Glossary
absolute advantage
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In a two-goods (grapes and nuts) two-persons (Tom and Mary) economy, Tom would have absolute advantage in producing nuts if he could produce more nuts in a day than Mary. In graphical terms, Tom's PPC (PPF) would have a higher intercept on the nuts axis in the grapes-nuts space. See also "comparative advantage."
adverse selection
: Link(s)The tendency of people with higher risk wanting to be insured and people with lower risk wanting to opt out.
antitrust laws
: Link(s)Laws intended to protect consumer interests and preserve market competition.
arbitrage
: Link(s)The purchase of goods at a market where prices are lower to sell at a market where the prices are higher. These markets could be separated by geography or time.
asymmetric information
: Link(s)Information that is not equally shared between parties in a transaction. For example, the seller of a used car is likely to know more about the quality of the car than an average potential buyer.
bundling
: Link(s)Offering a number of different goods in a package for one single price to maximize profit where the desired components in the package might vary among customers.
cartel
: Link(s)Combination of sellers (usually in a generic oligopoly) to control output, price, etc. at the expense of buyers. Cartels that are not sponsored by sovereign states are subject to prosecution under U.S. antitrust laws. OPEC (Organization of Petroleum Exporting Countries) is a prime example of international cartel sponsored by sovereign countries beyond the reach of U.S. antitrust laws.
Coase theorem
: Link(s)Negative or positive spillovers will occur at the optimal level (where marginal social benefit exactly offsets marginal social cost) regardless of the initial assignment of property rights if the cost of negotiating a settlement of spillover effects (i.e., transaction cost) is zero.
commons goods
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A commons good is one that is available to all potential users but subject to congestion. A popular public beach is a commons good prone to traffic congestion in summer.
comparative advantage
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In a two-goods (grapes and nuts) two-persons (Tom and Mary) economy, Tom would have comparative advantage in producing nuts if his opportunity cost of producing nuts in terms of grapes foregone is lower than Mary. In graphical terms, Tom's PPC (PPF) would have a flatter slope viewed from the nuts axis in the grapes-nuts space. But the intercept of Tom's PPC on the nuts axis need not be higher than that of Mary's PPC on the same axis.
compensating differential
: Link(s)Wage premium that is paid to compensate for above-average hardship in working conditions.
compensation board
: Link(s)Compensation board is a subset of the board of directors. Members are supposedly non-executive (not employees of the company) board members who decide on the compensation for the top executives. Since board members are paid very well by the company, they may not want to offend the top executives who more or less appoint them. Additionally, the top executive of one company may serve on the compensation committee of another company and vice versa.
complementary goods
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Two goods (A and B) are complementary when an increase in quantity demanded for A due to a price decrease of A leads to an increase in demand for B and vice versa. For example, when airfare to Hawaii goes down, more tickets are sold. That is, quantity demanded increases. When more tickets are sold, more hotel rooms at Hawaii are needed even though hotel rates have not changed. That is, demand has increased. (Note: Professor Richard Evans provided this example.)
congestion game
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A strategic game situation where the average payoff decreases as more people choose a given option.
consumer surplus
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Consumer surplus is the gap between what buyers are willing to pay and what they actually pay. Consumer surplus is highest when sellers' economic profit is zero and zero when sellers can practice perfect price discrimination (i.e., selling each unit at buyer's reservation price). See also "economic surplus."
- Cheap Pearls
- Just-in-time Labor Division
- Why Are Better Seats "Underpriced?"
- A la carte or table d’hote?
- Should parking be free?
- Consumer surplus under single pricing vs price discrimination
- Competitive Strategy
- How Much Is Anything Worth?
- Pricing and economic surplus
- Surplus under Single-pricing vs Price Discrimination
consumption rivalry
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The inability of a good to serve simultaneously more than one user without quality degradation. For example, there is consumption rivalry for an apple between more than one user. But there is no consumption rivalry for public radio signals among listeners. See also "private goods," "public goods," "low-congestion goods," and "commons goods."
coordination game
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A strategic game situation where the average payoff increases as more people choose a given option.
critical mass
: Link(s)The minimum size of subscribers needed to generate explosive growth of an activity.
de facto rights
: Link(s)De facto rights exist by custom or by default and cannot be easily taken away. But because of their uncertain legal status, they cannot be transferred or monetized. Therefore their money value is much less than their use value. The time customers can spend in a restaurant for their meals and the amount of soy sauce customers can use in a Chinese restaurant are examples of de facto rights.
