economics assignment Intermediate Microeconomics (Econ 021) August/6/2020 Quiz 6 (Time Allotted: 35 minutes) Student Name: _________________

economics assignment

Intermediate Microeconomics (Econ 021)

August/6/2020

Quiz 6 (Time Allotted: 35 minutes)

Student Name: ___________________________________ Score:_____/30

Part I: Multiple choice. Answer all questions in this part. (10 marks).

1. Which of the following is not a type of market structure?
A. Competitive monopoly
B. Oligopoly
C. Perfect competition
D. All of the above are types of market structures.

2. Which of the following methods of selecting a strategy is consistent with risk averting behavior?
A. If two strategies have the same expected profit, select the one with the smaller

standard deviation.

B. If two strategies have the same standard deviation, select the one with the smaller
expected profit.

C. Select the strategy with the larger coefficient of variation.
D. All of the above are correct.
E. gonzo selection.

3. Game theory is concerned with
A. predicting the results of bets placed on games like roulette.
B. the choice of an optimal strategy in conflict situations.
C. utility maximization by firms in perfectly competitive markets.
D. the migration patterns of caribou in Alaska.

4. Which of the following is a nonzero-sum game?
A. Prisoners dilemma
B. Chess
C. Competition among duopolists when market share is the payoff
D. All of the above.

5. Which one of the following does measure risk?
A. Coefficient of variation
B. Standard deviation
C. Expected value
D. All of the above are measures of risk.

6. If a decision maker is risk averse, then the best strategy to select is the one that yields the
A. highest expected payoff.
B. b. lowest coefficient of variation.
C. c. highest expected utility.
D. d. lowest standard deviation.

7. A risk-return tradeoff function
A. shows the minimum expected return required to compensate an investor for

accepting various levels of risk.

B. slopes upward for a risk averse decision maker.
C. is horizontal for a risk neutral decision maker.
D. All of the above are correct.

8. Which one of the following is a part of every game theory model?
A. Players
B. Payoffs
C. Probabilities
D. Strategies

9. In game theory, a choice that is optimal for a firm no matter what its competitors do is referred to
as

A. the dominant strategy.
B. the game-winning choice.
C. super optimal.

10. If a firm sells its output on a market that is characterized by a single seller and many buyers of a
homogeneous product for which there are no close substitutes and barriers to long-run resource

mobility, then the firm is

A. monopolist.
B. an oligopolist.
C. a perfect competitor.
D. a monopolistic competitor.

PART II Answer all questions.

QUESTION 1 (4 MARKS)

The demand curve is q
D
= 100 – 5p and the supply curve is q

S
= 5p.

a. A quantity tax of 2 per unit is placed on the good. Calculate the dead-weight loss of the tax.
b. A value (ad valorem) tax of 20 % is placed on the good. Calculate the dead-weight loss of the tax.

QUESTION 2 (7 MARKS)

The demand function is q(p) = (p+1)
-2

a. What is the price elasticity of demand?

b. At what price is the price elasticity of demand equal to minus one?

c. Write an expression for total revenue as a function of the price.

d. Answer a-c when the demand function takes the more general form q(p) = (p+a)
b
where a > 0 and

