Glossary
Click on the letter links below to access definitions of all key terms from the textbook.
Abatement cost
The cost borne by the producer in reducing an externality.
Action profile (outcome)
Combinations of actions that might be chosen by players.
Advances in technology (technological progress)
Changes in the state of technology over time.
Adverse selection
Asymmetric information exerts a negative externality on sellers of high-quality goods.
Anchor
Information used as the starting point for making a decision.
Arrow’s Impossibility Theorem
No rank-order voting system can convert individual preferences into a satisfactory social preference ordering.
Artificial monopoly
A firm’s monopoly power if derived from legal restrictions that prevent entry.
Asymmetric information
The situation in which players’ information sets differ.
Attributes
Observable signs, which can be manipulated by informed players and whose value is used by uninformed players to update priors.
Auction
Selling a good by inviting potential buyers to announce the amount they are willing to pay.
Auctioneer
A person who announces successive prices until declaring a set at which markets clear.
Availability
The ease of recall of an item, taken as a measure of its relative frequency.
Average cost
The production cost per unit of output.
Bayesian learning
Revision (or updating) of a prior on receipt of information.
Bayesian prior
A random variable, defining beliefs whose subjective probability distribution changes as information is received.
Bliss point
The ideal consumption bundle.
Budget (affordability) constraint
Those consumption bundles that cost the full amount of money available.
Budget (affordable) set
All the consumption bundles that can be acquired for a cost less than income.
Capital input
The monetary value of assets used in business.
Changes at the margin
Very small changes in the level of an activity.
Characteristics
Sources of utility embodied within a good.
Characteristics (of experience goods)
Underlying (unobservable) qualities of a good, which nevertheless determine its value.
Cognitions
Mental processes involved in knowledge acquisition.
Cognitive dissonance
Mental tension caused by mutually incompatible cognitions.
Collusion
Agreement between firms regarding their behaviour in order to increase their profits.
Common property resource
An excludable resource to which members of a group have access.
Common values
A good with the same value to all bidders, for which estimates of value are inferred from signals.
Compensated (Hicksian) demand
The demand of the expenditure-minimizing consumer.
Competitive game
A game in which increasing payoffs for one player require a reduction in others’ payoffs.
Completeness
A preference relation defi ned for every pair of consumption bundles.
Conjecture
A belief about actions that competitors will choose.
Consistent conjectures
All firms’ beliefs about competitors’ actions are correct.
Conspicuous consumption
A public display of consumption to demonstrate wealth.
Constrained maximization
Methods for solving problems of choice whereby solutions are drawn from a restricted set.
Consumption bundle
A combination of quantities of the goods available to the consumer.
Consumption profile
A list of total expenditure in a sequence of time periods.
Convexity
Every preferred set is convex.
Coordination game
A game with several equilibria, in which players realize gains by coordinating their actions.
Cost function
The least possible expenditure required to produce any level of output, given input prices.
Costs of production
The expenditure that is necessary in order to make sales.
Cournot conjecture
The belief that a competitor’s output will not vary with own output.
Demand function
The relation between the price of a good and the quantity that a consumer buys.
Discount factor
The ratio of the present value of money to its future value.
Dominant strategy
The action that is the best reply to all actions other players might choose.
Dominant strategy equilibrium
The Nash equilibrium in which every player’s strategy is dominant.
Dutch (descending) auction
An auction conducted by open outcry, with the WTA descending; the first bid wins.
Economic efficiency
A state in which reallocation of resources cannot improve the outcome.
Economic efficiency in production
A property of the cost-minimizing input bundle: changing inputs while holding expenditure constant causes costs to increase.
Economic surplus
The difference between WTP and WTA; the social benefit from a transaction.
Elastic (or inelastic) demand
A proportionate reduction in demand following a price rise that is greater than (less than) the proportionate price rise.
Elasticity of substitution
The proportional change in the composition of a bundle that results from a small proportional change in the marginal rate of substitution.
Engel curve
A graph of demand plotted against income.
English (ascending) auction
An auction in which bids are made verbally, ascending in value until no higher bid is received.
Envelope
A curve that forms boundary of other curves.
Equi-marginal principle
A rule that, when the resource is being used as effectively as possible, the ratio of marginal benefi ts to costs will be the same across all alternative uses of the resource.
Eventually diminishing returns to scale
Returns to scale that diminish only when output is high.
Excess demand
A situation in which potential sellers offer less of a good than buyers wish to purchase.
Excess market demands
A demand for a good that is beyond the quantity in the endowment.
