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Chapter Outline and Learning Objectives1.1 Three Key Economic
Ideas, page 4 Explain these three key economic ideas: People are
rational. People respond to incentives. Optimal decisions are made
at the margin. The Economic Problem That Every Society Must Solve,
page 7 Discuss how an economy answers these questions: What goods
and services will be produced? How will the goods and services be
produced? Who will receive the goods and services produced?
Economic Models, page 11 Understand the role of models in economic
analysis. Microeconomics and Macroeconomics, page 14 Distinguish
between microeconomics and macroeconomics. A Preview of Important
Economic Terms, page 15 Become familiar with important economic
terms.
1.2
1.3
1.4
1.5
APPENDIX: Using Graphs and Formulas, page 24 Review the use of
graphs and formulas.
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>> Microsoft Versus the U.S. Congresson Worker VisasThe
number of jobs requiring technical education and training continues
to increase. Many U.S. firms, particularly those involved with
information technology, have had difficulty filling all their
available job openings with U.S. citizens. U.S. law restricts the
number of foreign specialty workers who may enter the United States
under the H-1B visa program to just 65,000 per year. This visa
program covers a very broad range of workersfrom software engineers
to fashion models. Bill Gates, chairman of Microsoft, testified
before Congress in 2008 that limiting the number of foreign
technical workers allowed into the United States was resulting in a
critical shortage of scientific talent and hindering the ability of
U.S. firms to compete with foreign firms. Gates noted that foreign
students make up more than half of enrollments in computer science
programs at leading U.S. universities:We provide the worlds best
universities . . . and the students are not allowed to stay and
work in the country. The . . . smartest people want to come here,
and thats a huge advantage to us, and in a sense, were turning them
away.
In 2009, though, Congress tightened rather than loosened
restrictions on the immigration of technical workers to the United
States. As part of the 2009 Recovery and Reinvestment Act, a bill
intended to stimulate the U.S. economy during the recession,
Congress put strict limits on the ability of banks and other firms
receiving government aid to hire foreign workers. Economists and
policymakers have debated how restrictions on the immigration of
technical workers affect the U.S. economy. In this chapter and the
remainder of this book, we will see how economics provides us with
tools to analyze many important questions, including the economic
effect of the immigration of skilled workers. AN INSIDE LOOK AT
POLICY on page 18 discusses arguments for and against restricting
the number of H-1B visas for highly skilled workers.Sources:
Turning Away Talent, Wall Street Journal, March 10, 2009; Mehul
Srivastava, Anger Grows in India over U.S. Visa Rules,
BusinessWeek, February 24, 2009; and Grant Gross, Gates Repeats
Request for More H-1B Visas, InfoWorld, March 12, 2008.
Economics in YOUR LIFE!Will You Be Competing with Immigrant
Workers for Your Next Job? Immigrant workers holding H-1B visas
compete with U.S. workers for many high-paying jobs. For example,
the average salary of H-1B visa holders working in the social
sciencesincluding economicsis over $60,000. Managers with H-1B
visas and a professional degree earn $107,500, and computer
scientists earn $71,200. Suppose you plan on working as a software
engineer, a financial analyst, an accountant, a lawyer, or in
another industry where a high level of education is required. Is it
likely that during your career, you will be competing for a job
with immigrant workers from China, India, or some other foreign
country? As you read the chapter, see if you can answer this
question. You can check your answer against the one we provide at
the end of the chapter.Continued on page 16
3
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I Scarcity A situation in which unlimited wants exceed the
limited resources available to fulfill those wants.
n this book, we use economics to answer questions such as the
following:
How are the prices of goods and services determined? How does
pollution affect the economy, and how should government policy deal
with these effects? Why do firms engage in international trade, and
how do government policies affect international trade? Why does
government control the prices of some goods and services, and what
are the effects of those controls?
Economics The study of the choices people make to attain their
goals, given their scarce resources.
Economic model A simplified version of reality used to analyze
real-world economic situations.
Economists do not always agree on the answers to every question.
In fact, as we will see, economists engage in lively debate on some
issues. In addition, new problems and issues are constantly
arising. So, economists are always at work developing new methods
to analyze economic issues. All the issues we discuss in this book
illustrate a basic fact of life: People must make choices as they
try to attain their goals. We must make choices because we live in
a world of scarcity, which means that although our wants are
unlimited, the resources available to fulfill those wants are
limited. You might like to own five BMWs and spend three months
each summer in five-star European hotels, but unless Bill Gates is
a close relative, you probably lack the money to fulfill these
dreams. Every day, you make choices as you spend your limited
income on the many goods and services available. The finite amount
of time you have also limits your ability to attain your goals. If
you spend an hour studying for your economics midterm, you have one
less hour to study for your history midterm. Firms and the
government are in the same situation as you: They also must attain
their goals with limited resources. Economics is the study of the
choices consumers, business managers, and government officials make
to attain their goals, given their scarce resources. We begin this
chapter by discussing three important economic ideas that we will
return to many times in this book: People are rational, people
respond to incentives, and optimal decisions are made at the
margin. Then we consider the three fundamental questions that any
economy must answer: What goods and services will be produced? How
will the goods and services be produced? and Who will receive the
goods and services produced? Next, we consider the role of economic
models in analyzing economic issues. Economic models are simplified
versions of reality used to analyze real-world economic situations.
We will explore why economists use models and how they construct
them. Finally, we will discuss the difference between
microeconomics and macroeconomics, and we will preview some
important economic terms.
1.1 LEARNING OBJECTIVEExplain these three key economic ideas:
People are rational. People respond to incentives. Optimal
decisions are made at the margin. Market A group of buyers and
sellers of a good or service and the institution or arrangement by
which they come together to trade.
Three Key Economic IdeasAs you try to achieve your goals,
whether they are buying a new computer or finding a part-time job,
you will interact with other people in markets. A market is a group
of buyers and sellers of a good or service and the institution or
arrangement by which they come together to trade. Most of economics
involves analyzing what happens in markets. Throughout this book,
as we study how people make choices and interact in markets, we
will return to three important ideas: 1. People are rational. 2.
People respond to economic incentives. 3. Optimal decisions are
made at the margin.
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People Are RationalEconomists generally assume that people are
rational. This assumption does not mean that economists believe
everyone knows everything or always makes the best decision. It
means that economists assume that consumers and firms use all
available information as they act to achieve their goals. Rational
individuals weigh the benefits and costs of each action, and they
choose an action only if the benefits outweigh the costs. For
example, if Microsoft charges a price of $239 for a copy of
Windows, economists assume that the managers at Microsoft have
estimated that a price of $239 will earn Microsoft the most profit.
The managers may be wrong; perhaps a price of $265 would be more
profitable, but economists assume that the managers at Microsoft
have acted rationally on the basis of the information available to
them in choosing the price. Of course, not everyone behaves
rationally all the time. Still, the assumption of rational behavior
is very useful in explaining most of the choices that people
make.
People Respond to Economic IncentivesHuman beings act from a
variety of motives, including religious belief, envy, and
compassion. Economists emphasize that consumers and firms
consistently respond to economic incentives. This fact may seem
obvious, but it is often overlooked. For example, according to an
article in the Wall Street Journal, the FBI couldnt understand why
banks were not taking steps to improve security in the face of an
increase in robberies: FBI officials suggest that banks place
uniformed, armed guards outside their doors and install
bullet-resistant plastic, known as a bandit barrier, in front of
teller windows. FBI officials were surprised that few banks took
their advice. But the article also reported that installing
bullet-resistant plastic costs $10,000 to $20,000, and a
well-trained security guard receives $50,000 per year in salary and
benefits. The average loss in a bank robbery is only about $1,200.
The economic incentive to banks is clear: It is less costly to put
up with bank robberies than to take additional security measures.
FBI agents may be surprised by how banks respond to the threat of
robberiesbut economists are not. In each chapter, the Making the
Connection feature discusses a news story or another application
related to the chapter material. Read the following Making the
Connection for a discussion of whether people respond to economic
incentives even when making the decision to have children.
