Principles of Microeconomics

Production Possibilities Frontier

A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology.

Opportunity Cost

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

Comparative Advantage

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

Market

A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.

Product Markets

Markets for goods—such as computers—and services—such as medical treatment.

Factor Markets

Markets for the factors of production, such as labor, capital, natural resources, and entrepreneurial ability.

Factors of Production

The inputs used to make goods and services.

Perfectly Competitive Market

A market in which there are many buyers and sellers, all the products are identical, and there are no barriers to new sellers entering the market.

Demand schedule

A table showing the relationship between the price of a product and the quantity of the product demanded.

Quantity demanded

The amount of a good or service that a consumer is willing and able to purchase at a given price.

Demand curve

A curve that shows the relationship between the price of a product and the quantity of the product demanded.

Market demand

The demand by all the consumers of a given good or service.

Law of demand

The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

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 that are substitutes.

Income effect

The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.

Normal good

A good for which the demand increases as income rises and decreases as income falls.

Inferior good

A good for which the demand increases as income falls and decreases as income rises.

Substitutes

Goods and services that can be used for the same purpose.

Complements

Goods and services that are used together.

Quantity supplied

The amount of a good or service that a firm is willing and able to supply at a given price.

Supply schedule

A table that shows the relationship between the price of a product and the quantity of the product supplied.

Supply curve

A curve that shows the relationship between the price of a product and the quantity of the product supplied.

Law of supply

The rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

Market equilibrium

A situation in which quantity demanded equals quantity supplied.

Surplus

A situation in which the quantity supplied is greater than the quantity demanded.

Shortage

A situation in which the quantity demanded is greater than the quantity supplied.

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.

Explicit cost

A cost that involves spending money.

Implicit cost

A nonmonetary opportunity cost.

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 point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as 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.

Average variable cost

Variable cost divided by the quantity of output produced.

Long-run average cost curve

A curve showing 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 when a firm’s long-run average costs fall as it increases output.

Constant returns to scale

The situation when 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 when a firm’s long-run average costs rise as the firm increases output.

Elasticity

A measure of how much one economic variable responds to changes in another economic variable.

Price elasticity of demand

The responsiveness of the quantity demanded to a change in price, measured by dividing the percentage change in the quantity demanded of a product by the percentage change in the  product’s price.

Elastic demand

Demand is elastic when the percentage change in quantity demanded is greater than the percentage change in price, so the price elasticity is greater than 1 in absolute value.

Inelastic demand

Demand is inelastic when the percentage change in quantity demanded is less than the percentage change in price, so the price elasticity is less than 1 in absolute value.

Unit-elastic demand

Demand is unit-elastic when the percentage change in quantity demanded is equal to the  percentage change in price, so the price  elasticity is equal to 1 in absolute value.

Perfectly inelastic demand

The case where the quantity demanded is completely unresponsive to price, and the price elasticity of demand equals zero.

Perfectly elastic demand

The case where the quantity demanded is infinitely responsive to price, and the price elasticity of demand equals infinity.

Cross-price elasticity of demand

The percentage change in quantity demanded of one good divided by the percentage change in the price of another good.

Income elasticity of demand

A measure of the responsiveness of quantity demanded to changes in income, measured by the percentage change in quantity demanded divided by the percentage change in income.

Price elasticity of supply

The responsiveness of the quantity supplied to a change in price, measured by dividing the percentage change in the quantity supplied of a product by the percentage change in the product’s price.

Utility

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

Marginal utility (MU)

The change in total utility a person receives 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 consume 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.

Sunk cost

A cost that has already been paid and cannot be recovered

Perfectly competitive market

A market that meets the conditions of (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.

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.

Productive efficiency

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

Allocative efficiency

A state of the economy in which production represents 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.

Monopoly

A firm that is the only seller of a good or service that does not have a close substitute.

Natural monopoly

A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms.

Market power

The ability of a firm to charge a price greater than marginal cost.

Collusion

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

Antitrust laws

Laws aimed at eliminating collusion and promoting competition among firms.

Horizontal merger

A merger between firms in the same industry.

Vertical merger

A merger between firms at different stages of production of a good.

Monopolistic competition

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

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.

Game theory

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

Price leadership

A form of implicit collusion where one firm in an oligopoly announces a price change, which is matched by the other firms in the industry.

Rivalrous

A good that only one person can benefit from at any given time.

Excludable

Consumers can be excluded from benefitting from this good.

Public Good

A good that not rivalrous and not excludable.

Private Good

A good that is rivalrous and excludable.

Open Access Good

A good that is rivalrous but not excludable.

Natural Monopolies

Produces a good that is not rivalrous but excludable.

Free Rider Problem

Because public goods are not excludable, some people may benefit (free ride) from a good without paying for it.

Median Voter Model

The preferences of the median voter will dominate the preferences of all other voters.

Rational Ignorance

When the cost of understanding a particular issue is greater than the benefit obtained from understanding the issue.

Underground Economy

Market activity that goes unreported because it is illegal or because people want to evade taxes.

Externality

A cost or benefit that is external to the transaction (pollution; vaccination).

Common Pool Problem

Unrestricted access to a renewable resource results in overuse.

Marginal Social Cost

The sum of the marginal private cost and the marginal external cost.

Marginal Social Benefit

The sum of the marginal private benefit and the marginal external benefit.

Coase Theorem

As long as transaction costs are very low, the problem of externalities can be resolved by assigning property rights.