Microeconomics MID TERM Flashcards
1
Q
microeconomics -
A
Branch of economics that deals with the behavior of individual economic units—consumers, firms, workers, and investors—as well as the markets that these units comprise
2
Q
macroeconomics
A
Branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation
3
Q
market
A
Collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products.
4
Q
market definition
A
Determination of the buyers, sellers, and range of products that should be included in a particular market.
5
Q
arbitrage
A
The practice of buying at a low price at one location and selling at a higher price in another
6
Q
perfectly competitive market
A
Market with many buyers and sellers, so that no single buyer or seller has a significant impact on the price
7
Q
supply curve
A
Relationship between the quantity of a good that producers are willing to sell and the price of the good
8
Q
S shows…
A
The supply curve shows how the quantity of a good offered for sale changes as the price of the good changes. The supply curve is upward sloping: The higher the price, the more firms are able and willing to produce and sell. If production costs fall, firms can produce the same quantity at a lower price or a larger quantity at the same price.
9
Q
demand curve:
A
Relationship between the quantity of a good that consumers are willing to buy and the price of the good
10
Q
THE DEMAND CURVE
A
The demand curve, labeled D, shows how the quantity of a good demanded by consumers depends on its price. The demand curve is downward-sloping; holding other things equal, consumers will want to purchase more of a good as its price goes down. The quantity demanded may also depend on other variables, such as income, the weather, and the prices of other goods. For most products, the quantity demanded increases when income rises. A higher income level shifts the demand curve to the right (from D to D′).
11
Q
SHIFTING THE DEMAND CURVE
A
If the market price were held constant at P1, we would expect to see an increase in the quantity demanded—say, from Q1 to Q2 , as a result of consumers’ higher incomes. Because this increase would occur no matter what the market price, the result would be a shift to the right of the entire demand curve.
12
Q
substitutes
A
Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other
13
Q
complements
A
Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other.
14
Q
In economics, market clearing is
A
the process by which, in an economic market, the supply of whatever is traded is equated to the demand so that there is no leftover supply or demand.
15
Q
equilibrium (or market clearing) price
A
Price that equates the quantity supplied to the quantity demanded
16
Q
market mechanism
A
Tendency in a free market for price to change until the market clears.
17
Q
surplus
A
Situation in which the quantity supplied exceeds the quantity demanded.
18
Q
shortage
A
Situation in which the quantity demanded exceeds the quantity supplied.
19
Q
When the supply curve shifts to the right,
A
the market clears at a lower price P3 and a larger quantity Q3
20
Q
When the demand curve shifts to the right,
A
the market clears at a higher price P3 and a larger quantity Q3
21
Q
elasticity
A
Percentage change in one variable resulting from a 1-percent increase in another.
22
Q
price elasticity of demand
A
Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price.
23
Q
infinitely elastic demand
A
Principle that consumers will buy as much of a good as they can get at a single price, but for any higher price the quantity demanded drops to zero, while for any lower price the quantity demanded increases without limit.
24
Q
completely inelastic demand
A
Principle that consumers will buy a fixed quantity of a good regardless of its price.
25
theory of consumer behavior
Description of how consumers allocate incomes among different goods and services to maximize their wellbeing.
26
Consumer behavior is best understood in three distinct steps:
1. Consumer Preferences
2. Budget Constraints
3. Consumer Choices
27
market basket (or bundle)
List with specific quantities of one or more goods.
28
Completeness:
Preferences are assumed to be complete. In other words, consumers can compare and rank all possible baskets. Thus, for any two market baskets A and B, a consumer will prefer A to B, will prefer B to A, or will be indifferent between the two. By indifferent we mean that a person will be equally satisfied with either basket. Note that these preferences ignore costs. consumer might prefer steak to hamburger but buy hamburger because it is cheaper.
29
Transitivity:
Preferences are transitive. Transitivity means that if a consumer prefers basket A to basket B and basket B to basket C, then the consumer also prefers A to C. Transitivity is normally regarded as necessary for consumer consistency.
