(BQ) Part 2 book Microeconomics has contents: Competition among the few, economics of uncertainty, how markets determine incomes, the labor market; land, natural resources, and the environment; capital, interest, and proits; government taxation and expenditure; international trade,...and other contents.
CHAPTER Competition among the Few 10 Look at the airline price wars of 1992 When American Airlines, Northwest Airlines, and other U.S carriers went toe-to-toe in matching and exceeding one another’s reduced fares, the result was record volumes of air travel—and record losses Some estimates suggest that the overall losses suffered by the industry that year exceed the combined profits for the entire industry from its inception Akshay R Rao, Mark E Bergen, and Scott Davis “How to Fight a Price War” Earlier chapters analyzed the market structures of perfect competition and complete monopoly If you look out the window at the American economy, however, you will see that such polar cases are rare Most industries lie between these two extremes and are populated by a small number of firms competing with each other What are the key features of these intermediate types of imperfect competitors? How they set their prices and outputs? To answer these questions, we look closely at what happens under oligopoly and monopolistic competition, paying special attention to the role of concentration and strategic interaction We then introduce the elements of game theory, which is an important tool for understanding how people and businesses interact in strategic situations The final section reviews the different public policies used to combat monopolistic abuses, focusing on regulation and antitrust laws A BEHAVIOR OF IMPERFECT COMPETITORS Look back at Table 9-1, which shows the following kinds of market structures: (1) Perfect competition is found when a large number of firms produce an identical product (2) Monopolistic competition occurs when a large number of firms produce slightly differentiated products (3) Oligopoly is an intermediate form of imperfect competition in which an industry is dominated by a few firms (4) Monopoly is the most concentrated market structure, in which a single firm produces the entire output of an industry How we measure the power of firms in an industry to control price and output? How the different species behave? We begin with these issues 187 sam11290_ch10.indd 187 2/2/09 6:05:05 PM 188 CHAPTER 10 Concentration Measured by Value of Shipments in Manufacturing Industries, 2002 largest companies Next largest companies Cigarettes 4% 95% Automobiles 11% 85% Household refrigerators 14% 82% • COMPETITION AMONG THE FEW FIGURE 10-1 Concentration Ratios Are Quantitative Measures of Market Power For refrigerators, automobiles, and many other industries, a few firms produce most of the domestic output Compare this with the ideal of perfect competition, in which each firm is too small to affect the market price Source: U.S Bureau of the Census, 2002 data Breakfast cereals 13% 78% Computers 14% 76% Iron and steel mills 18% 45% 18% Women’s apparel 13% 5% 2% Machine shops 20 40 60 80 Percent of total shipments Measures of Market Power In many situations—such as deciding whether the government should intervene in a market or whether a firm has abused its monopoly position—economists need a quantitative measure of the extent of a firm’s market power Market power signifies the degree of control that a single firm or a small number of firms have over the price and production decisions in an industry The most common measure of market power is the concentration ratio for an industry, illustrated in Figure 10-1 The four-firm concentration ratio measures the fraction of the market or industry accounted for by the four largest firms Similarly, the eight-firm concentration ratio is the percent of the market taken by the top eight firms The market is customarily measured by domestic sales, shipments, or output In a pure monopoly, the four-firm and eight-firm concentration ratios would be 100 percent because one firm produces 100 percent of the output; under perfect competition, both ratios would be close to zero because even the largest firms produce only a tiny fraction of industry output 100 Many economists believe that traditional concentration ratios not adequately measure market power An alternative, which better captures the role of dominant firms, is the Herfindahl-Hirschman Index (HHI) This is calculated by summing the squares of each participant’s market share Perfect competition would have an HHI of near zero because each firm produces only a small percentage of the total output, while complete monopoly would have an HHI of 10,000 because one firm produces 100 percent of the output (1002 ϭ 10,000) (For the formula and an example, see question at the end of this chapter.) Warning on Concentration Measures Although concentration measures are widely used, they are often misleading because of international competition and competition from closely related industries Conventional concentration measures such as those shown in Figure 10-1 exclude imports and include only domestic production Because foreign www.ebook3000.com sam11290_ch10.indd 188 2/3/09 2:41:03 PM 189 THEORIES OF IMPERFECT COMPETITION competition is very intense in the manufacturing sector, the actual market power of domestic firms is much smaller than is indicated by measures of market power based solely on domestic production For example, the conventional concentration measures shown in Figure 10-1 indicate that the top four U.S automotive firms had 85 percent of the U.S market If we include imports as well, however, these top four U.S firms had only 43 percent of the U.S market In addition to ignoring international competition, traditional concentration measures ignore the impact of competition from other, related industries For example, concentration ratios have historically been calculated for a narrow industry definition, such as “wired telecommunications carriers.” Sometimes, however, strong competition comes from other quarters For example, cellular telephones are a major threat to traditional wired telephone service even though the two are produced by different industries Even though the four-firm concentration ratio for wired carriers alone is 60 percent, the four-firm ratio for all telecommunications carriers is only 46 percent, so the definition of a market can strongly influence the calculation of the concentration ratios In the end, some measure of market power is essential for many legal purposes, such as aspects of antitrust law, examined later in this chapter A careful delineation of the market to include all the relevant competitors can be helpful in determining whether monopolistic abuses are in fact a real threat THE NATURE OF IMPERFECT COMPETITION In analyzing the determinants of concentration, economists have found that three major factors are at work in imperfectly competitive markets These factors are economies of scale, barriers to entry, and strategic interaction (the first two were analyzed in the previous chapter, and the third is the subject of detailed examination in the next section): ● ● sam11290_ch10.indd 189 Costs When the minimum efficient size of operation for a firm occurs at a sizable fraction of industry output, only a few firms can profitably survive and oligopoly is likely to result Barriers to competition When there are large economies of scale or government restrictions to entry, these will limit the number of competitors in an industry ● Strategic interaction When only a few firms operate in a market, they will soon recognize their interdependence Strategic interaction, which is a genuinely new feature of oligopoly that has inspired the field of game theory, occurs when each firm’s business depends upon the behavior of its rivals Why are economists particularly concerned about industries characterized by imperfect competition? The answer is that such industries behave in certain ways that are inimical to the public interest For example, imperfect competition generally leads to prices that are above marginal costs Sometimes, without the spur of competition, the quality of service deteriorates Both high prices and poor quality are undesirable outcomes As a result of high prices, oligopolistic industries often (but not always) have supernormal profits The profitability of the highly concentrated tobacco and pharmaceutical industries has been the target of political attacks on numerous occasions Careful studies show, however, that concentrated industries tend to have only slightly higher rates of profit than unconcentrated ones Historically, one of the major defenses of imperfect competition has been that large firms are responsible for most of the research and development (R&D) and innovation in a modern economy There is certainly some truth in this idea, for highly concentrated industries sometimes have high levels of R&D spending per dollar of sales as they try to achieve a technological edge over their rivals At the same time, individuals and small firms have produced many of the greatest technological breakthroughs We review the economics of innovation in Chapter 11 THEORIES OF IMPERFECT COMPETITION While the concentration of an industry is important, it does not tell the whole story Indeed, to explain the behavior of imperfect competitors, economists have developed a field called industrial organization We cannot cover this vast area here Instead, we will focus on three of the most important cases of imperfect competition—collusive oligopoly, monopolistic competition, and small-number oligopoly 2/2/09 6:07:22 PM 190 CHAPTER 10 Collusive Oligopoly • COMPETITION AMONG THE FEW P DA MC G AC Price The degree of imperfect competition in a market is influenced not just by the number and size of firms but by their behavior When only a few firms operate in a market, they see what their rivals are doing and react For example, if there are two airlines operating along the same route and one raises its fare, the other must decide whether to match the increase or to stay with the lower fare, undercutting its rival Strategic interaction is a term that describes how each firm’s business strategy depends upon its rivals’ business behavior When there are only a small number of firms in a market, they have a choice between cooperative and noncooperative behavior Firms act noncooperatively when they act on their own without any explicit or implicit agreements with other firms That’s what produces price wars Firms operate in a cooperative mode when they try to minimize competition When firms in an oligopoly actively cooperate with each other, they engage in collusion This term denotes a situation in which two or more firms jointly set their prices or outputs, divide the market among themselves, or make other business decisions jointly During the early years of American capitalism, before the passage of effective antitrust laws, oligopolists often merged or formed a trust or cartel (recall Chapter 9’s discussion of trusts, page 184) A cartel is an organization of independent firms, producing similar products, that work together to raise prices and restrict output Today, with only a few exceptions, it is strictly illegal in the United States and most other market economies for companies to collude by jointly setting prices or dividing markets Nonetheless, firms are often tempted to engage in tacit collusion, which occurs when they refrain from competition without explicit agreements When firms tacitly