GloBAl
GloBAl
GloBAl
EdiTioN
Foundations of
Economics
For these Global Editions, the editorial team at Pearson has collaborated with educators across the world to address a wide range of subjects and requirements, equipping students with the best possible learning tools. This Global Edition preserves the cutting-edge approach and pedagogy of the original, but also features alterations, customization and adaptation from the North American version. SEVENTH EdiTioN
R
obin Bade • Michael Parkin
Bade • Parkin
This is a special edition of an established title widely used by colleges and universities throughout the world. Pearson published this exclusive edition for the beneit of students outside the United States and Canada. If you purchased this book within the United States or Canada you should be aware that it has been imported without the approval of the Publisher or Author.
FoundaTionS oF EconomicS
delivers a complete, hands-on learning system designed
around active learning.
A Learning-by-Doing
Approach
The Checklist that begins each chapter
highlights the key topics covered and the
chapter is divided into sections that directly
correlate to the Checklist.
The Checkpoint that ends each section
provides a full page of practice problems to
encourage students to review the material
while it is fresh in their minds.
Each chapter opens with a question about
a central issue that sets the stage for the
material.
why does tuition keep rising?
4
Demand and Supply
When you have completed your study of this chapter,
you will be able to
chaPTEr chEckliST
1 Distinguish between quantity demanded and demand, and explain
what
determines demand.
•
2 Distinguish between quantity supplied and supply, and explain
what determines supply.
3 Explain how demand and supply determine price and quantity in a
market, and explain the effects of changes in demand and supply.
MyEconLab Big picture
•
chEckPoinT 4.1
MyEconLab
Study Plan 4.1
key Terms quiz
Distinguish between quantity demanded and demand, and explain
what determines demand.
•
•
Solutions
Practice Problems
The following events occur one at a time in the market for cell phones:
• The price of a cell phone falls.
• Producers announce that cell-phone prices will fall next month.
• The price of a call made from a cell phone falls.
• The price of a call made from a land-line phone increases.
• The introduction of camera phones makes cell phones more popular.
1. Explain the effect of each event on the demand for cell phones.
2.
Use a graph to illustrate the effect of each event.
3.
Does any event (or events) illustrate the law of demand?
In the News
Eye On boxes apply theory to
important issues and problems
that shape our global society and
individual decisions.
Confidence-Building Graphs
use color to show the direction of shifts and
detailed, numbered captions guide students
step-by-step through the action.
100% of the figures are animated in
MyEconLab, with step-by-step audio narration.
EYE on TUITION
•
why does Tuition keep rising?
Tuition has increased every year since
In a given year, other things remain
1980 and at the same time, enrollment the same, but from one year to the
has steadily climbed. Figure 1 shows
next, some things change. The populathese facts. The points tell us the levels tion has grown, incomes have increased,
of enrollment (x-axis) and tuition (y-axis, jobs that require more than a highmeasured in 2010 dollars) in 1981, 1991, school diploma have expanded while
and each year from 2001 to 2010. We
jobs for high-school graduates have
can interpret the data using the demand shrunk, and government subsidized stuand supply model
dent loans programs have expanded.
More than 4,500 public and private, 2- These changes increase the demand for
4.4 4-year schools supply college
year and
■ FIGURE
college education.
education
services andDemanded
more than 20 VersusFigure
Change
in Quantity
Change
in Demand
2 illustrates
the market for
million people demand these services.
college education that we’ve just
Theinlaw
of demand says: Other things
A decrease
the
quantity demanded
The quantity demanded decreases
and there is a movement up along
the demand curve D0 if the price
of the good rises and other things
remain the same.
A decrease in demand
Demand decreases and the
demand curve shifts leftward
(from D0 to D1) if
The price of a substitute
falls or the price of a
complement rises.
The price of the good is
expected to fall.
Income decreases.*
Expected future income
or credit decreases.
The number of buyers
decreases.
* Bottled water is a normal good.
described. In 2001, demand was D01
and supply was S. The market was in
equilibrium with 16 million students
enrolled paying an average tuition of
$15,000. By 2010, demand had
increased to D10. At the tuition of
2001, there would be a severe shortage of college places, so tuition rises.
