(BQ) Part 2 book “Microeconomics - Theory and applications with calculus” has contents: Monopoly and monopsony, pricing and advertising, game theory, oligopoly and monopolistic competition, factor markets, property rights, externalities, rivalry, and exclusion, asymmetric information, contracts and moral hazards.
www.downloadslide.net Monopoly and Monopsony 11 Monopoly: one parrot A firm that creates a new drug may receive a patent that gives it the right to be the sole producer of the drug for up to 20 years As a result, the firm can charge a price much greater than its marginal cost of production For example, one of the world’s best-selling drugs, the heart medication Plavix, sold for about $7 per pill though it costs about 3¢ per pill to produce A new drug to treat hepatitis C, Harvoni, sells for $1,350 a pill or $113,400 for a 12-week course of treatment Every year, many pharmaceuticals lose their patent protection In 2015, drugs with $44 billion of sales lost patent protection, including Abilify (which treats neurological disorders), Avodart (prostatic hypertrophy), and Celebrex (pain and inflammation) In 2016, the patents for Crestor (cholesterol), Glumetz (diabetes), Nuvigil (attention disorder/weight loss), and others expire In 2017, patent protection for Tamiflu (viral infections), Acthar Gel (endocrine disorders), and others end Generally, when a patent for a highly profitable drug expires, firms enter the market and sell generic (equivalent) versions of the brand-name drug Generics’ share of all U.S prescriptions rose from about 18% in 1984 to nearly 80% currently The U.S Congress, when it originally passed a law permitting generic drugs to quickly enter a market after a patent expires, expected that patent expiration would subsequently lead to sharp declines in drug prices.1 If consumers view the generic product and the brand-name product as perfect substitutes, both goods will sell for the same price, and entry by many firms will drive the price down to the competitive level Even if consumers view the goods as imperfect substitutes, one might expect the price of the brand-name drug to fall However, the prices of many brand-name drugs have increased after their patents expired and generics entered the market The generic drugs are relatively inexpensive, but the brand-name drugs often continue to enjoy a significant market share and sell for high prices Regan (2008), who studied the effects of generic entry on post-patent price competition for 18 prescription drugs, found an average 2% increase in brand-name prices Studies based on older data have found up to a 7% average increase Why some brand-name prices rise after the entry of generic drugs? Under the 1984 Hatch-Waxman Act, the U.S government allows a firm to sell a generic product after a brand-name drug’s patent expires if the generic-drug firm can prove that its product delivers the same amount of active ingredient or drug to the body in the same way as the brand-name product Sometimes the same firm manufactures both a brand-name drug and an identical generic drug, so the two have identical ingredients Generics produced by other firms usually have a different appearance and name than the original product and may have different nonactive ingredients, but they have the same active ingredients M11_PERL4459_04_GE_C11.indd 385 CHAL L E N G E Brand-Name and Generic Drugs 385 3/30/17 5:02 PM www.downloadslide.net 386 CHAPTER 11 Monopoly and Monopsony A monopoly is the only supplier of a good that has no close substitute Monopolies have been common since ancient times In the fifth century BC, the Greek philosopher Thales gained control of most of the olive presses during a year of exceptionally productive harvests Similarly, the ancient Egyptian pharaohs controlled the sale of food In England, until Parliament limited the practice in 1624, kings granted monopoly rights called royal charters or patents to court favorites Today, virtually every country grants a patent—an exclusive right to sell that lasts for a limited time—to an inventor of a new product, process, substance, or design Until 1999, the U.S government gave one company, Network Solutions, the right to be the sole registrar of Internet domain names Consumers hate monopolies because monopolies charge high prices A monopoly can set its price—it is not a price taker like a competitive firm is A monopoly’s output is the market output, and the demand curve a monopoly faces is the market demand curve Because the market demand curve is downward sloping, the monopoly doesn’t lose all its sales if it raises its price, unlike a competitive firm Consequently, the monopoly sets its price above marginal cost to maximize its profit Consumers buy less at this high monopoly price than they would at the competitive price, which equals marginal cost As a result, welfare is lower than in a competitive market We also examine a monopsony: the only buyer of a good in a market We show that a profit maximizing monopsony sets its price below the competitive level, which lowers welfare compared to a competitive market In this chapter, we examine seven main topics Monopoly Profit Maximization Like all firms, a monopoly maximizes its profit by setting its price or output so that its marginal revenue equals its marginal cost Market Power and Welfare How much the monopoly’s price is above its marginal cost depends on the shape of the demand curve that the monopoly faces, and this gap between price and marginal cost lowers welfare relative to the competitive level Taxes and Monopoly Specific and ad valorem taxes increase the deadweight loss due to monopoly, may have consumer incidences in excess of 100%, and affect welfare differently from each other Causes of Monopolies Two major causes for a monopoly are a firm’s cost advantage over other potential firms and government actions Government Actions That Reduce Market Power A government can regulate the price a monopoly charges or allow other firms to enter the market to reduce or eliminate the welfare loss from a monopoly Networks, Dynamics, and Behavioral Economics If its current sales affect a monopoly’s future demand curve, a monopoly that maximizes its long-run profit may choose not to maximize its short-run profit Monopsony A monopsony—a single buyer—maximizes its profit by paying a price below the competitive level, so welfare is lower than the competitive level 11.1 Monopoly Profit Maximization Competitive firms and monopolies alike maximize their profits using a two-step procedure (Chapter 8) First, the firm determines the output at which it makes the highest possible profit Second, the firm decides whether to produce at that output level or to shut down, using the rules described in Chapter M11_PERL4459_04_GE_C11.indd 386 3/30/17 5:02 PM www.downloadslide.net 11.1 Monopoly Profit Maximization 387 For a competitive firm, we distinguished between a lowercase q, which represented a firm’s output, and an uppercase Q, which reflected the market quantity Because a monopoly sells the entire market quantity, we use Q to indicate both the monopoly’s quantity and the market quantity The Necessary Condition for Profit Maximization A monopoly’s first step is to pick its optimal output level A monopoly, like any firm (Chapter 8), maximizes its profit by operating where its marginal revenue equals its marginal cost, as we now show formally A monopoly’s profit function is π(Q) = R(Q) - C(Q), where R(Q) is its revenue function and C(Q) is its cost function The monopoly chooses output Q* to maximize its profit by using the necessary condition that the derivative of its profit function with respect to output equals zero: d2π(Q*) dR(Q*) dC(Q*) = = 0, (11.1) dQ dQ dQ where dR/dQ = MR is its marginal revenue function (Chapter 8) and dC/dQ = MC is its marginal cost function (Chapter 7) Thus, Equation 11.1 requires the monopoly to choose that output level Q* such that its marginal revenue equals its marginal cost: MR(Q*) = MC(Q*) For profit to be maximized at Q*, the second derivative of the profit function with respect to output must be negative: d2π(Q*) dQ2 = d2R(Q*) dQ2 - d2C(Q*) dQ2 0, (11.2) where d2R/dQ2 is the second derivative of the revenue function with respect to Q and d2C/dQ2 is the second derivative of the cost function By definition, d2R/dQ2 = dMR/dQ is the slope of its marginal revenue curve Similarly, d2C/dQ2 = dMC/dQ is the slope of the marginal cost curve Thus, Equation 11.2 requires that, at the critical point Q*, the slope of the marginal revenue curve be less than that of the marginal cost curve: d2R(Q*)/dQ2 d2C(Q*)/dQ2 or dMR(Q*)/dQ dMC(Q*)/dQ Typically, this condition is met because the marginal cost curve is constant or increasing with output (dMC/dQ Ú 0) and the monopoly’s marginal revenue curve is downward sloping (dMR/dQ 0), as we show next Marginal Revenue and the Demand Curves A firm’s marginal revenue curve depends on its demand curve We will demonstrate that a monopoly’s marginal revenue curve is downward sloping and lies below its demand curve at any positive quantity because its demand curve is downward sloping The following reasoning applies to any firm that faces a downward-sloping demand curve—not just to a monopoly The monopoly’s inverse demand function shows the price it receives for selling a given quantity: p(Q) That price, p(Q), is the monopoly’s average revenue for a given quantity, Q Its revenue function is its average revenue or price times the number of units it sells: R(Q) = p(Q)Q Using the product rule of differentiation, we can write the monopoly’s marginal revenue function as MR(Q) = M11_PERL4459_04_GE_C11.indd 387 dR(Q) d[p(Q)Q] dQ dp(Q) dp(Q) = = p(Q) + Q = p(Q) + Q. (11.3) dQ dQ dQ dQ dQ 3/30/17 5:02 PM www.downloadslide.net 388 CHAPTER 11 Monopoly and Monopsony Figure 11.1 Average and Marginal Revenue Price, p, $ per unit The demand curve shows the average revenue or price per unit of output sold The monopoly’s marginal revenue is less than the price p2 by area C (the revenue lost due to a lower price on the Q units originally sold) The monopoly’s initial revenue is R1 = p1Q = A + C If it sells one more unit, its revenue is R2 = p2(Q + 1) = A + B = A + p2 Thus, its marginal revenue (if one extra unit is a very small increase in its output) is MR = R2 - R1 = B - C = p2 - C, which is less than p2 Pearson MyLab Economics Video p1 p2 C Demand curve A B Q Q+1 Quantity, Q, Units per year The first term on the right-hand side of Equation 11.3, p(Q), is the price or average revenue The second term is the slope of the demand curve, dp(Q)/dQ, times the number of units sold, Q Because the monopoly’s inverse demand curve slopes downward, dp(Q)/dQ = 0, this second term is negative (In contrast, a competitive firm’s inverse demand curve has a slope of zero because it is horizontal, so the second term is zero, and the competitive firm’s marginal revenue equals the market price, as we saw in Chapter 8.) Thus, at a given positive quantity, a monopoly’s marginal revenue is less than its price or average