Terms and Tools Used in MicroECONOMICS
These are the more important terms you will encounter in your reading or class discussions. Additional terms and definitions can be found in the glossary at the back of the textbook.
The terms below are approximately in the order in which you are likely to encounter them. Notice that many of the terms below describe people’s behavior or imply a theory about behavior. However, a tool is a conceptual creation that enables theories to be applied to various situations. In other words, not all of the terms are names of tools.
Items marked with an asterisk (*) are not stressed in the book, but are important.
Terms are shown as Italic.
Tools are shown in boldface.
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Chapter One
economics -the study of choices people make in a world of limits
*choice- the act of selecting one of many alternative things to do or consume
scarcity- people cannot have everything they want; resources and goods are limited compared to desires.
goods- things people want.
scarce goods- things people want that are limited quantities compared to the desire for them; also called economic goods
resources- things that are used to make goods. Sometimes called factors or inputs. These include land, labor, skills, capital, and natural resources.
*land- the resource of space, especially when used to produce food. Generally, land can usually be used over and over without vanishing.
*labor- the time of people as they work to produce things.
*skills- ability, talents, and training enabling people to produce things.
*capital- a man-made resource, such as machines, tools, and equipment. Capital usually lasts a long time, and can be used without being used up.
*natural resources- resources such as oil, coal, minerals, lumber, and water which can be extracted from nature or produced in time with its help.
*products- goods or services which have been produced. Sometimes called output.
choices in economics -some of the choices that economics deals with are (1) which goods (or outcomes) we will pursue, (2) how will we obtain the goods or outcomes, and (3) who will get each good or benefit from the outcome?
rationing- distribution of scarce goods and resources, either by charging of prices or other means.
costs -things that have to be given up
free good -a good that is not scarce, and therefore a good that has no cost; there is no such thing
conflict -differences in opinions about what should be done or how it is to be accomplished
competition- conflicts and contests to gain control or use of scarce goods and resources. Competition is the natural result of scarcity and thus exists, in some form, whenever people's desires differ.
values- personal feelings about how desirable things or outcomes are
subjective values- different people view things and outcomesdifferently.
rational decision-making -choosing or behaving in the way that best gets a person what he or she wants, given the circumstances
*economic theory- ideas and models that describe the cause and effect relationships that are involved when decisions are made.
*scientific thinking- the approach we will take to economics; we try to predict a decision or its results rather than describe exactly how it is made or judge whether we agree with it.
scientific method -the approach of science; formulate a theory, test it, and revise it until it explains and predicts
model -a simplification or simplified theory
ceteris paribus- examining the effects of one event or circumstance in isolation from everything else by assuming that nothing else is changing. The term is Latin for "everything else being the same."
association- when one event happens at the same time or after another event, but one has not necessarily caused the other.
causation- when one event makes another event happen.
as-if -observing that a person's actions may be the same as they would be if they were doing something they may not be actually doing
normative economics- subjective judgments about what ought to be or what should happen. These cannot be tested or proven scientifically, as they are only opinion.
positive economics- scientific study of things as they are, often involving if-then relationships.
microeconomics- the study of small-scale decisions and their results. These include the production, consumption, and trade decisions made by individuals, households, business firms, and industries. Government regulation of trade, production, and consumption is also studied.
private sector - businesses and individuals
macroeconomics- the study of large scale decisions and their results. These include spending, taxing, production, and wealth transfer decisions by governments and countries. The policy decisions that result in unemployment, inflation, economic growth, and high interest rates are also studied
public sector -government
Chapter Two
utility- the benefit, happiness, or satisfaction expected from a choice or option.
opportunity cost-the highest valued alternative given up; the relevant cost in every decision.
*economic incentives- costs and utilities/benefits associated with an action, choice or opportunity.
response to incentives-people change behavior based on perceived changes in the costs or the benefits of an option.
long run- period of time long enough to permit a decision maker to change anything.
short run- a period of time in which some factors or conditions are fixed and cannot be changed by a decision-maker
marginal thinking-all decisions are made incrementally or a little at a time, examining the incremental or additional changes or effects of a decision.
margin -the part or increment that can be changed in a decision, or that is under a person's comtrol. "Marginal" is used to refer to this chunk that a decision can be made about.
marginal opportunity cost (marginal cost)-the highest valued alternative given up to do a marginal (or incremental) amount of an activity; the margin is often specified. Usually rises as quantity of a particular activity rises.
marginal utility -the benefit (satisfaction) received or anticipated when an additional amount of an activity is undertaken; usually used with marginal opportunity cost. Usually falls as quantity of a particular activity rises, according to the Law of Diminishing Returns.
