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Principles of Macroeconomics
Version 9.0
John B. Taylor and Akila Weerapana

978-1-4533-3498-0

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Principles of Macroeconomics
Version 9.0
John B. Taylor and Akila Weerapana

Published by:

FlatWorld
292 Newbury Street
Suite #282
Boston, MA 02115-2832

© 2021 by Boston Academic Publishing, Inc. d.b.a. FlatWorld

All rights reserved. Your use of this work is subject to the License Agreement available at
https://catalog.flatworldknowledge.com/legal.

No part of this work may be used, modified, or reproduced in any form or by any means except as expressly
permitted under the License Agreement.

Gen: 202208092011
© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Brief Contents

About the Authors

Acknowledgments
Preface
Chapter 1 The Central Idea
Chapter 2 Observing and Explaining the Economy
Chapter 3 The Supply and Demand Model
Chapter 4 Subtleties of the Supply and Demand Model
Chapter 5 Macroeconomics: The Big Picture
Chapter 6 Measuring the Production, Income, and Spending of Nations
Chapter 7 The Spending Allocation Model
Chapter 8 Unemployment and Employment
Chapter 9 Productivity and Economic Growth
Chapter 10 Money and Inflation
Chapter 11 The Nature and Causes of Economic Fluctuations
Chapter 12 The Economic Fluctuations Model
Chapter 13 Using the Economic Fluctuations Model
Chapter 14 Fiscal Policy
Chapter 15 Monetary Policy
Chapter 16 Capital and Financial Markets
Chapter 17 Economic Growth Around the World
Chapter 18 International Trade
Chapter 19 International Finance
Index

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Contents

About the Authors 1

Acknowledgments 3

Preface 7

Chapter 1 The Central Idea 13

1.1 Scarcity and Choice for Individuals 15

Consumer Decisions 15
Producer Decisions 17
International Trade 18
1.2 Scarcity and Choice for the Economy as a Whole 19
Production Possibilities 19
Increasing Opportunity Costs 20
The Production Possibilities Curve 20
1.3 Market Economies and the Price System 24
Key Elements of a Market Economy 25
The Price System 26
Financial Crises and Recessions 28
The Price System during National Disasters 28
Artificial Intelligence, Economics, and the Price System 29
1.4 End-of-Chapter Material 31
Conclusion 31

Chapter 2 Observing and Explaining the Economy 35

2.1 Why Has Driving Shifted into Reverse? 36

2.2 Variables, Correlation, and Causation 40
Correlation versus Causation 40
The Lack of Controlled Experiments in Economics 41
Economic Models 41
The Ceteris Paribus Assumption 46
The Use of Existing Models 46
The Development of Models 46
2.3 Recommending Appropriate Policies 47
Positive versus Normative Economics 48
Economics as a Science versus Partisan Policy Tool 48
Economics Is Not the Only Factor in Policy Issues 49
Disagreement between Economists 50

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
2.4 End-of-Chapter Material 51
Conclusion: A Reader’s Guide 51
2.5 Appendix: Reading, Understanding, and Creating Graphs 54
Visualizing Observations with Graphs 55
Visualizing Models with Graphs 61

Chapter 3 The Supply and Demand Model 67

3.1 Demand 68
The Demand Curve 69
Shifts in Demand 70
Movements Along versus Shifts of the Demand Curve 73
3.2 Supply 75
The Supply Curve 76
Shifts in Supply 78
Movements Along versus Shifts of the Supply Curve 81
3.3 Market Equilibrium: Combining Supply and Demand 82
Determination of the Market Price 83
Finding the Equilibrium with a Supply and Demand Diagram 85
Market Outcomes When Supply or Demand Changes 86
3.4 End-of-Chapter Material 90
Conclusion 90

Chapter 4 Subtleties of the Supply and Demand Model 95

4.1 Interference with Market Prices 96

Price Ceilings and Price Floors 96
Side Effects of Price Ceilings 97
Side Effects of Price Floors 99
4.2 Elasticity of Demand 102
Defining the Price Elasticity of Demand 102
The Size of the Elasticity: High versus Low 103
The Impact of a Change in Supply on the Price of Oil 105
4.3 Working with Demand Elasticities 107
The Advantage of a Unit-Free Measure 108
Elasticity versus Slope 108
Calculating the Elasticity with a Midpoint Formula 110
Talking about Elasticities 111
Revenue and the Price Elasticity of Demand 112
What Determines the Size of the Price Elasticity of Demand? 116
Income Elasticity and Cross-Price Elasticity of Demand 119
4.4 Elasticity of Supply 120
Working with Supply Elasticities 121
4.5 End-of-Chapter Material 126
Conclusion 126

Chapter 5 Macroeconomics: The Big Picture 131

5.1 Measuring the “Size” of an Economy 133

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Economic Growth: The Relentless Uphill Climb 134
Economic Fluctuations: Temporary Setbacks and Recoveries 135
5.2 Unemployment, Inflation, and Interest Rates 141
Unemployment during Recessions 141
Inflation 145
Interest Rates 146
5.3 Macroeconomic Theory and Policy 148
The Theory of Long-Term Economic Growth 149
Government Policy and Economic Growth 150
The Theory of Economic Fluctuations 151
Macroeconomic Policy and Economic Fluctuations 152
5.4 End-of-Chapter Material 153
Conclusion 153
5.5 Appendix: The Miracle of Compound Growth 156
How Compound Growth Works 156
Exponential Effects 157
Rule of 72 158
Plotting Growing Variables 158
5.6 Endnote 160

Chapter 6 Measuring the Production, Income, and Spending of Nations 161

6.1 Measuring GDP 162

A Precise Definition of GDP 162
The Spending Approach 164
The Income Approach 169
The Production Approach 173
6.2 Saving 174
Individual Saving 174
National Saving 174
6.3 Measuring Real GDP 176
Adjusting GDP for Inflation 176
The GDP Deflator 179
Alternative Inflation Measures 180
6.4 Shortcomings of the GDP Measure 182
Revisions to GDP 182
Omissions from GDP 183
Other Measures of Well-Being 184
6.5 End-of-Chapter Material 185
Conclusion 185
6.6 Endnotes 189

Chapter 7 The Spending Allocation Model 191

7.1 The Spending Shares 192

Defining the Spending Shares 193
If One Share Goes Up, Another Must Go Down 194
7.2 The Effect of Interest Rates on Spending Shares 196

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Consumption 196
Investment 198
Net Exports 199
Putting the Three Shares Together 201
7.3 Determining the Equilibrium Interest Rate 202
The Nongovernment Share of GDP 202
The Government’s Share of GDP and the Share of GDP Available for 203
Nongovernment Use
Finding the Equilibrium Interest Rate 204
Using the Spending Allocation Model to Analyze the Long-Run Implications of a Shift 206
in Government Purchases
7.4 The Relationship between Saving and Investment 207
7.5 End-of-Chapter Material 211
Conclusion 211
7.6 Endnote 214

Chapter 8 Unemployment and Employment 215

8.1 Unemployment and Other Labor Market Indicators 216

How Is Unemployment Measured? 217
8.2 The Nature of Unemployment 223
Reasons People Are Unemployed 223
The Duration of Unemployment 226
Unemployment for Different Groups 227
8.3 Modeling the Labor Market 228
Labor Demand and Labor Supply 229
Explaining Labor Market Trends 230
Why Is the Unemployment Rate Always Greater Than Zero? 231
8.4 End-of-Chapter Material 236
Conclusion 236
8.5 Endnotes 239

Chapter 9 Productivity and Economic Growth 241

9.1 Labor and Capital without Technology 242

Labor Alone and Capital without Technology 243
Adding Capital 244
9.2 Technology: The Engine of Growth 246
What Is Technology? 247
The Production of Technology: The Invention Factory 250
Special Features of Technology 251
9.3 Fundamental Causes of Economic Growth 252
9.4 Measuring Technology 254
The Formula 254
Using the Formula 254
9.5 Technology Policy 255
Policy to Encourage Investment in Human Capital 255
Policy to Encourage Research and Innovation 255

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Technology Embodied in New Capital 256
Is Government Intervention Appropriate? 257
9.6 End-of-Chapter Material 257
Conclusion: The Importance of Productivity Growth 257
9.7 Appendix: Deriving the Growth Accounting Formula 260
9.8 Endnotes 265

Chapter 10 Money and Inflation 267

10.1 What Is Money? 268

Three Functions of Money 268
Commodity Money 269
From Coins to Paper Money to Deposits 270
Cryptocurrencies 270
Measures of the Money Supply 271
10.2 The Fed, the Banks, and the Link from Reserves to Deposits 272
The Fed 273
The Banks 275
The Link between Reserves and Deposits 276
The Explosion of Reserves and the Reserve Ratio in the Aftermath of the 2008–09 279
Recession
How the Fed Controls the Money Supply: Currency plus Deposits 281
How a Credit Crunch Affects Deposit Expansion 282
10.3 Money Growth and Inflation 283
The Quantity Equation of Money 283
Evidence 284
10.4 End-of-Chapter Material 287
Conclusion 287

Chapter 11 The Nature and Causes of Economic Fluctuations 291

11.1 Changes in Aggregate Demand Lead to Changes in Production 293

Production and Demand at Individual Firms 296
Could Economic Fluctuations Also Be Due to Changes in Potential GDP? 297
11.2 Forecasting Real GDP 298
A Forecast for Next Year 298
Impact of a Change in Government Purchases 299
11.3 The Response of Consumption to Income 299
The Consumption Function 300
What about Interest Rates and Other Influences on Consumption? 303
11.4 Finding Real GDP When Consumption and Income Move Together 304
The 45-Degree Line 305
The Expenditure Line 305
Determining Real GDP through Spending Balance 308
A Better Forecast of Real GDP 309
11.5 Spending Balance and Departures of Real GDP from Potential GDP 311
Stepping Away from Potential GDP 311
11.6 End-of-Chapter Material 313

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
Conclusion 313
11.7 Appendix: Deriving the Formula for the Keynesian Multiplier and the 316
Forward-Looking Consumption Model
The Keynesian Multiplier 316
The Forward-Looking Consumption Model 321

Chapter 12 The Economic Fluctuations Model 327

12.1 The Aggregate Demand Curve 329

Interest Rates and Real GDP 331
Interest Rates and Inflation 335
Derivation of the Aggregate Demand Curve 338
12.2 The Inflation Adjustment Line 343
The Inflation Adjustment Line Is Flat 343
The Inflation Adjustment Line Shifts Gradually When Real GDP Departs from 344
Potential GDP
Changes in Expectations or Commodity Prices Shift the Inflation Adjustment Line 346
Does the Inflation Adjustment Line Fit the Facts? 346
12.3 Combining the Aggregate Demand Curve and the Inflation Adjustment Line 347
12.4 End-of-Chapter Material 348
Conclusion 348
12.5 Endnote 351

Chapter 13 Using the Economic Fluctuations Model 353

13.1 Changes in Government Purchases 354

Real GDP and Inflation over Time 354
Details on the Components of Spending 357
13.2 Changes in Monetary Policy 360
The Volcker Disinflation 361
Reinflation and the Great Inflation 362
13.3 Price Shocks 363
What Is a Price Shock? 363
The Effect of Price Shocks 363
13.4 Using the Economic Fluctuations Model to Understand the Great 365
Recession
What Caused the Recession? 366
How to Recover from the Recession 367
13.5 Using the Economic Fluctuations Model to Understand the Impact of the 370
COVID-19 Pandemic on the Macroeconomy
What Impact Has the COVID-19 Pandemic Had on the Economy? 370
How to Recover from the Recession 372
13.6 End-of-Chapter Material 374
Conclusion 374
13.7 Endnotes 376

Chapter 14 Fiscal Policy 377

14.1 The Government Budget 378

Setting the Annual Budget 378

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
A Look at the Federal Budget 380
The Federal Debt 382
State and Local Government Budgets 386
14.2 Countercyclical Fiscal Policy 387
Impacts of the Instruments of Fiscal Policy 387
Countercyclical Fiscal Policy 391
The Discretion versus Rules Debate for Fiscal Policy 397
14.3 The Structural versus the Cyclical Surplus 398
14.4 End-of-Chapter Material 399
Conclusion 399
14.5 Endnotes 401

Chapter 15 Monetary Policy 403

15.1 The Federal Reserve’s Balance Sheet 404

The Federal Reserve’s Assets and Liabilities 404
The Size of the Balance Sheet 405
15.2 Money Demand and Zero Interest Rate 407
The Money Demand Curve 408
15.3 When the Interest Rate Hits Zero 411
Quantitative Easing 413
Unwinding Quantitative Easing 414
15.4 The Economic Fluctuations Model 415
Aggregate Demand: Just Right, Too Hot, or Too Cold? 415
The Inherent Uncertainty in Monetary Policy 417
Increased Transparency and Predictability 417
15.5 Central Bank Independence 419
The Gain-Then-Pain Scenario 421
Potential Disadvantages of Central Bank Independence 424
15.6 The Exchange Rate 425
The Effects of a Fixed Exchange Rate System on Monetary Policy 426
The Rationale for Fixed Exchange Rates 428
15.7 End-of-Chapter Material 429
Conclusion 429
15.8 Endnotes 431