revenue by [dp(Q)/dQ]Q That is, a monopoly’s marginal revenue curve lies below its inverse demand curve at any positive quantity Figure 11.1 illustrates the reason a monopoly’s marginal revenue is less than its price The monopoly, which is initially selling Q units at p1, can increase the number of units it sells by one unit to Q = by lowering its price to p2 The monopoly’s initial revenue is R1 = p1Q = A + C When it sells the extra unit, its revenue is R2 = p2(Q + 1) = A + B Thus, its marginal revenue from selling one additional unit is MR = R2 - R1 = (A + B) - (A + C) = B - C The monopoly sells the extra unit of output at the new price, p2, so it gains extra revenue from that last unit of B = p2 * = p2, which corresponds to the p(Q) term in Equation 11.3 Because it had to lower its price, the monopoly loses the difference between the new price and the original price, ∆p = (p2 - p1), on the Q units it originally sold, C = ∆p * Q, which corresponds to the (dp/dQ)Q term in Equation 11.3 Thus, the monopoly’s marginal revenue, B - C = p2 - C, is less than the price it charges by an amount equal to area C M11_PERL4459_04_GE_C11.indd 388 3/30/17 5:03 PM www.downloadslide.net 11.1 Monopoly Profit Maximization 389 In general, the relationship between the marginal revenue and demand curves depends on the shape of the demand curve The relationship between the marginal revenue and demand curve is the same for all linear demand curves, as we show in Solved Problem 11.1 SOLVED PROBLEM 11.1 Show that if a monopoly’s inverse demand curve is linear, its marginal revenue curve is also linear, has twice the slope of the inverse demand curve, intersects the vertical axis at the same point as the inverse demand curve, and intersects the horizontal axis at half the distance as does the inverse demand curve Pearson MyLab Economics Solved Problem Answer Write a general formula for any downward-sloping linear inverse demand curve Any linear demand curve can be written as p(Q) = a - bQ, where a and b are positive constants Derive the monopoly’s revenue function and then derive its marginal revenue function by differentiating the revenue function with respect to its output The monopoly’s revenue function is R = p(Q)Q = aQ - bQ2 The marginal revenue function is the derivative of the revenue function with respect to quantity: MR(Q) = dR/dQ = a - 2bQ Describe the properties of the marginal revenue function relative to those of the inverse demand function Both the marginal revenue function and the inverse demand functions are linear Both hit the vertical (price) axis at a: MR(0) = a - (2b * 0) = a and p(0) = a - (b * 0) = a The slope of the marginal revenue curve, dMR/dQ = -2b, is twice the slope of the inverse demand curve dp(Q)/dQ = -b Consequently, the MR curve hits the quantity axis at half the distance of the demand curve: MR = = a - 2bQ, where Q = a/(2b), and p = = a - bQ, where Q = a/b Marginal Revenue Curve and the Price Elasticity of Demand The marginal revenue at any given quantity depends on the inverse demand curve’s height (the price) and the elasticity of demand From Chapter 2, we know that the price elasticity of demand is e = (dQ/dp)/(p/Q) 0, which tells us the percentage by which quantity demanded falls as the price increases by 1% According to Equation 11.3, MR = p + (dp/dQ)/Q By multiplying and dividing the second term by p, rearranging terms, and substituting using the definition of the elasticity of demand, we can write marginal revenue in terms of the elasticity of demand: MR = p + dp dp Q 1 Q = p + p = p J1 + R = p ¢ + ≤ (11.4) dQ dQ p (dQ/dp)(p/Q) e According to Equation 11.4, marginal revenue is closer to price as demand becomes more elastic In the limit where e S - ∞, a monopoly faces a perfectly elastic demand curve (similar to that of a competitive firm), and its marginal revenue equals its price In Figure 11.2, we illustrate the relationship between the marginal revenue and the price elasticity of demand for a particular linear inverse demand function, M11_PERL4459_04_GE_C11.indd 389 p(Q) = 24 - Q (11.5) 3/30/17 5:03 PM www.downloadslide.net 390 CHAPTER 11 Monopoly and Monopsony Figure 11.2 Elasticity of Demand and Total, Average, and Marginal Revenue p, $ per unit The demand curve (or the average revenue curve), p = 24 - Q, lies above the marginal revenue curve, 24 MR = 24 - 2Q Where the marginal revenue equals zero, Q = 12, and the elasticity of demand is e = - Perfectly elastic, ε→ – ϱ Elastic, ε < –1 ∆MR = –2 ∆Q = ∆p = –1 ∆Q = ε = –1 12 Inelastic, –1 < ε < Marginal Revenue (MR = 24 – 2Q) Demand ( p = 24 – Q) Perfectly inelastic, ε = 24 12 Q, Units per day Its corresponding demand function is Q(p) = 24 - p The slope of this demand function is dQ/dp = -1, so the elasticity of demand at a given output level is e = (dQ/dp)(p/Q) = -p/Q = -(24 - Q)/Q = - 24/Q From the results of Solved Problem 11.1, the monopoly’s marginal revenue function is MR(Q) = 24 - 2Q (11.6) Where the demand curve hits the price axis (Q = 0), the demand curve is perfectly elastic, so the marginal revenue equals price: MR = p At the midpoint of any linear demand curve, the demand elasticity is unitary (see Chapter 2), e = -1, so, using Equation 11.4, we know that the marginal revenue is zero: MR = p[1 + 1/e] = p[1 + 1/(-1)] = In our example at the midpoint of the demand curve where Q = 12, the elasticity is e = - 24/12 = -1, and the marginal revenue is MR = 24 - (2 * 12) = To the right of the midpoint of the demand curve, the demand curve is inelastic, -1 … e … 0, so the marginal revenue is negative An Example of Monopoly Profit Maximization In Chapter 8, we found that any type of firm maximizes its profit by selling its output such that its marginal cost equals its marginal revenue We now examine how a monopoly maximizes its profit using an example with the linear inverse M11_PERL4459_04_GE_C11.indd 390 3/30/17 5:03 PM www.downloadslide.net 11.1 Monopoly Profit Maximization 391 demand function in Equation 11.5, p(Q) = 24 - Q, and a quadratic short-run cost function, C(Q) = VC(Q) + F = Q2 + 12, (11.7) where the monopoly’s variable cost is VC(Q) = Q2 and its fixed cost is F = 12 (see Chapter 7) The firm’s marginal cost function is MC(Q) = dC(Q) = 2Q (11.8) dQ The average variable cost is AVC = Q2/Q = Q, so it is a straight line through the origin with a slope of The average cost is AC = C/Q = (Q2 + 12)/Q = Q + 12/Q, which is U-shaped Panel a of Figure 11.3 shows the MC, AVC, and AC curves Figure 11.3 Maximizing Profit (a) Monopolized Market p, $ per unit (a) At Q = 6, where marginal revenue, MR, equals marginal cost, MC, profit is maximized The rectangle showing the maximum profit $60 is average profit per unit, p - AC = $18 - $8 = $10, times six units (b) Profit is maximized at a smaller quantity, Q = (where marginal revenue equals marginal cost), than revenue is maximized, Q = 12 (where marginal revenue is zero) Pearson MyLab Economics Video MC 24 AC AVC e 18 p = 60 12 Demand MR 12 24 Q, Units per day R, π, $ (b) Profit, Revenue 144 Revenue, R 108 60 M11_PERL4459_04_GE_C11.indd 391 Profit, π 12 24 Q, Units per day 3/30/17 5:03 PM www.downloadslide.net 392 CHAPTER 11 Monopoly and Monopsony The Profit-Maximizing Output. The firm’s highest possible profit is obtained by producing at the quantity Q* where its marginal revenue equals its marginal cost function: MR(Q*) = 24 - 2Q* = 2Q* = MC(Q*) Solving this expression, we find that Q* = Panel a of Figure 11.3 shows that the monopoly’s marginal revenue and marginal cost curves intersect at Q* = Panel b shows the corresponding profit and revenue curves The profit curve reaches its maximum at units of output, where marginal profit—the slope of the profit curve—is zero Because marginal profit equals marginal revenue minus marginal cost (Chapter 8), marginal profit is zero where the marginal revenue curve intersects the marginal cost curve at units in panel a The height of the demand curve at the profit-maximizing quantity is p = 18 Thus, the monopoly maximizes its profit at point e, where it sells units per day at a price of $18 per unit Why does the monopoly maximize its profit by producing units where its marginal revenue equals its marginal cost? At smaller quantities, the monopoly’s marginal revenue is greater than its marginal cost, so its marginal profit is positive By increasing its output slightly, it raises its profit Similarly, at quantities greater than units, the monopoly’s marginal cost is greater than its marginal revenue, so it can increase its profit by reducing its output slightly The profit-maximizing quantity is smaller than the revenue-maximizing quantity The revenue curve reaches its maximum at Q = 12, where the slope of the revenue curve, the marginal revenue, is zero (panel a) In contrast, the profit curve reaches its maximum at Q = 6, where marginal profit equals zero so that marginal revenue equals marginal cost Because marginal cost is positive, marginal revenue must be positive when profit is maximized Given that the marginal revenue curve has a negative slope, marginal revenue is positive at a smaller quantity than where it equals zero Thus, the profit curve must reach a maximum at a smaller quantity, 6, than the revenue curve, 12 As we already know, marginal revenue equals zero at the quantity where the demand curve has a unitary elasticity Because a linear demand curve is more elastic at smaller quantities, monopoly profit is maximized in the elastic portion of the demand curve (Here, profit is maximized at Q = where the elasticity of demand is -3.) Equivalently, a monopoly never operates in the inelastic portion of its demand curve APPLICATION Apple started selling the iPad on April 3, 2010 The iPad was not the first tablet.2 But it was the most elegant one, and the first one that large numbers of consumers wanted to own The iPad was a pioneer in a multi-touch, fingersensitive touchscreen (rather than a pressure-triggered stylus) and a virtual onscreen keyboard Most importantly, the iPad offered an intuitive interface, which allows the user easy access to Apple’s iTunes, e-books, and various application programs Apple’s iPad Indeed, the iPad wasn’t Apple’s first tablet Apple sold another tablet, the Newton, from 1993–1998 M11_PERL4459_04_GE_C11.indd 392 3/30/17 5:03 PM www.downloadslide.net 11.1 Monopoly Profit Maximization 393 People loved the original iPad Even at $499 for the basic model, Apple had a virtual monopoly in its first year According to the research firm IDC, Apple’s share of the 2010 tablet market was 87% Moreover, most consumers didn’t view the competing tablets as close substitutes Apple sold 25 million iPads worldwide in its first full year, 2010–2011 According to one estimate, the basic iPad’s marginal cost was only $220 Unfortunately for Apple, its monopoly was short lived Within a year of the iPad’s introduction, over a hundred iPad want-to-be tablets were available Apple’s share of the tablet market fell to 20% by the end of 2015 SOLVED PROBLEM 11.2 When the iPad was introduced, Apple’s constant