Principles of Economics

Betsey Stevenson & Justin Wolfers

Every decision is an economic decision.

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What if you lose your job?


Unemployment is a macro phenomena with real consequences for individuals. Here, the authors provide sound advice on how students can protect themselves from the harmful effects of unemployment.

Protecting Yourself from the Harmful Effects of Unemployment

Unemployment can be terrible. But there are some things you can do to help protect yourself from the harmful effects of unemployment.

Do more job searching than you really want to do. Job searching when you’re unemployed is a miserable experience. Too often people procrastinate finding a job, doing too little search until their savings start to run out or their unemployment insurance is about to end. But remember the core principles of economics and apply for any job for which the marginal benefit of applying (the probability of getting a job offer times the wage) exceeds the marginal cost of applying (and remember that the emotional pain of applying is short-lived!).

Build up a nest egg. Now that you know half of those who lose their job end up unemployed for more than 10 weeks, and it’s not unusual for it to take six months to find work, you probably understand why financial advisers tell you to have three to six months of expenses saved up. You should find out if you’d be eligible for unemployment insurance and put away a bit more if you aren’t or if the unemployment rate is high. Remember that anyone can end up finding themselves unemployed. But the experience is not as bad if you have enough in savings that you don’t have to worry about paying the rent.

Build new skills. The economy is constantly adapting, and you must too. Continuing to learn and build your skills is necessary to advance your career, but it’ll also help you land on your feet if you find yourself unemployed.

Keep an eye out for better opportunities when you’re employed.Many employed people keep searching for other opportunities. Keeping an eye out for better opportunities when you’re employed can help you advance in your career by identifying jobs that use recent skills you’ve built, but it can also help if things start to get rocky in your current position. Many people who think their job is likely to come to an end begin searching long before a pink slip arrives. Such searching increases the chance that you’ll avoid unemployment by being able to start a new job right away.

Tap into all your networks if you become unemployed. You’re more likely to get hired if you have a referral. So if you find yourself unemployed, it’s time to call on everyone you know to tell them that you’re looking. It takes courage to tell your friends you’re looking for work, or to broadcast your job search through social media, but letting people know that you’re looking for a new opportunity can pay off.

Avoid long-term unemployment. Sometimes you’re offered a job that’s not quite as good as you think is possible. If it’s your first week searching, you might want to turn it down, but don’t keep turning jobs down forever. You’ve learned about the scarring effects of long-term unemployment—that means that you want to avoid it even if means settling for Mr. Not-So-Right Job. The good news is that, unlike marriage, you can keep searching for a better job even while you’re employed.

supply demand graph

What risks come with uncertainty?


Behavioral economics is one of the hottest topics in the discipline, and Stevenson and Wolfers address behavioral econ throughout micro, including a thorough examination of how we assess risk in Chapter 19.

Behavioral Economics: How People Make Mistakes Around Uncertainty

You’ve now developed a robust understanding of how to make good decisions in the face of uncertainty and learned some strategies you can pursue to reduce risk. But risk is a difficult concept, and people often struggle with it. In 2018, the Nobel Prize in economics was given to Richard Thaler, who in his acceptance speech said that he was receiving the prize because he “discovered the presence of human life in a place . . . my fellow economists thought it did not exist: the economy.” He and many economists in the last few decades have studied how human beings process information to understand what it means for economic decision making. This type of research has been called behavioral economics because it includes psychological factors in assessing how people make economic decisions. All of economics is concerned with human behavior; in recent decades economists have developed a better understanding of the behavior of actual humans.

This is a big deal when it comes to uncertainty because people often make fairly predictable mistakes when assessing probabilities and payoffs. These mistakes stem from relying on snap judgments, rather than more reasoned consideration. Psychologists distinguish between two styles of thinking. System 1 refers to your intuitive thoughts. They are fast, effortless, and almost automatic. These intuitions rely on rough, but often accurate, rules of thumb. The first psychologist to win the Nobel Prize in economics, Daniel Kahneman, calls System 1 “thinking fast.” By contrast, System 2 is your slower, deliberative, logical self, and it uses a methodical style of thinking that requires cognitive effort. Not surprisingly, he calls that “thinking slow.” When you’re thinking through expected utility calculations, you’re thinking slow. But most of the time, you’re using System 1 and thinking fast. Life is too short to think slow all the time. Even so, thinking fast leads us astray a lot, particularly when it comes to uncertainty.

Good decision makers know when it’s time to overrule their snap judgments and revert to thinking slow. And so you can think of what follows as an operating manual for your mind. This operating manual will help you figure out when thinking fast will yield bad answers, so that you pause your intuition and apply the more deliberate approach of thinking slow instead.

supply demand graph

What do you do when you're driving somewhere you've never been before?


Take a look at the roadmap and decide how you want to approach short run business cycles.

Here and throughout the book, Part Roadmaps like this one provide simple navigation tools to help you plan your course—and provide students with a sense of where they're going, and how what they've learned already fits in with the material ahead.


What does this course have to do with your car insurance?


A thorough exploration of adverse selection and moral hazard pr ompts students to think about how economic incentives might change their driving habits.

Will you soon pay more if you are a bad driver?

For decades, insurers have charged young people much higher rates for auto insurance. Their logic is that some young people take more risks behind the wheel and get in more accidents. But not all young people are bad drivers, and if you’re a good driver you might feel that you deserve a better deal. The problem is private information. Insurers don’t know if you’re a good or bad driver, so they have to charge you a price that accounts for the risk you’re a bad driver. But what if your auto insurer could use technology to close this information gap?

Auto insurers such as Progressive, Allstate, and State Farm now have programs where you can allow them to track your driving—in many cases, using a simple phone app. Why would you want an insurance company tracking your movements? It’s simple: If the data they collect show that you’re a safe driver, they’ll offer you cheaper insurance. This also helps insurance companies figure out who the bad drivers are—they’re the folks who won’t sign up to use the app.

