlicAtiOn 3 the Perils of Percentages 54
Economic View of the Current World Recession 37
The Economic Way of Thinking 37
2 The Key Principles of
Economics 57
Use Assumptions to Simplify 38
Isolate Variables—Ceteris Paribus 38
The Principle of Opportunity Cost 58
Think at the Margin 38
The Cost of College 58
Rational People Respond to Incentives 39
The Cost of Military Spending 59
APPlicAtiOn 1 incentives to buy hybrid vehicles 39
Opportunity Cost and the Production Possibilities
Curve 59
Example: London Addresses Its Congestion
Problem 40
APPlicAtiOn 1 don’t forget the costs of time
and invested funds 61
APPlicAtiOn 2 housing Prices in cuba 40
The Marginal Principle 62
Preview of Coming Attractions:
Macroeconomics 41
How Many Movie Sequels? 62
Using Macroeconomics to Understand Why
Renting College Facilities 63
Economies Grow 41
Automobile Emissions Standards 64
Using Macroeconomics to Understand Economic
Fluctuations 41 Driving Speed and Safety 64
4
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APPlicAtiOn 2 how fast to Sail? 65 Market Failure and the Role of Government 85
The Principle of Voluntary Exchange 65 Government Enforces the Rules of Exchange 85
Government Can Reduce Economic
Exchange and Markets 65
Uncertainty 86
Online Games and Market Exchange 66
APPlicAtiOn 3 Property rights and urban
APPlicAtiOn 3 rory Mcilroy and Weed- Slums 87
Wacking 66
* SuMMAry 87 * KEy tErMS 87
The Principle of Diminishing Returns 67 * ExErciSES 88
APPlicAtiOn 4 fertilizer and crop yields 68
4 Demand, Supply, and Market
The Real-Nominal Principle 68
Equilibrium 91
The Design of Public Programs 69
The Demand Curve 92
The Value of the Minimum Wage 69
The Individual Demand Curve and the Law
APPlicAtiOn 5 repaying Student loans 70
of Demand 92
* SuMMAry 70 * KEy tErMS 71
From Individual Demand to Market Demand 94
* ExErciSES 71
APPlicAtiOn 1 the law of demand for young
* ECONOMIC ExPERIMENT 75
Smokers 95
The Supply Curve 95
3 Exchange and Markets 76
The Individual Supply Curve and the Law
of Supply 96
Comparative Advantage and Exchange 77
Why Is the Individual Supply Curve Positively
Specialization and the Gains from Trade 77
Sloped? 97
Comparative Advantage versus Absolute
From Individual Supply to Market Supply 98
Advantage 79
Why Is the Market Supply Curve Positively
The Division of Labor and Exchange 79
Sloped? 99
Comparative Advantage and International
Trade 80 APPlicAtiOn 2 law of Supply and Woolympics 100
Outsourcing 80 Market Equilibrium: Bringing Demand
and Supply Together 100
APPlicAtiOn 1 Absolute disadvantage
and comparative Advantage in latvia 81 Excess Demand Causes the Price to Rise 100
Excess Supply Causes the Price to Drop 101
Markets 82
Virtues of Markets 82 APPlicAtiOn 3 Shrinking Wine lakes 102
The Role of Entrepreneurs 83 Market Effects of Changes in Demand 102
Example of the Emergence of Markets: POW
Change in Quantity Demanded versus Change in
Camps 84
Demand 102
APPlicAtiOn 2 the Market for Meteorites 84 Increases in Demand Shift the Demand Curve 103
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Decreases in Demand Shift the Demand Curve 105 The Components of GDP 125
A Decrease in Demand Decreases the Equilibrium Putting It All Together: The GDP Equation 128
Price 106
APPlicAtiOn 2 comparing recoveries from
APPlicAtiOn 4 chinese demand and Pecan recessions 129
Prices 106
The Income Approach: Measuring a Nation’s
Market Effects of Changes in Supply 107 Macroeconomic Activity Using National
Income 129
Change in Quantity Supplied versus Change in
Supply 107 Measuring National Income 129
Increases in Supply Shift the Supply Curve 107 Measuring National Income through Value
Added 130
An Increase in Supply Decreases the Equilibrium
Price 109 An Expanded Circular Flow 131
Decreases in Supply Shift the Supply Curve 110 APPlicAtiOn 3 the links between Self-reported
happiness and GdP 132
A Decrease in Supply Increases the Equilibrium
Price 110 A Closer Examination of Nominal and Real
GDP 132
Simultaneous Changes in Demand and Supply 111
Measuring Real versus Nominal GDP 133
APPlicAtiOn 5 the harmattan and the Price
of chocolate 113 How to Use the GDP Deflator 134
