Economics Midterm Guide

Ch.1
Economics- The study of how societies use scarce resources to produce valuable goods and
services and distribute them among different individuals.
Efficiency- Denotes the most effective use of a societys resources in satisfying peoples wants
and needs.
Scarcity-when goods are limited relative to desires.
Microeconomics- The branch of economics which today is concerned with the behavior of
individual entities such as markets, firms, and households.
Macroeconomics- concerned with the overall performance of the economy.
Market Economy- An economy in which individuals and private firms make the major decisions
about production and consumption.
Command Economy- An economy in which the government makes all important decisions about
production and distribution.
Mixed Economy- Contains elements of both a market and a command economy.
Inputs- Commodities or services that are used to produce goods and services.
Outputs- The various useful goods or services that result from the production process and are
either consumed or employed in further production.
Ch. 2
Market MechanismMarket- A mechanism through which buyers and sellers interact to determine prices and
exchange goods, services, and assets.
Market Equilibrium-

Dual MonarchyInvisible HandExternalities- Occur when firms or people impose costs or benefits on others outside the
marketplace.
Public Goods- Commodities which can be enjoyed by everyone and from which no one can be
excluded.

Ch. 3
The Law of Downward Sloping Demand- When the price of a commodity is raised (and other
things are held constant), buyers tend to buy less of the commodity. Similarly, when the price is
lowered, other things being constant, quantity demanded increases
Substitution Effect- Occurs because a good becomes relatively more expensive when its price
rises. When the price of good A rises, I will generally substitute goods B, C, D. for it. For
example, as the price of beef rises, I eat more chicken.
Income Effect- A higher price generally also reduces the quantity demanded. This comes into
play because when a price goes up, I find myself somewhat poorer than I was before. If gasoline
prices double, I have in effect less real income, so I will naturally curb my consumption of
gasoline and other goods.
Ch. 4
Price Elasticity of Demand- Measures how much the quantity demanded of a good changes when
its price changes. The precise definition of price elasticity is the percentage change in quantity
demanded divided by the percentage change in price
Price-elastic demand When a 1 percent change in price calls forth more than a 1 percent change
in quantity demanded. For example, if a 1 percent increase in price yields a 5 percent decrease in
quantity demanded, the commodity has a highly price-elastic demand.

Price-inelastic Demand- When a 1 percent change in price produces less than a 1 percent change
in quantity demanded. For instance, when a 1 percent increase in price yields only a 0.2 percent
decrease in demand.
Unit-Elastic Demand Occurs when the percentage change in quantity is exactly the same as the
percentage change in price. In this case, a 1 percent increase in price yields a 1 percent decrease
in demand.
Total Revenue- is by definition equal to price times quantity.
-

When demand is price-inelastic, a price decrease reduces total revenue.

When demand is price-elastic, a price decrease increases total revenue.
In the borderline case of unit-elastic demand, a price decrease leads to no change in
total revenue.

Price Discrimination- ?
Ch. 5
Law of Diminishing Marginal Utility- This law states that the amount of extra or marginal utility
declines as a person consumes more and more of a good.
Choice and Utility Theories- The fundamental premise that people choose those goods and
services they value most highly.
Income Elasticity- The change in the quantity demanded of a good because the change in its
price has the effect of changing a consumers real income.
Substitute Goods- When the price of good A increases then the Demand for good B increases.
Compliment Goods- An increase in the price of good A will cause a decrease in the demand for
its complementary good.
Independent Goods- a Price change for one good does not have an effect on another good.

Ch. 6
Returns to Scale (Constant, Decreasing, Increasing)-

Constant Returns to Scale = A case where a change in all inputs leads to a

proportional change in output. For example, if labor, land, capital, and other inputs

are doubled, then under constant returns to scale output would also double.
Increasing Returns to Scale = Arise when an increase in all inputs leads to a morethan-proportional increase in the level of output. For example, an engineer planning a
small-scale chemical plant will generally find that increasing the inputs of labor,
capital, and materials by 10 percent will increase the total output by more than 10

percent.
Decreasing Returns to Scale = Occur when a balanced increase of all inputs leads to a
less-than-proportional increase in total output.

Business Organizations- Business firms are specialized organizations devoted to managing the
process of production. Production is organized in firms because efficiency generally requires
large-scale production, the raising of significant financial resources, and careful management and
coordination of ongoing activities.
Partnerships- Any two or more people can get together and form a partnership. Each agrees to
provide a fraction of the work and capital and to share a percentage of the profits and losses.
Ch. 7
Fixed Cost- Are expenses that must be paid even if the firm produces zero output. Sometimes
called overhead or sunk costs, they consist of items such as rent for factory or office space,
interest payments on debts, salaries of tenured faculty, and so forth. They are fixed because they
do not change if output changes.
Variable Cost- Vary as output changes. Examples include materials required to produce
output(such as steel to produce automobiles), production workers to staff the assembly lines,
power to operate factories, and so on.

Average Cost- a concept widely used in business; by comparing average cost with price or
average revenue, businesses can determine whether or not they are making a profit. Average cost
is the total cost divided by the total number of units produced.
Total Cost- represents the lowest total dollar expense needed to produce each level of output. Q
TC rises as q rises
Net IncomeOpportunity Cost- The value of the most valuable good or service forgone. Example, the dollar
cost of going to a movie instead of studying is the price of a ticket, but the opportunity cost also
includes the possibility of getting a higher grade on the exam. The opportunity costs of a decision
include all its consequences, whether they reflect monetary transactions or not.
Ch. 8
Perfect Competition- There are many small firms, each producing an identical product and each
too small to affect the market price.
Marginal CostShutdown Point- The critically low market price at which revenues just equal variable costs (or,
equivalently, at which losses exactly equal fixed costs)
Efficiency and Equity of Competitive MarketsEconomic Surplus- The sum of the consumer surplus, which is the area between the demand
curve and the price line.
Producer Surplus- The area between the price line and the SS Curve. The producer surplus
includes the rent and profits to firms and owners of specialized inputs in the industry and
indicates the excess of revenues over cost of production.

Ch. 9
Imperfect Competition- prevails in an industry whenever individual sellers can affect the price of
their output. The major kinds of imperfect competition are monopoly, oligopoly, and
monopolistic competition
Monopoly- A single seller with complete control over an industry.
Oligopoly- Means Few Sellers. Few in this context can be a number as small as 2 or as large as
10 or 15 firms. The important feature of oligopoly is that each individual firm can affect the
market price.
Monopolistic Competition- In this situation, a large number of sellers produce differentiated
products. This market structure resembles perfect competition in that there are many sellers, none
of whom has a large share of the market. It differs from perfect competition in that the products
sold by different firms are not identical.
Differentiated Products- are ones whose important characteristics vary. Personal computers for
example, have differing characteristics such as speed, memory, hard disk, modem, size, and
weight. Differentiated products can be sold at slightly different prices.
Sources of Market Imperfections- 2 Sources
1. Industries tend to have fewer sellers when there are significant economies or largescale production and decreasing costs. Under these conditions, large firms can simply
produce more cheaply and then undersell small firms, which cannot survive.
2. Markets tend toward imperfect competition when there are Barriers to entry that
make it difficult for new competitors to enter an industry. In some cases, the barriers
may arise from government laws or regulations which limit the number of
competitors. In other cases, there may be economic factors that make it expensive for
a new competitor to break into a market.
Barriers to Entry- Factors that make it hard for new firms to enter an industry. When barriers are
high, an industry may have few firms and limited pressure to compete. Economies of scale act as
one common type of barrier to entry, but there are others, including legal restrictions, high cost
of entry, advertising, and product differentiation.