Microeconomics Final Exam: Cumulative Study Guide

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economics

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the social science that studies the production, distribution, and consumption of goods and services

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market economy

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production and consumption are the result of decentralized decisions by many firms and individuals

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invisible hand

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a term coined by Adam Smith to describe the self-regulating nature of the marketplace; refers to the way a market economy manages to harness the power of self-interest for the good of society

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microeconomics

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the study of how individuals make decisions and how these decisions interact

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market failure

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when the individual pursuit of self-interest, instead of promoting society's interest as a whole, makes society worse off

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macroeconomics

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the study of the overall ups and downs of the economy; can explain recessions and how government policies can minimize the damage of these fluctuations

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economic growth

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the ability of the economy to increase the production of goods and services

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individual choice

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decisions individuals make about what to do/not to do

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resource

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anything that can be used to produce something else; scarce

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scarcity

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when there is not enough of the resource available to satisfy all the ways a society wants to use it; reason why people must make choices

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opportunity cost

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what you must give up in order to get what you want in the end; every choice means foregoing another; all costs; sometimes money/not money

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trade-off

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a comparison of costs and benefits

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marginal decision

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whether to do a bit more or a bit less of an activity

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marginal analysis

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the study of marginal decisions

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incentive

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opportunity to make one's self better off; can change behavior

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interaction

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my choices affect your choices and vice versa

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trade

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people divide tasks among themselves and each person provides a good or service that other people want in return for different goods and services the other has

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gains from trade

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by dividing tasks and trading, two or more people can each get more of what they want than they could get by being self-sufficient

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specialization

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different people engage in different tasks, specializing/focusing on what they are good at

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equilibrium

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situation in which individuals can't make themselves better off by doing something different

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efficient economy

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takes all opportunities to make some people better off without making other people worse off

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equity

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issues of fairness; can conflict with efficiency

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model

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any simplified representation of reality that is used to better understand real-life situations

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other things equal assumption

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all other relevant factors remain unchanged

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production possibility frontier

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illustrates the trade-offs facing an economy that produces only two goods; shows the maximum quantity of one good that can be produced for any given quantity produced of the other; a simplified model of an economy; the point(s) of intersection of x any y represents efficiency

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factors of production

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resources used to produce goods and services; usually not used up in production

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technology

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the technical means for the production of goods and services

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comparative advantage

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when the opportunity cost of production of a good is lower for one group than it would be for another

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absolute advantage

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when one group won't benefit from trade because they are already better off on their own

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barter

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when one party directly trades a good or service for another good or service with another party

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circular flow diagram

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represents the transactions in an economy by two kinds of flows around a circle; physical things flow in one direction and money used to pay for these physical things flow in the opposite direction

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households

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an individual or group of people that share an income

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firms

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organizations that produce goods and services for sale

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markets for goods and services

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households buy the goods and services they want from firms and firms sell the goods and services households want

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factor markets

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firms buy resources needed to produce goods and services

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economy's income distribution

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how total income created in an economy is allocated between less-skilled workers and highly-skilled workers and owners of land and capital; determined by factor markets

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positive economics

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analysis that tries to answer questions about the way the world works; definite right and wrong answers; description

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normative economics

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analysis that involved saying how the world should work; prescription

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forecast

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a simple prediction of the future; involved in positive economics

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variable

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quantity that can take on more that one value

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competitive market

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a market in which there are many buyers and sellers of the same good or service, none of whom can influence the price at which the good or service is sold

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supply and demand model

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a model of how a competitive market works; includes five key elements: the demand curve, the supply curve, factors that shift supply and/or demand curves, the market equilibrium, the way the market equilibrium changes when the supply and/or demand curve shifts

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demand schedule

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a table showing how much of a good or service consumers will want to buy at different prices

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quantity demanded

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the actual amount consumers are willing to buy at some specific price

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demand curve

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a graphical representation of a demand schedule

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law of demand

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the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises

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shift of a demand curve

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shows the change in the quantity demanded of a good arising from a change in that good's price

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movements along the demand curve

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changes in the quantity demanded of a good arising from a change in that good's price

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5 principles that shift a demand curve

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1) changes in the price of related goods or services
2) changes in income
3) changes in tastes
4) changes in expectations
5) changes in the number of consumers

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substitues

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pairs of goods for which a rise in the price of one of the goods leads to an increase in the demand for the other good; similar in function

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complements

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two goods for which an increase in the price of one leads to a decrease in the demand for the other; usually consumes together

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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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individual demand curve

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shows the relationship between quantity demanded and price for an individual consumer

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quantity supplied

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the quantity that producers are willing and able to sell; usually depends on the price offered to them

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supply schedule

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shows how much of a good or service made available varies with money

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supply curve

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a graphical representation of a supply schedule

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shift of a supply curve

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movement of a supply curve based on the change in quantity supplied at any given price; like that of the demand curve; based on supple schedule

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movements along the supply curve

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changes in the quantity supplied arising from a change in price

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5 factors that shift the supply curve

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1) changes in input price
2) changes in the price of related goods or services
3) changes in technology
4) changes in expectations
5) changes in the number of producers

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input

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any good or service used to produce another good or service

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individual supply curve

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relationship between quantity supplied and price for an individual producer

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equilibrium price

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when the quantity bought and sold or supplied and demanded is equal; the market-clearing price; no shortages or surpluses

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market-clearing price

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the price that "clears" the market by ensuring every buyer is willing to pay at the price the sellers are willing to sell at and vice versa

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equilibrium quantity

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the quantity bought and sold at the equilibrium price

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surplus

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excess supply; if the price is above the equilibrium level, this will drive it back down

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shortage

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excess demand; opposite of surplus; if the price is below the equilibrium level, this will drive it back up

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willingness to pay

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the maximum amount that a buyer will pay for a good

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individual consumer surplus

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the net gain to an individual buyer from the purchase of a good; occurs when a person pays less than they were willing to pay

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total consumer surplus

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the sum of the individual consumer surpluses of all the buyers of a good in a market

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consumer surplus

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both individual and total consumer surplus

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seller's cost

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the lowest price at which a seller is willing to sell a good

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individual producer surplus

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the net gain to an individual seller from selling a good; equal to the difference between the price received and the seller's cost; how the supply curve is derived

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total producer surplus

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the sum of the individual producer surpluses of all the sellers of a good in a market

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producer surplus

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either individual or total producer surplus

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total surplus

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the sum of consumer surplus and producer surplus

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property rights

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a system in which valuable items in the economy have specific owners who can dispose of them as they choose

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economic signals

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any piece of information that helps people make better economic decisions

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price controls

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when the government intervenes to regulate prices; price ceiling or floor