(law of) diminishing returns- the observation that the benefit of an action tends to fall as it is repeated (in a particular span of time). Also implies that the cost of an action tends to rise as it is repeated.
costly information- information is scarce and thus many decisions are made with limited information; information costs are the costs of obtaining information.
secondary effects- when actions alter the incentives (costs and benefits) involved in making other decisions (or taking other actions); these can include decisions made by other people or decisions made in the future.
economization, economizing -- choosing so as to minimize cost or maximize benefits. Usually, this means choosing the option (or action) that has the lowest opportunity cost from among several options that give the same benefit; might also involve choosing the highest benefit option among those with identical costs.
trade- voluntarily giving up goods to another person in exchange for goods which are more highly valued.
Chapter Three
production possibilities - the combinations of two goods that can be produced with given resources
efficient, efficiency -getting the most possible of whatever you are trying to get; efficient is the adjective, efficiency is the noun
production efficiency - (sometimes also productive or productively efficient) the situation in which the amounts of goods being produced with available resources and abilities is as great as possible. When two or more goods are being considered, this requires that no good can be produced in greater quantity unless the output of some other good is reduced.
production possibilities curve -a graphical representation of the efficient combinations of two goods that are possible to produce at a particular time, given a set of resources (and their current abilities).
shift in production possibilities- movement in the production possibilities curve, indicating a change in the amounts of at least one good that can be produced. The curve will shift to the right, indicating greater production, if more resources are available, new technology enables more production, or if institutional changes (such as changes in the legal system) enable greater production.
comparative advantage -the ability to produce a good at a lower (or the lowest) marginal opportunity cost, when compared with other producers (resources)
law of comparative advantage -the rule that says that production of goods is maximized if each resource or producer is used to make the good that the resource or producer can produce at lowest marginal opportunity cost
specialization- concentration on producing one kind of good or performing one kind of action rather than producing a variety of goods for oneself.
division of labor- separating production into several different tasks, each of which is performed by a different worker. It is similar to specialization, except that one good is made instead of several different goods.
absolute advantage -the ability to produce a greater amount of some good than other producers
Chapter Four
allocative (allocation) efficiency -distributing goods in a way that maximizes total utility; sometimes called distributive or distribution efficiency
invisible hand -the principle that trade will lead a person to provide things that other people want, even though his intention is to acquire some thing that he wants
private property rights-the recognized and enforced ability to trade and use goods and to be protected from persons who might use force or threat to take goods; ownership rights
*incentives provided by property rights- owners of goods and resources will generally take care of things they own, develop and utilize resources they own, conserve valuable resources and goods for future use or sale, and take care that their property is not used in a way that harms others.
transactions costs-costs associated with the action of trade, including information and transportation costs.
middleman- a person who specializes in lowering transactions costs by buying and selling goods or otherwise arranging trades.
money -an item that is commonly used in exchanges, and is desired because of its value in exchanges, even though it is not consumed or used itself
medium of exchange -an item that is received in one exchange only so it can be traded away in another, and is desired only for this function; an item that is in the middle of most or all trades. Using a medium of exchange reduces transactions costs. Money is a medium of exchange.
market -a setting in which people negotiate and exchange with others
Chapter Five
demand-the relationship between the price and quantity demanded of a good, all else being held constant; demand is based on marginal utility.
quantity demanded-the amount of a good that buyers wish to buy at a particular price.
law of demand - the rule that says that the demand relationship is an inverse or negative one (as price rises, quantity demanded falls, all else being held constant)
substitute- good used instead of another
law of diminishing marginal utility- an example of the law of diminishing returns (see Chapter Two), which says that as larger quantities of a good are consumed, the value of an additional or marginal amount will fall. In other words, marginal utility declines as consumption goes up. This is one basis for the law of demand.
elastic demand- when buyers are very response to changes in price, due to the availability of substitutes.
inelastic demand- when buyers do not respond to changes in price, due to lack of substitutes.
market demand curve (schedule)- graphical depiction of demand; graph showing the relationship between prices and the amounts demanded of a good by all individuals in a market area.
opportunity cost of production- the opportunity cost of producing a good or service, including the costs of all resources to make the good or services..
quantity supplied-the amount of a good that sellers wish to sell at a particular price.
*supply-the relationship between the price and quantity supplied of a good, all else being held constant; the relationship between the amount of a good offered for sale by sellers and the price of the good; supply is based on marginal opportunity cost.
law of supply- states that the supply relationship is a direct one (as price of a good gets higher, the amount offered for sale will increase, all else being held constant).
*market- the total of trades and trade negotiations between buyers and sellers in which they express their desires (reflected in supply and demand).
demand and supply equilibrium-the unique price and quantity combination at which the quantity demanded equals the quantity supplied in a market; where the market is headed or will end up. Market forces pushing price up are in balance with those pushing price down. Notice, there is actually no “law of supply and demand,” but the equality implied by equilibrium is what people mean when they use this expression.
*disequilibrium- the state when a market in not in equilibrium.
