(BQ) Part 2 book Microeconomics - Global edition has contents: Pricing and advertising, oligopoly and monopolistic competition, game theory, factor markets, interest rates, investments, and capital markets, uncertainty, asymmetric information, contracts and moral hazards, externalities, open access, and public goods.
12 CHALLENGE Magazine Pricing and Advertising nonuniform pricing charging consumers different prices for the same product or charging a single customer a price that depends on the number of units the customer buys 416 www.downloadslide.com Pricing and Advertising Everything is worth what its purchaser will pay for it —Publilius Syrus (first century B.C.) To maximize their profits, magazine publishers use complex pricing schemes and rely on advertising Magazines typically charge higher prices at newsstands than to subscribers and charge some subscribers more than others Virtually all magazines carry ads All else the same, the larger a magazine’s circulation, the more advertisers pay per ad Consequently, a magazine may drop its subscription price to boost its circulation and, in turn, to increase its advertising revenue Adjusting subscription prices is the key to increasing sales for most magazines Kaiser and Wright (2006) examined the market for magazine readership and advertising in Germany They found that advertising “subsidizes” the cost to readers, and that magazines make most of their money from advertisers Moreover, they found that increased demand by magazine readers raises advertising rates, but that higher demand by advertisers decreases cover prices Between World War II and the mid-1990s, total U.S magazine circulation grew substantially The total number of magazines sold remained relatively constant at 360 million copies between 1994 and 2008 A combination of a long-term trend away from print media toward electronic media and the recession that started in 2007 hammered the magazine industry and caused magazine sales to dip to 347 million in 2009 Ad revenue rose from $15.5 billion in 1999 to $25.5 billion in 2007, fell to $19.4 billion in 2009, before rising 5.7% in the second quarter of 2010 compared to that quarter in 2009 Adjusting subscription prices is the key to increasing sales for most magazines Over time, magazine prices fell and advertising revenue rose (or fell less), so the share of revenue from advertising increased The percentage of advertising to total consumer magazine revenue rose from 50% in 1996 to 68% in 2009 Why magazines charge various groups of consumers different prices? How does magazine advertising pricing affect how firms set the price of magazines? Until now, we have examined how a monopoly (or other price-setting firm) chooses a single price given that it does not advertise We need to extend this analysis because many price-setting firms set multiple prices and advertise The analysis in this chapter helps to answer many real-world questions: Why does Disneyworld Florida charge local residents $219 for a one-week pass and out-of-towners $234? Why are airline fares substantially less if you book in advance? Why are some goods, including computers and software, bundled and sold at a single price? Often, these price-setting firms can use information about individual consumers’ demand curves to increase their profits Instead of setting a single price, they use nonuniform pricing: charging consumers different prices for the same product or charging a single customer a price that depends on the number of units purchased By replacing a single price with nonuniform pricing, the firm raises its profit www.downloadslide.com Challenge: Magazine Pricing and Advertising price discrimination practice in which a firm charges consumers different prices for the same good In this chapter, we examine seven main topics 417 Why can a monopoly earn a higher profit from using a nonuniform pricing scheme than from setting a single price? A monopoly that uses nonuniform prices can capture some or all of the consumer surplus and deadweight loss that results if the monopoly sets a single price As we saw in Chapter 11, a monopoly that sets a high single price only sells to the customers who value the good the most, and those customers retain some consumer surplus The monopoly loses sales to other customers who value the good less than the single price These lost sales are a deadweight loss: the value of these potential sales in excess of the cost of producing the good A monopoly that uses nonuniform pricing captures additional consumer surplus by raising the price to customers who value the good the most By lowering its price to other customers, the monopoly makes additional sales, thereby changing what would otherwise be deadweight loss into profit We examine several types of nonuniform pricing including price discrimination, two-part tariffs, and tie-in sales The most common form of nonuniform pricing is price discrimination, whereby a firm charges consumers different prices for the same good based on individual characteristics of consumers, membership in an identifiable subgroup of consumers, or on the quantity purchased by the consumers Many magazines price discriminate by charging college students less for subscriptions than they charge older adults If a magazine were to start setting a high price for everyone, many college student subscribers—who are sensitive to price increases (have relatively elastic demands)—would cancel their subscriptions If the magazine were to let everyone buy at the college student price, it would gain few additional subscriptions because most potential older adult subscribers are relatively insensitive to the price, and it would earn less from those older adults who are willing to pay the higher price Thus, the magazine makes more profit by price discriminating Some noncompetitive firms that cannot practically price discriminate use other forms of nonuniform pricing to increase profits One method is for a firm to charge a two-part tariff, whereby a customer pays one fee for the right to buy the good and another price for each unit purchased Health club members pay an annual fee to join the club and then shell out an additional amount each time they use the facilities Another type of nonlinear pricing is a tie-in sale, whereby a customer may buy one good only if also agreeing to buy another good or service Vacation package deals may include airfare and a hotel room for a single price Some restaurants provide only full-course dinners: a single price buys an appetizer, a main dish, and a dessert A firm may sell copiers under the condition that customers agree to buy all future copier service and supplies from it A monopoly may also increase its profit by advertising A monopoly may advertise to shift its demand curve so as to raise its profit, taking into account the cost of advertising Why and How Firms Price Discriminate A firm can increase its profit by price discriminating if it has market power, can identify which customers are more price sensitive than others, and can prevent customers who pay low prices from reselling to those who pay high prices Perfect Price Discrimination If a monopoly can charge the maximum each customer is willing to pay for each unit of output, the monopoly captures all potential consumer surplus, and the efficient (competitive) level of output is sold Quantity Discrimination Some firms profit by charging different prices for large purchases than for small ones, which is a form of price discrimination www.downloadslide.com 418 CHAPTER 12 Pricing and Advertising Multimarket Price Discrimination Firms that cannot perfectly price discriminate may charge a group of consumers with relatively elastic demands a lower price than other groups of consumers Two-Part Tariffs By charging consumers a fee for the right to buy any number of units and a price per unit, firms earn higher profits than they by charging a single price per unit Tie-In Sales By requiring a customer to buy a second good or service along with the first, firms make higher profits than they by selling the goods or services separately Advertising A monopoly advertises to shift its demand curve and to increase its profit 12.1 Why and How Firms Price Discriminate The prince travels through the forest for many hours and comes upon an inn, where he is recognized immediately He orders a light meal of fried eggs When he finishes, the prince asks the innkeeper, “How much I owe you for the eggs?” The innkeeper replies, “Twenty-five rubles.” “Why such an exorbitant price?” asks the prince “Is there a shortage of eggs in this area?” The innkeeper replies, “No, there is no shortage of eggs, but there is a shortage of princes.”1 Many noncompetitive firms increase their profits by charging nonuniform prices, which vary across customers We start by studying the most common form of nonuniform pricing: price discrimination Why Price Discrimination Pays For almost any good or service, some consumers are willing to pay more than others A firm that sets a single price faces a trade-off between charging consumers who really want the good as much as they are willing to pay and charging a low enough price that the firm doesn’t lose sales to less enthusiastic customers As a result, the firm usually sets an intermediate price A price-discriminating firm that varies its prices across customers avoids this trade-off A firm earns a higher profit from price discrimination than from uniform pricing for two reasons First, a price-discriminating firm charges a higher price to customers who are willing to pay more than the uniform price, capturing some or all of their consumer surplus—the difference between what a good is worth to a consumer and what the consumer paid—under uniform pricing Second, a pricediscriminating firm sells to some people who were not willing to pay as much as the uniform price We use a pair of extreme examples to illustrate the two benefits of price discrimination to firms—capturing more of the consumer surplus and selling to more customers These examples are extreme in the sense that the firm sets a uniform price at the price the most enthusiastic consumers are willing to pay or at the price the least enthusiastic consumers are willing to pay, rather than at an intermediate level Suppose that the only movie theater in town has two types of patrons: college students and senior citizens The college student will see the Saturday night movie if 1Thanks to Steve Salop www.downloadslide.com 12.1 Why and How Firms Price Discriminate 419 the price is $10 or less, and the senior citizens will attend if the price is $5 or less For simplicity, we assume that there is no cost in showing the movie, so profit is the same as revenue The theater is large enough to hold all potential customers, so the marginal cost of admitting one more customer is zero Table 12.1 shows how pricing affects the theater’s profit In panel a, there are 10 college students and 20 senior citizens If the theater charges everyone $5, its profit is $150 = $5 * (10 college students + 20 senior citizens) If it charges $10, the senior citizens not go to the movie, so the theater makes only $100 Thus, if the theater is going to charge everyone the same price, it maximizes its profit by setting the price at $5 Charging less than $5 makes no sense because the same number of people go to the movie as go when $5 is charged Charging between $5 and $10 is less profitable than charging $10 because no extra seniors go and the college students are willing to pay $10 Charging more than $10 results in no customers At a price of $5, the seniors have no consumer surplus: They pay exactly what seeing the movie is worth to them Seeing the movie is worth $10 to the college students, but they have to pay only $5, so each has a consumer surplus of $5, and their total consumer surplus is $50 If the theater can price discriminate by charging senior citizens $5 and college students $10, its profit increases to $200 Its profit rises because the theater makes as much from the seniors as before but gets an extra $50 from the college students By price discriminating, the theater sells the same number of seats but makes more money from the college students, capturing all the consumer surplus they had under uniform pricing Neither group of customers has any consumer surplus if the theater price discriminates In panel b, there are 10 college students and senior citizens If the theater