Microeconomics and Behavior, Tenth Edition
By Robert H. Frank
Contents:
PART 1 Introduction
Chapter 1 Thinking Like an Economist 1
The Cost-Benefit Approach to Decisions 2
The Role of Economic Theory 3
Common Pitfalls in Decision Making 4
Pitfall 1. Ignoring Implicit Costs 4
Pitfall 2. Failing to Ignore Sunk Costs 6
Pitfall 3. Measuring Costs and Benefits as Proportions
Rather Than Absolute Dollar Amounts 9
Pitfall 4. Failure to Understand the Average-Marginal Distinction 10
Using Marginal Benefit and Marginal Cost Graphically 12
The Invisible Hand 13
Self-Interest and Homo Economicus 14
The Economic Naturalist 15
ECONOMIC NATURALIST 1.1 16
ECONOMIC NATURALIST 1.2 16
Should You Think Like an Economist? 17
Microeconomics and Macroeconomics 17
Summary 18 ∙ Key Terms 18 ∙ Review
Questions 18 ∙ Problems 19 ∙ Answers to
Self-Texts 21
Chapter 2 Supply and Demand 23
Chapter Preview 23
Supply and Demand Curves 24
Equilibrium Quantity and Price 27
Adjustment to Equilibrium 28
Some Welfare Properties of Equilibrium 29
Free Markets and The Poor 30
Rent Controls 32
Price Supports 34
The Rationing and Allocative Functions of Prices 35
Determinants of Supply and Demand 36
Determinants of Demand 36
Determinants of Supply 37
Changes in Demand versus Changes in the Quantity
Demanded 38
Predicting and Explaining Changes
in Price and Quantity 39
ECONOMIC NATURALIST 2.1 39
The Algebra of Supply and Demand 40
Summary 41 ∙ Key Terms 42 ∙ Review
Questions 42 ∙ Problems 43 ∙ Answers to Self-
Tests 44 ∙ APPENDIX: How do Taxes Affect Equilibrium
Prices and Quantities? 45 ∙ Problems 48 ∙ Answers to
Appendix Self-Tests 50
PART 2 The Theory of Consumer Behavior
Chapter 3 Rational Consumer Choice 51
Chapter Preview 52
The Opportunity Set or Budget Constraint 52
Budget Shifts Due to Price or Income Changes 54
Budgets Involving More Than Two Goods 56
Kinked Budget Constraints 57
If the Budget Constraint Is the Same, the Decision Should
be the Same 58
Consumer Preferences 59
Indifference Curves 61
Trade-offs between Goods 64
Using Indifference Curves to Describe Preferences 65
The Best Feasible Bundle 65
Corner Solutions 67
Indifference Curves When There Are
More Than Two Goods 69
An Application of the Rational Choice Model 69
ECONOMIC NATURALIST 3.1 71
Summary 72 ∙ Key Terms 72 ∙ Review
Questions 73 ∙ Problems 73 ∙ Answers to Self-
Tests 75 ∙ APPENDIX: The Utility Function Approach to the Consumer Budgeting Problem 77
The Utility Function Approach to Consumer Choice 77
Cardinal Versus Ordinal Utility 81
Generating Indifference Curves Algebraically 83
Using Calculus to Maximize Utility 83
The Method of Lagrangian Multipliers 83
An Alternative Method 85
A Simplifying Technique 85
Problems 86
Chapter 4 Individual and Market Demand 87
Chapter Preview 87
The Effects of Changes in Price 88
The Price-Consumption Curve 88
The Individual Consumer’s Demand Curve 89
The Effects of Changes in Income 90
The Income-Consumption Curve 90
The Engel Curve 90
Normal and Inferior Goods 91
The Income and Substitution Effects of a Price Change 92
Giffen Goods 94
Consumer Responsiveness to Changes in Price 97
Market Demand: Aggregating Individual Demand
Curves 100
Price Elasticity of Demand 103
A Geometric Interpretation of Price Elasticity 103
The Unit-Free Property of Elasticity 105
Some Representative Elasticity Estimates 105
Elasticity and Total Expenditure 107
Determinants of Price Elasticity of Demand 110
The Dependence of Market Demand on Income 112
ECONOMIC NATURALIST 4.1 115
