MicroEconomics Final

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104 Terms

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Economics
the science of how individuals make choices under scarcity
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Scarcity
the concept that there is less of something freely available from nature than people would like
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Rationing
allocates scarce goods to those who want them
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Capital
human made resources used to produce other goods and services
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Trade-offs
made due to resources being scarce
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Opportunity Cost
the highest valued alternative that must be sacrificed when choosing an option
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Utility
the subjective benefit or satisfaction a person expects from a choice or course of action
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Law of Diminishing Marginal Utility
as consumption increases, the marginal utility derived from each additional unit declines
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Cost-Benefit Analysis
when making a decision one compares the marginal benefits and the marginal costs
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Secondary Effect
the indirect impact of an event or policy that may not be easily and immediately observable
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Positive Economics
the scientific study of what is (TESTABLE)
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Normative Economics
judgements about what ought to be (NOT TESTABLE)
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Ceteris Paribus
all other things held constant
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Nirvana Fallacy
The logical error of comparing the actual situation with its idealized counterpart rather than the alternative
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Mircroeconomics
focuses on how human behavior affects the conduct of affairs within individually defined units such as households or firms
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Macroeconomics
Focuses on how human behavior affects outcomes in highly aggregated markets such as the nations market for labor
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Pitfalls to Avoid in Economic Thinking
1. Violation of the ceteris paribus principle
2. the belief that good intentions guarantee desirable outcomes
3. the belief that association is causation
4. fallacy of composition: the fallacious belief that what is true for one is true for all
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How trade creates value
- When individuals engage in a voluntary exchange, both parties are made better off.
- By channeling goods and resources to those who value them most, trade creates value and increases the wealth created by a society's scarce resources
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Reasons why trade leads to economic progress
- gains from specialization and division of labor
- gains from mass production methods
- gains from innovation
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Creation of Wealth
the process by which people become rich in a market economy will make the economic pie bigger
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Transaction Costs
the time, effort, and other resources needed to search out and complete an exchange (do not include paid price)
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Middleman
a person or business that buys and sells goods and services or arranges trades- reduces transaction costs
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Private property rights
- the right to exclusive use of the property
- legal protection against invasion from other individuals
- the right to sell, transfer, exchange, or mortgage the property
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Incentives Created by Property Rights
1. to use resources in ways that are considered beneficial to others
2. to care for and manage what they own
3. to conserve for the future
4. to make sure their property does not damage your property
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Production Possibilities Curve (PPC)
1. fixed amount of productive resources
2. given amount of technical knowledge
3. full and efficient use of resources
4. conducive institutional environment
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Factors that Shift the PPC
1. a change in available resources
2. changes in technology
3. a change in the institutions
4. changes in work habits
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Law of Comparative Advantage
The total output of a group of individuals, an entire economy, or a group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost
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Three Economic Questions
1. What will be produced?
2. How will it be produced?
3. For whom will it be produced?
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Coercion
someone will devote resources to make you worse off if you dont comply
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Investment
the purchase, construction, or development of resources
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Socialism
A system of economic organization where:
1. ownership and control of the means of production rest with the government
2. resource allocation is determined by centralized planning
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Capitalism
A system of economic organization where:
1. productive resources are owned privately
2. goods and resources are allocated through market prices
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Collective Decision Making
the method of organization that relies on public sector decision making to resolve basic economic questions
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Market Organization
A method of organization in which private parties make their own plans and decisions with the guidance of market prices
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Law of Demand
there is an inverse (negative) relationship between the price of a good and the quantity that buyers are willing to purchase
-results in a downward sloping demand curve
-as price increases, quantity demanded decreases
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Consumer Surplus
The difference between the maximum amount consumers would be willing to pay and the amount that they pay
-the area below the demand curve but above the price
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Change in Quantity Demanded
- a movement along the curve
- caused by a change in price
- increase: movement to the right
- decrease: movement to the left
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Change in Demand
- a shift of the curve
- caused by a change in anything that effects the demand other than the price
- increase: curve shifts right
- decrease: curve shifts left
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Shifters of Demand
1. Change in consumer income
2. Change in number of consumers
3. Change in the price of a related good
4. Change in expectations
5. Change in consumer tastes and preferences
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Law of Supply
There is a direct (positive) relationship between the price of a good or service and the amount that suppliers are willing to provide
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Producer Surplus
the difference between the minimum prices that producers are willing to accept for a product and the price they actually receive
- the area above the supply curve but below the price of the good or service
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Shifters of the Supply Curve
1. Change in Resource Prices
2. Change in Technology
3. Change in the number of suppliers
4. Change in producer expectations
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Market Equilibrium
- A state in which the conflicting forces of supply and demand are in balance
- Occurs where the demand curve intersects the supply curve
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Efficient Market Equilibrium
- no excess supply or excess demand
- Excess Supply: QS \> QD
- Excess Demand: QD \> QS
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Invisible Hand Principle
The tendency for people, while pursuing their own self-interests, to promote the economic well-being of society
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The Labor Market
- Businesses and entrepreneurs demand resources in order to produce goods and services to sell in the market
- Price for labor is called the wage (W)
- Quantity of labor is called employment (E)
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Price Floor
- above the equilibrium creates a surplus
