The social science that studies how individuals, institutions, and society make the optimal best choices under conditions of scarcity
The Economic Perspective entails (3):
1. All choices involve costs and these costs must be involved in an economic decision 2. To achieve a goal, people must make decisions that reflect their purposeful self-interest 3. People compare marginal benefits and marginal costs when making a decision, and will choose the situation where the marginal beneift>marginal cost
Gathering data, testing hypotheses, and developing theories and principles.
Specific units in the economy (ex: how prices and output are determined for products and how customers react to price changes)d
the study of economy-wide phenomena, including inflation, unemployment, and economic growth
Investigates facts or cause-and-effect relationships; the right answer
Objective views of what ought to be or what policies should be used to address an economic issue
Causes of Economizing Problem (2):
1. Individuals and society have unlimited economic wants 2. The economic means or resources to satisfy those wants are limited
Production Possibilities Curve (PPC)
A graph that shows the various combinations of output that the economy can produce of two products, given the available factors of production and the available production technology.
A line that shows the different combinations of two products a consumer can purchase with a specific money income, given the products' prices.
The contributed time and abilities of people who are producing goods and services
The machines, tools, and equipment used to make other goods and services
The purchase of capital goods
The special human talents of individuals who combine the other factors of production
Law of Increasing Opportunity Cost
To produce more of one good, a successively larger amount of the other good must be sacrificed
An economic system where government should not interfere in the marketplace
A method of organizing an economy in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities; command economy; communism
All the product and resource markets of a market economy and the relationships among them; a method that allows the prices determined in those markets to allocate the economy's scarce resources and to communicate and coordinate the decisions made by consumers, firms, and resource suppliers
Five Fundamental Questions
1. What goods and services will be produced? 2. How will the goods and services be produced? 3. Who will get the goods and services? 4. How will the system accommodate change? 5. How will the system promote progress?
Circular Flow Diagram
A set of institutions and a coordinating mechanism to respond to the economizing problem for an economy
Freedom of Enterprise
The freedom of firms to obtain economic resources, to use those resources to produce products of the firm's own choosing, and to sell their products in markets of their choice
Freedom of Choice
The freedom of owners of property resources to employ or dispose of them as they see fit, of workers to enter any line of work for which they are qualified, and of consumers to spend their incomes in a manner that they think is appropriate
The struggle among producers for the dollars of consumers
Any arrangement that allows buyers and sellers to exchange things
Division of Labor/Specialization
When workers devote themselves to doing what they're best at, increasing the efficiency of the firm and of the economy
Anything that serves as a medium of exchange, a unit of account, and a store of value
The "votes" that consumers and entrepreneurs cast for the production of consumer and capital goods, respectively, when they purchase those goods in product and resource markets.
The term economists use to describe the self-regulating nature of the marketplace
New, technologically advanced machinery and production methods cause the disappearance of firms using old machinery and methods
One or more persons occupying a housing unit
Economic entities (firms) that purchase resources and provide goods and services to the economy.
Business owned and operated by a single person
A business in which two or more persons combine their assets and skills
A business owned by stockholders who share in its profits but are not personally responsible for its debts
The market in which households purchase the goods and services that firms produce
A market in which households sell and firms buy resources or the services of resources
Consumer willingness and ability to buy products
The amount of goods available
The amount of a good or service that a consumer is willing and able to purchase at a given price
The amount a supplier is willing and able to supply at a certain price
The price that balances quantity supplied and quantity demanded, it tends to prevail in the market
A graph of the relationship between the price of a good and the quantity demanded
A curve that shows the relationship between the price of a product and the quantity of the product supplied
A legal maximum on the price at which a good can be sold. It leads to a persistent shortage of products
A legal minimum on the price at which a good can be sold. It leads to a persistent surplus of products. Also leads to Black Markets for these items.
Law of Demand
There is an inverse relationship between price and quantity demanded
Diminishing Marginal Utility
Decreasing satisfaction or usefulness as additional units of a product are acquired
A higher price for a good decreases the purchasing power of consumers' incomes so they can't buy as much of the good
When consumers react to an increase in a good's price by consuming less of that good and more of other goods
Determinants of Demand (5):
1. Consumers' tastes (preferences) 2. The number of buyers in the market 3. Consumers' incomes 4. Prices of related goods 5. Consumer expectations
A good that consumers demand more of when their incomes increase
A good that consumers demand less of when their incomes increase
Products or services that can be used in place of each other. When the price of one falls, the demand for the other product falls; conversely, when the price of one product rises, the demand for the other product rises.
Products and services that are used together. When the price of one falls, the demand for the other increases (and conversely).
