Key Terms

CHAPTER 1

 Scarcity - inability to satisfy all our wants. Hence, we make choices.

 Incentive - a reward that encourages an action or a penalty that discourages an action.
 Opportunity Cost - positive opportunities missed out on by choosing a particular alternative (the
next-best option). In other words, it’s what you don’t get to do when you make a choice.
Example: Going to a concert (the opportunity cost of that decision includes the money you spent
on the concert tickets as well as whatever you missed out on (i.e., enjoyment of socializing) by
not going to the party.)
 Margin - most choices are “how-much” choices.
 Marginal Benefit - The benefit from pursuing an incremental increase in an activity. It is the
maximum amount a consumer will pay for an additional good or service. It is also the additional
satisfaction that a consumer receives when the additional good or service is purchased.
 Marginal Cost - The opportunity cost of pursuing an incremental increase in an activity. It is the
added cost to produce an additional good.

APPENDIX

 Economists measure variables (quantities produced and prices).

 Scatter diagram - plots the value of one variable against the value of another variable for a
number of different values of each variable. Reveals whether a relationship exists between the
two variables. (Variable examples could be movies and its revenue)
- To know if relationship exist:
o If the points cluster in a band running from lower left to upper right, there is a
positive correlation (if x increases, y increases).
o If the points cluster in a band from upper left to lower right, there is a negative
correlation (if x increases, y decreases).
 Positive relationship or Direct relationship - relationship between two variables that move in
the same direction.
 Negative relationship or Inverse relationship - relationship between two variables that move in
opposite directions.
 Maximum and Minimum - relationships are positive over part of their range and negative over
the other part.
 Ceteris paribus means “if all other relevant things remain the same.” (when there are more than
three variables).

CHAPTER 2: THE ECONOMIC PROBLEM

 Production possibilities frontier (PPF) - shows all the different combinations of output that can
be produced given current resources and technology. We focus on two goods at a time and hold
the quantities of all other goods and services constant.
Example:
  Production efficiency – is achieve if we
cannot produce more of one good without
producing less of some other good.
o All points on the PPF are efficient.
o Any point inside the frontier, such as Z, is
inefficient.
o The opportunity cost of a pizza is the cola
forgone.

 Decreasing marginal benefit - The more we have of any good, the smaller is its marginal benefit and the less we are
willing to pay for an additional unit of it.
 Marginal benefit curve - shows the relationship between the marginal benefit of a good and the quantity of that good
consumed. (Think of this as a demand curve).
 Allocative efficiency - When we cannot produce more of any one good without giving up some other good that we value
more highly. (marginal benefit = marginal cost <intersects>).
o all goods and services are optimally distributed among buyers in an economy.
o occurs when consumer demand is completely met by supply.
o Example is in slide 24
 Comparative advantage – a person can perform the activity at a lower opportunity cost than anyone else.
 Absolute advantage - if that person is more productive than others.

CHAPTER 3: DEMAND AND SUPPLY

 Competitive market – a market that has many buyers and sellers so no single buyer or seller can influence the price.
 Money price - of a good is the amount of money needed to buy it.
 Relative price - of a good—the ratio of its money price to the money price of the next best alternative good— is its
opportunity cost.
Example:
if the price of a pound of apples is $2 and the price of a dozen eggs is $4, then the relative price of apples to a dozen
eggs is 1:2, or 0.50. It can be said that apples are 50%, or half, as expensive as eggs.
 Quantity demanded - is the amount that consumers plan to buy during a particular time period, and at a particular price.
 Substitution Effect - when the relative price (opportunity cost) of a good or service rises, people seek substitutes for it,
so the quantity demanded of the good or service decreases.
 Income Effect - when the price of a good or service rises relative to income, people cannot afford all the things they
previously bought, so the quantity demanded of the good or service decreases.
 A demand curve - shows the relationship between the quantity demanded of a good and its price when all other
influences on consumers’ planned purchases remain the same.
 Change in demand - The quantity of the good that people plan to buy changes at each and every price, so there is a new
demand curve. There are six factors that influence it (slide 12).
o When demand increases, the demand curve shifts rightward.
o When demand decreases, the demand curve shifts leftward.
 Substitute - a good that can be used in place of another good.
 Complement - a good that is used in conjunction with another good.
 Normal good - is one for which demand increases as income increases. If demand decreases, it is called inferior good.
 Quantity supplied - the amount that producers plan to sell during a given time period at a particular price.
 Supply curve - shows the relationship between the quantity supplied of a good and its price when all other influences on
producers’ planned sales remain the same.
 Change in Supply - quantity of the good that producers plan to sell changes at each and every price, so there is a new supply
curve. There are six factors that influence it. (Slide 28).
o When supply increases, the supply curve shifts rightward.
o When supply decreases, the supply curve shifts leftward, equilibrium price rises and the equilibrium quantity decreases.
 Equilibrium price - the price at which the quantity demanded equals the quantity supplied.
o At prices above the equilibrium price, a surplus forces the price down.
o At prices below the equilibrium price, a shortage forces the price up.
 Equilibrium quantity - is the quantity bought and sold at the equilibrium price.

