Chapter 2 Competitive Product Markets 40
the price at the pump remains constant at the price ceiling, does that mean that the
“real price” of gasoline has remained constant?
9. If the government imposes a price floor on whole milk and buys the resulting surplus, can it
later sell what it has bought and recoup its expenditure? What else can the government do
with the milk surplus? Why would you, as a milk producer, want the price floor? Show
the industry benefits in a graph.
10. Henry Ford more than doubled his workers’ wages. Did worker real income double by
Ford’s pay policy? Reflecting on the general principles behind Ford’s pay action, when
should any firm – your firm – stop raising the pay of workers (not in terms of actual dollar
amount but in terms of some economic/management principle that you can devise)?
11. Workers and their employers often talk about how workers “earn” their wages but about
how firms “give” their workers health insurance (or any other fringe benefit). Should the
different methods of pay be discussed in different terms?
12. In state universities, why does the state subsidize full-time MBA programs but not
executive MBA programs? Should the two programs be treated differently? Does the
state subsidy explain the price differential for students in the two programs? READING: The Effect of Airline Deregulation on Travel Safety
William F. Shughart II, University of Mississippi

Before 1978 airlines in the United States were strictly controlled by government agencies. The safety of
airlines was, and remains today, regulated by the Federal Aviation Administration (FAA). In addition, the
Civil Aeronautics Board (CAB) controlled airline fares and routes. The effect of CAB regulations was to
restrict the ability of airlines to compete by price and entry into markets. Without CAB approval, for
example, Delta Airlines could not lower its air fares or enter new markets to expand its business.
In 1978 Congress passed legislation to eliminate gradually most of the economic controls the CAB had

been held in check by the considerable costs that airlines incur when they do have accidents. Airlines, in
other words, may have continued to maintain their safety records because of the fear and cost of liability
suits that are brought against them when they do have crashes. In addition, Congress never deregulated
safety.
Various government policies often have hidden, secondary market effects that economists and
policymakers must consider. Airline deregulation is a good case in point. Airline deregulation could have
reduced total travel deaths in the country by its indirect impact on highway travel and accidents.
By deregulating airlines fares, Congress increased air travel. At the same time, Congress increased the
relative cost of travel by car on the nation’s highways. This is because, as noted, after deregulation, air
travel became more convenient and often cheaper. Therefore, car travel became relatively expensive relative
to air travel.
Airline deregulation has had two distinct effects on automobile travel. It has had a price (or
substitution) effect. Less automobile travel would be expected with relatively lower airfares. Airline
deregulation has also had an income effect because greater efficiency in air travel may have led to more
national production and income. The greater national income may have led to more travel by air and cars.
Because the price and income effects of airline deregulation on automobile travel are not expected to be in
the same direction, theory alone does not give a clear answer to the question, “How has airline deregulation
affected automobile travel?” Statistical analysis is required, and the only study currently available on the
issue found that airline deregulation has, indeed, reduced travel by automobiles (by an annual average of
nearly 4 percent between 1979 and 1985).
4
However, because miles traveled on highways and automotive
accidents and deaths are likely to be directly related, the small estimated decrease in automobile travel may
have reduced automotive accidents and deaths by a sizable number. In fact, one of the authors estimates
that airline deregulation has probably reduced automobile accidents by an annual average of several
hundred thousand and deaths by an annual average of several hundred.
5
The indirect effects of policy changes, which are revealed through economic analysis, cannot be ignored
by policymakers. Policymakers need to be mindful of the fact that efforts to resurrect the type of airline
regulation abandoned in the late 1970s may, or may not, improve airline safety records. Re-regulation,


CHAPTER 3

Principles of Rational Behavior at
Work in Society and Business

We are not ready to suspect any person of being defective in selfishness.
Adam Smith

ith this chapter we begin a detailed examination of key issues in
microeconomics, namely the study of how prices are determined in individual
markets. Prices are important – or, rather, should be important – to managers
because of their unavoidable impact on the decisions of managers within individual
firms. We have already seen how the forces of supply and demand determine prices
(Chapter 2). Now we will explore the determinants of the supply and demand for goods,
services, and resources.
Microeconomics rests on certain assumptions about individual behavior. One is
that people are capable of envisioning various ways of improving their position in life.
This chapter reviews and extends the discussion begun in Chapter 1 of how people –
business people included -- go about choosing among those alternatives. According to
microeconomic theory, consumers and producers make choices rationally, so as to
maximize their own welfare and their firms’ profits. This seemingly innocuous basic
premise about human behavior will allow us to deduce an amazing variety of
implications for business and every other area of human endeavor. Rationality: A Basis for Exploring Human Behavior
People’s wants are ever expanding. We can never satisfy all our wants because we will
always conceive of new ones. The best we can do is to maximize our satisfaction, or
utility, in the face of scarcity. Utility is the satisfaction a person receives from the

by individuals. Economists would even say that group action cannot be distinguished
from individual action. Although economists do not deny the existence of group
psychology, they leave the study of social groups to others. Thus to understand group
behavior, the economist looks to the individual.
Of course individuals in a group affect one another’s behavior. In fact, the size
and structure of a group can have a dramatic effect on individual behavior. When
economists speak of a competitive market, they are actually talking about the influence
that other competitors have on the individual consumer or firm.

Rational Behavior
When individuals act to satisfy their wants, they behave rationally. Rational behavior is
consistent behavior that maximizes an individual’s satisfaction. The notion of rational
behavior rests on three assumptions:
• First the individual has a preference and can identify, within limits, what he or
she wants.
• Second, the individual is capable of ordering his or her wants consistently,
from most preferred to least preferred.
• Third, the individual will choose consistently from these ordered preferences
to maximize his or her satisfaction.
Even though the individual cannot fully satisfy all her wants, she will always choose
more of what she wants rather than less. Furthermore, she will always choose less rather
than more of what she does not want. In short, the rational individual always stands
ready to further her own interests.
Some readers will find these assertions obvious and acceptable. To others, they
may seem narrow and uninspiring. Later in the chapter we will examine some possible
objections to the concept of rational behavior, but first we must examine its logical
consequences.