Mr. Deetjen A.P. Microeconomics Summer Packet Attached you will find some information you need in order to be ready for class in fall. Upon arriving for the first day of class this packet should be read in its entirety, with the following sections completed: Check Your Understanding 1-1, I-2, I-3, Pages 20-21,#’s 1,3,5. Chapter 2 Appendix Problems: 1-10 and Appendix study Questions 3-6. It would be wise to refresh yourself on the information within before we begin class. There is a website that will accompany what we do in class, [)3.k~)~):~!~,~.com/~/~£g~:~L~o~omicsi Please continue to check the site for updates. If you have any questions or concerns you can contact me at Thank You,

Mr. Deetjen

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’.~ i ~ A set of pdndp[~ ~r under~n~lng ~ the economics ~ how ~nd~dua~

~ A set of pnn~ples ~r un~ers~ndmg how ind~dua[ choices ~e~

~ A set of pfindp[es ~r understanding economy-~e in~era~ons

Ind dua[ Choke: The Core of Econ mks £ve~ economic issue ~volves, at ~ most basic level, i~i~u~ choice--derisions by an indi~dual about what to do ~d what ~t to do, In ~, you might say that it isn’t economics if it isn’t about choice. Step into a bYg store like a Wal-Ma~ or Target. The~e a~e thousands of d~fferent p~odu~ available, and it is ~emely unl~ely that you-or anyone else-could afford td’buy eve~htng you might ~nt to have. ~d an~ay, th~e’s only so much space ....... ~,~,,,,,~ .,f~;::, ,:%j:,, .in,=:y6ur.dotm r~m o~ apa~ment. So ~11 you buy another bookcase or a mini~. , re~ge~tot? Given l~mitafions on you~ budget and yo~ liv~g space, you must choose

~.~:~’~:~:.~;~;’~:;:~;: ::’.;~: ~’ :" ~:" "::~t that fl]ose produc~ are on ~e shelf in the first place involves choice-the ...... ¯ ...:~ ~2~ ~..,~ :¢.;~.,.~:r.;w~:,~ : ~SY~manager ~ose to put them thee, and ~e manu~rers of ~e pro EcOn’o~ lba~aua[ .... :-. ~r ~..~ .~.~.~ ,,~~no]ce ~,~,, -: ....:~o produce ~. ~! economic ac~fies invoI~ indi~dual choice, 1 Resources .’._a~9~:. :.:.. .... . . Four economic p~inciples ~deflie the economics of indi~dual choice, as sho~ in Table 1-1. We’ll now examine each of these principles in more detail.

R durc es Are Scarce .’ 4. PeopLe usuatty exi)tolt opportunities to make ~hem~e[ves batter off~ .......

lridividual cbu~e.e is the decision b~/an individual ofwh~to.do whic,h.na~sahly

enoug~ of ~e resources ava~a~ e sa~s~ a!l ~e variaus ways a F~cieW wants to use

Y~.~n’t alwa~ ys get yvhat yon want. Eye,lone would like to have a beaufi~ house in ~ gi~t Iocafion .(ahd help wifl~ the housecleaning), ~o or ~ree l~u~ cars, and fieq~fl;t ~ca~ ~ ~n~hotels. B~ evdn in a rich coun~ like ~e U~ted States, not m~y families cap afford ~! ~t. So they ~ust ma~ choic~s-whe~er to go to D~s~yWofl~ ~tsy~r or.buy ~r ~r~ whether w make do ~th a ~maI1 bac~a~d ot d~ept a longe~k0~ut~ ~:.6td~ ~o liw.whe~e land is ch~per. ~n~ ~me is ai~0. in l~i~ ~upply;. ~e~fire only 2~ hou~ in a day. And the~me ~ h~d:is l~ited, ~hb6~g ~o: ~me on one act[~ also means choos~g no~ W spend fim~ .on a ~n~ a~=spending ~9 smd~ng for a~ e~m meaD~, forgoing a ni~t at the ~o~es. indeed, many people a~e so l~ited ~ the ~U~b~r of hours in the day ~at they aze:~!~g w ~ade mon~ for ~e. ~or exam~e~ c6hvenien~teres normally charge hi~#~ prices ~an a ~lar supe~arket. But ~ey ~filI a ~luable role by ca~fing to flme~p~essm’ed cu~omers who would rather paY ~ore ~afl ~avet farther to ~e supe{market. ~y do indi~duals have to make choices? ~e ~fimate ~eason is ~at resources are sca#ce.A reso~ce is anfih~g t~t can be used to produce some~ing else. Lists of t~d£~bn0~y’s resomces usually begin ~ffi land, labor (the time of worke~), capi~l (machin(~, b~Id~, ~d o~er man-made pr~u~ asse~), ~d h~n capi~ (flee educational achie~men~ and s~lls of workers). A r~o~ce is s~ce wh~ there’s not qqqU~ of ~e resource a~flable w safis~ a~ the ~fious ways a ~cie~ w~ to use ~4r~ are m~y scar~ resources. ~ese indue na~al resomces-[~outces ~at come ffo~;fla~ ~h~i~ efl~rommen~ su~ as miner, s, I~b~ and p~ol~: ~ere is ~ H~it~:quWnfi~ of hum~ r~omces-hbor, s~!, and ~telligence. ~d ifi a gro~ng world ~onomz ~h a ~p~dly ~creas~ng human ~afion, even clean air and water h~zg hecQ~e scarce resources. : ~ a~ ~{i~duals mu~ make choices ~e scam[~ of resources means that s~ie~ a£’~: ~6~ust make choices. One way for a sod~ to make ’choices is’ s~ty ~o all~tb~m to. emerge as the result of many ind~duat choice, which ~s what ~u~lly happ~s ’~ a ma~k~ economy. For ~ample, Americans as a ~oup have only so many

hours in a Week: how many of those hours wflI they spend going tO supermarkets to get !ower prices, rather than saving time, by shopping at conve~hence stores? The answer is the sum of individual decisions, each of the millions of individuals in the economy makes his or her own choice about where to shop, and the overall choice is simply the sum of those individual decisions, But for various reasons, there are some decisions that a society decides are best not left to individual cho!ce. For example, the authors live in an area that until recently was mainly farmland but is now being rapidly built up. Most local residents feel that the community would be a more pleasant place to live ff some of the land were left undeveloped. But no Individual has an incentive to keep his or her land as open space, rather than sell it to a developer, So a trend has emerged ha many communities across the United States of local governments purchasing undeveloped land and preserving it as open space. We’ll see in later chapters why derisions about how to use scarce resources are often best left to individuals but sometimes should be made at a higher, community-wide, level.

The Real Cost of Something Is What You Piust Give Up to Get It It is the last term before you graduate, and your class schedule allows you to take only one elective. There are two, however, that you would really like to take: History of Jazz and Beginning Tennis. Sup!5o~e you decide to take the History of Jasz course. What’s the cost of that deciSion? It !s the fact that you can’t take Beginning Tennis, your next best alternative .choice. Ecenomist~ cal! that kind of cost-what you must g!ve up in order to get an i~em you want-the opl~or ramify cost of that item. So the opportunity cost of taking the :History of ]~az class is the enioyment you would have derived from the Beg~aning Tennis class. The concept of opportun!ty cost is cmdal to understar~ding individual choice because, in the end, all costs are 6pportunity costs. That’s because every choice you make means forgoing some other alternative. Sometimes critics claim that economists are concerned only with costs and benefits that can be measured in dollars and cents. But that is not true. Much economic analysis involves cases like our elective course example, where it costs no ext~ baifion to take one elective course--that ~s,~here is no direct monetary cost. Nonetheless, the elective you choose ha~ an opportunity cost-the other desirable elective course that you must forgo became your limited time permits t~king only one. More specifically, the opportunity cost of a choice is what you forgo by not choosing your next best alternative. ’ ,You might think that opportunity cost is an add-on-that is, something additional to the monetary cost of an. item. Suppose that an el~’cfive class costs additional tuition of $750; now there is a monetary cost to taking History of Jazz. Is the opportunity cost of taking that course somethhng separate from that monetary cost? ~..Weli, consider two cases. First, suppose that tak!ng Beginning Tennis also costs $!Z~o in this case, you would have to spend that $750no matter which class you what yon give up to take the History of ~azz class is still the Beginning Tennis

........... c~s~,..,p erio cL~you ..would-have £o- spend-that-S7-50, either-way. ,But. suppose.-there isnt~ ........................................................................................ ~fee for the tennis class. In that case, what you give up to take the iazz class is the tennis class plus the enjoyment that you could have gained from the: $750 on other things. the real cost of~taking your preferred class is what you must give up to As you expand the set Of decisions that underlie each choide-wheth~r to take or not, whether to finish this term or not, whether to drop out or not: a![ costs are ultimately oppo~nity costs~. pay for something isia gooct indication of its : s not, One very impotent,example of how poor- ~ :’~" ....... r cost can indicate.opportunity cost i~ the cost Of attending college..Tuition - . ................... ¯ ............................

~ 8 PAR1:1 WHAT 1S ECONOMFC’S2

The answer is that a penny wasn’t At many cash tegisters-L~o~ example, the always such a negiigib[e sum: the one downstairs in our college cafeteria-purchasing power of a penny has been there is a tittle basket full of pennies. People are encouraged to use the basket to. greatiy reduced by inftation, a gene{ai rise in the prices of a{[ goods and services round their purchases up or down: if ft over time. Forty years ago, a penny had costs $5.02, you give the cashier $5 and more purchasing power than a nickei does take two pennies from the basket; if it today. costs $4.gg, you pay $5 and the cashier Why does this matter? Well, remember throws in a penny. It makes everyone’s life the saying: "A penny saved is a penny a bit easier. Of course, it woutd be eesieF earned." But there are other ways to earn still if we just abolished the penny, a step money, so you must de~de whether saving that some economists have urged, But then why do we have p6nnies in the a penny is a productive use of your time. first place? If i~s too sma|i a sum to worry Could you earn more by devoting that time about why catculate prices that exactly? to other eses~

Sixty years ago, the average wage was about $1.20 an hour, A penny’was equlvalent to 30 seconds orth of work--it was worth saving a penny if doing so took {ess than 30 seconds. But wages have risen along with overall prices, so that the aveFage worker is now pad more than $17 per. hour. A penny is therefore equNalent to just over ~ seconds of work--and so it’s not worth the oppor~unlty cost of the time it takes to worn] about a penny more or less.

In short, the rising opportunity cost of time in terms.of money has tun~ed a penny from a useful coin into a nuisance,

and housing are major monetary expenses for most students; but even if these thtfig~ were free, attending college wouId stil! be an expensive proposition because md~t co’llege students, if they were not in college, would have a job. That.is, by going tO d61te~e, students "forgo the income they could have made if they had worked [ ~t~. This means that the oppotlamity host of attending college is what you pay" f6b ~uitiibn and housing plus the forgone income you would have earned in a job. .It’s easy to see that the opportunity cost of going to college is espedally high for pe6~ple WhOcould be earning a tot dur£ng what would otherwise have beeii their colle~ ~i~s~ Tla~t is why star athletes like LeBron James often skip college. 5ome, like T~ef Wbeds’, leave before grad~atifig.

