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www.downloadslide.com The Seven Core Principles Scarcity: Having more of one good thing usually means having less of another. Incentives Matter: Comparing cost-benefit analyses enables us to predict actual decisions people make. 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. www.mhhe.com/fb4e.com ISBN 978-0-07-336266-3 MHID 0-07-336266-2 90000 9 780073 362663 www.mhhe.com ECONOMICS Fourth Edition Frank Bernanke Efficiency: When the economic pie grows larger through efficiency, everyone can have a larger slice. PRINCIPLES OF MICRO MD DALIM #974702 7/21/08 CYAN MAG YELO BLK Comparative Advantage: Everyone does best if they concentrate on their relatively most productive activity. Fourth Edition MICRO ECONOMICS Cost-Benefit Analysis: No action should be taken unless the marginal benefit is as great as the marginal cost. Media Integrated iPod® Content Available PRINCIPLES OF Students need the ability to understand and evaluate our changing economy. Principles of Microeconomics, by Robert H. Frank and Ben S. Bernanke, provides students with the tools necessary to analyze current economic problems. By eliminating overwhelming detail and focusing on Seven Core Principles, the Fourth Edition helps students achieve a deep mastery of what is essential to understanding economics. Robert H. Frank Ben S. Bernanke fra62662_fm_i-xxxii 7/12/08 8:55PM Page i ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: www.downloadslide.com PRINCIPLES OF MICROECONOMICS Fourth Edition fra62662_fm_i-xxxii 18/7/08 1:05 PM Page ii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030: www.downloadslide.com THE MCGRAW-HILL SERIES IN ECONOMICS ESSENTIALS OF ECONOMICS ECONOMICS OF SOCIAL ISSUES MONEY AND BANKING Brue, McConnell, and Flynn Essentials of Economics Second Edition Guell Issues in Economics Today Fourth Edition Mandel Economics: The Basics First Edition Sharp, Register, and Grimes Economics of Social Issues Eighteenth Edition Cecchetti Money, Banking, and Financial Markets Second Edition Schiller Essentials of Economics Seventh Edition ECONOMETRICS PRINCIPLES OF ECONOMICS Colander Economics, Microeconomics, and Macroeconomics Seventh Edition Frank and Bernanke Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Fourth Edition Frank and Bernanke Brief Editions: Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics First Edition McConnell, Brue, and Flynn Economics, Microeconomics, and Macroeconomics Eighteenth Edition McConnell, Brue, and Flynn Brief Editions: Economics, Microeconomics, Macroeconomics First Edition Miller Principles of Microeconomics First Edition Samuelson and Nordhaus Economics, Microeconomics, and Macroeconomics Eighteenth Edition Schiller The Economy Today, The Micro Economy Today, and The Macro Economy Today Eleventh Edition Slavin Economics, Microeconomics, and Macroeconomics Ninth Edition Gujarati and Porter Basic Econometrics Fifth Edition Gujarati and Porter Essentials of Econometrics Fourth Edition MANAGERIAL ECONOMICS Baye Managerial Economics and Business Strategy Sixth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Fifth Edition Thomas and Maurice Managerial Economics Ninth Edition INTERMEDIATE ECONOMICS Bernheim and Whinston Microeconomics First Edition URBAN ECONOMICS O’Sullivan Urban Economics Seventh Edition LABOR ECONOMICS Borjas Labor Economics Fourth Edition McConnell, Brue, and Macpherson Contemporary Labor Economics Eighth Edition PUBLIC FINANCE Rosen and Gayer Public Finance Eighth Edition Seidman Public Finance First Edition ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Fifth Edition INTERNATIONAL ECONOMICS Dornbusch, Fischer, and Startz Macroeconomics Tenth Edition Appleyard, Field, and Cobb International Economics Sixth Edition Frank Microeconomics and Behavior Seventh Edition King and King International Economics, Globalization, and Policy: A Reader Fifth Edition ADVANCED ECONOMICS Romer Advanced Macroeconomics Third Edition Pugel International Economics Fourteenth Edition fra62662_fm_i-xxxii 7/12/08 8:55PM Page iii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: www.downloadslide.com PRINCIPLES OF MICROECONOMICS 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: www.downloadslide.com 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 MHID 978-0-07-336266-3 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: www.downloadslide.com 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: www.downloadslide.com ABOUT THE AUTHORS ROBERT H. FRANK BEN S. BERNANKE Professor Frank is the Henrietta Johnson Louis Professor of Management and Professor of Economics at the Johnson Graduate School of Management at Cornell University, where he has taught since 1972. His “Economic View” column appears regularly in The New York Times. After receiving his B.S. from Georgia Tech in 1966, he taught math and science for two years as a Peace Corps Volunteer in rural Nepal. He received his M.A. in statistics in 1971 and his Ph.D. in economics in 1972 from The University of California at Berkeley. During leaves of absence from Cornell, he has served as chief economist for the Civil Aeronautics Board (1978–1980), a Fellow at the Center for Advanced Study in the Behavioral Sciences (1992–93), and Professor of American Civilization at l’École des Hautes Études en Sciences Sociales in Paris (2000–01). Professor Frank is the author of a best-selling intermediate economics textbook—Microeconomics and Behavior, Seventh Edition (Irwin/McGraw-Hill, 2008). He has published on a variety of subjects, including price and wage discrimination, public utility pricing, the measurement of unemployment spell lengths, and the distributional consequences of direct foreign investment. His research has focused on rivalry and cooperation in economic and social behavior. His books on these themes, which include Choosing the Right Pond (Oxford, 1995), Passions Within Reason (W. W. Norton, 1988), and