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    Microeconomics Theory and Applications With Calculus

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    Microeconomics Theory and Applications With Calculus

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    Microeconomics Theory and Applications With Calculus

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    Liyun Anthony Yao

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    Ths 6 ey ica. with Caleslus The Addison-Wesley Series in Economics ‘beBeraake/Croushore Macrame Dade/Parkin "indaton of Econo Bierman/Feenander ‘Game Theory with Bonomi ‘fepkestont Bingsofinan Fcetonom ith Coles Boyer niles of Tamportaton Bono facrocoomic Theory and Ply Bruce Tibi Finance and the Arercna Enemy Byrassine "Boones Carton! Peto ‘Modern ndril Organon Caves/FankeJones Trl Bade nd Byrn Aivoducion Chapman ‘Boonmental Eero Thea Appin a Pay conten Taw ont Economies owns ta Econ Theory of Democracy hsenber/Seoith Mole abo onomis Biclund/Resler/Tlison ‘Bonomi Fostta "The ie ofthe Eze Geber inretionn conor hin earns Bonomi Gordon Mcrocoories Grego ‘Brent of Bonomi Gregory/Stuaet ‘Rson and Soviet conomic Peformance and Stactare Harewih/Ohevils The ono of Nature Reoure Ue HofGnan/Averet ‘Woman rd the zonomy: ami Work, ae Pla Hott Perit Markets, Games ane Staeyic Behavior Miroeanomi Theory and oid Appiation ith Clos ‘Mona, the Financial Stem, Perman/Commen/McGivrays ‘and the conamy "Natural Recurces and Etonmertal pits Beonomics ‘Arneson Econom History Phelps ‘Health Ezonoies Hosteutm nematonal owns gd cet tan! ner Fee Reny SSNS tor City ‘Med Mirocnonie Thy evo Tf Johason-Lans i Ritterstber Lidell ‘A Wealth Economics Ermer Principles of Maney, Banking, Kein telah Sth “items Meds aa ‘for Economies Introduction to Economic Reasoning Kougmanrobau eee nice al Ce ns waiter iat “he bend for Mey eae Leeds linen oul ee Sons ae Leeson AlmenSchining ly Sac Sige, Economics cand Public Policy ue LipseytaganStre Seman conn "Market Regulation Maia stedavatson ‘tao Mony an Finance suntan Bonames Mee Sick Watson roe Toy Tien oeomersBisf Miles Ethion itera Modea Enos Stadeomund ee ay oma Ti Bei of Mac at Teteaberg Ensonmenta ad Natural Mile/Renjamin/North Remune Sonam, The Economics of Plc Bsnes Tictenberg aly Hanaiton ‘ronmental Economies ‘Urkan Ezonamie ‘and Peleg Mish ene ‘Todaro/Smith "Theonomies of Money, Banking ane and Pancal Marke?” pooner Pee ranite ula "boven f Economies of Money, Banking. nd Binal Maer Viskdman/ Jensen ‘Alternate Paton” Industrial Orgnizaion heey ‘Theory ond Practice "BeonbmitrissA Moder Introduction Weil abe ‘Economic Growth "Ronan Witiarason "Maereconomics Log onto werwmyeconlah.com te earn more Theory & Applications with C Gules Je effre ey ML. Perloff University of California, Berkeley For Lisa Publisher Greg Tobin Eorin-Chief Dents Clinton Senior Aquisions Editor Allene D'Ambrosio evelopment Editor Sy Mallory ‘Assan Pato Margaret Beste Managing itor Nancy Fenton Senior Production Supervisor Meredith Gertz ‘Cover Degner__Reglna Hagen Kolenda Supplements Editor Weather McNally Serie Media Prodyee Bethany Seige Maetng Manager Roxonne Hoch Marketing Asian! Ase Clevenger Sexi Prepees Superior Crone Fel Senige Manufactering Buyer Carol Mebvile Production Cnordinaton, CComposion, and iltsrations Elm Street Publishing Serves. tn. ‘Covecimage © Wik Kouls/ Getty mages ‘Copyright ©2008 by Pearson Edson, ne. Al ght sexerved. No ato tht polation may be epeodced red ns real temo tated nay form o by ny Ben, con, mechan photocopying recording or othervn, without the prior writen pecrision of the pubibher, Pinte in {he United Sate of Ameria Foe information an obtaining persion fr are of materi In thin work plea ub weien request Pearion Edacaton In, Rigs and Contracts Department 30 Boylston Sree, Suite 90, oxo, MA 02116 fax your equi to 617-671 3447, of eal tpyivis.pearsonedcomiealperisions i, 1S0N-13-978-0321-40898-1 ISAN-I0- 0921-46858 jou purchased hs book witha the United Ststes oF Canada oushoul beawate that hasbeen wrong pected without the appeval ofthe Publisher o the Author 23456789 10-DOW-A1 10 09 08 07 Prefuce 2 ‘CHAPTER 1 Introduction 1 Cuarter2 —SupplyandDenand 10 CHAPTERS A Consumer's Constrained Choice 60 Cuarter4 Demand 98 Cuarter 5S — Consumer Welfareand Policy Analysis 130 CHAPIER 6 Firmsand Production 168, CHAPTER 7 Costs 201 ‘CHAPTER B Competitive Firmsand Markets 242 ‘CHAPTER 9 Properties and Applications ‘of the Competitive Model 245, ‘ChAPTER 10 General Equilibrium and Economie Welfare 325 ‘CHAPTER 11 Monopoly 360, CHAPTER 12 Pricingand Advertising, 402 CHAPTER 13 Oligapolyand Monopeliste Competition 43 CHAPTER 14 Game'Theory 491 CHAPTER 15 Factor Markets 526 ‘CHAPTER 16 Uncertainty 567 ‘ChaPteR 17 Externalities, Open Access, and PublicGeods 599 CHAPTER 18 Asymmetric Information 634 ‘CHAPTER 19 Contractsand Moral Hazards st Calculus Appendix C1 Answers A Definitions Dt References el Sources $1 Credits ct Indes 1 Preface x EIS introduction 1 LL Microeconomics: The Allocation ‘of Scarce Resources. 1 TeadeOte 2 ‘Who Makes the Decisions 2 APPLICATION Addressing a Flu Vaccine Shortage 2 How Pies Deermine Alleaons. 