Is a Decision at the argin

Yo~ make a trade-eft when you compare the costs with the benefits of doing something,

SOme important decisions involve ~ "either-or" choice~or ~ample, you decide ei~er.toLgo tb college or to be~ wor~g; yo~ decide ei~er to ~ke eco~o~I~ or to t~e=:so~ethi~g else. But other imposer decisions i~olve "how ~uch" choices~for example, ~f you are taking bo~ economics and ch~i~ ~is semester, you must decide:how ~uch time to spe~d s~dfing for each. ~e~ tt comes to ~der~d~g "kow m~¢N’ d~isio~s, economics has an impo~m ~sight to offer: "how much" is ~ decision made at the mar#n. Suppose you are ta~ng both economics and chemis~. ~d suppose you are a pre=med s~de~t, so ~at your g~de in chemis~ ma~ers more to you ~an your grade ~n~conomks. Does that therefore imply that you should spend all your s~dy fime:6n.’~emIs~ and ~g~t on ~e economics e~m? Probably not; even if you t~ink’your chemi~ g~de is more impo~a~t, you should put some ef~rt i~to smd~ng,for ~onomks. ~ Spading more ~me ~dfing for e~nomics i~vol~s a benefit (a higher ~ted ~de ~n ~at course) and a cost (you could have ~ent that ~me dotn~ something d~:~c~ ,~s,~s~d~ng to get a higher grade ~ chemiC). ~at is, your decision I~o)ves{.B~e-off-a ~mpafiso~ of costs and benefits. Ho~:da’~ou decide this kind of "how much" ques~on? ~e ~ical Bn~er is that you ~ake ~e decision a b~t at a time;by as~ how you shoed spend ~e n~ hour. 8~::b~t~a~s are on ~e same day~ and the night before you ~end time re~g yoUF,~o~e~ for both courses: At 6:~ P.M., you decide ~at it’s a good idea to ~dat !~;~h hour on each course. At 8:00 P.M., you decide you’d be~r spend ano~er

mr on each course, At ~iO:00 r.M. you are getting tired and figure you have one more mr to study before bed-chemistry or economics? If you are pro-meal, it s likely to ¯ ~i ~:~ i~s’s ~f’a~ ~ c~vity are ~emistr55, if you are pre-MBA, it’s likety to be economics. . !i¢.Note how you’ve made the decision to allocate your time: at each point the ques- known as:ma~inal anal~, ~on is whether or not to spend one more hour on either course. And in deciding An ined~ve is ~n~in~ that offers ~hether to spend another hour studying for chemistry, you weigh the costs (an hour rewards t~ people wh~ chahge ~eir !~gone og studying for economics or an hour forgone of sleeping) versus the bene~ (a likely increase in your chemistry grade). As long as the benefit of studying or~e i~re hour for chemistry outweighs the cost, you should choose to study for that ~dttional hour. Decisions of this type-what to do with your next hour, what to do with your next i~ar, and so on-are marginal fledstons. They involve making trade-offs at’the marcomp~rfng the costs and benefits of doing a little bit more of an activity versus little bit less. The study of such decisions is known as marginal analysis. Many of the questions that we face in economics--as well as in real hfe-involve ’ workers should I hire in my shop? At what mileage the oil in my car? What is an acceptable rate of negative side effects neW medicine? Marginal analysis plays a central role in economics because it deciding "how much" of an activity to do.

Usually Exploit Opportunities Make Themselves l eLLer Off while listening to the morning f’mandal news, the authors heard a great tip park cheaply in Manhattan. Garages in the Wall Street area charge as $30 per d~y. But ~ccording to the n~wscaster; some people had found a r way: instead of parking in a garage, they had their off changed at the Manl~tattan. ~ube, where it costs $19.95 to change your oki-and they keep your car all day! a great story, but unfortunately it turned out not to be true-in fact, there is e in Manhattan. But if there were, you can be sure there would be a lot Because when people are offered opportunities to make , normally tak~ them-and if they could find a way ~o park r car al! day for $!9.95 rather than $30, they would. predict how individuals will behave in ~u economic situation, it L very good bet that they will exploit opportunities to make themselves~etter off. conttn~ to. ~91oit ~h~.0pp0rt~n.~fl~ ~tfl they have i ifuiiy exhausted-that is, people wi!I exploit opportunities until tho~e ~pportunii have been fully exploited. I~ there really was a Manhattan Jiffy tube and an oil change really was a cheap way car, we can safely predict that before long th’e waiting list for oil changes ff not months. ~ fact, the principle that people will explok opportunities to m~ke themselves bet:Off is the basis of all predictions by economists about individual behav~ur. If the of those who get MBAs soar while the earnings of those who get law degrees we can expect more students to go to business school and fewer to go to soline.r[ses.and~sta~s~high for an.extended period of time, we ....... ...... ~ ........... to buy sm~!ler cars with higher ~. ~l~age-rn~king themselves presence of higher gas prices by ~riving more fuel-efficient cars. in the avallabIe oppoiunities o{f~.#~wards to those who change we say that people face Dew incen~. ~If the pric~ of parking in n find alternative ways ~ g~t to their W~!I S~reet jobs ~, doiDg ~9-and so we can expect fe~.~r pgople to 4tive to work. economists tend to be skeptical of iny ~tempt to change people’s . : doesn’t change their incentives, l~or exam~ie, a pl~%n thgt calls on ma9to reduce poI1ution voluntarily p~pbably wont be effective; a plan that financial b~c~ntive to reduce p6iluti6n is~ lo~c more l{kely to work.

exams,:,.At.Pa~mtt ~iddie 5choob which }. offered ~he highest amounts, ~n eighth! grader with a top scorn on an exam i received a $50 savff~gs hoed,

Many people questioned the monetary ¯ a&ards. In fact, the great majori~ of teachers feel that cash rewards for learning am a bad idea=-the do[far ameunts cant ¯ be made large enough to give students a real. sense of how impoRant their education is, and they make learning seem lik~ work-for-pay. S~ why did the school~ engage in the practice? The answer, it turns out, is that the previous year the state government had introduced a pay-for-performance scheme for ~chool~: schools whose students earned high marks on the state exams ~’eceived ex~ state funds. The problem arose of how to motivatethe students to take the exams as seriously as the school,

administrators did. Pauot~s principal defended the pay-for.grades practice by poidfin~ out that ge~d s~uiJ~fits wbul~ orbed "~hristma~ tree" their exams--ignore. the questions and fil.l, ou~ th~ bubbl.e shee~s in the’sh~’pG of [~ristr~as ~r~. Wlth’large sums of money for the school, at stake, derided to set aside hi~ mlsgivings and pay stud6~f~ ~’do weft on the exams, Doe~ p~dng students for:grades l.ead to higher gn~de~? Interviews with stadents suggest ’that i~ does spur pt !east: some’

stud~nt~ s61~e Fl.6~ ~choo~s th’~t h~v~ in£roduced re~rt sa b~G~fi&i inlp~@~e’~ts iri s~ad~nt performance.

B diVidua[ Choice: Summing Up have just seen that there ar~. four basic prh~dples of individual choice:

CHAPTER I FIRST pRINCIPUES

equipped with a washing machine; the same wash took 41 minutes, koning was ¯ reduced to 3.% hours, and the distance walked was reduced by 90 percent, o ;:,~i~’,~i~n omie actlviizie£ involve ,,, The point is that in pro-appliance da~s, the opportunity cost of working o.uts~de the People mu~ m ake.choices, b~ca use. home wa.s very high: it was sumething women typically did only in the face of dire m~o~c~s am scarce, .:, financial necessity. With modern appliances, the oppommifies available t? women ~q,~ cOsLof ~meth]ng,.~s wha~ changed--and the rest is history./a VQ~ ~s~ gjye up to get ]t--spec~: cally, ~ivlD8 up your n~,hest aite~naflve. A!~ ~o~ are Explain how each of the following situations illustrates one of the four principles of ind~,Adua[ choice. a. You are on your third trip to s restaorant’a atbyou-cau-eat dessert beffet and are feeling very full ALthough it would cost you no additional money, you forgo a slice uf coconut cream pie but have a slice of chocolate cake. b. Even if there were more resources in the world, there would stiff be scarcity, c. Different teaching assistants teach several Economics 101 tutorials. Those taught by the teaching assistants with the best reputations fiil up quickly, with spaces left unfilled in the ones taught by assistants with poor reputations. d. To decide how many heaps per week to exercise, you compare the health benefits of one mere hour of exercise to the effect en year grades of one [e~s hour spent steal’ring,

ti~ a’good indicafor o~ opp6rt~ nity costs,.but not always. Ma~y ¢~ cos are not whetherto do so~ethidg.b~t how much, "How much" choices are made by ma~g a i6de2~.~ at t~e margin, The s~udy Be~ause;,~[e ~ally ~ploit 6~off~hi~ie~ tO ~ake themselves be~er ~ff;:iBe~Bf!~es can change p~ple’s beh~i6K.

You make $45,000 per year at your current job with Whiz Kids Consultants. You are considering a job offer from Brainiacs, Inc., which will pay you $50,000 per year. Which of the followin~ are elements of the opportunity cost of accepting the new job at Bralniacs, Inc,? a, The increased time spent commuting.to your new job b, The $45,000 salary from your old job c, The more spacious office at your new job

Interaction: Bow Economies Work As we learned in the Introduction, an economy ~s a system for coordinating the productive activities of many people. In a market economy, such as the one we ll~e.in, that coordination takes place without any coordinator: each individual make~ his or ~er ov~:c,hoices. Yet those chokes are by no means independent of e~’~ther; e,ach individual s opportunities, and hence choices, depend to a large extea~t or/the choxces ..~de.by other people. So to..understand how a market economy behaves, .~e t~a~ to ~ne this’interaction in which my choices affect your choices, and When studying economic interaction, we quickly learn that the end result 6f individual choices may be quite different from what any one individual intends. For example, over the past crnt~ry farmers in the United States have eagerly adoptat new farming techniques and crop strains that ~ave reduced their costs and mereased their yields. Clearbl it’s in the interest of each farmer to keep up with the latest farming t~ch~itues. B~ the end result of each farmer tx3fing to inereas~ b.is Or her Prindpies That Underllb the ~ncom8 has ac~ally been to drive many farmers out of business. Because American Interactioe.of Individual Choices f~nO’s hay6 been so suece.ssf~ at producb~g larger yidds, agricultural prices have 1: There a~egains’ffom trade, .......... -st-~a’dR~fifll~ Th~-faIllln-g "~e~h~Ve. ~yd~it-c-dth-e~-c6m~-af’many-farm-ers;wad-~s. ......... ~:~:~s~l~’f4@~r and fewer people find farming worth doing. That is, an individual farme~ , 2, Markets move toward .equilibrium. @1~6 ~iantsa better variety of cam ~s better off; but when many. farmers plarit a better ¯ 3; Resotirces should.be used a~ efficiently as possible to achieve varigty of ~orn, the resultm~y be to make farmers as a grnup.w6rse off. socieb/s goals., ¯ A farmer who plants a new, more productive corn variety doesn’t just grow more corn. Such a farmer also affects the market for: corn ~hrough the in,reused fields 4. Markets usually Lead to efficiency.

a~:~ed with consequences that will be felt by o~:her farmers, cqnsumers, and beYOn& Just as there are four economic principles that fall under the theme of choice, there are five princlples that fall under the theme of interaction. These five principles are sum,m, ar~ed in Table 1-2, We will now examine each of these principles more closely.

5.. When markets don’t achieve efficiency, govemmeht intervention can improve sgciety’s welfare,

12

PART

WHAT IS ECONOMIC,S?

There Are Gains from Trade engag~ in .trade: fd)ey proyiFIo goods and services to others and receive goods end se/yices,io return.

Why do,the choices I make i~iteract ~th the choices you make? A f~mily could t~ to ~ c~re of all i~ o~ needs--~ro~n~ ~ o~ food~ se~n~ Ks o~ clothing, ing i~elf ~ ente~a~m~n~ ~g i~ o~ economics to.books. But ~ng to l~ve ~a}1 ~y would be ve~ hard, The key to a much be~r s~ndard of ]~Mng for one is ~a~e, in which people diode tasks ~ong themselves and each person proAdds a good or se~ce that other people ~t. in return for ~fferent goods and se~ces that he or she ~nts, ~e r~son we have ~ economy, not many self-suffident indi~duals, ts ~at there am gai~ ~om ~ade: by ~ng ~sks ~d ~a~ng, ~o p~pte (or 6 billion people) can each get more of what @ey want th~ they co~d get by being self-suffident Gains £om ~de aft{e, in p~cutar, £om this ~sion of ~sks, which economis~ speci~adon-a sima~on to which different people each engage ~ a ~fferent ~sk. ~e ad~ntag~ of spedAka~on, ~d the rst~ng ga~s £om ~ade, were the ing point for Adam Smith’s 1776 book ~e Wealth of Na~o~, which many reg~d as be~ng of economis asa discipline. S~’s book b~s ~ a des~ipfion of eigh~
M rkets Nove Toward Equilibrium lt’d~ briny afternoon at the supermarket; there are long lines at the checkout counters, T~, ~n one of the/~revtousty dosed cash registers opens. What happens? Tt~ :~ir~t thing that happens, of course, is a rush to that register, After a couple of miiiUices,: however, things wilI have settled down; shoppers will have rearranged

themselves so that the line at the newly ’opened register is about the same length as the lines at all the other registers: How do we know that? We know frdm our fourth principle of ~ndlvidual choice that people will exploit oppor~anities to make themselves better off. This mea~s that people will rush to .the newly op~ned register in order to save time standing in line. And thi~g~ will settle down when shoppers can no longer improve their position by.switob3ng I£nes-that is, when the opportunities to make themselves better 6ff have all been exploited. A story about supermarket checkout lines may seem to have little to do w~th how L~div~dual choices interact, but in fact it illustrates an important principle. A siImation in which individuals cannot make themselves better off by doing something different--the situation in which all the checkout lines are the same length--is what economists ca!! an,equilibrium. An economic situation is in equilibrium when no individual would be better off doing something different. Recall the story about the raythical Jiffy Lube, where it Wgs supposedly cheaper to leave your car for an nil change than to pay for parking. If that opportunity had really existed and people were sdI1 paying $30 to park in garages, the situation would not have been an equilibrium. And that should have been a giveaway that the story couldn’t be tree. in reality, people would have seized an opportunity to park cheaply, just as they seize opportmqities to save lime at the checkout line. And in so doing they would-have eliminated the opportunityl Either it would have become very hard to get an appointment for an off change ov the price of a lube iob would have ~creased to the po~t th~ it was no longer an attractive option (unless you really needed a lube ’iob).