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price ceiling

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upper limit imposed on the price of a good or service; rent control

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price floor

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lower limit set for the price of a good

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deadweight loss

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the lost surplus associated with the transactions that no longer occur due to market intervention

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inefficient allocation to consumers

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when people who want a good don't get it and those who don't want it get

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wasted resources

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when people expend money, effort, and time to cope with the shortages caused by a price ceiling

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inefficiently low quality

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sellers offer low quality goods at a low price even though buyers would prefer a higher quality at a higher price

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black markets

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illegal markets that arise when price ceilings are in place; occur when there is an incentive to perform illegal activities

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minimum wage

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the lower limit on the hourly wage rate of worker's labor

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4 inefficiencies caused by price ceilings

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1) deadweight loss
2) inefficient allocation to consumers
3) wasted resources
4) inefficiently low quality

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4 inefficiencies caused by price floors

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1) deadweight loss
2) inefficient allocation of sales among sellers
3) waste of resources
4) inefficiently high quality

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inefficient allocation of sales among sellers

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sellers who are willing to sell at the lowest price are unable to make sales while sales go to sellers who are only willing to sell at a higher price

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inefficiently high quality

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sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price

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quality controls/quotas

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when the government regulates the quantity of a good that can be bought and sold rather than the price at which it is transacted; the upper limit

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quota limit

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the total amount of the good that can be legally transacted under a quantity control

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licenses

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legal permits to conduct business; only those with this can legally supply good; way that government can limit quantity

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demand price

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the price at which consumers want to buy a given quantity

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supply price

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the price at which producers will supply a given quantity

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wedge

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occurs in every case where the supply of a good is restricted; between the demand price of a quantity transacted and the supply price of the same quantity

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quota rent

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the earnings that accrue to the license-holder from ownership of the right to sell the good, which is a valuable commodity; wedge

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price elasticity of demand

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the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve

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midpoint method

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(Q2-Q1)/[(Q2+Q1)/2] / (P2-P1)/[(P2+P1)/2]

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perfectly inelastic demand

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demand in which quantity demanded does not respond at all to a change in price; when there is 0 price elasticity of demand

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perfectly elastic demand

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the case where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity; the amount people will pay always changes

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total revenue

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the total value of sales of a good or service; price x quantity

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cross-price elasticity of demand

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the ratio of the percent change in the quantity demanded of one good to the percent change in the price of the other

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income elasticity of demand

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a measure of how much the quantity demanded of a good is affected by a change in consumers' income

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income elastic goods

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if the income elasticity of demand for that good is greater than 1

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income inelastic goods

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if the income elasticity of demand is positive but less than 1

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price elasticity of supply

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a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price; same as price elasticity of demand but with no possible negative numbers

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perfectly inelastic supply

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the price elasticity of supply equals zero

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perfectly elastic supply

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the price elasticity of supply is equal to infinity

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excise tax

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a tax charged on each unit of a good or service that is sold

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incidence of a tax

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who really bears the burden of the tax

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tax rate

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the amount of tax levied per unit of whatever is being taxed

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administrative costs

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the resources used by government to collect the tax, and by taxpayers to pay it, over and above the amount of the tax

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benefits principle

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those who benefit from public spending should bear the burden of the tax that pays for that spending

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ability-to-pay principle

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those who can best afford to pay the tax should pay the most

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lump-sum tax

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a tax that is the same for everyone, regardless of any actions people take

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tax base

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measure or value that determines how much tax an individual or firm pays

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tax structure

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specifies how the tax depends on the tax base

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income tax

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depends on the income of an individual or firm from wages and investments

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payroll tax

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depends on the earnings an employer pays to an employee

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sales tax

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depends on the value of a good sold

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profits tax

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depends on a firm's profits

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property tax

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depends on the value of property

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wealth tax

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depends on an individual's wealth

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proportional tax

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a flat tax; it does not change with respect to income or wealth

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progressive tax

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a tax that imposes a higher percentage rate of taxation on people with higher incomes

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regressive tax

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a tax for which the percentage of income paid in taxes decreases as income increases; opposite of a progressive tax

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marginal tax rate

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the percentage of an increase in income that is taxed away

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explicit cost

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a cost that requires an outlay of money

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implicit cost

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a cost that is measured by value of the benefits foregone

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accounting profit

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total revenue minus total explicit cost

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economic profit

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total revenue minus total cost, including both explicit and implicit costs

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capital

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the total value of assets of an individual or firm

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implicit costs of capital

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the income the owner of the capital could have earned if the capital had been employed in its next best alternative use

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principle of "either-or" decision making

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when faced with an "either-or" choice between two activities, choose the one with the positive economic profit

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marginal cost of producing a good or service

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the additional cost incurred by producing one more unit of that good or service; the change in total cost divide by the change in quantity

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increasing marginal cost

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each additional unit costs more to produce than the previous one

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marginal cost curve

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graphical representation of marginal costs

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constant marginal cost

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when the cost of producing an additional unit is the same as the cost of producing the previous unit

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decreasing marginal cost

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when each additional unit costs less to produce than the previous one

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marginal benefit of producing a good or service

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the additional benefit earned from producing one more unit of a good or service

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decreasing marginal benefit

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when each additional unit of the activity yields less benefit than the previous unit

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marginal benefit curve

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graphical representation of marginal benefit

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optimal quantity

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the quantity that generates the maximum possible total profit

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profit-maximizing principle of marginal analysis

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when making a profit-maximizing "how much" decision, the optimal quantity is the largest quantity at which marginal benefit is greater than or equal to marginal cost

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sunk costs

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costs that have already been incurred and are nonrecoverable; have no effect on the future; should not be involved in decision making

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rational

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choosing the available option that leads to the most preferable outcome

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bounded rationality

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making a choice that is close to but not exactly the one that leads to the highest possible pay off because the effort of finding the outcome with the best payoff is too costly

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risk aversion

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the willingness to sacrifice some economic payoff in order to avoid a potential loss

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irrational

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when people make choices that leave them worse off in therm of economics payoff and other considerations, like fairness, than if they had chosen another available option

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6 (typical) causes of irrationality

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1) misperceptions of opportunity cost
2) overconfidence
3) unrealistic expectations about future behavior
4) mental accounting
5) loss aversion
6) status quo bias

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mental accounting

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the habit of mentally assigning dollars to different accounts so that some dollars are worth more than others

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loss aversion

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oversensitivity to loss, leading to unwillingness to recognize a loss and move on

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status quo bias

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the tendency to avoid making a decision altogether

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utility

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the idea that all people are trying to maximize some personal measure of satisfaction gained from consumption of goods and services

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consumption bundle

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the set of all goods and services and individual consumes