It’s worth thinking about where this will lead. As fewer good drivers buy unmonitored auto insurance, insurers will need to raise prices on unmonitored insurance to cover the higher average costs of covering mainly bad drivers. Those higher prices will push more good drivers into using the monitoring app. Eventually only bad drivers will be left buying unmonitored auto insurance. At that point, insurance companies have app-related data to identify the good drivers, and they can also identify the bad drivers, because they’re the ones refusing to use the app. The insurance company can use this information to offer prices tailored to each person’s driving skill. As a result, technology that reduces the adverse selection of buyers will lead to lower prices for good drivers and higher prices for bad drivers.

Why don't we always have full employment?


Unique coverage of labor market dynamics provides students with a more complete understanding of what unemployment numbers mean and why the fed doesn’t target zero unemployment.

The Dynamics of the Labor Market

To better understand the labor market, it’s helpful to start with an analogy. Picture a busy restaurant: As customers leave, new customers are seated. Tables are always turning over, so while most tables are full, new customers arriving are able to find a table without much of a wait. Sometimes, though, things clog up and there are more customers than tables or it takes a lot of time to get tables ready for new customers.

The labor market is in many ways like a crowded restaurant, where jobs are like tables and workers are like hungry diners. Every day, hundreds of thousands of people leave and start jobs. People leave jobs for all sorts of reasons—they may get laid off or fired, they may quit for a better job, or they may quit to exit the labor force. Just like a dynamic restaurant, where a large number of tables turning over regularly makes it easy for new people to arrive and find a table quickly, a dynamic labor market makes it easy for new people to enter the labor market and find a job quickly.

But, like a restaurant, the labor market can also get backed up. Potential workers may not be well matched to the jobs available. If many people become unemployed at once, there may not be enough job openings for everyone, and it may take longer to find a job. There may be barriers to employers eliminating inefficient jobs or workers, which slows down the process of creating new jobs or hiring new workers. Let’s take a closer look at the dynamics of the U.S. labor market.

supply demand graph

You can use economics to make work better.


Students learn how to put economics to work—at work. They'll see that smart employers invest in human capital, and use incentives to motivate workers and shape corporate culture.

Personnel Economics

Congratulations on your promotion! Now you’re the boss. Sure, you’ve worked for bad bosses in the past. But you’ll be different. You’ve just got to figure out how. As the boss, you’ll be in charge of your firm’s personnel policies. Your goal will be to get your workers to do more, without costing your company too much. We’ll explore five big ideas that realworld managers use:

  1. Ensure your workers have the right skills for the job.
  2. Motivate your staff with incentives.
  3. Shape your corporate culture.
  4. Offer the right benefits package.
  5. Attract and retain better workers.

As we explore these ideas we’ll discover that economic reasoning can lead to some unexpected insights into how to get your workers to be more effective. Let’s explore each of these big ideas in turn.

supply demand graph

You can motivate your workers with either carrots or sticks.

Should you buy one more gallon of gas? One more pair of jeans? One more subscription service?


Stevenson and Wolfers' four core principles yield a powerful rational rule: If the marginal benefit of buying ONE MORE is greater than the or equal to the price, go ahead and buy it.

The Rational Rule for Buyers

Working systematically through the core principles—as shown in Figure 5—leads to the conclusion that Darren should keep buying additional gallons of gas as long as the marginal benefit is greater than (or equal to) the price.

FIGURE 5: Rational Rule for Buyers

stranger things

We’ve uncovered a pretty powerful rule, which you can apply to any buying decision:

The Rational Rule for Buyers: Buy more of an item if the marginal benefit of one more is greater than (or equal to) the price.

The Rational Rule for Buyers puts together the advice from three of the four core principles in one sentence. You should think at the margin, comparing the marginal benefit of one more item with the marginal cost (in this case, the price), and evaluate these costs and benefits relative to your next best alternative. You can apply this rule to your realworld buying decisions. For instance, it says to Darren: You should buy another gallon of gas if it yields a marginal benefit greater than or equal to its price.

Which Star Wars film made the most money?


Students learn the importance of using real dollars by comparing box office receipts for eight films in the Star Wars franchise.

Do the Economics

You can see how this formula works by converting the box office take from different eras into today’s dollars (and to help you, Figure 6 shows you the price level for each year):

The Force Awakens was released in 2015, and it grossed $937 million in 2015 dollars, when the CPI was 237.0. Today (in 2018) the CPI is 251.1. Therefore:

do the econ graph
star wars

Why do more people go to the movies during a recession?


Students learn to apply the cost-benefit principle and the opportunity costs principle to just about every decision they make. They'll quickly see that when folks are unemployed, their time is less scarce; in economic terms, it's “cheaper” to go to the movies when you don't have to miss work to do it.

Why do more people go to the movies during an economic downturn?

During the recent economic downturn, the major film studios braced themselves for a major decline in business. But they shouldn’t have. Why? The most important cost of seeing a movie isn’t the $13 price of the ticket. Instead, it’s the opportunity cost of your time. The movie takes two hours, and you could spend this time doing something else. Perhaps you could be working instead of seeing the movie. But when the economy is weak, there are fewer jobs, and there is often less work to do, and so the opportunity cost of your time is lower. Or perhaps the alternative to the movie is going to a party. But fewer people throw parties when the economy is weak, so your alternative may be a night watching television. Because the opportunity cost of time is lower during an economic downturn, people choose to see more movies. In fact, a weak economy is often good news for the movie industry.


What goes on at the world’s most economically consequential meeting?


Give your students an insider’s view of the Federal Open Market Committee (FOMC) operations, with details on what’s discussed and how the public policy decisions that affect their lives are made—and by whom.

