Principles of Microeconomics, 8th Edition PDF

Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Firm Behavior and the Organization of Industry 13 The Costs of Production The theory of the firm sheds light on the d...

Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Firm Behavior and the Organization of Industry 13 The Costs of Production The theory of the firm sheds light on the decisions that lie behind supply in competitive markets. 14 Firms in Competitive Markets 15 Monopoly Firms with market power can cause market outcomes 16 Monopolistic Competition to be inefficient. 17 Oligopoly The Economics of Labor Markets 18 The Markets for the Factors of Production These chapters examine the special features of labor markets, 19 Earnings and Discrimination in which most people earn most of their income. 20 Income Inequality and Poverty Topics for Further Study 21 The Theory of Consumer Choice Additional topics in microeconomics include household decision making, asymmetric information, political economy, and 22 Frontiers of Microeconomics behavioral economics. Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  PRINCIPLES OF MICROECONOMICS Eighth Edition N. GREGORY MANKIW H ARVAR D U N IVER SITY Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  PRINCIPLES OF MICROECONOMICS Eighth Edition N. GREGORY MANKIW H ARVAR D U N IVER SITY Australia Brazil Mexico Singapore United Kingdom United States Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  Principles of Microeconomics, 8e © 2018, 2015 Cengage Learning N. Gregory Mankiw ALL RIGHTS RESERVED. No part of this work covered by the copyright herein Vice President, General Manager, Social Science may be reproduced or distributed in any form or by any means, except as & Qualitative Business: Erin Joyner permitted by U.S. copyright law, without the prior written permission of the copyright owner. Product Director: Jason Fremder Senior Product Manager: Michael Parthenakis For product information and technology assistance, contact us at Developmental Editor: Jane Tufts Cengage Learning Customer & Sales Support, 1-800-354-9706 Senior Digital Content Designer: Kasie Jean For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions Senior Content Developer: Anita Verma Further permissions questions can be emailed to Content Development Manager: Clara [email protected] Goosman Product Assistant: Emily Lehmann Unless otherwise noted, all items © Cengage Learning. 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WCN 02-200-203  About the Author N. Gregory Mankiw is the Robert M. Beren Professor of Economics at Harvard University. As a student, he studied economics at Princeton University and MIT. As a teacher, he has taught macroeconomics, microeco- nomics, statistics, and principles of economics. He even spent one summer long ago as a sailing instructor on Long Beach Island. Professor Mankiw is a prolific writer and a regular participant in academic and policy debates. His work has been published in scholarly journals, such as the American Economic Review, Journal of Political Econ- omy, and Quarterly Journal of Economics, and in more popular forums, such as the New York Times and The Wall Street Journal. He is also author of the best-selling Jordi Cabré intermediate-level textbook Macroeconomics (Worth Publishers). In addition to his teaching, research, and writing, Professor Mankiw has been a research asso- ciate of the National Bureau of Economic Research, an adviser to the Congressional Budget Office and the Federal Reserve Banks of Boston and New York, and a member of the ETS test development committee for the Advanced Placement exam in economics. From 2003 to 2005, he served as chairman of the President’s Council of Economic Advisers. Professor Mankiw lives in Wellesley, Massachusetts, with his wife, Deborah, three children, Catherine, Nicholas, and Peter, and their border terrier, Tobin. ix Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  Brief Brief Contents Contents PART I Introduction 1 PART V Firm Behavior and the Organization 1 Ten Principles of Economics 3 of Industry 245 2 Thinking Like an Economist 19 13 The Costs of Production 247 3 Interdependence and the Gains from Trade 47 14 Firms in Competitive Markets 267 15 Monopoly 289 16 Monopolistic Competition 319 PART II How Markets Work 63 17 Oligopoly 337 4 The Market Forces of Supply and Demand 65 5 Elasticity and Its Application 89 6 Supply, Demand, and Government Policies 111 PART VI The Economics of Labor Markets 359 18 The Markets for the Factors of Production 361 19 Earnings and Discrimination 383 PART III Markets and Welfare 131 20 Income Inequality and Poverty 401 7 Consumers, Producers, and the Efficiency of Markets 133 8 Application: The Costs of Taxation 153 PART VII Topics for Further Study 423 9 Application: International Trade 167 21 The Theory of Consumer Choice 425 22 Frontiers of Microeconomics 451 PART IV The Economics of the Public Sector 187 10 Externalities 189 11 Public Goods and Common Resources 211 12 The Design of the Tax System 227 xi Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  Preface: To the Student E “ conomics is a study of mankind in the ordinary business of life.” So wrote Alfred Marshall, the great 19th-century economist, in his textbook, Principles of Economics. We have learned much about the economy