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MACROECONOMICS Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203
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MACROECONOMICS
Thirteenth Edition
Roger A. Arnold
California State University
San Marcos
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Roger A. Arnold
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Printed in the United States of America

Print Number: 01 Print Year: 2017
To Sheila, Daniel, and David
BRIEF CONTENTS
An Introduction to Economics
Part 1 Economics: The Science of Scarcity
Chapter 1 What Economics is About 1 Part 5 Expectations and Growth
Appendix A Working with Diagrams 25
Chapter 16 Expectations Theory and the Economy 399
Appendix B Should You Major in Economics? 34
Chapter 17 Economic Growth: Resources, Technology, Ideas, and
Chapter 2 Production Possibilities Frontier Framework 41 Institutions 426
Chapter 3 Supply and Demand: Theory 59
Part 6 Government and the Economy
Chapter 4 Prices: Free, Controlled, and Relative 95
Chapter 5 Supply, Demand, and Price: Applications 116 Chapter 18 Debates in Macroeconomics Over the Role and Effects
of Government 443
Macroeconomics Part 7 arket Failure, Public Choice, and

M
Special-Interest Group Politics
Part 2 Macroeconomic Fundamentals
Chapter 19 Public Choice and Special-Interest Group Politics 459
Chapter 6 Macroeconomic Measurements, Part I: Prices and
Unemployment 138 Part 8 Economic Theory-Building and Everyday Life
Chapter 7 Macroeconomic Measurements, Part II: GDP and Real
Chapter 20 Building Theories to Explain Everyday Life: From
GDP 156
Observations to Questions to Theories to Predictions 480
Part 3 M
acroeconomic Stability, Instability, and Fiscal Policy
Chapter 8 Aggregate Demand and Aggregate Supply 181 The Global Economy
Chapter 9 Classical Macroeconomics and the Part 9 International Economics and Globalization
Self-Regulating Economy 215
Chapter 21 International Trade 506
Chapter 10 Keynesian Macroeconomics and Economic Instability:
A Critique of the Self-Regulating Economy 241 Chapter 22 International Finance 525
Chapter 11 Fiscal Policy and the Federal Budget 274
Web Chapters
Part 4 Money, The Economy, and Monetary Policy
Chapter 23 The Economic Case For and Against Government:
Chapter 12 Money, Banking, and the Financial System 301
Five Topics Considered 544
Chapter 13 T he Federal Reserve System 318
Chapter 24 Stocks, Bonds, Futures, and Options 563
Appendix C T he Market For Reserves (or The Federal
Funds Market) 337 Self-Test Appendix 544
Glossary 561
Chapter 14 M
oney and the Economy 341 Index 569
Chapter 15 M
onetary Policy 371
Appendix D Bond Prices and the Interest Rate 396
CONTENTS
An Introduction to Economics
Part 1 Economics: The Science of Scarcity
CHAPTER 1: What Economics is About 1

ECONOMICS 24/7
Your Life, 2019–2029 1
Rationing Spots at Yale 5 A Definition of Economics 2
Goods and Bads 2 Resources 2 Scarcity and a Definition of Economics 2
When Is It Too Costly to
Attend College? 8 Key Concepts in Economics 4
Opportunity Cost 4 Opportunity Cost and Behavior 6 Benefits and Costs 6
Can Incentives Make You Decisions Made at the Margin 7 Efficiency 9
Smarter? 12 Does It Matter to You . . . If You Are Efficient or Not? 11
Why Didn’t I Think of That? Economics Is About Incentives 12 Unintended Effects 13 Exchange 14
The Case of Uber and Ceteris Paribus and Theory 16
Airbnb 15 Ceteris Paribus Thinking 16 What Is a Theory? 17
Hear What and How the Economist Thinks . . . About Theories 19
Economic Categories 20
OFFICE Positive Economics and Normative Economics 20 Microeconomics and
HOURS Macroeconomics 20
Chapter Summary 22
“I Don’t Believe That Key Terms and Concepts 23
Every Time a Person Does
Questions and Problems 23
Something, He Compares
the Marginal Benefits and Working with Numbers and Graphs 24
Costs” 21
APPEnDIx A: WoRKInG WITH DIAGRAMS 25
Slope of a Line 26
Slope of a Line Is Constant 27
Slope of a Curve 27
The 45-Degree Line 27
Pie Charts 29
Bar Graphs 29
Line Graphs 30
Appendix Summary 32
Key Terms and Concepts 32
vi
Contents vii
APPEnDIx B: SHOULD YOU MAJOR IN ECONOMICS? 34
Five Myths About Economics and Being an Economics Major 35

What Awaits You as an Economics Major? 37
What Do Economists Do? 38
Places to Find More Information 40
Concluding Remarks 40

ECONOMICS 24/7 CHAPTER 2: PRODUCTION POSSIBILITIES FRONTIER FRAMEWORK 41
Deducing Where Sherlock The Production Possibilities Frontier 41

Holmes Was on His The Straight-Line PPF: Constant Opportunity Costs 41 The Bowed-Outward
Production Possibilities (Concave-Downward) PPF: Increasing Opportunity Costs 42
Frontier? 46 Does It Matter to You . . . If the Economy Is at One Point on the PPF Instead
of Another? 44
Studying and Your PPF 50
Law of Increasing Opportunity Costs 45 Economic Concepts in a Production Possibilities
Frontier Framework 46
Specialization and Trade Can Move Us Beyond Our Ppf 51
OFFICE A Simple Two-Person PPF Model 51 On or Beyond the PPF? 52
HOURS Hear What and How the Economist Thinks . . . About Manufacturing Jobs 53
Chapter Summary 56
“What Purpose Does the
PPF Serve?” 55 Key Terms and Concepts 57
Working with Numbers and Graphs 57
24/7 CHAPTER 3: SUPPLY AND DEMAND: THEORY 59

ECONOMICS
What Do the Following What Is Demand? 59
Have in Common? Losing The Law of Demand 60 Four Ways to Represent the Law of Demand 60 Why Does
One’s Temper, Arriving to Quantity Demanded Go Down as Price Goes Up? 61 Individual Demand Curve and
Class Late, and Buying the Market Demand Curve 62 A Change in Quantity Demanded Versus a Change in
Textbook for a Class 62 Demand 63 What Factors Cause the Demand Curve to Shift? 66 Movement Factors
and Shift Factors 68
Are You Buying More Than
Supply 69
You Want to Buy? 85
The Law of Supply 69 Why Most Supply Curves Are Upward Sloping 70 Changes
“Sorry, But This Flight Has in Supply Mean Shifts in Supply Curves 72 What Factors Cause the Supply Curve
Been Overbooked” 89 to Shift? 72 A Change in Supply Versus a Change in Quantity Supplied 74
The Market: Putting Supply and Demand Together 75
Supply and Demand at Work at an Auction 75 The Language of Supply and Demand: A
OFFICE Few Important Terms 76 Moving to Equilibrium: What Happens to Price When There Is
HOURS a Surplus or a Shortage? 76 Speed of Moving to Equilibrium 76
Hear What and How the Economist Thinks . . . About Higher Prices
“I Thought Prices Equaled and Buying More 78
Costs Plus 10 Percent” 90 Moving to Equilibrium: Maximum and Minimum Prices 79 The Connection Between
Equilibrium and Predictions 80 Equilibrium in Terms of Consumers’ and Producers’
Surplus 81 What Can Change Equilibrium Price and Quantity? 83
Does It Matter to You . . . If You Pay Equilibrium Prices or Not? 83
It Is Important to Know Why the Price Changed: Back to Substitutes and Complements 86
Epilogue: Who Feeds Cleveland? 87
viii Contents
Chapter Summary 91
CHAPTER 4: PRICES: FREE, CONTROLLED, AND RELATIVE 95

ECONOMICS 24/7
Price 95
A Price Ceiling in the Price as a Rationing Device 95 Price as a Transmitter of Information 96
Kidney Market 100 Price Controls 97
1973 and 1979 101 Price Ceiling 97
Hear What and How the Economist Thinks . . . About Price Ceilings and the Value of
What Does Price Have to Money 102
Do with Being Late to Price Floor: Definition and Effects 103
Class? 108
Does It Matter to You . . . If the Demand Curve for Unskilled Labor Is Steep or Not? 105
Obesity and a Soda Two Prices: Absolute and Relative 109
Tax 111 Absolute (Money) Price and Relative Price 109 Taxes on Specific Goods and Relative
Price Changes 110
Does It Matter to You . . . If Something You Buy Is Taxed or Subsidized? 112
OFFICE Chapter Summary 114
HOURS Key Terms and Concepts 114
“I Thought Price Ceilings Questions and Problems 114
Were Good for Consumers” Working with Numbers and Graphs 115
113
CHAPTER 5: SUPPLY, DEMAND, AND PRICE: APPLICATIONS 116

OFFICE Application 1: U-Haul Rates and Demand 116
HOURS Application 2: Subsidizing the Consumption of Anything Can Raise its Price 117
“Doesn’t High Demand Application 3: 10 a.m. Classes in College 119
Mean High Quantity Application 4: Why Do Colleges Use GPAs, ACTs, and SATs for Purposes
Demanded?” 134 of Admission? 121
Application 5: Why is Medical Care So Expensive? 122
Application 6: Do You Pay for Good Weather? 124
Application 7: The Price of an Aisle Seat 126
Application 8: College Superathletes 127
Application 9: Easier-to-Obtain Loans and Higher Housing Prices 129
Application 10: Speculators, Price Variability, and Patterns 130
Application 11: Supply and Demand on a Freeway 131
Application 12: Are Renters Better Off? 132
Chapter Summary 135
Contents ix
Macroeconomics
Part 2 Macroeconomic Fundamentals
CHAPTER 6: MACROECONOMIC MEASUREMENTS,

ECONOMICS 24/7 PART I: PRICES AND UNEMPLOYMENT 138
The Beatles at Shea Measuring The Price Level 138

Stadium 144 Using the CPI to Compute the Price Level 138 Inflation and the CPI 140 The Core
PCE Index 141
Who Should Be Considered
Unemployed? 150 Does It Matter to You . . . If Prices Rise or Fall? 142
Converting Dollars from One Year to Another 143
Hear What and How the Economist Thinks . . . About House Prices in the Past 145
OFFICE Measuring Unemployment 146
HOURS Who Are the Unemployed? 146 The Unemployment Rate and the Employment
Rate 147 Common Misconceptions about the Unemployment and Employment
“Is There More Than One Rates 147 Reasons for Unemployment 148 Discouraged Workers 148 Types of
Reason the Unemployment Unemployment 149 The Natural Unemployment Rate and Full Employment 150
Rate Will Fall?” 153 Cyclical Unemployment 151
Chapter Summary 154
CHAPTER 7: MACROECONOMIC MEASUREMENTS,

ECONOMICS 24/7 PART II: GDP AND REAL GDP 156
Gross Family Product 159
Gross Domestic Product 156
No One Utters the Actual Calculating GDP 156 Final Goods and Intermediate Goods 157 What GDP Omits 157
Number 159 GDP Is Not Adjusted for Bads Generated in the Production of Goods 158 Per-Capita
Money and Happiness 160 GDP 158
The Expenditure Approach to Computing GDP for a Real-World Economy 162
1820 168 Using the Expenditure Approach to Compute GDP 163 Common Misconceptions
about Increases in GDP 165
OFFICE The Income Approach to Computing GDP for a Real-World Economy 165
Computing National Income 167 From National Income to GDP: Making
HOURS Some Adjustments 168 Other National Income Accounting Measurements 170
Net Domestic Product 170 Personal Income 170 Disposable Income 170
“Why Do We Use the
Real GDP 171
Expenditure Approach to
Measure Production?” 176
Why We Need Real GDP 171 Computing Real GDP 171 The General Equation
for Real GDP 172 What Does It Mean if Real GDP Is Higher in One Year Than in
Another? 172 Real GDP, Economic Growth, and Business Cycles 172
Does It Matter to You . . . In Which Phase of the Business Cycle You Search
for a Job? 174
Hear What and How the Economist Thinks . . . About Economic Growth and Real GDP 175
Chapter Summary 177
x Contents
Part 3 Macroeconomic Stability, Instability, and Fiscal Policy
CHAPTER 8: AGGREGATE DEMAND AND AGGREGATE SUPPLY 181

ECONOMICS 24/7
A Way to View the Economy 181
When Would You Want to Aggregate Demand 182
Be Paid in a Currency Other Why Does the Aggregate Demand Curve Slope Downward? 183 An Important Word on
Than U.S. Dollars? 195 the Three Effects 186 A Change in Quantity Demanded of Real GDP Versus a Change
Different Ways to Get to the in Aggregate Demand 186 Changes in Aggregate Demand: Shifts in the AD Curve 187
Same Outcome 205 How Spending Components Affect Aggregate Demand 188 Why Is There More Total
Spending? 189 Factors That Can Change C, I, G, and NX (EX – IM) and Therefore
Your First Job After College Can Change AD (Shift the AD Curve) 189 Can a Change in the Money Supply Change
May Depend on the AD and Aggregate Demand? 194 If Consumption Rises, Does Some Other Spending Component
SRAS Curves 208 Have to Decline? 194
Does It Matter to You . . . If Velocity Falls? 196
Hear What and How the Economist Thinks . . . About Total Spending, the Money Supply,
OFFICE and Velocity 197
HOURS Short-Run Aggregate Supply 197
Short-Run Aggregate Supply Curve: What It Is and Why It Is Upward Sloping 197 What
“What Purpose Does the Puts the “Short Run” in the SRAS Curve? 199 Changes in Short-Run Aggregate Supply:
AD–AS Framework Serve?” Shifts in the SRAS Curve 200 Something More to Come: Peoples’ Expectations 201
210
Putting AD And Sras Together: Short-Run Equilibrium 202
How Short-Run Equilibrium in the Economy Is Achieved 202 Thinking in Terms of
Short-Run Equilibrium Changes in the Economy 203 An Important Exhibit 207
Long-Run Aggregate Supply 207
Going from the Short Run to the Long Run 207 Short-Run Equilibrium, Long-Run
Equilibrium, and Disequilibrium 209
Chapter Summary 211
ECONOMICS 24/7
CHAPTER 9: CLASSICAL MACROECONOMICS
AND THE SELF-REGULATING ECONOMY 215
Births, Marriage, and the
Savings Rate in China 219
Unpaid Internships 230 The Classical View 215
Classical Economists and Say’s Law 215 Classical Economists and Interest
If the Economy Is Removing
Rate Flexibility 216
Itself from a Recessionary
Gap, Where Is the Declining Does It Matter to You . . . How Much People Save? 218
Price Level? 236 Classical Economists on Prices and Wages: Both Are Flexible 219
Three States of the Economy 220
Real GDP and Natural Real GDP: Three Possibilities 220 The Labor Market and the
OFFICE Three States of the Economy 222 Common Misconceptions About the Unemployment
HOURS Rate and the Natural Unemployment Rate 223
The Self-Regulating Economy 226
“Do Economists Really What Happens If a Self-Regulating Economy is in a Recessionary Gap? 226 What’s the
Know What the Natural Connection Between a Slow Recovery and How Quickly or Slowly Wages Adjust? 227
Unemployment Rate What Happens If the Economy Is In an Inflationary Gap? 228 The Self-Regulating
Equals?” 237 Economy: A Recap 228
Contents xi
Hear What and How the Economist Thinks . . . About Laissez-Faire and the
Self-Regulating Economy 231
Policy Implication of Believing That the Economy Is Self-Regulating 231 Changes
in a Self-Regulating Economy: Short Run and Long Run 232 A Recap of Classical
Macroeconomics and a Self-Regulating Economy 234 Business-Cycle Macroeconomics
and Economic-Growth Macroeconomics 234
Chapter Summary 238
CHAPTER 10: KEYNESIAN MACROECONOMICS AND ECONOMIC

