Microeconomic Theory This book introduces the main concepts of microeconomics to upper-division undergraduate students or first-year graduate students who have undergone at least one elementary calculus course The book fully integrates graphical and mathematical concepts and offers over 150 analytical examples demonstrating numerical solutions The book has a strong theoretical basis, but shows how microeconomics can be brought to bear on the real world New features for this edition include: • • • an incorporation of the theory of stock externalities associated with greenhouse gases; development of the section on insurance, with particular reference to the new US healthcare program; greater integration of game-theoretic concepts throughout the book The book’s style is accessible, but also rigorous Mathematical examples are provided throughout the book, in particular for key concepts, and the result is a balanced approach in terms of prose, graphics, and mathematics Michael E Wetzstein is Professor of Agricultural and Applied Economics at The University of Georgia, USA Microeconomic Theory Concepts and connections Second edition Michael E Wetzstein First edition published 2005 by South-Western Second edition published 2013 by Routledge Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2013 Michael E Wetzstein The right of Michael E Wetzstein to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patent Act 1988 All rights reserved No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Wetzstein, Michael Eugene Microeconomic theory / Michael Wetzstein – 2nd ed p cm Rev ed of: Microeconomic theory: concepts and connections c2005 Microeconomics Economics, Mathematical I Title HB172.W48 2012 338.5–dc23 2012008345 ISBN: 978-0-415-60369-0 (hbk) ISBN: 978-0-415-60370-6 (pbk) ISBN: 978-0-203-09835-6 (ebk) Typeset in Times New Roman by Cenveo Publisher Services Contents Introduction PART I Consumers’ sovereignty 23 Consumer preferences 27 Utility maximization 68 Comparative statics 108 PART II Markets and consumer interaction 165 Market demand 167 Pure exchange 204 PART III Producers’ rules 235 Production technology 239 Theory of cost 281 PART IV Competitive forces 327 Perfect competition 329 10 Economic efficiency 375 11 General competitive equilibrium 420 vi Contents PART V Monopoly power 469 12 Monopoly and regulation 473 13 Price discrimination 521 PART VI Strategic agent interaction 565 14 Game theory 567 15 Industrial organization 602 PART VII Input markets 661 16 Competitive input markets 663 17 Monopoly power in input markets 705 PART VIII Risky world and intertemporal choices 747 18 Risky choice and risk aversion 749 19 Intertemporal choice and capital decisions 792 PART IX Missing markets 849 20 Welfare economics 853 21 Externalities 895 22 Public goods 935 23 Asymmetric information 966 Appendix Glossary Notes Index 1009 1053 1066 1073 Introduction Introduction Economics Defined Taxonomy of Economics Fields Microeconomics Macroeconomics Models Philosophy Positive Economics Development of Microeconomics Assumptions Normative Economics Analysis Partial Equilibrium General Equilibrium Tools Applied Economics Uses Explanation Prediction Control Outline and Conceptual Inquiries What is economics? Limits and tradeoffs Would you be sorry if all your wants were satisfied? Why study economics? Economics dissected Microeconomics versus macroeconomics Why will a team full of outstanding players not necessarily win? Positive versus normative economics Why can two people agree on the price of a movie, but possibly not agree on whether to go? Value of applied economics Why are economists artists? Application: Business schools spawning from applied economics Building models Making assumptions How humans differ from other animals? Doing analysis How did the Babylonian and Greek scientists differ? Using tools How is Adam Smith’s invisible hand made visible? Application: Economists as engineers Models provide scientific explanation, prediction, and control Origins of microeconomics Application: An alternative to the Marshallian cross? Partial-equilibrium versus general-equilibrium models Why are apertures changed on economic lenses? Summary Key concepts Key equation Questions Internet case studies Introduction An economist is armed and dangerous Watch out for the invisible hand (One of the top 10 reasons to study economics) Ever think about how our very complex economic and social world operates? Do we live in a centrally controlled system like the Matrix movies that makes choices for us? No, such a system generally only occurs in movies Instead, we live in a decentralized market system where each of us self-determines our own choices But how is it possible for each of us to make our own choices and yet the system as a whole is efficient in satisfying our choices? The simple answer is market prices operate as signals directing our choices The full answer lies in revealing Adam Smith’s invisible hand through economic theory Knowledge of economic theory creates a price-signal roadmap for understanding how the economy operates in a decentralized market system and how individuals within this economy interact as groups of consumers and producers With this roadmap, you can be armed and dangerous by knowing how this invisible hand works The economic theory roadmap describes how a decentralized system of resource allocation can result in efficiently allocating our limited resources The ability to understand economic theory and apply it to your everyday choices will provide you with the power to make correct choices and understand the choices made by others The roadmap can aid us in addressing practical, realistic problems such as environmental degradation, cartels, dishonest used car salespeople, and discrimination However, the economic profession is often criticized for its lack of realism in addressing practical problems As an example, consider the following poem: Our economic methodology is full of fine epistemology But when we come to problems practical our theories are too didactical If economics is a science, it needs to foster the alliance of theorist and statistician, with manager and prognostician; To tie the work of mathematicist to problems of the market strategist Herman Southworth Epistemology is a field of philosophy that critically investigates the nature, grounds, limits, and criteria or validity of human knowledge It is a theory of cognition, the act or process of knowing And economic theory does contain a great deal of epistemology Economists have gone to great lengths in developing a theory for examining how human behavior affects economic decisions For example, economists have worked effortlessly on specifying the exact minimal number of assumptions required for characterizing an individual consumer’s preferences This type of epistemology lends itself well to classroom instruction, so it is didactical in the sense it is suited for teaching Hence, Southworth (and others) contend that economic theory is more an instructional exercise than a science addressing practical realistic problems Introduction For economics to be a science, it should foster an alliance with fields that address practical problems, applying economic theory to these problems, to yield feasible solutions As discussed in this chapter, this is exactly what an applied economist does: combining economic theory with knowledge of institutions and the environment to address practical problems In the subsequent chapters, we develop the concepts and connections of microeconomic theory, yielding feasible solutions for practical problems However, prior to a discussion of the practical applications of economic theory, we should investigate how the focus of economics is on limits and tradeoffs What is economics? Limits and tradeoffs My riches consist not in the extent of my possessions, but in the fewness of my wants (J Brotherton) Riches in terms of fewness of wants are what economics is all about Unfortunately, from early childhood, we learn we are unable to satisfy all of our