University Press of Florida

Principles of Macroeconomics

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Title:
Principles of Macroeconomics
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Rice University
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University Press of Florida
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University Press of Florida
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isbn-13 - 978-1-938168-25-3
isbn-10 - 1938168259
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AA00026955:00001


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Principles of Macroeconomics

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OpenStax College Rice University 6100 Main Street MS380 Houston, Texas 77005 To learn more about OpenStax College, visit http://openstaxcollege.org Individual print copies and bulk orders can be purchased through our website. 2014 Rice University. Textbook content produced by OpenStax College is licensed under a Creative Commons Attribution 4.0 License. Under this license, any user of this textbook or the textbook contents herein must provide proper attribution as fol lows: If you redistribute this textbook in a digital format (including but not limited to EPUB, PDF, and HTML), then you must ret ain on every page the following attribution: Download for free at http://cnx.org/content/col11626/latest . If you redistribute this textbook in a print format, then you must include on every physical page the following attribution: Download for free at http://cnx.org/content/col11626/latest . If you redist ribute part of this textbook, then you must retain in every digital format page view (including but not limited to EPUB, PDF, and HTML) and on every physical printed page the following attribution: Download for free at http://cnx.org/content/col11626/latest . If you use this textbook as a bibliographic reference, then you should cite it as follow s: OpenStax College, Principles of Macroe conomics OpenStax College. 19 March 2014 < http://cnx.org/content/col11626/latest >. The OpenStax College name, OpenStax College logo, OpenStax College book covers, Connexions name, and Connexions logo are not subject to the license and may not be reproduced without the prior and express written consent of Rice University. For questions regarding this license, please contact partners@openstaxcollege.org. Trademarks The OpenStax College name, OpenStax College logo, OpenStax College book covers, Connexions name, and Connexions logo are registered trademarks of Rice University. All rights reserved. Any of the trademarks, service marks, collective marks, desi gn rights, or similar rights that are mentioned, used, or cited in OpenStax College, Connexions, or Connexions sites are the property of t heir respective owners. ISBN 10 1938168259 ISBN 13 9781 938168253 Revision MA 1 001RS

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OpenStax College OpenStax College is a non profit organization committed to improving student access to quality learning materials. Our free textbooks are developed and peer reviewed by educators to ensure they are readable, accurate, and meet the scope and sequence requir ements of modern college courses Through our partnerships with companies and foundations committed to reducing costs for students, OpenStax College is working to improve access to higher education for all. Connexions The technology platform supporting Op enStax College is Connexions ( http://cnx.org ), one of the worlds first and largest open education projects. Connexions provides students with free online and low cost print editions of the OpenStax College library and provides instructors with tools to customize the content so that they can have the perfect book for their course. Rice University OpenStax College and Connexions are initiative s of Rice University. As a leading research university with a distinctive commitment to undergraduate education, Rice University aspires to path breaking research, unsurpassed teaching, and contributions to the betterment of our world. It seeks to fulfill this mission by cultivating a diverse community of learning and discovery that produces leaders across the spectrum of human endeavor. Foundation Support OpenStax College is grateful for the tremendous support of our sponsors. Without their strong engagement, the goal of free access to highquality textbooks would remain just a dream Laura and John Arnold Foundation (LJAF) actively seeks opportunities to invest in organizations and thought leaders that have a sincere interest in implementing fundamental changes that not only yield immediate gains, but also repair broken systems for future generations. LJAF currently focuses its strategic investments on education, criminal justice, research integrity, and public accountability The William and Flora Hewlett Foundation has been making grants since 1967 to help solve social and environmental problems at home and around the world. The Foundation concentrates its resources on activities in education, the environment, global development and population, performing arts, and philanthropy, and makes grants to support disadvantaged communities in the San Francisco Bay Area. Guided by the belief that every life h as equal value, the Bill & Melinda Gates Foundation works to help all people lead healthy, productive lives. In developing countries, it focuses on improving peoples health with vaccines and other life saving tools and giving them the chance to lift thems elves out of hunger and extreme poverty. In the United States, it seeks to significantly improve education so that all young people have the opportunity to reach their full potential. Based in Seattle, Washington, the foundation is led by CEO Jeff Raikes a nd Co chair William H. Gates Sr., under the direction of Bill and Melinda Gates and Warren Buffett. The Maxfield Foundation supports projects with potential for high impact in science, education, sustainability, and other areas of social importance. Our mission at the Twenty Million Minds Foundation is to grow access and success by eliminating unnecessary hurdles to affordability. We support the creation, sharing, and proliferation of more effective, more affordable educational content by leveraging disruptive technologies, open educational resources, and new models for collaborat ion between forprofit, nonprofit, and public entities. !"#$%&'()*$+,!"#"$%&"$#%-*-.)%/$0-1*2&!)-* Calvin K. Kazanjian was the founder and president of Peter Paul Inc., the maker of the Mounds and Almond Joy candy bars, located in Naugatuck, Connecticut. He firmly believed that if more people understood basic economics the world would be a better place in which to live. Accordingly, he established the Foundation in the true spirit of unselfish service. The Calvin K. Kazanjian Economics Foundation Inc. is a non political education organization that was incorporated as a nonprofit organization under the Statue Laws of the State of Connecticut on April 4, 1947.