*excess supply- a greater quantity supplied than is demanded, indication of price above equilibrium; also called a surplus
*surplus- a greater quantity supplied than is demanded, indication of price above equilibrium; also called excess supply
*excess demand- greater quantity demanded than is supplied, indication of price below equilibrium; also called a shortage
*shortage-a greater quantity demanded than is supplied, indication of price below equilibrium; also called excess demand
Chapter Six
*increase in demand -a change in the relationship between price and quantity demanded so that a greater quantity of the good is demanded, at every possible price, than was true before. This is shown by moving the demand curve rightward. This is different from an increase in quantity demanded, which occurs without the demand curve moving.
*decrease in demand -a change in the relationship between price and quantity demanded so that a smaller quantity of the good is demanded, at every possible price, than was true before. This is shown by moving the demand curve to the left. This is different from an decrease in quantity demanded, which occurs without the demand curve moving.
complement- good used along with another
normal good- good which is purchased in greater quantity as the buyers’ incomes rise.
inferior good- good which is purchased in smaller quantity as the buyers’ incomes rise
*events that increase demand- increases in income (for normal goods), increases in the prices of substitutes (or fewer available substitutes), decreases in the prices of complements (or more available complements), higher expected future prices, more consumers, changes in consumer preferences (through advertising, information, fashions, or environmental factors such as laws and weather).
*events that decrease demand- decreases in income (for normal goods), decreases in the prices of substitutes (or more available substitutes), increases in the prices of complements (or fewer available complements), lower expected future prices, fewer consumers, changes in consumer preferences (through decreased advertising, information, fashions, or environmental factors such as laws and weather).
*increase in supply- a change in the relationship between price and quantity supplied so that a greater quantity of the good is offered for sale, at every possible price, than was true before. This is shown by moving the supply curve rightward. This is different from a change in quantity supplied, which occurs without the supply curve moving.
*decrease in supply- a change in the relationship between price and quantity supplied so that a smaller quantity of the good is offered for sale, at every possible price, than was true before. This is shown by moving the supply curve leftward. This is different from a change in quantity supplied, which occurs without the supply curve moving.
*events that increase supply- decreases in the prices of resources, improvements in technology, conditions favorable to production (such as laws or good weather), reductions in taxes.
*events that decrease supply- increases in the prices of resources, conditions unfavorable to production (such as laws or bad weather), increases in taxes.
Chapter Seven
consumer surplus-the total value buyers place on a good over the price they must pay for it; the gains to buyers from trade
producer surplus-the payment sellers receive for a good over the cost to them of selling it; the gains from sellers of trade
economic (allocative) efficiency -when all the gains (utility) possible fro trade have been achieved; the situation in which no person can be made better off without making another person worse off; producing the most utility from the resources available. Economic efficiency requires that production that produces more utility than it costs is undertaken, and that no production that produces less utility than it costs is undertaken.
price controls- prices set by government.
price floor-a minimum price set by the government; a price kept above equilibrium, resulting in a surplus. Price floors reduce the amount of trade immediately (by reducing the quantity buyers are willing to buy), increase the future supply of goods while reducing future demand, reduce the non-money payments that buyers are willing to make, cause discrimination on the part of buyers (since buyers must choose between many sellers and can not use price to make the selection), cause lucky sellers who can sell the product to gain at the expense of sellers who are unable to sell the good, and increase the demand for substitute goods.
surplus- a greater quantity supplied than is demanded, indication of price above equilibrium; also called excess supply.
minimum wage- a price floor on labor services. The effects of a minimum wage include a surplus (unemployment) of some kinds of labor (workers who are uneducated, unskilled, inexperienced, have criminal records, etc.), greater discrimination (selection by legal and illegal means) in hiring by employers, higher demand (and prices) for other resources (including labor that would have equilibrium prices above the minimum wage), and higher prices for goods produced using the higher priced resources.
price ceiling- a maximum price set by the government; a price kept below equilibrium, resulting in a shortage . Price ceilings reduce the amount of trade immediately (by reducing the amount sellers are willing to sell), cause black markets to appear, reduce the future supply of goods, reduce the quality of products, cause discrimination on the part of sellers (in addition to other forms of non-price distribution of goods), result in goods being used inefficiently by those who obtain them cheaply, cause lucky buyers who can obtain the product to gain at the expense of buyers who are unable to obtain the good, and increase the demand for substitute goods.
shortage-a greater quantity demanded than is supplied, indication of price below equilibrium; also called excess demand.
black market- a market in which illegal goods are sold, or in which illegal prices are charged. Black markets can result when price floors are imposed, when high taxes are levied, or when laws restrict trade.
excise tax- a tax of a fixed amount of money on each unit of a good sold.
tax base- the amount of trade (economic activity) that is taxed.
tax rate- the per unit amount or percentage of tax.
*tax revenue- money raised for the government by a tax.
tax incidence- the actual burden of a tax in terms of who is hurt by it.
statutory incidence- who is legally responsible for giving tax money to the government. The actual tax incidence is not affected by the statutory incidence
excess burden (deadweight loss)- loss of gains from trade due to a tax; loss of consumer surplus or producer surplus that is caused by a tax but that is not collected by the government as revenue; a measure of a tax's distortions.
elastic demand- when buyers are very response to changes in price.
inelastic demand- when buyers do not respond very much to changes in price.
elastic supply- when sellers are very response to changes in price.
inelastic supply- when sellers do not respond very much to changes in price.
