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FM.qxd10/5/131:36 AMPage iMICROECONOMICSFIFTH EDITIONDAV I D A . B E S A N KONorthwestern University,Kellogg School of ManagementRONALD R. BRAEUTIGAMNorthwestern University,Department of Economicswith Contributions fromMichael J. GibbsThe University of Chicago,Booth School of Business

FM.qxd10/5/131:36 AMPage iiTo our wives . . .Maureen and Jan. . . and to our childrenSuvarna and Eric, Justin, and JulieVICE PRESIDENT & PUBLISHEREXECUTIVE EDITORPROJECT EDITORASSISTANT EDITORSENIOR EDITORIAL ASSISTANTSENIOR CONTENT MANAGERSENIOR PRODUCTION EDITORCREATIVE DIRECTORSENIOR DESIGNERPHOTO RESEARCHERDIRECTOR OF MARKETINGASSISTANT MARKETING MANAGERSENIOR PRODUCT DESIGNERPRODUCT DESIGNERMEDIA SPECIALISTCOVER PHOTOGeorge HoffmanJoel HollenbeckJennifer ManiasCourtney LuzziErica HorowitzDorothy SinclairSandra DumasHarry NolanMadelyn LesureKathleen PepperAmy ScholzPuja KatariwalaAllison MorrisGreg ChaputElena Santa Maria Cseh Dániel/Getty ImagesThis book was set in 10/12 Janson Text LT Std by Laserwords Private Limited and printed and bound byR.R. Donnelley/Jefferson City. The cover was printed by RR Donnelley/Jefferson City.This book is printed on acid-free paper. qCopyright 2014, 2011, 2008, 2005, 2002 John Wiley & Sons, Inc. All rights reserved. No part of thispublication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic,mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorizationthrough payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive,Danvers, MA 01923, website Requests to the Publisher for permission should be addressed to thePermissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, (201) 748-6011, fax(201) 748-6008, website copies are provided to qualified academics and professionals for review purposes only, for use in theircourses during the next academic year. These copies are licensed and may not be sold or transferred to a thirdparty. Upon completion of the review period, please return the evaluation copy to Wiley. Return instructions anda free of charge return shipping label are available at Outside of the United States,please contact your local representative.To order books or for customer service, please call 1-800-CALL WILEY (225-5945).Main Book ISBN:978-1-118-57227-6Binder-Ready Version ISBN: 978-1-118-48887-4Printed in the United States of America10 9 8 7 6 5 4 3 2 1

FM.qxd10/9/135:47 PMPage iiiABOUT THE AUTHORSDAV I D B E S A N KO is the Alvin J. Huss Distinguished Professor of Management andStrategy at the Kellogg School of Management at Northwestern University. From 2007 to 2009he served as Senior Associate Dean for Academic Affairs: Strategy and Planning and from 2001to 2003 served as Senior Associate Dean for Academic Affairs: Curriculum and Teaching.Professor Besanko received his AB in Political Science from Ohio University in 1977, his MSin Managerial Economics and Decision Sciences from Northwestern University in 1980, andhis PhD in Managerial Economics and Decision Sciences from Northwestern University in1982. Before joining the Kellogg faculty in 1991, Professor Besanko was a member of the faculty of the School of Business at Indiana University from 1982 to 1991. In addition, in 1985, heheld a postdoctorate position on the Economics Staff at Bell Communications Research.Professor Besanko teaches courses in the fields of Management and Strategy, CompetitiveStrategy, and Managerial Economics. In 1995 and 2010, the graduating classes at Kelloggnamed Professor Besanko the L.G. Lavengood Professor of the Year, the highest teachinghonor a faculty member at Kellogg can receive. He is only one of two faculty members ofKellogg to have received this award twice. At the Kellogg School, he has also received theAlumni Choice Teaching Award in 2006, the Sidney J. Levy Teaching Award (1998, 2000, 2009,2011) the Chair’s Core Teaching Award (1999, 2001, 2003, 2005), and Certificate of Impactawards from students (2009, 2010, 2011, 2012, 2013).Professor Besanko does research on topics relating to competitive strategy, industrial organization, the theory of the firm, and economics of regulation. He has published two booksand over 40 articles in leading professional journals in economics and business, including theAmerican Economic Review, Econometrica, the Quarterly Journal of Economics, the RAND Journal ofEconomics, the Review of Economic Studies, and Management Science. Professor Besanko is aco-author of Economics of Strategy with David Dranove, Mark Shanley, and Scott Schaefer.RONALD R. BRAEUTIGAM is the Harvey Kapnick Professor of Business Institutionsin the Department of Economics at Northwestern University. He is currently Associate Provostfor Undergraduate Education, and he has served as Associate Dean for Undergraduate Studiesin the Weinberg College of Arts and Sciences. He received a BS in Petroleum Engineering fromthe University of Tulsa in 1970 and then attended Stanford University, where he received an MSin engineering and a PhD in Economics in 1976. He has taught at Stanford University and theCalifornia Institute of Technology, and he has also held an appointment as a Senior ResearchFellow at the Wissenschaftszentrum Berlin (Science Center Berlin). He also has worked in bothgovernment and industry, beginning his career as a petroleum engineer with Standard Oil ofIndiana. He served as research economist in The White House Office of TelecommunicationsPolicy and as an economic consultant to Congress, many government agencies, and private firmson matters of pricing, costing, managerial strategy, antitrust, and regulation.Professor Braeutigam has received many teaching awards, including the NorthwesternUniversity Alumni Association Excellence in Teaching Award (1991), and recognition as aCharles Deering McCormick Professor of Teaching Excellence at Northwestern (1997–2000),the highest teaching award that can be received by a faculty member at Northwestern.Professor Braeutigam’s research interests are in the field of microeconomics and industrialorganization. Much of his work has focused on the economics of regulation and regulatoryreform, particularly in the telephone, transportation, and energy sectors. He has publishedmany articles in leading professional journals in economics, including the American EconomicReview, the RAND Journal of Economics, the Review of Economics and Statistics, and theInternational Economic Review. Professor Braeutigam is a co-author of The Regulation Game withBruce Owen, and Price Level Regulation for Diversified Public Utilities with Jordan J. Hillman. Healso has served as President of the European Association for Research in Industrial Economics.iii

