Chapter 2

Question 1

Theoretical Tools

Answer 1

The set of tools designed to understand the mechanics behind economic decision making.

Question 2

Empirical Tools

Answer 2

The set of tools designed to analyze data and answer questions raised by theoretical analysis.

Question 3

Utility Function

Answer 3

A mathematical function representing an individual’s set of preferences, which translates her well-being from different consumption bundles into units that can be compared in order to determine choice.

Question 4

Constrained Utility Maximization

Answer 4

The process of maximizing the well-being (utility) of an individual, subject to her resources (budget constraint).

Question 5

Models

Answer 5

Mathematical or graphical representation of reality.

Question 6

Indifference Curve

Answer 6

A graphical representation of all bundles of goods that make an individual equally well off. Because these bundles have equal utility, an individual is indifferent as to which bundle he consumes.

Question 7

Marginal Utility

Answer 7

The additional increment to utility obtained by consuming an additional unit of a good.

Question 8

Marginal Rate of Substitution (MRS)

Answer 8

The rate at which a consumer is willing to trade one good for another. The MRS is equal to slope of the indifference curve, the rate at which the consumer will trade the good on the vertical axis for the good on the horizontal axis.

Question 9

Budget Constraint

Answer 9

A mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income.

Question 10

Opportunity Cost

Answer 10

The cost of any purchase is the next best alternative use of that money, or the forgone opportunity.

Question 11

Substitution Effect

Answer 11

Holding utility constant, a relative rise in the price of a good will always cause an individual to choose less of that good.

Question 12

Income Effect

Answer 12

A rise in the price of a good will typically cause an individual to choose less of all goods because her income can purchase less than before.

Question 13

Normal Goods

Answer 13

Goods for which demand increases as income rises.

Question 14

Inferior Goods

Answer 14

Goods for which demand falls as income rises.

Question 15

Welfare Economics

Answer 15

The study of the determinants of well-being, or welfare, in society.

Question 16

Demand Curve

Answer 16

A curve showing the quantity of a good demanded by individuals at each price.

Question 17

Elasticity of Demand

Answer 17

The percentage change in the quantity demanded of a good caused by each 1% change in the price of that good.

Question 18

Supply Curve

Answer 18

A curve showing the quantity of a good that firms are willing to supply at each price.

Question 19

Marginal Productivity

Answer 19

The impact of a one-unit change in any input, holding other inputs constant, on the firm’s output.

Question 20

Marginal Cost

Answer 20

The incremental cost to a firm of producing one more unit of a good.

Question 21

Profit

Answer 21

The difference between a firm’s revenues and costs, maximized when marginal revenues equal marginal costs.

Question 22

Market

Answer 22

The arena in which demanders and suppliers interact.

Question 23

Market Equilibrium

Answer 23

The combination of price and quantity that satisfies both demand and supply, determined by the interaction of the supply and demand curves.

Question 24

Consumer Surplus

Answer 24

The benefit that consumers derive from consuming a good, above and beyond the price they paid for the good.

Question 25

Producer Surplus

Answer 25

The benefit that producers derive from selling a good, above and beyond the cost of producing that good.

Question 26

Total Social Surplus (Social Efficiency)

Answer 26

The sum of consumer surplus and producer surplus.

Question 27

First Fundamental Theorem of Welfare Economics

Answer 27

The competitive equilibrium, where supply equals demand, maximizes social efficiency.

Question 28

Deadweight Loss

Answer 28

The reduction in social efficiency from preventing trades for which benefits exceed costs.

Question 29

Social Welfare

Answer 29

The level of well-being in society.

Question 30

Second Fundamental Theorem of Welfare Economics

Answer 30

Society can attain any efficient outcome by suitably redistributing resources among individuals and then allowing them to freely trade.

Question 31

Equity-efficiency Trade-off

Answer 31

The choice society must make between the total size of the economic pie and its distribution among individuals.

Question 32

Social Welfare Function (SWF)

Answer 32

A function that combines the utility functions of all individuals into an overall social utility function.

Question 33

Commodity Egalitarianism

Answer 33

The principle that society should ensure that individuals meet a set of basic needs, but that beyond that point income distribution is irrelevant.

Question 34

Equality of Opportunity

Answer 34

The principle that society should ensure that all individuals have equal opportunities for success but not focus on the outcomes of choices made.