Modern Principles of Economics

946 Pages·2015·53.21 MB·English

by  Tyler Cowen

THIRD EDITION THIRD EDITION
W
Dear Student:
C
e love economics. We talk economics, argue economics, and think about economics every day. We use economics o MODERN PRINCIPLES OF
in our lives, not just when we choose whether to refinance a mortgage but also when we choose strategies for dating, w
keeping a good marriage, and parenting. Yeah, we are weird. But now a warning. If you are afraid of being a little weird,
Do Not Read This Book. Once you have been exposed to the economic way of thinking, there is no going back—you will e E C O N O M I C S
n
see the world differently and that will make you different.

Will what you learn be worth the price? That is for you to decide. But we think economics is important. We need •
economics to make better investments and better life choices. Citizens in a democracy must evaluate issues of taxes, deficits, T
trade, health care policy, and inflation. These issues and many more cannot be understood without an understanding of a
economics. Do you want to vote ignorantly or intelligently? The economic way of thinking will help you to understand b
the issues of the day and to explain them with confidence to others.
a
We won’t lie: economics can be difficult. Few things worth knowing come easily and, to understand economics well,
r
you will need to master new tools and new ideas like supply and demand curves, marginal thinking, and equilibrium. We r
have worked hard, however, to strip away as much jargon and unnecessary verbiage as possible. We are going to give you o
what is important and not much else. We are also going to have fun. In addition, be sure to check out the new videos that k
can help you with the course content and enhance your fun.
Welcome to the world of economics.
E
M
Tyler Cowen Alex Tabarrok CO
LaunchPad logo suite 1 D
OE
R

LaunchPad makes preparing for class and studying for exams more This game-like quizzing system helps you focus your study time N
effective. Everything you need is right here in one convenient where it’s needed most. Quizzes adapt to correct and incorrect N
location—a complete interactive e-Book, all interactive study answers and provide instant feedback and a learning path unique
tools, and several ways to assess your understanding of concepts. to your needs, including individualized follow-up quizzes that help P
build skills in areas that need more work.
OR
I
LearningCurve is OVER 90% 95% Learn i ngCurve is N
BENEF ICIAL oLfe asrtundinegnCtsu rsvaei’ds tools oref csotumdmenetnsd w Loeualrdn ingCurve AbyP stPudRenOtsVED MC
and support helped them to another student.
manage their study time
LaunchPad and LearningCurve Build Success! and get better grades. I
P
LaunchPad is even more efficient when used with LearningCurve. In
fact, students overwhelmingly recommend its use to their friends and LearningCurve helped students... L
psheaerres. yWouoru ilmd yporeus?s iCoonns…tac.t us at [email protected] to PrepImaorpef r coboveuettr eksnre o fmowra lceteldargsiaesl 95% Rtoe octohmerm setundde Lnetsarning Curve IE
Earn better grades CS
Integrated Online Resources 0 2P5ercentage5 0of student7s5 100
New Work It Out online tutorials guide students through the process Strongly agree Agree Somewhat agree O
of applying economic analysis and math skills to solve the final S
problem in each chapter. New Videos F
Pioneers in teaching economics online, the authors have created a
series of videos that are clever, to the point, and will help you better
understand key economic concepts. The video links are included in
SCAN here for a sample Work It Out problem the book along with QR codes for mobile access.
http://qrs.ly/7t4d89p
SCAN Here for a sample Video
http://qrs.ly/p34ax6h
WORTH
@worthecon facebook.com/ModernPrinciples
WORTH
PUBLISHERS
Tyler Cowen • Alex Tabarrok
www.macmillanhighered.com
Cover images: Earth: Jim Roof/myLoupe.com; Hands: © Oleh Barabash / Alamy.
1
The Big Ideas
You’ll be hooked from page 1...
CHAPTER OUTLINE
520 • PARTB i6g •Id Eecaosn oinm Eicc Gonroowmthics
1. Incentives Matter
Asymmetric Information: Moral Hazard and Adverse Selection • CHAPTER 24 • 451
T 2. Good Institutions AligTnh eS eelxf-ample of South and North Korea is useful because we can rule out
he prisoners were dying of scurvy, typhoid fever, and small- Interest with the Ssoocmiael Ienxtpelraensattions for the huge differences in wealth between these two coun-
pox, but nothing was killing them more than bad incentives.
