Economics Final Exam

III. Bonds

A bond is an IOU, or promise to pay.

B. Changes in the Equilibrium Exchange Rate

A change in the demand for pesos, the supply of pesos, or both will change the equilibrium dollar price per peso; that is, the dollar-peso exchange rate. If the dollar price per peso rises, the peso is said to have appreciated and the dollar to have depreciated. A currency has appreciated in value if it takes more of a foreign currency to buy it than before. A currency has depreciated in value if it takes less of a foreign currency to buy it than before.

B. A Common Misconception About How Much We Can Consume

A country cannot consume beyond its PPF unless it specializes and trades with other countries.

A. Fixed Exchange Rates and Overvalued/Undervalued Currency

A currency is overvalued if its price is above its equilibrium level, and is undervalued if its price is below its equilibrium level. If the dollar price of pesos, for instance, is above its equilibrium level, the peso is overvalued and the dollar is undervalued.

F. Beyond Internalizing: Setting Regulations

A final way to deal with externalities, particularly negative externalities, is for government to apply regulations directly to the activity that generates the externality. For instance, if steel mills emit air pollutants through their smokestacks, the government may regulate smokestack emissions. Critics of the regulatory approach often complain that regulations, once instituted, are difficult to remove even if conditions warrant removal. Also, regulations are often applied across the board when circumstances dictate otherwise. Finally, regulation entails costs.

A. The Demand for a Factor

A firm hires factors of production for one specific purpose: to produce the firm's product. As a result, the firm's demand for factors is a derived demand, dependent upon the demand for the firm's product. If the demand for the product rises, the firm's demand for factors rises; if demand for the product falls, the firm's demand for factors falls.

A. Futures

A futures contract is an agreement to buy or sell a specific amount of something (commodity, currency, financial instrument) at a particular price on a stipulated future date.

1. Prediction 1:

A gift-giver will have less reason to move beyond his or her efficient number of gifts, the more persons he or she can give gifts too.

D. A Detour: The Issue of Falsifiability (Refutability)

A good theory has the virtue of falsifiability. To have the virtue of falsifiability, a theory must not only predict those things that we should observe if it is right, but it should also predict those things that we should observe if it is wrong. Scientists strive to build theories that not only are capable of telling them when they are right, but when they are wrong too.

C. Affecting the Supply of Union Labor

A labor union looks for ways to decrease the supply of union labor. Such an approach focuses on the use of union membership as a condition of hiring and/or continued employment. In the past, craft unions, in particular, were successful at turning many businesses into closed shops, where all employees had to belong to the union. Although the Taft-Hartley Act prohibited union membership as a pre-condition to hiring, union shops still exist. In a union shop, individuals do not have to join the union before being hired, but are required to join within a certain period of time in order to stay on the job. Today unions argue for union shops and for the repeal of legislation barring closed shops. They also argue against right-to-work laws, which make even union shops illegal in the states that have passed such laws.

B. Affecting the Demand for Union Labor

A labor union looks for ways to increase the demand for union labor. All other things held constant, this will improve wages and union employment. To boost demand, unions pursue the following:

A. Affecting Elasticity of Demand for Union Labor

A labor union looks for ways to lower the elasticity of demand for its labor. It does this mainly by attempting to reduce the availability of substitutes (both substitutes for the products its members produce and substitutes for the members themselves).

B. The Theory

A monetary gift or an in-kind gift will end up going for whatever is next on the recipient's list to purchase.

1. Prediction 1:

A mother will give more gifts of money and in-kind to the child whose next-on-the-list is more acceptable to her.

E. Nonrecourse Commodity Loans

A nonrecourse commodity loan is a particular type of price support. Granting these loans is the major way the government supports crop prices. A farmer pledges a quantity of a commodity to obtain a nonrecourse loan. The farmer can either repay the loan with interest or keep the loan and forfeit his crop. In this way, the farmer has been guaranteed a minimum price for his crop.

F. Do People Overestimate their Worth to others, are they Simply Seeking Economic Rent?

A person who may appear to others to be overestimating his worth may be attempting to obtain economic rent.

E. Divisive Society: A NonExcludable Public Bad

A possible unintended effect of the focus on transfer issues is that individuals begin to see their government as more heavily involved in taking sides than in serving the common interest. This perception creates a divisive society, which is a non-excludable public bad.

A. Goods

A private good is rivalrous in consumption, that is, consumption by one person reduces the consumption for another person. A public good is nonrivalrous in consumption, that is, consumption by one person does not reduce the consumption by another person. A public good is excludable if it is possible, or not prohibitively costly, to exclude someone from obtaining the benefits of the good after it has been produced. A public good is nonexcludable if it is impossible, or prohibitively costly, to exclude someone from obtaining the benefits of the good after it has been produced. National defense, flood control, or large-scale pest control are examples of nonexcludable public goods.

2. Quotas

A quota is a legal limit on the amount of a good that may be imported. A quota, like a tariff, raises the price paid by domestic consumers. The effects of a quota are a decrease in consumers' surplus, an increase in producers' surplus, and an increase in total revenue for the importers who sell the allowed number of imported units. A quota results in a net loss since the loss to consumers is greater than the gain to producers plus importers.

B. Maximizing the Total Wage Bill

A second possible objective is to maximize the total earnings of union members. In order to do this, the union would seek wage rate W2 in Exhibit 1 in the text.

2. Profit and Arbitrage Opportunities

A second theory holds that profit is the return for alertness to arbitrage opportunities. The way to make a profit, so it goes, is to "buy low and sell high." In the case of productive endeavors, we can interpret this as buying inputs at the lowest possible costs, combining those factors to make a product, and then selling that product at the highest price possible. If doing this results in profit, we would say it was a result of being alert to an arbitrage opportunity

A. The Case of Monopsony

A single buyer in a factor market is known as a monopsonist. Because the monopsonist is the sole buyer of labor—and, therefore, faces the market supply curve for the factor—it cannot hire additional units of labor without increasing the wage it pays. For the monopsonist, marginal factor cost (MFC) increases as it buys additional units of labor. More specifically, MFC rises faster than the wage rate—that is, the MFC curve lies above the supply curve. Suppose that the labor supply is not organized. As Exhibit 4(b) shows, the monopsonist will hire the quantity of labor such that MFC = MRP and pay the corresponding wage rate, but since MFC > W, the firm's MRP of labor will be greater than W. Now suppose that the labor supply was organized and represented by a union. In this case, the union would present the monopsonist with a labor supply curve like that depicted in Exhibit 4(c). Here MFC = W over much of the supply curve. Successful collective bargaining would force the firm to pay W2 for labor rather than W1. Both the wage rate and the number of workers working have increased. Real-world examples of monopsony are rare. The best example is the "company town" in which one firm hires a large proportion of the labor within that town.

E. Another Detour: After You Have One Theory That Explains and Predicts, Search for Another

A single-cause theory that predicts well (accurately) does not necessarily rule out other possible causes of the phenomenon at hand. Specifically, the lesson for the theory builder is that after you have developed one theory to explain something (segregated neighborhoods, dating relationships, ethical codes, inflation or unemployment), try to build another theory to explain the exact same thing.

2. Prediction 2:

A smaller percentage of students wear baseball caps when a lecture is being given than when an exam is being taken.

1. Prediction 1:

A smaller percentage of students wear baseball caps when they are taking an essay exam than when taking a multiple choice exam.

II. Stocks

A stock is a claim on the assets of a corporation that gives the purchaser a share in the corporation.

C. Target Prices and Deficiency Payments

A target price is a guaranteed price; if the market price is below the target price, the farmer receives a deficiency payment equal to the difference between the market price and the target price. Consumers do not necessarily pay the target price and there is no surplus for the government to purchase and store. Under the target price system, consumers get a lot of cheap crop for which taxpayers pay.

1. Tariffs

A tariff is a tax on imports. A tariff raises the price of the imported good to the domestic consumer. The effects of a tariff are a decrease in consumers' surplus, an increase in producers' surplus, and tariff revenue for government. A tariff results in a net loss since the loss to consumers is greater than the gain to producers plus the gain to government.

C. Maximizing Income for a Limited Number of Union Members

A third possible objective is to maximize the income of a limited number of members, which is brought about by seeking the maximum wage rate at which that group can be employed, given demand conditions in the labor market. In Exhibit 1 in the text, the union would maximize the wage rate for this group by seeking W3.

3. Profit and Innovation

A third theory holds that profit is the return to the entrepreneur as innovator: the person who creates new profit opportunities by devising a new product, production process, or marketing strategy.

D. Wage-Employment Trade-Off

A union can get higher wages at the cost of some members losing their jobs. The trade-off depends on the elasticity of labor demand.

A. Moving Toward the Middle: The Median Voter Model

According to the median voter model, a candidate for office, when faced with a distribution of voters that is largely made up of people "in the middle," tends to modify her positions and/or rhetoric in an attempt to appear closer to the middle of the political spectrum in an attempt to win votes. Since all candidates attempt this, they all tend to look "too similar" to voters.

D. Three Categories of Activities

Activities may be categorized according to whether negative or positive externalities exist, as follows: 1. If MEC and MEB both =0, there are no externalities. 2. If MEC > 0 and MEB = 0, then MSC > MPC and MSB = MPB, and a negative externality exists. 3. If MEB > 0 and MEC = 0, then MSB > MPB and MSC = MPC, and a positive externality exists.

2. The Case for Flexible Exchange Rates

Advocates of flexible exchange rates maintain that it is better for a nation to adopt policies to meet domestic economic goals than to sacrifice domestic economic goals to maintain an exchange rate. They also argue that there is too great a chance that a fixed exchange rate will diverge greatly from the equilibrium exchange rate, creating persistent balance of trade problems.

Chapter 24

Agriculture: Problems, Policies, and Unintended Effects

G. Uncertainty and the Entrepreneur

All entrepreneurs do something in the present that they hope will turn out well for them in the future. But no one knows exactly what the future will hold. It follows then that all entrepreneurs bear some degree of uncertainty.

3. Cost of Making the Loan

All loans have processing costs associated with them due to obtaining credit histories, collecting payments, keeping records, etc. The more it costs to process and administer a loan, the higher the interest rate; the lower the cost of making the loan, the lower the interest rate.

A. Price Supports

An agricultural price support is an example of a price floor. It is a government guaranteed minimum price. The effects of agricultural price supports are a surplus, fewer exchanges, higher prices paid by consumer, and government purchase and storage of the surplus (for which taxpayers pay). A benefit to farmers is that it puts a floor on their income

III. Internalizing Externalities

An externality is internalized if the parties that generate the externalities incorporate the external costs and/or benefits of their actions into their own private cost-benefit calculations. This can be achieved by several means.