30
More is better than less:
Goods are assumed to be desirable—i.e., to be good. Consequently, consumers always prefer more of any good to less. In
addition, consumers are never satisfied or satiated; more is always better, even if just a little better.
31
indifference curve
Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction.
32
indifference map
Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent.
33
The magnitude of the slope of an indifference curve measures
the consumer’s marginal rate of substitution (MRS) between two goods.
34
marginal rate of substitution (MRS)
Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good.
35
CONVEXITY
Observe that the MRS falls as we move down the indifference curve. The decline in the MRS reflects our fourth assumption regarding consumer preferences: a diminishing marginal rate of substitution. When the MRS diminishes along an indifference curve, the curve is convex.
36
perfect substitutes
Two goods for which the marginal rate of substitution of one for the other is a constant.
37
perfect complements
Two goods for which the MRS is zero or infinite; the indifference curves are shaped as right angles.
38
utility
Numerical score representing the satisfaction that a consumer gets from a given market basket.
39
utility function
Formula that assigns a level of utility to individual market baskets.
40
budget constraints
Constraints that consumers face as a result of limited incomes
41
budget line
All combinations of goods for which the total amount of money spent is equal to income.
42
A change in income (with prices unchanged) causes the
budget line to shift parallel to the original line (L1).
43
A change in the price of one good (with income unchanged) causes the
budget line to rotate about one intercept.
44
The maximizing market basket must satisfy two conditions:
1. It must be located on the budget line.
| 2. It must give the consumer the most preferred combination of goods and services.
45
Satisfaction is maximized (given the budget constraint) at the point where
MRS = P(F)/P(C)
46
marginal benefit
Benefit from the consumption of one additional unit of a good
47
marginal cost
Cost of one additional unit of a good.
48
satisfaction is maximized when
the marginal benefit—the benefit associated with the consumption of one additional unit of food—is equal to the marginal cost—the cost of the additional unit of food. The marginal benefit is measured by the MRS.
49
corner solution
Situation in which the marginal rate of substitution for one good in a chosen market basket is not equal to the slope of the budget line.
50
When a corner solution arises,
the consumer maximizes satisfaction by consuming only one of the two goods.
51
marginal utility (MU)
Additional satisfaction obtained from consuming one additional unit of a good.
52
diminishing marginal utility
Principle that as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility.
53
equal marginal principle
The principle that utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods.
54
Our analysis of demand proceeds in six steps:
1. We begin by deriving the demand curve for an individual consumer.
2. With this foundation, we will examine the effect of a price change in more detail.
3. Next, we will see how individual demand curves can be aggregated to determine the market demand curve.
4. We will go on to show how market demand curves can be used to measure the benefits that people receive when they consume products, above and beyond the expenditures they make.
5. We then describe the effects of network externalities—i.e., what happens when a person’s demand for goods also depends on the demands of other people.
6. Finally, we will briefly describe some of the methods that economists use to obtain empirical information about demand.
55
A reduction in the price of food, with income and the price of clothing fixed, causes
the consumer to choose a different market basket.
56
price-consumption curve
Curve tracing the utility-maximizing combinations of two goods as the price of one changes.
57
individual demand curve
Curve relating the quantity of a good that a single consumer will buy to its price.
58
The individual demand curve has two important properties:
1. The level of utility that can be attained changes as we move along the curve.
2. At every point on the demand curve, the consumer is maximizing utility by satisfying the condition that the marginal rate of substitution (MRS) of food for clothing equals the ratio of the prices of food and clothing
59
income-consumption curve
Curve tracing the utility-maximizing combinations of two goods as a consumer’s income changes.
60
An increase in income, with the prices of all goods fixed, causes
consumers to alter their choice of market baskets.
61
An increase in a person’s income can lead to:
less consumption of one of the two goods being purchased.
62
Engel curve
Curve relating the quantity of a good consumed to income.