Excess supply
A situation in which potential sellers offer more of a good than buyers wish to purchase.
Exchange economy
A model in which endowments take the form of bundles of goods, which are then traded.
Excludability
A property of a good that allows its owner to prevent others from using it.
Expected utility
A probability weighted sum of all possible values of utility scores from a lottery; the mean of utility.
Expected value
A probability weighted sum of all possible values of a random variable; the mean value of the variable.
Expenditure function
The least money required to reach an acceptable utility, given the prices of goods.
Expenditure share
The proportion of money spent on a specific good.
Experience good
A good whose nature can be confirmed only through use.
Extensive form of game
A representation of a strategic game in which decisions can be made sequentially.
Externality
The effect of one individual’s decisions on another’s payoffs.
Factor of production
An asset hired by a firm in its production process.
Firm
A business entity; often a limited company.
First-degree price discrimination
Selling each unit of a good at a different price.
First-price auction
An auction in which the highest bidder wins and pays their own bid.
Free-riding
Obtaining access to a public good without contributing to the cost of its provision.
Fungible assets
Assets such that individual units are perfect substitutes.
Future value
The value of a sum of money available at the present time, evaluated at a certain time in the future.
Game
A mathematical model of interactions between decision makers.
General equilibrium
All market prices are determined at the same time, with simultaneous market clearing.
Giffen behaviour
An increase in the price of a good leads to an increase in demand.
Heuristic
A decision-making rule.
History
The path through a decision tree, from the initial node to the payoffs.
Homogeneity of degree t
The responsiveness of a function to scalar changes in inputs.
Horizontal differentiation
Spatial differentiation such that consumers’ preferences over characteristics differ.
Incentive compatibility
A property of a mechanism such that participants reveal their true type.
Income effect
The change in demand following a price increase that is associated with a loss of purchasing power.
Income elasticity of demand
The responsiveness of a consumer’s demand to a change in income.
Income expansion path
A curve showing the most-preferred, affordable consumption bundles as income varies.
Income offer curve
An alternative name for the income expansion path.
Incomplete information
The situation in which a player in a game lacks information relevant to a decision.
Independence
A quality of successive trials, such that the outcome of one cannot be (causally) related to the outcome of the others.
Indifference
Equal ranking of outcomes, so that neither is seen as better than the other.
Indifference curve
The representation of all equally preferred consumption bundles.
Indirect utility
The greatest utility possible given prices and the money available to finance consumption.
Individual (firm) supply
The quantity of output produced by a fi rm at a given price.
Individual demand
The quantity of a good purchased at a given price.
Inferior good
A good for which demand decreases with income.
Instantaneous utility
The utility generated in a specific time period.
Inverse demand function
The price a firm can set as a function of the quantity consumers demand.
Isocost line
All of the input combinations that can be hired for a set price.
Isoprofit curve
A contour of profit function, showing combinations of firm outputs for which one firm achieves a target profit.
Isoquant
A curve that shows input combinations for which output is constant.
Labour input
The number of hours of effort directed to production activity.
Law of small numbers
The belief that a sample should have the distributional properties of the whole population.
Long run
A period in which the use of all factors can be varied.
Loss aversion
A desire to avoid losses.
Lottery
A description of an experiment in terms of the values taken by a random variable, representing outcomes and their associated probability distribution
Marginal cost
The rate at which costs change as output changes.
Marginal product
The rate of change of output as usage of one input varies.
Marginal rate of substitution (MRS)
The rate of decline in consumption of a good that compensates for the rising consumption of an alternative good.
Marginal rate of technical substitution
The rate at which one factor input must be substituted for another in order to maintain output.
Marginal rate of transformation
A rate at which output of one good falls as output of another increases.
Marginal utility
The rate of change of utility as the quantity available of one good increases.
Marginal utility of a good
The rate of change of utility as consumption of the good increases, consumption of other goods being held constant.
Market clearing
A situation in which potential sellers offer the quantity of a good that buyers wish to purchase.
Market coverage
Firms’ strategies ensure that all consumers are in the market, with no unmet demand.
Market demand
The total quantity of a good purchased in a market at a given price.
Market equilibrium
The market price and the quantity traded such that the market supply equals the market demand.
Market power
A situation in which market participants, by their actions, can affect the quantity traded or the market price.
Market price
The price at which all transactions completed in a market take place.
Market supply
The total quantity of a good brought to market at a given price.
Markets
An abstraction from the physical concept of a place and a time at which buyers and sellers of a good or a service meet to take part in exchanges.
Mechanism
An incentive structure designed to elicit the truthful revelation of type or preferences.
