Chapter 35

Chapter 35 explains the tradeoff relationship between unemployment and inflation in the short run. Phillips was the British economist that concluded that inflation and unemployment were linked. The Phillips Curve shows a negative relationship between unemployment and inflation. In the short run, a higher unemployment rate has a lower inflation rate. The Phillips curve basically demonstrates the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate demand curve move the economy along the short run aggregate supply curve. In the long run, the Phillips Curve is vertical, showing that the natural rate of unemployment is unchanged by different inflation rate levels. The vertical long run Phillips curve shows the classical idea of monetary neutrality. An increase in the money supply increases aggregate demand, raises the price level, and increases the inflation rate, but leaving output and unemployment at their natural rates. Friedman and Phelps introduced a new variable to the inflation-unemployment relationship: expected inflation. Expected inflation measures how much people expect the overall price level to change. Freidman and Phelps' work can be summarized into the equation: Unemployment rate= natural rate of unemployment-a(actual inflation-expected inflation). The natural rate hypothesis is that unemployment eventually returns to its natural rate, regardless of the rate of inflation. Stagflation is the combination of rising prices and falling output. The short-run Phillips Curve shifts due to supply shocks to aggregate supply. An adverse shift in aggregate supply lowers output and raises the price level. This gives policymakers a less favorable tradeoff between unemployment and inflation. Contradictory policy moves the economy down along the short run Phillips curve but in the long run expected inflation falls and the short run Phillips curve shifts to the left. The Volcker Disinflation shows how Volcker was successful at reducing inflation, but at a cost of having a high unemployment rate.

Chapter 34

Chapter 34 is about monetary and fiscal policy and their effects on the aggregate demand curve. Out of the three reasons that the aggregate demand is downward sloping, the interest-rate effect is the most important reason. The interest rate effect, as explained in the previous chapter, is that a lower price level reduces the amount of money people want to hold. The theory of liquidity preference is that the interest rate adjusts to the money supply and money demand's equilibrium. The two pieces of the theory of liquidity preference is money supply and money demand. Money supply is controlled by the Federal Reserve, who then alters the supply with the buying and selling of government bonds in open market operations. When the Fed increases the money supply, it lowers the interest rate and increases the quantity of goods and services demanded for any price level, shifting the aggregate demand curve right. The inverse situation of this is also true. Fiscal policy is the determining of the level of government spending and taxation by policymakers. The multiplier effect is the additional shifts in aggregate demand that result when expansionary fiscal policy increases income, which then increases consumer spending. The marginal propensity to consume (MPC) is the fraction of extra income that a household consumes rather than saves. The Multiplier equation is Multiplier=1+MPC+MPC^2+MPC^3... When x=MPC then the equation can be simplified to Multiplier= 1/(1-MPC). The larger the MPC, the greater effect on consumption, and the larger the multiplier. The crowding out effect is when expansionary fiscal policy raises the interest rate, which then reduces investment spending, creating a reduction in aggregate demand. Economic stabilization has been a clear goal of the United States policy since the Employment Act of 1946.  

Chapter 33

Chapter 33 is about analyzing short-run fluctuations with aggregate demand and aggregate supply curves. Economic fluctuations are irregular and unpredictable. Most macroeconomic quantities fluctuate together. Real GDP and investment spending have a direct relationship. As real GDP rises, investment spending rises. However, as real GDP rises, unemployment falls. They therefore have an inverse relationship. Most economics believe that classical theory describes the world in the long run but not in the short run. The aggregate demand curve is downward sloping while the short-run aggregate supply curve is upward sloping. The aggregate demand curve is downward sloping because wealthier consumers demand more consumption of goods, interest rates falling increases investment demand, and the depreciation of currency causes more demand of net exports. The aggregate demand curve might shift from changes in consumption, changes in investment, changes in government purchases, and changes in net exports. The long run aggregate supply curve is vertical because a change in the price level does not affect the quantity of goods and services supplied in the long run. The long run aggregate supply curve might shift from changes in labor, changes in capital, changes in natural resources, and changes in technological knowledge. The sticky-wage theory says wages are "sticky" in the short run, meaning that nominal wages are slow to adapt to new economic changes. The sticky-price theory says that prices of some goods are slow to adapt to new economic conditions. Stagflation is the economy experiencing both stagnation (falling output) and inflation (rising prices). Shifts in the aggregate supply can cause stagflation. Policymakers who can influence aggregate demand can potentially reduce the adverse impact on output but only at the cost of worsening the problem of inflation.

