Table of Contents

Chapter 1: A Brief Economic History of the United States 3

• Introduction 3
• Part 1: The American Economy in the 19th Century 4
• Agricultural Development 4
• The National Railroad Network 7
• The Age of the Industrial Capitalist 7
• Part 2: The American Economy from 1900 through World War I
• Industrial Development 8
• Agricultural Development 9
• Part 3: The American Economy between the Wars 9
• The Roaring Twenties 9
• The Great Depression 10
• Part 4: From World War II to the Vietnam War 13
• The 1940s: World War II and Peacetime Prosperity 13
• The 1950's: The Eisenhower Years 17
• The Soaring Sixties: The Years of Kennedy and Johnson 17
• Part 5: From the Vietnam War to the Breakup of the Soviet Empire 18
• The Sagging Seventies: The Stagflation Decade 18
• The 1980s: The Age of Reagan 19
• Part 6: To the Millennium and Beyond 20
• The Military 20
• Real Wages 20
• The State of American Agriculture 20
• Other Social and Economic Problems 22
• The "New Economy" of the Nineties 22

Chapter 2: Resource Utilization 29

• Economics Defined 29
• The Central Fact of Economics: Scarcity 30
• Scarcity and the Need to Economize 30
• The Economic Problem 30
• The Four Economic Resources 30
• Opportunity Cost 33
• Full Employment and Full Production 33
• The Production Possibilities Frontier 37
• Productive Efficiency and Allocative Efficiency 41
• Economic Growth 41
• Appendix: The Law of Increasing Costs 53

Chapter 3: Supply and Demand 59

• Demand 60
• Supply 61
• Equilibrium 62
• Surpluses and Shortages 62
• Shift in Demand and Supply 63
• Price Ceilings and Price Floors 67
• Applications of Supply and Demand 72
• Interest Rate Determination 72
• College Parking 74
• Price-Setting in the Soviet Union 74
• Low Wages in a High-Tech Economy 74
• The Rationing Function of the Price System 75

Chapter 4: The Mixed Economy 83

• The Three Question of Economics 83
• What Shall We Produce? 84
• How Shall These Goods Be Produced? 84
• For Whom Shall the Goods Be Produced? 85
• The Invisible Hand, the Price Mechanism, and Perfect Competition 85
• The Invisible Hand 86
• The Price Mechanism 87
• Competition 87
• Equity and Efficiency 88
• The Circular Flow Model 88
• The Economic Role of Government 90
• Market Failure 91
• Externalities 91
• Lack of Public Goods and Services 92
• Capital 94
• Specialization and Its Consequences 96
• Specialization and Exchange 96
• Specialization and Alienation 97
• The "Isms": Capitalism, Communism, Fascism, and Socialism 98
• The Decline and Fall of the Communist System 102
• China: The Premier Communist Power 104
• Last Word: The Mixed Economy 106

Chapter 5: The Household-Consumption

• Sector 111
• GDP and Big Numbers 111
• Consumption 112
• Saving 113
• Average Propensity to Consume (APC) 114
• Average Propensity to Save (APS) 115
• Marginal Propensity to Consume (MPC) 116
• Marginal Propensity to Save (MPS) 117
• Graphing the Consumption Function 118
• The Saving Function 121
• What the Consumer Buys 125
• Determinants of the Level of Consumption 126
• The Level of Disposable Income 126
• Credit Availability 127
• Stock of Liquid Assets in the Hands of Consumers 127
• Stock of Durable Goods in the Hands of Consumers 128
• Keeping Up with the Joneses 128
• Consumer Expectations 128
• The Permanent Income Hypothesis 129
• Determinants of the Level of Saving 129
• Why Do We Spend So Much and Save So Little? 130
• Total Saving: Individual Saving + Business Saving + Government Saving 132

Chapter 6: The Business-Investment Sector 139

• Proprietorships, Partnerships, and Corporations 139
• The Proprietorship 139
• The Partnership 140
• The Corporation 140
• Stocks and Bonds 142
• Capitalization and Control 142
• The Business Population 143
• Investment 143
• How Does Savings Get Invested? 148
• Gross Investment versus Net Investment 149
• Building Capital 149
• The Determinants of the Level of Investment 150
• (1) The Sales Outlook 150
• (2) Capacity Utilization Rate 150
• (3) The Interest Rate 151
• (4) The Expected Rate of Profit 152
• Why Do Firms Invest? 153
• Graphing the C + I Line 154
• The Summing Up of Investment 155

Chapter 7: The Government Sector 163

• Introduction: The Growing Economic Role of Government 163
• Government Spending 164
• Federal Government Spending 164
• State and Local Government Spending 167
• Government Purchases versus Transfer Payments 168
• Graphing the C + I + G Line 168
• Taxes 169
• The Average Tax Rate and the Marginal Tax Rate 169
• Types of Taxes 172
• Sources of Federal Revenue 175
• Conclusion 179
• Sources of State and Local Revenue 180
• The State and Local Fiscal Dilemma 181
• Comparison of Taxes in the United States and Other Countries 181
• Two Principles of Taxation: Ability to Pay versus Benefits Received 183
• The Economic Role of Government 184
• Provision of Public Goods and Services 185
• Redistribution of Income 185
• Stabilization 185
• Economic Regulation 186
• Conclusion 186

Chapter 8: The Export-Import Sector 193

• The Basis for International Trade 193
• U.S. Exports and Imports 194
• A Summing Up: C + I + G + Xn 199
• The World's Leading Trading Nations 200
• World Trade Agreements and Free Trade Zones 201
• Free Trade Zones 202
• World Trade Agreements 204

Chapter 9: Gross Domestic Product 211

• What Is Gross Domestic Product? 211
• How GDP Is Measured 213
• The Expenditures Approach 213
• The Flow-of-Income Approach 214
• Two Things to Avoid When Compiling GDP 221
• Multiple Counting 221
• Treatment of Transfer Payments 221
• GDP versus Real GDP 222
• International GDP Comparisons 227
• Per Capita Real GDP 228
• Shortcomings of GDP as a Measure of National Economic Well-Being 232
• Production That Is Excluded 232
• Treatment of Leisure Time 234
• Human Costs and Benefits 234
• What Goes Into GDP? 236
• The Last Word on GDP 236

Chapter 10: Economic Fluctuations, Unemployment, and Inflation 243

• Economic Fluctuations 243
• Is There a Business Cycle? 243
• Cycle Turning Points: Peaks and Troughs 245
• The Conventional Three-Phase Business Cycle 245
• Business Cycle Theories 246
• Endogenous Theories 246
• Exogenous Theories 248
• Business Cycle Forecasting 248
• The GDP Gap 250
• Unemployment 251
• The Problem 251
• How the Unemployment Rate Is Computed 252
• Types of Unemployment 256
• Natural Unemployment Rate 259
• Inflation 260
• Defining Inflation 260
• Deflation and Disinflation 261
• The Post-World War II History of Inflation 263
• The Construction of the Consumer Price Index 264
• Anticipated and Unanticipated Inflation: Who Is Hurt by Inflation and Who Is Helped? 266
• Theories of the Causes of Inflation 268
• Inflation as a Psychological Process 270
• Creeping Inflation and Hyperinflation 271
• Conclusion 272

Chapter 11: Classical and Keynesian Economics 279

• Part I: The Classical Economic System 279
• Supply and Demand Revisited 281
• The Classical Equilibrium: Aggregate Demand Equals Aggregate Supply 283
• The Aggregate Demand Curve 284
• The Long-Run Aggregate Supply Curve 285
• The Short-Run Aggregate Supply Curve 286
• Part II: The Keynesian Critique of the Classical System 288
• Part III: The Keynesian System 291
• The Keynesian Aggregate Expenditure Model 292
• Disequilibrium and Equilibrium 294
• Aggregate Demand Exceeds Aggregate Supply 294
• Aggregate Supply Exceeds Aggregate Demand 296
• Summary: How Equilibrium Is Attained 296
• Keynesian Policy Prescriptions 296