63
Two goods are substitutes if
an increase in the price of one leads to an increase in the quantity demanded of the other.
64
Two goods are complements if
an increase in the price of one good leads to a decrease in the quantity demanded of the other.
65
Two goods are independent if
a change in the price of one good has no effect on the quantity demanded of the other.
66
A fall in the price of a good has two effects:
1. Consumers will tend to buy more of the good that has become cheaper and less of those goods that are now relatively more expensive. This response to a change in the relative prices of goods is called the substitution effect.
2. Because one of the goods is now cheaper, consumers enjoy an increase in real purchasing power. The change in demand resulting from this change in real purchasing power is called the income effect.
67
substitution effect
Change in consumption of a good associated with a change in its price, with the level of utility held constant.
68
income effect
Change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant.
69
A decrease in the price of food has
an income effect and a substitution effect.
70
Giffen good
Good whose demand curve slopes upward because the (negative) income effect is larger than the substitution effect.
71
When food is an inferior good, and when the income effect is large enough to dominate the substitution effect, the demand curve will be
upward-sloping
72
market demand curve
Curve relating the quantity of a good that all consumers in a market will buy to its price.
73
The market demand curve is obtained by
summing our three consumers’ demand curves DA, DB, and DC.
74
Two points should be noted:
1. The market demand curve will shift to the right as more consumers enter the market.
2. Factors that influence the demands of many consumers will also affect market demand.
75
The aggregation of individual demands into market becomes important in practice when market demands are built up from the demands of different demographic groups or from consumers located in different areas.
Laikas mohitukui
76
INELASTIC DEMAND
When demand is inelastic, the quantity demanded is relatively unresponsive to changes in price. As a result, total expenditure on the product increases when the price increases.
77
ELASTIC DEMAND
When demand is elastic, total expenditure on the product decreases as the price goes up.
78
isoelastic demand curve
Demand curve with a constant price elasticity
79
consumer surplus
Difference between what a consumer is willing to pay for a good and the amount actually paid.
80
CONSUMER SURPLUS
Consumer surplus is the total benefit from the consumption of a product, less the total cost of purchasing it.
81
CONSUMER SURPLUS GENERALIZED
For the market as a whole, consumer surplus is measured by the area under the demand curve and above the line representing the purchase price of the good.
82
To examine the ways that people can compare and choose among risky alternatives, we take the following steps:
1. In order to compare the riskiness of alternative choices, we need to quantify risk.
2. We will examine people’s preferences toward risk.
3. We will see how people can sometimes reduce or eliminate risk.
4. In some situations, people must choose the amount of risk they wish to bear.
5. Sometimes demand for a good is driven partly or entirely by speculation— people buy the good because they think its price will rise.
83
probability
Likelihood that a given outcome will occur.
84
expected value
shows us what would be the average payoff of different
| scenarios
85
payoff
Value associated with a possible outcome.
86
The expected value measures the central tendency—
the payoff or value that we would expect on average
87
variability
Extent to which possible outcomes of an uncertain event differ
88
deviation
Extent to which possible outcomes of an uncertain event differ.
89
standard deviation
Square root of the weighted average of the squares of the deviations of the payoffs associated with each outcome from their expected values
90
OUTCOME PROBABILITIES FOR TWO JOBS
The distribution of payoffs associated with Job 1 has a greater spread and a greater standard deviation than the distribution of payoffs associated with Job 2. Both distributions are flat because all outcomes are equally likely.
91
UNEQUAL PROBABILITY OUTCOMES
The distribution of payoffs associated with Job 1 has a greater spread and a greater standard deviation than the distribution of payoffs associated with Job 2. Both distributions are peaked because the extreme payoffs are less likely than those near the middle of the distribution.
92
expected utility
Sum of the utilities associated with all possible outcomes, weighted by the probability that each outcome will occur.
93
risk averse
Condition of preferring a certain income to a risky income with the same expected value.
94
risk loving
Condition of preferring a risky income to a certain income with the same expected value.
