Behavioral economics combines elements of economics and psychology to understand how and why people behave the way they do in the real world. It differs from neoclassical economics, which assumes that most people have well-defined preferences and make well-informed, self-interested decisions based on those preferences.
By asking questions like these and identifying answers through experiments, the field of behavioral economics considers people as human beings who are subject to emotion and impulsivity, and who are influenced by their environments and circumstances.
Economics Terms
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Several principles have emerged from behavioral economics research that have helped economists better understand human economic behavior. From these principles, governments and businesses have developed policy frameworks to encourage people to make particular choices.
This classic example demonstrates that people are more willing to take a greater statistical risk if it means avoiding a $1,000 loss versus obtaining a $1,000 win, which contradicts expected utility theory. Prospect theory and other work by Tversky and Kahneman continues to inform many areas of behavioral economics research today.
In the 1980s, Richard Thaler began to build on the work of Tversky and Kahneman, with whom he collaborated extensively. Now the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the Booth School of Business, he is today considered a founder of the field of behavioral economics.
Bounded self-interest is the idea that people are often willing to choose a less-optimal outcome for themselves if it means they can support others. Giving to charity is an example of bounded self-interest, as is volunteering. While these are common activities, they are not captured by traditional economic models, which predict that people act mostly to further their own goals and those of their immediate family and friends, rather than strangers.
Loss aversion is the idea that people are more averse to losses than they are eager to make gains. For example, losing a $100 bill might be more painful than finding a $100 bill would be positive.
Prospect theory refers to a series of empirical observations made by Kahneman and Tversky (1979) in which they asked people about how they would respond to certain hypothetical situations involving wins and losses, allowing them to characterize human economic behavior. Loss aversion is key to prospect theory.
Mental accounting is the idea that people think about money differently depending on the circumstances. For example, if the price of gas goes down, they may begin to buy premium gas, leading them to ultimately spend the same amount, rather than taking advantage of the savings offered by the lower price.
A Collection of Keywords and Phrases
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A Collection of Financial Keywords and Phrases
A Collection of Keywords and Phrasesfor Decision Making
Absolute minimum: The output value of the lowest point on a graph over a given input interval or over all possible input values. An absolute minimum point is a local minimum point and occurs at an endpoint of the given input interval.
Absolute vs. Relative Price: Absolute price is the number of dollars that can be exchanged for a specified quantity of a given good. Relative price is the quantity of some other good that can be exchanged for a specified quantity of a given good. Suppose we have two goods A and B. The absolute price of good A is the number of dollars necessary to purchase a unit of good A. The relativeprice of good A in terms of B is the amount of good B necessary to purchase a unit of good A. The change in relative prices is not the same thing as changes in absolute prices. Sometimes, the absolute prices of goods may change but relative prices may remain constant. In general, we measure absolute prices in terms of dollars and relative prices in terms of units of some other good. However, many times we measure relative prices in terms of dollars also keeping in mind that the word dollar is being used to refer not to a piece of green paper but to a basket of goods. In microeconomics, the word prices always refer to relative prices.
Angle: The amount of rotation in a turn. An angle can be thought of as the counterclockwise rotation of its initial side into its terminal side. The size of an angle is the measure of this rotation, and a negative sign in front of the size indicates clockwise rotation.
Antiderivative: A function F is an antiderivative of another function f if the derivative of F is f. If F is an antiderivative of f, where both F and f have input x and C is an arbitrary constant, then y = F(x) + C is called a general antiderivative of f .
Annual percentage rate (APR): The percentage used in calculating interest each compounding period. In an investment context, the annual percentage rate (or nominal rate) is the advertised rate of interest, 100r%.
Annual percentage yield (APY): A percentage by which an investment grows over one year. Unlike APR, APY indicates the affect of the compounding periods. APY will be larger than APR any time interest is compounded more frequently than once a year.
Approximate change in a function: The rate of change of the function times a small change in the input of the function. That is, for the function f with input variable x, the approximate change in f is f ' (x).h where h represents the small change in x. The exact change is f(x + h) - f(x).
Autocorrelation: A correlation between a component of a stochastic process and itself lagged a certain period of time.
Average cost : The total production cost divided by the number of units produced.