Chapter 12: Fiscal Policy and the National Debt 303

• Putting Fiscal Policy into Perspective 303
• Part I: The Deflationary Gap and the Inflationary Gap 304
• The Deflationary Gap 305
• The Inflationary Gap 306
• Part II: The Multiplier and Its Applications 307
• The Multiplier 307
• Applications of the Multiplier 309
• Part III: The Automatic Stabilizers 312
• Personal Income and Payroll Taxes 313
• Personal Savings 313
• Credit Availability 313
• Unemployment Compensation 313
• The Corporate Profits Tax 314
• Other Transfer Payments 314
• Part IV: Discretionary Fiscal Policy 316
• Making the Automatic Stabilizers More Effective 316
• Public Works 317
• Transfer Payments 317
• Changes in Tax Rates 317
• Changes in Government Spending 318
• Who Makes Fiscal Policy? 318
• Part V: The Deficit Dilemma 319
• Deficits, Surpluses, and the Balanced Budget 319
• Deficits and Surpluses: The Record 320
• Why Are Large Deficits So Bad? 321
• Will We Be Able to Balance Future Budgets? 322
• Part VI: The Proposed Balanced Budget Amendment and the Line Item Veto 324
• Part VII: The Public Debt 325
• Appendix: The Full-Employment Budget and the Crowding-Out and Crowding-In Effects 333
• The Full-Employment Budget 333
• The Crowding-Out and Crowding-In Effects 334

Chapter 13: Money and Banking 339

• Money 340
• The Four Jobs of Money 340
• Medium of Exchange 340
• Standard of Value 340
• Store of Value 340
• Standard of Deferred Payment 341
• Money versus Barter 342
• Our Money Supply 342
• M1, M2, and M3 343
• Our Growing Money Supply 345
• The Demand for Money 345
• The Demand Schedule for Money 349
• The Liquidity Trap 350
• Determination of the Interest Rate 350
• Banking 353
• A Short History of Banking 353
• Modern Banking 355
• The Creation and Destruction of Money 360
• The Creation of Money 360
• The Destruction of Money 360
• Limits to Deposit Creation 360
• Bank Regulation 361
• Branch Banking and Bank Chartering 361
• The Federal Deposit Insurance Corporation 362
• The Savings and Loan Debacle 363
• Will the Commercial Banks Go the Way of the S&Ls? 365

Chapter 14: The Federal Reserve and Monetary Policy 373

• The Federal Reserve System 373
• The Federal Reserve District Banks 374
• The Board of Governors 375
• Independence of the Board of Governors 376
• Legal Reserve Requirements 377
• Primary and Secondary Reserves 378
• Deposit Expansions 379
• How Deposit Expansion Works 379
• The Deposit Expansion Multiplier 379
• Cash, Checks, and Electronic Money 381
• The Tools of Monetary Policy 382
• How Open-Market Operations Work 382
• The Federal Open-Market Committee 384
• Discount Rate Changes 386
• Changing Reserve Requirements 387
• Summary: The Tools of Monetary Policy 389
• The Fed's Effectiveness in Fighting Inflation and Recession 390
• The American Economy According to Chairman Greenspan 391
• The Depository Institutions Deregulation and Monetary Control Act of 1980 393
• The Banking Act of 1999 394
• Fiscal and Monetary Policies Should Mesh 395
• Last Word 395

