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The study of how people, firms, and societies use their scarce productive resources to best satisfy their unlimited material wants.
Factors of production, 4 categories: labor, physical capital, land/natural resources, and entrepreneurial ability
Marginal Benefit (MB)
The additional benefit received from the consumption of the next unit of a good or service
Marginal Cost (MC)
The additional cost incurred from the consumption of the next unit of a good or a service
Law of Increasing Costs
The more of a good that is produced, the greater the opportunity cost of producing the next unit of that good
Exists if a producer can produce a good at lower opportunity cost than all other producers
When firms focus their resources on production of goods for which they have comparative advantage
Production of maximum output for a given level of technology and resources. All points on the PPF are productively efficient
Production of the combination of goods and services that provides the most net benefit to society. The optimal quantity of a good is achieved when the MB = MC of the next unit and only occurs at one point on the PPF
Occurs when an economy's production possibilities increase. This can be a result of more resources, better resources, or improvements in technology.
Market Economy (Capitalism)
An economic system based upon the fundamentals of private property, freedom, self-interest, and prices
Law of Demand
Holding all else equal, when the price of a good rises, consumers decrease their quantity demanded for that good
The number of units of any other good Y that must be sacrificed to acquire good X. Only relative prices matter
The change in quantity demanded resulting from a change in the price of one good relative to other goods
The change in quantity demanded that results from a change in the consumer's purchasing power (or real income)
Determinants of Demand
Consumer income, prices of substitute and complementary goods, consumer tastes and preferences, consumer speculation, and number of buyers in the market all influence demand
Two goods are consumer substitutes if they provide essentially the same utility to consumers
Two goods are consumer complements if they provide more utility when consumed together than when consumed separately
Law of Supply
Holding all else equal, when the price of a good rises, suppliers increase their quantity supplied for that good
Determinants of Supply
Costs of inputs, technology and productivity, taxes/subsidies, producer speculation, price of other goods that could be produced, and number of sellers all influence supply
Excess demand; a shortage exists at a market price when the quantity demanded exceeds the quantity supplied
Excess supply; exists at a market price when the quantity supplied exceeds the quantity demanded.
The difference between your willingness to pay and the price you actually pay. It is the area below the demand curve and above the price
The difference between the price received and the marginal cost of producing the good. It is the area above the supply curve and under the price
Determinants of elasticity
Substitutes, cost as percentage of income, and time to adjust to price changes all influence price elasticity
Total Revenue Test
Total revenue rises with a price increase if demand is price inelastic and falls with a price increase if demand is price elastic
Cross-Price Elasticity of Demand
Ex,y = (%dQd good X) / (%d Price Y). If Ex,y > 0, goods X and Y are substitutes. If Ex,y < 0, goods X and Y are complementary
A per unit tax on production results in a vertical shift in the supply curve by the amount of the tax
Incidence of Tax
The proportion of the tax paid by the consumers in the form of a higher price for the taxed good is greater if demand for the good is inelastic and supply is elastic
Dead Weight Loss
The lost net benefit to society caused by a movement away from the competitive market equilibrium
Has opposite effect of an excise tax, as it lowers the marginal cost of production, forcing the supply curve down
A legal minimum price below which the product cannot be sold. If a floor is installed at some level above the equilibrium price, it creates a permanent surplus
A legal maximum price above which the product cannot be sold. If a floor is installed at some level above the equilibrium price, it creates a permanent shortage
Law of Diminishing Marginal Utility
The marginal utility from consumption of more and more of that item falls over time
Constrained Utility Maximization
For one good, constrained by prices and income, a consumer stops consuming a good when the price paid for the next unit is equal to the marginal benefit received
Direct, purchased, out-of-pocket costs paid to resource suppliers provided by the entrepreneur
Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur
A period of time too short to change the size of the plant, but many other, more variable resources can be changed to meet demand
A period of time long enough to alter the plant size. New firms can enter the industry and existing firms can liquidate and exit
The mechanism for combining production resources, with existing technology, into finished goods and services
Production inputs that cannot be changed in the short run. Usually this is the plant size or capital
Production inputs that the firm can adjust in the short run to meet changes in demand for their output. Often this is labor and/or raw materials
Total Product of Labor (TPL)
The total quantity, or total output of a good produced at each quantity of labor employed
Marginal Product of Labor (MPL)
The change in total product resulting from a change in the labor input. MPL = dTPL/dL, or the slope of total product
Total Fixed Costs (TFC)
Costs that do not vary with changes in short-run output. They must be paid even when output is zero.