b < -1. QUESTION 3 (Uncertainty) (3 MARKS) Fan Lei Lei is a young graduate who earns an income of $100. She has the option of participating in a lottery where she can win $30 with a probability of 0.5, and loose $30 with a probability of 0.5. Would she participate if she is risk averse? What if she is a risk lover? Explain Question 4 (6 MARKS) Figure 1 below represent production and sales of Reganmian dish that is mostly enjoyed by dwellers in Wuhan city. Use the markings to analyze the Figure 1 below. Remarks: Additional marks will be awarded based on clarity of explanations and the use of examples. 5 3.5 MICROECONOMICS SEVENTH EDITION THE PEARSON SERIES IN ECONOMICS Abel/Bernanke/Croushore Macroeconomics* Bade/Parkin Foundations of Economics* Berck/Helfand The Economics of the Environment Bierman/Fernandez Game Theory with Economic Applications Blanchard Macroeconomics* Blau/Ferber/Winkler The Economics of Women, Men, and Work Boardman/Greenberg/Vining/ Weimer Cost-Benefit Analysis Boyer Principles of Transportation Economics Branson Macroeconomic Theory and Policy Bruce Public Finance and the American Economy Carlton/Perloff Modern Industrial Organization Case/Fair/Oster Principles of Economics* Chapman Environmental Economics: Theory, Application, and Policy Cooter/Ulen Law & Economics Daniels/VanHoose International Monetary & Financial Economics Downs An Economic Theory of Democracy Ehrenberg/Smith Modern Labor Economics Farnham Economics for Managers Folland/Goodman/Stano The Economics of Health and Health Care Fort Sports Economics Froyen Macroeconomics Fusfeld The Age of the Economist Gerber International Economics* Gonzlez-Rivera Forecasting for Economics and Business Gordon Macroeconomics* Greene Econometric Analysis Gregory Essentials of Economics Gregory/Stuart Russian and Soviet Economic Performance and Structure Hartwick/Olewiler The Economics of Natural Resource Use Heilbroner/Milberg The Making of the Economic Society Heyne/Boettke/Prychitko The Economic Way of Thinking Holt Markets, Games, and Strategic Behavior Hubbard/OBrien Economics* Money, Banking, and the Financial System* Hubbard/OBrien/Rafferty Macroeconomics* Hughes/Cain American Economic History Husted/Melvin International Economics Jehle/Reny Advanced Microeconomic Theory Johnson-Lans A Health Economics Primer Keat/Young/Erfle Managerial Economics Klein Mathematical Methods for Economics Krugman/Obstfeld/Melitz International Economics: Theory & Policy* Laidler The Demand for Money Leeds/von Allmen The Economics of Sports Leeds/von Allmen/Schiming Economics* Lynn Economic Development: Theory and Practice for a Divided World Miller Economics Today* Understanding Modern Economics Miller/Benjamin The Economics of Macro Issues Miller/Benjamin/North The Economics of Public Issues Mills/Hamilton Urban Economics Mishkin The Economics of Money, Banking, and Financial Markets* The Economics of Money, Banking, and Financial Markets, Business School Edition* Macroeconomics: Policy and Practice* Murray Econometrics: A Modern Introduction OSullivan/Sheffrin/Perez Economics: Principles, Applications, and Tools* Parkin Economics* Perloff Microeconomics* Microeconomics: Theory and Applications with Calculus* Perloff/Brander Managerial Economics and Strategy* Phelps Health Economics Pindyck/Rubinfeld Microeconomics* Riddell/Shackelford/Stamos/ Schneider Economics: A Tool for Critically Understanding Society Roberts The Choice: A Fable of Free Trade and Protection Rohlf Introduction to Economic Reasoning Roland Development Economics Scherer Industry Structure, Strategy, and Public Policy Schiller The Economics of Poverty and Discrimination Sherman Market Regulation Stock/Watson Introduction to Econometrics Studenmund Using Econometrics: APractical Guide Tietenberg/Lewis Environmental and Natural Resource Economics Environmental Economics and Policy Todaro/Smith Economic Development Waldman/Jensen Industrial Organization: Theory and Practice Walters/Walters/Appel/ Callahan/Centanni/Maex/ ONeill Econversations: Todays Students Discuss Todays Issues Weil Economic Growth Williamson Macroeconomics *denotes MyEconLab titles Visit www.myeconlab.com to learn more. www.myeconlab.com to learn more iii MICROECONOMICS SEVENTH EDITION JEFFREY M. PERLOFF University of California, Berkeley Boston Columbus Indianapolis New York San Francisco Upper Saddle River
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Library of Congress Cataloging-in-Publication Data

Perloff, Jeffrey M.
Microeconomics / Jeffrey Perloff.7th edition.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-13-345691-2
1. Microeconomics. I. Title.
HB172.P39 2015
338.5dc22

