1 PRELIMINARIES 3
PART I Introduction: Markets and Prices 3
1.1 The Use and Limitations of Microeconomic Theory 4
1.2 Positive Versus Normative Analysis 5
LIST OF EXAPLES 6
1.1 Unemployment and the Labor Force Participation of Women 6
Corporate Decision Making: Ford Introduces the Taurus 8
1.3 Why Study Microeconomics? 8
Public Policy Design: Automobile Emission Standards 9
1.4 What Is a Market? 10
ComPetitive Versus Noncompetitive Markets 11
Market Price 11
The Extent of a Market 12
1.5 Real Versus Nominal Prices 13
1.2 The Price of Eggs and the Price of a College Education 14
2 THE BASICS OF SUPPLY AND DEMAND 17
2.1 The Market Mechanism 18
2.2 Shifts in Supply and Demand 20
2.1 The Price of Eggs and the Price of a College Education 24
2.2 The Long-Run Behavior of Mineral Prices 25
2.3 The Market for Wheat 27
2.3 Elasticities of Supply and Demand 28
Demand 32
2.4 Short-Run Versus Long-Run Elasticities 32
2.4 The Demands for Gasoline and Automobiles 36
Supply 37
2.5 The Weather in Brazil and the Price of Coffee in New York 39
*2.5 Understanding and Predicting the Effects of Changing Market Conditions 41
2.6 Declining Demand and the Behavior of Copper Prices 45
2.7 The World Oil Market on the Back of an Envelope 46
2.6 Effects of Government Intervention-Price Controls 49
2.8 Price Controls and the Natural Gas Shortage 50
PART II Producers, Consumers, and Competitive Markets 58
3 CONSUMER BEHAVIOR 58
3.1 Consumer Preferences 58
Some Basic Assumptions 59
Indifference Curves 59
Ordinal Versus Cardinal Rankings 63
The Marginal Rate of Substitution 64
Perfect Substitutes and Perfect Complements 66
3.1 Designing New Automobiles 67
3.2 Budget Constraints 69
The Budget Line 69
The Effects of Changes in Income and Prices 71
3.3 Consumer Choice 73
3.2 Designing New Automobiles 75
3.3 The Decision Making of a Local Public Official 77
A Corner Solution 79
3.4 A College Trust Fund 80
3.4 Revealed Preference 81
3.5 Revealed Preference for Recreation 84
3.5 The Concept of Utility 85
Utility and Satisfaction 85
Marginal Utility 87
3.6 Gasoline Rationing 88
4 INDMUAL AND MARKET DEMAND 93
4.1 Individual Demand 93
Price Changes 94
The Demand Curve 95
Income Changes 96
Engel Curves 99
4.1 Consumer Expenditures in the United States 100
SubstituteS and Complements 100
4.2 Income and Substitution Effects 101
Substitution Effect 103
A Special Case-The Giffen Good 104
Income Effect 104
4.2 The Effects of a Gasoline Tax 105
From Individual to Market Demand 107
4.3 Market Demand 107
Point and Arc Elasticities Of Demand 109
4.3 The Aggregate Demand for Wheat 111
4.4 The Demand for Housing 112
4.4 Consumer Surplus 113
4.5 The Value of Clean Air 116
4.5 NetWork Externalities 118
The Bandwagon Effect 118
The Snob Effect 120
4.6 Network Externalities and the Demands for Computers and Fax Machines 121
*4.6 Empirical Estimation of Demand 122
The Statistical Approach to Demand Estimation 123
Interview and Experimental Approaches to Demand Determination 123
The Form of the Demand Relationship 125
Utility Maximization 130
Appendix to 4 Demand Theory-A Mathematical Treatment 130
Marginal Rate of Substitution 131
The Consumer's Optimum 131
An Example 132
Marginal Utility of Income 133
Duality in Consumer Theory 134
Income and Substitution Effects 135
5 CHOICE UNDER UNCERTAINTY 138
5.1 Describing Risk 139
Probability 139
Expected Value 140
Variability 140
Decision Making 143
5.2 Preferences Toward Risk 144
Different Preferences Toward Risk 146
5.1 Business Executives and the Choice of Risk 148
5.2 Deterring Crime 149
Diversification 150
5.3 Reducing Risk 150
Insurance 151
5.3 The Value of Title Insurance When Buying a Home 153
The Value of Information 154
*5.4 The Demand for Risky Assets 155
5.4 The Value of Information in the Dairy Industry 155
Assets 156
Asset Returns 157
The Trade-off Between Risk and Return 158
The Investor's Choice Problem 159
6 PRODUCTION 167
6.1 The Technology of Production 167
6.2 lsoquants 168
6.3 Production with One Variable Input (Labor) 170
The Short Run Versus the Long Run 170
Averaage and Marginal Products 171
The Law of Diminishing Returns 174
6.1 Malthus and the Food Crisis 176
Labor Productivity 177
6.2 Will the Standard of Living in the United States Improve? 179
Diminishing Returns 180
Substitution Among Inputs 181
Production Functions-Two Special Cases 183
6.3 A Production Function for Wheat 185
6.5 Returns to Scale 187
6.4 Returns to Scale in the Rail Industry 189
7 THE COST OF PRODUCTION 194
7.1 Measuring Cost: Which Costs Matter? 194
Economic Cos Versus Accounting Cost 194
Sunk Costs 195
7.2 The Opportunity Cost of Waiting in a Gasoline Line 196
7.1 Choosing the Location for a New Law School Building 196
7.2 Cost in the Short Run 198
The Determinants of Short-Run Cost 199
The Shapes of the Cost Curves 201
The Cost-Minimizing Input Choice 204
The Isocost Line 204
7.3 Costs in the Long Run 204
Choosing Inputs 205
7.3 The Effect of Effluent Fees on Firms' Input Choices 207
COst Minimization with Varying Output Levels 209
7.4 Long-Run Versus Short-Run Cost Curves 210
The Inflexibility of Short-Run Production 210
Long-Run Average Cost 211
Economies and Diseconomies of Scale 212
The Relationship Between Short-Run and Long-Run Cost 213
7.5 Production with Two Outputs-Economies of Scope 216
7.4 Economies of Scope in the Trucking Industry 218
*7.6 Dynamic Changes in Cost-The Learning Curve 219
7.5 The Learning Curve in the Chemical Processing Industry 223
*7.7 Estmating and Predicting Cost 224
Cost Functions and the Measurement of Scale Economies 227
7.6 Cost Functions for Electric Power 227
7.7 A Cost Function for the Savings and Loan Industry 229
Appendix to 7 Production and Cost Theory-A Mathematical Treatment 233
COst Minimization 233
Marginal Rate of Technical Substitution 234
Duality in Production and Cost Theory 235
The Cobb-Douglas Cost and Production functions 236
8 PROFIT WAXIMIZATION AND COMPETITIVE SUPPLY 238
8.1 Profit Maximization 239
Do Firms Maximize Profit? 239
8.2 Marginal Revenue, Marginal Cost, and Profit Maximization 240
Demand and Marginal Revenue for a Competitive Firm 241
Short-Run Profit Maximization by a Competitive Firm 243
8.3 Choosing Output in the Short Run 243
Profit Maximization by a Competitive Firm 243
The Short-Run Profitability of a Competitive Firm 245
8.1 Some Cost Considerations for Managers 246
8.4 The Competitive Firm's Short-Run Supply Curve 248
The Firm's Response to an Input Price Change 249
8.2 The Short-Run Production of Petroleum Products 250
8.5 The Short-Run Market Supply Curve 251
8.3 The Short-Run World Supply of Copper 253
Elasticity of Market Supply 253
Producer Surplus in the Short Run 255
8.6 Choosing Output in the Long Run 256
Zero Profit 258
Long-Run Competitive Equilibrium 259
Economic Rent 261
Producer Surplus in the Long Run 262
