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economics

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the study of how people make choices under conditions of scarcity and of the results of those choices for society

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rational person

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someone with well-defined goals who tries to fulfill those goals as best as he or she can

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economic surplus

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the benefit of taking any action minus its cost

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opportunity cost

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the value of the next-best alternative that must be foregone in order to undertake the activity

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positive economics

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economic analysis that offers cause-and-effect explanations of economic relationships; the propositions, or hypotheses, that emrege from positive economics can, in principle, be confirmed or refuted by data; in principle, data can also be used to measure the magnitude of effects predicted by positive economics

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normative economics

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economic statements that reflect subjective value judgments and are based on ethical positions

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The Scarcity Problem

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Having to make a choice- more of one good thing means having less of another

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The Cost-Benefit Principle

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An individual will be better off taking an action if, and only if, the extra benefits from taking the action are greater than the extra costs

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time value of money

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the fact that a given dollar amount today is equivalnet to a larger dollar amount in the future, because the money can be invested in an interest-bearing account in the meantime

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sunk cost

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a cost that is beyond recovery at the moment a decision must be made

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marginal cost

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the increase in total cost that results from carrying out one additional unit of an activity

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marginal benefit

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the increase in total benefit that results from carrying out one more unit of an activity

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average cost

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total cost of undertaking n units of an activity divided by n

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average benefit

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total benefit of undertaking n units of an activity divided by n

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fixed cost

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a cost that does not very with the level of an activity

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variable cost

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a cost that varies with the level of activity

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microeconomics

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the study of individual choice under scarcity and its implications for the behaviour of prices and quantities in individual markets

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macroeconomics

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the study of the performance of national economies and the policies that governments use to try to improve that performance

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absolute advantage

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one person has an absolute advantage over another if he or she takes fewer hours to perfom a task than the other person

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comparative advantage

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one person has a comparative advantage over another if his or her opportunity cost of performing a task is lower than the other person's opportunity cost

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The Principle of Comparative Advantage

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total output is largest when each person concentrates on the activities for which his or her opportunity cost is lowest

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production possibilities curve

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a graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good

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excess supply

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the difference between the quantity supplied and the quantity demanded when the price of a good exceeds the equilibrium price

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excess demand

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he difference between the quantity supplied and the quantity demanded when the price of a good lies below the equilibrium price

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efficient quantity

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quantity that results in the maximum possible economic surplus from producing and consuming the good

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economic efficiency

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condition that occurs when all goods and services are produced and consumed at their respective socially optimal levels

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The Efficiency Principle

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economic efficiency occurs when total economic surplus is maximized

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The Equilibrium Principle

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a market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action

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normal good

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a good whose demand curve shifts rightward when the incomes of buyers increase

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inferior good

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a good whose demand curve shifts leftward when the incomes of buyers increase

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utility

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the sense of well-being, satisfaction, or pleasure a person derives from consuming a good or service

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The Rational Spending Rule

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to maximize utility, spending must be allocated across goods so that the marginal utility per dollar is the same for each good

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optimal combination of goods

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the affordable combination that yields the highest total utility

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income effect

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the change in quantity demanded of a good that occurs because a change in the price of the good changes the real income of the person who purchases it

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substitution effect

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the change in quantity demanded of a good whose relative price has changed that occurs when a consumer's real income is held constant

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real price

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dollar price of a good relative to the average dollar price of all other goods and services

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nominal price

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absoltue price of a good in dollar terms

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price elasticity of demand

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the percentage change in the quantity demanded of a good that results from a 1 percent change in its price

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elastic

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the demand for a good is elastic with respect to price if its price elasticity of demand is greater than one

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inelastic

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the demand for a good if its price elasticity of demand is less than one

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unit elastic

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the demand for a good is unit elastic with respect to price if its price elasticity of demand is equal to one

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point elasticity of demand

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elasticity calculated at a specific point on a demand curve

