Microeconomics 5th Edition Pdf

The Seven Core Principles Scarcity: Having more of one good thing usually means having less of another.
Incentives Matter: Comparing cost-benefit analyses enables us to predict actual decisions people make.
Increasing Opportunity Cost: Resources with the lowest opportunity cost should be used before turning to those with higher opportunity costs. Equilibrium: A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action.
www.mhhe.com/fb4e.com
ISBN 978-0-07-336266-3 MHID 0-07-336266-2
90000
9 780073 362663 www.mhhe.com
ECONOMICS Fourth Edition
Frank Bernanke
Efficiency: When the economic pie grows larger through efficiency, everyone can have a larger slice.
PRINCIPLES OF MICRO
MD DALIM #974702 7/21/08 CYAN MAG YELO BLK
Comparative Advantage: Everyone does best if they concentrate on their relatively most productive activity.
Fourth Edition
MICRO ECONOMICS
Cost-Benefit Analysis: No action should be taken unless the marginal benefit is as great as the marginal cost.
Media Integrated iPod® Content Available
PRINCIPLES OF
Students need the ability to understand and evaluate our changing economy. Principles of Microeconomics, by Robert H. Frank and Ben S. Bernanke, provides students with the tools necessary to analyze current economic problems. By eliminating overwhelming detail and focusing on Seven Core Principles, the Fourth Edition helps students achieve a deep mastery of what is essential to understanding economics.
Robert H. Frank Ben S. Bernanke
fra62662_fm_i-xxxii 7/12/08 8:55PM Page i ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PRINCIPLES OF
MICROECONOMICS Fourth Edition
fra62662_fm_i-xxxii 18/7/08 1:05 PM Page ii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030:
THE MCGRAW-HILL SERIES IN ECONOMICS ESSENTIALS OF ECONOMICS
ECONOMICS OF SOCIAL ISSUES
MONEY AND BANKING
Brue, McConnell, and Flynn Essentials of Economics Second Edition
Guell Issues in Economics Today Fourth Edition
Mandel Economics: The Basics First Edition
Sharp, Register, and Grimes Economics of Social Issues Eighteenth Edition
Cecchetti Money, Banking, and Financial Markets Second Edition
Schiller Essentials of Economics Seventh Edition
ECONOMETRICS
PRINCIPLES OF ECONOMICS Colander Economics, Microeconomics, and Macroeconomics Seventh Edition Frank and Bernanke Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Fourth Edition Frank and Bernanke Brief Editions: Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics First Edition McConnell, Brue, and Flynn Economics, Microeconomics, and Macroeconomics Eighteenth Edition McConnell, Brue, and Flynn Brief Editions: Economics, Microeconomics, Macroeconomics First Edition Miller Principles of Microeconomics First Edition Samuelson and Nordhaus Economics, Microeconomics, and Macroeconomics Eighteenth Edition Schiller The Economy Today, The Micro Economy Today, and The Macro Economy Today Eleventh Edition Slavin Economics, Microeconomics, and Macroeconomics Ninth Edition
Gujarati and Porter Basic Econometrics Fifth Edition Gujarati and Porter Essentials of Econometrics Fourth Edition
MANAGERIAL ECONOMICS Baye Managerial Economics and Business Strategy Sixth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Fifth Edition Thomas and Maurice Managerial Economics Ninth Edition
INTERMEDIATE ECONOMICS Bernheim and Whinston Microeconomics First Edition
URBAN ECONOMICS O’Sullivan Urban Economics Seventh Edition
LABOR ECONOMICS Borjas Labor Economics Fourth Edition McConnell, Brue, and Macpherson Contemporary Labor Economics Eighth Edition
PUBLIC FINANCE Rosen and Gayer Public Finance Eighth Edition Seidman Public Finance First Edition
ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Fifth Edition
INTERNATIONAL ECONOMICS
Dornbusch, Fischer, and Startz Macroeconomics Tenth Edition
Appleyard, Field, and Cobb International Economics Sixth Edition
Frank Microeconomics and Behavior Seventh Edition
King and King International Economics, Globalization, and Policy: A Reader Fifth Edition
ADVANCED ECONOMICS Romer Advanced Macroeconomics Third Edition
Pugel International Economics Fourteenth Edition
fra62662_fm_i-xxxii 7/12/08 8:55PM Page iii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PRINCIPLES OF
MICROECONOMICS Fourth Edition
ROBERT H. FRANK Cornell University
BEN S. BERNANKE Princeton University [affiliated] Chairman, Board of Governors of the Federal Reserve System
with special contribution by
LOUIS D. JOHNSTON College of Saint Benedict Saint John’s University
Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
fra62662_fm_i-xxxii 7/14/08 4:56PM Page iv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PRINCIPLES OF MICROECONOMICS Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2009, 2007, 2004, 2001 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 QPD/QPD 0 9 8 ISBN MHID
978-0-07-336266-3 0-07-336266-2
Design of book: The images in the design of this book are based on elements of the architecture of Frank Lloyd Wright, specifically from the leaded glass windows seen in many of his houses. Wright’s design was rooted in nature and based on simplicity and harmony. His windows use elemental geometry to abstract natural forms, complementing and framing the natural world outside. This concept of seeing the world through an elegantly structured framework ties in nicely to the idea of framing one’s view of the world through the window of economics. The typeface used for some of the elements was taken from the Arts and Crafts movement. The typeface, as well as the color palette, bring in the feeling of that movement in a way that complements the geometric elements of Wright’s windows. The Economic Naturalist icon is visually set apart from the more geometric elements but is a representation of the inspirational force behind all of Wright’s work. Editor-in-chief: Brent Gordon Publisher: Douglas Reiner Developmental editor: Angela Cimarolli Senior marketing manager: Melissa Larmon Senior project manager: Susanne Riedell Senior production supervisor: Debra R. Sylvester Lead designer: Matthew Baldwin Senior photo research coordinator: Jeremy Cheshareck Photo researcher: Robin Sand Senior media project manager: Cathy Tepper Cover design: Matt Diamond Cover image: © Jill Braaten Typeface: 10/12 Sabon Roman Compositor: Aptara, Inc. Printer: Quebecor World Dubuque Inc. Library of Congress Cataloging-in-Publication Data Frank, Robert H. Principles of microeconomics / Robert H. Frank, Ben S. Bernanke ; with special contribution by Louis D. Johnston.—4th ed. p. cm.—(The McGraw-Hill series in economics) Includes index. ISBN-13: 978-0-07-336266-3 (alk. paper) ISBN-10: 0-07-336266-2 (alk. paper) 1. Microeconomics. I. Bernanke, Ben S. II. Johnston, Louis (Louis Dorrance) III. Title. HB172.F72 2009 338.5—dc22 2008026579
www.mhhe.com
fra62662_fm_i-xxxii 7/14/08 10:07PM Page v ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
DEDICATION For Ellen
R. H. F. For Anna
B. S. B.
fra62662_fm_i-xxxii 7/12/08 8:55PM Page vi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
ABOUT THE AUTHORS
ROBERT H. FRANK
BEN S. BERNANKE
Professor Frank is the Henrietta Johnson Louis Professor of Management and Professor of Economics at the Johnson Graduate School of Management at Cornell University, where he has taught since 1972. His “Economic View” column appears regularly in The New York Times. After receiving his B.S. from Georgia Tech in 1966, he taught math and science for two years as a Peace Corps Volunteer in rural Nepal. He received his M.A. in statistics in 1971 and his Ph.D. in economics in 1972 from The University of California at Berkeley. During leaves of absence from Cornell, he has served as chief economist for the Civil Aeronautics Board (1978–1980), a Fellow at the Center for Advanced Study in the Behavioral Sciences (1992–93), and Professor of American Civilization at l’École des Hautes Études en Sciences Sociales in Paris (2000–01). Professor Frank is the author of a best-selling intermediate economics textbook—Microeconomics and Behavior, Seventh Edition (Irwin/McGraw-Hill, 2008). He has published on a variety of subjects, including price and wage discrimination, public utility pricing, the measurement of unemployment spell lengths, and the distributional consequences of direct foreign investment. His research has focused on rivalry and cooperation in economic and social behavior. His books on these themes, which include Choosing the Right Pond (Oxford, 1995), Passions Within Reason (W. W. Norton, 1988), and What Price the Moral High Ground? (Princeton, 2004), The Economic Naturalist (Basic Book, 2007), and Falling Behind (The University of California Press, 2007), have been translated into 15 languages. The Winner-Take-All Society (The Free Press, 1995), co-authored with Philip Cook, received a Critic’s Choice Award, was named a Notable Book of the Year by The New York Times, and was included in BusinessWeek’s list of the 10 best books of 1995. Luxury Fever (The Free Press, 1999) was named to the Knight-Ridder Best Books list for 1999. Professor Frank has been awarded an Andrew W. Mellon Professorship (1987–1990), a Kenan Enterprise Award (1993), and a Merrill Scholars Program Outstanding Educator Citation (1991). He is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought. He was awarded the Johnson School’s Stephen Russell Distinguished Teaching Award in 2004 and the School’s Apple Distinguished Teaching Award in 2005. His introductory microeconomics course has graduated more than 7,000 enthusiastic economic naturalists over the years.