In 2010, the market was in equilibrium
at a tuition of $21,000 with 21 million
students enrolled.
MyEconLab
animation
Demand for college
places will
keep
increasing and tuition will keep rising.
An increase in the
quantity demanded
The quantity demanded increases
and there is a movement down
along the demand curve D0 if
the price of the good falls and
other things remain the same.
Price (dollars per bottle)
2.50
2.00
An increase in demand
Demand increases and the
demand curve shifts rightward
(from D0 to D2) if
1.50
1.00
D2
0.50
D0
D1
0
8
9
10
11
12
13
Quantity (millions of bottles per day)
The price of a substitute
rises or the price of a
complement falls.
The price of the good is
expected to rise.
Income increases.
Expected future income
or credit increases.
The number of buyers
increases.
Chapter 10 • Externalities
293
But college graduates generate external benefits. On the average, college graduates communicate more effectively with others and tend to be better citizens.
Their crime rates are lower, and they are more tolerant of the views of others. A
society with a large number of college graduates can support activities such as
high-quality music, theater, and other organized social activities.
In the example in Figure 10.5, the marginal external benefit is $15,000 per student per year when 15 million students enroll in college. marginal social benefit
is the sum of marginal private benefit and marginal external benefit. For example,
when 15 million students a year enroll in college, the marginal private benefit is
$10,000 per student and the marginal external benefit is $15,000 per student, so the
marginal social benefit is $25,000 per student.
The marginal social benefit curve, MSB, is the sum of marginal private benefit and marginal external benefit. It is steeper than the MB curve because marginal
external benefit diminishes for the same reasons that MB diminishes.
When people make decisions about how much schooling to undertake, they
consider only its private benefits and if education were provided by private
schools that charged full-cost tuition, there would be too few college graduates.
Figure 10.6 shows the underproduction that would occur if all college education
were left to the private market. The supply curve is the marginal cost curve of the private schools, S = MC. The demand curve is the marginal private benefit curve,
D = MB. Market equilibrium is at a tuition of $15,000 per student per year and 7.5
million students per year. At this equilibrium, marginal social benefit is $38,000 per
student, which exceeds marginal cost by $23,000. Too few students enroll in college.
The efficient number is 15 million, where marginal social benefit equals marginal
cost. The gray triangle shows the deadweight loss created by the underproduction.
■
FIGURE 10.6
MyEconLab Animation
Underproduction with an External Benefit
Price (thousands of dollars per student per year)
Marginal
social
benefit
40
38
Deadweight
loss
S = MC
The market demand curve is the marginal private benefit curve, D = MB.
The supply curve is the marginal cost
curve, S = MC.
➊ Market equilibrium is at a tuition
of $15,000 a year and 7.5 million
students and is inefficient because
➋ marginal social benefit exceeds
➌ marginal cost.
30
25
➍ The marginal social benefit curve is
20
Marginal
cost
MSB, so the efficient number of
students is 15 million a year.
15
MSB
10
Market
equilibrium
0
5
7.5 10
15
D = MB
Efficient
quantity
20
25
Quantity (millions of students per year)
➎ The gray triangle shows the deadweight loss created because too
few students enroll in college.
294
Part 4 • MarKET faiLurE and puBLiC poLiCY
Government Actions in the Face of External Benefits
To get closer to producing the efficient quantity of a good or service that generates
an external benefit, we make public choices through governments and modify the
market outcome. To achieve a more efficient allocation of resources in the presence
of external benefits, such as those that arise from education, governments can use
three devices:
• Public provision
• Private subsidies
• Vouchers
Public Provision
Public provision
The production of a good or service
by a public authority that receives
most of its revenue from the
government.
■
Public provision is the production of a good or service by a public authority that
receives most of its revenue from the government. Education services produced
by the public universities, colleges, and schools are examples of public provision.