The Federal Open Market Committee

The Fed governors, the New York Federal Reserve Bank president, and the district Fed presidents form the Federal Open Market Committee (FOMC), whose purpose is to decide on U.S. interest rates. They all participate, but only the Fed governors, the New York Fed bank president, and a rotating group of four regional Fed presidents are voting members, meaning that they vote on policy decisions. The Fed chair runs the FOMC and is the most important spokesperson for the Fed. The FOMC meeting is that meeting mentioned at the start of the chapter—the one that’s one of the most important meetings in the world—so let’s take a look inside it.

Step into the meeting. When you walk into an FOMC meeting, you’ll see a big table with the members and participants seated around it. The Fed chair sits in the middle and decides who’s going to speak and in what order. These decisions sound minor, but they can have a bigger impact on outcomes than you might expect. Former Fed chair Alan Greenspan used to tell everyone what he thought the right monetary policy decision was first, making it awkward for other members to discuss alternatives. When Ben Bernanke took over as Fed chair in 2006, he took a more democratic approach. In order to foster debate, he waited to share his views until he’d heard everyone else speak. His successors, Janet Yellen and Jerome Powell, have followed a similar approach, resulting in a wider range of views and data being brought into the discussion. Research also shows that greater gender and racial diversity in meetings can improve decision making, and the Fed and Congress have made progress in bringing greater diversity to the FOMC in recent years.

So now that you know who’s at the meeting, let’s turn to what they talk about. To decide monetary policy, each member must be prepared to answer three questions:

  1. What are your forecasts for the U.S. economy?
  2. What are the right policy choices given the economic outlook?
  3. How should the Fed communicate its plans effectively to the public?

Each member prepares their answers to these questions in advance, and they’ll often arrive at the meeting with quite different views. The meeting is a time for them to discuss their answers to these three questions, develop a consensus view, and make a decision.

Federal Open Market

What role does economics have in driving public policy?


At the end of each chapter, students are invited to think comprehensively about what they've learned—how this chapter fits in with prior material and lays the groundwork for what’s ahead. Here, students consider the normative and positive questions surrounding welfare and efficiency--building on their understanding of how government interventions affect markets.

Tying It Together

It’s time to pull all these threads together and return to the debate about whether the government should allow ride-sharing companies like Uber to operate. You’ll see that the tools you’ve developed in this chapter provide a powerful lens for analyzing public policies.

The first stage of our analysis involves positive analysis, asking: What is going to happen when we ban or when we allow Uber? That means analyzing what’ll happen to the employment and wages of both taxi drivers and of Uber drivers; assessing whether Uber has increased the total quantity of rides; evaluating how much people have to pay for a ride; and accounting for nonfinancial costs and benefits such as whether Uber has reduced the typical wait time to get a ride home. Careful analysis has found that wages and employment of taxi drivers have fallen; employment of Uber drivers has risen, and they enjoy more flexible work hours. The overall number of rides has risen, and wait times have fallen. Your positive analysis tells you who gains from ride-sharing (Uber drivers and their customers), and who loses (taxi drivers), and by how much.

Balancing these competing interests requires a normative analysis, which assesses which is the better outcome and what policy the government should adopt. You might start by asking whether economic surplus increased. You know the quantity of rides went up, but in order to assess whether total economic surplus rose or fell, you’ll need to know why. The answer is that market failure, government failure, and technological change have all played a role in this rapidly shifting market.

Let’s start with market failure. When taxis first started out, passengers didn’t know whether their driver would be safe or reckless. Government responded by regulating taxis to ensure that only qualified drivers could offer rides. That made taxi licenses valuable.

That sparked a form of government failure. Here’s the problem: Existing taxis earn more when they face fewer competitors. And so taxi owners pressured the government to prevent new taxi drivers and new taxi companies from entering the market. Government officials relented, restricting the supply of taxis. This artificial restriction on supply led the quantity of rides to be less than the efficient quantity, creating deadweight loss. Sometimes market forces work to undo the inefficiencies created by government failure.

In this case, that’s what Uber did. It’s not technically a taxi company, and so it found a way to skirt these regulations. As a result, the entry of Uber increased the quantity of rides toward the efficient quantity, thereby raising economic surplus. Of course, Uber also adds congestion on the road, so it’s possible that there are now too many rides! In that case, economic surplus would be higher with some limitations on Uber.

Technological change also played an important role as ride-sharing apps provide efficient routing using GPS, they allow drivers to use a car that might otherwise sit in their driveway, and they permit drivers to flexibly schedule their shifts for when their opportunity costs are lowest. These changes all reduce the marginal cost of producing a ride. Lower marginal costs lead to a rise in the efficient quantity of rides. If there were no increase in the quantity supplied, this would have led to an even larger gap between the actual quantity and the efficient quantity of rides, creating even more deadweight loss.

All told, Uber likely increased the total amount of economic surplus and that’s why many economists tend to view ride-sharing as a good outcome. However, economic surplus doesn’t have to be your only criteria in a normative analysis. You might have concern about distributional effects of Uber or concerns about the fairness of undercutting the full-time profession of taxi drivers. Ultimately, your opinion will depend on how you value the gains to the winners relative to the losses for the losers. While reasonable people might bring different values to this discussion, weighing these costs and benefits differently, your analysis of economic surplus provides you with an important tool with which to begin crafting your view.

Carefully constructed figures walk students through the process of building economic graphs.



Is time spent thinking a good investment?


Ideas are engines for growth, for companies and for entire economies. Stevenson and Wolfers emphasize both the macro and micro implications of ideas—and show that human capital is worth investing in.

Innovative companies make time for new ideas

Successful managers know that new ideas are the key not just to economic growth, but to the growth of their own business. Google founders Larry Page and Sergey Brin recognized the trade-off workers face between producing goods and services and producing new ideas—and they wanted to ensure that their employees spent time working on new ideas. That’s why Google embraces the “20% rule,” which empowers all employees to spend up to 20% of their workweek dreaming up and developing their own ideas for new products. Google argues that this option helps keep their highly creative employees engaged in generating new ideas. It also ensures that workers maintain control over their creative energy and some of their work time. Does it work? It sure seems to: Gmail, Google Maps, and Google News all started as projects that employees pursued in their 20% time.