Average rate of change: The amount that a quantity changes over an interval divided by the length of the interval. That is, if a quantity changes from a value of m to a value of n over a certain interval, the average rate of change equals n - m length of interval. The average rate of change is the slope of the secant line. Average rates of change have labels of output units per input unit.
Beta: A measure of systematic risk.
Bias: Bias is the difference between the parameter and the expected value of the estimator of the parameter.
Black-Scholes Theory: Another name for option pricing theory. Differential equations approach is an informal name for derivatives pricing models based upon the original Black-Scholes methodology.
Bootstrapping: Bootstrapping method is to obtain an estimate by combining estimators to each of many sub-samples of a data set. Often M randomly drawn samples of T observations are drawn from the original data set of size n with replacement, where T is less than n.
Break-even point: The number of units (produced or sold) for which revenue equals cost so that profit is zero.
Business Cycle Frequency: The business cycle frequency is often considered to be three to five periods.
Buyer's Market: A buyer's market is a market for a good (stocks, housing, etc.) where prices are falling and there are more parties interested in selling than in buying.
Business risk: Exposure to uncertainty in economic value that cannot be marked-to-market.
Calculus: The branch of mathematics involving derivatives and integrals.
Capital allocation: A process of choosing what ventures, deals or trades to engage in, usually based upon some cost or risk-return analysis.
Capital asset pricing model: A model for valuing financial assets based upon their systematic risk.
Cash instrument: An instrument whose value, unlike that of a derivative instrument, is determined directly by the markets.
Change: If a quantity changes from a value of m to a value of n over a certain interval, then the change in the quantity is n - m.
Changes in demand: A change in price does not lead to a change in demand. But a change in a factor other than price such as income and prices of related goods etc, does lead to a change indemand. In that case the change in demand leads to a shift in the demand curve. A fall in demand shifts the demand curve to the left and a rise in demand shifts the curve to the right. Other factors includes:Sales tax is a tax that is paid directly by consumers to the government. A sales tax makes a good less desirable and as such it affects demand. It causes the demand curve to shift towardsthe left parallel to itself by the amount of the tax.So far, we have been concerned with the demand by a single buyer. If there are N buyers in the market, then market demand is the sum of the demand by all the N buyers. The market demand curve isthe horizontal summation of individual demand curves.
Compound interest: A method of crediting interest in which interest is earned on interest.
Composition: A method of combining two functions in which the output of one function (called the inside function) is used as the input of the other function (called the outside function).
Compound interest formulas: Exponential formulas that are used to determine the amount A(t) accumulated in an account after t years when P dollars are initially invested, if the nominal interest rate is 100r% compounded n times a year.
Concavity: A description of the curvature of a graph. A graph is concave up at a point if the tangent to that point lies below the graph near the point of tangency and concave down if the line tangent to that point lies above the graph near the point of tangency. The point at which the concavity changes to convexity is called an inflection point.
Constant dollars: Dollar values that have been adjusted for inflation by means of price indexes to eliminate inflationary factors and allow direct comparison across years. Conversion to constant dollars for a given year t may be calculated as the current dollar value multiplied by the purchasing power of the dollar based on a dollar value of $1 in year t.
Correlation: A parameter, related to covariance, that indicates the tendency for two random variables to "move together" of "co-vary."
Correlation matrix: A symmetric matrix indicating all the correlations of a random vector.
Consumer Behavior: The behavior of consumers in general depends upon two major factors:
1. Tastes (as represented by the concept called indifference curves)
2. Opportunities (as represented by the income or budget line)
Consumer price index (CPI): A measure that is 100 times the ratio obtained by comparing the current cost of a specified group of goods and services to the cost of comparable items determined at an earlier date. The consumer price index or CPI is a measure of the level of inflation. CPI measures how much the price of a basket of consumer goods has changed over a given time period.
Consumers' expenditure: The actual amount spent by consumers for a certain quantity of goods or services. The consumers' expenditure equals the market price times the quantity in demand.
Consumers' surplus: The amount that consumers are willing and able to spend but do not actually spend for a certain quantity of goods or services.
Consumers' willingness and ability to spend: The maximum amount that consumers say they will spend and/or actually spend for a certain quantity of goods or services.