8.7 The Industry's Long-Run Supply Curve 263
Constant-Cost Industry 264
Increasing-Cost Industry 265
The Short-Run and Long-Run Effects of a Tax 267
Decreasing-Cost Industry 267
8.4 The Long-Run Supply of Housing 270
Long-Run Elasticity of Supply 270
8.8 When Is a Market Perfectly Competitive? 271
Contestable Markets 272
9 THE ANLYSIS OF COMPETITIVE MARKETS 276
9.1 Evaluating the Gains and Losses from Government Policies--Consumer and Producer Surplus 277
Review of Consumer and Producer Surplus 277
Application of Consumer and Producer Surplus 279
9.1 Price Controls and the Natural Gas Shortage 281
9.2 The Efficiency of a Competitive Market 283
9.2 The Market for Human Kidneys 285
9.3 Minimum Prices 288
9.3 Airline RegUlation 290
9.4 Price Supports and Production Quotas 292
Price Supports 293
Production Quotas 294
9.4 Supporting the Price of Wheat 296
9.5 Import Quotas and Tariffs 300
9.5 The Sugar Quota 303
9.6 The Impact of a Tax or Subsidy 305
9.6 A Tax on Gasoline 310
10 MARKET POWER: MONOPOLY AND MONOPSONY 319
PART III Market Structure and Competitive Strategy 319
10.1 Monopoly 320
Average Revenue and Marginal Revenue 321
The Monopolist's Output Decision 322
An Example 324
A Rule of Thumb for Pricing 326
Shifts in Demand 327
The Effect of a Tax 328
*The Multiplant Firm 330
10.2 Monopoly Power 332
Measuring Monopoly Power 333
The Rule of Thumb for Pricing 334
10.1 Markup Pricing: Supermarkets to Designer Jeans 335
10.2 The Pricing of Prerecorded Videocassettes 336
10.3 Sources of Monopoly Power 337
The Number of firms 338
The Elasticity of Market Demand 338
The Interaction Among Firms 339
10.4 The Social Costs of Monopoly Power 340
Price Regulation 341
Regulation in Practice 344
10.5 Monopsony 345
Monopsony and Monopoly Compared 348
10.6 Monopsony Power 349
Sources of Monopsony Power 350
The Social Costs of MonoPsony POwer 350
10.3 Monopsony Power in U.S. Manufacturing 352
Bilateral Monopoly 352
10.7 Limiting Market Power: The Antitrust Laws 353
Enforcement of the Antitrust Laws 355
10.4 A Phone Call About Prices 356
11 PRICING WITH MARKET POWER 361
11.1 CaptUring Consumer Surplus 362
11.2 Price Discrimination 364
First-Degree price Discrimination 364
Second-Degree Price Discrimination 366
Third-Degree Price Discrimination 368
11.1 The Economics of Coupons and Rebates 372
11.2 How to Set Airline Fares 374
11.3 Intertemporal Price Discrimination and Peak-Load Pricing 375
11.3 How to Price a Best-Selling Novel 378
11.4 The Two-Part Tariff 379
11.4 Polaroid Cameras 383
*11.5 Bundling 384
Mixed Bundling 389
11.5 The Complete Dinner vs. a la Carte: A Restaurant's Pricing Problem 391
Tying 392
*11.6 Advertising 392
A Rule of Thumb for Advertising 395
11.6 Advertising: Supermarkets to Designer Jeans 396
Transfer Pricing When There Is No Outside Market 402
Appendix to 11 Transfer Pricing in the Integrated Firm 402
Transfer Pricing with a Competitive Outside Market 405
A Numerical Example 408
Transfer Pricing with a Noncompetitive Outside Market 408
12 MONOPOLISTIC COMPETITION AND OLIGOPOLY 413
12.1 Monopolistic Competition 414
The Makings of Monopolistic Competition 414
Equilibrium in the Short Run and the Long Run 415
MonoPoliStic Competition and Economic Efficiency 416
12.1 Monopolistic Competition in the Markets for Colas and Coffee 418
12.2 Oligopoly 419
Equilibrium in an Oligopolistic Market 420
The Cournot Model 421
Example: A Linear Demand Curve 424