ECONOMICS 24/7 INSTABILITY: A CRITIQUE OF THE SELF-REGULATING ECONOMY 241
The Financial and Economic Questioning the Classical Position and the Self-Regulating Economy 241
Crisis of 2007–2009: Can Keynes’s Criticism of Say’s Law in a Money Economy 242 Keynes on Wage Rates 243
a Housing Bust Lead to an Different Markets, Different Rates of Adjustment 244 Keynes on Prices 247 Is It a
Imploding Economy? 246 Question of the Time It Takes for Wages and Prices to Adjust? 248
Was Keynes a Revolutionary The Simple Keynesian Model 251
in Economics? 249 Assumptions 251 The Consumption Function 251 Consumption and Saving 253
The Multiplier 254 The Multiplier and Reality 255
The Economics of Spring
Does It Matter to You . . . How Much Spring Breakers Spend, the Value of the MPC,
Break 255 or Both? 256
The Simple Keynesian Model in the AD–AS Framework 257
Shifts in the Aggregate Demand Curve 257 The Keynesian Aggregate
OFFICE Supply Curve 257 The Economy in a Recessionary Gap 259 Government’s Role
HOURS in the Economy 260 The Theme of the Simple Keynesian Model 260
Hear What and How the Economist Thinks . . . About Why Not All Economists Agree on
“Does a Lot Depend on How the Economy Works 261
Whether Wages Are
The Simple Keynesian Model in the TE–TP Framework 262
Flexible or Inflexible?” 270
Deriving a Total Expenditures (TE) Curve 263 Where the Consumption Curve and
the Total Expenditures Curve Cut the Vertical Axis: More on Exhibit 12 264 What Will
Shift the TE Curve? 265 Comparing Total Expenditures (TE) and Total Production (TP)
265 Moving from Disequilibrium to Equilibrium 266 The Economy in a Recessionary
Gap and the Role of Government 268 Equilibrium in the Economy 269 The Theme of
the Simple Keynesian Model 269
Chapter Summary 271
CHAPTER 11: FISCAL POLICY AND THE FEDERAL BUDGET 274
The Federal Budget 274

Government Expenditures 274 Government Tax Revenues 275 Budget Projections 276
Budget Deficit, Surplus, or Balance 277 Structural and Cyclical Deficits 278 The Public
Debt 279 Valued-Added Tax 279 Tax Deductions Versus Subsidies 282
Fiscal Policy 283
Some Relevant Fiscal Policy Terms 283 Two Important Notes 283
xii Contents
Demand-Side Fiscal Policy 283

ECONOMICS 24/7 Shifting the Aggregate Demand Curve 283 Fiscal Policy: Keynesian Perspective (Economy
Is Not Self-Regulating) 284 Crowding Out: Questioning Expansionary Fiscal Policy 285
Lags and Fiscal Policy 287 Crowding Out, Lags, and the Effectiveness of Fiscal Policy 289
Two Cab Drivers on New
Democracy in Deficit 289
Year’s Eve, or Turning Equal
into Unequal 278 Hear What and How the Economist Thinks . . . About the Deficit as a Percentage
of GDP 292
Do Voting Rules Matter to
Supply-Side Fiscal Policy 292
Taxing and Spending? 281
Marginal Tax Rates and Aggregate Supply 293 The Laffer Curve: Tax Rates and Tax
Revenues 293
Does It Matter to You . . . If the Economy Is on the Upward-Sloping or
OFFICE Downward-Sloping Portion of the Laffer Curve? 295
Fiscal Policy and Expectations 296
HOURS Chapter Summary 298
“Is There a Looming Fiscal Key Terms and Concepts 299
Crisis?” 297 Questions and Problems 299
Part 4 Money, the Economy, and Monetary Policy
CHAPTER 12: MONEY, BANKING, AND THE FINANCIAL SYSTEM 301

ECONOMICS 24/7
Money: What Is It and How Did It Come To Be? 301
eBay and Dating Apps Money: A Definition 301 Three Functions of Money 302 From a Barter Economy to
308 a Money Economy: The Origins of Money 302
Economics on the Yellow Does It Matter to You . . . If You Live in a Barter or Money Economy? 304
Brick Road 309 Money, Leisure, and Output 304
Defining the Money Supply 305
M1 305 Money Is More Than Currency 306 M2 306 Where Do Credit Cards
OFFICE Fit In? 306
HOURS Hear What and How the Economist Thinks . . . About Money and Gold 307
How Banking Developed 308
“Do We Really Need The Early Bankers 308 The Bank’s Reserves and More 310
Financial Intermediaries?” The Financial System 311
315 Direct and Indirect Finance 312 Adverse Selection Problems and Moral Hazard
Problems 312 The Bank’s Balance Sheet 313 A Bank’s Business: Turning Liabilities
into Assets 313
Chapter Summary 315
Contents xiii
CHAPTER 13: THE FEDERAL RESERVE SYSTEM 318

ECONOMICS 24/7
The Structure and Functions of the Federal Reserve System (The Fed) 318
Inside an FOMC Meeting The Structure of the Fed 318 Functions of the Fed 319 Common Misconceptions
320 About the U.S. Treasury and the Fed 321
Some History of the Fed The Money Supply Expansion Process 323
322 A Quick Review of Reserves, Required Reserves, and Excess Reserves 323 The Money
Supply Expansion Process 323
Hear What and How the Economist Thinks . . . About Money and Currency 327
The Money Supply Contraction Process 327
OFFICE Does It Matter to You . . . If Banks Are Reserve Deficient or Not? 329
HOURS Other Fed Tools and Recent Fed Actions 329
“Can Something I Do End The Required Reserve Ratio 330 The Discount Window and the Federal Funds
Up Changing the Money Market 330 The Fed and the Federal Funds Rate Target 331 What Is Free
Supply?” 333 Banking? 331
Chapter Summary 334
APPEnDIx C: The Market For Reserves (or The Federal

Funds Market) 337
The Demand for Reserves 337

The Supply of Reserves 338
Two Different Supply Curves for Reserves 338
The Corridor and Changing the Federal Funds Rate 340
CHAPTER 14: MONEY AND THE ECONOMY 341

ECONOMICS 24/7
Money and the Price Level 341
The California Gold Rush, The Equation of Exchange 341 From the Equation of Exchange to the Simple
or Really Expensive Apples Quantity Theory of Money 343 The Simple Quantity Theory of Money in an AD–AS
347 Framework 344
Grade Inflation: It’s All Hear What and How the Economist Thinks . . . About More Money and Inflation 346
Relative 356 Dropping the Assumptions that V and Q Are Constant 348
Monetarism 349
The Four Monetarist Positions 349 Monetarism and AD–AS 349 The Monetarist View
OFFICE of the Economy 352
HOURS Does It Matter to You . . . If the AS Curve Is Vertical or Upward-Sloping? 352
Inflation 353
“What Is the Current One-Shot Inflation 353 Continued Inflation 357 Can You Get Rid of Inflation with
Expected Inflation Rate?” Price Controls? 360
367 Money and Interest Rates 360
Which Economic Variables Does a Change in the Money Supply Affect? 360 The Money
Supply, the Loanable Funds Market, and Interest Rates 361 What Happens to the
Interest Rate as the Money Supply Changes? 365 The Nominal and Real Interest
Rates 366
xiv Contents
Chapter Summary 367

CHAPTER 15: MONETARY POLICY 371

ECONOMICS 24/7
Transmission Mechanisms 371
Who Gets the Money First, The Money Market in the Keynesian Transmission Mechanism 371 The Keynesian
and What Happens to Transmission Mechanism: Indirect 373 The Keynesian Mechanism May Get
Relative Prices? 384 Blocked 374 The Monetarist Transmission Mechanism: Direct 377
Things May Not Always Monetary Policy and the Problem of Inflationary and Recessionary Gaps 378
Go the Way the Fed Wants A Different View of the Economy: Patterns of Sustainable Specialization and Trade
385 (PSST) 380
Monetary Policy and the Activist–Nonactivist Debate 381
The Case for Activist (or Discretionary) Monetary Policy 382 The Case for Nonactivist
(or Rules-Based) Monetary Policy 382
OFFICE Nonactivist Monetary Proposals 385
HOURS The Constant-Money-Growth-Rate Rule 386 The Predetermined-Money-Growth-Rate
Rule 386 The Fed and the Taylor Rule 386 Inflation Targeting 387 Nominal GDP
“Does Monetary Policy Targeting 387
Always Have the Same
Does It Matter to You . . . How Much of a Change There Is in the Money Supply? 388
Effects?” 392
A Gold Standard as Monetary Policy and the Value of the Dollar 389
Hear What and How the Economist Thinks . . . About Predicting Gold Prices 391
Chapter Summary 393
APPEnDIx D: Bond Prices and the Interest Rate 396
Appendix Summary 398

Part 5 Expectations and Growth
CHAPTER 16: EXPECTATIONS THEORY AND THE ECONOMY 399

ECONOMICS 24/7
Phillips Curve Analysis 399
Bubbles and Expectations The Phillips Curve 399 Samuelson and Solow: The Americanization of the Phillips
409 Curve 400
Rational Expectations in the The Controversy Begins: Are There Really Two Phillips Curves? 401
College Classroom 410 Things Aren’t Always as We Think They Are 401 Friedman and the Natural Rate
Theory 401 How Do People Form Their Expectations? 405
The Money Supply, an Rational Expectations and New Classical Theory 406
Increase in Productivity, and Rational Expectations 406 Do People Really Anticipate Policy? 406 Price-Level
What You Think 418 Expectations and the SRAS Curve 407 Expected and Actual Price Levels 411 New
Classical Economics and Four Different Cases 411 Comparing Exhibit 9 and 10 416
Contents xv
Does It Matter to You . . . If the Money Supply Rises or Falls? 417

OFFICE Hear What and How the Economist Thinks . . . About Economists’ Predictions 418
HOURS New Keynesians and Rational Expectations 419
Looking at Things from the Supply Side: Real Business Cycle Theorists 420
“Does New Classical
Chapter Summary 423
Theory Call the Effects of
Fiscal and Monetary Policy Key Terms and Concepts 424
into Question?” 422 Questions and Problems 424
CHAPTER 17: ECONOMIC GROWTH: RESOURCES, TECHNOLOGY,

ECONOMICS 24/7 IDEAS, AND INSTITUTIONS 426
Thinking in Terms of A Few Basics About Economic Growth 426

Production Functions and Do Economic Growth Rates Matter? 426
Equations 433 A Production Function and Economic Growth 428
Economic Freedom and The Graphical Representation of the Production Function 428 From the Production
Growth Rates 439 Function to the LRAS Curve 430 Emphasis on Labor 431
Does It Matter to You . . . At What Rate Technology Advances? 431
Emphasis on Capital 434 Emphasis on Other Resources: Natural Resources and Human
OFFICE Capital 434 Emphasis on the Technology Coefficient and Ideas 434
HOURS Hear What and How the Economist Thinks . . . About Economic Growth 435
Discovery and Ideas 436 Expanding Our Horizons 436 Institutions Matter 437
“What Is the Difference Chapter Summary 441
Between Business Cycle Key Terms and Concepts 441
Macroeconomics and
Economic Growth Questions and Problems 442
Macroeconomics?” 440 Working with Numbers and Graphs 442
Part 6 Government and the Economy
CHAPTER 18: Debates in Macroeconomics Over

ECONOMICS 24/7 the Role and Effects of Government 443
If It Sounds Reasonable, Macroeconomics and Government: The Debate 443

Is It Right? If It Sounds Tax Cuts, Tax Revenue, and Budget Deficits 444
Unreasonable, Is It Wrong?
446 The Economy: Self-Regulating or Not? 445
More Government Spending or a Cut in Taxes: Which Gives a Bigger Bang for the
Buck? 445
More Government Spending or a Cut in Taxes: The Size and Scope of Government 447
The Degree of Crowding Out 448
The Politics of Government Spending 449
Hear What and How the Economist Thinks . . . About the Economics of a Hurricane 450
Monetary Policy: Rules Versus Discretion 451
Bailouts 451
xvi Contents
Demand-Side and Supply-Side Views of the Economy and Government Tools

OFFICE for Changing Real GDP 452

“What Kinds of Debates Do Questions and Problems 457
Macroeconomists Have?”
455
Part 7 Market Failure, Public Choice, and Special-Interest Group Politics
CHAPTER 19: PUBLIC CHOICE AND SPECIAL-INTEREST

ECONOMICS 24/7 GROUP POLITICS 459
A Simple-Majority Voting Rule: Public Choice Theory 459