B. Optimal Currency Areas

An optimal currency area is a geographic region in which exchange rates can be fixed or a common currency used without sacrificing domestic economic goals.

B. Options

An option is a contract that gives the owner of the option the right, but not the obligation, to buy or sell shares of a stock at a specified price on or before a specified date. There are two types of options: calls and puts.

2. Protectionist Trade Policy (Quotas and Tariffs)

An overvalued currency can bring on or widen a trade deficit. Quotas and tariffs can be used to reduce domestic consumption of foreign goods, shrinking the trade deficit and reducing the demand for foreign currencies, thereby getting rid of the overvaluation.

3. Changes in Monetary Policy

An overvalued currency, as stated above, can bring on or widen a trade deficit. Monetary policy can be used to reduce this trade deficit and to reduce the overvaluation. Tight monetary policy by the Fed will reduce the U.S. rate of inflation and thereby lower U.S. prices relative to prices in other nations, causing net exports to rise. In addition, the resulting higher U.S. interest rates will encourage foreign investment fund inflows into the U.S.

B. What Is So Bad about an Overvalued Dollar?

An overvalued dollar makes American goods more expensive for foreigners, which in turn can affect the U.S. merchandise trade balance. An overvalued dollar can lead to fewer exports and a trade deficit.

1. Risk

Any time a lender makes a loan, there is a possibility the borrower will not repay it. As a rule, the greater the risk associated with a loan, the higher the interest rate; the lower the risk, the lower the interest rate.

A. The Question

Are criminals rational? Does their behavior respond to changes in costs and benefits?

IX. Observation/Thought 7:

Are people better off with or without health care vouchers?

C. Nonexcludable Public Goods

As also explained in an earlier chapter, individuals may want goods that the market cannot produce due to the free rider problem. The government can overcome the free rider problem by forcing people to pay for the non-excludable public good. The government can tax individuals and then use the tax money either to produce the good or to pay a private company to produce it.

B. Externalities

As explained in an earlier chapter, government can use taxes and subsidies to turn an inefficient outcome into an efficient one. With respect to a negative externality, it needs to create a tax equal to the marginal external cost. With a positive externality, it needs to create a subsidy equal to the marginal external benefit.

H. Why do Wage Rates Differ?

Assume the following conditions hold: (1) The demand for every type of labor is the same; (2) There are no special nonpecuniary aspects to any job; (3) All labor is ultimately homogeneous and can be costlessly trained (and retrained) for different types of unemployment; and (4) All labor is mobile at zero cost. In such a world, there would be no long-run difference in wage rates between labor markets. However, in the real world, none of these assumptions hold universally.

A. The Equilibrium Exchange Rate

Assuming fully flexible exchange rates, the equilibrium exchange rate between the dollar and the peso (or between any two currencies, for that matter) is determined by the equilibrium of the supply of and demand for pesos (in the dollar-peso market) in relation to the dollar. At the equilibrium exchange rate, the quantity supplied of pesos exactly equals the quantity demanded of pesos—there are no shortages or surpluses.

VI. Asymmetric Information

Asymmetric information can lead to market failure. It arises when one party to a transaction has information that the other does not. Asymmetric information can affect either the buyer or the seller and therefore either the demand (product market) or the supply (factor market) curve. The amount of the good sold and the equilibrium price will be different than in the case of symmetric information.

2. Candidates will call themselves middle-of-the-roaders, not right- or left-wingers

At the same time, the rational campaigner will label herself as a "moderate," who is on the side of, and in agreement with, the average voter.

5. Luck

At times good and bad luck (unexplainable consequences) influence income; luck isn't likely to have as much long-term impact, on average, as the other factors discussed here, however.

D. The Case for Smaller or Larger Government

Based on the above three factors, the case for government requires specific conditions to be satisfied. Not all economists accept this case for government. Some would argue that the optimum size of government is smaller than what would grow out of having to deal with the three problems. Others would argue that the government has an important role to play in other areas, such as income distribution, etc. The objective of this chapter, however, is not to identify the optimum size and scope of government, but rather to introduce some of the arguments for the government's role in, and effects on markets and the economy.

C. Economic Growth Versus Transfers

Because it takes enormous growth in the size of the economic pie before a special interest group would be indifferent between lobbying for a growth policy and a transfer policy, and because expecting this kind of growth is unrealistic, special interest groups will almost always prefer to lobby for transfer policies rather than economic growth policies. In fact, they are likely to push for policies that benefit themselves even if it means that the economy will shrink.

4. Similarities and Differences Between Emission Taxes and Tradable Pollution Permits

Both emission taxes and tradable pollution permits require firms to pay to pollute. However, under an emission tax, polluters know what price they have to pay to pollute, but government doesn't know how much pollution will be generated. Under a tradable pollution permits system (cap and trade), government knows the amount of pollution, but polluters don't immediately know what the price to pollute will be.

Chapter 19

Building Theories to Explain Everyday Life: From Observation to Questions to Theories to Predictions

A. Who are the Rich and How Rich are They?

By many interpretations, the lowest fifth (lowest 20 percent) of family income groups is considered to be poor, the top fifth is considered to be rich, and the three-fifths in between are considered middle income. Exhibit 1 in the text shows the annual income shares for different quintiles of households. From Exhibit 2, which shows the income shares of family groups in 1967 and 2009, we can see that income distribution has become somewhat less equal since 1967. One difficulty with determining income share is that the Census Bureau quintiles are unequal in size because they are based on a count of households rather than persons. In the U.S. high-income households tend to be married couples with many members and earners, while low-income households tend to be single persons with little or no earnings. Another difficulty is that the persons in each fifth do not all work the same number of hours. The average working-age adult in the lowest fifth worked about half as many hours a year as the working-age adult in the highest fifth.

1. Call Option

Call options give the owner of the option the right to buy shares of a stock at a specified price (called the strike price) within the time limits of the contract

1. Method 1: Government Regulation or Command-and-Control

Command-and-control policies require the government to specify the type of pollution control technology that firms should use or set quantitative limits on pollution. Exhibit 6 in the text explores the costs of this alternative for three firms. Each firm must lower its pollution to a certain level, and the cost of reducing pollution will vary from one firm to the next. Economists, however, do not favor command-and-control policies since they reduce the incentive to discover lower cost methods of reducing pollution and also ignore the fact that it might be less costly for some firms to reduce pollution compared to others.

VI. Constitutional Economics

Constitutional economics or constitutional political economy is a branch of economics, in which economists study the type of constraints that individuals might seek to place upon themselves in order to achieve some objective that doesn't seem achievable in a non-constrainable environment. Constitutional economists argue that better outcomes are more readily forthcoming out of government by changing institutions, constraints, laws, and rules than by changing people.

2. The Demand for Loanable Funds: Consumption Loans

Consumers demand loanable funds because they have a positive rate of time preference; that is, consumers prefer to consume today, rather than wait until later. Because consumers have a positive rate of time preference, there is a demand for consumption loans. The interest payment is the price consumers pay to consume today instead of later.

C. How Countries Know When They Have a Comparative Advantage

Countries do not plan their comparative advantages and trade accordingly; rather, the market provides price incentives to entrepreneurs when their country has a comparative advantage.

A. How Countries Know What to Trade

Countries specialize in the production of the goods in which they have a comparative advantage. A country has a comparative advantage in the production of a good when it can produce the good at a lower opportunity cost than another country can. After they have specialized in the production of the goods, two countries must agree on the terms of trade. Although there are several possible answers, the terms of trade must be such that both countries benefit by the exchange. As a result of specialization and trade, both countries become better off, even if one country has an absolute advantage in the production of the goods being traded.

V. Observation/Thought 4:

Criminals are not rational

J. Why did you Choose your Major?

Demand and supply play a role in your choice. There is greater demand for accountants than for English majors, and accountants receive higher salaries, so many students will choose accounting over English.

I. International Trade Theory

Different countries have different terrains, climates, resources, skills, etc. By specializing in the production of those goods for which each country is best suited and trading for other goods, all countries may be made better off by international exchange than by attempting to be self-supporting. Major U.S. exports include automobiles, computers, aircraft, a variety of agricultural products, scientific instruments, coal, and plastic materials. Major U.S. imports include petroleum, automobiles, clothing, iron and steel, office machines, footwear, fish, coffee, and diamonds.

A. The Question

Do small town people have a somewhat different (better?) ethical code than big city people?

III. Profit

Economic profits are the difference between total revenue and total costs, where total costs include both explicit and implicit costs.

II. Rent

Economic rent is a payment in excess of opportunity costs. Pure economic rent is a payment in excess of opportunity costs when opportunity costs are zero. Historically, the term pure economic rent was first used to describe the payment to the factor land, which is perfectly inelastic in supply.

F. Entrepreneurs and No $10 Bills on the Sidewalk

Economists argue that just as you aren't likely to see any $10 bills on the sidewalk, you aren't likely to see any economic opportunities (to earn money) going unrealized. That's because if there is an economic opportunity (to earn money) available, someone is going to snatch it up quickly - just as quickly as someone who finds a $10 bill on the sidewalk will snatch it up. Entrepreneurs are the people who go around trying to figure out on which sidewalks the $10 bills might exist; they are the people who go around trying to figure out where the available economic opportunities are.

3. Education and Other Training

Education and training develop an individual's human capital—education, skills, and anything else that increases individual productivity. Individuals who invest in developing their human capital will tend to be rewarded more once they enter the labor market than others without comparable training and skills, ceteris paribus.

A. Screening Potential Employees

Employers typically do not know how productive potential employees will be until they are actually hired and incorporated into the production process. What an employer wants, but lacks, is perfect information about a potential employee's future performance so that the employer can estimate MPP and VMP in order to make a rational salary or wage offer. To try to minimize the risk of making a bad hiring decision, employers screen potential employees based upon certain criteria that they have found to be good indicators of success in the past.

G. Putting Supply and Demand Together

Equilibrium occurs at the intersection of the labor supply and labor demand curves. At the equilibrium wage rate, the quantity supplied of labor equals the quantity demanded of labor. Market forces will work to remedy a shortage of labor caused by a lower-than-equilibrium wage rate or a surplus created by a higher-than-equilibrium wage rate.

B. Rational Ignorance

Even if a person decides to vote, other costs are associated with becoming informed about the candidates and issues. To the extent that the costs of becoming informed outweigh the benefits, voters practice what is called rational ignorance, choosing not to acquire additional information.

