McConnell Campbell R., Brue Stanley L., Barbiero Thomas P. Microeconomics. Ninth Edition

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preface xxiii

● Also available from the U.S. supplement list are:

● U.S. Test Bank II Written by William Walstad, this test bank contains

more than 5200 questions. All Test Bank II questions are categorized accord-

ing to level of difﬁculty: easy, moderate, or difﬁcult.

● U.S. Test Bank III Also prepared by William Walstad, this test bank con-

tains “constructive response” testing to evaluate student understanding in

a manner different from conventional multiple-choice and true-false ques-

tions. Suggested answers to the essay and problem questions are included.

● Instructor’s Resource CD-ROM The CD-ROM contains everything the in-

structor needs for a multimedia lecture:

● Electronic Instructor’s Resource Manual Available in this edition is an

MS-WORD version of the Manual. Instructors can print out portions of the

manual’s contents, complete with their own additions and alterations, for

use as student handouts or in whatever ways they wish. This capability

includes printing out answers to the end-of-chapter questions.

● Microsoft® PowerPoint® Slide Presentation

● Computerized Test Bank The Brownstone Diploma Testing System offers

the test items for Microeconomics and Macroeconomics on CD-ROM.

● CBC Video Cases Accompanying the text is a series of video segments pre-

pared by Bruno Fullone and Morris Marshall, George Brown College. Four are

on microeconomics and four are on macroeconomics, drawn from CBC broad-

casts of Undercurrents, The National, Current Affairs, and Venture. These videos

have been chosen to aid students in relating real-world economic issues to the

text, and to illuminate key ideas and concepts presented in the text. A set of

instructor notes accompanies the segments and will be available at the Instruc-

tor Online Learning Centre. The video segments will be available in a VHS

format for use in class and through video-streaming on the Online Learning

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xxiv Preface

● Study Guide (ISBN#0-07-088670-9) Torben Andersen, Chairperson of Human-

ities and Social Sciences at Red Deer College, revised the ninth edition of the

Study Guide, which many students ﬁnd indispensable. Each chapter contains

an introductory statement, a checklist of behavioural objectives, an outline, a

list of important terms, ﬁll-in questions, problems and projects, objective ques-

tions, and discussion questions. The answers to both Macroeconomics’ and

Microeconomics’ end-of-chapter Key Questions appear at the end of the corre-

sponding Study Guide. The Guide comprises a superb “portable tutor” for the

principles student.

● DiscoverEcon (ISBN# 0-07-246135-7) Developed by Jerry Nelson at the Uni-

versity of Illinois-Champagne/Urbana, DiscoverEcon is available in a CD for-

mat or on the Web site for those who purchase a code. This menu-driven

software provides students with a complete tutorial linked to the text. Each

chapter features two essay questions, interactive graphs, a multiple-choice test

bank, and links to the glossary—all tied cohesively to the textbook.

● Online Learning Centre Here students will ﬁnd self-grading Quiz Questions,

Internet Application Questions, Annotated Web links, and student projects or

cases (prepared by Morris Marshall of George Brown College)—all speciﬁc to

Microeconomics. For the math-minded student, there are Internet Math Notes,

which explore more deeply the mathematical detail of the concepts in the text.

For more information on the Online Learning Centre, see page xxvi.)

Supplements for Students

Acknowledgements

The ninth edition has beneﬁted from a number of perceptive reviews, which were a

rich source of suggestions for this revision. Reviewers include

Ather Akbari, St. Mary’s University

Morris Altman, University of Saskatchewan

Sal AmirKhalkhali, St. Mary’s University

Bagala Biswal, Memorial University

Dale Box, University College of Fraser Valley

Beverly Cameron, University of Manitoba

Norm Cameron, University of Manitoba

Shernaz Choksi, Vanier College

Santo Dodaro, St. Francis Xavier University

Bruno Fullone, George Brown College

Carl Graham, Assiniboine Community College

Geraldine Joosse, Lethbridge Community College

Nargess Kayhani, Mount St. Vincent University

Morris Marshall, George Brown College

Charlene Richter, British Columbia Institute of Technology

Richard Schwindt, Simon Fraser University

Judith Skuce, Georgian College

Lee Swanson, Lakeland College

Harold Swierenga, Algonquin College

A special thank you must be given to David Cape, Ryerson University, for his vig-

ilant efforts as the technical reviewer for the text. His keen eye and attention to

detail has contributed greatly to the quality of the ﬁnal product.

We also give special thanks to members of our U.S. team who have revised the

Fifteenth U.S. Edition of Economics.

