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Economy and Economic Analysis CONTENTS PREFACE SECTION I: INTRODUCTION TO SCARCITY, ECONOMY, AND ECONOMIC METHOD Chapter 1 Scarcity: The Essence of Economics 1 Scarcity: The Economic Problem 1 Scarcity Imposes Limits 2 Scarcity Demands Choices 3 Battling Scarcity 5 Rationing 6 Theft and Wars 11 Human Work 13 Human Skill and Invention 14 Utopian Dreams and Revolutions 16 Scarcity and Economic Analysis 18 Price and Scarcity 20 Scarcity and Efficiency 20 Chapter Summary 25 Problems for Practice 25 Chapter 2 What Is an Economy? Economies and Their Endowments 29 Economy as a System 29 Fundamental Economic Activities 30 Economic Institutions 33 The Importance of Institutions 34 Types of Economic Institutions 35 Economic Endowments 41 Natural Endowments 43 Capital Endowments 45 Human Endowments 46 Chapter Summary 51 Problems for Practice 51 Chapter 3 Economic Method: Rationality, Costs, and Benefits 53 Economic Principles of Human Behavior 53 Individuals Choose Rationally, Within Limits 53 Implications of Rationality 55 Other Principles of Human Behavior 62 Principles of Economic Method 67 Methodological Individualism 67 Economic Analysis Seeks to Explain Causality 68 Economic Relations Are Regular Enough 70 Economic Relations Also Have Uncertainty 71 Economic Analysis is Marginal Analysis 72 Willingness to Pay Measures Marginal Value 75 Economic Decisions Consider Opportunity Costs 78 Institutions Affect Economic Efficiency 79 Chapter Summary 84 Problems for Practice 85 SECTION II: ECONOMIC ACTIVITIES Chapter 4 Consumption: Buying and Using Products 87 Consumption and Scarcity: Cutting Costs with the Jones Family 88 Scarcity Imposes a Budget Constraint 88 Economizing to Stay Within Budget 90 Economic Analysis of Consumer Demand 95 Price Affects Quantity Demanded of Blue Jeans? 95 Other Determinants of Demand for Blue Jeans 96 Summarizing the Determinants of Demand 100 Illustrating Sources and Uses of Income 101 Sources of Household Income 101 Uses of Household Income 102 The Relation Between Income and Consumption 103 Psychological and Social Aspects of Consumption 103 The Relativity of Consumption 104 Habits Influence Consumer Behavior 105 Culture Shapes Preferences 106 Fear Influences Buying 106 Extra Satisfaction from Extra Consumption Diminishes 107 Controversies about Consumer Theory 107 Moral Criticism of Consumer Theory 107 Sociological Criticism of Consumer Theory 108 Are Consumer Preferences Really Stable? 108 Are Consumers Well Informed? 109 Do Consumers Need Government Help? 111 Chapter Summary 112 Problems for Practice 112 Chapter 5 Production: Creating Wealth 115 What Is Production? 115 Entrepreneurs and Production 116 Risk and Return in Production 118 Producing Blue Jeans at Montana Jeans 120 Goal of the Firm 121 Montana’s Income Statement 121 Montana’s Balance Sheet 124 How Profitable Is Montana Jeans? 125 Economic Analysis of Producer Supply 126 What Is Supply? 127 Price Affects Quantity Supplied of Blue Jeans 127 Other Determinants of Producer Supply 129 Summarizing Effects on Supply 134 Illustrating Flows of Business Income and Expenditure 135 Business Income 135 Business Expenditures 135 Business Borrowing 135 Business Saving 136 Organizing Production 136 Legal Aspects of Production 137 Managerial Aspects of Production 140 Chapter Summary 144 Problems for Practice 144
Chapter 6 Distribution: Rationing the Wealth 147 Methods of Distributing Output 148 Coercive Distribution 148 Voluntary Cooperation 149 Redistributing Income and Wealth 152 Distribution with Market Exchange 154 Benefits of Exchange 154 Barter Exchange in Theory 155 Exchange with Money 156 Return to Barter 158 Economic Analysis of Market Exchange: Demand and Supply in the Market for Jeans 159 Market Demand for Jeans 160 Market Supply of Jeans 160 Dynamics of Market Adjustment: Entry, Exit, and Long-Run Equilibrium 162 Circular Flow of Income and Expenditure: Meeting in Product and Resource Markets 169 Questions About Income Inequality 170 Income Distribution Among Households 170 Income Distribution Among Resource Sellers 170 Chapter Summary 174 Problems for Practice 174
Chapter 7 Finance: Paying for Commerce 177 Overview of Financial Activity 177 Six Functions of Financial Activity 177 Financial-Market Money Flows 180 Spontaneous Growth, Control, and Regulation of Financial Activity 183 Providing a Payments System 185 Money as a Means of Payment 188 Controlling the Money Supply 189 Making Medieval Payments 189 Making Payments Today 191 Taking Deposits and Making Loans 192 Basics of Lendings 192 Direct or Indirect Finance? 195 Medieval Lending and Deposit Banking 197 Economic Analysis of Interest Rates and Credit 199 Interest Rates Ration Credit 200 Three Parts of Interest 201 Why Do Interest Rates Vary? 204 Economic Effects of Consumer Saving and Borrowing 207 Financial Regulation 208 Clashing Interests 209 Spillover Effects of Bad Banking 210 Deposit Instability 210 Regulatory Agencies 211 Chapter Summary 212 Problems for Practice 213
