Principles of Microeconomics Textbook PDF Fourth Edition

Students need the ability to understand and evaluate our changing economy. Media Integrated Principles of Microeconomics, by Robert H. Frank and Ben S. Bernanke, provides stu-...

Students need the ability to understand and evaluate our changing economy. Media Integrated Principles of Microeconomics, by Robert H. Frank and Ben S. Bernanke, provides stu- iPod® Content Available Fourth dents with the tools necessary to analyze current economic problems. By eliminating Edition overwhelming detail and focusing on Seven Core Principles, the Fourth Edition helps students achieve a deep mastery of what is essential to understanding economics. PRINCIPLES OF The Seven Core Principles PRINCIPLES OF MICRO Scarcity: Having more of one good thing usually means having less of another. Cost-Benefit Analysis: No action should be taken unless the marginal benefit is as great as the marginal cost. ECONOMICS MICRO ECONOMICS Fourth Edition Incentives Matter: Comparing cost-benefit analyses enables us to predict actual decisions people make. MD DALIM #974702 7/21/08 CYAN MAG YELO BLK Comparative Advantage: Everyone does best if they concentrate on their relatively most productive activity. Increasing Opportunity Cost: Resources with the lowest opportunity cost should be used before turning to those with higher opportunity costs. Equilibrium: A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action. Efficiency: When the economic pie grows larger through efficiency, everyone Bernanke Frank can have a larger slice. www.mhhe.com/fb4e.com Robert H. Frank ISBN 978-0-07-336266-3 MHID 0-07-336266-2 90000 Ben S. Bernanke 9 780073 362663 www.mhhe.com fra62662_fm_i-xxxii 7/12/08 8:55PM Page i ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: PRINCIPLES OF MICRO- ECONOMICS Fourth Edition fra62662_fm_i-xxxii 18/7/08 1:05 PM Page ii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030: THE MCGRAW-HILL SERIES IN ECONOMICS ESSENTIALS OF ECONOMICS ECONOMICS OF SOCIAL ISSUES MONEY AND BANKING Brue, McConnell, and Flynn Guell Cecchetti Essentials of Economics Issues in Economics Today Money, Banking, and Financial Second Edition Fourth Edition Markets Second Edition Mandel Sharp, Register, and Grimes Economics: The Basics Economics of Social Issues URBAN ECONOMICS First Edition Eighteenth Edition O’Sullivan Schiller ECONOMETRICS Urban Economics Essentials of Economics Seventh Edition Seventh Edition Gujarati and Porter Basic Econometrics LABOR ECONOMICS PRINCIPLES OF ECONOMICS Fifth Edition Borjas Colander Gujarati and Porter Labor Economics Economics, Microeconomics, and Essentials of Econometrics Fourth Edition Macroeconomics Fourth Edition Seventh Edition McConnell, Brue, and Macpherson MANAGERIAL ECONOMICS Contemporary Labor Economics Frank and Bernanke Eighth Edition Principles of Economics, Principles of Baye Microeconomics, Principles of Managerial Economics and Business PUBLIC FINANCE Macroeconomics Strategy Fourth Edition Sixth Edition Rosen and Gayer Public Finance Frank and Bernanke Brickley, Smith, and Zimmerman Eighth Edition Brief Editions: Principles of Managerial Economics and Economics, Principles of Organizational Architecture Seidman Microeconomics, Principles of Fifth Edition Public Finance Macroeconomics First Edition Thomas and Maurice First Edition Managerial Economics ENVIRONMENTAL ECONOMICS McConnell, Brue, and Flynn Ninth Edition Field and Field Economics, Microeconomics, and Environmental Economics: An Macroeconomics INTERMEDIATE ECONOMICS Introduction Eighteenth Edition Bernheim and Whinston Fifth Edition McConnell, Brue, and Flynn Microeconomics Brief Editions: Economics, First Edition INTERNATIONAL ECONOMICS Microeconomics, Macroeconomics Dornbusch, Fischer, and Startz Appleyard, Field, and Cobb First Edition Macroeconomics International Economics Miller Tenth Edition Sixth Edition Principles of Microeconomics Frank King and King First Edition Microeconomics and Behavior International Economics, Globaliza- Samuelson and Nordhaus Seventh Edition tion, and Policy: A Reader Economics, Microeconomics, and Fifth Edition ADVANCED ECONOMICS Macroeconomics Pugel Eighteenth Edition Romer International Economics Advanced Macroeconomics Fourteenth Edition Schiller Third Edition The Economy Today, The Micro Economy Today, and The Macro Economy Today Eleventh Edition Slavin Economics, Microeconomics, and Macroeconomics Ninth Edition fra62662_fm_i-xxxii 7/12/08 8:55PM Page iii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: PRINCIPLES OF MICRO- ECONOMICS Fourth Edition ROBERT H. FRANK Cornell University BEN S. BERNANKE Princeton University [affiliated] Chairman, Board of Governors of the Federal Reserve System with special contribution by LOUIS D. JOHNSTON College of Saint Benedict | Saint John’s University Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis Bangkok Bogotá Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto fra62662_fm_i-xxxii 7/14/08 4:56PM Page