## Intermediate Microeconomic Theory

### Tools and Step-by-Step Examples

by Espinola-Arredondo, Muñoz-Garcia

### Instructor Requests

A short, rigorous introduction to intermediate microeconomic theory that offers worked-out examples, tools for solving exercises, and algebra support.

This book takes a concise, example-filled approach to intermediate microeconomic theory, focusing on worked-out examples and step-by-step solutions. Each chapter presents main theoretical models and then offers several examples and applications as well as the intuition behind each mathematical assumption and result. The book provides step-by-step tools for solving standard exercises, offering students a common approach for solving similar problems. The book walks readers through each algebra step and calculation, so only a basic background in algebra and calculus is assumed. The book includes 140 self-assessment exercises, giving students an opportunity to apply concepts from previous worked-out examples.

Topics covered include consumer theory; substitution and income effect; welfare gain or loss from a price change; and choice under uncertainty. Shifting to firm theory, the book discusses production functions, cost minimization, perfectly competitive markets, and monopolies. Two chapters on game theory provide building blocks for subsequent chapters that treat imperfect markets; games of incomplete information and auctions; contract theory; and externalities, public goods, and common pool resources. The book is suitable for use in undergraduate intermediate microeconomics courses, rigorous introduction to microeconomics courses, and master's-level microeconomics courses with an applied focus.

