BRIEF CONTENTS Guide to the text xiii Guide to the online resources xv Preface to this edition xvii Preface to the original edition xx To the students xxi About the authors xxii Acknowledgements xxiv Part Firm behaviour and the organisation of industry 278 Thinking like an economist 24 Chapter 13 The costs of production 280 Interdependence and the gains from trade 52 Chapter 14 Firms in competitive markets 303 Chapter 15 Monopoly 326 Supply and demand I: How markets work 68 Chapter 16 Monopolistic competition 356 Chapter 17 Oligopoly and business strategy 375 Chapter The market forces of supply and demand 70 Chapter 18 Competition policy 400 Chapter Elasticity and its application 97 Chapter Supply, demand and government policies 121 Part Supply and demand II: Markets and welfare 146 Chapter Consumers, producers and the efficiency of markets 148 Part Topics for further study 490 Chapter 22 The theory of consumer choice 492 Frontiers of microeconomics 521 Part Introduction Chapter Ten principles of economics Chapter Chapter Part Part The economics of labour markets 420 Chapter 19 The markets for the factors of production 422 Chapter 20 Earnings and discrimination 446 Chapter 21 Income inequity and poverty 468 Chapter Application: The costs of taxation 170 Chapter 23 Chapter Application: International trade 192 Part The economics of the public sector 216 Glossary 542 Suggestions for reading 546 Index 549 Chapter 10 Externalities 218 Chapter 11 Public goods and common resources 239 Chapter 12 The design of the tax system 260 v CONTENTS Guide to the text xiii Guide to the online resources xv Preface to this edition xvii Preface to the original edition xx To the students xxi About the authors xxii Acknowledgements xxiv Part Introduction Chapter Ten principles of economics How people make decisions Principle 1: People face trade-offs Principle 2: The cost of something is what you give up to get it Principle 3: Rational people think at the margin Principle 4: People respond to incentives Case study: Choosing when the stork comes 10 How people interact 11 Principle 5: Trade can make everyone better off 11 In the news: Outsourcing your own job 12 Principle 6: Markets are usually a good way to organise economic activity 13 FYI: Adam Smith and the role of markets 14 Case study: Adam Smith would have loved Uber 15 Principle 7: Governments can sometimes improve market outcomes 15 How the economy as a whole works 17 The economist as policy adviser 33 Positive versus normative analysis 33 Economists in government 34 Why economists’ advice is not always followed 35 Why economists disagree 36 Differences in scientific judgements 36 Differences in values 36 What Australian economists think 37 What Australian economists think 37 Let’s get going 37 Summary 39 Key concepts 39 Questions for review 39 Multiple choice 39 Problems and applications 40 Principle 8: A country’s standard of living depends on its ability to produce goods and services 17 Principle 9: Prices rise when the government prints too much money 17 Principle 10: Society faces a short-term trade-off between inflation and unemployment 18 Conclusion 20 Appendix: Graphing – a brief review Summary Chapter 21 Key concepts 21 Questions for review Multiple choice 21 Chapter 22 Thinking like an economist 24 The economist as scientist 25 The scientific method: Observation, theory and more observation 25 The role of assumptions 26 Economic models 27 42 Graphs of a single variable 42 Graphs of two variables: The coordinate system 42 Curves in the coordinate system 44 Slope and elasticity 47 Cause and effect 49 Interdependence and the gains from trade 52 A parable for the modern economy 21 Problems and applications vi Our first model: The circular-flow diagram 28 Our second model: The production possibilities frontier 29 Microeconomics and macroeconomics 31 53 Production possibilities 54 Specialisation and trade 55 The principle of comparative advantage 57 Absolute advantage 57 Opportunity cost and comparative advantage Comparative advantage and trade 58 FYI: The legacy of Adam Smith and David Ricardo 59 The price of trade 60 57 60 The variety of demand curves 100 FYI: The midpoint method: A better way to calculate percentage changes and elasticities 102 Total revenue and the price elasticity of demand 103 Case study: Pricing admission to an art gallery 105 Elasticity and total revenue along a linear demand curve 105 Other demand elasticities 107 Should Roger Federer mow his own lawn? 60 Should Australia trade with other countries? 61 In the news: Who has a comparative advantage in slaying ogres? 62 Conclusion Summary 63 64 Key concepts 64 Questions for review The elasticity of supply 64 Multiple choice 64 Problems and applications 65 The market forces of supply and demand 70 Markets and competition 71 Summary 117 What is a market? 71 What is competition? 71 Demand 72 Key concepts 80 The supply curve: The relationship between price and quantity supplied 80 Market supply versus individual supply 81 Shifts in the supply curve 82 Supply and demand together 85 Equilibrium 85 Three steps for analysing changes in equilibrium 87 93 Multiple choice 94 Problems and applications Chapter Chapter 95 Controls on prices 122 How price ceilings affect market outcomes 122 Case study: Lines at the petrol station 124 Case study: Rent control in the short run and long run 125 How price floors affect market outcomes 126 Case study: Minimum wage rates 128 What Australian economists think 130 Evaluating price controls 130 131 How taxes on sellers affect market outcomes 132 How taxes on buyers affect market outcomes 133 Case study: Who pays the payroll tax? 135 Elasticity and tax incidence 136 137 Key concepts 98 The price elasticity of demand and its determinants Computing the price elasticity of demand 99 FYI: A few elasticities from the real world 100 Supply, demand and government policies 121 Summary 142 Elasticity and its application 97 The elasticity of demand 118 How subsidies affect market outcomes 138 Case study: Who gets the benefits from the First Home Owner Grant scheme? 140 What Australian economists think 141 Conclusion 141 93 Questions for review 117 118 Problems and applications Subsidies 93 Key concepts Multiple choice Taxes Conclusion: How prices allocate resources 90 In the news: Mother Nature shifts the supply curve 92 Summary 117 Questions for review The demand curve: The relationship between price and quantity demanded 72 Market demand versus individual demand 74 FYI: Ceteris paribus 75 Shifts in the demand curve 76 Case study: Are smartphones and tablets substitutes or complements? 77 Case study: Two ways to reduce the quantity of smoking demanded 78 Supply 108 Three applications of supply, demand and elasticity 109 Can good news for farming be bad news for farmers? 111 Why did OPEC fail to keep the price of oil high? 113 Do drug bans increase or decrease drug-related crime? 114 Conclusion 116 Part Supply and demand I: How markets work 68 Chapter 108 The price elasticity of supply and its determinants Computing the price elasticity of supply 108 The variety of supply curves 109 CONTENTS Applications of comparative advantage 98 142 Questions for review Multiple choice 142 143 Problems and applications 143 vii Chapter The determinants of trade 149 Willingness to pay 149 Using the demand curve to measure consumer surplus 150 How a lower price raises consumer surplus 153 What does consumer surplus measure? 153 Case study: How parking meters help you find a parking space 155 Producer surplus 156 Cost and the willingness to sell 156 Using the supply curve to measure producer surplus 157 How a higher price raises producer surplus 158 Market efficiency 160 The benevolent social planner 160 Evaluating the market equilibrium 161 Case study: Should there be a market for organs? 163 Conclusion: Market efficiency and market failure 164 Summary 166 Multiple choice 166 CONTENTS Chapter 167 184 Key concept 184 184 184 Problems and applications 185 188 The welfare economics of subsidies 188 The cost of a subsidy 189 The deadweight loss from a subsidy 190 Understanding the deadweight loss from overproduction 191 viii 212 212 Multiple choice 212 Problems and applications 213 Part The economics of the public sector 216 175 The determinants of the deadweight loss 176 Case study: The deadweight loss debate 178 Deadweight loss and tax revenue as taxes vary 179 Case study: The Laffer curve and supply-side economics 181 Conclusion 183 Appendix 212 171 How a tax affects market participants 171 Deadweight losses and the gains from trade Multiple choice 205 The jobs argument 206 The national security argument 206 In the news: Should the winners from free trade compensate the losers? 