OUTLINE CONTENTS

Why study economics?

xiv

How to use this book

xvi

About the online resource centre

xviii

Outlines for short or modular courses

xxi

Acknowledgements

xxii

MICROECONOMICS
PART ONE MARKETS AND CONSUMERS

2 How Economists Work

20

3 Demand and Supply

36

4 Elasticity of Demand and Supply

5 Consumer Choice: Indifference Theory

PART TWO MARKETS AND FIRMS

58
81

107

6 The Cost Structure of Firms

109

7 Perfect Competition

130

8 Monopoly

154

9 Imperfect Competition

178

PART THREE MARKETS FOR INPUTS

201

10 Demand and Supply of Inputs

203

11 The Labour Market

12 Capital, Investment, and New Technology

224

PART

FOUR GOVERNMENT AND THE MARKET

13 Successes and Failures of Markets

ro

1 Economic Issues and Concepts

14 The Role of Government

244

267
269
301

MACROECONOMICS
PART FIVE MACROECONOMICS: ISSUES
AND FRAMEWORK

331

15 Macroeconomic Issues and Measurement

333

16 A Basic Model of the Determination of GDP in the Short Term

359

VI OUT LIN E CONTE NTS

17 GDP in an Open Economy with Government

385

18 GDP and the Price Level in the Short Run

404

19 GDP and the Price Level in the Long Run

424

PART SIX MACROECONOMIC POLICY IN A MONETARY

ECONOMY

445

20 Money and Monetary Institutions

447

21 The Role of Money in Macroeconomics

468

22 The Balance of Payments and Exchange Rates

505

23 Macroeconomic Policy in an Open Economy

530

PART SEVEN GLOBAL ECONOMIC ISSUES

555

24 Inflation

557

25 Unemployment

579

26 Economic Growth and Sustainability

601

27 International Trade

625

Glossary

649

Index

666

DETAILED CONTENTS

MICROECONOMICS

PART ONE MARKETS AND CONSUMERS

Chapter 1 Economic Issues and Concepts
The complexity of the modern economy
Resources and scarcity
Who makes the choices and how
Government and the market economy
Box 1.1 Toasting the complexity of a modern economy
Box 1.2 The failure of central planning
Box 1.3 The terminology of production possibilities
Box 1.4 Absolute and comparative advantage
Box 1.5 Government and the market

Chapter 2 How Economists Work

Economic advice: positive and normative statements
Economic theorizing
Economic data
Graphing economic relationships
Box 2.1 Prediction, prophecy, and forecasting
Box 2.2 An illustrative model
Box 2.3 Testability

Chapter 3 Demand and Supply

Demand
Supply
The determination of price
But markets are not really like that!
Box 3.1 Tea prices to soar after droughts
Box 3.2 Stocks and flows
Box 3.3 Weather matters
Box 3,4 Prices in periods of inflation
Box 3.5 Demand and supply: what really happens

fp

VIII DETAILED CONTENTS

Chapter 4 Elasticity of Demand and Supply

58

Demand elasticity
Supply elasticity

59
69

Measurement of demand and supply

70

Why the measurement of demand is important

74

Box 4.1 Real markets that elasticity will help understand

Box 4.2 The terminology of elasticity

59
62

Box 4.3 Measuring elasticity over a range

65

Box 4.4 Elasticity and income

Box 4.5 Elasticity matters

66
69

Chapter 5 Consumer Choice: Indifference Theory

81

Early insights
Consumer optimization without measurable utility

81
87

The consumer's response to price and income changes

94

The consumer's demand curve

96

Box 5.1 Happiness and utility

82

Box 5.2 The paradox of value

85

Box 5.3 Consumers' surplus

Box 5.4 Shapes of indifference curves

86
91

Box 5.5 Relative prices and inflation

95

Box 5.6 The Slutsky decomposition of income and substitution effects

98

PART TWO MARKETS AND FIRMS

107

Chapter 6 The Cost Structure of Firms

109

Costs, revenues, and profit maximization

Costs in the short run

110
112

Costs in the long run

118

The very long run: endogenous technical change

The definition of profit in economics

124
125

Box 6.1 Nuts and bolts of production costs

111

Box 6.2 Short-run cost curves when firms have excess capacity
Box 6.3 The economy-wide significance of the principle of substitution