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02%&!#% 6AH?KIAPK PrinciplesofMacroeconomics f=J.LAJ2P=T"KHHACANAOKQN?A3DEOPATP>KKGD=O>AAJ?NA=PA@SEPDOARAN=H CK=HOEJIEJ@=??AOOE>EHEPUf?QOPKIEV=PEKJf=J@OPQ@AJPAJC=CAIAJP`=HHSDEHAAJ?KQN=CEJCOPQ@AJPOPKS=N@DECDHARAHO KB=?=@AIE?O?DKH=NODEL(JOPNQ?PKNO=J@OPQ@AJPO=HEGASEHHBEJ@PD=PPDEOPATP>KKGKBBANO=OPNKJCBKQJ@=PEKJEJ I=?NKA?KJKIE?OEJ=J=??AOOE>HABKNI=P BHG(C8A,G4KB??8:8 .LAJ2P=T"KHHACAEO=JKJrLNKBEPKNC=JEV=PEKJ?KIIEPPA@PKEILNKREJCOPQ@AJP=??AOOPKMQ=HEPUHA=NJEJCI=PANE=HO.QN BNAAPATP>KKGOCKPDNKQCD=NECKNKQOA@EPKNE=HLQ>HEODEJCLNK?AOO.QNPATPO=NA@ARAHKLA@=J@LAANrNAREASA@>UA@Q?=PKNO PKAJOQNAPDAU=NANA=@=>HAf=??QN=PAf=J@IAAPPDAO?KLA=J@OAMQAJ?ANAMQENAIAJPOKBPK@=UbO?KHHACA?KQNOAO4JHEGA PN=@EPEKJ=HPATP>KKGOf.LAJ2P=T"KHHACANAOKQN?AOHERAKJHEJA=J@=NAKSJA@>UPDA?KIIQJEPUKBA@Q?=PKNOQOEJCPDAI 3DNKQCDKQNL=NPJANODELOSEPD?KIL=JEAO=J@BKQJ@=PEKJO?KIIEPPA@PKNA@Q?EJC?KOPOBKNOPQ@AJPOf.LAJ2P=T"KHHACAEO SKNGEJCPKEILNKRA=??AOOPKDECDANA@Q?=PEKJBKN=HH.LAJ2P=T"KHHACAEO=JEJEPE=PERAKB1E?A4JERANOEPU=J@EOI=@A LKOOE>HAPDNKQCDPDACAJANKQOOQLLKNPKBOARAN=HLDEH=JPDNKLE?BKQJ@=PEKJO BHG(C8A,G4KB??8:8RF+8FBHE68F .LAJ2P=T"KHHACANAOKQN?AOLNKRE@AMQ=HEPU=?=@AIE?EJOPNQ?PEKJ3DNAAGAUBA=PQNAOOAPKQNI=PANE=HO=L=NPBNKIKPDANO PDAU?=J>A?QOPKIEVA@>UEJOPNQ?PKNOBKNA=?D?H=OOfPDAU=NA=HEREJCNAOKQN?APD=PCNKSOKJHEJAPDNKQCD?KJPNE>QPEKJO BNKIO?EAJ?AA@Q?=PKNOf=J@PDAU=NA=R=EH=>HABNAAKNBKNIEJEI=H?KOP HFGB@A?QOPKIEVA@BKNA=?D?KQNOA.QNPATP>KKGOLNKRE@A=OKHE@ BKQJ@=PEKJKJSDE?DEJOPNQ?PKNO?=J>QEH@f=J@KQNNAOKQN?AO=NA?KJ?AERA@=J@SNEPPAJSEPDBHATE>EHEPUEJIEJ@(JOPNQ?PKNO ?=JOAHA?PPDAOA?PEKJOIKOPNAHAR=JPPKPDAEN?QNNE?QH==J@?NA=PA=PATP>KKGPD=POLA=GO@ENA?PHUPKPDAJAA@OKBPDAEN?H=OOAO =J@OPQ@AJP>K@U3A=?DANO=NAAJ?KQN=CA@PKATL=J@KJATEOPEJCAT=ILHAO>U=@@EJCQJEMQA?KJPATPRE=CAKCN=LDE?=HHU HK?=HEVA@=LLHE?=PEKJO=J@PKLE?=H?KJJA?PEKJO PrinciplesofMacroeconomics ?=J>AA=OEHU?QOPKIEVA@QOEJCKQNKJHEJALH=PBKNItDPPL?JTKNC?KJPAJP?KHn 2EILHUOAHA?PPDA?KJPAJPIKOPNAHAR=JPPKUKQN?QNNAJPOAIAOPAN=J@?NA=PA=PATP>KKGPD=POLA=GO@ENA?PHUPKPDAJAA@O KBUKQN?H=OO PrinciplesofMacroeconomics EOKNC=JEVA@=O=?KHHA?PEKJKBOA?PEKJOPD=P?=J>ANA=NN=JCA@fIK@EBEA@f=J@ AJD=J?A@PDNKQCDHK?