Median voter
A person at the centre point of a one-dimensional distribution of political beliefs.
Median voter theorem
The claim that the manifestos of political parties are very similar on the basis that to win power each party requires the support of the median voter.
Method of equal gradients
A method of solving problems of choice that explicitly applies the equimarginal principle and resource constraints.
Minimax strategy
The strategy of choosing the action that has the highest minimum payoff.
Mixed strategy
A probability distribution over actions, used to choose a player’s action.
Monopoly
The firm is the only supplier in a market.
Monotonically increasing transformation
A larger domain value leads to a larger image value.
Monotonicity
If bundle Y has no less of any good than bundle Z, then Y is (weakly) preferred to Z.
Nash equilibrium
An outcome in which all strategies are the best replies to other players’ actions.
Natural monopoly
A firm’s monopoly power if derived from increasing returns in production.
Negative externality
Externality with a harmful effect.
Network externality
A benefit accruing to the user of a good or a service from its use by others.
Nominal income
The money that is available to purchase goods and services.
Normal good
A good for which demand increases with income.
Numeraire
A good that serves as unit of value in the economy.
Oligopoly
A market structure in which a few fi rms supply a good or service.
Open access resource
A non-excludable but rivalrous resource.
Operant conditioning
Learning based on the acquisition of rewards (or the experience of punishment) for behaviour.
Opportunity cost
The quantity of goods forgone in order to increase consumption of some specific good.
Ordinary (Marshallian) demand
The demand of the utility-maximizing consumer.
Parameter
A value in a model that is fixed but indeterminate.
Pareto efficiency
A division such that no further Pareto improvements exist.
Pareto improvement
A division of endowment such that no one is worse off and at least one person is better off.
Pareto set (contract curve)
All divisions are Pareto-efficient.
Partial equilibrium
A market outcome that is determined by conditions in that market only.
Participation constraint
Faced with a discrete choice, participation does not make the agent worse off.
Perfect Bayesian equilibrium
Equilibrium of an extensive game with incomplete information, in which all players’ revisions of priors and strategies are consistent.
Perfect complements
A pair of goods for which the marginal rate of substitution is zero.
Perfect divisibility
Technology that allows infi nitesimally small increments in factor use.
Perfect information
A situation in which a person has all the information she or he needs to make a decision.
Perfect market
A market in which the assumptions of perfect competition all hold.
Perfect price discrimination
Selling each unit of a good at the buyer’s WTP.
Perfect substitutes
A pair of goods for which the marginal rate of substitution is constant.
Perfectly elastic demand
The demand falls to zero after any price rise.
Perfectly inelastic demand
No change in demand after a price rise.
Pigovian tax
A tax whose marginal rate is the marginal social cost less the marginal private cost.
Player
A participant in a game.
Point elasticity
The elasticity measure at a specific point on a curve.
Positional consumption
Utility depends upon the level of consumption relative to other consumers’ consumption.
Positive externality
Externality with a beneficial effect.
Preference
A ranking of two outcomes based on which one is considered better.
Preference ordering
A complete ranking of all consumption bundles.
Present value
The value of a sum of money available at some future date, as if available now.
Price discrimination
Selling units of a good at different prices.
Price elasticity of demand
The responsiveness of a consumer’s demand to changes in prices.
Price offer path
The set of all the most-preferred, affordable consumption bundles that are formed when the price of one good varies.
Price taker
A firm that accepts the market price as given.
Price–cost margin
A monopoly’s ability to make profits from a marginal transaction.
Private cost
The cost borne by an individual in making a decision that gives rise to an externality.
Private good
A good that is excludable and rivalrous.
Private values
Personal valuations derived from private signals.
Probability distribution
A function that measures the likelihood of particular events occurring.
Procedural (bounded) rationality
Making choices using some prescribed decision making process.
Product uniformity
The situation in which all units of a good are identical.
Production
The process by which a firm takes factor inputs and turns them into goods and services.
Production function
The relationship between inputs used and output.
Production possibility frontier
A curve formed from just feasible output combinations.
Profit
A firm’s revenues from sales, less the costs of production.
Profits
The difference between revenues and costs.
Prospect
An alternative name for a lottery.
Prospect theory
A behavioural theory of decision making when faced with uncertainty.
Public good
A good that is both non-excludable and non-rivalrous.
Quantity leader
The firm in an oligopoly that chooses its output level first.
Random variable
A function whose value is determined by random events.
Randomness
A quality of a trial such that all outcomes are equally likely to occur.
Reaction function
The optimal choice as a function of conjectures about competitors’ behaviour.