The Case of the Statue in the The Political Market 460
Public Square 462 Moving Toward the Middle: The Median Voter Model 460 What Does the Theory
Economic Illiteracy and Predict? 461
Democracy 466 Voters and Rational Ignorance 464
The Costs and Benefits of Voting 464
Does It Matter to You . . . If You Do Not Vote? 465
OFFICE Rational Ignorance 465
HOURS Hear What and How the Economist Thinks . . . About Rational Ignorance 467
More About Voting 468
“Doesn’t Public Choice Paint Example 1: Voting for a Nonexcludable Public Good 468 Example 2: Voting and
a Bleak Picture of Politics Efficiency 469
and Government?” 476 Special-Interest Groups 470
Information and Lobbying 470 Congressional Districts as Special-Interest Groups
471 Public-Interest Talk, Special-Interest Legislation 471 Rent Seeking 472
Bringing About Transfers 473 Information, Rational Ignorance, and Seeking
Transfers 473
Constitutional Economics 475
Chapter Summary 477
Part 8 Economic Theory-Building and Everyday Life
CHAPTER 20: BUILDING THEORIES TO EXPLAIN EVERYDAY LIFE: FROM

OBSERVATIONS TO QUESTIONS TO THEORIES TO PREDICTIONS 480
A Different Kind of Chapter 480

The Process 481
Contents xvii
Observation/Thought 1: The Birthrates in Various Countries are Different 482

ECONOMICS 24/7 The Question 482 The Theory 482 The Predictions 482 A Detour: The Issue of
Falsifiability (Refutability) 483
Can Social Media Affect Hear What and How the Economist Thinks . . . About Theories 483
Whom a Person Dates? Observation/Thought 2: The Ethical Code of People Who Live in a Small Town is
486 Different from that of People Who Live in a Large City 484
The Question 485 The Theory 485 The Predictions 485
Talking on a Cell Phone
Observation/Thought 3: The Closer the Dollar Tuition the Student Pays is to the
in Public 495
Equilibrium Tuition, the More on Time and Responsive University Instructors Will Be for
Office Hours 487
OFFICE Observation/Thought 4: Criminals Are Not Rational 489
HOURS The Question 489 The Theory 489 The Predictions 490 A Detour: Does
Evidence Prove a Theory Correct? 490 Another Detour: After You Have One Theory
“Can Anyone Build That Explains and Predicts, Search for Another 491 A Final Detour: Why Prediction Is
a Theory?” 503 So Important, Or Why Good-Sounding Stories Are Not Enough 492
Observation/Thought 5: More Students Wear Baseball Caps in Class on Exam Days
Than on Other Days 493
Observation/Thought 6: Houses in “Good” School Districts Are Often More Expensive
than Comparable Houses in “Bad” School Districts 496
Observation/Thought 7: Are People Better Off With or Without Health Care
Vouchers? 497
Observation/Thought 8: People Who Give to Others Often Complain That They
End Up Giving Too Much 498
Does It Matter to You . . . If and How You Are in Someone Else’s Utility Function? 502
Chapter Summary 503
The Global Economy

Part 9 International Economics and Globalization
CHAPTER 21: INTERNATIONAL TRADE 506

ECONOMICS 24/7
International Trade Theory 506
Dividing the Work 511 How Countries Know What to Trade 507
Does It Matter to You . . . If There Is Always Someone Who Can Do Something Better
Offshore Outsourcing,
Than You? 509
or Offshoring 519
A Common Misconception about How Much We Can Consume 510 How Countries
Know When They Have a Comparative Advantage 510
Hear What and How the Economist Thinks . . . About Common Sense 512
Trade Restrictions 512
xviii Contents
The Distributional Effects of International Trade 513 Consumers’ and Producers’

OFFICE Surpluses 513 The Benefits and Costs of Trade Restrictions 514 Why Nations
Sometimes Restrict Trade 518
“Should We Impose Tariffs if Key Terms and Concepts 523
They Impose Tariffs?” 521 Questions and Problems 523
CHAPTER 22: INTERNATIONAL FINANCE 525

ECONOMICS 24/7
The Foreign Exchange Market 525
The U.S. Dollar as the Primary The Demand for Goods 526 The Demand for, and Supply of, Currencies 526
Reserve Currency 531
Flexible Exchange Rates 527
Chinese Imports and the The Equilibrium Exchange Rate 527 Changes in the Equilibrium Exchange
U.S. Economy 534 Rate 528
Does It Matter to You . . . If the Dollar Depreciates? 528
Factors That Affect the Equilibrium Exchange Rate 529
OFFICE Fixed Exchange Rates 532
HOURS Fixed Exchange Rates and Overvalued or Undervalued Currency 533 What Is So
Bad about an Overvalued Dollar? 535 Government Involvement in a Fixed Exchange
“Why Is the Depreciation Rate System 536 Options Under a Fixed Exchange Rate System 536
of One Currency Tied to
Fixed Exchange Rates Versus Flexible Exchange Rates 538
the Appreciation of
Promoting International Trade 538 Optimal Currency Areas 538
Another?” 540
Chapter Summary 541
Web Chapters
CHAPTER 23: The Economic Case for and Against

ECONOMICS 24/7
Government: Five Topics Considered 544
Culture as a Public Economics and Government 544

Good 551 The Economic Case for Government 545
Government Can Remove Individuals from a Prisoner’s Dilemma Setting 545
Externalities 549 Nonexcludable Public Goods 550 The Case for Smaller or Larger
Government 552
OFFICE The Economic Case Against Government 553
HOURS Unintended Effects of Government Actions 553 Government as Transfer
Mechanism 554 Economic Growth Versus Transfers 556 Following the Leader in
“I’m No Longer Sure What Pushing for Transfers 557 Divisive Society: A Nonexcludable Public Bad 559
I Think” 560 Chapter Summary 560
Contents xix
CHAPTER 24: STOCKS, BONDS, FUTURES, AND OPTIONS 563

ECONOMICS 24/7
Financial Markets 563
Are Some Economists Poor Stocks 564
Investors? 568 Where Are Stocks Bought and Sold? 564 The Dow Jones Industrial Average (DJIA)
$1.3 Quadrillion 573 565 How the Stock Market Works 566 Why Do People Buy Stock? 567 How to Buy
and Sell Stock 567 Buying Stocks or Buying the Market 568 How to Read the Stock
Market Page 569
Bonds 571
The Components of a Bond 571 Bond Ratings 572 Bond Prices and Yields
OFFICE (or Interest Rates) 572 Common Misconceptions about the Coupon Rate and Yield
(Interest Rate) 573 Types of Bonds 574 How to Read the Bond Market Page 574
HOURS Risk and Return 576
“I Have Three Questions” Futures and Options 576
579 Futures 576 Options 577
Chapter Summary 580
Self-Test Appendix 544

Glossary 561
Index 569
Roger Arnold’s Macroeconomics opens up the world of economic
analysis. Substantive content, detailed diagrams, popular economic features,
and innovative pedagogy are just the beginning. Macroeconomics
continues to blaze the trail for constantly updated content and applications
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It Matter To You If You are Efficient or Not? or If the Economy is at One
Point on the PPF Instead of Another? or If Something You Buy Is Taxed or
Subsidized? It certainly does.
IN APPRECIATION
Many colleagues have contributed to the success of this text over the last twelve editions. Their feedback continues to influence
and enhance the text and ancillary package and I’m grateful for their efforts. Now into our 13th edition, space dictates that
we can no longer list the names of all reviewers for each past edition; we are including here instructors who contributed to
the development of the 13th edition, but continue to be grateful for the improvements suggested by all of the reviewers and
contributors to this product over the years.
Randy Barcus John Finley Brian Lynch

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xxv
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I would like to thank Peggy Crane of Southwestern College, who revised the Test Bank and wrote the questions for the Adaptive
Test Prep. I owe a debt of gratitude to all the fine and creative people I worked with at Cengage Learning. These persons include
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My deepest debt of gratitude goes to my wife, Sheila, and to my two sons, David and Daniel. They continue to make all my
days happy ones.
Roger A. Arnold
CHAPTER
What Economics Is About 1

INTRODUCTION
You are about to begin your
study of economics. Before
discussing particular topics in
economics, we think it best to
give you an overview of what
economics is and of some of the
key concepts. The key concepts
can be compared to musical
notes: Just as musical notes are
repeated in any song (you hear
the musical note G over and over
again), so are the key concepts
in economics repeated. Some
of these concepts are scarcity,
opportunity cost, e fficiency,
marginal decision making,
incentives, and exchange.
Denise Lett/Shutterstock.com
1-1 YOUR LIFE, 2019–2029

What will your life be like during the years 2019–2029? What kind of work will you do after
college? How much will you earn in that first job after college? Where will you be living and who
will your friends be? How many friends will you have? Will you buy a house in the next few years?
If so, how much will you pay for the house? And, perhaps most importantly, will you be happy?
The specific answers to these questions and many more have to do with economics. For
example, the salary you will earn has to do with the economic concept of opportunity cost. What
you will do in your first job after college has to do with the state of the economy when you graduate.
The price you pay for a house has to do with the state of the housing market. How many friends
you have has to do with the economic concept of scarcity. Whether you are happy will depend on
such things as the net benefits you receive in various activities, the utility you gain by doing certain
things, and more.
In this chapter, we begin our study of economics. As you read the chapter (and those which
follow), ask yourself how much of what you are reading is relevant to your life today and tomor-
row. Ask: What does what I am reading have to do with my life? Our guess is that after answering
this question a few dozen times, you will be convinced that economics explains much about your
present and future.
1
2 Part 1 Economics: The Science of Scarcity
1-2 A DEFINITION OF ECONOMICS

In this section, we discuss a few key economic concepts; then we incorporate knowledge of these
concepts into a definition of economics.
1-2a Goods and Bads

Economists talk about goods and bads. A good is anything that gives a person utility, or satisfaction.
Good Here is a partial list of some goods: a computer, a car, a watch, a television set, friendship, and love.
Anything from which indi- You will notice from our list that a good can be either tangible or intangible. A computer is a
viduals receive utility or tangible good; friendship is an intangible good. Simply put, for something to be a good (whether
satisfaction. tangible or intangible), it only has to give someone utility or satisfaction.
A bad is something that gives a person disutility or dissatisfaction. If the flu gives you disutility
Utility
The satisfaction one receives
or dissatisfaction, then it is a bad. If the constant nagging of an acquaintance is something that
from a good. gives you disutility or dissatisfaction, then it is a bad.
People want goods, and they do not want bads. In fact, they will pay to get goods (“Here is
Bad $1,000 for the computer”), and they will pay to get rid of bads (“I’d be willing to pay you, doctor,
Anything from which indi-
if you can prescribe something that will shorten the time I have the flu”).
viduals receive disutility or
dissatisfaction.
Can something be a good for one person and a bad for another person? Smoking cigarettes gives
some people utility; it gives others disutility. We conclude that smoking cigarettes can be a good
Disutility for some people and a bad for others. This must be why the wife tells her husband, “If you want
The dissatisfaction one to smoke, you should do it outside.” In other words, “Get those bads away from me.”
receives from a bad.
Land 1-2b Resources

All natural resources, such as
Goods do not just appear before us when we snap our fingers. It takes resources to produce goods.
minerals, forests, water, and
unimproved land.
(Sometimes resources are referred to as inputs or factors of production.)
Generally, economists divide resources into four broad categories: land, labor, capital, and
Labor entrepreneurship.
The work brought about
by the physical and mental • Land includes natural resources, such as minerals, forests, water, and unimproved land.
talents that people contribute For example, oil, wood, and animals fall into this category. (Sometimes economists refer
to the production process. to the category simply as natural resources.)
Capital • Labor consists of the physical and mental talents that people contribute to the production
Produced goods, such as process. For example, a person building a house is using his or her own labor.
factories, machinery, tools, • Capital consists of produced goods that can be used as inputs for further production.
computers, and buildings Factories, machinery, tools, computers, and buildings are examples of capital. One
that can be used as inputs country might have more capital than another; that is, it has more factories, machinery,
for further production. tools, and the like.
Entrepreneurship • Entrepreneurship refers to the talent that some people have for organizing the resources of
The talent that some people land, labor, and capital to produce goods, seek new business opportunities, and develop
have for organizing the new ways of doing things.
resources of land, labor,
and capital to produce
goods, seek new business
1-2c Scarcity and a Definition of Economics
opportunities, and develop We are now ready to define a key concept in economics: scarcity. Scarcity is the condition in which
new ways of doing things. our wants (for goods) are greater than the limited resources (land, labor, capital, and entrepreneur-
Scarcity
ship) available to satisfy those wants. In other words, we want goods, but not enough resources
The condition in which our are available to provide us with all the goods we want.
wants are greater than the Look at it this way: Our wants (for goods) are infinite, but our resources (which we need to
limited resources available to produce the goods) are finite. Scarcity is the result of our infinite wants hitting up against finite
satisfy those wants. resources.
Chapter 1 What Economics Is About 3
Many economists say that if scarcity didn’t exist, neither would economics. In other words, if Economics
our wants weren’t greater than the limited resources available to satisfy them, there would be no The science of scarcity; the
field of study called economics. This is similar to saying that if matter and motion didn’t exist, science of how individuals
neither would physics or that if living things didn’t exist, neither would biology. For this reason, and societies deal with the
fact that wants are greater
we define economics in this text as the science of scarcity. More completely, economics is the science
than the limited resources
of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those
available to satisfy those wants. wants.
THINKING LIKE AN ECONOMIST