=HEVA@AT=ILHAOKNPKEJ?KNLKN=PA=OLA?EBE?PDAIAKBUKQN?KQNOA3DEO?QOPKIEV=PEKJBA=PQNASEHH AJOQNAPD=PUKQNPATP>KKGPNQHUNABHA?POPDACK=HOKBUKQN?KQNOA HE4GNK=@AJ=??AOO=J@AJ?KQN=CA?KIIQJEPU?QN=PEKJf PrinciplesofMacroeconomics EOcKLAJOKQN?AdHE?AJOA@QJ@AN ="NA=PERA"KIIKJO PPNE>QPEKJt""r!8nHE?AJOA3DAA?KJKIE?O?KIIQJEPUEOEJREPA@PKOQ>IEPAT=ILHAOfAIANCEJC NAOA=N?Df=J@KPDANBAA@>=?GPKAJD=J?A=J@OPNAJCPDAJPDAI=PANE=H=J@GAALEP?QNNAJP=J@NAHAR=JPBKNPK@=UbOOPQ@AJPO 2Q>IEPUKQNOQCCAOPEKJOPKEJBKKLAJOP=T?KHHACAKNCf=J@?DA?GEJKJA@EPEKJOP=PQOf=HPANJ=PARANOEKJOfANN=P=f=J@JASO KJPDAP=T#=OD=PDPPLKLAJOP=T?KHHACAKNC BFG .QNPATP>KKGO=NA=R=EH=>HABKNBNAAKJHEJAf=J@EJHKSr?KOPLNEJP=J@Ar>KKGA@EPEKJO BHG Principles of Macroeconomics PrinciplesofMacroeconomics D=O>AAJ@ARAHKLA@PKIAAPPDAO?KLA=J@OAMQAJ?AKBIKOPEJPNK@Q?PKNUI=?NKA?KJKIE?O ?KQNOAO PPDAO=IAPEIAfPDA>KKGEJ?HQ@AO=JQI>ANKBEJJKR=PERABA=PQNAO@AOECJA@PKAJD=J?AOPQ@AJPHA=NJEJC (JOPNQ?PKNO?=J=HOK?QOPKIEVAPDA>KKGf=@=LPEJCEPPKPDA=LLNK=?DPD=PSKNGO>AOPEJPDAEN?H=OONKKI BI8E4:8A7,6BC8 3K@ARAHKL PrinciplesofMacroeconomics fSA=?MQENA@PDANECDPOPK3EIKPDU3=UHKNbOOA?KJ@A@EPEKJKB/NEJ?ELHAOKB $?KJKIE?O=J@OKHE?EPA@E@A=OBNKIA?KJKIE?OEJOPNQ?PKNO=P=HHHARAHOKBDECDANA@Q?=PEKJfBNKI?KIIQJEPU?KHHACAOPK /D#rCN=JPEJCQJERANOEPEAO3DAUPKH@QO=>KQPPDAEN?KQNOAOfOPQ@AJPOf?D=HHAJCAOfNAOKQN?AOf=J@DKS=PATP>KKG?=J>AOP IAAPPDAEN=J@PDAENOPQ@AJPObJAA@O 3DANAOQHPEO=>KKGPD=P?KRANOPDA>NA=@PDKBA?KJKIE?OPKLE?O=J@=HOKLNKRE@AOPDAJA?AOO=NU@ALPDPKAJOQNAPDA?KQNOA EOI=J=CA=>HABKNEJOPNQ?PKNO=J@OPQ@AJPO=HEGA J@PKI=GAEPIKNA=LLHEA@fSAD=RAEJ?KNLKN=PA@I=JU?QNNAJPPKLE?O 6ADKLAOPQ@AJPOSEHH>AEJPANAOPA@PKGJKSFQOPDKSB=NrNA=?DEJCPDANA?AJPNA?AOOEKJS=Ot=J@OPEHHEOn3DADKQOEJC>Q>>HA

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d /KH=N"=OAOKB$H=OPE?EPU=J@"KJOP=JP$H=OPE?EPU d $H=OPE?EPU=J@/NE?EJC d $H=OPE?EPUEJ NA=O.PDAND=J/NE?A JUKJASDKD=OOPQ@EA@A?KJKIE?OGJKSOPDAH=SKB@AI=J@=DECDANLNE?ASEHHHA=@PK=HKSANMQ=JPEPU@AI=J@A@6D=P UKQI=UJKPGJKSEODKSIQ?DHKSANPDAMQ=JPEPU@AI=J@A@SEHH>A2EIEH=NHUfPDAH=SKBOQLLHUODKSOPD=P=DECDANLNE?A SEHHHA=@PK=DECDANMQ=JPEPUOQLLHEA@3DAMQAOPEKJEO'KSIQ?DDECDAN3DEO?D=LPANSEHHATLH=EJDKSPK=JOSANPDAOA MQAOPEKJO=J@SDUPDAU=NA?NEPE?=HHUEILKNP=JPEJPDANA=HSKNH@ 3KBEJ@=JOSANOPKPDAOAMQAOPEKJOfSAJAA@PKQJ@ANOP=J@PDA?KJ?ALPKBAH=OPE?EPU Elasticity EO=JA?KJKIE?O?KJ?ALPPD=P IA=OQNAONAOLKJOERAJAOOKBKJAR=NE=>HAPK?D=JCAOEJ=JKPDANR=NE=>HA2QLLKOAUKQ@NKLPSKEPAIOBNKI=OA?KJ@rBHKKN >=H?KJU3DABENOPEPAIEO=PAJJEO>=HH3DAOA?KJ@EPAIEO=>NE?G6DE?DSEHH>KQJ?ADECDAN.