foundations of economics fourth edition Andrew Gillespie OXFORD UNIVERSITY PRESS

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1 foundations of economics fourth edition Andrew Gillespie OXFORD UNIVERSITY PRESS

2 Detailed contents Preface How to use this book About the Online Resource Centre Guided tour of Dashboard Acknowledgements New to this edition Overview of the book Why study economics? xxiii xxiv xxvi xxx xxxii xxxiii xxxv xxxvii PART 1 Microeconomics i 1 What is economics? 3 The basic economic problem 4 Solving the fundamental economic questions 8 Mixed economies 11 Types of economics 13 Key terms and concepts in economics 16 Rational behaviour 20 CASE STUDY 22 REVIEW QUESTIONS 23 PUT INTO PRACTICE 24 DEBATE 24 S The production possibility frontier (PPF) 26 Scarcity and choice 26 The production possibility frontier (PPF) 27 Reallocation of resources 29 Allocating resources in an economy 29 Productive inefficiency 31 Shifting the production possibility frontier outward Consumption outside the production possibility frontier Present versus future decisions The shape of the production possibility frontier

3 X Foundations of Economics CASE STUDY DATA ANALYSIS REVIEW QUESTIONS PUT INTO PRACTICE DEBATE 3 Demand Introduction The demand curve The shape of the demand curve Marginal and total Utility A movement along the demand curve Income and substitution effects Upward-sloping demand curves A shift in the demand curve The reasons for a shift in demand Individual and market demand Derived demand Joint demand CASE STUDY DATA ANALYSIS REVIEW QUESTIONS PUT INTO PRACTICE DEBATE REFERENCE 4 The elasticity of demand The elasticity of demand The price elasticity of demand Determinants of the price elasticity of demand The value of the price elasticity of demand along a demand curve The price elasticity of demand and total revenue The income elasticity of demand The cross-price elasticity of demand Practical limitations of the concept of elasticity of demand

4 Detailed contents xi CASE STUDY 98 DATA ANALYSIS 101 REVIEW QUESTIONS 102 PUT INTO PRACTICE 102 DEBATE REFERENCES Supply 107 Introduction to supply 107 Movement along the supply curve 108 Shifts in supply 110 The reasons for a shift in the supply curve 110 Industry supply 113 Joint supply 115 The price elasticity of supply 115 The value of the price elasticity of supply 117 Extreme cases of price elasticity of supply 117 CASE STUDY 121 REVIEW QUESTIONS 121 PUT INTO PRACTICE 122 DEBATE 123 REASEARCH TASK Market equilibrium 124 Markets 124 Equilibrium 125 The effects on the equilibrium price and quantity of a change in demand 126 The effects on the equilibrium price and quantity of a change in supply 130 How can supply and demand analysis help us? 134 The introduction of an indirect tax 137 The introduction of subsidies 139 Interrelated markets 140 CASE STUDY 140 DATA ANALYSIS 144 REVIEW QUESTIONS 144 PUT INTO PRACTICE 145 DEBATE 147

5 xii Foundations of Economics The free market system 149 The free market 149 Advantages of the free market system 150 The disadvantages of the market system: Market failures and imperfections 154 CASE STUDY 170 REVIEW QUESTIONS 170 PUT INTO PRACTICE 171 DEBATE Intervening in the market system 174 Intervention in markets 174 Examples of government Intervention in the market system 176 Who is responsible for UK merger review? 177 Consumer protection 178 Problems of government Intervention in the market system 187 Nationalization 188 Privatization 189 Reasons to privatize 190 Problems of privatization 191 Problems of government Intervention in markets 192 CASE STUDY 193 DATA ANALYSIS 194 REVIEW QUESTIONS 194 PUT INTO PRACTICE 195 DEBATE REFERENCE Costs: Short run and long run 198 The importance of costs 199 Short-run costs 199 Long-run cost curves 211 REVIEW QUESTIONS 220 PUT INTO PRACTICE 221

6 Detailed contents xiii DEBATE 10 Revenues, costs, and profits Introduction Total revenue Marginal revenue Marginal revenue and total revenue Total costs Marginal costs and total costs Profit and loss The difference between accounting profit and economists' profits: Normal and abnormal profit Profits versus profitability Profit-maximization: The marginal condition The decision of whether to produce or not Business objectives Other objectives Howtogrow CASE STUDY DATA ANALYSIS REVIEW QUESTIONS PUT INTO PRACTICE DEBATE REFERENCES 11 Perfect competition Why study market structures? Introduction to perfect competition Perfectly competitive firms as price takers Short-run equilibrium in perfect competition Long-run equilibrium in perfect competition Deriving the supply curve in perfect competition The short-run and long-run industry supply curve Summary CASE STUDY