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utility function

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the relationship between an individual's consumption bundle and the total amount of utility it generates for that individual

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utils

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a hypothetical unit of measurement used to quantify utility

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marginal utility

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the change in total utility generated by consuming one additional unit of that good or service

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marginal utility curve

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shows marginal utility

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principle of diminishing marginal utility

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an additional amount of satisfaction a consumer gets from 1 or more unit of a good or service declines as the amount of that good or service consumed rises

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budget constraint

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a consumer must choose a consumption bundle that costs no more than their income

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consumption possibilities

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the set of all consumption bundles that are affordable based on a consumer's budget constraints

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budget line

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a downward-sloping line that shows budget constraints

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optimal consumption bundle

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the consumption bundle that maximizes the consumer's total utility given their budget constraint

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marginal utility per dollar

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how much additional utility a consumer gets from spending an additional dollar on either good

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utility-maximizing principle of marginal analysis

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when a consumer maximizes utility in the face of a budget constraint, the marginal utility per dollar spent on each good or service in the consumption bundle is the same; MUr/Pr = MUc/Pc

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substitution effect

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the change in quantity consumed of a good as a consumer substitutes other goods now that are relatively cheaper in place of the good that has become relatively more expensive

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income effect of a price change

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the change in the quantity consumed of a good due to the effect that the change in overall purchasing power of a consumer due to the change in price of the good

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Giffen good

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a good that has an upward sloping demand curve; inferior good

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production function

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the quantity of output a firm produces depends on the quantity of inputs; the relationship between the quantity of inputs and outputs

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fixed input

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an input whose quantity is fixed for a period of time and cannot be varied

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variable input

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an input whose quantity the firm can vary at any time

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long run

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a long enough period of time elapsed in which inputs can be variable

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short run

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the time period in which at least one input is fixed; inputs can't vary

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total product curve

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curve that shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input

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marginal product of labor (MPL)

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the additional quantity of output using 1 more unit of labor; change in quantity divided by change in labor

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marginal product of input

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additional quantity of output produced by using one more unit of input

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diminishing returns to an input

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an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input; downward slope; diminishing returns to labor

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fixed cost (FC)

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cost that does not depend on the quantity of an output produced in the short run; overhead cost

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variable cost (VC)

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a cost that depends on the quantity of output produced

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total cost (TC)

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fixed costs plus variable costs

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total cost curve

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a curve that shows how total cost depends on the quantity of input; becomes steeper as more output is produced due to diminishing returns to a variable input

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average total cost/average cost

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total cost per unit of output

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U-shaped average total cost curve

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falls at low levels of output, then rises at higher levels

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average fixed cost (AFC)

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the fixed cost per unit of output; FC/quantity

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average variable cost (AVC)

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the variable cost per unit of output; VC/quantity

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minimum cost output

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the quantity of output that corresponds to the minimum average total cost

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long-run average total cost curve

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shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output

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increasing returns to scale

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economies of scale; when the long-run ATC declines as output increases; makes firms larger

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decreasing returns to scale

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dis-economies of scale; when the long-run ATC increases as output increases; tends to limit the size of a firm

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constant returns to scale

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when long-run ATC is constant as output increases; scale has no effect

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price-taking producers

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a producer whose actions have no effect on the market price of the good or service it sells

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price-taking consumers

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a consumer whose actions have no effect on the market price of the good or service they buy

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perfectly competitive market

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all market participants are price-takers

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perfectly competitive industry

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an industry in which producers are price-takers

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standardized product

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a product consumers regard as the same good even when it comes from different producers; commodity

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free entry and exit

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when there are no obstacles to entry into or exit from an industry; in perfectly competitive markets

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marginal revenue

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the additional revenue generated from the sale of an additional quantity of product

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optimal output rule

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profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced is equal to its marginal cost

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marginal revenue curve

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individual demand curve for output; individual firm faces horizontal, perfectly elastic demand curve for outputs

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break-even price

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The price at which economic profit is zero; price equals ATC

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shut-down price

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the price at which the firm ceases production in the short run

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short-run individual supply curve

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shows how an individual producer's profit-maximizing output quantity depends on the market price, taking fixed cost as given

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industry supply curve

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the relationship between the price of a good and the total output of the industry as a whole

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short-run industry supply curve

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shows the quantity that producers will supply at each price, taking the number of producers as given

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short-run market equilibrium

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when the quantity supplied equals the quantity demanded, taking the number of producers as given

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long-run market equilibrium

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when the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur

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long-run industry supply curve

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shows how the quantity supplied responds to the price once producers have had time to enter or exit the industry; often horizontal line

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monopolists

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sole suppliers of a good that has no close substitutes

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monopoly

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an industry controlled by a monopolist

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market power

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the ability of a monopolist to raise its price above the competitive level by reducing output

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anti-trust laws

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laws intended to prevent monopolies from emerging

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barriers to entry

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something that keeps other firms from going into the same business as a monopolistic firm

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5 principles of barriers to entry

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1) control of scare resource or input
2) increasing returns to scale
3) technological superiority
4) network externality
5) government-created barrier

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natural monopoly

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a monopoly created and sustained by increasing returns to scale

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patent

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gives the inventor the sole right to make, use, or sell the item for a period that in most countries lasts between 16-20 years

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answer

gives the creator of a literary or artistic work sole rights to profit from that work, usually for the period of that person's life plus 70 years

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public ownership

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the government establishes a public agency to provide the good and protect consumers interests

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price regulation

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limits the price that a monopolist is allowed to charge

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monopsony

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a market in which there is only one buyer but many sellers

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monopsonist

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a firm that is the sole buyer in a market

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single-price monopolist

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charges all consumers the same price

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price discrimination

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some monopolists that increase profits by charging different customers different prices for the same good

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perfect discrimination

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when the monopolist is able to capture the entire surplus as profit

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oligopoly

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an industry with only a small number of producers

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oligopolists

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individual firms in an oligopoly market

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imperfect competition

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firms that compete buy also posses market power; oligopoly and monopolistic competition

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duopoly

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the simplest form of oligopoly in which the industry has only 2 producing firms

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duopolists

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firms in a duopoly

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collusion

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companies that cooperate to raise joint product

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cartel

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the strongest form of collusion; an arrangement between producers that determines how much each producer is allowed to produce

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noncooperative behavior

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each firm acting in its own self-interest

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interdependence

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each firm's decision significantly affects the profit of other firms

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game theory

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the study of how people behave in strategic situations; used to understand how oligopolists behave

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payoff

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the reward received by a player in a game

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payoff matrix

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a table that shows the payoffs that each firm earns from every combination of strategies by the firms

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Nash equilibrium

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when all players choose the best strategy they can, given the choices of all other players