must charge a single price, it charges $10 Only college students see the movie, so the theater’s profit is $100 (If it charges $5, both students and seniors go to the theater, but its profit is only $75.) If the theater can price discriminate and charge seniors $5 and college students $10, its profit increases to $125 Here the gain from price discrimination comes from selling extra tickets to seniors (not from making more money on the same number of tickets, as in panel a) The theater earns as much Table 12.1 A Theater’s Profit Based on the Pricing Method Used (a) No Extra Customers from Price Discrimination Pricing Profit from 10 College Students Profit from 20 Senior Citizens Total Profit Uniform, $5 $50 $100 $150 Uniform, $10 $100 $0 $100 Price discrimination* $100 $100 $200 (b) Extra Customers from Price Discrimination Pricing Profit from 10 College Students Profit from Senior Citizens Total Profit Uniform, $5 $50 $25 $75 Uniform, $10 $100 $0 $100 Price discrimination* $100 $25 $125 *The theater price discriminates by charging college students $10 and senior citizens $5 Notes: College students go to the theater if they are charged no more than $10 Senior citizens are willing to pay at most $5 The theater’s marginal cost for an extra customer is zero www.downloadslide.com 420 CHAPTER 12 See Questions 1–3 Pricing and Advertising from the students as before and makes more from the seniors, and neither group enjoys consumer surplus These examples illustrate that firms can make a higher profit by price discriminating, either by charging some existing customers more or by selling extra units Leslie (1997) finds that Broadway theaters increase their profits 5% by price discriminating rather than using uniform prices Who Can Price Discriminate Not all firms can price discriminate For a firm to price discriminate successfully, three conditions must be met First, a firm must have market power; otherwise, it cannot charge any consumer more than the competitive price A monopoly, an oligopoly firm, a monopolistically competitive firm, or a cartel may be able to price discriminate A competitive firm cannot price discriminate Second, consumers must differ in their sensitivity to price (demand elasticities), and a firm must be able to identify how consumers differ in this sensitivity.2 The movie theater knows that college students and senior citizens differ in their willingness to pay for a ticket, and Disneyland knows that tourists and natives differ in APPLICATION Disneyland, in southern California, is a well-run operation that rarely misses a trick when it comes to increasing its profit (Indeed, Disneyland mints money: When you enter the park, you can exchange U.S currency for Disney dollars, which can be spent only in the park.)3 In 2010, Disneyland charges most out-of-state adults $299 for an annual pass to Disneyland and Disney’s California Adventure park but charges southern Californians $219 This policy of charging locals a discounted price makes sense if visitors are willing to pay more than locals and if Disneyland can prevent locals from selling discounted tickets to nonlocals Imagine a Midwesterner who’s never been to Disneyland and wants to visit Travel accounts for most of the trip’s cost, so an extra few dollars for entrance to the park makes little percentage difference in the total cost of the visit and hence does not greatly affect that person’s decision whether to go In contrast, for a local who has been to Disneyland many times and for whom the entrance price is a larger share of the total cost, a slightly higher entrance fee might prevent a visit Charging both groups the same price is not in Disney’s best interest If Disney were to charge the higher price to everyone, many locals wouldn’t visit the Disneyland Pricing 2Even if consumers are identical, price discrimination is possible if each consumer has a downwardsloping demand curve for the monopoly’s product To price discriminate over the units purchased by a consumer, the monopoly has to know how the elasticity of demand varies with the number of units purchased 3It costs $222,360 to raise a child from cradle through age 17 (“Cost of Raising a Child Ticks Up,” Wall Street Journal, June 20, 2010) Parents can cut that total in half, however: They don’t have to take their kids to Disneyland www.downloadslide.com 12.1 Why and How Firms Price Discriminate See Question See Questions and 421 park If Disney were to use the lower price for everyone, it would be charging nonresidents much less than they are willing to pay their willingness to pay for admission In both cases, the firms can identify members of these two groups by using driver’s licenses or other forms of identification Similarly, if a firm knows that each individual’s demand curve slopes downward, it may charge each customer a higher price for the first unit of a good than for subsequent units Third, a firm must be able to prevent or limit resale to higher-price-paying customers by customers whom the firm charges relatively low prices Price discrimination doesn’t work if resale is easy because the firm would be able to make only low-price sales A movie theater can charge different prices because senior citizens, who enter the theater as soon as they buy the ticket, not have time to resell it Except for competitive firms, the first two conditions—market power and ability to identify groups with different price sensitivities—frequently hold Usually, the biggest obstacle to price discrimination is a firm’s inability to prevent resale In some markets, however, resale is inherently difficult or impossible, so firms can take actions that prevent resale, or government actions or laws prevent resale Preventing Resale See Question Resale is difficult or impossible for most services and when transaction costs are high If a plumber charges you less than your neighbor for clearing a pipe, you cannot make a deal with your neighbor to resell this service The higher the transaction costs a consumer must incur to resell a good, the less likely that resale will occur Suppose that you are able to buy a jar of pickles for $1 less than the usual price Could you practically find and sell this jar to someone else, or would the transaction costs be prohibitive? The more valuable a product or the more widely consumed it is, the more likely it is that transaction costs are low enough that resale occur Some firms act to raise transaction costs or otherwise make resale difficult If your college requires that someone with a student ticket must show a student identification card with a picture on it before being admitted to a sporting event, you’ll find it difficult to resell your low-price tickets to nonstudents, who must pay higher prices When students at some universities buy computers at lower-than-usual prices, they must sign a contract that forbids them to resell the computer Disney prevents resale by locals who can buy a ticket at a lower price by checking a purchaser’s driver’s license and requiring that the ticket be used for same-day entrance Similarly, a firm can prevent resale by vertically integrating: participating in more than one successive stage of the production and distribution chain for a good or service Alcoa, the former aluminum monopoly, wanted to sell aluminum ingots to producers of aluminum wire at a lower price than was set for producers of aluminum aircraft parts If Alcoa did so, however, the wire producers could easily resell their ingots By starting its own wire production firm, Alcoa prevented such resale and was able to charge high prices to firms that manufactured aircraft parts (Perry, 1980) Governments frequently aid price discrimination by preventing resale State and federal governments require that milk producers, under penalty of law, price discriminate by selling milk at a higher price for fresh use than for processing (cheese, ice cream) and forbid resale Government tariffs (taxes on imports) limit resale by making it expensive to buy goods in a low-price country and resell them in a highprice country In some cases, laws prevent such reselling explicitly Under U.S trade laws, certain brand-name perfumes may not be sold in the United States except by their manufacturers www.downloadslide.com 422 CHAPTER 12 APPLICATION Preventing Resale of Designer Bags Pricing and Advertising It may not surprise you that during the holidays that stores limit how many of the hottest items—such as Wii game consoles in 2008 or Zhu Zhu Pets in 2009—a customer can buy at one time But it may surprise you that the Web sites of luxury retailers like Saks Fifth Avenue, Neiman Marcus, and Bergdorf Goodman limit how many designer handbags one can buy: “Due to popular demand, a customer may order no more than three units of these items every 30 days.” Why wouldn’t they want to sell as many as they can? How many customers can even afford more than three of Nancy Gonzalez’s crocodile and python totes at $2,850 each from Neiman Marcus (in 2010), Prada’s latest ruched nylon styles at $1,290, Bottega Veneta’s signature woven leather hobos at $1,490, or the rectangular Yves Saint Laurent clutch that looks like a postcard addressed to the designer at $1,395? The simple explanation is that the restriction has nothing to with “popular demand”; it’s designed to prevent resale that would enable manufacturers to price discriminate internationally The manufacturers pressure the U.S retailers to limit sales so as to prevent anyone from buying all the bags and reselling them in Europe or Asia where the same items in Prada and Gucci stores cost 20% to 40% more For example in October 2010, the Yves Saint Laurent Easy Medium Nylon Tote bag that sells at Saks Fifth Avenue and Bergdorf Goodman in New York for $995, sells at Harvey Nichols in London for £735 ($1,164) The weakening U.S dollar makes such international resale even more attractive Not All Price Differences Are Price Discrimination See Question perfect price discrimination (first-degree price discrimination) situation in which a firm sells each unit at the maximum amount any customer is willing to pay for it, so prices differ across customers and a given customer may pay more for some units than for others Not every seller who charges consumers different prices is price discriminating Hotels charge newlyweds more for bridal suites Is that price discrimination? Some hotel managers say no They contend that honeymooners, unlike other customers, always steal mementos, so the price differential reflects an actual cost differential The 2010 price for all weekly issues of the Economist magazine for a year is $520 if you buy it at the newsstand, $99 for a standard subscription, and $77 for a college student subscription The difference between the newsstand cost and the standard subscription cost reflects, at least in part, the higher cost of selling at a newsstand rather than mailing the magazine directly to customers, so the price difference does not reflect pure price discrimination The price difference between the standard subscription rate and the college student rate reflects pure price discrimination because the two subscriptions are identical in every respect except price Presumably students are less willing to pay for a subscription than the typical business person Types of Price Discrimination There are three main types of price discrimination With perfect price discrimination—also called first-degree price discrimination—the firm sells each unit at the maximum amount any customer is willing to pay for it, so prices differ across customers, and a given customer may pay more for some units than for others With quantity discrimination (second-degree price discrimination), the firm charges a different price for large quantities than for small quantities, but all customers who buy a given quantity pay the same price With multimarket price www.downloadslide.com 12.2 Perfect Price Discrimination quantity discrimination (second-degree price discrimination) situation in which a firm charges a different price for large quantities than for small quantities but all customers who buy a given quantity pay the same price 423 discrimination (third-degree price discrimination), the firm charges different groups of customers different prices, but it charges a given customer the same price for every unit of output sold Typically, not all customers pay different prices—the firm sets different prices only for a