Accounting Profit - Since accountants only track explicit cost (not implicit costs), accounting profit is anything that exceeds the explicit costs of doing business. Contrasted with normal profit and economic profit, accounting profit will be greater (because it ignores those implicit costs). Click here for a graphic portrayal.
Average Cost (AC) - total cost divided by the number of units produced. This is also called average total cost (ATC), to distinguish it from average variable cost (AVC) or average fixed cost (AFC). Contrast this with marginal cost and total cost. Click here for a graphical portrayal of the differences.
Allocative Efficiency - The apportionment of resources among firms and industries to obtain the production of the products most wanted by society (consumers); the output of each product at which its marginal cost and price or marginal benefit are equal.
Barriers to Entry
- things that make it difficult or impossible to enter an industry
Change in Demand - a change in the relationship between price and quantity demanded, caused by a change in one of the determinants of demand
Change in Quantity Demanded - a change in the quantity demanded, caused by a change in price
Change in Supply - a change in the relationship between price and quantity supplied, caused by a change in one of the determinants of supply
Change in Quantity Supplied - a change in the quantity supplied, caused by a change in price
Complements - goods that are usually used together, such as coffee and coffee mate
Constant Returns to Scale - average cost remains the same when production capacity increases, in the long run. For example, if you double all the inputs and output increases by 2.0X, then you have constant returns to scale. The fact that all inputs are variable here makes this a long run concept only. Click here for a graphical depiction.
Consumer Surplus - the amount by which the marginal utility of a product exceeds its price. In other words, you would probably pay more than the price, if you had to, in order to obtain most products you buy. The difference between what you would pay, if you had to, and what you actually pay, is the consumer surplus.
Cross Elasticity of Demand - the relationship between the percentage change in the quantity demanded of one good and the percentage change in price of another. If this relationship, expressed as a ratio, is positive, then the two goods are substitutes. If negative, the two goods are complements. Higher number reflect stronger relationships.
Deadweight Cost - a cost to one person that's not a benefit to anyone else
Demand - the relationship between price (or opportunity cost) and the quantity of something that will be demanded at that price
Demand, Law of - price and quantity demanded are inversely related. That is, when the price (or opportunity cost) of something decreases, the quantity demanded increases.
Demand Curve - a graph showing the relationship between price and quantity demanded
Demand Schedule - a listing of prices and the quantities demanded at each price
Determinants of Demand - the things that change the relationship between price and quantity demanded for a product. The list can be very long, but consider (1) consumer income, (2) consumer tastes and preferences, (3) a change in the price of substitutes, and (4) a change in the price of complements.
Determinants of Demand Elasticity - the things that change price elasticity of demand. Generally, they are (1) substitutability, (2) durability, (3) percentage of income spent on the product, (4) whether the item is considered a luxury or necessity (which, analytically is the same as #1), and (5) time.
Determinants of Supply - the things that change the relationship between price and quantity supplied for a product. The list can be very long, but it includes anything that changes the profitability of producing a product, relative to other products, and excluding a change in the market price of the product (because that would be a change in supply instead). For example, a (1) change in the price of inputs in the production process, (2) a change in the number of producers, or (3) a change in government taxes or subsidies for the product.
Diminishing (marginal) Returns - This is the area, sometimes called stage two of the production function, where the amount of extra output (marginal product) per unit of input is decreasing as successive units of input are used. Click here for a graphical depiction.
Diminishing Marginal Utility - the tendency of marginal utility to decline as additional units of a certain product are consumed.
Diseconomies of Scale - increasing average cost associated with larger production capacities, in the long run. [This is NOT the same thing as diminishing marginal returns. Diminishing marginal returns is concerned with a decreased rate in the increase in production of a product when increasing amounts of a single input are added to the production mix, holding all other inputs constant. Diseconomies of scale is concerned with the decrease in production when all inputs are increased by some fixed percentage.] For example, if you double all the inputs and output increases by 1.7X, then you have diseconomies of scale. This is typically due to inefficiencies associated with overly large and bureaucratic firms. So typically diseconomies of scale is associated with firms that are larger than firms experiencing economies of scale, all else equal. The fact that all inputs are variable here makes this a long run concept only. [This is also called decreasing returns to scale.] Click here for a graphical depiction.
Economic Cost - opportunity cost; any cost that represents an opportunity for choice
Economic Profit - If the firm is earning more than "normal profit," that is, if it is more than covering all the costs of doing business (including implicit costs), it is said to be earning an economic profit. In the long run, firms in perfectly competitive markets will make zero economic profits (a "normal profit") because the existence of economic profits attracts new firms into the market, increases supply, and reduces price until only a normal profit (i.e. zero economic profit) remains.
Economic Rent - the amount paid to a factor of production above and beyond its opportunity cost. For example, if you are worth no more than $6.00/hour to any other employer, but you're paid $50.00/hour by the Acme Economic Consulting Firm, then you're earning $6.00/hour in opportunity cost and $44.00/hour in economic rent.
