phoenix college > departments > Liberal Arts > economics > ECN112> Terms and Tools
These are the more important terms you will encounter in your
reading or class discussions. Additional terms can be found in
the glossary at the back of the textbook.
The terms below are approximately in the order in which you are
likely to encounter them. Notice that many of the terms below
describe people's behavior or imply a theory about behavior. However,
a tool is a conceptual creation that enables theories to
be applied to various situations. In other words, not all
of the terms are names of tools.
goods- things people want.
resources- things that are used to make goods. Sometimes called factors or inputs.
products- goods or services which have been produced. Sometimes called output.
scarcity- people cannot have everything they want; resources and goods are limited compared to desires.
marginal thinking-all decisions are made incrementally or a little at a time.
opportunity cost-the highest valued alternative given up; the relevant cost in every decision.
economization -people tend to pick the way of doing things that involves either the lowest cost or greatest benefit.
response to incentives-people change behavior based on perceived changes in the costs or the benefits of an option.
costly information- information is scarce and thus many decisions are made with limited information; information costs are the costs of obtaining information.
secondary effects- when actions alter the incentives (costs and benefits) involved in making other decisions (or taking other actions); these can include decisions made by other people or decisions made in the future.
subjective values- different people view costs and benefits differently.
scientific thinking- the approach we will take to economics; we try to predict a decision or its results rather than describe exactly how it is made or judge whether we agree with it.
(law of) diminishing returns- the observation that the benefit of an action tends to fall as it is repeated (in a particular span of time).
marginal opportunity cost (marginal cost)-the highest valued alternative given up to do a marginal (or incremental) amount of an activity; the margin is often specified. Usually rises as quantity of a particular activity rises.
marginal utility -the benefit (satisfaction) received or anticipated when an additional amount of an activity is undertaken; usually used with marginal opportunity cost. Usually falls as quantity of a particular activity rises, according to the Law of Diminishing Returns.
economic efficiency-obtaining a given result at minimum opportunity cost or gaining maximum benefit for a given cost. Based on economization. There are two specific kinds-- (1) productive efficiency-The situation in which no more output of one good can be produced without reducing output of some other good. (2) allocative (distribution) efficiency -The situation in which no person can be made better off without making another person worse off.
production possibilities curve (PPC)-a graphical depiction of all of the possible and (productive) efficient combinations of two goods which can be produced by an individual or group.
specialization- concentration on producing one kind of good or performing one kind of action rather than producing a variety of goods for oneself.
trade- voluntarily giving up goods to another person in exchange for goods which are more highly valued.
property rights-the recognized and enforced ability to trade and use goods
comparative advantage-the ability to produce at lowest opportunity cost; the basis for trade and specialization.
the law of comparative advantage says that people will specialize in production of goods for which they have the lowest marginal opportunity cost, and trade these goods for other goods that they desire.
absolute advantage-the ability to produce a greater amount with the same resources
transactions costs-costs associated with the action of trade, including information and transportation costs.
quantity demanded-the amount of a good that buyers wish to buy at a particular price.
demand-the relationship between the price and quantity demanded of a good, all else being held constant
law of demand-states that the demand relationship is an inverse or negative one (as price rises, quantity demanded falls, all else being held constant)
quantity supplied-the amount of a good that sellers wish to sell at a particular price.
supply-the relationship between the price and quantity supplied of a good, all else being held constant
demand and supply equilibrium-the unique price and quantity combination at which the quantity demanded equals the quantity supplied in a market; where the market is headed or will end up. Notice, there is actually no "law of supply and demand," but the equality implied by equilibrium is what people mean when they use this expression.
disequilibrium- the state when a market in not in equilibrium (generally due to price floors, price ceilings, or taxes)
price floor-price kept above equilibrium, resulting in a surplus
surplus- a greater quantity supplied than is demanded, indication of price above equilibrium; also called excess supply
price ceiling-price kept below equilibrium, resulting in a shortage
shortage-a greater quantity demanded than is supplied, indication of price below equilibrium; also called excess demand
consumer surplus-the total value buyers place on a good over the price they must pay for it; the gains to buyers from trade
producer surplus-the payment sellers receive for a good over the cost to them of selling it; the gains from sellers of trade
increase in demand (or supply)-a change in the relationship between price and quantity demanded (or supplied) so that a greater quantity of the good is demanded (supplied), at every possible price, than was true before. This is shown by moving the demand (supply) curve rightward.
decrease in demand (or supply)-a change in the relationship between price and quantity demanded (or supplied) so that a smaller quantity of the good is demanded (supplied), at every possible price, than was true before. This is shown by moving the demand (supply) curve to the left.
substitute- good used instead of another
complement- good used along with another
normal good- good which is purchased in greater quantity as the buyers' incomes rise.
inferior good- good which is purchased in smaller quantity as the buyers' incomes rise
excise tax- a tax on each unit of a good that is sold
invisible hand-the principle that individuals gain by satisfying the wants of others; markets cause individuals to promote the general welfare while promoting their own.