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noncooperative equilibrium

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in game theory, the equilibrium that results when all players choose the action that maximizes their payoffs given the actions of other players, ignoring the effect of that action on the payoffs of other players; Nash equilibrium

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strategic behavior

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taking account of the effects of the action it chooses today on the future actions of other players in the game

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tit-for-tat

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a strategy for the repeated prisoner's dilemma in which players cooperate on the first move, then mimic their partner's last move on each successive move

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tacit collusion

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firms act as if they have a way of making an enforceable agreement to limit output and raise prices

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4 factors that limit firms ability to cooperate on high prices

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1) less concentration
2) complex products and price schemes
3) differences in interests
4) bargaining power of buyers

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product differentiation

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firms make considerable efforts to create the perception that their product is different from the other's

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price leadership

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a pattern of behavior in which one firm sets its price and other firms in the industry follow

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non-price competition

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adding new features to products and spending large sums of money on advertisement that proclaim inferiority of rival's products

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monopolistic competition

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a market with a large number of competing producers, differentiated products, and free entry and exit in the long run

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3 types of product differentiation

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1) by style/type
2) by location
3) by quality

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zero-profit equilibrium

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firms just manage to cover their costs at their profit-maximizing output quantities

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excess capacity

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the failure to produce enough to minimize ATC

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brand names

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names owned by particular companies that differentiate their products in the minds of consumers

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physical capital

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"capital"; manufactured resources

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human capital

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the improvement in labor created by the education and knowledge embodied in the workforce

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factor distribution of income

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how the total income of the economy is divided among labor, land, and capital

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value of the marginal product of labor (VMPL)

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the extra value of output generated by employing 1 more unit of labor; price x labor

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VMPL curve

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curve shown when the horizontal axis in the number of employees in a firm and the vertical axis is the VMPL and wage rate

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shifts in the VMPL curve

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1) change in the price of output
2) change in the supply of other factors
3) change in technology

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equilibrium VMPL

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the additional value produced by the last unit of labor employed in the labor market as a whole

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marginal productivity theory of income distribution

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each factor is the paid value of output generated by the last unit of the factor employed in the factor market as a whole; the equilibrium VMPL

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compensating differentials

answer

across different types of jobs, wages are often higher or lower depending on how attractive or unattractive the job is

question

efficiency-wage model

answer

theory stating that higher wages lead to greater productivity

question

factors other than wage that alter willingness to work

answer

1) change in preferences or social norms
2) change in population
3) change in opportunities
4) change in wealth

question

welfare state

answer

the collection of government programs designed to alleviate economic hardship

question

government transfers

answer

payments by the government to individuals and families that provide financial aid to the poor, assistance to the unemployed, guaranteed income for the old, and assistance in paying medical bills for those with large health care expenses

question

3 economic rationales for creating the welfare state

answer

1) alleviating income inequality
2) alleviating economic insecurity
3) reducing poverty and providing access to healthcare

question

poverty programs

answer

a government program designed to aid the poor

question

social insurance programs

answer

programs designed to provide protection against unpredictable financial distress

question

poverty threshold

answer

a minimum annual income that is considered adequate to purchase the necessities of life

question

median household income

answer

the income of the household lying in the middle of the income distribution

question

Gini coefficient

answer

a measure of income inequality within a population, ranging from zero for complete equality, to one if one person has all the income

question

means-tested programs

answer

benefits that are available only to families or individuals whose income falls below the minimum

question

in-kind benefits

answer

benefits given in the form of goods and services rather than money

question

negative income tax

answer

a program that supplements the income of low-income workers

question

private health insurance

answer

each member of a large pool of individuals pays a fixed amount annually (premium) to a private company that agrees to pay most of the medical expenses of the pool's members

question

single-payer system

answer

a health care system in which the government acts as the principal payer of medical bills funded through taxes

question

external cost

answer

an uncompensated cost that an individual or firm imposes on others

question

external benefit

answer

benefits that individuals or firms confer on others without receiving compensation

question

externalities

answer

external costs and benefits

question

negative externalities

answer

external costs

question

positive externalities

answer

external benefits

question

marginal social cost of pollution

answer

the additional cost imposed on society as a whole by an additional unit of pollution

question

marginal social benefit of pollution

answer

additional benefit to society from an additional unit of pollution

question

Coase theorem

answer

even in the presence of externalities, an economy can always reach an efficient solution as long as transaction costs are sufficiently low

question

transaction costs

answer

the cost of making a deal

question

internalize the externality

answer

when individuals take external costs or benefits into account when making a decision

question

how transaction costs prevent an efficient outcome

answer

1) high cost of communication
2) high cost of making a legally binding and timely agreement

question

environmental standards

answer

rules that protect the environment by specifying actions by producers and consumers

question

emissions tax

answer

charge made to firms that pollute the environment based on the quantity of pollution they create

question

Pigouvian taxes

answer

taxes designed to reduce external costs

question

technology spillover

answer

spreading of knowledge across individuals and firms

question

network externality

answer

when the value of a good or service increases as the number of other people who also use it increases

question

positive feedback

answer

bandwagon effect; if a large number of people use a product, more people are likely to use it; a type of network externality

question

excludable good

answer

suppliers of the good can prevent people who don't pay from consuming it

question

rival in consumption good

answer

the same unit of the good cannot be consumed by more than one person at the same time

question

private good

answer

a good that is both rival and excludable

question

non-excludable good

answer

the supplier cannot prevent consumption by people who do not pay for it

question

non-rival in consumption good

answer

1 or more person can consume the same unit of the good at the same time

question

public good

answer

goods that are non-excludable and non-rival in consumption

question

common resource

answer

goods that are rival in consumption but non-excludable

question

artificially scarce good

answer

goods that are excludable but non-rival in consumption

question

free-ride problem

answer

people who benefit from a good without paying for it, taking advantage of those who do pay

question

cost-benefit analysis

answer

a decision-making process in which you compare what you will sacrifice and gain by a specific action; comparing social benefits and costs of providing public goods

question

overuse

answer

when individuals ignore the fact that their use depletes the amount of the resource remaining for others

question

3 fundamental ways to induce people who use common resources to internalize the costs they impose on others

answer

1) tax or regulate the use of the common resource
2) create a system of tradable licenses for the right to use the common resource
3) make the common resource excludable and assign property rights to some individuals