Chapter 16 Capital and Financial Markets 433

16.1 The Distinction between Physical Capital and Financial Capital 435
16.2 Markets for Physical Capital 437
Rental Markets 437
The Ownership of Physical Capital 441
The Housing Market 442
16.3 Markets for Financial Capital 443
Stock Prices and Rates of Return 444
Bond Prices and Rates of Return 445
16.4 The Trade-off between Risk and Returns 447
Behavior under Uncertainty 447

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
16.5 Corporate Governance Problems 453
Asymmetric Information: Moral Hazard and Adverse Selection 454
Incentives to Overcome Adverse Selection and Moral Hazard Problems 454
16.6 The Role of Government in Financial Markets 455
Examples from a Financial Crisis 456
Government Regulation of Financial Institutions 458
16.7 End-of-Chapter Material 459
Conclusion 459
16.8 Appendix: Present Discounted Value 462
Discounting the Future 462
Finding the Present Discounted Value 463
16.9 Endnote 465

Chapter 17 Economic Growth Around the World 467

17.1 Catching Up (or Not?) 468

Catch-up within the United States 469
Catch-up in the Industrial Countries 470
Catch-up in East Asia 471
Catch-up in the Whole World 472
17.2 Economic Development 474
Geographic Patterns 475
Billions Still in Poverty 476
Hope for the Future 477
17.3 The Spread and Use of Technology 479
Entrepreneurs in the Industrial Nations 479
Remaining Problems in Developing Countries 480
17.4 Increasing Capital per Worker 482
Population Growth 482
National Saving 482
Foreign Investment from the Advanced Economies 483
Borrowing from International Agencies 484
17.5 End-of-Chapter Material 485
Conclusion 485
17.6 Endnotes 488

Chapter 18 International Trade 489

18.1 Trends in International Trade 491

18.2 Comparative Advantage 493
Getting a Gut Feeling for Comparative Advantage 493
Productivity in Two Countries 494
Finding the Relative Price 496
Measuring the Gains from Trade 497
A Graphic Measure of the Gains from Trade 498
18.3 Reasons for Comparative Advantage 501
Labor versus Capital Resources 502
The Effect of Trade on Wages 502

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
18.4 Gains from Expanded Markets 503
An Example of Gains from Trade through Expanded Markets 503
Measuring the Gains from Expanded Markets 505
18.5 Tariffs and Quotas 511
Tariffs 512
Quotas 514
The Cost of Trade Restrictions 515
18.6 The History of Trade Restrictions 516
U.S. Tariffs 516
18.7 Arguments for Trade Barriers 521
High Transition Costs 521
The Infant Industry Argument 522
The National Security Argument 522
The Retaliation Argument 523
The Foreign Subsidies Argument 523
Environment and Labor Standard Arguments 524
The Public Health Argument 524
The Political Economy of Protection 525
18.8 How to Reduce Trade Barriers 525
Unilateral Disarmament 525
Multilateral Negotiations 526
Regional Trading Areas 527
18.9 End-of-Chapter Material 528
Conclusion 528

Chapter 19 International Finance 533

19.1 Exchange Rates 534

Important Definitions 534
Exchange Rates and Net Exports 534
19.2 Exchange Rate Determination 535
Interest Rate Differentials and Short-Run Exchange Rate Movements 537
Price Differentials and Long-Run Exchange Rate Movements 538
19.3 Fixed Exchange Rates 540
The Role of Reserves 541
Overvaluation and Undervaluation 543
Consequences of Sustained Overvaluation 545
Consequences of Sustained Undervaluation 546
19.4 Currency Unions 548
19.5 End-of-Chapter Material 550

Index 553

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
About the Authors

John B. Taylor
John B. Taylor is one of the field’s most inspiring teachers. As the Raymond Pro-
fessor of Economics at Stanford University, his distinctive instructional methods
have made him a legend among introductory economics students and have won
him both the Hoagland and Rhodes prizes for teaching excellence.
Professor Taylor is also widely recognized for his research on the founda-
tions of modern monetary theory and policy. One of his well-known research
contributions is a rule—now widely called the Taylor Rule—used at central
banks around the world.
Taylor has had an active career in public service, including a four-year stint
as the head of the International Affairs division at the United States Treasury,
where he had responsibility for currency policy, international debt, and oversight
of the International Monetary Fund and the World Bank and worked closely with
leaders and policymakers from countries throughout the world. He has also
served as economic adviser to the governor of California, to the U.S. Congres-
sional Budget Office, and to the President of the United States and has served on
several boards and as a consultant to private industry.
Professor Taylor began his career at Princeton, where he graduated with
highest honors in economics. He then received his Ph.D. from Stanford and
taught at Columbia, Yale, and Princeton before returning to Stanford.

Akila Weerapana
Akila Weerapana is an Associate Professor of Economics at Wellesley College. He
was born and raised in Sri Lanka and came to the United States to do his under-
graduate work at Oberlin College, where he earned a B.A. with highest honors in
Economics and Computer Science in 1994. He received his Ph.D. in Economics
from Stanford in 1999, writing his dissertation on monetary economics under the
mentorship of John Taylor.
Since then, Professor Weerapana has taught in the Economics Department
at Wellesley College. His teaching interests span all levels of the department’s cur-
riculum, including introductory and intermediate macroeconomics,
international finance, monetary economics, and mathematical economics. He
was awarded Wellesley’s Pinanski Prize for Excellence in Teaching in 2002.
He also enjoys working with thesis students. In addition to teaching, Profes-
sor Weerapana has research interests in macroeconomics, specifically in the areas
of monetary economics, international finance, and political economy.

Completing a project like this is a team effort, and we both have been blessed with good students
and colleagues who have given us advice and encouragement.

John B. Taylor
I am grateful to many colleagues and students, whom I have consulted over the years, including
Don Brown, Tim Breshanan, Marcelo Clerici-Arias, Anne Kreuger, Tom McCurdy, Paul Milgrom,
Roger Noll, John Pencavel, Paul Romer, Nate Rosenberg, Mark Tendell and Frank Wolak. I must
acknowledge with very special gratitude Akila’s partnership in this project. Akila first demon-
strated his extraordinary teaching and writing skills even before completing his PhD at Stanford.
After receiving his PhD, Akila joined the faculty at Wellesley College, where he has taught the Prin-
ciples course for many semesters and further established his reputation for teaching excellence,
and in 2002, received the Anna and Samuel Pinanski Teaching Award. His ability to get complex
topics across to his students and his enthusiasm for bringing policy implications alive is clearly
reflected in our new coauthored book.

Akila Weerapana
I am exceedingly grateful to John for giving me the opportunity to communicate my enthusiasm
for teaching economics to a broader audience than the students in my classes at Wellesley. My pas-
sion for economics stems from the inspiration I received from my economics professors: Barbara
Craig and Peter Montiel at the undergraduate level, and John Taylor, Frank Wolak, and Chad Jones
at the graduate level. I too have benefited immensely from working with my colleagues. The faculty
members in the Economics Department at Wellesley live up to the liberal arts ideal that I aspire to,
combining excellent teaching with active research. Special thanks are owed to the late Chip Case,
Courtney Coile and David Lindauer for the time they spent helping me understand how best to
pitch topics in microeconomics that I am less familiar with teaching than they are. The real inspi-
rations for this book, however, are the students that I have taught over the past two decades—two
years at Stanford, but especially, the last seventeen years at Wellesley. Without their enthusiasm
for economics, their willingness to be continually challenged, and their need to better understand
an ever-changing world, none of this would be possible. My contributions to this book are shaped
by countless hours spent talking economics with my students.

Together
Together, we would also like to thank William B. Stronge of Florida Atlantic University, who pro-
vided wonderful end-of-chapter problems that are conceptually challenging and require students
to think more deeply about the concepts. Bill’s efforts helped us meet an incredibly demanding
schedule, and we are grateful for his contributions. Numerous reviewers provided insights, sugges-
tions, and feedback along the way—often at critical points in product and supplement develop-
ment. These individuals include Mohsen Bahmani-Oskooee, University of Wisconsin, Milwaukee;
Erik Craft, University of Richmond; David H. Eaton, Murray State University; Lewis Freiberg, North-
eastern Illinois University; Wang Fuzhong, Beijing University of Aeronautics & Astronautics; Janet
Gerson, University of Michigan; Lisa Grobar, California State University, Long Beach; Ritika Gug-
nani, Jaipuria Institute of Management (Noida); Gautam Hazarika, University of Texas, Brownsville;
Aaron Johnson, Missouri State University; Jacob Kurien, Rockhurst University; Babu Nahata, Uni-
versity of Louisville; Soloman Namala, Cerritos College; Sebastien Oleas, University of Minnesota,
Duluth; Greg Pratt, Mesa Community College; Virginia Reilly, Ocean County College; Brian Rosario,
University of California, Davis; William B. Stronge, Florida Atlantic University; Della Lee Sue, Marist
College; J. S. Uppal, State University of New York, Albany; Michele T. Villinski, DePauw University;
and Laura Wolff, Southern Illinois University, Edwardsville. We are grateful to Sarah L. Stafford of
the College of William and Mary and Robert J. Rossana of Wayne State University for their detailed
and timely accuracy checks of the main texts and several key supplements. We are especially
appreciative of the contributions of the Sixth Edition supplements authors for their creativity,
dedication, and careful coordination of content; this group includes Sarah E. Culver, University
of Alabama, Birmingham; David H. Eaton, Murray State University; John Kane, State University
of New York, Oswego; Jim Lee, Texas A&M University, Corpus Christi; John S.Min, Northern Vir-
ginia Community College; Wm. Stewart Mounts, Jr., Mercer University; David H. Papell, University
of Houston; Virginia Reilly, Ocean County College Center for Economic Education; Brian Rosario,
University of California, Davis; John Solow, University of Iowa; William B. Stronge, Florida Atlantic
University; Eugenio D. Suarez, Trinity University; and Laura Wolff, Southern Illinois University,
Edwardsville. We would also like to thank Edward Gullason of Dowling College for reviewing many
of these supplements and Matthew Berg and Julia Ong for copyediting them.

Reviewers
• Matthew Alford, Southeastern Louisiana University
• Charles Anderson, Kean University
• Len Anyanwu, Union County College
• Kenneth Ardon, Salem State College
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• Paul Clement, Fashion Institute of Technology-SUNY

• Marcelo Clerici-Arias, Stanford University
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• Mitchell Dudley, The College of William & Mary
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• Tim McCabe, Tompkins Cortland Community College
• Todd McFall ,Wake Forest University
• Daniel Morvey, Piedmont Technical College
• Shahriar Mostashari, Campbell University
• Francis Mummery, Fullerton College
• Pattabiraman Neelakantan, East Stroudsburg University
• Ogbonnaya Nwoha, Grambling State University
• Olugbenga Onafowora, Susquehanna University
• Chuck Parker, Wayne State College
• Van Pham, Salem State College
• Roxana Postolache, Capital University
• Rahim Quazi, Prairie View A&M University
• MG Quibria, Morgan State University
• David Rodgers, Northwestern Connecticut Community College
• S. Scanlon Romer, Delta College
• Daniel Saros, Valparaiso University
• Mark Scanlan, Stephen F. Austin State University
• Ted Scheinman, Mt. Hood Community College
• Virginia Shingleton, Valparaiso University
• Noel Smith, Palm Beach State College

• Donald Sparks, The Citadel

• Mark Steckbeck, Campbell University
• TaMika Steward, Tarrant County College
• Chin-Chyuan Tai, Averett University
• Robert Tansky, St. Clair Community College
• Jill Trask, Tarrant County College
• Margie Vance, North Arkansas College
• Lisa Verdon, College of Wooster
• Ann Wimmer, Iowa Lakes Community College
• Benaiah YongoBure, Kettering University
• Christina Edmundson, North Idaho College
• Robb Freeman, Eastern Maine Community College
• Colleen Callahan, American University

Our goal in this book is to present modern economics in a form that is intuitive, relevant, and mem-
orable to students who have had no prior exposure to the subject. We both teach introductory
economics—Taylor at Stanford, Weerapana at Wellesley—and we enjoy teaching greatly. We espe-
cially enjoy interacting with students in the classroom as we endeavor to make the basic economic
ideas as clear and understandable as possible. In this book we aim for that same clarity and teacher-
student interaction, often imagining that we are talking with students or responding to their
questions as we write.