Real income
The capacity to generate utility from consumption.
Reflexivity
A preference relation that allows the bundle to be compared with itself.
Representativeness
The probability of an outcome greater where the sample’s distributional properties are the same as those of the population.
Returns to scale
A measure of the responsiveness of output to the scale of inputs.
Revenue (total revenue)
A firm’s income from selling output.
Revenues
The income that the seller obtains from sales of goods and services.
Risk aversion
Behaviour that reflects a preference for a certain outcome rather than participation in lotteries.
Risk-loving
Behaviour that reflects a preference for participation in lotteries rather than a certain outcome.
Risk neutrality
Indifference between certain outcomes and participation in lotteries.
Risk premium
The payment that a risk averse person will make to transfer the risk to someone else.
Rivalrousness
A property of a good such that use by one person reduces the quantity available to others.
Satisficing
Setting an acceptability target for a choice, and stopping a procedurally rational process as soon as the target is reached.
Scale of production
Given constant technology, a measure of the extent of use of all input factors.
Scarcity
The situation in which the quantity of a good or service that is sought is less than the amount that is available.
Sealed-bid auction
An auction in which bids are submitted in writing.
Second-degree price discrimination
Setting a different price for each buyer of the good.
Second-price auction
An alternative name for a Vickrey auction.
Self-perception theory
Justification of a choice by assertion of the existence of preferences.
Separation
The outcome of a game in which a signal allows correct identification of types.
Short run
A period in which the use of one factor is fixed.
Signal
Manipulation of an attribute to convey information about a characteristic.
Social cost
The cost of activity, including negative externalities.
Social planner
An individual with authority to allocate resources to maximize social welfare.
Social preferences
An aggregation of individual preferences over outcomes.
Social welfare function
A function that weights individual preferences.
Spatial differentiation
The distribution of goods’ characteristics that can be measured.
State of technology
A measure of the inputs required at any time to produce an output unit.
Strategic game of complete information
A game in which a fi xed group of players choose their actions at the same time, anticipating others’ behaviour.
Strategic interdependence
A situation in which the decisions of each participant affect all other participants’ payoffs.
Strategy
Actions that a player chooses, given that player’s beliefs (about other players’ actions).
Strategy (in extensive games)
A listing of the actions that a player chooses (given previous actions) whenever called on to make a choice.
Sub-game
The part of game that begins at the end of a sub-history, whose length is the number of decisions made in it.
Sub-game perfection
An outcome such that the choice made at the end of every sub-history is optimal within the subsequent sub-game.
Sub-history
The initial part of the history.
Subsistence
The minimum consumption required for survival.
Substitution effect
The change in demand following a price increase for a consumer with a fixed utility target.
Superior good
A good for which demand increases more rapidly than income.
Technical efficiency
Production using an input combination such that using less of any input produces a fall in output.
Technology
The relative intensity of use of input factors in production.
Technology of production
The combination of inputs used in producing a (unit) quantity of output.
Third-degree price discrimination
Setting a different price for each class of buyer.
Total effect
The change in demand following a price increase for a consumer with a fi xed amount of money to spend.
Total product
The output that a firm can produce when use of only one input varies.
Transitivity
A preference relation that is consistent, and can therefore be applied successively.
Two-part tariff
A charging structure based on an access fee plus usage fees.
Utility
A measure of the strength of preference for a bundle, set by the preference ordering.
Utility possibility frontier
A curve formed from utility combinations that are just feasible.
Variable
A value in a model that is obtained by solving the model.
Vertical differentiation
Spatial differentiation with agreement on the ranking of products.
Vickrey auction
An auction conducted with written bids, in which the highest bidder wins, and pays an amount equal to the second highest bid.
Vickrey–Clarke–Groves mechanism (VCG)
A mechanism that charges people for the costs that their choices impose on others.
Walrasian equilibrium
A set of prices that ensures that all markets clear at the same time.
Weak preference
Ranking two outcomes based on one being considered at least as good as the other.
(Weakly) preferred set
All consumption bundles that are ranked at least as highly as the reference bundle.
Welfare loss of monopoly
The cost to society of a good being produced by a monopoly rather than by a perfectly competitive industry.
Well-behaved preferences
An ordering represented by infinite, convex, closed, nested preferred sets.
Willingness to accept (WTA)
The minimum price for which a seller will sell one unit of a good.
Willingness to pay (WTP)
The maximum price that a consumer will pay for one unit of a good.
Zero-sum game
A game in which payoffs in all outcomes sum to zero: a purely competitive game.
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