EC6_A01.qxd 9/9/05 1:30 AM Page iii EC6_A01.qxd 9/9/05 1:30 AM Page iv Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk Original edition entitled Economicspublished by Addison-Wesley Publishing Company, Inc. A Pearson Education company This edition published by Pearson Education Limited 2005 ©Pearson Education Limited 2000, 2003, 2005 Authorised for sale only in Europe, the Middle East and Africa The rights of Michael Parkin, Melanie Powell and Kent Matthews to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. ISBN 10: 0-321-31264-3 ISBN 13: 978-0-321-31264-8 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Parkin, Michael, 1939- Economics / Michael Parkin, Melanie Powell, and Kent Matthews.–– 6th ed. p. cm. Includes index. ISBN 0-321-31264-3 (pbk.) 1. Economics. I. Powell, Melanie. II. Matthews, Kent. III. Title. HB171.5.P313 2005b 330––dc22 2004062675 10 9 8 7 6 5 4 3 2 10 09 08 07 06 05 Typeset in 9/12.5pt Stone Serif by 35 Printed and bound by Mateu-Cromo Artes Graficas, Madrid, Spain The publisher’s policy is to use paper manufactured from sustainable forests. EC6_A01.qxd 9/9/05 1:30 AM Page v u u u u u u u u u About the Authors Michael Parkin received his training as an economist at the Universities of Leicester and Essex in England. Currently in the Department of Economics at the University of Western Ontario, Canada, Professor Parkin has held faculty appointments at the University of Manchester, the University of Essex, Brown University and Bond University. He is a past president of the Canadian Economics Association and has served on the editorial boards of the American Economic Reviewand the Journal of Monetary Economicsand as managing editor of the Canadian Journal of Economics. Professor Parkin’s research on macroeconomics, monetary economics and international eco- nomics has resulted in over 160 publications in journals and edited volumes, including the American Economic Review, the Journal of Political Economy, the Review of Economic Studies, the Journal of Monetary Economicsand the Journal of Money, Credit and Banking. He became most visible to the public with his work on inflation that discredited the use of wage and price controls. Michael Parkin also spearheaded the movement towards European monetary union. Professor Parkin is an experienced and dedicated teacher of introduc- tory economics. Melanie Powell took her first degree at Kingston University and her MSc in economics at Birkbeck College, London University. She has been a research fellow in health economics at York University, a principal lecturer in eco- nomics at Leeds Metropolitan University, and the director of economic stud- ies and part-time MBAs at the Leeds University Business School. She is now a Reader at Derby University Business School. Her main interests as a microeconomist are in applied welfare economics, and she has many publica- tions in the area of health economics and decision making. Her current research uses the experimental techniques of psychology applied to economic decision making. Kent Matthews received his training as an economist at the London School of Economics, Birkbeck College University of London and the University of Liverpool. He is currently the Sir Julian Hodge Professor of Banking and Finance and Head of Economics at the Cardiff Business School. He has held research appointments at the London School of Economics, the National Institute of Economic and Social Research, the Bank of England and Lombard Street Research Ltd and faculty positions at the Universities of Liverpool, Western Ontario, Leuven, Liverpool John Moores and Humbolt Berlin. He is the author (co-author) of 6 books and over 50 articles in scholarly journals and edited volumes. EC6_A01.qxd 9/9/05 1:30 AM Page vii u u u u u u u u u Brief Contents Part 1 Part 5 The Scope of Economics 1 Macroeconomic Basics 415 Chapter 1 What is Economics? 3 Chapter 19 A First Look at Macroeconomics 417 Chapter 2 The Economic Problem 31 Chapter 20 Measuring GDP and Economic Growth 437 Part 2 Chapter 21 Monitoring Cycles, Jobs and Inflation 457 How Markets Work 51 Chapter 22 Aggregate Supply and Aggregate Demand 479 Chapter 3 Demand and Supply 53 Chapter 23 At Full Employment: The Classical Chapter 4 Elasticity 77 Model 503 Chapter 5 Efficiency and Equity 97 Chapter 24 Expenditure Multipliers: The Chapter 6 Markets in Action 117 Keynesian Model 525 Chapter 7 Utility and Demand 141 Chapter 8 Possibilities, Preferences Part 6 and Choices 159 Macroeconomic Policy 553 Chapter 25 Fiscal Policy 555 Part 3 Chapter 26 Money, Banks and Interest Rate 581 Firms and Markets 177 Chapter 27 Monetary Policy 603 Chapter 9 Organizing Production 179 Chapter 28 Fiscal and Monetary Interactions 625 Chapter 10 Output and Costs 201 Chapter 29 Inflation 653 Chapter 11 Perfect Competition 227 Chapter 30 Economic Growth 679 Chapter 12 Monopoly 251 Chapter 31 The Business Cycle 701 Chapter 13 Monopolistic Competition Chapter 32 Macroeconomic Policy Challenges 723 and Oligopoly 273 Part 7 Part 4 Globalization and the International Government in the Economy 305 Economy 747 Chapter 14 Government Regulation and Chapter 33 Trading with the World 749 Competition Policy 307 Chapter 34 International Finance 771 Chapter 15 Externalities 329 Chapter 16 Public Goods and Common Resources 347 Chapter 17 Demand and Supply in Factor Markets 365 Chapter 18 Economic Inequality and Redistribution 395 BRIEF CONTENTS vii EC6_A01.qxd 9/9/05 1:30 AM Page viii u u u u u u u u u Guided Tour Learning Objectives Review Quiz Each chapter begins with a list of learning objectives, A review quizat the end of most major sections enables which enables students to see exactly where the chapter students to determine whether a topic needs further is going and to set their goals before they begin the study before moving on. These quizzes tie directly to the chapter. We link these goals