3 APPLICATION ‘TwinkieTax 3 12 Models 4 ‘ApruicxTiOn lncore Threshold Model and China & Simplifications by Asumton 4 “Ting Theos 5 Macinisiag subject Conseinns 6 Pestive Verus Normative 6 13. Usesof Microeconomic Models & Summary 9 (EEE Supply and Demand 10 21 Demand 11 ‘The Demand Funeon 12 APPLICATION Sideways Wine 16 Surning Deenand Functions 17 ‘ArPucarion Aggregating the Demand TorBroadband Service 17 22° Supply is ‘TheSupply Functon 18 Summing Supply Functions 20 face of Government impor Policet ‘on Suppiycures 21 23, Market Equilibrium Fading the Market Equllbriuee 22 Forces That Deve the Market to Equilibrium 23 24 Shocking the Equillbrium: Comparative Statics 24 CCompscatve Static with Dict “sloivly Lage) Changes 24 Comparative Statics with Small Changes 26 ‘SOLVED PROBLEM 2327 ow Shape of Demand and Supply Caves Mater 28 25 Hlasticties 29 Demand Hassty 30 APPLICATION Wilingness to Surf 30 ‘SOLVED PROBLEM 2233 APPLICATION Substitution May Save Endangered Species 33 Supply Bastary 36 Loag Run Vers Short Run 37 ‘APPLICATION OI Dililagin the Arte National Wii Refuge, 38 Sowven rRoBiem a3 29 2.6 Blfects of Sales Tax 4 ‘TwohpesofSaes Taxes 4 Equlibrim Beets of Specie Tax 41 ie Speiie Tax ifs Depend on Hastites 42 “he Sane Egat No Matt: Who Ine 46 ‘The Sine Eect of Ad Vb and Specific Tes 45 27 Quantity Supplied Necd Not qual Quantity Demanded 46 Price Ceiting 45 APPLICATION Zimbabwe rice Controls 48 Price Foor 49 28° WhentoUsethe Supply-and-Demand Model 50 Summary $1 Questions 32 Problems 51 Appendix2 s7 Estimating canon Relations. 37 Confidence ia Qur Eximster 58 ‘altpleRegression 9 (EEIAETE 4 consumer's Constrained Choice «0 BA Preferences 61 Properties of Consumes Fetences 2 Peeetence Maps 63 Inference Cures 65 SOLVED PROALEM 3+ 6 32 Utlty Usiity Fonction 67 inal Preferences 6t Uiity and indienne Cues 68 ‘Wilingns to Subsite Beaween Goods 69 SOLVED PRoaLEM32 70 APPLICATION MRS Between MuslcCDs ‘and Movie OVDs 77 Curvature of idieence Curves 71 APPLICATION iadifoance Curves Between Food and Clthlag 73, 33° Budget Constraint 74 34 Constrained Consumer Choice 76 The Consumer's Optima! Bundle 76 SOLVED PROBLEN'33 75 Contents SOLVED PROBLEM 3.4 84 SOLVED PROBLEM 35 85 [APPLICATIOW Utlty Manimzation Fr Music CDs ‘and Move DVDs) ts simising Espendtce 87 SOLVED PROBLEM 3.6 88 Summary 99 Questions 39 Problems 91 EAE! demand 93 a2 43 44 Deriving Demand Curves. 94 ‘Sytem of Demand Equations 4 Gaphial interpretation 94 APPLICATION Going Upin Smoke $7 Effects of an Increase in Income 98 Howe Income Changes Shik Demand Corie 98 SOLVED PROBLEM 4s 100 ‘Consumer Theory and income Hasiciles 101 APPUCATION What te with Extra Income 105 SOLVED PRORLEM 42 107 Bffets ofa Price nerease 107 Income snd Sbetntion fects witha Noms Good. Tacomse and Sb Elects wth a Inferior Good Compensated Demand Carve 11 SoLveo PROBLEM 43 113, Slthy Equdon 114 SOLVEDPROBLEM A 115 [APPLICATION Shipping the Good Stuff Away 116 Costof-Living Adjustment 116 Indason Indes 117 tke of lion Adjntments 119 SOLVED PROBLEM 4.5 121 [APPLICATION fining the CPI Substitution Blas 123 Revealed Preferences 124 Recovering Praerences 24 Subeston fe 125 Summary 125 ‘Questions 127 Problems 128 ene sa Consumer Welfare ‘and Policy Analysis 130 Consumer Welfare 150 Messing Consuier Wlfre 131 APPLICATION Willingness to Pay on eBay 122 Efsct of «Price Change on Consomer Sorplns 134 SOLVED PROBLEMS 134 APPLICATION Bruce Springsteen's Gift to Hs Fans 108 no as 52. Expenditure Function and Consumer Welfare 136 Indiflernce Cue Arps 137 APPLICATION Compensating Varlton forTelevsion 138 Camping he These elie Measces 189 5.3 Market Consumer Surplus 14t oss oF Maat Contamer Sapa fom ‘Higher Paice 1d Marts in Which Consume Supls Loses Are Large 2 SOWVEDPROBLEM $2 144 54 Bffects of Government Policies ‘on Consumer Welfare 145, vous 4s Food Sarge 146 APPUCHTION FoodStampe 148 55 DerivingLabor Supply Curves 152 aborts Chace 152 SOLVED PROBLEM S3 135, Income and Substitution Bets 155, OWED PROBLEM 3.4157 APPLICATION teisutencome Choles offexle Workers 138 Shape of de Labor Supply Cave 159 [RDPLICATION Wieningthe Good tte 160 Incoene Tax Rteand Tabor Sepply 160 APPLICATION TaxRevenues end TexCuts 63 Summary 16t Questions 164 Problems 166 ESTER Firms and production ve 61 ‘The Ownership and Manegement of Fiems 162 “The Ovnedhip of Firms 169 ‘TheManagenentof Fras 170 VinatOnmers Want 171 62° Production 171 Production Functions 172 ‘Tmeand the Vaabity of apts 72 63. Short-Run Production: One Variable ‘and One Fixed Input 173 SOLVED PROBLEM G3. 174 Inerpreation of Gaphs 174 SOLVED PROBLEM G2 177 avr Dinching Marae Retwre 178 [APPLICATION Melts andthe Green Revolution 178 64 Long-Run Production: Two Variable Inputs 180 oquants 181 [APPLICATION A Semiconductor Integrated ‘alt soquant 184 Subaitting Inputs 186 SOLVED PROBLEM 186 Diminishing Marin! Rater o€ Technical ubetiasion 187 The Hasty fSubsieuion 188 SOLVED PROBLEM 6.4 189 6s Contents Returns o Scale 190 Corsant Increasing, an Decreasing RetornstoSeale 190 SOLVED PROBLEM 65 191 APPLICATION Retuns to Scalefn US. Manufacturing 192 ‘Voryng Reus Sele 193 Productivity and Technical Change 194 elie Prodoctly 194 Imoratons 195 APPLICATION Dall Computers Organizations! ‘anontions 197 Summary 197 Questions 195, Problems 199 TERA costs 20 a 7a 3 74 7 Measuring Costs 202 economic Cost 202 [APPLICATION Walingfoe he Doctor 203 CCaptul Cents 203 APPLICATION Swarthmore College's Cast of Capital 208 ‘Short-Run Costs 205 ShoreRun Cont Meares 205 SOLVED PROBLEM 73 206 Short Ron Cost Cures 207 Production Fanetontand the Shape of Cont Cures 208 APPLICATION Shor-Rua Cost Curves Tora Furature Manufacturer 210 et of Tees on Coss 212 SOLVED PROBLEM 2 213, Shoit-Run Com Sutaty 204 Long-Run Costs 214 Input Choice 214 APPLICATION The Internet and Outsourcing 221 SoLvED PROBLEM 73 222 oye Long-Run Con Varies with Outpt 224 SOLVED PROBLEM 7.4, 224 SOLVED PROBLEMS 125, ‘The Shape of Long Run Cost Career 227 APPLICATION Innosatlons and Economies of Scale. 228 imatng Cost Curves esis Intespection 229 Lower Gostsin the Long Run 230 ong-Ron Average Comat the Evelope of Shet-un Average ‘Cot Curves 230 [APPLICATION Choosing an In-etor a Laser Pinter 252 Shoe-Run and Long Ren Expansion ats 232 Hoy Leariagby Doig Lowers Coss 233 APPLICATION Leaznng by Doig In Computer CMps 235, Cost of Producing Multiple Goods 235 Summary 237 Questions 238 Problems 240 TERIA competitive Firms and Markets 242 81 Competition 20 Paice Tog, 248 Why Fim: Demand Gace ls Horizontal 243 Desiation ofa Compete Ficmit Demand Curve 245 ‘Why Pertct Competition Islnporaat 247 82 ProfitMaximizatfon 247 Prot 247 APPLICATION Breaking Even on Christmas Trees 248 ‘Do Steps to Maing Pret 249, 83 Competition inthe Short Run 252 Shoat Rin Comptitve Profit Maxmizaton 252 SOLED PROBLEM Ba 254 APPLICATION Ol| Sands Shutdowns 255 Shoe Run Fem Supply Carve 259 ‘SOLVED PROBLEM Bx 2<0 Shor-Run Market Sepp Corre 260 ‘heron Corspettive Eqs 263 SOLVED PROBLEM €3 264 84 CompetitionintheLong Run 265 Vong-Run CompeitnePoft Masiniation 266 Loog-Run Frm Supply Curve 256 Lang-Ran Market Supply Core 267 [APPLICATION UpwardSloping Long Run Supply ‘carve for Cott 271 APPLICATION Spel Blends and Gasolne Supply Curves. 