Laffer curve-a graphical representation of the relationship of tax rates to tax revenues. It shows that, as tax rates rise, tax revenues will rise and then fall.
invisible hand-the principle that individuals gain by satisfying the wants of others; markets cause individuals to promote the general welfare while promoting their own.
percentage change or percentage difference- this is not really an economic
tool, but it is a mathematical one. It is the change in some variable, divided
by the initial value of the variable. Often, it is calculated from one year
to the next. The shorthand used in class for this is
elasticity of demand-the responsiveness of buyers to changes in price. Specifically, the percentage change in quantity demanded for each percentage change in price, other things being equal. Elasticity can be determined using the formulas
Elasticity of demand will always be negative. For a straight-line demand curve, elasticity falls in absolute value as lower points on the demand curve are reached (i.e., at lower prices). Elasticity is greater in absolute value if there are more substitutes for a good, the good is more of the buyers' budgets, or if buyers have more time to adjust to price changes.
price discrimination-charging different prices to different buyers for the same good; charging a higher price to the buyers whose elasticity of demand is lower.
ouput- the quantity of a good or service produced. Abbreviated as q or Q.
factors of production-resources used to make goods or services; inputs.
inputs-resources used to make goods or services; factors of production.
materials- inputs which are altered in form or function to make goods. Abbreviated as M.
labor- a person's time when used as an input in a productive process. Labor can be used to produce a service or to transform materials into goods. Labor is abbreviated as L.
capital - machines, tools, buildings, and other durable inputs that do not generally get used up as they are used to produce goods. Capital differs from labor and materials in this respect. Capital is abbreviated as K.
long run-period of time over which all inputs or resources used in production are variable
short run-period in which some inputs or resources cannot be changed, but others can.
implicit cost-cost which considers opportunity cost of resources as well as money costs.
explicit cost-money costs or costs for which a bill is paid.
revenue-also called total revenue; the money received from the sale of a good or service. It is the price times the quantity sold (PxQ). Revenue is abbreviated as TR.
economic profit-revenue minus all costs (explicit and implicit)
accounting profit-revenues minus explicit costs
ixed cost (FC)-cost which does not rise as more of a good is produced in the short run; costs of inputs which are fixed in amounts in the short run
variable cost (VC)-that cost which rises as more of a good is produced in the short run; costs of inputs which can be varied in amounts in the short run. In the long run, all costs are variable, so we do not make the distinction in the long run.
total cost (TC)- all costs; the sum of FC+VC.
marginal product (MP)-the additional output that can be produced by
adding one more unit of a variable input (usually labor). 
diminishing returns- the situation in which adding an additional unit of variable input (such as labor) increases output by a smaller increment than previous units of labor
average product (AP)-the overall output per unit of variable input (usually labor). AP=q/L
wage (w)- the price of each unit of the variable input (usually labor).
marginal cost (MC)-the change in cost when one more unit of a good or
service is produced. This generally falls when output is increased from very
small amounts, but rises when output is increased from moderate or large levels.
; also MC=w/MP
average variable cost (AVC)-the overall variable cost (cost from variable input) per unit of output. This generally falls when output is increased from small amounts, but rises when output is increased from large levels. AVC=VC/q; also AVC=w/AP
average fixed cost (AFC)-the overall fixed cost (cost from fixed inputs) per unit of output; this declines as more output is produced. AFC=FC/q
average total cost (ATC)- the overall cost (from all inputs) per unit of output. This generally falls when output is increased from small amounts, but rises when output is increased from large levels. ATC=TC/q; also ATC=AFC+AVC.
price takers-sellers who cannot affect the price of the product by altering output. They exist in a Pure Competition market, and may exist in others.
homogeneous products- products so similar to one another that, for most purposes, they are identical.
long run average (total) cost (LRATC or LRAC)-average (total) cost in the long run, determined by the boundary of all the possible short run average total cost curves. This generally falls when output is increased from small amounts, is unchanged when output is moderate, but rises when output is increased from large levels.
economies of scale-declining long run average cost; also called increasing returns to scale
diseconomies of scale-rising long run average cost; also called decreasing returns to scale
constant returns to scale-long run average cost is neither rising nor falling.
shutdown decision-when operation in the short run is not sensible (when price is less than average variable cost), a firm ceases to make output. This occurs only when the price of a good is less than the AVC of producing it.
free entry-the process of new firms entering any market in the long run which offers economic profit. The process results in no long run profit for producers. The opposite of a market with free entry is one which has barriers to entry.
long run supply-the relationship between price and quantity offered for sale in the long run, assuming that firms are free to enter or leave the market.