~ h’~ighborhood supermarket,

As we will see, markets usually reach equilibrium via changes in prices, which rise An economic situation is in equilibrium or fall until no opportunities for individuals to make themselves better off rema.i~, when no individual would be better eft The concept of equilibrium is extremely helpful in understanding economic inter- doing something different actions because it provides a way of cutiing .~. roughthe someffmes complex details o~ those interactions. To understand what happens when a new Itne is opened a~ a ¯ market, you don’t need to worry about exactly how shoppers rearrange themselves, Who moves ahead of whom, which registez just opened, ~nd so on. What you need to know is that any time there is a change, the situation wiIl move to an eqpflibrinm.. ’:.

course, which side you drive on is deterdepended on the dominant form of ~’:ii:~Y do people in America drive on the m~ned by taw; some ’countries have even traffic, t4~n riding ho~se; and carrying !i. i?~.F~ght side of the road? Of course, it’s the taw. But Long before it was the taw, it was swords on their left hip pteferred.~o ride changed sides (Swede~ went from Left to on the Left (think abe)at getting on or off right ii,ae equilibrium, ~he horse, and you’ll, see why). On the ~ns? Them are no Laws--but there are ~ ~,.:;~ Before there were format tra~c taws, ~¢ tbera were fofon~al "ruins of the road," other hand, right-handed I~opte walking . informal rules, In the United 5tares, it i~[~e..%..t_h.a~t..e~F~e.’.R~Pe~&d’e~e~lone hut leading~horses apparently preferred to ---urban pedestrians normally keep to the ....... ¯ .fight. Bet if you shodld happen to v~sit a walk on the right, : , else to ~ltow. T~ese rules incioded an country where people drive on th~ [eft, g fJ~at people would normally ;Zn any ~a~, o,qee a role, of, the road ;;keep to one side of the road. In eome wa~ ~abtished, there., weAe strong focen= w~tch out; people who drive on the tires.lot each lndivi, dual ~:o stay on the also typicaliy waik on the left. So when as England, the rule was to ,in a foreign country, do as ~he L~)cais do. to the left; in others, sudh as France, "usRai~’. side of tbe4.road~ those who didn’t :,was to keep to the right. would ~e~p cgii:id~eg with dncoming tra~-- ~ ,,You won’t he arrested if you walk on the b.: VOhy would some places choose the fiG. So once established, th~ lute of the l;:~.flght, but you wiU he worse off than if ~, the left? That’s not road wouid be,:self.,~nforcing-~-that is, it. ,~ypu accept the equilibrium.and Waik on clear, although it may have would be’a~ e.q~itibrium. Nowadaye, of ., ~he ieff.

~, .,,~e fact that markets move tovcard equilibrium is why we c~a depend on them to work ~"<~ii~edJctabte wa}; in fact we can trust markets to supply us with the essentials of life, l~-~ple, people who live in big cities can be sure that the supermarket shelves will ~ be fully stocked. Because If some fo~lwho didn’t ,:i! ¯ m~:’~elivefies a big Why? profit opportunity wouldmerchants be createdwho for d~stribute any merchant did~[ !!~ I’ and
’ , ~ , Resources Sho~td [}e Used as Efficiently as Poss bt

¯/:;?

:iii-i::~ii!’,:!i:::: !::i, ~ !: -!: ~. i~ppo’se you are tatting a course in which the classroom is too small for the num : :~::!!i:.~:: ! i:!i~ ~ii: :~’:,.;::::~ :!",:. :)i~:~ ’?,~Y~dents-many people are forced to stand or sit on the floor-despite the fact that ,jii~!ii:i:i~.!:~~.’:’ .~..::,i’" l~gel empty classrooms are available nearby. You would say, correcfly,that this is no ¯ ’i:i:~i’~? ~:2:11:):...,~i!.:! ,,, : ~r~to~un a college. Economists would call this an inefficient use of resources, ’" ~,ii~i~:,~ :. : :~i~ if an inefficient use of resources ~s undesirable, iust what does it mean to use resources Oficimtly? You might imagine that the efficient use of resources has somethi~a~ to do with money, maybe that it is measured in dollars-and-cents terms. But in economics, as in life, money is only a means to other ends. The measure that economists really care about is not money but people’s happiness 6r welfare, Economists say that an economy’s resources are used efficiently whe~ they are used in a way thief fias fully exploited all opportunities to make everyone better off. To put it ariothd~f way, an economy is efficiel~t ff it takes all opportunities to make some peoi~le better off without making bther people worse off. Iii our classroom example, there deafly was a way to make everyone better offm~i~g the. ttas~ to a larger room would make p~opte in the class better off without : ~¯ 1~%~afi~,one else in the college. Assigning the course to the smaller classroom was : :, . . ¯ ¯~ ~:~nefficient Use of the coIlege’s resources, whereas assigning tl~e course to the Iatgi :~; ~.::i : ~ er cl~s~t66~outd have been an efficient use of the college’s resources. "~: ":’ ~en an economy is efficient, it is producing the maximum gains from trade possibl~’ give~ .the resources available. Why? Because there is no way to rearr~y~g~, h.9..w.. .... r~rces ai?~ used in a way that can make e~dr~one ’dett~r off. Wh~°ah’ e~dnomy i~!;: ef~i~nt, o~eperson can be made better off by rearranging how resources are used only by maI0ng someone else worse off. In our classroom example, if all larger classrooms Were already occupied, the coltege would have been run in an efficient way: your class could be made better off by moving to a larger classroom orfly by making people in the ’lhrger classroom worse off by making them move to a smaller elassrodm. ": Should economic policy makers always strive to achieve economic efficiency? Well, not quite, because efficiency is not the only criterion by which to evaluate an ~cono~ay. People also care about issues of faimessi or equity. And there is typically a tmde-dff between equity and effiden~: policies that promote equity 6fren come at ~g cost of decreased efficiency in the economy, and vice versa. To see ~his,. donsider the case of disabled-designated parking spaces in public p’arkin/~ lots; Many people have great difficulty walking due to age 6r disability, so : it seems ’0nly fak to ~ssign elose~ parking spaces specifically for their use. You may have ndficed,’]rowevhr, that a certain amount of inefficiency is involved’. To make shre that there is always an appropriate space available should a disabled person ~’~r~t 6~,~there are typically quite a number of disabled-designated spaces. So at afly ofi~’firfl4:there are typically more such spaces avallabIe that5 there are disabled people who want one. As a result, desirable parking spaces are unused. (And the

CHAPT~.R ~ ’ F{RST

PRINCiPlES 15

:emptation for nondisabled people to use,them is so great that we must be dissuaded ~y fear of getting a ticket.) So, short of~airing parking valets to allocate spaces, there s a conflict between equity, making life "fairer" for disabted peopte, and effl.dency, naking sure that nil opportunities to make penple better off have been fully exploited ~y never letting ctose-in parking spaces go unused. Exactly how far policy makers s]~o£fld go in promoting equity over efficiency is a lifficult question that goes to the heart of ~e political process, As such, it is not question that economists can answer. What is important for economists, however, ~ always to seek to use the economy’s resources as efficiently as possible in the ?ursuit of society’s goals, whatever those goals may be.

Markets Usualty Lead to Efficiency ~Io branch of the U.S. governmea~t is entrusted with ensuring the general economic ff’ficiency of our market economy-we don’t have agents who go around making sure iat brain surgeon( aren’t plowing fields, that Minnesota farmers aren’t trying to ~bw oranges~ that prime beachffant proper~y isn’t taken up by used-car dealerships, ~at colleges aren’t wasting valuable classroom space. The government doesn’t need to enforce efficiency because in most cases the invisible hand does the iob. In other words, the incentives built into a market economy already ensure that tesourcos are usually put to good use, that opportam~ties to make people better offare dot wasted~ tf a college were known for its habit of crowding student.5 into smalt 5assrooms while large classrooms go unused, it would soon find its enrollment drop~i~g, putting the obs of its adm~istrat~rs at tick. The "market" for co~leg~, ~’~hld respond in a way that induces adr~niztrator~ to rma the college $;’.’~ detailed explanation of why markets are usually ?e~y good at making sure’that ~gurc~s are used Well will have to vcalt cntil we have studied h;w" ~rkets ~l~y ~ork. But the most basic reason is that in a market economy, in which individuals, are fi~ to choose what to consume and what to produce, oppOrlzmities for mutual gain are ~’~traally take~. If there’is a way in Whkh ~6me people c~n be.made better off, people ~ usually be able to take advantage 6~ that 0bp~t~. And that is exactS/ ~nes efficien~j: a~l the o~6~prtur~ties to m~ke some people better offw~thout making

p ople worse off have be i: Ioi dL

"

~t’As we learned,in the Introduction, ~owever, there ar~ exceptions ~? this t~a~iple ~’~ markets ai~ ~rally effiel~n(. I~ eas~ Of market failure, the tndividu~!~sui~ ~2interegt fotind in mfirkets makes sodety worse off-that is, the mak~t outcom~ is ..... ""’~ ................. ~"’ inefficient. At/d, as we wi!l see in examining the next principle, when markets fail, ~etnment intervention tan help. B~tt short of instances of market failure, the gen~[ ~:~ie ~ ~ r~k~kets are a remarkably good way of organtzh~g an economy. ....

:,hen Markets Don’t Achieve Effkienoj, 6overnment i ervention Can Improve,Society’s Wetfare, ~;a xecali froN the Introduction the natfire of th~ market faiiure caused by tra.ffi~ :~on.. ~]~n-a commuter driving to work has no incentive to take into account the cost that " ~;!or. her actior~.inflicts_on.other_dr~vers~ the form.of ina:ea~ed traffic co~age~iion. ; .......... i...i~.~... ....................... i .................... ~ere are severn possible remedies to this situation; examples include charging mad .; ~i subsidizing the cost of publid transportation, mad tmfng sales of gasoline to indiiduai drivers. All these remedies work by changing the: ~ ~_~. ~v,es 5rating them to drive Iess, and use alternative trafi~i~tiono,Bht they :alsog~h~te ther feature:,each, reRes,on ~government intervention jn:the~market .... .’his brings ~s to our: fifth and, last.principle of i~teraction: Vghen .markets don’t !eve efficiency, government intervention can improve society’s welfare. That’i%"when ~rkets go wrong, an approp~atety designed government,policy can’ somet~me~ move !~ty closer to an effident outcome by chmaging how’~ociety’s res~hrces are:used~

WHAT IS ECONOMICS?

A very important branch of economics is devoted to studying why markets fail and what policies should be adopted to improve social welfare. We will study these problems and their remeddes in depth in later chapters, but here we give a brief overview of three principal ways in which they fail: ~ Individual actions have side effects that are not properly taken into account by the market. An example is an action that causes pollution. ~ One party prevents mutually benefidal trades from occurring in an attempt to capture a greater share of resources for itself. An example is a drug company that keeps its prices so high that some people who would benefit from their drugs cannot afford to buy them. ~ Some goods, by their very nature, are unsuited for efficient management by mazkets, An example of such a good is air traffic control, An important part of your education in economics is learning to identify not lust when markets work but also when they don’t work-and to )udge what government polities are appropriate in each situation.