Professor Bernanke received his B.A. in economics from Harvard University in 1975 and his Ph.D. in economics from MIT in 1979. He taught at the Stanford Graduate School of Business from 1979 to 1985 and moved to Princeton University in 1985, where he was named the Howard Harrison and Gabrielle Snyder Beck Professor of Economics and Public Affairs, and where he served as Chairman of the Economics Department. Professor Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. Professor Bernanke also serves as Chairman of the Federal Open Market Committee, the System’s principal monetary policymaking body. He was appointed as a member of the Board to a full 14-year term, which expires January 31, 2020 and to a four-year term as Chairman, which expires January 31, 2010. Before his appointment as Chairman, Dr. Bernanke was Chairman of the President’s Council of Economic Advisers from June 2005 to January 2006. Professor Bernanke’s intermediate textbook, with Andrew Abel, Macroeconomics, Sixth Edition (AddisonWesley, 2008), is a best seller in its field. He has authored more than 50 scholarly publications in macroeconomics, macroeconomic history, and finance. He has done significant research on the causes of the Great Depression, the role of financial markets and institutions in the business cycle, and measuring the effects of monetary policy on the economy. Professor Bernanke has held a Guggenheim Fellowship and a Sloan Fellowship, and he is a Fellow of the Econometric Society and of the American Academy of Arts and Sciences. He served as the Director of the Monetary Economics Program of the National Bureau of Economic Research (NBER) and as a member of the NBER’s Business Cycle Dating Committee. In July 2001, he was appointed Editor of the American Economic Review. Professor Bernanke’s work with civic and professional groups includes having served two terms as a member of the Montgomery Township (N.J.) Board of Education.
fra62662_fm_i-xxxii 18/7/08 1:07 PM Page vii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030:
PREFACE ■ lthough many millions of dollars are spent each year on introductory economics instruction in American colleges and universities, the return on this investment has been disturbingly low. Studies have shown, for example, that several months after having taken a principles of economics course, former students are no better able to answer simple economic questions than others who never even took the course. Most students, it seems, leave our introductory courses without having learned even the most important basic economic principles. The problem, in our view, is that these courses almost always try to teach students far too much. In the process, really important ideas get little more coverage than minor ones, and everything ends up going by in a blur. Many instructors ask themselves, “How much can I cover today?” when instead they should be asking, “How much can my students absorb?” Our textbook grew out of our conviction that students will learn far more if we attempt to cover much less. Our basic premise is that a small number of basic principles do most of the heavy lifting in economics, and that if we focus narrowly and repeatedly on those principles, students can actually master them in just a single semester. The enthusiastic reactions of users of our first three editions affirm the validity of this premise. Although recent editions of a few other texts now pay lip service to the less-is-more approach, ours is by consensus the most carefully thought-out and well-executed text in this mold. Avoiding excessive reliance on formal mathematical derivations, we present concepts intuitively through examples drawn from familiar contexts. We rely throughout on a well-articulated list of seven core principles, which we reinforce repeatedly by illustrating and applying each principle in numerous contexts. We ask students periodically to apply these principles themselves to answer related questions, exercises, and problems. Throughout this process, we encourage students to become “economic naturalists,” people who employ basic economic principles to understand and explain what they observe in the world around them. An economic naturalist understands, for example, that infant safety seats are required in cars but not in airplanes because the marginal cost of space to accommodate these seats is typically zero in cars but often hundreds of dollars in airplanes. Scores of such examples are sprinkled throughout the book. Each one, we believe, poses a question that should make any normal, curious person eager to learn the answer. These examples stimulate interest while teaching students to see each feature of their economic landscape as the reflection of one or more of the core principles. Students talk about these examples with their friends and families. Learning economics is like learning a language. In each case, there is no substitute for actually speaking. By inducing students to speak economics, the economic naturalist examples serve this purpose. For those who are interested in lerning more about the role of examples in learning economics, Bob Frank’s lecture on the topic is posted on You Tube’s “Authors @ Google” series (http://www.youtube.com/watch?v0002QalNVxeIKEE or search “Authors @ Google Robert Frank”).
A
vii
fra62662_fm_i-xxxii 7/14/08 4:22PM Page viii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
viii
PREFACE
FEATURES ■
An emphasis on seven core principles: As noted, a few core principles do most of the work in economics. By focusing almost exclusively on these principles, the text assures that students leave the course with a deep mastery of them. In contrast, traditional encyclopedic texts so overwhelm students with detail that they often leave the course with little useful working knowledge at all.
Scarcity
1 The Scarcity Principle: Having more of one good thing usually means having less of another.
Cost-Benefit
2 The Cost-Benefit Principle: Take no action unless its marginal benefit is at least as great as its marginal cost.
Incentive
3 The Incentive Principle: Cost-benefit comparisons are relevant not only for identifying the decisions that rational people should make, but also for predicting the actual decisions they do make.
Comparative Advantage
4 The Principle of Comparative Advantage: Everyone does best when each concentrates on the activity for which he or she is relatively most productive. 5 The Principle of Increasing Opportunity Cost: Use the resources with the lowest opportunity cost before turning to those with higher opportunity costs.
Increasing Opportunity Cost
6 The Efficiency Principle: Efficiency is an important social goal because when the economic pie grows larger, everyone can have a larger slice.
Efficiency
7 The Equilibrium Principle: A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action.
Equilibrium ■
Economic naturalism: Our ultimate goal is to produce economic naturalists— people who see each human action as the result of an implicit or explicit costbenefit calculation. The economic naturalist sees mundane details of ordinary existence in a new light and becomes actively engaged in the attempt to understand them. Some representative examples: ■
Why are whales and elephants, but not chickens, threatened with extinction?
■
Why do we often see convenience stores located on adjacent street corners?
■
Why do supermarket checkout lines all tend to be roughly the same length?
■
Active learning stressed: The only way to learn to hit an overhead smash in tennis is through repeated practice. The same is true for learning economics. Accordingly, we consistently introduce new ideas in the context of simple examples and then follow them with applications showing how they work in familiar settings. At frequent intervals, we pose exercises that both test and reinforce the understanding of these ideas. The end-of-chapter questions and problems are carefully crafted to help students internalize and extend core concepts. Experience with our first three editions confirms that this approach really does prepare students to apply basic economic principles to solve economic puzzles drawn from the real world.