The New Economics from Generation

to Generation
We remember what it was like when we first took introductory economics—Taylor in the 1960s,
Weerapana in the 1990s. People called 1960s-vintage economics the “new economics,” because many
new ideas, including those put forth by John Maynard Keynes, were being applied to public policy
for the first time. By the 1990s there was a “new” new economics, stressing incentives, expectations,
long-run fundamentals, institutions, and the importance of stable, predictable economic policies.
In the 1980s and 1990s, the United States experienced far fewer recessions than in the 1960s and
1970s and the recessions were relatively short and mild.
But instability returned with the crisis and recession of 2007–2009—one of the longest and
deepest in American history. The recession, and the long drawn-out recovery from the recession,
caused a great deal of harm to millions of people. In the first decade of the twenty-first century, the
global financial crisis, the great recessions in the United States and Europe, and explosive growth in
emerging markets required a re-examination of whether the traditional frameworks needed to be
augmented to explain this new reality, presenting new challenges and opportunities for instructors
of introductory macroeconomics.
Economists engaged in a vigorous debate about what caused the crisis and how best to prevent
future crises. After the recession ended, they grappled with whether the slow growth in the United
States was in fact “the new normal.” The concerns were not restricted to the United States, China’s
economy showed signs of slowing from the torrid pace it has sustained for much of the past two
decades. The move towards closer economic integration in Europe suffered a devastating blow in
2016 from the Brexit vote, adding to the strains that had been placed on the Eurozone by the Greek
debt crisis which neared the end of its 7th year with little relief in sight for the people of Greece,
experiencing a downturn that resembled the Great Depression in terms of the depth and length of
economic impact.
In this edition, we give these and other recent developments a prominent, clearly explained
place within the basic tradition of economics. We emphasize the central idea of economics: that
people make purposeful choices with scarce resources and interact with other people when they
make these choices. We explain this idea using examples of choices that students actually face. We
give real-world examples of how markets work, and we explain why markets are efficient when
the incentives are right and inefficient when the incentives are wrong. We stress long-run funda-
mentals, but we also discuss current public policy issues relating to the crisis where the short run
matters. The big policy questions about the role of government being debated by economists and

others today receive special attention. We know from our teaching experience that examples of
how economic ideas are used in practice make economics more interesting to students, thereby
making learning economics easier.

A Brief Tour
Principles of Economics is designed for a two-term course. Recognizing that teachers use a wide
variety of sequences and syllabi, the text allows for alternative plans of coverage. Furthermore, the
text is also available in two self-contained volumes, Principles of Microeconomics and Principles of
Macroeconomics. The following is a description of the Principles of Macroeconomics volume.
Because some colleges and universities may cover introductory macroeconomics before they
cover introductory microeconomics, we begin the text with four foundational chapters aimed at
the student who has no background in economics. The basic workings of markets and the reasons
they improve people’s lives are the subjects of Chapter 1, where we outline the unifying themes of
economics: scarcity, choice, and economic interaction. The role of prices, the inherent international
aspect of economics, the importance of property rights and incentives, and the difference between
central planning and markets are some of the key ideas in this chapter. Chapter 2 introduces the
field of economics through a case study showing how economists observe and explain economic
puzzles. Chapters 3 and 4 cover the basic supply and demand model and elasticity. Here, the goal is
to show how to use the supply and demand model to make sense of the world—and to learn how
to “think like an economist.”
The study of macroeconomics begins with Chapter 5. This chapter gives an overview of the
facts, emphasizing that macroeconomics is concerned with the growth and fluctuations in the
economy as a whole. The overall structure of the book is to begin by introducing students to key
macroeconomic variables, how they are measured and what their limitations are, then discuss eco-
nomic growth, followed by economic fluctuations before moving on to discussing financial markets
and economic interconnections between countries.
Chapter 6 shows how GDP and other variables are measured. Chapter 7 starts with the first
macro model to determine the long run shares of GDP, illustrating how saving and investment are
interrelated in the economy. Chapter 8 gives an analysis of how the level of unemployment in the
economy as a whole is determined, concluding the discussion of key macroeconomic variables.
Labor, capital, and technology are then presented in Chapter 9 as the fundamental determi-
nants of the economy’s growth path. One clear advantage of this approach is that it allows students
to focus first on issues about which there is general agreement among economists. Moreover, this
ordering helps students better understand short-term economic fluctuations. Similarly, the long-
run treatment of money, presented in Chapter 10, sets the stage for the discussion of economic
fluctuations.
Chapters 11–13 focus on how the economy fluctuates even as it grows over time. Declines in pro-
duction and increases in unemployment (characteristics of recessions) have not vanished from the
landscape as long-term growth issues have come to the fore. These chapters delve into the causes
of these fluctuations and propose an analysis of why they end. Chapters 14 and 15 take a deep dive
into the world of macroeconomic policy, first fiscal policy and then monetary policy. These chapters
discuss how policy can be used to minimize the impact of economic fluctuations but also point out
some of the debates that economists engage in as they assess whether policy has been successful
at achieving the overall goal of smoothing out fluctuations.
The last decade and a half have taught us that financial markets and global economic linkages
are key elements of the world that today’s students of economics will grow up to live in. Chapter 16
introduces students to capital markets as well as to financial markets where portfolio investments

are made. Chapter 17 discusses economic growth, development and convergence around the world
while Chapters 18 and 19 aim to equip students with a better understanding of how and why goods
and money are traded among countries. When issues about which there are many differing opin-
ions arise, the text tries to explain these opinions as clearly and as objectively as possible; it also
stresses the areas of agreement.
We hope you enjoy learning economics from this textbook. We are always receptive to feedback
and eager to hear from users of the text (instructors and students) about their experience and wel-
come feedback about how to present material in a way that is more instructive to the reader.

Pedagogical Features
Examples within the text. Illustrations of real-world situations help explain economic ideas and
models. We have attempted to include a wide variety of brief examples and case studies throughout
the text.
Examples to give real-life perspectives. Stimulating vignettes appear at the beginning of each
chapter. Examples of opening vignettes include explanation of economic events such as the price
of Super Bowl tickets in Chapter 3 and discussions on how the United Nations evaluated the Mil-
lennium Development Goals it established at the dawn of the new millennium. Complete captions
and small conversation boxes in graphs are also included. The captions and shaded conversation
boxes make many of the figures completely self-contained. In some graphs, sequential numbering
of these conversation boxes stresses the dynamic nature of the curves.
Use of photos to illustrate abstract ideas. Special care has gone into the search for and selec-
tion of photos to illustrate difficult economic ideas, such as inelastic supply curves or opportunity
costs. Many text photos or photo spreads have short titles and captions to explain their relevance
to the text discussion.
Key term definitions. Definitions of key terms appear in the margins next to where the key
term is presented in the text and are listed in the index, complete with page references.
Brief reviews appear at the end of each major section. These reviews summarize the key
points in abbreviated form as the chapter evolves; they are useful for preliminary skim reading as
well as for review.
Questions for review appear at the end of every chapter. These are tests of recall and require
only short answers; they can be used for oral review or as a quick self-check.
Problems. An essential tool in learning economics, the problems have been carefully selected,
revised, and tested for this edition. An ample supply of these problems appears at the end of every
chapter and appendix. Some of the problems ask the reader to work out examples that are slightly
different from the ones given in the text; others require a more critical thinking approach.

What's New in Version 9.0?

• Many graphs are now hyperlinked to the underlying Federal Reserve Economic Data (FRED)
source. Students can become familiar with manipulating FRED data and easily link to the most
updated FRED data for each graph.
• Key updates to this version include:

• Can AI and machine learning improve resource allocations? (Chapter 1)

• Netflix pricing and demand elasticity. (Chapter 4)
• Updated economic data includes increasingly positive economic data prior to 2020, initial
recessionary impact of the COVID-19 pandemic as reflected in first- and second-quarter
economic data, and fluctuations in labor market strength. (Chapter 5, Chapter 6, and Chap-
ter 7)
• New coverage of cryptocurrencies, Venezuela’s hyperinflation, negative interest rates, and
Fed tapering. (Chapter 10)
• Fully revised discussion of post-2016 recovery following the Great Recession and impact of
the COVID-19 pandemic on the recovery. (Chapter 11)
• New discussion of why inflation was absent from the Great Recession’s recovery—and
what considerations might be missing from economic models as a result. (Chapter 13)
• Tax discussions updated to align with Tax Cut and Jobs Act of 2017. (Chapter 14)
• Updated discussion of the Fed’s balance sheet normalization and unwinding of quantita-
tive easing (QE) from 2017–2019. Coverage of renewed growth of the Fed’s balance sheet in
response to the impact of the COVID-19 pandemic and prospects for eventual unwinding.
New coverage of negative interest rates in Sweden and Switzerland. (Chapter 15)
• Explains the switch from poverty-alleviation goals from Millennium Development Goals to
Sustainable Development Goals. China’s Belt and Road initiatives that propel that country
to a global leader in funding development projects. (Chapter 17)
• Explores the Trump Administration’s trade policies and their impacts, including the
USMCA’s replacement of NAFTA, the brewing trade war with China, and how import tariffs
impact U.S. consumers. (Chapter 18)
• Updates specific to the COVID-19 pandemic throughout include:
• New boxed feature on “The Price System During National Disasters.” (Chapter 1 Section
3)
• Clear illustration of differences between correlation and causation using impact of the
pandemic on gas prices and miles traveled. (Chapter 2 Section 2)
• Ventilators and impact of demand on pricing. (Chapter 3)
• Price elasticity of supply for scarce goods in a crisis. (Chapter 4 Section 4)
• General economic turmoil induced by early reactions to the pandemic including eco-
nomic slowdown, increase in unemployment, recessionary impact, and initial monetary
and fiscal policy responses. (Chapter 5, Chapter 5 Section 2, and Chapter 5 Section 3)
• The pandemic’s impact on unemployment. (Chapter 8)
• The pandemic’s impact on labor markets. (Chapter 8 Section 1)
• Fed interventions and a new round of quantitative easing (QE). (Chapter 10 Section 2)
• The pandemic-induced recession and its potential duration. (Chapter 11 and Chapter 11
Section 1)
• Passage and impact of CARES Act. (Chapter 12)
• Unexpected transition to the pandemic-induced recession and using the model to ana-
lyze the policy response. (Chapter 13 and Chapter 13 Section 5)
• Impact of policy responses to the pandemic on the national debt and differing policy
views on the right mix of fiscal interventions. (Chapter 14 Section 1 and Chapter 14 Sec-
tion 2)
• The Fed’s response to the pandemic, new balance sheet expansion, a return to zero
interest rate policy, security purchases, and “Main Street” lending program. (Chapter 15,
Chapter 15 Section 1, Chapter 15 Section 2, Chapter 15 Section 3, and Chapter 15 Section
5)

• Global economic shocks caused by the pandemic. (Chapter 17)

• National security-based trade restrictions on supply chains for personal protective
equipment (PPE) in a health crisis (Chapter 18 Section 7)

The Central Idea

At the center of economics is the idea that people make purposeful choices with scarce resources
economics
and interact with others when they make these choices. Sometimes those choices that people make
The study of how people
have substantial impacts on the global economy. Consider Mark Zuckerberg, the founder and CEO deal with scarcity.
of Facebook. He faced a big choice when he was in college in 2004: that is, whether to finish his
degree or to drop out and devote all his time to transforming a novel idea into a start-up firm. Com-
pleting college while pursuing the start-up was not an option, because time is scarce, only 24 hours
in a day. He did not have enough time to do both activities and sleep a bit, so he had to make a
choice. In choosing one activity, he would have to incur the cost of giving up the other activity.
Dropping out of college would mean passing up a degree that would help him get a good job, but
staying in college would mean he could not start up a new firm.
Zuckerberg chose to drop out of college, and it looks like he made the right
FIGURE 1.1 A Man Who Made a
choice: His firm, Facebook, is now worth billions of dollars and provides a social Purposeful Choice
media platform that connects hundreds of millions of people all over the world. Mark Zuckerberg, founder and CEO of
Or consider the story of Elon Musk, the founder and CEO of Tesla and SpaceX Facebook, had a great idea. However, bringing
this idea to fruition would require so much of his
among other companies. Musk chose to stay in college and earned not one but time that he had to make a choice about how
two degrees—one in economics and one in physics—at the University of Penn- to allocate his scarce time resources. Should he
sylvania, choosing to extend his time spent in college to five years. He joined the finish his degree at Harvard? Or drop out to
grow his new start-up company?
PhD program in Physics at Stanford University, but then decided to leave the pro-
gram in a matter of days, choosing instead to join the entrepreneurial start-up
culture of neighboring Silicon Valley. The resulting companies that Elon Musk
founded have expanded the technological frontier of the economy over the past
decade.
Of course, not every successful choice involves dropping out of college! In
most cases, the choice to stay in school and pursue an education is what pays off.
Consider the story of the late Maryam Mirzakhani. She was a mathematical
prodigy growing up in Iran, where she won two gold medals at the International
Mathematical Olympiad. After completing her undergraduate education in Iran,
Mirzakhani had to make a choice about whether to continue her mathematical
studies and also about where to pursue those further studies. She chose to pur-
sue her PhD at Harvard, became a professor at Stanford, and in 2014 was the first
woman to win the prestigious Fields Medal in Mathematics, considered by some
to be an achievement harder than winning a Nobel Prize in an academic disci- Source: catwalker/Shutterstock.com
pline.
The purposeful choices that these remarkable people made were magnified by the opportu-
nities they had to interact with people. Hundreds of millions of people around the world interact
through Facebook. Facebook benefits from this interaction, too, in part because people pay to
advertise products on their site. Mirzakhani’s discoveries have inspired other mathematicians and
researchers in other areas like physics and engineering to make more discoveries. The electric cars
produced by Tesla and the positive experiences of Tesla drivers has inspired many other manu-
facturers to pursue the use of electric motors in cars and to pursue other forms of technological
advances such as driverless cars.