Application: Forecasting Economic Trends 116
Cross-Price Elasticities of Demand 116
Summary 117 ∙ Key Terms 118 ∙ Review Questions 119 ∙
Problems 119 ∙ Answers to Self-Tests 121 ∙ APPENDIX:
Additional Topics in Demand Theory 123
The Constant Elasticity Demand Curve 123
Segment-Ratio Method 124
The Income-Compensated Demand Curve 126
Answers to Appendix Self-Tests 127
Chapter 5 Applications of Rational Choice and Demand Theories 129
Chapter Preview 129
Using the Rational Choice Model to Answer Policy Questions 130
Application: A Gasoline Tax and Rebate Policy 130
Application: School Vouchers 132
Consumer Surplus 134
Using Demand Curves to Measure Consumer Surplus 134
Application: Two-Part Pricing 136
ECONOMIC NATURALIST 5.1 136
ECONOMIC NATURALIST 5.2 137
Overall Welfare Comparisons 138
Application: The Welfare Effects of Changes in Housing Prices 139
Application: A Bias in the Consumer Price Index 140
Quality Change: Another Bias in the CPI? 142
Using Price Elasticity of Demand 143
Application: The MARTA Fare Increase 143
Application: The Price Elasticity of Demand for Alcohol 144
The Intertemporal Choice Model 145
Intertemporal Consumption Bundles 145
The Intertemporal Budget Constraint 146
Intertemporal Indifference Curves 147
Application: The Permanent Income and Life-Cycle
Hypotheses 150
Application: The Social Cost of Carbon 151
Factors Accounting for Differences in Time Preference 154
Summary 155 ∙ Key Terms 156 ∙ Review Questions 156 ∙
Problems 156 ∙ Answers to Self-Tests 158
Chapter 6 The Economics of Information
and Choice under Uncertainty 161
Chapter Preview 161
The Economics of Information 162
Communication between Potential Adversaries 162
The Costly-to-Fake Principle 163
Product Quality Assurance 163
Choosing a Trustworthy Employee 164
Choosing a Hard-Working, Smart Employee 165
Choosing a Relationship 165
ECONOMIC NATURALIST 6.1 165
Conspicuous Consumption as Ability Signaling 166
ECONOMIC NATURALIST 6.2 166
The Full-Disclosure Principle 167
Product Warranties 168
Regulating the Employment Interviewer 168
The Lemons Principle 169
ECONOMIC NATURALIST 6.3 169
The Stigma of the Newcomer 170
Choice Under Uncertainty 170
Probability and Expected Value 170
The Von Neumann–Morgenstern Expected Utility
Model 172
Are Entrepreneurs Risk-Seeking? 179
Insuring Against Bad Outcomes 180
Risk Pooling 180
Adverse Selection 182
ECONOMIC NATURALIST 6.4 183
Moral Hazard 184
Statistical Discrimination 185
Application: Always Self-Insure against Small
Losses 186
Can We Insure against Climate Catastrophe 187
Summary 188 ∙ Key Terms 188 ∙ Review Questions 189 ∙
Problems 189 ∙ Answers to Self-Tests 191 ∙ APPENDIX:
Search Theory and the Winner’s Curse 193
The Search for High Wages and Low Prices 193
The Winner’s Curse 197
Some Pitfalls for the Expected Utility Maximizer 200
Problems 202 ∙ Answers to Appendix Self-Tests 202
Chapter 7 Departures from Standard Rational
Choice Models (With and Without Regret) 203
Chapter Preview 204
Present Aim and Self-Interest Standards of Rationality 204
An Application of the Present-Aim Standard: Altruistic
Preferences 205
The Strategic Role of Preferences 207
How Strategic Preferences Can Help Solve Commitment
Problems 208
A Simple Thought Experiment 210
Tastes Not Only Can Differ, They Must Differ 211
ECONOMIC NATURALIST 7.1 212
Application: Predicting Variations in Voter Turnout 212
Application: Concerns about Fairness 213
The Importance of Tastes 215
Departures from Traditional Rational Choice