>REKQOHUfPDAPAJJEO>=HH 6ASKQH@O=UPD=PPDAPAJJEO>=HHD=OCNA=PANAH=OPE?EPU "KJOE@AN=JA?KJKIE?AT=ILHA"EC=NAPPAP=TAO=NA=JAT=ILHAKB=cOEJP=Tfd=P=TKJOKIAPDEJCPD=PEO>=@BKNUKQfHEGA =H?KDKH"EC=NAPPAO=NAP=TA@=PPDAOP=PA=J@J=PEKJ=HHARAHO2P=PAP=TAON=JCABNKI=HKSKB?AJPOLANL=?GEJ,EOOKQNE PKLANL=?GEJ-AS8KNG3DA=RAN=CAOP=PA?EC=NAPPAP=TEOLANL=?G3DA?QNNAJPBA@AN=HP=TN=PAKJ?EC=NAPPAO EOLANL=?Gf>QPEJ LNEHPDA.>=I= @IEJEOPN=PEKJLNKLKOA@N=EOEJCPDABA@AN=HP=TJA=NHU=@KHH=NPKLAN L=?GDAGAUMQAOPEKJEO'KSIQ?DSKQH@?EC=NAPPALQN?D=OAO@A?HEJA 3=TAOKJ?EC=NAPPAOOANRAPSKLQNLKOAOPKN=EOAP=TNARAJQABKNCKRANJIAJP=J@PK@EO?KQN=CA?KJOQILPEKJKB?EC=NAPPAO 'KSARANfEB=DECDAN?EC=NAPPAP=T@EO?KQN=CAO?KJOQILPEKJ>UMQEPA=HKPfIA=JEJC=CNA=PHUNA@Q?A@MQ=JPEPUKB?EC=NAPPAO EOOKH@fPDAJPDA?EC=NAPPAP=TKJA=?DL=?GSEHHJKPN=EOAIQ?DNARAJQABKNPDACKRANJIAJP HPANJ=PERAHUf=DECDAN?EC=NAPPA P=TPD=P@KAOJKP@EO?KQN=CA?KJOQILPEKJ>UIQ?DSEHH=?PQ=HHUN=EOAIKNAP=TNARAJQABKNPDACKRANJIAJP3DQOfSDAJ= CKRANJIAJP=CAJ?UPNEAOPK?=H?QH=PAPDAABBA?POKB=HPANEJCEPO?EC=NAPPAP=TfEPIQOP=J=HUVADKSIQ?DPDAP=T=BBA?POPDA MQ=JPEPUKB?EC=NAPPAO?KJOQIA@3DEOEOOQANA=?DAO>AUKJ@CKRANJIAJPO=J@P=TAOARANUBENIB=?AO=OEIEH=NEOOQA$RANU PEIA=BENI?KJOE@ANON=EOEJCPDALNE?APD=PEP?D=NCAOfEPIQOP?KJOE@ANDKSIQ?D=LNE?AEJ?NA=OASEHHNA@Q?APDAMQ=JPEPU @AI=J@A@KBSD=PEPOAHHO"KJRANOAHUfSDAJ=BENILQPOEPOLNK@Q?POKJO=HAfEPIQOPATLA?PtKNDKLAnPD=PPDAHKSANLNE?A SEHHHA=@PK=OECJEBE?=JPHUDECDANMQ=JPEPU@AI=J@A@ N )E<68?4FG<6A=>HAPK d "=H?QH=PAPDALNE?AAH=OPE?EPUKB@AI=J@ d "=H?QH=PAPDALNE?AAH=OPE?EPUKBOQLLHU !KPDPDA@AI=J@=J@OQLLHU?QNRAODKSPDANAH=PEKJODEL>APSAAJLNE?A=J@PDAJQI>ANKBQJEPO@AI=J@A@KNOQLLHEA@ Priceelasticity EOPDAN=PEK>APSAAJPDALAN?AJP=CA?D=JCAEJPDAMQ=JPEPU@AI=J@A@t0@nKNOQLLHEA@t0On=J@PDA ?KNNAOLKJ@EJCLAN?AJP?D=JCAEJLNE?A3DA priceelasticityofdemand EOPDALAN?AJP=CA?D=JCAEJPDAMQ=JPEPU demanded KB=CKK@KNOANRE?A@ERE@A@>UPDALAN?AJP=CA?D=JCAEJPDALNE?A3DA priceelasticityofsupply EOPDALAN?AJP=CA?D=JCA EJMQ=JPEPU supplied @ERE@A@>UPDALAN?AJP=CA?D=JCAEJLNE?A $H=OPE?EPEAO?=J>AQOABQHHU@ERE@A@EJPKPDNAA>NK=@?=PACKNEAOAH=OPE?fEJAH=OPE?f=J@QJEP=NU J elasticdemand KN elastic supply EOKJAEJSDE?DPDAAH=OPE?EPUEOCNA=PANPD=JKJAfEJ@E?=PEJC=DECDNAOLKJOERAJAOOPK?D=JCAOEJLNE?A$H=OPE?EPEAO PD=P=NAHAOOPD=JKJAEJ@E?=PAHKSNAOLKJOERAJAOOPKLNE?A?D=JCAO=J@?KNNAOLKJ@PK inelasticdemand KN inelasticsupply Unitary elasticities EJ@E?=PALNKLKNPEKJ=HNAOLKJOERAJAOOKBAEPDAN@AI=J@KNOQLLHUf=OOQII=NEVA@EJ -45?8 "9 -;8A A7"G"F??87 %I>PQF@ 5KFQ>OV )KBI>PQF@ -45?8 %I>PQF@f)KBI>PQF@f>KAKFQ>OVEOBB#>PBPLC%I>PQF@FQV #(!04%2X%,!34)#)49 4EFP@LKQBKQFP>S>FI>?IBCLOCOBB>QEQQM@KULOD@LKQBKQ@LI