Lots of companies implement similar tactics to ensure that their employees devote some time to developing new ideas. For example, the CEO of Bosch Group asked its entire workforce to form into teams that were tasked with trying to come up with ways to compete against Bosch. They took the best ideas these teams came up with and gave a selected group of people eight weeks leave from their regular duties to see if they could turn the idea into a new or improved product for Bosch. The bottom line is that it takes time to come up with new ideas, and smart managers make sure that their workers have time to innovate.

You may think it’s just a washing
machine, but it started with an

You've got an idea for a business. Should you become an entrepreneur?


Stevenson and Wolfers bring the analysis of market structure in line with modern thinking. Their innovative presentation covers everything instructors expect, with less emphasis on discrete market structures and more emphasis on the deeper economic forces that managers confront: Market power, the threat of new entrants, product positioning, and strategic interactions. Here and throughout the book, Part Roadmaps like this one provide a simple navigation tool to help you plan your course—and provide students with a sense of where they're going, and how what they've learned already fits in with the material ahead.

Market Structure and Business Strategy

Market Structure and Business Strategy

How can you best utilize your staff?


Chapter ending study problems put chapter content like comparative advantage into a small business context to show how managers can use economic thinking when allocating tasks among staff.

Study Problems

As the manager at a local florist, you supervise two employees, Anita and Jerome. There are two tasks that need to be completed: floral arrangements and flower delivery. It takes Anita 30 minutes to finish one floral arrangement and it takes her 40 minutes to make one delivery. It takes Jerome 10 minutes to finish one floral arrangement and it takes him 30 minutes to make one delivery.

  1. Who has an absolute advantage in each task?


    Jerome has an absolute advantage in floral arrangements. It takes him 10 minutes to finish a floral arrangement and it takes Anita 30 minutes. Jerome has an absolute advantage in deliveries. It takes him 30 minutes to make a delivery and it takes Anita 40 minutes.

  2. What are Anita and Jerome’s opportunity costs of making floral arrangements? What is each of their opportunity costs of making one delivery?


    It takes Anita 30 minutes to finish one floral arrangement. In that time, Anita could finish 3/4 of a delivery. So the opportunity cost of one floral arrangement is 3/4 of a delivery. It takes Anita 40 minutes for one delivery. In that time, Anita could finish 1 and 1/3 floral arrangements. So, the opportunity cost of one delivery is 4/3 floral arrangements.

    It takes Jerome 10 minutes to finish one floral arrangement. In that time, Jerome could finish 1/3 of a delivery. So the opportunity cost of one floral arrangement is 1/3 of a delivery. It takes Jerome 30 minutes for one delivery. In that time, Jerome could finish 3 floral arrangements. So, the opportunity cost of one delivery is 3 floral arrangements.

  3. Who has a comparative advantage in floral arrangements? What about deliveries?


    Jerome has a comparative advantage in floral arrangements. Jerome is the low-cost producer. Each floral arrangement costs Jerome 1/3 of a delivery while each floral arrangement costs Anita 3/4 of a delivery. Anita has a comparative advantage in deliveries. Anita is the low-cost producer. Each delivery costs Anita 4/3 of a floral arrangement while each delivery costs Jerome 3 floral arrangements.

  4. Suppose, initially, Jerome and Anita each spent 4 hours each day doing floral arrangements and 2 hours each day doing deliveries. If you changed their tasks so that each individual did nothing but the task for which they had a comparative advantage, how many more floral arrangements would your store make, and how many more deliveries?


    The shop would make 4 extra floral arrangements and 2 extra deliveries every 6-hour day. It takes Jerome 10 minutes for a floral arrangement and 30 minutes for a delivery. He completes 24 floral arrangements and 4 deliveries in a 6-hour day. It takes Anita 30 minutes for a floral arrangement and 40 minutes for a delivery. She completes 8 floral arrangements and 3 deliveries in a 6-hour day. The initial combined output is 32 floral arrangements and 7 deliveries. If you changed their tasks based on comparative advantage, Jerome will make floral arrangements, and Anita will make deliveries. In a 6-hour day, Jerome will finish 36 floral arrangements. In a 6-hour day, Anita will finish 9 deliveries.

What challenges do real firms face when trading internationally?


Students are invited to follow one family-owned American business as it facs the challenges of selling its products internationally.

International Finance and the Exchange Rate

In 1893, the Mathison family began a small farm in Washington State, producing enough to feed their family. Over time, the farm grew, and they began selling their crops at local markets. By the 1950s they were selling in markets outside of Washington, but they were struggling. They would load ripe, freshly harvested cherries onto trains packed with ice and hope they would still be good when they made it to their destination. If their fruit made it to New York with little spoilage, they were nearly guaranteed robust demand from the large population of New Yorkers. But if it got hot, spoilage rates were punishingly high. In 1958, they made a mere $88 after producing 100 tons of fruit because most of it rotted en route.

To succeed, the Mathisons needed to solve the problem of spoilage. They worked to improve their packing and transportation methods and by the 1970s, they had built a fruit packing, storage, and shipping facility that kept their fruit cold enough that it could survive a trip across the United States. This innovation not only gave them access to markets as far away as New York, but it also laid the foundation for exporting their fruit around the world. By the 1980s, they were exporting apples and cherries to a handful of countries. Over recent decades their business has grown as they’ve entered more foreign markets. Today, the Mathisons export fruit to 26 countries.

All of this has required the Mathisons to become conversant in exchange rates and international finance. We’ll follow the Mathisons’ decisions in this chapter, analyzing what determines how competitive they’ll be in the global market, and whether it makes sense to sell their produce abroad. International transactions often involve foreign currencies, and so we’ll dive into how exchange rates are determined, how they respond to changing economic conditions, and how they’ll affect the Mathisons’ business. Along the way we’ll see how developments in the global economy affect the prices you’ll pay as you seek goods, services, customers, investments, and investors from around the world. As you read this chapter, keep your eye on the broader theme, which is that increasingly all business is international business, and so the fates of businesses, communities, and countries around the world are becoming increasingly interdependent.


