Fluent Essays

Discussion Question 1 – CLO 1    Please read chapters One & Two of your textbook and demonstrate your understanding of The Fundamentals of Managerial Economics by answering the following questions: Jamie is considering leaving her current job, which pays $75,000 per year, to start a new company that develops applications for smartphones. Based on market research, she can sell about 50,000 units during the first year at a price of $4 per unit. With annual overhead costs and operating expenses amounting to $145,000. Jamie expects a profit margin of 20 percent. This margin is 5 percent larger than that of her largest competitor, Apps, Inc.  1. If Jamie decides to embark on her new venture, what will her accounting costs be during the first year of operation?      - Her company’s implicit costs?       - Her company’s opportunity costs?  2. Suppose that Jamie’s estimated selling price is lower than originally projected during the first year. How much revenue would she need in order to earn: 3. Positive accounting profits?  4. Positive economic profits Note:  1. Define the words in your own words. Do not directly quote from the textbook. 2. Need to write at least 2 paragraphs 3. Need to include the information from the textbook as the reference. 4. Need to include at least 2 peer-reviewed articles as the reference. 5. Need to provide examples whenever applicable. 6. Please find the related PowerPoint and textbook in the attachment.  7.  Please answer each of the following questions in detail and provide in-text citations in support of your argument. Include examples whenever applicable.  8. Please find the Course Learning Outcome list of this course in the attachment.  Textbook Information: Baye, M. R., & Prince, J. T. (2017). Managerial economics and business strategy (9th ed.). McGraw-Hill Education ISBN 9781259290619 The Fundamentals of Managerial Economics Chapter 1 © 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objectives Summarize how goals, constraints, incentives, and market rivalry affect economic decisions. Distinguish economic versus accounting profits and costs. Explain the role of profits in a market economy. Apply the five forces framework to analyze the sustainability of an industry’s profits. Apply present value analysis to make decisions and value assets. Apply marginal analysis to determine the optimal level of a managerial control variable. Identify and apply six principles of effective managerial decision making. © 2017 by McGraw-Hill Education. All Rights Reserved. 2 The Manager A person who directs resources to achieve a stated goal. Directs the efforts of others. Purchases inputs used in the production of the firm’s output. Directs the product price or quality decisions. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-3 Introduction 3 Economics The science of making decisions in the presence of scarce resources. Resources are anything used to produce a good or service, or achieve a goal. Decisions are important because scarcity implies trade-offs. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-4 Introduction 4 The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal. Should a firm purchase components – like disk drives and chips – from other manufacturers or produce them within the firm? Should the firm specialize in making one type of computer or produce several different types? How many computers should the firm produce, and at what price should you sell them? © 2017 by McGraw-Hill Education. All Rights Reserved. 1-5 Introduction Managerial Economics Defined 5 Basic principles comprising effective management: Identify goals and constraints Recognize the nature and importance of profits Understand incentives Understand markets Recognize the time value of money Use marginal analysis © 2017 by McGraw-Hill Education. All Rights Reserved. 1-6 Economics of Effective Management The Economics of Effective Management 6 Identify Goals and Constraints Well-defined goals Firm’s overall goal is to maximize profits Constraints make it difficult to achieve goals Available technology Prices of inputs used in production © 2017 by McGraw-Hill Education. All Rights Reserved. 7 The Economics of Effective Management Recognize the Nature and Importance of Profits Accounting profit Total amount of money taken in from sales (total revenue) minus the dollar cost of producing goods or services. Economic profit The difference between total revenue and cost opportunity cost. Opportunity cost The explicit cost of a resource plus the implicit cost of giving up its best alternative. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-8 The Economics of Effective Management 8 The role of profits Profits are a signal to resource holders where resources are most highly valued by society. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-9 The Economics of Effective Management Recognize the Nature and Importance of Profits 9 Five Forces and Industry Profitability © 2017 by McGraw-Hill Education. All Rights Reserved. 10 The Economics of Effective Management Understand Incentives Changes in profits provide an incentive to how resource holders use their resources. Within a firm, incentives impact how resources are used and how hard workers work. One role of a manager is to construct incentives to induce maximal effort from employees. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-11 The Economics of Effective Management 11 Two sides to every market transaction: buyer and seller Bargaining position of consumers and producers is limited by three rivalries in economic transactions: Consumer-producer rivalry Consumer-consumer rivalry Producer-producer rivalry Government and the market © 2017 by McGraw-Hill Education. All Rights Reserved. 1-12 The Economics of Effective Management Understand Markets 12 Recognize the Time Value of Money Often a gap exists between the time when costs are borne and benefits received. Managers can use present value analysis to properly account for the timing of receipts and expenditures. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-13 The Economics of Effective Management 13 Present Value Analysis 1 Present value of a single future value The amount that would have to be invested today at the prevailing interest rate to generate the given future value: Present value reflects the difference between the future value and the opportunity cost of waiting: © 2017 by McGraw-Hill Education. All Rights Reserved. 1-14 The Economics of Effective Management 14 Present Value Analysis II Present value of a stream of future values or, © 2017 by McGraw-Hill Education. All Rights Reserved. 