Chapter 15: Twentieth-Century Economic Theory 403

• The Equation of Exchange 404
• The Quantity Theory of Money 405
• Classical Economics 407
• Keynesian Economics 408
• The Monetarist School 410
• The Importance of the Rate of Monetary Growth 410
• The Basic Propositions of Monetarism 411
• The Monetary Rule 412
• The Decline of Monetarism 413
• Supply-Side Economics 413
• The Work Effect 414
• The Saving and Investment Effect 414
• The Elimination of Productive Market Exchanges 415
• The Laffer Curve 415
• Rational Expectations Theory 417
• Are Wages Downwardly Flexible? 420
• Twenty-First Century Economic Theory 421
• The Supply-Side Revival 421
• The Economic Behaviorists 422
• Conclusion 423
• Appendix A: The Great Money Debate: The Keynesians versus the Monetarists 431
• Preliminary Debate 431
• Round 1: How Stable Is V? 432
• Velocity and Changes in the Money Supply 432
• How Stable Is Velocity in the Short Run? 432
• Round 2: The Transmission Mechanism 434
• Introduction 434
• The Keynesian View 435
• The Monetarist View 436
• Comparison of Keynesian and Monetarist Transmission Mechanisms 437
• Who Is Right? 438
• Round 3: Monetary Policy 438
• Fighting Recessions 438
• Fighting Inflations 439
• Round 4: A Question of Timing 440
• The Lags 440
• Fiscal Policy Lags 440
• Monetary Policy Lags 441
• Fiscal versus Monetary Policy: A Summing Up 442
• Appendix B: A Guide to Macropolicy 447
• Fighting Recessions 447
• Conventional Fiscal Policy 448
• Conventional Monetary Policy 448
• Two Policy Dilemmas 448
• Fighting Inflation 448
• Conventional Fiscal Policy 448
• Conventional Monetary Policy 448
• Fighting Inflationary Recessions: Two More Policy Dilemmas 449
• The Limits of Macropolicy 449
• Conclusion 450

Chapter 16: Economic Growth and Productivity 453

• The Industrial Revolution and American Economic Development 453
• The Record of Economic and Productivity Growth 455
• Factors Affecting Productivity Growth 456
• The Labor Force: Rising Quantity and Declining Quality 460
• The Average Workweek 461
• Our Declining Educational System 461
• The Permanent Underclass: Poverty, Drugs, and Crime 462
• Restrictions on Immigration 463
• The Role of Technological Change 464
• Additional Factors Affecting Our Rate of Growth 465
• Conclusion 467
• The Productivity of Labor: An International Comparison 468
• Economic Growth in the Less Developed Countries 469

Chapter 17: Demand, Supply, and Equilibrium 479

• Demand Defined 479
• Individual Demand and Market Demand 480
• Changes in Demand 481
• Increases in Demand 481
• Decreases in Demand 482
• Problems 482
• What Causes Changes in Demand? 486
• Supply Defined 487
• Individual Supply and Market Supply 488
• Changes in Supply 489
• What Causes Changes in Supply? 491
• Changes in the Cost of Production 491
• Technological Advance 491
• Prices of Other Goods 491
• Change in the Number of Suppliers 492
• Changes in Taxes 492
• Expectation of Future Price Changes 492
• Graphing the Demand and Supply Curves 492
• Graphing the Demand Curve 493
• Graphing the Supply Curve 495
• Equilibrium 496
• Finding Equilibrium Price and Quantity 498
• Last Word 500

Chapter 18: The Elasticities of Demand and Supply 507

• The Elasticity of Demand 507
• Measuring Elasticity 508
• The Meaning of Elasticity 510
• Determinants of the Degree of Elasticity of Demand 514
• Advertising 517
• Elasticity and Total Revenue 519
• Elastic Demand and Total Revenue 519
• Inelastic Demand and Total Revenue 520
• Elasticity of Supply 520
• Elasticity over Time 521
• Tax Incidence 524
• Last Word 526

Chapter 19: Theory of Consumer Behavior 533

• Utility 534
• What Is Utility? 534
• Marginal Utility 534
• Total Utility 535
• Maximizing Utility 536
• The Water-Diamond Paradox 537
• Consumer Surplus 539
• Last Word 542