2013050602

ISBN-13: 978-0-13-345691-2
ISBN-10: 0-13-345691-9www.pearsonhighered.com

For Alexx, Gregg, Laura, and Spenser

10 9 8 7 6 5 4 3 2 1

www.pearsonhighered.com

v

Brief Contents
Preface xiv

Chapter 1 Introduction 1
Chapter 2 Supply and Demand 8
Chapter 3 Applying the Supply-and-Demand Model 42
Chapter 4 Consumer Choice 72
Chapter 5 Applying Consumer Theory 107
Chapter 6 Firms and Production 147
Chapter 7 Costs 179
Chapter 8 Competitive Firms and Markets 220
Chapter 9 Applying the Competitive Model 262
Chapter 10 General Equilibrium and Economic Welfare 308
Chapter 11 Monopoly 344
Chapter 12 Pricing and Advertising 384
Chapter 13 Oligopoly and Monopolistic Competition 424
Chapter 14 Game Theory 468
Chapter 15 Factor Markets 505
Chapter 16 Interest Rates, Investments, and Capital Markets 530
Chapter 17 Uncertainty 561
Chapter 18 Externalities, Open-Access, and Public Goods 595
Chapter 19 Asymmetric Information 623
Chapter 20 Contracts and Moral Hazards 651
Chapter Appendixes A-1
Answers to Selected Questions and Problems A-29

Sources for Challenges and Applications A-46

References A-56

Definitions A-64

Index A-69

Credits A-96

vi

Contents
Preface xiv

Chapter 1 Introduction 1

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

1.2 Models 3
APPLICATION Income Threshold Model

and China 3
Simplifications by Assumption 3
Testing Theories 4
Positive Versus Normative 5

1.3 Uses of Microeconomic Models 6
Summary 7

Chapter 2 Supply and Demand 8
CHALLENGE Quantities and Prices

of Genetically Modified Foods 8
2.1 Demand 9

The Demand Curve 10
APPLICATION Calorie Counting at Starbucks 13
The Demand Function 14
Solved Problem 2.1 15
Summing Demand Curves 16
APPLICATION Aggregating Corn

Demand Curves 16
2.2 Supply 17

The Supply Curve 17
The Supply Function 19
Summing Supply Curves 20
Effects of Government Import

Policies on Supply Curves 20
Solved Problem 2.2 21

2.3 Market Equilibrium 22
Using a Graph to Determine

the Equilibrium 22
Using Math to Determine the Equilibrium 22
Forces That Drive the Market to Equilibrium 23

2.4 Shocking the Equilibrium 24
Effects of a Shift in the Demand Curve 24
Solved Problem 2.3 25
Effects of a Shift in the Supply Curve 26

2.5 Equilibrium Effects of Government
Interventions 26
Policies That Shift Supply Curves 27
APPLICATION Occupational Licensing 27
Solved Problem 2.4 28
Policies That Cause Demand to Differ

fromSupply 29
APPLICATION Price Controls Kill 31
Solved Problem 2.5 33
Why Supply Need Not Equal Demand 33

2.6 When to Use the Supply-and-Demand Model 34
CHALLENGE SOLUTION Quantities and

Prices of Genetically Modified Foods 35
Summary 36 Questions 37

Chapter 3 Applying the Supply-and-Demand
Model 42

CHALLENGE Who Pays the Gasoline Tax? 42
3.1 How Shapes of Supply and Demand

Curves Matter 43
3.2 Sensitivity of the Quantity Demanded to Price 44

Price Elasticity of Demand 45
Solved Problem 3.1 46
Elasticity Along the Demand Curve 46
Demand Elasticity and Revenue 49
Solved Problem 3.2 49
APPLICATION Do Farmers Benefit

from a Major Drought? 50
Demand Elasticities over Time 51
Other Demand Elasticities 51

3.3 Sensitivity of the Quantity Supplied to Price 53
Elasticity of Supply 53
Elasticity Along the Supply Curve 54
Supply Elasticities over Time 55
APPLICATION Oil Drilling in the Arctic

National Wildlife Refuge 55
Solved Problem 3.3 56

3.4 Effects of a Sales Tax 58
Equilibrium Effects of a Specific Tax 58
The Equilibrium Is the Same No Matter

WhoIsTaxed 60
Solved Problem 3.4 60
Firms and Customers Share the Burden

of the Tax 61
APPLICATION Taxes to Prevent Obesity 62

viiContents

Solved Problem 3.5 63
Ad Valorem and Specific Taxes Have Similar

Effects 63
Solved Problem 3.6 64
Subsidies 65
APPLICATION The Ethanol Subsidy 66
CHALLENGE SOLUTION Who Pays the

Gasoline Tax? 66
Summary 67 Questions 68

Chapter 4 Consumer Choice 72
CHALLENGE Why Americans Buy

More E-Books Than Do Germans 72
4.1 Preferences 74

Properties of Consumer Preferences 74
APPLICATION You Cant Have Too

Much Money 75
Preference Maps 76
Solved Problem 4.1 78
APPLICATION Indifference Curves