1-15 The Economics of Effective Management 15 Consider a project that returns the following income stream: Year 1, $10,000; Year 2, $50,000; and Year 3, $100,000. At an annual interest rate of 3 percent, what is the present value of this income stream? © 2017 by McGraw-Hill Education. All Rights Reserved. 1-16 The Economics of Effective Management The Time Value of Money in Action 16 Net Present Value The present value of the income stream generated by a project minus the current cost of the project: © 2017 by McGraw-Hill Education. All Rights Reserved. 1-17 The Economics of Effective Management 17 Present value of decisions that indefinitely generate cash flows: Present value of this perpetual income stream when the same cash flow is generated : © 2017 by McGraw-Hill Education. All Rights Reserved. 1-18 Economics of Effective Management Present Value of Indefinitely Lived Assets 18 Profit maximization Maximizing profits means maximizing the value of the firm, which is the present value of current and future profits. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-19 Economics of Effective Management Present Value and Profit Maximization 19 Present Value and Estimating Values of Firms I The value of a firm with current profits , with no dividends paid out and expected, constant profit growth rate of (assuming ) is: © 2017 by McGraw-Hill Education. All Rights Reserved. 1-20 Economics of Effective Management 20 When dividends are immediately paid out of current profits, the present value of the firm is (at ex-dividend date): © 2017 by McGraw-Hill Education. All Rights Reserved. 1-21 Economics of Effective Management Present Value and Estimating Values of Firms II 21 Short-term and long-term profits If the growth rate in profits is less than the interest rate and both are constant, maximizing current (short-term) profits is the same as maximizing long-term profits. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-22 Economics of Effective Management Short-Term versus Long-Term Profits 22 Given a control variable, , of a managerial objective, denote the total benefit as . total cost as . Manager’s objective is to maximize net benefits: © 2017 by McGraw-Hill Education. All Rights Reserved. 1-23 Economics of Effective Management Use Marginal Analysis 23 How can the manager maximize net benefits? Use marginal analysis Marginal benefit: The change in total benefits arising from a change in the managerial control variable, . Marginal cost: The change in the total costs arising from a change in the managerial control variable, . Marginal net benefits: © 2017 by McGraw-Hill Education. All Rights Reserved. 1-24 Economics of Effective Management Use Marginal Analysis 24 Marginal principle To maximize net benefits, the manager should increase the managerial control variable up to the point where marginal benefits equal marginal costs. This level of the managerial control variable corresponds to the level at which marginal net benefits are zero; nothing more can be gained by further changes in that variable. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-25 Economics of Effective Management Use Marginal Analysis 25 Marginal Analysis In Action It is estimated that the benefit and cost structure of a firm is: Find the and functions. What value of makes zero? © 2017 by McGraw-Hill Education. All Rights Reserved. 1-26 Economics of Effective Management 26 © 2017 by McGraw-Hill Education. All Rights Reserved. 1-27 Quantity (Control Variable) Total benefits Total costs 0 Slope = Slope = Maximum total benefits Maximum net benefits Economics of Effective Management Determining the Optimal Level of a Control Variable 27 Determining the Optimal Level of a Control Variable II © 2017 by McGraw-Hill Education. All Rights Reserved. 1-28 Quantity (Control Variable) Net benefits 0 Maximum net benefits Slope = Economics of Effective Management 28 © 2017 by McGraw-Hill Education. All Rights Reserved. 1-29 Quantity (Control Variable) Marginal benefits, costs and net benefits 0 Maximum net benefits Economics of Effective Management Determining the Optimal Level of a Control Variable III 29 Marginal Value Curves Are the Slopes of Total Value Curves When the control variable is infinitely divisible, the slope of a total value curve at a given point is the marginal value at that point. The slope of the total benefit curve at a given Q is the marginal benefit of that level of Q. The slope of the total cost curve at a given Q is the marginal cost of that level of Q. The slope of the net benefit curve at given Q is the marginal net benefit of that level of Q. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-30 Economics of Effective Management 30 Marginal Value Curves Are the Slopes of Total Value Curves A calculus alternative Slope of a continuous function is the derivative /marginal value of that function: © 2017 by McGraw-Hill Education. All Rights Reserved. 1-31 Economics of Effective Management 31 Incremental revenues The additional revenues that stem from a yes-or-no decision. Incremental costs The additional costs that stem from a yes-or-no decision. “Thumbs up” decision . “Thumbs down” decision . © 2017 by McGraw-Hill Education. All Rights Reserved. 1-32 Economics of Effective Management Incremental Decisions 32 Learning Managerial Economics Practice, practice, practice … Learn terminology Break down complex issues into manageable components. Helps economics practitioners communicate efficiently. © 2017 by McGraw-Hill Education. All Rights Reserved. 1-33 Learning Managerial Economics 33 Market Forces: Demand and Supply Chapter 2 © 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Learning Objectives Explain the laws of demand and supply, and identify factors that cause demand and supply to shift. Calculate consumer surplus and producer surplus, and describe what they mean. Explain price determination in a competitive market, and show how equilibrium changes in response to changes in determinates of demand and supply. Explain and illustrate how excise taxes, ad valorem taxes, price floors, and price ceilings impact the functioning of a market. Apply supply and demand analysis as a qualitative forecasting tool to see the “big picture” in competitive markets. © 2017 by McGraw-Hill Education. All Rights Reserved. 2 Market demand curve Illustrates the relationship between the total quantity and price per unit of a good all consumers are willing and able to purchase, holding other variables constant. Law of demand The quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises). Price and quantity demanded are inversely related. 2-3 Copyright © 2014 by the McGraw-Hill Companies, Inc. All rights reserved. Demand Demand © 2017 by McGraw-Hill Education. All Rights Reserved. 3 Market Demand Curve © 2017 by McGraw-Hill Education. All Rights Reserved. 2-4 Quantity (thousands per year) Price ($) Demand $40 0 $30 $20 20 40 $10 60 80 Demand Changing only price leads to changes in quantity demanded. This type of change is graphically represented by a movement along a given demand curve, holding other factors that impact demand constant. Changing factors other than price lead to changes in demand. These types of changes are graphically represented by a shift of the entire demand curve. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-5 Demand Shift in Quantity Demanded versus a Shift in Demand Changes in Demand © 2017 by McGraw-Hill Education. All Rights Reserved. 2-6 Quantity 0 Price D1 Increase in demand Demand A B D0 D2 Decrease in demand Demand Shifters Income Normal good Inferior good Prices of related goods Substitute goods Complement goods Advertising and consumer tastes Informative advertising Persuasive advertising Population Consumer expectations Other factors © 2017 by McGraw-Hill Education. All Rights Reserved. 2-7 Demand Advertising and the Demand for Clothing © 2017 by McGraw-Hill Education. All Rights Reserved. 2-8 Quantity of high-style clothing 0 $50 $40 50,000 Price of high-style clothing D2 60,000 Due to an increase in advertising Demand D1 The Demand Function The demand function for good X is a mathematical representation describing how many units will be purchased at different prices for X, the price of a related good Y, income and other factors that affect the demand for good X. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-9 Demand The Linear Demand Function One simple, but useful, representation of a demand function is the linear demand function: where: is the number of units of good X demanded; is the price of good X; is the price of a related good Y; is income; is the value of any other variable affecting demand. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-10 Demand Understanding the Linear Demand Function The signs and magnitude of the coefficients determine the impact of each variable on the number of units of X demanded. For example: by the law of demand; if good Y is a substitute for good X; if good X is an inferior good. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-11 Demand The Linear Demand Function in Action Suppose that an economic consultant for X Corp. recently provided the firm’s marketing manager with this estimate of the demand function for the firm’s product: Question: How many of good X will consumers purchase when per unit, per unit, and ? Are goods X and Y substitutes or complements? Is good X a normal or an inferior good? Answer: units. Goods X and Y are substitutes. Good X is an inferior good. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-12 Demand Inverse Demand Function By setting and and the demand function is the linear demand function simplifies to Solving this for in terms of results in which is called the inverse demand function. This function is used to construct a market demand curve. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-13 Demand Graphing the Inverse Demand Function in Action © 2017 by McGraw-Hill Education. All Rights Reserved. 2-14 Quantity Price $2,020 0 6,060 Demand Marketing strategies – like value pricing and price discrimination – rely on understanding consumer value for products. Total consumer value is the sum of the maximum amount a consumer is willing to pay at different quantities. Total expenditure is the per-unit market price times the number of units consumed. Consumer surplus is the extra value that consumers derive from a good but do not pay extra for. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-15 Consumer Surplus Demand Quantity in liters Price per liter Demand $5 0 $3 $2 1 2 $1 4 5 Market Demand and Consumer Surplus in Action © 2017 by McGraw-Hill Education. All Rights Reserved. 2-16 Total Consumer Value: 0.5($5 - $3)x2+(3-0)(2-0) = $8 Expenditures: $(3-0) x (2-0) = $6 Consumer Surplus: 0.5($5 - $3)x(2-0) = $2 Demand $4 3 Consumer Surplus 16 Market supply curve A curve indicating the total quantity of a good that all producers in a competitive market would produce at each price, holding input prices, technology, and other variables affecting supply constant. Law of supply As the price of a good rises (falls), the quantity supplied of the good rises (falls), holding other factors affecting supply constant. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-17 Supply Supply Changes in Quantity Supplied versus Changes in Supply Changing only price leads to changes in quantity supplied. This type of change is graphically represented by a movement along a given supply curve, holding other factors that impact supply constant. Changing factors other than price lead to changes in supply. These types of changes are graphically represented by a shift of the entire supply curve. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-18 Supply © 2017 by McGraw-Hill Education. All Rights Reserved. 2-19 Changes in Supply Quantity Price S2 0 Decrease in supply Supply A B S0 S1 Increase in supply Input prices Technology or government regulation Number of firms Entry Exit Substitutes in production Taxes Excise tax: a tax on each unit of output sold, where tax revenue is collected from the supplier Ad valorem tax: percentage tax Producer expectations © 2017 by McGraw-Hill Education. All Rights Reserved. 2-20 Supply Supply Shifters © 2017 by McGraw-Hill Education. All Rights Reserved. 2-21 A Per Unit (Excise) Tax Quantity of gasoline per week Price of gasoline 0 t = per unit tax of 20¢ Supply S0 S0+t t = 20¢ $1.20 $1.00 t Excise tax © 2017 by McGraw-Hill Education. All Rights Reserved. 2-22 An Ad Valorem Tax Quantity of backpacks per week Price of backpacks 0 Supply S0 S1 = 1.20 x S0 $24 $10 Ad valorem tax $12 1,100 $20 2,450 The Supply Function The supply function for good X is a mathematical representation describing how many units will be produced at alternative prices for X, alternative input prices W, and alternative values of other variables that affect the supply for good X. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-23 Supply The Linear Supply Function One simple, but useful, representation of a supply function is the linear supply function: is the number of units of good X produced; is the price of good X; is the price of an input; is price of technologically related goods; is the value of any other variable affecting supply. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-24 Supply The signs and magnitude of the coefficients determine the impact of each variable on the number of units of X produced. For example: by the law of supply. increasing input price. technology lowers the cost of producing good X. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-25 Supply Understanding the Linear Supply Function Your research department estimates that the supply function for televisions sets is given by: Question: How many televisions are produced when , per unit, and ? Answer: television sets. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-26 Supply The Linear Supply Function in Action Inverse Supply Function By setting and in the linear supply function simplifies to Solving this for in terms of results in which is called the inverse supply function. This function is used to construct a market supply curve. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-27 Supply Producer surplus: the amount producers receive in excess of the amount necessary to induce them to produce the good. © 2017 by McGraw-Hill Education. All Rights Reserved. 2-28 Supply Producer Surplus © 2017 by McGraw-Hill Education. All Rights Reserved. 2-29 Producer Surplus in Action Quantity Price Supply $400 0 800 Supply Producer surplus 29 Competitive Market Equilibrium Determined by the intersection of the market demand and market supply curves. A price and quantity such that there is no shortage or surplus in the market. Forces that drive market demand and market supply are balanced, and there is no pressure on prices or quantities to change. The equilibrium price is the price that equates quantity demanded with quantity supplied © 2017 by McGraw-Hill Education. All Rights Reserved. 2-30 Market Equilibrium Market Equilibrium Market Equilibrium © 2017 by McGraw-Hill Education. All Rights Reserved. 2-31 Quantity Price Supply 0 280 Demand Surplus Shortage Market Equilibrium Consider a market with demand and supply functions, respectively, as and A competitive market equilibrium exists at a price, , such that . That is, and 6 units © 2017 by McGraw-Hill Education. All Rights Reserved. 2-32 Market Equilibrium in Action Market Equilibrium Price Restrictions and Market Equilibrium In a competitive market equilibrium, price and quantity freely adjust to the forces of demand and supply. Sometime government restricts how much prices are permitted to rise or fall. Price ceiling Price floor © 2017 by McGraw-Hill Education. All Rights Reserved. 2-33 Price Restrictions and Market Equilibrium A Price Ceiling © 2017 by McGraw-Hill Education. All Rights Reserved. 2-34 Quantity Price Supply 0 280 Demand Shortage Priceceiling Nonpecuniary price Lost social welfare Price Restrictions and Market Equilibrium Price Ceiling in Action Consider a market with demand and supply functions, respectively, as and Suppose a $1.50 price ceiling is imposed on the market. units. units. Since a shortage of units exists. Full economic price of unit is , or . Of this, $1.50 is the dollar price $1 is the nonpecuniary price © 2017 by McGraw-Hill Education. All Rights Reserved. 2-35 Price Restrictions and Market Equilibrium A Price Floor © 2017 by McGraw-Hill Education. All Rights Reserved. 2-36 Quantity Price Supply 0 280 Demand Surplus Pricefloor Price Restrictions and Market Equilibrium Cost of purchasing excess supply Price Floor in Action Consider a market with demand and supply functions, respectively, as and Suppose a $3.50 price floor is imposed on the market. units units Since a surplus of units exists The cost to the government of purchasing the surplus is . © 2017 by McGraw-Hill Education. All Rights Reserved. 2-37 Price Restrictions and Market Equilibrium Comparative static analysis The study of the movement from one equilibrium to another. Competitive markets, operating free of price restraints, will be analyzed when: Demand changes Supply changes Demand and supply simultaneously change © 2017 by McGraw-Hill Education. All Rights Reserved. 2-38 Comparative Statics Comparative Statics Increase in demand only Increase equilibrium price Increase equilibrium quantity Decrease in demand only Decrease equilibrium price Decrease equilibrium quantity Example of change in demand Suppose that consumer incomes are projected to increase 2.5% and the number of individuals over 25 years of age will reach an all time high by the end of next year. What is the impact on the rental car market? © 2017 by McGraw-Hill Education. All Rights Reserved. 2-39 Changes in Demand Comparative Statics © 2017 by McGraw-Hill Education. All Rights Reserved. 2-40 Effect of a Change in Demand for Rental Cars Quantity (thousands rented per day) Price Supply 0 $45 104 Demand1 $49 Demand0 100 Comparative Statics 108 Increase in supply only Decrease equilibrium price Increase equilibrium quantity Decrease in supply only Increase equilibrium price Decrease equilibrium quantity Example of change in supply Suppose that a bill before Congress would require all employers to provide health care to their workers. What is the impact on retail markets? © 2017 by McGraw-Hill Education. All Rights Reserved. 2-41 Changes in Supply Comparative Statics Effect of a Change in Supply © 2017 by McGraw-Hill Education. All Rights Reserved. 2-42 Quantity Price Supply0 0 Demand Supply1 Comparative Statics Simultaneous Shifts in Supply and Demand Suppose that simultaneously the following events occur: An earthquake hit Kobe, Japan and decreased the supply of fermented rice used to make sake wine. The stress caused by the earthquake led many to increase their demand for sake, and other alcoholic beverages. What is the combined impact on Japan’s sake market? © 2017 by McGraw-Hill Education. All Rights Reserved. 2-43 Comparative Statics Simultaneous Shifts in Supply and Demand in Action © 2017 by McGraw-Hill Education. All Rights Reserved. 