207 The infant industry argument 208 The unfair competition argument 208 The protection-as-a-bargaining-chip argument 208 Case study: Trade agreements and the World Trade Organization 209 Questions for review Application: The costs of taxation 170 Questions for review The arguments for restricting trade Key concepts The deadweight loss of taxation Summary The gains and losses of an exporting country 195 The gains and losses of an importing country 198 The effects of a tariff 200 FYI: Import quotas: Another way to restrict trade 202 The lessons for trade policy 202 Other benefits of international trade 203 In the news: Trade as a tool for economic development 204 Summary 166 Problems and applications 194 Conclusion 210 What Australian economists think 211 Key concepts 166 Questions for review 193 The equilibrium without trade 193 The world price and comparative advantage The winners and losers from trade 195 Consumers, producers and the efficiency of markets 148 Consumer surplus Application: International trade 192 Chapter Part Supply and demand II: Markets and welfare 146 Chapter 10 Externalities 218 Externalities and market inefficiency 220 Welfare economics: A recap 220 Negative externalities 220 Positive externalities 222 Case study: Technology spillovers, industrial policy and patent protection 223 What Australian economists think 224 Public policies on externalities 225 What Australian economists think 225 Command-and-control policies: Regulation 225 Market-based policy 1: Corrective taxes and subsidies 226 Case study: Taking out the garbage 227 Market-based policy 2: Tradeable pollution permits 228 Case study: British Columbia adopts a broad-based carbon tax 229 What Australian economists think 231 Objections to the economic analysis of pollution 231 Private solutions to externalities 232 Tax incidence and tax equity 273 Case study: Who pays company income tax? 273 The types of private solutions 232 The Coase theorem 232 Why private solutions not always work 233 Conclusion 234 Conclusion: The trade-off between equity and efficiency 274 Summary Key concepts Summary 275 235 Questions for review Multiple choice 235 Problems and applications Part Firm behaviour and the organisation of industry 278 Public goods and common resources 239 Chapter 13 242 Common resources 249 The Tragedy of the Commons 249 Some important common resources 250 In the news: The case for toll roads 251 What Australian economists think 253 Case study: Why the cow is not extinct 254 Conclusion: The importance of property rights 255 256 Questions for review 256 Multiple choice 256 Problems and applications Chapter 12 257 The design of the tax system 260 An overview of Australian taxation 261 Taxes collected by the federal government 261 Taxes collected by state and local governments 264 Taxes and efficiency 265 Deadweight losses 265 Case study: Should income or consumption be taxed? 266 Administrative burden 267 Marginal tax rates versus average tax rates 267 Lump-sum taxes 268 Taxes and equity 281 Total revenue, total cost and profit 281 Costs as opportunity costs 282 The cost of capital as an opportunity cost 282 Economic profit versus accounting profit 283 Production and costs 284 FYI: How long is the long run? 284 The production function 285 From the production function to the total-cost curve 287 The various measures of cost 288 Fixed and variable costs 289 Average and marginal cost 290 Cost curves and their shapes 290 Typical cost curves 292 256 Key concepts The costs of production 280 What are costs? The free-rider problem 242 Some important public goods 243 Case study: Are lighthouses public goods? 244 The difficult job of cost–benefit analysis 245 Case study: How much is a life worth? 246 Private provision of public goods 247 Case study: Is music a public good? 248 Summary 276 236 The different kinds of goods 240 Public goods 275 275 Problems and applications Multiple choice 235 Chapter 11 275 Questions for review 235 269 The benefits principle 269 The ability-to-pay principle 270 Case study: How the tax burden is distributed 271 Case study: Who should pay for higher education? 272 Costs in the short run and in the long run 294 The relationship between short-run and long-run average total cost 294 Economies and diseconomies of scale 295 Conclusion 296 FYI: Lessons from a pin factory 296 Summary 298 Key concepts 298 Questions for review Multiple choice 298 299 Problems and applications Chapter 14 CONTENTS Key concepts 299 Firms in competitive markets 303 What is a competitive market? 304 The meaning of competition 304 The revenue of a competitive firm 305 Profit maximisation and the competitive firm’s supply curve 306 A simple example of profit maximisation 306 The marginal-cost curve and the firm’s supply decision 307 The firm’s short-run decision to shut down 309 FYI: Spilt milk and sunk costs 310 ix Case study: Near-empty restaurants and off-season ski lodges 311 The firm’s long-run decision to exit or enter a market 312 Measuring profit in our graph for the competitive firm 313 The supply curve in a competitive market 314 The short run: Market supply with a fixed number of firms 315 The long run: Market supply with entry and exit 315 Why competitive firms stay in business if they make zero profit? 317 A shift in demand in the short run and long run 317 Why the long-run supply curve might slope upwards 319 Conclusion: Behind the supply curve 320 Summary Competition with differentiated products Questions for review Advertising 365 The debate about advertising 365 Case study: Advertising and the price of glasses Advertising as a signal of quality 367 Brand names 368 Problems and applications 371 Multiple choice 371 322 Monopoly 326 Why monopolies arise 327 Monopoly resources 328 Case study: The gas industry in south-eastern Australia 328 Government-created monopolies 329 Natural monopolies 329 CONTENTS How monopolies make production and pricing decisions 331 Monopoly versus competition 331 A monopoly’s revenue 332 Profit maximisation 334 FYI: Why a monopoly does not have a supply curve 336 A monopoly’s profit 336 Case study: Monopoly pharmaceuticals versus generic pharmaceuticals 337 The welfare cost of monopoly 338 The deadweight loss 339 The monopoly’s profit: A social cost? Price discrimination 342 350 Multiple choice Problems and applications x Markets with only a few sellers 351 376 A duopoly example 377 Competition, monopolies and cartels 377 The equilibrium for an oligopoly 378 How the size of an oligopoly affects the market outcome 379 Case study: OPEC and the world oil market 380 The economics of cooperation 381 The prisoners’ dilemma 382 Oligopolies as a prisoners’ dilemma 383 Other examples of the prisoners’ dilemma 384 The prisoners’ dilemma and the welfare of society 385 Why people sometimes cooperate 386 Case study: The prisoners’ dilemma tournament 387 Summary 388 389 389 Questions for review 389 Multiple choice 389 Problems and applications 390 Appendix: Types of oligopolistic competition 394 Anticipating your competitor’s response 394 Cournot quantity competition 394 Bertrand price competition 398 Comparing Cournot and Bertrand competition 399 Chapter 18 350 350 372 Oligopoly and business strategy 375 Key concepts Key concepts 350 Questions for review Chapter 17 Conclusion 341 A parable about pricing 342 The moral of the story 343 The analytics of price discrimination 344 Examples of price discrimination 345 In the news: Why Australians pay more for digital downloads? 