Microeconomics


Microeconomics
Fourth Edition

R. Glenn Hubbard
Columbia University

Anthony Patrick O’Brien
Lehigh University

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ISBN 13: 978-0-13-291198-6
ISBN 10: 0-13-291198-1


For Constance, Raph, and Will
—R. Glenn Hubbard

For Cindy, Matthew, Andrew, and Daniel
—Anthony Patrick O’Brien


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ABOUT THE
AUTHORS

Glenn Hubbard, policymaker, professor, and
researcher. R. Glenn Hubbard is the dean and Russell L.
Carson Professor of Finance and Economics in the Graduate
School of Business at Columbia University and professor of
economics in Columbia’s Faculty of Arts and Sciences. He is also
a research associate of the National Bureau of Economic Research
and a director of Automatic Data Processing, Black Rock
Closed-End Funds, KKR Financial Corporation, and MetLife.
He received his Ph.D. in economics from Harvard University in
1983. From 2001 to 2003, he served as chairman of the White
House Council of Economic Advisers and chairman of the OECD Economy Policy
Committee, and from 1991 to 1993, he was deputy assistant secretary of the U.S. Treasury
Department. He currently serves as co-chair of the nonpartisan Committee on Capital
Markets Regulation. Hubbard’s fields of specialization are public economics, financial
markets and institutions, corporate finance, macroeconomics, industrial organization,
and public policy. He is the author of more than 100 articles in leading journals, including
American Economic Review, Brookings Papers on Economic Activity, Journal of Finance,
Journal of Financial Economics, Journal of Money, Credit, and Banking, Journal of Political
Economy, Journal of Public Economics, Quarterly Journal of Economics, RAND Journal of
Economics, and Review of Economics and Statistics. His research has been supported by
grants from the National Science Foundation, the National Bureau of Economic Research,
and numerous private foundations.

Tony O’Brien, award-winning professor and
researcher. Anthony Patrick O’Brien is a professor of
economics at Lehigh University. He received his Ph.D. from the
University of California, Berkeley, in 1987. He has taught principles
of economics for more than 15 years, in both large sections and
small honors classes. He received the Lehigh University Award
for Distinguished Teaching. He was formerly the director of the

Diamond Center for Economic Education and was named a Dana
Foundation Faculty Fellow and Lehigh Class of 1961 Professor of
Economics. He has been a visiting professor at the University of
California, Santa Barbara, and the Graduate School of Industrial Administration at Carnegie
Mellon University. O’Brien’s research has dealt with such issues as the evolution of the U.S.
automobile industry, sources of U.S. economic competitiveness, the development of U.S.
trade policy, the causes of the Great Depression, and the causes of black-white income
differences. His research has been published in leading journals, including American
Economic Review, Quarterly Journal of Economics, Journal of Money, Credit, and Banking,
Industrial Relations, Journal of Economic History, and Explorations in Economic History. His
research has been supported by grants from government agencies and private foundations.
In addition to teaching and writing, O’Brien also serves on the editorial board of the Journal
of Socio-Economics.

vii


BRIEF
CONTENTS
Preface
A Word of Thanks

xxi
xlvi

Chapter 10: Consumer Choice and Behavioral
Economics

PART 1: Introduction
Chapter 1: Economics: Foundations and Models

Appendix: Using Graphs and Formulas

2
26

Chapter 2: Trade-offs, Comparative Advantage, and the
Market System

38

Chapter 3: Where Prices Come From: The Interaction of
Demand and Supply

68

Chapter 4: Economic Efficiency, Government
Price Setting, and Taxes
Appendix: Quantitative Demand and Supply
Analysis

PART 4: Microeconomic Foundations:
Consumers and Firms

100

Appendix: Using Indifference Curves and Budget
Lines to Understand Consumer Behavior
Chapter 11: Technology, Production, and Costs
Appendix: Using Isoquants and Isocost Lines to
Understand Production and Cost


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339
352
383

PART 5: Market Structure and Firm
Strategy
Chapter 12: Firms in Perfectly Competitive Markets

394

Chapter 13: Monopolistic Competition:
The Competitive Model in a More Realistic Setting

430

PART 2: Markets in Action: Policy and
Applications

Chapter 14: Oligopoly: Firms in Less Competitive
Markets

458

Chapter 5: Externalities, Environmental Policy, and
Public Goods

Chapter 15: Monopoly and Antitrust Policy


486

136

Chapter 16: Pricing Strategy

518

Chapter 6: Elasticity: The Responsiveness of Demand
and Supply

170

Chapter 7: The Economics of Health Care

204

131

PART 3: Firms in the Domestic and
International Economies
Chapter 8: Firms, the Stock Market, and Corporate
Governance

236

Appendix: Tools to Analyze Firms’ Financial
Information

263


Chapter 9: Comparative Advantage and the Gains
from International Trade

272

viii

PART 6: Labor Markets, Public Choice,
and the Distribution of Income
Chapter 17: The Markets for Labor and Other
Factors of Production

544

Chapter 18: Public Choice, Taxes, and the
Distribution of Income

580

Glossary
Company Index
Subject Index
Credits

G-1
I-1
I-3
C-1



CONTENTS
Preface
A Word of Thanks

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xlvi

PART 1: Introduction
Chapter 1: Economics: Foundations
and Models
Why Are Some Doctors Leaving Private Practice?
1.1 Three Key Economic Ideas
People Are Rational
People Respond to Economic Incentives
Making the Connection: Does Health Insurance Give
People an Incentive to Become Obese?
Optimal Decisions Are Made at the Margin
Solved Problem 1.1: A Doctor Makes a Decision
at the Margin
1.2 The Economic Problem That Every Society
Must Solve
What Goods and Services Will Be Produced?
How Will the Goods and Services Be Produced?
Who Will Receive the Goods and Services Produced?
Centrally Planned Economies versus Market Economies
The Modern “Mixed” Economy
Efficiency and Equity
1.3 Economic Models
The Role of Assumptions in Economic Models

Forming and Testing Hypotheses in
Economic Models
Normative and Positive Analysis
Economics as a Social Science
Don’t Let This Happen to You Don’t Confuse
Positive Analysis with Normative Analysis
Making the Connection: Should Medical School
Be Free?
1.4 Microeconomics and Macroeconomics
1.5 A Preview of Important Economic Terms
Conclusion
An Inside Look: Doctors Moving Less,
Retiring Later
*Chapter Summary and Problems

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Key Terms, Summary, Review Questions, Problems
and Applications

Appendix: Using Graphs and Formulas
Graphs of One Variable
Graphs of Two Variables
Slopes of Lines
Taking into Account More Than Two Variables
on a Graph

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Positive and Negative Relationships

