Chapter 1-4 Terms MicroEconomics CHAPTER 1 Macroeconomics o The study of aggregate economic factors Mircoeconomics o The study of the

e behavior of small economic units such as consumers and firms Price theory o Another term for microeconomics Positive analysis o Assessment of expected objective outcomes Normative analysis o A nonscientific value; a judgment Markets o The interplay of all potential buyers and sellers of a particular commodity or service Nominal price o The absolute price, not adjusted for the changing value of money Real price o The nominal price adjusted for the changing value of money Goal-oriented behavior o The behavior of market participants interested in fulfilling their own personal goals. Rational Behavior o The behavior of market participants based on a careful, deliberative process that weighs expected benefits and costs Scarce resources o Insufficient time, money, or other resources for individuals to satisfy all their desires. Explicit costs o Money used in the pursuit of a goal that could otherwise have been spent on an alternative objective Implicit costs o Costs associated with the individuals use of his or her own time and other resources in the pursuit of a particular activity versus alternatives Economic costs or opportunity costs o The sum of explicit and implicit costs Accounting costs o Costs reported in companies net income statements generated by accountants Sunk costs o Costs that have already been incurred and are beyond recovery Productive Possibilities frontier (PPF) o A depiction of all the different combinations of goods that a rational actor with certain personal goals can attain with the fixed amount of resources. o Chapter Summary Microeconomics is the branch of economics that studies the behavior of individual economic units such as consumer and business firms.

Microeconomics considers how the decisions of individuals and firms are coordinated through interactions in markets. Economists assume that market participants are goal-oriented, rational, and constrained by scarce resources. Because of scarce resources, market participants cant fulfill their desires to the extent they would like, and choices must be made. Whenever one alternative is chosen, an opportunity cost is involved. A Production possibilities frontier (PPF) allows us to graphically depict the basic economic assumptions about market participants, as well as the concept of opportunity cost. CHAPTER 2

Law of demand o The economic principle that says the lower the price of a good the larger the quantity consumers wish to purchase o Demand curve negative slope, higher prices associated with lower quantities Normal goods o Those goods for which an increase in income leads to greater consumption Inferior goods o Those goods whose consumption falls when income rises Complements o Two goods that tend to be consumed together. So consumption of both tends to rise or fall simultaneously Substitutes o Goods that can replace one another in consumption Tastes or preferences o The feelings of consumers about the desirability of different goods Movement alone a given demand curve o A change in quantity demanded that occurs in response to a change in price, other factors remaining the same Shift of a demand curve o A change in the demand curve itself that occurs with a change in factors, besides price (such as income, the price of related goods, and preferences) that affects the quantity demanded at each possible price. Law of supply o The economic principle that says the higher the price of a good, the larger the quantity firms want to produce o Supply curve positively sloped, shows that higher prices result in increased output Movement alone a given supply curve o A change in quantity supplied that occurs in response to a change in the goods selling price, other factors remaining the same Shift of a supply curve o A change in the supply curve itself occurs when the other factors besides price, that affect output change such as technological advances Equilibrium o A situation in which quantity demanded equals quantity supplied at the prevailing price Disequilibrium o A situation in which the quantity demand and the quantity supplied are not in balance

Shortage o Excess demand for a good Surplus o Excess supply of a good Price ceiling o A legislated maximum price for a good Price floor o A legislated minimum price for a good Rent control o Price ceilings applied to rental housing units Black markets o An illegal market for a good Elasticities o Measures of the magnitude of the responsiveness of any variable (such as quantity demanded or supplied) to a change in particular determinants Price elasticity of demand o A measure of how sensitive quantity demanded is to a change in a products price Elastic o The situation in which price elasticity of demand exceeds 1.0 Inelastic o The situation in which price elasticity of demand is less than 1.0 Unit elastic o The situation in which price elasticity of demand is equal to 1.0 Point elasticity formula o (Qd/Qd1)/(P/P1) use the 1 or 2 points o If the answers vary from different elasticities when used use the arc elasticity formula Arc elasticity formula o