deadweight loss
: Link(s)The loss of economic surplus due to an inefficient level of economic activities where economic surplus is defined as the difference between the reservation price (highest price one is willing to pay) and the marginal cost of a good.
demand schedule (curve)
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A set of price-quantity points that depicts how quantity demanded of a good is affected by changing prices. In graphical terms, a demand schedule is generally a downward-sloping curve with price on the vertical axis and quantity demanded on the horizontal axis. The downward-sloping curve shows the inverse relationship between price and quantity demanded. On a given demand curve, factors other than own price that might also affect quantity demanded are assumed to be unchanged.
demand vs quantity demanded
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Demand generally refers to the whole demand curve while quantity demanded refers to a point on the demand curve. A movement along a demand curve in response to a change in own price is called a change in quantity demanded , while a change in demand involves a physical shift of the demand curve in response to changes in factors other than own price.
differentiated products
: Link(s)Mature products that are modified to gain a slight edge over similar products to escape the fate of being a commodity.
diminishing marginal utility
: Link(s)When total utility increases at a decreasing rate as more of the same activity is pursued over a concentrated period of time, marginal utility is said to be diminishing.
disruptive technology
: Link(s)Game-changing technology that overthrows the dominant technology by first invading the low-end market that is ignored by the dominant technology.
dominant strategy
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A strategy that has better payoffs than others that a player might choose regardless of what strategy the other players choose. For example, in a PD game, choosing L is the dominant strategy as the L payoff curve is everywhere above the R payoff curve. But pursuing the dominant strategy does not guarantee a collectively superior solution.
economic profit
Total returns minus total opportunity cost. In other words, when economic profit is zero, all the opportunity costs are covered.
economic rent
: Link(s)Economic rent is a payment made to a resource in excess of what is required to elicit its supply. The payment arises from current supply scarcity or legacy benefits that are difficult to do away with. It is needed to determine the employment but not the availability of that resource.
economic surplus
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Economic surplus is the difference between the reservation price (highest price one is willing to pay) and the marginal cost of a good. Total economic surplus is the sum of total consumer surplus and total economic profit. Total economic surplus is also the difference between TWP and TC.
Under perfect price discrimination, economic surplus is maximized when profit is maximized. But under single pricing, maximizing profit does not generally maximize economic surplus.
effective care
: Link(s)Effective care interventions are viewed as medically necessary care on the basis of clinical outcome evidence (Wennberg).
efficiency
: Link(s)A state when the marginal social benefit of an activity is equal to its marginal social cost.
elastic demand
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Demand is elastic when the percentage change in quantity demanded is larger than the percentage change in price. Total revenue would increase with price decreases and decrease with price increases.
encompassing interest
: Link(s)If an individual, or an organization is entitled to a substantial portion of any increase in the output of a society and bears a large proportion of any drop in this social output, that individual or organization has an encompassing interest in that society.
equilibrium
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A state on which the system will settle after all the necessary adjustments are made and will persist if exogenous factors stay unchanged. A market is said to be in equilibrium when the quantity supplied is equal to the quantity demanded at the market-clearing price.
excess demand
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The excess of quantity demanded over quantity supplied at a given price. Also known as shortage.
excess supply
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The excess of quantity supplied over quantity demanded at a given price. Also known as surplus.
expected value
: Link(s)The expected value of a gamble is the average value of the payoffs weighted by their probabilities.
external benefits
: Link(s)Free benefits conferred on innocent third parties due to unassigned or poorly assigned property rights or when the cost exceeds the benefit of exercising properly assinged rights. Also known as positive externality.
external costs
: Link(s)Uncompensated cost imposed on innocent third parties due to unassigned or poorly assigned property rights or when the cost exceeds the benefit of exercising properly assigned rights. Also known as negative externality.
externality
: Link(s)Free benefits conferred or uncompensated cost imposed on innocent third parties due to unassigned or poorly assigned property rights or when the cost exceeds the benefit of exercising properly assinged rights.
- The Snowball Effect
- One Road's Congestion Is Another Road's Revenue
- Happiness - Absolute or Relative?
- Green Tax
- Fished Out!