347 Conclusion: The prevalence of monopoly 349 Summary 366 371 Problems and applications Chapter 15 364 369 Questions for review 321 359 371 Key concepts 321 357 359 The monopolistically competitive firm in the short run The long-run equilibrium 360 Monopolistic versus perfect competition 362 Monopolistic competition and the welfare of society Summary Key concepts 321 Multiple choice Between monopoly and perfect competition Conclusion 321 Monopolistic competition 356 Chapter 16 Competition policy 400 Public policy towards monopolies 401 Using the law to increase competition 401 ability-to-pay principle ceteris paribus corrective tax the idea that taxes should be levied on a person according to how well that person can shoulder the burden a tax enacted to correct the effects of a negative externality absolute advantage a Latin phrase, translated as ‘other things being equal’, used as a reminder that all variables other than the ones being studied are assumed to be constant the ability to produce a good using fewer inputs than another producer circular-flow diagram GLOSSARY adverse selection the tendency for the mix of unobserved attributes to become undesirable from the standpoint of an uninformed party goods that are excludable but not rival in consumption a person who is performing an act for another person, called the principal Coase theorem Arrow’s impossibility theorem a mathematical result showing that, under certain assumed conditions, there is no scheme for aggregating individual preferences into a valid set of social preferences the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own collusion average fixed cost an agreement among firms in a market about quantities to produce or prices to charge fixed costs divided by the quantity of output common resources average revenue goods that are rival in consumption but not excludable total revenue divided by the quantity sold comparative advantage total taxes paid divided by total income the ability to produce a good at a lower opportunity cost than another producer average total cost compensating differential total cost divided by the quantity of output a difference in wages that arises to offset the non-monetary characteristics of different jobs average tax rate average variable cost variable costs divided by the quantity of output awards the minimum wage rates that can be paid to particular workers in particular industries behavioural economics the subfield of economics that integrates the insights of psychology the idea that people should pay taxes based on the benefits they receive from government services budget constraint the limit on the consumption bundles that a consumer can afford capital the equipment and structures used to produce goods and services cartel a group of firms acting in unison the value of everything a seller must give up to produce a good cost−benefit analysis a study that compares the costs and benefits to society of providing a public good club goods agent benefits principle 542 a visual model of the economy that shows how dollars flow through markets among households and firms cost competition laws laws that promote competition by regulating the behaviour of firms with market power competitive market a market in which there are many buyers and many sellers so that each has a negligible impact on the market price complements two goods for which a decrease in the price of one good leads to an increase in the demand for the other good cross-price elasticity of demand a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good deadweight loss the reduction in total surplus that results from a market distortion such as a tax or a monopoly price demand curve a graph of the relationship between the price of a good and the quantity demanded demand schedule a table that shows the relationship between the price of a good and the quantity demanded diminishing marginal product the property whereby the marginal product of an input declines as the quantity of the input increases discrimination the offering of different opportunities to similar individuals who differ only by race, ethnic group, sex, age or other personal characteristics diseconomies of scale the property whereby long-run average total cost rises as the quantity of output increases dominant strategy the failure of majority rule to produce transitive preferences for society a strategy that is best for a player in a game regardless of the strategies chosen by the other players constant returns to scale economics the property whereby long-run average total cost stays the same as the quantity of output changes the study of how society manages its scarce resources consumer surplus the property whereby long-run average total cost falls as the quantity of output increases Condorcet paradox a buyer’s willingness to pay minus the amount the buyer actually pays economies of scale efficiency horizontal equity law of supply and demand the property of society getting the most it can from its scarce resources the idea that taxpayers with similar abilities to pay taxes should pay the same amount the claim that the price of any good adjusts to bring the supply and demand for that good into balance human capital liberalism efficient scale the accumulation of investments in people, such as education and on-the-job training the quantity of output that minimises average total cost imports the political philosophy according to which the government should choose policies deemed to be just, as evaluated by an impartial observer behind a ‘veil of ignorance’ elasticity goods and services that are produced abroad and sold domestically libertarianism a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants income effect efficiency wages above-equilibrium wages paid by firms in order to increase worker productivity equilibrium a situation in which supply and demand have been brought into balance the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve income elasticity of demand equilibrium price the price that balances quantity supplied and quantity demanded equilibrium quantity the quantity supplied and the quantity demanded at the equilibrium price equity the property of distributing economic prosperity fairly among the members of society excludable the property of a good whereby a person can be prevented from using it exit a long-run decision to leave the market exports goods and services that are produced domestically and sold abroad externality the uncompensated impact of one person’s actions on the wellbeing of a bystander A positive externality makes the bystander better off A negative externality makes the bystander worse off factors of production the inputs used to produce goods and services a measure of how much the quantity demanded of a good responds to a change in consumers’ income, calculated as the percentage change in quantity demanded divided by the percentage change in income a curve that shows consumption bundles that give the consumer the same level of satisfaction Giffen good a good for which an increase in the price raises the quantity demanded the period of time needed for all factors of production to become variable lump-sum tax a tax that is the same amount for every person macroeconomics the study of economy-wide phenomena, including inflation, unemployment and economic growth marginal change inflation marginal cost an increase in the overall level of prices in the economy the increase in total cost that arises from an extra unit of production in-kind transfers marginal product transfers to families in the form of goods and services rather than cash the increase in output that arises from an additional unit of input internalising an externality marginal product of labour altering incentives so that people take into account the external effects of their actions the increase in the amount of output from an additional unit of labour invisible hand the rate at which a consumer is willing to trade one good for another law of demand the study of how people behave in strategic situations long run a good for which, other things being equal, an increase in income leads to a decrease in quantity demanded a person who receives the benefit of a good but avoids paying for it game theory the regular pattern of income variation over a person’s life inferior good free rider costs that not vary with the quantity of output produced life cycle indifference curve the idea that buyers and sellers freely interacting in a market economy will create an outcome that allocates goods and services to those people who value them most highly and makes the best use of our scarce resources fixed costs the political philosophy according to which the government should punish crimes and enforce voluntary agreements but not redistribute income the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises law of supply the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises a small incremental adjustment to a plan of action marginal rate of substitution marginal revenue the change in total revenue from an additional unit sold marginal tax rate the amount by which an individual’s taxes increase with each additional dollar of income market a group of buyers and sellers of a particular good or service market economy an economy that allocates resources through the decentralised decisions of 543 Glossary many firms and households as they interact in markets for