want to sell insurance to the people who most want to buy—this is the basic 3. Trade-offs Are Evetrryiews.h Terhee explanation, for example, cannot be differences in the people, culture,
ptpphllruueoLrmmbeel sstea’ smar( eurg e siot vewwfed o oaac drntatvyohrepst r eh$sis1ene or2 sef,ee0 xuxl0ecas0eceml.td liSpe ocnulneatpr. tpsmh: olaeestecm w haoalasnnso isfc i(tarhuls asts etha dnaa mcpalaeyor)zsn. egwLdswod he itinetebmhi hprdyeseo l aAc acna mvoIulnksonen redot a rvr nsre1olihteonsc7hf tit ft8prwepe.l oy7s drSo.u o,r u oresObftpt;weshlh tplens one mooa $ nemosrB8dssern) ,i re 0vttecia oht0ea nei avdr0svdAhsto ;e buyngeas otgasrtaveaeie,ldn iram ,n. t mhosCteraee ornc vntote dhndhiatd,ani iod ta nionohsndn ie ros-es nitdwch kbiesr.ored eaaA rowdc fa f oitptrhrhtssaeteeOVIEPIX/GETTY IMAGES i nmsmthsh aieatptnnoes 456... T T TEhhhcoieenn kPIomionmpwgio ceor rtGn ao rntfoh cwTeer t aMohdfoWhcaa enaWrurp adgmgrei it eniaaafoInl lIt—gt, h hr ctae nahaprnaepehtdy iuytw .ar sBlaeh. lre aeSrfr eoeoasdrnuoe ytu htS hra ocedaeu vnstsa hdanwm taeaNnerg edoep srNae tbihonoo p ruhlKtethu o mtaKrhneaeoadn r se-aacmalmu swoalted ue ehrrin eeap — ddht hiyivsensiii md cSoeaioldtl ahu craeta thrp l teihwatvaseeo l ,li ersntd nh sodte, hf y toe hwpf e Nh We ynsoasotrim rcttlhaodel,
ttqhiuoeanrle it oyaf r eoa fse ytqhmueamilr enctuarrmic a bniendrfs o tohrmfa tl aettmhioeonrne: sA isas nsnudom pcelhu emtahspa. tN woaonywrtlh ey,f meo hT rsoaeh errwblekelue eniByrdesse rr tricshkts ri henusth aooekv wl elpedyy ui [ stboaathilslfrneis ceut g ahmuthdreiuayp sdhc]e- o bnneove inclo tpsv,ae i“ dfL ofeort r t ththheee mciro pndaivesis caatgns,ed .b ”bu1et idta wmNDATION /Mansend’t, 78.. I ECncasontinntouomtti oBicne sB AoMvoaomtidtsee rattrdhwen sedbop uN eBrtceu otCgssr itattoshhn n, e sw swahmiecrehe, awsplmalist o,a sttt h tahesra eitf f totihrmee,e Ss mpoluiott rhwe aiansn dddue Nsstirgoinareltihdz e Kadso tarh egaani aw nthet erse oS cioniua lat hlel.x Wipmehpreiomnr tetahnnett.
lemons froTmyp ep loufm cas.r Le.m.on.s (blow qyualit y) thPlprtbueaimreaietnlsitpsze (a’erh rs dieegfm odnhio ns tqed o uf o aaagvflno iiothvdyrue ) w motshafa tenbemtiret,ty tal ,ei gard nchecdtao t alnhoend gdsiiet sinalomaitrtne,on sr,ac sn ecpd lpeae srpistgrehyodee p rare.pe rNpg lmueeallwealetdisidiopc nnaatposl e rcrteaghsqr eJOHN KOBAL FOUeeu .di criY aitnopegw--t r 190i.. tB PP Crreeiii cnnMetntsrsoa TRdl oieBgsorea an MtWkeui dhnceghin MI sntsS K hopaoeone uSH reaG etokyahaouri t ndvtKthge hJ, roh eonarS bnmeooadeur e gnwtNaht an osi K rztneoh rer sve Keao rof hr aeah adpu umdcriafaepfn eic traaeclpdaisip tmiiantla,i lsta,t h npeedhic ryo Nsneiccoooarmltn hyoc, amKopifoic tra celio,an u sahrtnisatedud, t tbiceouocnthm s.ni mnoB lurSoonogaiiusdcmtlahyl.
Value $8,000 prin$1th2c,e0 0di0epath rlatee remsai neod shfock Mineagrlxyi scht iEgohco. nNonmotihcsio nGgr oaumpcpheoa reid cto sbe mThe Baiggrestk Ideea of tAll.:k En.coo.wnolemdigces are private, profit-seeking firms and entrepreneurs to a much
Asymmetric Informationw: Morokrainl gH auzanrdti la nadn Aedcvoernsoe mSeilsetc tsisuoangid g• eh Cset HeddiAd Pns’oTt mEwRaen t2th 4tion • gjo 4inn5 1eawny. Can you Is Fun greater extent than in North Korea. In South Korea a worker earns more
guess what the economist suggcelusbte tdh?at would have him as a money if he provides goods and services of value to consumers or if she
The market structure is simple but the assumption oInf satesyamd moef trpica yiinnfgo rmthae- capmtaeinmsb efro, rth uesa pciho neperriisnogn tehre placed on invents new ideas for more efficient production. Those same incentives do
tion has surprising consequences. analysis of adverse selection.
