Intermediate accounting 11e.pdf

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Contents
PART 1 INTRODUCTION 1
CHAPTER 1 Economic Models 3
What Is Microeconomics? 4
A Few Basic Principles 5
Uses of Microeconomics 7
Application 1.1: Economics in the Natural World? 8
Application 1.2: Is It Worth Your Time to Be Here? 9
The Basic Supply-Demand Model 10
Adam Smith and the Invisible Hand 10
Application 1.3: Remaking Blockbuster 11
David Ricardo and Diminishing Returns 13
Marginalism and Marshall’s Model of Supply and Demand 13
Market Equilibrium 15
Nonequilibrium Outcomes 15
Change in Market Equilibrium 15
How Economists Verify Theoretical Models 16
Testing Assumptions 17
Testing Predictions 17
Application 1.4: Economics According to Bono 18
The Positive-Normative Distinction 19
Application 1.5: Do Economists Ever Agree on Anything? 20
Summary 21
Review Questions 21
Problems 22
Appendix to Chapter 1 Mathematics Used in Microeconomics 26
Functions of One Variable 26
Graphing Functions of One Variable 28
Linear Functions: Intercepts and Slopes 28
Interpreting Slopes: An Example 29
Slopes and Units of Measurement 30
Changes in Slope 31
Nonlinear Functions 32
The Slope of a Nonlinear Function 33
Application 1A.1: How Does Zillow.com Do It? 34
Marginal and Average Effects 35
Calculus and Marginalism 36
ix
Application 1A.2: Can a ‘‘Flat’’ Tax Be Progressive? 37
Functions of Two or More Variables 38
Trade-Offs and Contour Lines: An Example 38
Contour Lines 39
Simultaneous Equations 41
Changing Solutions for Simultaneous Equations 41
Graphing Simultaneous Equations 42
Empirical Microeconomics and Econometrics 43
Random Influences 43
Application 1A.3 Can Supply and Demand Explain Changing
World Oil Prices? 44
The Ceteris Paribus Assumption 47
Exogenous and Endogenous Variables 47
The Reduced Form 48
Summary 49
PART 2 DEMAND 51
CHAPTER 2 Utility and Choice 53
Utility 53
Ceteris Paribus Assumption 54
Utility from Consuming Two Goods 54
Measuring Utility 55
Assumptions about Preferences 55
Completeness 55
Application 2.1: Can Money Buy Health and Happiness? 56
Transitivity 57
More Is Better: Defining an Economic ‘‘Good’’ 57
Voluntary Trades and Indifference Curves 58
Indifference Curves 58
Application 2.2: Should Economists Care about How the Mind
Works? 59
Indifference Curves and the Marginal Rate of Substitution 61
Diminishing Marginal Rate of Substitution 61
Balance in Consumption 62
Indifference Curve Maps 63
Illustrating Particular Preferences 64
A Useless Good 64
Application 2.3: Product Positioning in Marketing 65
An Economic Bad 66
Perfect Substitutes 67
Perfect Complements 67
Utility Maximization: An Initial Survey 67
Choices Are Constrained 68
An Intuitive Illustration 68
Showing Utility Maximization on a Graph 69
x CONTENTS
The Budget Constraint 69
Budget-Constraint Algebra 70
A Numerical Example 71
Utility Maximization 71
Using the Model of Choice 73
Application 2.4: Ticket Scalping 74
A Few Numerical Examples 76
Application 2.5: What’s a Rich Uncle’s Promise Worth? 77
Generalizations 80
Many Goods 80
Complicated Budget Constraints 80
Composite Goods 81
Application 2.6: Loyalty Programs 82
Summary 83
Review Questions 83
Problems 85
CHAPTER 3 Demand Curves 87
Individual Demand Functions 87
Homogeneity 88
Changes in Income 89
Normal Goods 89
Inferior Goods 90
Changes in a Good’s Price 90
Substitution and Income Effects from a Fall in Price 90
Application 3.1: Engel’s Law 91
Substitution Effect 92
Income Effect 94
The Effects Combined: A Numerical Example 94
The Importance of Substitution Effects 95
Substitution and Income Effects for Inferior Goods 96
Giffen’s Paradox 96
Application 3.2: The Consumer Price Index and Its Biases 98
An Application: The Lump-Sum Principle 100
A Graphical Approach 100
Generalizations 101
Changes in the Price of Another Good 101
Application 3.3: Why Not Just Give the Poor Cash? 102
Substitutes and Complements 104
Individual Demand Curves 105
Shape of the Demand Curve 105