Between Food and Clothing 82
4.2 Utility 82

Utility Function 82
Ordinal Preferences 83
Utility and Indifference Curves 83
Marginal Utility 85
Utility and Marginal Rates of Substitution 86

4.3 Budget Constraint 86
Slope of the Budget Constraint 88
Solved Problem 4.2 88
Effect of a Change in Price on the

Opportunity Set 89
Effect of a Change in Income on the

Opportunity Set 90
Solved Problem 4.3 90

4.4 Constrained Consumer Choice 90
The Consumers Optimal Bundle 91
APPLICATION Substituting Alcohol

for Marijuana 92
Solved Problem 4.4 93

Optimal Bundles on Convex Sections
of Indifference Curves 94

Buying Where More Is Better 95
Food Stamps 96
APPLICATION Benefiting from Food Stamps 98

4.5 Behavioral Economics 98
Tests of Transitivity 98
Endowment Effect 99
APPLICATION Opt In Versus Opt Out 100
Salience and Bounded Rationality 100
APPLICATION Unaware of Taxes 101
CHALLENGE SOLUTION Why Americans

Buy More E-Books Than Do Germans 101
Summary 102 Questions 103

Chapter 5 Applying Consumer Theory 107
CHALLENGE Per-Hour Versus Lump-Sum

Childcare Subsidies 107
5.1 Deriving Demand Curves 108

Indifference Curves and a Rotating
Budget Line 109

Price-Consumption Curve 110
APPLICATION Smoking Versus Eating

and Phoning 111
The Demand Curve Corresponds to the

Price-Consumption Curve 112
Solved Problem 5.1 112

5.2 How Changes in Income Shift
Demand Curves 113
Effects of a Rise in Income 113
Solved Problem 5.2 115
Consumer Theory and Income Elasticities 116
APPLICATION Fast-Food Engel Curve 119

5.3 Effects of a Price Change 120
Income and Substitution Effects with a

Normal Good 120
Solved Problem 5.3 122
Solved Problem 5.4 123
APPLICATION Shipping the Good

Stuff Away 124
Income and Substitution Effects with

an Inferior Good 124
Solved Problem 5.5 125

Compensating Variation and Equivalent
Variation 126

APPLICATION Whats the Value of Using the
Internet? 126

5.4 Cost-of-Living Adjustments 126
Inflation Indexes 127
Effects of Inflation Adjustments 129
APPLICATION Paying Employees to Relocate 130

5.5 Deriving Labor Supply Curves 132
Labor-Leisure Choice 132
Income and Substitution Effects 135
Solved Problem 5.6 136

Shape of the Labor Supply Curve 137
APPLICATION Working After Winning

the Lottery 138
Income Tax Rates and Labor Supply 139
CHALLENGE SOLUTION Per-Hour Versus

Lump-Sum Childcare Subsidies 141
Summary 142 Questions 143

Chapter 6 Firms and Production 147
CHALLENGE Labor Productivity During

Recessions 147
6.1 The Ownership and Management of Firms 148

Private, Public, and Nonprofit Firms 148

viii Contents

APPLICATION Chinese State-Owned
Enterprises 149

The Ownership of For-Profit Firms 149
The Management of Firms 150
What Owners Want 150

6.2 Production Function 151
6.3 Short-Run Production 153

Total Product 153
Marginal Product of Labor 154
Solved Problem 6.1 154
Average Product of Labor 155
Graphing the Product Curves 155
Law of Diminishing Marginal Returns 157
APPLICATION Malthus and the Green

Revolution 158
6.4 Long-Run Production 159

Isoquants 160
APPLICATION A Semiconductor Integrated

Circuit Isoquant 162
Substituting Inputs 163
Solved Problem 6.2 165

6.5 Returns to Scale 166
Constant, Increasing, and Decreasing

Returns to Scale 166
Solved Problem 6.3 167
APPLICATION Returns to Scale in Various

