Second Edition MICROECONOMICS Daron Acemoglu Massachusetts Institute of Technology David Laibson Harvard University John A. List University of Chicago ß Pearson Contents PART I INTRODUCTION TO ECONOMICS 2 Evidence-Based Economics: How much do wages increase when mandatory schooling laws force people to get an extra year of schooling? 30 Chapter 1: The Principles and Practice 2.3 Economic Questions and Answers 31 of Economics 2 Summary 32 Key Terms 33 1.1 The Scope of Economics 3 Questions 33 Economic Agents and Economic Resources 3 Problems 33 Definition of Economics 4 Appendix: Constructing and Interpreting Positive Economics and Normative Economics 5 Charts and Graphs 35 Microeconomics and Macroeconomics 6 A Study about Incentives 35 1.2 Three Principles of Economics 6 Experimental Design 35 1.3 The First Principle of Economics: Describing Variables 36 Optimization 7 Cause and Effect 38 Trade-offs and Budget Constraints 8 Appendix Key Terms 41 Opportunity Cost 9 Appendix Problems 41 Cost-Benefit Analysis 10 Evidence-Based Economics: Is Facebook Chapter 3: Optimization: Döing free? 11 the Best You Can 42 1.4 The Second Principle of Economics: Equilibrium 13 3.1 Optimization: Choosing the Best Feasible The Free-Rider Problem 14 Option 43 1.5 The Third Principle of Economics: Empiricism 15 Choice & Consequence: Do People Really 1.6 Is Economics Good for You? 16 Optimize? 44 Summary 17 3.2 Optimization Application: Renting the Key Terms 17 Optimal Apartment 44 Questions 17 Before and After Comparisons 47 Problems 18 3.3 Optimization Using Marginal Analysis 48 Marginal Cost 49 Chapter 2: Economic Methods and Evidence-Based Economics: How does Economic Questions 20 location affect the rental cost of housing? 52 Summary 55 2.1 The Scientific Method 21 Key Terms 56 Models and Data 21 Questions 56 An Economic Model 23 Problems 56 Evidence-Based Economics: How much more do workers with a College education earn? 24 Chapter 4: Demand, Supply, and Means and Medians 25 Equilibrium 58 Argument by Anecdote 25 2.2 Causation and Correlation 26 4.1 Markets 59 The Red Ad Blues 26 Competitive Markets 60 Causation versus Correlation 26 4.2 How Do Buyers Behave? 61 Choice & Consequence: Spend Now and Pay Demand Curves 62 Later? 29 Willingness to Pay 62 Experimental Economics and Natural Experiments 29 xiii From Individual Demand Curves to Aggregated The Income Elasticity of Demand 10 Demand Curves 63 Letting the Data Speak: Should McDonald's Building the Market Demand Curve 64 Be Interested in Elasticities? 107 Shifting the Demand Curve 65 Summary 107 Evidence-Based Economics: How much more Key Terms 108 gasoline would people buy if its price were lower? 67 Questions 108 4.3 How Do Seilers Behave? 69 Problems 109 Supply Curves 69 Appendix: Representing Preferences Willingness to Accept 69 with Indifference Curves: Another Use From the Individual Supply Curve to the of the Budget Constraint 111 Market Supply Curve 70 Appendix Questions 113 Shifting the Supply Curve 71 Appendix Key Terms 113 4.4 Supply and Demand in Equilibrium 73 Curve Shifting in Competitive Equilibrium 75 Chapter 6: Seilers and Incentives 114 Letting the Data Speak: Technological Breakthroughs Drive Down the Equilibrium 6.1 Seilers in a Perfectly Competitive Market 115 Price of Oil 76 6.2 The Seller's Problem 115 4.5 What Would Happen If the Government Making the Goods: How Inputs Are Turned into Tried to Dictate the Price of Gasoline? 78 Outputs 116 Choice & Consequence: The Unintended The Cost of Döing Business: Introducing Cost Curves 118 Consequences of Fixing Market Prices 80 The Rewards of Döing Business: Introducing Summary 81 Revenue Curves 120 Key Terms 82 Putting It All Together: Using the Three Questions 82 Components to Do the Best You Can 121 Problems 83 Choice & Consequence: Maximizing Total Profit, Not Per-Unit Profit 123 6.3 From the Seller's Problem to the PART II FOUNDATIONS OF Supply Curve 124 MICROECONOMICS 86 Price Elasticity of Supply 124 Shutdown 125 Choice & Consequence: Marginal Decision Chapter 5: Consumers and Incentives 86 Makers Ignore Sunk Costs 127 5.1 The Buyer's Problem 87 6.4 Producer Surplus 127 What You Eike 87 6.5 From the Short Run to the Long Run 129 Prices of Goods and Services 88 Long-Run Supply Curve 130 Choice & Consequence: Absolutes Versus Choice & Consequence: Visiting a Car Percentages 88 Manufacturing Plant 130 How Much Money You Have to Spend 89 6.6 From the Firm to the Market: Long-Run 5.2 Putting It All Together 90 Competitive Equilibrium 131 Price Changes 92 Firm Entry 131 Income Changes 93 Firm Exit 133 5.3 From the Buyer's Problem to the Demand Zero Profits in the Long Run 133 Curve 94 Economic Profit Versus Accounting Profit 134 5.4 Consumer Surplus 95 Evidence-Based Economics: How would an ethanol subsidy affect ethanol producers? 