Term
| Elements in the Construction of Economic Theory |
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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). |
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Definition
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Definition
| Point where quantity supplied exceeds quantity demanded, causing prices to fall |
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Definition
| Exists when quantity demanded = quantity supplied. Also called the market clearing price. |
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Definition
| Total Revenue - Total Cost |
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Definition
| Anything an individual wants more of at zero price |
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Definition
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Term
| 2 Basic Assumptions of Scarcity |
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Definition
| Goods are limited, and man has unlimited wants |
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Definition
| amount of currency in circulation plus the amount of checkable deposits |
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Term
| Review Indifference Curves and the Income Expansion Path |
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Definition
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Term
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Definition
| 1. Economic Cost: The monetary cost of doing something in addition to the value of the next highest valued alternative (Accounting + Opportunity) |
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Definition
| Good for which demand falls when income rises |
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Term
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Definition
| Firms purchase resources from households in exchange for income |
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Term
| Diminishing Marginal Value |
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Definition
| The more you have of any one good, the less the marginal value of that good. |
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Definition
| Studying the change from one additional unit - looking at the world in terms of degrees and realizing nothing is absolute |
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Term
| Price Elasticity of Demand (Definition and Formula) |
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Definition
A measure of the responsiveness of the quantity demanded by buyers to a change in price
Formula: ( ∆ Q / Q1) / (∆ P / P1) * will usually be a negative number |
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Definition
| Describes what should or ought to be and involves value judgments |
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Definition
| For a sufficient rise in price, individuals will tend to purchase less |
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Definition
| Households buy goods and services from firms in exchange for $ |
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Definition
| All other conditions held stable |
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Term
| Transactions Costs of Exchange |
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Definition
| Information Cost (Search Cost & Quality Identification Cost), Negotiating Cost, Transportation Cost |
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Term
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Definition
| The maximum amount of $ an individual will give up to acquire one more unit of a good |
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Term
| What determines price in the market? |
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Definition
| Demand. In other words, how much consumers are able and willing to pay. Relative prices coordinate production and consumption decisions. |
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Term
| Competition naturally moves prices toward _______________ |
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Definition
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Term
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Definition
| Supply is a schedule of the alternative quantities which suppliers are willing and able to sell at alternative prices |
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Definition
| Good for which demand falls when the price of another good increases |
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Definition
| Anything that could be used to produce a resource: Land, Labor, Capital |
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Definition
| The science of analyzing how individuals behave in a world of scarcity |
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Term
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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). |
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Term
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Definition
| % Change in QD / % Change in Price = 1 |
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Definition
| The interaction of buyers and sellers |
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Term
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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) |
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Term
| Laspeyre's Price Index (Formula and Problems with this index) |
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Definition
CPI --> Formula: (Pc X Qb) / (Pb X Qb) X 100
C = current year
B = 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. |
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Term
| 6 Postulates of Human Behavior |
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Definition
1. Scarcity
2. Unique Marginal Value
3. Unlimited Wants
4. Rationality
5. Diminishing MRS
6. Everyone will give up some amount of a good if offered enough of another |
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Term
| What do households maximize? |
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Definition
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Term
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Definition
| Describes what is or will be, and is testable. |
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Definition
| Goods offered at zero cost |
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Term
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Definition
| Schedule of the alternative quantities that individuals will purchase at certain prices |
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Term
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Definition
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Term
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Definition
1. Alternative Outputs
2. Technology
3. Cost of inputs
4. Number of Sellers (Market Supply) |
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Term
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Definition
| Point where demand exceeds supply, causing prices to rise. |
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Term
| Paashe Price Index (formula and problems) |
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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. |
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Term
| Price Elasticity of Demand (Definition and Formula) |
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Definition
A measure of the responsiveness of the quantity demanded by buyers to a change in price
Formula: ( ∆ Q / Q1) / (∆ P / P1) * will usually be a negative number |
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Term
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Definition
| Violence, Social-Political (Qualities/Characteristics), Market / Economic (Goods allocated to those who offer highest value in exchange) |
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Definition
| Good for which demand increases when the price of another good increases |
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Term
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Definition
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Term
| Transactions Costs of Exchange |
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Definition
| Information Cost (Search Cost & Quality Identification Cost), Negotiating Cost, Transportation Cost |
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Term
| Price Elasticity of Supply |
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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 |
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Term
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Definition
| Good for which demand rises when income rises |
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Term
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Definition
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Term
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Definition
| % Change in QD / % Change in Price < 1 (Increase in Price --> Increase in Revenue) |
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Term
| Characteristics of the Indifference Curve |
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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. |
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Term
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Definition
| List with specific quantities of one or more goods. |
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Term
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Definition
| % QD / % Price > 1 (Decrease in Price leads to increase in revenue) |
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Term
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Definition
Income Elasticity: Percentage change in the quantity demanded resulting from a 1% increase in income.