wants; there are limits For a society, these limits take the form of scarce (limited) resources For example, a society has a limited amount of land, water, energy, labor, and physical capital for satisfying wants Economics is the study of how to allocate these limited resources to satisfy our wants Specifically, economics is a social science concerned chiefly with the way society chooses to employ its limited (scarce) resources, which have alternative uses (tradeoffs), to produce goods and services for present and future consumption Note that economics is a social science, in contrast to a natural science A social science deals with human society or its characteristic elements, such as the individual, family, or state A society is the interaction of individuals within an environment Unfortunately, there is scarcity in all environments Scarcity means there are not enough resources around to satisfy every possible desire for them Using resources in one way has an opportunity cost (tradeoff) of not being able to use them in another way For example, an opportunity cost of allocating time (a resource) for studying is the lost enjoyment of facebooking instead Economics A social science concerned with the allocation of scarce resources for satisfying unlimited wants E.g., with your limited income, you go out to eat or eat at home? Do we pay down the national debt, maintain social programs, or fly to Mars? Society The interaction of individuals within an environment E.g., the United States and other countries These scarce resources are continuously changing through time Nonrenewable resources, such as petroleum, are declining and renewable resources, including fish and timber, may increase or decline over time Capital, both human and physical, will depreciate through time and must be augmented to maintain or increase present levels This is assuming individuals’ Introduction wants are insatiable (they want more and more goods) and the change in resources is a constraint (limitation) that prevents complete satisfaction Individuals’ wants are also continuously changing, depending on age, location, and even time of day Thus, economics is concerned with the way society chooses to allocate a continuously changing set of limited resources among a continuously changing set of unlimited wants Would you be sorry if all your wants were satisfied? Yes, we would often be sorry if all our wants were gratified, for tomorrow these current wants will change Everybody who has ever rubbed the magic oil lamp realizes the three wishes given to them by Genie Abdul only satisfied their current wants One of the most venturesome things left us is to go to sleep For no one can lay a hand on our dreams (E.V Lucus) Translation: When you sleep you are in global bliss; your dreams have no limits As our definition of economics implies, economics is a philosophical inquiry into the process of resource allocation (tradeoffs) Economic theory outlines how a society allocates its scarce resources to achieve prosperity and well-being for its citizens Thus, the objective of economics is to maximize the happiness for society as a whole (social welfare) subject to limited resources Economic theory provides a framework for obtaining local bliss, where for a given resource constraint social welfare is maximized In contrast, global bliss (or simply bliss) is where there are no resource constraints, and thus all wants are satisfied An example of global bliss is our dreams, in which we are free from the scarce resource constraints in our awaking hours Social welfare Happiness for society as a whole E.g., economists have suggested modifications to a country’s gross national product as a surrogate measure for social welfare Local bliss A state where social welfare is maximized for a given resource constraint E.g., a time of peace and prosperity Global bliss (or bliss) A state in which there are no resource constraints and all wants are satisfied E.g., our dreams For obtaining or at least moving toward local bliss, economics provides a theory for determining what commodities to produce, when to produce them, how to produce them, and for whom The theory describes the economic environment in which agents (households and firms) interact Having knowledge of this environment provides an understanding of how an economy operates Thus, economic theory offers both an explanation for and predicts how agents within an economy operate Agents must understand this operation of an economy to make efficient decisions on how to allocate resources In general, with the understanding of economic theory, the ability to explain, predict, and control our economy is possible Economic theory could then be used as a basis for the design of policies by governments 1084 Index Independent goods, 145–6 Indexing of prices, homogeneity of degree-zero demand functions in, 118–19, 118 Indifference, consumer preferences and, 32 Indifference curves, 39–43, 40, 44; see also Household preferences and indifference curves concavity of, 45–9, 46, 48 consumer preferences and, 39–41, 40 convexity of, 45–7, 46 household preferences and, 39–41, 40 income/leisure indifference function and, 153–4, 154 intertemporal choices, capital decisions and, 796–8, 797 Indifference sets, 38 Indifference space, 39–43, 40, 44 Industrial organization, 603–4 advertising (selling cost) and, 605–10 advertising assessment in, 608–10 cartels and, 636–41, 638, 639, 652–8, 654, 655, 657 collusion and, 624, 628, 630–1, 633–41, 633, 638, 639, 652–8, 654, 655, 657 equilibrium and, short- and long-run, under monopolistic competition, 611–16, 613, 614 location, perfectly competitive, 646–51, 647 monopolistic competition and, 610–16, 613, 614 oligopolies and, 616–17; see also Oligopolies product differentiation in, 604–10 Industry, 331 Inefficiency with moral hazard, principal-agent model and, 994–1002 Inequality aversion, social welfare and, 861, 862 Inferior goods, 123, 124 summary of ordinary, normal, inferior, Giffen goods and, 136–7, 136 Infinite horizon, 825–6 Inflation, Consumer Price Index (CPI) and, 138, 139–40 homogeneity of degree-zero demand functions in, 118–19, 118 Laspeyres Index and, 139–140 Information as goods, 967–90; see also Asymmetric information Information differentiation, 646–651, 647; see also Advertising; Selling costs Input markets, 663–4 competitive see Competitive input markets monopoly power in see Monopoly power in input markets Inputs, production technology and, 241 Institutionalist, 54 Insurance, 764–70 actuarially fair (favorable), 765–6 actuarially favorable outcomes in, 768–70 actuarially unfair (unfavorable), 766–8 assets and risk in, 768 asymmetric information and, 985–90, 987 coinsurance and, 986–8, 987 cross-subsidization in, 973 deductibles and, 988–90 medical insurance for elderly, saving rates, 767 moral hazard and, 986–90, 987 optimal level of, 764–70 pooling in, 974 Intensive margin, 246, 256–7, 309 Interest rates, 813–15, 815; see also Intertemporal choices and capital decision comparative statics and, 832–5, 833, 834, 845 equilibrium and, 813–15, 815 present-value analysis of, 822–7, 822 rate of return and, 815–17 real vs nominal, 815–18, 818 Slutsky equation (adjusted) and, 835–40, 836, 837 taxation on interest income and, 838–40, 839 Interior optimum, commodity bundles and, 80–1, 80 Interlopers, in cartel, 640 Internet and barriers to entry, monopoly, 476–7 Intertemporal choices and capital decisions, 793–4 budget constraint in, 798–801, 799 comparative statics and, 832–40, 833, 834, 835, 836, 837, 839 discounting and, 817–22, 818 discount rate in, 816–17 hyperbolic discounting and, 845–6 multiperiod, 820–7, 821, 822 present value maximization and, 822–4, 822 two-period model for, 818–20 durable inputs and, 819–20 equilibrium and, 801–5, 802 financial capital in, 793 hyperbolic discounting and, 845–6 human capital in, 805–13, 806, 809 human-capital production function and, 806, 806 utility maximization with financial markets (separation theory) and, 809–13, 809 utility maximization without financial markets