Who should decide how much you pay for this orange?


Students have their own ideas about whether the government should intervene in markets—here’s where we show them what happens when it does.

Why do farmers like price floors?

Farmers around the world often lobby their government to put price floors on agricultural products. Why? As you’ve already seen, price floors increase the price, which boosts businesses’ profit margins. But this higher price lowers the quantity demanded. Farmers get a higher price, but sell less. So why do they want the government to establish price floors? The answer is that they typically lobby their government for two things: to set a price floor for their product and to promise to buy up any surplus. In this way, farmers typically get to have their cake and eat it too—they sell less to consumers at higher prices and then sell the remaining surplus to the government at the same high prices. And this means that consumers lose twice: They pay more at the store and then they pay more in taxes so the government can afford to buy up all the surplus. What does the government do with the surplus it buys? Some of the surplus is sent to food banks and food pantries within the United States and some of it is sent overseas as a form of foreign aid.

Learn to negotiate like an economist.


Everyday Econ features present simple life hacks that take economic thinking—and economic research—and apply it to real-life situations every student will eventually face. Here, the authors walk students through a salary negotiation with advice on factoring in inflation.

How to beat money illusion by negotiating for a real raise

A few years back a friend of mine was negotiating a raise with his boss and reached out to me for advice. He was earning $100,000 per year and his boss offered him a contract that would see his wage rise by 5% over the five-year term of the contract. My friend wanted more, but he understood his boss had limited funds, and he was pleased to see his hard work rewarded with a pay increase.

But he wasn’t getting a real pay raise. Inflation was running at about 2% per year, so over five years, the average price level would rise by about 10% while his wages would only grow at half that rate. If your nominal wage rises by 5% over a period when prices rise by 10%, then your boss is actually cutting your real wage by about 5%.

My friend’s mistake was to think about his current nominal wage as the baseline in his wage negotiations. Relative to that reference point, any boost to his nominal wage was framed as good news. Instead, you want to make your current real wage thestarting point.

So when you next negotiate over your pay, begin the conversation with your boss by pointing out that inflation has reduced the value of your wage. Lay out the latest numbers and suggest that you expect an inflation-based adjustment to offset the rising cost of living. There’s not really a good counterargument, so it’s likely they’ll agree. Now that you’ve set your real wage as the baseline, turn the conversation to what sort of real wage boost you deserve for your hard work over the past year. If you’ve performed well, this conversation should also go well. How well? When I advised my friend to follow this script in his negotiation, he ended up with a much bigger raise than his boss originally offered—more than enough to offset inflation. If his experience is any guide, it will work for you, too.

the office

Learn to negotiate like an economist.


Everyday Econ features present simple life hacks that take economic thinking—and economic research—and apply it to real-life situations every student will eventually face. Here, the authors walk students through a negotiation with a household contractor.

How to save money on household repairs

Your roof starts leaking. A pipe bursts. Or perhaps your electrical wiring shorts. Whatever the domestic disaster, you want to make sure to shop around. If you just call one contractor and ask them to make the repair, it’s likely they’ll charge you a high price. They figure they have a lot of bargaining power, because your next best alternative— living without shelter, water, or electricity—is pretty terrible.

This shift will lead these competing contractors, who each want the job, to offer a much lower price. Even simpler: Just call one tradesman for a quote, but tell them that you’re going to get two more quotes. They won’t know if you ever make those calls, but the fact that you are considering it will likely lead them to offer you a more reasonable price.

Acceptable Buyer
Acceptable Buyer
home repairs

Why are there fewer stay-at-home moms?


Stevenson and Wolfers show connections between the four core principles and macroeconomic trends, such as child care and marriage decisions.

In 1975, more than half of all mothers stayed out of the labor force. Since then, things have changed, and the most recent data suggest that only 30% of moms stay at home. Why? Most mothers face a choice between staying at home and working for pay. Over recent decades, there has been a sharp rise in women’s wages, and since 1975, the annual earnings of a typical full-time female worker rose by around $10,000 (after adjusting for inflation), even as male earnings barely changed. Consequently, the opportunity cost of being a stay-at-home mom has risen. As this opportunity cost has risen, fewer women have chosen to stay at home. Instead, more women are now choosing to combine motherhood and working for increasingly better pay.


Is college really worth it?


The costs and benefits of college education are explored throughout Stevenson and Wolfers, with an emphasis not only on the financial returns of going to college, but also the opportunity costs involved in forgoing work to pursue more education. Do the benefits outweigh the costs? Usually, yes—and the benefits for econ majors are even greater!

The true cost of college

You now have the tools you need to assess the true cost of your own college experience. I bet you thought about the cost of college before applying, and you probably looked up the numbers on your college’s website. But you were probably thinking about it wrong. That website probably listed the cost of things such as tuition, housing, meals, books, and health insurance—a list that is surprisingly unhelpful for evaluating the true opportunity cost of attending college.

For that, you need to know: If you weren’t attending college, what would be different? It’s true that you wouldn’t be paying tuition, so that’s an opportunity cost. But you would surely continue to eat, so the cost of food isn’t an opportunity cost. The same goes for the cost of rent and health insurance. College websites always manage to omit the biggest cost of going to college, which is that if you weren’t studying, you would probably be working and earning tens of thousands of dollars. Those forgone earnings are an important opportunity cost that you need to consider.

Yes, going to college involves a large opportunity cost. But hopefully applying the opportunity cost principle to your decisions while you’re in college will help you make sure that the benefit of your college education exceeds the cost.

good choice bad choice

Why get married?


Students probably don't think about it, but marriage provides more than just companionship and love. It also provides a sort of safety net—especially if your spouse is different from you.