FM.qxd10/5/13iv1:36 AMPage ivA B O U T T H E AU T H O R SM I C H A E L G I B B S is Clinical Professor of Economics, and Faculty Director of theExecutive MBA Program, at the University of Chicago Booth School of Business. He also is aResearch Fellow of the Institute for the Study of Labor, and the Institute for CompensationStudies. Professor Gibbs earned his AB, AM, and PhD in Economics from the University ofChicago. He also has taught at Harvard, the University of Michigan, USC, Sciences Po (Paris),and the Aarhus School of Business (Denmark). Professor Gibbs has won several teaching and research awards. He is a leading scholar in personnel economics, publishing in journals such as theQuarterly Journal of Economics, Accounting Review, and Industrial & Labor Relations Review. Hisresearch focuses on organizational design, incentives, and the economics of personnel policies.He is co-author of the textbook Personnel Economics in Practice, with Edward Lazear. ProfessorGibbs is a Director at Cummins Western Canada and Huy Vietnam, and advisor to several startups.

FM.qxd10/9/135:47 PMPage vPREFACEAfter many years of experience teaching microeconomics at the undergraduate and MBAlevels, we have concluded that the most effective way to teach it is to present the contentwith a variety of engaging applications, coupled with an ample number of practiceproblems and exercises. The applications ground the theory in the real world, and theexercises and problems sets enable students to master the tools of economic analysis andmake them their own. The applications and the problems are combined with verbal intuition and graphs, so that they are reinforced and amplified. This approach enables studentsto see clearly the interplay of key concepts, to thoroughly grasp these concepts throughabundant practice, and to see how they apply in actual markets and business firms.Our reviewers and adopters of the first edition told us that this approach workedfor them and their students. In the second edition, we built on this approach, addingeven more applications and problems and revisiting every explanation, every graph, andevery Learning-By-Doing exercise to make sure the text was as clear as possible. In thethird edition, we continued in the spirit of the second edition, adding more current applications and problems. In fact, we added at least five problems to each chapter (nearly90 new problems in all). In the fourth edition, we added still more new problems, andwe introduced over 30 new applications. In addition, we added a new Appendix toChapter 4 that introduces the basic concepts of time value of money, such as presentand future value. Finally, every chapter now begins with a set of concrete, actionablelearning goals based on Bloom’s Taxonomy of Educational Objectives. In the fifth edition, we updated applications and chapter openers, and added new applicationsthroughout the book, many with a focus on current events. Each major section of everychapter now has at least one application. We also added new material to Chapter 15 onpay for performance and to Chapter 17 on contrasting emissions fees, emissions standards, and tradable permits. The Solution Is in the Problems. Our emphasis on practice exercises and numerous, varied problems sets this book apart from others. Based on our experience, studentsneed drills in order to internalize microeconomic theory. They need to work throughmany problems that are tangible, problems that have specific equations and numbers inthem. Anyone who has mastered a skill or a sport, whether it be piano, ballet, or golf, understands that a fundamental part of the learning process involves repetitive drills thatseemingly bear no relation tohow one would actually executeL E A R N I N G - B Y- D O I N G E X E R C I S E 2 . 6the skill under “real” conditions. Elasticities along Special Demand CurvesWe feel that drill problems in mi- Problem Q, P ( b)(P Q). Since b 10 and Q 400 10P,croeconomics serve the same (a) Suppose a constant elasticity demand curve is given when P 30,the formula Q 200P . What is the price elasticitypurpose. A student may never by30of demand? Q,P 10 ab 3400 10(30)have to do a numerical compara- (b) Suppose a linear demand curve is given by theand when P 10,Q 400 10P. What is the price elasticity oftive statics analysis after complet- formulademand at P 30? At P 10?10ing the microeconomics course. Q, P 10 ab 0.33400 10(10)SolutionHowever, having seen concretely,Note that demand is elastic at P 30, but it is inelastic at(a) Since this is a constant elasticity demand curve, thethrough the use of numbers and price elasticity of demand is equal to 1 2 everywhere P 10 (in other words, P 30 is in the elastic region ofthe demand curve, while P 10 is in the inelastic region).equations, how a shift in demand along the demand curve.