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MICROECONOMIC TERMS AND DEFINITIONS CHAPTER 1 CHAPTER 2 CHAPTER 3 CHAPTER 4 CHAPTER 5 CHAPTER 6 CHAPTER 7 CHAPTER 8 CHAPTER 9 CHAPTER 10 CHAPTER 11 CHAPTER 12 CHAPTER 13 CHAPTER 14 CHAPTER 15 TABLE OF CONTENTS LIMITS ALTERNATIVES AND CHOICES THE MARKET SYSTEM AND THE CIRCULAR FLOW DEMAND SUPPLY AND MARKET MARKET FAILURES PUBLIC GOODS AND EXTERNALITIES GOVERNMENT S ROLE AND GOVERNMENT FAILURE ELASTICITY UTILITY MAXIMIZATION BEHAVIORAL ECONOMICS BUSINESSES AND THE COSTS OF PRODUCTION PURE COMPETITION IN THE SHORT RUN PURE COMPETITION IN THE LONG RUN PURE MONOPOLY MONOPOLISTIC COMPETITION AND OLIGOPOLY THE DEMAND FOR RESOURCES WAGE DETERMINATION Appendix terms and concepts 13 16 18 20 22 23 27 CHAPTER 1 LIMITS ALTERNATIVES AND CHOICES TERMS DEFINITIONS economics The social science concerned with how individuals institutions and society make optimal best choices under conditions of scarcity economic perspective A viewpoint that envisions individuals and institutions making rational decisions by comparing the marginal benefits and marginal costs associated with their actions scarcity The limits placed on the amounts and types of goods and services available for consumption as the result of there being only limited economic resources from which to produce output the fundamental economic constraint that creates opportunity costs and that necessitates the use of marginal analysis costbene t analysis to make optimal choices opportunity cost The amount of other products that must be forgone or sacrificed to produce a unit of a product utility The wantsatisfying power of a good or service the satisfaction or pleasure a consumer obtains from the consumption of a good or service or from the consumption of a collection of goods and services marginal analysis The comparison of marginal extra or additional bene ts and marginal costs usually for decision making scientific method The procedure for the systematic pursuit of knowledge involving the observation of facts and the formulation and testing of hypotheses to obtain theories principles and laws economic principle A widely accepted generalization about the economic behavior of individuals or institutions otherthingsequal assumption The assumption that factors other than those being considered are held constant ceteris paribus assumption microeconomics The part of economics concerned with 1 decision making by individual units such as a household a rm or an industry and 2 individual markets specific goods and senices and product and resource prices macroeconomics The part of economics concerned with the performance and behavior of the economy as a whole Focuses on economic growth the business cycle interest rates inflation and the behavior of major economic aggregates such as the household business and government sectors aggregate A collection of specific economic units treated as if they were one unit Examples the prices of all individual goods and services are combined into the price level and all units of output are aggregated into gross domestic product Appendix terms and concepts positive economics normative economics economizing problem budget ne economic resources land labor capital investment entrepreneurial ability entrepreneurs factors of production consumer goods caphalgoods The analysis of facts or data to establish scientific generalizations about economic behavior The part of economics involving value judgments about what the economy should be like focused on which economic goals and policies should be implemented policy economics The choices necessitated because society39s economic wants for goods and services are unlimited but the resources available to satisfy these wants are limited scarce A line that shows the different combinations of two products a consumer can purchase with a specific money income given the products prices The land labor capital and entrepreneurial ability that are used to produce goods and senices the factors of production In addition to the part of the earth39s surface not covered by water this term refers to any and all natural resources free gifts of nature that are used to produce goods and senices Thus it includes the oceans sunshine coal deposits forests the electromagnetic spectrum and sheries Note that land is one of the four economic resources Any mental or physical exertion on the part of a human being that is used in the production of a good or service One of the four economic resources Humanmade resources buildings machinery and equipment used to produce goods and senices goods that do not directly satisfy human wants also called capital goods One of the four economic resources In economics spending for the production and accumulation of capital and additions to inventories For contrast see nancial investment The human resource that combines the other economic resources of land labor and capital to produce new products or make innovations in the production of existing products provided by entrepreneurs Individuals who provide entrepreneurial ability to rms by setting strategy advancing innovations and bearing the financial risk if their firms do poorly The four economic resources land labor capital and entrepreneurial ability Products and services that satisfy human wants directly See capital Appendix terms and concepts production possibilities curve law of increasing opportunity costs economic growth horizontal axis vertical axis direct relationship inverse relationship independent variable dependent variable slope of a straight line vertical intercept A curve showing the different combinations of two goods or services that can be produced in a fullemployment fullproduction economy where the available supplies of resources and technology are fixed The principle that as the production of a good increases the opportunity cost of producing an additional unit rises 1 An outward shift in the production possibilities curve that results from an increase in resource supplies or quality or an improvement in technology 2 an increase of real output gross domestic product or real output per capita The leftright or westeast measurement line on a graph or grid The updown or northsouth measurement line on a graph or grid The relationship between two variables that change in the same direction for example product price and quantity supplied a positive relationship The relationship between two variables that change in opposite directions for example product price and quantity demanded a negative relationship The variable causing a change in some other dependent variable A variable that changes as a consequence of a change in some other independent variable the effect or outcome The ratio of the vertical change the rise or fall to the horizontal change the run between any two points on a straight line The slope of an upward sloping line is positive reflecting a direct relationship between two variables the slope of a downwardsloping line is negative reflecting an inverse relationship between two variables The point at which a line meets the vertical axis of a graph CHAPTER 2 THE MARKET SYSTEM AND THE CIRCULAR FLOW TERMS DEFINITIONS economic system A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem a method of organizing an economy of which the market system and the command system are the two general types Appendix terms and concepts laissezfaire capitalism command system market system private property freedom of enterprise freedom of choice selfinterest competition market specialization division of labor A hypothetical economic system in which the government39s economic role is limited to protecting private property and establishing a legal environment appropriate to the operation of markets in which only mutually agreeable transactions would take place between buyers and sellers sometimes referred to as pure capitalism