marginal cost of producing its top-of-the-line iPad was about $220, its fixed cost was $2,000 million ( = $2 billion), and we estimate that its inverse demand function was p = 770 - 11Q, where Q is the millions of iPads purchased What was Apple’s average cost function? What was its marginal revenue function? What were its profit-maximizing price and quantity? What was its profit? Show Apple’s profit-maximizing solution in a figure P, $ per iPad Answer 1. D erive the average cost function using 770 495 p = 4.875 300 AC 220 MC MR 25 35 2. Derive Apple’s marginal revenue function Demand 70 Q, Millions of iPads per year M11_PERL4459_04_GE_C11.indd 393 the information about Apple’s marginal and fixed costs Given that Apple’s marginal cost was constant, its average variable cost, AVC, equaled its marginal cost, $220 Its average fixed cost, AFC, was its fixed cost divided by the quantity produced, 2,000/Q Thus, its average cost was AC = AVC + AFC = 220 + 2,000/Q using the information about its demand function Because the inverse demand function was p = 770 - 11Q, Apple’s revenue function was R = 770Q - 11Q2, so MR = dR/dQ = 770 - 22Q 3/30/17 5:03 PM www.downloadslide.net 394 CHAPTER 11 Monopoly and Monopsony Derive Apple’s profit-maximizing price and quantity by equating the marginal revenue and marginal cost functions and solving Apple maximized its profit where MR = 770 - 22Q = 220 = MC Solving this equation for the profit-maximizing output, we find that Q = 25 million iPads By substituting this quantity into the inverse demand equation, we determine that the profit-maximizing price was p = $495 per unit, as the figure shows Calculate Apple’s profit using the profit-maximizing price and quantity and the average cost At Q = 25, the firm’s average cost was AC = 220 + 2,000/25 = $300 The firm’s profit was π = (p - AC)Q = [495 - 300]25 = $4,875 million ( = $4.875 billion) The figure shows that the profit is a rectangle with a height of (p - AC) = $195 and a length of Q = 25 The Shutdown Decision. Should a profit-maximizing monopoly produce at the output level determined by its first-order condition, Q*, or shut down? In the short run, the monopoly shuts down if the monopoly-optimal price is less than its average variable cost In our short-run example in Figure 11.3, at the profitmaximizing output, the average variable cost is AVC(6) = 6, which is less than the price, p(6) = 18, so the firm chooses to produce Equivalently, the firm’s revenue, R(6) = p(6)6 = (24 - 6)6 = 108, exceeds its variable (or avoidable) cost, VC(6) = 62 = 36, so the firm chooses to produce Indeed, the monopoly makes a positive profit Because its profit is π = p(Q)Q - C(Q), its average profit is π/Q = p(Q) - C(Q)/Q = p(Q) - AC Thus, its average profit (and hence its profit) is positive only if price is above the average cost At Q* = 6, its average cost, AC(6) = 8, is above its price, p(6) = 18 Its profit is π = 60, which is the shaded rectangle with a height equal to the average profit per unit, p(6) - AC(6) = 18 - = 10, and a width of units Choosing Price or Quantity Unlike a competitive firm, a monopoly can adjust its price, so it has the choice of setting its price or its quantity to maximize its profit (A competitive firm must set its quantity to maximize profit because it cannot affect market price.) The monopoly is constrained by the market demand curve Because the demand curve slopes downward, the monopoly faces a trade-off between a higher price and a lower quantity or a lower price and a higher quantity The monopoly chooses the point on the demand curve that maximizes its profit Unfortunately for the monopoly, it cannot set both its quantity and its price and thereby pick a point that is above the demand curve If it could, the monopoly would choose an extremely high price and an extremely high output level and would become exceedingly wealthy If the monopoly sets its price, the demand curve determines how much output it sells If the monopoly picks an output level, the demand curve determines the price Because the monopoly wants to operate at the price and output at which its profit is maximized, it chooses the same profit-maximizing solution whether it sets the price or the output In this chapter, we assume that the monopoly sets the quantity M11_PERL4459_04_GE_C11.indd 394 3/30/17 5:03 PM www.downloadslide.net 770 Index Leaders, Stackelberg oligopoly model and, 529 Learning by doing, results in lower costs, 260–262 Leibniz’s rule, 339 Leisure demand for, 184 labor-leisure choice, 182–183 labor supply curve and, 185 Lemons comparing market for lemons and market for good cars, 663 products of unknown quality, 662–664 products with variable quality, 665 Lerner Index (price markup), 398–399 Licensing barriers to market entry, 408 liquor licenses, 311, 341–342 occupational, 47 Linear production function, elasticity of substitution and, 217 Liquor licenses, quotas on, 311, 341–342 Living-wage laws, 355 Loans, government crowding out private investment, 576 Long-run competition See Competitive firms, long-run Long-run costs approaches to minimizing, 247–248 calculus applied to minimizing, 249–250 estimating cost curves vs introspection, 257 factor price changes and, 252 input choices and, 245 isocost line for summarizing cost information, 245–247 maximizing output while minimizing costs, 250–251 overview of, 244–245 shape of cost curves, 255–256 varying with output, 252–255 Long-run elasticity, 59–62 Long-run factor demand curves comparing short- and long-run labor demand curves, 561–562 for competitive firm, 561 overview of, 560 paper firm example, 562 Long-run production, with two variable inputs diminishing marginal rates of technical substitution, 215–216 elasticity of substitution, 216–218 isoquants for interpreting production inputs and outputs, 210–211 overview of, 210 properties of isoquants, 211–212 shape of isoquants, 212–214 substituting inputs, 214–215 Long-run profit, zero profit in competitive firms, 312–314 Long-run supply curves See Supply curves, long-run Loss aversion, contracts, 619 Lowest-isocost rule, cost minimization, 247 Lucasfilm, cartel example, 512–513 Z05_PERL4459_04_GE_IDX.indd 770 M Malthus, Thomas, 208–209 Management, of firms, 201 Marginal benefit (MB), cost-benefit analysis of pollution, 637–638 Marginal costs (MC) cost-benefit analysis of pollution, 637–638 Counot model with many firms, 521–522 deciding whether to advertise, 462 effects of taxes on costs, 243–244 Lerner Index and, 398–399 in monopolistic competition, 543 output rules and, 279–280 price equal to marginal cost at competitive equilibrium, 322 prices of exhaustible resources and, 581–582 profit maximization in monopolies and, 387 profit maximization varying with price, 288 shape of cost curve, 240–241 short-run cost measures, 237–238 short-run output decisions, 281–284 short-run shutdown decisions, 286 welfare effects of pollution in competitive markets, 628–629 Marginal expenditure, in monopsonies, 420 Marginal profit, output rules and, 279–280 Marginal rate of substitution (MRS) competition and, 369–371 deriving contract curves, 360 determining for five different utility functions, 96–97 diminishing rate of substitution, 96 efficient product mixes and, 369 marginal rate of transformation compared with, 102 mutually beneficial trades and, 359 between recorded tracks and live music, 96 willingness to substitute between goods, 93–95 Marginal rate of technical substitution (MRTS) for Cobb-Douglas production function, 215 diminishing, 215–216 elasticity of substitution, 216–218 substituting inputs, 214–215 Marginal rate of transformation (MRT) benefits of trade, 367 comparative advantage and, 365–366 competition and, 369–371 efficient product mixes, 369–370 slope of budget line, 102 Marginal revenue (MR) Counot model with many firms, 521–522 in monopolies, 387–389 in monopolistic competition, 543 output rules and, 279–280 price elasticity of demand in monopolies, 389–390 profit maximization in monopolies and, 387–388 short-run output decisions, 281–284 Marginal revenue product of labor (MRPL) comparing short- and long-run labor demand curves, 561–562 effect of wage changes on short-run labor demand, 557–558 long-run factor demand curve, 560 long-run factor demand curve for competitive firm, 561 short-run factor demand curve for labor in competitive firm, 556–557 short-run factor demand curve for labor in noncompetitive firm, 559–560 Marginal tax rate, 190–192 Marginal utility of mutually beneficial trades, 358 relationship to marginal rate of substitution, 94–95 Marginal willingness to pay, for products, 166 Market consumer surplus, 170–171 Market equilibrium with asymmetric information, 664 comparative statics with discrete (relatively large) changes, 46–47 comparative statics with small changes, 47–50 competitive See Competitive equilibrium equilibrium effects of tax on supply and demand, 63–65 finding, 43–44 forces driving market to equilibrium, 44–45 general See General equilibrium overview of, 42 shocks to equilibrium, 45 short-run equilibrium effect of specific tax, 292–293 with symmetric information, 662–663 Theory of the Second Best, 379–380 Market makers, 45 Market power ability to price discriminate, 433–434 government actions that reduce, 410 impact on price of exhaustible resources, 582 monopolistic competition, 506 monopsonies, 422 resulting from price ignorance, 670 shape of demand curve and, 397–398 sources of, 399 two-part pricing and, 452 welfare effects of, 399–400 Market price producer surplus and, 316 short-run output decisions, 281–284 short-run shutdown decisions, 285–286 Market structures, externalities and monopolies, 639 monopolies vs competitive welfare, 639–640 overview of, 638–639 taxing externalities in noncompetitive markets, 641 3/30/17 5:15 PM www.downloadslide.net Index Markets cartels See Cartels competitive See Competitive market model competitive equilibrium in two interrelated markets, 351–353 deviations from perfect competition, 273–276 entry and exit See Entry/exit factor markets See Factor markets long-run competitive firms See Competitive firms, long-run market failure, 506 monopolies See Monopolies monopolistic competition See Monopolistic competition multimarket analysis of equilibrium, 351 mutual funds subject to market-wide risk, 606 oligopolies See Oligopolies overview of market structures, 507–508 perfectly competitive, 276 for pollution, 643–644 reasons for horizontal demand curves, 272–273 short-run competitive firms See Competitive firms, short-run Marshall, Alfred, 147 Marshallian demand curves, 147 Materials (M), inputs of production, 202 Maximizing well being See Consumers MB (Marginal benefit), cost-benefit analysis of pollution, 637–638 MC See Marginal costs (MC) Mergers, as alternative to collusion, 515 Microeconomics, introduction allocation of scarce resources, 23–25 maximizing subjects to constraints, 27–28 models, 25–26 positive vs normative statements, 28–29 simplification by assumption in microeconomic models, 26 summary, 30 testing theories, 