Economics Exam 2 Review

Sole Proprietorship

A firm owned by a single individual and not organized as a corporation.

Partnership

A firm owned jointly by two or more persons and not organized as a corporation

Corporation

A legal form of business that provides owners with protection from losing more than their investment should business fall.

Asset

Anything of value owned by a person or a firm

Limited Liability

A legal provision that shields owners of a coporation from losing than they have invested in the firm.

Corporate governance

The way in which a corporation is structured and the effect that structure has on the corporation’s behaviors.

Separation of ownership from Control

A situation in a corporation in which the top management, rather than the shareholders controls day-to-day operations.

Principal-Agent Problem

A problem caused by an agent pursing the agent’s own interests rather than the interests of the principal who hired the agent

Indirect Finance

A flow of funds from savers to borrowers through financial intermediaries such as banks. Intermediaries raise funds from savers to lend to firms

Direct finance

A flow of funds from savers to firms through financial markets such as New York Stock Exchange

Bond

A financial security that represents a promise to repay a fixed amount of funds.

Coupon payment

An interest payment on a bond

Interest Rate

The cost of borrowing funds, usually expressed as a percentage of the amount borrowed.

Stock

A financial security that represents partial ownership of a firm

Dividens

Payments by a corporation to its shareholders

Risk

The degree of uncertainty in return on an asset

Liability

Anything owned by a person or firm

Income statement

A financial statement that shows a firm’s revenues cost, and profit over a period of time

Accounting Profit

A firm’s net income measured as revenue minus operating expenses and taxes paid.

Opportunity Cost

The highest-valued alternative that must be given to engage in an activity

Explicit Cost

A cost that involves spending money

Implicit Cost

A non monetary opportunity cost

Economic Profit

A firm’s revenues minus all of its implicit and explicit costs

Balance Sheet

A financial statement that sums up a firm’s financial position on a particular day, usually the end of a quarter or year

Tariff

A tax imposed by a government on imports

Imports

Goods and services purchased domestically that have been produced in other countries

Exports

Goods and services produced domestically and sold in other countries.

Comparative Advantage

The ability of an individual, or, a firm, or a country to produce a good or service at a lower opportunity cost than competitors

Opportunity Cost

The highest-valued alternative that must be given up to engage in an activity.

Absolute Advantage

The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources

Autarky

A Situation in which a country does not trade with other countries

Terms of trade

The ratio at which a country can trade its exports for imports from other countries

External economies

Reductions in a firm’s costs that result from an increase in the size of an industry

Free Trade

Trade between countries that is without government restrictions

Quota

A numerical limit that a government imposes on the quantity of a good that can be imported into the country

Voluntary Export Restraint (VER)

A restriction on the quantity of a good that can be imported by one country from another country.

World Trade Organization (WTO)

An international organization that oversees international trade agreements.

Globalization

The process of countries becoming more open to foreign trade and investment.

Protectionism

The use of trade barriers to shield domestic firms from foreign competition.

Dumping

Selling a product for a price below its cost of production

Utility

The enjoyment or satisfaction people receive from consuming goods and services.

Marginal Utility (MU)

The change in total utility a person recieves from consuming one additional unit of a good or service

Law of diminishing marginal utility

The principle that consumers experience diminishing additional satisfaction as they consumer more of a good or service during a given period of time.

Budget constraint

The limited amount of income available to consumers to spend on goods and services

Income Effect

The change in the quantity demanded of a good that results from the effect of a change in price on consumer purchasing power, holding all other factors constant.

Substitution Effect

The change in the quantity demanded of a good that results from a change in price making the good more or less expensive relative to other goods, holding constant the effect of the price change on consumer purchasing power.

Network Externality

A situation in which the usefulness of a product increases with the number of consumers who use it.

Behavioral Economics

The study of situations in which people make choices that do not appear to be economically rational

Opportunity Cost

The highest valued alternative that must be given up to engage to engage in an activity.

Endowment Effect

The tendency of people to be unwilling to sell a good they already own even if they are offered a price that is greater than the price they would be willing to pay to buy the good if they didn’t already own it.