and, 805–8, 806 impatient vs patient consumer in, 797 indifference curves for, 796–8, 796 infinite horizon in, 825–6 interest rates (real vs nominal) and, 815–17 comparative statics and, 832–40, 833, 834, 835, 836, 837, 839 Index 1085 equilibrium and, 813–15, 815 rate of return and, 815–17 Slutsky equation (adjusted) and, 835–40, 836, 837 intertemporal choices defined for, 795–6 investment and, 822–3 life cycle model and, 795–6 marginal rate of time preference in, 796–8, 796 net present value (NPV) and, 822–7, 822 net present value criterion and, 822–7, 822 nondurable inputs and, 793 Polonius point and, 799, 799 present value in, 800 present value maximization and, 822–4, 822 present-value analysis of interest rates and, 822–7, 822 rate of return and, 816–17 real capital or real assets in, 793, 822 salvage value in, 823 separation theorem and human capital in, 809–13, 809 separation theory and, 809–13, 809 Slutsky equation (adjusted) and, 835–40, 836, 837 stocks and, 794 sunk cost and, 795 uncertainty, uncertain investment decisions and, 841–4 utility-based investment and, 844–5 Intertemporal price discrimination, 526–7 Intertemporal public goods, 952, 955 Interval measurement of utility, 786–7 Inventory control, 266–7 Inverse demand curves/functions, 116–17 Investing, 822–3; see also Intertemporal choices and capital decisions annuities, 825 appreciation in, 845 call options in, 842 hurdle rate in, 842–3 infinite horizon in, 825–6 investment and, 822–3 irreversible investment and, 842–3 net present value (NPV) and, 822–7, 822 net present value criterion in, 822–7, 822 option value in, 843 real option value in, 843 salvage value and, 823 two-period models for, 843–4 uncertainty, uncertain investment decisions and, 841–4 utility-based, 844–5 Invisible hand concept, 24–5, 90, 215, 349–50 Irreversible investments, 842–3 Isoclines, 261, 261 Isocosts, isocost curves, 287–9, 288 Isoprofit curves, competitive input markets and, 678–80, 678, 680 oligopolies and, 622–3, 623 Isoquants, 259–62, 259, 261 short-run cost curves and, 311–13, 312, 313 Isowelfare curves, 861–2, 862 Jackson, Thomas Penfield, 475 Jensens’ inequality, 757 Just-in-time production, 267 Kaldor compensation, 883–7, 883, 884, 885 Kasparov, Garry, 581 Kaufman, B.E., Kellogg, 495 Keynes, John Maynard, 8, 242 Keynes, John Nevelle, Khrushchev, Nikita, 263, 376 Kim, D., 595 Kim, D-H., 595 Kitae, S., 715 “Kitchen Debate,” 376 Klasen, S., 75 Koo, S., 181n, 193 Koot, G.M., 18–19 Kuan, J., 941 Kyoto Protocol, 577, 910 Labor, 151; see also Principal-agent model backward-bending labor supply curve using, 157–61, 157 bilateral Monopoly and bargaining in, 716–21, 718 comparative statics and, 154–6; see comparative statics analysis division of labor and, 266 firm hierarchies and wage rates, 683–4 income/leisure indifference function and, 153–4, 154 labor unions and, 721–8, 723, 724 market supply curve for labor in, 664–8, 664, 666 minimum wage effects and, 699–702, 700, 701 negatively sloping labor supply curve, 160–1 nonwage benefits and, input discrimination with, 736 output elasticity and, 254–5, 254 principal-agent model and, employer/employee relations and, 968, 990–1002 productivity and, 247–8 reservation wages for, 669–71, 671 shirking and, 995–6 slave labor and antebellum South, productivity of, 275 Slutsky equation and, 155–156, 154, 155 1086 Index Labor (Contd) strikes and, 726–8 unionization and cost of production, 293–4 wage discrimination and, 710, 734–43, 737 Labor inputs, 241 Labor market supply curve, 665–68, 666 Labor unions, 721–8, 723, 724 Laissez-faire policies, 459 Lall, S., 651 Lamanna, F., 75 Lancaster, K., 887 Land inputs, 241 Land rent, 670–4, 671 Lange, O., 461 Lange, R., 175 Laspeyres index and CPI, 139–40 Law of demand, 28–9, 29 Law of One Price see One Price, Law of Law of Small Numbers, 201, 203, 789 Lawson, R., 599–600 Leasing, commercial real estate, and asymmetric information, 972–3 Legal monopolies in, 476 Lemons problem, lemons market, asymmetric information and, 969–79, 970 Leontief (fixed-proportion) technologies, 271–2, 271 Lerner index, 482–6, 485 monopoly power in input markets (monopsony) and, 714–15, 715 Levin, L., 767 Levin-Waldman, O.M., 702 Life cycle model, 795–6 Limit price analysis and regulation of monopoly, 495 Lin, B.C., 54–5 Lindahl prices, public goods and, 951–2 Linder, J., 919–20 Linear demand, 184–6, 185, 186 Linear transformations, increasing (positive), 787–8 Lipsey, R., 887 Liquidity, 841 Liu, Z., 257 Local bliss, 4, 449, 449 one-household or homogeneous preferences economy in, 448–51, 449 satiated preferences in, 56–8, 57 Location, perfectly competitive, 647–8 Long-run costs, 287–9, 288 average cost (LAC), 295–8, 296 marginal (LMC), 294–8, 295, 296 minimization of, 288, 292–4 total cost (LTC), 288, 289–90, 292–5, 295, 296 Long-run period, 241 Loss, 286–7, 287 deadweight, 388–90, 390 Lottery see States of nature Luckstead, J., 667–8 Lump-sum principle, taxation and, 92–3, 92, 492–3, 493 Luxury goods, 122–3 Machan, T., 282–3 Machina’s paradox, 789 Macroeconomics, 5–6 Major League Baseball and monopsony power, 714–18, 718 Majority voting, 871–3, 872, 873 Marchant, M., 190 Margin, intensive vs extensive, 256 Marginal analysis, 79, 676 Marginal benefit of externality (MBE), 901, 901 Marginal cost, 294–8, 296, 303, 305–6 average cost relationship with, 300–1, 307–8 input (MIC), 688–9 long-run (LMC), 294–8, 296 Marginal product (MP), 245–7, 246 average product (AP) relationship to, 252–4, 252 Marginal production conditions, 438–43, 440, 442 Marginal productivity theory of factor demand, 676–84, 678, 679, 680, 682 Marginal rate of product transformation (MRPT), 428–33, 431 comparative advantage and, 446–7 Marginal rate of substitution (MRS), 42–9, 44, 46, 48 gains from trade (pure exchange economy) and, 206–7, 208 Marginal rate of technical substitution (MRTS), 259–60, 290 cost minimization and, 288, 290–4 general competitive equilibrium and, 422–6, 423, 424 opportunity cost condition and, 422–3, 423, 424 Marginal rate of time preference, 796–8, 796 Marginal revenue (MR), 336 Marginal revenue product (MRP), 684 Marginal social cost (MSC), 901–2, 901 Marginal utility (MU), 37–8 Marginal utility of consumption, 381–2 Marginal utility of income (MUI ), 85–6, 89, 778, 885 Marginal utility per dollar condition, commodity bundles and, 78–80, 88–9 Marginal-cost pricing, 496–9, 496 Market-clearing price, 17, 338–9 Market demand, 168–9 bandwagon effect and, 174–5 elasticity and, 180–4, 181, 182, 183 classification of, 183 cross-price, 193–4 defined, 180 Index 1087 income elasticity of demand and, 192, 192 linear demand and, 184–6, 185, 186 logarithmic representation of, 186–7 own-price elasticity, 180 perfectly elastic demand and, 182, 183 perfectly inelastic demand and, 181–2, 182 price consumption curve and, 185, 187, 190–1 proportionate price changes and, 186–7 responsiveness and, unit-free measurement of, 178–9 Slutsky equations and, 196 substitution, 196 total revenue/total expenditures and, 187–90, 189 units of measurement for, 178–9 market effect and, 175–7, 176 network externalities and, 171–7, 171, 176 price consumption curve and, 124–6, 125, 126, 145–6 shift in, 346–50, 347, 348, 350 total revenue/total expenditures and, 187–90, 189 Market economy, 166 Market effect, network externalities and, 171–7, 171, 176 Market equilibrium, 338–9, 338 Market niches, game theory and, 585–6, 585 Market period, 241–2, 332, 333 Market supply shifters, 350–2, 351 Markets, actuarially fair, 765–7 actuarially unfair, 766–8 black, 394–7, 395 centrally planned economies, 383, 396, 412, 422, 461, 877, 899 contestable, 498–500, 617 defining, equilibrium in, 338–9, 338 failure of, 380, 875–7 foreign exchange, 397 free, 24 general-equilibrium, 166 input, 661–2; see also Monopoly power in input markets market demand see Market demand monopolistic, 610–16, 613, 614 niche, game theory and, 585–6, 585 oligopolies and, generalized models of, 616–17 partial-equilibrium, 166 pure exchange, 206–7, 208; see also Pure exchange economy universality of, 71 well developed, 