(BQ) Part 2 book Microeconomics has contents: General equilibrium and economic welfare, monopoly, pricing and advertising, oligopoly and monopolistic competition, game theory, factor markets, interest rates, investments, and capital markets, uncertainty, externalities, open access, and public goods, asymmetric information, contracts and moral hazards.
10 CHALLENGE Anti-Price Gouging Laws 316 General Equilibrium and Economic Welfare Capitalism is the astounding belief that the most wickedest of men will the most wickedest of things for the greatest good of everyone —John Maynard Keynes After a disaster strikes, prices tend to rise For example, U.S gasoline prices increased by an average of 46¢ per gallon after Hurricane Katrina in 2005 damaged most Gulf Coast oil refineries Many state governments enforce anti-price gouging laws to prevent prices from rising, while prices may be free to adjust in neighboring states For example, Louisiana’s anti-price gouging law went into effect when Governor Bobby Jindal declared a state of emergency in response to the 2010 BP oil spill that endangered Louisana’s coast Arkansas, California, Maine, New Jersey, Oklahoma, Oregon, and West Virginia set a “percentage increase cap limit” on how much price may be increased after a disaster, ranging from 10% to 25% of the preemergency price California passed its law in 1994 after the Northridge earthquake Sixteen states prohibit “unconscionable” price increases After Hurricane Katrina disrupted gasoline deliveries, Massachusetts Governor Mitt Romney established a hotline for consumers to report evidence of price gouging Connecticut, Georgia, Hawaii, Kentucky, Louisiana, Mississippi, and Utah have outright bans on price increases during an emergency Georgia enacted its anti-price gouging statute after a 500-year flood in 1994 However, the Georgia state senate passed a bill in 2010 to remove its anti-price gouging legislation and allow gasoline prices to rise after an emergency Other states not have such laws Governments pass anti-price gouging laws because they’re popular After the post-Katrina gas price increases, an ABC News/Washington Post poll found that only 16% of respondents thought that the price increase was “justified,” 72.7% thought that “oil companies and gas dealers are taking unfair advantage,” 7.4% said both views were true, and the rest held other or no opinion In Chapter 2, we showed that a national price control causes shortages However, does a binding price control that affects one state but not a neighboring state cause shortages? How does it affect prices and quantities sold in the two states? Which consumers benefit from these laws? In addition to natural disasters, a change in government policies or other shocks often affect equilibrium price and quantity in more than one market To determine the effects of such a change, we must examine the interrelationships among markets In this chapter, we extend our analysis of equilibrium in a single market to equilibrium in all markets We then examine how a society decides whether a particular equilibrium (or change in equilibrium) in all markets is desirable To so, society must answer two questions: “Is the equilibrium efficient?” and “Is the equilibrium equitable?” For the equilibrium to be efficient, both consumption and production must be efficient Production is efficient only if it is impossible to produce more output at current cost given current knowledge (Chapter 7) Consumption is efficient only if goods cannot be reallocated across people so that at least someone is better off and no one is harmed In this chapter, we show how to determine whether consumption is efficient Challenge: Anti-Price Gouging Laws Pareto efficient describing an allocation of goods or services such that any reallocation harms at least one person In this chapter, we examine five main topics 317 Whether the equilibrium is efficient is a scientific question It is possible that all members of society could agree on how to answer scientific questions concerning efficiency To answer the equity question, society must make a value judgment as to whether each member of society has his or her “fair” or “just” share of all the goods and services A common view in individualistic cultures is that each person is the best— and possibly only legitimate—judge of his or her own welfare Nonetheless, to make social choices about events that affect more than one person, we have to make interpersonal comparisons, through which we decide whether one person’s gain is more or less important than another person’s loss For example, in Chapter we argued that a price ceiling lowers a measure of total welfare given the value judgment that the well-being of consumers (consumer surplus) and the well-being of the owners of firms (producer surplus) should be weighted equally People of goodwill—and others—may disagree greatly about equity issues As a first step in studying welfare issues, many economists use a narrow value criterion, called the Pareto principle (after an Italian economist, Vilfredo Pareto), to rank different allocations of goods and services for which no interpersonal comparisons need to be made According to this principle, a change that makes one person better off without harming anyone else is desirable An allocation is Pareto efficient if any possible reallocation would harm at least one person Presumably, you agree that any government policy that makes all members of society better off is desirable Do you also agree that a policy that makes some members better off without harming others is desirable? What about a policy that helps one group more than it hurts another group? What about a policy that hurts another group more than it helps your group? It is very unlikely that all members of society will agree on how to answer these questions—much less on the answers The efficiency and equity questions arise even in small societies, such as your family Suppose that your family has gathered together in November and everyone wants pumpkin pie How much pie you get will depend on the answer to efficiency and equity questions: “How can we make the pie as large as possible with available resources?” and “How should we divide the pie?” It is probably easier to get agreement about how to make the largest possible pie than about how to divide it equitably So far in this book (aside from Chapter 9’s welfare analysis), we’ve used economic theory to answer the scientific efficiency question We’ve concentrated on that question because the equity question requires a value judgment (Strangely, most members of our society seem to believe that economists are no better at making value judgments than anyone else.) In this chapter, we examine various views on equity General Equilibrium The welfare analysis in Chapter (involving gains and losses in consumer and producer surplus) changes when a government policy change or other shock affects several markets at once Trading Between Two People Where two people have goods but cannot produce more goods, both parties benefit from mutually agreed trades Competitive Exchange The competitive equilibrium has two desirable properties: Any competitive equilibrium is Pareto efficient, and any Pareto-efficient allocation can be obtained by using competition, given an appropriate income distribution Production and Trading The benefits from trade continue to hold when production is introduced Efficiency and Equity Because there are many Pareto-efficient allocations, a society uses its views about equity to choose among them 318 CHAPTER 10 General Equilibrium and Economic Welfare 10.1 General Equilibrium partial-equilibrium analysis an examination of equilibrium and changes in equilibrium in one market in isolation general-equilibrium analysis the study of how equilibrium is determined in all markets simultaneously So far we have used a partial-equilibrium analysis: an examination of equilibrium and changes in equilibrium in one market in isolation In a partial-equilibrium analysis in which we hold the prices and quantities of other goods fixed, we implicitly ignore the possibility that events in this market affect other markets’ equilibrium prices and quantities When stated this baldly, partial-equilibrium analysis sounds foolish It needn’t be, however Suppose that the government puts a tax on hula hoops If the tax is sizable, it will dramatically affect the sales of hula hoops However, even a very large tax on hula hoops is unlikely to affect the markets for automobiles, doctor services, or orange juice Indeed, it is unlikely to affect the demand for other toys greatly Thus, a partial-equilibrium analysis of the effect of such a tax should serve us well Studying all markets simultaneously to analyze this tax would be unnecessary at best and confusing at worst Sometimes, however, we need to use a general-equilibrium analysis: the study of how equilibrium is determined in all markets simultaneously For example, the discovery of a major oil deposit in a small country raises the income of its citizens, and the increased income affects all that country’s markets Sometimes economists model many markets in an economy and solve for the general equilibrium in all of them simultaneously, using computer models Frequently, economists look at equilibrium in several—but not all—markets simultaneously We would expect a tax on comic books to affect the price of comic books, which in turn would affect the price of video games because video games are substitutes for comics for some people But we would not expect a tax on comics to have a measurable effect on the demand for washing machines Therefore, it is reasonable to conduct a multimarket analysis of the effects of a tax on comics by looking only at the markets for comics, video games, and a few other closely related markets such as those for movies and trading cards That is, a multimarket equilibrium analysis covers the relevant markets, but not all markets, as a general equilibrium analysis would Markets are closely related if an increase in the price in one market causes the demand or supply curve in another market to shift measurably Suppose that a tax on coffee causes the price of coffee to increase The rise in the price of coffee causes the demand curve for tea to shift outward (more is demanded at any given price of tea) because tea and coffee are substitutes The coffee price increase also causes the demand curve for cream to shift inward because coffee and cream are complements Similarly, supply curves in different markets may be related If a farmer produces corn and soybeans, an increase in the price of corn will affect the relative amounts of both crops the farmer chooses to produce Markets may also be linked if the output of one market is an input in another A shock that raises the price of computer chips will also raise the price of computers Thus, an event in one market may have a spillover effect on other related markets for various reasons Indeed, a single