1 of 305

question

economics

answer

the social science that studies the production, distribution, and consumption of goods and services

question

market economy

answer

production and consumption are the result of decentralized decisions by many firms and individuals

question

invisible hand

answer

a term coined by Adam Smith to describe the self-regulating nature of the marketplace; refers to the way a market economy manages to harness the power of self-interest for the good of society

question

microeconomics

answer

the study of how individuals make decisions and how these decisions interact

question

market failure

answer

when the individual pursuit of self-interest, instead of promoting society's interest as a whole, makes society worse off

question

macroeconomics

answer

the study of the overall ups and downs of the economy; can explain recessions and how government policies can minimize the damage of these fluctuations

question

economic growth

answer

the ability of the economy to increase the production of goods and services

question

individual choice

answer

decisions individuals make about what to do/not to do

question

resource

answer

anything that can be used to produce something else; scarce

question

scarcity

answer

when there is not enough of the resource available to satisfy all the ways a society wants to use it; reason why people must make choices

question

opportunity cost

answer

what you must give up in order to get what you want in the end; every choice means foregoing another; all costs; sometimes money/not money

question

trade-off

answer

a comparison of costs and benefits

question

marginal decision

answer

whether to do a bit more or a bit less of an activity

question

marginal analysis

answer

the study of marginal decisions

question

incentive

answer

opportunity to make one's self better off; can change behavior

question

interaction

answer

my choices affect your choices and vice versa

question

trade

answer

people divide tasks among themselves and each person provides a good or service that other people want in return for different goods and services the other has

question

gains from trade

answer

by dividing tasks and trading, two or more people can each get more of what they want than they could get by being self-sufficient

question

specialization

answer

different people engage in different tasks, specializing/focusing on what they are good at

question

equilibrium

answer

situation in which individuals can't make themselves better off by doing something different

question

efficient economy

answer

takes all opportunities to make some people better off without making other people worse off

question

equity

answer

issues of fairness; can conflict with efficiency

question

model

answer

any simplified representation of reality that is used to better understand real-life situations

question

other things equal assumption

answer

all other relevant factors remain unchanged

question

production possibility frontier

answer

question

factors of production

answer

resources used to produce goods and services; usually not used up in production

question

technology

answer

the technical means for the production of goods and services

question

comparative advantage

answer

when the opportunity cost of production of a good is lower for one group than it would be for another

question

absolute advantage

answer

when one group won't benefit from trade because they are already better off on their own

question

barter

answer

when one party directly trades a good or service for another good or service with another party

question

circular flow diagram

answer

represents the transactions in an economy by two kinds of flows around a circle; physical things flow in one direction and money used to pay for these physical things flow in the opposite direction

question

households

answer

an individual or group of people that share an income

question

firms

answer

organizations that produce goods and services for sale

question

markets for goods and services

answer

households buy the goods and services they want from firms and firms sell the goods and services households want

question

factor markets

answer

firms buy resources needed to produce goods and services

question

economy's income distribution

answer

how total income created in an economy is allocated between less-skilled workers and highly-skilled workers and owners of land and capital; determined by factor markets

question

positive economics

answer

analysis that tries to answer questions about the way the world works; definite right and wrong answers; description

question

normative economics

answer

analysis that involved saying how the world should work; prescription

question

forecast

answer

a simple prediction of the future; involved in positive economics

question

variable

answer

quantity that can take on more that one value

question

competitive market

answer

a market in which there are many buyers and sellers of the same good or service, none of whom can influence the price at which the good or service is sold

question

supply and demand model

answer

question

demand schedule

answer

a table showing how much of a good or service consumers will want to buy at different prices

question

quantity demanded

answer

the actual amount consumers are willing to buy at some specific price

question

demand curve

answer

a graphical representation of a demand schedule

question

law of demand

answer

the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises

question

shift of a demand curve

answer

shows the change in the quantity demanded of a good arising from a change in that good's price

question

movements along the demand curve

answer

changes in the quantity demanded of a good arising from a change in that good's price

question

5 principles that shift a demand curve

answer

1) changes in the price of related goods or services
2) changes in income
3) changes in tastes
4) changes in expectations
5) changes in the number of consumers

question

substitues

answer

pairs of goods for which a rise in the price of one of the goods leads to an increase in the demand for the other good; similar in function

question

complements

answer

two goods for which an increase in the price of one leads to a decrease in the demand for the other; usually consumes together

question

normal goods

answer

goods for which demand goes up when income is higher and for which demand goes down when income is lower

question

inferior goods

answer

goods for which demand tends to fall when income rises

question

individual demand curve

answer

shows the relationship between quantity demanded and price for an individual consumer

question

quantity supplied

answer

the quantity that producers are willing and able to sell; usually depends on the price offered to them

question

supply schedule

answer

shows how much of a good or service made available varies with money

question

supply curve

answer

a graphical representation of a supply schedule

question

shift of a supply curve

answer

movement of a supply curve based on the change in quantity supplied at any given price; like that of the demand curve; based on supple schedule

question

movements along the supply curve

answer

changes in the quantity supplied arising from a change in price

question

5 factors that shift the supply curve

answer

1) changes in input price
2) changes in the price of related goods or services
3) changes in technology
4) changes in expectations
5) changes in the number of producers

question

input

answer

any good or service used to produce another good or service

question

individual supply curve

answer

relationship between quantity supplied and price for an individual producer

question

equilibrium price

answer

when the quantity bought and sold or supplied and demanded is equal; the market-clearing price; no shortages or surpluses

question

market-clearing price

answer

the price that "clears" the market by ensuring every buyer is willing to pay at the price the sellers are willing to sell at and vice versa

question

equilibrium quantity

answer

the quantity bought and sold at the equilibrium price

question

surplus

answer

excess supply; if the price is above the equilibrium level, this will drive it back down

question

shortage

answer

excess demand; opposite of surplus; if the price is below the equilibrium level, this will drive it back up

question

willingness to pay

answer

the maximum amount that a buyer will pay for a good

question

individual consumer surplus

answer

the net gain to an individual buyer from the purchase of a good; occurs when a person pays less than they were willing to pay

question

total consumer surplus

answer

the sum of the individual consumer surpluses of all the buyers of a good in a market

question

consumer surplus

answer

both individual and total consumer surplus

question

seller's cost

answer

the lowest price at which a seller is willing to sell a good

question

individual producer surplus

answer

the net gain to an individual seller from selling a good; equal to the difference between the price received and the seller's cost; how the supply curve is derived

question

total producer surplus

answer

the sum of the individual producer surpluses of all the sellers of a good in a market

question

producer surplus

answer

either individual or total producer surplus

question

total surplus

answer

the sum of consumer surplus and producer surplus

question

property rights

answer

a system in which valuable items in the economy have specific owners who can dispose of them as they choose

question

economic signals

answer

any piece of information that helps people make better economic decisions

question

price controls

answer

when the government intervenes to regulate prices; price ceiling or floor

question

price ceiling

answer

upper limit imposed on the price of a good or service; rent control

question

price floor

answer

lower limit set for the price of a good

question

deadweight loss

answer

the lost surplus associated with the transactions that no longer occur due to market intervention