Scarcity is a situation in which people’s resources are limited. People always face a scarcity of
scarcity
some sort. Scarcity implies that people must make a choice to forgo, or give up, one thing in favor
The situation in which the
quantity of resources is of another. The successes of Mirzakhani, Musk and Zuckerberg also reflect purposeful choices that
insufficient to meet all other individuals, organizations, firms and governments made with scarce resources. Harvard Uni-
wants. versity had to decide who received admission to the select few openings in their PhD program,
venture capitalists in Silicon Valley had to decide which of the many hundreds of entrepreneurs
choice
asking for their financial investments were the most worthy recipients, thousands of college stu-
A selection among dents had to decide that they needed to take a study break on a regular basis to connect with their
alternative goods,
services, or actions. friends, the government of Iran had to decide how much funding to allocate to their universities to
allow young talented students like Maryam Mirzakhani to achieve their full potential, and the gov-
ernment of the United States had to decide how many immigrants—like the South African–born
Musk and the Iranian-born Mirzakhani—should be granted the opportunity to become American
citizens and make contributions to the economy and the country. As you read this text, you may
find yourself reflecting on decisions that you have to make—whether to major in economics or
biology, whether to take all your classes after 10:00 A.M. or to schedule them all before noon,
whether to search the Internet or to study.
economic Economic interactions between people occur every time they trade or exchange goods with
interactions each other. A college student buys education services from a university in exchange for tuition. A
Exchanges of goods and teenager sells labor services to Taco Bell in exchange for cash. Within a household, one member
services between people. may agree to cook dinner in exchange for the other person agreeing to wash the dishes. Economic
interactions typically take place in a market. A market is simply an arrangement by which buyers
market
and sellers can interact and exchange goods and services with each other. There are many types of
An arrangement by which markets, ranging from the New York stock market to a local flea market. Interactions do not have
economic exchanges
between people take to take place with the buyer and seller in physical proximity to each other; the Internet, for exam-
place. ple, greatly enhances the opportunities for economic interaction.

Scarce versus Free Resources

Economics is the study of the allocation of scarce resources.

View in the online reader

The purpose of this book is to introduce you to the field of economics, to provide you with the
knowledge that will help you understand how so much of what happens in the world is shaped by
the actions of people who had to make choices when confronted by scarcity. A better understand-
ing of economics will equip you to handle the opportunities and challenges you face—should you
continue with schooling if the economy is weak and it is hard to find a job? It also will leave you bet-
ter informed about the challenges that the nation faces—should the government intervene in the
economy to regulate businesses, or should it provide economic stimulus packages to help the econ-
omy? Soon you will find yourself viewing the world through the lens of economics. Your friends
may tell you that you are “thinking like an economist.” You should take that as a compliment. The

first step on this path is to understand the enormous power of the central ideas of scarcity, choice,
and economic interactions. That’s the purpose of this chapter.

1.1 Scarcity and Choice for

Individuals
It is easy to find everyday examples of how people make purposeful choices when they are con-
fronted with a scarcity of time or resources. A choice that may be on your mind when you study
economics is how much time to spend on these studies versus other activities. If you spend all your
time on economics, you may get a 100 percent on the final exam, but a 0 percent in biology. If you
spend all your time on biology, then you may get a 100 percent in biology and a 0 percent in eco-
nomics. Most people resolve the choice by balancing out their time to get a decent grade in both
subjects. If you are pre-med, then you probably will devote more time to biology. If you are inter-
ested in business, then devoting more time to economics might be appropriate.
Now let us apply this basic principle to two fundamental economic problems: individual
choices about what to consume and what to produce. For each type of economic problem, we first
show how scarcity forces one to make a choice, and then we show how people gain from interact-
ing with other people.

Consumer Decisions
Consider Maria, who is going for a walk in a park on a sunny day. Maria would love to wear a hat
(baseball style with her school logo) and sunglasses on the walk, but she forgot them at home.
Maria has brought $20 with her, however, and there is a store in the park that is having a “two-
for-one” sale. She can buy two hats for $20 or two pairs of sunglasses for $20. She would prefer to
buy one hat and one pair of sunglasses, but that is not possible. Her scarcity of funds causes her
to make a choice. The $20 limit on her spending is an example of a budget constraint, a scarcity of
funds that limits her to spending no more than this amount. Her choice will depend on her tastes.
Let us assume that when she is forced by scarcity to make a choice, she will choose the sunglasses.

Opportunity Cost
Maria’s decision is an example of an economic problem that all people face: A budget constraint
opportunity cost
forces them to make a choice between different items that they want. Choosing one item means
The value of the next-best
that you have to give up other items. The opportunity cost of a choice is the value of the next-best forgone alternative that
forgone alternative that was not chosen. The opportunity cost of the hats is the loss from not being was not chosen because
able to wear the sunglasses. An opportunity cost occurs every time there is a choice. For example, something else was
chosen.
the opportunity cost of waking up to attend an 8:00 A.M. class rather than sleeping in is the hours
of sleep you lose when you get up early. The opportunity cost of Mark Zuckerberg’s staying in col-
lege versus pursuing his start-up would have been the money he earned from Facebook. In many
cases involving choice and scarcity, you have to choose from among many more than two options.
If you choose vanilla ice cream out of a list of many possible flavors, then the opportunity cost is
the loss from not being able to consume the next-best flavor, perhaps strawberry.
Now, suppose Maria is not the only hiker. Also in the park is Adam, who also has $20 to spend.
Adam also loves both hats and sunglasses, but he likes hats more than sunglasses. When forced to

make a choice, he buys the hats. His decision is shaped by scarcity just as Maria’s is: Scarcity comes
from the budget constraint. He must make a choice, and each choice has an opportunity cost.

Gains from Trade: A Better Allocation

Now suppose that Adam and Maria meet each other in the park. Let’s consider the possibility of
gains from trade
economic interaction between them. Maria has two pairs of sunglasses and Adam has two hats, so
Improvements in income,
production, or satisfaction Maria and Adam can trade with each other. Maria can trade one of her pairs of sunglasses for one
owing to the exchange of of Adam’s hats, as shown in Figure 1.2. Through such a trade, both Maria and Adam can improve
goods or services. their situation. There are gains from trade because the trade reallocates goods between the two
individuals in a way that they both prefer. Trade occurs because Maria is willing to exchange one
pair of sunglasses for one hat, and Adam is willing to exchange one hat for one pair of sunglasses.
Because trade is mutually advantageous for both Maria and Adam, they will voluntarily engage in
it if they are able to. In fact, if they do not gain from the trade, then neither will bother to make the
trade.
This trade is an example of an economic interaction in which a reallocation of goods through
trade makes both people better off. The total quantity of goods produced does not change. The
number of hats and sunglasses has remained the same. Trade simply reallocates existing goods.
The trade between Maria and Adam is typical of many economic interactions that we will
study in this book. Thinking like an economist in this example means recognizing that a voluntary
exchange of goods between people must make them better off. Many economic exchanges are like
this, even though they are more complicated than the exchange of hats and sunglasses.

FIGURE 1.2 Gains from Trade through a Better Allocation of Goods

Without trade, Maria has more pairs of sunglasses than she would like, and Adam has more hats than he would
like. By trading a hat for a pair of sunglasses, they both gain.

Producer Decisions
Now consider two producers—Emily, a poet, and Johann, a printer. Both face scarcity and must
make choices. Because of differences in training, abilities, or inclination, Emily is much better at
writing poetry than Johann is, but Johann is much better at printing greeting cards than Emily is.
If Emily writes poetry full time, she can produce 10 poems in a day; but if she wants to make
and sell greeting cards with her poems in them, she must spend some time printing cards and
thereby spend less time writing poems. However, Emily is not very good at printing cards; it takes
her so much time to do so that if she prints one card, she has time to write only one poem rather
than 10 poems during the day.
If Johann prints full time, he can produce 10 different greeting cards in a day. However, if he
wants to sell greeting cards, he must write poems to put inside them. Johann is so bad at writing
poems that if he writes only one poem a day, his production of greeting cards drops from 10 to one
per day.
The following is a summary of the choices Emily and Johann face because of a scarcity of time
and resources.

Emily, the Poet Johann, the Printer

Write Full Time Write and Print Print Full Time Write and Print
Cards 0 1 10 1
Poems 10 1 0 1

If Emily and Johann cannot interact, then each can produce only one greeting card with a
poem on the inside in a day. Alternatively, Emily could produce 10 poems without the cards and
Johann could produce 10 cards without the poems, but then neither would earn anything. We
therefore assume that when confronted with this choice, both Emily and Johann will each choose
to produce, by themselves, one greeting card with a poem inside. In total, they produce two greet-
ing cards.

Gains from Trade: Greater Production

Now consider the possibility of economic interaction. Suppose that Emily and Johann can trade.
Johann could sell his printing services to Emily, agreeing to print her poems on nice greeting cards.
Then Emily could sell the greeting cards to people. Under this arrangement, Emily could spend all
day writing poetry, and Johann could spend all day printing. In total, they could produce 10 differ-
ent greeting cards together, expending the same time and effort it took to produce two greeting
cards when they could not trade.
Note that in this example the interaction took place in a market: Johann sold his print jobs to
Emily. Another approach would be for Emily and Johann to go into business together, forming a
firm, Dickinson and Gutenberg Greetings, Inc. Then their economic interaction would occur within
the firm, without buying or selling in the market. Whether in a market or within a firm, the gains
from trade in this example are huge. By trading, Emily and Johann can increase their production
of greeting cards five fold, from two cards to 10 cards.

Specialization, Division of Labor, and Comparative

Advantage
This example illustrates another way in which economic interaction improves people’s lives. Eco-
specialization
nomic interaction allows for specialization: people concentrating their production efforts on what
A concentration of
production effort on a they are good at. Emily specializes in poetry, and Johann specializes in printing. The specialization
single specific task. creates a division of labor. A division of labor occurs when some workers specialize in one task
while others specialize in another task. They divide the overall production into parts, with some
division of labor workers concentrating on one part (printing cards) and other workers concentrating on another
The division of production part (writing poetry).
into various parts in which
different groups of workers The writing-printing example of Emily and Johann also illustrates another economic concept,
specialize. comparative advantage. In general, a person or group of people has a comparative advantage in
producing one good relative to another good if that person or group can produce that good at a
comparative lower opportunity cost (in terms of the other good) than another person or group can produce that
advantage
good. For example, compared with Johann, Emily has a comparative advantage in writing relative
A situation in which a to printing because for her, writing 10 poems requires giving up only 1 print (Johann would have to
person or group can
produce one good at a give up 100 prints to write 10 poems). And compared with Emily, Johann has a comparative advan-
lower opportunity cost tage in printing relative to writing because for him, printing 10 cards only requires giving up 1 poem
than another person or (Emily would have to give up 100 poems to print 10 cards). As this example shows, production can
group.
be increased if people specialize in the skill in which they have a comparative advantage—that is, if
Emily specializes in writing and Johann in printing.

Opportunity Cost

The opportunity cost for consumers and producers is the value of the choice not taken.

View in the online reader

International Trade
Thus far, we have said nothing about where Emily and Johann live or work. They could reside in
international trade
the same country, but they also could reside in different countries. Emily could live in the United
The exchange of goods
and services between States; Johann, in Germany. If this is so, when Emily purchases Johann’s printing service,
people or firms in different international trade will take place because the trade is between people in two different countries.
nations.
The gains from international trade are thus of the same kind as the gains from trade within a
country. By trading, people can better satisfy their preferences for goods (as in the case of Maria
and Adam), or they can better utilize their comparative advantage (as in the case of Emily and
Johann). In either situation, both participants can gain from trade.

Review

• All individuals face scarcity in one form or another. Scarcity forces people to make choices.
For every choice that is made, there is also an opportunity cost of not doing one thing
because another thing has been chosen.
• People benefit from economic interactions—trading goods and services—with other people.

• Gains from trade occur because goods and services can be allocated in ways that are more
satisfactory to people.
• Gains from trade also occur because trade permits specialization through the division of
labor. People should specialize in the production of goods in which they have a comparative
advantage.

1.2 Scarcity and Choice for the

Economy as a Whole
Just as individuals face scarcity and choice, so too does the economy as a whole. The total amount
of resources in an economy—workers, land, machinery, and factories—is limited. Thus, the econ-
omy cannot produce all the health care, crime prevention, education, or entertainment that people
want. A choice must be made. Let us first consider how to represent scarcity and choice in the
whole economy and then consider alternative ways to make those choices.