event may initiate a chain reaction of spillover effects that reverberates back and forth between markets Feedback Between Competitive Markets To illustrate the feedback of spillover effects between markets, we examine the corn and soybean markets using supply and demand curves estimated by Holt (1992) Consumers and producers substitute between corn and soybeans, so the supply and demand curves in these two markets are related The quantity of corn demanded and the quantity of soybeans demanded both depend on the price of corn, the price 10.1 General Equilibrium 319 of soybeans, and other variables Similarly, the quantities of corn and soybeans supplied depend on their relative prices Sequence of Events We can demonstrate the effect of a shock in one market on both markets by tracing the sequence of events in the two markets Whether these steps occur nearly instantaneously or take some time depends on how quickly consumers and producers react The initial supply and demand curves for corn, S c0 and Dc0, intersect at the initial equilibrium for corn, e c0, in panel a of Figure 10.1.1 The price of corn is $2.15 per Figure 10.1 Relationship Between the Corn and Soybean Markets (a) Corn Market Price, $ per bushel Supply and demand curves in the corn and soybean markets (as estimated by Holt, 1992) are related S 0c S 3c e 0c $2.15 D 0c e 1c $1.9171 $1.9057 e 3c D 1c 8.227 8.2613 8.44 Corn, Billion bushels per year Price, $ per bushel (b) Soybean Market S 0s e 0s $4.12 D 0s s S2 S 4s $3.8325 $3.8180 s e2 s e4 s D2 s D4 2.0505 2.0514 2.07 Soybeans, Billion bushels per year 1Until recently, the corn and soybean markets were subject to price controls (Chapter 9) However, we use the estimated supply and demand curves to ask what would happen in these markets in the absence of price controls 320 CHAPTER 10 General Equilibrium and Economic Welfare bushel, and the quantity of corn is 8.44 billion bushels per year The initial supply and demand curves for soybeans, S s0 and Ds0, intersect at e s0 in panel b, where price is $4.12 per bushel and quantity is 2.07 billion bushels per year The first row of Table 10.1 shows the initial equilibrium prices and quantities in these two markets Now suppose that the foreign demand for American corn decreases, causing the export of corn to fall by 10% and the total American demand for corn to shift from Dc0 to Dc1 in panel a The new equilibrium is at e c1, where Dc1 intersects Sc0 The price of corn falls by nearly 11% to $1.9171 per bushel, and the quantity falls 2.5% to 8.227 billion bushels per year, as the Step row of the table shows If we were conducting a partial-equilibrium analysis, we would stop here In a general-equilibrium analysis, however, we next consider how this shock to the corn market affects the soybean market Because this shock initially causes the price of corn to fall relative to the price of soybeans (which stays constant), consumers substitute toward corn and away from soybeans: The demand curve for soybeans shifts to the left from Ds0 to Ds2 in panel b In addition, because the price of corn falls relative to the price of soybeans, farmers produce more soybeans at any given price of soybeans: The supply curve for soybeans shifts outward to Ss2 The new soybean demand curve, Ds2, intersects the new soybean supply curve, Ss2, at the new equilibrium e s2, where price is $3.8325 per bushel, a fall of 7%, and quantity is 2.0514 billion bushels per year, a drop of less than 1% (Step row) As it turns out, this fall in the price of soybeans relative to the price of corn causes essentially no shift in the demand curve for corn (panel a shows no shift) but shifts the supply curve of corn, S c3, to the right The new equilibrium is e c3, where S c3 and Dc1 intersect Price falls to $1.9057 per bushel of corn and quantity to 8.2613 billion bushels per year (Step row) This new fall in the relative price of corn causes the soybean demand curve, Ds4, to shift farther to the left and the supply curve, S s4, to shift farther to the right in panel b At the new equilibrium at e s4, where Ds4 and Ss4 intersect, the price and quantity of soybeans fall slightly to $3.818 per bushel and 2.0505 billion bushels per year, respectively (Step row) These reverberations between the markets continue, with additional smaller shifts of the supply and demand curves Eventually, a final equilibrium is reached at which none of the supply and demand curves will shift further The final equilibria Table 10.1 Adjustment in the Corn and Soybean Markets Corn Step Initial (0) Price Quantity 2.15 8.44 1.9171 8.227 1.9057 1.90508 Price Quantity 4.12 2.07 3.8325 2.0514 3.818 2.0505 3.81728 2.05043 8.2613 Soybeans 8.26308 Final 1.90505 8.26318 3.81724 2.05043 10.1 General Equilibrium See Problems 23–25 321 in these two markets (last row of Table 10.1) are virtually the same as e c3 in panel a and e s4 in panel b Bias in a Partial-Equilibrium Analysis Suppose that we were interested only in the effect of the shift in the foreign demand curve on the corn market Could we rely on a partial-equilibrium analysis? According to the partial-equilibrium analysis, the price of corn falls 10.8% to $1.9171 In contrast, in the general-equilibrium analysis, the price falls 11.4% to $1.905, which is 1.2¢ less per bushel Thus, the partialequilibrium analysis underestimates the price effect by 0.6 percentage point Similarly, the fall in quantity is 2.5% according to the partial-equilibrium analysis and only 2.1% according to the general-equilibrium analysis In this market, then, the biases from using a partial-equilibrium analysis are small.2 Minimum Wages with Incomplete Coverage We used a partial-equilibrium analysis in Chapter to examine the effects of a minimum wage law that holds throughout the entire labor market The minimum wage causes the quantity of labor demanded to be less than the quantity of labor supplied Workers who lose their jobs cannot find work elsewhere, so they become unemployed The story changes substantially, however, if the minimum wage law covers workers in only some sectors of the economy, as we show using a general-equilibrium analysis This analysis is relevant because the U.S minimum wage law has not covered all workers historically When a minimum wage is applied to a covered sector of the economy, the increase in the wage causes the quantity of labor demanded in that sector to fall Workers who are displaced from jobs in the covered sector move to the uncovered sector, driving down the wage in that sector When the U.S minimum wage law was first passed in 1938, some economists joked that its purpose was to maintain family farms The law drove workers out of manufacturing and other covered industries into agriculture, which the law did not cover Figure 10.2 shows the effect of a minimum wage law when coverage is incomplete The total demand curve, D in panel c, is the horizontal sum of the demand curve for labor services in the covered sector, Dc in panel a, and the demand curve in the uncovered sector, Du in panel b In the absence of a minimum wage law, the wage in both sectors is w1, which is determined by the intersection of the total demand curve, D, and the total supply curve, S At that wage, L1c annual hours of work are hired in the covered sector, L1u annual hours in the uncovered sector, and L1 = L1c + L1u total annual hours of work If a minimum wage of w is set in only the covered sector, employment in that sector falls to L2c To determine the wage and level of employment in the uncovered sector, we first need to determine how much labor service is available to that sector Anyone who can’t find work in the covered sector goes to the uncovered sector The supply curve of labor to the uncovered sector in panel b is a residual supply curve: the quantity the market supplies that is not met by demanders in other sectors at any given wage (see Chapter 8) With a binding minimum wage in the covered sector, the residual supply function in the uncovered sector is3 Su(w) = S(w) - Dc(w) 2For an example where the bias from using a partial-equilibrium analysis instead of a generalequilibrium analysis is large, see MyEconLab, Chapter 10, “Sin Taxes.” 3If there is no minimum wage, the residual supply curve for the uncovered sector is Su(w) = S(w) - Dc(w) 322 CHAPTER 10 General Equilibrium and Economic Welfare Figure 10.2 Minimum Wage with Incomplete Coverage (a) Covered Sector (b) Uncovered Sector (c) Total Labor Market w, Wage per hour w, Wage per hour covered sector to fall The extra labor moves to the uncovered sector, driving the wage there down to w2 w, Wage per hour In the absence of a minimum wage, the equilibrium wage is w1 Applying a minimum wage, w, to only one sector causes the quantity of labor services demanded in the w – w1 w1 w1 w2 Dc Lc2 Lc1 L c , Annual hours See Question Su S Du Lu1 Lu2 L u , Annual hours D L1 = Lc1 + Lu1 L, Annual hours Thus, the residual supply to the uncovered sector, S u(w), is the total supply, S(w), at any given wage w minus the amount of labor used in the covered sector, L2c = Dc(w) The intersection of Du and S u determines w2, the new wage in the uncovered sector, and L2u, the new level of employment.4 This general-equilibrium analysis shows that a minimum wage causes employment to drop in the covered sector, employment to rise (by a smaller amount) in the uncovered sector, and the wage in the uncovered sector to fall below the original competitive level Thus, a minimum wage law with only partial coverage affects wage levels and employment levels in various sectors but need not create unemployment When the U.S minimum wage was first passed in 1938, only 56% of workers were employed in covered firms (see MyEconLab, Chapter 10, “U.S Minimum Wage Laws and Teenagers”) Today, many state minimum wages provide incomplete coverage More than 100 U.S cities and counties now have living-wage laws, a new type of minimum wage legislation where the minimum is high enough to allow a fully employed person to live above the poverty level in a given locale Living-wage laws provide incomplete coverage, typically extending only to the employees of a government or to firms that contract with that government (see MyEconLab, Chapter 10, “Living Wage Laws”) Chicago recently considered such a law for only employees of “big-box” stores such as Wal-Mart 4This analysis is incomplete if the minimum wage causes the price of goods in the covered sector to rise relative to those in the uncovered sector, which in turn causes the demands for labor in those two sectors, Dc and Du, to shift Ignoring that possibility is reasonable if labor costs are a small fraction of total costs (hence the effect of the minimum wage is minimal on total costs) or if the demands for the final goods are relatively price insensitive 10.1 General Equilibrium SOLVED PROBLEM 10.1 323 After the government starts taxing the cost of labor by τ per hour in a covered sector only, the wage that workers in both sectors receive is w, but the wage paid by firms