Intro to Economics (copy)

Midterm

Subsistence level

a level of income where the population remains constant over time; Supporting itself at minimum levels

Equilibrium

a point where there is no tendency to change unless something else in the economy changes

Capitalism

an economic system consisting of private firms and their pursuit of profit. The self-regulation of capitalist markets is represented by the invisible hand.

Institutions

the laws and informal rules that regulate social interactions among people and between people and the biosphere.

Economic system

a way of organizing the economy that is distinctive in its basic institutions

A natural experiment

is a situation where we use an external event, such as a change in institutions or a natural disaster, to compare the outcomes for economic actors who were affected by this event and those who were not.

A counterfactual event

is what would have happened if there had been no change

Malthusian Theory

believes that people were like animals and he also suggested that there is a subsistence level, where the population grows when they have enough supply but beyond that point where the population increases too much supply will be scarce which will result in everyone having a subsistent level of supply.

Malthusian Trap/Catastrophe

When population growth outpaces agricultural production, which subsequently will lead to famine/war then poverty/depopulation.

Average Product of Labour (APL)

the mean of how much product each worker can produce

Marginal Product of Labour (MPL)

the change in output when more workers are added

Path-dependence

the historical order of circumstances and events leads to a certain outcome like the cases with countries that adopted capitalism early on and had rapid economic growth. 

Purchasing Power Parity (PPP)

method used to compare currencies and their exchange rate.

Opportunity Cost

the value of the next best action not taken

Biosphere

The collection of all forms of life on earth. The physical environment and the _________ provide the essentials for life such as air, water and food as well as the raw materials that we use in production such as wood, metals and oil.

Willingness to pay (WTP)

the amount of money a consumer would be willing to pay for a good

Willingness to accept (WTA)

the amount of money the seller would be willing to trade the good for, also referred to as the seller's reservation price.

Market supply curve

Sum of what all firms would supply at each price point.

Characteristics of a competitive equilibrium

All transactions take place at the same price. This is known as the Law of One Price. The market clears. All participants are price-takers.

Conditions for a competitive equilibrium (perfect competition)

many buyers and sellers, acting independently; identical (homogeneous) goods; all buyers and sellers are aware of the prices at which others are trading, and always seek the best price available.

Business cycle

Alternating periods of positive and negative growth rates.

Recession

period when output is declining or below its potential level

Okun’s Law

a strong and stable relationship between unemployment and GDP growth.

Okun’s coefficient

degree of correlation

National accounts

system used to measure overall output and expenditure in a country.

Components of GDP

Consumption+Investment+Gov spending+NX

Shock

an unexpected event (such as extreme weather) which causes GDP to fluctuate.

Self-insurance

saving and borrowing. Other households are not involved.

Co-insurance

support from social network or government.

Smoothing consumption

Actions taken by an individual, family, or other group in order to sustain their customary level of consumption. Actions include borrowing or reducing savings to offset negative shocks, such as unemployment or illness; and increasing saving or reducing debt in response to positive shocks, such as promotion or inheritance.

Credit constraints

limits on amount borrowed/ability to borrow. The households unable to adjust to a temporary income shock have lower welfare.

Weakness of will

inability to commit to beneficial future plans.

Asset

something that is owned, and has value.

Asymmetric information

Information that is relevant to the parties in an economic interaction, but is known by some but not by others.

Bargaining power

The extent of a person or firm’s advantage in securing a larger share of the economic rents made possible by an interaction.

Bond

A financial asset where the government (or a company) borrows for a set period of time and promises to make regular fixed payments to the lender (and to return the money when the period is at an end).

budget constraint

An equation that represents all combinations of goods and services one could acquire that would exactly exhaust one’s budgetary resources.

capital goods

The durable and costly non-labour inputs used in production (such as machinery and buildings). They do not include some essential inputs (such as air, water, and knowledge) that are used in production at zero cost to the user.

Cartel

A group of firms that collude (work together) to set output and/or prices in order to raise their joint profits.

Collateral

An asset that a borrower pledges to a lender as a security for a loan. If the borrower is not able to make the loan payments as promised, the lender becomes the owner of the asset.

common-pool resource

A resource that is rival or partially rival (more people using it reduces the benefits to others) but non-excludable within a community of users. All members of the community are able (and in some cases have a legal right) to use it, but outsiders can be excluded

competition policy, antitrust policy

Government policies and laws to limit market power and prevent cartels, or to otherwise regulate the process of competition

Competitive equilibrium

A market is in competitive equilibrium if the quantity supplied is equal to the quantity demanded at the prevailing price, and all buyers and sellers are price-takers, so that no-one can benefit from attempting to trade at a different price

complete contract

occurs if it a) covers all of the aspects of the exchange in which any party to the exchange has an interest, and b) is enforceable (by the courts) at close to zero cost to the parties.

constant returns to scale

increasing all of the inputs to a production process by the same proportion increases output by the same proportion. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs.

consumer surplus

ach consumer who buys a good receives a surplus equal to their willingness to pay minus the price. The term ‘consumer surplus’ normally refers to the sum of these surpluses across all consumers.

convex preferences

A person whose indifference curves have a convex shape—they get flatter as you move along the curve to the right of the diagram—is said to have convex preferences. This typical shape arises because when someone has more of one good (relative to another) they are willing to give up more of it in exchange for a unit of the other good: their marginal rate of substitution falls along the curve.

copyright

Ownership rights over the use and distribution of an original work.

