fundamental concept of economics that indicates that there is less of a good freely available from nature than people would like
The act of selecting among alternatives
An input used to produce economic goods. Land,
Labor, skills, natural resources, and capital are examples.
Human-made resources (such as tools, equipment, and structures) used to produce other services. They enhance our ability to produce in the future.
A fact based on observable phenomena that is not
influenced by differences in personal opinion.
An opinion based on personal preferences and value judgments.
Allocating a limited supply of a good or resource among people who would like to have more of it.
A set definitions, postulates, and principles
assembled in a manner that makes clear the "cause-and-effect" relationships.
The highest valued alternative that must be
sacrificed as a result of choosing an option.
Choosing the option that offers the
greatest benefit at the least possible cost.
The subjective benefit or satisfaction a person expects from a choice or course of action.
Term used to describe the effects of a change in the current situation. For example, a producer's marginal cost is the cost of producing an additional unit of a product, given the
producer's current facility and production rate.
The indirect impact of an event or policy that
may not easily and immediately observable. In the area of policy, these effects are often both unintended and overlooked.
Developing a theory from basic principles and
testing it against events in the real world. Good theories are consistent with and help explain real-world events. Theories that are inconsistent with the real world are invalid and most be rejected.
the scientific study of "what is" among economic relationships
judgements about "what ought to be" in economic matters, cannot be proven false because they are based on value judgements
A Latin term meaning "other things constant" that is used when the effect of one change is being describes, recognizing that if other things changed, they also could effect the result
fallacy of composition
erroneous view that what is true for the individual will also be true for the group
the branch of economics that focuses on how human behavior affects the conduct of affairs within narrowly defined units, such as individual households or business firms
the branch of economics that focuses on how human behavior affects outcomes in highly aggregated markets, such as the markets for labor or consumer products
The time, effort, and other resources needed to
search out, negotiate, and complete an exchange
A person who buys and sells goods or services or
arranges trades. A middleman reduces transaction costs.
The rights to use, control, and obtain the benefits
from a good or resource.
Property rights that are held by an owner
and protected against invasion by others. Private property can be transferred, sold, or mortgaged at the owner's discretion.
production possibilities curve
a curve that outlines all possible combinations of total output that could be produced, assuming (1) a fixed amount of productive resources, (2) a given amount of technical knowledge, and (3) full and efficient use of those resources. The slope of the curve indicates the amount of one product that must be given up to produce more of the other
The purchase, construction, or development or
resources, including physical assets, such as plants and machinery, and human assets, such as better education. Investment expands an economy's resources.
The technological knowledge available in an
economy at any given time. The level of technology determines the amount of output we can generate with our limited resources.
The creation of a new product or process, often
facilitated by the knowledge of engineering and science.
The successful introduction and adoption of a new
product or process; the economic application of inventories and marketing techniques.
A person who introduces new products or improved technologies and decides which projects to undertake. A successful entrepreneur's actions will increase the value of resources and expand the size of the economic pie.
The replacement of old products and
production methods by innovative new ones that consumers judge to be superior. The process generates economic growth and higher living standards.
division of labor
A method that breaks down the production of a
product into a series of specific tasks, each performed by a different worker.
law of comparative advantage
a principle that states that individuals, firms, regions, or nations can gain by specializing in the production of goods that they produce cheaply (at a low opportunity cost) and the exchanging them for goods they cannot produce cheaply (at a high opportunity cost)
a method of organization in which private parties make their own plans and decisions with the guidance of unregulated market prices. The basic economic questions of consumption, production, and distribution are answered through there decentralized decisions
an economic system in which productive resources are owned privately and goods and resources are allocated through market prices
collective decision making
the method of organization that relies on public-sector decision making (voting, political bargaining, lobbying, and so on) to resolve basic economic questions
a system of economic organization in which (1) the ownership and control of the basic means of production rest with the state, and (2) resource allocation is determined by centralized planning rather than market forces
law of demand
a principle that states there is an inverse relationship between the price of a good and the quantity of it buyers are willing to purchase. As the price of a good increases, consumers will wish to purchase less of it. As price decreases, consumers will wish to purchase more of it
products that serve similar purposes. An increase in the price of one will cause an increase in demand for the other
the difference between the max price consumers are willing to pay and the price they actually pay. It is the net gain derived by the buyers of the good
products that are usually consumed jointly. A decrease in the price of one will cause an increase in demand for the other
opportunity cost of production
the total economic cost of producing a good or service
an excess of sales revenue relative to the opportunity cost of production, accures only when the value of the good produced is greater than the value of the resources for its production
a deficit of sales revenue relative to the opportunity cost of production, imposed on those who produce goods even though they are valued less than the resources required for their production
law of supply
a principle that states there is a direct relationship between the price of a good and the quantity of it producers are willing to supply. As the price of a good increase, producers will wish to supply more of it
the difference between the price suppliers actually recieve and the min price they would be wiling to accept, measures net gains to producers and resource suppliers from market exchange, not the same as profit
An abstract concept encompassing the forces of supply and demand, and the interaction of buyers and sellers with the potential for exchange to occur.
A state in which the conflicting forces of supply and demand are in balance. When a market is in equilibrium, the decisions of consumers and producers are brought into harmony with one another, and the quantity supplied will equal the quantity demanded.
A situation in which all of the potential gains
from trade have been realized. An action is efficient only if it creates more benefit than cost. With well-defined property rights and competition, market equilibrium is efficient.
invisible hand principle
The tendency of market prices to direct
individuals pursuing their own interests to engage in activities promotion the economic well being of society.
what are the two essential ingredients of economic analysis
scarcity and choice
How do societies deal with scarcity?
What is used as a rationing device?
What is a natural outgrowth of the need to ration scarce goods
what does the absence of poverty imply?
that some basic level of need has been met
what does the absence of scarcity imply?
that our desires for goods are fully satisfied
What are the eight points emphasized by the economic way of thinking?
1) The use of scarce resources to produce a good always has an opportunity cost.
2) Individuals make decisions purposefully, always seeking to choose the option they expect to be most consistent with their personal goals.
3) Incentives matter. The likelihood of people choosing an option increases as personal benefits rise and personal costs decline.
4) Economic reasoning focuses on the impact of marginal changes because it is the marginal benefits and marginal costs that influence choices.
5) Because information is scarce, uncertainty is a fact of life.
6) In addition to their direct impact, economic changes often generate secondary effects.
7) The value of a good or service is subjective and varies with individual preferences and circumstances.
8) The test of an economic theory is its ability to predict and explain
events in the real world.
What does a point inside the PPC represent?
What does a point on the PPC represent?
What does a point outside the PPC represent?
What four factors shift the PPC outward?
1) An increase in the economy's resource base would expand our ability to produce goods and services.
2) Advancements in technology can expand the economy's production possibilities.
3) An improvement in the rules under which the economy functions can also increase output.
4) By working harder and giving up current leisure, we could increase our production of goods and services.
What three things are involved in private property rights?
(1) the right to exclusive use of that property, (2) legal protection against invasion from other individuals who would seek to use or abuse the property without the owner's permission, and (3) the right to transfer, sell, exchange, or mortgage the property.
What incentives effect private ownership?
1) Private owners can gain by employing their resources in ways that are beneficial to others, and they bear the opportunity cost of ignoring the wishes of others.
2) Private owners have a strong incentive to care for and properly manage what they own.
3) Private owners have an incentive to conserve for the future particularly if the property is expected to increase in value.