117
120

Box 6.4 Economies of scale in the electronics industry

121

Box 6.5 Economies of scale and scope

122

Chapter 7 Perfect Competition

130

Market structure and firm behaviour

Perfectly competitive markets

131
133

Short-run equilibrium

136

Long-run equilibrium
The allocative efficiency of perfect competition

140
_147

Box 7.1 Some light on dark chocolate

132

Box 7.2 Demand under perfect competition: firm and industry

134

Box 7.3 Scrap or store, what airlines do in a downturn

136

Box 7.4 Who benefits and loses from changes in input costs?
Box 7.5 The effects of changing technology
Box 7.6 Declining industries

142
143
145

DETAILED CONTENTS 1X

--Cac---ter 8 Monopoly

A single-price monopolist

154

The allocative inefficiency of monopoly

A multi-price monopolist: price discrimination
Long-run monopoly equilibrium
Cartels as monopolies
Appendix: Price discrimination between two markets

155
160
161
164
166
175

Box 8.1 Losing at monopoly

155

Box 8.2 Demand for once-off production

Box 8.3 Examples of price discrimination

159
164

Chapter 9 Imperfect Competition

178

Patterns of concentration in UK industry

178

Imperfectly competitive market structures

Monopolistic competition

179
182

Oligopoly

185

Oligopoly as a game

188

Dynamics of oligopolistic industries

193

Box 9.1 Globalization of production and competition

Box 9.2 The price of haircuts and the profits of hairdressers

180
184

Box 9.3 Supermarket rivalry

185

Box 9.4 Games and their applications

Box 9.5 Real-world strategic games

190
192

Box 9.6 Brand proliferation in alcoholic drinks

194

PART THREE MARKETS FOR INPUTS

201

Chapter 10 Demand and Supply of Inputs

203

Overview of input markets

203

The demand for inputs

The supply of inputs

206
213

The operation of inplit markets

216

Economic rent

218

Box 10.1 Income distribution in the news

204

Box 10.2 Produced inputs and the supply chain

Box 10.3 Demand for inputs where there is more than one variable input

207
210

Box 10.4 The principles of derived demand

212

Box 10.5 The supply of labour

Box 10.6 Origin of the term 'economic rent'

214
219

Chapter 11 The Labour Market

224

Wage differentials

225

Heterogeneity, incentives, and monitoring costs

236

Box 11.1 Pay of senior executives

226

Box 11.2 The rental and purchase price of labour

Box 11.3 Why are women paid less than men?

229
230

X DETAI LED CONT ENTS

Chapter 12 Capital, Investment, and New Technology

244

Capital as an input

245

The investment decision

New technology

252
255

Box 12.1 Capital services growth, UK 1950-2007

246

Box 12.2 The value of a brand

Box 12.3 The future value of a present sum

248
249

Box 12.4 Real and nominal interest rates

253

Box 12.5 The option to invest

254

Box 12.6 Intangible assets matter

259

Box 12.7 The winner's curse

261

PART FOUR GOVERNMENT AND THE MARKET

267

Chapter 13 Successes and Failures of Markets

269

Basic functions of government

270

How well do markets work?

271

Rivalrous and excludable goods

275

Externalities

281

Public policy towards monopoly and competition

289

Box 13.1 The end of free-market economics?

271

Box 13.2 Pricing of galleries and museums

277

Box 13.3 Buffaloes, cows, and elephants

Box 13.4 Policies for environmental regulation

279
287

Box 13.5 Privatization in the United Kingdom

292

Box 13.6 UK competition policies

293

Chapter 14 The Role of Government

301

Government objectives

301

Tools and performance

306

The costs of government intervention

316

Government failure

320

Box 14.1 The impact of a per-unit tax in a competitive industry

Box 14.2 The effect of taxes on profits
Box 14.3 The great Microsoft antitrust case

308
309
315

MACROECONOMICS
PART FIVE MACROECONOMICS: ISSUES AND FRAMEWORK

331

Chapter 15 Macroeconomic Issues and Measurement

333

What is macroeconomics?
Why do we need macroeconomics?

