CLEP Principles of Microeconomics key terms

The condition in which human wants exceed the limited resources available to satisfy them. Because resources are finite, every choice involves giving something up, which forces individuals and societies to prioritize among competing uses.

The value of the next best alternative forgone when a choice is made. It includes both explicit monetary costs and implicit costs such as forgone time or income, and it underlies the shape of the production possibilities curve.

The resource inputs used to produce goods and services: land (natural resources), labor, capital (produced means of production such as machinery), and entrepreneurship. Payments to these inputs are rent, wages, interest, and profit respectively.

A graph showing the maximum combinations of two goods an economy can produce given fixed resources and technology. Points on the curve are efficient, points inside are inefficient, and the bowed-out shape reflects increasing opportunity cost.

The ability to produce a good at a lower opportunity cost than another producer. Specialization according to comparative advantage allows mutually beneficial trade even when one party has an absolute advantage in everything.

The ability to produce more output with the same resources, or the same output with fewer resources, than another producer. It concerns productivity levels rather than opportunity cost and does not by itself determine the gains from trade.

The rate at which one good exchanges for another in trade, often expressed as a price ratio. Mutually beneficial exchange requires a rate lying between the two parties' domestic opportunity costs.

A situation in which resources are allocated so that no reallocation can make someone better off without making someone else worse off, and all mutually beneficial exchanges have occurred. Productive efficiency means producing at minimum average cost.

The condition in which resources are distributed among goods so that the marginal benefit of the last unit produced equals its marginal cost. Price equals marginal cost in a perfectly competitive market at long-run equilibrium.

The principle that, all else equal, quantity demanded falls as price rises and rises as price falls. The inverse relationship reflects diminishing marginal utility and substitution toward cheaper alternatives.

A downward-sloping graph of the quantity of a good buyers are willing and able to purchase at each price, holding other influences constant. A shift of the curve reflects a change in a demand determinant rather than a price change.

The specific amount of a good buyers are willing and able to purchase at a particular price. A change in price moves along the demand curve and changes quantity demanded, not demand itself.

An upward-sloping graph showing the quantity sellers are willing to offer at each price, holding other factors constant. It reflects rising marginal cost, and its position shifts with technology, input prices, or the number of sellers.

The price and quantity at which quantity supplied equals quantity demanded. At this point there is neither a shortage nor a surplus, and the market clears without pressure for further price change.

The price at which the quantity of a good that buyers want to purchase exactly equals the quantity sellers want to sell. Also called the market-clearing price, it leaves no tendency for price to rise or fall.

A situation in which quantity demanded exceeds quantity supplied because the price is below equilibrium. Shortages create upward pressure on price until the market clears.

A situation in which quantity supplied exceeds quantity demanded because the price is above equilibrium. Surpluses create downward pressure on price, and the excess is sometimes called a glut.

A measure of how responsive quantity demanded is to a change in price, calculated as the percentage change in quantity divided by the percentage change in price. Demand is elastic when the value exceeds one and inelastic when it is below one.

A method of judging demand elasticity by observing how total revenue moves when price changes. If price and total revenue move in opposite directions, demand is elastic; if they move together, demand is inelastic.

The amount a firm receives from selling its output, equal to price multiplied by quantity sold. Its behavior as price changes reveals demand elasticity, and its relationship to total cost determines profit.

Goods that can replace one another in use, so that a rise in the price of one increases demand for the other. The availability of close substitutes tends to make demand more price elastic.

Goods consumed together, so that a rise in the price of one reduces demand for the other. Examples include printers and ink cartridges, where the products are jointly used.

A legally imposed maximum price, set below equilibrium to be binding. It produces shortages, nonprice rationing, and reduced quality or quantity supplied, and it lowers total surplus in the market.

A legally imposed minimum price, such as an agricultural support or minimum wage, that is binding when set above equilibrium. It creates surpluses or excess supply and typically reduces the quantity traded.

The difference between what consumers are willing to pay for a good and what they actually pay. Graphically it is the area below the demand curve and above the price, up to the quantity purchased.

The difference between the price a seller receives and the minimum price at which the seller would have supplied the good. It is the area above the supply curve and below the market price.