■
Modern Microeconomics: Economic surplus, introduced in Chapter 1 and employed repeatedly thereafter, is more fully developed here than in any other text. This concept underlies the argument for economic efficiency as an important social goal. Rather than speak of trade-offs between efficiency and other goals, we stress that maximizing economic surplus facilitates the achievement of all goals. Common decision pitfalls identified by 2002 Nobel Laureate Daniel Kahneman and others—such as the tendency to ignore implicit costs, the
fra62662_fm_i-xxxii 7/14/08 4:22PM Page ix ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PREFACE
tendency not to ignore sunk costs, and the tendency to confuse average and marginal costs and benefits—are introduced early in Chapter 1 and invoked repeatedly in subsequent chapters. There is perhaps no more exciting toolkit for the economic naturalist than a few principles of elementary game theory. In Chapter 10, we show how these principles enable students to answer a variety of strategic questions that arise in the marketplace and everyday life. We believe that the insights of Nobel Laureate Ronald Coase are indispensable for understanding a host of familiar laws, customs, and social norms. In Chapter 11 we show how such devices function to minimize misallocations that result from externalities. A few simple principles from the economics of information form another exciting addition to the economic naturalist’s toolkit. In Chapter 12 we show how the insights that earned the 2001 Nobel Prize in economics for George Akerlof, Joseph Stiglitz, and Michael Spence can be employed to answer a variety of questions from everyday experience.
IMPROVEMENTS Our less-is-more approach is well-suited for a wide spectrum of institutions. Yet it remains a formidable challenge for any single book to fit the needs and capabilities of all students across these diverse institutions. Some students arrive with AP credit in advanced calculus, while others still lack confidence in basic geometry and algebra. Guided by extensive reviewer feedback, our main goal in preparing our fourth edition has been to reorganize our presentation to accommodate the broadest possible range of student preparation. For example, while continuing to emphasize verbal and graphical approaches in the main text, we offer several appendices that allow for more detailed and challenging algebraic treatments of the same material. Among the hundreds of specific refinements we made, the following merit explicit mention. ■
More and clearer emphasis on the core principles: If we asked a thousand economists to provide their own versions of the most important economic principles, we’d get a thousand different lists. Yet to dwell on their differences would be to miss their essential similarities. It is less important to have exactly the best short list of principles than it is to use some well-thought-out list of this sort.
■
Integrated the outsourcing and international trade material from (previously) Chapter 9 into the discussions within: ■
Chapter 2: Comparative Advantage
■
Chapter 28: International Trade and Capital Flows
■
Chapter learning objectives: Students and professors can be confident that the organization of each chapter surrounds common themes outlined by five to seven learning objectives listed on the first page of each chapter. These objectives, along with AACSB and Bloom’s Taxonomy Learning Categories, are connected to all test Bank questions and end-of-chapter material to offer a comprehensive, thorough teaching and learning experience.
■
Assurance of learning ready: Many educational institutions today are focused on the notion of assurance of learning, an important element of some accreditation standards. Principles of Microeconomics, 4e is designed specifically to support your assurance of learning initiatives with a simple, yet powerful, solution. You can use our test bank software, EZTest, to easily query for Learning Objectives that directly relate to the objectives for your course. You can then
ix
fra62662_fm_i-xxxii 7/14/08 4:22PM Page x ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
x
PREFACE
use the reporting features of EZTest to aggregate student results in a similar fashion, making the collection and presentation of assurance of learning data simple and easy.
THE CHALLENGE The world is a more competitive place now than it was when we started teaching in the 1970s. In arena after arena, business as usual is no longer good enough. Baseball players used to drink beer and go fishing during the off season, but they now lift weights and ride exercise bicycles. Assistant professors used to work on their houses on weekends, but the current crop can now be found most weekends at the office. The competition for student attention has grown similarly more intense. There are many tempting courses in the typical college curriculum and even more tempting diversions outside the classroom. Students are freer than ever to pick and choose. Yet many of us seem to operate under the illusion that most freshmen arrive with a burning desire to become economics majors. And many of us do not yet seem to have recognized that students’ cognitive abilities and powers of concentration are scarce resources. To hold our ground, we must become not only more selective in what we teach, but also more effective as advocates for our discipline. We must persuade students that we offer something of value. A well-conceived and well-executed introductory course in economics can teach our students more about society and human behavior in a single term than virtually any other course in the university. This course can and should be an intellectual adventure of the first order. Not all students who take the kind of course we envisioned when writing this book will go on to become economics majors, of course. But many will, and even those who do not will leave with a sense of admiration for the power of economic ideas. A salesperson knows that he or she often gets only one chance to make a good first impression on a potential customer. Analogously, the principles course is often our only shot at persuading most students to appreciate the value of economics. By trying to teach them everything we know—rather than teaching them the most important things we know—we too often squander this opportunity.
SUPPLEMENTS FOR THE INSTRUCTOR McGraw-Hill’s Homework Manager Plus™: McGraw-Hill’s Homework Manager Plus is a complete, Web-based solution that includes and expands upon the actual problem sets found at the end of each chapter. It features enhanced technology that provides a varied supply of auto-graded assignments and graphing exercises, tied to the learning objectives in the book. McGraw-Hill’s Homework Manager can be used for student practice, graded homework assignments, and formal examinations; the results are easily integrated with your course management system, including WebCT and Blackboard. Instructor’s Manual: Prepared by Louis D. Johnston of the College of Saint Benedict Saint John’s University, this expanded manual will be extremely useful for all teachers. In addition to such general topics as Using the Web Site, Economic Education Resources, and Innovative Ideas, there will be for each chapter: An Overview, Core Principles, Important Concepts Covered, Teaching Objectives, Teaching Tips/Student Stumbling Blocks, More Economic Naturalists, In-Class and Web Activities, Annotated Chapter Outline, Answers to Textbook Problems, Sample Homework, and a Sample Reading Quiz.
fra62662_fm_i-xxxii 18/7/08 1:09 PM Page xi VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030:
PREFACE
Test Bank: Prepared by Kate Krause of the University of New Mexico, this manual contains more than 2,000 questions categorized by chapter Learning Objectives, AACSB learning categories, and Bloom’s Taxonomy Objectives. The test bank is available in the latest EZTest test-generating software, ensuring maximum flexibility in test preparation. PowerPoints: Prepared by Carol Swartz of the University of North CarolinaCharlotte, these slides contain a detailed, chapter-by-chapter review of the important ideas presented in the textbook, accompanied by animated graphs and slide notes. Customizable Micro Lecture Notes and PowerPoints: One of the biggest hurdles to an instructor considering changing textbooks is the prospect of having to prepare new lecture notes and slides. For the microeconomics chapters, this hurdle no longer exists. A full set of lecture notes for principles of microeconomics, prepared by Bob Frank for his award-winning introductory microeconomics course at Cornell University, is available as Microsoft Word files that instructors are welcome to customize as they see fit. The challenge for any instructor is to reinforce the lessons of the text in lectures without generating student unrest by merely repeating what’s in the book. These lecture notes address that challenge by constructing examples that run parallel to those presented in the book, yet are different from them in interesting contextual ways. Also available is a complete set of richly illustrated PowerPoint files to accompany these lecture notes. Instructors are also welcome to customize these files as they wish. Instructor’s CD-ROM: This remarkable Windows software program contains the complete Instructor’s Manual with solutions to the end-of-chapter problems, Solman Videos, Computerized Test Bank, PowerPoints, and the complete collection of art from the text. Online Learning Center (www.mhhe.com/fb4e): The contents of the IRCD are available online at the textbook’s Web site for quick download and convenient access for professors anytime.
SUPPLEMENTS FOR THE STUDENT Study Guide: Revised by Louis D. Johnson of the College of Saint Benedict Saint John’s University, this book contains for each chapter a pre-test; a “Key Point Review” that integrates the learning objectives with the chapter content; a self-test with matching and multiple choice problems; short answer problems; and an Economic Naturalist case study that helps students apply what they learned. Online Learning Center (www.mhhe.com/fb4e): For students there are such useful features as the Glossary from the textbook; Graphing Exercises, PowerPoints, a set of study and practice quizzes. Premium Content: The Online Learning Center now offers students the opportunity to purchase premium content. Like an electronic study guide, the OLC Premium Content enables students to take self-grading quizzes for each chapter as well as to download Frank and Bernanke-exclusive iPod content including podcasts by Brad Schiller, narrated lecture slides, and Paul Solman videos—all accessible through the student’s MP3 device. In the chapter when
EN 2
xi
fra62662_fm_i-xxxii 18/7/08 1:12 PM Page xii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030:
xii
PREFACE
you see an iPod icon, there is a podcast that correlates to that material. The label EN stands for Economic Naturalist, and the number represents the chapter number.
