# Shared Flashcard Set

## Details

Micro Study Cards
Micro Economics Final Study Cards
138
Economics
12/08/2010

Term
 Elements in the Construction of Economic Theory
Definition
 Abstraction (the process of studying relevant factors), Definition (defining reality), Assumption (observations we use to make theory), Implication (what we expect to see based on our assumptions - hypothesis), Adoption of Theory (final step).
Term
 What do firms maximize?
Definition
 Profit
Term
 Surplus
Definition
 Point where quantity supplied exceeds quantity demanded, causing prices to fall
Term
 Equilibrium Point
Definition
 Exists when quantity demanded = quantity supplied. Also called the market clearing price.
Term
 Profit
Definition
 Total Revenue - Total Cost
Term
 Good
Definition
 Anything an individual wants more of at zero price
Term
 Scarce
Definition
 Limited
Term
 2 Basic Assumptions of Scarcity
Definition
 Goods are limited, and man has unlimited wants
Term
 Money
Definition
 amount of currency in circulation plus the amount of checkable deposits
Term
 Review Indifference Curves and the Income Expansion Path
Definition
 See C. 4
Term
 Economic Cost
Definition
 1. Economic Cost: The monetary cost of doing something in addition to the value of the next highest valued alternative (Accounting + Opportunity)
Term
 Inferior Good
Definition
 Good for which demand falls when income rises
Term
 Resource Market
Definition
 Firms purchase resources from households in exchange for income
Term
 Diminishing Marginal Value
Definition
 The more you have of any one good, the less the marginal value of that good.
Term
 Marginal Analysis
Definition
 Studying the change from one additional unit - looking at the world in terms of degrees and realizing nothing is absolute
Term
 Price Elasticity of Demand (Definition and Formula)
Definition
 A measure of the responsiveness of the quantity demanded by buyers to a change in priceFormula: ( ∆ Q / Q1) / (∆ P / P1) * will usually be a negative number
Term
 Normative Analysis
Definition
 Describes what should or ought to be and involves value judgments
Term
 First law of Demand
Definition
 For a sufficient rise in price, individuals will tend to purchase less
Term
 Product Market
Definition
 Households buy goods and services from firms in exchange for \$
Term
 Ceteris Paribus
Definition
 All other conditions held stable
Term
 Transactions Costs of Exchange
Definition
 Information Cost (Search Cost & Quality Identification Cost), Negotiating Cost, Transportation Cost
Term
 Personal Marginal Value
Definition
 The maximum amount of \$ an individual will give up to acquire one more unit of a good
Term
 What determines price in the market?
Definition
 Demand. In other words, how much consumers are able and willing to pay. Relative prices coordinate production and consumption decisions.
Term
 Competition naturally moves prices toward _______________
Definition
 equilibrium
Term
 Supply
Definition
 Supply is a schedule of the alternative quantities which suppliers are willing and able to sell at alternative prices
Term
 Complement
Definition
 Good for which demand falls when the price of another good increases
Term
 Resources
Definition
 Anything that could be used to produce a resource: Land, Labor, Capital
Term
 Economics
Definition
 The science of analyzing how individuals behave in a world of scarcity
Term
 Arc Elasticity
Definition
 Ep = (∆ Q/ ∆ P) (Pbar / Qbar)P (bar) and Q (bar) are the averages of the Quantity and price. Use the sum of the highest and lowest points / 2).
Term
 Unitary Elastic
Definition
 % Change in QD / % Change in Price = 1
Term
 Market
Definition
 The interaction of buyers and sellers
Term
 Cross Price Elasticity
Definition
 Cross Price Elasticity: Percentage change in the quantity demanded for a good that results from a 1% increase in the price of another good.( ∆ Qb / Qb) / (∆ Pm / Pm)
Term
 Laspeyre's Price Index (Formula and Problems with this index)
Definition
 CPI --> Formula: (Pc X Qb) / (Pb X Qb) X 100C = current yearB = base year** b. The CPI overstates inflation because it puts too much weight on items that have gone up in price and too little on those that have gone down in price. The Laspeyres price index assumes that consumers do not alter their consumption patterns as prices change.