Makingthe
The populations of the United States, Japan, and most European
countries are aging as birthrates decline and the average person
lives longer. The governments of these countries have programs to
pay money to retired workers, such as the Social Security system in
the United States. Most of the money for these programs comes from
taxes paid by people currently working. As the population ages,
there are fewer workers paying taxes relative to the number of
retired people receiving government payments. The result is a
funding crisis that countries can solve only by either reducing
government payments to retired workers or by raising the taxes paid
by current workers. In some European countries, birthrates have
fallen so low that the total population will soon begin to decline,
which will make the funding crisis for government retirement
programs even worse. For the population of a country to be stable,
the average woman must have 2.1 children, which is enough to
replace both parents and account for children who die before
reaching adulthood. In recent years, the birthrates in a number of
countries, including France, Germany, and Italy, have fallen below
this replacement level. The concern about falling birthrates has
been particularly strong in the small European country of Estonia.
In 2001, the United Nations issued a report in which it forecast
that, given its current birthrate, by 2050, the population of
Estonia would decline from 1.4 million to only about 700,000. The
Estonian government responded by using economic incentives in an
attempt to increase the birthrate. Beginning in 2007, the
government began paying
Connection
|
Will Women Have More Babies if the Government Pays Them To?
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working women who take time off after having a baby their entire
salary for up to 15 months. Women who have a baby but who do not
work receive $200 per month, which is a substantial amount, given
that the average income in Estonia is only $650 per month. Will
women actually have more babies as a result of this economic
incentive? As the graph below shows, the birthrate in Estonia has
increased from 1.3 children per woman in the late 1990s to 1.7
children per woman in 2008. This is still below the replacement
level birthrate of 2.1 children, and it is too early to tell
whether the increased birthrate is due to the economic incentives.
But the Estonian government is encouraged by the results and is
looking for ways to provide additional economic incentives to raise
the birthrate further. And Estonia is not alone; more than 45 other
countries in Europe and Asia have taken steps to try to raise their
birthrates. These policies suggest that people may respond to
economic incentives even when making the very personal decision of
how many children to have.Fertility rate (births per woman) 2.4 2.2
2 1.8 1.6 1.4 1.2 1 0 1988 1990 1992 1994 1996 1998 2000 2002 2004
2006 2008
Source: Marcus Walker, In Estonia, Paying Women to Have Babies
Is Paying Off, Wall Street Journal, October 20, 2006; Sharon
Lerner, The Motherhood Experiment, New York Times, March 4, 2007;
and Statistics Estonia, Population Reference Bureau.
YOUR TURN: Test your understanding by doing related problem 1.7
on page 21 at the end of thischapter.
Optimal Decisions Are Made at the MarginSome decisions are all
or nothing: For instance, when an entrepreneur decides whether to
open a new restaurant, he or she either starts the new restaurant
or doesnt. When you decide whether to enter graduate school or to
take a job, you either enter graduate school or you dont. But
rather than being all or nothing, most decisions in life involve
doing a little more or a little less. If you are trying to decrease
your spending and increase your saving, the decision is not really
between saving all the money you earn or spending it all. Rather,
many small choices are involved, such as whether to buy a caff
mocha at Starbucks every day or just three times per week.
Economists use the word marginal to mean extra or additional.
Should you watch another hour of TV or spend that hour studying?
The marginal benefit (or, in symbols, MB) of watching more TV is
the additional enjoyment you receive. The marginal cost (or MC) is
the lower grade you receive from having studied a little less.
Should Apple produce an additional 300,000 iPhones? Firms receive
revenue from selling goods. Apples marginal benefit is the
additional revenue it receives from selling 300,000 more iPhones.
Apples marginal cost is the additional costfor wages, parts, and so
forthof producing 300,000 more iPhones. Economists reason that the
optimal decision is to continue any activity up to the point where
the marginal benefit equals the
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marginal costin symbols, where MB = MC. Often we apply this rule
without consciously thinking about it. Usually you will know
whether the additional enjoyment from watching a television program
is worth the additional cost involved in not spending that hour
studying, without giving the decision a lot of thought. In business
situations, however, firms often have to make careful calculations
to determine, for example, whether the additional revenue received
from increasing production is greater or less than the additional
cost of the production. Economists refer to analysis that involves
comparing marginal benefits and marginal costs as marginal
analysis. In each chapter of this book, you will see the special
feature Solved Problem. This feature will increase your
understanding of the material by leading you through the steps of
solving an applied economic problem. After reading the problem, you
can test your understanding by working the related problems that
appear at the end of the chapter and in the study guide that
accompanies this book. You can also complete Solved Problems on
www.myeconlab.com and receive tutorial help.
Marginal analysis Analysis that involves comparing marginal
benefits and marginal costs.
Solved Problem
| 1-1idea because we will make a total profit of $500 million if
we produce 11 million. Do you agree with her reasoning? What, if
any, additional information do you need to decide whether Apple
should produce the additional 1 million iPhones?
Apple Computer Makes a Decision at the MarginSuppose Apple is
currently selling 10 million iPhones per year. Managers at Apple
are considering whether to raise production to 11 million iPhones
per year. One manager argues, Increasing production from 10 million
to 11 million is a good
SOLVING THE PROBLEMStep 1: Review the chapter material. This
problem is about making decisions, so you may want to review the
section Optimal Decisions Are Made at the Margin, which begins on
page 6. Remember to think marginal whenever you see the word
additional in economics. Step 2: Explain whether you agree with the
managers reasoning. We have seen that any activity should be
continued to the point where the marginal benefit is equal to the
marginal cost. In this case, that involves continuing to produce
iPhones up to the point where the additional revenue Apple receives
from selling more iPhones is equal to the marginal cost of
producing them. The Apple manager has not done a marginal analysis,
so you should not agree with her reasoning. Her statement about the
total profit of producing 11 million iPhones is not relevant to the
decision of whether to produce the last 1 million iPhones. Step 3:
Explain what additional information you need. You will need
additional information to make a correct decision. You will need to
know the additional revenue Apple would earn from selling 1 million
more iPhones and the additional cost of producing them.YOUR TURN:
For more practice, do related problems 1.4, 1.5, and 1.6 on pages
2021 at the endof this chapter.
1.2 LEARNING OBJECTIVE
The Economic Problem That Every Society Must SolveBecause we
live in a world of scarcity, any society faces the economic problem
that it has only a limited amount of economic resourcessuch as
workers, machines, and raw materialsand so can produce only a
limited amount of goods and services. Therefore,
Discuss how an economy answers these questions: What goods and
services will be produced? How will the goods and services be
produced? Who will receive the goods and services produced?
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Trade-off The idea that because of scarcity, producing more of
one good or service means producing less of another good or
service. Opportunity cost The highestvalued alternative that must
be given up to engage in an activity.
every society faces trade-offs: Producing more of one good or
service means producing less of another good or service. In fact,
the best way to measure the cost of producing a good or service is
the value of what has to be given up to produce it. The opportunity
cost of any activitysuch as producing a good or serviceis the
highest-valued alternative that must be given up to engage in that
activity. The concept of opportunity cost is very important in
economics and applies to individuals as much as it does to firms or
to society as a whole. Consider the example of someone who could
receive a salary of $80,000 per year working as a manager at
Microsoft but decides to open her own consulting firm instead. In
that case, the opportunity cost of her managerial services to her
own firm is the $80,000 she gives up by not working for Microsoft,
even if she does not explicitly pay herself a salary. Trade-offs
force society to make choices when answering the following three
fundamental questions: 1. What goods and services will be produced?
2. How will the goods and services be produced? 3. Who will receive
the goods and services produced? Throughout this book, we will
return to these questions many times. For now, we briefly introduce
each question.
What Goods and Services Will Be Produced?How will society decide
whether to produce more economics textbooks or more Bluray players?
More daycare facilities or more football stadiums? Of course,
society does not make decisions; only individuals make decisions.
The answer to the question of what will be produced is determined
by the choices that consumers, firms, and the government make.
Every day, you help decide which goods and services firms will
produce when you choose to buy an iPhone instead of a BlackBerry or
a caff mocha rather than a chai tea. Similarly, Apple must choose
whether to devote its scarce resources to making more iPhones or
more MacBook laptop computers. The federal government must choose
whether to spend more of its limited budget on breast cancer
research or on homeland security. In each case, consumers, firms,
and the government face the problem of scarcity by trading off one
good or service for another. And each choice made comes with an
opportunity cost, measured by the value of the best alternative
given up.
How Will the Goods and Services Be Produced?Firms choose how to
produce the goods and services they sell. In many cases, firms face
a trade-off between using more workers or using more machines. For
example, a local service station has to choose whether to provide
car repair services using more diagnostic computers and fewer auto
mechanics or more auto mechanics and fewer diagnostic computers.