Total variable costs (TVC)
Costs that change with the level of output. If output is zero, so are TVCs.
Economies of Scale
The downward part of the LRAC curve where LRAC falls as plan size increases. This is the result of specialization, lower cost of inputs, or other efficiencies of larger scale.
Diseconomies of Scale
The upward part of the LRAC curve where LRAC rises as plant size increases. This is usually the result of the increased difficulty of managing larger firms, which results in lost efficiency and rising per unit costs.
Characterized by many small price-taking firms producing a standardized product in an industry in which there are no barriers to entry or exit
The output where AVC is minimized. If the price falls below this point, the firm chooses to shut down or produce zero units in the short run
Perfectly competitive long-run equilibrium
Occurs when there is no more incentive for firms to enter or exit. P=MR=MC=ATC and profit = 0
Another way of saying that firms are earning zero economic profits or a fair rate of return on invested resources
Constant cost industry
Entry (or exit) of firms does not shift the cost curves of firms in the industry
The least competitive market structure, characterized by a single producer, with no close substitutes, barriers to entry, and price making power
The case where economies of scale are so extensive that it is less costly for one firm to supply the entire range of demand
Monopoly long-run equilibrium
Pm > MR = MC, which is not allocatively efficient and dead weight loss exists. Pm > ATC, which is not productively efficient. Profit > 0 so consumer surplus is transferred to the monopolist as profit
The practice of selling essentially the same good to different groups of consumers at different prices
A market structure characterized by a few small firms producing a differentiated product with easy entry into the market
Monopolistic competition long-run equilibrium
Pmc < MR = MC and Pmc > minimum ATC so outcome is not efficient, but profit = 0.
The difference between the monopolistic competition output Qmc and the output at minimum ATC. Excess capacity is underused plant and equipment
A very diverse market structure characterized by a small number of interdependent large firms, producing a standardized or differentiated product in a market with a barrier to entry
Four-firm concentration ratio
A measure of industry market power. Sum the market share of the four largest firms and a ratio above 40% is a good indicator of oligopoly
Models where firms are competitive rivals seeking to gain at the expense of their rivals
A group of firms that agree not to compete with each other on the basis of price, production, or other competitive dimensions. Cartel members operate as a monopolist to maximize their joint profits
Marginal Revenue Product (MRP)
Measures the value of what the next unit of a resource (e.g., labor) brings to the firm. MRPL = MR x MPL. In a perfectly competitive product market, MRPL = P x MPL. In a monopoly product market, MR < P so MRPm < MRPc.
Marginal Resource Cost (MRC)
Measures the cost the firm incurs from using an additional unit of input. In a perfectly competitive labor market, MRC = Wage. In a monopsony labor market, the MRC > Wage
Profit Maximizing Resource Employment
The firm hires the profit maximizing amount of a resource at the point where MRP = MRC
Demand for Labor
Labor demand for the firm is MRPL curve. The labor demanded for the entire market DL = ∑MRPL of all firms
Demand for a resource like labor is derived from the demand for the goods produced by the resource
Determinants of Labor Demand
Product demand, productivity, prices of other resources, and complementary resources
The combination of labor and capital that minimizes total costs for a given production rate. Hire L and K so that MPL / PL = MPK / PK or MPL/MPK = PL/PK
Goods that are both rival and excludable. Only one person can consume the good at a time and consumers who do not pay for the good are excluded from consumption
Goods that are both nonrival and nonexcludable. One person's consumption does not prevent another from also consuming that good and if it is provided to some, it is necessarily provided to all, even if they do not pay for that good
In the case of a public good, some members of the community know that they can consume the public good while others provide for it. This results in a lack of private funding and forces the government to provide it
Additional benefits to society not captured by the market demand curve from the production of a good, result in a price that is too high and a market quantity that is too low. Resources are underallocated to the production of this good
Exists when the production of a good creates utility for third parties not directly involved in the consumption of production of the good
Additional costs to society not captured by the market supply curve from the production of a good, result in a price that is too low and a market quantity that is too high. Resources are overallocated to the production of this good
Exists when the production of a good imposes disutility upon third parties not directly involved in the consumption or production of the good
Marginal Productivity Theory
The philosophy that a citizen should receive a share of economic resources proportional to the marginal revenue product of his or her productivity
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