Change in Demand vs. Change in Quantity Demanded
A change in demand is when the whole curve shifts and a change in quantity demanded is movement along the demand curve due to a change in price. Price Doesn't shift the curve.
Law of Supply
A positive relationship between price and quantity supplied/ Other things equal, as the price of the good increases, more quantities will be offered for sale.
Determinents of Supply (6):
1. Resource prices 2. Technology 3. Taxes and subsidies 4. Prices of other goods 5. Price expectation 6. Number of sellers in the market
A situation in which quantity supplied is greater than quantity demanded
A situation in which quantity demanded is greater than quantity supplied
The quantity supplied and the quantity demanded at the equilibrium price
A situation in which a good or service is produced at the lowest possible cost. This doesn't need allocative efficiency to work
Resources are devoted to the production of goods and services society most highly values. This doesn't need productive efficiency to work
Demand Increases results in:
Price increases, quantity demanded increases
Demand decreases results in:
Price decreases, quantity demands decreases
Supply increases results in:
Prices decreases, quantity demanded increases
Supply decreases results in:
Price increases, quantity demanded decreases
Change in Demand
Causes entire demand curve to shift
Change in Quantity Demanded
A movement along an existing demand curve
National Income Accounting
Measurement of the national economy's performance, dealing with the overall economy's output and income
Gross Domestic Product (GDP)
The best estimate of the total goods and services produced within a country in a year
GDP is composed of these expenditure categories (4):
1. Personal consumption expenditures (C) 2. Gross private domestic investment (Ig) 3. Government purchases (G) 4. Net exports (Xn)
Total income earned by everyone in the economy
The production of goods and services valued at constant prices
The production of goods and services valued at current prices
Goods and services that have been purchased for final use and not for resale or further processing or manufacturing
Products that are purchased for resale or further processing or manufacturing
Wrongly including the value of intermediate goods in the gross domestic product; counting the same good or service more than once
The gross value of the product minus the costs of raw materials and energy
Expenditures Approach to GDP
The method that adds all expenditures made for final goods and final services to measure the GDP
Personal Consumption Expenditures (C)
The expenditures of households for durable and nondurable consumer goods and services
Goods that last for a relatively long time, such as refrigerators, cars, and DVD players
Goods that last a short period of time, such as food, light bulbs, and sneakers
Activities that are consumed at the same time they are produced
Gross Private Domestic Investment (Ig)
Expenditures for newly produced capital goods (such as machinery, equipment, tools, and buildings) and for additions to inventories
Increase in inventories leads to:
Increases in investment that year
Decrease in inventories lead to:
Decreases in investment that year
Government Purchases (G)
Spending on goods and services by local, state, and federal governments
Net Exports (Xn)
Exports (X) - Imports (M)
Equation for GDP:
C + Ig + G + Xn = GDP
Compensation of Employees
Includes wages, salaries, and various supplements—employer contributions to social insurance and pension funds, for example—paid to households by firms and by the government
Income received by property owners
A sum paid or charged for the use of money or for borrowing money
The profits or net income of sole proprietors or unincorporated business firms
Earning of corporations
Taxes on Production and Imports
Includes general sales taxes, excise taxes, business property taxes, license fees, and customs duties
National Income is these six categories added:
Compensation of employees, rents, interest, proprietor's income, corporate profits, and taxes
Consumption of Fixed Capital
An estimate of the amount of capital worn out or used up (consumed) in producing the gross domestic product; also called depreciation
Net Domestic Product (NDP)
Gross domestic product less the part of the year's output that is needed to replace the capital goods worn out in producing the output; the nation's total output available for consumption or additions to the capital stock
Salaries and wages as well as investment income and government payments to individuals
Income remaining for a person to spend or save after all taxes have been paid
A measurement that shows how the average price of a standard group of goods changes over time
Year serving as a point of comparison for other years in a price index or other statistical measure
GDP's shortcomings (7):
1. Excludes the value of non-market final goods 2. Excludes the amount of increased leisure enjoyed 3. Does not fully account for the value of improvements in quality of products 4. Does not measure the market value of the final goods and services 5. Does not record the pollution or environmental costs 6. Does not measure changes in the composition and the distribution of the domestic output 7. Does not measure noneconomic sources of well-being
Change in Demand vs. Change in Quantity Demanded
A change in demand is when the whole curve shifts and a change in quantity demanded is movement along the demand curve due to a change in price. Price Doesn't shift the curve.