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Contents (pg. v)
Chapter Examples (pg. xiii)
Preface (pg. xix)
Organization of the Book (pg. xx)
How to Use This Textbook (pg. xxi)
Ancillary Materials (pg. xxii)
Acknowledgments (pg. xxii)
1. Introduction (pg. 1)
1.1 What Is Microeconomics? (pg. 1)
1.2 Comparative Statics (pg. 2)
1.3 Overview of the Book (pg. 2)
1.3.1 Consumer Theory (pg. 2)
1.3.2 Production Theory (pg. 4)
1.3.3 Markets—Putting Consumers and Producers Together (pg. 4)
1.3.4 Strategy—Let's Play Games! (pg. 5)
1.3.5 Putting Game Theory to Work (pg. 5)
1.3.6 More Market Failures—When Markets Work Well and When They Don't (pg. 6)
2. Consumer Preferences and Utility (pg. 7)
2.1 Introduction (pg. 7)
2.2 Bundles (pg. 7)
2.3 Preferences for Bundles (pg. 8)
2.3.1 Ranking Bundles with More Units (pg. 10)
2.3.2 Satiation and Bliss Points (pg. 12)
2.4 Utility Functions (pg. 14)
2.5 Marginal Utility (pg. 18)
2.5.1 Diminishing Marginal Utility (pg. 19)
2.6 Indifference Curves (pg. 20)
2.6.1 Properties of Indifference Curves (pg. 22)
2.7 Marginal Rate of Substitution (pg. 25)
2.7.1 Diminishing MRS (pg. 26)
2.8 Special Types of Utility Functions (pg. 28)
2.8.1 Perfect Substitutes (pg. 29)
2.8.2 Perfect Complements (pg. 30)
2.8.3 Cobb-Douglas (pg. 32)
2.8.4 Quasilinear (pg. 34)
2.8.5 Stone-Geary (pg. 35)
2.9 A Look at Behavioral Economics—Social Preferences (pg. 36)
2.9.1 Fehr-Schmidt Social Preferences (pg. 36)
2.9.2 Bolton and Ockenfels Social Preferences (pg. 37)
Appendix. Finding the Marginal Rate of Substitution (pg. 37)
Exercises (pg. 38)
3. Consumer Choice (pg. 45)
3.1 Introduction (pg. 45)
3.2 Budget Constraint (pg. 45)
3.3 Utility Maximization Problem (pg. 49)
3.4 Utility Maximization Problem in Extreme Scenarios (pg. 55)
3.5 Revealed Preference (pg. 57)
3.6 Kinked Budget Lines (pg. 60)
3.6.1 Quantity Discounts (pg. 60)
3.6.2 Introducing Coupons (pg. 62)
Appendix A. Applying the Lagrange Method to Solve the Utility Maximization Problem (pg. 64)
Appendix B. Expenditure Minimization Problem (pg. vi)
Relationship between the Utility Maximization Problem and the Expenditure Minimization Problem (pg. 68)
Exercises (pg. 70)
4. Substitution and Income Effects (pg. 75)
4.1 Introduction (pg. 75)
4.2 Income Changes (pg. 75)
4.2.1 Using the Derivative of Demand (pg. 76)
4.2.2 Using Income Elasticity (pg. 77)
4.2.3 Using the Income-Consumption Curve (pg. 79)
4.2.4 Using the Engel Curve (pg. 80)
4.3 Price Changes (pg. 82)
4.3.1 Using the Derivative of Demand (pg. 83)
4.3.2 Using the Price-Elasticity of Demand (pg. 83)
4.3.3 Using Price-Consumption Curves (pg. 85)
4.4 Income and Substitution Effects (pg. 87)
4.5 Putting Income and Substitution Effects Together (pg. 88)
4.5.1 Income and Substitution Effects on the Labor Market (pg. 94)
Appendix A. Not All Goods Can Be Inferior (pg. 97)
Appendix B. An Alternative Representation of Income and Substitution Effects (pg. 98)
Using Elasticities to Represent the Slutsky Equation (pg. 101)
Exercises (pg. 102)
5. Measuring Welfare Changes (pg. 107)
5.1 Introduction (pg. 107)
5.2 Consumer Surplus (pg. 107)
5.3 Compensating Variation (pg. 110)
5.4 Equivalent Variation (pg. 114)
5.5 Measuring Welfare Changes with No Income Effects (pg. 116)
Appendix. An Alternative Representation of the Compensating and Equivalent Variations (pg. 120)
A.1 Compensating Variation (pg. 120)
A.2 Equivalent Variation (pg. 122)
Exercises (pg. 124)
6. Choice under Uncertainty (pg. 127)
6.1 Introduction (pg. 127)
6.2 Lotteries (pg. 128)
6.3 Expected Value (pg. 128)
6.4 Variance (pg. 129)
6.5 Expected Utility (pg. 131)