iv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: PRINCIPLES OF MICROECONOMICS Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2009, 2007, 2004, 2001 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 QPD/QPD 0 9 8 ISBN 978-0-07-336266-3 MHID 0-07-336266-2 Design of book: The images in the design of this book are based on elements of the architecture of Frank Lloyd Wright, specifically from the leaded glass windows seen in many of his houses. Wright’s design was rooted in nature and based on simplicity and harmony. His windows use elemental geometry to abstract natural forms, complementing and framing the natural world outside. This concept of seeing the world through an elegantly structured framework ties in nicely to the idea of framing one’s view of the world through the window of economics. The typeface used for some of the elements was taken from the Arts and Crafts movement. The typeface, as well as the color palette, bring in the feeling of that movement in a way that complements the geometric elements of Wright’s windows. The Economic Naturalist icon is visually set apart from the more geometric elements but is a representation of the inspirational force behind all of Wright’s work. Editor-in-chief: Brent Gordon Publisher: Douglas Reiner Developmental editor: Angela Cimarolli Senior marketing manager: Melissa Larmon Senior project manager: Susanne Riedell Senior production supervisor: Debra R. Sylvester Lead designer: Matthew Baldwin Senior photo research coordinator: Jeremy Cheshareck Photo researcher: Robin Sand Senior media project manager: Cathy Tepper Cover design: Matt Diamond Cover image: © Jill Braaten Typeface: 10/12 Sabon Roman Compositor: Aptara, Inc. Printer: Quebecor World Dubuque Inc. Library of Congress Cataloging-in-Publication Data Frank, Robert H. Principles of microeconomics / Robert H. Frank, Ben S. Bernanke ; with special contribution by Louis D. Johnston.—4th ed. p. cm.—(The McGraw-Hill series in economics) Includes index. ISBN-13: 978-0-07-336266-3 (alk. paper) ISBN-10: 0-07-336266-2 (alk. paper) 1. Microeconomics. I. Bernanke, Ben S. II. Johnston, Louis (Louis Dorrance) III. Title. HB172.F72 2009 338.5—dc22 2008026579 www.mhhe.com fra62662_fm_i-xxxii 7/14/08 10:07PM Page v ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: DEDICATION For Ellen R. H. F. For Anna B. S. B. fra62662_fm_i-xxxii 7/12/08 8:55PM Page vi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: ABOUT THE AUTHORS ROBERT H. FRANK BEN S. BERNANKE Professor Frank is the Professor Bernanke received Henrietta Johnson Louis Pro- his B.A. in economics from fessor of Management and Harvard University in 1975 Professor of Economics at and his Ph.D. in economics the Johnson Graduate from MIT in 1979. He School of Management at taught at the Stanford Grad- Cornell University, where he uate School of Business from has taught since 1972. His 1979 to 1985 and moved “Economic View” column to Princeton University in appears regularly in The 1985, where he was named New York Times. After re- the Howard Harrison and ceiving his B.S. from Georgia Tech in 1966, he taught math Gabrielle Snyder Beck Professor of Economics and Public and science for two years as a Peace Corps Volunteer in Affairs, and where he served as Chairman of the Economics rural Nepal. He received his M.A. in statistics in 1971 and Department. his Ph.D. in economics in 1972 from The University of Professor Bernanke was sworn in on February 1, 2006, California at Berkeley. During leaves of absence from Cor- as Chairman and a member of the Board of Governors of nell, he has served as chief economist for the Civil Aero- the Federal Reserve System. Professor Bernanke also serves nautics Board (1978–1980), a Fellow at the Center for as Chairman of the Federal Open Market Committee, the Advanced Study in the Behavioral Sciences (1992–93), and System’s principal monetary policymaking body. He was Professor of American Civilization at l’École des Hautes appointed as a member of the Board to a full 14-year term, Études en Sciences Sociales in Paris (2000–01). which expires January 31, 2020 and to a four-year term as Professor Frank is the author of a best-selling intermedi- Chairman, which expires January 31, 2010. Before his ap- ate economics textbook—Microeconomics and Behavior, pointment as Chairman, Dr. Bernanke was Chairman of the Seventh Edition (Irwin/McGraw-Hill, 2008). He has pub- President’s Council of Economic Advisers from June 2005 lished on a variety of subjects, including price and wage dis- to January 2006. crimination, public utility pricing, the measurement of Professor Bernanke’s intermediate textbook, with unemployment spell lengths, and the distributional conse- Andrew Abel, Macroeconomics, Sixth Edition (Addison- quences of direct foreign investment. His research has fo- Wesley, 2008), is a best seller in its field. He has authored cused on rivalry and cooperation in economic and social more than 50 scholarly publications in macroeconomics, behavior. His books on these themes, which