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INTRODUCTION
TO
MICROECONOMICS
E201

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Dr
...
Dilts
Department of Economics, School of Business and Management Sciences
Indiana - Purdue University - Fort Wayne
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May 10, 1995
First Revision July 14, 1995
Second Revision May 5, 1996
Third Revision August 16, 1996
Fourth Revision May 15, 2003
Fifth Revision March 31, 2004
Sixth Revision July 7, 2004
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Introduction to Microeconomics, E201

8 Dr
...
Dilts

All rights reserved
...
David A
...
P
...
W
...
David A
...
ii
Syllabus
...
Lecture Notes
1
...

2
...

3
...

4
...

5
...

6
...

7
...

8
...

9
...

10
...

11
...

12
...


2
7
12
18
29
33
37
43
50
56
60
68

II
...
Introduction to Economics
...
Economic Problems
...
Interdependence and the Global Economy
...
Supply and Demand
...
Elasticity
...
Consumer Behavior
...
Costs
...
Competition
...
Monopoly
...
Resource Markets
...
Wage Determination
...
Epilogue
...
Appendix A
Sample Midterm Examination
...
229
IV
...
236
i

PREFACE

This Course Guide was developed in part because of the high cost of college
textbooks, and in part, to help organize students= studying by providing lecture notes
...

Without the active participation of both the campus duplicating services, and its most
cooperative staff, and the bookstore this would not be available
...
In fact, the department=s budget and the professor=s own resources are used in
the writing of the Guide, and the numerous draft copies that are produced in the
revisions of this document
...
” Well, actually it was planned to be a non-profit enterprise in this particular
case
...
Naturally, any errors of omission or commission are
those of the professor alone
...
The commercially available student
guides and workbooks are notoriously inadequate and are simply of little value
...
What research has been done concerning these course specific
materials, suggests that students' performances are enhanced by having access to
these types of materials
...

The purpose of this Course Guide is fourfold
...
Second, the Guide provides the student a listing of the key
concepts covered in the lectures
...
Fourth, sample exams are offered as self-test exercises and to give
students an idea of the level of mastery expected in this course
...
At the end of each chapters in the reading
assignments there is a section containing the key concepts developed in the chapter,
sample exam questions and a brief study guide
...
Following the reading assignments are the lecture notes for each chapter
...


Note to Students
There is no substitute for doing the reading assignments, attending class, and
working through the material
...
It is hoped this Guide will help in the
learning effort
...
David A
...
In all respects, the policies of the School, Department, IPFW and the University
shall be applied in this course
...
Office hours will be posted on the professor's door, appointments may also be
arranged
...

3
...
In other words, 69
...
99
percent are both considered 70 percent and will earn the student a grade of C
...
The majority of undergraduate economics courses this professor has taught have
had average final grades that fall within the range centered on 2
...
0 scale
...
Course requirements:
The mid-term examination is worth 40% of the final grade, the final examination
is worth 50% of the final grade, and there will be at least three quizzes, the best
two scores on these quizzes will be worth 10% of the final grade
...
Examinations will consist of objective items
...


B
...
If there is a 10-point improvement on the final exam over
what was earned on the midterm, then the weights will be
change to the midterm being worth only 30 percent and the
final exam being worth 60 percent of the final grade
...
The final examination will be given at the time and place scheduled by the
university
...

7
...
If you cannot attend class at exam
time, you must make prior arrangements to take an equivalent
examination before your classmates
...
e
...

8
...
The over
whelming preponderance of students do not engage in dishonesty, and
the professor owes it to these students to strictly police this policy
...
The provisions of these policies and the course objectives are subject to
testing
...


COURSE OBJECTIVES

This is an introductory principles of economics course that covers topics in
microeconomics
...
The course will present factual material concerning the operation of the
firm and household as well as the development of rudimentary understanding of
economic decision-making
...
Dilts, Introduction to Microeconomics, E201
...

SUPPLEMENTAL TEXT
v

Campbell R
...
Bruce, Economics, twelfth edition
...
[M&B in the outline]

TENTATIVE COURSE OUTLINE
1
...
Economic Problems
Dilts, Chapter 2
M & B Chapter 2
3
...
The Basics of Supply and Demand
Dilts, Chapter 4
M & B Chapter 4
5
...
Consumer Behavior
Dilts, Chapter 6
M & B Chapter 21
MIDTERM EXAMINATION
7
...
Pure Competition
Dilts, Chapter 8
M & B Chapter 23
9
...
Introduction to Resource Markets
Dilts, Chapter 10
M & B Chapter 27
11
...
Epilogue
Dilts, Chapter 12

vii

LECTURE
NOTES

INTRODUCTION TO MICROECONOMICS
E201

1

1
...
Economics Defined - Economics is the study of the ALLOCATION of SCARCE
resources to meet UNLIMITED human wants
...
Microeconomics - is concerned with decision-making by individual
economic agents such as firms and consumers
...
Macroeconomics - is concerned with the aggregate performance of the
entire economic system
...
Empirical economics - relies upon facts to present a description of
economic activity
...
Economic theory - relies upon principles to analyze behavior of economic
agents
...
Inductive logic - creates principles from observation
...
Deductive logic - hypothesis is formulated and tested
...
Usefulness of economics - economics provides an objective mode of analysis,
with rigorous models that are predictive of human behavior
...
Scientific approach

b
...
Assumptions in Economics - economic models of human behavior are built upon
assumptions; or simplifications that permit rigorous analysis of real world events,
without irrelevant complications
...
model building - models are abstractions from reality - the best model is
the one that best describes reality and is the simplest B Occam=s Razor
...
simplifications:

1
...


2
...

Too often, the models built are inconsistent with observed reality therefore they are faulty and require modification
...


4
...
POSITIVE economics is concerned with what is;

b
...


1
...

c
...
Individual utility maximization versus social betterment

2
...
More is preferred to less
3

d
...
Economic efficiency,
2
...
Economic freedom,
4
...
Equitable distribution of income,
6
...
Price level stability, and
8
...


5
...
interpretation - precise meanings and measurements will often become
the subject of different points of view, often caused by politics
...
goals that are complementary are consistent and can often be
accomplished together
...
conflicting - where one goal precludes, or is inconsistent with another
...
priorities - rank ordering from most important to least important; again
involving value judgments
...
The Formulation of Public and Private Policy - Policy is the creation of guidelines,
regulations or law designed to affect the accomplishment of specific economic
goals
...
Steps in formulating policy:

1
...


2
...
evaluation - gathers and analyzes evidence to determine whether
policy was effective in accomplishing goal, if not re-examine options
and select option most likely to be effective
...
Objective Thinking:
a
...

1
...


b
...

c
...


1
...


2
...


a
...

5

d
...

1
...

a
...


6

2
...
The economizing problem involves the allocation of resources among competing
wants
...
unlimited wants
e
...
Resources and factor payments:

d
...
e
...

1
...
capital - are the physical assets used in production - i
...
, plant and
equipment
...
capital is paid interest

f
...

3
...
entrepreneurial talent - (risk taker) the economic agent who creates the
enterprise
...
entrepreneurial talent is paid profits

3
...
However, full production or 100%
capacity utilization cannot be maintained for a prolonged period without labor
and capital breaking-down:
7

a
...
D
...

4
...
allocative efficiency - is measured using a concept known as Pareto
Superiority (or Optimality)

1
...


2
...
[cost - benefit
approach]

b
...


c
...


5
...
Every choice is costly; there is always the lost alternative -- the
opportunity cost:

a
...


6
...
assumptions necessary to represent production possibilities in a simple
production possibilities curve model:

8

1
...
fixed resources
3
...
two products

Beer

Pizza

7
...
Notice - as we obtain more pizza (shift to the right along the
pizza axis) we have to give up large amounts of beer (downward shift along beer
axis)
...
Inefficiency, unemployment and underemployment are illustrated by a point
inside the production possibilities curve, as shown above
...
Inefficiency is a violation of the assumptions behind the model, but do not
change the potential output of the system
...
Economic Growth can also be illustrated with a production possibilities curve
...


9

a
...

b
...


10
...
The following classification of
systems is based on the dominant characteristics of those systems:
a
...


1
...


2
...


b
...
Often associated with dictatorships

c
...
Christmas gift giving is tradition

d
...


e
...
The former Soviet Union espoused communism, but also was mostly
10

command
2
...
S
...
mixed system - contains elements of more than one system - U
...

economy is a mixed system (capitalism, command, and socialism are the
major elements, with some communism and tradition)

1
...
Even with mixed systems there are substantial variations in the amounts
of socialism, capitalism, tradition, and command exist in each example
...
Interdependence and the Global Economy
Lecture Notes
1
...
e
...
S
...

a
...
Foreign investment versus U
...
investment abroad

1
...
Technological transfers

c
...


1
...
exports)
2
...
Capitalist Ideology - The characteristics of a capitalist economy and the ideology
that has developed concerning this paradigm are not necessarily the same thing
...
freedom of enterprise

b
...
competition

d
...
a very limited role for government
f
...
e
...

efficiency again
...
Market System Characteristics - the following characteristics are typical of a
system that relies substantially on markets for allocation of resources
...
division of labor & specialization

b
...
comparative advantage - is concerned with cost advantages
...
Comparative advantage is the motivation for trade among nations and
persons
...
Terms of trade are those upon which the parties may agree and
depends on the respective cost advantages and bargaining power
...
Trade among nations
a
...
For example, if Holland put all
13

their resources in tulip production they could produce 4000 tons of tulips
but no wine
...
If Belgium produced nothing but wine it would produce
4000, and if Holland produced nothing but tulips it would produce 4000
tons)
...


b
...


1
...

2
...


3
...
High income countries without economic development (Hong Kong,
Israel, Kuwait, Singapore, and UAE)
5
...
barter economy - is where commodities are directly traded without the use
of money
...
Direct trade requires a coincidence of wants
...
Prices become complicated by not having a method to easily measure
worth
...
functions of money:

1
...
store of value

3
...
Fiat money
1
...
Genghis Kahn in the 12th century in Asia B paper money

6
...
Hard currency B U
...
dollar, British Pound, Canadian dollar, Japanese
Yen, and the Euro B general acceptability of the currency and it being
demanded as reserves by central banks

1
...
Exchange rates affect both imports and exports; and foreign investment
here, U
...
investment abroad
...
Dollar gains strength, Imports cheaper here, exports more expensive
abroad

2
...
S
...
Strong dollar policy in exchange B based on interest rates, growth, and
relative strength of economy and stability of political system etc
...
Debt and supply of currency an important factor in economic
development

7
...
sectors [private-domestic]

1
...
resource markets

3
...
product markets

b
...
government
2
...
Model of interdependence:

16

______________________________________________________________________

____________________________________________________________________
FOREIGN SECTOR
_____________________________________________________________________
_____________________________________________________________________

Product markets are where the domestic parties obtain and sell commodities
[inside the pyramid], and the factor markets [shown with the dotted lines] are
where the domestic parties obtain and supply productive resources
...
The circular flow diagram shows that
each of the sectors relies on the others for resources and supplies the others
commodities and resources
...
Basics of Supply and Demand
Lecture Notes

1
...


2
...


a
...


As price falls from P1 to P2 the quantity demanded increases from Q1 to Q2
...


1
...


18

2
...


3
...


b
...


c
...


3
...
Price and quantity - again the demand curve shows the negative relation
between price and quantity
...
Individual versus market demand - a market demand curve is simply an
aggregation of all individual demand curves for a particular commodity
...
Nonprice determinants of demand; and a shift to the left (right) of the
demand curve is called a decrease (increase) in demand
...
tastes and preferences of consumers,
2
...
the money incomes of consumers,
4
...
consumers' expectations concerning future availability or prices of
the commodity
...
Changes in demand versus in quantity demanded

An increase in demand is shown in the first panel, notice that at each price there is a
greater quantity demanded along D2 (the dotted line) than was demanded with D1 (the
solid line)
...


20

Movement along a demand curve is called a change in the quantity demanded
...
When price
decreases from P1 to P2, the quantity demanded increases from Q1 to Q2; when price
increases from P2 to P1 the quantity demanded decreases from Q2 to Q1
...
The law of supply is that producers will supply more the higher the price of the
commodity
...
Supply schedule - are the quantities supplied at each and every price
...
Supply curve - is nothing more than a schedule of the quantities at each and
every price
...
There is a positive relation between price and quantity on a supply curve
...
Changes in one or more of the nonprice determinants of supply cause the
supply curve to shift
...
The
nonprice determinants of supply are:

1
...
technology,
3
...
prices of other goods,
5
...
the number of sellers
...
The
second panel shows an increase in supply, notice that there is a larger quantity supplied
at each price with S2 (dotted line) than with S1 (solid line)
...


6
...


a
...
This is analogous to a
cherry rolling down the side of a glass; the cherry falls due to gravity and
rolls past the bottom because of momentum, and continues rolling back
and forth past the bottom until all of its' energy is expended and it comes
to rest at the bottom - this is equilibrium [a rotten cherry in the bottom of a
glass]
...
Where the
supply and demand curves intersect, equilibrium price is determined (Pe) and
equilibrium quantity is determined (Qe)

23

a
...
Both the demand and supply curve can be expressed as
equations
...
Changes in supply and demand in a market result in new equilibria
...


24

Movement of the demand curve from D1 (solid line) to D2 (dashed line) is a
decrease in demand (as demonstrated in the above graph)
...
With a
decrease in demand there is a shift of the demand curve to the left along the supply
curve, therefore both equilibrium price and quantity decline
...
When
demand increases both equilibrium price and quantity increase as a result
...
Such increases are caused by a
change in a nonprice determinant (for example, the number of suppliers in the market
increased or the cost of capital decreased)
...
If we move
from S2 to S1 that is called an decrease in supply, possibly due to an increase in the
price of a productive resource (capital) or the number of suppliers decreased
...

That is the result of the supply curve moving up along the negatively sloped demand
curve (which remains
unchanged)
...

Consider the following graphs:

25

Notice that the
quantity remains the same in both graphs
...
In both cases, the equilibrium price
changes
...
In the second panel where demand decreases and supply
increases, the equilibrium price decreases
...
These results are illustrated in the following
diagrams
...
When both supply and demand
decrease quantity decreases to Q2
...
Shortages and surpluses occur because of effective government intervention in
the market
...
Shortage is caused by an effective price ceiling (the maximum price you
can charge for the product)
...


1
...
Note that the Qs is below the Qd,
which means that there is an excess demand for this commodity
that is not being satisfied by suppliers at this artificially low price
...


b
...
e
...
Notice that at the floor price Qd is less than Qs, the distance between Qd and Qs
is the amount of the surplus
...

9
...
In most
respects the supply and demand model is the beginning point for understanding
markets
...
Therefore,
the basic supply and demand model may accurately be thought of as the
beginning point from which we will explore more realistic market structures
...
Supply & Demand: Elasticities
Lecture Notes

1
...


a
...
Ed = Change in Qty
(Q1 + Q2)/2

)

Change in price
(P1 + P2)/2

b
...


c
...


d
...


2
...


a
...
Elasticity is concerned with changes along the
curve rather than the shape or position of the curve
...
Demand Curve and Total Revenue (total revenue = P x Q) Curve

30

In examining the above graphs, notice that as total revenue is increasing, demand is
elastic
...


4
...

Consider the following numerical example:
Total Quantity
1

Price per unit

Total Revenue

9

Elasticity

9
>+7
>+5

>-1

>-5

5

25

6

4

24

7

3

21

8

2

Inelastic

24

5

Inelastic

>-7

6

Inelastic

21

4

Inelastic

>-3

7

Elastic

16

3

Elastic

>+ 1

8

Elastic

>+3

2

Elastic

16

9

1

9

The total revenue test is simply the inspection of the data to see what happens to total
revenue
...
If
the marginal revenue is exactly zero then demand is unit elastic
...
The following determinants of the price elasticity of demand will determine how
responsive the quantity demanded is to changes in price
...
substitutability

31

b
...
luxuries versus necessities
d
...
Price Elasticity of Supply is determined by the following time frames
...


a
...
short run

c
...
Cross elasticity of demand measures the responsiveness of the quantity
demanded of one product to changes in the price of another product
...


8
...


9
...


32

6
...
Individual demand curves can be constructed from observing consumer
purchasing behaviors as we change price
...
This is called REVEALED PREFERENCE

b
...


2
...


a
...


The consumer is assumed to spend their resources on only beer and pizza
...


33

If the price of pizza doubles then the new budget constraint becomes the dashed
line
...


b
...
There are three assumptions that underpin the indifference curve,
these are:
1) Indifference curves are everyplace thick
2) Indifference curves do not intersect one another
3) Indifference curves are strictly convex to the origin

The dashed line (2) shows a higher level of total satisfaction than does the solid
line (1)
...


Consumer equilibrium is where the highest indifference curve they can reach is
exactly tangent to their budget constraint
...

Deriving the individual demand curve is relatively simple
...
The lower
price with the solid line budget constraint results in the level the higher level of pizza
being purchased (labeled 1for the indifference curve - not the units of pizza)
...


Notice that Q2 and P2 are associated with indifference curve 2 and budget constraint 2,
and that Q1 and P1 result from indifference curve 1 and budget constraint 1
...

35

3
...


a
...


b
...


c
...


d
...
This happens because the income effect results in
less of a quantity demanded for a product the lower the price
...
There is also the snob appeal possibility where the higher the price the
more desired the commodity is - Joy Perfume advertised itself as the
world's most expensive
...
Utility maximizing rule - consumers will balance the utility they receive against the
cost of each commodity to arrive at the level of each commodity they should
consume to maximize their total utility
...
algebraic restatement - MUa/Pa = MUb/Pb =
...
Costs of Production
Lecture Notes
1
...


a
...


3
...


2
...
These time periods
differ from industry to industry
...
market period - everything is fixed

b
...
long run - everything is variable

3
...
the law of diminishing returns is the fact that as you add variable factors of
production to a fixed factor at some point, the increases in total output
become smaller
...
total product is the total units of production obtained from the productive
resources employed
...
average product is total product divided by the number of units of the
variable factor employed

d
...
graphical presentation:

The top graph shows total product (total output)
...
When marginal product reaches its maximum, the total product curve
becomes flatter
...
When marginal product is below
average product, then average product is decreasing
...


38

4
...
total costs = VC + FC

b
...
e
...
fixed costs are those items that cannot be varied in the short-run, i
...
,
plant and equipment

The fixed cost curve is a horizontal line because they do not vary with
quantity of output
...
Notice that the total cost curve has the same shape as the
variable cost curve, but is above the variable cost curve by a distance
equal to the amount of the fixed cost
...
average total costs = TC/Q

e
...
average fixed cost = FC/Q
g
...


39

1
...


Notice that the average fixed cost approaches zero as quantity increases
...
The marginal cost curve intersects both the average total cost and
average variable cost curves at their respective minimums
...