Determining Cause and Effect
Are Graphs of Economic Relationships Always
Straight Lines?
Slopes of Nonlinear Curves
Formulas
Formula for a Percentage Change
Formulas for the Areas of a Rectangle and a Triangle
Summary of Using Formulas
Problems and Applications

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Chapter 2: Trade-offs, Comparative
Advantage, and the Market System

38

Managers Making Choices at BMW
2.1 Production Possibilities Frontiers
and Opportunity Costs
Graphing the Production Possibilities Frontier
Solved Problem 2.1: Drawing a Production
Possibilities Frontier for Rosie’s Boston Bakery
Making the Connection: Facing Trade-offs

in Health Care Spending
Increasing Marginal Opportunity Costs
Economic Growth
2.2 Comparative Advantage and Trade
Specialization and Gains from Trade
Absolute Advantage versus Comparative Advantage
Comparative Advantage and the Gains from Trade
Don’t Let This Happen to You Don’t Confuse
Absolute Advantage and Comparative
Advantage
Solved Problem 2.2: Comparative Advantage
and the Gains from Trade
2.3 The Market System
The Circular Flow of Income
The Gains from Free Markets
The Market Mechanism
Making the Connection: A Story of the Market
System in Action: How Do You Make an iPad?
The Role of the Entrepreneur
The Legal Basis of a Successful Market System
Conclusion
An Inside Look: Managers at General Motors
Approve Production of a Plug-in Cadillac

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Chapter 3: Where Prices Come From: The
Interaction of Demand and Supply

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The Tablet Computer Revolution
3.1 The Demand Side of the Market
Demand Schedules and Demand Curves
The Law of Demand

What Explains the Law of Demand?

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*These end-of-chapter resource materials repeat in all chapters.

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x

CONTENTS

Holding Everything Else Constant: The Ceteris
paribus Condition
Variables That Shift Market Demand
Making the Connection: Are Quiznos Sandwiches Normal
Goods and Subway Sandwiches Inferior Goods?
Making the Connection: The Aging of the Baby
Boom Generation
A Change in Demand versus a Change in Quantity
Demanded
Making the Connection: Forecasting the Demand
for iPads
3.2 The Supply Side of the Market
Supply Schedules and Supply Curves

The Law of Supply
Variables That Shift Market Supply
A Change in Supply versus a Change in Quantity
Supplied
3.3 Market Equilibrium: Putting Demand and Supply
Together
How Markets Eliminate Surpluses and Shortages
Demand and Supply Both Count
Solved Problem 3.3: Demand and Supply
Both Count: A Tale of Two Letters
3.4 The Effect of Demand and Supply Shifts on
Equilibrium
The Effect of Shifts in Supply on Equilibrium
Making the Connection: The Falling Price
of Blu-ray Players
The Effect of Shifts in Demand on Equilibrium
The Effect of Shifts in Demand and Supply over Time
Solved Problem 3.4: High Demand and Low
Prices in the Lobster Market?
Don’t Let This Happen to You Remember: A Change
in a Good’s Price Does Not Cause the Demand or
Supply Curve to Shift
Shifts in a Curve versus Movements along a Curve
Conclusion
An Inside Look: Will Shortage of Display Screens
Derail Computer Tablet Sales?
Chapter 4: Economic Efficiency,
Government Price Setting, and Taxes
Should the Government Control Apartment Rents?
4.1 Consumer Surplus and Producer Surplus

Consumer Surplus
Making the Connection: The Consumer Surplus
from Broadband Internet Service
Producer Surplus
What Consumer Surplus and Producer
Surplus Measure
4.2 The Efficiency of Competitive Markets
Marginal Benefit Equals Marginal Cost in
Competitive Equilibrium
Economic Surplus
Deadweight Loss
Economic Surplus and Economic Efficiency

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4.3 Government Intervention in the Market:
Price Floors and Price Ceilings
Price Floors: Government Policy in Agricultural
Markets
Making the Connection: Price Floors in Labor
Markets: The Debate over Minimum Wage Policy
Price Ceilings: Government Rent Control Policy in
Housing Markets
Don’t Let This Happen to You Don’t Confuse
“Scarcity” with “Shortage”
Black Markets
Solved Problem 4.3: What’s the Economic Effect
of a Black Market for Apartments?
The Results of Government Price Controls:
Winners, Losers, and Inefficiency
Positive and Normative Analysis of Price Ceilings
and Price Floors
4.4 The Economic Impact of Taxes
The Effect of Taxes on Economic Efficiency
Tax Incidence: Who Actually Pays a Tax?
Solved Problem 4.4: When Do Consumers Pay
All of a Sales Tax Increase?
Making the Connection: Is the Burden of the
Social Security Tax Really Shared Equally
between Workers and Firms?
Conclusion

An Inside Look at Policy: . . . and the RentControlled Apartment Goes to . . . Actress
Faye Dunaway!

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Appendix: Quantitative Demand and Supply Analysis
Demand and Supply Equations
Calculating Consumer Surplus and Producer Surplus

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PART 2: Markets in Action: Policy and
Applications

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Chapter 5: Externalities, Environmental
Policy, and Public Goods
Can Government Policies Help Protect the
Environment?
5.1 Externalities and Economic Efficiency
The Effect of Externalities
Externalities and Market Failure
What Causes Externalities?
5.2 Private Solutions to Externalities: The Coase
Theorem
The Economically Efficient Level of Pollution
Reduction
Making the Connection: The Clean Air Act: How a
Government Policy Reduced Infant Mortality
The Basis for Private Solutions to Externalities
Don’t Let This Happen to You Remember
That It’s the Net Benefit That Counts
Making the Connection: The Fable of the Bees

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CONTENTS

Do Property Rights Matter?
The Problem of Transactions Costs

The Coase Theorem
5.3 Government Policies to Deal with Externalities
Solved Problem 5.3: Using a Tax to Deal with a
Negative Externality
Making the Connection: Should the Government
Tax Cigarettes and Soda?
Command-and-Control versus Market-Based
Approaches
Are Tradable Emissions Allowances Licenses to
Pollute?
Making the Connection: Can a Cap-and-Trade
System Reduce Global Warming?
5.4 Four Categories of Goods
The Demand for a Public Good
The Optimal Quantity of a Public Good
Solved Problem 5.4: Determining the Optimal
Level of Public Goods
Common Resources
Conclusion
An Inside Look at Policy: Pros and Cons of Tougher
Air Pollution Regulations
Chapter 6: Elasticity: The Responsiveness of
Demand and Supply
Do People Respond to Changes in the Price
of Gasoline?
6.1 The Price Elasticity of Demand and Its
Measurement
Measuring the Price Elasticity of Demand
Elastic Demand and Inelastic Demand
An Example of Computing Price Elasticities