How Marriage Provides Insurance

Here’s an important benefit of marriage: It provides something akin to social insurance. Think about traditional wedding vows: Spouses promise to look after each other “for better, for worse, for richer, for poorer, in sickness and in health.” That sounds like a promise to provide unemployment insurance, disability insurance, and health insurance. Just as unemployment insurance ensures that you’ll still be able to get by when you lose your job, a working spouse effectively provides the same insurance. In both cases, someone—your spouse or the government—will help you pay for groceries if you lose your job. Your spouse can do a better job of insuring you if they don’t face the same risks as you do, which is one reason to marry someone who works in a different occupation or at least for a different employer—you’re less likely to both experience unemployment if you aren’t both working at the same company.

But marriage provides imperfect insurance, because there remains the risk that your spouse will also lose their job. Divorce also provides an escape hatch in which your spouse can fail to provide the promised coverage when a bad event happens.


How are the economy's vital signs?


Economic indicators provide useful insights. But just like blood pressure, heart rate, and EKG readings, each one only tells part of a large and complicated story. Stevenson and Wolfers provide students with a handy guide to interpreting the economic indicators that come up regularly in the news—along with some that don't—and show how they are used to assess the overall health of the economy.

Top 10 Economic Indicators

Okay, now that you know something about how to analyze macroeconomic data, let’s take a look at some key macroeconomic indicators. I often get asked what’s the one indicator that I follow to know how the economy is doing. My response? You shouldn’t only look at one indicator if you really want to know what’s happening. That’s because different types of data tell you different things. Let’s take a look at the top 10 economic indicators those who track the economy follow.

Indicator one: Real GDP is the broadest measure of economic activity. First, there’s real GDP, which measures the total size of the economy. Real GDP is the broadest measure of economic activity since it measures total production, total spending, and total income across the whole economy. It’s typically calculated by adding up all spending in the economy—you know, Y =C + I +G +NX. (See Chapter 9 for a refresher.) You should focus on GDP growth to see how fast the economy is growing. But keep in mind that GDP data are very incomplete when they’re first released.

Indicator two: Real GDI provides a useful cross-check on GDP. There’s another closely related measure of the economy’s total output. An alternative measure called Gross Domestic Income (or GDI, for short) is calculated by adding up total income. Because every dollar of spending is also a dollar of income for whomever received it, GDP and GDI should be equal. In practice, these measurements can differ because they’re each constructed using different data sources with different shortcomings. Early reports of the income data are often more reliable than the spending data, and so GDI often flashes warning signs for the economy sooner than GDP does. In fact, many countries combine income and expenditure measurements to create their primary GDP statistic. The United States doesn’t, so it’s worth tracking both measures.

Indicator three: Nonfarm payrolls tell you if the labor market is improving. Nonfarm payrolls track how many jobs are created each month. It’s called “nonfarm payrolls” because it tracks the number of workers on businesses’ payrolls. Don’t worry about the fact it misses farm jobs because they’re only a small fraction of the economy. Nonfarm payrolls is one of the most important indicators because it’s released soon after the end of each month, and so it provides an early and quite reliable look at how quickly the economy is creating jobs.

Indicator four: The unemployment rate is an indicator of excess capacity. The unemployment rate tells you the share of the labor force that wants a job and hasn’t been able to find one. It’s a snapshot of how strong the labor market is and how easy it is to find a job. It’s important both as an economic indicator—a measure of excess capacity— and also because unemployment is a major source of misery for many people.

Top 10 Economic Indicators

  1. Real GDP
  2. Real GDI
  3. Nonfarm payrolls
  4. Unemployment rate
  5. Initial unemployment claims
  6. Business confidence
  7. Consumer confidence
  8. Inflation
  9. Employment cost index
  10. The stock market

Why are your medications more expensive than your dog’s medications?


Students cae see price discriminination in action as they examine how pharmaceutical companies are able charge different species different prices for the same drug.

Why the same drugs cost less for Fido than for Freddy

You might be surprised to learn that humans and dogs often take the same medications. In some cases, they’re identical—they use the same active ingredients, meet the same FDA rules for quality and purity, and are often made in the same factory by the same drug company. The key difference between the dog and human versions is that people fill their prescriptions at a retail pharmacy, while dogs fill their prescriptions at a veterinary pharmacy.

A study that examined eight of these dog-and-human medications found that the human pharmacy typically charged a price that was around twice as high as the veterinary pharmacy. It’s a simple case of price discrimination— charging different species different prices for the exact same drug. This price differential is targeted to differences in reservation prices, suggesting that people care more about their own health than that of their four-legged friends. Woof!

interpreting the data

You're shopping for a new sofa. How does your choice affect the economy?


Stevenson and Wolfers take the classic definition of GDP and apply it to a tangible good—with real numbers—to show how the value added at each phase of production affects GDP figures.

Each stage of the production process before the final sale adds value.

As a therapist might say, let’s return to the couch to really explore these issues. The production process began when Bennett Lumber took raw material—a tree—and turned it into lumber that it sold to McCreary Modern for $400. That tree cost Bennett Lumber nothing (we’ll come back later to the problems of valuing natural resources as if they’re free). And so the work it did felling the tree, sawing it into planks, and drying and finishing it into commercial grade lumber that sold for $400, created $400 of value. Next, McCreary Modern used that $400 worth of lumber and turned it into a couch that it sold to a retailer for $1,000, which means that transforming raw lumber into a couch added $600 of value (again, for simplicity we’re ignoring fabric, cushion fillings, etc.). The couch then went to Crate & Barrel, which advertised it and helped get it in the hands of a customer who loves it. Crate & Barrel bought the couch for $1,000 and sold it for $1,500, which means that its efforts—online ads, the sales staff, and its retail location—added $500 of value.

GDP equals total output

How much does this item cost... and why?


A comprehensive guide provides useful strategies for future sellers—and valuable insights for every consumer.