in the covered sector is w + τ What effect does the subsidy have on the wages, total employment, and employment in the covered and uncovered sectors of the economy? Answer Determine the original equilibrium In the diagram, the intersection of the (a) Covered Sector (b) Uncovered Sector (c) Total Labor Market w, Wage per hour w, Wage per hour w, Wage per hour total demand curve, D1, and the total supply curve of labor, S, determines the original equilibrium, e1, where the wage is w1, employment in the covered sector is L1c , employment in the uncovered sector is L1u and total employment is L1 = L1c + L1u The total demand curve is the horizontal sum of the demand curves in the covered, Dc1, and uncovered, Du, sectors S τ w1 w2 w1 w2 w1 w2 e1 e2 D1 D2c D1c Lc2 Lc1 Lc , Annual hours Du Lu1 Lu2 Lu , Annual hours D2 L L1 L, Annual hours Show the shift in the demand for labor in the covered sector and the resulting shift in the total demand curve The tax causes the demand curve for labor in the covered sector to shift downward from Dc1 to Dc2 As a result, the total demand curve shifts inward to D2 Determine the equilibrium wage using the total supply and demand curves, See Questions 2–7 and Problem 26 and then determine employment in the two sectors Workers shift between sectors until the new wage is equal in both sectors at w2, which is determined by the intersection of the new total demand curve, D2, and the total supply curve, S Employment in the covered sector is L2c , and employment in the uncovered sector L2u Compare the equilibria The tax causes the wage, total employment, and employment in the covered sector to fall and employment in the uncovered sector to rise 324 CHAPTER 10 APPLICATION Urban Flight General Equilibrium and Economic Welfare Philadelphia and some other cities tax wages, while suburban areas not (or they set much lower rates) Philadelphia collects a wage tax from residents whether or not they work in the city and from nonresidents who work in the city Unfortunately, this approach drives people and jobs from Philadelphia to the suburbs To offset such job losses, the city has enacted a gradual wage tax reduction program During the program’s first five years, the wage tax on Philadelphia’s workers declined from a high of 4.96% in 1983 through 1995 to 4.5635% in 2000, 4.4625% in 2003, 4.331% in 2005, and 3.928% in the second half of 2010 A study conducted for Philadelphia estimated that if the city were to lower the wage tax by 0.4175 percentage point, 30,500 more people would work in the city Local wage tax cuts are more effective than a federal cut because generally employees will not leave the country to avoid paying a tax, but they will consider moving to the burbs Indeed, there has been much more growth on the suburban side of City Line Avenue, which runs along Philadelphia’s border, than growth within city limits 10.2 Trading Between Two People In Chapter 9, we learned that tariffs, quotas, and other restrictions on trade usually harm both importing and exporting nations The reason is that both parties to a voluntary trade benefit from that trade or else they would not have traded Using a general-equilibrium model, we will show that free trade is Pareto efficient: After all voluntary trades have occurred, we cannot reallocate goods so as to make one person better off without harming another person We first demonstrate that trade between two people has this Pareto property We then show that the same property holds when many people trade using a competitive market Endowments endowment an initial allocation of goods Suppose that Jane and Denise live near each other in the wilds of Massachusetts A snowstorm strikes, isolating them from the rest of the world They must either trade with each other or consume only what they have at hand Collectively, they have 50 cords of firewood and 80 bars of candy and no way of producing more of either good Jane’s endowment—her initial allocation of goods— is 30 cords of firewood and 20 candy bars Denise’s endowment is 20 (= 50 - 30) cords of firewood and 60 (= 80 - 20) candy bars So Jane has relatively more wood, and Denise has relatively more candy We show these endowments in Figure 10.3 Panels a and b are typical indifference curve diagrams (Chapters and 5) in which we measure cords of firewood on the vertical axis and candy bars on the horizontal axis Jane’s endowment is ej (30 cords of firewood and 20 candy bars) in panel a, and Denise’s endowment is ed in panel b Both panels show the indifference curve through the endowment If we take Denise’s diagram, rotate it, and put it on Jane’s diagram, we obtain the box in panel c This type of figure, called an Edgeworth box (after an English economist, Francis Ysidro Edgeworth), illustrates trade between two people with fixed endowments of two goods We use this Edgeworth box to illustrate a generalequilibrium model in which we examine simultaneous trade in firewood and in candy 10.2 Trading Between Two People 325 Figure 10.3 Endowments in an Edgeworth Box on I 1d (c) Their endowments are at e in the Edgeworth box formed by combining panels a and b Jane prefers bundles in A and B to e Denise prefers bundles in B and C to e Thus, both prefer any bundle in area B to e (a) Jane’s endowment is ej; she has 20 candy bars and 30 cords of firewood She is indifferent between that bundle and the others that lie on her indifference curve I 1j (b) Denise is indifferent between her endowment, ed (60 candy bars and 20 cords of wood), and the other bundles Firewood, Cords (b) Denise’s Endowment Denise’s wood ej 30 Jane’s wood I 1j 0j Jane’s candy 0d 20 ed 20 Candy, Bars I d1 60 Denise’s candy Candy, Bars (c) Edgeworth Box Denise’s candy 60 A Id1 e 30 20 f I 1j a Jane’s candy 30 B C 0j 0d Denise’s wood 80 50 Jane’s wood Firewood, Cords (a) Jane’s Endowment 20 40 50 80 The height of the Edgeworth box represents 50 cords of firewood, and the length represents 80 candy bars, which are the combined endowments of Jane and Denise Bundle e shows both endowments Measuring from Jane’s origin, 0j , at the lower left of the diagram, we see that Jane has 30 cords of firewood and 20 candy bars at endowment e Similarly, measuring from Denise’s origin, 0d, at the upper-right corner, we see that Denise has 60 bars of candy and 20 cords of firewood at e A-68 Index Tata Motors Nano auto, 177–178 technical progress, 176–177 Input choosing based on cost, in competitive factor markets, 528–529 competitive input combined with monopolized output, 529–530 competitive output combined with monopolized input, 530–531 converting into outputs, 152 factor price changes impacting costs of production, 204 isoquants showing substitutability of, 166 long-run costs and, 199–201 long-run production with two variable inputs, 163–164 market power and, 527–528 monopolies in successive markets, 531–533 rent of scarce inputs, 273 short-run production with one variable and one fixed input, 156 substitutability and marginal products, 170–171 substitutability of, 168–169 substitutability varying along isoquant, 169–170 supply curve when prices vary with output, 255–257 technologically and economically efficient, 199 timing and variability, 156 Insurance available only for diversifiable risks, 591 fairness and, 590–591 flight insurance, 600 health insurance, 666, 694 how much is wanted, 589–590 natural disasters and, 591–592 overview of, 589 strategies for dealing with risk, 589–592 Integrated circuits (ICs), isoquant for, 167–168 Intellectual property rights, piracy and, 377–378 Interest rates adjusting for inflation, 551 capital markets and, 565 compounding, 544–545 overview of, 543–544 using to connect present and future, 546 Interior solution, to consumer’s optimum, 94 Internal rate of return (irr), in investing, 555 Internalization of externality, by manufacturers, 614 International antitrust laws, 441–442 Introspection, vs estimating costs, 211 Inventors, patents stimulating research by, 375–377 Inverse demand functions, 16 Investments capital markets and, 565 choices over time, 553 discounting for risk, 593–595 diversification of, 588–589 government borrowing crowding out private investment, 566 internal rate of return approach, 555 net present value approach, 553–555 overview of, 542 purchase of Golden State Warriors, 555–556 risk-averse investing, 593 risk-neutral investing, 592 iPod Apple’s pricing strategy, 353, 386–387 effects of high-cost competition, 387 Lerner index for, 367 profit maximization in monopoly environment, 362–363 Isocost line approaches to minimizing costs, 201 expansion paths and, 206 factor prices affecting, 205 family of, 200 inputs and, 199–201 Isoquants expansion paths and, 206 factor prices affecting, 205 IC (integrated circuit) example, 167–168 properties of, 164–165 shape of, 165–167 showing efficient combinations of labor and capital, 164–165 slope of, A-10 substituting inputs and, 168–170 Isowelfare curves, 343 Iterated elimination of strictly dominated strategies, in game theory, 487–488 Job safety, asymmetric information and, 637, 660 Labor demand curves calculating for thread mill example, 522–523 shifts and movement along, 522 Labor (L) average product of labor, 158 competitive supply of, 528–529 defined, 155 diminishing marginal returns, 193 effect of extra labor on production, 160 factor demand, A-24–A-25 as fixed or variable input, 156 as input of production, 152 isocost line and, 199–200 isoquants showing efficient combinations of labor and capital, 164–165 marginal expenditure in buying services, 533–534 marginal product of, 158 minimizing costs by labor and capital choices, A-12–A-13 minimum wage law, 33–34 minimum wage law with incomplete coverage, 321–323 occupational licensing in labor market, 28 productivity during recessions, 151, 178–180 profit maximization, 520–521 relationship of production to variable labor, 159 short-run factor demand for, 518–521 technical progress saving, 177 total product related to, 157–158 Labor-leisure model, 136–138, A-9 Labor supply curves income and substitution effects related to, 138–140 income tax rates impacting, 142–146 labor-leisure choice, 136–138, A-9 overview of, 136 shape of, 140–141 winning the lottery and, 141–142 Lagrangian method applying to cost minimization, A-13 applying to maximization of utility, A-6–A-7 Land management practices, impact on per capita food production, 162 Laspeyres index, for correcting substitution bias in CPI, 135 Last-dollar rule, in cost minimization, 201, 203–204 Law of Demand demand curve slope and, 116 Griffen goods and, 128 negative slope of demand curve and, 15 overview of, 12 price elasticity of demand and, 45 Law of diminishing marginal returns, 161–163 Laws against cartels, 441–442 zoning laws as barrier to entry, 475 Lawyers, client-lawyer contracts contingent fees, 680 fixed fee contract, 680 hourly contract, 679 Layoffs, vs pay cuts, 691–692 Learning by doing, 215, 217 Learning curve, long-run costs and, 215–217 Leisure income elasticity of, 140 labor-leisure