Economies of Scale - average cost savings associated with larger production capacities, in the long run. [This is NOT the same thing as increasing marginal returns. Increasing marginal returns is concerned with an increased rate in the increase in production of a product when increasing amounts of a single input are added to the production mix, holding all other inputs constant. Economies of scale is concerned with the increase in production when all inputs are increased by some fixed percentage.] For example, if you double all the inputs and output increases by 2.3X, then you have economies of scale. The fact that all inputs are variable here makes this a long run concept only. [This is also called increasing returns to scale.] Click here for a graphical depiction.
Elastic Demand - the percentage change in quantity demanded is greater than the percentage change in price. This produces an elasticity coefficient greater than 1.0. Also, total receipts change inversely with price. In other words, a higher price results in lower total receipts. [Note: This doesn't necessarily mean lower profits because we haven't factored in the cost of production yet.]
Elasticity - a flexible (no pun intended) economic concept that relates the magnitude of change in any two economic variables. The most common application is price elasticity of demand.
Equilibrium Price - the price at market equilibrium
Equilibrium Quantity - the quantity at market equilibrium
- Plant resources which are underused when imperfectly competitive firms produce
less output than that associated with achieving minimum average total cost.
Explicit Cost - "out-of-pocket" cost or "money payments to nonowners of the firm for the resources they supply." These are also called "accounting costs" because they are the types of costs that accountants track; someone wrote a check (or made another type of payment) for these costs. See implicit cost to note the contrast.
Factors of Production - land, labor, capital, and entrepreneurship.
Fixed Cost - costs that do not change when the level of output (production) changes
Implicit Cost - Any cost of production associated with the use of a resource, often labor, that the owners of the firm already own. This is a cost (an "opportunity cost") because these resources could be used for something else. For example, you quit your job at Randall's and start a lawn mowing business. The lost salary from Randall's (i.e. what you could be making there if you still worked there) is an implicit cost of your business. Contrast this with an explicit cost, such as the cost of purchasing gasoline to run your equipment.
Income Effect - the effect of a change in a product's price on a consumer's real income, and hence on the quantity demanded of the product. For normal goods, a price increase reduces real income and therefore quantity demanded (supporting the law of demand).
Income Elasticity of Demand - the relationship between the percentage change in the quantity demanded of a product and the percentage change in consumer income. The ratio will be positive for normal goods and negative for inferior goods.
Increasing (marginal) Returns - This is the area, sometimes called stage one of the production function, where the amount of extra output (marginal product) per unit of input is increasing as successive units of input are used. Click here for a graphical depiction.
Inefficient - something that has greater costs than benefits
Inelastic Demand - the percentage change in quantity demanded is less than the percentage change in price. This produces an elasticity coefficient less than 1.0. Also, total receipts change directly with price. In other words, a higher price results in higher total receipts. [Note: This doesn't necessarily mean higher profits because we haven't factored in the cost of production yet.]
Inferior Goods - goods for which the quantity demanded varies inversely with consumer income.
Long Run - that period of time in which all costs are variable, including the cost of the production plant.
Marginal Cost - the extra cost associated with something, such as the production of an additional unit, an additional 10 units, or a decision to skip another day of school (!). Graphically, marginal cost is the slope of (i.e. the change in) the total cost curve.
Marginal Product - the increase in the amount of total product associated with the introduction of one more unit of a variable input, everything else remaining constant.
Marginal Revenue - the extra revenue generated by the sale of an additional unit of output. Marginal revenue equals price for sellers in price takers markets (i.e. perfect competition). Marginal revenue is less than price for other sellers, except those who are perfect price discriminators.
Marginal Utility - the extra utility associated with consuming one more unit of a product. Expressed graphically, it is the slope of the total utility curve. Click here for a graphic depiction.
Market Equilibrium - that price at which the tendency of price to rise is equal to the tendency of price to fall; quantity supplied = quantity demanded
Minimum Efficient Scale - the lowest level of production associated with the bottom of the long-run average cost curve. So, in other words, it's the level of production a firm must achieve in order to be able to compete on a cost basis with other firms in the industry.
Monopoly - a market with one seller
Competition - A market structure in which many firms sell
a differentiated product into which entry is relatively easy in which the firm
has some control over its product price and in which there is considerable
Natural Monopoly - a marketplace in which average cost continues to decline over the entire range of the likely size of the market. The result is that the largest firm will always be the lowest (average) cost producer. In a free market, the market will tend to be a monopoly.
Negative (marginal) Returns - This is the area, sometimes called stage three of the production function, where the marginal product is negative. In other words, adding extra units of the variable input actually reduces total product. Click here for a graphical depiction.
Normal Goods - goods for which the quantity demanded varies directly with consumer income.