Notice that at the maximum point on the average product curve, marginal cost
reaches a minimum
...

40

5
...
Is often called an envelope curve because it is the minimum points of all
possible short-run average total cost curves (allowing technology and fixed
cost to vary)
...
Economies of Scale are benefits obtained from a company becoming large and
Diseconomies of Scale are additional costs inflicted because a firm has become
too large
...
The causes of economies of scale are:

1
...
managerial specialization

3
...
ability to profitably use by-products

b
...

41

c
...


d
...


e
...
e
...


42

8
...
There are several models of market structure, these include:

a
...
pure monopoly (one seller, price giver, entry & exit blocked, unique
product, nonprice competition)

c
...
oligopoly (very few number of sellers, often collude, often price leadership,
entry difficult, nonprice competition, product differentiation)

1
...
Assumptions of Pure Competition:

a
...
standardized product

c
...
freedom of entry & exit
43

e
...
Revenue with a price taking firm:

a
...


b
...


4
...


a
...
Where MC = MR; revenue is at its maximum and costs are at their
minimum
...
Model of the purely competitive industry:

The purely competitive industry is the supply and demand diagram presented in
chapter 4
...
Firm in Perfect Competition
a
...
Because the firm is a price taker, meaning that it charges the same price
across all quantities of output, marginal revenue is always equal to price,
and average revenue will always be equal to price
...


c
...
The price is established by the interaction of supply and demand in the
industry (Pe) and the quantity exchanged in the industry is the summation
of all of the quantities sold by the firms in the industry
...
Economic profit for the competitive firm is shown by the rectangle labeled
AEconomic Profit@ in the following diagram:

f
...
At the point
where MC = MR the average total cost (ATC) is below the demand curve
(AR) and therefore costs are less than revenue, and an economic profit is
made
...


1
...
As firms enter the market, the industry supply curve shifts
to the right reducing price and thereby eliminating economic profits
...


g
...
The case where a firm is making a normal profit is illustrated above
...
Because the ATC includes the
profits from the next best alternative allocation of resources this firm is
making a normal profit
...
economic loss for a firm in pure competition:

i
...
The firm produces
where MC = MR, however, at that level of production the ATC is above the
demand curve, in other words, costs exceed revenues and the firm is
making a loss
...
shut-down case

1
...
)
above because the firm can cover all of its variable costs and
have something left to pay on its fixed costs - this is loss
minimization
...


7
...
Allocative efficiency criteria are satisfied by the competitive model
...


b
...


c
...
There
are several problems including which are typically associated with a purely
competitive market:

1
...

48

2
...


3
...


4
...


49

9
...
Assumptions of Monopoly Model

a
...
no close substitutes

c
...
blocked entry

e
...
The Firm is the Industry and therefore faces a downward sloping demand curve,
which is also the average revenue curve
...
If the firm wants to sell more it must lower its price therefore marginal
revenue is also downward sloping, but has twice the slope of the demand
curve
...
The point where the marginal revenue curve intersects the quantity
axis is of significance; this point is where total revenue is maximized
...


3
...


a
...
Monopolized Market

a
...
Because entry is blocked into this industry the economic profits shown
above can be maintained in the long run
...


51

c
...
This monopolist is making an economic loss
...
However, because AVC is below the demand curve at
where MC = MR the firm will not shut down so as to minimize its
losses
...
Economic Effects of Monopoly:

a
...
With allocative efficiency consider
the following graph:

52

1
...

However, where MC = D is where a perfectly competitive industry
produces and this is associated with Pc and Qc
...

b
...
Price discrimination is where you charge a different price
to different customers depending on their price elasticity of demand
...


c
...
Often a company must expend substantial
resources on research and development
...


6
...

Examples of regulated monopolies are electric utilities, cable TV companies, and
telephone companies (local)
...
A monopoly regulated at social optimum P = D = MC

53

1
...
The
price it is required to charge is also the competitive solution
...
It is also possible with
this solution that the firm could be making an economic loss (if ATC is
above demand) or even shut down (if AVC is above demand)
...
A monopolist regulated at the fair return P = D = AC

1
...
This
eliminates economic profits and the risk of loss or of even putting the
monopolist out of business
...
The dilemma of regulation is knowing where to regulate, at the social
optimal or at the fair return
...


1
...
This is called the Averch-Johnson Effect
...
X-efficiency is where the firm's costs are more than the minimum possible
costs for producing the output
...

9
...


a
...
Criminal Provisions

1
...
Civil Provisions

1
...
Treble damages

55

10
...
Resource Market Complications:
a
...


b
...


2
...
By derived
demand it is meant that it is the output of the resource and not the resource itself
for which there is a demand
...
marginal product is MP = ÎTP/ÎL where L is units of labor, (or K for
capital, etc
...
marginal revenue product is MRP = ÎTR/ÎL

3
...
Because the demand for a productive resource is a derived demand, the
demand schedule for that productive resource is simply the MRP schedule
of that resource
...
Determinants of Resource Demand:

a
...
quality of resource

c
...
Determinants of Resource Price Elasticity:
a
...
ease of resource substitutability

c
...
K/L ratios

6
...

a
...
The profit maximizing employment of resources is where MRP = MRC, where
MRC is the supply curve of the resource in a purely competitive resource market
...
resource market equilibrium

8
...


a
...
= MRPland/MRCland = 1

b
...
Marginal Productivity Theory of Income Distribution

a
...


b
...


58

1
...


2
...


59

11
...
Nominal versus Real Wages:

a
...


b
...


2
...
In theory an employee should be paid what she earns for the company,
MRP, however, this theory has serious flaws in practice
...
Market imperfections, i
...
, monopsony results in the earnings of workers
being paid to other factors of production
...
Problems with measuring MRP, because of engineering complications of
technology
...
Supply and Demand for Labor:

a
...
The supply and demand curves for the industry are summations of the
individual firms' respective demand and supply curves
...


b
...
Notice that MRC breaks out to the right of the supply curve and is
much steeper; this is due to the pricing policy the monopolist can
employ
...


4
...
minimum wages has been one approach to the control of monopsony
...
minimum wages under competition

2
...
The distance
between Qd and Qe is the number of workers who lost jobs, and
the distance between Qe and Qs is the number of workers
attracted to this market that cannot find employment
...
Minimum wage opponents argue that the minimum wage does
two things that are bad for the economy (and these arguments
are based on the competitive model)

b
...

c
...

62

1
...
In a monopsony the wage increases with the establishment of a
minimum wage, but if the employer is rationale so too does the
employment level
...
If the monopsony model is accurate then the conservative
argument does not hold water
...


5
...
craft union (exclusive union):

1
...
e
...
Craft unions can control the supply of labor somewhat because of
the fact that they represent primarily skilled employees and have
control of the apprentice programs and the standards for
achieving journeyman status
...
industrial union

1
...
e
...
The industrial union establishes the minimum acceptable wage,
below which they will strike rather than work
...


c
...
Perfectly competitive labor markets are
used to illustrate the effects of two different types of unions
...
However, unions are
necessary in imperfectly competitive labor markets
...
The pure craft and pure industrial union virtually no longer exist
...


6
...


a
...
The employer
(monopsonist) will equate MRC with demand and attempt to pay a wage
associated with that point on the supply curve
...
The situation shown in this graph shows that
the competitive wage is just about halfway between what the union and
employer would impose
...

65

b
...


c
...


7
...


a
...
S
...


b
...

c
...


d
...


e
...
Public Sector industrial relations more problematic
...
Civil Service Reform Act of 1974 governs Federal Employees

1
...
State employees covered by state statutes; most states have protective
legislation

1
...
Market Wage Differentials arise from several sources:

a
...
Discrimination

c
...
Ability

2
...
Human Capital refers to the various aspects of a person that makes them
productive
...


a
...


b
...


1
...


2
...


67

12
...
Changing World - Economically
a
...


1
...
Say=s Law B accounting identity B cost of product is factor
incomes

b
...
Fas – ethics

2
...
Lex - law

a
...
Self-interest - rationality

c
...
Comparative advantage is the basis for trade among nations as
well as people
...
Natural resources

b
...
Human capital

2
...
The middle east and different value systems and perceptions

2
...
Anti-American perspectives abroad

b
...
Perception of imperialism versus American generosity
1
...
Marshall Plan

3
...
Increasingly the U
...
is a service economy

1
...
Multi-national corporations

b
...
Lower incomes

2
...
Parting words

a
...


1
...
Marketing, finance, production management

b
...


70

READING
ASSIGNMENTS
INTRODUCTION TO MICROECONOMICS
E201

71

CHAPTER 1

Introduction to Economics
This is an introductory course in economics
...
This chapter and the following two chapters will lay those
foundations -- the rudimentary definitions, and basic concepts upon which the following
ideas will be built are discussed
...

Specifically, this chapter will focus on specific definitions, policy, and objective
thinking
...


Definitions

Economics is a social science
...
Economics is the mother discipline from which most of the business
disciplines arose
...

Economics is the study of the ALLOCATION of SCARCE resources to meet
UNLIMITED human wants
...
The key words in this definition are in all capital
letters
...
Because there are fewer resources than wants there must be allocation
mechanism of some sort – markets, government, law of the jungle, etc
...
" A "Worldly
Philosophy" is concerned with matters of how our material or worldly well-being is best
served
...
This worldly philosophy has been used to explain most
rational human behavior
...
) Underlying all of economics is the
72

base assumption that people act in their own perceived best interest (at least most of
the time and in the aggregate)
...
As limiting as this assumption may seem, it appears to be an accurate
description of reality
...
With its publication, capitalism was born, from the ashes of the
mercantilist system that preceded it
...

Adam Smith’s view of self-interest and exchange
An Inquiry in the Nature and Cause of the Wealth of Nations, Adam Smith, New York:
Knopf Publishing, 1910, p
...


...
But man has almost constant occasion for the
help of his brethren, and it is in vain for him to expect it from their benevolence only
...

Whoever offer to another a bargain of any kind, proposes to do this
...
It is not from the benevolence of the butcher,
the brewer, or the baker that we expect our dinner, but from their regard to their own
interest
...

Adam Smith, Wealth of Nations
...
Knopf, 1991, p
...


Experimental economics, using rats in mazes, suggests that rats will act in their
own best interest (incidentally, Kahneman won a Noble Prize for this sort of research –
it is serious business, not just fun and games like it sounds)
...
The result is that rats will pay a greater price (longer mazes
and electric shocks) to obtain root beer than they will to obtain water
...

Most academic disciplines have evolved over the years to become collections of
73

closely associated scholarly endeavors of a specialized nature
...
An examination of one of the scholarly journals published by the American
Economics Association, The Journal of Economic Literature, reveals a classification
scheme for the professional literature in economics
...
In other words, the realm of economics
has expanded over the centuries that it is nearly impossible for anyone to be an expert
in all aspects of the discipline, so each economist generally specializes in some narrow
portion of the discipline
...

In general, economics is bifurcated by the focus of the analysis – that is, there
are two bundles of issues that are examined by economists
...

Economics is generally classified into two general categories of inquiry, these two
categories are: (1) microeconomics and (2) macroeconomics
...
In other words, microeconomics is
concerned with the behavior of individuals or groups organized into firms, industries,
unions, and other identifiable agents
...
Microeconomics is the subject matter of this course
(E201)
...
That is, the performance of the U
...
economy or, in a more
modern sense, the global economy
...
These matters are the
topics to be examined the course that follows this one (E202)
...
These scientific endeavors can be classified into two
categories of activities, these are: (1) economic theory and (2) empirical economics
...

Economic theory relies upon principles to analyze behavior of economic
agents
...
A good theory is
one that accurately predicts future human behavior and can be supported with
evidence
...
Tinbergen (Netherlands); R
...
A
...
Kuznets (USA, Soviet Union)
1972 J
...
Hicks (United Kingdom); K
...
Arrow (USA)
1973 W
...
A
...
G
...
Koopmans (USA); L
...
Friedman (USA)
1977 B
...
Meade (United Kingdom)
1978 H
...
Simon (USA)
1979 T
...
Schultz (USA); A
...
R
...
Tobin (USA)
1982 G
...
Stigler (USA)
1983 G
...
Stone (United Kingdom)
1985 F
...
Buchanan (USA)
1987 R
...
Solow (USA)
1988 M
...
Haavelmo (Norway)
1990 H
...
Miller (USA); W
...
H
...
S
...
W
...
C
...
Selten (Germany); J
...
Harsanyi (USA); J
...
Nash (USA)
1995 R
...
Lucas (USA)
1996 J
...
Mirrlees (United Kingdom); William Vickery (Canada, USA)
1997 R
...
Merton (USA); M
...
Scholes (USA)
1998 A
...
A
...
J
...
L
...
A
...
M
...
E
...
Kahneman (USA, Isreal); V
...
Smith (USA)
Economic theory tends to be a very abstract area of the discipline
...
In the middle of the twentieth century, an economist, Paul
75

Samuelson, from M
...
T
...
(Incidentally Paul Samuelson won the Nobel Prize for Foundations,
and he is a Hoosier, Stiglitz is also from Indiana, and both are from Gary, Indiana)
...
Notice that the overwhelming majority of these persons are Americans – two
of whom are from Indiana, and several are from the University of Chicago
...
Further, it is
also interesting to note that the Nobel Prize in Economic Sciences is the newest of the
prizes, beginning with Tinbergen’s award in 1969
...
Empirical economics is used to test and refine theoretical
economics, based on tests of economic theory
...
The area is founded in mathematical
statistics and is critical to our ability to test the veracity of economic theories
...
Most of the social studies, i
...
,
sociology, psychology and anthropology typically rely on inductive logic to create theory
...
In other words, the
scientist will observe evidence and attempt to create a principle or a theory based on
any consistencies that may be observed in the evidence
...
Deductive logic
involves formulating and testing hypotheses
...

Often the theory that will be tested comes form inductive logic or sometimes
informed guess-work
...
The tests of hypotheses can only
serve to reject or fail to reject a hypothesis
...

However, examples of both types of logic can be found in each of the social
sciences and in most of the business disciplines
...
With increasing
76

regularity standard statistical methods are being employed across all of the social
sciences and business disciplines to test the validity and the predictability of theories
developed using these logical constructs
...
In other words, a good theory is one that is an accurate
description of reality
...
The internal consistency brought to economic theory
by mathematical models of economic behavior provides for this consistency
...
If the
assumptions are unrealistic, so too will be the models' predictions
...
That is, a systematic analysis of rational human behavior
...
It is the rationality that makes behavior
predictable, and what most economists don’t like to admit is without this underlying
premise, economics quickly falls into a quagmire of irreproducible results and disjointed
theories
...
Models are abstractions from reality - the best model is the
one that best describes reality and is the simplest (the simplest requirement is called
Occam's Razor)
...
Often (as will be pointed-out in this course) the assumptions underlying
a model are not accurate descriptions of reality
...

One assumption frequently used in economics is ceteris paribus which means
all other things equal (notice that economists, like lawyers and doctors will use Latin for
simple ideas)
...


77

Economic Goals, Policy, and Reality

Most people and organizations do, at least, rudimentary planning, the purpose of
planning is the establishment of an organized effort to accomplish some economic
goals
...
Goals are, in a sense, an
idea of what should be (what we would like to accomplish)
...

This brings another classification scheme to bear on economic thought
...
Positive economics is
concerned with what is; and normative economics is concerned with what should
be
...
Evidence concerning
economic performance or achievement of goals falls within the domain of positive
economics
...
In fact, economics contains numerous
value judgments
...
Self-interest is therefore presented as a positive element of behavior
...
Self-interest is probably descriptive of the majority of
Americans’ behaviors over the majority of time, however, each of us can think of
instances where self-less behavior is observed, and is frequently encouraged
...

However, efficiency is not always desirable
...
The efficiency criterion in economics is not always consistent with
equity; in fact, these two ideas are often in conflict
...
However, there are disposal problems, distributional effects, and
other problems where more may not be such a good thing
...
Pollution, poverty, and crime may also be examined as more begetting
problems
...

The types of goals a society adopts depends very much on the stage of economic
development, system of government, and societal norms
...


Each goal (listed above) has obvious merit
...
For example, it is easy for the very wealthy to
cite as their primary goal, economic freedom, but it is doubtful that anybody living in
poverty is going to get very excited about economic freedom; but equitable distributions
of income, full employment and economic security will probably find rather wide support
among the poor
...

Economics can hardly be separated from politics because the establishment of
national goals occurs through the political arena
...
A word of warning, eCONomics can be, and has often been used,
to further particular political agendas
...

An example liberals are fond of is, Ronald Reagan argued that government deficits
were inexcusable, and that the way to reduce the deficit was to lower peoples' taxes -thereby spurring economic growth, therefore more income that could be taxed at a
lower rate and yet produce more revenue
...
Reagan is often accused, by his
detractors, of having a specific political agenda that was well-hidden in this analysis
...
(Who really knows?)
Conservatives are fonder of criticizing the Clinton administration’s assertions that the
way to reduce the deficit was to spend money where it was likely to be respent, and
hence grow the economy and the result was more tax revenues, hence eliminate the
deficit
...
This adds to the
lack of objectivity that seems to increasingly dominate discourse on economic problems
...
President Lincoln was convinced that the working classes should have
access to higher education
...

By educating the working class, it was believed that several economic goals could be
achieved, including growth, a more equitable distribution of income, economic security
and freedom
...
Therefore, conflict need not be the
centerpiece of establishing economic goals
...
The process by which such decisions are made
is called prioritizing
...
Prioritizing of goals also involve value judgments, concerning which
goals are the most important
...


Policy

Policy can be generally classified into two categories, public and private policy
...

Public policy is how economic goals are pursued
...

Business students will have an in depth treatment of policy making in
Administrative Policy (J401) and the School of Public and Environmental Affairs requires
a similar course in some of its degree programs
...


The steps in formulating policy are:

1
...

2
...
evaluation - gather and analyze evidence to determine whether policy
was effective in accomplishing goal, if not reexamine options and
select option most likely to be effective
...

Economic goals change with public opinion and with achievement
...
Step 2 involves selecting the appropriate model and
the options associated with that model to accomplish the specified goal
...
The process of formulating policy is therefore a loop, and
requires continuous monitoring and revising
...
The Board of Directors or management
of a company will decide what goals are to be accomplished and what policy options are
best used to do so
...
The strength of public
policy is created in the open, with public debate, and often has the force of law (and not
just company rules and regulations)
...
After all,
economics deals with people's material well-being – a very serious matter to most
...
Rational and objective thought
requires approaching a subject with an open-mind and a willingness to accept what ever
answer the evidence suggests is correct
...

What conclusions an individual draws from an objective analysis using economic
principles, are not necessarily cast in stone
...
The respective evaluation
of the economic and "other values" (i
...
, ethics) may result in a conflict
...
e
...
An individual with a low value for ethics or morals may
find that a criminal act, such as theft, as involving minimal costs
...

