Principles of Microeconomics
Glossary
Chapter 1: The Central Idea
choice a selection among alternative goods, services, or actions.
command economy an economy in which the government determines prices and production; also called a centrally planned economy.
comparative advantage a situation in which a person or country can produce one good more efficiently than another good in comparison with another person or country.
division of labor the division of production into various parts in which different groups of workers specialize.
economic interaction exchanges of goods and services between people.
economics the study of how people deal with scarcity.
freely determined price a price that is determined by the individuals and firms interacting in markets.
gains from trade improvements in income, production, or satisfaction owing to the exchange of goods or services.
government failure a situation in which the government makes things worse than the market, even though there may be market failure.
incentive a device that motivates people to take action, usually so as to increase economic efficiency.
increasing opportunity cost a situation in which producing more of one good requires giving up producing an increasing amount of production of another good.
market an arrangement by which economic exchanges between people take place.
market economy an economy characterized by freely determined prices and the free exchange of goods and services in markets.
market failure any situation in which the market does not lead to an efficient economic outcome and in which there is a potential role for government.
opportunity cost the value of the next-best forgone alternative that was not chosen because something else was chosen.
production possibilities alternative combinations of production of various goods that are possible, given the economy’s resources.
production possibilities curve a curve showing the maximum combinations of production of two goods that are possible, given the economy’s resources.
property rights rights over the use, sale, and proceeds from a good or resource.
scarcity the situation in which the quantity of resources is insufficient to meet all wants.
Glossary
Chapter 2: Observing and Explaining the Economy
ceteris paribus all other things being equal; refers to holding all other variables constant or keeping all other things the same when one variable is changed.
circular flow diagram a diagram illustrating the flow of funds through the economy as people buy and sell in markets.
controlled experiments empirical tests of theories in a controlled setting in which particular effects can be isolated.
Council of Economic Advisers a three-member group of economists appointed by the president of the United States to analyze the economy and make recommendations about economic policy.
economic model an explanation of how the economy or part of the economy works.
economic variable any economic measure that can vary over a range of values.
experimental economics a branch of economics that uses laboratory experiments to analyze economic behavior.
gross domestic product (GDP) a measure of the value of all the goods and services newly produced in an economy during a specified period of time.
macroeconomics the branch of economics that examines the workings and problems of the economy as a whole—GDP growth and unemployment.
microeconomics the branch of economics that examines individual decision-making at firms and households and the way they interact in specific industries and markets.
mixed economy a market economy in which the government plays a very large role.
negatively related a situation in which an increase in one variable is associated with a decrease in another variable; also called inversely related.
normative economics economic analysis that makes recommendations about economic policy.
positive economics economic analysis that explains what happens in the economy and why, without making recommendations about economic policy.
positively related a situation in which an increase in one variable is associated with an increase in another variable; also called directly related.
relative price the price of a particular good compared to the price of other things.
Glossary
Chapter 3: The Supply and Demand Model
complement a good that is usually consumed or used together with another good.
deferred payment contract an agreement between a worker and an employer whereby the worker is paid less than the marginal revenue product when young, and subsequently paid more than the marginal revenue product when old.
demand a relationship between price and quantity demanded.
demand curve a graph of demand showing the downward-sloping relationship between price and quantity demanded.
demand schedule a tabular presentation of demand showing the price and quantity demanded for a particular good, all else being equal.
equilibrium price the price at which quantity supplied equals quantity demanded.
equilibrium quantity the quantity traded at the equilibrium price.
inferior good a good for which demand decreases when income rises and increases when income falls.
law of demand the tendency for the quantity demanded of a good in a market to decline as its price rises.
law of supply the tendency for the quantity supplied of a good in a market to increase as its price rises.
market equilibrium the situation in which the price is equal to the equilibrium price and the quantity traded equals the equilibrium quantity.
minimum wage a wage per hour below which it is illegal to pay workers.
normal good a good for which demand increases when income rises and decreases when income falls.
price refers to a particular good and is defined as the amount of money or other goods that one must pay to obtain the good.
price ceiling a government price control that sets the maximum allowable price for a good.
price control a government law or regulation that sets or limits the price to be charged for a particular good.
price elasticity of demand the percentage change in the quantity demanded of a good divided by the percentage change in the price of that good.
price elasticity of supply the percentage change in quantity supplied divided by the percentage change in price.