Continuous graph/function: A continuous graph is an unbroken curve whose set of inputs is assumed to fill up an entire interval of values along the horizontal axis. A continuous graph can be drawn without lifting the writing instrument from the page. A smooth continuous graph is one with no sharp points. A continuous function is a function whose graph is continuous. When modeling real-life situations, continuous functions could be used without restriction or could be discretely interpreted.
Continuous function used without restriction: A continuous function for which inputs of any value make sense in context.
Continuous function with discrete interpretation: A continuous function whose interpretation makes sense only at certain distinct points.
Continuous compound interest: A limiting form of compound interest where the frequency with which interest is credited approaches infinity.
Contour curve: A two-dimensional outline of a three-dimensional graph at a given output level. For a three-dimensional function f, the k-contour curve is the collection of all points (x, y) for which f (x, y) = k, where k is a constant. Contour curves are also called level curves.
Contour graph: A graph of the contour curves f(x, y) = k for several values of a constant k. Usually, the values of k are equally spaced.
Count data: Totals that are reported for a specific time period but that are not cumulative because the counter that tallies the data during the period is reset to zero at the beginning of each period. When working with count data, accumulated change in a quantity is calculated by summing the output data.
Control Variables: A control variable is a variable in a model controlled by an agent in order to optimize a specific objective.
Costs and Efficiency: A cost is a foregone opportunity. Comparative advantage is the ability to perform a given task at a lower cost. An individual/country is said to be more efficient if it has a comparative advantage in the production of some good. In other words it is said tobe more efficient.
Covariance: A parameter, related to correlation, that indicates the tendency for two random variables to "move together" or "co-vary."
Covariance matrix: A symmetric matrix indicating all the covariances and variances of a random vector.
Covariance stationarity: A property of some stochastic processes. A stochastic process is covariance stationary if neither its mean nor its autocovariances depend on the index t.
Critical point: A saddle point or a point corresponding to a relative maximum or relative minimum on a multivariable surface.
Cross section: For a two-variable function, the curve resulting when the function is intersected with a plane. A cross section of a function will always have one less dimension (variable) than the function itself.
Cross-sectional function/model: An equation describing a cross section of a multivariable function.
Cubic function/model: A function of the form f (x) = ax3+ bx2 + cx + d where a, b, c, and d are constants and not equal to zero. Cubic functions have one change in concavity (i.e., one inflection point) and no end behavior limiting values.
Cumulative density function: An accumulation function of a probability density function. The cumulative density function shows how probabilities accumulate as the value of the random variable increases.
Cyclic function: A periodic, continuous function that varies between two extremes. The part of the graph of the function that keeps repeating itself is called a cycle of the graph.
Data: Real-world information recorded as numerical values.
Decision Rules: A decision rule is either a function that maps from the current state to the agent's decision or choice, or a mapping from the expressed preferences of each of a group of agents to a group decision. The first is more relevant to decision theory and dynamic optimization; the second is relevant to game theory. The phrase allocation rule is sometimes used to mean the same thing as decision rule. The term strategy-proof has been defined in both contexts.
Decreasing without bound: A term applied to the output of a function that infinitely decreases in height. Decreasing without bound may describe either the end behavior of a function or the limiting value of a function as the input approaches a certain value.
Degree: One of 360 equal parts into which a complete revolution is divided. Degree measure is one of the ways angles can be measured and is denoted by a small circle as a superscript.
Delta: The Greek letter for the factor sensitivities measuring a portfolio's first order (linear) sensitivity to the value of an underlier.
Delta approximation: A linear approximation for how a portfolio's value will change in response to a small change in an underlier's value.
Delta-gamma approximation: A quadratic approximation for how a portfolio's value will change in response to a small change in an underlier's value.
Delta-gamma remapping: A quadratic remapping constructed from a portfolio's deltas and gammas.
Demand: The amount of a good or service that an individual is willing and able to buy at each possible price.
Demand curve/function: A graph or equation relating the quantity of goods or services that consumers demand and the price per unit of those goods or services. Mathematicians use price as input and quantity demanded as output; economists use quantity demanded as input and price per unit as output.
Demand curve: A graph illustrating demand, with prices on the vertical axis and quantity demanded on the horizontal axis. Demand curve slopes downward because of the negative relationship between price and quantity demanded.
