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Economics PRINCIPLES, PROBLEMS, AND POLICIES

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ESSENTIALS OF ECONOMICS Brue, McConnell, and Flynn Essentials of Economics Third Edition

Mandel Economics: The Basics Second Edition

Schiller Essentials of Economics Ninth Edition

PRINCIPLES OF ECONOMICS Colander Economics, Microeconomics, Macroeconomics Ninth Edition

Frank and Bernanke Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Fifth Edition

Frank and Bernanke Brief Editions: Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Second Edition

Karlan and Morduch Economics, Microeconomics, Macroeconomics First Edition

McConnell, Brue, and Flynn Economics, Microeconomics, Macroeconomics Twentieth Edition

McConnell, Brue, and Flynn Brief Editions: Microeconomics and Macroeconomics Second Edition

Miller Principles of Microeconomics First Edition

Samuelson and Nordhaus Economics, Microeconomics, Macroeconomics Nineteenth Edition

Schiller The Economy Today, The Micro Economy Today, The Macro Economy Today Thirteenth Edition

Slavin Economics, Microeconomics, Macroeconomics Eleventh Edition

ECONOMICS OF SOCIAL ISSUES Guell Issues in Economics Today Fifth Edition

Sharp, Register, and Grimes Economics of Social Issues Nineteenth Edition

ECONOMETRICS Gujarati and Porter Basic Econometrics Fifth Edition

Gujarati and Porter Essentials of Econometrics Fourth Edition

MANAGERIAL ECONOMICS Baye Managerial Economics and Business Strategy Eighth Edition

Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Fifth Edition

Thomas and Maurice Managerial Economics Tenth Edition

INTERMEDIATE ECONOMICS Bernheim and Whinston Microeconomics Second Edition

Dornbusch, Fischer, and Startz Macroeconomics Eleventh Edition

Frank Microeconomics and Behavior Eighth Edition

ADVANCED ECONOMICS Romer Advanced Macroeconomics Third Edition

MONEY AND BANKING Cecchetti and Schoenholtz Money, Banking, and Financial Markets Third Edition

URBAN ECONOMICS O’Sullivan Urban Economics Eighth Edition

LABOR ECONOMICS Borjas Labor Economics Fifth Edition

McConnell, Brue, and Macpherson Contemporary Labor Economics Ninth Edition

PUBLIC FINANCE Rosen and Gayer Public Finance Ninth Edition

Seidman Public Finance First Edition

ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Fifth Edition

INTERNATIONAL ECONOMICS Appleyard, Field, and Cobb International Economics Eighth Edition

King and King International Economics, Globalization, and Policy: A Reader Fifth Edition

Pugel International Economics Fifteenth Edition

THE MCGRAWHILL SERIES: ECONOMICS

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THE SIX VERSIONS OF MCCONNELL, BRUE, FLYNN