question

inefficient allocation to consumers

answer

when people who want a good don't get it and those who don't want it get

question

wasted resources

answer

when people expend money, effort, and time to cope with the shortages caused by a price ceiling

question

inefficiently low quality

answer

sellers offer low quality goods at a low price even though buyers would prefer a higher quality at a higher price

question

black markets

answer

illegal markets that arise when price ceilings are in place; occur when there is an incentive to perform illegal activities

question

minimum wage

answer

the lower limit on the hourly wage rate of worker's labor

question

4 inefficiencies caused by price ceilings

answer

1) deadweight loss
2) inefficient allocation to consumers
3) wasted resources
4) inefficiently low quality

question

4 inefficiencies caused by price floors

answer

1) deadweight loss
2) inefficient allocation of sales among sellers
3) waste of resources
4) inefficiently high quality

question

inefficient allocation of sales among sellers

answer

sellers who are willing to sell at the lowest price are unable to make sales while sales go to sellers who are only willing to sell at a higher price

question

inefficiently high quality

answer

sellers offer high-quality goods at a high price, even though buyers would prefer a lower quality at a lower price

question

quality controls/quotas

answer

when the government regulates the quantity of a good that can be bought and sold rather than the price at which it is transacted; the upper limit

question

quota limit

answer

the total amount of the good that can be legally transacted under a quantity control

question

licenses

answer

legal permits to conduct business; only those with this can legally supply good; way that government can limit quantity

question

demand price

answer

the price at which consumers want to buy a given quantity

question

supply price

answer

the price at which producers will supply a given quantity

question

wedge

answer

occurs in every case where the supply of a good is restricted; between the demand price of a quantity transacted and the supply price of the same quantity

question

quota rent

answer

the earnings that accrue to the license-holder from ownership of the right to sell the good, which is a valuable commodity; wedge

question

price elasticity of demand

answer

the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve

question

midpoint method

answer

(Q2-Q1)/[(Q2+Q1)/2] / (P2-P1)/[(P2+P1)/2]

question

perfectly inelastic demand

answer

demand in which quantity demanded does not respond at all to a change in price; when there is 0 price elasticity of demand

question

perfectly elastic demand

answer

the case where the quantity demanded is infinitely responsive to price and the price elasticity of demand equals infinity; the amount people will pay always changes

question

total revenue

answer

the total value of sales of a good or service; price x quantity

question

cross-price elasticity of demand

answer

the ratio of the percent change in the quantity demanded of one good to the percent change in the price of the other

question

income elasticity of demand

answer

a measure of how much the quantity demanded of a good is affected by a change in consumers' income

question

income elastic goods

answer

if the income elasticity of demand for that good is greater than 1

question

income inelastic goods

answer

if the income elasticity of demand is positive but less than 1

question

price elasticity of supply

answer

question

perfectly inelastic supply

answer

the price elasticity of supply equals zero

question

perfectly elastic supply

answer

the price elasticity of supply is equal to infinity

question

excise tax

answer

a tax charged on each unit of a good or service that is sold

question

incidence of a tax

answer

who really bears the burden of the tax

question

tax rate

answer

the amount of tax levied per unit of whatever is being taxed

question

administrative costs

answer

the resources used by government to collect the tax, and by taxpayers to pay it, over and above the amount of the tax

question

benefits principle

answer

those who benefit from public spending should bear the burden of the tax that pays for that spending

question

ability-to-pay principle

answer

those who can best afford to pay the tax should pay the most

question

lump-sum tax

answer

a tax that is the same for everyone, regardless of any actions people take

question

tax base

answer

measure or value that determines how much tax an individual or firm pays

question

tax structure

answer

specifies how the tax depends on the tax base

question

income tax

answer

depends on the income of an individual or firm from wages and investments

question

payroll tax

answer

depends on the earnings an employer pays to an employee

question

sales tax

answer

depends on the value of a good sold

question

profits tax

answer

depends on a firm's profits

question

property tax

answer

depends on the value of property

question

wealth tax

answer

depends on an individual's wealth

question

proportional tax

answer

a flat tax; it does not change with respect to income or wealth

question

progressive tax

answer

a tax that imposes a higher percentage rate of taxation on people with higher incomes

question

regressive tax

answer

a tax for which the percentage of income paid in taxes decreases as income increases; opposite of a progressive tax

question

marginal tax rate

answer

the percentage of an increase in income that is taxed away

question

explicit cost

answer

a cost that requires an outlay of money

question

implicit cost

answer

a cost that is measured by value of the benefits foregone

question

accounting profit

answer

total revenue minus total explicit cost

question

economic profit

answer

total revenue minus total cost, including both explicit and implicit costs

question

capital

answer

the total value of assets of an individual or firm

question

implicit costs of capital

answer

the income the owner of the capital could have earned if the capital had been employed in its next best alternative use

question

principle of "either-or" decision making

answer

when faced with an "either-or" choice between two activities, choose the one with the positive economic profit

question

marginal cost of producing a good or service

answer

the additional cost incurred by producing one more unit of that good or service; the change in total cost divide by the change in quantity

question

increasing marginal cost

answer

each additional unit costs more to produce than the previous one

question

marginal cost curve

answer

graphical representation of marginal costs

question

constant marginal cost

answer

when the cost of producing an additional unit is the same as the cost of producing the previous unit

question

decreasing marginal cost

answer

when each additional unit costs less to produce than the previous one

question

marginal benefit of producing a good or service

answer

the additional benefit earned from producing one more unit of a good or service

question

decreasing marginal benefit

answer

when each additional unit of the activity yields less benefit than the previous unit

question

marginal benefit curve

answer

graphical representation of marginal benefit

question

optimal quantity

answer

the quantity that generates the maximum possible total profit

question

profit-maximizing principle of marginal analysis

answer

when making a profit-maximizing "how much" decision, the optimal quantity is the largest quantity at which marginal benefit is greater than or equal to marginal cost

question

sunk costs

answer

costs that have already been incurred and are nonrecoverable; have no effect on the future; should not be involved in decision making

question

rational

answer

choosing the available option that leads to the most preferable outcome

question

bounded rationality

answer

making a choice that is close to but not exactly the one that leads to the highest possible pay off because the effort of finding the outcome with the best payoff is too costly

question

risk aversion

answer

the willingness to sacrifice some economic payoff in order to avoid a potential loss

question

irrational

answer

when people make choices that leave them worse off in therm of economics payoff and other considerations, like fairness, than if they had chosen another available option

question

6 (typical) causes of irrationality

answer

1) misperceptions of opportunity cost
2) overconfidence
3) unrealistic expectations about future behavior
4) mental accounting
5) loss aversion
6) status quo bias

