MICROECONOMICS Robert S. Pindyck Massachusetts Institute of Technology
Daniel L. Rubinfeld University of California, Berkeley
Prentice Hall Interna ional, Inc. London New York Toronto Sydney Tokyo Singapore Madrid Mexico City Munich Paris Capetown Hong Kong Montreal
PART 1
Introduction: Markets and Prices 1
1 Preliminaries The Basics of Supply and Demand
19
Producers, Consumers, and Competitive Markets 59 8 Consumer Behavior 61 Individual and Market Demand 101 5 Choice Under Uncertainty 149 Production 177 The Cost of Production 203 8 Profit Maximization and Competitive Supply 251 The Analysis of Competitive Markets 287 Market Structure and Competitive Strategy 325 Market Power: Monopoly and Monopsony 327 11 Pricing with Market Power 369 12 Monopolistic Competition and Oligopoly 423 18 Game Theory and Competitive Strategy 461 14 Markets for Factor Inputs 501 15 Investment, Time, and Capital Markets 533 Information, Market Failure, and the Role of Government 561
16 General Equilibrium and Economic Efficiency 563 17 Markets with Asymmetric Information 595 18 Externalities and Public Goods 621 Appendix: The Basics of Regression 655 Glossary 663 Answers to Selected Exercises 675 Index 687
Preface
PART 1
Introduction: Markets and Prices 1
I
Preliminaries The Themes of Microeconomics 4 Theories and Models 5 Positive versus Normative Analysis 6 1.2 What Is a Market? 7 Competitive versus Noncompetitive Markets 8 Market Price 8 Market Definition-The Extent a Market 9 1.3 Real versus Nominal Prices 11 1.4 Why Study Microeconomics? 15 Corporate Decision Making: Ford's Sport Utility Vehicles 15 Public Policy Design: Automobile Emission Standards the Twenty-first Century 1 6 Summary 17 Questions for Review 17 Exercises 18 1.1
The Basics of Supply and Demand 19 Supply and Demand 20 The Supply Curve 20 The Demand Curve 21 2.2 The Market Mechanism 23 2.3 Changes in Market Equilibrium 24 2.4 Elasticities of Supply and Demand 30 2.5 Short-Run versus Long-Run Elasticities 35 Demand 35 Supply 40 Understanding and Predicting the Effects of Changing Market Conditions 44 2.7 Effects of Government Intervention-Price Controls 53 Summary Questions for Review 56 Exercises 57 2.1
Contents
PART2
Producers, Consumers, and Competitive Markets 59 Consumer Behavior 61 Consumer Behavior 61 Consumer Preferences 62 Market Baskets 62 Some Basic Assumptions About Preferences 63 Indifference Curves 64 Indifference Maps 66 The Shapes of Indifference Curves 67 The Marginal Rate of Substitution 68 Perfect Substitutes and Perfect Complements 69 3.2 Budget Constraints 75 The Budget Line 75 The Effects of Changes in Income and Prices 77 3.3 Consumer Choice 79 Corner Solutions 84 3.4 Revealed Preference 86 3.5 Marginal Utility and Consumer Choice 89 Cost-of-Living Indexes 92 Ideal Cost-of-Living Index 93 Laspeyres Index 94 Paasche Index 95 Chain-Weighted Indexes 96 Summary 98 3.1
Questions for Review 99 Exercises 99
Individual and Market Demand 4.1
4.2
4.3
4.4 4.5
Individual Demand 102 Price Changes 102 The Individual Demand Curve 102 Income Changes 104 Normal versus Inferior Goods 106 Engel Curves 106 Substitutes and Complements 109 Income and Substitution Effects 110 Substit ut ion Effect 111 Income Effect 112 A Special Case: The Giffen Good 113 Market Demand 116 From Individual to Market Demand 116 Elasticity of Demand 117 Consumer Surplus 123 Consumer Surplus and Demand 123 Network Externalities 127 The Bandwagon Effect 127 The Snob Effect 129
Contents
Empirical Estimation of Demand 131 Interview and Experimental Approaches to Demand Determination 132 The Statistical Approach to Demand Estimation 132 The Form of the Demand Relationship 133 Summary 135 Questions for Review 136 Exercises 136 Appendix to Chapter 4 Demand Theory-A Mathematical Treatment 139 Utility Maximization 139 The Method of Lagrange Multipliers 140 The Equal Marginal Principle 141 Marginal Rate of Substitution 141 Marginal Utility of Income 142 A n Example 143 Duality in Consumer Theory 244 Income and Substitution Effects 245 Exercises 147
Choice Under Uncertainty
149
5.1
