MICROECONOMICS SEVENT H EDIT ION T H E P E A R S ON S ERIES IN ECONOM ICS Klein Mathematical Methods for Economics Perloff/Brander Managerial Economics and Strategy* Fusfeld The Age of the Economist Krugman/Obstfeld/Melitz International Economics: Theory & Policy* Phelps Health Economics Gerber International Economics* Laidler The Demand for Money González-Rivera Forecasting for Economics and Business Leeds/von Allmen The Economics of Sports Abel/Bernanke/Croushore Macroeconomics* Fort Sports Economics Bade/Parkin Foundations of Economics* Froyen Macroeconomics Berck/Helfand The Economics of the Environment Bierman/Fernandez Game Theory with Economic Applications Blanchard Macroeconomics* Gordon Macroeconomics* Blau/Ferber/Winkler The Economics of Women, Men, and Work Lynn Economic Development: Theory and Practice for a Divided World Greene Econometric Analysis Boardman/Greenberg/Vining/ Weimer Cost-Benefit Analysis Gregory Essentials of Economics Boyer Principles of Transportation 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Industry Structure, Strategy, and Public Policy Schiller The Economics of Poverty and Discrimination Sherman Market Regulation Stock/Watson Introduction to Econometrics Studenmund Using Econometrics: A Practical Guide Tietenberg/Lewis Environmental and Natural Resource Economics Environmental Economics and Policy Todaro/Smith Economic Development Waldman/Jensen Industrial Organization: Theory and Practice Walters/Walters/Appel/ Callahan/Centanni/Maex/ O’Neill Econversations: Today’s Students Discuss Today’s Issues Weil Economic Growth Williamson Macroeconomics Visit www.myeconlab.com to learn more iii MICROECONOMICS S EV EN T H E D IT ION JEFFREY M PERLOFF University of California, Berkeley Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo For Alexx, Gregg, Laura, and Spenser Editor in Chief: Donna Battista Executive 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Phoenix Text Font: Sabon Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within the text and on page A-96 Copyright © 2015, 2012, 2009 Pearson Education, Inc., publishing as Addison-Wesley, 75 Arlington Street, Boston, MA 02116 All rights reserved Manufactured in the United States of America This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise To obtain permission(s) to use material from this work, please submit a written request to Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290 Many of the designations by manufacturers and seller to distinguish their products are claimed as trademarks Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps Library of Congress Cataloging-in-Publication Data Perloff, Jeffrey M Microeconomics / Jeffrey Perloff.—7th edition p cm Includes bibliographical references and index ISBN 978-0-13-345691-2 Microeconomics I Title HB172.P39 2015 338.5–dc22 2013050602 10 www.pearsonhighered.com ISBN-13: 978-0-13-345691-2 ISBN-10: 0-13-345691-9 Brief Contents Preface xiv Chapter Introduction Chapter Supply and Demand Chapter Applying the Supply-and-Demand Model Chapter Consumer Choice Chapter Applying Consumer Theory Chapter Firms and Production Chapter Costs Chapter Competitive Firms and Markets Chapter Applying the Competitive Model Chapter 10 General Equilibrium and Economic Welfare Chapter 11 Monopoly Chapter 12 Pricing and Advertising Chapter 13 Oligopoly and Monopolistic Competition Chapter 14 Game Theory Chapter 15 Factor Markets Chapter 16 Interest Rates, Investments, and Capital Markets Chapter 17 Uncertainty Chapter 18 Externalities, Open-Access, and Public Goods Chapter 19 Asymmetric Information Chapter 20 Contracts and Moral Hazards Chapter Appendixes 42 72 107 147 179 220 262 308 344 384 424 468 505 530 561 595 623 651 A-1 Answers to Selected Questions and Problems A-29 Sources for Challenges and Applications A-46 References A-56 Definitions A-64 Index A-69 Credits A-96 v Contents Preface Chapter Introduction 1.1 1.2 1.3 Microeconomics: The Allocation of Scarce Resources Trade-Offs Who Makes the Decisions Prices Determine Allocations Models APPLICATION Income Threshold Model and China Simplifications by Assumption Testing Theories Positive Versus Normative Uses of Microeconomic Models Summary Chapter Supply and Demand xiv 1 2 2.6 3 2.1 2.2 2.3 2.4 vi Equilibrium Effects of Government Interventions Policies That Shift Supply Curves APPLICATION Occupational Licensing 26 27 27 Solved Problem 2.4 28 Policies That Cause Demand to Differ from Supply APPLICATION Price Controls Kill 29 31 Solved Problem 2.5 33 Why Supply Need Not Equal Demand When to Use the Supply-and-Demand Model CHALLENGE SOLUTION Quantities and Prices of Genetically Modified Foods Summary 36 ■ Questions 37 33 34 8 10 13 14 Solved Problem 2.1 15 Summing Demand Curves APPLICATION Aggregating Corn Demand Curves Supply The Supply Curve The Supply Function Summing Supply Curves Effects of Government Import Policies on Supply Curves 16 35 Chapter Applying the Supply-and-Demand Model CHALLENGE Quantities and Prices of Genetically Modified Foods Demand The Demand Curve APPLICATION Calorie Counting at Starbucks The Demand Function 2.5 3.1 3.2 CHALLENGE Who Pays the Gasoline Tax? How Shapes of Supply and Demand Curves Matter Sensitivity of the Quantity Demanded to Price Price Elasticity of Demand 42 42 43 44 45 Solved Problem 3.1 46 Elasticity Along the Demand Curve Demand Elasticity and Revenue 46 49 Solved Problem 3.2 APPLICATION Do Farmers Benefit 49 Solved Problem 2.2 21 from a Major Drought? Demand Elasticities over Time Other Demand Elasticities Sensitivity of the Quantity Supplied to Price Elasticity of Supply Elasticity Along the Supply Curve Supply Elasticities over Time APPLICATION Oil Drilling in the Arctic National Wildlife Refuge Market Equilibrium Using a Graph to Determine the Equilibrium Using Math to Determine the Equilibrium Forces That Drive the Market to Equilibrium Shocking the Equilibrium Effects of a Shift in the Demand Curve 22 Solved Problem 3.3 56 Effects of a Sales Tax Equilibrium Effects of a Specific Tax The Equilibrium Is the Same No Matter Who Is Taxed 58 58 Solved Problem 3.4 60 Firms and Customers Share the Burden of the Tax APPLICATION Taxes to Prevent Obesity 61 62 16 17 17 19 20 3.3 20 22 22 23 24 24 Solved Problem 2.3 25 Effects of a Shift in the Supply Curve 26 3.4 50 51 51 53 53 54 55 55 60 Contents Solved Problem 3.5 63 Ad Valorem and Specific Taxes Have Similar Effects 63 Solved Problem 3.6 64 Subsidies 65 66 Gasoline Tax? Summary 67 ■ Questions 68 66 Chapter Consumer Choice 72 APPLICATION The Ethanol Subsidy CHALLENGE SOLUTION Who Pays the CHALLENGE Why Americans Buy 4.1 More E-Books Than Do Germans Preferences Properties of Consumer Preferences APPLICATION You Can’t Have Too Much Money Preference Maps Solved Problem 4.1 APPLICATION Indifference Curves 4.2 4.3 75 76 78 Between Food and Clothing Utility Utility Function Ordinal Preferences Utility and Indifference Curves Marginal Utility Utility and Marginal Rates of Substitution Budget Constraint Slope of the Budget Constraint 82 82 82 83 83 85 86 86 88 Solved Problem 4.2 88 Effect of a Change in Price on the Opportunity Set Effect of a Change in Income on the Opportunity Set 4.4 72 74 74 89 90 Solved Problem 4.3 90 Constrained Consumer Choice The Consumer’s Optimal Bundle APPLICATION Substituting Alcohol for Marijuana 90 91 92 Solved Problem 4.4 93 ★ Optimal Bundles on Convex Sections of Indifference Curves Buying Where More Is Better Food Stamps APPLICATION Benefiting from Food Stamps 4.5 Behavioral Economics Tests of Transitivity Endowment Effect APPLICATION Opt In Versus Opt Out Salience and Bounded Rationality APPLICATION Unaware of Taxes CHALLENGE SOLUTION Why Americans Buy More E-Books Than Do Germans Summary 102 ■ Questions 103 94 95 96 98 98 98 99 100 100 101 101 Chapter Applying Consumer Theory vii 107 CHALLENGE Per-Hour Versus Lump-Sum 5.1 5.2 5.3 Childcare Subsidies Deriving Demand Curves Indifference Curves and a Rotating Budget Line Price-Consumption Curve APPLICATION Smoking Versus Eating and Phoning The Demand Curve Corresponds to the Price-Consumption Curve 107 108 Solved Problem 5.1 112 How Changes in Income Shift Demand Curves Effects of a Rise in Income 113 113 109 110 111 112 Solved Problem 5.2 115 Consumer Theory and Income Elasticities APPLICATION Fast-Food Engel Curve Effects of a Price Change Income and Substitution Effects with a Normal Good 116 119 120 Solved Problem 5.3 Solved Problem 5.4 APPLICATION Shipping the Good 122 123 120 Stuff Away Income and Substitution Effects with an Inferior Good 124 Solved Problem 5.5 125 ★ Compensating Variation and Equivalent Variation APPLICATION What’s the Value of Using the Internet? 