(b) For this linear demand curve, we can find the priceor supply affects the equilibrium, elasticity of demand by using equation (2.4): Similar Problems: 2.5, 2.6, 2.12a student will have a deeper12v

10/5/131:36 AMviPage viP R E FAC Eappreciation for comparative statics analysis and will be better prepared to interpret eventsin real markets.Learning-By-Doing exercises, embedded in the text of each chapter, guide the student through specific numerical problems. We use three to ten Learning-By-Doingexercises in each chapter and have designed them to illustrate the core ideas of the chapter. They are integrated with the graphical and verbal exposition, so that students canclearly see, through the use of numbers and tangible algebraic relationships, what thegraphs and words are striving to teach. These exercises set the student up to do similarpractice problems as well as more difficult analytical problems at the end of each chapter.As noted above, we have added to the already complete end-of-chapter problem setsto give students and instructors more opportunity to assess student understanding.Chapters have between 20 and 35 end-of-chapter exercises. There is at least one exercise for each of the topics covered in the chapter, and the topics covered by the exercises generally follow the order of topics in the chapter. At the end of the book, thereare fully worked-out solutions to selected exercises. It Works in Theory, but Does It Work in the Real World? Numerous “realworld” examples illustrate how microeconomics applies to business decision makingand public policy issues. We begin each chapter with an extended example that introduces the key themes of the chapter and uses real markets and companies to reinforceparticular concepts and tools.Each chapter contains, on avA P P L I C A T I O N2.8erage, seven examples, calledWhat Hurricane Katrina Tells UsApplications, woven into theprices usually rise in the spring through late summer, due to warmer weather, closed schools, andAbout the Price Elasticity of Demandnarrative or highlighted insummer vacations. They are usually lower in winter.for Gasolinesidebars. In this fifth edition,Gasoline prices can also fluctuate due to changesin crude oil prices, since gasoline is refined fromwe have taken care to updatecrude oil.Gasoline prices tend to be highly volatile. Figure 2.24In addition to these factors, gasoline prices areour applications and to add toillustrates this by plotting the average retail gasolinehighly responsive to changes in supply. Prices mayprice in the United States in 2005.23 Large swings inthem, so that we now havechange dramatically if there are disruptions toprice in short periods of time are common, as arethe supply chain. Typical inventory levels of commerseasonal fluctuations. The seasonal changes areover 120 Applications. A fullcial gasoline usually amount to only a few days oflargely attributable to shifts in demand. Gasolinelist may be found on the frontendpapers of this text. Newapplicationsincludehealth care reform in theU.S., federal income taxreform, parking meterSprivatization in Chicago,Excess supplywhen priceand the bailout of theis 5Parmesan cheese indus 5try in Italy.EFIGURE 2.5Excess Demand and ExcessSupply in Market for CornIf the price of corn were 3, per bushel, excessdemand would result because 14 billion bushelswould be demanded, but only 9 billion bushelswould be supplied. If the price of corn were 5per bushel, excess supply would result because13 billion bushels would be supplied but only8 billion bushels would be demanded.Price (dollars per bushel)FM.qxd 4 Graphs Tell theStory. We use graphs 3Excessdemandwhen price is 3D8 9 11 13 14Quantity (billions of bushels per year)and tables more abundantly than most texts,because they are centralto economic analysis, enabling us to depict complex interactions simply.