There are several common pitfalls to objective thinking in economics
...
Each of these will be reviewed, in
turn in the following paragraphs
...
An individual or small group of individuals may
exhibit behavior that is not common to an entire population
...
U
...
U
...
Statistical inference can be drawn from a sample of
individuals, but only within confidence intervals that provide information concerning the
likelihood of making an erroneous conclusion (E270, Introduction to Statistics provides a
more in depth discussion of confidence intervals and inference)
...
Simply because one event follows another does not
necessarily imply there is a causal relation
...
One event can follow another, but
there may be something other than direct causal relation that accounts for the timing of
the two events
...
Unfortunately,
some concluded that the plague was caused by cats so they killed the cats
...
When the rat population increased, cats were
attracted to the area because of the food supply
...
This increase in the rat population
also happened to attract cats, but cats did not cause the plague, if left alone they may
have gotten rid of the real carriers (the rats, therefore the fleas)
...
Simple answers to complex problems are appealing, abundant, and often
wrong
...
Too often the desire to have a simple
solution will blind individuals, and public opinion to the more complex and often more
harsh realities
...

Policy is fraught with danger
...

The following box presents an excellent historical example of the law of
unintended consequences
...
Dilts, Indiana Policy Review, Vol
...
5, pp
...
)
Many a cliché seems to center on pork
...
It only seems fitting that one more story
concerning pork should be brought to your attention
...
The farmers brought political
pressure to bear on the Congress and our representatives to deregulate the price of
pork
...

Shut down our steel mills? How could this be?
Since it is not intuitively obvious how this happened, I'll explain
...
And, as luck would have it, we
didn't have good trade relations with the new management -- the Japanese
...
We had not yet developed synthetic fibre and therefore has
to rely on the fibre previously available
...

Now hemp grows in the same places, under the same climatic conditions as
does corn
...
And because corn was not being grown in the
Midwest, the farmers sought alternative feed for the increased number of hogs they
were raising
...
)
Oats, wheat and barley were available from the Great Plains region
...

In their search for transportation, the farmers found that railroads were
regulated and reserved for military and heavy industry; trucks needed gasoline and
rubber, both in short-supply; and airplanes were being built almost exclusively for
military purposes
...
But they eventually found a source of shipping that was neither
regulated nor controlled, because it was international in nature -- the iron-ore barges
on the Great Lakes
...
And there you have it:
Without the requisite iron ore the steel mills could not produce; they were
actually shut down for a period as a direct result of deregulating the price of pork
...
Most of the statistical methods used in econometrics (statistical examination
of economic data) rely on correlation
...
This statistical association means that the two variables move
predictably with or against each other
...
For example, a graduate student once
found that Pete Rose's batting average was highly correlated with movement in GNP
during several baseball seasons
...

On the other hand, we can test for causation (where one variable actually causes
another)
...
As with
most statistical methods Granger causality models permit testing for the purpose of
rejecting that a causal relation does not exist, it cannot be used to prove causality
exists
...

As is true with economics, statistics are simply a tool for analyzing evidence
...
Caution is required in accepting
statistical evidence
...
Statistics do
not lie, but sometimes statisticians do!

Objectivity and Rationality

Objective thinking in economics also includes rational behavior
...
Acting in one's best interests is how rationality is
defined
...
This economic perspective involves weighing the costs against the
benefits of each additional action
...
Too often
people permit the costs already paid to influence their decision-making, and hence they
are lead astray by not focusing on the margin
...
Often what people believe is in their
own self-interest may not be
...
Education and the
gathering of information helps to make perceptions more accurate views of reality
...
However, there are costs associated with
information gathering and with education, therefore rationality may be costly
...
Empirical Economics
Inductive v
...
Normative Economics
Economic Goals
Policy Formulation
Objective Thinking
Fallacy of Composition
Post hoc, ergo propter hoc fallacy
Causation v
...
How might opinions be of
value? Explain
...


What evidence can statistical analysis provide? Critically evaluate this evidence
and explain the role of empirical economics in developing economic theory
...

B
...

D
...

B
...

D
...
{FALSE}
Assumptions are used to simplify the real world so that it may be rigorously analyzed
...
This chapter will examine scarcity, factors of production,
economic efficiency, opportunity costs, and economic systems
...


The Economizing Problem

Economics is concerned with decision-making
...
The fundamental
question in economics is called the economizing problem
...
The economizing
problem involves the allocation of resources among competing wants
...
Scarcity arises because of two
facts; (1) there are unlimited human wants, but (2) there are limited resources available
to meet those wants
...
Perhaps at some date in the future, a
utopian world may be obtained where everyone's desires can be fully satisfied -- most
economists probably hope that will not happen in their lifetimes because of their own
self-interest
...

Unfortunately, the want of a millionaire for a new Porsche is not differentiated from the
need of a starving child for food in the aggregate
...

The concept of scarcity is embedded in virtually every analysis found in
economics
...
Each decision
allocating resources to one use or economic agent is also, by necessity, a decision not
to allocate resources to an alternative use
...
The following section of this chapter examines resources
...

Productivity is the key
Head to Head (Lester Thurow, New York: William Morrow and Company, Inc
...
273
...
When under
competitive pressure, American firms first go the low-wage nonunion parts of
America and then on to succession of countries with ever-lower wages
...
For a brief time lower wages lead to higher profits, but
eventually other with even lower wages enter the business (low wages are easy to
copy), prices fall, and the higher profits generated by lower wages vanish
...
Since
rapid productivity growth is a moving target and therefore hard to copy, high long-run
profits can be sustained
...
High wages have to be paid,
but paradoxically high wages also leave firms with no choice but to go upscale in
technology
...

Resources and factor payments

The resources used to produce economic goods and services (also called
commodities) are called factors of production
...
The way that these resources are combined to
produce is called technology
...
Another technology that can produce
the same commodity as a man with a shovel is a backhoe and an operator -- the
former is more labor intensive, and the latter is more capital intensive
...
Land includes space, natural resources, and
what is commonly thought of as land
...
However, iron ore, water
resources, oil, and other natural resources obtained from land are also one dimension
of this factor of production
...

The location of a building site for a business is an important consideration
...
The factor payment
that accrues to land for producing is rent
...
e
...
Often accountants refer to capital as money balances
that are earmarked for the purchase of plant or equipment
...
Capital receives interest for its contributions to
production
...
Economists also called the skills,
abilities, and knowledge of human beings as human capital
...
Human capital can be acquired (i
...
, education) or may be
something inherent in a specific individual (i
...
, size, beauty, etc
...

Labor includes the broad range of services (and their characteristics)
exerted in the production process
...
Human beings
also play other roles in the economic system, such as consumer that complicates the
analysis of labor as a productive factor
...
Labor also includes hired management, and the lowest paid janitor
...

Entrepreneur (risk taker) is the economic agent who creates the enterprise
...
The vibrancy of the
U
...
economy is, in large measure, due to a wealth of entrepreneurial talent
...

To obtain the maximum amount of output from the available productive resources
an economic system should have full employment
...
Full employment includes the natural rate of unemployment,
which economists estimate to be between four and six percent (unemployment due to
job search and normal structural changes in the economy)
...
When the economy is operating at rates consistent with the natural rate
of unemployment it is producing the potential total output
...

Underemployment has been a persistent problem in most developed economies
...
There are two ways that underemployment manifests
itself
...
For example, in many European countries it is not uncommon for
an M
...
to be employed as a practical nurse
...


Economic Efficiency

Economic efficiency consists of three components; these are: (1) allocative
efficiency, (2) technical or productive efficiency, and (3) full employment
...

Allocative efficiency is concerned with how resources are allocated
...
Allocative
efficiency is measured using a concept known as Pareto Optimality (or Superiority in an
imperfect world)
...
A Pareto Optimal allocation of resources can
exist, theoretically, only in the case of a purely competitive economy (which has never
existed in reality)
...
A Pareto Superior allocation is that allocation where the benefit received by
one person is more than the harm inflicted on another
...
Technical
efficiency is defined as the minimization of cost for a given level of output or
(alternatively) for a given level of cost you maximize output
...

Again, a technically efficient operation is difficult to find in the real world
...

For an economic system to be economically efficient then full employment is also
required
...
The U
...
economy typically has one (during recoveries) to
four percent (during recessions) unemployment above that associated with the natural
rate of unemployment
...


90

Allocative Efficiency
The Economics of Welfare, fourth edition (A
...
Pigou, London: Macmillan Publishing
Company, 1932, p
...
)

...
The
old "law of diminishing utility" thus leads securely to the proposition: Any cause which
increases the absolute share of real income in the hands of the poor, provided that it
does not lead to a contraction in the size of the national dividend from any point of
view, will, in general, increase economic welfare
...
The “transference of income from a relatively rich
man to a relatively poor man of similar temperament” making one less poor, and the
other less rich, results in an application of the principle of diminishing marginal utility
and, hence, allocative efficiency
...
We take the last dollar from those with less value for that dollar and add that to
those more desperate for an additional dollar of income
...


Economic Cost

Economic cost consists of two distinct types of costs: (1) explicit (accounting)
costs, and (2) opportunity (implicit) costs
...
These are the items of cost with which accountants are concerned
...
Rather than a direct expenditure, an opportunity cost is the
implicit loss of an alternative because of a decision
...
V
...
Every choice is costly; that is, there is an
opportunity cost
...


91

Production Possibilities

The production possibilities frontier (or curve) is a simple model that can be used
to illustrate what a very simple economic system can produce under some restrictive
assumptions
...
) and the economic choices an economy must make with respect to
what will be produced
...
The assumption which underpin the production possibilities
curve model are: (1) the economy is economically efficient, (2) there are a fixed number
of productive resources, (3) the technology available to this economy is fixed, and (4) in
this economy we are going to produce only two commodities
...

Consider the following diagram:

Beer

Pizza
Along the vertical axis we measure the number of units of beer we can produce
and along the horizontal axis we measure the number of units of pizza we can produce
...
Where the solid line intersects
the pizza axis indicates the amount of pizza we can produce if all of our resources are
allocated to pizza production
...

The reason the line is curved, rather than straight, is that the resources used to
produce beer are not perfectly useful in producing pizza and vice versa
...

Increasing Opportunity Costs is illustrated in the above production possibilities
curve
...
In other words, the
slope of the production possibilities curve is the marginal opportunity cost of the
production of one additional unit of one commodity, in terms of the other commodity
...
A point consistent with
inefficiency, unemployment, or underemployment is identified by the symbol to
the inside of the curve
...

The dashed line in the above model shows a shift to the right of the curve
...
It is also possible that the curve could shift to the left (back
toward the origin -- the intersection of the beer axis with the pizza axis), this could result
from being forced to use less efficient technology (pollution controls) or the loss of
resources (racism or sexism)
...

Economic systems rarely exist in a pure form and the pure forms are assumed simply
for ease of illustration
...

Pure capitalism is characterized by private ownership of productive capacity, very
limited government, and motivated by self-interest
...
This type of system has the benefit of producing allocative efficiency if
there is no monopoly power, but this type of system tends towards heavy market
concentration left unregulated
...
These costs include significant loses of freedom, poverty, income inequity
93

and several social ills associated with the lack of protections afforded by stronger
government
...
Pure capitalism exists only in the tortured minds of
economists, and pages of the Wealth of Nations
...

The Struggle
The Theory of the Leisure Class, Thorstein Veblen, New York: Penguin Books, 1899,
pp
...

Wherever the institution of private property is found, even in a slightly developed
form, the economic process bears the character of a struggle between men for the
possession of goods
...
Such is, no doubt, its character in large part during the
earlier and less efficient phases of industry
...
But in all progressing communities an advance is
presently made beyond this early stage of technological development
...
It has not been
unusual for economic theory to speak of the further struggle for wealth on this new
industrial basis as a competition for an increase in the physical comforts of life, –
primarily for an increase of the physical comforts which the consumption of goods
affords
...
These
decisions are backed with the force of law (and sometimes martial force)
...
Even though political and economic
freedom could result in a reasonable allocation, but rarely will command economies be
associated with democratic forms of government
...

Traditional economies base allocations on social mores or ethics or other nonmarket, non-legislative bases
...
The purest forms of
traditional economies are typically observed in tribal societies
...
Many of these traditions
developed because of economic constraints
...
Hence a
tradition that arose from economic constraints
...
Socialist systems are
generally concerned more with perceived equity rather than efficiency
...
Sweden, Denmark, Norway and Iceland have systems that have large
elements of socialism
...

Communism is a system where everyone shares equally in the output of society
(according to their needs), at least theoretically
...
The former Soviet Union was not a communist society as
perceived by Karl Marx in Das Kapital
...
Both New Harmony, Indiana and Amana, Iowa were
utopian communist systems that were probably more in keeping with Marxist ideals, but
without the political implications and in very limited scope
...
19-20
...
People read snippets of Adam Smith, the few phrases they teach in school
...
But not many people get to the point hundreds
of pages later, where he says that division of labor will destroy human beings and
turn them into creatures as stupid and ignorant as it is possible for a human being to
be
...


95

Virtually all economic systems are mixed systems
...
The U
...
economy is a
mixed system, with significant amounts of capitalism, command, and socialism
...
S
...
Much of the political controversies concerning the
budget deficit, social security, and the environment focuses on the what the appropriate
mix of systems should exist in our economic system
...
As a society grows and
becomes more complex, simple pure examples of economic systems are incapable of
handling the demands placed on them
...
This is no more evident in the troubles being experienced in the former
Soviet Union and in China
...

Estranged Worker
The Economic & Philosophic Manuscripts of 1844, Karl Marx, New York: International
Publishers, 1964, p
...

The worker become all the poorer the more wealth he produces, the more his
production increases in power and size
...
With the increasing value of the world
of things proceeds in direct proportion the devaluation of the world of men
...

This fact expresses merely that the object which labor produces – labor’s
product – confronts it as something alien, as a power independent of the producer
...
Labor’s realization is its
objectification
...

Developed economies are generally high income economies, because the
production processes tend be capital intensive, and focused on high value-added
products
...
Less developed economies fall into two categories, middle income $8000 to
$800, and low income economies or those below $800
...
Middle income economies
are in the Middle East, Eastern Europe and Latin America
...

Perhaps the greatest economic issue facing the current generation is what can
be done to bring the low income economies into meaningful participation in the global
economy
...
AIDS, malaria, and a host of other health problems are associated with the
poverty in these nations
...
As income rise in low income countries,
cheap labor is no longer a cause for outsourcing from the high income, industrialized
parts of the world
...
The often used cliché “a rise tide makes all boats float higher” is exactly the
case in these nations emergence into full participation in the global economy
...


KEY CONCEPTS

Economizing problem
Scarce Resources
Unlimited Wants
Resources and Factors Payments
Land - rent
Labor - wages
Capital - interest
Entrepreneurial Talent - profits
Full Employment
Underemployment
Economic Efficiency
Allocative Efficiency
Technological Efficiency
Full Employment
Opportunity Cost
Implicit vs
...
Less Developed Economies
High Income
Middle Income
Low Income
Globalization

STUDY GUIDE
Food for Thought:

What is the economizing problem? What, precisely does scarcity have to do with this?
Explain
...


Compare and contrast the various economic systems? Is a mixed system best?
Explain
...
Is this differentiation important in
economic decisions? Explain
...

B
...

D
...
Which of the
following illustrates unemployment?
A
...

C
...


A shift to the left of the curve
A shift to the right of the curve
A point on the inside of the curve
A point on the outside of the curve

Which of the following is an implicit cost of your obtaining a college education if you go
to school exclusively?
A
...

C
...


Tuition
Books and supplies
Income lost from a job you didn’t take
All of the above

The U
...
economy is closest to which of the following economic systems?
A
...

C
...


Mixed
Pure Capitalism
Pure Command
None of the above

TRUE-FALSE

A laissez faire, purely capitalistic economy will always result in economically efficient
distributions of resources
...
{TRUE}
The former Soviet Union was an example of pure Communism and the Swedish
economy an example of pure socialism
...
{TRUE}

100

CHAPTER 3

Interdependence and the Global Economy
This chapter begins with a discussion of the interdependence of nations in the
modern global economy before proceeding to a discussion of capitalist ideology
...
The final section of this chapter develops the circular flow diagram
that illustrates interdependence within a global economy
...

Virtually every nation on earth has some sort of relations with other nations
...
Foreign economic relations involves the
importation and exportation of goods and services
...
When you work for Philips (Aero-Quip etc
...
Over the past
three decades our reliance on foreign produced goods has become increasingly
important to our standard of living
...
Without trade among nations then everyone
would suffer the loss of goods they desire that must be imported
...
From the very beginnings of the
United States European countries, i
...
, France, Britain and Germany have heavily
invested in the United States
...
S
...
) and
investment here was protected by the expanse of the two Oceans on our east and west
...
At the same
time, American industry sought to move into markets they presently served only by
exportation
...
The
outsourcing of jobs abroad has real costs for the affected households and is a source of
discontent among workers who have lost their jobs to foreign competition (more
concerning this will discussed in chapter 12)
...
Over the next
several decades these issues will take a more central place in political debate, and
concerns over the social responsibility of business
...
There are currently bands on the
transfer of certain technologies that have implications for national defense
...

The United States is presently experiencing large deficits in our balance of
payments
...
If the balance of payments
is positive, ignoring investment (capital accounts) for the moment, that means we are
exporting more than we are importing
...
S
...
e
...


Capitalist Ideology

Ideology is defined by Webster’s Dictionary as: that system of mental
philosophy which exclusively derives our knowledge from sensation
...
However, what
our system is, and what ideology has grown up around the system are two different
things
...
Further, what Adam Smith
envisioned for capitalism is in many respects very much different from the more radical
proponents of capitalism would have us believe is the ideal system
...

The following box is an excerpt from Adam Smith’s Wealth of Nations which
clearly and unambiguously examines the idea of social welfare, with respect to the
pursuit of individual welfare
...


102

Individual Self-Interest and Social Welfare
An Inquiry into the Nature and Causes of the Wealth of Nations (Adam Smith, New
York: Random House, Modern Library editions, 1937 [original published 1776] Book
IV, Ch
...
He generally, indeed, neither intends to promote the
public interest, nor knows how much he is promoting it
...
Nor is it always
the worse for society that it was no part of it
...
I have never known much good done by those who affected to trade
for the public good
...

Capitalist ideology is therefore what we wish to perceive it to be, rather a
dispassionate observation of some characteristics of a our economic system
...
Therefore capitalist ideology is different than the characteristics of a
market system
...
The elements of a capitalist ideology are:
(1) freedom of enterprise, (2) self-interest, (3) competition, (4) markets and
prices, and (5) a limited role for government
...
By limiting government participation in the
economy it is thought that economic freedom to pursue one's self-interest increases –
hence government participation is often called “interference
...
However,
there are often problems associated with the pursuit of self-interest
...
There is also a significant
amount of potential to limit economic freedom by predatory behaviors from the private
sector
...