Constant/Increasing/Decreasing Cost industry-if the long run average cost curve moves as the number of price taker firms changes, the long run supply curve for the industry may be upward sloping (for an increasing cost industry) or downward sloping (for a decreasing cost industry). If costs do not change as new firms enter the market, the industry is said to be a constant cost industry, and the long run supply curve is horizontal.
differentiated products- goods which are in some way different from their substitutes.
barriers to entry- characteristics of a market or good which make it difficult for new firms to begin or expand production. Generally, production costs are not considered barriers to entry. Barriers to entry do include patents, copyrights, trademarks, ownership of unique resources, licenses, government regulations, and extreme economies of scale.
price searchers-sellers who can affect price by altering the quantity they sell; they each have their own downward-sloping demand curve, and thus a downward sloping marginal revenue curve; they were once referred to as monopolies.
marginal revenue-change in revenue as one more unit of output is sold; generally less than the price for a price searcher, but equal to the price for a price taker.
oligopoly-a limited number of firms whose output decisions are interrelated.
cartel-a group of sellers who combine (collude) illegally to sell as a big price searcher. To be successful, a cartel needs to be able to monitor (detect) the output of its members, punish any member that produces too much output, and prevent firms which are not in the cartel from producing and selling output.
collusion- agreement among producers not to compete; such an agreement can take the form of a formal cartel or it can be less structured.
monopolistic competition-a market of sellers who face downward sloping demand curves in the short run, but due to free entry of rivals, earn no economic profit in the long run. Another way to refer to a price searcher market with low barriers to entry.
contestable market- a market in which the threat of entry by potential rivals exerts the same influence on long run profit as actual free entry by rivals.
natural monopoly - a situation in which it is not possible or efficient for more than one firm to produce a particular good or service. This is because of extreme economies of scale in the long run and/or downward-sloping ATC curves in the short run.
derived demand- the idea that resources are not desired for themselves, but rather for the value of what they can produce and how much they can produce.
productivity-the output produced by an input or resource. Generally, it is measured as the additional product that is produced by adding one more unit of input to the productive process (also called the marginal product of the resource).
marginal revenue product-the value to a resource buyer of one more unit of a resource. It is defined as the marginal product of the resource times the marginal revenue that can be earned for each unit of good produced by the resource. The marginal revenue product (MRP) is the basis of the demand curve for a resource.
human capital- skills, education, training and experience that enable a worker to become more productive. These are not used up as the worker works; the worker still has them even though she/he has used them on the job.
compensating wage differentials- wage difference that are based on job characteristics such as unpleasantness or danger of a profession.
economic rent-the excess of salary paid to a worker over her/his opportunity cost; similar to producer surplus.
monopsony -the situation in which there is only one buyer for a good, service, or resource.
marginal factor cost-the increase in cost perceived by a monopsonistic buyer of a resource if one more unit of the resource is purchased. It is generally more than the price of the resource, and is related to the demand curve in a manner similar to the relationship between the demand curve and marginal revenue of a price searching seller.
rate of time preference- the rate at which a person desires to have things in the present rather than waiting to have them at some future time.
(nominal) interest rate-the percentage difference between the amount of money borrowed at one time and the amount repaid at another, on an annual basis.
inflation rate-the rate of change in prices over time, on an annual basis.
real interest rate- the interest rate in terms of purchasing power, that is, when changes in prices have been accounted for. The real interest rate is approximately the nominal interest rate minus the inflation rate. One way to think of it is as the interest rate in terms of things rather than money. The real interest rate is based upon the rate of time preference as well as risks associated with the loan.
discounting -calculating the present value of a future payment. The present value will be inversely related to the interest rate and the amount of time that must pass before the payment is made.
present value formula- one of several mathematical formulas relating the interest rate, the future amount (future value) and principal amount (present value) from an investment or loan.
Specifically, 
, where PV is the present value, FV
is the future value, i is the interest rate, and n is the number of years in
which the future value will be received.
loanable funds market, money market, capital market - the market in which loans are made and interest rates are determined. The "buyers" of loans (capital) are borrowers, the "sellers" are lenders, and the "price" is the interest rate.
rate of return equalization principle- the tendency for interest rates or investment returns to be equal in all investments of equal risk, due to market forces.
Externality -when a decision imposes a cost (negative externality) or imparts a benefit (positive externality) to people not involved in the decision making.
Public Goods- goods for which the consumption by one person does not exhaust the amount available for others, and for which prevention of consumption is difficult.
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