Solution Manual for Microeconomics, 9th Edition

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Instructor’s Manual
By
Duncan M. Holthausen
North Carolina State University
For
Microeconomics
Ninth Edition
Robert S. Pindyck
Massachusetts Institute of Technology
Daniel L. Rubinfeld
University of California, Berkeley

ISBN-13: 978-0-13-418486-9
ISBN-10: 0-13-418486-6
Contents
PART 1: Introduction: Markets and Prices ................................................................................ 1
Chapter 1 Preliminaries................................................................................................................... 2
Chapter 2 The Basics of Supply and Demand .................................................................................. 8
PART 2: Producers, Consumers, and Competitive Markets ...................................................... 28
Chapter 3 Consumer Behavior......................................................................................................... 29
Chapter 4 Individual and Market Demand ....................................................................................... 50
Appendix Demand Theory—A Mathematical Treatment ................................................................. 72
Chapter 5 Uncertainty and Consumer Behavior ............................................................................... 78
Chapter 6 Production ...................................................................................................................... 90
Chapter 7 The Cost of Production ................................................................................................... 102
Appendix Production and Cost Theory—A Mathematical Treatment............................................... 118
Chapter 8 Profit Maximization and Competitive Supply .................................................................. 123
Chapter 9 The Analysis of Competitive Markets.............................................................................. 141
PART 3: Market Structure and Competitive Strategy................................................................ 163
Chapter 10 Market Power: Monopoly and Monopsony...................................................................... 164
Chapter 11 Pricing with Market Power.............................................................................................. 190
Appendix The Vertically Integrated Firm ........................................................................................ 215
Chapter 12 Monopolistic Competition and Oligopoly........................................................................ 222
Chapter 13 Game Theory and Competitive Strategy .......................................................................... 251
Chapter 14 Markets for Factor Inputs ................................................................................................ 268
Chapter 15 Investment, Time, and Capital Markets ........................................................................... 280
PART 4: Information, Market Failure, and the Role of Government ........................................ 294
Chapter 16 General Equilibrium and Economic Efficiency................................................................ 295
Chapter 17 Markets with Asymmetric Information............................................................................ 310
Chapter 18 Externalities and Public Goods........................................................................................ 323
Chapter 19 Behavioral Economics……………………………………………………………………... 342

Chapter 1
Preliminaries
 Teaching Notes
Chapter 1 covers basic concepts students first saw in their introductory course but could bear some
repeating. Since most students will not have read this chapter before the first class, it is a good time to get
them talking about some of the concepts presented. You might start by asking for a definition of economics.
Make sure to emphasize scarcity and trade-offs. Remind students that the objective of economics is to
explain observed phenomena and predict behavior of consumers and firms as economic conditions change.
Ask about the differences (and similarities) between microeconomics and macroeconomics and the
difference between positive and normative analysis. Review the concept of a market and the role prices
play in allocating resources. Discussions of economic theories and models may be a bit abstract at this
point in the course, but you can lay the groundwork for a deeper discussion that might take place when
you cover consumer behavior in Chapter 3.
Section 1.3 considers real and nominal prices. Given the reliance on dollar prices in the economy, students
must understand the difference between real and nominal prices and how to compute real prices. Most
students know about the Consumer Price Index, so you might also mention other price indexes such as the
Producer Price Index and the Personal Consumption Expenditures (PCE) Price Index, which is the Fed’s
preferred inflation measure.1 It is very useful to go over some numerical examples using goods that are in
the news and/or that students often purchase such as cell phones, food, textbooks, and a college education.
In general, the first class is a good time to pique student interest in the course. It is also a good time to tell
students that they need to work hard to learn how to do economic analysis, and that memorization alone
will not get them through the course. Students must learn to think like economists, so encourage them to
work lots of problems. Also encourage them to draw graphs neatly and large enough to make them easy to
interpret. It always amazes me to see the tiny, poorly drawn graphs some students produce. It is no wonder
their answers are often incorrect. You might even suggest they bring a small ruler and colored pencils to
class so they can draw accurate diagrams.
 Questions for Review
1. It is often said that a good theory is one that can be refuted by an empirical, data-oriented
study. Explain why a theory that cannot be evaluated empirically is not a good theory.
A theory is useful only if it succeeds in explaining and predicting the phenomena it was intended to
explain. If a theory cannot be evaluated or tested by comparing its predictions to known facts and
data, then we have no idea whether the theory is valid. If we cannot validate the theory, we cannot
have any confidence in its predictions, and it is of little use.
1 The CPI and PPI are reported by the Bureau of Labor Statistics (www.bls.gov). The PCE Price Index is compiled
by the Bureau of Economic Analysis in the Commerce Department (www.bea.gov).