directly to the chapter’s chapter’s learning objectives. major headings. Chapter Opener Each chapter opens with a brief student-friendly vignette, accompanied by an attractive, attention- grabbing image. The vignette and image raise questions Key Terms that both motivate the student and focus the chapter. Highlighted key terms within the text simplify the stu- We carry this story into the main body of the chapter, dent’s task of learning the vocabulary of economics. and relate it to the chapter-ending Reading Between the Each highlighted term appears in an end-of-chapter list Lines or Business Case Study feature for a cohesive and in an end-of-book glossary, with page numbers, are learning experience. emboldened in the index, and can also be found online in the Web glossary and Flash Card features. viii GUIDED TOUR EC6_A01.qxd 9/9/05 1:30 AM Page ix GUIDED TOUR ix Diagrams to Show Economic Action Boxes The goal of the diagrams is to show ‘where the eco- A new feature to this edition are boxes, which explore nomic action is’. Graphical analysis is the most power- for the student the application of theory in the real ful tool available for teaching and learning economics. world. Often accompanied by tables and figures com- We have developed the diagrams with the study and prising of real data, the boxes help contextualise the review needs of the student in mind, and feature: issue at hand for the student, whilst also encouraging them to apply their knowledge to the economic world u Original curves consistently shown in blue around them. u Shifted curves, equilibrium points and other impor- tant features highlighted in red u Colour-blended arrows to suggest movement u Graphs paired with data tables u Diagrams labelled with boxed notes u Extended captions that make each diagram and its caption a self-contained object for study and review. EC6_A01.qxd 9/9/05 1:31 AM Page x x GUIDED TOUR Reading Between the Lines and End-of-Chapter Study Material Business Case Studies Each chapter closes with a concise summaryorganized by major topics, lists of keyterms(all with page refer- In Reading Between the Lines and Business Case ences), problems, critical thinkingquestions, and web Studies, which appear at the end of each chapter, we exercises. show the student how to apply the tools they have just The end-of-chapter problems are organized in pairs. learned by analyzing an article from a newspaper or The solution to the odd-numbered problem in each pair news Web site. The Sixth Edition features 28 new items may be found at MyEconLab; the parallel even-numbered and 5 classics from the previous edition. Critical problem is left for students to solve on their own. This Thinking questions about the article appear with the arrangement offers help to students and flexibility to end-of-chapter questions and problems. lecturers who want to assign problems for credit. Study Guide The Sixth Edition Study Guide by Melanie Powell and Derek Fry is carefully coordinated with the text, MyEconLab, and the Test Banks. Each chapter of the Study Guide contains: u Key concepts u Helpful hints u True/false/uncertain questions that ask students to explain their answers u Multiple-choice questions u Short-answer questions u Common questions or misconceptions that the stu- dent explains as if he or she were the lecturer Each part allows students to test their cumulative understanding with sample midterm tests. EC6_A01.qxd 9/9/05 1:31 AM Page xi u u u u u u u u u Guided Tour – MyEconLab Packaged with every new book, MyEconLab puts stu- Tutorial Instruction dents in control of their own learning through a suite of study and practice tools tied to the online, interactive Launched from the additional practice exercises, tutorial version of the textbook and other media tools. At the instruction is provided in the form of solutions to prob- core of MyEconLab are the following features: lems, step-by-step explanations, and other media-based explanations. u Practice tests u Personalized study plan u Powerful Graphing Tool Additional practice exercises u Tutorial instruction A powerful graphing tool integrated into the practice u Powerful graphing tool tests and additional practice exercises lets students manipulate graphs so that they get a better feel for Practice Tests how the concepts, numbers and graphs are connected. Questions that use the graphing tool (like all the other Practice tests for each section of the textbook enable questions) can be submitted and marked. students to test their understanding and identify the areas in which they need to do further work. Lecturers Additional MyEconLab Tools can customize the practice tests or leave students to use the two pre-built tests. 1. E-text (the entire textbook in electronic format) 2. Animated figures (all the textbook figures in step- Personalized Study Plan by-step animations with audio explanations of the action) Based on a student’s performance on a practice test, a personal study plan is generated that shows where fur- 3. Electronic tutorials ther study needs to focus. This study plan consists of a 4. Glossary – key terms from the textbook series of additional practice exercises. 