ACTION Restoring Equilibrium on the Freeways B~ck in 19~4 a powerful earthquake struck the Los Angeles area, causing severa! freewa~;-’#ridges to collapse and thereby disrupting the normal commuting routes of hun-

o~.detqra~" .a!’ound the blockages by using city streets. ’P~blfc OffiCials an~:~e~ pr.q7 ~ tr~iel, reschedule their work to com=i~ ~fore or afro7 ~e.~, ?[.~,# mas~ transtLiTbes~ warnings were unexpectedly eff~fi~ce. I~. fact~ {o marly peGp!~ heeded A feature of most economic sitoa~ tlons is the intelaction of choices ’mode by indMduals, the end resuit of which may be quite different from what was intended. In a market economy, interactio9 takes the form of trade between individuals. tndMduals interact because there are gotns from t~de. Gains from trade arise from specialization, Economic sltuatlons normally move toward equilibrium, As far a~ possible, there should he an efficient use of resources to ~chieve socieff’s goa’~. But efficiency i~ qot the only way to evaluate an economy; equl~ may also be desirable; and there is offen a trade-off between equity and efficiency. Markets normally are efficient, except ~r certain welt-defined ~xceptioes, When markets fat! to achieve efficiency, government Inte~eotion can improve society’s welfare,

fia~a’~at i~ the fikst few days following t}~ qu~K~ ~ose ~Iaf ¢01mu~ routine a~atly found the drive t0.and of co~se~ ~is situation could not tasL As wo~d @~e~d ~at~ bad at a~,. people ab~doned ~elr l~s con#~fiient n~ rev~ea ~eir cars-and ~amc got s~dily worse, W[~ a quaY, s~ious ~affic jams had ap~aredi ~er a few ~ore wee~, however; ~e situation s~bil~e& ~e realIW of wor~-than-usuaI conges~on d~courag~ enough drivers t~ prevent ~e nigh~e of ci~de gri~ock from mattering. Lo~ ~gdes. ~ffic, in s5oA, had se~ed into a new equiSbfium, Jn whi~ ~ch co~utef ~s m~king ~e be~ &o~ce he orshe could, given what ~e~one else ~s’doi~g.

~’ ~e q~ak~ ~l ~e ~ways were back to no~, r~dy fo~e

~1-2 .... , - , . ,,,..’ £ .Explain how each of the for[owing situatio~ illustrates one of the five principles of fnterattlon, ".’ a:. Using the’(O[[e~e website, any student.who wa’nts to sell a u~ed texthot)k fdr at4~as~ $30 , is:able to self it to someone who is willing to-pay $30. "’" ""’ " , b:~ At~:~co[[ege tutoring co-op, students can ar[an9~ t~ provide t~toring in subjects .thee/are . ,,,~ood in (like economics) in re~urn for receiving tutoring i~. subjects they are poor in (like

p~iosophy),

c. "Phe rock[ municipatit~ imposes a Law that requires bars and nightclubs near r~sidentia[ areas to keep their noise revels below a ce~a n thresho~... d. To preNde be~er ~m for tow-income p~ien~, &e 1o~[ municipati~ has dedded~o close ¯sorer undem~[ized neighbe~ood c[in~ and sN~ ~nds to the main hospital e. 0n the cortege website, books of a given ~t[e M~ appro~mate[y the same rear of y~ear and tear set[ for about the same p~ce. Which of ~e ~Eo~ng d~c~bes an eq~[ibdum sit~#on? Which do~s not~ ~p[ain your a~wer. a. ~e ~umn~ acro~ the strut #ore &e unfversi~ dining haft sewe be~er-~s~ng and cheaper meaB than those sewed at the universi~ dining haLL ~e vest majority of s~den~ conSnae te eat at the dining hart, b. You ~rrentty take the subway to work. ALthough taking the bus is cheaper, the dde ~kes [onger. So you are M[ting to pay the higher subway ~re in order to save

Economy-Wide InteracUons As we mentioned in the Introduction, the economy as a whole has its ups and downs. For example, business in America’s shopping m~Is was somewhat depressed in 2002,

because the economy hadn’t fully recovered ~rom the 2001 recession. To understand recessinns, we need to unders~ud economy-wide interactions, and understanding the b~g picture of the economy requires understanding three more knpo~ant economic

principles. Those three economy-wide principles we summarized in Table

One Person’s Spending is Another Person~S !n.,2001, corporations that had been buying a lot of computers, software, and ~other high-tech supphes in the late 1990s suddenly decided to cut back on their pttrch~ses. me result, economists agree, was a recession caused m~inly, by these cuts in business investment spending, As we mentioned in the previous chapter, this was followed by a sharp drop-off in spending at the nation’s retail stores. But why should a cut in spending by businesses mean empty stores in the shopping mails? After all, malls are places where f@mil~es, not hustlerss, d~ t~e, ir shop-, ping The answer is that lower bus heSS spending led to low~ ificor~ ~6flghou~ the e~onomy, because people who had been m~king those ~omputess ~r d~i~t)in~ t.b~,t soffwam either lost their jobs or were forced to take pay cfl~s,:And ~s ific~flies fell, sb fl~d spending by consumers, ,. This stoY/illustrates a general principle: One person’s ~ending is another person’s income. In a market economy, people make a living se!ling things-including their l~{bor--to other people. If some group in the economy decides,’ for whatever reason, ~ spend more, the income of other groups will rise. If some group decides to spend !ess~ the income of other groups will fall. ’ ’L~ Because one pe~on’s spending is another person’s iqFome, a chain reaction of chan~es .in spending behavior tends to have repercussions that sp~-~ad through th~ ec0~omy. For ~:ample, a cut in business tovestment spending, like the one that happened in 200I, leads tO, reduced family incomes; families respond by reducing consumex spending; this lead~,to’ ~d~ ~6i~fia-b-f fi~c-’~u~ an’~-d so----0"~7~-~ercussions pi~y an important role in ! ,o,~u~, ~derstanding of recessions and recoveries,

i-~Veraff. ~nd~ng Sonietimes Gets out 6f’Lilne i~!,th the ’Economy’s Orodu~tive ,capacity, ’.

Prindp|es That UnderLie Economy-Wide Interactions I, 0he person’s spending is another person’s income, 2. Overa[[ ~pending some~me~: gets out of Line with the economy*s productive cBpadty.

3. Government po[kies can change spending. ¯ ", ~:. ~. ’ ...

~i~!~oeconomics emergdd as a ge~arate branch of ’~6fl6~ics’inl ~’~ 1930s, when !~’~t’l~se~ of consumer ~ind busir~s~ ~pending, ~ c~isi~’ i~!’:th~ baizFJng::ii~dqsfl’%. ~d :;16"~h~ ~ fa~tdr~ led t6: ~ plunge in bveralt spending. ~his~)[i~h~ ~ sp~fldi~g,’ iii ~rri’, ~,!to a period of very high unemployment known as the G~E~t’!~ep~ibfi: .... ~ ~’ ":

The:~lesson economists learned from the troubles of the 1930s is that overall ~pending-the amount of goods and sel-vbces that consumers and businesses want to bUy-sometimes doesn’t match the amount of goods and services the economy is capable of producing. In the 193Os, spending fell far short of what was needed to kee~ American work.s employed, and the result was a severe economic slump. In tact, shortfalls Jn spending are responsible for most, though not all, recessions-although nothing like the Great Depression has happened since the 1930s, It’s also possible for overall spending to be too high. In that case, the economy experiences in)q~tion, a rise in prices throughout the economy. This rise in prices occurs because when the amount that people want to buy outstrips the supply, producers can raise their prices and still find willing customers.

Government: Policies Can Change Spending Overall spending sometimes gets out of line with the economy’s productive capacity. But can anything be done about that? Yes, a lot. Government policies can have stron~ effects on spending, For one thing, the government itself does a tot of spending on everything from r~iitafi! equipment to education-and it can choose to do more or less. The governfibe~t can als’o v~ry how much it collects from the public in taxes, which in turn iffec~s how much income consumers and businesses have left to spend. And the eYh~ent’s control of the quantity of money in circulation, it turns out, ~ves it another powerful tool with which to affect total spending. Government spending, taxes, and control of money are the tools of macroeconomis policy. Modern governments deploy these tools of macroeconomic policy in an effort to manage overall spending in the economy, trying to steer it between the perils of reces~idh and inflation. These efforts aren’t always successful-recessions still happen, and so’do perinds of inflation. But it’s widely believed that the growing sophistication of fnht~e~ono~htc policy ts an important reason why the United States and other major i~0hbniies seem to be more stable today than they were in the past.

CONOM1zC$ .[N. AC ’ION ntures in Babyslt ing The website myarmylifetoo.com~ which offers advice to army families, sugges(s that pa~e~ts ioin a babysitting cooperative--an arra~ngement that is common in many ~ll~s of life. In a b~by~itting cooperative, a numhe~ of parents exchange babysitting se~es rather than h~re someone to babysit. But how do these organizati~ns make S~e ~hat everyone does their fair share of the work? As myarmyllfetoo.com explains, "i~st~ad of money, most co-ops exchange tickets or points. When you need a sitter, ~i’~!I a friend on the list, and you pay them with tickets. You earn tickets by bt~y~!tting other childrefi within the co-op." :?~Ifi 6~e~ words, a babysitting co-op? Is a mh~datufe economy in which ptople buy and ge~ ~I~ti~y~i~g sercices. ~d it happens to be a type of economy that can ha~e macro~c~fibinl~ p~bblemst A famous ar~ele titled "Monetary Theory and the Great Capitol Hiil B~bysitting Co-Op~%is," published in 1977, desetibed the troubles of a bahysi~ng cooperative that issued too few tickets. Bear in mind that, on average, .p.eople in a baby~ittLng co-op want to have a reserve of tickets ~shcd a~y. !r~ ca~ ~y, n.eed ~o go out sev~ra~ times before they can replenish their stash by doLng som~ mote ~a~ysttting. ’In this case, because there weren’t that ma~y tickets out there to begin ~th, mo~t pa~ent~ v~ere a~xious to add to their reserve~ by.babysitting but reluctant to run them ~q ,~.v~¢~o~ g.~Lng out. B(~t one parent’s derision to go out was another’s chance to baby~t ~9~it’ became difficult to earn tickets. Knowing this~ parents became eve~ more reluctant to ~se their reserves except on special occasions.

CH.~PTER 1 FIRST PRINCIP

:~’, Recessions in the larger, nonbabysitting economy are a bit m~’e complicated than is~but the troubles of the Capitol.Hi!! babysitlning co-o,p, demon,..~sW.a, te two c~,.our tee principles of economy-wide interactions. One person s spending is a4aother pern°s income: oppommities to babysit arose only to the extent tha~ otlie~ people went it. And an economy can suffer from too littJe spending: when not enough people ¯ .re willing to go out, everyone was fruslz~ted at the lack of babysitting, opportunities. And what about government policie~ ho change spending? A~ally, the Capitol ili c6=op did that, too° Eventually, ~t solved f~s probl~ by handing out more tick~, and with increased reserves, people were willing ~o go out more. ~.

F~p[ain how each of the following examples ~llustrates one of the throe p6ndples of economy-wide inter~ ~ck~oes. a, T~e Where Hous~ ~rged ~on~mss to pass ma~br ta~ cu~n the spring of 200L when it ~ecame clear that ~e U.S. economy was expeffendng a"siump, b. Oil companies are ~nves~ng hea~[y in proje~ that will ~ract o~[ from ~e %i[ san~s~ of Canada. ~n Edmonton, A~e~, near ~e project, res~uran~ and other consumer b~sin~ses are booming.. c. In the mid-200~, Spain, whkh was expedendng a big housing boom, a~o ha~ the highes~ in~a~on ~te in Europe,

~e twetve basic principles we have described lie behind almost all ~eo~omie analys. Although they can be immediately helpful in understanding many situations, my are usually not enough. Apptying the principles to real economic issues takes ~e.more step. That step is the creation of models--atmplifled representations of economic situ:ions. Models must be realistic enough to provide real-world guidance but simple ~o{Igh,~b ~low us to clearly see {he impli~{d~n~ ~f the princi~]~e~ ~e~:~ed i:~{his aal~ger~ $o .our next etep is to show how modeis are used ~:o actually dR economic ~:ly~!s.] ’: _. ..............