6.6 Risk Attitudes (pg. 132)
6.6.1 Risk Aversion (pg. 132)
6.6.2 Risk Loving (pg. 134)
6.6.3 Risk Neutrality (pg. 136)
6.7 Measuring Risk (pg. 138)
6.7.2 Certainty Equivalent (pg. 139)
6.7.3 Arrow-Pratt Coefficient of Absolute Risk Aversion (pg. 140)
6.8 A Look at Behavioral Economics—Nonexpected Utility (pg. 142)
6.8.1 Weighted Utility (pg. 144)
6.8.2 Prospect Theory (pg. 145)
Exercises (pg. 148)
7. Production Functions (pg. 155)
7.1 Introduction (pg. 155)
7.2 Production Function (pg. 156)
7.3 Marginal and Average Product (pg. 157)
7.4 Relationship between APL and MPL (pg. 161)
7.5 Isoquants (pg. 163)
7.6 Marginal Rate of Technical Substitution (pg. 165)
7.7 Special Types of Production Functions (pg. 168)
7.7.1 Linear Production Function (pg. 168)
7.7.2 Fixed-Proportions Production Function (pg. 169)
7.7.3 Cobb-Douglas Production Function (pg. 170)
7.7.4 Constant Elasticity of Substitution Production Function (pg. 171)
7.8 Returns to Scale (pg. 171)
7.9 Technological Progress (pg. 173)
7.9.1 Types of Technological Progress (pg. 174)
Appendix A. MRTS as the Ratio of Marginal Products (pg. 175)
Appendix B. Elasticity of Substitution (pg. 176)
Exercises (pg. 180)
8. Cost Minimization (pg. 183)
8.1 Introduction (pg. 183)
8.2 Isocost Lines (pg. 183)
8.3 Cost-Minimization Problem (pg. 185)
8.4 Input Demands (pg. 189)
8.4.1 Input Demand—Responses (pg. 192)
8.5 Cost Functions (pg. 193)
8.6 Types of Costs (pg. 195)
8.7 Average and Marginal Cost (pg. 198)
8.7.1 Output Elasticity to Total Cost (pg. 199)
8.8 Economies of Scale, Scope, and Experience (pg. 201)
8.8.1 Economies of Scale (pg. 201)
8.8.2 Economies of Scope (pg. 203)
8.8.3 Economies of Experience (pg. 205)
Appendix. Cost-Minimization Problem—A Lagrangian Analysis (pg. 206)
Exercises (pg. 208)
9. Partial and General Equilibrium (pg. 213)
9.1 Introduction (pg. 213)
9.2 Features of Perfectly Competitive Markets (pg. 214)
9.3 Profit Maximization Problem (pg. 214)
9.4 Supply Curves (pg. 217)
9.4.1 Individual Firm Supply (pg. 217)
9.4.2 Market Supply (pg. 220)
9.5 Short-Run Supply Curve (pg. 221)
9.6 Market Equilibrium (pg. 224)
9.6.1 Short-Run Equilibrium (pg. 224)
9.6.2 Long-Run Equilibrium (pg. 225)
9.7 Producer Surplus (pg. 226)
9.8 General Equilibrium (pg. 228)
9.8.1 Equilibrium Prices (pg. 230)
9.8.2 Efficient Allocations (pg. 233)
9.8.3 Equilibrium versus Efficiency (pg. 234)
9.8.4 Adding Production to the Economy (pg. 239)
9.9 A Look at Behavioral Economics—Market Experiments (pg. 240)
Appendix. Efficient Allocations and Marginal Rate of Substitution (pg. 241)
Exercises (pg. 242)
10. Monopoly (pg. 247)
10.1 Introduction (pg. 247)
10.2 Why Do Monopolies Exist? (pg. 247)
10.3 The Monopolist's Profit Maximization Problem (pg. 249)
10.3.1 A Closer Look at Marginal Revenue (pg. 250)
10.3.2 Solving the Monopolist's Problem (pg. 253)
10.4 Common Misunderstandings of Monopoly Markets (pg. 255)
10.5 The Lerner Index and Inverse Elasticity Pricing Rule (pg. 257)
10.6 Multiplant Monopoly (pg. 260)
10.7 Welfare Analysis under Monopoly (pg. 263)
10.8 Advertising in Monopoly (pg. 266)
10.9 Monopsony (pg. 268)
Exercises (pg. 271)
11. Price Discrimination and Bundling (pg. 277)
11.1 Introduction (pg. 277)
11.2 Price Discrimination (pg. 278)
11.2.1 First-Degree Price Discrimination (pg. 279)
11.2.2 Second-Degree Price Discrimination (pg. 281)
11.2.3 Third-Degree Price Discrimination (pg. 284)
11.3 Bundling (pg. 286)
Exercises (pg. 291)
12. Simultaneous-Move Games (pg. 297)
12.1 Introduction (pg. 297)
12.2 What Is a Game? (pg. 298)
12.3 Strategic Dominance (pg. 300)
12.4 Nash Equilibrium (pg. 306)
12.5 Common Games (pg. 310)
