Definitions of Key Concepts Econ 1101 Section 042 Konstantin Golyaev Department of Economics University of Minnesota December 12 2007 Abstract This document contains the most important definitions for the concepts we use throughout the course I plan to update it periodically as we move along You are assumed to know the definitions in this document Some extra comments that are inside might help to clarify those definitions that are not quite obvious 1 Contents 1 General Terms 3 2 Trade 4 3 Consumer Problem 5 3 1 Indifference Curves and Budget Lines 5 3 2 Demand 7 3 3 Elasticity 8 4 Producer Choice 9 4 1 Costs 4 2 Profit 9 11 5 Supply and Demand Equilibrium 12 5 1 Supply 12 5 2 Equilibrium 12 5 3 Government Policies 13 5 4 Welfare Measurement 14 6 Perfect Competition 15 7 Monopoly 16 8 Monopolistic Competition and Oligopoly 17 9 Game Theory 18 10 The Limitations of the Markets 20 2 1 General Terms Definition 1 Economics a social science that studies the choices a society makes when resources are scarce For this definition to make sense we should know what are resources and what does it mean for resources to be scarce Which brings us to the following definitions Definition 2 Resources the instruments provided by nature or by people that are used to create goods and services We also refer to those as inputs or factors of production Economists usually group all resources into three groups 1 Land and other natural resources like soil minerals water 2 Labor i e human labor 3 Capital mostly things created by people like factories and machines Definition 3 Scarcity means that resources are limited wants are greater than the resources available to satisfy those wants Now the definition of Economics should make sense but this a very broad definition As you probably already know there are two subfields in economics Microeconomics and Macroeconomics Micro like microscope focuses on small details individual units Macro larger scale focuses on many individuals acting together as aggregate units Definition 4 Microeconomics the study of how individual households or consumers and firms make decisions Definition 5 Macroeconomics the study of the behavior of the overall economy economic aggregates Aggregating means many things are all added together Definition 6 Economic model a simplified small scale version of some aspect of the economy Usually expressed in equations graphs or just words 3 Definition 7 Opportunity costs the value of the next best alternative that must be given up because of the decision Definition 8 Output the goods and services a firm or economy in general produces Definition 9 Optimal decision one that best serves the objectives of the decision maker whatever those could be This optimal decision is selected by comparison with the possible alternative choices Some people tend to make a mistake and interpret the word optimal as a synonym of good This is in general a mistake because in economics optimality bears no connotation of good and evil it is just a term that means what the definition states and nothing more than that Definition 10 Efficiency a term that refers to a situation that is efficient A set of outputs is efficient if given the technology available there is no way to produce larger amounts of any output without giving up some quantity of any other output Again like in the case with the word optimal there is no connotation with this word In particular efficiency and equality are two completely different terms see Homework 1 for a problem that explores this issue Definition 11 Allocation of resources decision on how to divide up the scarce resources inputs among the different outputs that are produced 2 Trade Definition 12 Production Possibilities Frontier a curve that shows the different combinations of various goods that a producer can turn out given the available resources and technology Definition 13 Absolute advantage AA country X has AA over country Y if both countries X and Y can produce the same good and X can produce more of this good than Y can 4 Definition 14 Comparative advantage CA country X has CA over country Y if both countries X and Y can produce the same good and X can produce this good less inefficiently i e with lower opportunity costs than Y can A good example that illustrates this principle would be me and some hypothetical lady called Linda who is a very gifted doctor Maybe she is also good as a lecturer in our class but the idea behind the principle of comparative advantage is that Linda should not try to teach the class because I would be a terrible doctor so I am less inefficient in teaching than Linda 3 3 1 Consumer Problem Indifference Curves and Budget Lines Definition 15 Total utility from given quantity of good X measured in money terms the maximum amount of money that consumer is willing to give up to exchange for this quantity of good X Definition 16 Marginal utility from extra unit of good X measured in money terms the maximum amount of money that consumer is willing to give up to get this extra unit of good X Definition 17 Law of diminishing marginal utility additional units of a commodity are worth less and less to the consumer in money terms An equivalent way to say this is to say that as the quantity of a commodity consumed by the consumer goes up the marginal utility of each additional unit of this good decreases Definition 18 Marginal analysis method for calculating optimal choices i e choices that best promote the decision maker s objectives It works by testing whether and by how much a small change in a decision will move things towards or away from the goal Definition 19 Bundle a term we use as a shorthand for the possible combination of commodities 5 Definition 20 Budget Line graphical representation of all possible combinations of two commodities that a consumer can purchase given the prices of these commodities and some fixed amount of money at their disposal that we call income The slope of the budget line is the amount of one commodity that the market requires a consumer to give up in order to obtain one additional unit of another commodity without any change in the total amount of money spent on the two Definition 21 Indifference Curve a curve that connects all the possible combinations of the commodities bundles that are equally desirable by the consumer i e all the bundles that the consumer is indifferent between Definition 22 Marginal Rate of Substitution also understood as the slope of an indifference curve the