Because indMdiJals in a market economy dedve their income seliin8 thin~s, Inciudln8 their labor, to other people, one person’s spendin~ is another pe~on’s income, ~ a resul~ chan~es in spendin8 behavior tend to have repercussions that spread through the e~onomy. Ove~l[ spendin$ sometimes ~ets ou~ of line with ~e econom~s ~paci~ to produce go~d~ and When ~ending 1~ ~b low, the result ls a r~esslon. Wheh spehdin~ ~s too hi8h; It ~u~s l~flat~on. Governments bav~ a number o~ tooi~ at theiE dis~sal that can sao~ ~ff&~ ~h~ o~r~il lewror spending; M6aem ~bverAments use these tools inan effort to steer the economy be~een the perils of recess ona~d nflation,

~,:.~;~orp2nities change~ so do~s behavior: people respond Interactlon--my choices depend on your ~hoices, vice vkrsa-adds another level to economic tmder~tanding. When individuals interact, the end result max be differe~ from what anyon~ intends. The x~ason for interaction is that there are galr~ from trade: by engaging in the trade of goods and services with one at/other, the members of an economy can all he nfade better off. Underlying gains from trade are the ad#antages of speciatization, of having individuals speci~itze i’n the tasks they are good at, 9.,Economies normally move toward equilibnllm-a situation in which no individual car/make himself or herself b~tter off by taking a different action. 10.A~I ~cgpozay is effl¢ient ff all opportunities to make some people better off without making other people

Individual cbnic~ p, ~ Resource, p. 6 Scarce, p. 6 Opp~ co~, p. 7

MargteaI decisions, Marginal encysts, Incentive, Intera~on,

worse off are taken. Resources should be used as dently as possible to achieve society’s goals, But efficiency is n~t the sole way to evaluate an economy, eqtuity~ or fairries~,’is also desirable, and there is often a trade-off between equity and efficiency. Markets usually lead to efficiency, with some weltdefined exceptions. When market~ fail and do not achieve efficiency, govern~ meht intervention can improve sodety’s welfare. 1~, One person’s spending is another person’s income. Overall spending in the economy can get out of line with the economy’s productive capacity, leading to recession or inflation. 15. Governments have the ability to strongly affect overall spending, an ability they use in an effort to steer the economy between recession and inflation,

Specialization, p. 12

Equity, p, 14

in each of the following situations, identify which of the"" ’" g. There is tiraited lab space available to do the ~roject rectuire~i ll~ Chemistry 10% The lab supervisor assigns lab twelve principles is at work, time:to each student based on when that student is able

a. You choose to shop at the local discount store rather than paying a higher price for the same merchandise at the .... h.You realize that yon can graduate a sefiaerter early by local department store. going a semester of study abroad. b. On your spring break trip, your budget is limited to t. At the student union, there is a bullet’m bgard 9n:wh~ i~: 1; $~5a day. people advertise used items for sale, ~h~-~ ~1~ l~ldycle~: Once c, The student union provides a website on which departing you have adjusted for differences in quality, all the bikes ¯ ,ajt~a.d~n~ ~an s~ll iter~ s~,ch,.~ ~{sad ~99}~s, xppliance% sell for about the same price,

~1~ 6f ~t: Cfispin~ hd~eU~s wafit~ to pu~has~ ~. :~y ~ore bnil~g ma~ ~nd hire many more ~,’/’. ~6tkerg:tha~ were available¯ on the tsl~d. As a result, ,~rice~ for goods and se~ces rose d~mafically across the board, . e.~ou b~ a used textbook horn ~our roomma~. Your :~ommat~ u~ ~e money to buy soags ff5~ iTf~es. fl You decide how m~ny cups of coff~ go have whm :;, ::3~g:the night before,an e~ by consideri~g hpw mu~ mote ~rk you can do by.~ving ano~ cup versus how

j. Yo~ ar~ better at iierforming lab experiments, arid your lab ’ ~er is better at writing lab rep6tts. S~ ~h~ ~:wo 6f ~ou agre~ tiiat ~,ot~ will do’all the experiments, and she will write up el! the reports. k. State governments mandat~ that it is ill~gal to drive without passing a driving exam, L Your parents’ after-tax income has increasedbe~attsff of a tax cut passed by Congress. They therefore increase ~o~r all%,~i~ce, which you spend on a sl~ing break ~tcat!~n. Describe some of the opportunity costs whe~ you deride¯to do ¯ the foI~owing. a. Art(rid college instead of taking a

CHAPTER 1

b. Watch a movie instead of studying for an exam ¯ ,. e, Ride the bus instead of driving your,Ear ’, ’ 3. Liza needs to buy a textbook for the next economics class. The price a{’the college bookstore is $65. One online site offers it for $55 and another site, for $57. ~11 prices include sales tax. The accompanying table indicates the typica! shipping and handling charges for the textbook ordered or~ine.

Standard shipping Second-day air Nex>day air

3-7 days 2 business days I business day

$3,99 8,98 13.98

a.’V~xt is the opportunity cost of buying online imt~ad of at the b60ksture? Note that ff you buy the boo~ 6nline, you must wait to get it. b. Show tile relevant shoices for this student. What determines which of these options the student will choose? 4. Use the concept of opportunity cost to explain the following. a. MOre people choose to get graduate degrees when’the job market is poor. h. More people choose to do thetr own home repairs when the economy is slow and hourly wages are down. c. There are more parks in suburban than in urban areas. d. Convenience stores, which have higher prices than supermarkets, cater to busy people. e. Fewer students enrol! in classes that meet before !0:00 A.M. S. In the following examples, state how you would use the prtuciple of marginal analysis to make a decision. a. Deciding how many days to wait before doing your lanudly b. Deciding how much library research to do before writing your torn paper .... " e. Deciding how many bags of chips to eat d. Deciding how many lectures of a class to skip 6. This m6ming you made the fullowing Ladividnal choke~: you bought a bagel and coffee at the local card, you ~rove to schoo! in your car during rush h?ur, and you type~t your roommate’s term paper because ypu are a fast typist-in return for which she will do your laundry for a month. For each of these actions, describe how your inddvidual choices

FIRST PRINCIPi

a. Tire two families are made better off when the Hatfields ........ specialize in raising chickens, the McCoys specialize in ¯ growing egrn and the two families trade, b.The two families are made better off when the McCoys specialize in raising chickens, the Hatflelds specialize in growing corn, and the two families trade.

I

8. Which of the following situations describes an equilihtium? Which does not? If the situation doe3 not describe an equilibtium, what wonld an eqtfillbfitml look like? a. Many people regularly commute from the suburbs to downtown Pleasantville. Due to traffic cong~gion, the trip takes 30 minutes when you travel by highway but only 15 minutes when you go by side si~eets. b. At the hiforsection of Main and Broadway are two gas stations One stafidn chases ~8,~00 per gallon for regular gas and the other charges $2.85 per gall6n. Customers can get sg~ce Lramediately at the first station but mu~ wait in a long line at the second. c. E;!e~3} stude~lt enroll~d in Economics 101 must also attend

a weekly tutorial. This year there are two ~ecti0ns offered: section A and section B, which meet at the same time in adjoining classrooms and are taught by equally g6mp~6mt instructors. Section A is overcrowded, w~th people sitting on the floor and often unable to see the chalkboard. Section B has many empty seats. 9.,In each of the.following cases explain whether you thin!~:~tEe situation iS’ ~fftOent or not. If it is i~ot" effldent~ What actions would in~e the situation efficient? a. Electricity ts included in the rent at your dorm. Some residents in your durra leave lights, computees, and appliances on when they are not in their rooms, b; ~i}d~&~h’ they cost the same amotmt to prepare, ~a n your dorm coherently provides too many dishes that ¯’ d~s. ~’{ ~ such. as tofu casserole, an~ too few dishes .... .’ t~at diners d~’l~ke Such as- rod@turkey ~h d~e~sing. ’ .......... c ~e "’~ 6 lme t fo a art~cu ~ cou~ e ex~#eds the spaces :’:, ~i~ thdr major are unahle to gxt ~ !~ceeven thougk " ~ :’b~er~’~h~ hr~ talons it a~ ~r~:dlecti4~ dS~get a space, il0).i~Disg0s{.fihe effi~ ency and ~quity imldicati~ns of each of the

~’::}8fig~ig~’polici{s’. ~o~v would ySa’ ~g ’about balancing the’ concerns of equity and efficiency in these areas? a. The government pays the full tuition for every co!lege student to study whatever subject he or she wishes. h. When people lose their jobs, the government provides

i¢~!. i~teracted w~th’the Individual’ choices made~by-other~:Were .......................... ~l~i~{"~3~i~{s--~l {fi~; ~a’i~i~i 5ne3. other people left better off or worse off by your choices in 11. Governments often adopt certain pol~cle3 in order to ~a~h case? desired behavior among their dfisens, For each of the followin policies, determine what the incentive is and what behavior the,::~ . 7. The Haff,e~d family live~ .on the east side of the Hxtainochie , ,gp, yemment wishes to promote. In each case, Ri~ver, arid the McCoy family lives on the west side. Each famthat the government might wish to change people’s behavior,:{i i!y~s die~ comists o{ ~ed chi&en and com~n-t~e-cob, and rather than allow their actions to be solely determined ~y thdi-i! ea~ is self-s~fident, r~sing their o~ chi&ens ~d ~o~ng vidual choice? their o~ corn, E~lain the con~tions under which ea~ of a. A tax of $5 per pack is imposed,on cigarettes. the following would be tree.

Economk Models: ~UNNEL VISION

T

N 1901 WILBUR AND ORVILLI~ WRIGHT BUILT in fact, you could say that eco~}ornic t~eory consists "~ something that would change the wqr]d, No, not mainly of a collect~on of models, a series of simplified rep~ the airplane-their successful flight at Kitty Hawk resentations of economic reality that allow ns to undez~would come two years later. What made the Wright stanc~ a variety of economic issues. L~ this chapter, we will ¯ l~others true ~dsionaries was their wind tur~el~ an appa- look at two econoriflc models that are credibly Importan~ ratus that let them experiment with many different in their own flg~c and ~flso illustrate why such models are ~slgns .for v~ngs and cdntrol surfaces. These experl- so useful. We’l! conclude with a look at holy economists ments gave them the knowledge that would make actually use models in their work. ~dv~er-than-air flight possible. "’ A miniat:ar~ airplane sitting motionless in a. ~ind tunnel isn’t the same tiring as an actual aircraft in flight. But it is a very useful model ~f a flying plane-a simplified representation ~ the real thing that can be used t9 ~fiswer crucia! questions, such as how mnc~ lift a given wing shape will generate at a given all., . Needless to say, testing an ~!rplar~e design : in a wind tunnel ts cheaper and safer than btfilding a full~scale version and hoping it w~l ~y. More generally, models play a crucial role i~" almost all scientific resd~rch-economics

Why models~slmplified representations ~- The drcu{ar~flow diagram, a of real~ty--p~y a cruclal role, in economics schematic representation Of the r ........... ~’S~ .........

describe the economy and predict its behavior, and normative’economics, WhiCh tries to prescribe economic poliC~

i~6aiparative adva~it~oe

s~m~mes disagree

e~dn6mic~, vih ch tfies~

23

u’re ~eading about economics in the W~I Street ]our~ or in yore" eco- A quantity t~at can tak~ on more than you will see many graphs. Visual images c~n make it much easier one value is tailed a vafiat~le, erbal descriptions, numerical information, or ideas. In economics, the type of visual image used to fadlitate understanding. To f~liy underthe ideas and information being discussed, you need to be familiar with how to these visual aids. This appendi~ explains how graphs are const!mcted and and how that are used in economks.

hs, Variables, and Economic Hode[s to attend college is that a bachelor’s degree p;ovides aeces~ to higherAdditional degrees, such as MBAs o~ law degree% increase e~mings even were to read an article about the relationship b~veen educational attainand income, you would probably see a graph showkng the h~come levels for graph would depict the idea more education increases income. ~’s graph, like most of those in depict the relationsl~fip betWeen tWo economic vati~bles. A variable quantity that can take on more than one value, such as the number of year~ of , the price era can of soda, or a household’s income. a this chapter, economic analysis relies heavily on models, simplif real situations. Most economic models describe the relationship ;, simplified by hotd~ng constant other variables that may affect relationship. ~or example, an economic model might describe the relationship the price of a can of soda and the number of ca~s of soda that consumers assuming that eve~hh~g else that affec~ consumers’ purchases of soda s constant. This type of model can be described mathematically or verbally, but’ the relationship in a graph makes it easier to understand. Next we show ~ graphs that depict economic models are constructed ~nd interpreted.

Graphs Work ~re based on a grid built around tWo perpendicula~ lines that values of tWo ~asiables, helping you visualize the relationship betWeen them. i~ understanding the use of such graphs is to see how th~s system works.

45

PART 1 WHAT IS ECONOMICS?

solid horizontal line in the graph is call~l the horizontal axis os x-eMs, and values of the x-variable-outside temperature-are measur~d’along it. Similarly, the solid ver~c~ line in the graph is called the vertical axis or },-axis, and values of the y-variablenumber of sodas sold-are measured along it. At the o~ghl, the point where the two axes meet, each variable Is equal to zero. ~s you move rightward from the origin along the x-ads, values of t~e x-variable are positive arid increasing. As you move up fl~m the orJg~n along the y-axis, values of the y-variable a~e positive and increasing. You can plot each of the five points A through E on this graph by t~iug a pa~r of Th .... numbers--the values that the x-variable and the y-variable take on for a g~ven polfft. ¯ " In Figure 2A-!~ at point C, the x-v~riable takes on the value 40 and the y-variable h~rizou~al axis or ~ axis The line along takes on the value B0. You plot point C by arawmg a une straight up n’om ~3 on me x-~s and a horizontal line across from BO on the y-axis. We write point C as which values of the’~-va~iable are 30). We write the origin as (0, 0). measured is called t~e valtieM axis or Looking at poL~.t A arid point B in I:igttre 2A-t, you can see that when one of the ~ ..;p_axis. The I~oint where the axes of a ! ........ - "-="eei two variables when the value.taken By i one variable directly influences or ! determines the value taken by the :~ other variable. In a causal relationship, the determining variable is called the independent vadebie; the variable it determines is called the [lepem~eut ~

the x-variable is zero, the point will lie on the vertical axis, like point A. If the v~ue of the y-variable is zero, the point wilt lie on the horizontal axis, like point B. Most gra.p.hs that depict relationships b~-ween two economic varYables represent a cal~’~ll relatio~ashitp, a relationship in wb_tch the value taken by one variable directiT influences or determines the value taken by the other variable. In a causal relationship, t~e deterl~ining variable.is called the hl~lepelt~le~llt variable; the variable determines is called the ~tepe~4ent variable. In our e.zampIe of soda sales, the outside temperature is the independent variable. It di~ctty influences the number of sodas that are sold, the del~endent variable in this case.

