Midterm review Flashcards
The study of how people, firms, and societies use their scarce productive resources to best satisfy their unlimited material wants.
Economics
Called factors of production, these are commonly grouped into the four categories of labor, physical capital, land or natural resources, and entrepreneurial ability.
Resources
The imbalance between limited productive resources and unlimited human wants. Because economic resources are scare, the goods and services a society can produce are also scarce.
Scarcity
Scarce resources imply that individuals, firms, and governments are constantly faced with difficult choices that involve benefits and costs
Trade-offs
The value of the sacrifice made to pursue a course of action
Opportunity cost
The next unit or increment of an action
Marginal
The addition benefit received form the consumption of the next unit of a good or service
Marginal Benefit (MB)
The addition cost incurred form the consumption of the next unit of a good or service
Marginal cost (MC)
Making decisions based upon weighing the marginal benefits and costs of that actin. The rational decision maker chooses an action if the MB > MC
Marginal Analysis
Different quantities of goods that an economy can produce with a given amount of scarece resources. Graphically, the trade-off between the productions of two goods is portrayed as a production possibility curve or frontier (PPC, PPF)
Production Possibilities
A graphical illustration that shows the maximum quantity of one good that can be produced, given the quantity of the other good being produced
Production possibility curve (PPC), Production possibility frontier (PPF)
The more of a goof that is produced, the greater the opportunity cost of production the next unit of that good.
Law of increasing costs
The exists if a producer can produce more of a good than all other producers
Absolute advantage
A producer has comparative advantage if he can produce a good at lower opportunity cost than all other producers.
Comparative advantage
When firms focus their resources on production of goods for which they have comparative advantage, they are said to be specializing
Specialization
Production of maximum output for a given level of technology and resources. All points on the PPF are productively efficient
Productive efficiency
Production of the combination of goods and services that provides the most net benefit to society. The optimal quantity of a good is achieved when the MB = MC of the next unit. This only occurs at one point on the PPF.
Allocative efficiency
This occurs when an economy’s production possibilities increase. It can be a result of more resources, better resources, or improvements in technology.
Economic growth
An economic system based upon the fundamentals of private property, freedom, self-interest, and prices
Market economy
Holding all else equal, when the price of a good rises, consumers decrease their quantity demanded for taht good
Law of demand
To predict how a change in one variable affects a sound, we hold all other variables constant. This is also referred to as the ceteris paribus assumption.
All Else Equal
The price of a good measured in units of currency
Absolute prices
The number of units of any other good Y that must be sacrificed to acquires the first good X. Only relative prices matter.
Relative prices
The change in quantity demanded resulting from a change in the price of one good relative to the price of other goods.
Substitution effect
The change in quantity demanded resulting from a change in he consumer’s purchasing power (real income)
Income effect
A table showing quantity demanded for a good at various prices
Demand schedule
A graphical depiction of the demand schedule. The curve is downward sloping, reflecting the law of demand.
Demand curve
A good for which higher income increases demand
Normal Goods
A goof for which higher income decreases demand
Inferior good
The external factors that shift demand to the left or right
Determinants of demand
Two goods are consumer substitues if they provide essentially the same utility to the consumer.
Substitute Goods
Two goods that provide more utility when consumed together than when consumed separately
Complementary goods
Holding all else equal, when the price of a good rises, suppliers increase their quantity supplied for that good
Law of supply
A table showing quantity supplied for a good at various prices
Supply schedule
A graphical depiction of the supply schedule. Upward sloping, reflecting the law of supply
Supply curve
One of the external factors that influences supply. When these variables change, the entire supply curve shifts to the left or the right.
Determinants of supply
Exists at the only price where the quantity supplied equals the quantity demanded.
Market equillibrium
Also known as excess demand, exists a market price when the quantity demanded exceeds the quantity supplied. The price rises to eliminate it.
Shortage
Any price where quantity demanded is not equal to quantity supplied
Disequillibrim
Also known as excess supple, exists at a market price when the quantity supplied exceeds the quantity demanded.
Surplus
The sum of consumer surplus and producer surplus. The free market equilibrium provides maximum combined gain to society
Total welfare
The difference between your willingness to pay and the price you actually pay. It is the area below the demand curve and above the price
Consumer surplus
The difference between the price received and the marginal cost of producing the good. It is the area above the supply curve and under the price.
Producer surplus
Measures the sensitivity, or responsiveness, of a choice to a change in an external factor.