since Marshall’s time, but this definition of economics is as true today as it was in 1890, when the first edition of his text was published. Why should you, as a student in the 21st century, embark on the study of economics? There are three reasons. The first reason to study economics is that it will help you understand the world in which you live. There are many questions about the economy that might spark your curiosity. Why are apartments so hard to find in New York City? Why do airlines charge less for a round-trip ticket if the traveler stays over a Saturday night? Why is Robert Downey, Jr., paid so much to star in movies? Why are living standards so meager in many African countries? Why do some countries have high rates of inflation while others have stable prices? Why are jobs easy to find in some years and hard to find in others? These are just a few of the questions that a course in economics will help you answer. The second reason to study economics is that it will make you a more astute participant in the economy. As you go about your life, you make many economic decisions. While you are a student, you decide how many years to stay in school. Once you take a job, you decide how much of your income to spend, how much to save, and how to invest your savings. Someday you may find yourself running a small business or a large corporation, and you will decide what prices to charge for your products. The insights developed in the coming chapters will give you a new perspective on how best to make these decisions. Studying economics will not by itself make you rich, but it will give you some tools that may help in that endeavor. The third reason to study economics is that it will give you a better understand- ing of both the potential and the limits of economic policy. Economic questions are always on the minds of policymakers in mayors’ offices, governors’ mansions, and the White House. What are the burdens associated with alternative forms of taxation? What are the effects of free trade with other countries? What is the best way to protect the environment? How does a government budget deficit affect the economy? As a voter, you help choose the policies that guide the allocation of society’s resources. An understanding of economics will help you carry out that responsibility. And who knows: Perhaps someday you will end up as one of those policymakers yourself. Thus, the principles of economics can be applied in many of life’s situations. Whether the future finds you following the news, running a business, or sitting in the Oval Office, you will be glad that you studied economics. N. Gregory Mankiw December 2016 xiii Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  Video A pplication V ideo application features the book’s author introducing chapter content. Author Greg Mankiw introduces the important themes in every chapter by delivering a highly relevant deposition on the real-world context to the economic principles that will be appearing in the upcoming chapter. These videos are intended to motivate students to better understand how economics relates to their day-to-day lives and in the world around them. C onceptClip Videos C onceptClip videos help students master economics terms. These high-energy videos, embedded throughout the interactive book, address the known student challenge of understanding economics terminology when initially introduced to the subject matter. Developed by Professor Mike Brandl of The Ohio State University, these concept-based animations provide students with memorable context to the key terminology required for your introductory economics course. “I have always wanted supplemental material such as this to help me understand certain concepts in economics.” Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 G raph Builder G raph Builder allows students to move step-by-step through complex graphical figures. Designed specifically for introductory economics students, Graph Builder interactive exercises help students first understand complex graphs by deconstructing a graph into finite steps that build upon one another, then practice graphing by drawing out a similar scenario from scratch. This drawing method supports the kinesthetic learning approach valued by instructors, like you— all within the context of the interactive book! “I have not used anything like this before.” “The Graph Builder is amazing! This would help me a lot and the concept is great. I think all students should have access to this feature because it would better their knowledge of how to make graphs.” Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Study and Test Prep The Mankiw Study Guide is now a part of MindTap! T he study guide by David Hakes for Mankiw’s Principles of Economics has long been the standard of what a print study guide could be. Students like how it reinforces the text and improves understanding of the chapter content. Now for the eighth edition, the study guide is integrated right into the MindTap course at no additional charge! For each chapter, students get the same great resources that users of the print Study Guide have always received: The Chapter Overview Problems and Short Answers Self-Test Advanced Critical Thinking Solutions for All Study Guide Questions “Additional practice with problems is extremely helpful, especially when combined with the immediate David Hakes and G reg Mankiw feedback that I received via the online server.” “The adaptive feedback system was incredibly useful, because by the time the test rolled around I didn’t always remember what I had struggled with in previous weeks.” Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Adaptive Test Prep Prepares Your Students for High-Stakes Testing A re your students constantly asking you for more practice questions as exam time comes closer? Do your students complain because the test bank-type questions in the exam do not have the same look and feel as their homework assignments? Adaptive Test Prep is a powerful tool that uses 4,000 new test bank-like questions to give students almost unlimited practice for each chapter and section. They can take as many tests as they like that are immediately graded for them. Students see how they did and the program gives them immediate remediation in the form of very robust feedback, a link right back into the text where the question topic resides, and for about 2,000 questions, they get a brief Quick Coach video with an instructor walking them through the exact question they missed! Students can generate reports that show them which chapters and sections they need the most help on so they can tailor future practice tests just on the areas they are struggling with. Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  Acknowledgments I n writing this book, I benefited from the input of many talented people. Indeed, the list of people who have contributed to this project is so long, and their contributions so valuable, that it seems an injustice that only a single name appears on the cover. Let me begin with my colleagues in the economics profession. The many edi- tions of this text and its supplemental materials have benefited enormously from their input. In reviews and surveys, they have offered suggestions, identified challenges, and shared ideas from their own classroom experience. I am indebted to them for the perspectives they have brought to the text. Unfortunately, the list has become too long to thank those who contributed to previous editions, even though students reading the current edition are still benefiting from their insights. Most important in this process has been David Hakes (University of Northern Iowa). David, a dedicated teacher, has served as a reliable sounding board for ideas and is a hardworking partner with me in putting together the superb pack- age of supplements. In addition, a special thanks to Ron Cronovich, an insightful instructor and trusted advisor, for his many years of consultation. A special thanks to the team of teaching economists who worked on the test bank and ancillaries for this edition, many of whom have been working on the Mankiw ancillaries from the beginning. To Ken McCormick for vetting the en- tire test bank (with 17,000 questions) for correctness, and to Ken Brown, Sarah Cosgrove, Harold Elder, Michael Enz, Lisa Jepsen, Bryce Kanago, Daniel Marburger, Amanda Nguyen, Alicia Rosburg, Forrest Spence, and Kelvin Wong for authoring new questions and updating existing ones. The following reviewers of the seventh edition provided suggestions for refining the content, organization, and approach in the eighth. Mark Abajian, San Diego Mesa William Aldridge, University of Ali Ataiifar, Delaware County College Alabama–Tuscaloosa Community College Rahi Abouk, University of Wisconsin Donald L. Alexander, Western Shannon Aucoin, University of Milwaukee Michigan University Louisiana Lafayette Mathew Abraham, Indiana University Hassan Aly, Ohio State University Lisa Augustyniak, Lake Michigan – Purdue University Indianapolis Michelle Amaral, University of the College Nathanael Adams, Cardinal Stritch Pacific Wesley Austin, University of Louisiana University Shahina Amin, University of Northern Lafayette Seemi Ahmad, Dutchess Community Iowa Dennis Avola, Framingham State College Catalina Amuedo-Dorantes, University May Akabogu-Collins, Mira Costa San Diego State University Regena M. Aye, Allen Community College–Oceanside Vivette Ancona, Hunter College Ercument Aksoy, Los Angeles Valley College–CUNY Sang Hoo Bae, Clark University College Aba Anil, University of Utah Karen Baehler, Hutchinson Basil Al-Hashimi, Mesa Community Diane Anstine, North Central College Community College College Carolyn Arcand, University of Sahar Bahmani, University of Rashid Al-Hmoud, Texas Tech Massachusetts Boston Wisconsin-Parkside University Becca Arnold, San Diego Community Mohsen Bahmani-Oskooee, College University of Wisconsin Milwaukee xix Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 xx ACKNOWLEDGMENTS Richard Baker, Copiah-Lincoln Stacey Brook, University of Iowa Dmitriy Chulkov, Indiana University Community College Keith Brouhle, Grinnell College Kokomo Stephen Baker, Capital University Byron Brown, Michigan State University Lawrence Cima, John Carroll University Tannista Banerjee, Auburn University Crystal Brown, Anderson University Cindy Clement, University of Bob Barnes, DePaul University Kris Bruckerhoff, University of Maryland Hamid Bastin, Shippensburg University Minnesota-Crookston Matthew Clements, St. Edward’s James Bathgate, Western Nevada College Christopher Brunt, Lake Superior State University Leon Battista, Albertus Magnus College University