goods and services market failure normal good a good for which, other things being equal, an increase in income leads to an increase in quantity demanded a situation in which a market left on its own fails to allocate resources efficiently normative statements market power oligopoly the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices a market structure in which only a few sellers offer similar or identical products claims that attempt to prescribe how the world should be opportunity cost maximin criterion the claim that the government should aim to maximise the wellbeing of the worst-off person in society median voter theorem a mathematical result showing that if voters are choosing a point along a line and each voter wants the point closest to their most preferred point, then majority rule will pick the most preferred point of the median voter microeconomics the study of how households and firms make decisions and how they interact in markets monopolistic competition two goods with right-angle indifference curves perfect substitutes two goods with straight-line indifference curves permanent income a person’s normal income Phillips curve the short-term trade-off between inflation and unemployment political economy the study of government using the analytic methods of economics monopoly claims that attempt to describe the world as it is moral hazard the tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behaviour Nash equilibrium a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen national minimum wage the minimum pay per hour workers are entitled to in a particular industry natural monopoly a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms negative income tax a tax system that collects revenue from high-income households and gives transfers to low-income households 544 perfect complements a market structure in which many firms sell products that are similar but not identical a firm that is the sole seller of a product without close substitutes Glossary the best alternative that must be given up to obtain some item positive statements poverty line an absolute level of income set by the federal government for each family size below which a family is deemed to be in poverty poverty rate the percentage of the population whose family income falls below an absolute level called the poverty line predatory pricing when a firm sells its product at an artificially low price in order to drive out an efficient competitor and reduce long-run competition calculated as the percentage change in quantity demanded divided by the percentage change in price price elasticity of supply a measure of how much the quantity supplied of a good responds to a change in the price of that good, calculated as the percentage change in quantity supplied divided by the percentage change in price price floor a legal minimum on the price at which a good can be sold price taker a buyer or seller who takes the price as given by market conditions principal a person for whom another person, called the agent, is performing some act prisoners’ dilemma a particular ‘game’ between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial private goods goods that are both excludable and rival in consumption producer surplus the amount a seller is paid for a good minus the seller’s cost production function the relationship between quantity of inputs used to make a good and the quantity of output of that good production possibilities frontier a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and the available production technology productivity the quantity of goods and services produced from each hour of a worker’s time profit total revenue minus total cost price ceiling progressive tax a legal maximum on the price at which a good can be sold a tax for which high-income taxpayers pay a larger fraction of their income than low-income taxpayers price discrimination the business practice of selling the same good at different prices to different customers property rights price elasticity of demand proportional tax a measure of how much the quantity demanded of a good responds to a change in the price of that good, a tax for which high-income and lowincome taxpayers pay the same fraction of income the ability of an individual to own and exercise control over scarce resources public goods social security total revenue (in a market) goods that are neither excludable nor rival in consumption government programs that supplement the incomes of the needy the amount paid by buyers and received by sellers of a good, calculated as the price of the good times the quantity sold quantity demanded strike the amount of a good that buyers are willing and able to purchase the organised withdrawal of labour from a firm by a union quantity supplied subsidy the amount of a good that sellers are willing and able to sell a payment from government, to consumers or sellers, for each unit of a good that is bought or sold regressive tax a tax for which high-income taxpayers pay a smaller fraction of their income than low-income taxpayers substitutes two goods for which a decrease in the price of one good leads to a decrease in the demand for the other good resale price maintenance when a wholesaler requires that its retailers not sell its products to their customers below a specified retail price rival in consumption the property of a good whereby one person’s use diminishes other people’s use substitution effect the change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution Tragedy of the Commons a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole transaction costs the costs that parties incur in the process of agreeing to, and following through on, a bargain tying when a firm will only sell customers one product if they also buy another product union a worker association that bargains with employers over wages and working conditions sunk cost utilitarianism a cost that has already been committed and cannot be recovered the political philosophy according to which the government should choose policies to maximise the total utility of everyone in society scarcity the limited nature of society’s resources supply curve screening a graph of the relationship between the price of a good and the quantity supplied utility supply schedule value of the marginal product a table that shows the relationship between the price of a good and the quantity supplied the marginal product of an input times the price of the output an action taken by an uninformed party to induce an informed party to reveal information shortage a situation in which quantity demanded is greater than quantity supplied short run a period of time during which at least one factor of production is fixed shutdown a short-run decision to produce nothing for a specific period of time signalling an action taken by an informed party to reveal private information to an uninformed party social insurance government policy aimed at protecting people against the risk of adverse events a measure of happiness or satisfaction variable costs surplus a situation in which quantity supplied is greater than quantity demanded costs that vary with the quantity of output produced vertical equity tariff a tax on goods produced abroad and sold domestically the idea that taxpayers with a greater ability to pay taxes should pay larger amounts tax incidence welfare economics the study of who bears the burden of taxation the study of how the allocation of resources affects economic wellbeing total cost willingness to pay the amount a firm pays to buy the inputs into production the maximum amount that a buyer will pay for a good total revenue (for a firm) world price the amount a firm receives for the sale of its output the price of a good that prevails in the world market for that good 545 Glossary SUGGESTIONS FOR READING If you enjoyed the economics course you have just finished, you might like reading more about economic issues in the following books • Freakonomics: A Rogue Economist Explores the Hidden Side of Everything, Steven D Levitt and Stephen J Dubner (New York: William Morrow, 2005) Economic principles and clever data analysis applied to a wide range of offbeat topics, including drug dealing, online dating and sumo wrestling • The Undercover Economist: Exposing Why the Rich Are Rich, the Poor Are Poor and Why You Can Never Buy A Decent Used Car!, Tim Harford (Oxford: Oxford University Press, 2006) An easyto-read and thought-provoking introduction to the key economic issues of the day • Supercrunchers: Why