334
334

The GDP gap

338

Measurement of national output

The circular flow of income, output, and spending

339
342

GDP, GNI, and GNP

343

DETAI LED CONT EN TS X1

GDP income-based
Interpreting national income and output measures

347
350

Box 15.1 Macroeconomics in the news

Box 15.2 Value added through stages of production

335
341

Box 15.3 Calculation of nominal and real GDP

351

Chapter 16 A Basic Model of the Determination of GDP in the Short Term

359

The macro problem: inflation and unemployment

359

Key assumptions

362

What determines aggregate spending?

Equilibrium GDP

365
373

Changes in GDP

376

Box 16.1 The terminology of business cycles

361

Box 16.2 Savings make the news

Box 16.3 A hydraulic analogue of GDP determination

366
375

Box 16.4 The multiplier: a numerical example

Box 16.5 The derivation of the multiplier

379
380

Chapter 17 GDP in an Open Economy with Government

385

Government spending and taxes

386

Net exports
Equilibrium GDP

388
391

Changes in aggregate spending

394

Box 17.1 Deficits in the news

387

Box 17.2 The multiplier in an open economy with taxes

Box 17.3 The Keynesian Revolution

395
396

Chapter 18 GDP and the Price Level in the Short Run

404

Aggregate demand

405

Aggregate supply and macroeconomic equilibrium

411

Changes in GDP and the price level

415

Box 18.1 Excess capacity may persist for a few years yet
Box 18.2 The shape of the aggregate demand curve

405
409

Box 18.3 The Keynesian SRAS curve

Box 18.4 More on the shape of the SPAS curve

415
418

Chapter 19 GDP and the Price Level in the Long Run

424

Induced changes in input prices

The long-run consequences of aggregate demand shocks

425
428

Real GDP in the short and long runs

433

Government policy and the business cycle

435

Box 19.1 Worries about budget deficits and debt

Box 19.2 Shocks and potential: an alternative view
.4*****smoixiOilitiftusitawkillift#640**A410,-

424
434

PART SIX MACROECONOMIC POLICY IN A MONETARY ECONOMY

445

Chapter 20 Money and Monetary Institutions

447

The nature of money

The origins of money

448
449

X i l D E TA I L E D C O N T E N T S

How does money get into the economy?

Two models of banking

453
456

Financial crises

462

Box 20.1 If in doubt take it out

Box 20.2 Gresham's Law

448
451

Box 20.3 Definitions of UK monetary aggregates

Box 20.4 The implications of electronic money for the monetary system
Box 20.5 Neither a borrower nor a lender be!

455
461

Chapter 21 The Role of Money in Macroeconomics

468

462

Money values and relative values

469

The valuation of financial assets

472

The supply of money and the demand for money

Monetary forces and aggregate demand

473
478

Macroeconomic cycles and aggregate shocks

483

Implementation of monetary policy

Appendix: An alternative derivation of the AD curve: 15/ LM

488
499

Box 21.1 Monetary policy in the news

469

Box 21.2 The quantity theory of money

Box 21.3 The accelerator theory of investment

477
481

Box 21.4 Multiplieraccelerator interaction

Box 21.5 Monetary policy reactions and the Taylor rule

484
486

Chapter 22 The Balance of Payments and Exchange Rates

505

The balance of payments

505

The market for foreign exchange

The determination of exchange rates

512
515

Box 22.1 Global imbalances and the financial crisis

506

Box 22.2 Trade and modern mercantilism

Box 22.3 Balance of payments crises
Box 22.4 Exchange rates and the quantity theory of money
Box 22.5 'News' and the exchange rate

510
511
520

Chapter 23 Macroeconomic Policy in an Open Economy

530

Why does openness matter?

Macro policy in a world with perfect capital mobility

531
534

Some implications

547

Box 23.1 The globalization of financial markets

Box 23.2 Types of financial crisis

532
533

Box 23.3 The exchange rate crisis in Argentina 2001-2

Box 23.4 The J-curve

538
543

Box 23.5 International linkages and the world business cycle

521

549

PART SEVEN GLOBAL ECONOMIC ISSUES

555

Chapter 24 Inflation

557

Inflation in the macro model

559
565
572
574

The Phillips curve

The Lucas aggregate supply function
Is inflation dead?