Chapter 8: Government: Powers, Functions, Institutions, and Finance 216 Government Powers 217 The Basis for Power 217 Limiting Government Powers: The Rule of Law 217 The U.S. Constitution and the American Economy 220 Constitutional Rules 220 The Changing Economic Rules 222 Economic Functions of Government 225 Pr otecting 226 Mediating 226 Regulating 226 Redistributing 226 Supplementing 227 Stabilizing 228 Government Finance: Fiscal Policy 229 Government Taxes 230 Government Spending 237 Government Borrowing 241 On the Nature of Government and the Economy 243 Public-Interest View 243 Public-Choice View 243 Institutional View 245 Marxist-Radical View 246 Chapter Summary 246 Problems for Practice 247 Chapter 9 International Trade: Importing, Exporting, and Financing 249 Overview of International Economics International Money Flows 250 Balance of Payments 254 International Finance 257 Foreign Investment 258 Changing Currencies 259 Fluctuating Exchange Rates 261 Exchange Rate Systems 264 International Trade 269 Importance of International Trade to the U.S. 269 Benefits and Peculiarities of Trade 270 Why International Trade Flourishes 272 Trade Restrictions and Their Justifications 277 Economic Analysis of Free Trade and Protectionism 281 Chapter Summary 282 Problems for Practice 283 SECTION III: ECONOMIC SYSTEMS AND THEIR INSTITUTIONS Chapter 10 Capitalism: Theory, Practice, and Institutions 288 Principles of Capitalism 288 Free Enterprise 289 Private Property, Wages, and Profits 289 Coordination by Market Prices 290 Moral Self Restraint in Exchange 291 Minimal Government in Capitalism 292 Economic Institutions of Capitalism 294 Markets: Organizations of Buyers and Sellers 294 Governmental Institutions to Promote Enterprise 297 Institutions that Augment Government 301 Banking, Finance, and Insurance 301 Institutional Concessions to Democratic Politics 305 Capitalism in Practice 306 How Much Economic Freedom? Capitalism and U.S. Health Care 306 Disputes About Patent Law and Copyrights 307 The Market Economy: Stable or Unstable Chaos? 307 Private or National Banking? 309 Debating Global Trade 311 Global Finance and Economic Instability 312 Chapter Summary 315 Problems for Practice 316 Chapter 11 Alternatives to Capitalism: Socialist, Neo-Mercantilist, and Social-Welfare States 317 Soviet Socialism in Theory and Practice 318 Principles of Soviet Socialism 318 Institutions of Command Socialism 320 Practicing Soviet Socialism 322 Changing Socialist Minds and Behavior 329 Neo-Mecantilist States 331 Principles of Neo-Mercantilism 332 Institutions and Interventions of Neo-Mercantilist States 333 Practicing Neo-Mercantilism 337 Social-Welfare States and the Mixed-Market System 340 Principles of a Social-Welfare State 340 Institutions and Interventions of Social-Welfare States 341 Practicing National Social Welfare 343 Chapter Summary 347 Problems for Practice 348 SECTION IV: ECONOMIC ANALYSIS Chapter 12: What Is Economics? A Brief History of Economic Thought 351 Ancient Economics 351 Greek Stewardship at Home 351 Christian Stewardship: Economics in God’s Kingdom 352 Early Political Economy 353 Mercantilists as Economic Advocates 355 Physiocrats as Advocates 356 English Political Economy: Discovering Economic Laws 357 Adam Smith’s Optimism 357 Other Classical Economists 358 Critics of Classical Economics 359 German Historicists and American Institutionalists 360 Literary Critics 362 Socialist Critics 362 Neoclassical Microeconomics of Optimization and Balance 365 Marshall’s Economics 365 J. B. Clark 366 Commentary on Neoclassical Theory 366 Twentieth Century Responses to Neoclassical Economics 369 Austrian Economics of Individualism 369 Keynesian Macroeconomics 371 Monetarism 372 Public Choice Theory 373 Other Recent Theories and Schools 374 Chapter Summary 376 Problems for Practice 377 Chapter 13: Microeconomics: Price, Elasticity, and Market Structure 379 Demand and Supply Shifts: Disequilibrium and Adjustment 380 Five Steps to Analyzing Shifts in Demand or Supply 380 A Further Example: Increasing Consumer Income and the Car Market 383 Elasticity of Demand and Shifting Supply 385 Illustrating Elasticity of Demand 385 Calculating a Price Elasticity of Demand for Coffee 387 Elasticity and Total Revenue 388 Why Elasticity of Demand Varies 391 Elasticity of Supply 394 Supply in the Market Period 394 Supply in the Short Run 395 Supply in the Long Run 395 Market Structure and Price Theory 395 Long-Run Competitive Pricing 396 Monopoly Pricing 398 Other Market Imperfections 400 Transfer Prices and Economic Efficiency 401 Let the Market Price Be the Guide 401 The Inefficiency of a Zero Transfer Price 402 Making Transfer Prices Work 403 Chapter Summary 405 Problems for Practice 406
Chapter 14: Macroeconomics: Concepts, Theory, and History Macroeconomic Concepts Macroeconomic Problems Measuring Macroeconomic Activity Two Macroeconomic Models The Complete Circular Flow Aggregate Demand and Aggregate Supply Historical Beginnings of Macroeconomics The Roosevelt Era and Keynesian Economics The Keynesian/Neoclassical Concensus in the 1960s Keynesian Activism Falters The Current Concensus Debates about Fiscal and Monetary Policy Budget Deficits and Discretionary Fiscal Policy Theory and Evidence on Money and Economic Activity Chapter Summary Problems for Practice
Appendix A: Answers and Hints to Problems Index
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