Elasticity The price elasticities of demand for individual good are determined by the economic characteristics of demand.

. Price elasticities tend to be higher when the good are luxuries, when substitutes are available and when consumers have more time to adjust their behavior Elasticites are lower for necessities for good with few substitutes, and for the short run. Price-elastic demand a 1 percent change in price calls forth more than a 1 percent change in quantity demanded Price inelastic demand a 1 percent change in price produces less than a 1 percent change in the quantity demanded o Food & footwear are inelastic Unit elastic demand the percentage change in quantity is exactly the same as the percentage change in price Completely inelastic demands, ones with zero elasticity, are ones where the quantity demanded responds not at all to price changes; such demand is seen to be a vertical demand curve When demand is infinitely elastic, a tiny change in price will lead to an indefinitely large change in quantity demanded as in the horizontal demand curve. Elasticity depends upon the slope of the demand curve, but it also depends upon the specific price and quantity pair o Dont confuse the elasticity of a curve with its slope Along a straight line demand curve, the price elasticity varies from zero to infinity The slope is not the same as the elasticity because the demand curves slope depends upon the changes in P and Q, whereas the elasticity depends upon the percentage changes in P and Q o The only exceptions are the polar cases of completely elastic and inelastic demands Elasticity can be calculated as the ratio of the length of the straight line or tangent segment below the point to the length of the segment above the point Qd > P inelastic Total revenue = P x Q When demand is price inelastic a price decrease reduces total revenue When demand is price elastic a price decrease increases total revenue In the borderline case of unit elastic demand, a price decrease leads to no change in total revenue Price discrimination is the practice of charging different prices for the same service to different customers The paradox of the bumper harvest: the demand for basic food products such as wheat and corn tend to be inelastic; for these necessitates, consumption changes very little in response to price. This means farmers as a whole receive less total revenue when the harvest is good than when it is bad. The

increase in supply arising from an abundant harvest tends to lower the price. But the lower price doesnt increase quantity demanded very much. Price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price The major factor influenced supply elasticity is the ease with which production in the industry can be increased. Restrictions on production are a typical example of government interference in individual markets, They often raise the income of one group at the expense of consumers. These policies are generally inefficient: the gain to farmers is less than the harm to consumers. With price inelastic demand, farm incomes decline with increases in supply Consumer behavior Utility how consumers rank different goods and services People choose those goods and services they value most highly In the theory of demand, we assume that people maximize their utility, which means that they choose the bundle of consumption goods that they most prefer. The expression marginal is a key term that means additional or extra. Marginal utility denotes the additional utility you get from the consumption of an additional unit of a commodity Law of diminishing marginal utility: the amount of extra or marginal utility declines as a person consumes more and more of a good o Utility tends to increase as you consume more of a good. However as you consumer more and more your total utility will grow at a slower and slower rate. This is the same thing as saying that your marginal utility (the extra utility assed by the last unit consumed of a good) diminishes as more of a good is consumed. o As the amount of a good consumed increases the marginal utility of that goods tends to decline Total utility is the sum of all the marginal utilities that were added from the beginning Consumer surplus The gap between the total utility of a good and its total market value is called consumer surplus o The surplus arises because we receive more than we pay for as a result of the law of diminishing marginal utility Because consumers pay the price of the last unit for all units consumed, the enjoy a surplus of utility over cost. Consumer surplus measures the extra value that consumers receive above what they pay for a commodity Production and Business Organization The production function specifies the maximum output that can be produced with a given quantity of inputs. It is defined for a given state of engineering and technical knowledge