275, SOLVED PROBLEM By 276 ‘og Ran Competve Bguiibem 277 SOLVED PROBLEM 85 273 Summary 279 Questions 280 Problems 283 Properties and Applications of the Competitive Model 235 94 Zero Profit for Competitive Fems inthe Long Run 36 Zero Long-Hos Profit with Fee Enry 296 Zero Lond Ra Prof when Entry Tinted 287 ‘The Needto Maximize rot 229 92 ProducerWelfare 289 Measuring Producer Surps Using Supply Cure 289 sing Peer Surplus 291 SOLVED PROBLEM 9. 291 93 How Competition Maximizes Welfare 292 ‘Why Producing Les thn the Compt Outpt Lawes ‘Weliue 23 ‘Why Producing Moc tht the Compete Outpt Lawes ‘Welace 2k APPLICATION Deadweight Loss of Cistmas Presents 296 Contents 9A Policies"That Shift Supply Curves 297 Resiciag the Number ef Fires 297 APPucarion Cab Fare 299 ing Ete and it Cone 300, 9.5. Policies That Createa Wedge Between ‘Supply and Demand Curves 302 Wale Est of Sales Tx 302 APPLICATION Deodneigh Loss from Wireless Taxes 303, Wile Bec ofa Price oer 208 SOWED PROBLEM 2 306 ‘APPLICATION Giving Money 1 Farmers 303 Welt Hess of a Pe Ceing 308 SOLVED PROBLEM 93 308 9.6 Comparing Both Types of Policies: Trade 310 Fee rade Verte aBan.en nperts 310 SOLVED PROBLEMS 312, Fre rade ers rif 318 SOLVEDPROBLEM9S 515 FreTadeVerais Quota 316 Rent Secking 216 Summary 318 Questions 318, Problems. 320 BU General Equilibrium ane 101 General Equilibrium 324 Compete Equiv in Tyo Inetelted Markets $25 APPLICATION Parl Equlloium Versus General quirium Analysis in Cornand Soy Markets 526 ‘Mininam Wages with Incomplete Coverage 327 SOLVED PRODLEM2 529, APPLICATION Urban Flght 330 10.2 General-Rqullibrium Exchange Economy: “Trading Between Two People 330 Endowment 31 Metutly Benefcl Trades 592 ‘SOLVED PROBLEM 302 291, Detving the Contract Cure 884 ‘SOLVED PROBLEM s03 235 Bacpining Abiy 326 103 Competitive Rechange 336 CompeitiveEquilirum 337 SOLVED PROBLEM 0.4 239 “The Bceney of Compeiion 389 Obuiang Any fen Allocation Using Compton 239 104 Production and Trading 3400 Comparative Advantage 30 SOLED PROBLEMOS 342 ficient Produc Mix 344 Conpeton 345 AOS. Efficiency and Equity 947 Rel of te Goverment 347 [APPLicATION Weatth Dstbuslon inthe United States 317 Bliency 30) Enuity 350 [APPLICATION Wow You VoteMatters 253 fcleny Verne Eauty 354 Theory ofthe Second Best 358 Summary 397 Questions 357 Problems 352 EEEEEN monopoly 20 ALI Monopoly Profit Maximization 361 The Necetry Condition for Proft Maximiation 261 MarginlRevenee and the Deatand Cares 362 SOLVEDPROBLEM 1s 363 Margo] Revenue Ors and he Fle Hasty ‘of Demand 364 ‘An Buanle of Monopely Profit Maxinizton 365, [APPLICATION Cable Cars and Proft Maxilzaton 567 Choosing Prise or Quenity 368 lect of Shift efthe Demand Came 68 112 Market Power 3 [asket Pwerand the Shape ofthe Demand Carve 369 Lene Index 971 APPLICATION Apple's Pod 371 SOLVED PROBLEMsta 372 Sours of Matt Power 279, 11.3 Welfare Effects of Monopoly 574 114 Taxesand Monopoly 375 Biles ofa Specie Tax 576 SOLVEDPROBLEM s13 377 ‘elie Ee of A Valorem Vert Specie Tases 379 ALS CostAdvantages That Crete Monopolies 80 Soures of Cos Adveniges 380 Natual Manopely 382 SOLVED PROBLEM stg 282 APPuICATION Elecse Power Uses 382 11.6 GoveramentActions That Create Monopolies 382 Bari toauy 384 Patents 384 APPLICATION Botox Patent Monopoly 335 APPLICATION tnteret and Other Pirates: Protecting Invltecuat Property Righis 387 117 Government Actions That Reduce Market Power 388 Regulating Monopolies 388 SOLVED PROBLEM 45 290 Incrssing Competition 398 APPLICATION Creating and Destoying ‘an Auto Monopoly 394 x Contents 118 Monopoly Decisions over Time 394 Newodk Bxerastes 294 "Neowor Exeraitis aan Explanation Toe Menopois 396 ‘ATwo-Pctod Monopoly Mods! 396 Summary 397 Questions 397 Problems 339 ESTES Pricing and Advertising 02 121 Why and Hw Firms Pelee Diseriminste 403, Why Price Discrimination Pays 403 Who Can Pie Discriminate 04 Preventing Reler 406 APPLICATION Disneyland Pricing 405 Not All eee Differences Ae FriceDsciminalon 06 ‘Typeset Price Discrimination 405, 122 Perfect Price Discrimination «07 How 3 Fim Pcl Pie Diserminates 407 APPLICATION Amazons Watching You 410 Perfect Price Discriminsion: ficientbot Harm ‘e Consimere APPUCATION Botox Revisited 412 Transction Cas and Peect Price Discrimination 413 SOLVED PROBLEN 32 44 APPLICATION Unione Thal Have RA 415 123, Quantity Diserimination 4s 124. Multimarkot Price Discrimination 417 Mulinartet Price Discrimination ‘wih Te Groups AI? APPLICATION Smugelng Prescaton Drugs intothe United States 120 ‘SoWveD PROBLEM s2.2 421 dentiving Groups 428 APPLICATION ConsumersPay for Lower Prices 24 ‘SOIVED PRoBLEM23 425 ‘Wel Beas of Mulimarket Price Discretion 25 125 TwoPert Tariffs 26 ATwo Par Tarif with Mental Consumes 427 ‘A To-Pat Tarif with NenidentielCansomers 8 126 Tie-inSales <0 Requirement Tie-In Sales 30 AarPucation (BM 430 Bundling Ot 127 Advertising 2 APPLICATION Magazine Advertising 435 SOLVED FROBLEN 12.4436 Sommary 47 Questions 58 Problems 440 EREIEIES oligopoty and Monopotistic Competition 1s 13.1 Market Structures. «44 132 Cartels 46 Why Carle Syceed or a6 APPLICATION Catwalk Cartel 469 Maintining Cates 20 APPLICATION Ball Bonds 431 Mergers 452 [APPLICATION Aine Mergers: Market Power ‘Versus Fight Frequency #52 133. Noncooperative Olgopaly 452 134 Cournot Oligopoly Model 433 Cournot Model of Aitine Meret 