• Supply curve: Relationship between the quantity of a good that producers are willing to
sell and the price of the good.
• Qs = Qs(P)
• Change in supply to refer to shifts in the supply curve, while reserving the phrase
change in the quantity supplied to apply to movements along the supply curve.
• Q D Q (D)
• Change in demand to refer to shifts in the demand curve and reserve the phrase change
in the quantity demanded to apply to movements along the demand curve
• Substitutes: Two goods for which an increase in the price of one leads to an increase in
the quantity demanded of the other
• Complements: Two goods for which an increase in the price of one leads to a decrease
in the quantity demanded of the other
• Equilibrium (or market-clearing) price: Price that equates the quantity supplied to the
• Market mechanism: Tendency in a free market for price to change until the market
• Surplus: Situation in which the quantity supplied exceeds the quantity demanded.
• Shortage: Situation in which the quantity demanded exceeds the quantity supplied.
• Elasticity: Percentage change in one variable resulting from a 1-percent increase in
• Price elasticity of demand: Percentage change in quantity demanded of a good
resulting from a 1-percent increase in its price.
∆ ∆ P¿
o EP= ( Q)/(%
o E = ∆ Q/Q)/ ( ) = (P/Q)( ∆Q/∆ P¿
• linear demand curve: Demand curve that is a straight line. Q = a –bP
• infinitely elastic demand: Principle that consumers will buy as much of a good as they
can get at a single price, but for any higher price the quantity demanded drops to zero,
while for any lower price the quantity demanded increases without limit.
• completely inelastic demand: Principle that consumers will buy a fixed quantity of a
good regardless of its price.
• income elasticity of demand: Percentage change in the quantity demanded resulting
from a 1-percent increase in income.
• cross-price elasticity of demand: Percentage change in the quantity demanded of one
good resulting from a 1-percent increase in the price of another.
• price elasticity of supply”: Percentage change in quantity supplied resulting from a 1-
percent increase in price. • point elasticity of demand: Price elasticity at a particular point on the demand curve.
• arc elasticity of demand: Price elasticity calculated over a range of prices. Ep = (LlQ/
• cyclical industries: Industries in which sales tend to magnify cyclical changes in gross
domestic product and national income.
• linear demand curve: Q = a - bP + cI
• Elasticity and parallel demand shift: Ep = ( Q/ P)(P/Q) = -b(P /Q)
• Log-linear form: the isoelastic demand curve appears as follows:
o –b is price elasticity, income elasticity is c
o log(Q)= a - b log(P)+ c log(I)
• Multiple regression analysis: Statistical procedure for quantifying economic
relationships and testing hypotheses about them.
• Linear regression Model specifying a linear relationship between a dependent variable
and several independent (or explanatory) variables and an error term.
• Linear regression:
• Logarithm of income:
• Least-squares criterion: Criterion of "best fit" used to choose values for regression
parameters, usually by minimizing the sum of squared residuals between the actual
values of the dependent variable and the fitted values.
• Sample: Set of observations for study, drawn from a larger universe.
• 95% confidence interval: b ± 1.96 (standard error of b
• Standard error of the regression: Estimate of the standard deviation of the regression
• R-squared (R ): Percentage of the variation in the dependent variable that is accounted
for by all the explanatory variables.
• Theory of the firm: explanation of how a firm makes cost-minimizing production
decisions and how its cost varies with its outputs
• Production decisions of firms: (1) production technology; (2) cost constraints; (3) input
• Factors of production: inputs into the production process
• Production function: function showing the highest output that a firm can produce for
every specified combination of inputs
o q = F(K,L) = highest output = F(capital, labour) • Short run: period of time in which quantities of one or more production factors cannot be
• Fixed input: production factor cannot be varied
• Long run: amount of time needed to make all production inputs variable
• Average product: output per unit of a particular input
o Average product of labour = q/L
• Marginal product: additional output produced as an output is increased by one unit
o Marginal product of labour =
• Law of diminishing returns: principle that as the use of an input increases with other
inputs fixed, the resulting additions to output will eventually decrease
• Labour productivity: average product of labour for an entire industry or for the
economy as a whole
• Stock of capital: total amount of available for use in production
• Technological change: development of new technologies allowing factors of production
to be used more effectively
• Isoquant: curve showing all possible combinations of inputs that yield the same output
• Marginal rate of technical substitution (MRTS): amount by which the quantity of one
input can be reduced when one extra unit of another input is used, so that output
o MRTS = - Change in capital input / change in labour input = -∆ K/ ∆ L
• Additional output from increased use of labour = (MP L( ∆ L¿
• Reduction in output from decreased use of labour = (MP )K ∆ K ¿
∆ ∆K ¿=0
• (MP L( L) + (MPK)(
• (MP L/(MP )K= (- = MRTS
• Fixed-proportions production function: production function with L-shaped isoquants,
so that only one combination of labor and capital can be used to produce each level or
• Returns to scale: rate at which output increase and inputs are increased proportionately
• Increasing returns to scale: situation in which output more than doubles when all
inputs are doubled
• Constant returns to scale: situation in which output doubles when all inputs are
• Decreasing returns to scale: situation in which output less than doubles when all
inputs are doubled
• Accounting costs: actual expenses plus depreciation charges for capital equipment
• Economic cost: cost to a firm of utilizing economic resource in production, including
opportunity cost • Opportunity cost: cost associated with opportunities that are foregone when a firm’s
resources are not put to their best alternative use
• Sunk cost: expenditure that has been made and cannot be recovered
• Total cost (TC or C): total economic cost of production, consisting of fixed and variable
• Fixed cost (FC): cost that does not vary with the level of output and that can be
eliminated only by shutting down
• Variable cost (VC): cost that varies as output varies
• Amortization: policy of treating a one-time expenditure as an annual cost spread out
over some number of years
• Marginal cost (MC): increase in cost resulting from the production of one extra unit of
o MC = ∆ VC/ ∆ q = ∆ TC/ ∆ q
• Average total cost (ATC): firm’s total cost divided by its level of output
• Average fixed cost (AFC): fixed cost divided by the level of output (FC/q)
• Average variable cost (AVC): variable costs divided by the level of output (VC/q)
∆ ∆ ∆ ∆
• MC = VC/ q = w L/