A NOTE ON THE WRITING OF THIS EDITION Ben Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. From June 2005 until January 2006, he served as chairman of the President’s Council of Economic Advisers. These positions have allowed him to play an active role in making U.S. economic policy, but the rules of government service have restricted his ability to participate in the preparation of the Fourth Edition. Fortunately, we were able to enlist the aid of Louis D. Johnston of the College of Saint Benedict Saint John’s University to take the lead in revising the macro portions of the book and to assist Robert Frank in revising the micro portions of the book. Ben Bernanke and Robert Frank express their deep gratitude to Louis for the energy and creativity he has brought to his work on the book. He has made the book a better tool for students and professors.
ACKNOWLEDGMENTS Our thanks first and foremost go to our publisher, Douglas Reiner, and our development editor, Angela Cimarolli. Douglas encouraged us to think deeply about how to improve the book and helped us transform our ideas into concrete changes. Angie shepherded us through the revision process in person, on the telephone, through the mail, and via e-mail with intelligence, sound advice, and good humor. We are grateful as well to the production team, whose professionalism (and patience) was outstanding: Susanne Riedell, senior project manager; Matthew Baldwin, designer; Debra Sylvester, senior production supervisor; Jeremy Cheshareck, senior photo research coordinator; and all of those who worked on the production team to turn our manuscript into the book you hold in your hands. Finally, we also thank Melissa Larmon, senior marketing manager, for getting our message into the wider world. Finally, our sincere thanks to the following teachers and colleagues, whose thorough reviews and thoughtful suggestions led to innumerable substantive improvements.
Adel Abadeer, Calvin College Cynthia Abadie, Southwest Tennessee Community College Hesham Abdel-Rahman, University of New Orleans Teshome Abebe, Eastern Illinois University Roger L. Adkins, Marshall University Richard Agesa, Marshall University
Frank Albritton, Seminole Community College Rashid Al-Hmoud, Texas Tech University Farhad Ameen, SUNY - Westchester Community College Mauro C. Amor, Northwood University Nejat Anbarci, Florida International University
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xiii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PREFACE
Giuliana Campanelli Andreopoulos, William Paterson University
Denis G. Carter, University of North Carolina, Wilmington
Michael Applegate, Oklahoma State University
Shawn Carter, Jacksonville State University
Becca Arnold, Mesa College
Peter Cashel-Cordo, University of Southern Indiana
Mohsen Bahmani-Oskooee, University of Wisconsin-Milwaukee Sudeshna Bandyopadhyay, West Virginia University Gyanendra Baral, Oklahoma City Community College James Bartkus, Xavier University Hamid Bastin, Shippensburg University John H. Beck, Gonzaga University Klaus Becker, Texas Tech University Doris Bennett, Jacksonville State University Derek Berry, Calhoun Community College Tom Beveridge, Durham Technical Community College Okmyung Bin, East Carolina University Robert G. Bise, Orange Coast College
Andrew Cassey, University of Minnesota Rebecca Chakraborty, Northwood University Joni S. Charles, Texas State University–San Marcos Adhip Chaudhuri, Georgetown University Richard Cherrin, Delaware Technical & Community College Eric P. Chiang, Florida Atlantic University Unk Christiadi, University of the Pacific, Stockton James Cobbe, Florida State University Howard Cochran, Belmont University Jeffrey P. Cohen, University of Hartford
John Bishop, East Carolina University
Barbara Connolly, Westchester Community College
John L. Brassel, Southwest Tennessee Community College
Jim Couch, University of North Alabama
William J. Brennan, Minnesota State University at Mankato
Elizabeth Crowell, University of Michigan–Dearborn
Jozell Brister, Abilene Christian University
William Dawes, SUNY at Stony Brook
Taggert Brooks, University of Wisconsin–La Crosse
Matthew Dawson, Charleston Southern University
Christopher Burkart, University of West Florida
Marcelin W. Diagne, Towson University
Joseph Calhoun, Florida State University
Vernon J. Dobis, Minnesota State University, Moorhead
Colleen Callahan, American University
Amrik Singh Dua, Mt. San Antonio College
xiii
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xiv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xiv
PREFACE
Tran Dung, Wright State University Faruk Eray Duzenli, Bowling Green State University Angela Dzata, Alabama State University Dennis S. Edwards, Coastal Carolina University
Mehdi Haririan, Bloomsburg University of Pennsylvania Robert Harris, Indiana UniversityPurdue University Indianapolis Tina J. Harvell, Blinn College Joe Haslag, University of Missouri
Ishita Edwards, Oxnard College
Philip S. Heap, James Madison University
Ceyhun Elgin, University of Minnesota
George Heitmann, Muhlenberg College
Paul Emberton, Texas State University
John Hejkal, University of Iowa
Jim Fain, Oklahoma State University
Mickey Hepner, University of Central Oklahoma
Nick Feltovich, University of Houston William J. Field, DePauw University
Michael J. Hilmer, San Diego State University
Harold Steven Floyd, Manatee Community College
George E. Hoffer, Virginia Commonwealth University
Charles Fraley, Cincinnati State Technical and Community College
Carol Hogan, University of Michigan–Dearborn
Johanna Francis, Fordham University Dan Friesner, Gonzaga University
James Holcomb, University of Texas at El Paso
Marc Fusaro, East Carolina University
Lora Holcombe, Florida State University
Mary N. Gade, Oklahoma State University
Calvin Hoy, County College of Morris
S. N. Gajanan, University of Pittsburgh Alejandro Gallegos, Winona State University Subrahmanyam Ganti, University at Buffalo Suman Ghosh, Florida Atlantic University George M. Greenlee, St. Petersburg College Sandra Grigg, East Carolina University
Yu Hsing, Southeastern Louisiana University Eric Isenberg, DePauw University David E. Kalist, Shippensburg University Lillian Kamal, Northwestern University Brad Kamp, University of South Florida Tim D. Kane, University of Texas at Tyler Janis Y. F. Kea, West Valley College
Sunil Gulati, Columbia University
Brian Kench, University of Tampa
Barnali Gupta, Miami University
Kamau Kinuthia, American River College–Sacramento
Richard L. Hannah, Middle Tennessee State University
Mary Knudson, University of Iowa
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PREFACE
Janet Koscianski, Shippensburg University Stephan Kroll, California State University, Sacramento Patricia Kuzyk, Washington State University
Lewis E. Metcalf, Parkland College Arthur W. Meyer, Lincoln Land Community College Douglas Miller, University of Missouri–Columbia
Felix Kwan, Maryville University
Norman C. Miller, Miami University–Oxford
Katherine Lande, University of Minnesota
Ed Miseta, Penn State University–Erie
Gary F. Langer, Roosevelt University
David Mitch, University of Maryland Baltimore County
Fritz Laux, Northeastern State University, Oklahoma Sang H. Lee, Southeastern Louisiana University Hui Li, Eastern Illinois University Yan Li, University of Iowa Clifford A. Lipscomb, Valdosta State University Donald Liu, University of Minnesota, Twin Cities Teresa Long, Marymount University Alina Luca, Drexel University Brian M. Lynch, Lake Land College Karla Lynch, North Central Texas College Alyson Ma, University of San Diego Rita Madarass, Westminster College Y. Lal Mahajan, Monmouth University
Amlan Mitra, Purdue University at Calumet Robert Moden, Central Virginia Community College James A. Moreno, Blinn College Thaddeaus Mounkurai, Daytona Beach Community College Sudesh Mujumdar, University of Southern Indiana David C. Murphy, Boston College Christopher Mushrush, Illinois State University Annette Najjar, Lindenwood University Helen Naughton, University of Oregon Charles Newton, Houston Community College Daniel Nguyen, Purdue University
John G. Marcis, Coastal Carolina University
James Nguyen, Southeastern Louisiana University
Dale Matcheck, Northwood University
Sung C. No, Southern University and A&M College
Mike McIlhon, Metropolitan State University
Richard Numrich, Community College of Southern Nevada
Russell McKenzie, Southeastern Louisiana University
Norman P. Obst, Michigan State University
Matthew McPherson, Gonzaga University
Thomas A. Odegaard, Baylor University
Kimberly D. Mencken, Baylor University
Babatunde Odusami, Southeastern Louisiana University
xv
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xvi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xvi
PREFACE
Sebastien Oleas, University of Minnesota Duluth
Brian Rosario, University of California–Davis
Maria P. Olivero, Drexel University