5.4 Cost-of-Living Adjustments Inflation Indexes Effects of Inflation Adjustments APPLICATION Paying Employees to Relocate 5.5 Deriving Labor Supply Curves Labor-Leisure Choice Income and Substitution Effects Solved Problem 5.6 ★ Shape of the Labor Supply Curve APPLICATION Working After Winning the Lottery Income Tax Rates and Labor Supply CHALLENGE SOLUTION Per-Hour Versus Lump-Sum Childcare Subsidies Summary 142 ■ Questions 143 Chapter Firms and Production 124 126 126 126 127 129 130 132 132 135 136 137 138 139 141 147 CHALLENGE Labor Productivity During 6.1 Recessions The Ownership and Management of Firms Private, Public, and Nonprofit Firms 147 148 148 viii Contents APPLICATION Chinese State-Owned 6.2 6.3 6.4 6.5 6.6 Effects of Taxes on Costs 149 149 150 150 151 153 153 154 Solved Problem 7.3 198 Solved Problem 6.1 154 Factor Price Changes 199 Average Product of Labor Graphing the Product Curves Law of Diminishing Marginal Returns APPLICATION Malthus and the Green Revolution Long-Run Production Isoquants APPLICATION A Semiconductor Integrated Circuit Isoquant Substituting Inputs 155 155 157 Solved Problem 7.4 199 The Long-Run Expansion Path and the Long-Run Cost Function 200 193 193 193 193 194 196 202 202 171 171 173 Chapter Competitive Firms and Markets 220 162 163 165 166 Solved Problem 6.3 APPLICATION Returns to Scale in Various 167 7.4 166 168 169 171 171 7.5 8.1 179 at Home Versus Abroad The Nature of Costs Opportunity Costs APPLICATION The Opportunity Cost of an MBA 181 Solved Problem 7.1 181 Costs of Durable Inputs Sunk Costs Short-Run Costs Short-Run Cost Measures Short-Run Cost Curves Production Functions and the Shape of Cost Curves APPLICATION Short-Run Cost Curves for a Beer Manufacturer 182 183 183 184 186 179 180 180 187 190 205 206 206 207 208 208 209 209 211 212 213 214 CHALLENGE The Rising Cost of Keeping 173 CHALLENGE Technology Choice 7.2 192 Short-Run Cost Summary Long-Run Costs All Costs Are Avoidable in the Long Run Minimizing Cost Isocost Line Combining Cost and Production Information The Shape of Long-Run Cost Curves APPLICATION Economies of Scale in Nuclear Power Plants Estimating Cost Curves Versus Introspection Lower Costs in the Long Run Long-Run Average Cost as the Envelope of Short-Run Average Cost Curves APPLICATION Long-Run Cost Curves in Beer Manufacturing APPLICATION Choosing an Inkjet or a Laser Printer Short-Run and Long-Run Expansion Paths The Learning Curve APPLICATION Learning by Drilling Cost of Producing Multiple Goods APPLICATION Economies of Scope CHALLENGE SOLUTION Technology Choice at Home Versus Abroad Summary 215 ■ Questions 216 158 159 160 Returns to Scale Constant, Increasing, and Decreasing Returns to Scale Industries Varying Returns to Scale Productivity and Technical Change Relative Productivity APPLICATION A Good Boss Raises Productivity Innovations APPLICATION Tata Nano’s Technical and Organizational Innovations CHALLENGE SOLUTION Labor Productivity During Recessions Summary 175 ■ Questions 175 7.3 Solved Problem 7.2 Solved Problem 7.5 Solved Problem 6.2 Chapter Costs 7.1 191 Enterprises The Ownership of For-Profit Firms The Management of Firms What Owners Want Production Function Short-Run Production Total Product Marginal Product of Labor 8.2 8.3 On Truckin’ Perfect Competition Price Taking Why the Firm’s Demand Curve Is Horizontal Deviations from Perfect Competition Derivation of a Competitive Firm’s Demand Curve 220 221 221 222 223 224 Solved Problem 8.1 225 Why We Study Perfect Competition Profit Maximization Profit Two Steps to Maximizing Profit Competition in the Short Run Short-Run Output Decision 226 226 226 227 230 231 Solved Problem 8.2 233 Short-Run Shutdown Decision APPLICATION Oil, Oil Sands, and Oil Shale Shutdowns 234 236 Solved Problem 8.3 237 Short-Run Firm Supply Curve 237 Contents 8.4 Short-Run Market Supply Curve Short-Run Competitive Equilibrium 238 240 APPLICATION The Deadweight Cost Solved Problem 8.4 242 Solved Problem 9.4 287 Competition in the Long Run Long-Run Competitive Profit Maximization Long-Run Firm Supply Curve APPLICATION The Size of Ethanol Processing Plants Long-Run Market Supply Curve APPLICATION Fast-Food Firms’ Entry in Russia APPLICATION Upward-Sloping Long-Run Supply Curve for Cotton APPLICATION Reformulated Gasoline Supply Curves 243 243 243 Welfare Effects of a Subsidy 288 245 248 9.7 252 Solved Problem 8.5 253 Long-Run Competitive Equilibrium CHALLENGE SOLUTION The Rising Cost of Keeping On Truckin’ Summary 256 ■ Questions 257 254 CHALLENGE “Big Dry” Water Restrictions 9.2 9.3 9.5 9.6 Zero Profit for Competitive Firms in the Long Run Zero Long-Run Profit with Free Entry Zero Long-Run Profit When Entry Is Limited APPLICATION Tiger Woods’ Rent The Need to Maximize Profit Consumer Welfare Measuring Consumer Welfare Using a Demand Curve APPLICATION Willingness to Pay and Consumer Surplus on eBay Effect of a Price Change on Consumer Surplus APPLICATION Goods with a Large Consumer Surplus Loss from Price Increases 255 286 Solved Problem 9.5 288 Welfare Effects of a Price Floor 289 Solved Problem 9.6 APPLICATION How Big Are Farm Subsidies 291 and Who Gets Them? Welfare Effects of a Price Ceiling 292 293 Solved Problem 9.7 APPLICATION The Social Cost of a 294 Natural Gas Price Ceiling Comparing Both Types of Policies: Imports Free Trade Versus a Ban on Imports Free Trade Versus a Tariff Free Trade Versus a Quota APPLICATION The Chicken Tax Trade War Rent Seeking CHALLENGE SOLUTION “Big Dry” Water Restrictions Summary 303 ■ Questions 303 295 295 296 297 299 300 300 301 262 Chapter 10 General Equilibrium 263 263 264 266 266 267 267 269 270 and Economic Welfare CHALLENGE Anti-Price Gouging Laws 10.1 General Equilibrium Feedback Between Competitive Markets 272 Producer Welfare Measuring Producer Surplus Using a Supply Curve Using Producer Surplus 273 Solved Problem 9.2 275 Competition Maximizes Welfare 276 Solved Problem 9.3 APPLICATION Deadweight Loss 278 273 274 279 280 281 283 284 285 285 308 308 310 311 Solved Problem 10.1 313 Minimum Wages with Incomplete Coverage 314 Solved Problem 10.2 APPLICATION Urban Flight 10.2 Trading Between Two People Endowments Mutually Beneficial Trades Solved Problem 10.3 271 Solved Problem 9.1 of Christmas Presents Policies That Shift Supply and Demand Curves Restricting the Number of Firms APPLICATION Licensing Cabs Raising Entry and Exit Costs Policies That Create a Wedge Between Supply and Demand Welfare Effects of a Sales Tax of Raising Gasoline Tax Revenue 244 244 Chapter Applying the Competitive Model 262 9.1 ix Bargaining Ability 10.3 Competitive Exchange Competitive Equilibrium The Efficiency of Competition Obtaining Any Efficient Allocation Using Competition 10.4 Production and Trading Comparative Advantage Solved Problem 10.4 Efficient Product Mix Competition 10.5 Efficiency and Equity Role of the Government APPLICATION The Wealth and Income of the 1% Efficiency Equity APPLICATION How You Vote Matters Efficiency Versus Equity 316 317 317 317 319 321 321 321 322 323 323 324 324 326 328 328 330 330 331 332 334 336 338 Index comparing with Cournot and collusive equilibria, 450–451 graphical model (airline example), 447–449 why sequential movement is essential, 450 Natural disasters anti-price gouging laws, 308, 339–340 impact on equilibrium price, 309 insurance and, 581–582 Natural monopolies, 363–364 Negative externalities See also Externalities defined, 596 Spam example, 597 Net