Thinking-by-Numbers Is the New Way to Be Smart, Ian Ayres (New York: Bantam, 2007) What happens when you combine economics, statistics and large datasets? The answer is ‘answers’, and lots of them, to issues that drive government and business • Reinventing the Bazaar: A Natural History of Markets, John McMillan (New York: Norton, 2002) The late, great New Zealand economist provides a deep and nuanced, yet still very readable, analysis of how society can make the best use of market mechanisms • Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life, 2nd edn, Avinash Dixit and Barry Nalebuff (New York: Norton, 2008) This introduction to game theory discusses how all people – from corporate executives to arrested criminals – should and make strategic decisions that affect themselves and others • Micromotives and Macrobehavior, rev edn, Thomas Schelling (New York: Norton, 2006) The Nobel Prize winning game theorist explains how to construct models to explain how seemingly small and meaningless decisions have a big impact on the patterns of large groups • Information Rules: A Strategic Guide to the Network Economy, Carl Shapiro and Hal R Varian (Boston: Harvard Business School Press, 1999) Two microeconomists explain how businesses succeed in the modern information-driven economy • Co-opetition, Adam M Brandenburger and Barry J Nalebuff (New York: Doubleday, 1996) This book explains the usefulness of game theory for business decision making in a competitive environment • Capitalism and Freedom, Milton Friedman (Chicago: University of Chicago Press, 1962) In this classic book, one of the most important economists of the twentieth century argues that society should rely less on the government and more on the free market • The Worldly Philosophers, Robert L Heilbroner (New York: Touchstone, 1953) This classic book discusses the lives, times and ideas of the great economic thinkers, including Adam Smith, David Ricardo and John Maynard Keynes • Murder at the Margin, Marshall Jevons (Princeton, NJ: Princeton University Press, 1993), and The Fatal Equilibrium, Marshall Jevons (Cambridge, Mass.: MIT Press, 1985) In each of these two mystery novels, an economist-sleuth applies the principles of economics to figure out who did it Yes, the books are corny, but they are also fun • The Logic of Life, Tim Harford (Random House, 2009) The best review of how economics can be used to explain aspects of everyday life 546 Suggestions for reading • The Limits of Organization, Kenneth J Arrow (New York: Norton, 1974) A Nobel laureate conducts a thoughtful examination of the foundations of economic decision making and the organisation of society • Core Economics for Managers, Joshua Gans (Melbourne: Cengage Learning, 2005) Take your economics one step further into bargaining and strategy with this text designed to teach economics to business students • Getting It Right: Markets and Choices in a Free Society, Robert J Barro (Cambridge, Mass: MIT Press, 1996) In this collection of essays based on his Wall Street Journal columns, conservative economist Robert Barro offers his view about the workings of the economy and the proper scope of economic policy • Hard Heads, Soft Hearts: Tough-minded Economics for a Just Society, Alan S Blinder (Reading, Mass: Addison-Wesley, 1987) How should government policymakers balance economic efficiency and social compassion? Alan Blinder, who served as an economic adviser to President Clinton, offers his answers in this wide-ranging book • New Ideas from Dead Economists, Todd G Buchholz (New York: Penguin Books, 1989) This amusing book provides an overview of the history of economic thought • The Winner-take-all Society: How More and More Americans Compete for Ever Fewer and Bigger Prizes, Encouraging Economic Waste, Income Inequality, and an Impoverished Cultural Life, Robert H Frank and Philip J Cook (New York: The Free Press, 1995) This book examines some of the reasons for, and the effects of, increasing inequality of incomes in the United States • The Age of Diminished Expectations: US Economic Policy in the 1990s, Paul Krugman (Cambridge, Mass: MIT Press, 1990) Liberal economist Paul Krugman considers the problems that face the US economy and the policies that might improve economic performance • Peddling Prosperity: Economic Sense and Nonsense in the Age of Diminished Expectations, Paul Krugman (New York: Norton, 1994) This book examines the evolution of economic ideas and economic policy, with an emphasis on developments over the past 30 years • The Armchair Economist: Economics and Everyday Life, Steven E Landsburg (New York: The Free Press, 1993) Why does popcorn cost so much at movie theatres? Steven Landsburg discusses this and other puzzles of economic life in this offbeat yet engaging book • Unlocking the Infrastructure: The Reform of Public Utilities in Australia, Stephen King and Rodney Maddock (Sydney: Allen & Unwin, 1996) This book looks at competition policy and microeconomic reform in Australia • Great Expectations: Microeconomic Reform and Australia, John Quiggin (Sydney: Allen & Unwin, 1996) John Quiggin takes a critical look at microeconomic reform in Australia • A Random Walk down Wall Street, Burton G Malkiel (New York: Norton, 1973, revised 1996) This introduction to stocks, bonds and financial economics is not a ‘get rich quick’ book, but it might help you get rich slowly • John Maynard Keynes: Hopes Betrayed, 1883–1920, Robert Skidelsky (New York: Viking, 1983) and John Maynard Keynes: The Economist as Saviour, 1920–1937, Robert Skidelsky (London: Macmillan, 1992) These two books constitute the first two volumes of a biographical trilogy (the third is not yet published) that covers the life of one of the most important and interesting economists of all time • Nudge, Richard H Thaler and Cass R Sunstein (New Haven & London: Yale University Press, 2008) and Sway, Ori Brafman and Rom Brafman (New York: Doubleday, 2008) Both of these books look at the way our perceptions and biases affect the way we make decisions about economic matters 547 Suggestions for reading Pick of the economics blogs • Marginal Revolution: www.marginalrevolution.com The most popular economics blog from two economists at George Mason University • Freakonomics: freakonomics.com The two authors of Freakonomics extend their commentary of economics and everyday life • Greg Mankiw: gregmankiw.blogspot.com One of the authors of this textbook takes a hard-headed look at macroeconomics and economic policy • Brad DeLong’s Semi-Daily Journal: delong.typepad.com The oldest and one of the most influential economics blogs, from a Berkeley professor who grasps reality with both hands • The Becker–Posner Blog: www.becker-posner-blog.com A Nobel laureate and a judge debate economic trends and policies • Core Economics: economics.com.au Australian academic economists examine policy, economics and strategy • John Quiggin: johnquiggin.com Australia’s foremost economic commentator looks at the world from a social democratic perspective 548 Suggestions for reading a ability-to-pay principle, 270 horizontal equity, 270–1 pay for higher education, 272b tax burden, 271–2b tax systems, 270t vertical equity, 270 above-equilibrium wages, 453 ABS see Australian Bureau of Statistics (ABS) absolute advantage, 57 absolute value, 100 ACCC see Australian Competition and Consumer Commission (ACCC) accounting profit, 283, 317 economic profit vs., 283 adverse selection, 524 example, 524 moral hazard and, 527 problem, 525 advertising, 365 brand names, 368–9 critique of, 366 debate about, 365–7 defence of, 366 and price of glasses, 366–7b prohibition of cigarette, 79b as signal of quality, 367–8 signalling theory of, 451–2 theory of, 368 AFC see average fixed cost (AFC) agent, 522 principal–agent problem, 524 tax, 267 airline prices, 345 antipoverty programs advocates of, 244 and work incentives, 484–5 antitrust laws see competition laws AR see average revenue (AR) arms races, 384–5 game, 385f Arrow’s impossibility theorem, 529–30 see also median voter theorem asymmetric information, 522 economics of, 522 hidden actions, 522–3 hidden characteristics, 524–5 and public policy, 527 ATC see average total cost (ATC) Australian Bureau of Statistics (ABS), 34 Australian Competition and Consumer Commission (ACCC), 34, 402, 408, 411 lawyers and economists, 401 Australian income inequality, 469, 470t distribution, 470t women’s movement and income distribution, 471b Australian taxation, 261 federal government, taxes collected by, 261–4 Australian