choice, 136–138, A-9 Lemons market with fixed quality, 642–645 limiting lemons, 646–649 with variable quality, 645–646 Lerner index, 367 Licenses business license fee effecting costs, 197–198 occupational licensing, 28 Licensing laws policies that cause shifts in supply curves, 27–28 profit and, 273 taxicab example, 292 Limited liability, in corporate ownership, 153–154 Linear demand function, 15 Living wage laws See also Minimum wage laws, 322 Long run competition in See Competition, longrun costs in See Costs, long-run production in, Production, long–run zero profit in See Zero long-run profit Lowest isocost rule, approaches to minimizing costs, 201–202, 204 Lump-sum costs, impact on market equilibrium, 263 Luxury goods, income elasticity of demand and, 52 Malthus, Thomas, 162 Management of firms, 154 what owners want, 154–155 Marginal benefit, of advertising, 428 Marginal cost (MC) cost curves, 192 Index cost curves for furniture manufacturer, 195 deciding whether to advertise, 426–427 in monopolies, 365 output decisions in monopolies and, 363–364 overview of, 190 perfect price discrimination and, 402 profit maximizing output rules, 235 relationship to price in Lerner index, 367 rent and, 272–273 shape of cost curves for, 194 shape of long-run cost curves and, 207–209 short-run firm supply curves and, 241–242 short-run output decisions, 236, 238 taxes effecting, 196–197 vs price in changes to welfare, 288 Marginal expenditures (ME), buying labor services and, 533–534 Marginal firms, entry into market at zero long-run profit, 251 Marginal product formula, Cobb-Douglas production function, 203 Marginal product of capital (MPK), A-24–A-25 Marginal product of labor (MPL) factor demand and, A-24–A-25 graphing product curves, 159–160 overview of, 157–158 relationship to average product of labor, A-10 Marginal products, substitutability of inputs and, 170–171 Marginal profit, profit maximizing output rules, 234–235 Marginal rate of substitution (MRS) curvature of indifference curves and, 81–82 marginal utility and, A-5 utility and, 87–88 willingness to substitute goods, 80–81 Marginal rate of technical substitution, Cobb-Douglas production function, 171 Marginal rate of technical substitution (MRTS) approaches to minimize costs, 203 for Cobb-Douglas production function, 186 overview of, 169–170 Marginal rate of transformation (MRT) comparative advantage and, 333 number of producers and, 334–335 slope of budget line, 90 Marginal revenue (MR) deciding whether to advertise, 426–427 perfect price discrimination and, 402 profit maximizing output rules, 235 relationship between linear demand curve and, A-16 Marginal revenue (MR), in monopolies deriving marginal revenue curves, 356–357 overview of, 354 price and, 354–356 price elasticity of demand and, 358–359 profit maximizing output rules, 360–361 Marginal revenue product of labor (MRPL) approach to determining labor demand, 524–525 calculating labor demand curve, 522 overview of, 519–520 Marginal tax rates, 143–145 Marginal utility always nonnegative (more-is-better), A-5 nonsatiation in mutually beneficial trades, 326 overview of, 86–87 Marginal willingness to pay consumer surplus and, 278 eBay example, 276–277 measuring consumer welfare, 276 Market clearing price, 25 Market demand alternative approach to determining labor demand, 525–526 competitive equilibrium and, 261 in competitive factor markets, 524 marginal revenue product approach in determining labor demand, 524–525 Market failures due to adverse selection, 639 due to asymmetric information, 638 due to externalities, 610 societal welfare and, 286–288 Market power conditions allowing price discrimination, 398 government actions reducing, 378 impact on price of exhaustible resources, 564 mergers and efficiency and, 446 modeling in input and output markets, 527–528 of monopolies, 364 monopolized factor market and competitive output market, 530–531 monopoly in successive markets, 531–533 shape of demand curves reflecting, 364–366 sources of, 368 Market power, related to price ignorance advertising, 653 overview of, 650–651 Tourist Trap model, 651–653 Market structure defined, 227 externalities and, 615–616 factor markets, 527 overview of, 438–439 types of, 439 Market supply curve, in long-run competition competitive equilibrium and, 261 entry and exit of firms, 251–252 example of Chinese art factories, 253 example of cotton production, 254–255 example of identical vegetable oil firms, 252 free entry and exit of firms, 252–253 for increasing-cost, constant cost, and decreasing cost markets, 255–257 limited entry and exit of firms, 254 overview of, 250–251 reflecting differences in firms, 254 reflecting trade, 257–260 for reformulated gasoline, 259–261 when input prices vary with output, 255–257 Market supply curve, in short-run competition, 244–246 A-69 Markets defined, equilibrium See Equilibrium, market for factors See Factor markets for lemons and good cars, 643 in long-run competition See Competition, long-run in perfect competition See Perfect competition profit maximization in See Profit maximization for public goods, 626 in short-run competition See Competition, short-run taxes in noncompetitive, 618 Mass production, in auto industry, 177 Materials (M) cost increase impacting supply curve, 244 defined, 155 as input of production, 152 as variable input over time, 156 Mathematical analysis of equilibrium quantity, 24 functions See Functions, mathematical of profit maximization in monopolies, 361–363 Maturity date, of bonds, 556 Maximization of well-being/pleasure, in model of consumer behavior, 73 Maximum price (price ceiling) See Price controls Mergers as alternative to collusion, 445 hospital example, 446 how monopolies are created, 371 Microeconomics decision making regarding allocation, defined, prices determining allocations, summary, trade-offs in resource allocation, Mills, John Stuart, 83, 345 Minimum efficient scale (full capacity), in monopolistic competition, 473 Minimum price (price floor) See Price controls Minimum wage laws effects of incomplete coverage, 321–323 as example of price floor, 33–34 Mixed strategies, in predicting game outcome applying, 491–492 overview of, 489–490 Models assumptions in, 4–5 Bertrand model See Bertrand model of competitive firms See Competitive model, applying of consumer behavior, 73 Cournot model See Cournot model defined, income threshold, positive vs normative statements in, 6–7 of principal-agent problem, 668 Stackelberg model See Stackelberg model summary, supply and demand See Supply and demand, applying model for testing economic theories, 5–6 Tourist Trap model, 651–653 two-period monopoly model, 386–387 uses of microeconomic models, 7–8 A-70 Index Money value, today vs future compounding interest, 544–545 discount rates, 544 future value, 546 inflation and discounting, 551–552 interest rates, 543–544 lottery example, 552–553 overview of, 543 present value, 547 stream of payments, 547–550 using interest rates to connect present and future, 546 Monitoring contract fulfillment after-the-fact monitoring, 687–690 bonding, 683–685 deferred payments, 685 efficiency wages, 685–687 overview of, 682–683 Monopolies advertising See Advertising, in monopolies barriers to entry, 374 comparing properties of market structures, 439 cost advantages that create, 371 externalities in, 616–617 government actions creating, 374 government actions encouraging competition, 383 government actions reducing market power, 378 graphical approach to, 359–361 incidence of specific tax on, A-16–A-17 Lerner index, 367 marginal revenue and elasticity of demand, 358–359 marginal revenue and price, 354–356 marginal revenue curves, 356–357 market power of, 364 mathematical approach to, 361–363 multimarket price discrimination vs single price monopoly, 417 natural monopolies, 372–373 network externalities and, 383–385 output rules for profit maximization, 360–361 overview of, 353–354 patents and, 374–377 perfect price discrimination in, A-17 as price setters, 36, 438 price vs quantity in, 359 pricing See Pricing, in monopolies profit maximization and, 354 regulating, 378–382 shape of demand curves reflecting market power, 364–366 shifts in demand curve effecting, 363–364 shutdown rules and, 361 sources of cost advantages, 372 sources of market power, 368 in successive factor and output markets, 531–533 two-period model, 386–387 types of market structures, 439 welfare effects of, 368–371 welfare under regulated monopolies, 617–618 Monopolistic competition among airlines, 474 comparing properties of market structures, 439 fixed costs and number of firms and, 473–474 monopolistically competitive equilibrium, 472–473 overview of, 438, 471–472 price setting in, 438 types of market structures, 439 zoning laws as example of barrier to entry, 475 Monopolistic factor markets combined with competitive output market, 530–531 defined, 518 market structure and factor demands, 527 monopoly in successive markets, 531–533 overview of, 527 Monopolistically competitive equilibrium, 472–473 Monopoly price, 652 Monopsonies company town example, 535–536 defined, 517–518 overview of, 533 profit maximization, A-25–A-26 welfare effects, 536–538 Monopsony power, 535 Moral hazard See also Contracts adding terms to contracts that address, 681 asymmetric information and, 676 bonding and, 683–684 checks on principals (employers), 690 designing contracts to eliminate, 667 efficiency in production and, 669–670, 675 health insurance and, 666, 694 leased cars example, 687 principals giving agents choice of contract, 692 punishment as monitoring strategy, 687 shirking as, 677 subprime borrowing example, 688 types of opportunistic behavior, 639–640 More-is-better consumer’s optimum, 98–99 properties of consumer preferences, 76 Movement along demand curve increase in price causing, 118 for labor, 522 vs shifts in, 14–15 Movement along indifference curve, substitution effect causing, 127 Movement along supply curve, 18–20 Multimarket price discrimination identifying groups for, 415–416 Mama Mia DVD example, 410–412 overview of, 409–410 smuggling prescription drugs and, 412–415 with two groups, 410, A-18 types of price discrimination, 400–401 welfare effects of, 417 Multiperiod (repeated) games overview of, 502–504 types of dynamic games, 496 Multiple regression, A-3 Mutual benefit, in trades between two people, 326–328 Mutual funds, as means of diversification, 588–589 Nano, examples of organizational innovations, 177–178 Nash-Bertrand equilibrium See Bertrand model Nash-Cournot equilibrium See Cournot model Nash equilibrium applying to oligopolies, 446 predicting game outcome, 488–489 pure and mixed strategies and, 492 Nash, John, 446, 488 Natural disasters, insurance and, 591–592 Natural monopolies Internet and, 385 natural gas example, 381–382 overview of, 372–373 Needs and wants, economists focusing on, Negative externality, 606–607 Net present value (NPV) approach to investing, 553–555 investing and discounting, 593–594 Net profit, in