The Pearson Series in Economics - 8th Edition

726 • ANSWERS TO SELECTED EXERCISES c. An entry fee of $50 per week would attract only serious players. With 3000 serious players, total so that MR = MC. Marginal revenue is 213.33 - revenues would be $150,000, and profits would 2.67Q. Setting this equal to marginal cost implies be $140,000 per week. With both serious and occa- a profit-maximizing quantity of 65 with a price of sional players, entry fees would be equal to 4000 $126.67. In the New York market, quantity is equal times the consumer surplus of the occasional to 60 - 0.25(126.67) = 28.3, and in the Los Angeles player: T = 4000(32 - 4P + P2/8). Court fees market, quantity is equal to 100 - 0.50(126.67) = 36.7. are P[3000(10 - P) + 1000(4 - P/4)] = 34,000P - Together, 65 units are purchased at a price of $126.67. 3250P2. Then TR = 128,000 + 18,000P - 2750P2. Marginal cost is zero, so setting ⌬TR/⌬P = 18,000 - c. Sal is better off in the situation with the highest profit, 5500P = 0 implies a price of $3.27 per hour. Then total which occurs in part (a) with price discrimination. revenue is equal to $157,455 per week, which is more Under price discrimination, profit is equal to than the $150,000 per week with only serious play- p = PNYQNY + PLAQLA - [1000 + 40(QNY + QLA)], ers. The club owner should set annual dues at $1053, or p = $140(25) + $120(40) - [1000 + 40(25 + 40)] charge $3.27 for court time, and earn profits of $7.67 = $4700. Under the market conditions in part million per year. ( b ) , p r o f i t i s p = PQT - [1000 - 40QT], or p = $126.67(65) - [1000 + 40(65)] = $4633.33. 11. Mixed bundling is often the ideal strategy when Therefore, Sal is better off when the two markets are demands are only somewhat negatively correlated separated. Under the market conditions in (a), the con- and/or when marginal production costs are sig- sumer surpluses in the two cities are nificant. The following tables present the reservation CSNY = (0.5)(25)(240 - 140) = $1250, and CSLA = prices of the three consumers and the profits from the (0.5)(40)(200 - 120) = $1600. Under the market con- three strategies: ditions in (b), the respective consumer surpluses are CSNY = (0.5)(28.3)(240 - 126.67) = $1603.67, and RESERVATION PRICE CSLA = (0.5)(36.7)(200 - 126.67) = $1345.67. New Yorkers prefer (b) because their price is $126.67 instead FOR 1 FOR 2 TOTAL of $140, giving them a higher consumer surplus. Customers in Los Angeles prefer (a) because their price Consumer A $ 3.25 $ 6.00 $ 9.25 is $120 instead of $126.67, and their consumer surplus Consumer B 8.25 3.25 11.50 is greater in (a). Consumer C 20.00 10.00 10.00 10. a. With individual demands of Q1 = 10 - P, individual consumer surplus is equal to $50 per week, or $2600 PRICE 1 PRICE 2 BUNDLED PROFIT per year. An entry fee of $2600 captures all consumer surplus, even though no court fee would be charged, Sell separately $ 8.25 $6.00 — $28.50 since marginal cost is equal to zero. Weekly prof- Pure bundling — — $ 9.25 27.75 its would be equal to the number of serious players, Mixed bundling 6.00 11.50 29.00 1000, times the weekly entry fee, $50, minus $10,000, 10.00 the fixed cost, or $40,000 per week. The profit-maximizing strategy is to use mixed b. When there are two classes of customers, the club bundling. owner maximizes profits by charging court fees above marginal cost and by setting the entry fee equal to the 15. a. For each strategy, the optimal prices and profits are remaining consumer surplus of the consumer with the smaller demand—the occasional player. The entry fee, PRICE 1 PRICE 2 BUNDLED PROFIT T, is equal to the consumer surplus remaining after the court fee is assessed: T = (Q2 - 0)(16 - P)(1/2), Sell separately $80.00 $80.00 — $320.00 where Q2 = 4 - (1/4)P, or T = (1/2)(4 - (1/4)P) Pure bundling — — $120.00 480.00 (16 - P) = 32 - 4P + P2/8. Entry fees for all play- Mixed bundling 94.95 94.95 429.00 ers would be 2000 (32 - 4P + P2/8). Revenues from 120.00 court fees equals P (Q1 + Q2) = P[1000(10 - P) + 1000(4 - P/4)] = 14,000P - 1250P2. Then total rev- Pure bundling dominates mixed bundling because enue = TR = 64,000 + 6000P - 1000P2. Marginal cost is with marginal costs of zero, there is no reason to zero and marginal revenue is given by the slope of the exclude purchases of both goods by all customers. total revenue curve: ⌬TR/⌬P = 6000 - 2000P. Equating marginal revenue and marginal cost implies a price of $3.00 per hour. Total revenue is equal to $73,000. Total cost is equal to fixed costs of $10,000. So profit is $63,000 per week, which is greater than the $40,000 when only serious players become members.

ANSWERS TO SELECTED EXERCISES • 727 b. With marginal cost of $30, the optimal prices and several brands with different prices and characteris- profits are tics is one method of splitting the market into sets of customers with different price elasticities. PRICE 1 PRICE 2 BUNDLED PROFIT 3. a. To maximize profit p = 53Q - Q2 - 5Q, we find Sell separately $80.00 $80.00 — $200.00 ⌬p/⌬Q = - 2Q + 48 = 0. Q = 24, so P = 29. Profit Pure bundling — — $120.00 240.00 Mixed bundling 94.95 94.95 249.90 is equal to 576. 120.00 b. P = 53 Q1 - Q2, p1 = PQ1 - C(Q) = 53Q1 - Q 2 - 1 Q1Q2 - 5Q1 a n d p2 = PQ2 - C(Q2) = 53Q2 - Q1Q2 - Q22 - 5Q2. Now mixed bundling dominates all other strategies. c. The problem facing Firm 1 is to maximize profit, given that the output of Firm 2 will not change in reaction to the output decision of Firm 1. Therefore, Firm 1 CHAPTER 11—APPENDIX chooses Q1 to maximize p1, as above. The change in p1 with respect to a change in Q1 is 53 - 2Q1 - Q2 - 5 = 0, 2. We examine each case, then compare profits. implying Q1 = 24 - Q2/2. Since the problem is symmet- ric, the reaction function for Firm 2 is Q2 = 24 - Q1/2. a. Optimal quantities and prices with no external mar- ket for engines are QE = QA = 2000, PE = $8000, d. Solve for the values of Q1 and Q2 that satisfy both reac- tion functions: Q1 = 24 - (1/2)(24 - Q1/2). So, Q1 = 16 #and PA = $18,000. For the engine-building division, and Q2 = 16. The price is P = 53 - Q1 - Q2 = 21. Profit is p1 = p2 = P · Qi - C(Qi) = 256. Total profit in the TR = 2000 $8000 = $16M, TC = 2(2000)2 = $8M, industry is p1 + p2 = 512. and pE = $=8M20.0F0o#r$t1h8e,0a0u0to=m$o3b6ilMe-,aTssCem=bl$y80d0iv0i#- 5. True. The reaction curve of Firm 2 will be q2 = 7.5 - sion, TR 1/2q1 and the reaction curve of Firm 1 will be q1 = 15 - 1/2q2. Substituting yields q2 = 0 and q1 = 15. The 2000 + 16M = $32M, and pA = $4M. Total profits price will be 15, which is the monopoly price. are $12M. b. Optimal quantities and prices with an external market 7. a. (i) In a Cournot equilibrium, when firm A has an for engines are QE = 1500, QA = 3000, PE = $6000, increase in marginal cost, its reaction function shifts inward. The quantity produced by firm A will #and PA = $17,000. For the engine-building divi- decrease and the quantity produced by firm B will increase. Total quantity produced will decrease and sion, TR = 1500 $6000 = $9M, TC = 2(1500)2 = price will increase. (ii) In a collusive equilibrium, the two firms will collectively act like a monopolist. a$s4s.5eMm,blyanddivpisi=on$,4.5TMR .=F3o0r00t#h$e17a,0u0t0om= $o5b1iMle-, When the marginal cost of Firm A increases, Firm A will reduce its production to zero, because Firm B TC = (8000 + 6000)3000 = $42M, and p = $9M. can produce at a lower marginal cost. Because Firm B can produce the entire industry output at a marginal Total profits are $13.5M. cost of $50, there will be no change in output or price. However, the firms will have to come to some agree- c. Optimal quantities and prices with a monopoly ment on how to share the profit earned by B. (iii) Because the good is homogeneous, both produce market for engines are QE = 2200, QA = 1600, where price equals marginal cost. Firm A increases price to $80 and firm B raises its price to $79.99. PE = $8800, and PA = $18,400, with 600 engines Assuming firm B can produce enough output, it will supply the entire market. sold in the monopolized market for $19640000.# For the ne-building divis ion, TR = $ 8800 + e60n0g#i 9400 = $19.72M, TC = 2(2200)2 = $9.68M, and p= $=10.10640M0 .#F$o1r8t,h4e00au=tomToRbil=e-a1s6s0em0 #bl$y1d8,i4v0is0io=n, TR $29.44M, TC = (8000 + 8800)1600 = $26.88M, and p = $2.56M. Total profits are $12.6M. The upstream division, building engines, earns the most profit when it has a monopoly on engines. The downstream division, building automobiles, earns the most when there is a competitive market for engines. b. (i) The increase in the marginal cost of both firms shifts both reaction functions inward. Both firms decrease Given the high cost of engines, the firm does best output, and price will increase. (ii) When marginal cost increases, both firms will produce less and price when engines are produced at the lowest cost with an will increase, as in the monopoly case. (iii) Price will increase and quantity produced will decrease. external, competitive market for engines. CHAPTER 12 c. (i) Both reaction functions shift outward and both firms produce more. Price will increase. (ii) Both firms 1. Each firm earns economic profit by distinguishing will increase output, and price will also increase. (iii) its brand from all other brands. If these competitors Both firms will produce more. Because marginal cost merge into a single firm, the resulting monopolist is constant, price will not change. would not produce as many brands as would have been produced before the merger. But, producing

728 • ANSWERS TO SELECTED EXERCISES 4. a. There are two Nash equilibria: (100,800) and (900,600). 11. a. To determine the Nash equilibrium, we calculate the b. Both managers will follow a high-end strategy, and reaction function for each firm, then simultaneously the resulting equilibrium will be (50,50), yielding less solve for price. Assuming marginal cost is zero, profit profit to both parties. for Firm 1 is P1Q1 = P1(20 - P1 + P2) = 20P1 + P12 + P2P1. MR1 = 20 - 2P1 + P2. At the profit- c. The cooperative outcome (900,600) maximizes the maximizing price, MR1 = 0. So, P1 = (20 + P2)/2. joint profit of the two firms. Because Firm 2 is symmetric to Firm 1, its profit-max- imizing price is P2 = (20 + P1)/2. We substitute Firm d. Firm 1 benefits the most from cooperation. Compared 2’s reaction function into that of Firm 1: to the next best opportunity, Firm 1 benefits by 900 - P1[20 + (20 + P1)/2]/2 = 15 + P1/4. P1 = 20. By 100 = 800, whereas Firm 2 loses 800 - 600 = 200 under symmetry P2 = 20. Then Q1 = 20, and by symmetry Q2 cooperation. Therefore, Firm 1 would need to offer = 20. Profit for Firm 1 is P1Q1 = 400, and profit for Firm 2 at least 200 to compensate for Firm 2’s loss. Firm 2 is also 400. 6. a. Yes, there are two: (1) Given Firm 2 chooses A, Firm 1 b. If Firm 1 sets its price first, it takes Firm 2’s reaction chooses C; given Firm 1 chooses C, Firm 2 chooses A. function into account. Firm 1’s profit is p1 = (2) Given Firm 2 chooses C, Firm 1 chooses A; given P1[20 - P1 + (20 + P1)/2]. Then, dp1/dP1 = 20 - Firm 1 chooses A, Firm 2 chooses C. 2P1 + 10 + P1. Setting this expression equal to zero, P1 = 30. We substitute for P1 in Firm 2’s reaction b. If both firms choose according to maximin, Firm 1 will function, P2 = 25. At these prices, Q1 = 20 - 30 + choose Product A and Firm 2 will choose Product A, 25 = 15 and Q2 = 20 + 30 - 25 = 25. Profit is resulting in -10 payoff for both. p1 = 30 .15 = 450 and p2 = 25 . 25 = 625. c. Firm 2 will choose Product C in order to maximize c. Your first choice should be (iii), and your sec- payoffs at 10, 20. ond choice should be (ii). Setting prices above the Cournot equilibrium values is optional for both 12. Although antique auctions often have private-value firms when Stackelberg strategies are followed. elements, they are primarily common value because From the reaction functions, we know that the price dealers are involved. Our antique dealer is disap- leader provokes a price increase in the follower. pointed in the nearby town’s public auction because But the follower increases price less than the price estimates of the value of the antiques vary widely and leader, and hence undercuts the leader. Both firms she has suffered from the winner’s curse. At home, enjoy increased profits, but the follower does best, where there are fewer well-informed bidders, the and both do better than they would in the Cournot winner’s curse has not been a problem. equilibrium. CHAPTER 14 CHAPTER 13 2. With the new program, the budget line shifts up 1. If games are repeated indefinitely and all players by the $5000 government grant when the worker know all payoffs, rational behavior will lead to appar- does no work at all and takes the maximum amount ently collusive outcomes. But, sometimes the payoffs of leisure hours. As the number of hours worked of other firms can only be known by engaging in increases (i.e., leisure decreases), the budget line has extensive information exchanges. half the slope of the original budget line because Perhaps the greatest problem to maintaining a earned income is taxed at 50 percent. When the collusive outcome is exogenous changes in demand after-tax income is $10,000, the new budget line coin- and in the prices of inputs. When new information is cides with the original budget line. The result is that not available to all players simultaneously, a rational the new program will have no effect if the worker reaction by one firm could be interpreted as a threat originally earned more than $10,000 per year, but by another firm. it will probably reduce the amount of time worked (i.e., increase leisure) if the worker earned less than 2. Excess capacity can arise in industries with easy entry $10,000 originally. and differentiated products. Because downward- sloping demand curves for each firm lead to outputs 6. The demand for labor is given by the marginal with average cost above minimum average cost, revenue product of labor; MRPL = MR · MPL. In increases in output result in decreases in average cost. a competitive market, price is equal to marginal The difference between the resulting output and the revenue, so MR = 10. The marginal product of output at minimum long-run average cost is excess labor is equal to the slope of the production func- capacity, which can be used to deter new entry. tion Q = 12L - L2. This slope is equal to 12 - 2L. The firm’s profit-maximizing quantity of labor occurs where MRPL = w, the wage rate. If w = 30,

solving for L yields 4.5 hours per day. Similarly, if ANSWERS TO SELECTED EXERCISES • 729 w = 60, solving for L yields 3 hours per day. 12,000/(1 + 0.04)6 = -10,516.22. The present value 8. The equilibrium wage is where the quantity of labor cost of leasing the car is -3600 - 3600/(1 + 0.04)1 - supplied is equal to the quantity of labor demanded, 3600/(1 + 0.04)2 = -10,389.94. You are better off or 20w = 1,200 - 10w. Solving, w = $40. Substituting leasing the car if r = 4 percent. into the labor supply equation, for example, the equilibrium quantity of labor is: LS = (20)(40) = 800. b. Again, compare buying to leasing: 20,000 + 12,000/ Economic rent is the difference between the equilib- (1 + 0.12)6 = -13,920.43 with buying, versus -3600 - rium wage and the wage given by the labor supply 3600/(1 + 0.12)1 - 3600/(1 + 0.12)2 = -9,684.18 with leas- curve. Here, it is the area above the labor supply curve ing. You are better off leasing the car if r = 12 percent. up to L = 800 and below the equilibrium wage. This area is (0.5)(800)($40) = $16,000. c. Consumers will be indifferent when the present value cost of buying and later selling the car equals CHAPTER 15 the present value cost of leasing: -20,000 + 12,000/ (1 + r)6 = -3600 - 3600/(1 + r)1 - 3600/(1 + r)2. This 3. The present discounted value of the first $80 payment is true when r = 3.8 percent. You can solve this one year from now is PDV = 80/(1 + 0.10)1 = $72.73. equation using a graphing calculator or computer The value of all these coupon payments can be found spreadsheet, or by trial and error. the same way: PDV = 80[1/(1.10)1 + 1/(1.10)2 + 1/(1.10)3 + 1/(1.10)4 + 1/(1.10)5] = $303.26 . The CHAPTER 16 present value of the final payment of $1000 in the sixth year is 1000/1.16 = $564.47. So the present value 6. Even with identical preferences, the contract curve of this bond is $303.26 + $564.47 = $867.73. With an may or may not be a straight line. This can easily be interest rate of 15 percent, PDV = $700.49. shown graphically. For example, when both individu- als have utility functions U = x2y, the marginal rate of 5. Using R = 0.04, we can substitute the appropriate val- substitution is given by 2y/x. It is not difficult to show ues into Equation 15.5. We find that NPV = -5 - 4.808 that the MRS’s of both individuals are equal for all - 0.925 - 0.445 + 0.821 + 0.789 + 0.759 + 0.730 + 0.701 points on the contract curve y = (Y/X)x, where X and + 0.674 + 0.649 + 0.624 + 0.600 + 0.577 + 0.554 + 0.533 Y are the total quantities of both goods. One example + 0.513 + 0.493 + 0.474 + 0.456 + 0.438 + 0.456 = –0.338. in which the contract curve is not a straight line is The investment loses $338,000 and is not worthwhile. when the two individuals have different incomes and However, were the discount rate 3%, the NPV = one good is inferior. $866,000, and the investment would be worth under- taking. 7. The marginal rate of transformation is equal to the ratio of the marginal costs of producing the two goods. 9. a. If we buy a bottle and sell it after t years, we pay $100 Most production possibilities frontiers are “bowed now and receive 100t0.5 when it is sold. The NPV of outward.” However, if the two goods are produced this investment is NPV = - 100 + e-rt100t0.5 = with constant returns to scale production functions, - 100 + e-0.1t100t0.5. the production possibilities frontier is a straight line. If we do buy a bottle, we will choose t to maximize the NPV. The necessary condition is dNPV/dt = e -0.1t 10. A change from a constant-returns-to-scale produc- (50 - t )-0.5 - 0.1e -0.1t · 100t0.5 = 0. Solving, t = 5. If we tion process to a sharply-increasing-returns-to-scale hold the bottle 5 years, the NPV is -100 + e -0.1·5100 · process does not imply a change in the shape of the 50.5 = 35.62. Since each bottle is a good investment, we isoquants. One can simply redefine the quantities should buy all 100 bottles. associated with each isoquant such that proportional increases in inputs yield greater than proportional b. You are offered $130 for resale, so you would make increases in outputs. Under this assumption, the mar- an immediate profit of $30. However, if you hold ginal rate of technical substitution would not change, the wine for 5 years, the NPV of your profit is $35.62 and there would be no change in the production con- as shown in part (a). Therefore, the NPV if you sell tract curve. immediately rather than hold for 5 years is $30 - 35.62 = -$5.62, and you should not sell. CHAPTER 17 c. If the interest rate changes from 10 percent to 5 per- 5. a. In the recent past, American automobiles appeared to cent, the NPV calculation changes to NPV = -100 + customers to be of low quality. To reverse this trend, American companies invested in quality control, #e- 0.05t 100t0.5. If we hold the bottle 10 years, the maxi- improving the potential repair records of their prod- # #mum NPV is -100 + e- 0.05·10 100 100.5 = $91.80. ucts. They signaled the improved quality of their products through improved warranties. 11. a. Compare buying the car to leasing the car, with r = 0.04. The present value net cost of buying is -20,000 + b. Moral hazard occurs when the party to be insured (the owner of an American automobile with an extensive

730 • ANSWERS TO SELECTED EXERCISES not high enough to permit swimming, the fee could be increased. warranty) can influence the probability or the magni- tude of the event that triggers payment (the repair of The setting of a standard will be efficient only if the automobile). Covering all parts and labor associ- the policymaker has complete information regard- ated with mechanical problems reduces the incentive ing the marginal costs and benefits of abatement. to maintain the automobile. Hence, a moral hazard Further, the standard will not encourage firms to problem is created with extensive warranties. reduce effluent further if new filtering technologies become available. A transferable effluent permit 7. Moral hazard problems arise with fire insurance when system still requires the policymaker to determine the insured party can influence the probability of a the efficient effluent standard. Once the permits are fire. The property owner can reduce the probability of distributed, a market will develop and firms with a fire or its impact by inspecting and replacing faulty a higher cost of abatement will purchase permits wiring, installing warning systems, etc. After purchas- from firms with lower abatement costs. However, ing complete insurance, the insured has little incentive unless permits are sold initially, no revenue will be to reduce either the probability or the magnitude of generated. the loss, so the moral hazard problem can be severe. In order to compare a $10,000 deductible and 90 per- 9. a. Profit is maximized when marginal revenue is equal cent coverage, we need information on the value of the to marginal cost. With a constant marginal revenue of potential loss. Both policies reduce the moral hazard $40 and a marginal cost of 10 + 5Q, Q = 6. problem of complete coverage. However, if the prop- erty is worth less (more) than $100,000, the total loss b. If bees are not forthcoming, the farmer must will be less (more) with 90 percent coverage than with pay $10 per acre for artificial pollination. Since the $10,000 deductible. As the value of the property the farmer would be willing to pay up to $10 to the increases above $100,000, the owner is more likely to beekeeper to maintain each additional hive, the engage in fire prevention efforts under the policy that marginal social benefit of each is $50, which offers 90 percent coverage than under the one that is greater than the marginal private benefit of offers the $10,000 deductible. $40. Equating the marginal social benefit to the marginal cost, Q = 80. CHAPTER 18 c. The most radical change that would lead to more 4. One needs to know the value to homeowners of efficient operations would be the merger of the farm- swimming in the river, and the marginal cost of er’s business with the beekeeper’s business. This abatement. The choice of a policy tool will depend on merger would internalize the positive externality of the marginal benefits and costs of abatement. If firms bee pollination. Short of a merger, the farmer and are charged an equal rate effluent fee, the firms will beekeeper should enter into a contract for pollina- reduce effluent to the point where the marginal cost tion services. of abatement is equal to the fee. If this reduction is