Scarcity Affects Everyone Everyone in the world—even a billionaire—has to face
scarcity. Billionaires may be able to satisfy more of their wants for tangible goods (houses,
cars) than most people, but they still may not have the resources to satisfy all their wants.
Their wants might include more time with their children, more friendship, no disease in the
world, peace, and a hundred other things that they don’t have the resources to “produce.”
Thinking in Terms of Scarcity’s Effects Scarcity has effects. Here are three: (1) the need to
make choices, (2) the need for a rationing device, and (3) competition.
Choices People have to make choices because of scarcity. Because our unlimited wants are greater
than our limited resources, some wants must go unsatisfied. We must choose which wants we will
satisfy and which we will not. Jeremy asks, “Do I go to Hawaii or do I pay off my car loan earlier?”
Ellen asks, “Do I buy the new sweater or two new shirts?”
Need for a Rationing Device A rationing device is a means of deciding who gets what of available Rationing Device
resources and goods. Scarcity implies the need for a rationing device. If people have infinite wants A means for deciding who
for goods and if only limited resources are available to produce the goods, then a rationing device gets what of available
is needed to decide who gets the available quantity of goods. Dollar price is a rationing device. For resources and goods.
instance, 100 cars are on the lot, and everyone wants a new car. How do we decide who gets what
quantity of the new cars? The answer is to use the rationing device called dollar price. The people
who pay the dollar price for a new car end up with one.
Scarcity and Competition Do you see competition in the world? Are people competing for jobs?
Are states and cities competing for businesses? Are students competing for grades? The answer
to all these questions is yes. The economist wants to know why this competition exists and what
form it takes. First, the economist concludes, competition exists because of scarcity. If there were
enough resources to satisfy all our seemingly unlimited wants, people would not have to compete
for the available, but limited, resources.
Second, the economist sees that competition takes the form of people trying to get more of
the rationing device. If dollar price is the rationing device, people compete to earn dollars. Look
at your own case. You are a college student working for a degree. One reason (but perhaps not
the only reason) you are attending college is to earn a higher income after graduation. But why
do you want a higher income? You want it because it will allow you to satisfy more of your wants.
Suppose muscular strength (measured by lifting weights), instead of dollar price, were the
rationing device. Then people with more muscular strength would receive more resources and
goods than people with less muscular strength. In that case, people would compete for muscular
strength. (Would they spend more time at the gym lifting weights?) The lesson is simple: Whatever
the rationing device is, people will compete for it.
FINDING ECONOMICS
At the campus bookstore To learn economics well, you must practice what you learn.
One of the ways to practice economics is to find it in everyday life. Consider the following
scene: You are in the campus bookstore buying a book for your computer science course,
and you are handing over $85 to the cashier. Can you find the economics in this simple
scene? Before you read on, think about it for a minute.
Let’s work backward to find the economics. You are currently handing the cashier $85.
We know that dollar price is a rationing device. But let’s now ask ourselves why we would
need a rationing device to get the book. The answer is scarcity. In other words, scarcity is
casting its long shadow there in the bookstore as you buy a book. We have found one of the
key economic concepts—scarcity—in the campus bookstore. (If you also said that a book is a
good, then you have found even more economics in the bookstore. Can you find more than
scarcity and a good?)
SELF-TEST
(Answers to Self-Test questions are in Answers to Self-Test Questions at the back of the book.)
1. True or false? Scarcity is the condition of finite resources. 2. How does competition arise out of scarcity?
Explain your answer. 3. How does choice arise out of scarcity?
1-3 KEY CONCEPTS IN ECONOMICS

A number of key concepts in economics define the field. We discuss a few of these concepts next.
1-3a Opportunity Cost

So far, we have established that people must make choices because scarcity exists. In other words,
because our seemingly unlimited wants push up against limited resources, some wants must go
unsatisfied. We must therefore choose which wants we will satisfy and which we will not. The most
highly valued opportunity or alternative forfeited when we make a choice is known as
Opportunity Cost pportunity cost. Every time you make a choice, you incur an opportunity cost. For example, you
o
The most highly valued have chosen to read this chapter. In making this choice, you denied yourself the benefits of doing
opportunity or alternative something else. You could have watched television, written text messages to a friend, taken a nap,
forfeited when a choice is eaten a few slices of pizza, read a novel, shopped for a new computer, and so on. Whatever you
made.
would have chosen to do is the opportunity cost of your reading this chapter. For instance, if you
would have watched television instead of reading this chapter—if that was your next best
alternative—then the opportunity cost of reading the chapter is watching television.
There Is No Such Thing as a Free Lunch Economists are fond of saying that “there is
no such thing as a free lunch.” This catchy phrase expresses the idea that opportunity costs are
incurred whenever choices are made. Perhaps this is an obvious point, but consider how often
people mistakenly assume that there is a free lunch. For example, some parents think that educa-
tion is free, because they do not pay tuition for their children to attend public elementary school.
That’s a misconception. “Free” implies no sacrifice and no opportunities forfeited, but an elemen-
tary school education requires resources that could be used for other things.
Consider the people who speak about free medical care, free housing, free bridges (“there’s no
charge to cross it”), and free parks. Again, free medical care, free housing, free bridges, and free
parks are misconceptions. The resources that provide medical care, housing, bridges, and parks
could have been used in other ways.
Economics 24/7
Rationing Spots at Yale
Each year, Yale University receives Yale might also decide that it wants
more applications for admission to to admit certain students over others,
the freshmen class than spots are even if the two categories of students
available. In most years, for every have the same academic credentials.
100 applications for admission that For example, suppose Yale wants at
Yale receives, it can accept only least one student from each state in
iStock.com/peterspiro
seven applicants for admission. the country, and only 10 students from
What Yale has to do, then, is ration Wyoming have applied to go to Yale
its available admission spots. whereas 500 students from California
How does it ration its available have applied. Then Yale could very
spots? One way is simply to use well use the rationing device of state
money as a rationing device. In other words, raise the dollar amount diversity to decide in favor of the student from Wyoming instead of
of attending Yale to a high enough level so that the number of the applicant from California.
spots equals the number of students willing and available to pay In the first week of April each year, Yale sends out many more
for admission. To illustrate, think of Yale as auctioning off spots in its rejection letters than acceptance letters. No doubt, some students
freshman class. It calls out a price of $50,000 a year, and at this price who are rejected by Yale feel that some of the students who were
more people wish to be admitted to Yale than there are spots avail- accepted might not be as academically strong as they are. No doubt,
able. Yale keeps on raising the price until the number of students the student with a 4.00 GPA and a perfect SAT score of 2400 feels that
who are willing and able to pay the tuition is equal to the number he might have been slighted by Yale when he learns that a student in
of available spots. Maybe this price is, say, $200,000. his high school with a 3.86 GPA and SAT score of 2180 was chosen over
As we know, Yale does not ration its available spots this way. him. What did the 3.86–2180 student have that he didn’t have? What
In fact, it uses numerous rationing devices in an attempt to whittle rationing device benchmark did the rejected student score lower on?
down the number of applicants to the number of available spots. In life, you will often hear people arguing over what the rationing
For example, it might use the rationing device of high school device for certain things should be. Should high school grades and
grades. Anyone with a GPA in high school of less than, say, 3.50 is standardized test scores be the only two rationing devices for college
not going to be admitted. If, after doing this, Yale still has too admission? What role should money play as a rationing device when
many applicants, it might then make use of the rationing device of a high school graduate applies to college? What role should ethnic
standardized test scores. Anyone with an SAT score of under, say, or racial diversity, or state diversity, or income diversity play in the
2100 is eliminated from the pool of applicants. If there are still too application process? Our point is a simple one: With scarcity comes
many applicants, then perhaps other rationing devices will be used, the need for a rationing device. More people want a spot at Yale
such as academic achievements, community service, degree of than there are spots available. Yale has to use one or more rationing
interest in attending Yale, and so on. devices to decide who will be accepted and who will be rejected.

Zero Price Doesn’t Mean Zero Cost A friend gives you a ticket to an upcoming
concert for zero price (i.e., you pay nothing). Does it follow that zero price means zero cost?
No. There is still an opportunity cost of attending the concert. Whatever you would be doing
if you don’t go to the concert is the opportunity cost of attending. To illustrate, if you don’t
attend the concert, you would hang out with friends. The value you place on hanging out with
friends is the opportunity cost of your attending the concert.
1-3b Opportunity Cost and Behavior

Economists believe that a change in opportunity cost can change a person’s behavior. For exam-
ple, Ryan, who is a sophomore at college, attends classes Monday through Thursday of every
week. Every time he chooses to go to class, he gives up the opportunity to do something else,
such as earn $15 an hour working at a job. The opportunity cost of Ryan’s spending an hour
in class is $15.
Now let’s raise the opportunity cost of attending class. On Tuesday, we offer Ryan $70 to skip
his economics class. He knows that if he attends his economics class, he will forfeit $70. What
will Ryan do? An economist would predict that as the opportunity cost of attending class increases
relative to the benefits of attending, Ryan is less likely to go to class.
This is how economists think about behavior: The higher the opportunity cost of doing something,
the less likely it is that it will be done. This is part of the economic way of thinking.
Look at Exhibit 1, which summarizes some of the things about scarcity, choice, and opportu-
nity cost up to this point.
EXHIBIT 1
Scarcity and Related Concepts
Because of scarcity, a Whatever the rationing device, people will compete

rationing device is needed. for it. Scarcity and competition are linked.
Scarcity
Because of scarcity, people When choices are made, Changes in opportunity cost
must make choices. opportunity costs are incurred. affect behavior.
FINDING ECONOMICS
In Being Late to Class John is often a few minutes late to his biology class. The class starts
at 10 a.m., but John usually walks into the class at 10:03 a.m. The instructor has asked John
to be on time, but John usually excuses his behavior by saying that the traffic getting to college
was bad or that his alarm didn’t go off at the right time or that something else happened to
delay him. One thing the instructor observes, though, is that John is never late when it comes to
test day. He is usually in class a few minutes before the test begins. Where is the economics?
We would expect behavior to change as opportunity cost changes. When a test is being
given in class, the opportunity cost of being late to class is higher than when a test is not being
given and the instructor is simply lecturing. If John is late to class on test day, he then has fewer
minutes to complete the test, and having less time can adversely affect his grade. In short, the
higher the opportunity cost of being late to class, the less likely it is that John will be late.
1-3c Benefits and Costs

If we could eliminate air pollution completely, should we do it? If your answer is yes, then you
are probably focusing on the benefits of eliminating air pollution. For example, one benefit might
be healthier individuals. Certainly, individuals who do not breathe polluted air have fewer lung
disorders than people who do breathe polluted air.
But benefits rarely come without costs. The economist reminds us that, although eliminat-
ing pollution has its benefits, it has costs too. To illustrate, one way to eliminate all car pollution
tomorrow is to pass a law stating that anyone caught driving a car will go to prison for 40 years.
With such a draconian law in place and enforced, very few people would drive cars and all car
pollution would be a thing of the past. Presto! Cleaner air! However, many people would think
that the cost of obtaining that cleaner air is too high. Someone might say, “I want cleaner air, but
not if I have to completely give up driving my car. How will I get to work?”
What distinguishes the economist from the noneconomist is that the economist thinks in terms
of both costs and benefits. Often, the noneconomist thinks in terms of one or the other. Studying
has its benefits, but it has costs too. Coming to class has benefits, but it has costs too. Getting
up early each morning and exercising has its costs, but let’s not forget that there are benefits too.
1-3d Decisions Made at the Margin

It is late at night, and you have already studied three hours for your biology test tomorrow. You look
at the clock and wonder if you should study another hour. How would you summarize your thinking
process? What question or questions do you ask yourself to decide whether to study another hour?
Perhaps without knowing it, you think in terms of the costs and benefits of further study. You
probably realize that studying an additional hour has certain benefits (you may be able to raise your
grade a few points), but it has costs too (you will get less sleep or have less time to watch television
or talk on the phone with a friend). That you think in terms of costs and benefits, however, doesn’t
tell us how you think in terms of costs and benefits. For example, when deciding what to do, do
you look at the total costs and total benefits of the proposed action, or do you look at something
less than the total costs and benefits? According to economists, for most decisions, you think in
Marginal Benefits (MB)
terms of additional, or marginal, costs and benefits, not total costs and benefits. That’s because
Additional benefits; the
most decisions deal with making a small, or additional, change. benefits connected with con-
To illustrate, suppose you just finished eating a hamburger and drinking a soda for lunch. You suming an additional unit of
are still a little hungry and are considering whether to order another hamburger. An economist would a good or undertaking one
say that, in deciding whether to order another hamburger, you compare the additional benefits of more unit of an activity.
the second hamburger with its additional costs. In economics, the word marginal is a synonym for
Marginal Costs (MC )
additional. So, we say that you compare the marginal benefits (MB ) of the (next) hamburger to its Additional costs; the costs
marginal costs (MC ). If the marginal benefits are greater than the marginal costs, you obviously connected with consuming
expect a net benefit to ordering the next hamburger, and therefore you order another. If, however, an additional unit of a good
the marginal benefits are less than the marginal costs, you obviously expect a net cost to ordering or undertaking one more unit
the next hamburger, and therefore you do not order another. Logically, the situation is as follows: of an activity.
Condition Action
MB of next hamburger . MC of next hamburger Buy next hamburger
MB of next hamburger , MC of next hamburger Do not buy next hamburger
What you don’t consider when making this decision are the total benefits and total costs of
hamburgers. That’s because the benefits and costs connected with the first hamburger (the one you
have already eaten) are no longer relevant to the current decision. You are not deciding between eat- Decisions at the Margin
Decision making
ing two hamburgers or eating no hamburgers; your decision is whether to eat a second h amburger
characterized by weighing
after you have already eaten one. the additional (marginal)
According to economists, when individuals make decisions by comparing marginal benefits benefits of a change against
with marginal costs, they are making decisions at the margin. The employee makes a decision at the additional (marginal)
the margin in deciding whether to work two hours overtime; the economics professor makes a costs of a change with
decision at the margin in deciding whether to put an additional question on the final exam. respect to current conditions.
Economics 24/7
When Is It Too Costly to Attend College?
Look around your class. Are there any big-name actors, sports
stars, or comedians between the ages of 18 and 25 in your class?
Probably not. The reason is that, for these people, the opportu-
nity cost of attending college is much higher than it is for most
18-to-25-year-olds. Think of LeBron James, a basketball star,
Chris Rock, a comedian, Johnny Depp, an actor, Will Smith, also
an actor—these people and many more like them chose not to
go to college. Why didn’t they go to college? The fact is that they
didn’t go to college because it was too expensive for them to go
to college. Not “too expensive” in the sense that the “tuition was
too high,” but expensive in terms of what they would have had
to give up if they attended college—expensive in opportunity
cost terms.
To understand this idea, think of what it’s costing you to attend
college. If you pay $3,000 tuition a semester for eight semesters, the
Kent Smith/NBAE/Getty Images
full tuition amounts to $24,000. However, $24,000 is not the full cost
of attending college, because if you were not a student, you could
be earning income working at a job. For example, you could be
working at a full-time job earning $32,000 annually. Certainly, this
$32,000, or at least part of it if you are currently working part time,
is forfeited because you are attending college. It is part of the total
cost of your attending college.
The tuition cost may be the same for everyone who attends Second, we said that economists believe that individuals think
your college, but the opportunity cost is not. Some people have and act in terms of costs and benefits and that they undertake actions
higher opportunity costs of attending college than others. It just only if they expect the benefits to outweigh the costs. Thus, Johnny
so happens that Johnny Depp, LeBron James, Will Smith, and Chris Depp, LeBron James, Will Smith, and Chris Rock saw certain benefits
Rock had extremely high opportunity costs of attending college. to attending college—just as you see certain benefits to attending
Each would have to give up hundreds of thousands of dollars if he college. But those benefits—although they may be the same for
were to attend college on a full-time basis. you and everyone else—are not enough to get everyone to attend
Simply put, our story illustrates two related points we have college. That’s because the benefits are not all that matters. The
made in this chapter. First, earlier we said that the higher the oppor- costs matter, too. In the case of Johnny Depp, LeBron James, Will
tunity cost of doing something, the less likely it will be done. The Smith, and Chris Rock, the costs of attending college were much
opportunity cost of attending college is higher for some people higher than the benefits, so they chose not to attend college.
than others, and that is why not everyone who can pay for college In your case, the benefits are higher than the costs, so you have
chooses to attend college. decided to attend college.
1-3e Efficiency
What is the right amount of time to study for a test? In economics, the right amount of anything
is the optimal or efficient amount—the amount for which the marginal benefits equal the marginal
costs. Stated differently, you have achieved efficiency when the marginal benefits equal the m
arginal Efficiency
costs. Exists when marginal
Suppose you are studying for an economics test, and for the first hour of studying, the marginal benefits equal marginal
benefits (MB) are greater than the marginal costs (MC): costs.
MB studying first hour . MC studying first hour
Given this condition, you will certainly study for the first hour, because it is worth it:
The additional benefits are greater than the additional costs, so there is a net benefit to studying.
Suppose, for the second hour of studying, the marginal benefits are still greater than the
marginal costs:
MB studying second hour . MC studying second hour
Then you will study for the second hour, because the additional benefits are still greater than
the additional costs. In other words, studying the second hour is worthwhile. In fact, you will
continue to study as long as the marginal benefits are greater than the marginal costs. Exhibit 2
illustrates this discussion graphically.
EXHIBIT 2
MB, MC Efficiency
MB 5 marginal benefits and
MB = MC MC 5 marginal costs. In
MC of Studying the exhibit, the MB curve of
studying is downward sloping
A
and the MC curve of studying
MB > MC is upward sloping. As long
MC > MB as MB > MC, the person
will study. The person stops
studying when MB 5 MC.
This point is where efficiency
MB of Studying is achieved.
0 1 2 3 4 5 Time Spent
Studying
Efficient Number (hours)
of Hours to Study
The MB curve of studying is downward sloping because we have assumed that the ben-
efits of studying for the first hour are greater than the benefits of studying for the second
hour and so on. The MC curve of studying is upward sloping because we have assumed that
studying the second hour costs a person more (in terms of goods forfeited) than studying
the first hour, studying the third hour costs more than studying the second, and so on. (If
we assume that the additional costs of studying are constant over time, the MC curve is
horizontal.)
In the exhibit, the marginal benefits of studying equal the marginal costs of studying at
three hours. So, three hours is the efficient length of time to study in this situation. At less
than three hours, the marginal benefits of studying are greater than the marginal costs; thus,
at all these hours, studying has net benefits. At more than three hours, the marginal costs
of studying are greater than the marginal benefits, so studying beyond three hours is not
worthwhile.
Maximizing Net Benefits Take another look at Exhibit 2. Suppose you had stopped
studying after the first hour (or, equivalently, after the 60th minute). Would you have given
up anything? Yes, you would have given up the net benefits of studying longer. To illustrate,
notice that between the first and the second hour, the MB curve lies above the MC curve.
This means that studying the second hour has net benefits. But if you hadn’t studied that
second hour—if you had stopped after the first hour—then you would have given up the
opportunity to collect those net benefits. The same analysis holds for the third hour. We
conclude that, by studying three hours (but not one minute longer), you have maximized
net benefits. In short, efficiency, which is consistent with MB 5 MC, is also consistent with
maximizing net benefits.

