Chapter 1/2 Definitions

9 Key Concepts

• scarcity

• choice

• efficiency

• equity

• economic wellbeing

• sustainability

• change

• interdependence

• intervention

Production Possibilites Curve

Represents all combinations of the maximum amounts of two goods that can be produced by an economy.

Circular Flow of Income

Shows that in any given time period, the value of output produced in an economy is equal to the total income generated in producing that output which is equal to the expenditures made to purchase that output.

Positive Economics

The study based on the scientific method in order to gain knowledge about the economic world.

Normative Economics

Based on value judgements, since it identifies major economic problems to be addressed and how to solve them.

Demand

The willingness and ability of a consumer to purchase goods and services at a specific price, ceteris paribus.

Law of Demand

States that there is a negative relationship between the price of a good and its quantity demanded over a period of time, ceteris paribus; as price falls, quantity demanded increases, vice versa.

Law of Diminishing Marginal Utility

As the consumption of a good increases, the extra benefit decreases with each additional unit consumed.

Supply

The willingness and ability of a firm to produce and supply to the market for sale at different prices, ceteris paribus.

Law of Supply

There is a positive relationship between the quantity of a good supplied over time and its price; as the price of the good increases, the quantity suppled also increases, vice versa.

Law of Diminishing Marginal Returns

When more and more units of a variable input are added to fixed inputs, the marginal product first increases, until a certain point when it begins to decrease.

Substitution Effect

If the price of a good falls, the consumer substitutes (buys more) of the less expensive good.

Income Effect

When the consumer’s purchasing power has increased.

Economies of Scale

The cost advantage experienced by a firm when it increases its output.

Price Mechanism

Prices determined by forces of supply and demand in competitive markets.

Allocative Efficiency

When resources are distributed in a way that maximizes social welfare (MB=MC).

Marginal Benefit

The extra benefit you get from each additional unit of something bought.

Marginal Cost

The extra cost incurred to producers from each additional unit of output produced.

Consumer Surplus

The highest price consumers are willing to pay for a good minus the price actually paid.

Producer Surplus

The price received by firms for selling goods minus the lowest price they are willing to accept.

Completeness Assumption

When a consumer is able to rank goods according to their preferences.

Transitivity Assumption

When an individual’s preferences among alternative choices are consistent.

Non-satiation Assumption

When the consumer always prefers more of a good to less.

Rule of thumb

Quick decision making tool based on common sense.

Framing

The way in which choices are presented to decision makers which affect their decision-making.

Anchoring

First piece of information received that then influences following decisions.

Availability

Recent information/events have a stronger influence on decisions.

Bounded Rationality

Consumers are rational only within limits - they seek a satisfactory outcome rather than optimal.

Bounded Self Control

People only have self control within limits.

Bounded Selfishness

People are only selfish within limits and may want to contribute to the public good.

Nudge Theory

A method designed to influence consumer’s choices in a predictable way without limiting choices or having financial incentives.

Choice Architecture

The design of particular ways or environments - how options are presented to consumers