want to sell insurance to the people who most want to bbuoya—rd thshisi pis itnh eG braesaict Britain, the economist suggested paying for not exist in North Korea, where workers are rewarded for being loyal to the
problemS uopf paodsvee trhsaet syeoleuc wtieorne. a buyer in this market. Howe amchu cphr iwsoonueldr tyhoaut bwe awlkielld- off the ship in Australia. InGES 1793, the new system ruling Communist Party. In short, South Korea
chsfhtnpslhyuoraaeasepirrlnrtTcses epe tehd a!rhml ey b oiAeptsv e lo ros aiihlo .spnofsb i fTtrggwiejiaicut hh ct ehessoe aaht dpin pt itoc’n r d dpsaiobt oc or tuyndeehiirn nnte atearoudl gt o iaohfhnev l s iru euii testtcqrsrrhytle ruarii eij minftiocci o cndatabnirkonn na .iali bgeaeycw Athl -h eeaeadht un,sss s e eu rdbsktvprrk hpeyiehaoycepcr sisa toa tlgshsniatuicheihtppttqltbeegeskhhier allu eol-pnsmuuedpeeet. daLn rat i. rrrmmlBiieotsaleei eicn hcvrtna$Ehsmaeio csstutoeygneeaeao’ oan xa1fasssyvfara lr(g sus n u. dp lT0ileeu eort pTNSegl ffb, sic haiet eeBa r, n lctsirfsnissr0to12hothlehmsecn o veoeioe— weiueTV ywcc0 tft qmniiedei cwt Pry d ehasatgroemfw0hpotum egt o pr erdbl h hea nht iu waarc he aacaehrphmi rnfpbitey.ie tseeasre lsotoariy c d el eia uuoy eeoh nrA uylteerarnpmorScs flfsoacshytftog i poonetm sy,aeu hu ka$aaerui c o ue irsrsdrnyvns rtttmi1ebenraaiiit s rs f hhhouc eicgcest.w aor e r2lw nap o ryfebeeeeusm -a pt ekf,onaeeghliufi i0 erlxurl:gnnalduxud se lsrl0Sccmeiise oef ass m nsb0aoietc el dmtweg vflsgoL$elh.ardit,e x n,l an er 8hm Sp efcab aia,plttt acm ,csatunaulholha l0brust eaaroetcetehipo,ae 0t? tur r n mmp,kha tiS t cnp0isYmtop ghgn p:a pehs e ocopoylihn lyaa rervaeunaes(conl eumot-l:cseeecr momf aib suq u orwt hnAtrw eiimleaayuhrsaosasrsagl.bla s ? yt naesnqni oscTuinsa aiolg oa udN luiai srf(osois fhcnt u femr et12apihy(te ,aypo tr sdl hulsoc iirla×sep eu.ltes erasuthunyied c I lesme esdtuw)ds$snemhaa a t de c 8mnaahr12s.w afoP o do fTsampo, cpaafra.r0f rsht neo lrta ehtc,h cyN0o w ydhr trn)tusada,z0hstn oi,. a P$ oc raoths seo)n$enlg. nwatL,y1lw we adiue 1yol +ooyl2B et eb itmyos,2w? fson , tbmh uou0us (ouhh, iusiyie•0 12s0ytrygswn eo p ( e0a0eew Agawhrc×cmw abttOsnCbun lr0re hateieullskeluigsos ateHoe .ktsae larn $ raneiunlhtuyrrTBtDsotkmea yaAsrn1s h rs eetdl brer fe ouoqo yldh2edPteotiver ieaoo.n eruhhmugf kf ,s re To s ni s f0bt Doeacthreayewn nwapt.plElth p,0e slt lybo neoooirScseuooar tRop kt0iil otnsuisheywuenwl reulrosnotele)r elfedb)cca ume’ien kt7 ptyswr ’ris n = dhelihir tmlv tyetpe etsnlma •t eg.o iainl aihtleq ”hmlwo n$iv nnls i$os lker?ioutin2w1o1esestgegast8 nh oodseeou2sa e gm0fs,Ne s),ig te rbk 1lst m d0,ut,lx tcsGruoa l0 rpoo tohton 0 yipwaasnhua mhp0wsano.rhaua rm0p:lthdeyoe0-e aesltn. okma;ae ewy ii.u eHydn e nnmmo ca bc tews tceotnohnh o e oheiedtofiwwlamrdonnoasM lyen stflta. nv w ihtmtial▲id ihlevcrrh erxesbhteaoed iwesets u i s> tiadCaahhde g tnrEiHxidaeehGPadpdcdpanbliEosocoys s’o la Ct us naaht usomowiKitnotstaln h m oladmep teaui hsenBy nc p.eeisYtp aco W tge sstysOesroenn oeu a hn eafGU eoPetar jnaveoivmdttmrRcdl eohsitida:n S vriu sseio esyEe“csctaa usohatyhsLEnlo h :rrsooetyFc tc?phrui ihh noanr a iefitfngnctioseref r iore n msni JOHN KOBAL FOUNDATION /MOVIEPIX/GETTY IMAbrtnmts g iiho vg ymbotoe i siitrvg bod ma dereuteaialaepFef tts f d ts biIessicteGreeonou.thnn a lUeatti 9l icv.mtR9tooih%onEe aruno.t. n tm2LO