Microeconomics Flashcards
Definition Economics
Economics is the science that investigates the means to satisfy unlimited needs with limited resources
Difference Microeconomics/Macroeconomics
Microeconomics: studies the behaviour of individuals (househoulds and firms)
Macroeconomics: studies the aggregates (actors) in an economy (househoulds, firms and government)
Physiocracy
- ‘Government of Nature’
- Physiocrats = founders of economic science
- ‘Laissez faire, laissez passer’ -> economic liberalism
- taxation only in agricultural sector
Adam Smith (Scottish philosopher)
- father of modern economics (preceded mercantilism)
- supporter of free trade
- rational self-interest and competition can lead to economic prosperity
John Maynar Keynes (founder of macroeconomics)
- ‘classical theory can’t be applied to economic society we live in’
- prices partially flexible
- wages can lead to unemployment (real vs. nominal)
- markets may need intervention (e.g. regulation by government, no self-clearing
- demand creates its own supply instead of other way around
3 basic questions of economic systems
- What gets produced?
- How is it produced?
- Who receives what is produced?
Definition Capital
Things that are themselves produced and that are then used in the production of other goods and services
Definition Factors of Production
The inputs into production process (land, labor, capital)
Definition Production
The process that transforms scarce resources intro useful goods and services
Definition Inputs or Resources
Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants
Definition Outputs
Usable products; necessarily final (consumption) good
Definition Opportunity Cost
The best alternative that we give up or forgo, when we make a choice or decision
Definition absolute advantage
A producer has an absolute advantage over another in the production of a good or service if it can produce that product using fewer resources
Definition comparative advantage
A producer has a comparative advantage over another in the production of a good or service if it can produce that product at a lower opportunity cost
Definition Consumer Goods
Goods produced for present consumption
Definition Investment
The process of using resources to produce new capital
Definition Production Possibility Frontier (PPF)
A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently
Definition Command Economy
In the command economy every question is answered by the government
Definition Free Market Economy
Free markets are opposite to command economies, laissez-faire economies (allow them to do) and means the complete lack of government interference in the economy
Actors of a closed, laissez faire economy
firms, households, entrepreneur
Definition Firm
An organization that transforms resources (inputs) products (outputs). Firms are the primary producing units in a market economy
Definition Household
The consuming unit in an economy
Definition Entrepreneur
A person who organizes, manages and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business
Markets of a closed, laissez faire economy
- Products or output markets (where goods and services are exchanged)
- Factor or input markets (where resources are used to produce products that are then exchanged)
Definition labor market
The input/factor market in which households supply work for wages to firms that demand labor
Definition capital market
The input/factor market in which households supply their savings, for interest or for claims to future profits, to firms that demand fundsto buy capital goods
Definition land market
The input/factor market in which households supply land or other real property in exchange for rent
Definiton Goods and services market (Output market)
The market in which final (and intermediate) goods are transacted. This is the market we will consider throughout this course
Definition quantity demanded
The amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price
Factors the quantity demanded depends on
1) product price
2) available household incomce
3) accumulated wealth of household
4) prices of other products available to the household
5) household’s tastes and preferences
6) household’s expectations about future income, wealth and prices
Definition demand schedule
Table showing how much of a given product a household would be willing to buy at different prices
Definition demand curve
A graph illustrating how much of a given product a household would be willing to buy at different prices
Definition Law of Demand
Negative relationship between price and quantity demanded (price rises, quantity decreases price decreases, quantity rises)
Definition substitution effect
The consumer would now purchase more of the commodity whose price has fallen
Definition income effect
Because of the reduction in price, the consumer now has increased real income and increased purchasing power
Definition income (flow measure)
Sum of all household’s salaries, interest payments and all forms of earnings in given period of time
Definition wealth / net worth (stock measure)
Total value of what a household owns minus what it owes
Definition normal goods
Goods for which demand goes up when income is higher and for which demand goes down then income is lower
Definition inferior goods
Goods for which demand tends to fall when income rises (public transportation, rice, potato, noodles)
Definition Giffen Good
Special type of inferior good, where it’s price increases and the demand increases as well
Definition substitutes
Goods that can serve as replacements for one another. When the price of one increases, demand for the other goes up
Definition perfect substitutes
Identical products
Definition complementary goods
Goods that ‘go together’. Decrease in price of one results in increase in demand of the other
Demand in output markets: Shift of demand curve