7 xiv Foundations of Economics REVIEW QUESTIONS 261 PUT INTO PRACTICE 262 DEBATE AAonopoly 263 Infroduction to monopoly 263 Demand and marginal revenue for a monopolist 264 Price and output decisions in a monopoly 264 Monopoly and efficiency 266 Monopoly compared to perfect competition 267 Should monopolies be prevented? 267 Contestable markets 270 Barriers to entry 270 Price discrimination 273 Conditions for effective price discrimination 274 Perfect price discrimination 276 The benefits of price discrimination 277 CASE STUDY 277 REVIEW QUESTIONS 279 PUT INTO PRACTICE 279 DEBATE REFERENCES Oligopoly 282 Infroduction 282 The kinked demand curve model 284 Cartels 288 Game theory 290 Summary 294 CASE STUDY 294 DATA ANALYSE 295 PUT INTO PRACTICE 296 DEBATE REFERENCES

8 Detailed contents 14 Monopolistic competition and non-price competition 299 Introduction 299 Non-price competition 301 Porter's five forces analysis of market structure 303 CASE STUDY 306 REVIEW QUESTIONS 307 PUT INTO PRACTICE 307 DEBATE The labour market 309 The labour market 309 The supply of and demand for labour 310 Labour supply 310 Transfer earnings and economic rent 312 The wage elasticity of supply of labour 312 The demand for labour 315 The wage elasticity of demand for labour 316 Wages in a perfectly competitive labour market 318 A firm's decision to hire employees 319 Changes in demand and supply conditions in the labour market 320 Wage differentials in labour markets 321 Limitations of the marginal revenue product model of wage determination 327 Minimum wages 327 Living wage 329 CASE STUDY 330 DATA ANALYSIS 331 REVIEW QUESTIONS 333 PUT INTO PRACTICE 334 DEBATE PART 2 Macroeconomics Introduction to macroeconomics 339 Introduction 339

9 xvi Foundations of Economics Government economic objectives Policy Instruments Policy debates Policy conflicts CASE STUDY REVIEW QUESTIONS PUT INTO PRACTICE DEBATE Equilibrium in the economy 351 Infroduction 351 Equilibrium in the economy 352 The circular flow of income 352 Injections (J) 353 Withdrawals (W) 355 Adding in injections and withdrawals to the circular flow 357 Gelting to equilibrium: The adjustment process 358 Changes in planned injections and withdrawals 360 The aggregate demand schedule 362 Aggregate demand and potential Output 364 Reflationary policies 366 The multiplier effect 367 How does the multiplier work? 368 The size of the multiplier 369 The multiplier in an open economy 370 CASE STUDY 371 DATA ANALYSIS 372 REVIEW QUESTIONS 374 PUT INTO PRACTICE 374 DEBATE National income and the Standard of living 376 Infroduction 376 Measuring national income 377 Real national income versus nominal national income 380

10 Detailed contents xvii National income and living Standards 380 The Lorenz curve and the Gini coefficient 381 Limitations of real GDP per caplta as a measure of a country's Standard of living 383 Human Development Index (HDI) 389 CASE STUDY 389 PUT INTO PRACTICE 390 DEBATE REFERENCES Aggregate demand, aggregate supply, and the price level 392 Introduction 392 Aggregate demand 393 Aggregate supply 394 Equilibrium in the economy 396 The short-run and long-run aggregate supply curve 398 Government policy and the level of national income 405 CASE STUDY 410 DATA ANALYSIS 411 REVIEW QUESTIONS 412 PUT INTO PRACTICE 412 DEBATE Consumption 415 Introduction 415 The Keynesian consumption function 415 The average propensity to consume 417 Other influences on consumption spending 418 CASE STUDY 422 DATA ANALYSIS 422 REVIEW QUESTIONS 423 PUT INTO PRACTICE 423 DEBATE REFERENCES