Photo Credits CHAPTER 10 p. 364 Leonard Lessin/Photo Researchers, Inc. CHAPTER 1 p. 372 Ryan McVay/Photodisc p. 11 Natsuki Sakai/AFLO/Newscom p. 388 Nataliya Hora/Shutterstock p. 393 Moodboard/Alamy CHAPTER 2 p. 394 Chunche/Dreamstime p. 28 Joegough/Dreamstime p. 29 Vladislav Gajic/Shutterstock CHAPTER 11 p. 37 Orientaly/Shutterstock p. 408 Catherine Lane/iStockphoto p. 46 Bajinda/Shutterstock p. 413 Bosca78/iStockphoto p. 54 Slavoljub Pantelic/Shutterstock p. 417 Donna Beeler/iStockphoto p. 427 Warren Millar/Fotolia CHAPTER 3 p. 432 Michael Newman/PhotoEdit, Inc. p. 77 Hakan Caglav/iStockphoto p. 90 Alexander Raths/Shutterstock CHAPTER 12 p. 94 Kzenon/Shutterstock p. 455 Jack Plekan/Fundamental Photographs p. 97 Sharon Dominick/iStockphoto p. 480 AP Wide World Photos p. 481 EyeWire Collection/Getty Images CHAPTER 4 p. 117 Cultura Limited/SuperStock CHAPTER 13 p. 129 Richard Goldberg/Shutterstock p. 501 Tony Freeman/PhotoEdit, Inc. p. 131 Konstantin Sutyagin/Shutterstock p. 501 John Connell/Corbis p. 134 Dudarev Mikhail/Shutterstock p. 509 Spencer Tirey/AP Images p. 138 Chris Price/iStockphoto p. 515 Blend Images/SuperStock p. 142 Frank Franklin II/AP Images p. 522 David Young-Wolff/PhotoEdit, Inc. CHAPTER 5 CHAPTER 14 p. 173 Amy Etra/PhotoEdit, Inc. p. 536 Corbis Royalty-Free p. 175 Antonia Reeve/Photo Researchers, Inc. p. 545 Les Stone/Sygma/Corbis p. 183 Gerald Holubowicz/Alamy p. 548 Mark Peterson/Saba/Corbis p. 186 Robyn Beck/AFP/Getty Images/ p. 549 Spencer Grant/PhotoEdit, Inc. Newscom p. 554 Dennis MacDonald/PhotoEdit, Inc. p. 188 Corbis/SuperStock p. 196 Quavondo/iStockphoto CHAPTER 15 p. 576 Michael Newman/PhotoEdit, Inc. CHAPTER 6 p. 579 Mark Antman/The Image Works p. 211 Konstantin Chagin/Shutterstock p. 582 Aaron Bacall/Images.com p. 215 iQoncept/Shutterstock p. 587 Grahame McConnell/Photolibrary New York/ p. 221 Svetlana Gajic/Shutterstock Getty Images p. 225 Image Source/Alamy CHAPTER 16 CHAPTER 7 p. 598 James Shaffer/PhotoEdit, Inc. p. 247 Andrey Kekyalyaynen/Shutterstock p. 622 Voisin/Photo Researchers, Inc. p. 260 Gary Blakeley/Shutterstock p. 264 Pavel Kosek/Shutterstock CHAPTER 17 p. 268 Arogant/Shutterstock p. 637 Mike Powell/Getty Images p. 642 Scott Stulberg/SuperStock CHAPTER 8 p. 645 Exactostock/SuperStock p. 290 Steven Gullen/iStockphoto p. 649 Doug Martin/Photo Researchers, Inc. p. 294 Natalia Bratslavsky/Shutterstock p. 656 Everett Collection/Alamy p. 313 Robophobic/Shutterstock CHAPTER 18 CHAPTER 9 p. 672 EyeWire Collection/Getty Images p. 325 Antonia Reeve/Photo Researchers, Inc. p. 678 Picsfive/Shutterstock.com p. 330 Michael Rosa/Shutterstock p. 682 Carrieanne/Dreamstime p. 335 David Frazier/Corbis p. 689 Christian Goupi/AGE Fotostock p. 342 Tim Page/Corbis p. 693 Jeff Greenberg/PhotoEdit, Inc. p. 349 Heather A. Craig/Shutterstock 731

Index A predatory pricing and, 390 Autor, David H., 554n10 private proceedings and, 391 Average costs, 239 Abadie, Alberto, 3n6 Apple, 8, 390 Average expenditure Absolute advantage, 618–619 Apple iPod, 621–622 Accounting costs, 230 Arbitrage, definition of, 8 curve, 537, 546, 547 Accounting profit, long-run competitive Arc elasticity of demand, 36–37 definition of, 383 Archer Daniels Midland Company, 10, monopsony power and, 546–547 equilibrium and, 301–302 Average fixed costs, 237 Ackerman, Frank, 677n12 379, 393 Average products Acreage limitation programs, 334 Asset beta, 575 of labor curve, 209 Actual returns, 178 Asset returns, 177–179 production process and, 206–207 Actuarial fairness, 172–173 Assets relationship with marginal Adams, Frank A., III, 327n4 Ad valorem tax, 345 definition of, 176 products, 209 Adverse selection, 634 expected vs. actual returns, 178 Average revenue, monopoly and, Advertising, 429–433 risky and riskless, 177 Astra-Merck, 364–365 358–359 effects of, 430 Asymmetric information Average total costs, 237 elasticity of demand and, 431 adverse selection and, 634 Average variable costs, 237, 291–292 in practice, 432–433 cost-benefit comparison, 640–641 Axelrod, Robert, 498n9 rule of thumb for, 431–432 efficiency wage theory and, 654–656 Advertising game, 491 equilibrium, 640 B Advertising-to-sales ratio, 431 guarantees and warranties, 642 Agency relationships, 645–651 implications of, 634–635 Babock, Linda, 196n34 Aggregate demand, 128–129 integrated firms and, 652–654 Backward-bending supply of labor, 539 Agostini, Claudio, 51n15 labor markets and, 654–656 Badger Meter, 501 Airbus, 513–514 managerial incentives and, 652–654 Bads (goods), 76–77 Airline/aircraft industries market signaling and, 638–643 Bailey, Elizabeth, 675n10 competition and collusion in, 501–502 moral hazard and, 643–645 Baily, Martin N., 46n12 jet fuel demand and, 536–537 principal-agent problem, 645–651 Bajari, Patrick, 522n22 learning curves and, 265 quality uncertainty and, 632–638 Baker, Jonathan B., 142n12 price discrimination and fares, 409–410 reputation and, 636 Bandwagon effect, 136 regulation and, 330–331 standardization and, 636 Bankruptcies, recent rise in, 282 strategic policy and, 512–514 AT&T, 417–419 Banzhaf, Spencer, 665n2 Akerlof, George A., 194n29, 632n1 Auction markets, defined, 516 Bargaining Allen, Mike, 337n9 Auctions, 516–524 Allocations, efficient, 604–606 bidding and collusion and, 521 Coase theorem and, 685, 687 Aluminum smelting common-value auctions, 519–520 economic efficiency and, 685–686 short-run cost of, 240–242 formats, 517 strategy and, 508–509, 685 short-run output of, 290–291 Internet, 522–524 Bargaining power, 548 American Airlines, 392–393, 501–502 legal services and, 522 Barlow, Connie C., 59n22 Amortization, 234–235 maximizing auction revenue, 520–521 Barnes, James, 39n9 Anchoring, 194–195 private-value auctions, 517–518 Barnett, A. H., 327n4 Andreyeva, T., 370n6 valuation and information and, 517–518 Barney, Dwane L., 327n4 Animal health warranties, 645 winner’s curse and, 519–520 Barriers to entry, 376 Antitrust laws, 389–395 Automobile industry. See also specific Baseball. See Major league baseball anticompetitive conduct and, 391 BASF A.G. of Germany, 393 Antitrust Division of Department companies Battle of the sexes game, 497–498 choosing new car, 579–580 Baye, Michael, 175n8 of Justice and, 391 demand and, 40–45 Beach location game, 493–494 enforcement of, 391–392 design and, 77–78, 88–89 Bebchuk, Lucian A., 648n14–15 in Europe, 392 emission standards and, 17–18 Becker, Gary S., 164n5 Federal Trade Commission and, hybrid cars, 16 Behavioral economics, 67–69, 189–197 product differentiation and, 452 anchoring and, 194–195 391, 392 variable cost curve and, 266 decision making biases and, 194–195 illegal combinations and, 389–390 endowment effect and, 190–191 parallel conduct and, 390 loss aversion and, 191 732

INDEX • 733 probabilities and uncertainty, 195 Capital-intensive technology, 221 Commercial banking, price rigidity and reference point and, 190–191 Capital investment leadership in, 475 rule-of-thumb and, 194–195 Beijing sulfur dioxide emissions, 672–673 discount rate and, 569 Commercial paper rate, 590 Bell, Frederick W., 689n22 negative future cash flows and, 572 Commercial real estate, September 11 Berliner, Diane T., 622n9 net present value criterion for, 569–573 Berndt, Ernst R., 433n23 opportunity cost of capital, 570 effects on, 31–32 Berry, Steven, 89n8 real vs. nominal discount rates Commitment, credibility and, 506–508 Bertrand, Joseph, 465 Common property resources, 687–690 Bertrand model, 465–466 and, 571–572 Common-value auctions, 518, 519–520 “Best fit” criterion, 701 Capital loss, 177 Company cost of capital, 576 Bicycle markets, 11–12 Card, David, 16n8, 549n7 Comparative advantage, 618–619 Bidding, collusion and, 521 Cardinal utility function, 80 Compensation, executive, 647–648 Bilateral monopoly, 388 Carpet industry, returns to scale in, Competition Directorate, 392 Blackley, Dixie M., 313n10 Competition vs. collusion, 469–472 Blair, Roger D., 327n5 225–226 Competitive buyer, competitive seller Block pricing, 404 Cartels, 477–482 BMW, 426 compared, 383 Boeing, 513–514 analyzing CIPEC, 479–480 Competitive equilibrium, 301–304, 607–609 Bonds analyzing OPEC, 478–479 Competitive firms. See also Profit cash flow value from, 565 conditions for success of, 478 definition of, 564 definition of, 452 maximization effective yield on, 566–567 monopoly power and, 478 demand and marginal revenue for, perpetuities, 565–566 price analysis and, 478–480 value of, 564–569 Case-Shiller Housing Price Index, 186, 188 285–287 Bonus-payment systems, 651 Cash flows, negative future, 572 economic rent and, 304–305 Boskin, Michael, 105n15 Caulkins, Jonathan P., 673n7 incurring losses and, 289 Boyle, Robert, 6n2 Ceiling prices, 58, 319 input price changes and, 293–294 Bram, Jason, 32n5 Cellular phone service pricing, 417–419 long-run equilibrium and, 301–304 Braniff Airways, 392–393 Centner, Terence J., 645n8 long-run profit maximization and, Brealey, Richard, 574n12 CEO compensation, 647–648 Brownell, K.D., 370n6 Cereal, ready-to-eat, 142 300–301 Bryan, Michael F., 105n17 Chain-weighted price index, 104 long-run supply and, 306–314 Bubbles, 185–189 Chandler, Alfred Jr., 202n1 producer surplus in long run and, Budget constraints, 82–86 Chay, Kenneth Y., 135n9 Budget line, 82–84 Chemical processing industry, learning 305–306 definition of, 82 producer surplus in short run and, income changes and, 84 curve and, 264–265 market baskets and, 83 China Mobile, 417, 418 298–300 Bundling, 419–429 Chinese housing bubble, 187 profit maximization by, 287 mixed vs. pure bundling, 423–426 Christensen, Laurits, 268n19 short-run profit maximization by, in practice, 426–427 Christie’s auction house, 521, 522 relative valuations and, 420–423 Chrystal, K. Alec, 622n9 287–289 tying and, 428–429 Cigliano, Joseph M., 536n2 short-run supply curve and, 292–295 zero marginal costs and, 425 Cinemax, 426 Competitive markets Burrows, James, 297n5 Civil Aeronautics Board (CAB), 330 consumer and producer surplus and, Business executives, risk choice and, 169–170 Clayton Act (1914), 390 Business school, value of, 582–584 Clean Air Act, 134–135, 674 318–323 Buyer interaction, monopsony and, 387 Clinton Corn Processing Company, 10 consumer equilibrium and, 607–609 Buyer numbers, monopsony and, 387 Coal, demand for (multiple regression deadweight loss and, 321 economic efficiency of, 323–328, C analysis), 706–707 Coase, Ronald, 203n2, 685n20, 691n23 609–610 Cable television, bundling and, 426 Coase theorem, 685, 687 efficiency of, 623–625 CAFE (Corporate Average Fuel Cobb-Douglas production function, 276–278 failure and, 625–627 Cobb-Douglas utility function, 153 government policies and, 317–323 Economy), 17 Coffee markets incentive programs and, 334–335 Camerer, Colin, 189n23, 196n34 market failure and, 323–325 Capacity constraints, 45 monopolistic competition in, 455–456 minimum prices and, 328–331 Capital weather conditions and pricing, 46–48 perfectly competitive markets, 279–281 Cohen, Alma, 648n15 price supports and, 332–339 company cost of, 576 Cola markets, monopolistic competition in, production quotas and, 333–338 price of, 244 supply in, 537–539 rental rate of, 244–245 455–456 taxes or subsidies and, 345–351 Capital asset pricing model, 575–576 College education welfare loss and, 324 Capital gain, 177 Complementary goods, 24–25, 118–119 costs of, 13–14, 28 Completely inelastic demand, 34, 35 net present value of, 581 Completeness, consumer preferences College trust funds, 92 Collusion, 469–472, 521 and, 70 Commercial airlines. See Airline/aircraft Computers industries production costs of, 235–236 wage inequality and, 554–555 Concentration ratio, 376n10 Condominiums, 283–284