No $10 Bills on the Sidewalk An economist says that people try to maximize their
net benefits. You ask for proof. The economist says, “You don’t find any $10 bills on the
sidewalk.” What is the economist getting at by making this statement? Keep in mind that you
don’t find any $10 bills on the sidewalk because, if there were a $10 bill on the sidewalk,
the first person to see it would pick it up; when you came along, it wouldn’t be there. But why
would the first person to find the $10 bill pick it up? The reason is that people don’t pass by
net benefits, and picking up the $10 bill comes with net benefits. The benefits of having an
additional $10 are obvious; the costs of obtaining the additional $10 bill are simply what
you give up during the time you are stooping down to pick it up. In short, the marginal ben-
efits are likely to be greater than the marginal costs (giving us net benefits), and that is why
the $10 bill is picked up. Saying that there are no $10 bills on the sidewalk is the same as
saying that no one leaves net benefits on the sidewalk. In other words, people try to maxi-
mize net benefits.
Does It Matter to You . . .

If You Are Efficient or Not?
The efficient amount of an activity is the amount at which the
marginal benefits (MB) of the activity equal the marginal costs
(MC). With this in mind, look at Exhibit 3. The activity of bowling is
on the horizontal axis, measured in minutes. The marginal benefits
and costs of bowling are on the vertical axis. The efficient amount
Action Plus Sports Images/Alamy Stock Photo

of time spent bowling—the time at which the marginal benefits of
bowling are equal to the marginal costs of bowling—is 60 minutes.
Now let’s ask what is so special about the efficient amount of
owling? Why, in our example, is 60 minutes of bowling preferred to,
b
say, 30 minutes of bowling? To answer the question, consider what
the net benefits of bowling are at 30 minutes and at 60 minutes.
The net benefits of bowling 30 minutes are shown in the diagram
as the shaded red area. To understand why this area represents the
could be better. Notice that there are net benefits gained by b
owling
net benefits of bowling for 30 minutes, consider that from 0 minutes
additional minutes. In fact, there are net benefits gained by bowling
through 30 minutes, the MB curve lies above the MC curve. In other
30 additional minutes (from the 31st through the 60th minute). The
words, from 0 minutes through 30 minutes the marginal benefits of
area of net benefits is shown in the diagram as the shaded blue area.
bowling are greater than the marginal costs, leaving us with net ben-
We have assigned a dollar figure of $6 to these net benefits.
efits. We have assigned a dollar figure of $8 to these net benefits.
Is it better to bowl 30 minutes or 60 minutes? The answer is 60 min-
Now if a person stopped bowling after 30 minutes, he or she would
utes, because having bowled 60 minutes a person receives overall
have received $8 worth of net benefits. That is not bad, but things
net benefits of $8 plus $6 or $14. But bowling only 30 minutes
EXHIBIT 3 leaves a person having gained only $8 worth of net benefits. In
other words, by not bowling after the 30th minute, it is as if a per-
The Efficient Amount of Time to Bowl son is leaving $6 (worth of net benefits) on the table. That’s sort of
like leaving $6 on the street instead of picking it up.
NB = +$8
We started with a question: Does it matter if you are efficient or not?
MB, MC The answer is that it does matter. If you are efficient, you have done
NB = +$6 as well as can be done; you have maximized net benefits.
NC = –$4 Now, if 60 minutes of bowling is better than 30 minutes, then why
isn’t 75 minutes of bowling better than 60 minutes? If you look
MC at the diagram, the answer is obvious. Because bowling for more
than 60 minutes comes with marginal benefits less than marginal
costs. The shaded green area in the exhibit represents the net costs
of bowling from the 60th minute to the 75th minute. We have
MB
assigned a dollar value of $4 to this net cost. What then would your
overall net benefits be if you bowled 75 minutes instead of 60 min-
0 30 60 75 Bowling
(minutes) utes? They would be equal to $8 1 $6 2 $4 or $10. And that, we
notice, is a lower overall net benefit than one receives by bowling
just 60 minutes.
1-3f Economics Is About Incentives

Incentive An incentive is something that encourages or motivates a person to undertake an action.
Something that encourages Often, what motivates a person to undertake an action is the belief that, by taking that action,
or motivates a person to she can make herself better off. For example, if we say that Dawn has an incentive to study for the
undertake an action. upcoming exam, we imply that, by studying, Dawn can make herself better off, probably in terms
of receiving a higher grade on the exam than if she didn’t study.
Incentives are closely related to benefits and costs. Individuals have an incentive to undertake
actions for which the benefits are greater than the costs or, stated differently, for which they expect
to receive net benefits (benefits greater than costs).
Economics 24/7
Can Incentives Make You Smarter?
Most people seem to think themselves smarter when it comes
to some things than other things. For example, a person may say
that she is fairly smart when it comes to learning biology, but not
so smart when it comes to learning mathematics. Another person
might say that he is smart when it comes to fixing cars, but not so
smart when it comes to learning foreign languages.
wavebreakmedia/Shutterstock.com
Now ask yourself if incentives can affect how smart you are
when it comes to any given subject: economics, mathematics,
biology, history, and so on. Consider the experiment described next,
and consider what you think the results of the experiment are likely
to be.
An economics instructor teaches two classes of economics,
A and B. In each class there are 45 students, and in each class the
instructor gives the same eight quizzes. In class A, the instructor
tells each student that, for every quiz on which the student receives or motivated you to study harder (and more), which then had the
a grade of 90 or higher, he or she will receive $100. In class B, the unintended effect of getting you to realize you were smarter than
instructor offers no such incentive. you initially thought.
Now predict whether grades in the two classes will be the Now suppose someone asks how smart you are when it
same or different? If different, in which class, A or B, are students comes to physics or mathematics. If you feel that these subjects
likely to earn higher grades? Finally, ask yourself if you would are beyond you somehow, you might say, “I don’t think I’m
study harder for a quiz given in class A or class B? If your answer to that smart when it comes to physics or mathematics. I don’t
the last question is class A (in which there is a chance of earning really understand a lot that is taught in those subjects.” But
$800 over eight quizzes), then it is very likely that your grades perhaps the correct answer is, “I’m not sure how smart or not
will be higher in class A than in class B. In fact, by studying harder I am when it comes to physics or mathematics. A lot depends
and earning higher grades, you might even end up concluding on the incentives that exist to learn physics and mathematics.
that you are smarter when it comes to economics than you Under certain incentives, I seem to be smarter than under other
thought you were. It’s very likely that the incentive encouraged incentives.”
Economists are interested in what motivates behavior. Why does the person buy more of good
X when its price falls? Why might a person work longer hours when income tax rates decline?
Why might a person buy more of a particular good today if he expects the price of that good to
go up next week? The general answer to many of these questions is that people do what they have
an incentive to do. Economists then hunt for what the incentive is. For example, if a person buys
more of good X when its price goes down, what specifically is the incentive? How, specifically, does
the person make himself better off by buying a good when its price declines. Does he get more
utility or satisfaction? Or how does a person make herself better off if she buys a good today that
she expects will go up in price next week?
1-3g Unintended Effects

Economists think in terms of unintended effects. For instance, Andrés, 16 years old, currently
works after school at a grocery store. He earns $9.50 an hour.
Suppose the state legislature passes a law specifying that the minimum dollar wage a person can
be paid to do a job is $15 an hour. The legislators’ intention in passing the law is to help people
like Andrés earn more income.
Will the $15-an-hour legislation have the intended effect? Perhaps not. The manager of the
grocery store may not find it worthwhile to continue employing Andrés if she has to pay him $15
an hour. In other words, Andrés may have a job at $9.50 an hour but not at $15 an hour. If the
law specifies that no one may earn less than $15 an hour and the manager of the grocery store
decides to fire Andrés rather than pay that amount, then an unintended effect of the legislation
is Andrés losing his job.
As another example, let’s analyze mandatory seat-belt laws to see whether they have any unin-
tended effects. States have laws that require drivers to wear seat belts. The intended effect is
to reduce the number of car-related fatalities by making it more likely that drivers will survive
accidents.
Could these laws have an unintended effect? Some economists think so. They look at accident
fatalities in terms of this equation:
Total number of fatalities 5 Number of accidents 3 Fatalities per accident
For example, if there are 200,000 accidents and 0.10 fatality per accident, the total number
of fatalities is 20,000.
The objective of a mandatory seat-belt program is to reduce the total number of fatalities by
reducing the number of fatalities per accident (the fatality rate). Many studies have found that
wearing seat belts does just that. If you are in an accident, you have a better chance of not being
killed if you are wearing a seat belt.
Let’s assume that, with seat belts, there is 0.08, instead of 0.10, fatality per accident. If there
are still 200,000 accidents, then the total number of fatalities falls from 20,000 to 16,000. Thus,
as the following table shows, the total number of fatalities drops if the number of fatalities per
accident is reduced and the number of accidents is constant:
Number of Fatalities per Total Number

Accidents Accident of Fatalities
200,000 0.10 20,000
200,000 0.08 16,000
However, some economists wonder whether the number of accidents stays constant. Specifi-
cally, they suggest that seat belts may have an unintended effect: The number of accidents may
increase because wearing seat belts may make drivers feel safer. Feeling safer may cause them to
take chances that they wouldn’t ordinarily take, such as driving faster or more aggressively, or con-
centrating less on their driving and more on the music on the radio. For example, if the number
of accidents rises to 250,000, then the total number of fatalities is again 20,000:
Number of Fatalities per Total Number