rdauei7encntnr’s.de-ss.6 NKOO1RRpInTeEcHnAea nlttiivees st haarte mreowtiavradtse abnedh avior. umamiciKlaramnendlsreos oaevd euFOTarrsera nrekl iexhWnt gvatme stpe”t ue httaei h eshrarsegss er earapftydeeikv ix nm lfi2 seeipGtsc pt7y ctoeNaetebse.u innfr 6ycner oist tei.memgsosbaaraen llt eraehldlNh yos nnsa s irilyvtoetmdKangh, ee rtra oes teinoaCpnhlb rrma r,lei e fhr eiztra.ateaT fhaoetn tfnipa eiimand cciit nwt g.trei rsedeS Broa isn soeSnupuu scduo3 otrlty,teot u a sh wrasnd it uons hpudsh Kcfdp ra c ehot aoabtCrh4 cpinelroaee.ehevedsn , aer“ i tn ati reoNnias amxe s r , issopetEume at erahcekstorishohnee--tf
price will fall. More generally, price signalsb aen wd itlhlien ga ctcoo mpa-y for a used car is $8,000. club that would have him as a P’YONGYANG We said earlier that countries with a high
panying profits and losses tell entreprenTeuhres mNwaohrtakitce eta rswetrahusa ctot uifs r ew riso nsigm wplieth b tuhti st hoeu tacsosumme.p Etivoenn oiff laostysm omf peetoripcl ei nwfoorumlda -like tom ember, thus pioneering the GDP per capita have a lot of p hysical and human
the economy consumers want expantidoend h baausny ds ua rwppMlhruiasmti n agart e c$aos1n 2s,e0q0u0e nanceds .lots of people would like to sell a plum at $12,000a,n alysis of adverse selection. capital that is organized using the best techno-
they want contracted. If consumers wanSt umtphpoeorreese c itsoh Omnatop y uomtuear rwsk, eert ef oa rb upyluemr isn. Pthluism ms—arkteChote.w eHhn3ioeg_whEc- omqn_uuCacHlh0it1 y.iwn duod su e1ldd ycoarus —bed wonil’lt- trade. 8/18/14 4:23 PloMgical knowledge to be highly productive. But
pthreic eins daunsdt rpyr owfiitlls einx pthane dc.omputer induionsfg trl eytmo Tw ohpinlWaaly sti e niaf socn aCarrdse s muaap smaleuur seakmedned std ,t ch ftaahairtle? u tYrpheore.o ureb mawbiieglirhteyt oriesn al1syo tnthw atoth ayttyo spuien swc eoi lflt hubesere edp uarrec heaqsuinagl nau lmembeorns SEOUL KSOOURETHA fmacatnonras ofrfo pmro hdeuacvtieonn. Fdaoc ntoorts foalfl pfrroomdu tchteio snk ym liukset
iaocPtbmtmthhnaarsoaaeen. ndnlL res a kmkyeEvobrbr eoesneeuuactsnit tr,nepdotr kg seste,mng oeu rpmootP coopr pc teadreaabrefs nyn niosasrmf fetindmoub.eAu ukulresA rm rc cfsiciauslts hre, san mpa w dps t otosse ari.h.mrt ev kia oBtspeeslHau i oan lsflllnimew toaenm,kcirs dle.ih sr noeruutiEtf srnhospua evtgaa tlr se cnneyicurtmyr ,odhc s ca hm?paiebtts steho u ps Aabefrta$Ehsmbaeiteurhettt in ax1eadvt ar llusted edpl 0 dlneo oTNSeef,iwbc e o,nocrtlnidfs0o12huohlw c noofoi eectTsttguahteas n0 ftl sihhhippicwvtirsra loy iesosaniSfog0hhi t t etieeeeanre prd nomwhurhmhan On wsaret yhraredeaoa f, pb gedeeate e o kay oo alslbt iiiafgg pbu uy s. ll lscm h”yt.lttn rrtm o ucsatef eeohp uhly taoo tc uohe ataraB wsds nahuaIreVISIBLEHAND.ru t ,ooyeue enr qirnyvn s iCareacapuncore rs ue fc uottueeiesi w ntrh e owmh adwiyenerl r orhafsuaalptya yk w eeons rae seghclilfriepnr aslboo e r iriclgna lfdthuoi se tl tfnllfros,feulronopceii seyo abooha l ro mn anysrba ritvcyc ulslec gwueor ebcnsy favf ltgooeaeea eeit t-,ex eristtf,qt a nanrc hrr cufo b htia,ptltt a sauo chs’uathfhota ut egbruit aohtm ecaseehieia seohe ulr nrrem p,keai t cista efiewtAtp ggn r.dah g his ecc cpeA eylithi yaoh awvgasuaanlahaclsc moyt-ksrrerneeer lmf eaaiyiq sss u orrtoton tlrt re.t riwse-l ayuhreo ssrfs mfifg lTq.vol ? ni y laeceoe oscTula eatuurlk aahg v Nmhrai rrf (toses$rs ate ulefeshare12eephkydtle 8tanoo g isid deoleson ilr t×,epou.v neees y e0 tnu gemdq cI l wi, mescpd 0uw cps$osna a u paate a aio0cn8nmrrht2.w urfoaor yodr fTiao.r,i dee.lefctcauer0 fe rsih▲foror,r e htetTc ,r vc0 s s eyfyhtoirns, t duse oa d,n0hibh , ca shm ororsiosaro)n $ye niel.sa,yo w atrre f>fte 1 oC sl+uo eycB uw erbap ssla2w?usolnhHr eor liIpeu uure(ogm,neibsu’idiuwo,lE0 t12svgy tyeyg.wn, i au ps oc0 Ceehnedagaw gerog×mcuenrrr0relt -Kg edefi , ilsonos t edtcq.