454 ‘The Cournot Bauiibiom with "hwo or More Fins 57 ‘The Cournor Mosk! with Nonidencal Firms 460 SOLED PROBLEM 33 460 SOLVED PROBLEM S32 462 APPLICATION AlrTgke Paces ond Raley 495 Stackelberg Oligopoly Medel 464 Cale Slaton: Aine Example 465 Graphical Slatin: Aine Example 466 Why Moving Sequential Ie Een 456 SttegicTade Policy An Applation othe Suckelberg Model 165 ArrLicasiON Government Acrat Subsdles 471 SOLVED FROBLEN 33, 471 13.6 Comparison of Collsive, Cournot, Stackelberg and Competitive Baulibria 73 APPLICATION Deadweight Losses the Food ‘and Tobacco inustlas 475, 137 Bertrand Oligopoly Model 476 RegrandBquiliam wit dene Products 7 NasBertrand Bgulibrium with Diecetiatd Products «78 APPLICATION Welfare Gain rom Greater ‘lle Paper Varley 422 138 Monopolistc Competition 433 ‘Monopolsially Cmpettve Bgl 483 Feed Cont sod the amber of Firms 484 SOLVED PROBLEM 34 486 Summary 486 Questions 487 Problems 438 EEREIRYS came theory an 41 An Overview ofGame Theory 92 142 SttieGames 196 Normal form Game 4 Predciags Game's Outcome 95 Contents Mutple Nuh equibls,No Nath Equi, and Mice Seseies 498 APPLICATION Chicken so1 ‘SOLVED PROBLEM a4 50L Conperafon 502 APPLICATION Strategie Advertising S04 143. DynamicGames 505 Sequenisl Game 506 SOLVED PROBLEM 142 SIL APPLICATION Advantages and Disadventanes of Moving Fest 312 epeaedGame 513 144 Auctions. 516 ements of Actions S18 Biting Strategies in Private Niue Actions S16 APPLICATION Who Bis Optimally? 517 Winners use 8 Summary 518 Questions 319 Problems 522 Appendix Solving for Med Strateges sg Caleuls 525 SEE rector markets ss 151 Competitive Factor Market 527 Finis Short Ran Factor Demand 527 SOWVED PROBLEM 5 530, Finis ong Run Ficor Demands 531 ‘ctor Maket Demand 534 Compete Factor Maret Equi 334 APPLICATION Black Death Raises Wages 335 SOLVED PROBLEM 5.253% 18.2. Noncompetitive Pactor Market 537 153 Monopsony 538 Monopsony Prot Maxinieaton $38 APPLICATION Company Towns 541 SOLVED PROBLEM 153.542 Welt ects of Monopseny 53 154 Capital Merkets and Investing S44 Interest ates 545 Disoune Rate 346 Seam of Payments 546 [APPLICATION Saving for Retirement 547 leveting, S18 SOLVED PROBLEM 5.4, 550 ‘SOLVED PROBLEM 55 551 Danity 351 APPLICATION Durabily of Telephone Poles $51 Haman pind 353 APPLICATION Returns to Studying Economies. 535, Time-Varying Discounting 556 x 155. Eshaus ‘Wheat Selen Eshastble Rene 397 Pale of Scarce xhaustle Resource 558 APPLICATION Redwood Trees 6 Why Price May Be Constant or Fall 582 Summary 58 Questions $53 Problems 56 FETA Uncertainty sor 161 Degree of Risk Sot Probability $68 APPLICATION Biased Estimates? 570 EspectVsle 570, SOLVED PROBLEM 362 571 ‘sane and Sanda Deviation 57 162 Decision Meking Under Uncertainty 573 Expect Uy 573 Attides Toad R574 ‘SOLVED PROBLEM 36.2 577 SOLVED PROBLEM 163.577 APPLICATION Garbiing 579 Degeof Rik Avesion 582 SOLVED PROBLEM 36.4 584 163 Avolding Risk 584 ust Sy No. 536 APPLICATION Hany Potters Magic 535 (Obtain formation 585 Dsesly 585 Inauze 597 SOLVED PROBLEM 165 39 APPUCATION Airnsurance 560 APPLICATION No insurance for Natural Dhastrs s9t 164 Investing Under Uncertainty 591 ow investing Dapens on Avitudes Toward Rie 592 APPLICATION Risk Pomivm 595 Tovestng with Unceemngy and Discounting 594 Investing wih Akered Pubs 594 Summary 338 Questions 395 Problems) 597 TEMA externatties, open access, and Public Goods 559 ITA Externalities 600 APPLICATION Hopatve Ederality SUVs KI OL APPUCATION PostiveExterrallty: Michael Jordan. 601 17.2. Tholneffciency of Competition ‘with Externalities "02 Supply-and-Demand Amaljls 62 CostbenetAnadais 605 xii Contents 173 Regulating Externalities 606 APPLICATION Pulp and Paper Mal Pollution and Regulation <08 SOLVED PROBLEM 10 ‘APPLCATION Soberng Druck Divers 610 Emisons Fes Ves Standards Under Unecanty 6 ‘ApPLcaTOn U.S. and EU Approaches to Regulating Pollan 612 174. Market Structure and Externalities 613 Monapolyand Eeteasiies 613 ‘Monopal Vrs Corpetve Wel SOLVED PROBLEMAr2 615, “Taxing Exemalies in Noncompetane Markee 615, 17. Allocating Property Rights toReduce Externallties 616 ComeTheorm 616 Markets for Folluior 619 APPLICATICN Selling the Right toPalute 619 176 Open-Access Common Property 620 (Overuseof Open-Access Common Property 620 APPLICATION Emptying the Seas <2t Solving the Commons Peoles 622 172 Public Goods 622 Typesof Goods 622 Markets for Publi Goods 523 Free Riding 626 APPLICATION Free Riding on Water 927 Reducing Free Riding, 628 APPLICATION What's Tel Beef? 528 Valuing Pubic Goods 629 Summary 60 Questions «7 Problems 6 RERETEET Asymmetric information «x4 18.1 Problems Due to Asymmetric Information 635 |APPLICATION Removing Pounds or Dollars? 636 182 Responsesto Adverse Selection 657, Controling Opportunistic Behatoe Trough Unser ‘Covesge 63? quan lafoemaon 637 APPLICATION Risky Hobbes, 638 183 How Ignorance About Quality Drives, ‘Out High-Quality Goods 639 amonsMathet with Fieed Quality 639 SOLVED PROBLEM 8 G12 ‘emous Market with Varble Quality 642 Ligiting tamone 543 APPLICATION Adverse Selection on eBay 6 184 Market Power from Price Ignorance 4s TowstTap Model 647 SOLVED PROBLEM 0.2.8 Advertsing and Pricer 619 swith Esteli 614 185. Problems Arising from Ignorancewhen Hiring 619 Information bout Employment Riks 619 (Cheap Tae 650 Eivestion sr Signal 652 ‘SOLVED PROBLEM R363 Sertningia Hiring 656 Summary 65 Questions 68 Problems 659 (ERERSEIEEY contracts and Moral Hazards 6st 19.1 Principal Agent Problem 652 Model 562 Types of Contac 663 Effeney 664 19.2 Production Bficioney 64s lest Contract 565 Ful nformation 656 SOLVED PROBLEMs9 669 Asymmetric afornation 620 ‘APPLICATION Contats and Productivity Tn Agatiuce 67 193 Trade-Off Between Efficiency in Production ‘and in Risk Bearing 672 conta nd Eency 672 Choosing the Best Contact 675 APPLICATION Corlagent Fes Versus Hourly Pay 676 ‘SOLVED PROBLEM9.2 «75 19.4 PaymentsLinked to Production or Profit. 67 ace Rate Hie Contact. 