Creative destruction

process by which old technologies and the firms that do not adapt are swept away by the new, because they cannot compete in the market. In his view, the failure of unprofitable firms is creative because it releases labour and capital goods for use in new combinations.

Crowding out

There are two quite distinct uses of the term. One is a negative effect that is observed when economic incentives displace people’s ethical or social motivations. In studies of individual behaviour, incentives may have a crowding out effect on social preferences. The second use of the term is to refer to the effect of an increase in government spending in reducing private spending, as would be expected for example in an economy working at full capacity utilization, or when a fiscal expansion is associated with a rise in the interest rate.

discount rate

A measure of someone’s impatience: how much the person values an additional unit of consumption now relative to an additional unit of consumption later. It is equal to the slope of the indifference curve for consumption now and consumption later, minus one.

economic rent

the difference between the net benefit (monetary or otherwise) that an individual receives from a chosen action, and the net benefit from the next best alternative (or reservation option).

endowment

the things that a person have that enable them to receive income. They include physical wealth (for example: land, housing, machinery); financial wealth (for example: savings, stocks/shares, bonds); intellectual property (for example: patents, copyrights); knowledge, skills, abilities, and experience that affect labour income; citizenship and rights to work. They can include characteristics such as nationality, gender, race, and social class, if these affect their income.

Equity

An individual holds equity in a project or business if some of their own wealth (rather than borrowed funds) is invested in it. There is a second entirely different use of the term, meaning fairness, as in ‘an equitable division of the pie’.

exogenous

‘generated outside the model’. In an economic model, a variable is ____________ if its value is set by the modeller, rather than being determined by the workings of the model itself.

Factors of production

Any input into a production process. May include labour, machinery and equipment (usually referred to as capital), land, energy, and raw materials.

Feasible frontier

All of the combinations of goods or outcomes that a decision-maker could choose, given the economic, physical, or other constraints that they face.

Gini coefficient

A measure of inequality of a quantity such as income or wealth, varying from a value of zero (if there is no inequality) to one (if a single individual receives all of it). It is the average difference in, say, income between every pair of individuals in the population relative to the mean income, multiplied by one-half.

government bond

A financial asset where the government borrows for a set period of time and promises to make regular fixed payments to the lender (and to return the money when the period is at an end).

Disposable income

the amount of profit, interest, rent, labour earnings, and other payments (including transfers from the government) received, net of taxes paid, measured over a period of time such as a year. Your income is the maximum amount that you could consume per period and leave your wealth unchanged.

Income effect

The effect that an increase in income has on an individual’s demand for a good (the amount that the person chooses to buy) because it expands the feasible set of purchases. When the price of a good changes, this has an income effect because it expands or shrinks the feasible set, and it also has a substitution effect. See also: substitution effect.

Incomplete contract

A contract that does not specify, in a way that can be enforced by a court, every aspect of the exchange that affects the interests of parties to the exchange (or of others).

Innovation rent

Profits in excess of the opportunity cost of capital that an innovator gets by introducing a new technology, organizational form, or marketing strategy.

Interest rate

the price paid by the borrower to the lender (or saver) for a loan. It is expressed as the payment per period, as a percentage of the loan amount. For a borrower it is the cost of bringing buying power forward from the future; for a saver it is the benefit of deferring buying power to the future.

Investment

is the expenditure undertaken in order to generate a return in future: for example, buying financial assets that will generate income in future, or a house that will provide accommodation, or capital goods to be used by a firm to produce output. In the national accounts, investment expenditure refers more specifically to fixed investment (gross fixed capital formation) together with inventory investment.

Nash Equilibrium

an economic outcome where none of the individuals involved could bring about an outcome they prefer by unilaterally changing their own action. More formally, in game theory it is defined as a set of strategies, one for each player in the game, such that each player’s strategy is a best response to the strategies chosen by everyone else.

Law of One Price

states that in equilibrium, identical goods or services will be traded at the same price by all buyers and sellers.

Lorenz curve

A graphical representation of the inequality of some quantity such as income or wealth. Taking income as an example, individuals in the population are arranged in ascending order of income. First we calculate the total income of the population. Then for each level of income, we plot the percentage of total income held by people at this income level or lower, against the percentage of people at this income level or lower. The area between the Lorenz curve and the 45-degree line, expressed as a fraction of the total area below the 45-degree line, is a measure of inequality. Other than for small populations, it is a close approximation to the Gini coefficient.