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<:HE8"A9IIFKBPPELTQE>Q>KFKCFKFQBNR>KQFQVTFII?BABJ>KABALOPRMMIFBA>Q> PMB@FCF@MOF@BEFPFIIRPQO>QBPQEB@>PBPLC>MBOCB@QIVtLOFKCFKFQBIVnBI>PQF@ABJ>KA@ROSB>KAPRMMIV@ROSBEB NR>KQFQVPRMMIFBALOABJ>KABAFPBUQOBJBIVOBPMLKPFSBQLMOF@B@E>KDBPfJLSFKDCOLJWBOLCLOMOF@BP@ILPBQLQL FKCFKFQBTEBKMOF@BOB>@E Zeroelasticity KN perfectinelasticity f=O@ALE?PA@EJ <:HE8 NABANOPKPDAATPNAIA?=OAEJSDE?D=LAN?AJP=CA?D=JCA EJLNE?AfJKI=PPANDKSH=NCAfNAOQHPOEJVANK?D=JCAEJMQ=JPEPU6DEHA=LANBA?PHUEJAH=OPE?OQLLHUEO=JATPNAIAAT=ILHAf CKK@OSEPDHEIEPA@OQLLHUKBEJLQPO=NAHEGAHUPKBA=PQNADECDHUEJAH=OPE?OQLLHU?QNRAO$T=ILHAOEJ?HQ@A@E=IKJ@NEJCO KNDKQOEJCEJLNEIAHK?=PEKJOOQ?D=O=L=NPIAJPOB=?EJC"AJPN=H/=NGEJ-AS8KNG"EPU2EIEH=NHUfSDEHALANBA?PHUEJAH=OPE? @AI=J@EO=JATPNAIA?=OAfJA?AOOEPEAOSEPDJK?HKOAOQ>OPEPQPAO=NAHEGAHUPKD=RADECDHUEJAH=OPE?@AI=J@?QNRAO3DEOEO PDA?=OAKBHEBArO=REJC@NQCO=J@C=OKHEJA <:HE838EB?4FG<6IPRMMIV@ROSB>KASBOQF@>IABJ>KA@ROSBPELTQE>QQEBOBTFII?BWBOL MBO@BKQ>DB@E>KDBFKNR>KQFQVt>nPRMMIFBALOt?nABJ>KABAfOBD>OAIBPPLCQEBMOF@BEFPFIIRPQO>QBPQEB@>PBLCWBOL BI>PQF@FQVtLOMBOCB@QFKBI>PQF@FQVnEBNR>KQFQVPRMMIFBALOABJ>KABAFPKLQOBPMLKPFSBQLMOF@B@E>KDBP "KJOP=JPQJEP=NUAH=OPE?EPUfEJAEPDAN=OQLLHUKN@AI=J@?QNRAfK??QNOSDAJ=LNE?A?D=JCAKBKJALAN?AJPNAOQHPOEJ= MQ=JPEPU?D=JCAKBKJALAN?AJP <:HE8 ODKSO=@AI=J@?QNRASEPD?KJOP=JPQJEPAH=OPE?EPU OSAIKRA@KSJPDA @AI=J@?QNRABNKI PK!fPDALNE?AB=HHO>U=J@MQ=JPEPU@AI=J@A@NEOAO>U=OUKQIKRABNKI!PK"fPDALNE?A B=HHO>U=J@PDAMQ=JPEPU@AI=J@A@NEOAO>U=OUKQIKRABNKI"PK#fPDALNE?AB=HHO>U=J@PDAMQ=JPEPU NEOAO>U-KPE?APD=PEJ=>OKHQPAR=HQAfPDA@A?HEJAOEJLNE?Af=OUKQOPAL@KSJPDA@AI=J@?QNRAf=NAJKPE@AJPE?=H (JOPA=@fPDALNE?AB=HHO>UBNKI PK!f>U=OI=HHAN=IKQJPKBBNKI!PK"f=J@>U=OPEHHOI=HHAN=IKQJPKB BNKI"PK# O=NAOQHPf=@AI=J@?QNRASEPD?KJOP=JPQJEP=NUAH=OPE?EPUIKRAOBNKI=OPAALANOHKLAKJPDAHABP=J@=BH=PPAN OHKLAKJPDANECDP`=J@=?QNRA@OD=LAKRAN=HH #(!04%2X%,!34)#)49