Industries 168
Varying Returns to Scale 169

6.6 Productivity and Technical Change 171
Relative Productivity 171
APPLICATION A Good Boss Raises

Productivity 171
Innovations 171
APPLICATION Tata Nanos Technical and

Organizational Innovations 173
CHALLENGE SOLUTION Labor Productivity

During Recessions 173
Summary 175 Questions 175

Chapter 7 Costs 179
CHALLENGE Technology Choice

at Home Versus Abroad 179
7.1 The Nature of Costs 180

Opportunity Costs 180
APPLICATION The Opportunity Cost

of an MBA 181
Solved Problem 7.1 181
Costs of Durable Inputs 182
Sunk Costs 183

7.2 Short-Run Costs 183
Short-Run Cost Measures 184
Short-Run Cost Curves 186
Production Functions and the Shape

of Cost Curves 187
APPLICATION Short-Run Cost Curves

for a BeerManufacturer 190

Effects of Taxes on Costs 191
Solved Problem 7.2 192
Short-Run Cost Summary 193

7.3 Long-Run Costs 193
All Costs Are Avoidable in the Long Run 193
Minimizing Cost 193
Isocost Line 194
Combining Cost and Production Information 196
Solved Problem 7.3 198
Factor Price Changes 199
Solved Problem 7.4 199
The Long-Run Expansion Path and

the Long-RunCost Function 200
Solved Problem 7.5 202
The Shape of Long-Run Cost Curves 202
APPLICATION Economies of Scale in Nuclear

Power Plants 205
Estimating Cost Curves Versus Introspection 206

7.4 Lower Costs in the Long Run 206
Long-Run Average Cost as the Envelope

ofShort-RunAverage Cost Curves 207
APPLICATION Long-Run Cost Curves in Beer

Manufacturing 208
APPLICATION Choosing an Inkjet or a Laser

Printer 208
Short-Run and Long-Run Expansion Paths 209
The Learning Curve 209
APPLICATION Learning by Drilling 211

7.5 Cost of Producing Multiple Goods 212
APPLICATION Economies of Scope 213
CHALLENGE SOLUTION Technology Choice

at Home Versus Abroad 214
Summary 215 Questions 216

Chapter 8 Competitive Firms and Markets 220
CHALLENGE The Rising Cost of Keeping

On Truckin 220
8.1 Perfect Competition 221

Price Taking 221
Why the Firms Demand Curve Is Horizontal 222
Deviations from Perfect Competition 223
Derivation of a Competitive Firms

Demand Curve 224
Solved Problem 8.1 225
Why We Study Perfect Competition 226

8.2 Profit Maximization 226
Profit 226
Two Steps to Maximizing Profit 227

8.3 Competition in the Short Run 230
Short-Run Output Decision 231
Solved Problem 8.2 233
Short-Run Shutdown Decision 234
APPLICATION Oil, Oil Sands, and Oil Shale

Shutdowns 236
Solved Problem 8.3 237
Short-Run Firm Supply Curve 237

ixContents

Short-Run Market Supply Curve 238
Short-Run Competitive Equilibrium 240
Solved Problem 8.4 242

8.4 Competition in the Long Run 243
Long-Run Competitive Profit Maximization 243
Long-Run Firm Supply Curve 243
APPLICATION The Size of Ethanol

ProcessingPlants 244
Long-Run Market Supply Curve 244
APPLICATION Fast-Food Firms Entry

in Russia 245
APPLICATION Upward-Sloping Long-Run

Supply Curve for Cotton 248
APPLICATION Reformulated Gasoline

SupplyCurves 252
Solved Problem 8.5 253
Long-Run Competitive Equilibrium 254
CHALLENGE SOLUTION The Rising Cost

of Keeping On Truckin 255
Summary 256 Questions 257

Chapter 9 Applying the Competitive Model 262
CHALLENGE Big Dry Water Restrictions 262

9.1 Zero Profit for Competitive Firms
in the Long Run 263
Zero Long-Run Profit with Free Entry 263
Zero Long-Run Profit When Entry Is Limited 264
APPLICATION Tiger Woods Rent 266
The Need to Maximize Profit 266