few groups of customers Because this last type of discrimination is the most common, the phrase price discrimination is often used to mean multimarket price discrimination In addition to price discriminating, many firms use other, more complicated types of nonuniform pricing Later in this chapter, we examine two other frequently used nonuniform pricing methods—two-part tariffs and tie-in sales—that are similar to quantity discrimination 12.2 Perfect Price Discrimination multimarket price discrimination (third-degree price discrimination) a situation in which a firm charges different groups of customers different prices but charges a given customer the same price for every unit of output sold reservation price the maximum amount a person would be willing to pay for a unit of output If a firm with market power knows exactly how much each customer is willing to pay for each unit of its good and it can prevent resale, the firm charges each person his or her reservation price: the maximum amount a person would be willing to pay for a unit of output Such an all-knowing firm perfectly price discriminates By selling each unit of its output to the customer who values it the most at the maximum price that person is willing to pay, the perfectly price-discriminating monopoly captures all possible consumer surplus For example, the managers of the Suez Canal set tolls on an individual basis, taking into account many factors such as weather and each ship’s alternative routes We first show how a firm uses its information about consumers to perfectly price discriminate We then compare the perfectly price-discriminating monopoly to competition and single-price monopoly By showing that the same quantity is produced as would be produced by a competitive market and that the last unit of output sells for the marginal cost, we demonstrate that perfect price discrimination is efficient We then illustrate how the perfect price discrimination equilibrium differs from single-price monopoly by using the Botox application from Chapter 11 Finally, we discuss how firms obtain the information they need to perfectly price discriminate How a Firm Perfectly Price Discriminates Suppose that a firm has market power, can prevent resale, and has enough information to perfectly price discriminate The firm sells each unit at its reservation price, which is the height of the demand curve: the maximum price consumers will pay for a given amount of output Figure 12.1 illustrates how this perfectly price-discriminating firm maximizes its profit (see Appendix 12A for a mathematical treatment) The figure shows that the first customer is willing to pay $6 for a unit, the next is willing to pay $5, and so forth This perfectly price-discriminating firm sells its first unit of output for $6 Having sold the first unit, the firm can get at most $5 for its second unit The firm must drop its price by $1 for each successive unit it sells A perfectly price-discriminating monopoly’s marginal revenue is the same as its price As the figure shows, the firm’s marginal revenue is MR1 = +6 on the first unit, MR2 = +5 on the second unit, and MR3 = +4 on the third unit As a result, the firm’s marginal revenue curve is its demand curve This firm has a constant marginal cost of $4 per unit It pays for the firm to produce the first unit because the firm sells that unit for $6, so its marginal revenue exceeds its marginal cost by $2 Similarly, the firm certainly wants to sell the second unit for $5, which also exceeds its marginal cost The firm breaks even when it sells www.downloadslide.com 424 CHAPTER 12 Pricing and Advertising The monopoly can charge $6 for the first unit, $5 for the second, and $4 for the third, as the demand curve shows Its marginal revenue is MR1 = +6 for the first unit, MR2 = +5 for the second unit, and MR3 = +4 for the third unit Thus, the demand curve is also the marginal revenue curve Because the firm’s marginal and average cost is $4 per unit, it is unwilling to sell at a price below $4, so it sells units, point e, and breaks even on the last unit p, $ per unit Figure 12.1 Perfect Price Discrimination e MC Demand, Marginal revenue MR1 = $6 MR2 = $5 MR3 = $4 See Question APPLICATION Google Uses Bidding for Ads to Price Discriminate Q, Units per day the third unit for $4 The firm is unwilling to sell more than three units because its marginal cost would exceed its marginal revenue on all successive units Thus, like any profit-maximizing firm, a perfectly price-discriminating firm produces at point e, where its marginal revenue curve intersects its marginal cost curve (If you find it upsetting that the firm is indifferent between producing two and three units, assume that the firm’s marginal cost is $3.99 so that it definitely wants to produce three units.) This perfectly price-discriminating firm earns revenues of MR1 + MR2 + MR3 = +6 + +5 + +4 = +15, which is the area under its marginal revenue curve up to the number of units, three, it sells If the firm has no fixed cost, its cost of producing three units is +12 = +4 * 3, so its profit is $3 When you a search using Google, paid advertising appears next to your results The ads that appear vary according to your search term By making searches for unusual topics easy and fast, Google helps firms reach difficult-tofind potential customers with targeted ads For example, a lawyer specializing in toxic mold lawsuits can place an ad that is seen only by people who search for “toxic mold lawyer.” Such focused advertising has higher payoff per view than traditional print and broadcast ads that reach much larger, nontargeted groups (“wasted eyeballs”) and avoids the problem of finding addresses for direct mailing Google uses auctions to price these ads Advertisers are willing to bid higher to be listed first on Google’s result pages Goldfarb and Tucker (2010) found that how much lawyers will pay for context-based ads depends on the difficulty of making a match Lawyers will pay more to advertise when there are www.downloadslide.com 12.2 Perfect Price Discrimination 425 fewer self-identified potential customers—fewer people searching for a particular phrase They also found that lawyers bid more when there are fewer customers, and hence the need to target ads is greater Some states have anti-ambulance-chaser regulations, which prohibit personal injury lawyers from directly contacting potential clients by snail mail, phone, or e-mail for a few months after an accident In those states, the extra amount bid for ads linked to personal injury keywords rather than for other keywords such as “tax lawyer” is $1.01 (11%) more than in unregulated states We’re talking big bucks here: Trial lawyers earned $40 billion in 2004, which is 50% more than Microsoft or Intel and twice that of Coca-Cola By taking advantage of advertisers’ desire to reach small, difficult-to-find segments of the population and varying the price according to advertisers’ willingness to pay, Google is essentially perfectly price discriminating Perfect Price Discrimination: Efficient But Hurts Consumers A perfect price discrimination equilibrium is efficient and maximizes total welfare, where welfare is defined as the sum of consumer surplus and producer surplus As such, this equilibrium has more in common with a competitive equilibrium than with a single-price-monopoly equilibrium If the market in Figure 12.2 is competitive, the intersection of the demand curve and the marginal cost curve, MC, determines the competitive equilibrium at ec, where price is pc and quantity is Qc Consumer surplus is A + B + C, producer surplus is D + E, and there is no deadweight loss The market is efficient because the price, pc, equals the marginal cost, MCc With a single-price monopoly (which charges all its customers the same price because it cannot distinguish among them), the intersection of the MC curve and the single-price monopoly’s marginal revenue curve, MCs, determines the output, Qs The monopoly operates at es, where it charges ps The deadweight loss from monopoly is C + E This efficiency loss is due to the monopoly’s charging a price, ps, that’s above its marginal cost, MCs, so less is sold than in a competitive market A perfectly price-discriminating monopoly sells each unit at its reservation price, which is the height of the demand curve As a result, the firm’s marginal revenue curve, MRd, is the same as its demand curve The firm sells the first unit for p1 to the consumer who will pay the most for the good The firm’s marginal cost for that unit is MC1, so it makes p1 - MC1 on that unit The firm receives a lower price and has a higher marginal cost for each successive unit It sells the Qd unit for pc, where its marginal revenue curve, MRd, intersects the marginal cost curve, MC, so it just covers its marginal cost on the last unit The firm is unwilling to sell additional units because its marginal revenue would be less than the marginal cost of producing them The perfectly price-discriminating monopoly’s total producer surplus on the Qd units it sells is the area below its demand curve and above its marginal cost curve, A + B + C + D + E Its profit is the producer surplus minus its fixed cost, if any Consumers receive no consumer surplus because each consumer pays his or her reservation price The perfectly price-discriminating monopoly’s equilibrium has no deadweight loss because the last unit is sold at a price, pc, that equals the marginal cost, MCc, as in a competitive market Thus, both a perfect price discrimination equilibrium and a competitive equilibrium are efficient www.downloadslide.com A-70 Index Marginal rate of technical substitution (MRTS) approaches to minimize costs, 225 for Cobb-Douglas production function, 208 overview of, 191–192 Marginal rate of transformation (MRT) comparative advantage and, 355 number of producers and, 356–357 slope of budget line, 112 Marginal revenue (MR) deciding whether to advertise, 448–449 perfect price discrimination and, 424 profit maximizing output rules, 257 relationship between linear demand curve and, A:16 Marginal revenue (MR), in monopolies deriving marginal revenue curves, 378–379 overview of, 376 price and, 376–378 price elasticity of demand and, 380–381 profit maximizing output rules, 382–383 Marginal revenue product of labor (MRPL) approach to determining labor demand, 546–547 calculating labor demand curve, 544 overview of, 541–542 Marginal tax rates, 165–167 Marginal utility always nonnegative (more-is-better), A:5 nonsatiation in mutually beneficial trades, 348 overview of, 108–109 Marginal willingness to pay consumer surplus and, 300 eBay example, 298–299 measuring consumer welfare, 298 Market clearing price, 47 Market demand alternative approach to determining labor demand, 547–548 competitive equilibrium and, 283 in competitive factor markets, 546 marginal revenue product approach in determining labor demand, 546–547 Market failures due to adverse selection, 661 due to asymmetric information, 660 due to externalities, 632 societal welfare and, 308–310 Market power conditions allowing price discrimination, 420 government actions reducing, 400 impact on price of exhaustible resources, 586 mergers and efficiency and, 468 modeling in input and output markets, 549–550 of monopolies, 386 monopolized factor market and competitive output market, 552 monopoly in successive markets, 553–555 new monopolies of rare earth resources in China, 388 shape of demand curves reflecting, 387–388 sources of, 390 Market power, related to price ignorance advertising, 675 overview of, 672–673 Tourist Trap model, 673–675 Market structure defined, 249 externalities and, 637–638 factor markets, 549 overview of, 460–461 types of, 461 Market supply curve, in long-run competition competitive equilibrium and, 283 entry and exit of firms, 273–274 example of Chinese art factories, 275 example of cotton production, 276–277 example of identical vegetable oil firms, 274 free entry and exit of firms, 274–275 for increasing-cost, constant cost, and decreasing cost markets, 277–279 limited entry and exit of firms, 276 overview of, 272–273 reflecting differences in firms, 276 reflecting trade, 279–282 for reformulated gasoline, 281–283 when input prices vary with output, 277–279 Market supply curve, in short-run competition, 266–268 Markets defined, 25 equilibrium See Equilibrium, market for factors See Factor markets for lemons and good cars, 665 in long-run competition