question

mental accounting

answer

the habit of mentally assigning dollars to different accounts so that some dollars are worth more than others

question

loss aversion

answer

oversensitivity to loss, leading to unwillingness to recognize a loss and move on

question

status quo bias

answer

the tendency to avoid making a decision altogether

question

utility

answer

the idea that all people are trying to maximize some personal measure of satisfaction gained from consumption of goods and services

question

consumption bundle

answer

the set of all goods and services and individual consumes

question

utility function

answer

the relationship between an individual's consumption bundle and the total amount of utility it generates for that individual

question

utils

answer

a hypothetical unit of measurement used to quantify utility

question

marginal utility

answer

the change in total utility generated by consuming one additional unit of that good or service

question

marginal utility curve

answer

shows marginal utility

question

principle of diminishing marginal utility

answer

an additional amount of satisfaction a consumer gets from 1 or more unit of a good or service declines as the amount of that good or service consumed rises

question

budget constraint

answer

a consumer must choose a consumption bundle that costs no more than their income

question

consumption possibilities

answer

the set of all consumption bundles that are affordable based on a consumer's budget constraints

question

budget line

answer

a downward-sloping line that shows budget constraints

question

optimal consumption bundle

answer

the consumption bundle that maximizes the consumer's total utility given their budget constraint

question

marginal utility per dollar

answer

how much additional utility a consumer gets from spending an additional dollar on either good

question

utility-maximizing principle of marginal analysis

answer

when a consumer maximizes utility in the face of a budget constraint, the marginal utility per dollar spent on each good or service in the consumption bundle is the same; MUr/Pr = MUc/Pc

question

substitution effect

answer

the change in quantity consumed of a good as a consumer substitutes other goods now that are relatively cheaper in place of the good that has become relatively more expensive

question

income effect of a price change

answer

the change in the quantity consumed of a good due to the effect that the change in overall purchasing power of a consumer due to the change in price of the good

question

Giffen good

answer

a good that has an upward sloping demand curve; inferior good

question

production function

answer

the quantity of output a firm produces depends on the quantity of inputs; the relationship between the quantity of inputs and outputs

question

fixed input

answer

an input whose quantity is fixed for a period of time and cannot be varied

question

variable input

answer

an input whose quantity the firm can vary at any time

question

long run

answer

a long enough period of time elapsed in which inputs can be variable

question

short run

answer

the time period in which at least one input is fixed; inputs can't vary

question

total product curve

answer

curve that shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input

question

marginal product of labor (MPL)

answer

the additional quantity of output using 1 more unit of labor; change in quantity divided by change in labor

question

marginal product of input

answer

additional quantity of output produced by using one more unit of input

question

diminishing returns to an input

answer

an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input; downward slope; diminishing returns to labor

question

fixed cost (FC)

answer

cost that does not depend on the quantity of an output produced in the short run; overhead cost

question

variable cost (VC)

answer

a cost that depends on the quantity of output produced

question

total cost (TC)

answer

fixed costs plus variable costs

question

total cost curve

answer

a curve that shows how total cost depends on the quantity of input; becomes steeper as more output is produced due to diminishing returns to a variable input

question

average total cost/average cost

answer

total cost per unit of output

question

U-shaped average total cost curve

answer

falls at low levels of output, then rises at higher levels

question

average fixed cost (AFC)

answer

the fixed cost per unit of output; FC/quantity

question

average variable cost (AVC)

answer

the variable cost per unit of output; VC/quantity

question

minimum cost output

answer

the quantity of output that corresponds to the minimum average total cost

question

long-run average total cost curve

answer

shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output

question

increasing returns to scale

answer

economies of scale; when the long-run ATC declines as output increases; makes firms larger

question

decreasing returns to scale

answer

dis-economies of scale; when the long-run ATC increases as output increases; tends to limit the size of a firm

question

constant returns to scale

answer

when long-run ATC is constant as output increases; scale has no effect

question

price-taking producers

answer

a producer whose actions have no effect on the market price of the good or service it sells

question

price-taking consumers

answer

a consumer whose actions have no effect on the market price of the good or service they buy

question

perfectly competitive market

answer

all market participants are price-takers

question

perfectly competitive industry

answer

an industry in which producers are price-takers

question

standardized product

answer

a product consumers regard as the same good even when it comes from different producers; commodity

question

free entry and exit

answer

when there are no obstacles to entry into or exit from an industry; in perfectly competitive markets

question

marginal revenue

answer

the additional revenue generated from the sale of an additional quantity of product

question

optimal output rule

answer

profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced is equal to its marginal cost

question

marginal revenue curve

answer

individual demand curve for output; individual firm faces horizontal, perfectly elastic demand curve for outputs

question

break-even price

answer

The price at which economic profit is zero; price equals ATC

question

shut-down price

answer

the price at which the firm ceases production in the short run

question

short-run individual supply curve

answer

shows how an individual producer's profit-maximizing output quantity depends on the market price, taking fixed cost as given

question

industry supply curve

answer

the relationship between the price of a good and the total output of the industry as a whole

question

short-run industry supply curve

answer

shows the quantity that producers will supply at each price, taking the number of producers as given

question

short-run market equilibrium

answer

when the quantity supplied equals the quantity demanded, taking the number of producers as given

question

long-run market equilibrium

answer

when the quantity supplied equals the quantity demanded, given that sufficient time has elapsed for entry into and exit from the industry to occur

question

long-run industry supply curve

answer

shows how the quantity supplied responds to the price once producers have had time to enter or exit the industry; often horizontal line

question

monopolists

answer

sole suppliers of a good that has no close substitutes

question

monopoly

answer

an industry controlled by a monopolist

question

market power

answer

the ability of a monopolist to raise its price above the competitive level by reducing output

question

anti-trust laws

answer

laws intended to prevent monopolies from emerging

question

barriers to entry

answer

something that keeps other firms from going into the same business as a monopolistic firm

question

5 principles of barriers to entry

answer

1) control of scare resource or input
2) increasing returns to scale
3) technological superiority
4) network externality
5) government-created barrier

question

natural monopoly

answer

a monopoly created and sustained by increasing returns to scale

question

patent

answer

gives the inventor the sole right to make, use, or sell the item for a period that in most countries lasts between 16-20 years

question

answer

gives the creator of a literary or artistic work sole rights to profit from that work, usually for the period of that person's life plus 70 years

question

public ownership

answer

the government establishes a public agency to provide the good and protect consumers interests

question

price regulation

answer

limits the price that a monopolist is allowed to charge

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monopsony

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a market in which there is only one buyer but many sellers