95
risk neutral
Condition of preferring a risky income to a certain income with the same expected value.
96
risk premium
Maximum amount of money that a risk-averse person will pay to avoid taking a risk.
97
The risk premium, CF, measures the
amount of income that an individual would give up to leave her indifferent between a risky choice and a certain one.
98
diversification
Practice of reducing risk by allocating resources to a variety of activities whose outcomes are not closely related.
99
negatively correlated variables
Variables having a tendency to move in opposite directions.
100
mutual fund
Organization that pools funds of individual investors to buy a large number of different stocks or other financial assets.
101
positively correlated variables
Variables having a tendency to move in the same direction.
102
THE LAW OF LARGE NUMBERS
Insurance companies are firms that offer insurance because they know that when they sell a large number of policies, they face relatively little risk. The ability to avoid risk by operating on a large scale is based on the law of large numbers, which tells us that although single events may be random and largely unpredictable, the average outcome of many similar events can be predicted.
103
ACTUARIAL FAIRNESS
When the insurance premium is equal to the expected payout
104
actuarially fair -
Characterizing a situation in which an insurance premium is equal to the expected payout.
105
value of complete information
Difference between the expected value of a choice when there is complete information and the expected value
when information is incomplete.
106
asset
Something that provides a flow of money or services to its owner
107
risky asset
Asset that provides an uncertain flow of money or services to its owner.
108
riskless (or risk-free) asset
Asset that provides a flow of money or services that is known with certainty (užtikrintumas)
109
return
Total monetary flow of an asset as a fraction of its price.
110
real return
Simple (or nominal) return on an asset
111
expected return
Return that an asset should earn on average.
112
actual return
Return that an asset earns.
113
The Trade-Off Between Risk and Return
Let’s denote the risk-free return on the Treasury bill by Rf. Because the return is risk free, the expected and actual returns are the same. In addition, let the expected return from investing in the stock market be Rm and the actual return be rm.
114
Price of risk
Extra risk that an investor must incur to enjoy a higher expected return.
115
An investor is dividing her funds between two assets—
Treasury bills, which are risk free, and stocks. To receive a higher expected return, she must incur some risk.
116
The budget line describes
the trade-off between the expected return and its riskiness, as measured by the standard deviation of the return.
117
The utility-maximizing investment portfolio is at the point where...
indifference curve U2 is tangent to the budget line.
118
bubble
An increase in the price of a good based not on the fundamentals of demand or value, but instead on a belief that the price will keep going up.
119
Recall that the basic theory of consumer demand is based on three assumptions:
(1) consumers have clear preferences for some goods over others;
(2) consumers face budget constraints; and
(3) given their preferences, limited incomes, and the prices of different goods, consumers choose to buy combinations of goods that maximize their satisfaction.
120
reference point
The point from which an individual makes a consumption decision.
121
endowment effect
Tendency of individuals to value an item more when they own it than when they do not.
122
● loss aversion
Tendency for individuals to prefer avoiding losses over acquiring gains.
123
framing
Tendency to rely on the context in which a choice is described when making a decision.
124
anchoring
Tendency to rely heavily on one or two pieces of information when making a decision.
125
law of small numbers
Tendency to overstate the probability that a certain event will occur when faced with relatively little information.
126
factors of production
Inputs into the production process
127
production function
Function showing the highest output that a firm can produce for every specified combination of inputs.
128
short run
Period of time in which quantities of one or more production factors cannot be changed.
129
fixed input
Production factor that cannot be varied.
130
long run
Amount of time needed to make all production inputs variable.
131
average product
Output per unit of a particular input.
132
marginal product
Additional output produced as an input is increased by one unit.
133
Average product of labor =
Output/labor input = q/L
134
Marginal product of labor =
Change in output/change in labor input = Δq/ΔL
135
law of diminishing marginal returns
Principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease.
136
law of diminishing marginal returns
Principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease.
137
labor productivity
Average product of labor for an entire industry or for the economy as a whole.