GRAPHS tN ECONOMICS

By convention, we put the ~.depend~t variable on the horizontal a,~s and tb~ t variable on the veriical ~s. Fibre 2A-I ts con~ consi~nt ~ ~s ~e independent ~iable (ou~ide ~mpem~e) is on ~e ho~on~ ~s nu~er of sod~ ~old) is on ~e v~cal ~s. ~ ~mpo~n~ to t~s conv~on ~s in g~phs sho~ng ~e econo~c rel~ons~p be~een produ~ and qu~fi~ of ~e produ~: although price is geneml~ ~e inde: v~able ~at detaches quaffS, it N ~ m~sur~ on ~e vexed ~s.

~ ~:urve i~ ~line on a graph that depicts’ a relal~onship between two reliables, It maybe eider a stralght lin~ or a cu~ed line, If ~a c~e ~s a ~aight l~.e, the ¯ e cu~e is not a straight vadabtes have a ~o~li~ear

on a Graph (a) of Figure 2A-2 contains some of the same information as Figure 2A-1, w~th line drawn through the points C, D, and ~. or Such a line line. on a If graph is called regardless of wl~th~ it isB, a straight line a curved the curve thata the r~Iationship between two variables is a straight line, or linear, the Xariables a linear relatto~shlp. When the cu~e is not a straight line, or nordinear, the ~ have n0~t~ea~" relafionsMI~A point on aacurve indicates the w~l~e of the y-variable for a specific value of the For example, point D indicates that at a tempera~ar~ of 60°t:, a vendor can ect to seli 50 sodas. The shape and orientation of a curve reveal the general nature ! the relationship between the two variables, The upward tilt of the cm~e in pa~el ) of Figure 2A-2 suggests that vendors can expect to sell more sodas at higher out-

J (oo 70) ¯ K (zo, ~o) L (40 30)

70, 0)

WHAT iS ECONOMICS?

Two variables have a positive relationship when an increase in the value of one variable is associated w~ an increase in the value of the other variable, It is-illustrated by a cuwe ~at s~opes upward ~om t~ to 5g~ Two variables have a aegat~e rela~eas~ip when an i~crease in ~e value ~ one variable is associated ~ a decrease in the value of~e o~er variable. It i~ ill,fated by a cede that stapes dewnwa rd from le~ to dgh~ the point at ~c~ ~ hi~ ~e hedzo~l axis; ~ indicates the value ~f the xvariable v~e~ ~ valu~ of ~e ~ vada~le is zero, The vertical ietercept of a curve is the point at which it hits the vertical axis; it shows the v~lue of the y-variable when the value of the x-variable is zero. The slope ef s line ~r curve is a measure of bow steep it is. The slope of a line is measured by "rise over run"-the change in the y-variable hetweee two points on the line divided by the change in ~e x-variable baleen these

When variables are related this w~y-that is, when an increase Jn one var~ahle is associated with an increase in the other variable-the v~iables are said to h~ve a ~si~ve re~ons~p. I~ is filtrated by ~ cu~e ~at slopes u~ward from le~ to ri~t. Beca~ this cu~e is a~o ]ine~, ~e relafions~p be~ ou~ide ~d number of sodas sold tinseled by the cu~e in panel (a) of Fibre 2A-2 posi~ve ~ear relationship. ~ ~ inhere in one ~fiable is assodated ~ a de.ease in the o~er ~fiable, ~e ~o ~ables are s~ to have a negative rel~fio~hi~. It is t~us~a~ by a ~at s[opm dotard from left W ~h~ ~ke ~e cu~e ~ p~el (b) of ~e 2A-2. Becan~ ~s curve ~ ~so ~ea~ the re~fion~p it ~e~i~ is a negative l~ear relationshi~. Two va~ble~ ~at might have snch a relafions~ ~e ~e outside tempera~re ~d ~e nnmMr of hot dr~s a v~dur c~ e~e~ to s~l at a baseb~ Ream for a merest to ~e c~e in p~ (a) of H~re ~2 ~d yon c~ it ~t~ ~e ho~on~ ~ at point B. ~s po~t, kno~ as ~e ho~o~t~ shows ~e v~ne of ~e x-~bte wh~ ~e v~ue of ~e y-~fiable is ~ro. In panel (b) of ~re 2A-2, the c~e ~ ~e ve~c~ ~ at po~t~. ~s poin~ ea~ed ~e intercept, ~cates ~e ~ue of ~e y-variable when ~e value of the ~-v~able is zero.

A Key Concept: The Stope of a Curve The slope of a line or curve is a measure of how steep it is and indicates how sensitive the y-variable is to a change in the x-variable, In our example of outside tempe.rature "and the nnmber of cans of soda a vendor can expect to sell, the slope of the curve would k~clicate how many more cans of soda the vendor could expect to sel! with each 1° increase in temperature. Interpreted this way, the slope gives meaningful information. Even without numbers for x and y, it is possible to arrive at important conclusions about the relationship between the two variables tiy examining the slope of a c’oawe at various points,

The S[ope of a Linear Curve Alon~ a linear curve the slope, or steepness, is meamred by dividing the "rise" between two points on the curve by the "run" between’ those same two points. The rise is the amount that y c~anges, and the run is the amotmt that x changes. Here is the formula: Change.~_ff_ Change in x = ~ = Slope

In the formula, the symbol A (the Greek uppercase delta) stands for "change in." When a variable increases, the change in that variable is positive; when a variable decreases, the change in that variable is negative. The slope of a curve is positive when the rise (the change in the y-variable) has the same sign as the run (the change in the x-variable). That’s because when two numbers have the same sign, the ratio of those two nnmbers is positive. The curve in panel (a) of Pigure 2A-2 has a positive slope: along the curve, both the y-variable and the x-variable .............................................................................. ~.e~s~, The .slol~._oLa~curx~e.is.negafi~ze.~vhen .the.~se- and .the.r tin. ha~e dJ fferent.signs ...................... That’s became when two n_~bers have different signs, the ratio of those two numbers is negative. The eta-re in panel (b) of Figure 2A-2 has a negative slope: along the cn~e, an increase i~ the x-variabIe is associated with a decrease in the y-vaxiable, Figure 2A-3 illustrates how to calculate the slope of a linear curve. Let’s focus first on panel (a). From point A to point B the value of the y-variable changes from 25 to 20 and the value of the x-variable ¢Jaanges from 10 to 20. So the slope of the line between the~e two points is:

Change in x - z~x ~’6 - -~=-0’5

CHAPTER 2 APPENDI×: GRAPHS ~N ECONOMI~S 49

F~GUR~ 2A-3

~ecause a straight I~ne is equally ~teep at all points, the slope of a sa-aight line is ~he in other words, a straight line has a constant slope. You can check by calculating the slope of the 1Laear curce between points A and B and between : arid: D in panel (b) of ~gure Ay 10 5 Between A and/3:

_~=~-=5 20

and Verticat Curves and Their Stopes a curve is horizontal, the value of the y-variable along that curve never Everywhere along the c~e, the change ~ y ts zero. Now, ~umb~ ~s zero. So, reg~dless of ~e value of the ch~ge in x, the of a’ho~zont~ cu~e is ~ways z~o.’ t ~e is ve~cal, the value of ~e x-variable ~ong ~e ~e never ch~ges-~t Eye.here along the cu~e, the change ~ x is zero, ~is m~ns ~at the ve~ line is a raGo ~ ~ero ~n the deno~nator. A raGo ~ zero in qu~ to ~fin£W--~at is, an ~finitely l~ge number. So ~e slope is equ~ to ~nfini~. . . ho~ontal c~e has a ~eci~ ~pli~a~on: ~t means that ~e x-vanm~ela~d. ~o ~fiables are unr~ated wh~ a change in ~ndependent variable) h~ no effect on the o~er ~able (the (~e ). Or ~o put it a slightly d~e~n[ t~, ~ va~ables ~e u~etated dependent variable is con~nt ~gardIess of the vNue of ~e indep~dent is usuN, ~e y-vagable is ~e dep~dent va~able, ~e cu~e is boronde.dent vafiabte ~s ~e x-vaNable, ~e cu~e i~

WHAT IS

ECONOMICS?

The Stepe of a Nontinear Curve A neelinear curve is one in wilic h slope is not the ~ar~e between every pair ~ points.

A no~e~r ctlrve is one in which the slope changes as you move along it. Pane.ls (a), (b), (c), and (d) of ~i~ure 2A-4 show various nonlinear curves. Panels (a) and (b) show nonlinear curves whose slopes change as you move along th~n, but the slopes always ramai~ positive. Although both curves tilt upward, the curve in panel

= -15

CHAPTER 2 APPENDIX: GRAPHS IN ECONOM(CS 5~. ~,

The ahs61~te rains of a negates num~a) gets steeper as you move from lefr to right in contrast to the curVe in panel (b)~ ~,ets flatter. A curVe that is upward sloping and gets steeper, as in panel (a), is ber is thevalne ~fthe negative number witfloot the minus sign. increasing slope. A curve that is upward sloping but gets flatter, A tange~ line is a ~ralgM line that ju~ panel (b), is said to have positive decreasing slope. touches; or is ~ngent to, a nonlinsar When we calculate the slope along these nonlinear cta~es, we obtain different valcuwe at a pa~cular point ~e slope of s for the slope at different points. How the slope changes along the curve determines carve’s shape. For example, in panel (a) of Figure 2A-4, the slope of the curve is a ¯ e tangent line is equal ~ ~e slope of number that steadily increases as you move from left to right, whereas in ~e nonlinear cuwe at~at (b), the slope is a positive number that steadily decreases. The slopes of the cur~es in panels (c) and (d) are negative numbers. Economists prefer to express a negative nmnber as its absolute value, which is the value negative number without the minus sign. In general, we denote th~ absolute of a number by two parallel bars around the number; for example, the absolute .~ of-4 is written as 1-4 [ = 4. In panel (c), the absolute value of the slope steadiyou move from left to right. The curVe therefore has negative increasing panel (d), the absolute value of the slope of the curve steadily decreasalong the curve. This curVe therefore has negative decreasing slope.

[cu[ating the SLope Along a NonLinear Curve ust seen that along a nonlinear ctwve, the value of the slope depends on where are on that curve. So how do you calculate the slope of a nonlinear carVe? We focus on two methods: the orc matho~ and the point m*tho&

Arc Method of Catcutat~ng the Slope An arc of a curve is some piece or of that curVe. For example, panel (a) of Figure 2A-4 shows an arc consisting the segment of the curVe between points A and B. To calculate the slope along a using the arc method, you draw a straight line between the two ~dof the ~c. ~e stops of ~at ~ight line is a measure of ~e average slope cu~e be~een ~ose ~o end-points. You can see from pond (a) of Fi~e ~-4 line dra~ b~een points A and B incr~ses along ~e x-~s from 10 (so ~at ~ = 4) as it incre~es along ~e y-~s from 10 to 20 (so ~at Ay = ~erefore ~e slope of ~e ~ai~t line connoting points A and B

means that the average slope of the curve between points A and B is 2,5. :onsider the arc on the same curve between points C and D, A straight line these two points increases along the x-axis from 11 to 12 (~x = 1) as along the y-axis from 25 to 40 (ky = !5), So the average slope between is:

points C and D is larger than the average slope points A and B. These calculations verify what we have already observed-c~rve gets steeper as you move from left to right and therefore

increasing slope,

Point Method of Caku[ating the Stops The point method calculates the of a nonlinear carve at a specific point on that curve. Figure 2A-5 on the next how to calculate the slope at point B on the curve. First, we draw a t line that just touches the curve at point B, Such a line is called a taltge!lt lille: it just touches the curVe at point B and does not touch the curve at any he curVe means that the straight line is tangent to the carVe at point B. ,e oft~s tangent line is equal to the slope of the nonlinear curve at point ~.

PART 1

WHAT IS ECONOMICS?

You can see from Figure 2A-5 how the slope of the tangent line is calculated: from point A to point C, the change in y is 15 and the change in x ts 5, generating a slope of:

Ar 3s=3 tot

By the point method, the slope of the curve at point B is equal to 3. A natural question to ask at this point is how to determine which method to usethe arc method or the point m~thod--in calculating the slope of a nonlinear curve. The answer depends on the curve itself and the data used to construct it. You use the arc method when you don’t have enough information to be able to draw a smooth curve. For example, suppose that in panel (a) of Figure 2A-4 you have only the data represented by points A, C, and D and don’t have the data represented by point B or any of the rest of the curve. Clearly, then, you can’t use the point method to calculate the slope at point B; you would have to use the arc method to approximate the s]ope of the curve in this area by drav~g a straight line between points A and C. But if you have sufficient data to draw the smooth curve shown in panel (a) of Figure 2A4, then you could use the point method to calculate the slope at point B-and at every other point along the curve as well.

Haximum and Minimum Points

point, the highest point along the :ur~e. Atthe maximum, the slope of the curve changes from positive to negative,

The slope of a nonlinear curve can change from poskive to negative or vice versa, When the slope of a curve changes from positive to negative, it creates what is called a maximum point of the curve, When the slope of a curve changes from negative to positive, it creates a minimum point, Panel (a) of Figure 2A-6 illustrates a curve in which the slope changes from positive to negative as you move from left to right. When x is between 0 and 50, the slope of the curve is positive. At x equal to 50, the curve attains its highest point--the largest value cry along the curve. This point is called the ma~imm of the curve, When x exceeds 50, the slope becomes negative as the curve turns downward. Many important curves in economks, such as the curve that represents how the profit of a fiTm changes as it produces more output, are hill-shaped-like this,

CHAPTER 2 APPENDIX: GRAPHS IN ECONOM CS 53

In contrast, the curve shown ha panel (b) of Figure 2A-6 is U-shaped: it has a slope that changes from negative to positive. At x equal to 50, the curve reaches its lowest point-the smallest value ely along the curve. This point is called the minimum of ¯ the curve. Various kmportant curves in economics, such as the curve that represents how the costs of some firms change as output increases, are U-shaped like this.

:iCa&cu[ating the Area Betow or Above a Curve i!iiPmetimes it is useful to be able to measure the size of the area below or above a ~i~urve. We will encounter one such case in Chapter 4. To keep thing~ sil}fple, we’l! ~hly calculate the area below or above a lhaear curve. How large is the shaded area below the linear curve in panel (a) of Figure 2A-7 on i!~e next page? First note that this area has the shape of a right ttiangle. A right ~gle is a t~iangle that has two sides that make a right angle w~th each other, We wlJl i:i~fer to one of these sides as the height of the triangle and the other side as the base the triangle. For our purposes, it doesn’t matter which of these two sides we refer as the base and which as the height, Calculating the area of a right triangle is multiply the height of the triangle by the base of the triangle, and 2. The height of the triangle in panel (a) of Figure 2A-7 is "10 - 4 Arid the base of the triangle is 3 - 0 = 3. go the area of that triangle is

aaded area above the linear curve in panel (b) of Figure 2A-77 We e formula to calculate the area of this fight triangle. The height of the 2 = 6, And the base of the triangle is 4 - 0 = 4. So the area of that tfipoint, the Iowest point along the curve. ¯ At the minimum, the slope of the curve changes from negative to positive,

]PART 1 WHAT IS ECONOMICS?

Graphs That Depict Numericat Information Graphs can also be used as a convenient way to summarize and display data without assuming some onderlimg causal relationship, Graphs that simply display numerical information are called numerfcal graphs. Here we will consider four types of numerical graphs: time-series graphs, scatter diagrams, pie charts, and bar graphs. These are widely used to display real, empirical data about different economic variables because they often help economists and policy makers identify patterns or trends in the economy. But as we will also see, you m~st be careful not to misinterpret or draw unwarranted conclusions from numerical graphs. That is, yod must be aware of both the usefulness and the limitations of numerical graphs.

Types ef Numer ca{ Graphs

horizontal axis and values of a variable veaical axis.

You have probably seen graphs in newspapers that show what has happened over t~me to economic variables such as the unemployment rate or stock prices. A t~lme-series graph has successive dates on the horizontal axis and the values of a variable that occurred on those dates on the vertical axis. For example, Figure 2A-8 shows the unemployment rate in the United States from 1989 to late 2006. A line connecting the points that correspond to the unemployment rate for each month during those years gives a clear idea of th~ overall trend in unemployment over these years. Figure 2A~9 is an example of a different kind of numerical graph. It represents information from a sample of 158 countries on average life expectancy ~d gross national product (GNP) per capita-a rough measure of a country’s ~andard of living, Each point here indicates an average resident’s life expectancy and the log of GNP per capita for a given country. (Economists have found that the log of GNF rather than the simple level of GNP is reom closely tied to average life expectancy.)

CHAPTER 2 APPENDIX:

GRAPHS IN ECONOM{;pS 55 I

The points lying in the upper right of the graph, which show combinations of high life expectancy and high log GNP per capita, represent economically advanced counkries such as the United States, Points lying in the bottom lef~ of the graph, which ~how combinations of low life expectancy and low log GNP per capita, represent ecofiomicalty less advanced countries such as Afghanistan and Sierra Leone. The pattern ~f points indicates that there is a positive relationship between life expectancy and .log GNP per capita: on the whole, people live longer in countries with a higher standard of living. This type of graph is called a scatter diagram, a diagram in which ehch point corresponds to am actual obsercation of the x-variable and the y-variable. .in scatter diagrams, a curve is typically fitted to the scatter of points; that is, a curve A scatter diagram shows points that is drawn that approximates as closely as possible the genera1 relationship between the correspond to actoal observations of ¯ ~ariables. As you can see, the fitted curve in Figure 2A-9 is upward-sloping, indicat- the x- and ywariables, A curve is usualing the underlying positive relationship between the two variables. Scatter diagrams {y f’~ed to ~e scatter of points. are often used to show how a genemt relationship can be inferred from a set of data.

56 ~PART 1

WHAT IS ECONOMICS?

A pie ch~a,r t shows how some total is divided among ;ts components, usually expressed in percentages, A bar graph uses bars of van/ing height or length to show the comparative sizes of different observations of a variable,

A pie chart shows the share of a total amount that is accounted for by various components, usually expressed in percentages. I:or example, I?igurc 2A-10 is a pie chart that depicts the various sources of revenue for the U.S. government budget in 2005, expressed in percentages of the total revenue amount, $2,153.9 bilhon. As you can see, social insurance receipts (the revenues collected to fund Social Security, Medicare, and unemployment insurance) accounted for 37% of total government revenue and individual income tax receipts accounted for 43%. Bar ~qcaphs use b~rs of various heights or lengths to indicate values of a variable. in the bar graph in Figure 2A-11~ the bars show the perc~nb change in the number of unemployed workers in the United States from 2001 to 2002, separately for White, Black or African-American, and Asian workers. £xact values of the variable that is being measured may be wrilien at the end of the bar, as in this figure. For instance, the number of unemployed Asian workers in the United .States increased by 35% between 2001 and 2002. But even without the precise values, comparing the heights or lengths of the bars can give useful insight into the relative magnitudes of the d~fferent values of the variable,

CHAPTER 2 APPENDIX: GRAPHS IN ECONOMI~C$ 57

Probtems Interpreting Numerical Graphs Although the beginning of this appendix emphasized that graphs are v~sua] images ~at m~e ideas or information easier to understand, graphs can be co~c~d (intentionally or unin~nttonally) ~ ways ~at are mislead~g and can lead to inac~ra~ conc!~ions, ~is section raises some issues that you should be aware of wh~ you ~te~r~ graphs,

Features of fio.stru~o~ Before drawing ~y conclusions about what a n~eric~ ~aph implies, you should pay a~fion to the scale, or ske of in~emenS, sho~ on ~e ~es. Small increments ~nd to ~sutly ~aggerate changes in the variables, whereas large incr~ents tend to ~sua!ly dim~ish ~em. So ~e scale used in con~on of a g~ph can ~fluence your interpreta~on of ~e sig~flcance of ~e changes it illu~ates-perhaps ~ ~ unwar~nted way, Take, for example, Figure 2A-!2, which shows the unemployment rate in the United States in 2002 using a 0.1% sc~e, You can se~ that @e unemplo~ent rate rose from 5.6% at the beginning of 2002 to 6.0% by ~e end of the year. Here, rise of 0.4% in ~e unempto~ent rate looks enormous and could lead a policy maker to conclude that it was a relatively significant event. But if you go back and re.amine Fibre 2A-8, which shows the unemployment rate in ~e United States from 1989 to late 2006, you can see ~at ~is would be a misguided conclusion. Figure ~-8 ~ndudes ~e same data sho~ ia Figure 2A-12, but it is constructed wi~ a 1% scale ra~er ~an a 0,1% scale. From it you can see that the rise of in the unemployment rate during 2002 was, in fach a relatively insi~ficant ~ent, at least compared to ~e rise ~ unemployment dur~g 1990 or during 2001. ~is comgarison shows that if you are not cereal to factor in @e choice of scale in interfering a graph, you can arrive at very different, and possibly mis~ided, conclusions. Related to ~e choice of scale is ~e use of ~ncafion ~ cons~ng a graph. ~s is ~cate~ when part of the range ~s omi~ed. ~is is indicat~ by ~o slashes (//) in ~e ~s near ~e origin. You c~ see ~at ~e ve~c~ ~s of Fibre 2A-12 has ~en ~uncated=~e range of values from 0 to 5.6 has ~ omi~ed ~d a//app~rs in ~e ~s, Truncation saves space in ~e presentation of a graph ~d allows smaller in~ents to be us~ in cons~cting it. As a result, changes in the variable depi~: ed on a g~ph ~at has been ~uncated appear lar~er compared to a ~aph ~at has not been ~ncated and ~at uses larger increment.

An axis is truncated when some oft~e values on the axis are omitted, usually to save space,

WHAT IS ECONOMICS?

¯ An emitted varieble is an unobserved variable that, through its influence on other varia hies, creates the erroneous appearance of a direct causal relationship among those variables, The error of reverse ceosalil,/is corn. m~ed when the true direction of causal~ between two variables is ~ reversed.

You must also pay close attention to exactly what a graph is illustrating. For example, In l:igure 2A-1!, you should recognize that what is being shown here are percentage changes in the number of unemployed, not numericaI changes. The unemployment rate for Asian workers increased by the highest percentage, 35% in this exampIe. If you confused numerical changes with percentage changes, you would erroneously conclude that the greatest number of newly unemployed workers were Asian. But, fin fact, a correct interpretation of Figure 2A-11 shows that the greatest number of newly unemp]oyed workers were White: the total number of unemployed White workers grew by 1,168,000 workers, which is greater than the increase in the number of unemployed Asian workers, which is 101~000 in this example. Although there was a higher percentage increase in the number of unemployed Asian workers, the number of unemployed Asian worker~ in the United States fin 2001 was much smaller than the number of unemployed White workers, leading to a smaller number of newly unemployed Asian workers than White workers. Omitted Variables From a scatter diagram that shows two variables moving either positively or negatively in reAation to each other, it is easy to conclude that there is a causal relationship. But relationships between two variables are not always due to direct cause and effect. Quite possibly an observed relationship between two variabIes is due to the unobserved effect of a third variab~te on each of the other two variables. An unobserved variable that, through its iz~fluence on other variables, creates the erroneous appearance of a direct causal relationship among those variables is called an omitted variable, For example, in New England, a greater amount of snowfall during a given week will typically cause people to buy more snow shovels. It will also cause people to buy more de-icer fluid. But if you omitted the influence of the snowfall and simply plotted the number of snow shovels sold versus the number of bottles of de-icer fluid sold, you would produce a scatter d~agram that showed an upward tilt in the pattern of points, indicating a positive relationship between snow shovels sold and de-icer fluid sold. To attribute a causal relationship between these two variables, however, Is misguided; more snow shovels sold do not cause more de-icer fluid to be sold, or vice versa. They move together because they are both influenced by a third, determining, variable-the weekly snowfall, which is the omitted variable in this case. So before assuming that a pattern in a scatter diagram implies a cause-and-effect reIationst~ip, it is important to consider whether the pattern is instead the result of an omitted variable. Or to put it succinctly: correlation is not causation.

