micro unit 3 more detailed

Comparative advantage

A country's ability to produce a good at a lower opportunity cost than another country. Basis for all gains from international trade.

Absolute advantage

The ability to produce more of a good using the same amount of resources as another country. Does NOT determine what to produce — opportunity cost does.

Autarky

A situation in which a country does not trade with other countries. Price and quantity depend entirely on domestic supply and demand.

Gains from trade

When countries specialize by comparative advantage and trade, total world production rises and both countries can consume more of both goods.

Heckscher-Ohlin model

Countries export goods that intensively use their abundant factors of production. Example: Canada exports lumber (land-abundant); Bangladesh exports clothing (labor-abundant).

Factor endowment

The supply of a factor of production (land, labor, capital) a country possesses relative to other countries. Determines comparative advantage in the H-O model.

Increasing returns to scale

When output rises proportionally more than the increase in inputs, causing per-unit costs to fall as production expands.

Tariff

A tax levied on imported goods. Raises domestic price, increases domestic production, reduces imports, generates government revenue, and creates deadweight loss.

Import quota

A legal limit on the quantity of a good that can be imported. Same price/quantity effect as a tariff, but revenue goes to license holders instead of the government.

Trade protection (protectionism)

Policies that limit imports to shield domestic industries. Includes tariffs, quotas, and subsidies.

Infant industry argument

New domestic industries need temporary protection to develop before facing foreign competition. Critique: governments are poor at picking winners; protection often becomes permanent.

National security argument

A country should protect domestic suppliers of crucial goods (steel, semiconductors) to remain self-sufficient in emergencies. Considered one of the stronger arguments for protection.

WTO (World Trade Organization)

International body that oversees trade agreements and resolves disputes between countries.

Hyperglobalization

The phenomenon of extremely high levels of international trade and economic integration driven by global supply chains.

Offshoring

Relocating business processes or production to another country. Can involve outsourcing or establishing overseas subsidiaries.

Effect of imports on surplus

Imports lower domestic price → consumer surplus rises, producer surplus falls, net welfare gain for the country overall.

Effect of exports on surplus

Exports raise domestic price → producer surplus rises, consumer surplus falls, net welfare gain for the country overall.

Opportunity cost

The true cost of any choice — what you must give up to get it, including implicit costs. The foundation of all economic decision-making.

Explicit costs

Actual monetary payments made — wages paid, rent, materials purchased.

Implicit costs

The opportunity cost of using resources you already own, for which no direct payment is made. Example: salary you forgo by running your own business.

Accounting profit

Total revenue minus explicit costs only. Formula: Accounting profit = TR − Explicit costs.

Economic profit

Total revenue minus both explicit AND implicit costs. Better basis for decisions than accounting profit. Formula: Economic profit = TR − Explicit − Implicit costs.

Normal profit

Occurs when economic profit = 0. The firm earns exactly enough to cover all opportunity costs; resources are as well-used as in any alternative.

Sunk cost

A cost already incurred that cannot be recovered. Should be IGNORED in future decisions. Example: $80 already spent on lost concert tickets.

Marginal analysis

Comparing the additional benefit of doing a bit more of something with the additional cost. Optimal: choose quantity where MB = MC.

Marginal cost (MC)

The additional cost of producing one more unit of a good or service. Can be increasing, constant, or decreasing.

Marginal benefit (MB)

The additional benefit from consuming or producing one more unit. Typically decreasing — each extra unit adds less than the previous one.

Optimal quantity rule

Produce or consume up to the point where MB = MC. If MB > MC, do more. If MB < MC, do less.

Behavioral economics

The study of how psychological factors affect economic decision-making. Identifies predictable departures from rational behavior.

Bounded rationality

Making a "good enough" choice rather than the perfectly optimal one because full optimization requires too much mental effort.

Loss aversion

People feel the pain of losing about twice as much as the pleasure of gaining the same amount. Example: reluctance to sell a losing stock.

Sunk cost fallacy

Mistakenly letting a sunk cost influence a future decision. Example: continuing to watch a bad movie because you paid for the ticket.

Framing bias

Making a decision based on how choices are presented rather than their actual outcomes. Example: "75% effective" feels better than "fails 25% of the time."

Status quo bias

The tendency to avoid making a decision, defaulting to the current situation. Example: organ donation rates differ dramatically between opt-in vs. opt-out countries.

Mental accounting

Mentally placing dollars into different categories so some dollars feel more valuable than others. Example: spending more freely with credit cards than cash.