678 CContngtt Contact Rewards Linked t2Fiem'sSuccss 79 19.5 Monitoring 679 Bonding 680 SOLVED FROBLEM253 St Defered Payments 682 ficiency Wages 689 Afire-fed Moolxing 684 APPLICATION Abusing Leased Cats 684 [APPLICATION Mortgaging Our Future 685 SOLVED PROBLEIRI9.4 686 196 Contract Choice 687 Summary 69 Questions 689 Problems 69 Calculus Appendix. cy.1 Ad Functions CA. Functions ofa Sing Viable Chl functions of Several Vrsbles | CA2 A2 Properties of Functions CA-2 Monotoscty C43 Ccatinaity CAS Coocavityand Gaoveriy CAS AS Aa AS Contents Homogeneous Functions CAS ‘Special Popertosof Logic Funaions CAS Derivatives cas Rules for Caleabng Devatives CAT Higher OoderDesivatnes CA-9 Parl Deraies CAS Fale?’ Homogeneous Functor Tacorem CATE Maximum and Minimum CA12 ecalEeens CMI Goin! Buea CAI Esisteee of tema CA13 Unigene of Esrens CAS Ieseroe Beem Ch-L4 [nding the Extrema of Function CA.1t Buamples CAAT Inet Objective Pct andthe Eneepe Theorem Ch8 Comparative statics CA19 ‘AS Maximizing with Equality Constraints CA.20 Ssbetton Method CA20 ageanges Meiod Cat AZ Maximizing with Inequality Constraints C22 ‘An lation ofthe Kuha-Tucher Method CA23 ‘Recipe for Finding the Consaned Exes of Function cas AB Dudlity cA29 Answers 4-1 Definitions p-1 References ®1 Sources 5.1 edits C1 Index tt thechoice was between books that use calculus to present formal theory dryly 11. and with few, if any, applications to the real world and books that include applications but present theory using only graphs and algebra. This book uses caleu- lus, algebra, and graphs to present microeconomic theory using actual examples, and applies the theory to analyze real-world problems, My purpose is to show students that economic theory has practical, problem-solving uses and is not an empty academi exercise, : This book shows how individuals, policy makers, and firms use microeconomic tools to analyze and resolve problems, For example, students learn that: | ‘his book is a new type of intermediate microeconomics textbook. Until now, ‘© individuals can draw on microecononic theories when deciding about issues such as whether to invest and whether to sign a contract that pegs prices tothe govern ments measure of inflation: ‘© policymakers (and voters) can employ microeconomics to predict, before they are enacted, the impact of taxes regulations, and other measures; ss lawyers and judges use microeconom ust diserimi = firms apply microeconomic principles to produce at least cost and maximize profit, select strategies, decide whether to buy from a market orto produce inter- nally, and write contracts to provide optimal incentives for employees. jon, and contract My experience in teaching microeconomics for the departments of economics at MIT, the University of Pennsylvania, and the University of California, Berkeley; the Department of Agricultural and Resource Economics at Berkeley; and the Wharton Business School has convinced me that students prefer this emphasis on real-world issues This book differs from most other microeconomics texts in four main ways. First it uses a mixture of calculus, algebra, and graphs to make economic theory clear. Second, itintegrates real-world, “widget-free” examples throughout the exposition, in addition to offering extended applications. Third, it places greater emphasis than otber texts on modern theories—such as industrial organization theories, game theory, transaction cost theory, information theory, and contract theory—that are useful in analyzing actual markets. Fourth, it employsa step-by-step approach to demonstrate how to use microeconomic theory to solve problems and analyze policy issues. CALCULUS Much of microeconomic theory is based on maximizing behavior. Calculus i particu Jarly helpful in solving maximization problems. Thus this book combines calculus, algebra, graphs, and verbal descriptions to make the theory as clear as possible. EE ECONOMICS: ‘To convince students that economics is practical and useful, not just a textbook exer: cise, this text presents theories using real-world examples rather than made-up analy- ses of widgets, those nonexistent products beloved by earlier generations of textbook writers. These real economic “stories” are integrated into the formal presentation of many economic theories, discussed in Applications, and analyzed in what-if policy discussions. INTEGRATED REAL-WORLD EXAMPLES ‘This book uses real-world examples throughout the narrative to illustrate many basic theories of microeconomics. Students learn the basic model of supply and demand using estimated supply-and-demand curves for Canadian processed pork and US. sweetheart roses. They analyze consumer choice by employing typical consumers’ est- mated indifference curves between beer and wine and mill workers’ indifference curves between income and leisure. They learn about production and cost functions using evidence froma US. furniture manufacturer. Students see monopoly theory applied to a patented pharmaceutical, Botox. They use oligopoly theories to analyze the rivalry between United Airlines and American Airlines on the Chicago-Los Angeles route and between Coke and Pepsi in the cola industry. They see Apple's monopaly pricing of iPods and learn about multimarket price discrimination through the use of data on how Warner Home Entertainment priced its Harry Potter and the Prisoner of Azkaban two-DVD movie set in various countries. APPLICATIONS The text also inchides many featured Applications to illustrate the versatility of microeconomic theory. The Applications focus on such diverse topics as: t= the derivation of an isoquant for semiconductors, using actual data; t= the measures of the pleasurethat consumers get from television; = theamount by which recipients value Christmas presents relative to the cost to git sivers; how auction houses that provide more information achieve higher prices