Term
 6 Postulates of Human Behavior
Definition
 1. Scarcity2. Unique Marginal Value3. Unlimited Wants4. Rationality5. Diminishing MRS6. Everyone will give up some amount of a good if offered enough of another
Term
 What do households maximize?
Definition
 Utility
Term
 Positive Analysis
Definition
 Describes what is or will be, and is testable.
Term
 Free Goods
Definition
 Goods offered at zero cost
Term
 Demand
Definition
 Schedule of the alternative quantities that individuals will purchase at certain prices
Term
 Consumer Surplus Value
Definition
 Consumer Value - Price
Term
 Determinants of Supply
Definition
 1. Alternative Outputs2. Technology3. Cost of inputs4. Number of Sellers (Market Supply)
Term
 Shortage
Definition
 Point where demand exceeds supply, causing prices to rise.
Term
 Paashe Price Index (formula and problems)
Definition
 GDP Deflator: (Pc X Qc) / (Pb X Qc) X 100** The GDP deflator understates inflation because it assumes that the individual will buy the current year bundle in the base period.
Term
 Price Elasticity of Demand (Definition and Formula)
Definition
 A measure of the responsiveness of the quantity demanded by buyers to a change in priceFormula: ( ∆ Q / Q1) / (∆ P / P1) * will usually be a negative number
Term
 3 types of competition
Definition
 Violence, Social-Political (Qualities/Characteristics), Market / Economic (Goods allocated to those who offer highest value in exchange)
Term
 Substitute
Definition
 Good for which demand increases when the price of another good increases
Term
 Snob Effect
Definition
 Negative Network Effect
Term
 Transactions Costs of Exchange
Definition
 Information Cost (Search Cost & Quality Identification Cost), Negotiating Cost, Transportation Cost
Term
 Price Elasticity of Supply
Definition
 Elasticity of supply is the percentage change in the quantity supplied resulting from a 1% increase in price.Calculated by: ( ∆ Q / Q) / (∆ P / P) * will usually be a positive number
Term
 Normal Good
Definition
 Good for which demand rises when income rises
Term
 Bandwagon Effect
Definition
 Positive Network Effect
Term
 Inelastic Demand
Definition
 % Change in QD / % Change in Price < 1 (Increase in Price --> Increase in Revenue)
Term
 Characteristics of the Indifference Curve
Definition
 The indifference curve is downward sloping, showing the trade-off process that consumers must go through in determining how to spend their income. The fact that it slopes downward shows that people are willing to trade-off between different amounts of 2 goods, but never give up more of both goods for less of both.Convexity: The slope becomes flatter and flatter as we move down the curve, which shows the diminishing rate of marginal substitution.
Term
Definition
 List with specific quantities of one or more goods.
Term
 Elastic Demand
Definition
 % QD / % Price > 1 (Decrease in Price leads to increase in revenue)
Term
 Income Elasticity
Definition
 Income Elasticity: Percentage change in the quantity demanded resulting from a 1% increase in income.( ∆ Q / Q) / (∆ I / I)
Term
 What is the budget constraint? Purpose? Change in income? Prices?
Definition
 Limits how much can be spent – limits the expansion of the indifference curveThe budget line indicates all combinations of F and C for which the total amount money spent is equal to income. Income Changes: Change in income alters the vertical intercept of the budget line, but not slope. Increase in income causes an outward shift, fall in income causes the graft to shift inward.Price Changes: If the price of one good changes, but the other does not, the slope will change although the vertical intercept of the budget line is unchanged
Term
 Determinants of Price Elasticity
Definition
 Demand Elasticity:Number and closeness of Substitute products. Information about price change and availability of Substitutes. Percentage of income spent. Amount of time following the price change.