4) Private owners have an incentive to lower the chance that their property will cause damage to the property of others.
What do private-property rights motivate owners to do?
use their resources in ways that benefit others and avoid doing harm to them, take proper care of their resources and conserve them
What causes a change in the quantity demanded and how does it move along the curve?
caused by a change in the price of a good, movement along the demand curve
What causes a change in demand and how does it affect the curve?
shifts entire curve, from
1) Changes in consumer income.
2) Changes in the number of consumers in the market.
3) Changes in the price of a related good.
4) Changes in expectations.
5) Demographic changes.
6) Changes in consumer tastes and preferences.
What causes a change in the quantity supplied and how does it move along the curve?
movement along the curve and caused by a change in price
What causes a change in supply and how does it affect the curve
shifts the supply curve, due to
1) Changes in resource prices.
2) Changes in technology.
3) Elements of nature and political disruptions.
4) Changes in taxes.
What affects the steepness of the supply curve?
the more willing producers are to alter the quantity suppled in response to a change in price, the flatter more elastic, the supply curve
In a market economy, when the demand for a good increases, its price will rise, which will cause?
(1) motivate consumers to search for substitutes and cut back on additional purchases of the good
(2) motivate producers to supply more of the good. These two forces will eventually bring the quantity demanded and quantity supplied back into balance.
increase in demand causes?
increase in both price and quantity
decrease in demand causes?
decrease in both price and quantity
increase in supply causes?
decrease in price and increase in quantity
decrease in supply causes?
increase in price and decrease in quantity
What are three important functions performed by market prices?
1) Prices communicate information to decision makers.
2) Prices coordinate the actions of market participants.
3) Prices motivate economic players.
What do market prices do?
register information derived form the choices of
million of consumers, producers, and resource suppliers, and provide them with everything they need to know to make wise decisions.
What is the efficiency of the system dependent upon?
competitive market conditions, and well-defined and secure property rights
Gross domestic product (GDP)
The market value of all final goods and services produced within a country during a specific period.
Goods purchased for resale or for use in
producing another good or service. They are not counted in GDP.
final market goods and services
Goods and services purchased by their ultimate user.
household spending on consumer goods and service during the current period
the floe of private-sector expenditure on durable assets (fixed investment) plus the addition to inventories (inventory investment) during a period, enhance our ability to provide consumer benefits in the future
the estimated amount of physical capital that is worn out or used up producing goods during a period
changes in the stock of unsold goods and raw materials held during a period
exports minus imports
goods and services produced domestically but sold to foreigners
goods and services produced by foreigners but purchased by domestic consumers, businesses, and governments
indirect business taxes
taxes that increase a business firm's costs of production and therefore, the prices charged to consumers (property, sales, excise)
the total income earned by a country's nationals (citizens) during a period, the sum of employee compensation, self-employment income, rents, interest, and corporate profits
gross national product (GNP)
the total market value of all final goods and services produced by the citizens of a country, equal to GDP minus the net income of foreigners
net income of foreigners
the income that foreigners earn by contributing labor and capital resources to the production of goods within the borders of a country minus the income the nationals of country earn abroad
values expressed in current dollars
values that have been adjusted for the effects of inflation
consumer price index (CPI)
An indicator of the general level of
prices. It attempts to compare the cost of purchasing the market basket bought during a specific period with the cost of purchasing the same market basket during an earlier period.
A price index that reveals the cost during the
current period of purchasing the items included in GDP relative to the cost during a base year
An increase in the general level of prices of goods and services. The purchasing power of the monetary unit, such as the dollar, declines when inflation is present.
GDP expressed at current prices, often called money GDP
GDP adjusted for changes in the price level
unreported barter and cash transactions that take place outside recorded market channels, some are otherwise legal activities undertaken to evade taxes, others involved illegal activities, such as trafficking drugs and prostitution
What is included in the GDP?
(1) Only final goods and services count.
(2) Only transactions involving production count. (3) Only production within the country is counted. (4) Only goods produced during the current period are counted.
What is the difference between CPI and GDP?
Unlike the CPI the GDP deflator also measures the prices of capital goods and other services purchased by businesses and governments. Because of this, the GDP deflator is thought to be a more accurate measure of changes in the general level of prices than the CPI.
fluctuations in the general level of economic activity as measured by variable such as the rate of unemployment and changes in the real GDP
a downturn in economic activity characterized by declining real GDP and rising unemployment, two consecutive quarters with decline in GDP
a prolonged and very severe recession
civilian labor force
the number of people 16 years and over who are either employed or unemployed (employed +unemployed)
the term used to describe a person not currently employed who is either (1) actively seeking employment or (2) waiting to begin or return to a job
labor force participation rate
the number of people in the civilian labor force 16 or over who are either employed or actively seeking employment as a percentage of the total civilian population 16 and over (number in labor force/population)
the percentage of people in the labor force who are unemployed (number unemployed/number in labor force)
the number of people 16 and over employed as civilians divided by the total civilian population 16 and older, expressed as a percentage (number employed/population)
Unemployment due to constant changes in the economy that prevent qualified unemployed workers from being immediately matched up with existing job openings. It results form imperfect information and search activities related to suitably matching employees with employers.
Unemployment due to the structural
characteristics of the economy that make it difficult for job seekers to find employment and for employers to hire workers. Although job openings are available, they generally require skills many unemployed workers do not have.
Unemployment due to recessionary
business conditions and inadequate labor demand.
The level of employment that results from the
efficient use of the labor force taking into account the normal (natural) rate of unemployment due to information costs, dynamic changes, and structural conditions of the economy.
natural rate of unemployment
The "normal" unemployment rate due to frictional and structural conditions in labor markets. The unemployment rate when the economy is operating at a sustainable rate of output.
the level of output that can be achieved and sustained in the future, given the size of the labor force, its expected productivity, and the natural rate of unemployment consistent with the efficient operation of the labor market
an increase in the general level of prices that was not expected by most decision makers
an increase in the general level of prices that was expected by most decision makers
when does full employment exist in the US?
when approx. 95% of the labor force is employed
What two factors are considered in full employment
frictional and structural
what are high rates of inflation associated with?
substantial year-to-year swings in the inflation rate
Why does inflation adversely affect the economy?
(1) High and variable inflation reduces investment.
(2) Inflation distorts the information delivered by prices.
(3) High and variable inflation results in less productive use of resources.
the use of government taxation and expenditure policies for the purpose of achieving macroeconomic goals
the deliberate control of the money supply, and, in some cases, credit conditions, for the purpose of achieving macroeconomic goals
the supply of currency, checking account funds, and traveler's checks, these items are counted as money because they are used as a means of payment for purchases
a highly aggregated market encompassing all resources contributing to the production of a current output, labor is the largest component
goods and services market
a highly aggregated market encompassing the flow of all final user goods and services, the market counts all items that enter into the GDP, real output in this market is equal to real GDP
loanable funds market
a general term used to describe the market that coordinates the borrowing and lending decisions of business firms and households. Commercial banks, saving and load associations, the stock and bond markets, and insurance companies are important financial institutions in this market
the portion of after-tax income that is not spent on consumption
foreign exchange market
the market in which the currencies of different countries are bought and sold
the price of one unit of foreign currency in terms of the domestic currency
aggregate demand curve
a downward-sloping curve showing the relationship between the price level and the quantity of domestically produced goods and services all households, business firms, governments, and foreigners are willing to purchase
aggregate supply curve
the curve showing the relationship between a nation's price level and the quantity of good supplied by its producers, in the short run it is an upward sloping curve, but in the long run it is vertical
money interest rate
The percentage of the amount borrowed that
must be paid to the lender in addition to the repayment of the principal (amount borrowed). The money interest rate overstates the real cost of borrowing during an inflationary period. When inflation is anticipated an inflationary premium will be incorporated into this rate. This is often called the nominal interest rate.
real interest rate
The interest rate adjusted for expected inflation:
it indicates the real cost to the borrower, and yield to the lender, in term of goods and services.
real interest rate = money interest rate - inflationary premium
A component of the money interest rate that
reflects compensation to the lender for the expected decrease, due to inflation, in the purchasing power of the principal and interest during the course of the loan. Determined by the expected rate of inflation in the future
An increase in the value of a currency relative to
foreign currencies. An appreciation increases the purchasing power of the currency over foreign goods.
