## TABLE OF CONTENTS

**Part 1 Introduction to Microeconomics**

**Chapter 1 Analyzing Economic Problems 1
**Microeconomics and Climate Change

1.1 Why Study Microeconomics? 4

1.2 Three Key Analytical Tools 5

Constrained Optimization 6

Equilibrium Analysis 12

Comparative Statics 14

1.3 Positive and Normative Analysis 18

**Learning-By-Doing-Exercises**

1.1 Constrained Optimization: The Farmer’s Fence 7

1.2 Constrained Optimization: Consumer Choice 8

1.3 Comparative Statics with Market Equilibrium in the U.S. Market for Corn 16

1.4 Comparative Statics with Constrained Optimization 18

**Chapter 2 Demand and Supply Analysis 26
**What Gives with the Price of Corn?

2.1 Demand, Supply, and Market Equilibrium 30

Demand Curves 30

Supply Curves 32

Market Equilibrium 34

Shifts in Supply and Demand 35

2.2 Price Elasticity of Demand 44

Elasticities Along Specific Demand Curves 46

Price Elasticity of Demand and Total Revenue 49

Determinants of the Price Elasticity of Demand 49

Market-Level Versus Brand-Level Price Elasticities of Demand 51

2.3 Other Elasticities 53

Income Elasticity of Demand 53

Cross-Price Elasticity of Demand 54

Price Elasticity of Supply 56

2.4 Elasticity in the Long Run Versus the Short Run 56

Greater Elasticity in the Long Run than in the Short Run 56

Greater Elasticity In the Short Run than in the Long Run 57

2.5 Back-of-the-Envelope Calculations 59

Fitting Linear Demand Curves Using Quantity, Price, and Elasticity Information 60

Identifying Supply and Demand Curves on the Back of an Envelope 61

Identifying the Price Elasticity of Demand from Shifts in Supply 63

Appendix Price Elasticity of Demand along a Constant Elasticity Demand Curve 74

**Learning-By-Doing-Exercises**

2.1 Sketching a Demand Curve 31

2.2 Sketching a Supply Curve 33

2.3 Calculating Equilibrium Price and Quantity 34

2.4 Comparative Statics on the Market Equilibrium 37

2.5 Price Elasticity of Demand 47

2.6 Elasticities along Special Demand Curves 49

**Part 2 Consumer Theory**

**Chapter 3 Consumer Preferences and the Concept of Utility 75
**Why Do You Like What You Like?

3.1 Representations of Preferences 77

Assumptions About Consumer Preferences 77

Ordinal and Cardinal Ranking 80

3.2 Utility Functions 80

Preferences with a Single Good: The Concept of Marginal Utility 80

Preferences with Multiple Goods: Marginal Utility, Indifference Curves, and the Marginal Rate of Substitution 84