D E TA I L E D C O N T E N T S X 1 1 1

Box 24.1 Hyperinflation

564

Box 24.2 The shifting trade-off between inflation and unemployment

Box 24.3 The Lucas critique

571
574

Chapter 25 Unemployment

579

Unemployment characteristics

580

Cyclical unemployment

586

Equilibrium unemployment: the NAIRU

Reducing unemployment

592
596

Box 25.1 How is unemployment measured?

581
Box 25.2 The impact of the recent recession on vulnerable employment and working poverty 585
Box 25.3 The impact of the recent recession on participation rates
Box 25.4 Unemployment experience in Europe

587
592

Box 25.5 False trails: what won't cure unemployment

597

Chapter 26 Economic Growth and Sustainability

601

Trend and cycle

Benefits and costs of growth

601
604

Theories of economic growth

607

Growth and sustainability

616

Box 26.1 Are economic growth and cycles related?

602

Box 26.2 The end of work?

606

Box 26.3 The Solow-Swan growth model

Box 26.4 To eliminate growth or control it?

610
617

Chapter 27 International Trade

625

Sources of the gains from trade

The terms of trade

625
630

The theory of commercial policy

631

Global commercial policy

639

Box 27,1 The gains from trade with varying opportunity costs
Box 27.2 Problems with the Doha Round

641

Glossary
Index

649
666

WHY STUDY ECONOMICS?

Some of you may already be excited by the prospect of studying economics, but others among
you will answer the question posed in the heading with 'It was part of my course of study, so I
had no choice.' To both the reluctant conscripts and the willing volunteers we offer hope and
encouragement.
Economics studies topics that are highly relevant both to decision making in most jobs that
you are likely to do in life and to understanding many of the most pressing issues facing
today's worldfree markets versus government intervention, resource exhaustion, pollution
and environmental degradation, climate change, the revolution in digital communications
media, government taxes and spending, employment, unemployment and recessions, inflation, the EU, the euro, changing living standards in advanced nations, growth and stagnation
among many of the world's poorest nations. Thus, economics is both a preparation for taking
day-to-day decisions in a firm or other organization, and training in the analysis of many of
the 'big issues' of our time.
One of the most important events in the first three quarters of the twentieth century was
the rise of communism. One of the most important events in the last quarter of that century

629

was communism's fall. By the first decade of the twenty-first century, the century-long battle
between free markets and government planning as alternatives for organizing economic
activity had been settled in almost all countries with a degree of decisiveness that is rare for
great social issues. Understanding why market-oriented, capitalist economies perform so
much better than fully planned or highly government-controlled economies is a core issue
in economics. Economic theories are expressly designed to help us understand the successes
(and, where they occur, the failures) of free-market economies.
The triumph of market-oriented economies suggests that income- and wealth-creating
activities are usually best accomplished through the efforts of private citizens operating in
largely unregulated markets. But this is not the end of the story, for at least three fundamen tal
reasons.
First, although market economies certainly work better than fully planned economies, they
do not work perfectly. One of today's great social issues is how best to allocate the responsi bilities of government, leaving it to do what it can do best and leaving free markets to do what
they can do best. We ask: 'What are the important roles that governments can play in improving the functioning of a basically market-oriented economy?' During the three decades or so
up to 2007 the consensus was moving in favour of more market freedom. However, the global
financial crisis of 2007-8 has raised questions about the extent to which markets can be left
alone. At the time of writing, there is an ongoing debate in official and academic circles about
the regulatory structure needed to avoid, or at least mitigate, any future crises in the financial
systemcrises that can have ramifications far beyond the bounds of the financial system,
spreading to adversely affect the entire economy.
Secondly, market economies produce severe short-term cycles as well as long-term growth.
Long-term growth has raised the living standards of the ordinary working person from the
horrors and degradations in the early and mid-nineteenth century and described by Charles
Dickens to those of the property-owning workers of today, whose living standards are higher
than those of 99.9 per cent of all the people of all classes who ever lived on Earth. Yet capitalist growth is uneven growth because economic activity cycles around its rising trend.
In recessions, unemployment is high and living standards typically stand still or even fall
temporarily. Although each cycle tends to leave living standards higher than all previous