A reduction in the value of a currency relative to
foreign currencies. A depreciation reduces the purchasing power of the currency over foreign goods.
The situation when a country's imports of goods and services are greater than its exports.
The situation when a country's exports of goods
and services are greater than its imports.
What does the SRAS curve show?
the various quantities of goods and services domestic firms will supply in response to changing demand conditions that alter the level of prices in the goods and services market.
What does the LRAS curve show?
the relationship between the price level and
quantity of output after decision makers have had time to adjust their prior commitments, or take steps to counterbalance them, when the price level changes.
Why is the LRAS curve vertical?
because once people have had time to
adjust fully to a new price level; the normal relationship between product prices and resource costs will be restored.
When is short run equilibrium present in the AD-AS model
when aggregate quantity demanded is equal to aggregate quantity supplied.
What happens at long run equilibrium
output will be at its maximum sustainable level
What happens when the exchange rate is determined by market forces?
trade deficits will be closely linked with an inflow of capital. In contrast, trade surpluses will be closely linked with an outflow of capital.
What is interest from the viewpoint of the borrowers?
the price they have to pay to get money now
What is interest from the viewpoint of the lender?
the reward they get for waiting, for not being able to spend their money now because they've loaned it to someone else
a change that is foreseen by decision makers in time for them to make adjustments
a change that the decision makers could not reasonable foresee, the choices they made prior to the change did not take it into account
the average output produced per worker during a specific time period, usually measured in terms of output per hour worked
an unexpected event that temporarily increases or decreases aggregate supply
Where does the economy's output deviate from in the short run?
full employment capacity when prices in the goods and services market deviate from the price level people anticipated.
How long does an increase in GDP above the economy's long-run potential?
only until temporarily fixed resource prices (and interest rates) can be adjusted upward by people in light of the new stronger demand conditions.
What do unanticipated changes in either aggregate demand or aggregate supply do?
disrupt long-run equilibrium and cause current output to differ from the economy's long-run potential
What can unanticipated increases in AD and favorable supply shocks cause?
economic booms that push output beyond the economy's long-run potential and unemployment below its natural rate. Resource prices and interest rate will then rise, and output will recede to long-run capacity.
What can unanticipated reductions in aggregate demand and adverse supply shocks cause?
can lead to below-capacity output and abnormally high rates of unemployment. Eventually, lower resource prices and lower interest rates will direct the economy back to long-run equilibrium.
what three factors increase LRAS
(1) An increase in the supply of
(2) Technology and productivity improvements,
(3) Institutional changes that improve the efficiency of resource use.
what three factors decrease LRAS
(1) A decrease in the supply of
(2) Technology and productivity deteriorations, (3) Institutional changes that reduce the efficiency of resource use.
What two forces self correct macroeconomic markets?
1) Changes in real resource prices will help direct an economy toward equilibrium.
2) Changes in real interest rates help stabilize aggregate demand and redirect economic fluctuations.
concept that an increase in spending on a project will generate income for the resource suppliers, who will then increase their consumption spending. In turn, their additional consumption will generate income for others and lead to still more consumption. As this process goes through successive rounds, total income will expand by a multiple of the initial increase in spending
the ratio of the change in equilibrium output to the independent change in investment, consumption, or government spending that brings about the change. Numerically, the multiplier is equal to 1 divided by (1-MPC) when the price level is constant
Marginal propensity to consume (MPC)
additional current consumption divided by additional current disposable income
a situation in which current government revenue from taxes, fees, and other sources is just equal to current government expenditures
a situation in which total government spending exceeds total government revenue during a specific time period, usually one year
a situation in which total government spending is less than total government revenue during a time period, usually a year
discretionary fiscal policy
a change, in laws or appropriation levels, that alters government revenues and/or expenditures
expansionary fiscal policy
an increase in government expenditures and/or a reduction in tax rates, such that the expected size of the budget deficit expands
restrictive fiscal policy
A reduction in government expenditures
and/or an increase in tax rates such that the expected size of the budget deficit declines or the budget surplus increases.
A policy that tends to move the economy in
an opposite direction from the forces of the business cycle. This would stimulate demand during the contraction phase of the business cycle and restrain demand during the expansion phase.
built-in features that tend to automatically promote a budget deficit during a recession and a budget surplus during an inflationary boom, even without a change in policy
the relationship between disposable income and consumption. When disposable income increases, current consumption expenditures rise, but by less than the increase in income
expenditures that do not vary with the level of income. They are determined by factors such as business expectations and economic policy
the ability of policy makers to time fiscal policy changes in a countercyclical manner is reduced by?
(1) the inability of the political process to act rapidly,
(2) the time lag between when a policy change is instituted and when it affects the economy, and (3) inability to forecast accurately the future direction of the economy.
What do Keynesians call for when an economy is operating below its potential capacity?
expansionary fiscal policy-a deliberate change in expenditures and/or taxes that will increase the size of the government's budget deficit.
What do Keynesians believe is the thing to do to combat inflation generated by excessive aggregate demand?
a shift toward a more restrictive fiscal
it will be difficult to institute fiscal policy in a stabilizing manner because politicians will find...
budget deficits attractive during a recession, but they will be reluctant to run budget surpluses during an expansion.
Which of the following is a major deficiency of fiscal policy as a stabilization tool?
Both political and economic factors make it unlikely that changes in fiscal policy will be timed correctly.
Which of the following best illustrates the use of discretionary countercyclical fiscal policy?
Congress passes a bill authorizing $100 billion in additional spending when it receives news of a deepening recession.
Suppose the economy is in long-run equilibrium at the level of potential output. What will be the long-run effect of an expansionary monetary policy?
higher price level
In an economy in which real output grows at an average rate of 3 percent per year, a 7 percent average rate of growth in the money supply would result in..
an inflation rate of 4 percent, if velocity were constant.
Supply-side economics stresses that high marginal tax rates
discourage people from working harder and using their resources productively.
If the Fed wanted to expand the money supply as part of an anti-recession strategy, it could
buy U.S. securities on the open market.
Which of the following actions would the Fed undertake if it wants to follow a more restrictive monetary policy?
sell some of its holdings of government bonds
The main purpose of the Fed is to
maintain the proper functioning of our money system.
Which of the following most clearly limits the ability of the commercial banking industry to expand the money supply?
the reserve requirements mandated by the Fed
Suppose that in a country people gain more confidence in the banking system and so hold relatively less currency and more deposits, then bank reserves will
increase and the money supply will eventually increase.