Sophisticated Pricing Strategies

As Hurricane Irma passed through the Caribbean it generated winds as high as 185 miles per hour, causing catastrophic damage wherever it made landfall. It destroyed much of the Virgin Islands, killing several people along the way. It then turned northwest, setting its sights on Florida. The governor declared a state of emergency and ordered thousands of people to evacuate.

That’s when one technology lover— the owner of a Tesla electric car—discovered a problem. Their car—a Tesla Model S60— could hold enough charge to drive 200 miles, but it would take a trip of 230 miles to escape the evacuation zone. A quick phone call to Tesla asking for help yielded a surprising result. Quietly, Tesla sent a fragment of computer code to potentially stranded car owners, temporarily unlocking the car’s latent ability to drive further.

You see, Tesla sold two versions of their Model S. The Model S75 came with a 75 kWh battery which gave it a range of 250 miles. The Model S60 was $6,500 cheaper, and as you might expect if it had a 60 kWh battery, it had a shorter range of 200 miles. But in reality, it had the same 75 kWh battery as its more expensive sibling. The only real difference was that Tesla had added a snippet of code to the cheaper car, and it was that line of code—not any physical battery limitations—that gave it the shorter range.

Why would Tesla purposely cripple some of its cars? The answer is that it’s part of a sophisticated pricing strategy. Tesla figured out a way to get different customers to pay different prices for the same good. Price-sensitive customers could pay $68,000 for the S60—as long as they’re willing to live with the shorter range. And less price-sensitive customers could pay $74,500 for the S75 and avoid the hassle of charging the car more often.

It’s a surprising answer to a question that many managers ask: How can I make as much money as I can from each of my customers? Tesla’s answer is to charge some customers more than others. As we’re about to discover, there are many sophisticated pricing strategies you can use to do this. Get this pricing strategy right, and you’ll drive your profits up.


Your phone is a multitasker. So is economics.


Students probably reach for their phones 100 times a day: It’s a communication device, a camera, a calculator, a library, a music player, a calendar… and so much more. Stevenson & Wolfers show them that economists think of their toolkit the same way: As they master the four core principles of economic decisions, they'll quickly see how these tools can be applied to just about any decision they face, no matter what their major or career aspirations, and also apply these tools to their personal lives.

A Systematic Framework for Making Decisions

The atom is the basic unit of matter, and so physicists begin by trying to understand the atom, and from that, build their insights into the functioning of our physical world. Biologists start with the cell, the basic building block of all living things, and build from there to understand how different organisms live. And for economists, individual decisions—choices—are the foundation of all economic forces. Your decisions, and those of others, collectively determine what’s made, who gets it, and whether it yields fair outcomes. Because these broad economic outcomes are the product of many individual choices, economic analysis always begins by focusing on individual decisions.

This is where the four core principles come in. Together, they provide a systematic framework for analyzing individual decisions. In particular, through the rest of this chapter, we’ll see that whenever economists evaluate a decision:

  • We consider the costs and benefits of a choice. (The cost-benefit principle.)
  • Before making a choice, we consider the alternatives, asking: “Or what?” (The opportunity cost principle.)
  • We think at the margin, always asking whether a bit more or a bit less of something would be an improvement. (The marginal principle.)
  • And we are particularly attuned to understanding how different decisions depend on each other. (The interdependence principle.)

Sounds straightforward, right? The challenge is going to be applying these ideas— which we’ll analyze through the rest of this chapter—to the wide array of decisions you’ll face in your life.

This systematic approach provides insight into just about every decision you face. Going shopping? Apply the core principles of economics, and you’ll likely make better choices about what to buy. Trying to decide whether to do further study? We’ll see that the core principles can help you sort out whether that’s a good idea. Thinking of starting your own business? Apply these principles to figure out whether that’s your best choice. Settling down, and trying to decide how many children you should have? Again, apply these principles.

If you get in the habit of thinking about economics through the core principles, you’ll develop a sharper understanding and make better decisions. Speaking of which, you now face an important decision: You have to decide whether to keep reading, or not. Thousands of my past students can attest that the benefit of learning to think like an economist far exceeds the cost. And as you’re about to discover, when the benefits exceed the costs, the first of these principles tells you that it’s a choice worth making.

stranger things

What’s easier: Beating a video game or beating the stock market?


The stock market is more a game of chance than the games students play on their laptops, consoles, and devices. Stevenson and Wolfers provide a solid overview of the financial sector along with useful tips based on economic principles.

How to invest like an economist

What do economists do with their own money? Given the evidence so far, you won’t be surprised to hear that most of them invest in well-diversified index funds. Figure 10 shows the results of a survey that asked economists how they handle their money. Buying all 500 stocks in the S&P 500 ensures that you have a well-diversified portfolio. An index fund doesn’t pay for any fancy stock pickers, which helps them keep their fees really low. The best of these funds are so lean that they have very few expenses—about 0.2% of the money they’re handling for you, compared to a number closer to 1% or sometimes as much as 2% for an actively managed mutual fund. Economists ignore past stock-picking performance because it doesn’t predict future performance. The only indicator they focus on is the fees that are charged, which are sometimes called expense ratios. They focus on fees because they’re the best predictor of a fund’s returns. After all, even if it’s hard to predict good stocks, it’s easy to predict that paying high fees will make you poorer. While saving a fraction of a percentage point on fees each year doesn’t sound like a big deal, it is. If you put $100,000 in an index fund for 30 years and let it compound, you’ll end up saving around $120,000 in fees if you choose the lowest-cost option.

How Economists Handle Their Money

games vs stock market

Like games? Have we got a chapter for you.


A deep dive into game theory shows students how they can use economic thinking to make strategic decisions in situations ranging from chess matches to dating to bank runs to pricing.

