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Chapter 5 Notes- Demand: The benefit side of the market

-Law of demand: people do less of what they want to do as the cost of doing it rises
-utility- is the concept to represent the satisfaction people derive from their consumption
-utility maximization- people try to allocate their incomes so as to maximize their satisfaction
-Marginal Utility = change in utility/ change in consumption
-denotes the amount by which total utility changes when consumption changes by one
-law of diminishing marginal utility- tendency for marginal utility to decline as consumption
increases beyond some point
-rational spending rule- spending should be allocated across goods so that marginal utility per
dollar is the same for each good
-consumer surplus- economic surplus received by buyers
-real price- the dollar price of a good relative to the average dollar price of all other goods
-nominal price- the absolute price of a good in dollar terms
Chapter 6 Notes- Perfectly competitive supply: The cost side of the market

-profit- the total revenue a firm receives from the sale of its product minus all costs (explicit and
implicit) incurred in producing it
-Profit = Total Revenue- Total Cost
-Profit = Total Revenue- Variable Cost- Fixed Cost
-profit-maximizing firm – a firm whose primary goal is to maximize the amount of profit it earns
-perfectly competitive markets- markets in which individual firms have no influence over the
market prices of the products they sell
-perfectly competitive firms- can be described as price takers because their inability to influence
market price
-4 characteristics of markets that are perfectly competitive:
-all firms sell the same standardized product
-the market has many buyers and sellers, each of which buys or sells only a small fraction
of the total quantity exchanged.
-productive resources are mobile
-buyers and sellers are well informed
-imperfectly competitive firms- a firm that has at least some control over the market price of its
-factor of production- an input used in the production of a good or service
-a firm’s factor of production are employees and the machine(s)
-short run- a period of time sufficiently short that at least some of the firm’s factors of
production are fixed
-long run- a period of time of sufficient length that all the firm’s factors of production are
-law of diminishing returns-a property of the relationship between the amount of a good or
service produced and the amount of a variable factor required to
produce it; it says that when some factors of production are fixed,
increased production of the good eventually requires ever-larger
increases in the variable factor.
-fixed factor of production- an input whose quantity cannot be altered in the short run
-variable factor of production- an input whose quantity can be altered in the short run
-variable cost- the sum of all payments made to the firm’s variable factors of production
-total cost- the sum of all payments made to the firm’s fixed and variable factors of production
-marginal cost- as output changes from one level to another, the change in total cost divided by
the corresponding change in output
-short-run shutdown condition- Profit is less than the minimum value of AVC
-P<minimum value of AVC
-average total cost(ATC) – ATC= Total Cost(TC) / total output (Q)
-average variable cost(AVC) – AVC= variable cost (VC)/ total output(Q)
-maximum profit condition- price=marginal cost
Chapter 7 Notes-Efficiency and Exchange

-efficient(or Pareto efficient) – a situation is efficient if no change is possible that will help some
people without harming others
-deadweight loss- the reduction in total economic surplus that results from the adoption of a
Chapter 8 Notes-The quest for profit and the invisible hand

-three types of profit

-accounting profit= total revenue- explicit costs
-economic profit = total revenue – explicit costs – implicit costs
-normal profit = accounting profit-economic profit= implicit costs =
-the opportunity cost of the resources supplied by a firm’s owners
-explicit costs- the actual payments the firm makes to its factors of production and other
-implicit costs- the opportunity costs of all the resources supplied by the firm’s owners

the invisible hand theory

-Adam Smith’s theory that the actions of independent, self-interested buyers and sellers will
often result in the most efficient allocation of resources
-2 functions of price
-rationing function of price- to distribute scarce goods among potential claimants,
ensuring that those who get them are the ones who value
them most
-allocative function of price- to direct productive resources to different sectors of the
-barrier to entry- any force that prevents firms from entering a new market
-economic rent- that part of the payment for a factor of production that exceeds the owner’s
reservation price

-present value of a perpetual annual payment

-for an annual interest rate r, the present value (PV) of a perpetual annual payment (M) is
the amount that would have to be deposited today at that interest rate to generate annual
interest earnings of M: PV = M/r
-time value of money – the fact that a given dollar amount today is equivalent to a larger dollar

amount in the future because the money can be invested in an

interest-bearing account in the meantime
-efficient markets hypothesis- the theory that the current price of stock in a corporation reflects
all relevant information about its current and future earnings prospects