Chapter* 1. Limits, Alternatives, and Choices x x x x x x

2. The Market System and the Circular Flow x x x x x x

3. Demand, Supply, and Market Equilibrium x x x x x x

4. Market Failures: Public Goods and Externalities x x x x x x

5. Government’s Role and Government Failure x x x x x x

6. Elasticity x x x x

7. Utility Maximization x x

8. Behavioral Economics x x

9. Businesses and the Costs of Production x x x x

10. Pure Competition in the Short Run x x x x

11. Pure Competition in the Long Run x x x x

12. Pure Monopoly x x x x

13. Monopolistic Competition and Oligopoly x x x x

13W. Technology, R&D, and Efficiency (Web Chapter) x x

14. The Demand for Resources x x

15. Wage Determination x x x x

16. Rent, Interest, and Profit x x

17. Natural Resource and Energy Economics x x

18. Public Finance: Expenditures and Taxes x x x

19. Antitrust Policy and Regulation x x

20. Agriculture: Economics and Policy x x

21. Income Inequality, Poverty, and Discrimination x x x x

22. Health Care x x

23. Immigration x x

24. An Introduction to Macroeconomics x x

25. Measuring Domestic Output and National Income x x x x

26. Economic Growth x x x x

27. Business Cycles, Unemployment, and Inflation x x x x

28. Basic Macroeconomic Relationships x x

29. The Aggregate Expenditures Model x x

30. Aggregate Demand and Aggregate Supply x x x x

31. Fiscal Policy, Deficits, and Debt x x x x

32. Money, Banking, and Financial Institutions x x x x

33. Money Creation x x

34. Interest Rates and Monetary Policy x x x x

35. Financial Economics x x

36. Extending the Analysis of Aggregate Supply x x x

37. Current Issues in Macro Theory and Policy x x

38. International Trade x x x x x x

39. The Balance of Payments, Exchange Rates, and Trade Deficits x x x x x x

39W. The Economics of Developing Countries (Web Chapter) x x

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*Chapter numbers refer to Economics: Principles, Problems, and Policies. A red “X” indicates chapters that combine or consolidate content from two or more Economics chapters.

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Economics PRINCIPLES, PROBLEMS, AND POLICIES

Tw en

tie th

E di

tio n

Campbell R. McConnell University of Nebraska

Stanley L. Brue Pacific Lutheran University

Sean M. Flynn Scripps College

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ECONOMICS: PRINCIPLES, PROBLEMS, AND POLICIES, TWENTIETH EDITION

Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2015 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2012, 2009, and 2008. 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 the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

1 2 3 4 5 6 7 8 9 0 DOW/DOW 1 0 9 8 7 6 5 4

ISBN 978-0-07-802175-6 (student edition) MHID 0-07-802175-8 (student edition) ISBN 978-0-07-766058-1 (instructor’s edition) MHID 0-07-766058-7 (instructor’s edition)

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Library of Congress Cataloging-in-Publication Data McConnell, Campbell R. Economics : principles, problems, and policies / Campbell R. McConnell, University of Nebraska, Stanley L. Brue, Pacific Lutheran University, Sean M. Flynn, Scripps College.—Twentieth edition. pages cm.—(The McGraw-Hill series in economics) Includes index. ISBN 978-0-07-802175-6 (student edition : alk. paper)—ISBN 0-07-802175-8 (student edition : alk. paper)—ISBN 978-0-07-766058-1 (instructor’s edition : alk. paper)—ISBN 0-07-766058-7 (instructor’s edition : alk. paper) 1. Economics. I. Brue, Stanley L., 1945- II. Flynn, Sean Masaki. III. Title. HB171.5.M47 2015 330—dc23 2013038889

The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

www.mhhe.com

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To Mem and to Terri and Craig, and to past instructors

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x

ABOUT THE AUTHORS

CAMPBELL R. MCCONNELL earned his Ph.D. from the University of Iowa after receiving degrees from Cornell College and the University of Illinois. He taught at the University of Nebraska–Lincoln from 1953 until his retirement in 1990. He is also coauthor of Contemporary Labor Economics, ninth edition; Essentials of Economics, second edition; Macroeconomics: Brief Edition; and Microeconomics: Brief Edition (all The McGraw-Hill Companies), and has edited readers for the principles and labor economics courses. He is a recipient of both the University of Nebraska Distinguished Teaching Award and the James A. Lake Academic Freedom Award and is past president of the Midwest Economics Association. Professor McConnell was awarded an honorary Doctor of Laws degree from Cornell College in 1973 and received its Distinguished Achievement Award in 1994. His primary areas of interest are labor economics and economic education. He has an extensive col- lection of jazz recordings and enjoys reading jazz history.

STANLEY L. BRUE did his undergraduate work at Augustana College (South Dakota) and received its Distinguished Achievement Award in 1991. He received his Ph.D. from the University of Nebraska–Lincoln. He is retired from a long career at Pacific Lutheran University, where he was honored as a recipient of the Burlington Northern Faculty Achievement Award. Professor Brue has also received the national Leavey Award for excellence in economic education. He has served as national president and chair of the Board of Trustees of Omicron Delta Epsilon International Economics Honorary. He is coauthor of Economic Scenes, fifth edition (Prentice-Hall); Contemporary Labor Economics, ninth edition; Essentials of Economics, second edition; Macroeconomics: Brief Edition; Microeconomics: Brief Edition (all The McGraw-Hill Companies); and The Evolution of Economic Thought, seventh edition (South-Western). For relaxation, he enjoys international travel, attending sporting events, and skiing with family and friends.