Chapter 20: Cost 547

• Costs 547
• Fixed Costs 548
• Variable Costs 548
• Total Costs 548
• Marginal Costs 548
• The Short Run and the Long Run 551
• The Short Run 551
• The Long Run 551
• The Decision to Shut Down 551
• The Decision to Go Out of Business 553
• Average Cost 554
• Average Fixed Cost 554
• Average Variable Cost 555
• Average Total Cost 555
• Graphing the AFC, AVC, ATC, and MC Curves 556
• Why Are the AVC and ATC Curves U-Shaped? 561
• The Law of Diminishing Returns 562
• Economies of Scale 563
• Diseconomies of Scale 565
• A Summing Up 566
• The Long-Run Planning Envelope Curve 566

Chapter 21: Profit Maximization 573

• Total Revenue and Marginal Revenue 573
• Graphing Demand and Marginal Revenue 574
• Profit Maximization and Loss Minimization 575
• The Short-Run and Long-Run Supply Curves 580
• Derivation of the Firm's Short-Run and Long-Run Supply Curves 580
• Finding the Firm's Shut-Down and Break-Even Points 583
• A Summing Up 583
• Efficiency 586
• Review: Efficiency and Profit Maximization 587
• Final Word 589

Chapter 22: Perfect Competition 595

• Definition of Perfect Competition 596
• The Perfect Competitor's Demand Curve 597
• The Short Run 598
• The Long Run 600
• Efficiency 605
• Economic and Accounting Profits 606
• Decreasing, Constant, and Increasing Cost Industries 607
• Decreasing Costs and the Breakdown of Perfect Competition 608

Chapter 23: Monopoly 617

• Monopoly Defined 618
• The Graph of the Monopolist 618
• Calculating the Monopolist's Profit 620
• Review the Monopolist's Economic Analysis 622
• The Monopolist in the Short Run and the Long Run 624
• Demand and Supply under Monopoly 625
• Are All Monopolies Big Companies? 625
• Barriers to Entry 625
• Limits to Monopoly Power 628
• Economies of Scale and Natural Monopoly 629
• When Is Bigness Bad? 632
• When Is Bigness Good? 633
• The Economic Case against Bigness 635
• Two Policy Alternatives 635
• Conclusion 636

Chapter 24: Monopolistic Competition 643

• Monopolistic Competition Defined 643
• The Monopolistic Competitor in the Short Run 644
• The Monopolistic Competitor in the Long Run 645
• Product Differentiation 647
• The Typical Monopolistic Competitor 648
• Price Discrimination 650
• Is the Monopolistic Competitor Inefficient? 652

Chapter 25: Oligopoly 659

• Oligopoly Defined 659
• Two Measures of the Degree of Oligopolization 660
• Concentration Ratios 660
• The Herfindahl-Hirschman Index (HHI) 662
• The Competitive Spectrum 663
• Cartels 663
• Open Collusion 664
• Covert Collusion 666
• Price Leadership 667
• Cutthroat Competition 667
• Conclusion 670
• Last Word 672
• Appendix: The Four Types of Competition: A Review 677
• Perfect Competition 677
• Monopoly 679
• Monopolistic Competition 680
• Oligopoly 681
• Perfect Competition versus Imperfect Competition 682

Chapter 26: Corporate Mergers and Antitrust 687

• A Historical Perspective on Corporate Concentration 687
• Antitrust 688
• The Political Background 688
• The Sherman Antitrust Act 689
• The Clayton Antitrust Act 690
• The Federal Trade Commission Act (1914) 691
• Modern Antitrust 692
• Partial Breakdown of the Rule of Reason 692
• The 60 Percent Rule 692
• Four Landmark Cases 693
• European Antitrust 694
• Types of Mergers 695
• Horizontal Mergers 695
• Vertical Mergers 695
• Conglomerate Mergers 696
• Deregulation 697
• How Effective Is Antitrust? 697
• The Trend Toward Bigness 700

Chapter 27: Demand in the Factor Market 707

• Derived Demand 707
• Productivity 708
• Prices of Substitute Resources 708
• Marginal Revenue Product (MRP) 709
• Graphing the MRP 713
• The MRP of the Imperfect Competitor 715
• Changes in Resource Demand 717
• Changes in Resource Demand versus Changes in Quantity of Resource Demanded 717
• The Four Reasons for Changes in Resource Demand 718
• Optimum Resource Mix for the Firm 722