12.3 First Mover Advantage-The Stackelberg Model 427
Price Competition with Homogeneous Products-The Bertrand Model 428
12.4 Price Competition 428
Price Competition with Differtiated Products 430
12.2 A Pricing Problem for Procter Gamble 432
12.5 Competition Versus Collusion: The Prisoners' Dilemma 433
12.3 Procter Gamble in a Prisoners' Dilemma 436
12.6 Implications of the Prisoners' Dilemma for Oligopolistic Pricing 437
Price Rigidity 438
Price Signaling and Price Leadership 439
12.4 Price Leadership and Price Rigidity in Commercial Banking 440
The Dominant Firm Model 442
12.7 Cartels 444
The Analysis of Cartel Pricing 445
12.5 The Cartelization of Intercollegiate Athletics 447
13 GAME THEORY AND COMPETITIVE STRATEGY 453
Noncooperative Versus Cooperative Games 454
13.1 Gaming and Strategic Decisions 454
13.1 Acquiring a Company 455
13.2 Dominant Strategies 456
13.3 The Nash Equilibrium Revisited 458
Maxim in Strategies 460
*Mixed Strategies 461
13.4 Repeated Games 463
13.2 Oligopolistic Cooperation in the Water Meter Industry 467
13.3 Competition and Collusion in the Airline Industry 468
13.5 Sequential Games 469
The Advantage of Moving First 470
The Extensive Form OF a Game 470
13.6 Threats, Commitments, and Credibility 472
Commitment and Credibility 473
Empty Threats 473
13.4 Wal-Mart Stores' Investment Strategy 475
13.7 Entry Deterrence 477
Strategic Trade Policy and International Competition 479
13.5 Du Pont Deters Entry in Titanium Dioxide Industry 481
13.6 Diaper Wars 482
13.8 Bargaining Strategy 484
14 MARKETS FOR FACTOR INPUTS 491
14.1 Competitive Factor Markets 491
Demand fOr a Factor Input When Only One Input Is Variable 492
Demand for a Factor Input When Sereral Inputs Are Variable 495
The market Demand Curve 496
14.1 The Demand for Jet Fuel 498
The Supply of Inputs to a Firm 500
The Market Supply of Inputs 502
14.2 Labor Supply for One-and Two-Earner Households 504
14.2 Equilibrium in a Competitive Factor Market 506
Economic Rent 507
14.3 Pay in the Military 509
14.3 Factor Markets with Monopsony Power 511
Marginal and Average Expenditure 511
The Input PurChasing Decision of the Firm 512
14.4 Monopsony Power in the Market for Baseball Players 513
14.4 Factor Markets with Monopoly Power 514
Monopoly Power over the Wage Rate 514
A Two-Sector Model of Labor Employment 516
Bilateral Monopoly in the Labor Market 517
14.5 The Decline of Private Sector Unionism 518
15 INVESTMENT, TIME, AND CAPITAL MARKETS 522
15.1 Stocks Versus Flows 523
15.2 Present Discounted Value 524
Valuing payment Streams 525
15.1 The Value of Lost Earnings 526
15.3 The Value of a Bond 528
Perpetuities 529
The Effective Yield on a Bond 529
15.2 The Yields on Corporate Bonds 531
15.4 The Net Present Value Criterion for Capital Investment Decisions 532
The Electric Motor Factory 533
Real Versus Nominal Discount Rates 534
Negative Future Cash flows 535
15.5 Adjustments for Risk 536
Diversifiable Versus Nondiversifiable Risk 536
The Capital Asset Pricing Model 538
15.3 Capital Investment in the Disposable Diaper Industry 539
15.6 Investment Decisions by Consumers 541
15.4 Choosing an Air Conditioner 542
*15.7 Intertemporal Production Decisions-Depletable Resources 543
The ProductiOn Decision of an Individual Resource Producer 543
The Behavior of Market Price 544
User Cost 545
Resource Production by a Monopolist 546
15.5 How Depletable Are Depletable Resources? 546