Shifts in an Individual’s Demand Curve 107
Be Careful in Using Terminology 108
Two Numerical Examples 109
Perfect Complements 109
Some Substitutability 109
CONTENTS xi
Consumer Surplus 110
Demand Curves and Consumer Surplus 110
Consumer Surplus and Utility 112
Market Demand Curves 113
Construction of the Market Demand Curve 113
Application 3.4: Valuing New Goods 114
Shifts in the Market Demand Curve 115
Numerical Examples 116
A Simplified Notation 116
Elasticity 117
Use Percentage Changes 117
Linking Percentages 118
Price Elasticity of Demand 118
Values of the Price Elasticity of Demand 119
Price Elasticity and the Substitution Effect 119
Price Elasticity and Time 120
Price Elasticity and Total Expenditures 120
Application 3.5: Brand Loyalty 121
Application 3.6: Volatile Farm Prices 123
Demand Curves and Price Elasticity 124
Linear Demand Curves and Price Elasticity: A Numerical
Example 124
A Unit Elastic Curve 126
Application 3.7: An Experiment in Health Insurance 128
Income Elasticity of Demand 129
Cross-Price Elasticity of Demand 129
Some Elasticity Estimates 130
Summary 132
Review Questions 132
Problems 133
PART 3 UNCERTAINTY AND STRATEGY 137
CHAPTER 4 Uncertainty 139
Probability and Expected Value 139
Application 4.1: Blackjack Systems 141
Risk Aversion 142
Diminishing Marginal Utility 142
A Graphical Analysis of Risk Aversion 142
Willingness to Pay to Avoid Risk 144
Methods for Reducing Risk and Uncertainty 144
Insurance 145
Application 4.2: Deductibles in Insurance 147
Diversification 148
Application 4.3: Mutual Funds 150
Flexibility 151
xii CONTENTS
Application 4.4: Puts, Calls, and Black-Scholes 155
Information 156
Information Differences among Economic Actors 158
Pricing of Risk in Financial Assets 159
Application 4.5: The Energy Paradox 160
Investors’ Market Options 161
Choices by Individual Investors 162
Application 4.6: The Equity Premium Puzzle 163
Two-State Model 164
Summary 171
Review Questions 171
Problems 172
CHAPTER 5 Game Theory 175
Background 176
Basic Concepts 176
Players 176
Strategies 176
Payoffs 177
Information 177
Equilibrium 178
Illustrating Basic Concepts 178
The Prisoners’ Dilemma 178
Application 5.1: A Beautiful Mind 179
The Game in Normal Form 180
The Game in Extensive Form 180
Solving for the Nash Equilibrium 181
Dominant Strategies 182
Mixed Strategies 184
Matching Pennies 184
Solving for a Mixed-Strategy Nash Equilibrium 185
Interpretation of Random Strategies 186
Application 5.2: Mixed Strategies in Sports 187
Multiple Equilibria 188
Battle of the Sexes 188
Computing Mixed Strategies in the Battle of the Sexes 189
The Problem of Multiple Equilibria 191
Sequential Games 192
The Sequential Battle of the Sexes 192
Application 5.3: High-Definition Standards War 194
Subgame-Perfect Equilibrium 197
Backward Induction 199
Repeated Games 200
Application 5.4: Laboratory Experiments 201
Definite Time Horizon 202
Indefinite Time Horizon 202
CONTENTS xiii
Continuous Actions 204
Tragedy of the Commons 204
Shifting Equilibria 205
N-Player Games 206
Incomplete Information 206
Application 5.5: Terrorism 207
Summary 208
Review Questions 208
Problems 209
PART 4 PRODUCTION, COSTS, AND SUPPLY 213
CHAPTER 6 Production 215
Production Functions 215
Two-Input Production Function 216
Application 6.1: Every Household Is a Firm 217
Marginal Product 218
Diminishing Marginal Product 218
Marginal Product Curve 218
Average Product 219
Appraising the Marginal Product Concept 220
Isoquant Maps 220
Application 6.2: What Did U.S. Automakers Learn from the
Japanese? 221
Rate of Technical Substitution 222
The RTS and Marginal Products 223
Diminishing RTS 224
Returns to Scale 224
Adam Smith on Returns to Scale 224
Application 6.3: Engineering and Economics 225
A Precise Definition 226
Graphic Illustrations 226
Application 6.4: Returns to Scale in Beer and Wine 228
Input Substitution 229
Fixed-Proportions Production Function 229
The Relevance of Input Substitutability 230