Chapter 32

Chapter 32 talks about the causes of macroeconomic variables (like net exports, net capital outflow, and real/nominal exchange rates) and how they are related to each other. The first topic is of two markets and their supply and demand. These markets are the market of loanable funds and the market for foreign currency exchange. The market of loanable funds' supply curve is derived from national saving meanwhile the demand curve is derived from domestic investment and net capital outflow. At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net capital outflow. The market for foreign currency exchange's supply curve is derived from net capital outflow, meanwhile its demand curve is derived from net exports. The important determinant of net capital outflow is the real interest rate, as was said in the previous chapter. There's a negative relationship between interest rate and net capital outflow. A budget deficit reduces the supply of loanable funds which then increases the real interest rate and reduces net capital outflow. That decrease in net capital outflow reduces the supply of dollars to be exchanged into foreign currency which causes the real exchange rate to appreciate. Trade policies don't affect the trade balance. This is because they don't change national saving or domestic investment. Free trade allows everyone to be better off because everyone specializes in their what they are best at. However, trade barriers/restrictions block these gains from trade and reduce the overall economic well-being, which is why economists usually oppose trade policies. Capital flight is a big and sudden reduction in the demand for assets in a country. 

Chapter 31

Chapter 31 is about open economies, which means there's free trade and interactions between multiple economies. Economies interact in an open economy by buying and selling goods in world product markets and by buying and selling capital assets like stocks and bonds. Balanced trade occurs if exports equals imports. Net exports are the value of a country's exports minus the value of a country's imports. Net capital outflow equals the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. Foreign direct investment differs from foreign portfolio investment because the former actively manages the investment while the latter has a more passive role. Net capital outflow equals net exports. National saving equals Y -C -G. Saving, investment, and international capital flows are all linked and entangled. Saving equals domestic investment plus net capital outflow. The nominal exchange rate is the rate where a person can trade the currency of one country for the currency of another. Appreciation of currency strengthens because it can buy more foreign currency. Currency weakens when it depreciates. The real exchange rate depends on the nominal exchange rate and on the price of goods in the two countries measured in local currencies. Purchasing -power parity is a theory that a unit of currency must have that same real value in all the other countries. If the purchasing power of the dollar is always the same at home and elsewhere, then the real exchange rate can't change. The nominal exchange rate between the currencies of two countries must reflect the price levels in those countries. The theory of purchasing- power parity isn't completely accurate because many goods are not easily traded and even tradable goods aren't always perfect substitutes when produced in different countries.

Chapter 30

Chapter 30 discussed inflation and its causes/ effects. Inflation is the increase in the overall level of prices. Deflation is long periods where most prices fell. Hyperinflation is an extraordinarily high rate of inflation. When the overall price level rises, the value of money falls. In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. At the equilibrium price level, the quantity of money that people want to hold exactly balances the quantity of money supplied by the Fed. The equilibrium of the money supply and money demand determines the price level and the value of money. Classical dichotomy is the theoretical separation of nominal and real variables. The difference between real and nominal variables is that real variables are measured in physical units, while nominal variables are measured in monetary units. To calculate the velocity of money, the equation V= ( P X Y ) / M. The quantity theory of money states that growth in the money supply is the primary cause of inflation. The inflation tax is like a tax on everyone who holds money. The Fisher effect is the one-for-one adjustment of the nominal interest rate to the inflation rate. The Fisher effect is a long-run perspective because inflation is unexpected and can't therefore be held in the short-run. Inflation does not in itself reduce people's real purchasing power. Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings. The six costs of inflation are: shoeleather costs (reduced money holdings), menu costs (more frequent adjustment of prices), increased variability of relative prices, unintended in tax liabilities, confusing from changing unit of account, and arbitrary redistributions of wealth between creditors and debtors.  