The Midpoint Formula
Solved Problem 6.1: Calculating the Price
Elasticity of Demand
When Demand Curves Intersect, the Flatter
Curve Is More Elastic
Polar Cases of Perfectly Elastic and Perfectly
Inelastic Demand
Don’t Let This Happen to You Don’t Confuse
Inelastic with Perfectly Inelastic
6.2 The Determinants of the Price Elasticity of Demand
Availability of Close Substitutes
Passage of Time
Luxuries versus Necessities
Definition of the Market
Share of a Good in a Consumer’s Budget
Some Estimated Price Elasticities of Demand
Making the Connection: The Price Elasticity
of Demand for Breakfast Cereal
6.3 The Relationship between Price Elasticity
of Demand and Total Revenue
Elasticity and Revenue with a Linear Demand Curve
Solved Problem 6.3: Price and Revenue Don’t
Always Move in the Same Direction

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Estimating Price Elasticity of Demand
Making the Connection: Determining the Price
Elasticity of Demand through Market Experiments
6.4 Other Demand Elasticities
Cross-Price Elasticity of Demand
Income Elasticity of Demand
Making the Connection: Price Elasticity, Cross-Price
Elasticity, and Income Elasticity in the Market
for Alcoholic Beverages
6.5 Using Elasticity to Analyze the Disappearing
Family Farm
Solved Problem 6.5: Using Price Elasticity
to Analyze a Policy of Taxing Gasoline
6.6 The Price Elasticity of Supply and Its Measurement
Measuring the Price Elasticity of Supply
Determinants of the Price Elasticity of Supply
Making the Connection: Why Are Oil Prices
So Unstable?
Polar Cases of Perfectly Elastic and Perfectly

Inelastic Supply
Using Price Elasticity of Supply to Predict
Changes in Price
Conclusion
An Inside Look: Gasoline Price Increases Change
Consumer Spending Patterns, May Stall Recovery

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Chapter 7: The Economics of Health Care
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Small Businesses Feel the Pinch of Escalating
Health Care Costs
7.1 The Improving Health of People in the
United States
Changes over Time in U.S. Health
The Rise and Fall and Rise of American Heights
Reasons for Long-Run Improvements in
U.S. Health
7.2 Health Care around the World

The U.S. Health Care System
The Health Care Systems of Canada, Japan, and the
United Kingdom
Comparing Health Care Outcomes around the World
7.3 Information Problems and Externalities
in the Market for Health Care
Adverse Selection and the Market for “Lemons”
Asymmetric Information in the Market for Health
Insurance
Don’t Let This Happen to You Don’t Confuse
Adverse Selection with Moral Hazard
Solved Problem 7.3: Dealing with Adverse Selection
Externalities in the Market for Health Care
Making the Connection: Should the Government
Run the Health Care System?
7.4 The Debate over Health Care Policy in the
United States
The Rising Cost of Health Care
Explaining Rapid Increases in Health Care Spending
The Debate over Health Care Policy

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CONTENTS

Making the Connection: How Much Is That
MRI Scan?
Making the Connection: Health Exchanges, Small
Businesses, and Rising Medical Costs
Conclusion
An Inside Look at Policy: Health Care Spending
Expected to Increase 70 Percent by End of Decade

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PART 3: Firms in the Domestic and
International Economies
Chapter 8: Firms, the Stock Market, and
Corporate Governance
How Can You Buy a Piece of Facebook?
8.1 Types of Firms
Who Is Liable? Limited and Unlimited Liability
Corporations Earn the Majority of Revenue and
Profits
Making the Connection: How Important Are Small
Businesses to the U.S. Economy?
8.2 The Structure of Corporations and the
Principal–Agent Problem
Corporate Structure and Corporate Governance
Solved Problem 8.2: Does the Principal–Agent
Problem Apply to the Relationship between
Managers and Employees?
8.3 How Firms Raise Funds
Sources of External Funds
Making the Connection: The Rating Game: Is the
U.S. Treasury Likely to Default on Its Bonds?
Stock and Bond Markets Provide Capital—and
Information
Don’t Let This Happen to You When Google Shares
Change Hands, Google Doesn’t Get the Money
Why Do Stock Prices Fluctuate So Much?
Making the Connection: Following Abercrombie &
Fitch’s Stock Price in the Financial Pages
8.4 Using Financial Statements to Evaluate a

Corporation
The Income Statement
The Balance Sheet
8.5 Corporate Governance Policy and the
Financial Crisis of 2007–2009
The Accounting Scandals of the Early 2000s
The Financial Crisis of 2007–2009
Did Principal–Agent Problems Help Bring on the
Financial Crisis?
Making the Connection: Are Buyers of Facebook
Stock Getting a Fair Deal?
Conclusion
An Inside Look: Shares of Private Companies
Available to Qualified Investors
Appendix: Tools to Analyze Firms’ Financial
Information
Using Present Value to Make Investment Decisions

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Solved Problem 8A.1: How to Receive Your
Contest Winnings
Using Present Value to Calculate Bond Prices
Using Present Value to Calculate Stock Prices
A Simple Formula for Calculating Stock Prices
Going Deeper into Financial Statements
Analyzing Income Statements
Analyzing Balance Sheets

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Chapter 9: Comparative Advantage
and the Gains from International Trade

272

Does the Federal Government’s “Buy American” Policy
Help U.S. Firms?
9.1 The United States in the International Economy
The Importance of Trade to the U.S. Economy
U.S. International Trade in a World Context
Making the Connection: How Caterpillar
Depends on International Trade
9.2 Comparative Advantage in International Trade
A Brief Review of Comparative Advantage
Comparative Advantage in International Trade
9.3 How Countries Gain from International Trade
Increasing Consumption through Trade
Solved Problem 9.3: The Gains from Trade
Why Don’t We See Complete Specialization?
Does Anyone Lose as a Result of International Trade?
Don’t Let This Happen to You Remember
That Trade Creates Both Winners and Losers
Where Does Comparative Advantage Come From?
Making the Connection: Leave New York City?
Risky for Financial Firms

Comparative Advantage over Time: The Rise and Fall—
and Rise—of the U.S. Consumer Electronics Industry
9.4 Government Policies That Restrict
International Trade
Tariffs
Quotas and Voluntary Export Restraints
Measuring the Economic Effect of the Sugar Quota
Solved Problem 9.4: Measuring the Economic
Effect of a Quota
The High Cost of Preserving Jobs with Tariffs
and Quotas
Making the Connection: Save Jobs Making
Hangers . . . and Lose Jobs in Dry Cleaning
Gains from Unilateral Elimination of Tariffs
and Quotas
Other Barriers to Trade
9.5 The Arguments over Trade Policies
and Globalization
Why Do Some People Oppose the World Trade
Organization?
Making the Connection: The Unintended
Consequences of Banning Goods Made
with Child Labor
Dumping
Positive versus Normative Analysis (Once Again)

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CONTENTS

Conclusion
An Inside Look at Policy: Did Home Depot
Knowingly Defy the “Buy American” Policy?