Models (With Regret) 216
Bounded Rationality 217
The Asymmetric Value Function 218
Sunk Costs 220
Out-of-Pocket Costs Versus Implicit Costs 220
Affective Forecasting Errors 221
Judgmental Heuristics and Biases 223
Availability 223
Representativeness 224
ECONOMIC NATURALIST 7.2 225
Anchoring and Adjustment 226
The Psychophysics of Perception 227
The Difficulty of Actually Deciding 227
ECONOMIC NATURALIST 7.3 229
The Self-Control Pitfall 229
Cognitive Illusions and Public Policy 230
Summary 231 ∙ Key Term 232 ∙ Review Questions 233 ∙
Problems 233 ∙ Answers to Self-Tests 234
PART 3 The Theory of Firm and Market
Structure
Chapter 8 Production 235
Chapter Preview 235
The Input-Output Relationship, or Production
Function 236
Intermediate Products 237
Fixed and Variable Inputs 237
Production in the Short Run 238
ECONOMIC NATURALIST 8.1 239
Total, Marginal, and Average Products 241
The Relationships among Total, Marginal, and Average
Product Curves 242
The Practical Significance of the Average-Marginal
Distinction 244
Production in the Long Run 247
The Marginal Rate of Technical Substitution 248
Returns to Scale 250
ECONOMIC NATURALIST 8.2 251
Showing Returns to Scale on the Isoquant Map 251
The Distinction between Diminishing Returns
and Decreasing Returns to Scale 252
The Logical Puzzle of Decreasing Returns to Scale 252
Summary 253 ∙ Key Terms 253 ∙ Review
Questions 254 ∙ Problems 254 ∙ Answers to Self-
Tests 255 ∙ APPENDIX: Mathematical Extensions of
Production Theory 257
Application: The Average-Marginal Distinction 257
Isoquant Maps and the Production Mountain 260
Some Examples of Production Functions 261
The Cobb-Douglas Production Function 261
The Leontief, or Fixed-Proportions, Production
Function 262
A Mathematical Definition of Returns to Scale 263
Problems 264 ∙ Answers to Appendix Self-Tests 264
Chapter 9 Costs 265
Chapter Preview 265
Costs in the Short Run 266
Graphing the Total, Variable, and Fixed Cost Curves 268
Other Short-Run Costs 270
Graphing the Short-Run Average and Marginal Cost
Curves 271
Allocating Production Between Two Processes 275
The Relationship Among MP, AP, MC, and AVC 276
Costs in the Long Run 278
Choosing the Optimal Input Combination 278
ECONOMIC NATURALIST 9.1 280
ECONOMIC NATURALIST 9.2 282
ECONOMIC NATURALIST 9.3 283
The Relationship between Optimal Input Choice and Long-
Run Costs 283
Long-Run Costs and the Structure of Industry 286
The Relationship between Long-Run and Short-Run Cost
Curves 287
Summary 288 ∙ Key Terms 289 ∙ Review Questions 289 ∙
Problems 290 ∙ Answers to Self-Tests 291 ∙
APPENDIX: Mathematical Extensions of the Theory of
Costs 293
The Relationship Between Long-Run and Short-Run Cost
Curves 293
The Calculus Approach to Cost Minimization 296
Problems 297 ∙ Answers to Appendix Self-Test 298
Chapter 10 Perfect Competition 299
Chapter Preview 299
The Goal of Profit Maximization 300
The Four Conditions for Perfect Competition 303
The Short-Run Condition for Profit Maximization 305
The Shutdown Condition 307
The Short-Run Competitive Industry Supply 308
Short-Run Competitive Equilibrium 310
The Efficiency of Short-Run Competitive Equilibrium 312
Producer Surplus 312
Adjustments in the Long Run 316
The Invisible Hand 318
Application: The Cost of Extraordinary Inputs 319
The Long-Run Competitive Industry Supply Curve 321
Long-Run Supply Curve with U-Shaped LAC Curves 321
Industry Supply when Each LAC Curve is Horizontal 322
How Changing Input Prices Affect Long-Run Supply 322