9.2 Consumer Welfare 267
Measuring Consumer Welfare Using

a Demand Curve 267
APPLICATION Willingness to Pay

and Consumer Surplus on eBay 269
Effect of a Price Change on Consumer

Surplus 270
APPLICATION Goods with a Large Consumer

Surplus Loss from Price Increases 271
Solved Problem 9.1 272

9.3 Producer Welfare 273
Measuring Producer Surplus Using

a Supply Curve 273
Using Producer Surplus 274
Solved Problem 9.2 275
Competition Maximizes Welfare 276
Solved Problem 9.3 278
APPLICATION Deadweight Loss

of Christmas Presents 279
9.5 Policies That Shift Supply and Demand

Curves 280
Restricting the Number of Firms 281
APPLICATION Licensing Cabs 283
Raising Entry and Exit Costs 284

9.6 Policies That Create a Wedge Between
Supply and Demand 285
Welfare Effects of a Sales Tax 285

APPLICATION The Deadweight Cost
ofRaisingGasoline Tax Revenue 286

Solved Problem 9.4 287
Welfare Effects of a Subsidy 288
Solved Problem 9.5 288
Welfare Effects of a Price Floor 289
Solved Problem 9.6 291
APPLICATION How Big Are Farm Subsidies

and Who Gets Them? 292
Welfare Effects of a Price Ceiling 293
Solved Problem 9.7 294
APPLICATION The Social Cost of a

Natural Gas Price Ceiling 295
9.7 Comparing Both Types of Policies: Imports 295

Free Trade Versus a Ban on Imports 296
Free Trade Versus a Tariff 297
Free Trade Versus a Quota 299
APPLICATION The Chicken Tax Trade War 300
Rent Seeking 300
CHALLENGE SOLUTION Big Dry Water

Restrictions 301
Summary 303 Questions 303

Chapter 10 General Equilibrium
and Economic Welfare 308

CHALLENGE Anti-Price Gouging Laws 308
10.1 General Equilibrium 310

Feedback Between Competitive Markets 311
Solved Problem 10.1 313
Minimum Wages with Incomplete Coverage 314
Solved Problem 10.2 316
APPLICATION Urban Flight 317

10.2 Trading Between Two People 317
Endowments 317
Mutually Beneficial Trades 319
Solved Problem 10.3 321
Bargaining Ability 321

10.3 Competitive Exchange 321
Competitive Equilibrium 322
The Efficiency of Competition 323
Obtaining Any Efficient Allocation Using

Competition 323
10.4 Production and Trading 324

Comparative Advantage 324
Solved Problem 10.4 326
Efficient Product Mix 328
Competition 328

10.5 Efficiency and Equity 330
Role of the Government 330
APPLICATION The Wealth and Income

of the 1% 331
Efficiency 332
Equity 334
APPLICATION How You Vote Matters 336
Efficiency Versus Equity 338

x Contents

CHALLENGE SOLUTION Anti-Price Gouging
Laws 339

Summary 340 Questions 341

Chapter 11 Monopoly 344
CHALLENGE Brand-Name and Generic

Drugs 344
11.1 Monopoly Profit Maximization 346

Marginal Revenue 346
Solved Problem 11.1 348
Choosing Price or Quantity 350
Graphical Approach 351
Mathematical Approach 352
APPLICATION Apples iPad 353
Solved Problem 11.2 353
Effects of a Shift of the Demand Curve 354

11.2 Market Power 355
Market Power and the Shape of the

Demand Curve 355
APPLICATION Cable Cars and Profit

Maximization 357
Lerner Index 358
Solved Problem 11.3 358
Sources of Market Power 358

11.3 Market Failure Due to Monopoly Pricing 359
Solved Problem 11.4 361

11.4 Causes of Monopoly 362
Cost-Based Monopoly 362
Solved Problem 11.5 364
Government Creation of a Monopoly 364
APPLICATION Botox Patent Monopoly 366

11.5 Government Actions That Reduce
Market Power 367
Regulating Monopolies 367
Solved Problem 11.6 370
APPLICATION Natural Gas Regulation 371
Increasing Competition 372
APPLICATION Generic Competition

for Apples iPod 373
Solved Problem 11.7 373

11.6 Networks, Dynamics, and Behavioral
Economics 374
Network Externalities 375
Network Externalities and Behavioral

Economics 375
Network Externalities as an Explanation for

Monopolies 376
APPLICATION Critical Mass and eBay 376
A Two-Period Monopoly Model 377
CHALLENGE SOLUTION Brand-Name