Elasticity
Measures the sensitivity of consumer quantity demanded for good X when the price of good X changes
Price elasticity of demand
E d = (%∆Q d )/(%∆P)
Price elasticity formula
E d > 1 or the (%∆Q d ) > (%∆P )
Price elastic demand
E d < 1 or the (%∆Q d ) < (%∆P).
Price inelastic demand
E d = 1 meaning the (%∆Q d ) = (%∆P).
Unit elastic demand
E d = 0. In this special case, the demand curve is vertical and there is absolutely no response to a price change.
Perfectly inelastic
E d = ∞. In this special case, the deamdn curve is horizontal meaning consumers have an instantaneous and infinite response to a price change
Perfectly elastic
In general, the more vertical a good’s demand curve, the more inelastic the demand for that good. The more horizontal a good’s demand curve, the more elastic the demand for that good.
Slope and elasticity
If a good has more readily available substitutes, it is likely that consumers are more price elastic for that good. If a high proportion of a consumer’s income in devoted to a particular good, consumers are generally more price elastic for that good. When consumers have more time to adjust to a price change, their response is usually more elastic.
Determinants of elasticity
TR = P x Q d
Total revenue formula
Total revenue rises with a price increase if a demand is price inelastic and falls with a price increase if demand is price elastic.
Total revenue test
At the midpoint of a linear deamdn curve, E d = 1. Above the midpoint demand is elastic and below the midpoint demand is inelastic
Elasticity and demand curves
A measure of how sensitive consumption of good X is to a change in the consumer’s income.
Income elasticity
E I = (%∆Q d good X )/(% ∆ income)
Income elasticity formula
A good for which the income elasticity is greater than one
luxury
A good for which the income elasticity is above zero but less than one
Necessity
If E1 > 1, the good is normal and a luxury. If 1 > E1 > 0, the good is normal and income inelastic (necessity). If E1 < 0 the good is inferior
Values of income elasticity
A measure of how sensitive consumption of good X is to a change in the price of good Y.
Cross-price elasticity of demand
E x,y = (%∆Q d good X)/(% ∆ price Y)
Cross-price elasticity formula
If E x,y > 0, goods X and Y are
substitutes. If E x,y < 0, goods X and Y are complementary.
Values of cross-price elasticity of demand
Measures the sensitivity of quantity supplied for good X when the price of good X changes.
Price elasticity of supply
E s = (%∆Q s )/(%∆ P )
Price elasticity of supply formula
A per unit tax on production results in a vertical shift upward in the supply curve by the amount of the tax
Excise tax
The proportion of the tax paid by consumers in the form of higher price for the taxed good is greater if demand for the good is inelastic and supply is elastic
Incidence of tax
The plost net benefit to society caused by a movement away from the competitive market equilibrium. Polices like excise taxes create lost welfare to society.
Deadweight loss
Has the opposite effect of an excise tax, as it has the effect of lowering the MC of production, resulting in a downward vertical shift in the supply curve for good X
Subsidy
A legal minimum price below which the product cannot be sold. If a floor is installed at some level above the equilibrium price, it creates a permanent surplus.
Price floor
A legal maximum price above which the product cannot be sold. If a ceiling is installed at a level below the equilibrium price, it creates a permanent shortage.
Price ceiling
Happiness, benefit, satisfaction, or enjoyment gained from consumption
Utility
Total happiness received from consumption of a number of units of a good
Total utility
The incremental happiness received, or lost, when the consumer increases consumption of a good by one unit
Marginal utility
A unit of measurement often used to quantify utility.
Utils
In a given time period, the marginal utility from consumption of more and more of that item falls.
Law of diminishing marginal utility
For a one-good case. Constrained by prices and income, a consumer stops consuming a good when the price paid for the next unit is equal to the marginal benefit received.
Constrained utility maximalization
The consumer maximizes utility when they choose amounts of goods X and Y, with their limited income, so that the marginal utility per dollar spent is equal for both goods.
Utility maximizing rule
An organization that employs factors of production to produce a good or service that it hopes to profitably sell.
Firm
The difference between TR and Total expllicit costs
Accounting profit
The difference between TR and total explicit and implicit costs
Economic profit
Direct, purchased, out of pocket costs paid to resource suppliers outside the firm
Explicit costs
Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneaur
Implicit costs
A period of time too short to change the size of the plant, but many other, more variable resources can be adjusted to meet demand
Short run
A period of time long enough to alter the plant size. New firms can enter the industry and existing frims can liquidate and exit
Long run
The mechanism for combining production resources, with existing technology, into finished goods and services. Inputs are turned into outputs.