If a customer deposits $1,000 cash into her checking account, the bank's..
assets and liabilities both rise by $1,000.
The legal requirement that commercial banks hold reserves equal to some fraction of their deposits..
limits the ability of banks to expand the money supply by extending additional loans.
The value (purchasing power) of each unit of money...
is inversely related to the general level of prices.
Which of the following tends to make the size of a shift in aggregate demand resulting from a tax change smaller than would otherwise be the case?
the crowding-out effect
In a world where capital moves rapidly across national boundaries, if a larger budget deficit leads to higher real interest rates,
there will be an inflow of foreign capital, which will cause the dollar to appreciate and net exports to decline.
If the economy is experiencing less than full-employment, the Keynesian model recommends that the government
undertake expansionary fiscal policy to stimulate aggregate demand.
The Keynesian analysis of fiscal policy implies that
the federal budget should be used to maintain aggregate demand at a level consistent with full employment.
If Congress votes to increase government purchases and at the same time decrease personal income taxes, they
have voted for the proper policy to counteract a recession.
According to the Keynesian view, if real GDP is slowing and the economy appears to be headed for a recession, a reduction in tax rates is
highly appropriate because it will stimulate aggregate demand and, thereby, help to strengthen the economy.
An unexpected increase in the supply of money will
reduce the real rate of interest and, thereby, trigger an increase in current spending by households and businesses.
In the aggregate demand-aggregate supply model, the short-run effects of an unanticipated increase in the money supply will be
lower real interest rates and an increase in aggregate demand.
When the Fed buys bonds and injects additional reserves into the banking system, this action will
place downward pressure on short-term interest rates.
Which one of the following is an area of agreement among modern macroeconomists with regard to the use of fiscal policy?
It is difficult to time changes in discretionary fiscal policy in a manner that will promote stability.
Within the framework of the AD-AS model, an increase in savings by households will:
increase the supply of loanable funds and reduce interest rates.
By scientific method we mean:
the dispassionate development and testing of theories about how the world works
The opportunity cost of an action is:
the value of the best opportunity that must be sacrificed in order to take the action
The Economic Way of Thinking is:
a set of basic concepts that helps one understand human choices
The most fundamental concept in economics is:
changes in incentives influence behavior in a predictable way--people will be less likely to choose an option as it becomes more expensive
Because information is costly to acquire:
people will rationally choose not to become fully informed when making decisions
If an airline company has several empty seats on a flight and the full price of an air ticket is $500 and the marginal cost per passenger is $100, then it will be profitable for the airline to:
charge a stand-by passenger more than $100
Which of the following statements is correct?
Government programs can be implemented with good intentions but can lead to undesirable outcomes because of unintended consequences
The expression "There's no such thing as a free lunch" means:
the use of resources to produce a good has an opportunity cost because of scarcity
The fallacy of composition is the incorrect view that:
if something is true for an individual, then it must also be true for the group
Which of the following most clearly distinguishes between positive and normative economics?
Positive economics is the study of the facts; normative economics is concerned with what ought to be (opinion)
The difference between positive economic statements and normative economic statements is that:
positive statements are based on fact while normative statements are based on opinion
8. According to Adam Smith, individual self-interest:
is a powerful force for economic progress when it is directed by competitive markets
9. Recent legislation provides parents with a substantial reduction in their personal income tax liability for each child that they have. The economic way of thinking indicates that legislation of this type will:
reduce the after-tax cost of raising children and, therefore, increase the birth rate
Land used to grow alfalfa could also be used to grow hay. Which of the following is true when the farmer plants hay and the market price of alfalfa rises?
The opportunity cost of producing hay increases
A nation that protects its workers from unemployment by limiting the use (by employers) of technological improvements will:
grow less rapidly because technological change is an important factor contributing to the growth of output
Creative destruction refers to the process where:
new products and methods of production are continuously replacing old ones
In order to prosper, entrepreneurs must:
undertake projects that create wealth and increase the value of resources
A production possibilities curve indicates that when resources are being used efficiently,
you can only produce more of one good only if you produce less of another good
Which of the following is true of private ownership?
Private ownership links responsibility with the right of control
Rebecca decides to buy a dress that Hillary has for sale; they agree on a price of $20. Which of the following best describes who gains and who loses from the transaction?
Both parties expect to gain from this transaction
"Henry Ford made millions of dollars producing and marketing automobiles. Many workers and consumers must have suffered in order for Ford to amass such enormous wealth." The person who made this observation:
has failed to understand that specialization and exchange generally result in mutual economic gain
According to the law of comparative advantage:
individuals and nations gain when they specialize in producing those items for which they are the low opportunity cost producers and exchange for other desired goods they can't produce as cheaply
Which of the following statements about exchange is true?
Exchange tends to move each good toward those individuals who value the good more highly
Don can produce 10 pens or 20 pencils in one hour while Bob can produce 15 pens or 5 pencils in one hour. Which of the following statements is correct?
Bob has a comparative advantage over Don in the production of pens
When collective decision making is utilized to resolve economic questions regarding the allocation of resources,
central planning and political bargaining will replace market forces
If Crusoe and Friday want to maximize their consumption possibilities:
Crusoe should specialize in producing good X and Friday in producing good Y; trade should occur to maximize joint consumption
Economic debates that focus on the distribution of a nation's income are generally associated with which basic economic question?
For whom will the goods be produced?
At a price of $5, Sam buys 10 units of a product; when the price increases to $6, Sam buys 8 units. Which of the following is correct about Sam's behavior?
Sam's quantity demanded has decreased, and his demand has not changed
Other things being equal, the effect of a decrease in the price of orange juice would be illustrated by:
An increase in the quantity demanded of orange juice
Consumers buy less of a good as its price increases because:
Substitute goods are now relatively cheaper
Which of the following would decrease the price of sugar?
The tariff (tax) on imported sugar increases. (more expensive so more suppliers want to produce it, shifting the supply curve to the right, decreasing the price of sugar)
According to the law of supply:
more of a good will be offered by suppliers as the price rises
Markets coordinate output decisions by pushing:
Up price when there is a shortage. (supply curve shifts left which increases the price.)
When economists say the demand for a product has increased, they mean the:
Demand curve has shifted to the right
When economists say the quantity supplied of a product has decreased, they mean the:
price of the product has fallen, and consequently, suppliers are producing less of it
When economists say the supply of a product has increased, they mean the:
Supply curve has shifted to the right
Which of the following would reduce the price of DVD players and increase the quantity sold?
An increase in the supply of DVD players
If we observe an increase in the price of a good and an increase in the amount of the good bought and sold, this could be explained by:
An increase in the demand for the good
If a surplus exists in a market we know that the actual price is:
above equilibrium price and quantity supplied is greater than quantity demanded
The term market always refers to:
a group of buyers and sellers of a particular good or service
Suppose demand decreases and supply increases. Which of the following will happen?
Equilibrium quantity will rise, fall, or stay the same while equilibrium price will decrease
Suppose demand increases and supply decreases. Which of the following will happen?
Equilibrium quantity will rise, fall, or stay the same and equilibrium price will increase
According to Adam Smith, what is the primary source of a nation's wealth?
