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ECONOMICS PRINCIPLES OF MICRO Fourth Edition Robert H. Frank Ben S. Bernanke Media Integrated iPod ® Content Available
ECONOMICSPRINCIPLES OF MICRO
Fourth Edition
Fourth Edition
FrankB
ernanke
Robert H. FrankBen S. Bernanke
9 780073 362663
9 0 0 0 0
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ISBN 978-0-07-336266-3MHID 0-07-336266-2
The Seven Core Principles
Scarcity: Having more of one good thing usually means having less of another.
Cost-Bene� t Analysis: No action should be taken unless the marginal bene� t is as great as the marginal cost.
Incentives Matter: Comparing cost-bene� t analyses enables us to predict actual decisions people make.
Comparative Advantage: Everyone does best if they concentrate on their relatively most productive activity.
Increasing Opportunity Cost: Resources with the lowest opportunity cost should be used before turning to those with higher opportunity costs.
Equilibrium: A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action.
Ef� ciency: When the economic pie grows larger through ef� ciency, everyone can have a larger slice.
Students need the ability to understand and evaluate our changing economy. Principles of Microeconomics, by Robert H. Frank and Ben S. Bernanke, provides stu-dents with the tools necessary to analyze current economic problems. By eliminating overwhelming detail and focusing on Seven Core Principles, the Fourth Edition helps students achieve a deep mastery of what is essential to understanding economics.
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PRINCIPLES OF
MICRO-ECONOMICSFourth Edition
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ESSENTIALS OF ECONOMICS
Brue, McConnell, and FlynnEssentials of EconomicsSecond Edition
MandelEconomics: The BasicsFirst Edition
SchillerEssentials of EconomicsSeventh Edition
PRINCIPLES OF ECONOMICS
ColanderEconomics, Microeconomics, andMacroeconomicsSeventh Edition
Frank and BernankePrinciples of Economics, Principles ofMicroeconomics, Principles of MacroeconomicsFourth Edition
Frank and BernankeBrief Editions: Principles of Economics, Principles of Microeconomics, Principles of MacroeconomicsFirst Edition
McConnell, Brue, and FlynnEconomics, Microeconomics, andMacroeconomicsEighteenth Edition
McConnell, Brue, and FlynnBrief Editions: Economics, Microeconomics, MacroeconomicsFirst Edition
MillerPrinciples of MicroeconomicsFirst Edition
Samuelson and NordhausEconomics, Microeconomics, andMacroeconomicsEighteenth Edition
SchillerThe Economy Today, The Micro Economy Today, and The MacroEconomy TodayEleventh Edition
SlavinEconomics, Microeconomics, andMacroeconomicsNinth Edition
ECONOMICS OF SOCIAL ISSUES
GuellIssues in Economics TodayFourth Edition
Sharp, Register, and GrimesEconomics of Social IssuesEighteenth Edition
ECONOMETRICS
Gujarati and PorterBasic Econometrics Fifth Edition
Gujarati and PorterEssentials of Econometrics Fourth Edition
MANAGERIAL ECONOMICS
BayeManagerial Economics and BusinessStrategySixth Edition
Brickley, Smith, and ZimmermanManagerial Economics and Organizational ArchitectureFifth Edition
Thomas and MauriceManagerial EconomicsNinth Edition
INTERMEDIATE ECONOMICS
Bernheim and WhinstonMicroeconomicsFirst Edition
Dornbusch, Fischer, and StartzMacroeconomicsTenth Edition
FrankMicroeconomics and BehaviorSeventh Edition
ADVANCED ECONOMICS
RomerAdvanced MacroeconomicsThird Edition
MONEY AND BANKING
CecchettiMoney, Banking, and Financial MarketsSecond Edition
URBAN ECONOMICS
O’SullivanUrban EconomicsSeventh Edition
LABOR ECONOMICS
BorjasLabor EconomicsFourth Edition
McConnell, Brue, and MacphersonContemporary Labor EconomicsEighth Edition
PUBLIC FINANCE
Rosen and GayerPublic FinanceEighth Edition
SeidmanPublic FinanceFirst Edition
ENVIRONMENTAL ECONOMICS
Field and FieldEnvironmental Economics: An IntroductionFifth Edition
INTERNATIONAL ECONOMICS
Appleyard, Field, and CobbInternational EconomicsSixth Edition
King and KingInternational Economics, Globaliza-tion, and Policy: A ReaderFifth Edition
PugelInternational EconomicsFourteenth Edition
THE MCGRAW-HILL SERIES IN ECONOMICS
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PRINCIPLES OF
Fourth Edition
ROBERT H. FRANKCornell University
BEN S. BERNANKEPrinceton University [affiliated]
Chairman, Board of Governors of the Federal Reserve System
Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis
Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City
Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
MICRO-ECONOMICS
with special contribution by
LOUIS D. JOHNSTON
College of Saint Benedict | Saint John’s University
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PRINCIPLES OF MICROECONOMICS
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2009, 2007, 2004, 2001 by TheMcGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without theprior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in anynetwork or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customersoutside the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 0 QPD/QPD 0 9 8
ISBN 978-0-07-336266-3MHID 0-07-336266-2
Design of book: The images in the design of this book are based on elements of the architecture of Frank Lloyd Wright, specifically from the leaded glass windows seen in many of his houses.Wright’s design was rooted in nature and based on simplicity and harmony. His windows useelemental geometry to abstract natural forms, complementing and framing the natural world outside. This concept of seeing the world through an elegantly structured framework ties in nicely to the idea of framing one’s view of the world through the window of economics.
The typeface used for some of the elements was taken from the Arts and Crafts movement. Thetypeface, as well as the color palette, bring in the feeling of that movement in a way that complements the geometric elements of Wright’s windows. The Economic Naturalist icon is visually set apart from the more geometric elements but is a representation of the inspirational force behind all of Wright’s work.
Editor-in-chief: Brent GordonPublisher: Douglas ReinerDevelopmental editor: Angela CimarolliSenior marketing manager: Melissa LarmonSenior project manager: Susanne RiedellSenior production supervisor: Debra R. SylvesterLead designer: Matthew BaldwinSenior photo research coordinator: Jeremy CheshareckPhoto researcher: Robin SandSenior media project manager: Cathy TepperCover design: Matt DiamondCover image: © Jill BraatenTypeface: 10/12 Sabon RomanCompositor: Aptara, Inc.Printer: Quebecor World Dubuque Inc.