Production Possibilities
To simplify things, let us suppose that production in the economy can be divided into two broad
categories. Suppose the economy can produce either computers (laptops, desktops, servers) or
movies (thrillers, love stories, mysteries, musicals). The choice between computers and movies is
symbolic of one of the most fundamental choices individuals in any society must face: how much
to invest to produce more or better goods in the future versus how much to consume in the present.
Computers help people produce more or better goods. Movies are a form of consumption. Other
pairs of goods also could be used in our example. Another popular example is guns versus butter,
representing defense goods versus nondefense goods.
With a scarcity of resources, such as labor and capital, a choice exists between producing some production
goods, such as computers, versus other goods, such as movies. If the economy produces more of possibilities
one, then it must produce less of the other. Table 1.1 gives an example of the alternative choices, or Alternative combinations of
the production possibilities, for computers and movies. Observe that six different choices could be production of various
goods that are possible,
made, some with more computers and fewer movies, others with fewer computers and more given the economy’s
movies. resources.

Table 1.1 tells us what happens as available resources in the economy are moved from movie
production to computer production or vice versa. If resources move from producing movies to pro-
ducing computers, then fewer movies are produced. For example, if all of the resources are used to
produce computers, then 25,000 computers and zero movies can be produced, according to the
table. If all resources are used to produce movies, then no computers can be produced. These are
two extremes, of course. If 100 movies are produced, then we can produce 24,000 computers rather
than 25,000 computers. If 200 movies are produced, then computer production must fall to 22,000.

TABLE 1.1 Production Possibilities

Movies Computers
A 0 25,000
B 100 24,000

Movies Computers
C 200 22,000
D 300 18,000
E 400 13,000
F 500 0

Increasing Opportunity Costs

The production possibilities in Table 1.1 illustrate the concept of opportunity cost for the economy
as a whole. The opportunity cost of producing more movies is the value of the forgone computers.
For example, the opportunity cost of producing 200 movies rather than 100 movies is 2,000 comput-
ers.
increasing An important economic idea about opportunity costs is demonstrated in Table 1.1. Observe that
opportunity costs movie production increases as we move down the table. As we move from row to row, movie pro-
A situation in which duction increases by the same number: 100 movies. The decline in computer production between
producing more of one the first and second rows—from 25,000 to 24,000 computers—is 1,000 computers. The decline
good requires giving up an
increasing amount of between the second and third rows—from 24,000 to 22,000 computers—is 2,000 computers. Thus,
production of another the decline in computer production gets greater as we produce more movies. As we move from 400
good. movies to 500 movies, we lose 13,000 computers. In other words, the opportunity cost, in terms of
computers, of producing more movies increases as we produce more movies. Each extra movie
requires a loss of more and more computers. What we have just described is called increasing
opportunity costs, with an emphasis on the word increasing.
Why do opportunity costs increase? You can think about it in the following way. Some of the
available resources are better suited for movie production than for computer production, and vice
versa. Workers who are good at building computers might not be so good at acting, for example,
or moviemaking may require an area with a dry, sunny climate. As more and more resources go
into making movies, we are forced to take resources that are much better at computer making and
use them for movie making. Adding specialized computer designers to a movie cast would be quite
costly in terms of lost computers, and it might add little to movie production. Thus, more and more
computer production must be lost to increase movie production by a given amount.

The Production Possibilities Curve

Figure 1.3 is a graphical representation of the production possibilities in Table 1.1 that nicely illus-
trates increasing opportunity costs. We put movies on the horizontal axis and computers on the
vertical axis of the figure. Each pair of numbers in a row of the table becomes a point on the graph.
For example, point A on the graph is from row A of the table. Point B is from row B, and so on.
production When we connect the points in Figure 1.3, we obtain the production possibilities curve. This
possibilities curve curve shows the maximum number of computers that can be produced for each quantity of movies
A curve showing the produced. Note that the curve in Figure 1.3 slopes downward and is bowed out from the origin. That
maximum combinations of the curve is bowed out indicates that the opportunity cost of producing movies increases as more
production of two goods
that are possible, given the movies are produced. As resources move from computer making to movie making, each additional
economy’s resources. movie means a greater loss of computer production.

FIGURE 1.3 The Production Possibilities Curve

Each point on the curve shows the maximum number of computers that can be produced when a given amount of
movies is produced. The points with letters are the same as those in Table 1.1 and are connected by smooth lines.
Points in the shaded area inside the curve are inefficient. Points outside the curve are impossible. For the efficient
points on the curve, the more movies that are produced, the fewer computers that are produced. The curve is
bowed out because of increasing opportunity costs.

Inefficient, Efficient, or Impossible?

The production possibilities curve shows the effects of scarcity and choice in the economy as a
whole. Three situations can be distinguished in Figure 1.3, depending on whether production is in
the shaded area, on the curve, or outside the curve.
First, imagine production at point I. This point, with 100 movies and 18,000 computers, is inside
the curve. But the production possibilities curve tells us that it is possible to produce more com-
puters, more movies, or both with the same amount of resources. For some reason, the economy is
not working well at point I. For example, a talented movie director may be working on a computer
assembly line because her short film has not yet been seen by studio executives, or perhaps a finan-
cial crisis has prevented computer companies from getting loans and thus disrupted all production
of computer chips. Points inside the curve, like point I, are inefficient because the economy could
produce a larger number of movies, as at point D, or a larger number of computers, as at point B.
Points inside the production possibilities curve are possible, but they are inefficient.
Second, consider points on the production possibilities curve. These points are efficient. They
represent the maximum amount that can be produced with available resources. The only way to
raise production of one good is to lower production of the other good. Thus, points on the curve
show a trade-off between one good and another.
Third, consider points to the right and above the production possibilities curve, like point J in
Figure 1.3. These points are impossible. The economy does not have the resources to produce those
quantities.

Shifts in the Production Possibilities Curve

The production possibilities curve is not immovable. It can shift out or in. For example, the curve
is shown to shift out in Figure 1.4. More resources—more workers, for example, or more cameras,
lights, and studios—would shift the production possibilities curve out. A technological innovation
that allowed one to edit movies faster also would shift the curve outward. When the production
possibilities curve shifts out, the economy grows because more goods and services can be produced.
The production possibilities curve need not shift outward by the same amount in all directions.
The curve could move up more than it moves to the right, for example.

FIGURE 1.4 Shifts in the Production Possibilities Curve

The production possibilities curve shifts out as the economy grows. The maximum numbers of movies and
computers that can be produced increase. Improvements in technology, more machines, or more labor permits the
economy to produce more.

As the production possibilities curve shifts out, impossibilities are converted into possibilities.
Some of what was impossible for the U.S. economy in 1975 is possible now. Some of what is impos-
sible now will be possible in 2035. Hence, the economists’ notion of possibilities is a temporary one.
When we say that a certain combination of computers and movies is impossible, we do not mean
“forever impossible,” we mean only “currently impossible.”

Scarcity, Choice, and Economic Progress

However, the conversion of impossibilities into possibilities is also an economic problem of choice
and scarcity: If we invest less now—in machines, in education, in children, in technology—and con-
sume more now, then we will have less available in the future. If we take computers and movies
as symbolic of investment and consumption, then choosing more investment will result in a larger
outward shift of the production possibilities curve, as illustrated in Figure 1.5. More investment
enables the economy to produce more in the future.

The production possibilities curve represents a trade-off, but it does not mean that some peo-
ple win only if others lose. First, it is not necessary for someone to lose in order for the production
possibilities curve to shift out. When the curve shifts out, the production of both items increases.
Although some people may fare better than others as the production possibilities curve is pushed
out, no one necessarily loses. In principle, everyone can gain. Second, if the economy is at an inef-
ficient point (like point I in Figure 1.3), then production of both goods can be increased with no
trade-off. In general, therefore, the economy is more like a win-win situation, where everyone can
achieve a gain.

FIGURE 1.5 Shifts in the Production Possibilities Curve Depend on Choices

On the left, few resources are devoted to investment for the future; hence, the production possibilities curve shifts
only a little over time. On the right, more resources are devoted to investment and less to consumption; hence, the
production possibilities curve shifts out by a larger amount over time.

Review

• The production possibilities curve represents the choices open to a whole economy when it
is confronted with a scarcity of resources. As more of one item is produced, less of another
item must be produced. The opportunity cost of producing more of one item is the reduced
production of another item.
• The production possibilities curve is bowed out because of increasing opportunity costs.
• Points inside the curve are inefficient. Points on the curve are efficient. Points outside the
curve are impossible.
• The production possibilities curve shifts out as resources increase.
• Outward shifts of the production possibilities curve or moves from inefficient to efficient
points are the reasons why the economy is not a zero-sum game, despite the existence of
scarcity and choice.

1.3 Market Economies and the Price

System
Every economy, whether it is a small island economy or a large economy like the United States,
must find a way to solve three essential questions or problems.
• What is to be produced: movies, computers, guns, butter, greeting cards, Rollerblades, health
care, or something else? In other words, where on the production possibilities curve should an
economy be?
• How are these goods to be produced? In other words, how can an economy use the available
resources so that it is not at an inefficient point inside the production possibilities curve?
• For whom are the goods to be produced? We know from the hat versus sunglasses example
that the allocation of goods in an economy affects people’s well-being. An economy in which
Maria could not trade her sunglasses for a hat would not work as well as one in which such
trades and reallocations are possible. Moreover, an economy in which some people get every-
thing and others get virtually nothing also is not working well.

FIGURE 1.6 Three Fundamental Questions for Any Economic System

Any economic system has to answer three questions: What goods and services should be produced—cars,
movies, or something else? How should these goods or services be produced—in what type of factory, and with
how much equipment and labor? And for whom should these goods be produced?

Source: MikeDotta/Shutterstock.com

Broadly speaking, the market economy and the command economy are two alternative
market economy
approaches to answering these questions. In a market economy, most decisions about what, how,
An economy characterized
by freely determined prices and for whom to produce are made by individual consumers, firms, governments, and other orga-
and the free exchange of nizations interacting in markets. In a command, or centrally planned, economy, most decisions
goods and services in about what, how, and for whom to produce are made by those who control the government, which,
markets.
through a central plan, commands and controls what people do.
command economy Command economies are much less common in the twenty-first century than they were in the
An economy in which the mid-twentieth century, when nearly half the world’s population, including the residents of Eastern
government determines Europe, the Soviet Union, and China, lived in centrally planned economies. After many decades of
prices and production also
struggling to make this system work, leaders of the command economies gradually grew disillu-
called a centrally planned
economy. sioned with the high degree of inefficiency resulting from the planned approach, which required
that the state, or central planners, make critical detailed production decisions; this often resulted
in shortages or surplus of products and, as a by-product, in political unrest. Since 1990, most com-
mand economies have, with varying degrees of success, tried to convert from a command to a
market system. The difficulties with converting these systems are partly due to the fact that these
economies have none or few of the social, legal, or political fixtures critical to the market system.
China has been by far the most successful of these economies at making the transition, developing
a model that the Chinese term “socialism with Chinese characteristics.” Beginning in the 1970s, ele-

ments of both the command and market economies coexisted in China; in the mid-1990s, market
mechanisms grew more dominant. In the twenty-first century, while its political system is still
highly centralized, China’s economy is much more decentralized. Many people credit China’s rapid
economic growth in recent years to its successful transition away from a centralized economic sys-
tem.

Key Elements of a Market Economy

Let’s take a closer look at some of the ingredients critical to a market economy.

Freely Determined Prices

In a market economy, most prices—such as the price of computers—are freely determined by indi-
freely determined
viduals and firms interacting in markets. These freely determined prices are an essential prices
characteristic of a market economy. In a command economy, most prices are set by government,
Prices that are determined
and this leads to inefficiencies in the economy. For example, in the former Soviet Union, the price by the individuals and firms
of bread was set so low that farmers fed bread to the cows. Feeding bread to livestock is an enor- interacting in markets.
mous waste of resources. Livestock could eat plain grain. By feeding the cows bread, farmers added
the cost of the labor to bake the bread and the fuel to heat the bread ovens to the cost of livestock
feed. This is inefficient, like point I in Figure 1.3.
In practice, not all prices in market economies are freely determined. For example, some cities
control the price of rental apartments. We will look at these exceptions later. But the vast majority
of prices are free to vary.

Property Rights and Incentives

Property rights are another key element of a market economy. Property rights give individuals the
property rights
legal authority to keep or sell property, whether land or other resources. Property rights are needed
Rights over the use, sale,
for a market economy because they give people the ability to buy and sell goods. Without property and proceeds from a good
rights, people could take whatever they wanted without paying. People would have to devote time or resource.
and resources to protecting their earnings or goods.
Moreover, by giving people the rights to the earnings from their work, as well as letting them incentive
suffer some of the consequences or losses from their mistakes, property rights provide an A device that motivates
incentive. For example, if an inventor could not get the property rights to an invention, then the people to take action,
incentive to produce the invention would be low or even nonexistent. Hence, there would be few usually to increase
economic efficiency.
inventions, and we all would be worse off. If property rights did not exist, people would not have
incentives to specialize and reap the gains from the division of labor. Any extra earnings from spe-
cialization could be taken away.

Freedom to Trade at Home and Abroad

Economic interaction is a way to improve economic outcomes, as the examples in this chapter indi-
cate. Allowing people to interact freely is thus another necessary ingredient of a market economy.
Freedom to trade can be extended beyond national borders to other economies.
International trade increases the opportunities to gain from trade. This is especially important
in small countries, where it is impossible to produce everything. But the gains from exchange and
comparative advantage also exist for larger countries.

