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Business economics

GreGory MaNkiw,

ashwiN Third ediTioN Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Mark P. Taylor, aNdrew

This is an electronic version of the print textbook. Due to electronic rights restrictions, some third party content may be suppressed. Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. The publisher reserves the right to remove content from this title at any time if subsequent rights restrictions require it. For valuable information on pricing, previous editions, changes to current editions, and alternate formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest.

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Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

Business Economics, Third Edition

N. Gregory Mankiw, Mark P. Taylor, Andrew Ashwin

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ISBN: 978-1-4737-6277-0

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Printed in China by RR Donnelley Print Number: 01 Print Year: 2018 Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

iii BRIEF CONTENTS About the authors vii Preface viii Acknowledgements x PART 1 The economic and business environment 1 1 What is business economics? 1 2 Economics and business decision making 16 3 The business environment 26 PART 2 Microeconomics: The market system 41 4 Supply and demand: How markets work 41 5 Elasticity and its applications 74 6 Taxes and subsidies 105 PART 3 Microeconomics: The limitations of markets 119 7 Market failure 119 8 The consumer and consumer behaviour 140 PART 4 Microeconomics: The economics of firms in markets 161 9 Costs and revenues in production 161 10 Business goals and behaviour 180 11 Firm behaviour and the organization of industry 199 12 Market structures: Perfect competition 215 13 Market structures: Monopoly 233 14 Market structures: Imperfect or monopolistic competition 257 15 Market structures: Oligopoly 271 16 Corporate strategy and pricing policy 289 PART 5 Microeconomics: Factor markets 315 17 Labour markets 315 18 Financial markets 342 PART 6 Introduction to macroeconomics 369 19 The macroeconomic environment 369 20 Aggregate demand and aggregate supply as a model to describe the economy 393 21 Government economic policy and the effect on business: Fiscal, monetary and supply side policy 417 PART 7 Global business and economics 447 22 The global economy 447 23 Issues in global business and economics 502 Glossary 524 Index 531 Formulas 541 Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

the authors vii Preface viii Acknowledgements x Part 1 tHE ECONOMIC aND BUSINESS ENVIrONMENt 1 1 What is business economics? 1 What is business economics? 1 Some key ideas in economics 4 2 Economics and business decision making 16 Economics: The science (or art) of decision making 16 Business decision making 19 Conclusion 23 3 the business environment 26 The transformation process 26 The PESTLE framework 30 Shareholder value and stakeholders 35 Conclusion 36 Part 2 MICrOECONOMICS: tHE MarKEt SYStEM 41 4 Supply and demand: How markets work 41 The market forces of supply and demand 41 Markets and competition 43 Supply 44 Shifts versus movements along the supply curve 46 Demand 49 Shifts versus movements along the demand curve 51 Demand and supply together 55 How prices allocate resources 69 5 Elasticity and its applications 74 Elasticity and its application 74 Price elasticity of supply 75 The price elasticity of demand 81 Other demand elasticities 88 Applications of supply and demand elasticity 98 6 taxes and subsidies 105 Introduction 105 Taxation and business 105 Conclusion 113 Part 3 MICrOECONOMICS: tHE LIMItatIONS OF MarKEtS 119 7 Market failure 119 Introduction 119 Externalities 122 Using the demand curve to measure consumer surplus 123 Producer surplus 124 Government, business and externalities 131 Conclusion 135 8 the consumer and consumer behaviour 140 Introduction 140 Behavioural economics 151 Asymmetric information 153 Conclusion 156

About

CONtENtS

PART 5 MICROECONOMICS: FACTOR MARKETS 315

CONTENTS v

THE ECONOMICS OF FIRMS IN MARKETS 161 9 Costs and revenues in production 161 The costs of production 161 What are costs? 162 Production and costs 164 The various measures of cost 168 Conclusion 175 10 Business goals and behaviour 180 The goals of firms 180 Financial objectives 184 Break-even analysis 184 Non-financial objectives 193 11 Firm behaviour and the organization of industry 199 Isoquants and isocosts 199 Costs in the short run and in the long run 204 Economies and diseconomies of scale 207 12 Market structures: Perfect competition 215 Competition and competitive markets 215 The supply curve in a competitive market 222 Conclusion: Behind the supply curve 227 13 Market structures: Monopoly 233 Introduction 233 The sources of monopoly power 235 How monopolies make production and pricing decisions 237 The welfare cost of monopoly 242 Price discrimination 244 Public policy towards monopolies 248 Conclusion: The prevalence of monopoly 251 14 Market structures: Imperfect or monopolistic competition 257 The nature of monopolistic competition 257 Advertising and branding 261 Brand names 264 Contestable markets 265 Monopolistic competition and the welfare of society 266 15 Market structures: Oligopoly 271 Oligopoly 271 Interdependence, game theory and the economics of competition 276 Public policies toward oligopolies 281 Conclusion 284 16 Corporate strategy and pricing policy 289 Introduction 289 Business strategy 289 Pricing strategies 297 Business forecasting 301 Sales forecasting 305 Qualitative data 310