Income elasticity of demand o A measure of how responsive consumption of some item is to a change in income, assuming the price of the good itself remains unchanged. o (Qd/Qd)/(I/I) Cross-price elasticity of demand o A measure of how responsive consumption of one good is to a change in the price of a related good o (Qdx/Qdx)/(Py/Py) Price elasticity of supply o A measure of the responsiveness of the quantity supplied of a commodity to a change in the commoditys own price o (Qs/Qs)/(P/P)

Chapter Summary Most economic issues involve the workings of individual markets. In the supply-demand model, we analyze the behavior of buyers by using the demand curve. The demand curve shows how much people will purchase at different pricers when other facts remain the same. The demand curve slopes downward, reflecting the law of demand. Analysis of the sellers side of the marker relies on the supply curve, which shows the amount that firms will offer for sale at different, prices, other factors being constant. The supply curve typically slopes upward. The intersection of the deamdn and supply curves, reflecs the behavior of buys and sellers, identifies the equlilbrium price and quantity. A shift in the supply of demand curve produces a change in the equilibrium price and quantity. For the market mechanism to operate, price must be free to adjust to any change affecting the behavior of buyers and sellers in the market. Thus when the government steps into regulate prices, the market does not function in the same way. A government-imposed price ceiling results in a shortage and may lead to decrease in product quality, non-price rationing, black markets, administrative costs, and increased demand for and supply for substitute goods. Sellers are clearly harmed by the imposition of a price ceiling, and the effect on buyers as a group may not be beneficial. Elasticities provide a quantitative measure of the magnitude of the responsiveness of quantity demanded or supplied to a change in some other variable. The most important elasticity in economics is price elasticity of demand, which measures how responsive the quantity demanded of a commodity is to a change in the commoditys own price. It is measured by the percentage change in quantity demanded divided by the percentage change in price. When price elasticity exceeds 1.0, demand is elastic and a lower price expands purchases so sharply that total expenditure rises. When price elasticity is less than 1.0, demand is inelastic and a lower price leads to a reduction in total expenditure. When price elasticity equals 1.0, demand is unit elastic, and total expenditure is unchanged at a lower price. Three other important elasticities are the income elasticity of demand, cross-price elasticity of demand, and price elasticity of supply. They are constructed in a manner analogous to that employed to construct price elasticity of demand and measure, respectively, the responsiveness of quantity demanded to income, the responsiveness of quantity demanded of one good to the price of a related good, and the responsiveness of the quantity supplied of a commodity to the commoditys own price. CHAPTER 3 Economic bads o Commodities of which less is preferred to more over all possible ranges Economic goods o Commodities of which more is better than less Market baskets o Combination of goods Indifference curve o A plot of all the market baskets the consumer views as being equally satisfactory

Indifference map o A set of indifference curves that shows the consumers entire preference ranking Marginal rate of substitution (MRS) o A measure of the consumers willingness to trade one good for another Diminishing MRS o A consumers willingness to give up less and less of some other good to obtain still more of the first good Economic Neuter o A case in which the consumer doesnt care one way or another about a particular good Perfect substitutes o The case where a consumer is willing to substitute one good for another at some constant rate and remain equally well-off Perfect complements o Goods that must consumed in a precise combination in order provide a consumer a given level of satisfaction Budget constraint o The way in which a consumers income and the prices that must be paid for various goods limit choices Budget line o A line that shows the combinations of goods that can be purchased at the specified prices and assuming that all of the consumers income is expended Marginal benefit o The value the consumer derives from consuming one more unit of a good Marginal cost o The cost of consuming one more unit of a good Corner solution o A situation in which a particular good is not consumer at all by an individual consumer because the value of the first unit of the good is less than the cost Composite good o A number of goods treated as a group Income-consumption curve o The line that joins all the optimal consumption points generated by varying income Total utility o Assuming that it is measurable, the total, satisfaction a consumer receives from a given level of consumption Marginal utility o The amount by which total utility rises when consumption increases by one unit Diminishing marginal utility o The assumption that as more of a given good is consumed, the marginal utility associated with the consumption of additional units tends to decline, other things equal

Chapter Summary The theory of consumer choice is designed to explain why consumers purchase the goods they do. The theory emphasizes two factors: The consumers budget line, which shows the market baskets that can be bought.

