Economic logic skousen pdf

Fourth Edition

ECONOMIC LOGIC

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page i

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page ii

Fourth Edition

by Mark Skousen Benjamin Franklin Chair of Management

Grantham University

ECONOMIC LOGIC

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page iii

COPYRIGHT ©2014, 2010, 2008, 2000 BY MARK SKOUSEN

All rights reserved. No part of this publication may be reproduced or transmitted in any

form or by any means electronic or mechanical, including photocopy, recording, or any

information storage and retrieval system now known or to be invented, without permission

in writing from the publisher, except by a reviewer who wishes to quote brief passages in

connection with a review written for inclusion in a magazine, newspaper, or broadcast.

ISBN 978-1-62157-222-0

Published in the United States by

Capital Press

An Eagle Publishing Company

One Massachusetts Avenue, NW

Washington, DC 20001

Distributed to the trade by

National Book Network

4720-A Boston Way

Lanham, MD 20706

Manufactured in the United States of America

10 9 8 7 6 5 4 3 2

Books are available in quantity for promotional or premium use. Write to Director of Special

Sales, Regnery Publishing, Inc., One Massachusetts Avenue, NW, Washington, DC 20001, for

information on discounts and terms or call (202) 216-0600.

Cover design by Elise Elswood

Book design by Pitts•LaVigne Associates

First ebook © 2013 eISBN 978-1-62157-226-8

The Library of Congress has cataloged the hardcover edition as follows:

Dedicated to two giants

of the 20th Century,

Friedrich Hayek and Milton Friedman.

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page v

OTHER ACADEMIC BOOKS BY MARK SKOUSEN

Playing the Price Controls Game

The Structure of Production

Economics on Trial

Dissent on Keynes (editor)

The Investor’s Bible: Mark Skousen’s Principles of Investment

Puzzles and Paradoxes in Economics (co-authored with Kenna C. Taylor)

The Making of Modern Economics

Vienna and Chicago, Friends or Foes?

The Big Three in Economics

Econo Power

The Maxims of Wall Street

A Viennese Waltz Down Wall Street

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page vi

“While the earth remaineth, seedtime and harvest, and cold and heat, and summer and winter, and day and night shall not cease.”

–GENESIS 8:22

“After all, the chief business of the American people is business. They are profoundly concerned with the producing, buying, selling, investing, and prospering in the world. I am strongly of the opinion that the great majority of people will always find these are moving impulses of our life.”

–CALVIN COOLIDGE (1925)

“No science in the world is more elevated, more necessary, and more useful than economics.”

—CARL LINNAEUS, Swedish naturalist

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page vii

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page viii

Acknowledgements

PART I: OVERVIEW

Introduction Page

1. What Is Economics? 7 Influential Economist: Adam Smith

2. The Fundamentals of Economic Behavior 27 Influential Economist: Ludwig von Mises

3. Production, Exchange and Consumption: 49 The Structure of Economic Activity Influential Economist: Carl Menger

PART II: MICROECONOMICS

4. The Theory of the Firm: The Role of Profit and Loss 73 Influential Economist: Edward Deming

5. Determining Prices and Output: The Law of Demand 109 Influential Economist: Alfred Marshall

6. Supply and Demand 123 Influential Economist: Gary S. Becker

7. How Costs Affect Prices 151 Influential Economist: William Stanley Jevons

8. Monopoly and Competition 171 Influential Economist: George J. Stigler

9. The Factors of Production: Land, Rent and Natural Resources 191 Influential Economists: Thomas Malthus and David Ricardo

10. The Factors of Production: Wages, Employment and the Productivity of Labor 209 Influential Economist: John Bates Clark

11. The Factors of Production: Capital and Interest 253 Influential Economist: Eugen Böhm-Bawerk

12. The Factors of Production: The Role of Entrepreneurship 275 Influential Economist: Peter F. Drucker

13. Financing Capitalism: Stock and Bond Markets 289 Influential Economist: Harry Markowitz

CONTENTS

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page ix

PART III: MACROECONOMICS Page

14. Understanding the Macro Economy 327 Influential Economist: Wassily Leontief

15. Measures of Economic Activity, Income and Wealth 343 Influential Economist: Simon Kuznets

16. Price Inflation and the Purchasing Power of Money 365 Influential Economist: Irving Fisher

17. Economic Growth: 379 The Role of Saving, Investment, and Technology Influential Economists: J. B. Say and Robert Solow

