economics

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

rational person

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

economic surplus

the benefit of taking any action minus its cost

opportunity cost

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

positive economics

economic analysis that offers cause-and-effect explanations of economic relationships;

the propositions, or hypotheses, that emrege from positive economics can, in principle,
be confirmed or refuted by data; in principle, data can also be used to measure the
magnitude of effects predicted by positive economics

normative economics

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

The Scarcity Problem

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

The Cost-Benefit Principle

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

time value of money

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

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

marginal cost

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

marginal benefit

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

average cost

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

average benefit

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

fixed cost

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

variable cost

a cost that varies with the level of activity

microeconomics

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

macroeconomics

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

absolute advantage

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

comparative advantage

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

The Principle of Comparative Advantage

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

production possibilities curve

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

excess supply

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

excess demand

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

efficient quantity

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

economic efficiency

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

The Efficiency Principle

economic efficiency occurs when total economic surplus is maximized

The Equilibrium Principle

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

normal good

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

inferior good

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

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

The Rational Spending Rule

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

optimal combination of goods

the affordable combination that yields the highest total utility

income effect

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

substitution effect

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

real price

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

nominal price

absoltue price of a good in dollar terms

price elasticity of demand

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

elastic

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

inelastic

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

unit elastic

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

elasticity calculated at a specific point on a demand curve

arc elasticity of demand

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

income elasticity of demand

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

change in income

cross-price elasticity of demand for two goods

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

percent change in the price of a second good

price taker (perfectly competitive firm)

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

production function

a technological relationship between inputs and output

marginal product

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

law of diminishing marginal returns

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

average product

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

short-run cost-minimizing quantity of output

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

short-run shutdown point

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

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

consumer surplus

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

producer surplus

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

price ceiling

a maximum allowable price, specified by law

price floor

a minimum allowable price, specified by law

deadweight loss

reduction in economic surplus that results from adoption of that policy

accounting profit

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

economic profit

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

normal profit

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

long-run average cost

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

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

economies of scale

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

indivisible factor of production

a factor of production that must be available in some minimum amount if a productive

activity, even of minimal size, is to occur at all

indivisible cost

the cost of an indivisible factor of production

constant returns to scale

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

minimum efficient quantity

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

diseconomies of scale

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

rationing function of price

distributes scarce goods to those consumers who value them most highly

allocative function of price

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

barrier to entry

any force that prevents firms from entering a new market

economic rent

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

price setter (imperfectly competitve firm)

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

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

oligopoly

a market in which there are only a few rival sellers

monopolistic competition

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

market power

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

natural monopoly

a monopoly that results from economies of scale

price discrimination

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

perfectly discriminating monopolist

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

hurdle method of price discrimination

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

perfect hurdle

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

dominant strategy

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

dominated strategy

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

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

prisoner's dilemma

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

cartel

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

ultimate barganing game

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

credible threat

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

commitment problem

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

commitment device

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

credible

external cost (negative externality)

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

external benefit (positive externality)

a benefit received by others that arises from an activity undertaken by an individual,

firm, or other eonomic agent for which the agent is not compensated in the market
price paid for the good or service involved

side payments

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

Coase theorem

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

tragedy of the commons

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

positional externality

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

positional arms race

a series of mutually offsetting investments in performance enhancement that is

stimulated by a positional externality

positional arms control agreement

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

performance enhancement

free-rider problem

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

expected value of a gamble

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

fair gamble

a gamble whose expected value is zero

better-than-fair gamble

a gamble whose expeceted value is positive

risk-neutral person

someone who would accept any gamble that is fair or better than fair
risk-adverse person

someone who would refuse any fair gamble

asymmetric information

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

lemons model

George Akerlof's explanation of how asymmetric information tends to reduce the

average quality of goods offered for sale

costly-to-fake principle

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

difficult to fake

statistical discrimination

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

adverse selection

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

technical efficiency in production

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

cost-plus regulation

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

informational asymmetry

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

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

nonrival good

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

nonexcludable good

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

collective good

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

private good

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

commons good

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

head tax

a tax that collects the same amount from every taxpayer

regressive tax

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

proportional income tax

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

progressive tax

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

rent-seeking

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