Chapter 29

Chapter 29 talks about the monetary system. Money is the set of assets in the economy that people regularly use to buy goods and services from other people. Money has three functions in the economy: medium of exchange, unit of account, and a store value. Commodity and fiat are two kinds of money. Intrinsic value means that the item would have value even if it were not used as money. Money stock for the US economy includes currency and deposits in banks/other financial institutions that can be easily accessed to buy goods and services. The Federal Reserve was created in 1913 to ensure the health of the nation's banking system. The Federal Reserve System is made up of the Federal Reserve Board in D.C. and twelve regional Federal Reserve Banks across the country. The Fed has two jobs: regulating the banks/ ensuring the health of the banking system and controlling the quantity of money that is made available. The second job is considered more important than the first. Deposits that banks have received but have not loaned out are called reserves. Since all deposits are help as reserves, in this imaginary economy, the system is called 100 percent reserve banking. When banks hold only a fraction of deposits in reserve, banks create money. The money multiplier is the reciprocal of the reserve ratio. The higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier. If banks hold all deposits in reserve, banks do not influence the supply of money. The Fed has three tools in its monetary toolbox: open-market operations (buying/selling government bonds), reserve requirements, and the discount rate. The problems with the Fed's three tools are that the Fed doesn't control the amount of money that households choose to hold as deposits in banks and that it doesn't control the amount that bankers choose to lend.

Chapter 28

Chapter 28 talks about unemployment. It tells us how to calculate the unemployment rate and the labor participation rate. The unemployment rate is calculated as the number of unemployed people divided by the labor force times one hundred. The labor participation rate is calculated as the labor force divided by the adult population times one hundred. It differentiates between employed, unemployed, and not in the labor force. The labor force consists of employed and unemployed people. The natural rate of unemployment is the normal rate at which the unemployment rate fluctuates. Cyclical unemployment is the drifting of unemployment from its natural rate. Women have been starting to have increasing labor participation rates while the men's decreases because more men are becoming stay at home dads while their wives work, and older men retire earlier and live longer. Discouraged workers are people who would like to work but have given up looking for a job. With regard to minimum wage laws, if the wage is kept above the equilibrium level, the result is unemployment. Unemployment is an imperfect measure. One reason unemployment exists is because of how long it takes for people to find a job that suits their interests and skills. Another reason is that because of minimum wage laws the resulting surplus of labor symbolizes unemployment. A third reason is the market power of unions because they create a surplus of labor. A fourth reason is the theory of efficiency wages, which states that paying employees higher wages increases worker quantity/health and worker effort. Unemployment is not a straightforward problem with simple solution.

Chapter 27

Chapter 27 talks about using financial thinking to people's decisions in the financial market. The future value is the money in the future that would be produced today. Present value is the money available today that would be needed, using current interest rates, to produce a future amount of money. The equation X/(1+r)^N where "r" is the interest rate and "N" is the number of years that would amount to "X". Most people dislike uncertainty and are risk averse. To deal with that, in the economy, there's insurance, diversification, and risk-return trade off. Insurance suffers from problems that prevent their ability to spread risk. One problem is adverse selection, where a high risk person is more likely to desire insurance because they would benefit more from insurance protection than a low risk person. With diversification, risk can be reduced by placing a large number of small bets, rather than a small number of large bets. Even though diversification reduces the risk of holding stocks, it doesn't completely eliminate it. When people increase the percentage of their savings that they have invested in stocks, they increase the average return they can anticipate to earn. However, they also increase the risks they face, showing the trade off with risk and return. To determine the value of a company, the fundamental analysis is used. The value of an asset is determined by the efficient markets hypothesis, which implies that stock prices should follow a random walk. The efficient markets hypothesis is controversial because some economists believe that irrational psychological factors also impact asset prices and value. 

Chapter 26

Chapter 26 is about examining our financial system and its relationship with saving and investment. Financial markets are places where a person can provide money to some who needs to borrow it. Two financial markets are the bond market and the stock market. There are three characteristics of ds that are most important: a bond's term, its credit risk, and its tax treatment. In the stock market, equity finance is the sale of a stock to rise money. Debt finance is the sale of bonds. Financial intermediaries are institutions where savers can indirectly provide funds to borrowers. Two important financial intermediaries are banks and mutual funds  The interest rate in the economy adjusts its itself to balance the supply and demand for loanable funds. Saving is the source of supply, while investment is the source of demand. A closed economy is one that doesn't interact with other economies. Its equation is Y=C+I+G. This equation shows that GDP is the sum of consumption, investment, and government purchases. Imports and exports are zero because a closed economy isn't involved in trade. The interest rate in the economy adjusts to balance the supply and demand for loanable funds. Saving is the source of supply, meanwhile investment is the source of demand for loanable funds. The interest rate is the price of the loan. If a reform of tax laws encouraged greater saving, the result would be lower interest rates and greater investment. If a reform of tax laws encouraged more investment, the result would be higher interest rates and greater saving. A budget surplus increases the supply of loanable funds, reduces the interest rate, and encourages investment. I thought the section of this chapter on the history of the US government debt was interesting and informative.   