Figure 10.7 shows how public provision might overcome the underproduction that arises in Figure 10.6. Public provision cannot lower the cost of production, so marginal cost is the same as before. marginal private benefit, marginal
external benefit, and marginal social benefit are also the same as before.
The efficient quantity occurs where marginal social benefit equals marginal
cost. In Figure 10.7, this quantity is 15 million students per year. Tuition is set to
ensure that the efficient number of students enroll. That is, tuition is set at the level
that equals the marginal private benefit at the efficient quantity. In Figure 10.7,
tuition is $10,000 a year. The rest of the cost of the public university is borne by the
taxpayers and, in this example, is $15,000 per student per year.
FIGURE 10.7
MyEconLab Animation
Public Provision to Achieve an Efficient Outcome
➊ Marginal social benefit equals marginal cost with 15 million students
enrolled in college, the ➋ efficient
quantity.
Price and cost
(thousands of dollars per student per year)
40
➌ Tuition is set at $10,000 per year,
and ➍ the taxpayers cover the
S = MC
Marginal social
benefit equals
marginal cost
remaining $15,000 of marginal
cost per student.
25
Paid by
taxpayer
20
MSB
10
Tuition
0
5
D = MB
Efficient
quantity
10
15
20
25
Quantity (millions of students per year)
Chapter 10 • Externalities
295
Private subsidies
A subsidy is a payment by the government to a producer to cover part of the costs
of production. By giving producers a subsidy, the government can induce private
decision makers to consider external benefits when they make their choices.
Figure 10.8 shows how a subsidy to private colleges works. In the absence
of a subsidy, the marginal cost curve is the market supply curve of private college education, S = MC. The marginal benefit is the demand curve, D = MB. In
this example, the government provides a subsidy to colleges of $15,000 per student per year. We must subtract the subsidy from the marginal cost of education
to find the colleges’ supply curve. That curve is S = MC - subsidy in the figure.
The equilibrium tuition (market price) is $10,000 a year, and the equilibrium
quantity is 15 million students. To educate 15 million students, colleges incur a
marginal cost of $25,000 a year. The marginal social benefit is also $25,000 a year.
So with marginal cost equal to marginal social benefit, the subsidy has achieved
an efficient outcome. The tuition and the subsidy just cover the colleges’ marginal cost.
Subsidy
A payment by the government to a
producer to cover part of the costs
of production.
Public Provision Versus Private Subsidy In the two methods we’ve just studied, the
same number of students enroll and tuition is the same. So are these two methods
of providing education services equally good? This question is difficult to resolve.
The bureaucrats that operate public schools don’t have as strong an incentive to
minimize costs and maximize quality as those who run private schools. But for elementary and secondary education, charter schools (see p. 297) might be an efficient
compromise between traditional public schools and subsidized private schools.
■
FIGURE 10.8
MyEconLab Animation
Private Subsidy to Achieve an Efficient Outcome
With a ➊ subsidy of $15,000 per
student, the supply curve is
S = MC - subsidy.
Price and cost
(thousands of dollars per student per year)
40
S = MC
Marginal social
benefit equals
marginal cost
➌ The market equilibrium is efficient
Subsidy of
$15,000
per student
S = MC – subsidy
25
20
Dollar
price
10
MSB
Efficient
market
equilibrium
0
5
➋ The equilibrium price is $10,000.
10
D = MB
15
20
25
Quantity (millions of students per year)
with 15 million students enrolled
in college because ➍ marginal
social benefit equals marginal cost.
296
Part 4 • MarKET faiLurE and puBLiC poLiCY
Vouchers
Voucher
A token that the government
provides to households, which they
can use to buy specified goods or
services.
A voucher is a token that the government provides to households, which they can
use to buy specified goods or services. Food stamps that the U.S. Department of
Agriculture provides under a federal Food Stamp Program are examples of
vouchers. Vouchers for college education could be provided to students. Let’s see
how they would work.
The government would provide each student with a voucher. Students would
choose the school to attend and pay the tuition with dollars plus a voucher. Schools
would exchange the vouchers they receive for dollars from the government. If the
government set the value of a voucher equal to the marginal external benefit of a
year of college at the efficient quantity, the outcome would be efficient.