decision to advertise, 426–427 Network externalities direct size effect, 384 eBay example, 385 as explanation for monopolies, 385 indirect effect, 384 overview of, 383–384 Nominal price adjusting interest for inflation, 551 vs real price, 130 Non-profit firms, 152–153 Noncompetitive markets, taxes in, 618 Noncooperative oligopolies See Oligopolies, noncooperative Nondiversifiable risks, 591–592 Nonoptimal price regulation, of monopolies, 378–379 Nonrenewable resources See Exhaustible resources Nonuniform pricing overview of, 394–395 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, 485–486 Normal goods goods that are both inferior and normal, 124 income and substitution effects, 125–127 income inelasticity and, 121 some goods must be normal, 123 Number of buyers in oligopsonies, 533 in perfectly competitive market, 228 Number of firms, in market Cournot equilibrium and, 451–452 entry and exit and See Entry and exit, of firms market structures and, 227 monopolistic competition and, 473–474 oligopolies, 437 restrictions on, 290–292 Number of producers, in market, 334–335 Number of sellers, in perfectly competitive market, 228 Number of units, elements of auctions, 504 Occupational licensing, 28 Ocean fisheries, problems with commons, 623 Index Oil See Petroleum products (oil, gasoline) Oligopolies Bertrand model See Bertrand model collusive See Cartels comparing properties of market structures, 439 Cournot model See Cournot model defined, 437 Duopolies, 446 noncooperative, 438, 446 as price setters, 36, 438 Stackelberg model See Stackelberg model types of market structures, 439 Oligopsony, number of buyers in market, 533 Open-access common property bridge example, 624 externalities and, 606 overview of, 622–623 problems with, 623 resources with rivalry but no exclusion, 625 solving the commons problem, 624 Opportunistic behavior adverse selection and moral hazard in, 639–640 asymmetric information and, 638 full information and, 667 laws preventing, 646 restricting through universal coverage, 640 Opportunity costs of attending seminar, 187 of durable goods, 187–188 of MBA degree, 186 overview of, 186–187 profit and, 232–233, 271 rent and, 272–273 vs sunk costs, 188 Opportunity set cash vs food stamps and, 100 comparing water vs other goods, 92 defined, 89 effect of income change on, 90–91 effect of price change on, 90 effect of rationing on, 92 Optimal price regulation of monopolies, 378–379 Ordinal measures, of utility, 84–85 Organization of Petroleum Exporting Countries (OPEC), 442 Organizational change, productivity and, 177–180 Organizations See Firms Output in competitive factor market, 528–529 converting inputs into, 152 costs varying with, 189, 205–207 deciding how much to produce, 226 determining cost-minimizing level, 205 determining labor demand, 525–526 market power and, 527–528 in monopolies, 363–364 in monopolized factor market, 529–531 physical product as, 155 profit maximization, 234–235 profit maximization in factor markets, 520–521 profit maximization in monopolies, 360–361, A-19 quotas on, 299–300 reducing from competitive level results in lower welfare, 286–287 relationship of labor to total product, 157 in short-run competition, 236–239 Outsourcing, costs of moving production abroad vs using intensive technology at home, 184, 220–221 Overconfidence, behavioral economics of risk, 595 Overuse, problems with commons, 623 Ownership, of firms, 152 private, public, and nonprofit, 152–153 for profit firms, 153–154 Ownership of land, vs rental in determining profit, 273 Paasche index, for correcting substitution bias in CPI, 135 Package tie-in sales See Bundling Pareto efficient allocation of goods and service, 317 competitive equilibrium and, 331 contract curves, 327–328 government policies, 340–342 Pareto principle, 317 Pareto property, of Trades between two people, 324 Partial equilibrium analysis bias in, 321 overview of, 318 Partnerships, ownership structures, 153 Patents alternatives to, 377 Botox example, 375–377 overview of, 374–375 piracy and, 377–378 stimulation of research, 375 Pay cuts, vs layoffs, 691–692 Payments, over time future value, 549–550 overview of, 547 payments for finite period, 547–548 payments forever, 548–549 present value, 547, A-26 saving for retirement example, 549–550 Payoff matrix (profit matrix), for normalform games, 485 Payoffs, of games, 483–485 Perfect competition derivation of firm’s demand curves, 229–231 deviations from, 229 overview of, 227 price taking, 227–228 properties of price taking firms, 228–229 qualities of perfectly competitive markets, 35 reasons for studying, 231–232 Perfect complements, 82 Perfect information in game theory, 484 repeated games and, 502 Perfect price discrimination Botox example, 405–406 impact on consumers, 403–406 in a monopoly, A-17 overview of, 401 transaction costs impacting, 406–408 types of price discrimination, 400 union example, 407–408 Perfect substitutes Coke/Pepsi example, 120–121 vs perfect complements, 82 Perfectly elastic demand curves, 47 A-71 Perfectly elastic supply curves, 54 Perfectly inelastic demand curves, 46, 48 Perfectly inelastic supply curves, 54 Perpetuities, 556, A-26 Petroleum products (oil, gasoline) anti-price gouging laws applied to gasoline, 316, 347–348 cost curves for oil pipelines, 213–214 demand elasticity and, 50 impact of drilling in Arctic National Wildlife Refuge on oil prices, 56–59 market supply curve for reformulated gasoline, 259–261 short and long-run impacts of carbon tax, 68 shutdown rules applied to production of, 242–243 taxes designed to reduce global warming, 42 who pays for tax on gasoline (incidence), 67 Physical product, as output of production, 155 Piracy, intellectual property rights and, 377–378 Policies antitrust laws in international setting, 441 cash vs food stamps, 101 implication of tax salience on tax policies, 105 Pareto efficient, 340–342 regulating mergers, 446 strategic trade policies, 461–462 tax rates and cuts, 142 uses of microeconomic models, Policies, regulating imports ban on rice imports, 29 free trade vs ban on imports, 304–305 free trade vs quotas, 307–308 free trade vs tariffs, 305–307 overview of, 303 quotas, 28–30 rent seeking and, 308–310 supply curves effected by, 20–22 Policies, that create wedge between supply and demand, 30–33 minimum wage example, 33 overview of, 294 price ceilings, 30–32 price floors, 32–33 welfare effects of price floors, 297–301 welfare effects of sales taxes, 294–295 welfare effects of subsidies, 295–297 Policies, that shift supply curves ban on rice imports, 29 entry and exit barriers, 293 import regulation, 20–22 licensing laws, 27–28 overview of, 289 quotas, 28–30 restrictions on number of firms in a market, 290–292 Pollution controlling externalities related to automobiles, 615 emission standards, 612–613 emissions fees, 613–614 free trade and, 605, 631–632 markets for, 621–622 property right to be free of pollution, 619–620 property right to pollute, 620 pulp and paper mill example, 613 A-72 Index taxing externalities due to, 614–615 welfare effects in competitive market, A-26–A-27 Pooling equilibrium comparing with separating equilibrium, 657 defined, 655 efficiency and, 658–659 example of paying all workers an average wage, 656–658 Positive externality, 607–608 Positive monotonic transformation, utility function and, 85 Positive statements in explaining consumer behavior, 74 vs normative statements, 6–7 Predicting game outcome best response and Nash equilibrium, 488–489 dominant strategies, 486–487 iterated elimination of strictly dominated strategies, 487–488 overview of, 486 Predictions positive statements about cause and effect, role of models in, testing, Preference (indifference) maps overview of, 77–78 properties of, 78–80 Preferences curvature of indifference curves, 81–83 defined, 74 indifference curves, 78–80 overview of, 74–75 preference (indifference) maps, 77–78 present-biased, 557 properties of consumer preferences, 75–76 risk preference, 580, 583–585 social welfare functions and, 345–346 U.S vs European preference for SUVs, 95 voting preferences, 343–344 willingness to substitute and, 80–81 Present-biased preferences falling discount rates and self control, 558 time consistency, 557 Present value (PV) of money, 547 of payments over time, 547 of perpetuity, A-26 Price advertising and, 653 of alternative goods in consumer purchasing, 11 in competitive market, 329 controls See Price controls demand curves and, 11–13 in determining allocations, discrimination See Price discrimination equilibrium price (or market clearing price), 25 of exhaustible resources remains constant or fall over time, 563–564 increasing over time (inflation), 130 and marginal revenues in monopolies, 354–356 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, 236, 238 price change effecting consumer surplus, 279–282 price change effecting factor demand, 521 price change effecting opportunity set, 90 price change effecting revenue, 49 price differences vs price discrimination, 400 relationship to marginal cost in Lerner index, 367 reservation price, 401 of scarce exhaustible resource in twoperiod example, 560–562 of scarce exhaustible resources, 559–560 sensitivity of quantity demanded to, 44 supply curves and, 18–19 supply varying with market price, 241 vs marginal cost in changes to welfare, 288 vs quantity in monopolies, 359 Price-consumption curve correspondence to demand curve, 116–117 indifference curves and, 114–115 tobacco use, 115 Price controls alternative price support program in agriculture, 299 anti-price gouging laws applied to gasoline, 316, 347–348 ceilings, 30–32 floors, 33–34 nonoptimal price regulation of monopolies, 378–379 optimal price regulation of monopolies, 378–379 social cost of natural gas price ceiling, 302–303 supply not equal to demand, 34–35 welfare effects of price ceilings, 301–303 welfare effects of price floors, 297–299 who benefits, 300 Zimbabwe example, 32–33 Price discrimination conditions allowing, 398–399 Disneyland example, 398–399 due to false beliefs about quality, 649–650 factors preventing resale, 399–400 Google example, 402 multimarket See Multimarket price discrimination nonuniform pricing, 394–395 overview of, 395 perfect See Perfect price discrimination price differences vs., 400 quantity discrimination and, 400, 408–409 theater ticket example, 397–398 types of, 400–401 why it pays, 396–397 Price elasticity of demand consumer sensitivity to price, 398 consumer surplus and, 281–282, A15–A-16 downward-sloping linear demand curves, 46–48 elastic demand curve, 47 horizontal demand curves, 48 impact of drilling in Arctic National Wildlife Refuge on oil prices, 56–59 Lerner index and, 367 in monopolies, 358–359, 365 over time, 50–51 overview of, 45–46 residual demand and, 231, A-14 revenue and, 48–50 in Slutsky equation, A-8 specific (unit) taxes related to, 60 tax incidence related to, 61–62 vertical demand curves, 48 Price elasticity of supply elastic supply curve, 54 impact of drilling in Arctic