Accidents Accident of Fatalities
200,000 0.10 20,000
250,000 0.08 20,000
We conclude the following: If a mandatory seat-belt law reduces the number of fatalities per
accident (the intended effect) but increases the number of accidents (an unintended effect), then
the law may not, contrary to popular belief, reduce the total number of fatalities. In fact, some
economics studies show just that.
What does all this mean for you? You may be safer if you know that this unintended effect
exists and you adjust accordingly. To be specific, when you wear your seat belt, your chances
of getting hurt in a car accident are less than if you don’t wear your seat belt. But if this added
sense of protection causes you to drive less carefully than you would otherwise, then you could
unintentionally offset the measure of protection your seat belt provides. To reduce the probability
of hurting yourself and others in a car accident, the best policy is to wear a seat belt and to drive as
carefully as you would if you weren’t wearing a seat belt. Knowing about the unintended effect of
wearing your seat belt could save your life.
1-3h Exchange
Exchange (Trade) Exchange, or trade, is the giving up of one thing for something else. Economics is sometimes
The giving up of one thing called the science of exchange because so much that is discussed in economics has to do with
for something else. exchange.
We start with a basic question: Why do people enter into exchanges? The answer is that they
do so to make themselves better off. When a person voluntarily trades $100 for a jacket, she is
saying, “I prefer to have the jacket instead of the $100.” And, of course, when the seller of the
jacket voluntarily sells the jacket for $100, he is saying, “I prefer to have the $100 instead of the
jacket.” In short, through trade or exchange, each person gives up something he values less for
something he values more.
You can think of trade in terms of utility or satisfaction. Imagine a utility scale that goes
from 1 to 10, with 10 being the highest utility you can achieve. Now, suppose you currently
have $40 in your wallet and you are at 7 on the utility scale. A few minutes later, you are in a
store looking at some new shirts. The price of each is $20, and you end up buying two shirts
for $40.
After you traded your $40 for the shirts, are you still at 7 on the utility scale? The likely
answer is no. If you expected to have the same utility after the trade as you did before, you
probably would not have traded your $40 for the shirts. The only reason you entered into the
trade is that you expected to be better off after the trade than you were before it. In other words,
you thought that trading your $40 for the shirts would move you up the utility scale from 7 to,
say, 8.
Economics 24/7
Why Didn’t I Think of That? The Case of Uber and Airbnb
Consider two companies, both head- exchange or trade is giving up one
quartered in San Francisco. The first is thing for something else. In the case of
Uber and the second is Airbnb. Uber Uber, one person is giving up money
is a company that operates a mobile- for a ride to the airport. The other
app-based transportation network. person is giving up his time and his car
Here are how things work. One person to drive the first person to the airport
svetikd/E+/Getty Images
needs transportation from his home for money. In the case of Airbnb, one
to the airport. Another person, with person is giving up money for a week’s
a car, who is in the vicinity of this first stay in a house. The other person is
person, is willing and able to drive the giving up his occupancy of his house
person to the airport for a fee. Uber for money.
takes a percentage of the dollar transaction between driver and Now what Uber and Airbnb essentially do is bring people
rider. In a way, you could say that Uber is a taxi company, but owns together who want to trade with each other. Uber knows that
no taxis. there are people who want to be transported from one location to
Now consider Airbnb, which is essentially a website. Here are another and other people who want to do the transporting. Uber
how things work at the website. One person wants to rent a room brings these two sets of people together. Airbnb knows that there
in a house, or an entire house, or say a couch in the living room of are people who want to rent a room or a house in, say, Miami Beach
someone’s house for a night, a week, or more. Another person, with for a day or a week and other people who want to rent out their
a room or a house or a couch in the living room, is willing to accom- room or a house in Miami for a day or a week. Airbnb brings these
modate this person. What Airbnb essentially does is put these two two sets of people together.
people in contact with each other and Airbnb charges a fee. In a way, So, how does one come up with the Uber or Airbnb ideas?
you could say that Airbnb is a hotel, but owns no rooms. Basically, both ideas have to do with trying to answer this
Now what many people think when first learning about Uber question: How do I bring together people who want to trade with
and Airbnb is to ask themselves: Why didn’t I think of that? How each other, but who are not currently trading with each other?
ingenious to start your own taxi business but not own any taxis, or That is the question the founders of both Uber and Airbnb asked
to start your own hotel businesses but not own any rooms. and answered, albeit the first with respect to transportation and
Now what must the founders of Uber and Airbnb have been the second with respect to lodging. Are there other instances
thinking that others didn’t? Whether they knew it or not, what they where people who want to trade with each are just waiting to be
were thinking about was exchange or trade. As we stated earlier, brought together?
SELF-TEST
1. Give an example to illustrate how a change in opportunity be consistent with having maximized the net benefits of
cost can affect behavior. studying? Explain your answer.
2. Studying has both costs and benefits. If you continue to 3. You stay up an additional hour to study for a test.
study (e.g., for a test) for as long as the marginal benefits The intended effect is to raise your test grade. What might
of studying are greater than the marginal costs, and you be an unintended effect of staying up another hour to
stop studying when the two are equal, will your action study?
1-4 CETERIS PARIBUS AND THEORY

We cover two important topics in this section: (1) ceteris paribus and (2) theory.
1-4a Ceteris Paribus Thinking