A Role For Government

Just because prices are freely determined and people are free to trade in a market economy does
market failure
not mean that there is no role for government. For example, in virtually all market economies, the
Any situation in which the
market does not lead to an government provides defense and police protection. The government also helps establish property
efficient economic rights. But how far beyond that should it go? Should the government also address the “for whom”
outcome and in which the question by providing a safety net—a mechanism to deal with the individuals in the economy who
government has a
potential role.
are poor, who go bankrupt, who remain unemployed? Most would say yes, but what should the
government’s role be? Economics provides an analytical framework to answer such questions. In
government failure certain circumstances—called market failure—the market economy does not provide good
A situation in which the enough answers to the “what, how, and for whom” questions, and the government has a role to play
government fails to in improving on the market. However, the government, even in the case of market failure, may do
improve on the market or worse than the market, in which case economists say there is government failure.
even makes things worse.

The Role of Private Organizations

It is an interesting feature of market economies that many economic interactions between people
take place in organizations—firms, families, charitable organizations—rather than in markets.
Some economic interactions that take place in an organization also take place in a market. For
example, many large firms employ lawyers as part of their permanent staff. Other firms simply pur-
chase the services of such lawyers in the market; if the firm wants to sue someone or is being sued
by someone, it hires an outside lawyer to represent it.
Economic interactions in firms differ from those in the market. Staff lawyers inside large firms
are usually paid annual salaries that do not depend directly on the number of hours worked or
their success in the lawsuits. In contrast, outside lawyers are paid an hourly fee and a contingency
fee based on the number of hours worked and how successful they are.
Incentives within an organization are as important as incentives in markets. If the lawyers on
a firm’s legal staff get to keep some of the damages the firm wins in a lawsuit, they will have more
incentive to do a good job. Some firms even try to create market-like competition between depart-
ments or workers in order to give more incentives.
Why do some economic interactions occur in markets and others in organizations? Ronald
Coase of the University of Chicago won the Nobel Prize for showing that organizations such as
firms are created to reduce market transaction costs, the costs of buying and selling, which include
finding a buyer or a seller and reaching agreement on a price. When market transaction costs are
high, we see more transactions taking place within organizations. For example, a firm might have
a legal staff rather than outside lawyers because searching for a good lawyer every time there is a
lawsuit is too costly. In a crisis, a good lawyer may not be available.

The Price System

The previous discussion indicates that in market economies, freely determined prices are essential
for determining what is produced, how, and for whom. For this reason, a market economy is said
to use the price system to solve these problems. In this section, we show that prices do a surprising
amount of work: (1) Prices serve as signals about what should be produced and consumed when
there are changes in tastes or changes in technology, (2) prices provide incentives to people to alter
their production or consumption, and (3) prices affect the distribution of income, or who gets what
in the economy.