- A Good Fence Makes Good Neighbors
- Systems Competition and Network Effects
- Spillovers Are Not Always Externalities
- Tragedy of the commons
- Games people play
- Property Rights and Externality
fixed cost
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Cost that stays the same in the short run regardless of the level of output or action taken. Graphically, fixed cost is represented by a horizontal line from the cost axis in the cost-ouput space.
free rider
: Link(s)A non-paying user of non-excludable goods which might or might not be subject to consumption rivalry.
gross profit margin
: Link(s)Gross profit margin is gross profit (gross of administrative and selling expenses) divided by net sales.
income
Income includes wages, government transfer payments such as Social Security, dividend income from stocks. Gains on assets, such as stocks, or the increase in equity in a house are not considered as saving. Both income and saving are flows of currently produced goods and services.
increasing returns
See "scale economies."
inelastic demand
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Demand is inelastic when the percentage change in quantity demanded is smaller than the percentage change in price. Total revenue would increase with price increases and decrease with price decreases.
inferior goods
: Link(s)Goods that are purchased less with higher income, such as generic products or house brands.
inflection point
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A transition point between the increasing-slope segment and the decreasing-slope segment of an S-shaped curve.
intercept
The point at which a curve intersects the vertical or horizontal axis of a two dimensional diagram.
law of demand
The inverse relationship between the price and the quantity demanded of a good when all other factors are assumed to be constant.
law of diminishing returns
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The law says that when some factors of production (inputs) are fixed in capacity in the short run, increasing the variable input working with the fixed inputs would first lead to increasing additional output per additional unit of variable input, but eventually decreasing additional output per additional unit of variable input.
low-congestion goods
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Goods that are not subject to consumption rivalry but can easily exclude non-payers.
marginal benefit
: Link(s)Addition to total benefit arising from buying one more unit or taking one more step. It is represented by the reservation price (highest possible price) the buyer is willing to pay. It is equal to the marginal revenue received by the perfect price discriminator, but higher than the marginal revenue received by the single-price searcher and generally by the price taker except for the last unit sold.
marginal cost
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Addition to total cost arising from producing one more unit or taking one more step. In the short run with fixed cost, these additions consist of entirely variable costs. Under diminishing returns, marginal cost will be higher than average cost if average cost is rising and marginal cost will be lower than average cost if average cost is falling.
marginal revenue
: Link(s)Addition to total revenue arising from producing one more unit or taking one more step. Marginal revenue (MR) is equal to price (P) for price takers who must accept the single market price and perfect price discriminators who can sell each unit at its reservation price. MR is below P under single-price searchers who must lower the price for all units just to sell one more unit.
market signaling
: Link(s)Proxy information that is sent between buyers and sellers to convey the quality of the product that is difficult to detect by visual inspection. To be convincing, the signal must be difficult to fake.
market structure
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Market structure depends on the uniqueness of the products, barrier to entry, and scale economy. Specifically, the more unique the product, the higher the entry barrier, and the larger the scale economy is, the greater the pricing power.
market-clearing price
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The price at which the supply and demand curves intersect and the quantity supplied is just equal to the quantity demanded.
mixed bundling
: Link(s)Offering a number of different goods in a package for one single price as well as selling the goods separately at higher prices.
monopolistic competition
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An industry with many small competitors each with some price-setting power selling slightly differentiated products. Also known as price searchers.
monopoly
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An industry with a single seller selling a unique (or patented) product and has enough market power to practice effective price discrimination.
Nash equilibrium
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A stable solution in a game situation where no parties want to change strategy given the choice of other parties. A Nash equilibium may not be collectively superior as in the case of the Prisoner's Dilemma game.
natural monopoly
: Link(s)A monopoly that arises from persistently declining average total cost (ATC) over the whole span of the demand curve. As a result, marginal cost (MC) is always below the monopolist's ATC.
network externality
: Link(s)The interdependence of demand among users of some goods whose usefulness varies with how many others are also using the goods in question. For example, fax machines and telephones.
oligopoly
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An industry dominated by a few large firms. A generic oligopoly sells homogeneous products. A differentiated oligopoly sells differentiated products.
opportunity cost
: Link(s)The cost of a resource or an action as measured by the value of the current best alternative opportunity, rather than by its committed value. As such, opportunity cost could be higher or lower than the committed cost depending on the abundance or lack of alternative uses for a given resource.
patent
: Link(s)A temporary but exclusive right given by the government to an inventor to profit from the invention in exchange for sharing the information with the public.
payoffs matrix
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In a two-party two-strategy game, the payoffs matrix is a 2 by 2 table with 4 cells each of which containing the cardinal payoffs to each party for adopting one of the 4 possible combinations of strategies. For example, the payoffs matrix for a Prisoner's Dilemma game for John and Mary with the L and R strategies may look like the following:
perfect price discriminators
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Sellers facing a downward-sloping curve whose products are unique enough to allow the sellers to charge the highest possible price that each unit can command. Total revenue (TWP) rises until price goes down to zero. On the other hand, total revenue of single-pricing sellers assumes an inverted U shape.