Chapter Eight
marginal utility -the benefit (satisfaction) received or anticipated when an additional amount of an activity is undertaken; usually used with marginal opportunity cost. Usually falls as quantity of a particular activity rises, according to the Law of Diminishing Returns.
(law of) diminishing returns- the observation that the benefit of an action tends to fall as it is repeated (in a particular span of time).
marginal benefit -the measure in money of the benefit (satisfaction) received or anticipated when an additional amount of an activity is undertaken; the dollar value of marginal utility. The price a buyer would be willing to pay for an additional amount of a good.
*demand-the relationship between the price and quantity demanded of a good, all else being held constant; demand is based on marginal utility.
*quantity demanded-the amount of a good that buyers wish to buy at a particular price.
*law of demand-states that the demand relationship is an inverse or negative one (as price rises, quantity demanded falls, all else being held constant)
*optimizing- choosing in a way to maximize utility, given the constraints and limitations on consumption. Optimizing in purchasing requires that a consumer makes purchases in such a way that the marginal utility per dollar spent on one item is equal to the marginal utility per dollar spent on every other good. If there is some good that, by spending a dollar on it a person could add more to utility than by spending the dollar any other way, then the person will increase utility by purchasing it rather than something else.
substitution effect- the tendency to seek substitutes when price changes; the portion of the change in quantity demanded (when price changes) that is due to buyers comparing prices with other goods.
income effect- the effect of budget limitations when price changes; the portion of the change in quantity demanded (when price changes) that is due to buyers being able to afford less or more of a good when the price changes.
*time constraints- consumers are limited in their consumption by time as well as money; consuming many goods requires "spending" time out of the "budget" of a day, thus economizing in time used.
*individual demand curve (schedule)- graphical depiction of demand of one buyer; graph showing the relationship between prices and the amounts demanded of a good by a single consumer.
*market demand curve (schedule)- graphical depiction of demand; graph showing the relationship between prices and the amounts demanded of a good by all individuals in a market area. It is the sum (horizontally or in quantity terms) of all the individuals' demand curves.
total value vs. marginal value- the decisions a person (or market) makes about consumption depend on marginal values and tradeoffs. Items already consumed (or purchased), while providing utility, are not part of the decision process. The total utility a good provides (the sum of all the marginal utilities of units already consumed) will not affect the marginal decision of whether to acquire or consume one more of the good.
*percentage change or percentage difference- this is not really an economic tool, but it is a mathematical one. It is the change in some variable, divided by the initial value of the variable. The shorthand used in class for this is %Æ.
(price) elasticity of demand-the responsiveness of buyers to changes in price. Specifically, the percentage change in quantity demanded for each percentage change in price, other things being equal. Elasticity can be calculated using the formulas
Elasticity of demand will always be negative. For a straight-line demand curve, elasticity falls in absolute value as lower points on the demand curve are reached (i.e., at lower prices). Elasticity is greater in absolute value if there are more substitutes for a good, the good is more of the buyers’ budgets, or if buyers have more time to adjust to price changes.
arc elasticity of demand- a method of mathematically calculating elasticity, using the average of the starting and ending prices and the average of the starting and ending quantities that result when a price change occurs. This is used so that the measure of elasticity will be the same whether price is going down from some initial price to a second price, or from the second price back up to the initial price. While the range of a price change will affect the value of arc elasticity, the direction of the price change will not. Arc elasticity can be calculated using the formulas
(relatively) elastic demand- when the elasticity of demand is greater than one, in absolute value. This means the percentage change in quantity demanded is greater than the percentage change in price. This occurs on the top half of a straight-line (downward sloping) demand curve. While a flat demand curve is relatively more elastic than a steep one going through the same price and quantity combination on a graph, elastic demand can occur even in a steep demand curve. If demand is elastic, an increase in product price will reduce revenue (see below).
(relatively) inelastic demand- when the elasticity of demand is less than one, in absolute value. This means the percentage change in quantity demanded is less than the percentage change in price. This occurs on the bottom half of a straight-line (downward sloping) demand curve. While a steep demand curve is relatively less elastic than a flat one going through the same price and quantity combination on a graph, inelastic demand can occur even in a flat demand curve. If demand is inelastic, an increase in product price will increase revenue (see below).
unitary elastic demand- when the elasticity of demand is exactly one, in absolute value. This means the percentage change in quantity demanded is equal to the percentage change in price. This occurs halfway down a straight-line (downward sloping) demand curve. It can also occur if the demand curve is shaped as a special curve (bending towards the origin). If demand is unitary elastic, revenue is maximized (see below).
expenditures (revenues)- the amount spent on a good (or money payment received by the seller). This is the price of the good times the quantity of it that is purchased.
total revenue- the same as expenditures, the price of a good times the quantity of it that is purchased.
perfectly elastic demand- when the elasticity of demand is infinite (in absolute value). This means that quantity demanded is so responsive to changes in price that if price goes above a certain level, none of the good will be purchased. This would imply a horizontal demand curve.
price-expenditure relationship- as the price of a good is increased, ceteris paribus, the expenditure on the good (revenue from its sale) will rise if and only if demand is inelastic. If demand is elastic, lower price will increase revenue. If demand elasticity is exactly -1, then revenue is maximized.
