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Twinkie Tax 3 Income Threshold Model and China 3 Aggregating Corn Demand Curves 17 The Opioid Epidemic’s Labor Market Effects 26 The Demand Elasticities for Google Play and Apple Apps 32 Oil Drilling in the Arctic National Wildlife Refuge 39 Subsidizing Ethanol 47 Venezuelan Price Ceilings and Shortages 51 You Can’t Have Too Much Money 65 MRS Between Recorded Tracks and Live Music 75 Indifference Curves Between Food and Clothing 79 Utility Maximization for Recorded Tracks and Live Music 89 How You Ask a Question Matters 98 Cigarettes Versus E-Cigarettes 110 Fast-Food Engel Curve 116 Substituting Marijuana for Alcohol 122 Reducing the CPI Substitution Bias 134 Willingness to Pay and Consumer Surplus on eBay 146 Compensating Variation and Equivalent Variation for

Smartphones and Facebook 150 Food Stamps Versus Cash 159 Fracking Causes Students to Drop Out 164 Chinese State-Owned Enterprises 179 Malthus and the Green Revolution 187 Self-Driving Trucks 192 Returns to Scale in Various Industries 199 Robots and the Food You Eat 203 A Good Boss Raises Productivity 204 The Opportunity Cost of an MBA 211 The Sharing Economy and the Short Run 215 Short-Run Cost Curves for a Japanese Beer Manufacturer 220 3D Printing 234 A Beer Manufacturer’s Long-Run Cost Curves 236 Choosing an Inkjet or Laser Printer 237 Solar Power Learning Curves 240 Fracking and Shutdowns 264 The Size of Ethanol Processing Plants 272 Industries with High Entry and Exit Rates 274 Upward-Sloping Long-Run Supply Curve for Cotton 276 Reformulated Gasoline Supply Curves 280 What’s a Name Worth? 294 The Deadweight Loss of Christmas Presents 301 Welfare Effects of Allowing Fracking 303 The Deadweight Loss from Gas Taxes 306 How Big Are Farm Subsidies and Who Gets Them? 310 The Social Cost of a Natural Gas Price Ceiling 312 Russian Food Ban 315 Partial-Equilibrium Versus Multimarket-Equilibrium Analysis in Corn

and Soybean Markets 331 Urban Flight 335 Extremely Unequal Wealth 352 Amazon Prime Revenue 371 Apple’s iPad 373 Taylor Swift Concert Pricing 375 The Botox Patent Monopoly 390 Natural Gas Regulation 395 Movie Studios Attacked by 3D Printers! 397

Critical Mass and eBay 399 Disneyland Pricing 415 Preventing Resale of Designer Bags 416 Botox and Price Discrimination 422 Google Uses Bidding for Ads to Price Discriminate 423 Tesla Price Discrimination 424 Age Discrimination 426 Buying Discounts 428 Pricing iTunes 437 Ties That Bind 438 Super Bowl Commercials 445 Strategic Advertising 460 Boomerang Millennials 465 Keeping Out Casinos 475 Bidder’s Curse 480 GM’s Ultimatum 481 Employer “No-Poaching” Cartels 497 Cheating on the Maple Syrup Cartel 499 Airline Mergers 500 Mobile Number Portability 508 How Do Costs, Price Markups, and Profits Vary Across Airlines 510 Differentiating Bottled Water Through Marketing 512 Rising Market Power 526 Monopolistically Competitive Food Truck Market 527 Subsidizing the Entry Cost of Dentists 531 Black Death Raises Wages 549 Saving for Retirement 554 Durability of Telephone Poles 558 Behavioral Economics: Falling Discount Rates and Self-Control 560 Redwood Trees 566 Risk of a Cyberattack 577 Stocks’ Risk Premium 584 Gambling 586 Failure to Diversify 592 Flight Insurance 594 Flooded by Insurance Claims 595 Biased Estimates 600 Disney’s Positive Externality 612 Spam: A Negative Externality 617 Why Tax Drivers 620 Buying a Town 627 Acid Rain Program 628 Road Congestion 630 Microsoft Word Piracy 631 Free Riding on Measles Vaccinations 634 What’s Their Beef? 636 Discounts for Data 653 Adverse Selection and Remanufactured Goods 654 Reducing Consumers’ Information 657 Cheap Talk in eBay’s Best Offer Market 662 Honest Cabbie? 678 Sing for Your Supper 685 Health Insurance and Moral Hazard 689 Capping Oil and Gas Bankruptcies 693 Walmart’s Efficiency Wages 695 Layoffs Versus Pay Cuts 697