Demand vs. Quantity demanded: Demand is a set of number that lists the quantitydemanded corresponding to each possible price whereas quantity demanded is the amount of a good or service that an individual is willing and able to buy at a given price. For instance, the information on price and quantity demanded presented in a table/demand schedule is collectively referredto as the demand.
Derivative: The mathematical term for an instantaneous rate of change. The terms derivative, rate of change, instantaneous rate of change, slope of a curve, and slope of the line tangent to a curve are synonymous.
Derivative instrument: An instrument which derives its value from the value of other financial instruments.
Depression: A depression is a severe downturn in economic activity. These are considerably worse than recessions.
Determinants of demand: Demand is affected by a number of factors. Price is the most important factor but there are other factors also thatcan influence demand such as:incomeprices of related goodstasteexpectation of the future, price and other factors
Deterministic Functions and Variables: Deterministic means not random. A deterministic function or variable often means one that is not random, in the context of other variables available. That is, those other variables determine the variable in question unerringly, by a function that would give the same value every time those other variables were given to it as arguments, unlike a random one which with some probability would give different answers.
Differential equation: An equation involving one or more derivatives. A general solution for a differential equation is a function that has derivatives that satisfy the differential equation, and a particular solution is a function obtained from the general solution and the initial conditions stated in a specific problem.
Diminishing marginal utility: Each additional unit of X yields less utility than the previous ones. This is known as the law of diminishing marginal utility. For instance,a thirsty person would derive more utility from the first glass of water than the successive ones.
Direct proportionality: For variables x and y, y is proportional to x if there exists some constant k such that y = kx. The terms proportional and directly proportional are used interchangeably. The constant k is referred to as the constant of proportionality.
Discrete: Discrete information is represented by a scatter plot or a table of data. Discrete graphs are scatter plots of data. In some situations, continuous functions are interpreted discretely; that is, outputs of the function have meaning in the context of a real-life situation only at some, not all, input values in an interval.
Diverge: A term applied to an improper integral for which the limit does not exist.
Dynamic Optimization: Dynamic optimizations are maximization problems to which the solution is a function; equivalently, optimization problems in infinite-dimensional spaces.
Econometric Model: An econometric model is an economic model formulated so that its parameters can be estimated if one makes the assumption that the model is correct.
Economics: Economics is the study of how scarce resources are allocatedto satisfy unlimited and competing ends.
Efficiency: Efficiency activity or turnover ratios provide information about management's ability to control expenses and to earn a return on the resources committed to the business, for example:Cash Turnover = Net Sales / CashInventory Turnover = Cost of Goods Sold / Average Inventory
Efficient frontier: A theoretical set of portfolios offering optimal risk-reward tradeoffs.
Elasticity: A measure of responsiveness. The responsiveness of behavior measured by variable Z to a change in environment variable Y is the change in Z observed in response to a change in Y. Specifically, elasticity = (percentage change in Z) / (percentage change in Y).
(Price) Elasticity of Demand: It is a measure of how much the quantity demanded ofa good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price:
Ed = Price Elasticity of demand = (Percentage change in quantity demanded) / (Percentage change in Price)
Inelastic: If percentage change in quantity demanded is less than the percentage change in price.
Unit Elastic: If percentage change in quantity demanded is exactly equal to the percentage change in price.
Elastic: If percentage change in quantity demanded is greater than the percentage change in price.
Elasticity and the Shape of the Demand curves: A steep demand curve represents inelastic demand whereas a flat demand curve represents elastic demand. A vertical demandcurve represents perfectly inelastic demand. A horizontal demand curve represents perfectly elastic demand curve.
(Price) Elasticity of Supply: It is a measure of how much the quantity supplied ofa good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.
Es = Price Elasticity of supply = (Percentage change in quantity supplied) / (Percentage change in Price)
Inelastic: If percentage change in quantity supplied is less than the percentage change in price.
Unit Elastic: If percentage change in quantity supplied is exactly equal to the percentage change in price.