An indifference curve graphically depicts all the combinations of goods considered equally desirable by a consumer. For economic goods, indifference curves are assumed to be downward sloping, convex, and not intersecting. The slope of an indifference curve measures the MRS, which is the willingness of the consumer to trade on good another. A budget line shows the combinations of goods a consumer can purchase with given prices for the good and assuming all the consumers income is spent on the good. The consumers income and the market prices of the goods determine the positions and slope of the budget line. The slope of the budget line is equal to the ratio of the prices of the goods and measures the relative price of one good compared with another. From among the market baskets the consumer can purchase, we assume the consumers will select the one that results in the greatest possible level of satisfaction or well-being. Graphically, this optimal choice is shown by the tangency between the budget line and the indifference curve, where the consumers MRS equals the price ratio. A change in the consumers budget line leads to a change in the market basket selected. An income increase when the prices of goods are held constant parallel shifts out the budget line. Either an increase or a decrease in the consumption of a good may result. When the consumption of a good rises with an increase in income, the good is a normal good. An inferior good is one for which consumption falls as income increases. The utility approach to consumer choice does not differ significantly from the indifference curve approach. CHAPTER 4 Price-consumption curve o A curve that identifies the optimal market basket associated with each possible price of a good, holding constant al other determinants of demand Income effect o A change in a consumers real purchasing power brought about by a change in the price of a good Substitution effect o An incentive to increase consumption of a good whose price falls, at the expense of other, now relatively more expensive good. Excise tax o A tax on a specific good Giffen good o The result of an income effect being larger than the substitution effect for an inferior good, so that the demand curve will have a positive slope Consumer surplus o A measure of the net gain to consumers from purchasing a good arising from its cost being below the maximum that consumers are willing to pay Total benefit o The total value a consumer derives from a particular amount of a good and thus the maximum amount the consumer would be willing to pay for that amount of the good Marginal benefit o The incremental value a consumer derives from consuming an additional unit of a good and thus the maximum amount the consumer would pay for that additional unit

Network effects o The extent to which an individual consumers demand for a good is influenced by other individuals purchases Bandwagon effect o A positive network effect, exists when quantity of a good demanded by a particular consumer is greater the larger number of consumers purchasing same good Snob effect o A negative network effect, occurs when the quantity of a good demanded by a particular consumer is smaller the larger the number of other consumers purchasing the same good

Chapter Summary By rotating the budget line confronting a consumer, we can determine prices, while factors such as income, preferences, and the prices of other goods are held constant. The various pricequantity combinations identified in this way can be plotted as the consumers demand curve. To determine whether a demand curve must have a negative slope, we separate the effect of a change in price on quantity demanded into two components, an income effect and a substitution effect. For a normal good, both income and substitution effects imply greater consumption at a lower price. Thus the demand curve for a normal good must slope downward. For an inferior good, the income and substitution effects of a price change operate in opposing directions. If the income effect is larger, the demand curve will slope upward. However, both theoretical reasoning and empirical evidence suggest this case is quite rare. Consumer surplus is a measure of the net benefit a consumer receives from consuming a good. It is shown graphically by the area between the consumers demand curve and the price line. Consumer surplus can also show the benefit or loss a consumer receives as a result of a change in the price of the good. Individual consumers demand curves can be aggregated to obtain the market demand. The price-consumption curve provides important information about an individuals elasticity of demand. An individual consumers purchases of a good may be influenced by other individuals purchases through network effects. Three methods allow us to estimate individuals or market demand curves: experimentation, surveys and regression analysis or econometrics.