eighth edition exploring microeconomics

EIGHTH EDITION

exploring

MICROECONOMICS

Robert L. Sexton

Pepperdine University

(DSAGE

Los Angeles | London j New Delhi Singapore | Washington DC | Melbourne

Detailed Contents

Preface xxxi

Visual Learning Features xxxiv

Applications xxxv

SAGE edge and Online Resources xxxviii

About the Author xxxix

Acknowledgments xl

Parti. Introduction i

Chapteri. The Role and Method of Economics 2

Learning Outcomes 2

1.1 Economics: A Brief Introduction 3

Economics—A Word with Many Different Meanings 3

Economics Is All Around Us 4

1.2 Economic Behavior 5

Self-Interest 5

What Is Rational Behavior? 6

1.3 Economic Theories and Models 8

Economic Theories and Models 8

Abstraction Is Important 9

Developing a Testable Proposition 9

The Ceteris Paribus Assumption io

Why Are Observation and Prediction Härder in the Social Sciences? 10

Why Do Economists Predict on a Group Level? 10

The Two Branches of Economics: Microeconomics and Macroeconomics 11

1.4 Pitfalls to Avoid in Scientific Thinking 12

Confusing Correlation and Causation 12

The Fallacy of Composition 13

1.5 Positive Statements and Normative Statements 14

Positive Statement 14

Normative Statement 14

Positive versus Normative Analysis 14

Disagreement Is Common in Most Disciplines 15

Often Economists Do Agree 16

Interactive Summary 19

Key Terms and Concepts 20

Additional Section Quiz Answers 20

Problems 22

Appendix: Workingwith Graphs 24

Chapter2. Economics: Eight Powerful Ideas 32

Learning Outcomes 32

2.1 Idea I: People Face Scarcity and Costly Trade-offs 33

Human Wants Exceed Available Resources 33

Scarcity and Resources 33

What Are Goods and Services? 34

What Are Bads? 35

Does Everyone Face Scarcity? 35

Will Scarcity Ever Be Eradicated? 35

Wants versus Needs 35

Scarcity Forces Us to Choose 36

Trade-offs 36

To Choose Is to Lose 36

Money Costs and Non-money Costs 37

The Opportunity Cost of Going to College or Having a Child 38

2.2 Idea 2: People Engage in Rational Decision Making and Marginal Thinking 40

What Is Rational Decision Making? 40

Many Choices We Face Involve Marginal Thinking 40

2.3 Idea 3: People Respond Predictably to Changes

in Incentives 44

Changes in Incentives Change Individual Behavior 44

Positive and Negative Incentives 44

2.4 Idea 4: Specialization and Trade Can Make People

Better Off 47

Why Do People Specialize? 47

Absolute versus Comparative Advantage 47

We All Specialize 48

The Advantages of Specialization 48

Specialization and Trade Lead to Greater Wealth and Prosperity 49

2.5 Idea 5: Markets Can Improve Economic Efficiency 52

How Does the Market Work to Allocate Resources? 52

Market Prices Provide Important Information 52

What Effect Do Price Controls Have on the Market System? 53

2.6 Idea 6: Appropriate Government Policies Can Improve Market Outcomes 54

Property Rights and the Legal System 54

Market Failure 54

2.7 Idea 7: Government Policies May Help Stabilize the Economy 56

Inflation 56

Unemployment 57

2.8 Idea 8: Increasing Productivity Leads to Economic Growth 58

Defining Economic Growth 58

Economic Growth, Productivity, and the Standard of Living 59

What Factors Contribute to Increases in Productivity? 59




Problems 67

Chapterg. Scarcity, Trade-OfFs, and Production Possibilities 70


3.1 The Three Economic Questions Every Society Faces 71

The Three Economic Questions 72

What Goods and Services Will Be Produced? 72

How Will the Goods and Services Be Produced? 73

Who Will Get the Goods and Services Produced? 73

3.2 The Circular Flow Model 77

Product Markets 77

Factor Markets 77

The Simple Circular Flow Model 77

3.3 The Production Possibilities Curve 79

The Production Possibilities Curve 79

Inefficiency and Efficiency 81

The Law of Increasing Opportunity Cost 81

3.4 Economic Growth and the Production Possibilities Curve 84

Generating Economic Growth 84

Growth Does Not Eliminate Scarcity 84

The Effects of a Technological Change on the Production Possibilities Curve 85

Summing up the Production Possibilities Curve 86




Problems 90

Part 2. Supply and Demand 93

Chapter4. Demand, Supply, and Market Equilibrium 94


4.1 Markets 95 Defining a Market 95 Buyers and Seilers 95

4.2 Demand 96 The Law of Demand 96 Individual Demand 97 What Is a Market Demand Curve? 97 Ceteris Paribus and the Law of Demand 98