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monopsonist

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a firm that is the sole buyer in a market

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single-price monopolist

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charges all consumers the same price

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price discrimination

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some monopolists that increase profits by charging different customers different prices for the same good

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perfect discrimination

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when the monopolist is able to capture the entire surplus as profit

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oligopoly

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an industry with only a small number of producers

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oligopolists

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individual firms in an oligopoly market

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imperfect competition

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firms that compete buy also posses market power; oligopoly and monopolistic competition

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duopoly

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the simplest form of oligopoly in which the industry has only 2 producing firms

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duopolists

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firms in a duopoly

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collusion

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companies that cooperate to raise joint product

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cartel

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the strongest form of collusion; an arrangement between producers that determines how much each producer is allowed to produce

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noncooperative behavior

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each firm acting in its own self-interest

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interdependence

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each firm's decision significantly affects the profit of other firms

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game theory

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the study of how people behave in strategic situations; used to understand how oligopolists behave

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payoff

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the reward received by a player in a game

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payoff matrix

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a table that shows the payoffs that each firm earns from every combination of strategies by the firms

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Nash equilibrium

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when all players choose the best strategy they can, given the choices of all other players

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noncooperative equilibrium

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strategic behavior

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taking account of the effects of the action it chooses today on the future actions of other players in the game

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tit-for-tat

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a strategy for the repeated prisoner's dilemma in which players cooperate on the first move, then mimic their partner's last move on each successive move

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tacit collusion

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firms act as if they have a way of making an enforceable agreement to limit output and raise prices

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4 factors that limit firms ability to cooperate on high prices

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1) less concentration
2) complex products and price schemes
3) differences in interests
4) bargaining power of buyers

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product differentiation

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firms make considerable efforts to create the perception that their product is different from the other's

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price leadership

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a pattern of behavior in which one firm sets its price and other firms in the industry follow

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non-price competition

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adding new features to products and spending large sums of money on advertisement that proclaim inferiority of rival's products

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monopolistic competition

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a market with a large number of competing producers, differentiated products, and free entry and exit in the long run

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3 types of product differentiation

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1) by style/type
2) by location
3) by quality

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zero-profit equilibrium

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firms just manage to cover their costs at their profit-maximizing output quantities

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excess capacity

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the failure to produce enough to minimize ATC

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brand names

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names owned by particular companies that differentiate their products in the minds of consumers

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physical capital

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"capital"; manufactured resources

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human capital

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the improvement in labor created by the education and knowledge embodied in the workforce

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factor distribution of income

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how the total income of the economy is divided among labor, land, and capital

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value of the marginal product of labor (VMPL)

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the extra value of output generated by employing 1 more unit of labor; price x labor

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VMPL curve

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curve shown when the horizontal axis in the number of employees in a firm and the vertical axis is the VMPL and wage rate

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shifts in the VMPL curve

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1) change in the price of output
2) change in the supply of other factors
3) change in technology

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equilibrium VMPL

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the additional value produced by the last unit of labor employed in the labor market as a whole

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marginal productivity theory of income distribution

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each factor is the paid value of output generated by the last unit of the factor employed in the factor market as a whole; the equilibrium VMPL

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compensating differentials

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across different types of jobs, wages are often higher or lower depending on how attractive or unattractive the job is

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efficiency-wage model

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theory stating that higher wages lead to greater productivity

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factors other than wage that alter willingness to work

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1) change in preferences or social norms
2) change in population
3) change in opportunities
4) change in wealth

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welfare state

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the collection of government programs designed to alleviate economic hardship

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government transfers

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3 economic rationales for creating the welfare state

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1) alleviating income inequality
2) alleviating economic insecurity
3) reducing poverty and providing access to healthcare

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poverty programs

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a government program designed to aid the poor

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social insurance programs

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programs designed to provide protection against unpredictable financial distress

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poverty threshold

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a minimum annual income that is considered adequate to purchase the necessities of life

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median household income

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the income of the household lying in the middle of the income distribution

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Gini coefficient

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a measure of income inequality within a population, ranging from zero for complete equality, to one if one person has all the income

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means-tested programs

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benefits that are available only to families or individuals whose income falls below the minimum

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in-kind benefits

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benefits given in the form of goods and services rather than money

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negative income tax

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a program that supplements the income of low-income workers

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private health insurance

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each member of a large pool of individuals pays a fixed amount annually (premium) to a private company that agrees to pay most of the medical expenses of the pool's members

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single-payer system

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a health care system in which the government acts as the principal payer of medical bills funded through taxes

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external cost

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an uncompensated cost that an individual or firm imposes on others

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external benefit

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benefits that individuals or firms confer on others without receiving compensation

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externalities

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external costs and benefits

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negative externalities

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external costs

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positive externalities

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external benefits

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marginal social cost of pollution

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the additional cost imposed on society as a whole by an additional unit of pollution

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marginal social benefit of pollution

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additional benefit to society from an additional unit of pollution

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Coase theorem

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even in the presence of externalities, an economy can always reach an efficient solution as long as transaction costs are sufficiently low

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transaction costs

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the cost of making a deal

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internalize the externality

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when individuals take external costs or benefits into account when making a decision

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how transaction costs prevent an efficient outcome

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1) high cost of communication
2) high cost of making a legally binding and timely agreement

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environmental standards

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rules that protect the environment by specifying actions by producers and consumers

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emissions tax

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charge made to firms that pollute the environment based on the quantity of pollution they create

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Pigouvian taxes

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taxes designed to reduce external costs

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technology spillover

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spreading of knowledge across individuals and firms

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network externality

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when the value of a good or service increases as the number of other people who also use it increases

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positive feedback

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bandwagon effect; if a large number of people use a product, more people are likely to use it; a type of network externality

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excludable good

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suppliers of the good can prevent people who don't pay from consuming it

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rival in consumption good

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the same unit of the good cannot be consumed by more than one person at the same time

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private good

answer

a good that is both rival and excludable

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non-excludable good

answer

the supplier cannot prevent consumption by people who do not pay for it

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non-rival in consumption good

answer

1 or more person can consume the same unit of the good at the same time

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public good

answer

goods that are non-excludable and non-rival in consumption

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common resource

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goods that are rival in consumption but non-excludable

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artificially scarce good

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goods that are excludable but non-rival in consumption

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free-ride problem

answer

people who benefit from a good without paying for it, taking advantage of those who do pay

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cost-benefit analysis

answer

a decision-making process in which you compare what you will sacrifice and gain by a specific action; comparing social benefits and costs of providing public goods

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overuse

answer

when individuals ignore the fact that their use depletes the amount of the resource remaining for others

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3 fundamental ways to induce people who use common resources to internalize the costs they impose on others

answer

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