SEAN M. FLYNN did his undergraduate work at the University of Southern California before completing his Ph.D. at U.C. Berkeley, where he served as the Head Graduate Student Instructor for the Department of Economics after receiving the Outstanding Graduate Student Instructor Award. He teaches at Scripps College (of the Claremont Colleges) and is the author of Economics for Dummies (Wiley) and coauthor of Essentials of Economics, second edition; Macroeconomics: Brief Edition; and Microeconomics: Brief Edition (all The McGraw-Hill Companies). His research interests include finance, behavioral econom- ics, and health economics. An accomplished martial artist, he has repre- sented the United States in international aikido tournaments and is the author of Understanding Shodokan Aikido (Shodokan Press). Other hob- bies include running, traveling, and enjoying ethnic food.

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LIST OF KEY GRAPHS

1.2 The Production Possibilities Curve 13

2.2 The Circular Flow Diagram 43

3.6 Equilibrium Price and Quantity 63

7.1 Total and Marginal Utility 154

9.2 The Law of Diminishing Returns 203

9.5 The Relationship of the Marginal-Cost Curve to the Average-Total-Cost and Average-Variable-Cost Curves 207

9.8 The Long-Run Average-Total-Cost Curve: Unlimited Number of Plant Sizes 210

10.3 Short-Run Profit Maximization for a Purely Competitive Firm 228

10.6 The P 5 MC Rule and the Competitive Firm’s Short-Run Supply Curve 231

11.6 Long-Run Equilibrium: A Competitive Firm and Market 245

12.4 Profit Maximization by a Pure Monopolist 261

13.1 A Monopolistically Competitive Firm: Short Run and Long Run 282

13.4 The Kinked-Demand Curve 292

15.3 Labor Supply and Labor Demand in (a) a Purely Competitive Labor Market and (b) a Single Competitive Firm 334

28.2 Consumption and Saving Schedules 617

28.5 The Investment Demand Curve 624

29.2 Equilibrium GDP in a Private Closed Economy 640

29.7 Recessionary and Inflationary Expenditure Gaps 651

30.7 The Equilibrium Price Level and Equilibrium Real GDP 671

34.1 The Demand for Money, the Supply of Money, and the Equilibrium Interest Rate 749

34.5 Monetary Policy and Equilibrium GDP 762

34.6 The AD-AS Theory of the Price Level, Real Output, and Stabilization Policy 770

38.2 Trading Possibilities Lines and the Gains from Trade 845

39.1 The Market for Foreign Currency (Pounds) 872

xi

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xii

PREFACE

Welcome to the 20th edition of Economics, the best-selling economics textbook in the world. An estimated 15 million students have used Economics or its companion editions, Macroeconomics and Microeconomics. Economics has been adapted into Australian and Canadian editions and trans- lated into Italian, Russian, Chinese, French, Spanish, Portuguese, and other languages. We are pleased that Economics continues to meet the market test: nearly one out of five U.S. students in principles courses used the 19th edition.

Fundamental Objectives We have three main goals for Economics: • Help the beginning student master the principles

essential for understanding the economizing problem, specific economic issues, and policy alternatives.

• Help the student understand and apply the economic perspective and reason accurately and objectively about economic matters.

• Promote a lasting student interest in economics and the economy.

Student Feedback The twentieth edition has a renewed focus on today’s stu- dents and their various approaches to learning. How do today’s students study? How are they using mobile tech- nology? When are they using the textbook, and how are they using the textbook? To help answer these questions, McGraw-Hill and author Sean Flynn formed a Student Advisory Board consisting of students from Belmont University, the University of Louisiana–Lafayette, Tarrant County College, and West Virginia University Institute of Technology. The Student Advisory Board participated in a wide variety of evaluation and testing activities over six months and provided targeted recommendations to im- prove the 20th edition and its ancillary learning materials. Their feedback was incredibly valuable, and the authors incorporated their suggestions in this revision.