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PART 4: Microeconomic Foundations:
Consumers and Firms
Chapter 10: Consumer Choice and
Behavioral Economics
Can Justin Bieber and Ozzy Osbourne Get You
to Shop at Best Buy?
10.1 Utility and Consumer Decision Making
The Economic Model of Consumer Behavior
in a Nutshell
Utility
The Principle of Diminishing Marginal Utility
The Rule of Equal Marginal Utility per Dollar Spent
Solved Problem 10.1: Finding the Optimal
Level of Consumption
What If the Rule of Equal Marginal Utility per
Dollar Does Not Hold?
Don’t Let This Happen to You Equalize Marginal
Utilities per Dollar
The Income Effect and Substitution Effect of a
Price Change
10.2 Where Demand Curves Come From

Making the Connection: Are There Any
Upward-Sloping Demand Curves in
the Real World?
10.3 Social Influences on Decision Making
The Effects of Celebrity Endorsements
Making the Connection: Why Do Firms Pay Tom
Brady to Endorse Their Products?
Network Externalities
Does Fairness Matter?
Making the Connection: What’s Up with “Fuel
Surcharges”?
10.4 Behavioral Economics: Do People Make
Their Choices Rationally?
Ignoring Nonmonetary Opportunity Costs
Failing to Ignore Sunk Costs
Making the Connection: A Blogger Who
Understands the Importance of Ignoring
Sunk Costs
Being Unrealistic about Future Behavior
Making the Connection: Why Don’t Students
Study More?
Solved Problem 10.4: How Do You Get People
to Save More of Their Income?
Conclusion
An Inside Look: Findings Are Mixed on the
Success of Celebrity Endorsements
Appendix: Using Indifference Curves and
Budget Lines to Understand Consumer Behavior

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Consumer Preferences
Indifference Curves
The Slope of an Indifference Curve
Can Indifference Curves Ever Cross?
The Budget Constraint
Choosing the Optimal Consumption of Pizza
and Coke
Making the Connection: Dell Determines
the Optimal Mix of Products
Deriving the Demand Curve
Solved Problem 10A.1: When Does a Price
Change Make a Consumer Better Off ?
The Income Effect and the Substitution Effect
of a Price Change
How a Change in Income Affects Optimal Consumption
The Slope of the Indifference Curve, the Slope
of the Budget Line, and the Rule of Equal Marginal
Utility per Dollar Spent
The Rule of Equal Marginal Utility per Dollar
Spent Revisited

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Chapter 11: Technology, Production, and Costs

352

Sony Uses a Cost Curve to Determine the Prices
of Radios
11.1 Technology: An Economic Definition
Making the Connection: Improving Inventory
Control at Wal-Mart
11.2 The Short Run and the Long Run in Economics
The Difference between Fixed Costs and Variable
Costs
Making the Connection: Fixed Costs in the
Publishing Industry
Implicit Costs versus Explicit Costs
The Production Function
A First Look at the Relationship between
Production and Cost
11.3 The Marginal Product of Labor and the Average
Product of Labor
The Law of Diminishing Returns
Graphing Production
Making the Connection: Adam Smith’s Famous
Account of the Division of Labor in a Pin Factory
The Relationship between Marginal Product
and Average Product
An Example of Marginal and Average
Values: College Grades
11.4 The Relationship between Short-Run

Production and Short-Run Cost
Marginal Cost
Why Are the Marginal and Average Cost
Curves U Shaped?
Solved Problem 11.4: Calculating Marginal
Cost and Average Cost
11.5 Graphing Cost Curves
11.6 Costs in the Long Run
Economies of Scale

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CONTENTS

Long-Run Average Cost Curves for Bookstores
Solved Problem 11.6: Using Long-Run Average
Cost Curves to Understand Business Strategy
Making the Connection: The Colossal River Rouge:
Diseconomies of Scale at Ford Motor Company
Don’t Let This Happen to You Don’t Confuse
Diminishing Returns with Diseconomies
of Scale
Conclusion
An Inside Look at Policy: New Technology
Could Lower the Cost of Solar Panels
Appendix: Using Isoquants and Isocost Lines to

Understand Production and Cost
Isoquants
An Isoquant Graph
The Slope of an Isoquant
Isocost Lines
Graphing the Isocost Line
The Slope and Position of the Isocost Line
Choosing the Cost-Minimizing Combination
of Capital and Labor
Different Input Price Ratios Lead to Different
Input Choices
Making the Connection: The Changing Input
Mix in Walt Disney Film Animation
Another Look at Cost Minimization
Solved Problem 11A.1: Determining the Optimal
Combination of Inputs
Making the Connection: Do National Football
League Teams Behave Efficiently?
The Expansion Path

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391

PART 5: Market Structure and Firm
Strategy
Chapter 12: Firms in Perfectly Competitive
Markets
Perfect Competition in Farmers’ Markets
12.1 Perfectly Competitive Markets
A Perfectly Competitive Firm Cannot Affect the
Market Price
The Demand Curve for the Output of a Perfectly
Competitive Firm
Don’t Let This Happen to You Don’t Confuse the
Demand Curve for Farmer Parker’s Wheat
with the Market Demand Curve for Wheat
12.2 How a Firm Maximizes Profit in a Perfectly
Competitive Market
Revenue for a Firm in a Perfectly Competitive
Market

Determining the Profit-Maximizing Level of
Output
12.3 Illustrating Profit or Loss on the Cost
Curve Graph

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403

Showing a Profit on the Graph
Solved Problem 12.3: Determining ProfitMaximizing Price and Quantity
Don’t Let This Happen to You Remember That
Firms Maximize Their Total Profit, Not
Their Profit per Unit
Illustrating When a Firm Is Breaking Even
or Operating at a Loss
Making the Connection: Losing Money in the
Medical Screening Industry
12.4 Deciding Whether to Produce or to Shut Down
in the Short Run
Solved Problem 12.4: When to Pull the Plug
on a Movie