The loss of total surplus that occurs when a market produces less or more than the efficient quantity, as with taxes, price controls, or monopoly pricing. It measures the value of mutually beneficial trades that do not occur.

The additional cost of producing one more unit of output. The marginal cost curve is the competitive firm's supply curve above minimum average variable cost, and price equals marginal cost at the efficient output.

The additional revenue a firm gains from selling one more unit. For a perfectly competitive firm it equals price, while for a firm facing a downward-sloping demand curve it is less than price.

The rule that a firm maximizes profit by producing the quantity at which marginal revenue equals marginal cost, provided price covers average variable cost. At that output the difference between total revenue and total cost is greatest.

A market structure with many small sellers, an identical product, easy entry and exit, and complete information, so each firm is a price taker. Long-run equilibrium occurs where price equals minimum average total cost and economic profit is zero.

A seller that must accept the market price because its own output is too small to affect price. A price taker faces a horizontal demand curve, so price, average revenue, and marginal revenue are all equal.

A market with a single seller of a product having no close substitutes, protected by barriers to entry. The monopolist faces the market demand curve, sets output where marginal revenue equals marginal cost, and charges a price above marginal cost.

Conditions that prevent new firms from entering a market, such as legal patents, control of a key resource, economies of scale, or government licenses. They allow incumbent firms to sustain above-normal profit.

A market dominated by a few large firms whose decisions are interdependent, so each must consider rivals' reactions. Outcomes range from competitive to collusive, and strategic behavior is central.

A market with many sellers offering differentiated products and free entry, giving each firm some price-setting power. Short-run profits attract entry, shifting each firm's demand leftward until economic profit is zero in long-run equilibrium.

The practice of making a product distinct from rivals through branding, quality, location, or features. It gives firms downward-sloping demand curves and limited market power even when entry is easy.

The study of strategic interaction in which each player's payoff depends on the choices of others. Tools such as the payoff matrix and Nash equilibrium are used to analyze oligopoly pricing and output decisions.

An agreement among rival firms to restrict output or fix prices in order to raise joint profit. Collusion is unstable when firms have incentives to cheat and is generally illegal under antitrust law.

The level of profit just sufficient to keep a firm's resources in their current use, equal to the opportunity cost of the entrepreneur's inputs. It corresponds to zero economic profit and marks long-run competitive equilibrium.

Total revenue minus total cost, where total cost includes both explicit outlays and implicit opportunity costs. It differs from accounting profit, which deducts only explicit costs.

The markets in which households supply labor, capital, and land to firms and receive wages, interest, and rent. Demand for a factor is derived from the demand for the products it helps produce.

Demand for an input that exists because of demand for the final good it helps produce. A rise in the price of a product raises the demand for the labor and materials used to make it.

The additional revenue a firm earns by employing one more unit of an input, equal to marginal product times marginal revenue. A profit-maximizing firm hires until this value equals the input's marginal cost.

A good that is both nonrival in consumption and nonexcludable, such as national defense. Because people cannot be excluded, markets tend to underprovide it and free riding is common, justifying government provision.

The tendency of people to benefit from a good without paying for it when exclusion is impossible. It leads to underprovision of public goods and complicates voluntary collective action.

A cost or benefit of an activity that falls on third parties not involved in the transaction. Negative externalities lead to overproduction and positive externalities to underproduction relative to the efficient level.

The proposition that with clearly defined property rights and low transaction costs, private bargaining can resolve externalities efficiently regardless of who holds the rights. It highlights the role of transaction costs in practice.

A situation in which a free market fails to allocate resources efficiently, producing a deadweight loss. Causes include externalities, public goods, market power, and imperfect information.

Government action to prevent anticompetitive behavior such as price fixing, monopolization, and mergers that substantially lessen competition. Enforcement aims to preserve market competition and protect consumers.

A tax for which the average tax rate rises as income rises, so higher-income taxpayers pay a larger share of income. It contrasts with proportional and regressive structures and affects the distribution of income.

The division of a tax's burden between buyers and sellers, determined by relative elasticities rather than by who legally pays. The less elastic side of the market bears the larger share of the tax.