B. Income Differences: Some Are Voluntary, Some Are Not

Even in a world of no discrimination, differences in income would still exist. Some degree of income inequality exists because people are innately different and make different choices. On the other hand, some income differences are due to factors unrelated to innate ability or choices, such as luck or discrimination. Some people argue that wage discrimination would be lessened if markets were allowed to be more competitive, more open, and freer. Individuals holding this view usually propose that government deregulate, reduce legal barriers to entry, and in general not hamper the workings of the free market mechanism. Others think the government should play an active legislative role in reducing both wage discrimination and other types of discrimination that they believe ultimately result in wage discrimination.

D. Common Misconceptions about Income Inequality

Everyone can be made better off even if the income distribution becomes more unequal. Some people don't realize that this is true.

D. A Detour: Does Evidence Prove a Theory Correct?

Evidence does not prove a theory correct. The best evidence can do is give us reason not to reject a theory.

F. Diagram of a Negative Externality

Exhibit 1 in the text shows, as a shaded triangle, the net social cost of moving from the socially optimal output to the market output when the socially optimal output is smaller than the market output.

G. Diagram of a Positive Externality

Exhibit 2 in the text shows, as a shaded triangle, the net social cost of moving from the socially optimal output to the market output when the socially optimal output is larger than the market output.

B. The Demand for and Supply of Currencies

Exhibit 2 shows the market for pesos. The quantity of pesos is on the horizontal axis, and the exchange rate—stated in terms of the dollar price per peso—is on the vertical axis. In Exhibit 2(a), the demand curve for pesos is downward sloping, indicating that as the dollar price per peso declines, the quantity demanded of pesos (by Americans) rises. The supply curve for pesos in Exhibit 2(b) is upward-sloping, indicating that as the dollar price of a peso rises - that is, as Mexicans receive more for a peso - the quantity supplied of pesos (by Mexicans) rises.

E. Externalities in Consumption and in Production

Externalities can arise from both consumption and production of something that has an external cost or benefit.

D. Voluntary Agreements

Externalities can sometimes be internalized through voluntary agreements between the creator(s) of the externality and the third party (-ies) affected by it. In order for such an agreement to be reached, however, the transactions costs associated with making the agreement must be lower than the expected benefits of the agreement.

Chapter 13

Factor Markets: With Emphasis on the Labor Market

2. Supply for Labor

Factors on the labor supply side will also cause wage differentials between labor markets. First, there is the problem of nonpecuniary aspects of a given job—some jobs are more "unpleasant" than others, and the wage paid reflects that fact. Second, labor supply reflects available skills, and some jobs require sufficient technical skills and/or training such that the supply of potential workers is limited. Third, training costs to acquire certain skills may be sufficiently high that they restrict the supply of labor. Finally, labor immobility will create wage differentials if there is a mismatch between job location and worker location.

3. Paying Farmers Not to Produce

Farmers are paid to take part of their land out of cultivation. The effects of this policy are similar to the effects of assigning acreage allotments.

D. Price Variability and Futures Contracts

Farmers can insure themselves against adverse price swings by entering into a futures contract. A futures contract passes the risk of future price fluctuations from the farmer to the speculator who sells the contract. No matter what happens to the price of the commodity between the purchase of the futures contract and the delivery date, the farmer's price is guaranteed. Although the futures contract protects the farmer against a fall in the price of wheat or some other commodity, the farmer can no longer benefit from any increase in wheat prices.

I. Financial Markets

Financial markets serve the purpose of channeling money from some people to other people.

3. The Demand for Loanable Funds: Investment Loans

Firms demand loanable funds so they can invest in capital goods and finance roundabout methods of production, where the firm first directs its efforts to produce capital goods and then uses those capital goods to produce finished goods. Because capital goods improve productivity and make finished goods production more lucrative, firms are willing to borrow the funds necessary to produce them

E. Can Bad Weather Be Good for Farmers?

For an individual farmer, concerned with total revenue in a market where market forces set price, good weather is always preferable to bad weather, for good weather will increase the farmer's production and total revenue, given the market price. For farmers as a whole, however, bad weather may be preferable to good weather, as bad weather may reduce supply sufficiently to raise price; if demand is inelastic (as we have assumed), total revenues will rise.

B. Congressional Districts as Special Interest Groups

For some issues, a particular congressional district may be a special interest group. For instance, suppose that a piece of legislation is before Congress that would significantly benefit or harm a particular congressional district. The Congressional representative from that district would have an incentive to take his constituents' opinions into account, and the voters in that district will let their voices be heard if the proposal is important enough. But there's a problem: no single member of Congress has enough power to pass or defeat legislation by herself. As a result, members of Congress must seek the support of their colleagues on legislation that is important to them and offer their own support on other legislation in return. This type of vote trading—the exchange of votes to gain support for legislation—is referred to as logrolling.

I. Agriculture: The Issues

From the perspective of some farmers, there are three issues of major concern: high productivity in the agricultural sector, income inelasticity for certain foodstuffs, and price inelasticity for certain foodstuffs. Related to these three issues is the problem of price instability in the agricultural sector.

III. Why Income Inequality Exists

Generally, income inequality exists because people do not receive the same labor income, asset income, and transfer payments; or pay the same taxes. This section discusses some of the specific reasons for income inequality by focusing on factors that often contribute to differences in labor and asset income.

1. Candidates will label their opponent as being either too far to the right or too far to the left

Given the importance of attracting the median voter, a rational campaigner will paint her opponent(s) as being "too liberal" or "too conservative" for the average voter's tastes.

B. What does the Theory Predict?

Given this process of modifying positions to try to appeal to the median voter, we see a pattern emerging that describes many U.S. election campaigns.

II. The Economic Case for Government

Government's raison d'être is that it can give individuals what they want when they don't seem capable of getting it on their own. This theme plays out in three cases: removal from the prisoner's dilemma, externalities, and nonexcludable public goods.

G. Risk and Return

Higher returns come with higher risk, and lower returns come with lower risks. Treasury bonds, for example, will often pay (relatively) low returns because they are so safe (risk-free).

C. Unions' Effects on Prices

Higher union wages mean higher production costs, which in turn mean higher prices for the products that union labor produces. Conversely, lower nonunion wages, also brought about by union activity, lower production costs for nonunion employers and thus reduce the prices of the products that nonunion labor produces.

VIII. Observation 6:

Houses in "good" school districts are often more expensive than comparable houses in "bad" school districts

3. Prediction 3:

Houses located in cities with clean air will sell for higher prices than comparable houses located in cities with dirty air.

2. Prediction 2:

Houses located in major metropolitan areas (where there are many things to do) will sell for higher prices than comparable houses in small towns.

1. Prediction 1:

Houses with ocean views will sell for higher prices than comparable houses with no view.

4. Prediction 4:

If a major professional sports team were to move to a city that previously did not have a major professional sports team, house prices in the city would rise.

3. Prediction 3:

If a person treats her coworkers poorly, the theory predicts that she treats others worse.

F. A Final Detour: Why Prediction Is So Important, Or Why Good-Sounding Stories Are Not Enough?

If a theory doesn't have any predictions, then it might be nothing more than a fictional account of what someone thinks explains something. By accepting theories simply because they confirm our beliefs, or because they sound right, or because we want them to be right, we do ourselves a disservice.

2. Prediction 2:

If each of two candidates running for office says that she will do X, Y, and Z if elected, people will be more willing to vote for the candidate they more nearly agree with in terms of what comes next.

1. A Difference in Income Growth Rates

If one nation's income grows and another's lags behind, the currency of the higher-growth-rate-country will depreciate and the currency of the lower-growth-rate country will appreciate. This is because, as national income rises, consumers in that country will tend to buy more imports, increasing the demand for foreign exchange, and causing a depreciation of their currency

2. Differences in Relative Inflation Rates

If one nation's price level rises relative to another nation's, the currency of the higher-inflation-country will depreciate and the currency of the lower-inflation-country will appreciate. For example, a relative increase in the U.S. price level will make Mexican goods relatively less expensive for Americans and American goods relatively more expensive for Mexican consumers. As a result, the American demand for Mexican goods and for Mexican pesos will increase, while the Mexican demand for U.S. goods and dollars will decline. According to the purchasing power parity (PPP) theory, changes in the relative price levels of two countries will affect exchange rates such that one unit of a nation's currency will continue to buy the same amount of foreign goods as it did before the change in the relative price levels. For instance, if the price level in the United States rose 10 percent more than in Mexico, then the value of the dollar would fall by 10 percent, relative to the peso. While this theory is not, by any means, a completely accurate reflection of the "real world," it proves to be a fairly good gauge of long-run exchange rates.

3. Changes in Real Interest Rates

If real interest rates in one nation rise relative to another nation's, the currency of the higher-real-interest-rate country will appreciate and the currency of the lower-real-interest-country will depreciate. For instance, if the real interest rate in the United States rises, foreigners will increase their demand for dollars, in order to purchase financial assets in the United States, and will therefore supply more of their own currencies. As the demand for dollars and the supply of foreign currencies rises, the exchange rate between the dollar and these currencies will change such that the dollar appreciates, while the currencies of the prospective foreign investors will depreciate (relative to the dollar).

2. Prediction 2:

If the costs of committing a crime rise, fewer crimes will be committed.

2. Increasing Substitute Factor Prices

If union action leads to a rise in the relative price of other factors, the demand for union labor will rise. In this regard, unions have often lobbied for an increase in the minimum wage—the price of unskilled (and usually nonunion) labor.

3. Increasing Marginal Physical Product

If unions can increase the productivity of their members, the demand for their labor will rise. With this in mind, unions prefer to add skilled labor to their ranks, and will often support training programs for members.

D. Economic Rent and Baseball Players: Perspective Matters

If we compare the salary of a baseball player to his potential salary as a high school coach, we get a significantly different picture of economic rent than if we compare his salary with one team to his potential salary with another team.

2. Trade and Labor Immobility

If workers cannot move and the relative demand changes between countries, then, if exchange rates are flexible, the higher demand for goods in one country will cause its exchange rates to rise, and that will moderate the impact of the demand change (its goods will be more expensive to foreigners). If exchange rates are fixed, however, they will not adjust and the change in demand can lead to permanent changes in economic activity.

3. How you can use Call and Put Options

If you think the price of a stock will rise during the next few months then you can make money by buying a call option and exercising that option when (if) the price rises. The further the price rises, the more valuable your call option becomes. If you think the price of a stock will fall during the next few months then you can make money by buying a put option and exercising that option when (if) the price falls. The further the price falls, the more valuable your put option becomes.