The Supply Curve of a Firm in the Short Run
The Market Supply Curve in a Perfectly
Competitive Industry
12.5 “If Everyone Can Do It, You Can’t Make Money
at It”: The Entry and Exit of Firms in the Long Run
Economic Profit and the Entry or Exit Decision
Long-Run Equilibrium in a Perfectly Competitive
Market
The Long-Run Supply Curve in a Perfectly
Competitive Market
Making the Connection: In the Applie iPhone
Apps Store, Easy Entry Makes the Long Run
Pretty Short
Increasing-Cost and Decreasing-Cost Industries
12.6 Perfect Competition and Efficiency
Productive Efficiency
Solved Problem 12.6: How Productive Efficiency
Benefits Consumers
Allocative Efficiency
Conclusion
An Inside Look: Organic Farming on the Decline
in the United Kingdom
Chapter 13: Monopolistic Competition: The
Competitive Model in a More Realistic Setting
Starbucks: The Limits to Growth through Product
Differentiation
13.1 Demand and Marginal Revenue for a Firm in a
Monopolistically Competitive Market
The Demand Curve for a Monopolistically
Competitive Firm

Marginal Revenue for a Firm with a DownwardSloping Demand Curve
13.2 How a Monopolistically Competitive Firm
Maximizes Profit in the Short Run
Solved Problem 13.2: Does Minimizing Cost
Maximize Profits?
13.3 What Happens to Profits in the Long Run?
How Does the Entry of New Firms Affect the
Profits of Existing Firms?
Don’t Let This Happen to You Don’t Confuse Zero
Economic Profit with Zero Accounting Profit

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CONTENTS

Making the Connection: The Rise and Decline
and Rise of Starbucks
Is Zero Economic Profit Inevitable in the Long Run?
Solved Problem 13.3: Can It Be Profitable to Be the
High-Price Seller?
13.4 Comparing Monopolistic Competition and
Perfect Competition
Excess Capacity under Monopolistic Competition
Is Monopolistic Competition Inefficient?
How Consumers Benefit from Monopolistic Competition
Making the Connection: Netflix: Differentiated
Enough to Survive?

13.5 How Marketing Differentiates Products
Brand Management
Advertising
Defending a Brand Name
13.6 What Makes a Firm Successful?
Making the Connection: Is Being the First Firm
in the Market a Key to Success?
Conclusion
An Inside Look: Starbucks Expands Into Juice
Business
Chapter 14: Oligopoly: Firms in Less
Competitive Markets
Competition in the Computer Market
14.1 Oligopoly and Barriers to Entry
Barriers to Entry
14.2 Using Game Theory to Analyze Oligopoly
A Duopoly Game: Price Competition between
Two Firms
Firm Behavior and the Prisoner’s Dilemma
Don’t Let This Happen to You Don’t Misunderstand
Why Each Firm Ends Up Charging a
Price of $1,000
Solved Problem 14.2: Is Advertising a Prisoner’s
Dilemma for Coca-Cola and Pepsi?
Making the Connection: Is There a Dominant
Strategy for Bidding on eBay?
Can Firms Escape the Prisoner’s Dilemma?
Making the Connection: With Price Collusion,
More Is Not Merrier
Cartels: The Case of OPEC

14.3 Sequential Games and Business Strategy
Deterring Entry
Solved Problem 14.3: Is Deterring Entry Always
a Good Idea?
Bargaining
14.5 The Five Competitive Forces Model
Competition from Existing Firms
The Threat from Potential Entrants
Competition from Substitute Goods or Services
The Bargaining Power of Buyers
The Bargaining Power of Suppliers
Making the Connection: Can We Predict
Which Firms Will Continue to Be Successful?

xv

Conclusion
An Inside Look: Can Intel’s “Ultrabook”
Compete with MacBook Air?

477

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441
441

Chapter 15: Monopoly and Antitrust Policy

486


Is Cable Television a Monopoly?
15.1 Is Any Firm Ever Really a Monopoly?
Making the Connection: Is Google a Monopoly?
15.2 Where Do Monopolies Come From?
Government Action Blocks Entry
Making the Connection: The End of the
Christmas Plant Monopoly
Control of a Key Resource
Making the Connection: Are Diamond Profits
Forever? The De Beers Diamond Monopoly
Network Externalities
Natural Monopoly
Solved Problem 15.2: Is the OpenTable
Web Site a Natural Monopoly?
15.3 How Does a Monopoly Choose Price
and Output?
Marginal Revenue Once Again
Profit Maximization for a Monopolist
Solved Problem 15.3: Finding the Profit-Maximizing
Price and Output for a Monopolist
Don’t Let This Happen to You Don’t Assume
That Charging a Higher Price Is Always More
Profitable for a Monopolist
15.4 Does Monopoly Reduce Economic Efficiency?
Comparing Monopoly and Perfect Competition
Measuring the Efficiency Losses from Monopoly
How Large Are the Efficiency Losses Due to
Monopoly?
Market Power and Technological Change
15.5 Government Policy toward Monopoly

Antitrust Laws and Antitrust Enforcement
Mergers: The Trade-off between Market Power
and Efficiency
The Department of Justice and FTC Merger
Guidelines
Making the Connection: Should AT&T Have Been
Allowed to Merge with T-Mobile?
Regulating Natural Monopolies
Conclusion
An Inside Look at Policy: The End of the
Cable TV Monopoly?

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488
489
490

Chapter 16: Pricing Strategy

518

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Getting into Walt Disney World: One Price Does
Not Fit All
16.1 Pricing Strategy, the Law of One Price, and
Arbitrage
Arbitrage
Solved Problem 16.1: Is Arbitrage Just a Rip-off ?
Why Don’t All Firms Charge the Same Price?

478

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xvi

CONTENTS

16.2 Price Discrimination: Charging Different
Prices for the Same Product
Don’t Let This Happen to You Don’t Confuse
Price Discrimination with Other Types of
Discrimination
The Requirements for Successful Price
Discrimination
Solved Problem 16.2: How Apple Uses Price
Discrimination to Increase Profits
Airlines: The Kings of Price Discrimination
Making the Connection: How Colleges Use Yield

Management
Perfect Price Discrimination
Price Discrimination across Time
Can Price Discrimination Be Illegal?
Making the Connection: Price Discrimination
with a Twist at Netflix
16.3 Other Pricing Strategies
Odd Pricing: Why Is the Price $2.99 Instead of $3.00?
Why Do Some Firms Use Cost-Plus Pricing?
Making the Connection: Cost-Plus Pricing in the
Publishing Industry
Why Do Some Firms Use Two-Part Tariffs?
Conclusion
An Inside Look: Paying for the Right to Pay to
See the Kansas Jayhawks Play Football

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530
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531
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532
534
537
538