Again, assuming that monopoly power is not exerted over otherwise competitive
markets, the competition among producers in a market economy will approximate a
103

Pareto Optimal (see Chapter 2) allocation of resources
...

The market system is largely responsible for our high standard of living and the ability
to effectively respond to changes in the global economy
...
S
...
In the 1970s the U
...
car producers did not have effective
competition, and their prices increased as the quality of U
...
built cars declined
...
S
...
S
...
This caused the U
...
manufacturers to significantly increase the quality
of their products and keep their prices in check
...
S
...
Consumer Guide’s
Recommended List for 2004:
(http://auto
...
com/auto/new/index
...
This is a significant benefit from competition
that is fundamental to capitalism
...
Poverty, high rates of litigation, pollution,
crime and several other social problems are associated with freedom and limiting
government's role
...
As social responsibility by producers and consumers declines, the
legitimate roles of government generally expand
...
S
...
The accounting and analyst frauds at Enron, WorldCom, Health
South, and an array of brokerage firms and investment banks, have illustrated that the
ethic of self-interest is hardly a reasonable basis for an economic system – without
some countervailing forces
...
Therefore there is a strong need not only for a
strong ethic of honest and forthright dealings, but also governmental regulation to
proscribe the worst abuses
...
The exact magnitude of the
role of government in a free economy has always been controversial, but there is little
doubt of its potential for positive outcomes
...
This reference was for the need for certain elements of socialism to provide
limited assurance for the disabled, the elderly, and children freedom from poverty
...
Mixed economic systems are the response to the
104

drawbacks of capitalism
...
The Europeans and major Asian economies have far
more socialism than we do
...
Whatever the proportions, two things are
certain
...


Market System Characteristics

The characteristics of the market system is both practically and intellectually
different than capitalist ideology
...
The characteristics of a typical of market system are: (1)
the division of labor & specialization, (2) significant reliance on capital goods,
and (3) reliance on comparative advantage
...

In market economies the competition among producers requires high levels of
technical efficiency, which, in turn, requires labor to become specialized and focused on
narrow aspects of a particular production process
...
As efficiency increases, cost per unit declines
...
P
...
)
To take an example
...
But in the way in which this business is now carried on, not only
the whole work is a peculiar trade, but it is divided into a number of branches, of
which the greater part are likewise peculiar trades
...
I have seen a small manufactory of this kind where ten men
only were employed, and where some them consequently performed two or three
distinct operations
...
There are in a
pound upwards of four thousands pins of middling size
...

Each person, therefore making a tenth part of forty-eight thousand pins, might be
considered as making four thousand eight hundred pins in a day
...


Because of the need to compete, capital is typical used where it is less costly
...


Comparative Advantage and Trade

However, comparative advantage is somewhat more complicated
...
Terms of trade are
106

those upon which the parties may agree and depends on the relative cost advantages
of trading partners and their respective bargaining power
...
2)

...
The taylor does not attempt to
make his own shoes, but buys them of the shoemaker
...
The farmer attempts to maler
neither the one nor the other, but employs those different artificers
...

What is prudence to the conduct of every private family, can scarce be folly in
that of a great kingdom
...

Consider the following illustration:
Texas
Cows
Oranges

Florida

1000
100

100
1000

The data above show what each state could produce if all of their resources were
put into each commodity
...
Assuming the data give the
rate at which the commodities can be substituted, if both states equally divided their
resources between the two commodities, Texas can produce 500 cows and 50 oranges
and Florida can produce 50 cows and 500 oranges (for a total of 550 units of each
commodity produced by the two states together)
...
If the countries traded on terms where one orange was worth one cow then both
states would have 500 units of each commodity and obviously benefit from
specialization and trade
...

Trade between industries and individuals also arises from comparative
107

advantage
...
Barter requires a
coincidence of wants, it does no good to have apples if you want oranges and the only
people who have oranges hate apples
...
Therefore, as complexity rises, so does
the need for the ability to conduct business without reliance on barter, therefore the
need for money
...
S
...
2
998
...
7
988
...
9
1356
...
3
1489
...
7
– 358
...
7
– 501
...

With money people can avoid the problems associated with coincidence of wants
...
Prices stated in the terms of all
possible trading goods makes it difficult to determine what anything costs
...

The functions of money include; (1) medium of exchange, (2) store of value,
and (3) a measure of worth
...
Money can be easily stored in a tin can or
bank account, so commodities need not be stored and can be purchased when needed
...
In other words, money is
the grease that lubricates any complex economic system
...
Fiat money is
money that is defined as legal tender by either a government or some
organization with the authority to define legal tender
...
The currency used here is backed by nothing except the
faith of the general public that this money will be acceptable by everyone else with
whom you could have an economic transaction
...
Up to
that point of time the value of the dollar was expressed in some fixed ratio to the
commodity – gold
...
When the U
...
abandoned the gold standard gold went from less than forty
dollars an ounce, to over $1000 an ounce in a matter of weeks
...

Fiat money is not a new idea
...
The receipts were commands over that gold
and silver, and began to trade as easily as the commodity itself, to the extent that the
parties to the transaction knew of the smith and the note bearer
...
Hence, in this case the value of money is based
on some mutual trust between the principles to these transactions
...
Because of the shortage of gold and silver to run the Mongol Empire,
Genghis Kahn began to issue orders, in writing, that the written order was to be given
deference as a specific amount of gold or silver
...
Perhaps, in retrospect, it is better
that currency be acceptable on economic grounds, than under threat of violence from a
government
...
You are unlikely to accept the Turkish Lire in payment for your wages in this
country, simply because you can’t easily use that money to buy anything
...
S
...

Countries act the same way you do
...

109

The currency of the big, developed, high income economies are the hard currencies –
U
...
dollar, Japanese Yen, Canadian dollar, British pound and the E
...
U
...

Prior to the Euro, there were seven countries whose currencies were considered
hard currencies
...
S
...

These seven nations are called the G-7 countries because the size and strength of their
economies made them the leading economic forces on the planet, and their currencies
the most accepted
...
For example, one
U
...
dollar may buy 109 Japanese Yen but only
...
It is these currency
exchange rates that, in large measure, determine net exports and foreign investment in
the U
...

As the dollar gains strength, i
...
, goes from 109 Yen to the dollar to 120 Yen to
the dollar, then imports are cheaper
...
2 million Yen
...
2 million Yen car is only $17,600
...
If the dollar becomes weak then that advantage turns to disadvantage
...
2 million Yen vehicle was available at $17,600 at
125 Yen per dollar, the additional cost of $2400 would be observed if the dollar could
only purchase 110 Yen
...
With an expensive dollar
it is hard to sell American goods abroad
...

Currency also impacts foreign investment
...
S
...
S
...

On the other hand, if the Mexican investor bought dollars at 25 cents per peso and over
a year the dollar fell to 10 cents per peso, his investment went from $500,000 to only
40% of his original investment
...

A strong dollar policy means that the government will undertake policies that will
increase the value of the dollar with respect to other currencies
...
Strength a nation’s currency is
typically a reflection of its strong economy and institutions
...

Strong dollar policies promote the importation of goods and services from
abroad, and foreign investment in our domestic enterprises
...
S
...
Often, the international aspects of domestic monetary and fiscal
policies are less important than political consideration in the U
...
or policy consideration
concerning unemployment or inflation
...


The Circular Flow Diagram

The circular flow diagram is used to show the interdependence that exists among
sectors of the economy
...
Households provide resources to government
and business and consume the outputs of these other sectors
...

The markets in which the output of business and in some cases government is sold are
called product markets
...
However, when a
foreign sector or substantial governmental sector is added it becomes more
complicated
...

Consider a relatively simple open-economy, trade and foreign investment occurs
...
The
interdependence in the sectors is represented by the flows in both the resource and
factor markets
...
Private goods and services flow from the businesses to households and
government, and public goods and services flow from the government to both
households and businesses
...
Foreign households, business, and even
governments (in limited ways) participate in the flows that would otherwise have been
purely domestic if the economy was a closed economy
...
This is the nature of interdependence
...


Explain the role of money in a modern economic system
...


Develop the traditional circular flow diagram and illustrate the interdependence between
the sectors
...


The following two commodities are produced by Tennessee and Kentucky:
Sour Mash Whiskey

Bourbon

5,000

500

500

10,000

Tennessee
Kentucky

Assuming free trade and that each state wishes to consume as much of each
commodity as possible, what will each state produce? What will the terms of trade be?

Explain the role of currency exchange rates in international trade
...

B
...

D
...
Why has barter
been displaced by more modern systems?
A
...

C
...


Coincidence of wants makes exchange complicated
Coincidence of wants no longer exists in the world’s economy
Gold and silver are now in plentiful supply so that money can be used
None of the above

If the dollar gains value with respect to the Euro what would we expect to observe?
A
...

C
...


U
...
imports increase, foreign investment in the U
...
increases
U
...
exports decrease, foreign investment in the U
...
decreases
U
...
imports decrease, U
...
investment abroad increases
None of the above

True - False

The circular flow model demonstrates that there is interdependence between the
sectors but does not identify how the sectors are interdependent
...
{TRUE}
The majority of the countries in the world are high income, developed countries
...
In this chapter we will develop the model of a simple
market – supply and demand (the industry in pure competition – discussed further in
Chapter 8)
...
The market presented here is the starting
point for the analysis of all market structures
...
Transactions
occur because consumers and suppliers are able to purchase and sell at a price that is
determined through the free interaction of demand and supply
...
He wrote that the interaction of supply and demand "as though moved by an
invisible hand" would determine the price and the quantity of a good exchanged
...
If competitive, a market will always satisfy
those consumers willing and able to pay the market price and provide suppliers with the
opportunity to sell their wares at the market price
...


Demand

The law of demand is a principle of economics because it has been consistently
observed and predicts consumers’ behavior accurately
...
In other words, there is an inverse relationship
between the quantity demanded and the price of a particular commodity
...
Most people behave this way, they buy more the lower the
price
...


116

The demand schedule (demand curve) reflects the law of demand
...


Price

P1
P2
Demand
Q1

Q2

Quantity

As price falls from P1 to P2 the quantity demanded increases from Q1 to Q2
...

Consumers obtain utility (use, pleasure, jollies) from the consumption of
commodities
...
The change in
utility derived from the consumption of one more unit of a commodity is called marginal
utility
...
This
principle is called diminishing marginal utility
...
These two effects are called the; (1) income
effect, and (2) the substitution effect
...

The income effect is the fact that as a person's income increases (or the
price of item goes down [which effectively increases command over goods] more
of everything will be demanded
...

117

The substitution effect is the fact that as the price of a commodity
increases, consumers will buy less of it and more of other commodities
...
The substitution effect simply reinforces the idea of a downward
sloping demand curve
...
To this point, our discussion has
focused on individuals and their behavior
...
One
needs only to sum all of the quantities demanded by individuals at each price to obtain
the market demand curve
...
If price
decreases, then we move down and to the right along the demand curve; this is an
increase in the quantity demanded
...
Remember, (it is
important) such changes are called changes in the quantity demanded because the
demand curve is a schedule of the quantities demanded at each price
...
A change in demand is caused by a change in one or more of
the nonprice determinants of demand
...

The nonprice determinants of demand are; (1) tastes and preferences of
consumers, (2) the number of consumers, (3) the money incomes of consumers, (4)
the prices of related goods, and (5) consumers' expectations concerning future
availability or prices of the commodity
...
If consumers find a commodity more desirable, ceteris paribus, then an increase
in demand will be observed
...

An increase in the number of consumers or their money income will result in a
shift to the right of the demand curve (an increase in demand)
...
Consumers will also react to expectations
concerning future prices and availability
...

118

The prices of related commodities also effect the demand curve
...
A substitute is something that is
alternative commodity, i
...
, Pepsi is a substitute for Coca-Cola
...
e
...
If the
price of a substitute increases, then the demand for our commodity will increase
...
In other
words, the price of a substitute and the demand for our commodity move in the same
direction
...
If the price of a complement increases, the
demand for our commodity will decrease
...


Decrease in Demand

Increase in Demand
Price

Price

D2
D1
Quantity

D2

D1

Quantity

An increase in demand is shown in the first panel, notice that at each price there is a
greater quantity demanded along D2 (the dotted line) than was demanded with D1 (the
solid line)
...


119

Changes in Quantity Demanded
Price
P1

P2
Demand
Q1

Q2

Quantity

Movement along a demand curve is called a change in the quantity demanded
...
When price
decreases from P1 to P2 the quantity demanded increases from Q1 to Q2; when price
increases from P2 to P1 the quantity demanded decreases from Q2 to Q1
...
The supply curve is an upward sloping function showing a direct
relationship between prices and the quantity supplied
...

As with the demand curve a change in the price will result in a change in the
quantity supplied
...

Again, this is because the supply curve is a schedule of the quantities supplied at each
price
...
A shift to the left of the supply curve is called a decrease in supply; a shift
to the right is called an increase in supply
...

When resource prices increase, supply decreases (shifts left); and when
120

resource prices decrease, supply increases (shifts right)
...
An increase in a subsidy effects the supply curve in the
same way as a cut in taxes, an increase in supply
...
For example, if the price of corn drops, a farmer will
supply more beans
...
In other words, supply will decrease (a shift
to the left, and exactly the opposite response will occur if producer expect future prices
to be lower
...


Decrease in Supply

Increase in Supply
Price

Price
S2

S1
S2

S1

Quantity

Quantity

A decrease in supply is shown in the first panel, notice that there is a lower quantity
supplied at each price with S2 (dotted line) than with S1 (solid line)
...


121

Changes in Quantity Supplied
Price

Supply
P1
P2

Q2

Quantity

Q1

Changes in price cause changes in quantity supplied, an increase in price from P2 to P1
causes an increase in the quantity supplied from Q2 to Q1; a decrease in price from P1
to P2 causes a decrease in the quantity supplied from Q1 to Q2
...
An equilibrium implies that there is no force that will cause further
changes in price, hence quantity exchanged in the market
...


122

Price and Value
Principles of Economics, 8th edition (Alfred Marshall, London: Macmillan Publishing
Company, 1920, p
...
)

...
It is true that when one blade is held still, and the cutting is
effected by moving the other, we may say with careless brevity that the cutting is
done by the second; but the statement is not strictly accurate, and is to be excused
only so long as it claims to be merely a popular and not a strictly scientific account of
what happens
...
Where the
supply and demand curves intersect, equilibrium price is determined (Pe) and
equilibrium quantity is determined (Qe)

Price

Supply

Pe

Demand
Qe

Quantity

The graph of a market in equilibrium can also be expressed using a series of
equations
...


Demand Curve is Qd = 22 - P
(Notice the negative sign in front the price variable, indicating a downward sloping
function)
123

Supply Curve is

Qs = 10 + P

(Notice the positive sign in front of the price variable, indicating an upward sloping
function)
The equilibrium condition is Qd = Qs
(For this market to obtain equilibrium, the quantity demanded must equal the quantity
supplied in this market)

Therefore:
22 - P = 10 + P
adding P to both sides of the equation yields:
22 = 10 + 2P
subtracting 10 from both sides of the equation yields:
12 = 2P or P = 6
To find the equilibrium quantity, we plug 6 (for P) into either the supply or
demand curve and get:
22 - 6 = 16 (Demand side) & 10 + 6 = 16 (Supply side)
The system of equations approach to solving for equilibrium gives a specific
number for price and for quantity
...
However, the graph provides a visual demonstration of equilibrium which may
aid learning
...
The
following graphs demonstrate what happens in a market when there are changes in
nonprice determinants of supply and demand
...
Such decreases are
caused by a change in a nonprice determinant of demand (for example, the number of
consumers in the market declined or the price of a substitute declined)
...
If we move from D2 to D1
that is called an increase in demand, possibly due to an increase in the price of a
substitute good or an increase in the number of consumers in the market
...

Considering the following graph, movement of the supply curve from S1 (solid
line) to S2 (dashed line) is an increase in supply
...
With an increase in supply there is a shift of
the supply curve to the right along the demand curve, therefore equilibrium price and
quantity move in opposite directions (price decreases, quantity increases)
...
When
supply decreases, equilibrium price increases and the quantity decreases as a result
...


125

Changes in Supply
S1

Price

S2
P1
P2
Demand
Q1 Q2

Quantity

If both the demand curve and supply curve change at the same time the analysis
becomes more complicated
...
Therefore, the change
in the equilibrium quantity is indeterminant and its direction and size depends on the
relative strength of the changes between supply and demand
...
In the first case where demand increases, but supply
decreases the equilibrium price increases
...

In the event that demand and supply both increase then price remains the same
126

(is indeterminant) and quantity increases, and if both decrease then price is
indeterminant and quantity decreases
...

Increase in Supply
Decrease in Supply

and in Demand

and in Demand

Price

Price
D2

D1

D1

D2
P

P
S2
S1

S2

Q1 Q2 Quantity

Q2 Q1

S1

Quantity

The graphs show that price remains the same (is indeterminant) but when supply
and demand both increase quantity increases to Q2
...


Shortages and Surpluses

There is some rationale for limited government intervention in a free market
economy
...
Shortages and surpluses can only
result because by having some sort of price controls in the market
...
The government also was the sole employer and paid very low wages,
therefore prices were also controlled at below market equilibrium levels
...
The popular Russian immigrant comedian, Yakov Simirnov, summed-up
the plight of the working class consumer in Russia prior to break-up of the Soviet Union
...
Effective, in this sense, means that the government can and
does actively enforce the price ceiling
...

Consider the following diagram that demonstrates the effect of a price ceiling in an
otherwise purely competitive industry
...
Note that the Qs is below the Qd, which means that there is an excess
demand for this commodity that is not being satisfied by suppliers at this artificially low
price
...

It is interesting to consider the last time that wage and price controls were
attempted during the Carter administration
...
For example, warranties were no longer included in the sales price, service
was extra, delivery was extra, and where possible, the product was reduced in size
...
The lesson is simple, if
government is going to control prices, they must be prepared to control virtually all other
aspects of doing business
...

Notice that at the floor price Qd is less than Qs, the distance between Qd and Qs is the
amount of the surplus
...

Implicit in these analyses is the fact that without government we could have
neither shortage or surplus
...
Even with the
power of government to enforce law, the only way that a shortage or surplus could
occur is if the price ceiling or the price floor were effective
...
In
Chapter 8 the analysis of a purely competitive market is offered
...
The assumptions are (1) perfect information about all past, and future
prices, (2) no barriers to entry or exit from the market, (3) no non-price competition
(advertising etc
...
If all of these assumptions accurately represent reality, then the
firm must sell at whatever price is established in the industry
...
In other words, the competitive industry impose
price discipline on all of the firms that together comprise that competitive industry
...

