Economics: Profit, Costs, Utility, and Consumer Choice

Accounting profit

Revenue minus explicit cost (cash loss, e.g., tuition).

Economic profit

Revenue minus opportunity cost, which includes both explicit and implicit costs.

Implicit cost of capital

Income the owner could've earned if they were employed somewhere else.

Marginal cost

Total cost minus total cost.

Marginal benefit

Total benefit minus total benefit.

Optimal point

Where marginal cost (MC) and marginal benefit (MB) intersect.

Profit maximizing

How much decision; optimal quantity is the largest quantity where benefit is greater than or equal to marginal cost.

Sunk costs

Costs that have already been spent.

Bounded choice

Choosing something close to the highest possible payoff but not that because the effort of finding it is too much.

Framing bias

Making decisions based on how choices are framed instead of true values.

Nudge

Automatic enrollment into 401k.

Consumption bundle

Everything that a person consumes.

Utility function

The relationship between a consumption bundle and the total utility it generates.

Budget line

Downward sloping because in order to consume more of one thing, you have to consume less of another.

Optimal consumption bundles

Lie on the budget line and maximize total utility given the budget constraint.

Utility per additional dollar spent

Util divided by dollar.

Marginal utility

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

Substitution effect

The change in quantity consumed as consumers substitute other goods that are relatively cheaper.

Income effect

When a change in the price of a good effectively changes a consumer's income by altering purchasing power.

Inferior goods

Goods for which demand increases as consumer income decreases.

Giffen good

A good that has an upwards sloping demand curve, typically a hypothetical scenario.

Firm

An organization that produces goods or services for sale through transforming inputs into outputs.

Production function

The relationship between the quantity of output produced and the quantity of input used.

Fixed inputs

Inputs that are fixed over time and cannot vary.

Variable inputs

Quantities that can vary over time.

Short run

A period where at least one input is fixed.

Total product curve

Shows how quantity of output depends on quantity of variable input for a given quantity of fixed input.

Marginal product of labor

Additional quantity of output from using one more unit of labor.

Diminishing returns to input

When increase in quantity of input holding quantity of other inputs fixed, reduces input's marginal product.

Fixed costs

Costs that do not depend on the quantity produced; also known as overhead costs.

Total cost

The sum of fixed cost and variable cost.

Total cost curve

A graphical representation showing how total cost depends on the quantity of output.

Average total cost

Total cost divided by the quantity of output.

Average fixed cost

Fixed cost divided by quantity.

Average variable cost

Variable cost divided by quantity.

Average total cost curve

A U-shaped curve that shows how average total cost first falls then rises as output increases.

Spreading effect

As output increases, the fixed cost is spread over a larger quantity of output, leading to lower average fixed cost.

Diminishing returns effect

As output increases, a greater amount of variable input is required to produce additional units, leading to higher variable cost.

Minimum cost output

The quantity of output that relates to minimum average total cost.

Utility

A measure of satisfaction that consumers aim to maximize.

Util

Hypothetical units used to measure utility.

Marginal utility curve

A graphical representation that typically slopes downward, indicating diminishing marginal utility.

Principle of diminishing marginal utility

The assumption that consumption of another unit of a good or service yields less additional utility than the previous unit.

Budget constraint

A limit that restricts a consumer's spending to no more than their income.

Consumption possibilities

The set of all affordable consumption bundles defined by a budget constraint.

Optimal consumption bundle

The consumption bundle that maximizes total utility.

Marginal utility per dollar

The marginal utility of a good divided by its price.

Utility-maximizing principle of marginal analysis

At the optimal consumption bundle, the marginal utility per dollar spent on each good and service is the same.

Normal Goods

Goods for which the substitution and income effects reinforce each other.

Giffen Goods

An inferior good in which the income effect outweighs the substitution effect, causing the demand curve to slope upward.

Opportunity Cost

The cost of using a resource for a particular activity, measured by the benefits that are forgone.

