Intermediate Microeconomics

1 Intermediate MicroeconomicsA Modern ApproachNinth EditionIntermediateMicroeconomicsA Modern ApproachNinth EditionHal R. VarianUniversity of California at BerkeleyW. W. Norton & Company New York LondonW. W. Norton & Company has been independent since its founding in 1923,when William Warder Norton and Mary D. Herter Norton first published lec-tures delivered at the People s Institute, the adult education division of NewYork City s Cooper Union. The firm soon expanded its program beyond the In-stitute, publishing books by celebrated academics from America and abroad. Bymid-century, the two major pillars of Norton s publishing program trade booksand college texts were firmly established.

2 In the 1950s, the Norton family trans-ferred control of the company to its employees, and today with a staff of fourhundred and a comparable number of trade, college, and professional titles pub-lished each year W. W. Norton & Company stands as the largest and oldestpublishing house owned wholly by its 2014, 2010, 2006, 2003, 1999, 1996, 1993, 1990, 1987 by Hal rights reservedPrinted in the United States of AmericaNINTH EDITIONE ditor: Jack RepcheckSenior project editor: Thom FoleyProduction manager: Andy EnsorEditorial assistant: Theresia KowaraTEXnician: Hal VarianISBN 978-0-393--W. W. Norton & Company, Inc., 500 Fifth Avenue, New York, 10110W. W. Norton & Company, Ltd., Castle House, 75/76 Wells Street, London W1T CarolCONTENTSP refacexix1 The MarketConstructing a Model1 Optimization and Equilibrium3 The De-mand Curve3 The Supply Curve5 Market Equilibrium7 Com-parative Statics9 Other Ways to Allocate Apartments11 The Dis-criminating Monopolist The Ordinary Monopolist Rent Control Which Way Is Best?

3 14 Pareto Efficiency15 Comparing Ways to Al-locate Apartments16 Equilibrium in the Long Run17 Summary18 Review Questions192 Budget ConstraintThe Budget Constraint20 Two Goods Are Often Enough21 Prop-erties of the Budget Set22 How the Budget Line Changes24 TheNumeraire26 Taxes, Subsidies, and Rationing26 Example: TheFood Stamp ProgramBudget Line Changes31 Summary31 ReviewQuestions32 VIIICONTENTS3 PreferencesConsumer Preferences34 Assumptions about Preferences35 Indif-ference Curves36 Examples of Preferences37 Perfect Substitutes Perfect Complements Bads Neutrals Satiation DiscreteGoods Well-Behaved Preferences44 The Marginal Rate of Substitu-tion48 Other Interpretations of the MRS50 Behavior of the MRS51 Summary52 Review Questions524 UtilityCardinal Utility57 Constructing a Utility Function58 Some Exam-ples of Utility Functions59 Example.

4 Indifference Curves from UtilityPerfect Substitutes Perfect Complements Quasilinear Preferences Cobb-Douglas Preferences Marginal Utility65 Marginal Utilityand MRS66 Utility for Commuting67 Summary69 ReviewQuestions70 Appendix70 Example: Cobb-Douglas Preferences5 ChoiceOptimal Choice73 Consumer Demand78 Some Examples78 Perfect Substitutes Perfect Complements Neutrals and Bads Discrete Goods Concave Preferences Cobb-Douglas Preferences Estimating Utility Functions83 Implications of the MRS Condition85 Choosing Taxes87 Summary89 Review Questions89 Appen-dix90 Example: Cobb-Douglas Demand Functions6 DemandNormal and Inferior Goods96 Income Offer Curves and Engel Curves97 Some Examples99 Perfect Substitutes Perfect Complements Cobb-Douglas Preferences Homothetic Preferences QuasilinearPreferences Ordinary Goods and Giffen Goods104 The Price OfferCurve and the Demand Curve106 Some Examples107 PerfectSubstitutes Perfect Complements A Discrete Good Substitutesand Complements111 The Inverse Demand Function112 Summary114 Review Questions115 Appendix115 CONTENTSIX7 Revealed PreferenceThe Idea of Revealed Preference119 From Revealed Preference to Pref-erence120 Recovering Preferences122 The Weak Axiom of Re-vealed Preference124 Checking WARP125 The

5 Strong Axiom ofRevealed Preference128 How to Check SARP129 Index Numbers130 Price Indices132 Example: Indexing Social Security PaymentsSummary135 Review Questions1358 Slutsky EquationThe Substitution Effect137 Example: Calculating the Substitution Ef-fectThe Income Effect141 Example: Calculating the Income EffectSign of the Substitution Effect142 The Total Change in Demand143 Rates of Change144 The Law of Demand147 Examples of Incomeand Substitution Effects147 Example: Rebating a Tax Example:Voluntary Real Time PricingAnother Substitution Effect153 Com-pensated Demand Curves155 Summary156 Review Questions157 Appendix157 Example: Rebating a Small Tax9 Buying and SellingNet and Gross Demands160 The Budget Constraint161 Changingthe Endowment163 Price Changes164 Offer Curves and DemandCurves167 The Slutsky Equation Revisited168 Use of the Slut-sky Equation172 Example: Calculating the Endowment Income EffectLabor Supply173 The Budget Constraint Comparative Statics ofLabor Supply174 Example: Overtime and the Supply of LaborSum-mary178 Review Questions179 Appendix179 XCONTENTS10 Intertemporal ChoiceThe Budget Constraint182 Preferences for Consumption185 Com-parative Statics186 The Slutsky Equation and Intertemporal Choice187 Inflation189 Present Value.