553 Marshall, Alfred, 17, 19–20, 135–7, 210, 244 Marshallian-cross analysis, 18–19, 18 Martin, G.J., 52 Marx, Karl, 475 Mass production, 266–7 Matrix of game or payoff, 571 Maximin strategies, in game theory, 594, 594 Maximum-utility commodity bundle, 75–7, 76; see also Utility maximization May’s Theorem and majority voting, 871 McCain, R.A., 228 McCarthy, P.S., 181n, 192n McDade, S., 175 McDonald’s, 267 Meagher, K.J., 683–4 Measurability of utility, 63–4 Mechanism design, welfare economics and, 871–2 Medical insurance for elderly, saving rates, 767 Microeconomics, 5–6, 17 Microsoft and monopoly, 475, 494–5, 500 Miller, R.A., 310–11 Mills, D., 485–6 Minimum efficient scale, 488 Minimum wage effects, competitive input markets and, 699–702, 700, 701 Minuit, Peter, 206, 821 Missing markets, 379, 849–51 Modeling, 10–12 analysis of, 12–14, 13 assumptions, properties, systems in, 10–11 econometrics in, 12 hypotheses in, 12 Marshallian-cross analysis, 18–19, 18 optimization, 16–17, 17 partial-equilibrium vs general-equilibrium, 19–20, 205 scientific explanation, prediction control and, 16 scientific method and, 12–13, 13 statistics in, 9, 12 theoretical vs statistical, 13 tools for, 14–15 variables in, exogenous and endogenous, 11 Moneylenders and bankers, 615–16 Monopoly and regulation, 474–5; see also Monopoly power in input markets auctions and, 562–3 barriers to entry in, 475–7 Baumol firms in, 515–17, 516 bilateral, 716–21, 718 capitalist vs socialist government regulation of, 495 contestable markets and, 498–500, 617 deadweight loss in, 488–92, 489 demand curves in, 477–8, 478 discount firms and, 512, 585 duopolies and, 616–17 economic efficiency of, 488–92, 489 equilibrium in, 479–82, 479, 480, 481, 486–8, 487 long-run, 486–8, 487 short- and long-run, under monopolistic competition, 610–16, 613, 614 franchises and, 475 1088 Index Monopoly and regulation (Contd) full capacity and average cost of production in, 488 full-cost (rate-of-return) pricing in, 496–9, 496 industrial organization and, 603–4 legal, 475 Lerner Index and, 482–6 limit price analysis and regulation of, 495 lump-sum taxes and, 492–3, 493 marginal-cost pricing and, 496–9, 496 minimum efficient scale in, 488 monopoly defined for, 474 monopoly rents, 487 monopsonies in, 706 multiple plants and production output in, 506–8, 507 natural monopolies and, 476–7 nonprofit organizations and, 508–12, 510 oligopsonies in, 706 opportunity cost of capital and, 486–7 patent, 476–7 power of, 470–1 price and output determination in, 477–82, 478, 479, 480, 481 price makers in, 477 pricing policies and, 495–9, 496 profit maximization in, 479 profit taxes and, 492–3, 493 regulation of, 495–9, 496 rent-seeking behavior in, 489, 490–1 revenue maximization in, 512–17, 513, 516 revenue maximization with profit constraints in, 515–17, 516 taxing rents and, 492–4, 493 technological barriers to entry and, 476 welfare economics and, 875–7 welfare loss from, 488–92, 489 Monopoly power in input markets (monopsonies), 706; see also Monopoly and regulation bilateral monopoly and bargaining in, 716–21, 718 inefficient, 713–15 input supply and monopoly in, 715–16, 716 labor unions and, 721–8, 723, 724 Lerner index and, 714–15 monopsony in, 706 nonwage benefits and, input discrimination with, 736 oligopsonies in, 706 profit maximization in, 709–12, 710 strikes and, 726–8 wage and employment determination in monopsony and, 709–12, 710 wage discrimination and, 710, 734–43, 737 Monopoly rents, 487 Monopsony see Monopoly power in input markets Monotonic transformation of utility functions, 64–6 Monotonicity axiom, production technology and, 234 Mooradian, R.M., 973 Moral hazard, 980–1000, 984 inefficiency with, 994–1002 insurance market and, 973–80 Pareto-efficiency without, 981–6 Morality and economics, 36, 868 Motor Carrier Act of 1980, 743 Movie industry and product differentiation, 605 Muir, E., 460 Multilateral externalities, 909–10 Multi-period discounting, 820–2, 821 Multiple plants and production output, monopoly and, 506–8, 507 Nash equilibrium, 573 oligopolies and, 618–19, 621–2, 624, 626, 628–9, 631, 655 National Cash Register Company, 991 Natural monopolies, 476–7 Natural resources damage, counting losses in, 886–7 Necessary goods, 122–3 Necessary profit see Normal profit Negative externality, 899 Negatively sloping labor supply curve, 160–1 Neoclassical economics, 17 Net present value (NPV), 822–7, 822 Net present value criterion, 822–7, 822 Network externalities and market demand, 171–7, 171, 176 bandwagon effect and, 174–5 market effect and, 175–7, 176 positive vs negative, 172 Neurobiological measurement (hedonimeters), 64 Neutral preferences, neutral commodities, 56, 57 New Deal programs, 401 Nieberding, J.F., 485n Nixon, Richard M., 376 No-arbitrage condition, 841 Nonconvexity and interior optimum, commodity bundles and, 80–1, 80 Noncooperative game theory, 568–9 Nondurable inputs, 793 Nonexpenditure costs see Implicit costs Nonlinear budget constraints, 75, 76 Nonlinear pricing, 534 Nonprofit organizations, 508–12, 510 Nonrival commodity see Public good Nonsatiation axiom, 36–9, 39 consumer preferences and, 36–9, 39 utility maximization and, 77, 84 Nonwage benefits, input discrimination with, 736 Index 1089 Normal (necessary, ordinary, opportunity-cost) profit in, 286, 287 Normal goods, 121–3 summary of ordinary, normal, inferior, Giffen goods and, 136–7, 136 Normative economics, 7–8 North American Free Trade Agreement (NAFTA), 412, 722 Numeraire commodities, 31 Numerical solutions, 14–15 O’Connor, M., 460 Offer curves, First Theorem of Welfare Economics, 217–19, 218, 224–5 Oligopolies, 616–7 antitrust laws and legal provisions for, 475, 640–1, 651–3 Bertrand model of, 631–6, 633 cartels and, 636–41, 638, 639, 652–8, 654, 655, 657 cheating in, 631 collusion in, 624, 628, 630–1, 633–41, 633, 638, 639, 652–8, 654, 655, 657 conjectural variations and, 618 Cournot model of, 619–25, 621, 623 dominant firm in, 657–8, 657 duopolies and, 616–17 generalized models of, 636, 637 interlopers in, 640 isoprofit curves in, 622–3, 623 market structures and, 636, 637 Nash equilibrium and, 618–19, 621–2, 624, 626, 628–9, 631, 655 Organization of Petroleum Exporting Countries (OPEC) cartel, 638–41, 639 perfect vs imperfect, 616–17, 631–2 price and output determination in, 617 price leadership, 656–8, 657 price wars and, 654 reaction function in, 621 Stackelberg disequilibrium in, 627, 630 Sweezy’s kinked demand curve, 654–6, 654 treble damage model, 651–3 Oligopsonies, 706 Oliva, T., 175 One-household or homogeneous preferences economy, 448–51, 449 One Price, Law of, 330–1, 333 Opera tickets and public goods, 940–1 Opportunity cost, 72–3, 73, 433 comparative advantage and, 446–7 diseconomies of scope and, 435–7, 435 economic rent and, 669–70, 669, 670 economies of scope and, 431, 433–5 Edgeworth box in, 423–6, 424 marginal rate of product transformation (MRPT) and, 428–33, 431 marginal rate of technical substitution (MRTS) in, 422–6, 423, 424 monopoly and, of capital, 486–7 opportunity costs and, 433 production contract curve (efficiency locus) in, 424–6, 424 production possibilities frontier in, 426–9, 426 Opportunity-cost profit see Normal profit Optimal choice, commodity bundles and, 78 Optimal reallocation of endowments in, 459–60 Optimization models, 16–17, 17 Option value, 843 Options, 842–3 Ordinal scales and ordinal utility, 63 Ordinary goods, 124–5, 125; see also Giffen goods summary of ordinary, normal, inferior, Giffen goods and, 136–7, 136 Ordinary profit see Normal profit Organization of Petroleum Exporting Countries (OPEC) cartel, 638–41, 639 O’Tool, R., 651 Output effect, competitive input markets and, 696–7, 696 Output efficiency, 448–51, 449 Output elasticity, 254–5, 254 China’s grain production and, 257 Output taxes, 367–8, 368, 405, 493–4 Own-price elasticity, 180 Oyster industry and property rights, 899–900 Paradigms, 10 Paradox of Choice, 201, 202 Paradox of Thrift, Pareto criterion, social welfare and, 855–6 Pareto improvement, 210, 211 Pareto, Vilfredo, 210 Pareto-efficient