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The study of how people, both as individuals and societies, make decisions when faced with wants that exceed their resources
An experiment that can be repeated, and in which only one thing at a time is changed.
Fallacy of Composition
The false belief that if something is true for an individual part, it is necessarily true of the whole system
Production Possibility Curve (PPC)
Shows all the combinations of two goods a person or economy can produce, given its available resources and technology
Being able to produce a good at the lowest opportunity cost in terms of other goods
Process by which sellers (supply side) and buyers (demand side) interact to exchange a certain type of good or service
Change in Demand
Occurs if the buyer's side of the market is the root cause of a change. Buyers change the amount they are willing and able to buy at a given price.
Reaction by sellers to a change in price. The amount sellers are willing and able to sell at a given price
Change in Supply
Sellers are willing to bring a different amount to market, even if the price stays the same
Reaction by buyers to a change in price. The amount of a good that buyers are willing and able to purchase at a particular price.
The relationship between the price of a good and the amount buyers are willing and able to buy
Law of Demand
The inverse relationship between price and quantity demanded. As price rises, Qd decreases. As price decreases, Qd increases
Goods that can serve as replacements for one another, when the price of one increases, demand for the other goes up
Determinants of Demand
Number or potential buyers, tastes or preferences, income of buyers, price of related goods, other
Two goods for which an increase in the price of one leads to a decrease in the demand for the other
things that Shift Supply
Costs of resources, production technology, number of potential buyers, other
No Central Coordination
Decision making is largely atomistic and decentralized. Results in ORDER: The goods people want in right quantity and place
Markets are based on greed. Markets generally result in people doing good things for others. Because self-interest is a powerful and reliable motivator, many think markets benefit society
The time period in which the economy can, without any government intervention, be away from its normal levels of output (Qnat) and employment. 0-5 years
One sector of the economy taking resources away from another sector with bad consequences for (very) long run growth. A Long-Run problem.
The time period in which the economy can be expected to return to its normal levels of output (Qnat) and unemployment (Unat). 5+ years
The time period in which the economy's normal levels of output (Qnat) can show marked change. 25+ years
Growth of Capacity
Growing the economy's normal levels of output (Qnat) and (perhaps) reducing its normal level of unemployment (Unat)
Gross Domestic Product (GDP)
The $ value of all goods and services provided within a nation's borders, and sold in legal markets, each year
Ways to measure GDP
1. Adding up the selling price of all final goods and services produced 2. Adding up all income created in an economy
The difference between a good's selling price and the "intermediate goods" used to make the good
Adjusted for changes in the price level. How much an item would be worth in base year dollars
Circular Flow Model
Shows the basic components of an economy. Households are the ultimate owners of resources.
The percentage change in the general price level per year. Inflation= ( ( Cost t - Cost t-1) / Cost t-1 ) ) X 100%
How much the market basket costs in that year relative to what it cost in the base year. PI= ( Cost in year t / Cost in base year ) X 100
Structural Unemployment (Ustruc)
Results from workers not having the skills or being in the location that firms want
Production Process (P)
Captures technology, legal institutions, and any other aspects affecting how an economy uses its resources
The combination of capital (K), labor (L), and natural resources (N), through the production process
The right to reap the rewards (and costs) of one's actions. The right to do what you want with your resources, the right to transfer property, the right to have your resources protected from damage by others without your permission
Intellectual Property Rights
The Patents and Copyrights that establish temporary ownership of ideas, processes, artisitc creations, and written works
Good Rule of Law
Rules by which people and businesses play are known and fixed. People make decisions confidently knowing that the government will not arbitrarily change the business environment
A system of government in which each layer of government has different powers and responsibilities. State governments compete in a healthy way to provide the best economic environment
Occur when the government takes income from one person and gives it to another person, but receives nothing in exchange. Taxes
The government commands that more resources go to the government. "Great Leap Forward" in 1950's China and a modern military draft
New sources of spending funded by leakages, namely investment (I) and government spending (G)
The amount of spending on domestically produced goods. Varies with the price level (C+I+G+X-M)
Foreign Purchases Effect
When U.S prices rise, foreigners find U.S goods more expensive and exports (X) fall. Americans find foreign goods cheaper and buy more imports (M). Aggregate Demand slopes down
Short-Run Aggregate Supply (SRAS)
Intersects with AD to determine where an economy is in the short run
The Real Balances Effect
Assets such as savings accounts, bonds, etc. keep the same nominal value even if the economy experiences inflation
Government actions to affect the amount of money in an economy and interest rates. The Federal Reserve putting money into the economy and cutting interest rates during a recession by buying government bonds
Classical or new-classical view. The government should not take an active role in trying to keep the economy at or near its PPC. The Private sector is inherently stable and can take car of itself
Activist View (Keynesian)
The private sector spending is inherently unstable. Private individuals and first base most of their decisions on what they see and feel right now rather than on slowly changing long-run trends.
John Maynard Keynes
Author of "The General Theory of Employment, Interest, and Money" (The General Theory). The biggest proponent of the activist view
Phenomenon in which the financial sector hoards cash, a very liquid asset, instead of lending it out
The initial wave of increased spending by government and households spending their tax cuts
The time it takes people to realize that the economy is in a recession. 6 months after an economy enters a recession for it to become widely recognized and the recession to become a major political issue
Automatic Fiscal Policy
Changes in tax collections and government spending, with no change in budget laws, as the economy moves through the business cycle
Requires a double coincidence of wants. Quantities and qualities must also match. Encourages people not to specialize and therefore lowers living standards
Money that has no intrinsic value as a commodity. It is simply money because that is what society has chosen to use as money
Fractional Reserve Banking
The reserves a bank keeps are only a fraction of the amount people have deposited in the bank
Channeling the money of savers into the hands of borrows. Much of this borrowing goes to physical investment. Without it, there would not be near as much physical investment
Required Reserves Ration (R)
Ratio instilled by the Federal Reserve that balances how much reserves a bank has to hold to back each $1 of checking. Usually 10%
Banks paying money into a fund. Money is used to insure savers' deposits should the bank fail
Lender of Last Resorts
Government loans to banks when banks need cash and can not get it from each other
The only institution in a country that can print and issue currency. Acts as a lender of last resort. Conducts monetary policy
United States Federal Reserve
The central bank for the U.S; regulates the banking industry. Acts a check clearinghouse between banks. Can often afford to ignore popular and political opinion
Trying to increase the money supply, encouraging lending by banks, and pushing interest rates down. Increase spending and aggregate demand
Taking steps to decrease the money supply, discouraging lending by banks, and driving interest rates down
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