and Generic Drugs 378
Summary 379 Questions 379

Chapter 12 Pricing and Advertising 384
CHALLENGE Sale Prices 384

12.1 Conditions for Price Discrimination 386

Why Price Discrimination Pays 386
APPLICATION Disneyland Pricing 388
Which Firms Can Price Discriminate 388
Preventing Resale 389
APPLICATION Preventing Resale

of Designer Bags 390
Not All Price Differences Are Price

Discrimination 390
Types of Price Discrimination 390

12.2 Perfect Price Discrimination 391
How a Firm Perfectly Price Discriminates 391
APPLICATION Google Uses Bidding for

Ads to Price Discriminate 392
Perfect Price Discrimination Is Efficient

but Harms Some Consumers 393
APPLICATION Botox Revisited 395
Solved Problem 12.1 396
Transaction Costs and Perfect Price

Discrimination 396
12.3 Group Price Discrimination 396

APPLICATION Warner Brothers Sets
Prices for a Harry Potter DVD 397

Group Price Discrimination with
Two Groups 397

Solved Problem 12.2 398
APPLICATION Reselling Textbooks 399
Solved Problem 12.3 400
Identifying Groups 402
APPLICATION Buying Discounts 402
Welfare Effects of Group Price Discrimination 403

12.4 Nonlinear Price Discrimination 404
12.5 Two-Part Pricing 406

Two-Part Pricing with Identical Customers 407
Two-Part Pricing with Nonidentical

Consumers 408
APPLICATION iTunes for a Song 410

12.6 Tie-In Sales 410
Requirement Tie-In Sale 410
APPLICATION Ties That Bind 411
Bundling 411
Solved Problem 12.4 413

12.7 Advertising 414
The Decision Whether to Advertise 414
How Much to Advertise 415
APPLICATION Super Bowl Commercials 416
CHALLENGE SOLUTION Sale Prices 417
Summary 418 Questions 419

Chapter 13 Oligopoly and Monopolistic
Competition 424

CHALLENGE Government Aircraft Subsidies 424
13.1 Market Structures 426
13.2 Cartels 427

Why Cartels Form 427
Laws Against Cartels 429
APPLICATION Catwalk Cartel 431

xiContents

Why Cartels Fail 432
Maintaining Cartels 432
APPLICATION Casket Entry 433
Mergers 434
APPLICATION Hospital Mergers:

MarketPowerVersus Efficiency 434
13.3 Cournot Oligopoly 435

The Duopoly Nash-Cournot Equilibrium 436
An Airlines Market Example 436
Equilibrium, Elasticity, and the Number

of Firms 440
APPLICATION Mobile Number Portability 442
Nonidentical Firms 442
Solved Problem 13.1 443
Solved Problem 13.2 445
APPLICATION Bottled Water 446

13.4 Stackelberg Oligopoly 447
Graphical Model 447
Solved Problem 13.3 449
Why Moving Sequentially Is Essential 450
Comparison of Competitive, Stackelberg,

Cournot,and Collusive Equilibria 450
13.5 Bertrand Oligopoly 451

Identical Products 452
Differentiated Products 453
APPLICATION Welfare Gain from More

Toilet Paper 455
13.6 Monopolistic Competition 456

APPLICATION Monopolistically Competitive
Food Truck Market 456

Equilibrium 457
Solved Problem 13.4 458
Fixed Costs and the Number of Firms 458
Solved Problem 13.5 460
APPLICATION Zoning Laws as a Barrier

to Entry by Hotel Chains 460
CHALLENGE SOLUTION Government Aircraft

Subsidies 461
Summary 462 Questions 463

Chapter 14 Game Theory 468
CHALLENGE Competing E-book Standards 468

14.1 Static Games 470
Normal-Form Games 470
Predicting a Games Outcome 471
Multiple Nash Equilibria, No Nash

Equilibrium, and Mixed Strategies 474
APPLICATION Tough Love 477
Solved Problem 14.1 477
Cooperation 478
APPLICATION Strategic Advertising 479

14.2 Repeated Dynamic Games 480
Strategies and Actions in Dynamic Games 481
Cooperation in a Repeated Prisoners

Dilemma Game 481
Solved Problem 14.2 483

14.3 Sequential Dynamic Games 483
Game Tree 483
Subgame Perfect Nash Equilibrium 484
Credibility 486
Dynamic Entry Game 487
APPLICATION Dominant Airlines 488
Solved Problem 14.3 489

14.4 Auctions 490
Elements of Auctions 491
Bidding Strategies in Private-Value Auctions 492
Winners Curse 493
APPLICATION Bidders Curse 494

14.5 Behavioral Game Theory 494
APPLICATION GMs Ultimatum 495
CHALLENGE SOLUTION Competing E-book

Standards 496
Summary 497 Questions 498

Chapter 15 Factor Markets 505
CHALLENGE Athletes Salaries and

Ticket Prices 505
15.1 Competitive Factor Market 506

Short-Run Factor Demand of a Firm 507
Solved Problem 15.1 509
Solved Problem 15.2 510
Long-Run Factor Demand 511
Factor Market Demand 512
Competitive Factor Market Equilibrium 514

15.2 Effects of Monopolies on Factor Markets 515
Market Structure and Factor Demands 515
A Model of Market Power in Input

andOutputMarkets 516
APPLICATION Unions and Profits 519
Solved Problem 15.3 520

15.3 Monopsony 521
Monopsony Profit Maximization 521
APPLICATION Walmarts Monopsony

Power 523
Welfare Effects of Monopsony 524
Solved Problem 15.4 525
CHALLENGE SOLUTION Athletes Salaries

and Ticket Prices 525
Summary 526 Questions 527

Chapter 16 Interest Rates, Investments, and
Capital Markets 530

CHALLENGE Should You Go to College? 530
16.1 Comparing Money Today to Money

in the Future 531
Interest Rates 531
Using Interest Rates to Connect the Present

andFuture 534
APPLICATION Power of Compounding 534
Stream of Payments 536
Solved Problem 16.1 537
APPLICATION Saving for Retirement 538

xii Contents

Inflation and Discounting 539
APPLICATION Winning the Lottery 540

16.2 Choices over Time 541
Investing 541
Solved Problem 16.2 543
Solved Problem 16.3 544
Rate of Return on Bonds 544

Behavioral Economics: Time-Varying
Discounting 545

APPLICATION Falling Discount Rates
and Self-Control 546

16.3 Exhaustible Resources 546
When to Sell an Exhaustible Resource 547
Price of a Scarce Exhaustible Resource 547
APPLICATION Redwood Trees 550
Why Price May Be Constant or Fall 551

16.4 Capital Markets, Interest Rates,
and Investments 553
Solved Problem 16.4 554
CHALLENGE SOLUTION Should You Go to

College? 555
Summary 557 Questions 557

Chapter 17 Uncertainty 561
CHALLENGE BP and Limited Liability 561

17.1 Assessing Risk 563
Probability 563
Expected Value 565
Solved Problem 17.1 565
Variance and Standard Deviation 566

17.2 Attitudes Toward Risk 567
Expected Utility 567
Risk Aversion 568
Solved Problem 17.2 570
APPLICATION Stocks Risk Premium 571
Risk Neutrality 572
Risk Preference 573
APPLICATION Gambling 573

17.3 Reducing Risk 574
Obtain Information 575
Diversify 575
APPLICATION Diversifying Retirement

Funds 577
Buy Insurance 577
Solved Problem 17.3 578
APPLICATION Flight Insurance 580
APPLICATION Limited Insurance

for Natural Disasters 581
17.4 Investing Under Uncertainty 582

Risk-Neutral Investing 582
Risk-Averse Investing 582
Solved Problem 17.4 583

17.5 Behavioral Economics of Uncertainty 584
Biased Assessment of Probabilities 584
APPLICATION Biased Estimates 585

Violations of Expected Utility Theory 586
Prospect Theory 587
CHALLENGE SOLUTION BP and Limited

Liability 589
Summary 590 Questions 591

Chapter 18 Externalities, Open-Access,
and Public Goods 595

CHALLENGE Trade and Pollution 595
18.1 Externalities 596

APPLICATION Negative Externalities
from Spam 597

18.2 The Inefficiency of Competition with
Externalities 597

18.3 Regulating Externalities 600
APPLICATION Pulp and Paper Mill

Pollution and Regulation 602
Solved Problem 18.1 603
APPLICATION Why Tax Drivers 603
Benefits Versus Costs from Controlling

Pollution 604
APPLICATION Protecting Babies 604

18.4 Market Structure and Externalities 605
Monopoly and Externalities 605
Monopoly Versus Competitive Wel