734 • INDEX Congleton, Roger D., 379n12 Copper Dedrick, Jason, 621n8 Constant-cost industries, 307–308 price of, 29–30, 52–54 Deere, Donald, 550n8 Constant returns to scale, 223 short-run world supply of, 297–298 Degree of economies of scope, 259–260 Constant sum game,488n2 supply and demand for, 53 De La Torre Ugarte, Daniel G., 39n9 Constrained optimization, 149 supply of, 45–46 Dell, 8, 235 Consumer behavior. See also Consumer Delta Air Lines, 234, 243 Copyrights, 376 Demand. See also Demand curves; Supply preferences Corner solutions, 89–90 assumptions and, 68–70 Corporate bonds and demand budget constraints and, 82–86 competitive firms and, 285–287 consumer choice and, 86–92 versus prime rate, 475 consumer surplus and, 132–134 consumer preferences, 69–82 rates and, 590 cyclical industries and, 41–43 corner solutions and, 89–90 yields on, 567–569 durability and, 40–41 cost-of-living indexes and, 100–105 Corporate takeovers, 646 elasticity of, 126–127 marginal utility and consumer Corts, Kenneth S., 241n5 income elasticities and, 40–43 Cost-benefit comparison, 640–641 short-run vs. long-run elasticities, 39–48 choice, 95–100 Cost constraints, production and, 202 speculative, 129 price supports and, 332 Cost curves, 238–240 Demand curves, 23–25. See also Supply and revealed preference and, 92–95 Cost functions, 265–269 steps and, 68 Cost minimization, 249–250, 273–274 demand; Individual demand theory of, 67–68 Cost-of-living adjustments, 102 competitive firms and, 285–288 trade-offs and, 4 Cost-of-living indexes, 100–105 complementary goods and, 24–25 Consumer choice, 86–92 chain weighting and, 104 individual demand curves, 112–114 Consumer expenditures ideal, 101–102 market demand curves, 124–132 price elasticity and, 126–128 Laspeyres index, 102–103 monopolies and, 365 in United States, 117–118 Paasche index, 103–104 shifting of, 24 Consumer groups, creation of, 405–406 Cost-reducing innovation, 515 substitute goods and, 24–25 Consumer investment decisions, 578–580 Costs. See Production costs Demand estimation, 139–143 Consumer preferences, 69–82. See also Cost theory, duality in, 275–276 demand relationship form and, 140–142 Coughlin, Cletus, 622n9 interview and experimental approaches Consumer behavior Coupons, economics of, 408–409 basic assumptions about, 70 Cournot, Augustin, 458 to, 143 completeness and, 70 Cournot equilibrium, 460–461, 464–465 statistical approach to, 139–140 fairness and, 192–194 Cournot model, 458–461 Demand for loanable funds, 588 framing, 191 equilibrium in, 460–461 Demand shifts, monopolies and, 365–366 health care choices, 90–91 linear demand curve and, 461–463 Demand theory, 149–157 indifference curves and, 71–72 reaction curves and, 460 Cobb-Douglas utility function and, 153 indifference maps and, 72–73 Cournot-Nash equilibrium, 460 duality in consumer theory and, marginal rate of substitution and, 74–75 Cramer, Gail L., 343n13 market baskets and, 69–70 Crandall, Robert, 392, 502 154–155 more vs. less and, 70 Crawfish fishing in Louisiana, 689–690 equal margin principle, 151 perfect substitutes and perfect Credibility, 506–508 income and substitution effects and, Credit market, adverse selection and, 635 complements and, 75–77 Cremers, Martjin, 648n14 155–157 reference points and, 190–191 Crime deterrence, 164–165 marginal rate of substitution and, transitivity and, 70 Cross-price elasticity of demand, 35 Consumer Price Index (CPI), 12, 100, 105 Crude oil, price of, 55 151–152 Consumer satisfaction maximization, Cubic cost function, 267 marginal utility of income and, 152 Customer preferences method of Lagrange multipliers and, 86–88 ordinal vs. cardinal utility, 80 Consumer surplus, 132–135, 318–323 utility functions and, 79–80 150–151 Cyclical industries, 41–43 utility maximization and, 149–150 application of, 134 Department of Justice Antitrust Division, capturing, 400–401 D change in, 319–320 391, 394 demand and, 132–134 Dahl, Carol, 44n11 Depletable resources, 584–587 generalized, 133 Deadweight loss Deposits, refundable, 677 Consumption decisions. See also Bundling Depreciation, 243–244 products bundled, 421 definition of, 321 Deregulation, 330–331 products sold separately, 421 from monopoly power, 378 Derived demands, 530 Contract curve, 606–607 from monopsony power, 387 Dermisi, Sofia, 32n6 Convenience stores taxes and, 346 Developed countries, labor productivity advertising and, 432–433 Deaton, Angus, 98n11 markup pricing and, 372–373 Decision making, 163–164 in, 215 Cooper, John C. B., 55n18 Decision making biases, 194–195 Deviations, risk and, 161–163 Cooperative games, 488–489 Decreasing-cost industries, 309 Diaper wars, 515–516 Cooperatives, 283–284 Decreasing returns to scale, 223 Differentiated products, price competition Cooter, Robert, 685n19 Cootner, Paul H., 46n12 and, 465–467 Diminishing marginal returns, 217–219 Diminishing marginal utility, 95 Direct marketing experiments, 143 Discount bonds, 589

INDEX • 735 Discounted present value, 561, 562 Economies of scale, 255–256 Entry and exit, competitive equilibrium Discount rate barriers to entry and, 376 and, 300, 302–304 learning versus, 262–264 commercial banks and, 589 Entry barriers determination of, 569–570 Economies of scope, 258–261 competitive strategy and, 376 real vs. nominal, 571–572 Edgeworth box, 603–604 oligopolies and, 456 risk-adjusted, 575–576 Education Discounts, quantity, 404 Entry deterrence, 510–516 Discrimination, price. See Price benefits of, 640–642 Entry fees, 414 college costs and, 13–14, 28 Equal marginal principle, 96, 151 discrimination determining spending levels of, Equilibrium, 25–26, 640 Diseconomies of scale, 255–256, 308 Diseconomies of scope, 259 694–695 competitive, 301–304, 607–609 Disequilibrium, market, 608 net present value and, 581 consumer, 607–609 Disney Channel, 426 public, 691 Cournot equilibrium, 460–461, 464–465 Disneyland, 416 Effective yield, bond, 566–567 dominant strategies and, 491 Disposable diaper industry, capital Efficiency, public goods and, 691–692 exchange efficiency and, 607–609 Efficiency wage theory, 654–656 factor markets and, 542–545 investment in, 576–578 Efficient allocations, 602, 604–606 general analysis and, 595–602 DiTella, Raphael, 81n4 Effluent fees, 247–249 labor market, 542–545 Diversifiable risk, 574–575 Egalitarian view of equity, 611, 612 long-run, 301–304, 453–454 Diversification Eggs, cost of, 13–14, 28 market changes and, 26–32 Elasticity in supply and demand, 33–39, Nash equilibrium, 458, 466, 467, 469, risk and, 170–171 stock market and, 171 126–128. See also Price elasticity 492–498 Dividend yields for S&P 500, 184 advertising and, 431 oligopoly and, 457–458 Dixit, Avinash, 492n5, 516n19, 570n10 arc elasticity of demand, 36–37 short-run, 453–454 Dollar bill game, 489 cross-price elasticity of demand, 35 Stackelberg equilibrium, 492, 492n6 Dominant firm model, 476–477 definition of, 33 supply and demand and, 25–26 Dominant strategy, 490–491 income elasticity of demand, 34–35, Equilibrium price, 49 Double marginalization, 442–443 Equilibrium quantity, 49 Dranove, David, 176n9 40–43 Equitable allocations, 610–613 Dreyfus, Mark K., 580n15 linear demand curve, 34 egalitarian view of, 611, 612 Duality, 154–155 long-run, 311–312 market-oriented view of, 611, 612 Dulberger, Ellen R., 105n15 monopolies and, 376 perfect competition and, 612–613 Duopoly, 458, 462 monopsony and, 385–389 Rawlsian view of, 611, 612 DuPont, 514–515 oil and, 56–58 social welfare functions and, 611–612 Durability point vs. arc elasticities, 36–37 utilitarian view of, 611, 612 demand and, 40–41 price markup and, 373 utility possibilities frontier and, supply and, 45–46 short-run market and, 296–297 Durable equipment short-run vs. long-run elasticities, 39–48 610–612 consumption of, 43 soft drinks and, 370 Equity, four views of, 612 investment in, 42–43 tax impact on, 347 Espey, Molly, 44n11 Dutch auction, 517 Electric power, cost functions for, 268–269 Ethanol global market, 598–600 DVD rentals, effect on movie theater Ellerman, A.D., 675n10 European antitrust laws, 392 Ellerman, Denny, 675n10 European Merger Control Act, 392 tickets, 596–597 Elliott, Kimberly Ann, 622n9 European Union, 392 Ellis, Gregory M., 587n21 ex ante forecasts, 704 E Elobeid, Amani, 598n1 Excess demand, 58, 608 Emissions Excess supply, 608 eBay, 522–524 efficient levels of, 668 Exchange economy, defined, 602 Economic efficiency emissions trading and clear air, 673–675 Exchange efficiency, 602–610 marginal external costs of, 666 bargaining and, 685–686 standards vs. fees and, 669–671 advantages of trade and, 602–603 of competitive markets, 323–328, stock externalities and, 678–684 competitive equilibrium and, 607–609 sulfur dioxide, 665–666, 672–673 contract curve and, 606–607 609–610 transferable emissions permits, 671–672 Edgeworth box and, 603–604 equity and, 610–613 Emissions fee, 668–669 efficient allocations and, 604–606 exchange and, 602–610, 624 Emissions standard, 668 Excise tax, effects on monopolies, 367 free trade and, 618–623 Empty threats, 506 Executive compensation, 647–648 market failure and, 625–627 Endowment effect, 190–191 Exhaustible resources, 584–587 monopolistic competition and, Energy efficiency, 251–253 Expansion path, 249–251 through capital substitution for labor, 252 Expansion strategy, 509 454–455 through technological change, 252 Expected payoff, 495 production and, 613–618, 624 Energy Independence and Security Act, 17 Expected returns, 178 Economic forecasting, 704–705 Engel curves, 116–118 Expected utility, 165, 195 Economic inefficiency, moral hazard English (or oral) auction, 517 Expected value, 161 Enomoto, Carl E., 374n9 ex post forecasts, 705 and, 645 Extensive form of a game, 503–504 Economic rent definition of, 305 factor markets and, 542–544 Economic theories, 5–6