PART 6: Labor Markets, Public Choice,
and the Distribution of Income
Chapter 17: The Markets for Labor
and Other Factors of Production
Why Did the San Diego Padres Trade Their
Best Player to the Boston Red Sox?
17.1 The Demand for Labor
The Marginal Revenue Product of Labor
Solved Problem 17.1: Hiring Decisions by a Firm
That Is a Price Maker
The Market Demand Curve for Labor
Factors That Shift the Market Demand Curve
for Labor
17.2 The Supply of Labor
The Market Supply Curve of Labor
Factors That Shift the Market Supply Curve
of Labor
17.3 Equilibrium in the Labor Market
The Effect on Equilibrium Wages of a Shift in
Labor Demand
Making the Connection: Will Your Future Income
Depend on Which Courses You Take in College?
The Effect on Equilibrium Wages of a Shift
in Labor Supply
17.4 Explaining Differences in Wages

Don’t Let This Happen to You Remember That
Prices and Wages Are Determined at the Margin

Making the Connection: Technology and the
Earnings of “Superstars”
Compensating Differentials
Making the Connection: Are U.S. Firms
Handicapped by Paying for Their Employees’
Health Insurance?
Discrimination
Solved Problem 17.4: Is Passing “Comparable
Worth” Legislation a Good Way to Close
the Gap between Men’s and Women’s Pay?
Making the Connection: Does Greg Have
an Easier Time Finding a Job Than Jamal?
Labor Unions
17.5 Personnel Economics
Should Workers’ Pay Depend on How Much
They Work or on How Much They Produce?
Making the Connection: Raising Pay,
Productivity, and Profits at Safelite AutoGlass
Other Considerations in Setting Compensation
Systems
17.6 The Markets for Capital and Natural Resources
The Market for Capital
The Market for Natural Resources
Monopsony
The Marginal Productivity Theory of Income
Distribution
Conclusion

An Inside Look: Basketball Coaches’ Salaries:
A March to Madness?
Chapter 18: Public Choice, Taxes, and the
Distribution of Income

544
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549
550
551
552
552
553
554
555
556
556

Should the Government Use the Tax System to
Reduce Inequality?
18.1 Public Choice
How Do We Know the Public Interest? Models
of Voting
Government Failure?
Is Government Regulation Necessary?
18.2 The Tax System

An Overview of the U.S. Tax System
Progressive and Regressive Taxes
Making the Connection: Which Groups Pay the
Most in Federal Taxes?
Marginal and Average Income Tax Rates
The Corporate Income Tax
International Comparison of Corporate Income
Taxes
Evaluating Taxes
Making the Connection: Should the United States
Shift from an Income Tax to a Consumption Tax?
18.3 Tax Incidence Revisited: The Effect
of Price Elasticity
Don’t Let This Happen to You Remember Not to
Confuse Who Pays a Tax with Who Bears the
Burden of the Tax

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CONTENTS

Making the Connection: Do Corporations

Really Bear the Burden of the Federal
Corporate Income Tax?
Solved Problem 18.3: The Effect of Price
Elasticity on the Excess Burden of a Tax
18.4 Income Distribution and Poverty
Measuring the Income Distribution and Poverty
Explaining Income Inequality
Showing the Income Distribution with a Lorenz
Curve
Problems in Measuring Poverty and the
Distribution of Income
Solved Problem 18.4: Are Many Individuals
Stuck in Poverty?

595
596
597
597
598
600
601
602

xvii

Income Distribution and Poverty around the World
Conclusion
An Inside Look at Policy: Should a Tax on Soda
Be Used to Reduce Budget Deficits?


603
605

Glossary

G-1

606

Company Index

I-1

Subject Index

I-3

Credits

C-1


FLEXIBILITY
CHART

The following chart helps you organize your syllabus based on your teaching preferences and
objectives:

Core
Chapter 1: Economics: Foundations and

Models

Optional

Policy

Chapter 1 Appendix: Using Graphs
and Formulas

Chapter 2: Trade-offs, Comparative
Advantage, and the Market System
Chapter 3: Where Prices Come From: The
Interaction of Demand and Supply
Chapter 4 Appendix: Quantitative
Demand and Supply Analysis

Chapter 4: Economic Efficiency,
Government Price Setting, and
Taxes
Chapter 5: Externalities,
Environmental Policy, and Public
Goods

Chapter 6: Elasticity: The Responsiveness
of Demand and Supply
Chapter 7: The Economics of
Health Care
Chapter 8: Firms, the Stock Market,
and Corporate Governance
Chapter 8 Appendix: Tools to

Analyze Firms’ Financial Information
Chapter 9: Comparative Advantage and
the Gains from International Trade
Chapter 10: Consumer Choice and
Behavioral Economics

Chapter 11: Technology, Production, and
Costs
Chapter 12: Firms in Perfectly
Competitive Markets

xviii

Chapter 10 Appendix: Using
Indifference Curves and Budget
Lines to Understand Consumer
Behavior
Chapter 11 Appendix: Using
Isoquants and Isocost Lines to
Understand Production and Cost


Core

Optional

Policy

Chapter 13: Monopolistic Competition:
The Competitive Model in a More

Realistic Setting
Chapter 14: Oligopoly: Firms in Less
Competitive Markets
Chapter 15: Monopoly and Antitrust
Policy
Chapter 16: Pricing Strategy
Chapter 17: The Markets for Labor and
Other Factors of Production
Chapter 18: Public Choice, Taxes,
and the Distribution of Income

xix


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PREFACE
When George Lucas was asked why he made Star Wars, he replied, “It’s the kind of movie
I like to see, but no one seemed to be making them. So, I decided to make one.” We realized
that no one seemed to be writing the kind of textbook we wanted to use in our classes. So,
after years of supplementing texts with fresh, lively, real-world examples from newspapers,
magazines, Web sites, and professional journals, we decided to write an economics text that
delivers complete economics coverage with many real-world business examples. Our goal
was to keep our classes “widget free.”

New to the Fourth Edition
The severe economic downturn that began in 2007 with the bursting of the housing bubble
was still affecting the economy in 2011. Unemployment had risen to levels not seen in decades and remained above 9 percent for more than two and a half years. The crisis in the
financial system was the worst since the Great Depression of the 1930s. Policy debates intensified as Congress passed and President Barack Obama enacted the American Recovery and

