Introduction to Microeconomics (ECON 2106) - Exam #3 Review

Law of Diminishing Marginal Utility

The basic economic principle that as the consumption of a product increases, the marginal utility derived from consuming more of it (per unit of time) will eventually decline.

Marginal Utility

The additional utility, or satisfaction, derived from consuming an additional unit of a good.

Marginal Benefit

The maximum price a consumer will be willing to pay for an additional unit of a product. It is the dollar value of the consumer's marginal utility from the additional unit, and therefore it falls as consumption increases.

Substitution Effect

That part of an increase (decrease) in amount consumed that is the result of a good being cheaper (more expensive) in relation to other goods because of a reduction (increase) in price.

Income Effect

That part of an increase (decrease) in amount consumed that is the result of the consumer's real income being expanded (contracted) by reduction (rise) in the price of a good.

Price Elasticity of Demand

The percentage change in the quantity of a product demanded divided by the percentage change in price that caused the change in quantity. The price elasticity of demand indicates how responsive consumers are to change in a product's price.

Income Elasticity

The percentage change in the quantity of a product demanded divided by the percentage change in consumer income that caused the change in quantity demanded. It measures the responsiveness of the demand for a good to a consumer's change in income.

Normal Good

A good that has a positive income elasticity, so that as consumer income rises, demand for the good rises, too.

Inferior Good

A good that has a negative income elasticity, so that as consumer income rises, the demand for the good falls.

Price Elasticity of Supply

The percentage change in quantity supplied, divided by the percentage change in the price that caused the change in quantity supplied.

Tax Incidence

The way the burden of a tax is distributed among economic units (consumers, producers, employees, employers, and so on). The actual tax burden does not always fall on those who are statutorily assigned to pay the tax.

Tax Base

The level or quantity of an economic activity that is taxed. Higher tax rates reduce the level of the tax base because they make the activity less atractive.

Tax Rate

The per-unit amount of the tax or the percentage rate at which the economic activity is taxed.

Deadweight Loss

The loss of gains from trade to buyers and sellers that occurs when a tax is imposed. The deadweight loss imposes a burden on both buyers and sellers over and above the actual payment of the tax.

Excess Burden of Taxation

Another term for deadweight loss. It reflects losses that occur when beneficial activities are forgone because they are taxed.

Average Tax Rate (ATR)

Tax liability divided by taxable income. It is the percentage of income paid in taxes.

Progressive Tax

A tax in which the average tax rate rises with income. People with higher incomes will pay a higher percentage of their income in taxes.

Proportional Tax

A tax in which the average tax rate is the same at all income levels. Everyone pays the same percentage of income in taxes.

Regressive Tax

A tax in which the average tax rate falls with income. People with higher incomes will pay a lower percentage of their income in taxes.

Marginal Tax Rate (MTR)

The additional tax liability a person faces divided by his or her additional taxable income. It is the percentage of an extra dollar of income earned that must be paid in taxes. It is the marginal tax rate that is relevant in personal decision-making.

Laffer Curve

A curve illustrates the relationship between the tax rate and tax revenue. Tax revenues will be low at both very high and very low tax rates. When tax rates are quite high, lowering them can increase tax revenue.

Subsidy

A payment the government makes to either the buyer or the seller, usually on a per-unit basis, when a good or service is purchased or sold.

Residual Claimants

Individuals who personally receive the excess, if any, of revenues over costs. Residual claimants gain if the firm's costs are reduced or revenues increase.

Team Production

A production process in which employees work together under the supervision of the owner or the owner's representative.

Shirking

Working at less than the expected rate of productivity, which reduces output. Shirking is more likely when workers are not monitored, so that the cost of lower output falls on others.

Principal-Agent Problem

The incentive problem that occurs when the purchaser of services (the principal) lacks full informaton about the circumstances faced by the seller (the agent) and cannot know how well the agent performs the purchases services. The agent many to some extent work toward objectives other than those sought by the principal paying for the service.

Proprietorship

A business firm owned by an individiaual who possesses the ownership right to the firm's profits and is personally liable for the firm's debts.

Partnership

A business firm owned by two or more individuals who possess ownership rights to the firm's profits and are personally liable for the debts of the firm.

Corporation

A business firm owned by shareholders who possess ownership rights to the firm's profits, but whose liability is limited to the amount of their investment in the firm.

Explicit Costs

Payments by a firm to purchase the services of productive resources.