A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities socialism communism Compare with market system 1 An economic system in which individuals own most economic resources and in which markets and prices serve as the dominant coordinating mechanism used to allocate those resources capitalism Compare with command system 2 All the product and resource markets of a market economy and the relationships among them The right of private persons and rms to obtain own control employ dispose of and bequeath land capital and other property The freedom of rms to obtain economic resources to use those resources to produce products of the firm39s own choosing and to sell their products in markets of their choice The freedom of owners of property resources to employ or dispose of them as they see fit of workers to enter any line of work for which they are qualified and of consumers to spend their incomes in a manner that they think is appropriate That which each rm property owner worker and consumer believes is best for itself and seeks to obtain The effort and striving between two or more independent rivals to secure the business of one or more third parties by offering the best possible terms The effort and striving between two or more independent rivals to secure the business of one or more third parties by offering the best possible terms The use of the resources of an individual a rm a region or a nation to concentrate production on one or a small number of goods and senices The separation of the work required to produce a product into a number of different tasks that are performed by different workers specialization of workers Appendix terms and concepts medium of exchange barter money consumer sovereignty dollar votes creative destruction invisible hand circular flow diagram households businesses sole proprietorship partnership corporation product market resource market Any item sellers generally accept and buyers generally use to pay for a good or service money a convenient means of exchanging goods and senices without engaging in barter The direct exchange of one good or senice for another good or service Any item that is generally acceptable to sellers in exchange for goods and senices The determination by consumers of the types and quantities of goods and senices that will be produced with the scarce resources of the economy consumers direction of production through their dollar votes The votes that consumers cast for the production of preferred products when they purchase those products rather than the alternatives that were also available The hypothesis that the creation of new products and production methods destroys the market power of existing monopolies The tendency of competition to cause individuals and rms to unintentionally but quite effectively promote the interests of society even when each individual or firm is only attempting to pursue its own interests An illustration showing the flow of resources from households to rms and of products from firms to households These flows are accompanied by reverse flows of money from firms to households and from households to firms Economic entities of one or more persons occupying a housing unit that provide resources to the economy and use the income received to purchase goods and services that satisfy economic wants Economic entities rms that purchase resources and provide goods and senices to the economy An unincorporated rm owned and operated by one person An unincorporated rm owned and operated by two or more persons A legal entity person chartered by a state or the federal government that is distinct and separate from the individuals who own it A market in which products are sold by rms and bought by households A market in which households sell and rms buy resources or the services of resources Appendix terms and concepts CHAPTER 3 DEMAND SUPPLY AND MARKET TERMS DEFINITIONS demand demand schedule law of demand diminishing marginal utility income effect substitution effect demand curve determinants of demand normal goods inferior goods substitute good A schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time A table of numbers showing the amounts of a good or service buyers are willing and able to purchase at various prices over a specified period of time The principle that other things equal an increase in a product39s price will reduce the quantity of it demanded and conversely for a decrease in price See law of diminishing marginal utility A change in the quantity demanded of a product that results from the change in real income purchasing power caused by a change in the product39s price 1 A change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in the good39s own price 2 the reduction in the quantity demanded of the second of a pair of substitute resources that occurs when the price of the first resource falls and causes rms that employ both resources to switch to using more of the first resource whose price has fallen and less of the second resource whose price has remained the same A curve that illustrates the demand for a product by showing how each possible price on the vertical axis is associated with a specific quantity demanded on the horizontal axis Factors other than price that determine the quantities demanded of a good or senice Also referred to as demand shifters because changes in the determinants of demand will cause the demand cune to shift either right or left A good or service whose consumption increases when income increases and falls when income decreases price remaining constant A good or service whose consumption declines as income rises prices held constant Products or services that can be used in place of each other When the price of one falls the demand for the other product falls conversely when the price of one product rises the demand for the other product nses Appendix terms and concepts complementary good change in demand change in quantity demanded supply supply schedule law of supply supply curve determinants of supply change in supply change in quantity supplied equilibrium price equilibrium quantity surplus Products and services that are used together When the price of one falls the demand for the other increases and conversely A movement of an entire demand cune or schedule such that the quantity demanded changes at every particular price caused by a change in one or more of the determinants of demand A change in the quantity demanded along a fixed demand curve or within a fixed demand schedule as a result of a change in the price of the product A schedule or curve that shows the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specified period of time A schedule or curve that shows the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specified period of time The principle that other things equal an increase in the price of a product will increase the quantity of it supplied and conversely for a price decrease A curve that illustrates the supply for a product by showing how each possible price on the vertical axis is associated with a specific quantity supplied on the horizontal axis Factors other than price that determine the quantities supplied of a good or senice Also referred to as supply shifters because changes in the determinants of supply will cause the supply curve to shift either right or left A movement of an entire supply curve or schedule such that the quantity supplied changes at every particular price caused by a change in one or more of the determinants of supply A change in the quantity supplied along a fixed supply curve or within a fixed supply schedule as a result of a change in the product39s price The price in a competitive market at which the quantity demanded and the quantity supplied are equal there is neither a shortage nor a surplus and there is no tendency for price to rise or fall 1 The quantity at which the intentions of buyers and sellers in a particular market match