Thomas Rossi, Broome Community College
Una Okonkwo Osili, Indiana University-Purdue University Indianapolis
Sara Saderion, Houston Community College–Southwest
Stephanie Owings, Fort Lewis College
George E. Samuels, Sam Houston State University
Debashis Pal, University of Cincinnati
Jonathan Sandy, University of San Diego
Michel-Ange Pantal, University of Missouri
George Santopietro, Radford University
James M. Payne, Calhoun Community College
Samuel Sarri, University & Community College System of Nevada
Richard Peck, University of Illinois at Chicago Robert L. Pennington, University of Central Florida Martin M. Perline, Wichita State University
Eric Schansberg, Indiana University Southeast Gerald Scott, Florida Atlantic University Mourad Sebti, Central Texas College
Genevieve Peters, University of California–San Diego
Ousmane Seck California State University at Fullerton
Josh Pickrell, South Plains College
Anirban Sengupta, Texas A&M University
Rex Pjesky, Northeastern State University Linnea Polgreen, University of Iowa Robert C. Posatko, Shippensburg University Edgar Preugschat, University of Minnesota William Pritchard, Metropolitan State University Farhad Rassekh, University of Hartford Mitchell Redlo, Monroe Community College Jong C. Rhim, University of Southern Indiana Terry L. Riddle, Central Virginia Community College Richard M. Romano, SUNY/Broome Community College
Luis Guillermo Serpa, University of Illinois at Chicago Dennis Shannon, Southwestern Illinois College Rimma Shiptosva, Utah State University Noel S. Smith, Palm Beach Community College Stephen Smith, Bakersfield College Nick Spangenberg, Ozarks Technical Community College Vera Tabakova, East Carolina University Henry S. Terrell, University of Maryland College Park Charles Thompson, Troy University Wendine R. Thompson-Dawson, University of Utah
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xvii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PREFACE
Steve Thorpe, Phoenix College Derek Tittle, Georgia Institute of Technology
Sudeshna Bandyopadhay, West Virginia University Michael Bar, University of Minnesota
Elwin Tobing, California State University at Fullerton
Klaus Becker, Texas Tech University
Brian M. Trinque, The University of Texas at Austin
Daniel Berkowitz, University of Pittsburgh
Boone A. Turchi, University of North Carolina at Chapel Hill
Guatam Bhattacharya, University of Kansas
Markland Tuttle, Sam Houston State University
Scott Bierman, Carleton College
Jesus M. Valencia, Slippery Rock University James Walker, Indiana University, Bloomington Elizabeth Wark, Worcester State College James Wetzel, Virginia Commonwealth University Jennifer Wissink, Cornell University Kristen Wolfe, St. Johns River Community College James Woods, Portland State University
Ariel Belason, Binghamton University
Calvin Blackwell, College of Charleston Bruce Blonigen, University of Oregon Beth Bogan, Princeton University George Borts, Brown University Nancy Brooks, University of Vermont Clair Brown, University of California–Berkeley Douglas Brown, Georgetown University Andrew Buck, Temple University Marie Bussings-Burk, Southern Indiana University
J. Christopher Wreh, North Central Texas College
James Butikofer, Washington University in St. Louis
Mickey Wu, Coe College
Randy Campbell, Mississippi State University
Steven Yamarik, California State University at Long Beach
Lon Carlson, Illinois State University
Tao Chen Yeh, University of Alabama
David Carr, University of Colorado
Andrew M. Yuengert, Pepperdine University
Nevin Cavusoglu, University of New Hampshire
Reviewers for previous editions
Jack Chambless, Valencia Community College
Ugur Aker, Hiram College Ercument Aksoy, Los Angeles Valley College Rashid Al-Hmoud, Texas Tech University Richard Anderson, Texas A&M University
Xia Chen, Tulane University Nan-Ting Chou, University of Louisville James Cover, University of Alabama Eleanor Craig, University of Delaware
xvii
fra62662_fm_i-xxxii 7/14/08 4:22PM Page xviii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xviii
PREFACE
Ward Curran, Trinity College Donald Dale, Muhlenberg College Carl Davidson, Michigan State University Fred Derrick, Loyola University Maryland Lynn Pierson Doti, Chapman College Donald Dutkowsky, Syracuse University Linda Dynan, Northern Kentucky University Michael Enz Western, New England College Belton Fleisher, The Ohio State University Robert Florence, St. Bonaventure University Kent Ford, Onondaga Community College Nancy Fox, Saint Joseph’s College Joseph Friedman, Temple University Ynon Gablinger, City University of New York–Hunter College Rob Garnett, Texas Christian University Jonah Gelbach, University of Maryland Linda Ghent, East Carolina University Kirk Gifford, Ricks College Robert Gillette, University of Kentucky Stephen Gohman, University of Louisville
Refet Gurkaynak, Princeton University Paul Hamilton, DePauw University Mehdi Haririan, Bloomsburg University of Pennsylvania Joe Haslag, University of Missouri–Columbia Jeff Hefel, Saint Mary’s University Barry Hirsch, Trinity University, Texas Mary Jean Horney, Furman University Nancy Jianakoplos, Colorado State University Robert Johnson, University of San Diego Brett Katzman, Kennesaw State University Brendan Kennelly, National University of Ireland Herbert Kiesling, Indiana University Bruce Kingma, State University of New York–Albany Frederick Kolb, University of Wisconsin–Eau Claire Stephan Kroll, California State University–Sacramento Christopher Laincz, Drexel University Leonard Lardaro, University of Rhode Island Tom Lehman, Indiana Wesleyan Anthony Lima, California State University–Hayward Patricia Lindsey, Butte College
Gregory Green, Idaho State University
Tom Love, North Central University
Sunil Gulati, Columbia University
Alina Luca, Drexel University
Alan Gummerson, Florida International University
Jeffrey Macher, Georgetown University
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xix ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
PREFACE
Steven McCafferty, The Ohio State University
David Romer, University of California–Berkeley
Edward McNertney, Texas Christian University
Greg Rose, Sacramento City College
William Merrill, Iowa State University Norman Miller, Miami University Ohio Christopher Mushrush, Illinois State University
Robert Rossana, Wayne State University Dan Rubenson, Southern Oregon University Richard Salvucci, Trinity University Edward Scahill, University of Scranton
Paul Nelson, Northeast Louisiana State University
Pamela Schmitt, Indiana University
Wilhelm Neuefeind, Washington University in St. Louis
Esther-Mirjam Sent, University of Notre Dame
Neil Niman, University of New Hampshire
John Solow, University of Iowa
Norman Obst, Michigan State University
Dennis Starleaf, Iowa State University
Frank O’Connor, Eastern Kentucky University
Petia Stoytcheva, Louisiana State University
Thomas Odegaard, Baylor University
Helen Tauchen, University of North Carolina–Chapel Hill
Charles Okeke, Community College of Southern Nevada Ronald Olive, University of Massachusetts–Lowell Terry Olson, Truman State University Duane Oyen, University of Wisconsin–Eau Claire Theodore Palivos, Louisiana State University Santiago Pinto, West Virginia University Michael Potepan, San Francisco State University
Sumati Srinivas, Radford University
Marie Truesdell, Marian College Indiana Nora Underwood, Central Florida University Kay Unger, University of Montana Norman Van Cott, Ball State University Kristin Van Gaasbeck, California State University–Sacramento Stephan Weiler, Colorado State University
Robert Rebelein, Vassar College
Jeffrey Weiss, City University of New York–Baruch College
Steve Robinson, University of North Carolina–Wilmington
William Welch Saginaw, Valley State University
Michael Rolleigh, University of Minnesota
Richard Winkelman, Arizona State University
Christina Romer, University of California–Berkeley
Mark Wohar, University of Nebraska–Omaha
xix
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xx ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xx
PREFACE
Louise Wolitz, University of Texas–Austin
Darrel Young, University of Texas–Austin
Paula Worthington, University of Chicago
Zenon Zygmont, Western Oregon University
Micky Wu, Coe College Zhenhui Xu, Georgia College and State University
AACSB STATEMENT McGraw-Hill Companies is a proud corporate member of AACSB International. Recognizing the importance and value of AACSB accreditation, the author of Principles of Microeconomics, 4e has sought to recognize the curricula guidelines detailed in AACSB standards for business accreditation by connecting questions in the test bank and end-of-chapter material to the general knowledge and skill guidelines found in the AACSB standards. It is important to note that the statements contained in Principles of Microeconomics, 4e are provided only as a guide for the users of this text.