Describing Risk 150 Probability 150 Expected Value 150 Variability 152 Decision Making 153 5.2 Preferences Toward Risk 155 Different Preferences Toward Risk 157 5.3 Reducing Risk 161 Diversification 161 Insurance 162 The Value of Information 264 The Demand for Risky Assets 166 Assets 166 Risky and Riskless Assets 266 Asset Returns 267 The Trade-off Between Risk and Return 168 The Investor's Choice Problem 169 Summary 174 Questions for Review 175 Exercises 175
6
Production 6.1 6.2
6.3
177
The Technology of Production 178 The Production Function 178 Isoquants 179 Input Flexibility 280 The Short Run versus the Long Run 180 Production with One Variable Input (Labor) 183 Average and Marginal Products 182
xi
xii
Contents
The Slopes of the Product Curve 283 The Average Product of Labor Curve 284 The Marginal Product of Labor Curve 285 The l a w of Diminishing Marginal Returns 185 Labor Productivity 188 6.4 Production with Two Variable Inputs 191 Diminishing Marginal Returns 292 Substitution Among Inputs 292 Production Functions-Two Special Cases 294 6.5 Returns to Scale 197 Increasing Returns to Scale 198 Constant Returns to Scale 298 Decreasing Returns to Scale 298 Describing Returns to Scale 298 Summary 201 Questions for Review 201 Exercises 202
7
The Cost of Production 203 7.1
7.2
7.3
7.4
7.5
Measuring Cost: Which Costs Matter? 203 Economic Cost versus Accounting Cost 204 Opportunity Cost 204 Sunk Costs 205 Fixed Costs and Variable Costs 206 Fixed versus Sunk Costs 207 Cost in the Short Run 208 The Determinants of Short-Run Cost 220 The Shapes of the Cost Curves 221 Cost in the Long Run 215 The User Cost of Capital 225 The Cost-Minimizing Input Choice 226 The lsocost Line 227 Choosing Inputs 218 Cost Minimization with Varying Output levels 222 The Expansion Path and long-Run Costs 222 Long-Run versus Short-Run Cost Curves 224 The Inflexibility of Short-Run Production 224 Long-Run Average Cost 225 Economies and Diseconomies of Scale 227 The Relationship Between Short-Run and Long-Run Cost 227 Production with Two Outputs-Economies of Scope 229 Product Transformation Curves 230 Economies and Diseconomies of Scope 231 The Degree of Economies of Scope 232 Dynamic Changes in Costs-The Learning Curve 232 Graphing the Learning Curve 234 Learning versus Economies of Scale 234
Contents
Estimating and Predicting Cost Cost Functions and the Measurement Scale Economies Summary Questions for Review Exercises 243 Appendix to Chapter 7: Production and Cost TheoryA Mathematical Treatment 246 Cost Minimization 246 Marginal Rate of Technical Substitution 247 Duality in Production and Cost Theory 248 The Cobb-Douglas Cost and Production Functions 248 Exercises 250 *
8
Profit Maximization and Competitive Supply 251 8.1
Perfectly Competitive Markets 252 When Is a Market Highly Competitive? 253 8.2 Profit Maximization 254 Do Firms Maximize Profit? 254 8.3 Marginal Revenue, Marginal Cost, and Profit Maximization 255 Demand and Marginal Revenue for a Competitive Firm 256 Profit Maximization by a Competitive Firm 257 8.4 Choosing Output in the Short Run 258 Short-Run Profit Maximization by a Competitive Firm 258 The Skort-Run Profit of a Competitive Firm 259 8.5 The Competitive Firm’s Short-Run Supply Curve 263 The Firm’s Response to an Input Price Change 264 8.6 The Short-Run Market Supply Curve 266 Elasticity of Market Supply 266 Producer Surplus in the Short Run 269 8.7 Choosing Output in the Long Run 271 Long-Run Profit Maximization 272 Long-Run Competitive Equilibrium 272 Economic Rent 275 Producer Surplus in the long Run 276 8.8 The Industry’s Long-Run Supply Curve 277 Constant-Cost lndustry 277 Increasing-Cost Industry 279 Decreasing-Cost lndustry 280 The Effects of a Tax 280 Long-Run Elasticity of Supply 281 Summary 283 Questions for Review 284 Exercises 284
9
The Analysis of Competitive Markets 287 9.1
Evaluating the Gains and Losses from Government PoliciesConsumer and Producer Surplus 288 Review of Consumer and Producer Surplus 288 Application of Consumer and Producer Surplus 289
:iv
Contents
9.2 9.3 9.4