We are greatly indebted to the many professionals at McGraw-Hill Ryerson—in

particular Lynn Fisher, Senior Sponsoring Editor; Ron Doleman, Economics Editor;

Maria Chu, Developmental Editor; Kelly Dickson, Manager, Editorial Services; and

Kelly Smyth, Marketing Manager —for their publishing and marketing expertise.

We thank Dawn Hunter and Lisa Berland for their thorough and sensitive edit-

ing and Jacques Cournoyer for his vivid Last Word illustrations. Dianna Little

developed the interior design and the colourful cover.

We also strongly acknowledge the McGraw-Hill Ryerson sales staff, which

greeted this edition with wholehearted enthusiasm.

Campbell R. McConnell

Stanley L. Brue

Thomas Barbiero

IN THIS CHAPTER

OU WILL LEARN:

The Ten Key Concepts to

retain for a lifetime.

•

The deﬁnition of economics.

•

About the economic

way of thinking.

•

How economists

construct theories.

•

The distinction between

microeconomics and

macroeconomics.

•

The pitfalls to objective

thinking.

The Nature

and Method

of Economics

ant is a growing giant whom the

coat of Have was never large

enough to cover.

Ralph Waldo Emerson

The Conduct of Life, 1860

People’s wants are many and diverse. Bio-

logically, humans need only air, water, food,

clothing, and shelter. But in contemporary

society we also seek the many goods and

services associated with a comfortable stan-

dard of living. Fortunately, society is blessed

with productive resources—labour and man-

agerial talent, tools and machinery, land and

mineral deposits—that are used to produce

goods and services. This production satisﬁes

many of our wants and takes place through

the organizational mechanism called the eco-

nomic system or, more simply, the economy.

ONE

The blunt reality, however, is that our wants far exceed the productive capacity

of our limited resources. So the complete satisfaction of society’s wants is impos-

sible. This fact provides our deﬁnition of economics: it is the social science con-

cerned with the efﬁcient use of scarce resources to achieve the maximum satisfaction of

economic wants.

Numerous problems and issues arise from the challenge of using limited

resources efﬁciently. Although it is tempting to plunge into them, that sort of analy-

sis must wait. In this chapter, we need to discuss some important preliminaries.

Suppose you unexpectedly meet your introductory economics professor on the

street ﬁve or ten years after you complete this course. What will you be able to tell

her you retained from the course she taught? More than likely you will not be able

to remember very much. To help you retain the main ideas that economics has to

offer for many years after you complete it, we have come up with Ten Key Concepts

we believe are essential to understand the world around you and help you in your

chosen career. These key concepts will be reinforced throughout the textbook. When

a key concept is about to be discussed you will be alerted with an icon and the con-

cept description.

The 10 key concepts will simply be listed here; elaboration on each of the key con-

cepts will be found as we progress through the textbook. At the end of the course

you should review these 10 key concepts. They will help you organize and better

understand the materials you have studied. We have divided the 10 key concepts

into three categories: (a) those pertaining to the individual; (b) concepts that explain

the interaction among individuals; and (c) concepts that deal with the economy as

a whole and the standard of living.

The Individual

CONCEPT 1 (“Facing Tradeoffs”): Scarcity in relation to wants means you face

tradeoffs; therefore you have to make choices.

CONCEPT 2 (“Opportunity Costs”): The cost of the choice you make is what you

give up for it, or the opportunity cost.

CONCEPT 3 (“Choosing a Little More or Less”): Choices are usually made at the

margin; we choose a “little” more or a “little” less of something.

CONCEPT 4 (“The Inﬂuence of Incentives”): The choices you make are inﬂuenced

by incentives.

Interaction Among Individuals

CONCEPT 5 (“Specialization and Trade”): Specialization and trade will improve

the well-being of all participants.

CONCEPT 6 (“The Effectiveness of Markets”): Markets usually do a good job of

coordinating trade among individuals, groups, and nations.

CONCEPT 7 (“The Role of Governments”): Governments can occasionally improve

the coordinating function of markets.

chapter one • the nature and method of economics 3

Ten Key Concepts to Retain for a Lifetime

economics

The social science

concerned with

efﬁcient use of

scarce resources

to achieve the maxi-

mum satisfaction

of economic wants.

Facing

Tradeoffs

Opportunity

Costs

Choosing

a Little More

or Less

The Inﬂuence

of Incentives

Specialization

and Trade

The

Effectiveness

of Markets

The Role of

Governments

The Economy as a Whole and the Standard of Living

CONCEPT 8 (“Production and the Standard of Living”): The standard of living of

the average person in a particular country is dependent on its production of goods

and services. A rise in the standard of living requires a rise in the output of goods

and services.