than sellers on eBay: ‘= whether buying flight insurance makes sense. Additional Applications are available at wwwaw-be.com/perloff, WHAT-IF POLICY ANALYSIS In addition, this book uses economic models to probe the likely outcomes of changes in public policies. Students learn how to conduct what-if analyses of policies such as ‘exes, subsidies, barriers to entry, price floors and ceilings, quotas and tariffs, zoning, pollution controls, and licensing laws. The text analyzes the effects of taxes on virtually every type of market, ‘The book also reveals the imits of economic theory for policy analysis. For exam- pie, to illustrate why attention to actual institutions js important the text uses three different models to show how the effects of minimum wages vary across types of markets Preface vii and institutions. Similarly, the tex illustrates that a minimus wage law that is harm- ful in a competitive market may be desirable in certain noncompetitive markets. MODERN THEORIES ‘The first half of the book (Chapters 2-10) examines competitive markets and shows that competition has very desirable properties. The ret of the book (Chapters 11-19) concentrates on imperfectly competitive markets in which fitms have market power, firms and consumers are uncertain about the future and have limited information, and there are externalities and public goods. The book uses behavioral economics to discuss bandwagon effects on monopoly pricing overtime and the importance of time-varying discounting in explaining procrastination and in avoiding environmental disasters. ‘This book goes beyond basic microeconomic theory and looks at theories and applications from many important contemporary fields of economics. Extensive coy- erage of problems from resource economics, labor economics, international trade, public finance, and industrial organization is featured throughout. This book also differs from other microeconomics texts by using game theory throughout the second half rather than isolating the topic in a single chapter. Game ‘theory is introduced in Chapter 14, where itis used to study oligopoly quantity and price setting, entry by firms, strategic behavior in multiperiod games (such as collu- sion and preventing entry), strategic advertising, and auctions. Game theory is ‘employed in later chapters to analyze investing given an uncertain Future, pollution (the Coase Theorem), and other topics. Unlike most texts, this book covers pure and ‘mixed strategies and analyzes both normal-form and extensive-form games. The lst two chapters draw from modern contract theory to analyze adverse selec- tion and moral hazard extensively, instead of (as other texts do) mentioning these top- ics only in passing, if at all The text covers lemons markets, signaling, preventing shirking, and revealing information (including through contract choice). ‘STEP-BY-STEP PROBLEM SOLVING Many instructors report that their biggest challenge in teaching microeconomics is helping students learn to solve new problems. This book is based on the belief that the best way to teach this important skill isto demonstrate problem solving repeatedly and then to give students exercises to do on their own. All the chapters after Chapter 1 pro- vide several Solved Problems that show students how to answer qualitative and quan- titative problems using a step-by-step approach, Rather than empty arithmetic exercises demanding no mote of studenis than employing algebra or a memorized mathemati 0. The foreign firms may supply as much as they want, Qj, as ong as they supply no more than the quota: Q, = Q. (Ee ey ‘The supply and demand curves determine the price and quantity at which goods and services are bought and sold. The demand curve shows the quantities that consumers 22 CHAPTER 2 Supply and Demand want to buy at various prices, and the supply curve shows the qua want to sell at various prices. Unless the price is set so that consumers want to buy exactly the same amount that suppliers want to sel, either some buyers cannot buy as ‘much as they want or some sellers cannot sell as much as they want. When all traders are able to buy or sell as much as they want, we say that the m: ium: a situation in which no participant wants to change its behavior. A price at which consumers can buy as much as they want and sellers can sell as much as they want is called an equilibrium price. The quantity that is bought and sold at the equilibrium price i called the equilibrium quantity. FINDING THE MARKET EQUILIBRIUM. This litle piggy went to market... ‘To illustrate how supply and demand curves determine the equilibrium price and «quantity, we use our old friend, the processed pork example. Figure 2.6 shows the sup- ply, S, nd the demand, D, curves for pork. The supply and demand curves intersect at pointe, the market equilibrium, where the equilibrium price is $3.30 and the equilib- rium quantity is 220 million kg per year, which is the quantity that firms want to sell and the quantity that consumers want to buy at the equilibrium price. ‘We can determine the processed pork market equilibrium mathematically using the supply and demand finctions, Equations 2.3 and 2.4, We use these two functions to solve for the equlibriom price at which the quantity demanded equals the quantity supplied (the equilibrium quantity). Excess supply = 39 a Sporng 3.95 330} 2.85} 220 0. Mion kg of pork Per year Figure 2.6 Marke: Equilibrium, The intersection of the supply curve Sand the demand ‘curve, D, for processed pork determines the market equilibrium point, where p= $3.30 per bg and Q= 220 milion kg per year At the lower price of p= $2.65, the quantity supplied is ‘only 194, whereas the quantity demanded i 233, so thercis excess demand of 39.t p= 85:95, price higher than the equilibrium pele, there isan exess supply of 39 because the ‘quantity demanded, 207, iss than the quantity supplied 