27 use of models, 29–30 Microsoft Word, rivalry and exclusion and, 646–647 Mill, John Stuart, 377 Minimum efficient scale (full capacity), in monopolistic competition, 544 Minimum wages analysis of minimum wages with incomplete coverage, 353–356 unemployment caused by, 73–74 Mixed bundling, 459–460 Mixed strategies, static games, 482–484 Moble Number Portability (MNP), 523 Models maximizing subject to constraints, 27–28 overview of, 25–26 positive vs normative statements in, 28–29 of principal-agent problem, 687–688 simplification by assumption, 26 testing theories, 27 use of, 29–30 Monitoring after-the-fact monitoring, 707–708 bonds in, 703–704 Z05_PERL4459_04_GE_IDX.indd 771 deferred payments to prevent moral hazard, 706 efficiency wages to prevent moral hazard, 706–707 problems with bonds, 705 to reduce moral hazard, 703, 707–708 Monopolies Botox example, 409–410 brand name and generic drug example, 385, 424–425 cable car example of profit maximization, 396 causes of, 404–405 choosing price vs quantity, 394 cost advantages that create, 405–407 deciding how much to advertise, 462–463 deciding whether to advertise, 461–462 dynamic analysis, 416–417 effects of shift in demand curve, 395–396 example of profit maximization, 390–391 exercises, 426–429 externalities and, 639 government actions that create, 407–408 government actions that increase competition, 415–416 government actions that reduce market power, 410 group price discrimination vs singleprice monopoly, 450 introductory pricing in a two-period monopoly, 419 iPad example, 392–394 Lerner Index (price markup), 398–399 marginal revenue and demand curves, 387–389 marginal revenue and price elasticity of demand, 389–390 market power and shape of demand curve, 397–398 market power affecting welfare, 399–400 market power resulting from price ignorance, 671–672 market structures and, 507–508 network externalities and, 417–419 overview of, 386 problems with regulation, 413 profit maximization, 386–387 profit maximizing output, 391 regulating, 410–414 regulating natural gas, 414–415 shutdown decisions, 394 sources of market power, 399 specific tax affecting, 401–404 summary, 425–426 taxes affecting, 401 uniform vs nonuniform pricing, 431–432 vs competitive welfare, 639–640 welfare effects of ad valorem tax vs specific tax, 404–405 Monopolistic competition fixed costs and fixed number of firms, 544–545 market power and, 506 771 market structures and, 507–508 monopolistically competitive equilibrium, 543–544 overview of, 542–543 price setters in, 74 Monopsonies exercises, 429 overview of, 419–420 profit maximization, 420–422 summary, 426 welfare effects of, 422–424 Monopsony power, 422 Moral hazard after-the-fact monitoring, 707–708 arising from hidden actions, 661 bonds, 703–705 deferred payments to prevent, 706 due to inefficient use of resources, 686 efficiency wages to prevent, 706–707 eliminating by making information more symmetric, 697 health insurance and, 701–702 honest cabbie example, 690 monitoring to reduce, 703 problems related to opportunism, 660 More-is-better (Nonsatiation) consumer preferences, 86–87 in mutually beneficial trades, 358 More-is-better (nonsatiation) property, consumer preferences, 86–87 Movement along demand curve consumer choice and, 127 due to price change, 35–36 equilibrium effect of, 46 Movement along indifference curve, substitution effects causing, 143 Movement along supply curve, due to price change, 39–40 Moves, game, 472 MRPL See Marginal revenue product of labor (MRPL) MRS See Marginal rate of substitution (MRS) MRT See Marginal rate of transformation (MRT) MRTS See Marginal rate of technical substitution (MRTS) Multimarket analysis of corn and soybean markets, 352–353 of equilibrium, 351 Multiperiod (repeated) games, 472, 485–486 Multiple equilibria, static games, 480–481 Mutual funds, diversification (risk pooling), 605–606 N Nash-Bertrand equilibrium compared with Nash-Cournot equilibrium, 538–539 with differentiated products, 539–542 with identical products, 537–538 Nash-Cournot equilibrium airlines example, 531–532 applying to many firms, 520–522 applying to nonidentical firms, 526–527 3/30/17 5:15 PM www.downloadslide.net 772 Index Nash-Cournot equilibrium (continued) compared with Nash-Bertrand equilibrium, 538–539 comparing collusive, Nash-Cournot, Stackelberg, and competitive equilibria, 534–535 duopoly example, 536 duopoly Nash-Cournot equilibrium, 516–520 varying with number of firms, 523 Nash equilibrium achieving profit maximization in oligopoly, 477–480 game strategies and, 475–477 mixed strategies and, 482–484 multiple equilibria, 480–481 oligopolies and, 506 subgame perfect Nash equilibrium, 488–489 Nash, John, 476 Natural disasters government policies and, 348–349 limited insurance for, 610–611 Natural gas industry, regulation of, 414 Natural monopolies, 406–407 Needs, study of wants vs needs, 28 Negative externalities market structure and, 638–639 overview of, 626–627 pollution as See Pollution spam as, 631–632 taxing drivers to reduce, 636 taxing in noncompetitive markets, 641 welfare effects in competitive markets, 629–630 Net present value (NPV), approach to investing, 570–571 Network externalities behavioral economics, 417–418 eBay example, 418–419 as explanation for monopolies, 418 Nominal price, of goods, 151 Noncompetitive firms, short-run factor demand curves for, 559 Nondurable services, factor markets, 554 Nonlinear price discrimination See Price discrimination, nonlinear Nonprofit firms, 199 Nonrival goods, 626 Nonsatiation (more-is-better) consumer preferences, 86–87 in mutually beneficial trades, 358 Nonuniform pricing bundling, 457–460 price discrimination See Price discrimination two-part pricing See Two-part pricing Normal-form representation, of static games, 474–477 Normal goods income and substitution effects, 141–144 vs inferior goods, 139 Normative statements, vs positive statements, 28–29 NPV (Net present value), approach to investing, 570–571 Z05_PERL4459_04_GE_IDX.indd 772 O Oil See Petroleum/petroleum products Oligopolies airlines game tree, 487 Bertrand model See Bertrand oligopoly model cartels See Cartels Cournot model See Cournot oligopoly model defined, 472 exercises, 548–553 market structures and, 507–508 mixed strategies and, 482–484 with multiple equilibria, 480–481 overview of, 505–506 price setting in, 74 profit maximization in, 477–480 repeated games, 485–486 Stackelberg model See Stackelberg oligopoly model strategic advertising example, 479–480 subgame perfect Nash equilibrium for predicting outcome, 488–489 summary, 548 OPEC (Organization of Petroleum Exporting Countries) See also Petroleum/petroleum products cartel example, 508 demand elasticity over time, 59 impact of market power on price of exhaustible resources, 582 price controls on, 70–71 Open-access common property overview of, 626 rivalry and exclusion and, 645–646 Open skies agreement, 514 Opportunistic behavior See also Adverse selection; Moral hazard due to asymmetric information, 660 preventing, 669–670 Opportunity costs of capital, 234–235 economic profit and, 313 in formula for profit, 277 of MBA degree, 233 overview of, 233 Opt in vs opt out, endowment effects, 119 Optimal bundle (consumer’s optimum) See also Bundle of goods (market basket) on convex sections of indifference curves, 114–115 corner solutions, 111 deriving optimal choice with indifference curves, 134–135 income and substitution effects with inferior good, 144–145 income and substitution effects with normal good, 141–144 interior solution using calculus, 105–106 interior solution using graph, 103–105 interior solution using short cut, 109–110 Lagrangian method, 108–109 perfect substitutes utility function, 111–112 quasilinear utility function, 112–114 substitution method, 106–107 theory of revealed preference, 157–158 Optimal price, regulation of monopolies and, 410–412 Ordinal preferences, in choosing bundle of goods, 91–92 Organization of Petroleum Exporting Countries See OPEC (Organization of Petroleum Exporting Countries) Organizational innovations cost advantages that create monopolies, 405 productivity and, 224–225 Output decisions output rules, 278–280 producing less than competitive output lowers welfare, 319–320 producing more than competitive output lowers welfare, 320–322 in profit maximization, 278 in short-run competition, 281–284 Outputs, production elasticity in respect to labor, 207 isoquants for interpreting, 210–211 long-run costs varying with, 252–255 maximizing while minimizing costs, 250–251 profit maximization in monopolies, 391 in short-run production, 203–204 technological efficiency in, 231 types of, 199 Overconfidence, biased assessments of probabilities, 615 Overhead, types of fixed costs, 236 Ownership, of for-profit firms, 200 P Paasche index, 156–157 Package tie-in sales, 457–460 Paper mills, reducing pollution from, 634 Parasite singles, 483–484 Pareto efficient allocations, 364–365, 374 applying to optimal provision of public good, 649–650 competitive equilibrium, 364 competitive exchange, 361–362 contract curve of allocations, 359 efficiency vs equity, 378–379 free trade, 356 overview of, 349 Pareto improvement, 349 Pareto principle applying to allocations and government policies, 374 overview of, 349 Pareto, Vilfredo, 349 Partial-equilibrium analysis of corn and soybean markets, 352–353 general equilibrium compared with, 350 Partnerships, ownership of for-profit firms, 200 Patents Botox example, 409–410 brand name vs generic drugs and, 385 government actions that create monopolies, 407–408 overview of, 386 Pay cut, vs layoff, 709–711 3/30/17 5:15 PM www.downloadslide.net Index Payoff function, in game theory, 472 Payoff (profit) matrix, in normal-form games, 474 Per-unit prices, in two-part pricing, 452 Perfect competition in Chicago Commodity Exchange, 273 deviations from, 273–274 deviations of demand curve, 274–276 market structures and, 507–508 maximizing well-being, 318 overview of, 270–271 price taking, 74, 271–272 reasons for horizontal demand curves, 272–273 why it is important, 276 Perfect complements demand functions for perfect complements utility function, 128 indifference curve for, 98 Perfect price discrimination See Price discrimination, perfect Perfect substitutes, indifference curve for, 97–98 Perfect substitutes utility function demand functions for, 128–129 finding optimal bundle using corner solutions, 111–112 Perfectly elastic demand curve, 54 Perfectly elastic supply curve, 58 Perfectly inelastic supply curve, 58–59 Petroleum/petroleum products anti-price gouging laws, 348, 380–381 demand elasticity over time, 59–62 effect of tariff or quota on oil, 338–339 effects of price ceiling on gasoline, 71 fracking and shutdown decisions, 286–287 social cost of natural gas price ceiling, 333 supply curve for reformulated gasoline, 302–303 surety bond for capping oil and gas bankruptcies, 705–706 Piece rate, types of contracts, 688 Pixar, cartel example, 512–513 Players, in static games, 473 Policies See also Laws/legality; Rules and