ECONOMIC NATURALIST 10.1 324
The Elasticity of Supply 325
Applying the Competitive Model 326
Price Supports as a Device for Saving Family Farms 326
The Illusory Attraction of Taxing Business 328
The Adoption of Cost-Saving Innovations 329
ECONOMIC NATURALIST 10.2 330
Summary 330 ∙ Key Terms 331 ∙ Review Questions 331 ∙
Problems 332 ∙ Answers to Self-Tests 333
Chapter 11 Monopoly 335
Chapter Preview 335
Defining Monopoly 336
Five Sources of Monopoly 337
Information as a Growing Source of Economies
of Scale 340
The Profit-Maximizing Monopolist 341
The Monopolist’s Total Revenue Curve 341
Marginal Revenue 343
Marginal Revenue and Elasticity 345
Graphing Marginal Revenue 346
Graphical Interpretation of the Short-Run Profit
Maximization Condition 347
A Profit-Maximizing Monopolist Will Never Produce on the
Inelastic Portion of the Demand Curve 349
The Profit-Maximizing Markup 349
The Monopolist’s Shutdown Condition 349
A Monopolist has No Supply Curve 351
Adjustments in the Long Run 351
Price Discrimination 352
Sale in Different Markets 352
ECONOMIC NATURALIST 11.1 354
ECONOMIC NATURALIST 11.2 355
The Perfectly Discriminating Monopolist 355
Second-Degree Price Discrimination 357
The Hurdle Model of Price Discrimination 357
The Efficiency Loss From Monopoly 359
Public Policy Toward Natural Monopoly 360
- State Ownership and Management 361
- State Regulation of Private Monopolies 362
- Exclusive Contracting for Natural Monopoly 364
- Vigorous Enforcement of Antitrust Laws 364
- A Laissez-Faire Policy toward Natural Monopoly 365
Does Monopoly Suppress Innovation? 368
Summary 369 ∙ Key Terms 369 ∙ Review
Questions 369 ∙ Problems 370 ∙ Answers to Self-
Tests 371
Chapter 12 A Game-Theoretic Approach to
Strategic Behavior 373
Chapter Preview 373
The Prisoner’s Dilemma: An Introduction to the Theory
of Games 374
ECONOMIC NATURALIST 12.1 376
The Nash Equilibrium Concept 378
The Maximin Strategy 379
Strategies for Repeated Play in Prisoner’s Dilemmas 380
Sequential Games 382
ECONOMIC NATURALIST 12.2 384
ECONOMIC NATURALIST 12.3 386
The Evolution of Strategic Preferences 386
A Parable of Hawks and Doves 386
The Commitment Problem 389
Illustration: The Cheating Problem 390
Summary 395 ∙ Key Terms 396 ∙ Review Questions 396 ∙
Problems 396 ∙ Answers to Self-Tests 398
Chapter 13 Oligopoly and Monopolistic
Competition 401
Chapter Preview 402
Some Specific Oligopoly Models 402
The Cournot Model 402
The Bertrand Model 405
The Stackelberg Model 406
Comparison of Outcomes 408
Competition When There are Increasing Returns to
Scale 409
Monopolistic Competition 411
The Chamberlin Model 411
Chamberlinian Equilibrium in the Short Run 412
Chamberlinian Equilibrium in the Long Run 413
Perfect Competition versus Chamberlinian Monopolistic
Competition 414
Criticisms of the Chamberlin Model 415
A Spatial Interpretation of Monopolistic Competition 415
The Optimal Number of Locations 417
ECONOMIC NATURALIST 13.1 420
The Analogy to Product Characteristics 421
Paying for Variety 421
Historical Note: Hotelling’s Hot Dog Vendors 424
Which Model Applies? 425
Consumer Preferences and Advertising 425
Summary 426 ∙ Key Terms 427 ∙ Review Questions 427 ∙
Problems 427 ∙ Answers to Self-Tests 428
PART 4 Factor Markets
Chapter 14 Labor 431
Chapter Preview 432
The Perfectly Competitive Firm’s Demand for Labor 432
Short-Run Demand 432
Long-Run Demand for Labor 433
The Market Demand Curve for Labor 434
An Imperfect Competitor’s Demand for Labor 435
The Supply of Labor 436
ECONOMIC NATURALIST 14.1 439