at a particular price such that the quantity demanded and the quantity supplied are equal 2 the profit maximizing output of a rm The amount by which the quantity supplied of a product exceeds the quantity demanded at a specific aboveequilibrium price Appendix terms and concepts shonage productive efficiency allocative efficiency price ceiling price floor The amount by which the quantity demanded of a product exceeds the quantity supplied at a particular belowequilibrium price The production of a good in the least costly way occurs when production takes place at the output at which average total cost is a minimum and marginal product per dollar39s worth of input is the same for all inputs The apportionment of resources among rms and industries to obtain the production of the products most wanted by society consumers the output of each product at which its marginal cost and price or marginal bene t are equal and at which the sum of consumer surplus and producer surplus is maximized A legally established maximum price for a good or service Normally set at a price below the equilibrium price A legally established minimum price for a good or service Normally set at a price above the equilibrium price CHAPTER 4 MARKET FAILURES PUBLIC GOODS AND EXTERNALITIES TERMS DEFINITIONS market failures demandside market failures supplyside market failures consumer surplus producer surplus efficiency losses or deadweight losses The inability of a market to bring about the allocation of resources that best satisfies the wants of society in particular the overallocation or underallocation of resources to the production of a particular good or service because of externalities or informational problems or because markets do not provide desired public goods Underallocations of resources that occur when private demand curves understate consumers full willingness to pay for a good or service Overallocations of resources that occur when private supply curves understate the full cost of producing a good or senice The difference between the maximum price a consumer is or consumers are willing to pay for an additional unit of a product and its market price the triangular area below the demand curve and above the market price The difference between the actual price a producer receives or producers receive and the minimum acceptable price the triangular area above the supply curve and below the market price Reductions in combined consumer and producer surplus caused by an underallocation or overallocation of resources to the production of a good or service Also called deadweight loss Appendix terms and concepts private goods A good or service that is individually consumed and that can be profitably provided by privately owned rms because they can exclude nonpayers from receiving the benefits rivalry 1 The characteristic of a private good the consumption of which by one party excludes other parties from obtaining the benefit 2 the attempt by one rm to gain strategic advantage over another firm to enhance market share or pro t excludability The characteristic of a private good for which the seller can keep nonbuyers from obtaining the good public goods A good or senice that is characterized by nonrivalry and nonexcludability These characteristics typically imply that no private rm can break even when attempting to provide such products As a result they are often provided by governments who pay for them using general tax revenues nonrivalry The idea that one person39s benefit from a certain good does not reduce the benefit available to others a characteristic of a public good nonexcludability The inability to keep nonpayers free riders from obtaining benefits from a certain good a characteristic of a public good freerider problem The inability of potential providers of an economically desirable good or service to obtain payment from those who benefit because of nonexcludability costbenefit analysis A comparison of the marginal costs of a project or program with the marginal bene ts to decide whether or not to employ resources in that project or program and to what extent marginalcost marginalbenefit As it applies to costbene t analysis the tenet that a government rule project or program should be expanded to the point where the marginal cost and marginal bene t of additional expenditures are equal quasipublic goods A good or senice to which excludability could apply but that has such a large positive externality that government sponsors its production to prevent an underallocation of resources externality A cost or benefit from production or consumption that accrues to to someone other than the immediate buyers and sellers of the product being produced or consumed see negative externality and positive externality Coase theorem The idea first stated by economist Ronald Coase that some externalities can be resolved through private negotiations among the affected parties Appendix terms and concepts 10 optimal reduction of an externality asymmetric information moral hazard problem adverse selection problem The reduction of a negative externalify such as pollution to the level at which the marginal bene t and marginal cost of reduction are equal A situation where one party to a market transaction has much more information about a product or service than the other The result may be an under or overallocation of resources The possibility that individuals or institutions will change their behavior as the result of a contract or agreement Example A bank whose deposits are insured against losses may make riskier loans and investments A problem arising when information known to one party to a contract or agreement is not known to the other party causing the latter to incur major costs Example Individuals who have the poorest health are most likely to buy health insurance CHAPTER 5 GOVERNMENT S ROLE AND GOVERNMENT FAILURE TERMS DEFINITIONS government failure principleagent problems collectiveaction problem specialinterest effect inefficiencies in resource allocation caused by problems in the operation of the public sector government Specific examples include the principalagent problem the specialinterest effect the collective action problem rent seeking and political corruption 1 At a rm a conflict of interest that occurs when agents workers or managers pursue their own objectives to the detriment of the principals stockholders39 goals 2 In public choice theory a conflict of interest that arises when elected officials who are the agents of the people pursue policies that are in their own interests rather than policies that would be in the better interests of the public the principals The idea that getting a group to pursue a common collective goal gets harder the larger the group39s size Larger groups are more costly to organize and their members more difficult to motivate because the larger the group the smaller each member39s share of the benefits if the group succeeds Any political outcome in which a small group special interest gains substantially at the expense of a much larger number of persons who each individually suffers a small loss Appendix terms and concepts 11 earmarks rent seeking unfunded liability budgetde ch debt crisis scalpohcy monetary policy unintended consequences regulatory capture deregulation loan guarantees political corruption public choice theory logroling Narrow specially designated spending authorizations placed in broad legislation by senators and representatives for the purpose of providing benefits to rms and organizations within their constituencies Earmarked projects are exempt from competitive bidding and normal evaluation procedures The appeal to government for special benefits at taxpayers or someone else39s expense A future government spending commitment liability for which the government has not legislated an offsetting revenue source A government runs an annual budget deficit whenever