include Choos- macroeconomic history, and finance. He has done significant ing the Right Pond (Oxford, 1995), Passions Within Reason research on the causes of the Great Depression, the role of fi- (W. W. Norton, 1988), and What Price the Moral High nancial markets and institutions in the business cycle, and Ground? (Princeton, 2004), The Economic Naturalist (Basic measuring the effects of monetary policy on the economy. Book, 2007), and Falling Behind (The University of Califor- Professor Bernanke has held a Guggenheim Fellowship nia Press, 2007), have been translated into 15 languages. The and a Sloan Fellowship, and he is a Fellow of the Econo- Winner-Take-All Society (The Free Press, 1995), co-authored metric Society and of the American Academy of Arts and with Philip Cook, received a Critic’s Choice Award, was Sciences. He served as the Director of the Monetary named a Notable Book of the Year by The New York Times, Economics Program of the National Bureau of Economic and was included in BusinessWeek’s list of the 10 best books Research (NBER) and as a member of the NBER’s Business of 1995. Luxury Fever (The Free Press, 1999) was named to Cycle Dating Committee. In July 2001, he was appointed the Knight-Ridder Best Books list for 1999. Editor of the American Economic Review. Professor Professor Frank has been awarded an Andrew Bernanke’s work with civic and professional groups includes W. Mellon Professorship (1987–1990), a Kenan Enterprise having served two terms as a member of the Montgomery Award (1993), and a Merrill Scholars Program Outstanding Township (N.J.) Board of Education. Educator Citation (1991). He is a co-recipient of the 2004 Leontief Prize for Advancing the Frontiers of Economic Thought. He was awarded the Johnson School’s Stephen Russell Distinguished Teaching Award in 2004 and the School’s Apple Distinguished Teaching Award in 2005. His introductory microeconomics course has graduated more than 7,000 enthusiastic economic naturalists over the years. fra62662_fm_i-xxxii 18/7/08 1:07 PM Page vii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030: PREFACE lthough many millions of dollars are spent each year on introductory A economics instruction in American colleges and universities, the return on this investment has been disturbingly low. Studies have shown, for example, that several months after having taken a principles of economics course, former students are no better able to answer simple economic questions than others who never even took the course. Most students, it seems, leave our introductory courses without having learned even the most important basic economic principles. The problem, in our view, is that these courses almost always try to teach students far too much. In the process, really important ideas get little more cov- erage than minor ones, and everything ends up going by in a blur. Many instruc- tors ask themselves, “How much can I cover today?” when instead they should be asking, “How much can my students absorb?” Our textbook grew out of our conviction that students will learn far more if we attempt to cover much less. Our basic premise is that a small number of basic principles do most of the heavy lifting in economics, and that if we focus narrowly and repeatedly on those principles, students can actually master them in just a single semester. The enthusiastic reactions of users of our first three editions affirm the va- lidity of this premise. Although recent editions of a few other texts now pay lip service to the less-is-more approach, ours is by consensus the most carefully thought-out and well-executed text in this mold. Avoiding excessive reliance on formal mathematical derivations, we present concepts intuitively through ex- amples drawn from familiar contexts. We rely throughout on a well-articulated list of seven core principles, which we reinforce repeatedly by illustrating and applying each principle in numerous contexts. We ask students periodically to apply these principles themselves to answer related questions, exercises, and problems. Throughout this process, we encourage students to become “economic nat- uralists,” people who employ basic economic principles to understand and ex- plain what they observe in the world around them. An economic naturalist understands, for example, that infant safety seats are required in cars but not in airplanes because the marginal cost of space to accommodate these seats is typ- ically zero in cars but often hundreds of dollars in airplanes. Scores of such ex- amples are sprinkled throughout the book. Each one, we believe, poses a question that should make any normal, curious person eager to learn the answer. These examples stimulate interest while teaching students to see each feature of their economic landscape as the reflection of one or more of the core principles. Students talk about these examples with their friends and families. Learning eco- nomics is like learning a language. In each case, there is no substitute for actu- ally speaking. By