Chapter 24

Chapter 24 is about calculating the cost of living. The consumer price index (CPI) is used to observe changes in the cost of living over time. CPI is a measure of the overall cost of goods purchased  by an average consumer. The inflation rate is the percentage change in the prices from previous levels. The Bureau of Labor produces only reports on the consumer price index. These are the steps in calculating consumer price index: 1. Survey consumers to get a fixed basket of goods. 2. Find the rice of each good per year. 3. Compute the basket's cost. 4. Choose a base year and compute the index. 5. Compute the inflation rate. Three problems with the consumer price index are substitution bias, the introduction of new goods, and unmeasured quality change. The producer price index is a measure of how much an average producer pays for a good or service rather than a consumer. One difference between GDP deflator and CPI is that GDP deflator reflects all the prices of goods/services domestically produced, meanwhile CPI reflects the prices of goods/services bought by consumers. The second difference is that the CPI compares the price of a fixed basket of goods/services to the price of the basket in the base year. Meanwhile, the GDP deflator compares the price of currently produced goods/services to the price of the same goods/services in the base year. Real interest rate equals the nominal interest rate minus the inflation rate. The real interest rate tells you how fast the purchasing power of your bank account rises over time.

Chapter 23

Chapter 23 introduces GDP (gross domestic product). It's a part of macroeconomics, which studies the economy as a whole. Meanwhile, microeconomics, studies single firms and how they behave with one another. GDP is meant to judge a how well a country's economy is doing based on its total income earned as a nation. For an economy as a whole, income must equal expenditure. It's true because every expenditure has a buyer and a seller. The GDP's identity is denoted in the equation Y=C+I+G+NX. GPD(Y) is divided into four parts: consumption (C), investment (I), government purchases (G), and net exports (NX). Consumption is what households spend for goods and services. Investment is purchasing goods that'll be used later to make even more goods. Government purchases is what state, local, and federal governments spend on goods and services. Net exports is buying domestically produced goods from foreigners minus the domestic purchases of foreign goods. In short, it's the exports minus the imports. The GDP deflator is calculated from the ratio of the nominal to real GDP. The equation is GDP deflator= (Nominal GDP)/(Real GDP) * 100. The nominal GDP is the production of services and goods valued at current prices. The real GDP is the production of services and goods valued at constant prices. The goal in calculating GDP is to see how well the economy is performing overall. The gross domestic product seen as a good but not perfect measure of economic well-being. This is because GDP excludes the value of leisure, clean Earth, and volunteer work.

Chapter 18

Chapter 18 talks about the factors of production, which include land, capital, and labor. To make a hiring decision, a firm must consider how the size of its work force affects the amount of output produced. The diminishing marginal product is that as the numbers of workers increases, the marginal product of labor declines. The theory of neoclassical production is that the amount paid to each factor of production depends on the supply and demand for that factor. The marginal revenue product is the extra revenue the firm gets from hiring an additional unit of a factor of production. The value of the marginal product curve is the labor-demand curve for a competitive profit maximizing firm. A competitive profit-maximizing firm hires workers up to the point where the value of the marginal product of labor equals the wage. Changes in taste, changes in alternative opportunities, and immigration causes the shifts to the labor supply curve. Any event that changes the supply or demand for labor must change the equilibrium wage and the value of the marginal product by the same amount. This is because these must always be equal. Capital is used to refer to the stock of equipment and structures used for production. The economy's capital represents the building up of goods produced in the past that are being used now to produce new goods and services. Labor, land, and capital each earn the value of their marginal contribution to the production process. Since the factors of production are used together, the marginal product of any factor depends on the total quantities available. I thought that the case study of the Black Death was helping in understanding the topics covered in this chapter.  