Fear of missing out (FOMO)

Investing in an asset based on past performance out of fear of being a "loser." Past performance is no guarantee of future results.

Risk aversion

Willingness to sacrifice some expected payoff to avoid uncertainty. One of four reasons a rational person may choose a lower-expected-value option.

Excludable good

A good from which people who have not paid can easily be prevented from consuming. Example: jeans, streaming subscription.

Rival good

A good where one person's consumption reduces the amount available to others. Example: a cheeseburger.

Private good

Both excludable AND rival. Markets supply these efficiently. Example: wheat, Uber rides.

Public good

Both nonexcludable AND nonrival. Subject to free-rider problem; government must provide. Example: national defense, public sanitation.

Common resource

Nonexcludable but rival. Tends to be overused. Example: fish in the ocean, clean water in a river.

Artificially scarce good

Excludable but nonrival. Sold above MC = 0, causing underconsumed deadweight loss. Example: on-demand movies, software.

Free-rider problem

Individuals consume a nonexcludable good without paying because they cannot be prevented from doing so. Results in underproduction by private markets.

Tragedy of the Commons

Common resources tend to be overused because individuals acting in self-interest collectively deplete the shared resource. Solution: regulation, privatization, or Pigouvian taxes.

Pigouvian tax

A tax on activities that generate negative externalities, designed to align private costs with social costs. Example: carbon tax, London congestion charge.

Negative externality

A cost imposed on a third party; private MC < social MC → overproduction. Example: factory pollution.

Positive externality

A benefit to a third party; private MB < social MB → underproduction. Example: vaccinations.

Marginal social benefit of a public good

The vertical sum of all individuals' marginal benefit curves — everyone benefits simultaneously from the same unit of a public good.

Cost-benefit analysis (public goods)

Provide the public good up to the quantity where MSB = MC. Estimating benefits is difficult because people cannot be charged directly.

Welfare state

The collection of government programs designed to alleviate economic hardship. Three rationales: reduce inequality, reduce insecurity, reduce poverty and provide health care.

Poverty threshold

The annual income below which a family is officially considered poor. In 2021, 11.6% of Americans (37.9 million) lived below this line.

Supplemental Poverty Measure (SPM)

A poverty measure that includes income from government aid programs. Considered more accurate than the official rate, which counts only cash income.

Lorenz curve

A graph plotting cumulative share of income against cumulative share of households. The further it bows below the 45° equality line, the more unequal the distribution.

Gini coefficient

A number from 0 to 1 measuring income inequality. 0 = perfect equality; 1 = complete inequality. U.S. post-redistribution Gini ≈ 0.37.

Means-tested programs

Government programs available only to individuals whose income falls below a threshold. Examples: SNAP, Medicaid, TANF, EITC.

In-kind benefit

Government assistance given as goods or services rather than cash. Examples: SNAP (food), Medicaid (health care), housing subsidies.

Earned Income Tax Credit (EITC)

A negative income tax that supplements the earnings of low-income working families. One of the most effective U.S. anti-poverty programs.

Social Security

A non-means-tested program providing retirement income, disability benefits, and survivor benefits funded by payroll taxes. Signed by FDR in 1935; $1.13 trillion in 2021.

Medicare

Social insurance providing health coverage to all Americans 65+, regardless of income. Funded by payroll taxes. Not means-tested.

Medicaid

A means-tested health insurance program for low-income individuals, funded by federal and state governments. Covered 61.9 million Americans in 2021.

Adverse selection (health insurance)

Healthy people opt out of voluntary insurance pools, leaving only sicker people, which raises premiums and can collapse the market.

Affordable Care Act (ACA)

Law requiring everyone to purchase health insurance (mandate) to prevent adverse selection and expand coverage. Modeled on Massachusetts "Romneycare."

Single-payer health care system

Government is the principal payer of medical bills, funded through taxes. Example: Medicare (U.S.), Canadian health care.

Benefits notch

A sharp drop in total income when a means-tested benefit is lost as income crosses a threshold. Creates a work disincentive — a major critique of means-testing.

Median vs. mean income

Median = the middle household's income. Mean = the average. Economists prefer median because it is not skewed by extremely high earners.

Utility

The value or satisfaction a consumer derives from consuming goods and services. Measured in utils.

Marginal utility (MU)

The additional utility gained from consuming one more unit of a good. Typically diminishing.