inducing students to speak economics, the economic naturalist examples serve this purpose. For those who are interested in lerning more about the role of examples in learning economics, Bob Frank’s lecture on the topic is posted on You Tube’s “Authors @ Google” series (http://www.youtube.com/watch?vQalNVxeIKEE or search “Authors @ Google Robert Frank”). vii fra62662_fm_i-xxxii 7/14/08 4:22PM Page viii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: viii PREFACE FEATURES An emphasis on seven core principles: As noted, a few core principles do most of the work in economics. By focusing almost exclusively on these principles, the text assures that students leave the course with a deep mastery of them. In con- trast, traditional encyclopedic texts so overwhelm students with detail that they often leave the course with little useful working knowledge at all. 1 The Scarcity Principle: Having more of one good thing usually means hav- Scarcity ing less of another. 2 The Cost-Benefit Principle: Take no action unless its marginal benefit is at Cost-Benefit least as great as its marginal cost. 3 The Incentive Principle: Cost-benefit comparisons are relevant not only for Incentive identifying the decisions that rational people should make, but also for pre- dicting the actual decisions they do make. 4 The Principle of Comparative Advantage: Everyone does best when each Comparative Advantage concentrates on the activity for which he or she is relatively most productive. 5 The Principle of Increasing Opportunity Cost: Use the resources with the low- Increasing est opportunity cost before turning to those with higher opportunity costs. Opportunity Cost 6 The Efficiency Principle: Efficiency is an important social goal because when Efficiency the economic pie grows larger, everyone can have a larger slice. 7 The Equilibrium Principle: A market in equilibrium leaves no unexploited Equilibrium opportunities for individuals but may not exploit all gains achievable through collective action. Economic naturalism: Our ultimate goal is to produce economic naturalists— people who see each human action as the result of an implicit or explicit cost- benefit calculation. The economic naturalist sees mundane details of ordinary existence in a new light and becomes actively engaged in the attempt to under- stand them. Some representative examples: Why are whales and elephants, but not chickens, threatened with extinction? Why do we often see convenience stores located on adjacent street corners? Why do supermarket checkout lines all tend to be roughly the same length? Active learning stressed: The only way to learn to hit an overhead smash in tennis is through repeated practice. The same is true for learning economics. Accordingly, we consistently introduce new ideas in the context of simple examples and then follow them with applications showing how they work in familiar settings. At fre- quent intervals, we pose exercises that both test and reinforce the understanding of these ideas. The end-of-chapter questions and problems are carefully crafted to help students internalize and extend core concepts. Experience with our first three editions confirms that this approach really does prepare students to apply basic economic principles to solve economic puzzles drawn from the real world. Modern Microeconomics: Economic surplus, introduced in Chapter 1 and em- ployed repeatedly thereafter, is more fully developed here than in any other text. This concept underlies the argument for economic efficiency as an important social goal. Rather than speak of trade-offs between efficiency and other goals, we stress that maximizing economic surplus facilitates the achievement of all goals. Common decision pitfalls identified by 2002 Nobel Laureate Daniel Kahneman and others—such as the tendency to ignore implicit costs, the fra62662_fm_i-xxxii 7/14/08 4:22PM Page ix ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: PREFACE ix tendency not to ignore sunk costs, and the tendency to confuse average and marginal costs and benefits—are introduced early in Chapter 1 and invoked repeatedly in subsequent chapters. There is perhaps no more exciting toolkit for the economic naturalist than a few principles of elementary game theory. In Chapter 10, we show how these principles enable students to answer a variety of strategic questions that arise in the marketplace and everyday life. We believe that the insights of Nobel Laureate Ronald Coase are indispensable for understanding a host of familiar laws, customs, and social norms. In Chapter 11 we show how such devices function to minimize misallocations that result from externalities. A few sim- ple principles from the economics of information form another exciting addi- tion to the economic naturalist’s toolkit. In Chapter 12 we show how the insights that earned the 2001 Nobel Prize in economics for George Akerlof, Joseph Stiglitz, and Michael Spence can be employed to answer a variety of questions from everyday experience. IMPROVEMENTS