*perfectly elastic demand- when the elasticity of demand is infinite (in absolute value). This means that quantity demanded is so responsive to changes in price that if price goes above a certain level, none of the good will be purchased. This would imply a horizontal demand curve.
*perfectly inelastic demand- when the elasticity of demand is zero. This means that quantity demanded is unresponsive to changes in price. This does not occur in reality (except for those goods with no demand at all).
income elasticity- the percentage change in quantity demanded divided by the percentage change in income. Income elasticity could be positive or negative, depending on the good.
normal good- a good that will have an increase in demand as income of buyers goes up; the income elasticity for such a good will be positive.
inferior good- a good that will have a decrease in demand as income of buyers goes up; the income elasticity for such a good will be negative.
Chapter Nine
*firm- productive entity (such as a business or farm) that converts inputs into output.
output- the quantity of a good or service produced. Abbreviated as q or Q.
factors of production-resources used to make goods or services; inputs.
inputs-resources used to make goods or services; factors of production.
materials- inputs which are altered in form or function to make goods. Abbreviated as M.
labor- a person’s time when used as an input in a productive process. Labor can be used to produce a service or to transform materials into goods. Labor is abbreviated as L.
capital - machines, tools, buildings, and other durable inputs that do not generally get used up as they are used to produce goods. Capital differs from labor and materials in this respect. Capital is abbreviated as K.
short run-period in which some inputs or resources cannot be changed, but others can. The inputs which cannot be changed in the short run are assumed to be capital.
long run-period of time over which all inputs or resources used in production are variable, including capital.
total product (TP)-the total output that can be produced by utilizing a given number of units of a variable input (usually labor)
marginal product (MP)-the additional output that can be produced by adding one more unit of a variable input (usually labor). MP=change in q/change in L
(law of) diminishing returns- the situation in which adding an additional unit of variable input (such as labor) increases output by a smaller increment than previous units of labor
average product (AP)-the overall output per unit of variable input (usually labor). AP=q/L
Chapter Ten
fixed cost (FC)-cost which does not rise as more of a good is produced in the short run; costs of inputs which are fixed in amounts in the short run
variable cost (VC)-that cost which rises as more of a good is produced in the short run; costs of inputs which can be varied in amounts in the short run. In the long run, all costs are variable, so we do not make the distinction in the long run.
total cost (TC)- all costs; the sum of FC+VC.
implicit cost-cost which considers opportunity cost of resources as well as money costs.
explicit cost-money costs or costs for which a bill is paid.
sunk costs- costs that are associated with past decisions and thus cannot influence current decisions.
total cost- the sum of all costs, including implicit and explicit costs.
opportunity cost of capital- the normal or usual annual return one could expect from the dollar value of a capital investment (if the dollar amount was invested in some other way). This is the implicit cost of capital assets of a firm.
wage (w)- the price of each unit of the variable input (usually labor).
marginal cost (MC)-the change in cost when one more unit of a good or service is produced. This generally falls when output is increased from very small amounts, but rises when output is increased from moderate or large levels. Inversely related to marginal product (see below).
MC=change in TC/change in q ; also MC=w/MP
average variable cost (AVC)-the overall variable cost (cost from variable input) per unit of output. This generally falls when output is increased from small amounts, but rises when output is increased from large levels. Inversely related to average product (see below).
AVC=VC/q; also AVC=w/AP
economic profit-revenue minus all costs (explicit and implicit)
accounting profit-revenues minus explicit costs
average fixed cost (AFC)-the overall fixed cost (cost from fixed inputs) per unit of output; this declines as more output is produced. AFC=FC/q
average total cost (ATC)- the overall cost (from all inputs) per unit of output. This generally falls when output is increased from small amounts, but rises when output is increased from large levels.
ATC=TC/q; also ATC=AFC+AVC.
price takers-sellers who cannot affect the price of the product by altering output. They exist in a Pure Competition market, and may exist in others.
*homogeneous products- products so similar to one another that, for most purposes, they are identical.
long run average (total) cost (LRATC or LRAC)-average (total) cost in the long run, determined by the boundary of all the possible short run average total cost curves. This generally falls when output is increased from small amounts, is unchanged when output is moderate, but rises when output is increased from large levels.
economies of scale-declining long run average cost; also called increasing returns to scale
diseconomies of scale-rising long run average cost; also called decreasing returns to scale
constant returns to scale-long run average cost is neither rising nor falling.