CONCEPT 9 (“Money and Inﬂation”): If the monetary authorities of a country annu-

ally print money in excess of the growth of output of goods and services it will even-

tually lead to inﬂation.

CONCEPT 10 (“Inﬂation-Unemployment Tradeoff”): In the short run, society faces

a short-run tradeoff between inﬂation and its level of unemployment.

These concepts will be elaborated on throughout this textbook. Be sure to be on

the lookout for the icon that alerts you that one of these concepts is being discussed.

We now turn to our ﬁrst topic, the economic way of thinking.

Close your eyes for a minute and pretend you are in paradise, a place where you can

have anything you want whenever you desire it. On a particular day you may

decide you want a new pair of jeans, a new portable computer, a cellular phone,

tickets to see ‘N Sync, and a new red Ferrari sports car to cruise around in. Your

friends may have a completely different list of wants, but all of their desires will also

be satisﬁed. Indeed, everyone’s desires are satisﬁed. The following day you can start

all over and make any request you have, and they will all be fulﬁlled. And so it will

continue forever. Your body will never get old or sick, you will have all the friends

and love you want, etc., etc.

Of course, paradise may be waiting for us in the afterlife, but in this world our

wants greatly outstrip our ability to satisfy them. Anytime there is a situation in

which wants are greater than the resources to meet those desires, we have an eco-

nomic problem. It is this reality that gives economists their unique perspective. This

economic perspective or economic way of thinking has several critical and closely

interrelated features.

Scarcity and Choice

From our deﬁnition of economics, it is easy to see why economists view the world

through the lens of scarcity. Since human and property resources are scarce (lim-

ited), it follows that the goods and services we produce must also be limited.

Scarcity limits our options and necessitates that we make choices. Because we “can’t

have it all,” we must decide what we will have, and what we must forgo.

Limited resources have given economics its core: the idea that “there is no free

lunch.” You may get treated to lunch, making it “free” to you, but there is a cost to

someone—ultimately to society. Scarce inputs of land, equipment, farm labour, the

labour of cooks and waiters, and managerial talent are required. Because these

resources could be used in other production activities, they and the other goods and

services they could have produced are sacriﬁced in making the lunch available.

Economists call these sacriﬁces opportunity costs. To get more of one thing, you forgo

the opportunity of getting something else. So, the cost of that which you get is the

value of that which is sacriﬁced to obtain it. We will say much more about oppor-

tunity costs in Chapter 2.

4 Part One • An Introduction to Economics and the Economy

The Economic Perspective

economic

perspective

A viewpoint that

envisions individu-

als and institutions

making rational

decisions by com-

paring the marginal

beneﬁts and mar-

ginal costs associ-

ated with their

actions.

Inﬂation-

Unemployment

Tradeoff

Production

and the

Standard of

Living

Money and

Inﬂation

Opportunity

Costs

Rational Behaviour

Economics is grounded on the assumption of “rational self-interest.” Individuals

pursue actions that will allow them to achieve their greatest satisfaction. Rational

behaviour implies that individuals will make different choices under different cir-

cumstances. For example, Jones may decide to buy Coca-Cola in bulk at a ware-

house store rather than at a convenience store where it is much more expensive.

That will leave him with extra money to buy something else that provides satisfac-

tion. Yet, while driving home from work, he may stop at the convenience store to

buy a single can of Coca-Cola.

Rational self-interest also implies that individuals will make different choices. High

school graduate Alvarez may decide to attend college or university to major in busi-

ness. Baker may opt to take a job at a warehouse and buy a new car. Chin may accept

a signing bonus and join the Armed Forces. All three choices reﬂect the pursuit of self-

interest and are rational, but they are based on different preferences and circumstances.

Of course, rational decisions may change as costs and beneﬁts change. Jones may

switch to Pepsi when it is on sale. And, after taking a few business courses, Alvarez

may decide to change her major to social work.

Rational self-interest is not the same as selﬁshness. People make personal sacri-

ﬁces to help family members or friends, and they contribute to charities because

they derive pleasure from doing so. Parents help pay for their children’s education

for the same reason. These self-interested, but unselﬁsh, acts help maximize the

givers’ satisfaction as much as any personal purchase of goods or services. Self-

interest behaviour is simply behaviour that enables a person to achieve personal sat-

isfaction, however that may be derived.