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Brief Contents Preface xiv

Chapter 1 Introduction 1

Chapter 2 Supply and Demand 10

Chapter 3 A Consumer’s Constrained Choice 62

Chapter 4 Demand 105

Chapter 5 Consumer Welfare and Policy Analysis 142

Chapter 6 Firms and Production 177

Chapter 7 Costs 209

Chapter 8 Competitive Firms and Markets 248

Chapter 9 Properties and Applications of the Competitive Model 290

Chapter 10 General Equilibrium and Economic Welfare 327

Chapter 11 Monopoly and Monopsony 365

Chapter 12 Pricing and Advertising 412

Chapter 13 Game Theory 452

Chapter 14 Oligopoly and Monopolistic Competition 490

Chapter 15 Factor Markets 539

Chapter 16 Uncertainty 574

Chapter 17 Property Rights, Externalities, Rivalry, and Exclusion 610

Chapter 18 Asymmetric Information 645

Chapter 19 Contracts and Moral Hazards 672

Calculus Appendix E-1

Regression Appendix E-29

Answers to Selected Exercises E-32

Definitions E-53

References E-59

Sources for Applications and Challenges E-68

Index E-77

Credits E-109

v

Contents

Preface xiv

Chapter 1 Introduction 1

1.1 Microeconomics: The Allocation of Scarce Resources 1 Trade-Offs 2 Who Makes the Decisions 2 How Prices Determine Allocations 2 APPLICATION Twinkie Tax 3

1.2 Models 3 APPLICATION Income Threshold Model

and China 3 Simplifications by Assumption 4 Testing Theories 5 Maximizing Subject to Constraints 5 Positive Versus Normative 6 New Theories 7

1.3 Uses of Microeconomic Models in Your Life and Career 8 Summary 9

Chapter 2 Supply and Demand 10

CHALLENGE Quantities and Prices of Genetically Modified Foods 10

2.1 Demand 11 The Demand Function 12 Summing Demand Functions 16 APPLICATION Aggregating Corn

Demand Curves 17 2.2 Supply 17

The Supply Function 18 Summing Supply Functions 20 How Government Import Policies

Affect Supply Curves 20 2.3 Market Equilibrium 21

Finding the Market Equilibrium 22 Forces That Drive a Market to Equilibrium 23

2.4 Shocking the Equilibrium: Comparative Statics 24 Comparative Statics with Discrete (Large)

Changes 25 APPLICATION The Opioid Epidemic’s

Labor Market Effects 26 Comparative Statics with Small Changes 26 Solved Problem 2.1 28 Why the Shapes of Demand and Supply

Curves Matter 29

2.5 Elasticities 30 Demand Elasticity 30 Solved Problem 2.2 31 APPLICATION The Demand Elasticities

for Google Play and Apple Apps 32 Solved Problem 2.3 35 Supply Elasticity 36 Solved Problem 2.4 38 Long Run Versus Short Run 38 APPLICATION Oil Drilling in the Arctic

National Wildlife Refuge 39 Solved Problem 2.5 40

2.6 Effects of a Sales Tax 41 Effects of a Specific Tax on the Equilibrium 42 The Same Equilibrium No Matter Who

Is Taxed 44 Firms and Customers Share the Burden

of the Tax 44 Solved Problem 2.6 46 APPLICATION Subsidizing Ethanol 47 The Similar Effects of Ad Valorem and