Chapter Eleven
price takers-sellers who cannot affect the price of the product by altering output. They exist in a purely competitive market, and may exist in others. Usually, they produce products that are nearly identical to those of other sellers, they compete with many other sellers, each firm produces a small part of the total market output of the product, and there is free entry into the market.
price searchers-sellers who can affect price by altering the quantity they sell; they each have their own downward-sloping demand curve, and thus a downward sloping marginal revenue curve; they were once referred to as monopolies.
*homogeneous products- products so similar to one another that, for most purposes, they are identical.
free entry-the process of new firms entering any market in the long run which offers economic profit. The process results in no long run profit for producers. The opposite of a market with free entry is one which has barriers to entry.
barriers to entry- characteristics of a market or good which make it difficult for new firms to begin or expand production. Generally, production costs are not considered barriers to entry. Barriers to entry do include patents, copyrights, trademarks, ownership of unique resources, licenses, government regulations, and extreme economies of scale.
competition- rivalry between sellers; a lack of cooperation or agreement between sellers.
purely competitive market- market in which there are a large number of sellers of nearly identical products, and in which there is free entry. Also called "pure competition," "perfect competition," or "perfectly competitive."
shutdown decision-when operation in the short run is not sensible (when price is less than average variable cost), a firm ceases to make output. This occurs only when the price of a good is less than the average variable cost of producing it (P<AVC). This does not mean that the firm sells its capital assets or goes out of business.
*optimal output of a price taker- in the short run, the output of a price taker will be determined by the price and marginal cost. Specifically, the firm will produce every unit of output for which price (marginal revenue) is at least as great as marginal cost (MR=P=MC).
going out of business- selling a firm's capital (which can only occur in the long run). This will occur if price is less than average total cost in the long run (P<ATC in Long Run).
*short run profit- a firm will be making short run profits if the price of the good is greater than the average total cost of making the optimal output (P>ATC).
*short run losses- a firm will be making short run losses if the price of the good is less than the average total cost of making the optimal output (P<ATC). Even still, it will not go out of business until the long run.
*short rum market supply- the relationship between the quantity supplied by all the firms in a market and the price, in the short run. This is based on the horizontal (quantity) sum of all of the individual sellers' marginal cost curves (above average variable cost).
*long run supply- the relationship between price and quantity offered for sale in the long run, assuming that firms are free to enter or leave the market.
*long run equilibrium in a price taker market- a situation in which all sellers are making zero economic profit, due to the entry and exit of firms forcing long run price to be equal to long run average cost (P=LRATC).
constant cost industry-if the long run average cost curve does not change as new firms enter the market, the industry is said to be a constant cost industry, and the long run supply curve is horizontal.
increasing cost industry-if the long run average cost curve moves up as the number of price taker firms rises, the long run supply curve for the industry may be upward sloping. This may happen if there are diseconomies of scale in producing some input that this industry requires.
decreasing cost industry-if the long run average cost curve moves down as the number of price taker firms rises, the long run supply curve for the industry may be downward sloping. This may happen if there are economies of scale in producing some input that this industry requires.
Chapter Twelve
price searcher- a seller that has a downward-sloping demand for its products as an individual seller, and that must lower price to increase quantity sold.
market power- also called monopoly power, this power exists if a seller can increase its price and still keep many of its customers. In other words, it is the name for being a price searcher.
differentiated products- goods which are in some way different from their substitutes. This would give each seller a downward-sloping demand curve for its product
marginal revenue (MR)-change in revenue as one more unit of output is sold; generally less than the price for a price searcher, but equal to the price for a price taker (MR=P).
competitive price searcher market- when firms have a downward-sloping demand curve but it is easy for them to enter or leave the market. Another way to refer to a price searcher market with low barriers to entry. Also called a "monopolistically competitive" market, or "monopolistic competition."
monopolistic competition- more common name for competitive price searcher markets.
contestable market- a price searcher market in which entry and exit is very easy, forcing price to the level of average total cost in the long run, and thus forcing a state of zero economic profit in the long run. A market in which the threat of entry by potential rivals exerts the same influence on long run profit as actual free entry by rivals. Even if capital requirements for entering the market are high, the capital can be easily resold, thus the risks of entering a contestable market are low.
*optimal output of a price searcher (short run)- in the short run, the output of a price searcher will be determined by the marginal revenue and marginal cost. Specifically, the firm will produce every unit of output for which marginal revenue is at least as great as marginal cost (MR=MC). This will result in a price higher than marginal cost.