Often the results of the simple supply and demand diagram are not bad rough
approximations of reality – but remember that it is only a rough approximation – based
on assumptions that are not very accurate depictions of reality
...
One
must be careful in applying these models, and in policy debates concerning these
models
...

The real value of the simple supply and demand model is to provide a beginning
point for coming to understand how markets really work
...
Pure monopoly, monopolistic competition and
oligopoly are, in some important respects, refinements from the purely competitive
market model
...
Change in Quantity Demanded
Price changes v
...
Change in Quantity Supplied
Price changes v
...
Do the same exercise
showing only the demand curve increasing and decreasing and only the supply curve
increasing or decreasing
...


131

Repeat exercise 2, using a price ceiling
...
An excess demand for labor
B
...
There will be unemployment created by people losing jobs, but there will be no
new employees attracted to this labor market
...
Nothing will be caused by the introduction of this minimum wage

If there is an increase in demand and an increase in the quantity supplied in a product
market what should be observed?
A
...

C
...


Price increases, quantity exchanged is indeterminant
Price decreases, quantity exchanged is indeterminant
Price decreases, quantity exchanged decreases
Price increases, quantity exchanged increases

132

True - False

If the price of Pepsi-Cola increases we should expect the demand for Coca-Cola
increase, ceteris paribus
...
{FALSE}

133

CHAPTER 5

Supply & Demand: Elasticities
The purpose of this chapter is to extend the supply and demand analysis
presented in the previous chapter
...
Other topics examined in this chapter are the price elasticity
of supply, cross-elasticities, the income elasticity of demand and the interest elasticity of
demand
...
In other words, as price increases
(decreases), the quantity demanded by consumers will decrease (increase)
...
It is
this consumer responsiveness that is the subject of this chapter
...
Suppliers
will wish to obtain the most revenue the market will bear from the sales of their products
– in other words, maximize their profits
...

There are three methods that are used to measure the price elasticity of demand,
these are; (1) the price elasticity coefficient (midpoints formula), (2) the total revenue
test, and (3) a simple examination of the demand curve
...


Elasticity Coefficient

The elasticity coefficient is a number calculated using price and quantity data
to determine how responsive consumers are to changes in the price of a commodity
...
Point elasticity is
134

measuring responsiveness at a specific point along a demand curve
...
Because the midpoints formula cuts down on the
confusion of which prices and quantities are to be used, it is the only coefficient we will
use in this course
...
The value of that
number provides the answer as to whether demand is price elastic or price inelastic
...
Inelastic demand means that the consumers' quantities demanded do not respond
very much to changes in price; with inelastic demand the coefficient is less than
one
...

What this equation states is illustrated in the graph below
...


Price

P1
Midpoint
P2
Demand
Q1

M
135

Q2

Quantity

On the graph this number is the difference between Q1 and Q2 divided by the
distance between the origin and the point labeled M on the quantity axis for the
numerator and the difference between P1 and P2 divided the distance between the
origin and the point labeled midpoint on the price axis for denominator
...

Examining the demand curve can also provide clues concerning the price
elasticity of demand
...
This type of demand curve is
called a perfectly inelastic demand curve
...

This is called a perfectly elastic demand curve
...


Perfectly elastic demand

Perfectly inelastic demand

Price

Price

Demand

Demand

Quantity

Quantity

Perfectly Elastic and Perfectly Inelastic Demand Curves
There is a trick to remembering inelastic and elastic demand
...
The perfectly
inelastic demand curve is vertical (looks like an I)
...
In the case
of perfectly inelastic demand consumers will buy exactly the same quantity of a product
without regard for its price
...

Slope and elasticity are two different concepts
...
Elasticity is
136

concerned with responses in one variable to changes in the other variable
...
e
...


Demand Curve and Total Revenue (total revenue = P x Q) Curve

Price

Unit

Elastic

Demand
Inelastic

Quantity

Total
Revenue
Total Revenue
Quantity
The total revenue curve in the bottom graph is plotted by multiplying price and quantity
to obtain total revenue and then plotting total revenue against quantity
...
When
the total revenue curve flattens-out at the top then demand becomes unit elastic, and
when total revenue falls demand is inelastic
...

The total revenue test uses the relation between the total revenue curve and the
demand curve to determine the price elasticity of demand
...


137

Consider the following numerical example:
_____________________________________________________________________
_____________________________________________________________________
Table 1: Total Revenue Test
_____________________________________________________________________
Total Quantity
Price per unit
Total Revenue
Elasticity
_____________________________________________________________________
1

7

7
>+5
>+3

Elastic

>-1

Inelastic

>-3

6

Elastic

>+1

2

Elastic

Inelastic

12

3

5

15

4

4

16

5

3

15

6

2

12

>-5
Inelastic
7
1
7
_____________________________________________________________________
_____________________________________________________________________

Marginal revenue is the change in total revenue due to the a change in
quantity demanded
...
If the change in total revenue (marginal
revenue) is positive the demand is price elastic, if the change in total revenue is
negative the demand is price inelastic
...

The following determinants of the price elasticity of demand will determine how
responsive the quantity demanded by consumers is to changes in price
...

If there are no close substitutes then the demand for the commodity will be price
inelastic, ceteris paribus
...
For example, if the price of
Pepsi goes up, then certain consumers will buy Coke, if the price of Coke has not
increased, hence the demand for Pepsi is likely to be elastic
...
Most home owners are familiar with
how this determinant works
...

Commodities that are viewed as luxuries typically have price elastic demand, and
commodities that are necessities have price inelastic demand
...
Because insulin is a
necessity for which there is no substitute, the demand will be price inelastic
...
If a price changes, it may
take consumers a certain amount of time to discover alternative lifestyles or
commodities to account for the price change
...
In other words, the longer the time frame for the decision to purchase the more
price elastic the demand for the commodity
...
The price elasticity of supply is determined by the following time
frames; (1) market period, (2) short-run, and (3) long-run
...

The time frames for producers will be discussed in more detail in Chapter 7 as
they pertain to a firm's cost structure
...
The market period
is defined to be that period in which the producer can vary nothing, therefore the supply
is perfectly inelastic
...
The short-run is the period in which
plant and equipment cannot be varied, but most other factors' usage can be varied,
therefore it depends on a producers capital - intensity as to how elastic supply is at any
particular point
...
The
cross elasticity of demand, the income elasticity of demand, and the interest rate
elasticity of demand
...

The cross elasticity of demand measures the responsiveness of the
quantity demanded of one product to changes in the price of another product
...

Cross elasticity of demand gives an indication of how close a substitute or complement
one commodity is for another
...

For example, as the price of coke increases, then consumers may purchase
proportionately more Pepsi products
...
The equation for the cross elasticity
of demand described here is presented below
...
This is
typically measured by replacing the price variable with income (economists use the
letter Y to denote income) in the midpoints formula
...

Housing and automobiles, as well as, several big ticket luxury items have demand that
is sensitive to changes in income
...


Ed = Change in Qty
(Q1 + Q2)/2

÷

Change in income
(Y1 + Y2)/2

Often interest rates will also present a limitation on a consumer’s quantity of
demand for a particular commodity
...
With the
record low mortgage rates in the Spring of 2003 the quantity demanded for housing,
both new and existing homes, witnessed dramatic increases
...
Rebates, which are temporary reductions in
price, and attractive financing rates are the hooks offered to get the consumer in the
showroom and into the new car
...
The interest rate elasticity formula is (where interest rate is
“r”):

Ed = Change in Qty
(Q1 + Q2)/2

÷

Change in interest rate
(r1 + r2)/2

These analyses are important to businesses in determining what issues are
important to the successful sales of their products
...
The
bankruptcies of United Airlines and US Air being excellent examples
...
By offering financing the car companies are,
essentially, maintaining some modicum of control over one important aspect of their
business
...
The
total cost of a commodity is not just its price, but also what must be paid to borrow
money to purchase that item
...

Therefore the interest charges are a part of the total cost of acquiring that big ticket item
– hence consumer sensitivity to interest rates when buying a house or a car
...
What is often referred to as
“pricing power” in the business press, means the ability to take advantage of the price
elasticity of demand or one of the other elasticities examined here – hence implying
some market structure, hence market power not otherwise identified in the model of
pure competition
...
Necessities
Time
Elasticity of Supply
Time periods
Market period
Short-run
Long-run
Cross Elasticity of Demand
Income Elasticity
Interest Rate Sensitivity
Pricing Power

142

STUDY GUIDE

Food for Thought:

List and explain the determinants of the price elasticity of demand and of supply
...


3
...
Perform a total revenue test
and determine the ranges of price elastic and price inelastic demand
...


Using the data in question 3 above calculate the price elasticity coefficient moving from
price of 3 to a price of 4; from a price of 5 to a price of 6
...
Might it be useful in the airline industry? Why?

Sample Questions:
Multiple Choice:

Which of the following is a determinant of the price elasticity of demand?
A
...

C
...


Proportion of income spent on commodity
Price of complements
Number of consumers
None of the above

Where is the range of unit price elasticity of demand for the following demand curve?
Price Quantity
8
7
6
5
4
3
A
...

C
...


3
4
5
6
7
8

From price 8 to price 6
From price 6 to price 5
From price 5 to price 3
From price 7 to price 4

Calculate the elasticity coefficient from the data above for the interval where price
changes from 8 to 7
...

B
...

D
...
47
1
...
14
None of the above

144

True - False:

The longer the period the more suppliers can adjust to price changes, hence the greater
the price elasticity of supply
...
{FALSE}

The maximum point on the total revenue curve correlates with the elastic range of the
demand curve
...
This chapter will also introduce the idea of Giffin’s Paradox,
consumer equilibrium, and the utility maximization rule
...


Income and Substitution Effects Revisited

The income and substitution effects combine to cause the demand curve to slope
downwards as was discussed earlier in Chapter 4
...
For students who are interested, it is recommended
that you take E321, Intermediate Microeconomics; or at a minimum go through the
appendix to this chapter
...
The income effect results from the price of a
commodity going down having the effect of a consumer having to spend less on that
commodity, hence the same as having more resources
...
It is the combination of the income and substitution effects, and
their relative strength, that causes an individual (hence generally a market) demand
curve to slope downward
...

Giffin's Paradox is the fact that some commodities may have an upward
sloping demand curve
...
(Not
necessarily because of quality problems with the product, but because the analysis is
inferior -- not generalizable to all commodities)
...
(In other words, the income effect
overwhelms the substitution effect)
...
One is necessity for very poor people and the other is one for which a
high price creates a snob effect
...

146

Price

Demand
with Giffin’s
Paradox

P1

P2

Quantity

In the diagram above notice that as price is decreased from P1 to P2 the quantity
demanded decreases, hence snob appeal may go down from the loss of a prestigiously
high price – consumers who value the product simply because it is high priced leave the
market as the price falls
...

In the case of poor people who experienced the price of necessity increasing,
their limited resources may result in their buying more of the commodity when its price
increases
...
To maintain their caloric intake rice
will be substituted for the still more expensive beans and fish
...
There is the snob appeal
possibility where the higher the price, the more desired the commodity it
...
If the car is extremely
expensive, i
...
, Rolls Royce, the snob effect may be the primary motivation for the
purchase
...
For example, Joy
Perfume advertised itself as the world's most expensive to attract consumers that their
marketing surveys indicated would respond to the snob effect
...
(Alfred Marshall, London: Macmillan Publishing
Company, 1920, pp
...
)

...
If the desires to
secure with of two pleasures will induce people in similar circumstances each to do
just an hour's extra work, or will induce men in the same rank of life and with the
same means each to pay a shilling for it; we they may say that those pleasures are
equal for our purposes, because the desires for them are equally strong incentives to
action for persons under similar conditions
...
It
is the idea of rational behavior that permits the rigorous examination of economic
activity
...

Consumers (when acting in their own self interest) will generally attempt to maximize
their utility, given some fixed level of available resources and income with which to
purchase goods and services
...

The algebraic restatement of the rule:

MUa/Pa = MUb/Pb =
...
If any single ratio is greater than one, the marginal utility
received from the consumption of the good is greater than the price, and this means the
consumer has not purchased enough of that good
...
If the ratio is less than one, where MU< P,
then the consumer has purchased too much of the commodity (price is larger than the
marginal utility received from the commodity) and needs to cut back
...
In reality, a consumer is
always seeking those levels, but because of changing prices and changing preferences,
it is understood that the consumer is always seeking, but never quite at equilibrium
...
It is provided simply to demonstrate how an
individual demand can be derived
...
Therefore we can derive an individual
demand curve using what we have learned about utility in this chapter
...

A consumer's budget constraint is a mapping of the ability to purchase goods and
services
...

The following budget constraint shows the consumer's ability to purchase goods, beer
and pizza
...
If all
resources are spent on beer then the intercept on the beer axis is the amount of beer
the consumer can purchase; on the other hand, if all resources are spent on pizza then
the intercept on that axis is the amount of pizza that can be had
...
The slope of the budget constraint is the negative of the relative prices of beer and
pizza
...
There are three assumptions
necessary to show a consumer's utility with an indifference mapping
...

The following indifference curve shows the consumer's preferences:

Beer

2
1
Pizza

The dashed line (2) shows a higher level of total satisfaction than does the solid
line (1)
...

Consumer equilibrium is where the highest indifference curve they can reach is
exactly tangent to their budget constraint
...

Deriving the individual demand curve is relatively simple
...
The lower
price with the solid line budget constraint results in the level the higher level of pizza
being purchased (labeled 1for the indifference curve - not the units of pizza)
...

Price

P2

P1

Quantity
Q2

Q1

Notice that Q2 and P2 are associated with indifference curve 2 and budget
constraint 2, and that Q1 and P1 result from indifference curve 1 and budget constraint
1
...

151

KEY CONCEPTS

Revealed preference
Utility
Budget Constraint
Indifference Curves
Income Effect
Substitution Effect
Giffin’s Paradox, Inferior goods
Consumer Equilibrium

STUDY GUIDE

Food for Thought:

What is utility and diminishing marginal utility? Explain
...


How is a market demand curve derived? What does this have to do with indifference
curves and budget constraints?

152

Sample Questions:
Multiple Choice:
Which of the following describes the utility maximization rule? (where MU is marginal
utility and P is price)
A
...

C
...


MUa/Pa = MUb/Pb =
...
= MUz
None of the above describe the rule

True - False:

The law of diminishing marginal utility states that total utility will become negative as
more units of a commodity are consumed
...
{TRUE}

153

CHAPTER 7

Costs of Production
The purpose of this chapter is to examine the production costs of a firm
...
The second section presents the models of short-run costs
...


Production and Costs

The reason that an entrepreneur assumes the risk of starting a business is to
earn profits
...
However, before anything can be said about profits we must
first understand costs and revenues
...

An economist's view of costs includes both explicit and implicit costs
...
e
...
Accountants subtract total cost from total
revenue and arrive a total accounting profits
...
g
...
Therefore, there is a significant
difference in how accountants' and economists' view profits B economic profits versus
accounting profits
...
In a purely
competitive world, a business should be able to cover their costs of production and the
opportunity cost of the next best alternative (and nothing more in the long-run)
...
Instead various financial ratios are used to determine how the firm has done
with respect to similarly situated companies
...
These time
periods differ from industry to industry, and will differ by the technology employed
between firms
...

In the market period, all costs are fixed costs (nothing can be varied)
...
Generally, plant,
equipment, and technology are fixed, and things like labor, electricity, and materials can
still be varied
...
That is, the plant, equipment, and
even the business into which you put productive assets can all be changed
...
Because
everything is fixed in the market period, this period is of little interest in economic
analysis
...
The long-run is of
interest because it is also the planning horizon for the business
...
Variable costs are called variable
because they increase or decrease with the level of production
...

Total product or total output is the total number of units of production obtained
from the productive resources employed
...
Marginal product is the change in
total product associated with a change in units of a variable factor of production
...
However, with a fixed level of available capital as variable factors are added to
the production process, there is a point where the increases in total output begin to
diminish
...
In fact, it is possible, at some point, that further additions in
the units variable factors to a fixed level of capital could actually reduce the total output
of the firm
...
In reality, most firms
come to realize that their total additions to total output diminish, long before they begin
to experience negative returns to additions to their workforce or other variable factors
...


The top graph shows total product
...
When the total product curve reaches
its maximum, increased output results in negative marginal product
...
The
ranges of marginal returns are identified on the above graphs
...
Total costs (TC) are equal to variable costs (VC) plus fixed costs
(FC)
...
e
...
Fixed costs are those costs that cannot be varied in the short-run, i
...
,
plant (interest)
...

These relations are presented in a graphical form in the following diagram:
156

The fixed cost curve is a horizontal line
...
The variable cost curve
has a positive slope because it varies with output
...
This is because we added fixed cost
(the horizontal line) to variable cost (the positively sloped line)
...

These are the marginal cost, and the total, variable, and fixed costs relation to various
levels of output (averages)
...
Marginal
cost (MC) is the change (denoted by the Greek symbol delta), in total cost (TC) divided
by the change in the quantity of output (Q)
...


The following diagram presents the average costs and marginal cost curve in
graphical form
...

This occurs because a constant is being divided by increasingly large numbers
...
Because average fixed cost approaches zero, the difference between average
variable cost and average total cost also approaches zero (the difference between ATC
and AVC is AFC)
...
In other words, as marginal
cost is below average total (and average variable) cost the average function is falling to
meet marginal cost
...

The following graph relates average and marginal product to average variable

and marginal cost
...
Where marginal cost equals average variable cost, the marginal
product curve intersects the average product curve
...

This presents some interesting disconnects from how business is presently
evolving
...
In other words, the costs of production seemingly fail to account
for the history of the 21st century thus far
...


The Long Run Average Total Cost Curve

In the long-run all costs are variable
...
Therefore, anything that is technologically feasible is available to this firm in
the long-run
...


159

The long-run average total cost curve (LRATC) is therefore a mapping of all
minimum points of all possible short-run average total cost curves (allowing technology
and all factors of production (i
...
, costs) to vary)
...
Therefore, the
LRATC is also called the planning horizon for the firm
...
The downward sloping
range of the LRATC is due to economies of scale, the upward sloping range of the
LRATC is due to diseconomies of scale, and if there is a flat range at the minimum point
of the LRATC this is called a range of constant returns to scale
...
The causes of economies of scale are that as a firm becomes larger it may be
able to utilize labor and managerial specialization more effectively, capital more
effectively, and may be able to profitably use by-products from its operations
...

Constant returns to scale are large ranges of operations where the firm's size
matters little
...
Several public utilities, such as electric
generating companies, telephone company, and water and sewer service have
160

relatively large ranges of constant returns to scale
...
Minimum efficient scale is the smallest size of
operations where the firm can minimize its long-run average costs
...
For example, the
minimum efficient scale in agriculture in the Great Lakes area for dairy operations is
relatively small (in the $200,000 range)
...

There is an interesting implication of the LRATC analysis
...
A natural monopoly is a
market situation where per unit costs are minimized by having only one firm serve the
market
...