Sondra Collins, University of Southern Gerald Baumgardner, Susquehanna Laura Bucila, Texas Christian University Mississippi University Donna Bueckman, University of Tina Collins, San Joaquin Valley College Christoph Bauner, University of Tennessee–Knoxville Scott Comparato, Southern Illinois Massachusetts–Amherst Don Bumpass, Sam Houston State University Elizabeth Bayley, University of Delaware University Kathleen Conway, Carnegie Mellon Ergin Bayrak, University of Southern Joe Bunting, St. Andrews University University California Benjamin Burden, Temple College Stephen Cotten, University of Houston Nihal Bayraktar, Pennsylvania State Mariya Burdina, University of Central Clear Lake University Oklahoma Jim Cox, Georgia Perimeter College Mike Belleman, St. Clair County Rob Burrus, University of North Michael Craig, University of Community College Carolina–Wilmington Tennessee–Knoxville Audrey Benavidez, Del Mar College James Butkiewicz, University of Delaware Matt Critcher, University of Arkansas Cynthia Benelli, University of California William Byrd, Troy University Community College at Batesville Santa Barbara Anna Cai, University of George Crowley, Troy University, Troy Charles Bennett, Gannon University Alabama–Tuscaloosa David Cullipher, Arkansas State Bettina Berch, Borough of Manhattan Samantha Cakir, Macalester College University-Mountain Home Community College Michael Carew, Baruch College Dusan Curcic, University of Virginia Stacey Bertke, Owensboro Community & William Carner, Westminster College Norman Cure, Macomb Community Technical College Craig Carpenter, Albion College College Tibor Besedes, Georgia Institute of John Carter, California State Maria DaCosta, University of Technology University-Stanislaus Wisconsin–EauClaire Abhijeet Bhattacharya, Illinois Valley Ginette Carvalho, Fordham University Bruce Dalgaard, St. Olaf College Community College Onur Celik, Quinnipiac University Anusua Datta, Philadelphia University Ronald Bishop, Lake Michigan College Avik Chakrabarti, University of Earl Davis, Nicholls State University Thomas Bishop, California State Channel Wisconsin–Milwaukee Amanda Dawsey, University of Islands Kalyan Chakraborty, Emporia State Montana Nicole Bissessar, Kent State University Prabal De, City College of New York University-Ashtabula Suparna Chakraborty, Baruch Rooj Debasis, Kishwaukee College Janet Blackburn, San Jacinto South College–CUNY Dennis Debrecht, Carroll University College Dustin Chambers, Salisbury University William DeFrance, University of Jeanne Boeh, Augsburg College Silvana Chambers, Salisbury University Michigan-Flint Natalia Boliari, Manhattan College Krishnamurti Chandrasekar, New York Theresa J. 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All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  ACKNOWLEDGMENTS xxi Caf Dowlah, Queensborough Community Edgar Ghossoub, University of Texas at Eric Jacobson, University of Delaware College–CUNY San Antonio Bolormaa Jamiyansuren, Augsburg Tanya Downing, Cuesta College Alex Gialanella, Manhattanville College College Michael J. 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WCN 02-200-203 xxii ACKNOWLEDGMENTS Yuexing Lan, Auburn Montgomery Charles Meyrick, Housatonic Germain Pichop, Oklahoma City Daniel Lawson, Oakland Community Community College Community College College Heather Micelli, Mira Costa College Lodovico Pizzati, University of Southern Elena Lazzari, Marygrove College Laura Middlesworth, University of California Quan Le, Seattle University Wisconsin–Eau Claire Florenz Plassmann, Binghamton Chun Lee, Loyola Marymount Meghan Mihal, St. Thomas Aquinas University University College Lana Podolak, Community College of Daniel Lee, Shippensburg University Eric Miller, Oakton Community College Beaver County Jihoon Lee, Northeastern University Phillip Mixon, Troy University–Troy Gyan Pradhan, Eastern Kentucky Jim Lee, Texas A&M–Corpus Christi Evan Moore, Auburn University Junghoon Lee, Emory University University–Montgomery Curtis Price, University of Southern Ryan Lee, Indiana University Francis Mummery, California State Indiana Sang Lee, Southeastern Louisiana University–Fullerton Silvia Prina, Case Western Reserve University John Mundy, St. Johns River State University James Leggette, Belhaven University University Thomas Prusa, Rutgers University Bozena Leven, The College of New Jersey Charles Murray, The College of Saint Conrad Puozaa, University of Qing Li, College of the Mainland Rose Mississippi Zhen Li, Albion College James Murray, University of John Stuart Rabon, Missouri State Carlos Liard-Muriente, Central Wisconsin–LaCrosse University Connecticut State University Christopher Mushrush, Illinois State Mark Reavis, Arkansas Tech University Larry Lichtenstein, Canisius College University Robert Rebelein, Vassar College Jenny Liu, Portland State University John Nader, Davenport University Agne Reizgeviciute, California State Jialu Liu, Allegheny College Max Grunbaum Nagiel, Daytona State University-Chico Sam Liu, West Valley College College Matt Rendleman, Southern Illinois Xuepeng Liu, Kennesaw State University Mihai Nica, University of Central University Jie Ma, Indiana University Oklahoma Judith Ricks, Onondaga Community Michael Machiorlatti, Oklahoma City Scott Niederjohn, Lakeland College College Community College Mark Nixon, Fordham University Chaurey Ritam, Binghamton University Bruce Madariaga, Montgomery College George Norman, Tufts University Jared Roberts, North Carolina State and Northwestern University David O’Hara, Metropolitan State University Brinda Mahalingam, University of University Josh Robinson, University of Alabama-Huntsville Brian O’Roark, Robert Morris University Alabama-Birmingham C. 