Reinvestment Act of 2009, the largest package of spending increases and tax cuts in history.
The Federal Reserve sailed into uncharted waters as it developed new policy tools to deal
with the unprecedented financial turmoil. Other long-running policy debates continued
as well, as comprehensive health care legislation, looming cost increases for Social Security
and Medicare, huge long-run budget deficits, environmental problems, income inequality,
and changes to the tax system all received attention from economists, policymakers, and the
public.
In this new edition, we help students understand recent economic events and the policy
responses to them. As in the earlier editions, we place applications at the forefront of the
discussion. We believe that students find the study of economics more interesting and easier
to master when they see economic analysis applied to real-world issues that concern them.
Here is a summary of the changes in this fourth edition. Please see the next section,
starting on the next page, for details on each of these changes:
• A new Chapter 7, “The Economics of Health Care,” covers health care around the world,
information problems and externalities in the market for health care, and the debate
over President Obama’s Patient Protection and Affordable Care Act.
• There is new coverage of the slow recovery from the recession and financial crisis of
2007–2009.
• There is new coverage of initiatives by the Federal Reserve, including quantitative easing and Operation Twist.
• There is new coverage of fiscal policy, including analysis of the debate over fiscal stimulus and the magnitude of multipliers for government spending and taxes.
• All companies in the chapter openers have been either replaced with new companies or
updated with current information.
• All chapters include new An Inside Look newspaper articles and analyses to help students apply economic thinking to current events and policy debates.
• There are 21 new Making the Connection features to help students tie economic concepts to current events and policy issues.
• Figures and tables have been updated, using the latest data available.
• Many of the end-of-chapter problems have been either replaced or updated.
In this new edition, we have taken the opportunity to make many changes throughout
the text, while concentrating on the key areas described in the following sections.
xxi



xxii

PREFACE

Policy debates, including health care, trade, and pollution. The number of jobs in the
health care sector continues to increase. In Chapter 1, “Economics: Foundations and Models,” we use the debate about whether public policy is resulting in physicians leaving private practice to introduce students to positive and normative economic analysis. In Chapter
9, “Comparative Advantage and the Gains from International Trade,” we explore the “Buy
American” provision in the 2009 stimulus package.
As this book goes to press, the debate continues over the consequences of the 2010
overhaul of the U.S. health care system. In Chapter 2, “Trade-offs, Comparative Advantage, and the Market System,” we discuss the trade-offs involved in health care spending
and the Medicare and Medicaid programs. We revisit the topic of health care in the new
Chapter 7, “The Economics of Health Care,” where we discuss projections of health care
spending and the role of the U.S. government in the health care system. In Chapter 17,
“The Markets for Labor and Other Factors of Production,” we discuss whether U.S. firms
are handicapped in competing with foreign firms by paying for their employees’ health
insurance. We return to the health care topic in Chapter 18, “Public Choice, Taxes, and
the Distribution of Income,” with a news article and analysis on a proposed soda tax to
pay for health care.
The United States has made progress in reducing air pollution in the years since Congress passed the Clean Air Act in 1970. In Chapter 5, “Externalities, Environmental Policy,
and Public Goods,” we use the economic concepts of marginal cost, marginal benefit, and
efficiency to discuss environmental policy, including President Barack Obama’s proposed
cap-and-trade policy to reduce emissions of carbon dioxide.
The recession and financial crisis of 2007–2009 and its aftermath. Today’s students feel
the effects of the slow recovery from the worst economic crisis since the Great Depression
of the 1930s. The problems in the financial system in the United States and the euro zone
have proven that it is important for students in both microeconomics and macroeconomics courses to understand the basics of how financial markets work and the role of government in financial regulation. In Chapter 8, “Firms, the Stock Market, and Corporate
Governance,” we cover the basics of the stock and bond markets, discuss why stock prices
fluctuate, and examine the role of the principal–agent problem in the financial meltdown
of 2007–2009.

New initiatives by the Federal Reserve. During 2008, the Fed dramatically broke with precedent by setting up a number of new “lending facilities” and by participating in actions such
as the purchase of Bear Stearns by JPMorgan Chase. In this new edition, we provide students
with a basic background on investment banks and the process of securitization; the mortgage-backed securities market, including the roles of Fannie Mae and Freddie Mac.
Real-world company examples and newspaper articles. As in previous editions, we open
each chapter by highlighting a company to establish a real-world context for learning and
to spark students’ interest in economics. We have chosen new companies for some chapters
and updated the information in the other chapters. As in previous editions, each chapter
closes with the An Inside Look feature, which shows students how to apply the concepts from
the chapter to the analysis of a news article. We have replaced all the An Inside Look features
in this edition. Here is a snapshot of some of these changes:
Chapter 3, “Where Prices Come From: The Interaction of Demand and Supply,”
opens with a discussion of the iPad and the tablet reader revolution. The An Inside
Look feature presents an article and analysis of how a shortage of display screens
could affect the sale of tablet readers.
Chapter 7, “The Economics of Health Care,” opens with a discussion of the rising
health care costs for small businesses. The An Inside Look feature presents an article
and analysis of health care spending and the Patient Protection and Affordable Care
Act of 2010.


P R E FAC E

Chapter 8, “Firms, the Stock Market, and Corporate Governance,” opens with a discussion of the runaway success of the private company Facebook and how some of
the company’s stock is available for sale in private markets. An Inside Look features
Internet companies that allow qualified investors a chance to buy stock in private
companies.
Chapter 10, “Consumer Choice and Behavioral Economics,” opens with a discussion
of how aging rock star Ozzy Osbourne and teenage singing sensation Justin Bieber
endorsed Best Buy’s new electronics program. The An Inside Look feature presents
an article and analysis of how endorsements from celebrities ranging from Jennifer

Lopez to Charlie Sheen can help or hurt a brand.

Further changes to the fourth edition
The following are further changes to the fourth edition:
• This edition provides many new Making the Connection features, which help students
tie economic concepts to current events and policy issues, as well as updated sections,
figures, and tables:
Chapter 1 opens with a new discussion of doctors in private practice and includes
two new Making the Connections, “Does Health Insurance Give People an Incentive
to Become Obese?” and “Should Medical School Be Free?”
Chapter 2 includes a new Making the Connection, “A Story of the Market System in
Action: How Do You Make an iPad?”
Chapter 3 opens with discussion of the tablet computer industry and includes three
new Making the Connections: “The Aging of the Baby Boom Generation,” “Forecasting the Demand for iPads,” and “Are Quiznos Sandwiches Normal Goods and Subway Sandwiches Inferior Goods?”
Chapter 5 includes revised graphs of the economic effects of government taxes and
subsidies to improve student understanding of this sometimes difficult subject,
and two new Making the Connections: “Should the Government Tax Cigarettes and
Soda?” and “Can a Cap-and-Trade System Reduce Global Warming?”
Chapter 7 is new to this edition and covers health care around the world; information problems and externalities in the market for health care; and the Patient Protection and Affordable Care Act in the United States. The chapter contains Making the
Connections titled “How Much Is That MRI Scan?” and “Health Exchanges, Small
Businesses, and Rising Medical Costs.”
Chapter 8 has a new section on the financial crisis of 2007–2009 and two new Making the Connections: “The Rating Game: Is the U.S. Treasury Likely to Default on Its
Bonds?” and “Are Buyers of Facebook Stock Getting a Fair Deal?”
Chapter 9 includes two new Making the Connections: “Leave New York City? Risky
for Financial Firms” and “Save Jobs Making Hangers . . . and Lose Jobs in Dry
Cleaning.”
Chapter 10 opens with a new discussion of Justin Bieber and Ozzy Osbourne and includes two new Making the Connections: “Why Do Firms Pay Tom Brady to Endorse
Their Products?” and “What’s Up with ‘Fuel Surcharges’?”
Chapter 11 includes a new Solved Problem, “Using Long-Run Average Cost Curves to
Understand Business Strategy.”