Our less-is-more approach is well-suited for a wide spectrum of institutions. Yet it re- mains a formidable challenge for any single book to fit the needs and capabilities of all students across these diverse institutions. Some students arrive with AP credit in advanced calculus, while others still lack confidence in basic geometry and algebra. Guided by extensive reviewer feedback, our main goal in preparing our fourth edi- tion has been to reorganize our presentation to accommodate the broadest possible range of student preparation. For example, while continuing to emphasize verbal and graphical approaches in the main text, we offer several appendices that allow for more detailed and challenging algebraic treatments of the same material. Among the hundreds of specific refinements we made, the following merit explicit mention. More and clearer emphasis on the core principles: If we asked a thousand econ- omists to provide their own versions of the most important economic principles, we’d get a thousand different lists. Yet to dwell on their differences would be to miss their essential similarities. It is less important to have exactly the best short list of principles than it is to use some well-thought-out list of this sort. Integrated the outsourcing and international trade material from (previously) Chapter 9 into the discussions within: Chapter 2: Comparative Advantage Chapter 28: International Trade and Capital Flows Chapter learning objectives: Students and professors can be confident that the organization of each chapter surrounds common themes outlined by five to seven learning objectives listed on the first page of each chapter. These objec- tives, along with AACSB and Bloom’s Taxonomy Learning Categories, are connected to all test Bank questions and end-of-chapter material to offer a comprehensive, thorough teaching and learning experience. Assurance of learning ready: Many educational institutions today are focused on the notion of assurance of learning, an important element of some accreditation standards. Principles of Microeconomics, 4e is designed specifically to support your assurance of learning initiatives with a simple, yet powerful, solution. You can use our test bank software, EZTest, to easily query for Learning Objectives that directly relate to the objectives for your course. You can then fra62662_fm_i-xxxii 7/14/08 4:22PM Page x ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: x PREFACE use the reporting features of EZTest to aggregate student results in a similar fashion, making the collection and presentation of assurance of learning data simple and easy. THE CHALLENGE The world is a more competitive place now than it was when we started teaching in the 1970s. In arena after arena, business as usual is no longer good enough. Base- ball players used to drink beer and go fishing during the off season, but they now lift weights and ride exercise bicycles. Assistant professors used to work on their houses on weekends, but the current crop can now be found most weekends at the office. The competition for student attention has grown similarly more intense. There are many tempting courses in the typical college curriculum and even more tempting diversions outside the classroom. Students are freer than ever to pick and choose. Yet many of us seem to operate under the illusion that most freshmen arrive with a burning desire to become economics majors. And many of us do not yet seem to have recognized that students’ cognitive abilities and powers of concentra- tion are scarce resources. To hold our ground, we must become not only more se- lective in what we teach, but also more effective as advocates for our discipline. We must persuade students that we offer something of value. A well-conceived and well-executed introductory course in economics can teach our students more about society and human behavior in a single term than virtually any other course in the university. This course can and should be an intel- lectual adventure of the first order. Not all students who take the kind of course we envisioned when writing this book will go on to become economics majors, of course. But many will, and even those who do not will leave with a sense of admi- ration for the power of economic ideas. A salesperson knows that he or she often gets only one chance to make a good first impression on a potential customer. Analogously, the principles course is often our only shot at persuading most students to appreciate the value of economics. By trying to teach them everything we know—rather than teaching them the most im- portant things we know—we too often squander this opportunity. SUPPLEMENTS FOR THE INSTRUCTOR McGraw-Hill’s Homework Manager Plus™: McGraw-Hill’s Homework Man- ager Plus is a complete, Web-based solution that includes and expands upon the actual problem sets found at the end of each chapter. It features enhanced technology that provides a varied supply of auto-graded assignments and graphing exercises, tied to