trade with other countries, 61 Australia’s competition regulator, 402–4b AVC see average variable cost (AVC) average cost, 290 marginal and, 291 pricing, 404 of production, 404 average fixed cost (AFC), 290, 292 ATC, 292 cost curves for, 292–3 average revenue (AR), 306, 307 for competitive firm, 305t monopoly’s, 332t TR/Q, 336 average tax rate, 267 marginal tax rates vs., 267–8 average total cost (ATC), 290 downward-sloping portion, 362 and MC, 293 price and, 314f of production, 313 in short and long-run, 295f U-shaped, 292 average variable cost (AVC), 290 b baby bonus, 10–11b bar graph, 42, 43f Baxter case, 413b behavioural economics, 522 inconsistent people over time, 536 irrationality of people, 532–4 people care about fairness, 535–6 benefits principle, 269 benevolent social planner, 160 consumer surplus, 160 efficient level of output, 340f monopoly firm, 339 real policymakers, 161 bilateral monopoly, 465 monopsony, 465 possibilities frontier, 466f reasonable negotiators, 467 brand names, advertising, 368–9 broadcasters, 247 budget constraint, 493 change in, 505 consumer’s budget constraint, 495f consumer’s opportunities, 494t Natalie’s, 495 Sally’s, 510 slope of, 494, 501 bundling see tying business-stealing externality, 364, 365 c capital, 436 cost of, 282–3 income, 437b land and, 436–7 carbon tax, 229–30b cartel, 378, 386, 408 Catherine demand curve, 73f demand schedule, 73f cellular biologists study cells, 31 central planners, 13, 14 ceteris paribus, 75–6 change in demand, 88 change in quantity demanded, 88 change in quantity supplied, 88 change in supply, 88, 89 circular-flow diagram, 28–9 clean air, 231, 250 climate change, 250 club goods, 241, 330 Coase theorem, 232–3 collective bargaining, 463 collusion, 378 command-and-control policies, 225–6 commercial radio, 248 common resources, 241, 249 clean air, 250 climate change, 250 congested roads, 250–1 fish, whales and other wildlife, 253 tragedy of commons, 249–50 company income tax, 246, 264, 273b comparative advantage, 57 absolute advantage, 57 applications, 60 country trade, 61 Federer, 60 opportunity cost, 57–8 principle, 57 in slaying ogres, 62 Smith arguments, 59 and trade, 58–9 comparative statics, 87 compensating differential, 447–8 person’s labour, 469 wage differences, 454–5 Competition and Consumer Act, 401, 408, 410 competition laws, 401 Australia’s, 408 critics of, 402 restraint of trade and, 408–10 tying arrangements, 412–13 competition policy, 400, 401 controversies over, 410–14 monopolies, 401–7 oligopolies, 408–14 competitive firm long-run decision, 312–13 marginal cost, 309f profit maximisation, 308f profit measuring, 313–14 revenue of, 305–6 short-run decision, 309–10 supply decision, 307–9 zero-profit condition, 317 competitive markets, 71–2, 316 characteristics, 304 firm supply decision, 307–9 INDEX Note: page numbers followed by f, t or b respectively indicate figure, table or box 549 long run, 315–17 long-run decision, 312–13 long-run supply curve, 319 marginal-cost curve, 307–9 profit maximisation, 306–7 profit measurement, 313–14 revenue of competitive firm, 305–6 shift in demand, 317–19 short-run decision, 309–10, 315 spilt milk, 310–11b sunk costs, 310–11b supply curve, 314 competitive profit-maximising firm, 424–5, 444 complements, 77, 499, 499f Condorcet voting paradox, 528–9, 531 congested roads, 250–1 congestion pricing, 252 constant returns to scale, 295 consumer choice theory, 492 applications, 508–15 budget constraint, 493–5 consumer’s preferences, 495–500 optimisation, 500–7 consumer’s preferences, 495, 496f with indifference curves, 495–6, 500 consumer surplus, 149, 150, 160 see also producer surplus lower price affecting, 153, 154f measurement, 153–5 using demand curve, 150–3, 152f willingness to pay, 149–50 consumption taxes, 266 coordinate system, 42 curves in, 44–7 corporate management, 523–4b corporation, 264 corrective taxes, 226 equivalence of, 229f polluting firms, 229f regulation and, 226 cost(s), 156, 156t, 281 average cost, 290 of capital, 282–3 curves and shapes, 290–2 economic profit vs accounting profit, 283 fixed cost, 289 George’s total-cost curve, 289f in long run, 294–5 marginal cost, 290 measurements, 288 as opportunity costs, 282 pin factory, 296–7b production and, 284 production function, 285–6 profit, 281–2 in short run, 294–5 total cost, 281–2 total-cost curve, 287–8 total revenue, 281–2 typical cost curves, 292–3 variable cost, 289 cost–benefit analysis, 245 cost curves, 290 MC and ATC, 292 550 Index rising marginal cost, 291 typical, 292–3 U-shaped average total cost, 292 cross-price elasticity of demand, 107 d deadweight loss, 174, 175f, 265–7 deadweight loss debate, 178–9b determinants, 176–7 and gains, 175–6 of tariff, 200 and tax revenue, 179, 180f decrease in demand, 76 decrease in supply, 82 demand, 72 see also supply curve, 72–4 equilibrium, 85–7 individual demand schedule, 74t market demand schedule, 74t market vs individual demand, 74–5 prices allocation, 90–1 schedule, 74 shifts in demand curve, 76–80 demand curve, 45, 46f, 74, 151f, 506–7 consumer surplus measurement, 150–3, 152f Giffen good, 508f, 509 schedule for buyers, 151t slope downwards, 508–9 demand for labour, 423 competitive profit-maximising firm, 424–5 imperfect competition and monopoly, 444–5 labour demand curve, 427–9 marginal product of labour, 425–6 production function, 425–6 supply and demand versatility, 424f value of marginal product, 426–7 diminishing marginal product, 286, 291 see also marginal product discrimination, economics of, 454 customers and governments, 457–8 by employers, 456 labour-market discrimination measurement, 454–5 in sports, 458–9 diseconomies of scale, 295 dominant strategy, 383, 384, 385 duopoly, 377 e economic life cycle, 474 economic mobility, 475–6 economic profit, 283 accounting profit vs., 283 positive, 357 Economic Society of Australia (ESA), 37 economics, country standard of living, 17 economic activity, 13–14 market outcomes improvement, 15–16 opportunity cost, people facing trade-offs, people interaction, 11 people thinking, 7–9 prices rising, 17–18 responding to incentives, 9–10 short-term trade-off, 18–19 trading, 11–12 economies of scale, 295 economist advice, 35 Australian economists, 37 circular-flow diagram, 28–9 differences in values, 36–7 economic models, 27–8 economists disagree, 36 in government, 34–5 macroeconomics, 31–3 microeconomics, 31–3 as policy adviser, 33 positive vs normative analysis, 33–4 production possibilities frontier, 29–31 role of assumptions, 26–7 scientific judgements differences, 36 scientific method, 25–6 as scientist, 25 websites, 34t economist as policy adviser, 33 Australian economists, 37 differences in values, 36–7 economists disagree, 36 in government, 34–5 positive vs normative analysis, 33–4 scientific judgements differences, 36 websites, 34t economist as scientist, 22 circular-flow diagram, 28–9 economic models, 27–8 macroeconomics, 31–3 microeconomics, 31–3 production possibilities frontier, 29–31 role of assumptions, 26–7 scientific method, 25–6 efficiency, economic, 228 of equilibrium quantity, 162f free markets, 164 wage, 453 efficient scale, 292, 363 Einstein’s comment, 25 elasticity, 49, 98, 136–7 applications, 109 cross-price elasticity of demand, 107 drug-related crime, 114–16 income elasticity of demand, 107 increase in supply, 112f linear demand curve, 105–6, 106t news for farmers, 111–13 OPEC, 113–14 price elasticity of demand, 98–105 price elasticity of supply, 108–9 and total revenue along linear demand curve, 105–6 use of illegal drugs, 115f Emma’s demand curve for novels, 45, 45t equilibrium, 85 decrease in supply, 89f increase in demand, 88f markets not in, 86f price, 85 quantity, 85 shift in supply and demand, 90f shortage, 86 steps for analysing changes, 87–90 supply and demand, 85f equilibrium in labour market, 432 productivity and wages, 435f shifts in labour demand, 434–5 shifts in labour supply, 432–4 equilibrium wages determinants ability, effort and chance, 449 benefits of beauty, 450–1b changing value of skills, 449b compensating differential, 447–8 human capital, 448–9 signalling, 451–2 superstar phenomenon, 452 equity, ability-to-pay principle, 270–2 benefits principle, 269 tax incidence, 273 taxes and, 269, 273 ESA see Economic Society of Australia (ESA) excess capacity, 362–3 excludable, 240 exit, 309 exporting country, 195 see also importing country changes in welfare, 197t domestic price, 195 free trade affecting welfare, 197f gains and losses measuring, 195–7 international trade in, 196f exports, 61 