The Efficiency of a Competitive Market 294 Minimum Prices 298 Price Supports and Production Quotas 302 Price Supports 302 Production Quotas 304 9.5 Import Quotas and Tariffs 309 9.6 The Impact of a Tax or Subsidy 313 The Efects of a Subsidy 317 Summary 320 Questions for Review 320 Exercises 321
Market Structure and Competitive Strategy 325
10 Market Power: Monopoly and Monopsony 327 10.1 Monopoly 328
Average Revenue and Marginal Revenue 328 The Monopolist's Output Decision 329 An Example 331 A Rule of Thumbfor Pricing 333 Shifts in Demand 335 The Efect of a Tax 335 'The Multiplant Firm 337 10.2 Monopoly Power 339 Measuring Monopoly Power 340 The Rule of Thumb for Pricing 341 10.3 Sources of Monopoly Power 345 The Elasticity of Market Demand 345 The Number of Firms 345 The Interaction Among Firms 346 10.4 The Social Costs of Monopoly Power 347 Rent Seeking 348 Price Regulation 348 Natural Monopoly 350 Regulations in Practice 351 10.5 Monopsony 352 Monopsony and Monopoly Compared 354 10.6 Monopsony Power 355 Sources of Monopsony Power 356 The Social Costs of Monopsony Powev 357 Bilateral Monopoly 358 10.7 Limiting Market Power: The Antitrust Laws 359 Enforcement of the Antitrust Laws 361 Summary 364 Questions for Review 365 Exercises 365
Contents
11 Pricing with Market Power 369 11.1 Capturing Consumer Surplus 370 11.2 Price Discrimination 371
First-Degree Price Discrimination 371 Second-Degree Price Discrimination 374 Third-Degree Price Discrimination 375 11.3 Intertemporal Price Discrimination and Peak-Load Pricing 382 Intertemporal Price Discrimination 382 Peak-Load Pricing 383 11.4 The Two-Part Tariff 385 *11.5 Bundling 392 Relative Valuations 393 Mixed Bundling 397 Bundling in Practice 399 Tying 402 *11.6 Advertising 403 A Rule of Thumb for Advertising 405 Summary 407 Questions for Review 408 Exercises 408 Appendix to Chapter 11: Transfer Pricing in the Integrated Firm 413 Transfer Pricing When There Is No Outside Market 413
Transfer Pricing with a Competitive Outside Market 415 Transfer Pricing with a Noncompetitive Outside Market 41 7 A Numerical Example 420 Exercises 421
12 Monopolistic Competition and Oligopoly 423 12.1 Monopolistic Competition 424
12.2
12.3
12.4 12.5
12.6
The Makings of Monopolistic Competition 424 Equilibrium in the Short Run and the Long Run 425 Monopolistic Competition and Economic Efficiency 426 Oligopoly 429 Equilibrium in an Oligopolistic Market 430 The Cournot Model 431 The Linear Demand Curve-An Example 433 First Mover Advan tage-The Stackelberg Model 436 Price Competition 437 Price Competition with Homogeneous Products-The Bertrand Model 437 Price Competition with Differentiated Products 438 Competition versus Collusion: The Prisoners’ Dilemma 442 Implications of the Prisoners’ Dilemma for Oligopolistic Pricing 445 Price Rigidity 446 Price Signaling and Price Leadership 447 The Dominant Firm Model 450 Cartels 451 Analysis of Cartel Pricing 452
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Contents
Summary 456 Questions for Review 457 Exercises 457
13 Game Theory and Competitive Strategy 461 13.1 Gaming and Strategic Decisions 461
Noncooperative versus Cooperative Games 462 13.2 Dominant Strategies 464 13.3 The Nash Equilibrium Revisited 466 Maximin Strategies 468 *Mixed Strategies 470 13.4 Repeated Games 472 13.5 Sequential Games 476 The Extensive Form of a Game 477 The Advantage of Moving First 478 13.6 Threats, Commitments, and Credibility 479 Empty Threats 480 Commitment and Credibility 480 13.7 Entry Deterrence 483 Strategic Trade Policy and International Competition 485 13.8 Bargaining Strategy 489 93.9 Auctions 491 Auction Formats 491 Valuation and Information 492 Private-Value Auctions 492 Common-Value Auctions 494 Maximizing Auction Revenue 495 Summary 496 Questions for Review 497 Exercises 498
14 Markets for Factor Inputs 501 14.1 Competitive Factor Markets 501 Demand for a Factor Input When Only One Input Is Variable 502 Demand for a Factor Input When Several Inputs Are Variable 505