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All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  ACKNOWLEDGMENTS xxiii Michael Schultz, Menlo College Dean Stansel, Florida Gulf Coast Mark Tuttle, Sam Houston State Jessica Schuring, Central College University University Danielle Schwarzmann, Towson Sylwia Starnawska, D’Youville College Jennifer VanGilder, Ursinus College University Keva Steadman, Augustana College Ross vanWassenhove, University of Gerald Scott, Florida Atlantic University Rebecca Stein, University of Houston Elan Segarra, San Francisco State Pennsylvania Ben Vaughan, Trinity University University Dale Steinreich, Drury University Roumen Vesselinov, Queens College, Bhaswati Sengupta, Iona College Paul Stock, University of Mary City University of New York Reshmi Sengupta, Northern Illinois Hardin-Baylor Rubina Vohra, St. Peter’s College University Michael Stroup, Stephen F. 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Douglas Wellington, Husson Sanchit Shrivastava, University of Utah John Susenburger, Utica College University Johnny Shull, Wake Tech Community James Swofford, University of South Adam Werner, California Polytechnic College Alabama State University Suann Shumaker, Las Positas College Vera Tabakova, East Carolina U Sarah West, Macalester College Nicholas Shunda, University of niversity Elizabeth Wheaton, Southern Methodist Redlands Ariuna Taivan, University of University Milan Sigetich, Southern Oregon Minnesota-Duluth Oxana Wieland, University of University Eftila Tanellari, Radford University Minnesota, Crookston Jonathan Silberman, Oakland University Eric Taylor, Central Piedmont Christopher Wimer, Bowling Green Joe Silverman, Mira Costa Community College State University–Firelands College College–Oceanside Erdal Tekin, Georgia State University Do Youn Won, University of Utah Silva Simone, Murray State University Noreen Templin, Butler Community Kelvin Wong, University of Minnesota Harmeet Singh, Texas A&M College Ken Woodward, Saddleback College University–Kingsville Thomas Tenerelli, Central Washington Irena Xhurxhi, York College Catherine Skura, Sandhills Community University Xu Xu, Mississippi state university College Anna Terzyan, California State Ying Yang, University of Rhode Island Gary Smith, Canisius College University-Los Angeles Young-Ro Yoon, Richard Smith, University of South Petros Tesfazion, Ithaca College Wayne State University Florida–St. Petersburg Charles Thompson, Brunswick Eric Zemjic, Kent State University Joe Sobieralski, Southwestern Illinois Community College Yongchen Zhao, Towson University College–Belleville Flint Thompson, Chippewa Valley Zhen Zhu, University of Central Mario Solis-Garcia, Macalester College Technical College Oklahoma Arjun Sondhi, Wayne State University Deborah Thorsen, Palm Beach State Kent Zirlott, University of Soren Soumbatiants, Franklin College–Central Alabama–Tuscaloosa University James Tierney, University of California Joseph Zwiller, Matt Souza, Indiana University – Purdue Irvine Lake Michigan College University Columbus Julie Trivitt, Arkansas Tech University Nekeisha Spencer, Binghamton Arja Turunen-Red, University of New University Orleans Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 xxiv ACKNOWLEDGMENTS The team of editors who worked on this book improved it tremendously. Jane Tufts, developmental editor, provided truly spectacular editing—as she always does. Michael Parthenakis, senior product manager, did a splendid job of over- seeing the many people involved in such a large project. Anita Verma, senior con- tent developer, was crucial in assembling an extensive and thoughtful group of reviewers to give me feedback on the previous edition, while putting together an excellent team to revise the supplements. Colleen Farmer, senior content project manager, had the patience and dedication necessary to turn my manuscript into this book. Kasie Jean, digital content designer and a trained economist, designed and implemented all of the valuable student resources in MindTap. Michelle Kunkler, senior art director, gave this book its clean, friendly look. Bruce Morser, the illustrator, helped make the book more visually appealing and the economics in it less abstract. Pamela Rockwell, copyeditor, refined my prose, and Lumina Datamatic’s indexer, prepared a careful and thorough index. John Carey, exec- utive marketing manager, worked long hours getting the word out to potential users of this book. The rest of the Cengage team has, as always, been consistently professional, enthusiastic, and dedicated. I am grateful also to Denis Fedin and Nina Vendhan, two star Harvard undergraduates, who helped me refine the manuscript and check the page proofs for this edition. As always, I must thank my “in-house” editor Deborah Mankiw. As the first reader of most things I write, she continued to offer just the right mix of criticism and encouragement. Finally, I would like to mention my three children