Chapter 2 Flashcards
Theoretical Tools of Public Finance (34 cards)
Theoretical Tools
The set of tools designed to understand the mechanics behind economic decision making.
Empirical Tools
The set of tools designed to analyze data and answer questions raised by theoretical analysis.
Utility Function
A mathematical function representing an individual’s set of preferences, which translates her well-being from different consumption bundles into units that can be compared in order to determine choice.
Constrained Utility Maximization
The process of maximizing the well-being (utility) of an individual, subject to her resources (budget constraint).
Models
Mathematical or graphical representation of reality.
Indifference Curve
A graphical representation of all bundles of goods that make an individual equally well off. Because these bundles have equal utility, an individual is indifferent as to which bundle he consumes.
Marginal Utility
The additional increment to utility obtained by consuming an additional unit of a good.
Marginal Rate of Substitution (MRS)
The rate at which a consumer is willing to trade one good for another. The MRS is equal to slope of the indifference curve, the rate at which the consumer will trade the good on the vertical axis for the good on the horizontal axis.
Budget Constraint
A mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income.
Opportunity Cost
The cost of any purchase is the next best alternative use of that money, or the forgone opportunity.
Substitution Effect
Holding utility constant, a relative rise in the price of a good will always cause an individual to choose less of that good.
Income Effect
A rise in the price of a good will typically cause an individual to choose less of all goods because her income can purchase less than before.
Normal Goods
Goods for which demand increases as income rises.
Inferior Goods
Goods for which demand falls as income rises.
Welfare Economics
The study of the determinants of well-being, or welfare, in society.
Demand Curve
A curve showing the quantity of a good demanded by individuals at each price.
Elasticity of Demand
The percentage change in the quantity demanded of a good caused by each 1% change in the price of that good.
Supply Curve
A curve showing the quantity of a good that firms are willing to supply at each price.
Marginal Productivity
The impact of a one-unit change in any input, holding other inputs constant, on the firm’s output.
Marginal Cost
The incremental cost to a firm of producing one more unit of a good.
Profit
The difference between a firm’s revenues and costs, maximized when marginal revenues equal marginal costs.
Market
The arena in which demanders and suppliers interact.
Market Equilibrium
The combination of price and quantity that satisfies both demand and supply, determined by the interaction of the supply and demand curves.
Consumer Surplus
The benefit that consumers derive from consuming a good, above and beyond the price they paid for the good.