price floor a government price control that sets the minimum allowable price for a good.
quantity demanded the quantity of a good that people want to buy at a given price during a specific time period.
quantity supplied the quantity of a good that firms are willing to sell at a given price.
rent control a government price control that sets the maximum allowable rent on a house or apartment.
shortage the situation in which quantity demanded is greater than quantity supplied.
substitute a good that has many of the same characteristics as and can be used in place of another good.
supply a relationship between price and quantity supplied.
supply curve a graph of supply showing the upward-sloping relationship between price and quantity supplied.
supply schedule a tabular presentation of supply showing the price and quantity supplied of a particular good, all else being equal.
surplus the situation in which quantity supplied is greater than quantity demanded.
Glossary
Chapter 4: Elasticity and Its Uses
elastic demand demand for which price elasticity is greater than 1.
income elasticity of demand the percentage change in quantity demanded of one good divided by the percentage change in income.
inelastic demand demand for which the price elasticity is less than 1.
perfectly elastic demand demand for which the price elasticity is infinite, indicating an infinite response to a change in the price and therefore a horizontal demand curve.
perfectly elastic supply supply for which the price elasticity is infinite, indicating an infinite response of quantity supplied to a change in price and thereby a horizontal supply curve.
perfectly inelastic demand demand for which the price elasticity is zero, indicating no response to a change in price and therefore a vertical demand curve.
perfectly inelastic supply supply for which the price elasticity is zero, indicating no response of quantity supplied to a change in price and thereby a vertical supply curve.
unit-free measure a measure that does not depend on a unit of measurement.
Glossary
Chapter 5: The Demand Curve and the Behavior of Firms
budget constraint an income limitation on a person’s expenditure on goods and services.
consumer surplus the difference between what a person is willing to pay for an additional unit of a good—the marginal benefit—and the market price of the good; for the market as a whole, it is the sum of all the individual consumer surpluses, or the area below the market demand curve and above the market price.
income effect the amount by which the quantity demanded falls because of the decline in real income from a price increase.
individual demand curve a curve showing the relationship between quantity demanded of a good by an individual and the price of the good.
marginal benefit the increase in the benefit from, or the willingness to pay for, one more unit of a good.
market demand curve the horizontal summation of all the individual demand curves for a good; also simply called the demand curve.
substitution effect the amount by which quantity demanded falls when the price rises, exclusive of the income effect.
utility a numerical indicator of a person’s preferences in which higher levels of utility indicate a greater preference.
utility maximization an assumption that people try to achieve the highest level of utility given their budget constraint.
Glossary
Chapter 6: The Supply Curve and the Behavior of Firms
competitive market a market in which no firm has the power to affect the market price of a good.
diminishing returns to labor a situation in which the incremental increase in output due to a unit increase in labor declines with increasing labor input; a decreasing marginal product of labor.
firm an organization that produces goods or services.
fixed costs costs of production that do not depend on the quantity of production.
marginal cost the change in total costs due to a one-unit change in quantity produced.
marginal product of labor the change in production due to a one-unit increase in labor input.
marginal revenue the change in total revenue due to a one-unit increase in quantity sold.
price-taker any firm that takes the market price as given; this firm cannot affect the market price because the market is competitive.
producer surplus the difference between the price received by a firm for an additional item sold and the marginal cost of the item’s production; for the market as a whole, it is the sum of all the individual firms’ producer surpluses, or the area above the market supply curve and below the market price.
production function a relationship that shows the quantity of output for any given amount of input.
profit maximization an assumption that firms try to achieve the highest possible level of profits—total revenue minus total costs—given their production function.
profits total revenue received from selling the product minus the total costs of producing the product.
total costs the sum of variable costs and fixed costs.
total revenue the price per unit times the quantity the firm sells.
variable costs costs of production that vary with the quantity of production.
Glossary
Chapter 7: The Interaction of People in Markets
competitive equilibrium model a model that assumes utility maximization on the part of consumers and profit maximization on the part of firms, along with competitive markets and freely determined prices.
consumer surplus the difference between what a person is willing to pay for an additional unit of a good—the marginal benefit—and the market price of the good; for the market as a whole, it is the sum of all the individual consumer surpluses, or the area below the market demand curve and above the market price.
deadweight loss the loss in producer and consumer surplus due to an inefficient level of production.
double-auction market a market in which several buyers and several sellers state prices at which they are willing to buy or sell a good.
equilibrium price the price at which quantity supplied equals quantity demanded.
first theorem of welfare economics the conclusion that a competitive market results in an efficient outcome; sometimes called the "invisible hand theorem"; the definition of efficiency used in the theorem is Pareto efficiency.
income inequality disparity in levels of income among individuals in the economy.
invisible hand the idea that the free interaction of people in a market economy leads to a desirable social outcome; the term was coined by Adam Smith.