“sne toas m$ oae tturac w uDukdmiyagn i1sl h cra tlnbYr ecoeeao rhd2 dhorotieootlir gaaOagfuh f ,ini hes n sons tnnt0t bhetraye hnowaUyge-agrwhs,0es t.o no e Rtp h0iir uisrhwnlleetS l)elff u’ie nk sesE isn=oie mll tenLllmagvo u,lil F$ie nl t r lk?hoctwr1 etga h eeeotsm0sN h i stest g,l e Guo l0pohtoo sh ms0ewavn.rhpue-yor0.opeaae y .uHy-!ne o c twsttnohh ASHLEY COOPER/CORBIShtoiwlaoolyetfl. ▲ >C HGPabiEocoaC tusoKst oe t hsB .eY aWsyOe h aUPanitRcd da SssoEes oayLrsoFc?uh ifnofre r JONATHAN ERNST/REUTERS/LANDOV JASON REED/REUTERS/LANDOVCSoouautnet hrY sKopouar ceTeae. lal nWd hNicohrt hC Koournetar yp hHoatos gBraepttheerd Iants ntiitguhtti ofrnosm? bncoTwaoGlaeorfwieD pgg tDTrtopia nhePton hroa ef otrsilur p hgez,dyo wseelaaoau,mf rdtn-enuwc i iai cde nzpntlerad tehtuec phte .ceme reit raS tpnhceoianeiohntesf mm it hmsntvn nirwieaovboolsavsaeelewdti oerltimrluyloh vg yiB dcen ya,nt ttsetio sfsho.tg.a etm eePri cpbCItry tuhud eeso aoosyn tecnrtipuscah osdior ni bcanOoa outpaeglsdrf lr t no iiu etcen cpeouhrcosart ?dna taeopm iwt Tndrvid ietnmebediuhast.rsi lthcenBast,. ittsk ehtaiieauoegdnu tin hdmIidiat odiie ndngaeniannohdgass
Speculation Nosatilcee iws haa tl eims wonro. nTgh we itrhe atlhitiys oisu ttchoamt ea. bEovuetn e 3irfn5 ml oemtnst i losleifo nptn et eoxpt lmeI news tsoahgueel dsm tlaoi krkee tto f or used cars . . . The lemons are the only
buy au pseludm c aaNrt s $1(a2n,0d0 0s manaldl ltortus cokfs )p ewoeprlee wboouulgdh etlvi keaeryn tudos e ssr oeollfld oa i l paslukuimnsge dtah tce am$r1s t 2oth, 0a0t 0w, ill be bought and sold.
Suppose that you expect that a war in the Middle East is likely next year and use more or less oil as the case
that, if it should occur, the supply of tTohihel arwet iiislsl adn meoc armreEIkaaesretk ,fe attih lfueorrree .b pylu pmuss.h Pinlugm usp— ththee high-qwmuaerasrlsaiantgytei ndug. s Sseyudspt epcmoasr ews —othrkadet odth nvee’ tr yt rade.
price of oil. How could you profit fromW yeo uasrs uemxpHeedc ttahtaiot nth? eTre.h ew. ew.reay ao tnol ynm twakode typ es towf heulls. eIsde s uch a mbessaeging says- utiful, uncluttered design with
money is to buy low and sell high, so you should buy oil today when the tem likely to allocate resources
price is low, hold the oil in storage, acnadrs ,t hbeunt tshelel Toitu ntceoxmt yee gare tas fteevre nw amr obrree adkisst urbing aws wheelnl a s prices? Why or why Cowen3e_Econ_CH27.indd 520 8/26/14 3:03 PM
out, when the price is higher. Figure t7h.e2r eo nar eth me anEneyx tq puaaglieti eshs oowf su stehdis cparro cfreosms, low ton ohti?g Wh.h at is the difference
which is called speculation. WCeo whean3vee_E Tucohsnee_dC Hg v2e4en.irnetdridca al4 l5El 1osugpicp liys tchuartv oesf, tmphee avniicinicogu tsh tcaitr ucle, orr “ebadnedetw atethsheen p trhiceea m syesstnseamg?e dsystem captions that 9/d6/14 9r:40 AiMve the story.