5. Glossary Flashcards 6. Office Hours Additional Practice Exercises 7. Weekly Economics in the Newsupdates and archives Generated by the student’s own performance on a prac- 8. Links to the most useful economic data and informa- tice test, additional practice exercises are keyed to the tion sources on the Internet. textbook and provide extensive practice and link stu- dents to the e-text with animated graphs and to other tutorial instruction resources. EC6_A01.qxd 9/9/05 1:31 AM Page xiii u u u u u u u u u Preface This book presents economics as a serious, lively, and evolving science. Its goal is to open students’ eyes to the “economic way of thinking” and to help them gain insights into how the economy works and how it might be made to work better. We provide a thorough and complete coverage of the subject, using a straightfor- ward, precise, and clear writing style. We are conscious that many students find economics hard, so we place the student at centre stage and write for the student. We use language that doesn’t intimidate and that allows the student to concentrate on the substance. We open each chapter with a clear statement of learning objectives, a brief student- friendly vignette and an illustration to grab attention. We illustrate principles with examples that are selected to hold the student’s interest and to make the subject lively. And we put principles to work by using them to illuminate current real- world problems and issues. We present some new ideas, such as dynamic comparative advantage, game theory, the modern theory of the firm, public choice theory, rational expectations, new growth theory, and real business cycle theory. But we explain these topics with familiar core ideas and tools. Today’s introductory economics course springs from today’s issues – the informa- tion revolution and the new economy, the expansion of global trade and invest- ment, the economic shockwaves after 9/11, global terrorism and corporate scandals. But the principles that we use to understand these issues remain the core principles of our science. Governments and international agencies place continued emphasis on long-term fundamentals as they seek to promote economic growth. This book reflects this emphasis. To help promote a rich, active learning experience, we have developed a compre- hensive online learning environment featuring a dynamic e-book, interactive tutori- als and quizzes, weekly news updates, and more. PREFACE xiii EC6_A01.qxd 9/9/05 1:31 AM Page xiv xiv PREFACE 4. Output and Costs (Chapter 10): A new appendix on The Sixth Edition Revision isoquants and isocost lines and the derivation of the least-cost factor inputs. ECONOMICS, Sixth Edition, retains all of the improve- 5. Monopolistic Competition and Oligopoly (Chap- ments achieved in its predecessor with its thorough and ter 13): An amplified explanation of the effects of detailed presentation of modern economics, emphasis advertising on price and output in monopolistic com- on real-world examples and critical thinking skills, dia- petition and the roles of signalling and brand names; grams renowned for pedagogy and precision and path- an expanded explanation of natural barriers that lead breaking technology. to oligopoly and an improved discussion of oligopoly New to this edition are: games and how game theory illuminates the question u A thoroughly revised introductory chapter of when and whether the pursuit of self-interest leads u Revised and updated microeconomics content to outcomes that are in the social interest. u Revised and updated macroeconomics content 6. Government Regulation and Competition Policy u (Chapter 14): Repositioned after the chapters on MyEconLab monopoly and oligopoly; a general introduction to the public choice approach; new material on price Revised Introductory Chapter cap regulation. 7. Public Goods and Common Resources (Chapter 16): Chapter 1 has been thoroughly revised to place greater New section on the problem of the commons with emphasis on the role of incentives in influencing people’s special emphasis on overfishing and rainforest choices and on the central question: Can choices made depletion. in the pursuit of self-interest also serve the social inter- 8. Economic Inequality and Redistribution (Chap- est? This question is introduced through ten pressing ter 18): Improved description of inequality and issues in today’s world that are explored further at vari- explanation of the Gini coefficient; new material on ous later points in the text. A description of the factors the sources of inequality including a discussion of of production and their incomes has been moved from the sources of increased inequality in recent years. Chapter 2 into this chapter Also we have restored this chapter’s appendix on graphs in economics. Revised and Updated Revised and Updated Macroeconomics Content Microeconomics Content In addition to thorough and extensive updating, includ- ing the major revision of the UK National Accounts of In addition to thorough and extensive updating, the 2004, the macroeconomics chapters feature the follow- microeconomics chapters feature the following eight ing nine major revisions: major revisions: 1. A First Look at Macroeconomics (Chapter 19): This 1. The Economic Problem (Chapter 2): An improved revised chapter overviews the macroeconomic land- discussion of efficiency; a better paced explanation scape, previews the issues, and shows a productivity of comparative advantage and the gains from spe- growth slowdown matters vastly more than a reces- cialization and exchange. sion by contrasting the magnitudes of the Lucas 2. Markets in Action (Chapter 6): An expanded section wedge and the Okun gap in the United Kingdom. on taxes that consolidates material distributed across 2. Measuring GDP and Economic Growth (Chapter two chapters in the previous edition and that empha- 20): Thoroughly revised chapter that provides a sizes the fact that elasticities of demand and supply, sharper focus on the definition and measurement not governments, allocate the burden of a tax; an of GDP along with a carefully paced explanation of improved section on intervention in markets for farm the new chained-volume measure and its method of products and the EU Common Agricultural Policy. calculation. 3. Organizing Production (Chapter 9): An expanded 3. Monitoring Cycles, Jobs and Inflation (Chapter 21): explanation of the consequences of asymmetric This chapter now includes two new sections: one on information for the principal–agent problem. the identification of cycles (including growth cycles)