econ mt 2

Indifference Curves (ICs)

Curves whose shape reveals information about the relationship between goods. More straight ICs describe goods that are more easily substitutable for one another, and more curved ICs describe goods that are more complementary to one another.

Perfect Substitutes

Goods that are perfectly interchangeable.

Perfect Complements

Goods that must be consumed in a fixed proportion.

Substitution Effect (SE)

The change in choices resulting from a change in relative prices, ignoring the effect that purchasing power has gone up.

Income Effect (IE)

The change in choices resulting from a change in purchasing power, ignoring the impact of the good now being cheaper than other goods.

Total Effect (TE)

The combination of the Substitution Effect and the Income Effect.

Normal Good

Following a fall in price, the SE and IE go the same way. Specifically, an increase in purchasing power leads to an increase in demand.

Inferior Good

Following a fall in price, the SE and IE go in opposite directions. Specifically, an increase in purchasing power leads to a decrease in demand.

Production Function

Denoted F(⋅,⋅), it describes how outputs (Q) are produced from inputs, such as Labor (L) and Capital (K).

Marginal Product of Labor (MP_L)

The additional output produced when the quantity of labor used is increased by one unit. In the two-input case, this is holding Capital constant.

Marginal Revenue Product of Labor (MRP_L)

The additional revenue generated when the quantity of labor used is increased by one unit (MRPL = p⋅MPL).

Profit Maximization (One Input)

Optimal choice of input (or output) is achieved where Marginal Benefit equals Marginal Cost (p⋅MP_L (L∗)=w or p=MC(Q∗)).

Marginal Cost (MC)

The cost of producing one extra unit of output. Algebraically, MC=w⋅(1/MP_L) in a one-input case.

Isoquant

A curve representing combinations of inputs (K and L) that allow a firm to make a particular quantity of output.

Isocost Line

A line that shows all input combinations that yield the same cost (C=rK+wL), where r is the rental rate of capital and w is the wage rate.

Marginal Rate of Technical Substitution (MRTS)

The ratio of the Marginal Products along the isoquant (ΔK/ΔL=−MPL/MPK). The cost-minimizing way of producing occurs when MRTS equals the ratio of input prices (MPK/MPL = r/w).

Returns to Scale

Describes the relationship between input changes and output changes. Constant (output doubles when inputs double), Increasing (output more than doubles), and Decreasing (output less than doubles).

Fixed Costs (FC)

Costs which do not change as quantity of output changes.

Variable Costs (VC)

Costs which do change as quantity of output changes.

Total Costs (TC)

The sum of fixed and variable costs. TC(Q)=wL∗(Q)+rK∗(Q).

Average Total Cost (ATC or AC)

Total Cost divided by output quantity (TC/Q), also equal to Average Fixed Cost plus Average Variable Cost (AFC+AVC).

Relationship between MC and AC

If Marginal Costs are greater than Average Costs, then AC are rising; if MC are less than AC, then AC are falling. When MC is equal to AC, then Average Costs are at a minimum.

Economic Costs

The sum of accounting costs and opportunity costs. These are the costs that are relevant for decision-making.

Economic Profits

Revenue less economic costs. In Long Run Equilibrium in Perfect Competition, economic profits are driven to zero.

Perfect Competition (PC)

A market characterized by a homogenous good, a very large number of buyers and sellers, and free entry (no barriers to entry).

Short-Run Shutdown Decision

In the short run, a firm should operate as long as price (p) is greater than Average Variable Cost (AVC(q∗)). If operating means earning a loss, shutting down results in a loss equal to the fixed costs (−FC).

PC Firm's Supply Curve

That part of its Marginal Cost curve that is above the Average Variable Cost curve.

Long-Run PC Equilibrium

Occurs when price equals Average Cost (P=AC), meaning economic profits are zero.

Pareto Dominance

Allocation B dominates allocation A if, in moving from A to B, no one is worse off and at least one person is better off.

Pareto Efficiency (PE)

An allocation is PE if no feasible allocation Pareto Dominates it.

First Welfare Theorem of Economics

The claim that the allocation of resources in a perfectly competitive equilibrium is Pareto Efficient.

Second Welfare Theorem of Economics

Any given Pareto-efficient allocation in a perfectly competitive market is a general equilibrium outcome for some initial allocation of resources.

Market Power

A firm's control over price, meaning that if it increases price, it can still sell some quantity.

Monopoly

The most extreme form of market power, where there is only one seller in the industry.

Monopolist's Marginal Revenue (MR)

For a monopolist facing a downward sloping demand curve, MR is calculated by considering the gain from selling an additional unit minus the loss incurred because all previous units must now be sold cheaper.

Income and Substitution Effects Decomposition

Graph depicting the Total Effect and its decomposition using Indifference Curves and Budget Constraints.

Cost Minimization using Isoquants and Isocost Lines

Isoquant/Isocost Diagram showing Capital (K) on the vertical axis and Labor (L) on the horizontal axis.

Cost Curves (Short-Run)

Graph showing U-shaped Average Total Cost (ATC) and Average Variable Cost (AVC) curves, along with the Marginal Cost (MC) curve.

Firm Supply and Profit in Perfect Competition (Short-Run)

Profit/Loss Diagram for a PC Firm showing Price (p), MC, and AC/ATC curves relative to quantity (q).

Profit Calculation

Profit is calculated as π=(p−AC)q.

Monopolist's Demand and Marginal Revenue

Graph showing a downward sloping Demand Curve and the Marginal Revenue curve.

Demand Curve Equation

P=a−bQ.

Marginal Revenue Curve Equation

MR(Q)=a−2bQ.