Specific Taxes 47 2.7 Quantity Supplied Need Not Equal Quantity

Demanded 48 Price Ceiling 49 APPLICATION Venezuelan Price Ceilings

and Shortages 51 Price Floor 52

2.8 When to Use the Supply-and-Demand Model 53 CHALLENGE SOLUTION Quantities and

Prices of Genetically Modified Foods 54 Summary 55 7 Exercises 56

Chapter 3 A Consumer’s Constrained Choice 62

CHALLENGE Why Americans Buy E-Books and Germans Do Not 62

3.1 Preferences 64 Properties of Consumer Preferences 64 APPLICATION You Can’t Have Too

Much Money 65 Preference Maps 66 Indifference Curves 67 Solved Problem 3.1 69

3.2 Utility 69 Utility Function 69 Willingness to Substitute Between Goods 72

vi

viiContents

Solved Problem 4.7 127 Slutsky Equation 127

4.4 Cost-of-Living Adjustment 129 Inflation Indexes 129 Effects of Inflation Adjustments 131 APPLICATION Reducing the CPI

Substitution Bias 134 4.5 Revealed Preference 135

Recovering Preferences 135 Substitution Effect 136 CHALLENGE SOLUTION Paying Employees

to Relocate 137 Summary 138 7 Exercises 139

Chapter 5 Consumer Welfare and Policy Analysis 142

CHALLENGE Per-Hour Versus Lump-Sum Childcare Subsidies 142

5.1 Uncompensated Consumer Welfare 143 Willingness to Pay 144 An Individual’s Consumer Surplus 144 A Market’s Consumer Surplus 145 APPLICATION Willingness to Pay and

Consumer Surplus on eBay 146 Effect of a Price Change on Consumer Surplus 147 Solved Problem 5.1 147

5.2 Compensated Consumer Welfare 148 Indifference Curve Analysis 148 APPLICATION Compensating Variation

and Equivalent Variation for Smartphones and Facebook 150

Compensated Demand Curves and Consumer Welfare 151

Comparing the Three Welfare Measures 152 Solved Problem 5.2 154

5.3 Effects of Government Policies on Consumer Welfare 155 Quotas 155 Food Stamps 157 APPLICATION Food Stamps Versus Cash 159

5.4 Deriving Labor Supply Curves 159 Labor-Leisure Choice 159 Solved Problem 5.3 162 Income and Substitution Effects 163 Solved Problem 5.4 164 APPLICATION Fracking Causes Students

to Drop Out 164 Solved Problem 5.5 165 Shape of the Labor Supply Curve 166 Income Tax Rates and the Labor

Supply Curve 167 Solved Problem 5.6 169 CHALLENGE SOLUTION Per-Hour Versus

Lump-Sum Childcare Subsidies 170 Summary 172 7 Exercises 173

Solved Problem 3.2 74 APPLICATION MRS Between Recorded

Tracks and Live Music 75 Curvature of Indifference Curves 75 Solved Problem 3.3 78 APPLICATION Indifference Curves Between

Food and Clothing 79 3.3 Budget Constraint 79 3.4 Constrained Consumer Choice 81

Finding an Interior Solution Using Graphs 82 Solved Problem 3.4 84 Finding an Interior Solution Using Calculus 84 Solved Problem 3.5 86 Solved Problem 3.6 87 Solved Problem 3.7 89 APPLICATION Utility Maximization for

Recorded Tracks and Live Music 89 Finding Corner Solutions 90 Minimizing Expenditure 94 Solved Problem 3.8 95

3.5 Behavioral Economics 96 Tests of Transitivity 97 Endowment Effect 97 APPLICATION How You Ask a Question

Matters 98 Salience 98 CHALLENGE SOLUTION Why Americans

Buy E-Books and Germans Do Not 100 Summary 100 7 Exercises 101

Chapter 4 Demand 105

CHALLENGE Paying Employees to Relocate 105

4.1 Deriving Demand Curves 106 System of Demand Functions 106 Graphical Interpretation 107 APPLICATION Cigarettes Versus E-Cigarettes 110

4.2 Effects of an Increase in Income 110 How Income Changes Shift Demand Curves 111 Solved Problem 4.1 112 Consumer Theory and Income Elasticities 113 Solved Problem 4.2 114 APPLICATION Fast-Food Engel Curve 116 Solved Problem 4.3 118

