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Market equilibrium
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supply = demand
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Supply depends on
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production technology, cost of input, market price
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Demand depends on
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consumer tastes, price and availability of other products, consumer income
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budget is used to
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buy consumer goods, save, enjoy leisure
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preference
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decides 'amount of' happiness (utility) a consumer derives from a bundle of goods.
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Completeness
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the consumer either has a preference for bundle A or bundle B, or is indifferent
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Transitivity
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If a>b and b>c, then a>c
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Utility
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usefulness
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Properties of indifference curves
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1. Indifference curves never cross
2. The farther out an indifference curve lies, the higher the level of total utility it indicates
3. Indifference curves slope downward
4. Indifference curves have a convex shape
2. The farther out an indifference curve lies, the higher the level of total utility it indicates
3. Indifference curves slope downward
4. Indifference curves have a convex shape
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Marginal Rate of Substitution (MRS)
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the rate at which a consumer would be willing to trade off one good for another. So, reducing the amount of go o d X can (often) b e compensated by increasing the amount of go o d Y (without affecting utility). MRS is the derivative of the indifference curve.
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utility function
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formula that assigns a level of utility to individual market baskets
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marginal utility
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the extra usefulness or satisfaction a person gets from acquiring or using one more unit of a product
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limited budget
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constraint on the amount of consumption.
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opportunity set
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all possible combinations of consumption that someone can afford given the prices of goods and the individual's income
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concave indifference curve
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indifference curve
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a curve that shows consumption bundles that give the consumer the same level of satisfaction
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Lagrange multiplier method
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demand curve
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a curve that shows the relationship between the price of a product and the quantity of the product demanded
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price elasticity of demand
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a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price
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giffen goods
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goods that are exceptions to the law of demand where at very low prices, with consumers on low incomes and dependent upon the good for survival, as price rises, then so does demand
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cross price elasticity
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the percentage change in demand for product A that occurs in response to a percentage change in price of product B
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substitute goods
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Products or services that can be used in place of each other. When the price of one falls, the demand for the other product falls; conversely, when the price of one product rises, the demand for the other product rises.
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Complement goods
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Two or more goods that tend to be used together. If two goods are complements, an increase in the price of one will lead to a decrease in the demand of the other.
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engel curve
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a curve that shows the relationship between the quantity of a good consumed and a consumer's income
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Income Elasticity
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sensitivity of demand for a product relative to changes in income
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normal goods
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Goods for which demand goes up when income is higher and for which demand goes down when income is lower.
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inferior goods
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Goods for which demand tends to fall when income rises.
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neutral goods
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a good for which the demand remains unchanged as income rises or falls
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probability distribution
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list of possible outcomes with associated probabilities
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expected value
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the average of each possible outcome of a future event, weighted by its probability of occurring
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uncertainty
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consumers are risk avers
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variance
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the square of the standard deviation
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standard deviation
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the square root of the variance
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risk
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The chance of loss from an event that cannot be entirely controlled
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risk averse
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Reluctant to take any kind of risk.
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risk neutral
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condition of being indifferent between a certain income and an uncertain income with the same expected value
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risk seeking
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having a high willingness to take on situations with risk
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risk premium
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The maximum price a risk-averse person will pay to avoid taking a risk
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fair insurance
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insurance for which the premium is equal to the expected value of the loss
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asymmetric information
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a situation in which one party to an economic transaction has less information than the other party
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moral hazard
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Arises when people behave recklessly because they know they will be saved if things go wrong
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adverse selection
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the problem of incomplete information - of choosing alternatives without fully knowing the details of available options
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divisible goods
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can be bought in any quantity desired
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indivisible goods
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goods that cannot be divided in their consumption
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Revenue Equivalence Theorem
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under certain assumptions, the four auction types are expected to raise the same revenues
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Winner's Curse
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the plight of the winning bidder who overestimates an asset's true value
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signaling
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an action taken by an informed party to reveal private information to an uninformed party
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behavorial economics
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the study of situations in which people make choices that do not appear to be economically rational
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Consumer Theory
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the study of how people decide what to spend their money on given their preferences and their budget constraints
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producer theory
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all producers want to maximize profits, specialization and division of labor leads to increasing marginal product
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profit
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total revenue minus total cost
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Input to production
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capital and labor
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short-run production function
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shows the output produced with a given amount of employment when capital and technology are fixed
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law of diminishing marginal returns
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As more of a variable resource is added to a given amount of a fixed resource, marginal product eventually declines and could become negative
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marginal product of labor
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the change in output from hiring one additional unit of labor
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long-run production function
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A production function showing the relationship between a flow of inputs and the resulting flow of output, where all inputs are variable
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isoquant
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curve showing all possible combinations of inputs that yield the same output
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straight isoquants
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substitutable
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curved isoquant
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complementary
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return to scale
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the relationship between changes in the scale of production and the corresponding change in the amount of output
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increasing returns to scale
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when output increases more than in proportion to an increase in all inputs
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decreasing returns to scale
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when output increases less than in proportion to an increase in all inputs
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constant returns to scale
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the situation in which a firm's long-run average costs remain unchanged as it increases output
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neutral technological change
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A firm can produce more output using the same ratio of inputs
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Non-neutral technological change
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results from innovations that alter the proportions in which inputs are used
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capital-saving technological change
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fewer machines are needed to produce the same output
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labor-saving technological change
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fewer workers are needed to produce the same output
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cost minimization problem
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the problem of finding the input combination that minimizes a firm's total cost of producing a particular level of output
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tangency rule
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pick the bundle of inputs where the desired isoquant is tangent to the budget line
MRTS = -w/r
MRTS = -w/r
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explicit costs
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The actual payments a firm makes to its factors of production and other suppliers.
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implicit costs
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Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur
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sunken cost
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a cost that has already been incurred and cannot be recovered
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total cost
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fixed costs plus variable costs (FC + VC)
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law of demand
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consumers buy more of a good when its price decreases and less when its price increases
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giffen good
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a good for which an increase in the price raises the quantity demanded
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invisible hand
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term economists use to describe the self-regulating nature of the marketplace
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market equilibrium
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a situation in which quantity demanded equals quantity supplied
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scarce resources
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The amount of resources available is limited
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welfare economics
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the study of how the allocation of resources affects economic well-being
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consumer surplus
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the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it
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pareto efficiency
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describes an allocation in which the only way to make any individual or group of individuals better off would require making at least one other person worse off
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barriers to entry
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factors that make it difficult and costly for an organization to enter a particular task environment or industry
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Nash Equilibrium
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a situation in which economic actors interacting with one another each choose their best strategy given the strategies that all the other actors have chosen
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Nash-Cournot Equilibrium
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a set of quantities chosen by firms such that, holding the quantities of all other firms constant, no firm can obtain a higher profit by choosing a different quantity
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Betrand Equilibrium
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Firm sets prices rather than quantities. Each firm will lower price until price is equal to marginal cost.
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Completeness of preferences
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