Figure 10.9 illustrates an efficient voucher scheme in action. The government
issues vouchers worth $15,000 per student per year. Each student pays $10,000
tuition and the government pays $15,000 per voucher, so the school collects $25,000
per student. The voucher scheme results in 15 million students attending college,
the marginal cost of a student equals the marginal social benefit, and the outcome is
efficient.
Do Vouchers Beat Public Provision and Subsidy? Vouchers provide public financial
resources to the consumer rather than the producer. Economists generally believe
that vouchers offer a more efficient outcome than public provision and subsidies
because they combine the benefits of competition among private schools with the
injection of the public funds needed to achieve an efficient level of output. Also,
students and their parents can monitor school performance more effectively than
the government can (see Eye on the U.S. Economy opposite.)
■
FIGURE 10.9
MyEconLab Animation
Vouchers Achieve an Efficient Outcome
With vouchers, buyers are willing to
pay MB plus the value of the voucher.
Price and cost
(thousands of dollars per student per year)
➊ The government issues vouchers
40
to each student valued at $15,000.
Efficient
market
equilibrium
➋ The market equilibrium is efficient. With 15 million students
enrolled in college, ➌ marginal
social benefit equals marginal cost.
➍ Each student pays tuition of
$10,000 (the dollar price) and the
school collects $15,000 (the value
of the voucher) from the
government.
S = MC
30
Marginal social
benefit equals
marginal cost
Value of
voucher
25
20
MSB
10
Dollar
price
0
5
D = MB
10
15
20
25
Quantity (millions of students per year)
Chapter 10 • Externalities
297
EYE on the U.S. ECOnOmY
Education quality: charter Schools and vouchers
The three methods of achieving efficient education have similar effects on
the quantity of education but different
effects on its quality, and quality has become a big issue: international league
tables show U.S. students performing
worse on standardized math and science tests than those in more than 20
other countries. Here, we look at two
ways of trying to improve the quality
of U.S. education: charter schools and
school vouchers.
Charter Schools
A charter school is a public school but
one that is free to make its own education policy. Around 4,000 charter
schools in 40 states are operating
today and they teach more than 1 million students. When the demand for
places in a charter school exceeds the
supply, students are chosen by lottery.
How efficient are the charter schools?
School efficiency has two dimensions: cost per student and educational
standard attained.
Charter schools perform well on
both criteria. They cost less than public schools and they achieve more.
Cost per student in New York charter
schools is 18 percent less than regular
public schools. And charter school students perform higher in math and
reading than equivalent students who
apply to but (randomly) don’t get into
a charter school.
Vouchers
School vouchers are much less used
than charter schools and more controversial. But an increasing number of
states, among them Wisconsin,
Louisiana, ohio, the district of
Columbia, and New York, operate a
Stanford University professor Caroline
Hoxby says: “Tell me your goals and I’ll
design you a voucher to achieve them.”
school voucher program.
Studies of the effects of vouchers
have generated more controversies
than firm conclusions, but some economists are convinced that they offer
the best solution.
EYE on YOUr LIFE
Externalities in your life
Think about the externalities, both
negative and positive, that play a huge
part in your life; and think about the
incentives that attempt to align your
self-interest with the social interest.
You respond to the gasoline tax by
buying a little bit less gas than you otherwise would. As you saw in Eye on
Climate Change (p. 290), this incentive
is small compared to that in some other
countries. With a bigger gas tax, such
as that in the United Kingdom for
example, you would find ways of getting
by with a smaller quantity of gasoline
and your actions and those of millions
of others would make the traffic on
our highways much lighter.
You are responding to the huge
incentive of subsidized tuition by being
in school. Without subsidized college
education, fewer people would attend
college and university and with fewer
college graduates, the benefits we all
receive from living in a well-educated
society would be smaller.
Think about your attitude as a citizen–voter to these two externalities.
Should the gas tax be higher to discourage the use of the automobile?
Should tuition be even lower to
encourage even more people to enroll
in school? or have we got these incentives just right in the social interest?