3.3 Special Preferences 95

Perfect Substitutes 95

Perfect Complements 96

The Cobb–Douglas Utility Function 97

Quasilinear Utility Functions 98

3.4 Behavioral Aspects of Choice 100

**Learning-By-Doing-Exercises**

3.1 Marginal Utility 86

3.2 Marginal Utility That is Not Diminishing 86

3.3 Indifference Curves with Diminishing *MRS _{x,Y }*93

3.4 Indifference Curves with Increasing *MRS _{x,Y }*94

**Chapter 4 Consumer Choice 109
**How Much of What You Like Should You Buy?

4.1 The Budget Constraint 111

How Does a Change in Income Affect the Budget Line? 113

How Does a Change in Price Affect the Budget Line? 113

4.2 Optimal Choice 116

Using the Tangency Condition to Understand When a Basket is *Not *Optimal 120

Finding an Optimal Consumption Basket 121

Two Ways of Thinking About Optimality 122

Corner Points 124

4.3 Consumer Choice with Composite Goods 127

Application: Coupons and Cash Subsidies 127

Application: Joining a Club 131

Application: Borrowing and Lending 132

Application: Quantity Discounts 137

4.4 Revealed Preference 138

Are Observed Choices Consistent with Utility Maximization? 139

4.5 Maximizing Utility Using Lagrange Multipliers 144

Appendix The Time Value of Money 157

**Learning-By-Doing-Exercises**

4.1 Good News/Bad News and the Budget Line 116

4.2 Finding an Interior Optimum 121

4.3 Finding a Corner Point Solution 125

4.4 Corner Point Solution with Perfect Substitutes 126

4.5 Consumer Choice That Fails to Maximize Utility 140

4.6 Other Uses of Revealed Preference 142

4.7 Finding an Interior Optimum Using the Method of Lagrange 148

4.8 Finding a Corner Point Solution Using the Method of Lagrange 149

**Chapter 5 The Theory of Demand 163
**Why Understanding the Demand for Cigarettes is Important for Public Policy

5.1 Optimal Choice and Demand 165

The Effects of a Change in Price 165

The Effects of a Change in Income 168

The Effects of a Change in Price or Income: An Algebraic Approach 173

5.2 Change in the Price of a Good: Substitution Effect and Income Effect 175

The Substitution Effect 176

The Income Effect 176

Income and Substitution Effects When Goods Are Not Normal 178

5.3 Change in the Price of a Good: The Concept of Consumer Surplus 186

Understanding Consumer Surplus from the Demand Curve 186

Understanding Consumer Surplus from the Optimal Choice Diagram: Compensating Variation and Equivalent Variation 188

5.4 Market Demand 195

Market Demand with Network Externalities 197

5.5 The Choice of Labor and Leisure 200

As Wages Rise, Leisure First Decreases, then Increases 200

The Backward-Bending Supply of Labor 202

5.6 Consumer Price Indices 206

**Learning-By-Doing-Exercises**

5.1 A Normal Good Has a Positive Income Elasticity of Demand 172

5.2 Finding a Demand Curve (No Corner Points) 173

5.3 Finding a Demand Curve (with a Corner Point Solution) 174

5.4 Finding Income and Substitution Effects Algebraically 181

5.5 Income and Substitution Effects with a Price Increase 183

5.6 Income and Substitution Effects with a Quasilinear Utility Function 184

5.7 Consumer Surplus: Looking at the Demand Curve 187

5.8 Compensating and Equivalent Variations with No Income Effect 191

5.9 Compensating and Equivalent Variations with an Income Effect 193

5.10 The Demand for Leisure and the Supply of Labor 204

**Part 3 Production and Cost Theory**

**Chapter 6 Inputs and Production Functions 216
**Can They Do It Better and Cheaper?

6.1 Introduction to Inputs and Production Functions 218

6.2 Production Functions with a Single Input 220

Total Product Functions 221

Marginal and Average Product 222

Relationship Between Marginal and Average Product 226

6.3 Production Functions with More Than One Input 227

Total Product and Marginal Product with Two Inputs 227

Isoquants 229

Economic and Uneconomic Regions of Production 233

Marginal Rate of Technical Substitution 233

6.4 Substitutability Among Inputs 236

Describing a Firm’s Input Substitution Opportunities Graphically 237

Elasticity of Substitution 239

Special Production Functions 242

6.5 Returns to Scale 248

Definitions 248

Returns to Scale Versus Diminishing Marginal Returns 251

6.6 Technological Progress 251

Appendix The Elasticity of Substitution for a Cobb–Douglas Production Function 261

**Learning-By-Doing-Exercises**

6.1 Deriving the Equation of an Isoquant 232

6.2 Relating the Marginal Rate of Technical Substitution to Marginal Products 236

6.3 Calculating the Elasticity of Substitution from a Production Function 240

6.4 Returns to Scale for a Cobb–Douglas Production Function 250

6.5 Technological Progress 253

**Chapter 7 Costs and Cost Minimization 263
**What’s Behind the Self-Service Revolution?

7.1 Cost Concepts for Decision Making 265

Opportunity Cost 266

Economic versus Accounting Costs 269

Sunk (Unavoidable) versus Nonsunk (Avoidable) Costs 269

7.2 The Cost-Minimization Problem 272

Long Run versus Short Run 272

The Long-Run Cost-Minimization Problem 272

Isocost Lines 273

Graphical Characterization of the Solution to the Long-Run Cost-Minimization Problem 274