National Wildlife Refuge on oil prices, 56–59 impacts of big freeze in California on vegetable prices and industry revenues, 55–56 over time, 56–59 overview of, 53–54 specific (unit) taxes related to, 60 supply curves, 54–55 tax incidence related to, 61–62 Price line endowment and, 329 leading to competitive equilibrium, 330 Price setters market structures and, 438 monopolies See Monopolies monopolistic competition See Monopolistic competition oligopolies See Oligopolies Price takers competitive firms and, 227–229 consumers and firms as, 36 properties of price taking firms, 228–229 trade between two people, 329 Price theory See also Microeconomics, Pricing, in monopolies bundling as form of tie-in sales, 422–425 conditions allowing price discrimination, 398–399 identifying groups for multimarket price discrimination, 415–416 impact of perfect discrimination on consumers, 403–406 magazine example, 394 multimarket price discrimination, 409–410 multimarket price discrimination with two groups, 410–415 nonuniform pricing, 394–395 perfect price discrimination, 401 price differences vs price discrimination, 400 price discrimination, 395 quantity discrimination, 408–409 requirement tie-in sales, 421 resale prevention, 399–400 tie-in sales, 420–421 transaction costs impacting perfect price discrimination, 406–408 two-part tariffs, 417–418 two-part tariffs with identical customers, 418–419 two-part tariffs with nonidentical customers, 419–420 types of price discrimination, 400–401 welfare effects of multimarket price discrimination, 417 why price discrimination pays, 396–398 Index Principal-agent problem model of, 668 types of contracts, 669 Principals checks on, 690 giving agents choice of contracts, 692 principal-agent problem, 668–670 Prisoner’s dilemma, 487 Private costs cost of production without externalities, 608 social marginal costs vs private marginal costs, 610 Private firms, ownership of See also Firms, 153 Private (For-profit) firms See also Firms, 152–154 Private goods See also Goods, 624–625 Private investment, government borrowing crowding out, 566 Private-value auctions, 505–507 Privatization, reducing free riding, 629 Prizes, alternatives to patents, 377 Probability certainty effect (Allais effect), 597–598 difficulty in assessing, 595–596 frequency of outcomes and, 574–576 insurance diversification and, 591 low-probability gambles, 596–597 probability distribution, 575–576 subjective probability, 574–575 Probability distribution, 575–576 Producer surplus (PS) comparing pricing methods, 425 elimination of free trade and, 304 measuring with supply curve, 282–283 in monopolies, 368–371 in monopsonies, 537 output levels and, 287 overview of, 282 perfect price discrimination, 403–406 pollution effecting competitive market, 609 price supports, 298, 301–302 quantity discrimination, 409 regulation of monopolies, 379, 381 restrictions on number of firms in a market, 291 specific tax on roses, 295 subsidies, 295–297 tariffs and quotas, 306 using to study the effects of shocks, 283–284 welfare and, 285 Producer welfare measuring producer surplus with supply curve, 282–283 overview of, 282 using producer surplus to study the effects of shocks, 283–284 Producers incidence of taxes on, 64–65 number in market, 334–335 number of producers impacting production possibility frontier, 334–335 Product curves, showing total product, marginal product, and average product, 158–161 Product differentiation bottled water example of spurious differentiation, 458 impact on oligopoly, 456 welfare and, 471 Production See also Output choosing inputs based on cost, combining cost and production information, 201–204 costs of moving abroad vs using intensive technology at home, 184, 220–221 cotton production example, 254–255 efficiency See Production efficiency excess as market distortions, 299 function See Production function inputs in, 152 in long-run See Production, long-run mass production in auto industry, 177 methods as source of cost advantages, 372 minimizing costs by labor and capital choices, A-12–A-14 overview of, 155 relationship with variable labor, 159 in short-run See Production, short-run shutdown rules applied to oil production, 242–243 timing and variability of inputs, 156 trading and See Production and trading Production and trading benefits of trade, 333–334 comparative advantage, 332 competition and, 336–338 efficiency of product mix, 335–336 marginal rate of transformation (MRT), 333 number of producers and, 334–335 production possibility frontier, 332 Production efficiency asymmetric information, 676–677 contracts and, 670 efficient contracts, 670–671 equilibrium and, 316 full information, 671–675 moral hazard and, 675 principal-agent problem, 669–670 technological, 155 Production efficiency, trade off with risk bearing choosing best contract, 680–682 contingent fees, 680 contracts and efficiency, 678 fixed fee contract, 678–679 hourly contract, 679 overview of, 677 Production function overview of, 155–156 shape of cost curves, 192–193 shape of cost curves and, 192–195 Production function, Cobb-Douglas constant, increasing, and decreasing returns to scale, 172–173 marginal product formula, 203 marginal rate of technical substitution, 171 overview of, 186 Production, long-run isoquants showing efficient combinations of labor and capital, firms, 164–165 shape of isoquants, 165–167 substitutability of inputs and marginal products, 170–171 substitutability of inputs varying along isoquant, 169–170 substituting inputs, 168–169 time factors in, 156 with two variable inputs, 163–164 A-73 Production possibility frontier (PPF) comparative advantage and, 332 costs of producing multiple goods, 218–219 in firewood and candy example, 334 number of producers impacting, 334–335 optimal product mixes, 335–336 Production, short-run average product of labor, 158 effect of extra labor on, 160 graphs of product curves, 158–160 law of diminishing marginal returns, 161–163 marginal product of labor, 158 with one variable and one fixed input, 156 relationship between product curves, 160–161 time factors in production, 156 total product, 157–158 Productivity innovations increasing, 176–177 organizational change increasing, 177–180 relative, 175–176 technical change and, 175 Products Cournot model with differentiated products costs between firms, 454–456 efficiency of product mix, 335–336 identical or homogeneous products as property of perfectly competitive market, 228 as output of production, 155 Profit defined, 232–233 as difference between revenue and costs, 154 opportunity costs and, 271 Profit function, 234 Profit maximization advertising and production in monopoly, A-19 example of cable cars in San Francisco, 366 market structures and, 438 necessary condition for, A-14–A-15 overview of, 154 sufficient condition for, A-15 using labor or output, 520–521 Profit maximization, in competitive firms example of competitive firm, 237 in long-run competition, 249 need for, 275 output rules, 234–235 overview of, 232 profit defined, 232–233 in short-run competition, 236 shutdown rules, 235–236 steps in, 234 Profit maximization, in monopolies graphical approach, 360–361 marginal revenue and, 354 mathematical approach, 361–363 overview of, 359 Profit maximization, in monopsonies, 533–536, A-25–A-26 Profit-sharing contracts asymmetric information contracts, 676 full information contracts, 674–675 Property rights allocating to reduce externalities, 618 A-74 Index assigning as means of addressing problems of commons, 624 Coase Theorem and, 619–621 externalities caused by lack of clearly defined, 606 intellectual property rights, 377–378 Prospect theory, behavioral economics of risk and, 598–600 Prospect theory value function, 599 Public firms See also Firms, 153 Public goods beef example, 629 demand for, 626–627 externalities and, 606 free riding and, 627–628 markets for, 626 overview of, 624 Radiohead experiment, 628–629 reducing free riding, 629 rivalry and exclusion and, 624–625 valuing, 630–631 Public utilities, as example of natural monopoly, 372 Punishment as monitoring strategy, 687 threatening to punish as strategy in repeated games, 503 Purchasing decisions income threshold model related to purchase of durable goods, uses of microeconomic models, Pure strategy applying two Nash equilibria, 490 in predicting game outcome, 489 Qualitative change, using supply-anddemand model to predict, 42 Quality ignorance drives out high-quality goods, 642 lemons market with fixed quality, 642–645 lemons market with variable quality, 645–646 limiting lemons, 646–649 overview of, 642 price discrimination due to false beliefs about quality, 649–650 Quantitative change, using supply-anddemand model to predict, 43 Quantity demanded See also Demand choosing price vs quantity in monopolies, 359 cross-price elasticity of demand and, 52 demand curves and, 11–12 in demand function, 14–15 excess demand and excess supply and, 24 falling as price rises, 112 impact of prices on, 12–13 income elasticity of demand, 51–52 not equal to quantity supplied, 34–35 relationship of income to, 118–119 sensitivity to price, 44 summing demand curves, 16–17 Quantity discounts, 408 Quantity discrimination block-pricing schedules used by utility monopoly, A-18 overview of, 408–409 as type of price discrimination, 400 Quantity supplied See also Supply excess demand and excess supply and, 24 not equal to quantity demanded, 34–35 price elasticity of supply and, 53 sensitivity to price, 53 supply curves and, 18 supply function and, 19–20 Quotas effects of, 306 on farm output, 299–300 free trade vs., 307–308 import policies effecting supply curves, 21–22 policies that cause shifts in supply curves, 28–30 Rate of return, on bonds, 556 Rationing impact on consumer’s opportunity set, 92 water rationing during Australian drought, 270, 309–310 Rawls, John, 346 Rawlsian welfare functions, 346 Real present value, 552 Real price adjusting interest for inflation, 551 vs nominal price, 130 Rebates, as meaning of identifying consumer groups, 416 Recessions labor productivity during, 151, 178–180 layoffs vs pay cuts, 691–692 Reflection effect, in attitudes about risk, 598 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, 624 demand effects of, 11 emission standards, 612–613 emissions fees, 613–614 microeconomic models in predicting impact of, pulp and paper mill example, 613 reducing market power, 378–382 restricting number of firms in a market, 290–292 supply effects of, 17–18 taxicab example, 291–292 Regulation, of monopolies comparing welfare under competition with welfare under regulated monopoly, 617–618 natural gas example, 381–382 nonoptimal price regulation, 380 optimal price regulation, 378–379 overview of, 378 problems with, 379–380 Relative productivity, measuring, 175–176 Rent defined, 273 determining, 274 of exhaustible resources, 561 as fixed cost, 272–273 Rent seeking activities, of governments, 308–310 Repeated (or multiperiod) games overview of, 502–504 types of dynamic games, 496 Requirement