18. Money and the Commercial Banking System 405 Influential Economist: Murray Rothbard

PART IV: GOVERNMENT POLICY

19. Inflation, Central Banking and Monetary Policy 423 Influential Economist: Milton Friedman

20. Fiscal Policy and the Role of Government 457 Influential Economists: James Buchanan and Gordon Tullock

21. Government Revenues and Tax Policy 485 Influential Economists: A. C. Piguo and Arthur B. Laffer

22. Deficit Spending and the National Debt 517 Influential Economist: John Maynard Keynes

23. Government Regulations and Controls 549 Influential Economist: Ronald Coase

24. Environmental Economics 575 Influential Economist: Julian L. Simon

25. Expansion and Contraction: Economics of the Business Cycle 591 Influential Economist: Friedrich Hayek

26. Globalization, Protectionism and Free Trade 619 Influential Economist: Robert Mundell

27. Development Economics: Capitalism, Socialism and Democracy 645 Influential Economists: Karl Marx and Muhammad Yunus

AFTERWORD:

28. What Do Economists Do? 669

Glossary of Economic Terms 681

Index 697

About the Author 709

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page x

Thanks especially to economics professor Jeffrey Zucker of McMaster University for editing and updating the Fourth Edition of Economic Logic, both for micro and macro editions. Every chapter has been revised and updated, and with the addition of a glossary, is 30 pages longer than the third edition. I also thank Jim Cox at Georgia Perimeter College for preparing the test bank. For a copy of the test bank, instructors should contact Jim Cox at jcox@gpc.edu. I’d also like to thank the following economists, colleagues, and friends who have reviewed, edited, or made suggestions for Economic Logic over the various editions. While their advice has been invaluable, none can be held responsible for the final product. I would especially like to thank my wife, Jo Ann, for her editing skills. Her suggestions and changes were invaluable. In addition, I’d like to thank the following for their assistance in this and past editions:

Brian Addis, Grantham University Martin Anderson, Hoover Institution Dominick T. Armentano, University of Hartford Manuel F. Ayau, Universidad Francisco Marroquin Charles W. Baird, California State University East Bay Peter Bach, University of Relands Whitehead College Richard Band, Profitable Investing P. T. Bauer, London School of Economics Bret Barker, Schurr High School, California Bruce Barlett, Alexis de Tocqueville Institution Robert Barro, Harvard University Robert Batemarco, Marymount College Gary S. Becker, University of Chicago Don Bellante, University of South Florida Peter L. Bernstein, Peter L. Bernstein, Inc., New York Mark Blaug, University of London Walter Block, Loyola University Peter Boettke, George Mason University Donald J. Boudreaux, George Mason University H. L. Brockman, Central Piedmont Community College Stanley Brue, Pacific Lutheran University Eamonn Butler, Adam Smith Institute Roger Clites, Milligan College David Colander, Middlebury College Kent Cowie, Henry Hazlitt Foundation Jim Cox, Georgia Perimeter College Thomas J. DiLorenzo, Loyola College Edwin G. Dolan, George Mason University Peter F. Drucker, Claremont Graduate University Richard M. Ebeling, Northwood University Kenneth G. Elzinga, University of Virginia