allocation, 211–14, 212, 447–57, 449, 452, 456 auctions and, 556–8, 556 competitive input markets and, 665 constrained (second-best) Pareto-optimum allocations, 850, 854, 887, 896, 951, 973 contract curve in, 211–14, 212 general competitive equilibrium and, 214–24, 218, 452, 456, 457–9 moral hazard, 974–6, 976, 978–86, 979, 982, 983, 984, 991–4, 992, 993 multiple household preferences, 451–7, 452, 456 price system efficiency and, 226–8 public goods and, 944–51, 948, 949 social welfare and, 855–6 tatonnement (trial-and-error) process of equilibrium establishment in, 219–20, 457–9 Walras’ law and, 219–21 Pareto-welfare criterion, 212–13 Partial-equilibrium analysis, 19–20, 205 Participation constraint equation, 991–5 Patent monopolies, 476 Patterson, John Henry, 991 Payoff, in game theory, 571 1090 Index Peak-load pricing, 953–5, 953 Pecuniary externalities, 897 Peer, 201, 203 Perfect (pure) competition, 664, 664 competitive input markets and, 664–8 economic efficiency and, 388–9, 390 general competitive equilibrium and, 214–24, 218, 452, 456, 457–9 homogeneous products in, 331–2 industrial organization and, 603 industry in, 331 invisible hand concept and, 24–5, 90, 215, 349–50 Law of One Price in, 330–1, 333 location and, 647–8, 647 long-run in, 357–8 constant-cost industries and, 361, 362–3, 367–8, 368 cost adjustment in, 358–60, 358, 359 decreasing-cost industries and, 365–8, 368 equilibrium conditions and, 360–1, 360 hurdle rate and, 361 increasing-cost industries and, 363–5, 364 new technology adoption and, 368–9, 369 support prices and, 398–400, 399 market period and, 332, 333 short-run in, 332–6 average fixed cost (AFC) curve in, 303–4, 303 average revenue (AR) in, 337, 337 elasticity of market supply in, 335 firm’s short-run supply curve in, 345–6, 345 individual firm supply curves in, 345–6, 345 invisible hand concept and, 24–5, 90, 215, 349–50 loss in, 342–3, 343 marginal revenue (MR) in, 336 market demand shifters in, 346–50, 347, 348, 350 market equilibrium in, 338–9, 338 market supply shifters in, 350–2, 351 market/industry supply curve in, 333–4, 334 market-clearing price in, 17, 338–9 normal profit in, 340–2, 341 price and output determination in, 336–7, 337 profit in, 338, 340 pure profit in, 338, 340 shutting down point in, 343–5, 345 support prices and, 398–400, 399 Perfect complements and, 52–5, 53 Perfect substitutes, 50–2, 51, 269–70, 270 Perfect-substitute technologies, 269–70, 270 Perfectly competitive price systems, 215 Perfectly elastic demand, 182, 183 Perfectly inelastic demand, 181–2, 182 Permit systems and, externalities and, 910–16, 914 Perroni, C., 673–4 Persuasive advertising, 609–10 Pesticide cancellation, cost effect of, 356, 357 Physical constraints, 70, 70 Physiocrats, physiocracy, 244 Pigouvian taxes, 917–19, 917 Pivotal consumers, 955 Players or agents, 568 Pogue, D., 610 Poitras, M., 755 Polonius point, 799, 799 Pommerehne, W.W., 52 Ponzi schemes, 750 Ponzi, Charles, 750 Pooling equilibrium, asymmetric information and, 978 Pools, insurance, 974 Portfolio selection, risk aversion and, 770–2 Positive economics, 7–8 Positive externality, 899 Positive feedback from new technology, effect on cost curves, 321–2 Positive monotonic transformation of utility function, 64–6 Post, 495 Precautionary principle, 773–4 Prediction, modeling in, 16 Preemption games, game theory and, 584, 584 Preference ordering and axioms, 33 Preference relation, consumer preferences and, 32 Preferences see Consumer preferences Premium, risk, 776 Present value, 822–4, 822 Price (see also Price discrimination) actuarially fair, 765–7 actuarially unfair, 766–8 bundling and, 530–4, 533 ceiling, 390–8, 391, 392 changes in price of another commodity and, 143–6, 144 changes in, comparative statics and, 108–61 compensated law of demand and, 128 compensated price changes/effect and, 127–8, 133 complements and substitution in, 144–5, 145 Consumer Price Index (CPI), 138, 139–40 cross-price elasticity and, 193–6 discrimination in see Price discrimination elasticity of demand and, 180, 181 first-degree (complete, perfect) price discrimination in, 523–6, 525 full-cost (rate-of-return) pricing in, 496–9, 496 Giffen goods and, 109, 125–6, 126, 133–7, 135, 136 Giffen’s paradox and, 133–6, 135 Hicks vs Slutsky price compensation in, 138–43, 138 Index 1091 Income effects on, 128–30, 133 Income elasticity of demand and, 191–2 Independent goods and, 145–6 Intertemporal price discrimination in, 526–7 Laspeyres Index and, 139–40 Lindahl, 951–2 linear demand and, 184–6, 185, 186 marginal-cost, 496–9, 496 market-clearing, 17, 338–9 minimum wage effects and, 699–702, 700, 701 monopoly pricing policies and, 477–9 nonlinear, 534 numeraire, 120 ordinary goods and, 124–5, 125 own-price elasticity and, 180 perfectly elastic demand and, 182, 183 perfectly inelastic demand and, 181–2, 182 price consumption curve and, 124–6, 125, 126, 145–6 price efficiency in, 679–80, 679 price leadership and, 656–8, 657 price makers in, 477 price wars and, 654 proportionate changes in, elasticity and, 186–7 public goods and, 944–51, 948, 949 quality discrimination and, 546–7 relative, 120, 221–5 Slutsky equation and, 130–8, 133, 134, 135 subsidies, subsidized prices and, 94–7, 95, 403–4, 403 substitution effect (Hicksian substitution) and, 127–8, 133 support, 398–400, 399 tie-in sales and, 530, 530 total revenue/total expenditures and, 187–90, 189 treble damage model, in price fixing, 651–3 Price consumption curve, 124–6, 125, 126, 145–6 household’s demand curve and, 124–6, 125, 126 Price discrimination, 522–3 arbitrage and, 523 auctions and, 553–63 bundling and, 530–4, 533 combination techniques for, 545–6 conditions for, 523 degrees of, 522, 524 first-degree (complete, perfect), 523–6, 525 Intertemporal, 526–7 no, absence of, 534, 535, 540, 544–5 opera tickets example, 940–1 quality discrimination and, 546–7 second-degree (nonlinear pricing), 534–8, 535 self-selection constraint in, 537–8, 736 social welfare and, 383 third-degree, 538–43, 540 tie-in sales and, 530, 530 treble damage model, 651–3 two-part tariffs and, 525, 527–30 well-developed markets and, 553 Price efficiency, competitive input markets and, 664–8 Price fixing, treble damage model, 651–3 Price leadership, 656–8, 657 Price makers, 477 Price system efficiency, 226–8 equitable distribution of endowments and fair allocations in, 226–8 Pareto-efficient allocation and, 206, 210–15, 210, 212, 447–57, 449, 452, 456 perfectly competitive, 215 relative prices and, 120, 221–5 social welfare and, 383 tatonnement (trial-and-error) process of equilibrium establishment in, 219–20, 457–9 Walras’ law and, 219–21 Welfare Economics, First Theorem of, 215 Welfare Economics, First Theorem of offer curves and, 217–19, 218, 224–5 Welfare Economics, Second Theorem of, 215 Price takers, budget constraints and, 70–2, 72 Price wars, 654 Principal-agent model, 968, 990–1002; see also Labor bonding and, 1000–2 coinsurance and, 968, 986–8, 987 contingent contract and, 1000 deductibles and, 988–90 deferred payments and, 1001 efficiency wage and, 1001 employee buyouts and, 996–7 employer/employee relations and, 968, 990–1002 hedonic adaption, 201, 203 hidden actions and, 981 hyperbolic discounting, 201, 203, 845–6 incentive-compatibility constraint and, 995–6 inefficiency with moral hazard and, 994–1002 insurance market and moral hazard, 984, 985–6 Pareto efficiency without moral hazard and, 981–5, 982, 983, 984 participation constraint equation and, 991–5 principal defined for, 981 reservation-utility levels and, 992 residual claimants and, 996–8 sharecropping, 999–1000 shirking and, 995–6 Principle of sequential rationality, 583, 583 Prisoner of War (POW) camp and pure exchange economies, 216–17 Prisoners’ Dilemma, 575–6, 575 Private goods, horizontal summation for, 947–8, 948 Private property rights, 898 Probability, 751; see also Risk and risk aversion independence axiom and, 753 1092 Index Probability (Contd) mutually exclusive, 752–3 outcome and, 752 states of nature (lottery) and, 752 subjective and objective, 751–2 Producer surplus (PS), 384–7, 385, 386 Producers’ rules, 235–7 Producers, Product differentiation, 604–10 Production and exchange economy, social welfare and, 858, 858, 859 Production contract curve (efficiency locus), opportunity costs and, 424–6, 424 Production efficiency, 422 General competitive equilibrium and, 452, 456, 457–9 Production functions, 242–4; see also Production technology Production possibilities frontier, opportunity costs and, 433 Production technology, 242–4 agile manufacturing and, 267 average product (AP) in, 247–8, 246 classification of production functions in, 263 Cobb–Douglas technologies in, 272–4, 272 Cobb–Douglas production function and, 244, 272–4, 272 constant elasticity of substitution (CES) technologies and, 274–5 cost curves and, 321–2, 321 diminishing marginal returns, law of, 249–52, 252, 302–5, 303 distribution and efficiency, 460 division of labor in, 266 elasticity of substitution and, 268–9, 269 factors of production in, 241–2 fixed-proportion (Leontief) technologies and, 271–2, 271 functions of, 242–3 inputs for, 241–2 inventory control and, 266–7 isoclines and, 261, 261 isoquants in, 259–62, 259, 261 just-in-time production and, 267 long-run period and, 241 margin and, intensive vs extensive, 256 marginal product (MP) to average product (AP) in, relationship of, 245–7, 246 marginal product (MP) in, 245–7, 246 marginal production conditions and, 438–43, 440, 442 marginal rate of product transformation (MRPT) and, 428–33, 431 marginal rate of technical substitution (MRTS) in, 259–60, 290 market period and, 241–2 mass production and, 266–7 monopoly and, full capacity and average cost of production in, 488 monotonicity axiom in, 234 multiple plants and production output in, 506–8, 507 output efficiency and, 448–51, 449 output elasticity and, 254–5, 254 perfect-substitute technologies and, 269–70, 270 positive feedback from new technology, effect on cost curves, 321–2 production defined, 240 production efficiency and, 422 production possibilities frontier in, 426–9, 426 productivity and, 247–8 profit and loss considerations of new technologies, 368–9, 369 returns to scale and, constant, increasing, decreasing, 263–5, 265 ridgelines and, 261, 261 short-run period and, 241 stages of production in, 246, 251, 255–7, 256 returns to scale and, 267–8 strict convexity axiom in, 243 technological efficiency in, 243 time and, 241–2 total product (TP) in, 243 with two variable inputs, 258 diminishing MRTS in, 260–2, 261 isoclines and, 261, 261 isoquants in, 259–62, 259, 261 marginal rate of technical substitution (MRTS) in, 259–60, 290 ridgelines and, 261, 261 Productivity, 247–8 slave labor in antebellum South, 275 Profit, 285–7; see also Cost theory isoprofit curves in, 678–80, 678, 680 normal, 286, 340–2, 341 pure, 286, 338, 340–2 Profit maximization, 335–6 competitive input markets and, 664–8 industrial organization and, 606–7, 611–12, 617–18, 631–3 monopoly and, 479, 479 monopoly power input markets (monopsony) and, 709–10, 710 Profit taxes, 492–493, 493 Properties, 10–11 Property rights, 898 Proportionate price change, 186–7 Public Choice Theory, 54, 854 Public goods, 936 Clarke tax and, 955–8 defining, 937–8, 938 exclusive and nonexclusive commodities in, 936–8, 938 exclusive-good characteristics and, 936–8, 938 free-rider problem and, 942–4, 943 horizontal summation of private goods vs., 947–8, 948 intertemporal and public goods, 952, 955 Index 1093 nonrival but exclusive characteristic of, 938–41, 940 Pareto-efficient allocation and, 944–7 peak-load pricing and, 953–5, 953 permit systems and, 951 pivotal consumers and, 955 prices, Lindahl prices for, 951–2 private-goods market and provision of, 947–8, 948 pure, 937 rent vs sale of product and, 938–41, 940 rivalry and, 936–7 vertical summation for, 949–50, 949 Pure competition see Perfect competition Pure exchange economy, 206–7, 208 core solution in, 210, 211 Edgeworth box and, 217–25, 218 gains from trade in, 206–7, 208 contract curve (Pareto-efficient allocation) in, 211–14, 212 core solution in, 210, 211 Edgeworth box and, 217–25, 218 feasible allocation and Edgeworth box in, 208–10, 209 marginal rate of substitution (MRS), 206–7, 208 Pareto-efficient allocation in, 210–14, 210, 214 Pareto-welfare criterion and, 212–13 two-commodity and two-household economy in, 207–8, 208 general-equilibrium analysis in, 205 Pareto-efficient allocation and, 210–14, 210, 214 partial-equilibrium analysis in, 205 price system efficiency in, 226–8 equitable distribution of endowments and fair allocations in, 226–8 perfectly competitive, 214–17 relative prices and, 221–5 social welfare and, 225–8 tatonnement (trial-and-error) process of equilibrium establishment in, 219–20, 457–9 Walras’ law and, 219–21 Walrasian equilibrium in, 216–17 Welfare Economics, First Theorem of, 215 Welfare Economics, First Theorem of, offer curves and, 217–19, 218, 224–5 Welfare Economics, Second Theorem of, 215 social welfare and, 225–8, 855–7, 856, 857, 860, 863, 862 tatonnement (trial-and-error) process of equilibrium establishment in, 219–20, 457–9 Walras’ law and, 219–21 Walrasian equilibrium in 216–17 Welfare Economics, First Theorem of, 215 Welfare Economics, First Theorem of, offer curves and, 217–19, 218, 224–5 Welfare Economics, Second Theorem of, 215 Pure profit, 338, 340 Pure public good, 937, 938 Pyramid schemes, 750 Quaker Oats, 495 Quality discrimination, 546–547 Quantity tax, 405; see also Output taxes Quid pro quo, in game theory and, 598–600, 599 Quotas, 410, 412, 916–23, 917, 921, 922 externalities and, 916–23, 917, 921, 922 Racial wage discrimination in trucking industry, 743 Radford, R.A., 216–17 Randall, A., 886–7 Rangel, A., 64 Rate of return, 816–17 Rational behavior, game theory and, 596–7, 596 Rationality, consumer preferences and, 34–5, 101–5, 102, 103 bounded rationality and, 34–5 Rationality principle, revealed preference and, 101–2, 102 Rationalizable strategy, game theory and, 573 Rationing, 89–91, 91, 213, 394 invisible hand concept and, 90 Rawlsian criterion, social welfare and, 865, 866–7 Reaction function, oligopolies and, 621 Real capital or real assets, 793, 822 Real estate leasing and asymmetric information, 972–3 Real income, 120 Rebate, income tax rebates, 141–3, 143 Reference point, 201–2, 201 Relative consumption, 201, 203 Relative prices, 120, 221–5 price system efficiency and, 226–8 Rent economic, 668–74, 669, 670, 671 Henry George Theory in, 668, 670–2, 671 land, 670–4, 671 monopoly, 487 optimal commodity tax based on, 673–4, 674 Ricardian, 674–6, 675 single-tax scheme and, 670–2, 671 taxing rents and, 492–4, 493 Rent-seeking behavior, 489, 490–1 Rent vs sale of product, 938–41, 940 Reproductions as substitutes, 52 Reservation price, auctions and, 562 Reservation-utility levels, principal-agent model and, 992 Reservation wages, 669–71, 671 Residual claimants, principal-agent model and, 996–8 1094 Index Resource allocation, 2, 4, 69, 458–9 allocation conditions and, 422 allocative efficiency in, 289–90, 377, 488, 679, 679 constrained (second-best) Pareto-optimum allocations, 850, 854, 887, 896, 951, 973 equitable distribution of endowments and fair allocations in, 226–8 externalities and, 896–7 missing markets and, 849–51, 896–7, 969–74, 970 optimal reallocation of endowments in, 459–60 Pareto-efficient, 210–14, 210, 214, 451–7, 452, 456, 556–8, 556 rationing and, 89–91, 91, 213, 394 support prices and, 398–400, 399 welfare economics and, 871–2 Resources, 3–6 nonrenewable, renewable, Responsiveness, unit-free measurement of, 178–9 Returns to scale, constant, increasing, decreasing, 263–5, 265 Revealed preference, 101–5, 102, 103 rationality principle and, 101–2, 102 strong axiom of, 103–5 weak axiom of, 103–5, 103 Revenue maximization, monopoly and, 512–17, 513, 516 Rhine, R., 299 Ricardian rent, 674–6, 675 Ricardo, David, 446, 674 Ridgelines, production technology and, 261, 261 Right to Work (RTW) laws and free-rider problem, 943 Ringel, J.S., 181n Risk and risk aversion, 755–8, 757 actuarially fair games and, 756 actuarially fair prices and, 765–7 actuarially