Chapter 12 includes a new Solved Problem, “When to Pull the Plug on a Movie.”
Chapter 15 has a new Making the Connection: “Should AT&T Have Been Allowed to
Merge with T-Mobile?”

xxiii


xxiv

PREFACE

Chapter 17 opens with a new discussion of the San Diego Padres trading Adrian
Gonzalez to the Red Sox and includes a new Making the Connection: “Does Greg
Have an Easier Time Finding a Job Than Jamal?”
• Figures and tables have been updated using the latest data available.
• Many of the end-of-chapter problems have been either replaced or updated.
• Finally, we have gone over the text literally line-by-line, tightening the discussion, rewriting unclear points, and making many other small changes. We are grateful to the
many instructors and students who made suggestions for improvements in the previous edition. We have done our best to incorporate as many of those suggestions as
possible.

The Foundation:
Contextual Learning and Modern Organization
We believe a course is a success if students can apply what they have learned in both personal and business settings and if they have developed the analytical skills to understand
what they read in the media. That’s why we explain economic concepts by using many realworld business examples and applications in the chapter openers, graphs, Making the Connection features, An Inside Look features, and end-of-chapter problems. This approach helps
both business majors and liberal arts majors become educated consumers, voters, and citizens. In addition to our widget-free approach, we also have a modern organization and place
interesting policy topics early in the book to pique student interest.
We are convinced that students learn to apply economic principles best if they are taught
in a familiar context. Whether they open an art studio, do social work, trade on Wall Street,
work for the government, or tend bar, students benefit from understanding the economic
forces behind their work. And though business students will have many opportunities to see

economic principles in action in various courses, liberal arts students may not. We therefore
use many diverse real-world business and policy examples to illustrate economic concepts
and to develop educated consumers, voters, and citizens.
• A strong set of introductory chapters. The introductory chapters provide students
with a solid foundation in the basics. We emphasize the key ideas of marginal analysis
and economic efficiency. In Chapter 4, “Economic Efficiency, Government Price Setting, and Taxes,” we use the concepts of consumer surplus and producer surplus to measure the economic effects of price ceilings and price floors as they relate to the familiar
examples of rental properties and the minimum wage. (We revisit consumer surplus
and producer surplus in Chapter 9, “Comparative Advantage and the Gains from International Trade,” where we discuss outsourcing and analyze government policies that
affect trade; in Chapter 15, “Monopoly and Antitrust Policy,” where we examine the
effect of market power on economic efficiency; and in Chapter 16, “Pricing Strategy,”
where we examine the effect of firm pricing policy on economic efficiency.) In Chapter
8, “Firms, the Stock Market, and Corporate Governance,” we provide students with a
basic understanding of how firms are organized, how they raise funds, and how they
provide information to investors. We also illustrate how in a market system entrepreneurs meet consumer wants and efficiently organize production.
• Early coverage of policy issues. To expose students to policy issues early in the course,
we discuss immigration in Chapter 1, “Economics: Foundations and Models”; rent control and the minimum wage in Chapter 4, “Economic Efficiency, Government Price Setting, and Taxes”; air pollution, global warming, and whether the government should
run the health care system in Chapter 5, “Externalities, Environmental Policy, and


P R E FAC E

Public Goods”; government policy toward illegal drugs in Chapter 6, “Elasticity: The
Responsiveness of Demand and Supply”; and health care policy in Chapter 7, “The Economics of Health Care.”
• Complete coverage of monopolistic competition. We devote a full chapter, Chapter
13, “Monopolistic Competition: The Competitive Model in a More Realistic Setting,”
to monopolistic competition prior to covering oligopoly and monopoly in Chapter 14,
“Oligopoly: Firms in Less Competitive Markets,” and Chapter 15, “Monopoly and Antitrust Policy.” Although many instructors cover monopolistic competition very briefly or
dispense with it entirely, we think it is an overlooked tool for reinforcing the basic message of how markets work in a context that is much more familiar to students than are
the agricultural examples that dominate other discussions of perfect competition. We
use the monopolistic competition model to introduce the downward-sloping demand

curve material usually introduced in a monopoly chapter. This helps students grasp the
important point that nearly all firms—not just monopolies—face downward-sloping
demand curves. Covering monopolistic competition directly after perfect competition
also allows for the early discussion of topics such as brand management and sources of
competitive success. Nevertheless, we wrote the chapter so that instructors who prefer
to cover monopoly (Chapter 15, “Monopoly and Antitrust Policy”) directly after perfect
competition (Chapter 12, “Firms in Perfectly Competitive Markets”) can do so without
loss of continuity.
• Extensive, realistic game theory coverage. In Chapter 14, “Oligopoly: Firms in Less
Competitive Markets,” we use game theory to analyze competition among oligopolists.
Game theory helps students understand how companies with market power make strategic decisions in many competitive situations. We use familiar companies such as Apple, Hewlett-Packard, Coca-Cola, PepsiCo, and Dell in our game theory applications.

•

Unique coverage of pricing strategy. In Chapter 16, “Pricing Strategy,” we explore how
firms use pricing strategies to increase profits. Students encounter pricing strategies everywhere—when they buy a movie ticket, book a flight for spring break, or research
book prices online. We use these relevant, familiar examples to illustrate how companies use strategies such as price discrimination, cost-plus pricing, and two-part tariffs.

Special Features:
A Real-World, Hands-on Approach
to Learning Economics
Business Cases and An Inside Look News Articles
Each chapter-opening case provides a real-world context for learning, sparks students’ interest in economics, and helps to unify the chapter. The case describes an actual company
facing a real situation. The company is integrated in the narrative, graphs, and pedagogical
features of the chapter. Many of the chapter openers focus on the role of entrepreneurs in developing new products and bringing them to the market. For example, Chapter 3 covers Bill
Gates of Microsoft and Steve Jobs of Apple, Chapter 8 covers Mark Zuckerberg of Facebook,
and Chapter 13 covers Howard Schultz of Starbucks. Here are a few examples of companies
we explore in the chapter openers in this new edition:
• Apple (Chapter 3, “Where Prices Come From: The Interaction of Demand and Supply”)
• Facebook (Chapter 8, “Firms, the Stock Market, and Corporate Governance”)

• Starbucks (Chapter 13, “Monopolistic Competition”)

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