Normal Profit - This is making just enough money to cover all the costs of doing business, including the implicit costs. In other words, you're doing just as well as you could be doing if you were doing the next best thing. It is called "normal" profit because it's what producers make, in the long run, in a perfectly competitive market. If profits begin to exceed normal levels, new competitors jump in, lured by the big bucks. This increases supply, lowers the price, and eventually returns profit to the "normal" level. Normal profit is also called "zero economic profit." [It is, however, a positive level of "accounting profit" because accountants don't count implicit costs.] Got all that?
Oligopoly - A market structure in which a few firms sell either a standardized or differentiated product into which entry is difficult in which the firm has limited control over product price because of mutual interdependence (except when there is collusion among firms) and in which there is typically nonprice competition
Opportunity Cost - the value of sacrificed opportunities. It's what you have to give up to get what you want.
Optimal Purchase Rule - P=MU. That is, a consumer will purchase all units of a product up to the point at which the marginal utility (which is declining) is equal to the price of the product.
Price Ceiling - a government-mandated maximum price on a product
Price Controls - a government control on price, either a maximum price (price ceiling), a minimum price (price floor), a rule barring certain changes in price (price freeze), or an offer to buy product at a given price (price support)
Price Discrimination - charging different prices to different customers for the same product.
Price Elasticity of Demand - the relationship between the magnitude of change in quantity demanded and the magnitude of change in price. Expressed mathematically, it is the percentage change in quantity demanded divided by the percentage change in price.
Price Floor - a government-mandated minimum price on a product
Price Freeze - usually, a price ceiling set at the current equilibrium price
Price Rationing - Scarce goods must be rationed. In a free market economy, like ours, the most frequent way of rationing scarce goods is by price. Those most willing and able to give up the bucks are those who get the product.
Price Searcher - a seller who may sell some amount of product at a variety of different prices, and therefore must search for the profit maximizing price. This would include any seller in imperfect competition.
Price Support - a government offer to buy any amount of a product at a guaranteed price
Price Taker - a seller who must accept the going market price in order to sell any amount of output. That is, a seller in pure competition.
Product Differentiation - the process of making your company's product different somehow than those of competitors. This is an effort to decrease demand elasticity and allow higher price.
Efficiency - The production of a good in the least costly
way; occurs when production takes place at the output at which average total
cost is a minimum and at which marginal product per dollarís worth of input is
the same for all inputs.
Profit - Total Revenue - Total Cost
Profit-Maximizing Output - that level of output where marginal cost is equal to marginal revenue (MC=MR), or Total Revenue exceeds Total Cost by the maximum amount. These to output levels will be the same.
Pure Competition (a.k.a. perfect competition) - A market structure in which a very large number of firms sell a standardized product into which entry is very easy in which the individual seller has no control over the product price and in which there is no nonprice competition; a market characterized by a very large number of buyers and sellers.
- A market structure in which one firm sells a unique product into which entry
is blocked in which the single firm has considerable control over product price
and in which nonprice competition may or may not be found.
Short Run - that period of time in which at least one cost is fixed, typically the cost of the plant.
Substitutes - goods that can be used in place of one another, or instead of one another, such as hot dogs and hamburgers
Substitution Effect - the effect of a change in a product's price on its relative price (i.e. price relative to its substitutes), and hence on the quantity demanded of the product. For normal goods, a price increase makes the product relatively more expensive, consumers find substitutes and therefore quantity demanded decreases (supporting the law of demand).
Supply - the relationship between price (or opportunity cost) and the quantity of something that will be supplied at that price
Supply, Law of - price and quantity supplied are directly related. That is, when the price (or benefit) of something increases, the quantity supplied also increases.
Supply Curve - a graph showing the relationship between price and quantity supplied
Supply Schedule - a listing of prices and the quantities supplied at each price
Total Cost - all the costs of production of a certain number of units: fixed costs plus variable costs.
Total Receipts - the same thing as total revenue. [Well, some may quibble with this. For example, a widget manufacturer may sell its old building. This is another source of revenue, but not part of total receipts for sales.]
Total Revenue - price times the number of units sold
Total Utility - the total utility associated with the consumption of a given number of units of a product. In other words, if you own 47 CDs, total utility is what all those CDs are worth to you. Compare to marginal utility, where we're talking about the extra value to you of owning a 48th CD. Click here for a graphical depiction of the relationship between total and marginal utility.
Unit Elastic Demand - the percentage change in quantity demanded is equal to the percentage change in price. This produces an elasticity coefficient equal to 1.0. Also, total receipts do not change when the price changes. In other words, a higher price results in the same total receipts. [Note: This doesn't necessarily mean equal profits because we haven't factored in the cost of production yet.]
Utility Maximizing Rule - a consumer should allocate her income so that the marginal utility of the last unit consumed of each product is the same. MUa/Pa = MUb/Pb. Combined with the optimal purchase rule, it is MUa/Pa = MUb/Pb = 1.
Variable cost - the cost that changes when the level of output changes