The people's ability to produce products and trade in free markets
Criteria for rationing goods and reasources must be established because of
Scarcity imposed by nature
the value of a good
depends on many factors, including who uses it and under what circumstances
If an economy operates at a point within its production possibilities curve,
it is not efficiently using all of its resources
With time, which one of the following strategies would most likely result in an outward shift in the production possibilities curve of an economy?
instituting a tax policy encouraging investment at the expense of consumption
Opportunity costs differ among nations primarily because
nations have different amounts of land, labor skills, capital, and technology
With time, which one of the following strategies would most likely result in an outward shift in the production possibilities curve of an economy?
price of the product has fallen, and consequently, consumers are buying more of it.
In which statement(s) are "supply" and "quantity supplied" used correctly?
(I) "An increase in the price of computers will increase the quantity supplied of computers."
(II) "A technological advance that lowers the cost of producing computers will increase the supply of computers."
both statements 1 and II
according to the law of supply,
more of a good will be offered by suppliers as the price rises
If Georgia experiences a late frost that damages the peach crop, we should expect the
supply curve for peaches to shift to the left and the price of peaches to rise
if the price of a good is below equilibrium price,
suppliers will find inventories being depleted. They will increase production and raise prices
Suppose, in dollar terms, nominal GDP increased approximately 4% during a given year, and real GDP decreased 1%. Which of the following best explains these events?
prices increased by approximately 5%
your boss gives you an increase in the number of dollars you earn per hour. This increase in pay makes:
your nominal wage increase. If your nominal wage rose by a greater percentage than the price level, then your real wage also increased
which on of the following events will leave GDP unchanged?
you lose $500 playing blackjack with friends
If this year the CPI is 110 and last year it was 100, then:
the price level as measured by the CPI has increased by 10 percent
US exports are:
included in US GDP because they are produced domestically
which statement represents most correctly the relationship between nominal GDP and real GDP?
nominal GDP measures current production using current prices, whereas real GDP measures current production using base-year prices
If US net exports are negative:
US consumers are spending more on foreign goods than foreign consumers are spending on US goods
If the underground economy is sizable, then GDP will:
understate the economy's performance
if a used car dealer purchases a used car for $3000, refurbishes it, and sells it for $8000, the:
dealer contributes value added equal to $5000, and consequently $5000 is added to GDP
one difficulty of computing the value of GDP is that there are no market prices for:
government goods and services
over time, people have come to rely more on market-produced goods and less on goods that they produce for themselves. For example, busy people with high incomes, rather than cleaning their own houses, hire people to clean their houses. By itself, this change has:
caused GDP to rise
which of the following is a positive effect of job search and the unemployment that often accompanies it?
it permits individuals to better match their skills and preferences with the requirements of a job
the economy is considered to be at full employment when:
the rate of cyclical unemployment is zero
If Sam Jackson voluntarily quits one job, possesses marketable skills, and expects to find a new job in a few weeks, then Mr. Jackson is considered:
the concept of full employment
reflects the "shopping" of employees looking for employment and of employers seeking to hire workers
during a recession, the actual rate of unemployment will be
greater than the natural rate of unemployment
actual GDP will be below potential GDP
during a recession
if the nominal interest rate was 12% and the inflation rate was 10% in 1980, while the nominal interest rate was 7% and the inflation rate was 2% in 2009, then:
real rates were higher in 2009
suppose that a large number of men who used to work or seek work now no longer do either. Other things the same, this makes the:
number of people unemployed and the labor force both falls
Anna has just finished high school and started looking for her first job, but has not yet found one. As a result, the unemployment rate:
increases, and the labor-force participation rate increases
the expansionary phase of the business cycle is characterized by:
increasing real output and declining unemployment
a vertical long-run aggregate supply curve indicates that:
an increase in the price level will not expand an economy's output capacity in the long run
Within the framework of the AD/AS model, when the current price level in the goods and services market is above the level anticipated at the time decision makers agreed to long-term resource contracts:
the actual rate of unemployment will fall below the natural rate of unemployment
if scientific research produces a technological breakthrough in the production of computer memory, then:
business costs will fall, profits will improve, and production will increase
when prices in the goods and services market are below the level anticipated:
output will temporarily fall short of the economy's long-run potential
as the dollar depreciates, which of the following is most likely to occur?
more foreigners will visit the US
if net exports are negative, then:
net capital outflow is negative, so American assets bought by foreigners are greater than foreign assets bought by Americans
if the dollar price of the English pound goes from $1.50 to $2.00, the dollar has:
depreciated, and the English will find US goods cheaper
if you go to the bank and notice that a dollar buys more Mexican pesos than it used to, then the dollar has:
appreciated/ Other things the same, the appreciation would make you more likely to travel to Mexico
what would happen in the market for loanable funds if the government were to decrease the tax rate on interest income?
the supply of loanable funds would shift right and investment would increase
which of the following is most likely to throw an economy into a recession?
an unanticipated reduction in aggregate demand
if an unanticipated reduction in aggregate demand throws a market economy into a recession:
lower real resource prices and interest rates will act as a stabilizing force and direct the economy back to its full employment potential
which of the following is the most accurate statement about nominal and real interest rates?
nominal and real interest rates often do not move together
if an economy operates at a short-run equilibrium output that exceeds its long-run capacity, which of the following will be most likely to direct the economy toward full employment?
resource prices will increase, causing the SRAS to shift to the left
when output is greater than the economy's long-run capacity, which of the following is most likely to occur?
increases in real interest rates and real resource prices
For an oil-importing country such as the United States, the immediate effect of a supply shock caused by an increase in the price of imported oil would tend to be:
a decrease in real output and an increase in the general level of prices
which of the following would cause prices to fall and output to rise in the short run?
short-run aggregate supply shifts right
within the AD/AS model, how does an economy adjust to an output beyond its long-run capacity as a result of an unanticipated increase in aggregate demand?
resource prices and real interest rates will rise causing output to fall back to its long-run sustainable rate
a recession abroad would:
reduce US net exports and reduce aggregate demand
which of the following shifts both short-run and long-run aggregate supply to the left?
a decrease in the capital stock
which of the following would cause prices and real GDP to rise in the short run?
aggregate demand shifts right
if a currency appreciates, a country's net exports:
fall and AD decreases
which of the following shifts short-run, but not long-run aggregate supply to the right?
a decrease in the expected rate of inflation
if an economy is growing, but experiences no inflation, this means:
aggregate demand and aggregate supply increased by the same amount
an increase in capital formation that expands long-run aggregate supply will:
increase output and decrease prices
If nominal GDP increased 2 percent during a year, while real GDP increased 4 percent, the:
price level must have decreased approximately 2 percent compared to the prior year.
