Chapter 9: Decision Making by Individuals & Firms

Explicit Cost
a cost that involves actually laying out money

Implicit Cost
does not require an outlay of money; it is measured by the value, in dollar terms, of the benefits that are forgone

Accounting Profit
the business’s revenue minus the explicit costs and depreciation

Economic Profit (Often less than the accounting profit.)
the business’s revenue minus the opportunity cost of its resources.

Marginal Cost
the additional cost incurred by producing one more unit of a good or service

Constant Marginal Cost
occurs when the cost of producing an additional unit is the same as the cost of producing the previous unit

Decreasing Marginal Cost
when marginal cost falls as the number of units produced increases

Marginal Benefit
the additional benefit earned from producing one more unit of that good or service

Optimal Quantity
the quantity that generates the maximum possible total net gain

Principle of Marginal Analysis
says that the optimal quantity is the quantity at which marginal benefit is equal to marginal cost

Sunk Cost
a cost that has already been incurred and is nonrecoverable

Bounded Rationality
making a choice that is close to but not exactly the one that leads to the greatest possible economic payoff because the effort of finding the best payoff is too costly

Risk Aversion
willingness to sacrifice some economic payoff in order to avoid a potential loss

a benefit foregone

a cost forgone

Total Opportunity Cost
Total Explicit Cost + Total Implicit Cost

suppose a local hardware store has explicit costs of $2 million per year and implicit costs of $44,000 per year. If the store earned an economic profit of $50,000 last year, this means that the store’s accounting profit equaled

After earning your BA, you have to decide whether to take a job that will pay you $45,000 per year or spend an additional two years earning an MBA. If you decide to pursue the graduate degree, your annual expenses for tuition, books, board, and lodging will be $32,000. You have been offered a scholarship for $10,000 per year, but to pay the remaining $22,000 per year, you would have to cash in savings bonds from your grandparents that have been earning $500 in interest per year. The annual opportunity cost of earning your MBA is

You decide to quit your $60,000-per-year job as an information technology specialist and illustrate children’s books. At the end of the first year of illustrating, you have earned $20,000. You also spent $5,000 for paint and paper. Your economic profit in the first year as an illustrator is:

Less than; an activity should be reduced
According to the profit-maximizing principle of marginal analysis, if the marginal benefit is _____ the marginal cost, _____.

Behavioral Economics
Economists’ and psychologists’ attempts to understand and explain why people make decisions that appear to be irrational is the field of study called ________

Bounded Rationalilty
The “good enough” method of decision making is also called

Utility Function
The relation between an individual’s consumption bundle and her satisfaction is called a _________

higher consumption will increase utility, but only up to a point; after that utility will start to decrease
To say that you can’t have too much of a good thing means that for any good that you enjoy (for example, pizza):

paint, because you need enough to paint at least one entire room
Which of the following goods is MOST likely to display increasing marginal utility over some range?

Xavier notices that the marginal utility of working with a tutor seems to fall with each hour the tutor helps him study. If Xavier keeps the tutor until his grade actually begins to fall, his marginal utility for the last hour of tutoring will be:

the addition to total utility obtained from the nth unit of the good will be less than that obtained from the immediately preceding unit of the good.
Which of the following best describes the principle of diminishing marginal utility? As an individual consumes more of a good:

Assume that the marginal utilities for the first three units of a good consumed are 200, 150, and 125, respectively. The total utility when two units are consumed is:

Zero (The slope of the total utility curve equals the marginal utility)
When total utility is at a maximum, marginal utility is:

marginal utility is less than zero.
Freddy has eaten three corn dogs at the county fair, and if he eats another, he will get sick on the roller coaster. Knowing this, and ignoring any impact that price might have on his decision, we can say that at the fourth corn dog the:

the ratio of the marginal utility to price is the same for pork as it is for chicken
Assume that Siri is consuming the utility-maximizing quantities of pork and chicken. We can conclude that:

purchasing power caused by a change in the price of the good
The income effect of a price change is the effect on consumption changes as a result of a change in

her marginal benefit of studying equals her marginal cost of studying
To maximize her grade in economics, Stacey should study until: