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Three fundamental economic questions
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What is produced?
How is it produced?
For whom is it produced?
How is it produced?
For whom is it produced?
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Market-orientated economy
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An economy where most decisions are made by buyers and sellers
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Command economy
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An economy where the government either makes or strongly influences how economic decisions are made
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Division of labor
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The way in which the work required to produce a good or service is divided into tasks performed by different workers
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Specialization
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When workers focus on particular tasks in the overall production process for which they are well suited
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Three categories of economic resources
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Land, Labor, Capital
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Budget constraint
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Model used to illustrate individual choice in a situation of scarcity
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Utility
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The amount of satisfaction or pleasure people receive from their choices. Measured in utils
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Simple interest
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The quick method of calculating the interest charged on a loan
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Compound interest
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Interest that is calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan
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Opportunity Cost
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Whatever must be given up to obtain what is desired
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Marginal analysis
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Comparing the costs and benefits of choosing a little more or a little less
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Law of diminishing returns
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As a person consumes more of a good, the marginal utility from each additional unit is smaller than from the previous unit
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Sunk cost
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Costs that were incurred in the past, can not be recovered and thus should not affect current decisions
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Individuals are _________ maximizers
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Utility
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Firms exist to maximize _________
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Profits
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Profit formula
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Profit = Total Revenue - Total Cost
and
Profit = (Price x Quantity sold) - (Average cost x Quantity produced)
and
Profit = (Price x Quantity sold) - (Average cost x Quantity produced)
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Total Revenue formula
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Total Revenue = Price x Quantity Sold
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Total Cost formula
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Total Cost = Average Cost x Quantity produced
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Productive efficiency
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When it is impossible to produce more of one good without decreasing the quantity produced of another. Occurs at any point on the PPF. Occurs when average cost is minimized
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Allocative efficiency
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When the mix of goods produced represents the allocation that society most desires. Occurs at one point on the PPF. Occurs when price meets marginal cost
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Substitution effect
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When there is a utility maximizing incentive to consume more of a relatively lower priced good and less of the higher priced good
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Income effect
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A change in the demand of a good or service, induced by a change in the consumer's income
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What stops us from having everything we desire?
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Scarcity
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What is a consequence of the division of labor?
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A greater number of goods and services offered in an economy
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Why has globalization become so prevalent in the past half century?
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Transportation and communication have become much cheaper than in the past
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Law of Demand
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As price rises, quantity demanded falls
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Law of Supply
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As price rises, quantity supplied rises
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Equilibrium
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Where quantity supplied meets quantity demanded
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Factors that cause the demand curve to shift
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1. Change in income
2. Change in the composition of the population
3. Change in taste
4. Change in expectations of future conditions and prices
5. Change in the price of related goods
2. Change in the composition of the population
3. Change in taste
4. Change in expectations of future conditions and prices
5. Change in the price of related goods
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Factors that cause the supply curve to shift
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1. Change in natural conditions
2. Change in the price of a key input production
3. Discovery of new technology
4. Change in government policies
2. Change in the price of a key input production
3. Discovery of new technology
4. Change in government policies
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Normal good
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As income increases, demand increases
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Inferior good
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As income increases, demand decreases
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Price Ceiling
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Maximum price allowed by law. May cause shortages
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Price Floor
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Minimum price allowed by law. May cause surpluses
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Consumer surplus
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The benefit consumers receive from buying a good or service. The area below the demand curve, but above market price
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Producer surplus
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The benefit producers receive from selling a good or service. The area above the supply curve, but below the market price
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Social Surplus
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Social surplus = Consumer surplus + producer surplus
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Deadweight loss
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The loss in social surplus due to the market producing an inefficient quantity. When the market is not at equilibrium
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Price elasticity of demand
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How much a percentage change in price leads to a percentage change quantity demanded
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Elastic
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Any change in price leads to a greater magnitude change in quantity demanded. From 1 to infinity
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Inelastic
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Any change in price leads to a smaller magnitude change in quantity demanded. From 0 to 1
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Unitary elastic
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PED = 1, total revenue is maximized
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Perfectly elastic
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PED = infinity
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Perfectly inelastic
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PED = 0
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As price increases, price elasticity of demand....
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Increases
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As the price of a good increases in an elastic price range, what will happen to total revenue?