4.3 Shifts in the Demand Curve IOO

A Change in Demand versus a Change in Quantity Demanded 100

Shifts in Demand ("PYNTE") 101

Changes in the Prices of Related Goods and Services (P) 101

Changes in Income (Y) 103 Changes in the Number of Buyers (N) 105

Changes in Tastes (T) 105 Changes in Expectations (E) 106

Changes in Demand versus Changes in Quantity Demanded—Revisited 106

4.4 Supply 109

The Law of Supply 109 A Positive Relationship between Price and Quantity Supplied 109

An Individual Supply Curve 109

The Market Supply Curve 110

4.5 Shifts in the Supply Curve in

A Change in Quantity Supplied versus a Change in Supply m

Shifts in Supply ("SPENT") 112

Change in Supply versus Change in Quantity Supplied—Revisited 115

4.6 Market Equilibrium Price and Quantity 117

Equilibrium Price and Quantity 117

Shortages and Surpluses 117

Don't Confuse Scarcity and Shortages 118




Problems 124

Chapter 5. Markets in Motion and Price Controls 130


5.1 Changes in Market Equilibrium 131

The Effects of a Change in Demand 131

The Effects ofa Change in Supply 132

The Effects of Changes in Both Supply and Demand 133

The Combinations of Supply and Demand Shifts 136

Supply, Demand, and the Market Economy 136

5.2 Price Controls 141

Price Controls 141

Price Ceilings: Rent Controls 142

Price Floors: The Minimum Wage 143

Price Ceilings: Price Controls on Gasoline 145

Unintended Consequences 146




Problems 152

Chapter 6. Elasticities 154


6.1 Price Elasticityof Demand 155

ls the Demand Curve Elastic or Inelastic? 155

Types of Demand Curves 156

Calculating the Price Elasticity of Demand: The Midpoint Method 157

The Determinants of the Price Elasticity of Demand 158

6.2 Total Revenue and the Price Elasticity of Demand 162

How Does the Price Elasticity of Demand Impact Total Revenue? 162

Price Elasticity Changes along a Linear Demand Curve 163

6.3 Other Types of Demand Elasticities

The Cross-Price Elasticity of Demand

167

167

Cross-Price Elasticity and Sodas 167

The Income Elasticity of Demand 167

6.4 Price Elasticity ofSupply 169

What Is the Price Elasticity of Supply? 169




Problems 180

Part 3. Market Efficiency, Market Failure,

and the Public System 183

Chapter 7. Market Efficiency and Weifare 184


7.1 Consumer Surplus and Producer Surplus 185

Consumer Surplus 185

Marginal Willingness to Pay Falls as More Is Consumed 185

Price Changes and Changes in Consumer Surplus 186

Producer Surplus 187

Market Efficiency and Producer and Consumer Surplus 188

Market Efficiency and Market Failure: A Caveat 190

7.2 The Weifare Effects of Taxes, Subsidies, and

Price Controls 193

Using Consumer and Producer Surplus to Find the Weifare Effects of a Tax 193

Elasticity and the Size of the Deadweight Loss 195

Deadweight Loss and Tax Revenues When Tax Size Changes 195

The Weifare Effects of Subsidies 197

Price Controls and Weifare Effects 200

Price Ceilings 200

Rent Controls 201

Rent Controls—Short Run versus Long Run 201

Price Floors 202

The Weifare Effects of a Price Floor When the Government Guys the Surplus 203

Deficiency Payment Program 204




Problems 210

Chapter 8. Market Failure 212

LearningOutcomes 212

8.1 Externalities 213

Negative Externalities in Production 213

What Can the Government Do to Correct for Negative Externalities? 215

Positive Externalities in Consumption 216

What Can the Government Do to Correct for Positive Externalities? 217

Nongovernmental Solutions to Externalities 218

8.2 Public Policy and the Environment 220

Why Is a Clean Environment Not Free? 220

The Costs and Benefits of Pollution Control 220

Command and Control Policies: Regulation 221

Corrective Taxes: A Market-Based Policy 222

Transferable Pollution Rights 222

8.3 Property Rights and the Environment 224

The Coase Theorem 224

Transaction Costs and the Coase Theorem 224

8.4 Public Goods 225

Private Goods versus Public Goods 226

Public Goods and the Free-Rider Problem 226

The Government and Benefit-Cost Analysis 227

Common Resources and the Tragedy of the Commons 227

8.5 Asymmetrie Information 230

What Is Asymmetrie Information? 230

What Is Moral Hazard? 233




Problems 239

Chapter 9. Public Finance and Public Choice 241


9.1 Public Finance: Government Spending and Taxation 242

Growth in Government 242

State and Local Spending 244

Generating Government Revenue 244

Financing State and Local Government Activities 247

Should We Have a Fiat Tax? 247

Taxes: Efficiency and Equity 248

9.2 Public Choice 252

What Is Public Choice Theory? 252

Scarcity and the Public Sector 253

The Individual Consumption-Payment Link 253

Majority Rule and the Median Voters 253

Voters and Rational Ignorance 254

Special Interest Croups 255




Problems 259

Part 4. Households and Market Structure 261

Chapter 10. Consumer Choice Theory 262


10.1 Consumer Behavior 263

Utility 264

Utility Is a Personal Matter 265

Total Utility and Marginal Utility 265

Diminishing Marginal Utility 267

10.2 The Consumer's Choice 268

What Is the "Best" Decision for Consumers? 268

Consumer Equilibrium 269

The Law of Demand and the Law of Diminishing Marginal Utility 270

10.3 Behavioral Economics 272

Bounded Rationality and Rule of Thumb 272

Self-Control 273

Compartmentalizing 273

Framing 273

Anchoring 274

The Endowment Effect 274

Fairness Matters 274




Problems 278

Appendix: A More Advanced Theory of Consumer Choice 281

Chaptern. The Firm: Production and Costs 291


n.i Costs and Profits 292

Explicit Costs 292

Implicit Costs 292

Profits 293

Are Accounting Profits the Same as Economic Profits? 293

A Zero Economic Profit Is a Normal Profit 294

Sunk Costs 295

n.2 Production in the Short Run 297

The Short Run versus the Long Run 297

Production in the Short Run 298

Diminishing Marginal Product 298

11.3 Costs in the Short Run 301

Fixed Costs, Variable Costs, and Total Costs 301

Ave rage Costs 301

Marginal Costs 302

How Are These Costs Related? 302

11.4 The Shape of the Short-Run Cost Curves 305

The Relationship between Marginal Costs and Marginal Product 305

The Relationship between Marginal and Ave rage Amounts 306

The Average Total Cost Curve Is Usually U-Shaped 306

The Relationship between Marginal Costs and Average and Average Total Costs 306

11.5 Cost Curves: Short Run versus Long Run 309

Long-Run Cost Curves 309

The Shape of the Long-Run Average Total Cost Curve 310

Why Do Economies and Diseconomies of Scale Occur? 310




Problems 315

Chapter 12. Firms in Perfectly Competitive Markets 320

Learning Outcomes 32°

i2.i A Perfectly Competitive Market 321

Many Buyers and Seilers 321

Identical (Homogeneous) Products 321

Easy Entry and Exit 321

12.2 An Individual Price Taker's Demand Curve

An Individual Firm's Demand Curve

323 323

12.3 Profit Maximization 325

Revenues in a Perfectly Competitive Market 325

Total Revenue 325

Average Revenue and Marginal Revenue 325

How Do Firnis Maximize Profits? 326

Equating Marginal Revenue and Marginal Cost 326

12.4 Short-Run Profits and Losses 328

The Three-Step Method 328

Evaluating Economic Losses in the Short Run 329

Deriving the Short-Run Market Supply Curve 331

12.5 Long-Run Equilibrium 335

Economic Profits and Losses Disappear in the Long Run 335

The Long-Run Equilibrium for the Competitive Firm 335

12.6 Long-Run Supply 339

A Constant-Cost Industry 339

An Increasing-Cost Industry 339

A Decreasing-Cost Industry 342

Perfect Competition and Economic Efficiency 342




Problems 349

Chapter-13. Monopoly and Antitrust 354


13.1 Monopoly: The Price Maker 355

What Is a Monopoly? 355

Pure Monopoly Is a Rarity 355

Barriens to Entry 356

