RONALD R. BRAEUTIGAM is the Harvey Kapnick Professor of Business Institutions in the Department of Economics at Northwestern University. He is Associate Dean for Undergraduate Studies in the Weinberg College of Arts and Sciences. He received a BS in Petroleum Engineering from the University of Tulsa in 1970 and then attended Stanford University and the California Institute of Technology, and he has also held an appointment as a Senior Research Fellow at the Wissenschaftszentrum Berlin (Science Center Berlin). He has also worked in both government and industry, beginning his career as a petroleum engineer with Standard Oil of Indiana (now BP), serving as research economist in The White House office of Telecommunications Policy, and as an economic consultant to Congress, many government agencies and private firms on matters of pricing, costing, managerial strategy, antitrust, and regulation.

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 13

1.3 Positive and Normative Analysis 18

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

2.1 Demand, Supply, and Market Equilibrium 29

Demand Curves 30

Supply Curves 32

Market Equilibrium 33

Shifts in Supply and Demand 35

2.2 Price Elasticity of Demand 45

Elasticities Along Specific Demand Curves 47

Price Elasticity of Demand and Total Revenue 49

Determinants of the Price Elasticity of Demand 50

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 58

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

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 79

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

Chapter 4 Consumer Choice 105
How Much of What You Like Should You Buy?

4.1 The Budget Constraint 107

How Does a Change in Income Affect the Budget Line? 109

How Does a Change in Price Affect the Budget Line? 109

4.2 Optimal Choice 112

Using the Tangency Condition to Understand When a Basket is Not Optimal 116

Finding an Optimal Consumption Basket 117

Two Ways of Thinking About Optimality 118

Corner Points 120

4.3 Consumer Choice with Composite Goods 123

Application: Coupons and Cash Subsidies 123

Application: Joining a Club 127

Application: Borrowing and Lending 128

Application: Quantity Discounts 133

4.4 Revealed Preference 134

Are Observed Choices Consistent with Utility

Maximization? 135

Appendix 1 The Mathematics of Consumer Choice 145

Appendix 2 The Time Value of Money 146

Chapter 5 The Theory of Demand 152
Why Understanding the Demand for Cigarettes is Important for Public Policy

5.1 Optimal Choice and Demand 154

The Effects of a Change in Price 154

The Effects of a Change in Income 157

The Effects of a Change in Price or Income: An Algebraic Approach 162

5.2 Change in the Price of a Good: Substitution Effect and Income Effect 164

The Substitution Effect 165

The Income Effect 165

Income and Substitution Effects When Goods are Not Normal 167

5.3 Change in the Price of a Good: The Concept of Consumer Surplus 175

Understanding Consumer Surplus from the Demand Curve 175

Understanding Consumer Surplus from the Optimal Choice Diagram: Compensating Variation and Equivalent Variation 177

5.4 Market Demand 184

Market Demand with Network Externalities 186

5.5 The Choice of Labor and Leisure 189

As Wages Rise, Leisure First Decreases, Then Increases 189

The Backward-Bending Supply of Labor 191

5.6 Consumer Price Indices 195

Part 3 Production and Cost Theory

Chapter 6 Inputs and Production Functions 204
Can They Do It Better and Cheaper?

6.1 Introduction to Inputs and Production Functions 206

6.2 Production Functions with a Single Input 208

Total Product Functions 209

Marginal and Average Product 210

Relationship Between Marginal and Average Product 214

6.3 Production Functions with More Than One Input 214

Total Product and Marginal Product with Two Inputs 214

Isoquants 216

Economic and Uneconomic Regions of Production 220

Marginal Rate of Technical Substitution 221

6.4 Substitutability Among Inputs 223

Describing a Firm’s Input Substitution Opportunities Graphically 224

Elasticity of Substitution 226

Special Production Functions 229

6.5 Returns to Scale 234

Definitions 234

Returns to Scale versus Diminishing Marginal Returns 237

6.6 Technological Progress 237

Appendix The Elasticity of Substitution for a Cobb–Douglas Production Function 247

Chapter 7 Costs and Cost Minimization 249
What’s Behind the Self-Service Revolution?

7.1 Cost Concepts for Decision Making 251

Opportunity Cost 251

Economic versus Accounting Costs 254

Sunk (Unavoidable) versus Nonsunk (Avoidable) Costs 255

7.2 The Cost-Minimization Problem 257

Long Run versus Short Run 257

The Long-Run Cost-Minimization Problem 258

Isocost Lines 259

Graphical Characterization of the Solution to the Long-Run Cost-Minimization Problem 260

Corner Point Solutions 262

7.3 Comparative Statics Analysis of the Cost-Minimization Problem 264

Comparative Statics Analysis of Changes in Input Prices 264

Comparative Statics Analysis of Changes in Output 268

Summarizing the Comparative Statics Analysis: The Input Demand Curves 269

The Price Elasticity of Demand for Inputs 271

7.4 Short-Run Cost Minimization 273

Characterizing Costs in the Short Run 274

Cost Minimization in the Short Run 276

Comparative Statics: Short-Run Input Demand versus Long-Run Input Demand 277

More Than One Variable Input in the Short Run 278

Appendix Advanced Topics in Cost Minimization 285

Chapter 8 Cost Curves 289
How Can HiSense Get a Handle on Costs?