Catherine, Nicholas, and Peter. Their contribution to this book was putting up with a father spending too many hours in his study. The four of us have much in common—not least of which is our love of ice cream (which becomes apparent in Chapter 4). N. Gregory Mankiw December 2016 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  Contents Preface: To the Student xiii 1-3c Principle 10: Society Faces a Short-Run Trade-off Acknowledgments xix between Inflation and Unemployment 14 1-4 Conclusion 15 Summary 16 Key Concepts 16 Questions for Review 16 Problems and Applications 17 CHAPTER 2 Thinking Like an Economist 19 2-1 The Economist as Scientist 20 2-1a The Scientific Method: Observation, Theory, and More Observation 20 2-1b The Role of Assumptions 21 2-1c Economic Models 22 2-1d Our First Model: The Circular-Flow Diagram 22 2-1e Our Second Model: The Production Possibilities Frontier 24 2-1f Microeconomics and Macroeconomics 26 2-2 The Economist as Policy Adviser 27 PART I Introduction 1 2-2a Positive versus Normative Analysis 27 2-2b Economists in Washington 28 CHAPTER 1 2-2c Why Economists’ Advice Is Not Always Followed 29 Ten Principles of Economics 3 2-3 Why Economists Disagree 30 2-3a Differences in Scientific Judgments 30 1-1 How People Make Decisions 4 2-3b Differences in Values 30 1-1a Principle 1: People Face Trade-offs 4 2-3c Perception versus Reality 31 1-1b Principle 2: The Cost of Something ASK THE EXPERTS: Ticket Resale 32 Is What You Give Up to Get It 5 1-1c Principle 3: Rational People Think at the Margin 6 2-4 Let’s Get Going 32 1-1d Principle 4: People Respond to Incentives 7 IN THE NEWS: Why You Should Study Economics 33 Summary 34 1-2 How People Interact 8 Key Concepts 34 1-2a Principle 5: Trade Can Make Everyone Better Off 8 Questions for Review 35 1-2b Principle 6: Markets Are Usually a Good Way to Problems and Applications 35 Organize Economic Activity 9 Appendix Graphing: A Brief Review 37 FYI: Adam Smith and the Invisible Hand 10 CASE STUDY: Adam Smith Would Have Loved Uber 11 1-2c Principle 7: Governments Can Sometimes CHAPTER 3 Improve Market Outcomes 11 1-3 How the Economy as a Whole Works 13 Interdependence and the Gains 1-3a Principle 8: A Country’s Standard of Living Depends from Trade 47 on Its Ability to Produce Goods and Services 13 3-1 A Parable for the Modern Economy 48 1-3b Principle 9: Prices Rise When the Government 3-1a Production Possibilities 49 Prints Too Much Money 13 3-1b Specialization and Trade 50 xxv Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 xxvi CONTENTS 3-2 Comparative Advantage: The Driving Force 4-3 Supply 73 of Specialization 52 4-3a The Supply Curve: The Relationship between Price 3-2a Absolute Advantage 52 and Quantity Supplied 73 3-2b Opportunity Cost and Comparative Advantage 52 4-3b Market Supply versus Individual Supply 74 3-2c Comparative Advantage and Trade 53 4-3c Shifts in the Supply Curve 75 3-2d The Price of the Trade 54 4-4 Supply and Demand Together 76 FYI: The Legacy of Adam Smith and David Ricardo 55 4-4a Equilibrium 76 3-3 Applications of Comparative Advantage 55 4-4b Three Steps to Analyzing Changes in Equilibrium 78 3-3a Should Serena Williams Mow Her Own Lawn? 55 4-5 Conclusion: How Prices Allocate Resources 83 IN THE NEWS: Economics within a Marriage 56 ASK THE EXPERTS: Price Gouging 83 3-3b Should the United States Trade with Other Countries? 56 IN THE NEWS: Price Increases after Disasters 84 ASK THE EXPERTS: Trade between China and Summary 86 the United States 58 Key Concepts 86 3-4 Conclusion 58 Questions for Review 87 Summary 59 Problems and Applications 87 Key Concepts 59 Questions for Review 60 Problems and Applications 60 CHAPTER 5 Elasticity and Its Application 89 5-1 The Elasticity of Demand 90 5-1a The Price Elasticity of Demand and Its Determinants 90 5-1b Computing the Price Elasticity of Demand 91 5-1c The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities 92 5-1d The Variety of Demand Curves 93 FYI: A Few Elasticities from the Real World 93 5-1e Total Revenue and the Price Elasticity of Demand 95 5-1f Elasticity and Total Revenue along a Linear Demand Curve 96 5-1g Other Demand Elasticities 98 5-2 The Elasticity of Supply 99 5-2a The Price Elasticity of Supply and Its Determinants 99 5-2b Computing the Price Elasticity of Supply 99 5-2c The Variety of Supply Curves 100 5-3 Three Applications of Supply, Demand, and Elasticity 102 5-3a Can Good News for Farming Be Bad News for PART II How Markets Farmers? 102 Work 63 5-3b Why Did OPEC Fail to Keep the Price of Oil High? 104 5-3c Does Drug Interdiction Increase or Decrease Drug-Related Crime? 105 CHAPTER 4 5-4 Conclusion 107 The Market Forces of Supply and Summary 108 Demand 65 Key Concepts 108 Questions for Review 109 4-1 Markets and Competition 66 Problems and Applications 109 4-1a What Is a Market? 66 4-1b What Is Competition? 66 4-2 Demand 67 CHAPTER 6 4-2a The Demand Curve: The Relationship between Price and Quantity Demanded 67 Supply, Demand, and Government 4-2b Market Demand versus Individual Demand 68 Policies 111 4-2c Shifts in the Demand Curve 69 6-1 Controls on Prices 112 CASE STUDY: Two Ways to Reduce the Quantity of Smoking 6-1a How Price Ceilings Affect Market Outcomes 112 Demanded 71 CASE STUDY: Lines at the Gas Pump 114 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203  CONTENTS xxvii CASE STUDY: Rent Control in the Short Run and the Long 7-3 Market Efficiency 142 Run 115 7-3a The Benevolent Social Planner 143 6-1b How Price Floors Affect Market Outcomes 116 7-3b Evaluating the Market Equilibrium 144 ASK THE EXPERTS: Rent Control 116 IN THE NEWS: The Invisible Hand Can Park Your Car 146 CASE STUDY: The Minimum Wage 118 CASE STUDY: Should There Be a Market for Organs? 