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<:HE8-;8.A8@C?BL@8AGA7DH8G )K>I>?LOJ>OHBQTFQECIBUF?IBT>DBPfQEB BNRFIF?OFRJTFIIL@@RO>QT>DBB>KANR>KQFQVBfTEBOBQEBKRJ?BOLCMBLMIBILLHFKDCLOGL?PtPELTK?VnBNR>IP QEBKRJ?BOLCGL?P>S>FI>?IBtPELTK?V$n .JALKOOE>EHEPUBKNQJAILHKUIAJPEOPD=PLAKLHASDK=NAQJAILHKUA@=NAPDKOASDK=NAJKPSEHHEJCPKSKNG=PPDA?QNNAJP AMQEHE>NEQIS=CAfO=U=JDKQNf>QPSKQH@>ASEHHEJCPKSKNG=P=DECDANS=CAfHEGALANDKQN3DAIKJPDHU"QNNAJP /KLQH=PEKJ2QNRAUSKQH@?KQJPPDAOALAKLHA=OQJAILHKUA@f>A?=QOAPDAUO=UPDAU=NANA=@U=J@HKKGEJCBKNSKNGt=P LANDKQNn!QPBNKI=JA?KJKIEOPbOLKEJPKBREASfPDAOALAKLHA=NA?DKKOEJCPK>AQJAILHKUA@ /NK>=>HU=BASLAKLHA=NAQJAILHKUA@>A?=QOAKBQJNA=HEOPE?ATLA?P=PEKJO=>KQPS=CAOf>QPPDAU@KJKPNALNAOAJPPDA I=FKNEPUKBPDAQJAILHKUA@(JOPA=@fQJAILHKUA@LAKLHAKBPAJD=RABNEAJ@OKN=?MQ=EJP=J?AOKBOEIEH=NOGEHHHARAHOSDK=NA AILHKUA@f=J@PDAQJAILHKUA@SKQH@>ASEHHEJCPKSKNG=PPDAFK>O=J@S=CAOOEIEH=NPKSD=PEO>AEJCNA?AERA@>UPDKOA LAKLHA!QPPDAAILHKUANOKBPDAENBNEAJ@O=J@=?MQ=EJP=J?AO@KJKPOAAIPK>ADENEJC(JKPDANSKN@OfPDAOALAKLHA=NA EJRKHQJP=NEHUQJAILHKUA@D=P?=QOAOEJRKHQJP=NUQJAILHKUIAJP 0;L4:8F&<:;G,G<6>LBJAJ4E7 (B=H=>KNI=NGAPIK@AHSEPDBHATE>HAS=CAO@KAOJKP@AO?NE>AQJAILHKUIAJPRANUSAHH`>A?=QOAEPLNA@E?POPD=P=JUKJA SEHHEJCPKSKNG=PPDACKEJCS=CA?=J=HS=UOBEJ@=FK>`PDAJEPI=ULNKRAQOABQHPK?KJOE@ANA?KJKIE?IK@AHOEJSDE?D S=CAO=NAJKPBHATE>HAKN=@FQOPKJHURANUOHKSHU(JL=NPE?QH=NfARAJPDKQCDS=CAEJ?NA=OAOI=UK??QNSEPDNAH=PERAA=OAf S=CA@A?NA=OAO=NABAS=J@B=N>APSAAJ .JAOAPKBNA=OKJOSDUS=CAOI=U>AcOPE?GU@KSJS=N@fd=OA?KJKIEOPOLQPEPfEJRKHRAOA?KJKIE?H=SO=J@EJOPEPQPEKJO %KNHKSrOGEHHA@SKNGANO>AEJCL=E@PDAIEJEIQIS=CAfEPEOEHHAC=HPKNA@Q?APDAENS=CAO%KNQJEKJSKNGANOKLAN=PEJCQJ@AN =IQHPEUA=N?KJPN=?PSEPD=?KIL=JUfS=CA?QPOIECDPREKH=PAPDA?KJPN=?P=J@?NA=PA=H=>KN@EOLQPAKN=OPNEGA'KSARANf IEJEIQIS=CAO=J@QJEKJ?KJPN=?PO=NAJKP=OQBBE?EAJPNA=OKJSDUS=CAOSKQH@>AOPE?GU@KSJS=N@BKNPDA4A?KJKIU =O=SDKHA BPAN=HHfKQPKBPDAIEHHEKJKNOKSKNGANOEJPDA4A?KJKIUfKJHU=>KQPIEHHEKJ`HAOOPD=JKB PDAPKP=H`=NAL=E@PDAIEJEIQIS=CA2EIEH=NHUfKJHU=>KQPKB IANE?=JS=CA=J@O=H=NUSKNGANO=NANALNAOAJPA@>U =H=>KNQJEKJ(JKPDANDECDrEJ?KIA?KQJPNEAOfIKNASKNGANOI=UD=RAPDAENS=CAO@APANIEJA@>UQJEKJOKNPDAIEJEIQI S=CAI=U>AOAP=P=HARAHPD=P=LLHEAOPK=H=NCANOD=NAKBSKNGANO!QPBKNPDA4JEPA@2P=PAOfPDAOAPSKB=?PKNO?KI>EJA@ =BBA?PKJHU=>KQPKJArBEBPDKNHAOOKBPDAH=>KNBKN?A $?KJKIEOPOHKKGEJCBKNNA=OKJOSDUS=CAOIECDP>AOPE?GU@KSJS=N@OD=RABK?QOA@KJB=?PKNOPD=PI=U?D=N=?PANEVAIKOP H=>KNNAH=PEKJODELOEJPDAA?KJKIUfJKPFQOP=BAS JQI>ANKB@EBBANAJPPDAKNEAOD=RA>AAJLNKLKOA@f>QPPDAUOD=NA= ?KIIKJPKJA .JA=NCQIAJPEOPD=PARAJAILHKUAAOSDK=NAJKPQJEKJIAI>ANOKBPAJSKNGQJ@AN=J implicitcontract fSDE?DEOPD=PPDA AILHKUANSEHHPNUPKGAALS=CAOBNKIB=HHEJCSDAJPDAA?KJKIUEOSA=GKNPDA>QOEJAOOEOD=REJCPNKQ>HAf=J@PDAAILHKUAA SEHHJKPATLA?PDQCAO=H=NUEJ?NA=OAOSDAJPDAA?KJKIUKNPDA>QOEJAOOEOOPNKJC3DEOS=CArOAPPEJC>AD=REKN=?POHEGA= BKNIKBEJOQN=J?APDAAILHKUAAD=OOKIALNKPA?PEKJ=C=EJOPS=CA@A?HEJAOEJ>=@PEIAOf>QPL=UOBKNPD=PLNKPA?PEKJSEPD HKSANS=CAOEJCKK@PEIAO"HA=NHUfPDEOOKNPKBEILHE?EP?KJPN=?PIA=JOPD=PBENIOSEHH>ADAOEP=JPPK?QPS=CAOfHAOPSKNGANO BAAH>APN=UA@=J@SKNGHAOOD=N@KNARAJHA=RAPDABENI Efficiencywagetheory =NCQAOPD=PPDALNK@Q?PEREPUKBSKNGANO@ALAJ@OKJPDAENL=Uf=J@OKAILHKUANOSEHHKBPAJBEJ@EP SKNPDSDEHAPKL=UPDAENAILHKUAAOOKIASD=PIKNAPD=JI=NGAP?KJ@EPEKJOIECDP@E?P=PA.JANA=OKJEOPD=PAILHKUAAOSDK =NAL=E@>APPANPD=JKPDANOSEHH>AIKNALNK@Q?PERA>A?=QOAPDAUNA?KCJEVAPD=PEBPDAUSANAPKHKOAPDAEN?QNNAJPFK>OfPDAU SKQH@OQBBAN=@A?HEJAEJO=H=NU O=NAOQHPfPDAU=NAIKPER=PA@PKSKNGD=N@AN=J@PKOP=USEPDPDA?QNNAJPAILHKUAN(J =@@EPEKJfAILHKUANOGJKSPD=PEPEO?KOPHU=J@PEIAr?KJOQIEJCPKDENA=J@PN=EJJASAILHKUAAOfOKPDAUSKQH@LNABANPKL=U SKNGANO=HEPPHAATPN=JKSN=PDANPD=JPKHKOAPDAI=J@D=RAPKDENA=J@PN=EJJASSKNGANO3DQOf>U=RKE@EJCS=CA?QPOfPDA AILHKUANIEJEIEVAO?KOPOKBPN=EJEJC=J@DENEJCJASSKNGANOf=J@NA=LOPDA>AJABEPOKBSAHHrIKPER=PA@AILHKUAAO #(!04%2X.%-0,/9-%.4 4EFP@LKQBKQFP>S>FI>?IBCLOCOBB>QEQQM@KULOD@LKQBKQ@LI

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3DA adverseselectionofwagecutsargument LKEJPOKQPPD=PEB=JAILHKUANNA=?POPKLKKN>QOEJAOO?KJ@EPEKJO>UNA@Q?EJC S=CAOBKN=HHSKNGANOfPDAJPDA>AOPSKNGANOfPDKOASEPDPDA>AOPAILHKUIAJP=HPANJ=PERAO=PKPDANBENIOf=NAPDAIKOPHEGAHU PKHA=RA3DAHA=OP=PPN=?PERASKNGANOfSEPDBASANAILHKUIAJP=HPANJ=PERAOf=NAIKNAHEGAHUPKOP=U"KJOAMQAJPHUfBENIO =NAIKNAHEGAHUPK?DKKOASDE?DSKNGANOODKQH@@AL=NPfPDNKQCDH=UKBBO=J@BENEJCOfN=PDANPD=JPNEIIEJCS=CAO=?NKOOPDA >K=N@2KIAPEIAO?KIL=JEAOPD=P=NACKEJCPDNKQCDPKQCDPEIAO?=JLANOQ=@ASKNGANOPKP=GA=L=U?QPBKNPDAODKNPPANIf =J@OPEHHNAP=EJIKOPKBPDABENIbOSKNGANO!QPPDAOAOPKNEAO=NAJKP=>HA>A?=QOAPDAU=NAOKQJ?KIIKJ(PEOB=NIKNAPULE?