What’s New and Improved? One of the benefits of writing a successful text is the op- portunity to revise—to delete the outdated and install the new, to rewrite misleading or ambiguous statements, to introduce more relevant illustrations, to improve the orga- nizational structure, and to enhance the learning aids. We trust that you will agree that we have used this op- portunity wisely and fully. Some of the more significant changes include the following.

Restructured Introductory Chapters We have divided the five-chapter grouping of introduc- tory chapters common to Economics, Microeconomics, and Macroeconomics into two parts. Part 1 contains Chapter 1 (Limits, Alternatives, and Choices) and Chapter 2 (The Market System and the Circular Flow). The content in Part 2 has changed and now consists of the following three chapters: Chapter 3 (Demand, Supply, and Market Equilibrium), Chapter 4 (Market Failures: Public Goods and Externalities), and Chapter 5 (Government’s Role and Government Failure). As restructured, the three chapters that now form Part 2 give students a panorama of: • The efficiency and allocation benefits of competitive

markets. • How and why governments can help when there are

cases of market failure. • An appreciation of government failure so that stu-

dents do not assume that government intervention is an easy or guaranteed panacea for the misallocations and inefficiencies caused by market failure.

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Preface xiii

For example, the “Last Word” section for Chapter 1 (Limits, Alternatives, and Choices) examines pitfalls to sound economic reasoning, while the “Last Word” section for Chapter 4 (Market Failures: Public Goods and Externalities) examines cap-and-trade versus carbon taxes as policy responses to excessive carbon dioxide emissions. There are 14 new “Last Word” sections in this edition. If you are unfamiliar with Economics, we encourage you to thumb through the chapters to take a quick look at these highly visible features.

New Chapter on Government’s Role and Government Failure We have responded to instructor suggestions by placing this new chapter on Government’s Role and Government Failure into the introductory section of the book. Its early placement gives students a taste of political economy and the practical difficulties with government regulation and intervention. Topics covered include the special-interest effect, rent seeking, regulatory capture, political corrup- tion, unfunded liabilities, and unintended consequences. The chapter begins, however, by reminding students of government’s great power to improve equity and efficiency. When read along with Chapter 4 on market failure, this new chapter on government failure should provide students with a balanced perspective. After learning why government in- tervention is needed to counter market failures, they will also learn that governments often have difficulty in fulfilling their full potential for improving economic outcomes. An optional appendix incorporates the material on public choice theory and voting paradoxes that was for- merly located in Chapter 17 of the 19th edition. Instructors wishing to give their students an even deeper appreciation of government failure may wish to assign this material. Meanwhile, the material on asymmetric information that was located in Chapter 17 of the 19th edition has

Our new approach responds to suggestions by re- viewers to:

• Move the elasticity chapter back into Microeconomics. • Boost the analysis of government failure to help

students better understand many of the problems currently besetting the U.S. economy.

Our new approach embraces these suggestions. For microeconomics instructors, the new ordering provides a clear supply-and-demand path to the subsequent chapters on consumer and producer behavior while also giving stu- dents a stronger policy background on not only market failures but government interventions in the economy and whether they are likely to improve efficiency. For macro- economics instructors, the new sequence provides a theo- retical grounding that can help students better understand issues such as excessive government deficit spending and why there may be insufficient regulation of the financial sector. And because Chapters 4 and 5 are both optional and modular, instructors can skip them if they wish to move directly from Chapter 3’s discussion of supply and demand to the core microeconomics or macroeconomics chapters.

New “Consider This” and “Last Word” Pieces Our “Consider This” boxes are used to provide analo- gies, examples, or stories that help drive home central economic ideas in a student-oriented, real-world manner.

