PED-% change in Q demanded of a good resulting from ordinal U function U that generates a ranking of market

a 1% increase in its price. baskets in order of most to least preferred.

cardinal utility function Utility function describing by
how much one market basket is preferred to another.
budget line

infinitely elastic
demand Principle
consumers will buy as
much of a good as they
can get at single P, but
for any higher P the Q
drops to zero, for any
lower P the Q demanded increases without limit.
The ability to avoid risk by operating on a large scale is
based on the law of large numbers, which tells us that
although single events may be random and largely
unpredictable, the average outcome of many similar
events can be predicted.
reference point The point from which an individual
arc elasticity of D P elasticity calculated over range of P makes a consumption decision.
● endowment effect to value an item more when they
own it than when they do not.
● loss aversion to prefer avoiding losses over acquiring
gains.
● framing to rely on the context in which a choice is
described when making a decision
anchoring Tendency to rely heavily on one or two
pieces of information when making a decision
law of small numbers Tendency to overstate the
MRS = PF/PC marginal utility (MU) Additional probability that a certain event will occur when faced
satisfaction obtained from consuming one additional unit with relatively little information.
of a good. diminishing marginal utility Principle that as Production:
more of a good is consumed, the consumption of Firms offer a means of coordination that is extremely
additional amounts will yield smaller additions to utility. important and would be sorely missing if workers
equal marginal principle U is max when consumer has operated independently
equalized the MU per $ of expenditure across all goods. APL=Q/L MPL= ΔQ/ ΔL AP=MP if AP=max.
Laspeyres price index TP = max if MP=0. IF MP>AP, then AP ↑ or vice versa
Amount of money at Diminishing marginal returns applies. Stock of capital
current year prices that an and technical advancement-Reasons of L productivity ↑
individual requires to isoquants Curve showing all possible combinations of
purchase a bundle of inputs that yield the same output.
goods and services
chosen in a base year
divided by the cost of
purchasing the same bundle at base-year prices. Paasche
index Amount of money at current-year prices that an
individual requires to purchase a current bundle of goods
For most goods: foods, beverages, fuel, entertainment the and services divided by the cost of purchasing the same
IE of D is larger in the LR than in the SR. For a durable bundle in a base year.
good, the opposite is true.

Perfect substitute Fixed-proportion

1. Completeness: A>B, A<B, A=B 2. Transitivity: A>B, RISK
B>C then A>C 3. More is better than less 4. diminishing E(X) = Pr1X1 + Pr2X2 – expected value
MRS. When the MRS diminishes along an indifference Deviation = X-Ẍ St d= √ ∑ Pr(X- Ẍ)^2
curve, the curve is convex. indifference curves cannot St d lower, risk lower. expected utility Sum of the U
intersect. MRS Max amount of a good that a consumer associated with all possible outcomes, weighted by the
is willing to give up to obtain one additional unit of probability that each outcome will occur. diversification
another. Convex-concave up. perfect substitutes Two Practice of reducing risk by allocating resources to a
goods for which the marginal rate of substitution of one varietyof activities whose outcomes are not closely
for the other is a constant. perfect complements Two related.
goods for which the MRS is zero or infinite; the
indifference curves are shaped as right angles. bad Good
for which less is preferred rather than more. returns to scale Rate at which output increases as inputs
are increased proportionately. increasing returns to
scale Situation in which output more than doubles when
all inputs are doubled. constant returns to scale
Situation in which output doubles when all inputs are
doubled. decreasing returns to scale Situation in which
output less than doubles when all inputs are doubled.
COST accounting cost Actual expenses plus
depreciation charges for capital equipment. economic
cost to a firm of utilizing economic resources in
production. opportunity cost Cost associated with
opportunities forgone when a firm’s resources are not put
to their best alternative use. Economic cost = (LAC) Curve relating average cost of production to
Opportunity cost. sunk cost Expenditure that has been output when all inputs, including capital, are variable.
made and cannot be recovered. Because it has no (SAC) Curve relating average cost of production to
alternative use, its opportunity cost is zero. output when level of capital is fixed. (LMC) Curve
total cost (TC or C) Total economic cost of production, showing the change in long-run total cost as output is
consisting of fixed and variable costs. fixed cost (FC) increased incrementally by 1 unit.
Cost that does not vary with the level of output and that AC ↓ : larger scale, worker can specialize, scale can
can be eliminated only by shutting down. variable cost provide flexibility, acquiring inputs at low cost
(VC) Cost that varies as output varies. amortization economies of scale Situation in which output can be
Policy of treating a one-time expenditure as an annual doubled for less than a doubling of cost.diseconomies of
cost spread out over some number of years. scale Situation in which a doubling of output requires
marginal cost (MC) Increase in cost resulting from the more than a doubling of cost.
production of one extra unit of output.
when occurs,
=ΔL*w/Δq=w/MPL MC<AC and Ec is less than 1 or vice versa. When Ec=1,
MPL ↓ if L↑ MC ↑ if q ↑, high MPL – low MC nor occurs.

economies of scope Situation in which joint output of a

single firm is greater than output that could be achieved
MC cross ATC and AVC = min. distance between ATC by two different firms when each produces a single
and AVC ↓ if Q ↑. User annual cost owning and using C product. diseconomies of scope Situation in which joint
output of a single firm is less than could be achieved by
separate firms when each produces a single product.
The price of if negative,
capital is its user cost. If the capital market is diseconomies of
competitive, the rental rate should be equal to the scope.
user cost, r. Why? Firms that own capital expect to earn If greater than 1, economies of scope
a competitive return when they rent it. This competitive degree of economies of scope (SC) Percentage of cost
return is the user cost of capital. Capital that is purchased savings resulting when two or more products are
can be treated as though it were rented at a rental rate produced jointly rather than Individually.
equal to the user cost of capital. isocost line Graph learning curve Graph relating amount of inputs needed
showing all possible combinations of labor and capital by a firm to produce each unit of output to its cumulative
that can be purchased for a given total cost.
output.

The isocost line has a slope of ΔK/ΔL = -(w/r)

(MRTS) is the negative of the slope of the isoquant and
is equal to the ratio of the marginal products of labor and

capital:

The functions at minimize the cost

expansion path Curve passing through points of
tangency between a firm’s isocost lines and its isoquants.
Slope is equal to ΔK/ΔL

Cost minimize function

Profit-max
Perfectly competitive market:
1. price taker, 2. product homogeneity, 3. Free enter-exit
π(q) = R(q) - C(q)

π = R - wL – rK. economic rent Amount that firms are

willing to pay for an input less the minimum amount
necessary to obtain it.
The demand curve d facing an individual firm in a
competitive market is both its average revenue curve and
its marginal revenue curve. Along this demand curve,
MR, AR, and P are all equal.