Similarly, movie studios have to choose whether to produce animated
films using highly skilled animators to draw them by hand or fewer
animators and more computers. In deciding whether to move
production offshore to China, firms may need to choose between a
production method in the United States that uses fewer workers and
more machines and a production method in China that uses more
workers and fewer machines.
Who Will Receive the Goods and Services Produced?In the United
States, who receives the goods and services produced depends
largely on how income is distributed. Individuals with the highest
income have the ability to buy the most goods and services. Often,
people are willing to give up some of their income and, therefore,
some of their ability to purchase goods and servicesby donating to
charities to increase the incomes of poorer people. Each year,
Americans donate more than $300 billion to charity, or an average
donation of $2,750 for each household in the country. An important
policy question, however, is whether the government should
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intervene to make the distribution of income more equal. Such
intervention already occurs in the United States, because people
with higher incomes pay a larger fraction of their incomes in taxes
and because the government makes payments to people with low
incomes. There is disagreement over whether the current attempts to
redistribute income are sufficient or whether there should be more
or less redistribution.
Centrally Planned Economies versus Market EconomiesTo answer the
three questionswhat, how, and whosocieties organize their economies
in two main ways. A society can have a centrally planned economy in
which the government decides how economic resources will be
allocated. Or a society can have a market economy in which the
decisions of households and firms interacting in markets allocate
economic resources. From 1917 to 1991, the most important centrally
planned economy in the world was that of the Soviet Union, which
was established when Vladimir Lenin and the Communist Party staged
a revolution and took over the Russian Empire. In the Soviet Union,
the government decided what goods to produce, how the goods would
be produced, and who would receive the goods. Government employees
managed factories and stores. The objective of these managers was
to follow the governments orders rather than to satisfy the wants
of consumers. Centrally planned economies like the Soviet Union
have not been successful in producing low-cost, high-quality goods
and services. As a result, the standard of living of the average
person in a centrally planned economy tends to be low. All
centrally planned economies have also been political dictatorships.
Dissatisfaction with low living standards and political repression
finally led to the collapse of the Soviet Union in 1991. Today,
only a few small countries, such as Cuba and North Korea, still
have completely centrally planned economies. All the high-income
democracies, such as the United States, Canada, Japan, and the
countries of western Europe, are market economies. Market economies
rely primarily on privately owned firms to produce goods and
services and to decide how to produce them. Markets, rather than
the government, determine who receives the goods and services
produced. In a market economy, firms must produce goods and
services that meet the wants of consumers, or the firms will go out
of business. In that sense, it is ultimately consumers who decide
what goods and services will be produced. Because firms in a market
economy compete to offer the highest-quality products at the lowest
price, they are under pressure to use the lowest-cost methods of
production. For example, in the past 10 years, some U.S. firms,
particularly in the electronics and furniture industries, have been
under pressure to reduce their costs to meet competition from
Chinese firms. In a market economy, the income of an individual is
determined by the payments he receives for what he has to sell. If
he is a civil engineer, and firms are willing to pay a salary of
$85,000 per year for engineers with his training and skills, that
is the amount of income he will have to purchase goods and
services. If the engineer also owns a house that he rents out, his
income will be even higher. One of the attractive features of
markets is that they reward hard work. Generally, the more
extensive the training a person has received and the longer the
hours the person works, the higher the persons income will be. Of
course, luckboth good and badalso plays a role here, as elsewhere
in life. We can conclude that market economies respond to the
question Who receives the goods and services produced? with the
answer Those who are most willing and able to buy them.Centrally
planned economy An economy in which the government decides how
economic resources will be allocated. Market economy An economy in
which the decisions of households and firms interacting in markets
allocate economic resources.
The Modern Mixed EconomyIn the nineteenth and early twentieth
centuries, the U.S. government engaged in relatively little
regulation of markets for goods and services. Beginning in the
middle of the twentieth century, government intervention in the
economy dramatically increased in the United States and other
market economies. This increase was primarily caused by the high
rates of unemployment and business bankruptcies during the Great
Depression of the 1930s. Some government intervention was also
intended to raise the incomes of
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Mixed economy An economy in which most economic decisions result
from the interaction of buyers and sellers in markets but in which
the government plays a significant role in the allocation of
resources.
the elderly, the sick, and people with limited skills. For
example, in the 1930s, the United States established the Social
Security system, which provides government payments to retired and
disabled workers, and minimum wage legislation, which sets a floor
on the wages employers can pay workers in many occupations. In more
recent years, government intervention in the economy has also
expanded to meet such goals as protection of the environment and
the promotion of civil rights. Some economists argue that the
extent of government intervention makes it no longer accurate to
refer to the U.S., Canadian, Japanese, and western European
economies as pure market economies. Instead, they should be
referred to as mixed economies. A mixed economy is still primarily
a market economy because most economic decisions result from the
interaction of buyers and sellers in markets. However, the
government plays a significant role in the allocation of resources.
As we will see in later chapters, economists continue to debate the
role government should play in a market economy. One of the most
important developments in the international economy in recent years
has been the movement of China from being a centrally planned
economy to being a more mixed economy. The Chinese economy had
suffered decades of economic stagnation following the takeover of
the government in 1949 by Mao Zedong and the Communist Party.
Although China remains a political dictatorship, production of most
goods and services is now determined in the market rather than by
the government. The result has been rapid economic growth that in
the near future may lead to total production of goods and services
in China surpassing total production in the United States.
Efficiency and EquityProductive efficiency A situation in which
a good or service is produced at the lowest possible cost.
Allocative efficiency A state of the economy in which production is
in accordance with consumer preferences; in particular, every good
or service is produced up to the point where the last unit provides
a marginal benefit to society equal to the marginal cost of
producing it. Voluntary exchange A situation that occurs in markets
when both the buyer and seller of a product are made better off by
the transaction.
Equity The fair distribution of economic benefits.
Market economies tend to be more efficient than centrally
planned economies. There are two types of efficiency: productive
efficiency and allocative efficiency. Productive efficiency occurs
when a good or service is produced at the lowest possible cost.
Allocative efficiency occurs when production is in accordance with
consumer preferences. Markets tend to be efficient because they
promote competition and facilitate voluntary exchange. With
voluntary exchange, both the buyer and seller of a product are made
better off by the transaction. We know that the buyer and seller
are both made better off because, otherwise, the buyer would not
have agreed to buy the product or the seller would not have agreed
to sell it. Productive efficiency is achieved when competition
among firms in markets forces the firms to produce goods and
services at the lowest cost. Allocative efficiency is achieved when
the combination of competition among firms and voluntary exchange
between firms and consumers results in firms producing the mix of
goods and services that consumers prefer most. Competition will
force firms to continue producing and selling goods and services as
long as the additional benefit to consumers is greater than the
additional cost of production. In this way, the mix of goods and
services produced will match consumer preferences. Although markets
promote efficiency, they dont guarantee it. Inefficiency can arise
from various sources. To begin with, it may take some time to
achieve an efficient outcome. When Blu-ray players were introduced,
for example, firms did not instantly achieve productive efficiency.
It took several years for firms to discover the lowest-cost method
of producing this good. As we will discuss in Chapter 4,
governments sometimes reduce efficiency by interfering with
voluntary exchange in markets. For example, many governments limit
the imports of some goods from foreign countries. This limitation
reduces efficiency by keeping goods from being produced at the
lowest cost. The production of some goods damages the environment.
In this case, government intervention can increase efficiency
because without such intervention, firms may ignore the costs of
environmental damage and thereby fail to produce the goods at the
lowest possible cost. An economically efficient outcome is not
necessarily a desirable one. Many people prefer economic outcomes
that they consider fair or equitable, even if those outcomes are
less efficient. Equity is harder to define than efficiency, but it
usually involves a fair distribution of economic benefits. For some
people, equity involves a more equal distribution of economic
benefits than would result from an emphasis on efficiency alone.
For example, some people support taxing people with higher incomes
to provide the
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funds for programs that aid the poor. Although governments may
increase equity by reducing the incomes of high-income people and
increasing the incomes of the poor, efficiency may be reduced.
People have less incentive to open new businesses, to supply labor,
and to save if the government takes a significant amount of the
income they earn from working or saving. The result is that fewer
goods and services are produced, and less saving takes place. As
this example illustrates, there is often a trade-off between
efficiency and equity. Government policymakers often confront this
trade-off.