135 An Empty Feeling: Loss in Consumer Surplus When Price Increases 96 Summary 138 Evidence-Based Economics: Would a smoker Key Terms 139 quit the habit for $100 per month? 97 Questions 139 5.5 Demand Elasticities 100 Problems 140 The Price Elasticity of Demand 100 Appendix: When Firms Have Different Cost The Cross-Price Elasticity of Demand 105 Structures 142 xiv Contents Chapter 7: Perfect Competition Determinants of a Country's Comparative Advantage 190 and the Invisible Hand 144 8.5 Arguments Against Free Trade 190 National Security Concems 190 7.1 Perfect Competition and Efficiency 145 Fear of Globalization 191 Social Surplus 146 Environmental and Resource Concems 191 Pareto Efficiency 147 Infant Industry Arguments 191 7.2 Extending the Reach of the Invisible Hand: The Effects of Tariffs 191 From the Individual to the Firm 148 Choice & Consequence: Tariffs Affect Trade 7.3 Extending the Reach of the Invisible Hand: Between Firms 193 Allocation of Resources Across Industries 152 Evidence-Based Economics: Will free trade 7.4 Prices Guide the Invisible Hand 154 cause you to lose your Job? 194 Deadweight Loss 156 Summary 196 Evidence-Based Economics: Do companies Key Terms 196 like Uber make use of the invisible band? 157 Questions 196 The Command Economy 161 Problems 197 Choice & Consequence: FEMA and Walmart After Katrina 161 Chapter 9: Externalities and The Central Planner 163 Public Goods 200 Choice & Consequence: Command and Control at Kmart 164 9.1 Externalities 201 7.5 Equity and Efficiency 164 A "Bröken" Invisible Hand: Negative Extemalities 202 Evidence-Based Economics: Can markets A "Bröken" Invisible Hand: Positive Extemalities 204 composed of only self-interested people Pecuniary Extemalities 206 maximize the overall well-being of society? 165 Choice & Consequence: Positive Extemalities Summary 169 in Spots You Never Imagined 206 Key Terms 169 9.2 Private Solutions to Externalities 207 Questions 169 Private Solution: Bargaining 208 Problems 170 The Coase Theorem 208 Private Solution: Döing the Right Thing 209 Chapter 8: Trade 172 9.3 Government Solutions to Externalities 210 Government Regulation: 8.1 The Production Possibilities Curve 173 Command-and-Control Policies 210 Calculating Opportunity Cost 175 Evidence-Based Economics: What can the 8.2 The Basis for Trade: Comparative govemment do to lower the number of Advantage 176 earthquakes in Oklahoma? 211 Specialization 177 Government Regulation: Market-Based Approaches 213 Absolute Advantage 177 Corrective Taxes 213 Choice & Consequence: An Experiment Corrective Subsidies 214 on Comparative Advantage 178 Letting the Data Speak: How to Value The Price of the Trade 179 Extemalities 215 8.3 Trade Between States 180 Letting the Data Speak: Pay as You Throw: Choice & Consequence: Should LeBron James Consumers Create Negative Extemalities Too! 216 Paint His Own House? 181 9.4 Public Goods 216 Economy-Wide PPC 182 Government Provision of Public Goods 218 Comparative Advantage and Specialization Choice & Consequence: The Free-Rider's Among States 183 Dilemma 218 8.4 Trade Between Countries 184 Private Provision of Public Goods 220 Determinants of Trade Between Countries 186 9.5 Common Pool Resource Goods 222 Letting the Data Speak: Fair Trade Products 187 Choice & Consequence: Tragedy of Exporting Nations: Winners and Losers 187 the Commons 223 Importing Nations: Winners and Losers 188 Choice & Consequence: The Race to Fish 224 Where Do World Prices Come From? 189 Contents XV Evidence-Based Economics: How can the Choice & Consequence: Producing Web Queen of England lower her commute time to Sites and Computer Programs 266 Wembley Stadium? 225 Labor Market Equilibrium: Supply Meets Demand 266 Summary 226 Letting the Data Speak: "Get Your Hot Key Terms 227 Dogs Here!" 266 Questions 227 Labor Demand Shifters 267 Problems 227 Factors That Stuft Labor Supply 268 Letting the Data Speak: Do Wages Really Chapter 10: The Government in the Go Down If Labor Supply Increases? 269 Economy: Taxation and Regulation 230 11.3 Wage Inequality 269 Differences in Human Capital 270 10.1 Taxation and Government Spending Choice & Consequence: Paying for Worker in the United States 231 Training 271 Where Does the Money Come From? 232 Differences in Compensating Wage Differentials 271 Why Does the Government Tax and Spend? 234 Discrimination in the Job Market 271 Choice & Consequence: The Government Choice & Consequence: Compensating Budget Constraint 235 Wage Differentials 273 Letting the Data Speak: Understanding Oranges in Wage Inequality over Time 274 Federal Income Tax Brackets 236 Letting the Data Speak: Broadband Letting the Data Speak: Reducing and Inequality 275 Inequality the Scandinavian Way 239 11.4 The Market for Other Factors Taxation: Tax Incidence