=H BKN?KIL=JEAOPKH=UKBBOKIASKNGANOfN=PDANPD=JPK?QPS=CAOBKNARANUKJA 3DA insider-outsidermodel KBPDAH=>KNBKN?AfEJOEILHAPANIOf=NCQAOPD=PPDKOA=HNA=@USKNGEJCBKNBENIO=NAcEJOE@ANOfd SDEHAJASAILHKUAAOf=PHA=OPBKN=PEIAf=NAcKQPOE@ANOd BENI@ALAJ@OKJEPOEJOE@ANOPKCNA=OAPDASDAAHOKBPDA KNC=JEV=PEKJfPK>AB=IEHE=NSEPDNKQPEJALNK?A@QNAOfPKPN=EJJASAILHKUAAOf=J@OKKJ'KSARANf?QPPEJCS=CAOSEHH =HEAJ=PAPDAEJOE@ANO=J@@=I=CAPDABENIbOLNK@Q?PEREPU=J@LNKOLA?PO %EJ=HHUfPDA relativewagecoordinationargument LKEJPOKQPPD=PARAJEBIKOPSKNGANOSANADULKPDAPE?=HHUSEHHEJCPKOAA =@A?HEJAEJPDAENKSJS=CAOEJ>=@A?KJKIE?PEIAO=OHKJC=OARANUKJAAHOA=HOKATLANEAJ?AOOQ?D=@A?HEJAfPDANAEOJK K>REKQOS=UBKN=@A?AJPN=HEVA@A?KJKIUPKEILHAIAJPOQ?D=LH=J(JOPA=@fSKNGANO?KJBNKJPA@SEPDPDALKOOE>EHEPUKB= S=CA?QPSEHHSKNNUPD=PKPDANSKNGANOSEHHJKPD=RAOQ?D=S=CA?QPf=J@OK=S=CA?QPIA=JO>AEJCSKNOAKBB>KPDEJ =>OKHQPAPANIO=J@NAH=PERAPKKPDANO O=NAOQHPfSKNGANOBECDPD=N@=C=EJOPS=CA?QPO 3DAOAPDAKNEAOKBSDUS=CAOPAJ@JKPPKIKRA@KSJS=N@@EBBANEJPDAENHKCE?=J@PDAENEILHE?=PEKJOf=J@BECQNEJCKQPPDA OPNAJCPDO=J@SA=GJAOOAOKBA=?DPDAKNUEO=JKJCKEJCOQ>FA?PKBNAOA=N?D=J@?KJPNKRANOU=IKJCA?KJKIEOPO HHPAJ@PK EILHUPD=PS=CAOSEHH@A?HEJAKJHURANUOHKSHUfEB=P=HHfARAJSDAJPDAA?KJKIUKN=>QOEJAOOEOD=REJCPKQCDPEIAO6DAJ S=CAO=NAEJBHATE>HA=J@QJHEGAHUPKB=HHfPDAJAEPDANODKNPrNQJKNHKJCrNQJQJAILHKUIAJP?=JNAOQHP3DEO?=J>AOAAJEJ <:HE8 <:HE8,G<6>L4:8F8G "B@>RPBQEBT>DBO>QBFPPQR@H>Qf>?LSBQEBBNRFIF?OFRJfQEB KRJ?BOLCGL?PBBHBOPt1PnFPDOB>QBOQE>KQEBKRJ?BOLCGL?LMBKFKDPt1AnEBOBPRIQFPRKBJMILVJBKQfPELTK?V QEB?O>@HBQFKQEBCFDROB 3DAEJPAN=?PEKJ>APSAAJODEBPOEJH=>KN@AI=J@=J@S=CAOPD=P=NAOPE?GU@KSJS=N@=NAODKSJEJ <:HE8 <:HE8 t=nEHHQOPN=PAOPDAOEPQ=PEKJEJSDE?DPDA@AI=J@BKNH=>KNODEBPOPKPDANECDPBNKI# PK# (JPDEO?=OAfPDAAMQEHE>NEQIS=CA NEOAOBNKI6 PK6 =J@PDAAMQEHE>NEQIMQ=JPEPUKBH=>KNDENA@EJ?NA=OAOBNKI0 PK0 (P@KAOJKPDQNPAILHKUAAIKN=HA =P=HHBKNS=CAOPKNEOA <:HE8 t>nODKSOPDAOEPQ=PEKJEJSDE?DPDA@AI=J@BKNH=>KNODEBPOPKPDAHABPfBNKI# PK# f=OEPSKQH@PAJ@PK@K EJ=NA?AOOEKJ!A?=QOAS=CAO=NAOPE?GU@KSJS=N@fPDAU@KJKP=@FQOPPKS=N@SD=PSKQH@D=RA>AAJPDAJASAMQEHE>NEQI S=CAt0 nf=PHA=OPJKPEJPDAODKNPNQJ(JOPA=@f=BPANPDAODEBPEJPDAH=>KN@AI=J@?QNRAfPDAO=IAMQ=JPEPUKBSKNGANO EOSEHHEJCPKSKNG=PPD=PS=CA=O>ABKNADKSARANfPDAMQ=JPEPUKBSKNGANO@AI=J@A@=PPD=PS=CAD=O@A?HEJA@BNKIPDA KNECEJ=HAMQEHE>NEQIt0 nPK0 3DAC=L>APSAAJPDAKNECEJ=HAMQEHE>NEQIMQ=JPEPUt0 n=J@PDAJASMQ=JPEPU@AI=J@A@KB H=>KNt0 nNALNAOAJPOSKNGANOSDKSKQH@>ASEHHEJCPKSKNG=PPDACKEJCS=CA>QP?=JJKPBEJ@FK>O3DAC=LNALNAOAJPOPDA A?KJKIE?IA=JEJCKBQJAILHKUIAJP #(!04%2X.%-0,/9-%.4

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