15.8 How Are Interest Rates Determined? 548
A Variety of Interest Rates 549
16 GENERAL EQUILIBRIUM AND ECONOMIC EFFICIENCY 557
Two Interdependent Markets-Moving to General Equilibrium 558
16.1 General Equilibrium Analysis 558
The Attainment of General Equilibrium 560
16.1 The Interdependence of International Markets 561
16.2 Efficiency in Exchange 562
The Advantages of Trade 563
The Edgeworth Box Diagram 564
Efficient Allocations 564
The Contract Curve 566
Consumer Equilibrium in a Competitive Market 568
16.3 Equity and Efficiency 570
The Utility Possibilities Frontier 571
Equity and Perfect Competition 573
16.4 Efficiency in Production 573
Production in the Edgeworth Box 574
Input Efficiency 575
Producer Equilibrium in a Competitive Input Market 576
The Production Possibilities Frontier 577
Output Efficiency 579
Efficiency in Output Markets 580
Comparative Advantage 582
16.5 The Gains from Free Trade 582
An Expanded Production Possibilities Frontier 583
16.2 The Effects of Automobile Import Quotas 585
16.3 The Costs and Benefits of Special Protection 586
16.6 An Overview--The Efficiency of Competitive Markets 587
16.7 Why Markets Fail 588
Incomplete Information 589
INDEX 589
Market Power 589
Externalities 590
Public Goods 590
17 MRKETS WITH ASYWMETRIC INFORMATION 593
17.1 Quality Uncertainty and the Market for "Lemons" 594
The Market for Used Cars 594
Implications of Asymmetric Information 596
Insurdnce 596
The Market for Credit 597
17.1 Lemons in Major League Baseball 598
The Importance of Reputation and Standardization 598
17.2 Market Signaling 600
A Simple Model of Job Market Signaling 601
Guarantees and Warranties 604
17.3 Moral Hazard 604
17.2 Reducing Moral Hazard-Warranties of Animal Health 606
17.3 Crisis in the Savings and Loan Industry 607
The Principal-Agent Problem in Private Enterprises 608
17.4 The Principal-Agent Problem 608
The Principal-Agent Problem in Public Enterprises 609
17.4 The'Managers of Nonprofit Hospitals as Agents 610
Incentives in the Principal-Agent Framework 611
*17.5 Managerial Incentives in an Integrated Firm 613
Asymmetric Information and Incentive Design in the Integrated Firm 613
Applications 616
17.6 Asymmetric Information in Labor Markets: Efficiency Wage Theory 616
17.5 Efficiency Wages at Ford Motor Company 619
18 EXTERNALITIES AND PUBLIC GOODS 623
Negative Externalities and Inefficiency 624
18.1 Externalities 624
Positive Externalities and Inefficiency 626
18.2 Ways of Correcting Market Failure 627
An Emissions Standard 629
Standards Versus Fee 630
An Emissions Fee 630
Transferable Emissions Permits 633
18.1 The Costs and Benefits of Reduced Sulfur Dioxide Emissions 634
18.2 Emissions Trading and Clean Air 636
Recycling 637
18.3 Regulating Municipal Solid Wastes 640
Bargaining and Economic Efficiency 641
18.3 Externalities and Property Rights 641
Property Rights 641
Costly Bargaining-The Role of Strategic Behavior 643
A Legal Solution-Suing for Damages 643
18.4 The Coase Theorem at Work 644
18.4 Common Property Resources 645
18.5 Crawfish Fishing in Louisiana 647
18.5 Public Goods 648
Efficiency and Public Goods 650
Public Goods and Market Failure 651
18.6 The Demand for Clean Air 652
18.6 Private Preferences for Public Goods 654
An Example 659
APPENDIX THE BASICS OF REGRESSION 659
Estimation 660
Statistical Tests 662
Goodness of Fit 663
Economic Forecasting 664
A.1 The Demand for Coal 665
GLOSSARY 669