13.2 Demand and Marginal Revenue in Monopoly 359

The Monopolist's Price in the Elastic Portion of the Demand Curve 362

13.3 The Monopolist^ Equilibrium 363

How Does the Monopolist Determine the Profit-Maximizing Output? 363

The Three-Step Method for the Monopolist 364

Profits for a Monopolist 364

Losses for the Monopolist 364

Patents 365

13.4 Monopol/ and Weifare Loss 368

Does Monopoly Promote Inefficiency? 368

Does Monopoly Retard Innovation? 369

13.5 Monopol/ Polle/ 371

Antitrust Policies 371

Antitrust Laws 372

Have Antitrust Policies Been Successful? 372

Government Regulation 373

Public Ownership 375

13.6 Price Discrimination 377

Price Discrimination 377

Conditions for Price Discrimination 377

Price Discrimination and the Profit-Maximization Motive 377

Examples of Price Discrimination 378




Problems 385

Chapter 14. Monopolistic Competition and Product Differentiation 390


14.1 Monopolistic Competition 391

What Is Monopolistic Competition? 391

The Three Basic Characteristics of Monopolistic Competition 392

14.2 Price and Output Determination in Monopolistic Competition 393

Determining Short-Run Equilibrium 393

Short-Run Profits and Losses in Monopolistic Competition 394

Determining Long-Run Equilibrium 395

Achieving Long-Run Equilibrium 396

14.3 Monopolistic Competition versus Perfect Competition 397

The Significance of Excess Capacity 397

Failing to Achieve Productive Efficiency 397

Failing to Meet Allocative Efficiency, Too 398

What Are the Real Costs of Monopolistic Competition? 398

14.4 Advertising 399 Why Do Firnis Advertise? 399

Is Advertising "Good" or "Bad" from Society's Perspective? 400




Problems 405

Chapter-15. Oligopoly and Strategie Behavior 408


15.1 Oligopoly 409

What Is Oligopoly? 409

Mutual Interdependence 409

Why Do Oligopolies Exist? 409

Economies of Scale as a Barrier to Entry 409

Other Barriers to Entry 410

Equilibrium Price and Quantity in Oligopoly 410

15.2 Collusion and Cartels 411

Uncertainty and Pricing Decisions 411

Collusion 412

Joint Profit Maximization 412

Why Are Most Collusive Oligopolies Short Lived? 412

15-3 Other Oligopoly Models 414

Price Leadership 414

What Happens in the Long Run if Entry Is Easy? 414

How Do Oligopolists Deter Market Entry? 415

Antitrust and Mergers 415

Antitrust and Pricing Strategies 416

Is Oligopoly Efficient? 417

15.4 Game Theory and Strategie Behavior 418

Some Strategies for Non-collusive Oligopolies 418

What Is Game Theory? 418

Cooperative and Non-cooperative Games 418

The Prisoners' Dilemma 419

Profits under Different Pricing Strategies 420

Advertising 421

Repeated Games 423

Network Externalities 423




Problems 431

Part 5. Input Markets and Microeconomic

Policy Issues 435

Chapter 16. The Markets for Labor, Capital, and Land 436


16/1 Supply and Demand in the Labor Market 437

Determining the Price of a Productive Factor: Derived Demand 437

Will Hiring That Input Add More to Revenue Than to Costs? 437

The Demand Curve for Labor Slopes Downward 438

How Many Workers Will an Employer Hire? 44°

The Market Labor Supply Curve 44">

16.2 Labor Market Equilibrium 444

Determining Equilibrium in the Competitive Labor Market 444

Shifts in the Labor Demand Curve 444

Shifting the Labor Supply Curve 44&

Monopsony 447

16.3 Labor Unions 450

Labor Unions in the United States 45°

Why Are There Labor Unions? 452

Union Impact on Labor Supply and Wages 452

Wage Differences for Similarly Skilied Workers 453

Can Unions Lead to Increased Productivity? 453

16.4 The Markets for Land and Capital 454

The Supply of and Demand for Land 454

What Causes High Rents? 454

Supply and Demand in the Capital Market 454

The Interdependence of Input Markets 455

Income Distribution and Marginal Productivity 456




Problems 460

Chapter 17. Income, Poverty, and Health Care 464