See Competition, long-run in perfect competition See Perfect competition profit maximization in See Profit maximization for public goods, 648 in short-run competition See Competition, short-run taxes in noncompetitive, 640 Mass production, in auto industry, 199 Materials (M) cost increase impacting supply curve, 266 defined, 177 as input of production, 174 as variable input over time, 178 Mathematical analysis of equilibrium quantity, 46 functions See Functions, mathematical of profit maximization in monopolies, 383–385 Maturity date, of bonds, 578 Maximization of well-being/pleasure, in model of consumer behavior, 95 Maximum price (price ceiling) See Price controls Mergers as alternative to collusion, 467 hospital example, 468 how monopolies are created, 393 Microeconomics decision making regarding allocation, 24 defined, 23 prices determining allocations, 25 summary, 30 trade-offs in resource allocation, 24 Mills, John Stuart, 105, 367 Minimum efficient scale (full capacity), in monopolistic competition, 495 Minimum price (price floor) See Price controls Minimum wage laws effects of incomplete coverage, 343–345 as example of price floor, 55–56 Mixed strategies, in predicting game outcome applying, 513–514 overview of, 511–512 Models assumptions in, 26–27 Bertrand model See Bertrand model of competitive firms See Competitive model, applying of consumer behavior, 95 Cournot model See Cournot model defined, 25 income threshold, 26 positive vs normative statements in, 28–29 of principal-agent problem, 690 Stackelberg model See Stackelberg model summary, 30 supply and demand See Supply and demand, applying model for testing economic theories, 27–28 Tourist Trap model, 673–675 two-period monopoly model, 408–409 uses of microeconomic models, 29–30 Money value, today vs future compounding interest, 566–567 discount rates, 566 future value, 568 inflation and discounting, 573–574 interest rates, 565–566 lottery example, 574–575 overview of, 565 present value, 569 stream of payments, 569–572 summary, questions, problems, 591–594 using interest rates to connect present and future, 568 Monitoring contract fulfillment after-the-fact monitoring, 709–712 bonding, 705–707 deferred payments, 707 efficiency wages, 707–709 overview of, 704–705 Monopolies advertising See Advertising, in monopolies barriers to entry, 396 comparing properties of market structures, 461 cost advantages that create, 393 externalities in, 638–639 government actions creating, 396 government actions encouraging competition, 405 government actions reducing market power, 400 www.downloadslide.com Index graphical approach to, 381–383 incidence of specific tax on, A:16–A:17 Lerner index, 388–389 marginal revenue and elasticity of demand, 380–381 marginal revenue and price, 376–378 marginal revenue curves, 378–379 market power of, 386 mathematical approach to, 383–385 multimarket price discrimination vs single price monopoly, 439 natural monopolies, 394–395 network externalities and, 405–407 new monopolies of rare earth resources in China, 388 output rules for profit maximization, 382–383 overview of, 375–376 patents and, 396–399 perfect price discrimination in, A:17 as price setters, 58, 460 price vs quantity in, 381 pricing See Pricing, in monopolies profit maximization and, 376 regulating, 400–404 shape of demand curves reflecting market power, 387–388 shifts in demand curve effecting, 385–386 shutdown rules and, 383 sources of cost advantages, 394 sources of market power, 390 in successive factor and output markets, 553–555 summary, questions, problems, 410–415 two-period model, 408–409 types of market structures, 461 welfare effects of, 390–393 welfare under regulated monopolies, 639–640 Monopolistic competition among airlines, 496 comparing properties of market structures, 461 fixed costs and number of firms and, 495–496 monopolistically competitive equilibrium, 494–495 overview of, 460, 493–494 price setting in, 460 summary, questions, problems, 499–503 types of market structures, 461 zoning laws as example of barrier to entry, 497 Monopolistic factor markets combined with competitive output market, 552 defined, 540 example of unions in United Kingdom, 553 market structure and factor demands, 549 monopoly in successive markets, 553–555 overview of, 549 Monopolistically competitive equilibrium, 494–495 Monopoly price, 674 Monopsonies company town example, 557–558 defined, 539–540 overview of, 555 profit maximization, A:25–A:26 welfare effects, 558–560 Monopsony power, 557 Moral hazard See also Contracts adding terms to contracts that address, 703 asymmetric information and, 698 bonding and, 705–706 checks on principals (employers), 712 designing contracts to eliminate, 689 efficiency in production and, 691–692, 697 health insurance and, 688, 716 leased cars example, 709 principals giving agents choice of contract, 714 punishment as monitoring strategy, 709 shirking as, 699 subprime borrowing example, 710 types of opportunistic behavior, 661–662 More-is-better consumer’s optimum, 120–121 properties of consumer preferences, 98 Movement along demand curve increase in price causing, 140 for labor, 544 vs shifts in, 36–37 Movement along indifference curve, substitution effect causing, 149 Movement along supply curve, 40–42 Multimarket price discrimination identifying groups for, 437–438 Mama Mia DVD example, 432–434 overview of, 431–432 smuggling prescription drugs and, 434–437 with two groups, 432, A:18 types of price discrimination, 422–423 welfare effects of, 439 Multiperiod (repeated) games overview of, 524–526 types of dynamic games, 518 Multiple regression, A:3 Mutual benefit, in trades between two people, 348–350 Mutual funds, as means of diversification, 610–611 N Nano, examples of organizational innovations, 199–200 Nash-Bertrand equilibrium See Bertrand model Nash-Cournot equilibrium See Cournot model Nash equilibrium applying to oligopolies, 468 predicting game outcome, 510–511 pure and mixed strategies and, 514 Nash, John, 468, 510 Natural disasters, insurance and, 613–614 Natural monopolies Internet and, 407 natural gas example, 403–404 overview of, 394–395 Needs and wants, economists focusing on, 29 A-71 Negative externality, 628–629 Net present value (NPV) approach to investing, 575–577 investing and discounting, 615–616 Net profit, in decision to advertise, 448–449 Network externalities direct size effect, 406 eBay example, 407 as explanation for monopolies, 407 indirect effect, 406 overview of, 405–406 Nominal price adjusting interest for inflation, 573 vs real price, 152 Non-profit firms, 174–175 Noncompetitive markets, taxes in, 640 Noncooperative oligopolies See Oligopolies, noncooperative Nondiversifiable risks, 613–614 Nonoptimal price regulation, of monopolies, 400–401 Nonrenewable resources See Exhaustible resources Nonuniform pricing overview of, 416–417 price discrimination See Price discrimination tie-in sales See Tie-in sales two-part tariffs See Two-part tariffs Normal-form representation, of static games, 507–508 Normal goods goods that are both inferior and normal, 146 income and substitution effects, 147–149 income inelasticity and, 143 some goods must be normal, 145 Number of buyers in oligopsonies, 555 in perfectly competitive market, 250 Number of firms, in market Cournot equilibrium and, 473–474 entry and exit and See Entry and exit, of firms market structures and, 249 monopolistic competition and, 495–496 oligopolies, 459 restrictions on, 312–314 Number of producers, in market, 356–357 Number of sellers, in perfectly competitive market, 250 Number of units, elements of auctions, 526 O Occupational licensing, 50 Ocean fisheries, problems with commons, 645 Oil See Petroleum products (oil, gasoline) Oligopolies Bertrand model See Bertrand model collusive See Cartels comparing properties of market structures, 461 Cournot model See Cournot model defined, 459 Duopolies, 468 www.downloadslide.com A-72 Index noncooperative, 460, 468 as price setters, 58, 460 Stackelberg model See Stackelberg model summary, questions, problems, 499–503 types of market structures, 461 Oligopsony, number of buyers in market, 555 Open-access common property bridge example, 646 externalities and, 628 overview of, 644–645 problems with, 645 resources with rivalry but no exclusion, 647 solving the commons problem, 646 Opportunistic behavior adverse selection and moral hazard in, 661–662 asymmetric information and, 660 full information and, 689 laws preventing, 668 restricting through universal coverage, 662 Opportunity costs of attending seminar, 209 of durable goods, 209–210 of MBA degree, 208 overview of, 208–209 profit and, 254–255, 293 rent and, 294–295 vs sunk costs, 210 Opportunity set cash vs food stamps and, 122 comparing water vs other goods, 114 defined, 111 effect of income change on, 112–113 effect of price change on, 112 effect of rationing on, 114 Optimal price regulation of monopolies, 400–401 Ordinal measures, of utility, 106–107 Organization of Petroleum Exporting Countries (OPEC), 464 Organizational change, productivity and, 199–202 Organizations See Firms Output in competitive factor market, 550 converting inputs into, 174 costs varying with, 211, 227–229 deciding how much to produce, 248 determining cost-minimizing level, 227 determining labor demand, 547–548 market power and, 549–550 in monopolies, 385–386 in monopolized factor market, 551–552 physical product as, 177 profit maximization, 256–257 profit maximization in factor markets, 542–543 profit maximization in monopolies, 382–383, A:19 quotas on, 321–322 reducing from competitive level results in lower welfare, 308–309 relationship of labor to total product, 179 in short-run competition, 258–261 Outsourcing, costs of moving production abroad vs using intensive technology at home, 206, 242–243 Overconfidence, behavioral economics of risk, 617 Overuse, problems with commons, 645 Ownership, of firms, 174 private, public, and nonprofit, 174–175 for profit firms, 175–176 Ownership of land, vs rental in determining profit, 295 P Paasche index, for correcting substitution bias in CPI, 157 Package tie-in sales See Bundling Parasite singles, impact of recession on young people in Japan, 514–515 Pareto efficient allocation of goods and service, 339 competitive equilibrium and, 353 contract curves, 349–350 government policies, 362–364 Pareto principle, 339 Pareto property, of Trades between two people, 346 Partial equilibrium analysis bias in, 343 overview of, 340 Partnerships, ownership structures, 175 Patents alternatives to, 399 Botox example, 397–399 overview of, 396–397 piracy and, 399–400 stimulation of research, 397 Pay cuts, vs layoffs, 713–714 Payments, over time future value, 571–572 overview of, 569 payments for finite period, 569–570 payments forever, 570–571 present value, 569, A:26 saving for retirement example, 571–572 Payoff matrix (profit matrix), for normalform games, 507 Payoffs, of games, 505–507 Perfect competition derivation of firm’s demand curves, 251–253 deviations from, 251 overview of, 249 price taking, 249–250 properties of price taking firms, 250–251 qualities of perfectly competitive markets, 57 reasons for studying, 253–254 summary, questions, problems, 286–291 Perfect complements, 104 Perfect information in game theory, 506 repeated games and, 524 Perfect price discrimination Botox example, 427–428 impact on consumers, 425–428 in a monopoly, A:17 overview of, 423 transaction costs impacting, 428–430 types of price discrimination, 422 union example, 429–430 Perfect substitutes Coke/Pepsi example, 142–143 vs perfect complements, 104 Perfectly elastic demand curves, 69 Perfectly elastic supply curves, 76 Perfectly inelastic demand curves, 68, 70 Perfectly inelastic supply curves, 76 Perpetuities, 578, A:26 Petroleum products (oil, gasoline) anti-price gouging laws applied to gasoline, 338, 369–370 cost curves for oil pipelines, 235–236 demand elasticity and, 72 impact of drilling in Arctic National Wildlife Refuge on oil prices, 78–81 market supply curve for reformulated gasoline, 281–283 short and long-run impacts of carbon tax, 90 shutdown rules applied to production of, 264–265 taxes designed to reduce global warming, 64 who pays for tax on gasoline (incidence), 89 Physical product, as output of production, 177 Piracy, intellectual property rights and, 399–400 Policies antitrust laws in international setting, 463 cash vs food stamps, 123 implication of tax salience on tax