o Assuming that firms always strive to produce efficiently. they always attempt to produce the maximum level of output for a given dose of inputs Total product, which designates the total number of output produced, in physical units such as bushels of wheat or number of sneakers Marginal product of an input is the extra output produced by one additional unit of that input while other inputs are held constant Average product total output divided by total units of input Under the law of diminishing returns a firm will get less and less extra output when it adds additional units of an input while holding other inputs fixed. In other words the marginal product of each unit of input will decline as the amount of that input increases holding all other inputs constant. As more of an input such as labor is added to a fixed amount of land, machinery, and other inputs, the labor has less and less of the other factors to work with. The land gets more crowded, the machinery is overworked, and the marginal product of labor declines. Diminishing returns and marginal products refer to the response of output to an increase of a single input when all other inputs are held constant Returns to scale the effects of scale increases of inputs on the quantity produced o Constant returns to scale a case where a change in all inputs leads to a proportional change in output Handicraft industries hair cutting o Increasing returns to scale also called economies of scale arise when an increase in all inputs leads to a more than proportional increase in the level of output. o Decreasing returns to scale when a balanced increase of all inputs leads to a less than proportional increase in total output. Production shows increasing, decreasing or constant returns to scale when a balanced increase in all inputs leads to a more than proportional, less than proportional, or just proportional increase in output. Short run a period in which firms can adjust production by changing variable factors such as materials and labor but cannot change fixed factors such as capital o The factors which are increased in the short run are variable factors. Long run a period sufficiently long that all factors including capital can be adjusted. Efficient production requires time as well as conventional inputs like labor. We therefore distinguish between two different time periods in production and cost analysis. The short run is the period of time in which only some inputs, the variable inputs, can be adjusted. In the short run, fixed factors such as plant and equipment, cannot be fully modified or adjusted. The long run is the period in which all factors employed by the firm, including capital, can be changed. Technological Change

We distinguished process innovation, which occurs when new engineering knowledge improves production techniques for existing products, from the product innovation, whereby new or improved products are introduced in the marketplace Process innovation is equivalent to a shift in the production function Network markets are special because consumers derive benefits not simply from their own use of a good but also from the number of other consumers who adopt the good Productivity and the aggregate production function Productivity is a concept measuring the ratio of total output to a weighted average of inputs o Labor productivity calculates the amount of output per unit of labor o Total factor productivity measures output per unit of total inputs Total factor productivity is output divided by an index of all inputs (labor, capital, materials,), while labor productivity measures output per unit of labor (such as hours worked) When output is growing faster than inputs, this represents productivity growth o Technological advances process and product innovations o Economies of scale and scope Economies of scope when a number of different products can be produced more efficiently together than apart o Like the specialization and division of labor that increase productivity as economies become larger and more diversified Business Organizations Business firms are specialized organizations devoted to managing the process of production Production is organized in firms because of economies of specialization. Efficient production requires specialized labor and machinery, coordinated production, and the division of production into many small operations Function of firms - Raising resources for large scale production A third reason for the existence of firms is to manage and coordinate the production process o Once all the factors of production are engaged someone has to monitor their daily activities to ensure that the job Is being done effectively and honestly. Business firms are specialized organizations devoted to managing the process of production. Production is organized in firms because efficiency generally requires large scale production, the raising of significant financial resources, and careful management and coordination of ongoing activities. Analysis of Costs Fixed costs expenses that must be paid even if the firm produces zero output they do not change if output changes Variable costs do vary as output changes

o VC begins at zero when q is zero. VC is a part of TC that grows with output; indeed the jump in TC between any two outputs is the same as the jump in VC Total costs represents the lowest total dollar expense needed to produce each level of output q. o TC rises as q rises Fixed cost represents the total dollar expense that is paid out even when no output is produced; fixed cost is unaffected by any variation in the quantity of output Variable costs represents expenses that vary with the level of output- such as raw materials, wages and fuel and includes all costs that are not fixed TC = FC + VC To attain the lowest level of costs, the firms managers have to make sure that they are paying the least possible amount for necessary materials, that the lowest-cost engineering techniques are incorporated into the factory layout, that employees are being honest, and that countless other decisions are made in the most economical fashion Marginal cost denotes the extra or additional cost of producing 1 extra unit of output The marginal cost of production is the additional cost incurred in producing 1 extra unit of output Average cost is a concept widely used in business; by comparing average cost with price or average revenue, businesses can determine whether or not they are making a profit Average cost is the total cost divided by the total number of units produced Average fixed cost is defined as FC/q. Since total fixed cost is a constant, dividing it by an increasing output gives a steadily falling average fixed cost curve o As a firm sells more output, it can spread its overhead cost over more and more units Average variable cost equals variable cost divided by output When marginal cost is below average cost it is pulling average cost down o If MC is below AC this means that the last unit produced costs less than the average cost of all the previous units produced When MC is above AC, it is pulling up AC When MC just equals AC AC is constant. At the bottom of the Ushaped AC, MC=AC=minimum AC In terms of our cost curves, if the MC curve is below the AC curve, the AC curve must be falling. By contrast if MC is above AC, AC is rising. Finally when MC is just equal to AC, the AC curve is flat. The AC curve is always pierced at its minimum point by a rising MC curve Key elements of the costs curves are factor prices and firms production function The short run is the period of time that is long enough to adjust variable inputs, such as materials and production labor, but too short to allow all