ACKNOWLEDGEMENTS

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page xi

Fred Foldvary, Santa Clara University Burton W. Folsom, Jr., Hillsdale College Milton Friedman, Hoover Institution Lowell E. Gallaway, Ohio University Roger W. Garrison, Auburn University George Gilder Bettina B. Greaves, Foundation for Economic Education James D. Gwartney, Florida State University Steve H. Hanke, Johns Hopkins University G. C. Harcourt, Cambridge University Fred Harwood, American Institute for Economic Research Friedrich A. Hayek, University of Freiberg Robert L. Heilbroner, New School for Social Research David R. Henderson, Naval Postgraduate School Paul Heyne, University of Washington John Hicks, Oxford University Robert Higgs, Seattle University Randall Holcombe, Florida State University John M. Hood, John Locke Foundation Arthur M. Hughes, University of Maryland Joseph Kecheissen, Universidad Francisco Marroquin Matt King, Rollins College Israel M. Kirzner, New York University Martin Krause, University of Buenos Aires Don Lavoie, George Mason University Stanley Lebergott, Wesleyan University Kary Ledbetter, Grantham University Dwight R. Lee, University of Georgia Henri Lepage, Institut Euro 92 John List, University of Chicago John Mackey, CEO, Whole Foods Market Burton G. Malkiel, Princeton University Yuri N. Maltsev, Carthage College N. Gregory Mankiw, Harvard University Deidre N. McCloskey, University of Illinois at Chicago Richard B. McKenzie, University of California, Irvine Roger LeRoy Miller, University of Texas, Arlington Hyman P. Minsky, Washington University Glenn Moots, Northwood University Charles Murray, American Enterprise Institute Charles R. Nelson, University of Washington Gary North, Institute of Christian Economics E. C. Pasour, Jr., North Carolina State University

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page xii

Judd W. Patton, Bellevue University William H. Peterson, Campbell University Mark J. Perry, University of Michigan, Flint Madsen Pirie, Adam Smith Institute Robert Poole, Reason Foundation Alvin Rabushka, Hoover Institution Lawrence Reed, MacKinac Center for Public Policy George G. Reisman Alan Reynolds, Cato Institute Benjamin Rogge, Wabash College Murray N. Rothbard, University of Nevada at Las Vegas Roy J. Ruffin, University of Houston Joseph Salerno, Pace University Paul A. Samuelson, Massachusetts Institute of Technology Ken Schoolland, Pacific Hawaii University George A. Selgin, University of Georgia Hans F. Sennholz, Grove City College Robert Shiller, Yale University Gary Shilling Jeremy Siegel, Wharton School of Business Julian L. Simon, University of Maryland Robert Skidelsky, University of Warwick Royal J. Skousen, Brigham Young University Gene Smiley, Marquette University Garvin Smith, Daytona Beach Community College Robert Sobel, Hofstra University Jesus Huerta de Soto, Universidad Rey Juan Carlos (Spain) Thomas Sowell, Hoover Institution Erich Streissler, University of Vienna Richard L. Stroup, Montana State University Richard Swedberg, University of Sweden Kenna C. Taylor, Rollins College Timothy Taylor, Macalester College Glen Tenney, Great Basin College Paul and Vicki Terhorst Clifford F. Thies, Shenandoah University Gordon Tullock, George Mason University Richard Vedder, Ohio University Murray Weidenbaum, Washington University Walter Williams, George Mason University Larry T. Wimmer, Brigham Young University Leland Yeager, Auburn University Harry C. Veryser, University of Detroit-Mercy

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page xiii

For comments and suggestions, write:

Professor Mark Skousen

P.O. Box 2488

Winter Park, FL 32790

E-mail: editor@markskousen.com

Webpage: www.mskousen.com; www.markskousen.com

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page xiv

WHAT’S UNIQUE ABOUT ECONOMIC LOGIC

1. It offers a logical, step-by-step approach to economics, starting with the basics of microeco- nomics (the theory of wealth creation, individual behavior and the firm), and leading into macroeconomics (the theory of economy-wide behavior and government policy).

2. Students can actually predict that the next chapter will be. Hence, the textbook is “econological.”

3. It introduces a new powerful four-stage universal model of the economy (resources, produc- tion, distribution, and consumption/investment), and shows how micro and macro are logical- ly linked together and demonstrate a “stakeholder” model for business. (See for example figure 4.1.)

4. It is the first and only textbook to begin with a profit-and-loss income statement to demon- strate the dynamics of the economy. The principles of supply and demand are drawn out of the P&L statement. Business students, in particular, find this approach attractive. (See for example figure 4.4.)

5. It integrates other disciplines into the study—finance, business, marketing, management, histo- ry, and sociology.

6. It makes frequent references to major economic events in history, such as the origin of money and the Great Depression, and the inventors of economic theories and terms (major economic thinkers are highlighted at the end of each chapter). Thus, in this textbook, economic theory is never far from history because new theories almost always develop out of historical events (Adam Smith’s competitive model came out of the Enlightenment; Karl Marx’s radical distribu- tion economics was in response to the Industrial Revolution; and John Maynard Keynes’s aggre- gate demand model rose out of the Great Depression of the 1930s.)