regulations comparing trade policies, 333 creating wedge between supply and demand curves, 325 cutting taxes, 190–191 entry barriers, 324 exit barriers, 324–325 food stamps, 180–182 free trade vs ban on imports, 334–336 free trade vs quotas, 340 free trade vs tariffs, 336–339 import policies impacting supply curves, 41–42 liquor licenses, 311, 341–342 overview of, 178 price ceilings, 70–73, 331–333 price floors, 73–74, 327–330 promoting price discrimination and preventing resale, 435 quotas, 178–180 rent seeking and trade policies, 340–341 Z05_PERL4459_04_GE_IDX.indd 773 sales taxes, 325–327 shifting supply curves, 323 subsidizing ethanol, 68 subsidizing farms, 330–331 tax salience and, 120 welfare policies, 178 Pollution benefits vs costs in pollution control, 636–637 cost-benefit analysis, 630–631 emissions fees, 634–635 emissions fees vs emissions standards, 637–638 emissions standards, 633–634 property rights and, 625, 641–643 regulating externalities, 632–633 supply and demand analysis, 627–630 taxes for controlling, 635–636 trade and, 625, 653–654 Pooling equilibrium, applied to wages, 676–679 Positive externalities, 627 Positive statements, vs normative statements, 28–29 PPF See Production Possibility Frontier (PPF) Predictions model use for, 25 positive statements, 28 regarding income elasticities, 140 Prefectly inelastic demand curve, 53 Preference maps, 87 Preferences, consumer indifference curves, 88–90 overview of, 85 preference maps, 87 properties of, 85–86 quasilinear utility function, 99 theory of revealed preference, 157–158 Present bias (self-control issue), resulting in falling discount rates, 575 Present value (PV) determining when to sell an exhaustible resource (coal example), 577 interest rates and, 566–567 Price ceilings See also Price controls nonoptimal price regulation of monopolies, 412 optimal price regulation of monopolies, 410–412 overview of, 70–72 shortages due to (Venezuelan example), 72–73 social cost of ceiling on natural gas, 333 welfare effects of, 331–333 Price-consumption curve, applying to beer consumption, 131 Price controls anti-price gouging laws, 348, 380–381 for farm products, 327–329 farm subsidies, 330–331 government role in efficiency and equity, 371 optimal regulation of monopolies, 410–412 policies creating wedge between supply and demand curves, 325 price ceilings, 70–72 773 price floors, 73–74 shortages due to price ceiling (Venezuelan example), 72–73 social cost of, 333 welfare effects of price ceilings, 331–333 welfare effects of price floors, 327–330 Price discrimination Disneyland example, 434 exercises, 466–470 not all prices differences are due to price discrimination, 435–436 resale prevention, 434–435 summary, 466 types of, 436 which firms can price discriminate, 433–434 why it pays, 433 Price discrimination, group example of textbook resale, 445–447 Harry Potter example, 443–444 identifying groups, 447–449 overview of, 442–443 prices and elasticities and, 444–445 types of price discrimination, 436 welfare effects of, 449–450 Price discrimination, nonlinear bundling tie-in sales, 457–460 iTunes pricing example, 456 overview of, 450–452 requirement tie-in sales, 457 tie-in sales, 456–457 two-part pricing, 452 two-part pricing with differing consumers, 454–455 two-part pricing with identical consumers, 453–454 types of price discrimination, 436 Price discrimination, perfect Botox example, 441 calculus analysis, 437–438 efficient but harms consumers, 439–441 Google ads example, 442 graphical analysis, 436–437 overview of, 436 transaction costs and, 442 Price elasticity of demand See also Elasticity of demand overview of, 52–53 varying along demand curve, 53–56 Price elasticity of supply See also Elasticity of supply, 57 Price floors See also Price controls overview of, 73–74 welfare effects of, 327–330 Price markup (Lerner Index), 398–399 Price setters monopolies as, 386 in monopolistic competitive markets, 74 Price taking perfect competition and, 271–272 in perfectly competitive markets, 74 in trade between two people, 362 Price theory See also Microeconomics, introduction, 23 Prices advertising and, 460–461, 672–673 applying Counot model to many firms, 521 3/30/17 5:15 PM www.downloadslide.net 774 Index Prices (continued) change causing movement along demand curve, 35–36 change causing movement along supply curve, 39–40 change affecting consumer surplus, 169–170 choosing price vs quantity in monopolies, 394 deciding how much to advertise, 462–464 deciding whether to advertise, 461–462 demand impacted by, 33, 141 determining allocation of scarce resources, 24 discrimination See Price discrimination equal to marginal cost at competitive equilibrium, 322 exercises, 466–470 Heinz ketchup sales price example, 431, 464–465 Lerner Index and, 398–399 market power resulting from price ignorance, 670–672 in monopolistic competition, 543 nominal and real, 152 not all prices differences are due to price discrimination, 435–436 optimal regulation of monopolies, 410–412 overview of, 431–433 profit maximization varying with, 288 summary, 466 tobacco use relative to, 131–132 Prices, of scarce exhaustible resources overview of, 577–578 reasons for rising prices, 579–580 reasons why price does not rise, 581–582 redwood tree example, 580–581 rents, 579 in two-period example, 578–579 Principal-agent problem, 687–688 Principals, in contracts checks on, 709–711 efficiency of contracts, 688–689 overview of, 686 principal-agent problem, 687–688 production efficiency and, 691–692 Prisoners’ dilemma game best responses, 476 joint profit maximizing, 478 repeated games, 485–486 Private firms overview of, 199 ownership of, 200 Private goods, rivalry and exclusion and, 644–645 Private marginal costs, welfare effects of pollution in competitive markets, 628–629 Private-value auctions, bidding strategies in, 494–495 Privatization, of state-owned monopolies, 408 Probability assessing risk, 590–592 biased assessments of, 614–615 Z05_PERL4459_04_GE_IDX.indd 774 Probability distributions, in assessing risk, 592 Producer surplus (PS) applying, 317 effect of tariff or quota on oil, 338–339 iTunes pricing example, 456 measuring welfare, 318–321 measuring with supply curve, 315–317 overview of, 315 relationship to profit, 312 tomato example, 317–318 welfare effects of eliminating free trade, 335–336 welfare effects of pollution in competitive markets, 628–629 welfare effects of sales taxes, 325–327 Producers, number of, 368–369 Product liability, laws preventing opportunism, 669 Production constant, increasing, and decreasing returns to scale, 219–220 diminishing marginal rates of technical substitution, 215–216 elasticity of output in respect to labor, 207 elasticity of substitution, 216–218 exchange economy and See Trade, with production exercises, 227–230 firm inputs, 202 graphing relationship to variable labor, 205–207 isoquants for interpreting inputs and outputs, 210–211 labor productivity during downturns, 225–226 law of diminishing marginal returns, 208–209 in long-run with two variable inputs, 210 organizational innovations, 224–225 production costs impacting supply, 39 production functions, 202 properties of isoquants, 211–212 relative productivity, 222–223 returns to scale, 218 returns to scale by industries, 220–221 shape of isoquants, 212–214 in short-run with one variable and one fixed input, 203–204 substituting inputs, 214–215 summary, 226–227 technical change and, 222 technical innovations, 223–224 technological efficiency in, 231 time and variability of inputs, 202–203 trade-offs between efficiency and riskbearing, 698–700 varying returns to scale, 221–222 Production efficiency, trade-off with risk bearing, 698–700 Production functions Cobb-Douglas production functions, 210, 215 elasticity of substitution and, 216–218 overview of, 202 for rice in China, 207 shape of short-run cost curves and, 240–243 Production Possibility Frontier (PPF) comparative advantage and, 366 efficient product mixes, 369–370 example, 367 marginal rate of transformation and, 365–366 number of producers and, 368–369 optimal product mixes, 368 overview of, 365 Productivity labor productivity during downturns, 198, 225–226 organizational innovations and, 224–225 relative productivity, 222–223 technical innovations and, 223–224 Products adverse selection due to products of unknown quality, 662–664 adverse selection with products of variable quality, 665 differentiated, 525–527, 539–542 durability of, 572–573 efficient product mixes, 369–370 gas and oil-related See Petroleum/ petroleum products identical, 272–273, 537–538 optimal product mixes, 368 reasons for horizontal demand curves, 272 undifferentiated products in Cournot oligopoly, 516 Profit cable car example of profit maximization in monopolies, 396 deciding whether to advertise, 461–463 defined, 277–278 maximization as firm motive, 201 maximization in long-run competition, 293 maximization in monopolies, 386–387, 390–391 maximization in monopsonies, 420–422 maximization in short-run competition, 281 maximization required for surviving in competitive market, 315 overview of, 276–277 profit maximizing output in monopolies, 391 steps in maximizing, 278–280 varying with price, 288 zero long-run profit in competitive firms, 312–314 Profit (payoff) matrix, in normal-form games, 474 Profit-sharing contracts asymmetric information and, 697 full information and, 695–696 Property ownership, risk reduction and, 603–604 Property rights See also Externalities allocating to reduce externalities, 641 Coase Theorem and, 641–643 exercises, 655–657 overview of, 625–626 summary, 654–655 3/30/17 5:15 PM www.downloadslide.net Index Prospect theory (Kahneman and Tversky) comparing with Expected Utility theory, 618 overview of, 617 properties of, 618–619 PS See Producer surplus (PS) Public firms, 199 Public goods free riding and, 647–649 optimal provision of, 649–650 overview of, 647 reducing free riding, 651 rivalry and exclusion and, 626 valuing, 651–653 Public utilities barriers to market entry, 408 as natural monopoly, 406–407 Pulp mills, reducing pollution from, 634 Pure bundling, 457–459 PV (Present value) determining when to sell an exhaustible resource (coal example), 577 interest rates and, 566–567 Q Quality adverse selection due to products of unknown quality, 662–664 adverse selection due to products of variable quality, 665 profit maximization in monopolies and, 387 Quantity choosing price vs quantity in monopolies, 394 profit maximization in monopolies and, 387 Quantity demanded See Demand Quantity supplied See Supply Quasilinear utility function demand functions for, 128 finding optimal bundle using corner solutions, 112–114 indifference curves and, 99 Quotas on liquor licenses, 311, 341–342 on oil, 338–339 vs free trade, 340 as welfare policy, 178–180 R Rate of return, on investment, 569 Rationality See Transitivity (rationality) Real price, of goods, 151 Rebates, in group price discrimination, 448–449 Reciprocity, in behavioral game theory, 498 Reflection effect, violations of expected utility theory, 617 