6 A Closer Look191 Analyz-ing Present Value for Several Periods193 Use of Present Value194 Example: Valuing a Stream of Payments Example: The True Cost ofa Credit Card Example: Extending CopyrightBonds198 Exam-ple: Installment LoansTaxes200 Example: Scholarships and Sav-ingsChoice of the Interest Rate201 Summary202 Review Ques-tions20211 Asset MarketsRates of Return203 Arbitrage and Present Value205 Adjustmentsfor Differences among Assets205 Assets with Consumption Returns206 Taxation of Asset Returns207 Market Bubbles208 Applica-tions209 Depletable Resources When to Cut a Forest Example:Gasoline Prices during the Gulf WarFinancial Institutions213 Sum-mary214 Review Questions215 Appendix21512 UncertaintyContingent Consumption217 Example: Catastrophe BondsUtilityFunctions and Probabilities222 Example: Some Examples of UtilityFunctionsExpected Utility223 Why Expected Utility Is Reasonable224 Risk Aversion226 Example: The Demand for InsuranceDi-versification230 Risk Spreading230 Role of the Stock Market231 Summary232 Review Questions232 Appendix233 Example:The Effect of Taxation on Investment in Risky Assets13 Risky AssetsMean-Variance Utility236 Measuring Risk241 Counterparty Risk243 Equilibrium in a Market for Risky Assets243 How ReturnsAdjust245 Example.

7 Value at Risk Example: Ranking Mutual FundsSummary249 Review Questions250 CONTENTSXI14 Consumer s SurplusDemand for a Discrete Good252 Constructing Utility from Demand253 Other Interpretations of Consumer s Surplus254 From Con-sumer s Surplus to Consumers Surplus255 Approximating a Continu-ous Demand255 Quasilinear Utility255 Interpreting the Change inConsumer s Surplus256 Example: The Change in Consumer s SurplusCompensating and Equivalent Variation258 Example: Compensatingand Equivalent Variations Example: Compensating and Equivalent Vari-ation for Quasilinear PreferencesProducer s Surplus262 Benefit-CostAnalysis264 Rationing Calculating Gains and Losses266 Sum-mary267 Review Questions267 Appendix268 Example: AFew Demand Functions Example: CV, EV, and Consumer s Surplus15 Market DemandFrom Individual to Market Demand270 The Inverse Demand Function272 Example: Adding Up Linear Demand CurvesDiscrete Goods273 The Extensive and the Intensive Margin273 Elasticity274 Example: The Elasticity of a Linear Demand CurveElasticity and De-mand276 Elasticity and Revenue277 Example: Strikes and ProfitsConstant Elasticity Demands280 Elasticity and Marginal Revenue281 Example.

8 Setting a PriceMarginal Revenue Curves283 Income Elas-ticity284 Summary285 Review Questions286 Appendix287 Example: The Laffer Curve Example: Another Expression for Elasticity16 EquilibriumSupply293 Market Equilibrium293 Two Special Cases294In-verse Demand and Supply Curves295 Example: Equilibrium with Lin-ear CurvesComparative Statics297 Example: Shifting Both CurvesTaxes298 Example: Taxation with Linear Demand and SupplyPass-ing Along a Tax302 The Deadweight Loss of a Tax304 Example:The Market for Loans Example: Food Subsidies Example: Subsidies inIraqPareto Efficiency310 Example: Waiting in LineSummary313 Review Questions313 XIICONTENTS17 MeasurementSummarize data316 Example: Simpson s paradoxTest320 Esti-mating demand using experimental data320 Effect of treatment321 Estimating demand using observational data322 Functional form Statistical model Estimation Identification324 What can gowrong?

9 326 Policy evaluation327 Example: Crime and policeSummary328 Review Questions32918 AuctionsClassification of Auctions331 Bidding Rules Auction Design332 Example: Goethe s auctionOther Auction Forms336 Example: LateBidding on eBayPosition Auctions338 Two Bidders More ThanTwo Bidders Quality Scores Should you advertise on your brand?341 Auction revenue and number of bidders342 Problems with Auc-tions343 Example: Taking Bids Off the WallThe Winner s Curse344 Stable Marriage Problem345 Mechanism Design346 Sum-mary348 Review Questions34919 TechnologyInputs and Outputs350 Describing Technological Constraints351 Examples of Technology352 Fixed Proportions Perfect Substi-tutes Cobb-Douglas Properties of Technology354 The MarginalProduct356 The Technical Rate of Substitution356 DiminishingMarginal Product357 Diminishing Technical Rate of Substitution357 The Long Run and the Short Run358 Returns to Scale358Ex-ample: Datacenters Example: Copy Exactly!

10 Summary361 ReviewQuestions362 CONTENTSXIII20 Profit MaximizationProfits363 The Organization of Firms365 Profits and Stock MarketValue365 The Boundaries of the Firm367 Fixed and Variable Fac-tors368 Short-Run Profit Maximization368 Comparative Statics370 Profit Maximization in the Long Run371 Inverse Factor DemandCurves372 Profit Maximization and Returns to Scale373 RevealedProfitability374 Example: How Do Farmers React to Price Supports?Cost Minimization378 Summary378 Review Questions379Ap-pendix38021 Cost MinimizationCost Minimization382 Example: Minimizing Costs for Specific Tech-nologiesRevealed Cost Minimization386 Returns to Scale and theCost Function387 Long-Run and Short-Run Costs389 Fixed andQuasi-Fixed Costs391 Sunk Costs391 Summary392 ReviewQuestions392 Appendix39322 Cost CurvesAverage Costs396 Marginal Costs398 Marginal Costs and VariableCosts4