Economic ModelsEconomists rely on economic theories, or models
(the words theory and model are used interchangeably), to analyze
real-world issues, such as the economic effects of immigration. As
mentioned earlier, economic models are simplified versions of
reality. Economists are certainly not alone in relying on models:
An engineer may use a computer model of a bridge to help test
whether it will withstand high winds, or a biologist may make a
physical model of a nucleic acid to better understand its
properties. One purpose of economic models is to make economic
ideas sufficiently explicit and concrete so that individuals,
firms, or the government can use them to make decisions. For
example, we will see in Chapter 3 that the model of demand and
supply is a simplified version of how the prices of products are
determined by the interactions among buyers and sellers in markets.
Economists use economic models to answer questions. For example,
consider the question from the chapter opener: What effect does
immigration of technical workers have on the U.S. economy? For a
complicated question like this one, economists often use several
models to examine different aspects of the issue. For example, they
may use a model of how wages are determined to analyze the effect
of the immigration of technical workers on wages in particular
industries. Economists may use a model of international trade to
analyze how labor costs affect the competitiveness of
high-technology firms. Sometimes economists use an existing model
to analyze an issue, but in other cases, they must develop a new
model. To develop a model, economists generally follow these steps:
1. 2. 3. 4. 5. Decide on the assumptions to use in developing the
model. Formulate a testable hypothesis. Use economic data to test
the hypothesis. Revise the model if it fails to explain well the
economic data. Retain the revised model to help answer similar
economic questions in the future.
1.3 LEARNING OBJECTIVEUnderstand the role of models in economic
analysis.
The Role of Assumptions in Economic ModelsAny model is based on
making assumptions because models have to be simplified to be
useful. We cannot analyze an economic issue unless we reduce its
complexity. For example, economic models make behavioral
assumptions about the motives of consumers and firms. Economists
assume that consumers will buy the goods and services that will
maximize their well-being or their satisfaction. Similarly,
economists assume that firms act to maximize their profits. These
assumptions are simplifications because they do not describe the
motives of every consumer and every firm. How can we know if the
assumptions in a model are too simplified or too limiting? We
discover this when we form hypotheses based on these assumptions
and test these hypotheses using real-world information.
Forming and Testing Hypotheses in Economic ModelsAn economic
variable is something measurable that can have different values,
such as the wages paid to software programmers. A hypothesis in an
economic model is a statement that may be either correct or
incorrect about an economic variable. An example of a hypothesis in
an economic model is the statement that immigration of technical
workers reduces wages paid to software programmers in the United
States. An economic hypothesis is usually about a causal
relationship; in this case, the hypothesis states that immigration
causes, or leads to, lower wages for U.S. software
programmers.Economic variable Something measurable that can have
different values, such as the wages of software programmers.
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We have to test a hypothesis before we can accept it. To test a
hypothesis, we analyze statistics on the relevant economic
variables. In our H1-B visas example, we would gather statistics on
the wages paid to software programmers and perhaps on other
variables as well. Testing a hypothesis can be tricky. For example,
showing that the wages paid to software programmers fell at a time
when immigration was increasing would not be enough to demonstrate
that immigration caused the wage fall. Just because two things are
correlatedthat is, they happen at the same timedoes not mean that
one caused the other. For example, suppose that the U.S. economy
went into a recession at the same time that immigration of software
engineers was increasing. In that case, the recession, rather than
the immigration of foreign engineers, might have caused the fall in
wages paid to software engineers in the United States. Over a
period of time, many economic variables change, which complicates
the testing of hypotheses. In fact, when economists disagree about
a hypothesis, such as the effect of immigration on wages, it is
often because of disagreements over interpreting the statistical
analysis used to test the hypothesis. Note that hypotheses must be
statements that could, in principle, turn out to be incorrect.
Statements such as Immigration is good or Immigration is bad are
value judgments rather than hypotheses because it is not possible
to disprove them. Economists accept and use an economic model if it
leads to hypotheses that are confirmed by statistical analysis. In
many cases, the acceptance is tentative, however, pending the
gathering of new data or further statistical analysis. In fact,
economists often refer to a hypothesis having been not rejected,
rather than having been accepted, by statistical analysis. But what
if statistical analysis clearly rejects a hypothesis? For example,
what if a model leads to a hypothesis that immigration lowers wages
of U.S. software programmers but the data reject this hypothesis?
In that case, the model must be reconsidered. It may be that an
assumption used in the model was too simplified or too limiting.
For example, perhaps the model used to determine the effect of
immigration on wages paid to software programmers assumed that
foreign software programmers entering the United States had the
same training and experience as software programmers in the United
States. If, in fact, U.S. software programmers have more training
and experience than immigrant programmers, this difference may
explain why the data rejected our hypothesis. The process of
developing models, testing hypotheses, and revising models occurs
not just in economics but also in disciplines such as physics,
chemistry, and biology. This process is often referred to as the
scientific method. Economics is a social science because it applies
the scientific method to the study of the interactions among
individuals.
Normative and Positive AnalysisPositive analysis Analysis
concerned with what is. Normative analysis Analysis concerned with
what ought to be.
Throughout this book, as we build economic models and use them
to answer questions, we need to bear in mind the distinction
between positive analysis and normative analysis. Positive analysis
is concerned with what is, and normative analysis is concerned with
what ought to be. Economics is about positive analysis, which
measures the costs and benefits of different courses of action. We
can use the federal governments minimum wage law to compare
positive and normative analysis. In 2009, under this law, it was
illegal for an employer to hire a worker at a wage less than $7.25
per hour. Without the minimum wage law, some firms and some workers
would voluntarily agree to a lower wage. Because of the minimum
wage law, some workers have difficulty finding jobs, and some firms
end up paying more for labor than they otherwise would have. A
positive analysis of the federal minimum wage law uses an economic
model to estimate how many workers have lost their jobs because of
the law, its impact on the costs and profits of businesses, and the
gains to workers receiving the minimum wage. After economists
complete this positive analysis, the decision as to whether the
minimum wage law is a good idea or a bad idea is a normative one
and depends on how people evaluate the trade-off involved.
Supporters of the law believe that the losses to employers and to
workers who are unemployed as a
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Dont Let This Happen to YOU!Dont Confuse Positive Analysis with
Normative AnalysisEconomic analysis has shown that the minimum wage
law is a bad idea because it causes unemployment. Is this statement
accurate? As of 2009, the federal minimum wage law prevents
employers from hiring workers at a wage of less than $7.25 per
hour. This wage is higher than some employers are willing to pay
some workers. If there were no minimum wage law, some workers who
currently cannot find any firm willing to hire them at $7.25 per
hour would be able to find employment at a lower wage. Therefore,
positive economic analysis indicates that the minimum wage law
causes unemployment (although economists disagree about how much
unemployment the minimum wage causes). But, those workers who still
have jobs benefit from the minimum wage because they are paid a
higher wage than they otherwise would be. In other words, the
minimum wage law creates both losers (the workers who become
unemployed and the firms that have to pay higher wages) and winners
(the workers who receive higher wages). Should we value the gains
to the winners more than we value the losses to the losers? The
answer to this question involves normative analysis. Positive
economic analysis can show the consequences of a particular policy,
but it cannot tell us whether the policy is good or bad. So, the
statement at the beginning of this box is inaccurate.
YOUR TURN: Test your understanding by doing relatedproblem 3.9
on page 23 at the end of this chapter.
result of the law are more than offset by the gains to workers
who receive higher wages than they would without the law. Opponents
of the law believe the losses are greater than the gains. The
assessment by any individual depends, in part, on that persons
values and political views. The positive analysis an economist
provides would play a role in the decision but cant by itself
decide the issue one way or the other. In each chapter, you will
see a Dont Let This Happen to You! box like the one above. These
boxes alert you to common pitfalls in thinking about economic
ideas. After reading this box, test your understanding by working
the related problem that appears at the end of the chapter.
Economics as a Social ScienceBecause economics studies the
actions of individuals, it is a social science. Economics is
therefore similar to other social science disciplines, such as
psychology, political science, and sociology. As a social science,
economics considers human behaviorparticularly decision-making
behaviorin every context, not just in the context of business.
Economists have studied such issues as how families decide the
number of children to have, why people have difficulty losing
weight or attaining other desirable goals, and why people often
ignore relevant information when making decisions. Economics also
has much to contribute to questions of government policy. As we
will see throughout this book, economists have played an important
role in formulating government policies in areas such as the
environment, health care, and poverty.
Makingthe
Connection
|
Should the Federal Government Have Increased Restrictions on the
Immigration of Skilled Workers?