138
stock of capital
Total amount of capital available for use in production
139
technological change
Development of new technologies allowing factors of production to be used more effectively.
140
isoquants
Curve showing all possible combinations of inputs that yield the same output.
141
isoquant map
Graph combining a number of isoquants, used to describe a production function
142
A set of isoquants, or isoquant map, describes the...
firm’s production function.
143
Input Flexibility
Isoquants show the flexibility that firms have when making production decisions: They can usually obtain a particular output by substituting one input for another. It is important for managers to understand the nature of this flexibility.
144
marginal rate of technical substitution (MRTS)
Amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constant.
145
MRTS =
−Change in capital input/change in labor input = − ∆𝐾Τ∆𝐿 (for a fixed level of q)
146
the case of perfect substitutes and the fixed proportions production function, sometimes called
a Leonitief production function.
147
fixed-proportions production function
Production function with L-shaped isoquants, so that only one combination of labor and capital can be used to produce each level of output.
148
The fixed-proportions production function describes situations in which
methods of production are limited.
149
When the isoquants are straight lines, the MRTS is
constant.
150
When the isoquants are Lshaped,
only one combination of labor and capital can be used to produce a given output
151
returns to scale
Rate at which output increases as inputs are increased proportionately
152
increasing returns to scale
Situation in which output more than doubles when all inputs are doubled.
153
constant returns to scale
Situation in which output doubles when all inputs are doubled.
154
decreasing returns to scale
Situation in which output less than doubles when all inputs are doubled.
155
accounting cost
Actual expenses plus depreciation charges for capital equipment.
156
economic cost
Cost to a firm of utilizing economic resources in production
157
opportunity cost
Cost associated with opportunities forgone when a firm’s resources are not put to their best alternative use.
158
Economic cost =
Opportunity cost
159
sunk cost
Expenditure that has been made and cannot be recovered.
160
total cost (TC or C)
Total economic cost of production, consisting of fixed and variable costs.
161
fixed cost (FC)
Cost that does not vary with the level of output and that can be eliminated only by shutting down.
162
variable cost (VC)
Cost that varies as output varies.
163
marginal cost (MC)
Increase in cost resulting from the production of one extra unit of output.
164
MC =
∆VC/∆𝑞 = ∆TC/∆q
165
average total cost (ATC)
Firm’s total cost divided by its level of output.
166
average fixed cost (AFC
Fixed cost divided by the level of output.
167
average variable cost (AVC)
Variable cost divided by the level of output.
168
user cost of capital
Annual cost of owning and using a capital asset, equal to economic depreciation plus forgone interest.
169
User Cost of Capital =
Economic Depreciation + (InterestRate)(Value of Capital)
170
We can also express the user cost of capital as a rate per dollar of capital:
𝑟 = Depreciation rate + Interest rate
171
rental rate
Cost per year of renting one unit of capital.
172
isocost line
Graph showing all possible combinations of labor and capital that can be purchased for a given total cost.
173
Isocost curves describe the
combination of inputs to production that cost the same amount to the firm.
174
When the price of labor increases, the isocost curves become:
steeper.
175
expansion path
Curve passing through points of tangency between a firm’s isocost lines and its isoquants.
176
To move from the expansion path to the cost curve, we follow three steps:
1. Choose an output level represented by an isoquant. Then find the point of tangency of that isoquant with an isocost line.
2. From the chosen isocost line, determine the minimum cost of producing the output level that has been selected.
3. Graph the output-cost combination.
177
long-run average cost curve (LAC)
Curve relating average cost of production to output when all inputs, including capital, are variable.
178
short-run average cost curve (SAC)
Curve relating average cost of production to output when level of capital is fixed.
179
● long-run marginal cost curve (LMC)
Curve showing the change in longrun total cost as output is increased incrementally by 1 unit.
180
economies of scale
Situation in which output can be doubled for less than a doubling of cost.
181
diseconomies of scale
Situation in which a doubling of output requires more than a doubling of cost.