If that happens to be at the beginning of a long range of constant costs, it is the first
point (on the left of the range) where costs are at their minimum
...

Where minimum efficient scale is very large for capital intensive operations, it
may be more cost effective to permit one company to spread its fixed costs over a very
large number of consumers, rather than have several competing firms suffer the fixed
costs of a minimum efficient scale and have to share a customer base
...
These types of firms are frequently natural monopolies
...


KEY CONCEPTS

Explicit v
...
Accounting Costs
Normal Profit
Next Best Alternative
Time Periods of Analysis
Market Period
Short-run
161

Long-run
Law of Diminishing Returns
Total, average, and marginal product
Short-run Costs
Total costs
Average Total
Average Fixed
Average Variable
Marginal
Long-run average total cost
Economies of Scale
Diseconomies of Scale
Minimum efficient scale
Planning Horizon
Natural Monopoly

STUDY GUIDE

Food for Thought:

Complete the following table then draw the relevant curves from the data (fixed cost is
$200)
...


Explain, in detail, why normal profit is included in average total costs?

Draw a LRATC demonstrating diseconomies, economies and constant returns to scale
...
What does this have to do
with planning? Explain
...

B
...

D
...

B
...

D
...
{FALSE}
Long Range Average Total Cost reaches its minimum where short run marginal cost is
equal to LRATC
...
{TRUE}
Marginal costs are the change in costs associated with the addition of one more unit of
output
...
The simple supply and
demand diagram is the model of a perfectly competitive industry
...

The purpose of this chapter is to introduce models of the firm that are not purely
competitive
...
In particular, this chapter will
develop the model of the perfectly competitive firm, examine its relation to the industry,
and then offer some critical evaluation of this important paradigm
...
In the product market, the two
extremes are perfect competition and pure monopoly
...
However, there are
intermediate market structures
...

The assumptions in pure competition are:

(1) there is atomized competition (a large number of very small suppliers
and buyers relative to the market),
(2) there is complete freedom of entry and exit into and from this market,
(3) there is no nonprice competition,
(4) suppliers offer a standardized product, and
(5) firms in this industry must accept the price determined in the industry
...
Probably as close
as the real world comes to the competitive ideal is agriculture, during the period in which
this industry was dominated by the relatively small family farms prior to World War II
...


Pure monopolies abound in reality, including public utilities and manufacturing
firms producing products protected from competition by patents or copyrights
...

The assumptions underlying the model of a monopolistically competitive industry
are:

(1) a relatively small number of sellers compared to pure competition, but
this number can still be large, in some cases a few hundred
independent sellers,
(2) pricing policies exist in these firms,
(3) entry into this market is generally somewhat difficult,
(4) there is substantial nonprice competition, mostly designed to create
product differentiation, at least some of which is spurious
...

These industries include computer manufacturers, software manufacturers, most retail
industries, and liquor distillers
...
In general, the graphical analysis of a monopolistic
competitive industry is identical to a monopoly, except the demand curve is somewhat
more elastic than the monopolists'
...


Examples of oligopolies abound, the U
...
automobile industry, the soft-drink
industry, the brewing industry, segments of the fast-food industry, and airplane
manufacturers
...

All of these market structures also assume perfect knowledge concerning
present and future prices (by both producers and consumers) and all other information
relative to the operation of the market, i
...
, product availability, quality etc
...


The Purely Competitive Firm

Total, average and marginal product were developed with the various cost curves
in Chapter 7
...
Because a purely competitive
firm sells its output at the one price determined in the industry, price does not change as
the quantity sold increases
...
The result is that average revenue is equal marginal revenue, and both of these
are equal to price
...

A firm is assumed to be rationally managed and therefore it will attempt to
maximize its profits
...
The reason for this is relatively
simple
...
If a firm produces at a
quantity in excess of where MC = MR, the firm adds more to its costs than it receives in
revenues
...

167

The model of the purely competitive industry is the simple supply and demand
diagram you mastered in Chapter 4
...
This model is revisited below:

Supply
Price
Pe

Demand
Quantity

Qe

The firm in perfect competition is just one of thousands that are summed to arrive
at the industry levels of output and price
...
If the firm charges a
price lower that the price established in the industry it is irrational and will lose revenue
it could have otherwise had
...
Because
the firm sells at the single price established in the industry it has a perfectly elastic
demand curve
...


168

The demand curve for the perfectly competitive firm is illustrated below:

Price

D = MR = AR = P

Quantity
Because the firm is a price taker, meaning that it charges the same price across all
quantities of output, marginal revenue is always equal to price, and average revenue
will always be equal to price
...

Establishing the price in the industry is simply setting the equilibrium in the
familiar supply and demand diagram, and that is the price at which the firm is obliged to
sell its output
...
However, this yields little information save
what price will be charged and what quantity the industry produce
...

Economic profits are total revenues in excess of total costs
...
In this short-run it plausible that some firms in pure
competition can exact an economic profit from consumers, but because of freedom of
entry, the economic profit will attract new firms to the industry, hence increasing supply,
and thereby lowering price and wiping out the short-run economic profits
...
At the point where
MC = MR the average total cost (ATC) is below the demand curve (AR) and therefore
costs are less than revenue, and an economic profit is made
...

However, the firm cannot continue to operate at an economic profit because
those profits are a signal to other firms to enter the market (free entry)
...
Because of the atomized competition assumption, the
number of firms that must enter the market to increase industry supply must be
170

substantial
...
Where MC
= MR is where the firm produces, and at that point ATC is exactly tangent to the
demand curve
...

A firm in pure competition can also make an economic loss
...
The firm produces where MC
= MR, however, at that level of production the ATC is above the demand curve, in other
words, costs exceed revenues and the firm is making a loss
...
The relation of
average total cost with average revenue determines the amount of profit or loss, but we
to know what relation average revenue has with average variable cost to determine
whether the firm will continue in business
...
It is shuts down it would lose all of its fixed costs,
therefore the rational approach is to continue to operate to minimize losses
...

In sum, to determine whether a firm is making a loss or profit we must consider
the relation of average total cost with average revenue
...
The following diagram illustrates the shutdown case for the firm making a loss:
MC
Price

ATC
AVC

AVC SAVED BY SHUT- DOWN

D=MR

Qe

Quantity

In the case above you can see that the AVC is above the demand curve at where
MC=MR, therefore the firm cannot even cover its variable costs and will shut down to
minimize its losses
...
If the firm shuts-down, all that is lost
is the fixed costs
...

What may not be intuitively obvious is that this analysis determines the industry
supply curve
...
To obtain the industry’s supply curve one needs only sum all of
the firms’ marginal cost curves about their average variable cost curves
...
Because P =
MC, in every market in the economy there is no over- or under- allocation of resources
in this economy
...

However, this result is obtained only if all industries in that economic system are purely
competitive
...
The problem is that this is economic theory that is
not necessarily supported by empirical evidence
...
In the
real world the ideal of technical efficiency is rarely attained
...

As you may recall from the definition of economic efficiency, allocative and
technical efficiency are only two of the three necessary and sufficient conditions for
economic efficiency
...
If full employment is also in evidence then a purely competitive world is
economically efficient
...
Conclusions
from the competitive models are straightforward and fairly simple, hence accessible to
the population in general
...
However, as Adam Smith himself, notes there
was never a point at which competition was observed, let alone, was the general rule
...
While it is true that there
is a Nobel Prize in Economic Science, economics is not a science in the same vain that
physics or chemistry is
...
However, the
assumptions may reflect value judgments (biases) more than what the analyst believes
reflects the state of nature in the real world
...


173

Criticism of Pure Competition as a Mode of Analysis for the Real World
...
There are several problems that
are not excluded by meeting the assumptions behind the competitive models
...
Public goods and other commodities may not be available
through competitive industries because of the lack of a profit potential
...

Further because of technical efficiency requirements, externalities such as
pollution, work environment safety, and other such problems are likely to arise because
of the constraint imposed on the firms by the price being determined by the industry
...

The distribution of income may lack equity or even technical efficiency
...
If the product they produce is not highly valued then some
workers could be paid very low wages, even though the human capital and effort
requirements are substantial
...
This type of
result often creates substantial social problems, i
...
, alienation, occasionally resulting in
alienation, crime, drug abuse, and in the developing world even political instability
...
This standardization might very well result in a
substantial loss of consumer choice
...

The present state of technology simply requires the existence of many natural
monopolies
...
This misallocation of resources results in an
insufficient amount of some commodities, with an excess of resources available to other
products, and prices that are not specifically determined by the actual costs of
production
...
This issue will
be discussed in greater detail in the following chapter (Chapter 9, Monopoly)
...
Perhaps the simplicity of this is appealing,
however, supply and demand reflects, at best, a very superficial understanding of a
modern economic system
...
Economics, is not pure science, and it is not value free as
many would lead you to believe
...
183
...
The normal economic community, upon which theoretical interest has converged,
is a business community, which centers about the market, and whose scheme of life
is a scheme of profit and loss
...

As one can see, Thorstein Veblen was very suspicious of economic theories of
the time as being little more that an apology for self-interest of the rich and powerful
posing as markets
...
Adam Smith, New
York: Knopf Publishing, 1910, pp
...

Such are the inequalities in the whole of the advantages and disadvantages of
the different employments if labour and stock, which the defect of any of the three
requisites above mentioned must occasion, even where there is most perfect liberty
...

It does this chiefly in the three following ways
...

Adam Smith suspicious of the motivations of businessmen, and craftsmen in the
pursuit of their own self-interest
...
Adam Smith, therefore, had first hand
experience with the early beginnings of monopoly and knew their potential for evil
...
It is this consumer ability to choose, that motivated
Smith’s view that capitalism would produce socially beneficial results – and monopoly
power is a threat to those results
...
Firm
Profit Maximizing Rule
MC = MR
Economic v
...


Why is the profit maximizing (loss minimizing) point where Marginal Cost equals
Marginal Revenue? Explain, fully
...


177

Sample Questions:
Multiple Choice:
A purely competitive firm’s short-run supply curve it its marginal cost curve, for all:
A
...

C
...


Quantities of output
Output where marginal cost exceeds minimum average total cost
Output where marginal cost exceeds minimum average fixed cost
Output where marginal cost exceeds minimum average total cost

If all of the firms producing a commodity in a purely competitive market are required to
adopt antipollution devices that increase their costs of production (even though it cleans
up the air), one would expect:
A
...

C
...


The demand for the product to decrease
The market supply curve to shift to the left
The long-run economic profits of the individual firms to decrease
The short-run economic profits of the individual firms to decrease

True - False
If all industries within an economy were pure competitors, the economy would be
economically efficient
...
{FALSE}

178

CHAPTER 9

Pure Monopoly
The purpose of this chapter is to examine the pure monopoly model in the
product market
...
Once the monopoly model is mastered, it will be critically evaluated
...


The Assumptions of Monopoly Revisited

The assumptions upon which the monopoly model is based were presented in
Chapter 8
...
The
assumptions of the monopoly model are:
(1) there is a single seller (or a few sellers who collude, hence a cartel),
(2) the single seller offers a unique product,
(3) entry and generally exit are blocked,
(4) there is non-price competition, and
(5) the monopolist dictates price in the market
...

Further, the difference in assumptions also creates substantially different results in
price and output between the two models
...
The second model was that of the firm, the firm faced a perfectly elastic
demand curve, in which demand, price, average revenue and marginal revenue were all
the same
...
The firm, in
monopoly, is the industry (by definition)
...

If the firm wants to sell more it must lower its price therefore marginal revenue is also
downward sloping, but has twice the slope of the demand curve
...

Consider the following diagram:

Price
El

as
ti

c

Ra
ng
e

In
ela
st i
cR
an
ge

Marginal
Revenue

Demand
Quantity

The point where the marginal revenue curve intersects the quantity axis is of
significance; this point is where total revenue is maximized
...

Unlike the purely competitive model here is no supply curve in an industry which
is a monopoly
...
In this sense, the monopolist is a price dictator,
in that it is the cost structure, together with the change in total revenue with respect to
change in quantity sold that directs the monopolist’s pricing behavior, rather than the
interaction of the monopolist’s supply schedule, with the demand schedule of
consumers (demand curve)
...

A monopolist can make an economic profit
...
As you recall from Chapter 8, in pure
180

competition if there is an economic profit, that profit is a signal to other assets to enter
the market
...

One of the objections to pure monopoly is that there is closed entry
...
The self-correcting advantages from pure
competition are lost because of these barriers to entry
...
The monopolist produces where MC
= MR (where MC intersects MR), but the price charged is all the market will bear, that
is, the price on the demand curve that is immediately above the intersection of MC =
MR
...

On the other hand, there is nothing in the analysis that requires any given
monopolist will be profitable
...

The following diagram shows a monopolist that is unfortunate enough to be
operating at an economic loss
...
The ATC is above the demand
curve (AR) at where MC = MR (the loss is the labeled rectangle)
...
The firm can pay back a portion of its fixed costs by continuing to
operate at this level because the AVC is still below the demand curve
...


The Effects of Monopoly

There are several implications of the monopoly model; many of which lead to
criticisms of monopoly on issues of both technical and allocative efficiency
...
In monopoly there are too many resources allocated to production of this
product, for which we receive too little output as illustrated by comparison with the
competitive solution, the dotted line (discussed below)
...

Consider the following diagram of a pure monopoly making an economic profit, in
this case:

182

Price
Pm

MC

Economic
Profit

ATC

Pc
D

MR

Qc

Qm

Quantity

The above graph shows the profit maximizing monopolist, Pm is the price the
monopoly commands in this market and Qm is the quantity exchanged in this market
...
The monopolist therefore produces less and charges more
than a purely competitive industry
...

Price discrimination is where you charge a different price to different customers
depending on their price elasticity of demand
...
This practice
enhances the allocative inefficiency
...
The end result is even more resources
flow into the monopolist’s coffers, and out of other industries – hence even more
inefficient allocations of productive resources
...

Sometimes a monopolist is in the best interests of society (besides the natural
monopoly situation)
...
e
...
If these types of firms were forced to
permit free use of their technological developments (hence no monopoly power) then
the economic incentive to develop new technology and products would be eliminated –
hence economic irrationality would have to prevail for the technological progress we
have come to expect in the beginning of the twenty-first century
...
The purpose of the rate regulation was to ensure that the public would
not suffer price gouging as a result of the monopoly position of the firms
...

Throughout the 1980s and 1990s, up through 2002, there was substantial
deregulation of the power industry, cable TV industry, and telecom
...
e
...
The idea was to permit competition in long distance and local service
...
The local providers had much invested in microwave
towers, switches, and telephone lines – there would be charges permitted for the use of
these assets by competitors, and what resulted was poorer service, at higher prices in
most areas
...
Consumers were victims of
unscrupulous business practices that resulted in billions of dollars in overcharges that
cannot be recovered
...
If
allocative efficiency is the goal, then the monopolist should be constrained to charge a
price where MC = D or the social optimum
...
If we are concerned about consistently and reliably having the product of the
monopolist available, at a reasonable price, then it might be more sensible to regulate
the monopolist to charge a price at where ATC = D, or the fair rate of return
...
The potential prices at which a monopolist could be regulated,
and the potential results of those price levels, is called the dilemma or regulation
...

Consider the following diagram, this is a monopolist that is being regulated at the
social optimum (MC = D):

184

Price
MC
ATC

Pr
D
MR

Qr

Quantity

This firm is being regulated at the social optimum, in other words, what the
industry would produce if it were a purely competitive industry
...
However, notice the ATC is below the
demand curve at the social optimum which means this firm is making an economic
profit
...

Consider the following diagram of a monopolist that is being regulated at the fair
rate of return:

Price
MC
ATC

Pr
D
MR

Qr

Quantity

The fair rate of return enforces a normal profit because the firm must price its
output and produce where ATC is equal to demand
...
Virtually every
185

state public utility commission relies on this model to regulate their electric companies
and other public utilities
...
There are problems with rate regulation
...
Because of
the closeness of the legal advocates, economists, and others involved in the litigation of
rate cases, there has been accusations that the public utility commissions have been
over-taken by the industries they regulate
...
While there have been instances
where conflicts of interest have been noted, this “capture theory of regulation” probably
overstates the relations between the industries regulated and the public utility
commissions in most jurisdictions
...
This is
called the Averch-Johnson Effect
...
Therefore, given a choice, the utilities
will invest in expensive (sometimes overly-expensive) capital to maximize the base
upon which they can earn a rate of return
...

In the management literature there is come discussion of “organizational slack
...
However, economists have observed the same
inefficienies, with different conclusions
...
Electric
companies over-capitalize and use excess capital to avoid labor and fuel expenditures
(which are generally much cheaper than the additional capital) - nuclear generating
plants are a good example of this of this type of planned inefficiency
...
Electricity is not something that is
easily stored, and therefore the relevant demand for electricity is the peak demand on
the system
...
To smooth
this peak out and make more consistent use of “slack” electric utilities, particularly in
Europe, price their power at different rates taking into consideration the peaks and
troughs in demand – higher rates in the peak times, lower rates in the troughs
...


Monopoly
Essentials of Economic Theory
...
375-77
...
No description could exaggerate the evil which is in store for a society given
hopelessly over to a regime of private monopoly
...
Monopoly checks progress in
production and infuses into distribution an element of robbery
...
It makes prices and wages
abnormal and distorts the form of the industrial mechanism
...
The system
of industrial groups and sub-groups is thrown out of balance by putting too much
labor and capital at certain points and too little at others
...


187

APPENDIX TO CHAPTER 9
STATUTORY PROVISIONS AND GUIDELINES
OF THE ANTITRUST DIVISION1
Sherman Antitrust Act, 15 U
...
C
...
S
...
§ 1
Trusts, etc
...
Every person who shall make any contract or engage in any
combination or conspiracy hereby declared to be illegal shall be deemed guilty of a
felony, and, on conviction thereof, shall be punished by fine not exceeding $10,000,000
if a corporation, or, if any other person, $350,000, or by imprisonment not exceeding
three years, or by both said punishments, in the discretion of the court
...
S
...
§ 2
Monopolizing trade a felony; penalty
Every person who shall monopolize, or attempt to monopolize, or combine or
conspire with any other person or persons, to monopolize any part of the trade or
commerce among the several States, or with foreign nations, shall be deemed guilty of
a felony, and, on conviction thereof, shall be punished by fine not exceeding
$10,000,000 if a corporation, or, if any other person, $350,000, or by imprisonment not
exceeding three years, or by both said punishments, in the discretion of the court
...
S
...
§ 3
Trusts in Territories or District of Columbia illegal; combination a felony
Every contract, combination in form of trust or otherwise, or conspiracy, in
restraint of trade or commerce in any Territory of the United States or of the District of
Columbia, or in restraint of trade or commerce between any such Territory and another,
or between any such Territory or Territories and any State or States or the District of
Columbia, or with foreign nations, or between the District of Columbia and any State or
States or foreign nations, is declared illegal
...

