Terms in this set (74)
The study of individual household and firm behaviour,
individual markets and industries
The study of aggregate behaviour at the country or
income must equal
- Every transaction has a buyer and a seller.
- Every dollar of spending by some buyer is a dollar of
income for some seller.
Circular flow diagram
Gross domestic product (GDP)
is a measure of
the income and expenditures of an economy; it is the total market value of all final goods and
services produced within a country in a given time
Six important features of GDP
• Market prices.
• Final goods, not intermediate goods.
• Goods and services.
• Only goods and services currently produced.
• Production within the geographic confines of a country.
• Production within a specific interval of time.
consumption; the spending by households
on goods and services.
investment; the spending on capital
equipment, structures and inventories
government purchases; the spending on
goods and services by local and central
governments (excluding transfer payments).
NX (or Xn)
net exports; exports minus imports
production of goods and services
at current prices.
Σ(price per good x quantity of good)
production of goods and services at
constant prices. Σ(base year price per good x quantity of good)
Higher GDP per person indicates
standard of living.
Factors that contribute to well-being that are not included in GDP
The value of leisure
The value of the environment
The value of home production
The effects of unequal income distribution
The consumer price index (CPI)
measure of the overall cost of the goods and services in a fixed basket bought by a typical consumer; used to monitor changes in the cost of
living over time; used to correct for inflation for comparing cost of living over time
(base year basket quantities x current year prices/base year basket quantities x base year prices)x 100
100% x (CPI2-CPI1)/CPI1
Factors that contribute to cost of living that are not taken into account in the CPI
Introduction of new goods
Unmeasured quality change
represents a payment in the future
for a transfer of money from the past.
Nominal interest rate
rate not corrected for inflation (i)
Real interest rate
interest rate that is corrected for inflation (r)
Real interest rate = Nominal interest rate - Inflation
Factors of production
capital and labor
capital; tools, machines, and structures
used in production
labour; the physical and mental efforts of
Y=F(K,L) Shows how much output (Y) the economy can produce from
K units of capital and L units of labour; reflects the economy's level of technology; exhibits constant returns to scale
price of L
price of K
diminishing marginal returns
As one input is increased (holding other inputs constant), its marginal product falls. If L increases while holding K fixed machines per worker falls, worker productivity falls.
Demand for goods and services
C = consumer demand for goods and services, I = demand for investment goods, G = government demand for goods and services
(if closed economy: no NX)
Marginal propensity to consume(MPC)
The change in C when disposable income increases by one dollar
The real interest rate
the cost of borrowing; the opportunity cost of using one's own funds to finance investment spending
Taxes >Government Spending
Taxes <Government Spending
natural rate of unemployment
the average rate of unemployment around which the economy fluctuates (U/L)
workers in the work force, endogenously fixed
caused by the time it takes workers to search for a job; even when wages are flexible and there are enough jobs to go around because workers have different abilities and preferences, jobs have different skill requirements, geographic mobility of workers is not instantaneous, flow of information about vacancies and job candidates is imperfect
pays part of a worker's former wages for a limited time after the worker loses his/her job, increases frictional unemployment. May lead to better matches between jobs and workers, leading to increased productivity and higher incomes
unemployment resulting from real wage rigidity and job rationing, minimum wage, unions, efficiency wages, hiring and firing costs
government standard of lowest rage per hour, may exceed equilibrium wage of unskilled workers
exercise monopoly powers to secure higher wages for their members, at the cost of losing jobs when union wage exceeds equilibrium wages.
firms willingly pay above equilibrium wages to raise worker productivity; attracting higher quality job applicants, increasing worker effort, reducing "shirking," reducing turnover (which is costly to firms), improving health of workers (in developing countries)
the set of assets in the economy that agents regularly use to buy goods and services from other agents. Functions as a medium of exchange, unit of account, and a store of value
Medium of exchange
anything that is readily acceptable as payment
unit of account
the yardstick people use to record prices and debts
store of value
an item that people can use to transfer purchasing power from the present to the future
the ease with which an asset can be
converted into the economy's medium of exchange - money is the most liquid asset
takes the form of a commodity with
intrinsic value. ex: Gold, silver, cigarettes
used as money because of government decree; no intrinsic value.
Ex: Coins, currency, bank deposits
functions of the central bank
Regulates banks; acts as a banker's bank, making loans to banks and as a lender of last resort; conducts monetary policy
controlling the money supply or the nominal interest rate with open market operations
open market operations
buying or selling of government bonds to change the money supply
notes and coins in circulation and reserves
total currency circulating in the public plus the non-bank deposits with commercial banks
fractional reserve banking
banks hold a fraction of the money deposited as reserves and lend out the rest
the reciprocal of the reserve ratio
imposing minimum reserve requirements limits the ability of commercial banks to create money
velocity of money
(V) average number of times a pound is used in a given period; The velocity of money is relatively stable over long
periods of time - this is an alternative way of saying that the main determinant of money demand is nominal expenditure. Money demand and velocity are inversely related
Quantity Theory of Money
M x V = P x Y; V is stable and Y is determined by the quantity of inputs and the production function, so changes in M cause proportional changes in P
If the central bank causes the money supply to increase continuously then the price level will rise at the same rate (on average)
Prices are flexible and respond to changes in supply or demand, output and employment are always at their natural rates, and the classical theory
Many prices are "sticky" at a
predetermined level. The economy behaves very differently when prices are sticky; shocks can push output and
employment away from their natural rates.
unemployment equals its natural rate (not zero)
exogenous changes in aggregate supply or demand that temporarily push the economy away from full employment
alters production costs, affects the
prices that firms charge. (also called price shocks) can be favorable and adverse ex: weather, unions, governmental regulations,
reasons for sticky prices
long-term contracts between firms and customers, menu costs, firms not wishing to annoy customers with
frequent price changes. assumption that firms set their own prices
the deviation of the actual rate of unemployment from the natural rate
the "stock of ideas" about the best products and the best production processes
(A) the state of knowledge and production techniques which determines the quantity of output that is obtainable from a given quantity of inputs
any change in the state of knowledge and production techniques which make it possible to obtain more output from the same quantity of inputs. Arises from research and development-either public (universities and public research institutes) or private (within firms)
(H) the stock of skills and knowledge embodied in a given set of workers
Human capital accumulation
the change in the stock of knowledge and skills. requires training, education or learning-by-doing