Is Leisure a Giffen Good? 441
The Noneconomist’s Reaction to the Labor Supply
Model 442
The Market Supply Curve 442
Monopsony 444
Minimum Wage Laws 448
Labor Unions 450
Discrimination in the Labor Market 452
Statistical Discrimination 454
The Internal Wage Structure 457
Winner-Take-All Markets 460
Summary 461 ∙ Key Terms 461 ∙ Review
Questions 462 ∙ Problems 462 ∙ Answers to Self-
Tests 464 ∙ APPENDIX: The Economics of Workplace
Safety 467
Compensating Wage Differentials: The Case
of Safety 467
Safety Choices and Relative Income 471
Problem 472
Chapter 15 Capital 473
Chapter Preview 473
Financial Capital and Real Capital 474
The Demand for Real Capital 474
The Relationship Between the Rental Rate and the
Interest Rate 475
The Criterion for Buying a Capital Good 475
Interest Rate Determination 476
Real Versus Nominal Interest Rates 477
The Market for Stocks and Bonds 478
The Efficient Markets Hypothesis 480
ECONOMIC NATURALIST 15.1 482
The Anomaly of the Investment Newsletter 482
Tax Policy and the Capital Market 484
Economic Rent 485
Peak-Load Pricing 486
Exhaustible Resources as Inputs in Production 487
Summary 489 ∙ Key Terms 489 ∙ Review
Questions 490 ∙ Problems 490 ∙ Answers to Self-
Tests 490 ∙ APPENDIX: A More Detailed Look at
Exhaustible Resource Allocation 491
Natural Resources as Inputs in Production 491
Renewable Resources 491
More on Exhaustible Resources 493
Summary 496 ∙ Review Question 496 ∙ Problems 496 ∙
Answer to Appendix Self-Test 497
PART 5 General Equilibrium and Welfare
Chapter 16 Externalities, Property Rights,
and the Coase Theorem 499
Chapter Preview 499
The Reciprocal Nature of Externalities 500
Application: External Effects from Nuclear Power
Plants 506
Property Rights 507
Private Property Laws and Their Exceptions 507
ECONOMIC NATURALIST 16.1 507
ECONOMIC NATURALIST 16.2 508
ECONOMIC NATURALIST 16.3 509
ECONOMIC NATURALIST 16.4 510
The Tragedy of the Commons 512
Externalities, Efficiency, and Free Speech 514
Positive Externalities 515
Positional Externalities 516
Limiting the Workweek 517
Savings 518
Workplace Safety 518
Taxing Externalities 519
Carbon Tax or Direct Restrictions on Emissions? 520
Taxing Positional Externalities 522
Summary 523 ∙ Review
Questions 524 ∙ Problems 524 ∙ Answers to Self-
Tests 528
Chapter 17 General Equilibrium and Market
Efficiency 529
Chapter Preview 529
A Simple Exchange Economy 530
Only Relative Prices Are Determined 536
The Invisible Hand Theorem 536
Efficiency in Production 537
Efficiency in Product Mix 539
Gains From International Trade 542
Taxes in General Equilibrium 544
Other Sources of Inefficiency 545
Monopoly 545
Externalities 546
Taxes as a Solution to Externalities and Monopoly 546
Public Goods 546
Summary 547 ∙ Key Terms 547 ∙ Review
Questions 548 ∙ Problems 548 ∙ Answers to Self-Tests 549
Chapter 18 Government 551
Chapter Preview 552
Public Goods 552
Optimal Quantity of Public Good 553
Paying for Q* 554
Private Provision of Public Goods 555
Funding by Donation 555
Sale of By-Products 556
Development of New Means to Exclude Nonpayers 557
Private Contracts 557
The Economics of Clubs 557
Public Choice 559
Majority Voting 559
Cost-Benefit Analysis 561
Rent Seeking 563
Income Distribution 564
The Rawlsian Critique 565
Reasons for Redistribution 566
Fairness and Efficiency 567
Methods of Redistribution 568
Reprise: Thinking Like an Economist 575
Summary 576 ∙ Key Terms 577 ∙ Review
Questions 577 ∙ Problems 577 ∙ Answers to Self-Tests 579
Index 581