Changes in Technology 231
Technical Progress versus Input Substitution 231
Multifactor Productivity 232
A Numerical Example of Production 233
The Production Function 233
Application 6.5: Finding the Computer Revolution 234
Average and Marginal Productivities 235
The Isoquant Map 235
Rate of Technical Substitution 237
Technical Progress 237
xiv CONTENTS
Summary 238
Review Questions 238
Problems 239
CHAPTER 7 Costs 243
Basic Concepts of Costs 244
Labor Costs 244
Capital Costs 245
Entrepreneurial Costs 245
Application 7.1: Stranded Costs and Deregulation 246
The Two-Input Case 247
Economic Profits and Cost Minimization 247
Cost-Minimizing Input Choice 247
Graphic Presentation 248
An Alternative Interpretation 248
The Firm’s Expansion Path 250
Cost Curves 250
Application 7.2: Is Social Responsibility Costly? 251
Average and Marginal Costs 253
Marginal Cost Curves 254
Average Cost Curves 255
Distinction between the Short Run and the Long Run 256
Holding Capital Input Constant 257
Types of Short-Run Costs 257
Application 7.3: Findings on Firms’ Average Costs 258
Input Inflexibility and Cost Minimization 260
Per-Unit Short-Run Cost Curves 260
Shifts in Cost Curves 262
Changes in Input Prices 262
Application 7.4: Congestion Costs 263
Technological Innovation 264
Economies of Scope 264
A Numerical Example 264
Application 7.5: Are Economies of Scope in Banking a Bad Thing? 265
Long-Run Cost Curves 266
Short-Run Costs 266
Summary 269
Review Questions 270
Problems 271
CHAPTER 8 Profit Maximization and Supply 274
The Nature of Firms 274
Why Firms Exist 274
Contracts within Firms 275
Contract Incentives 276
Firms’ Goals and Profit Maximization 276
CONTENTS xv
Profit Maximization 277
Marginalism 277
The Output Decision 277
Application 8.1: Corporate Profits Taxes and the Leveraged
Buyout Craze 278
The Marginal Revenue/Marginal Cost Rule 279
Marginalism in Input Choices 280
Marginal Revenue 281
Marginal Revenue for a Downward-Sloping Demand Curve 281
A Numerical Example 281
Marginal Revenue and Price Elasticity 282
Marginal Revenue Curve 285
Numerical Example Revisited 285
Application 8.2: Maximizing Profits from Bagels and Catalog Sales 286
Shifts in Demand and Marginal Revenue Curves 288
Supply Decisions of a Price-Taking Firm 288
Price-Taking Behavior 288
Application 8.3: How Did Airlines Respond to Deregulation? 289
Short-Run Profit Maximization 290
Application 8.4: Price-Taking Behavior 291
Showing Profits 292
The Firm’s Short-Run Supply Curve 292
The Shutdown Decision 293
Summary 294
Application 8.5: Why Is Drilling for Crude Oil Such a Boom-or-Bust
Business? 295
Review Questions 296
Problems 297
PART 5 PERFECT COMPETITION 301
CHAPTER 9 Perfect Competition in a Single Market 303
Timing of a Supply Response 303
Pricing in the Very Short Run 304
Shifts in Demand: Price as a Rationing Device 304
Applicability of the Very Short-Run Model 305
Short-Run Supply 305
Application 9.1: Internet Auctions 306
Construction of a Short-Run Supply Curve 307
Short-Run Price Determination 308
Functions of the Equilibrium Price 308
Effect of an Increase in Market Demand 309
Shifts in Supply and Demand Curves 310
Short-Run Supply Elasticity 310
Shifts in Supply Curves and the Importance of the Shape of
the Demand Curve 311
xvi CONTENTS
Shifts in Demand Curves and the Importance of the Shape
of the Supply Curve 312
A Numerical Illustration 313
Application 9.2: Ethanol Subsidies in the United States and
Brazil 314
The Long Run 316
Equilibrium Conditions 316
Profit Maximization 317
Entry and Exit 317
Long-Run Equilibrium 317
Long-Run Supply: The Constant Cost Case 318
Market Equilibrium 318
A Shift in Demand 319
Long-Run Supply Curve 319
Shape of the Long-Run Supply Curve 319
The Increasing Cost Case 320
Long-Run Supply Elasticity 321
Estimating Long-Run Elasticities of Supply 321
Can Supply Curves Be Negatively Sloped? 322
Application 9.3: How Do Network Externalities Affect Supply
Curves? 323
Consumer and Producer Surplus 324
