Principles of Microeconomics: Key Terms & Concepts

Comprehensive vocabulary flashcards covering basic economic methodology, market systems, demand, supply, market equilibrium, government price controls, and elasticity from Chapters 1, 2, 3, and 6.

Economics

The social science concerned with how individuals, institutions, and society make optimal choices under conditions of scarcity.

Opportunity Cost

The amount of other products or value that must be forgone or sacrificed to produce or obtain a unit of a specific good or choice.

Utility

The satisfaction, pleasure, or happiness a person obtains from consuming a good or service.

Marginal Analysis

The economic perspective of making rational decisions by comparing marginal benefits ($MB$) and marginal costs ($MC$) of an extra or additional unit.

Ceteris Paribus (Other-Things-Equal Assumption)

The assumption that factors other than those currently being considered are held constant.

Microeconomics

The part of economics concerned with individual decision-making units, such as an individual consumer, household, specific firm, or particular market.

Macroeconomics

The study of the entire economy or major economic aggregates, examining phenomena such as economic growth, the business cycle, interest rates, inflation, and unemployment.

Positive Economics

Economic analysis that is factual and describes cause-and-effect relationships ("what is"), avoiding value judgments.

Normative Economics

Economic analysis based on subjective value judgments about what the economy should be like or what policies should be pursued ("what ought to be").

Budget Line

A schedule or curve showing various combinations of two products a consumer can purchase with a specific money income given the prices of the products.

Factors of Production

The scarce economic resources combined to produce goods and services, categorized into land, labour, capital, and entrepreneurial ability.

Capital Goods

All manufactured aids used in producing consumer goods and services, including factories, machinery, tools, equipment, and distribution facilities.

Law of Increasing Opportunity Costs

The principle that as the production of a particular good increases, the opportunity cost of producing an additional unit rises, caused by the lack of perfect adaptability of resources.

Production Possibilities Curve (PPC)

An economic curve showing the maximum combination of two goods an economy can produce under conditions of full employment, fixed resources, and fixed technology.

Laissez-Faire Capitalism

An economic system ("let it be") in which the role of government is strictly limited to protecting private property and enforcing contracts, keeping the state from interfering in markets.

Command System

An economic system (such as socialism or communism) characterized by public ownership of resources and central planning boards that dictate economic decisions.

Market System (Mixed Economy)

An economic system that combines private ownership of resources and decentralized market decisions with an active but limited degree of government control.

Consumer Sovereignty

The principle in a market economy where consumers determine the types and quantities of goods and services produced by casting "dollar votes."

Creative Destruction

The hypothesis that the creation of new products and production methods destroys the market power of existing businesses and established monopolies.

The Invisible Hand

The tendency of competitive markets described by Adam Smith (1776) where individuals and businesses seeking their own private self-interest unintentionally promote social and economic efficiency.

Coordination Problem

A major failure in central planning where government planners fail to effectively balance output targets and resource supplies across millions of interdependent economic activities.

Incentive Problem

A breakdown in command economies where central managers are rewarded solely for meeting quantitative quotas without regard to product quality, consumer preferences, or price signals.

Product Market

The market where goods and services produced by businesses are bought by households.

Factor Market

The market in which households sell economic resources (land, labour, capital, and entrepreneurial ability) to businesses in exchange for income (wages, rent, interest, and profits).

Circular Flow Model

A visual diagram illustrating the real flows of resources and products, alongside the opposite flows of money income and expenditures, between households and businesses across markets.

Market

An institution or mechanism that brings together buyers ("demanders") and sellers ("suppliers") of a particular product or service to establish an exchange price and quantity.

Law of Demand

The principle that, other things equal, there is an inverse or negative relationship between a product's price and the quantity demanded by buyers.

Law of Diminishing Marginal Utility

The principle that each additional unit of a good consumed yields less additional utility (satisfaction) than the previous unit, explaining why consumers will only buy more if the price falls.

Income Effect

The change in quantity demanded of a product resulting from a change in a consumer's purchasing power (real income) caused by a change in that product's price.