CHAPTER 4: ELASTICITY

 price elasticity of demand - used to describe the scenario where the change in demand is sensitive to a small change in price.
For example, if we see a large change in the price of Lays chips, consumers are more likely to shift to a different brand, driving
the demand down and vice versa.
 absolute value - that reveals how responsive the quantity change has been to a price change. (Demand can be inelastic, unit
elastic, or elastic)
 perfectly inelastic demand - If the quantity demanded doesn’t change when the price changes, the price elasticity of demand is
zero. (The demand curve is vertical).
 unit elastic demand - If the percentage change in the quantity demanded equals the percentage change in price. Price elasticity
of demand equals 1. (demand curve with ever declining slope).
 inelastic demand - percentage change in the quantity demanded is smaller than the percentage change in price. (price elasticity
of demand is less than 1). Example: Gas or Necessities
 elastic demand - percentage change in the quantity demanded is greater than the percentage change in price. (price elasticity of
demand is greater than 1).
 perfectly elastic demand - If the percentage change in the quantity demanded is infinitely large when the price barely changes.
Price elasticity of demand is infinite. (horizontal demand curve.)
 total revenue test - a method of estimating the price elasticity of demand by observing the change in total revenue that results
from a price change (when all other influences on the quantity sold remain the same).
o If a price cut increases total revenue, demand is elastic.
o If a price cut decreases total revenue, demand is inelastic.
o If a price cut leaves total revenue unchanged, demand is unit elastic.
 income elasticity of demand - measures how the quantity demanded of a good responds to a change in income, other things
remaining the same.
 cross elasticity of demand - a measure of the responsiveness of demand for a good to a change in the price of a substitute or a
complement, other things remaining the same.
 elasticity of supply - measures the responsiveness of the quantity supplied to a change in the price of a good, when all other
influences on selling plans remain the same.

*** glossary of all the elasticity measures is in slide 41***

 CHAPTER 5: EFFICIENCY AND EQUITY
 Scarce resources - when the demand for a resource is greater than the supply of that resource, as resources are limited.
 A demand curve is a marginal benefit curve.
 individual demand. - relationship between the price of a good and the quantity demanded by one person.
 market demand - relationship between the price of a good and the quantity demanded by all buyers.
 market demand curve - is the horizontal sum of the individual demand curves.
 Consumer surplus - is the excess of the benefit received from a good over the amount paid for it. (Slide 21).
 A supply curve is a marginal cost curve.
 individual supply - relationship between the price of a good and the quantity supplied by one producer.
 market supply - relationship between the price of a good and the quantity supplied by all producers.
 market supply curve - is the horizontal sum of the individual supply curves.
 Producer surplus - excess of the amount received from the sale of a good over the cost of producing it.
 When production is …
o less than the equilibrium quantity, MSB > MSC.
o greater than the equilibrium quantity, MSC > MSB.
o equal to the equilibrium quantity, MSC = MSB. (Resources are used efficiently)
 total surplus - the sum of consumer surplus and producer surplus.
 Market failure - arises when a market delivers an inefficient outcome. ( due to underproduction and overproduction = dead
weight loss for both)
 deadweight loss - equals the decrease in total surplus—the gray triangle. (social loss)

***Sources of market failure is in slide 41***

CHAPTER 6: GOVERNMENT ACTIONS IN MARKETS

 price ceiling or price cap - is a regulation that makes it illegal to charge a price higher than a specified level.
 rent ceiling - price ceiling is applied to a housing market.
 If the rent ceiling is set above the equilibrium rent, it has no effect. The market works as if there were no ceiling.
 rent ceiling set below the equilibrium rent creates a housing shortage, Increased search activity, An illicit market. ( leads
to an inefficient underproduction of housing services).
 blocks voluntary exchange, it does not generally benefit the poor, decreases the quantity of housing
 price floor - a regulation that makes it illegal to trade at a price lower than a specified level.
 minimum wage - price floor is applied to labour markets.
o If the minimum wage is set below the equilibrium wage rate, it has no effect. The market works as if there were no
minimum wage.
o If the minimum wage is set above the equilibrium wage rate, it has powerful effects. (the quantity of labour supplied by
workers exceeds the quantity demanded by employers = surplus of labour and unemployment occurs)
 Tax incidence - is the division of the burden of a tax between buyers and sellers.
o If the market price rises by the full amount of the tax, buyers pay the tax.
o If the market price rises by a lesser amount than the tax, buyers and sellers share the burden of the tax.
o If the market price doesn’t rise at all, sellers pay the tax.
 Perfectly inelastic demand: the buyer pays the entire tax. The demand curve is vertical. (Slide 38 – graph example)
 Perfectly elastic demand: the seller pays the entire tax. The demand curve is horizontal.
 Perfectly inelastic supply: the seller pays the entire tax.the supply curve is vertical.
  Perfectly elastic supply: the buyer pays the entire tax. the supply curve is horizontal.
 benefits principle - is the proposition that people should pay taxes equal to the benefits they receive from the services provided
by government.
 ability-to-pay principle - is the proposition that people should pay taxes according to how easily they can bear the burden of the
tax. (Rich and the poor example)
 production quota - is an upper limit to the quantity of a good that may be produced during a specified period.
 Subsidy - is a payment made by the government to a producer.

CHAPTER 7: GLOBAL MARKETS IN ACTION

 Imports are the good and services that we buy from people in other countries.
 Exports are the goods and services we sell to people in other countries.
 comparative advantage - force that generates trade. (Example: Two countries have comparative advantage in producing good
a.nd both can reap gains from each other, hence, trade occurs).
 National comparative advantage is the ability of a nation to perform an activity or produce a good or service at a lower
opportunity cost than any other nation.
 International trade lowers the price of an imported good and raises the price of an exported good.
 Tariff - a tax on a good that is imposed by the importing country when an imported good crosses its international boundary.
(There is a change in total surplus – importer will gain, and consumers lose = decrease in consumer surplus).
 import quota - is a restriction that limits the maximum quantity of a good that may be imported in a given period.
 export subsidy - is a payment made by the government to a domestic producer of an exported good.

CHAPTER 10: OUTPUT AND COST

 A firm’s goal is to maximize profit.

 opportunity cost of production - value of the best alternative use of the resources that a firm uses in production.
 implicit rental rate of capital - firm’s opportunity cost of using the capital it owns.
 short run - is a time frame in which the quantity of one or more resources used in production is fixed.
 long run - is a time frame in which the quantities of all resources—including the plant size—can be varied.
 sunk cost - is a cost incurred by the firm and cannot be changed.
 Total product - is the total output produced in a given period.
 marginal product of labour - is the change in total product that results from a one-unit increase in the quantity of labour
employed, with all other inputs remaining the same.
 average product of labour - is equal to the total product divided by the quantity of labour employed.
 Product curves - show how the firm’s total product, marginal product, and average product change as the firm varies the
quantity of labour employed.
 Increasing Marginal Returns
o Initially, the marginal product of a worker exceeds the marginal product of the previous worker.
o The firm experiences increasing marginal returns.
 Diminishing Marginal Returns
o Eventually, the marginal product of a worker is less than the marginal product of the previous worker.
o The firm experiences diminishing marginal returns.
 Marginal cost (MC) - is the increase in total cost that results from a one-unit increase in total product.
 Economies of scale are features of a firm’s technology that lead to falling long-run average cost as output increases.
 Diseconomies of scale are features of a firm’s technology that lead to rising long-run average cost as output increases.
 Constant returns to scale are features of a firm’s technology that lead to constant long-run average cost as output increases.
(straight linear line in graph outside curve – check homework)
 Minimum efficient scale is the smallest quantity of output at which the long-run average cost reaches its lowest level.