Elastic: If percentage change in quantity supplied is greater than the percentage change in price
Elasticity and the Shape of the Supply curves: A steep supply curve represents inelastic supply whereas a flat supply curve represents elastic supply. A vertical supply curve represents perfectly inelastic supply. A horizontal supply curve represents perfectly elastic supply curve.Since the economic incidence of a sales or an excise tax is independent of its legal incidence.In other words, the burden of the tax is shared by both buyers and sellers regardless of whether it is a sales tax or an excise tax. The magnitude of the burden however depends upon the elasticity of demand and supply curves. For instance, buyers will share a greater burden of the tax if demand is less elastic and sellers will share a greater burden if supply is less elastic.
End behavior: The behavior of the output of a graph as the input becomes infinitely large or infinitely small.
Endogenous: A variable is endogenous in a model if it is at least partly a function of other parameters and variables in a model, in contrast to exogenous.
Equilibrium: Equilibrium is some balance that can occur in a model, which can represent a prediction if the model has a real-world analogue. The standard case is the price-quantity balance found in a supply and demand model. If the term is not otherwise qualified, it often refers to the supply and demand balance.
Equilibrium point: The point at which the demand curve and the supply curve intersect. At this point, there is market equilibrium; that is, the supply of a product is equal to the demand for that product.
Event: An outcome of some happening whose results are subject to chance.
Exogeneous: A variable is exogenous to a model if it is not determined by other parameters and variables in the model, but it is set externally and any changes to it come from external forces, in contrast to endogenous.
Expected value : The expected value is a parameter indicating the "center of gravity" of a probability/density distribution. It is also the average of the data. The expected value is a parameter indicating the "center of gravity" of a probability distribution.
Exponential function/model: A function with an equation of the form f(x) = abx or f (x) = aekx . Exponential models are characterized by constant percentage change (percentage differences) in output values when input values are evenly spaced.
Extrapolation: The process of predicting an output value using an input value that is outside a given interval of input data. Extrapolation should always be viewed with caution.
Extreme point: A point at which a maximum or minimum output occurs. At an extreme point on a graph, the slope of the line tangent to the curve at that point is zero or the slope does not exist at that point (but the function output exists at that point). Extreme points occur at an input value, but the extreme value is an output value. For multivariable functions, relative extreme points cannot be visually identified on the edges of tables or contour graphs.
First differences: The changes in successive output values. It is helpful to calculate first differences for a data set only if all input data values are evenly spaced.
Fixed costs: Also called start-up costs, these costs do not vary with the number of items produced or the amount of service performed.
Four-Step Method: An algebraic method of finding the derivative of a function using the definition of the derivative.
Function: A function is a rule that assigns exactly one output to each input. Functions are represented verbally by word descriptions, numerically in tables, visually with graphs, or algebraically with equations. If x is the input symbol and f is the rule, then f(x) symbolizes the output. Input/output diagrams display the input, how the input is measured (input units), the rule that relates the input and output; and the output, including how the output is measured (output units).
Future value: The value of an investment at some time in the future. Future value for discrete situations is calculated using the appropriate compound interest formula. The future value of a continuous income stream is the total accumulated value of the income stream and its earned interest.
Gamma: The Greek letter for the factor sensitivities measuring a portfolio's second order (quadratic) sensitivity to the value of an underlie.
Generalized Linear Model: A generalized linear model is a model where y is a vector of dependent variable, and x is a column vector of independent variables. The model is often called a link function.
Graph: One of the ways to represent a function or a real-life situation by plotting output and input points on coordinate axes. Discrete graphs are scatter plots. Continuous graphs can be drawn without lifting the writing instrument from the page.
Hedging: The taking of offsetting risks.
Hessian Matrix: The Hessian matrix is the matrix of second derivatives of a multivariate function. That is, the gradient of the gradient of a function. Properties of the Hessian matrix at an optimum of differentiable function are relevant in many places in economics and finance.
Histogram: A graph that is composed of rectangles and constructed so that the area of each rectangle is the percentage of outputs in the corresponding input interval. These histograms are also called probability histograms because the area of each rectangle is the probability that the value of the random variable under discussion is in the interval that forms the base of the rectangle.
Identification: A parameter in a model is identified, if and only if, complete knowledge of the joint distribution of the observed variables gives enough information to calculate the parameter exactly.
If the model has been written in such a way that its parameters can be consistently estimated from the observables, then the parameters are identified. A model is identified if there is no observationally equivalent model. That is, potentially observable random variables in the model have different distributions for different values of the parameter.