Term
 Second Law of Demand
Definition
 Demand is more elastic in the long run
Term
 Four Determinants of Demand
Definition
 Taste and Preference, Income (Normal Goods, Inferior Goods), Prices (Substitutes and Compliments), Future ExpectationsMarket Demand: Add number of buyers
Term
 Shirking
Definition
 Tendency of individuals in a team to slack off in the hopes of other members carrying their weight
Term
 Monitoring
Definition
 Hiring an individual to oversee a team to prevent shirking (ideally, owner)
Term
 Alternative Periods of Analysis
Definition
 Short Term: One input (capital) fixed, labor flexibleLong Run: No inputs fixedMarket Period: All inputs fixed, vertical supply
Term
 Law of diminishing marginal returns:
Definition
 As you add more of one input to a fixed amount of other inputs (Bldg. & Equip are fixed), output goes up, but at a decreasing rate, Marginal Product Declines
Term
 Explicit Cost
Definition
 Outlay of \$ (Accounting Cost)
Term
 Implicit Cost
Definition
 Opportunity Cost
Term
 Average Fixed Cost
Definition
 Fixed cost divided by total output --> decreases as total output increases
Term
 Average Variable Cost
Definition
 Variable Cost divided by total output
Term
 Total cost
Definition
 Sum of all costs
Term
 ∆VC / ∆Q =
Definition
 ∆TC / ∆Q
Term
 Marginal Cost Curve
Definition
 [image]
Term
 Average Total Cost Curve
Definition
 [image]
Term
 Where does average total cost = marginal total cost?
Definition
 a. Marginal cost is equal to average total cost at the point where average total cost is neither increasing nor decreasing. This means the cost of one more unit is equal to the cost of total cost / output.
Term
 Economies of Scale
Definition
 Firm doubles output for less than 2x cost
Term
 Diseconomies of Scale
Definition
 2x output requires more than 2x cost
Term
 Monopoly (basic definition)
Definition
 Domination of the market by a single firm
Term
 Oligopoly
Definition
 Domination of the market by a few firmsCharacteristics:-Products may or may not be differentiated- Few firms account for most of production- Some or all firms earn substantial profits over the long run because barriers to entry make it difficult or impossible for new firms to enterAutomobiles, Steel, Aluminum, Petrochemicals, Electrical Equipment, Computers
Term
 Monopolistic Competition
Definition
 A form of imperfect competition in which numerous firms offer imperfect substitutes for one another. In the short term, firms may behave like monopolies, but in the long run, more firms enter the market and elasticity of demand increases. Characteristics: Free Entry and Exit, Differentiated Products that may be imperfectly substituted for one another
Term
 Perfect Competition:
Definition
 Enough perfect substitutes that all firms are “price takers”
Term
 What is the profit maximizing rule?
Definition
 Set marginal revenue = marginal costorSet Price = Marginal Cost
Term
 3 Characteristics of Long Run Industry Equilibrium
Definition
 Firms are maximizing profitAll firms are earning zero economic profit, so that there is no incentive to enter or exit the industryQD is equal to QS
Term
 Constant Cost Industry
Definition
 Industry whose long-run supply curve is horizontal. In other words, the long-run supply curve for a constant-cost industry is a horizontal line at a price equal to the long-run minimum average cost of production.
Term
 Increasing Cost Industry
Definition
 Prices of all or some inputs to production increase as the industry expands and the demand for inputs grow. Long-run supply curve is upward sloping.
Term
 Decreasing Cost Industry
Definition
 Industry whose long-run supply curve is downward sloping. Larger industries and increases in demand cause firms to take advantage of their size and to obtain inputs more cheaply.
Term
 Two Functions of Price
Definition
 Allocative Function of Price: Price allocates the amount produced to the highest valued buyers. Coordinative Function of Price: The market price efficiently coordinates the productive use of resources.
Term
Definition
 Consumer Surplus: (Area between Market Demand and Market Price)Producer Surplus: (Area between market price and marginal cost) - Revenue - Total Variable Cost
Term
 Price Ceiling
Definition
 Sets a limit on high a price can rise (rent control). This causes a decrease in supply (shortage), increase in non-market rationing, decrease in quality, and an increase in transactions costs.