8.1 Long-Run Cost Curves 291

Long-Run Total Cost Curve 291

How Does the Long-Run Total Cost Curve Shift When Input Prices Change? 293

Long-Run Average and Marginal Cost Curves 296

8.2 Short-Run Cost Curves 306

Short-Run Total Cost Curve 306

Relationship Between the Long-Run and the Short-Run Total Cost Curves 307

Short-Run Average and Marginal Cost Curves 309

Relationships Between the Long-Run and the Short-Run Average and Marginal Cost Curves 310

When are Long-Run and Short-Run Average and Marginal Costs Equal, and When are They Not? 311

8.3 Special Topics in Cost 314

Economies of Scope 314

Economies of Experience: The Experience Curve 317

8.4 Estimating Cost Functions 319

Constant Elasticity Cost Function 320

Translog Cost Function 320

Appendix Shephard’s Lemma and Duality 327

Part 4 Perfect Competition

Chapter 9 Perfectly Competitive Markets 331
A Rose is a Rose is a Rose

9.1 What is Perfect Competition? 333

9.2 Profit Maximization by a Price-Taking Firm 336

Economic Profit versus Accounting Profit 336

The Profit-Maximizing Output Choice for a Price-Taking Firm 338

9.3 How the Market Price is Determined: Short-Run Equilibrium 341

The Price-Taking Firm’s Short-Run Cost Structure 341

Short-Run Supply Curve for a Price-Taking Firm When All Fixed Costs are Sunk 343

Short-Run Supply Curve for a Price-Taking Firm When Some Fixed Costs are Sunk and Some are Nonsunk 345

Short-Run Market Supply Curve 349

Short-Run Perfectly Competitive Equilibrium 352

Comparative Statics Analysis of the Short-Run Equilibrium 353

9.4 How the Market Price is Determined: Long-Run Equilibrium 356

Long-Run Output and Plant-Size Adjustments by Established Firms 356

The Firm’s Long-Run Supply Curve 357

Free Entry and Long-Run Perfectly Competitive Equilibrium 358

Long-Run Market Supply Curve 360

Constant-Cost, Increasing-Cost, and Decreasing-Cost Industries 362

What Does Perfect Competition Teach Us? 370

9.5 Economic Rent and Producer Surplus 371

Economic Rent 371

Producer Surplus 374

Economic Profit, Producer Surplus, Economic Rent 380

Appendix Profit Maximization Implies Cost Minimization 388

Chapter 10 Competitive Markets: Applications 390
Is Support a Good Thing?

10.1 The Invisible Hand, Excise Taxes and Subsidies 392

The Invisible Hand 393

Excise Taxes 394

Incidence of a Tax 398

Subsidies 402

10.2 Price Ceilings and Floors 404

Price Ceilings 405

Price Floors 412

10.3 Production Quotas 417

10.4 Price Supports in the Agricultural Sector 421

Acreage Limitation Programs 422

Government Purchase Programs 422

10.5 Import Quotas and Tariffs 426

Quotas 426

Tariffs 429

Part 5 Market Power

Chapter 11 Monopoly and Monopsony 442
Why Do Firms Play Monopoly?

11.1 Profit Maximization by a Monopolist 444

The Profit-Maximization Condition 444

A Closer Look at Marginal Revenue: Marginal Units and Inframarginal Units 448

Average Revenue and Marginal Revenue 449

The Profit-Maximization Condition Shown Graphically 451

A Monopolist Does Not Have a Supply Curve 453

11.2 The Importance of Price Elasticity of Demand 454

Price Elasticity of Demand and the Profit-Maximizing Price 454

Marginal Revenue and Price Elasticity of Demand 455

Marginal Cost and Price Elasticity of Demand: The Inverse Elasticity Pricing Rule 457

The Monopolist Always Produces on the Elastic Region of the Market Demand Curve 458

The IEPR Applies Not Only to Monopolists 460

Quantifying Market Power: The Lerner Index 461

11.3 Comparative Statics for Monopolists 462

Shifts in Market Demand 462

Shifts in Marginal Cost 465

11.4 Monopoly with Multiple Plants and Markets 467

Output Choice with Two Plants 467

Output Choice with Two Markets 469

Profit Maximization by a Cartel 470

11.5 The Welfare Economics of Monopoly 473

The Monopoly Equilibrium Differs from the Perfectly Competitive Equilibrium 473

Monopoly Deadweight Loss 475

Rent-Seeking Activities 475

11.6 Why Do Monopoly Markets Exist? 475

Natural Monopoly 476

Barriers to Entry 477

11.7 Monopsony 479

The Monopsonist’s Profit-Maximization Condition 479

An Inverse Elasticity Pricing Rule for Monopsony 481

Monopsony Deadweight Loss 482

Chapter 12 Capturing Surplus 489
Why Did Your Carpet or Your Airline Ticket Cost So Much Less Than Mine?