CHAPTER 11: PERFECT COMPETITION

 Perfect competition is a market in which

o Many firms sell identical products to many buyers.
o There are no restrictions to entry into the industry.
o Established firms have no advantages over new ones.
o Sellers and buyers are well informed about prices
 price taker is a firm that cannot influence the price of a good or service. it must “take” the equilibrium market price.
 marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold. (curve is horizontal)
 MR = MC (maximized profit output) – graph in slide 16
o If MR > MC, economic profit increases if output increases.
o If MR < MC, economic profit decreases if output increases.
o If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized.
 shutdown point - is the price and quantity at which it is indifferent between producing the profit-maximizing quantity and
shutting down.
 firm’s supply curve - shows how the firm’s profit-maximizing output varies as the market price varies, with other things
remaining the same.
 short-run market supply curve- shows the quantity supplied by all firms in the market at each price when each firm’s plant and
the number of firms remain the same
 To see if a firm is making a profit or incurring a loss compare the firm’s ATC at the profit-maximizing output with the market
price. (slide 33)
o In part (a) price equals average total cost and the firm makes zero economic profit (breaks even).
o In part (b), price exceeds average total cost and the firm makes a positive economic profit.
o In part (c) price is less than average total cost and the firm incurs an economic loss—economic profit is negative.
 In short-run equilibrium, a firm might make an economic profit, break even, or incur an economic loss.
 In long-run equilibrium, firms break even because firms can enter or exit the market.
 Equilibrium occurs where the quantity demanded equals the quantity supplied.

CHAPTER 12: MONOPOLY

 monopoly is a market:
o That produces a good or service for which no close substitute exists
o In which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.
 natural monopoly is a market in which economies of scale enable one firm to supply the entire market at the lowest possible
cost.
 legal monopoly is a market in which competition and entry are restricted by the granting of a Public franchise, Government
license, Patent or copyright.
 single-price monopoly is a firm that must sell each unit of its output for the same price to all its customers. (marginal revenue is
less than price at each level of output) and (marginal revenue is related to the elasticity of demand for the good – slide 17).
 Price discrimination is the practice of selling different units of a good or service for different prices. Many firms price
discriminate, but not all of them are monopoly firms.
 MR = MC. (monopoly sets its price at the highest level at which it can sell the profit-maximizing quantity)
 Compared to perfect competition, monopoly produces a smaller output and charges a higher price.
 economic rent - Any surplus—consumer surplus, producer surplus, or economic profit.
 Rent seeking is the pursuit of wealth by capturing economic rent. (buying or creating monopoly).
 Perfect price discrimination occurs if a firm is able to sell each unit of output for the highest price someone is willing to pay.
(MR = P).
 Social interest theory is that the political and regulatory process relentlessly seeks out inefficiency and regulates to eliminate
deadweight loss.
 Capture theory is that regulation serves the self-interest of the producer, who captures the regulator and maximizes economic
profit.
 Marginal cost pricing rule is a regulation that sets the price equal to the monopoly’s marginal cost.

CHAPTER 13: MONOPOLISTIC COMPETITION

 Monopolistic competition is a market structure in which

o A large number of firms compete.
o Each firm produces a differentiated product.
o Firms compete on product quality, price, and marketing.
o Firms are free to enter and exit the industry. (firms cannot make an economic profit in the long run.)
o It makes an economic profit when P > ATC.
o P < ATC and the firm incurs an economic loss.
o P = ATC and each firm earns zero economic profit.
 The four-firm concentration ratio is the percentage of the total revenue accounted for by the four largest firms in an industry.
 Herfindahl-Hirschman Index (HHI) is the square of the percentage market share of each firm summed over the largest 50 firms
(or all firms if there are fewer than 50).
o A market in which the HHI is between 1,500 and 2,500 is regarded as being competitive—monopolistic competition.
o A market in which the HHI exceeds 2,500 is regarded as being concentrated and uncompetitive.
 markup - is the amount by which its price exceeds its marginal cost.

CHAPTER 14: OLIGOPOLY

 Oligopoly is a market structure in which
o Natural or legal barriers prevent the entry of new firms.
o A small number of firms compete.
 duopoly—a market with two firms that compete.
 Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions.
 Temptation to Cooperate: Firms in oligopoly face the temptation to form a cartel.
 cartel is a group of firms acting together to limit output, raise prices, and increase profit. Cartels are illegal. (Are in a collusive
agreement)
 Game theory is a tool for studying strategic behavior, which is behavior that takes into account the expected behavior of others
and the mutual recognition of interdependence.