Which of the following, other things the same, would make the price level decrease and real GDP increase?
long-run aggregate supply shifts right
Other things constant, an increase in the real interest rate will
cause consumers to reduce their purchases of durable items like appliances and automobiles
Suppose the economy is initially in long-run equilibrium and aggregate demand rises. In the long run prices
are higher and output is the same as the original long-run equilibrium
Which of the following will most likely occur in the US as a result of an unexpected rapid growth in real income in Canada and Mexico?
an increase in aggregate demand and output in the short run
Within the AD/AS model, if an unanticipated reduction in aggregate demand results in less than the full-employment rate of output,
lower resource prices and declining interest rates will direct the economy back to full employment
Which of the following events would cause the interest rate to rise?
an increase in the demand for loanable funds
If the dollar price of the English pound goes fro, $1.75 to $1.50, the dollar has
appreciated, and the Americans will find English goods cheaper
When an economy is in long run equilibrium,
the actual and natural rates of unemployment will be equal
When the actual rate of unemployment is less than the natural rate of unemployment, the economy
operates at an output greater than its long-run potential
Which of the following would generally cause firms to expand output in the short run?
higher profit margins as the result of an unexpected increase in the prices of goods and services
The recessionary phase of the business cycle is characterized by
increasing real output and declining unemployment
The expansionary phase of the business cycle is characterized by
increasing real output and declining unemployment
Suppose you received a 4 percent increase in your nominal wage. Over the year, inflation ran about 6 percent. Which of the following is true?
your real wage fell
During an economic boom,
the output of the economy will exceed its long-run potential output
During a recession, the actual rate of unemployment will be
greater than the natural rate of unemployment
Higher unemployment insurance benefits tend to increase unemployment because they,
reduce the opportunity cist of job search and, hence, increase the search and time
Because of transactions which take place in the underground economy, the
GDP calculation tend to undersate the actual value of goods sold in the economy
U.S. exports are
included in U.s. GDP because they are produced domestically
General Motors Corporation (a US based firm) produces a Saab vehicle in Sweden, and sells it in the United States. In which country's GDP is it included?
Sweden because it was produced there
Suppose the dollar value of GDP increased approximately 2 percent between October
2007 and August 2008, but real GDP fell 1 percent during the period. Which of the following best explains these data?
Prices increased approximately 3 percent during period.
A reduction in private spending as a result of
higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market.
new classical economists
Economists who believe that there are
strong forces pushing a market economy toward full-employment equilibrium and that macroeconomic policy is an ineffective tool with which to reduce economic instability.
The view that a tax reduction financed with
government debt will exert no effect on current consumption and aggregate demand because people will fully recognize the higher future taxes implied by the additional debt.
Paradox of thrift
the idea that when many households simultaneously try to increase their saving, actual saving may fail to increase because the reduction in consumption and aggregate demand will reduce income and employment
Economists who believe that changes in
marginal tax rates exert important effects on aggregate supply.
What does the crowding-out effect imply?
that the demand stimulus effects of
budget deficits will be weak because borrowing to finance the deficits will increase interest rates and thereby crowd out private spending on investment and consumption.
What is an ineffective weapon against inflation?
restrictive fiscal policy
What does the crowding-out model indicate?
that expansionary fiscal policy
will lead to higher real interest rates and less private spending, particularly for investment.
In an open economy, the higher interest rates lead to what secondary effects?
an inflow of capital, appreciation of the
dollar, and a reduction in net exports. The crowding-out theory implies that these secondary effects will largely offset the demand stimulus of expansionary fiscal policy.
What does the new classical model stress?
that financing government spending with debt rather than taxes changes the timing, but not the level, of taxes
What will people expect according to the new classical model view?
people will expect higher future taxes, which
will lead to more saving and less private spending. This will tend to offset the expansionary effects of a deficit.
What do the new classical economists stress?
that debt financing simply substitutes higher future taxes for lower current taxes. Thus, budget deficits affect the timing of the taxes but not their magnitude.
What issues are Keynesian and non-Keynesian economics in agreement on?
(1) proper timing of discretionary fiscal policy is both difficult to achieve and crucially
(2) automatic stabilizers reduce the fluctuation of
aggregate demand and help promote economic stability; and
(3) fiscal policy is much less potent than early Keynesians thought.
What do Keynesian economists believe will promote recovery from a recession like in 2008-2009?
increases in government spending financed by borrowing will exert aggregate demand and help promote recovery
What side effects do non-keynesians believe will occur when increases in government spending are financed by borrowing?
(1) higher future interest rates and taxes,
(2) coordination problems that will undermine the effectiveness of the increased spending and lead an expansion in unproductive activities, and (3) increased rent seeking as groups fight to obtain more funds from the government.
On the supply-side what do lower tax rates do?
increase the incentive of people to work, supply resources, and use them more efficiently and thereby increase aggregate supply
What type of strategy is supply-side economics?
long-run, growth oriented strategy
Why to high taxes retard output?
(1) high marginal tax rates
discourage work effort and productivity,
(2) high tax rates will adversely affect the rate of capital formation and the efficiency of its
(3) high marginal tax rates encourage people to substitute less-desired tax deductible goods for more-desired nondeductible
What happens when fiscal policy changes marginal tax rates?
it influences aggregate supply by altering the attractiveness of productive activity relative to leisure and tax avoidance. Other things being
constant, lower marginal tax rates will increase aggregate supply.
medium of exchange
an asset that is used to buy and sell goods or services
money that has neither intrinsic value nor the backing of a commodity with intrinsic value; paper currency is an example
an asset that can be easily and quickly converted to money without loss of value
store of value
an asset that will allow people to transfer purchasing power from one period to the next
unit of account
a unit of measurement used by people to post prices and keep track of revenues and costs
M1 (money supply)
the sum of (1) currency in circulation, (2) checkable deposits maintained in depository institutions, and (3) travelers' checks
medium of exchange made of metal or paper
non-interest-earning checking deposits that can either be withdrawn or made payable on demand to a third party, widely used means of payment
other checkable deposits
interest-earning deposits that are also available for checking
M2( money supply)
equal to M1 plus (1) savings deposits, (2) time deposits held in depository institutions, and (3) money market mutual find shares
businesses that accept checking and savings deposits and use a portion of them to extend loans and make investments, banks, savings and loan associations, and credit unions are examples
money market mutual funds
interest-earning accounts that pool depositors' funds and invest them in highly liquid short-term securities, because these securities can be quickly converted to cash, depositors are permitted to write checks against their accounts
funds acquired by borrowing
Federal reserve system
The central bank of the US; it carries
out banking regulatory policies and is responsible for the conduct of
monetary policy, a central banking authority
designed to provide a stable monetary framework for the entire
economy. The Fed is a banker's bank.
An institution that regulates the banking system and controls the supply of a country's money.
savings and loan associations
Financial institutions that accept
deposits in exchange for shares that pay dividends.
Financial cooperative organizations of individuals
with common affiliation (such as an employer or a labor union). They accept deposits, including checkable deposits, pay interest (or dividends) on them out of earnings, and lend funds primarily to members.
Financial institutions that offer a wide range of
services (for example, checking accounts, savings accounts, and loans) to their customers. They are owned by stockholders and seek to operate at a profit.
Vault cash plus deposits of banks with Federal
fractional reserve banking
A system that permits banks to hold
reserves of less than 100 percent against their deposits.
The minimum amount of reserves that a bank
is required by law to keep on hand to back up its deposits.
federal deposit insurance corporation (FDIC)
A federally chartered corporation that insures the deposits help by commercial banks, savings and loans, and credit unions.
required reserve ratio
The ratio of reserves relative to a specified
liability category that banks are required to maintain.
Actual reserves that exceed the legal
deposit expansion multiplier
The multiple by which an increase in
reserves will increase the money supply. It is inversely related to the required reserve ratio.
potential deposit expansion multiplier
The maximum potential increase in the money supply as a ratio of the new reserves injected into the banking system. It is equal to the inverse of the required reserve ratio.
Federal open market committee (FOMC)
A committee of the Federal Reserve system that established Fed policy with regard to the buying and selling of government securities- the primary mechanism used to control the money supply, composed of the seven members of the Board of governors and the 12 district bank presidents of the Fed
open market operations
The buying and selling of US government securities and other financial assets in the open market by the Federal Reserve.