spiral.” Buyers can’t easily tell the quality of a used car so
theT ahme otuonpt poafn oeill sihs ofiwxse dw, htoat shimapppliefynt sht hewyei tpdhlioaaygu rtta hsmepS e.acvuerlaatgieosn. A. Pn raovdeuracgtieo pnr itcoed, ahyo weve>r, mFnierevmeasrn iwsn e tnhte b oalndk Sruopvtie. tH Uonwio dno NDOV
idspospioi selhir Tcniutguohtp hldebta e .taabidynoo dbnta yt,nt o otdtmhhd eeat h py ww’easnya apr re, prl di pucsiuhets rs ohuiiswtip nlitsongs w w ttuohh p (eap s tttoho ohieirnla a ftpttguahgmu ihvaposoenteae)aueow—u.trrdr n daekF etgss tecmh u heppatwuet uirrru nqsasiiico c crnttuhrdwiheeedale r l n(pboodsifpptpoeurnpuyoroerry l cisy icdoocee nt ueruufohstt ssh l ctft e ab thteaijh)tohirure .io efiwe o mg Nncc tnohwaaq,hpo .rrreueh issstrSl f.t iao-l r fcmpiTnqolowneeeutrmahg mcie trCa teshuvkl ytao iaopeellt onaeOtyrt oa wt, ,sp wvi oa atnwaananhWruiyrtitsdee.ei tl h lroa,ra bT l osef b iEs uobnbh utlooaryee yetN trf su erapnhrelr ne’idotg., u•Sp chgrprcee-oee isdqntfsyrncit auuTotugoic tncula mefaortli gA totinihonchit omfyge -ai gnnBi nkr foni ustwoAh ttuvtihshar eRe?tini oapfnltRurt ieeacmnneOcd pce tehdK cat toonh- gee s. MODERN PRINCIPLESATHAN ERNST/REUTERS/LA OF ECONOMICS, THIRD EDITION
Of course, in the real world not every used car for ON
for consumption today and pushes up today’s price (point c). Next year, J
sale is a lemon. The reality is that about 35 million
however, when the war occurs, production is low but consumption is higher In the market for used cars . . . The lemons are the only
than it would have been without spuesceudl actiaorsn (aanndd psrmicaelsl atrreu clkosw) ewr ebreec abuosue ght and sold used cars that will be bought and sold.
the speculators sell oil from their inventories (point d). Notice that with
speculation, preparations are made for any disruption in oil production and
oil prices are smoothed.
Cowen3e_Econ_CH24.indd 451 9/6/14 9:40 AM
Cowen3e_Econ_CH07.indd 121 8/18/14 4:25 PM
C O W E N • T A B A R R O K MODERN PRINCIPLES OF ECONOMICS, THIRD EDITION
The compelling examples enhance the
story and illuminate concepts...
KEY: CHAPTER OPENING means chapter opening example; Chapter 9: International Trade S
E
RUNNING EXAMPLE means running example in the chapter. Page 163: What is the cost of the sugar tariff?
E
Page 168: How does trade affect child labor?
Chapter 1: The Big Ideas T
Page 1 CHAPTER OPENING: A small change in wording has Chapter 10: Externalities: When the Price H
is Not Right E
a big effect on the incentives of captains transporting
I
convicts to Australia. Page 177 CHAPTER OPENING: The death of Calvin Coolidge’s N
Page 3: How can drugs be too safe? son from a burst blister
V
Page 182: How is beekeeping a private solution to
Chapter 2: The Power of Trade and I
Comparative Advantage externality problems? S
Page 187: How do tradable pollution allowances I
Page 21: Economics is about cooperation, not just B
really work?
competition. L
Chapter 11: Costs and Profit Maximization E
Chapter 3: Supply and Demand
Under Competition H
Page 29 CHAPTER OPENING and RUNNING EXAMPLE: Intuitive A
Page 195 CHAPTER OPENING and RUNNING EXAMPLE: What are
picture of the demand for oil and why it slopes N
nodding donkeys?
downward D
Page 36: Intuitive picture of the supply of oil and why it Chapter 12: Competition and the Invisible Hand
.
slopes upward Page 230: How does the invisible hand minimize the total C
O
Chapter 4: Equilibrium: How Supply and Demand industry costs of production?
M
Determine Prices
Chapter 13: Monopoly
Page 47 CHAPTER OPENING and RUNNING EXAMPLE: What Page 235 CHAPTER OPENING and RUNNING EXAMPLE: Why is the
pushes and pulls prices toward their equilibrium values?
life-saving drug Combivir that fights AIDS priced so
Page 49: Why does a free market maximize consumer plus
much higher than marginal cost?
producer surplus?
Page 242: How prone are monopolies to corruption?
Chapter 5: Elasticity and Its Applications Page 244: Are patent buyouts a possible solution to
monopolies of vital drugs?
Page 74: How have American farmers worked themselves
Page 247: Why can cable TV be so bad and so good?
out of a job?
Page 248: How did regulation make California’s 2000
Page 75: Why is the war on drugs hard to win?
power crisis worse?