Game Theory and Strategic Choices

Scene one: Judit Polgar surveys the men in front of her. The strongest female chess player of all time, she’s now coaching the Hungarian national men’s team. Her challenge is to teach these men what she knows instinctively: To beat your opponent you have to know them better than they know themselves. Scene two: Soviet Leader Nikita Khrushchev has secretly shipped nuclear missiles to Cuba, just 90 miles off the coast of Florida. President Kennedy demands that Khrushchev withdraw his missiles. Khrushchev refuses. The stakes couldn’t be higher, as each country possesses enough nuclear weapons to destroy the other. With negotiations at a stalemate, President Kennedy huddles with his advisers, aware that the world is on the brink of a catastrophic nuclear war. Scene three: Mary Barra’s agenda is packed. She runs General Motors, and she’s arranged separate meetings to evaluate whether to release an electric car, to decide what technologies to incorporate into GM cars, to plan her next negotiation with unions, and to figure out how quickly to expand into China. As she considers each alternative, she wonders how her rivals at Ford will respond.

Economics sees the same basic logic at work in all three scenes. Each strategist is trying to outfox their rivals, and each wants to stay a few moves ahead. As each ponders the next move, they all rely on the same set of ideas. These ideas come from game theory, and they provide a framework for making decisions in any strategic interaction.

We’ll start with the analytic tools you’ll need to analyze strategic interactions. Then we’ll highlight two big strategic issues: getting people to cooperate, and getting them to coordinate. For some students, that’s as far as they’ll dig with game theory. But if you want to dig into some advanced material, we’ll then evaluate how to navigate strategic interactions that play out over time.

I bet that you’ll find game theory to be incredibly useful as you navigate the strategic issues that arise in your own life. Or maybe I’m just saying this as a strategy to keep you reading. How can you tell?


How does comparative advantage affect family life?


The authors’ extensive research into the economic forces that shape family life highlight the wide range of topics that today’s economists explore, and introduce students to new ways of looking at their own experiences.

How shifting comparative advantage explains changes in family life

Comparative advantage can explain some of the most important social changes of the past century, including the changing nature of work, families, and relationships. Let me explain.

Most couples have two broad sets of tasks to manage: the task of earning money, and housework. Historically housework was a full-time job, and the opportunity cost of doing this work was the forgone earnings from not pursuing a career. Comparative advantage suggests that whether the couple assigns the housework to the man or the woman depends on who can do it at the lowest opportunity cost.

Back in your grandparents’ day, discrimination kept women’s wages down. As a result, each hour of housework came with a lower opportunity cost for your grandmother than for your grandfather, because it meant forgoing an hour of low-paid work. That’s why so many women of that era were homemakers, while their husbands pursued their careers.

As the twentieth century progressed, social and economic changes led more women to go to college. More education led to higher potential wages for women, increasing the opportunity cost of staying home. As the logic of comparative advantage suggests, this led more women to enter the workforce.

What happened to housework, then? A parallel development—the invention of new household appliances—led families to reorganize their domestic priorities. Here’s why: Your washing machine has a comparative advantage at laundry, your dishwasher has a comparative advantage at washing dishes, and the Roomba has a comparative advantage at vacuuming. Your microwave oven means that industrial kitchens can churn out easily reheated meals at a lower opportunity cost than any homemaker. As a result, your parents’ generation does a lot less housework than their parents did, because they employ a small army of domestic robots to wash, clean, and cook, instead. Your generation will do even less, as online services make it easier for you to outsource and automate chores like paying your bills.

In turn, these robots mean that the opportunity cost of pursuing a career has fallen— the housework will still get done!—and so in many more households today, both parents work. They’re following the dictates of comparative advantage, doing what they’re relatively good at—working in their job—and relying on others (including domestic robots!) to do the other stuff.

family life

What does summertime mean for house sales?


Quick, integrated features demonstrate the way economists think about numbers and data, helping students to develop their own economic intuition.

Why do house sales boom during the summer, but house prices don’t?

Every summer, the quantity of houses sold rises dramatically, but the price of housing doesn’t change much. What do these market movements tell us?

It’s easy to see why many buyers want to move in the summer—work is typically slower, and their kids won’t have to change schools during the school year. Consequently, the demand for housing increases. But if this were the whole story, then housing prices would typically rise in the summer, when in reality they’re usually flat. This suggests that there is also an increase in supply. In fact, this makes sense: Many people trying to buy a new house are also trying to sell their old house. Consequently, both supply and demand increase in the summer. Both of these forces lead to an increase in the quantity sold. And because the increase in supply is roughly equal to the increase in demand, the pressure on housing prices to rise (due to increasing demand) is offset by pressure on them to fall (due to increasing supply).

supply demand graph

Learn to use your time like an economist.


Studying like an economist means making the most of study time. Our authors provide students with a nudge in the right direction, integrating proven study tools right into the book. Each chapter ends not with a repetitive summary, but with a clear, one-page “crib sheet” that crystallizes the key concepts and graphs. Thoughtfully structured headings create a built-in study guide for review while reading, and chapter-ending assessments help students to test their understanding.

Evaluating Public Policies

Evaluating Public Policies

Betsey Stevenson and Justin Wolfers present a new synthesis of economic principles for a new generation of students. Their unique focus on useful economics, compelling explanations, and real-life examples will help students use the basic tools of economics to develop economic intuition and apply it to everyday decisions—from personal and professional goals to public policy and the broader economy. Should you buy a car or rely on Uber? Get a job, or go to grad school? Spend or save? Start a business, or shut it down? Worry about inflation or unemployment?

With verve and clarity, the authors provide a fresh take on fundamental principles topics and develop Macroeconomics from its Micro foundations, in an engaging and student-focused presentation. Principles of Economics has drawn enthusiastic reviews from hundreds of instructors and thousands of students in pre-publication class tests and reviews.

Technology that offers the best value and price. Our most powerful learning option is also our most affordable. Principles of Economics is available in a new, integrated online learning system that features effective tools for each step of the learning path: pre-class, in-class, and post-class. The unique Decision Points digital features move students step-by-step through decision-making scenarios and offer feedback on how economic principles did (or did not) play into their choices.

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