the learning objectives in the book. McGraw-Hill’s Homework Manager can be used for student practice, graded homework assignments, and formal examinations; the results are easily integrated with your course management system, including WebCT and Blackboard. Instructor’s Manual: Prepared by Louis D. Johnston of the College of Saint Benedict | Saint John’s University, this expanded manual will be extremely use- ful for all teachers. In addition to such general topics as Using the Web Site, Economic Education Resources, and Innovative Ideas, there will be for each chapter: An Overview, Core Principles, Important Concepts Covered, Teach- ing Objectives, Teaching Tips/Student Stumbling Blocks, More Economic Nat- uralists, In-Class and Web Activities, Annotated Chapter Outline, Answers to Textbook Problems, Sample Homework, and a Sample Reading Quiz. fra62662_fm_i-xxxii 18/7/08 1:09 PM Page xi VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030: PREFACE xi Test Bank: Prepared by Kate Krause of the University of New Mexico, this manual contains more than 2,000 questions categorized by chapter Learn- ing Objectives, AACSB learning categories, and Bloom’s Taxonomy Objec- tives. The test bank is available in the latest EZTest test-generating software, ensuring maximum flexibility in test preparation. PowerPoints: Prepared by Carol Swartz of the University of North Carolina- Charlotte, these slides contain a detailed, chapter-by-chapter review of the important ideas presented in the textbook, accompanied by animated graphs and slide notes. Customizable Micro Lecture Notes and PowerPoints: One of the biggest hurdles to an instructor considering changing textbooks is the prospect of having to prepare new lecture notes and slides. For the microeconomics chapters, this hurdle no longer exists. A full set of lecture notes for princi- ples of microeconomics, prepared by Bob Frank for his award-winning introductory microeconomics course at Cornell University, is available as Microsoft Word files that instructors are welcome to customize as they see fit. The challenge for any instructor is to reinforce the lessons of the text in lectures without generating student unrest by merely repeating what’s in the book. These lecture notes address that challenge by constructing examples that run parallel to those presented in the book, yet are different from them in interesting contextual ways. Also available is a complete set of richly illustrated PowerPoint files to accompany these lecture notes. Instructors are also welcome to customize these files as they wish. Instructor’s CD-ROM: This remarkable Windows software program con- tains the complete Instructor’s Manual with solutions to the end-of-chapter problems, Solman Videos, Computerized Test Bank, PowerPoints, and the complete collection of art from the text. Online Learning Center (www.mhhe.com/fb4e): The contents of the IRCD are available online at the textbook’s Web site for quick download and con- venient access for professors anytime. SUPPLEMENTS FOR THE STUDENT Study Guide: Revised by Louis D. Johnson of the College of Saint Benedict | Saint John’s University, this book contains for each chapter a pre-test; a “Key Point Review” that integrates the learning objectives with the chapter con- tent; a self-test with matching and multiple choice problems; short answer problems; and an Economic Naturalist case study that helps students apply what they learned. Online Learning Center (www.mhhe.com/fb4e): For students there are such useful features as the Glossary from the textbook; Graphing Exercises, PowerPoints, a set of study and practice quizzes. Premium Content: The Online Learning Center now offers students the op- portunity to purchase premium content. Like an electronic study guide, the OLC Premium Content enables students to take self-grading quizzes for each chapter as well as to download Frank and Bernanke-exclusive iPod content including podcasts by Brad Schiller, narrated lecture slides, and Paul Solman EN 2 videos—all accessible through the student’s MP3 device. In the chapter when fra62662_fm_i-xxxii 18/7/08 1:12 PM Page xii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030: xii PREFACE you see an iPod icon, there is a podcast that correlates to that material. The label EN stands for Economic Naturalist, and the number represents the chapter number. A NOTE ON THE WRITING OF THIS EDITION Ben Bernanke was sworn in on February 1, 2006, as Chairman and a mem- ber of the Board of Governors of the Federal Reserve System. From June 2005 until January 2006, he served as chairman of the President’s Council of Economic Advisers. These positions have allowed him to play an active role in making U.S. economic policy, but the rules of government service have re- stricted his ability to participate in the preparation of the Fourth Edition. Fortunately, we were able to enlist the aid of Louis D. Johnston of the College of Saint Benedict | Saint John’s University to take the lead in re- vising the macro