Indifference curve (IC): IC is a locus of points representing different baskets of commodities X and Y that may give consumers the same level of utility or satisfactionso that he is indifferent among them.
Income stream : A flow of money into an interest-bearing account over a period of time. When the money flows continuously into the account, the flow is called a continuous income stream. A discrete income stream is a one into which money flows at specific intervals of time (quarterly, monthly, daily, and so on.)
Increasing without bound: A term applied to the output of a function that infinitely increases in height. Increasing without bound may describe either the end behavior of a function or the limiting value of a function as the input approaches a certain value.
Inflation: An ongoing rise in the average level of absolute prices.
Inflection point : A point where the concavity of a graph changes. Cubic and logistic functions have one point. Sine and cosine functions have two inflection points in each cycle and an infinite number of inflection points over all real number inputs. In real-life applications, the inflection point is interpreted as the point of most rapid change or least rapid change in an area near the inflection point.
Initial condition : A known point on the graph of a particular solution for a differential equation.
Instantaneous rate of change: The instantaneous rate of change at a point on a curve is the slope of the curve at that point and the slope of the line tangent to the curve at that point. Instantaneous rates of change have labels of output units per input unit.
Integration: The process of evaluating a definite integral to determine the accumulation of change or the process of recovering a quantity function from a rate-of-change function.
Interpretation of a result: A simple non-technical sentence explaining the real-life meaning of a result.
Intercept: The input value where the graph crosses or touches the horizontal axis or the output value where the graph touches or crosses the vertical axis.
Interpolation: The process of predicting an output value using an input value that is within a given interval of input data.
Inverse function: If a rule obtained by reversing the input and output of a function is also a function, then it is called an inverse function.
Ito Process: An Ito process is a stochastic process: a generalized Wiener process with normally distributed jumps. A generalized Wiener process is a continuous-time random walk with a drift and random jumps at every point in time.
Jackknife Estimator: A jackknife estimator creates a series of estimates, from a single data set by generating that statistic repeatedly on the data set, leaving one data value out each time. This produces a mean estimate of the parameter and a standard deviation of the estimates of the parameter.
Joint proportionality: For variables x, y, and z, y is jointly proportional to x and z if there exists some constant k such that y = kxz. The constant k is the constant of proportionality.
Kurtosis: A parameter describing the peakedness and tails of a probability distribution.
Law of demand: All else equal, if the price of a good goes up, quantity demanded goes down and vice versa.
Least squares method: A procedure to determine the line that best fits a set of data using the criterion that the sum of the squares of the deviations of all the data points from the fitted line, i.e., SSE is at a minimum.
Least squares line: The linear function that best fits a set of data, where best fit is defined according to the least squares method.
Legal Incidence vs. Economic Incidence of a Tax Legal incidence refers to the division of a tax burden according to who is required by law to pay the tax, while economic incidence refers to the division of a tax burden according to who actually pays the tax after all price adjustments are taken into account. A change in the legal incidence of a tax will have no effect on the economic incidence. If the legal incidence of a per-unit tax is entirely on suppliers, the supply curve will shift up by the amount of the tax. On the other hand, if the legal incidence is entirely on demanders, the demand curve will shift down by the amount of the tax. In both situations, the equilibrium quantity will fall, suppliers will receive a lower post-tax price, and demanders will pay a higher post-tax price.
Leverage Ratios: Leverage ratios measure the degree of protection of suppliers of long-term funds and can also aid in judging a firm's ability to raise additional debt and its capacity to pay its liabilities on time, for example:Total Debts to Assets = Total Liabilities / Total AssetsCapitalization Ratio= Long-Term Debt /(Long-Term Debt + Owners' Equity)
Limit: A number to which the output of a function becomes closer and closer as the input becomes closer and closer to a stated value.
Linear function/model: A function that repeatedly and at even intervals adds the same value to the output. A linear model is a function of the form f(x) = ax + b representing a situation in which incremental change is constant. In the linear function, a is the constant rate of change of the output, i.e., the slope of the graph of the linear function and b is the output corresponding to an input of zero, i.e., the vertical axis intercept. When input values in a set of data are evenly spaced and the first differences of the output values are constant, the data should be modeled by a linear function.