Regulation See Laws/legality; Policies; Rules and regulations Relative productivity, 222–223 Rent contract (fixed fee) asymmetric information and, 696 full information and, 693 Rent seeking, trade policies and, 340–341 Z05_PERL4459_04_GE_IDX.indd 775 Rents farm rent example of zero long-run profit, 313–314 of scarce exhaustible resource, 579 Repeated (multiperiod) games, 472, 485–486 Requirement tie-in sales, 457 Resale designer bag example, 435 preventing, 434–435 price discrimination and, 434 textbook example, 445–447 Reservation prices by customer groups, 442 of lemon owners, 662 in mixed bundling, 459–460 price discrimination and, 433 in pure bundling, 458–459 Residual demand curves, 274–276 Residual supply curves, 354 Resources, exhaustible allocation of, 23–25 exercises, 587–588 overview of, 576–577 price in two-period example, 578–579 price of (coal example), 577–578 reasons for rising prices, 579–580 reasons why price does not rise, 581–582 redwood tree example, 580–581 rents, 579 summary, 585 when to sell, 577 Retirement, saving for, 568–569 Returns to scale constant, increasing, and decreasing, 219–220 by industries, 220–221 overview of, 218 technical change and, 222 varying, 221–222 Returns to specialization, 221 Revenue economic profit and, 313 in formula for profit, 277 shutdown rules and, 280 Revenue-sharing contract asymmetric information and, 697 full information and, 694 Reverse auctions, 448 Risk Arrow-Pratt measure of, 601–603 assessing, 590 behavioral economics and, 614 biased assessments, 614–615 diversification for reducing, 604–607 expected utility theory applied to, 595–596 expected value and, 592–593 gambling example, 600–601 information for reducing, 604 insurance for reducing, 608–611 investing depending on attitudes toward, 611–613 investing with uncertainty and discounting, 613–614 liability and (BP and Transocean oil spill example), 589, 619–620 probability of, 591–592 prospect theory and, 617–619 775 reducing risk, 603–604 risk aversion, 596–598 risk neutrality, 599–600 risk preference, 599–600 trade-offs between production efficiency and risk-bearing, 698–700 variance and standard deviation and, 594–595 violations of expected utility theory, 616–617 willingness to gamble, 602–603 worldwide financial crisis due to excessive risk taking, 685 Risk aversion Arrow-Pratt measure of, 601–603 choosing contracts and, 699–700 determining amount of insurance to buy, 607–608 expected utility theory applied to, 595–596 investing and, 612 risk premium and, 598–599 unwillingness to take a fair bet, 596–598 Risk neutrality choosing contracts and, 699–700 investing and, 611–613 overview of, 599–600 Risk pooling See Diversification (risk pooling) Risk preference, 599–600 Risk premium, 598–599 Rivalry/exclusion club goods, 645–647 exercises, 657 open-access common property, 645–646 overview of, 625–626, 644–645 private goods, 644–645 public goods, 645, 647–650 reducing free riding, 651 summary, 655 valuing public goods, 651–653 Rules and regulations See also Laws/ legality; Policies cost/benefit analysis of pollution control, 636–637 demand impacted by, 33 emissions fees, 634–635, 637–638 emissions standards, 633–634, 637–638 mergers and, 515 monopolies and, 410–414 of natural gas industry, 414–415 problems with government intervention, 534 problems with regulation of monopolies, 413 of public goods, 646 regulation externalities, 632–633 supply impacted by, 39 trucking industry example, 270, 305–306 valuing public goods, 651–653 Rules, static games, 473 S Safety, worker safety example, 659, 680–681 Sales prices, Heinz ketchup example, 431, 464–465 3/30/17 5:15 PM www.downloadslide.net 776 Index Sales taxes policies creating wedge between supply and demand curves, 325 tariffs compared with, 337 welfare effects of, 325–327 Sales taxes, equilibrium effects ad valorem taxes and specific taxes having similar effects, 68–69 effect same regardless of who is taxed, 65 overview of, 63 of specific taxes, 63–64 who pays, 65–66 Salience, in behavioral economics, 119–120 Savings interest rates and, 575 for retirement, 568–569 SC (Scope economies) See Economies of scope Scale, returns to See Returns to scale Scarce resources See also Resources, exhaustible, 23–25 Scarcity maximizing subject to constraints, 27–28 prices of exhaustible resources and, 581 Scholarship, impact on labor-leisure choice, 187–188 Scope economies (SC) See Economies of scope Screening in hiring, 679–680 reducing adverse selection, 666–667 remanufactured goods and, 668–669 Sealed-bid auction bidding strategy in, 495–496 defined, 494 Second-degree price discrimination See Price discrimination, nonlinear Second-price auction strategy, 494–495 Secret ingredients, advertising and, 479 Self-control issue (present bias), resulting in falling discount rates, 575 Separating equilibrium, education as signal in labor market, 676–678 Sequential games airlines example, 486–487 credibility in, 489–490 game tree applied to airlines industry, 487 overview of, 472 subgame perfect Nash equilibrium for predicting outcome, 488–489 Shareholders, ownership of for-profit firms, 200 Sharing contracts See Splitting (sharing) contracts Sharing economy, short-run costs and, 237 Sherman Antitrust Act in 1,912, 511–512 Shift in demand curves due to factors other than price, 36–37 effects in monopolies, 395–396 income causing, 132–135 Shift in supply curves depends on shape of demand curve, 50 due to factors other than price, 40–41 equilibrium effect of, 46 Shocks to equilibrium comparative statics with discrete (relatively large) changes, 46–47 Z05_PERL4459_04_GE_IDX.indd 776 comparative statics with small changes, 47–50 overview of, 45 value of producer surplus in measuring, 317 Short-run competition See Competitive firms, short-run Short-run costs cost curve for Japanese beer manufacturer, 242–243 cost curves, 239–240 long-run average cost as envelope of short-run average cost curves, 257–259 measures, 236–239 overview of, 236 shape of average cost curve, 241–242 shape of cost curves, 240 shape of marginal cost curve, 240–241 short-run and long-run expansion paths, 260–261 tax effects on, 243 Short-run elasticity, 59–62 Short-run equilibrium effect, of specific tax, 292–293 Short-run factor demand curves comparing short and long-run labor demand curves, 561–562 for competitive firms, 556–559 for noncompetitive firms, 559 overview of, 555–556 Short-run output decisions, 281–284 Short-run production, with one variable and one fixed input elasticity of output in respect to labor, 207 graphing relationship of production to variable labor, 205–207 law of diminishing marginal returns, 208–209 overview of, 203–204 Short-run shutdown decisions, 285–286 Short-run supply curves See Supply curves, short-run Shutdown decisions fracking and, 286–287 in monopolies, 394 in profit maximization, 278 in short-run competition, 284–286 shutdown rules, 280 Signaling education as signal in labor market, 675–676 reducing adverse selection, 667–668 repeated games and, 485–486 Simplification by assumption, in models, 26 Simultaneous entry game See Static games Slutsky equation, applying to income and substitution effects, 149–151 Slutsky, Eugene, 150 Smith, Adam, 44, 318 Social costs, of open-access common property, 645 Social demand curve See Willingness-topay (social demand curve) Social marginal costs, welfare effects of pollution in competitive markets, 628–629 Social welfare functions equity and, 375, 377–378 monopolies and externalities and, 400 SOEs (State-owned enterprises), in China, 200 Software, rivalry and exclusion and, 646–647 Sole proprietorships, ownership of forprofit firms, 200 Spam, as negative externality, 631–632 Specialization, returns to, 221 Specific tariff, free trade vs tariffs, 336–339 Specific (unit) taxes effect on short-run labor demand, 558–559 effects on monopolies, 401–405 equilibrium effects of, 63–64 having similar market effects as ad valorem taxes, 68–69 overview of, 63 short-run equilibrium effect of, 292–293 welfare effects of, 326 Splitting (sharing) contracts asymmetric information and, 697 full information and, 696 profit-sharing contracts with full information, 695–696 revenue-sharing contract, 694 types of contracts, 688 Spurious differentiation, 525–526 Stackelberg equilibrium, applying to airlines examples, 530 Stackelberg game game tree in representation of, 487 overview of, 487 subgame perfect Nash equilibrium, 488–489 Stackelberg, Heinrich von, 527 Stackelberg oligopoly model applying to strategic trade policy, 530–533 calculus solution, 528–529 comparing collusive, Nash-Cournot, Stackelberg, and competitive equilibria, 534–535 graphical solution, 529 overview of, 506, 527–528 problems with government intervention, 534 why sequential moves are essential, 529–530 Standard & Poor’s Composite Index of 522 Stocks (S&P 522), 605–606 Standard deviation, in measuring/assessing risk, 594–595 Standards emissions standards, 633–634, 637–638 methods for reducing adverse selection, 668 State-owned enterprises (SOEs), in China, 200 State-owned monopolies, privatization of, 408 States of nature decision making regarding, 590 3/30/17 5:15 PM www.downloadslide.net Index probability and, 593 property owners and risk, 603–604 Static games achieving profit maximization in oligopoly, 477–480 credibility in, 489–490 mixed strategies and, 482–484 multiple equilibria and, 480–481 normal-form representation of, 474–477 overview of, 473 Statistical discrimination, screening in hiring, 679–680 Stock, of durable goods, 566 Stocks (investment), diversification, 605–606 Strategies, in game theory best response and Nash Equilibrium, 475–476 dominant strategies, 474–475 mixed, 482–484 overview of, 472 static games, 473 ultimatum games, 497 Strategies, in private-value auctions, 494 Stream of payments, 567–568 Subgame perfect Nash equilibrium, predicting outcomes with, 488–489 Subgames, airlines example, 487 Subjective probability in assessing risk, 591 risk neutrality and, 599 Subsidies airlines example, 505, 531–533, 546 childcare example, 164–165, 193–194 ethanol example, 68 farm example, 330–331 government role in efficiency and equity, 371 policies creating wedge between supply and demand curves, 325 problems with government intervention, 534 welfare effects of trade without subsidy, 375 Substitutes cross-price elasticity of demand and, 57 demand function and, 33 demand functions for perfect substitutes utility function, 128–129 demand impacted by, 33 indifference curve for imperfect substitutes, 98 indifference curve for perfect substitutes, 97–98 market power and, 399 perfect substitutes utility function, 111–112 price increases impacting, 141 Substitution alcohol for marijuana, 144 applying Slutsky equation to, 149–151 CPI measuring size of substitution bias, 156–157 elasticity of, 216–218 with inferior goods, 144–145 interior solution for finding optimal bundle, 106–107 Z05_PERL4459_04_GE_IDX.indd 777 interior solution to maximizing wellbeing, 106–107 Law of Demand and, 158–160 marginal rate of (MRS), 93–96 with normal