present value (NPV) approach to investments, 541–542 example (Golden State Warriors), 543 internal rate of return and, 543 Network externalities behavioral economics and, 375–376 eBay example, 376–377 as explanation for monopolies, 376 overview of, 375 Nominal prices, inflation and, 539 Nonlinear price discrimination example of uniform pricing (iTunes), 410 overview of, 404–406 questions, 421–422 summary, 418 two-part pricing, 406–407 two-part pricing with identical consumers, 407–408 two-part pricing with nonidentical consumers, 408–409 types of price discrimination, 391 Nonprofit firms, 148–149 Nonsatiation property, consumer preferences, 75 Nonuniform pricing market power and, 384 price discrimination See Price discrimination tie-in sales, 410–413 two-part pricing, 406–409 Normal-form, representation of static games, 470–471 Normal goods fast-food example, 119–120 income effects, 120–124 income elasticities of, 117 some goods must be normal, 118 substitution effects, 120–124 Normative statements, in microeconomics, 5–6 NPV See Net present value (NPV) O Observable characteristics, identifying groups by, 402 Oligopolies applying static game to strategic advertising by oligopolies, 480–481 Bertrand oligopoly See Bertrand oligopoly cartels See Cartels comparing market structures, 426 Cournot oligopoly See Cournot oligopoly defined, 424 overview of, 424–425 Stackelberg oligopoly See Stackelberg oligopoly OPEC (Organization of Petroleum Exporting Countries) as example of cartel, 427 market power and price of exhaustible resources and, 552–553 Open-access common property, 611–612 Opportunistic behavior adverse selection See Adverse selection asymmetric information and, 624 moral hazards and, 624–625 restricting, 630–631 Opportunity costs of durable goods, 182–183 example problem, 181–182 of MBA degree, 181 overview of, 180–181 Opportunity sets bundle of goods and, 87 impact of income change on, 90 impact of price change on, 89–90 impact of water quotas on, 88–89 Optimal bundle on convex sections of indifference curves, 94–95 corner solution, 93 Giffen goods and, 124–125 interior solution, 91–92 A-85 more-is-better and, 95 overview of, 91–92 Options (stock), contracts for avoiding moral hazard, 662–663 Ordinal preferences, utility and, 83 Organization of Petroleum Exporting Countries (OPEC) as example of cartel, 427 market power and price of exhaustible resources and, 552–553 Organizational change productivity and, 172–173 Tata Motors example, 173 Outputs competitive factor and output markets, 516–517 competitive factor market and monopolized output markets, 517–518 converting inputs into, 148, 151 cost of producing multiple goods, 212 decisions in short-run competition, 231–234 determining profit-maximizing output in monopolies, 351–352 effect of adding extra labor, 156 graphing product curves, 155–156 isoquants for combining inputs for single level of output, 162–163 law of diminishing marginal returns, 157–159 learning curve and cumulative output, 210 long-run market supply when input prices vary with output, 248–250 market power in output markets, 516 monopolized factor market and competitive output markets, 518–519 monopoly in both input and output markets, 519–521 production function and, 151–152 profit maximization and, 228–229 profit maximization for labor, 509–510 reducing below competitive level lowers welfare, 277–279 relationship between labor market and output market, 508 A-86 Index Outputs (continued) relationship of product curves, 156–157 returns to scale varying by output levels, 169–170 of short-run production, 153–154 technical progress increasing levels of, 172 technological and economic efficiency and, 179 Overconfidence, biases in assessing risk probability, 585 Owners management of firms and, 150 what owners want, 150–151 Ownership, of for-profit firms, 149–150 P Package tie-in sales See Bundling (package tie-in sales) Pareto-efficient allocations competitive exchange and, 323 contract curves and, 320 efficiency of competition and, 329–330 government policies and, 332–334 obtaining any efficient allocation using competition, 323–324 Pareto principle government policies and, 332–333 in study of welfare, 309 Pareto, Vilfredo, 309 Partial-equilibrium analysis applied to effects of minimum wage, 32–34 applied to feedback between competitive markets, 311 overview of, 310 Partnerships, ownership of for-profit firms, 149–150 Patents brand name vs generic drugs, 344–345 example (Botox), 366–367 government role in creating monopolies, 365 as monopoly, 345 Pay cuts, vs layoffs, 672–674 Payoff function cooperation and, 478–479 in games, 469 Payoff (or profit) matrix, in static games, 471 Payoffs, in games, 469 Per-hour subsidies, for childcare, 107, 141–142 Perfect competition characteristics of, 222–223 comparing market structures, 426 deriving demand curve for competitive firm, 224–226 deviations from, 223–224 overview of, 221 price taking and, 221–222 questions, 257 reasons for studying, 226 summary, 256 Perfect complements, marginal rate of substitution and, 81 Perfect monitoring, 655 Perfect price discrimination calculating, A:17–A:18 efficiency of, 393–394 example (Botox), 395 overview of, 391–393 questions, 419–420 summary, 418 transaction costs and, 396 types of price discrimination, 390 Perfect substitutes Coke/Pepsi choice, 112–113, 115–116 marginal rate of substitution and, 80–81 Perfectly elastic demand, 47–48 Perfectly elastic supply, 54 Perfectly inelastic demand, 47–48 Perfectly inelastic supply, 53 Perpetuities, 544, A:26 Physical products See Products Piece-rate contracts, 663 Piracy, of software, 613 Policies See also Government policies and regulation creating barriers to entry or exit, 284 free trade vs ban on imports, 296–297 free trade vs quotas, 299–300 free trade vs tariffs, 297–299 regulating imports, 295–296 rent seeking and, 300–301 that create wedge between supply and demand, 285 that restrict number of firms, 281–283 that restrict number of firms (Taxicab example), 283 that shift supply and demand curves, 280–281 welfare effects of price ceilings, 293–295 welfare effects of price floors, 289–293 welfare effects of sales taxes, 285–288 welfare effects of subsidies, 288–289 Pollution Coase Theorem, 607–609 controlling by allocating property rights, 607 emissions fees, 602–603 emissions standards, 601–602 markets for pollution externalities, 609 regulating externalities, 600–601 regulating externalities (pulp and paper mill example), 602 taxes in controlling, 603 trade and, 617–619 welfare effects in competitive market, A:26–A:28 Pooling equilibrium, 641–642 Positive externalities See also Externalities defined, 597 markets for, 610 Positive monotonic transformation, 83 Positive statements, in microeconomics, 5–6 PPF See Production possibility frontier (PPF) Predictions of game outcome, 471 positive statements, Preference maps for bundle of goods, 76–77 indifference curves and, 77 properties, 77 Preferences, consumer curvature of indifference curves, 79–81 defined, 73 indifference curves, 77–79 indifference curves (food/clothing example), 82 ordinal preferences, 83 overview of, 74 preference maps, 76–77 properties, 74–76 willingness to substitute, 79 Index Preferences, social, 336–337 Present biases food stamp example, 546 time-varying discounting and, 545 Present value (PV) calculating real present value of payment, 540 interest rates connecting present and future value, 534–536 of stream of payments, 536–537, A:26 Price ceilings anti-price gouging laws, 308, 339–340 government regulation of monopolies, 367–369 nonoptimal price regulation, 369–371 social costs of, 295 supply and demand and, 30–32 welfare effects of, 293–294 Price-consumption curves demand curve corresponding to, 112 example (tobacco use), 111 taste (indifference curves) impacting, 110–111 Price discrimination due to false beliefs about quality, 634–635 example (Disneyland), 388 example (Google), 392–393 group See Group price discrimination nonlinear See Nonlinear price discrimination nonuniform pricing, 385 not all prices differences