For instance, a “Consider This” box titled “McHits and McMisses” illustrates consumer sovereignty through a listing of suc- cessful and unsuccessful products. How businesses exploit price discrimina- tion is driven home in a “Consider This” box that explains why ballparks charge different admis- sion prices for adults and children but only one set of prices at their conces- sion stands. These brief vignettes, each accompa- nied by a photo, illustrate key points in a lively, col-

orful, and easy-to-remember way. We have added 14 new “Consider This” boxes in this edition. Our “Last Word” pieces are lengthier applications or case studies that are placed near the end of each chapter.

CONSIDER THIS . . .

Why Do Hospitals Sometimes Charge $25 for an Aspirin? To save taxpayers money, Medicare and Medicaid set

their payment rates for medical services above marginal cost but below average total cost. Doing so gives health care pro- viders an incentive to provide services to Medicare and Medicaid patients because MR . MC. But it also means that government health insurance programs are not reimbursing the full cost of treating Medicare and Medicaid patients. In particular, the programs are not picking up their share of the fixed costs associated with providing health care. As an example, consider an elderly person who uses Medicare. If he gets into a car accident and is taken to the lo- cal emergency room, the hospital will run up a wide variety of marginal costs, including ambulance charges, X-rays, med- ications, and the time of the nurses and doctors who help him. But the hospital also has a wide variety of fixed costs in- cluding rent, utility bills, computer networks, and lots of hid- eously expensive medical equipment. These costs have to be borne by somebody. So when Medicare and Medicaid fail to pay their full share of the fixed costs, other patients must pick up the slack. The re- sult has been for hospitals to transfer as much as possible of the fixed costs onto patients with private health insur- ance. The hospitals overbill private insurance companies so as to make up for the fixed costs that the government refuses to pay. That is why you will hear stories about hospitals charging patients with private insurance $25 for a single aspirin or

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Can Economic Growth Survive Population Decline? The Demographic Transition Is Causing Greying Populations, Shrinking Labor Forces, and Overall Population Decreases in Many Nations. Can Economic Growth Survive?

LAST WORD

As you know from this chapter, Real GDP 5 hours of work 3 labor productivity. The number of hours of work depends heavily, however, on the size of the working- age population. If it begins to shrink, the number of hours of work almost always falls. In such cases, the only way real GDP can rise is if labor pro- ductivity increases faster than hours of work decreases. The world is about to see if that can happen in coun- tries that have populations that are greying and shrinking. The historical background has to do with the fact that as nations industrialize, their economies shift from agriculture to industry. As that happens, fertility levels plummet because the shift to modern technology transforms children from being economically essential farm hands that can contrib-

h i f ili ’ i f i

investment goods that require many years of costly schooling before they can support themselves.

As people react to this change, birthrates tend to fall quite dramati- cally. The key statistic is the total fertility rate that keeps track of the average number of births that women have during their lifetimes. To keep the population stable in modern societies, the total fertility rate must be about 2.1 births per woman per lifetime (5 1 child to replace mom, 1 child to replace dad, and 0.1 child to compensate for those people who never end up reproducing as adults).

Every rich industrial nation has now seen its total fertility rate drop below the replacement level of 2.1 births per woman per lifetime. In Japan and many Eastern E t i th b h b l f l th t

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Prefacexiv

the financial crisis, the recession, and the hesitant recov- ery. We first introduce the debate over the policy response to the 2007–2009 recession in Chapter 24 (An Introduction to Macroeconomics) via a new “Last Word” that briefly lays out the major opposing viewpoints about the nature and size of the stimulus that was applied during and after the crisis. In Chapter 25 (Measuring Domestic Output and National Income), we point out that the main flows in the National Income and Product Accounts usually ex- pand over time, but not always, as demonstrated by the recession. In Chapter 26 (Economic Growth), we discuss how the recession relates to the growth/production possi- bilities dynamics of Figure 26.2. In Chapter 27 (Business Cycles, Unemployment, and Inflation), we have a new “Last Word” that discusses the very slow recovery in em- ployment after the Great Recession. In Chapter 28 (Basic Macroeconomic Relationships), we include two “Consider This” boxes, one on how the paradox of thrift applied to consumer behavior during the recession and the other on the riddle of plunging invest- ment spending at the same time the interest rate dropped to near zero during the recession. In Chapter 29 (The Aggregate …

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