Substitution Effect

The change in quantity demanded that occurs because a lower price relative to other products incentivizes consumers to substitute the cheaper good for more expensive alternatives.

Normal Goods

Goods or services for which demand increases when consumer income rises and decreases when consumer income falls.

Inferior Goods

Goods or services for which demand decreases as consumer income increases and increases as consumer income decreases.

Substitute Goods

Two products related in such a way that an increase in the price of one leads to an increase in the demand for the other ($E_{xy} > 0$).

Complementary Goods

Two products related such that an increase in the price of one leads to a decrease in the demand for the other ($E_{xy} < 0$).

Law of Supply

The principle that, other things equal, as price rises, the quantity supplied rises, and as price falls, the quantity supplied falls.

Market Equilibrium

The state where the quantity demanded equals the quantity supplied at an intersection point, establishing the equilibrium price and equilibrium quantity.

Productive Efficiency

The production of any particular good in the least costly way by using optimal technology and the right combination of scarce resources.

Allocative Efficiency

The production of the particular mix of goods and services most highly valued by society, achieved when marginal benefit equals marginal cost ($MB = MC$).

Rationing Function of Prices

The ability of market forces to establish an equilibrium price that clears the market, eliminating shortages and surpluses.

Price Ceiling

A maximum legal price set by the government below the market equilibrium price, resulting in persistent shortages and black markets.

Price Floor

A minimum legal price fixed by the government above the market equilibrium price, resulting in persistent chronic surpluses.

Price Elasticity of Demand

A measure of the responsiveness or sensitivity of quantity demanded of a product to a change in its price, defined as the percentage change in quantity demanded divided by the percentage change in price.

Midpoint Formula (Price Elasticity)

A method of calculating elasticity that evaluates percentage changes using average quantities and prices: $E_d = \frac{\Delta Q}{(Q_0 + Q_1)/2} \div \frac{\Delta P}{(P_0 + P_1)/2}$ .

Elastic Demand

A condition where the price elasticity coefficient exceeds 1 ($E_d > 1$), indicating that the percentage change in quantity demanded is greater than the percentage change in price.

Inelastic Demand

A condition where the price elasticity coefficient is less than 1 ($E_d < 1$), indicating that the percentage change in quantity demanded is smaller than the percentage change in price.

Unit Elastic Demand

A condition where the price elasticity coefficient equals 1 ($E_d = 1$), meaning the percentage change in quantity demanded matches the percentage change in price, leaving total revenue unchanged.

Total-Revenue Test

A test evaluating elasticity by observing how total revenue ($TR = P \times Q$) responds to a price change: an inverse move indicates elastic demand, a direct move indicates inelastic demand, and no change indicates unit elasticity.

Price Elasticity along a Linear Demand Curve

The property that a downward-sloping straight-line demand curve has elastic demand in the upper-left segment, unit elasticity at the midpoint, and inelastic demand in the lower-right segment.

Perfectly Inelastic Demand

A condition where quantity demanded remains completely unchanged when price changes ($E_d = 0$), graphically depicted as a vertical line.

Perfectly Elastic Demand

A condition where consumers will purchase an infinite quantity at a specific price, but a minuscule price increase drops quantity demanded to zero ($E_d = \infty$), represented by a horizontal demand curve.

Price Elasticity of Supply

A measure of the responsiveness of the quantity supplied of a product to a change in its price ($E_s = \% \Delta Q_s / \% \Delta P$), dependent primarily upon the time available for producers to adjust resources.

Cross Elasticity of Demand

A measure of how the quantity demanded of one good ($X$) responds to a change in the price of another good ($Y$), calculated as $E_{xy} = \% \Delta Q_x / \% \Delta P_y$.

Income Elasticity of Demand

A measure of the responsiveness of quantity demanded to a change in consumer income, calculated as $E_i = \% \Delta Q_x / \% \Delta I$.

Deadweight Loss (Efficiency Loss of a Tax)

The loss of combined consumer and producer surplus caused by an excise tax or distortion that reduces output below the socially optimal equilibrium quantity.