182
Increasing Returns to Scale:
Output more than doubles when the quantities of all inputs are doubled.
183
Economies of Scale:
A doubling of output requires less than a doubling of cost.
184
economies of scope
Situation in which joint output of a single firm is greater than output that could be achieved by two different firms when each produces a single product.
185
The product transformation curve describes the
different combinations of two outputs that can be produced with a fixed amount of production inputs.
186
price taker
Firm that has no influence over market price and thus takes the price as given.
187
When the products of all of the firms in a market are perfectly substitutable with one another—that is, when they are
homogeneous
188
homogeneous—
—no firm can raise the price of its product above the price of other firms without losing most or all of its business.
189
when products are heterogeneous,
each firm has the opportunity to raise its price above that of its competitors without losing all of its sales.
190
free entry (or exit)
Condition under which there are no special costs that make it difficult for a firm to enter (or exit) an industry
191
cooperative
Association of businesses or people jointly owned and operated by members for mutual benefit.
192
condominium
A housing unit that is individually owned but provides access to common facilities that are paid for and controlled jointly by an association of owners.
193
profit
Difference between total revenue and total cost
194
marginal revenue
Change in revenue resulting from a one-unit increase in output.
195
A perfectly competitive firm should choose its output so that marginal cost equals price:
MC(q) = MR = P
196
A competitive firm should shut down if
price is below AVC.
197
The short-run industry supply curve is the summation of
the supply curves of the individual firms.
198
producer surplus
Sum over all units produced by a firm of differences between the market price of a good and the marginal cost of production.
199
The producer surplus for a firm is measured by the yellow area below the market price and above
the marginal cost curve
200
Producer surplus =
PS = R − VC
201
Profit =
π = R − VC − FC
202
The producer surplus for a market is the area
below the market price and above the market supply curve
203
The firm maximizes its profit by choosing the output at which price equals
long-run marginal cost LMC
204
The long-run output of a profit-maximizing competitive firm is the point at which
long-run marginal cost equals the price.
205
zero economic profit
A firm is earning a normal return on its investment— i.e., it is doing as well as it could by investing its money elsewhere.
206
In a market with entry and exit, a firm enters when
it can earn a positive longrun profit and exits when it faces the prospect of a long-run loss.
207
long-run competitive equilibrium
All firms in an industry are maximizing profit, no firm has an incentive to enter or exit, and price is such that quantity supplied equals quantity demanded.
208
When a firm earns zero economic profit,
it has no incentive to exit the industry. Likewise, other firms have no special incentive to enter.
209
A long-run competitive equilibrium occurs when three conditions hold:
1. All firms in the industry are maximizing profit.
2. No firm has an incentive either to enter or exit the industry because all firms are earning zero economic profit.
3. The price of the product is such that the quantity supplied by the industry is equal to the quantity demanded by consumers.
210
economic rent
Amount that firms are willing to pay for an input less the minimum amount necessary to obtain it.
211
welfare effects
Gains and losses to consumers and producers.
212
deadweight loss
Net loss of total (consumer plus producer) surplus.
213
economic efficiency
Maximization of aggregate consumer and producer surplus.
214
market failure
Situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers.
215
There are two important instances in which market failure can occur:
1. Externalities
| 2. Lack of Information
216
externality
Action taken by either a producer or a consumer which affects other producers or consumers but is not accounted for by the market price.
217
price support
Price set by government above free-market level and maintained by governmental purchases of excess supply.
218
import quota
Limit on the quantity of a good that can be imported.
219
tariff
Tax on an imported good.
220
Specific tax
Tax of a certain amount of money per unit sold.
221
subsidy
Payment reducing the buyer’s price below the seller’s price
222
What happens to the level of utility moving downward along the demand curve?
As the price of a good falls, the budget line pivots outward, and the consumer is able to move to a higher indifference curve. Therefore the level of utility increases.
223
Producer surplus is
the difference between total revenue and total variable cost