As mentioned in the opener to this chapter, in the 2009 Recovery
and Reinvestment Act, Congress put strict limits on the ability of
banks and other firms receiving government aid to hire foreign
workers under the H-1B visa program. Supporters of the limits
argued that firms were hiring foreign workers primarily because
their wages were lower than those of domestic workers with the same
skills. If firms could not hire foreign workers at lower wages, the
firms would have to hire U.S. workers at higher wages. Higher wages
for technical jobs would also increase
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Does restricting the immigration of skilled workers affect the
employment opportunities of recent U.S. graduates?
the incentives for U.S. high school and college students to
obtain the training necessary to qualify for these jobs. Opponents
of the new limits on immigration argued that they undermine the
ability of U.S. firms to recruit the best available workers,
regardless of nationality. By increasing the costs to U.S. firms
and by making them less productive, the limits would lead to U.S.
firms losing sales to foreign firms. In addition, some U.S. firms
might be led to outsource some of their operations to foreign
countries where the limits on hiring foreign workers would not
apply. For instance, Microsoft relocated some of its software
development activity to a new research center in Vancouver, Canada,
largely to avoid restrictive U.S. immigration rules. Some U.S.
graduate schools also worried that they would be unable to continue
to attract top students from around the world if the students would
have difficulty being hired for jobs in the United States following
graduation. Like many other policy debates, the debate over the
immigration of skilled workers has both positive and normative
elements. By gathering data and using economic models, it is
possible to assess some of the quantitative claims made by each
side in the debate: What impact has immigration had on the wages of
software engineers and other skilled workers? What effect do
limitations on the ability to hire immigrant workers have on the
costs of U.S. firms? How will greater restrictions on immigration
affect the enrollments of foreign students in U.S. colleges? These
are all positive questions, so it is possible to formulate
quantitative answers. Ultimately, though, this debate also has a
normative element. For instance, some supporters of the
restrictions are opposed to unlimited immigration for political or
cultural reasons, while some opponents of the restrictions object
on philosophical grounds to governments interfering with the free
flow of workers and goods between countries. The debate over the
immigration of skilled workers demonstrates that economics is often
at the center of important policy issues.Source: Paul Danos,
Matthew J. Slaughter, and Robert G. Hansen, Its a Terrible Time to
Reject Skilled Workers, Wall Street Journal, March 11, 2009.
YOUR TURN: Test your understanding by doing related problem 3.7
on page 22 at the end of thischapter.
1.4 LEARNING OBJECTIVEDistinguish between microeconomics and
macroeconomics. Microeconomics The study of how households and
firms make choices, how they interact in markets, and how the
government attempts to influence their choices. Macroeconomics The
study of the economy as a whole, including topics such as
inflation, unemployment, and economic growth.
Microeconomics and MacroeconomicsEconomic models can be used to
analyze decision making in many areas. We group some of these areas
together as microeconomics and others as macroeconomics.
Microeconomics is the study of how households and firms make
choices, how they interact in markets, and how the government
attempts to influence their choices. Microeconomic issues include
explaining how consumers react to changes in product prices and how
firms decide what prices to charge for the products they sell.
Microeconomics also involves policy issues, such as analyzing the
most efficient way to reduce teenage smoking, analyzing the costs
and benefits of approving the sale of a new prescription drug, and
analyzing the most efficient way to reduce air pollution.
Macroeconomics is the study of the economy as a whole, including
topics such as inflation, unemployment, and economic growth.
Macroeconomic issues include explaining why economies experience
periods of recession and increasing unemployment and why, over the
long run, some economies have grown much faster than others.
Macroeconomics also involves policy issues, such as whether
government intervention can reduce the severity of recessions.
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The division between microeconomics and macroeconomics is not
hard and fast. Many economic situations have both a microeconomic
and a macroeconomic aspect. For example, the level of total
investment by firms in new machinery and equipment helps to
determine how rapidly the economy growswhich is a macroeconomic
issue. But to understand how much new machinery and equipment firms
decide to purchase, we have to analyze the incentives individual
firms facewhich is a microeconomic issue.
A Preview of Important Economic TermsIn the following chapters,
you will encounter certain important terms again and again.
Becoming familiar with these terms is a necessary step in learning
economics. Here we provide a brief introduction to some of these
terms. We will discuss them all in greater depth in later
chapters:
1.5 LEARNING OBJECTIVEBecome familiar with important economic
terms.
Entrepreneur. An entrepreneur is someone who operates a
business. In a market system, entrepreneurs decide what goods and
services to produce and how to produce them. An entrepreneur
starting a new business puts his or her own funds at risk. If an
entrepreneur is wrong about what consumers want or about the best
way to produce goods and services, the entrepreneurs funds can be
lost. This is not an unusual occurrence: In the United States,
about half of new businesses close within four years. Without
entrepreneurs willing to assume the risk of starting and operating
businesses, economic progress would be impossible in a market
system. Innovation. There is a distinction between an invention and
innovation. An invention is the development of a new good or a new
process for making a good. An innovation is the practical
application of an invention. (Innovation may also be used more
broadly to refer to any significant improvement in a good or in the
means of producing a good.) Much time often passes between the
appearance of a new idea and its development for widespread use.
For example, the Wright brothers first achieved self-propelled
flight at Kitty Hawk, North Carolina, in 1903, but the Wright
brothers plane was very crude, and it wasnt until the introduction
of the DC-3 by Douglas Aircraft in 1936 that regularly scheduled
intercity airline flights became common in the United States.
Similarly, the first digital electronic computerthe ENIACwas
developed in 1945, but the first IBM personal computer was not
introduced until 1981, and widespread use of computers did not have
a significant effect on the productivity of U.S. business until the
1990s. Technology. A firms technology is the processes it uses to
produce goods and services. In the economic sense, a firms
technology depends on many factors, such as the skill of its
managers, the training of its workers, and the speed and efficiency
of its machinery and equipment. Firm, company, or business. A firm
is an organization that produces a good or service. Most firms
produce goods or services to earn profits, but there are also
nonprofit firms, such as universities and some hospitals.
Economists use the terms firm, company, and business
interchangeably. Goods. Goods are tangible merchandise, such as
books, computers, or Blu-ray players. Services. Services are
activities done for others, such as providing haircuts or
investment advice. Revenue. A firms revenue is the total amount
received for selling a good or service. It is calculated by
multiplying the price per unit by the number of units sold. Profit.
A firms profit is the difference between its revenue and its costs.
Economists distinguish between accounting profit and economic
profit. In calculating accounting profit, we exclude the cost of
some economic resources that the firm
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does not pay for explicitly. In calculating economic profit, we
include the opportunity cost of all resources used by the firm.
When we refer to profit in this book, we mean economic profit. It
is important not to confuse profit with revenue.
Household. A household consists of all persons occupying a home.
Households are suppliers of factors of productionparticularly
laborused by firms to make goods and services. Households also
demand goods and services produced by firms and governments.
Factors of production or economic resources. Firms use factors of
production to produce goods and services. The main factors of
production are labor, capital, natural resourcesincluding landand
entrepreneurial ability. Households earn income by supplying to
firms the factors of production. Capital. The word capital can
refer to financial capital or to physical capital. Financial
capital includes stocks and bonds issued by firms, bank accounts,
and holdings of money. In economics, though, capital refers to
physical capital, which includes manufactured goods that are used
to produce other goods and services. Examples of physical capital
are computers, factory buildings, machine tools, warehouses, and
trucks. The total amount of physical capital available in a country
is referred to as the countrys capital stock. Human capital. Human
capital refers to the accumulated training and skills that workers
possess. For example, college-educated workers generally have more
skills and are more productive than workers who have only high
school degrees.
Continued from page 3
Economics in YOUR LIFE!At the beginning of the chapter, we posed
the question Is it likely that during your career, you will be
competing for a job with immigrant workers from China, India, or
some other foreign country? Some information helpful in answering
this question appears in the Making the Connection on pages 1314
and in the chapter opener. Supporters of restrictions on H-1B visas
for highly skilled workers argue that reducing the ability of firms
to hire foreign workers would increase the jobs and wages available
to U.S. workers. The chapter opener points out, however, that the
total number of H-1B visas is limited to 65,000 per year and that
this category of visas covers a broad range of skilled workers,
from computer programmers to fashion models. In 2009, Congress
placed additional restrictions on the ability of banks and other
firms receiving government aid to hire foreign workers. Is 65,000
workers a large number? To put the number in perspective, between
June 2007 and June 2008, the U.S. economy created 29.4 million new
jobs, even though part of the period was during an economic
recession. So, although you may encounter difficulty finding a job
and you may lose your job one or more times during your career,
competition from foreign workers will probably not be the
reason.