unfair prices and, 778–80, 779 Allais’s paradox and, 788 arbitrage and, 840–1 assets and risk in, 768 certainty equivalence and, 762–4, 763 concave utility function in, 756–8, 757, 770 contingent commodities and, 774–7, 776, 780–1, 780 expected (von Neumann–Morgenstern) utility function in, 754 Independence Axiom and, 753 insurance and, 764–70 actuarially fair (favorable), 765–6 actuarially favorable outcomes in, 768–70 actuarially unfair (unfavorable), 766–8 assets and risk in, 786 optimal level of, 764–70 interval measurement of utility and, 786–7 Jensens’ inequality and, 757 Machina’s paradox and, 789 no-arbitrage condition and, 840–1 outcome and probability in, 752 portfolio selection and, 770–2 precautionary principle and, 773–4 probability (mutually exclusive) in, 752–3 probability (subjective and objective), 751–2 risk preference in, 755–6 risk premium in, 776 risk-averse preference in, 756–8, 757 risk-aversion coefficient (Arrow–Pratt) for, 770–1 riskless arbitrage and, 841 risk-neutral preference in, 760–2, 762 risk-seeking preference in, 758–60, 759 St Petersburg Paradox and, 790 state-dependent utility in, 774 states of nature (lottery) and, 752 uncertainty, uncertain investment decisions and, 841–4 utility maximization in, 750 variance of, 755–7 violations of expected utility and, 788–90 Risk-averse preference, 756–8, 757 Risk-aversion coefficient (Arrow–Pratt) for, 770–1 Risk-free assets, 768 Riskless arbitrage, 841 Risk-neutral preference, 760–2, 762 Risk premium, 776 Risk-seeking preference, 758–60, 759 Ritty, James, 990 Rival commodity see Private good Rivalry, public goods and, 936–8, 738 Roberts, Cecil, 734 Robin Hood and social welfare, 225, 861 Roosen, J., 356 Root and nodes, in game theory and, 572, 582–3 Roth, A., 15 Saffer, H., 355 Salant, S., 652 Salant, Y., 35 Sales taxes, 405–8, 405, 407 Salvage value, 823 Samuels, W.J., 54 Samuelson, Paul A., 13 Satiation nonsatiation axiom and, 36–9, 39 satiated preferences in, 57–8, 57 Scale agile manufacturing and, 267 economies of, 263–7, 265, 296, 298, 299 just-in-time production and, 267 minimum efficient scale in, 488 returns to, constant, increasing, decreasing, 263–7, 265, 296, 298, 299 scale efficiency in, 376–8, 679, 679 stages of production and, return to, 267–8 Scale efficiency, 376–8, 679, 679 Index 1095 Scarcity, 3–4 Scientific method, 12–13, 13 Scope see Economies of scope Screening mechanisms, asymmetric information and, 978–9, 979 Scrooge, 793 Seale, J., 190 Sealed bids, 555 Sears drills and quality discrimination, 547 Second-best mechanism design, asymmetric information and, 968, 973–9, 976, 979, 987, 987 Second Best, Theory of, 887–93, 890 Second-bid or Vickrey auctions, 555–7 Security value, game theory and, 594 Sedgwick, J., 605 Self-selection constraint, price discrimination and, 537–8 Selling cost, 605–6; see also Advertising Selten, Reinhard, 580 Separating equilibrium, asymmetric information and, 976–8 Separation theorem, 809–13, 809 human capital and, 809–13, 809 September 11th Victim Compensation Fund of 2001, 824 Sequential games, 581–3, 582, 583 Sequential rationality, principle of, 583, 583 Sequential voting, 874–5, 874 Sharecropping, 999–1000 Sherman Antitrust Act of 1890, 641 Shirking, 995–6 Short-run average total cost (SATC), 303–4, 303 Short-run average variable cost (SAVC), 303–4, 303 Short-run costs, 286 Short-run marginal cost (SMC), 303, 305–6 Short-run period, 241 Short-run total cost (STC), 302, 303 Short-run total variable cost (STVC), 303, 303 Shutting down point, 343–5, 345 Signaling mechanisms, asymmetric information and, 974–9, 976 GED and, 977 Simon, H., 34–5 Single-tax scheme, 670–2, 671 Sinn, H., 958 Slave labor in antebellum South, productivity, 275 Slutsky equation, 130–8, 133, 134, 135, 155–6, 154, 155, 835–40, 836, 837 adjusted, 155–6, 154, 155, 835–40, 836, 837 backward-bending labor supply curve using, 157–61, 157 elasticity and, 196 Hicks vs Slutsky price compensation in, 138–43, 138 household’s supply of labor curve using, 156–61, 157 income/leisure indifference function and, 153–4, 154 intertemporal choices, capital decisions and, (adjusted) and, 835–40, 836, 837, 839 negatively sloping labor supply curve, 157–61, 157 substitution and income effects in, 126–7, 127 time and income constraints in, 151–2, 152 utility maximization and, 153–4, 153 Smith, Adam, 2, 25, 90–1, 215, 266, 349, 805 Social indifference (isowelfare) curves, 861–3, 862 Social science, Social welfare, 225–8, 855–7, 856, 857, 860, 863, 862 Benthamite welfare function in, 867–8, 868 classical utilitarian function in, 868–9, 868 economic efficiency and, 388–9, 390, 447–57, 449, 452, 456 efficient allocation and, 206, 210–15, 210, 212, 447–57, 449, 452, 456 egalitarian economies and, 863–7, 865 inequality aversion in, 861 maximization of, 860–3, 862 monopoly and, loss from, 488–90, 489 one-household or homogeneous preferences economy in, 448–51, 449 price discrimination and, 525, 529–30, 535, 544–5 production and exchange economy and, 858, 858, 859 pure-exchange economies and, 225–8, 855–7, 856, 857, 860, 863, 862 Rawlsian criterion in, 865, 866–7 social indifference (isowelfare) curves and, 861–3, 862 utility possibilities frontier in, 856–7, 857 Socialism, 461, 651, 981 Society, 3–4 Souza-Monteito, 172–3 Sovereignty of consumer, 378 Spatial differentiation, 646–7, 647 Spence, Michael, 975 Spencer, Herbert, 475 Spillover efficiency loss, 413–14, 414 St Petersburg Paradox, 790 Stackelberg disequilibrium, 627, 630 Stackelberg oligopolies, 628–9 Stages of production, 246, 251, 255–7, 256, 309, 310 isoquant map of, 262–3, 263 returns to scale and, 267–8 short-run cost curves and, 309, 310 Standards, externalities and, 916–23, 917, 921, 922 State-dependent utility, 774 State Street v Signature Financial Group, monopoly case, 476 States of nature (lottery), 752 1096 Index Statistics, 9, 12 modeling, 10 Status quo bias, 201, 202 Stiglitz, J.E., 616 Stocks, 794 Stone, J.A., 293–4 Strategic (normal) form, game theory and, 571 Strategic agent interaction, 565–6 Strategic interdependence, 568–9 Strategic voting, 873–5, 874 Strategy or decision rule, game theory and, 570–1 Strategy pairs, game theory and, 571 Strict convexity axiom, production technology and, 243 Strikes, 726–8 Strong and weak compensation test, welfare economics and, 883–7, 883, 884, 885 Strong axiom of revealed preference, 103–5 Strong signals, 974 Subsidies, 94–7, 95, 403–4, 403 cross-subsidization and, 973 Substitution, 127–8, 133, 144–6, 144 complements and, 144–6, 144 constant elasticity of substitution (CES) technologies and, 274–5 cost minimization and, economic rate of substitution and, 288, 290 elasticity and, 196, 268–9, 269 Giffen’s paradox and, 133–6, 135 imperfect substitutes and, 49 marginal rate of (MRS), 42–9, 44, 46, 48 marginal rate of technical substitution (MRTS), 259–60, 290 perfect substitutes and, 50–2, 51 perfect-substitute technologies and, 269–70, 270 reproductions as, 52 Slutsky equation and, 130–8, 133, 134, 135 substitution effect (Hicksian substitution) and, 127–8, 133 Substitution effect (Hicksian substitution), 127–8, 133 Summary of ordinary, normal, inferior, Giffen goods, 136–7, 136 Sumner, William Graham, 475 Sunk cost, 795 Supply, 17–18, 18 comparative statics and, 151; see also Comparative statics analysis market demand shifters in, 346–50, 347, 348, 350 market supply shifters in, 350–2, 351 market/industry supply curve in, 333–4, 334 supply and demand curves in, 17–18, 18 Supply and demand curves, 17–18, 18 Support prices, 398–400, 399 acreage controls, Acreage Adjustment Act (AAA), 400–3, 401 agricultural policy and, 359, 359, 398–400, 399 subsidies and, 403–4, 403 target prices, 376 Surplus, 327–8 consumer (CS), 380–4, 381, 382 producer (PS), 384–7, 385, 386 total, 388–9, 390 trade restrictions and, 408–13, 409, 410 Sutter, D., 755 Sweezy’s kinked demand curve, 654–6, 654 Systems, 10–11 Tacit collusion, 653–8, 654, 655, 657 Taft–Hartley Act of 1935, 641 Tangency condition, commodity bundles and, 76, 77–8, 80, 88–9 Tanku, A., 397 Target prices, 376 