Corner Point Solutions 277

7.3 Comparative Statics Analysis of the Cost-Minimization Problem 278

Comparative Statics Analysis of Changes in Input Prices 278

Comparative Statics Analysis of Changes in Output 282

Summarizing the Comparative Statics Analysis: The Input Demand Curves 283

The Price Elasticity of Demand for Inputs 285

7.4 Short-Run Cost Minimization 289

Characterizing Costs in the Short Run 289

Cost Minimization in the Short Run 291

Comparative Statics: Short-Run Input Demand versus Long-Run Input Demand 292

More Than One Variable Input in the Short Run 293

7.5 Minimizing Long-Run Costs Using Lagrange Multipliers 295

Appendix Advanced Topics in Cost Minimization 307

**Learning-By-Doing-Exercises**

7.1 Using the Cost Concepts for a College Campus Business 270

7.2 Finding an Interior Cost-Minimization Optimum 276

7.3 Finding a Corner Point Solution with Perfect Substitutes 277

7.4 Deriving the Input Demand Curves from a Production Function 285

7.5 Short-Run Cost Minimization with One Fixed Input 293

7.6 Short-Run Cost Minimization with Two Variable Inputs 294

7.7 Finding an Interior Optimum Using the Method of Lagrange 299

7.8 Finding a Corner Point Solution Using the Method of Lagrange 300

**Chapter 8 Cost Curves 310
**How Can Hisense Get a Handle on Costs?

8.1 Long-Run Cost Curves 312

Long-Run Total Cost Curve 312

How Does the Long-Run Total Cost Curve Shift When Input Prices Change? 314

Long-Run Average and Marginal Cost Curves 316

8.2 Short-Run Cost Curves 328

Short-Run Total Cost Curve 328

Relationship Between the Long-Run and the Short-Run Total Cost Curves 328

Short-Run Average and Marginal Cost Curves 331

Relationships Between the Long-Run and the Short-Run Average and Marginal Cost Curves 332

When Are Long-Run and Short-Run Average and Marginal Costs Equal, and When Are They Not? 333

8.3 Special Topics in Cost 336

Economies of Scope 336

Economies of Experience: The Experience Curve 340

8.4 Estimating Cost Functions 343

Constant Elasticity Cost Function 343

Translog Cost Function 343

Appendix Shephard’s Lemma and Duality 350

**Learning-By-Doing-Exercises**

8.1 Finding the Long-Run Total Cost Curve from a Production Function 314

8.2 Deriving Long-Run Average and Marginal Cost Curves from a Long-Run Total Cost Curve 319

8.3 Deriving a Short-Run Total Cost Curve 329

8.4 The Relationship between Short-Run and Long-Run Average Cost Curves 334

**Part 4 Perfect Competition**

**Chapter 9 Perfectly Competitive Markets 354
**A Rose is a Rose is a Rose

9.1 What is Perfect Competition? 357

9.2 Profit Maximization by a Price-Taking Firm 359

Economic Profit versus Accounting Profit 359

The Profit-Maximizing Output Choice for a Price-Taking Firm 361

9.3 How the Market Price is Determined: Short-Run Equilibrium 364

The Price-Taking Firm’s Short-Run Cost Structure 364

Short-Run Supply Curve for a Price-Taking Firm When All Fixed Costs Are Sunk 366

Short-Run Supply Curve for a Price-Taking Firm When Some Fixed Costs Are Sunk and Some Are Nonsunk 368