tie-in sales, 421 Resale ability to prevent or limit as condition of price discrimination, 399 designer bag example, 400 Research, patents stimulating, 375–377 Reservation price, 401, A-17 Residual demand curve deriving, 230–231 elasticity of, A-14 Residual supply curve market supply curve reflecting trade, 257–260 minimum wage law with incomplete coverage and, 321 trade and, 257 Resource allocation See Microeconomics Resources, exhaustible See Exhaustible resources Retirement, saving for, 550 Returns to scale Cobb-Douglas production function and, 172–173 constant, increasing, and decreasing, 171–172 long-run costs and, 209 overview of, 171 in U.S manufacturing, 173–174 varying, 174–175 Returns to specialization, 174 Revenue demand elasticities over time and, 51 demand elasticity and, 48–50 profit and, 154, 232 relationship to marginal tax rate, 143–145 shutdown rules and, 234–235, 239 Revenue-sharing contracts, asymmetric information contracts, 676 Reverse auctions, 415–416 Risk See also Uncertainty avoiding, 586 defined, 573 degree of, 574 discounting for risk in investments, 593–595 diversification in dealing with, 587–589 efficiency in risk bearing, 670 expected value and, 576–577 gambling and, 584–585 insurance and, 589–592 obtaining information in dealing with, 586–587 probability and, 574–576 saying no to, 586 trade off between production efficiency and risk bearing, 677 variance and standard deviation in measuring, 577–578 Risk aversion See also Avoiding risk decision making and, 580–582 expected utility and, 579–580 insurance and, 589–590 risk-averse investing, 593 unwilling to make a fair bet, 580 working in dangerous industries and, 637 Risk neutrality decision making and, 582–583 indifferent regarding fair bet, 580 risk-neutral investing, 592 Risk pooling, 587 Risk preference decision making and, 583–585 willing to make a fair bet, 580 Index Risk premium, 581 Rivalry and exclusion, goods and, 624–625 Robber barons, 441 Rules and regulations See also Regulation impacting demand, 11 impacting supply, 17–18 Rules of the game, 484 Safety, protection of workers in dangerous industries, 637 Sales taxes equilibrium effects of specific taxes, 60–61 incidence of specific taxes on consumers, 61–63 relationship between equilibrium and incidence of tax, 64–65 similar effects of ad valorem and specific taxes, 65–68 tax salience, 104 types of, 59 welfare effects of, 294–295 who pays for tax on gasoline, 42 Sales, when to sell exhaustible resources, 558–559 Salience, informed decisions and, 104–106 Scale, returns to See Returns to scale Scarcity economics and, positive producer surplus and, 282 price of scarce exhaustible resources, 559–560 rent and scarce inputs, 273 School lunch programs, transfer of wealth programs, 339 Screening actions for equalizing information, 640–641 consumers avoiding lemons by screening, 646–647 in hiring, 659–660 Sealed-bid auctions, 505 Second-degree price discrimination See Quantity discrimination Second-price auctions bidding strategies, 505–506 sealed-bid auctions, 505 Sellers, number in perfectly competitive market, 228 Separating equilibrium comparing with pooling equilibrium, 657 defined, 655 efficiency and, 658–659 example of paying high ability people higher wages, 656–657 Sequential games advantages/disadvantages to first mover, 501–502 credible threat and, 499–500 dynamic entry games, 500–501 game trees and, 497–498 overview of, 497–498 subgame perfect Nash equilibrium, 498–499 Sequential movement, in Stackelberg model, 461 Services marginal expenditure in buying, 533–534 as output, 152 as output of production, 155 Pareto efficient allocations, 317 trade-offs in deciding which to produce, Shareholders, in corporations, 153 Sherman Antitrust Act in 1809, 441 Shifts of demand curve income increase causing, 118 for labor, 522 monopolies and, 363–364 shocks to equilibrium, 25–26 vs movement along, 14 Shifts of supply curve policies that cause, 27–30 shocks to equilibrium, 25–26 vs movement along, 19 Shirking bonding to prevent, 683 efficiency wage in preventing, A-27–A-28 as moral hazard, 677 Shocks, to market equilibrium causing shifts in demand curve, 25 causing shifts in supply curve, 25–26 defined, 10 overview of, 25 producer surplus for studying effects of, 283–284 sequence of events in related markets following, 319–321 shape of supply and demand curves reflecting equilibrium price and quantity, 43–44 Short run competition See Competition, short-run costs See Costs, short-run demand elasticities in factor markets, 50 production See Production, short-run Shortages, excess demand causing, 31 Shutdown rules applied to oil production, 242–243 monopolies and, 361 producer surplus and, 283 in profit maximization, 235–236 in short-run competition, 239–241 Signaling actions for equalizing information, 640–641 by firms regarding product quality, 648 firms strategies in repeated games, 503 hiring with eduction as signal, 655–659 Simplification, role of assumptions in models, 4–5 Simultaneous-move games, 499 Slutsky equation, 125, A-8 Slutsky, Eugene, A-8 Smith, Adam, 440 Sniping, at auctions, 277 Snob effect, network externalities, 384 Social costs cost of production with externalities, 608–609 of natural gas price ceiling, 302–303 social marginal costs vs private marginal costs, 610 Social optimum government policies and, 618 monopolies and competition and, 616 Social pressure, in reducing free riding, 629 Social welfare functions See also Welfare Arrow’s Impossibility Theorem and, 344 efficiency vs equity and, 346–348 equality in allocation of goods and, 345–346 A-75 Sole proprietorships, of firms, 153 Specialization, returns to, 174 Specific tariffs, 305 Specific (unit) taxes effects on equilibrium, A-3–A-4 equilibrium effects of, 60–61 incidence of taxes on consumers, 61–63 incidence on monopoly, A-16–A-17 on roses, 295 short and long-run impacts of carbon tax, 68 similar effects of ad valorem and specific taxes, 65–68 types of sales taxes, 59 Spillover effects, in multimarket analysis, 318 Spurious differentiation bottled water example, 458 differentiation of product shifting, 456 Stackelberg equilibrium comparing collusive, Cournot, Stackelberg, and competitive equilibria, 464–467 overview of, 459 sequential movement in, 461 Stackelberg model best response function in determining follower’s output, A-22 comparing collusive, Cournot, Stackelberg, and competitive equilibria, 464–467 game tree, 497 graphical model, 459–461 overview of, 438, 458–459 sequential movement in, 461 Standard deviation, in measuring risk, 578 Standard error, in regression calculation, A-3 Standards, in limiting lemons, 647–648 Static games cooperation in, 493–495 defined, 484 normal-form games, 485–486 overview of, 485 predicting outcomes, 486–489 pure strategy, 489–490 Statistical discrimination, in hiring, 659–660 Stocks defined, 543 diversification in investing, 588–589 Storage, factors impacting short-run demand elasticities, 50 Strategic behaviors, player actions in games, 483–484 Strategic independence, in game theory, 484 Strategies, in game theory best response, 488 distinguished from actions, 497 dominant strategies, 486–487 in game theory, 483 iterated elimination of strictly dominated strategies, 486–487 Nash equilibrium, 488–489 pure vs mixed, 489–490 in repeated games, 503 Stream of payments See Payments, over time Subgame perfect Nash equilibrium predicting outcome of sequential game, 498–499 solving using backward induction, 501 Subgames, 498 A-76 Index Subjective probability, 574–575 Subsidies of aircraft manufacturing, 463 for farmers, 300–301 impact of, 295–297 per-hour vs lump sum for child care, 111, 145–146 problems with, 462–463 strategic trade policies, 461–462 welfare effects of price floors, 297–301 Substitution better substitutes causing greater elasticity of demand, 368 cross-price elasticity of demand and, 52 of inputs, 168–169 of inputs and marginal product, 170–171 of inputs varying along isoquant, 169–170 isoquants showing substitutability of inputs, 166 lacking in monopoly, 353 marginal rate of substitution, 87–88 marginal rate of technical substitution (MRTS), 169 non-price impacts on demand, 13 perfect and imperfect substitutes, 82 price of alternative goods effecting consumer purchasing, 11 short-run demand elasticities effected by, 50 willingness to substitute, 80–81 Substitution bias, in Consumer Price Index (CPI), 134–135 Substitution effect with inferior goods, 127–129 with normal good, 125–127 price change effecting demand, 124–125, A-8 related to labor supply, 138–140 Sunk costs costs of entry into a market, 293 overview of, 188 shutdown rules and, 235 Supplemental Nutrition Assistance Program (SNAP), 99–101 Supply defined, 10 excess, 24–25 import policies effecting supply curves, 20–22 overview of, 17–18 policies creating wedge between supply and demand curves, 30, 294 policies that cause shifts in supply curves, 27–30 price elasticity of See Price elasticity of supply shifts in supply curve effecting market equilibrium, 25–26 summing supply curves, 19–20 supply curve, 18–19 supply function, 19–20 Supply and demand demand, 10–11 demand curve, 11–14 demand function, 14–16 externalities analyzed in terms of, 608–611 forces that cause equilibrium, 24–25 government intervention effecting equilibrium, 27 import policies effecting supply curves, 20–22 market equilibrium, 22–23 methods for determining equilibrium, 23–24 overview of, 10 policies that cause demand to differ from supply, 30 policies that shift supply curves, 27–30 price ceilings impacting equilibrium, 30–33 price floors impacting equilibrium, 33–34 quantities and prices of genetically modified foods, reasons why supply need not equal demand, 34–35 shifts in demand curve, 25 shifts in supply curve, 25–26 shocks to equilibrium, 25 summing demand curves, 16–17 summing supply curves, 19–20 supply, 17–18 supply curve, 18–19 supply function, 19–20 when to use supply-and-demand model, 35–37 Supply and demand, applying model for ad valorem and specific taxes and, 65–68 cross-price elasticity of demand, 52–53 demand elasticity and revenue, 48–50 demand elasticity over time, 50–51 elasticity along demand curve, 46–48 elasticity along supply curve, 54–56 elasticity of supply, 53–54 equilibrium and incidence of tax, 64–65 equilibrium effects of specific taxes, 60–61 income elasticity of demand, 51–52 interpreting shapes of supply and demand curves, 43–44 overview of, 42–43 price elasticity of demand, 45–46 sensitivity of quantity demanded to price, 44 sensitivity of quantity supplied to price, 53 supply elasticity over time, 56–59 tax incidence of specific taxes, 61–63 types of sales taxes, 56–59 when to use, 35–37 Supply and demand, policies that create wedge between overview of, 294 price floors, 297–301 sales taxes, 294–295 subsidies, 295–297 Supply curves entry and exit barriers, 293 firm supply curves in long-run competition, 249–250 firm supply curves in short-run competition, 241–244 import policies effecting, 20–22 interpreting