Chapter 1 Preliminaries 3
3
2. Which of the following two statements involves positive economic analysis and which normative?
How do the two kinds of analysis differ?
a. Gasoline rationing (allocating to each individual a maximum amount of gasoline that can be
purchased each year) is poor social policy because it interferes with the workings of the
competitive market system.
Positive economic analysis is concerned with explaining what is and predicting what will be.
Normative economic analysis describes what ought to be. Statement (a) is primarily normative
because it makes the normative assertion (i.e., a value judgment) that gasoline rationing is “poor
social policy.” There is also a positive element to statement (a), because it claims that gasoline
rationing “interferes with the workings of the competitive market system.” This is a prediction
that a constraint placed on demand will change the market equilibrium.
b. Gasoline rationing is a policy under which more people are made worse off than are made
better off.
Statement (b) is positive because it predicts how gasoline rationing affects people without
making a value judgment about the desirability of the rationing policy.
3. Suppose the price of regular-octane gasoline were 20 cents per gallon higher in New Jersey than
in Oklahoma. Do you think there would be an opportunity for arbitrage (i.e., that firms could
buy gas in Oklahoma and then sell it at a profit in New Jersey)? Why or why not?
Oklahoma and New Jersey represent separate geographic markets for gasoline because of high
transportation costs, so arbitrage is unlikely. There would be an opportunity for arbitrage only if
transportation costs were less than 20 cents per gallon. Then arbitrageurs could make a profit by
purchasing gasoline in Oklahoma, paying to transport it to New Jersey and selling it in New Jersey. If
the transportation costs were 20 cents or higher, however, no arbitrage would take place.
4. In Example 1.3, what economic forces explain why the real price of eggs has fallen while the
real price of a college education has increased? How have these changes affected consumer
choices?
The price and quantity of goods such as eggs and services, like a college education, are determined
by the interaction of supply and demand. The real price of eggs fell from 1970 to 2016 because of
either a reduction in demand (e.g., consumers switched to lower-cholesterol food), an increase in
supply due perhaps to a reduction in production costs (e.g., improvements in egg production
technology), or both. In response, the price of eggs relative to other foods decreased. The real price of
a college education rose because of either an increase in demand (e.g., the perceived value of a college
education increased, population increased), a decrease in supply due to an increase in the cost of
providing an education (increases in faculty salaries, costs of complying with new regulations, etc.),
or both.
5. Suppose that the Japanese yen rises against the U.S. dollar—that is, it will take more dollars to
buy a given amount of Japanese yen. Explain why this increase simultaneously increases the
real price of Japanese cars for U.S. consumers and lowers the real price of U.S. automobiles for
Japanese consumers.
As the value of the yen grows relative to the dollar, it takes more dollars to purchase a yen, and it
takes fewer yen to purchase a dollar. Assume that the costs of production for both Japanese and U.S.
automobiles remain unchanged. Then using the new exchange rate, the purchase of a Japanese
automobile priced in yen requires more dollars, so for U.S. consumers the real price of Japanese cars