246. When there is exess demand ‘or supply, market forces drive the price bac to the equilbsium price of $3.30. Market Equilibrinm 2 ‘The demand function, Equation 2.3, shows the relationship between the quantity demanded, Qx and the price: Qa = 286 ~ 20p. ‘The supply function, Equation 2.4, describes the relationship between the quantity supplied, Q, and the price Q, = 88 + 40p. ‘We want to find the price at which Q,=@, = Q, the equilibrium quantity. Because the left-hand sides of the two equations are equal in equilibrium, Q,™= Qj, the right- hhand sides ofthe two equations must be equal: 286 ~ 20p ~ 88 + 40p. Adding 20p to both sides of this expression and subtracting 88 from both sides, we find that 198 = 60p. Dividing both sides ofthis last expression by 60, we learn that the equi- librium price is p = $3.30. We can determine the equilibrium quantity by substituting this equilibrium price, p= $3.30, into either the supply or the demand equation: Qa= 286 — (20 X 3.30) = 88 + (40 x 3.30) 220 = 220. ‘Thus the equilibrium quantity is 20, FORCES THAT DRIVE THE MARKET TO EQUILIBRIUM ‘A market equilibrium is not just an abstract concept or a theoretical possibility. We ‘observe matkets in equilibrium. Indirect evidence that a market is in equilibrium is that you can buy as much as you want of a good at the market price. You can almost always buy as much as you want of milk, ballpoint pens, and most other goods. ‘Amavingly, a market equilibrium occurs without any explicit coordination between ‘consumers and firma. Ina competitive market stich as that for agricultural goods, mil- lions of consumers and thousands of firms make their buying and selling decisions independently. Yet each firm can sell as much as it wants; each consumer can buy 36 uch as he or she wants. Its as though an unseen market force ike an invisible hand, directs people to coordinate their activities to achieve a market equilibrium, ‘What really causes the market to move to an equilibrium? Ifthe price s not at the equilibrium level, consumers or firms have an incentive to change their behavior in a ‘way that will drive the price to the equilibrium level* If the price were initially lower than the equilibrium price, consumers would want to buy more than suppliers would want to sell If the price of porkis $2.65 in Figure 2.6, firms will be willing to supply 194 million kg per year, but consumers will demand 233 rillion kg. At this price, the market is in disequlibriwt, meaning that the quantity demanded is not equal to the quantity supplied. There is excess demand—the amount by which the quantity demanded exceeds the quantity supplied at a specified pric ‘of 39 (= 233 — 194) million kg per year ata price of $265. Our model of competitive market equilibrium, which occurs at a polat fate, does not for- mally explain how dynamic adjustments occu The following explanation, though plausible, s just one of 2 numberof posible djoamic adjustnent stories that economists have modeled “4 2.4 CHAPTER 2 Supply and Demand Some consumers are lucky enough to be able to buy the pork at $2.65. Other con- sumers cannot find anyone who is willing to sell them pork at that price, What can they do? Some frustrated consumers may offer to pay suppliers more than $2.65 Alternatively, suppliers, noticing these disappointed consumers, may raise their prices, Such actions by consumers and producers cause the market price to rise. As the price "ses, the quantity that firms want to supply incteases and the quantity that consumers want to buy decreases. This upward pressure on price continues until it reaches the equilibrium price, $3.30, where there is no excess demand. If, instead, price is initially above the equilibrium level, suppliers want to sell more than consumers want to buy. For example, ta price of pork of $3.95, suppliers want to sell 246 milion kg per year but consumers want to buy only 207 million, as the figure shows. At $3.95, the market is in disequilibrium. Theres an excess supply—the amount by which the quantity supplied is greater than the quantity demanded at a specified price—of 39 (~ 246 ~ 207) ata price of $3.95. Not all firms can sell as much a they want. Rather than incur storage costs (and possibly have their unsold pork spoil) firms lower the pric: to attract additional customers. As long as price remains above the equilibrium price, some firms have unsold pork and want to lower the price further. The price falls until it reaches the equilibrium level, $3.30, where there is no «excess supply and hence no more pressure to lower the price further, Insummary, at any price other than the equilibrium price, either consumers or sup- pliers are unable to trade as much as they want, These disappointed people act to change the price, driving the price to the equilibrium level. The equilibrium price is ‘alled the market clearing price because it removes from the market all frustrated buy- crs and sellers: There is no excess demand or excess supply at the equilibrium price. Shocking the Equilibrium: Comparative Stati If the variables we hold constant in the demand and supply fanetions co not change, an equilibrium can persist indefinitely because none of the participants applies pres- sure to change the price. However, the equilibrium changes if shock occurs such that ‘one of the variables we were holding constant changes, causing a shift in either the demand curve or the supply curve, Comparative statics i the method that economists use to analyze how variables controlled by consumers and firms—here, price and quantity—react to a change in environmental variables (also called exogenous variables), such as prices of substitutes ‘and complements, income, and prices of inputs. The term comparative statis literally refers to comparing a static equilibrium—an equilibrium at a point in time—from before the change toa static equilibrium after the change. (In