Marginal Analysis: Beneﬁts and Costs

The economic perspective focuses largely on marginal analysis—comparisons of

marginal beneﬁts and marginal costs. (Used this way, “marginal” means “extra,”

“additional,” or “a change in.”) Most choices or decisions involve changes in the sta-

tus quo (the existing state of affairs). Should you attend school for another year or

not? Should you study an extra hour for an exam? Should you add fries to your fast-

food order? Similarly, should a business expand or reduce its output? Should gov-

ernment increase or decrease health care funding?

Each option involves marginal beneﬁts and, because of scarce resources, marginal

costs. In making choices rationally, the decision maker must compare those two

amounts. Example: You and your ﬁancé are shopping for an engagement ring.

Should you buy a

⁄4-carat diamond, a

⁄2-carat diamond, a

⁄4-carat diamond, or a

larger one? The marginal cost of the larger diamond is the added expense beyond

the smaller diamond. The marginal beneﬁt is the greater lifetime pleasure (utility)

from the larger stone. If the marginal beneﬁt of the larger diamond exceeds its mar-

ginal cost, you should buy the larger stone. But if the marginal cost is more than the

marginal beneﬁt, you should buy the smaller diamond instead.

In a world of scarcity, the decision to obtain the marginal beneﬁt associated with

some speciﬁc option always includes the marginal cost of forgoing something else.

The money spent on the larger diamond means forgoing something else. Again,

there is no free lunch!

One surprising implication of decisions based on marginal analysis is that there

can be too much of a good thing. Although certain goods and services seem inher-

ently desirable—education, health care, a pristine environment—we can in fact have

too much of them. “Too much” occurs when we keep obtaining them beyond the

chapter one • the nature and method of economics 5

marginal

analysis

The

comparison or mar-

ginal (“extra” or

“additional”) bene-

ﬁts and marginal

costs, usually for

decision making.

Choosing

a Little More

or Less

point where their marginal cost (the value of the forgone options) equals their mar-

ginal beneﬁt. Then we are sacriﬁcing alternative products that are more valuable at

the margin—the place where we consider the very last units of each. Society can have

too much health care and you can have too many fries. (Key Question 1)

This chapter’s Last Word provides an everyday application of the economic

perspective.

Like the physical and life sciences, as well as other social science, economics relies

on the scientiﬁc method. It consists of a number of elements:

● The observation of facts (real world data);

● Based on those facts, the formulation of possible explanations of cause and

effect (hypotheses).

● The testing of these explanations by comparing the outcomes of speciﬁc events

to the outcomes predicted by the hypotheses.

● The acceptance, rejection, or modiﬁcation of the hypotheses, based on these

comparisons.

● The continued testing of the hypotheses against the facts. As favourable results

accumulate, the hypotheses evolve into a theory, sometimes referred to as a model.

A very well-tested and widely accepted theory is referred to as a law or principle.

Laws, principles, and models enable the economist, like the natural scientist, to

understand and explain economic phenomena and to predict the various outcomes

of particular actions. But as we will soon see, economic laws and principles are usu-

ally less certain than the laws of physics or chemistry.

Deriving Theories

Economists develop models of the behaviour of individuals (consumers, workers)

and institutions (business, government) engaged in the production, exchange, and

consumption of goods and services. They start by gathering facts about economic

activity and economic outcomes. Because the world is cluttered with innumerable

interrelated facts, economists, like all scientists, must select the useful information.

They must determine which facts are relevant to the problem under consideration.

But even when this sorting process is complete, the relevant information may at ﬁrst

seem random and unrelated.

The economist draws on the facts to establish cause–effect hypotheses about eco-

nomic behaviour. Then the hypotheses are tested against real world observation and

6 Part One • An Introduction to Economics and the Economy

● Economics is concerned with obtaining maxi-

mum satisfaction through the efﬁcient use of

scarce resources.

● The economic perspective stresses (a) resource

scarcity and the necessity of making choices, (b)

the assumption of rational behaviour, and (c) com-

parisons of marginal beneﬁt and marginal cost.

Economic Methodology

scientiﬁc

method

The

systematic pursuit

of knowledge

through the formu-

lation of a problem,

collection of data,

and the formulation

and testing of

hypotheses.

data. Through this process, the economist tries to discover hypotheses that rise to

the level of theories and principles (or laws)—well-tested and widely accepted gen-

eralizations about how individuals and institutions behave. The process of deriving

theories and principles is called theoretical economics (see the lower box in Figure

1-1). The role of economic theorizing is to systematically arrange facts, interpret them, and

generalize from them. Theories and principles bring order and meaning to facts by

arranging them in cause-and-effect order.