188

if a corporation, or, if any other person, $350,000, or by imprisonment not exceeding
three years, or by both said punishments, in the discretion of the court
...
S
...
§ 4
Jurisdiction of courts; duty of United States attorneys; procedure
The several district courts of the United States are invested with jurisdiction to
prevent and restrain violations of sections 1 to 7 of this title; and it shall be the duty of
the several United States attorneys, in their respective districts, under the direction of
the Attorney General, to institute proceedings in equity to prevent and restrain such
violations
...
When the parties
complained of shall have been duly notified of such petition the court shall proceed, as
soon as may be, to the hearing and determination of the case; and pending such
petition and before final decree, the court may at any time make such temporary
restraining order or prohibition as shall be deemed just in the premises
...
S
...
§ 5
Bringing in additional parties
Whenever it shall appear to the court before which any proceeding under section
4 of this title may be pending, that the ends of justice require that other parties should
be brought before the court, the court may cause them to be summoned, whether they
reside in the district in which the court is held or not; and subpoenas to that end may be
served in any district by the marshal thereof
...
S
...
§ 6
Forfeiture of property in transit
Any property owned under any contract or by any combination, or pursuant to
any conspiracy (and being the subject thereof) mentioned in section 1 of this title, and
being in the course of transportation from one State to another, or to a foreign country,
shall be forfeited to the United States, and may be seized and condemned by like
proceedings as those provided by law for the forfeiture, seizure, and condemnation of
property imported into the United States contrary to law
...
S
...
§ 6a (Foreign Trade Antitrust Improvements Act of 1982)
Conduct involving trade or commerce with foreign nations
Sections 1 to 7 of this title shall not apply to conduct involving trade or commerce
(other than import trade or import commerce) with foreign nations unless-(1) such conduct has a direct, substantial, and reasonably foreseeable effect-189

(A) on trade or commerce which is not trade or commerce with foreign nations, or
on import trade or import commerce with foreign nations; or
(B) on export trade or export commerce with foreign nations, of a person
engaged in such trade or commerce in the United States; and
(2) such effect gives rise to a claim under the provisions of sections 1 to 7 of this
title, other than this section
...

§ 8 Sherman Act, 15 U
...
C
...


KEY CONCEPTS
Monopoly
Economic Profits
Comparisons with pure competition
Economic efficiency induced by monopoly
Rate Regulation
Social Optimum
Fair Rate of Return
Proce Discrimination
Averch-Johnson Effect
Dilemma of Regulation
X-efficiency
Sherman Antitrust Act

190

Study Guide

Food for Thought:
Compare and contrast the monopoly model with the purely competitive model
...


Develop and explain the monopoly model, showing an economic profit, a normal profit,
and an economic loss
...


Sample Questions:
Multiple Choice:

An unregulated monopolist when compared with a purely competitive industry will:
A
...

C
...


Produce more, and charge more
Produce more, and charge less
Produce less, and charge more
Produce less, and charge less

Which of the following statements is true of an unregulated monopolist?
A
...

C
...


Price is less than marginal cost
Price is more than average revenue
Price is more than marginal revenue
Price is set where the monopolist chooses regardless of cost

191

True - False

Society would be unambiguously better-off without monopolists
...
{TRUE}

192

Chapter 10

Resource Markets
To this point the discussion of markets has focused on product markets
...
The markets to be examined in this chapter are those
where firms purchase productive resources (in other words, factors of production)
...
In particular, capital and labor markets
have been the focus of substantial regulation
...
Many of these scandals were from conflicts of interest, resulting in 2003
beginning to witness the regulation of financial markets in the U
...
The late 1990s
witnessed the abuse of managerial trust by high ranking executives in awarding
themselves very high compensation levels, while laying-off productive employees, and
cutting wages and benefits for those who performed the work of the organizations
...

The United States seems to go through cycles where regulation and deregulation ebb and flow
...
If history is instructive then market ups and
downs are the natural order of things in a mixed economy
...
However, this controversy also serves
to make resource market extremely interesting
...
, 1992,
p
...

Historians trace much of America’s economic success to cheap, plentiful, welllocated raw materials and farm land
...
A small population lived in a very large,
resource-rich environment
...
Together they gave America an economic edge
...
Once rich, America also found it easy to stay rich
...
Natural resources
essentially drop out of the competitive equation
...
Technology get turned upside down
...

And in the twenty-first century, the education and skills of the work force will end up
being the dominant competitive weapon
...
By derived
demand it is meant that it is the output of the resource and not the resource itself
for which there is a demand by its employer
...

The marginal product (MP) of a productive resource is the change in total output
where ▵TP (▵ means change) attributable to the employment of one more unit of that
productive resource ▵L, in this case change in labor
...
)
The marginal revenue product of labor (MRP labor) is MRP labor = ▵TR/▵L
where ▵TR is the change in total revenue attributable to the employment of one more
193

unit of that resource:

MRP = ▵TR/▵L
The demand for a productive resource comes from the business sector and the
supply of that productive resource comes from the households (see Chapter 3)
...

Because the demand for a productive resource is a derived demand, the demand
schedule for that productive resource is simply the MRP schedule for that resource by
the firm
...
Notice, if you will, this demand schedule is downward sloping and
is therefore for an industry is pure competition
...
e
...
), and

(3) the technology in which the resource will be employed
...
If, on the other
hand, a change in one of the non-price determinants of demand occurs then the
demand curve will shift either left (decrease) or right (increase)
...
Likewise if the quality of the resource
declines, so too will its demand
...

The non-price determinants of supply are pretty much factor of production
specific
...
The supply of capital depends on several issues, such as investor expectations
and the life of plant and equipment, capital supply is dealt with in greater detail in
finance (F301)
...

The greater the rate of decline of the MRP schedule the more inelastic the
demand for the factor production, and the lesser the rate of the decline in MRP the more
elastic the demand for the factor
...
The more price
elastic the demand for the product, the more elastic will be the demand for the factor of
production, and the more inelastic the demand for the product, the more inelastic will be
the demand for the factor of production
...
The more intensely a factor is used the more inelastic its demand, all
other things equal, and the less intensely the factor is used in a given technology the
elastic the demand for the factor
...

Marginal resource cost (MRC) is the amount that the addition of one more unit of a
productive resource (▵L) adds to total resource costs (▵TC), which is:

195

MRC =

▵TRC/▵L

The supply curve of a factor production in a purely competitive market is simply
the MRC curve for that factor
...

The profit maximizing employment of resources is where MRP = MRC, where
MRC is the supply curve of the resource in a purely competitive resource market and
MRP is the demand curve for a purely competitive resource market
...

This equilibrium is similar to that found in the product market
...
Further, if there is a change in price, then all that happens is a movement
along the curve, i
...
, a change in the quantity demanded or a change in the quantity
supplied of this factor of production
...
Best, in this case, being judged by the most technologically efficient
...


196

MRP /MRC
labor

labor

= MRP

/MRC

capital

capital

=
...
Hiring more of that factor results in
moving down the MRP curve and up the MRC curve until you reach the equilibrium level
of employment
...
Hiring less of that factor results in moving down the MRP
curve and up the MRC curve until you reach the equilibrium level of employment
...
The dashed line to the left of the equilibrium identifies
the “too little level of employment” and the need to move up the MRP and down the
MRC to arrive at an equilibrium price for this factor
...


Marginal Productivity Theory of Income Distribution

MRC=supply

Price

Pe

MRP=demand
Too little

Qe

Too Much

Quantity of
Resource

Economic freedom (see Chapter 1, economic goals) has both positive and
negative implications
...
At the same time executive salaries and entertainers’ incomes
have enjoyed historically high levels
...
)
The marginal productivity of resource markets has important implications for
economic welfare
...
However, in a world with both
purely competitive markets and monopoly power in some product and factor markets we
will observe misallocations of resources as discussed in the monopoly chapter, and in
the following chapter
...
Both results have negative implications for allocative efficiency and for
workers who may be disadvantaged by such markets
...
Where there is one employer or a small number of employers, especially
when they collude to depress wages, this has the effect of giving the employer an
exploitable market imperfection that has negative implications for allocative efficiency
and any workers caught in such a market
...
Monopsony is one buyer of a resource
(or product) and cause factor payments (or prices) to be below the competitive
equilibrium
...

Remember that the derived demand for a factor of production arises because the MRP
schedule facing an employer is the demand curve for a factor of production
...
If the
product is over-priced because it is sold in a monopolized market, then the MRP for that
factor is too high
...

Professional athletes are a prime example of this exercise of monopoly power
...
The end result is that their
products have become very much 0ver-priced and because their industry is highly labor
intensive, the professional athletes are paid a large multiple of their true MRPs
...
The
allocation of resources to this industry also has a depressing effect on wages in other
industries (after all there are limited resources)
...


Using the following data complete the following table and derive a demand curve for
labor (price of output is $2 per unit):

199

Workers
1
2
3
4
5
6
7
8
9

Total Product
22
42
60
76
90
102
112
120
126

Marginal Product

MRP

Fully explain the concept of derived demand
...


Sample Questions:
Multiple Choice:
Which of the following is the decision rule to determine the optimal combination of
productive factors?
A
...

C
...


MRP = MRP =
...
= MRP = 1
MRP /MRC = MRP /MRC =
...
= MRP /MRC = 1
labor

capital

land

labor

capital

land

labor

labor

labor

labor

capital

capital

capital

land

capital

land

land

land

An increase in the productivity of a factor of production will typically increase the
demand for that factor
...
A person's acquisition of human capital
B
...
A decrease in the price of a factor of production that is a substitute for the factor
under consideration
D
...
{TRUE}
The MRP slopes downward in an imperfectly competitive (resource) market serving an
imperfectly competitive product market because the MP diminishes and the price of the
output must be lowered to sell more
...
The model of the purely competitive
firm's labor market will be developed
...
These models will be
used to analyze minimum wages and unionization
...
The result of
the inseparability of labor from the people who provide it, is that the wage for the last
hour worked must be equal to the utility lost from the use of that hour for leisure
activities (all other activities except work
...

Workers offer their services in the labor market for the standard of living that their
wages will provide for them and their households
...
The relevant wage variable is the real wage
rate, which is the money wage (W) adjusted for the cost of living or price level (P); or
W/P
...
What the employee contributes to the revenues of the firm is
the marginal revenue product, MRP (the marginal physical product (MPP) times the
price of the product produced (P) – MRP = MPP x P)
...
In a competitive labor market the wage is
determined in the industry
...
The
equilibrium wage and level of employment is then determined by the intersection of the
factor's MRP with the factor's marginal resource cost, MRC
...
Notice that the firm faces a perfectly elastic supply of labor
curve, while the supply curve for the industry is upward sloping just like that observed in
the product markets
...

Factor markets are generally imperfect, and labor markets are generally monopsonies
or contain elements of monopsony power in the hands of employers
...
The monopsony model is based on the assumption that
there is one employer, or a group of employers that collude, they purchase standardized
labor, and the supply side of the market is competitive
...
The result is that the employer has a pricing policy
...
Therefore the monopsonist faces an MRC that
is to the left of the supply curve and has twice the slope of the supply curve
...
The employer equates
MRC with MRP to determine the least cost level of employment and then imposes the
lowest wage the market will bear, that being the point on the supply curve associated
with the intersection of MRP and MRC
...


Control of Monopsony

It is clear that monopsony in the labor market is not consistent with allocative
efficiency and has the effect of withholding significant amounts the employees' MRP
from them, that becomes profits, advertising, charitable expenditures, or payments to
other factors that did not earn those payments
...

One approach to the control of monopsony has been the imposition of minimum
204

wages
...
A minimum
wage does little to correct monopsony inefficiencies in all by the lowest paying
occupations
...
To prove their point they argue the minimum
wages' effects under the assumptions of a purely competitive labor market
...


Supply = MRC

W/P

Minimum Wage
Pe

Demand = M
Qd

Qe

Qs Quantity of Lab

The minimum wage acts the same as an effective price floor in that it creates a
surplus of labor -- unemployment
...
This analysis is exactly correct
under these assumptions
...
e
...
To the extent that there may be
some labor markets that approximate a competitive labor markets, the minimum wage
creates unemployment
...

If minimum wages are analyzed in the context of the monopsony model for which
the policy was intended the results obtained are far different than those of the
competitive model
...
If we assume competitive labor
markets, we are making a normative statement, because only imperfectly competitive
markets can be described in the real world
...
In the monopsony model
there are no negative employment effects of the minimum wage unless it is established
above the intersection of MRC with MRP
...

Most of the research done concerning minimum wage effects have focused on the
hospitality industry, in particular fast-food restaurants
...
S
...
However, most of this research suffers from significant data problems
...

In most industrialized countries the approach to controlling monopsony power
has been to establish collective bargaining or co-determination as a matter of public
policy and to provide legislation protecting organizational and collective bargaining
rights for workers
...
The Harvard
Business School studies published recently indicate that unions effects in the U
...
have
been to restore much of the efficiency lost due to monopsony
...
The most common analyses are to subdivide unions into two classes, craft and industrial unions and show their effects in an
otherwise competitive industry
...
e
...

Consider the following diagram
...
Because unions are the
ones that train the skilled labor it is presumed that they can restrict the supply of labor
within their craft and drive up wages
...

An industrial union is one that was a CIO affiliate (before the AFL-CIO merger in
1956), organizes all skill classes within a firm (i
...
, UAW), and is called an inclusive
union
...
Again, consider the following model of an industrial
union in an otherwise competitive labor market
...
This approach depends upon
solidarity among the work force to make the threat of a strike effective
...

The serious flaw in this analysis is the market model used to analyze unions
makes little sense
...
If labor markets were competitive and there were not
market imperfections unions would likely not be an economic priority for workers
...

Further, it is interesting to note that the pure craft and pure industrial unions
virtually no longer exist
...
Today, the Teamsters represent
a wide range of employees working in most occupations and industries in the U
...

economy
...
e
...
Most unions today are more consistent
with the old model of industrial unions
...
Kelley,
Reprints of Economics Classics, 1970, [original published 1928] pp
...
)
In the evolution of the psychology of the American wage earner, the fruition of
this "job and wage conscious" unionism and its eventual mastery of the whole field
meant a final and complete rupture with the old "producing classes" point of view,
which saw the road to economic democracy in a restoration to the individual, or to
intimately associated groups of individuals, of access to economic opportunity in
land, marketing, and credit; this opportunity once restored, competition alone would
suffice to preserve it all around
...
The predominance of the "anti-monopoly" point of
view in the American labor movement down to this time actually denoted a mental
subordination of the wage earner to the farmer, a labor movement in the grip of a
rural ideology
...
It was based on a consciousness of
limited job opportunities, -- a situation which required that the individual, both in his
own interest and in that of a group to which he immediately belonged, should not be
permitted to occupy any job opportunity except on the condition of observing the
"common rule" laid down by his union
...
Where such an outright "ownership" of the jobs was
impossible, the union would seek, by collective bargaining with the employers, to
establish "rights" in the jobs, both for the individual and for the whole group, by
incorporating, in the trade agreement, regulations applying to overtime, to "equal
turn", to priority seniority in employment, to apprenticeship, and so forth
...

As with the minimum wage, the appropriate analysis is where there is a problem,
in the imperfect labor markets
...
When a monopsony
exists, working conditions and compensation levels are allocatively inefficient resulting
in an employee's desire for a voice in their working conditions and a method to offset
the monopsony power that binds them to wages below the competitive equilibrium
...
Not only in this country, but in Europe and Asia too,
where the industrialized nations have higher proportions of union organization
...
To offset monopsony power, unions attempt to approximate a
monopoly, which theoretically should neutralize the monopsony
...
The
MRC
Supply

W/P

Monopsonist
Monopolist
Pure Competition

Demand = MRP

MRP'

Quantity of Labor
following diagram shows a monopsony that has been confronted by a monopoly
...
The employer (monopsonist)
will equate MRC with demand and attempt to pay a wage associated with that point on
the supply curve
...
The
situation shown in this graph shows that the competitive wage is just about half-way
between what the union and what the employer would impose
...
The
theory is that if the union and employer have equal bargaining power, the results of their
collective bargaining should approximate the competitive labor market solution and
restore allocative efficiency in these markets
...
In fact, marginal analysis has
210

not yet evolved to such an extent that it can successfully explain collective bargaining
results
...

The following box provides the language of Section 7 of the National Labor
Relations Act, which is commonly called the Employee Bill of Rights
...
449 (1935) as amended
Employees shall have the right to self-organization, to form, join or assist labor
organizations, to bargain collectively through representatives of their own choosing,
and to engage in other concerted activities for the purpose of collective bargaining or
other mutual aid or protection, and shall also have the right to refrain from any or all
such activities except to the extent that such right may be affected by an agreement
requiring membership in a labor organization as a condition of employment as
authorized in section 8(a) (3)
...
Up to 1932 the U
...
government actively persecuted unions and
their members
...
S
...
This British common law doctrine was applied to unions until
1842, when three things happened
...
Second, in the United States a judicial decision
made it difficult to apply the doctrine to unions
...
Hunt (Mass
...
Crt
...
He reasoned that if unionists were to be convicted of a criminal
conspiracy there would be evidence required to prove that the purposes of the union
were to violate some established criminal proscription
...
The use of an injunction prevented, rather
than prosecuted unions after they were already established and operating
...

Injunctions are court orders that require someone to do something or to refrain
from doing something
...
The violation of an injunction is punishable as
contempt of court
...
Because jurists came from the propertied class they often permitted their
biases to interfere in the proper exercise of their obligations
...
Frequently, unions and their representatives were not
given an opportunity to even be present in court when the petition for the injunction was
first heard (a temporary restraining order) and the restraining order was converted to a
permanent injunction without a hearing
...
The "Yellow-dog"
contract was an instrument where an employee agreed that they would neither join nor
associate themselves with unions (and if they did they by so doing resigned their
position with the company)
...
The Congress finally banded the
use of labor injunctions and made "Yellow-dog" contracts unenforceable in 1932 with
the passage of the Norris-LaGuardia Act
...
The Sherman Act was passed in 1890 to break the power
of these giant businesses or trusts
...
e
...
However, these anti-trust laws were
routinely used against organized labor to prevent or punish labor unions
...
Again, the
courts ignored the law, and finally in 1932 these issues were not made subject to
judicial inquiry, unless a product market was effected or there was clear evidence of
union misconduct
...
The first law passed was
the Norris-LaGuardia Act and President Hoover (a conservative Republican) signed it
into law
...