Short-Run Producer Surplus 325
Long-Run Producer Surplus 325
Ricardian Rent 325
Economic Efficiency 326
Application 9.4: Does Buying Things on the Internet Improve
Welfare? 328
A Numerical Illustration 329
Some Supply-Demand Applications 330
Tax Incidence 330
Long-Run Incidence with Increasing Costs 332
Application 9.5: The Tobacco ‘‘Settlement’’ Is Just a Tax 334
A Numerical Illustration 335
Trade Restrictions 336
Application 9.6: The Saga of Steel Tariffs 339
Summary 340
Review Questions 340
Problems 341
CHAPTER 10 General Equilibrium and Welfare 345
A Perfectly Competitive Price System 346
Why Is General Equilibrium Necessary? 346
Disturbing the Equilibrium 346
Reestablishing Equilibrium 348
A Simple General Equilibrium Model 348
CONTENTS xvii
Application 10.1: Modeling Excess Burden with a Computer 349
The Efficiency of Perfect Competition 351
Some Numerical Examples 353
Prices, Efficiency, and Laissez-Faire Economics 355
Why Markets Fail to Achieve Economic Efficiency 356
Imperfect Competition 356
Externalities 356
Public Goods 356
Imperfect Information 357
Efficiency and Equity 357
Application 10.2: Gains from Free Trade and the NAFTA and
CAFTA Debates 358
Defining and Achieving Equity 360
Equity and Competitive Markets 360
The Edgeworth Box Diagram for Exchange 360
Mutually Beneficial Trades 361
Efficiency in Exchange 361
Contract Curve 362
Efficiency and Equity 363
Equity and Efficiency with Production 363
Money in General Equilibrium Models 364
Application 10.3: The Second Theorem of Welfare Economics 365
Nature and Function of Money 366
Money as the Accounting Standard 366
Commodity Money 367
Fiat Money and the Monetary Veil 367
Application 10.4: Commodity Money 368
Summary 369
Review Questions 370
Problems 370
PART 6 MARKET POWER 375
CHAPTER 11 Monopoly 377
Causes of Monopoly 377
Technical Barriers to Entry 377
Legal Barriers to Entry 378
Application 11.1: Should You Need a License to Shampoo
a Dog? 379
Profit Maximization 380
A Graphic Treatment 380
Monopoly Supply Curve? 381
Monopoly Profits 381
What’s Wrong with Monopoly? 382
Deadweight Loss 383
Redistribution from Consumers to the Firm 384
xviii CONTENTS
Application 11.2: Who Makes Money at Casinos? 385
A Numerical Illustration of Deadweight Loss 386
Buying a Monopoly Position 388
Price Discrimination 388
Perfect Price Discrimination 389
Market Separation 390
Application 11.3: Financial Aid at Private Colleges 391
Nonlinear Pricing 393
Application 11.4: Mickey Mouse Monopoly 396
Application 11.5: Bundling of Cable and Satellite Television
Offerings 398
Durability 399
Natural Monopolies 400
Marginal Cost Pricing and the Natural Monopoly Dilemma 400
Two-Tier Pricing Systems 402
Rate of Return Regulation 402
Application 11.6: Does Anyone Understand Telephone Pricing? 403
Summary 404
Review Questions 404
Problems 405
CHAPTER 12 Imperfect Competition 408
Overview: Pricing of Homogeneous Goods 409
Competitive Outcome 409
Perfect Cartel Outcome 409
Other Possibilities 410
Cournot Model 411
Application 12.1: Measuring Oligopoly Power 412
Nash Equilibrium in the Cournot Model 414
Comparisons and Antitrust Considerations 415
Generalizations 416
Application 12.2: Cournot in California 417
Bertrand Model 418
Nash Equilibrium in the Bertrand Model 418
Bertrand Paradox 419
Capacity Choice and Cournot Equilibrium 419
Comparing the Bertrand and Cournot Results 420
Product Differentiation 421
Market Definition 421
Bertrand Model with Differentiated Products 421
Product Selection 422
Application 12.3: Competition on the Beach 423
Search Costs 425
Advertising 426
Application 12.4: Searching the Internet 427
Tacit Collusion 428
CONTENTS xix
Application 12.5: The Great Electrical Equipment Conspiracy 429
Finite Time Horizon 430
Indefinite Time Horizon 430
Generalizations and Limitations 431
Entry and Exit 432
Sunk Costs and Commitment 433
First-Mover Advantages 433
Entry Deterrence 434
A Numerical Example 435
Limit Pricing 436
Asymmetric Information 437