policies, 127 Pareto efficient, 362–364 regulating mergers, 468 strategic trade policies, 483–484 tax rates and cuts, 164 uses of microeconomic models, 29 Policies, regulating imports ban on rice imports, 51 free trade vs ban on imports, 326–327 free trade vs quotas, 329–330 free trade vs tariffs, 327–329 overview of, 325 quotas, 50–52 rent seeking and, 330–332 supply curves effected by, 42–44 Policies, that create wedge between supply and demand, 52–55 minimum wage example, 55 overview of, 316 price ceilings, 52–54 price floors, 54–55 welfare effects of price floors, 319–323 welfare effects of sales taxes, 316–317 welfare effects of subsidies, 317–319 Policies, that shift supply curves ban on rice imports, 51 entry and exit barriers, 315 import regulation, 42–44 licensing laws, 49–50 overview of, 311 quotas, 50–52 restrictions on number of firms in a market, 312–314 Pollution controlling externalities related to automobiles, 637 www.downloadslide.com Index emission standards, 634–635 emissions fees, 635–636 free trade and, 627, 653–654 markets for, 643–644 property right to be free of pollution, 641–642 property right to pollute, 642 pulp and paper mill example, 635 taxing externalities due to, 636–637 welfare effects in competitive market, A:26–A:27 Pooling equilibrium comparing with separating equilibrium, 679 defined, 677 efficiency and, 680–681 example of paying all workers an average wage, 678–680 Positive externality, 629–630 Positive monotonic transformation, utility function and, 107 Positive statements in explaining consumer behavior, 96 vs normative statements, 28–29 Predicting game outcome best response and Nash equilibrium, 510–511 dominant strategies, 508–509 iterated elimination of strictly dominated strategies, 509–510 overview of, 508 Predictions positive statements about cause and effect, 28 role of models in, 29 testing, 27 Preference (indifference) maps overview of, 99–100 properties of, 100–102 Preferences curvature of indifference curves, 103–105 defined, 96 indifference curves, 100–102 overview of, 96–97 preference (indifference) maps, 99–100 present-biased, 579 properties of consumer preferences, 97–98 risk preference, 602, 605–607 social welfare functions and, 367–368 U.S vs European preference for SUVs, 117 voting preferences, 365–366 willingness to substitute and, 102–103 Present-biased preferences falling discount rates and self control, 580 time consistency, 579 Present value (PV) of money, 569 of payments over time, 569 of perpetuity, A:26 Price advertising and, 675 of alternative goods in consumer purchasing, 33 in competitive market, 351 controls See Price controls demand curves and, 33–35 in determining allocations, 25 discrimination See Price discrimination equilibrium price (or market clearing price), 47 of exhaustible resources remains constant or fall over time, 585–586 increasing over time (inflation), 152 and marginal revenues in monopolies, 376–378 market power and See Market power, related to price ignorance in monopolies See Pricing, in monopolies nonuniform See Nonuniform pricing output level when marginal cost equals market price, 258, 260 price change effecting consumer surplus, 301–304 price change effecting factor demand, 543 price change effecting opportunity set, 112 price change effecting revenue, 71 price differences vs price discrimination, 422 relationship to marginal cost in Lerner index, 388–389 reservation price, 423 of scarce exhaustible resource in twoperiod example, 582–584 of scarce exhaustible resources, 581–582 sensitivity of quantity demanded to, 66 supply curves and, 40–41 supply varying with market price, 263 vs marginal cost in changes to welfare, 310 vs quantity in monopolies, 381 Price-consumption curve correspondence to demand curve, 138–139 indifference curves and, 136–137 tobacco use, 137 Price controls alternative price support program in agriculture, 321 anti-price gouging laws applied to gasoline, 338, 369–370 ceilings, 52–54 floors, 55–56 nonoptimal price regulation of monopolies, 400–401 optimal price regulation of monopolies, 400–401 social cost of natural gas price ceiling, 324–325 supply not equal to demand, 56–57 welfare effects of price ceilings, 323–325 welfare effects of price floors, 319–321 who benefits, 322 Zimbabwe example, 54–55 Price discrimination conditions allowing, 420–421 Disneyland example, 420–421 due to false beliefs about quality, 671–672 factors preventing resale, 421–422 Google example, 424 multimarket See Multimarket price discrimination nonuniform pricing, 416–417 A-73 overview of, 417 perfect See Perfect price discrimination price differences vs., 422 quantity discrimination and, 422, 430–431 theater ticket example, 419–420 types of, 422–423 why it pays, 418–419 Price elasticity of demand consumer sensitivity to price, 420 consumer surplus and, 303–304, A:15–A:16 downward-sloping linear demand curves, 68–70 elastic demand curve, 69 horizontal demand curves, 70 impact of drilling in Arctic National Wildlife Refuge on oil prices, 78–81 Lerner index and, 388–389 in monopolies, 380–381, 387–388 over time, 72–73 overview of, 67–68 residual demand and, 253, A:14 revenue and, 70–72 in Slutsky equation, A:8 specific (unit) taxes related to, 82 tax incidence related to, 83–84 vertical demand curves, 70 Price elasticity of supply elastic supply curve, 76 impact of drilling in Arctic National Wildlife Refuge on oil prices, 78–81 impact of volcanic eruptions on African flower exporters, 77–78 over time, 78–81 overview of, 75–76 specific (unit) taxes related to, 82 supply curves, 76–77 tax incidence related to, 83–84 Price line endowment and, 351 leading to competitive equilibrium, 352 Price setters market structures and, 460 monopolies See Monopolies monopolistic competition See Monopolistic competition oligopolies See Oligopolies Price takers competitive firms and, 249–251 consumers and firms as, 58 properties of price taking firms, 250–251 trade between two people, 351 Price theory See also Microeconomics, 23 Pricing, in monopolies bundling as form of tie-in sales, 444–447 conditions allowing price discrimination, 420–421 identifying groups for multimarket price discrimination, 437–438 impact of perfect discrimination on consumers, 425–428 magazine example, 416 multimarket price discrimination, 431–432 multimarket price discrimination with two groups, 432–437 nonuniform pricing, 416–417 www.downloadslide.com A-74 Index perfect price discrimination, 423 price differences vs price discrimination, 422 price discrimination, 417 quantity discrimination, 430–431 requirement tie-in sales, 443 resale prevention, 421–422 summary, questions, problems, 452–457 tie-in sales, 442–443 transaction costs impacting perfect price discrimination, 428–430 two-part tariffs, 439–440 two-part tariffs with identical customers, 440–441 two-part tariffs with nonidentical customers, 441–442 types of price discrimination, 422–423 welfare effects of multimarket price discrimination, 439 why price discrimination pays, 418–420 Principal-agent problem model of, 690 types of contracts, 691 Principals checks on, 712 giving agents choice of contracts, 714–715 principal-agent problem, 690–692 Prisoner’s dilemma, 509 Private costs cost of production without externalities, 630 social marginal costs vs private marginal costs, 632 Private firms, ownership of See also Firms, 175 Private (For-profit) firms See also Firms, 174–176 Private goods See also Goods, 646–647 Private investment, government borrowing crowding out, 588 Private-value auctions, 527–529 Privatization, reducing free riding, 651 Prizes, alternatives to patents, 399 Probability certainty effect (Allais effect), 619–620 difficulty in assessing, 617–618 frequency of outcomes and, 596–598 insurance diversification and, 613 low-probability gambles, 618–619 probability distribution, 597–598 subjective probability, 596–597 Probability distribution, 597–598 Producer surplus (PS) comparing pricing methods, 447 elimination of free trade and, 326 measuring with supply curve, 304–305 in monopolies, 390–393 in monopsonies, 559 output levels and, 309 overview of, 304 perfect price discrimination, 425–428 pollution effecting competitive market, 631 price supports, 320, 323–324 quantity discrimination, 431 regulation of monopolies, 401, 403 restrictions on number of firms in a market, 313 specific tax on roses, 317 subsidies, 317–319 tariffs and quotas, 328 using to study the effects of shocks, 305–306 welfare and, 307 Producer welfare measuring producer surplus with supply curve, 304–305 overview of, 304 using producer surplus to study the effects of shocks, 305–306 Producers incidence of taxes on, 86–87 number in market, 356–357 number of producers impacting production possibility frontier, 356–357 Product curves, showing total product, marginal product, and average product, 180–183 Product differentiation bottled water example of spurious differentiation, 480 impact on oligopoly, 478 welfare and, 493 Production See also Output choosing inputs based on cost, 24 combining cost and production information, 223–226 costs of moving abroad vs using intensive technology at home, 206, 242–243 cotton production example, 276–277 efficiency See Production efficiency excess as market distortions, 321 function See Production function inputs in, 174 in long-run See Production, long-run mass production in auto industry, 199 methods as source of cost advantages, 394 minimizing costs by labor and capital choices, A:12–A:14 overview of, 177 relationship with variable labor, 181 in short-run See Production, short-run shutdown rules applied to oil production, 264–265 timing and variability of inputs, 178 trading and See Production and trading Production and trading benefits of trade, 355–356 comparative advantage, 354 competition and, 358–360 efficiency of product mix, 357–358 marginal rate of transformation (MRT), 355 number of producers and, 356–357 production possibility frontier, 354 summary, questions, problems, 371–374 Production efficiency asymmetric information, 698–699 contracts and, 692 efficient contracts, 692–693 equilibrium and, 338 full information, 693–697 moral hazard and, 697 principal-agent problem, 691–692 technological, 177 Production efficiency, trade off with risk bearing choosing best contract, 702–704 contingent fees, 702 contracts and efficiency, 700 fixed fee contract, 700–701 hourly contract, 701 overview of, 699 Production function overview of, 177–178 shape of cost curves, 214–215 shape of cost curves and, 214–217 Production function, Cobb-Douglas constant, increasing, and decreasing returns to scale, 194–195 marginal product formula, 225 marginal rate of technical substitution, 193 overview of, 208 Production, long-run isoquants showing efficient combinations of labor and capital, firms, 186–187 shape of isoquants, 187–189 substitutability of inputs and marginal products, 192–193 substitutability of inputs varying along isoquant, 191–192 substituting inputs, 190–191 time factors in, 178 with two variable inputs, 185–186 Production possibility frontier (PPF) comparative advantage and, 354 costs of producing multiple goods, 240–241 in firewood and candy example, 356 number of producers impacting, 356–357 optimal product mixes, 357–358 Production, short-run average product of labor, 180 effect of extra labor on, 182 graphs of product curves, 180–182 law of diminishing marginal returns, 183–185 marginal product of labor, 180 with one variable and one fixed input, 178 relationship between product curves, 182–183 time factors in production, 178 total product, 179–180 Productivity innovations increasing, 198–199 organizational change increasing, 199–202 relative, 197–198 technical change and, 197 Products Cournot model with differentiated products costs between firms, 476–478 efficiency of product mix, 357–358 identical or homogeneous products as property of perfectly competitive market, 250 as output of production, 177 Profit defined, 254–255 as difference between revenue and costs, 176 opportunity costs and, 293 www.downloadslide.com Index Profit function, 256 Profit maximization advertising and production in monopoly, A:19 market structures and, 460 necessary condition for, A:14–A:15 overview of, 176 sufficient condition for, A:15 using labor or output, 542–543 Profit maximization, in competitive firms example of competitive firm, 259 in long-run competition, 271 need for, 297 output rules, 256–257 overview of, 254 profit defined, 