The ups and downs in real output of the economy that occur over several years
An increase in the general level of prices; arbitrarily redistributes real income and wealth in the economy
Unemployment rate equation
# of persons in the labor force that are unemployed divided by the total # of people in the labor force
Those who have left the labor force and are not seeking jobs
All workers are employed and there is no unemployment
Unemployment that occurs when people take time to find a job
unemployment that occurs when workers' skills do not match the jobs that are available due to technological advances and changes in consumer demands
Unemployment that rises during economic downturns and falls when the economy improves
actual GDP - potential GDP
1 percent more unemployment results in 2 percent less output
Consumer Price Index (CPI)
a measure of the overall cost of the goods and services bought by a typical consumer; primary measure of inflation
100 x (cost of basket in current year/cost of basket in base year)
The rule of 70
A method for determining the number of years it will take for some measure to double, given its annual percentage increase. Example: To determine the number of years it will take for the price level to double, divide 70 by the annual rate of inflation.
Rule of 70 formula
70/inflation or deflation
increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand; "too much money chasing too few goods"; may reduce real output, or may be a by-product of economic growth
When prices rise due to an increase in the cost of production; reduces real output, employment, and income
the underlying increases in the price level after volatile food and energy prices are removed
The amount of goods and services that can be purchased with nominal income during some period of time; nominal income adjusted for inflation.
Real income equation
(nominal income/CPI) x 100
The number of dollars received by an individual or group for its resources during some period of time.
increases in the price level (inflation) at a rate greater than expected; hurts fixed-income receivers, savers, and creditors
Cost-of-living adjustment (COLA)
Automatic adjustments of nominal income to the rate of inflation
Increases in the price level (inflation) that occur at the expected rate.
nominal interest rate
the interest rate as usually reported without a correction for the effects of inflation
real interest rate
the interest rate corrected for the effects of inflation
A situation in which prices are declining
A very rapid rise in the price level; an extremely high rate of inflation; can lead to a breakdown of the economy by redistributing income and reducing real output and employment
full-employment rate of unemployment
The unemployment rate at which there is no cyclical unemployment of the labor force; equal to between 4 and 5 percent in the United States because some frictional and structural unemployment is unavoidable.
unexpected changes in the demand for goods and services
unexpected events that affect supply, sometimes only temporarily
A list of possessions or goods on hand.
inflexible prices ("sticky prices")
Product prices that remain in place (at least for a while) even though supply or demand has changed; stuck prices or sticky prices.
product prices that freely move upward or downward when product demand or supply changes
Aggregate Demand-Aggregate Supply Model
Explains why real domestic output and the price level fluctuate in the economy
Aggregate Demand (AD)
A curve that shows the total quantity demand for all goods and services of a nation at various price levels at a given period of time; slopes downward
The tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.
The tendency for increases in the price level to increase the demand for money, raise interest rates, and, as a result, reduce total spending and real output in the economy (and the reverse for price-level decreases).
The inverse relationship between the net exports of an economy and its price level relative to foreign price levels; if buying power of dollar goes up, Net Exports goes down
determinants of aggregate demand (4)
1. Consumer Spending 2. Investment Spending 3. Government Spending 4. Net Export Spending
Aggregate Supply (AS)
The total amount of goods and services that all the firms in all the industries in a country will produce at various price levels in a given period of time.
immediate-short-run aggregate supply curve
An aggregate supply curve for which real output, but not the price level, changes when the aggregate demand curve shifts; a horizontal aggregate supply curve that implies an inflexible price level; horizontal
short-run aggregate supply curve
shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed; flat horizontal
long-run aggregate supply curve
shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible; vertical
The GDP at which the total quantity of final goods and services purchased is equal to the total quantity of final goods and services produced.
equilibrium price level
The price level at which the aggregate demand curve intersects the aggregate supply curve.
Increase in Aggregate Demand leads to:
An increase in both real domestic output and the price level
Decrease in Aggregate Demand leads to:
A reduction in real output and increase in cyclical unemployment, may not decrease price level
the costs of changing prices
above-equilibrium wages paid by firms to increase worker productivity
Decrease in Aggregate Supply leads to:
a decrease in real domestic output and employment along with a rise in the price level, or cost-push inflation
Increase in Aggregate Supply leads to:
Improves real domestic output and employment while maintaining a steady price level
What can change the Aggregate Demand Curve?
Only C, Ig, Xn, and G
An increase in the price level is:
A decrease in the price level is:
If Aggregate Demand is low,
you have extra resources you aren'r using
How economy functions at low levels of output
short-run aggregate supply curve (graph)
long-run aggregate supply curve (graph)
Can still produce more, may be working people 40 hours a week but you can do more
the condition in which virtually all who are able and willing to work are employed; "driving a car at 100mph"
period of reduced economic activity; result of a decrease in aggregate demand
a curve that shows the short-run trade-off between inflation and unemployment
high inflation and high unemployment; only present in the short run, as in the long run the Phillips curve is a straight line; is the AD curve in graphs
An economic philosophy that holds the sharply cutting taxes will increase the incentive people have to work, save, and invest. Greater investments will lead to more jobs, a more productive economy, and more tax revenues for the government.
shows the relationship between the size of the tax and tax revenue; suggests that cuts in tax rates can increase tax revenues; critics say incentives are too small, potentially inflammatory, and can have positive or negative effects on rax revenues
a reduction in the rate of inflation
products requiring relatively large amounts of labor to produce; ex: textiles or toys
products requiring relatively large amounts of land to produce; ex: beef or vegetables
products that require relatively large amounts of capital to produce; ex: airplanes and chemicals
the ability to produce a good at a lower opportunity cost than another producer
opportunity cost ratio
An equivalency showing the number of units of two products that can be produced with the same resources
principle of comparative advantage
Total output will be greatest when each nation specializes in the production of a product for which it has the lowest domestic opportunity cost
terms of trade
the ratio at which a country can trade its exports for imports from other countries
trading possibilities line
a line that shows the different combinations of two products that an economy is able to obtain (consume) when it specializes in the production of one product and trades (exports) it to obtain the other product
equilibrium world price
The price of an internationally traded product that equates the quantity of the product demanded by importers with the quantity of the product supplied by exporters; the price determined at the intersection of the export supply curve and the import demand curve.
export supply curve
An upward-sloping curve that shows the amount of a product that domestic firms will export at each world price that is above the domestic price.
import demand curve
a downsloping curve showing the amount of a product that an economy will import at each world price below the domestic price
restrictions to free trade
Taxes on imported goods
limitations set by a government on the amount of a product allowed to enter a country
taxes designed to raise funds for the importing government
Non-tariff barriers (NTBs)
trade barriers that include customs documentation requirements, marks of origin, food and drug laws, labeling laws, antidumping laws, "buy national" policies, and subsidies.
voluntary export restraint (VER)
A quota on trade imposed from the exporting country's side, instead of the importer's; usually imposed at the request of the importing country's government.
A government payment to a domestic producer to enable the firm to reduce the price of a good or service to foreign buyers.
Economic policy of shielding an economy from imports.
Selling goods in another country below market prices
Cooperative compacts among three or more states to ensure that a concerted policy is implemented toward alleviating a common problem, such as levels of future weapons capabilities.
A region where a group of countries has agreed to reduce or eliminate trade barriers
General Agreement on Tariffs and Trade (GATT)
a 1947 agreement that established an international forum for negotiating mutual reductions in trade restrictions
World Trade Organization (WTO)
a trade organization that replaced the old General Agreement on Tariffs and Trade (GATT)
Doha Development Agenda
An initiative of the World Trade Organization focused on issues of trade and development.
European Union (EU)
a free trade zone encompassing 27 European countries
North American Free Trade Agreement (NAFTA)
Agreement that created a free-trade area among the United States, Canada, and Mexico.
Trade Adjustment Assistance Act
A U.S. law passed in 2002 that provides cash assistance, education and training benefits, health care subsidies, and wage subsidies (for persons age 50 or older) to workers displaced by imports or relocations of U.S. plants to other countries.
The practice of exporting U.S. jobs to lower paid employees in other nations.
the price of a good or service within a country, determined by domestic demand and supply
domestic price < world price
Export the good The country has comparative advantage
domestic price > world price
Import the good The world has comparative advantage
balance of payments
the difference between the flow of money into and out of a country
in the balance of payments, records transactions involving the export or import of goods and services
balance on goods and services
the exports of goods and services of a nation less its imports of goods and services in a year
balance on current account
the exports of goods and services of a nation less its imports of goods and services plus its net investment income and net transfers in a year
capital and financial account
The section of a nation's international balance of payments that records (1) debt forgiveness by and to foreigners and (2) foreign purchases of assets in the United States and U.S. purchases of assets abroad.
balance on capital and financial account
the sum of the capital account balance and the financial account balance
balance of payments deficit
shortfall that occurs when more money flows out of a nation than into that nation
overage that occurs when more money flows into a nation than out of that nation
foreign currencies owned by the central bank of a nation
flexible exchange rate
arrangement in which the forces of supply and demand are allowed to set the price of various currencies
floating exchange rate
an exchange rate policy under which a government permits its currency to be traded on the open market without direct government control or intervention
fixed exchange rate system
a currency system in which governments try to keep the values of their currencies constant against one another
determinants of exchange of rate
1. relative price levels 2. relative rates of productivity growth 3. preferences for domestic and foreign goods 4. tariffs and quotas
Purchasing Power Parity theory
A theory of international exchange holding that exchange rates are set so that the price of similar goods in different countries is the same.