its tax revenues are less than its spending during a particular year The government is unable to borrow any more money Changes in government spending and tax collections designed to achieve full employment price stability and economic growth also called discretionary scal policy Changes in interest rates discount rates and open market operations designed to achieve full employment price stability and economic growth also called discretionary monetary policy Unexpected results of government policies Can be good or bad but normally refer to unexpected negative outcomes The situation that occurs when a governmental regulatory agency ends up being controlled by the industry that it is supposed to be regulating The removal of most or even all of the government regulation and laws designed to supervise an industry Sometimes undertaken to combat regulatory capture The removal of most or even all of the government regulation and laws designed to supervise an industry Sometimes undertaken to combat regulatory capture The unlawful misdirection of governmental resources or actions that occurs when government officials abuse their entrusted powers for personal gain Also see corruption The economic analysis of government decision making politics and elections The trading of votes by legislators to secure favorable outcomes on decisions concerning the provision of public goods and quasipublic goods Appendix terms and concepts 12 paradox of voting medianvoter model CHAPTER 6 ELASTICITY TERMS A situation where pairedchoice voting by majority rule fails to provide a consistent ranking of society39s preferences for public goods or public services The theory that under majority rule the median middle voter will be in the dominant position to determine the outcome of an election DEFINITIONS midpoint formula elastic demand inelastic demand unit elasticity perfectly inelastic demand perfectly elastic demand total revenue TR totalrevenue test A method for calculating price elasticity of demand or price elasticity of supply that averages the starting and ending prices and quantities when computing percentages Product or resource demand whose price elasticity of demand is greater than 1 so that any given percentage change in price leads to a larger percentage change in quantity demanded As a result quantity demanded is relatively sensitive to elastic with respect to price Product or resource demand for which the price elasticity of demand is less than 1 so that any given percentage change in price leads to a smaller percentage change in quantity demanded As a result quantity demanded is relatively insensitive to inelastic with respect to price Demand or supply for which the elasticity coef cient is equal to 1 means that the percentage change in the quantity demanded or quantity supplied is equal to the percentage change in price Product or resource demand in which price can be of any amount at a particular quantity of the product or resource that is demanded when the quantity demanded does not respond to a change in price graphs as a vertical demand cune Product or resource demand in which quantity demanded can be of any amount at a particular product or resource price graphs as a horizontal demand curve The total number of dollars received by a rm or firms from the sale of a product equal to the total expenditures for the product produced by the firm or firms equal to the quantity sold demanded multiplied by the price at which it is sold A test to determine elasticity of demand Demand is elastic if total revenue moves in the opposite direction from a price change it is inelastic when it moves in the same direction as a price change and it is of unitary elasticity when it does not change when price changes Appendix terms and concepts 13 price elasticity of supply The ratio of the percentage change in quantity supplied of a product or resource to the percentage change in its price a measure of the responsiveness of producers to a change in the price of a product or resource immediate market period The length of time over which producers are unable to respond to a change in price with a change in quantity supplied short run In microeconomics a period of time in which producers are able to change the quantities of some but not all of the resources they employ a period in which some resources usually plant are fixed and some are variable 2 In macroeconomics a period in which nominal wages and other input prices do not change in response to a change in the price level long run 1 In microeconomics a period of time long enough to enable producers of a product to change the quantities of all the resources they employ so that all resources and costs are variable and no resources or costs are fixed 2 In macroeconomics a period sufficiently long for nominal wages and other input prices to change in response to a change in a nation39s price level cross elasticity of demand The ratio of the percentage change in quantity demanded of one good to the percentage change in the price of some other good A positive coefficient indicates the two products are substitute goods a negative coefficient indicates they are complementary goods income elasticity of demand The ratio of the percentage change in the quantity demanded of a good to a percentage change in consumer income measures the responsiveness of consumer purchases to income changes CHAPTER 7 UTILITY MAXIMIZATION TERMS DEFINITIONS law of diminishing marginal The principle that as a consumer increases the consumption of a good utility or service the marginal utility obtained from each additional unit of the good or service decreases utility The wantsatisfying power of a good or service the satisfaction or pleasure a consumer obtains from the consumption of a good or service or from the consumption of a collection of goods and services total utility The total amount of satisfaction derived from the consumption of a single product or a combination of products marginal utility The extra utility a consumer obtains from the consumption of 1 additional unit of a good or service equal to the change in total utility divided by the change in the quantity consumed Appendix terms and concepts 14 rational behavior budget constraint utilitymaximizing rule consumer equilibrium income effect substitution effect budgetHne indifference curve marginal rate of substitution MRS indifference map The consumer is a rational person who tries to use his or her money income to derive the greatest amount of satisfaction or utility from it Consumers want to get the most for their money or technically to maximize their total utility They engage in rational behavior The limit that the size of a consumer39s income and the prices that must be paid for goods and senices imposes on the ability of that consumer to obtain goods and services The principle that to obtain the greatest total utility a consumer should allocate money income so that the last dollar spent on each good or service yields the same marginal utility MU For two goods X and Y with prices amounts of X and Y such that MU on each good In marginal utility theory the combination of goods purchased that maximizes total utility by applying the utilitymaximizing rule In indifference curve analysis the combination of goods purchased that maximizes total utility by enabling the consumer to reach the highest indifference curve given the consumer39s budget line or budget constraint A change in the quantity demanded of a product that results from the change in real income purchasing power caused by a change in the product39s price 1 A change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in the good39s own price 2 the reduction in the quantity demanded of the second of a pair of substitute resources that occurs when the price of the first resource falls and causes rms that employ both resources to switch to using more of the first resource