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
BRIEF CONTENTS
Preface
PART 1
vii
Introduction
1
Thinking Like an Economist 3
2
Comparative Advantage 35
3
Supply and Demand 61
PART 2
Competition and the Invisible Hand
4
Elasticity 97
5
Demand 125
6
Perfectly Competitive Supply 150
7
Efficiency and Exchange 175
8
The Invisible Hand in Action 203
PART 3 9
Market Imperfections Monopoly, Oligopoly, and Monopolistic Competition 233
10
Games and Strategic Behavior 269
11
Externalities and Property Rights 297
12
The Economics of Information 325
PART 4
Economics of Public Policy
13
Labor Markets, Poverty, and Income Distribution 349
14
The Environment, Health, and Safety 375
15
Public Goods and Tax Policy 397 Glossary G-1 Index
I-1
xxi
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
CONTENTS
Preface
PART I Chapter 1
vii
Introduction Thinking Like an Economist
3
Economics: Studying Choice in a World of Scarcity 4 Applying the Cost-Benefit Principle 6 Economic Surplus 6 Opportunity Cost 7 The Role of Economic Models 7 Three Important Decision Pitfalls 8 Pitfall 1: Measuring Costs and Benefits as Proportions Rather Than Absolute Dollar Amounts 9 Pitfall 2: Ignoring Implicit Costs 9 Pitfall 3: Failure to Think at the Margin 11 Normative Economics versus Positive Economics 15 Economics: Micro and Macro 15 The Approach of This Text 16 Economic Naturalism 17 EXAMPLE 1.1 THE ECONOMIC NATURALIST: Why do many hardware
manufacturers include more than $1,000 worth of “free” software with a computer selling for only slightly more than that? 17 EXAMPLE 1.2 THE ECONOMIC NATURALIST: Why don’t auto manufacturers make cars without heaters? 18 EXAMPLE 1.3 THE ECONOMIC NATURALIST: Why do the keypad buttons on drive-up automatic teller machines have Braille dots? 18 Summary 19 Core Principles 20 Key Terms 20 Review Questions 20 Problems 20 Answers to In-Chapter Exercises 22 Appendix: Working with Equations, Graphs, and Tables
Chapter 2
Comparative Advantage
23
35
Exchange and Opportunity Cost 36 The Principle of Comparative Advantage 37 EXAMPLE 2.1 THE ECONOMIC NATURALIST: Where have all the 400 hitters gone? 39 Sources of Comparative Advantage 40 EXAMPLE 2.2 THE ECONOMIC NATURALIST: Televisions and videocassette
recorders were developed and first produced in the United States, but today the United xxii
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxiii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
CONTENTS
xxiii
States accounts for only a minuscule share of the total world production of these products. Why did the United States fail to retain its lead in these markets? 41
Comparative Advantage and Production Possibilities 41 The Production Possibilities Curve 41 How Individual Productivity Affects the Slope and Position of the PPC 44 The Gains from Specialization and Exchange 46 A Production Possibilities Curve for a Many-Person Economy 47 Factors That Shift the Economy’s Production Possibilities Curve 49 Why Have Some Countries Been Slow to Specialize? 51 Can We Have Too Much Specialization? 52 Comparative Advantage and International Trade 53 EXAMPLE 2.3 THE ECONOMIC NATURALIST: If trade between nations is so beneficial, why are free-trade agreements so controversial? 53 Outsourcing 53 EXAMPLE 2.4 THE ECONOMIC NATURALIST: Is PBS economics reporter Paul Solman’s job a likely candidate for outsourcing? 54 Summary 56 Core Principles 56 Key Terms 56 Review Questions 57 Problems 57 Answers to In-Chapter Exercises 58
Chapter 3
Supply and Demand 61 What, How, and for Whom? Central Planning versus the Market 63 Buyers and Sellers in Markets 64 The Demand Curve 65 The Supply Curve 66 Market Equilibrium 68 Rent Controls Reconsidered 71 Pizza Price Controls? 73 Predicting and Explaining Changes in Prices and Quantities 74 Shifts in Demand 75 EXAMPLE 3.1 THE ECONOMIC NATURALIST: When the federal government
implements a large pay increase for its employees, why do rents for apartments located near Washington Metro stations go up relative to rents for apartments located far away from Metro stations? 77
Shifts in the Supply Curve 78 EXAMPLE 3.2 THE ECONOMIC NATURALIST: Why do major term papers go through so many more revisions today than in the 1970s? 80
Four Simple Rules 81 EXAMPLE 3.3 THE ECONOMIC NATURALIST: Why do the prices of some goods, like airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down? 84
Efficiency and Equilibrium 84 Cash on the Table 85 Smart for One, Dumb for All 86 Summary 87 Core Principles 88 Key Terms 89 Review Questions 89 Problems 89
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxiv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xxiv
CONTENTS
Answers to In-Chapter Exercises 90 Appendix: The Algebra of Supply and Demand
93
PART 2
Competition and the Invisible Hand
Chapter 4
Elasticity 97 Price Elasticity of Demand 98 Price Elasticity Defined 98 Determinants of Price Elasticity of Demand 100 Some Representative Elasticity Estimates 101 Using Price Elasticity of Demand 102 EXAMPLE 4.1 THE ECONOMIC NATURALIST: Will a higher tax on cigarettes curb teenage smoking? 102 EXAMPLE 4.2 THE ECONOMIC NATURALIST: Why was the luxury tax on yachts such a disaster? 102 A Graphical Interpretation of Price Elasticity 103 Price Elasticity Changes along a Straight-Line Demand Curve 105 Two Special Cases 106 Elasticity and Total Expenditure 107 Income Elasticity and Cross-Price Elasticity of Demand 111 The Price Elasticity of Supply 112 Determinants of Supply Elasticity 114 EXAMPLE 4.3 THE ECONOMIC NATURALIST: Why are gasoline prices so much more volatile than car prices? 116 Unique and Essential Inputs: The Ultimate Supply Bottleneck 117 Summary 118 Key Terms 119 Review Questions 119 Problems 119 Answers to In-Chapter Exercises 121 Appendix: The Midpoint Formula 123
Chapter 5
Demand 125 The Law of Demand 126 The Origins of Demand 126 Needs versus Wants 127 EXAMPLE 5.1 THE ECONOMIC NATURALIST: Why does California experience chronic water shortages? 128 Translating Wants into Demand 128 Measuring Wants: The Concept of Utility 128 Allocating a Fixed Income between Two Goods 132 The Rational Spending Rule 135 Income and Substitution Effects Revisited 135 Applying the Rational Spending Rule 138 Substitution at Work 138 EXAMPLE 5.2 THE ECONOMIC NATURALIST: Why do the wealthy in Manhattan live in smaller houses than the wealthy in Seattle? 138 EXAMPLE 5.3 THE ECONOMIC NATURALIST: Why did people turn to four-cylinder cars in the 1970s, only to shift back to six- and eight-cylinder cars in the 1990s? 138 EXAMPLE 5.4 THE ECONOMIC NATURALIST: Why are automobile engines smaller in England than in the United States? 140 The Importance of Income Differences 140
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
CONTENTS