are due to price discrimination, 390 perfect See Perfect price discrimination preventing resale, 389–390 questions, 419–420 summary, 418–419 types of, 390–391 welfare effects of, 403–404 which firms can price discriminate, 388–389 why it pays, 386–388 Price elasticity of demand downward-sloping linear demand curve, 46–48 example (oil drilling in Arctic National Wildlife Refuge), 55–57 example (price of corn), 46 group price discrimination and, 399 horizontal demand curve, 48 Lerner Index and, 358 monopolies and, 349–350 over time, 51 overview of, 45–46 residual demand curves, A:14 revenue and, 49–51 Slutsky equation applied to, A:8–A:9 surplus and, A:15–A:16 total, average, and marginal revenue and, 348 vertical demand curve, 48–49 Price elasticity of supply along supply curve, 54–55 example (oil drilling in Arctic National Wildlife Refuge), 55–57 over time, 54 overview of, 53–54 Price floors agricultural, 290–292 supply and demand and, 32–33 welfare effects of, 289–290 Price supports, redistribution of wealth and, 330 Price taking, in competitive markets, 221–222 Prices/pricing advertising and, 638 allocations determined by, anti-price gouging laws, 308, 339–340 block pricing, 405–406, A:18–A:19 bundling tie-in sales, 411–413 choosing price vs quantity in monopolies, 350 compensating variation and equivalent variation and, 126 effect of price change on consumer surplus, 270–273 effect of price change on demand, 120, 144 effect of price change on factor demand, 510 effect of price change on opportunity set, 89–90 effect of price change on revenue, 49 efficiency of perfect price discrimination, 393–394 A-87 example (buying discounts), 402–403 Giffen goods and, 124–125 group price discrimination, 396–397, A:18 group price discrimination (text book resale example), 399–402 group price discrimination with two groups, 397–399 identifying groups for price discrimination, 402 impact on quantity demanded, 12 impact on quantity supplied, 17–18 long-run market supply when input prices vary with output, 248–250 marginal revenue and price in monopolies, 346–347 market failure due to monopoly pricing, 359–362 market failure when marginal costs are not equal to price, 277 market failure when price exceeds marginal cost, 359 market power from price ignorance, 636 nominal vs real prices, 127 nonlinear price discrimination, 404–406 not all prices differences are due to price discrimination, 390 overview of, 384–385 perfect price discrimination, 391–393, A:17–A:18 preventing resale, 389–390 price discrimination, 390–391 price discrimination (Botox example), 395 price taking in competitive markets, 221 quantity vs price in monopolies, A:19–A:20 questions, 419–422 relationship to marginal cost in Lerner Index, 358 requirement tie-in sales, 410–411 sale prices, 417–418 sales prices, 384 sensitivity of quantity demanded to, 44–45 sensitivity of quantity supplied to, 53 short-run firm supply curve and, 237–238 A-88 Index Prices/pricing (continued) summary, 418–419 tie-in sales, 410 transaction costs and perfect price discrimination, 396 two-part pricing, 406–407 two-part pricing with identical consumers, 407–408 two-part pricing with nonidentical consumers, 408–409, A:19–A:20 uniform pricing (iTunes example), 410 welfare effects of price discrimination, 403–404 which firms can price discriminate, 388–389 why price discrimination pays, 386–388 Prices/pricing, of exhaustible resources constant or falling prices, 551–553 overview of, 547–550 scarce exhaustible resources (redwood tree example), 550–551 Principal-agent problem asymmetric information, 655–657 efficiency of contracts, 654 example (agriculture), 664 example (doctors), 656, 659–660 example (subprime loans), 657 overview of, 653–654 symmetric information, 654–655 Principals, checks on principals in contracts, 671–674 Prisoner’s dilemma game cooperation in repeated prisoner’s dilemma game, 481–483 dominant strategies in, 471–472 Private costs, cost of production without externalities, 597 Private firms overview of, 148–149 ownership of, 149–150 Private goods, rival goods compared with, 610–611 Private value auctions, 491 Probability of risk biases in assessing, 584–585 frequency of events and, 563 overview of, 563 probability distribution, 564–565 subjective probability, 564 Producer surplus (PS) applying, 274–275 block pricing and, 405–406 competition maximizing welfare, 276 effects of pollution, 598–599 effects of tariff or quotas, 298–299 example (rose production), 275 group price discrimination and, 403 loss from eliminating free trade, 296–297 measuring with supply curve, 273–274 monopsonies and, 524 nonoptimal price regulation, 370 optimal price regulation, 368 overview of, 273 perfect price discrimination and, 393–394 policies restricting number of firms, 281–283 reducing output below competitive level lowers welfare, 277–279 rent seeking and, 300–301 welfare effects of price ceilings, 294 welfare effects of price floors, 290–293 welfare effects of sales taxes, 285–288 welfare effects of subsidies, 289 Producer welfare See Producer surplus (PS) Producers, number of producers and comparative advantage, 327–328 Product curves, graphing, 155–157 Production average product of labor, 155 combining cost and production information, 196–197 constant, increasing, and decreasing returns to scale (CRS), 166–168 graphing product curves, 155–157 isoquants, 160–163 law of diminishing marginal returns, 157–159 long-run, 159–160 marginal product of labor, 154 overview of, 147–148 production function, 151–152 quantity vs price in monopolies, A:19–A:20 questions, 175–177 returns to scale by industry, 168–169 returns to scale varying by output levels, 169–170 short-run, 153 substituting inputs and, 163–166 summary, 175 total product in short-run production, 153–154 Production and trading comparative advantage, 324–328 competition and, 328–330 efficient product mixes, 328 overview of, 324 questions, 342–343 summary, 341 Production functions Cobb-Douglas production function See Cobb-Douglas production function determining shape of cost curves, 187–188 example (beer manufacturer), A:11–A:12 fixed-proportions production function, 161 relationship of inputs to outputs, 151–152 returns to scale and, 170 Production possibility frontier (PPF) comparative advantage and, 324–325 cost of producing multiple goods, 212–213 efficiency of competition and, 329–330 efficient product mixes, 328 example, 326–327 number of producers and, 327–328 optimal product mix, 327 Productivity innovations and technical progress and, 170–171 of labor during recession, 147, 173–174 organizational change and, 171–172 questions, 178 relative productivity, 170 summary, 175 Products See also Outputs adverse selection with products of unknown quality, 626–630 Index Bertrand oligopoly with differentiated products, 453–455 Bertrand oligopoly with identical products, 452–453 efficient product mixes, 328 example of spurious product differentiation (bottled water), 446–447 identical or homogeneous in competitive markets, 222 nonidentical firms with differentiated products in Cournot oligopoly, 444–446 as output, 151–152 Profit firms must maximize profit to survive, 266 formula for, 226–227 graphical approach to profit maximization, 351–352 mathematical approach to profit maximization, 352–354 maximizing, 150–151, A:15 maximizing for output, 509–510 maximizing for output (airlines example), 437–438 maximizing in long-run competition, 243 maximizing in monopolies, 346, A:19–A:20 maximizing in monopsonies, 521–523 maximizing in short-run competition, 226 output rules, 228–229 questions, 257–258 shutdown rule, 229–230 steps in maximizing, 227–228 summary, 257 zero long-run profit with free entry, 263–264 zero long-run profit with limited entry, 264–266 Profit-sharing contracts, 660–662 Properties consumer preferences, 74–76 preference maps, 77 Property rights, allocating to reduce externalities, 607 Prospect theory comparing with expected utility theory, 587–588 overview of, 587 properties of, 588–589 PS See Producer surplus (PS) Public firms overview