whose price has fallen and less of the second resource whose price has remained the same A line that shows the different combinations of two products a consumer can purchase with a specific money income given the products prices A curve showing the different combinations of two products that yield the same satisfaction or utility to a consumer The rate at which a consumer is willing to substitute one good for another from a given combination of goods and remain equally satisfied have the same total utility equal to the slope of a consumer39s indifference curve at each point on the curve A set of indifference curves each representing a different level of utility that together show the preferences of a consumer Appendix terms and concepts 15 equilibrium position In the indifference curve model the combination of two goods at which a consumer maximizes his or her utility reaches the highest attainable indifference curve given a limited amount to spend a budget constraint CHAPTER 8 BEHAVIORAL ECONOMICS TERMS DEFINITIONS neoclassical economics behavioral economics rational systematic errors heuns cs cognitive biases framing effects The dominant and conventional branch of economic theory that attempts to predict human behavior by building economic models based on simplifying assumptions about people39s motives and capabilities These include that people are fundamentally rational motivated almost entirely by selfinterest good at math and unaffected by heuristics time inconsistency and selfcontrol problems The branch of economic theory that combines insights from economics psychology and biology to make more accurate predictions about human behavior than conventional neoclassical economics which is hampered by its core assumptions that people are fundamentally rational and almost entirely selfinterested Behavioral economics can explain framing effects anchoring mental accounting the endowment effect status quo bias time inconsistency and loss aversion In terms of economic terminology we feel that our decisions are rational meaning that they maximize our chances of achieving what we want Suboptimal choices that 1 are not rational because they do not maximize a person39s chances of achieving his or her goals and 2 occur routinely repeatedly and predictably The brain39s lowenergy mental shortcuts for making decisions They are fast and frugal and work well in most situations but in other situations result in systematic errors Misperceptions or misunderstandings that cause systematic errors Most result either 1 from heuristics that are prone to systematic errors or 2 because the brain is attempting to solve a type of problem such as a calculus problem for which it was not evolutionarily evolved and for which it has little innate capability In prospect theory changes in people39s decision making caused by new information that alters the context or frame of reference that they use to judge whether options are viewed as gains or losses relative to the status quo Appendix terms and concepts 16 status quo loss aversion prospect theory anchonng mental accounting endowment effect status quo bias myopia time inconsistency selfcontrol problems precommitments fairness The existing state of affairs in prospect theory the current situation from which gains and losses are calculated in prospect theory the property of most people39s preferences that the pain generated by losses feels substantially more intense than the pleasure generated by gains A behavioral economics theory of preferences having three main features 1 people evaluate options on the basis of whether they generate gains or losses relative to the status quo 2 gains are subject to diminishing marginal utility while losses are subject to diminishing marginal disutility and 3 people are prone to loss aversion The tendency people have to unconsciously base or anchor the valuation of an item they are currently thinking about on recently considered but logically irrelevant information The tendency people have to create separate mental boxes or accounts in which they deal with particular financial transactions in isolation rather than dealing with them as part of an overall decision making process that would consider how to best allocate their limited budgets across all possible options by using the utilitymaximizing rule The tendency people have to place higher valuations on items they possess are endowed with than on identical items that they do not possess perhaps caused by loss aversion The tendency most people have when making choices to select any option that is presented as the default status quo option Explainable by prospect theory and loss aversion Refers to the difficulty human beings have with conceptualizing the more distant future Leads to decisions that overly favor present and nearterm options at the expense of more distant future possibilities The human tendency to systematically misjudge at the present time what will actually end up being desired at a future time Refers to the difficulty people have in sticking with earlier plans and avoiding suboptimal decisions when finally confronted with a particular decisionmaking situation A manifestation of time inconsistency and potentially avoidable by using precommitments Actions taken ahead of time that make it difficult for the future self to avoid doing what the present self desires See time inconsistency and selfcontrol problems A person39s opinion as to whether a price wage or allocation is considered morally or ethically acceptable Appendix terms and concepts 17 dictator game ultimatum game A mutually anonymous behavioral economics game in which one person the dictator unilaterally determines how to split an amount of money with the second player A behavioral economics game in which a mutually anonymous pair of players interact to determine how an amount of money is to be split The first player suggests a division The second player either accepts that proposal in which case the split is made accordingly or rejects it in which case neither player gets anything CHAPTER 9 BUSINESSES AND THE COSTS OF PRODUCTION TERMS DEFINITIONS economic cost A payment that must be made to obtain and retain the services of a resource the income a rm must provide to a resource supplier to attract the resource away from an alternative use equal to the quantity of other products that cannot be produced when resources are instead used to make a particular product explicit costs The monetary payment made by a rm to an outsider to obtain a resource implicit costs The monetary income a rm sacrifices when it uses a resource it owns accounting profit normal profit economic profit rather than supplying the resource in the market equal to what the resource could have earned in the bestpaying alternative employment includes a normal pro t The total revenue of a rm less its explicit costs the profit or net income that appears on accounting statements and that is reported to the government for tax purposes The payment made by a rm to obtain and retain entrepreneurial ability the minimum income that entrepreneurial ability must receive to induce entrepreneurs to provide their entrepreneurial ability to a firm the level of accounting pro t at which a firm generates an economic pro t of zero after paying for entrepreneurial ability The return flowing to those who provide the economy with the economic resource of entrepreneurial ability the total revenue of a rm less its economic costs which include both explicit costs and implicit costs also called pure profit and above normal profit Appendix terms and concepts 18 short run long run total product TP marginal product MP average product AP law of diminishing returns fixed costs variable costs total cost average fixed cost AFC average variable cost AVC average total cost ATC marginal cost MC 1 ln microeconomics a period of time in which producers are able to change