736 • INDEX Extent of market, 9–12 Foley, Patricia, 53n16 long-run demand for, 131–132 External costs, negative, 662–664 Food, Conservation, and Energy prices and per capita consumption, 131 Externalities, 661–666 rationing of, 98–100 Act of 2008, 39 taxes on, 122–124, 349–351 common property resources, 687–690 Food cooperatives, 283 Gates, Bill, 394 crawfish fishing in Louisiana, 689–690 Food crisis, 212–214 Gateway, 234 emissions example, 667–678 General Electric, 43 marginal external benefit, 664 cereal yields and world price of food, 213 General equilibrium analysis, 595–602 marginal external costs, 663 index of world food production per “contagion” across world stock marginal social benefit, 664 marginal social costs, 663 capita, 213 markets, 600–601 market failure, 323–325, 667–678 Ford, Henry, 656 economic efficiency, 601–602 municipal solid waste example, 678 Ford Motor Company, 17, 77–78, 88, 310, General Foods, 456 negative externalities and inefficiency, General Mills, 67 389, 457, 656 General Motors, 5, 43, 89, 177, 178, 201, 662–664 Formby, John P., 130n5 positive externalities and inefficiency, Fox, Merritt B., 646n9 267, 310, 358, 389 Framing, 191 Ghemawat, Pankaj, 509n12, 514n16 664–665 Frech, H. E., III, 98n12 Ghosh, Soumendra N., 374n9 property rights, 684–687 Free entry and exit, perfect competition Gibson, Robert C., 44n11 public goods, 690–694 Giffen good, 122 recycling example, 675–677 and, 280–281 Gillette, 417 stock, 678–684 Free riders, 693 Gillingham, Kenneth, 251n8 Free trade, 618–623 Glaister, Stephen, 44n11 F Global warming, 679–684 comparative advantage and, 618–619 Facebook, 138–139 expanded possibilities frontier and, reducing GHG emissions, 683 Factor inputs Gokhale, Jagadeesh, 105n17 619–620 Golden parachutes, 648 demand when one input is variable, gains from, 618–623 Gonik, Jacob, 654n19 530–533 protectionism and, 622–623 Gordon, Robert J., 105n15 Friedlaender, Ann F., 260n11 Government bailouts, 185 demand when several inputs are vari- Friedman, James W., 492n5 Government intervention able, 533–534 Frijters, Paul, 81n5 Fudenberg, Drew, 492n5 competitive markets and, 317–323 marginal revenue product, 531 Fullerton, Don, 673n7 price controls, 58–60 market supply of, 539–541 Future cash flows, negative, 572 price supports and, 332–333 supply to a firm, 537–539 Graham, Daniel, 44n11 Factor markets G Graham, David, 331n7 competitive, 529–542 Greene, David, 44n11 economic rent and, 542–544 Games, defined, 487 Greene, William H., 269n19 equilibrium in, 542–545 Game theory. See also Prisoners’ dilemma Greenhouse gases. See Global warming market demand curve and, 534–535 Greenstone, Michael, 135n9 with monopoly power, 550–555 acquiring a company and, 490 Griffin, James M., 55n18, 294n4 with monopsony power, 546–550 auctions and, 516–524 Griliches, Zvi, 105n15 Factors of production, 204 bargaining strategy and, 508–509 Gross domestic product (GDP), 42–43 Factory, net present value of, 570–571 battle of the sexes game, 497–498 Grossman, Gene M., 621n7 Fair, Ray C., 541n3 beach location game, 493–494 Guarantees, product, 642 Fairness, 192–194 commitment and credibility and, Farber, Henry S., 196n34 H Federal funds rate, 590 506–508 Federal Trade Commission Act (1914, dominant strategy and, 490–491 Hahn, Robert W., 673n8 empty threats and, 506 Haisken-Denew, John P., 81n5 amended 1938, 1973, 1975), 391 entry deterrence and, 510–516 Hall, Robert E., 91n10 Financial losses, competitive firm extensive form of a game and, 503–504 Halvorsen, Robert, 587n21 finite number of repetitions and, 499 Hamermesh, Daniel, 643n7 incurring, 289–290 infinitely repeated game, 499 Hamilton, James D., 54n19 Firm interactions, monopoly power and, 377 matching pennies game, 496–497 Hansen, Julia, 130n5 First-degree price discrimination, 401–404 maximin strategies and, 494–496 Happiness First mover advantage, 463–464 mixed strategies and, 496–498 Fisher, Franklin M., 46n12 moving first advantage and, 504–505 marginal utility and, 97–98 Fishing industry Nash equilibrium and, 492–498 ordinal scale for, 81–82 noncooperative vs. cooperative games, Harrison, David, Jr., 693n25 common property resources and, Hauser, John, 467n5 687–690 488–489 Health care product choice problem, 492–493 consumer choice of, 90–91 property rights and, 685 repeated games, 498–502 inefficiency in health care system, Fishman, Alan, 647 reputation and, 507–508 Fixed costs, 233–234 sequential games, 502–505 626–627 Fixed input, 205 strategic decisions and, 487–490 production function for, 211–212 Fixed-proportions production function, tit-for-tat strategy, 498–499 winner’s curse and, 519–520 219–220 Gasoline Fixed-weight indexes, 103 demand for, 40–41, 43–45 Flows vs. stocks, 560–561

INDEX • 737 Herd behavior, 184, 195 Giffen good and, 122 Internet auctions, 522–524 Hersey Products, 501 income and substitution effects and, Internet bubble, 185 Herzlinger, Regina E., 649n16 Intertemporal price discrimination, 410–413 Hester, Gordon L., 673n8 119–124 Intertemporal production decisions, 584–587 Hewlett-Packard, 8, 235 income changes and, 114–115 Hicks, John, 156 individual demand curve and, 112–114 individual resource producers and, Hicksian substitution effect, 156–157 normal vs. inferior goods and, 115–116 584–585 Himmelberg, Charles, 195n33 price changes and, 112, 113 Hochman, Eithan, 222n11 substitutes and complements and, market price behavior and, 584–585 Holden, Reed, 291n3 resource production by monopolist, Home Box Office, 426 118–119 Homogeneous products, price competition Individual resource producer, production 586–587 user cost and, 585–586 with, 465–467 decisions by, 584–585 Interviews, demand determination and, 143 Horizontal integration, 439, 651 Industries, definition of, 8 Investment decisions, consumer, 578–580 Horizontal summation of demand, 124 Industry demand for labor, determining, Investment portfolio, risk and, 179–180 Hortaçsu, Ali, 522n22 iPod production, 621–622 Hossain, Tankim, 195n32 534–535 Irvin, Thomas R., 665n3 Hotelling, Harold, 585n20 Inefficiency Irwin, D. A., 265n26 Hotelling rule, 585n20 Isocost line, 245 Housing negative externalities and, 662–664 Isoelastic demand, 127–128 positive externalities and, 664–665 Isoquant maps, 217 cooperatives, 283–284 Inelastic demand, 126, 321 Isoquants, 216–217 demand for, 129–130 Inferior goods, 115–116, 121 Isoutility curve, 79 long-run supply of, 313–314 Infinitely elastic demand, 34, 35 selling a house, 192 Infinitely repeated game, 499 J Housing price bubble, 185–188 Infiniti, 426 Hufbauer, Gary Clyde, 622n9 Inflation-adjusted returns, 178 Jensen, Clarence W., 343n13 Human capital, 580–584 Inflexibility, short-run production, 253–254 Jet fuel, demand for, 536–537 Human kidneys, market for, 325–328 Information Job market signaling, 638–643 Hybrid cars, 16 market failure and, 324 Johnson, D. Gale, 343n13 value of and risk, 174–176 Jones, Charles I., 91n10 I Informational cascades, 187, 189 Jorgenson, Dale W., 105n15 Inglehart, Ronald, 81n6 Joskow, Paul, 675n10 IBM, 235, 429 Input choices, production and, 202 Just, Richard E., 222n11 Ideal cost-of-living indexes, 101–102 Input efficiency, 613–614 Import tariffs or quotas, 340–344 Input flexibility, 217 K Incentive design, in integrated firms, Input price changes, 293–294 Input substitution, 218–219 Kahn, James R., 44n11 652–654 Insurance, 171–173 Kahneman, Daniel, 98n11, 189n24, 191n27, Incentive programs, 334–335 actuarial fairness and, 172–173 Income adverse selection and, 634–635 194n31 law of large numbers and, 172 Kao Soap Ltd., 467–469, 471–472 budget constraints and, 84 moral hazard and, 643–645 Kaplan, Daniel P., 331n7 distribution of, 29 risk and, 172–173 Kaplow, Louis, 671n5 elasticities of demand, 34–36, 41 title insurance, 173–174 Kaserman, David L., 327n4, 327n5 happiness and, 82 Integrated firm, asymmetric information Katz, Lawrence, 554n10 individual demand and, 113–114 Kessler, Daniel, 176n9 risk aversion and, 166–167 in, 652–654 Killinger, Kerry, 647, 648n13–14 from sales jobs, 161, 164 Intercollegiate athletics, cartelization of, Kimberly-Clark, 515–516, 576–578 Income-consumption curve, 114–115 Kinked demand curve model, 473–474 Income effects, 121–122, 155–157 480–481 Klein, Benjamin, 429n19 Increasing-cost industries, 308–309 Interest rates Klenow, P. J., 265n15 Increasing returns to scale, 223, 256 Knetsch, Jack, 189n24, 191n27 Incremental profit, 402n3 determination of, 588–590 Knight, Frank, 160n1 Indifference curves present discounted value and, 561–564 Knittel, Chris, 131n6 consumer preferences and, 71–72 variety of, 589–590 Kohlhase, Janet E., 541n3 convexity, 75 International Bauxite Association (IBA), 477 Kraemer, Kenneth L., 621n8 ordinal utility function and, 80 International Coffee Agreement Kraft General Foods, 142 risk and, 180–183 Krasker, William S., 649n16 risk aversion and, 169 (ICA), 47n13 Kreps, David, 465n2, 497n7 shape of, 73–74 International competition, strategic trade Krueger, Alan, 16n8, 549n7, 554n10 utility functions and, 79–80 Krugman, Paul R., 513n14 Indifference maps, 72–73 policy and, 512–514 Individual demand, 112–119. See also International Competition Network, 392 L International Council of Copper Exporting Market demand; Network Labor curve externalities Countries (CIPEC), 479, 480 average product of, 209 Engel curves and, 116–118 International trade marginal product of, 209 comparative advantage and, 619 expanded possibilities frontier and, 619–620 gains from, 618–623 protectionism and, 622–623