Predicting and Explaining Market Changes 113 Fluctuations in GDP 135
APPlicAtiOn 6 Why lower drug Prices? 114 GDP as a Measure of Welfare 137
* SuMMAry 114 * KEy tErMS 115 Shortcomings of GDP as a Measure of Welfare 137
* ExErciSES 115
* SuMMAry 138 * KEy tErMS 139
* ECONOMIC ExPERIMENT 119 * ExErciSES 139
6 Unemployment and Inflation 143
PArt 2
the basic concepts in Macroeconomics
Examining Unemployment 144
How Is Unemployment Defined and
5 Measuring a Nation’s Production Measured? 144
and Income 120
Alternative Measures of Unemployment and Why
They Are Important 146
The “Flip” Sides of Macroeconomic Activity:
Who Are the Unemployed? 147
Production and Income 121
APPlicAtiOn 1 declining labor force
The Circular Flow of Production and Income 122
Participation 148
APPlicAtiOn 1 using value Added to Measure the
true Size of Walmart 123 Categories of Unemployment 149
Types of Unemployment: Cyclical, Frictional,
The Production Approach: Measuring a
and Structural 149
Nation’s Macroeconomic Activity Using
Gross Domestic Product 123 The Natural Rate of Unemployment 150
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7
APPlicAtiOn 2 less unemployment insurance, Labor Market Equilibrium and Full
More Employment? 151 Employment 170
The Costs of Unemployment 151 Using the Full-Employment Model 171
Taxes and Potential Output 171
APPlicAtiOn 3 Social norms, unemployment,
And Perceived happiness 152 Real Business Cycle Theory 172
The Consumer Price Index and the Cost APPlicAtiOn 2 do European Soccer Stars change
of Living 153 clubs to reduce their taxes? 174
The CPI versus the Chain Index for GDP 154
APPlicAtiOn 3 Government Policies and Savings
rates 175
APPlicAtiOn 4 the introduction of cell Phones
and the bias in the cPi 155 Dividing Output among Competing Demands
for GDP at Full Employment 175
Problems in Measuring Changes in Prices 155
International Comparisons 176
Inflation 155
Crowding Out in a Closed Economy 176
Historical U.S. Inflation Rates 156
Crowding Out in an Open Economy 178
The Perils of Deflation 157
Crowding In 178
The Costs of Inflation 158
* SuMMAry 179 * KEy tErMS 179
* ExErciSES 179
Anticipated Inflation 158
Unanticipated Inflation 158
8 Why Do Economies Grow? 183
* SuMMAry 159 * KEy tErMS 160
* ExErciSES 160
Economic Growth Rates 184
Measuring Economic Growth 185
PArt 3
Comparing the Growth Rates of Various
the Economy in the long run
Countries 186
Are Poor Countries Catching Up? 187
7 The Economy at Full
APPlicAtiOn 1 Global Warming, rich countries,
Employment 163
and Poor countries 188
APPlicAtiOn 2 behavioral incentives in
Wage and Price Flexibility and Full
development 189
Employment 164
Capital Deepening 189
The Production Function 164
Saving and Investment 190
Wages and the Demand and Supply for
Labor 167 How Do Population Growth, Government,
and Trade Affect Capital Deepening? 191
Labor Market Equilibrium 168
The Key Role of Technological Progress 193
Changes in Demand and Supply 168
How Do We Measure Technological Progress? 193
APPlicAtiOn 1 the black death and living
Standards in Old England 169 Using Growth Accounting 194
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APPlicAtiOn 3 Sources of Growth in china and Understanding Aggregate Demand 214
india 195
What Is the Aggregate Demand Curve? 214
APPlicAtiOn 4 the End of Growth? 196
The Components of Aggregate Demand 215
What Causes Technological Progress? 196
Why the Aggregate Demand Curve Slopes
Downward 215
Research and Development Funding 196
Shifts in the Aggregate Demand Curve 216
Monopolies That Spur Innovation 197
How the Multiplier Makes the Shift Bigger 217
The Scale of the Market 197
Induced Innovations 198 APPlicAtiOn 2 two Approaches to determining the
causes of recessions 221
Education, Human Capital, and the Accumulation
of Knowledge 198
Understanding Aggregate Supply 221
New Growth Theory 199
The Long-Run Aggregate Supply Curve 221
APPlicAtiOn 5 the role of Political factors in
The Short-Run Aggregate Supply Curve 223
Economic Growth 199
Supply Shocks 224
APPlicAtiOn 6 culture, Evolution, and Economic
Growth 200 APPlicAtiOn 3 Oil Price declines and the u.S.