The Market Demand Curve 506 The Supply of Inputs to a Firm 509 The Market Supply of Inputs 511 14.2 Equilibrium in a Competitive Factor Market 514 Economic Rent 515 14.3 Factor Markets with Monopsony Power 518 Marginal and Average Expenditure 519 The Input Purchasing Decision of tke Firm 520 14.4 Factor Markets with Monopoly Power 523 Monopoly Power over the Wage Rate 523 Unionized and Nonunionized Workers 524 Bilateral Monopoly in the Labor Market 525
Contents
Summary 529 Questions for Review 530 Exercises 530
15 Investment, Time, and Capital Markets 533 15.1 Stocks versus Flows 534 15.2 Present Discounted Value 534 Valuing Payment Streams 535 15.3 The Value of a Bond 538 Perpetuities 538 The Effective Yield on a Bond 539 15.4 The Net Present Value Criterion for Capital Investment Decisions 542 The Electric Motor Factory 543 Real versus Nominal Discount Rates 543 Negative Future Cask Flows 545 15.5 Adjustments for Risk 545 Diversifiable versus Nondiversifable Risk 546 The Capital Asset Pricing Model 547 15.6 Investment Decisions by Consumers 549 "15.7 Intertemporal Production Decisions-Depletable Resources 551 The Production Decision of an Individual Resource Producer 552 The Behavior of Market Price 553 User Cost 553 Resource Production by a Monopolist 554 15.8 How Are Interest Rates Determined? 555 A Variety of lnterest Rates 557 Summary 558 Questions for Review 558 Exercises 559
PART 4
Information, Market Failure, and the Role of Government 561
16 General Equilibrium and Economic Efficiency 563 16.1 General Equilibrium Analysis 563
Two lnterdependent Markets-Moving to General Equilibrium 564 The Attainment of General Equilibrium 565 16.2 Efficiency in Exchange 567 The Advantages of Trade 568 The Edgeworth Box Diagram 569 Efficient Allocations 570 The Contract Curve 571 Consumer Equilibrium in a Competitive Market 572 The Economic Efficiency of Competitive Markets 574 16.3 Equity and Efficiency 575 The Utility Possibilities Frontier 575 Equity and Perfect Competition 577
Contents
16.4 Efficiency in Production 578
Production in the Edgeworth Box 578 Input Efficiency 579 Producer Equilibrium in a Competitive Input Market 580 The Production Possibilities Frontier 581 Output Efficiency 583 Efficiency in Output Markets 584 16.5 The Gains from Free Trade 585 Comparative Advantage 585 An Expanded Production Possibilities Frontier 587 16.6 An Overview-The Efficiency of Competitive Markets 590 16.7 Why Markets Fail 591 Market Power 592 Incomplete Information 592 Externalities 592 Public Goods 593 Summary 593 Questions for Review 594 Exercises 594
17 Markets with Asymmetric Information 595 17.1 Quality Uncertainty and the Market for Lemons 596 The Market for Used Cars 596 Implications of Asymmetric Information 598 The Importance of Reputation and Standardization 599 17.2 Market Signaling 601 A Simple Model of Job Market Signaling 602 Guarantees and Warranties 604 17.3 Moral Hazard 606 17.4 The Principal-Agent Problem 609 The Principal-Agent Problem in Private Enterprises 610 The Principal-Agent Problem in Public Enterprises 610 Incentives in the Principal-Agent Framework 612 *17.5 Managerial Incentives in an Integrated Firm 613
Asymmetric Information and Incentive Design in the Integrated Firm 614 Applications 616 17.6 Asymmetric Information in Labor Markets: Efficiency Wage Theory 616 Summary 619 Questions for Review 619 Exercises 619
18 Externalities and Public Goods 621 18.1 Externalities 621
Negative Externalities and Inefficiency 622 Positive Externalities and Inefficiency 623 18.2 Ways of Correcting Market Failure 625 A n Emissions Standard 626 A n Emissions Fee 626
Contents
Standards versus Fees 627 Transferable Emissions Permits 630 Recycling 634 18.3 Externalities and Property Rights 638 Property Rights 638 Bargaining and Economic Efficiency 638 Costly Bargaining-The Role of Strategic Behavior 640 A Legal Solution-Suing for Damages 640 18.4 Common Property Resources 642 18.5 Public Goods 644 Efficiency and Public Goods 646 Public Goods and Market Failure 647 18.6 Private Preferences for Public Goods 649 Summary 651 Questions for Review 651 Exercises 652
The Basics of Regression 655 An Example 655 Estimation 656 Statistical Tests 657 Goodness of Fit 659 Economic Forecasting 660 Glossary 663 Answers to Selected Exercises 675 Index 687
