Microeconomics: Consumer Choice, Elasticity, and Market Equilibrium

Vocabulary practice flashcards covering introductory microeconomics, including consumer preference axioms, indifference curve analysis, utility functions, market equilibrium, elasticities, taxation, and behavioral economics.

Opportunity Cost

The value of the next best alternative forgone when making a decision.

Net Present Value (NPV)

A formula measuring current net value of an investment over time: $NPV = -c + \frac{P}{(1+r)^t}$, where $-c$ is initial cost, $P$ is payment rate, $r$ is interest rate, and $t$ is time.

Comparative Advantage

The ability to produce a good at a lower opportunity cost in terms of other goods ($x$ and $y$) compared to another producer.

Absolute Advantage

The ability of an entity to produce more of a good ($x$) than another entity ($B$) using the same or fewer resources.

Positive Economics

Objective and testable economic statements that can be verified or refuted against empirical facts.

Normative Economics

Value judgements and opinion-based statements about what ought to be, which cannot be tested scientifically.

Ceteris Paribus

An analytical simplifying assumption meaning "all other things remain equal."

Equilibrium Price

The unique market price at which quantity supplied equals quantity demanded ($Q_S = Q_D$).

Perfectly Competitive Market

A benchmark market structure characterized by many buyers and sellers, none of whom can solely influence the market price.

Substitution Effect

The change in quantity demanded resulting from a change in the relative price of a good ($-\frac{p_x}{p_y}$), incentivizing consumers to switch toward cheaper alternatives.

Income Effect

The change in consumption resulting from a change in a consumer's real purchasing power ($\frac{M}{p_x}$) caused by a price change.

Consumer Surplus

The measure of consumer welfare defined as the difference between the maximum price consumers are willing to pay and the lower price they actually pay.

Producer Surplus

The economic welfare gained by producers, calculated as the difference between the actual price received and the minimum price they were willing to accept.

Price Ceiling

A legal maximum price set below the market equilibrium price, resulting in excess demand (shortages), queues, lotteries, or black markets.

Arc Elasticity of Demand

A measure of price responsiveness across a discrete interval: $\text{PED} = \frac{\frac{\text{Change in } Q}{\text{Mean } Q}}{\frac{\text{Change in } P}{\text{Mean } P}}$.

Unit Elasticity

A condition where price elasticity of demand equals $-1$ (or absolute value $1$), marking the point where total revenue ($TR = P \times Q$) is maximized.

Cross-Price Elasticity of Demand

The percentage change in quantity demanded of good A divided by the percentage change in the price of good B; positive for substitutes and negative for complements.

Income Elasticity of Demand

The responsiveness of quantity demanded to a change in consumer income, calculated as the percentage change in quantity divided by the percentage change in income.

Luxury Good

A good with an income elasticity greater than $1$ (such as champagne), meaning demand increases by a greater percentage than the increase in income.

Necessity Good

A good with an income elasticity strictly between $0$ and $1$, where consumption increases with income, but proportionately less.

Inferior Good

A good whose consumption falls when consumer income increases, giving it a negative income elasticity.

Specific Tax

A fixed monetary tax levied per physical unit of a good sold (such as an excise duty of $22\text{p}$ per $\text{ml}$).

Ad Valorem Tax

A percentage tax applied directly to the monetary value or price of a transaction (such as Value Added Tax / VAT).

Deadweight Loss (DWL)

The net loss of total social surplus caused by a market distortion (such as a tax or price ceiling), represented by a triangle pointing at the original equilibrium.

Tax Incidence

The division of the economic tax burden between consumers and producers, dictated by the relative elasticities of demand and supply.

Pigouvian Tax

An excise or sin tax levied on goods that generate negative externalities or social/health costs, aiming to internalize third-party harm.

Marginal Rate of Substitution (MRS)

The rate at which a consumer is willing to give up good $y$ to obtain one more unit of good $x$; equal to the slope of the indifference curve ($MRS = \frac{dy}{dx}$).

Budget Constraint

The boundary of consumption bundles a consumer can afford given income and prices; the consumer's equivalent of the PPF.

Consumer Optimum Condition

The bundle choice where the budget line is tangent to the highest reachable indifference curve, satisfying $|MRS| = \frac{p_x}{p_y}$.

Ordinal Utility

A ranking framework where the order of preferences matters, but the numerical difference between utility levels contains no measurable meaning.

Cardinal Utility

A utility concept where satisfaction is assigned an exact, measurable quantitative figure (e.g., $100$ units is quantitatively $50$ units more than $50$).

Transitivity

The preference axiom stating that if bundle A is preferred to B, and B to C, then A must be preferred to C; this ensures indifference curves cannot cross.

Local Non-Satiation

The preference axiom that more is always preferred to less, which prevents indifference curves from having thickness.

Perfect Complements

Goods consumed together in fixed proportions, having L-shaped indifference curves given by the utility function $U = \text{min}(x, y)$.

Perfect Substitutes

Goods that a consumer is willing to trade at a constant rate, characterized by linear indifference curves of the form $U = c x + d y$.

Present Bias

A behavioral economic tendency where individuals place disproportionate weight on immediate rewards over delayed rewards, beyond what interest rates justify.

Nudge

A low-cost adjustment to how a choice is presented designed to influence behavior without restricting any choices or altering economic incentives.

Automatic Enrolment

The UK's workplace pension default introduced in $2012$, which raised eligible worker participation from $55\%$ in $2012$ to $88\%$ by $2022$ without altering budget lines or preferences.

Choice Overload

A behavioral phenomenon where presenting consumers with too many choices increases cognitive decision costs, making them less likely to make a decision.