© 2021 Boston Academic Publishing, Inc., d.b.a FlatWorld. All rights reserved.
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CHAPTER XXXIII
AN OMINOUS VISIT
At the inn Strode was waiting for me in some impatience, if not
alarm, fearing foul play, from the delay in my return. After dinner we
lit our cigars and strolled out. Then I told him the whole story, which
indoors I had dared only hint at. I should have taken him into my
confidence anyhow, situated as I was, and feeling quite certain of
his staunchness and grit; but, beyond that, I had come to the
conclusion that his help would be absolutely necessary in the next
night’s most hazardous undertaking. This he readily promised, as I
felt sure he would, and even with more alacrity than could have
been counted on.
“I shall simply revel in being your comrade in this affair, or
humble servant, if you like,” he said heartily. “I’m sick of hanging
and mooning about, taking pot-shots at birds and vermin, with an
occasional wink at a stupid grinning peasant girl. Ah, my dear fellow,
I’ve been in the swim, and know what it is; slow enough, Heaven
knows, at the best; I’ve gone under through my own folly, and if you
knew what the feeling is, the sense of failure and degradation, you
wouldn’t wonder that the excitement of a business like this is like
brandy to a knocked-out man. I was thinking I’d have soon to get up
a shine on my own account, but this will suit me far better; we have
the merit of a decent action at our backs and are not a pair of idiots
joining in a scrimmage out of sheer devilry. Why, hang it! man,
there’s a touch of the old-time chivalry about the racket, with
brainwork thrown in. Yes; I’m your man, to see you through this
little frolic, and be thankful for the chance.”
We talked over the plan I had laid and the necessary
preparations. The delay kept me in a disagreeable state of chafing
and suspense, but we both voted it to be unavoidable. To have any
chance of success, the attempt had to be made by night, and that
night it was impracticable. Our walk had taken us near the entrance
to the tunnel.
“I don’t know what it is,” I said, “but now the way is found, I
feel I cannot keep from that poor girl’s prison.”
“You are going through?” Strode asked. “Will you let me come
with you? I may as well get the hang of the place.”
With the half-formed intention, I had provided myself with a
supply of light. We let ourselves down into the passage and set
forward towards the Monastery, scarcely purposing, perhaps, to
reach the other end. But we groped on and on, Strode often making
me smile by his characteristic comments and ejaculations. Neither of
us suggested turning back, until some twenty minutes’ uneasy
progress brought us to the steps leading to the trap-door. Here we
stayed awhile.
“So we are actually within the walls of that cursed den of
iniquity, are we?” Strode observed. “Look here! We’ve got our
revolvers; I’m game, if you are, to carry the place by surprise and
hurry these hellish Johnnies to the warm quarters that are waiting
for them.”
I knew that was sheer madness, so checked his ardour. At the
same time, however, this dare-devil ally of mine gave me a very
pleasant feeling of confidence.
“Before we return,” I said, “I have a good mind to run up and
see that all is yet well. It is worth while as we are so near.”
Strode laughed and nodded sagaciously. “All right, mein Herr.
Can’t say I see the utility of the move since you don’t fall in with my
suggestion, but then probably utility is not altogether your motive.
I’ll wait for you here. Don’t make a fool of yourself, that’s all.”
I was already up the steps, and in a few seconds had passed
through the trap-door. It was pitch dark, but the way was familiar
now, and I found the passage without difficulty. If I expected to see
the light at the farther end I was disappointed; all was dark. I
groped my way along on tip-toe till the wall against my hand came
to an end at the entrance of the room into which the prison window
looked. All was dark here too. I crept to the window but could see
nothing, hear nothing. If there had been a light in the room some
indication would have been visible, even though the curtain were
carefully drawn across the window. No. I was satisfied that the room
was in darkness. And yet it was almost too early for the prisoner to
have retired for the night. The darkness and silence might mean
nothing, and yet they filled me with a horribly uncomfortable
surmise. I stood for a while in a state of indecision. But I could not
bring myself to turn back in that spirit of uncertainty. I was
committed to the business, my whole heart and soul were in it now,
and the risk was nothing to me. The idea that I had that afternoon
perhaps missed a chance, even if ever so desperate, of rescuing the
prisoner maddened me. Of course all might be well and my anxiety
groundless, but looking at the situation as calmly as I could it was
impossible, knowing Furello and his creatures, not to fear.
With no exact purpose except to look about for what chance
might show me, I made my way from the room and proceeded to
explore the long passage further. It was an utterly rash and foolish
move, but the impulse was strong upon me, and the very stillness of
the place led me on. I ventured now to strike a light which showed
me a distant door, towards which I hastened. Contrary to my
expectations it was unlocked. I passed through it quietly; still all was
darkness, and the same oppressive silence. Another lighted match
showed me I was in a large basement room with a flagged floor,
green with disuse. A door was opposite; I crossed and opened it.
Darkness still. But another match revealed a flight of steps. I crept
up and passed through yet another door. Then, by the aid of my
light, I recognized my whereabouts. I was in a kind of inner
courtyard on which I had lighted in my search the night before. To
find my way to the great hall was now an easy matter, though risky
enough.
Arrived there, I stood awhile and listened. The same death-like
stillness pervaded the place. What light from without penetrated
through the high, dark coloured windows was just enough to show
me indistinctly the objects around. I took out my revolver and crept
to the stairs, then suddenly I stopped, hearing voices. Men’s voices,
indistinct, and at some distance. I turned aside, drawing stealthily,
yard by yard, nearer to the sound. I dared not waste time, fearing
what rash thing Strode might do if I stayed too long. The hangings
on the walls helped me now as they had done before; a man could,
with care, move along behind them without much fear of detection.
A little farther on I seemed quite close to the voices, and recognized
the Count’s; but the direction from which it came puzzled me, until I
discovered a kind of grating or loophole in the door of the room from
which the sound proceeded. I was preparing to look through, when
suddenly I started, thunder-struck. The Count’s voice had ceased
and another replied, a voice which I knew at once, the most dreaded
in that kingdom—Rallenstein’s. As I recovered from the momentary
shock of something more than surprise, I looked through the
grating. Yes; there he was, the terrible Chancellor, sitting back in a
great easy chair, at his side a small table with wine and fruit, and
before him Furello, standing with hands clasped behind him, the
fingers, as I noticed, for his back was towards me, working as with
passion or strong excitement.
If the Count’s face (which I could not see) was ruffled, the
Chancellor’s was as impassive and inscrutable as ever.
“You will hardly persuade me, my dear Count,” he was saying in
that smooth masked voice which I knew so well, “that you have
blundered through stupidity. You are no fool—or you would not be
here—at all.” The sinister significance with which he spoke the last
words was indescribable. “And,” he went on, “I tell you frankly, I am
far from satisfied.”
Furello drew himself up and spoke more quietly now. “In
matters of this sort at least I am not fool enough to look for explicit
instructions. Your Excellency has been accustomed to convey your
wishes in hints. Acting on them I have done your work faithfully.
There are words better left unsaid, wishes better——”
“Pfui, Count!” Rallenstein interrupted with a wave of the hand.
“You are trifling. You should know well enough what my real
instructions were. I told you expressly the girl might be wanted.
That it might be necessary to produce her.”
“At that time. But the time is past. Surely it was inconceivable
that you really wished her kept alive. Who could have foreseen what
you have just told me, the secret marriage of Prince Theodor?”
“That is all no business of yours,” the Chancellor returned, with
a momentary lapse from his usual bland manner to a sneer that was
almost brutal. “When I saved your neck from the gallows-rope, it
was on the understanding that you should yield me implicit
obedience, that the life I gave you was to do my will. You are not
required to think for yourself, and you had best beware how you
take upon yourself to do so. Let me remind you that that rope with
the ugly knot in it still dangles. Enough! I do not trouble to concern
myself with your motives—oh, do not protest”—for the other had
made a deprecating gesture—“I am no fool either, and know men do
not thwart my will for nothing—for nothing. So! And the girl is dead.
She is dead?”
Such a searching look, so fierce, so threatening, so piercing,
that I wondered how the Count had nerve to answer quietly. “Three
days ago.”
“Ha! And buried—where?”
“In the wood, by the grave of Herr Pfarrer Gerrsdorff. If your
Excellency wishes to be satisfied——”
“I am satisfied, mein Graf,” Rallenstein said sharply, “that you
have played me a knavish trick; and I know not yet that it has been
with impunity. Recollect that an unnecessary crime is the worst of
blunders.”
“Not so unnecessary, Excellency,” the Count protested as the
other tossed off a glass of wine as dismissing the subject. “One of
my reasons for the haste by which I regret to have offended you
was that our meddling Englishman has been here.”
Rallenstein nodded. “I know it. Now there, my dear Count——”
There was significance enough in the aposiopesis to make me
shudder. The Count laughed; he was evidently beginning to feel
easier.
“We made a good attempt,” he replied grimly. “But the fellow
wriggled out of our hands somehow. Bleisst says he must be own
brother to the devil himself.”
The conversation, if flattering, had become less momentous. I
had heard enough; and the thought of Strode urged me to retreat
while I could do so with safety. I slipped back to the inner hall, and
thence found my way to the entrance of the long passage. As I was
hurrying along this, I suddenly came into collision with some one,
and next instant was seized very prettily by the throat. Luckily the
pressure left just room enough to allow me to get out the word
“Strode!” when to my double relief the fingers relaxed, and the
Englishman’s voice said:
“A million apologies, my dear fellow, only I had to make sure. I
was coming after you, as the love-scene appeared to have lasted
long enough. Hope I haven’t hurt you?”
It was no place for conversation, and it was not until we were
safely through the trap-door that I stayed to tell what I had heard.
“You don’t think the girl has come to any harm?” Strode
inquired as we began to grope our way outwards.
“I have my fears about it. If this visit of Rallenstein’s has taken
the Count by surprise, there is no telling to what extremities panic
may have driven him. On the other hand, he may simply have
hidden her away more securely. He said she had been murdered
three days ago.”
“The black scoundrel!”
“Whereas, we know she was alive this afternoon. I have hope
there.”
“And that is the most likely thing to have happened. I’d stake
my life on hers up to now. Only there is no time to be lost, if we
have to take this devil’s den by assault to-morrow.”
“Let’s hope force won’t be necessary,” I said. “It would be
simple madness, however justifiable. Much will depend on the length
of Rallenstein’s stay.”
“That won’t be long,” Strode replied confidently. “Put yourself in
the old Jaguar’s place and ask yourself how long you’d feel inclined
to stay in that rural Chamber of Horrors.”
So discussing the chances of the situation, we at length reached
the entrance, and without further incident returned to our inn.
CHAPTER XXXIV
WE OUTSTRIP OUR FORTUNE
Next morning I packed a small valise and paid the landlord,
telling him we were going on a shooting expedition to a district some
twenty miles off, whence the time of our return might be uncertain.
Then we set off for Carlzig. Our first business there was to buy a
carriage and a pair of fast horses. This was not an easy matter, and
it was some hours before we found just what we wanted. But at last
we got hold of two good strong-winded animals and a serviceable
light carriage, somewhat like an old-fashioned calèche, our pretext
being that we intended them for a driving tour through the country.
We then laid in a stock of provisions, bought another revolver each,
with a good supply of cartridges, and having provided ourselves with
the necessary tools for the removal of the bars, we were ready. We
had an early dinner, and afterwards drove quietly out of the town.
Strode, who was going to be coachman, had mounted the box, and I
drove inside so as to avoid observation as much as possible. By an
indirect route and at an easy pace we made our way to a spot we
had settled upon, perhaps a quarter of a mile from the entrance to
the underground passage. Here, in a wild piece of woodland
approached by a rough grass road, the carriage could stay with very
little chance of attracting attention even from the Count’s spies. We
had agreed that I should go through to the Monastery alone, for if
the prisoner should be in the same room there would probably,
unless we were interrupted, be no difficulty in my effecting her
release single-handed; if, on the other hand, I could not find her, or
any unexpected difficulty should arise, I was to hurry back for
Strode.
It was now dusk—almost dark. I put the tools in my pocket and
hastened impatiently to the entrance of the passage. I had bought a
small lantern in Carlzig, and with this protection for my light was
able to make much quicker progress, especially as the way was now
familiar. I reached the steps and trap-door; left my lantern at the
bottom and passed through. Then, as I drew near, a horrible fear
came upon me that a few steps would show me the disappointment
to which I might be doomed. I scarcely dared approach the doorway
where my worst fears might in an instant be confirmed. The
momentary weakness was overcome and I peered out into the
passage. To my intense joy and relief a faint glimmer of light fell
across it at half its length. In a few seconds I was by the window.
Approaching cautiously, I heard no sound of voices; the curtains
were drawn slightly apart, I peeped through and saw Fräulein Asta
sitting there alone. A tap on the glass brought her joyfully to the
window. In reply to my sign of inquiry she nodded that all was safe,
so without delay I set to work on the screws that held the bars.
They had evidently been recently put in and yielded readily to the
wrench. One after another the bars were turned down while the
prisoner kept watch by the door. In a few minutes every obstacle
was removed; I beckoned, and the Fräulein ran to the window and
opened it.
"Is all safe?" were my first words.
"Yes," she answered. “I do not think Telka will return, and the
Count”—she gave a little shudder—“is away. Oh, I have feared!”
“And I too. But we will talk of that presently when you are safe.
Quick, now; bring a chair. So. Now let me lift you through.”
Her arms were round my neck, and I had little difficulty in
drawing her through the open window. “So far good,” I said; “let me
replace the bars to throw them off the track.”
The delay was risky, but I judged it worth while to prevent the
prisoner’s manner of escape from being too obvious. Pursuit would
be certain in any case, and this precaution might gain us time.
The bars were soon in position. “Now, Fräulein, quick! Let me
hold your arm and guide you. The way is not easy.”
I led her along the dark passage and so to the trap-door. “Once
down here I trust we shall be safe,” I said, lifting it. The girl
hesitated a moment—the descent was not inviting—then, holding my
hand, crept down. I took up my lantern and went on in front, for
there was no room for us to walk abreast. The dark, dripping,
noisome gallery must have seemed horrible to the girl, but she kept
bravely on at my heels, I guiding and encouraging her as best I
could, considering how hurried our progress had to be. “We are
nearly at the end now,” I was able at length to say, and then we
began the ascent which brought us to the entrance.
Bidding her stay a moment while I reconnoitred, I scrambled
warily up till my head was just enough above ground to look about.
All seemed safe, so pulling myself out of the hole, I lifted my
companion after me, and we set off for the place where the carriage
was waiting.
As we came in sight of Strode he waved his hand joyfully.
“This is better than I dared to hope,” was his excited greeting.
The girl gave him a grateful nod and smile—there was no time
for words as we hurried into the carriage—the good fellow sprang up
and set his horses going as fast as he dared down the bumpy lane.
In ten minutes, however, the jolting ceased; we had struck the high
road, along which we began to bolt at a rare pace.
I now had time to notice that my companion was evidently
feeling the unusual exertions and excitement she had just gone
through. She lay back half-fainting. I hastily opened a flask of wine;
this revived her. She was a plucky girl, and in a few minutes had so
far recovered as to be able to laugh at her weakness and begin to
chat.
“I was in the Monastery again last night,” I said.
“Again! Why did you come?” she asked.
“I could not keep away. The feeling that you were in such
danger was too strong for me, and I wanted, in case of accidents, to
show Strode the way.”
Perhaps she felt intuitively that there had been a more strongly
impelling reason behind the others. Anyhow her look was more than
grateful as she said:
“It was rash of you to venture again. If I had known you were
there I should have been terribly anxious. For they took me away to
a distant part of the building.”
“You know why?”
“Rallenstein had come unexpectedly.”
“I know.”
“You know?” she cried in surprise.
“Yes. I saw him.”
“Herr Tyrrell! What fearful risks you run.”
“I admit, Fräulein, it was foolish, since it was scarcely fair to
you. But at least I heard some interesting news.”
“Tell me.”
“That Prince Theodor cannot marry your Princess.”
“Cannot?”
“For he is secretly married already. So it follows that these
ghastly political murders have all been unnecessary. There is every
reason now why you should live.”
“Ah!”
“But unfortunately you died three days ago.”
“I died—three days ago!”
“So Count Furello told his Excellency.”
She thought a moment. “Ah, yes, I understand.”
“So it seems to me, Fräulein, that now it is only the Count you
have to fear.”
She gave a little shudder. “And that is bad enough. But at least I
would rather a million times have his hate than his love. Ah, I cannot
bear to think of it, yet I must tell you. About half an hour after you
had gone yesterday the Count came to my prison room. He told me
that to let me live was as much as his life was worth. His own risk
was so great that only upon one condition would he face it. Of
course you guess the condition; that I would marry him; otherwise
that day must be my last. ‘Remember,’ he urged in his smooth
hateful voice, ‘you are already dead in theory. The grave is dug for
you in the wood outside; in ten minutes from the moment I give the
word you will be lying in it. It is painful for me to have to tell you
this, but my life is precious too; I cannot afford to risk it unless I
have a stake to play for.’
“I pretended to be in great fear and distress, which perhaps was
not all pretence—but for your brave discovery what should I have
felt? I begged for time; I could not die, I was too young for that,
and yet—how could I love him at once? You see what a hypocrite I
can be. He was rejoiced, when he saw signs of my yielding, at the
success of his appeal. He went down on his knees and vowed he
would gladly risk his life for one loving look from me, that he would
be my slave—I need not recapitulate the hateful scene. Happily it
was interrupted, just as I was beginning to fear I could not stave off
his love-making without arousing his suspicions. The girl Telka came
in; he turned upon her, furious at the interruption. She said to him
under her breath, yet loud enough in her flurry for me to catch the
words, ‘Rallenstein is here!’ He turned grey at the news, and his face
changed to the index of the man he really is.”
“I can well imagine it,” I said. “It was a critical moment for you.”
“Yes. He turned upon me in panic with such a look in his eyes, a
look in which fear, desperation, irresolution, cruelty, and what he
would call love were all mingled. Ah! it was horrible. Then he took
Telka out of the room, and the suspense of the next few minutes,
when I was left alone, was so fearful that I almost fainted with
terror. At last the door opened and Telka came back, followed by a