Short-Run Market Supply Curve 372

Short-Run Perfectly Competitive Equilibrium 375

Comparative Statics Analysis of the Short-Run Equilibrium 376

9.4 How the Market Price is Determined: Long-Run Equilibrium 382

Long-Run Output and Plant-Size Adjustments by Established Firms 382

The Firm’s Long-Run Supply Curve 383

Free Entry and Long-Run Perfectly Competitive Equilibrium 384

Long-Run Market Supply Curve 386

Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries 387

What Does the Theory of Perfect Competition Teach Us? 395

9.5 Economic Rent and Producer Surplus 396

Economic Rent 396

Producer Surplus 399

Economic Profit, Producer Surplus, Economic Rent 405

Appendix Profit Maximization Implies Cost Minimization 413

**Learning-By-Doing-Exercises**

9.1 Deriving the Short-Run Supply Curve for a Price-Taking Firm 368

9.2 Deriving the Short-Run Supply Curve for a Price-Taking Firm with Some Nonsunk Fixed Costs 370

9.3 Short-Run Market Equilibrium 376

9.4 Calculating a Long-Run Equilibrium 385

9.5 Calculating Producer Surplus 404

**Chapter 10 Competitive Markets: Applications 415
**Is Support a Good Thing?

10.1 The Invisible Hand, Excise Taxes, and Subsidies 417

The Invisible Hand 418

Excise Taxes 419

Incidence of a Tax 423

Subsidies 427

10.2 Price Ceilings and Floors 429

Price Ceilings 430

Price Floors 438

10.3 Production Quotas 443

10.4 Price Supports in the Agricultural Sector 447

Acreage Limitation Programs 447

Government Purchase Programs 449

10.5 Import Quotas and Tariffs 451

Quotas 451

Tariffs 455

**Learning-By-Doing-Exercises**

10.1 Impact of an Excise Tax 422

10.2 Impact of a Subsidy 429

10.3 Impact of a Price Ceiling 436

10.4 Impact of a Price Floor 441

10.5 Comparing the Impact of an Excise Tax, a Price Floor, and a Production Quota 446

10.6 Effects of an Import Tariff 458

**Part 5 Market Power**

**Chapter 11 Monopoly and Monopsony 468
**Why Do Firms Play Monopoly?

11.1 Profit Maximization by a Monopolist 470

The Profit-Maximization Condition 470

A Closer Look at Marginal Revenue: Marginal Units and Inframarginal Units 474

Average Revenue and Marginal Revenue 475

The Profit-Maximization Condition Shown Graphically 477

A Monopolist Does Not Have A Supply Curve 479

11.2 The Importance of Price Elasticity of Demand 480

Price Elasticity of Demand and the Profit-Maximizing Price 480

Marginal Revenue and Price Elasticity of Demand 481

Marginal Cost and Price Elasticity of Demand: The Inverse Elasticity Pricing Rule 483

The Monopolist Always Produces on the Elastic Region of the Market Demand Curve 484