Marginal rate of substitution

The trade-off that a person is willing to make between two goods. At any point, it is the absolute value of the slope of the indifference curve.

Marginal rate of transformation

The quantity of a good that must be sacrificed to acquire one additional unit of another good. At any point, it is the absolute value of the slope of the feasible frontier.

Market clearing

A market clears when the amount of the good supplied is equal to the amount demanded.

Market failure

If the allocation resulting from market interactions is not Pareto efficient, we describe the situation as a __________. The term may be used loosely to refer to any interaction resulting in a Pareto-inefficient allocation, whether or not a specific market is concerned.

Market power

A firm has this if it can sell its product at a range of feasible prices, so that it can benefit by acting as a price-setter (rather than a price-taker).

Matching market

A market for interactions between two distinct groups, in which the members have different characteristics from other members of their own group, and would benefit from matching with particular members of the other group. For example, firms and workers in the labour market, men and women in what is sometimes called the marriage market.

Monopsony power

A firm has labour market power if it can reduce the wage it needs to pay its workers by lowering the number of workers that it employs. It is sometimes called _____________________ because it applies, in particular, to a firm that is the only employer in a particular labour market.

Nominal interest rate

The interest rate uncorrected for inflation. It is the interest rate quoted by high-street banks.

non-rival

Occurs when a good is made availaible to one person, it can be made available to everyone else at no additional cost. ________ is the primary characteristic of a public good.

Normal profits

the returns on investment that the firm must pay to the shareholders to induce them to hold shares. The ____________ rate is equal to the opportunity cost of capital and is included in the firm’s costs. Any additional profit (revenue greater than costs) is called economic profit. A firm making normal profits is making zero economic profit.

Patent

A right of exclusive ownership of an idea or invention, which lasts for a specified length of time. During this time, it effectively allows the owner to be a monopolist or exclusive user.

Price discrimination

A selling strategy in which different prices are set for different buyers or groups of buyers based on the buyers’ differing willingness to pay.

price elasticity of demand

The percentage change in demand that would occur in response to a 1% increase in price. We express this as a positive number. Demand is elastic if this is greater than 1, and inelastic if less than 1.

Price markup

The price minus the marginal cost divided by the price. In other words, the profit margin as a proportion of the price. If the firm sets the price to maximize its profits, the markup is inversely proportional to the elasticity of demand for the good at that price.

Price-taker

A buyer or seller acts as a price-taker if they cannot benefit from attempting to trade at any other price than the prevailing market price. A price-taker has no power to influence the market price, but can buy or sell as many items as they wish at that price.

Producer surplus

The producer of a good receives a surplus on each unit, equal to the price minus the marginal cost of producing it. The term ‘producer surplus’ normally refers to the sum of these surpluses across all units sold.

public good game

a game in which individual players can take an action that would be costly to themselves, but would produce benefits for all players (including themselves).

research and development

Expenditures by a private or public entity to create new methods of production, products, or other economically relevant new knowledge.

sequential game

A game in which players do not all choose their strategies at the same time, and players who choose later can see the strategies already chosen by the other players. An example is the ultimatum game.

Simultaneous game

A game in which the players choose their strategies simultaneously, for example, the prisoners’ dilemma.

substitution effect

When the price of a good changes, the change in the consumption of the good that occurs because of the change in the good’s relative price. The price change also has an income effect, because it expands or shrinks the feasible set. See also: income effect.

ultimatum game

A game in which the first player proposes a division of a ‘pie’ with the second player, who may either accept, in which case they each get the division proposed by the first person, or reject the offer, in which case both players receive nothing.

Wealth

The stock of things owned, or value of that stock. It may generate income, or contribute to the owner’s wellbeing in some other way. It includes the market value of a home, car, any land, buildings, machinery, or other capital goods that a person may own, and any financial assets such as shares or bonds. To calculate wealth, debts are subtracted—for example, the mortgage owed to the bank. Debts owed to the person are added.

Consumer price index (CPI)

measures the general level of prices that consumers have to pay for goods and services, including consumption taxes

GDP deflator

A measure of the level of prices for domestically produced output (ratio of nominal to real GDP)

Autonomous consumption

the fixed amount one will spend, independent of income

Broad wealth

=broad assets - debt

Target wealth

the level of wealth that a household aims to hold, based on its economic goals (or preferences) and expectations.

Precautionary savings

An increase in saving to restore wealth to its target level.

Aggregate investment function

An equation that shows how investment spending in the economy as a whole depends on other variables (interest rate and profit expectations)

Marginal propensity to import

The fraction of each additional unit of income that is spent on import

automatic stabilisers

they automatically offset an expansion or contraction of the economy