portions of the book and to assist Robert Frank in re- vising the micro portions of the book. Ben Bernanke and Robert Frank express their deep gratitude to Louis for the energy and creativity he has brought to his work on the book. He has made the book a better tool for students and professors. ACKNOWLEDGMENTS Our thanks first and foremost go to our publisher, Douglas Reiner, and our develop- ment editor, Angela Cimarolli. Douglas encouraged us to think deeply about how to improve the book and helped us transform our ideas into concrete changes. Angie shepherded us through the revision process in person, on the telephone, through the mail, and via e-mail with intelligence, sound advice, and good humor. We are grate- ful as well to the production team, whose professionalism (and patience) was out- standing: Susanne Riedell, senior project manager; Matthew Baldwin, designer; Debra Sylvester, senior production supervisor; Jeremy Cheshareck, senior photo re- search coordinator; and all of those who worked on the production team to turn our manuscript into the book you hold in your hands. Finally, we also thank Melissa Lar- mon, senior marketing manager, for getting our message into the wider world. Finally, our sincere thanks to the following teachers and colleagues, whose thorough reviews and thoughtful suggestions led to innumerable substantive improvements. Adel Abadeer, Calvin College Frank Albritton, Seminole Community College Cynthia Abadie, Southwest Tennessee Community College Rashid Al-Hmoud, Texas Tech University Hesham Abdel-Rahman, University of New Orleans Farhad Ameen, SUNY - Westchester Community College Teshome Abebe, Eastern Illinois University Mauro C. Amor, Northwood University Roger L. Adkins, Marshall University Nejat Anbarci, Florida International Richard Agesa, Marshall University University fra62662_fm_i-xxxii 7/12/08 8:55PM Page xiii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: PREFACE xiii Giuliana Campanelli Andreopoulos, Denis G. Carter, University of North William Paterson University Carolina, Wilmington Michael Applegate, Oklahoma State Shawn Carter, Jacksonville State University University Becca Arnold, Mesa College Peter Cashel-Cordo, University of Southern Indiana Mohsen Bahmani-Oskooee, University of Wisconsin-Milwaukee Andrew Cassey, University of Minnesota Sudeshna Bandyopadhyay, West Virginia University Rebecca Chakraborty, Northwood University Gyanendra Baral, Oklahoma City Community College Joni S. Charles, Texas State University–San Marcos James Bartkus, Xavier University Adhip Chaudhuri, Georgetown University Hamid Bastin, Shippensburg University Richard Cherrin, Delaware Technical & Community College John H. Beck, Gonzaga University Eric P. Chiang, Florida Atlantic Klaus Becker, Texas Tech University University Doris Bennett, Jacksonville State Unk Christiadi, University of the University Pacific, Stockton Derek Berry, Calhoun Community James Cobbe, Florida State College University Tom Beveridge, Durham Technical Howard Cochran, Belmont Community College University Okmyung Bin, East Carolina Jeffrey P. Cohen, University of University Hartford Robert G. Bise, Orange Coast College Barbara Connolly, Westchester John Bishop, East Carolina University Community College John L. Brassel, Southwest Jim Couch, University of North Tennessee Community College Alabama William J. Brennan, Minnesota State Elizabeth Crowell, University of University at Mankato Michigan–Dearborn Jozell Brister, Abilene Christian William Dawes, SUNY at Stony University Brook Taggert Brooks, University of Matthew Dawson, Charleston Wisconsin–La Crosse Southern University Christopher Burkart, University of Marcelin W. Diagne, Towson West Florida University Joseph Calhoun, Florida State Vernon J. Dobis, Minnesota State University University, Moorhead Colleen Callahan, American Amrik Singh Dua, Mt. San Antonio University College fra62662_fm_i-xxxii 7/12/08 8:55PM Page xiv ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: xiv PREFACE Tran Dung, Wright State University Mehdi Haririan, Bloomsburg University of Pennsylvania Faruk Eray Duzenli, Bowling Green State University Robert Harris, Indiana University- Purdue University Indianapolis Angela Dzata, Alabama State University Tina J. Harvell, Blinn College Dennis S. Edwards, Coastal Joe Haslag, University of Missouri Carolina University Philip S. Heap, James Madison Ishita Edwards, Oxnard College University Ceyhun Elgin, University of George Heitmann, Muhlenberg Minnesota College Paul Emberton, Texas State John Hejkal, University of Iowa University Mickey Hepner, University of Jim Fain, Oklahoma State University Central Oklahoma Nick Feltovich, University of Houston Michael J. Hilmer, San Diego State William J. Field, DePauw University University Harold Steven Floyd, Manatee George E. Hoffer, Virginia Community College Commonwealth University Charles Fraley, Cincinnati State Carol Hogan, University of Technical and Community College Michigan–Dearborn Johanna Francis, Fordham University James Holcomb, University of Texas Dan Friesner, Gonzaga University at El Paso Marc Fusaro, East Carolina Lora Holcombe, Florida State University University Mary N. Gade, Oklahoma State Calvin Hoy, County College of Morris University Yu Hsing, Southeastern Louisiana S. N. 