the quantities of some but not all of the resources they employ a period in which some resources usually plant are fixed and some are variable 2 in macroeconomics a period in which nominal wages and other input prices do not change in response to a change in the price level 1 ln microeconomics a period of time long enough to enable producers of a product to change the quantities of all the resources they employ so that all resources and costs are variable and no resources or costs are fixed 2 in macroeconomics a period sufficiently long for nominal wages and other input prices to change in response to a change in a nation39s price level The total output of a particular good or senice produced by a rm or a group of firms or the entire economy The additional output produced when 1 additional unit of a resource is employed the quantity of all other resources employed remaining constant equal to the change in total product divided by the change in the quantity of a resource employed The total output produced per unit of a resource employed total product divided by the quantity of that employed resource The principle that as successive increments of a variable resource are added to a fixed resource the marginal product of the variable resource will eventually decrease Any cost that in total does not change when the rm changes its output A cost that increases when the rm increases its output and decreases when the firm reduces its output The sum of xed cost and variable cost A rm39s total xed cost divided by output the quantity of product produced A firm39s total variable cost divided by output the quantity of product produced A firm39s total cost divided by output the quantity of product produced equal to average xed cost plus average variable cost The extra additional cost of producing 1 more unit of output equal to the change in total cost divided by the change in output and in the short run to the change in total variable cost divided by the change in output Appendix terms and concepts 19 economies of scale diseconomies of scale constant returns to scale minimum efficient scale MES natural monopoly The situation when a firm39s average total cost of producing a product decreases in the long run as the firm increases the size of its plant and hence its output The situation when a firm39s average total cost of producing a product increases in the long run as the firm increases the size of its plant and hence its output The situation when a firm39s average total cost of producing a product remains unchanged in the long run as the firm varies the size of its plant and hence its output The lowest level of output at which a rm can minimize longrun average total cost An industry in which economies of scale are so great that a single rm can produce the industry39s product at a lower average total cost than would be possible if more than one firm produced the product CHAPTER 10 PURE COMPETITION IN THE SHORT RUN TERMS DEFINITIONS market structure pure competition pure monopoly monopolistic competition Appendix terms and concepts The characteristics of an industry that define the likely behavior and performance of its rms The primary characteristics are the number of firms in the industry whether they are selling a differentiated product the ease of entry and how much control firms have over output prices The most commonly discussed market structures are pure competition monopolistic competition oligopoly pure monopoly and monopsony A market structure in which a very large number of rms sells a standardized product into which entry is very easy in which the individual seller has no control over the product price and in which there is no nonprice competition a market characterized by a very large number of buyers and sellers A market structure in which one rm sells a unique product into which entry is blocked in which the single firm has considerable control over product price and in which nonprice competition may or may not be found A market structure in which many rms sell a differentiated product entry is relatively easy each firm has some control over its product price and there is considerable nonprice competition 20 oligopoly imperfect competition price taker average revenue total revenue marginal revenue breakeven point MR MC rule shortrun supply curve A market structure in which a few rms sell either a standardized or differentiated product into which entry is difficult in which the firm has limited control over product price because of mutual interdependence except when there is collusion among firms and in which there is typically nonprice competition All market structures except pure competition includes monopoly monopolistic competition and oligopoly A seller or buyer that is unable to affect the price at which a product or resource sells by changing the amount it sells or buys Total revenue from the sale of a product divided by the quantity of the product sold demanded equal to the price at which the product is sold when all units of the product are sold at the same price The total number of dollars received by a rm or firms from the sale of a product equal to the total expenditures for the product produced by the firm or firms equal to the quantity sold demanded multiplied by the price at which it is sold The change in total revenue that results from the sale of 1 additional unit of a rm39s product equal to the change in total revenue divided by the change in the quantity of the product sold An output at which a rm makes a normal pro t total revenue total cost but not an economic pro t The principle that a rm will maximize its profit or minimize its losses by producing the output at which marginal revenue and marginal cost are equal provided product price is equal to or greater than average variable cost Tells us the amount of output the firm will supply at each price in a series of prices CHAPTER 11 PURE COMPETITION IN THE LONG RUN TERMS DEFINITIONS longrun supply curve constantcost industry The crucial factor of the longrun supply curve is the effect if any that changes in the number of firms in the industry will have on costs of the individual firms in the industry An industry in which the entry and exit of rms have no effect on the prices firms in the industry must pay for resources and thus no effect on production costs Appendix terms and concepts 21 increasingcost industry decreasingcost industry productive efficiency allocative efficiency consumer surplus producer surplus creative destruction An industry in which expansion through the entry of new rms raises the prices firms in the industry must pay for resources and therefore increases their production costs An industry in which expansion through the entry of rms lowers the prices that firms in the industry must pay for resources and therefore decreases their production costs The production of a good in the least costly way occurs when production takes place at the output at which average total cost is a minimum and marginal product per dollar39s worth of input is the same for all inputs The apportionment of resources among rms and industries to obtain the production of the products most wanted by society consumers the output of each product at which its marginal cost and price or marginal bene t are equal and at which the sum of consumer surplus and producer surplus is maximized The difference between the maximum price a consumer is or consumers are willing to pay for an additional unit of a product and its market price the triangular area below the demand curve and above the market price The difference between the actual price a producer receives or producers receive and the minimum acceptable price the triangular area above the supply curve and below the market price The hypothesis that the creation of new products and production methods destroys the market power of existing monopolies CHAPTER 12 PURE MONOPOLY TERMS