254–255 in short-run competition, 258 shutdown rules, 257–258 steps in, 256 summary, questions, problems, 286–291 Profit maximization, in monopolies graphical approach, 382–383 marginal revenue and, 376 mathematical approach, 383–385 overview of, 381 Profit maximization, in monopsonies, 555–558, A:25–A:26 Profit-sharing contracts asymmetric information contracts, 698 full information contracts, 696–697 Property rights allocating to reduce externalities, 640 assigning as means of addressing problems of commons, 646 Coase Theorem and, 641–643 externalities caused by lack of clearly defined, 628 intellectual property rights, 399–400 Prospect theory, behavioral economics of risk and, 620–622 Prospect theory value function, 621 Public firms See also Firms, 175 Public goods beef example, 651 demand for, 648–649 externalities and, 628 free riding and, 649–650 markets for, 648 overview of, 646 Radiohead experiment, 650–651 reducing free riding, 651 rivalry and exclusion and, 646–647 valuing, 652–653 Public utilities, as example of natural monopoly, 394 Punishment as monitoring strategy, 709 threatening to punish as strategy in repeated games, 525 Purchasing decisions income threshold model related to purchase of durable goods, 26 uses of microeconomic models, 29 Pure strategy applying two Nash equilibria, 512 in predicting game outcome, 511 Q Qualitative change, using supply-anddemand model to predict, 64 Quality ignorance drives out high-quality goods, 664 lemons market with fixed quality, 664–667 lemons market with variable quality, 667–668 limiting lemons, 668–671 overview of, 664 price discrimination due to false beliefs about quality, 671–672 Quantitative change, using supply-anddemand model to predict, 65 Quantity demanded See also Demand choosing price vs quantity in monopolies, 381 cross-price elasticity of demand and, 74 demand curves and, 33–34 in demand function, 36–37 excess demand and excess supply and, 46 falling as price rises, 134 impact of prices on, 34–35 income elasticity of demand, 73–74 not equal to quantity supplied, 56–57 relationship of income to, 140–141 sensitivity to price, 66 summing demand curves, 38–39 Quantity discounts, 430 Quantity discrimination block-pricing schedules used by utility monopoly, A:18 overview of, 430–431 as type of price discrimination, 422 Quantity supplied See also Supply excess demand and excess supply and, 46 not equal to quantity demanded, 56–57 price elasticity of supply and, 75 sensitivity to price, 75 supply curves and, 40 supply function and, 41–42 Quotas effects of, 328 on farm output, 321–322 free trade vs., 329–330 import policies effecting supply curves, 43–44 policies that cause shifts in supply curves, 50–52 R Rate of return, on bonds, 578 Rationing impact on consumer’s opportunity set, 114 water rationing during Australian drought, 292, 331–332 Rawls, John, 368 Rawlsian welfare functions, 368 Real present value, 574 Real price adjusting interest for inflation, 573 vs nominal price, 152 Rebates, as meaning of identifying consumer groups, 438 Recessions labor productivity during, 173, 200–202 layoffs vs pay cuts, 713–714 A-75 Reflection effect, in attitudes about risk, 620 Regression confidence in estimates, A:2–A:3 estimating economic relations, A:1–A:2 multiple, A:3 overview of, A:1 Regulation of commons, 646 demand effects of, 33 emission standards, 634–635 emissions fees, 635–636 microeconomic models in predicting impact of, 29 pulp and paper mill example, 635 reducing market power, 400–404 restricting number of firms in a market, 312–314 supply effects of, 39–40 taxicab example, 313–314 Regulation, of monopolies comparing welfare under competition with welfare under regulated monopoly, 639–640 natural gas example, 403–404 nonoptimal price regulation, 402 optimal price regulation, 400–401 overview of, 400 problems with, 401–402 Relative productivity, measuring, 197–198 Rent defined, 295 determining, 296 of exhaustible resources, 583 as fixed cost, 294–295 Rent seeking activities, of governments, 330–332 Repeated (or multiperiod) games overview of, 524–526 types of dynamic games, 518 Requirement tie-in sales, 443 Resale ability to prevent or limit as condition of price discrimination, 421 designer bag example, 422 Research, patents stimulating, 397–399 Reservation price, 423, A:17 Residual demand curve deriving, 252–253 elasticity of, A:14 Residual supply curve market supply curve reflecting trade, 279–282 minimum wage law with incomplete coverage and, 343 trade and, 279 Resource allocation See Microeconomics Resources, exhaustible See Exhaustible resources Retirement, saving for, 572 Returns to scale Cobb-Douglas production function and, 194–195 constant, increasing, and decreasing, 193–194 long-run costs and, 231 overview of, 193 in U.S manufacturing, 195–196 varying, 196–197 Returns to specialization, 196 www.downloadslide.com A-76 Index Revenue demand elasticities over time and, 73 demand elasticity and, 70–72 profit and, 176, 254 relationship to marginal tax rate, 165–167 shutdown rules and, 256–257, 261 Revenue-sharing contracts, asymmetric information contracts, 698 Reverse auctions, 437–438 Risk See also Uncertainty avoiding, 608 defined, 595 degree of, 596 discounting for risk in investments, 615–617 diversification in dealing with, 609–611 efficiency in risk bearing, 692 expected value and, 598–599 gambling and, 606–607 insurance and, 611–614 obtaining information in dealing with, 608–609 probability and, 596–598 saying no to, 608 trade off between production efficiency and risk bearing, 699 variance and standard deviation in measuring, 599–600 Risk aversion See also Avoiding risk decision making and, 602–604 expected utility and, 601–602 insurance and, 611–612 risk-averse investing, 615 unwilling to make a fair bet, 602 working in dangerous industries and, 659 Risk neutrality decision making and, 604–605 indifferent regarding fair bet, 602 risk-neutral investing, 614 Risk pooling, 609 Risk preference decision making and, 605–607 willing to make a fair bet, 602 Risk premium, 603 Rivalry and exclusion, goods and, 646–647 Robber barons, 463 Rules and regulations See also Regulation impacting demand, 33 impacting supply, 39–40 Rules of the game, 506 S Safety, protection of workers in dangerous industries, 659 Sales taxes equilibrium effects of specific taxes, 82–83 incidence of specific taxes on consumers, 83–85 relationship between equilibrium and incidence of tax, 86–87 similar effects of ad valorem and specific taxes, 87–90 tax salience, 126 types of, 81 welfare effects of, 316–317 who pays for tax on gasoline, 64 Sales, when to sell exhaustible resources, 580–581 Salience, informed decisions and, 126–128 Scale, returns to See Returns to scale Scarcity economics and, 23 positive producer surplus and, 304 price of scarce exhaustible resources, 581–582 rent and scarce inputs, 295 School lunch programs, transfer of wealth programs, 361 Screening actions for equalizing information, 662–663 consumers avoiding lemons by screening, 668–669 in hiring, 681–682 Sealed-bid auctions, 527 Second-degree price discrimination See Quantity discrimination Second-price auctions bidding strategies, 527–528 sealed-bid auctions, 527 Sellers, number in perfectly competitive market, 250 Separating equilibrium comparing with pooling equilibrium, 679 defined, 677 efficiency and, 680–681 example of paying high ability people higher wages, 678–679 Sequential games advantages/disadvantages to first mover, 523–524 credible threat and, 521–522 dynamic entry games, 522–523 game trees and, 519–520 overview of, 519–520 subgame perfect Nash equilibrium, 520–521 Sequential movement, in Stackelberg model, 483 Services marginal expenditure in buying, 555–556 as output, 174 as output of production, 177 Pareto efficient allocations, 339 trade-offs in deciding which to produce, 24 Shareholders, in corporations, 175 Sherman Antitrust Act in 1809, 463 Shifts of demand curve income increase causing, 140 for labor, 544 monopolies and, 385–386 shocks to equilibrium, 47–48 vs movement along, 36 Shifts of supply curve policies that cause, 49–52 shocks to equilibrium, 47–48 vs movement along, 41 Shirking bonding to prevent, 705 efficiency wage in preventing, A:27–A:28 as moral hazard, 699 Shocks, to market equilibrium causing shifts in demand curve, 47 causing shifts in supply curve, 47–48 defined, 32 overview of, 47 producer surplus for studying effects of, 305–306 sequence of events in related markets following, 341–343 shape of supply and demand curves reflecting equilibrium price and quantity, 65–66 Short run competition See Competition, shortrun costs See Costs, short-run demand elasticities in factor markets, 72 production See Production, short-run Shortages, excess demand causing, 53 Shutdown rules applied to oil production, 264–265 monopolies and, 383 producer surplus and, 305 in profit maximization, 257–258 in short-run competition, 261–263 Signaling actions for equalizing information, 662–663 by firms regarding product quality, 670 firms strategies in repeated games, 525 hiring with eduction as signal, 677–681 Simplification, role of assumptions in models, 26–27 Simultaneous-move games, 521 Slutsky equation, 147, A:8 Slutsky, Eugene, A:8 Smith, Adam, 462 Sniping, at auctions, 299 Snob effect, network externalities, 406 Social costs cost of production with externalities, 630–631 of natural gas price ceiling, 324–325 social marginal costs vs private marginal costs, 632 Social optimum government policies and, 640 monopolies and competition and, 638 Social pressure, in reducing free riding, 651 Social welfare functions See also Welfare Arrow’s Impossibility Theorem and, 366 efficiency vs equity and, 368–370 equality in allocation of goods and, 367–368 Sole proprietorships, of firms, 175 Specialization, returns to, 196 Specific tariffs, 327 Specific (unit) taxes effects on equilibrium, A:3–A:4 equilibrium effects of, 82–83 incidence of taxes on consumers, 83–85 incidence on monopoly, A:16–A:17 on roses, 317 short and long-run impacts of carbon tax, 90 similar effects of ad valorem and specific taxes, 87–90 types of sales taxes, 81 Spillover effects, in multimarket analysis, 340 www.downloadslide.com Index Spurious differentiation bottled water example, 480 differentiation of product shifting, 478 Stackelberg equilibrium comparing collusive, Cournot, Stackelberg, and competitive equilibria, 486–489 overview of, 481 sequential movement in, 483 Stackelberg model best response function in determining follower’s output, A:22 comparing collusive, Cournot, Stackelberg, and competitive equilibria, 486–489 game tree, 519 graphical model, 481–483 overview of, 460, 480–481 sequential movement in, 483 summary, questions, problems, 499–503 Standard deviation, in measuring risk, 600 Standard error, in regression calculation, A:3 Standards, in limiting lemons, 669–670 Static games cooperation in, 515–517 defined, 506 normal-form games, 507–508 overview of, 507 predicting outcomes, 508–511 pure strategy, 511–512 Statistical discrimination, in hiring, 681–682 Stocks defined, 565 diversification in investing, 610–611 Storage, factors impacting short-run demand elasticities, 72 Strategic behaviors, player actions in games, 505–506 Strategic independence, in game theory, 506 Strategies, in game theory best response, 510 distinguished from actions, 519 dominant strategies, 508–509 in game theory, 505 iterated elimination of strictly dominated strategies, 508–509 Nash equilibrium, 510–511 pure vs mixed, 511–512 in repeated games, 525 Stream of payments See Payments, over time Subgame perfect Nash equilibrium predicting outcome of sequential game, 520–521 solving using backward induction, 523 Subgames, 520 Subjective probability, 596–597 Subsidies of aircraft manufacturing, 485 for farmers, 322–323 impact of, 317–319 per-hour vs lump sum for child care, 133, 167–168 problems with, 484–485 strategic trade policies, 483–484 welfare effects of price floors, 319–323 Substitution better substitutes causing greater elasticity of demand, 390 cross-price elasticity of demand and, 74 of inputs, 190–191 of inputs and marginal product, 192–193 of inputs varying along isoquant, 191–192 isoquants showing substitutability of inputs, 188 lacking in monopoly, 375 marginal rate of substitution, 109–110 marginal rate of technical substitution (MRTS), 191 non-price impacts on demand, 35 perfect and imperfect substitutes, 104 price of alternative goods