The inequality of bargaining power between employees who do not possess
full freedom of association or actual liberty of contract, and employers who are
organized in the corporate or other forms of ownership association substantially
burdens and affects the flow of commerce, and tends to aggravate recurrent
business depressions, by depressing wage rates and the purchasing power of wage
earners in industry and by preventing the stabilization of competitive wage rates and
working conditions within and between industries
...
1932-1935 was the only period in U
...
history that the government was
neutral towards unions
...
L
...
A
...
The N
...
R
...
was amended
several times
...
Until 1981, the federal
government fostered peaceful labor-management relations and enforced the provisions
of the N
...
R
...
in a more or less neutral way
...

The purposes of the N
...
R
...
was to foster peaceful labor-management relations
and to maintain a reasonable balance between the power of unions and management
so that society benefits
...
S
...
This is called the pendulum theory, Democrats seem to support
collective bargaining and pro-worker legislation, Republicans seem to support
management and government non-involvement (and there are notably exceptions to
political party or individual candidate association with one side or the other)
...
The theory behind the N
...
R
...

213

was to permit free and equal negotiations to solve the monopsony problem in the
nation's labor markets
...

Of the world's industrialized nations, the United States has among the most
peaceful labor relations
...
Even Germany
and Japan generally experience more lost time due to strikes than does the United
States
...
This situation seems
to be worsening over time
...

204-06) the standard of living in the United States has steadily fallen since 1980
...
As of the summer of 1995 the purchasing power of American family's
dollars had dropped out of the top ten among the world's industrialized nations (this is
strikingly similar to the 1920s)
...

After a series of Federal Executive Orders extending collective bargaining rights to
employees and the Postal Reorganization Act extending the N
...
R
...
to postal
employees, the Congress passed the Civil Service Reform Act of 1974 which extending
bargaining right by statute
...

State and local employee bargaining rights have some piece-meal
...
Only the old
Confederate, and some poor western states, and Indiana do not have such statutes to
protect these bargaining rights
...
Market wage differentials arise from several other sources, including, (1)
the variations in geographic immobility within segments of the U
...
labor force,
...
S
...

The abilities, skills, and characteristics of workers that add to their productivity is
called human capital
...
Education, training, and the acquisition of skills are human capital that is
either developed or obtained
...

There are significant wage differentials to be observed by sector of the economy
...
Consider the following table:

Weekly Earnings - Bureau of Labor Statistics (in current dollars)
Year

U
...
Economy

1999
2000
2001
2002
2003(est)

456
...
72
489
...
13
513
...
63
597
...
58
625
...
66

672
...
68
720
...
16
751
...
61
273
...
35
297
...
44

The average weekly hours in the U
...
economy for calendar year 2002 was just
over 34 hours per week
...


KEY CONCEPTS
Nominal v
...
Do these distinctions have any
bearing on motivation? Explain
...


Develop the two models of unions in otherwise competitive labor markets
...


Outline and explain the theory of human capital and how it relates to labor earnings
...

B
...

D
...

B
...

D
...
{TRUE}
Human capital is concerned with the characteristics of labor that contribute to its
productivity
...

However, the subject matter has been primarily focused on ideas that are, in the main,
at least vaguely familiar
...
A stroll through almost
any retail establishment will also make clear that the U
...
economy is rapidly becoming
very internationalized
...


Outsourcing

There are several issues involved in the outsourcing of production in the U
...

economy
...
This has
two significant implications
...
Normally, when something is outsourced it is a method used to cut labor costs
...
This action was taken to cut costs, but that same cost cutting
has implications for consumer incomes
...
In the principles of macroeconomics,
you will study something called Say=s Law
...
When outsourcing results in the loss of
income to workers, they consume less, in turn, reducing other people=s income, which
has the effect of further depressing incomes, and hence demand
...
What may be a good idea in terms of technical
efficiency may actually harm allocative efficiency and / or full employment
...
However, economists
assume that rationality is a function of demonstrable self-interest
...
The acceleration of corporate scandals through the early
part of this century seems to suggest a disregard for issues other than material wellbeing by many people who were in positions of authority in several major companies
(Enron, Worldcom, Tyco etc
...

Ethics and morality are self-imposed (or societal) constraints without the binding
authority of law
...
However, the proper thing is too often less binding than what is the most personally
profitable
...
CEOs stealing from the companies they direct are clearly wrong, but there
are also many shades of gray
...

Clarence Updegraff (Arbitration and Labor Relations, Washington, D
...
: Bureau
of National Affairs, Inc
...
In the Roman law, these
social controls were designated as fas, boni mores, and lex
...
In all
legal systems that truly develop to maturity it comes to be the dominate
factor, but fas, the ethical or religious teaching, and boni mores, public
opinion (or literally good morals) always remain important factors
...
At any rate, it dominates his
technique of decision
...
However, look around you
and see how economic self-interest is the dominate factor in ruling a person=s conduct
...
Personal embarrassment may restrain greed, but the probability
of being caught, and doing jail time is a far greater restrain on unbridled greed for most
people
...
Microeconomics provides decisional tools in
making efficient decisions
...
As a scientific approach to resource allocation, economics has
much to offer, but as a philosophy of what is right, moral, or decent, it falls far short
...
The United States is part of a global economic system,
and there is much that can be gained or lost by how we conduct our role on the world
economic stage
...
Egypt, Greece, Rome, Persia, the Mongol Empire, and the British Empire
all rose and most had economic sources of their failing
...
Technological
innovation, natural resources, and human capital can provide significant comparative
advantages in the production of commodities for trade internationally
...
S
...

As cultural barriers to economic activity, tolerance and understanding become
evident; Americans will have to learn what values dominate in other cultures, and what
constraints exist
...
With the advances in communications,
transportation, and the increased demands on natural resources, it is clear this
economy will become increasingly internationalized
...

The work-world in the future of most college students today is far different from
what confronted their parents
...

Greater understanding of the world=s religion, ethnic diversity, and cultural backgrounds
will be absolutely essential if one never leaves the State of Indiana
...
Because of this country=s inability to be independent
and self-sufficient in energy, this critical area of the world will continue to be very
important to our economic well-being
...
The love that most people had for the United States, outside of this
220

country has been seriously mitigated over the past couple decades
...
The great generosity (i
...
, Peace
Corps, the Marshall Plan etc
...
It will be a
challenge to regain this sort of love and respect from countries that are now mistrustful
...
S
...
The deindustrialization of the U
...
economy portends potentially hard economic times
...
Education, investment, and determination will undoubtedly make our future
bright, but there is competition, and we must not become complacent
...
One of the hallmarks of sound economic reasoning is marginal analysis
...
It is hoped that this course
will help make you think more like an economist, and act more rationally in your
decision-making
...
A solid foundation microeconomics is going to make
marketing, production management, and finance far easier to master and apply
...
Therefore,
microeconomics will follow throughout your academic career if you are a business major
and throughout your real world career if you make decisions
...


Sample Midterm Examination

2
...

Multiple Choice (4 points each):
1
...

B
...

D
...
Which of the following terms means "all other things equal"?
A
...

C
...


Post Hoc, Ergo Propter Hoc
Fallacy of Composition
Ceteris Paribus
None of the above

3
...

B
...

D
...
A small developing country in Central America has an economy that exhibits the
following characteristics: (1) exchange occurs through markets, (2) private
property is permitted, but there is also a large public sector, (3) what will be
produced is decided by the government and the operation of markets, and (4)
there is also a strong social desire to maintain the status quo
...

B
...

D
...
If Kansas can produce either 400 tons of wheat or 100 tons of corn and
Nebraska can produce 300 tons of corn or 200 tons of wheat then it makes
sense for the two states to specialize and trade
...
Kansas will produce 0 wheat and 100 tons of corn, Nebraska will produce
300 tons of wheat and 0 corn, the terms of trade will be between 1
...

B
...

C
...

D
...

6
...

B
...

D
...
If there were a decrease in demand and a decrease in supply, what would we
expect to observe in a purely competitive market?
A
...

C
...


price will increase, quantity exchanged is indeterminate
price will decrease, quantity exchanged is indeterminate
price is indeterminate, and quantity exchanged will increase
price is indeterminate, and quantity exchanged will decrease

8
...
However, it has been discovered that corn oil is far better in keeping
cholesterol within acceptable limits than was once believed
...

B
...

D
...
If the supply curve shifts left and there is also an increase in demand what
happens to equilibrium price and quantity?
A
...

C
...


Price increases, quantity is indeterminate
Price decreases, quantity is indeterminate
Price is indeterminate, quantity increases
Price is indeterminate, quantity decreases

10
...
No country can yet produce enough to satisfy completely everybody's
wants for everything
B
...
Even in the richest country some people go hungry
D
...
A city government regulates taxi fares
...
At
one time vacant taxis were scarce and hard to find; but when the city increased
the allowable fares 25 percent, vacant taxis suddenly became plentiful
...

B
...

D
...
"The compact disk player has literally revolutionized the recording industry with
its state-of-the-art sound, clarity, durability, and the fact that it costs less than
cassette tape players
...

B
...

D
...
Which of the following is a function of money?
A
...

C
...


Investment
Store of value
Bartering for goods
All of the above are functions of money

14
...

B
...

D
...
Which of the following describes the utility maximization rule? (where MU is
marginal utility and P is price)
A
...

C
...


MUa/Pa = MUb/Pb =
...
= MUz
None of the above describe the rule

16
...
Over the
past three months, while the $500 fare has been in effect each of the two daily
flights have averaged 10 passengers
...
What is the coefficient of price
elasticity?
A
...

C
...


0
...
00
1
...
33

17
...

B
...

D
...
Where is the range of unit elasticity for the following demand curve?
Price Quantity
8
7
6
5
4
3
A
...

C
...


3
4
5
6
7
8

From price 8 to price 6
From price 6 to price 5
From price 5 to price 3
From price 7 to price 5

19
...

B
...

D
...
The price of Pepsi decreased from
...
40 and the quantity demanded
increased from 100 million to 150 million
...

B
...

D
...
A laissez faire economy will always result in economic efficiency
...
Business sell to households in the resource markets, but households sell to
businesses in the product markets
...
If the prices of Fords decrease, we should expect the demand for Chevrolet to
227

decrease, ceteris paribus
...
If the price of MacDonald's Cheeseburgers increases, we would expect the
demand for Coca-Cola to decrease, ceteris paribus
...
Correlation can only test whether two variables are statistically associated, it
cannot test for causation
...
The circular flow diagram illustrates that there is interdependence in modern
industrialized economic systems
...
Giffin's paradox states that a demand curve can only be downward sloping if
consumers have a limited income
...
An increase in the quantity demanded of a good can occur because consumers
expect the price of that good to increase in the near future
...
A price ceiling imposed above the competitive equilibrium will result in a
shortage
...
The demand curve slopes downward because of the income and substitution
effects
...
The United States is the example of a laissez faire, capitalist economy
...
Microeconomics is concerned with decision-making within the firm, household or
on the individual level, but macroeconomics is concerned with the behavior of the
entire economic system
...
Economic goals are complementary with one another, but may be conflicting with
other social goals
...
The quantity supplied of a commodity will increase if we increase an ad valorem
tax on the commodity
...
A price floor established above a competitive equilibrium will cause a surplus
...
The income effect results from consumers having more resources available to
purchase everything, if the price of one good decreases
...
The maximum point (where it is goes flat or from increasing to decreasing) in the
total revenue curve is associated with the unitary range in the demand curve
...
The price elasticity of demand is the slope of the demand curve
...
The law of diminishing marginal utility states that some consumers experience
less utility from the consumption of a commodity than do other consumers
...
When total revenue and price move in the same direction, demand is price
inelastic; when they move in opposite directions demand is price elastic
...
B
2
...
B
4
...
C
6
...
D
8
...
A
10 A

1
...
F
3
...
T
5
...
T
7
...
F
9
...
A
12
...
B
14
...
A
16
...
A
18
...
D
20
...
F
12
...
F
14
...
T
16
...
T
18
...
F
20
...
In a purely competitive market, the firm will take the price established in the
industry
...
The firm makes this decision based on which of the following
criteria?
A
...

C
...


Where average total cost is equal to average revenue
Where the marginal cost is equal to marginal revenue
Where the industry supply curve is equal to the demand curve
The firm cannot "decide" where to produce, this is imposed by the industry
equilibrium

2
...
For all output where marginal cost exceeds minimum average variable
cost
B
...
For all output where marginal cost exceeds minimum average fixed cost
D
...
A newspaper reports, "COFFEE GROWERS' MONOPOLY BROKEN INTO
SEVERAL COMPETING FIRMS
...

B
...

D
...
To regulate a monopolist at the social optimum implies:
A
...

C
...


We risk forcing the monopolist to make a loss
We will approximate a purely competitive market solution
The point where the social optimum is obtained is where P = D = MC
All of the above are true

230

5
...

B
...

D
...
Which of the following is the decision rule to determine the optimal combination
of productive factors?
A
...

C
...


MRP /MRC = MRP /MRC =
...
= MRP /MRC = 1
MRP = MRP =
...
= MRP = 1
labor

labor

capital

capital

land

land

labor

labor

capital

capital

land

land

labor

capital

land

labor

capital

land

7
...

B
...

D
...
The demand for capital for a firm that can easily automate its production
operations (all other things equal) can be characterized as:
A
...

C
...


Price elastic
Price inelastic
Demand is increasing
Demand is decreasing

9
...
If we assume a monopsony in the labor market, then there are likely no
employment effects of the minimum wage as long as it's imposed below
the monopsonist=s desired wage rate
...
If it is imposed above the competitive equilibrium, there will be
unemployment as a result of the minimum wage
...
If it is imposed below the competitive equilibrium, it will not be a binding
constraint on the market
...
All of the above are true
...
A monopsonist in an otherwise competitive labor market will cause (as compared
with the competitive labor market):
A
...

C
...


Employment to increase, wages to decrease
Employment to decrease, wages to decrease
Employment to increase, wages to increase
Employment to decrease, wages to increase

11
...
Changes supply by manipulation of apprentice programs
B
...
Organizes only one skill group of employees and was associated with the
AFL
D
...
In a small Ohio community, we have only five employers who pay wages within a
narrow range that is basically acceptable to each of the employers
...
The effects of this unionization in the small
community was:
A
...

C
...


A higher wage, but with increased employment
A higher wage, but with decreased employment
The wage didn't change, but there was increased employment
We simply do not know because the underlying economic model is
indeterminant

13
...
If we were to regulate
the monopolist at competitive equilibrium we have regulated the monopolist at:
A
...
At where marginal cost is equal to average revenue
C
...
All of the above are true
14
...

B
...

D
...
Because of the underlying assumptions of the purely competitive model, all of the
following are true, but one, which of the following is not true of competition?
A
...

C
...


Economic profits are a signal for new firms to enter the market
Purely competitive industries are economically efficient
Competitive firms= are guaranteed a profit at where MC=MR
All of the above are true

16
...

B
...

D
...
What are the causes of economies of scale?
A
...

C
...


Ability to use by-products
Ability to use specialized management
Use of specialized capital goods in production
All of the above

18
...
The costs that are associated with factors of production that can be varied
in the short-rum
B
...
Any and all costs to the firm that are termed accounting costs
D
...
Which of the following is true?
A
...

C
...


TC - MC = VC
AVC + TC = FC
AFC + AVC = ATC
MC + MR = profits

20
...

B
...

D
...
Other things equal, a monopolist will produce less, at a higher price than a
competitive firm will
...
Oligopoly is an industry with a large number of suppliers, but few buyers
...
Society would be unequivocally better off without monopolists
...
X-inefficiency occurs when a firm's actual costs of producing any output are
greater than the minimum possible costs
...
Price discrimination occurs when a firm can segment the market and charge
different prices, which do not necessarily reflect the costs of production
...
The MRP slopes downward in an imperfectly competitive (resource) market
serving an imperfectly competitive product market because the MP diminishes
and the price of the output must be lowered to sell more
...
The demand for a factor of production in a competitive factor market is the MRP
schedule for that factor, and this is why we refer to the demand as being a
derived demand
...
Human capital is concerned with the characteristics of labor that contribute to its
productivity
...
Labor offers its services for the nominal wage and the determinants of demand
for labor are basically utility maximizing decisions within the household
...
The marginal revenue curve in a monopoly model has exactly half the slope as
the demand curve
...
The supply curve in a monopoly is the marginal cost curve above average fixed
costs
...
The lower the value of the commodity produced, the lower the wage earned by
labor, ceteris paribus
...
In a purely competitive industry, supply is the summation of all the firms= marginal
cost curves above average variable cost
...
The shut down point is where the firm cannot cover its fixed costs of operation
...
A firm in pure competition has a horizontal demand curve, which is also equal to
the marginal revenue, and average revenue curves
...
Long run average total cost curve is also referred to commonly as a planning
horizon
...
An economic profit cannot be maintained in the long run in monopoly, but can be
in pure competition
...
In the market period, all costs are variable, in the short-run there are both fixed
and variable costs and in the long run all costs are fixed
...
The cost structure of the firm is unrelated to the theory of production in pure
competition
...
The average fixed cost increases as the marginal cost curve is above it
...
B
2
...
B
4
...
C
6
...
C
8
...
D
10 B

1
...
F
3
...
F
5
...
T
7
...
T
9
...
D
12
...
D
14
...
C
16
...
A
18
...
C
20
...
F
12
...
T
14
...
T
16
...
F
18
...
F
20
...
Chicago: University
of Chicago Press, 1993
Friedman, Milton, Essays in Positive Economics
...
*
Friedman, Milton and Rose D
...
Chicago: University
of Chicago Press, 1972
...
New York: Houghton - Mifflin,
Company, 1997
...
, The Worldly Philosophers, seventh edition
...
*
Higham, Charles, Trading with the Enemy: The Nazi-American Money Plot - 1933-1949
...

Hilgert, Raymond L
...
Dilts, Cases in Collective Bargaining and Industrial
Relations, tenth edition
...

Manchester, William, The Arms of Krupp: 1587-1968
...
*
Marx, Karl, Das Kapital, New York: International Publishers, Incorporated, 1982
...
and Stanley Brue, Principles of Economics, sixteenth edition,
New York: McGraw-Hill / Irwin, 2004
...
Economic Growth in the United States: 1790-1860
...
, 2003
...
Dilts, Doing
Business in Indebted Less Developed Countries
...


237

Schumpeter, Joseph A
...
New York: Porcupine Press, Incorporated,
1982
...
and Fred Witney, Labor Relations, eleventh edition
...
J
...

Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nations
...
Knopf, Inc
...
*
Steinbeck, John, Grapes of Wrath
...
*
Stiglitz, Joseph E
...
New York: W
...
Norton &
Company, 2003
...
New York: Penguin Books, Inc
...
*
Thurow, Lester, Head to Head New York: Warner Books, Inc
...

Terkel, Studs, Working
...
*
Tuchman, Barbara, A Distant Mirror: The Calamitous Fourteenth Century
...
*
Veblen, Thorstein, The Theory of the Leisure Class, New York: Penguin Books, 1967
(first published 1899)

* denotes classic, must read sometime while you are still in school

238



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