contrast, economists may ‘examine a dynamic model, in which the dynamic equilibrium adjusts over time.) COMPARATIVE STATICS WITH DISCRETE (RELATIVELY LARGE) CHANGES: ‘We can determine the comparative statics properties of an equilibrium by examining the effects of a discrete (relatively large) change in one environmental variable. We can do so by solving for the before- and after-equilibria and comparing them using math- ‘matics or a graph, We illustrate this approach using our beloved pork example. Suppose all the environmental variables remain constant except the price of hogs, Shocking the Equilibrium: Comparative States as oie m0 215 BO xcoss demand = 18 ©, Niion kg of perk par year Figure 27 The Bgulibrium Efecto Shift of the Supply Curve. A 25¢ increas nthe price of hogs causes the supply curve for processed pork to shift tothe left from $1 to $2, Aving the market equlbtum fom eo ey and he mati equllblum price ir $30 1355, which increases by 256, It is now more expensive to produce pork because the price of 4 major input, hogs, has increased. Because the price of hogs is not an argument tothe demand function change in the price of an input does not affect consumers’ desires—the demand curve does not shift As we have already seen, the increase in the price of hogs causes the supply curve for pork to shift 15 units to the left from S! to S? in Figure 2.7. At the original equilibrium price of pork, $3.30, consumers stil want 220 units, but suppliers are now willing to supply only 205, so there is excess demand of 15, as pane! a shows. Market pressure forces the price of pork upward until it reaches a new equi- librium ate, where the new equilibrium price is $3.55 and the new equilibrium quan- tity is 215. Thus the increase in the price of hogs causes the equilibrium price to rise by 25¢ a pound but the equilibrium quantity to fall by 15 units. Here the increase in the price of a factor causes a shift ofthe supply curve and a movement along the demand curve, ‘We can derive the same result by using equations to solve forthe equilibrium before the change and after the discrete change inthe price of hogs and by comparing the two equations. We have alceady solved for the original equilibrium, e, by setting quantity in the demand function 2.3 equal tothe quantity in the supply Function 2.7. We obtain the new equilibrium, e,, by equating the quantity in the demand function 2.3 to that ‘of the new supply function 2.8: 286 ~ 20p = 73-+ 40p. Simplifying this expression, We find thatthe nev equilibrium price is p, = $3.55. Substituting that price into either the demand or the supply function, we learn that the new equilibrium quantity is Q,=215, 26 CHAPTER 2 Supply and Demand as panel a shows. Thus both methods show that an increase in the price of hogs causes the equilibrium price to rise and the equilibrium quantity to fall, COMPARATIVE STATICS WITH SMALL CHANGES Alternatively, we can use calculus to determine the effect ofa small change (as opposed to the discrete change we just used) in one environmental variable, holding the other such variables constant. Until now, we have used calculus to examine how an argument ofa demand function affects the quantity demanded or how an argument of a supply function affects the quantity supplied. Now, however, we want to know how an envi- ronmental variable affects the equilibrium price and quantity that are determined by the intersection ofthe supply and demand curves. (Our fitst step isto characterize the equilibrium values a functions of the relevant environmental variables. Suppose that we hold constant all the environmental vari- ables that affect demand so that the demand function is Q= Dy). 09) One environmental variable, a, in the supply function changes, causing the supply curve to shift. We write the supply function as Q= Spa). (20) ‘um price by equating the quantities, Q. in AAs before, we determine the equi Equations 2.9 and 2.10: Dip) = St, 4). an) ‘The equilibrium equation 2.11 is an example of an identity. As a changes, p changes so that this equation continues to hold—the market remains in equilibrium. Thus based on this equation, we can write the equilibrium priceas an implicit function of the envi- ronmental variable: p= p(a). That is, we can write the equilibrium condition 2.11 as D(PLa)) ~ S(pla), a). (2.12) ‘We can characterize how the equilibrium price changes with a by differentiating the equilibrium condition 2.12 with respect to a using the chain rule at the original equilibrium,” AD(PL@)) dp _ 28(PC@), 4) dp, 98(PC6)r4) = 2.13) a da ap da aa oY Using algebra, we can rearrange Equation 2.13 as = oa aoe 214) dp ap where we suppress the arguments of the functions for notational simplicity. Equation 2.14 shows the derivative of p(a) with respect to a. The chain eule isa formula forthe derivative of the composite of evo Functions, such as fit) ‘According co this cule, dfdx ~ (Afi). See the Calculus Appendix. ‘Shocking the Equllibrium: Comparative Saties 7 ‘We know that dD/dp < Oby the Law of Demand. If the supply curve is upward slop- ing, then aS/ap is positive, so the denominator of Equation 2.14, dDidp ~ Sidp, i ne ative, Thus dp/da has the same sign as the numerator of Equation 2.14, If aS/oa is negative, then dp/da is postive: Asa increases, the equilibrium price rises. If 3S/aais positive, an increase in « causes the equilibrium price to fall. By using either the demand function or the supply function, we can use this result concerning the effect of « on the equilibrium price to determine the effect of « on the equilibrium quantity. For example, we can revrite the demand function 2.9 as Q= DEM). (2.15) Differentiating the demand function 2.15 with respect to a using the chain rule, we find that ee es (2.16) Because aDlap < 0 by the Law of Demand, the sign of dQida isthe opposite ofthat of

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