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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.

economic theory

A set definitions, postulates, and principles
assembled in a manner that makes clear the "cause-and-effect" relationships.

opportunity cost

The highest valued alternative that must be
sacrificed as a result of choosing an option.

economizing behavior

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.

secondary effects

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.

scientific thinking

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.

positive economics

the scientific study of "what is" among economic relationships

normative economics

judgements about "what ought to be" in economic matters, cannot be proven false because they are based on value judgements

ceteris paribus

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

transaction costs

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.

property rights

The rights to use, control, and obtain the benefits
from a good or resource.

private-property rights

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.

creative destruction

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)

market organization

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

consumer surplus

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

producer surplus

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.

economic efficiency

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.

intermediate goods

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.

personal consumption

household spending on consumer goods and service during the current period

private investment

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

inventory investment

changes in the stock of unsold goods and raw materials held during a period

net exports

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)

national income

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

nominal values

values expressed in current dollars

real values

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.

GDP deflator

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.

nominal GDP

GDP expressed at current prices, often called money GDP

real GDP

GDP adjusted for changes in the price level

underground economy

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.

business cycle

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)

unemployment rate

the percentage of people in the labor force who are unemployed (number unemployed/number in labor force)

employment/population ratio

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)

frictional unemployment

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.

structural unemployment

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.

cyclical unemployment

Unemployment due to recessionary
business conditions and inadequate labor demand.

full employment

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.

potential 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

unanticipated inflation

an increase in the general level of prices that was not expected by most decision makers

anticipated inflation

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.

fiscal policy

the use of government taxation and expenditure policies for the purpose of achieving macroeconomic goals

monetary policy

the deliberate control of the money supply, and, in some cases, credit conditions, for the purpose of achieving macroeconomic goals

money supply

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

resource market

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

exchange rate

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

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.

trade deficit

The situation when a country's imports of goods and services are greater than its exports.

trade surplus

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

anticipated change

a change that is foreseen by decision makers in time for them to make adjustments

unanticipated change

a change that the decision makers could not reasonable foresee, the choices they made prior to the change did not take it into account

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