147 ASK THE EXPERTS: The Minimum Wage 119 ASK THE EXPERTS: Supplying Kidneys 148 6-1c Evaluating Price Controls 120 7-4 Conclusion: Market Efficiency and Market Failure 148 6-2 Taxes 120 Summary 150 6-2a How Taxes on Sellers Affect Market Outcomes 121 Key Concepts 150 6-2b How Taxes on Buyers Affect Market Outcomes 122 Questions for Review 150 CASE STUDY: Can Congress Distribute the Burden Problems and Applications 150 of a Payroll Tax? 124 6-2c Elasticity and Tax Incidence 124 CASE STUDY: Who Pays the Luxury Tax? 126 CHAPTER 8 6-3 Conclusion 127 Application: The Costs of Taxation 153 Summary 128 Key Concepts 128 8-1 The Deadweight Loss of Taxation 154 Questions for Review 128 8-1a How a Tax Affects Market Participants 155 Problems and Applications 129 8-1b Deadweight Losses and the Gains from Trade 157 8-2 The Determinants of the Deadweight Loss 158 CASE STUDY: The Deadweight Loss Debate 160 8-3 Deadweight Loss and Tax Revenue as Taxes Vary 161 CASE STUDY: The Laffer Curve and Supply-Side Economics 162 ASK THE EXPERTS: The Laffer Curve 163 8-4 Conclusion 164 Summary 165 Key Concept 165 Questions for Review 165 Problems and Applications 165 CHAPTER 9 Application: International Trade 167 9-1 The Determinants of Trade 168 PART III Markets and 9-1a The Equilibrium without Trade 168 9-1b The World Price and Comparative Advantage 169 Welfare 131 9-2 The Winners and Losers from Trade 170 9-2a The Gains and Losses of an Exporting Country 170 CHAPTER 7 9-2b The Gains and Losses of an Importing Country 171 9-2c Effects of a Tariff 173 Consumers, Producers, and the Efficiency FYI: Import Quotas: Another Way to Restrict Trade 175 of Markets 133 9-2d The Lessons for Trade Policy 175 7-1 Consumer Surplus 134 9-2e Other Benefits of International Trade 176 7-1a Willingness to Pay 134 IN THE NEWS: Trade as a Tool for Economic Development 177 7-1b Using the Demand Curve to Measure Consumer 9-3 The Arguments for Restricting Trade 178 Surplus 135 9-3a The Jobs Argument 178 7-1c How a Lower Price Raises Consumer Surplus 136 IN THE NEWS: Should the Winners from Free Trade 7-1d What Does Consumer Surplus Measure? 137 Compensate the Losers? 179 7-2 Producer Surplus 139 9-3b The National-Security Argument 180 7-2a Cost and the Willingness to Sell 139 9-3c The Infant-Industry Argument 180 7-2b Using the Supply Curve to Measure Producer Surplus 140 9-3d The Unfair-Competition Argument 181 7-2c How a Higher Price Raises Producer Surplus 141 9-3e The Protection-as-a-Bargaining-Chip Argument 181 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 xxviii CONTENTS CASE STUDY: Trade Agreements and the World Trade Summary 207 Organization 181 Key Concepts 207 ASK THE EXPERTS: Trade Deals 182 Questions for Review 207 9-4 Conclusion 182 Problems and Applications 208 Summary 184 Key Concepts 184 CHAPTER 11 Questions for Review 184 Problems and Applications 185 Public Goods and Common Resources 211 11-1 The Different Kinds of Goods 212 11-2 Public Goods 214 11-2a The Free-Rider Problem 214 11-2b Some Important Public Goods 214 CASE STUDY: Are Lighthouses Public Goods? 216 11-2c The Difficult Job of Cost–Benefit Analysis 216 CASE STUDY: How Much Is a Life Worth? 217 11-3 Common Resources 218 11-3a The Tragedy of the Commons 218 11-3b Some Important Common Resources 219 ASK THE EXPERTS: Congesting Pricing 219 IN THE NEWS: The Case for Toll Roads 220 CASE STUDY: Why the Cow Is Not Extinct 222 11-4 Conclusion: The Importance of Property Rights 223 Summary 224 PART IV The Economics of the Key Concepts 224 Questions for Review 224 Public Sector 187 Problems and Applications 224 CHAPTER 10 CHAPTER 12 Externalities 189 The Design of the Tax System 227 10-1 Externalities and Market Inefficiency 191 10-1a Welfare Economics: A Recap 191 12-1 An Overview of U.S. Taxation 228 10-1b Negative Externalities 192 12-1a Taxes Collected by the Federal Government 228 10-1c Positive Externalities 193 12-1b Taxes Collected by State and Local Governments 231 CASE STUDY: Technology Spillovers, Industrial Policy, 12-2 Taxes and Efficiency 232 and Patent Protection 194 12-2a Deadweight Losses 232 10-2 Public Policies toward Externalities 195 CASE STUDY: Should Income or Consumption 10-2a Command-and-Control Policies: Regulation 195 Be Taxed? 233 10-2b Market-Based Policy 1: Corrective Taxes and 12-2b Administrative Burden 234 Subsidies 196 12-2c Marginal Tax Rates versus Average Tax Rates 235 ASK THE EXPERTS: Vaccines 196 12-2d Lump-Sum Taxes 235 CASE STUDY: Why Is Gasoline Taxed So Heavily? 197 12-3 Taxes and Equity 236 IN THE NEWS: What Should We Do about Climate 12-3a The Benefits Principle 236 Change? 