PLCY640 Midterm Exam Vocabulary

Reservation price

the price at which a person would be indifferent between doing x and not doing x

Opportunity cost of activity

the value of all that must be sacrificed to do the activity

marginal cost

the increase in total cost that results from carrying out one additional unit of an activity

marginal benefit

the increase in total benefit that results from carrying out one additional unit of an activity

average cost

the average cost of undertaking n units of an activity is the total benefit of the activity divided by n

external cost of an activity

a cost that falls on people who are not directly involved in the activity

invisible hand

the individual pursuit of self interest is often not only consistent with broader social objectives, but actually required by them

normative question

a question about what policies or institutional arrangements lead to the best outcomes

positive question

a question about the consequences of specific policies or institutional arrangements

real price of a product

its price relative to the prices of other goods and services

law of demand

the empirical observation that when the price of a product falls, people demand larger quantities of it

law of supply

the empirical observation that when the price of a product rises, firms offer more of it for sale

excess supply

the amount by which quantity supplied exceeds quantity demanded

excess demand

the amount by which quantity demanded exceeds quantity supplied

price ceiling

the level above which the price of a good is not permitted by law to rise

price floor

a minimum price for a good, established by law, and supported by government's offer to buy the good at that price

rationing function of price

the process whereby price directs existing supplies of a product to the users who value it most highly

allocative function of price

the process whereby price acts as a signal that guides resources away from the production of goods whose prices lie below cost toward the production of goods whose prices exceed cost

determinants of demand

incomes, tastes, prices of substitutes and complements, expectations, population

determinants of supply

technology, factor prices, number of suppliers, expectations, weather

predicting and explaining changes in price and quantity

- an increase in demand will lead to an increase in both the equilibrium price and quantity

- a decrease in demand will lead to a decrease in both the equilibrium price and quantity

- an increase in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity

- a decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity

bundle

a particular combination of two or more goods

budget constraint

the set of all bundles that exactly exhaust the consumer's income at given prices. also called budget line

affordable set

bundles on or below the budget constraint; bundles for which the required expenditure at given prices is less than or equal to the income available

composite good

in a choice between a good X and numerous other goods, the amount of money the consumer spends on those goods

preference ordering

a ranking of all possible consumption bundles in order of preference

indifference curve

a set of bundles among which the consumer is indifferent

indifference map

a representative sample of the set of consumer's indifference curves, used as a graphical summary of their preference ordering

marginal rate of substitution (MRS)

at any point on an indifference curve, the rate at which the consumer is willing to exchange the good measured along the vertical axis for the good measured along the horizontal axis; equal to the absolute value of the slope of the indifference curve

best affordable bundle

the most preferred bundle of those that are affordable

corner solution

in a choice between two goods, a case in which the consumer does not consume one of the goods

price-consumption curve (PCC)

holding income and the price of Y constant, the PCC for a good X is the set of optimal bundles traced on an indifference map as the price of X varies

income-consumption curve (ICC)

holding the prices of X and Y constant, the ICC for a good X is the set of optimal bundles traced on an indifference map as income varies

Engel curve

a curve that plots the relationship between the quantity of X consumed and income

normal good

one whose quantity demanded rises as income rises

inferior good

one whose quantity demanded falls as income rises

substitution effect

the component of the total effect of a price change that results from the associated change in the relative attractiveness of other goods

income effect

the component of the total effect of a price change that results from the associated change in real purchasing power

giffen good

one for which the quantity demanded rises as its price rises

price elasticity of demand

the percentage change in the quantity of a good demanded that results from a 1 percent change in price

income elasticity of demand

the percentage change in the quantity of a good demanded that results from a 1 percent change in income

cross-price elasticity of demand

the percentage change in the quantity of one good demanded that results from a 1 percent change in the price of the other good

income-compensated demand curve

a demand curve that tells how much consumers would buy at each price if they were fully compensated for the income effects of price changes

consumer surplus

a dollar measure of the extent to which a consumer benefits from participating in a transaction

long run

the shortest period of time required to alter the amounts of all inputs used in a production process

short run

the longest period of time during which at least one of the inputs used in a production process cannot be varied

variable input

an input that can be varied in the short run

fixed input

an input that cannot vary in the short run

law of diminishing returns

if other inputs are fixed, the increase in output from an increase in the variable input must eventually decline

total product curve

a curve showing the amount of output as a function of the amount of variable input

marginal product

change in total product due to a 1-unit change in the variable input

average product

total output divided by the quantity of the variable input

isoquant

the set of all input combinations that yield a given level of output

marginal rate of technical substitution

the rate at which one input can be exchanged for another without altering the total level of output

increasing returns to scale

the property of a production process whereby a proportional increase in every input yields a more than proportional increasing in output

constant returns to scale

the property of a production process whereby a proportional increase in every input yields a less than proportional increase in output

decreasing returns to scale

the property of a production process whereby a proportional increase in every input yields a less than proportional increase in output

fixed cost

the cost that does not vary with the level of output in the short run (the cost of all fixed factors of production)

variable cost

cost that varies with the level of output in the short run (the cost of all variable factors of production)

total cost

all costs of production: the sum of variable cost and fixed cost

average fixed cost

fixed cost divided by the quantity of output

average variable cost

variable cost divided by the quantity of output

average total cost

total cost divided by the quantity of output

isocost line

a set of input bundles each of which costs the same amount

output expansion path

the locus of tangencies (minimum-cost input combinations) traced out by an isocost line of given slope as it shifts outward into the isoquant map for a production process

natural monopoly

an industry whose market output is produced at the lowest cost when production is concentrated in the hands of a single firm

Giffen good

product people consume more of as the price rises