preference-sensitive care
: Link(s)Preference-sensitive care comprises treatments that involve significant tradeoffs affecting the patient's quality and/or length of life, such as breast cancer surgery. (Wennberg).
presumed rights
: Link(s)Presumed rights exist because of sympathy and solidarity with victims of sudden misfortune. Such rights tend to dissipate over time unless enshrined into mis-guided laws.
price ceiling
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When prices are set artificially below the market-clearing level, the controlled price is a ceiling above which it is not allowed to rise. A price ceiling would result in excess demand or shortage.
price discrimination
: Link(s)Charging different customers at or close to their reservation prices for the same goods. Price discrimination is intended to increase sellers' economic profit and reduce consumer surplus.
- Airlines in Asia Offer Personalized Prices by Age, Race, Gender
- Fare Game
- Why Are Plane Tickets Nontransferable?
- Virtual Scalping
- Banks and Others Base Their Service On Their Most-Profitable Customers
- Discriminating Business Sense
- Why Are the Prices Different?
- Get in Where You Fit in
- Total revenue under single pricing vs price discrimination
- Consumer surplus under single pricing vs price discrimination
- Profit maximization under single pricing vs price discrimination
- Competitive Strategy
- Pricing and economic surplus
- Market structure taxonomy
price fixing
: Link(s)Collusion among sellers to set prices which are likely to be higher than those under unrestricted price competition.
price floor
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When prices are set artificially above the market-clearing level, the supported price is a floor below which it is not allowed to fall. A price floor would result in excess supply or surplus.
price searchers
: Link(s)Sellers facing a downward-sloping curve who must search for the profit-maximizing price.
price takers
: Link(s)Sellers facing a horizontal demand curve who must sell all their goods at the market-determined prices.
prisoner's dilemma
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A game situation where self interest conflicts with group interest.
private goods
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Goods that are subject to consumption rivalry but can easily exclude non-payers.
private goods (demand for)
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The demand curve for private goods is a horizontal summation of individual demands because consumption of private goods is subject to rivalry.
production possibilities curve (frontier)
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A convex (bowed out from the origin) curve that shows all the possible maximum (i.e., efficient) combinations of goods that could be produced with the available resources given existing technology. The convexity of the curve shows increasing opportunity cost of producing good X in terms of foregone Y as more X is produced, and vice versa.
profit maximization
: Link(s)In the short run with fixed costs, a firm maximizes economic profit by equating marginal revenue (MR) with marginal variable cost (MC) when MC is increasing. Marginal revenue is lower than price (i.e., MR < P) if the firm must lower the price for all units just to sell one more unit.
property right
: Link(s)The control over the use or transfer of a resource. Property right is conducive to efficient use of scarce resources as owners have an incentive to maximize their long-term returns.
- Patently Deadly
- Water Disputes in California
- Making Animal Conservation Pay
- Enforce It or Lose It
- Dying for Money?
- The Dust Bowl - Natural or Man-made Disaster?
- Windfall Profit
- What Makes Rights?
- Squatters' Rights
- Shovelers Keepers?
- Right Makes Might
- Fished Out!
- A Good Fence Makes Good Neighbors
- The Tragedy of the Anticommons
- The Soviet Union - Super Power or Paper Tiger?
- Owners, Keepers?
- Spillovers Are Not Always Externalities
- Yellow Cabs, Red Tape
- Tragedy of the commons
- Market Entry
- Market Intervention and Regulation
- Pricing and economic surplus
- Property Rights and Externality
- Free-Market Solutions
- Rivalry and Excludability in Goods
public goods
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Goods that are not subject to consumption rivalry but cannot easily exclude non-payers either by design or due to technical difficuty.
public goods (demand for)
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The demand curve for public goods represents a vertical summation of individual demands because consumption of public goods is not subject to rivalry.
regulation
: Link(s)Government actions to temper the adverse effects of uncontrolled market activities.
- Making Animal Conservation Pay
- Strange Bedfellows!
- Bottom Fishing
- Windfall Profit
- The Flipper Factor
- Licensed to Kill?
- Flying in the Red
- Byrding for Profit
- The Orphan Chase
- Prices and Sanctions?
- Transaction Costs and Market Structure
- Milked to Order
- Too Much Vitamin C?
- Bundle of Sorrows
- Guilt-free Pollution
- Regulation vs price discrimination under natural monopoly
- Market Intervention and Regulation
- Free-Market Solutions
rent dissipation
: Link(s)Economic rent is dissipated when it is neither available to rent seekers nor those who creates the rent by restricting economic activities desired by rent seekers.