ConclusionThe best way to think of economics is as a group of
useful ideas about how individuals make choices. Economists have
put these ideas into practice by developing economic models.
Consumers, business managers, and government policymakers use these
models every day to help make choices. In this book, we explore
many key economic models and give examples of how to apply them in
the real world. Most students taking an introductory economics
course do not major in economics or become professional economists.
Whatever your major, the economic principles you
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17
will learn in this book will improve your ability to make
choices in many aspects of your life. These principles will also
improve your understanding of how decisions are made in business
and government. Reading newspapers and other periodicals is an
important part of understanding the current business climate and
learning how to apply economic concepts to a variety of real-world
events. At the end of each chapter, you will see a two-page feature
titled An Inside Look. This feature consists of an excerpt of an
article that relates to the company or economic issue introduced at
the start of the chapter and also to the concepts discussed in the
chapter. A summary and an analysis and supporting graphs highlight
the key economic points of the article. Read An Inside Look at
Policy on the next page to explore arguments for and against
restricting or reducing the number of H-1B visas for highly skilled
workers. Test your understanding by answering the Thinking
Critically about Policy questions.
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AN INSIDE
at Pol icy
LOOK
>> Do Immigrants Displaceor Complement Domestic
Workers?THE ECONOMIST
Give Me Your Scientists . . .JOE BIDEN, Americas new
vicepresident, is prone to gaffes. In 2006 it was the turn of some
Americans of Asian descent to take offence at his comment about
needing a slight Indian accent to go to a 7-Eleven or a Dunkin
Donuts in Delaware. Mr Bidens defence was that he was trying to
compliment the immigrant group on its entrepreneurial zeal. Many
Americans are less favoura ably disposed towards immigrants. And
rising unemployment is hardening attitudes. In the hubbub over the
insertion of Buy American provisions into President Obamas
fiscal-stimulus package, the Grassley-Sanders amendment was largely
overlooked. This restricts the freedom of recipients of federal
bail-out money to hire highskilled foreign workers under the
governments H-1B visa programme. Some people were delighted at what
they saw as a significant, if small, first step in cracking down on
those who they fear crowd skilled American workers out of the
workplace. But others contend that such restrictions could dull
Americas edge in innovation, just when it is needed to help revive
the economy. Mr Obama says that part of the solution to Americas
economic problems should come from its universities and research
laboratories. Yet these institutions in America are now manned
disproportionately by immi-
grants, who made up 47% of scientists years between 2000 and
2004. Nearly and engineers in America with PhDs, 40% of patents
filed in 2005 by Intel, a according to the 2000 census.
Immisilicon-chip maker, were for work done grants accounted for
two-thirds of the by people of Chinese or Indian origin. net
addition to Americas stock of Some of these patents may have been
such workers between 1995 and 2006. awarded to American-born
children of Their role in innovation may seem earlier migrants, but
Mr Kerr reckons obvious: the more clever people there that most
changes over time arise from are, the more ideas are likely to
flourfresh immigration. ish, especially if they can be commer- c
What of the criticism that these cialised. But although
contemporary workers are displacing native scientists theories of
growth emphasise the who would have been just as inventive?
importance of ideas, they assign no To address this, Mr Kerr and
William special role to immigration. EconoLincoln, an economist at
the University mists have tended to think of innovaof Michigan,
used data on how patents tion as driven by the demand for
betresponded to periodic changes in the ter goods, which generates
a need for number of H-1B entrants. If immiskilled innovators.
Peoples choices of grants were merely displacing natives, career
and education should respond increases in the H-1B quota should not
to the labour markets demands, have led to increases in innovation.
But encouraging more of them to become Messrs Kerr and Lincoln
found that innovators if needed. But because when the federal
government increased career choices cannot be expected to the
number of people allowed in under adjust instantly, there might be
scope the programme by 10%, total patentfor skilled immigrants to
fill the gap. ing increased by around 2% in the b Addressing these
issues requires short run. This was driven mainly by data on just
how inventive immigrants more patenting by immigrant scienare, a
question that until recently was tists. But even patenting by
native scithe province of educated guesswork. entists increased
slightly, rather than But William Kerr, an economist at
Hardecreasing as proponents of crowding vard Business School, used
nameout would have predicted. matching software to identify the
ethIf anything, immigrants seemed to nicity of each of the 8m
scientists who crowd in native innovation, perhaps had acquired an
American patent since because ideas feed off each other. Econ1975.
He found that the share of patents omists think of knowledge,
unlike awarded to scientists born in America physical goods, as
non-rival: use by fell between 1975 and 2004. The share one person
does not necessarily preof all patents given to scientists of
Chiclude use by others . . . nese and Indian descent living in
AmerSource: Give Me Your Scientists. . . , The Econoica more than
tripled, from 4.1% in the mist, March 5, 2009. second half of the
1970s to 13.9% in the
18
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Key Points in the ArticleThis article discusses the possibility
that as highly skilled Chinese, Indian, and other immigrants are
restricted from working in the United States, U.S. firms will
become less competitive with foreign companies. Restricting the
number of highly-skilled workers in the United States could
undermine economic growth and reduce increases in living standards.
The article argues that one strength of the United States is that
it attracts the best and brightest from all around the world.
Analyzing the NewsFigure 1 shows that the fraction of scientists
and engineers in the United States who are foreign born has been
slowly increasing. Figure 2 shows the countries of origin of
foreign-born students receiving Ph.D.s in science and engineering.
The article states that some people are in favor of restricting the
number of H-1B visas for highly skilled workers, while other people
would prefer that more of these visas be granted. In this chapter,
we learned
a
that people are rational. So, how can rational people come to
different conclusions about such a fundamental question? Being
rational means that people have goals and pursue actions that
further those goals. U.S. firms argue that if more skilled workers
are not allowed to immigrate to the United States, the firms will
have difficulty competing with foreign companies that do not face
restriction on whom they can hire. On the other hand, skilled
workers who were born in the United States prefer not to have
competition from foreign workers for the jobs that are available.
Reduced competition would drive up wages. So, each party to the
debate is advocating pursuing policies according to its own
interests. b We have seen in this chapter that economists use
models to analyze economic questions. When studying an economic
question, economists form a hypothesis that can be tested using
available data. In this case, the issue is how many innovations are
attributed to immigrant scientists and engineers. William Kerr of
the Harvard Business School attempted to answer the question by
calculating how
many patents had been granted to scientists whose names
indicated that they were of Chinese or Indian descent. He
discovered that the percentage of innovations discovered by
scientists of Chinese and Indian descent increased from 4.1 percent
in the late 1970s to 13.9 percent by the early 2000s. c One key
aspect of the debate over H1B visas concerns whether new immigrants
are displacing native workers or whether they are adding to the
productive capacity of the economy by increasing the total amount
of innovation. The study by William Kerr and William Lincoln
mentioned in the article indicates that new immigrants increase the
total amount of innovation, as measured by increases in the number
of patents granted. In fact, the authors show that both native
workers and foreign workers increase their patenting when the
number of H-1B visas increases. This study will not end the debate
over the value of immigration. But it does provide some evidence
that immigrant scientists appear to be complementing domestic
workers rather than displacing them.
Percentage of foreign-born scientists and engineers 41.5% 41.0
40.5 40.0 39.5 39.0 38.5 38.0 37.5 37.0 2000 2005
Others 35.5% Mexico 1.7% Japan 1.7% Iran 1.8% Thailand 1.8%
Turkey 2.1% Canada 3.3% India 9.9% 2001 2002 2003 2004 South Korea
10.0% Taiwan 10.1%
China 22.0%
Figure 1 Foreign-Born Scientists and Engineers as a Percentage
of All Scientists and Engineers in the United States
Figure 2 Foreign Recipients of U.S. Science and Engineering
Doctorates, 19852005
Source: National Science Foundation, Division of Science
Resources Statistics, Science and Engineering Indicators: 2008, NSF
08-01 (Arlington, VA, February 2008).
Thinking Critically About Policy1. According to the article,
many Americans would like the government to further restrict the
number of H-1B work visas. What evidence from the article indicates
that further limits on the immigration of
highly-skilled workers would create job vacancies that firms
would have difficulty filling using only native-born scientists and
engineers? 2. The article points out that when the number of
immigrant scientists and engineers increases 10 percent, the number
of patents increases by 2 percent and
that both immigrant and native-born scientists and engineers
were responsible for this increase. Why would patenting by
native-born scientists increase at the same time that the number of
foreign-born scientists and engineers was increasing?