( ∆ Q / Q) / (∆ I / I) |
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Term
| What is the budget constraint? Purpose? Change in income? Prices? |
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Definition
Limits how much can be spent – limits the expansion of the indifference curve
The 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 |
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Term
| Determinants of Price Elasticity |
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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. |
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Term
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Definition
| Demand is more elastic in the long run |
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Term
| Four Determinants of Demand |
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Definition
Taste and Preference, Income (Normal Goods, Inferior Goods), Prices (Substitutes and Compliments), Future Expectations
Market Demand: Add number of buyers |
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Term
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Definition
| Tendency of individuals in a team to slack off in the hopes of other members carrying their weight |
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Term
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Definition
| Hiring an individual to oversee a team to prevent shirking (ideally, owner) |
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Term
| Alternative Periods of Analysis |
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Definition
Short Term: One input (capital) fixed, labor flexible
Long Run: No inputs fixed
Market Period: All inputs fixed, vertical supply |
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Term
| Law of diminishing marginal returns: |
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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 |
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Term
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Definition
| Outlay of $ (Accounting Cost) |
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Term
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Definition
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Term
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Definition
| Fixed cost divided by total output --> decreases as total output increases |
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Term
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Definition
| Variable Cost divided by total output |
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Term
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Definition
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Term
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Definition
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Term
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Definition
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Term
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Definition
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Term
| Where does average total cost = marginal total cost? |
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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. |
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Term
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Definition
| Firm doubles output for less than 2x cost |
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Term
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Definition
| 2x output requires more than 2x cost |
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Term
| Monopoly (basic definition) |
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Definition
| Domination of the market by a single firm |
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Term
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Definition
Domination of the market by a few firms
Characteristics:
-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 enter
Automobiles, Steel, Aluminum, Petrochemicals, Electrical Equipment, Computers |
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Term
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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 |
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Term
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Definition
| Enough perfect substitutes that all firms are “price takers” |
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Term
| What is the profit maximizing rule? |
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Definition
Set marginal revenue = marginal cost
or
Set Price = Marginal Cost |
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Term
| 3 Characteristics of Long Run Industry Equilibrium |
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Definition
Firms are maximizing profit
All firms are earning zero economic profit, so that there is no incentive to enter or exit the industry
QD is equal to QS |
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Term
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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. |
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Term
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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. |
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Term
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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. |
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Term
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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. |
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Term
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Definition
Consumer Surplus: (Area between Market Demand and Market Price)
Producer Surplus: (Area between market price and marginal cost) - Revenue - Total Variable Cost |
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Term
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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. |
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Term
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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. |
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Term
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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. |
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Term
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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. |
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Term
| Tax Burden (Elasticity Relationship) |
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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. |
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Term
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Definition
| Ability of a Firm to influence price in the market |
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Term
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Definition
Measure of Market Power in the firm
[ Price – Marginal Cost / Price ] |
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Term
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Definition
Natural Monopoly
Patents
Firm actions
Legal harassment
Exclusive licensing
Bundling |
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Term
| First Degree Price Discrimination |
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Definition
| Different prices for different buyers according to different Marginal Values |
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Term
| Second Degree Price Discrimination |
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Definition
| Lower prices for additional units of the good. All buyers see the same price schedule. |
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Term
| Third Degree Price Discrimination |
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Definition
| Different Prices to different Groups of buyers based on Different elasticity of demand. |
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Term
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Definition
| 2 part-pricing. Costco Membership, Amusement Park with entry fee and ride fees |
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Term
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Definition
| Tying two products together |
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Term
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Definition
| More specific form of bundling (packaging an undesired good with a desired one) |
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Term
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Definition
| Firms are doing the best they can and have no reason to change their output |
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Term
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Definition
| Firms are doing the best they can given what other firms are doing. |
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Term
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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 |
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Term
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Definition
| Domination of the Market by 2 firms |
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Term
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Definition
| The relationship between a firm's profit-maximizing output and the amount it believes another firm will produce |
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Term
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Definition
| Each firm correctly assumes how much other firms will produce, and arranges output accordingly. |
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Term
| Relationships between Collusive Joint Output, Oligopoly Joint Output, and Competitive Joint Output |
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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 |
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Term
| Stackelberg First Mover Advantage |
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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. |
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Term
Bertrand Model [how is this different from the Cournot Model?]
Potential for Profit? |
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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. |
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Term
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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) |
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Definition
| Game in which players can negotiate binding contracts that allow them to plan joint strategies. |
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Term
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Definition
| Game in which negotiation and enforcement of binding contracts are not possible. |
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Term
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Definition
| Table showing profit (or payoff) to each firm given its decision and the decision of its competitor. |
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Term
| Kinked Demand Model and Price Rigidity |
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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. |
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Term
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Definition
| A firm of implicit collusion, in which firms attempt to agree on what a price should be through different outlets (press conference, etc.) |
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Term
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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. |
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Term
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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 |
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Term
| Cartel Pricing and Elasticity |
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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. |
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Term
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Definition
| i. Situation in which players (participants) make strategic decisions that take into account each other’s actions and responses. |
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Term
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Definition
| Rule or plan of action for playing the game |
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Term
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Definition
| Value associated with a potential outcome |
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Term
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Definition
| Strategy which maximizes a player's potential payoff |
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Term
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Definition
| Strategy that is optimal regardless of what the opponent does (special case of nash equilibrium) |
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Term
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Definition
| Strategy that maximizes the minimum gain that can be earned. |
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Term
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Definition
| Strategy in which a player decides on and goes with a specific course of action |
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Term
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Definition
| Player makes a random choice among two or more options based on probabilities (mud wrestling vs. opera, pennies) |
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Term
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Definition
Infinite #: Tit-for-tat strategy (high pricing)
Known #: Undercutting leads to charging lower price |
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Term
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Definition
| Action by a consumer or producer that affects other consumers or producers but is not factored into the market price |
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Term
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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 |
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Term
| Marginal Social Cost of Production |
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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. |
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Term
| Solutions to negative externalities |
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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 |
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Term
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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) |
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Term
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Definition
| If parties can bargain without cost and to mutual benefit, then outcome will be efficient regardless of who has the property rights. |
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Term
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Definition
| Resources to which anyone has free access (rival, but not excludable). Ie; fish in ocean |
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Term
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Definition
| Non-rival and non-excludable--> arial fireworks, national defense |
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Term
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Definition
| Good people cannot be prevented from using |
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Term
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Definition
| Goods for which the marginal cost of their provision to an additional consumer is zero |
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Term
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Definition
| Excludable and rival in consumption |
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Term
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Definition
| Excludable, but not rival |
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