of, 148–149 state-owned enterprises in China, 149 Public goods example (Radiohead), 615 free riding and, 613–615 overview of, 613 reducing free riding, 615–616 valuing, 616–617 Public utilities block pricing by, 405–406 as natural monopoly, 364 PV See Present value (PV) Q Quality goods price discrimination due to false beliefs about quality, 634–635 shipping fees and, 124 varying quality with asymmetric information, 629–630 warranties as signal of quality, 633 Quantity demanded cross-price elasticity of demand and, 52 demand curves and, 10–11 effect of prices on, 12 income elasticity of demand and, 52, 116–117 relationship to income, 113, 115–116 sensitivity to price, 44–45 Quantity supplied price and, 17 supply elasticity and, 53–54 Quotas effects of, 298 free trade vs., 299–300 impact on supply curves, 21 import policies and, 295 R Rate of return on bonds, 544 internal rate of return approach to investing, 543–544 Rawls, John, 337–338 Rawlsian welfare functions, 338 Real prices, inflation and, 539 A-89 Rebates, group price discrimination and, 403 Recessions layoffs vs pay cuts, 672–674 productivity of labor during, 147, 173–174 Reformulated Fuels Program (RFG), 252–253 Regression confidence in estimates, A:2–A:3 estimating economic relations, A:1–A:2 multiple regression, A:3 overview of, A:1 Regulations See Government policies and regulation Relative productivity, 170 Rent seeking policies, 300–301 Rents celebrities collecting, 265–266 example of zero long-run profit with limited entry, 264–266 on scarce resources, 549 Repeated games cooperation example (airlines), 483 cooperation in repeated prisoner’s dilemma game, 481–483 overview of, 480–481 questions, 500 strategies in dynamic games, 481 summary, 498 Reputation of employees, 674 screening by, 632 Requirement tie-in sales, 410–411 Resale prevention example (designer bags), 390 example (textbooks), 399–400 price discrimination and, 389–390 Reservation prices of lemon owners, 626 in perfect price discrimination, 391 Reserves, of exhaustible resources, 552 Residual demand curves deriving for competitive firm, 224–226 elasticity of, A:14 Residual supply curves example (cotton in Japan), 251 international trade and, 250 long-run market supply with trade and, 250 A-90 Index Resources allocating scarce See Allocation of scarce resources exhaustible See Exhaustible resources opportunity cost of using, 180 Retirement investments, diversification of, 577 Returns to scale constant, increasing, and decreasing, 166–168 by industry, 168–169 long-run costs and, 204 questions, 177–178 summary, 175 varying by output levels, 169–170 Returns to specialization, 170 Revenue (R) comparing competitive firm with monopoly, 347 demand elasticity and, 49–50 demand elasticity over time and, 51 impact of drought on revenue from corn, 50–51 marginal See Marginal revenue (MR) marginal revenue product of labor See Marginal revenue product of labor (MRPL) profit and, 150 Reverse auctions, 403 RFG (Reformulated Fuels Program), 252–253 Risk assessment biases in, 584–585 expected value, 565–566 overview of, 563 probability of risk, 563–565 prospect theory, 587–589 questions, 591 summary, 590 variance and standard deviation from expected value, 566–567 violations of expected utility theory, 586–587 Risk attitudes expected utility theory and, 567–568 gambling and, 573–574 overview of, 567 questions, 591–592 risk aversion, 568–571 risk neutrality, 572 risk preference, 573 summary, 590 Risk aversion attitudes toward risk, 568–571 investing and, 582–584 unwillingness to take a fair bet, 568 Risk preferring attitudes toward risk, 572 indifferent regarding fair bet, 568 investing and, 582 overview of, 573–574 willing to take a fair bet, 568 Risk premiums, 571 Risk reduction diversification, 575–577 flight insurance example, 580 insurance, 577–581 natural disaster insurance, 581–582 obtaining information, 575 overview of, 574 questions, 592 summary, 590 Rival goods, 610–611 Rivalry/exclusion club goods, 612 free riding and, 615–616 open-access common property, 611–612 overview of, 610–611 piracy and, 613 public goods, 613–615 questions, 622 summary, 620 valuing public goods, 616–617 Robinson-Patman Act, 386 Rules, of games, 469 S Sales, of exhaustible resources, 547 Sales prices, 384 Sales taxes burden shared by firms and customers, 61–63 effect on supply-and-demand, 58 effects of ad valorem and specific taxes, 63–65 equilibrium effects of, 58–61 example (gasoline tax), 66–67 example (prevention of obesity), 62 impact on demand, 10 welfare effects of, 285–288 Salience, bounded rationality and, 100–101 Satiation more-is-better and, 95 mutually beneficial trades and, 319 Scale, return to See Returns to scale Scarce resources allocation of See Allocation of scarce resources causes of monopolies, 363 pricing, 547–550 Screening actions for equalizing information, 631–632 bad workers, 674 Sealed-bid auction overview of, 491 strategies in, 493 Second-degree price discrimination See Nonlinear price discrimination Second-price strategy in auctions, 492 example (eBay), 269–270 Second Theorem of Welfare Economics, 321, 324 Self-control problems, resulting in falling discount rate, 546 Sellers, in competitive markets, 222 Separating equilibrium, education as signal of ability and, 641 Sequential games credible threat and, 486–487 dynamic entry games, 487–488 dynamic entry games (airlines example), 488–489 game trees, 483–484 limit pricing, 489 overview of, 481, 483 questions, 501–503 subgames perfect Nash equilibrium, 484–486 summary, 498 Sequential movement, in Stackelberg oligopoly, 450 Services as output, 151 price determining allocations, trade-offs in resource allocation, Shareholders, 149 Shares, corporate, 149 Sherman Antitrust Act in 1890, 429 Index Shift in demand curve comparing competitive firm with monopoly, 355 effect of factors other than price on demand, 12–13 effects of rise in income on demand, 113 effects on monopolies, 354–355 equilibrium effects of, 25 labor example, 511 policies causing, 280–281 shocks to equilibrium, 24–26 Shift in supply curve causing movement along demand curve, 43 equilibrium effects of, 25 example, 19 policies causing, 280–281 shocks to equilibrium, 26 variables causing, 18–19 Shirking bonding to prevent, 667–669 contracts for avoiding moral hazard, 674–675 deferred payments to prevent, 669 efficiency wages to prevent, 669–670, A:28 monitoring for avoiding, 666 Shocks effects of supply shock depend on shape of demand curve, 43–44 feedback between competitive markets, 311 to market equilibrium, 24–26 Short and long-run expansion paths, 209–210 Short-run average cost curves (SRAC) laser printer example, 208–209 long-run average cost as envelope of short-run average cost curves, 207–208 Short-run competition competitive equilibrium, 240–242 firm supply curve, 237–238 market supply curve, 238–240 output decisions, 231–234 overview of, 230 questions, 258–260 shutdown decisions, 234–237 summary, 257 Short-run cost curves example (beer manufacturer), 190, A:11–A:12 long-run average cost as envelope of short-run average cost curves, 207–209 overview of, 186–187 production functions determining shape of, 187–188 shape of average cost curve, 189–190 shape of marginal cost curve, 189 shape of variable cost curve, 188–189 Short-run costs average, 185 fixed, variable, and total, 184 marginal, 184–185 overview of, 183–184 production functions and shape of cost curves, 187–188 shape of average cost curve, 189–190 shape of marginal cost curve, 189 shape of variable cost curve, 188–189 short-run cost curve (beer manufacturer example), 190 short-run cost curves, 186–187 summary, 193 taxes impacting, 191–192 Short-run demand demand elasticity over time, 51 factor demand in competitive factor market, 507–510 Short-run production average product of labor, 155 defined, 152 graphing product curves, 155–157 law of diminishing marginal returns, 157–159 marginal product of labor, 154 overview of, 153 questions, 176–177 summary, 175 total product, 153–154 Shutdown applied to oil sands and oil shale, 236–237 