17.1 Income Distribution 465

Measuring Income Inequality 465

The Lorenz Curve 466

Are We Overstating the Disparity in the Distribution of Income? 467

Why Do Some Earn More Than Others? 469

Income Distribution in Other Countries 471

17.2 Income Redistribution 472

Equality 472

Income Redistribution Can Reduce Incentives to Work, Invest, and Save 473

Revisiting Marginal Productivity Theory 474

17-3 The Economicsof Discrimination 475

Job-Entry Discrimination 475

Wage Discrimination 475

Discrimination or Differences in Productivity? 476

Why Do People Discriminate? 477

The Costs of Discrimination 477

17.4 Poverty 479

Defining Poverty 479

Income Redistribution 480

17.5 Health Gare 483

Introduction 483

The Rising Cost of Health Care 484

The Economics of Rising Health Care Costs 485

The Health Care Market 486

Income 486

Insurance and Third-Party Payers 486

Demographic Changes 488

Obesity 488

The Supply of Health Care 488

Effects of Health Insurance 488

Technological Progress and Quality of Care 488

Shortages 489

The Market for Human Organs 490

Health Care Reform 49°




Problems 498

Part 6. The Global Economy 501

Chapter 18. International Trade 5°2

LearningOutcomes 502

18.1 The Growth in World Trade 503

Importance of International Trade 503

U.S. Exports and Imports 503

Trading Partners 504

18.2 Comparative Advantage and Gains from Trade 504

Economic Growth and Trade 504

The Principle of Comparative Advantage 505

Comparative Advantage, Specialization, and the Production Possibilities Curves 505

Why Does Comparative Advantage Occur? 509

Regional Comparative Advantage 509

18.3 Supply and Demand in International Trade 512

The Importance of Trade: Producer and Consumer Surplus 512

Free Trade and Exports—Domestic Producers Gain More Than Domestic Consumers Lose 513 Free Trade and Imports—Domestic Consumers Gain More Than Domestic Producers Lose 5H

18.4 Tariffs, Import Quotas, and Subsidies 516

Tarifs 516

The Domestic Economic Impact of Tariffs 516

Arguments for Tariffs 518

Import Quotas 519 The Domestic Economic Impact of an Import Quota 520

The Economic Impact of Subsidies 521

GATT Agreements and the World Trade Organization 521

Regional Trading Areas 522




Problems 528

Chapter 19. International Finance 532


i9-i The Balance of Payments 533

Balance of Payments 533

The Current Account 533

The Financial Account 536

19.2 Exchange Rates 538

The Need for Foreign Currencies 538

The Exchange Rate 538

Changes in Exchange Rates Affect the Domestic Demand for Foreign Goods 538

The Demand for Foreign Currency 539

The Supply of Foreign Currency 539

Determining Exchange Rates 539

The Demand Curve for Foreign Currency 539

The Supply Curve for Foreign Currency 540

Equilibrium in the Foreign Exchange Market 540

The Loanable Funds Market in an Open Economy 540

19.3 Equilibrium Changes in the Foreign Exchange Market 542

Determinants in the Foreign Exchange Market 542

Increased Tastes for Foreign Goods 542

Relative Income Increases or Reductions in U.S. Tariffs 543

Increases in European Incomes, Reductions in European Tariffs, or Changes in European Tastes 544

How Do Changes in Relative Real Interest Rates Affect Exchange Rates? 544

Changes in the Relative Inflation Rate 544

Expectations and Speculation 546

19.4 Flexible Exchange Rates 548

The Flexible Exchange Rate System 548

Are Exchange Rates Managed at All? 548

When Exchange Rates Change 548

The Advantages of Flexible Rates 54§

Fixed Exchange Rates Can Result in Currency Shortages 549

Flexible Rates Solve the Currency Shortage Problem 549

Flexible Rates Affect Macroeconomic Policies 549

The Disadvantages of Flexible Rates 55°




Problems 55&

Glossary 55&

Index 563

eighth edition exploring microeconomics

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