The interest rate the Federal Reserve charges
banking institutions for short-term loans.
federal funds market
A loanable funds market in which banks
seeking additional reserves borrow short-term funds (generally for seven days or less) from banks with excess reserves. The interest rate in this market is called the federal funds rate.
term auction facility (TAF)
Newly established procedure used by
the Fed to auction credit for an eighty-four-day period to depository institutions willing to bid the highest interest rates for the funds.
The sum of currency in circulation plus bank
reserves (vault cash and reserves with the Fed). It reflects the purchases of financial assets and extension of loans by the Fed.
what is the main thing that makes money valuable
demand relative to supply
what is money
a financial asset that is widely accepted as a medium of exchange. It is a means of storing purchasing power for the future and is used as a unit of account.
where does money derive its value from
its supply relative to its demand
What do banks provide their depositors with?
safekeeping of money, check-clearing services on demand deposits, and interest payments on time (and some checking) deposits.
Where do banks ger most of their income from?
by extending loans and investing in interest-earning securities
What happens with the lower the percentage of reserves required?
the larger thepotential expansion in the money supply generated by creation of new reserves. However, the fractional reserve requirement puts a ceiling on the expansion in the money supply resulting from the creation of new reserves.
How is the structure of the Fed designed?
to insulate it from political pressures so that it will have greater freedom to follow policies more consistent with economic stability.
What are the four major tools the Fed has to control the money supply?
(1) the establishment of reserve requirements, (2) open market operations,
(3) the extension of loans,
(4) setting the interest rate paid to banks on their reserves.
What would the fed do if it wanted to increase money supply?
it could decrease the reserves banks are required to hold, buy government bonds
and other financial assets in the open market, extend more loans, or reduce the interest rate it pays banks on their reserves.
What does the monetary base provide?
the foundation for the money supply.
The Fed alters the monetary base through its purchases of assets and extension of loans.
Compare the Federal reserve and the US treasury?
The Federal Reserve and the US Treasury are distinct agencies. The Fed is concerned primarily with the money supply and the
establishment of a stable monetary climate, whereas the Treasury focuses on budgetary matters-tax revenues, government
expenditures, and the financing of government debt.
What happens when the Fed buys things?
it injects "new money" into the economy
in the form of additional currency in circulation and deposits with commercial banks. In essence, the Fed creates money out of nothing.
What will an increase in the reserve requirements do?
reduce the supply of money
A group of economists who believe that (1) monetary instability is the major cause of fluctuations in real GDP and (2) rapid growth of the money supply is the major cause of inflation.
demand for money
A curve that indicates the relationship
between the interest rate and the quantity of money people want to hold. Because higher interest rates increase the opportunity cost of holding money, the quantity of money demanded will be inversely related to the interest rate.
expansionary monetary policy
A shift in monetary policy designed
to stimulate aggregate demand. Injection of additional bank reserves, lower short-term interest rates, and acceleration in the growth rate of the money supply are indicators of a more expansionary monetary policy.
restrictive monetary policy
A shift in monetary policy designed to
reduce aggregate demand and put downward pressure on the general level of prices (or the rate of inflation). A reduction in bank reserves, higher short-term interest rates, and a reduction in the growth rate of the money supply are indicators of a more restrictive monetary policy.
quantity theory of money
A theory the hypothesizes that a
change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money.
velocity of money
The average number of times a dollar is used
to purchase final goods and services during a year. It is equal to GDP divided by the stock of money.
equation of exchange
MV=PY, where M is the money supply, V is
the velocity of money, P is the price level, and Y is the output of goods and services produced in an economy.
What will an unexpected increase in the supply of money?
reduce the real rate of interest, thereby triggering an increase in the demand for goods and services. The increase in aggregate demand will expand real output and employment in the short run.
How is the quantity of money people want to hold related to the money interest rate?
inversely becausehigher interest rates make it more costly to hold money instead of interest-earning assets like bonds. The supply of money is vertical because the Fed determines it.
What will the money interest rate gravitate towards?
the rate at which the quantity of money people want to hold is just equal to the quantity supplied by the Fed.
How is the impact of a shift in monetary policy generally transmitted
through interest rates, exchange rates, and asset prices.
What does the Fed do when instituting a more expansionary monetary policy
the Fed generally increases the reserves available to banks and pushes interest rates downward. In the short run, and unanticipated shift to a more expansionary policy will stimulate aggregate demand and thereby increase output and employment.
What does the Fed do when instituting a more restrictive monetary policy?
the Fed drains reserves from the banking system and pushes interest rates upward. In the short run, an unanticipated shift to a more restrictive monetary policy will increase real interest rates and reduce aggregate demand, output, and employment.
rate of inflation + growth rate of real output =
Growth rate of the money supply + Growth rate of velocity
What is the link between money growth and inflation, when looked at over a lengthy period of time?
one of the most consistent relationships in all
What is inflation in relation to money growth?
monetary phenomenon, Persistently low rates of
money growth lead to low rates of inflation. Similarly, high rates of money growth lead to high rates of inflation.
What does the quantity theory of money postulate?
that the velocity of money is constant (or approximately so) and that real output is independent of monetary factors. When these assumptions hold, an increase in the stock of money will lead to a proportional increase in
While monetary policy can influence real output in the short run, the the long run?
the primary impact of monetary policy will be on prices rather than output. Rapid monetary growth will merely lead to inflation.
per capita GDP
Income per person. Increases in income per
person are vital for the achievement of higher living standards.
Rule of 70
If a variable grows at a rate of x percent per year, 70/x will approximate the number of years required for the variable to double.
The introduction of new techniques
or methods that increase output per unit of input.
The legal, regulatory, and social constraints that affect the security of property rights and enforcement of contracts. They exert a major impact on transaction costs between parties, particularly when the trading partners do not know each other.
Countries with low per capita incomes,
low levels of education, widespread illiteracy, and widespread use of production methods that are largely obsolete in high-income countries. They are sometimes referred to as developing countries.
What does economic growth increase?
the production possibilities of an
economy. The growth of per capita real GDP means more goods and services per person, which typically leads to higher living
standards and improvements in life expectancy, literacy, and health.
What will seemingly small differences in growth rates sustained over two or three decades substantially alter?
relative incomes. For example, if Country A and Country B have the same initial income but the growth rate of A is 2 percent greater than that of B, after thirty five years the income level of Country A will be twice that of B.
What are the three major sources of economic progess stressed by economists?
(1) gains from trade and expansion in the size of the market,
(2) discovery of new technologies and innovative applications, and
(3) investment in physical and human capital.
Gains from trade
Specialization, division of labor, and
economies of scale lead to larger outputs.
Innovation, technological improvements,
and discovery of better ways of doing things make larger outputs and higher income levels possible.
investment in physical and human capital?
Machines, structures, and tools (physical capital) and education, and training (human capital) make larger outputs possible.
While population growth, natural resources, foreign aid, and climactic conditions can influence growth and income, what will happen without sound institutions and policies ?
these factors will fail to generate long-term
sustained growth and prosperity.
What institutions and policies provide the foundation for efficient use of resource, economic growth, and the acievement of high levels of income?
