Fundamentals of Economics

What are the factors of production?

Labor, capital, land, and entrepreneurial ability.

What does opportunity cost represent?

What you give up to get something.

What is a production possibilities frontier?

A model showing how much an economy can produce using all factors of production efficiently.

What does increasing opportunity cost imply?

As more factors are used for one good, production of other goods is sacrificed at an increasing rate.

What is absolute advantage?

Having the lowest absolute production cost relative to others.

What is comparative advantage?

Having the lowest opportunity cost relative to others.

What does a demand schedule show?

The relationship between price and the quantity of a good that buyers are willing to buy.

What is a demand curve?

A picture of how an individual responds to changing prices of a good.

What is the law of demand?

As the price of a good increases, ceteris paribus, the quantity demanded decreases.

What is price elasticity of demand?

A measure of the relationship between a percentage change in price and quantity demanded.

What is a supply schedule?

A table showing the relationship between price and the quantity that sellers are willing to produce.

What does the law of supply state?

As the price of a good increases, ceteris paribus, the quantity supplied of the good increases.

What is market equilibrium?

An economic balance where no individual would benefit from changing their action; an equality of supply and demand.

What is nominal GDP?

The market value of final goods and services produced at current year prices.

What is real GDP?

A measure of production value controlling changes in the price level.

What are transfer payments?

Sums of money that the government gives as outright grants, like social security or unemployment benefits.

What is the unemployment rate?

The percent of people who want a job, have been looking for one, but haven't found one, divided by the labor force.

What are the three basic functions of money?

Medium of exchange, store of value, and unit-of-account.

What is fiat money?

Paper money that has no intrinsic value, deriving its status from government declaration.

What is the classical dichotomy?

The separation of real and nominal variables in the long run.

What is fiscal policy?

The government's plan for managing aggregate demand through taxation and spending.

What are the four factors of production?

Land, labor, capital, and entrepreneurial ability.

What does opportunity cost refer to?

The cost of what you give up to partake in any activity.

What is a production possibilities frontier?

A model that shows how much an economy can produce using its factors of production efficiently.

What is absolute advantage?

The lowest absolute production cost relative to others.

What is comparative advantage?

The lowest opportunity cost relative to others.

How does the law of increasing opportunity cost manifest in production?

It is reflected in the bowed-out shape of the production possibilities frontier.

Why must scarce resources be allocated among society?

Because the factors of production are limited in supply.

What happens to opportunity cost as more of one good is produced?

The opportunity cost usually increases.

What is the opportunity cost of producing one bottle of wine for Elizabeth?

One-eighth of a unit of clothing.

What is the opportunity cost of producing one unit of clothing for Kyle?

Four units of clothing.

What can be concluded about specialization and trade?

Individuals or businesses should specialize in the production of goods where they have a comparative advantage.

What is the impact of trade on production possibilities?

Trade allows individuals or businesses to operate beyond their self-sufficient production possibilities frontier.

What is the range of acceptable trade terms for clothing between Elizabeth and Kyle?

More than one-eighth of a unit of clothing and less than eight bottles of wine.

What is the opportunity cost of one crab dinner for Nantucket?

Two lobster dinners.

What should Cape Cod specialize in producing?

Lobster dinners.

What should Nantucket specialize in producing?

Crab dinners.

What is the classical dichotomy?

The separation of real and nominal variables in the long run.

What is monetary neutrality?

The idea that the money supply affects only nominal variables and not real variables.

What is aggregate demand?

The total quantity of real GDP demanded at various price levels by all groups in the economy.

What does a shift in the aggregate demand curve to the north-east indicate?

An increase in consumption, investment, government purchases, or net exports.

What are the three explanations for the downward slope of the aggregate demand curve?

Interest rate effect, wealth effect, and open economy effect.

What is the interest rate effect?

A decrease in the price level leads to an increase in the supply of loanable funds, resulting in lower interest rates and increased investment.

What is the wealth effect?

A decrease in the price level increases consumers' real wealth, thus increasing the quantity of goods and services demanded.

What is the open economy effect?

A decrease in the price level leads to a depreciation of the real exchange rate, increasing net exports.

How does the short run aggregate supply curve differ from the long run aggregate supply curve?

The short run aggregate supply curve is upward sloping; the long run aggregate supply curve is vertical at potential real GDP.

What causes the profit effect in the short run aggregate supply curve?

Sticky nominal wages lead firms to increase production when the price level rises.

What is the misperceptions effect?

Producers respond to price changes in their markets based on misperceptions about the causes of those price changes.

Define menu costs effect.

Businesses are reluctant to change prices frequently due to costs associated with re-pricing, leading to decreased production when prices fall.

What is the natural rate of unemployment?

The unemployment rate when the economy is at potential real GDP; includes structural and frictional unemployment.

What is an inflationary gap?

The difference between potential real GDP and actual real GDP when the economy is overheating, leading to higher unemployment.

What fiscal policies can be used in a deflationary gap?

Increase government purchases, increase transfer payments, or decrease taxes to stimulate aggregate demand.

What are automatic stabilizers?

Fiscal policies that automatically increase or decrease with the economic cycle, such as unemployment insurance and welfare benefits.