EXAMPLE 5.5 THE ECONOMIC NATURALIST: Why are waiting lines longer in poorer neighborhoods? 140 Individual and Market Demand Curves 140 Horizontal Addition 141 Demand and Consumer Surplus 142 Calculating Consumer Surplus 142 Summary 145 Key Terms 145 Review Questions 145 Problems 146 Answers to In-Chapter Exercises 147
Chapter 6
Perfectly Competitive Supply 150 Thinking about Supply: The Importance of Opportunity Cost 150 Individual and Market Supply Curves 152 Profit-Maximizing Firms in Perfectly Competitive Markets 153 Profit Maximization 153 The Demand Curve Facing a Perfectly Competitive Firm 154 Production in the Short Run 155 Some Important Cost Concepts 156 Choosing Output to Maximize Profit 157 A Note on the Firm’s Shutdown Condition 159 Average Variable Cost and Average Total Cost 159 A Graphical Approach to Profit Maximization 159 Price 0002 Marginal Cost: The Maximum-Profit Condition 161 The “Law” of Supply 163 Determinants of Supply Revisited 164 Technology 164 Input Prices 164 The Number of Suppliers 165 Expectations 165 Changes in Prices of Other Products 165 Applying the Theory of Supply 165 EXAMPLE 6.1 THE ECONOMIC NATURALIST: When recycling is left to private market forces, why are many more aluminum beverage containers recycled than glass ones? 165
Supply and Producer Surplus 168 Calculating Producer Surplus 168 Summary 169 Key Terms 170 Review Questions 170 Problems 170 Answers to In-Chapter Exercises
Chapter 7
173
Efficiency and Exchange 175 Market Equilibrium and Efficiency 176 Efficiency Is Not the Only Goal 179 Why Efficiency Should Be the First Goal 179 The Cost of Preventing Price Adjustments 179 Price Ceilings 180 Price Subsidies 183 First-Come, First-Served Policies 185
xxv
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxvi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xxvi
CONTENTS
EXAMPLE 7.1 THE ECONOMIC NATURALIST: Why does no one complain any longer about being bumped from an overbooked flight? 185 Marginal Cost Pricing of Public Services 188 Taxes and Efficiency 190 Who Pays a Tax Imposed on Sellers of a Good? 190 EXAMPLE 7.2 THE ECONOMIC NATURALIST: How will a tax on cars affect their prices in the long run? 191 How a Tax Collected from a Seller Affects Economic Surplus 192 Taxes, Elasticity, and Efficiency 194 Taxes, External Costs, and Efficiency 195 Summary 196 Key Terms 197 Review Questions 197 Problems 197 Answers to In-Chapter Exercises 199
Chapter 8
The Invisible Hand in Action 203 The Central Role of Economic Profit 204 Three Types of Profit 204 The Invisible Hand Theory 207 Two Functions of Price 207 Responses to Profits and Losses 208 The Importance of Free Entry and Exit 214 Economic Rent versus Economic Profit 215 The Invisible Hand in Action 216 The Invisible Hand at the Supermarket and on the Freeway 216 EXAMPLE 8.1 THE ECONOMIC NATURALIST: Why do supermarket checkout lines all tend to be roughly the same length? 216 The Invisible Hand and Cost-Saving Innovations 217 The Invisible Hand in Regulated Markets 217 EXAMPLE 8.2 THE ECONOMIC NATURALIST: Why do New York City taxicab medallions sell for more than $300,000? 218 EXAMPLE 8.3 THE ECONOMIC NATURALIST: Why did major commercial airlines install piano bars on the upper decks of Boeing 747s in the 1970s? 219 The Invisible Hand in Antipoverty Programs 220 The Invisible Hand in the Stock Market 220 EXAMPLE 8.4 THE ECONOMIC NATURALIST: Why isn’t a stock portfolio consisting of Canada’s “50 best-managed companies” a particularly good investment? 223 The Distinction between an Equilibrium and a Social Optimum 224 Smart for One, Dumb for All 225 EXAMPLE 8.5 THE ECONOMIC NATURALIST: Are there “too many” smart people working as corporate earnings forecasters? 225 Summary 226 Key Terms 227 Review Questions 227 Problems 227 Answers to In-Chapter Exercises 229
PART 3
Market Imperfections
Chapter 9
Monopoly, Oligopoly, and Monopolistic Competition 233 Imperfect Competition 234
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxvii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
CONTENTS
xxvii
Different Forms of Imperfect Competition 234 The Essential Difference between Perfectly and Imperfectly Competitive Firms 236 Five Sources of Market Power 237 Exclusive Control over Important Inputs 237 Patents and Copyrights 237 Government Licenses or Franchises 237 Economies of Scale and Natural Monopolies 238 Network Economies 238 Economies of Scale and the Importance of Start-Up Costs 239 EXAMPLE 9.1 THE ECONOMIC NATURALIST: Why does Intel sell the
overwhelming majority of all microprocessors used in personal computers? 241
Profit Maximization for the Monopolist 242 Marginal Revenue for the Monopolist 242 The Monopolist’s Profit-Maximizing Decision Rule 245 Being a Monopolist Doesn’t Guarantee an Economic Profit 246 Why the Invisible Hand Breaks Down under Monopoly 247 Using Discounts to Expand the Market 249 Price Discrimination Defined 249 EXAMPLE 9.2 THE ECONOMIC NATURALIST: Why do many movie theaters
offer discount tickets to students? 250
How Price Discrimination Affects Output 250 The Hurdle Method of Price Discrimination 252 Is Price Discrimination a Bad Thing? 255 Examples of Price Discrimination 255 EXAMPLE 9.3 THE ECONOMIC NATURALIST: Why might an appliance retailer instruct its clerks to hammer dents into the sides of its stoves and refrigerators? 256 Public Policy toward Natural Monopoly 257 State Ownership and Management 257 State Regulation of Private Monopolies 258 Exclusive Contracting for Natural Monopoly 258 Vigorous Enforcement of Antitrust Laws 259 Summary 260 Key Terms 261 Review Questions 261 Problems 261 Answers to In-Chapter Exercises 264 Appendix: The Algebra of Monopoly Profit Maximization 267
Chapter 10
Games and Strategic Behavior 269 Using Game Theory to Analyze Strategic Decisions 270 The Three Elements of a Game 270 Nash Equilibrium 272 The Prisoner’s Dilemma 274 The Original Prisoner’s Dilemma 274 The Economics of Cartels 275 EXAMPLE 10.1 THE ECONOMIC NATURALIST: Why are cartel agreements 275 Tit-for-Tat and the Repeated Prisoner’s Dilemma 277 EXAMPLE 10.2 THE ECONOMIC NATURALIST: How did Congress unwittingly solve the television advertising dilemma confronting cigarette producers? 278
notoriously unstable?
fra62662_fm_i-xxxii 7/14/08 4:22PM Page xxviii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xxviii
CONTENTS
EXAMPLE 10.3 THE ECONOMIC NATURALIST: Why do people shout 280 Games in Which Timing Matters 280 Credible Threats and Promises 282 Monopolistic Competition When Location Matters 283 EXAMPLE 10.4 THE ECONOMIC NATURALIST: Why do we often see convenience stores located on adjacent street corners? 284 Commitment Problems 285 The Strategic Role of Preferences 287 Are People Fundamentally Selfish? 288 Preferences as Solutions to Commitment Problems 288 Summary 289 Key Terms 290 Review Questions 290 Problems 290 Answers to In-Chapter Exercises 294
at parties?