Tariffs, 408–11, 410 two-part, 525, 527–30 Tâtonnement (trial-and-error) process of equilibrium establishment, 219, 457–9 Taxes, 142, 354–5, 355, 405, 405–8, 405, 407, 408, 673–4, 917–19, 917 cigarette, 405, 407–8 Clarke, 936, 955–8 commodity, 405–8, 405, 407, 408, 673–4 excise, 142, 354–5, 355, 405 externalities and, 917–19, 917 income tax rebate, 141–3, 143 interest income and, 838–40, 839 lump-sum, 92–3, 92, 492–3, 493 monopoly and, taxing rents and, 492–4, 493 output, 367–8, 368, 405, 493–4 Pigouvian, 917–19, 917 profit, 492–3, 493 rent and, optimal commodity tax based on, 673–4, 674 sales, 405–8, 405, 407 single-tax scheme in, 670–2, 671 Taxicab, 402 Taxing rents, 492–4, 493 Taxonomy of economics, 5–8 Taylor, F., 461 Technical efficiency, China’s grain production and, 257 Technological barriers to entry, 476 Technological efficiency, 243, 377 Theory of cost see Cost theory Threats, in game theory, 586–7, 587 Thrift, paradox of, Tie-in sales, 530, 530 Time, 191, 241–2 long-run period and, 241–2 market period and, 241–2 production technology and, 241–2 short-run period and, 241 Time Warner, 616 Tinamidae, George, 357 Index 1097 Tit-for-tat or trigger strategy, in game theory, 577–80 Tornado hit and demand for shelters, probability and risk, 755 Total cost (TC), 286 long-run (LTC), 288, 289–90, 292–5, 295, 296 short-run (STC), 302, 303 Total fixed cost (TFC), 302–3, 303 Total input cost (TIC), 688–9 Total product (TP), 241 Total revenue/total expenditures, 187–90, 189 Total surplus, economic efficiency and, 388–9 Toyota Corporation, 267, 975 Toyota, Kiichiro, 267 Trade restrictions, 408–13, 409, 410 deadweight loss and, 409–11, 410 free trade and, 206–7, 208, 408–9, 410, 444, 446–7 quotas and, 410, 412 surplus and, 409–10, 410 tariffs and, 408–11, 410 Transitivity axiom, consumer preferences and, 34–5 Treble damage model, 651–3 Trembling hand games, 596 Trucking industry, racial wage discrimination in, 743 Tsebelis, G., 595 Tullock, G., 54 Turgot, A., 244 Two-commodity assumption, consumer preferences and, 31–2 Two-household economy with heterogeneous preferences in, 452–7, 452, 456 Two-part tariffs, 525, 527–30 US Department of Defense and monopoly, 477 US Post Office and monopoly power, 470–1, 508 Uncertainty, 747–8 investment decisions and, 841–4 Unionization and cost of production, 293–4 United Nations World Food Program, 412 Universality of markets, budget constraints and, 71 Utilitarian function, classical, in social welfare and, 868–9, 868 Utility and utility functions Allais’s paradox and, 788 cardinal vs ordinal, 63–4 characteristics of, 36 concave utility function in, 756–8, 757, 770 concavity of indifference curves in, 39–43, 40, 44 consumer preferences and, 29, 30–1, 101–5, 102, 103 convexity of indifference curves in, 45–7, 46 diminishing MRS (strict convexity) in, 45–7, 46 expected (von Neumann–Morgenstern) utility function in, 754 good (desirable vs bad (undesirable) commodities in, 37, 52, 55–6, 55 imperfect substitutes and, 49 indifference curve derived from, 41 interval measurement of, 786–7 investing, utility-based investment and, 844–5 linear transformations and, increasing (positive), 787 Machina’s paradox and, 789 marginal rate of substitution (MRS) in, 42–9, 44, 46, 48 marginal utility (MU) in, 37–8 maximization of utility in see Utility maximization measurability of utility, 63–4 neurobiological measurement (hedonimeters) in, 64 neutral preferences, neutral commodities in, 56, 57 perfect complements and, 52–5, 53 perfect substitutes and, 50–2, 51 positive monotonic transformation of, 64–6 risk-aversion coefficient (Arrow–Pratt), 770–771 satiated preferences in, 56–8, 57 St Petersburg Paradox and, 790 state-dependent utility in, 774 utility defined for, 35–6 violations of expected, 788–90 Utility-based investment, 844–5 Utility bundles, welfare economics and, 883 Utility maximization, 75–80, 76, 809–13, 809 budget constraints in, 71–5, 72, 73 concavity of indifference curves in, 39–43, 40, 44 continuous choice and, 70–71 corner solution in, 81–4, 81, 82, 83 first order conditions (FOCs) and, implications of, 85–9 human capital and, without financial markets and, 805–8, 806 income constraints and, 85, 110, 151 intertemporal choices, capital decisions and, separation theory, with financial markets, 809–13, 809 lump-sum principle and, 92–3, 92, 492–3, 493 marginal analysis and, 79 marginal utility of income (MUI) in, 85–6, 89 marginal utility per dollar condition in, 78–80, 88–9 maximum-utility commodity bundle and, for household, 75–7, 76 missing markets and, 849–51 nonconvexity and interior optimum in, 80–1, 80 perfect complements and, 87–8 perfect substitutes and, 82–3, 82 rationing and, 89–91, 91, 213, 394 1098 Index Utility maximization (Contd) revealed preference and, 101–5, 102, 103 risk and, 750 Slutsky equations and, 130–8, 133, 134, 135 subsidies, subsidized prices and, 94–7, 95 tangency condition in, 76, 77–8, 80, 88–9 Utility possibilities frontier, 861–3, 862 Value of marginal product (VMP), 677 Variable costs, 286 short-run (STVC), 303, 303 Variables, exogenous and endogenous, 11 Variance, risk and, 755–7 Viacom, 616 Vickrey auctions, 555–7 Violations of expected utility, 788–90 von Newmann–Morgenstern utility function, 754; see also Expected utility function von Stackelberg, Heinrich, 625 von Thunen, Johann, 244, 268 Voting systems majority, 871–3, 872, 873 sequential, 874–5, 874 strategic, 873–5, 874 Wage discrimination, 710, 734–43, 737 Wage rates, firm hierarchies and, 683–4 Walras, Leon, 20, 216 Walras’ law, 219–21 Walrasian equilibrium, 216–17 Wang, H., 651 Wants defined, 3–4 Weak axiom of revealed preference, 103, 103–5 Weak signals, 978 Wealth of Nations, 90–1 Weatherby, J Jr., 210 Webb–Pomerene Act of 1918, 641 Welfare economics, 854–5 Arrow’s Impossibility theorem and, 870–3 Coase theorem and, 907–9 compensation principle and, 882, 882 Condorcet paradox and, 871–2, 872 First Theorem of, 215 First Theorem, offer curves and, 217–19, 218, 224–5 government interventions and permit systems, 910–16, 914 Kaldor compensation and, 883–7, 883, 884, 885 market failure and, 380, 875–7 May’s Theorem and majority voting in, 871 mechanism design and, 968, 973–9, 976, 979, 987, 987 monopoly power and, 875–7 natural resources losses and damage in, 886–7 Pareto-welfare criterion and, 212–13 Public Choice Theory in, 854 resource allocation and, 854–5 Second Best, Theory of, 887–93, 890 Second Theorem of, 215 social welfare and, 855–6 Benthamite welfare function in, 867–8, 868 classical utilitarian function in, 868, 868 egalitarian economies and, 863–7, 865 inequality aversion in, 861 maximization of, 860–3, 862 Pareto criterion and, 855–6 production and exchange economy and, 858, 858, 859 pure-exchange economies and, 855–7, 856, 857, 860, 863, 862 Rawlsian criterion in, 865, 866–7 social indifference (isowelfare) curves and, 861–3, 862 utility possibilities frontier in, 856–7, 857 strong and compensation tests in, 883–4, 883 utility bundles in, 883 utility possibilities frontier in, 856–7, 857 voting in, majority, 871–3, 872, 873 voting in, sequential, 874–5, 874 voting in, strategic, 873–5, 874, 874 Well-developed markets, 553 Whalley, J., 673–4 Winner’s curse, auctions and, 558–61 Win-stay/lose-shift strategy, game theory and, 578–80 Women in workforce, egalitarian households and, 867 Wozniak, G.D., 369 Yang, S.X., 973 Yao, S., 257–8 Yue, C., 447 Zichermann, G., 919–20 Zimbabwe and Zambia famine, 412–13 Zizzo, D.J., 64 ... Data Wetzstein, Michael Eugene Microeconomic theory / Michael Wetzstein – 2nd ed p cm Rev ed of: Microeconomic theory: concepts and connections c2005 Microeconomics Economics, Mathematical I Title... prose, graphics, and mathematics Michael E Wetzstein is Professor of Agricultural and Applied Economics at The University of Georgia, USA Microeconomic Theory Concepts and connections Second... The ability to understand economic theory and apply it to your everyday choices will provide you with the power to make correct choices and understand the choices made by others The roadmap can