Term
 Price Floor
Definition
 Sets a limit on how low a price can go (minimum wage). Increase in quality (but not demand driven), continued surplus, increase in non-market discrimination, increase in transactions costs.
Term
 Excise Tax
Definition
 Tax on a specific good. Such a tax may raise the price of the commodity to the consumer and reduce the net price received by the producer. It generally will do both and reduce the amount marketed and purchased.
Term
 Sales Tax (elasticity)
Definition
 If the demand is highly elastic (that is, customers are able to switch), the supplier will be forced to lower selling prices considerably to continue on selling some of his/her products. Thus, if demand is elastic while supply is inelastic the burden of the tax is shifted almost in its entirety to the supplier.
Term
 Tax Burden (Elasticity Relationship)
Definition
 If demand is more inelastic then supply --> Buyers bare a larger portion of the burden.Is supply is more inelastic than demand --> sellers bare a larger portion of the burden.
Term
 Market Power
Definition
 Ability of a Firm to influence price in the market
Term
 Lerner Index
Definition
 Measure of Market Power in the firm[ Price – Marginal Cost / Price ]
Term
 Sources of Monopoly
Definition
 Natural MonopolyPatentsFirm actionsLegal harassmentExclusive licensingBundling
Term
 First Degree Price Discrimination
Definition
 Different prices for different buyers according to different Marginal Values
Term
 Second Degree Price Discrimination
Definition
 Lower prices for additional units of the good. All buyers see the same price schedule.
Term
 Third Degree Price Discrimination
Definition
 Different Prices to different Groups of buyers based on Different elasticity of demand.
Term
 Two Part Tariff Pricing
Definition
 2 part-pricing. Costco Membership, Amusement Park with entry fee and ride fees
Term
 Bundling
Definition
 Tying two products together
Term
 Tying
Definition
 More specific form of bundling (packaging an undesired good with a desired one)
Term
 Market Equilibrium
Definition
 Firms are doing the best they can and have no reason to change their output
Term
 Nash Equilibrium
Definition
 Firms are doing the best they can given what other firms are doing.
Term
 Cournot Model
Definition
 Model in which firms produce a homogeneous good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously how much to produce
Term
 Duopoly
Definition
 Domination of the Market by 2 firms
Term
 Reaction Curve
Definition
 The relationship between a firm's profit-maximizing output and the amount it believes another firm will produce
Term
 Cournot Equilibrium
Definition
 Each firm correctly assumes how much other firms will produce, and arranges output accordingly.
Term
 Relationships between Collusive Joint Output, Oligopoly Joint Output, and Competitive Joint Output
Definition
 Collusive Joint Output: When firms collude, and change their prices to the same price (one that will maximize both their profits) they are better off than they were previously --> Output is least, price is highest.Oligopoly Joint Output: Joint output is greater than the monopoly quantity but less than the competitive industry quantity.[Output is median, price is median.]Competitive Joint Output: Greatest Output at the lowest price
Term
Definition
 One firm must set its output first, and the other must base its decision on the one made by the completion. “Fait Accompli” – Regardless of what the second competitor does, the output of the first will be larger. The second competitor will not want to drive prices down by producing a large amount, and for that reason, the first competitor will make a great profit.
Term
 Bertrand Model [how is this different from the Cournot Model?]Potential for Profit?
Definition
 Oligopoly model in which firms produce a homogenous good, each firm treats the price of its competitors as fixed, and all firms decide simultaneously what price to change.Firms will set a price at the marginal cost – if the price is higher, each firm will undercut the other to gain a competitive advantage until P = MC.
Term
 Prisoner Dilemma Model
Definition
 a. Game theory example in which two prisoners must decide separately whether to confess to a crime; if a prisoner confesses, he will receive a lighter sentence and his accomplice will receive a heavier one, but if neither confesses, sentences will be lighter than if both confess. (Both will confess - their sentence is lighter with a confession regardless of what the other prisoner does)
Term
 Cooperative Strategy
Definition
 Game in which players can negotiate binding contracts that allow them to plan joint strategies.