inputs to be changed. In the short run fixed or overhead factors such as plant and equipment cannot be fully modified or adjusted. Therefore in the short run, labor and materials costs are typically variable costs, while capital costs are fixed. In the long run, all inputs can be adjusted including labor, materials, and capital. Hence in the long run all cost are variable and none are fixed. Diminishing returns to the variable factor will imply an increasing short run marginal cost this shows why diminishing returns lead to rising marginal costs The u- shaped cost curves are based on diminishing returns in the short run. With fixed land and variable labor the marginal product of labor first rises to the left of B, peaks at B and then falls at D as diminishing returns to labor set in In the short run, when factors such as capital are fixed, variable factors tend to show an initial phase of increasing marginal product followed by diminishing marginal product. The corresponding cost curves show an initial phase of declining marginal costs, followed by increasing MC after diminishing returns have set in Least cost rule: To produce a given level of output at least cost, a firm should buy inputs until it has equalized the marginal product per dollar spend on each input Substitution rule: If the price of one factor falls while all the factor prices remain the same, firms will profit by substituting the now cheaper factor for the other factors until the marginal products per dollar equal for all inputs Net income (profit) = total revenue total expenses Income statement o The first three cost categories materials, labor cost, and miscellaneous operating costs basically correspond to the variable costs of the firm, or its cost of goods sold o The next three categories lines 6-8 correspond to the firms fixed costs, since in the short run they cannot eb changed We call the amount that is used up depreciation and calculate that amount as the cost of the capital input for that year. Depreciation measures the annual cost of a capital input that a company actually owns itself Balance sheet a picture of financial conditions on a given date records what a firm person, or nation is worth at a given point in time Assets valuable prosperities or rights owned by the firm Liabilities money or obligations owned by the firm Net worth net value equal to total assets minus total liabilities One important distinction between the income statement and the balance sheet is that between stocks and flows Stock represents the level of a variable, such as the amount of water in a lake or, in this case, the dollar value of a firm

Flow variable represents the change per unit of time, like the flow of water in a river or the flow of revenue and expenses into and out of a firm The income statement measures the flows into and out of the firm, while the balance sheet measures the stocks of assets and liabilities at the end of the accounting year Total assets = total liabilities + net worth A balance sheet must always balance because net worth is a residual defined as assets minus liabilities The income statement shows the flow of sales, cost, and revenue over the year or accounting period. It measures the flow of dollars into and out of the firm over a specified period of time The balance sheet indicates an instantaneous financial picture or snapshot. It is like a measure of the stock of water in a lake. The major items are assets, liabilities, and net worth Resources are scarce every time we choose to use a resource one way weve given up the opportunity to utilize it another way. Making a choice in effect costs us the opportunity to do something else. The value of the best alternative forgone is called the opportunity cost The opportunity costs of a decision include all its consequences, whether they reflect monetary transactions or not Decisions have opportunity costs because choosing one thing in a world of scarcity means giving up something else The opportunity cost is the value of the most valuable good or service forgone Opportunity cost is the actual expenses and the forgone cost In well functioning markets, when all costs are included, price equals opportunity costs Economic costs include, in addition to explicit money outlays, those opportunity costs incurred because resources can be used in alternative ways. Analysis of Perfectly Competitive Markets Perfect competition is the world of price takers A perfectly competitive firm sells a homogenous product (one identical to the product sold by others in the industry). o The firm is so small relative to its market that it cannot affect the market price; it simply takes the price as given Because a competitive industry is populated by firms that are small relative to the market, the firms segment of the demand curve is only a tiny segment of the industrys curve o Graphically, the competitive firms portion of the demand curve is so small that to the Lilliputian eye of the perfect competitor, the firms dd demand curve looks completely horizontal or infinitely elastic Under perfect competition, there are many small firms, each producing an identical product and each too small to affect the market. The perfect competitor faces a completely horizontal demand of dd curve