4.3 Effects of a Price Increase 118 Income and Substitution Effects with a

Normal Good 119 Solved Problem 4.4 121 APPLICATION Substituting Marijuana

for Alcohol 122 Solved Problem 4.5 122 Income and Substitution Effects with

an Inferior Good 123 Solved Problem 4.6 123 Compensated Demand Curve 124

viii Contents

Solved Problem 7.1 212 Opportunity Cost of Capital 212 Sunk Costs 213

7.2 Short-Run Costs 214 Short-Run Cost Measures 214 APPLICATION The Sharing Economy

and the Short Run 215 Solved Problem 7.2 216 Short-Run Cost Curves 217 Production Functions and the Shape of

Cost Curves 218 APPLICATION Short-Run Cost Curves

for a Japanese Beer Manufacturer 220 Effects of Taxes on Costs 221 Short-Run Cost Summary 221

7.3 Long-Run Costs 222 Input Choice 223 Solved Problem 7.3 226 Solved Problem 7.4 228 How Long-Run Cost Varies with Output 230 Solved Problem 7.5 231 Solved Problem 7.6 233 The Shape of Long-Run Cost Curves 233 APPLICATION 3D Printing 234 Estimating Cost Curves Versus

Introspection 235 7.4 Lower Costs in the Long Run 235

Long-Run Average Cost as the Envelope of Short-Run Average Cost Curves 235

APPLICATION A Beer Manufacturer’s Long-Run Cost Curves 236

APPLICATION Choosing an Inkjet or Laser Printer 237

Short-Run and Long-Run Expansion Paths 238 How Learning by Doing Lowers Costs 238 APPLICATION Solar Power Learning

Curves 240 7.5 Cost of Producing Multiple Goods 240

CHALLENGE SOLUTION Technology Choice at Home Versus Abroad 242

Summary 243 7 Exercises 244

Chapter 8 Competitive Firms and Markets 248

CHALLENGE The Rising Cost of Keeping On Truckin’ 248

8.1 Perfect Competition 249 Price Taking 249 Why a Firm’s Demand Curve Is Horizontal 250 Perfect Competition in the Chicago

Commodity Exchange 251 Deviations from Perfect Competition 251 Derivation of a Competitive Firm’s

Demand Curve 252 Solved Problem 8.1 254 Why Perfect Competition Is Important 254

Chapter 6 Firms and Production 177

CHALLENGE Labor Productivity During Downturns 177

6.1 The Ownership and Management of Firms 178 Private, Public, and Nonprofit Firms 178 APPLICATION Chinese State-Owned

Enterprises 179 The Ownership of For-Profit Firms 179 The Management of Firms 180 What Owners Want 180

6.2 Production 181 Production Functions 181 Time and the Variability of Inputs 181

6.3 Short-Run Production: One Variable and One Fixed Input 182 Solved Problem 6.1 183 Interpretation of Graphs 184 Solved Problem 6.2 186 Law of Diminishing Marginal Returns 186 APPLICATION Malthus and the Green

Revolution 187 6.4 Long-Run Production: Two Variable Inputs 189

Isoquants 189 APPLICATION Self-Driving Trucks 192 Substituting Inputs 193 Solved Problem 6.3 194 Diminishing Marginal Rates of

Technical Substitution 194 The Elasticity of Substitution 194 Solved Problem 6.4 197

6.5 Returns to Scale 197 Constant, Increasing, and Decreasing

Returns to Scale 197 Solved Problem 6.5 198 APPLICATION Returns to Scale in Various

Industries 199 Varying Returns to Scale 200

6.6 Productivity and Technical Change 201 Relative Productivity 201 Innovations 202 APPLICATION Robots and the Food You Eat 203 APPLICATION A Good Boss Raises

Productivity 204 CHALLENGE SOLUTION Labor

Productivity During Downturns 204 Summary 205 7 Exercises 206

Chapter 7 Costs 209

CHALLENGE Technology Choice at Home Versus Abroad 209

7.1 Measuring Costs 210 Opportunity Costs 211 APPLICATION The Opportunity Cost of

an MBA 211

ixContents

9.5 Policies That Create a Wedge Between Supply and Demand Curves 304 Welfare Effects of a Sales Tax 304 APPLICATION The Deadweight Loss

from Gas Taxes 306 Welfare Effects of a Price Floor 306 Solved Problem 9.3 309 APPLICATION How Big Are Farm