shapes of, 43–44 labor See Labor supply curves market See Market supply curve movement along vs shifts in, 19 policies creating wedge between supply and demand curves, 294 policies that cause shift in, 289 policies that cause shifts in, 27–30 price effect on, 18–19 price elasticity along, 54–56 price supports and, 297–298 producer surplus measure by, 282–283 restrictions on number of firms in a market, 290–292 shifts in impacting market equilibrium, 25–26 summing, 19–20 variables other than price impacting, 19 Supply function in determining equilibrium, 23 overview of, 19–20 Surplus See Consumer surplus (CS) Symmetric information, 643 Tangency rule, approaches to minimize costs, 201, 203–204 Tariffs (duties) defined, 303 effects of, 306 free trade vs., 305–307 government actions that prevent resale, 399 Taste See also Preferences in model of consumer behavior, 73 price-consumption curve and, 114 role of consumer tastes in determining demand, 10 U.S vs European preference for SUVs, 95 Tata Motors, examples of organizational innovations, 177–178 Taxes cigarette taxes, 115 city wage tax causing urban flight, 324 controlling externalities due to pollution, 614–615 controlling externalities related to automobiles, 615 effects on costs, 196–198 impact of Twinkie tax on consumption, income taxes, 142–146 marginal tax rates, 143–145 microeconomic models in predicting impact of, in noncompetitive markets, 618 on pollution, 613–614 reduction in income taxes and wealth distribution, 339 sales taxes See Sales taxes tax salience, 104–105 Technology costs of moving production abroad vs using intensive technology at home, 184, 220–221 efficient input combinations, 199 impact on per capita food production, 162 impact on price of exhaustible resources, 564 sources of cost advantages, 372 technical change, 175 technical progress, 176 Testing economic theories, 5–6 Third-degree price discrimination See Multimarket price discrimination Third-party comparisons, product quality and, 647 Threatening to punish, firms strategies in repeated games, 503 Tie-in sales bundling as form of, 422–425 IBM example, 421 overview of, 420–421 requirement tie-in sales, 421 as type of nonuniform pricing, 395 Index 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, 557 price elasticity of demand over, 50–51 price elasticity of supply over, 56–59 Time varying discounts, 556–557 Tobacco use, price-consumption curve related to, 115 Total cost (C) cost curves, 192 overview of, 189 sum of labor and capital costs, 199–200 Total effect, of price change, 127 Total product See also Output graphing product curves, 159–160 of labor, 157–158 variable costs and, 193 Tourist Trap model, 651–653 Trade See also Competitive exchange benefits of, 333–334 combining with production capacity See Production and trading market supply curve reflecting, 257–260 number of producers and, 334–335 Trade, between two people bargaining ability and, 328 endowment effect, 325–326 mutually beneficial trades, 326–328 Pareto property of, 324 Trade-offs, in resource allocation, Transaction costs impacting appropriateness of supplyand-demand model, 36 impacting perfect price discrimination, 406–408 negligible in perfectly competitive market, 228–229 resale difficult when transaction costs are high, 399 Transitivity properties of consumer preferences, 75–76 testing in consumer choice, 102 voting preferences and, 343–344 Trucking industry, impact of new fixed costs on, 226, 262–263 True cost-of-living adjustments, 133–134 Trusts See Cartels Twinkie tax, Two-part tariffs with identical customers, 418–419 with nonidentical customers, 419–420, A-18–A-19 overview of, 417–418 as type of nonuniform pricing, 395 Two-period model, monopolies, 386–387 Two-stage games, types of dynamic games, 496 Uncertainty avoiding risk, 586 behavioral economics of risk, 595 behaviors varying with circumstances, 596–598 decision making and, 578–579 degree of risk, 574 difficulty in assessing probabilities, 595–596 diversification in dealing with risk, 587–589 expected utility in decision making, 579–580 expected value and, 576–577 fear of flying, 573, 600 gambling and, 584–585 insurance in dealing with risk, 589–592 investing and, 592 investing and discounting, 593–595 obtaining information in dealing with risk, 586–587 overview of, 573 probability of risk, 574–576 prospect theory, 598–600 risk-averse investing, 593 risk aversion, 580–582 risk-neutral investing, 592 risk neutrality, 582–583 risk preference, 583–585 saying no to risk, 586 variance and standard deviation, 577–578 weather prediction and, 587 Unemployment efficiency wages, 686–687 resulting from minimum wage laws, 33–34 Unit taxes See Specific (unit) taxes Unitary elasticity of demand curves, 47 of supply curves, 54 Utilitarian philosophers, 345 Utility consumer welfare and, 275 defined, 74 expected utility in decision making, 579–580 as function of leisure and income in labor-leisure model, A-9 marginal rate of substitution, 87–88 marginal utility, 86–87 maximizing, A-6–A-8 mutually beneficial trades maximizing, 326 ordinal measure of, 84–85 ranking goods by, 83 relationship with indifference curves, 85–86, A-4–A-6 risk aversion and, 580–582 risk neutrality and, 582–583 risk preference and, 583–585 utility function, 84 Utility function, 84 Utility possibility frontier (UPF), 342 Value, elements of auctions, 505 Value judgments normative statements contrasted with positive statements, social welfare functions in ranking allocations, 342 Variable costs (VC) overview of, 189 shape of cost curves for, 193–194 shutdown rules and, 235, 239 Variable input, types of input in production, 156 Variable quality, lemons market with, 645–646 A-77 Variance, in measuring risk, 577–578 Vertical integration, firm approaches to preventing resale, 399 Voting as mean of allocation of goods in democracies, 343–345 valuing public goods, 630–631 Wages change in impacts factor demand, 521 city wage tax causing urban flight, 324 efficiency wages, 685–687 minimum wage law with incomplete coverage, 321–323 minimum wage laws, 33–34 union role in setting, 407–408 Wants and needs, economists focusing on, Water rationing, drought in Australia, 270, 309–310 Wealth inequity, 338–339 Welfare comparing competition with regulated monopoly, 617–618 of consumers See Consumer welfare deadweight loss and, 285, 288–289 economists use of term, 270 elimination of free trade, 304 government policies effecting, 289 market failures effecting, 286 maximization of, 342–343 in monopolies, 368–371 in monopsonies, 536–538 multimarket price discrimination, 417 in natural monopolies, 372 output levels and, 287–288 perfect price discrimination, 403–406 pollution effects in competitive market, 609, A-26–A-27 price ceilings, 301–302 price supports, 298 of producers See Producer welfare product differentiation and, 471 quantity discrimination and, 409 regulation of monopolies, 379, 381 restrictions on number of firms in a market, 291 specific tax on roses, 295 subsidies, 295–297 as sum of consumer surplus and producer surplus, 285 tariffs and quotas, 306 transfer of wealth via, 339 Welfare economics, 270 Willingness to pay (WTP) deadweight loss of Christmas presents and, 288–289 measuring consumer welfare, 276–277 for public goods, 626 Winner’s curse, auctions, 507–508 Work hours, union role in setting, 407–408 Zero long-run profit comparing competition with monopolistic competition, 472 with free entry, 271–272 free entry and exit of firms and, 251 need to maximize profit and, 275 when entry is limited, 272–274 Zoning laws as example of barrier to entry, 475 Credits p 9: Superstock p 353: Courtesy of author p 31: U.S Government Printing Offfice p 366: Courtesy of author p 33: Desmond Kwande/Getty Images p 375: Courtesy of John W Shore, MD p 42: Courtesy of author p 394: Courtesy of author p 52: Image Plan/Corbis p 398: Courtesy of author p 57: Corbis p 421: Shedland Software Design/IBM p 81: Cornered copyright © 2010 by Mike Baldwin/Distributed by Universal Uclick p 428: Amy E Conn/AP Images p 96: Courtesy of author p 456: Hayley Chouinard p 101: Courtesy USDA p 458: Courtesy of author p 111: Michael Newman/Photoedit, Inc p 469: Lee Bennack p 129: Photodisc/Getty Images p 472: ScienceCartoonsPlus.com p 151: Michael Macor/San Francisco Chronicle/Corbis p 482: Courtesy of author p 178: Sajjad Hussain/AFP/Getty Images/Newscom p 491: Courtesy of author p 184: Shutterstock p 495: Dorling Kindersley p 226: Shutterstock p 535: John Springer/Corbis p 243: Dan Lamont/Corbis p 550: Shawn Michienzi/Ripsaw Photography p 270: Ian Waldie/Getty Images p 562: Courtesy of author p 273: Courtesy of author p 579: Courtesy of author p 277: Courtesy of Johannes Pascalpaoli p 288: Courtesy of author p 580: Copyright © 1966 and 2010 by William Cole and Mike Thaler p 292: Courtesy of author p 584: Courtesy of author p 340: Library of Congress Prints and Photographs Division [LC-USZ61-204] p 591: NOAA p 341: Library of Congress Prints and Photographs Division [LC-D418-1217] p 613: Shutterstock p 341: Library of Congress Prints and Photographs Division [LC-DIG-nclc-01130] p 637: Newscom p 341: Library of Congress Prints and Photographs Division [LC-USF34-9058-C] p 341: Courtesy Ronald Reagan Presidential Library p 341: Pete Souza/Library of Congress Prints and Photographs Division [LC-DIG-ppbd-00358] A-78 p 436: Courtesy of author p 596: Photodisc/Getty Images p 628: Andy Shepherd/Redfers/Getty Images p 641: Tribune Media Services p 641: Mary Rich, art director/Cliff Leicht, writer/Craig Orsinii, photographer/Boeri p 642: Beth Anderson/Pearson p 677: Carl and Ann Purcell/Corbis 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 AVC = average variable cost = variable cost divided by output = VC/q AC = average cost = total cost divided by output = C/q APZ = average product of input Z (for example, APL is the average product of labor) 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) MR = marginal revenue = ΔR/Δq MRS = marginal rate of substitution MRTS = marginal rate of technical substitution MUZ = marginal utility of good Z n = number of firms in an industry p = price 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 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 72 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 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 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 ... Quantity 2. 15 8.44 1.9171 8 .22 7 1.9057 1.90508 Price Quantity 4. 12 2.07 3.8 325 2. 0514 3.818 2. 0505 3.81 728 2. 05043 8 .26 13 Soybeans 8 .26 308 Final 1.90505 8 .26 318 3.81 724 2. 05043... 1981–19 82 Deep recession 1938 Fair Labor Standards Act creates a minimum wage 42. 6 35.4 32. 1 35.1 33 .2 30.1 30.7 30 30 28 .7 27 .8 28 26 .1 BIG BUSINESS 31 31.4 36.6 35.1 32. 7 33.8 30.3 22 .6 19.8... $2. 15 D 0c e 1c $1.9171 $1.9057 e 3c D 1c 8 .22 7 8 .26 13 8.44 Corn, Billion bushels per year Price, $ per bushel (b) Soybean Market S 0s e 0s $4. 12 D 0s s S2 S 4s $3.8 325 $3.8180 s e2 s e4 s D2