Economy 225
A Key Governmental Role: Providing
the Correct Incentives and Property From the Short Run to the Long Run 226
Rights 200
* SuMMAry 228 * KEy tErMS 228
APPlicAtiOn 7 lack of Property rights hinders * ExErciSES 228
Growth in Peru 201
* SuMMAry 202 * KEy tErMS 202
* ExErciSES 203 10 Fiscal Policy 231
APPEndix: A Model of capital deepening 206
The Role of Fiscal Policy 232
Fiscal Policy and Aggregate Demand 232
PArt 4
The Fiscal Multiplier 233
Economic fluctuations and fiscal Policy
The Limits to Stabilization Policy 234
9 Aggregate Demand and Aggregate APPlicAtiOn 1 increasing life Expectancy and
Aging Populations Spur costs of Entitlement
Supply 211
Programs 236
Sticky Prices and Their Macroeconomic The Federal Budget 237
Consequences 212
Federal Spending 237
Flexible and Sticky Prices 212
Federal Revenues 238
How Demand Determines Output in the Short
The Federal Deficit and Fiscal Policy 240
Run 213
Automatic Stabilizers 240
APPlicAtiOn 1 Measuring Price Stickiness in
consumer Markets 214 Are Deficits Bad? 241
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APPlicAtiOn 2 the confucius curve? 242 Exports and Imports 267
Fiscal Policy in U.S. History 242 APPlicAtiOn 4 the locomotive Effect: how foreign
demand Affects a country’s Output 269
The Depression Era 242
The Kennedy Administration 242 The Income-Expenditure Model and the
Aggregate Demand Curve 270
The Vietnam War Era 243
* SuMMAry 272 * KEy tErMS 272
The Reagan Administration 244
* ExErciSES 272
The Clinton and George W. Bush
* ECONOMIC ExPERIMENT 275
Administrations 244
APPEndix: formulas for Equilibrium income and the
APPlicAtiOn 3 how Effective was the 2009
Multiplier 276
Stimulus? 245
* SuMMAry 246 * KEy tErMS 247
* ExErciSES 247
12 Investment and Financial
Markets 280
11 The Income-Expenditure Model 249
An Investment: A Plunge into the
Unknown 281
A Simple Income-Expenditure Model 250
Equilibrium Output 250 APPlicAtiOn 1 Energy Price uncertainty reduces
investment Spending 282
Adjusting to Equilibrium Output 251
Evaluating the Future 283
The Consumption Function 253
Understanding Present Value 283
Consumer Spending and Income 253
Changes in the Consumption Function 254 Real and Nominal Interest Rates 285
APPlicAtiOn 1 falling home Prices, the Wealth APPlicAtiOn 2 the value of an Annuity 286
Effect, and decreased consumer Spending 255
Understanding Investment Decisions 287
Equilibrium Output and the Consumption
Investment and the Stock Market 288
Function 256
Saving and Investment 257 APPlicAtiOn 3 underwater homeowners and debt
forgiveness 290
Understanding the Multiplier 258
How Financial Intermediaries Facilitate
APPlicAtiOn 2 Multipliers in Good times and
Investment 290
bad 260
When Financial Intermediaries
Government Spending and Taxation 260
Malfunction 293
Fiscal Multipliers 260
APPlicAtiOn 4 Securitization: the Good, the bad,
Using Fiscal Multipliers 262 and the ugly 294
Understanding Automatic Stabilizers 264 * SuMMAry 295 * KEy tErMS 295
* ExErciSES 296
APPlicAtiOn 3 the broken Window fallacy
and Keynesian Economics 265 * ECONOMIC ExPERIMENT 297
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