7. It devotes an entire chapter (13) to the financial markets, which are playing a growing role in the expanding global economy. Students must understand Wall Street and the financial world to have a complete education in economics.

8. It integrates a new national income statistic called Gross Domestic Expenditures (GDE), which measures total spending at all four stages of production, and shows how it relates to Gross Domestic Product (GDP) and other aggregate business cycle statistics. (See chapter 15.)

9. It introduces a new “growth” diagram that improves upon the “circular flow” diagram found in other textbooks, and demonstrates why saving and investing drive the economy, not consumer spending. (See figure 17.7.)

10. It provides a new alternative to the standard Aggregate Supply (AS) and Aggregate Demand (AD) curves, called Aggregate Supply Vectors (ASV) and Aggregate Demand Vectors (ADV), which do a better job of explaining the business cycle. (See chapters 14 and 25.)

11. It provides a new diagram to show the optimal size of government. (See figure 20.1)

For updates on Economic Logic, go to www.economiclogic.net. For a test bank for instructors, email editor@markskousen.com.

For comments and suggestions, write: Professor Mark Skousen

P. O. Box 2488 • Winter Park, FL 32790 Email: editor@markskousen.com.

Other related websites: www.markskousen.com • www.mskousen.com

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page xv

Prefaces Pages (EL rev 2013) 9/9/13 10:35 AM Page xvi

1

Introduction to the Fourth Edition

A LOGICAL APPROACH TO ECONOMICS

Economics, the youngest of the social sciences, is sometimes described as adifficult subject. “There are so many complicated bits and pieces,” PaulHeyne writes in The Economic Way of Thinking, “and they are so hard for students to grasp.” In the beginning of his textbook, Martin Bronfenbrenner warns students, “You may temporarily find yourself unlearning more than you learn, or operating in a fog of confusion.”

But economic science need not be laborious or perplexing. This textbook offers a rigorous course in college economics without unnecessary complications or con- fusion. It represents a new, integrated approach that establishes the purpose of eco- nomics and develops strategies to achieve the economic goals of society. This approach moves from the simple to the complex by systematically building an edi- fice that, when complete, will hopefully be both elegant and practical. It also attempts to integrate disciplines closely associated with economics—business, mar- keting, management, finance, and sociology.

Today’s economics textbooks are often a hodgepodge of esoteric theories, unre- alistic graphs, and specialized terms. Chapters are so bewildering that students have no idea what subject matter they are going to study next. Economists argue over which should be taught first, microeconomics or macroeconomics, neither of which is integrated into a whole. Supply and demand are usually introduced at the begin- ning of a book, and then reintroduced in later chapters. Government policy is mixed throughout. International trade has traditionally been placed in the back of the book, almost as an afterthought, but some recent textbooks have begun to integrate global issues.

Introduction (EL 2013) 9/9/13 10:36 AM Page 1

2

I N T R O D U C T I O N • A L O G I C A L A P P R O A C H T O E C O N O M I C S

PART I: AN OVERVIEW

This textbook takes a more systematic approach. Part I begins with the funda- mental rationale of economics; what motivates economic activity, how wealth is cre- ated or destroyed, and how the standard of living may improve or decline. Scarcity, choice, incentives, and the allocation of resources are important characteristics of economic life and change. Throughout this textbook we emphasize how individuals as consumers, workers, landlords, and capitalists work individually and together to create prosperity, and the extent to which government improves or impedes eco- nomic progress. In short, economics concerns itself with wealth, income, choices, incentives, living standards and growth—themes of vital interest to everyone.

In Part I, we discuss the universal characteristics of the world we live in—the limitations of time and resources, the uncertainty of the future, the necessity of work, and the variety of consumer demand. Based on these basic assumptions regarding human behavior, we develop a common-sense model of economic behav- ior and consumer satisfaction. We show that virtually all usable wealth must go through a series of processes from unfinished resources to final use by consumers and business, a cooperative process that takes time and involves numerous stages of production in the allocation of limited resources. The idea that all goods and ser- vices take time to produce and consume forms the foundation of our economic model. In this new edition, I replace the industrial four-stage model (natural resources, manufacturing, wholesale, and retail) with a more universal four-stage model of production that includes services (resources, production, distribution, and consumption/investment).