Economics: Allocation of Scarce Resources

Market

A means for individuals and businesses to exchange goods, services, assets, and labor

Economic Model

Abstract description of part of an economy

Marginal Return

Additional amount of a good produced by increasing inputs used to make it by 1

Marginal Benefit

Additional benefit from a decision

Marginal Cost

Additional cost from a decision

Marginal Utility

Additional happiness or satisfaction from consuming one more unit of a good

Diminishing Marginal Returns

Additional output from one more unit of input tends to decrease

Long Run

All possible production decisions, all inputs are variable

Efficient Market Hypothesis

All public information about publicly traded corporate stocks will be reflected in their current share prices

Efficient Market Hypothesis

All public information about publicly traded stocks is reflected in their current share prices

Marginal Opportunity Cost

Amount of the other good given up when increasing production by 1

Law of Demand

As the price of a good increases, the quantity demanded decreases

Law of Supply

As the price of a good increases, the quantity supplied increases

Long Run Average Cost (LRAC)

Average cost in the long run, can be constant or not due to economies of scale

Externalities

Benefits or costs outside the market that affect consumption or production

Conspicuous Consumption

Buying to show off

Increasing Marginal Cost

Caused by diminishing marginal returns

Bonds

Certificate purchased from a company/government, specifies future payments

Variable Costs

Change as output changes

Marginal Product

Change in output for one additional unit of input

Marginal Product of Labor

Change in output for one additional unit of labor

Nash Equilibrium

Combination of strategies where no player has an incentive to unilaterally adjust their strategy

Invisible Hand

Concept by Adam Smith, individuals working in their own self-interest promote the good of others as a side effect

Fixed Costs

Constant costs for any level of output

Marginal Cost

Cost created to provide one additional unit of a good

Sunk Cost

Cost that has already been paid and cannot be recovered

Economies of Scale

Costs decrease as firm grows

Diseconomies of Scale

Costs increase as firm grows

Implicit Cost

Costs that are not visible, such as opportunity cost

Explicit Cost

Costs that are visible and have prices

Diversification

Decreasing risk by investing in a variety of assets

Labor Demand

Derived from the demand for goods and services produced

Risk Premium

Difference in expected return between a safe asset and a risky asset

Production Possibilities Frontier (PPF)

Economic model showing possible combinations of outputs given the full use of inputs and technology

Socialism

Economic system based on goodwill towards others, ownership of means of production resides with the government

Capitalism

Economic system based on markets, ownership of means of production resides with individuals

Human Capital

Factors that affect the value of a worker's marginal product

Short Run

Firm has constraints in production decisions, some inputs are fixed

Total Cost

Fixed costs plus variable costs

Game Theory

Formal economic reasoning applied to situations with interdependent decisions

Inferior Goods

Goods for which an increase in income leads to a decrease in demand

Normal Goods

Goods for which an increase in income leads to an increase in demand

Substitute Goods

Goods that can be interchanged easily, when the price of one increases, demand for the other increases

Complementary Goods

Goods that provide little utility without the use of another good simultaneously, when the price of one increases, demand for the other decreases

Marginal Revenue Product

Increase in revenue resulting from hiring one additional worker

Socially Responsible Investing (SRI)

Investing based on social and environmental factors

Economic Institutions

Laws, common practices, and organizations that affect the economy

Economic Decision Rule

MB = MC (Marginal Benefit equals Marginal Cost)

Maximizing Utility

MUA / Pa = MUB / Pb

Bounded Rationality

Making decisions based on rules of thumb

Positive Externality

Marginal social benefit is greater than marginal private benefit

Negative Externality

Marginal social cost is greater than marginal private cost

Market Economic System

Market forces dominate, factors of production are owned by households

Pollution

Negative externality, optimal policy is to tax or permit production

Stocks

Newly issued in the primary market, can be resold in the secondary market

Public Goods

Non-rivalrous and non-excludable goods

Club Goods

Non-rivalrous but excludable goods

Market Failure

Occurs when the market doesn't yield a price and quantity that consider all costs and benefits

Incentives

One of the big problems with socialism

Information

One of the big problems with socialism

Capital

One of the three primary inputs in economics

Labor

One of the three primary inputs in economics

Land

One of the three primary inputs in economics

Firms

Organize factors of production, produce goods/services, maximize profits

Government

Plays two roles in the economy: collects taxes to spend on projects and sets rules for business and homes

Centrally Planned Economic System

Political forces dominate, factors of production are owned by the government

Households

Ppl living together making decisions, supply labor and capital

Absolute Advantage

Producer can produce more of a good than others

Comparative Advantage

Producer has a lower opportunity cost in the production of a good

Allocative Efficiency

Producing the goods and services that are valued most by society

Demand

Quantity of a good or service that buyers are willing and able to buy at various prices

Income Effect

Reduction in quantity demanded when price increases because it makes one poorer

Substitution Effect

Reduction in quantity demanded when price increases because of substitution with another good

Land Demand Curve

Represents how a change in real wages affects the amount of labor a firm would like to hire

Property Rights

Rights to use, income, and transfer resources

Private Goods

Rivalrous and excludable goods

Common Pool Goods

Rivalrous but non-excludable goods

Time

Scarce resource in economics

Prospect Theory

Set a reference point and compare future states to that point

Traditional Economic System

Social forces dominate, factors of production are owned by society or its god(s)

Backwards Induction

Solving for best strategies in the last round of a game

Economics

Study of allocation of scarce resources

Macroeconomics

Study of inflation, unemployment, economic growth

Microeconomics

Study of pricing policy of firms, household decisions on what to buy, how markets allocate resources among alternative ends

Positive Economics

Study of what is

Normative Economics

Study of what should be

Expected Value

Sum of payouts multiplied by their probabilities

Framing Effects

Tendency for people to base choices on how they're presented

Reservation Price

The maximum amount a buyer is willing to pay for a good

Opportunity Cost

The value of the next best use of a resource

Long Run

Time period long enough to allow firm to change all its inputs

Wages

Total compensation paid by employer and received by employee

Average Cost

Total cost divided by quantity

Average Product

Total product divided by amount of input utilized

Economic Profit

Total revenue minus explicit and implicit costs

Accounting Profit

Total revenue minus explicit costs

Technical Efficiency

Using all available resources in the economy

Economic Efficiency

Using all resources so that the economy is as well off as possible

Average Variable Cost

Variable cost divided by output