effecting consumer purchasing, 33 short-run demand elasticities effected by, 72 willingness to substitute, 102–103 Substitution bias, in Consumer Price Index (CPI), 156–157 Substitution effect with inferior goods, 149–151 with normal good, 147–149 price change effecting demand, 146–147, A:8 related to labor supply, 160–162 Sunk costs costs of entry into a market, 315 overview of, 210 shutdown rules and, 257 Supplemental Nutrition Assistance Program (SNAP), 121–123 Supply defined, 32 excess, 46–47 import policies effecting supply curves, 42–44 overview of, 39–40 policies creating wedge between supply and demand curves, 52, 316 policies that cause shifts in supply curves, 49–52 price elasticity of See Price elasticity of supply shifts in supply curve effecting market equilibrium, 47–48 summing supply curves, 41–42 supply curve, 40–41 supply function, 41–42 Supply and demand demand, 32–33 demand curve, 33–36 demand function, 36–38 externalities analyzed in terms of, 630–633 forces that cause equilibrium, 46–47 government intervention effecting equilibrium, 49 import policies effecting supply curves, 42–44 market equilibrium, 44–45 methods for determining equilibrium, 45–46 overview of, 32 policies that cause demand to differ from supply, 52 policies that shift supply curves, 49–52 price ceilings impacting equilibrium, 52–55 price floors impacting equilibrium, 55–56 A-77 quantities and prices of genetically modified foods, 31 reasons why supply need not equal demand, 56–57 shifts in demand curve, 47 shifts in supply curve, 47–48 shocks to equilibrium, 47 summary, questions, problems, 59–63 summing demand curves, 38–39 summing supply curves, 41–42 supply, 39–40 supply curve, 40–41 supply function, 41–42 when to use supply-and-demand model, 57–59 Supply and demand, applying model for ad valorem and specific taxes and, 87–90 cross-price elasticity of demand, 74–75 demand elasticity and revenue, 70–72 demand elasticity over time, 72–73 elasticity along demand curve, 68–70 elasticity along supply curve, 76–77 elasticity of supply, 75–76 equilibrium and incidence of tax, 86–87 equilibrium effects of specific taxes, 82–83 income elasticity of demand, 73–74 interpreting shapes of supply and demand curves, 65–66 overview of, 64–65 price elasticity of demand, 67–68 sensitivity of quantity demanded to price, 66 sensitivity of quantity supplied to price, 75 summary, questions, problems, 90–94 supply elasticity over time, 78–81 tax incidence of specific taxes, 83–85 types of sales taxes, 78–81 when to use, 57–59 Supply and demand, policies that create wedge between overview of, 316 price floors, 319–323 sales taxes, 316–317 subsidies, 317–319 Supply curves entry and exit barriers, 315 firm supply curves in long-run competition, 271–272 firm supply curves in short-run competition, 263–266 import policies effecting, 42–44 interpreting shapes of, 65–66 labor See Labor supply curves market See Market supply curve movement along vs shifts in, 41 policies creating wedge between supply and demand curves, 316 policies that cause shift in, 311 policies that cause shifts in, 49–52 price effect on, 40–41 price elasticity along, 76–77 price supports and, 319–320 producer surplus measure by, 304–305 restrictions on number of firms in a market, 312–314 shifts in impacting market equilibrium, 47–48 www.downloadslide.com A-78 Index summing, 41–42 variables other than price impacting, 41 Supply function in determining equilibrium, 45 overview of, 41–42 Surplus See Consumer surplus (CS) Symmetric information, 665 T Tangency rule, approaches to minimize costs, 223, 225–226 Tariffs (duties) defined, 325 effects of, 328 free trade vs., 327–329 government actions that prevent resale, 421 Taste See also Preferences in model of consumer behavior, 95 price-consumption curve and, 136 role of consumer tastes in determining demand, 32 U.S vs European preference for SUVs, 117 Tata Motors, examples of organizational innovations, 199–200 Taxes cigarette taxes, 137 city wage tax causing urban flight, 346 controlling externalities due to pollution, 636–637 controlling externalities related to automobiles, 637 effects on costs, 218–220 impact of Fat tax on consumption, 25 income taxes, 164–168 marginal tax rates, 165–167 microeconomic models in predicting impact of, 29 in noncompetitive markets, 640 on pollution, 635–636 reduction in income taxes and wealth distribution, 361 sales taxes See Sales taxes tax salience, 126–127 Technology costs of moving production abroad vs using intensive technology at home, 206, 242–243 efficient input combinations, 221 impact on per capita food production, 184 impact on price of exhaustible resources, 586 sources of cost advantages, 394 technical change, 197 technical progress, 198 Testing economic theories, 27–28 Third-degree price discrimination See Multimarket price discrimination Third-party comparisons, product quality and, 669 Threatening to punish, firms strategies in repeated games, 525 Tie-in sales bundling as form of, 444–447 IBM example, 443 overview of, 442–443 requirement tie-in sales, 443 as type of nonuniform pricing, 417 Time choices over See Choices over time comparing money today with money in the future See Money value, today vs future payments over See Payments, over time present-biased preferences, 579 price elasticity of demand over, 72–73 price elasticity of supply over, 78–81 Time varying discounts, 578–579 Tobacco use, price-consumption curve related to, 137 Total cost (C) cost curves, 214 overview of, 211 sum of labor and capital costs, 221–222 Total effect, of price change, 149 Total product See also Output graphing product curves, 181–182 of labor, 179–180 variable costs and, 215 Tourist Trap model, 673–675 Trade See also Competitive exchange benefits of, 355–356 combining with production capacity See Production and trading market supply curve reflecting, 279–282 number of producers and, 356–357 Trade, between two people bargaining ability and, 350 endowment effect, 347–348 mutually beneficial trades, 348–350 Pareto property of, 346 summary, questions, problems, 371–374 Trade-offs, in resource allocation, 24 Transaction costs impacting appropriateness of supplyand-demand model, 58 impacting perfect price discrimination, 428–430 negligible in perfectly competitive market, 250–251 resale difficult when transaction costs are high, 421 Transitivity properties of consumer preferences, 97–98 testing in consumer choice, 124 voting preferences and, 365–366 Trucking industry, impact of new fixed costs on, 248, 284–285 True cost-of-living adjustments, 155–156 Trusts See Cartels Two-part tariffs with identical customers, 440–441 with nonidentical customers, 441–442, A:18–A:19 overview of, 439–440 as type of nonuniform pricing, 417 Two-period model, monopolies, 408–409 Two-stage games, types of dynamic games, 518 U Uncertainty avoiding risk, 608 behavioral economics of risk, 617 behaviors varying with circumstances, 618–620 decision making and, 600–601 degree of risk, 596 difficulty in assessing probabilities, 617–618 diversification in dealing with risk, 609–611 expected utility in decision making, 601–602 expected value and, 598–599 fear of flying, 595, 622 gambling and, 606–607 insurance in dealing with risk, 611–614 investing and, 614 investing and discounting, 615–617 obtaining information in dealing with risk, 608–609 overview of, 595 probability of risk, 596–598 prospect theory, 620–622 risk-averse investing, 615 risk aversion, 602–604 risk-neutral investing, 614 risk neutrality, 604–605 risk preference, 605–607 saying no to risk, 608 summary, questions, problems, 623–626 variance and standard deviation, 599–600 weather prediction and, 609 Unemployment efficiency wages, 708–709 resulting from minimum wage laws, 55–56 Unions monopoly power of unions in United Kingdom, 553 role in setting hours worked, 429–430 Unit taxes See Specific (unit) taxes Unitary elasticity of demand curves, 69 of supply curves, 76 Utilitarian philosophers, 367 Utility consumer welfare and, 297 defined, 96 expected utility in decision making, 601–602 as function of leisure and income in labor-leisure model, A:9 marginal rate of substitution, 109–110 marginal utility, 108–109 maximizing, A:6–A:8 mutually beneficial trades maximizing, 348 ordinal measure of, 106–107 ranking goods by, 105 relationship with indifference curves, 107–108, A:4–A:6 risk aversion and, 602–604 risk neutrality and, 604–605 risk preference and, 605–607 utility function, 106 Utility function, 106 Utility possibility frontier (UPF), 364 V Value, elements of auctions, 527 Value judgments normative statements contrasted with positive statements, 28 www.downloadslide.com Index social welfare functions in ranking allocations, 364 Variable costs (VC) overview of, 211 shape of cost curves for, 215–216 shutdown rules and, 257, 261 Variable input, types of input in production, 178 Variable quality, lemons market with, 667–668 Variance, in measuring risk, 599–600 Vertical integration, firm approaches to preventing resale, 421 Voting as mean of allocation of goods in democracies, 365–367 valuing public goods, 652–653 W Wages change in impacts factor demand, 543 city wage tax causing urban flight, 346 efficiency wages, 707–709 minimum wage law with incomplete coverage, 343–345 minimum wage laws, 55–56 union role in setting, 429–430 Wants and needs, economists focusing on, 29 Water rationing, drought in Australia, 292, 331–332 Wealth inequity, 360–361 Welfare comparing competition with regulated monopoly, 639–640 of consumers See Consumer welfare deadweight loss and, 307, 310–311 economists use of term, 292 elimination of free trade, 326 government policies effecting, 311 market failures effecting, 308 maximization of, 364–365 in monopolies, 390–393 in monopsonies, 558–560 multimarket price discrimination, 439 in natural monopolies, 394 output levels and, 309–310 perfect price discrimination, 425–428 pollution effects in competitive market, 631, A:26–A:27 price ceilings, 323–324 price supports, 320 of producers See Producer welfare product differentiation and, 493 quantity discrimination and, 431 regulation of monopolies, 401, 403 restrictions on number of firms in a market, 313 specific tax on roses, 317 A-79 subsidies, 317–319 as sum of consumer surplus and producer surplus, 307 tariffs and quotas, 328 transfer of wealth via, 361 Welfare economics, 292 Whaples, Robert, 78 Willingness to pay (WTP) deadweight loss of Christmas presents and, 310–311 measuring consumer welfare, 298–299 for public goods, 648 Winner’s curse, auctions, 529–530 Work hours, union role in setting, 429–430 Z Zero long-run profit comparing competition with monopolistic competition, 494 with free entry, 293–294 free entry and exit of firms and, 273 need to maximize profit and, 297 when entry is limited, 294–296 Zoning laws as example of barrier to entry, 497 www.downloadslide.com Credits p 31: Superstock p 375: Courtesy of author p 53: U.S Government Printing Offfice p 388: Courtesy of author p 55: Desmond Kwande/Getty Images p 397: Courtesy of John W Shore, MD p 64: Courtesy of author p 416: Courtesy of author p 74: Image Plan/Corbis p 420: Courtesy of author p 79: Corbis p 443: Shedland Software Design/IBM p 103: Cornered copyright © 2010 by Mike Baldwin/Distributed by Universal Uclick p 450: Amy E Conn/AP Images p 118: Courtesy of author p 478: Hayley Chouinard p 123: Courtesy USDA p 480: Courtesy of author p 133: Michael Newman/Photoedit, Inc p 491: Lee Bennack p 151: Photodisc/Getty Images p 493: ScienceCartoonsPlus.com p 173: Michael Macor/San Francisco Chronicle/Corbis p 504: Courtesy of author p 200: Sajjad Hussain/AFP/Getty Images/Newscom p 513: Courtesy of author p 206: Shutterstock p 417: Dorling Kindersley p 248: Shutterstock p 557: John Springer/Corbis p 265: Dan Lamont/Corbis p 572: Shawn Michienzi/Ripsaw Photography p 292: Ian Waldie/Getty Images p 584: Courtesy of author p 295: Courtesy of author p 601: Courtesy of author p 299: Courtesy of Johannes Pascalpaoli p 310: Courtesy of author p 602: Copyright © 1966 and 2010 by William Cole and Mike Thaler p 314: Courtesy of author p 606: Courtesy of author p 362: Library of Congress Prints and Photographs Division [LC-USZ61-204] p 613: NOAA p 363: Library of Congress Prints and Photographs Division [LC-D418-1217] p 635: Shutterstock p 363: Library of Congress Prints and Photographs Division [LC-DIG-nclc-01130] p 659: Newscom p 363: Library of Congress Prints and Photographs