11 xviii Foundations of Economics 21 Investment 426 Infroduction 426 Gross and net Investment 427 Factors affecting the level of Investment in an economy 427 The importance of Investment 429 The marginal efficiency of capital IMEC) 430 The accelerator-multiplier model 433 Limitations of the accelerator model 435 Cost-benefit analysis 436 CASE STUDY 437 DATA ANALYSIS 438 REVIEW QUESTIONS 438 PUT INTO PRACTICE 439 DEBATE Fiscal policy 441 Infroduction 441 Government expenditure 442 Taxation revenue 444 Marginal and average tax rates 447 Taxation systems 449 A 'fair' tax system 450 Using taxation as a government policy Instrument 451 The Laffer curve 451 Types of benefit 452 Fiscal drag 454 The public sector net borrowing 455 Deficit and debt 455 Automatic and discretionary fiscal policy 457 Austerity 458 Changing taxes versus changing spending to affect the aggregate demand 462 Supply-side fiscal policy 464 CASE STUDY 465 DATA ANALYSIS 466 REVIEW QUESTIONS 467 PUT INTO PRACTICE 467 DEBATE 468

12 Detailed contents )) xix REFERENCE 23 Money Introduction Banks and financial institutions The market for money Fisher's equation of exchange The Quantity Theory of Money and Monetarists Controlling the money supply Problems Controlling the money supply CASE STUDY DATA ANALYSIS REVIEW QUESTIONS PUT INTO PRACTICE DEBATE REFERENCE 24 Economic growth and the economic cycle Introduction Types of growth The output gap What can a government do to promote growth? Productivity The problems of growth The economic cycle The stages of the economic cycle What causes the economic cycle? Indicators of the economic cycle CASE STUDY DATA ANALYSIS REVIEW QUESTIONS PUT INTO PRACTICE DEBATE

13 XX Foundations of Economics 25 Unemployment 513 Infroduction 513 Causes of unemployment 515 Voluntary and involuntary unemployment 518 The natural rate of unemployment 520 Government policies to reduce unemployment 521 The possible costs of unemployment 525 CASE STUDY 526 DATA ANALYSIS 528 REVIEW QUESTIONS 529 PUT INTO PRACTICE 530 DEBATE Inflation and monetary policy 532 Infroduction 532 Calculating Inflation 533 Why does Inflation matter? 535 Anticipated and unanticipated Inflation 536 What causes Inflation? 537 Controlling Inflation 539 Deflation 540 The Monetary Policy Committee in the UK 542 The effect of a decrease in interest rates by the Monetary Policy Committee 542 Quantitative easing 543 Why use quantitative easing? 544 Real interest rates versus nominal interest rates 546 The Phillips curve: Inflation and unemployment 549 CASE STUDY 551 DATA ANALYSIS 553 REVIEW QUESTIONS 554 PUT INTO PRACTICE 555 DEBATE

14 Detailed contents xxi 27 Exchange rates 557 Introduction 557 Exchange rate 557 What determines the external value of a currency? 558 Equilibrium in the currency market 562 Appreciation and depreciation of the exchange rate 564 The impact of changes in the exchange rate 564 A strong currency 565 A weaker or falling currency 566 The advantages and disadvantages of a floating exchange rate system 567 A fixed exchange rate system 568 The exchange rate mechanism 571 The Single European currency: The euro 571 The advantages of being in the euro 572 Eurozone crisis 573 The real exchange rate 577 Purchasing power parity (PPP) 578 CASE STUDY 579 DATA ANALYSIS 580 REVIEW QUESTIONS 581 PUT INTO PRACTICE 581 DEBATE International trade and balance of payments 583 Introduction 583 Exports 584 Imports 585 Absolute and comparative advantage 586 The benefits of trade 586 Terms of trade 588 The balance of payments 590 The balance of payments and exchange rates 592 A current account deficit on the balance of payments 594 Free trade 598 CASE STUDY 603 REVIEW QUESTIONS 604

15 xxii Foundations of Economics PUT INTO PRACTICE 604 DEBATE REFERENCE Protectionism and globalization 607 Protectionism 607 The effect of tariffs 609 The effects of quotas 611 Theeffectsofsubsidies 611 Globalization 614 Defining globalization 614 What benefits can globalization bring? 615 What are the dangers of globalization? 617 Why has globalization been occurring? 618 Rieh vs poor? 619 Critics of globalization 620 What limits the growth of some developing economies? 622 Conclusion 627 CASE STUDY 628 REVIEW QUESTIONS 629 PUT INTO PRACTICE 629 DEBATE 630 S REFERENCES 630 Index 631

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