Linear system of equations: Two or more equations in which all the variables occur to the first power and there are no terms in which two different variables are multiplied or divided.
Liquidity Ratios: Liquidity ratios measure a firm's ability to meet its current obligations, for example:Acid Test or Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current LiabilitiesCash Ratio = (Cash Equivalents + Marketable Securities) /Current Liabilities
Local linearity: The principle that if we graph a smooth, continuous function over a small enough interval around a point, then the graph looks like the line tangent to the curve at that point. That is, the tangent line and the curve are basically indistinguishable over the interval.
Logarithmic (log) function/model: A function with an equation of the form f(x) = a + blnx. This function is the inverse of the exponential function y = AB , where A = ex/b and B = e-a/b.
Logistic function/model: A function of the form f(x) = L + Ae-bx. The graph of a logistic function is bounded by the horizontal axis and the line f(x) = L. We refer to L as the limiting value (or carrying capacity or saturation level) of the function.
Marginal analysis: A type of approximation of change used in economics. The rates of change of cost, revenue, and profit with respect to the number of units produced or sold are called marginal cost, marginal revenue, and marginal profit. These rates are often used to approximate the actual change in cost, revenue, or profit when the number of units produced or sold is increased by one.
Marginal utility: The marginal utility of a good say X is defined to be the amount ofadditional utility derived from the consumption of an additional unit of X while keeping the quantity of the other good say Y as constant.
Market price: The actual price that a consumer pays for one unit of goods or services.
Mathematical modeling: The process of translating a real-world problem into a useable mathematical equation.
Matrix: A rectangular arrangement of numbers in rows and columns. Matrices are useful in solving systems of linear equations.
Mean: One of the measures of the center of a probability distribution, the mean (also called the expected value or average) is the input value of the "balance point" of the region between the density function and the horizontal axis.
Microeconomics: Microeconomics is the study of the economic choices made by individualeconomic units such as consumers, households and firms etc.
Model: A mathematical model is an equation, along with descriptions and units of the variables, that describes a real-life situation. There are four important elements to every model: an equation, a label denoting the units on the output, a description (including units) of what the input variable represents, and an indication of the interval of input values over which the model is valid.
Monopoly: If a certain firm is the only one that can produce a certain goodsor service, it has a monopoly in the market for that goods or service.
Mortgage Terms: "Good faith" estimate: It is an estimate of the fees that you will pay to close your loan. A cash-out option? If your equity in your property qualifies, you can refinance with a loan amount greater than your current mortgage - and keep the difference! Use it for home improvement, debt consolidation, or whatever you desire.Housing-to-income ratio: Your income, debt, and mortgage payments are the primary factors that affect whether you qualify for a loan. If you do qualify for a loan, you can apply, and ditech.com will move to the next step of checking to see if you can be approved. To determine your qualification, the first thing ditech.com will do is divide the monthly payment of your proposed loan by your gross monthly income. This provides your housing-to-income ratio. If the resulting percentage falls within a certain range, the next step is to divide your total monthly debt by your gross monthly income. This provides your debt-to-income ratio. Again, if the ratio falls within prescribed limits, you are qualified for the loan. The limits within which your housing and debt ratios must fall are determined primarily by the size of the loan, the value of the property, and the ratio between the two (known as the loan-to-value ratio, or LTV). This loan-to-value ratio is one of the most important factors in determining a home loan.Appraisal: The appraisal determines the value of the property in question, which becomes a prime factor in determining the loan-to-value - or LTV - ratio (the amount of your loan divided by the value of your property). Your LTV is important because it determines your equity in the property. With the exception of leveraged equity and some second mortgages, ditech.com will arrange an appraisal of your property to verify its value. An appraiser is an authorized professional who estimates the value of the property and sends the information to ditech.com and to you. An impound/escrow account: An impound account or an escrow account (the terms are interchangeable; each is used in different states) is the name of the account in which a lender collects payments you make toward your property taxes and hazard/fire insurance. If you have an impound/escrow account, each of your monthly payments will contain a fraction of your annual property tax and insurance costs. Your lender keeps these funds in the impound/escrow account and then pays your taxes and insurance directly when they become due. 152ee80cbc