PART 4 MICROECONOMICS:

17 Labour markets 315 The markets for the factors of production 315 The demand for labour 316 The supply of labour 321 The gig economy 325 The other factors of production: Land and capital 328 Imperfections in the labour market 331 The economics of discrimination 335 Conclusion 337 18 Financial markets 342 Sources of business finance 342 Financial institutions in the economy 346 Measuring the time value of money 349 Managing risk 351 Asset valuation 354 Savings and investments in the national income accounts 355 An overview of Islamic finance 360 Fintech 361 Conclusion 364 Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

INTRODUCTION TO MACROECONOMICS 369

PART 7 GLOBAL BUSINESS AND ECONOMICS 447

22 The global economy 447

International trade 448

The principle of comparative advantage 452

The determinants of trade 455

The winners and losers from trade 456

Restrictions on trade 460

Criticisms of comparative advantage theory 467

Other theories of international trade 468

The prices for international transactions: Real and nominal exchange rates 470 A model of exchange rate determination: Purchasing power parity 472

The single European market and the euro 475 Common currency areas and European monetary union 477

Brexit 484

The financial crisis 502

Austerity policies: Too far too quickly? 511

The productivity puzzle 515

Sustainability 518

Glossary 524

Index 531

Formulas 541

vi CONTENTS PART 6

The macroeconomic environment 369 Introduction 369 Key economic indicators 370 The components of GDP 373 Real versus nominal GDP 375 Inflation: Measuring the cost of living 377 Unemployment 381 The balance of payments 383 Conclusion 388 20 Aggregate demand and aggregate supply as a model to describe the economy 393 Introduction 393 Three key facts about economic fluctuations 394 Explaining short run economic fluctuations 395 The aggregate demand curve 397 The aggregate supply curve 401 Two causes of economic fluctuations 409

Government economic policy and the effect on business: Fiscal, monetary and supply side policy 417 Government economic policies 417 Monetary policy 418 The banking system 420 The central bank’s tools of monetary control 423 Fiscal policy

Supply side policies

How monetary policy influences aggregate demand 437 How fiscal policy influences aggregate demand 440 Conclusion

426

433

442

Fiscal policy and common currency areas 481

Global business, culture and ethics 488

The costs and benefits of globalization 490 Business in emerging markets 492

Outsourcing 496

Foreign direct investment 497

23 Issues in global business and economics 502

ABOUT THE AUTHORS

N. GREGORY MANKIW is Robert M. Beren Professor of Economics at Harvard University. As a student, he studied economics at Princeton University and the Massachusetts Institute of Technology. As a teacher he has taught macroeconomics, microeconomics, statistics and principles of economics. Professor Mankiw is a prolific writer and a regular participant in academic and policy debates. His work has been published in scholarly journals such as the American Economic Review, Journal of Political Economy and Quarterly Journal of Economics. In addition to his teaching, research and writing, Professor Mankiw has been a research associate of the National Bureau of Economic Research, an advisor to the Federal Reserve Banks of Boston and New York, and the Congressional Budget Office. From 2003 to 2005 he served as chairman of the US President’s Council of Economic Advisors.

MARK P. TAYLOR is Dean of the Olin Business School, Washington University and was previously Dean of Warwick Business School at the University of Warwick, UK and Professor of International Finance. He obtained his first degree in philosophy, politics and economics from Oxford University and his master’s degree in economics from London University, from where he also holds a doctorate in economics and international finance. Professor Taylor has taught economics and finance at various universities (including Oxford, Warwick and New York) and at various levels (including principles courses, advanced undergraduate and advanced postgraduate courses). He has also worked as a senior economist at the International Monetary Fund and at the Bank of England and, before becoming Dean of Warwick Business School, was a managing director at Black Rock, the world’s largest financial asset manager, where he worked on international asset allocation based on macroeconomic analysis. His research has been extensively published in scholarly journals and he is today one of the most highly cited economists in the world. He was also a member of the Academic Advisory Group of the Bank of England Fair and Effective Markets Review.

ANDREW ASHWIN has over 20 years’ experience as a teacher of economics. He has an MBA from the University of Hull and a PhD from the University of Leicester. Andrew is an experienced author writing a number of texts on Economics and Business for students at different levels and publications related to his PhD research. Andrew was Chair of Examiners for a major awarding body in England and Wales for Business and Economics and is a former Editor of the Economics, Business and Enterprise Association (EBEA) journal. Andrew is also a subject expert for economics to the qualifications regulator in England and Wales and is a Chartered Educational Assessor and a Fellow of the Chartered Institute of Educational Assessors.

vii

How much of business is economics and how much of economics is business? This is a difficult question to answer but perhaps what is at the heart of both is decision making. This book is about decision making. Alfred Marshall, the great nineteenth-century British economist, in his textbook, Principles of Economics published in 1890 wrote: ‘Economics is a study of mankind in the ordinary business of life.’ For many people, the ordinary business of life is interwoven with relationships with business. Every single day, billions of people around the world make decisions. When we make decisions, we are being economists. A great proportion of these decisions are made by people in the context of their work which in turn is part of business. So Business and Economics are very closely linked.

A study of economics in a business context will help you understand the world in which you live. There are many questions about businesses and the economy that might spark your curiosity. Why do airlines charge less for a return ticket if the traveller stays over a Saturday night? Why are movie businesses prepared to pay some actors extremely large sums to star in films, while others struggle to even get a bit part? Why are living standards so meagre in many African countries? Why do some countries have high rates of inflation while others have stable prices? Why do businesses produce many products that are so similar? Surely they succeed only in cannibalizing their market? Why is it so important to have a better understanding of how consumers behave? Why have some European countries adopted a common currency? These are just a few of the questions that a course in Business Economics will help you answer.

The second reason to study Business Economics is that it will make you a more astute participant in the economy and in business. As you go about your life, you make many economic decisions. While you are a student, you decide how many years to stay in full-time education. When you have completed your degree, you will have to decide on a career path and find a job (which may be difficult despite being highly qualified). Once you take a job, you decide how much of your income to spend, how much to save and how to invest your savings. In your daily work, you will have to make many decisions and respond to an ever-changing environment. One day you may find yourself running your own small business or a large firm, and you will decide what prices to charge for your products and what products to offer for sale. The insights developed in the coming chapters will give you a new perspective on how best to make these decisions.

A study of Business Economics will give you a better understanding of the potential and limits of economic policy and how such policy can influence business behaviour. In your business career, you may find yourself asking various questions about economics. What are the burdens associated with alternative forms of taxation? What are the effects of free trade with other countries? To what extent do businesses have a responsibility to protect the environment? How does the government budget deficit affect the economy and thus your business?

A study of Business Economics will go some way towards helping you make more sense of the world, your place in it and how business is affected and behaves as a consequence.

FOR WHOM IS THIS BOOK WRITTEN?

The book has been written for the non-specialist economist who has to embark on a course of study in economics as part of a degree in Business. Your degree might be Business Economics, it might be Business Management or it might be Sports Coaching and Management. An increasing number of degree courses will include some coverage of economic principles, and this book is designed for just such courses. We have tried to put ourselves in the position of someone seeing economics for the first time and not necessarily looking forward to the prospect. Our goal has been to emphasize the material that students should and do find interesting about the study of the economy and business.

One result is that this book is briefer than many books used to introduce students to economics. Throughout this book we have tried to return to applications and policy questions as often as possible. All the chapters include a case study which illustrates how the principles of economics are applied. In addition, ‘In the News’ boxes offer highlights from news events showing how economic ideas shed light on current issues facing

viii

PREFACE

business and society, along with questions to help you apply your knowledge to new contexts – a vitally important part of learning.

Readers should note that part of this book is adapted from Greg Mankiw’s best-selling US undergraduate Principles of Economics text. The adaptation to Professor Mankiw’s text takes into account the needs of students and lecturers in the EMEA region and as such, may reflect different views to those in the original US text.

Responsibility for the adaptation lies with Cengage EMEA.

LEARNING TOOLS

The purpose of this book is to help you learn the fundamental lessons of economics and to apply these lessons to a business context. Towards that end, we have used various learning tools that recur throughout the book.

● Case Studies. Economic theory is useful and interesting only if it can be applied to understanding actual events and policies. This book, therefore, contains numerous case studies that apply the theory that has just been developed in a business context.