Predatory Pricing 438
Application 12.6: The Standard Oil Legend 439
Other Models of Imperfect Competition 440
Price Leadership 440
Monopolistic Competition 442
Barriers to Entry 443
Summary 444
Review Questions 445
Problems 445
PART 7 INPUT MARKETS 449
CHAPTER 13 Pricing in Input Markets 451
Marginal Productivity Theory of Input Demand 451
Profit-Maximizing Behavior and the Hiring of Inputs 452
Price-Taking Behavior 452
Marginal Revenue Product 452
A Special Case: Marginal Value Product 453
Responses to Changes in Input Prices 454
Single-Variable Input Case 454
A Numerical Example 454
Application 13.1: Jet Fuel and Hybrid Seeds 455
Two-Variable Input Case 457
Substitution Effect 457
Output Effect 457
Summary of Firm’s Demand for Labor 458
Responsiveness of Input Demand to Input Price Changes 459
Ease of Substitution 459
Costs and the Output Effect 459
Input Supply 460
Application 13.2: Controversy over the Minimum Wage 461
Labor Supply and Wages 462
Equilibrium Input Price Determination 462
Shifts in Demand and Supply 463
Monopsony 464
Marginal Expense 464
xx CONTENTS
Application 13.3: Why Is Wage Inequality Increasing? 465
A Numerical Illustration 466
Monopsonist’s Input Choice 467
A Graphical Demonstration 468
Numerical Example Revisited 469
Monopsonists and Resource Allocation 469
Causes of Monopsony 470
Bilateral Monopoly 470
Application 13.4: Monopsony in the Market for Sports Stars 471
Application 13.5: Superstars 473
Summary 474
Review Questions 474
Problems 475
Appendix to Chapter 13 Labor Supply 478
Allocation of Time 478
A Simple Model of Time Use 478
The Opportunity Cost of Leisure 480
Utility Maximization 480
Application 13A.1: The Opportunity Cost of Time 481
Income and Substitution Effects of a Change in the Real Wage Rate 482
A Graphical Analysis 482
Market Supply Curve for Labor 484
Application 13A.2: The Earned Income Tax Credit 485
Summary 486
CHAPTER 14 Capital and Time 487
Time Periods and the Flow of Economic Transactions 487
Individual Savings: The Supply of Loans 488
Two-Period Model of Saving 488
A Graphical Analysis 489
A Numerical Example 490
Substitution and Income Effects of a Change in r 490
Firms’ Demand for Capital and Loans 492
Rental Rates and Interest Rates 492
Application 14.1: Do We Need Tax Breaks for Savers? 493
Ownership of Capital Equipment 494
Determination of the Real Interest Rate 494
Application 14.2: Do Taxes Affect Investment? 495
Changes in the Real Interest Rate 496
Application 14.3: Usury 497
Present Discounted Value 498
Single-Period Discounting 498
Multiperiod Discounting 498
Application 14.4: The Real Interest Rate Paradox 499
Present Value and Economic Decisions 500
Pricing of Exhaustible Resources 501
Scarcity Costs 501
CONTENTS xxi
Application 14.5: Discounting Cash Flows and Derivative
Securities 502
The Size of Scarcity Costs 503
Application 14.6: Are Any Resources Scarce? 504
Time Pattern of Resource Prices 505
Summary 505
Review Questions 506
Problems 507
Appendix to Chapter 14 Compound Interest 509
Interest 509
Compound Interest 509
Interest for One Year 509
Interest for Two Years 510
Interest for Three Years 510
A General Formula 510
Compounding with Any Dollar Amount 511
Present Discounted Value 512
An Algebraic Definition 512
Application 14A.1: Compound Interest Gone Berserk 513
General PDV Formulas 514
Discounting Payment Streams 515
An Algebraic Presentation 515
Application 14A.2: Zero-Coupon Bonds 516
Perpetual Payments 517
Varying Payment Streams 518
Calculating Yields 519
Reading Bond Tables 519
Frequency of Compounding 520
Semiannual Compounding 520
A General Treatment 521
Real versus Nominal Interest Rates 521
Application 14A.3: Continuous Compounding 522
The Present Discounted Value Approach to Investment
Decisions 523
Present Discounted Value and the Rental Rate 524
Summary 525
PART 8 MARKET FAILURES 527
CHAPTER 15 Asymmetric Information 529
Principal-Agent Model 530
Application 15.1: Principals and Agents in Franchising and