Wilson has eaten regular ice cream for years, and for years his weight has been 190 pounds.
One day, Wilson decides he wants to lose weight. With this objective in mind, he buys a new
fat-free ice cream at the grocery store. The fat-free ice cream has half the calories of regular
ice cream.
Wilson eats the fat-free ice cream for the next few months. He then weighs himself and
finds that he has gained two pounds. Does this mean that fat-free ice cream causes people to
gain weight and regular ice cream does not? The answer is no. Why did Wilson gain weight
when he substituted fat-free ice cream for regular ice cream? Perhaps Wilson ate three times as
much fat-free ice cream as regular ice cream. Or perhaps during the time he was eating fat-free
ice cream, he wasn’t exercising, and during the time he was eating regular ice cream, he was
exercising. In other words, a number of factors—such as eating more ice cream or exercising
less—may have offset the weight loss that Wilson would have experienced had these other
factors not changed.
Now, suppose you want to make the point that Wilson would have lost weight by substituting
fat-free ice cream for regular ice cream had these other factors not changed. What would you say?
A scientist would say, “If Wilson has been eating regular ice cream and his weight has stabilized
at 190 pounds, then substituting fat-free ice cream for regular ice cream will lead to a decline in
weight, ceteris paribus.”
Ceteris Paribus The term ceteris paribus means all other things constant or nothing else changes. In our ice cream
A Latin term meaning all example, if nothing else changes—such as how much ice cream Wilson eats, how much exercise
other things constant or he gets, and so on—then switching to fat-free ice cream will result in weight loss. This expectation
nothing else changes. is based on the theory that a reduction in calorie consumption will result in weight loss and an
increase in calorie consumption will result in weight gain.
Using the ceteris paribus assumption is important because, with it, we can clearly designate
what we believe is the correct relationship between two variables. In the ice cream example, we
can designate the correct relationship between calorie intake and weight gain.
Economists don’t often talk about ice cream, but they will often make use of the ceteris paribus
assumption. An economist might say, “If the price of a good decreases, the quantity of it consumed
increases, ceteris paribus.” For example, if the price of Pepsi-Cola decreases, people will buy more
of it, assuming that nothing else changes.
But some people ask, “Why would economists want to assume that when the price of
Pepsi-Cola falls, nothing else changes? Don’t other things change in the real world? Why make
assumptions that we know are not true?”
Of course, economists do not specify ceteris paribus because they want to say something false
about the world. They specify it because they want to clearly define what they believe to be the
real-world relationship between two variables. Look at it this way: If you drop a ball off the roof
of a house, it will fall to the ground, unless someone catches it. This statement is true, and prob-
ably everyone would willingly accept it as true. But here is another true statement: If you drop a
ball off the roof of a house, it will fall to the ground, ceteris paribus. In fact, the two statements
are identical in meaning. This is because adding the phrase “unless someone catches it” in the first
sentence is the same as saying “ceteris paribus” in the second sentence. If one statement is a cceptable
to us, the other should be too.
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impress on the minds of others, a due and full sense of his own
importance. Even to Mr Kipperson his familiarity was obviously
condescension, though not so felt or regarded by Mr Kipperson
himself. We will leave this gentleman for awhile to go and transact
important business in the city, and we will attend upon Miss
Primrose.
As soon as the poor girl had found her way to the residence of the
Countess of Smatterton, she was received by her ladyship with the
greatest kindness.
“Now, my dear Miss Primrose, this is very good of you to come up
to town so soon. But how did you come—you did not come all the
way by yourself. Surely you did not travel by the stage coach?”
Penelope informed her ladyship concerning her fellow traveller,
and expressed herself perfectly well satisfied with the mode of
travelling which she had adopted.
“Well, that was fortunate; but really, if I had thought of it in time,
you might have come with our family when we travelled up. But I am
very glad you are come. You will be quite indispensable to us to-
morrow evening. I am happy to see you looking so well, and how did
you leave Mrs Greendale? Poor woman! Her loss is very great!”
Fortunately for Penelope, the Countess was not one of those
unreasonable persons who ask questions for the sake of answers,
but one of those, who are not a small number, who ask questions
purely for the sake of asking them, and by way of shewing their own
very great condescension in deigning to ask so particularly
concerning what interests their inferiors. It is however not good
policy that the models of politeness should, in their manifest
heedlessness of answers to their questions, so decidedly testify to
their own insincerity and heartlessness.
Penelope was glad to be liberated from the interview with her
ladyship, and to enjoy for a while the solitude which her apartment
afforded. An apartment had been provided for her reception in the
town residence of the Earl of Smatterton; and though the ascent to it
was rather laborious, yet it had the blessed comfort of affording to
the troubled one an opportunity of sitting alone, and shedding a few
tears, and communing with her own heart. There are some states of
mind in which the sufferer feels most and greatest consolation in
being left to the thoughts of solitude. There was however even in
solitude nothing pleasing for Penelope to meditate upon: but hope is
an artist that draws its finest scenes upon the darkest ground.
Amidst all the losses which she had experienced, and the pains
which she had suffered, and the dreaded anticipations of evils yet to
come, still Penelope could think that her father was yet living, and
might perhaps soon make his appearance in England, and fulfil
those promises of which she had often indirectly heard. It was painful
to her that she could not form any idea of her father. She had always
regarded him as an object of compassion; for her uncle in the
candour of his heart never uttered words of reproach against Mr
Primrose; but, when he spoke of him, called him his poor brother, his
unfortunate kinsman, and he always seemed to regard him as a
victim to others’ vices and not to his own. Penelope could not form
an idea of a being more fatherly than Dr Greendale had always been
to her; and whenever her young ears caught the sound of sympathy
or sorrow for her lot as a poor fatherless child, she denied in her own
heart the applicability of such language to herself. She knew that she
had a father living abroad, but she felt that a father had died at
home. When, however, upon this absent living father Penelope knew
that her only hope and dependence could rest, then did she with
more fixedness of mind direct her thoughts and prayers thitherward.
It was some consolation to her that some little time must elapse
before she could by any possibility make her appearance in public;
this would be some alleviation, and might perhaps produce some
change. The language however which the Countess had used
respecting to-morrow, seemed to indicate that some commencement
of publicity was destined for her even at that early date. And this
thought was a dark spot in the picture of hope. So all the bright
expectations which mortals cherish, have in their foreground
something harshly real and coarsely literal. Many hours however the
poor deserted one did not meditate upon melancholy, or on brighter
scenes. The weariness which had resulted from her long journey,
and the agitation of spirits which she had suffered, were too much for
her strength, and she soon sank to the silence of repose. Happy was
it for her that the outlines of her destiny were but faintly traced; she
scarcely knew for what mode of public display her patroness had
designed her; but she could and did hope for the best. In all her
thoughts the image of Robert Darnley was not in her mind’s eye for
any length of time; it frequently made its appearance, and as
frequently it was dismissed; not in anger—not, or scarcely, in sorrow,
but in resignation and philosophy. She had endeavoured to wean her
mind from the thought of a fickle lover, without having recourse to
hatred, reproach or resentment. She exercised great diligence to
cultivate a degree of indifference, and she so far deceived herself as
to fancy that she had succeeded. Youth never so thoroughly
deceives itself as when it says, “I don’t care.”
CHAPTER XII.
Another day dawned upon the multitudinous interests and
emotions of humanity. To the mind which can spare time from the
intensity of its own feelings, and the selfishness of its own concerns,
to think of others—to think, not merely to talk morality and sentiment
about them, but to realise the emotions and agitations of thoughts
which harass the human breast, there is in the thought of a day
dawning in a great city a deep and serious fulness of interest. The
sun’s first blush upon the mountains and woods and streams and
spangled meadows, is poetical and pretty enough, but the same light
beaming on the condensed and crowded habitations of men, brings
to the mind far other thoughts, and excites widely different emotions.
It awakens misery from its dreams of bliss, and guilt from its dreams
of innocence, poverty from its dreams of wealth, and despair from its
dreams of hope. Anxiety begins anew its busy work in the breast of
the needy parent, and gnawing hunger oft reminds the sufferer of the
opening of another day. Bitter are the feelings which morning
ofttimes brings to the sons and daughters of poverty; but not to them
alone are confined the agonizing throbs of the heart. There is among
the inmates of those proud mansions which seemed built for festivity
alone, and tenanted by luxury and repose, many, many a bitter pang.
There is the thought of keener anguish than any mere physical
privation or suffering can inflict, there are pangs of heart for which
language has no words, and fancy no figures, there are fears and
dreads of which the humbler sufferers of life’s ills have no
conception. Not enviable were the feelings of our heroine on the first
morning in which she woke in the great city.
Then did she feel her truly desolate and destitute condition. She
had been as a beauteous flower hanging on a slender film over the
current of a river, that film had broken, and the flower had dropped
upon the stream at the mercy of its waves. With the opening day
there had been accustomed to enter into her mind thoughts of
devotion and gratitude. These thoughts came, but not as usual. It
seemed to her as though she had not been sufficiently thankful to
her Creator for his blessings, and that they had been withheld. She
would have prayed but she dared not, she would have wept but she
could not. Her bodily fatigue was gone, but the weariness of mind
was felt more strongly. She endeavoured to compose her scattered
thoughts, but that was a task of no small difficulty. One of the
greatest concerns of all, however, was, that by this new arrangement
she was placed out of all communication with her father; for the late
Dr Greendale was the only person in England with whom Mr
Primrose had any correspondence. It was even doubtful whether Mrs
Greendale herself knew his address. These circumstances,
therefore, though they might not break off his communication with
England, would naturally produce a long and serious interruption to
it. For her own part, it was out of her power to convey to her father
any knowledge of her situation, so as to be able by his intervention
to avoid that publicity which she so much dreaded.
Not long had her mind been thus painfully occupied, before she
received a visit in her apartment from her friend Lady Smatterton:
and as she was now totally dependent on her ladyship, she was
desirous of conciliating her regards as much as possible; nor indeed
was that a very difficult task. A little sense of humility and feeling of
obligation and submission to her ladyship’s superior wisdom, would
always ensure the Countess of Smatterton’s good will. When,
therefore, Penelope with great humility, and a look of gratification,
expressed her thanks to her ladyship for her very kind attentions, the
Countess being pleased to see that her condescension had made its
impression, was in very high spirits, and became more gracious and
condescending still.
“My dear Miss Primrose, you look quite charmingly this morning. I
am delighted to find that you have not experienced any
inconvenience from the fatigue of your journey. I think you will be in
most excellent voice this evening. Now, I expect a few select friends
to-night; and some of them are amateurs, and I assure you I have
promised them a treat, in which I know they will not be disappointed.
I have all your favourite songs and duets, so you may make your
selection in the course of the morning; and I have a new harp which I
wish you to try. I think you will like it.”
With a very great effort to suppress a very deep sigh, Penelope
replied: “I shall be most happy to use my best exertions to gratify
your ladyship, but I fear that before so many persons who are total
strangers to me, and without any previous scientific instruction, I may
disappoint the expectations which your ladyship’s kindness has
excited.”
“Oh dear no, my dear, I beg you will not entertain any such notion;
we shall have a very small party indeed, and of the amateurs, I can
assure you that there is not one that is half so well acquainted with
the science of music as you are. It will be time enough for you to
take lessons previously to your performance in public, and that not
because you need musical instruction, but there are certain
peculiarities which it is necessary that public performers should
know.”
Miss Primrose, knowing how much the Countess disliked
objections to any of her own arrangements, submitted as resignedly
as she could; but with a feeling that neither her bodily nor mental
strength were equal to the task which awaited her. The visit of the
Countess concluded with requesting Penelope to take her breakfast
with the family, unless she preferred being quite alone. But Penelope
found little pleasure in solitude, and therefore very readily accepted
the invitation to take breakfast at the family table, where she very
soon after made her appearance.
At this table there sat down the Earl and Countess of Smatterton
and Lord Spoonbill. This was the usual party, and Penelope was
received by them all three with so much kindness, and such genuine
politeness of manner, that she felt herself no stranger. And they all
asked very kindly after Mrs Greendale, and they all hoped that Miss
Primrose had not suffered from the fatigue of the journey; and when
Lord Spoonbill asked how Miss Primrose had travelled, and when he
heard that she had travelled by the stage-coach in company with Mr
Kipperson, he was astonished and grieved; and he thought it a great
pity that arrangements had not been previously made for
accommodating the young lady in one of their carriages. The Earl
also expressed himself much concerned at the same neglect. Alas,
thought Penelope, what a multitude of words on trifles. How she had
travelled was now nothing to her, but it was something to her when
she thought for what purpose that journey had been made.
Lord Spoonbill, after a proper interval, and with a very becoming
seriousness of manner, gently adverted to the death of Dr
Greendale, and perceiving that it was a subject on which Penelope
loved to dwell, notwithstanding the melancholy and painful
associations connected with it, he proceeded to extol the virtues of
her deceased relative, and to express his own great obligations to
the good man for the many valuable pieces of advice he had
received from the late rector of Smatterton; he thought that it was a
great pity that some of the doctor’s sermons should not be given to
the public, for they would undoubtedly be productive of good.
Penelope was very well pleased, and indeed quite interested by the
manner in which Lord Spoonbill condescended to speak of her
departed relative; and she began to think that his lordship was not
quite so great a coxcomb as she had once taken him to be.
Gradually her mind recovered a little of its natural vivacity, and her
looks resumed part of their wonted cheerfulness. She was
comparatively easy and composed. Then did the young nobleman
ingeniously, and without forced transition, turn the conversation to
other topics, and he spoke much of the metropolis and its many
magnificences; but with peculiar delicacy avoided saying anything of
public concerts. Penelope felt grateful for such kind and considerate
attentions, and began to think that in the manners of the higher ranks
there was something peculiarly fascinating which could render such
a man as Lord Spoonbill not only tolerable but really agreeable. The
Earl of Smatterton was also very courteous and kind to his guest,
though he could not well avoid majestic manifestations of his
kindness. He condescended to hope that Miss Primrose would find
herself happy in the metropolis, and dwelt with much complacency
on the opportunity she would enjoy of introduction to society; and he
spake largely of the patronizing propensities of the Countess; he
also mentioned other titled ladies, to whose saloons the young
dependent might be admitted; and concluded a long harangue by
saying, that on proper occasions she would be a welcome guest at
his own house.
Now it happened that on the breakfast table there was lying a
newspaper, which was occasionally taken up and laid down by one
or other of the noble family of Smatterton. Penelope was not a
politician, but seeing the words “Ship News” printed in distinct and
distantly visible characters, she felt some curiosity to read that same
news, for she thought it possible that there might be in that article
something deeply interesting to herself. It appeared however to her
that it would be making herself rather too much at home to take up
the paper; she endeavoured therefore as it lay to catch a glimpse of
the intelligence. Lord Spoonbill observed the direction of her eyes,
and very politely offered her the paper, which she thankfully
accepted. Just as she was in the act of directing her eyes towards
that part of the paper which contained the intelligence most
important to her, something addressed to her by Lord Smatterton
called her away from the page almost in the very moment that the
name of Primrose caught her eye. And as Penelope laid down the
paper on being spoken to by his lordship, Lord Spoonbill took it up
again, and by some means or other it was no longer visible. What
she had seen was enough to excite strong feelings and to raise her
hopes. She had a recollection of the word “arrived,” and the name of
“Primrose” among the list of passengers; at least so it seemed to her
from the hasty glance which she had taken of the paper. This of
course was quite sufficient to fill her mind with the most pleasing
visions for the rest of the day: and hearing that Mr Kipperson might
very probably be one of the party in the evening, and knowing that
this gentleman was deeply versed in matters of business, it occurred
to her that he might bring her some pleasing intelligence from the
city touching the arrival of vessels from the East Indies, and the
names of passengers. It is true, there might be one of the name of
Primrose and still no relation of hers. But she might at least enjoy the
hope as long as possible; and it would cheer her spirit amidst the
darkness of reality.
The evening came, and with it the few select friends of the
Countess of Smatterton, who were to compose her party. There
were not many persons in town at this time; but Penelope had never
before seen anything bearing the slightest resemblance to a
fashionable party, for she had never been at the Easter ball at the
Mansion house, or at Bartholomew fair; to her therefore this very
small select party looked like a very tumultuous and promiscuous
multitude. Every face was strange to her, and as the apartments
were splendidly lighted up, the drawing and music rooms opening
into each other, and displaying by means of mirrors a deceiving
appearance as to their real dimensions. Thus magnified and
multiplied, they looked to her unpractised eye as awfully public as a
great theatre. Part of the company was assembled before Penelope
made her appearance. When therefore she entered the middle
drawing-room, which was the apartment most usually occupied by
the family, she was surprised at the sight of lighted apartments on
both sides of this, and these apartments to her eye filled with elegant
company. She was still more surprised at entering the room to find
that no one took the slightest notice of her in the way of courtesy, but
that three or four young gentlemen who were standing together near
a fire-place absolutely and immovably stared at her: and then, as
soon as she caught sight of the Countess of Smatterton, she
observed that her ladyship was engaged in conversation with a
great, broad, coarse, overdressed female, who was talking very loud
and looking very majestically. This stranger appeared like a very
vulgar woman to our unfashionable heroine, but was in reality no
less a personage than the Duchess of Steeple Bumstead. Her Grace
put her glass to her eye, and contemplated by its means the face
and figure of Penelope. The poor girl felt very uncomfortable and ill
at ease being thus gazed at so unmercifully. As soon as her Grace
had satisfied her curiosity she dropt her glass, and wheeled round
and sailed away in another direction. The Countess of Smatterton
then approached the confused and embarrassed dependent, and
after giving her a good-humoured rebuke for making her appearance
in such very sable attire, told her that the Duchess of Steeple
Bumstead was very desirous of hearing her sing.
Penelope saw by the nearest mirror that the aspect of her attire
was dark indeed, but dark as it was it could not express the
mourning which she felt for her great loss. She was by no means in
a proper frame of mind for the enjoyment of society, or at all fit for
anything that wore the aspect of festivity. She suffered herself to be
led into the music-room by the Countess, and she made a most
respectful curtesy to the Duchess of Steeple Bumstead, when she
had the honor of being introduced to a personage of such elevated
rank. But still Penelope could not help thinking that fashionable
manners were not agreeable: for she recollected that her late uncle
used to define politeness as being that kind of behaviour which was
least calculated to give pain to others; and yet Penelope felt more
pain from the behaviour of the Duchess of Steeple Bumstead, and
that of some of the whiskered boys in Lady Smatterton’s drawing
room, than she would have felt from persons not so high in rank and
so fashionable in manners. All that arose from her ignorance of ways
of the world. Why did she take the opinion of her uncle as oracular in
those matters of which he could not possibly know anything at all? A
country clergyman, who studies books all his life-time, can know
nothing of the world.
The Duchess was pleased to question Penelope on the subject of
music, and was pleased to express her approbation of the good
taste which the young lady displayed. By degrees the manners of
her Grace appeared less repulsive, and Penelope felt herself more
at her ease. There was standing by the pianoforte a young lady of
mild, pleasing, and prepossessing countenance, to whom the
Duchess addressed herself:
“My dear Jemima, you will perhaps have the goodness to
accompany Miss Primrose on the pianoforte to some song, if there
be one there that our friend would like to sing.”
The young lady expressed great readiness to oblige the Duchess
—and the leaves of many books were turned over. It was not difficult
to find a song that Penelope was familiar with, but it was difficult to
find one which did not bring by its language or its expression some
association painful and distressing to her mind. The Duchess was
very patient during the search, and at length a piece was selected.
Miss Primrose had a style of singing peculiarly her own. It was not
marked by any very strong singularity, but its decided character was
expression: and she shone most in those songs which admit of what
may be called the rhetoric of music. There was also a very
considerable degree of emotion in her musical expression, and it
required a skilful hand to accompany her. That requisite she now
had. As her voice was full and deep, it was also searching, and
those who were within its reach felt themselves as it were addressed
by the singer. This style was truly commanding and attractive. The
company gradually surrounded the performer, and well for her she
knew not till the song was finished, that any one was attending to her
besides the Duchess of Steeple Bumstead and the Countess of
Smatterton.
Very abundant and very sincere applause followed the music’s
close. But the music or the applause was too much for our heroine,
and she nearly fainted; kind and prompt assistance soon recovered
her, and thus she was saved from an immediate repetition of that
which her hearers would gladly have heard again. There was much
talk in the room as to, who is she? But few could answer the
question. One impertinent coxcomb said “She looks too modest to
be a woman of great fashion.”
Just at this moment who should enter the room but Peter
Kipperson, Esq.! Peter was in all his glory. He had been occupied
during the whole of the day in business of the utmost importance. He
had been consulted and had given his advice, and his advice had
been taken. He now presented himself to Lady Smatterton’s party, in
which were several members of parliament, and as these were
mostly men of business, Peter was personally known to most of
them, and he received and returned their salutations with great self-
satisfaction. Peter was an active little man, and he was nimbly
moving about the apartments in search of Miss Primrose; but before
he could meet with her he encountered the Earl of Smatterton.
“Mr Kipperson,” said his lordship, “I am most happy to see you.
Have you met your committee to-day in the city? Have you taken any
farther steps in that business, of which you were speaking to me the
other day at Smatterton? Really, Mr Kipperson, something must be
done, it is becoming a very serious affair. Those merchants are very
crafty, selfish people. We must put a stop to their encroachments
before it is too late.”
“My lord,” replied Mr Kipperson, “I am very happy to have it in my
power to assure you that the resolution which I suggested is
adopted. I was forced to use all my powers of persuasion. I said to
them in so many words, ‘Gentlemen,’ says I, ‘Gentlemen, if you do
not adopt this resolution, the nation is ruined, we shall have the
country deluged with corn, and we shall of course be all starved.’”
“That was excellent, Mr Kipperson; you have saved the nation. I
see you have right views of the matter.”
Several members also of the lower house, who were present,
expressed themselves to the same effect; and it was very
satisfactory to Mr Kipperson to think that he had so timely and wisely
interfered with his prodigious wisdom to save the nation from being
starved.
After many interruptions, the wise and learned agriculturist found
his way to Penelope Primrose; and in answer to her interrogations
concerning what she thought she had seen in the papers of the
morning, informed her that two or three of the Company’s ships had
arrived, that in one of them there certainly was a passenger named
Primrose. By Mr Kipperson’s answer to a few more interrogations,
Penelope was nearly certain that this could be no other than her long
lost father. The very possibility of such an event was agitating to her
mind, and the increasing probability of it was too great for her weak
spirits to bear. A thousand thoughts at once confusedly rushed into
her mind. She knew not how to inform her father of her present
situation. She was doubtful whether he was returning home
dependent or independent. She supposed that he would in the first
instance find his way to Smatterton, and then it must be some days
before she could see him. These and many more like considerations
entered into her mind, and their united influence was such as to
harass and perplex her beyond measure. She was most happy when
the evening party of the Countess had dispersed, and when she was
left alone to meditation and to hope. Then she endeavoured to
conjecture on the probability of being rescued from the publicity
which so awfully and imminently threatened her, and with these
thoughts others also entered the mind, and none of them were of a
nature to soothe or compose.
Suffice it to say, that these various agitating feelings, and this new
life into which Penelope was so unexpectedly and so painfully
thrown, conspired together to produce a serious illness.
CHAPTER XIII.
There are few, perhaps, of our female readers who could have
passed through what Penelope was compelled to suffer, without
sinking under the weight of such an accumulation of distressing
circumstances. The wonder is, that she bore up so long, rather than
that she sunk at last.
It is with reluctance that we withdraw the attention of our readers
from the bedside of the dependent sufferer. We can only state that
the Countess was very assiduous in her attentions to her patient,
that the best medical assistance was immediately procured, that
Lord Spoonbill was very regular in his enquiries, and that the Earl of
Smatterton desired that the young woman might not want for
anything that was useful or that might contribute to her comfort and
recovery. He said so every morning.
It is now absolutely necessary that we violate two of the unities,
viz. of time and place. We must violate the unity of time, by doing
what time itself with all its power cannot do; we must go backwards;
and we must also violate the unity of place, by transporting our
readers to the island of St Helena. Their expatriation will be but
short.
About the beginning of November, in the year 18—, two of the
Company’s ships touched at this island in their passage homeward.
The crews and the passengers were not sorry to have such
symptoms of home as this accidental meeting produced. Those of
the passengers who were going to England for the last time, found in
the word “last” a different charm from any which Dr Johnson
attributes to it, in the last paper of the Rambler. It was a cheerful and
animating feeling which pervaded their bosoms, a sentiment joyous
even to tears. The first enquiries of all were for news from England,
and the post-office was an object of general attraction. There were to
be seen there cheerful and disappointed countenances, but every
one was too much occupied with his own thoughts to take any notice
of others.
There came out of the office a middle-aged stout gentleman,
reading with great seriousness and emotion a letter which he held
open in his hands, and there passed him and entered into the office
a younger man, a fine tall handsome man, who would naturally have
excited any one’s attention by the mere force of his appearance; but
the middle-aged gentleman was too deeply engaged to notice him at
the moment. In a few seconds the younger of the two came out of
the office, not reading a letter, but holding one in his hand unopened;
and looking upon that one more sadly than he would have done had
it been accompanied with another. Presently he also opened his
letter and read it, not cheerfully, not sorrowfully, but anxiously and
enquiringly. The letter was finished and returned to his pocket; and
he endeavoured to look more cheerfully, but his efforts failed. He
quickened his pace, and presently he overtook the middle-aged
gentleman; and, as they were passengers in different ships, they
looked at each other rather earnestly, and the elder greeted the
younger. The young man returned the greeting readily, and, as well
as he could, cheerfully. The elder stranger said, that he was going to
see the place where Bonaparte was buried; the younger was going
to the same place, but he called it the tomb of Napoleon. The elder
did not quarrel about the expression, but took the young man’s
offered arm, and they walked very sociably together.
Very few words passed between them on their way to the place of
their destination; and when they arrived there they both seemed to
feel a little disappointment that there was not something more to
gratify their curiosity, or to excite emotion. Place, considered in itself,
has no charm. The imagination must make the mystery all for itself,
and that it may do absent as well as present. Nebuchadnezzar was
not unreasonable when he desired that his wise men should tell him
his dream, as well as the interpretation thereof: for if they really had
wisdom from heaven for one purpose, they would as likely have
wisdom for the other. So it is with place connected with the memory
of the distinguished sons of mortality. The imagination can as well
form the place to the mind’s eye as it can fill the place when seen
with these emotions and feelings, which we expect to be excited by
such views.
The elder stranger turning to the younger, said, “What is your real
opinion of Napoleon Bonaparte?”
“He was certainly a great man,” was the safe and quiet answer.
The elder did not make any immediate reply to this enunciation of
opinion on the part of his young companion. The other therefore
supposed, and very naturally, that the answer which he had given
was not altogether satisfactory. He proceeded, therefore, but still
cautiously:—“He was a man of great ambition; and he was also a
disappointed man.” All this seemed but the echo of everybody’s
opinion, let their view of the man’s character otherwise be what it
may. The elder stranger then spoke again:
“I do not think he was a great man. The word great is an epithet
too comprehensive to be applicable to a disappointed man. To be a
great man, it is necessary that there should be in the mind those
powers and that forethought which will guard against frustration and
disappointment. Greatness is not in place and in name, it is purely in
the mind. I will grant you that Napoleon Bonaparte had great military
powers—great legislative powers—great discernment of human
character; but he was not great over himself: he wanted power to
guide his power. And let a man have all other powers and all other
talent, if he have not the power of power and the talent of talent, he
may be a distinguished, he may be a notorious man, he may
produce grand effects; but he will not be a great man. True
greatness is calm; for it feels and guides its own power.”
The young man listened to this, and to more than this; for the elder
one was more voluble than we have represented him. He perhaps
loved paradox; many persons do; and some love to listen to
paradox, if it be agreeably uttered, and be not too obviously a
determined contradiction of the common feelings and opinions of
mankind. The young man then replied:
“But Napoleon produced great changes in men’s minds, and great
effects on the frame of civil society, and he has left many monuments
of his wisdom.”
“True,” replied the elder one: “Napoleon, as you call him, has done
much in the world, and perhaps more than any other individual in
whose ambitious steps he seems to have trodden. But he was raised
up by a wise Providence to teach humanity that it may grasp at what
is beyond its power. Alexander was a lesson merely to warriors;
Cæsar to men of intrigue and aspiring talent; Bonaparte to men of
consummate talent of almost every description; and if the world be
not pestered with a hero till there shall rise a man of greater talents
than Napoleon Bonaparte, it may rest in peace for many centuries.”
“I never took that view of the subject,” replied the young man.
“There is however something in what you say. Still I cannot but think
that Napoleon was a great man.”
“According to your opinions of greatness, no doubt he was. But I
have told you my ideas of greatness, and according to those he was
not. Greatness requires consistency and uniformity; and it is not in a
man of disappointed ambition that we look for those characters. It
seems to be the ordinance of heaven, that all its blessings should
not centre in one individual among created beings. Where it bestows
wit, it does not always grant wisdom to direct it; where it gives power,
it does not always bestow discretion to use that power, of whatever
quality it may be, according to the best possible principles. True
greatness implies wisdom, and wisdom in man makes the most of
and does the best with its means. Now I have at this moment a letter
in my pocket from England, bringing me an account of a good, and, I
think, great man. But he was nothing more than the humble rector of
a small parish in the country. He was by no means a man of great
genius; nor was he a man of great eloquence; but he was a man of
great moral power. I will venture to affirm that, whatever were the
moral capabilities of the parish over which he presided as pastor, he
would call them forth to the utmost. It is owing to that man that I am
now living, and comparatively happy. It is owing to me,
perhaps,”——
Here the voice of the speaker was interrupted by the swelling of
his bosom, and he passed his hand convulsively on his forehead and
gave way to an agony of tears and sobs, which it would have been
painful to witness in a younger person, but which was quite
distressing to see in one of such appearance and at such an age; for
he seemed full fifty years of age, and had the appearance of a man
of good understanding and gentlemanly manners. The young man
took him by the hand and faintly uttered a few words of consolation,
that he might a little abate a sorrow which he could not wholly stay.
When the violence of the emotion had a little subsided, and the
sufferer had regained the power of speech, he first asked pardon for
his weakness, and apologised for having given way to his feelings.
“For,” continued he, “I have lost a benefactor just at a moment when
I was flattering myself that I should be able to thank him for his
kindness, and to gratify him by letting him know that his kindness
had not been in vain, and that his friendly admonitions had not all
been lost. I will not so far encroach upon your patience as to tell you
my history; but I cannot forbear from indulging in the pleasure which
I mention—the conduct of this most excellent man towards me and
my family.”
“I shall have great pleasure, sir,” replied the young man, “in
listening to any particulars with which you may be pleased to favour
me. The history of the human mind is always interesting and always
instructive.”
With this encouragement the elder stranger proceeded: “This most
excellent man, of whose death I have been speaking, was a
clergyman, whose unfortunate sister I married more than twenty
years ago. I respected and honored him when I first knew him for the
purity and simplicity of his manners. He was of a respectable family,
but not wealthy: his living was nearly his whole maintenance. I could
never induce him to spend a week with us in town. He always
pleaded his parochial duties as demanding his whole attention. It
was in vain for me, or for any one else, to suggest any hint
respecting preferment or bettering his circumstances by the ordinary
means of professional advancement. During the whole of the time I
resided in England after my marriage, I saw nothing of my respected
brother-in-law. We had, it is true, several letters from him, and letters
of a most interesting description. Well would it have been for me,
and well for my dear child, and well for my beloved companion, had I
regarded these letters as something more than models of epistolary
correspondence; had I attended to those kind paternal hints which
they contained. They gave me admonition without assuming airs of
superiority or the affectations of a would-be hermit. He wrote to me
in the world, and as from the world, making allowances for all the
temptations with which I was surrounded, and speaking of them as if
he had not learned their existence or ascertained their nature merely
by the means of books or talk. I was content with admiring the good
man’s virtues. I did not seek to imitate them. I suffered one scoundrel
after another to creep into an intimacy with me, and in a very few
years my patrimony was wasted, and all my inheritance was melted
away at the gaming-table.”
There was again, at these words, a pause of passionate and deep
feeling, but it passed away, and the emotion subsided, and the
narrator went on to say:
“Then, sir, I became a widower. My beloved partner left me an only
child, a daughter, for whom I resolved to live, or, more properly
speaking, for whose sake I endeavoured to preserve and support
life, which without this stimulus would have been a burden too heavy
to be borne. I took my poor little innocent child to this venerable and
amiable clergyman. I found even then nothing like reproach. The
good man pitied me, and he pitied my child. His pity touched me
more sorely and more deeply than any reproaches which human
language could have uttered. I felt my heart melt within me. I dared
not say a word of exculpation. I stood self-condemned. I proposed to
leave my native land, and to seek elsewhere the means of
maintenance for myself and my child. He offered to take my little girl
and be a father to her: and he has been so.
She, poor innocent, hardly knows that she has any other father. I
am to her but as a name; but I do long most ardently once more to
see her. I think years have not so altered her that I shall not
recognize her. I have pleased myself during my long exile of sixteen
years with forming to myself an image of my dear child growing up to
woman’s estate; and the miniature likeness of her dear mother
assists my imagination now in forming an idea of my daughter. She
is now expecting my return; and the last letter which I received of my
most excellent brother-in-law, informed me that the poor girl had
bestowed her affections, and would with my approbation bestow her
hand, on a worthy and respectable man. I left all these matters to my
relative in England. I was sure that he would act towards my child as
a parent, and as a wiser and more truly kind parent than I have
been. I was happy till this hour in the thought that I was hastening
home to England to return my thanks to my benefactor, to see my
dear child, and receive her at his hands—and now alas this happy,
this blessed, prospect is blighted by the melancholy intelligence of
this good man’s death, and would to heaven that this were the worst
—but the most painful intelligence is yet to be added. I am informed
from the best authority that my poor dear child has been simple
enough to be captivated by a young man of high rank, who is too
vain to love any one but himself, and too proud to marry beneath his
own rank. I am, therefore, likely to be greeted with sorrows and
perplexities on my very return to England.”
The elder stranger sighed calmly; and as it were resignedly, when
he had finished speaking. The younger one looked thoughtful and
sighed also. A pause of some minutes’ silence followed, and the
young man said:
“You must hope better things, sir; a long absence from home
should indeed always prepare us for something of change and
calamity; we must look for those fluctuations of humanity: but still we
may be permitted to hope, and to enjoy pleasing thoughts as long as
possible.”
“Yes, sir, your remarks are very true, but they are not so easily
applied. Hope does not come and go at the command of reason, and
the spirits do not rise and fall according to the dictates of the
understanding, or by any force of ratiocination. I ought to apologise
for troubling you, a stranger, with my sorrows; they cannot be
interesting to you; but it is not easy when the heart is full to prevent it
from overflowing.”
“No apology, sir, is necessary: or, if it were, I might adopt the
language of your apology, and use it as a preface to my tale of
sorrow and disappointment awaiting me also at my return to my
native land. I have also cause for grief.”