Library of Congress Cataloging-in-Publication Data
Frank, Robert H.Principles of microeconomics / Robert H. Frank, Ben S. Bernanke ; with special contribution
by Louis D. Johnston.—4th ed.p. cm.—(The McGraw-Hill series in economics)
Includes index.ISBN-13: 978-0-07-336266-3 (alk. paper)ISBN-10: 0-07-336266-2 (alk. paper)1. Microeconomics. I. Bernanke, Ben S. II. Johnston, Louis (Louis Dorrance) III. Title.
HB172.F72 2009338.5—dc22
2008026579
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D E D I C A T I O N
For Ellen
R. H. F.
For Anna
B. S. B.
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ROBERT H. FRANK
Professor Frank is theHenrietta Johnson Louis Pro-fessor of Management andProfessor of Economics atthe Johnson GraduateSchool of Management atCornell University, where hehas taught since 1972. His“Economic View” columnappears regularly in TheNew York Times. After re-
ceiving his B.S. from Georgia Tech in 1966, he taught mathand science for two years as a Peace Corps Volunteer inrural Nepal. He received his M.A. in statistics in 1971 andhis Ph.D. in economics in 1972 from The University ofCalifornia at Berkeley. During leaves of absence from Cor-nell, he has served as chief economist for the Civil Aero-nautics Board (1978–1980), a Fellow at the Center forAdvanced Study in the Behavioral Sciences (1992–93), andProfessor of American Civilization at l’École des HautesÉtudes en Sciences Sociales in Paris (2000–01).
Professor Frank is the author of a best-selling intermedi-ate economics textbook—Microeconomics and Behavior,Seventh Edition (Irwin/McGraw-Hill, 2008). He has pub-lished on a variety of subjects, including price and wage dis-crimination, public utility pricing, the measurement ofunemployment spell lengths, and the distributional conse-quences of direct foreign investment. His research has fo-cused on rivalry and cooperation in economic and socialbehavior. His books on these themes, which include Choos-ing the Right Pond (Oxford, 1995), Passions Within Reason(W. W. Norton, 1988), and What Price the Moral HighGround? (Princeton, 2004), The Economic Naturalist (BasicBook, 2007), and Falling Behind (The University of Califor-nia Press, 2007), have been translated into 15 languages. TheWinner-Take-All Society (The Free Press, 1995), co-authoredwith Philip Cook, received a Critic’s Choice Award, wasnamed a Notable Book of the Year by The New York Times,and was included in BusinessWeek’s list of the 10 best booksof 1995. Luxury Fever (The Free Press, 1999) was named tothe Knight-Ridder Best Books list for 1999.
Professor Frank has been awarded an Andrew W. Mellon Professorship (1987–1990), a Kenan EnterpriseAward (1993), and a Merrill Scholars Program OutstandingEducator Citation (1991). He is a co-recipient of the 2004Leontief Prize for Advancing the Frontiers of EconomicThought. He was awarded the Johnson School’s StephenRussell Distinguished Teaching Award in 2004 and theSchool’s Apple Distinguished Teaching Award in 2005. Hisintroductory microeconomics course has graduated morethan 7,000 enthusiastic economic naturalists over the years.
BEN S. BERNANKE
Professor Bernanke receivedhis B.A. in economics fromHarvard University in 1975and his Ph.D. in economicsfrom MIT in 1979. Hetaught at the Stanford Grad-uate School of Business from1979 to 1985 and movedto Princeton University in1985, where he was namedthe Howard Harrison and
Gabrielle Snyder Beck Professor of Economics and PublicAffairs, and where he served as Chairman of the EconomicsDepartment.
Professor Bernanke was sworn in on February 1, 2006,as Chairman and a member of the Board of Governors ofthe Federal Reserve System. Professor Bernanke also servesas Chairman of the Federal Open Market Committee, theSystem’s principal monetary policymaking body. He wasappointed as a member of the Board to a full 14-year term,which expires January 31, 2020 and to a four-year term asChairman, which expires January 31, 2010. Before his ap-pointment as Chairman, Dr. Bernanke was Chairman of thePresident’s Council of Economic Advisers from June 2005to January 2006.
Professor Bernanke’s intermediate textbook, withAndrew Abel, Macroeconomics, Sixth Edition (Addison-Wesley, 2008), is a best seller in its field. He has authoredmore than 50 scholarly publications in macroeconomics,macroeconomic history, and finance. He has done significantresearch on the causes of the Great Depression, the role of fi-nancial markets and institutions in the business cycle, andmeasuring the effects of monetary policy on the economy.
Professor Bernanke has held a Guggenheim Fellowshipand a Sloan Fellowship, and he is a Fellow of the Econo-metric Society and of the American Academy of Arts andSciences. He served as the Director of the MonetaryEconomics Program of the National Bureau of EconomicResearch (NBER) and as a member of the NBER’s BusinessCycle Dating Committee. In July 2001, he was appointedEditor of the American Economic Review. ProfessorBernanke’s work with civic and professional groups includeshaving served two terms as a member of the MontgomeryTownship (N.J.) Board of Education.
A B O U T T H E A U T H O R S
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vii
P R E F A C E
■
lthough many millions of dollars are spent each year on introductoryeconomics instruction in American colleges and universities, the return onthis investment has been disturbingly low. Studies have shown, for
example, that several months after having taken a principles of economics course,former students are no better able to answer simple economic questions than otherswho never even took the course. Most students, it seems, leave our introductorycourses without having learned even the most important basic economic principles.
The problem, in our view, is that these courses almost always try to teachstudents far too much. In the process, really important ideas get little more cov-erage than minor ones, and everything ends up going by in a blur. Many instruc-tors ask themselves, “How much can I cover today?” when instead they shouldbe asking, “How much can my students absorb?”
Our textbook grew out of our conviction that students will learn far moreif we attempt to cover much less. Our basic premise is that a small number ofbasic principles do most of the heavy lifting in economics, and that if we focusnarrowly and repeatedly on those principles, students can actually master themin just a single semester.
The enthusiastic reactions of users of our first three editions affirm the va-lidity of this premise. Although recent editions of a few other texts now pay lipservice to the less-is-more approach, ours is by consensus the most carefullythought-out and well-executed text in this mold. Avoiding excessive reliance onformal mathematical derivations, we present concepts intuitively through ex-amples drawn from familiar contexts. We rely throughout on a well-articulatedlist of seven core principles, which we reinforce repeatedly by illustrating andapplying each principle in numerous contexts. We ask students periodically toapply these principles themselves to answer related questions, exercises, andproblems.