Chapter 17

Chapter 17 is about oligopolies and their behavior in the market. Oligopolistic firms are interdependent on each other, unlike competitive firms. An oligopolistic market has few sellers that impact each other's profits with their behaviors. It is part of imperfect competition in which firms have competitors but do not face as much competition because they are price takers not price makers. An oligopoly with only two members is called a duopoly, which is the simplest type of oligopoly. When firms in an oligopoly individually choose to produce at maximum profit, they produce at a quantity greater than the level of a monopoly and less than the level produced by competitive. An oligopoly's price is less than the monopoly price but more than the competitive price. The output effect is that selling one more quantity at the price (as above marginal cost) would raise profit. The price effect is that raising production would increase the total quantity sold, which would lower the price of water and its profit on the other products sold. As the number of sellers in an oligopoly increases, it begins to look more like a competitive market. In return, the price begins to reach marginal cost and the quantity would start to reach the socially efficient level. Policymakers use antitrust laws to prevent oligopolies from reducing competition with their behavior. Controversies have arisen over the types of behavior antitrust laws should prohibit. Three examples of controversial business practices are resale price maintenance, predatory pricing, and tying. I thought this chapter was informative in its comparison of oligopolies, competitive, and monopolistic markets. It helped clarify the differences between the different markets.

Chapter 16

Chapter 16 is about monopolistic competitive markets. They are markets that contain elements of competitive markets and some elements of monopolies. A monopolistic competitive market is defined by having many sellers, product differentiation, and free entry. Similar to monopolies, monopolistic competitive markets produce at the quantity where marginal revenue equals marginal costs. It then uses the demand curve to set the price at that quantity. In the long run equilibrium of a monopolistic competitive market, price equals average total cost, like a competitive market. Also, price exceeds marginal cost, as in a monopoly. There are positive and negative externalities from the entry of new firms. The product-variety externality is where an entry of a new firm creates a positive externality on consumers because consumers get some consumer surplus. The business-stealing externality is where the entry of a new firm creates a negative externality on existing firms because a new competitor causes other firms to lose customers and profits. The product differentiation apparent in monopolistic competitive markets leads to the use of brand names and advertising. This leads to critics and defenders of advertising. Like monopolies, monopolistic competitive markets don't produce at the welfare-maximizing level of output. Similar to monopolies, monopolistic competitive markets have price exceeds marginal costs and are not price takers. Like competitive markets, monopolistic competitive markets contain many firms in the market and can have entry in the long run. Monopolistic competitive, monopolies, and perfectly competitive markets all have the goal to maximize profits. I thought this chapter was interesting in its comparison of the different types of markets and how monopolistic competitive markets are hybrids of monopolies and perfectly competitive markets.

Chapter 15

Chapter 15 is about monopolies and their role in the market. They are the sole producers of a product, and are given exclusive rights by the government to produce their good through patents and copyright laws. A natural monopoly is a firm that is the sole producer of a product and supplies the market at a lower cost than multiple firms could. Since a competitive firm is a price taker, their demand curve is a horizontal line. However, since monopolies are sole producers of a product, its demand curve is downward-sloping This is because as the monopoly reduces its quantity of output it sells, the price of its output increases. A monopoly's MR<P. For a competitive firm: P=MR=MC. However, for a monopoly: P>MR=MC. The socially efficient quantity is where the demand curve and marginal-cost curve intersect. However, monopolies produce less than the socially efficient quantity and produce a deadweight loss. A monopoly causes deadweight losses similar to the deadweight losses produced by taxes. The deadweight losses of a monopoly are eliminated only in extreme cases of perfect price discrimination. Monopolists try to raise their profits by charging different prices for the same item based on a buyer's willingness to pay. Policymakers respond to the problems of monopolies by: trying to make the monopolized industries more competitive, regulating the behaviors of monopolies, turning some private monopolies into public enterprises, or by doing nothing at all. Overall, I thought this chapter was dense in information. I thought that Table 2 on page 338 was very helpful in summarizing the similarities and differences between monopolies and competitive firms.