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Macroeconomics Part 7  arket Failure, Public Choice, and

CHAPTER 1: What Economics is About 1

APPEnDIx B: SHOULD YOU MAJOR IN ECONOMICS? 34

Five Myths About Economics and Being an Economics Major 35

Deducing Where Sherlock The Production Possibilities Frontier 41

24/7 CHAPTER 3: SUPPLY AND DEMAND: THEORY 59

CHAPTER 4: PRICES: FREE, CONTROLLED, AND RELATIVE 95

CHAPTER 5: SUPPLY, DEMAND, AND PRICE: APPLICATIONS 116

Part 2 Macroeconomic Fundamentals

CHAPTER 6: MACROECONOMIC MEASUREMENTS,

The Beatles at Shea Measuring The Price Level 138

CHAPTER 7: MACROECONOMIC MEASUREMENTS,

Part 3 Macroeconomic Stability, Instability, and Fiscal Policy

CHAPTER 8: AGGREGATE DEMAND AND AGGREGATE SUPPLY 181

CHAPTER 10: KEYNESIAN MACROECONOMICS AND ECONOMIC

CHAPTER 11: FISCAL POLICY AND THE FEDERAL BUDGET 274

The Federal Budget 274

Demand-Side Fiscal Policy 283

Part 4 Money, the Economy, and Monetary Policy

CHAPTER 12: MONEY, BANKING, AND THE FINANCIAL SYSTEM 301

CHAPTER 13: THE FEDERAL RESERVE SYSTEM 318

APPEnDIx C: The Market For Reserves (or The Federal

The Demand for Reserves 337

CHAPTER 14: MONEY AND THE ECONOMY 341

Chapter Summary 367

CHAPTER 15: MONETARY POLICY 371

APPEnDIx D: Bond Prices and the Interest Rate 396

Appendix Summary 398

Part 5 Expectations and Growth

CHAPTER 16: EXPECTATIONS THEORY AND THE ECONOMY 399

Does It Matter to You . . . If the Money Supply Rises or Falls? 417

CHAPTER 17: ECONOMIC GROWTH: RESOURCES, TECHNOLOGY,

Thinking in Terms of A Few Basics About Economic Growth 426

Part 6 Government and the Economy

CHAPTER 18: Debates in Macroeconomics Over

If It Sounds Reasonable, Macroeconomics and Government: The Debate 443

Demand-Side and Supply-Side Views of the Economy and Government Tools

HOURS Chapter Summary 456

Part 7 Market Failure, Public Choice, and Special-Interest Group Politics

CHAPTER 19: PUBLIC CHOICE AND SPECIAL-INTEREST

A Simple-Majority Voting Rule: Public Choice Theory 459

Part 8 Economic Theory-Building and Everyday Life

CHAPTER 20: BUILDING THEORIES TO EXPLAIN EVERYDAY LIFE: FROM

Macroeconomics Part 7 arket Failure, Public Choice, and

CHAPTER 6: MACROECONOMIC MEASUREMENTS,

CHAPTER 7: MACROECONOMIC MEASUREMENTS,

CHAPTER 10: KEYNESIAN MACROECONOMICS AND ECONOMIC

CHAPTER 11: FISCAL POLICY AND THE FEDERAL BUDGET 274

CHAPTER 13: THE FEDERAL RESERVE SYSTEM 318

APPEnDIx C: The Market For Reserves (or The Federal

CHAPTER 14: MONEY AND THE ECONOMY 341

APPEnDIx D: Bond Prices and the Interest Rate 396

CHAPTER 17: ECONOMIC GROWTH: RESOURCES, TECHNOLOGY,

CHAPTER 18: Debates in Macroeconomics Over

CHAPTER 19: PUBLIC CHOICE AND SPECIAL-INTEREST

CHAPTER 20: BUILDING THEORIES TO EXPLAIN EVERYDAY LIFE: FROM

CHAPTER 21: INTERNATIONAL TRADE 506

CHAPTER 22: INTERNATIONAL FINANCE 525

CHAPTER 23: The Economic Case for and Against

CHAPTER 24: STOCKS, BONDS, FUTURES, AND OPTIONS 563