Sunk Cost

A cost that has already been paid and cannot be recovered

Indifference curve

A curve that shows the combinations of consumption bundles that give the consumer the same utility.

Marginal rate of substitution (MRS)

The rate at which a consumer would be willing to trade off one good for another.

Technology

The processes a firm uses to turn inputs into outputs of goods and services.

Technological Change

A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.

Short run

The period of time during which at least one of a firm’s inputs is fixed

Long run

The period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant.

Total Cost

The cost of all the inputs a firm uses in production

Variable Costs

Costs that change as output changes.

Fixed Costs

Costs that remain constant as output changes.

Production Function

The relationship between the inputs employed by a firm and the maximum output the firm can produce with those inputs.

Average total cost

Total Cost divided by the quantity of output produced.

Marginal product of labor

The additional output a firm produces as a result of hiring one more worker

Law of diminishing returns

The principle that, at some points, adding more of a variable input, such as labor, to the same amount of a fixed input, such as the capital, will cause the marginal product of the variable input to decline.

Average product of labor

The total output produced by a firm divided by the quantity of workers

Marginal Cost

The change in a firm’s total cost from producing one more unit of a good or service.

Average fixed cost

Fixed cost divided by the quantity of output produced

Long run average cost curve

A curve that shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed.

Economies of scale

The situation in which a firm’s long-run average cost falls as it increases the quantity of output it produces.

Constant returns to scale

The situation in which a firm’s long-run average costs remain unchanged as it increases output

Minimum efficient scale

The level of output at which all economies of scale are exhausted

Diseconomies of scale

The situation in which a firm’s long-run average cost rises as the firm increases output.

Perfectly Competitive Market

A market that meets the conditions of having (1) many buyers and sellers, (2) all firms selling Identical products, and (3) no barriers to new firms entering the market.

Price taker

A buyer or seller that is unable to affect the market price.

Profit

Total revenue minus total cost

Average Revenue (AR)

Total revenue divided by the quantity of the product sold.

Marginal Revenue (MR)

The change in total revenue from selling one more unit of a product.

Shutdown Point

The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.

Economic Profit

A firm’s revenues minus all of its implicit and explicit costs.

Economic Loss

The situation in which a firm’s total revenue is less than its total cost, including all implicit costs.

Long-run competitive equilibrium

The situation in which the entry and exit of firms has resulted in the typical firm breaking even

Long-run supply curve

A curve that shows the relationship in the long run between the market price and the quantity supplied

Productive Efficiency

A situation in which a good or service is produced at the lowest possible cost

Allocative Efficiency

A state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

Monopolistic Competition

A market structure in which barriers to entry are low and many firms compete by selling similar, but not identical, products.

Market

All the activities necessary for a firm to sell a product to a consumer

Brand management

The actions of a firm intended to maintain the differentiation of a product over time.

Oligopoly

A market structure in which a small number of interdependent firms compete.

Barrier to entry

Anything that keeps new firms from entering an industry in which firms are earning economic profits

Economies of scale

The situation in which a firm’s long-run average cost falls as it increases the quantity of output it produces

Patent

The exclusive legal rights to produce a product for a period of 20 years from the date the patent application is filed with the government

Game Theory

The study of how people make decisions in situations in which attaining the goals depends on their interactions with others; in economics, the study of the decisions of firms in industries where the profits of a firm depend on its interactions with other firms.

Business Strategy

A set of actions that a firm takes to achieve a goal, such as maximizing profits.

Payoff matrix

A table that shows the payoffs that each firm earns from every combination of strategies by the firms

Collusion

An agreement among firms to charge the same price or otherwise not to compete.

Dominant Strategy

A strategy that is the best for a firm, no matter what strategies other firms use

Nash equilibrium

A situation in which each firm chooses the best strategy, given the strategies chosen by other firms

Cooperative equilibrium

An equilibrium in a game in which their players cooperate to increase their mutual payoff

Noncooperative equilibrium

An equilibrium in a game in which players do not cooperate but pursue their own self-interest

Prisoner’s Dilemma

A game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off.