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Pindyck/Rubinfeld, Microeconomics, Ninth Edition
4
in dollars increases. Similarly, the purchase of a U.S. automobile priced in dollars requires fewer yen,
and thus for Japanese consumers the real price of a U.S. automobile in yen decreases.
6. The price of long-distance telephone service fell from 40 cents per minute in 1996 to 22 cents
per minute in 1999, a 45% (18 cents/40 cents) decrease. The Consumer Price Index increased
by 10% over this period. What happened to the real price of telephone service?
Let the CPI for 1996 equal 100 and the CPI for 1999 equal 110, which reflects a 10% increase in the
overall price level. Now let’s find the real price of telephone service (in 1996 dollars) in each year.
The real price in 1996 is simply 40 cents. To find the real price in 1999, divide CPI1996 by CPI1999
and multiply the result by the nominal price in 1999. The result is (100/110)  22  20 cents. The real
price therefore fell from 40 to 20 cents, a 50% decline.
 Exercises
1. Decide whether each of the following statements is true or false and explain why:
a. Fast-food chains like McDonald’s, Burger King, and Wendy’s operate all over the United
States. Therefore the market for fast food is a national market.
This statement is false. People generally buy fast food locally and do not travel large distances
across the United States just to buy a cheaper fast-food meal. Because there is little potential for
arbitrage between fast-food restaurants that are located some distance from each other, there are
likely to be multiple fast-food markets across the country.
b. People generally buy clothing in the city in which they live. Therefore there is a clothing
market in, say, Atlanta that is distinct from the clothing market in Los Angeles.
This statement is mostly false. Although consumers are unlikely to travel across the country to
buy clothing, they can purchase many items online. In this way, clothing retailers in different
cities compete with each other and with online stores such as Amazon, L.L. Bean and
Zappos.com. Also, suppliers can easily move clothing from one part of the country to another.
Thus, if clothing is more expensive in Atlanta than Los Angeles, clothing companies can shift
supplies to Atlanta, which would reduce the price in Atlanta. Occasionally, there may be a
market for a specific clothing item in a faraway market that results in a great opportunity for
arbitrage, such as the market for blue jeans in the old Soviet Union.
c. Some consumers strongly prefer Pepsi and some strongly prefer Coke. Therefore there is
no single market for colas.
This statement is false. Although some people have strong preferences for a particular brand of
cola, the different brands are similar enough that they constitute one market. There are consumers
who do not have strong preferences for one type of cola, and there are consumers who may have
a preference, but who will also be influenced by price. Given these possibilities, the price of cola
drinks will not tend to differ by very much, particularly for Coke and Pepsi.
2. The following table shows the average retail price of butter and the Consumer Price Index from
1980 to 2010, scaled so that the CPI  100 in 1980.

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Pindyck/Rubinfeld, Microeconomics, Ninth Edition
6
a. Calculate the real price of butter in 1980 dollars. Has the real price increased/decreased/
stayed the same from 1980 to 2000? From 1980 to 2010?
Real price of butter in year t  1980
t
CPI
CPI  nominal price of butter in year t.
1980 1990 2000 2010
Real price of butter (1980 $) $1.88 $1.26 $1.21 $1.32
The real price of butter decreased from $1.88 in 1980 to $1.21 in 2000, and it decreased from
$1.88 in 1980 to $1.32 in 2010, although it did increase between 2000 and 2010.
b. What is the percentage change in the real price (1980 dollars) from 1980 to 2000? From
1980 to 2010?
Real price decreased by $0.67 (1.88  1.21  0.67) between 1980 and 2000. The percentage
change in real price from 1980 to 2000 was therefore (0.67/1.88)  100%  35.6%. The
decrease was $0.56 between 1980 and 2010 which, in percentage terms, is (0.56/1.88) 
100%  29.8%.
c. Convert the CPI into 1990  100 and determine the real price of butter in 1990 dollars.
To convert the CPI so that 1990  100, divide the CPI for each year by the CPI for 1990 and
multiply that result by 100. Use the formula from answer (a) and the new CPI numbers below to
find the real price of butter in 1990 dollars.
1980 1990 2000 2010
New CPI 63.07 100 131.80 137.53
Real price of butter (1990 $) $2.98 $1.99 $1.91 $2.09
d. What is the percentage change in the real price (1990 dollars) from 1980 to 2000? Compare
this with your answer in (b).