Subsidies and Who Gets Them? 310 Welfare Effects of a Price Ceiling 310 Solved Problem 9.4 311 APPLICATION The Social Cost of a

Natural Gas Price Ceiling 312 9.6 Comparing Both Types of Policies: Trade 312

Free Trade Versus a Ban on Imports 313 Solved Problem 9.5 315 APPLICATION Russian Food Ban 315 Free Trade Versus a Tariff 316 Solved Problem 9.6 318 A Tariff Versus a Quota 319 Rent Seeking 320 CHALLENGE SOLUTION Liquor Licenses 321 Summary 322 7 Exercises 323

Chapter 10 General Equilibrium and Economic Welfare 327

CHALLENGE Anti–Price Gouging Laws 327 10.1 General Equilibrium 329

Competitive Equilibrium in Two Interrelated Markets 330

APPLICATION Partial-Equilibrium Versus Multimarket-Equilibrium Analysis in Corn and Soybean Markets 331

Minimum Wages with Incomplete Coverage 332

Solved Problem 10.1 334 APPLICATION Urban Flight 335

10.2 Trading Between Two People 335 Endowments 335 Mutually Beneficial Trades 337 Solved Problem 10.2 339 Deriving the Contract Curve 339 Solved Problem 10.3 340 Bargaining Ability 340

10.3 Competitive Exchange 340 Competitive Equilibrium 341 Solved Problem 10.4 343 The Efficiency of Competition 343 Obtaining Any Efficient Allocation

Using Competition 343 10.4 Production and Trading 344

Comparative Advantage 344 Solved Problem 10.5 346 Efficient Product Mix 348 Competition 348

8.2 Profit Maximization 254 Profit 255 Two Steps to Maximizing Profit 256

8.3 Competition in the Short Run 259 Short-Run Competitive Profit Maximization 259 Solved Problem 8.2 261 APPLICATION Fracking and Shutdowns 264 Short-Run Firm Supply Curve 265 Solved Problem 8.3 266 Short-Run Market Supply Curve 267 Short-Run Competitive Equilibrium 269 Solved Problem 8.4 270

8.4 Competition in the Long Run 271 Long-Run Competitive Profit Maximization 271 Long-Run Firm Supply Curve 271 APPLICATION The Size of Ethanol

Processing Plants 272 Long-Run Market Supply Curve 273 APPLICATION Industries with High Entry

and Exit Rates 274 APPLICATION Upward-Sloping Long-Run

Supply Curve for Cotton 276 APPLICATION Reformulated Gasoline

Supply Curves 280 Solved Problem 8.5 281 Long-Run Competitive Equilibrium 282 CHALLENGE SOLUTION The Rising

Cost of Keeping On Truckin’ 283 Summary 284 7 Exercises 285

Chapter 9 Properties and Applications of the Competitive Model 290

CHALLENGE Liquor Licenses 290 9.1 Zero Profit for Competitive Firms in the

Long Run 291 Zero Long-Run Profit with Free Entry 291 Zero Long-Run Profit When Entry Is Limited 292 APPLICATION What’s a Name Worth? 294 The Need to Maximize Profit 294

9.2 Producer Surplus 294 Measuring Producer Surplus Using a

Supply Curve 294 Using Producer Surplus 296 Solved Problem 9.1 296

9.3 Competition Maximizes Welfare 297 Measuring Welfare 298 Why Producing Less Than the

Competitive Output Lowers Welfare 298 Solved Problem 9.2 300 APPLICATION The Deadweight Loss

of Christmas Presents 301 9.4 Policies That Shift Supply or Demand

Curves 302 APPLICATION Welfare Effects of

Allowing Fracking 303

x Contents

APPLICATION Natural Gas Regulation 395 Increasing Competition 396 APPLICATION Movie Studios Attacked

by 3D Printers! 397 Solved Problem 11.8 397

11.6 Internet Monopolies: Networks Effects, Behavioral Economics, and Economies of Scale 398 Network Externalities 398 APPLICATION Critical Mass and eBay 399 Introductory Prices: A Two-Period