Production function
Production inputs that cannot be changed in the short run. Usually this is the plant size or capital
Fixed inputs
Production inputs that the firm can adjust in the short run to meet changes in demand for their output. Often this is labor and/or raw materials.
Variable inputs
The total quantity, or total output, of a good produced at each quantity of labor emplyed.
Total Product of Labor (TPL)
The change in total product resulting from a change in the labor input. Input. MPL = ∆TPL/∆L, or the slope of total product.
Marginal Product of Labor (MPL)
Total product divided by labor employed: APL = TPL/L
Average product of labor (APL)
As successive units of a variable resource are added to a fixed resource, beyond some point the marginal product declines.
Law of diminishing marginal returns
Costs that do not vary with changes in short-run output. They must be paid even when output is zero.
Total fixed costs (TFC)
Costs that change with the level of output. If output is zero, so are these
Total Variable Cost (TVC)
The sum of total fixed cost and total variable costs at each level of output: TC = TVC + TFC
Total cost (TC)
The additional cost of producing one more unit of output.
Marginal Cost
Total fixed cost / output
Average fixed cost (AFC)
Total variable cost / output
Average variable cost (AVC)
Total cost / output
Average total cost (ATC)
If labor is the variable input being paid a fixed wage, MC and MPL are inverses of each other.
Relationship between MPL and MC
In the simplified case where labor is the variable input being paid a fixed wage. AVC and APL are inverses of each other.
Relationship between APL and AVC
The downward part of the LRAC curve where LRAC falls as plant size increases. This is the result of specialization, lower costs of inputs, or other efficiencies from larger scale.
Economies of scale
Occurs when LRAC is constant over a variety of plant sizes
Constant returns to scale
The upward part of LRAC curve where LRAC rises as plant size increases. This is usually the result of the increased difficulty of managing larger firms, which results in lost efficiency and rising per unit costs
Diseconomies of scale
The most competitive market structure, characterized by many small price-taking firms producing a standardized product in an industry in which there are no barriers to entry or exit.
Perfect Competition
All firms maximize profit by producing where MR = MC
Profit maximizing rule
The output in perfect competition where ATC is minimized and economic profit is zero.
Breakeven point
The output where AVC is minimized. If the price falls below this point, the firm chooses to shut down or produce zero units in the short run.
Shutdown point
Occurs when there is no more incentive for firms to enter or exit
Perfectly competitive long-ruin equilibrium
Another way of saying that firms are earning zero economic profits or a fair rate of return on invested resources
Normal profit
Entry (or exit) of firms does not shift the cost curves of firms in the industry
Constant cost industry
Entry of new firms shifts the cost curves for all firms upward
Increasing cost industry
Entry of new firms shifts the cost curves for all firms downward
Decreasing cost industry
The least competitive market structure; it is characterized by a single producer, with no close substitutes, barriers to entry, and price-making power.
Monopoly
The ability to set the price above the perfectly competitive level
Market power
The case where economies of scale are so extensive that it is less costly for one firm to supply the entire range of demand.
natural monopoly
Pm > MR = MC, which is not allocatively efficient and deadweight loss exists. Pm > ATC, which is not productively efficient. π π m >
0 so consumer surplus is transferred to the monopolist as profit.
Monopoly long-run equilibrium
The practice of selling essentially the same good to different groups of consumers at different prices
Price discrimination
A market structure characterized by a few small firms producing a differentiated product with easy entry into the market
Monopolistic competition
Pmc > MR = MC and Pmc > min ATC, so the outcome is not efficient, but π π mc = 0.
Monopolistic competition long-run equilibrium
The difference between the monopolistic competition output Qmc and the output at minimum ATC. Excess capacity is underused plant and equipment
Excess capacity
A very diverse market structure characterized by a small number of interdependent large firms, producing a standardized or differentiated product in a market with a barrier to entry
Oligopoly
A measure of industry market power. If the combined market share of the four largest firms is above 40%, it is a good indicator of oligopoly
Four-firm concentration ratio
Models where firms are competitive rivals seeking to gain at the expense of their rivals.
Non-collusice oligopoly
A game where the two rivals achieve a less desirable outcome because they are unable to coordinate their strategies
Prisoners’ dilemma
A strategy that is always the best strategy to pursue, regardless of what a rival is doing
Dominant strategy
Models where firms agree to mutually improve their situation
Collusive oligopoly
A group of firms that agree not to compete with each other on the basis of price, production, or other competitive dimensions. Members operate as a monopolist to maximize their joint profits.
Cartel