Explicit Costs

Opportunity costs that involve a direct outlay of money.

Implicit Costs

Opportunity costs that involve no outlay of money but are measured by the dollar value of benefits forgone.

Either-Or Decisions

Decisions where the question is whether or not to do something.

How Much Decisions

Decisions that involve determining how much of a resource to allocate to a given activity.

Marginal Analysis

A method of decision-making that involves comparing the benefit to the cost of doing an additional unit of an activity.

Marginal Cost Curve

The graphical illustration of marginal cost.

Marginal Benefit Curve

The graphical illustration of marginal benefit.

Constant Marginal Cost

A situation where each additional unit costs the same amount to produce as the previous unit.

Increasing Marginal Cost

A situation where each unit costs more to produce than the previous unit, represented by an upward-sloping curve.

Decreasing Marginal Cost

A situation where each unit costs less to produce than the previous unit, leading to a downward-sloping curve.

Decreasing Marginal Benefit

A situation where each additional unit produces a smaller benefit than the unit before.

Optimal Quantity

The quantity that generates the highest possible total profit.

Profit-Maximizing Principle

The principle that the optimal quantity is where marginal benefit is greater than or equal to marginal cost.

Sunk Cost

A cost that has already been incurred and is nonrecoverable.

Sunk Cost Fallacy

The mistaken belief that sunk costs should be counted in making a decision.

Behavioral Economics

A branch of economics that combines economic modeling with insights from psychology to understand decision-making.

Rational Behavior

The choice of the available option that leads to the most preferred outcome.

Explicit cost

Direct payments made to others in the course of running a business.

Implicit cost

The opportunity cost of using resources owned by the firm for its own production rather than selling them.

Capital

The financial assets or physical assets used in the production of goods and services.

Principle of "either-or" decision making

A decision-making principle that involves choosing between two alternatives.

Profit-maximizing principle of marginal analysis

The principle that firms maximize profit by producing at a level where marginal cost equals marginal revenue.

Rational

Making decisions based on logical reasoning and available information.

Nonmonetary rewards

Benefits received that do not involve direct monetary compensation.

Bounded rationality

A concept that suggests individuals are limited in their decision-making capabilities due to cognitive limitations.

Risk aversion

The tendency to prefer certainty over uncertainty, leading to a preference for lower-risk options.

Irrational

Making decisions that do not align with logical reasoning or available information.

Mental accounting

The cognitive process of categorizing and evaluating financial activities.

Loss aversion

The tendency to prefer avoiding losses rather than acquiring equivalent gains.

Fear of missing out (FOMO)

The anxiety that one might miss an opportunity, leading to poor decision-making.

Status quo bias

The preference to keep things the same rather than change.

Nudges

Subtle changes in the environment that influence decision-making and behavior.

Monopolistic competition

A market structure with many producers offering differentiated products and free entry and exit.

Zero-profit equilibrium

A long-run situation in which firms earn zero economic profit.

Excess capacity

A situation where firms produce less than the minimum-cost output.

Brand name

A name given to a product or service that distinguishes it from others.

Oligopoly

A market structure characterized by a small number of firms that have market power.

Duopoly

A market structure with only two sellers.

Oligopolist

A firm that is part of an oligopoly.

Imperfect competition

Market structures that fall between perfect competition and monopoly.

Interdependence

The situation where each firm's profit depends on the actions of other firms.

Duopolist

A firm that is part of a duopoly.

Collusion

An agreement among firms to limit competition, often by setting prices.

Cartel

A group of firms that collude to set prices and output levels.

Noncooperative behavior

Actions taken by firms that do not consider the potential reactions of other firms.

Game theory

A study of strategic decision making among interdependent players.

Payoff

The outcome of a particular strategy in a game.

Payoff matrix

A table that shows the payoffs for each player based on their strategies.

Prisoner's dilemma

A situation in which two players may not cooperate even if it is in their best interest.