738 • INDEX Labor market Long-run costs, 243–253 Marginal rate of substitution, 74–75, 114, asymmetric information in, 654–656 average costs, 254–255 151–152 equilibrium in, 542–545 choosing inputs and, 245–247 predicting requirements in, 263 cost minimization with varying output Marginal rate of technical substitution, 218, productivity and, 214 levels and, 249–250 247, 274–275 signaling in, 638–642 cost minimizing input choice and, 244–245 Marginal rate of transformation, 614–615 Labor supply effluent fees and, 247–249 Marginal revenue elasticities of, 541 expansion path and, 249–251 for one- and two-earner households, isocost line and, 245 monopoly and, 358–359 541–542 price of capital and, 244 one variable input and, 530–533 shifts in, 532 relationship with short-run costs, profit maximization and, 284–287, 257–258 Lagrange multipliers, 150–151 rental rate of capital and, 244–245 361–362 Lagrangian function, 150 user cost of capital and, 243–244 several variable inputs and, 533–534 Land rent, 544 Marginal revenue product, 531 Langley, Sudchada, 37n8, 129n3 Long-run elasticities, 39–48, 311–312 Marginal social cost, 663 Laspeyres price index, 102–103 Long-run expansion path, 253 Marginal utility Law of diminishing marginal returns, Long-run marginal cost curve, 254–255 consumer choice and, 95–100 Long-run producer surplus, 305–306 of income, 152 209–211 Long-run production, 205 utility maximization and, 149 Law of large numbers, 172 Long-run profit maximization, 300–301 Market baskets (market bundles) Law of small numbers, 195 Long-run supply, 306–314 budget line and, 83 Learning curve consumer preferences and, 69–70 constant-cost industries and, 307–308 Market-clearing price, 25, 326 changes in cost and, 261–265 decreasing-cost industries and, 310 Market concentration, monopolies and, 376 versus economies of scale, 262–264 elasticity and, 311–312 Market data, fitting supply and demand graphing of, 261–262 increasing-cost industries and, 308–309 in practice, 264–265 tax effects and, 310–311 curves to, 49–52 Least-squares criterion, 701 Loss aversion, 191 Market definition, 8, 9–10 Least-squares estimator, 702n2 Lost earnings, value of, 563–564 Market demand, 124–132 Least-squares regression, 266 Lustgarten, Steven H., 389n17 Lee, Jungmin, 643n7 coupons and rebates and, 409 Lee, William C., 98n12 M curve of, 534–535 Legal service auctioning, 522 elasticity of demand and, 126–128 Legal solutions, property rights and, MacAvoy, Paul W., 59n22 from individual to market demand, MacCrimmon, Kenneth R., 169n7 686–687 MacCulloch, Robert, 81n4 124–126 Lehn, Kenneth, 637n3 MacKie-Mason, Jeffrey K., 478n12 inelastic demand, 126 Lemons problem, 633 Macroeconomics, definition of, 3 isoelastic demand, 127–128 Lenovo, 8 Macunovich, Diane J., 541n3 Market failure, 323–325 Leontief production function, 219–221 Majority-rule voting, 694 correcting, 667–678 Lerner Index of Monopoly Power, 371–373 Major league baseball externalities and, 324, 626 Levinsohn, James, 89n8 incomplete information and, 625–626 Lewbel, Arthur, 425n17 asymmetric information and, 638 lack of information and, 324 Lexus, 426 lemons in, 637–638 market power and, 625 Lieberman, Marvin, 264n13 monopsony power and, 548–549 public goods and, 626, 692–693 Lin, William, 39n9 Maloney, M. T., 674n9 Marketing experiments, direct, 143 Linden, Greg, 621n8 Malthus, Thomas, 211, 212 Market mechanism, supply and demand Linear demand curves, 34 Managerial incentives, 652–654 Linear regression, 700 applications, 654 curve and, 21, 25–26 Linear supply and demand curves, 49–52, Manthy, Robert S., 30n4 Market-oriented view of equity, 611, 612 Marginal benefit, 87 Market power, 358, 625 127, 461–463 Marginal costs Linux, 390 average-marginal relationship, 239–240 elasticities of demand for soft drinks, 370 List, John A., 191n8 consumer choice and, 87 production, price, and monopoly Loanable funds, supply and estimation of, 291–292 external, 663 power, 371 demand of, 588–590 monopolies and, 359–361 vertical integration and, 439–443 Loewenstein, George, 189n23, 196n34 opportunity, 551 Market price, 8–9 Long, M.W., 370n6 production and, 236–237 Market price behavior, 585 Long-run average cost curve (LAC), 254 profit maximization and, 284–287 Markets Long-run competitive equilibrium, 303 short-run, 238 competitive vs. noncompetitive, 8 Marginal expenditure, 383, 537, 546–547 extent of, 9–12 accounting profit and, 301–302 Marginal products nature of, 7–12 economic profit and, 301–302 labor curve and, 209 perfectly competitive, 8 entry and exit and, 300, 302–304 production process and, 206–207 role of, 5 firms having different costs and, 304 relationship with average products, 209 Market signaling, asymmetric information firms having identical costs, 304 monopolistic competition and, 453–454 and, 638–643 opportunity cost of land and, 304 Market supply zero economic profit and, 302 elasticity of, 296–297 short-run curves and, 295–300 Market value maximization, 282n1 Markup pricing, 372–373

INDEX • 739 Matching pennies game, 496–497 perfect competition versus, 454 National defense, 691 Maximin strategies, game theory and, power of, 368–375 National Organ Transplantation Act, price regulation and, 379–380 494–496 pricing rule of thumb and, 363–364, 372 325, 326 Mayer, Christopher, 195n33 production with two plants, 369 Natural Gas Policy Act of 1978, 59n22 McAfee, Preston, 516n19 regulation in practice and, 381–382 Natural gas shortages, price controls and, McClennan, Mark, 176n9 rent seeking and, 378–379 McDermott, Shaun P., 673n7 resource production by monopolist, 59–60, 322–323 McDonald’s, 428, 636 Natural monopoly, 377 McKean, Brian J., 673n8 586–587 Natural resource prices, 29–31 Medical care, value of information short and long run equilibrium Negative externalities, 662–664 Negatively correlated variables, 171 and, 175–176 and, 453–454 Negative network externalities, Medicare, 635n2, 636–637 social costs of, 377–382 Menell, Peter S., 678n13 sources of power, 375–377 137–138 Merck, 281 tax effects and, 366–367 Neptune Water Meter Company, 501 Mercurio Europeo, 478 unionized and nonunionized Net present value Metals, supply of, 45–46 Metering demand, 428–429 workers and, 552 capital investment decisions and, Method of Lagrange multipliers, 150–151 wage rates and, 551–552 569–573 Microeconomics Monopsony, 382–385 bargaining power and, 548 of college education, 581 definition of, 3 buyer interaction and, 387 discount rates and, 575–576 reasons to study, 16–18 deadweight loss from, 387 interest rates and, 589–590 themes of, 4–7 definition of, 357, 358 Network externalities, 135–139 Microsoft, 390, 567–569 elasticity of market supply and, bandwagon effect and, 136 Microsoft Corporation, 235, 394–395, Internet auctions and, 523 386–387 negative, 137–138 429, 530 factor markets and, 546–550 positive, 135–137 Milgrom, Paul, 516n19 marginal and averaged expenditure snob effect and, 137 Military pay, 545 Neumark, David, 16n8, 550n8 Milk cartel, 481–482 and, 546–547 Nevin, John R., 456n1 Miller, Jonathan, 284n2 monopoly compared, 385 Nevo, Aviv, 408n5 Mineral resources, 29–31 monopsonist buyer, 384 Newell, Richard G., 251n8 Minimum cost, producing an number of buyers and, 387 New York taxicab supply, 312–313, power and, 382–385 output and, 246 purchasing decisions and, 547–548 338–339, 573 Minimum prices, 328–331 social costs of, 387–388 Noll, Roger, 548n5 Minimum wage sources of power, 386–387 Nominal discount rate, 571–572 U.S. manufacturing and, 388–389 Nominal prices, 12–16 history of, 15–16 Montero, J. P., 675n10 Noncompetitive markets, 8 teenage labor markets and, 549–550 Moral hazard, 643–645 Nonconstant sum game, 488n2 unemployment and, 329 Morgan, John, 175n8, 195n32 Noncooperative games, 470, 488–489 Miranda, Marie Lynn, 678n13 Morkre, Morris E., 343n13 Nondiversifiable risk, 179, 574–575 Mixed bundling, 423–426 Morrison, S., 331n7 Nonexclusive goods, 690–691 Mixed strategies, game theory and, Movies Nonprice rationing, 98–100 bundling of, 419–420 Nonprofit hospitals, 649 496–498 DVD rental effect on, 596–597 Nonprofit organizations, 649 Mobil Oil, 429 Mueller, Michael J., 587n21 Nonrival goods, 690 Models, 5–6 Multiplant firms, monopolies and, 367–368 Nonsystematic risk, 574n12 Monopoly, 358–368, 452–456. See also Multiple regression analysis, 700–707 Nonunionized workers, monopoly power demand for coal (example), 706–707 Antitrust laws; Monopsony economic forecasting, 704–705 and, 552 average and marginal revenue and, estimation, 701–702 Normal vs. inferior goods, 115–116 goodness of fit, 704 Normative analysis, 6–7 358–359 statistical tests, 702–704 North American Free Trade Agreement bilateral monopoly, 388 Municipal solid waste regulation, 678 cartels and, 478 Murphy, Kevin M., 550n8 (NAFTA), 622–623 deadweight loss and, 378 Mutual funds, diversification and, 171 Northeast Interstate Dairy Compact, 481 definition of, 357, 358, 452 Myers, Stewart, 574n12 Northwestern University Law School, demand shifts and, 365–366 economic efficiency and, 454–455 N 232–233 elasticity of market demand and, 376 No-shirking constraint curve, 655 factor markets and, 550–555 Nagle, Thomas, 291n3 firm interactions and, 377 Narasimhan, Chakravarthi, 408n5 O Lerner Index and, 371–372 Nash, John, 458 makings of, 452–453 Nash equilibrium, 458, 466, 467, 469, 492–498 Office space, September 11 measuring power of, 371–372 National Collegiate Athletic Association effects on, 31–32 monopsony compared, 385 multiplant firms and, 367–368 (NCAA), 481 Oi, Walter Y., 414n12 natural monopoly, 380–381 Oil market, upheaval in, 54–58 number of firms and, 376–377 output decisions and, 359–361 price elasticity estimates, 55 price of crude oil, 55 Saudi production cut, impact of, 57

740 • INDEX Oligopoly, 456–464 Perfectly competitive markets, 279–281 consumer expenditures and, 126–128 Cournot model and, 458–461 free entry and exit and, 280–281 coupons and, 409 definition of, 452 price taking and, 280 housing demand and, 129–130 dominant firm model and, 476–477 product homogeneity and, 280 Price elasticity of demand, 33 first mover advantage and, 463–464 Price elasticity of supply, 36 kinked demand curve model and, Perfectly elastic supply, 297 Price leadership, 474 473–474 Perfectly inelastic supply, 297 Price minimums, 328–331 market equilibrium and, 457–458 Perfect price discrimination, 402 Price of capital, 244 Nash equilibrium and, 458 Perfect substitutes, 75–77 Price of risk, 180 prisoners’ dilemma and, 472–477 Perpetuities, 565–566 Price regulation, monopolies and, 379–380 Stackelberg model and, 463–464 Persian Gulf stability, 54–55 Price rigidity, 473–475 Petrin, Amil, 77n3 Prices, role of, 5 Oligopsony, 382 Petroleum products, short-run production Price setting, by dominant firm, 476–477 Olson, C. Vincent, 331n7 Price signaling, 474 Omidyar, Pierre, 523 of, 294–295 Price supports, 332–339 One-earner households, labor Peyer, Urs, 648n14 consumers and, 332 Pfizer, 281 government and, 332–333 supply and, 541–542 Phelps Dodge, 53 import quotas and tariffs and, 340–344 Online consumer electronics market, value Pillsbury, 409 producers and, 332 Pindyck, Robert S., 44n11, 55n18, 59n22, Price taking, 280, 285–287 of information in, 175 Pricing, monopolies and, 363–364 Online trading, 183 372n8, 478n12, 570n10, 587n21, Prilosec pricing, 364–365 Opportunity costs 684n18, 700n1 Prime rate, 475, 590 Point elasticity of demand, 36 Principal-agent problem, 645–651 of capital, 570 Polinsky, A. Mitchell, 164n5 incentives and, 650–651 of land, 304 Pollution in private enterprises, 646–647 marginal cost and, 292 demand for clean air and, 693–694 in public enterprises, 648–649 measuring, 230–231 emissions example, 667–678 Prisoners’ dilemma, 470–472, 495–496 Optimal strategy, defined, 488 global warming and, 679–684 Prius, 16 Optimization, constrained, 149 recycling and, 675–677 Private proceedings, antitrust laws and, 391 Orange, 417, 418 solid waste, 678 Private-sector unionism, decline of, Ordinal utility function, 80 value of clean air and, 134–135 Organization of Petroleum Exporting Positive analysis, 6–7 553–554 Positively correlated variables, 171 Private-value auctions, 517–518 Countries (OPEC), 44, 54–58, Positive network externalities, 135–137 Probabilities, subjective, 195 478–479, 585, 587 Potential interactions, 8 Procter & Gamble, 452, 467–469, 471–472, Organ Procurement and Transplantation Predatory pricing, 390 Network (OPTN), 325 Prediction accuracy, 6 515–516, 576–578 Orr, James, 32n5 Preemptive investment strategy, 509–510 Producer Price Index (PPI), 12, 100 Output decisions, monopolies and, Present discounted value, 561–564 Producers, price supports and, 332 359–361 Price caps, 382 Producer surplus, 318–323 Output efficiency, 615–616 Price changes Output rule, 288 budget constraints and, 84–86 change in, 320–321 Over-the-counter drugs, advertising individual demand and, 112 in long run, 305–306 expenditures and, 432–433 Price competition, 465 versus profit, 299–300 Bertrand model and, 464–465 short run, 298–300 P choosing prices and, 466–467 Production. See also Production costs with differentiated products, 465–467 cost constraints and, 202 Paasche index, 103–104 with homogeneous products, 465–467 decisions of firms and, 201–202 Pakes, Ariel, 89n8 Price-consumption curve, 112 factors of, 201–202 Palmer, Karen, 251n8 Price controls, 58–60, 319–323 firms and their production decisions, Parallel conduct, 390 Price discrimination, 401–410. See also Pareto, Vilfredo, 602 Bundling 202–205 Pareto efficient allocation, 602, 611 consumer group creation and, 405–406 flows (inputs and outputs), 204 Pareto inefficient allocation, 611 first-degree, 401–404 function of, 202 Parry, Ian, 44n11 imperfect, 402–404 health care, production function for, Partial equilibrium analysis, 595, 596 intertemporal, 410–412 Patents, 376 peak-load pricing and, 410, 412–413 211–212 Payment streams, valuing of, 562–563 perfect, 402 input choices and, 202 Payoff relative prices and, 406–407 measuring costs of, 229–237 second-degree, 404, 405 production function, 204 defined, 488 third-degree, 404–410 returns to scale and, 223–226 expected, 495 two-part tariffs and, 414–419 short run vs. long run, 205 matrix, 470 Price elasticity. See also Elasticity in supply technology and, 201–202 risk and, 161 and demand Production choice problem, 507 Peak-load pricing, 410, 412–413 air travel and, 409–410 Production costs P/E ratio for S&P 500, 184 accounting costs, 230 Perfect competition, equity and, 612–613 average costs, 237 Perfect complements, 75–77