- below equilibrium does nothing
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Price Ceiling
- below the equilibrium creates a shortage
- above equilibrium does nothing
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Average Tax Rate
tax liability / taxable income
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Marginal Tax Rate
change in tax liability / change in taxable income
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The Laffer Curve
a curve illustrating the relationship between tax rate and tax revenue
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Subsidy
a payment the government makes to either the buyer or seller when a good or service is purchased or sold - are costly
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Economic Efficiency
1. all actions generating more benefits than costs should be undertaken
2. no actions generating more costs than benefits should be undertaken
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Lack of Competition
With no competition, a firm can provide lower quantities and raise prices
Firms make larger profits while customers pay higher prices for fewer goods
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Negative Externality
harmful side effect that affects an uninvolved third party
ex.- loud music in apartment building
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Positive Externality
beneficial side effect that affects an uninvolved third party
ex.- immunizations
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Free-Rider
A person who receives the benefit of a good without paying for it
This will cause the good to become under- supplied
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4 types of market failure
1. lack of competition
2. externalities
3. public goods
4. lack of information
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Law of Marginal Utility
As the consumption of a product increases, the marginal utility derived from additional consumption will eventually decline
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Price elasticity of demand
%∆QD / %∆P
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Inelastic
- describes demand that is not very sensitive to price changes
- The price effect dominates - Increasing price increases total revenue
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Elastic
- describes demand that is very sensitive to a change in price
- The quantity effect dominates - Increasing price decreases total revenue
- more substitutes available
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Normal Good
positive income elasticity
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Necessity Good
income elasticity between 0 and 1
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Luxury Good
income elasticity is greater than 1
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Inferior Good
negative income elasticity
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Residual Claimants
Individuals who personally receive the excess of revenues over costs
They have the incentive to increase revenues or reduce costs
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Principle-Agent Problem
The incentive problem that occurs when the purchaser of services lacks full information about the circumstances faced by the seller, and therefore, cannot knowhow well the seller performs the service
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Explicit Costs
the payments a firm makes to purchase the goods and services of productive resources
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Implicit Costs
The opportunity costs associated with the firm's use of resources that it owns
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Economic Profit
The difference between the firm's total revenue and its total costs (including both explicit and implicit costs)
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Accounting Profit
The sales revenue minus the expenses of the firm (does not usually include implicit costs)
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Normal Profit Rate
Zero economic profit, the competitive rate of return on the capital and labor of the owners
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Short Run
A period so short that a firm is unable to vary some of its factors of production.
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Long Run
period long enough to allow the firm to vary all its factors of production
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Law of Dimininishing Returns
As more and more units of a variable resource are applied to a fixed number of other resources; output will eventually increase by smaller and smaller amounts
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Average Total Cost
u-shaped graph
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Average Fixed Cost
falls with output
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he Long Run Average Total Cost Curve (LRATC)
Shows the minimum average cost ofproducing each output level when the firm is free to choose among all possible plant sizes
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Economies of Scale
Occurs when the firm's per-unit costs decrease as output increases (the left of the LRATC)
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Diseconomies of Scale
Occurs when the firm's per-unit costs increase as output increases (the right of the LRATC)
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Sunk Costs
costs that have already been incurred as a result of a past decision- should be ignored
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Price Takers
The sellers who must take the market price in order to sell their product
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Price Searchers
Firms that choose the price they charge for their product, but the quantity they are able to sell is inversely related to price
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Characteristics of Price Taker Markets
1. there are many firms in the market
2. Each firm produces identical products
3. Their output is small relative to the total market
4. They can sell all of their output at the market price
5. There are no barriers to entry or exit of firms in the market
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Barriers to Entry
Obstacles that limit the freedom of potential rivals to enter and compete in an industry or market
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Profit Maximizing Rule
MR\=MC
* a firm should produce when MR \> MC
* a firm should never produce when MC \> MR
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Economic Profit
If MR \= MC occurs above the ATC curve
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Economic Loss
If MR \= MC below the ATC curve
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Entry and Exit in the Long Run
1. If firms are making an economic profit: new firms will enter and drive price down
2. If firms are making an economic loss: firms will leave the market and drive price up
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Competitive Price Searcher
1. Has low barriers to entry
2. Faces a downward sloping demand curve (because they produce differentiated products)
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Long Run Equilibrium
When firms in a price searcher market make an economic profit (loss), new firms will enter(exit) and drive price down (up) by shifting demand.
In the Long-run, firms will make zero economic profit.
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Contestable Market
1. Prices above the level necessary to achieve zero economic profits will not be maintained
2. The costs of production will be kept to a minimum
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Price Discrimination
1. Identify and separate at least two groups with different elasticities of demand
2. Prevent those who buy at the low price from reselling to those who buy at the high price
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Bundling
The sale of two or more goods and services together
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Tying
The act of making the purchase of one good conditional on the purchase of a second good
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What causes high barriers to entry?
1. Economies of scale
2. Government licensing and other legal barriers to entry
3. Patents
4. Control over an essential resource
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Monopoly
- High barriers to entry
- A single seller of a well-defined product that has no good substitutes
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Oligopoly
market that consists of a small number of sellers
1. A small number of rival firms
2. Interdependence among the sellers
3. High barriers to entry in the market
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Game Theory
The analysis of strategic choices made by competitors in a conflict situation