ECON 251-H Key Terms

explicit cost

the direct monetary expense of a decision

implicit cost

the indirect monetary expense of a decision that arises from a trade-off

absolute advantage

the ability to complete a task in a shorter amount of time

comparative advantage 

the ability to complete a task with a lower opportunity cost than someone else 

production possibilities frontier

a curve that represents the maximal production available if all resources are used efficiently

total optimization

the goal of optimizing by considering Total Cost and Total Benefits

production possibilities frontier

a curve that represents the maximal production available if all resources are used efficiently 

marginal optimization

the goal of optimizing by considering marginal benefits and marginal cost

marginal benefit

the incremental change in total benefit from an additional unit of something 

marginal cost

the incremental change in total cost from an additional unit of something 

net benefits

total benefits minus total cost

the first equimarginal principle

the principle that states net benefits will be maximized when marginal benefits are equal to marginal cost

sunk cost fallacy

the willingness of humans to consider costs that have already happened and cannot be reverse in making future decisions 

anchoring

the tendency of humans to have their valuation of a good or service influenced by seemingly unrelated mental processing of numbers 

framing 

a technique used by firms to increase a consumer’s willingness to pay for a good or service by offering it alongside other options 

decoys

used in framing by firms as the other option that the firm doesn’t want their customer to pick even though they are offering it 

social value

the value humans place on actions that do not have direct economic consequence

economic value

the value humans place on actions that have direct economic consequence

the gambler’s fallacy

the tendency of humans to see patterns and believe those patterns will stop occurring

the hot-hand fallacy

the tendency of humans to see patterns and believe those patterns will continue

information asymmetry

when one side of a transaction has more information than the other

expected value

the hypothetical value of a decision computed by considering all possible outcomes with respect to their likelihood of occurring

duopoly

a market with exactly two competing firms 

game theory

a branch of economics that deals with strategic decision making 

best-response functions

the mathematical representation of how firms should respond to their competitors’ decisions 

strategic decision making 

the act of making firm choices while considering the behavior of other firms 

dominant strategies 

in game theory when a single strategy does better than any other strategy 

cooperative games

games in which the goals are strategically aligned between the players 

non-cooperative games

games in which the goals are not strategically aligned between the players

collusive outcome

the outcome of a game when players share information or make decisions jointly

trust

the ability of players in a game to rely on the promises made by other players

rationality

the idea the players always choose the outcome that is best for them

nash equilibrium

an outcome of a game in which neither player would wish to deviate from given the strategy of the other player

mixed strategies

when no one strategy is better than all other strategies in a game

sequential game

a game that is played by taking turns

decision node

any point in a sequential game

non-credible nash equilibrium

a nash equilibrium that can be improved upon by decisions made earlier in the game 

sub-game nash equilibrium

a nash equilibrium that cannot be improved upon by decisions made earlier in the game

backwards induction 

a strategy in games that starts by looking at the end of the game in developing the strategies

utilitarianism

a school of philosophical thought which asserts that human decisions are made in an effort to increase satisfaction and that in such an effort those decisions are generally regarded as good for society

social welfare function

a mathematical consideration of societal happiness as some function of the happiness of each person in society 

human prosperity 

a general notion of the overall level of social progress

utilitarian social welfare function 

a version of the social welfare function that seeks to maximize the aggregate level of social happiness by assuming each person cares for their own happiness and the happiness of others 

Rawlsian Social Welfare Function

a version of the social welfare function that seeks to maximize the happiness of the individual with the least amount of happiness 

the social contract

a democratically determined agreement among society as to the general rules and norms to be followed to achieve success under a social welfare function 

social safety net

a form of economic security meant to prevent members of society from economic misery

social efficiency

a general notion of society maximizing its social welfare function

pareto frontier

a mathematical representation of the maximal level of societal happiness given by Economic Efficiency

diminishing marginal utility

the idea that as you consume more of a good or service the marginal utility of each incremental unit decreases

pareto efficient

an outcome is __________ if it lies on the pareto frontier

pareto inefficient

an outcome is __________ if it lies to the left of the pareto frontier

pareto improvement 

a movement from a pareto inefficient position to a pareto efficient position that does not reduce any one person’s happiness 

economic efficiency 

efficiency that arises from buyers and sellers voluntarily engaging in transactions 

first fundamental welfare theorem

competitive markets maximize economic efficiency and lead to Pareto efficient outcomes

equity vs efficiency trade-off

the generally accepted idea that to make an economy more efficient requires less equity and vice versa 

second fundamental welfare theorem

any outcome can be redistributed to another Pareto Efficient outcome

Veil of Ignorance

a philosophical idea that poses decisions should be made assuming that people do not know what place in society they occupy

consumer theory

the idea that consumers maximized utility subject to a budget constraint 

utility

the economic term for human satisfaction or happiness

utility function

a mathematical representation of human utility

consumption

the act of enjoying a good, service, or amenity

law of diminishing marginal returns

the idea that as consumption increases the returns of that consumption will decline 

marginal utility

the incremental change in utility after a unit of consumption

indifference curves

a mathematical representation of utility levels where each bundle on a curve yields the same level of utility

budget constraint

a person’s income that restricts their ability to consume

choice set

all the possible bundles that are affordable to an individual 

marginal rate of substitution 

the willingness about consumer to switch consumption between two goods based on their relative level of marginal utility 

optimal bundle

the bundle that maximizes utility and spends all income

reservation price

the maximum willingness to pay a consumer has for a good, service, or amenity.

demand curve

the mathematical representation of reservation prices and their subsequent quantity demand 

normal good

a good who’s demand rises with income

inferior good

a good whose demand falls as income rises

complement good

goods that are often purchased and consumed in conjunction with one another 

substitute good

goods that satisfy similar wants and are generally interchangeable with one another

total expenditure

the total amount of money spent on consumption of a good in the market 

price elasticity of demand 

the extent to which changes in price lead to changes in quantity demand along a demand curve 

cross-price elasticity

the extent to which changes in the price of one good lead to changes in quantity demand for another good

income elasticity of demand 

the extent to which changes in income lead to changes in quantity demand for a good