19
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Key TermsAllocative efficiency, p. 10 Centrally planned economy,
p. 9 Economic model, p. 4 Economic variable, p. 11 Economics, p. 4
Equity, p. 10 Macroeconomics, p. 14 Marginal analysis, p. 7 Market,
p. 4 Market economy, p. 9 Microeconomics, p. 14 Mixed economy, p.
10 Normative analysis, p. 12 Opportunity cost, p. 8 Positive
analysis, p. 12 Productive efficiency, p. 10 Scarcity, p. 4
Trade-off, p. 8 Voluntary exchange, p. 10
1.1
Three Key Economic Ideas, pages 47LEARNING OBJECTIVE: Explain
these three key economic ideas: People are rational. People respond
to incentives. Optimal decisions are made at the margin.
SummaryEconomics is the study of the choices consumers, business
managers, and government officials make to attain their goals,
given their scarce resources. We must make choices because of
scarcity, which means that although our wants are unlimited, the
resources available to fulfill those wants are limited. Economists
assume that people are rational in the sense that consumers and
firms use all available information as they take actions intended
to achieve their goals. Rational individuals weigh the benefits and
costs of each action and choose an action only if the benefits
outweigh the costs. Although people act from a variety of motives,
ample evidence indicates that they respond to economic incentives.
Economists use the word marginal to mean extra or additional. The
optimal decision is to continue any activity up to the point where
the marginal benefit equals the marginal cost.Visit
www.myeconlab.com to complete these exercises online and get
instant feedback.
bandit barrier. According to a special agent with the FBI,
Bandit barriers are a great deterrent. Weve talked to guys who rob
banks, and as soon as they see a bandit barrier, they go find
another bank. Despite this finding, many banks have been reluctant
to install these barriers. Wouldnt banks have a strong incentive to
install bandit barriers to deter robberies? Why, then, do so many
banks not do so?Source: Richard Cowen, FBI: Banks Are to Blame for
Rise in Robberies, NorthJersey.com, March 10, 2009.
1.4 [Related to Solved Problem 1-1 on page 7] During 2009, movie
studios began to release a substantial number of films in 3-D
format. To show films in this format, theater owners have to invest
in 3-D equipment that costs $75,000 for each projector. Typically,
theater owners can charge about $3 more for a ticket to a 3-D movie
than for a movie in the conventional 2-D format. If you owned a
movie theater, discuss how you would go about deciding whether to
invest in 3-D equipment.Source: Lauren A. E. Schuker, Can 3-D Save
Hollywood? Wall Street Journal, March 20, 2009.
Review Questions1.1 Briefly discuss each of the following
economic ideas: People are rational. People respond to incentives.
Optimal decisions are made at the margin. 1.2 What is scarcity? Why
is scarcity central to the study of economics?
1.5 [Related to Solved Problem 1-1 on page 7] Two students are
discussing Solved Problem 1-1: Joe: I think the key additional
information you need to know in deciding whether to produce 1
million more iPhones is the amount of profit you are currently
making while producing 10 million. Then you can compare the profit
earned from selling 11 million iPhones with the profit earned from
selling 10 million. This information is more important than the
additional revenue and additional cost of the last 1 million
iPhones produced. Jill: Actually, Joe, knowing how much profits
change when you sell 1 million more iPhones is exactly the same as
knowing the additional revenue and the additional cost. Briefly
evaluate their arguments.
Problems and Applications1.3 Bank robberies are on the rise in
New Jersey, and according to the FBI, this increase has little to
do with the economic downturn. The FBI claims that banks have
allowed themselves to become easy targets by refusing to install
clear acrylic partitions, called bandit barriers, which separate
bank tellers from the public. Of the 193 banks robbed in New Jersey
in 2008, only 23 had these barriers, and of the 40 banks robbed in
the first 10 weeks of 2009, only 1 had a
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1.6 [Related to Solved Problem 1-1 on page 7] Late in the
semester, a friend tells you, I was going to drop my psychology
course so I could concentrate on my other courses, but I had
already put so much time into the course that I decided not to drop
it. What do you think of your friends reasoning? Would it make a
difference to your answer if your friend has to pass the psychology
course at some point to graduate? Briefly explain. 1.7 [Related to
the Making the Connection on page 5] The country of Estonia has
attempted to increase its birthrate by making payments to women who
have babies. According to an article in the Wall Street Journal,
Some demographers argue that paying people to have a baby simply
makes them have one earlier; it doesnt necessarily make them have
more. Reread the description of Estonias programs. Could the
program be changed in ways that might make it more likely that
Estonian women will have more children rather than simply changing
the timing of when they have children? What information would we
need to have to resolve the question of whether Estonian women are
responding to the gov-
ernments incentives by having more children or simply by having
them earlier?Source: Marcus Walker, In Estonia, Paying Women to
Have Babies Is Paying Off, Wall Street Journal, October 20, 2006,
p. A1.
1.8 In a paper written by Bentley College economists Patricia M.
Flynn and Michael A. Quinn, the authors state, We find evidence
that Economics is a good choice of major for those aspiring to
become a CEO [chief executive officer]. When adjusting for size of
the pool of graduates, those with undergraduate degrees in
Economics are shown to have had a greater likelihood of becoming an
S&P 500 CEO than any other major. A list of famous economics
majors published by Marietta College includes business leaders
Warren Buffet, Donald Trump, Ted Turner, and Sam Walton, as well as
former presidents George H.W. Bush, Gerald Ford, and Ronald Reagan.
Why might studying economics be particularly good preparation for
being the top manager of a corporation or a leader in
government?Sources: Patricia M. Flynn and Michael A. Quinn,
Economics: A Good Choice of Major for Future CEOs, Social Science
Research Network, November 28, 2006; and Econ 360: Law and
Economics, Famous Economics Majors, Marietta College, September 27,
2008.
>>1.2
End Learning Objective 1.1
The Economic Problem That Every Society Must Solve, pages
711LEARNING OBJECTIVE: Discuss how an economy answers these
questions: What goods and services will be produced? How will the
goods and services be produced? Who will receive the goods and
services produced?
SummarySociety faces trade-offs: Producing more of one good or
service means producing less of another good or service. The
opportunity cost of any activitysuch as producing a good or
serviceis the highest-valued alternative that must be given up to
engage in that activity. The choices of consumers, firms, and
governments determine what goods and services will be produced.
Firms choose how to produce the goods and services they sell. In
the United States, who receives the goods and services produced
depends largely on how income is distributed in the marketplace. In
a centrally planned economy, most economic decisions are made by
the government. In a market economy, most economic decisions are
made by consumers and firms. Most economies, including that of the
United States, are mixed economies in which most economic decisions
are made by consumers and firms but in which the government also
plays a significant role. There are two types of efficiency:
productive efficiency and allocative efficiency. Productive
efficiency occurs when a good or service is produced at the lowest
possible cost. Allocative efficiency occurs when production is in
accordance with consumer preferences. Voluntary exchange is a
situation that occurs in markets when both the buyer and seller
of
a product are made better off by the transaction. Equity is more
difficult to define than efficiency, but it usually involves a fair
distribution of economic benefits. Government policymakers often
face a trade-off between equity and efficiency.Visit
www.myeconlab.com to complete these exercises online and get
instant feedback.
Review Questions2.1 What are the three economic questions that
every society must answer? Briefly discuss the differences in how
centrally planned, market, and mixed economies answer these
questions. 2.2 What is the difference between productive efficiency
and allocative efficiency? 2.3 What is the difference between
efficiency and equity? Why do government policymakers often face a
tradeoff between efficiency and equity?
Problems and Applications2.4 Does Bill Gates, one of the richest
people in the world, face scarcity? Does everyone? Are there any
exceptions?
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PA R T 1
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Introduction
2.5 Would you expect new and better machinery and equipment to
be adopted more rapidly in a market economy or in a centrally
planned economy? Briefly explain. 2.6 Centrally planned economies
have been less efficient than market economies. a. Has this
happened by chance, or is there some underlying reason? b. If
market economies are more economically efficient than centrally
planned economies, would there ever be a reason to prefer having a
centrally planned economy rather than a market economy? 2.7 Leonard
Fleck, a philosophy professor at Michigan State University, has
written, When it comes to health care in America, we have limited
resources for unlimited health care needs. We want everything
contemporary medical technology can offer that will improve the
length or quality of our lives as we age. But as presently healthy
taxpayers, we want costs controlled. Why is it necessary for all
economic systems to limit services such as health care? How does a
mar-
ket system prevent people from getting as many goods and
services as they want?Source: Leonard Fleck, Just Caring: Health
Care Rationing and Democratic Deliberation, New York: Oxford
University Press, 2009.