Page 80: How successful are gun buyback programs?
Page 81: The economics of slave redemption in Africa Chapter 14: Price Discrimination and
Page 84: How much would the price of oil fall if the Pricing Strategy
Arctic National Wildlife Refuge were opened up
Page 259 CHAPTER OPENING: Why is the AIDS drug Combivir
to drilling?
priced high in Europe and lower in Africa?
Chapter 6: Taxes and Subsidies Page 264: How do universities practice perfect price
Page 101: Health insurance mandates and tax analysis discrimination?
Page 102: Who pays the cigarette tax? Page 268: Tying: Why does Hewlett-Packard force you to
Page 106: What is the deadweight loss of California’s buy their ink if you use their printers?
water subsidies to cotton growers? Page 269: Why does Microsoft bundle together a bunch
Page 108 : Wage subsidies? of programs in their office software?
Chapter 7: The Price System: Signals, Chapter 15: Oligopoly and Game Theory
Speculation, and Prediction Page 288: How prevalent is the Prisoner’s Dilemma?
Page 115 CHAPTER OPENING: The Invisible Hand and a Page 292: Why do price matching guarantees tend to
Valentine’s Day rose lead to higher prices?
Page 117: How does the price of oil affect the price of Page 294: What is the cost of loyalty programs to you?
brick driveways? Chapter 16: Competing for Monopoly:
Chapter 8: Price Ceilings and Floors The Economics of Network Goods
Page 133 CHAPTER OPENING and RUNNING EXAMPLE: Why did Page 310: Why did the QWERTY keyboard win out over
Nixon’s price controls lead to shortages and lines? the Dvorak keyboard?
Page 143: How do rent controls work: and fail? Page 313: Is music a network good?
C O W E N • T A B A R R O K MODERN PRINCIPLES OF ECONOMICS, THIRD EDITION
S Chapter 17: Monopolistic Competition Page 540: Why bombing a country can raise its
E and Advertising growth rate
E Page 319: How much market power does Page 553: How do spillovers dampen the generation of
T
new ideas?
Stephen King have?
H
Page 325: What aspects of Coca-Cola are advertised? Chapter 29: Saving, Investment, and the
E
I Chapter 18: Labor Markets Financial System
N
Page 335: How much is education worth? Page 586: Why was leverage a chief cause of the financial
V
Page 340: How much of labor market outcomes can be crisis?
I
S attributed to discrimination? Page 589: How did shadow banking contribute to the
I financial crisis?
Chapter 19: Public Goods
B
Chapter 30: Unemployment and Labor
L Page 353: How likely will an asteroid hit Earth and cause a
Force Participation
E catastrophe?
H Page 360: How New Zealand prevented a tragedy Page 616: Percent job losses in post-1945 recessions
A of the commons Page 620: How did the pill help increase female labor
N force participation?
Chapter 20: Political Economy and Public Choice
D
Chapter 31: Inflation and the Quantity Theory
. Page 373: How do special interests such as U.S. sugar
of Money
C growers push for favorable legislation?
O Page 380: Democracies and the mean voter theorem Page 627: Why did money growth lead to hyperinflation
M Page 383: Democracies and famine in Zimbabwe?
Page 642: Why is inflation painful to stop?
Chapter 21: Economics, Ethics, and Public Policy
Chapter 32: Business Fluctuations:
Page 396: Should eating horses be banned?
Aggregate Demand and Supply
Page 397: Is the French government paternalistic?
Page 658: Real shocks and the weather in India
Chapter 22: Managing Incentives
Page 670: Aggregate demand shocks and real shocks in
Page 411: Is it smart to have profit-seeking firms
the Great Depression
run prisons?
Chapter 33: Transmission and
Page 420: Do nudges work?
Amplification Mechanisms
Chapter 23: Stock Markets and Personal Finance
Page 682: Labor adjustment costs
Page 440: Can speculative bubbles be identified?
Page 686: Collateral damage
Chapter 24: Asymmetric Information:
Chapter 34: The Federal Reserve System and
Moral Hazard and Adverse Selection
Open Market Operations
Page 451: Adverse selection in the used-car market
Page 703: The Fed, short run interest rates, and the
Page 456: How do you signal your skills in the
Federal Funds rate
job market?
Page 706: The Fed and systemic risk
Chapter 25: Consumer Choice
Chapter 35: Monetary Policy
Page 478: How much should Costco charge for
Page 729: Can the Fed deal with asset price bubbles?
membership?
Page 730: Rules versus discretion: What about a nominal
Page 482: Labor supply and welfare programs
GDP rule?
Chapter 26: GDP and the Measurement
Chapter 36: The Federal Budget:
of Progress
Taxes and Spending
Page 503: GDP does not count leisure.
Page 754: Is government spending wasted?
Page 504: Why does GDP not count environmental costs?
Page 758: Will the U.S. government go bankrupt?