collude, they often quote identical high prices, pushing up profits and decreasing the risk of doing business In recent years, sellers of online music, diamonds, and kosher Passover products have been investigated for price fixing, while private universities, art dealers, airlines, and the telephone industry have been accused of collusive behavior The rewards for successful collusion can be great Consider an industry where four firms have tired of ruinous price wars They agree to charge the same price and share the market They form a collusive E MR DA Q Quantity FIGURE 10-2 Collusive Oligopoly Looks Much Like Monopoly After experience with disastrous price wars, firms will surely recognize that each price cut is canceled by competitors’ price cuts So oligopolist A may estimate its demand curve DADA by assuming that others will be charging similar prices When firms collude to set a jointly profit-maximizing price, the price will be very close to that of a single monopolist Can you see why profits are equal to the blue rectangle? oligopoly and set a price which maximizes their joint profits By joining together, the four firms in effect become a monopolist Figure 10-2 illustrates oligopolist A’s situation, where there are four firms with identical cost and demand curves We have drawn A’s demand curve, DADA, assuming that the other three firms always charge the same price as firm A The maximum-profit equilibrium for the collusive oligopolist is shown in Figure 10-2 at point E, the intersection of the firm’s MC and MR curves Here, the appropriate demand curve is DADA The optimal price for the collusive oligopolist is shown at point G on DADA, above point E This price is identical to the monopoly price: it is above marginal cost and earns each of the colluding oligopolists a handsome monopoly profit When oligopolists collude to maximize their joint profits, taking into account their mutual www.ebook3000.com sam11290_ch10.indd 190 2/2/09 6:07:22 PM 191 THEORIES OF IMPERFECT COMPETITION interdependence, they will produce the monopoly output and price and earn the monopoly profit Although many oligopolists would be delighted to earn such high profits, in reality many obstacles hinder effective collusion First, collusion is illegal Second, firms may “cheat” on the agreement by cutting their price to selected customers, thereby increasing their market share Clandestine price cutting is particularly likely in markets where prices are secret, where goods are differentiated, where there is more than a handful of firms, or where the technology is changing rapidly Third, the growth of international trade means that many companies face intensive competition from foreign firms as well as from domestic companies Indeed, experience shows that running a successful cartel is a difficult business, whether the collusion is explicit or tacit A long-running thriller in this area is the story of the international oil cartel known as the Organization of Petroleum Exporting Countries, or OPEC OPEC is an international organization which sets production quotas for its members, which include Saudi Arabia, Iran, and Algeria Its stated goal is “to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” Its critics claim it is really a collusive monopolist attempting to maximize the profits of producing countries OPEC became a household name in 1973, when it reduced production sharply and oil prices skyrocketed But a successful cartel requires that members set a low production quota and maintain discipline Every few years, price competition breaks out when some OPEC countries ignore their quotas This happened in a spectacular way in 1986, when Saudi Arabia drove oil prices from $28 per barrel down to below $10 Another problem faced by OPEC is that it must negotiate production quotas rather than prices This leads to high levels of price volatility because demand is unpredictable and highly price-inelastic in the short run Oil producers became rich in the 2000s as prices soared, but the cartel had little control over actual events The airline industry is another example of a market with a history of repeated—and failed—attempts sam11290_ch10.indd 191 at collusion It would seem a natural candidate for collusion There are only a few major airlines, and on many routes there are only one or two rivals But just look back to the quote at the beginning of the chapter, which describes one of the recent price wars in the United States Airline bankruptcy is so frequent that some airlines spend more time bankrupt than solvent Indeed, the evidence shows that the only time an airline can charge supernormal fares is when it has a near-monopoly on all flights to a city Monopolistic Competition At the other end of the spectrum from collusive oligopolies is monopolistic competition Monopolistic competition resembles perfect competition in three ways: there are many buyers and sellers, entry and exit are easy, and firms take other firms’ prices as given The distinction is that products are identical under perfect competition, while under monopolistic competition they are differentiated Monopolistic competition is very common—just scan the shelves at any supermarket and you’ll see a dizzying array of different brands of breakfast cereals, shampoos, and frozen foods Within each product group, products or services are different, but close enough to compete with each other Here are some other examples of monopolistic competition: There may be several grocery stores in a neighborhood, each carrying the same goods but at different locations Gas stations, too, all sell the same product, but they compete on the basis of location and brand name The several hundred magazines on a newsstand rack are monopolistic competitors, as are the 50 or so competing brands of personal computers The list is endless The important point to recognize is that each seller has some freedom to raise or lower prices because of product differentiation (in contrast to perfect competition, where sellers are price-takers) Product differentiation leads to a downward slope in each seller’s demand curve Figure 10-3 might represent a monopolistically competitive computer magazine which is in short-run equilibrium with a price at G The firm’s dd demand curve shows the relationship between sales and its price when other magazine prices are unchanged; its demand curve slopes downward since this magazine is a little different from everyone else’s because 2/3/09 2:41:04 PM 192 CHAPTER 10 • COMPETITION AMONG THE FEW Monopolistic Competition before Entry Monopolistic Competition after Entry P P d MC MC Price G Price C AC A d′ B AC G′ E d MR E′ Q d′ Q MR ′ Quantity FIGURE 10-3 Monopolistic Competitors Produce Many Similar Goods Under monopolistic competition, numerous small firms sell differentiated products and therefore have downwardsloping demand Each firm takes its competitors’ prices as given Equilibrium has MR ϭ MC at E, and price is at G Because price is above AC, the firm is earning a profit, area ABGC of its special focus The profit-maximizing price is at G Because price at G is above average cost, the firm is making a handsome profit represented by area ABGC But our magazine has no monopoly on writers or newsprint or insights on computers Firms can enter the industry by hiring an editor, having a bright new idea and logo, locating a printer, and hiring workers Since the computer magazine industry is profitable, entrepreneurs bring new computer magazines into the market With their introduction, the demand curve for the products of existing monopolistically competitive computer magazines shifts leftward as the new magazines nibble away at our magazine’s market The ultimate outcome is that computer magazines will continue to enter the market until all economic profits (including the appropriate opportunity costs for owners’ time, talent, and contributed capital) have been beaten down to zero Figure 10-4 shows the final long-run equilibrium for the typical seller Quantity FIGURE 10-4 Free Entry of Numerous Monopolistic Competitors Wipes Out Profit The typical seller’s original profitable dd curve in Figure 10-3 will be shifted downward and leftward to d Јd Ј by the entry of new rivals Entry ceases only when each seller has been forced into a long-run, no-profit tangency such as at G Ј At long-run equilibrium, price remains above MC, and each producer is on the left-hand declining branch of its longrun AC curve In equilibrium, the demand is reduced or shifted to the left until the new d Јd Ј demand curve just touches (but never goes above) the firm’s AC curve Point G Ј is a long-run equilibrium for the industry because profits are zero and no one is tempted to enter or forced to exit the industry This analysis is well illustrated by the personal computer industry Originally, such computer manufacturers as Apple and Compaq made big profits But the personal computer industry turned out to have low barriers to entry, and numerous small firms entered the market Today, there are dozens of firms, each with a small share of the computer market but no economic profits to show for its efforts The monopolistic competition model provides an important insight into American capitalism: The rate of profit will in the long run be zero in this kind of imperfectly competitive industry as firms enter with new differentiated products www.ebook3000.com sam11290_ch10.indd 192 2/3/09 2:41:04 PM 193 PRICE DISCRIMINATION In the long-run equilibrium for monopolistic competition, prices are above marginal costs but economic profits have been driven down to zero Critics of capitalism argue that monopolistic competition is inherently inefficient They point to an excessive number of trivially different products that lead to wasteful duplication and expense To understand the reasoning, look back at the long-run equilibrium price at G Ј in Figure 10-4 At that point, price is above marginal cost and output is reduced below the ideal competitive level This economic critique of monopolistic competition has considerable appeal: It takes real ingenuity to demonstrate the gains to human welfare from adding Apple Cinnamon Cheerios to Honey Nut Cheerios and Whole Grain Cheerios It is hard to see the reason for gasoline stations on every corner of an intersection But there is logic to the differentiated goods and services produced by a modern market economy The great variety of products fills many niches in consumer tastes and needs Reducing the number of monopolistic competitors might lower consumer welfare because it would reduce the diversity of available products People will pay a premium to be free to choose among various options Rivalry among the Few For our third example of imperfect competition, we turn back to markets in which only a few firms compete This time, instead of focusing on collusion, we consider the fascinating case where firms have a strategic interaction with each other Strategic interaction is found in any market which has relatively few competitors Like a tennis player trying to outguess her opponent, each business must ask how its rivals will react to changes in key business decisions If GE introduces a new model of refrigerator, what will Whirlpool, its principal rival, do? If American Airlines lowers its transcontinental fares, how will United react? Consider as an example the market for air shuttle services between New York and Washington, currently served by Delta and US Airways This market is called a duopoly because industry output is produced by only two firms Suppose that Delta has determined that if it cuts fares 10 percent, its profits will rise as long as US Airways does not match its cut sam11290_ch10.indd 193 but its profits will fall if US Airways does match its price cut If they cannot collude, Delta must make an educated guess as to how US Airways will respond to its price moves Its best approach would be to estimate how US Airways would react to each of its actions and then to maximize profits with strategic interaction recognized This analysis is the province of game theory, discussed in Section B of this chapter Similar strategic interactions are found in many large industries: in television, in automobiles, even in economics textbooks Unlike the simple approaches of monopoly and perfect competition, it turns out that there is no simple theory to explain how oligopolists behave Different cost and demand structures, different industries, even different managerial temperaments will lead to different strategic interactions and to different pricing strategies Sometimes, the best behavior is to introduce some randomness into the response simply to keep the opposition off balance Competition among the few introduces a completely new feature into economic life: It forces firms to take into account competitors’ reactions to price and output decisions and brings strategic considerations into their markets PRICE DISCRIMINATION When firms have market power, they can sometimes increase their profits through price discrimination Price discrimination occurs when the same product is sold to different consumers for different prices Consider the following example: You run a company selling a successful personal-finance program called MyMoney Your marketing manager comes in and says: Look, boss Our market research shows that our buyers fall into two categories: (1) our current customers, who are locked into MyMoney because they keep their financial records using our program, and (2) potential new buyers who have been using other programs Why don’t we raise our price, but give a rebate to new customers who are willing to switch from our competitors? I’ve run the numbers If we raise our price from $20 to $30 but give a $15 rebate for people who have been using other financial programs, we will make a bundle 2/2/09 6:08:03 PM 194 CHAPTER 10 • COMPETITION AMONG THE FEW (a) Old Customers (b) New Customers P P 60 Po* ϭ 30 30 Do single price 20 Pn* ϭ 15 Dn 30 60 q 30 60 q MRn MRo FIGURE 10-5 Firms Can Increase Their Profits through Price Discrimination You are a profit-maximizing monopoly seller of computer software with zero marginal cost Your market contains established customers in (a) and new customers in (b) Old customers have more inelastic demand because of the high costs of switching to other programs If you must set a single price, you will maximize profits at a price of $20 and earn profits of $1200 But suppose you can segment your market between locked-in current users and reluctant new buyers This would increase your profits to ($30 ϫ 30) ϩ ($15 ϫ 30) ϭ $1350 You are intrigued by the suggestion Your house economist constructs the demand curves in Figure 10-5 Her research indicates that your old customers have more price-inelastic demand than your potential new customers because new customers must pay substantial switching costs If your rebate program works and you succeed in segmenting the market, the numbers show that your profits will rise from $1200 to $1350 (To make sure you understand the analysis, use the data shown in Figure 10-5 to estimate the monopoly price and profits if you set a single monopoly price and if you price-discriminate between the two markets.) Price discrimination is widely used today, particularly with goods that are not easily transferred from the low-priced market to the high-priced market Here are some examples: ● Identical textbooks are sold at lower prices in Europe than in the United States What prevents wholesalers from purchasing large quantities abroad and undercutting the domestic market? A protectionist import quota prohibits the practice ● ● ● However, as an individual, you might well reduce the costs of your books by buying them abroad through online bookstores Airlines are the masters of price discrimination (review our discussion of “Elasticity Air” in Chapter 4) They segment the market by pricing tickets differently for those who travel in peak or off-peak times, for those who are business or pleasure travelers, and for those who are willing to stand by This allows them to fill their planes without eroding revenues Local utilities often use “two-part prices” (sometimes called nonlinear prices) to recover some of their overhead costs If you look at your telephone or electricity bill, it will generally have a “connection” price and a “per-unit” price of service Because connection is much more price-inelastic than the per-unit price, such two-part pricing allows sellers to lower their per-unit prices and increase the total quantity sold Firms engaged in international trade often find that foreign demand is more elastic than domestic demand They will therefore sell at www.ebook3000.com sam11290_ch10.indd 194 2/2/09 6:08:03 PM 195 PRICE DISCRIMINATION ● lower prices abroad than at home This practice is called “dumping” and is sometimes banned under international-trade agreements Sometimes a company will actually degrade its topof-the-line product to make a less capable product, which it will then sell at a discounted price to capture a low-price market For example, IBM inserted special commands to slow down its laser printer from 10 pages per minute to pages per minute so that it could sell the slow model at a lower price without cutting into sales of its top model What are the economic effects of price discrimination? Surprisingly, they often improve economic welfare To understand this point, recall that monopolists raise their price and lower their sales to increase profits In doing so, they may capture the market for eager buyers but lose the market for reluctant buyers By charging different prices for those willing to pay high prices (who get charged high prices) and those willing to pay only lower prices (who may sit in the middle seats or get a degraded product, but at a lower price), the monopolist can increase both its profits and consumer satisfactions.1 B GAME THEORY Strategic thinking is the art of outdoing an adversary, knowing that the adversary is trying to the same to you Avinash Dixit and Barry Nalebuff, Thinking Strategically (1991) Economic life is full of situations in which people or firms or countries compete for profits or dominance The oligopolies that we analyzed in the previous section sometimes break out into economic warfare Such rivalry was seen in the last century when Vanderbilt and Drew repeatedly cut shipping rates on their parallel railroads In recent years, airlines would occasionally launch price wars to attract sam11290_ch10.indd 195 For an example of how perfect price discrimination improves efficiency, see question at the end of this chapter customers and sometimes end up ruining everyone (see this chapter’s introductory quote) But airlines learned that they needed to think and act strategically Before an airline cuts its fares, it needs to consider how its rivals will react, and how it should then react to that reaction, and so on Once decisions reach the stage of thinking about what your opponent is thinking, and how you would then react, you are in the world of game theory This is the analysis of situations involving two or more interacting decision makers who have conflicting objectives Consider the following findings of game theorists in the area of imperfect competition: ● ● ● ● As the number of noncooperative oligopolists becomes large, the industry price and quantity tend toward the perfectly competitive outcome If firms succeed in colluding, the market price and quantity will be close to those generated by a monopoly Experiments suggest that as the number of firms increases, collusive agreements become more difficult to police and the frequency of cheating and noncooperative behavior increases In many situations, there is no stable equilibrium for an oligopolistic market Strategic interplay may lead to unstable outcomes as firms threaten, bluff, start price wars, punish weak opponents, signal their intentions, or simply exit from the market Game theory analyzes the ways in which two or more players choose strategies that jointly affect each other This theory, which sounds frivolous, is in fact fraught with significance and was largely developed by John von Neumann (1903–1957), a Hungarianborn mathematical genius Game theory has been used by economists to study the interaction of oligopolists, union-management disputes, countries’ trade policies, international environmental agreements, reputations, and a host of other topics Game theory offers insights for politics and warfare, as well as for everyday life For example, game theory suggests that in some circumstances a carefully chosen random pattern of behavior may be the best strategy Inspections to catch illegal drugs or weapons should sometimes search randomly rather than predictably Likewise, you should occasionally bluff at poker, not simply to win a pot with a weak hand but also to ensure that other players not drop out 2/3/09 2:41:05 PM 196 CHAPTER 10 P1 BASIC CONCEPTS EZBooks’ price Amazing’s matching COMPETITION AMONG THE FEW or raise my price, or leave it alone? Once you begin to consider how others will react to your actions, you have entered the realm of game theory $20 $10 • EZBooks’ undercutting $10 Amazing’s price $20 P2 FIGURE 10-6 What Happens When Two Firms Insist on Undercutting Each Other? Trace through the steps by which dynamic price cutting leads to ever-lower prices for two rivals when you bet high on a good hand We will sketch out some of the major concepts of game theory in this section Thinking about Price Setting Let’s begin by analyzing the dynamics of price cutting You are the head of an established firm, Amazing.com, whose motto is “We will not be undersold.” You open your browser and discover that EZBooks.com, an upstart Internet bookseller, has an advertisement that says, “We sell for 10 percent less.” Figure 10-6 shows the dynamics The vertical arrows show EZBooks’ price cuts; the horizontal arrows show Amazing’s responding strategy of matching each price cut By tracing through the pattern of reaction and counterreaction, you can see that this kind of rivalry will end in mutual ruin at a zero price Why? Because the only price compatible with both strategies is a price of zero: 90 percent of zero is zero Finally, it dawns on the two firms: When one firm cuts its price, the other firm will match the price cut Only if the firms are shortsighted will they think that they can undercut each other for long Soon each begins to ask, What will my rival if I cut my price, We will illustrate the basic concepts of game theory by analyzing a duopoly price game A duopoly is a market which is served by only two firms For simplicity, we assume that each firm has the same cost and demand structure Further, each firm can choose whether to charge its normal price or lower its price below marginal costs and try to drive its rival into bankruptcy and then capture the entire market The novel element in the duopoly game is that the firm’s profits will depend on its rival’s strategy as well as on its own A useful tool for representing the interaction between two firms or people is a two-way payoff table A payoff table is a means of showing the strategies and the payoffs of a game between two players Figure 10-7 shows the payoffs in the duopoly price game for our two companies In the payoff table, a firm can choose between the strategies listed in its rows or columns For example, EZBooks can choose between its two columns and Amazing can choose between its two rows In this example, each firm decides whether to charge its normal price or to start a price war by choosing a lower price Combining the two decisions of each duopolist gives four possible outcomes, which are shown in the four cells of the table Cell A, at the upper left, shows the outcome when both firms choose the normal price; D is the outcome when both choose to conduct a price war; and B and C result when one firm has a normal price and one a war price The numbers inside the cells show the payoffs of the two firms, that is, the profits earned by each firm for each of the four outcomes The number in the lower left shows the payoff to the player on the left (Amazing); the entry in the upper right shows the payoff to the player at the top (EZBooks) Because the firms are identical, the payoffs are mirror images Alternative Strategies Now that we have described the basic structure of a game, we next consider the behavior of the players The new element in game theory is analyzing not only your own actions but also the interaction www.ebook3000.com sam11290_ch10.indd 196 2/2/09 6:08:19 PM 394 Inputs—Cont interdependent demand, 233–234 law of diminishing returns, 108–111 least-cost factor combination, 145–147 least-cost rule, 134, 237 marginal productivity theory, 243 marginal product of, 234–235 market demand for, 239–240 optimal combination, 146 prices of, 52, 53 in production function, 107–108 returns to scale, 111–112 substitution rule, 134–135, 238 Insurable risks, 296 Insurance, 216 adverse selection, 217 conditions for efficiency, 217 health care, 220 moral hazard, 217 risk spreading, 216 social, 218–219 Intangible capital, 283 Intel Corporation, 176, 206, 341 Intellectual property rights, 223 effect of Internet, 223 Interdependence of demands, 233–234 Interest, Fisher theory, 292–293 Interest rates, 284 and asset liquidity, 288 and asset prices, 287 definition, 285 determinants of, 293 and financial assets, 285 Fisher theory, 292–293 graphical analysis, 289–290 and inflation, 288–290 on loans, 287 on major asset classes, 289 present value analysis, 285–287 real vs nominal, 288–291 and return on capital, 293–295 riskless, 288 Interlocking directorates, in Clayton Act, 204 Intermediate Microeconomics (Varian), 61 Internal Revenue Service, 321 International competition, and concentration ratios, 188–189 International finance, 340 International Flavors and Fragrances, 113 International Labour Organization, 265 International Monetary Fund, 363 International monetary system, 308 INDEX International specialization, 342–344 International trade, 4, 339–361 beggar-thy-neighbor policy, 358 benefits of, 339 bilateral, 348 capital in, 33–34 comparative advantage, 341–349 consumption possibilities curve, 346, 347 decline in Great Depression, 349 division of labor for, 31 versus domestic trade, 340 dumping, 195 gains for small countries, 345 globalization, 31–33 in goods and services 2007, 340 impact on wages, 330 intraindustry, 341 key considerations, 30–31 money in, 33 multilateral negotiations appraisal, 361 General Agreement on Tariffs and Trade, 360 regional approaches, 361 World Trade Organization, 360 nature of, 339–341 negotiating free trade, 359–461 price discrimination in, 194–195 promoting competition, 175–176 and protectionism, 349–359 sources of, 340–341 cost differences, 341 differences in taste, 341 diversity in resources, 341 specialization for, 31 supply and demand analysis, 350–355 trends in, 340 triangular or multilateral, 348 Internet origins of, 311–312 as provider of information, 223 Internet providers, 155 Internet shopping, 172 Interstate Commerce Commission, 201, 306 Intraindustry trade, 341 Invention, social return to, 222 Investment bankers, 328 Investments allocation of capital across, 284–285 in capital goods, 291 determinants of profits, 295–297 equity premium, 297 in financial assets, 284 for future consumption, 291–292 and government policy, 333 hedging, 213 prices and rentals on, 283–284 rate of return on, 284, 285 risk spreading, 217 risky, 288 Schumpeter’s view, 295 world’s safest, 290–291 Investors, risk-averse, 297 Invisible hand, 29 for income, 243 limitations of, 30 limits of, 306–307 as market mechanism, 28–30 and perfect competition, 35 qualifications of, 163–164 and speculation, 213 iPods, 32 Iraq war, 34, 45 costs of, 9, 140 Irrational Exuberance (Shiller), 298 Isoquant, 146 Italy, wages and fringe benefits, 250 J Jackson, Thomas Penfield, 186, 205–206 Japan gains from trade, 31 lending by, 32 trade war with, 357 voluntary export quotas, 359 wages and fringe benefits, 250 Jevons, William Stanley, 87 Jim Crow legislation, 261 Job creation lacking in Europe, 359 in U.S 1990–99, 359 Jobs choice of new immigrants, 256–257 differences in, 254 reasons for wage differences, 328 Johnson, Lyndon B., 305 Joint Center for Poverty Research, 337 Josephson, Matthew, 185 Journal of Economic Perspectives, 43, 299 K Kahneman, Daniel, 89, 99, 185 Katz, Lawrence F., 255, 265, 266 Kennedy-Johnson tax cuts, 6, 322 Keynes, John Maynard, 222 and business cycles, 39 on economics, 14 founder of macroeconomics, Keynesian revolution, 39 Keynesian unemployment, 260 Kilby, Jack, 296 Knight, Frank, 126 Kohler, Heinz, 93 Korean immigrants, 256–257 Kraemer, Kenneth L., 43 Krueger, Alan, 82 Krugman, Paul, 43 Kyoto Protocol, 279 L Labonte, Marc, 124 Labor derived demand for, 233, 234 as factor of production, law of diminishing returns, 109–111 marginal product of, 144 marginal revenue product, 236 in production function, 107–108 total, average, and marginal product, 108–110 Labor force cheap foreign competition, 356 conditions in 1800s, 248 trends in wages, 296 of United States, 250 unskilled workers, 349 wage differentials, 253–257 Labor force participation, 252 in egalitarian countries, 333 by groups of workers, 253 Labor income, 230 share of national income, 231, 260, 330 taxes on, 318, 319 Labor legislation, 258 Labor market demand side international comparisons, 250–251 marginal productivity differences, 249–250 effect of immigration, 58–59 effect of unions, 257–260 effects of welfare reform, 335 entry and exit, 257 general wage level, 248–249 noncompeting groups, 256–257 perfectly competitive, 254 segmented, 256–257 supply side determinants, 251–253 empirical findings, 253 Labor market discrimination definition, 260 by exclusion, 260 minorities, 261–263 noncompeting groups, 257 puzzle concerning, 260 reducing, 264 statistical, 262–263 taste for, 262 against women, 263 www.ebook3000.com sam44230_ind.indd 394 2/25/09 10:19:12 AM 395 INDEX Labor productivity, 116 division of labor, 31 growth in, 117 specialization, 31 Labor quality, 254–256 Labor supply; see also Demand for labor and classical unemployment, 260 decisions about, 238 definition, 251 determinants hours worked, 251–252 immigration, 252–253 income effect, 252 labor force participation, 252 substitution effect, 252 effect of immigration, 58–59 effect on wages, 328 and minimum wage, 78–79 patterns, 253 talented individuals, 256 and total wages, 242–243 Labor supply curve, 159 Labor time, 160n Labor unions collective bargaining by, 257–259 as conspiracy, 258 decline of, 330 declining in United States, 260 effects of on unemployment, 260 on wages, 259–260 a legal monopoly, 258 market power, 257 membership, 257, 258 political goals, 258–259 strikes by, 260 wage increases, 258–259 work rules, 258 Laffer, Arthur, 322 Laffer curve, 322 Laissez-faire economy, 8, 40 economic inequality in, 307 and government control, 305–306, 306–307 and income distribution, 38 and rise of welfare state, 40 Land compared to capital, 33 decisions about, 238 derived demand for, 270 as factor of production, law of diminishing returns, 109–111 marginal product of, 144 marginal revenue product, 236 market demand curve for, 239 ownership of, 269 production of, 269n property tax, 271 rent income, 242 rent on, 269–270 single-tax movement, 271 specialization of, 31 sam44230_ind.indd 395 supply curve for, 269–270 taxation of, 270–271 Law of diminishing marginal product, 144–146 Law of diminishing marginal utility, 84–85, 86, 213–214 Law of diminishing returns, 108–109, 108–111, 160, 235 and demand for capital, 291–292 and increasing costs, 158 and marginal product, 144–145 and return on capital, 294 and supply curve, 51 Law of downward-sloping demand, 47, 57 Law of substitution, 101 Leaky bucket experiment, 331 Least-cost conditions, 147 Least-cost factor combination equal-cost lines, 146 equal-product curves, 145–146 least-cost conditions, 147 least-cost tangency, 146–147 Least-cost rule, 134, 237 Least-cost tangency, 146–147 Leisure time, 160n Leisure vs work, 88 Leonardo da Vinci, 159 Levine, David, 208 Liabilities, 137 accounts payable, 138 on balance sheet, 137 notes and bonds payable, 138 Liability laws, 277–278 Lighthouses, 37 Limited liability, 120, 121 Limited-liability partnerships, 120 Lincoln, Abraham, 272, 355 Lindeck, Assar, 166 Linden, Greg, 43 Linear demand curve, 69–70 Lines, curved, 21 Liquidity, 288 Living standards, 107 effect of trade on, 31 improved by trade, 339 in poor countries, 111 reasons for increase in, 250–251 Loans, term/maturity, 288 Local government expenditures, 310–311 Local public goods, 310 Local taxes, 317–318 Loewenstein, George, 99 Long run, 112 for competitive industries, 156–157 costs in, 133–134 Long-run equilibrium in competitive industries, 155–157 return on capital, 295 Long-run industry supply, 155–156 Long-run price, 157 Long-run supply curve, 158 Lorenz curve, 325, 326 Loss aversion, marginal principle, 183 Losses, chronic, 156–157 Lotteries, 318 Lump-sum taxes, 319 M MacKie-Mason, Jeffrey K., 225 Macroeconomic growth, 39–40 Macroeconomic policies and assistance programs, 308 to control business cycles, 39 coordination of, 308 for economic stabilization, 307–308 fiscal policy, 39 monetary policy, 39 protection of global environment, 308 to reduce trade barriers, 308 to reduce unemployment, 359 tools of fiscal policy, 308 monetary policy, 308 Macroeconomics, Mali, 342 Malkiel, Burton, 298 Managers, 120 principal-agent problem, 122 versus stockholders, 121 Mankiw, N Gregory, 344, 363 Mansfield, Edwin, 61 Marginal, concept of, 85 Marginal abatement cost, 276 Marginal cost, 127–128 benchmark for efficiency, 162 calculation of, 127–128 in competitive equilibrium, 161–162 in diagrams, 128–129 and diminishing returns, 158 essential role of, 163 and marginal utility, 162 of pollution abatement, 273, 274–275 price equal to, 150–152 relation to average cost, 130–132 of software distribution, 128 and total cost, 129 Marginal cost curve, 152 and shutdown point, 153 Marginal principle, 183, 316 and loss aversion, 183 Marginal private benefit, 273, 276 Marginal product, 108, 109–110, 234–235 least-cost rule, 134 substitution rule, 134–135 Marginal productivity and demand for labor, 249–250 and distribution of national income, 241–243 with many inputs, 243 theory of factor prices, 232–243 Marginal product of capital, 293 Marginal product of labor, 144, 233 United States vs Mexico, 356 Marginal product of land, 144 Marginal rate of return over cost, 292 Marginal rate of substitution, 101 Marginal revenue, 177 derived from demand curve, 178–179 and monopoly price, 177–179 price, quantity, and total revenue, 177 price elasticity of demand, 179–180 for perfect competition, 182–183 and profit maximization, 180–183 Marginal revenue product, 235 in distribution theory, 235–236 and factor demands, 236–238 imperfect competition, 236 of labor, 236 of land, 236 perfect competition, 236 for perfectly competitive firms, 235 Marginal social benefit, 273, 274–275 Marginal social costs, 273 Marginal tax rate, 315, 315–316 Marginal utility, 84–85, 85 in competitive equilibrium, 161–162 equimarginal principle, 87 versus indifference curves, 89–90 and law of substitution, 101 and marginal cost, 162 paradox of value, 96 and slope of demand curve, 87–88 and total utility, 85–86 Marginal utility curve, 85–86 Marginal utility of income, 87 Marginal value, 22 Market(s), 26 for addictive substances, 94–95 centralized vs decentralized, 26 competitive equilibrium with many, 162–163 demand and size of, 48, 49 determination of prices, 27 2/25/09 10:19:12 AM 396 Market(s)—Cont for factors of production, 27 with free trade, 351 with imperfect competition, 35–36 imperfectly competitive, 169–170 for land, 270 network, 114–116 and opportunity cost, 140–141 with perfect competition, 35 provision of public goods, 37 risk and uncertainty in, 211–216 risk spreading in, 216–217 winner-take-all, 116 Marketable securities, 288 Market allocation schemes, 204 Market-clearing price, 54 Market demand, 48 and demand shifts, 92 derivation of, 91 for inputs, 239–240 price and income elasticities, 93 for substitutes and complements, 92–93 Market demand curve, 48, 91, 237–238 Market economy, 8, 25–26; see also Economy/ Economies; Mixed economy business cycles in, 39 in China, 41 corporations, 120–122 entry and exit of firms, 155 and equity, 38 income distribution, 38–39 income vs wealth distribution, 326 invisible hand, 28–30 limits of invisible hand, 306–307 and market failures, 30 need for government role, 303 partnerships, 120 property rights, 34 proprietorships, 120 and rise of welfare state, 40 in Russia and Eastern Europe, 41 Market equilibrium, 54 concept of, 57–58 definition, 28 effects of supply and demand shifts, 55–57 for factors of production, 240 land and rent, 269–270 outline of, 27–28 with supply and demand curves, 54–59 Market equilibrium of supply and demand, 27 Market failure, 30 and equity, 38–39 INDEX externalities, 36, 164 global public goods, 272 and government intervention, 39–40 and health care as social insurance, 220 imperfect competition, 35–36, 163–164 imperfect information, 164 in information, 221, 223 adverse selection, 217 asymmetric information, 217–218 moral hazard, 217 policies to deal with, 307 and social insurance, 218 and technological regress, 114 Market mechanism, 40 characteristics, 26–27 circular flow diagram, 28–29 concept of efficiency, 160 definition of market, 26 efficiency of competitive equilibrium, 161–162 equilibrium of supply and demand, 27 equilibrium with many consumers and markets, 162–163 functions of, 149 invisible hand, 28–30 marginal cost as benchmark of efficiency, 163 order vs chaos, 26–27 price, 27 and public goods, 37 qualifications externalities, 164 imperfect competition, 163–164 imperfect information, 164 rationing by prices, 59–60 solution to economic organization, 27–28 tastes and technology, 28 Marketplace, 26 Market power, 188 and antitrust laws, 203–206 containing, 201–202 measures of, 188–189 policies to combat, 199–202 price discrimination, 193–195 of unions, 257, 258 Market price in perfect competition, 150–152 and shutdown condition, 153 Market size and demand, 48, 49 and market structure, 173–174 Market structure duopoly, 193, 196 imperfect competition, 35–36 and market size, 173–174 measures of market power, 188–189 monopolistic competition, 171–172, 187 monopoly, 171, 172, 177–184, 187 oligopoly, 171, 172–173, 187 perfect competition, 35, 169, 172, 187 Market supply curve, derivation of, 154–155 Market value of Coca-Cola Company, 176–177 Marshall, Alfred, 16, 61, 185, 358 Marx, Karl, 331 Mass production techniques, 111–112 Maturity of loans, 288 Maximum-profit equilibrium, 190 Mayer, Christopher, 185 McDonald’s, 113, 169, 176 MCI Communications, 205 McMillan, John, 202 Median income, 324 Medicaid, 310, 334 Medicare, 310, 334 Mellon, Andrew, 184 Mercantilism, and tariffs, 355 Mercedes-Benz, 176 Mergers in Clayton Act, 204 in Federal Trade Commission Act, 204 monopolistic, 205 Merit goods, 94 Metropolitan Museum of Art, 184 Mexico and North American Free Trade Agreement, 361 wages and fringe benefits, 250 wages in, 251 Microeconomic policies, 306 Microeconomics, 5, 65 Microeconomics: Theory and Practice (Mansfield & Yohe), 61 Microsoft Corporation, 28, 36, 116, 128, 170, 176, 328 antitrust case, 205–206 Microsoft Windows, 112, 115, 171, 206, 222 Microsoft Word, 176 Mill, John Stuart, 149, 330, 358 Mine safety acts, 306 Minimum attainable costs, 127 Minimum wage controversy, 77–79 and teenage unemployment, 78–79 Minorities discrimination against, 261–263 in poverty, 328 Miron, Jeffrey A., 99 Mixed economy, 8, 25–26, 39; see also Economy/Economies; Market economy current status, 41 income redistribution as goal in, 331 social safety net, 323 Mona Lisa, 159 Monetary History of the United States (Friedman & Schwartz), 298 Monetary policy to control business cycles, 39 for economic stabilization, 308 international coordination, 308 to reduce unemployment, 359 Money, 33 Money interest rate, 288 Money supply, government control of, 33 Monopolist, 35–36 Monopolistic competition, 171, 191 behavior of, 187–189 compared to perfect competition, 191 economic critique of, 193 in market structure, 172, 187 measures of market power, 188–189 prices in, 193 product differentiation, 171–172 Monopolistic mergers, 205 Monopoly, 30, 171 and antitrust laws, 36 compared to collusive oligopoly, 190 created by government, 175 encouraged by government, 223 franchises, 175 in Gilded Age, 183–184 marginal principle, 183 and marginal revenue key points, 180 and price, 177–179 price, quantity, and total revenue, 177, 179 price elasticity of demand, 179–180 in market structure, 187 profit-maximizing conditions, 180–183 reasons for persistence of, 171 restriction of output, 199–200 deadweight loss, 200 static costs, 200 Schumpeter’s support for, 221–222 unions as, 258 Monopoly equilibrium, 180–182 Monthly Labor Review, 265 Moral hazard, 217 in navigation, 37 Morgan, J P., 183, 205 Morgenstern, Oscar, 208 www.ebook3000.com sam44230_ind.indd 396 2/25/09 10:19:12 AM 397 INDEX Movement along a demand curve, 50, 57 Movement along a supply curve, 52–53 Movements along curves, 22 Mullis, Kary, 296 Multicurve diagram, 23 Multilateral trade, 348 Multilateral trade negotiations, 359–361 General Agreement on Tariffs and Trade, 360 regional agreements, 361 World Trade Organization, 360 Murphy, Kevin, 124 N Nalebuff, Barry J., 195, 208 Nasar, Silvia, 208 Nash, John, 198, 208 Nash equilibrium, 197–199, 198 National Academy of Sciences, 327 National defense, 272 National income corporate profits in, 297 distribution of, 241–243 division of, 230 labor share of, 260, 330 share of labor in, 231 National Labor Relations Act, 258 National public goods, 310 National security argument, 355 National Tax Association, 321 Nations egalitarian, 333 income inequality across, 326–327 labor demand comparisons, 250–251 taxes and Gross domestic product, 305 wages and fringe benefits, 250 Natural monopoly, 173–175 economies of scale, 201 economies of scope, 201 examples, 175 regulation of, 201–202 undermined by technological advances, 175 Natural resources, 9; see also Resources categories appropriable, 268 inappropriable, 268 nonrenewable, 268–269 renewable, 269 diversity in, 341 economics of, 267–271 efficient management of, 269 environmentalist view, 267 land, 269–271 major types, 268 technological optimists’ view, 268 sam44230_ind.indd 397 Nature of Capital and Income (Fisher), 292 Negative externalities, 36, 271 Negotiations among parties, 278 Neoclassical economics, factorincome distribution, 241–243 Netherlands, 333 Net income, 135 Network industries, 175, 202 Network markets, 114–116 Net worth, 324 Neumann, John von, 195, 208 New Americans, The (National Academy of Sciences), 61 New Deal, 331 New Jersey cigarette tax, 72 Newport, Rhode Island, 184 New York Mercantile Exchange, 26 New York Stock Exchange, 120 Nike, Inc., 119 Nippon Steel, 112 Nokia, 176 Nominal interest rate, 288 versus real interest rate, 288–291 Noncompeting groups, wage differentials, 256–257 Noncooperative equilibrium, 198 Noncooperative oligopolies, 190 Nonexcludability, 37 Nonlinear curves, 21 Nonprice rationing, 221 Nonprohibitive tariff, 352 Nonrenewable resource, 268–269 Nonrival goods, 37 Nontariff trade barriers, 359 Normative economics, Normative theory of government, 308 North American Free Trade Agreement, adoption of, 361 opposition to, 356 Northwest Airlines, 187 Norway, 341 Notes payable, 138 No-trade equilibrium, 350–351 Numerical production function, 144 O Office of Management and Budget, 321 Offshoring, 344 Oil industry, 153–154 and Organization of Petroleum Exporting Countries, 191 Oil prices, 53, 140 Oil rigs, unemployed, 153–154 Oil spill, 274 Okun, Arthur M., 323, 331, 331n, 332, 333, 337, 338 Oligopoly, 171; see also Game theory behavior of, 187–189 cartels, 190 collusive, 190–191 compared to perfect competition, 173 cooperative vs noncooperative, 190 examples of, 171 measures of market power, 188–189 obstacles to collusion, 191 supernormal profits, 189 O’Neal, Shaquille, 256 Online shopping, 172 Open-access resources, 34 Operating expenses, 135–136 Opportunity cost, 139 of business decisions, 139 of going to college, 138 and implicit returns, 295 of invested capital, 295 and Iraq war, 140 and markets, 140–141 outside of markets, 140–141 and scarcity, 139–140 Optimal-tariff argument, 357–358 Ordinal utility, 89 Organization for Economic Cooperation and Development, 363 Organization of Petroleum Exporting Countries, 191 Other things constant, Outputs, aggregate production function, 117–118 analysis of costs for, 126–135 law of diminishing returns, 108–111 least-cost factor combination, 146–147 least-cost rule, 134 of monopoly, 177–180 needed for economies of scale, 174 in perfect competition, 35 in production function, 107–108 profit-maximizing, 152 reduced, 199–200 restricted by monopoly, 200 returns to scale, 111–112 total, average, and marginal product, 108–110 Outsourcing, 119, 344 Overhead, 127 P Palepu, Krishna G., 142 Panel Study on Income Dynamics, 245 Paradox of bumper harvest, 71 Paradox of value, 95–96 Pareto, Vilfredo, 87 Pareto efficiency, 160 Pareto optimality, 160 Partnerships, 120 Pasteur, Louis, 256 Patents, 175, 223 Payoffs, 196 Payoff table, 196 for price war, 197 Payroll tax, 317 Pearce, David W., 82 Penetration pricing, 116 People differences in, 254–256 unique individuals, 256 People magazine, 229 PepsiCo, 170, 176 Percentage changes in demand, 66–68 in price and quantity, 69–70 in quantity supplied, 72–73 Perfect competition, 35, 150 breakdown of, 307 compared to monopolistic competition, 191 compared to oligopoly, 173 cost and demand curve, 173, 174 effect of Internet on, 223 firm demand curve, 170 as idealized market, 169 in market structure, 172, 187 as polar case of imperfect competition, 182–183 price takers, 150 supply under, 152 Perfectly competitive firms; see Competitive firms Perfectly competitive industries; see Competitive industries Perfectly competitive labor market, 254 Perfectly competitive markets; see Competitive markets Perfectly elastic demand, 68 Perfectly inelastic demand, 68 Perloff, Jeffrey M., 208 Perot, Ross, 356 Perpetuities, 286 Per se illegal concept, 204 Personal computer industry, 192 Personal exemption, 315 Personal income, 323–324 Pesek, John T., 110 Peterson Institute for International Economics, 363 “Petition of the Candle Makers” (Bastiat), 349 Philippines, wages and fringe benefits, 250 Physical capital, 216–217 Pigou, A C., 16 Piketty, Thomas, 122, 124, 329 Political action committees, 356 2/25/09 10:19:12 AM 398 Political rights, 331 Political risk, 211 Politics and labor unions, 258–259 public-choice theory, 309 of tariffs, 356 Poll tax, 319 Pollution and climate change, 278–280 cost-benefit analysis, 273 economic inefficiency of, 272–273 graphical analysis, 274–275 and property rights, 34 reduced to zero, 273 socially efficient, 273 valuing damages from, 274 Pollution abatement, 273, 277 cost-benefit analysis, 274–275 marginal cost, 274–275, 276 Pollution control, 272 carbon taxes, 278–279 government policies, 275–277 inefficiency of, 276 marginal social benefit, 273 measuring benefits of, 274 private approaches, 277–278 and property rights, 277–278 Pollution costs, 114 Pollution standards, 276–277 Pollution tax, 319–320 Poor, the defining, 327–328 incentive problems, 334 Poor countries diminishing returns in, 111 economic inequality, 307 lack of property rights, 34 poverty trap, 33 Positive economics, Positive externalities, 164, 271 public goods, 36–37 Posner, Richard, 206, 208 Post hoc fallacy, Poverty, 4; see also Antipoverty policies defined in U.S., 327 defining poor and rich, 327–328 illusive concept of, 327 and income redistribution, 333 population groups, 327 as relative-income status, 327 roots of, 333 trends in inequality diminishing 1929–1975, 328–330 widening gaps 1975–1980, 330 two views of, 334 Poverty line, 327 Poverty trap, 33 Predatory behavior, 128 Preferences effect on demand, 48, 49 INDEX factor in international trade, 341 Premiere smokeless cigarette, 28 Present value, 285 discounting future payments, 286 formula, 286 general formula, 286–287 maximizing, 287 for perpetuities, 286 Price(s), 27, 53; see also Equilibrium price before and after trade, 343 and average cost, 129 in circular flow diagram, 28–29 and demand curve, 46–49 demand rule, 158 in distribution theory, 233 effect of crop restrictions, 75 effects of supply and demand shifts, 55–57 equal to marginal cost, 150–152 equal to opportunity cost, 140 equilibrium ratio, 345–347 factor prices, 28 of farm products, 74 under free trade, 351 and gains from trade, 343–344 of gasoline, 45, 46 geographic patterns, 212 government regulation of, 36 for homogeneous products, 150 with hyperinflation, 33 impact of taxes, 75–77 in imperfect competition, 35–36, 170–171 and income effect, 47 inflated, 199–200 of inputs, 52, 53 interpreting changes in, 57 in long run, 157 and marginal revenue, 177–179 market-clearing, 54 and market demand curve, 48 in market equilibrium, 28 in monopolistic competition, 193 or related goods, 52 in perfect competition, 35, 182–183 of personal computers, 48, 49 profit-maximizing, 180–183 rationing by, 59–60, 80–81 of related goods, 48, 49 relation to quantity demanded, 46–47 for revenue maximization, 177 ruinously low, 204 and shutdown condition, 153 as signals, 27 and speculation arbitrage, 212 economic impacts, 213–215 hedging, 213 price behavior over time, 212–213 and substitution effect, 47 supply curve, 51 supply rule, 158 two-part, 194 whole price, 172 and zero-profit point, 157 Price ceilings, 79–80 Price changes and commodities, 92–93 consumer response to, 66 and demand curve, 92 effect of supply shifts, 52–53 effect on consumer equilibrium, 105 effect on revenue, 70–72 effect on supply, 72–73 hedging against, 213 income effect, 90–91 and independent goods, 92–93 and substitutes, 92–93 substitution effect, 90 Price competition, 27 Price controls energy prices, 79–80 legal and illegal evasions, 81 minimum wage, 77–79 range of, 77 and rationing, 80–81 Price cutting, 196 clandestine, 191 Price discrimination, 71, 193 antitrust interpretation, 204 in Clayton Act, 204 economic effects of, 195 to increase profits, 194–195 uses of, 193–195 Price-elastic demand, 66–68 effect of price changes, 70–72 Price elasticity; see Price elasticity of demand; Price elasticity of supply Price elasticity of demand, 65–66 airline industry, 70–71 algebra of, 69 calculating, 66–68 categories of, 66–68 and cigarette taxes, 72 diagramming, 67–68 empirical estimates, 93 formula, 67 for illegal drugs, 94–95 linear demand curve, 70 and marginal revenue, 179 paradox of bumper harvest, 71 and price discrimination, 71, 194 reasons for variations in, 66 and revenue, 70 short-cut for calculating, 68–79 versus slope, 69–70 Price elasticity of supply, 72 determinants, 73 extremes of, 72–73 Price fixing, 36, 204–205 Price floors, 77–79 Price-inelastic demand, 66–68, 94 effect of price changes, 70–72 for farm products, 75 Price makers, 170–171 Price ratios, 346–347 Price takers, 150 versus price makers, 171 Price war oil producers, 153–154 payoff table, 197 Pricing duopoly price game, 196 in game theory, 196 penetration pricing, 116 Principal-agent problem, 121–122 Principle of comparative advantage, 341–342 Principle of utility, 87 Principles of Economics (Marshall), 61, 185 Principles of Money, Banking, and Financial Markets (Ritter, Silber, & Udell), 298 Private goods, 12–13, 272 versus public goods, 271 Private pollution control approaches liability laws, 277–278 negotiation among parties, 278 property rights issue, 278 Private property, and capital, 34 Process innovation, 113–114 Producers, in circular flow diagram, 28–29 Producer surplus, 161 Product differentiation as barrier to entry, 176 importance of location, 172 logic of, 193 in monopolistic competition, 171–172 and product quality, 172 Product innovation, 113–114 Production aggregate production function, 116–118 basic concepts law of diminishing returns, 108–111 production function, 107–108 total, average, and marginal product, 108–110 crop restrictions, 75 effect of supply curve, 51 effects of supply shifts, 52–53 fast-food industry, 112–113 in firms or market, 118–119 holdup problem, 119 www.ebook3000.com sam44230_ind.indd 398 2/25/09 10:19:12 AM 399 INDEX least-cost factor combination, 145–147 linked to costs, 132–134 long-run, 111, 133–134 and nature of firms, 118–122 outsourcing, 119 returns to scale, 111–112 role of capital in, 33 roundabout, 291 roundabout methods, 33 short-run, 111, 133–134 technological change, 113–116 Production costs average costs, 129–132 and business accounting, 135–139 choice of inputs, 134–135 and comparative advantage, 342–343 constant-cost curve, 158 cost minimization assumption, 134 and demand, 162 derivation of, 132–134 determination of input prices, 52 technological advances, 52 effect of supply shifts, 52–53 effect on supply curve, 52, 53 effects of tariffs, 353 factor in international trade, 341 fixed costs, 126–127 on income statement, 135–136 increasing costs and diminishing returns, 158 influences on, 126 least-cost condition, 147 least-cost factor combination, 145–147 least-cost rule, 134 marginal cost, 127–129 minimization assumption, 135 and opportunity cost, 139–141 shutdown condition, 152–154 source of imperfect competition, 173–175 substitution rule, 134–135 total cost, 126–129 variable costs, 127 Production function, 108–109, 234–235; see also Aggregate production function Cobb-Douglas, 144 and cost curves, 132 effect of technological change, 113–114 numerical, 144 Production possibilities, 10 diversity in, 341 Production possibilities frontier, 9–14, 10 sam44230_ind.indd 399 applied to society’s choices, 10–13 and business cycles, 14 and consumer tastes, 28 and efficiency, 13–14, 160 and environmental degradation, 14 graphing, 10–12, 18–22 growth of capital, 33 with imperfect competition, 35 and inefficiency, 14 opening up to trade, 345–347 opportunity costs, 13 productive efficiency, 13–14 without trade, 344–345 in two-product economy, 9–10 and use of time, 13 world, 346–347 Production process, 118 Production theory, 107–116, 234–235 Productive capacity, 107 Productive efficiency, 13, 162 economies of specialization, 118 from marginal cost, 163 and production possibilities frontier, 13–14 Productivity, 116 aggregate production function, 117–118 in agriculture, 74 definition, 39 promoted by trade, 339 Productivity growth, 116 from economies of scale, 116–117 from economies of scope, 116–117 measurement difficulty, 117–118 Product market, in circular flow diagram, 28–29 Product quality, 172 Products degrading, 195 homogeneous, 150 network, 116 Professions, 256 highest earners, 328 women in, 263 Profitability, long-run, 157 Profit-and-loss statement; see Income statement Profit maximization of competitive firms, 147–148 conditions for monopoly, 179–183 factor demands, 236–237 least-cost rule, 237 price equal to marginal cost, 151 and shutdown condition, 153 Profit-maximizing output, 180–183 of competitive firms, 152 Profits, 27 accounting vs economic, 295 and average cost, 129 decline in pretax rate, 297 determinants implicit returns, 295 rewards for innovation, 296–297 rewards for risk bearing, 296 determining, 135 effect of supply curve, 51 government regulation of, 36 increased by price discrimination, 194–195 of oligopoly, 189 as residual income, 297 as return to capital, 295–297 Schumpeterian, 296, 328 trends in, 296 trends in U.S., 296 zero-point, 152 Progress and Poverty (George), 271 Progressive Era, 184 Progressive income taxes, 313, 314, 330, 331 Progressive taxation, 38 Prohibition era, 94 Prohibitive tariff, 352 Project Braveheart, 138 Property income, 230–231, 328 Property rights; see also Intellectual property rights limits on, 34 and pollution, 34 and pollution control, 277–278 Property tax, 271, 318 Proportional income taxes, 313, 314 Protectionism, 349–359 beggar-thy-neighbor policy, 358 in Brazil, 358–359 economics of, 355–359 noneconomic goals, 355 unsound grounds for tariffs, 355–357 high point of, 359 potentially valid arguments for cheap foreign labor, 356 infant industry argument, 358–359 national security argument, 355 terms-of-trade argument, 357–358 unemployment problem, 359 in sovereign nations, 340 supply and demand analysis costs of tariffs, 353–355 free trade vs no trade, 350–351 trade barriers, 351–353 textile industry, 354–355 and transportation costs, 353 Public-choice theory, 308–309 Public goods, 12–13, 36, 272, 307 global, 272, 310 Global Positioning System, 37 health care, 220 key attributes, 37 lighthouses, 37 local, 310 and market mechanism, 37 national, 310 versus private goods, 271 provided by markets, 37 from taxation, 38 Pure economic rent, 159, 256, 269 basis of single-tax movement, 271 results of taxes, 270–271 Pure food and drug acts, 306 Q Qualcomm, 138 Quantity under free trade, 351 impact of taxes, 75–77 interpreting changes in, 57 and marginal revenue, 177–179 Quantity demanded and substitution effect, 47 versus change in change in demand, 50 and income effect, 47 and income elasticity, 90–91 and market price, 46–47 and price elasticity, 66–68 and surplus or shortage, 55 Quantity supplied of automobiles, 53 and economic rent, 159 and price elasticity, 72–73 supply curve, 51 and surplus or shortage, 55 Queue, rationing by, 79–80 Quintiles, 324 of household incomes, 325 income changes 1975–2006, 330 Quotas, 351 compared to tariffs, 352–353 on sugar, 356 voluntary, 359 QWERTY keyboard, 115–116 Qwest Communications, 138 R Rabin, Matthew, 99 Rabushka, Alvin, 316–317 Race to the bottom, 335–336 Radford, R A., 43 Radithor, 164 Railroad building era, 184 2/25/09 6:35:02 PM 400 Ramsey, Frank, 271 Ramsey tax rule, 271, 319 Random Walk down Wall Street (Malkiel), 298 Rao, Akshay R., 187 Rate of return on capital, 284–285, 292, 294–295 examples of, 285 and interest rates, 284–285 on investments, 285 Rate of return on investments, 284, 285 Rationing of health care, 220–221 nonprice, 221 by prices, 59–60 by queue, coupons, or price, 80–81 Reagan, Ronald W., 260, 313 Real income, 90–91 Real interest rate, 286, 288 algebra of, 290n versus nominal interest rate, 288–291 Real wage, 248 and gains from trade, 343 increase 1890–2008, 249 raised by unions, 260 Recessions, 14 Redistributive systems, 39 Regional free trade agreements, 361 Regressive taxes, 313, 314 Regulation; see also Government intervention; Government policies of addictive substances, 95 command-and-control type, 275–276 economic, 306 of externalities, 36 of financial markets, 202 growth of, 305–306 of industry to contain market power, 201–202 reasons for, 201 to remedy information failure, 202 scope of, 201 inefficiency of, 276 as policy tool, 304 of prices and profits, 36 slower growth since 1970, 306 social, 275, 306 sports analogy, 202 Relative-income status, 327 Renewable resources, 269 Rent, 159, 269 income of land, 242 on land market equilibrium, 269–270 return on fixed factors, 270 single-tax movement, 271 INDEX results of taxes on, 270–271 of unique individuals, 256 Rent controls, 77 Report on Manufactures (Hamilton), 358 Research, government role, 312 Research and development, 189 Residual income, 297 Resource allocation, 160–163 Resource categories, 268–269 Resource costs, 139 Resources; see also Natural resources inefficient uses of, 14 for large-scale production, 118 open-access, 34 scarcity of, and technological possibilities, 8–14 Restraint of trade, 203, 205, 306 Retained earnings, 138 Retaliatory tariffs, 357 Return on capital determinants of interest rate, 293 graphical analysis, 293–295 long-run equilibrium, 295 short-run equilibrium, 293–295 Returns to scale and information technology, 112 kinds of, 111 and mass production, 111–112 Revenue and paradox of bumper harvest, 71 and price elasticity of demand, 70–72 total, 70, 71 Revenue maximization, 177 Reverse discrimination, 264 Ricardo, David, 362, 363 on comparative advantage, 342–344 Rich, the, 327–328 Rich countries, assistance programs, 308 Risk of default, 296 hedging, 213 in loans, 288 political risk, 211 and social insurance, 218 systematic, 296 and uncertainty, 215 Risk-averse, 215 Risk-averse investors, 297 Risk aversion, and insurance, 215 Risk bearing, profits as reward for, 296 Risk premium, 32 Risk sharing, 215 Risk spreading, 216 in capital markets, 216–217 by insurance, 216 Ritter, Lawrence, 298 Rivalry versus competition, 172–173 among the few, 193 in pricing, 196 Rivalry game, 198 Road to Serfdom (Hayek), 43 Roaring Nineties, The (Stiglitz), 43 Rockefeller, John D., 183, 184 Rodriguez, Alex, 269 Rogers, Will, 267 Roosevelt, Franklin D., 305, 330 Roosevelt, Theodore, 305, 326 Ross, David, 174, 185 Roth, Al, 208 Rothschild family, 183 Roundabout methods of production, 33, 291 Ruinously low prices, 204 Rule of reason doctrine, 205 Russia, turn toward markets, 41 S Saez, Emmanuel, 122, 124, 329 Safety net, 38–39, 323 Sales, of personal computers, 48 Sales tax, 318 Samuelson, Paul, 87 Sandburg, Carl, 13 Saving, and government policy, 333 Scarcity, and opportunity cost, 13, 139–140 production possibilities tradeoff, 10 and substitution value, 101 Scatter diagrams, 23 Scherer, F M., 174, 185 Schlosser, Eric, 113n Schumpeter, Joseph, 16, 40, 225, 226, 295, 303, 309 biography of, 222 on innovation, 221–222 Schumpeterian profits, 296, 328 Schwartz, Anna Jacobson, 298 Science, government role, 312 Scientific approach, Securities government bonds, 290–291 marketable, 288 Securities and Exchange Commission, 202 Segmented markets, 256–257 Self-employment, 120 Semiconductor industry, 355 Separation of ownership and management, 121–122 Shakespeare, William, 84 Shapiro, Carl, 124, 225 Shareholders; see Stockholders Sherman Antitrust Act, 203, 203–204, 205, 306 Shift in demand, 50, 57 effects of, 55–57 and market demand, 92 Shift in supply, 52–53 in competitive markets, 159–160 effects of, 55–57 Shifts of curves, 22 Shiller, Robert, 298, 299 Shortages definition, 55 from price controls, 80 Shorter, Gary, 124 Short run, 112 costs in, 133–134 Short-run equilibrium, 155 in competitive industries, 156 return on capital, 294–295 Short-run supply curve, 155 Shutdown condition chronic losses, 157 and total cost, 152–154 Shutdown rule, 153 Silber, William L., 298 Simon, Julian, 268, 281 Single-parent families, 328 Single-tax movement, 271 Sin taxes, 319 Sixteenth Amendment, 314 Skilled trades, 256 Slope, 19 of curved line, 21 versus elasticity, 69–70 of equal-cost curves, 146, 147 of equal-cost lines, 146 of indifference curve, 101, 104 key points, 20 as marginal value, 22 for straight lines, 20 Small companies, in competitive industries, 150 Smith, Adam, 16, 25, 35, 77, 86, 95, 349, 356, 363 founder of economics, 30 founder of microeconomics, and invisible hand, 28–30 Smith, Robert S., 265 Smith, Vernon L., 89, 99 Smoot-Hawley tariff of 1930, 359 Social contract, 305 Social insurance, 218 health care insurance, 220–221 versus private insurance, 218 result of market failure, 218 unemployment insurance, 218–219 Social insurance taxes, 317 Socialism, and welfare state, 40 Socialist countries, income redistribution in, 332 Socially efficient pollution, 273 Social regulation, 275–276, 306 Social return to invention, 222 Social safety net, 323 www.ebook3000.com sam44230_ind.indd 400 2/25/09 6:35:02 PM 401 INDEX Social Security, 310, 334 original opposition to, 305 payroll tax, 317 Software distribution costs, 128 Software industry, 176 Software programs, 116–117 South Korea, wages and fringe benefits, 250 Sovereign nations, 340 Soviet Union, Special influences on demand curve, 48, 49 effect on supply curve, 52, 53 Special interests, tariffs for, 355–356 Specialization economics of, 118 and globalization, 32 international, 342–344 promoted by trade, 339 and trade, 31 Speculation, 212 arbitrage, 212 benefits of, 212 compared to gambling, 215–216 economic impacts, 213–215 on financial assets, 214–215 geographic price patterns, 212 and hedging, 213 invisible hand principle, 213 price behavior over time, 212–213 Spillovers; see Externalities Spotted owl habitat, 274 Stabilization policies, 307–308 Standard deduction, 315 Standard Oil Trust, 184 antitrust case, 205 Stanley Steamer, 28 State governments devolution of responsibility to, 335–336 expenditures, 310–311 taxes, 317–318 Statement of profit and loss; see Income statement Static costs of monopoly, 200 Statistical discrimination, 262 areas of, 263 inefficiency of, 262 pernicious nature of, 262–263 Stavins, Robert, 281 Stigler, George, 16, 309 Stiglitz, Joseph E., 43, 140, 142 Stockholders, 120 versus managers, 121 Stockholders’ equity, 138 Stock market crash of 1929, 292–293 Stock options, 121–122 Stock variable, 137 Stock watering, 183 Stolper-Samuelson theorem, 356 Straight-line depreciation, 136 sam44230_ind.indd 401 Strategic interaction, 189 and collusive oligopoly, 190 with few competitors, 193 payoff table, 196 Strikes, 260 Subprime mortgage problem, 89 Subsidies to encourage production, 76–77 for ethanol, 52 medical care, 219–220, 221 Substitute, 92, 93 and elastic demand, 66 Substitution, 14 Substitution effect, 47, 90, 93 and illegal drugs, 95 and labor supply, 252 and market demand curve, 48 and taxation, 318 Substitution ratio, 101, 104, 147 Substitution rule, 134–135, 238 Sugar quotas, 356 Sulfur dioxide emissions, 274 Sunk cost, 127 ignoring, 183 Supernormal profits, 189 Supply in circular flow diagram, 28–29 effect of shifts in, 52–53, 55–57 effect of tariffs, 352 elasticities of, 72–73 of factors of production, 238–239 fixed, 159 interpreting changes in, 57 long-run industry supply, 155–156 shifts in, 159–160 where price equals marginal cost, 150–152 Supply and demand attaining equilibrium, 27–28 for competitive economy, 160–162 for competitive firms, 149–154 for competitive industries, 154–157 in competitive markets, 154–164 concept of equilibrium, 57–58 determination of factor prices by, 239–240 equilibrium, 54–55 interference with laws of, 77 market equilibrium, 27 market equilibrium changes, 55–57 and microeconomics, 65 price elasticities, 65–73 rationing by prices, 59–60 theory of, 45 Supply and demand analysis agriculture, 73–75 automobiles, 49, 50 bread prices, 55–57 for capital, 294–295 changes in price and quantity, 57 cornflake market, 54 of discrimination by exclusion, 261 gasoline prices, 45, 46, 57 of immigration, 58–59 of income distribution, 240–241 paradox of value, 95–96 personal computers, 48, 49 price controls, 77–81 taxes, prices, and quantity, 75–77 of trade and tariffs, 350–355 Supply and demand diagram, 23 Supply and demand equilibrium, 53–60 Supply behavior of competitive firms, 149–154 of competitive industries, 154–157 Supply curve, 51, 65 backward-bending, 159 equilibrium with, 54–59 forces behind government policy, 52, 53 input prices, 52, 53 prices of related goods, 52, 53 production costs, 52, 53 special influences, 52, 53 technological advances, 52, 53 for gasoline, 76 for land, 269–270 market supply derived from, 154–155 movement along, 52–53 response of work to taxes, 319 as rising marginal cost curve, 152 shifts in, 52–53 short-run, 155 and shutdown point, 153 upward-sloping, 51 Supply rule, 158 corollaries of, 159–160 with free trade, 350 Supply schedule, 51 Surgeons, market for, 240 Surplus, 55 Sustainable economic growth, 267 Sweden, 333, 341 Systematic risk, 296 T Tacit collusion, 190 Talented individuals, 256 Tangency of consumer equilibrium, 104 Tangent lines, 21 Tangible assets, 283, 284 Tariffs, 351; see also Protectionism antidumping, 357 as barrier to entry, 175–176 countervailing duties, 357 diagrammatic analysis, 353–354 economic costs, 353–355 economic effects, 352 effect on prices and wages, 343 during Great Depression, 349 for infant industries, 358 main effects of, 354 national comparisons, 351 nonprohibitive, 352 optimal-tariff argument, 357–358 prohibitive, 352 Smoot-Hawley tariff of 1930, 359 supply and demand analysis costs of tariffs, 353–355 free trade vs no trade, 350–351 trade barriers, 351–353 and transportation costs, 353 and unemployment, 359 in U.S history, 359–360 unsound grounds for cheap foreign labor, 356 favoring special interests, 355–356 import relief, 357 mercantilism, 355 retaliation, 357 Taste for discrimination, 262 Tastes, 28, 45 diversity in, 341 effect on demand, 48, 49 Taxable income, 315 Taxation cigarette tax and smoking, 71–72 of corporations, 121 to discourage consumption, 75–76 double, 121, 318 earned-income tax credit, 335, 336 economic aspects, 312–320 efficiency vs fairness, 319–320 federal consumption taxes, 317 corporate income tax, 317 individual income tax, 314–317 social insurance taxes, 317 federal receipts in 2009, 314 flat tax proposal, 316–317 goal of efficiency impact of globalization, 318–319 taxes on capital income, 318 taxes on labor income, 318 green taxes, 319–320 in Gross domestic product, 231 2/25/09 6:35:02 PM 402 Taxation—Cont growth 1930–2008, 304 impact on price and quantity, 75–77 Laffer curve, 322 of land, 270–271 loopholes, 316 lump-sum, 319 national comparisons, 305 as policy tool, 304 poll tax, 319 principles of ability-to-pay principle, 312 benefit principle, 312 direct or indirect taxes, 313–314 horizontal equity, 312–313 pragmatic compromises, 313–314 progressive taxes, 313 proportional taxes, 313 regressive taxes, 313 vertical equity, 313 progressive, 38, 330 for public goods, 38 Ramsey tax rule, 271, 319 and revenue from gambling, 216 single-tax movement, 271 sin taxes, 319 for social insurance, 218 state and local, 317–318 highway user taxes, 318 lottery revenue, 318 property tax, 318 sales tax, 318 in U.S 1930–2008, 304 user fees, 313 value-added tax, 317 Tax cuts, Kennedy-Johnson, 6, 322 Tax incidence, 76–77 of payroll tax, 317 Tax integration, 121 Tax preferences, 316 Tax rates, 315 major inefficiencies, 332–333 Tax revolts, 323 Tax shifting, 159 to consumers, 76 general rules on, 77 taxes on land, 270 Technological advances in agriculture, 74 effect on supply curve, 52, 53 in health care, 219 undermining natural monopoly, 175 Technological change, 27 aid to talented individuals, 256 effect on production function, 114 effect on wages, 330 examples, 113 process vs product innovation, 113–114 INDEX Technological optimists, 268 Technological possibilities inputs and outputs, and limited resources, 8–9 production possibilities frontier, 9–14 Technological regress, 114 Technology, 45 determinant of production, 28 impact of government spending, 311–312 inferior, 114 for inputs and outputs, source of imperfect competition, 173–175 Teenage unemployment, 78–79 Telecommunications industry, 205 Temporary Assistance for Needy Families, 335 Term loans, 288 Terms of trade, 345, 357 Terms-of-trade argument, 357–358 Textbook market, 194 Textile industry, protectionism in, 354–355 Thatcher, Margaret, 319 Theoretical approaches, Theoretical indeterminacy of collective bargaining, 259 Theory of capital, profits, and interest, 291–297 Theory of demand in behavioral economics, 88–89 and law of diminishing marginal utility, 85 and ordinal utility, 89 and utility, 84–85 Theory of Economic Development (Schumpeter), 222 Theory of economic value, 96 Theory of Games and Economic Behavior (Morgenstern), 208 Theory of income distribution, 232 Theory of Interest (Fisher), 292, 298 Theory of Price (Stigler), 16 Theory of supply and demand, 45 Theory of the Leisure Class (Veblen), 184 Thinking Strategically (Dixit & Nalebuff), 208 Third-party payment effect, 220 Three Trillion Dollar War (Bilmes), 142 Tietenberg, Thomas H., 277, 281 Time involved in production, 112–113 opportunity cost of, 139 optimal allocation of, 88 price behavior over, 212–213 spent in shopping, 172 use of, 13 Time discounting, 292 Time series graphs, 22–23 Titan (Chernow), 185 Total assets, 137 Total cost, 127 and shutdown condition, 152–154 Total cost curve, 131 Total cost schedule, 130 Total factor productivity, 117 Total factor productivity, 116 Total product, 108, 109–110 Total revenue, 70, 71, 177 and marginal revenue, 177–179 and profit maximization, 180–183 Total utility and consumer surplus, 96–97 and consumption, 85–86 and marginal utility, 85–86 paradox of value, 96 and speculation, 214 Toyota Motor Corporation, 28, 169, 176 Trade; see Domestic trade; International trade Tradeable emission permits, 277 Trade barriers in Great Depression, 359 lowering, 360–361 nontariff, 359 quotas, 351, 352–353 reducing, 308, 360–361 tariffs, 351–352 transportation costs, 353 Trade wars, 357 Transaction costs, 278 Transfer payments, 38–39, 231, 304 Transistor, 311 Transportation costs, 353 Treasury bonds, 290–291 Treasury inflation-protected securities, 290–291 Triangular trade, 348 Trusts, 184 Tullock, Gordon, 309 Tversky, Amos, 185 Two-part prices, 194 Tying contracts antitrust interpretation, 204 in Clayton Act, 204 Typewriter keyboard, 115–116 U Udell, Gregory F., 298 Uncertainty and risk, 215–216 and speculation, 212–215 Unemployment classical, 260 in eastern Germany, 260 effect of minimum wage on, 77–79 Keynesian, 260 results of globalization, 32 and tariffs, 359 among teenagers, 78–79 and unions, 260 Unemployment insurance, 7, 218–219 Unions; see Labor unions Unique individuals, 256 Unit cost, 129 United Kingdom, poll tax proposal, 319 United States capitalist economy, 283 capital stock in 2008, 33, 283 comparative advantage, 344–347 credit crisis, 308 decline in unionism, 260 definition of poverty, 327 distribution of money incomes, 324 early public works, 37 federal expenditures, 310, 311 financial crisis of 2007–2009, 32 with free trade, 350 government spending and taxes, 304 history of inequality in diminishing 1929–1975, 328–330 widening gaps 1975–1980, 330 history of tariffs, 359–360 immigration, 252–253 income supplemental programs, 335 international trade in 2007, 340 job creation 1990–99, 359 largest borrower, 32 major interest rates, 289 number and size of firms, 119 number of business failures, 155 production possibilities frontier with trade, 345–347 without trade, 344–345 state and local expenditures, 310–311 sugar quotas, 356 top income groups, 329 trade wars, 357 trends in inequality, 329 trends in wages and profits, 296 wages and fringe benefits, 250 wages in, 251 United States Constitution, 223 broadly interpreted, 306 Sixteenth Amendment, 314 www.ebook3000.com sam44230_ind.indd 402 2/25/09 10:19:13 AM 403 INDEX United States International Trade Commission, 357 United States Lighthouse Service, 37 United States Steel case, 205 United States Supreme Court, 205, 258 Unit-elastic demand, 66 effect of price changes, 70–72 for food products, 71 and marginal revenue, 179 Unlimited liability, 120 Unskilled workers, 349 Upward-sloping supply curve, 51 Urban Institute, 337 Urban society, 12 Uruguay Round, 360 US Airways, 193 User fees, 313 U-shaped cost curve, 133–134 Usury laws, 77 Utilitarianism, 86–87 Utility, 84 cardinal, 89 in competitive equilibrium, 162 and consumer surplus, 96–97 numerical example, 85–86 ordinal, 89 and paradox of value, 95–96 principle of, 87 and speculation, 213–214 and theory of demand, 84–85 Utility maximization, 84, 87, 163 Utility theory allocation of time, 88 alternative approaches, 89–91 analytical developments, 89 and choice, 84–87 equimarginal principle, 87, 89 history of, 86–87 meaning of, 84 Utils, 160n V Value of brands, 176–177 and consumer surplus, 96–97 historical cost, 138 and opportunity cost, 140 paradox of, 95–96 theory of, 96 Value-added tax, 317 Valuing damages from pollution, 274 Vanderbilt, Cornelius, 183, 195 sam44230_ind.indd 403 Variable costs, 127, 153 average, 130 and total cost, 128 Variable factors of production, 112 Variables, 19 ordinal, 89 Varian, Hal R., 32, 43, 61, 124, 128, 225 Veblen, Thorstein, 184 Vertical equity, 313 Voluntary export quotas, 359 W Wage differentials compensating, 254 differences in people, 254–255 and discrimination, 260–264 economic differences, 253 and education, 255 industry comparisons, 253–254 international comparisons, 250–251 investment in human capital, 255–256 job differences, 254 labor quality, 254–255 for minorities, 260–263 noncompeting groups, 256–257 and perfectly competitive labor market, 254 reasons for, 328 in segmented markets, 256–257 unique/talented individuals, 256 for women, 263 Wage-price spiral, 260 Wages before and after trade, 343 and cheap foreign competition, 356 in China, 341 from collective bargaining, 257–259 compared to executive compensation, 121–122 and demand for labor international comparisons, 250–251 marginal productivity differences, 249–250 determination of, 248–257, 257 determination of total, 242–243 effect of comparative advantage, 349 effect of immigration, 58–59 effect of technological change, 330 effects of unions on, 259–260 effects of welfare reform, 335 and gains from trade, 343–344 general wage level, 248–249 impact of trade on, 330 improvement with decline in hours, 248–249 international gains, 248 and labor supply determinants, 251–253 empirical findings, 253 hours worked, 251–252 immigration, 252–253 labor force participation, 252 minimum wage, 77–79 in poor countries, 159 and quality of work force, 250 real wage, 248 reasons for differences in, 328 trends in, 296 of union vs nonunion workers, 259 United States vs Mexico, 251 Wagner Act, 258 Wall Street Journal, 287 Wal-Mart, 204, 328 Walt Disney Company, 176 Walton family, 328 Waste from business cycles, 14 caused by monopoly, 200 from environmental degradation, 14 Waste Management, 138 Water distribution systems, 202 Wealth, 231, 324 components, 232 differences in total returns to, 241 distribution of, 324–326 extremes of, 229 and factor prices, 240–241 during Gilded Age, 184 inherited, 38 property income, 328 as stock, 231–232 trends in, 232 underlying market forces, 241 Wealth of Nations (Smith), 5, 28, 30, 95 Welfare reform appraisal of, 335–336 battle over, 334–336 current income supplemental programs, 335 devolution of responsibility, 335 earned-income tax credit, 335, 336 effect on labor market, 335 legislation of 1996, 335–336 and race to the bottom, 335–336 views of poverty, 334 Welfare state, 40, 307, 323, 330 conservative backlash, 40–41 less inequality in, 327 major policies, 330–331 rise of, 40, 330–331 Wendy’s, 169 Western Electric, 205 Westinghouse Corporation, 204 What to produce, determination of, 27 effect of prices, 59–60 Whole price, 172 Wilde, Oscar, 45, 248 Wilson, Edward O., 267, 281 Wilson, William Julius, 334 Wilson, Woodrow, 305 Winner-take-all markets, 116 Women economic discrimination against, 264 family gap, 264 female-headed households, 328 labor force participation, 252 in poverty, 327–328 in professions, 263 Worker safety acts, 306 Work rules, 258 World Bank, 308, 363 WorldCom, 121, 155 World production possibilities frontier, 346–347 World Trade Organization, 360 Y Yahoo!, 138 Yohe, Gary, 61 Z Zero-economic-profit, 157 Zero-profit condition, 157 Zero-profit long run equilibrium, 157 Zero-profit point, 152, 157 and shutdown point, 153 Zweibel, Jeffrey, 99 2/25/09 10:19:13 AM GOVERNMENT DEBT SINCE THE AMERICAN REVOLUTION Debt-GDP Ratio 120 110 World War II Federal Debt as a Percentage of Gross Domestic Product 100 90 Postwar Expansion 80 70 60 Deficit Reduction and “New Economy” Boom 50 40 Constitution Ratified 30 World War I “Supply-Side Economics” Civil War 20 10 Great Depression 1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010 www.ebook3000.com sam44230_GraphsAndTree.indd 404 2/25/09 1:28:32 PM U.S PRICE LEVEL SINCE 1800 120 80 60 U.S Consumer Price Index (2008 = 100) 40 Price Level 20 16 12 1800 sam44230_GraphsAndTree.indd 405 1825 1850 1875 1900 1925 1950 1975 2000 2/25/09 1:28:32 PM FAMILY FAMILYTREE TREE OF OF ECONOMICS PHYSIOCRATS Quesnay, 1758 David Ricardo, 1817 SOCIALISM K Marx, 1867 V Lenin, 1917 www.ebook3000.com sam44230_GraphsAndTree.indd 406 2/25/09 1:28:32 PM MERCANTILISTS 17th and 18th Centuries Adam Smith, 1776 CLASSICAL SCHOOL T.R Malthus, 1798 J.S Mill, 1848 NEOCLASSICAL ECONOMICS Walras, Marshall, Fisher, 1880–1910 J.M Keynes, 1936 MODERN MAINSTREAM ECONOMICS sam44230_GraphsAndTree.indd 407 2/25/09 1:28:32 PM www.ebook3000.com sam44230_GraphsAndTree.indd 408 2/25/09 1:28:32 PM ... invest their (a) Without Carryover (b) With Carryover P1 S1 P2 S2 D D P2 P1 A2 D D E1 A1 3 2 D S1 Q1 E2 1 D S2 Q2 D Q1 D Q2 FIGURE 11 -2 Speculative Storage Can Improve Efficiency The blue areas... of the Department of Justice, at www.usdoj.gov/atr/public/ div_stats /21 1491.htm, contains an overview of antitrust issues www .ebook3 000.com sam1 129 0_ch10.indd 20 8 2/ 2/09 6:09:41 PM 20 9 QUESTIONS... shift in the supply curve (say, due to cheating by a cartel member) www .ebook3 000.com sam1 129 0_ch10.indd 21 0 2/ 3/09 6 :22 :28 PM CHAPTER 11 Economics of Uncertainty Pearls lie not on the seashore