Monopoly Model 400 Two-Sided Markets 400 Economies of Scale on the Internet 401 Disruptive Technologies 401

11.7 Monopsony 402 Monopsony Profit Maximization 402 Welfare Effects of Monopsony 404 Solved Problem 11.9 405 CHALLENGE SOLUTION Brand-Name

and Generic Drugs 406 Summary 407 7 Exercises 407

Chapter 12 Pricing and Advertising 412

CHALLENGE Sale Price 412 12.1 Conditions for Price Discrimination 414

Why Price Discrimination Pays 414 Which Firms Can Price Discriminate 414 APPLICATION Disneyland Pricing 415 Preventing Resale 415 APPLICATION Preventing Resale of

Designer Bags 416 Not All Price Differences Are Price

Discrimination 416 Types of Price Discrimination 417

12.2 Perfect Price Discrimination 417 How a Firm Perfectly Price Discriminates 417 Solved Problem 12.1 419 Perfect Price Discrimination Is Efficient

but Harms Some Consumers 420 APPLICATION Botox and Price

Discrimination 422 Transaction Costs and Perfect Price

Discrimination 423 APPLICATION Google Uses Bidding for

Ads to Price Discriminate 423 12.3 Group Price Discrimination 423

APPLICATION Tesla Price Discrimination 424 Prices and Elasticities 425 APPLICATION Age Discrimination 426 Solved Problem 12.2 426 Identifying Groups 428 APPLICATION Buying Discounts 428 Solved Problem 12.3 429 Welfare Effects of Group Price Discrimination 430

10.5 Efficiency and Equity 350 Role of the Government 350 Efficiency 351 Equity 351 APPLICATION Extremely Unequal Wealth 352 Efficiency Versus Equity 357 Theory of the Second Best 358 CHALLENGE SOLUTION Anti–Price

Gouging Laws 360 Summary 361 7 Exercises 361

Chapter 11 Monopoly and Monopsony 365

CHALLENGE Brand-Name and Generic Drugs 365

11.1 Monopoly Profit Maximization 367 The Necessary Condition for Profit

Maximization 367 Marginal Revenue and the Demand

Curves 367 Solved Problem 11.1 369 Marginal Revenue Curve and the Price

Elasticity of Demand 369 APPLICATION Amazon Prime Revenue 371 An Example of Monopoly Profit

Maximization 371 APPLICATION Apple’s iPad 373 Solved Problem 11.2 373 Choosing Price or Quantity 375 APPLICATION Taylor Swift Concert

Pricing 375 Solved Problem 11.3 375 Effects of a Shift of the Demand Curve 376

11.2 Market Power and Welfare 377 Market Power and the Shape of the

Demand Curve 377 The Lerner Index 379 Solved Problem 11.4 379 Sources of Market Power 380 Effect of Market Power on Welfare 380

11.3 Taxes and Monopoly 381 Effects of a Specific Tax 382 Solved Problem 11.5 383 Welfare Effects of Ad Valorem Versus

Specific Taxes 385 11.4 Causes of Monopolies 386

Cost Advantages 386 Solved Problem 11.6 388 Government Actions That Create

Monopolies 388 APPLICATION The Botox Patent

Monopoly 390 11.5 Government Actions That Reduce

Market Power 391 Regulating Monopolies 391 Solved Problem 11.7 393

xiContents

Chapter 14 Oligopoly and Monopolistic Competition 490

CHALLENGE Government Aircraft Subsidies 490

14.1 Market Structures 492 14.2 Cartels 493

Why Cartels Form 494 Why Cartels Fail 495 Laws Against Cartels 496 APPLICATION Employer “No-Poaching”

Cartels 497 Maintaining Cartels 498 APPLICATION Cheating on the Maple

Syrup Cartel 499 Mergers 500 APPLICATION Airline Mergers 500

14.3 Cournot Oligopoly Model 501 The Duopoly Nash-Cournot Equilibrium 501 The Cournot Model with Many Firms 505 APPLICATION Mobile Number Portability 508 The Cournot Model with Nonidentical