Diminishing marginal utility

As a consumer consumes more of a good, the additional satisfaction from each extra unit falls. Explains downward-sloping demand curves.

Budget constraint (budget line)

The set of consumption bundles a consumer can afford. Equation: M = Px·X + Py·Y. Slope = −Px/Py (the relative price ratio).

Optimal consumption bundle

The affordable bundle that maximizes a consumer's total utility. Found where MU_A/P_A = MU_B/P_B for all goods.

Utility-maximizing rule

Allocate income so the last dollar spent on each good yields the same marginal utility: MU_A/P_A = MU_B/P_B. If unequal, shift spending toward the higher MU/P good.

Substitution effect (consumer theory)

When a good's price rises, consumers substitute toward relatively cheaper goods. Always works opposite to the price change.

Income effect (consumer theory)

When a good's price rises, real purchasing power falls, changing quantity demanded. Reinforces substitution effect for normal goods; partially offsets it for inferior goods.

Giffen good

A rare inferior good where the income effect outweighs the substitution effect, causing demand to rise when price rises. Example: staple foods among very poor households.

Indifference curve

A curve showing all combinations of two goods that give a consumer equal utility. Properties: downward-sloping, convex to origin, never cross, higher = more utility.

Marginal rate of substitution (MRS)

The rate at which a consumer willingly trades one good for another while staying equally satisfied. Equals the slope of the indifference curve. Diminishes along the curve.

Consumer equilibrium (indifference analysis)

Where the budget line is tangent to the highest attainable indifference curve. At equilibrium: MRS = Px/Py.

Indifference map

A set of indifference curves representing a consumer's preferences. Curves further from the origin represent higher utility levels.

Factor of production

Any resource used by firms to produce goods: land, labor, physical capital, and human capital. Factor markets determine the distribution of income.

Physical capital

Manufactured productive resources — equipment, buildings, tools, machines. Distinct from human capital and financial capital.

Human capital

The improvement in labor productivity resulting from education, training, and knowledge. Workers with more human capital earn higher wages.

Factor distribution of income

Division of total income among factors: labor (wages), land (rent), capital (interest + profit). In the U.S., employee compensation ≈ 68% of total income.

Value of marginal product of labor (VMPL)

The monetary value of extra output from hiring one more worker: VMPL = P × MPL. Firm hires until VMPL = W.

Optimal hiring rule

Hire labor until VMPL = W (wage rate). Hire capital until VMPL_K = r (rental rate). Marginal benefit of the last unit equals its marginal cost.

Marginal product of labor (MPL)

Additional output from hiring one more worker: MPL = ΔQ/ΔL. Diminishes as more workers are added.

Diminishing marginal returns

As more variable input is added to a fixed input, MPL eventually falls. Causes the labor demand (VMPL) curve to slope downward.

Shifts in factor demand

Three causes: (1) change in output price, (2) change in supply of other factors, (3) technological change. Example: higher wheat price raises VMPL → more farm workers hired.

Compensating differentials

Wage differences compensating workers for unpleasant, dangerous, or undesirable job characteristics. Example: hazardous-materials truckers earn more than regular truckers.

Monopsony

A labor market with a single dominant employer who can pay workers below their VMPL. Example: large hospital in a small town paying nurses below-competitive wages.

Efficiency wages

Wages set above the market rate to increase worker productivity, reduce turnover, and attract skilled workers. A deliberate employer strategy.

Substitution effect (labor supply)

A wage increase raises the opportunity cost of leisure → workers want to work MORE hours.

Income effect (labor supply)

A wage increase makes workers richer → they buy more leisure (work FEWER hours) because leisure is a normal good.

Backward-bending labor supply curve

At high wages, the income effect dominates the substitution effect, so workers choose to work fewer hours as wages rise further.

Adverse selection (general)

When the less-informed party in a transaction ends up with a disproportionate share of high-risk or low-quality counterparts due to information asymmetry.

Moral hazard

One party changes behavior after a contract is signed in a way that is costly to the other party. Example: insured drivers may drive less carefully. Solved by deductibles.

Screening

Efforts by the less-informed party to gather information about the more-informed party. Example: employer aptitude tests or background checks.

Signaling

Efforts by the more-informed party to credibly reveal information. Example: getting a college degree to signal productivity to potential employers.

Cobb-Douglas production function

Q = K^a × L^b. MPL = bK^a L^(b−1); MPK = aK^(a−1) L^b. Used to calculate marginal products and optimal input levels algebraically.