externalities, 16, 219 Coase theorem, 232–3 command-and-control policies, 225–6 economic analysis of pollution, 231 examples, 219–20 market-based policy, 226–9 market for aluminium, 221f market inefficiency, 220 negative, 220–2 positive, 222–3 private solutions, 232–4 public policies, 225 transaction costs, 233–4 welfare economics, 220 f factors of production, 28, 29, 423 capital income, 437b economics of Black Death, 438–9b linkages, 438 markets for land and capital, 436–7, 436f federal government, taxes collected by, 261–4 company income taxes, 264 goods and services tax (GST), 264 individual income taxes, 262–3 Federer, Roger, 60–1 fighting poverty, 244 firm’s efficient scale, 316 First Home Owner Grant scheme, 140–1 fixed cost, 289 average, 290 farmer’s, 310 flypaper theory, 273 free rider, 242 problem, 242–3 g game theory, 376, 381 arms races, 384–5 common-resources game, 386f Jack and Jill’s oligopoly game, 384 oligopolies, 383–4 people cooperation, 386–7 prisoners’ dilemma story, 382–3 and welfare of society, 385–6 General Agreement on Tariffs and Trade (GATT), 209b general equilibrium effects, 434 generic pharmaceuticals, monopoly pharmaceuticals versus, 337–8b geo-blocking, 347 Giffen good, 508f, 509 global warming, 36 goods, 240 club, 241 common resources, 241 private, 240 public, 240–1, 242–8 types, 241t goods and services tax (GST), 36, 264 government-created monopolies, 329 government policies affecting market outcomes, 138–41 controls on prices, 122 elasticity, 136–7 evaluating price controls, 130–1 First Home Owner Grant scheme, 140–1 payroll tax, 135–6b price ceiling, 122–6 price floors, 126–30 subsidies, 137–41 tax incidence, 136–7 taxes on buyers, 133–5 taxes on sellers, 132–3 graphing, 42 cause and effect, 49 curves in coordinate system, 44–6 elasticity, 47–9 of single variable, 42 slope, 47–9 of two variables, 42–4 GST see goods and services tax (GST) h hidden actions, 522–4 hidden characteristics adverse selection, 524 asymmetric information and public policy, 527 lemons problem, 524 screening, 526 signalling, 525–6 homo economicus, 532 Homo sapiens, 533 horizontal equity, 270 human capital, 448–9, 525 i import quota, 61, 200 importing country, 198 changes in welfare, 199t free trade affecting welfare, 199t gains and losses, 198–200 international trade in, 198f world price, 196 in-kind transfers, 474, 483–4 inequality, alternative measures of, 475 income, 76–7 effects, 505–6 elasticity of demand, 107 income taxes company, 264 individual, 262–3 increase in demand, 76 increase in supply, 82 indifference curve, 495 bowed, 498f extreme examples, 498–500 impossibility of intersecting, 497f properties of, 496–8 individual income taxes, 262–3 industrial organisation, 281, 358f inequality measurement, 469 Australian income inequality, 469–71 poverty rate, 472–3 problems in, 474–6 infant industry argument, 208 inferior good, 77, 502 inflation, 17 information asymmetry, 522 input prices, 83 interdependence and gains from trade absolute advantage, 57 applications, 60–1 comparative advantage, 57–8 country trade, 61 Federer, 60 modern economy, 53 opportunity cost, 57–8 principle of comparative advantage, 57 production possibilities, 54–5 551 Index in slaying ogres, 62 specialisation, 55–6 and trade, 58–9 interest rates affect household saving, 513 consumption–saving decision, 514f increase in, 515f internalising an externality, 222 International trade, 193 arguments for restricting trade, 205 benefits, 203 comparative advantage, 194–5 determinants of trade, 193 equilibrium without trade, 193–4 exporting country, 195–7 importing country, 198–200 infant industry argument, 208 jobs argument, 206 lessons for trade policy, 202–3 national security argument, 206 protection-as-a-bargaining-chip argument, 208–9 tariff effects, 200–1 unfair competition argument, 208 winners and losers, 195 world price, 194–5 invisible hand, 13, 163, 327 j jobs argument, 206 l labour demand curve output price, 428 supply of factors, 429 technological change, 428 labour-market discrimination measurement, 454–5 labour markets, 463 bilateral monopoly, 465–7 labour demand and union monopoly power, 464f union, 463 unions as monopolists, 463–5 labour supply curve changes in alternative opportunities, 430 changes in tastes, 430 immigration, 430 Laffer curve, 181–2b law of demand, 73, 87 law of supply, 80, 87 lemons problem, 524–5 liberalism, 478–9 libertarianism, 479 lighthouses, 244–5b linear demand curve, 105–6, 106t local governments, taxes collected by, 264–5 long run, 284, 294 diseconomies of scale, 295 economies of scale, 295 equilibrium, 360–1 552 Index and short-run average total cost, 294 lump-sum taxes, 268 m macroeconomics, 31–3 marginal change, marginal cost (MC), 290 and ATC, 293 equality of marginal revenue and, 335 firm’s supply curve, 317 George’s average-cost and, 291f marginal revenue and, 306 price and, 363 marginal product, 285 factors of production, 438 labour, 425–6 marginal rate of substitution (MRS), 495, 497, 501 marginal revenue (MR), 306, 307 Jack’s, 395 monopoly’s total and, 444t marginal tax rate, 262, 267 average tax rate vs., 267–8 mark-up over marginal cost, 363–4 market, 71, 99 economy, 13 failure, 16, 242 power, 16 market-based policy, 226 corrective taxes and subsidies, 226–7 tradeable pollution permits, 228–9 market-clearing price, 85 market demand, 74 individual demand vs., 74–6 sum of individual demands, 74f market efficiency, 160 benevolent social planner, 160–1 evaluating market equilibrium, 161–3 market in organs, 163–4b market equilibrium, 161 consumer and producer surplus, 161f equilibrium quantity efficiency, 162f evaluation, 161–3 market inefficiency externalities and, 220 negative externalities, 220–2 positive externalities, 222–3 welfare economics, 220 maximin criterion, 478 MC see marginal cost (MC) median voter theorem, 530–1 microeconomics, frontiers of, 31–3, 522 asymmetric information, 522–7 behavioural economics, 532–7 political economy, 528–32 midpoint method, 102 minimum-wage laws, 453–4, 480–1 minimum wage rates, 128–9b affecting labour market, 130f Australian economists, 130 monopolistic competition, 357, 358 advertising, 365–9 cases of perfection, 357–9 competitive firm in short run, 359–60 long-run equilibrium, 360–1 market structure, 358f perfect competition vs., 362–4, 370t and welfare of society, 364–5 monopoly, 72, 327 see also oligopoly Australia’s competition regulator, 402–3b competition vs., 331–2, 401–2 deadweight loss, 339 demand and marginal-revenue curves, 334f digital downloads, 347–8b efficient level of output, 340f gas industry, 328–9b government-created monopolies, 329 monopoly pharmaceuticals versus generic pharmaceuticals, 337–8b inefficiency, 341f marginal-cost pricing, 405f natural monopoly, 329–31 price discrimination, 342–6 prices and patents, 338f privatisation, 405–6 profit maximization, 334–6, 336 public ownership, 405–6 public policy towards, 401 regulation, 404–5 resources, 328 revenue, 332–4 social cost, 341–2 sources, 328 supply curve, 336b welfare cost, 338 monopsony, 465 moral hazard, 522, 527 movie tickets, 345 MR see marginal revenue (MR) MRS see marginal rate of substitution (MRS) n Nash equilibrium, 379, 383 national defence, 243 national security argument, 206 natural monopoly, 329–31 negative correlation, 44 negative income tax, 481–2 normal good, 77 normative statements, 33 natural monopoly, 404 marginal-cost pricing for, 405 neoclassical theory of distribution, 439 o oligopoly, 357, 376 affecting market outcome, 379–80 cartels, 377 competition laws, 378, 408–10 controversies over competition policy, 410–14 duopoly, 377 equilibrium for, 378–9 monopolies, 377–8 OPEC, 380–1b restraint of trade, 408–10 world oil market, 380–1b omitted variables, 49–50 OPEC see Organization of Petroleum Exporting Countries (OPEC) opportunity cost, 7, 31, 57–8, 282 optimisation, 500 changes in income, 502–3 changes in prices, 503, 504f, 505 consumer’s optimum, 502f consumer’s optimum choices, 500–2 demand curve derivation, 506–7 income and substitution effects, 505–6 inferior good, 504f utility, 500–1b optimum point, 501 organ donation, 434 Organization of Petroleum Exporting Countries (OPEC), 109, 124b, 380–1b pricing level, 113 reduction in supply, 113, 114f p parable for modern economy, 53 consumption opportunities, 56f gains from trade, 56t production possibilities, 54–5 specialisation, 55–6 parking meters, 155 patent protection, 224b payroll tax, 135b, 265 Peltzman’s analysis, 10 percentage changes and elasticities, calculating, 102 perfect complements, 499f, 