Throughout this process, we encourage students to become “economic nat-uralists,” people who employ basic economic principles to understand and ex-plain what they observe in the world around them. An economic naturalistunderstands, for example, that infant safety seats are required in cars but not inairplanes because the marginal cost of space to accommodate these seats is typ-ically zero in cars but often hundreds of dollars in airplanes. Scores of such ex-amples are sprinkled throughout the book. Each one, we believe, poses aquestion that should make any normal, curious person eager to learn the answer.These examples stimulate interest while teaching students to see each feature oftheir economic landscape as the reflection of one or more of the core principles.Students talk about these examples with their friends and families. Learning eco-nomics is like learning a language. In each case, there is no substitute for actu-ally speaking. By inducing students to speak economics, the economic naturalistexamples serve this purpose.
For those who are interested in lerning more about the role of examplesin learning economics, Bob Frank’s lecture on the topic is posted on You Tube’s“Authors @ Google” series (http://www.youtube.com/watch?v�QalNVxeIKEEor search “Authors @ Google Robert Frank”).
A
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FEATURES
■ An emphasis on seven core principles: As noted, a few core principles do most ofthe work in economics. By focusing almost exclusively on these principles, thetext assures that students leave the course with a deep mastery of them. In con-trast, traditional encyclopedic texts so overwhelm students with detail that theyoften leave the course with little useful working knowledge at all.
1 The Scarcity Principle: Having more of one good thing usually means hav-ing less of another.
2 The Cost-Benefit Principle: Take no action unless its marginal benefit is atleast as great as its marginal cost.
3 The Incentive Principle: Cost-benefit comparisons are relevant not only foridentifying the decisions that rational people should make, but also for pre-dicting the actual decisions they do make.
4 The Principle of Comparative Advantage: Everyone does best when eachconcentrates on the activity for which he or she is relatively most productive.
5 The Principle of Increasing Opportunity Cost: Use the resources with the low-est opportunity cost before turning to those with higher opportunity costs.
6 The Efficiency Principle: Efficiency is an important social goal because whenthe economic pie grows larger, everyone can have a larger slice.
7 The Equilibrium Principle: A market in equilibrium leaves no unexploitedopportunities for individuals but may not exploit all gains achievablethrough collective action.
■ Economic naturalism: Our ultimate goal is to produce economic naturalists—people who see each human action as the result of an implicit or explicit cost-benefit calculation. The economic naturalist sees mundane details of ordinaryexistence in a new light and becomes actively engaged in the attempt to under-stand them. Some representative examples:
■ Why are whales and elephants, but not chickens, threatened with extinction?
■ Why do we often see convenience stores located on adjacent street corners?
■ Why do supermarket checkout lines all tend to be roughly the same length?
■ Active learning stressed: The only way to learn to hit an overhead smash in tennisis through repeated practice. The same is true for learning economics. Accordingly,we consistently introduce new ideas in the context of simple examples and thenfollow them with applications showing how they work in familiar settings. At fre-quent intervals, we pose exercises that both test and reinforce the understandingof these ideas. The end-of-chapter questions and problems are carefully crafted tohelp students internalize and extend core concepts. Experience with our first threeeditions confirms that this approach really does prepare students to apply basiceconomic principles to solve economic puzzles drawn from the real world.
■ Modern Microeconomics: Economic surplus, introduced in Chapter 1 and em-ployed repeatedly thereafter, is more fully developed here than in any othertext. This concept underlies the argument for economic efficiency as an importantsocial goal. Rather than speak of trade-offs between efficiency and other goals,we stress that maximizing economic surplus facilitates the achievement of allgoals. Common decision pitfalls identified by 2002 Nobel Laureate DanielKahneman and others—such as the tendency to ignore implicit costs, the
viii PREFACE
Cost-Benefit
Comparative Advantage
Increasing
Opportunity Cost
Incentive
Scarcity
Efficiency
Equilibrium
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tendency not to ignore sunk costs, and the tendency to confuse average andmarginal costs and benefits—are introduced early in Chapter 1 and invokedrepeatedly in subsequent chapters.
There is perhaps no more exciting toolkit for the economic naturalist thana few principles of elementary game theory. In Chapter 10, we show how theseprinciples enable students to answer a variety of strategic questions that arisein the marketplace and everyday life. We believe that the insights of NobelLaureate Ronald Coase are indispensable for understanding a host of familiarlaws, customs, and social norms. In Chapter 11 we show how such devicesfunction to minimize misallocations that result from externalities. A few sim-ple principles from the economics of information form another exciting addi-tion to the economic naturalist’s toolkit. In Chapter 12 we show how theinsights that earned the 2001 Nobel Prize in economics for George Akerlof,Joseph Stiglitz, and Michael Spence can be employed to answer a variety ofquestions from everyday experience.
IMPROVEMENTS
Our less-is-more approach is well-suited for a wide spectrum of institutions. Yet it re-mains a formidable challenge for any single book to fit the needs and capabilities ofall students across these diverse institutions. Some students arrive with AP credit inadvanced calculus, while others still lack confidence in basic geometry and algebra.Guided by extensive reviewer feedback, our main goal in preparing our fourth edi-tion has been to reorganize our presentation to accommodate the broadest possiblerange of student preparation. For example, while continuing to emphasize verbal andgraphical approaches in the main text, we offer several appendices that allow formore detailed and challenging algebraic treatments of the same material. Among thehundreds of specific refinements we made, the following merit explicit mention.
■ More and clearer emphasis on the core principles: If we asked a thousand econ-omists to provide their own versions of the most important economic principles,we’d get a thousand different lists. Yet to dwell on their differences would be tomiss their essential similarities. It is less important to have exactly the best shortlist of principles than it is to use some well-thought-out list of this sort.
■ Integrated the outsourcing and international trade material from (previously)Chapter 9 into the discussions within:
■ Chapter 2: Comparative Advantage
■ Chapter 28: International Trade and Capital Flows
■ Chapter learning objectives: Students and professors can be confident that theorganization of each chapter surrounds common themes outlined by five toseven learning objectives listed on the first page of each chapter. These objec-tives, along with AACSB and Bloom’s Taxonomy Learning Categories, areconnected to all test Bank questions and end-of-chapter material to offer acomprehensive, thorough teaching and learning experience.
■ Assurance of learning ready: Many educational institutions today are focused onthe notion of assurance of learning, an important element of some accreditationstandards. Principles of Microeconomics, 4e is designed specifically to supportyour assurance of learning initiatives with a simple, yet powerful, solution.
You can use our test bank software, EZTest, to easily query for LearningObjectives that directly relate to the objectives for your course. You can then
PREFACE ix
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use the reporting features of EZTest to aggregate student results in a similarfashion, making the collection and presentation of assurance of learning datasimple and easy.
THE CHALLENGE
The world is a more competitive place now than it was when we started teaching inthe 1970s. In arena after arena, business as usual is no longer good enough. Base-ball players used to drink beer and go fishing during the off season, but they nowlift weights and ride exercise bicycles. Assistant professors used to work on theirhouses on weekends, but the current crop can now be found most weekends at theoffice. The competition for student attention has grown similarly more intense.There are many tempting courses in the typical college curriculum and even moretempting diversions outside the classroom. Students are freer than ever to pick andchoose. Yet many of us seem to operate under the illusion that most freshmen arrivewith a burning desire to become economics majors. And many of us do not yetseem to have recognized that students’ cognitive abilities and powers of concentra-tion are scarce resources. To hold our ground, we must become not only more se-lective in what we teach, but also more effective as advocates for our discipline. Wemust persuade students that we offer something of value.
A well-conceived and well-executed introductory course in economics canteach our students more about society and human behavior in a single term thanvirtually any other course in the university. This course can and should be an intel-lectual adventure of the first order. Not all students who take the kind of course weenvisioned when writing this book will go on to become economics majors, ofcourse. But many will, and even those who do not will leave with a sense of admi-ration for the power of economic ideas.
A salesperson knows that he or she often gets only one chance to make a goodfirst impression on a potential customer. Analogously, the principles course is oftenour only shot at persuading most students to appreciate the value of economics. Bytrying to teach them everything we know—rather than teaching them the most im-portant things we know—we too often squander this opportunity.
SUPPLEMENTS FOR THE INSTRUCTOR
McGraw-Hill’s Homework Manager Plus™: McGraw-Hill’s Homework Man-ager Plus is a complete, Web-based solution that includes and expands uponthe actual problem sets found at the end of each chapter. It features enhancedtechnology that provides a varied supply of auto-graded assignments andgraphing exercises, tied to the learning objectives in the book. McGraw-Hill’sHomework Manager can be used for student practice, graded homeworkassignments, and formal examinations; the results are easily integratedwith your course management system, including WebCT and Blackboard.
Instructor’s Manual: Prepared by Louis D. Johnston of the College of SaintBenedict | Saint John’s University, this expanded manual will be extremely use-ful for all teachers. In addition to such general topics as Using the Web Site,Economic Education Resources, and Innovative Ideas, there will be for eachchapter: An Overview, Core Principles, Important Concepts Covered, Teach-ing Objectives, Teaching Tips/Student Stumbling Blocks, More Economic Nat-uralists, In-Class and Web Activities, Annotated Chapter Outline, Answers toTextbook Problems, Sample Homework, and a Sample Reading Quiz.
x PREFACE
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Test Bank: Prepared by Kate Krause of the University of New Mexico, thismanual contains more than 2,000 questions categorized by chapter Learn-ing Objectives, AACSB learning categories, and Bloom’s Taxonomy Objec-tives. The test bank is available in the latest EZTest test-generating software,ensuring maximum flexibility in test preparation.
PowerPoints: Prepared by Carol Swartz of the University of North Carolina-Charlotte, these slides contain a detailed, chapter-by-chapter review of theimportant ideas presented in the textbook, accompanied by animated graphsand slide notes.
Customizable Micro Lecture Notes and PowerPoints: One of the biggesthurdles to an instructor considering changing textbooks is the prospect ofhaving to prepare new lecture notes and slides. For the microeconomicschapters, this hurdle no longer exists. A full set of lecture notes for princi-ples of microeconomics, prepared by Bob Frank for his award-winningintroductory microeconomics course at Cornell University, is available asMicrosoft Word files that instructors are welcome to customize as they seefit. The challenge for any instructor is to reinforce the lessons of the text inlectures without generating student unrest by merely repeating what’s in thebook. These lecture notes address that challenge by constructing examplesthat run parallel to those presented in the book, yet are different from themin interesting contextual ways. Also available is a complete set of richlyillustrated PowerPoint files to accompany these lecture notes. Instructors arealso welcome to customize these files as they wish.
Instructor’s CD-ROM: This remarkable Windows software program con-tains the complete Instructor’s Manual with solutions to the end-of-chapterproblems, Solman Videos, Computerized Test Bank, PowerPoints, and thecomplete collection of art from the text.
Online Learning Center (www.mhhe.com/fb4e): The contents of the IRCDare available online at the textbook’s Web site for quick download and con-venient access for professors anytime.
SUPPLEMENTS FOR THE STUDENT
Study Guide: Revised by Louis D. Johnson of the College of Saint Benedict |Saint John’s University, this book contains for each chapter a pre-test; a “KeyPoint Review” that integrates the learning objectives with the chapter con-tent; a self-test with matching and multiple choice problems; short answerproblems; and an Economic Naturalist case study that helps students applywhat they learned.
Online Learning Center (www.mhhe.com/fb4e): For students there are suchuseful features as the Glossary from the textbook; Graphing Exercises,PowerPoints, a set of study and practice quizzes.
Premium Content: The Online Learning Center now offers students the op-portunity to purchase premium content. Like an electronic study guide, theOLC Premium Content enables students to take self-grading quizzes for eachchapter as well as to download Frank and Bernanke-exclusive iPod contentincluding podcasts by Brad Schiller, narrated lecture slides, and Paul Solmanvideos—all accessible through the student’s MP3 device. In the chapter when
PREFACE xi
EN 2
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you see an iPod icon, there is a podcast that correlates to that material. Thelabel EN stands for Economic Naturalist, and the number represents thechapter number.
A NOTE ON THE WRITING OF THIS EDITION
Ben Bernanke was sworn in on February 1, 2006, as Chairman and a mem-ber of the Board of Governors of the Federal Reserve System. From June2005 until January 2006, he served as chairman of the President’s Council ofEconomic Advisers. These positions have allowed him to play an active rolein making U.S. economic policy, but the rules of government service have re-stricted his ability to participate in the preparation of the Fourth Edition.
Fortunately, we were able to enlist the aid of Louis D. Johnston of theCollege of Saint Benedict | Saint John’s University to take the lead in re-vising the macro portions of the book and to assist Robert Frank in re-vising the micro portions of the book. Ben Bernanke and Robert Frankexpress their deep gratitude to Louis for the energy and creativity he hasbrought to his work on the book. He has made the book a better tool forstudents and professors.
ACKNOWLEDGMENTS
Our thanks first and foremost go to our publisher, Douglas Reiner, and our develop-ment editor, Angela Cimarolli. Douglas encouraged us to think deeply about how toimprove the book and helped us transform our ideas into concrete changes. Angieshepherded us through the revision process in person, on the telephone, through themail, and via e-mail with intelligence, sound advice, and good humor. We are grate-ful as well to the production team, whose professionalism (and patience) was out-standing: Susanne Riedell, senior project manager; Matthew Baldwin, designer;Debra Sylvester, senior production supervisor; Jeremy Cheshareck, senior photo re-search coordinator; and all of those who worked on the production team to turn ourmanuscript into the book you hold in your hands. Finally, we also thank Melissa Lar-mon, senior marketing manager, for getting our message into the wider world.
Finally, our sincere thanks to the following teachers and colleagues, whosethorough reviews and thoughtful suggestions led to innumerable substantiveimprovements.
xii PREFACE
Adel Abadeer, Calvin College
Cynthia Abadie, SouthwestTennessee Community College
Hesham Abdel-Rahman, Universityof New Orleans
Teshome Abebe, Eastern IllinoisUniversity
Roger L. Adkins, Marshall University
Richard Agesa, Marshall University
Frank Albritton, SeminoleCommunity College
Rashid Al-Hmoud, Texas TechUniversity
Farhad Ameen, SUNY - WestchesterCommunity College
Mauro C. Amor, NorthwoodUniversity
Nejat Anbarci, Florida InternationalUniversity
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Giuliana Campanelli Andreopoulos,William Paterson University
Michael Applegate, Oklahoma StateUniversity
Becca Arnold, Mesa College
Mohsen Bahmani-Oskooee,University of Wisconsin-Milwaukee
Sudeshna Bandyopadhyay, WestVirginia University
Gyanendra Baral, Oklahoma CityCommunity College
James Bartkus, Xavier University
Hamid Bastin, ShippensburgUniversity
John H. Beck, Gonzaga University
Klaus Becker, Texas Tech University
Doris Bennett, Jacksonville StateUniversity
Derek Berry, Calhoun CommunityCollege
Tom Beveridge, Durham TechnicalCommunity College
Okmyung Bin, East CarolinaUniversity
Robert G. Bise, Orange Coast College
John Bishop, East Carolina University
John L. Brassel, SouthwestTennessee Community College
William J. Brennan, Minnesota StateUniversity at Mankato
Jozell Brister, Abilene ChristianUniversity
Taggert Brooks, University ofWisconsin–La Crosse
Christopher Burkart, University ofWest Florida
Joseph Calhoun, Florida StateUniversity
Colleen Callahan, AmericanUniversity
Denis G. Carter, University of NorthCarolina, Wilmington
Shawn Carter, Jacksonville StateUniversity
Peter Cashel-Cordo, University ofSouthern Indiana
Andrew Cassey, University ofMinnesota
Rebecca Chakraborty, NorthwoodUniversity
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PREFACE xiii
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Preface vii
PART 1 Introduction
1 Thinking Like an Economist 3
2 Comparative Advantage 35
3 Supply and Demand 61
PART 2 Competition and the Invisible Hand
4 Elasticity 97
5 Demand 125
6 Perfectly Competitive Supply 150
7 Efficiency and Exchange 175
8 The Invisible Hand in Action 203
PART 3 Market Imperfections
9 Monopoly, Oligopoly, and Monopolistic Competition 233
10 Games and Strategic Behavior 269
11 Externalities and Property Rights 297
12 The Economics of Information 325
PART 4 Economics of Public Policy
13 Labor Markets, Poverty, and Income Distribution 349
14 The Environment, Health, and Safety 375
15 Public Goods and Tax Policy 397
Glossary G-1
Index I-1
xxi
B R I E F C O N T E N T S
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Preface vii
PART I Introduction
Chapter 1 Thinking Like an Economist 3
Economics: Studying Choice in a World of Scarcity 4Applying the Cost-Benefit Principle 6
Economic Surplus 6Opportunity Cost 7The Role of Economic Models 7
Three Important Decision Pitfalls 8Pitfall 1: Measuring Costs and Benefits as Proportions Rather Than Absolute Dollar Amounts 9Pitfall 2: Ignoring Implicit Costs 9Pitfall 3: Failure to Think at the Margin 11
Normative Economics versus Positive Economics 15Economics: Micro and Macro 15The Approach of This Text 16Economic Naturalism 17EXAMPLE 1.1 THE ECONOMIC NATURALIST: Why do many hardwaremanufacturers include more than $1,000 worth of “free” software with a computer selling for only slightly more than that? 17EXAMPLE 1.2 THE ECONOMIC NATURALIST: Why don’t auto manufacturers make cars without heaters? 18EXAMPLE 1.3 THE ECONOMIC NATURALIST: Why do the keypad buttons on drive-up automatic teller machines have Braille dots? 18Summary 19Core Principles 20Key Terms 20Review Questions 20Problems 20Answers to In-Chapter Exercises 22Appendix: Working with Equations, Graphs, and Tables 23
Chapter 2 Comparative Advantage 35
Exchange and Opportunity Cost 36The Principle of Comparative Advantage 37
EXAMPLE 2.1 THE ECONOMIC NATURALIST: Where have all the400 hitters gone? 39
Sources of Comparative Advantage 40EXAMPLE 2.2 THE ECONOMIC NATURALIST: Televisions and videocassetterecorders were developed and first produced in the United States, but today the United
C O N T E N T S
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States accounts for only a minuscule share of the total world production of these products. Why did the United States fail to retain its lead in these markets? 41Comparative Advantage and Production Possibilities 41
The Production Possibilities Curve 41How Individual Productivity Affects the Slope and Position of the PPC 44The Gains from Specialization and Exchange 46A Production Possibilities Curve for a Many-Person Economy 47
Factors That Shift the Economy’s Production Possibilities Curve 49Why Have Some Countries Been Slow to Specialize? 51Can We Have Too Much Specialization? 52
Comparative Advantage and International Trade 53EXAMPLE 2.3 THE ECONOMIC NATURALIST: If trade between nations is so beneficial, why are free-trade agreements so controversial? 53
Outsourcing 53EXAMPLE 2.4 THE ECONOMIC NATURALIST: Is PBS economics reporter Paul Solman’s job a likely candidate for outsourcing? 54Summary 56Core Principles 56Key Terms 56Review Questions 57Problems 57Answers to In-Chapter Exercises 58
Chapter 3 Supply and Demand 61
What, How, and for Whom? Central Planning versus the Market 63Buyers and Sellers in Markets 64
The Demand Curve 65The Supply Curve 66
Market Equilibrium 68Rent Controls Reconsidered 71Pizza Price Controls? 73
Predicting and Explaining Changes in Prices and Quantities 74Shifts in Demand 75
EXAMPLE 3.1 THE ECONOMIC NATURALIST: When the federal governmentimplements a large pay increase for its employees, why do rents for apartments located near Washington Metro stations go up relative to rents for apartments located far away from Metro stations? 77
Shifts in the Supply Curve 78EXAMPLE 3.2 THE ECONOMIC NATURALIST: Why do major term papers gothrough so many more revisions today than in the 1970s? 80
Four Simple Rules 81EXAMPLE 3.3 THE ECONOMIC NATURALIST: Why do the prices of some goods, like airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down? 84Efficiency and Equilibrium 84
Cash on the Table 85Smart for One, Dumb for All 86
Summary 87Core Principles 88Key Terms 89Review Questions 89Problems 89
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Answers to In-Chapter Exercises 90Appendix: The Algebra of Supply and Demand 93
PART 2 Competition and the Invisible Hand
Chapter 4 Elasticity 97
Price Elasticity of Demand 98Price Elasticity Defined 98Determinants of Price Elasticity of Demand 100Some Representative Elasticity Estimates 101Using Price Elasticity of Demand 102
EXAMPLE 4.1 THE ECONOMIC NATURALIST: Will a higher tax on cigarettes curb teenage smoking? 102EXAMPLE 4.2 THE ECONOMIC NATURALIST: Why was the luxury tax on yachts such a disaster? 102A Graphical Interpretation of Price Elasticity 103
Price Elasticity Changes along a Straight-Line Demand Curve 105Two Special Cases 106
Elasticity and Total Expenditure 107Income Elasticity and Cross-Price Elasticity of Demand 111The Price Elasticity of Supply 112
Determinants of Supply Elasticity 114EXAMPLE 4.3 THE ECONOMIC NATURALIST: Why are gasoline prices so much more volatile than car prices? 116
Unique and Essential Inputs: The Ultimate Supply Bottleneck 117Summary 118Key Terms 119Review Questions 119Problems 119Answers to In-Chapter Exercises 121Appendix: The Midpoint Formula 123
Chapter 5 Demand 125
The Law of Demand 126The Origins of Demand 126Needs versus Wants 127
EXAMPLE 5.1 THE ECONOMIC NATURALIST: Why does California experience chronic water shortages? 128Translating Wants into Demand 128
Measuring Wants: The Concept of Utility 128Allocating a Fixed Income between Two Goods 132The Rational Spending Rule 135Income and Substitution Effects Revisited 135
Applying the Rational Spending Rule 138Substitution at Work 138
EXAMPLE 5.2 THE ECONOMIC NATURALIST: Why do the wealthy in Manhattan live in smaller houses than the wealthy in Seattle? 138EXAMPLE 5.3 THE ECONOMIC NATURALIST: Why did people turn to four-cylindercars in the 1970s, only to shift back to six- and eight-cylinder cars in the 1990s? 138EXAMPLE 5.4 THE ECONOMIC NATURALIST: Why are automobile engines smallerin England than in the United States? 140
The Importance of Income Differences 140
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EXAMPLE 5.5 THE ECONOMIC NATURALIST: Why are waiting lines longer in poorer neighborhoods? 140Individual and Market Demand Curves 140
Horizontal Addition 141Demand and Consumer Surplus 142
Calculating Consumer Surplus 142Summary 145Key Terms 145Review Questions 145Problems 146Answers to In-Chapter Exercises 147
Chapter 6 Perfectly Competitive Supply 150
Thinking about Supply: The Importance of Opportunity Cost 150Individual and Market Supply Curves 152Profit-Maximizing Firms in Perfectly Competitive Markets 153
Profit Maximization 153The Demand Curve Facing a Perfectly Competitive Firm 154Production in the Short Run 155Some Important Cost Concepts 156Choosing Output to Maximize Profit 157A Note on the Firm’s Shutdown Condition 159Average Variable Cost and Average Total Cost 159A Graphical Approach to Profit Maximization 159Price � Marginal Cost: The Maximum-Profit Condition 161The “Law” of Supply 163
Determinants of Supply Revisited 164Technology 164Input Prices 164The Number of Suppliers 165Expectations 165Changes in Prices of Other Products 165
Applying the Theory of Supply 165EXAMPLE 6.1 THE ECONOMIC NATURALIST: When recycling is left to private market forces, why are many more aluminum beverage containers recycled than glass ones? 165Supply and Producer Surplus 168
Calculating Producer Surplus 168Summary 169Key Terms 170Review Questions 170Problems 170Answers to In-Chapter Exercises 173
Chapter 7 Efficiency and Exchange 175
Market Equilibrium and Efficiency 176Efficiency Is Not the Only Goal 179Why Efficiency Should Be the First Goal 179
The Cost of Preventing Price Adjustments 179Price Ceilings 180Price Subsidies 183First-Come, First-Served Policies 185
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EXAMPLE 7.1 THE ECONOMIC NATURALIST: Why does no one complain anylonger about being bumped from an overbooked flight? 185Marginal Cost Pricing of Public Services 188Taxes and Efficiency 190
Who Pays a Tax Imposed on Sellers of a Good? 190EXAMPLE 7.2 THE ECONOMIC NATURALIST: How will a tax on cars affect their prices in the long run? 191
How a Tax Collected from a Seller Affects Economic Surplus 192Taxes, Elasticity, and Efficiency 194Taxes, External Costs, and Efficiency 195
Summary 196Key Terms 197Review Questions 197Problems 197Answers to In-Chapter Exercises 199
Chapter 8 The Invisible Hand in Action 203
The Central Role of Economic Profit 204Three Types of Profit 204
The Invisible Hand Theory 207Two Functions of Price 207Responses to Profits and Losses 208The Importance of Free Entry and Exit 214
Economic Rent versus Economic Profit 215The Invisible Hand in Action 216
The Invisible Hand at the Supermarket and on the Freeway 216EXAMPLE 8.1 THE ECONOMIC NATURALIST: Why do supermarket checkout lines all tend to be roughly the same length? 216
The Invisible Hand and Cost-Saving Innovations 217The Invisible Hand in Regulated Markets 217
EXAMPLE 8.2 THE ECONOMIC NATURALIST: Why do New York City taxicabmedallions sell for more than $300,000? 218EXAMPLE 8.3 THE ECONOMIC NATURALIST: Why did major commercial airlinesinstall piano bars on the upper decks of Boeing 747s in the 1970s? 219
The Invisible Hand in Antipoverty Programs 220The Invisible Hand in the Stock Market 220
EXAMPLE 8.4 THE ECONOMIC NATURALIST: Why isn’t a stock portfolio consisting of Canada’s “50 best-managed companies” a particularly good investment? 223The Distinction between an Equilibrium and a Social Optimum 224
Smart for One, Dumb for All 225EXAMPLE 8.5 THE ECONOMIC NATURALIST: Are there “too many” smart peopleworking as corporate earnings forecasters? 225Summary 226Key Terms 227Review Questions 227Problems 227Answers to In-Chapter Exercises 229
PART 3 Market Imperfections
Chapter 9 Monopoly, Oligopoly, and Monopolistic Competition 233
Imperfect Competition 234
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Different Forms of Imperfect Competition 234The Essential Difference between Perfectly and Imperfectly Competitive Firms 236
Five Sources of Market Power 237Exclusive Control over Important Inputs 237Patents and Copyrights 237Government Licenses or Franchises 237Economies of Scale and Natural Monopolies 238Network Economies 238
Economies of Scale and the Importance of Start-Up Costs 239EXAMPLE 9.1 THE ECONOMIC NATURALIST: Why does Intel sell the overwhelming majority of all microprocessors used in personal computers? 241Profit Maximization for the Monopolist 242
Marginal Revenue for the Monopolist 242The Monopolist’s Profit-Maximizing Decision Rule 245Being a Monopolist Doesn’t Guarantee an Economic Profit 246
Why the Invisible Hand Breaks Down under Monopoly 247Using Discounts to Expand the Market 249
Price Discrimination Defined 249EXAMPLE 9.2 THE ECONOMIC NATURALIST: Why do many movie theaters offer discount tickets to students? 250
How Price Discrimination Affects Output 250The Hurdle Method of Price Discrimination 252Is Price Discrimination a Bad Thing? 255Examples of Price Discrimination 255
EXAMPLE 9.3 THE ECONOMIC NATURALIST: Why might an appliance retailerinstruct its clerks to hammer dents into the sides of its stoves and refrigerators? 256Public Policy toward Natural Monopoly 257
State Ownership and Management 257State Regulation of Private Monopolies 258Exclusive Contracting for Natural Monopoly 258Vigorous Enforcement of Antitrust Laws 259
Summary 260Key Terms 261Review Questions 261Problems 261Answers to In-Chapter Exercises 264Appendix: The Algebra of Monopoly Profit Maximization 267
Chapter 10 Games and Strategic Behavior 269
Using Game Theory to Analyze Strategic Decisions 270The Three Elements of a Game 270Nash Equilibrium 272
The Prisoner’s Dilemma 274The Original Prisoner’s Dilemma 274The Economics of Cartels 275
EXAMPLE 10.1 THE ECONOMIC NATURALIST: Why are cartel agreementsnotoriously unstable? 275
Tit-for-Tat and the Repeated Prisoner’s Dilemma 277EXAMPLE 10.2 THE ECONOMIC NATURALIST: How did Congress unwittingly solvethe television advertising dilemma confronting cigarette producers? 278
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EXAMPLE 10.3 THE ECONOMIC NATURALIST: Why do people shout at parties? 280Games in Which Timing Matters 280
Credible Threats and Promises 282Monopolistic Competition When Location Matters 283
EXAMPLE 10.4 THE ECONOMIC NATURALIST: Why do we often see convenience stores located on adjacent street corners? 284Commitment Problems 285The Strategic Role of Preferences 287
Are People Fundamentally Selfish? 288Preferences as Solutions to Commitment Problems 288
Summary 289Key Terms 290Review Questions 290Problems 290Answers to In-Chapter Exercises 294
Chapter 11 Externalities and Property Rights 297
External Costs and Benefits 298How Externalities Affect Resource Allocation 298How Do Externalities Affect Supply and Demand? 299The Coase Theorem 301Legal Remedies for Externalities 305
EXAMPLE 11.1 THE ECONOMIC NATURALIST: What is the purpose of free speech laws? 306EXAMPLE 11.2 THE ECONOMIC NATURALIST: Why does government subsidize private property owners to plant trees on their hillsides? 306
The Optimal Amount of Negative Externalities Is Not Zero 307Compensatory Taxes and Subsidies 307
Property Rights and the Tragedy of the Commons 309The Problem of Unpriced Resources 309The Effect of Private Ownership 311When Private Ownership Is Impractical 312
EXAMPLE 11.3 THE ECONOMIC NATURALIST: Why do blackberries in public parks get picked too soon? 313EXAMPLE 11.4 THE ECONOMIC NATURALIST: Why are shared milkshakesconsumed too quickly? 313Positional Externalities 314
Payoffs That Depend on Relative Performance 314EXAMPLE 11.5 THE ECONOMIC NATURALIST: Why do football players take anabolic steroids? 315
Positional Arms Races and Positional Arms Control Agreements 316Social Norms as Positional Arms Control Agreements 317
Summary 318Key Terms 320Review Questions 320Problems 320Answers to In-Chapter Exercises 323
Chapter 12 The Economics of Information 325
How the Middleman Adds Value 326The Optimal Amount of Information 328
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The Cost-Benefit Test 328The Free-Rider Problem 329
EXAMPLE 12.1 THE ECONOMIC NATURALIST: Why is finding a knowledgeablesalesclerk often difficult? 329EXAMPLE 12.2 THE ECONOMIC NATURALIST: Why did Rivergate Books,the last bookstore in Lambertville, New Jersey, go out of business? 329
Two Guidelines for Rational Search 330The Gamble Inherent in Search 331The Commitment Problem When Search Is Costly 332
Asymmetric Information 333The Lemons Model 334The Credibility Problem in Trading 336The Costly-to-Fake Principle 336
EXAMPLE 12.3 THE ECONOMIC NATURALIST: Why do firms insert the phrase “Asadvertised on TV” when they advertise their products in magazines and newspapers? 337EXAMPLE 12.4 THE ECONOMIC NATURALIST: Why do many companies care so much about elite educational credentials? 337