Chapter 28: Labor Unions 729

• A Short History of the American Labor Movement 729
• The Early Years 729
• Key Labor Legislation 730
• The Labor Movement since the New Deal 732
• The Economic Power of Labor Unions 736
• The Economic Power of Large Employers 736
• Collective Bargaining 738
• The Collective Bargaining Process 738
• The Collective Bargaining Agreement 740
• The Strike 741
• Averting Strikes: Mediation and Arbitration 743
• Have Unions Raised Wages? 744

Chapter 29: Labor Markets and Wage Rates 751

• Income Disparity 751
• The Supply of Labor 752
• Noncompeting Groups 752
• The Theory of the Dual Labor Market 752
• The Backward-Bending Labor Supply Curve 753
• The Demand for Labor 755
• The Marginal Revenue Product Schedule 755
• Nonhomogeneous Jobs 756
• Graph of the Demand for Labor 757
• The Wage Rate: Supply and Demand 757
• High Wage Rates and Economic Rent 758
• Real Wages and Productivity 760
• Real Wages versus Nominal Wages 761
• The Minimum Hourly Wage Rate 763
• Should There Be a Minimum Wage Rate? 764

Chapter 30: Rent, Interest, and Profit 773

• Rent 773
• What Is Land? 773
• How Is Rent Determined? 774
• Economic Rent 776
• Are Prices High because Rents Are High, or Are Rents High because Prices Are High? 777
• Interest 778
• What Is Capital? 778
• How Is the Interest Rate Determined? 778
• Interest Rates and Consumer Loans 779
• Determination of the Level of Investment 781
• The Net Productivity of Capital 782
• The Capitalization of Assets 783
• The Present Value of Future Income 784
• Profits 786
• How Are Profits Determined? 786
• How Large Are Profits? 787
• Theories of Profit 788
• Conclusion 790

Chapter 31: Income Distribution and Poverty 795

• Income Distribution in the United States 796
• The Poor, the Middle Class, and the Rich 796
• Distribution of Wealth in the United States 799
• Distribution of Income: Equity and Efficiency 801
• What Determines Income Distribution? 802
• Mobility 806
• Poverty in America 806
• Poverty Defined 806
• Who Are the Poor? 808
• Child Poverty 810
• The Main Government Transfer Programs 812
• Theories of the Causes of Poverty 813
• The Conservative View versus the Liberal View 815
• Solutions 819
• Conclusion 823

Chapter 32: International Trade 829

• Part I: A Brief History of U.S. Trade 830
• U.S. Trade Before 1975 830
• U.S. Trade Since 1975 830
• U.S. Government Trade Policy 832
• Part II: The Theory of International Trade 833
• Specialization and Trade 833
• Domestic Exchange Equations 834
• The Terms of Trade 835
• Absolute Advantage and Comparative Advantage 837
• The Arguments for Protection 842
• Tariffs or Quotas 846
• Conclusion 847
• Part III: The Practice of International Trade 849
• What Are the Causes of Our Trade Imbalance? 849
• What Can We Do? 852
• Part IV: Our Trade Deficit with Japan and China 854
• Japanese Trading Practices 855
• Our Trade Deficit with China 858
• Trading with China and Japan: More Differences than Similarities 858
• Final Word 859

Chapter 33: International Finance 867

• The Mechanics of International Finance 867
• Financing International Trade 868
• The Balance of Payments 868
• Exchange Rate Systems 871
• The Gold Standard 872
• The Gold Exchange Standard, 1934-73 873
• The Freely Floating Exchange Rate System, 1973 to the Present 874
• How Well Do Freely Floating (Flexible) Exchange Rates Work? 878
• The Euro 878
• Running up a Tab in the Global Economy 880
• From Largest Creditor to Largest Debtor 880
• Living beyond Our Means 882
• Closing Word: Will Foreigners Soon Own America? 883

Glossary 891

Index 901