1) Legal system that protects property rights and enforces contracts in an even-handed manner
2) Competitive markets
3) Monetary and price stability
4) Minimal regulation
5) Avoidance of high tax rates
6) Openness to international trade
purchasing power parity (PPP) method
Method in which the relative purchasing power of each currency is determined by comparing the amount of each currency required to purchase a common bundle of goods and services in the domestic market. This information is then used to convert the GDP of each nation to a common monetary unit like the US dollar.
method of organizing economic activity characterized by (1) personal choice, (2) voluntary exchange coordinated by markets, (3) freedom to enter and compete in markets, and (4) protection of people and their property from aggression by others
A quarter (25 percent) of a group. The quartiles are often arrayed on the basis of an indicator like income or degree of economic freedom.
a form of political organization in which adult citizens are free to participate in the political process, elections are free and open, and outcomes are decided by majority voting, either directly or by elected representatives
What do purchasing power parity comparisons indicate?
that the per person income in wealthy countries such as Norway and the United States
is about fifty times the income level of the world's poorest countries. While these figures may result in some overstatement because
GDP excludes production within the household sector, it is clear that the income differences between high and low-income countries
What have countries with institutions and policies consistent with economic freedom achieved?
higher income levels and grown more
rapidly than those that are less free.
The ability to produce a good at a lower
opportunity cost than others can produce it. Relative costs determine comparative advantage.
A situation in which a nation, as the result of
its previous experience and/or natural endowments, can produce more a good (with the same amount of resources) than another nation.
A tax levied on goods imported into a country.
A specific limit or maximum quantity (or value) of a good permitted to be imported into a country during a given period.
Selling a good in a foreign country at a lower price than it's sold for in the domestic market.
General Agreement on Tariffs and Trade (GATT)
An organization formed after WWII to set the rules for the conduct of international trade and reduce trade barriers among nations
World Trade Organization (WTO)
The new name given to GATT in 1994, the WTO is currently responsible for monitoring and enforcing multilateral trade agreements among its 153 member countries
North American Free Trade Agreement (NAFTA)
a comprehensive trade agreement between the United States, Mexico, and Canada that went into effect in 1994
When will gains from specialization and trade will be possible?
as long as the realtive costs of producing the two goods differ in the two countries
What is the source of gains from trade?
comparative advantage, as long as relative production costs of goods differ, trading partners will be able to gain from trade
What do specialization and trade make possible?
for trading partners to produce a larger joint output and expand their consumption possibilities.
What percent of the GDP are international trade?
international trade (imports and exports) summed to 31 percent of GDP in 2008, compared with 12 percent in 1980 and 6 percent in 1960.
What are the leading imports and exports in the US?
Capital goods like automobiles, computers, semiconductors, telecommunications equipment, and industrial machines
What do import restrictions do?
reduce the supply of foreign goods to domestic markets. This causes the domestic price to rise. Essentially, the restrictions are a subsidy to producers (and workers) in protected industries at the expense of (1) consumers and (2) producers (and workers) in export industries. Jobs protected by import restrictions are offset by jobs destroyed in export-related industries.
Who do trade restrictions provide benefits to?
producers in the industries they are designed to protect
What do trade restrictions typically provide?
highly visible, concentrated benefits for a small group of people, while imposing on the general
citizenry costs that are widely dispersed and difficult to identify.
What are the two trade fallacies?
Trade Fallacy 1) Trade restrictions that limit imports save jobs and expand employment. Trade Fallacy 2) Free trade with low-wage countries like Mexico and China will reduce the wages of Americans.
When individuals and business are are permitted to trade freely over a larger market area
they will be able to produce a larger output and consume a more diverse bundle of goods
In the long-run, the primary effect of rapid monetary growth is
which of the following is a driving force underlying economic growth
entrepreneurial discovery and production of improved products
a legal system that protects private property and enforces contracts in an even-handed manner helps promote economic growth because it
provides people with a strong incentive to supply others with things that they value at an economical price
if the fed sells bonds to member banks, what happens to reserves and the money supply
if equilibrium is present in the foreign exchange market and a nation is experiencing a trade surplus,
the nation must be experiencing a net capital outflow
the law of comparative advantage explains why a nation will benefit from trade when
it exports goods for which it is a low-opportunity cost producer, while importing those for which it is a high-opportunity cost producer
which of the following would be expected if the tariff on foreign-produced automobiles were increased?
the supply of foreign automobiles to the domestic market would decline, causing auto prices to rise
trade restrictions that limit the sale of low-price foreign goods in the US market
benefit domestic producers in the protected industries at the expense of consumers and domestic producers in export industries
Suppose you withdraw $1000 from your checking account. If the reserve requirement is 10 percent, how does this transaction affect the supply of money and the excess reserves of your bank?
there is no change in the supply of money, your bank's excess reserves are reduced by $900
the argument that import restrictions save jobs and promote prosperity fails to recognize that?
US imports provide people in other countries with the purchasing power required for the purchase of US exports
When economists say the quantity demanded of a product has decreased, they mean the
price of the product has risen, and consequently, consumers are buying less of it
if there is a decrease in demand for baseball hats, we would expect
both the price and quantity sold to decrease
which of the following would reduce the price of Wii consoles and increase the quantity sold?
an increase in the supply of Wii consoles
when the residents of a nation are free to trade with foreigners, domestic producers will be able to
supply a larger quantity of goods they can produce at a relatively low cost
if the government cuts the tax rate, workers get to keep
more of each additonal dollar they earn, so work effort increases, and aggregate supply shifts right
Henry lived in a home that was newly constructed in 2002. In 2002, he paid $100,000 fir the brand new house. He sold the house in 2009 for $150,000. Which of the following statements is correct regarding the sale of the house?
the 2009 sale affected neither 2002 GDP nor 2009 GDP
Suppose, in dollar terms, nominal GDP increased approx 4% during a given year, and real GDP decreased 1%. Which of the following best explains these events?
prices increased approx 5%
Kim is a stay at home mom. Last week, she was busy with her normal household chores. She is
not a member of the labor force
On average, countries that have a larger degree of economic freedom tend to have
both higher per capita income levels and more rapid growth rates than countries with less economic freedom
according to non keynesians, how will an increase in government spending financed by borrowing during a recession affect recovery?
higher future taxes and interest rates will be required to finance the larger debt and this will weaken the recovery
which of the following is a positive effect of job search and the unemployment that often accompanies it?
it permits individuals to better match their skills and preferences with the requirements of a job
full employment is the situation in which the economy operates at an unemployment rate equal to the sum of
structural and frictional unemployment
actual GDP will be greater than potential GDP
during an economic boom
Suppose you recieved a 4% increase in your nominal wage. Over the year, inflation ran about 6%. Which of the following is true?
although your nominal wage rose, your real wage decreased
other things constant, an increase in resource prices will
increase the cost of producing goods and services, which will lead to a higher price level
which of the following is the most accurate statement about real and nominal interest rates?
real interest rates can either be positive of negative, but nominal interest rates must be positive
Other things constant, a decrease in resource prices will
increase short-run aggregate supply
In the AD/AS supply model, when the output of an economy is less than its long-run potential, the economy will experience
declining real wages and interst rates that will stimulate employment and real output
with the keynesian model, the multiplier effect tends to
magnify small changes in spending into much larger changes in output and employment
when economists say the supply of a product has increased, they mean the
supply curve has shifted to the right
the government is pursuing an restrictive fiscal policy if it
decreases government spending and/or increases taxes
economic theory indicates that the size of the government will be
postively related to economic growth at small levels of government but is negatively related to economic growth at large levels of government
the crowding-out model implies that restrictive fiscal policy will
reduce real interst rates
if the dollar depreciates relative to the Peso, it can be said that
the peso appreciates relative to the dollar