499–500 perfect price discrimination, 344 perfect substitutes, 498–9 permanent income, transitory vs., 474–5 petrol tax, 9, 251 Phillips curve, 18–19 pie chart, 42, 43f pin factory, 296–7b political economy Arrow’s impossibility theorem, 529–30 Borda count, 530t Condorcet voting paradox, 528–9 individual preferences, 529t median voter theorem, 530–1 politicians, 532 political philosophy of redistributing income, 476 liberalism, 478–9 libertarianism, 479 utilitarianism, 476–7 positive correlation, 44 positive statements, 33 poverty antipoverty programs, 484–5 in-kind transfers, 483–4 line, 473 minimum-wage laws, 480–1 negative income tax, 481–2 policies to reduce, 480 social security, 481 work incentives, 484–5 poverty rate, 472, 473t income inequality around world, 471–2 poverty line, 473 predatory pricing, 411 see also transparent pricing price ceiling, 122 binding constraint, 123 lines at petrol station, 124b market for petrol, 125f market with, 123f rent control, 125–6b, 127f price competition, 398 price discrimination airline prices, 345 analytics, 344–5 monopoly, 341–2 moral of story, 343–4 movie tickets, 345 parable about pricing, 342–3 quantity discounts, 346 store brands, 346 welfare, 344f price elasticity of demand, 98 classification, 100–2 computation, 99–100 market, 99 midpoint method, 102 necessities vs luxuries, 99 substitutes availability, 98–9 time horizon, 99 total revenue and, 103–5 price elasticity of supply, 108, 110f computation, 108 variation, 111f price floor, 122, 126 market with, 127f minimum wage rates, 128–9b price takers, 304 principal, 522 prisoners’ dilemma, 381, 382–3, 387 arms races, 384–5 common-resources game, 386f Jack and Jill’s oligopoly game, 384f oligopolies as, 383–4 people cooperation, 386–7 tournament, 387b and welfare of society, 385–6 private goods, 240 private ownership, 404–5 privatisation, 405–6 producer surplus, 156, 157 cost, 156 higher price affecting, 158–9 using supply curve, 156–7 willingness to sell, 156 product-variety externality, 364 production negative externalities, 220–2 positive externalities, 222–3 production function, 285, 425 Poh’s cake factory, 285t Poh’s production function, 286f Poh’s total-cost curve, 287–8, 287f production possibilities, 29–31, 54–5 frontier, 54f, 55 Sheldon and Leonard opportunities, 54t shift in, 32f productivity, 17 profit, 281–2 profit maximisation, 306–7, 308f for competitive firm, 308f monopoly, 334–6 profit motive, 456 segregated streetcars and, 457b progressive tax, 270 see also regressive tax proportional tax, 270 see also regressive tax protection-as-a-bargaining-chip argument, 208–9 public choice see political economy public goods, 240–1, 252 basic research, 243–4 cost–benefit analysis, 245 fighting poverty, 244 free-rider problem, 242–3 lighthouses, 244–5b music, 248b national defence, 243 private provision, 247–8 public ownership, 405–6 public policies on externalities, 225 command-and-control policies, 225–6 economic analysis of pollution, 231 market-based policy, 226–7 public policy, 204–5b q quantity competition, 394 quantity demanded, 72 quantity discounts, 346 quantity supplied, 80–1 quintiles, 271b r receipts estimated tax, 263t regressive tax, 270 see also proportional tax rent control, 125–6b, 127f resale price maintenance, 410–11 reverse causality, 49, 50–1 rising marginal cost, 291 rival in consumption, 240 553 Index s scarcity, scatterplot graph, 44 screening, 526–7 shifting demand curves, 47f short run, 284, 294 diseconomies of scale, 295 economies of scale, 295 and long-run average total cost, 294 shortage, 86 shutdown, 309 signalling private information conveying, 525 theory of advertising, 451–2 slope, defined, 105 social cost, 341–2 social security, 481 specialisation, 55–6 sports, discrimination in, 458–9 state and local governments, taxes collected by, 264–5 store brands, 346 strike, 453 subsidies, 138 affecting market outcomes, 138–9 changes in welfare, 191t cost, 189 deadweight loss, 190–1 to sellers, 139f welfare economics, 188 substitutes, 77 substitution effects, 505–6 sunk cost, 310, 310–11b supply, 80 decision, 307–9 and demand, 85f equilibrium, 85–7 market supply vs individual supply, 81 prices allocation, 90–1 schedule, 81, 82t shifts in supply curve, 82–4 supply curve, 80–1 supply curve, 81, 81f, 157, 157f in competitive market, 314 long run, 315–17 producer surplus measurement, 157–8, 158f schedule for sellers, 157t shift in demand, 317, 319 short run, 315 supply of labour, 429 curve, 430 work and leisure trade-off, 429–30 supply-side economics, 181–2b surplus, 86 consumer, 150, 339 producer, 156 t tariff changes in welfare, 201t deadweight loss, 200–1 effects, 200–1 554 Index tax, 131 burden, 271–2b on buyers, 133–5 corrective taxes, 226–7 and efficiency, 265–8 and equity, 269–73 federal income tax rates, 264t incidence, 132, 136–7, 273 inevitable, 261 payroll tax, 135b, 265 revenue, 173f, 179–80, 180f on sellers, 132–3 tax liability, 262, 482 tax system design, 261 ability-to-pay principle, 270–1 administrative burden, 267 Australian taxation, 261–5 benefits principle, 269 company income tax, 273b deadweight losses, 265–6 and efficiency, 265 and equity, 269 HECS experience, 272b lump-sum taxes, 268 marginal tax rates vs average tax rates, 267–8 tax systems, 270t taxation costs, 171 affecting market participants, 171–4 deadweight loss, 171 deadweight loss debate, 178–9b deadweight loss determinants, 176 deadweight losses and gains, 174–5 Laffer curve, 181–2b supply-side economics, 181–2b tax affecting welfare, 173f tax distortions and elasticities, 177f tax effects, 172f tax revenue, 173f, 179–80, 180f TC see total cost (TC) technology policy, 224b spillover, 223–4b television broadcast, 247 time horizon, 99 time-series graph, 42, 43f tit-for-tat strategy, 387 toll roads, 251–3b total cost (TC), 281–2, 336 measuring profit, 313–14 monopoly profit, 336 production function and, 285t, 287–8 of subsidy, 189 total revenue (TR), 103f, 313, 336 of competitive firm, 305–6 for firm profit, 281–2 linear demand curve, 105–6b in market, 103 Town Common, 249 TR see total revenue (TR) trade, price of, 60 trade agreements, 209b trade arguments, 205 infant industry argument, 208 jobs argument, 206 national security argument, 206 protection-as-a-bargaining-chip argument, 208–9 unfair competition argument, 208 trade determinants, 193 comparative advantage, 194–5 equilibrium without trade, 193–4 world price, 194–5 trade policy, 202–3 Trade Practices Act, 401 tradeable pollution permits, 228–9, 229f transaction costs, 233 transitivity, 528 transparent pricing, 414 tying, 412–13 u U-shaped average total cost, 292 ultimatum game, 535 unfair competition argument, 208 union(s), 453, 463 for economy, 467 as monopolists, 463–5 unit elasticity, 100 utilitarianism, 476–7 see also libertarianism v value of marginal product, 426–7 variable cost (VC), 289, 310 vertical equity, 270 virtual private network (VPN), 12b w wages affecting labour supply, 509 equilibrium wages, 447–54 increase in, 511f work–leisure decision, 510f Warhol, Andy, 204–5b welfare changes in welfare, 174, 174t, 197t economics, 149, 220 free trade affects, 197f implications of market activity, 165, 191 price discrimination, with and without, 343f subsidies economics, 188 of tariff, 200 with tax, 174 without tax, 172–4 tax affecting welfare, 173f welfare cost deadweight loss, 339–40 efficient level of output, 341f inefficiency, 341f of monopoly, 338 social cost, 341–2 willingness to pay, 149–50 consumer surplus, 149–50, 339 perfect price discrimination, 344 total surplus in market, 160 work incentives, 484–5 work–leisure decision, 510f worker(s) ability, 449–50 central planners, 13 marginal contribution value, 447 marginal product value, 426–7 in oilfields, 435 strawberry picking, 465 unions, 463, 470, 471 world oil market, 124, 380–1b world price, 194–5 World Trade Organization (WTO), 209b, 380–1b z zero-profit equilibrium, 317 555 Index ... measuring inequality 474 Case study: Alternative measures of inequality 475 The political philosophy of redistributing income 476 Utilitarianism 476 Liberalism 478 Libertarianism 479 What Australian... elasticity of supply 64 Multiple choice 64 Problems and applications 65 The market forces of supply and demand 70 Markets and competition 71 Summary 1 17 What is a market? 71 What is competition? 71 Demand... quantity demanded 72 Market demand versus individual demand 74 FYI: Ceteris paribus 75 Shifts in the demand curve 76 Case study: Are smartphones and tablets substitutes or complements? 77 Case study: