Principles of Microeconomics Betsey Stevenson University of Michigan Justin Wolfers University of Michigan Senior Vice President, Content Strategy: Charles Linsmeier Program Director: Shani Fisher Senior Executive Program Manager: Simon Glick Senior Development Editors: Ann Kirby-Payne and Lukia Kliossis Marketing Manager: Andrew Zierman Market Development Manager: Stephanie Ellis Director of Media Editorial and Assessment: Noel Hohnstine Assessment Manager: Kristyn Brown Senior Assessment Editor: Joshua Hill Senior Media Editor: Lindsay Neff Assistant Editor: Amanda Gaglione Director, Content Management Enhancement: Tracey Kuehn Senior Managing Editor: Lisa Kinne Senior Content Project Manager: Martha Emry Director of Design, Content Management: Diana Blume Design Services Manager: Natasha A S Wolfe Interior Design: Kevin Kall and Dirk Kaufman Cover Design: Dirk Kaufman Illustrations: Network Graphics Art Manager: Matthew McAdams Illustration Coordinator: Janice Donnola Executive Permissions Editor: Robin Fadool Photo Researcher: Richard Fox, Lumina Datamatics, Inc Senior Workflow Project Supervisor: Susan Wein Production Supervisor: Lawrence Guerra Media Project Manager: Andrew Vaccaro Composition: Lumina Datamatics, Inc Cover Images: Shutterstock ISBN 978-1-319-25289-2 (ePub) Library of Congress Control Number: 2019938339 © 2020 by Worth Publishers All rights reserved 1 2 3 4 5 6 23 22 21 20 19 Worth Publishers One New York Plaza Suite 4600 New York, NY 10004-1562 www.macmillanlearning.com Dedication With thanks to those in previous generations who inspired, educated, and raised us In awe of those in the next generation—you are better, faster, and smarter And with inspiration from introductory students who are about to learn that economics will give you superpowers—our hope is that you’ll use those superpowers to create a more joyful world www.freebookslides.com About the Authors Betsey Stevenson is a professor of economics and public policy at the University of Michigan Her research focuses on the impact of public policies on the labor market, and explores women’s labor market experiences, the economic forces shaping the modern family, and the role of subjective well-being data for public policy She serves on the Executive Committee of the American Economic Association, and is also a research associate with the National Bureau of Economic Research, a fellow of the Institute for Economic Research in Munich, a visiting associate professor of economics at the University of Sydney, and a research Fellow with the Centre for Economic Policy Research in London She served as a member of the Council of Economic Advisers from 2013 to 2015, where she advised President Obama on social policy, labor market, and trade issues She also served as the chief economist of the U.S Department of Labor from 2010 to 2011 Betsey is an occasional editorialist for Bloomberg, and a trusted presence in the public debate about economics and public policy She earned a BA in economics and mathematics from Wellesley College and an AM and PhD in economics from Harvard University www.freebookslides.com Justin Wolfers is a professor of economics and public policy at the University of Michigan He has research in both macroeconomics and applied microeconomics topics, having explored unemployment and inflation, the power of prediction markets, the economic forces shaping the modern family, discrimination, and happiness He is a research associate with the National Bureau for Economic Research, a fellow of the Brookings Institution, a fellow of the Peterson Institute for International Economics, a research fellow with the Centre for Economic Policy Research in London, a fellow of the Institute for Economic Research in Munich, a visiting professor of economics at the University of Sydney, and an international research fellow at the Kiel Institute for the World Economy in Germany He has been an editor of the Brookings Papers on Economic Activity, a board member on the Committee on the Status of Women in Economics, a member of the Panel of Advisors of the U.S Congressional Budget Office, among many other board and advisory positions He is currently a contributing columnist for the New York Times, and has written about economic issues in numerous other outlets He is frequently quoted in the media on economic policy and relied upon to provide unbiased assessments of the current state of the macroeconomy Justin earned a BA in economics from the University of Sydney and an AM and PhD in economics from Harvard University One of them was once described by Jezebel.com as the “hippest-economist-ever.” The other was not Betsey and Justin live in Ann Arbor, Michigan, with their children Matilda and Oliver and their lovable mutt, Max They’re thinking of getting a cat www.freebookslides.com A Fresh Perspective on Economics A slow-motion revolution has transformed economics We’ve moved beyond the widget factory—the standardized set of business interactions involving inputs, outputs, and pricing decisions—toward a social science that can speak to the decisions we make in every aspect of our lives Successive cohorts of economists have transformed the field so that it has greater relevance and a closer relationship to actual human behavior, making it more meaningful to more people This is no longer your parents’ economics This transformation presents a once-in-a-generation teaching opportunity More than ever before, we have the capacity to deliver a compelling introductory economics class that will deliver an extraordinary return on our students’ investment in the field This opportunity requires a textbook that works with instructors to showcase how economics has become broader, and we show that it is more relevant to a larger, more diverse population of students It has to show that economics has become more useful for the ordinary business of life, and our students delight in seeing the relevance of economic tools to the real-world decisions they face We believe that by focusing on intuition, we can reorient students to seeing themselves as economic actors poised to apply the lessons they’re learning throughout their lives Our fresh perspective gives us an opportunity to write in a voice that students actually want to read If you’ve ever had the pleasure of reading one of those popular economics books that takes readers on a joyous romp through our field, you quickly understand why millions of people spend their weekends reading them Podcast rankings and best-seller lists reveal a latent demand for an approach that supplies some of the same magic We aim to bring that sense of delight and discovery to your introductory economics class Economics can provide students with a toolkit of extraordinary breadth, usefulness, and insight It’s a toolkit they can use to better understand and navigate their world, empowering them to make better decisions in the many different roles they’ll play in the economy, their communities, and their careers—indeed, in every aspect of their lives For economics instructors, the opportunity is larger still, giving us the capacity to transform www.freebookslides.com measuring responsiveness of, 110–113 minimum wage and, 112–113 opportunity cost principle and, 113–114 revenue and, 118–120 Price elasticity of supply, 125–130 calculating, 129–130 determinants of, 127–129 of labor supply, wages and, 282–283 measuring responsiveness of supply and, 125–127 Price floors, 149–151 binding, 149, 150–151 Price gouging, laws prohibiting, 148 Price regulations See also Price ceilings; Price floors quantity regulations compared with, 154 Price setting, 350–357 in competitive markets, 66 cost-benefit principle and, 355 firm’s demand curve and, 351–353 of group prices, 432–434 marginal revenue curve and, 353–354 Rational Rule for Sellers and, 354–357 Price-takers, 66, 214, 346 See also Perfect competition Pricing strategies, 425–442 demand elasticity and, 120–122 group pricing as See Group pricing hurdle method as See Hurdle method in imperfect competition, 349 price discrimination as See Price discrimination Principal-agent problem, 520–521 Prison, phone calls in, 363–364 Prisoner’s Dilemma, 448–453 collusion and, 464–465 examples of, 452–453 failure of cooperation and, 450–452 Nash equilibrium and, 450 tragedy of the commons and, 453 Private bargaining, to solve externalities, 252 Private benefit, marginal, 243 Private cost, marginal, 242 Private information, 506–525 www.freebookslides.com decisions involving See Adverse selection; Moral hazard market failure and, 173–174 Private interest, society’s interest vs., 242–243 Probability assessment cost-benefit principle and, 495 problems with, 495–497 Producer surplus, 165–166 foreign competition and, 217 Product differentiation, 347, 402–404 market power and, 349, 403 methods of, 403–404 Product positioning away from rival, 407 interdependence principle and, 407 next to rival, 406 product type and, 405 Production costs of See Costs of production deadweight loss and, 174–176 efficient, 169–170, 177 negative externalities and, 246–247, 248–249 under production problem and, 360–361 Production possibility frontier, opportunity cost principle and, 18–19 Productivity education and, 296–297, 298 gains in, production possibility frontier shifts and, 19 labor demand and, 276–277 shift in the supply curve and, 76 unions and, 303 wages and, 231 Profit See Accounting profit; Economic profit Profit margin, 375–376 product positioning and, 408 Profit maximization, Rational Rule for Sellers and, 69 Profitability buyers and, 401 existing competitors and, 398, 399–400 Five Forces framework and, 398–402 long-term, market structure and, 398–399 of marginal firm, average cost and, 382–383 www.freebookslides.com marginal principle and, 383 potential competitors and, 398, 400 potential substitutes and, 400–401 suppliers and, 401 Progressive, 516 Progressive taxes, 326, 330, 331, 490 Prune the tree method, 461–462 Public goods, 259 facts about, 260 government support for, 259–261 provided by communities, 260 turning into club goods, 260–261 Public policies evaluating, 160–161 to restrain market power, 361–364 as solution to adverse selection, 511–512, 517 as solution to moral hazard problems, 523 Publishing industry, 101 Punishment, cooperation and, 467–468 Q Quaker, 173 Quality hidden, adverse selection and See Adverse selection product differentiation on, 403 Quantity to buy, choosing, core principles and, 41, 42 decisions about See Marginal principle efficient, 171–173, 177 equilibrium, 88 midpoint formula for calculating changes in, 117 smaller, due to market power, 358–359 surplus-maximizing, 172 Quantity demanded, change in, 47 Quantity discounts, 439–440 Quantity regulations, 151–154 mandates as, 151 price regulations compared with, 154 www.freebookslides.com quotas as, 151–154 Quantity sold decline in, taxes and, 137 increase by price discrimination, 427 product positioning and, 408 tax on buyers and, 138 Quantity supplied change in, 74 elasticity of supply and, 126–127 Quintiles, 318 Quotas, 151–154 import, 229 to solve externalities, 255 R Rational Rule, 21 applying, 24–25 marginal principle and, 21–25 maximizing economic surplus using, 21–24 Rational Rule for Buyers, 41–43, 44, 164 economic surplus and, 42 failure to follow, 174 individual demand and, 41–43 Rational Rule for Employers, 272–275 Rational Rule for Entry, 377, 379, 380 Rational Rule for Exit, 378, 379, 380 Rational Rule for Markets, 171 core principles and, 171 finding, 174–175 Rational Rule for Sellers, 355 deciding on quantity to produce and, 432 failure to follow, 174 price setting and, 354–357, 358 Rational Rule for Sellers in Competitive Markets, 68–70, 71–72 producer surplus and, 165–166 Rational Rule for Society, 244–245, 246, 248 Rational Rule for Workers, 280–283 Reasoning backward, in games, 461, 465 www.freebookslides.com Regressive taxes, 331 Regulation(s) as barriers to entry, 387–388, 390 as coordination problem solution, 458 international trade and, 224 lobbying and, 388 market failure and, 174 minimum wage and, 301–302 overcoming, 391 price See Price ceilings; Price floors quantity See Quantity regulations to solve externalities, 257 REI, 312 Relationship(s) coordination games and, 455 moral hazard in, 520–521 with suppliers, as barrier to entry, 386 Relationship-specific investments, hold-up problem and, 414–415 Relative poverty, 323–324 Reliability, product differentiation on, 403 Repeated games, 465 Representativeness bias, 496–497 Reputation, as barrier to entry, 384, 389 Resale, prevention of, price discrimination and, 430–431 Reservation price, 427 Resources allocation of, comparative advantage and See Comparative advantage common, 261–262 financial, as barrier to entry, 389 limited, interdependency principle and, 26–27 Restaurants, hygiene grade cards for, 522 Revenue average, 374–375 marginal See Marginal revenue total, demand elasticity and, 118–120 Risk(s), 478–479 components of, 478 fair bets and, 478–479 systematic, 489 underestimation of, 494–495 www.freebookslides.com Risk aversion, 478–485 cost-benefit principle and, 480, 482, 483 diminishing marginal utility and, 479–480 expected utility and, 483–485 risk-reward trade-off and, 480–483 Risk-loving, 484–485 Risk neutrality, 486 Risk reduction, 485–493 by diversification, 487–489 by gathering information, 491–493 insurance for, 489–490 by offsetting risks, 490–491 by risk spreading, 485–487 Risk spreading, 485–487 Rival(s) See Competitors Rival goods, 259 tragedy of the commons and, 261 Robots, worker replacement by, 277–279 Roomba, 192, 194, 400 Rouse, Cecilia, 307 Rules, to solve externalities, 257–258 S Safelite AutoGlass, 310, 312 Sam’s Club, 440 Samsung, 345 market share of, 371 SAS Institute, benefits at, 312 Saudi Arabia, comparative advantage of, 211 Saving, income inequality and, 320 Scale effect, price of capital and labor demand and, 276 Scarcity, 12 core principles and, 12–13, 26–27 opportunity costs and, 12–13 Schultz, Howard, 121 Search goods, informational advertising and, 409 Second-mover advantage, first-mover advantage vs., 463 Secondhand market, 400 www.freebookslides.com Selective discounts, 428, 429 Sellers adverse selection of See Adverse selection of sellers bargaining power of See Bargaining power benefit from exchange, economic burden of taxes borne by, 141 market power exploitation by, 358 Rational Rule for Sellers and, 354–357, 358 taxes on, 136–138 type and number of, shift in the supply curve and, 77 Seqirus, 248 Service, poor, as hurdle, 439 Shareholders, funding corporations and, 486–487 Shell, competition of, 404 Shift in the demand curve, 48–52 equilibrium and, 92–94 interdependence principle and, 47–52, 54 for labor, 275–277 movement along the demand curve vs., 53–54 simultaneous shift in the supply curve and, 98–101 Shift in the labor supply curve, 286–287 Shift in the supply curve, 74–78 equilibrium and, 94–95 interdependence principle and, 74–78, 79 for labor, 286–287 movement along the supply curve vs., 78–79 simultaneous shift in the demand curve and, 98–101 taxes on sellers and, 136–137 Short run, 376 Shortages, 90 of kidney donors, 148–149 price ceilings causing, 146–147, 148 rise in prices due to, 90 Side payments, to solve externalities, 250–251 Signals, 297 education as, 297, 298 interests as, 297–298 prices as, 196 of product’s quality, 510–511 Skin in the game, as solution to moral hazard problems, 522–523 www.freebookslides.com Smart parking meters, 91–92 Smith, Adam, 173 Snapchat, 51 Social benefit, marginal, 243 Social cost, marginal, 242–243 Social insurance, 328–330 See also Medicaid; Medicare; Social Security taxes funding, 331 Social norms, as solution to moral hazard problems, 523 Social pressure, shift in the demand curve and, 50 Social recognition, to solve externalities, 254 Social safety net, 328–330 See also Medicare Social sanctions, to solve externalities, 254 Social Security, 329–330 statutory burden of, 140 Social spending, differences in, 338 Socially optimal outcome, 244 Someone else’s shoes technique, 29–30 Sony, 430 South Korea, economy of, 198–199 Southwest Airlines competitors’ fares and, 383 elasticity of demand for flights and, 114 hedging of fuel costs by, 490 market analysis by, 109 pricing strategy of, 121 Soviet Union, North Korea and, 198 Spanx, 269 Specialization, comparative advantage and, 190, 192–193 Spending inequality in, 320 social, differences in, 337–338 Sports-betting markets, 198 Sprint, 347 Staples.com, 432 Starbucks business strategy of, 397, 418–420 competition of, 400 elasticity and, 121 employee stock options at, 491 Starz, 437 www.freebookslides.com State Farm, 516 Statistical discrimination, 307–308 Statutory burden, 137 of Social Security, 140 tax incidence and, 139–140 of tax on sellers, 137 Stock diversification of investment in, 487–489 employee options to buy, 491 index funds and, 488 Strategic interactions, 446–448 See also Game theory Strategic investments, to solve externalities, 251 Strategic plans, 466 Style, product differentiation on, 403 Subsidies, 143–145 for child care, 144 corrective, to solve externalities, 254 on insurance, 517 labor demand and, 277 labor supply and, 287 Substitute goods (substitutes), 50 cross-price elasticity of demand and, 122–124 interdependence principle and, 400 potential, profitability and, 400–401 price elasticity of demand and, 114, 116 prices of, shift in the demand curve and, 50 Substitutes-in-production, 76 labor and capital as, 276 prices of, shift in the supply curve and, 76 Substitution effect, 280 labor demand and, 280, 281–282 price of capital and labor demand and, 276 Subway, 409 Sunk costs, 16 opportunity cost principle and, 16 Superstars, 299 Supplemental Security Income, 327, 328 Suppliers bargaining power of, profitability and, 401 prices as signals to, 196 www.freebookslides.com relationships with, as barrier to entry, 386 Supply, 61–82 decrease in, 75 elastic, quantity supplied and, 126, 127 elasticity of See Elasticity of supply; Price elasticity of supply equal to demand, at equilibrium, 88–90 increase in, 75 individual See Individual supply; Individual supply curve inelastic, quantity supplied and, 126, 127 of labor See Labor supply; Labor supply curve law of, 65 market See Market supply parallels between demand and, 80 price elasticity of See Price elasticity of supply world, 213–214 Supply curve domestic, 214 individual See Individual supply curve for labor See Labor supply curve market See Market supply curve movement along See Movement along the supply curve shift in See Shift in the supply curve Supply decisions, core principles and, 67–68 Supply-side strategies as barriers to entry, 385–387, 390 overcoming, 390–391 for product positioning, 408 Surpluses, 90 fall in prices due to, 90–91 price floors and, 150–151 quantity maximizing, 172 Switching costs, as barrier to entry, 384, 400 Switzerland, comparative advantage of, 212 Systematic risk, 489 T T-Mobile, 347 Target www.freebookslides.com income and purchases at, 49 pricing strategy of, 463 product differentiation by, 403 Tariffs, 227–228 TaskRabbit, 193 Tax(es), 136–143 on buyers, 138–139 corrective, to solve externalities, 252–254 evaluating, 142–143 fraud and, 335 funding social insurance, 331 income, 330–331 interdependence principle and, 136, 138 labor demand and, 277 labor supply and, 287 progressive, 328, 330, 331, 490 reduction of incentive to work and, 334 regressive, 331 on sellers, 136–138 tariffs as, 227–228 in United States, 330–331 Tax avoidance, 334–335 Tax evasion, 335 Tax incidence, 138 economic burden and, 140–141 statutory burden and, 139–140 Tax rate, marginal, effective, 334 Taxis fare setting for, 148 quotas on, 151–152 Uber See Uber Technology coordination games and, 454–455 shift in the supply curve and, 76 worker replacement by robots and, 277–279 Temporary Assistance for Needy Families (TANF), 327 Terrorist attacks of 9/11, Manhattan office space market and, 102 Tesla, 390–391 Thaler, Richard, 493 Third-party verifiers, as solution to adverse selection, 510 www.freebookslides.com Tiffany, 509 Time See also Long run; Short run elasticity of supply and, 129 increase in elasticity of demand over, 116 interdependency principle and, 28 Total revenue, demand elasticity and, 118–120 Toyota, 416 barriers to entry and, 387 network effects and, 385 Tradable emissions permits See Cap and trade Trade See Gains from trade; International trade Trade costs, 209–210 Trade-offs, 12 See also Opportunity cost(s); Opportunity cost principle demand-side vs supply-side, in product positioning, 404, 408 equality-efficiency, 335–336 in price setting, 350–351 risk-reward, 480–483 Trade policy, 226–230 current, 229–230 tools of, 227–229 Tragedy of the commons, 261–262 Prisoner’s Dilemma and, 451 TripAdvisor, 510 Trump, Donald, 229, 230 TurboTax, 400, 401 U Uber changes brought by, 159 economic surplus and, 161 surge pricing by, 51, 125–126, 130, 148 taxi quotas and, 151–152, 153 Ugg, 50 Uncertainty, 477–501 See also Risk(s); Risk aversion; Risk reduction overconfidence and, 494–495 problems assessing probability and, 495–497 problems evaluating payoffs and, 497–498 Under production problem, 360–361 www.freebookslides.com Unemployment insurance, 329 Unions productivity and, 303 wages and, 303 United Airlines, 128, 362, 383 United States comparative advantage of, 211–212 income inequality in, 231–232, 319 intergenerational mobility in, 321 manufacturing wages in, 231 poverty in, 322–324, 325–326 social safety net in, 328–330 social spending in, 337–338 South Korea and, 198 taxes in, 330–331 trade agreements of, 210–211, 230 trade policy of, 229–230 US Airways, merger with American, 362, 387 U.S Consumer Product Safety Commission, 512 U.S Department of Agriculture, 511 U.S News & World Report, 510 U.S Postal Service, 400–401 University of California system, 436 University of Southern California, 426 Used cars, adverse selection and, 506–508 USMCA, 230 Usury laws, 148 Utilitarianism, 333 Utility, 332, 479 expected, 483–485 income redistribution and, 332–333 marginal, 332 marginal, diminishing, 479–480 V Variable costs, 68 Variable inputs, elasticity of supply and, 128 Verifiable characteristics, market segmentation based on, 435 www.freebookslides.com Verizon, 347 Vertical integration, 416–417 Visa, 409 Voluntary exchange, 166–167 gains from trade and, 167 von Tobel, Alexa, 337, 338 W Wages, 301–308 See also Earnings; Income capital investment and, 277 compensating differentials and, 300–301 discrimination and, 304–308 efficiency, 298–299 gender wage gap and, 305–306 government regulations and, 301–302 labor demand and, 272 labor supply and, 284, 286 licensing and, 302 minimum, 301–302, 304 monopsony and, 303–304 price elasticity of labor supply and, 282–283 productivity and, 231 unions and, 303 Walmart, 403, 488 economic profits of, 383 food donations of, 199 income and purchases at, 49 price matching by, 463 relationships with suppliers, 386 Walmart Supercenters, 114 Waters, Alice, 191 Wealth, 322 growth of, diminishing marginal utility and, 479–480 inequality of, 320 WeChat, 51 Wegmans, benefits at, 312 Welfare, 327, 328 efficiency and equity and, 161 www.freebookslides.com Well-being See Utility Wells Fargo, 523 What else” questions, interdependence principle and, 28 WhatsApp, 385 Willingness to pay, demand decisions and, 36–43 economic efficiency and, 178 quantifying costs and benefits using, Winfrey, Oprah, 495 Wirecutter, 510 Workers attracting, 312–313 intrinsic and extrinsic motivation of, 311 motivating, 309–311 number of, labor supply and, 286 skills of, 309 Workers’ compensation, 329 World market, 213–214 World price, 213–214 World Trade Organization (WTO), 230 Y Yahoo!, 257 Yelp, 164, 510 YKK, 347, 348 YouTube, 164 Z Zany Brainy, 352 Zuckerberg, Mark, 495 ... Principles of Microeconomics Betsey Stevenson University of Michigan Justin Wolfers University of Michigan Senior Vice President, Content Strategy:... www.freebookslides.com About the Authors Betsey Stevenson is a professor of economics and public policy at the University of Michigan Her research focuses on the impact of public policies on the labor market,... Activity, a board member on the Committee on the Status of Women in Economics, a member of the Panel of Advisors of the U.S Congressional Budget Office, among many other board and advisory positions