12.6 Mixed-Strategy Nash Equilibrium (pg. 316)
12.6.1 Graphical Representation of Best Responses (pg. 321)
Exercises (pg. 323)
13. Sequential and Repeated Games (pg. 329)
13.1 Introduction (pg. 329)
13.2 Game Trees (pg. 330)
13.3 Why Don't We Just Find the Nash Equilibrium of the Game Tree? (pg. 332)
13.4 Subgame-Perfect Equilibrium (pg. 334)
13.4.1 Subgame Perfect Equilibrium in More Involved Games (pg. 335)
13.5 Repeated Games (pg. 340)
13.5.1 Finite Repetitions (pg. 340)
13.5.2 Infinite Repetitions (pg. 341)
13.6 A Look at Behavioral Economics—Cooperation in the Experimental Lab? (pg. 346)
Exercises (pg. 347)
14. Imperfect Competition (pg. 355)
14.1 Introduction (pg. 355)
14.2 Measuring Market Power (pg. 356)
14.3 Models of Imperfect Competition (pg. 357)
14.3.1 Cournot Model—Simultaneous Quantity Competition (pg. 358)
14.3.2 Bertrand Model—Simultaneous Price Competition (pg. 365)
14.3.3 Cartels and Collusion (pg. 369)
14.4 Stackelberg Model—Sequential Quantity Competition (pg. 373)
14.5 Product Differentiation (pg. 377)
Appendix. Cournot Model with N Firms (pg. 380)
Exercises (pg. 383)
15. Games of Incomplete Information and Auctions (pg. 391)
15.1 Introduction (pg. 391)
15.2 Extending Nash Equilibria to Games of Incomplete Information (pg. 392)
15.3 Auctions (pg. 396)
15.3.1 Auctions as Allocation Mechanisms (pg. 396)
15.4 Second-Price Auctions (pg. 397)
15.5 First-Price Auctions (pg. 400)
15.5.1 Privately Observed Valuations (pg. 400)
15.5.2 Equilibrium Bidding in First-Price Auctions (pg. 401)
15.5.3 Extending the First-Price Auction to N Bidders (pg. 405)
15.5.4 First-Price Auctions with Risk-Averse Bidders (pg. 407)
15.6 Efficiency in Auctions (pg. 409)
15.7 Common-Value Auctions (pg. 410)
15.8 A Look at Behavioral Economics—Experiments with Auctions (pg. 411)
Appendix. First-Price Auctions in More General Settings (pg. 412)
Exercises (pg. 414)
16. Contract Theory (pg. 419)
16.1 Introduction (pg. 419)
16.2 Moral Hazard (pg. 421)
16.2.1 Contracts When Effort Is Observable (pg. 422)
16.2.2 Contracts When Effort Is Unobservable (pg. 424)
16.2.3 Preventing Moral Hazard (pg. 428)
16.3.1 Market for Lemons (pg. 428)
16.3.2 Market for Lemons—Symmetric Information (pg. 429)
16.3.3 Market for Lemons—Asymmetric Information (pg. 429)
16.3.4 Principal-Agent Model (pg. 431)
16.3.5 Principal-Agent Model—Symmetric Information (pg. 431)
16.3.6 Principal-Agent Model—Asymmetric Information (pg. 433)
16.3.7 Principal-Agent Model—Comparing Information Settings (pg. 436)
16.3.8 Preventing Adverse Selection (pg. 438)
Appendix. Showing That PCH and ICL Hold with Equality (pg. 439)
Exercises (pg. 440)
17. Externalities and Public Goods (pg. 445)
17.1 Introduction (pg. 445)
17.2 Externalities (pg. 445)
17.2.1 Unregulated Equilibrium (pg. 446)
17.2.2 Social Optimum (pg. 448)
17.3 Restoring the Social Optimum (pg. 451)
17.3.1 Bargaining between the Affected Parties (pg. 451)
17.3.2 Government Intervention (pg. 453)
17.4 Public Goods (pg. 455)
17.4.1 A Look at Behavioral Economics—Public-Good Experiments (pg. 459)
17.5 Common-Pool Resources (pg. 459)
17.5.1 Finding Equilibrium Appropriation (pg. 460)
17.5.2 Common-Pool Resources—Joint Profit Maximization (pg. 462)
Exercises (pg. 464)
References (pg. 469)
Index (pg. 471)

#### Ana Espinola-Arredondo

Ana Espinola-Arredondo is Associate Director and Professor in the School of Economic Sciences at Washington State University.

#### Felix Muñoz-Garcia

Felix Muñ oz-Garcia is Professor in the School of Economic Sciences at Washington State University.

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