2-44 Quantity Price Supply0 0 Demand1 Supply1 Demand0 Comparative Statics Japan’s Sake Market Supply2 A B C Issues in Economics Today Eighth Edition The McGraw-Hill Economics Series ESSENTIALS OF ECONOMICS Brue, McConnell, and Flynn Essentials of Economics Third Edition Mandel M: Economics, The Basics Third Edition Schiller and Gebhardt Essentials of Economics Tenth Edition PRINCIPLES OF ECONOMICS Asarta and Butters Connect Master: Economics First Edition Colander Economics, Microeconomics, and Macroeconomics Tenth Edition Frank, Bernanke, Antonovics, and Heffetz Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Sixth Edition Frank, Bernanke, Antonovics, and Heffetz Streamlined Editions: Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Third Edition Karlan and Morduch Economics, Microeconomics, Macroeconomics Second Edition McConnell, Brue, and Flynn Economics, Microeconomics, Macroeconomics Twenty-First Edition Samuelson and Nordhaus Economics, Microeconomics, and Macroeconomics Nineteenth Edition Schiller and Gebhardt The Economy Today, The Micro Economy Today, and The Macro Economy Today Fourteenth Edition Slavin Economics, Microeconomics, and Macroeconomics Eleventh Edition ECONOMICS OF SOCIAL ISSUES Guell Issues in Economics Today Eighth Edition Register and Grimes Economics of Social Issues Twenty-First Edition ECONOMETRICS Gujarati and Porter Basic Econometrics Fifth Edition Hilmer and Hilmer Practical Econometrics First Edition MANAGERIAL ECONOMICS Baye and Prince Managerial Economics and Business Strategy Ninth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Sixth Edition Thomas and Maurice Managerial Economics Twelfth Edition INTERMEDIATE ECONOMICS Bernheim and Whinston Microeconomics Second Edition Dornbusch, Fischer, and Startz Macroeconomics Twelfth Edition Frank Microeconomics and Behavior Ninth Edition ADVANCED ECONOMICS Romer Advanced Macroeconomics Fourth Edition MONEY AND BANKING Cecchetti and Schoenholtz Money, Banking, and Financial Markets Fifth Edition URBAN ECONOMICS O’Sullivan Urban Economics Eighth Edition LABOR ECONOMICS Borjas Labor Economics Seventh Edition McConnell, Brue, and Macpherson Contemporary Labor Economics Eleventh Edition PUBLIC FINANCE Rosen and Gayer Public Finance Tenth Edition ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Seventh Edition INTERNATIONAL ECONOMICS Appleyard and Field International Economics Ninth Edition Pugel International Economics Sixteenth Edition Issues in Economics Today Eighth Edition ROBERT C. GUELL Indiana State University ISSUES IN ECONOMICS TODAY, EIGHTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2018 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2015, 2012, and 2010. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. ISBN 978-1-259-74639-0 MHID 1-259-74639-9 Chief Product Officer, SVP Products & Markets: G. Scott Virkler Vice President, General Manager, Products & Markets: Michael Ryan Vice President, Content Production & Technology Services: Betsy Whalen Managing Director: Susan Gouijnstook Executive Brand Manager: Katie Hoenicke Product Developer: Jamie Koch Editorial Coordinator: Christian Lyon Marketing Manager: Virgil Lloyd Marketing Coordinator: Brittany Bernholdt Director of Digital Content Development: Douglas Ruby Director, Content Design & Delivery: Linda Avenarius Program Manager: Mark Christianson Content Project Managers: Melissa M. Leick & Karen Jozefowicz Buyer: Catt Mattura, Jolyn Thomas, Abby Davis Design: Studio Montage, Inc. Content Licensing Specialists: Beth Thole Cover Image: Cala Image/Glow Images Compositor: MPS Limited All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Guell, Robert C., author. Issues in economics today/Robert C. Guell, Indiana State University. Eighth edition. | New York, NY : McGraw-Hill Education, [2018] LCCN 2017003633 | ISBN 9781259746390 (alk. paper) LCSH: Economics. LCC HB87 .G83 2018 | DDC 330—dc23 LC record available at https://lccn.loc.gov/2017003633 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites. mheducation.com/highered To Susan, Katie, Manny, Angel, Matt, and Lilly vi About the Author Dr. Robert C. Guell (pronounced “Gill”) is a professor of economics at Indiana State University in Terre Haute, Indiana. He earned a B.A. in statistics and economics in 1986 and an M.S. in economics one year later from the University of Missouri–Columbia. In 1991, he earned a Ph.D. from Syracuse University, where he discovered the thrill of teaching. He has taught courses for freshmen, upper-division undergraduates, and graduate students from the principles level, through public finance, all the way to mathematical economics and econometrics. Dr. Guell has published numerous peer-reviewed articles in scholarly journals. He has worked extensively in the area of pharmaceutical economics, suggesting that the private market’s patent system, while necessary for drug innovation, is unnecessary and inefficient for production. In 1998, Dr. Guell was the youngest faculty member ever to have been given Indiana State University’s Caleb Mills Distinguished Teaching Award. His talent as a champion of quality teaching was recognized again in 2000 when he was named project manager for the Lilly Project to Transform the First-Year Experience, a Lilly Endowment–funded project to raise first-year persistence rates at Indiana State University. He was ISU’s Coordinator of First-Year Programs until January 2008, when he happily stepped aside to rejoin his depart- ment full time. Dr. Guell’s passion for teaching economics led him to request an assignment with the larg- est impact. The one-semester general education basic economics course became the vehicle to express that passion. Unsatisfied with the books available for the course, he made it his calling to produce what you have before you today—an all-in-one readable issues-based text. vii Brief Contents Preface xviii Issues for Different Course Themes xxviii Required Theory Table xxx 1 Economics: The Study of Opportunity Cost 1 2 Supply and Demand 19 3 The Concept of Elasticity and Consumer and Producer Surplus 40 4 Firm Production, Cost, and Revenue 56 5 Perfect Competition, Monopoly, and Economic versus Normal Profit 68 6 Every Macroeconomic Word You Ever Heard: Gross Domestic Product, Inflation, Unemployment, Recession, and Depression 79 7 Interest Rates and Present Value 98 8 Aggregate Demand and Aggregate Supply 107 9 Fiscal Policy 119 10 Monetary Policy 131 11 Federal Spending 145 12 Federal Deficits, Surpluses, and the National Debt 155 13 The Housing Bubble 168 14 The Recession of 2007–2009: Causes and Policy Responses 177 15 Is Economic Stagnation the New Normal? 186 16 Is the (Fiscal) Sky Falling?: An Examination of Unfunded Social Security, Medicare, and State and Local Pension Liabilities 193 17 International Trade: Does It Jeopardize American Jobs? 201 18 International Finance and Exchange Rates 213 19 European Debt Crisis 222 20 Economic Growth and Development 231 21 NAFTA, CAFTA, GATT, TPP, WTO: Are Trade Agreements Good for Us? 238 22 The Line between Legal and Illegal Goods 248 23 Natural Resources, the Environment, and Climate Change 258 24 Health Care 271 25 Government-Provided Health Insurance: Medicaid, Medicare, and the Children’s Health Insurance Program 283 26 The Economics of Prescription Drugs 296 27 So You Want to Be a Lawyer: Economics and the Law 304 28 The Economics of Crime 310 29 Antitrust 319 30 The Economics of Race and Sex Discrimination 327 31 Income and Wealth Inequality: What’s Fair? 339 32 Farm Policy 349 33 Minimum Wage 358 34 Ticket Brokers and Ticket Scalping 366 35 Rent Control 373 36 The Economics of K–12 Education 379 37 College and University Education: Why Is It So Expensive? 