decisions in monopolies, 352 decisions in short-run competition, 234–236 example (ethanol processing plants), 244 rules in profit maximization, 229–230 A-91 Signaling actions for equalizing information, 632–633 education as signal of ability, 640–644 employees signaling regarding productivity, 674 strategies in dynamic games, 482 Simplification, models and, Single-price monopoly comparing welfare effects with of type of price discrimination, 403 group price discrimination compared with, 404 perfect price discrimination, 394 Slutsky equation, 120, A:8–A:9 Slutsky, Eugene, A:8 Snob effect, network externalities and, 376 Social costs cost of production with externalities, 598 social marginal costs, 599 Social producer surplus, 599 Social welfare functions efficiency vs equity, 338–339 in ranking allocations, 334–335 voting as means of ranking allocations, 337–338 SOEs (state-owned enterprises), in China, 149 Sole proprietorships, ownership of for-profit firms, 149–150 Specialization, returns to, 170 Specific taxes (unit taxes) equilibrium effects of, 59, 63–65, A:3–A:4 example (roses), 286 free trade vs tariffs, 297 impact on monopolies, 361–362, A:16–A:17 impact on short-run equilibrium, 242 types of sales taxes, 58 Spurious product differentiation Cournot oligopoly and, 444–445 example (bottled water), 446–447 SRAC (short-run average cost curves) laser printer example, 208–209 long-run average cost as envelope of short-run average cost curves, 207–208 A-92 Index Stackelberg game tree, 484 Stackelberg oligopoly comparing types of equilibria, 450–451 as dynamic entry game, 487–488 graphical model of, 447–449 limit pricing and, 489–490 overview of, 447 questions, 465 as sequential game (airline example), 483–487 sequential movement in, 450 summary, 463 Standard deviation, from expected value, 566–567 Standards, actions for equalizing information, 634 State-contingent contracts, 659–660 State-owned enterprises (SOEs), in China, 149 States of nature, decision making and, 562 Static games applying to strategic advertising by oligopolies, 479–480 best response and Nash Equilibrium, 472–474 cooperation and, 478–479 dominant strategies, 471–472 in explanation of parent/child interaction, 477–478 mixed strategies, 475–476 multiple Nash equilibria and, 475 normal-form representation of, 470–471 overview of, 470 predicting outcomes, 471 questions, 498–500 summary, 497 Statistical discrimination, in hiring, 644–646 Stocks (investment) investing in corporations, 149 retirement investments, 577 risk premium of, 571 Stocks (of durable goods), 531 Strategies, in game theory auction strategies, 492–493 best response and Nash Equilibrium, 472–474 defined, 469 dominant strategies in static games, 471–472 in dynamic games, 481 mixed strategies, 475–476 multiple Nash equilibria and, 475 in normal-form representation of static games, 471 pure strategy and mixed strategy, 474–475 in repeated prisoner’s dilemma game, 482–483 Stream of payments interest rates on, 536–538 present value of perpetuity, A:26 Subgames, in sequential games, 484 Subgames perfect Nash equilibrium, 484–486 Subjective probability, 564 Subsidies effects on supply and demand, 65–67 example (aircraft construction), 424, 461–462 example (childcare), 107, 141–142 example (Ethanol), 66 as negative tax, 62 welfare effects of, 288–289 Substitute goods cross-price elasticity of demand and, 53 demand and price and, 10 example (substituting alcohol for marijuana), 92 imperfect substitutes, 81 marginal rate of substitution (MRS) and, 79–81 market power and lack of, 358 perfect complements, 81 perfect substitutes, 80–81 Substitution bias, in CPI, 132 Substitution effects example (apple pie), 122–123 example (plate prices at two types of stores), 123–124 inferior goods and, 124–125 labor-leisure choice and, 135–137 with normal goods, 120–124 overview of, 120 Slutsky equation applied to, A:8–A:9 Sunk costs as barrier to entry, 284 overview of, 183 Supply excess supply, 24 impact of import policy on supply curves, 20–21 overview of, 17 policies creating wedge between supply and demand, 285 policies that cause demand to differ from supply, 29 policies that shift supply curves, 27–29 shock impact depending on shape of demand curve, 43–44 summing supply curves, 20 supply curve, 17–19 supply function, 19 when supply need not equal demand, 33–34 when to use supply-and-demand model, 34–36 Supply and demand demand curves, 10–11 demand function, 14–16 effect of factors other than price on demand, 12–13 equilibrium effects of government interventions, 26 example (genetically modified food), import policy impacting supply curves, 20–21 market equilibrium, 22–24 overview of, policies that cause demand to differ from supply, 29 policies that shift supply curves, 27–29 price ceilings, 30–32 price floors, 32–33 questions, 37–41 shocks to equilibrium, 24–26 summary, 36–37 summing demand curves, 16–17 summing supply curves, 20 supply curves, 17–19 supply function, 19 when supply need not equal demand, 33–34 Supply-and-demand model applying demand and supply elasticity (oil drilling example), 55–57 cross-price elasticity of demand, 52–53 demand elasticity along downward-sloping linear curve, 46–48 Index demand elasticity along horizontal curve, 48 demand elasticity along vertical curve, 48–49 demand elasticity and revenue, 49–51 demand elasticity over time, 51 effects of ad valorem and specific taxes, 63–65 effects of sales taxes, 58 effects of subsidies, 65–67 equilibrium effects of specific sales tax, 58–61 example (gasoline tax), 42 income elasticity of demand, 52 overview of, 43 price elasticity of demand, 45–46 price elasticity of supply, 53–54 quantity demanded sensitivity to price, 44–45 quantity supplied sensitivity to price, 53 sales tax burden shared by firms and customers, 61–63 shapes of supply and demand curves, 43–44 summary, 67 supply elasticity along supply curve, 54–55 supply elasticity over time, 54 use by economists, when to use, 34–36 Supply curves defined, 17 determining market equilibrium, 22 effects of specific tax on short-run equilibrium, 242 example (avocados), 18 example (cotton), 248 example (gasoline), 252–254 import policy impacting, 20–21 long-run competitive equilibrium and, 254–255 long-run firm supply curve, 243–244 long-run market supply curve, 245–246 measuring producer surplus, 273–274 monopsonies and, 521 movement along See Movement along supply curve overview of, 17–19 shape of, 43–44 shift in See Shift in supply curve short-run firm supply curve, 237–238 short-run market supply curve, 238–240 summing, 20 supply elasticity along, 54–55 Supply curves, for labor deriving, 132 income and substitution effects applied to labor-leisure choice, 135–137 income tax rates and, 139–141 labor-leisure choice, 132–135 shape of, 137–139 Supply function, 19 Surplus consumer surplus See Consumer surplus (CS) producer surplus See Producer surplus (PS) Symmetric information, in efficient contracts, 654–655 T Tangency rule, minimizing costs and, 197–198 Tariffs (duty) example (chicken tax), 300 free trade vs., 297–299 import policies and, 295 resale prevention, 389 Tastes, consumer See also Preferences, consumer, Taxes bounded rationality and tax salience, 100 burden of sales tax shared by firms and customers, 61–63 effect of sales tax on supply-anddemand, 58 effects of ad valorem and specific taxes, 63–65 effects of specific tax on monopolies, 361–362 effects of specific tax on short-run equilibrium, 242 effects of tax on output on demand for labor, 510–511 equilibrium effects of specific sales tax, 58–61 example (gasoline tax), 66–67 example (tobacco use), 111 A-93 on externalities in noncompetitive markets, 607 impact of sales taxes on demand, 10 incidence of, 61–62 income tax rates and labor supply curve, 139–141 for pollution control, 603–604 redistribution of wealth and, 330 shifting burden to middle class, 331–332 short-run costs impacted by, 191–192 subsidies as negative tax, 62 urban flight due to tax on wages, 317 welfare effects of sales taxes, 285–288 who pays the gasoline tax, 42–43 