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