FM.qxd10/5/131:36 AMPage viiviiP R E FAC EIn economics, a picture truly is worth a thousand words. In each new edition we haveworked to make the graphs even clearer and more useful for students. Get to the Point. All too often, verbal explanations of economic ideas and concepts seem convoluted and unintuitive. Tables and graphs are powerful economictools, but many students cannot interpret them readily at first. We believe our exposition of the economic intuition underlying the graphs is clear and easy to follow. Wehave worked through every line to streamline the exposition. Patient step-by-stepexplanations with examples enable even nonvisual learners to understand how graphsare constructed and what they mean.O R G A N I Z AT I O N A N D C OV E R AG EThis book is traditional in its coverage and organization. To the extent that we have madea trade-off, it is to cover traditional topics more thoroughly, as opposed to adding a broadrange of additional topics that might not easily fit into a one-quarter or one-semestermicroeconomics course. Thus an instructor teaching a one-semester microeconomicscourse could use all or nearly all of the chapters in the book, and an instructor teachinga one-quarter microeconomics or managerial economics course could use more thantwo-thirds of the chapters. The following chart shows how the book is organized.Introduction toMicroeconomics1Overview andintroductionto constrainedoptimization,equilibriumanalysis, andcomparativestatics analysis2Introductionto demandcurves, supplycurves, marketequilibrium,and elasticityConsumerTheory3Introductionto consumerchoice4Budget lines,utility maximization, andanalysis ofrevealedpreferenceProduction andCost Theory6Productionfunction,marginaland averageproduct, andreturnsto scale7Concept ofcost, inputchoice andcostminimization58Comparativestatics ofconsumerchoice andconsumersurplusConstructionof total,average, andmarginal costcurvesPerfectlyCompetitiveMarketsMonopoly andMonopsonyImperfectlyCompetitiveMarkets andStrategic BehaviorSpecial Topics9111315Profit-maximizingoutput choice by aprice-taking firmand prices in shortrun and long-runequilibriumTheories ofmonopoly andmonopsonyprice settingPrice determination in imperfectlycompetitivemarketsRisk,uncertainty,and information,including autility-theoreticapproach touncertainty anddecision treeanalysis, Insurancemarkets andasymmatric information, andauctions10Using thecompetitivemarket modelto analyzepublic policyinterventions12Price discrimination14Simultaneousmove gamesand sequentialmove games16Overview ofgeneral equilibrium theoryand economicefficiency17Externalitiesand publicgoods

FM.qxd10/5/13viii1:36 AMPage viiiP R E FAC EA LT E R N AT I V E C O U R S E D E S I G N SIn writing this book, we have tried to serve the needs of instructors teaching microeconomics in a variety of different formats and time frames. One-quarter course (10 weeks): An instructor teaching a one-quarter undergraduate microeconomics course that fully covers all of the traditionaltopics (including consumer theory and production and cost theory) wouldprobably assign Chapters 1–11. If the instructor prefers to deemphasize consumer theory or production theory, he or she might also be able to coverChapters 13 and 14. One-semester course (15 weeks): In a one-semester undergraduate course, aninstructor should be able to cover Chapters 1–15. If the course must includegeneral equilibrium theory, public goods, and externalities, then Chapter 15could be dropped and the instructor could assign Chapters 1–14, 16, and 17. Two-quarter course (20 weeks): For a two-quarter sequence (the structurewe have at Northwestern), the first quarter could cover Chapters 1–11, andthe second quarter could pick up where the first quarter left off and coverChapters 12–17. MBA-level managerial economics course (10 weeks or 15 weeks): For aone-quarter course, the instructor would probably want to skip the chapters onconsumer theory, production functions, and cost minimization (Chapters 3–6and the second half of Chapter 7) and cover Chapters 1–2, the first half ofChapter 7—economic concepts of cost—Chapter 8, and Chapters 9–14.Extending such a co

MICROECONOMICS FIFTH EDITION DAVID A. BESANKO Northwestern University, Kellogg School of Management RONALD R. BRAEUTIGAM Northwestern University, Department of Economics with Contributions from Michael J. Gibbs The University of Chicago, Booth School of Business FM.qxd 10/5/13 1:36 AM Page i

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