Term
 Noncooperative Strategy
Definition
 Game in which negotiation and enforcement of binding contracts are not possible.
Term
 Payoff Matrix
Definition
 Table showing profit (or payoff) to each firm given its decision and the decision of its competitor.
Term
 Kinked Demand Model and Price Rigidity
Definition
 Price Rigidity: Firms tend not to want to move their price out of fear that other firms may not do the same, or of sending the wrong message to consumers.Leads to the Kinked Demand Model: each firm faces a demand curve kinked at the currently prevailing price: at higher prices, demand is very elastic whereas at lower prices it is inelastic.
Term
 Price Signaling
Definition
 A firm of implicit collusion, in which firms attempt to agree on what a price should be through different outlets (press conference, etc.)
Term
Definition
 If a pattern is established whereby one firm regularly announces price changes and other firms follow suit, this firm becomes the price leader and the price followers in the market will follow its pattern.
Term
 Dominant Firm
Definition
 Firm which dominates a large share of the market, and acts as the price setter for smaller firms. Smaller firms act as perfect competitors, taking the price as given and producing accordingly. The dominant firm will maximize its own profits by setting MR = MC
Term
 Cartel Pricing and Elasticity
Definition
 In order for a Cartel to effectively collude and raise prices, demand must be fairly inelastic, and the producers within the cartel must account the supply response of competitive (non cartel) producers when setting a price.
Term
 Game
Definition
 i. Situation in which players (participants) make strategic decisions that take into account each other’s actions and responses.
Term
 Strategy
Definition
 Rule or plan of action for playing the game
Term
 Payoff
Definition
 Value associated with a potential outcome
Term
 Optimal Strategy
Definition
 Strategy which maximizes a player's potential payoff
Term
 Dominant Strategy
Definition
 Strategy that is optimal regardless of what the opponent does (special case of nash equilibrium)
Term
 Maximin Strategy
Definition
 Strategy that maximizes the minimum gain that can be earned.
Term
 Pure Strategy
Definition
 Strategy in which a player decides on and goes with a specific course of action
Term
 Mixed Strategy
Definition
 Player makes a random choice among two or more options based on probabilities (mud wrestling vs. opera, pennies)
Term
 Repeated Games
Definition
 Infinite #: Tit-for-tat strategy (high pricing)Known #: Undercutting leads to charging lower price
Term
 Externalities
Definition
 Action by a consumer or producer that affects other consumers or producers but is not factored into the market price
Term
 Negative Externalities
Definition
 Action by a consumer or producer that has a negative effect on other consumers or producers without being factored into market price --> may lead to market inefficiency
Term
 Marginal Social Cost of Production
Definition
 Marginal Cost of Production + Marginal External Cost (Socially, this should be the level at which price is set)Negative Externalities cause the Marginal Social Cost of Production to be higher than the Marginal Cost of Production, and firms stay in the market even when it is not socially efficient.
Term
 Solutions to negative externalities
Definition
 Unless the firm has fixed proportions production technology (by which only lowering the amount of production will solve negative externalities) there are options to solving the problem.- Fees (more efficient than standards if firms do not have identical costs)- Standards- Permits- Tax on seller or buyer
Term
 Positive Externalities
Definition
 Consumers under-consume (socially) because they do not factor in the benefit to other parties (home repair example).Subsidies to buyers or sellers (potential solutions)
Term
 Coase Theorem
Definition
 If parties can bargain without cost and to mutual benefit, then outcome will be efficient regardless of who has the property rights.
Term
 Property Resources
Definition
 Resources to which anyone has free access (rival, but not excludable). Ie; fish in ocean
Term
 Public Good
Definition
 Non-rival and non-excludable--> arial fireworks, national defense
Term
 Non-Exclusive Good
Definition
 Good people cannot be prevented from using
Term
 Non-Rival Good
Definition
 Goods for which the marginal cost of their provision to an additional consumer is zero
Term
 Private Goods
Definition
 Excludable and rival in consumption
Term
 Natural Monopolies
Definition
 Excludable, but not rival
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