2.8 Suppose that your local police department recovers 100
tickets to a big NASCAR race in a drug raid. It decides to
distribute these to residents and announces that tickets will be
given away at 10 A.M. Monday at City Hall. a. What groups of people
will be most likely to try to get the tickets? Think of specific
examples and then generalize. b. What is the opportunity cost of
distributing the tickets this way? c. Productive efficiency occurs
when a good or service (such as the distribution of tickets) is
produced at the lowest possible cost. Is this an efficient way to
distribute the tickets? If possible, think of a more efficient
method of distributing the tickets. d. Is this an equitable way to
distribute the tickets? Explain.
>>1.3
End Learning Objective 1.2
Economic Models, pages 1114LEARNING OBJECTIVE: Understand the
role of models in economic analysis.
SummaryEconomists rely on economic models when they apply
economic ideas to real-world problems. Economic models are
simplified versions of reality used to analyze real-world economic
situations. Economists accept and use an economic model if it leads
to hypotheses that are confirmed by statistical analysis. In many
cases, the acceptance is tentative, however, pending the gathering
of new data or further statistical analysis. Economics is a social
science because it applies the scientific method to the study of
the interactions among individuals. Economics is concerned with
positive analysis rather than normative analysis. Positive analysis
is concerned with what is. Normative analysis is concerned with
what ought to be. Because economics is based on studying the
actions of individuals, it is a social science. As a social
science, economics considers human behavior in every context of
decision making, not just in business.Visit www.myeconlab.com to
complete these exercises online and get instant feedback.
with normative analysis or with positive analysis? Briefly
explain.
Problems and Applications3.4 Do you agree or disagree with the
following assertion: The problem with economics is that it assumes
that consumers and firms always make the correct decision. But we
know everyones human, and we all make mistakes. 3.5 Suppose an
economist develops an economic model and finds that it works great
in theory, but it fails in practice. What should the economist do
next? 3.6 Dr. Strangeloves theory is that the price of mushrooms is
determined by the activity of subatomic particles that exist in
another universe parallel to ours. When the subatomic particles are
emitted in profusion, the price of mushrooms is high. When
subatomic particle emissions are low, the price of mushrooms also
is low. How would you go about testing Dr. Strangeloves theory?
Discuss whether this theory is useful. 3.7 [Related to the Making
the Connection on page 13] The Making the Connection explains that
the debate over the immigration of skilled workers has both
positive and normative elements. What economic statistics would be
most useful in evaluating the positive elements in this debate?
Assuming that these statistics are available or could be gathered,
are they likely to resolve the normative issues in this debate?
Review Questions3.1 Why do economists use models? How are
economic data used to test models? 3.2 Describe the five steps by
which economists arrive at a useful economic model. 3.3 What is the
difference between normative analysis and positive analysis? Is
economics concerned mainly
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3.8 [Related to the Chapter Opener on page 3] Many U.S. firms
have had difficulty filling available jobs with U.S. citizens. U.S.
law restricts the number of foreign specialty workers who may enter
the United States under the H-1B visa program to just 65,000 per
year. In 2009, Congress tightened these restrictions even more. a.
Why have U.S. firms had difficulty filling available jobs with U.S.
citizens? b. What affect might the tightening of restrictions on
immigration of foreign workers have on the U.S. economy? 3.9
[Related to the Dont Let This Happen to You! on page 13] Explain
which of the following statements represent positive analysis and
which represent normative analysis. a. A 50-cent-per-pack tax on
cigarettes will lead to a 12 percent reduction in smoking by
teenagers. b. The federal government should spend more on AIDS
research.
c. Rising paper prices will increase textbook prices. d. The
price of coffee at Starbucks is too high.
3.10 In Australia, anyone providing financial advice must be
licensed through the Australia Securities and Investment Commission
(ASIC). ASIC chairman Jeffrey Lucy reminded consumers of this law
after receiving complaints that people were continuing to invest
large sums of money with people who were not authorized to provide
financial advice. This law applies to financial advice from the
Internet in the same way it applies to financial advice in any
other medium. a. How would this law help protect consumers? b. How
might this law protect financial advisors more than consumers? c.
Briefly discuss whether you consider this law to be a good
law.Sources: Australian Services and Investment Commission, 06-162:
Has your financial adviser got a license? May 24, 2006; and
Securities Advice, Oz NetLaw, 2008.
>>1.4
End Learning Objective 1.3
Microeconomics and Macroeconomics, pages 1415LEARNING OBJECTIVE:
Distinguish between microeconomics and macroeconomics.
SummaryMicroeconomics is the study of how households and firms
make choices, how they interact in markets, and how the government
attempts to influence their choices. Macroeconomics is the study of
the economy as a whole, including topics such as inflation,
unemployment, and economic growth.Visit www.myeconlab.com to
complete these exercises online and get instant feedback.
a. The effect of higher cigarette taxes on the quantity
of cigarettes soldb. The effect of higher income taxes on the
total
amount of consumer spendingc. The reasons for the economies of
East Asian coun-
Review Question4.1 Briefly discuss the difference between
microeconomics and macroeconomics.
Problems and Applications4.2 Briefly explain whether each of the
following is primarily a microeconomic issue or a macroeconomic
issue.
tries growing faster than the economies of subSaharan African
countries d. The reasons for low rates of profit in the airline
industry 4.3 Briefly explain whether you agree with the following
assertion: Microeconomics is concerned with things that happen in
one particular place, such as the unemployment rate in one city. In
contrast, macroeconomics is concerned with things that affect the
country as a whole, such as how the rate of teenage smoking in the
United States would be affected by an increase in the tax on
cigarettes.
>>
End Learning Objective 1.4
1.5
A Preview of Important Economic Terms, pages 1516LEARNING
OBJECTIVE: Become familiar with important economic terms.
SummaryBecoming familiar with important terms is a necessary
step in learning economics. These important economic terms
include capital, entrepreneur, factors of production, firm,
goods, household, human capital, innovation, profit, revenue, and
technology.
>>
End Learning Objective 1.5
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AppendixLEARNING OBJECTIVEReview the use of graphs and
formulas.
Using Graphs and FormulasGraphs are used to illustrate key
economic ideas. Graphs appear not just in economics textbooks but
also on Web sites and in newspaper and magazine articles that
discuss events in business and economics. Why the heavy use of
graphs? Because they serve two useful purposes: (1) They simplify
economic ideas, and (2) they make the ideas more concrete so they
can be applied to real-world problems. Economic and business issues
can be complicated, but a graph can help cut through complications
and highlight the key relationships needed to understand the issue.
In that sense, a graph can be like a street map. For example,
suppose you take a bus to New York City to see the Empire State
Building. After arriving at the Port Authority Bus Terminal, you
will probably use a map similar to the one shown below to find your
way to the Empire State Building. Maps are very familiar to just
about everyone, so we dont usually think of them as being
simplified versions of reality, but they are. This map does not
show much more than the streets in this part of New York City and
some of the most important buildings. The names, addresses, and
telephone numbers of the people who live and work in the area arent
given. Almost none of the stores and buildings those people work
and live in are shown either. The map doesnt indicate which streets
allow curbside parking and which dont. In fact, the map shows
almost nothing about the messy reality of life in this section of
New York City, except how the streets are laid out, which is the
essential information you need to get from the Port Authority to
the Empire State Building.
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Think about someone who says, I know how to get around in the
city, but I just cant figure out how to read a map. It certainly is
possible to find your destination in a city without a map, but its
a lot easier with one. The same is true of using graphs in
economics. It is possible to arrive at a solution to a real-world
problem in economics and business without using graphs, but it is
usually a lot easier if you do use them. Often, the difficulty
students have with graphs and formulas is a lack of familiarity.
With practice, all the graphs and formulas in this text will become
familiar to you. Once you are familiar with them, you will be able
to use them to analyze problems that would otherwise seem very
difficult. What follows is a brief review of how graphs and
formulas are used.
Graphs of One VariableFigure 1A-1 displays values for market
shares in the U.S. automobile market, using two common types of
graphs. Market shares show the percentage of industry sales
accounted for by different firms. In this case, the