Implicit Costs

The opportunity costs associated with a firm's use of resources that it owns. These costs do not involve a direct money payment. Examples include wage income and interest forgone by the owner of a firm who also provides labor services and equity capital to the firm.

Total Costs

The costs, both explicit and implicit, of all the resources used by the firm. Total cost includes a normal rate of return for the firm's equity capital.

Opportunity Cost of Equity Capital

The rate of return that must be earned by investors to induce them to supply financial capital to the firm.

Economic Profit

The difference between the firm's total revenues and its total costs, including both the explicit and implicit cost components.

Normal Profit Rate

Zero economic profit, providing just the competitive rate of return on the capital (and labor) of owners. An above-normal profit will draw more entry into the market, whereas a below-normal profit will lead to an exit of investors and capital.

Accounting Profits

The sales revenues minus the expenses of a firm over a designated time period, usually one year. Accounting profits typically make allowances for changes in the firm's inventories and depreciation of its assets. No allowance is made, however, for the opportunity cost of the equity capital of the firm's owners, or other implicit costs.

Short Run (in production)

A time period so short that a firm is unable to vary some of its factors of production. The firm's plant size typically cannot be altered in the short run.

Long Run (in production)

A time period long enough to allow the firm to vary all of its factors of production.

Total Fixed Cost

The sum of the costs that do not vary with output. They will be incurred as long as a firm continues in business and the assets have alternative uses.

Average Fixed Cost

Total fixed cost divided by the number of units produced. It always declines as output increases.

Total Variable Cost

The sum of those costs that rise as output increases. Examples of variable costs are wages paid to workers and payments for raw materials.

Average Variable Cost

The total variable cost divided by the number of units produced.

Average Total Cost

Total cost divided by the number of units produced. It is sometimes called per-unit cost.

Marginal Cost

The change in total cost required to produce an additional unit of output.

Law of Diminishing Returns

The postulates that as more and more units of a variable resource are combined with a fixed amount of other resources, using additional units of the variable resource will eventually increase output only at a decreasing rate. Once diminishing returns are reached, it will take successively larger amounts of the variable factor to expand output by one unit.

Total Product

The total output of a good that is associated with each alternative utilization rate of a variable input.

Marginal Product

The increase in the total product resulting from a unit increase in the employment of a variable input. Mathematically, it is the ratio of the change in total product to the change in the quantity of the variable input.

Average Product

The total product (output) divided by the number of units of the variable input required to produce that output level.

Economies of Scale

Reductions in the firm's per-unit costs associated with the use of large plants to produce a large volume of output.

Constant Returns to Scale

Unit costs that are constant as the scale of the firm is altered. Neither economics nor diseconomies of scale are present.

Sunk Costs

Costs that have already been incurred as a result of past decisions. They are sometimes referred to as historical costs.

Price Takers

Sellers who must take the market price in order to sell their product. Because each price taker's output is small relative to the total market, price takers can sell all their output at the market price, but they are unable to sell any of their output at a price higher than the market price.

Price Searchers

Firms that face a downward-sloping demand curve for their product. The amount the firm is able to sell is inversely related to the price it charges.

Competition as a Dynamic Process

Rivalry or competitiveness between or among parties (for example, producers or input suppliers) to deliver a better deal to buyers in terms of quality, price, and product information.

Pure Competition

A market structure characterized by a large number of small firms producing an identical product in an industry (market area) that permits complete freedom of entry and exit. Also called price-taker markets.

Barriers to Entry

Obstacles that limit the freedom of potential rivals to enter and also compete in an industry or market.

Marginal Revenue (MR)

The incremental change in total revenue derived from the sale of one additional unit of a product.

Shutdown

A temporary halt in the operation of a firm. Because the firm anticipates operating in the future, it does not sell its assets and go out of business. The firm's variable cost is eliminated by the shutdown, but its fixed costs continue.

Going out of Business

The sale of a firm's assets and its permanent exit from the market. By going out of business, a firm is able to avoid its fixed costs, which would continue during a shutdown.

Constant-Cost Industry

An industry for which factor prices and costs of production remain constant as market output is expanded. The long-run market supply curve is therefore horizontal in these industries.

Increasing-Cost Industry

An industry for which costs of production rise as output is expanded. In these industries, even in the long run, higher market prices will be needed to induce firms to expand total output. As a result, the long-run market supply curve in these industries will slope upward to the right.

Decreasing-Cost Industry

An industry for which costs of production decline as the industry expands. The market supply is therefore inversely related to price. Such industries are atypical.