DEFINITIONS pure monopoly barriers to entry simultaneous consumption network effects A market structure in which one rm sells a unique product into which entry is blocked in which the single firm has considerable control over product price and in which nonprice competition may or may not be found Anything that artificially prevents the entry of rms into an industry The sametime derivation of utility from some product by a large number of consumers Increases in the value of a product to each user including existing users as the total number of users rises Appendix terms and concepts 22 Xine icientcy rentseeking behavior price discrimination socially optimal price fairreturn price The production of output whatever its level at a higher average and total cost than is necessary for producing that level of output The actions by persons rms or unions to gain special benefits from government at the taxpayers or someone else39s expense The selling of a product to different buyers at different prices when the price differences are notjustified by differences in cost The price of a product that results in the most efficient allocation of an economy39s resources and that is equal to the marginal cost of the product For natural monopolies subject to rate price regulation the price that would allow the regulated monopoly to earn a normal pro t a price equal to average total cost CHAPTER 13 MONOPOLISTIC COMPETITION AND OLIGOPOLY TERMS DEFINITIONS monopolistic competition product differentiation nonprice competition fourfirm concentration ratio Herfindahl index excess capacity oligopoly A market structure in which many rms sell a differentiated product entry is relatively easy each firm has some control over its product price and there is considerable nonprice competition A strategy in which one rm39s product is distinguished from competing products by means of its design related senices quality location or other attributes except price Competition based on distinguishing one39s product by means of product differentiation and then advertising the distinguished product to consumers The percentage of total industry sales accounted for by the top four rms in an industry A measure of the concentration and competitiveness of an industry calculated as the sum of the squared percentage market shares of the individual rms in the industry Plant resources that are underused when imperfectly competitive rms produce less output than that associated with achieving minimum average total cost A market structure in which a few rms sell either a standardized or differentiated product into which entry is difficult in which the firm has limited control over product price because of mutual interdependence except when there is collusion among firms and in which there is typically nonprice competition Appendix terms and concepts 23 homogeneous oligopoly differentiated oligopoly strategic behavior mutual interdependence interindustry competition import competition game theory collusion kinkeddemand curve price war cartel price leadership onetime game simultaneous game An oligopoly in which rms produce a standardized product An oligopoly in which firms produce a differentiated product Selfinterested economic actions that take into account the expected reactions of others A situation in which a change in price strategy or in some other strategy by one rm will affect the sales and profits of another firm or other firms Any firm that makes such a change can expect its rivals to react to the change The competition for sales between the products of one industry and the products of another industry The competition that domestic rms encounter from the products and senices of foreign producers The study of how people behave in strategic situations in which individuals must take into account not only their own possible actions but also the possible reactions of others Originally developed to analyze the best ways to play games like poker and chess A situation in which rms act together and in agreement collude to fix prices divide a market or otherwise restrict competition A demand curve that has a flatter slope above the current price than below the current price Applies to a noncollusive oligopoly firm if its rivals will match any price decrease but ignore any price increase Successive competitive and continued decreases in the prices charged by rms in an oligopolistic industry At each stage of the price war one rm lowers its price below its rivals price hoping to increase its sales and revenues at its rivals expense The war ends when the price decreases cease Aformal agreement among rms or countries in an industry to set the price of a product and establish the outputs of the individual firms or countries or to divide the market for the product geographically An informal method that rms in an oligopoly may employ to set the price of their product One firm the leader is the first to announce a change in price and the other firms the followers soon announce identical or similar changes In game theory a game in which the parties select their optimal strategies in a single time period without regard to possible interaction in subsequent time periods In game theory a game in which both parties choose their strategies and execute them at the same time Appendix terms and concepts 24 positivesum game zerosum game dominant strategy Nash equilibrium credible threat empty threat repeated game sequential game firstmover advantage In game theory a game in which the gains and losses add up to more than zero one party39s gains exceed the other party39s losses in game theory a game in which the gains and losses add up to zero one party39s gain equals the other party39s loss In game theory a game in which the gains and losses add up to some amount less than zero one party39s losses exceed the other party39s gains in game theory an option that is better for a player than any other alternative option regardless of what the player39s opponents may do In game theory a statement of harmful intent by one party that the other party views as believable often issued in conditional terms of if you do this we will do that In game theory a statement of harmful intent that is easily dismissed by the recipient because the threat is not viewed as being believable compare to credible threat in game theory a game that is played again sometime after the previous game ends in game theory a game in which the parties make their moves in turn with one party making the first move followed by the other party making the next move and so on In game theory the benefit obtained by the party that moves first in a sequential game CHAPTER 14 THE DEMAND FOR RESOURCES TERMS DEFINITIONS derived demand marginal product MP marginal revenue product MRP The demand for a resource that depends on the demand for the products it helps to produce The additional output produced when 1 additional unit of a resource is employed the quantity of all other resources employed remaining constant equal to the change in total product divided by the change in the quantity of a resource employed The change in a firm39s total revenue when it employs 1 additional unit of a resource the quantity of all other resources employed remaining constant equal to the change in total revenue divided by the change in the quantity of the resource employed Appendix terms and concepts 25 marginal resource cost MRC The amount by which the total cost of employing a resource increases when a rm employs 1 additional unit of the resource the quantity of all other resources employed remaining constant equal to the change in the total cost of the resource divided by the change in the quantity of the resource employed MRP MRC rule The principle that to maximize profit or minimize losses a rm should employ the quantity of a resource at which its marginal revenue product MRP is equal to its marginal resource cost MRC