Chapter 11
Externalities and Property Rights
297
External Costs and Benefits 298 How Externalities Affect Resource Allocation 298 How Do Externalities Affect Supply and Demand? 299 The Coase Theorem 301 Legal Remedies for Externalities 305 EXAMPLE 11.1 THE ECONOMIC NATURALIST: What is the purpose of free speech laws? 306 EXAMPLE 11.2 THE ECONOMIC NATURALIST: Why does government subsidize private property owners to plant trees on their hillsides? 306 The Optimal Amount of Negative Externalities Is Not Zero 307 Compensatory Taxes and Subsidies 307 Property Rights and the Tragedy of the Commons 309 The Problem of Unpriced Resources 309 The Effect of Private Ownership 311 When Private Ownership Is Impractical 312 EXAMPLE 11.3 THE ECONOMIC NATURALIST: Why do blackberries in public parks get picked too soon? 313 EXAMPLE 11.4 THE ECONOMIC NATURALIST: Why are shared milkshakes consumed too quickly? 313 Positional Externalities 314 Payoffs That Depend on Relative Performance 314 EXAMPLE 11.5 THE ECONOMIC NATURALIST: Why do football players take anabolic steroids? 315 Positional Arms Races and Positional Arms Control Agreements 316 Social Norms as Positional Arms Control Agreements 317 Summary 318 Key Terms 320 Review Questions 320 Problems 320 Answers to In-Chapter Exercises 323
Chapter 12
The Economics of Information
325
How the Middleman Adds Value 326 The Optimal Amount of Information 328
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxix ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
CONTENTS
xxix
The Cost-Benefit Test 328 The Free-Rider Problem 329 EXAMPLE 12.1 THE ECONOMIC NATURALIST: Why is finding a knowledgeable salesclerk often difficult? 329 EXAMPLE 12.2 THE ECONOMIC NATURALIST: Why did Rivergate Books, the last bookstore in Lambertville, New Jersey, go out of business? 329 Two Guidelines for Rational Search 330 The Gamble Inherent in Search 331 The Commitment Problem When Search Is Costly 332 Asymmetric Information 333 The Lemons Model 334 The Credibility Problem in Trading 336 The Costly-to-Fake Principle 336 EXAMPLE 12.3 THE ECONOMIC NATURALIST: Why do firms insert the phrase “As advertised on TV” when they advertise their products in magazines and newspapers? 337 EXAMPLE 12.4 THE ECONOMIC NATURALIST: Why do many companies care so much about elite educational credentials? 337 Conspicuous Consumption as a Signal of Ability 337 EXAMPLE 12.5 THE ECONOMIC NATURALIST: Why do many clients seem to prefer lawyers who wear expensive suits? 338 Statistical Discrimination 338 EXAMPLE 12.6 THE ECONOMIC NATURALIST: Why do males under 25 years of age pay more than other drivers for auto insurance? 339 Adverse Selection 340 Moral Hazard 340 Disappearing Political Discourse 341 EXAMPLE 12.7 THE ECONOMIC NATURALIST: Why do opponents of the death penalty often remain silent? 341 EXAMPLE 12.8 THE ECONOMIC NATURALIST: Why do proponents of legalized drugs remain silent? 342 Summary 342 Key Terms 344 Review Questions 344 Problems 344 Answers to In-Chapter Exercises 346
PART 4 Chapter 13
Economics of Public Policy Labor Markets, Poverty, and Income Distribution 349 The Economic Value of Work 350 The Equilibrium Wage and Employment Levels 352 The Demand Curve for Labor 352 The Supply Curve of Labor 353 Market Shifts 354 Explaining Differences in Earnings 355 Human Capital Theory 355 Labor Unions 355 EXAMPLE 13.1 THE ECONOMIC NATURALIST: If unionized firms have
to pay more, how do they manage to survive in the face of competition from their nonunionized counterparts? 357
Compensating Wage Differentials 357
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxx ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
xxx
CONTENTS
EXAMPLE 13.2 THE ECONOMIC NATURALIST: Why do some ad–copy writers earn more than others? 357 Discrimination in the Labor Market 358 Winner-Take-All Markets 360 EXAMPLE 13.3 THE ECONOMIC NATURALIST: Why does Renée Fleming earn millions more than sopranos of only slightly lesser ability? 360 Recent Trends in Inequality 361 Is Income Inequality a Moral Problem? 362 Methods of Income Redistribution 364 Welfare Payments and In-Kind Transfers 364 Means-Tested Benefit Programs 364 The Negative Income Tax 365 Minimum Wages 366 The Earned-Income Tax Credit 367 Public Employment for the Poor 368 A Combination of Methods 369 Summary 370 Key Terms 371 Review Questions 371 Problems 371 Answers to In-Chapter Exercises 373
Chapter 14
The Environment, Health, and Safety 375 The Economics of Health Care Delivery 376 Applying the Cost-Benefit Criterion 376 Designing a Solution 378 The HMO Revolution 379 EXAMPLE 14.1 THE ECONOMIC NATURALIST: Why is a patient with a sore knee more likely to receive an MRI exam if he has conventional health insurance than if he belongs to a health maintenance organization? 379
Paying for Health Insurance 380 EXAMPLE 14.2 THE ECONOMIC NATURALIST: In the richest country on Earth, why do so many people lack basic health insurance? 381 Using Price Incentives in Environmental Regulation 382 Taxing Pollution 382 Auctioning Pollution Permits 384 Workplace Safety Regulation 385 EXAMPLE 14.3 THE ECONOMIC NATURALIST: Why does the government require safety seats for infants who travel in cars but not for infants who travel in airplanes? 389
Public Health and Security 390 EXAMPLE 14.4 THE ECONOMIC NATURALIST: Why do many states have laws requiring students to be vaccinated against childhood illnesses? 390 EXAMPLE 14.5 THE ECONOMIC NATURALIST: Why do more Secret Service
agents guard the president than the vice president, and why do no Secret Service agents guard college professors? 391 Summary 392 Key Terms 393 Review Questions 393 Problems 393 Answers to In-Chapter Exercises
395
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxxi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
CONTENTS
Chapter 15
xxxi
Public Goods and Tax Policy 397 Government Provision of Public Goods 398 Public Goods versus Private Goods 398 Paying for Public Goods 400 EXAMPLE 15.1 THE ECONOMIC NATURALIST: Why don’t most married couples contribute equally to joint purchases? 402 The Optimal Quantity of a Public Good 403 The Demand Curve for a Public Good 405 Private Provision of Public Goods 405 EXAMPLE 15.2 THE ECONOMIC NATURALIST: Why do television networks favor
406 Additional Functions of Government 408 Externalities and Property Rights 408 Local, State, or Federal? 409 Sources of Inefficiency in the Political Process 410 Pork Barrel Legislation 410
Jerry Springer over Masterpiece Theater?
EXAMPLE 15.3 THE ECONOMIC NATURALIST: Why does check-splitting make the total restaurant bill higher? 410 EXAMPLE 15.4 THE ECONOMIC NATURALIST: Why do legislators often support one another’s pork barrel spending programs? 411 Rent-Seeking 411 Starve the Government? 413 What Should We Tax? 414 Summary 416 Key Terms 417 Review Questions 417 Problems 417 Answers to In-Chapter Exercises 420
Glossary G-1 Index I-1
fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxxii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm:
SEVEN CORE PRINCIPLES
CORE PRINCIPLE 1 The Scarcity Principle (also called “The No-Free-Lunch Principle”) Scarcity
Although we have boundless needs and wants, the resources available to us are limited. So having more of one good thing usually means having less of another.
CORE PRINCIPLE 2 The Cost-Benefit Principle Cost-Benefit
An individual (or a firm or a society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs.
CORE PRINCIPLE 3 The Incentive Principle Incentive
A person (or a firm or a society) is more likely to take an action if the benefit rises and less likely to take it if the cost rises.
CORE PRINCIPLE 4 The Principle of Comparative Advantage Comparative Advantage
Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.
CORE PRINCIPLE 5 The Principle of Increasing Opportunity Cost (also called “The Low-Hanging-Fruit Principle”) Increasing Opportunity Cost
In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterward turn to resources with higher opportunity costs.
CORE PRINCIPLE 6 The Efficiency Principle Efficiency
Efficiency is an important social goal because when the economic pie grows larger, everyone can have a larger slice.
CORE PRINCIPLE 7 The Equilibrium Principle (also called “The No-Cash-onthe-Table Principle”) Equilibrium xxxii
A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action.