wretch named Bleisst——”
“I know. The Count’s head villain.”
“If you know him you will realize what my feelings were at the
sight. Then, indeed, I was sure that my last moment had come. My
heart almost stopped with terror; oh, it was awful, the thought of
having to die like that, there in that horrible place, and just as the
hope of life and liberty had come to me. Telka came close up and
spoke to me. I was so sick and beside myself with fear that at first I
did not comprehend her words. I cried out in my agony for mercy,
for the Count—fancy my wishing his presence! The girl spoke again,
entreating more plainly, and I understood her then. I was to be
removed to a hiding-place in another part of the Monastery, for the
Chancellor was to suppose me dead. No harm would befall me
unless he discovered my whereabouts; everything would depend
upon my keeping quiet and obeying orders. I mistrusted them——”
“Naturally. No other feeling in that place could be possible.”
“No, and Bleisst is the very incarnation of treachery. Still I could
only obey. He told me pleasantly he had orders to shoot me on the
spot if I resisted. So I went with them, Telka leading the way, Bleisst
following me, pistol in hand. I felt like a condemned prisoner on my
way to the scaffold, but it was not to be as bad as I feared. We went
on for a long while, through dark passages, across vault-like
chambers, till at length we ascended to a room on an upper floor.
Here Bleisst went to the fire-place and unscrewed one of a row of
knobs in the woodwork. Into the hole thus discovered he inserted a
key. On turning this the jamb of the mantel revolved, disclosing a
narrow aperture just wide enough for a person to pass through.
Telka entered this, bidding me follow. I went in and found myself in
a small chamber not much larger than this carriage.
“‘You are to stay here till the Chancellor is safely gone,’ Telka
said. ‘We shall bring you your meals as usual. It is uncomfortable,
but it is necessary, and you have nothing to fear.’
“I had a great deal to fear; my imagination told me that this
might be my living grave. What better way to get rid of me than to
leave me here to starve and die? The girl went, warning me that any
attempt to escape would seal my fate. She is an extraordinary
creature, of a nationality unknown even to herself; the daughter of a
spy; she seems to have lived everywhere and to know everything. I
have always thought she has hated me under her pretence of
sympathy. So the door shut upon me and I was left alone with my
thoughts; you may fancy how anxious and bitter they were.”
“In the idea that our plan was rendered futile.”
“Yes; I thought of you, and of all your courage, and the danger
you had faced, and how they were to go for nothing. But there I
was, helpless, well-nigh hopeless again. I would have given anything
to have been able to send you a message, but that was impossible.
Here was a prison within a prison. I stayed there in darkness for a
long while—hours, it seemed; at last the muffled sound of the slowly
opening door brought my terrors back to me. It was Telka with a
lantern and some refreshments. The sight of this rejoiced me as
evidence that the fear of starvation was groundless. I could even eat
a morsel and drink some wine.
“‘His Excellency is still here,’ she said. ‘Directly he is well on his
way you shall be released.’
“She gave me one of her cunning smiles and disappeared.
“So I passed the night trying to get sleep on some rugs which
had been provided for my bed. In the morning Telka brought my
breakfast.
“‘Courage!’ she said. ‘His Excellency is about to start, and your
release will come soon. It is lucky he did not suspect you were lying
here so snug.’ She laughed, and left me without another word. But
in about an hour she returned and beckoned me to come out. Bleisst
was waiting, and they conducted me back to my former prison room.
My joy at getting there with the hope of escape was so great that I
feared Telka’s sharp eyes might notice it. I feigned to be so upset
and ill by the night I had passed that I could only go to bed. By this
I hoped to avoid a visit from the Count, and certainly I was left to
myself all day. Towards evening Telka came in and told me that the
Count had accompanied Rallenstein from the Geierthal that morning,
but was expected back that night. I still pretended to be very ill, and
could see that the girl was quite unsuspicious of any idea of escape
being so near at hand. I kept her with me for some time, then, as
the critical hour approached, begged her to leave me for a good long
sleep. Left alone I made ready for my departure, and the rest you
know. Ah, those terrible days! Can I ever thank my preserver
enough for all you have risked for me?”
In listening to her story I had not noticed that for some time
past a storm had been gathering. It now burst over us with a
violence peculiar to those regions of mountainous woodland. The
words deprecating her gratitude, which was, however, delightful
enough to me, were drowned in a terrific thunderclap which burst
over us. The rain came down so violently, the wind swept round us
in such gusts, that we became concerned for Strode’s welfare,
exposed as he was to their full fury. But he returned a cheery, “All
right! Don’t worry about me,” to my entreaty that he would come
into shelter. There was one thing, however, that the plucky fellow
could hardly battle with, and that was the intense darkness that had
enveloped us. Not to be stopped altogether, he jumped down from
his seat, ran to the horses’ heads and led them on as well as he
could. Our progress was now necessarily slow, but it was something
to keep moving at all, and Strode was resolved that we should not
stop. We watched anxiously for some indication of a break in the
storm, but its fury continued unabated, indeed it seemed to
increase.
“This is madness, Strode!” I shouted. “Make the horses fast and
come inside.”
Not he. The rain would not melt him, he was determined to get
us across the frontier by the morning, and we were yet miles from
the little town where we had planned to change horses. So we went
on for a while in the full pelting of the storm. Suddenly a great flash
of lightning seemed to sweep the road just in front of us. The horses
reared in terror, then swerved, and, before Strode could prevent it,
one side of the carriage sank into a ditch at the roadside.
“Sit still!” Strode cried. But I had jumped out to lighten the
vehicle. Each taking a horse’s head, we soon had the carriage on the
level again. “We can’t go on in this,” I expostulated. As I spoke
another great flash showed us a house standing near the road a few
yards farther on. I called Strode’s attention to it, and insisted that we
should seek refuge there till the storm was over; and, as the result
proved, it was lucky I overruled him. Between us we led the horses
up to the building, which proved to be a deserted and dilapidated
wayside lodge.
“At least there is perfect shelter here,” I said as I assisted the
Fräulein to alight and hurried her into the tumble-down place.
A ruinous shed stood beside the house and this afforded some
sort of shelter for the horses. We gave them corn and made them as
comfortable as we could. Then I took some food and a bottle of
wine from the carriage, and ran back to the house. By the aid of the
lantern we were just preparing to make the best of our wretched
quarters when Strode rushed in with a more perturbed look than I
had thought him capable of. He caught up the lantern and
extinguished it, checking my exclamation with,—
“Quick! Help me to bar the door. They are after us! Hark! They
are outside!”
CHAPTER XXXV
THE ATTACK
I rushed with Strode to the doorway, and for a moment could
discern nothing in the intense darkness. But just as I was beginning
to hope it might be a false alarm a flash of lightning showed me a
man on horseback in the road some twenty yards away. It was
hardly probable that he saw us in the same instant; anyhow, we
could hear no voice above the raging of the storm. Without another
moment’s delay we set ourselves to close the door, which hung to its
post by a single hinge.
“Stay, for Heaven’s sake!” Strode cried suddenly. “The pistols
and cartridges are in the carriage. Without them we are dead men.”
In another instant he had forced the door a little way open
again and dashed out. It was an anxious twenty seconds for me, but
in that time he was back with our second revolvers and the
ammunition bags.
“Now,” he said, “take the Fräulein upstairs while I barricade this
as well as I can.”
She had heard him, and, as I turned, was already climbing the
crazy steps that led to the upper floor.
“It is terrible,” she said, trying, as I could see, to master her
agitation, “if all you have done for me is to end in failure.”
“Let us hope not,” I replied. “Strode may be mistaken. It is
hardly conceivable——”
My words were cut short by a shout and a loud beating on the
door. I ran to the window of the front upper room and looked down.
The storm was now gradually passing away; the intense darkness
was relieved sufficiently for me to be able to make out the forms of
several men standing before the house. That they were Count
Furello and his followers there could be now little doubt. How they
had tracked and overtaken us so quickly was surprising; but there
they were, and we could only be thankful that an accident had given
us a shelter in which to stand at bay. Had we remained in the
carriage a few minutes longer they would have surrounded us and
we should not have had a chance.
As I drew back from the window I heard the Count’s voice cry:
“Come out, you foul Englishman, before I fetch and hang you.”
This pleasant invitation had scarcely left his lips when a shot
rang out followed by a cry. In the hope that the leader of the gang
had been accounted for, I sprang to the window only to hear to my
disappointment the same hateful voice giving order to his men to fall
back.
“Settled one of them, Tyrrell!” Strode called up to me. “We’ll
have some rare sport here.”
I was glad to think our enemies were one the fewer, and I sent
a chance shot on my own account after them to hasten their retreat
to a respectful distance.
But I could not remain there leaving Strode the impossible task
of defending all the weak spots in the lower floor.
“You will not be afraid to stay in this room alone, Fräulein,” I
said, with probably more confidence than I felt. “I must back up
Strode downstairs. Between us there is little doubt we can keep
these ruffians out and drive them off, but Strode cannot do it alone.
You will trust us and not fear?”
She shook her head with a little shudder. I had, in the stress of
the moment, laid my hand on her shoulder. Suddenly, before I could
turn to leave her she flung her arms impulsively round my neck and
kissed me twice. “Darling! my own darling!” she cried, her voice
trembling with excitement and fear. “If you are to die for me you
shall know that I am grateful, that I love you.”
Her cheek was pressed to mine. I whispered back my love in
her ear, the love I had known, but had not dared to show. Strode
called me.
“I must go now,” I said. “If I am to die I have lived my life in
this minute.”
We kissed again, as though it were the last kiss on earth, and I
ran down to Strode, my head whirling with joy. Perhaps to him, who
had rather anticipated the situation, my delay in coming to his call
was not surprising.
“If you don’t look alive,” he said reproachfully, “we shall be
taken and strung up, or whatever your friends’ favourite method
may be of getting rid of people who annoy them. I dropped one of
the brutes and they have drawn off in consequence. Their obvious
line now is to attack us on two or more sides, flank and rear; our
game is to pick them off one by one till they are not more than two
to one. I am only praying for the chance of a pot-shot at that
scoundrelly Count.”
All the time he was muttering thus to me we were busily
examining the ground floor of the cottage and noting its vulnerable
points. Luckily the place was small and plainly built. A narrow
passage ran from the front door to the back, having on its one side
simply the outer wall and the staircase, on the other the two lower
rooms. As luck would have it, the rusty key was in the door of the
front room. This with some little difficulty we were able to lock on
the outside; consequently all fear of an entry through the front
window was obviated. We had now simply to guard the two
entrances and the window of the back room.
So we stood, back to back, a revolver in each hand, grimly
waiting the enemy’s next move. There was little doubt that an
attempt would be made at the back this time. We could not be
certain how many men were with the Count; the danger was that a
combined rush might be made and a simultaneous entry effected
through door and window. From our stand in the doorway of the
room we should probably account for at least two of our assailants,
but after that numbers would tell at close quarters and our chance
would not be worth much.
Realizing this, I made a whispered suggestion to Strode that we
should abandon our present position and hold the staircase against
them.
“No,” he answered, “we must keep them out as long as we can.
We might hold the upper floor for a week, but once let these devils
get into the place and the odds would be on their setting fire to it.
They can’t do that from outside, thanks to the rain.”
I saw at once the likelihood of that danger, and what an
excellent stroke it would be to end Furello’s difficulty. Presently
Strode touched me, and I turned, on the alert.
He only nodded towards the window. Something was moving;
we could only guess what. Strode covered it with his revolver and
waited. Then he fired. His shot seemed to be the signal for a regular
volley which was poured into the room, but without touching us in
our cover. “Look out!” Strode whispered. “They are bound to come
now. Keep the passage!”
Sure enough, as the words were spoken there was a rush from
both window and door. We blazed away, each with both weapons,
right and left, since anything like deliberate aim was impossible. Our
fire was returned; then our assailants seemed to fall back, but we
could tell nothing clearly. In the midst of my excitement I heard
Strode ask:
“Are you hit?”
“No,” I replied.
“I am,” he said, “but it is not much. We can’t hold this; the fun’s
all right but too risky for the girl. We must take to the upper regions
and chance it.”
He was slipping in fresh cartridges as he spoke. “Now,” he said,
“bang away, and make a rush for it. Once up the stairs we are safe.”
Through the hanging smoke in the passage nothing could be
seen. I sent a shot through it and made a spring for the stairs.
Strode was on my heels; our fire was not returned, and we gained
comparative safety. As we reached the landing we saw Asta rush
back to the room in terror, locking the door.
“It is all right, Fräulein,” I cried. “We are both safe so far.”
At my voice the door was unfastened, and my love stood before
me.
“Thank Heaven!” she said. “I have been nearly mad with fear. I
felt sure all must be over with you both. It is terrible that you should
go through all this for me.”
“Asta!” I whispered reproachfully. “It is only for you we fear,
dearest.”
Strode had evidently heard her. “We like it,” he observed with a
pre-occupied cheeriness, for he was hanging over the rails of the
staircase keeping a sharp look-out. “It suits me exactly. If only we
could get you, Fräulein, away snugly, it might go on till this time to-
morrow, eh, Tyrrell?”
I went to him. “Your wound, Strode?”
“Hush, don’t bother about it,” he answered. “It is only a graze
on the shoulder. Now, what are these devils about?” he muttered, “I
can’t see them, can you?”
Neither could I, so I went back to reconnoitre from the
windows. At the back of the house, in what had been once the
garden, a movement was perceptible. Men were stirring, but so
cautiously that nothing more was to be made out. I told Strode of
this, and he suggested my sending a shot or two at them.
“It can’t do any harm, with our stock of cartridges, and you
might bring one of the brutes down, the Count for choice, if that
isn’t too much to hope for.”
I returned to the window and promptly acted on this advice. My
second shot I had reason to think took effect, for something like a
smothered cry reached my ears. Then the Count’s voice gave an
order, upon which, so far as I could see, four men made a stealthy
rush towards the house.
“Look out!” I called to Strode. “They are upon us!”
He sprang back to the top of the stairs as I joined him. For
some seconds we heard nothing; then a slight noise, a foot
accidentally striking against some object, gave warning that the
enemy was near. Strode waited a little, then cautiously leaned
forward and sent down a shot. It was returned.
“Blaze away, man! They are on the stairs,” he cried; and we did
blaze away into the unseen.
A dead silence followed. Peering round into the darkness we
waited for the next move. Then we heard men stirring beneath. The
slight noise of stealthy movement went on for some time;
occasionally we could detect a whisper, that was all. Suddenly there
came a glimmer of light, but it showed us nothing. Instead of dying
away as I expected, it increased, and then we knew what we feared
was about to happen.
“Are they firing the place?”
A crackle of burning wood gave the answer; the light increased
and spread. The danger now was critical.
“We can’t stand this,” I said. “The old place will burn like
matchwood. We must make a rush for it.”
Strode muttered something between his teeth—a not very
flattering comment on Count Furello and his methods.
“If we hadn’t to think of her,” he said, jerking his head towards
the room with the closed door, “we could sally out and meet these
beasts, taking our chance. But with her we can’t. Stay here, while I
go and see what I can do. Nonsense! I’m the man to take the risk,
not you.” For I had begun to hold him back and demur.
He threw me off and crept down the stairs. He stayed looking
over the rail for a while, then came back to me.
“I think,” he said, “with fair luck I can put the fire out. There’s
not much alight, and our friends seem to have drawn off to see the
fun. One chap is lying dead down there, so what with the others
we’ve peppered there can’t be many left. Anyway, if I come across
them there will be at least one fewer, if next moment is my last. I’m
no good, so don’t bother about me. Think of the girl; it is our duty to
get her out of this at any cost.”
So saying, he stole down again. At the bottom of the staircase
he stayed a moment, then, darting forward, disappeared from my
sight. Next I heard a banging, as though he were trying to beat out
the flames; then two pistol shots in rapid succession, followed by a
laugh of exultation from Strode. Doubtful whether this should
betoken good luck or bad, I called down to know if he was all right.
“Very much all right!” was the cheering answer. “I guess we’re
safe now.”
On that I ventured to leave my post, and ran down to him. He
was kicking and stamping out the remains of the nearly extinguished
fire. The old wood-work had been set alight in several places, and
the door was half consumed.
“I don’t fancy the Herr Graf will trouble us much more to-night,”
he laughed. “Pity I missed him, though. Anyhow I put a bullet
through some tender part of that other scoundrel’s anatomy, if
howling goes for anything. I say! Our pot-shots have gone home
much better than we could have hoped. Strikes me we’ve tucked up
most of them.”
“Our luck——” I began, when, crack! a bullet whistled between
us and went through the partition wall with a sharp plug.
“Whew! That was handy!” Strode laughed, as by a common
impulse we dropped on our hands and knees below the line of fire.
“Look to the passage,” he whispered; “don’t let them cut us off.”
I crept to the door and sent a couple of haphazard shots out
into the night. Strode crawled to the window and fired. Then,
detecting no sign of the enemy, it occurred to me that I ought to
keep an eye on the floor above. Scarcely had the thought passed
through my mind when I heard a cry, the door of the upstairs room
flung open, and Asta calling me. I rushed up, meeting her on the
stairs, and on into the room.
“They are climbing to the window,” she said, as I passed.
The room was empty. I ran to the window and looked out. No
one was to be seen; it was now pitch dark again. In the pauses of
the wind I fancied I could hear a movement in the shrubs between
the house and the road. I did not hesitate to send a shot in that
direction. As the report died away, a laugh followed and a voice
called out with startling unexpectedness.
“Well aimed, Herr Engländer!”
It was Furello. I made no reply, but waited. Then out of the
darkness came the vile voice again.
“Herr Tyrrell! Herr Tyrrell!” it cried.
“Good-evening, Count!” I replied mockingly.
“Good-night, Herr Tyrrell,” he returned. “My compliments. You
are a clever fellow, for an Englishman. But you will need to be much
cleverer when next we meet. So look to yourself and make the most
of the few hours of life we leave you. Auf Wiedersehen!”
The metallic voice had rung out so that not a word escaped me.
Then the wind dying fitfully away let me hear the sound of retreating
hoofs, and I knew that for the time we were safe. I turned to find
Asta standing behind me.

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