Pareto efficient a situation in which it is not possible to make someone better off without making someone else worse off.
producer surplus the difference between the price received by a firm for an additional item sold and the marginal cost of the item’s production; for the market as a whole, it is the sum of all the individual firms’ producer surpluses, or the area above the market supply curve and below the market price.
surplus the situation in which quantity supplied is greater than quantity demanded.
Chapter 8: Costs and the Changes at Firms Over Time
average fixed cost (AFC) fixed costs divided by the quantity produced.
average product of labor the quantity produced divided by the amount of labor input.
average total cost (ATC) total costs of production divided by the quantity produced (also called cost per unit).
average variable cost (AVC) variable costs divided by the quantity produced.
breakeven point the point at which price equals the minimum of average total cost.
constant returns to scale a situation in which long-run average total cost is constant as the output of a firm changes.
diseconomies of scale also called decreasing returns to scale; a situation where long-run average total cost increases as the output of a firm increases.
economies of scale also called increasing returns to scale; a situation in which long-run average total cost declines as the output of a firm increases.
fixed costs costs of production that do not depend on the quantity of production.
long run the minimum period of time during which all inputs to production can be changed.
long-run average total cost curve the curve that traces out the short-run average total cost curves, showing the lowest average total cost for each quantity produced as the firm expands in the long run.
marginal cost the change in total costs due to a one-unit change in quantity produced.
minimum efficient scale the smallest scale of production for which long-run average total cost is at a minimum.
production function a relationship that shows the quantity of output for any given amount of input.
short run the period of time during which it is not possible to change all inputs to production; only some inputs, such as labor, can be changed.
shutdown point the point at which price equals the minimum of average variable cost.
total costs the sum of variable costs and fixed costs.
variable costs costs of production that vary with the quantity of production.
Chapter 9: The Rise and Fall of Industries
accounting profits total revenue minus total costs, where total costs exclude the implicit opportunity costs; this is the definition of profits usually reported by firms.
economic profits total revenue minus total costs, where total costs include opportunity costs, whether implicit or explicit.
external diseconomies of scale a situation in which growth in an industry causes average total cost for the individual firms to rise because of some factor external to the firm; it corresponds to an upward-sloping long-run industry supply curve.
external economies of scale a situation in which growth in an industry causes average total cost for the individual firm to fall because of some factor external to the firm; it corresponds to a downward-sloping long-run industry supply curve.
free entry and exit movement of firms into and out of an industry that is not blocked by regulation, other firms, or any other barriers.
industry a group of firms producing a similar product.
long-run competitive equilibrium model a model of firms in an industry in which free entry and exit produce an equilibrium such that price equals the minimum of average total cost.
long-run equilibrium a situation in which entry into and exit from an industry are complete and economic profits are zero, with price equal to average total cost (ATC).
long-run industry supply curve a curve traced out by the intersections of demand curves shifting to the right and the corresponding short-run supply curves.
normal profits the amount of accounting profits when economic profits are equal to zero.
price-cost margin the difference between price and marginal cost divided by the price. This index is an indicator of market power, where an index of 0 indicates no market power and a higher price-cost margin indicates greater market power.
price-maker a firm that has the power to set its price, rather than taking the price set by the market.
Standard Industrial Classification (SIC) a taxonomy used to label and group industries for statistical purposes; each industry is given an SIC code.
Chapter 10: Monopoly
average revenue total revenue divided by quantity.
barriers to entry anything that prevents firms from entering a market.
contestable market a market in which the threat of competition is enough to encourage firms to act like competitors.
market power a firm’s power to set its price without losing its entire share of the market.
monopoly one firm in an industry selling a product for which there are no close substitutes.
natural monopoly a single firm in an industry in which average total cost is declining over the entire range of production and the minimum efficient scale is larger than the size of the market.
price discrimination a situation in which different groups of consumers are charged different prices for the same good.
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