What is the role of the Federal Reserve in monetary policy?

To manage the money supply and influence interest rates to stabilize the economy.

How does the Federal Reserve address a deflationary gap?

By increasing the money supply and decreasing interest rates to stimulate spending.

What is the effect of a contractionary monetary policy during an inflationary gap?

Decreased money supply raises interest rates, reducing consumption and investment, thus slowing down the economy.

What does the demand schedule illustrate in an economy?

It shows how many units of a good or service will be bought at different prices.

What is the law of demand?

When the price of a good increases, the quantity demanded decreases, and vice versa.

What are complementary goods?

Goods that are consumed together, such as wine and Gouda cheese.

What is the relationship between a good's price and the quantity supplied according to the law of supply?

If the price of a good increases, the quantity supplied increases, and vice versa.

What is the market equilibrium price?

The price at which the quantity demanded equals the quantity supplied.

How does income elasticity of demand differ between normal and inferior goods?

Normal goods have positive elasticity (demand increases with income), while inferior goods have negative elasticity (demand decreases with income).

What effect does an increase in the number of buyers have on the market demand curve?

It shifts the market demand curve to the north-east.

What is the price elasticity of demand?

A measure of the responsiveness of the quantity demanded of a good to a change in its price.

How does a price ceiling affect the market?

It can create a shortage if set below the equilibrium price.

What happens when the price of a complement good increases?

The demand for the related good decreases, resulting in a south-west shift of the demand curve.

What does a binding price floor create in the market?

A surplus, as the quantity supplied exceeds the quantity demanded.

What is the effect of a $20 tax on buyers in the wine market?

The demand curve shifts south-west, leading to higher prices and lower quantities sold.

What is expected to happen to the supply curve if the price of production inputs increases?

The supply curve shifts to the north-west (to the left), indicating a decrease in supply.

What does the term 'ceteris paribus' mean in economic analysis?

It means 'all else being equal', holding other factors constant when analyzing the relationship between two variables.

What formula is typically used to calculate the price elasticity of supply?

It is calculated by dividing the percentage change in quantity supplied by the percentage change in price.

What is indicated by a price elasticity of demand coefficient with an absolute value less than one?

It indicates inelastic demand; consumers are less responsive to price changes.

What is the formula for Sarah’s demand function expressed in general terms?

Q = f(P_wine; P_complement, P_substitute, I, T & P, E) where Q is quantity demanded.

What happens to the quantity demanded of a normal good when a consumer's income increases?

It generally increases, as the good is favorable to the consumer.

What does GDP stand for?

Gross Domestic Product.

What is the difference between GDP and Net Domestic Product?

GDP does not account for depreciation, whereas Net Domestic Product does.

What defines a recession in terms of GDP?

A recession occurs when there is an economic contraction lasting two or more quarters.

What is the formula for calculating nominal GDP?

Nominal GDP = Sum of (Quantity of goods * Price of goods) for all final goods and services.

What does 'per capita' mean in the context of GDP?

It refers to total GDP divided by the population, providing an average production value per person.

What are the main components of GDP according to the U.S. Department of Commerce’s BEA?

Consumption expenditures, Investment expenditures, Government expenditures, and Net exports.

What are discouraged workers?

Workers who want a job but have stopped looking for work due to frustration or belief that no jobs are available.

What is the unemployment rate?

The percentage of the labor force that is unemployed and actively seeking employment.

What are the three types of unemployment?

Frictional unemployment, Structural unemployment, and Cyclical unemployment.

How is the Consumer Price Index (CPI) calculated?

CPI measures changes over time in the cost of a fixed market basket of goods and services.

What is the primary objective of a private business owner according to Chapter 3?

The primary objective is to maximize profits.

What are the two main categories of costs of production?

Fixed costs and variable costs.

What are fixed costs?

Costs that do not vary with increases in the quantity produced.

What are variable costs?

Costs that do vary with increases in the quantity produced.

What type of cost cannot be recovered once incurred?

Sunk cost.

In economic terms, how is the short run defined?

The short run is a time horizon where some fixed costs exist and cannot be changed.

How is average fixed cost calculated?

Average fixed cost equals fixed cost divided by the quantity produced.

What does marginal cost represent?

Marginal cost is the change in total cost that arises from an extra unit of production.

What is the profit maximizing rule?

A business maximizes profits when it produces where the marginal revenue equals the marginal cost.

In a perfectly competitive industry, what is a key difference between businesses in terms of pricing?

Businesses are price takers, meaning they cannot influence the market price.

What happens to total revenue when market price is fixed and quantity changes in a perfectly competitive market?

Total revenue changes in direct proportion to the quantity sold at the fixed market price.

What is the short-run shut-down rule?

A business should shut down if revenue is less than variable costs at the profit maximizing quantity.

What defines a monopolistic industry?

There are many buyers and only one seller, the good is heterogeneous, and barriers to enter the market exist.

What are economies of scale?

Economies of scale occur when increasing production lowers the average total cost per unit.

What is the cost advantage of economies of scope?

The ability to produce multiple products together at lower costs than separate production.

What is money?

Money is any asset that may be used to carry out a transaction between a buyer and a seller.