Chapter 27: The Wealth of Nations and
Chapter 37: Fiscal Policy
Economic Growth
Page 779: Why did fiscal policy make matters worse
Page 520: Economic growth: South Korea versus North
in Argentina?
Korea
Page 780: When is fiscal policy a good idea?
Page 526: Why do landlocked countries have lower per
capita GDP? Chapter 38: International Finance
Chapter 28: Growth, Capital Accumulation, and Page 790: Thinking about the U.S. trade deficit and your
the Economics of Ideas (Solow Model) trade deficit
MODERN PRINCIPLES OF
ECONOMICS
Third Edition
Tyler Cowen
George Mason University
Alex Tabarrok
George Mason University
Vice President, Editorial: Charles Linsmeier
Vice President, Editing, Design, and Media Production: Catherine Woods
Executive Editor: Carlise Stembridge
Marketing Manager: Tom Digiano
Consulting Editor: Paul Shensa
Senior Developmental Editor: Bruce Kaplan
Supplements and Media Editor: Lindsay Neff
Art Director: Diana Blume
Cover and Text Designer: Diana Blume
Director of Editing, Design, and Media Production: Tracey Kuehn
Managing Editor: Lisa Kinne
Project Editor: Fred Dahl, TSIevolve
Photo Editor: Robin Fadool
Production Manager: Barbara Anne Seixas
Supplements Production Manager: Stacey Alexander
Supplements Project Editor: Edgar Doolan
Composition: TSIevolve
Printing and Binding: RR Donnelley
Cover Image: © Oleh Barabash/Alamy and Jim Roof/myLoupe.com
Library of Congress Preassigned Control Number: 2014952563
ISBN-13: 978-1-4292-7839-3
ISBN-10: 1-4292-7839-0
© 2015, 2013, 2010 by Worth Publishers
All rights reserved.
Printed in the United States of America
First printing
Worth Publishers
41 Madison Avenue
New York, NY 10010
www.worthpublishers.com
Economics is the study of how to get the most out of life.
Tyler and Alex
this page left intentionally blank
K
O
R
R
A
B
A
T
X
E
AL
A B O U T T H E A U T H O R S
Tyler Cowen (left, in North Korea) is Holbert C. Harris Professor of
Economics at George Mason University. His latest book is The Great Stagnation.
With Alex Tabarrok, he writes an economics blog at MarginalRevolution.com.
He has published in the American Economic Review, Journal of Political Economy,
and many other economics journals. He also writes regularly for the popular
press, including the New York Times, the Washington Post, Forbes, the Wilson
Quarterly, Money Magazine, and many other outlets.
Alex Tabarrok (right, in South Korea) is Bartley J. Madden Chair in Economics
at the Mercatus Center at George Mason University. His latest book is Launching
the Innovation Renaissance. His research looks at bounty hunters, judicial incen-
tives and elections, crime control, patent reform, methods to increase the supply
of human organs for transplant, and the regulation of pharmaceuticals. He is the
editor of the books Entrepreneurial Economics: Bright Ideas from the Dismal Science
and The Voluntary City: Choice, Community, and Civil Society, among others.
His papers have appeared in the Journal of Law and Economics, Public Choice,
Economic Inquiry, the Journal of Health Economics, the Journal of Theoretical Politics,
the American Law and Economics Review, and many others. Popular articles have
appeared in the New York Times, the Wall Street Journal, Forbes, and many other
magazines and newspapers.
v
BRIEF CONTENTS
Preface ...........................................................................................................xxiv
CHAPTER 1 The Big Ideas ...............................................................................1
CHAPTER 2 The Power of Trade and Comparative Advantage ....................13
Part I: Supply and Demand
CHAPTER 3 Supply and Demand ..................................................................27
CHAPTER 4 Equilibrium: How Supply and Demand Determine Prices .........47
CHAPTER 5 Elasticity and Its Applications ....................................................67
CHAPTER 6 Taxes and Subsidies ..................................................................95
Part 2: The Price System
CHAPTER 7 The Price System: Signals, Speculation, and Prediction ..........115
CHAPTER 8 Price Ceilings and Floors .........................................................133
CHAPTER 9 International Trade ..................................................................161
CHAPTER 10 Externalities: When the Price Is Not Right .............................177
Part 3: Firms and Factor Markets
CHAPTER 11 Costs and Profit Maximization Under Competition ...............195
CHAPTER 12 Competition and the Invisible Hand......................................225
CHAPTER 13 Monopoly ..............................................................................235
CHAPTER 14 Price Discrimination and Pricing Strategy ..............................259
CHAPTER 15 Oligopoly and Game Theory .................................................281
CHAPTER 16 Competing for Monopoly: The Economics of
Network Goods ..........................................................................................307
CHAPTER 17 Monopolistic Competition and Advertising ..........................319
CHAPTER 18 Labor Markets ........................................................................329
Part 4: Government
CHAPTER 19 Public Goods and the Tragedy of the Commons ..................353
CHAPTER 20 Political Economy and Public Choice ....................................371
CHAPTER 21 Economics, Ethics, and Public Policy .....................................393
vi