1. Devaluation and Revaluation

If, for instance, there is a fixed exchange rate between the peso and the U.S. dollar, and the peso is persistently overvalued, Mexico and the U.S. could agree to reset the official price of the dollar and the peso. A devaluation occurs when the official price of a currency is lowered. A revaluation occurs when the official price of a currency is raised. Net exports tend to fall for a country that revalues its currency, relative to another currency.

D. Production Flexibility Contract Payments, (Fixed) Direct Payments, and Countercyclical Payments

In 1996, the federal government instituted production flexibility contract payments, which are direct payments to farmers. In 2002, the federal government replaced production flexibility contract payments with fixed direct payments, which essentially work the same way. The payment to a farmer = contract acreage × a percentage set by the government × yield per acre × crop payment rate. Countercyclical payments are similar to production flexibility contract payments and direct payments, but they are based on the difference between an effective price and a target price.

A. A Few Facts

In 2000, there were 2.1 million farms in the United States, with an average farm size of 441 acres. Only 1 percent of the total population worked on farms in 2000. In 2010, agriculture accounted for 1.8 percent of the GDP. Each of these numbers is smaller than in 1930. Agriculture productivity has increased more rapidly in the United States than has nonagriculture productivity, pushing the supply curve of farm products rightward and leading to more food available at lower prices.

II. Flexible Exchange Rates

In a flexible exchange rate system, exchange rates are determined in the foreign exchange market by the forces of supply and demand.

A. David Ricardo, the Price of Grain, and Land Rent

In nineteenth-century England, prevailing wisdom argued that grain prices were rising because land rents were rising. David Ricardo thought that the prevailing wisdom had things backward: he argued that land prices were high because grain prices were high, creating more derived demand for land.

B. Consumers' and Producers' Surplus

In order to understand the effects of trade and trade restrictions on consumers and producers, we should first understand the concepts of consumers' and producers' surplus. Consumers' surplus is the difference between the actual price buyers pay for a good and the maximum price they are willing and able to pay for it. It is a dollar measure of the benefit gained by being able to purchase a unit of a good for less than one is willing to pay for it. Producers' surplus is the difference between the price sellers receive for a good and the minimum price for which they would be willing and able to sell the good. It is a dollar measure of the benefit gained by being able to sell a unit of output for more than one is (minimally) willing to sell it.

C. Why Do Interest Rates Differ?

In reality, there are many interest rates, because of differences in risk, the length of the loan, and loan processing costs.

D. Adverse Selection

In the case of adverse selection, asymmetric information exists prior to an exchange. Adverse selection exists when parties on one side of a transaction have information that leads them to self-select in or out of a market in a way that adversely affects the parties on the other side of the market. Used car buyers may face adverse selection since better used cars are less likely to be offered for sale at good prices, while "lemons" will be plentiful in the market. Theoretically, the adverse selection problem could lead to the total elimination of the market. Several possible solutions for adverse selection are discussed, including government action.

E. Moral Hazard

In the case of moral hazard, asymmetric information exists after an exchange. Moral hazard exists when one party to a transaction changes his behavior in a way that is hidden from or costly to the other party. For example, once we are covered by insurance, we may take greater risks, knowing the insurance will cover our mistakes. Firms try to control for moral hazard in different ways.

B. Agriculture and Income Inelasticity

Income elasticity of demand measures the responsiveness of a change in quantity demanded to changes in income. Many studies put U.S. income elasticity for food at less than 0.2, which means that as income increases by 10 percent, food purchases increase by 2 percent.

C. A Simple Equation

Individual income is a function of labor income, asset income, transfer payments, and taxes. Labor income is the wage rate times the number of hours worked. Asset income consists of such things as interest earned on savings, the return on capital investment, and the return to land. Transfer payments are payments to persons (from the government) that are not made in return for any goods or services currently supplied. From the sum of labor income, asset income, and transfer payments, we subtract taxes to see what an individual is left with, in order to focus on the direct and indirect factors that affect an individual's income and the degree of income inequality.

E. Competing for Artificial and Real Rents

Individuals and firms compete for artificial and real rents. Artificial rent is an economic rent that is artificially contrived by government that would not otherwise exist; for instance, monopoly rents created by granting a patent or exclusive license. Because of legal protection, firms will devote resources in an effort to secure these artificial rents—resources that would otherwise be used in productive pursuits. As a consequence, competition for artificial rents is socially wasteful and causes significant inefficiencies. If a rent is real (it has not been artificially created) and there are no barriers to competing for it, resources are used in a way that is socially productive.

1. Innate Abilities and Attributes

Individuals are not all born with the same innate abilities and attributes. Intelligence, creativity, strength, size, and appearance vary widely from person to person. To the extent that the market rewards some innate abilities and attributes more than others, the possessors of those desired qualities will tend to have higher incomes than others

4. Risk Taking

Individuals differ as to the degree of risk they are willing to take. Individuals who are willing to take risks have a greater earning potential than those who do not; they also have the potential of losing more than less risk-oriented individuals.

1. Prediction 1:

Instructors at universities with a big gap will be less nearly punctual and less responsive for office hours than instructors at universities with a small gap.

Chapter 16

Interest, Rent, and Profit

Chapter 21

International Finance

Chapter 20

International Trade

1. Corporate Bonds

Issued by a private corporation and may sell for a price above or below face value. The interest is fully taxable.

2. Municipal Bonds

Issued by state and local governments. The interest is not subject to federal taxes.

4. Inflation-Indexed Treasury Bonds

Issued by the federal government and guarantees the purchaser a certain real rate of return.

3. Treasury Bills, Notes, and Bonds

Issued by the federal government. Bills mature in 13, 26, or 532 weeks, notes mature in 2 to 10 years, and bonds mature in more than 10 to 30 years

B. The Effect of Age on the Income Distribution

It is important to distinguish between individuals who are temporarily poor due to career changes or layoffs, and those who are poor for long periods of time, and to understand how income changes over the course of one's life. As a whole, people's income tends to be low up until the mid-20s, to rise during their late 20s, 30s, and 40s, to peak sometime in the late 40s or early 50s, and remain fairly level until retirement, at which point it drops significantly. Owing to this, one could argue that the appropriate income comparison would be to look at lifetime income, rather than income at one particular point in time. In the United States, there seems to be quite a bit of upward income mobility over time.

I. Objectives of Labor Unions

Labor unions usually seek one of three objectives: to employ all their members, to maximize the total wage bill, or to maximize income for a limited number of union members.

2. Term of the Loan

Lenders require interest rate premiums to give up their money for long periods of time. As a result, the longer the term of the loan, the higher the interest rate; the shorter the term of the loan, the lower the interest rate.

3. Prediction 3:

Lower foregone income lowers the cost of burglary and thus will lead to more burglaries.

1. Prediction 1:

Lowering the benefits of burglary will lead to fewer burglaries.

E. An Important Question: Is MRP = VMP?

MRP equals VMP for price takers but not for price searchers. MRP equals VMP for a perfectly competitive firm because price equals marginal revenue for a perfectly competitive firm. VMP > MRP for monopolists, monopolistic competitors, and oligopolists because P > MR for these firms.

V. Public Goods: Excludable and NonExcludable

Many economists maintain that the market fails to produce nonexcludable public goods.

A. Persuasion

Many negative externalities occur simply because the parties that create them do not consider the effects of their actions on others. By informing the parties responsible for an externality of the consequences of their actions and persuading them to alter their behavior, we may get them to adjust their behavior to take these costs into account.

F. Marginal Factor Cost: The Firm's Factor Supply Curve

Marginal factor cost (MFC) is the additional cost incurred by employing an additional factor unit. It is calculated as MFC = ΔTC/ΔQuantity of the factor

K. Marginal Productivity Theory

Marginal productivity theory states that if a firm sells its product and purchases its factors in competitive markets, it pays its factors their MRP or VMP (which are equal).

B. Marginal Revenue Product: Two Ways to Calculate It

Marginal revenue product (MRP) is the additional revenue generated by employing an additional unit of a factor; that is: MRP = ΔTR/ΔQuantity of the factor Alternatively, we can calculate MRP using the concept of marginal revenue, such that: MRP = MR × MPPX Where MPPX, the marginal physical product of factor X, is the additional quantity of output produced by using one more unit of factor X.

B. Marginal Costs and Benefits of Activities

Marginal social costs (MSC) are the sum of marginal private costs (MPC) and marginal external costs (MEC). Marginal social benefits (MSB) are the sum of marginal private benefits (MPB) and marginal external benefits (MEB).

Chapter 17

Market Failure: Externalities, Public Goods, and Asymmetric Information

I. Market Failure

Market failure is a situation in which the market produces more or less than the ideal or optimal amount of a particular good.

VII. Observation 5:

More students wear baseball caps in class on exam days than on other days.

B. Unions' Effects on Wages

Most empirical studies show that some unions have increased members' wages substantially, while others have not. Data are provided in Exhibit 5 in the text. The relevant question, it seems, is not so much the effect on the average wage but the creation of a union-nonunion wage gap—that is, a differential between the wages earned by union workers and their nonunion counterparts for similar labor. As Exhibit 6 in the text illustrates, changes in the labor supply and wage conditions in the unionized sector can bring about changes in supply and wages in the nonunion sector, which will lead to the creation of a wage gap between the two sectors. It is important to note that, due to entry and exit, the higher wages that go to union employees don't necessarily come out of profits.

I. Economics and Government

Not all economists agree on government's role in and effects on markets. This chapter presents some of what economists say when they argue the case for and against government.

B. The Theory

Often, for most four-year tradition universities, the student tuition is below the equilibrium tuition. If most four-year traditional universities are charging students less than equilibrium tuition, there is a dollar gap between what a student pays and the equilibrium tuition. The theory states that the cost of not hurrying to office or of being less responsive is lower for the instructor at a university with a big gap than for the instructor at a university with a small gap.

3. Prediction 3:

On a multiple-choice exam, a larger percentage of cheaters in the class will be male than female.

4. Prediction 4:

On exam day, instructors will more often look at the students wearing baseball caps than at other students.

A. Employment for All Members

One possible objective is to maximize employment. Suppose the demand for labor is as illustrated in Exhibit 1 in the text. If the union chose to maximize employment, it would have to choose wage rate W1.

1. Profit and Uncertainty

One theory holds that profit would not exist in a world of certainty; hence, uncertainty is the source of profit. Uncertainty exists when a potential occurrence is so unpredictable that a probability cannot be estimated for it. Because uncertainty exists, expected profits may or may not materialize. Between the time a firm purchases its inputs and sells its output, unanticipated changes may make the firm's plans either overambitious or underambitious. In short, unanticipated changes create winners and losers, profit-makers and loss-takers.

C. Turning Potential Trades into Actual Trades

One way to describe entrepreneurs is to say they turn potential trades into actual trades. They do this either by satisfying an unmet demand or by lowering transaction costs.

2. Nonmoney, or Nonpecuniary, Aspects of a Job

Other things held constant, people prefer "enjoyable" jobs to ones that involve dirty, heavy, socially unacceptable, or dangerous work. An increase in the overall "unpleasantness" of a job will cause a leftward shift in the labor supply curve; an increase in the overall "pleasantness" of a job will cause a rightward shift in the labor supply curve.

B. The Price for Loanable Funds and the Return on Capital Goods Tend to Equality

Over time, the price of loanable funds and the rate of return on capital goods tend toward equality. For instance, if the rate of return on capital is higher than the price of loanable funds, firms would borrow additional funds—which increases the demand for loanable funds and the price of loanable funds—in order to buy additional capital, which increases the supply of capital and reduces the rate of return on capital.

4. Prediction 4:

Paying more to stay out of prison raises the cost of burglary, and fewer burglaries will be committed.

2. Prediction 2:

People are more likely to practice the principle of treating others as they want to be treated in a small numbers setting (small number of persons setting) that they frequent often than in a large numbers setting that they rarely frequent.

D. What Is the Justification for the Government Redistributing Income?

People argue for and against the government redistribution of income from the rich to the poor. Those who favor it generally either use the public good-free rider justification, that the reduction of poverty is a public good that benefits the whole, or the social insurance justification that all might need public assistance one day, so today's payments are in effect insurance against one's own future potential needs.

X. Observation/Thought 8:

People who give to others often complain that they end up giving too much.

5. Prediction 5:

People will pay (donate money) to meet the President of the United States. While people might not be willing to pay to meet just an average, everyday human being, they would be willing to pay to meet a unique human being. The President of the United States is similar to a house with an ocean view while most people are similar to a house without a view.

3. Candidates will take polls, and, if they are not doing well in the polls and their opponents are, they will modify their positions to become more like their opponents

Polls tell candidates how well their message is getting across. A rational candidate who finds that he is not appealing to a majority of voters will modify his positions accordingly in order to improve his standing.

E. Present Value: What is Something Tomorrow Worth Today?

Present value measures the current value of some future dollar amount. Specifically, the present value (PV) of some future sum can be calculated using the formula: PV = An/(1 + i)n where An is the actual amount of income or receipts in a particular year in the future, i is the interest rate, and n refers to the number of years until the "payoff." If there is a future income stream, the formula would be: PV = ∑ An/(1 + i)n

E. Bringing about Transfers

Producers lobby with the government for the prices in order to transfer surpluses from consumers to producers in a way that benefits the producers. The resources that the producers expended to get the transfer are referred to as the rent seeking costs, that is, the costs of trying to bring about the transfer. From society's perspective, the resources expended to effect the transfer are wasted in that they cannot be used to produce goods and services.

1. The Case for Fixed Exchange Rates

Proponents of fixed exchange rates argue that they promote international trade, whereas flexible rates stifle international trade. A major advantage of fixed exchange rates is certainty, which is a necessary ingredient in international trade. The main case against flexible exchange rates is that they break up the world market.

Chapter 18

Public Choice and Special Interest-Group Politics

A. The Costs and Benefits of Voting

Public choice economists often explain low voter turnouts in terms of the costs and benefits of voting. Low voter turnouts that appear to be a result of voter apathy may instead be a result of cost-benefit calculations. The rational voter must weigh the benefits of voting against the costs of doing so, in order to determine whether or not it is "worth it" to vote and, if so, how much time and effort to spend becoming informed about the candidates and issues. The benefits of voting vary from person to person. The people who vote probably receive some benefits (e.g., from doing their civic duty or from being part of the excitement of election day) from voting that nonvoters do not receive.

I. Public Choice Theory

Public choice is the branch of economics that deals with the application of economic principles and tools to public-sector decision making. According to public choice theorists, people in the market sector and people in the public sector behave differently because the two sectors have different institutional arrangements.

2. Put Option

Put options give the owner the right, but not the obligation, to sell shares of a stock at a strike price within the time limits of the contract.

2. Prediction 2:

Recipients in dating relationships will be less likely to push for more-than-the efficient-number-of-gifts than recipients in a marriage.

D. Rent Seeking

Rent seeking consists of the actions of individuals and groups who spend resources to influence public policy in the hope of redistributing (transferring) income to themselves from others. Rent seekers use resources to effect a transfer, which is socially wasteful since the money spent trying to effect a transfer cannot be used to produce goods and services. Therefore, rent seeking is a socially wasteful activity.

A. Theories of Profit

Several different theories address the question of the source of profits. Three are discussed here. An entrepreneur bears uncertainty, is alert to arbitrage opportunities, and exhibits innovative behavior. Entrepreneurship cannot be measured. An entrepreneur receives profit as a residual after the other factors of production have been paid.

A. Example 1: Voting for a Nonexcludable Public Good

Simple majority voting by a group of voters with differing preferences results in the outcome that represents the preferences of the median voter.

A. Factors Contributing to Income Inequality

Six factors that contribute to income inequality are innate abilities and attributes, work and leisure, education and other training, risk taking, luck, and wage discrimination.

C. Assigning Property Rights

Some economists argue that many negative externalities occur because no one "owns" the air, oceans, etc. As a result, there is no one to take action against polluters for infringing on property rights. If we could only assign property rights—that is, determine legal ownership of these natural resources—we could reduce negative externalities. The absence of land ownership on grazing lands in the western United States in the 19th century led to overgrazing that reduced the quality of the land.

C. Who are the Poor?

Some groups are represented much more prominently in the poverty figures than others. A disproportionate percentage of the poor are African American or Hispanic and live in large families headed by a female who is young and has little education. In absolute numbers, there are more poor whites than any other racial group, but that is because there are more whites in the total population than any other racial group.

D. Why Do People Buy Stock?

Some people buy stocks for (1) the dividends, which are payments made to stockholders based on a company's profits and (2) the expected gain in its price.

B. The Theory

Some students will use baseball caps to shield their eyes from view when they are taking a test. With a baseball cap as a shield, these students can look right and left to collect answers from other students.

2. A New View: The Labor Union as a Collective Voice

Some studies show that, in some industries, union firms have a higher rate of productivity than nonunion firms. Some economists argue that this indicates that unionization makes workers feel more confident, less intimidated, and more secure in their work, causing them to be happier, more productive employees. One consequence, economists predict, is that union employees should be less likely to quit their jobs. And, in fact, empirical evidence suggests that unionization does reduce quit rates.

B. Promoting from Within

Sometimes employers promote from within their company because they have better information on their own employees than on potential employees. What may look like discrimination to outsiders may simply be a reflection of the costs of acquiring relevant information on employees inside and outside the company

B. Government as Transfer Mechanism

Sometimes the government functions as a transfer mechanism, taking money from one group of persons to give to another. There are three types of transfers: voluntary, involuntary, and involuntary-voluntary. Involuntary transfers are the kind of transfers used in the case against government. As discussed in the previous chapter, special interest groups engage in rent-seeking activities to get transfers from others to themselves. The case against government often makes two points about special interest groups. First, much of the legislation that looks like public interest legislation is really just special interest legislation. Second, special interest groups are often more inclined to press government for transfers instead of economic growth.

II. Externalities

Sometimes, when goods are produced and consumed, side effects, or externalities, occur that are felt by people who are not directly involved in the market exchanges. These externalities may be negative or positive.

D. Following the Leader in Pushing for Transfers

Special interest groups may find themselves in a prisoner's dilemma as they lobby to effect transfer payments, and they may want to get out of the setting but can't as long as government will not say no to all special interest legislation. Some economists argue that the current incentive structure for elected representatives isn't likely to allow this to happen.

C. Public Interest Talk, Special Interest Legislation

Special interest legislation usually isn't called by that name by the special interest group lobbying for it. Instead, they will try to persuade the general public that it is legislation in the best interest of the public.

A. Where are Stocks Bought and Sold?

Stocks and bonds are bought and sold in stock exchanges (like the NYSE) and markets (like NASDAQ, which is a sophisticated computer and telecommunications network), both domestic and foreign.

Chapter 23

Stocks, Bonds, Futures, and Options

6. Prediction 6:

Students who wear baseball caps backwards on lecture days but wear baseball caps on frontwards on exam days are probably cheating on exam days.

5. Prediction 5:

Students who wear baseball caps to class on exam days and lecture days will likely be cheating if the bill of their baseball caps is more sloped (at a greater angle) on exam days than on lecture days.

H. When There Is More Than One Factor, How Much of Each Factor Should the Firm Buy?

Suppose a firm requires two factors, labor and capital. To minimize costs, the firm should purchase those factors such that the MPP-to-price ratio for one factor equals the MPP-to-price ratio for the other factor. In other words, MPPK/PK = MPPL/PL where L = labor and K = capital. This is the least-cost rule, which shows the firm how it can spend its money on labor and capital most effectively.

1. Trade and Labor Mobility

Suppose there are two neighboring countries. When demand increases in one country relative to the other, wages will tend to rise in the high-demand country. If labor is mobile between them, workers will move to that country, and that will moderate the wage and demand changes.

B. Taxes and Subsidies

Taxes and subsidies are sometimes used as corrective devices for a market failure. Specifically, a tax is used to adjust for a negative externality, and a subsidy to promote an activity with positive externalities. If a negative externality exists, the objective of a corrective tax would be to shift the supply curve such that the equilibrium level of output falls from the market output to the socially optimal output. If the government misjudges external costs, it may reduce output more than is socially optimal.

III. Observation 1:

The Birth Rates in Various Countries are Different

1. Coase Theorem

The Coase theorem can be expressed in other ways, for example: (1) in the case of trivial or zero transaction costs, a property rights assignment will be undone if it benefits the relevant parties to undo it; (2) in the case of trivial or zero transaction costs, the resource allocative outcome will be the same no matter who is assigned the property right. The Coase theorem is significant for two reasons: (1) it shows that under certain conditions the market can internalize externalities, and (2) it provides a benchmark for analyzing externality problems.

B. The Dow Jones Industrial Average (DJIA)

The DJIA is a weighted average of 30 widely traded stocks on the New York Stock Exchange. According to many economists, the Dow is closely connected to changes in such things as consumer credit, business expectations, exports and imports, personal income, and the money supply.

Chapter 15

The Distribution of Income and Poverty

Chapter 22

The Economic Case For and Against Government: Five Topics Considered

IV. Observation/Thought 2:

The Ethical Code of People who live in a small town is different from that of people who live in a large city.

B. The Gini Coefficient

The Gini coefficient measures the degree of inequality in the income distribution as the difference between the line of perfect income equality (or 45-degree line) and the actual Lorenz curve for an economy. Specifically, the Gini coefficient is calculated as: Gini Coefficient = Area between line of perfect income equality and actual Lorenz curve/ Entire triangular area under the line of perfect income equality. The Gini coefficient is a number between 0 and 1. The larger the Gini coefficient, the greater is the degree of income inequality; the smaller the Gini coefficient, the smaller is the degree of income inequality. A Gini coefficient of 0 would indicate that there is no difference between the actual Lorenz curve and the line of perfect income equality; therefore, if the Gini coefficient = 0, the economy has a perfectly equal income distribution. A Gini coefficient of 1 would mean that the area between the actual Lorenz curve and the line of perfect income equality is equal to the area of the triangle under the line of perfect income equality—that is, the Lorenz curve is as far away from the line of perfect income equality as possible; therefore, if the Gini coefficient = 1, the economy has a perfectly unequal distribution of income, or perfect income inequality.

A. The Lorenz Curve

The Lorenz Curve is a graphical representation of the distribution of income, expressing the relationship between cumulative percentage of families and cumulative percentage of income. One can look at a particular point on a Lorenz Curve and see what percentage of income is earned by what percentage of the population. The Lorenz curve for one economy may look substantially different from that of another, depending upon how evenly income is distributed among their populations. If there were perfect income equality, the Lorenz curve would be a 45-degree line.

C. The MRP Curve is the Firm's Factor Demand Curve

The MRP curve for factor X is also the factor demand curve for factor X. According to the law of diminishing marginal returns, the MPP of a factor will diminish eventually. Because MRP = MR x MPP, it follows that MRP will eventually decline too.

A. The Demand for Goods

The U.S. demand for Mexican goods leads to (1) a demand for Mexican pesos and (2) a supply of U.S. dollars on the foreign exchange market. Similarly, the Mexican demand for U.S. goods leads to (1) a demand for U.S. dollars and (2) a supply of Mexican pesos on the foreign exchange market.

1. Assigning Acreage Allotments

The allowable total acreage is distributed among farmers in a predetermined manner. One consequence of restricting acreage is that farmers take their least productive land out of production, meaning that government is not always able to restrict the output of a crop to the degree it seeks. Another consequence is that is makes it more costly to produce crops.

The Labor Market

The basic factor concepts are used to build a specific theory of the demand for and supply of labor, the optimal level of employment, and the equilibrium wage.

3. Method 3: Tradable Pollution Permits (Cap and Trade)

The basic idea is that, for a given area, a certain amount of pollution is "acceptable." That "acceptable" amount of each given type of pollution is then parceled into permits that would-be polluters bid for in an auction. This allows polluters to compare the (internalized) cost of polluting to the revenues that could be earned by producing the additional output that would generate that pollution. If one firm can reduce its pollution more cheaply than another firm, it can sell pollution rights to the other firm and profit from the transaction. The same level of pollution is achieved as under the regulations discussed above, but the firms that are the most efficient at reducing pollution carry out these activities rather than having all firms reduce pollution.

3. Costs, Benefits, and Optimal Currency Areas

The benefits of flexible exchange rates are their ability to equalize economic forces between nations. The costs of flexible exchange rates are the transactions costs of swapping one currency for another. When labor is mobile, it is possible for countries to get the benefits of flexible exchange rates without incurring the costs by having fixed exchange rates or a common currency. When labor is mobile enough to easily and quickly adjust to changes in relative demand, then the countries are said to be an optimal currency area. The states of the U.S. are an example of an optimal currency area. Economists do not yet agree on whether or not the same is true for the European states.

2. Prediction 2:

The bigger the gap, the more flexibility the instructor has to teach a course the way he or she wants to teach it.

IV. Dealing with a Negative Externality in the Environment

The classic negative externality is pollution, and pollution in all of its forms, along with other environmental issues, has become the focus of increasing economic scrutiny in the past decade.

V. Observation/Thought 3:

The closer the dollar tuition the student pays is to the equilibrium tuition, the more on time and responsive university instructors will be for office hours

E. Combining Property Rights Assignments and Voluntary Agreements

The combination of property rights assignments and voluntary agreements can be combined. For instance, if a property right is assigned to one party, that property right may be undone with a voluntary agreement between that party and another one. This idea led to the Coase theorem, which holds that in the case of trivial or zero transaction costs, the property rights assignment does not matter to the resource allocative outcome.

C. Economic Rent and Other Factors of Production

The concept of economic rent applies to any factor of production that is receiving a payment in excess of its opportunity cost.

A. Costs and Benefits of Activities

The costs and benefits of an activity that affect only the person engaged in the activity are called private costs and private benefits. A negative externality exists when a person's or group's actions cause a cost (or adverse side effect) to be felt by others. A positive externality exists when a person's or group's actions cause a benefit (or beneficial side effect) to be felt by others.

1. Demand for Labor

The demand for labor may be quite different between markets. For one thing, the demand for labor is largely conditioned on the demand for the product it produces; and to the extent that product demand varies from producer-to-producer and market-to market, the demand for labor to produce that product will also vary. Secondly, worker productivity will vary between workers as workers' abilities, skills, and degrees of effort are different. To the extent that the wage paid is also a function of the individual worker's productivity (MPP), different MPPs will yield different MRPs, which will cause wage differentials.

C. Agriculture and Price Inelasticity

The demand for many agricultural products is inelastic. Since the supply of many food products is volatile, large changes in supply bring about relatively large fluctuations in the price of agricultural products and large changes in total revenue, or farmers' gross income. The instability in price and total revenue increases the uncertainties of farming.

I. The Foreign Exchange Market

The difference between the value of a country's exports and the value of its imports is called net exports. Net exports are sometimes referred to as the trade balance (or balance of trade). If the value of exports is greater than the value of imports, a country is said to be running a trade surplus; if the value of imports is greater than the value of exports, it is running a trade deficit. One factor that affects the trade balance of a country is the value of its currency in relationship to other currencies. Currencies of different countries are exchanged (bought and sold for a price) in the foreign exchange market. The price that currencies are bought and sold for is called the exchange rate.

A. Earth's Temperature and Global Warming

The earth's temperature is determined by short-wave radiation and long-wave radiation. If greenhouse gases become more abundant in the atmosphere, shortwave and long-wave radiation is trapped and re-emitted causing the earth's temperature to rise. The major contributors to global increases in carbon dioxide concentrations are the burning of fossil fuels and deforestation.

III. The Economic Case against Government

The economic case against government is based on the unintended effects of government actions, government as a transfer mechanism, and special interest groups.

III. Effects of Labor Unions

The effects of labor unions on wage rates in different labor markets are addressed in this section.

C. The Elasticity of Demand for Labor

The elasticity of demand for labor (EL) is the percentage change in the quantity demanded of labor divided by the percentage change in the price of labor (wage rate). There are three main determinants of the elasticity of demand for labor.

A. Loanable Funds: Demand and Supply

The equilibrium interest rate is determined by the demand for and supply of loanable funds. The demand for loanable funds is composed of the demand for consumption loans, the demand for investment loans, and government's demand for loanable funds. The supply of loanable funds is composed of people's saving and newly created money. This chapter focuses on the first two types of demand and the first type of supply.

G. How Many Units of a Factor Should a Firm Buys?

The firm should continue to buy/hire units of a factor as long as MRP > MFC— that is, as long as the new factor adds more to the firm's revenues than it takes away in additional cost. The firm maximizes profits by buying/hiring just enough factors so that for the last factor unit added, MRP = MFC.

2. Assigning Market Quotas

The government sets a limit on the quantity of a product that a farmer is allowed to bring to market.

1. Increasing Product Demand

The greater the demand for the product of labor, the greater the demand for labor. Consequently, unions occasionally urge the public to buy the products they produce.

1. Elasticity of Demand for the Product that Labor Produces

The higher the elasticity of demand for the product, the higher the elasticity of demand for labor; the lower the elasticity of demand for the product, the lower the elasticity of demand for labor.

2. Ratio of Labor Costs to Total Costs

The higher the labor cost-total cost ratio, the higher the elasticity of demand for labor; the lower the labor cost-total cost ratio, the lower the elasticity of demand for labor

1. Prediction 1:

The higher the opportunity cost for a woman to have a child, the fewer children she will have.

B. Market Demand for Labor

The market demand curve for labor is not simply a horizontal summation of the MRP curves of each individual firm in the market. Instead, the market demand curve must take into account the effect of wage increases on the supply and price of the output produced by the firms in the market. Since MRP reflects the price of those products, as supply and price adjust to higher wages, the MRP will also adjust, so that the market demand curve for labor tends to be much steeper than any individual firm's demand for labor.

D. Market Supply of Labor

The market labor supply curve is upward-sloping because, as the wage rate rises, the quantity supplied of labor rises, ceteris paribus.

C. Nonexcludable vs. Nonrivalrous

The market only fails to produce a demanded good when the good is nonexcludable because the free rider problem only arises if the good is nonexcludable. The rivalry versus nonrivalry issue is not relevant to the issue of market failure.

A. Information and Lobbying Efforts

The more directly and intensely an issue affects someone, the greater is his incentive to become informed about that issue. Because of their intense feelings about their particular issue(s), members of special interest groups tend to be better informed than average voters and participate more actively in the political process. Therefore, there is a good chance that special interest bills will be passed.

B. Bond Ratings

The more likely the bond issuer will pay the face value of the bond at maturity and will meet all scheduled coupon payments, the higher the bond's rating. If a bond gets a rating of AAA from Standard & Poor's or a rating of Aaa from Moody's, it has received the highest rating possible.

3. Number of Substitute Factors

The more substitutes for labor, the higher the elasticity of demand for labor; the fewer substitutes for labor, the lower the elasticity of demand for labor.

D. Nominal and Real Interest Rates

The nominal interest rate is the interest rate determined by the forces of supply and demand in the loanable funds market. It is the interest rate in current dollars, unadjusted for expected inflation. The nominal interest rate will change if the demand and/or the supply of loanable funds changes. The real interest rate is the nominal interest rate adjusted for expected inflation. The real interest rate, not the nominal interest rate, matters to lenders and borrowers, since the real interest rate is the better reflection of the opportunity costs of borrowing and lending.

1. Prediction 1:

The owner of a car repair shop in a small town will be more careful not to overcharge customers than the owner of a car repair shop in a large city.

C. Is there Market Failure?

The presence of asymmetric information does not guarantee that the market fails. What matters is whether the asymmetric information brings about a different outcome than the outcome that would exist if there were symmetric information. If this occurs, then the case for market failure can be made.

B. Restricting Supply

The prices of agricultural products can be increased indirectly by restricting supply. Historically, government has used three methods to accomplish this objective.

E. Strikes

The purpose of a strike is to convince management that the union can control the supply of labor. Often, this depends on the union's ability to keep non-striking and nonunion employees from working at the disputed wage and/or working conditions.

E. An Individual's Supply of Labor

The slope of an individual's labor supply curve reflects both substitution and income effects. As the wage rises, the worker will tend to substitute away from leisure and toward labor. Also, as the wage rises, income rises, and the worker will tend to buy more goods, including more leisure (implying that he will work less). These two effects work in opposite directions. If the substitution effect is stronger, the individual's labor supply curve will be upward-sloping.

C. Social Optimality, Efficiency, Conditions

The socially optimal amount (output), or the efficient amount (output) is the amount at which MSB = MSC.

4. The Loanable Funds Market

The sum of the demand for consumption loans and the demand for investment loans is the total demand for loanable funds. The demand for loanable funds curve is downward sloping and shows that there is an inverse relationship between the interest rate and the willingness of consumers and firms to borrow funds

1. The Supply of Loanable Funds

The supply of loanable funds curve is upward sloping, showing that the supply of loanable funds increases as the interest rate increases, and decreases as the interest rate decreases.

2. Pigou versus Coase

The text recounts the night when Coase successfully defended his idea that assigning property rights is a more efficient way of dealing with externalities than introducing taxes or subsidies.

B. The Theory

The theory is based on a rational criminal, holding that the criminal thinks and acts in terms of costs and benefits. The theory posits that the criminal has two equations. The first is related to the benefits of committing a criminal act. The second equation is related to the costs of committing the criminal act. If the expected benefits are greater than the expected costs, the criminal commits the crime.

B. The Theory

The theory is based on the opportunity cost for a woman of having a child over earning an income.

B. The Theory

The theory is based on what percentage of the population an individual represents. The theory says that the larger a percentage of the population a person is, the more likely that person will treat others as he or she wants to be treated.

C. The Predictions

The theory makes five predictions:

C. The Predictions

The theory makes four predictions:

C. The Predictions

The theory makes six predictions:

C. The Predictions

The theory makes three predictions:

C. The Predictions

The theory makes two predictions:

B. The Theory

The theory states that the benefits of being in the higher-ranked school district are incorporated into the price of the house

1. The Traditional (or Orthodox) View

The traditional view holds that unions reduce labor productivity and efficiency. First, they argue, labor unions often have unnecessary staffing requirements and insist that only certain people do certain jobs. Because of this, the economy operates below its potential and inefficiency results. Second, strikes disrupt production and thus prevent the economy from realizing its productive potential. Third, unions drive an artificial wedge between the wages of comparable labor in the union and nonunion sectors, causing a misallocation of labor resources and reducing resource allocative efficiency.

1. Wage Rates in Other Labor Markets

The wage rate offered in other labor markets will serve as a check on the wage rate in a particular labor market. To the extent that workers can find employment in other markets, the wage rate will have to accurately reflect their opportunity cost of employment. If wage rates rise in other labor markets, the market labor supply curve will shift left; if wages fall in other labor markets, the market labor supply curve will shift to the right.

I. Interest

The word interest is used in two ways in economics. Sometimes it refers to the price for credit or loanable funds. Sometimes it refers to the return earned by capital as an input in the production process. Over time there is a tendency for the two to become equal.

D. Common Misconceptions About the Coupon Rate and Yield (Interest Rate)

The yield (or interest rate) and the coupon rate are two different things. The yield will equal the coupon rate when the price of the bond equals the face value of the bond. The yield will be greater than the coupon rate when the price of the bond is lower than the face value of the bond. The yield will be lower than the coupon rate when the price of the bond is greater than the face value of the bond.

C. Bond Prices and Yields (or Interest Rates)

The yield on a bond is the coupon payment divided by the price paid for the bond.

II. The Process

There are five steps in the process of building an economic theory: (1) observation or thought, (2) Question based on observation, (3) Building a theory to answer the question, (4) Making predictions based on the theory, and (5) Testing the theory. The chapter discusses the first four steps.

D. Why Nations Sometimes Restrict Trade

There are several arguments for trade restriction.

D. Options Under a Fixed Exchange Rate System

There are several options available to deal with persistently overvalued currencies.

B. Limitations of the Official Poverty Income Statistics

There are several shortcomings in the official poverty statistics gathered and published by the U.S. government. First, they are based solely on money income—that is, they exclude in-kind transfer payments. Second, they are not adjusted for unreported or illegal income. Third, they ignore regional differences in the cost of living. Fourth, they exclude a part of the population that cannot be "found," because they are homeless or illegal aliens. As a result, the official poverty figures may well be distorted.

A. The Components of a Bond

There are three major components of a bond: face (par) value, maturity date, and coupon rate. The face value is the total amount the issuer of the bond will repay to the buyer of the bond. The maturity date is the day when the issuer of the bond must pay the buyer of the bond the face value of the bond. The coupon rate is the percentage of the face value that the bondholder receives each year until the bond matures.

A. What is Poverty?

There are two basic views of poverty. One view holds that poverty should be defined in absolute terms—for instance, any individual earning less than $X per year is in poverty. The other view holds that poverty should be defined in relative terms. Viewing poverty in relative terms means that poverty will always exist, unless there is absolute income equality. Given any unequal distribution of income, people with lower incomes (no matter how high) will be considered poor, while people with higher incomes (no matter how low) will be considered rich. The U.S. government defines poverty in absolute terms. Specifically, the Department of Agriculture annually determines the minimum necessary level of income, called the poverty line. Anyone receiving an income below the poverty line is considered to be poor. In 2012, the poverty line for a family of four was $23,050. In 2010, 15.1 percent of the U.S. population was living below the poverty line.

II. Measuring Income Inequality

There are two commonly used measurements of income inequality: the Lorenz curve and the Gini coefficient.

D. Unions' Effects on Productivity and Efficiency: Two Views

There are two major views of the effects labor unions have on productivity and efficiency.

B. How Can the Entrepreneur Increase Trade?

There are two major ways of increasing trade. The first is to produce a good or service that satisfies an unmet demand. A second major way of increasing trade is to reduce the transaction costs of making trades.

Factor Markets

There is a demand for and a supply of a factor or resource.

2. Work and Leisure

There is a tradeoff between work and leisure. Those who choose to work more (enjoy less leisure time), ceteris paribus, will earn more income than those who choose to work less (enjoy more leisure time).

B. What is Global Warming and What Controversies Do and Do Not Surround It?

There is widespread divergence in public opinion regarding the rate of increase in global temperature, the effects of climate change, the tradeoffs between carbon emissions and economic growth, and the division of the costs of dealing with climate change among different countries.

2. The Infant Industry Argument

This argument claims that "infant" or new industries ought to be protected against import competition until they are mature enough to compete on an equal basis. Critics charge that removing the protection may be impossible and that all new industries, whether or not they could currently compete successfully with foreign producers, would argue for protection on infant industry grounds.

5. The Low-Foreign-Wages Argument

This argument claims that U.S. products cannot compete with foreign products because U.S. producers pay their workers higher wages than foreign producers pay their workers. Critics say that this argument overlooks the fact that U.S. wages are higher because U.S. workers are more productive than their foreign counterparts.

1. The National Defense Argument

This argument claims that certain industries—such as steel, aircraft, petroleum, chemicals, and the like—are of vital strategic importance and must be maintained in the interest of national security, even if the industry is not economically competitive. The main problem with such an argument is that industries that are not really necessary to the national defense may claim otherwise.

3. The Antidumping Argument

This argument claims that dumping (the sale of goods abroad at a price below their cost of production and below the price charged in the domestic market) is an unfair trade practice that is often used to drive domestic competitors out of the market so that the dumper can then raise prices and reap monopoly profits. Critics of this argument claim that dumping allows consumers access to lower-priced goods.

6. The Saving Domestic Jobs Argument

This argument claims that imports displace domestic output and create domestic unemployment. Critics reply that as long as the jobs are being lost due to more efficient foreign production, the job loss is a signal that resources can be better allocated elsewhere.

4. The Foreign Export Subsidies Argument

This argument claims that when governments subsidize firms that export goods and services, it is giving an "unfair" advantage to subsidized firms at the expense of unsubsidized competitors. Critics of this argument claim that consumers benefit from foreign export subsidies.

B. Asymmetric Information in a Factor Market

This can occur if the buyer (here the firms) has private information about the good that would affect the sellers' (workers') demand. Exhibit 9 in the text illustrates an example where supply of labor is higher for workers who do not know that there are workplace hazards. If the firms reveal this, then supply will fall to the symmetric information level at a higher wage and a lower quantity of labor.

A. Asymmetric Information in a Product Market

This can occur if the seller has private information about the good that would affect the buyers' demand. Exhibit 8 in the text illustrates an example where demand is higher for smokers who do not know that smoking causes cancer. If the sellers reveal this, then demand will fall to the symmetric information level at a lower P and Q.

I. A Different Kind of a Chapter

This chapter differs from the others in the experience it provides and in its content. It explains the process by which economists build theories. The topics discussed in this chapter are closely related to situations of everyday life.

IV. Futures and Options

This section discusses futures and options.

IV. Fixed Exchange Rates vs. Flexible Exchange Rates

This section discusses some of the arguments and issues surrounding fixed and flexible exchange rate systems.

C. Environmental Policy

This section discusses the specifics of three types of environmental policies.

II. Trade Restrictions

This section discusses why, if countries gain from international trade, there are trade restrictions.

II. Practices of Labor Unions

This section explains how labor unions try to meet their objectives.

G. How to Read the Stock Market Page

This section explains how to read a typical stock market page in the newspaper or online. Among other things, it defines dividends, yields, and P/E ratios.

F. How to Read the Bond Market Page

This section explains how to read the information in the newspaper relating to corporate bonds and Treasury bonds.

II. The Political Market

This section explains the behavior of politicians, especially near or at election time.

V. Special Interest Groups

This section explains the behavior of special interest groups. Special interest groups are subsets of the general population that hold (usually) intense preferences for or against a particular government service, activity, or policy. In recent decades, they have played a major role in government.

III. Voters and Rational Ignorance

This section explains the behavior of voters.

III. Fixed Exchange Rates

This section focuses on the fixed exchange rate system where the exchange rates are not allowed to fluctuate freely in response to the forces of supply and demand. Central banks buy and sell currencies to maintain agreed-on exchange rates.

A. Unintended Effects of Government Actions

This section gives several examples of government actions that had unintended effects. One example involves the health-care bill passed in Congress in March 2010. Another example is the minimum wage law.

III. Labor Markets and Information

This section looks at job hiring, employment practices, and employment discrimination and how information, or the lack of it, affects these processes.

I. Some Facts about Income Distribution

This section presents a few facts about the distribution of income.

A. Government can remove individuals from a prisoner's dilemma setting

This section presents an example that shows that the government can remove individuals from a prisoner's dilemma setting (by apprehending and fining them for undesirable behavior) and thus make them better off. Government can define and enforce property rights that individuals want defined and enforced. And as long as government charges each individual a tax that is less than the gain received by being removed from the setting, the government makes that individual better off. If individuals opt for government in order to get out of the prisoner's dilemma setting, they automatically turn over certain powers to government. But once government has the power to apprehend and fine, in addition to the power to tax, it could abuse those powers. Depending on the amount of taxes and on who pays what tax, government can (1) make everyone better off, (2) make everyone worse off, or (3) make some people better off and others worse off. The strongest case that can be made for government with reference to the prisoner's dilemma setting is that taxes need to be low enough to make everyone better off with government than without it.

C. A Limitation of the Gini Coefficient

Though the Gini coefficient can tell us a great deal about the overall distribution of income in a society, it cannot tell us about what is happening to specific groups. For instance, if the Gini coefficient is 0.10 in country A and 0.20 in country B, we cannot necessarily conclude that the top 20 percent have a smaller percentage of the income in A, or that the bottom 20 percent are worse off in B. Additionally, it is possible for everyone in a country to become better off even while the income distribution becomes more unequal.

A. The Distributional Effects of International Trade

Though trade benefits all people on net, trade will hurt certain individuals. If the groups harmed by international trade have sufficient economic and/or political clout, they are often able to get the government to restrict imports, even though doing so hurts the economy as a whole.

C. Factors That Affect the Equilibrium Exchange Rate

Three factors affect the equilibrium exchange rate.

C. Government Involvement in a Fixed Exchange Rate System

To maintain a fixed exchange rate, whenever a currency is overvalued (there is a surplus of that currency), one solution would be for central banks to use their reserves to buy the surplus currency. This drives up the demand for the overvalued currency, restoring the market to equilibrium.

3. The Current System

Today's international monetary system is described as a managed flexible exchange rate system, sometimes referred to more casually as a managed float. Nations now and then intervene to adjust their official reserve holdings to moderate major swings in exchange rates.

F. Shifts in the Labor Supply Curve

Two main factors will affect the market labor supply curve: wage rates in other markets and the nonmoney aspects of a job.

C. The Benefits and Costs of Trade Restrictions

Two of the most commonly used methods to restrict free trade are the tariff and the quota.

A. Shifts in a Firm's MRP, or Factor Demand, Curve

Two things can change MRP and, thus, the firm's demand for factors: (1) the price of the product and (2) the MPP of the factor. An increase in the price of the product will shift the MRP curve to the right; a decrease in the price of the product will shift the MRP curve to the left. An increase in the productivity (MPP) of a given factor, relative to other factors, will shift the MRP curve for that factor to the right; a decrease in the MPP of a factor, relative to other factors, will shift the MRP curve to the left.

D. Affecting Wages Directly: Collective Bargaining

Unions can directly affect wage rates through collective bargaining—the process whereby wage rates are determined by the union bargaining with management on behalf of its members. In collective bargaining, union members act as a single unit in order to increase their bargaining power. On the other side of the market, employers may also try to band together to improve their position as well. From the viewpoint of the union, collective bargaining is unlikely to be successful unless the union can strike. A strike occurs when union employees refuse to work at a certain wage or under certain working conditions.

D. Value Marginal Product

Value marginal product (VMP) is equal to the price of the product times the marginal physical product of the factor (VMP = P × MPP), and is a dollar measure of how much an additional unit of the factor is worth to the firm.

4. Candidates will speak in general, instead of specific, terms

Voters agree more on ends than on means. As most campaigns indicate, candidates and voters on both sides of the political spectrum share concern over a number of issues, it is their proposed solutions that differ. Thus, by concentrating on stating the problems—the "ends"—rather than the more politically volatile solutions—the "means"—the rational candidate will appeal to a broader base of support.

IV. More about Voting

Voting is often the method used to make decision in the public sector.

6. Wage Discrimination

Wage discrimination exists when individuals of equal ability and productivity, as measured by their marginal revenue products, are paid different wage rates. Most people agree that discrimination exists, although they differ on the degree to which they think it affects income.

Chapter 14

Wages, Unions, and Labor

C. Discrimination or an Information Problem?

What is called "discrimination" may, instead, be a problem of either low relative productivity or the high cost of information. Suppose that a firm hires and promotes one type of person more than other types of people. If people of that type are relatively more productive, they should be hired and promoted disproportionately. If a firm turns down an applicant because they had never employed anyone like her, and the cost of acquiring the information necessary to assess her potential was considered prohibitive, the company could rationalize its action on the basis of overly costly information.

A. The Question

What purpose does wearing a baseball cap in class on exam days serve that it doesn't serve on other days?

C. How the Stock Market Works

When a company is formed, the owners set up a certain amount of stock, which is worth very little and is hard to sell. As the company grows and needs more money, it may decide to offer its stock on the open market by making an initial public offering (IPO) of its stock. Once there is an IPO for a stock, it is usually traded on a stock exchange or in an electronic stock market. Usually people buy a particular stock if they think the earnings of the company that initially issued the stock are likely to rise.

B. The Free Rider

When a good is nonexcludable, it is possible for individuals to benefit from the good without paying for it. Persons who do so are called free riders, and it is because of free riders that the market will fail to produce the appropriate quantities of public goods, if it produces them at all. The reason is that no rational producer will supply a good for which no one has to pay in order to consume (unless, perhaps, the cost of production is zero). The free rider problem is the basis for accepting the public provision of nonexcludable public goods. We need to remind ourselves, though, that not all government-provided goods are public goods. The government provides many goods and services that are not public goods.

B. The Theory

When a person G gives a gift to another person R, this gift not only benefits R, but it benefits G. too. Person G likes seeing R happy and benefits more the happier R becomes. The law of diminishing marginal utility (benefits) holds for gift-giving. The efficient level of gift giving for G is when marginal benefits equal marginal costs.

3. Prediction 3:

When buying package deals, there will often be something in the package the customer would have preferred not to have purchased.

B. Example 2: Voting and Efficiency

When people vote for nonexcludable public goods, their choice will depend on the tax system that will fund the public goods. If the voters believe that they will be charged a tax that equals their individual marginal private benefit (MPB) of the good, then the voting will yield an efficient outcome. If, on the other hand, voters believe that the taxes will not reflect their own MPB (say an equal or proportional to income tax), then their voting can lead to an inefficient outcome.

E. Can Increasing Trades in One Area Reduce Trades in Another?

While in some cases an entrepreneur may actually increase the number of trades, at other times, he may change the nature of trades. Sometimes, he increases the number of trades and also changes the nature of trades at the same time.

D. A Necessary Condition: Turning Potential Trades into Actual Trades in a Way that is Acceptable to Customers

While the entrepreneur seeks to turn potential trades into actual trades, he or she has to do so in a way that is acceptable to consumers. For example, an exorbitantly priced product will find few takers even if an unmet demand for it exists.

B. The Supply Curve of Land can be Upward-Sloping

While the total supply of available land is basically fixed, any given parcel of land may have multiple, competing uses. The supply curve for land with competing uses is upward sloping, suggesting that potential users will have to bid against one another for the right to use the land and to acquire additional land for their use. In this case, economic rent is less than before, but still positive.

A. The Question

Why are birth rates different in various countries?

A. The Question

Why are comparable houses (same square footage, size of lot, etc.) often priced differently?

A. The Question

Why don't people simply stop giving at the efficient proof of giving - where the marginal benefits of giving equal the marginal costs?

F. Information, Rational Ignorance, and Seeking Transfers

Why won't politicians and voters rally against a rent seeker when the loss to consumers is greater than the gain to the rent seeker? The answer is that people may be rationally ignorant about the rent seeking, and even if they do know, they may not know that their loss is greater than the gain to the rent seeker, especially if the special interest legislation is wrapped in what might be called "public interest talk." They also might not rally against the rent seeker if the cost of fighting the rent seeking exceeds the value of fighting.

A. The Question

Will instructors who teach at universities where there is a smaller gap between student tuition and the equilibrium tuition be more on time and responsive for office hours than instructors who teach at universities where there is larger gap?

A. The Question

Will people who do not have any health insurance purchase more health care with health care vouchers than without it? The obvious answer to this question seems to be yes, but is it necessarily the correct answer?

2. Method 2: Emission Taxes

With a tax on emissions, a firm that is emitting pollution would consider how much it would have to pay to eliminate a given amount of pollution and how much it would have to pay in terms of the tax if it made no attempt to reduce pollution. Since a cleaner way of producing goods means less pollution and a lower tax bill for polluting, firms have the incentive to find less-polluting ways of producing goods. Exhibit 6 can be used to explain how a tax of $30 would eliminate a given amount of pollution but in a more efficient manner.

2. Prediction 2:

Women in rich countries will have fewer children than women in poor countries.

3. Prediction 3:

Women physicians are predicted to have fewer children, on average, than women school teachers.

E. How to Buy and Sell Stock

You can buy or sell stock through a full-service stockbrokerage firm, a discount broker, or an online broker.

F. Buying Stocks or Buying the Market

You can use various methods to decide which stocks to purchase. One way is to buy shares of stock that you think are going to rise in price. Another way is to invest in a stock mutual fund, which is a collection of stocks. A third way is to buy the stocks that make up a stock index. For instance, "Spyders" are securities representing ownership in the SPDR trust, which buys the stocks that make up the Standard & Poor's (S&P) 500 index.