Econ 2001.01 Midterm II OSU

What is utility?

A measure of the satisfaction a person derives from a good or service

What is revealed preference?

The principle that people's preferences can be determined by observing their choices and behavior

What is a bundle?

A unique combination of goods and services that a person could choose to consume

What is marginal utility?

∆ in satisfaction from consumption of one additional good or service

What is the law of diminishing marginal utility?

The additional utility gained from a consuming successive units of a good or service tends to be smaller than the utility gained from the previous unit or service

What is a utility function?

A formula for calculating the total utility that an individual yields from consumed bundles

How is utility measured?

Relative satisfaction per the cost

What does a budget constraint determine?

The possible bundles a consumer can buy at a given income

How do individuals maximize utility within constraints?

Allocate resources on bundles that produce highest possible total utility

What is the relationship between income and bundle affordability?

Direct

What results from a change in income?

A budget line shift

In what ways does price change affect budget constraint?

Income effect and substitution effect

What is the income effect?

A change in the consumption based on a change in price at a given income (relative effective wealth)

What is the substitution effect?

The change in consumption based on a change in the relative prices of goods

What will lead to an increase or decrease in the opportunity cost of utility?

The change of the price of the utility

What results from a change in price?

A budget line rotation

What does the slope of the budget line reflect?

The relative cost of two goods or services

What is altruism?

A motive for action in which a person's utility increases simply because someone else's utility increases

What is reciprocity?

A response to another's action with a similar action

Why does the value of money change over time?

Opportunity costs and benefits change over time

Why is the future uncertain?

Only approximate future costs and benefits are known

What are interest rates?

The change of present monetary value over time

When considering money today versus future money, what do individuals consider?

The opportunity cost of waiting until the future to receive the money

What is the future value?

The present value of money with interest rate

What is compounding?

Analyzing the value of money over a time period other than a year, allowing interest to accumulate

What is the equation for PV?

PV = FV/(1+r), where r is a fraction or decimal

What is the equation of FV?

FV = PV(1+r), where r is a fraction or decimal

What is the equation for compounding?

FV = PV (1+r)^n, where r is a fraction or decimal

What is FV?

Future value

What is PV?

Present value

What is r?

Interest rate (a.k.a. i)

What is n?

Number of years; time compounded

What is the rule of 70?

A measure of how long it takes for (PV) money to double given at at an interest rate r

What is the equation for the rule of 70?

n = 70/r, where r is a percent

What is expected value?

The average of each possible outcome of a future event weighted by its probability of occurring

What is uncertainty?

The inability to compare future costs and benefits against current costs and benefits

How are decisions based on present values made in the state of uncertainty ?

Risk taking

What is risk?

A class of uncertainty in which future costs and benefits are not definite, but can be calculated and weighted with probability

How is risk evaluated?

Rationally analyzing possible outcomes

What is an expected value?

The average of each possible outcome of a future event weighted by its probability (likeliness)

What is the formula for expected value?

The sum of: each possible event S multiplied by the event's probability P.... EV = (P1 S1) + (P2S1)+...(Pn*Sn)

What are the two qualities of risk taking?

Risk averse and risk seeking

What is risk averse?

Avoiding risk, choosing an outcome the lower variance and more consistency, even if outcomes are lower

What is risk seeking?

Pursuing risk, choosing an outcome with highest possible value, even if the variance is large

What is the propensity of risk?

Choosing the outcome with the lower risk

What do risk takers need to receive in order to take higher risks?

Compensation

What is an insurance policy?

A product that compensates individuals to reduce risk in decision making

What is insurance?

An agreement in which an individual pays a regular fee, as long as the risk is being taken

What does an insurance company cover?

Costs associated with specific event outcomes

Why do insurance companies cover costs of risk?

They receive more in premium than they pay for the expected cost of the risk

What is a premium?

The cost of insurance

What determines the cost of a premium?

The degree of risk possible

What does insurance reallocate?

Costs from individuals to insurance companies

What is risk pooling?

Organizing people into a group to collectively absorb the risk faced by each individual

What is risk diversification?

The process by which risks are shared across many different assets or people, reducing the impact of any particular risk on any one individual

What is adverse selection?

A state that occurs when buyers and sellers have different information about the quality of a good or the riskness of a situation; results in failure to complete transactions that would have been possible if both sides had the same information

What is moral hazard?

The tendency for people to behave in a riskier way or to renege on contracts when they do not face the full consequences of their situations

What is a firm's goal?

To maximize profits

What is profit?

Total revenue - total cost

What is total revenue?

The amount that a firm receives from the sale of goods and services

How is total revenue calculated?

The quantity sold multiplied by the price paid per unit

What is the equation for total revenue?

Sum of Quantity*Price

What is total cost?

The amount that a firm pays for inputs used to produce goods and services

How is total cost calculated?

Fixed costs + variable costs

What are fixed costs?

Costs that do not depend on the quantity of output produced

What are types of fixed costs?

One-time, upfront payments (e.g. equipment) needed for production; continuous payments (e.g. rent)

How do fixed costs change as quantity output increases?

The costs remain constant

What are variable costs?

Costs that depend on the quantity of output produced

What are types of variable costs?

Amount of labor and raw material consumed

How do variable costs change as quantity output increases?

The costs increase

What are explicit costs?

Opportunity costs that require a firm to spend money

What are implicit costs?

Opportunity costs that require a firm to forgo profits or other costs

What is economic profit?

Total revenue - total opportunity costs (a.k.a. accounting profit - implicit costs)

What is total opportunity costs?

Explicit costs + implicit costs

What is accounting profit?

Total revenue - explicit costs

What is significant about accounting profit?

It may be a misleading indicator of how well a business is really doing.

What is the short run?

A period where fixed costs may not be adjusted

What is the long run?

A period where fixed costs may be adjusted, therefore turning fixed costs into variable costs

What is marginal product?

The increase of output generated by an additional unit of input

What is diminishing marginal product?

A principle stating that the marginal product of an input decreases as the quantity of the input decreases

What is average total cost (ATC)?

The total cost divided by the quantity of output (TC/Q or ATC + AFC)

What are the average fixed costs (AFC)?

The fixed costs divided by the quantity of output (FC/Q)

What are the average variable costs (AVC)?

The variable costs divided by the quantity of output (VC/Q)

What is marginal cost (MC)?

The increase of cost generated by an additional unit of output

What are returns to scale?

Economies of scale, diseconomies of scale, and constant returns to scale

When do economies of scale result?

When the scale increase of outputs of production decreases the minimum average total cost of production

When do diseconomies of scale result?

When the scale increase of outputs of production increases the minimum average total cost of production

When do constant returns to scale result?

When the minimum average total costs of production does not depend on the scale change of outputs of production

When does an efficient scale result?

When average total cost is minimized by the quantity of output