Cobb-Douglas production function Products INDEX • 741 and, 276–278 choice problem, 492–493 curve slopes, 207–209 Raphael, Stephen S., 314n11 cost functions and, 266–267 differentiation, price competition and, Raphael, Steven, 130n4 cost minimization and, 273–274 465–467 Rate of return. See Effective yield, bond degree of economies of scope, 259–260 diversity, monopolistic competition Rate-of-return regulation, 381 diseconomies of scope and, 259 and, 455 Rationing, gasoline, 98–100 duality in production and cost theory, homogeneity, perfect competition Rawls, John, 611n3 and, 280 Rawlsian view of equity, 611, 612 275–276 transformation curves, 258–259 Raw material costs, 23 dynamic changes in costs, 261–265 Reaction curves, Cournot economic costs, 230 Profit maximization, 282–284. See also economies and diseconomies of scale Competitive firms equilibrium and, 460 Real discount rate, 571–572 and, 255–256 assumptions of, 282 Real prices, 12–16 economies of scope and, 258–261 choosing output in the long run, Real returns, 178 energy reduction, 251–253 Rebates, 123–124, 408–409 estimating and predicting of, 265–269 300–306 Recreation, revealed preference for, 94–95 fixed costs, 233–234 highly competitive markets, 281 Recycling, 675–677 learning curve and, 261–265 long run, 300–301 Reference point, 190–191 long-run and short-run relationship management cost considerations and, Refundable deposits, 677 Regression. See Multiple regression analysis and, 257–258 291–292 Regression residual, 701 long-run average costs and, 254–255 marginal cost and revenue and, 284– Regulation, monopolies and, 381 long-run costs, 243–253 Regulatory lag, 382 marginal costs, 236–237 287, 362 Reiley, David Jr., 492n5 marginal rate of technical substitution, organizational forms and, 283 Relative prices, determination of, 406–407 short-run by competitive firm, 287–289 Relative valuations, bundling and, 420–423 274–275 Profits Rental rate of capital, 244–245 opportunity costs, 230–231 competitive equilibrium and, 301–304 Rent-maximizing policy, 552 product transformation curves, 258–259 producer surplus versus, 299–300 Rent seeking, 378–379 short-run costs, 237–242 Property rights, 684–685 Repeated games, 498–502 short-run production inflexibility, bargaining and economic efficiency, Reputation, 507–508 Research and development (R&D), 665, 679 253–254 685–686 Reservation prices, 401, 420 shutting down and, 233 legal solutions and, 686–687 Reserve price, auctioning and, 517 sunk costs, 231–232 Prospective sunk costs, 232, 234 Resource depletion, 584–587 total costs, 233 Protectionism, 622–623 variable costs, 233–234 Public education, 691 degrees of, 587 Production decisions, intertemporal, 584–587 Public goods, 690–694 price of exhaustible resource, 586 Production efficiency, 613–618 definition of, 626 Resource production, by monopolist, input efficiency, 613–614 efficiency and, 691–692 marginal rate of transformation and, market failure and, 692–693 586–587 nonexclusive goods, 690–691 Restaurants, pricing and, 427–428 614–615 private preferences for, 694–696 Return, tradeoff with risk, 179–180 output efficiency and, 615–616 Public organizations, principal-agent Return on assets, 177–179 output markets and, 617–618 Returns to scale, 223–226 Production possibilities frontier, 614–615 problem and, 648–649 Production quotas, 333–338 Publishing, price discrimination constant, 223 Production technology, 201–202 decreasing, 223 Production with one variable input (labor), and, 413 description of, 224 Purchasing decisions, with monopsony increasing, 223 206–215 Revealed preference, 92–95 average and marginal products and, power, 547–548 Revenue-sharing arrangements, 651 Purchasing power, 85 Reynolds, R. Larry, 327n4 206–207 Pure bundling, 423–424 Rhône-Poulenc of France, 393 average product of labor curve and, 209 Pure monopoly, 357, 368 Rigidity, price, 473–474 labor productivity and, 214 Pure monopsony, 358 Risk. See also Assets; Behavioral economics law of diminishing marginal returns Putnam, Howard, 392 aversion to, 166–169 budget line and, 180 and, 209–211 Q business executives and, 169–170 marginal product of labor curve and, 209 decision making and, 163–164 product curve slopes and, 207–209 Quadratic cost function, 267 demand for risky assets, 176–184 Production with two variable inputs, Quality uncertainty, 632–638 description of, 160–165 Quantity discounts, 404 diversification and, 170–171 216–223 Quantity forcing, 443 expected value and, 161 diminishing marginal returns and, Quigley, John, 130n4, 314n11 indifference curves and, 180–183 information value and, 174–176 217–219 R insurance and, 172–173 fixed-proportions production function Rabin, Matthew, 189n23 and, 219–220 Range of products, 9 input flexibility and, 217 Rapaport, Carol, 32n5 isoquants and, 216–217 perfect substitutes and, 219, 220 substitution among inputs and, 218–219

742 • INDEX Risk (continued) Sherman Act (1890), 390, 391 Statistical tests, 702–704 investment portfolio and, 179–180 Sherwin, Robert A., 10n3 Steel production, 247–249 investor’s choice problem and, 180–183 Shields, Dennis, 39n9 Sterner, Thomas, 44n11 nondiversifiable risk, 178 Shields, Michael A., 81n5 Stigler, George J., 10n3 pooling of, 635 Shirking model, 655 Stiglitz, Joseph E., 654n20 preferences toward, 165–170 Shortage, price pressures and, 25–26 Stock externalities, 678–684 premiums, 166–168, 573 Short-run average cost curve (SAC), 254 price of, 180 Short-run costs, 237–242 stock buildup and impact of, 679–682 probability and, 160–161 Stockholder control, 647 reduction of, 170–176 average-marginal relationship, 239–240 Stock of capital, 214 risk loving, 166, 167 cost curves and, 238–240 Stocks and stock market risk neutral, 166, 167 determinants of, 237–238 tradeoff with return, 179–180 diminishing marginal returns and, 238 buying on margin, 183 variability and, 161–163 inflexibility and, 253–254 “contagion,” 600–601 marginal costs and, 238 diversification and, 171 Risk adjustments, 573–578 relationship with long-run costs, 257–258 investing in, 183–184 capital asset pricing model and, 575–576 total cost as a flow, 240 risk and, 177–179 discount rate and, 575–576 Short-run elasticities, 39–48 stock prices in U.S. and Europe, 601 diversifiable vs. nondiversifiable Short-run equilibrium, monopolistic com- Stocks vs. flows, 560–561 risk, 574–575 Stollery, Kenneth R., 587n21 petition and, 453–454 Strategic behavior, 686 Riskless assets, 177 Short-run expansion path, 254 Strategic decisions, gaming and, 487–490 Risky assets, 177 Short-run production, 205 Strategic trade policy, international Short-run profit maximization, 285, 287–289 asset returns, 177–179 Short-run supply curves, 295–300 competition and, 512–514 Rite Aid, 567–569 Shubik, Martin, 489, 489n3 Strategy, defined, 488 Robinson-Patman Act (1936), 391 Shut downs, 233, 289–290 Subjective probability, 160 Roche A.G. of Switzerland, 393 Sibley, David S., 331n7 Subsidies, effects of, 348–349 Rockwell International, 501 Signaling, 641 Substitute goods, 24–25, 118–119 Rose, Nancy L., 331n7 Substitution among inputs, 218–219 Rose-Ackerman, Susan, 327n5 market, 638–643 Substitution effects, 120–121, 155–157 Rossi-Hansberg, Esteban, 621n7 price, 474 Sugar quota, 342–344 Rotemberg, Julio J., 194n30, 474n10 Simonsohn, Uri, 190n25 Sulfur dioxide emissions, 665–666, Roth, Alvin E., 327n4 Sinai, Todd, 195n33 R-squared (R2), 704 Skeath, Susan, 492n5, 516n19 672–673. See also Emissions Rubinfeld, Daniel L., 134n8, 142n12, Skinner, Robert, 39n9 Sumner, Daniel A., 347n14 Slutsky equation, 156 Sunk costs, 231–232 693n25, 700n1 Small, Kenneth, 44n11 Rule-of-thumb, 194–195 Smith, Adam, 609 amortizing of, 234–235 Smith, Vernon, 190n25 entry deterrence and, 509, 510 S Smith, W. James, 130n5 Snob effect, 137 versus fixed costs, 234–235 Saft, Lester F., 429n19 Snow shovel demand, 193 Supermarket chains Salaries. See Wages Social costs Salathe, Larry, 37n8, 129n3 monopolies and, 377–382 advertising and, 432–433 Sales jobs, income from, 161, 164 monopsonies and, 387–388 markup pricing and, 372–373 Salesperson incentives, 654 Social rate of discount, 682 Supplemental Security Income, 105 Saloner, Garth, 474n10 Social Security system solvency, 105 Supply. See also Supply and demand Sample, 702 Social welfare functions, 611–612 durability and, 45–46 Sanford, Scott, 39n9 Soft drinks, elasticities of demand for, 370 elasticities of, 36 Sanger, David E., 337n9 Software, production costs of, 235–236 of loanable funds, 588–590 Satterthwaite, Mark, 176n9 Sönmez, Tayfun, 327n4 long-run, 306–314 Saudi Arabia oil production, 56–58 Sotheby’s auction house, 521, 522 restrictions, 333–334 Scale economies index (SCI), 267 Specific taxes, effects of, 345–348 supply curves, 22–23 Schaller, Bruce, 338n11 Speculative demand, 129 variables affecting, 23 Scheinkman, Jose, 465n2 Spence, Michael, 638n4 Supply and demand. See also Elasticity in Schelling, Thomas, 512n13 Sprint, 417–419 Scherer, F. M., 10n4, 343n13 Stackelberg equilibrium, 492, 492n6 supply and demand Schill, Michael H., 284n2 Stackelberg model, 463–464, 502, 505 changing market conditions and, 48–52 Schmalensee, R., 675n10 Standard and Poor’s/Case-Shiller Housing demand curves, 23–25 Schmalensee, Richard L., 425n17 equilibrium and, 25–26 Scholten, Patrick, 175n8 Price Index, 186, 188 linear curves and, 49–52 Sealed-bid auction, 517 Standard deviation, 162–163 market equilibrium changes and, Secondary supply, 45 Standard error of forecast (SEF), 705 Second-degree price discrimination, 404, 405 Standard error of the regression, 704 26–32 September 11 terrorist attacks, 31–32 Standard of living, labor productivity market mechanism and, 25–26 Sequential games, 502–505 price controls and, 58–60 Shavell, Steven, 164n5, 671n5 and, 214–215 supply curves, 22–23 Surplus consumer, 132–135 market clearance and, 25–26 Systematic risk, 574n12

INDEX • 743 T Triplett, Jack E., 105n16 W Trucking industry, economies of scope in, Takeda Chemical Industries of Japan, 393 Wages Tariffs, 340–342 260–261 computer skills and, 554–555 Tullock, Gordon, 379n12 discrimination in, 552 two-part tariffs, 414–419 Tussing, Arlon R., 59n22 efficiency and, 654–656 world ethanol market and, 598–600 Tversky, Amos, 194n31 inequality of, 29 Tarr, David G., 343n13 Two-earner households, labor supply for, monopoly power and, 551–552 Taubenslag, Nancy, 501n10 substitution and income effects, 540 Taubman, Alfred, 521 541–542 Taxes Two-part tariff, 414–419 Wal-Mart, 509–510 effects of, 345–348 Walt Disney World, 416 firm output and, 311 many consumers and, 415–417 Walton, Sam, 509 monopolies and, 366–367 single consumer and, 414 Wang, Charles C.Y., 648n15 specific, 345–348 two consumers and, 415 Wang, Judy S., 260n11 Taxes, and transfer pricing, 448–449 Tying, 428–429 Warranties, 642, 645 Tax-exempt status, 649 Wascher, William, 16n8, 550n8 Taxicab drivers, 196–197 U Washington Mutual, 647 Taxicab supply, in New York, 312–313, Waste disposal, 675–677 Ulen, Thomas, 685n19 Water meter industry, 501 338–339, 573 Ultimatum game, 193 Webb-Pomerene Act (1918), 390n18 Technical efficiency, 613 Uncertainty, consumer behavior and, 195 Wehrung, Donald A., 169n7 Technical feasibility, 205 Weitzman, Martin, 587n21, 654n19, 684n18 Technological change, 214 bubbles, 185–189 Welch, Finis, 550n8 Technological improvements, effect informational cascades, 187, 189 Welfare economics, 609 Unemployment, 656 Welfare effects, 319, 611–612 of, 210 Unequal probability outcomes, 163 Welfare loss, 332–333 Technology, production, 201, 204 Unilever, Ltd., 467–469, 471–472 Westcott, Paul C., 39n9 Teece, David J., 55n18 Unionized workers Wetzstein, Michael E., 645n8 Teenage labor markets, minimum wage decline of, 552 Wheat monopoly power and, 552 and, 549–550 as percentage of total, 553 aggregate demand for, 128–129 Thaler, Richard, 189n24, 191n27, 196n34 Unit-elastic demand curve, 127 market for, 37–39 Theory of the firm, 5, 201 Ünver, M. Utku, 327n4 price supports and, 335–338 Third-degree price discrimination, 404–410 Usage fees, 414 production function for, 221–222 Tirole, Jean, 492n5 Used car market, asymmetric information Whinston, Clifford, 331n7 Titanium dioxide industry, entry deter- Whitacre, Mark, 393n20 and, 632–634 White, Lawrence J., 689n21 rence and, 514–515 User cost of capital, 243–244 Williamson, Oliver, 204n3 Tit-for-tat strategy, 498–499 User cost of production, 585–586 Winner’s curse, 519–520 Title insurance, 173–174 Utilitarian view of equity, 611, 612 Wohlgenant, Michael K., 347n14 T-Mobile, 417–419 Utility, 78 Wolfram, Catherine, 408n5 Tokgoz, Simla, 598n1 Utility functions, 79–80, 149 Wood, Geoffrey E., 622n9 Tollison, Robert D., 379n12 Utility maximization, demand theory and, Workers, trade-offs and, 4–5 Toothpaste market, 452 World copper industry, 297–298 Total costs, 233, 240 149–150 World food production per capita, 213 Toyota, 16, 310 Utility possibilities frontier, 610–612 Trade, advantages of, 602–603 X Tradeable emissions permits, 671–672, 674 V Trade-offs, optimal, 4–5 Xerox Corporation, 428–429, 643 Transfer pricing Value of complete information, 174 in online consumer electronics Y with competitive outside market, market, 175 446–448 Yandle, Bruce, 674n9 Variability, 161–163 Yellen, Janet L., 654n20 in integrated firm, 443–449 Variable costs, 233–234 with noncompetitive outside market, 448 Variable profit, 401, 402, 402n3 Z no outside market and, 443–446 Variance, calculating, 162 taxes and, 448–449 Verizon, 417–419 Zavodny, Madeline, 549n7 Transitivity, consumer preferences and, 70 Vertical integration, 651 Zero economic profit, 302, 306 Trapani, John M., 331n7 Zero emissions policy, 681 Treasury bills alternatives to, 443 Zilberman, David, 222n11 rates of, 589 market power and double marginaliza- risk and, 178 Treasury bond rate, 589 tion, 439–443 Treaty of the European Community, 392 purpose of, 439–443 Videos, pricing of, 374–375 Viscusi, W. Kip, 580n15 Voicu, Ioan, 284n2

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LIST OF EXAMPLES 1.1 The Market for Sweeteners 10 5.4 The Value of Information in an Online Consumer 1.2 A Bicycle Is a Bicycle. Or Is It? 11 Electronics Market 175 1.3 The Price of Eggs and the Price of a College 5.5 Doctors, Patients, and the Value of Information 175 Education 13 5.6 Investing in the Stock Market 183 1.4 The Minimum Wage 14 5.7 The Housing Price Bubble (I) 186 2.1 The Price of Eggs and the Price of a College 5.8 The Housing Price Bubble (II) 188 5.9 Selling a House 192 Education Revisited 28 5.10 New York City Taxicab Drivers 196 2.2 Wage Inequality in the United States 29 6.1 A Production Function for Health Care 211 2.3 The Long-Run Behavior of Natural Resources 6.2 Malthus and the Food Crisis 212 6.3 Labor Productivity and the Standard of Living 215 Prices 29 6.4 A Production Function for Wheat 221 2.4 The Effects of 9/11 on the Supply and Demand for 6.5 Returns to Scale in the Carpet Industry 225 7.1 Choosing the Location for a New Law School New York City Office Space 31 2.5 The Market for Wheat 37 Building 232 2.6 The Demand for Gasoline and Automobiles 43 7.2 Sunk, Fixed, and Variable Costs: Computers, 2.7 The Weather in Brazil and the Price of Coffee in Software, and Pizzas 235 New York 46 7.3 The Short-Run Cost of Aluminum Smelting 240 2.8 The Behavior of Copper Prices 52 7.4 The Effect of Effluent Fees on Input Choices 247 2.9 Upheaval in the World Oil Market 54 7.5 Reducing the Use of Energy 251 2.10 Price Controls and Natural Gas Shortages 59 7.6 Economies of Scope in the Trucking Industry 260 3.1 Designing New Automobiles (I) 77 7.7 The Learning Curve in Practice 264 3.2 Can Money Buy Happiness? 81 7.8 Cost Functions for Electric Power 268 3.3 Designing New Automobiles (II) 88 8.1 Condominiums versus Cooperatives in 3.4 Consumer Choice of Health Care 90 3.5 A College Trust Fund 92 New York City 283 3.6 Revealed Preference for Recreation 94 8.2 The Short-Run Output Decision of an Aluminum 3.7 Marginal Utility and Happiness 97 3.8 The Bias in the CPI 105 Smelting Plant 290 4.1 Consumer Expenditures in the United States 117 8.3 Some Cost Considerations for Managers 291 4.2 The Effects of a Gasoline Tax 122 8.4 The Short-Run Production of Petroleum Products 294 4.3 The Aggregate Demand for Wheat 128 8.5 The Short-Run World Supply of Copper 297 4.4 The Demand for Housing 129 8.6 Constant-, Increasing-, and Decreasing-Cost 4.5 The Long-Run Demand for Gasoline 131 4.6 The Value of Clean Air 134 Industries: Coffee, Oil, and Automobiles 310 4.7 Facebook 138 8.7 The Supply of Taxicabs in New York 312 4.8 The Demand for Ready-to-Eat Cereal 142 8.8 The Long-Run Supply of Housing 313 5.1 Deterring Crime 164 9.1 Price Controls and Natural Gas Shortages 322 5.2 Business Executives and the Choice of Risk 169 9.2 The Market for Human Kidneys 325 5.3 The Value of Title Insurance When Buying a 9.3 Airline Regulation 330 9.4 Supporting the Price of Wheat 335 House 173 9.5 Why Can’t I Find a Taxi? 338

LIST OF EXAMPLES 9.6 The Sugar Quota 342 14.2 Labor Supply for One- and Two-Earner 9.7 A Tax on Gasoline 349 Households 541 10.1 Astra-Merck Prices Prilosec 364 10.2 Elasticities of Demand for Soft Drinks 370 14.3 Pay in the Military 545 10.3 Markup Pricing: Supermarkets to Designer Jeans 372 14.4 Monopsony Power in the Market for Baseball 10.4 The Pricing of Videos 374 10.5 Monopsony Power in U.S. Manufacturing 388 Players 548 10.6 A Phone Call about Prices 392 14.5 Teenage Labor Markets and the Minimum Wage 549 10.7 Go Directly to Jail. Don’t Pass Go. 393 14.6 The Decline of Private-Sector Unionism 553 10.8 The United States and the European Union versus 14.7 Wage Inequality Revisited 554 15.1 The Value of Lost Earnings 563 Microsoft 394 15.2 The Yields on Corporate Bonds 567 11.1 The Economics of Coupons and Rebates 408 15.3 The Value of a New York City Taxi Medallion 573 11.2 Airline Fares 409 15.4 Capital Investment in the Disposable Diaper 11.3 How to Price a Best-Selling Novel 413 11.4 Pricing Cellular Phone Service 417 Industry 576 11.5 The Complete Dinner versus á la Carte: A 15.5 Choosing an Air Conditioner and a New Car 579 15.5 Should You Go to Business School? 582 Restaurant’s Pricing Problem 427 15.6 How Depletable are Depletable Resources? 587 11.6 Advertising in Practice 432 16.1 The Global Market for Ethanol 598 12.1 Monopolistic Competition in the Markets for Colas 16.2 “Contagion” across Stock Markets around the and Coffee 455 World 600 12.2 A Pricing Problem for Procter & Gamble 467 16.3 Trading Tasks and iPod Production 621 12.3 Procter & Gamble in a Prisoners’ Dilemma 471 16.4 The Costs and Benefits of Special Protection 622 12.4 Price Leadership and Price Rigidity in Commercial 16.5 Inefficiency in the Health Care System 626 17.1 Medicare 636 Banking 475 17.2 Lemons in Major League Baseball 637 12.5 The Prices of College Textbooks 476 17.3 Working into the Night 642 12.6 The Cartelization of lntercollegiate Athletics 480 17.4 Reducing Moral Hazard: Warranties of Animal 12.7 The Milk Cartel 481 13.1 Acquiring a Company 490 Health 645 13.2 Oligopolistic Cooperation in the Water Meter 17.5 CEO Salaries 647 17.6 Managers of Nonprofit Hospitals as Agents 649 Industry 501 17.7 Efficiency Wages at Ford Motor Company 656 13.3 Competition and Collusion in the Airline 18.1 The Costs and Benefits of Sulfur Dioxide Industry 501 Emissions 665 13.4 Wal-Mart Stores’ Preemptive Investment Strategy 509 18.2 Reducing Sulfur Dioxide Emissions in Beijing 672 13.5 DuPont Deters Entry in the Titanium Dioxide 18.3 Emissions Trading and Clean Air 673 18.4 Regulating Municipal Solid Wastes 678 Industry 514 18.5 Global Warming 682 13.6 Diaper Wars 515 18.6 The Coase Theorem at Work 687 13.7 Auctioning Legal Services 522 18.7 Crawfish Fishing in Louisiana 689 13.8 Internet Auctions 522 18.8 The Demand for Clean Air 693 14.1 The Demand for Jet Fuel 536 A.1 The Demand for Coal 706