Results from new relationship between quantity demanded of a good and price of that good (change in original conditions)
Demand in output markets: Movement along a demand curve
Change in quantity demanded brought about by a change in price
Definition market demand
Sum of all quantities of a good or service demanded per period by all the households buying in the market for that good or service
Definition quantity supplied
The amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period
Definition supply schedule
Table showing how much of a product firms will sell at different prices
Definition Law of Supply
Positive relationship between price and quantity of a good supplied:
Increase in market price –> increase in quantity supplied
Decrease in market price –> decrease in quantity supplied
Supply in output markets: Movement along supply curve
The change in quantity supplied brought about by a change in price
Supply in output markets: Shift of a supply curve
Results from new relationship between quantity supplied of a good and price of that good (change in original conditions)
Definition equilibrium
Quantity supplied = quantity demanded (no tendency for price to change)
Excess demand or shortage
Quantity demanded > quantity supplied at the current price
Excess supply or surplus
Quantity supplied > quantity demanded at the current price
Definition price rationing
Process by which the market allocates goods and services to consumers when quantity demanded exceeds quantity supplied (Who gets what is produced? –> limited quantity is automatically rationed by the highest bidder
Definition price ceiling
A maximum price that sellers may charge for a good, usually set by government (BELOW natural market equilibrium), causes a shortage –> more demand and less supply than at equilibrium price –> inefficiency (quantity supplied marginal benefits exceed marginal cost)
Methods to assign who gets the low supply of a product, when price ceiling is set
- lottery
- black market
- queue (first come first serve)
- historical use (people who consumed already in the past, are allow to continue to consume)
- coupons (purchase right)
Definition price floor
lowest legal price a commodity can be sold at (must be ABOVE equilibrium price otherwise market won’t sell below equilibrium price)
example: minimum wage: minimum price for labor
Definition consumer surplus
Difference between maximum amount a person is willing to pay for a good and its current market price
Definition producer surplus
Difference between the current market price the full cost of production for the company
Definition deadweight loss
The net loss of producer and consumer surplus from underproduction or overproduction
Definition elasticity
- General concept used to quantify the response in one variable when another variable changes
- can be quantified as the ratio of the percentage change in one variable to the percentage change in another variable, when the latter variable has a causal influence on the former
Definition price elasticity of demand
Ratio of percentage of change in quantity demanded to the percentage of change in price; measures RESPONSIVENESS of demand to changes in price
% change in quantity demanded / % change in price
Calculating percentage changes (demand or price)
((Quantity2 - Quantity1) / Quantity1) x 100
((Price2 - Price1) / Price1)) x 100
Calculating elasticity
- elasticity is ratio of percentages
price elasticity in demand = % change in quantity demanded / % change in price
Midpoint formula
value halfway between P1 and P2 (also Q1 and Q2) as base for calculating –> independent from value taken as new value and better approximations
% change in quantity (price) = ((Q2 - Q1) / (Q1 + Q2) / 2) x 100
Types of elasticity (5)
1) unitary elasticity: change of product demanded = price in absolute value (demand elasticity = -1)
2) elastic demand: change quantity demanded > change in price (demand elasticity >1)
3) inelastic demand: change quantity demanded < absolute change in price (demand elasticity < 1)
4) perfectly elastic demand: quantity demanded drops to zero after slightest increase in price
5) perfectly inelastic demand: quantity demanded doesn’t respond at all to change in price
Definition total revenue
TR = price x quantity
- Change in total revenue depends on where the greater change (either price or quantity) is
- depends whether demand is elastic / inelastic
Definition income elasticity of demand
Measures the responsiveness of demand to changes in income
income elasticity of demand = % change in quantity demanded / % change in income
Definition cross-price elasticity of demand
Measures the response the quantity of one good demanded to a change in the price of another good
CPED = % change in quantity of Y demanded / % change in price of X
Definition elasticity of supply
A measure of the response of quantity of a good supplied to a change in price of that good. Likely to be positive in output markets
elasticity of supply = % change in quantity supplied / % change in price
Definition perfect competition
Industry structure in which there are many firms, each small relative to the industry and producing virtually identical products and firm is large enough to control prices
Basic decisions of every household
1) How much of each product or output to demand
2) How much labor to supply
3) How much to spend and how much to save for the future
Definition budget constraint
The limits imposed on household choices by income, wealth and product prices
Definition choice / opportunity set
Set of options that is defined and limited by a budget constraint
Definition real income
Set of opportunities to purchase real goods and services available to a household as determined by prices and money income
Formula budget constraint
PxX + PyY = Income
Definition utility
Satisfaction or reward a product yields relative to its alternatives. The basis of choice