The extra revenue gained from each extra unit sold is therefore the market price. The maximum profit comes at that output where marginal cost equals price The competitive firm can always make additional profit as long as the price is greater than the marginal cost of the last unit o Total profit reaches its peak is maximized where there is no longer any extra profit to be earned by selling extra output o At the maximum-profit point, the last unit produced brings in an amount of revenue exactly equal to that units cost Extra revenue the price per unit Extra cost marginal cost Rule for a firms supply under perfect competition: A firm will maximize profits when it produces at that level where marginal cost equals price o Marginal cost = price Zero profit point the production level at which the firm makes zero economic profits; at the zero profit point, price equals average cost, so revenues just cover costs. A profit maximizing firm will set its output at that level where marginal cost equals price. Diagrammatically, this means that a firms marginal cost curve is also its supply curve the firm should not necessarily shut down if it is losing money. The firm should minimize its losses, which is the same thing as maximizing profits. The critically low market price at which revenues just equal variable costs (or, equivalently, at which losses exactly equal fixed costs) is called the shutdown point. For prices above the shutdown point, the firm will produce along its marginal cost curve because, even though the firm might be losing money, it would lose more money by shutting down. Shutdown rule: The shutdown point comes where revenues just cover variable costs or where losses are equal to fixed costs. When the price falls below average variable costs, the firm will maximize profits (minimize its losses) by shutting down The zero profit point comes where price is equal to AC, while the shutdown points comes where price is equal to AVC. The quantity supplied by a firm will be determined by each firms marginal costs. The total quantity brought to market at a given price will be the sum of the individual quantities that all firms supply at that price. The market supply curve for a good in a perfectly competitive market is obtained by adding horizontally the supply curves of all the individual producers of that good Short run equilibrium when output changes must use the same fixed amount of capital Long run equilibrium when capital and all other factors are variable and there is free entry and exit of firms into and from the industry

Increased inputs of variable factors will produce a greater quantity of fish along the short run supply curve The high price lead to high profits, which in the long run coax out more shipbuilding and attract more sailors into the industry. Additionally new firms may start up or enter the industry. This gives the long run supply curve and long run equilibrium. o The intersection of the long run supply curve with the new demand curve yields the long run equilibrium attained when all economic conditions have adjusted to the new level of demand The long run supply curve of industries using scarce factors rises because of diminishing returns N the long run firms will produce only when price is at or above the zero profit condition where price equals average cost In the long run the price in a competitive industry will tend toward the critical point where revenues just cover full competitive costs. Zero profit long run equilibrium in a competitive industry populated by identical firms with free entry and exit, the long run equilibrium condition is that price equals marginal cost equals the minimum long run average cost for each identical firm o P=MC = minimum long run AC = zero profit price o This is the long run zero economic profit condition The long run equilibrium in a perfectly competitive industry is therefore on with no economic profits Demand rule o Generally an increase in demand for a commodity (the supply curve being unchanged) will raise the price of the commodity. o For most commodities an increase in demand will also increase the quantity demanded. A decrease in demand will have the opposite effects Supply rule o An increase in supply of a commodity (the demand curve being constant) will generally lower the price and increase the quantity bought and sold o A decrease in supply has the opposite effects. When the quantity supplied is constant at every price, the payment for the use of such a factor of production is called rent or pure economic rent At firms the more labor supplied rises as higher wages coax out more labor. But beyond a certain point higher wages lead people to work fewer hours and to take more leisure. An increase in demand raises the price of labor, as was stated in the demand rule Increased supply must decrease price and increase quantity demanded An increased supply will decrease P most when demand is inelastic An increased supply will increase Q lease when demand is inelastic

An economy is efficient when it provides its consumers with the most desired set of goods and services given the resources and technology of the economy Pareto efficiency (or sometimes just efficiency) occurs when no possible reorganization of production or distribution can make anyone better off without making someone else worse off. Under conditions of allocative efficiency, one persons satisfaction or utility can be increased by lowering someone elses utility. An a minimum an efficient economy is on its ppf, but efficiency goes further and requires not only the right mix of goods be produced but also that these goods be allocated among consumers to maximize consumer satisfactions Economic surplus between the supply and demand curves at the equilibrium the sum of the consumer surplus, which is the area between the demand curve and the price line o The welfare or net utility gain from production and consumption of a good; it is equal to the consumer surplus plus the producer surplus Producer surplus the area between the price line and the SS curve the producer surplus includes the rent and profit to firms and owners of specialized inputs in the industry and indicates the excess of revenues over cost of production The marginal gain to society from the last unit consumed equals the marginal cost to society of that last unit produced- which guarantees that a competitive equilibrium is efficient A perfectly competitive economy is efficient when marginal private cost equals marginal social cost and when both equal marginal utility The perfectly competitive market is a device for synthesizing the willingness of consumers possessing dollar votes to pay for goods with the marginal costs of those goods as represented by firms supply. Under certain conditions, competition guarantees efficiency, in which no consumers utility can be raised without lowering another consumers utility. This is true even in a world of many factors and products Marginal cost is a fundamental concept for efficiency. For any goal oriented organization, efficiency requires that the marginal cost of attaining the goal should be equal in every activity. In a market, an industry will produce its output at minimum total cost only when each firms MC is equal to a common price Markets may be inefficient in situations where pollution or other externalities are present or when thee is imperfect competition or information The distribution of incomes under competitive markets, even when it is efficient, may not be socially desirable or acceptable Market failures o Imperfect competition drug patent the firm can raise the price of its product above its marginal cost. consumers buy less of such goods than they would under perfect competition