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Chapter 1 Preliminaries 7
7
b. Stated in real 1990 dollars, what is the percentage change in the real minimum wage from
1985 to the present?
The minimum wage in 1985 was $3.35. You can get a complete listing of historical minimum
wage rates from the Department of Labor, Wage and Hour Division at http://www.dol.gov/
whd/minwage/chart.htm.
Real minimum wage in 1985  1990
1985
CPI
CPI  $3.35  130.7
107.6  $3.35  $4.07 in 1990 dollars.
The real minimum wage (in 1990 dollars) therefore decreased slightly from $4.07 in 1985 to
$3.92 in 2016. This is a decrease of $4.07  3.92  $0.15, so the percentage change
is (0.15/4.07)  100%   3.69%.

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Chapter 2
The Basics of Supply and Demand
 Teaching Notes
This chapter reviews the basics of supply and demand that students should be familiar with from their
introductory economics courses. You may choose to spend more or less time on this chapter depending
on how much review your students require. Chapter 2 departs from the standard treatment of supply and
demand basics found in most other intermediate microeconomics textbooks by discussing many real-world
markets (copper, office space in New York City, wheat, gasoline, natural gas, coffee, and others) and
teaching students how to analyze these markets with the tools of supply and demand. The real-world
applications are intended to show students the relevance of supply and demand analysis, and you may
find it helpful to refer to these examples during class.
One of the most common problems students have in supply/demand analysis is confusion between a
movement along a supply or demand curve and a shift in the curve. You should stress the ceteris paribus
assumption, and explain that all variables except price are held constant along a supply or demand curve.
So movements along the demand curve occur only with changes in price. When one of the omitted factors
changes, the entire supply or demand curve shifts. You might find it useful to make up a simple linear
demand function with quantity demanded on the left and the good’s price, a competing good’s price and
income on the right. This gives you a chance to discuss substitutes and complements and also normal and
inferior goods. Plug in values for the competing good’s price and income and plot the demand curve. Then
change, say, the other good’s price and plot the demand curve again to show that it shifts. This demonstration
helps students understand that the other variables are actually in the demand function and are merely
lumped into the intercept term when we draw a demand curve. The same, of course, applies to supply
curves as well.
It is important to make the distinction between quantity demanded as a function of price, QD  D(P), and
the inverse demand function,

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Chapter 2 The Basics of Supply and Demand 9
use of elasticity information. A common source of confusion is the negative value for the price elasticity
of demand. We often talk about it as if it were a positive number. The book is careful in referring to the
“magnitude” of the price elasticity, by which it means the absolute value of the price elasticity, but students
may not pick this up on their own. I warn students that I will speak of price elasticities as if they were
positive numbers and will say that a good whose elasticity is 2 is more elastic (or greater) than one whose
elasticity is 1, even though the mathematically inclined may cringe.
Section 2.6 brings a lot of this material together because elasticities are used to derive demand and supply
curves, market equilibria are computed, curves are shifted, and new equilibria are determined. This shows
students how we can estimate the quantitative (not just the qualitative) effects of, say, a disruption in oil
supply as in Example 2.9. Unfortunately, this section takes some time to cover, especially if your students’
algebra is rusty. You’ll have to decide whether the benefits outweigh the costs.
Price controls are introduced in Section 2.7. Students usually don’t realize the full effects of price controls.
They think only of the initial effect on prices without realizing that shortages or surpluses are created, so
this is an important topic. However, the coverage here is quite brief. Chapter 9 examines the effects of
price controls and other forms of government intervention in much greater detail, so you may want to
defer this topic until then.
 Questions for Review
1. Suppose that unusually hot weather causes the demand curve for ice cream to shift to the right.
Why will the price of ice cream rise to a new market-clearing level?
Suppose the supply of ice cream is completely inelastic in the short run, so the supply curve is
vertical as shown below. The initial equilibrium is at price P1. The unusually hot weather causes the
demand curve for ice cream to shift from D1 to D2, creating short-