12.1 Capturing Surplus 491

12.2 First-Degree Price Discrimination: Making the Most from Each Consumer 494

12.3 Second-Degree Price Discrimination: Quantity Discounts 499

Block Pricing 499

Subscription and Usage Charges 502

12.4 Third-Degree Price Discrimination: Different Prices for Different Market Segments 505

Two Different Segments, Two Different Prices 505

Screening 508

Third-Degree Price Discrimination with Capacity Constraints 510

Implementing the Scheme of Price Discrimination: Building “Fences” 512

12.5 Tying (Tie-In Sales) 516

Bundling 517

Mixed Bundling 519

12.6 Advertising 522

Part 6 Imperfect Competition and Strategic Behavior

Chapter 13 Market Structure and Competition 532
Is Competition Always the Same? If Not, Why Not?

13.1 Describing and Measuring Market Structure 534

13.2 Oligopoly with Homogeneous Products 537

The Cournot Model of Oligopoly 537

The Bertrand Model of Oligopoly 545

Why are the Cournot and Bertrand Equilibria Different? 547

The Stackelberg Model of Oligopoly 548

13.3 Dominant Firm Markets 550

13.4 Oligopoly with Horizontally Differentiated Products 553

What is Product Differentiation? 553

Bertrand Price Competition with Horizontally Differentiated Products 556

13.5 Monopolistic Competition 562

Short-Run and Long-Run Equilibrium in Monopolistically Competitive Markets 562

Price Elasticity of Demand, Margins, and Number of Firms in the Market 564

Do Prices Fall When More Firms Enter? 564

Appendix The Cournot Equilibrium and the Inverse Elasticity Pricing Rule 574

13.1 Computing a Cournot Equilibrium 540

13.2 Computing the Cournot Equilibrium for Two or More Firms with Linear Demand 544

13.3 Computing the Equilibrium in the Dominant Firm Model 552

13.4 Computing a Bertrand Equilibrium with Horizontally Differentiated Products 560

Chapter 14 Game Theory and Strategic Behavior 575
What’s in a Game?

14.1 The Concept of Nash Equilibrium 577

A Simple Game 577

The Nash Equilibrium 578

The Prisoners’ Dilemma 578

Dominant and Dominated Strategies 579

Games with More Than One Nash Equilibrium 583

Mixed Strategies 586

Summary: How to Find All the Nash Equilibria in a Simultaneous-Move Game with Two Players 588

14.2 The Repeated Prisoners’ Dilemma 588

14.3 Sequential-Move Games and Strategic Moves 594

Analyzing Sequential-Move Games 594

The Strategic Value of Limiting One’s Options 597

Part 7 Special Topics

Chapter 15 Risk and Information 608
Risky Business

15.1 Describing Risky Outcomes 610

Lotteries and Probabilities 610

Expected Value 612

Variance 612

15.2 Evaluating Risky Outcomes 615

Utility Functions and Risk Preferences 615

Risk-Neutral and Risk-Loving Preferences 618

15.3 Bearing and Eliminating Risk 621

Risk Premium 621

When Would a Risk-Averse Person Choose to Eliminate Risk? The Demand for Insurance 624

Asymmetric Information in Insurance Markets: Moral Hazard and Adverse Selection 627

15.4 Analyzing Risky Decisions 633

Decision Tree Basics 633

Decision Trees with a Sequence of Decisions 635

The Value of Information 637

15.5 Auctions 639

Types of Auctions and Bidding Environments 640

Auctions When Bidders Have Private Values 641

Auctions When Bidders Have Common Values: The Winner’s Curse 645

Chapter 16 General Equilibrium Theory 654
How Do Gasoline Taxes Affect the Economy?

16.1 General Equilibrium Analysis: Two Markets 656

16.2 General Equilibrium Analysis: Many Markets 660

The Origins of Supply and Demand in a Simple Economy 660

The General Equilibrium in Our Simple Economy 666

Walras’ Law 670

16.3 General Equilibrium Analysis: Comparative Statics 671

16.4 The Efficiency of Competitive Markets 675

What is Economic Efficiency? 675

Exchange Efficiency 676

Input Efficiency 682

Substitution Efficiency 684

Pulling the Analysis Together: The Fundamental Theorems of Welfare Economics 687

16.5 Gains from Free Trade 688

Free Trade is Mutually Beneficial 688

Comparative Advantage 692

Appendix Deriving the Demand and Supply Curves for General Equilibrium in Figure 16.9 and Learning-by-Doing Exercise 16.2 698

Chapter 17 Externalities and Public Goods 703
When Does the Invisible Hand Fail?

17.1 Introduction 705

17.2 Externalities 706

Negative Externalities and Economic Efficiency 708

Positive Externalities and Economic Efficiency 722

Property Rights and the Coase Theorem 726

17.3 Public Goods 728

Efficient Provision of a Public Good 729

The Free-Rider Problem 732

Mathematical Appendix 739

Solutions to Selected Problems 759

Glossary 781

Index 789

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