o Externalities some of the side effects of production or consumption are not included in market prices o Imperfect information Monopoly There is a single seller of a good or service which has not close substitute The monopoly power of a firm refers to the extent of its control over the supply of the product that is produced by the industry of which it is a part The monopoly power of a firm in a imperfectly competitive market is greater the larger the firms output is relative to the output of the industry as a whole. It is less the smaller the firms output is relative to the output of the entire industry Concentration ratio the percentage of industry sales accounted for by the four (or eight) largest firms in an industry; a measure of monopoly power. o Significant degree of monopoly power when the concentration ratio reaches 70 or 80 percent The price which sellers are able to charge is always limited by what buyers are willing to pay Marginal revenue the increase in revenue accruing to the firm from selling an additional unit of its product Profits the difference between total revenue and total cost; maximized by producing the output at which marginal revenue equals marginal cost MR is les than Mc and profits decrease MR is greater than Mc, an increase in output level will increase profits Profits are maximized by producing the output level at which MR equals MC (competitive) The monopolist faces the market demand curve which is downward sloping to the right instead of horizontal. This fact has important implications for marginal revenue. Any firm that faces a demand curve that is sloping downward to the right will find that its marginal revenue is less than product price at any given output level. To recapitulate the analysis, in a monopolized market the price of the product tends to be higher and the output tends to be less that it would be if the industry could be and were competitive Monopolist downward sloping demand curve Deadweight welfare loss due to monopoly- the reduction in social welfare due to the exercise of monopoly power Barriers to entry impediments to the entry of new firms into a market, such as product differentiation and government licensing, usually used by monopolists to protect their favored positions Firms or firms already in a market won or control most of some key raw material needed for making the product. All they must do to restrict entry is deny potential entrants access to it Suppose that when new firms are in the process of entering, the existing firms threaten to lower prices to the extent that the newcomers would experience substantial losses.

Product differentiation may be successful in retarding entry in some instances Network economies situation in which the value of a product to a consumer is enhanced when others also choose to consume the same product Government barriers legislation and licensed occupations Advertising is a major form of non price competition Periodic change in the design and quality of the product is another major form of non price competition When imperfectly competitive firms restrict output and increase prices, they impose an economic cost on society in the form of reduced social well being o Deadweight welfare loss due to monopoly When firms grow extremely large in terms of employment, the economic decision to simply let them fail becomes a difficult call for politicians, especially those from states that would be hard hit by the collapse of one or more of their primary employers Average cost ratio of costs to the number of units being produce, sometimes called the per unit cost Economies of scale situation that occurs when long run average cost can be reduced simply be increasing the firms size and producing more of the product diseconomies of scale situation that occurs beyond a certain size and production level, when average cost rises as production is increase. Natural monopoly an industry in which the average cost of production is minimized by having only one firm produce the product Capture theory of regulation the belief that regulatory agencies, regardless of their initial intentions eventually come to service the interest of the firms being regulated rather than the interest of the general public Corporations firms organized as legal entities separate from their owners, the stockholders, who by law, have limited liability Stock options guarantees issued by a corporation which allow the holder to purchase a set number of shares at a fixed price, often called the strike price; stock options are frequently used as a form as managerial compensation Natural resources and the environment Externality is an activity that imposes involuntary costs of benefits on others, or an activity whose effects are not completely reflected in its market price Public good a commodity that can be provided to everyone as easily as it can be provided to one person The decision to provide a certain level of a public good like national defense will lead to a number of battalions, airplanes, and tanks to protect each of us. By contrast the decision to consume a private good like bread is an individual act Public goods are ones who benefits are indivisibly spread among the entire community, whether or not individuals desire to consume the public good. Private goods, by contrast, are ones that can be divided up and provided separately to different individuals with no external benefits or costs to