goods, 141–143 wage change impacting, 186–188 Substitution elasticity of demand, 150 Sugar, complement good with coffee, 57 Sunk costs barriers to market entry, 324 fixed costs and, 236 overview of, 235 shutdown rules and, 280 Supply competitive equilibrium and, 363 elasticity of, 57–59 elasticity over time, 60–61 impact of import policies on supply curves, 41–42 overview of, 38–39 quantity supplied need not equal quantity demanded, 69–70 significance of shapes of demand and supply curves, 50–51 summing supply functions, 41 supply function, 39–41 Supply-and-demand model ad valorem and specific tax effects, 68–69 in analysis of pollution, 627–630 comparative statics with discrete (relatively large) changes, 46–47 comparative statics with small changes, 47–50 demand, 32–33 demand elasticity, 52–57 demand elasticity over time, 59 demand function, 33–37 elasticities in general, 51 equilibrium effects of taxes, 63–65 exercises, 77–82 finding market equilibrium, 43–44 forces driving market to equilibrium, 44–45 long-run vs short-run elasticities, 59–62 market equilibrium and, 42 overview of, 31–32 policies impacting supply curves, 41–42 price ceiling and, 70–73 price floors and, 73–74 quantity supplied need not equal quantity demanded, 69–70 sales taxes impacting, 63 shocks to equilibrium, 45 significance of shapes of demand and supply curves, 50–51 summary, 76–77 summing demand functions, 37–38 summing supply functions, 41 supply, 38–39 supply elasticity, 57–59 supply elasticity over time, 60–61 supply function, 39–41 when to use supply-and-demand model, 74–76 who pays sales tax, 65–66 777 Supply curves competitive factor market equilibrium, 564 elasticity of supply and, 57–59 finding market equilibrium, 43–44 import policies impacting, 41–42 for labor See Labor supply curves monopolies not having, 395 for monopsonies, 420 movement along due to price change, 39–40 policies creating wedge between supply and demand curves, 325 policies that shift See Policies producer surplus measured with, 315–317 for reformulated gasoline, 302–303 shift due to factors other than price, 40–41 shift due to policies, 323 significance of shapes of, 50–51 Supply curves, long-run firm supply curves in competitive market, 293–294 market supply curve in competitive market, 295–296 market supply for cotton, 298–299 market supply when entry is limited, 297–298 market supply when firms differ, 298–299 market supply when input prices vary with output, 299–300 market supply with identical firms and free entry and exit, 297 market supply with trade, 300–303 Supply curves, short-run firm supply curves in competitive market, 287–288 market supply curve in competitive market, 289–291 Supply elasticity See Elasticity of supply Supply functions movement along supply curve due to price change, 39–40 overview of, 39 shift of supply curves, 40–41 summing, 41 Symmetric information market equilibrium with, 662–663 overview of, 660 T Tangency rule, cost minimization, 247 Tariffs See also Taxes effect of tariff on oil, 338–339 promoting price discrimination and preventing resale, 435 vs free trade, 336–339 Tastes, consumer, 33 Tata Motors, innovations at, 224–225 Tax salience, 120 Taxes See also Tariffs costs impacted by, 243 emissions fees vs emissions standards, 637–638 equilibrium effects on supply and demand, 63–65 3/30/17 5:15 PM www.downloadslide.net 778 Index Taxes See also Tariffs (continued) on externalities in noncompetitive markets, 641 government role in efficiency and equity, 371 income taxes and labor supply curves, 189–191 in pollution control, 635 sales taxes See Sales taxes, equilibrium effects short-run equilibrium effect of specific tax, 292–293 wage tax effect on urban flight, 356 Taxes, on monopolies ad valorem vs specific tax, 404–405 overview of, 401 specific tax, 401–404 Technical progress, impact on marginal cost, 582 Technological efficient input choices and, 245 in production, 231 Technology cost advantages that create monopolies, 405 cost factor in choice of at home vs abroad, 231, 264–265 technical innovations that improve productivity, 222–224 Testing theories, in models, 27 Tests of transitivity, behavioral economics, 118 Tests, screening in hiring, 679 Theories, testing, 27 Theory of revealed preference, 157–158 Theory of the Second Best, 379–380 Third-degree price discrimination See Price discrimination, group Third-party information, methods for reducing adverse selection, 668 Threatening to punish, repeated games and, 485–486 Tie-in sales bundling tie-in sales, 457–460 overview of, 456–457 requirement tie-in sales, 457 Time-consistent preferences, discounting and, 574 Time-varying discounting falling discount rates and self-control, 575 overview of, 573–574 Tobacco, use relative to price, 131–132 Total costs (C), 236, 238 Total effect, combining income and substitution effects, 142–143 Total product of labor See also Outputs, production, 203 Tourist-trap model, 670–672 Trade applying Stackelberg model to strategic trade policy, 530–533 welfare effects of trade without subsidy, 375 Trade, between two people deriving contract curves, 360–361 endowment effects, 356–358 exercises, 382–383 mutually beneficial, 358–360 Z05_PERL4459_04_GE_IDX.indd 778 overview of, 356 summary, 381 Trade, competitive exchange competitive equilibrium and, 362–364 efficiency of competition, 364 exercises, 383 obtaining efficient allocation using competition, 364–365 overview of, 361–362 summary, 362–364 Trade-offs, in allocation of scarce resources, 24 Trade policies comparing types of, 333 free trade vs ban on imports, 334–336 free trade vs quotas, 340 free trade vs tariffs, 336–339 rent seeking and, 340–341 Trade, with production benefits of, 367 comparative advantage, 365 competition and, 369–371 efficient product mixes, 369 exercises, 383–384 number of producers and, 368–369 optimal product mixes, 368 Production Possibility Frontier (PPF), 365–367 summary, 368 Transaction costs perfect competition in Chicago Commodity Exchange, 273 preventing resale and, 434–435 price discrimination and, 442 reasons for horizontal demand curves, 272–273 Transitivity (rationality) consumer preferences, 86 preferences and, 376 tests of, 118 Transocean Deepwater Horizon oil rig, liability related to oil spill, 589, 619–620 Trucking industry, regulation of, 270, 305–306 Trusts See Cartels Twinkie tax, impact on production, 25 Two-part pricing with differing consumers, 454–455 with identical consumers, 453–454 overview of, 452 Two-part tariffs See Two-part pricing U Ultimatum games, 497 Uncertainty Arrow-Pratt measure of risk aversion, 601–603 assessing risk, 590 behavioral economics and, 614 biased assessments of probabilities, 614–615 diversification as risk reduction method, 604–607 exercises, 621–624 expected utility theory applied to risk, 595–596 expected value and, 592–593 gambling example, 600–601 information for risk reduction, 604 insurance as risk reduction method, 607–608 investing depending on attitudes toward risk, 611–613 investing with uncertainty and discounting, 613–614 liability and (oil spill example), 589, 619–620 overview of, 589–590 probability of risk, 591–592 prospect theory and, 617–619 reducing risk, 603–604 risk aversion, 596–598 risk neutrality, 599–600 risk preference, 599–600 summary, 621 variance and standard deviation and, 594–595 violations of expected utility theory, 616–617 willingness to gamble, 602–603 Uncompensated consumer welfare consumer surplus and, 166–169 effect of price change on consumer surplus, 169–170 market consumer surplus, 170–171 overview of, 165–166 willingness to pay, 166 Undifferentiated products in Cournot oligopoly, 516 Unemployment, minimum wage causing, 73–74 Uniform pricing, profit maximization and, 431 Unit taxes See Specific (unit) taxes Unitary elasticity, 53 United Airlines See Airlines Units, number available in auction, 493 Universal coverage, preventing opportunism in health insurance market, 670 Unwillingness to take a fair bet, risk aversion, 596 UPF (utility possibility frontier), 375 U.S Food Stamp Plan See also Food stamps, 180–182 Utility curvature of indifference curves, 96–100 expected utility (EU) theory, 595–596 indifference curves and, 92–93 labor-leisure choice, 182–185 marginal rate of substitution (MRS), 94–96 maximizing in mutually beneficial trades, 358 maximizing (music example), 110–111 ordinal preferences, 91–92 overview of, 90–91 social welfare functions and, 377–378 utility function, 90–91 willingness to substitute, 93–94 Utility functions applying to trade between two people, 361 corner solutions for finding optimal bundle, 111–115 demand functions for, 128 3/30/17 5:15 PM www.downloadslide.net Index deriving contract curves, 360 determining marginal rate of substitution, 96–97 indifference curve for, 98 interior solution for finding optimal bundle using calculus, 105–111 interior solution for finding optimal bundle using graphs, 103–105 minimizing expenditure while maximizing well-being, 116–117 overview of, 90–91 quasilinear utility functions, 99 Utility possibility frontier (UPF), 375 V Value, private or common in auctions, 494 Variable costs (VC) short-run cost measures, 236, 238 short-run shutdown decisions, 285 shutdown rules and, 280 Variance, in measuring/assessing risk, 594–595 Vehicle miles traveled tax (VMT), 636 Vertical integration, in prevention of resale, 435 VMT (Vehicle miles traveled tax), 636 Voting, efficiency and Equity, 376–377 W Wages analysis of minimum wages with incomplete coverage, 353–356 Black Death causing rise in, 564–565 cartel example, 512–513 cost-of-living adjustments, 155–156 Z05_PERL4459_04_GE_IDX.indd 779 income and substitution effects due to change in, 186–188 licensing impacting, 47 pooling equilibrium, 676–679 price floors, 73–74 short-run labor demand affected by change in, 557–558 tax on resulting in urban flight, 356 worker safety example, 659, 680–681 Wants, study of wants vs needs, 28 Water pollution, supply and demand analysis of, 627–630 Wealth efficiency and equity of distribution, 372–374 government role in efficiency and equity, 371 how much is enough, 86 Weighted income elasticities, 139–140 Welfare See also Consumer welfare competition maximizing, 318 deadweight loss of Christmas presents, 322–323 defined, 311–312 differentiated products and, 542 efficiency of measures for, 374 eliminating free trade affecting, 335–336 group price discrimination affecting, 449–450 market power affecting, 399–400 measuring, 318–319 monopolies vs competitive welfare, 639–640 monopsonies and, 422–424 pollution in competitive market and, 628–629 779 price ceilings affecting, 331–333 price floors effecting, 327–330 producing less than competitive output lowers, 319–320 producing more than competitive output lowers, 320–322 sales taxes effecting, 325–327 social welfare function, 377–378 tariff or quota on oil effecting, 338–339 trade without subsidy and, 375 Welfare economics, 312 Welfare policies food stamps, 180–182 overview of, 178 quotas, 178–180 Willingness to gamble, 602–603 Willingness-to-pay (social demand curve) consumer surplus and, 166–168 eBay example, 168 for products, 166 for public goods, 648–649 Willingness to substitute, 93–94 Winner’s curse, 496 Worker safety example, 659, 680–681 World Trade Organization (WTO) aircraft subsidies and, 505 trade and pollution and, 625 Z Zero long-run profit, in competitive market model with free entry, 312–313 when entry limited, 313–314 Zoning laws, as barrier to entry, 546 3/30/17 5:15 PM www.downloadslide.net Credits p 27, cartoon: Pearson Education, Inc p 270, epigraph: From George Bernard Shaw p 31, photo: Age fotostock/Superstock p 270, photo: Nomad_Soul/Fotolia p 34, photo: Lev/Fotolia p 45, cartoon: Pearson Education p 276, epigraph: From The Great Goldwyn, Random House, 1937 p 53, photo: lurin/123RF p 287, diagram: jaddingt/Fotolia p 60, photo: Corbis p 311, photo: Monkey Business/Fotolia p 70, photo: U.S Government Printing Office p 314, photo: Jeffrey M Perloff p 72, photo: Carlos Garcia Rawlins/Reuters p 322, cartoon: Pearson Education p 83, photo: Jeffrey M Perloff p 323, photo: Jeffrey M Perloff p 86, cartoon: Pearson Education p 330, epigraph: From Harper’s Index, 2004 p 94, cartoon: Pearson Education p 336, photo: JackF/Fotolia p 96, photo: Kohlhuber Media Art/Shutterstock p 348, photo: National Oceanic and Atmospheric Admin istration (NOAA) p 105, epigraph: From Donald N Smith, President of Burger King p 126, photo: John Foxx Collection/Pearson Education p 372, photo (bottom): National Gallery of Art, Washing ton, DC p 138, photo: Elena Shashkina/Shutterstock p 372, photo (top): Library of Congress p 144, photo: Kesu/Shutterstock p 373, photos (all): Library of Congress p 164, photo: Michael Newman/PhotoEdit p 385, photo: Jeffrey M Perloff p 168, photo: Jeffrey M Perloff p 393, photo: Pearson Education p 181, excerpt: From Fasciano, Nancy, Daryl Hall, and Harold Beebout, eds., New Directions in Food Stamp Policy Research, Alexandria, Va.: U.S Department of Agriculture, Food and Nutrition Service, 1993 p 396, excerpt in box: From Rachel Gordon, “A Fare Too Steep?”, San Francisco Chronicle, September 12, 2006: B-1, Hearst Communications Inc., 08/06/2016 p 182, epigraph: Department of Social Services, Greene ville, South Carolina p 399, cartoon: Pearson Education p 182, photo: U.S Dept of Agriculture p 183, cartoon: Pearson Education p 198, photo: Bernhard Classen/Alamy p 209, photo (bottom): Micheline Pelletier/Sygma/Corbis p 209, sketch (top): Pearson Education p 396, photo: Jeffrey M Perloff p 409, photos: Philadelphia Inquirer/KRT/Newscom p 431, photo: Jeffrey M Perloff p 434, photo: Jeffrey M Perloff p 448, cartoon: Pearson Education p 457, photo: Paul Broadbent/Shutterstock p 223, cartoon: Pearson Education p 461, epigraph: From Philip Dusenberry, quoted in Eric Clark, The Want Makers: Inside the World of Advertising, 1988, New York: Penguin Books, p 56 p 223, epigraph: From Harper’s Index, 2003 p 471, photo: Pablo Hidalgo/Shutterstock p 231, photo: Christian Delbert/Shutterstock p 479, photo: Trevor Smith/Alamy Stock Photo p 232, epigraph: From S J Perelman p 480, epigraph: From “Monty Python’s Flying Circus,” (1969–1974) p 219, cartoon: Pearson Education p 236, cartoon: Pearson Education 780 Z06_PERL4459_04_GE_CRED.indd 780 5/3/17 1:36 PM www.downloadslide.net Credits 781 p 482, cartoon: Pearson Education p 489, cartoon: Pearson Education p 505, photo: ZUMA Wire Service/Alamy p 512, cartoon: Pearson Education p 525, photo: Hayley Chouinard p 527, photo: Jeffrey M Perloff p 542, photo: Lee Bennack p 554, epigraph: From Richard Nixon p 554, photo: Jeffrey M Perloff p 564, photo: © The British Library Board All Rights Reserved [Royal E VI] p 600, photo: Courtesy of Boeri SRL p 601, photo: Jeffrey M Perloff p 607, epigraph: From Stephen Leacock p 609, cartoon: Pearson Education p 616, photo: Uryadnikov Sergey/Fotolia p 625, photo: Barry Sweet/AP Images p 629, cartoon: Pearson Education p 634, photo: Solares/Shutterstock p 643, photo: Doral Chenoweth III/The Columbus Dispatch/AP Images p 659, photo: Davis Turner/EPA/Newscom p 576, epigraph: From J Paul Getty p 581, photo: Jeffrey M Perloff p 589, epigraph: From Adlai Stevenson p 589, photo: U.S Coast Guard p 596, photo: Jeffrey M Perloff p 662, photo: Beth Anderson/Pearson Education p 666, cartoon: Pearson Education p 685, cartoon: Pearson Education p 697, photo: Andy Sheppard/Redferns/Getty Images p 701, photo: Damian Dovarganes/AP Images Z06_PERL4459_04_GE_CRED.indd 781 5/3/17 1:36 PM www.downloadslide.net Featured Applications in This Book Twinkie Tax 25 Income Threshold Model and China 25 Aggregating Corn Demand Curves 38 Occupational Licensing 47 The Demand Elasticities for Google Play and Apple Apps 53 Oil Drilling in the Arctic National Wildlife Refuge 60 Subsidizing Ethanol 68 Venezuelan Price Ceilings and Shortages 72 You Can’t Have Too Much Money 86 MRS Between Recorded Tracks and Live Music 96 Indifference Curves Between Food and Clothing 100 Utility Maximization for Recorded Tracks and Live Music 110 Opt In Versus Opt Out 119 Smoking Versus Eating and Phoning 131 Fast-Food Engel Curve 138 Substituting Alcohol for Marijuana 144 Reducing the CPI Substitution Bias 156 Willingness to Pay and Consumer Surplus on eBay 168 Compensating Variation and Equivalent Variation for the Internet 173 Food Stamps Versus Cash 182 Working After Winning the Lottery 189 Chinese State-Owned Enterprises 200 Malthus and the Green Revolution 208 A Semiconductor Integrated Circuit Isoquant 213 Returns to Scale in Various Industries 220 A Good Boss Raises Productivity 223 Tata Nano’s Technical and Organizational Innovations 224 The Opportunity Cost of an MBA 233 The Sharing Economy and the Short Run 237 Short-Run Cost Curves for a Japanese Beer Manufacturer 242 3D Printing 256 Choosing an Inkjet or Laser Printer 259 Medical Economies of Scope 264 Fracking and Shutdowns 286 The Size of Ethanol Processing Plants 294 Entry and Exit of Solar Power Firms 296 Upward-Sloping Long-Run Supply Curve for Cotton 298 Reformulated Gasoline Supply Curves 302 The Deadweight Loss of Christmas Presents 322 Welfare Effects of Allowing Fracking 324 How Big Are Farm Subsidies and Who Gets Them? 330 The Social Cost of a Natural Gas Price Ceiling 333 Russian Food Ban 336 Partial-Equilibrium Versus Multimarket-Equilibrium Analysis in Corn and Soybean Markets 352 Urban Flight 356 The Wealthy Get Wealthier 372 Apple’s iPad 392 Cable Cars and Profit Maximization 396 The Botox Patent Monopoly 409 Natural Gas Regulation 414 Z06_PERL4459_04_GE_CRED.indd 782 Movie Studios Attacked by 3D Printers! 415 Critical Mass and eBay 418 Disneyland Pricing 434 Preventing Resale of Designer Bags 435 Botox and Price Discrimination 441 Google Uses Bidding for Ads to Price Discriminate 442 Harry Potter Price Discrimination 443 Reselling Textbooks 445 Buying Discounts 448 Pricing iTunes 456 Ties That Bind 457 Super Bowl Commercials 464 Strategic Advertising 479 Tough Love 483 Keeping Out Casinos 492 Bidder’s Curse 496 GM’s Ultimatum 497 The Apple-Google-Intel-Adobe-Intuit-Lucasfilms-Pixar Wage Cartel 512 Cheating on the Maple Syrup Cartel 514 Mergers to Monopolize 515 Mobile Number Portability 523 Bottled Water 527 Deadweight Losses in the Food and Tobacco Industries 536 Zoning Laws as a Barrier to Entry by Hotel Chains 546 Black Death Raises Wages 564 Saving for Retirement 568 Durability of Telephone Poles 572 Falling Discount Rates and Self-Control 575 Redwood Trees 580 Gambling 600 Failure to Diversify 606 Flight Insurance 609 Limited Insurance for Natural Disasters 610 Biased Estimates 615 Loss Aversion Contracts 619 Spam: A Negative Externality 631 Reducing Pulp and Paper Mill Pollution 634 Why Tax Drivers 636 Protecting Babies 637 Buying a Town 643 Acid Rain Program 644 Microsoft Word Piracy 646 What’s Their Beef? 653 Discounts for Data 667 Adverse Selection and Remanufactured Goods 668 Cheap Talk in eBay’s Best Offer Market 675 Honest Cabbie? 690 Sing for Your Supper 697 Health Insurance and Moral Hazard 701 Capping Oil and Gas Bankruptcies 705 Layoffs Versus Pay Cuts 709 5/3/17 1:36 PM www.downloadslide.net Symbols Used in This Book α [alpha] = ad valorem tax (or tariff) rate, or a coefficient ∆ [capital delta] = a change in the following vari able—for example, the change in p between Periods 1 and is ∆p = p2 - p1, where pi is the change in Period i d = notation for a derivative—for example, df(x)/dx is the derivative of the function f(x) with respect to x [“curly d”] = notation for a partial derivative— for example, 0f(x1, x2)/0x1 is the partial derivative of the function f(x1, x2) with respect to x1, hold ing x2 constant γ [gamma] = returns to scale e [epsilon] = the price elasticity of demand η [eta] = the price elasticity of supply λ [lambda] = Lagrangian multiplier ℒ = lump@sum tax or a Lagrangian function, depending on context π [pi] profit = revenue - total cost = R - C σ [sigma] = elasticity of substitution t = specific or unit tax (or tariff) θ [theta] = probability or share ω [omega] = share ξ [xi] = income elasticity Abbreviations, Variables, and Function Names AFC = average fixed cost = fixed cost divided by output = F/q AVC = average variable cost = variable cost divided by output = VC/q AC = average cost = total cost divided by output = C/q APi = average product of input i—for example, APL is the average product of labor C = total cost = variable cost + fixed cost = VC + F CS = consumer surplus CV = compensating variation D(p) = market demand function DWL = deadweight loss EV = equivalent variation F = fixed cost i = interest rate I = indifference curve K = capital L = labor LR = long run m = constant marginal cost MC = marginal cost = dC/dq MPi = marginal (physical) product of input i—for example, MPL is the marginal product of labor Z06_PERL4459_04_GE_CRED.indd 783 MR = marginal revenue = dR/dq MRS = marginal rate of substitution MRTS = marginal rate of technical substitution n = number of firms in an industry p = price PPF = production possibility frontier PS = producer surplus Q = market (or monopoly) output q = firm output R = revenue = pq r = price of capital services s = per@unit subsidy S(p) = market supply function SR = short run T = tax revenue (αpQ, τQ) U = utility Ui = marginal utility of good i—for example, Uz = 0U(x, z)/0z VC = variable cost w = wage W = welfare Y = income or budget 5/3/17 1:36 PM www.downloadslide.net Z06_PERL4459_04_GE_CRED.indd 784 5/3/17 1:36 PM ... function with respect to output must be negative: d2π(Q*) dQ2 = d2R(Q*) dQ2 - d2C(Q*) dQ2 0, (11 .2) where d2R/dQ2 is the second derivative of the revenue function with respect to Q and d2C/dQ2 is... 12, the elasticity is e = - 24 / 12 = -1 , and the marginal revenue is MR = 24 - (2 * 12) = To the right of the midpoint of the demand curve, the demand curve is inelastic, -1 … e … 0, so the marginal... Revenue (MR = 24 – 2Q) Demand ( p = 24 – Q) Perfectly inelastic, ε = 24 12 Q, Units per day Its corresponding demand function is Q(p) = 24 - p The slope of this demand function is dQ/dp = -1 , so the