Reverse Causa[ity Even when you are confident that there is no omitted variable and that there is a causal relationship between two variables shown in a numerical graph, you must also be careful that you don’t make the mistake of reverse cmlsalit~ycoming to an erroneous conclusion about which is the dependent and which is the independent variable by reversing the true direction of causality between the two variables~. For example, imagine a scatter diagram that depicts the grade point averages (GPAs) of 20 of your classmates on one ax~s and the nmnber of hours that each of them spends studying on the other. A line fitted between the points will probably have a positive slope, showing a positive relationship between GPA and hours of studying. We could reasonably infer that hours spent studying is the fudependent variab]e and that GPA is the dependent variable. But you could make the error of reverse causality: you could infer that a high GPA causes a student to study more, whereas a low GPA causes a student to study less, The significance of understanding how graphs can mislead or be incorrectly interpreted is not purely academic. Policy decisions, business decisions, and political arguments are often based on interpretation of the types of numerical graphs that we’ve just discussed. Problems of misleading features of construction, omitted vatiabIes, and reverse causality can lead to very important and undesirable consequences.

CHAPTER 2 APPENDIX: GRAPHS IN ECONOMICS 59,I

Study the four accompanying diagrams. Consider the following statements and indicate which diagram matches each statement. Which variable would appear on the horizontal and which on the vertical axis? In each of these ~tatements, is the slope positive, negative, zero, or infinity? Panel (a)

Panel (b)

b. What would tax revenue be at a 0%o income tax rate? e. The maximum possible income tax rate is !00%, What would tax revenue be at a 100% income tax rate? d. Estimates now sh~a that the maximum point on the Laffer curve is (approximately) at a tax rate of 80%, For tax rates less than 80%, how would you describe the relationship between the tin( rate and tax revenue, and how is this relationship reflected in the slope? For tax rates higher than 80%, how would you describe the relationship be~veen the tax rate and tax revenue, mad how is this relationship reflected in the slope?

In the accompanying figures, the numbers on the axes have been lost All you know is that the units shown on the vertical ax~ are the same as the units on the horizontal arJs. Pane[ (c)

Pane[ (d)

a. If the price of movies increases, fewer consumers go to see b.More experienced workers typically have higher incomes than less experienced workers. the same number of hot dogs per day. d, Consumers buy more frozen yogurt when the price of ice e.Research finds no relationship between the number of diet books purchased and the number of pounds lost by the

a, In panel (a), what is the slope of the line? Show that the slope is constant along the line. b. In panel (b), what is the slope of the line? Show that the slope is constant along the line. 4.Answer e~h of the following ques~ons by drawing a schematic diagram.

Taking measurements of the slope of a curve at three points farther and farther to the tight a!ong the horizonf. Regardless of its price, Americans buy the same quantity tel axis, the slope of the curve changes from -0,3, to of salt, -0.8, ~ -2.5, measured by the point method, Draw a 2. During the Reagan administration, economist Arthur Laffer schematic diagram of this curve. How would you describe argued in favor of lowering income tax rates in order to the relationship illustrated in your diagram? increase tax revenues. Like most economists, he believed that b. Taking measurements of the slope of a curve at five poflat~ at tax rates above a certain level, tax revenue would fall farther and farther to the tight along the horkontal axis, because high taxes would discourage some people from work~ the slope of the curve changes from 1.5, to 0.5, to O, to tng and that.people would reinse.to ~ork at all if they received .................-0.5, to,~%5, measured by the pgint method, Dr~ g schematic diagram of this curve, Does it have a maximum no income after paying taxes. This reladonship between tax rates and tax revenue is graphically summarized in what is widely known as the L~ffer curve. ]?lot the Laffer curve ~elationship assuming that it has the shape of a nonlinear eurge. The following questions ~I1 help you conatnlet the graph. a.VChich is the independent variable? Which is the dependent variable? On which axis do you therefore measure the income tax rate? On which m~s do you measure income tax revenue?

or a minimum?

WHAT IS ECONOMICS?

5. Pot each of the accompanying diagrams, cafoulats the area of the shaded right triangle~ Panel (a)

Panel (b) Y

80 6O

20 2

3

4

0

x

5

10 15 20 25 x Panel (d)

Panel (e) Y

%0 Z0 30 40 50 x

0

l

2345x

The base of a right ~riangle is 10, and its area is 20. What is the height of this right triangle? The accompanying table shows the relationship between workers’ ho~s of work per week and their hourly wage rate. Apa~c from the fact that they receive a different hourly vrage rate and work different hours, these five warkers are othe~se identical,

curve between Diego’s and Emily~ data points using the arc method?

Studies have found a relationship between a country’s year{ rate of economic growth and the yearly rate of increase in air borne pollutants. It is believed that a higher rate of economi growth allows a country’s residents to have more cars am h’avel more, thereby releasing more aJrborn, e pollutants. a. Which variable is the independent variable? Which is the dependent variable? b. Suppose that in the country of gudian~, when the yearly rate of economic growth fell from 3,0% to 1,5%, the yearly rate of increase in airborne pollutants fell from 6% to 5%, What is the average slope of a nonlinear c~rve between these points using the arc method? c. Now suppose that when the yearly rate of economic growth rose from B,5% to 4.5%, the yearly rate of increase in airborne pollutants rose from 5,5% to 25%. What is the average slope of a uonlinear curve between these two points using the arc method? d. How would you describe the relationship between the two variables here? 9. An insurance company has found that the severity of property damage in a fire is positively related m the number of firefighters arriving at the scene, a. Draw a diagram that depicts this finding with number of firefighters on the horizontal axis and amount of property damage on the vertical axis, What is the argument made by this diagram? Suppose you reverse what is measured on the two axes. What is the argument made then? b. in order to reduce its payouts to policyholders, should the" ir~urance company therefore ask the city to send fewer fLrefighters to any fire? :lO.The accompanyihg table illustrates annual salaries and income tax owed by five individuals Apart firom the fact that’ they receive different salaries and owe different amounts of become tax~ these five individuals am otherwise idenfical.

30 30 60 75 a. Which variable is the independent variable? Which is the

dependent variable? b. Draw a scatter diagram illustratthg this relationship. Draw a (nonlinear) curve that connects the points, Put the hourly wage rate on the vertical a~ds, c. As the wage rate Increases from $15 to $30, how does the number of hours worked respond according to the relationship depleted here? What is the average slope of the curve between Athena’s and Eorig’s data points using the arc method? d.As the wage rate increases from $60 to $75, how does the number of hours worked respond according to the relationship depicted here? What is the average slope of the

$3,304 14,317 454 23,927 7,020 a. If you were to plot these points on a graph, what would be the average slope of the curve between the points for Eduardo’s and Camila’s salaries and taxes using the arc method? How would you interpret this v~lue for slope? b. What is the average slope of the curve between the points’ for John’s and Susan’s salaries and taxes using the arc method? How would you interpret that vaine for slope? e. What happens to the slope as salary increases? What does this relationship imply about how the level of income taxes affects a person’s incentive to earn a Mgher sala.ur?

dow~ along it. Thus, its slope constantly changes; the curve has a different slope at each poLar To measure the slope at a specific polar, we draw a straight 1Lae tangent to the curce at that polar. A line is tangent at a polar if it touches, hut does not intersect, the curve at that point. Thus line aa is tangeat to the curve in Figure 4 at point A. The slope of the era-re at that point is equal to the slope of the tangent line. Specifically, the totsd vertical change (drop) in the tangent line na is -20 and the total horizontal change (rtm) is + 5. Because the stope of the tangent line aa is -20/+5, or -4, the slope o£ the coxve at Ix~Lat .d is also -4. . 1.1 Line bb in Figt~re 4 is tangent to o~es ~aa sloV~ the curve at point B. Fo!towing the same procedure, we find the slope at B to be -5/+15, or -½. Thus, La this flatter part of the cnaxve, the slope is tess negative. (Key Appendix Questlo~a 7)

2o 15 I0

5

I0

15

20

SUNNARY

AppENDIX

6. The slope of a st~ght l.ir~e is the ratio of the verdeal change to ~e ho~on~ ~ge be~ee~ any ~o point, The slope o~ upslop~g ~e is posi~v~ ~e slope ofa do~lop~g ~e ~ aegagve. 7. The slope of a ~e or c~e d~ends on ~e ~ ~ed ~ mea~g ~e v~hbl~. It is espe~alty relev~ for eco~oM~ became ir me~es mar~ chiVeS. 8, The slope of a ho~n~ line is ~ro; ~e slope o~ a ve~cal ~e is ~te. 9- The verdcal ~ter~pt ~d slope o~ a ~e delete i~ to~do~; ~ey are ~ed ~ ~ess~g ~e ~d ~e rdafioasNp ~een ~e ~o ~abl~as an equafiom 10. ~e slope of a ~e at aW po~t ~ de~ by ~l~a~g ~e slope era s~Nghs ~e ~ngent m ~e ~e at ~at po~t.

1. Graphs are a convenient and revealLag way to represent economic reLationships. 2. Two variables are positively or direedy related when their values change in the same direction. The li~e (c-,arTe) representing two directly related variables slopes upward. 3. Two variables are negatively or inversely related when tl}eir v~ues change in opposite dlxectlop~, The cttwe representing two inversely related v~adables slopes downward, 4. The vaI~e o{ the dependent ~a=able (the effect") is d ten~ned by the val~e of the independent varlaSle (the 5. Whe~ the "other factors" that might affect a two-variable relationship ~re avowed m chive, the graph of the relatio~ship wig likely shift to a new location.

S AND CON CP2PTS

APPENDIX TERN

..... i~dependent waxiable ..... depead~nt variable

hb~figal ax~ ....................... dkec~ relationship ..... inverse relado~Np

~s!pp~ of a ~ight verde.a[ h~tercept

AppENDiX STUDY QUESTIONS Briefly explain the ,ase of graphs as a way to represer~t econo~c relado~ps. ~at ~ ~ ~e relafi~ns~p? How graph? G~ph ~d ~lam ~e rela~o~mps y

e~

to grad between (a) the nmnber of in’as of ra~f~ per mon~ ~d ~e ~e of ~bre~, (b) ~e amo~t of ~ of ~ enter~er ~d ~e p~ of her conce~

2O

In each case cite and expl~ how variables other than those spcciilcally mentioned might upset the expected relationship. !s your graph in part b, above, consistent with the fact that, historicall)~ em’ollments and tuition have both inereesed? If not, explain a~y differemce, Key ,d~pendlx QneaC.on Indicate how each of the followhag aright affect the data shown in Table 2 ~ F~gace 2 of this appendix: a. GSI.Ps athletic director sched~tes tfigher-quality oppoAn NBA team locate~ in the dty where GSU plays. GSU contracts to have fdl its home games televised. Key ~/ppendix Queer/on The following table contains d~ta on the relationship between savkng mad income. Rearrange these data into a meanlngf~ order and graph them on the accompanying grid. What is the slope of the lhae? The verficat intercept? Interpret the meaning of both the slope and the intercept. Wr~te the equation that represents tlds line. What wo~Id you predict saving to be at the $12,500 level of income?

$t500

1000

500

-500

4. Constt~ct a table from the data shown on the graph below. Which is the dependent variable and which the ~adependent variable? Summarize the dats in eguatiun form.

t00

2O 0

2

4 6 8 Study time (hours)

Suppose that when the inxerest rate on loans is i6 percent, busine~es find it unprofitable to invest in maehinery and equipment; However~ when the interest rate is 14 pereen% $5 billion worth of investment is profitable. At 12 percent interest, a total of $ I 0 billion o£investment is proflts ble, Sin~rly, total ixwestment increases by $5 bilJJon for each successive 2percentage-point decline in the interest tate~ Describe the relevant relationship between the katetest fate ~md inve.~maent in words, in a table, o~ a graph, and as at} equado~. Pat the int~rest rate on the vertical axis and ~estmenr on the horizontal axis, In yot~r equaden use the form i = a + bl, where i is the interest rate, ~ is the ver~cal intercept, b is the slope of the line (which is aega dye), a~d I is the level of investmen~ Comment o~ the advaatages and dlsedvadtages of the verlyal, tabalar, graphical, and egaatio~ forms of description. Suppose that C = ~ + bY~ where C = constmaptior4 g = cor, sumption at zero income, b = slope, and Ir = income. a. Are C and Ir positively related or are they negatively related? b. If graphed, wo~dd the cur~e for this eqr~ation slope upward or slope downward? Are the variables C and g haversely related or directly related? d. What is the value of C ira -- 10, b = .50, and Y = 200? e. WhatisthevaineofYifC= lOO, a= lO, a~db=.257

~ the ~ccor~panyhag grap~, is the slope of co~e AH’ positive or negative? Does the slope iacrease or decrease as we move along d~e cox~e fi:om A to A’? Aaswer the same two queztiorrs for cur~e BB’.

0

2 4 6 8 10 12 14 16 ~8 20 22 24 26 28

X