others. Efficient provision of public goods often requires government action, while private goods can be efficiently allocated by private markets Managers therefore decide to clean up just to the point where profits are maximized this requires that the benefits to the firm from additional abatement marginal private benefits be equal to the cost of additional cleanup marginal cost of abatement In an unregulated environment, firms will determine their most profitable pollution levels by equating the marginal private benefit from abatement with the marginal private cost of abatement Efficiency requires that the marginal social benefits from abatement equal the marginal social cost of abatement Cost benefit analysis efficient emissions are set by balancing the marginal costs of an action against the marginal benefits of that action Reducing pollution to zero would generally impose astronomically high cleanup costs while the marginal benefits of reducing the law few grams of pollution may be quite modest. An unregulated market economy will generate levels of pollution (other than externalities) at which the marginal private benefits of abatement equals the marginal private cost of abatement. Efficiency requires that the marginal social benefit of abatement equals the marginal social cost of abatement. In an unregulated economy, there will be too little abatement and too much pollution An efficient strategy for containing climate change requires weighing the marginal costs of reducing carbon dioxide emissions against the marginal benefits International Trade Trade promotes specialization and specialization increases productivity Over the long run increased trade and higher productivity raise living standards for all nations The major advantage of international trade is that it expands the scope of trade Sovereign nations each nation is a sovereign entity which regulates the flow of people, goods, and finance crossing its borders The international financial system must ensure a smooth flow and exchange of dollars, yen, and other currencies- or else risk a breakdown in trade. Benefits of international trade: diversity in the conditions of production, differences in tastes among nations, and decreasing costs of large scale production An important feature in todays world is that some companies or countries enjoy economies of scale that is they tend to have lower average costs of production as the volume of output expands o When a particular country gets a head start in producing a particular product it can become the high volume, low cost producer. The economies of scale give it a significant cost and technological

advantage over other countries, which find it cheaper to buy from the leading producer than make the product themselves. The principle of comparative advantage holds that a country can benefit from trade even if it is absolutely more efficient than other countries in production of every good The principle of comparative advantage holds that each country will benefit if it specializes in the production and export of those goods that it can produce at relatively low cost. Conversely, each country will benefit if it imports those goods, which it produces at relatively high cost. We can most easily reckon the gains from trade by calculating the effect of trade upon the real wages of workers. Real wages are measured by the quantity of goods that a worker can buy with an hours pay When countries concentrate on their areas of comparative advantage under free trade each country is better off. Compared to a no-trade situation, workers in each region can obtain a larger quantity of consumer goods for the same amount of work when the specialize in their areas of comparative advantage and trade their own production for goods in which they have a relative disadvantage. Outsourcing refers to the locating services or production processes abroad The ratio of export prices to import prices the terms of trade The world PPF represents the maximum output that can be obtained from the worlds resources when goods are produced in the most efficient manner that is with the most efficient division of labor and regional specialization Free trade in competitive markets allows the world to more to the frontier of its production possibility curve Notwithstanding its limitations, the theory of comparative advantage is one of the deepest truths in all of economics. Nations that disregard comparative advantage pay a heavy price in terms of their living standards and economic growth Tariff is a tax levied on imports Quota is a limit on the quantity of imports. A tariff will tend to raise price, lower the amounts consumed and imported, and raise domestic production of the covered good Tariffs crease economic inefficiencies. When tariffs are imposed, the economic loss to consumer exceeds the revenue gained by the government plus the extra profits earned by producers. Imposing a tariff has three effects: it encourages inefficiently high domestic production; it raises prices, thus inducing consumers to reduce their purchases of the tariffed good below efficient levels; and it raises revenues for the government. Only the first two of these necessarily impose efficiency costs on the economy. The cheap foreign labor argument is flawed because it ignores the theory of comparative advantage. A country will benefit from trade even though its wages are far above those of its trading partners. High wages come from high efficiency, not from tariff protection.

Tariffs and import protection are an inefficient way to create jobs or to lower unemployment. A more effective way to increase productive employment is through domestic monetary and fiscal policy.