What Price the Moral High Ground? (Princeton, 2004), The Economic Naturalist (Basic Book, 2007), and Falling Behind (The University of California Press, 2007), have been translated into 15 languages. The Winner-Take-All Society (The Free Press, 1995), co-authored with Philip Cook, received a Critic’s Choice Award, was named a Notable Book of the Year by The New York Times, and was included in BusinessWeek’s list of the 10 best books of 1995. Luxury Fever (The Free Press, 1999) was named to the Knight-Ridder Best Books list for 1999. Professor Frank has been awarded an Andrew W. Mellon Professorship (1987–1990), a Kenan Enterprise Award (1993), and a Merrill Scholars Program Outstanding 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. Professor Bernanke received his B.A. in economics from Harvard University in 1975 and his Ph.D. in economics from MIT in 1979. He taught at the Stanford Graduate School of Business from 1979 to 1985 and moved to Princeton University in 1985, where he was named the Howard Harrison and Gabrielle Snyder Beck Professor of Economics and Public Affairs, and where he served as Chairman of the Economics Department. Professor Bernanke was sworn in on February 1, 2006, as Chairman and a member of the Board of Governors of the Federal Reserve System. Professor Bernanke also serves as Chairman of the Federal Open Market Committee, the System’s principal monetary policymaking body. He was appointed as a member of the Board to a full 14-year term, which expires January 31, 2020 and to a four-year term as Chairman, which expires January 31, 2010. Before his appointment as Chairman, Dr. Bernanke was Chairman of the President’s Council of Economic Advisers from June 2005 to January 2006. Professor Bernanke’s intermediate textbook, with Andrew Abel, Macroeconomics, Sixth Edition (AddisonWesley, 2008), is a best seller in its field. He has authored more than 50 scholarly publications in macroeconomics, macroeconomic history, and finance. He has done significant research on the causes of the Great Depression, the role of financial markets and institutions in the business cycle, and measuring the effects of monetary policy on the economy. Professor Bernanke has held a Guggenheim Fellowship and a Sloan Fellowship, and he is a Fellow of the Econometric Society and of the American Academy of Arts and Sciences. He served as the Director of the Monetary Economics Program of the National Bureau of Economic Research (NBER) and as a member of the NBER’s Business Cycle Dating Committee. In July 2001, he was appointed Editor of the American Economic Review. Professor Bernanke’s work with civic and professional groups includes having served two terms as a member of the Montgomery Township (N.J.) Board of Education. fra62662_fm_i-xxxii 18/7/08 1:07 PM Page vii VK TeamA:Desktop Folder:TEMPWORK:July:18/07/08:MHBR030: www.downloadslide.com PREFACE ■ lthough many millions of dollars are spent each year on introductory 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 coverage than minor ones, and everything ends up going by in a blur. Many instructors 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 validity 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 examples 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 naturalists,” people who employ basic economic principles to understand and explain 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 typically zero in cars but often hundreds of dollars in airplanes. Scores of such examples 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 economics is like learning a language. In each case, there is no substitute for actually 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”). A vii fra62662_fm_i-xxxii 7/14/08 4:22PM Page viii ntt 204:MHBR030:mhfra4_Main(Micro):fra4fm: www.downloadslide.com 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 contrast, traditional encyclopedic texts so overwhelm students with detail that they often leave the course with little useful working knowledge at all. Scarcity 1 The Scarcity Principle: Having more of one good thing usually means having less of another. Cost-Benefit 2 The Cost-Benefit Principle: Take no action unless its marginal benefit is at least as great as its marginal cost. Incentive 3 The Incentive Principle: Cost-benefit comparisons are relevant not only for identifying the decisions that rational people should make, but also for predicting the actual decisions they do make. Comparative Advantage 4 The Principle of Comparative Advantage: Everyone does best when each 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 lowest opportunity cost before turning to those with higher opportunity costs. Increasing Opportunity Cost 6 The Efficiency Principle: Efficiency is an important social goal because when the economic pie grows larger, everyone can have a larger slice. Efficiency 7 The Equilibrium Principle: A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action. Equilibrium ■ Economic naturalism: Our ultimate goal is to produce economic naturalists— people who see each human action as the result of an implicit or explicit costbenefit calculation. The economic naturalist sees mundane details of ordinary existence in a new light and becomes actively engaged in the attempt to understand 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 frequent 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 employed 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: www.downloadslide.com PREFACE 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 simple principles from the economics of information form another exciting addition 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 remains 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 edition 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 economists 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 objectives, 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 ix