Chapter 14

Chapter 14 is about how firms want to maximize profits with production decisions in competitive markets. Buyers and sellers need to accept the prices in the market and are seen as price takers. Three characteristics make up perfectly competitive markets: 1. There are many buyers and sellers in the market. 2. The items offered by the numerous sellers are largely the same. 3. Firms can freely enter or exit the market. Average revenue is the total revenue divided by the quantity sold. For all firms, the average revenue equals the price of the good. The marginal-cost curve, on a graph, is also the competitive firm's supply curve because it determines the quantity of the good the firm is willing to supply at any price. The competitive firm's short-run supply curve is the portion of the marginal-cost curve that is above AVC. The competitive firm's long-run supply curve is the portion of its marginal-cost curve that is above ATC. A firm's profit is (P-ATC) X Q. The process of exit and entry ends only when price and average total cost are driven to equality. Since firms can enter and exit more easily in the long-run than in the short-run, the long-run supply curve is more elastic than the short-run supply curve. I thought this chapter had helpful graphs for visualization. For example: Figure 8 had numerous graphs depicting the increases in demand in the short-run and long-run, which was helpful in understanding this concept.  

Chapter 13

Chapter 13 talks about expanding our knowledge in firm behavior, by analyzing them more closely. Industrial organization is the study of how firms' decisions about the prices and quantities are relied on the market condition. Profit is total revenue minus total cost. Explicit costs are costs that make it mandatory for the firm to pay out some money. Implicit costs are costs that do not require a cash outlay from a firm. Economists study both implicit and explicit costs when studying how firms make production and pricing decisions. However, accountants only measure explicit costs and ignore implicit costs. Production function is the relationship between quantity of inputs to outputs of a good. The diminishing marginal product is the property where the marginal product of an input decreases as the quantity of input increases. Total cost can be divided into two types: fixed costs and variable costs. Variable costs vary with the quantity of output produced, unlike fixed costs. A firm's total cost is the sum of fixed costs and variable costs. Average total cost is the total cost divided by quantity. Marginal cost is the change in total cost divided by change in quantity. These show how the average total cost and marginal cost are obtained from total cost. Whenever the marginal cost is less than average total cost, average total cost is falling. However, whenever marginal cost is greater than average total cost, average total cost is rising. Costs vary with the quantity of output a firm produces. I thought this chapter was extremely informative and full of terminology that are well summarized in Table 3. 

Chapter 11

Chapter 11 observes the problems that appear with goods that don't have a market price and shows their effects on the market. Two characteristics of goods are excludability and rival in consumption. Excludability refers to whether one can be prevented from using a good. Rival in consumption refers to whether someone's use of good diminishes another person's ability to use it. Goods with these characteristics are split into four categories: private goods, public goods, common resources, and natural monopolies. Private goods are both excludable and rival in consumption. Most goods tend to be private goods. Public goods are neither excludable nor rival in consumption. Common resources are rival in consumption but not excludable. Natural monopolies are excludable but not rival in consumption. A free rider is someone who benefits from a good without paying for it. Since public goods are not excludable, the free-rider problem stops the private market from producing them. Cost-benefit analysts have the tough job of finding the cost and benefits of a good to society and their conclusions tend to just be approximates. Common resources arise the problem of Tragedy of Commons, which is a story explaining why common resources get used more than is desirable. The lesson of the Tragedy of Commons is that when one person uses a common resource, it reduces other people's pleasure of it. This illustrates a negative externality that the government can solve through taxes/regulation or by converting the common resource to a private good. I thought this chapter was well-explained through the multiple examples of common resources and public goods.

Chapter 10

Chapter 10 talks about externalities and how they create inefficiencies in the market. When there's a negative externality, the socially optimal quantity in a market is less than the equilibrium quantity. When there's a positive externality, the socially optimal quantity in a market is greater than the equilibrium quantity. The Coase theorem states that people can solve the problems of externalities on their own. People can bargain until they reach an efficient solution that benefits everyone. When this private bargaining doesn't work, the government intervenes. The government can respond to externalities by command-and-control policies or market-based policies. Command-and-control policies usually mean the government makes laws banning or requiring certain actions to remedy an externality. Market-based policies the government can internalize the externality by applying taxes to goods that cause negative externalities or by subsidizing goods that have positive externalities. The corrective taxes on negative externalities raise revenue for the government and also enhance economic activity. Another market-based policy is tradable pollution permits. The markets that trade these permits are guided by the invisible hand to ensure efficiency. From this, the pollution permits will be given to firms that value it most highly, according to their willingness to pay. A firm's willingness to pay is based on its cost of reducing pollution. The more it costs for a firm to cut back on pollution, the more it would be willing to pay for a permit. I thought this chapter was interesting because it expanded my knowledge of externalities and their effects on the market.