● ‘In the News’ boxes. One benefit that students gain from studying economics is a new perspective and greater understanding about news from around the world. To highlight this benefit, we have incorporated discussions of news events including excerpts from newspaper articles from around Europe, and the wider world. These articles, together with our brief introductions, show how basic economic theory can be applied and raise important questions for discussion in business. To help further develop application skills we have included some questions at the end which can either be used as practice for self-study or as the basis for seminar or tutorial discussion.

● ‘FYI’ boxes These boxes provide additional material ‘for your information’. Some of them offer a glimpse into the history of economic thought. Others clarify technical issues. Still others discuss supplementary topics that instructors might choose either to discuss or skip in their lectures but which students should find useful in supplementing their knowledge and understanding.

● Definitions of key concepts. When key concepts are introduced in the chapter, they are presented in bold typeface. In addition, their definitions are placed in a box in the page. This treatment is designed to help with learning and reviewing the material.

● Pitfall Prevention boxes. The authors have used their collective teaching wisdom to outline areas where students make frequent mistakes and which can be a cause of confusion. The Pitfall Prevention boxes alert you to the potential for these mistakes.

● Jeopardy Problem boxes. These are problems designed to help you think as an economist. You will be given end-points or solutions and you must think through the different ways in which the solutions or end-point given might have been arrived at using your knowledge of economics and business.

● What if…? boxes. Questions designed to get you thinking about different scenarios in business and economics.

● Self-Test Questions. After most major sections, you are offered a ‘self-test’ to check your comprehension of what you have just learned. If you cannot readily answer these questions, you should stop and reread material before continuing.

● Chapter summaries. Each chapter ends with a brief summary that reminds you of the most important lessons that you have just learned. Later in your study it offers an efficient way to revise for exams.

● Questions for review. At the end of each chapter are questions for review that cover the chapter’s primary lessons. You can use these questions to check your comprehension and to prepare for exams.

● Problems and applications. Each chapter also contains a variety of problems and applications that ask you to apply the material you have learned. Some instructors may use these questions for private study assignments. Others may use them as a starting point for classroom discussions.

PREFACE ix

ACKNOWLEDGEMENTS

The authors would like to thank the following reviewers for their comments on this and previous editions:

Andrew Abbott – University of Hull, UK

Dr Turner Anna – CEU Business School, Hungary

Emanuele Bracco – Lancaster University, UK

Dr Yu-Fu Chen – Dundee University, UK

Matthew T. Col – University College Dublin, Ireland

Gary Cook – University of Liverpool, UK

Dr John Duignan – University of the West of Scotland, UK

Aat van Eeden – Zuyd University of Applied Science, Netherlands

Robert Elliott – University of Birmingham, UK

John Forde – University of Salford, UK

Richard Godfrey – Cardiff School of Management, UK

Marco Gundermann – Cardiff Metropolitan University, UK

Dr Hala Helmi El Hadidi – British University, Egypt

Juan Garcia Lara – Universidad Carlos III Madrid, Spain

Qamarullah Bin Tariq Islam – Rajshahi University, Bangladesh; University of Glasgow, UK

Paul L. Latreille – Swansea University, UK

Paul Lovejoy – University of Portsmouth, UK

Dr Bobby Mackie – University of the West of Scotland, UK

Tim Maxfield – University of Worcester, UK

Pedro Martins – Queen Mary, University of London, UK

Fearghal J. McHugh – Galway Mayo Institute of Technology, Ireland

Natalie Moore – University of Nottingham, UK

Yoko Nagase – Oxford Brookes University, UK

Adel Nemeth – Jacobs University, Bremen

Dr Matthew Olczak – Aston University, UK

Quentin Outram – Leeds University Business School, UK

Bruce Philp – Nottingham Business School, UK

Julia Planko – Hogeschool Utrecht, Netherlands

Robert Price – University of Suffolk, UK

Neil Reaich – Economics, Business and Enterprise Association

Jose R. Sanchez-Fung – Kingston University London, UK

Ulrich Schüle – School of Business FH MainzUniversity of Applied Sciences, Germany

Cemil Selcuk – Cardiff University, UK

Vasilios Sogiakas – University of Glasgow, UK

Nicholas Spearman – University of the Witwatersrand, South Africa

Dr F Steffen – University of Liverpool Management School, UK

Michael Wood – London South Bank University, UK

Dr Michael Wynn-Williams – University of Greenwich, UK

Gaston Yalonetzky – Leeds University Business School, UK

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