Definition marginal utility (MU)
The additional satisfaction gained by the consumption or use of one more unit of something
Definition total utility
The total amount of satisfaction obtained from consumption of a good or service
Law of diminishing marginal utility
The more of any good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good
Utility-maximizing rule
Utility-maximizing consumers spread out their expenditures until the following condition holds:
MUx / Px = MUy / Py for all pairs of goods (MU = marginal utility of product x or y)
Marginal rate of substitution
MUx / MUy
-> ratio at which a household is willing to substitute X for Y
Assumptions for indifference curves
1) goods yield positive marginal utility (more is better)
2) Diminishing marginal rate of substitution
3) Consumer can choose between goods and services
4) Consumer choices are consistent and rational
5) indifference curve is convex to origin
6) two indifference curves never intersect
7) consumers are more satisfied with bundles of goods on higher indifference curves
8) transitivity: if A > B and B > C then A > C
Definition indifference curve
Set of points, each point representing a combination of goods X and Y, all of which yield the same utility
Reason for convex shape of indefference curve
Diminishing marginal utility –> each extra unit yields less utility (saturation)
Definition preference map
- Whole set of indifference curves
- shapes of indifference curves depend on customer preferences
Consumer Utility-Maximizing Equilibrium
combination of goods, that yields the maximum amount of utility while still matching the budget constraint
Labor Supply Decision
Households muss decide how much labor to supply. Choice affected by:
1) Availability of jobs
2) Market wage rates
3) Skills they possess
Price of leisure
- Reallocation of time between work and leisure
- wage rate is price of leisure (consumption of one hour of leisure means giving up one hour’s wage)
- hours not spent at leisure can be spent at work to to earn money and buy other goods
- -> wages are represented by slope (steeper slope is higher wage)
Marginal Rate of Substitution
- slope of indifference curve
- ratio of substitution of two goods while maintaining the same level of utility
Leisure-Work Choice (solely increase in income)
increase in income with no change in wage (pure income effect) shifts out the budget constraint
–> demanding more normal goods, including leisure
Leisure-Work Choice (wage increase)
increase in wage has both income (budget line moves out) and substitution (budget line’s slope changes) effects
income effect: work less
substitution effect: work more
Definition Perfect competition
market structure with following criteria:
- homogeneous product sold by every company
- all firms are price takers (can’t influence price of their products)
- market share has no influence on price
Decisions for maxiumum profits (primary objective)
1) How much output to supply (price of input per unit)
2) Which production technology to use (which are available)
3) How much of each input to demand (price of input per unit)
Definition profit (economic profit)
profit = total revenue - total cost
Definition total revenue
revenue = quantity sold * price per unit
Definition total cost (total economic cost)
total cost = out-of-pocket costs + normal rate of return on capital + opportunity cost of each factor of production
Definition normal rate of return
return rate on capital that is just sufficient to keep owners and investors satisfied
Short run
period of time, in which the firm operates under a fixed scale of production and firms neither can enter nor exit the industry
Long run
period of time, in which firm can increase or decrease scale of operation and firms can enter or exit the industry
Definition production technology
Quantitive relationships between input and outputs
Definition labor-intensive technology
Technology, that relies heavily on human labor instead of capital
Definition capital-intensive technology
Technology, that relies heavily on capital instead of human labor
Definition marginal product
The additional output that can be produced by adding one more unit of a specific input, ceteris paribus
Definition law of diminishing returns
When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines
Definition average product
Average amount produced by each unit of variable factor of production
average product of labor = total product / total units of labor
Production functions with two variable factors of production
- capital increases productivity of labor
- capital (buildings, machines) have to be operated by people
- -> capital and labor are complementary input factors
Sunk Costs
another name for fixed costs in the short run, because firms have no choice but to pay them
(Assumption: no fixed costs in the long run)
Spreading Overhead
Process of dividing total fixed costs by more units of output. Average fixed cost declines as quantity rises
Marginal Cost (MC)
- The increase in total variable cost that results from producing on more unit of output. Marginal costs reflect changes in variable costs
- Marginal Cost is Supply Curve of a perfectly competitive firm
Average Variable Cost and Marginal Cost
MC < AVC: AVC is declining
MC > AVC: AVC is increasing
MC < ATC: ATC is declining
MC > ATC: ATC is increasing
Definition: Accounting Costs
Out-of-pocket costs or costs as an accountant would define them. Sometimes referred to as explicit costs.
Definition: Economic Costs
Costs that include the full opportunity costs of all inputs. These include what are often called implicit costs.
Marginal Revenue (MR)
The additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition: MR = P
Profit-Maximizing Level of Output
Aim: Maximize difference between total revenue and total cost
Not: Difference between Marginal Revenue and Marginal Cost