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Rec- ognizing the importance and value of AACSB accreditation, the author of Principles of Microeconomics, 4e has sought to recognize the curricula guidelines detailed in AACSB standards for business accreditation by connecting questions in the test bank and end-of-chapter material to the general knowledge and skill guidelines found in the AACSB standards. It is important to note that the statements contained in Principles of Microeconomics, 4e are provided only as a guide for the users of this text. fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxi ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: BRIEF CONTENTS Preface vii PART 1 Introduction 1 Thinking Like an Economist 3 2 Comparative Advantage 35 3 Supply and Demand 61 PART 2 Competition and the Invisible Hand 4 Elasticity 97 5 Demand 125 6 Perfectly Competitive Supply 150 7 Efficiency and Exchange 175 8 The Invisible Hand in Action 203 PART 3 Market Imperfections 9 Monopoly, Oligopoly, and Monopolistic Competition 233 10 Games and Strategic Behavior 269 11 Externalities and Property Rights 297 12 The Economics of Information 325 PART 4 Economics of Public Policy 13 Labor Markets, Poverty, and Income Distribution 349 14 The Environment, Health, and Safety 375 15 Public Goods and Tax Policy 397 Glossary G-1 Index I-1 xxi fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: CONTENTS Preface vii PART I Introduction Chapter 1 Thinking Like an Economist 3 Economics: Studying Choice in a World of Scarcity 4 Applying the Cost-Benefit Principle 6 Economic Surplus 6 Opportunity Cost 7 The Role of Economic Models 7 Three Important Decision Pitfalls 8 Pitfall 1: Measuring Costs and Benefits as Proportions Rather Than Absolute Dollar Amounts 9 Pitfall 2: Ignoring Implicit Costs 9 Pitfall 3: Failure to Think at the Margin 11 Normative Economics versus Positive Economics 15 Economics: Micro and Macro 15 The Approach of This Text 16 Economic Naturalism 17 EXAMPLE 1.1 THE ECONOMIC NATURALIST: Why do many hardware manufacturers include more than $1,000 worth of “free” software with a computer selling for only slightly more than that? 17 EXAMPLE 1.2 THE ECONOMIC NATURALIST: Why don’t auto manufacturers make cars without heaters? 18 EXAMPLE 1.3 THE ECONOMIC NATURALIST: Why do the keypad buttons on drive-up automatic teller machines have Braille dots? 18 Summary 19 Core Principles 20 Key Terms 20 Review Questions 20 Problems 20 Answers to In-Chapter Exercises 22 Appendix: Working with Equations, Graphs, and Tables 23 Chapter 2 Comparative Advantage 35 Exchange and Opportunity Cost 36 The Principle of Comparative Advantage 37 EXAMPLE 2.1 THE ECONOMIC NATURALIST: Where have all the 400 hitters gone? 39 Sources of Comparative Advantage 40 EXAMPLE 2.2 THE ECONOMIC NATURALIST: Televisions and videocassette recorders were developed and first produced in the United States, but today the United xxii fra62662_fm_i-xxxii 7/12/08 8:55PM Page xxiii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: CONTENTS xxiii States accounts for only a minuscule share of the total world production of these products. Why did the United States fail to retain its lead in these markets? 41 Comparative Advantage and Production Possibilities 41 The Production Possibilities Curve 41 How Individual Productivity Affects the Slope and Position of the PPC 44 The Gains from Specialization and Exchange 46 A Production Possibilities Curve for a Many-Person Economy 47 Factors That Shift the Economy’s Production Possibilities Curve 49 Why Have Some Countries Been Slow to Specialize? 51 Can We Have Too Much Specialization? 52 Comparative Advantage and International Trade 53 EXAMPLE 2.3 THE ECONOMIC NATURALIST: If trade between nations is so beneficial, why are free-trade agreements so controversial? 53 Outsourcing 53 EXAMPLE 2.4 THE ECONOMIC NATURALIST: Is PBS economics reporter Paul Solman’s job a likely candidate for outsourcing? 54 Summary 56 Core Principles 56 Key Terms 56 Review Questions 57 Problems 57 Answers to In-Chapter Exercises 58 Chapter 3 Supply and Demand 61 What, How, and for Whom? Central Planning versus the Market 63 Buyers and Sellers in Markets 64 The Demand Curve 65 The Supply Curve 66 Market Equilibrium 68 Rent Controls Reconsidered 71 Pizza Price Controls? 73 Predicting and Explaining Changes in Prices and Quantities 74 Shifts in Demand 75 EXAMPLE 3.1 THE ECONOMIC NATURALIST: When the federal government implements a large pay increase for its employees, why do rents for apartments located near Washington Metro stations go up relative to rents for apartments located far away from Metro stations? 77 Shifts in the Supply Curve 78 EXAMPLE 3.2 THE ECONOMIC NATURALIST: Why do major term papers go