Conspicuous Consumption as a Signal of Ability 337EXAMPLE 12.5 THE ECONOMIC NATURALIST: Why do many clients seem to preferlawyers who wear expensive suits? 338
Statistical Discrimination 338EXAMPLE 12.6 THE ECONOMIC NATURALIST: Why do males under 25 years of age pay more than other drivers for auto insurance? 339
Adverse Selection 340Moral Hazard 340
Disappearing Political Discourse 341EXAMPLE 12.7 THE ECONOMIC NATURALIST: Why do opponents of the death penalty often remain silent? 341EXAMPLE 12.8 THE ECONOMIC NATURALIST: Why do proponents of legalized drugs remain silent? 342Summary 342Key Terms 344Review Questions 344Problems 344Answers to In-Chapter Exercises 346
PART 4 Economics of Public Policy
Chapter 13 Labor Markets, Poverty, and Income Distribution 349
The Economic Value of Work 350The Equilibrium Wage and Employment Levels 352
The Demand Curve for Labor 352The Supply Curve of Labor 353Market Shifts 354
Explaining Differences in Earnings 355Human Capital Theory 355Labor Unions 355
EXAMPLE 13.1 THE ECONOMIC NATURALIST: If unionized firms have to pay more, how do they manage to survive in the face of competition from theirnonunionized counterparts? 357
Compensating Wage Differentials 357
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EXAMPLE 13.2 THE ECONOMIC NATURALIST: Why do some ad–copy writers earn more than others? 357
Discrimination in the Labor Market 358Winner-Take-All Markets 360
EXAMPLE 13.3 THE ECONOMIC NATURALIST: Why does Renée Fleming earn millions more than sopranos of only slightly lesser ability? 360Recent Trends in Inequality 361Is Income Inequality a Moral Problem? 362Methods of Income Redistribution 364
Welfare Payments and In-Kind Transfers 364Means-Tested Benefit Programs 364The Negative Income Tax 365Minimum Wages 366The Earned-Income Tax Credit 367Public Employment for the Poor 368A Combination of Methods 369
Summary 370Key Terms 371Review Questions 371Problems 371Answers to In-Chapter Exercises 373
Chapter 14 The Environment, Health, and Safety 375
The Economics of Health Care Delivery 376Applying the Cost-Benefit Criterion 376Designing a Solution 378The HMO Revolution 379
EXAMPLE 14.1 THE ECONOMIC NATURALIST: Why is a patient with a sore knee more likely to receive an MRI exam if he has conventional health insurance than if he belongs to a health maintenance organization? 379
Paying for Health Insurance 380EXAMPLE 14.2 THE ECONOMIC NATURALIST: In the richest country on Earth,why do so many people lack basic health insurance? 381Using Price Incentives in Environmental Regulation 382
Taxing Pollution 382Auctioning Pollution Permits 384
Workplace Safety Regulation 385EXAMPLE 14.3 THE ECONOMIC NATURALIST: Why does the government require safety seats for infants who travel in cars but not for infants who travel in airplanes? 389Public Health and Security 390EXAMPLE 14.4 THE ECONOMIC NATURALIST: Why do many states have lawsrequiring students to be vaccinated against childhood illnesses? 390EXAMPLE 14.5 THE ECONOMIC NATURALIST: Why do more Secret Service agents guard the president than the vice president, and why do no Secret Service agents guard college professors? 391Summary 392Key Terms 393Review Questions 393Problems 393Answers to In-Chapter Exercises 395
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Chapter 15 Public Goods and Tax Policy 397
Government Provision of Public Goods 398Public Goods versus Private Goods 398Paying for Public Goods 400
EXAMPLE 15.1 THE ECONOMIC NATURALIST: Why don’t most married couples contribute equally to joint purchases? 402The Optimal Quantity of a Public Good 403
The Demand Curve for a Public Good 405Private Provision of Public Goods 405
EXAMPLE 15.2 THE ECONOMIC NATURALIST: Why do television networks favorJerry Springer over Masterpiece Theater? 406Additional Functions of Government 408
Externalities and Property Rights 408Local, State, or Federal? 409
Sources of Inefficiency in the Political Process 410Pork Barrel Legislation 410
EXAMPLE 15.3 THE ECONOMIC NATURALIST: Why does check-splitting make thetotal restaurant bill higher? 410EXAMPLE 15.4 THE ECONOMIC NATURALIST: Why do legislators often support one another’s pork barrel spending programs? 411
Rent-Seeking 411Starve the Government? 413
What Should We Tax? 414Summary 416Key Terms 417Review Questions 417Problems 417Answers to In-Chapter Exercises 420
Glossary G-1
Index I-1
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CORE PRINCIPLE 1
The Scarcity Principle (also called “The No-Free-Lunch
Principle”)
Although we have boundless needs and wants, the resources available to us arelimited. So having more of one good thing usually means having less of another.
CORE PRINCIPLE 2
The Cost-Benefit Principle
An individual (or a firm or a society) should take an action if, and only if, theextra benefits from taking the action are at least as great as the extra costs.
CORE PRINCIPLE 3
The Incentive Principle
A person (or a firm or a society) is more likely to take an action if the benefit risesand less likely to take it if the cost rises.
CORE PRINCIPLE 4
The Principle of Comparative Advantage
Everyone does best when each person (or each country) concentrates on theactivities for which his or her opportunity cost is lowest.
CORE PRINCIPLE 5
The Principle of Increasing Opportunity Cost (also called
“The Low-Hanging-Fruit Principle”)
In expanding the production of any good, first employ those resources with thelowest opportunity cost, and only afterward turn to resources with higheropportunity costs.
CORE PRINCIPLE 6
The Efficiency Principle
Efficiency is an important social goal because when the economic pie growslarger, everyone can have a larger slice.
CORE PRINCIPLE 7
The Equilibrium Principle (also called “The No-Cash-on-
the-Table Principle”)
A market in equilibrium leaves no unexploited opportunities for individuals butmay not exploit all gains achievable through collective action.
S E V E N C O R EP R I N C I P L E S
Cost-Benefit
Comparative Advantage
Increasing
Opportunity Cost
Equilibrium
Incentive
Scarcity
Efficiency
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