the latter being the wage rate in a purely competitive labor market substitution effect 1 A change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in the good39s own price 2 the reduction in the quantity demanded of the second of a pair of substitute resources that occurs when the price of the first resource falls and causes rms that employ both resources to switch to using more of the first resource whose price has fallen and less of the second resource whose price has remained the same output effect The possibility that when the price of the first of a pair of substitute resources falls the quantity demanded of both resources will rise because the reduction in the price of the first resource so greatly reduces production costs that the volume of output created with the two resources increases by so much that the quantity demanded of the second resource increases even after accounting for the substitution e ect elasticity of resource demand A measure of the responsiveness of rms to a change in the price of a particular resource they employ or use the percentage change in the quantity demanded of the resource divided by the percentage change in its price leastcost combination of The quantity of each resource that a rm must employ in order to resources produce a particular output at the lowest total cost the combination at which the ratio of the marginal product of a resource to its marginal resource cost to its price if the resource is employed in a competitive market is the same for the last dollar spent on each of the resources employed profitmaximizing combination The quantity of each resource a rm must employ to maximize its pro t of resources or minimize its loss the combination of resource inputs at which the marginal revenue product of each resource is equal to its marginal resource cost to its price if the resource is employed in a competitive market Appendix terms and concepts 26 marginal productivity theory of income distribution The contention that the distribution of income is equitable when each unit of each resource receives a money payment equal to its marginal revenue product its marginal contribution to the revenue of the rm using the unit CHAPTER 15 WAGE DETERMINATION TERMS DEFINITIONS wage rate See wage nominal wage The amount of money received by a worker per unit of time hour day etc money wage real wage The amount of goods and senices a worker can purchase with his or purely competitive labor market monopsony exclusive unionism occupational licensing inclusive unionism bilateral monopoly minimum wage wage differentials marginal revenue productivity her nominal wage the purchasing power of the nominal wage A resource market in which many rms compete with one another in hiring a specific kind of labor numerous equally qualified workers supply that labor and no one controls the market wage rate A market structure in which there is only a single buyer of a good senice or resource The policy pursued by many craft unions in which a union first gets employers to agree to hire only union workers and then excludes many workers from joining the union so as to restrict the supply of labor and drive up wages Compare with inclusive unionism The policies typically employed by a craft union The laws of state or local governments that require that a worker satisfy certain specified requirements and obtain a license from a licensing board before engaging in a particular occupation The policy pursued by industrial unions in which a union attempts to include every worker in a given industry so as to be able to restrict the entire industry39s labor supply and thereby raise wages Compare with exclusive unionism A market in which there is a single seller monopoly and a single buyer monopsony The lowest wage that employers may legally pay for an hour of work The difference between the wage received by one worker or group of workers and that received by another worker or group of workers See marginal revenue product Appendix terms and concepts 27 noncompeting groups human capital compensating differences principleagent problem incentive pay plan American Federation of Labor and the Congress of Industrial Organizations AFLClO Change to Win independent unions unionization rate collective bargaining closed shop union shop agency shop Collections of workers who do not compete with each other for employment because the skill and training of the workers in one group are substantially different from those of the workers in other groups The knowledge and skills that make a person productive Differences in the wages received by workers in differentjobs to compensate for the nonmonetary differences between the jobs 1 At a rm a conflict of interest that occurs when agents workers or managers pursue their own objectives to the detriment of the principals stockholders39 goals 2 In public choice theory a conflict of interest that arises when elected officials who are the agents of the people pursue policies that are in their own interests rather than policies that would be in the better interests of the public the principals A compensation structure that ties worker pay directly to performance Such plans include piece rates bonuses stock options commissions and pro tsharing plans An acronym for the American Federation of Labor Congress of Industrial Organizations the largest federation of labor unions in the United States A loose federation of American unions that includes the Service Workers and Teamsters unions the second largest union federation after the AFLCIO US unions that are not affiliated with the AFL CIO or Change to Win The percentage of a particular population of workers that belongs to labor unions alternatively the percentage of a population of workers that is represented by one union or another in collective bargaining The negotiation of labor contracts between labor unions and rms or government entities A place of employment where only workers who are already members of a labor union may be hired A place of employment where the employer may hire either labor union members or nonmembers but where nonmembers must become members within a specified period of time or lose theirjobs A place of employment where the employer may hire either labor union members or nonmembers but where those employees who do notjoin the union must either pay union dues or donate an equivalent amount of money to a charity Appendix terms and concepts 28 righttowork laws open shop strike lockout National Labor Relations Act N LRA National Labor Relations Board NLRB voice mechanism exit mechanism Appendix terms and concepts Union and agency shops are legal except in the 22 states that expressly prohibit them through socalled righttowork laws A place of employment in which the employer may hire nonunion workers and in which the workers need not become members of a labor union The withholding of labor services by an organized group of workers a labor union A negotiating tactic in which a rm forbids its unionized workers to return to work until a new collective bargaining agreement is signed a means of imposing costs lost wages on union workers The basic laborrelations law in the United States Defines the legal rights of unions and management and identifies unfair union and management labor practices established the National Labor Relations Board Often referred to as the WagnerAct after the legislation39s sponsor New York Senator Robert F Wagner The board established by the National Labor Relations Act of 1935 to investigate unfair labor practices issue ceaseanddesist orders and conduct elections among employees to determine if they wish to be represented by a labor union Communication by workers through their union to resolve grievances with an employer The method of resolving workplace dissatisfaction by quitting one39s job and searching for another 29
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