Technical progress defined, 171 example (Tata Motors), 173 impact on price of exhaustible resources, 552 productivity and, 170–171 Technological efficiency choices at home vs abroad, 214–215 long-run costs and, 194 maximizing profits, 151 output decisions, 179 Testing theories, with microeconomic model, 4–5 Tests of transitivity, 98–99 Thales, 345 Third-degree price discrimination See Group price discrimination Third-party information, actions for equalizing information, 633–634 Threatening to punish credibility of in sequential dynamic games, 486–487 strategies in dynamic games, 481–482 Tie-in sales bundling, 411–413 overview of, 410 questions, 422 requirement tie-in sales, 410–411 summary, 418–419 Time choices over, 541 investing and See Investments A-94 Index Time (continued) price elasticity of demand over, 51 supply elasticity over, 54 time-varying discounting, 545–546 Total costs (C) long-run cost curves, 203 overview of, 184 short-run cost curves, 187 Total effects apple pie example, 122–123 labor-leisure choice and, 135–137 as sum of income and substitution effects, 122 Total product See Outputs Tourist-trap model monopoly pricing, 637 overview of, 636 uncompetitive pricing, 636–637 Trade benefits of, 325–326 long-run market supply with, 250–254 pollution and, 617–619 trade wars (chicken tax example), 300 Trade laws, resale prevention, 389 Trade-offs marginal rate of transformation measuring, 88 resource allocation and, Trades, between two people bargaining ability and, 321 endowment as basis of, 317–318 mutually beneficial trades, 319–321 overview of, 317 questions, 342 summary, 340 Transaction costs in competitive markets, 222–223 perfect price discrimination and, 396 resale difficult when transaction costs are high, 389 Transitivity property, consumer preferences, 74–75 Transitivity (rationality) assumption, 335 Trigger strategy, in dynamic games, 482 Trusts See also Cartels, 429 Two-part pricing with identical consumers, 407–408 with nonidentical consumers, 408–409, A:19–A:20 overview of, 406–407 questions, 422 summary, 418 types of nonuniform pricing, 385 Two-period monopoly model, 377 U Ultimatum games, 494–495 Uncertainty assessing risk, 563 behavioral economics of, 584 biases in assessing risk probability, 584–585 diversification as risk reduction method, 575–577 example (British Petroleum), 561–562, 589–590 example (flight insurance), 580 expected utility theory and, 567–568 expected value in assessing risk, 565–566 information in risk reduction, 575 insurance as risk reduction method, 577–581 investing and, 582 natural disaster insurance, 581–582 overview of, 562 probability of risk, 563–565 prospect theory, 587–589 questions, 590–594 reducing risk, 574 risk attitudes, 567 risk-averse investing, 582–584 risk aversion, 568–571 risk-neutral investing, 582 risk neutrality, 572 risk preferring, 573–574 summary, 590 variance and standard deviation from expected value, 566–567 violations of expected utility theory, 586–587 Unified Carrier Registration Agreement, 220 Uniform pricing example (iTunes), 410 overview of, 384 Unions, as monopoly, 519 Unit taxes See Specific taxes (unit taxes) Unitary elasticity, of supply, 54 Universal coverage, restricting opportunistic behavior, 630 Utility defined, 73 expected utility, 567–568 indifference curves and, 83–85, A:4–A:6 in labor-leisure choice, A:9–A:10 marginal rate of substitution (MRS), 86 marginal utility, 85–86 maximizing in mutually beneficial trades, 319 maximizing subject to budget constraint, 91–92, A:6–A:8 ordinal preferences, 83 overview of, 82 risk aversion and, 568–570 risk neutrality and, 572 risk preferring and, 573 social welfare functions maximizing, 337–338 utility function, 82–84 Utility function, 82–84 V Variable costs (VC) overview of, 184 shape of variable cost curve, 188–189 short-run cost curves, 187 shutdown decisions in short-run competitive firms, 234–236 taxes impacting short-run cost curves, 191 Variable inputs, 152 Variance, from expected value, 566–567 VC See Variable costs (VC) Vertical integration, as means of preventing resale, 389 von Neumann, John, 567 Voting, as allocation method, 335–337 W Wages compensating differentials for occupational safety, 623–624 efficiency wages to prevent moral hazard, 669–670 Index factor demand impacted by change in, 509–510, A:24–A:25 income and substitution impacted by change in, 135–136 layoffs vs pay cuts, 672–674 minimum wages with incomplete coverage, 314–316 occupational licensing and, 27 price floors, 32–34 shape of labor supply curves, 137 unions ability to raise, 519 urban flight resulting from tax on, 317 Warranties, as signal of quality, 633 Water quotas, impacting opportunity set, 88–89 Wealth government programs in redistribution of, 330 inequitable distribution of, 331–332 Welfare applying producer surplus and, 274–275 barriers to entry or exit reducing, 284 block pricing and, 405–406 competition maximizing, 276 of consumers See Consumer surplus (CS) deadweight loss and, 276–277 deadweight loss (Christmas presents example), 279–280 differentiated products and, 455 in economists’ terminology, 262 effects of monopsonies, 524–526 effects of nonoptimal price regulation, 370 effects of optimal price regulation, 368 effects of pollution, 598–599, A:26–A:28 effects of price ceilings, 293–295 effects of price changes, 270–273 effects of price discrimination, 403–404 effects of price floors, 289–293 effects of restrictions on number of firms, 281–283 effects of sales taxes, 285–288 effects of subsidies, 288–289 government policies and, 333–334, 280 group price discrimination and, 403 maximizing, 334 measuring consumer surplus with demand curve, 267–270 measuring producer surplus with supply curve, 273–274 monopolies vs competitive welfare with externalities, 606–607 overproduction causing decrease in, 278–279 A-95 perfect price discrimination and, 393–394 of producers See Producer surplus (PS) Welfare economics, 262 Willingness-to-accept (WTA), deadweight loss of Christmas presents and, 279 Willingness-to-pay (WTP), deadweight loss of Christmas presents and, 279 Willingness to substitute See Marginal rate of substitution (MRS) Winner’s curse, 493–494 World Trade Organization (WTO) aircraft subsidies and, 424 pressure on governments to reduce/eliminate barriers to trade, 372 ruling on genetically modified crops, Z zero long-run profit for competitive firms with free entry, 263–264 for competitive firms with limited entry, 264–266 Zoning laws, as barrier to entry by hotel chains, 460–461 Credits p 8: AGE Fotostock/SuperStock p 12: © 2013 Zach Weinersmith/smbc-comics.com p 14: Shutterstock p 30: United States Government Printing Office p 32: Jeffrey M Perloff p 42: Jeffrey M Perloff p 333 bottom left: Breaker boys working in Ewen Breaker of Pennsylvania Coal Co (1911), Lewis Wickes Hine Library of Congress Prints and Photographs Division [LC-USZ62-12876] p 333 middle right: Library of Congress Prints and Photographs Division [LC-USZ62-13040] p 43: Pearson Education, Inc p 333 far right: Pete Souza/Library of Congress Prints and Photographs Division [LC-DIG-ppbd-00358] p 50: Shutterstock p 344: Jeffrey M Perloff p 56: United States Geological Survey (USGS) p 357: Jeffrey M Perloff p 72: Jeffrey M Perloff p 359: Pearson Education, Inc p 79: Pearson Education, Inc p 366: John W Shore, M.D p 98: United States Department of Agriculture (USDA) p 384: Jeffrey M Perloff p 107: Jim West/Alamy p 388: Jeffrey M Perloff p 133: Pearson Education, Inc p 403: Pearson Education, Inc p 147: Bernhard Classen/Alamy p 424: Tom Mareschal/Alamy p 158 top: Pearson Education, Inc p 429: Pearson Education, Inc p 158 bottom: Jeffrey M Perloff p 444: Hayley Chouinard p 167: Pearson Education, Inc p 446: Jeffrey M Perloff p 172: Pearson Education, Inc p 453: Lee Bennack p 179: Christian Delbert/Shutterstock p 456: Jeffrey M Perloff p 184: Pearson Education, Inc p 468: Jeffrey M Perloff p 212: iStockphoto/Thinkstock p 476: Pearson Education, Inc p 220: Konstantin Sutyagin/Fotolia p 480: Dorling Kindersley, Ltd p 236: Design Pics Inc./Alamy