*optimal output of a price searcher (long run)- in the long run, the output of a price searcher in a monopolistically competitive market will be determined by the demand curve and average total cost. Specifically, the firm will produce every unit of output for which price (indicated by the demand curve) is at least as great as average total cost (P=ATC). This will result in zero economic profit in the long run, as entry by rival firms (or its threat) will force the demand curve to the left if economic profit is made.
allocative efficiency -The situation in which no person can be made better off without making another person worse off; producing the most utility from the resources available. Allocative efficiency requires that production that produces more utility than it costs is undertaken, and that no production that produces less utility than it costs is undertaken. In other words, price is equal to marginal cost in the short run and average total cost in the long run. Price searchers violate the conditions for such efficiency.
price discrimination-charging different prices to different buyers for the same good; charging a higher price to the buyers whose elasticity of demand is lower. This requires that sellers set up some method for preventing the buyers who buy the good for the low price from reselling it to other buyers. Price discrimination may increase efficiency by increasing production of goods to levels greater than could be obtained if all buyers were charged an identical price.
barriers to entry- characteristics of a market or good which make it difficult for new firms to begin or expand production. Generally, production costs are not considered barriers to entry. Barriers to entry do include patents, copyrights, trademarks, ownership of unique resources, licenses, government regulations, and extreme economies of scale.
licensing- a barrier to entry caused by the requirement to get government permission to operate.
patent- legal exclusive right to an invention or process.
copyright- legal exclusive right to a creative work.
trademark- legal exclusive right to a name or symbol.
monopoly- a single seller of a good with no good substitutes and with substantial barriers to entry.
*optimal output of a price searcher with barriers to entry (short run)- in the short run, the output of a price searcher will be determined by the marginal revenue and marginal cost. Specifically, the firm will produce every unit of output for which marginal revenue is at least as great as marginal cost (MR=MC). This will result in a price higher than marginal cost.
*optimal output of a price searcher (long run)- in the long run, the output of a price searcher in a monopolistic market will be determined by the marginal revenue and marginal cost. Specifically, the firm will produce every unit of output for which marginal revenue is at least as great as marginal cost (MR=MC). This will result in a price higher than marginal cost. This may result in positive economic profit in the long run.
oligopoly-a limited number of firms whose output decisions are interrelated. This type of market has few sellers, interdependence between sellers, economies of scale, and high barriers to entry. Goods of different sellers may be similar or distinct. Two extreme possible outcomes in such a market are quasi-competition and cartel.
quasi-competition- in an oligopoly market, if rivals compete with one another, they may force each other's demand curves to the left. If this happens, the result is much the same as if the firms were price takers, with price close to marginal cost in the short run and average cost in the long run.
cartel-a group of sellers who combine (collude) illegally to sell as a big price searcher. To be successful, a cartel needs to be able to monitor (detect) the output of its members, punish any member that produces too much output, and prevent firms which are not in the cartel from producing and selling output.
collusion- agreement among producers not to compete; such an agreement can take the form of a formal cartel or it can be less structured. Firms in collusion have a constant incentive to "cheat" on the collusive agreement, since each faces costs much lower than their product's price. Successful collusion is difficult if there are many firms, if price cutting schemes are hard to detect, if product quality alterations are difficult to detect, if entry barriers are low, if demand is unstable, and if antitrust laws are enforced.
antitrust laws- laws against monopoly or collusion.
*inefficiencies from price searching- with price searchers, especially if there are high barriers to entry, inefficiencies result. Specifically, the choice of consumers is reduced, allocative efficiency does not occur, consumers are less able to communicate their desires to producers through the pricing mechanism, and resources will be expended in seeking government favoritism and licensing.
natural monopoly - a situation in which it is not possible or efficient for more than one firm to produce a particular good or service. This is because of extreme economies of scale in the long run and/or downward-sloping ATC curves in the short run. The effects of natural monopoly can be mitigated (partly or fully) by reducing barriers to trade with other regions, regulation, or by allowing price discrimination.
*regulation of natural monopoly- natural monopolies have historically been regulated so as to allow price to equal average total cost. This allows zero long-run profit, but is inefficient in the short run. Setting price to marginal cost through regulation would be efficient in the short run, but would result in the producer going out of business.
*problems with regulation of monopoly- it is difficult to regulate a natural monopoly, even if the goal is to establish a price equal to average costs. First, costs are difficult to estimate. Second, there is no incentive under such an arrangement for firms to economize, since all costs are passed on in the price. Third, the regulated monopoly becomes a special interest and tends to influence the regulatory agency's policies by providing information, expertise, and future job opportunities for the regulators.
Chapter Thirteen
resource markets- also called "factor markets", these are where labor, capital and natural resources are bought and sold.
wage- the price of labor resources. Wages and other resource prices affect the cost of goods and services, and thus their supply.
human capital- skills, education, training and experience that enable a worker to become more productive. These are not used up as the worker works; the worker still has them even though she/he has used them on the job. They also require an investment to obtain, and thus resemble capital, because of the investment and durability characteristics.
derived demand- the idea that resources are not desired for themselves, but rather for the value of what they can produce and how much they can produce.
substitution-in-production effect- when the price of a resource rises, less of that resource will be used and other resources will be used instead.
substitution-in-consumption effect- when the price of a resource rises, the prices of products containing that resource will rise, and thus consumption of those products will fall, reducing use of the resource.
productivity-the output produced by an input or resource. Generally, it is measured as the additional product that is produced by adding one more unit of input to the productive process (also called the marginal product of the resource).
marginal revenue product (MRP)-the value to a resource buyer of one more unit of a resource. It is defined as the marginal product of the resource times the marginal revenue that can be earned for each unit of good produced by the resource. The marginal revenue product (MRP) is the basis of the demand curve for a resource.