Observe that the arrow from “theories” to “facts” in Figure 1-1 moves in both

directions. Some understanding of factual, real-world evidence is required to for-

mulate meaningful hypotheses. And hypotheses are tested through gathering and

organizing factual data to see if the hypotheses can be veriﬁed.

Economic theories and principles are statements about economic behaviour that

enable prediction of the probable effects of certain actions. Good theories are those that do

a good job of explaining and predicting. They are supported by facts concerning

how individuals and institutions actually behave in producing, exchanging, and

consuming goods and services. But these facts may change over time, so economists

must continually check theories against the shifting economic environment.

Several other points relating to economic principles are important to know.

chapter one • the nature and method of economics 7

FIGURE 1-1 THE RELATIONSHIP BETWEEN FACTS, THEORIES,

AND POLICIES IN ECONOMICS

Theories

Facts

POLICY ECONOMICS

THEORETICAL ECONOMICS

Theoretical econom-

ics involves estab-

lishing economic

theories by gathering,

systematically

arranging, and gen-

eralizing from facts.

Economic theories

are tested for validity

against facts. Econo-

mists use these

theories—the most

reliable of which are

called laws or princi-

ples—to explain and

analyze the economy.

Policy economics

entails using the eco-

nomic laws and prin-

ciples to formulate

economic policies.

theoretical

economics

The process of

deriving and apply-

ing economic theo-

ries and principles.

principles

Statements about

economic behaviour

that enable predic-

tion of the probable

effects of certain

actions.

TERMINOLOGY

Economists speak of “hypotheses,” “theories,” “models,” “laws,” and “principles.”

Some of these terms overlap but usually reﬂect the degree of conﬁdence in the gen-

eralizations. A hypothesis needs initial testing; a theory has been tested but needs

more testing; a law or principle is a theory that has provided strong predicative

accuracy, over and over. The terminology economic laws and principles are useful,

even though they imply a degree of exactness and universal application that is rare

in any social science. The word theory is often used in economics even though many

people incorrectly believe theories have nothing to do with real-world applications.

In this book, custom and convenience will govern the use of “theory,” “law,”

“principle,” and “model.” Thus, we will use the term law of demand to describe the

relationship between the price of a product and the amount of it purchased, rather

than the theory or principle of demand, simply because this is the custom. We will

refer to the circular ﬂow model, not the circular ﬂow law, because it combines several

ideas into a single representation.

GENERALIZATIONS

As we have already mentioned, economic theories, principles, and laws are gener-

alizations relating to economic behaviour or to the economy itself. They are impre-

cise because economic facts are usually diverse; no two individuals or institutions

act in exactly the same way. Economic principles are expressed as the tendencies of typi-

cal or average consumers, workers, or business ﬁrms. For example, when economists say

that consumer spending rises when personal income increases, they are well aware

that some households may save all of an increase in their incomes. But, on average,

and for the entire economy, spending goes up when income increases. Similarly,

economists claim that consumers buy more of a particular product when its price

falls. Some consumers may increase their purchases by a large amount, others by a

small amount, and a few not at all. This “price–quantity” principle, however, holds

for the typical consumer and for consumers as a group.

“OTHER-THINGS-EQUAL” ASSUMPTION

Like other scientists, economists use the ceteris paribus or other-things-equal

assumption to arrive at their generalizations. They assume that all other variables

except those under immediate consideration are held constant for a particular

analysis. For example, consider the relationship between the price of Pepsi and the

amount of it purchased. It helps to assume that, of all the factors that might inﬂu-

ence the amount of Pepsi purchased (for example, the price of Pepsi, the price of

Coca-Cola, and consumer incomes and preferences), only the price of Pepsi varies.

We can then focus on the “price of Pepsi–purchases of Pepsi” relationship without

being confused by changes in other variables.

Natural scientists such as chemists or physicists can usually conduct controlled

experiments where “all other things” are in fact held constant (or virtually so). They

can test with great precision the assumed relationship between two variables. For

example, they might examine the height from which an object is dropped and the

length of time it takes to hit the ground. But economics is not a laboratory science.

Economists test their theories using real-world data, which are generated by the

actual operation of the economy. In this complex environment, “other things” do

change. Despite the development of sophisticated statistical techniques designed to

hold other things equal, control is less than perfect. As a result, economic theories

are less certain and less precise than those of laboratory sciences. That also means

8 Part One • An Introduction to Economics and the Economy

generaliza-

tion

Statement

of the nature of the

relation between

two or more sets

of facts.

other-

things-

equal

assumption

The assumption

that factors other

than those being

considered are

held constant.