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arc elasticity of demand

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elasticity calculated between the endpoints of a segment of a demand curve

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income elasticity of demand

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the percentage change in the quantity demanded of a good in response to a 1 percent change in income

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cross-price elasticity of demand for two goods

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the percentage change in the quantity demanded of one good in response to a 1 percent change in the price of a second good

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price taker (perfectly competitive firm)

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a firm that has no influence over the price at which it sells its product

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production function

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a technological relationship between inputs and output

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marginal product

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the increase in total output caused by an increase of one unit in the variable factor of production, holding technology and all other inputs constant

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law of diminishing marginal returns

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a property of the relationship between the amount of a good or service produced and the amount of a variable factor required to produce it

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average product

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total output divided by total units of the variable factor of production

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short-run cost-minimizing quantity of output

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the quantity of output at which a factory reaches minimum average total cost

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short-run shutdown point

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a firm's minimum average variable cost; if price drops below minimum average variable cost, the firm will minimize its losses by shutting down

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Pareto-efficient

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a situation is efficient if no change is possible that will help some people without harming others

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consumer surplus

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the economic gain of the buyers of a product, as measured by the cumulative difference between their respective reservation prices and the price they actually paid

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producer surplus

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the economic gain of the sellers of a product as measured by the cumulative difference between the price received and their respective reservation prices

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price ceiling

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a maximum allowable price, specified by law

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price floor

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a minimum allowable price, specified by law

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deadweight loss

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reduction in economic surplus that results from adoption of that policy

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accounting profit

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the difference between a firm's total revenue and its explicit costs

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economic profit

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the difference between a firm's total revenue and the sum of its explicit and implicit costs

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normal profit

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the opportunity cost of the resources supplied by the firm's owners; accountin profit-economic profit

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long-run average cost

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the lowest cost per unit that can be achieved for a given level of output when all factors of production, all costs , and the size of the firm are variable

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scale

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the size of a firm relative to other possible sizes of firms serving a particular market

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economies of scale

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a situation in which long-run average cost decreases as a firm's output increases

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indivisible factor of production

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a factor of production that must be available in some minimum amount if a productive activity, even of minimal size, is to occur at all

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indivisible cost

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the cost of an indivisible factor of production

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constant returns to scale

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a situation in which long-run average cost does not change as scale changes

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minimum efficient quantity

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the smallest quantity of output that will achieve minimum long-run average cost

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diseconomies of scale

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a situation in which long-run average cost increases as a firm's output increase

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rationing function of price

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distributes scarce goods to those consumers who value them most highly

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allocative function of price

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directs resources away from overcrowded markets and toward markets that are undeserved

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barrier to entry

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any force that prevents firms from entering a new market

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economic rent

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that part of the payment for a factor of production that exceeds the owner's reservation price, the price below which the owner would not supply the factor

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price setter (imperfectly competitve firm)

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a firm with at least some latitude to set its own price

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pure monopoly

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a maket in which there is only one supplier of a unique product with no close substitutes

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oligopoly

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a market in which there are only a few rival sellers

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monopolistic competition

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a market structure in which a large number of firms sell slightly differentiated products that are reasonably close for one another

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market power

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a firm's ability to raise the price of a good without losing all its sales

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natural monopoly

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a monopoly that results from economies of scale

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price discrimination

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the practice of charging different buyers different prices for essentially the same good or service

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perfectly discriminating monopolist

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a firm that charges each buyer exactly his or her reservation price

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hurdle method of price discrimination

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the practice by whcih a seller offers a discount to all buyers who overcome some obstacle

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perfect hurdle

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one that completely segregates buyers whose reservation prices lie above some threshold from others whose reservatio prices lie below it, imposing no cost on those that jump the hurdle

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dominant strategy

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one that yields a higher payoff no matter what the other players in a game choose

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dominated strategy

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any other strategy available to a player who has a dominant strategy

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Nash equilibrium

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any combination of strategies in which each player's strategy is his or her best choice, given the other players' strategies