The IEPR Applies not Only to Monopolists 486

Quantifying Market Power: The Lerner Index 487

11.3 Comparative Statics for Monopolists 488

Shifts in Market Demand 488

Shifts in Marginal Cost 491

11.4 Monopoly with Multiple Plants and Markets 493

Output Choice with two Plants 494

Output Choice with two Markets 495

Profit Maximization by a Cartel 496

11.5 The Welfare Economics of Monopoly 499

The Monopoly Equilibrium Differs from the Perfectly Competitive Equilibrium 499

Monopoly Deadweight Loss 501

Rent-Seeking Activities 501

11.6 Why Do Monopoly Markets Exist? 501

Natural Monopoly 502

Barriers to Entry 503

11.7 Monopsony 505

The Monopsonist’s Profit-Maximization Condition 505

An Inverse Elasticity Pricing Rule for Monopsony 507

Monopsony Deadweight Loss 508

**Learning-By-Doing-Exercises**

11.1 Marginal and Average Revenue for a Linear Demand Curve 477

11.2 Applying the Monopolist’s Profit-Maximization Condition 479

11.3 Computing the Optimal Monopoly Price for a Constant Elasticity Demand Curve 483

11.4 Computing the Optimal Monopoly Price for a Linear Demand Curve 484

11.5 Computing the Optimal Price Using the Monopoly Midpoint Rule 490

11.6 Determining the Optimal Output, Price, and Division of Production for a Multiplant Monopolist 495

11.7 Determining the Optimal Output and Price for a Monopolist Serving Two Markets 496

11.8 Applying the Monopsonist’s Profit-Maximization Condition 507

11.9 Applying the Inverse Elasticity Rule for a Monopsonist 508

**Chapter 12 Capturing Surplus 515
**Why Did Your Carpet or Your Airline Ticket Cost So Much Less Than Mine?

12.1 Capturing Surplus 517

12.2 First-Degree Price Discrimination: Making the Most from Each Consumer 520

12.3 Second-Degree Price Discrimination: Quantity Discounts 525

Block Pricing 525

Subscription and Usage Charges 528

12.4 Third-Degree Price Discrimination: Different Prices for Different Market Segments 531

Two Different Segments, Two Different Prices 531

Screening 534

Third-Degree Price Discrimination with Capacity Constraints 536

Implementing the Scheme of Price Discrimination: Building “Fences” 538

12.5 Tying (Tie-In Sales) 543

Bundling 544

Mixed Bundling 546

12.6 Advertising 548

**Learning-By-Doing-Exercises**

12.1 Capturing Surplus: Uniform Pricing versus First-Degree Price Discrimination 522

12.2 Where is the Marginal Revenue Curve with First-Degree Price Discrimination? 523

12.3 Increasing Profits with a Block Tariff 527

12.4 Third-Degree Price Discrimination in Railroad Transport 533

12.5 Third-Degree Price Discrimination for Airline Tickets 535

12.6 Price Discrimination Subject to Capacity Constraints 537

12.7 Markup and Advertising-to-Sales Ratio 551

**Part 6 Imperfect Competition and Strategic Behavior**

**Chapter 13 Market Structure and Competition 558
**Is Competition Always the Same? If Not, Why Not?

13.1 Describing and Measuring Market Structure 560

13.2 Oligopoly with Homogeneous Products 563

The Cournot Model of Oligopoly 563

Cournot Equilibrium and the IEPR 571

The Bertrand Model of Oligopoly 571

Why are the Cournot and Bertrand Equilibria Different? 573

The Stackelberg Model of Oligopoly 574

13.3 Dominant Firm Markets 576

13.4 Oligopoly with Horizontally Differentiated Products 579

What is Product Differentiation? 579

Bertrand Price Competition with Horizontally Differentiated Products 582

13.5 Monopolistic Competition 588

Short-Run and Long-Run Equilibrium in Monopolistically Competitive Markets 588

Price Elasticity of Demand, Margins, and Number of Firms in the Market 590

Do Prices Fall When More Firms Enter? 590

Appendix The Cournot Equilibrium and the Inverse Elasticity Pricing Rule 600

**Learning-By-Doing-Exercises**

13.1 Computing a Cournot Equilibrium 566

13.2 Computing the Cournot Equilibrium for Two or More Firms with Linear Demand 570

13.3 Computing the Equilibrium in the Dominant Firm Model 578

13.4 Computing a Bertrand Equilibrium with Horizontally Differentiated Products 586

**Chapter 14 Game Theory and Strategic Behavior 601
**What’s in a Game?

14.1 The Concept of Nash Equilibrium 603

A Simple Game 603

The Nash Equilibrium 604

The Prisoners’ Dilemma 604

Dominant and Dominated Strategies 605

Games with more Than One Nash Equilibrium 609

Mixed Strategies 615

Summary: How to Find All the Nash Equilibria in a Simultaneous-Move Game with Two Players 616

14.2 The Repeated Prisoners’ Dilemma 617

14.3 Sequential-Move Games and Strategic Moves 622

Analyzing Sequential-Move Games 623

The Strategic Value of Limiting One’s Options 624

**Learning-By-Doing-Exercises**

14.1 Finding the Nash Equilibrium: Coke versus Pepsi 608

14.2 Finding All of the Nash Equilibria in a Game 612

14.3 An Entry Game 625

**Chapter 15 Risk and Information 637
**Risky Business?

15.1 Describing Risky Outcomes 639

Lotteries and Probabilities 639

Expected Value 641

Variance 641

15.2 Evaluating Risky Outcomes 644

Utility Functions and Risk Preferences 644

Risk-Neutral and Risk-Loving Preferences 647

15.3 Bearing and Eliminating Risk 650

Risk Premium 650

When Would a Risk-Averse Person Choose to Eliminate Risk? the Demand for Insurance 653

Asymmetric Information: Moral Hazard and Adverse Selection 656

Prospect Theory and Loss Aversion: An Alternative to Expected Utility Theory 662

15.4 Analyzing Risky Decisions 665

Decision Tree Basics 665

Decision Trees with a Sequence of Decisions 668

The Value of Information 670

15.5 Auctions 672

Types of Auctions and Bidding Environments 672

Auctions When Bidders Have Private Values 673

Auctions When Bidders Have Common Values: The Winner’s Curse 677

**Learning-By-Doing-Exercises**

15.1 Computing the Expected Utility for Two Lotteries for a Risk-Averse Decision Maker 647

15.2 Computing the Expected Utility for Two Lotteries: Risk-Neutral and Risk-Loving Decision Makers 649

15.3 Computing the Risk Premium from a Utility Function 653

15.4 The Willingness to Pay for Insurance 654

15.5 Verifying the Nash Equilibrium in a First-Price Sealed-Bid Auction with Private Values 675

**Chapter 16 General Equilibrium Theory 686
**How Do Gasoline Taxes Affect the Economy?

16.1 General Equilibrium Analysis: Two Markets 688

16.2 General Equilibrium Analysis: Many Markets 692

The Origins of Supply and Demand in a Simple Economy 692

The General Equilibrium in Our Simple Economy 698

Walras’ Law 702

16.3 General Equilibrium Analysis: Comparative Statics 703

16.4 The Efficiency of Competitive Markets 707

What is Economic Efficiency? 707

Exchange Efficiency 708

Input Efficiency 714

Substitution Efficiency 716

Does the General Competitive Equilibrium Satisfy Substitution Efficiency? 717

Pulling the Analysis Together: The Fundamental Theorems of Welfare Economics 719

16.5 Gains From Free Trade 720

Free Trade is Mutually Beneficial 720

Comparative Advantage 724

Appendix Deriving the Demand and Supply Curves for the General Equilibrium in Figure 16.10 and Learning-By-Doing Exercises 16.2 730

**Learning-By-Doing-Exercises**

16.1 Finding the Prices at a General Equilibrium with Two Markets 692

16.2 Finding the Conditions for a General Equilibrium with Four Markets 701

16.3 Checking the Conditions for Exchange Efficiency 712

**Chapter 17 Externalities and Public Goods 736
**When Does the Invisible Hand Fail?

17.1 Introduction 738

17.2 Externalities 740

Negative Externalities and Economic Efficiency 742

Positive Externalities and Economic Efficiency 756

Property Rights and the Coase Theorem 760

17.3 Public Goods 762

Efficient Provision of a Public Good 763

The Free-Rider Problem 766

**Learning-By-Doing-Exercises**

17.1 The Efficient Amount of Pollution 745

17.2 Emissions Fee 748

17.3 The Coase Theorem 761

17.4 Optimal Provision of a Public Good 765

Mathematical Appendix A-1

Solutions to Selected Problems S-1

Glossary G-1

Index I-1

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