Division [LC-USF34-9058-C] p 363: Courtesy Ronald Reagan Presidential Library p 363: Pete Souza/Library of Congress Prints and Photographs Division [LC-DIG-ppbd-00358] A-80 p 458: Courtesy of author p 618: Photodisc/Getty Images p 650: Andy Shepherd/Redfers/Getty Images p 663: Tribune Media Services p 663: Mary Rich, art director/Cliff Leicht, writer/Craig Orsinii, photographer/Boeri p 664: Beth Anderson/Pearson p 699: Carl and Ann Purcell/Corbis www.downloadslide.com Symbols Used in This Book α [alpha] = ad valorem tax (or tariff) rate, or an exponent in a Cobb-Douglass production function Δ [capital delta] = change in the following variable (for example, the change in p between Periods and is Δ p = p2 - p1, where p2 is the value of p in Period and p1 is the value in Period 1) ᏸ = lump-sum tax π [pi] = profit = revenue - total cost = R - C ρ [rho] = profit tax rate σ [sigma] = standard deviation τ [tau] = specific or unit tax (or tariff) θ [theta] = probability or share ε [epsilon] = the price elasticity of demand ω [omega] = share η [eta] = the price elasticity of supply ξ [xi] = the income elasticity of demand Abbreviations, Variables, and Function Names AFC = average fixed cost = fixed cost divided by output = F/q MR = marginal revenue = ΔR/Δq MRS = marginal rate of substitution AVC = average variable cost = variable cost divided by output = VC/q MRTS = marginal rate of technical substitution AC = average cost = total cost divided by output = C/q MUZ = marginal utility of good Z n = number of firms in an industry APZ = average product of input Z (for example, APL is the average product of labor) p = price C = total cost = variable cost + fixed cost = VC + F CRS = constant returns to scale CS = consumer surplus CV = compensating variation D = market demand curve Dr = residual demand curve DRS = decreasing returns to scale DWL = deadweight loss F = fixed cost i = interest rate I = indifference curve IRS = increasing returns to scale K = capital L = labor LR = long run m = constant marginal cost M = materials MC = marginal cost = ΔC/Δq MPZ = marginal (physical) product of input Z (for example, MPL is the marginal product of labor) PPF = production possibility frontier PS = producer surplus = revenues - variable costs = R - VC Q = market (or monopoly) output _ Q = output quota q = firm output R = revenue = pq r = price of capital services s = per-unit subsidy S = market supply curve So = supply curve of all the other firms in the market SC = a market of economies of scope SR = short run T = tax revenue (α pQ, τQ, ρπ) U = utility VC = variable cost w = wage W = welfare Y = income or budget www.downloadslide.com Provides the Power of Practice Optimize your study time with MyEconLab, the online assessment and tutorial system When you take a sample test online, MyEconLab gives you targeted feedback and a Personalized Study Plan to identify the topics you need to review Study Plan The Study Plan consists of exercises from the textbook’s end-of-chapter Questions and Problems, as well as interactive versions of the text’s Solved Problems These can be completed for practice or as instructor assignments { CHAPTER Applying the Supply-and-Demand Model *33 Use calculus to prove that the elasticity of demand is a constant ε everywhere along the demand curve whose demand function is Q = Apε C 34 In the application “Aggregating the Demand for Broadband Service” in Chapter (based on DuffyDeno, 2003), the demand function for broadband service is Qs = 15.6pϪ0.563 for small firms and Ql = 16.0pϪ0.296 for larger ones As the graph in the application shows, the two demand functions cross What can you say about the elasticities of demand on the two demand curves at the point where they cross? What can you say about the elasticities of demand more generally (at other prices)? (Hint: The question about the crossing point may be a red herring 39 Solved Problem 3.3 claims that a new war in the Persian Gulf could shift the world supply curve to the left by million barrels a day or more, causing the world price of oil to soar regardless of whether we drill in ANWR How accurate is that claim? Use the same type of analysis as in the solved problem to calculate how much such a shock would cause the price to rise with and without the ANWR production 40 In Figure 3.6, applying a $1.05 specific tax causes the equilibrium price to rise by 70¢ and the equilibrium quantity to fall by 14 million kg of pork per year Using the estimated pork demand function and the original and after-tax supply functions, derive these results using algebra Unlimited Practice As you work each exercise, instant feedback helps you understand and apply the concepts Many Study Plan exercises contain algorithmically generated values to ensure that you get as much practice as you need Learning Resources Registering for Study Plan problems link to learning resources that further reinforce concepts you need to master If your book came packaged with a MyEconLab access code, go to www.myeconlab.com to register and log in You will need a Course ID from your instructor to enroll in their course If your book did not come packaged with a MyEconLab access code, visit MyEconLab to purchase access at any time ■ Step-by-step Guided Solutions help you break down a problem much the same way as an instructor would during office hours Guided Solutions are available for select problems ■ Select problems include video solutions that take you through each step of the solution with clear verbal and mathematical explanations ■ Links to the eText promote reading of the text when you need to revisit a concept or explanation ■ Animated graphs, with audio narration, appeal to a variety of learning styles ■ A graphing tool enables you to build and manipulate graphs to better understand how concepts, numbers, and graphs connect www.downloadslide.com Additional Applications in MyEconLab Chapter 1: Tax on Fast-Food Containers Chapter 2: American Steel Quotas Gas Lines Mad Cow: Shifting Supply and Demand Curves Minimum Wage Law in Puerto Rico Sideways Wine Chapter 3: Booze Sin Taxes Cigarette Tax Condoms Demanding Rail Safety Gasoline Taxes as a Revenue Source Incidence of Federal Ad Valorem Taxes Incidence of Tax on Restaurant Meals Specific Taxes Turning Off the Faucet Why the Wealthy Buy More Houses Willingness to Surf Chapter 4: Should Youths Be Allowed to Drink? Substitution Effects in Canada Taxes and Internet Shopping Chapter 5: Christmas Price Index Do Taxes Affect Click-VersusBrick Decisions? Income Elasticities of Demand for Cars International Comparison of Substitution and Income Effects Leisure-Income Choices of Textile Workers Quality Improvements, New Products, and the CPI Wealth of Developing Countries What to Do with Extra Income Chapter 6: Does That Compute Down on the Farm? German Versus British Productivity More Productive Death Nonneutral Technical Change in Pin Manufacturing Rolls-Royce U.S Electric Generation Efficiency Chapter 7: Average Cost of Cement Firms Cost of Caring for Parents Cost of Names Depreciation Learning by Doing in Computer Chips Learning by Drilling Lowering Transaction Costs for Used Goods at eBay and Abebooks Opportunity Cost of Going to Church Quality and Factor Proportions Rice Milling on Java Swarthmore College's Cost of Capital Tax Rules The Internet and Outsourcing Waiting for the Doctor Chapter 8: Abortion Market Apple Crunch Changes in Banking Shutting Down Lesotho Slope of Long-Run Market Supply Curves Threat of Entry in Shipping Chapter 9: Barriers to Protect Our Way of Life Bruce Springsteen’s Gift to His Fans Deadweight Loss from Wireless Taxes Discriminating Against Groups Japanese Nontariff Barriers Jefferson’s Trade Embargo Job Termination Laws Trucking Unions and Guilds Zoning Chapter 10: Living-Wage Laws Sin Taxes U.S Minimum Wage Laws and Teenagers Chapter 11: A Drug Patent Airport Monopolies Banking Market Power Carlos Slim and the Mexican Monopolies Competitive Versus Monopoly Sugar Tax Incidence Creating and Destroying an Auto Monopoly Deadweight Loss of the U.S Postal Service Electric Power Utilities Ending the Monopoly in Telephone Service Government Sales of Monopolies Humana Hospitals Iceland’s Government Creates Genetic Monopoly Near Monopolies Regulating a Telephone Monopoly Chapter 12: A Hot Sale of Coke Amazon Is Watching You Automatic Savings Bundling Hardware with Software and Service Buying Supplies from the Manufacturer Examples of Product Differentiation Flight of the Thunderbirds Generics and Brand-Name Loyalty Gray Markets International Price Discrimination O.J Trial Effect Product Differentiation of Corporate Jets Tagamet Revisited Tailoring Credit Cards Taking Women to the Cleaners www.downloadslide.com The Supreme Court’s View on Tie-in Sales Using Information to Perfectly Price Discriminate Warehouse Stores Chapter 13: A Government-Created Cartel Airline Mergers: Market Power Versus Flight Frequency Bad Bakers Blue Fries, Green Ketchup Designer Glasses Economists Prevent Collusion Hospital Mergers Insurance Price Wars Oligopoly Competition Among Governments Tacit Collusion in Long-Distance Service The Art of Price Fixing Toothbrushes Virgin America’s Fixed Costs Vitamin Price Fixing Chapter 14: Advertising Expenditures Advertising Targets Brand-Switching Advertising Buttering Up Legislatures Celebrities Cleaning the Air Drug Commercials Evidence on Strategic Entry Deterrence Exclusive Dealing Experienced Bidders Generic Milk Promotions Government Deterrence Government’s Helping Hand Hitting Rivals Where It Hurts Legislating Barriers to Entry Nonprice Strategies Phone Companies Preventing Customers from Switching Restroom Advertising Smoking-Gun Evidence? Splenda Chapter 15: Black Death Raises Wages Cutting Off Oxygen Is Limiting Entry into Casket Sales a Grave Restriction? Life Cycle of a Firm Monopsony Price Discrimination Monopsony Wage Setting Outsourcing Piggish Vertical Integration Record Prices Union Monopoly Power Vertical Integration and Essential Facilities: Barnes & Noble Vertical Integration of Auto Manufacturers Chapter 16: Buying Versus Renting a Phone Consumed Investments Costs of Gold Mining Dam Price of Aluminum over Time Rates of Return on Paintings, Prints, and Coins Reserves of Natural Resources Returns to Studying Economics Taking from Future Generations Usury Chapter 17: Acceptable Risk Baseball Versus College Bond Ratings Diversification Traps Dorm Insurance International Risks Laws Limiting Diversification Lloyd’s of London Loans, Defaults, and Usury Laws Lotteries Risk Premium Risky Hobbies and Occupations Risky Jobs Pay (Slightly) More S&P 500 Funds Socially Irresponsible Mutual Fund Chapter 18: Claiming Lobster Fisheries Commons and Highways Effect of Police on Crime Emissions Standards for Ozone Emptying the Seas For Whom the Bridge Tolls Free Riding on Water International Pollution-Control Expenditures Quantity Controls on Pig Pollution Recycling Sobering Drunk Drivers Taxes on Fuels Waste Not Chapter 19: Advertising Lowers Prices Commercial Free Speech Versus Strength Wars Everyone Talks About the Weather Finding a Good Surgeon Guaranteed College Keeping Consumers Ignorant Labeling Laws Price Dispersion Recycling Lemons Removing Pounds or Dollars? Rent-to-Own Stores Taking Candy from Babies and Their Parents Wages Rise with Education Wholesale Market for Cherries Wholesale Used-Car Auctions Chapter 20: Australian Compensation BMW Incentives Bonding by British Trading Companies Contingent Fees Versus Hourly Pay Deferred Payments Versus Efficiency Wages in Fast-Food Restaurants Effectiveness of Monitoring Efficiency Wage and Supervision in Petrochemical Firms High-Tech Stock Options Incentives for Financial Advisors Increasing Use of Incentives Inspiring Directors Piece Rates at Lincoln Electric Pleased to Be Paid by the Piece ... panel a) In Country 2, the inverse demand curve is p2 = - Q2, so the monopoly chooses Q2 such that MR2 = - 2Q2 = = m Thus, it maximizes its profit in Country where Q2 = and p2 = 5, as panel b shows... B1 + C1 = + 2, 450, and Consumer a fee of A2 + B2 + C2 = +4,050, for a 80 100 D2 D1 A2 = $3 ,20 0 A1 = $1,800 20 10 C2 = $50 C1 = $50 B1 = $600 20 m 60 70 80 q1, Units per day 8If 10 B2 = $800 m... the profits The monopoly’s profits are π = (4 - 1)4 = 12, 2 = (4 - 1)5 = 15, and π = 12 + 15 = 27 Comments: The monopoly’s profit falls from 28 .50 to 27 if it loses the ability to price discriminate