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prisoner's dilemma

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a game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy

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cartel

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a coalition of firms that agree to restrict output for the purpose of earning an economic profit

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ultimate barganing game

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one in which the first player has the power to confront the second player with a take-it-or-leave-it offer

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credible threat

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a threat to take an action that is in the threatener's interest to carry out

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commitment problem

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a situation in which people cannot achieve their goals because of an inability to make credible threats or promises

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commitment device

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a way of changing incentives so as to make otherwise empty threats or promises credible

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external cost (negative externality)

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a cost that arises from an activity undertaken by an individual, firm, or other economic agent and that is borne by others because the cost is not incorporated in market prices the agent pays

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external benefit (positive externality)

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a benefit received by others that arises from an activity undertaken by an individual, firm, or other eonomic agent for which the agent is not compensated in the market price paid for the good or service involved

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side payments

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a payment made by one party to another in compensation or an external cost or benefit

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Coase theorem

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if at no cost, people can negotiate the purchase and sale of the right to perform activites that cause externalities they can always arrive at efficient solutions to the problems caused by externalities

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tragedy of the commons

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the tendency for a resource that has no price to be used until its marginal benefit falls to zero

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positional externality

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occurs when an increase in one person's performance reduces the expected reward of another's in situations in which reward depends on relative performance

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positional arms race

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a series of mutually offsetting investments in performance enhancement that is stimulated by a positional externality

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positional arms control agreement

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an agreement in which contestants attempt to limit mutually offsetting investments in performance enhancement

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free-rider problem

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an incentive problem in which too little of a good or service is produced because non-payers canot be excluded from using it

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expected value of a gamble

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the sum of the possible outcomes of the gamble multiplied by their respective probabilities

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fair gamble

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a gamble whose expected value is zero

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better-than-fair gamble

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a gamble whose expeceted value is positive

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risk-neutral person

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someone who would accept any gamble that is fair or better than fair

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risk-adverse person

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someone who would refuse any fair gamble

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asymmetric information

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situations in which buyers and sellers are not equally well informed about the characteristics of goods and services for sale in the marketplace

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lemons model

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George Akerlof's explanation of how asymmetric information tends to reduce the average quality of goods offered for sale

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costly-to-fake principle

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to communicate information credibly to a potential rival, a signal must be costly or difficult to fake

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statistical discrimination

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the practice of making judgments about the quality of people, goods, or services based on the characteristics of the groups to which they belong

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adverse selection

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the parttern that occurs when, at any given cost of insurance, peole with a greater expectation of loss buy insurance while people with a lower expected value of claims choose not to buy insurance

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technical efficiency in production

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occurs when the least possible amount of inputs is used to produce a given level of output

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cost-plus regulation

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a method of regulation under which the refulated firm is permitted to charge a price equal to its explicit costs of production plus a makrupto cover the oportunity cost of resources provided by the firm's owners

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informational asymmetry

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occurs when two parties in a relationship do not have the same level of knowledge of product quality

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public good

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a good or service that, to at least some degree, is both nonrival and nonexcludable

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nonrival good

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a good whose consumption by one person does not diminish its availability for others

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nonexcludable good

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a good that is difficult, or costly, to exclude nonpayers from consuming

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collective good

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a good or service that, to at least some degree, is nonrival but excludable

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private good

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one for which nonpayers can easily be excluded and for which each unit consumed by one person means one fewer unit is available for others

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commons good

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one for which nonpayers cannot easily be excluded and for which each unit consumed by one person means one fewer unit is available for others

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head tax

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a tax that collects the same amount from every taxpayer

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regressive tax

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a tax u nder which the proportioin of income paid in taxes declines as income rises

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proportional income tax

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a tax under which all taxpayers pay the same proportion of their incomes in taxes

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progressive tax

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a tax in which the proportion of income paid in taxes rises as income rises

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rent-seeking

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the socially unproductive efforts of people or firms to win a prize

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