*value of marginal product (VMP)-the marginal product of the resource times the price of the good produced by the resource. The value of marginal product is the same as the marginal revenue product (MRP) if the resource buyer is a price taker in selling its product.
*optimizing- Optimizing in production requires that a producer purchases resources in such a way that the marginal revenue gained per dollar spent on one resource is equal to the marginal revenue gained per dollar spent on every other resource, and that every unit of a resource that adds more to revenue than it does to costs is purchased.
nonpecuniary job characteristics- working conditions (including job location, prestige, freedom, coworkers, and other factors) that make some jobs more desirable than others. These are not differences based on wage or salary payments.
compensating wage differentials- wage differences that are based on job characteristics such as unpleasantness or danger of a profession.
automation- technology that reduces the amount of labor required for production, or that increases labor productivity.
economic rent- how much more a supplier of a good or resource is paid than is necessary to make them willing to supply the good or resource. In cases for which the only benefit of supplying the good or resource is the payment, the economic rent is equivalent to the producer surplus.
labor union- an organization of labor sellers that together tend to act as a cartel
marginal factor cost - the cost to an employer of buying one more unit of a resource, such as labor. In competition, this will be the same as the wage. However, for a monopsony, it will be greater than the wage.
monopsony- a single buyer of a good or resource, such as the only employer of a particular kind of labor.
Chapter Fourteen
capital- a man-made resource, such as machines, tools, and equipment. Capital usually lasts a long time, and can be used without being used up.
investment- the purchase of capital (usually by businesses).
saving- current income that is not spent on consumption.
rate of time preference- the rate at which a person desires to have things in the present rather than waiting to have them at some future time.
(nominal) money interest rate-the percentage difference between the amount of money borrowed at one time and the amount repaid at another, on an annual basis.
*inflation rate-the rate of change in prices over time, on an annual basis.
inflationary premium- component of the money interest rate that compensates a lender for the effects of inflation.
real interest rate- the interest rate in terms of purchasing power, that is, when changes in prices have been accounted for. The real interest rate is approximately the nominal interest rate minus the inflation rate. One way to think of it is as the interest rate in terms of things rather than money. The real interest rate is based upon the rate of time preference as well as risks associated with the loan.
present value formula- one of several mathematical formulas relating the interest rate, the future amount (future value) and principal amount (present value) from an investment or loan. Specifically, PV= FV/(1+i)n, where PV is the present value, FV is the future value, i is the interest rate, and n is the number of years in which the future value will be received.
discounting -calculating the present value of a future payment. The present value will be inversely related to the interest rate and the amount of time that must pass before the payment is made.
asset value (AV)- the present value of the expected net benefits of owning an asset, assuming the asset will last (virtually) forever. Asset value is the annual net income from the asset divided by the interest rate; Asset value = Annual net income/ interest rate
*investment in human capital- choosing to enhance skills and training to enhance future earnings.
loanable funds market, money market, capital market - the market in which loans are made and interest rates are determined. The ?buyers? of loans (capital) are borrowers, the ?sellers? are lenders, and the "price" is the interest rate.
Chapter Fifteen
economic efficiency- requires that production that produces more utility than it costs is undertaken, and that no production that produces less utility than it costs is undertaken.
Externality -when a decision imposes a cost (negative externality) or imparts a benefit (positive externality) to people not involved in the decision making.
Public Goods- goods for which the consumption by one person does not exhaust the amount available for others, and for which prevention of consumption is difficult.
repeat purchase item- a good frequently purchased by the buyer. Since they are frequently purchased, buyers have a great deal of information about quality and producer reputation that they acquire on their own.
asymmetric information problem- when the buyer or seller of a good has information that the other does not posses (and that could only be acquired at great cost).
resource owner incentives- incentives that property rights give to owners of a natural resource. These include the incentives to conserve the resource, allow use of the resource when its value is high, exercise good stewardship over the resource, prevent others from damaging the resource, and consider the future consequences of present decisions concerning the resource.
resource depletion- running out of a natural resource, such as oil. Predictions of resource depletion have often ignored the roles of technology and resource prices in conservation.
response to incentives-people change behavior based on perceived changes in the costs or the benefits of an option. One way to encourage responsible decisions towards the environment is to provide benefits for behaving responsibly. Another is to ensure that costs of irresponsible choices are imposed on the decision-maker.
secondary effects- when actions alter the incentives (costs and benefits) involved in making other decisions (or taking other actions); these can include decisions made by other people or decisions made in the future. Environmental regulations can have profound secondary effects, often causing problems which may be regarded worse than those they were meant to counteract.