390 viii Brief Contents 38 Poverty and Welfare 400 39 Head Start 411 40 Social Security 418 41 Personal Income Taxes 429 42 Energy Prices 440 43 If We Build It, Will They Come? And Other Sports Questions 455 44 The Stock Market and Crashes 467 45 Unions 478 46 Walmart: Always Low Prices (and Low Wages)—Always 488 47 The Economic Impact of Casino and Sports Gambling 494 48 The Economics of Terrorism 499 Index 505 ix Table of Contents Preface xviii Issues for Different Course Themes xxviii Required Theory Table xxx Chapter 1 Economics: The Study of Opportunity Cost 1 Economics and Opportunity Cost 1 Economics Defined 1 Choices Have Consequences 2 Modeling Opportunity Cost Using the Production Possibilities Frontier 2 The Intuition behind Our First Graph 2 The Starting Point for a Production Possibilities Frontier 3 Points between the Extremes of a Production Possibilities Frontier 3 Attributes of the Production Possibilities Frontier 5 Increasing and Constant Opportunity Cost 5 Economic Growth 6 How Is Growth Modeled? 6 Sources of Economic Growth 7 The Big Picture 7 Circular Flow Model: A Model That Shows the Interactions of All Economic Actors 8 Thinking Economically 8 Marginal Analysis 8 Positive and Normative Analysis 8 Economic Incentives 9 Fallacy of Composition 9 Correlation ≠ Causation 10 Kick It Up a Notch: Demonstrating Constant and Increasing Opportunity Cost on a Production Possibilities Frontier 10 Demonstrating Increasing Opportunity Cost 11 Demonstrating Constant Opportunity Cost 11 Summary 11 Appendix 1A Graphing: Yes, You Can. 15 Cartesian Coordinates 15 Please! Not Y = MX + B . . . Sorry. 16 What on God’s Green Earth Does This Have to Do with Economics? 18 Chapter 2 Supply and Demand 19 Supply and Demand Defined 20 Markets 20 Quantity Demanded and Quantity Supplied 20 Ceteris Paribus 22 Demand and Supply 22 The Supply and Demand Model 22 Demand 22 Supply 23 Equilibrium 24 Shortages and Surpluses 25 All about Demand 25 The Law of Demand 25 Why Does the Law of Demand Make Sense? 25 All about Supply 26 The Law of Supply 26 Why Does the Law of Supply Make Sense? 26 Determinants of Demand 27 Taste 28 Income 28 Price of Other Goods 28 Population of Potential Buyers 29 Expected Price 29 Excise Taxes 29 Subsidies 29 The Effect of Changes in the Determinants of Demand on the Supply and Demand Model 29 Determinants of Supply 31 Price of Inputs 31 Technology 32 Price of Other Potential Outputs 32 Number of Sellers 32 Expected Price 32 Excise Taxes 33 Subsidies 33 The Effect of Changes in the Determinants of Supply on the Supply and Demand Model 33 The Effect of Changes in Price Expectations on the Supply and Demand Model 35 x Table of Contents Kick It Up a Notch: Why the New Equilibrium? 35 Summary 37 Chapter 3 The Concept of Elasticity and Consumer and Producer Surplus 40 Elasticity of Demand 41 Intuition 41 Definition of Elasticity and Its Formula 41 Elasticity Labels 42 Alternative Ways to Understand Elasticity 42 The Graphical Explanation 42 The Verbal Explanation 43 Seeing Elasticity through Total Expenditures 44 More on Elasticity 44 Determinants of Elasticity of Demand 44 Elasticity and the Demand Curve 44 Elasticity of Supply 46 Determinants of the Elasticity of Supply 47 Consumer and Producer Surplus 49 Consumer Surplus 49 Producer Surplus 49 Market Failure 50 Categorizing Goods 50 Kick It Up a Notch: Deadweight Loss 51 Summary 52 Chapter 4 Firm Production, Cost, and Revenue 56 Production 57 Just Words 57 Graphical Explanation 58 Numerical Example 58 Costs 59 Just Words 59 Numerical Example 60 Revenue 62 Just Words 62 Numerical Example 63 Maximizing Profit 64 Graphical Explanation 64 Numerical Example 64 Summary 65 Chapter 5 Perfect Competition, Monopoly, and Economic versus Normal Profit 68 From Perfect Competition to Monopoly 69 Perfect Competition 69 Monopoly 70 Monopolistic Competition 70 Oligopoly 71 Which Model Fits Reality 71 Supply under Perfect Competition 73 Normal versus Economic Profit 73 When and Why Economic Profits Go to Zero 73 Why Supply Is Marginal Cost under Perfect Competition 74 Just Words 74 Numerical Example 74 Graphical Explanation 75 Summary 76 Chapter 6 Every Macroeconomic Word You Ever Heard: Gross Domestic Product, Inflation, Unemployment, Recession, and Depression 79 Measuring the Economy 80 Measuring Nominal Output 80 Measuring Prices and Inflation 81 Problems Measuring Inflation 83 Real Gross Domestic Product and Why It Is Not Synonymous with Social Welfare 86 Real Gross Domestic Product 86 Problems with Real GDP 86 Measuring and Describing Unemployment 87 Measuring Unemployment 87 Problems Measuring Unemployment 89 Types of Unemployment 90 Productivity 90 Measuring and Describing Productivity 90 Seasonal Adjustment 91 Business Cycles 92 Kick It Up a Notch: National Income and Product Accounting 94 Summary 95 Chapter 7 Interest Rates and Present Value 98 Interest Rates 99 The Market for Money 99 Nominal Interest Rates versus Real Interest Rates 99 Present Value 100 Simple Calculations 100 Mortgages, Car Payments, and Other Multipayment Examples 101 Table of Contents xi Future Value 102 Kick It Up a Notch: Risk and Reward 104 Summary 104 Chapter 8 Aggregate Demand and Aggregate Supply 107 Aggregate Demand 108 Definition 108 Why Aggregate Demand Is Downward Sloping 108 Aggregate Supply 109 Definition 109 Competing Views of the Shape of Aggregate Supply 109 Shifts in Aggregate Demand and Aggregate Supply 110 Variables That Shift Aggregate Demand 110 Variables That Shift Aggregate Supply 113 Causes of Inflation 114 How the Government Can Influence (but Probably Not Control) the Economy 115 Demand-Side Macroeconomics 115 Supply-Side Macroeconomics 115 Summary 116 Chapter 9 Fiscal Policy 119 Nondiscretionary and Discretionary Fiscal Policy 119 How They Work 119 Using Aggregate Supply and Aggregate Demand to Model Fiscal Policy 120 Using Fiscal Policy to Counteract “Shocks” 121 Aggregate Demand Shocks 121 Aggregate Supply Shocks 122 Evaluating Fiscal Policy 123 Nondiscretionary Fiscal Policy 123 Discretionary Fiscal Policy 123 The Political Problems with Fiscal Policy 124 Criticism from the Right and Left 125 The Rise, Fall, and Rebirth of Discretionary Fiscal Policy 125 The Obama Stimulus Plan 126 Kick It Up a Notch: Aggregate Supply Shocks 128 Summary 128 Chapter 10 Monetary Policy 131 Goals, Tools, and a Model of Monetary Policy 132 Goals of Monetary Policy 132 Traditional and Ordinary Tools of Monetary Policy 132 Modeling Monetary Policy 133 The Monetary Transmission Mechanism 134 The Additional Tools of Monetary Policy Created in 2008 135 Central Bank Independence 137 Modern Monetary Policy 138 The Last 30 Years 138 Summary 143 Chapter 11 Federal Spending 145 A Primer on the Constitution and Spending Money 146 What the Constitution Says 146 Shenanigans 146 Dealing with Disagreements 147 Using Our Understanding of Opportunity Cost 148 Mandatory versus Discretionary Spending 148 Where the Money Goes 149 Using Our Understanding of Marginal Analysis 151 The Size of the Federal Government 151 The Distribution of Federal Spending 151 Budgeting for the Future 151 Baseline versus Current-Services Budgeting 151 Summary 152 Chapter 12 Federal Deficits, Surpluses, and the National Debt 155 Surpluses, Deficits, and the Debt: Definitions and History 156 Definitions 156 History 156 How Economists See the Deficit and the Debt 159 Operating and Capital Budgets 159 Cyclical and Structural Deficits 159 The Debt as a Percentage of GDP 160 International Comparisons 160 Generational Accounting 161 Who Owns the Debt? 161 Externally Held Debt 162 A Balanced-Budget Amendment 162 Projections 165 Summary 166 xii Table of Contents Chapter 13 The Housing Bubble 168 How Much Is a House Really Worth? 168 Mortgages 170 How to Make a Bubble 172 Pop Goes the Bubble! 173 The Effect on the Overall Economy 174 Summary 175 Chapter 14 The Recession of 2007–2009: Causes and Policy Responses 177 Before It Began 177 Late 2007: The Recession Begins as Do the Initial Policy Reactions 180 The Bottom Falls Out in Fall 2008 181 The Obama Stimulus Package 182 Extraordinary Monetary Stimulus 183 Summary 184 Chapter 15 Is Economic Stagnation the New Normal? 186 Periods of Robust Economic Growth 187 Sources of Growth 187 Causes and Consequences of Slowing Growth 187 Causes 187 Consequences 188 What Can Be Done to Jump-Start Growth, or Is This the New Normal? 189 Summary 191 Chapter 16 Is the (Fiscal) Sky Falling?: An Examination of Unfunded Social Security, Medicare, and State and Local Pension Liabilities 193 What Is the Source of the Problem? 193 How Big Is the Social Security and Medicare Problem? 194 How Big Is the State and Local Pension Problem? 196 Is It Possible That the Fiscal Sky Isn’t About to Fall? 198 Summary 199 Chapter 17 International Trade: Does It Jeopardize American Jobs? 201 What We Trade and with Whom 201 The Benefits of International Trade 204 Comparative and Absolute Advantage 204 Demonstrating the Gains from Trade 205 Production Possibilities Frontier Analysis 205 Supply and Demand Analysis 206 Whom Does Trade Harm? 206 Trade Barriers 207 Reasons for Limiting Trade 207 Methods of Limiting Trade 208 Trade as a Diplomatic Weapon 209 Kick It Up a Notch: Costs of Protectionism 210 Summary 210 Chapter 18 International Finance and Exchange Rates 213 International Financial Transactions 213 Foreign Exchange Markets 215 Alternative Foreign Exchange Systems 217 Determinants of Exchange Rates 219 Summary 220 Chapter 19 European Debt Crisis 222 In the Beginning There Were 17 Currencies in 17 Countries 222 The Effect of the Euro 223 Why Couldn’t They Pull Themselves Out? The United States Did 226 Is It Too Late to Leave the Euro? 228 Where Should Europe Go from Here? 229 Summary 229 Chapter 20 Economic Growth and Development 231 Growth in Already Developed Countries 231 Comparing Developed Countries and Developing Countries 233 Fostering (and Inhibiting) Development 234 The Challenges Facing Developing Countries 235 What Works 236 Summary 236 Table of Contents xiii Chapter 21 NAFTA, CAFTA, GATT, TPP, WTO: Are Trade Agreements Good for Us? 238 The Benefits of Free Trade 239 Why Do We Need Trade Agreements? 239 Strategic Trade 240 Special Interests 240 What Trade Agreements Prevent 240 Trade Agreements and Institutions 241 Alphabet Soup 241 Are They Working? 242 Economic and Political Impacts of Trade 243 The Bottom Line 245 Summary 245 Chapter 22 The Line between Legal and Illegal Goods 248 An Economic Model of Tobacco, Alcohol, and Illegal Goods and Services 249 Why Is Regulation Warranted? 249 The Information Problem 249 External Costs 250 Morality Issues 252 Taxes on Tobacco and Alcohol 253 Modeling Taxes 253 The Tobacco Settlement and Why Elasticity Matters 254 Why Are Certain Goods and Services Illegal? 254 The Impact of Decriminalization on the Market for the Goods 254 The External Costs of Decriminalization 255 Summary 255 Chapter 23 Natural Resources, the Environment, and Climate Change 258 Using Natural Resources 259 How Clean Is Clean Enough? 259 The Externalities Approach 260 When the Market Works for Everyone 260 When the Market Does Not Work for Everyone 260 The Property Rights Approach to the Environment and Natural Resources 262 Why You Do Not Mess Up Your Own Property 262 Why You Do Mess Up Common Property 262 Natural Resources and the Importance of Property Rights 262 Environmental Problems and Their Economic Solutions 263 Environmental Problems 263 Economic Solutions: Using Taxes to Solve Environmental Problems 265 Economic Solutions: Using Property Rights to Solve Environmental Problems 265 No Solution: When There Is No Government to Tax or Regulate 267 Summary 268 Chapter 24 Health Care 271 Where the Money Goes and Where It Comes From 271 Insurance in the United States 272 How Insurance Works 272 Varieties of Private Insurance 273 Public Insurance 273 Economic Models of Health Care 274 Why Health Care Is Not Just Another Good 274 Implications of Public Insurance 275 Efficiency Problems with Private Insurance 276 Major Changes to Insurance Resulting from PPACA 277 The Blood and Organ Problem 279 Comparing the United States with the Rest of the World 279 Summary 281 Chapter 25 Government-Provided Health Insurance: Medicaid, Medicare, and the Children’s Health Insurance Program 283 Medicaid: What, Who, and How Much 284 Why Medicaid Costs So Much 285 Why Spending Is Greater on the Elderly 286 Cost-Saving Measures in Medicaid 287 Medicare: Public Insurance and the Elderly 287 Why Private Insurance May Not Work 287 Why Medicare’s Costs Are High 288 Medicare’s Nuts and Bolts 289 Provider Types 289 Part A 289 Part B 290 Prescription Drug Coverage (Part D) 290 Cost Control Provisions in Medicare 291 xiv Table of Contents The Medicare Trust Fund 292 The Relationship between Medicaid and Medicare 293 Children’s Health Insurance Program 293 Summary 294 Chapter 26 The Economics of Prescription Drugs 296 Profiteers or Benevolent Scientists? 297 Monopoly Power Applied to Drugs 297 Important Questions 299 Expensive Necessities or Relatively Inexpensive Godsends? 299 Price Controls: Are They the Answer? 301 FDA Approval: Too Stringent or Too Lax? 301 Summary 302 Chapter 27 So You Want to Be a Lawyer: Economics and the Law 304 Private Property 304 Intellectual Property 305 Contracts 305 Enforcing Various Property Rights and Contracts 305 Negative Consequences of Private Property Rights 306 Bankruptcy 306 Civil Liability 306 Summary 308 Chapter 28 The Economics of Crime 310 Who Commits Crimes and Why 310 The Rational Criminal Model 311 Crime Falls When Legal Income Rises 311 Crime Falls When the Likelihood and Consequences of Getting Caught Rise 312 Problems with the Rationality Assumption 312 The Costs of Crime 312 How Much Does an Average Crime Cost? 313 How Much Crime Does an Average Criminal Commit? 313 Optimal Spending on Crime Control 314 What Is the Optimal Amount to Spend? 314 Is the Money Spent in the Right Way? 315 Are the Right People in Jail? 315 What Laws Should We Rigorously Enforce? 315 What Is the Optimal Sentence? 316 Summary 317 Chapter 29 Antitrust 319 What’s Wrong with Monopoly? 319 High Prices, Low Output, and Deadweight Loss 319 Reduced Innovation 320 Natural Monopolies and Necessary Monopolies 320 Natural Monopoly 320 Patents, Copyrights, and Other Necessary Monopolies 321 Monopolies and the Law 322 The Sherman Anti-Trust Act 322 What Constitutes a Monopoly? 323 Examples of Antitrust Action 323 Standard Oil 323 IBM 324 Microsoft 324 Apple, Google, and the European Union 325 Summary 325 Chapter 30 The Economics of Race and Sex Discrimination 327 The Economic Status of Women and Minorities 327 Women 327 Minorities 328 Definitions and Detection of Discrimination 330 Discrimination, Definitions, and the Law 330 Detecting and Measuring Discrimination 331 Discrimination in Labor, Consumption, and Lending 332 Labor Market Discrimination 332 Consumption Market and Lending Market Discrimination 333 Affirmative Action 334 The Economics of Affirmative Action 334 What Is Affirmative Action? 335 Gradations of Affirmative Action 335 Summary 336 Chapter 31 Income and Wealth Inequality: What’s Fair? 339 Measurement of Inequality 339 Income Inequality 339 Wealth Inequality 342 The Shrinking Middle Class 343 Table of Contents xv Causes of Household Income and Wealth Inequality 344 Costs and Benefits of Income Inequality 345 Summary 347 Chapter 32 Farm Policy 349 Farm Prices Since 1950 349 Corn and Gasoline 350 Price Variation as a Justification for Government Intervention 351 The Case for Price Supports 351 The Case against Price Supports 352 Consumer and Producer Surplus Analysis of Price Floors 352 One Floor in One Market 352 Variable Floors in Multiple Markets 353 What Would Happen without Price Supports? 353 Price Support Mechanisms and Their History 353 Price Support Mechanisms 353 History of Price Supports 355 Is There a Bubble on the Farm? 355 Kick It Up a Notch 356 Summary 356 Chapter 33 Minimum Wage 358 Traditional Economic Analysis of a Minimum Wage 359 Labor Markets and Consumer and Producer Surplus 359 A Relevant versus an Irrelevant Minimum Wage 360 What Is Wrong with a Minimum Wage? 361 Real-World Implications of the Minimum Wage 361 Alternatives to the Minimum Wage 362 Rebuttals to the Traditional Analysis 362 The Macroeconomics Argument 362 The Work Effort Argument 363 The Elasticity Argument 363 Where Are Economists Now? 363 Kick It Up a Notch 364 Summary 364 Chapter 34 Ticket Brokers and Ticket Scalping 366 Defining Brokering and Scalping 367 An Economic Model of Ticket Sales 367 Marginal Cost 367 The Promoter as Monopolist 367 The Perfect Arena 368 Why Promoters Charge Less Than They Could 369 An Economic Model of Scalping 369 Legitimate Scalpers 370 Summary 371 Chapter 35 Rent Control 373 Rents in a Free Market 373 Reasons for Controlling Rents 374 Consequences of Rent Control 375 Why Does Rent Control Survive? 377 Summary 378 Chapter 36 The Economics of K–12 Education 379 Investments in Human Capital 379 Present Value Analysis 380 External Benefits 380 Should We Spend More? 381 The Basic Data 381 Cautions about Quick Conclusions 383 Literature on Whether More Money Will Improve Educational Outcomes 385 School Reform Issues 385 The Public School Monopoly 385 Merit Pay and Tenure 386 Private versus Public Education 386 School Vouchers 387 Collective Bargaining 387 Summary 388 Chapter 37 College and University Education: Why Is It So Expensive? 390 Why Are the Costs So High? 390 Why Are College Costs Rising So Fast? 392 Why Have Textbook Costs Risen So  Rapidly? 393 What a College Degree Is Worth 395 How Do People Pay for College? 396 Summary 398 Chapter 38 Poverty and Welfare 400 Measuring Poverty 400 The Poverty Line 401 Who’s Poor? 401 xvi Table of Contents Poverty through History 402 Problems with Our Measure of Poverty 403 Poverty in the United States versus Europe 404 Programs for the Poor 404 In Kind versus In Cash 404 Why Spend $789 Billion on a $96 Billion Problem? 406 Is $789 Billion Even a Lot Compared to Other Countries? 406 Incentives, Disincentives, Myths, and Truths 406 Welfare Reform 407 Is There a Solution? 407 Welfare as We Now Know It 408 Is Poverty Necessarily Bad? 408 Summary 408 Chapter 39 Head Start 411 Head Start as an Investment 411 The Early Intervention Premise 411 Present Value Analysis 412 External Benefits 412 The Early Evidence 412 The Remaining Doubts 412 The Head Start Program 413 The Current Evidence 414 Evidence that Head Start Works 414 Evidence that Head Start Does Not Work 415 More Evidence Is Coming and Some Is In 415 The Opportunity Cost of Fully Funding Head Start 416 Summary 416 Chapter 40 Social Security 418 The Basics 418 The Beginning 418 Taxes 419 Benefits 419 Changes over Time 419 Why Do We Need Social Security? 420 Social Security’s Effect on the Economy 421 Effect on Work 421 Effect on Saving 421 Whom Is the Program Good For? 422 Will the System Be There for Me? 424 Why Social Security Is in Trouble 424 The Social Security Trust Fund 424 Options for Fixing Social Security 425 Summary 426 Chapter 41 Personal Income Taxes 429 How Income Taxes Work 429 Issues in Income Taxation 434 Horizontal and Vertical Equity 434 Equity versus Simplicity 434 Incentives and the Tax Code 434 Do Taxes Alter Work Decisions? 435 Do Taxes Alter Savings Decisions? 435 Taxes for Social Engineering 435 Who Pays Income Taxes? 435 The Tax Debates of the Last Two Decades 436 Summary 437 Chapter 42 Energy Prices 440 The Historical View 440 Oil …