199 12-3b The Ability-to-Pay Principle 237 10-2c Market-Based Policy 2: Tradable Pollution CASE STUDY: How the Tax Burden Is Distributed 238 Permits 200 12-3c Tax Incidence and Tax Equity 239 ASK THE EXPERTS: Carbon Taxes 200 IN THE NEWS: Tax Expenditures 240 10-2d Objections to the Economic Analysis of Pollution 202 CASE STUDY: Who Pays the Corporate Income Tax? 240 10-3 Private Solutions to Externalities 202 12-4 Conclusion: The Trade-off between Equity and 10-3a The Types of Private Solutions 202 Efficiency 242 10-3b The Coase Theorem 203 Summary 243 10-3c Why Private Solutions Do Not Always Work 204 Key Concepts 243 IN THE NEWS: The Coase Theorem in Action 205 Questions for Review 244 10-4 Conclusion 206 Problems and Applications 224 Copyright 2018 Cengage Learning. 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WCN 02-200-203  CONTENTS xxix CHAPTER 14 Firms in Competitive Markets 267 14-1 What Is a Competitive Market? 268 14-1a The Meaning of Competition 268 14-1b The Revenue of a Competitive Firm 269 14-2 Profit Maximization and the Competitive Firm’s Supply Curve 270 14-2a A Simple Example of Profit Maximization 270 14-2b The Marginal-Cost Curve and the Firm’s Supply Decision 271 14-2c The Firm’s Short-Run Decision to Shut Down 273 14-2d Spilt Milk and Other Sunk Costs 275 CASE STUDY: Near-Empty Restaurants and Off-Season Miniature Golf 275 14-2e The Firm’s Long-Run Decision to Exit or Enter a Market 276 PART V Firm Behavior and 14-2f Measuring Profit in Our Graph for the Competitive Firm 277 the Organization of 14-3 The Supply Curve in a Competitive Market 279 14-3a The Short Run: Market Supply with a Fixed Number Industry 245 of Firms 279 14-3b The Long Run: Market Supply with Entry CHAPTER 13 and Exit 279 14-3c Why Do Competitive Firms Stay in Business The Costs of Production 247 If They Make Zero Profit? 280 13-1 What Are Costs? 248 14-3d A Shift in Demand in the Short Run and 13-1a Total Revenue, Total Cost, and Profit 248 Long Run 281 13-1b Costs as Opportunity Costs 249 14-3e Why the Long-Run Supply Curve Might Slope 13-1c The Cost of Capital as an Opportunity Cost 249 Upward 282 13-1d Economic Profit versus Accounting Profit 250 14-4 Conclusion: Behind the Supply Curve 284 13-2 Production and Costs 251 Summary 285 13-2a The Production Function 251 Key Concepts 285 13-2b From the Production Function to the Total-Cost Questions for Review 285 Curve 253 Problems and Applications 286 13-3 The Various Measures of Cost 254 13-3a Fixed and Variable Costs 255 13-3b Average and Marginal Cost 255 CHAPTER 15 13-3c Cost Curves and Their Shapes 256 Monopoly 289 13-3d Typical Cost Curves 258 15-1 Why Monopolies Arise 290 13-4 Costs in the Short Run and in the Long Run 259 15-1a Monopoly Resources 291 13-4a The Relationship between Short-Run and Long-Run 15-1b Government-Created Monopolies 291 Average Total Cost 260 15-1c Natural Monopolies 292 13-4b Economies and Diseconomies of Scale 261 FYI: Lessons from a Pin Factory 261 15-2 How Monopolies Make Production and Pricing Decisions 293 13-5 Conclusion 262 15-2a Monopoly versus Competition 293 Summary 263 15-2b A Monopoly’s Revenue 294 Key Concepts 264 15-2c Profit Maximization 296 Questions for Review 264 15-2d A Monopoly’s Profit 298 Problems and Applications 264 FYI: Why a Monopoly Does Not Have a Supply Curve 298 CASE STUDY: Monopoly Drugs versus Generic Drugs 299 Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 xxx CONTENTS 15-3 The Welfare Cost of Monopolies 300 17-2 The Economics of Cooperation 342 15-3a The Deadweight Loss 301 17-2a The Prisoners’ Dilemma 343 15-3b The Monopoly’s Profit: A Social Cost? 303 17-2b Oligopolies as a Prisoners’ Dilemma 344 CASE STUDY: OPEC and the World Oil Market 345 15-4 Price Discrimination 303 17-2c Other Examples of the Prisoners’ Dilemma 346 15-4a A Parable about Pricing 304 17-2d The Prisoners’ Dilemma and the Welfare of Society 347 15-4b The Moral of the Story 305 17-2e Why People Sometimes Cooperate 348 15-4c The Analytics of Price Discrimination 305 CASE STUDY: The Prisoners’ Dilemma Tournament 348 15-4d Examples of Price Discrimination 306 IN THE NEWS: Price Discrimination in Higher 17-3 Public Policy toward Oligopolies 349 Education 308 17-3a Restraint of Trade and the Antitrust Laws 349 CASE STUDY: An Illegal Phone Call 350 15-5 Public Policy toward Monopolies 308 17-3b Controversies over Antitrust Policy 350 15-5a Increasing Competition with Antitrust Laws 308 CASE STUDY: The Microsoft Case 352 15-5b Regulation 309 IN THE NEWS: Europe versus Google 354 ASK THE EXPERTS: Airline Mergers 309 15-5c Public Ownership 310 17-4 Conclusion 354 15-5d Doing Nothing 311 Summary 355 15-6 Conclusion: The Prevalence of Monopolies 311 Key Concepts 356 Summary 313 Questions for Review 356 Key Concepts 313 Problems and Applications 356 Questions for Review 314 Problems and Applications 314 CHAPTER 16 Monopolistic Competition 319 16-1 Between Monopoly and Perfect Competition 320 16-2 Competition with Differentiated Products 322 16-2a The Monopolistically Competitive Firm in the Short Run 322 16-2b The Long-Run Equilibrium 323 16-2c Monopolistic versus Perfect Competition 324 16-2d Monopolistic Competition and the Welfare of Society 327 16-3 Advertising 328 16-3a The Debate over Advertising 328 CASE STUDY: Advertising and the Price of Eyeglasses 329 16-3b Advertising as a Signal of Quality 330 PART VI The Economics 16-3c Brand Names 331 of Labor Markets 359 16-4 Conclusion 332 Summary 333 CHAPTER 18 Key Concepts 334 The Markets for the Factors Questions for Review 334 Problems and Applications 334 of Production 361 18-1 The Demand for Labor 362 CHAPTER 17 18-1a The Competitive Profit-Maximizing Firm 363