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10 Pindyck/Rubinfeld, Microeconomics, Ninth Edition
2. Use supply and demand curves to illustrate how each of the following events would affect the
price of butter and the quantity of butter bought and sold:
a. An increase in the price of margarine.
Butter and margarine are substitute goods for most people. Therefore, an increase in the price of
margarine will cause people to increase their consumption of butter, thereby shifting the demand
curve for butter out from D1 to D2 in Figure 2.2.a. This shift in demand causes the equilibrium
price of butter to rise from P1 to P2 and the equilibrium quantity to increase from Q1 to Q2.
Figure 2.2.a
b. An increase in the price of milk.
Milk is the main ingredient in butter. An increase in the price of milk increases the cost of
producing butter, which reduces the supply of butter. The supply curve for butter shifts from
S1 to S2 in Figure 2.2.b, resulting in a higher equilibrium price, P2 and a lower equilibrium
quantity, Q2, for butter.
Figure 2.2.b

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Chapter 2 The Basics of Supply and Demand 11
Note: Butter is in fact made from the fat that is skimmed from milk; thus butter and milk are joint
products, and this complicates things. If you take account of this relationship, your answer might
change, but it depends on why the price of milk increased. If the increase were caused by an
increase in the demand for milk, the equilibrium quantity of milk supplied would increase. With
more milk being produced, there would be more milk fat available to make butter, and the price
of milk fat would fall. This would shift the supply curve for butter to the right, resulting in a drop
in the price of butter and an increase in the quantity of butter supplied.
c. A decrease in average income levels.
Assuming that butter is a normal good, a decrease in average income will cause the demand
curve for butter to decrease (i.e., shift from D1 to D2). This will result in a decline in the
equilibrium price from P1 to P2, and a decline in the equilibrium quantity from Q1 to Q2. See
Figure 2.2.c.
Figure 2.2.c
3. If a 3% increase in the price of corn flakes causes a 6% decline in the quantity demanded, what
is the elasticity of demand?
The elasticity of demand is the percentage change in the quantity demanded divided by the
percentage change in the price. The elasticity of demand for corn flakes is therefore
% 6 2.
%

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12 Pindyck/Rubinfeld, Microeconomics, Ninth Edition
5. Explain why for many goods, the long-run price elasticity of supply is larger than the short-run
elasticity.
The price elasticity of supply is the percentage change in the quantity supplied divided by the
percentage change in price. In the short run, an increase in price induces firms to produce more by
using their facilities more hours per week, paying workers to work overtime and hiring new workers.
Nevertheless, there is a limit to how much firms can produce because they face capacity constraints
in the short run. In the long run, however, firms can expand capacity by building new plants and
hiring new permanent workers. Also, new firms can enter the market and add their output to total
supply. Hence a greater change in quantity supplied is possible in the long run, and thus the price
elasticity of supply is larger in the long run than in the short run.
6. Why do long-run elasticities of demand differ from short-run elasticities? Consider two goods:
paper towels and televisions. Which is a durable good? Would you expect the price elasticity of
demand for paper towels to be larger in the short run or in the long run? Why? What about the
price elasticity of demand for televisions?
Long-run and short-run elasticities differ based on how rapidly consumers respond to price changes
and how many substitutes are available. If the price of paper towels, a nondurable good, were to
increase, consumers might react only minimally in the short run because it takes time for people to
change their consumption habits. In the long run, however, consumers might learn to use other
products such as sponges or kitchen towels instead of paper towels. Thus, the price elasticity would
be larger in the long run than in the short run. In contrast, the quantity demanded of durable goods,
such as televisions, might change dramatically in the short run. For example, the initial result of a
price increase for televisions would cause consumers to delay purchases because they could keep
on using their current TVs longer. Eventually consumers would replace their televisions as they wore
out or became obsolete. Therefore, we expect the demand for durables to be more elastic in the short

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