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Total revenue will decrease
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Labor Market
Supply:
Demand:
Supply:
Demand:
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Supply: Individuals
Demand: Firms
Demand: Firms
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Financial Capital Market
Supply:
Demand:
Supply:
Demand:
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Supply: Savers/Lenders/Investors
Demand: Borrowers
Demand: Borrowers
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Shifts in Labor Demand
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1. Change in the quantity of the product being produced
2. Change in how the output is produced
3. Change in technology
4. Government Regulation
2. Change in how the output is produced
3. Change in technology
4. Government Regulation
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Shifts in Labor Supply
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1. How the job is perceived by workers relative to other choices, regardless of pay
2. Government policies affecting the number of workers trained
2. Government policies affecting the number of workers trained
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Shifts in Financial Capital Supply
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1. Anything that makes people want to alter existing levels of present and future consumption
2. Change in comparable rates of return
3. Change in comparable risk
2. Change in comparable rates of return
3. Change in comparable risk
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Shift in Financial Capital of Demand
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1. Change in confidence of the ability to repay
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Venture capital
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Financial investments in new companies that are still relatively small in size, but have the potential to grow substantially
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Bonds
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A financial contract through which a borrower agrees to repay the amount that was borrowed and also a rate of interest over time. Must pay interest rate on time, but keep ownership
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Stocks
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Claim on a partial ownership of a firm. You don't have to pay interest, but you lose ownership
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Three factors investors consider before supplying financial captial
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Liquidity, rate, return
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Dividends
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A direct payment from a firm to its shareholders
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Liquidity
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How easy it is to convert to cash
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Fundamental trading
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Buying or selling stocks based on estimates of the future expected profits of a firm
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Momentum trading
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Buying or selling stocks by following current trend. Buying when the price seem to be rising
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Absolute advantage
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When one nation can produce a product at a lower resource cost relative to another nation
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Comparative advantage
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When one nation can produce a product at a lower opportunity cost relative to another nation. It is impossible for one country to have advantage in both goods
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Protectionism
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Government policies to reduce or block imports. It benefits domestic producers and harms domestic consumers
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Tariff
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Tax imposed on imports
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Quotas
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Numerical limitations on imports
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Total Cost
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Total cost = Fixed Cost + Variable Cost
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Fixed cost
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Expenditures that must be made before production starts and do not change regardless of the level of production
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Variable cost
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Costs of production that increase with the quantity produced. Slope curves rapidly due to diminishing marginal returns
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Average cost
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Total cost / Quantity. Tells us whether or not we are making a profit while factoring out fixed cost.
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Average variable cost
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Variable cost / Quantity. Shows us the shut down point
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Average fixed cost
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Fixed cost / Quantity
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Marginal cost
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Change in Total Cost / Change in Quantity. Shows us whether any unit of output is adding to or taking away from profit
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Perfect Competition
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Near infinite number of firms
Massive competition
Each firm sells identical products
Productive and allocative efficient long run
Don't have control of the price
Massive competition
Each firm sells identical products
Productive and allocative efficient long run
Don't have control of the price
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Profit maximizing point
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Marginal revenue = marginal cost
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Shutdown point
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Price = Average variable cost
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Zero profit point
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Price = Average cost. Should be expected in long run
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In the short run _______ costs can be adjusted
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some
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In the long run _____ costs can be adjusted
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all
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Barriers to entry
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The legal forces that may discourage or prevent potential competitors from entering a market
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Monopoly
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-Long run profit
- One firm
-High barriers to entry
- One firm
-High barriers to entry
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Monopolistic Competition
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-Many firms selling a differentiated product
-Distinguishable from other in some way
-Low barriers of entry
-Long run zero profit
-Distinguishable from other in some way
-Low barriers of entry
-Long run zero profit
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Oligopoly
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-Few firms
-A majority of sales within a market are held by a small number of firms
-Long run profit
-Collusion
-Not productive or allocative
-A majority of sales within a market are held by a small number of firms
-Long run profit
-Collusion
-Not productive or allocative
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Collusion
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When firms act together to reduce output and raise prices
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Four firm concentration ratio
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Calculated by adding the market shares of the four largest firms
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Herfindahl - Hirshman Index
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Take the market share of each firm, square them, and add them together
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Nationalization
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When government takes ownership of a firm
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Privatization
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When government owned firms become privately owned
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Externality
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The impact of a market exchange on a third party who is outside or "external" to the exchange
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Positive externality
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Third parties benefits at no cost to them. Exists when social benefits are greater than private benefits
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Negative externality
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Third party incurs costs at no benefit to them. Example pollution. Exists when social costs are greater than private costs
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Market failure
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A situation in which the market on its own fails to allocate resources efficiently in a way that balances social costs and benefits
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Command and control regulation
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Laws that specify allowable quantities of pollution and may also detail which pollution control technologies must be used
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Natural monopoly
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When one firm would be more efficient producing a good or service than multiple firms
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Public good
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A good that is nonexcludable and nonrivalrous and thus difficult for producers to sell to consumers
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Nonexcludable
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When it is costly or impossible to keep someone from using the good
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Nonrivalrous
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When one person uses the good, others can also use it
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Free rider
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Someone who wants others to pay for a public good but then plan to use it anyway
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Imperfect information
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A situation where either the buyer, the seller, or both, are uncertain about the qualities of what is being bought/sold
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The Lemon
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As a buyer, you can not be sure that what you're buying is of good value
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Moral hazard
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When people have insurance against a certain event, they are less likely to guard against that event
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Adverse selection problem
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The problem that arises when one party has more information than the other party. As a result the party with less information feels that they are at a disadvantage
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Special interest politics
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Small but organized group that can exert a disproportionate effect on political outcomes
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Pork barreling
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Spending that benefits mainly a single political district
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Logrolling
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When a group of legislators all agree to vote for a package of otherwise unrelated laws that they individually favor
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Voting cycle
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Occurs with three or more choice in which no choice has a majority