p 486: Pearson Education, Inc p 262: Getty Images p 505: Joseph Sohm/Visions of America, LLC/Alamy p 265: Jeffrey M Perloff p 523: United States Department of Energy (DOE) p 269: Jeffrey M Perloff p 530: Jeffrey M Perloff p 279: Pearson Education, Inc p 551: Jeffrey M Perloff p 280: Jeffrey M Perloff p 561: United States Coast Guard p 283: Jeffrey M Perloff p 563: Courtesy of Boeri, SRL p 308: National Oceanic and Atmospheric Administration (NOAA) p 568: Jeffrey M Perloff p 332 top: Abraham Lincoln (5 Feb 1865), Alexander Gardner Gelatin silver print Library of Congress Prints and Photographs Division [LC-USZ62-11896] p 580: Pearson Education, Inc p 332 bottom: George Washington (Vaughan Portrait) (1795), Gilbert Stuart Oil on canvas, 73 x 60.5 cm (28 3/4 x 23 13/16 in.) Andrew W Mellon Collection, National Gallery of Art, Washington, DC p 602: Shutterstock p 333 top left: Destitute pea pickers in California Mother of seven children Age thirty-two Nipomo, California (“Migrant Mother”) (1936), Dorothea Lange Library of Congress Prints and Photographs Division [LC-USZ62-95653] A-96 p 573: Jeffrey M Perloff p 595: Barry Sweet/AP Images p 600: Pearson Education, Inc p 609: Doral Chenoweth III/The Columbus Dispatch/AP Images p 623: Davis Turner/EPA/Newscom p 626: Pearson Education, Inc p 631: Pearson Education, Inc p 651: Pearson Education, Inc p 659: Damian Dovarganes/AP Images Symbols Used in This Book α [alpha] = ad valorem tax (or tariff) rate, or an exponent in a Cobb-Douglass production function ᏸ = lump-sum tax Δ [capital delta] = change in the following variable (for example, the change in p between Periods and is Δp = p2 - p1, where p2 is the value of p in Period and p1 is the value in Period 1) ρ [rho] = profit tax rate ε [epsilon] = the price elasticity of demand ω [omega] = share η [eta] = the price elasticity of supply ξ [xi] = the income elasticity of demand π [pi] = profit = revenue - total cost = R - C σ [sigma] = standard deviation θ [theta] = probability or share Abbreviations, Variables, and Function Names AFC = average fixed cost = fixed cost divided by output = F/q MR = marginal revenue = ΔR/Δq MRS = marginal rate of substitution AVC = average variable cost = variable cost divided by output = VC/q MRTS = marginal rate of technical substitution AC = average cost = total cost divided by output = C/q n = number of firms in an industry MUZ = marginal utility of good Z APZ = average product of input Z (for example, APL is the average product of labor) p = price C = total cost = variable cost + fixed cost = VC + F PS = producer surplus = revenues - variable costs = R - VC CRS = constant returns to scale PPF = production possibility frontier CV = compensating variation Q = market (or monopoly) output _ Q = output quota D = market demand curve q = firm output Dr = residual demand curve R = revenue = pq DRS = decreasing returns to scale r = price of capital services DWL = deadweight loss s = per-unit subsidy F = fixed cost S = market supply curve i = interest rate So = supply curve of all the other firms in the market CS = consumer surplus I = indifference curve IRS = increasing returns to scale K = capital L = labor LR = long run m = constant marginal cost M = materials SC = a market of economies of scope SR = short run t = specific or unit tax (or tariff) T = tax revenue (α pQ, τQ, ρπ) U = utility VC = variable cost MC = marginal cost = ΔC/Δq w = wage MPZ = marginal (physical) product of input Z (for example, MPL is the marginal product of labor) Y = income or budget W = welfare Featured Applications in This Book Chapter 1: Income Threshold Model and China Chapter 2: Calorie Counting at Starbucks Aggregating Corn Demand Curves Occupational Licensing Price Controls Kill 13 16 27 31 Do Farmers Benefit from a Major Drought? 50 Oil Drilling in the Arctic National Wildlife Refuge 55 Taxes to Prevent Obesity 62 The Ethanol Subsidy 66 Chapter 4: You Can’t Have Too Much Money 75 Indifference Curves Between Food and Clothing 85 Substituting Alcohol for Marijuana 92 Benefiting from Food Stamps 98 Opt In Versus Opt Out 100 Unaware of Taxes 101 Chapter 5: 111 119 124 126 130 138 Chapter 6: Chinese State-Owned Enterprises Malthus and the Green Revolution 162 168 171 173 Chapter 7: Chapter 3: Smoking Versus Eating and Phoning Fast-Food Engel Curve Shipping the Good Stuff Away What’s the Value of Using the Internet? Paying Employees to Relocate Working After Winning the Lottery A Semiconductor Integrated Circuit Isoquant Returns to Scale in Various Industries A Good Boss Raises Productivity Tata Nano’s Technical and Organizational Innovations 149 158 The Opportunity Cost of an MBA 181 Short-Run Cost Curves for a Beer Manufacturer 190 Economies of Scale in Nuclear Power Plants 205 Long-Run Cost Curves in Beer Manufacturing 208 Choosing an Inkjet or a Laser Printer 208 Learning by Drilling 211 Economies of Scope 213 Chapter 10: Urban Flight The Wealth and Income of the 1% How You Vote Matters 317 331 336 Chapter 11: Apple’s iPad Cable Cars and Profit Maximization Botox Patent Monopoly Natural Gas Regulation Generic Competition for Apple’s iPod Critical Mass and eBay 353 357 366 372 373 377 Chapter 12: Chapter 8: Oil, Oil Sands, and Oil Shale Shutdowns The Size of Ethanol Processing Plants Fast-Food Firms’ Entry in Russia Upward-Sloping Long-Run Supply Curve for Cotton Reformulated Gasoline Supply Curves The Deadweight Cost of Raising Gasoline Tax Revenue 286 How Big Are Farm Subsidies and Who Gets Them? 292 The Social Cost of a Natural Gas Price Ceiling 295 The Chicken Tax Trade War 300 236 244 245 248 252 Chapter 9: Tiger Woods’ Rent 266 Willingness to Pay and Consumer Surplus on eBay 269 Goods with a Large Consumer Surplus Loss from Price Increases 271 Deadweight Loss of Christmas Presents 279 Licensing Cabs 283 Disneyland Pricing 338 Preventing Resale of Designer Bags 390 Google Uses Bidding for Ads to Price Discriminate 392 Botox Revisited 395 Warner Brothers Sets Prices for a Harry Potter DVD 397 Reselling Textbooks 399 Buying Discounts 402 iTunes for a Song 410 Ties That Bind 411 Super Bowl Commercials 416 Chapter 13: Catwalk Cartel 431 Casket Entry 433 Hospital Mergers: Market Power Versus Efficiency 434 Mobile Number Portability 442 Bottled Wate 446 Welfare Gain from More Toilet Paper 455 Monopolistically Competitive Food Truck Market 456 Zoning Laws as a Barrier to Entry by Hotel Chains 460 Chapter 14: Tough Love Strategic Advertising Dominant Airlines Bidder’s Curse GM’s Ultimatum 477 479 488 494 495 Winning the Lottery Falling Discount Rates and Self-Control Redwood Trees 540 546 550 Chapter 17: Stocks’ Risk Premium 571 Gambling 573 Diversifying Retirement Funds 577 Flight Insurance 580 Limited Insurance for Natural Disasters 581 Biased Estimates 585 Chapter 15: Unions and Profits Wal Mart’s Monopsony Power 609 610 613 615 616 Chapter 19: Changing a Firm’s Name Adverse Selection on eBay Motors Reducing Consumers’ Information 632 633 635 Chapter 20: 519 523 Chapter 16: Power of Compounding Saving for Retirement Buying a Town Acid Rain Program Piracy Radiohead’s “Public Good” Experiment What’s Their Beef? 534 538 Chapter 18: Negative Externalities from Spam 597 Pulp and Paper Mill Pollution and Regulation 602 Why Tax Drivers 603 Protecting Babies 604 Selfless or Selfish Doctors? Contracts and Productivity in Agriculture Music Contracts: Changing Their Tunes Abusing Leased Cars Layoffs Versus Pay Cuts 656 664 665 671 672 ... Principles, Applications, and Tools* Parkin Economics* Perloff Microeconomics* Microeconomics: Theory and Applications with Calculus* Pindyck/Rubinfeld Microeconomics* Riddell/Shackelford/Stamos/ Schneider... Cataloging-in-Publication Data Perloff, Jeffrey M Microeconomics / Jeffrey Perloff. —7th edition p cm Includes bibliographical references and index ISBN 978-0-13-345691-2 Microeconomics I Title HB172.P39... Growth Williamson Macroeconomics Visit www.myeconlab.com to learn more iii MICROECONOMICS S EV EN T H E D IT ION JEFFREY M PERLOFF University of California, Berkeley Boston Columbus Indianapolis