Medicine 531
Moral Hazard: Manager’s Private Information about Effort 532
Full Information About Effort 532
Incentive Schemes When Effort Is Unobservable 534
xxii CONTENTS
Problems with High-Powered Incentives 536
Application 15.2: The Good and Bad Effects of Stock Options 537
Substitutes for High-Powered Incentives 539
Manager’s Participation 539
Summing Up 540
Adverse Selection: Consumer’s Private Information about
Valuation 540
Application 15.3: Moral Hazard in the Financial Crisis 541
One Consumer Type 542
Two Consumer Types, Full Information 544
Two Consumer Types, Asymmetric Information 544
Examples 547
Agent’s Participation 548
Adverse Selection Leads to Inefficiency 548
Warranty and Insurance Contracts 548
Application 15.4: Adverse Selection in Insurance 550
Asymmetric Information in Competitive Markets 551
Moral Hazard with Several Agents 551
Auctions and Adverse Selection 551
The Market for Lemons 554
Signaling 555
Spence Education Model 555
Application 15.5: Looking for Lemons 556
Separating Equilibrium 558
Pooling Equilibria 559
Predatory Pricing and Other Signaling Games 560
Inefficiency in Signaling Games 561
Summary 561
Review Questions 562
Problems 563
CHAPTER 16 Externalities and Public Goods 566
Defining Externalities 566
Externalities between Firms 567
Externalities between Firms and People 567
Externalities between People 568
Reciprocal Nature of Externalities 568
Externalities and Allocational Efficiency 568
Application 16.1: Secondhand Smoke 569
A Graphical Demonstration 570
Property Rights, Bargaining, and the Coase Theorem 571
Costless Bargaining and Competitive Markets 572
Ownership by the Polluting Firm 572
Ownership by the Injured Firm 572
The Coase Theorem 573
Distributional Effects 573
CONTENTS xxiii
Application 16.2: Property Rights and Nature 574
The Role of Transaction Costs 575
Externalities with High Transactions Costs 575
Legal Redress 575
Taxation 576
Regulation of Externalities 576
Application 16.3: Product Liability 577
Optimal Regulation 578
Fees, Permits, and Direct Controls 578
Application 16.4: Power Plant Emissions and the Global Warming
Debate 580
Public Goods 582
Attributes of Public Goods 582
Nonexclusivity 582
Nonrivalry 583
Categories of Public Goods 583
Public Goods and Market Failure 584
Application 16.5: Ideas as Public Goods 585
A Graphical Demonstration 586
Solutions to the Public Goods Problem 587
Nash Equilibrium and Underproduction 587
Compulsory Taxation 588
The Lindahl Equilibrium 589
Revealing the Demand for Public Goods 589
Application 16.6: Fund Raising on Public Broadcasting 590
Local Public Goods 591
Voting for Public Goods 591
Majority Rule 591
Application 16.7: Referenda on Limiting Public Spending 592
The Paradox of Voting 593
Single-Peaked Preferences and the Median Voter Theorem 594
Voting and Efficient Resource Allocation 595
Representative Government and Bureaucracies 595
Summary 596
Review Questions 597
Problems 597
CHAPTER 17 Behavioral Economics 601
Should We Abandon Neoclassical Economics? 602
Limits to Human Decision Making: An Overview 603
Limited Cognitive Power 604
Uncertainty 605
Application 17.1: Household Finance 606
Prospect Theory 608
Framing 610
Paradox of Choice 610
xxiv CONTENTS
Multiple Steps in Reasoning 611
Evolution and Learning 613
Application 17.2: Cold Movie Openings 614
Self-Awareness 615
Application 17.3: Going for It on Fourth Down 616
Application 17.4: Let’s Make a Deal 617
Limited Willpower 618
Hyperbolic Discounting 618
Numerical Example 619
Further Applications 621
Commitment Strategies 621
Limited Self-Interest 623
Altruism 623
Application 17.5: ‘‘Put a Contract Out on Yourself’’ 624
Fairness 625
Market versus Personal Dealings 628
Application 17.6: Late for Daycare Pickup 629
Policy Implications 630
Borrowing and Savings Decisions 630
Other Goods and Services 631
Market Solutions 631
‘‘Nudging’’ the Market 631
Summary 632
Review Questions 633
Problems 634
Glossary 637
Index 645